<PAGE>
This Quarterly Report is filed by Norcal Waste Systems, Inc.
pursuant to certain contractual requirements and not
pursuant to the Securities Exchange Act of 1934
and the rules and regulations thereunder.
QUARTERLY REPORT
For the Quarterly Period ended June 30, 2000
NORCAL WASTE SYSTEMS, INC.
(Exact Name of Company as specified in its charter)
California 94-2922974
---------- ----------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
160 Pacific Avenue, Suite 200
San Francisco, CA 94111
-----------------------
(Address of Principal executive offices)
(415) 875-1000
-----------------------------------------------
Company's telephone number, including area code
Norcal Waste Systems, Inc. is currently 100% owned by an employee stock
ownership plan.
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date. On August 7, 2000, there were
24,134,973 shares of $.01 par value Common Stock outstanding.
<PAGE>
NORCAL WASTE SYSTEMS, INC.
Quarterly Report for the period ended June 30, 2000
Index
Part I - Financial Information
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets - June 30, 2000 and September 30, 1999
Consolidated Statements of Operations - Three and Nine months ended
June 30, 2000 and 1999
Consolidated Statement of Stockholder's Equity - Nine months ended
June 30, 2000
Consolidated Statements of Cash Flows - Nine months ended June 30,
2000 and 1999
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Part II - Other Information
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Certain Reports
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
June 30, September 30,
2000 1999
-------- -------------
Assets
<S> <C> <C>
Current assets:
Cash $ 62,654 $ 42,166
Marketable securities 6,561 5,552
Accounts receivable, less allowance for doubtful accounts of
$2,021 at June 30, 2000 and $2,017 at September 30, 1999 44,346 46,369
Parts and supplies 2,377 2,102
Prepaid expenses 2,955 3,362
-------- --------
Total current assets 118,839 99,551
-------- --------
Property and equipment:
Land 45,240 46,392
Landfills 25,457 27,300
Buildings and improvements 48,812 51,904
Vehicles and equipment 161,121 150,908
Construction in progress 4,906 8,530
-------- --------
Total property and equipment 285,536 285,034
Less accumulated depreciation and amortization 123,235 120,024
-------- --------
Property and equipment, net 162,301 165,010
-------- --------
Franchises, permits and other intangibles, net 79,928 79,217
Trust accounts 24,164 36,744
Deferred financing costs, net 4,572 5,578
Other assets 1,802 7,709
-------- --------
Total other assets 110,466 129,248
-------- --------
Total assets $391,660 $393,809
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
3
<PAGE>
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
June 30, September 30,
2000 1999
--------- -------------
<S> <C> <C>
Liabilities and Stockholder's Equity
Current liabilities:
Current portion:
Long-term debt $ 322 $ 383
Capital lease obligations 287 582
Accounts payable 6,646 6,064
Accrued expenses 47,590 53,534
Accrued litigation settlement 6,561 --
Income taxes payable 640 1,311
Deferred revenues 3,780 3,592
Other accrued liabilities 2,775 4,164
--------- ---------
Total current liabilities 68,601 69,630
--------- ---------
Long-term debt 176,243 176,002
Obligations under capital leases 108 285
Deferred income taxes 6,776 6,850
Landfill closure liability 16,501 27,009
Postretirement medical benefits 34,807 34,177
Other liabilities 14,037 14,886
--------- ---------
Total liabilities 317,073 328,839
--------- ---------
Commitments and contingencies
Stockholder's equity:
Common stock, $.01 par value; 100,000,000 shares authorized;
24,134,973 shares issued and outstanding 241 241
Additional paid-in-capital 166,919 166,919
Accumulated deficit (70,467) (79,372)
Accumulated other comprehensive income (370) (200)
--------- ---------
96,323 87,588
Less net scheduled contribution to the ESOP (21,736) (22,618)
--------- ---------
Total stockholder's equity 74,587 64,970
--------- ---------
Total liabilities and stockholder's equity $ 391,660 $ 393,809
========= =========
</TABLE>
See accompanying notes to consolidated financial statements
4
<PAGE>
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues $ 88,855 $ 87,173 $ 258,579 $ 253,290
--------- --------- --------- ---------
Cost of operations:
Operating expenses 62,145 61,928 179,811 180,120
Depreciation and amortization 5,709 5,508 17,210 15,815
ESOP compensation expense 1,033 442 3,116 2,891
Litigation settlement 6,561 -- 6,561 --
General and administrative 9,634 9,849 27,816 28,424
--------- --------- --------- ---------
Total cost of operations 85,082 77,727 234,514 227,250
--------- --------- --------- ---------
Operating income 3,773 9,446 24,065 26,040
Interest expense (6,474) (6,453) (19,721) (19,454)
Interest income 1,247 784 3,395 2,434
Other income, net 403 205 1,440 928
--------- --------- --------- ---------
Income (loss) before income taxes (1,051) 3,982 9,179 9,948
Income tax expense 35 199 274 199
--------- --------- --------- ---------
Net income (loss) $ (1,086) $ 3,783 $ 8,905 $ 9,749
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements
5
<PAGE>
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
For the nine months ended June 30, 2000
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Accumulated Net
Additional other scheduled
Common Stock paid-in Accumulated comprehensive contribution
Shares Amount capital deficit income to the ESOP Total
------- ------- ---------- ----------- ------------- ------------ --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, September 30, 1999 24,135 $ 241 $166,919 $(79,372) $ (200) $(22,618) $64,970
Net income -- -- -- 8,905 -- -- 8,905
Other comprehensive income,
net of tax -- -- -- -- (170) -- (170)
Contributions to ESOP 882 882
------ ----- -------- -------- ------- -------- -------
