NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

1. BUSINESS

Waste Management, Inc., a Delaware corporation, and subsidiaries ("Waste Management" or the "Company") is its industry's leading provider of integrated waste services in North America. Through its subsidiaries, the Company provides collection, transfer, recycling and resource recovery, and disposal services. The Company is also a leading developer, operator and owner of waste-to-energy facilities in the United States.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of consolidation -- The accompanying consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries after elimination of all material intercompany balances and transactions. Investments in affiliated companies in which the Company has a controlling interest are consolidated for financial reporting purposes. Investments in affiliated entities in which the Company does not have a controlling interest are accounted for under either the equity method or cost method of accounting, as appropriate. These investments are regularly reviewed for impairment issues and propriety of current accounting treatment.

Reclassifications -- Certain reclassifications have been made to the prior year balance sheet to conform to the current year presentation. In the Company's Annual Report on Form 10-K for the year ended December 31, 2001, the Company reported accrued interest of $137 million as a component of accounts payable. In 2002, the Company started reporting accrued interest as a component of accrued liabilities instead of accounts payable. In order to conform the prior period presentation of accrued interest to the current period presentation, the Company has reclassified the $137 million of accrued interest at December 31, 2001 to accrued liabilities in the consolidated balance sheet presented elsewhere herein.

Cash and cash equivalents -- Cash and cash equivalents consist primarily of cash on deposit, certificates of deposit, money market accounts, and investment grade commercial paper purchased with original maturities of three months or less.

Concentrations of credit risk -- Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. The Company places its cash and cash equivalents with high quality financial institutions and limits the amount of credit exposure with any one institution. Concentrations of credit risk with respect to accounts receivable are limited because a large number of geographically diverse customers comprise the Company's customer base, thus spreading the trade credit risk. At December 31, 2002 and 2001, no single group or customer represented greater than 5% of total accounts receivable. The Company controls credit risk through credit evaluations, credit limits, and monitoring procedures. The Company performs credit evaluations for commercial and industrial customers and performs ongoing credit evaluations of its customers, but generally does not require collateral to support accounts receivable. Credit losses are provided for in the financial statements. Credit risk relating to derivative instruments results from the fact the Company enters into interest rate and commodity price swap agreements with various counterparties. However, the Company monitors its derivative positions by regularly evaluating its positions and the credit worthiness of the counterparties, all of whom the Company considers credit worthy, or who have issued letters of credit to support their performance. See Note 10 for discussion related to the previously outstanding waste paper swap agreements with Enron North America Corp. ("Enron").

Trade, notes and other receivables -- The Company's receivables are recorded when billed, advanced or accrued and represent claims against third parties that will be settled in cash. The carrying value of the Company's receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. The Company estimates its allowance for doubtful accounts based on historical collection trends, type

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of customer such as municipal or non-municipal, the age of outstanding receivables and existing economic conditions. If events or changes in circumstances indicate that specific receivable balances may be impaired, further consideration is given to the collectiblity of those balances and the allowance is adjusted accordingly. Past-due receivable balances are written-off when the Company's internal collection efforts have been unsuccessful in collecting the amount due. Also, the Company generally recognizes interest income on long-term interest-bearing notes receivable as the interest accrues under the terms of the note.

Operations held-for-sale -- On January 1, 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for Impairment or Disposal of Long-Lived Assets ("SFAS No. 144"). That statement requires that assets held-for-sale be recorded at the lower of their carrying amount or their fair value less cost to sell. Held-for-sale assets are not depreciated. Assets are classified as held-for-sale only if (i) management commits to a plan to sell the asset, (ii) the asset is available for immediate sale, (iii) the asset is actively being marketed for sale at a price that is reasonable in relation to its current fair value and (iv) management believes the sale of the asset is probable and expects transfer within one year. See Note 22 for further discussion of operations held-for-sale.

Property and equipment -- Property and equipment are recorded at cost. Expenditures for major additions and improvements are capitalized. Except for the Company's waste-to-energy facilities and independent power production plants ("IPPs"), minor replacements, maintenance and repairs are charged to expense as incurred.

At the Company's waste-to-energy facilities and IPPs, the Company accrues for major repair and maintenance expenditures. Such accruals are based upon planned maintenance expenditures and are classified as current or non-current liabilities based on the expected timing of the expenditures. In the first quarter of 2003, the Company changed its method of accounting to one that expenses these costs as incurred. See Note 25 for further discussion.

When property and equipment are retired, sold, or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations as increases or offsets to operating expense for the respective period. Depreciation is provided over the estimated useful lives of the related assets using the straight-line method. The Company assumes no salvage value for its depreciable property and equipment. The estimated useful lives for significant property and equipment categories are as follows (in years):

                                                              USEFUL LIVES
                                                              ------------
Office equipment............................................     3 to 7
Vehicles....................................................    3 to 10
Machinery and equipment.....................................    3 to 10
Commercial and roll-off containers..........................    8 to 12
Rail haul cars..............................................    10 to 20
Buildings and improvements..................................    5 to 40
Waste-to-energy facilities..................................    up to 50

The Company capitalizes certain costs associated with developing or obtaining internal-use software. These costs include external direct costs of materials and services used in developing or obtaining the software and payroll and payroll-related costs for employees directly associated with the software development project. For the years ended December 31, 2002 and 2001, the Company capitalized $110 million and $63 million, respectively, of software development costs that are primarily related to the development of the Company's enterprise-wide software systems. The Company includes these costs as office equipment within furniture and fixtures and depreciates the software development costs over a period up to five years once the systems are placed in service.

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Leases -- The Company leases certain office space and plant and equipment for varying periods. The Company's leases have varying terms. Some may include renewal or purchase options, escalation clauses, restrictions, penalties or other obligations that we consider in determining minimum lease payments disclosed in Note 20. The leases are classified as either capital leases or operating leases, as appropriate.

Assets under capital leases are capitalized using interest rates appropriate at the inception of each lease and are amortized over the shorter of either the useful life of the asset in accordance with the Company's policy for owned assets or the lease term on a straight line basis. The present value of the related lease payment is recorded as a debt obligation. The Company's future minimum annual capital lease payments are included in the Company's total future debt obligations as disclosed in Note 7.

Management expects that in the normal course of business, operating leases will be renewed or replaced by other leases. See Note 20 for the Company's future contractual operating lease payments.

Landfill accounting -- The discussion below details the Company's accounting policies for landfills through December 31, 2002. As of January 1, 2003, the Company's practice will change upon the Company's adoption of SFAS No. 143, Accounting for Asset Retirement Obligations ("SFAS No. 143"). See Note 25 for additional information.

The Company utilizes the life cycle method of accounting for landfill costs. Landfill site costs that qualify for capitalization are recorded at cost. Capitalized landfill site costs, net of recorded amortization, are added to estimated projected capitalizable costs to be incurred over the remaining life of the landfill, to determine the amount to be amortized over the remaining capacity of a site as discussed below. Amortization is recorded on a units of consumption basis, applying cost as a rate per ton over the remaining capacity of a site. Landfill site costs are amortized to expected net realizable value upon closure of a landfill. See Note 3 for discussion on landfill related estimates.

The Company has material financial commitments for the costs associated with its future obligations for closure and post-closure obligations with respect to the landfills it owns or operates as prescribed by the EPA's Subtitles C and D regulations. The difference between the present value of a landfill's estimated total closure and post-closure costs and amounts accrued to date is accrued prospectively on a units of consumption basis by applying a rate per ton over the remaining capacity of the landfill. The present value of closure and post-closure costs is fully accrued for each landfill once the site discontinues accepting waste and is included in environmental liabilities.

The remaining capacity of a landfill is determined by the unused permitted airspace and expansion airspace when the success of obtaining an expansion permit is probable. Remaining capacity is estimated in cubic yards and converted to tons using a landfill-specific airspace utilization factor. These factors are developed by Company engineers and are reviewed by management, typically at least once per year.

To include airspace associated with an expansion effort in remaining capacity, the Company must generally expect the expansion permit application to be submitted within one year, and the expansion permit to be received within five years. Also, the Company must believe the success of obtaining the expansion permit is probable, using the following criteria:

- Personnel are actively working to obtain land use and local and state approvals for an expansion of an existing landfill;

- At the time the expansion is added to the permitted site life, it is probable that the approvals will be received within the normal application and processing time periods for approvals in the jurisdiction in which the landfill is located;

- Either the Company or the respective landfill owners have a legal right to use or obtain land to be included in the expansion plan;

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- There are no significant known technical, legal, community, business, or political restrictions or similar issues that could impair the success of such expansion;

- Financial analysis has been completed, and the results demonstrate that the expansion has a positive financial and operational impact; and

- Airspace and related costs, including additional closure and post-closure costs, have been estimated based on conceptual design.

These criteria are initially evaluated by the Company's field-based engineers, accountants, managers and others to identify potential obstacles to obtaining the permits. However, the Company's policy provides that, based on the facts and circumstances of a specific landfill, if these criteria are not met, inclusion of unpermitted airspace may still be allowed. In these circumstances, inclusion must be approved through a landfill-specific process that includes approval of the Chief Financial Officer and a review by the Audit Committee of the Board of Directors on a quarterly basis. Of the 91 landfill sites with expansions at December 31, 2002, 26 landfills required the Chief Financial Officer to approve the inclusion of the unpermitted airspace. Approximately two-thirds of these landfills required approval by the Chief Financial Officer because of legal or community issues that could impede the expansion process, while the remaining were primarily due to permit application processes beyond the one-year limit, which in most cases were due to state-specific permitting procedures. When expansion airspace is included in the calculation of available airspace, the projected costs for development and final capping of the expansion are included in the amortization base of the landfill, and the projected costs for closure and post-closure of the expansion are considered in determining closure and post-closure expense. See Note 3 for further discussion on related estimates and assumptions.