Balances, June 30, 2000 24,135 $ 241 $166,919 $(70,467) $ (370) $(21,736) $74,587
====== ===== ======== ======== ======= ======== =======
</TABLE>
See accompanying notes to consolidated financial statements
6
<PAGE>
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
June 30,
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 8,905 $ 9,749
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 17,210 15,815
ESOP compensation expense 134 673
Accrual for litigation settlement 6,561 --
Senior notes interest and amortized financing costs (4,526) (4,618)
Other 3,807 (2,881)
Changes in assets and liabilities, net of effects of acquisitions and
dispositions 1,855 6,340
-------- --------
Net cash provided by operating activities 33,946 25,078
-------- --------
Cash flows from investing activities:
Acquisitions of property and equipment (15,036) (25,837)
Payments for businesses acquired (3,068) (9,866)
Proceeds from dispositions 4,848 960
Other 550 188
-------- --------
Net cash used in investing activities (12,706) (34,555)
-------- --------
Cash flows from financing activities:
Principal payments on long-term debt and capitalized leases (752) (1,524)
Proceeds from other debt -- 149
-------- --------
Net cash used in financing activities (752) (1,372)
-------- --------
Net increase (decrease) in cash and cash equivalents 20,488 (10,849)
Cash and cash equivalents, beginning balance 42,166 39,752
-------- --------
Cash and cash equivalents, ending balance $ 62,654 $ 28,903
======== ========
Supplemental cash flow information:
Interest $ 24,389 $ 24,443
======== ========
Income taxes $ 1,270 $ 36
======== ========
Schedule of noncash investing and financing activities:
Debt issued and liabilities assumed in acquisitions $ 122 $ 2,945
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
7
<PAGE>
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
Notes to Consolidated Financial Statements
(1) General
The interim consolidated financial statements presented herein include
Norcal Waste Systems, Inc. ("Norcal") and its subsidiaries (collectively, Norcal
and its subsidiaries are referred to herein as the "Company"). These interim
consolidated financial statements should be read in conjunction with the
Company's consolidated financial statements and the notes thereto, which include
information as to significant accounting policies, for the year ended September
30, 1999. Such interim consolidated financial statements are unaudited but, in
the opinion of management, reflect all adjustments necessary (consisting of
items of a normal recurring nature) for a fair presentation of the Company's
interim financial position, results of operations, and cash flows. Results of
operations for interim periods are not necessarily indicative of those of a full
year.
(2) Nature of Business
Through its subsidiaries, the Company provides integrated waste services to
residential, commercial, municipal and industrial customers in California. The
Company operates in one business segment - solid waste management services.
These services primarily consist of refuse collection, recycling and other waste
diversion, transfer station and hauling operations, and operation of
Company-owned landfills and third party landfill management services (including
engineering and construction management services). The Company continues to be,
with limited exceptions, the sole provider of commercial and residential refuse
collection for the City and County of San Francisco.
(3) Long-term Debt
Long-term debt at June 30, 2000 and September 30, 1999 is summarized as
follows:
<TABLE>
<CAPTION>
(in thousands)
June 30 September 30
--------- ------------
<S> <C> <C>
Senior Notes due November 15, 2005, interest at 13.5% $ 171,663 $ 171,374
Note payable for business acquired, due in monthly installments
through 2016, interest imputed at 8.75% 1,553 1,584
Convertible notes payable for business acquired, due in eight quarterly
installments beginning December 2001, interest imputed at 8.5% 1,869 1,838
Notes payable to former shareholders, due in monthly installments
through 2017, interest at 6% to 8.5% 635 676
Other notes 845 913
--------- ---------
Total debt 176,565 176,385
Less current portion 322 383
--------- ---------
Long-term debt $ 176,243 $ 176,002
========= =========
</TABLE>
On November 21, 1995, the Company completed a private debt offering of
$175.0 million in Senior Notes (the "Senior Notes"). The Senior Notes mature in
November 2005 with interest payable semi-annually. The Senior Notes are
redeemable at the option of the Company, in whole or in part, at any time during
or after November 2000. In the event of a change in control of the Company, the
Company would be required to offer to purchase the Senior Notes. The Senior
Notes are unsecured and rank pari passu in right of payment to all existing and
future senior indebtedness of the Company. The Senior Notes are guaranteed, on a
senior unsecured basis, by the Company's wholly-owned subsidiaries. The
Indenture governing the Senior Notes contains provisions which, among other
things, (i) limit the Company's and its subsidiaries' ability to declare or pay
dividends or other distributions (other than dividends or distributions payable
to Norcal or any wholly owned subsidiary of Norcal), (ii) limit the purchase,
redemption or retirement of capital stock and (iii) limit the incurrence of
additional debt. In September 1996, the Company completed the exchange of all of
its outstanding privately-placed Senior Notes for Senior Notes with identical
terms and provisions, which exchange was registered under the Securities Act of
1933. The interest rate on the Senior Notes is currently 13.5%, however, the
interest rate reverts to 12.5% if Norcal (in one or more transactions) offers to
purchase (whether or not any actual purchases are made) or redeems an aggregate
of $25.0 million in principal amount of Senior Notes out of the proceeds of
equity sales.
8
<PAGE>
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
Notes to Consolidated Financial Statements - (Continued)
Commencing November 15, 2000, the Senior Notes are redeemable in whole or
in part at the Company's option, upon not less than 30 nor more than 60 days'
notice. Any such voluntary redemptions by the Company through November 14, 2003
will include a redemption premium payment that declines annually over such
period. For any redemptions made by the Company during the period commencing
November 15, 2000 through November 14, 2001, the redemption price, expressed as
a percentage of the principal amount of Senior Notes redeemed, is 106.25%, plus
accrued and unpaid interest to the applicable redemption date.
In conjunction with the private debt offering, the Company entered into a
new Credit Agreement (the "Credit Agreement") with a group of lenders and Fleet
National Bank, as Agent. The Credit Agreement, as amended, provides for a
revolving credit facility in an amount currently of up to $82.5 million
(depending upon certain financial ratios), up to $25.0 million of which may be
used for letters of credit. At June 30, 2000, the Company had utilized $2.3
million of its credit facility for letters of credit and had availability under
the Credit Agreement (based on limitations imposed by certain financial ratios)
of $44.3 million along with $22.7 million which may be utilized for additional
letters of credit. Changes in availability under the Credit Agreement are a
function of changes in operating results, among other things.
(4) Guarantee of Securities
Norcal is a holding company and has no independent operations other than
those relating to its subsidiaries. The Senior Notes are guaranteed by all
wholly owned subsidiaries of Norcal. The guarantees of the guarantors are full,
unconditional and joint and several. Separate financial statements of each
guarantor have not been presented since management has determined such separate
financial statements are not material to investors.
(5) Income Taxes
The Company elected to become taxable as an S corporation effective October
1, 1998. In addition, in connection with the Company's S Corporation election
the Company also elected, for income tax purposes only, to treat a substantial
number of its subsidiaries as divisions of the Company. Generally, the taxable
income (or loss) of an S Corporation (including its divisions) is not taxable at
the corporate level, but is instead passed through to its shareholders. However,
because the sole shareholder of the Company, the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust, is a tax-exempt employee stock
ownership plan, it will not be subject to tax on its allocable share of the
Company's taxable income. The Company will still be subject to certain taxes as
an S Corporation, including a minimum state franchise tax of 1.5% and federal
and California built-in gains tax (set at the corporate tax rate) on sales of
certain built-in gain assets (such as real estate and securities).
9
<PAGE>
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
Notes to Consolidated Financial Statements - (Continued)
(6) Comprehensive Income
Effective October 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income" which establishes standards for the reporting of
comprehensive income and its components in financial statements. Comprehensive
income consists of net income and other gains and losses affecting stockholder's
equity, that under generally accepted accounting principles, are excluded from
net income. The components of comprehensive income for the interim periods
presented is as follows:
Nine Months Ended
June 30, 2000 June 30, 1999
------------- -------------
(in thousands)
Net income $ 8,905 $ 9,749
Other comprehensive income:
Unrealized gains (losses) on
trust accounts, net of tax (170) (386)
------- -------
Total comprehensive income $ 8,735 $ 9,363
======= =======
(7) San Bernardino Contract
Included in the footnotes to the financial statements as contained in the
Company's Annual Report for the fiscal year ended September 30, 1999 was a
discussion of matters relating to the status and other information concerning
the San Bernardino contract.
Effective as of July 26, 2000, Norcal and Norcal/San Bernardino, Inc.
("Norcal/SB" and together with Norcal, the "Norcal Parties") entered into a
settlement, expressly denying any wrongdoing or legal liability of any kind,
with San Bernardino County (the "County"), its current County Administrative
Officer and certain County-related entities (collectively the "County Parties")
to settle all of the claims asserted against the Norcal Parties in a lawsuit
filed by the County Parties on June 8, 2000 in San Bernardino County (the
"Action"). The lawsuit also includes claims unrelated to the Norcal Parties
against various other defendants, against which the Action will proceed. In the
claims against the Norcal Parties, the complaint generally also names as
additional defendants James J. Hlawek, the immediate former County
Administrative Officer, Harry M. Mays, Mr. Hlawek's predecessor as County
Administrative Officer and a former consultant to Norcal, Bio-Reclamation
Technologies, Inc., a company affiliated with Mays ("Bio-Reclamation"), and
Kenneth James Walsh, a former employee of Norcal. The County Parties' complaint
alleged against the Norcal Parties claims for breach of fiduciary duty, fraud,
unjust enrichment and constructive trust, as well as certain claims under
California statutes, including alleged violations of the Political Reform Act,
the Unfair Competition law and the False Claims Act. The complaint also alleged
that the County was entitled to restitution of all payments made to the Norcal
Parties under Norcal's 1995 contract with the County (the "1995 Contract"),
based on Section 1090 of the California Government Code, which prohibits
government officials from being "financially interested in any contract made by
them in their official capacity, or by any body or board of which they are
members," and Section 1092 of the California Government Code, which provides
that contracts violating Section 1090 "may be avoided." The complaint was based
on allegations of, inter alia, a conspiracy to influence and reward Hlawek in
connection with procuring and obtaining solid waste management work connected
with the 1995 Contract, pursuant to which Norcal operates (through Norcal/SB)
all active landfills owned by the County and is primarily responsible for
implementing the County's strategic plan concerning the County's long-term waste
disposal needs. The complaint further alleged that money was paid to Hlawek by
Mays and/or Walsh out of proceeds of payments Norcal made to Bio-Reclamation
under a consulting agreement and kickbacks Walsh allegedly received from a
Norcal/SB subcontractor.