After determining the costs at its landfills, including closure and post-closure costs, and the remaining capacity, the Company then determines the per ton rate that will be expensed. Factors considered include the waste stream, geography and rate of compaction, among others, to determine the number of tons it will take to fill the remaining capacity. The determined costs are then divided by that number of tons, giving the Company the rate per ton to expense.

Business combinations -- All acquisitions since January 1, 2000 have been accounted for using the purchase method of accounting. The Company allocates the cost of the acquired business to the assets acquired and the liabilities assumed based on estimates of fair values thereof. These estimates are revised during the allocation period as necessary if, and when, information regarding contingencies becomes available to further define and quantify assets acquired and liabilities assumed. The allocation period generally does not exceed one year. To the extent contingencies such as preacquisition environmental matters, litigation and related legal fees are resolved or settled during the allocation period, such items are included in the revised allocation of the purchase price. After the allocation period, the effect of changes in such contingencies is included in results of operations in the periods in which the adjustments are determined. The Company does not believe potential differences between its fair value estimates and actual fair values are material.

In certain business combinations, the Company agrees to pay additional amounts to sellers contingent upon achievement by the acquired businesses of certain negotiated goals, such as targeted revenue levels, targeted disposal volumes or the issuance of permits for expanded landfill airspace. Contingent payments, when incurred, are recorded as purchase price adjustments or compensation expense, as appropriate, based on the nature of each contingent payment.

Goodwill and other intangible assets -- Goodwill is the excess of cost over net assets of acquired businesses. In accordance with SFAS No. 142, Accounting for Goodwill and Other Intangible Assets ("SFAS No. 142"), the Company did not amortize goodwill that arose from purchases after June 30, 2001. In addition, the Company continued through December 31, 2001 the amortization of goodwill which arose from purchase business combinations completed prior to or on June 30, 2001. All amortization of goodwill ceased

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January 1, 2002. Other intangible assets consist primarily of customer contracts, customer lists, covenants not-to-compete, licenses and permits (other than landfill permits, as all landfill related intangible assets are combined with landfill tangible assets and amortized using the Company's landfill amortization policy). Other intangible assets are recorded at cost and amortized on a straight-line basis. Customer contracts and customer lists are generally amortized over five to seven years. Covenants not-to-compete are amortized over the term of the agreement, which is generally three to five years. Licenses, permits and other contracts are amortized over the definitive terms of the related agreements. If the underlying agreement does not contain definitive terms and the useful life is determined to be indefinite, the asset is not amortized. As of December 31, 2002, the Company has approximately $3 million of other intangible assets that are not amortized. For further discussion, see Note 6.

Restricted funds held by trustees -- Restricted funds held by trustees are included in other non-current assets and consist principally of funds held in trust for the construction of various facilities, funds deposited in connection with landfill closure and post-closure obligations and insurance escrow deposits. Of the restricted funds balance of $533 million at December 31, 2002, $412 million relates to industrial revenue bonds issued primarily for the construction of various facilities. Proceeds from these financing arrangements are directly deposited into trust funds, and the Company does not have the ability to utilize the funds in regular operating activities. Accordingly, these amounts are reported as an investing activity when the cash is released from the trust funds and as a financing activity when the industrial revenue bonds are repaid out of the Company's cash balances. In 2002, proceeds from tax-exempt borrowings, net of principal payments made directly from trust funds were $424 million. These transactions were treated as non-cash financing activities for purposes of the statement of cash flows.

Asset impairments -- Long-lived assets consist primarily of property, plant and equipment, goodwill and other intangible assets. Property, plant, equipment and other intangible assets are carried on the Company's financial statements based on their cost less accumulated depreciation or amortization. The recoverability of these assets is tested whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Typical indicators that an asset may be impaired include:

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

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

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

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

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

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

If any of these or other indicators occur, the asset is reviewed to determine whether there has been an impairment. An impairment loss is recorded as the difference between the carrying amount and fair value of the asset. See Note 3 for further discussion on related estimates and assumptions. There are other considerations for impairments of landfills and goodwill, as described below.

Landfills -- There are certain indicators listed above that require significant judgment and understanding of the waste industry when applied to landfill development or expansion projects. For example, a regulator may

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initially deny a landfill expansion permit application though the expansion permit is ultimately granted. In addition, management may periodically divert waste from one landfill to another to conserve remaining permitted landfill airspace. Therefore, certain events could occur in the ordinary course of business and not necessarily be considered indicators of impairment due to the unique nature of the waste industry.

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

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

Foreign currency -- The functional currency of the Company's foreign operations is the local currency of the country in which the Company operates. Adjustments resulting from the translation of financial information are included in comprehensive income.

Revenue recognition -- The Company recognizes revenues when all four criteria noted below have been satisfied:

- Persuasive evidence of an arrangement exists, such as executed service agreements, new customer account forms or other relevant documentation.

- Services, such as providing hauling services and accepting waste at the Company's disposal facilities, are rendered or products are delivered.

- The Company's price to the buyer is fixed or determinable.

- Collectibility is reasonably assured.

The Company bills for certain services prior to performance. Such services include, among others, certain residential contracts that are billed on a quarterly basis and rights to utilize assets such as containers or other equipment rentals continuously over time. These advance billings are included in deferred revenues and recognized as revenue in the period earned for services provided.

Loss contracts -- The Company reviews its revenue-producing contracts in the ordinary course of business to determine if the direct costs, exclusive of any non-variable costs, to service the contractual arrangements exceed the revenues to be produced by the contract. Any resulting net loss over the life of the contract is expensed at the time of such determination. During the life of a contract that is deemed to be a loss contract, the Company may estimate intermittent periods of contract profitability. Intermittent profitability projected or realized on loss contracts is deferred to offset future projected losses. In 2002, the Company reduced expenses by approximately $26 million through the utilization of the accrual to offset actual losses. The Company also increased loss contract reserves by approximately $15 million as additional operating expenses for projected future losses on contracts.

In the first quarter of 2003, the Company changed its method of accounting to one that expenses losses on contracts as they are incurred. See Note 25 for further discussion.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Self-insurance property and casualty -- The Company has retained a portion of the risks related to its automobile, general liability and workers' compensation insurance programs. The exposure for unpaid claims and associated expenses, including incurred but not reported losses, is determined by external actuaries. The related liability is included in accrued liabilities if expected to be settled within one year or otherwise is included in other long term liabilities.

Derivative financial instruments -- SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended ("SFAS No. 133"), became effective for the Company on January 1, 2001. SFAS No. 133 establishes accounting and reporting standards requiring that all derivative instruments, including certain derivative instruments embedded in other contracts, be recorded as either assets or liabilities measured at fair value. SFAS No. 133 also requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Adoption of SFAS No. 133 resulted in a gain, net of tax, of approximately $2 million in the first quarter of 2001, which is reflected as a cumulative effect of change in accounting principle. See further discussion at Note 7 and Note 10.

The Company utilizes derivative financial instruments to manage its foreign currency, interest rate and commodity pricing exposure. The estimated fair values of derivatives used to hedge risks fluctuate over time. These changes in fair values should be viewed in relation to the underlying hedging transaction and to the overall management of the Company's exposure to fluctuations in foreign exchange rates, interest rates and commodity prices.

The fair value of derivatives is included in other current assets, other long-term assets, accrued liabilities or other long-term liabilities, as appropriate. The offsetting amounts for those derivatives designated as fair value hedges are recorded as an adjustment to the carrying value of the hedged instrument. Upon termination, this carrying value adjustment is amortized to earnings over the remaining life of the hedged instrument. The offsetting amounts for those derivatives designated as cash flow hedges are recorded in other comprehensive income. Upon termination, the associated balance in other comprehensive income is amortized to earnings as the hedged cash flows occur. Any ineffectiveness present in either fair value or cash flow hedges is recognized immediately in earnings without offset.

Capitalized interest -- Interest is capitalized on certain projects under development, including landfill projects and probable landfill expansion projects, and on certain assets under construction, including internal-use softwares, operating landfills and waste-to-energy facilities. The capitalization of interest for operating landfills is based on the costs incurred on discrete cell construction projects, plus an allocated portion of the common site costs. The common site costs include the development costs of a landfill project or the purchase price of an operating landfill, and the ongoing infrastructure costs benefiting the lifecycle of the landfill. Cell construction costs include the construction of cell liners and final capping during the operating life of the site. During 2002, 2001 and 2000, total interest costs were $482 million, $557 million and $770 million, respectively, of which $20 million, $16 million and $22 million, respectively, were capitalized primarily for landfill construction costs.

Accounting for stock options -- The Company accounts for its stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25") and Financial Accounting Standards Board ("FASB") Interpretation No. 44 ("FIN 44"). The Company makes disclosures regarding its stock-based compensation in accordance with SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). In accordance with APB 25, the Company does not recognize compensation cost for stock options granted to employees as all employee options are granted with an exercise price equal to the fair market value of the underlying stock.

As of December 31, 2002, 2001, and 2000, the Company had approximately 44.5 million, 41.5 million and 40.3 million stock options and warrants outstanding, respectively. The weighted average fair value per

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share of stock options granted during 2002, 2001 and 2000 was $12.16, $10.83 and $6.78, respectively. See Note 12 for further discussion on the Company's common stock options and warrants.

The fair value of each common stock option granted to employees or directors during 2002, 2001 and 2000 was estimated utilizing the Black-Scholes option pricing model. The following weighted average assumptions were used:
dividend yield of 0%, risk-free interest rates which vary for each grant and range from 2.91% to 6.19%, expected life of four to seven years for all grants, and stock price volatility primarily ranging from 23.7% to 50.4%. Black-Scholes is a formula that calculates an estimated value of stock options based on appreciation and interest rate assumptions and therefore, the fair value calculation of a stock option using Black-Scholes is not necessarily indicative of the actual value of a stock option.

The following schedule reflects the impact on net income and earning per common share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock based employee compensation (in millions, except per share amounts).