The Norcal Parties have vigorously contested each and every claim alleged
against them. Based on its own internal investigation, Norcal believes that
Messrs. Walsh and Mays were acting purely for their own personal gain and that
no other
10
<PAGE>
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
Notes to Consolidated Financial Statements - (Continued)
employees or consultants of the Company were aware of or otherwise involved with
Messrs. Walsh's and May's illegal conduct. While the Norcal Parties believe that
they have meritorious defenses to the County Parties' claims, they also believe
that the settlement agreement is in their best interest because, among other
reasons, it resolves this litigation and thereby avoids the further investment
by the Company of significant time and expense, management distraction,
continuing adverse publicity and uncertainties inherent in litigation,
particularly where extraordinary damages are sought.
The settlement agreement, among other terms, provides for a mutual release
by the County and the Norcal Parties of all claims asserted in the Action and
various other claims and counterclaims related to the subject matter of the
Action, preserving, however, any claims that may arise out of acts occurring
after a future date specified in the settlement agreement and certain claims to
enforce obligations under the 1995 Contract. The releases generally extend, with
certain exceptions, to the parties' officers, directors, employees, agents and
others, as well as to any affiliated parties that control, are controlled by or
under common control with the parties. On July 27, 2000, the Superior Court of
the State of California entered the order required by the settlement agreement
and on August 4, 2000 the County Parties dismissed with prejudice the Action as
against the Norcal Parties. Pursuant to the settlement, Norcal has paid to the
County $6,561,000, and has agreed to pay 50% of any net proceeds of certain
claims that the Norcal Parties, or either of them, may choose, in their sole
discretion, to assert against certain other defendants in the Action. It is
Norcal's current intention to pursue these claims. The Company has recorded the
$6,561,000 settlement amount as a litigation expense for the quarterly period
ending June 30, 2000. The settlement agreement also provides that the Norcal
Parties may not bid on any successor contract with the County until five years
after the expiration of the 1995 Contract. Further, the settlement agreement
requires both the Norcal Parties and the County Parties to continue to perform
their obligations under the 1995 Contract until its final termination.
During fiscal years 1999, 1998, and 1997 and the nine months ended June 30,
2000, revenues derived from the services the Company performed in the County
were approximately $55.1 million (16% of the Company's total revenue), $65.1
million (19% of the Company's total revenue), $55.1 million (17% of the
Company's total revenue), and $22.8 million (9% of the Company's total revenue),
respectively. Revenues less direct expenses including consulting fees (excluding
allocable corporate management fees, lease charges, interest expense and the
non-cash portion of ESOP expense, and depreciation and amortization), related to
the Company's San Bernardino operations for fiscal years 1999, 1998, and 1997
and the nine months ended June 30, 2000 were approximately $6.6 million, $7.9
million, $7.4 million and $2.8 million, respectively.
Pursuant to a January 2000 amendment to the 1995 Contract, the 1995
Contract will end no later than 90 days from Norcal's receipt of written notice
of termination by the County after identification of the successful proposer
under the Request for Proposal process for a new contract, and in any event no
later than June 30, 2001. Although the Company's results of operations and cash
flows will be adversely impacted by the termination of the 1995 Contract, based
on its belief that revenues and expenses from its operations, exclusive of
San Bernardino, will remain comparable to the Company's 1999 fiscal year,
management believes that such termination will not have a material adverse
effect on the Company's financial condition or on its ability to maintain its
other operations and service its debt.*
In October 1999, the United States Attorney for the Central District of
California announced criminal indictments of Messrs. Hlawek, Mays and Walsh. All
three defendants have pled guilty to federal charges of conspiring to pay and
accept bribes to influence or reward Mr. Hlawek in connection with his official
duties. Although the United States Attorney has advised the Company that its
investigation is ongoing and that the Company is one of its targets, neither the
Company nor any of its affiliates has been charged. If the Company is charged
and held responsible for the conduct of its employee, it may become subject to
penalties and fines.
(8) Sale of Eureka Landfill and Transfer Station
In November 1999, the Company, through its subsidiary, City Garbage Company
of Eureka, entered into an agreement with Humboldt Waste Management Authority
("HWMA") pursuant to which the Company would sell the Cummings Road Landfill and
the Company's Eureka Transfer Station to HWMA. On June 16, 2000, the Company and
HWMA completed the sale of the properties. Related agreements also resolved all
outstanding disputes with the County of
11
<PAGE>
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
(a wholly owned subsidiary of the Norcal Waste Systems, Inc.