                                                              YEARS ENDED DECEMBER 31,
                                                              -------------------------
                                                               2002     2001     2000
                                                              ------   ------   -------
Reported net income (loss)..................................  $ 822    $ 503    $  (97)
Less: compensation expense per SFAS No. 123, net of tax.....     85       83        75
                                                              -----    -----    ------
Pro forma net income (loss).................................  $ 737    $ 420    $ (172)
                                                              =====    =====    ======
BASIC EARNINGS PER COMMON SHARE:
Reported net income (loss)..................................  $1.34    $0.80    $(0.16)
Less: compensation expense per SFAS No. 123, net of tax.....   0.14     0.13      0.12
                                                              -----    -----    ------
Pro forma net income (loss).................................  $1.20    $0.67    $(0.28)
                                                              =====    =====    ======
DILUTED EARNINGS PER COMMON SHARE:
Reported net income (loss)..................................  $1.33    $0.80    $(0.16)
Less: compensation expense per SFAS No. 123, net of tax.....   0.14     0.13      0.12
                                                              -----    -----    ------
Pro forma net income (loss).................................  $1.19    $0.67    $(0.28)
                                                              =====    =====    ======

3. USE OF ESTIMATES AND ASSUMPTIONS

In preparing the Company's financial statements, several estimates and assumptions are made that affect the accounting for and recognition of assets, liabilities, revenues and expenses. These estimates and assumptions must be made because certain of the information that is used in the preparation of the Company's financial statements is dependent on future events, cannot be calculated with a high degree of precision from data available or is simply not capable of being readily calculated based on generally accepted methodologies. In some cases, these estimates are particularly difficult to determine and the Company must exercise significant judgment. The most difficult, subjective and complex estimates and the assumptions that deal with the greatest amount of uncertainty are related to the Company's accounting for landfills, environmental liabilities and asset impairments, as described below.

The discussion below details the Company's accounting policies for landfills through December 31, 2002. As of January 1, 2003, the Company's practice will change upon the Company's adoption of SFAS No. 143. See Note 25 for additional information.

Accounting for Landfills -- The Company utilizes the life cycle method of accounting for landfill costs and the units of consumption method to amortize landfill construction costs and record closure and post-closure obligations over the estimated remaining capacity of a landfill. Under this method the Company

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includes future estimated construction costs, as well as costs incurred to date, in the amortization base. Additionally, the Company includes probable expansion airspace (yet to be permitted airspace) in the calculation of the total remaining capacity of the landfill. See Note 2 for further discussion.

This accounting method requires the Company to make estimates and assumptions, as described below. Any changes in the Company's estimates will impact the Company's income from operations prospectively from the date changes are made.

Landfill Costs -- The Company estimates the total cost to develop each landfill site to its final capacity. This includes certain projected landfill site costs that are uncertain because they are dependent on future events. The total cost to develop a site to its final capacity includes amounts previously expended and capitalized, net of accumulated airspace amortization, and projections of future purchase and development costs, landfill final capping costs, liner construction costs, operating construction costs, and capitalized interest costs.

Closure and Post-Closure Costs -- The costs for closure and post-closure obligations at landfills the Company owns or operates are generally estimated based on interpretations of current requirements and proposed or anticipated regulatory changes. The estimates for landfill closure and post-closure costs also consider when the costs would actually be paid and factor in, where appropriate, inflation and discount rates. The possibility of changing legal and regulatory requirements and the forward-looking nature of these types of costs make any estimation or assumption less certain.

Available Airspace -- The Company's engineers determine the remaining capacity at landfills by estimating the available airspace. This is done by using surveys and other methods to calculate, based on height restrictions and other factors, how much airspace is left to fill and how much waste can be disposed of at a landfill before it has reached its final capacity.

Expansion Airspace -- The Company will also consider currently unpermitted airspace in the estimate of remaining capacity in certain circumstances.

It is possible that the Company's estimates or assumptions will ultimately turn out to be significantly different from actual results. In some cases the Company may be unsuccessful in obtaining an expansion permit or the Company may determine that an expansion permit that the Company previously thought was probable has become unlikely. To the extent that such estimates, or the assumptions used to make those estimates, prove to be significantly different than actual results, or the belief that the Company will receive an expansion permit changes adversely in a significant manner, the costs of the landfill, including the costs incurred in the pursuit of the expansion, may be subject to impairment testing, as described below, and lower profitability may be experienced due to higher amortization rates, higher closure and post-closure rates, and higher expenses or asset impairments related to the removal of previously included expansion airspace.

Environmental Remediation Liabilities -- Under current laws and regulations, the Company may have liability for environmental damage caused by operations, or for damage caused by conditions that existed before a particular site was acquired. Remedial costs are all costs relating to the remedy of any identified situation that occurs by natural causes or human error not expected in the normal course of business. These costs include costs relating to legal defense, potentially responsible party ("PRP") investigation, settlement, and consultant fees, as well as costs directly associated with site investigation and clean up, such as materials and incremental internal costs directly related to the remedy. Costs required to remediate sites where liability is probable based on site-specific facts and circumstances are estimated. The Company routinely reviews and evaluates sites that require remediation, including sites listed on the EPA's National Priorities List ("NPL sites"). Consideration is given to whether the Company was an owner, operator, transporter, or generator at the site, the amount and type of waste hauled to the site and the number of years the Company was connected

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with the site. Next, the same information with respect to other named and unnamed PRPs is reviewed. The cost for the likely remedy is then estimated based on:

- Management's judgment and experience in remediating Company and unrelated parties' sites;

- Information available from regulatory agencies as to costs of remediation;

- The number, financial resources and relative degree of responsibility of other PRPs who may be liable for remediation of a specific site; and

- The typical allocation of costs among PRPs.

See Note 8 for further discussion.

Asset Impairments -- Accounting standards require that assets be written down if they become impaired. If significant events or changes in circumstances indicate that the carrying value of an asset may not be recoverable, a test of recoverability is performed by comparing the carrying value of the asset or asset group to its undiscounted expected future cash flows. If the carrying values are in excess of undiscounted expected future cash flows, impairment is measured by comparing the fair value of the asset to its carrying value. Fair value is determined by either an actual third-party evaluation or an internally developed discounted projected cash flow analysis of the asset. Cash flow projections are sometimes based on a group of assets, rather than a single asset. If cash flows cannot be separately and independently identified for a single asset, the Company will determine whether an impairment has occurred for the group of assets for which the projected cash flows can be identified. If the fair value of an asset is determined to be less than the carrying amount of the asset or asset group, an impairment in the amount of the difference is recorded in the period that the impairment indicator occurs. Several impairment indicators are beyond the Company's control, and cannot be predicted with any certainty whether or not they will occur. Estimating future cash flows requires significant judgment and projections may vary from cash flows eventually realized. Also, there are other considerations for impairments of landfills and goodwill as discussed in Note 2. Also see Note 16 for further discussion.

Other -- Other estimates and assumptions that the Company considers to be significant in the preparation of its financial statements include the following:

- Allowance for Doubtful Accounts -- The Company estimates losses for uncollectible accounts based on the aging of the accounts receivable and the evaluation of the likelihood of success in collecting the receivable.

- Acquisition Accounting -- The Company estimates the fair value of assets and liabilities when allocating the purchase price of an acquisition.

- Derivative Financial Instruments -- In order to estimate the fair market value of derivative financial instruments to be recorded on the balance sheet, the Company estimates future prices of commodity fiber products and obtains current valuations of interest rate and foreign currency hedging instruments from third parties.

- Income Taxes -- The Company assumes the deductibility of certain costs in its income tax filings and estimates the future recovery of deferred tax assets.

- Contingent Liabilities -- The Company estimates the amount of potential exposure it may have with respect to litigation, claims and assessments in accordance with SFAS No. 5, Accounting for Contingencies, ("SFAS No. 5").

- Loss Contracts -- The Company evaluates its revenue-producing contracts to determine whether the projected revenues of such contracts exceed the direct costs to service such contracts. These evaluations include estimates of future revenues and expenses. Accruals for loss contracts are adjusted upward or downward based on these evaluations. In the first quarter of 2003, the Company changed

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

from this accounting method to one that recognizes losses on contracts as they are incurred. See Note 25 for further discussion.

- Self-Insurance Reserves -- Through the use of actuarial calculations, the Company estimates the amounts required to settle asserted and unasserted insurance claims.

- Facility Maintenance Accruals -- The Company accrues for major repair and maintenance expenditures at its waste-to-energy and IPP facilities. Such accruals, which include only anticipated third party costs, are based upon planned maintenance expenditures and are classified as current or noncurrent liabilities based on the expected timing of the expenditures. In the first quarter of 2003, the Company changed from this accounting method to one that expenses major repair and maintenance expenditures at its waste-to-energy and IPP facilities as incurred. See Note 25 for further discussion.

Actual results could differ materially from the estimates and assumptions that the Company uses in the preparation of its financial statements.

4. BUSINESS COMBINATIONS AND DIVESTITURES

PURCHASE ACQUISITIONS

In both 2002 and 2001, the Company consummated over 50 acquisitions of North American Solid Waste ("NASW") operations that were accounted for under the purchase method of accounting. Cash paid for acquisitions, net of cash acquired, was approximately $162 million and $116 million for 2002 and 2001, respectively. As a result of 2002 acquisitions, the Company recorded approximately $183 million in additional assets, including $81 million of goodwill, approximately $17 million of other intangible assets, and $21 million in additional liabilities. See Note 15 for information regarding goodwill acquired by each reportable segment as a result of 2002 purchase acquisitions.

DIVESTITURES

The approximate aggregate sales prices for divestitures of the Company's non-integrated North American operations in 2002 and 2001 was $103 million and $23 million, respectively, which was comprised substantially of cash proceeds. As a result of divestitures during 2002, the Company recorded a reduction in net assets of approximately $80 million.

                                                               2002      2001
                                                              -------   -------
Land........................................................  $   454   $   506
Landfills...................................................    8,607     8,119
Vehicles....................................................    3,388     3,258
Machinery and equipment.....................................    2,579     2,326
Containers..................................................    2,072     2,001
Buildings and improvements..................................    1,573     1,432
Furniture and fixtures......................................      437       293
                                                              -------   -------
                                                               19,110    17,935
Less accumulated depreciation on tangible property and
  equipment.................................................   (4,959)   (4,444)
Less accumulated landfill airspace amortization.............   (3,539)   (3,134)
                                                              -------   -------
                                                              $10,612   $10,357
                                                              =======   =======

Depreciation and amortization expense for property and equipment for 2000, 2001 and 2002 was $1.21 billion, $1.18 billion and $1.19 billion, respectively. In 2002, depreciation and amortization expense, which includes amortization on assets recorded as capital leases, was comprised of $778 million for the depreciation of tangible property and equipment and $409 million for the amortization of landfill airspace.

                                          CUSTOMER CONTRACTS   COVENANTS   LICENSES,
                                                 AND            NOT-TO-     PERMITS
                                            CUSTOMER LISTS      COMPETE    AND OTHER    TOTAL
                                          ------------------   ---------   ----------   -----
December 31, 2002
  Intangible assets.....................         $128            $ 91         $21       $ 240
  Less accumulated amortization.........          (76)            (52)         (7)       (135)
                                                 ----            ----         ---       -----
                                                 $ 52            $ 39         $14       $ 105
                                                 ====            ====         ===       =====
December 31, 2001
  Intangible assets.....................         $123            $ 99         $20       $ 242
  Less accumulated amortization.........          (60)            (52)         (7)       (119)
                                                 ----            ----         ---       -----
                                                 $ 63            $ 47         $13       $ 123
                                                 ====            ====         ===       =====

Landfill operating permits are not presented above and are recognized on a combined basis with other landfill assets and amortized using the Company's landfill amortization method. Amortization expense for other intangible assets was $35 million and $37 million for 2002 and 2001, respectively. The intangible asset amortization expense estimated as of December 31, 2002, for the five years following 2002 is as follows (in millions):

2003   2004   2005   2006   2007
----   ----   ----   ----   ----
$32    $24    $14     $9     $6

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Amortization expense for goodwill and other intangible assets was $193 million and $219 million for 2001 and 2000, respectively. In accordance with SFAS No. 142, the Company did not amortize goodwill that arose from purchases of businesses after June 30, 2001. The Company continued, through December 31, 2001, the amortization of goodwill that was recorded prior to July 1, 2001. Amortization of goodwill ceased on January 1, 2002.

The Company incurred no impairment of goodwill upon its initial adoption of SFAS No. 142, or as a result of its annual goodwill impairment test. However, there can be no assurance that goodwill will not be impaired at any time in the future. Additionally, adopting SFAS No. 141, Accounting for Business Combinations, ("SFAS No. 141") required the Company to write-off net negative goodwill of approximately $2 million, which was recorded as a credit to cumulative effect of change in accounting principle in the first quarter of 2002. During interim periods in 2002, the Company did not encounter any events or changes in circumstances that indicated that impairment was more likely than not.

The following schedule reflects the 2001 and 2000 adjusted net income (excluding goodwill and negative goodwill amortization) as compared to the results of operations for December 31, 2002 (in millions, except per share amounts).

                                                              YEARS ENDED DECEMBER 31,
                                                              -------------------------
                                                               2002     2001     2000
                                                              ------   ------   -------
Reported net income (loss)..................................  $ 822    $ 503    $  (97)
Add back: goodwill amortization, net of taxes...............     --      124       139
                                                              -----    -----    ------
Adjusted net income.........................................  $ 822    $ 627    $   42
                                                              =====    =====    ======
BASIC EARNINGS PER COMMON SHARE:
Reported net income (loss)..................................  $1.34    $0.80    $(0.16)
Goodwill amortization, net of taxes.........................     --     0.20      0.22
                                                              -----    -----    ------
Adjusted net income.........................................  $1.34    $1.00    $ 0.06
                                                              =====    =====    ======
DILUTED EARNINGS PER COMMON SHARE:
Reported net income (loss)..................................  $1.33    $0.80    $(0.16)
Goodwill amortization, net of taxes.........................     --     0.20      0.22
                                                              -----    -----    ------
Adjusted net income.........................................  $1.33    $1.00    $ 0.06
                                                              =====    =====    ======

                                                               2002     2001
                                                              ------   ------
Bank credit facilities......................................  $   --   $   --
Senior notes and debentures, maturing through 2032, interest
  of 6.375% to 8.75%........................................   6,164    6,169
4% Convertible subordinated notes due 2002..................      --      427
5.75% Convertible subordinated notes due 2005, (2% interest
  rate and 3.75% issuance discount).........................      32       31
Tax-exempt and project bonds, principal payable in periodic
  installments, maturing through 2031, fixed and variable
  interest rates ranging from 1.25% to 10.0% (weighted
  average interest rate of 4%) at December 31, 2002.........   1,896    1,404
Capital leases and other notes payable, maturing through
  2022, interest rates up to 12%............................     201      193
                                                              ------   ------
                                                              $8,293   $8,224
                                                              ======   ======

The schedule of debt (including the current portion) maturities for the next five years and thereafter is as follows (in millions):

2003(A),(B)   2004   2005   2006   2007   THEREAFTER
-----------   ----   ----   ----   ----   ----------
   $231       $737   $900   $494   $474     $5,457

(a) The Company has $434 million of 6.375% senior notes due December 1, 2003. The Company also has $450 million of 7.1% senior notes due August 1, 2026 that are subject to early redemption on August 1, 2003 at the option of the holder. The Company has classified $770 million of these borrowings as long-term at December 31, 2002 based upon its ability to use its revolving credit facilities, which are both long-term, to refinance these borrowings at their respective maturity or repayment date. The Company intends to pursue other sources of long-term financing to refinance the borrowings; however, in the event other sources of long-term financing are not available, the Company intends to use its revolving credit facilities.

(b) The Company has $546 million of tax-exempt bonds at December 31, 2002 that mature through 2031 that are remarketed weekly by a remarketing agent. The Company has classified these borrowings as long-term at December 31, 2002 because the borrowings are supported by letters of credit issued under the Company's bank credit facilities, which are long-term.

As of December 31, 2002, the Company had a $650 million syndicated revolving credit facility (the "Three Year Revolver"), and a $1.75 billion syndicated revolving credit facility (the "Five Year Revolver"). The Three Year Revolver matures in June 2005 and the Five Year Revolver matures in June 2006. As of December 31, 2002, the Company had letters of credit in the aggregate amount of approximately $1.75 billion (of which approximately $1.63 billion are issued under the revolving credit facilities) that generally have terms allowing automatic renewal after one year. At December 31, 2002, no balances were outstanding under the Company's revolving credit facilities and it had unused and available credit capacity under these facilities of approximately $770 million.

As of December 31, 2002, the financial covenants the Company is required to maintain under its credit facilities include (i) an interest coverage ratio;
(ii) total debt to EBITDA and; (iii) minimum net worth, all as defined in the credit facilities solely for the purpose of determining compliance with the covenants. The interest coverage ratio requires that at the end of any fiscal quarter the Company will not permit the ratio of (A) the Company's consolidated net income plus interest expense and income taxes ("EBIT") for the four fiscal quarters then ending to (B) consolidated total interest expense for such period to be less than 2.5 to 1 for quarters ending on or before December 31, 2002 and 3 to 1 thereafter. The total debt to EBITDA covenant

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

requires that at the end of any fiscal quarter, the Company will not permit the ratio of (A) all indebtedness and certain contingent liabilities such as financial guarantees to (B) EBIT plus depreciation and amortization expense ("EBITDA") for the four fiscal quarters then ending to exceed 3 to 1. The Company's minimum net worth covenant requires that the Company will not allow the sum of stockholders' equity to be less than $3.5 billion plus 75% of the Company's cumulative consolidated net income for each fiscal quarter, beginning with the first fiscal quarter ended March 31, 2001. At December 31, 2002, the Company is in compliance with all covenants under its credit facilities and all other debt instruments.

The Company's 5.75% convertible subordinated notes due 2005 are subordinated to all existing and future senior indebtedness of the Company. Each note bears cash interest at the rate of two percent per annum of the $1,000 principal amount at maturity, payable semi-annually. The stated discount is $282.20 . At the option of the holder, each note was redeemable for cash by the Company on March 15, 2000, at $843.03 along with the related accrued unpaid interest. The notes have been callable by the Company since March 15, 2000, for cash at the stated issue price plus accrued stated discount and accrued interest through the date of redemption. In addition, each note is convertible at any time prior to maturity into approximately 18.9 shares of the Company's common stock, subject to adjustment upon the occurrence of certain events. Upon any such conversion, the Company has the option of paying cash equal to the market value of the shares which would otherwise be issuable.

During the fourth quarter of 2002, the Company elected to repay approximately $145 million of its senior debt issuances prior to their maturity dates. In connection with these repayments, the Company recognized an extraordinary charge of approximately $2 million, net of tax benefit, for prepayment penalties and other costs incurred.

In November 2002, the Company privately placed $400 million of 6 3/8% senior unsecured notes due November 15, 2012. Interest on the notes is due on May 15 and November 15 of each year. The net proceeds of the offering were approximately $396 million after deducting underwriters discounts and expenses. The Company used these proceeds primarily to pay the $350 million of 6.5% senior notes that came due December 15, 2002.

In May 2002, the Company privately placed $500 million of 7 3/4% senior unsecured notes due May 15, 2032. Interest on the notes is due on November 15 and May 15 of each year. The net proceeds of the offering were approximately $498 million, after deducting underwriters' discounts and expenses. The Company used these proceeds to pay the $300 million of 6.625% senior notes that matured on July 15, 2002 and a portion of the $285.7 million of 7.7% senior notes that matured on October 1, 2002.