Employee Stock Ownership Plan and Trust)
Notes to Consolidated Financial Statements - (Continued)
Humboldt pertaining to the final payments due under the Solid Waste Disposal
Agreement of 1978, as amended. The Company received cash payments totaling
approximately $3.5 million from HWMA. HWMA assumed certain closure/post-closure,
corrective action and operational responsibilities with respect to the Cummings
Road Landfill for which the Company had recorded liabilities of $12.7 million.
The Company also received approximately $1.3 million from the Operator Liability
trust fund that the Company had established for the landfill. The Company
retains certain liabilities for its operation of the landfill prior to the
closing of the transaction and for defects in corrective action work performed
by the Company at the landfill prior to the closing of the transaction. The
Company transferred to HWMA its interest in the closure/post-closure trust
funds, corrective action trust fund and deposits of $15.8 million related to the
landfill and transferred other net assets of $1.7 million. The Company, as part
of the transaction with HWMA, secured franchise agreement extensions in the City
of Eureka and other areas in Humboldt County where the Company provides
collection services, to until at least December 31, 2009. The transaction
resulted in an immaterial loss to the Company.
(9) San Francisco Pension
On April 24, 1997, employees represented by the Sanitary Truck Drivers and
Helpers Union Local 350 International Brotherhood of Teamsters ("Local 350")
initiated a strike against certain San Francisco operations of the Company. The
strike was resolved on April 26, 1997 when Local 350 voted to accept a five-year
contract. A provision of the new contract related to an increase in pension
benefits. The effect of this provision has been subject to dispute between the
Company and Local 350. The Company believes that it was agreed that the increase
to certain pension benefits was to be prospective. Subsequently, Local 350
asserted that it understood the increase to be retroactive.
After further discussion with the Union on this and other matters, on June
28, 2000, the Company announced that effective October 1, 2000, the Company will
make changes to the pension benefits through plan amendments consistent with the
Local 350 interpretation of the 1997 contract. As a result of this change, the
Company estimates that the accumulated benefit obligation ("ABO") as of
September 30, 2000 will increase by an additional $9.7 million. The Company also
estimates that the increase in its annual accruals for pension and other
post-retirement costs, directly attributable to this change, will be
approximately $2.0 million. The Company believes that future increases in
expense will most likely be offset by higher revenue, if the Company is
successful in obtaining increased rates to cover the additional expense. The
Company has not determined when it will submit a rate application and the timing
and ultimate outcome of the rate application cannot be predicted with certainty.
The above estimates are based on a discount rate of 7.5%. The discount rate
applied under generally accepted accounting principles ("GAAP") fluctuates with
market conditions. A change in the discount rate can result in significant
adjustments to the ABO as well as changes in annual accruals for pension costs.
12
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements. Those statements followed by an asterisk (*)
are forward looking statements. These forward looking statements, which reflect
management's beliefs, objectives and expectations as of the date hereof, are
necessarily estimates based on the best judgment of the Company's senior
management. Any such statements should be considered in light of various risks
and uncertainties that could cause results to differ materially from
expectations, estimates or forecasts expressed. Readers are cautioned not to
place undue reliance on these forward looking statements, which speak only as of
the date of this quarterly report. The various risks and uncertainties include,
but are not limited to: changes in general economic conditions, inability to
maintain rates sufficient to cover costs, inability to obtain timely rate
increases, inability to reduce costs related to the loss of revenues, loss of
material contracts (including the loss of the Company's contract with the County
of San Bernardino), fluctuations in commodities prices, changes in environmental
regulations or related laws, inability to settle union labor contract disputes,
competition and consequences of the Company's S Corporation status. The Company
does not undertake any obligation to publicly update or release any revision to
these forward looking statements to reflect events or circumstances after the
date of this report or to reflect the occurrence of unanticipated events.
On November 21, 1995, the Company issued 12.5% Series A Senior Notes in an
aggregate principal amount of $175.0 million, for which it received proceeds,
after original issue discount, of approximately $170.2 million. The Company used
the proceeds from this offering (less certain associated expenses), together
with certain cash balances, to retire approximately $199.1 million of its then
outstanding indebtedness and certain of the ESOP's indebtedness to third
parties. Concurrent with this offering, the Company entered into a new bank
credit agreement providing for a revolving credit facility with a maximum
current availability of $82.5 million, of which up to $25.0 million may be used
for letters of credit. These transactions are collectively referred to as the
"Refinancing Transaction."
The following discussion pertains to the Company's operations for the three
and nine months ended June 30, 2000 and 1999 and should be read in conjunction
with the unaudited consolidated financial statements and related notes thereto
included elsewhere herein, and the Company's Annual Report for the fiscal year
ended September 30, 1999.
Introduction
Norcal Waste Systems, Inc. ("Norcal") and its subsidiaries (collectively
referred to herein as the "Company") provide solid waste management services
throughout California, including collection, transfer, disposal, landfill
management, recycling and other waste services. The Company operates 13
landfills in California, three of which it owns and 10 of which are owned by
local governmental entities. The Company currently serves an estimated 477,000
customers.
The Company's revenues are comprised primarily of fees charged to
residential, commercial, municipal and industrial customers for the collection
and disposal of solid waste, disposal fees (known as "tipping fees") charged to
third party waste collectors who dispose of solid waste at the Company's
transfer stations and landfills, revenues generated from the sale of recyclable
materials and fees charged to third party landfill owners for landfill
operations and solid waste systems management activities.