During the first quarter of 2002, the Company refinanced approximately $49 million of fixed-rate tax-exempt bonds maturing in 2011 with variable-rate tax-exempt bonds maturing in 2022. As a result, the Company incurred prepayment penalties and other fees for a total extraordinary item charge, net of tax benefit, of approximately $1 million. Also in the first quarter of 2002, the Company retired its 4% convertible subordinated notes due February 2002 by payment of $427 million to the holders of the outstanding notes.

The Company's debt balances are generally unsecured, except for approximately $618 million of the tax-exempt and project bonds outstanding at December 31, 2002 that are issued by the Company's subsidiaries and are secured by the related subsidiary's assets and revenue.

                         NOTIONAL
AS OF                     AMOUNT            RECEIVE                     PAY                   MATURITY DATE
-----                    --------   -----------------------   -----------------------   -------------------------
December 31, 2001......   $   20    Floating   1.88%          Fixed      7.27%          Through December 31, 2012
December 31, 2001......   $1,750    Fixed      6.50%-8.75%    Floating   3.23%-4.00%    Through May 1, 2018
December 31, 2002......   $   19    Floating   1.38%          Fixed      7.27%          Through December 31, 2012
December 31, 2002......   $2,000    Fixed      6.375%-7.65%   Floating   2.965%-4.91%   Through July 15, 2028

                              FAIR VALUE
AS OF                    ASSET/(LIABILITY)(A)
-----                    --------------------
December 31, 2001......          $ (2)(b)
December 31, 2001......          $ --(c)
December 31, 2002......          $ (3)(b)
December 31, 2002......          $ 34

(a) The fair value of interest rate derivatives is included in the Company's balance sheets as components of other long-term assets and other long-term liabilities. Fair values of these interest rate derivatives are based on third party pricing models.

(b) The interest rate derivative contract's terms do not qualify for hedge accounting. Therefore, the contract is accounted for at fair value with changes in fair value recognized immediately in interest expense.

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

In 2002, the Company elected to terminate several interest rate swap agreements with a notional amount of $2.95 billion prior to the scheduled maturities and received cash of $200 million (which is comprised of $166 million for the fair value of the swaps that were terminated and $34 million of accrued but unpaid interest receivable) from the counterparties to the interest rate swaps. The Company had designated these swap agreements as fair value hedges, and as such the unamortized adjustment to long-term debt for the change in fair value of the swaps remains classified with long-term debt. The proceeds received from the termination of the interest rate swap agreements have been classified as a change in other assets or other liabilities within operating activities in the accompanying consolidated statement of cash flows.

The carrying value of debt instruments has been increased by approximately $239 million and $62 million as of December 31, 2002 and December 31, 2001, respectively, related to fair value hedge accounting for interest rate swap contracts. The following table summarizes the accumulated fair value adjustments from interest rate swap agreements by underlying debt instrument category at December 31 (in millions):

INCREASE IN CARRYING VALUE OF DEBT DUE TO
HEDGE ACCOUNTING FOR INTEREST RATE SWAPS                      2002   2001
-----------------------------------------                     ----   ----
Senior notes and debentures:
     Active swap agreements.................................  $ 34   $--
     Terminated swap agreements.............................   203    60
                                                              ----   ---
                                                               237    60
Tax-exempt and project bonds:
     Terminated swap agreements.............................     2     2
                                                              ----   ---
                                                              $239   $62
                                                              ====   ===

Interest rate swap agreements reduced net interest expense by $86 million and $39 million for the years ended 2002 and 2001, respectively. The significant terms of the interest rate contracts and the underlying debt instruments are identical, thus no ineffectiveness has been realized.

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

INTEREST RATE LOCKS

During 2002, the Company entered into cash flow hedges to secure the underlying interest rates in anticipation of its 2002 senior note issuances. The Company settled with the counterparties for approximately $66 million, which was paid concurrently with the related 2002 senior note issuance. In 2001, the Company completed a similar cash flow hedge to secure the then current market interest rate in anticipation of senior unsecured note issuances. These 2001 and 2002 hedging agreements resulted in a deferred loss, net of taxes, of $43 million at December 31, 2002, which is included in accumulated other comprehensive income. Of this amount, $7 million (on a pre-tax basis) is scheduled to be reclassified into interest expense in 2003. The ineffective portion of these hedges was immaterial to the Company in 2002.

FOREIGN CURRENCY DERIVATIVES

During June 2002, the Company entered into forward contracts and cross-currency swaps, which expire through May 2004, with net notional amounts of $165 million Canadian dollars, to mitigate the risk of foreign currency exchange rate fluctuations associated with the conversion of Canadian dollars into US dollars. These instruments hedge the expected future cash flows associated with an intercompany note denominated in Canadian dollars and are therefore accounted for as cash flow hedges. At December 31, 2002, these derivatives have a net fair value of approximately $3 million and are included in other long-term assets. The Company did not incur any ineffectiveness with respect to these derivative transactions. The Company had no foreign currency derivatives outstanding at December 31, 2001.

8. ENVIRONMENTAL LIABILITIES

The Company has material financial commitments for closure and post-closure obligations with respect to the landfills it owns or operates. Estimates of closure and post-closure costs are developed using input from the Company's engineers and accountants and are reviewed by management, typically at least once per year. Adjustments for closure and post-closure estimates are accounted for prospectively over the remaining capacity of the landfill. The estimates are based on the Company's interpretation of current requirements and proposed regulatory changes. For landfills, the present value of closure and post-closure liabilities is accrued using a calculated rate per ton and charged to expense as airspace is consumed. Each year the Company revises its calculated rate per ton to reflect accretion on the present value of the liability. The revised rate per ton is calculated by dividing the revised present value of the liability, less the accumulated liability recognized to date, by the estimated remaining capacity of the landfill. The present value of total estimated 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 the cap and cover for the site, methane gas control, leachate management and groundwater monitoring, and other operational and maintenance costs to be incurred after the site discontinues accepting waste, which is generally expected to be for a period of up to thirty years after final site closure. For purchased disposal sites, the Company assesses and records a present value-based closure and post-closure liability at the time the Company assumes closure and post-closure responsibility. This liability is based on the estimated closure and post-closure costs and the percentage of airspace used as of the date the Company has assumed this responsibility. Thereafter, the difference between the closure and post-closure liability recorded at the time of acquisition and the present value of total estimated closure and post-closure costs to be incurred is accrued using the calculated rate and charged to operating costs as airspace is consumed.

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

The Company routinely reviews and evaluates sites that require remediation, including sites listed on the EPA's NPL sites. The Company considers whether the Company was an owner, operator, transporter, or

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

generator at the site, the amount and type of waste hauled to the site and the number of years the Company was connected with the site. The Company also reviews the same information with respect to other named and unnamed PRPs. The Company then reviews the estimated cost for the likely remedy, which is based on management's judgment and experience in remediating such sites for the Company as well as for unrelated parties, information available from regulatory agencies as to costs of remediation, and the number, financial resources and relative degree of responsibility of other PRPs who may be liable for remediation of a specific site, as well as the typical allocation of costs among PRPs. These estimates are sometimes a range of reasonably possible outcomes. In those cases, the Company uses the amount within the range that constitutes its best estimate. If no amount within the range appears to be a better estimate than any other, the Company uses the amounts that are the low ends of such ranges in accordance with SFAS No. 5 and its interpretations. Were the Company to use the high ends of such ranges, the Company's potential liability would be approximately $220 million higher on a discounted basis in the aggregate than the estimate recorded in the consolidated financial statements as of December 31, 2002. As used in this context, "reasonably possible" means the Company believes it is more than remote but less than likely.

Estimates of the Company's degree of responsibility for remediation of a particular site and the method and ultimate cost of remediation require a number of assumptions and are inherently difficult, and the ultimate outcome may differ materially from current estimates. It is possible that technological, regulatory or enforcement developments, the results of environmental studies, the inability to identify other PRPs, the inability of other PRPs to contribute to the settlements of such liabilities, or other factors could necessitate the recording of additional liabilities that could be material. Additionally, the Company's ongoing review of its remediation liabilities could result in revisions that could cause upward or downward adjustments to income from operations. These adjustments could be material in any given period. See Note 20 for further discussion.

As part of its ongoing operations, the Company reviews its reserve requirements for remediation and other environmental matters based on an analysis of, among other things, the regulatory context surrounding landfills and remaining airspace capacity in light of changes to operational efficiencies. Accordingly, revisions to remediation reserve requirements may result in upward or downward adjustments to income from operations, which may be material, in any given period. Adjustments for closure and post-closure estimates are accounted for prospectively over the remaining capacity of the landfill.

Where the Company believes that both the amount of a particular environmental liability and the timing of the payments are reliably determinable, the cost in current dollars is inflated (at 2% at both December 31, 2002 and 2001) until expected time of payment and then discounted to present value (at 5.0% and 5.5% at December 31, 2002 and 2001, respectively). The inflation rate and discount rates, which are based on the rates for United States Treasury bonds, are reviewed on an annual basis. For landfills that are in the post-closure monitoring period and for remedial liabilities at all sites, interest accretion is included in operating costs and expenses and is based on the effective interest method. For operating landfills, the accretion of the interest related to the discounted environmental liabilities is included in the annual calculation of the landfill's closure and post-closure cost per ton and is charged to operating costs as landfill airspace is consumed. The Company's method of accounting for landfill closure and post-closure, as well as landfill final capping, will change upon the Company's adoption of SFAS No. 143. See Note 25 for additional discussion on SFAS No. 143. The portion of the Company's recorded environmental liabilities that has never been subject to inflation or discounting was approximately $79 million and $108 million at December 31, 2002 and 2001, respectively. Had the Company not discounted any portion of its liability, the amount recorded would have been increased by approximately $462 million at December 31, 2002.

                                                              DECEMBER 31,
                                                              -------------
                                                               2002    2001
                                                              ------   ----
Current portion, included in accrued liabilities:
  Closure/Post-closure......................................  $   49   $ 55
  Remediation...............................................      65     66
                                                              ------   ----
                                                                 114    121
                                                              ------   ----
Long-term:
  Closure/Post-closure......................................     606    570
  Remediation...............................................     278    255
                                                              ------   ----
                                                                 884    825
                                                              ------   ----
Total recorded..............................................     998   $946
                                                                       ====
Amount to be provided on a units-of-consumption basis over
  the remaining expected useful life of landfills (including
  discount of $462 million related to recorded amounts).....   1,994
                                                              ------
Expected aggregate environmental liabilities based on
  current cost..............................................  $2,992
                                                              ======

The changes to environmental liabilities are as follows (in millions):

                                                               YEARS ENDED
                                                              DECEMBER 31,
                                                              -------------
                                                              2002     2001
                                                              ----     ----
Balance, beginning of year..................................  $946     $962
Expense.....................................................    65       65
Spending....................................................   (80)     (91)
Acquisitions, divestitures and other adjustments............    67(a)    10
                                                              ----     ----
Balance, end of year........................................  $998     $946
                                                              ====     ====

(a) The majority of the $67 million of transactions in 2002 classified as acquisitions, divestitures and other adjustments relates to reclassification entries to increase environmental liabilities and correspondingly increase other long-term assets.

Anticipated payments (based on current costs) of currently identified environmental liabilities for the next five years and thereafter are as follows (in millions):

2003   2004   2005   2006   2007   THEREAFTER
----   ----   ----   ----   ----   ----------
$114   $69    $68    $56    $46      $2,639

The Company has, from time to time, filed suit against insurance carriers seeking reimbursement for environmentally related remedial, defense and tort claim costs at a number of sites. The majority of these claims have been settled. The Company is actively pursuing its remaining claims. For 2002, 2001, and 2000, the Company recorded approximately $1 million, $105 million, and $2 million, respectively, of such recoveries from insurance carriers. These recoveries are included as reductions to operating costs and expenses.

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value amounts of the Company's financial instruments have been determined by the Company using available market information and commonly accepted valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company or holders of the instruments could realize in a current market exchange. The use of different assumptions and/or estimation methodologies may have a material effect on the estimated fair values. The fair value estimates presented herein are based on information available to management as of December 31, 2002 and 2001. Such amounts have not been revalued since those dates, and current estimates of fair value may differ significantly from the amounts presented herein.

The carrying values of cash and cash equivalents, short-term investments, trade accounts receivable, trade accounts payable, financial instruments included in notes and other receivables and financial instruments included in other assets or other liabilities are estimated to approximate their fair values principally because of the short-term maturities of these instruments. At December 31, 2002 and 2001, the carrying amount of debt was $8.29 billion and $8.22 billion, and the fair value of debt was estimated at $8.68 billion and $8.19 billion, respectively. The fair value of the Company's senior notes and convertible subordinated notes are based on quoted market prices. The fair value of project debt and other debt is estimated using discounted cash flow analysis, based on rates the Company would currently pay for similar types of instruments.

10. FIBER DERIVATIVES AND HEDGING TRANSACTIONS

The Company is a market maker in over the counter derivatives for waste paper and other paper commodities ("fiber derivatives"). Since there is no regulated exchange market for these commodities, fair value assessments of the Company's fiber derivatives are based on information from independent, third party broker dealers, alternate price sources, and the Company's view of the market's economic fundamentals. Although these assessments represent the Company's best estimates on any given day, the values, as reported on December 31, 2002, will change over time due to subsequent fluctuations in market conditions.

The Company has entered into certain fiber swap agreements with the objective of generating profits from changes in market prices of waste paper and other paper products. These derivatives are not designated as hedges and are accounted for at fair value, with changes in value reflected immediately in earnings. These derivatives increased revenues by approximately $2 million for the year ended December 31, 2002.

The Company also enters into fiber swap agreements to mitigate the variability in cash flows of certain paper products expected to be sold from its material recovery facilities and accounts for these derivatives as cash flow hedges. The Company's fiber swap agreements have an average term of approximately two years with the maximum term being five years. The terms of the agreements represent the span of time over which the Company is hedging its exposure to variability in future cash flows from the sale of waste paper products. The ineffective portion of these hedges was immaterial to the Company in 2002.

The notional amounts and terms of fiber derivatives outstanding at December 31, 2002 are summarized in the table below (dollars in millions):

NOTIONAL AMOUNT              RECEIVE      PAY            MATURITY DATE         FAIR VALUE
---------------              --------   --------         -------------         ----------
(IN TONS)
2,347,098..................   Fixed     Floating   Through December 31, 2007     $    3
 359,200...................  Floating    Fixed     Through December 31, 2005          1
                                                                                 ------
                                                                                 $    4
                                                                                 ======

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

As of December 31, 2002, the Company has included in accumulated other comprehensive income a net deferred gain of approximately $1 million, which is net of taxes. Approximately $408,000 (on a pre-tax basis) of deferred gain is expected to be reclassified to revenues in 2003.

As of December 31, 2001, the Company had two fiber financial swap transactions with counterparties other than Enron. The fair value of these swaps was not material to the Company at December 31, 2001. Due to Enron's bankruptcy in December of 2001, the Company recorded a loss in 2001 of approximately $11 million to adjust the fair value of these swap agreements to zero. In February 2002, the Company terminated its derivative instruments with Enron. Included in accumulated other comprehensive income at December 31, 2002 is a deferred gain, net of tax of approximately $2 million for fiber swap agreements the Company had with Enron in 2001. This deferred gain is being amortized into earnings as the forecasted transactions that were previously hedged actually occur and approximately $2 million (on a pre-tax basis) is expected to be reclassified into earnings in 2003.

11. CAPITAL STOCK

The Board of Directors is authorized to issue preferred stock in series, and with respect to each series, to fix its designation, relative rights (including voting, dividend, conversion, sinking fund, and redemption rights), preferences (including dividends and liquidation), and limitations. The Company has ten million shares of authorized preferred stock, $0.01 par value, none of which is currently outstanding.

The Company declared cash dividends of $0.01 per common share, or approximately $6 million, during each of 2002, 2001 and 2000. As of December 31, 2002, the Company has the ability, under its most restrictive loan covenant financial tests, to make dividend payments and repurchase shares in the aggregate amount of up to approximately $800 million, plus 25% of future net income.

In February 2002 the Company announced that its Board of Directors had approved a stock repurchase program for up to $1 billion in annual repurchases each year for 2002 through 2004 to be implemented at management's discretion. Any purchases may be made in either open market or privately negotiated transactions primarily using cash flows from operations.

The following is a summary of 2002 activity for the Company's stock buyback program (in millions, except shares in thousands and price per share).

                                   AGREEMENT                    COMMON STOCK                                         NET
                       ---------------------------------   ----------------------   PURCHASE     SETTLEMENT      COMMON STOCK
TRANSACTION TYPE       INITIATING DATE   SETTLEMENT DATE   SHARES       PRICE        PRICE     RECEIVED/(PAID)   REPURCHASES
----------------       ---------------   ---------------   ------   -------------   --------   ---------------   ------------
Private Accelerated
  Purchase(a)........  March 2002        August 2002       10,925      $27.46        $  300         $ 18(b)          $282
Private Accelerated
  Purchase(a)........  December 2002     February 2003      1,731      $24.52            42           --(c)            42
Open Market
  Purchases(d).......  N/A               N/A               25,594   $23.01-$28.19       658          N/A              658
                                                           ------                    ------                          ----
                                                           38,250                    $1,000                          $982
                                                           ======                    ======                          ====

(a) The Company accounted for the initial payment as a purchase of treasury stock and classified the future settlement with the counterparty as an equity instrument because the Company had the option under the agreement to settle its obligations, if any, in shares of its common stock.

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

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(c) The weighted average daily market price of our stock during the valuation period times the number of shares the Company purchased was approximately $3 million less than the approximately $42 million the Company initially paid. Pursuant to the agreement the counterparty will pay the Company the difference of approximately $3 million at the end of the valuation period to settle the agreement.

(d) The Company engaged in open market purchases when trading was allowed pursuant to law and the Company's insider trading policy.

12. COMMON STOCK OPTIONS AND WARRANTS

Under the Company's 1993 Stock Option Incentive Plan and the Company's 2000 Stock Option Incentive Plan, options to purchase 26.5 million and 29.0 million shares, respectively, of the Company's common stock may be granted to officers, directors, and key employees. Options are granted under these plans at exercise prices at least equal to the fair market value of common stock on the date of grant. The option plans have various vesting periods, and expire up to ten years from the date of grant. The Company also has a 2000 Broad-Based Employee Plan under which options to purchase an aggregate of 3.0 million shares can be granted to any non-officer employees. The exercise prices for options under the Broad-Based Plan are at least equal to the fair market value of common stock on the date of grant, may vest over various periods, and expire up to ten years from the date of grant. Stock options granted by the Company in 2002, 2001 and 2000 generally have ten year terms and vest over four or five years.

During the majority of 2000, the Company made original issuances of its common stock upon exercises of stock options and warrants. Beginning in the fourth quarter of 2000, the Company issued treasury stock upon exercises of stock options and warrants. When issuing shares of treasury stock, the difference between the stock option exercise price and the average treasury stock cost is recorded as an addition to or deduction from additional paid-in-capital.

Under the Company's 1996 Stock Option Plan for Non-Employee Directors, the Company's outside directors receive an annual grant of 10,000 options on each January 1. In accordance with the plan, options to purchase up to 2.4 million shares of the Company's common stock may be granted, with one-year vesting periods and expiration dates ten years from the date of grant. The options are granted at exercise prices equal to the fair market value of the common stock on the date of grant.

The Company also has outstanding options and warrants related to various predecessor plans acquired through merger and acquisition activity. These options and warrants generally continue to vest under their original schedules which range up to five years from the date of grant, although some vested immediately upon the change of control related to the merger or acquisition.