Operating expenses include labor, disposal fees paid to third parties,
landfill project and subcontractor costs, fuel, equipment maintenance and
rentals, engineering, consulting and other professional services and other
direct costs of operations. Also included are accruals for future landfill
closure and corrective action costs, consistent with regulatory requirements.
General and administrative expenses include management salaries, administrative
and clerical overhead, professional services costs and other fees and expenses.
ESOP compensation expense includes amounts contributed by the Company to
the ESOP to allow the ESOP to pay interest and repay principal on its
intercompany loans to the Company along with amounts to fund payments of cash
benefits to retired, terminated or withdrawing participants. The total
contributions are subject to various limitations imposed by the Internal Revenue
Code of 1986, as amended, and are generally tax deductible. The debt repayments
by the ESOP result in allocation of Company common stock to ESOP participants'
accounts pursuant to an allocation formula.
13
<PAGE>
Results of Operations
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
Summary Statements of Operations
<TABLE>
<CAPTION>
Relationship to Total Revenues
Three Months Ended Nine Months Ended
June 30, June 30,
2000 1999 2000 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues:
Collection and disposal operations 81.4% 77.7% 81.7% 77.9%
Third party landfill management services 10.9% 18.4% 11.0% 18.1%
Recycled commodities sales 7.7% 3.9% 7.3% 4.0%
----- ----- ----- -----
Total revenues 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
Cost of operations:
Operating expenses 69.9% 71.0% 69.5% 71.1%
Depreciation and amortization 6.4% 6.3% 6.7% 6.2%
ESOP compensation expense 1.2% 0.5% 1.2% 1.1%
Litigation settlement 7.4% 0.0% 2.5% 0.0%
General and administrative 10.8% 11.3% 10.8% 11.3%
----- ----- ----- ------
Total cost of operations 95.7% 89.1% 90.7% 89.7%
----- ----- ----- -----
Operating income 4.3% 10.9% 9.3% 10.3%
Interest expense -7.3% -7.4% -7.6% -7.7%
Interest income 1.4% 0.9% 1.3% 1.0%
Other income, net 0.4% 0.2% 0.6% 0.3%
----- ----- ----- -----
Income (loss) before income taxes -1.2% 4.6% 3.6% 3.9%
Income tax expense 0.0% 0.3% 0.2% 0.1%
----- ----- ----- -----
Net income (loss) -1.2% 4.3% 3.4% 3.8%
===== ===== ===== =====
</TABLE>
14
<PAGE>
The following table sets forth the dollar and percentage changes for the three
month periods ended June 30, 2000 and June 30, 1999 and the dollar and
percentage changes for the nine month periods ended June 30, 2000 and June 30,
1999:
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES
Summary Statements of Operations
<TABLE>
<CAPTION> Comparison of Comparison of
Three Month Periods Nine Month Periods
$ % $ %
------------------- ----------------------
<S> <C> <C> <C> <C>
Revenues:
Collection and disposal operations 4,590 6.8% 13,828 7.0%
Third party landfill management services -6,364 -39.6% -17,202 -37.6%
Recycled commodities sales 3,456 102.4% 8,663 85.4%
----- ----- ------- -----
Total revenues 1,682 1.9% 5,289 2.1%
----- ----- ------- -----
Cost of operations:
Operating expenses 217 0.4% -309 -0.2%
Depreciation and amortization 201 3.7% 1,395 8.8%
ESOP compensation expense 591 133.7% 225 7.8%
Litigation settlement 6,561 100.0% 6,561 100.0%
General and administrative -215 -2.2% -608 -2.1%
----- ------ ------- -----
Total cost of operations 7,355 9.5% 7,264 3.2%
------ ------ ------- -----
Operating income -5,673 -60.1% -1,975 -7.6%
Interest expense -21 0.3% -267 1.4%
Interest income 463 59.1% 961 39.5%
Other income, net 198 96.6% 512 55.2%
------ ------ ------- -----
Income (loss) before income taxes -5,033 -126.4% -769 -7.7%
Income tax expense -164 -82.4% 75 37.7%
------ ------ ------- -----
Net income (loss) -4,869 -128.7% -844 -8.7%
====== ====== ======= =====
</TABLE>
Three months ended June 30, 2000 and 1999
Revenues. Revenues for the three months ended June 30, 2000 increased $1.7
million (1.9%) to $88.9 million from $87.2 million for the three months ended
June 30, 1999. Waste collection and disposal revenues increased $4.6 million,
approximately $3.0 million due to general volume increases, $1.1 million due to
rate increases in several service areas and the remainder due to operations
acquired in the Los Angeles area. Recycled commodities sales revenues increased
$3.5 million due primarily to higher commodity prices. Third party landfill
management revenues decreased $6.4 million due primarily to a $7.7 million
decrease in project related activity in San Bernardino County due to decreases
in both the timing and scope of projects. The Company's contract with San
Bernardino County and the associated revenues will end no later than June 30,
2001. See Note 7 of Notes to Consolidated Financial Statements. These lower
project revenues were partially offset by an increase totaling $0.8 million from
an adjustment in the per ton compensation rate for landfill operations in San
Bernardino and revenues of $0.7 million from waste tire remediation projects.