The following table summarizes common stock option and warrant transactions under the aforementioned plans and various predecessor and assumed plans for 2002, 2001 and 2000 (shares in thousands):

                                                 YEARS ENDED DECEMBER 31,
                                 ---------------------------------------------------------
                                       2002                2001                2000
                                 -----------------   -----------------   -----------------
                                          WEIGHTED            WEIGHTED            WEIGHTED
                                          AVERAGE             AVERAGE             AVERAGE
                                          EXERCISE            EXERCISE            EXERCISE
                                 SHARES    PRICE     SHARES    PRICE     SHARES    PRICE
                                 ------   --------   ------   --------   ------   --------
Outstanding at beginning of
  year.........................  41,465    $27.96    40,257    $30.10    37,827    $34.12
Granted........................  10,376    $27.60    11,469    $24.59     8,069    $15.46
Exercised......................  (1,758)   $15.23    (3,292)   $15.89    (1,308)   $18.78
Forfeited or expired...........  (5,614)   $35.96    (6,969)   $40.46    (4,331)   $41.36
                                 ------              ------              ------
Outstanding at end of year.....  44,469    $27.36    41,465    $27.96    40,257    $30.10
                                 ======              ======              ======
Exercisable at end of year.....  21,789    $29.55    21,159    $31.60    24,598    $32.87
                                 ======              ======              ======

                                        OUTSTANDING                           EXERCISABLE
                        --------------------------------------------   -------------------------
RANGE OF                         WEIGHTED AVERAGE   WEIGHTED AVERAGE            WEIGHTED AVERAGE
EXERCISE PRICES         SHARES    EXERCISE PRICE    REMAINING YEARS    SHARES    EXERCISE PRICE
---------------         ------   ----------------   ----------------   ------   ----------------
$5.00-$10.00..........      59        $ 7.54              1.69             59        $ 7.54
$10.01-$20.00.........   9,012        $15.23              6.62          5,163        $15.07
$20.01-$30.00.........  25,809        $25.69              7.09          8,045        $24.85
$30.01-$40.00.........   3,824        $35.11              4.99          3,556        $35.35
$40.01-$50.00.........   2,603        $43.53              4.53          2,520        $43.42
$50.01-$62.28.........   3,162        $53.23              5.67          2,446        $53.39
                        ------                                         ------
$5.00-$62.28..........  44,469        $27.36              6.55         21,789        $29.55
                        ======                                         ======

The Company's President, CEO, and Chairman of the Board was granted 650,000 stock options upon joining the Company in November 1999. The options, which are included in the above tables, vest according to certain performance goals in lieu of the normal vesting schedules. Notwithstanding these performance goals, all of these options will vest no later than five years from the date of grant.

13. EMPLOYEE BENEFIT PLANS

The Waste Management Retirement Savings Plan ("Savings Plan") covers employees (except those working subject to collective bargaining agreements, which do not provide for coverage under such plans) following a 90 day waiting period after hire, and allows eligible employees to contribute up to 15% of their annual compensation, as limited by IRS regulations. Under the Savings Plan, the Company matches in cash employee contributions up to 3% of their eligible compensation and matches 50% of employee contributions in excess of 3% but no more than 6% of eligible compensation. Both employee and Company contributions vest immediately. Charges to operations for the Company's defined contribution plans were $43 million, $41 million and $38 million, during 2002, 2001 and 2000, respectively.

In addition, Company subsidiaries sponsor defined benefit plans that cover employees not covered by the Savings Plan but are members of a bargaining unit whose agreement provides for participation in the plan (the "Collectively Bargained Employees Plan"). The normal form of benefit is a monthly annuity payable over the lifetime of the participant, commencing on his or her normal retirement at age 65, or after 30 years of benefit service if a participant is at least age 50.

Waste Management Holdings, Inc. ("WM Holdings") had a qualified defined benefit pension plan (the "Plan") for all eligible non-union domestic employees which was terminated as of October 31, 1999 in connection with the Company's acquisition of WM Holdings in July 1998 (the "WM Holdings Merger"). The Company contributed approximately $145 million to the Plan's trusts during 2000 and contributed approximately $14 million in 2001 related to the final liquidation of the Plan. The Company recorded an expense for the Plan during 2000 of approximately $197 million, which was included in asset impairment and unusual items. No expense was recorded in 2001 or 2002.

In conjunction with the WM Holdings Merger, the Company terminated certain non-qualified supplemental benefit plans for certain officers and non-officer managers, the most significant plan being the WM Holdings' Supplemental Executive Retirement Plan ("SERP") (collectively the "Supplemental Plans").

The Plan, Supplemental Plans and Collectively Bargained Employees Plan are combined in the tables below under the caption "Pension Benefits."

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

WM Holdings and certain of its subsidiaries provided post-retirement health care and other benefits to eligible employees. In conjunction with the WM Holdings Merger, the Company limited participation in these plans to participating retired employees as of December 31, 1998. These plans are combined under the caption "Other Benefits" in the tables that follow. Additionally, the Company sponsors an ongoing post-retirement plan that is fully funded and is also included in "Other Benefits" in the tables below.

The following tables provide a reconciliation of the changes in the benefit obligations and the fair value of assets over the two-year period ended December 31, 2002, a statement of the funded status for both years for the related plans and the amount recognized in the consolidated balance sheets as of December 31 for both years (in millions):

                                                          PENSION BENEFITS    OTHER BENEFITS
                                                          ----------------    ---------------
                                                           2002       2001     2002     2001
                                                          ------     ------   ------   ------
CHANGE IN BENEFIT OBLIGATION:
  Benefit obligation at beginning of year...............   $18        $75      $ 54     $ 51
  Service cost..........................................     2          1        --       --
  Interest cost.........................................     1          2         3        4
  Actuarial (gain)/loss.................................     4         (4)        1        3
  Benefits paid.........................................    (1)        --        (3)      (4)
  Curtailments..........................................    --        (56)       --       --
                                                           ---        ---      ----     ----
  Benefit obligation at end of year.....................   $24        $18      $ 55     $ 54
                                                           ===        ===      ====     ====
CHANGE IN PLAN ASSETS:
  Fair value of plan assets at beginning of year........   $12        $16      $ --     $ --
  Actual return on plan assets..........................     8         (2)       --       --
  Employer contributions................................     3         52         3        4
  Benefits paid.........................................    (1)       (54)       (3)      (4)
                                                           ---        ---      ----     ----
  Fair value of plan assets at end of year..............   $22        $12      $ --     $ --
                                                           ===        ===      ====     ====
FUNDED STATUS:
  Funded status at December 31..........................   $(2)       $(6)     $(55)    $(54)
  Unrecognized loss.....................................     1          4         3        2
  Unrecognized prior service cost.......................    --         --       (15)     (16)
                                                           ---        ---      ----     ----
  Net amount recognized.................................   $(1)       $(2)     $(67)    $(68)
                                                           ===        ===      ====     ====
BALANCE SHEET:
  Accrued benefit liability.............................   $(1)       $(4)     $(67)    $(68)
  Accumulated other comprehensive income before tax
     benefit............................................    --          2        --       --
                                                           ---        ---      ----     ----
                                                           $(1)       $(2)     $(67)    $(68)
                                                           ===        ===      ====     ====

                                              PENSION BENEFITS      OTHER BENEFITS
                                             ------------------   ------------------
                                             2002   2001   2000   2002   2001   2000
                                             ----   ----   ----   ----   ----   ----
Components of net periodic benefit cost:
  Service cost.............................  $  2   $  1   $  1   $ --   $ --   $ --
  Interest cost............................     1      2     21      3      4      4
  Expected return on plan assets...........    (1)    (1)   (11)    --     --     --
  Amortization of prior service cost.......    --     --     --     (1)    (2)    (2)
  Recognized loss..........................    --     --     13     --     --     --
                                             ----   ----   ----   ----   ----   ----
  Net periodic benefit cost................     2      2     24      2      2      2
  Settlement/Curtailment (gain)/loss
     (included in asset impairments and
     unusual items)........................    --     (1)   175     --     --     --
                                             ----   ----   ----   ----   ----   ----
  Net periodic benefit cost after
     curtailments and settlements..........  $  2   $  1   $199   $  2   $  2   $  2
                                             ====   ====   ====   ====   ====   ====

The assumptions used in the measurement of the Company's benefit obligations are shown in the following table (weighted average assumptions as of December 31):

                                                          PENSION BENEFITS    OTHER BENEFITS
                                                          -----------------   --------------
                                                           2002       2001    2002     2001
                                                          ------     ------   -----    -----
Discount rate...........................................   6.50%      7.19%   6.50%    7.25%
Expected return on plan assets..........................   9.00%      9.00%    n/a      n/a
Rate of compensation increases..........................   3.50%      3.50%    n/a      n/a

The principal element of the "other benefits" referred to above is the post-retirement health care plan. Participants in the WM Holdings post-retirement plan (one of two plans that comprise the "other benefits" information) contribute to the cost of the benefit, and for retirees since January 1, 1992, the Company's contribution is capped at between $0 and $600 per month per retiree, based on years of service. For measurement purposes, a 12.0% annual rate of increase in the per capita cost of covered health care claims was assumed for 2002 (being an average of the rate used by all plans); the rate was assumed to decrease to 6.0% in 2006 and remain at that level thereafter.

A 1% change in assumed health care cost trend rates has no significant effect on total service and interest cost components of net periodic post-retirement health care costs. A 1% increase or decrease in assumed health care cost trend rates would increase or decrease the accumulated post-retirement benefit obligation by approximately $5 million.

Company subsidiaries participate in various multi-employer pension plans and in two instances, site or contract specific plans (one of which terminated and completed liquidation in 2002), covering certain employees not covered under the Company's pension plans. These multi-employer plans are generally defined benefit plans; however, in many cases, specific benefit levels are not negotiated with or known by the employer contributors. The projected benefit obligation, plan assets and unfunded liability of the multi-employer pension plans, and the site or contract specific plans are not material and are not included in the tables above. Contributions of $31 million, $23 million and $28 million for subsidiaries' defined benefit plans were charged to operations in 2002, 2001 and 2000, respectively.