Operating Expenses. Operating expenses for the three months ended June 30,
2000 increased $0.2 million (0.4%) to $62.1 million from $61.9 million for the
three months ended June 30, 1999. As a percentage of revenues, operating
expenses decreased to 69.9% for the three months ended June 30, 2000 from 71.0%
for the three months ended June 30, 1999. Payroll
15
<PAGE>
costs increased $2.7 million due to scheduled union wage increases, recycling
purchasing costs increased $1.6 million due primarily to higher commodity
prices, professional services increased $1.3 million due primarily to on-going
legal matters in San Bernardino County, disposal costs increased $0.5 million
due primarily to increased volumes and fuel costs increased $0.5 million due to
higher prices. These increased costs were partially offset by lower project and
subcontractor related costs of $6.4 million, primarily as a result of decreased
activity in San Bernardino County, described above.
ESOP Compensation Expense. ESOP compensation expense is primarily based on
the cost of shares allocated as determined by the Company's contribution to the
ESOP to allow the ESOP to pay interest on its intercompany loans, along with
contributions to fund payments of cash benefits to retired, terminated and
withdrawing participants. ESOP compensation expense for the three months ended
June 30, 2000 increased $0.6 million (133.7%) to $1.0 million from $0.4 million
for the three months ended June 30, 1999. The increase in expense can be
attributed to an increase in contributions made to fund payments of cash
benefits. In addition, changes in contributions were made to the ESOP, based
upon a revised payment schedule, which was adopted in the third quarter of the
Company's 1999 fiscal year as a result of the Company's S Corporation election,
which resulted in the recognition of the full year expense for fiscal year 1999
as of December 31, 1998.
Litigation Settlement Expense. The Company recorded an expense of $6.6
million under terms of a settlement agreement reached between San Bernardino
County and the Company for litigation initiated by the County in June 2000. See
Note 7 of Notes to Consolidated Financial Statements.
Operating Income. Operating income decreased $5.7 million (60.1%) to $3.8
million for the three months ended June 30, 2000 from $9.4 million for the three
months ended June 30, 1999. As a percentage of revenues, operating income
decreased to 4.3% for the three months ended June 30, 2000 from 10.9% for the
three months ended June 30, 1999. The primary cause of the decrease in operating
income for the three months ended June 30, 2000 was the litigation settlement
expense of $6.6 million described above.
Interest Income. Interest income for the three months ended June 30, 2000
increased $0.5 million (59.1%) to $1.2 million from $0.7 million for the three
months ended June 30, 1999. The increase is due to additional interest earned on
higher cash balances in the current period.
Net Loss. The Company recorded a net loss of $1.1 million for the three
months ended June 30, 2000 due to lower operating income resulting from the
litigation settlement expense of $6.6 million described above.
Nine months ended June 30, 2000 and 1999
Revenues. Revenues for the nine months ended June 30, 2000 increased $5.3
million (2.1%) to $258.6 million from $253.3 million for the nine months ended
June 30, 1999. Waste collection and disposal revenues increased $13.8 million,
approximately $9.1 million due to general volume increases, $3.0 million due to
rate increases in several service areas and the remainder due to operations
acquired in the Los Angeles area in October and November 1998. Recycled
commodities sales revenues increased $8.7 million due primarily to higher
commodity prices. Third party landfill management revenues decreased $17.2
million due to a $20.4 million decrease in project related activity in San
Bernardino County as a result of decreases in both the timing and scope of
projects. The Company's contract with San Bernardino County and the associated
revenues will end no later than June 30, 2001. See Note 7 of Notes to
Consolidated Financial Statements. These lower project revenues were partially
offset by revenues of $3.0 million from waste tire remediation projects.
Operating Expenses. Operating expenses for the nine months ended June 30,
2000 decreased $0.3 million (0.2%) to $179.8 million from $180.1 million for the
nine months ended June 31, 1999. As a percentage of revenues, operating expenses
decreased to 69.5% for the nine months ended June 30, 2000 from 71.1% for the
nine months ended June 30, 1999. Project and subcontractor related costs
decreased $14.3 million, primarily as a result of decreased activity in San
Bernardino County described above. Landfill operating expenses decreased $0.7
million in San Bernardino due primarily to reduced operations from the loss of
tonnage from the city of Ontario, which signed a long-term disposal agreement
with a third party landfill effective January 1, 1999. These decreased costs
were partially offset by higher payroll costs of $7.1 million due to scheduled
union wage increases, increased recycling purchasing costs of $4.0 million due
primarily to higher commodity purchase prices, higher disposal costs of $2.6
million due primarily to increased volumes and increased fuel costs of $1.4
million due to higher prices.
16
<PAGE>
Depreciation and Amortization. Depreciation and amortization increased $1.4
million (8.8%) to $17.2 million for the nine months ended June 30, 2000 from
$15.8 million for the nine months ended June 30, 1999. As a percentage of
revenues, depreciation and amortization increased to 6.7% for the nine months
ended June 30, 2000 from 6.2% for the nine months ended June 30, 1999. The
primary causes of the increase in depreciation and amortization for the nine
months ended June 30, 2000 was higher capital expenditures in the previous year
and the acceleration of amortization for certain intangible assets in San
Bernardino in the current period. As a consequence of increased capital
expenditures, the Company contemplates increased depreciation expense.*
Litigation Settlement Expense. The Company recorded an expense of $6.6
million under terms of a settlement agreement reached between San Bernardino
County and the Company for litigation initiated by the County in June 2000. See
Note 7 of Notes to Consolidated Financial Statements.