                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                                2002      2001     2000
                                                              --------   ------   ------
Domestic....................................................   $1,244     $742     $491
International...............................................        3       45     (170)
                                                               ------     ----     ----
Income before income taxes and extraordinary item and
  cumulative effect of changes in accounting principle......   $1,247     $787     $321
                                                               ======     ====     ====

The provision for income taxes before extraordinary item and cumulative effect of change in accounting principle consisted of the following (in millions):

                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               2002      2001      2000
                                                              ------    ------    ------
Current:
  Federal...................................................   $ 97      $ 95      $238
  State.....................................................     26        40        74
  Foreign...................................................    (18)       18        41
                                                               ----      ----      ----
                                                                105       153       353
                                                               ----      ----      ----
Deferred:
  Federal...................................................    259       149        50
  State.....................................................     58        19         6
  Foreign...................................................      2       (37)        9
                                                               ----      ----      ----
                                                                319       131        65
                                                               ----      ----      ----
     Provision for income taxes.............................   $424      $284      $418
                                                               ====      ====      ====

The federal statutory rate is reconciled to the effective rate as follows:

                                                              YEARS ENDED DECEMBER 31,
                                                              -------------------------
                                                               2002     2001     2000
                                                              ------   ------   -------
Income tax expense at federal statutory rate................  35.00%   35.00%    35.00%
State and local income taxes, net of federal income tax
  benefit...................................................   4.40     4.86     16.17
Nondeductible costs relating to acquired intangibles........   0.76     0.87     48.40
Writedown of investments in subsidiaries....................     --     1.92     12.81
Minority interest...........................................   0.20     0.23      2.54
Sale of subsidiaries........................................  (0.90)      --     23.53
Deferred tax valuation and other tax reserves...............     --       --      1.21
Tax rate differential on foreign income.....................  (2.24)    3.05      3.13
Cumulative effect of change in Canadian tax rates...........     --    (5.28)       --
Nonconventional fuel tax credit.............................  (3.08)   (3.75)    (8.30)
Other.......................................................  (0.14)   (0.81)    (4.27)
                                                              -----    -----    ------
     Provision for income taxes.............................  34.00%   36.09%   130.22%
                                                              =====    =====    ======

                                                                DECEMBER 31,
                                                              -----------------
                                                               2002      2001
                                                              -------   -------
Deferred tax assets:
  Net operating loss, capital loss and tax credit
     carryforwards..........................................  $   298   $   328
  Environmental and other reserves..........................    1,045     1,047
  Reserves not deductible until paid........................       73        75
                                                              -------   -------
       Subtotal.............................................    1,416     1,450
                                                              -------   -------
Valuation allowance.........................................     (463)     (454)
Deferred tax liabilities:
  Property, equipment, intangible assets, and other.........   (1,950)   (1,697)
                                                              -------   -------
       Net deferred tax liabilities.........................  $  (997)  $  (701)
                                                              =======   =======

At December 31, 2002 the Company's subsidiaries have approximately $19 million of federal net operating loss ("NOL") carryforwards, $3.6 billion of state NOL carryforwards, and $32 million of foreign NOL carryforwards. The NOL carryforwards have expiration dates through the year 2022. The Company's subsidiaries have approximately $1 million of alternative minimum tax credit carryforwards that may be used indefinitely; state tax credit carryforwards of $13 million; and foreign tax credit carryforwards of $18 million.

Valuation allowances have been established for uncertainties in realizing the benefit of tax loss and credit carryforwards and other deferred tax assets. While the Company expects to realize the deferred tax assets, net of the valuation allowances, changes in estimates of future taxable income or in tax laws may alter this expectation. The valuation allowance increased approximately $9 million and $10 million in 2002 and 2001, respectively, primarily due to the uncertainty of realizing foreign and state NOL carryforwards and tax credits.

With respect to its Canadian operations, the Company provided $24 million for the repatriation of $230 million of capital in 2001. Unremitted earnings in foreign operations were approximately $167 million at December 31, 2002, which the Company intends to reinvest. It is not practicable to determine the amount of United States based income taxes that would be payable upon remittance of the assets that represent those earnings.

15. SEGMENT AND RELATED INFORMATION

The Company manages and evaluates its operations primarily through six operating Groups, the Company's Eastern, Midwest, Southern, Western, Canadian Waste Services Inc. ("CWS" or "Canada"), and Wheelabrator Technologies Inc. ("WTI") groups. These six operating Groups are presented below as the Company's reportable segments. These reportable segments, when combined with certain other operations not managed through the six operating Groups ("Other NASW"), comprise the Company's NASW operations. NASW, the Company's core business, provides integrated waste management services consisting of collection, disposal (solid waste landfill and hazardous waste landfill), transfer, waste-to-energy facilities and IPPs that are managed by WTI, recycling and other miscellaneous services to commercial, industrial, municipal and residential customers throughout the United States, Puerto Rico and Canada. The Company also had international waste management and non-solid waste services, all of which were divested by March 31, 2002. These operations are included in the table below as "Other."

                         GROSS     INTERCOMPANY      NET                      DEPRECIATION
                       OPERATING    OPERATING     OPERATING    INCOME FROM        AND          CAPITAL          TOTAL
                       REVENUES    REVENUES(C)    REVENUES    OPERATIONS(D)   AMORTIZATION   EXPENDITURES   ASSETS(E),(F)
                       ---------   ------------   ---------   -------------   ------------   ------------   -------------
2002
Canada...............   $   524      $   (51)      $   473       $   37          $   49         $   50         $ 1,114
Eastern..............     3,816         (734)        3,082          511             369            377           5,365
Midwest..............     2,289         (327)        1,962          357             258            258           2,999
Southern.............     3,016         (456)        2,560          577             266            262           2,817
Western..............     2,480         (341)        2,139          376             184            195           2,825
WTI..................       789          (58)          731          209              43             26           2,404
Other NASW(a)........       219          (32)          187          (55)              8              3             928
                        -------      -------       -------       ------          ------         ------         -------
Total NASW...........    13,133       (1,999)       11,134        2,012           1,177          1,171          18,452
Other................         9           (1)            8           (3)             --             --              21
Corporate(b).........        --           --            --         (365)             45            116           1,873
                        -------      -------       -------       ------          ------         ------         -------
Total................   $13,142      $(2,000)      $11,142       $1,644          $1,222         $1,287         $20,346
                        =======      =======       =======       ======          ======         ======         =======
2001
Canada...............   $   530      $   (51)      $   479       $   73          $   59         $   32         $ 1,111
Eastern..............     3,783         (715)        3,068          530             409            393           5,216
Midwest..............     2,327         (341)        1,986          361             289            277           2,981
Southern.............     2,999         (446)        2,553          585             283            230           2,773
Western..............     2,541         (356)        2,185          428             210            210           2,740
WTI(g)...............       802          (55)          747          229              72             18           2,567
Other NASW(a)........       174          (30)          144          (30)              8              9             500
                        -------      -------       -------       ------          ------         ------         -------
Total NASW...........    13,156       (1,994)       11,162        2,176           1,330          1,169          17,888
Other................       204          (44)          160          (47)             --              1             124
Corporate(b).........        --           --            --         (846)             41            158           1,880
                        -------      -------       -------       ------          ------         ------         -------
Total................   $13,360      $(2,038)      $11,322       $1,283          $1,371         $1,328         $19,892
                        =======      =======       =======       ======          ======         ======         =======
2000
Canada...............   $   548      $   (55)      $   493       $   59          $   74         $   47         $ 1,236
Eastern..............     3,849         (747)        3,102          546             409            414           5,193
Midwest..............     2,408         (342)        2,066          374             315            203           2,962
Southern.............     3,010         (434)        2,576          542             298            240           2,790
Western..............     2,552         (363)        2,189          468             211            165           2,711
WTI(g)...............       902          (53)          849          152              44             55           1,901
Other NASW(a)........       175          (28)          147          (25)              7             39             390
                        -------      -------       -------       ------          ------         ------         -------
Total NASW...........    13,444       (2,022)       11,422        2,116           1,358          1,163          17,183
Other................     1,108          (38)        1,070         (253)             30             80             741
Corporate(b).........        --           --            --         (825)             41             70           1,681
                        -------      -------       -------       ------          ------         ------         -------
Total................   $14,552      $(2,060)      $12,492       $1,038          $1,429         $1,313         $19,605
                        =======      =======       =======       ======          ======         ======         =======

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(a) Other NASW includes national recycling, national accounts and methane gas recovery operations that provide services throughout the Groups. Also included are certain year-end adjustments related to the reportable segments but not included in the measure of segment profit or loss used to assess their performance for the periods disclosed.

(b) Corporate functions include the treasury, legal, information technology, tax, insurance, management of closed landfills and related insurance recoveries, centralized service center and other typical administrative functions.

(c) Intercompany operating revenues reflect each segment's total intercompany sales including intercompany sales within a segment and between segments. Transactions within and between segments are generally made on a basis intended to reflect the market value of the service.

(d) For those items included in the determination of income from operations, the accounting policies of the segments are generally the same as those described in the summary of significant accounting policies (see Note 2). Income from operations included goodwill amortization of $180 million and $156 million for the years ended December 31, 2000 and 2001 respectively. As discussed in Note 6, the Company ceased amortizing goodwill upon adoption of SFAS No. 142 on January 1, 2002. In 2002, the Company's corporate functions charged NASW operations an expense similar in amount to prior goodwill amortization. For the year ended December 31, 2002, this charge increased income from operations for the corporate functions by $148 million and decreased income from operations by the same amount for NASW.

(e) The reconciliation of total assets reported above to total assets on the consolidated balance sheets is as follows (in millions):