Operating Income. Operating income decreased $1.9 million (7.6%) to $24.1
million for the nine months ended June 30, 2000 from $26.0 million for the nine
months ended June 30, 1999. As a percentage of revenues, operating income
decreased to 9.3% for the nine months ended June 30, 2000 from 10.3% for the
nine months ended June 30, 1999. The primary cause of the decrease in operating
income for the nine months ended June 30, 2000 was the litigation settlement
expense of $6.6 million described above. This settlement accrual more than
offset higher collection and disposal volumes and recycling revenues, partially
offset by lower earnings from third party landfill management services described
above.
Interest Income. Interest income for the nine months ended June 30, 2000
increased $1.0 million (39.5%) to $3.4 million from $2.4 million for the nine
months ended June 30, 1999. The increase is due to additional interest earned on
higher cash balances in the current period.
Income Tax Expense. The Company experienced an effective rate of 2.0% for
the nine months ended June 30, 2000 based primarily on the state tax rate of
1.5% for S Corporations. The Company experienced an effective rate of 2.0% for
the nine months ended June 30, 1999 as a result of the Company's S Corporation
election, effective October 1, 1998 and anticipated results of operations from
the Company's four subsidiaries that did not elect to become divisions of the S
Corporation.
Net Income. Net income decreased $0.8 million to $8.9 million for the nine
months ended June 30, 2000 from $9.7 million for the nine months ended June 30,
1999. The decrease in net income for the nine months ended June 30, 2000 was due
to the litigation settlement expense described above partially offset by higher
interest income described above.
Liquidity and Capital Resources
The Company's cash requirements consist principally of working capital
requirements, interest on outstanding indebtedness, capital expenditures and
deposits to trust funds to satisfy certain environmental statutes and
regulations. The Company had working capital of $50.2 million at June 30, 2000
compared to $29.9 million at September 30, 1999.
As part of the Refinancing Transaction the Company entered into the Credit
Agreement which currently provides for up to $82.5 million of additional
borrowings (which maximum amount may be reduced by $2.5 million per calendar
quarter) and which, subject to certain limitations and covenant restrictions
(including financial ratios), can be drawn by the Company to fund ongoing
operations, invest in capital equipment and/or facilities and to finance
acquisitions. The Credit Agreement expires in November 2000. At June 30, 2000,
the Company had utilized $2.3 million of the credit facility provided by the
Credit Agreement for letters of credit and had availability under the Credit
Agreement of approximately $44.3 million for borrowings unrelated to letters of
credit, with an additional $22.7 million available for letters of credit.
Changes in availability under the Credit Agreement are a function of changes in
operating results, among other things. In addition, certain covenant measures
become more restrictive over time.
17
<PAGE>
The Indenture governing the Senior Notes contains provisions which, among
other things, (i) limit the Company's and its subsidiaries' ability to declare
or pay dividends or other distributions (other than dividends or distributions
payable to Norcal or any wholly owned subsidiary of Norcal or, in certain cases,
the ESOP), (ii) limit the purchase, redemption or retirement of capital stock
and (iii) limit the incurrence of certain additional debt.
The Senior Notes mature in November 2005. As of June 30, 2000, interest on
the Senior Notes accrued at the rate of 13.5% per annum. However, the interest
rate on the Senior Notes is subject to decrease to 12.5% at such time the
Company (in one or more transactions) offers to purchase (whether or not any
actual purchases are made) or redeems an aggregate of $25.0 million in principal
amount of Senior Notes out of the proceeds of equity sales.
Commencing November 15, 2000, the Senior Notes are redeemable in whole or
in part at the Company's option, upon not less than 30 nor more than 60 days'
notice. Any such voluntary redemptions by the Company through November 14, 2003
will include a redemption premium payment that declines annually over such
period. For any redemptions made by the Company during the period commencing
November 15, 2000 through November 14, 2001, the redemption price, expressed as
a percentage of the principal amount of Senior Notes redeemed, is 106.25%, plus
accrued and unpaid interest to the applicable redemption date.
Cash Flow from Operating Activities. Cash provided by operating activities
was $33.9 million for the nine months ended June 30, 2000 compared to $25.1
million for the same period last year. The increase in cash provided from
operating activities was primarily due to the absence of cash contributions to
pension plans in the current period and reductions in accounts receivable from
the County of San Bernardino due to reduced project activity. During the nine
months ended June 30, 1999, the Company contributed $5.1 million to the
Company's pension plans to execute certain tax planning strategies.
Additionally, on June 16, 2000, the Company received approximately $1.3 million
from the Operator Liability trust fund concurrent with the sale of the Cummings
Road Landfill. See Note 8 of Notes to Consolidated Financial Statements.
Cash Flow from Investing Activities. Cash used in investing activities was
$12.7 million for the nine months ended June 30, 2000 compared to cash used of
$34.6 million for the same period last year. During the current period, the
Company used $15.0 million on capital expenditures, primarily vehicles,
containers and other equipment compared to $25.8 million for similar equipment
in the same period last year. In October and November 1998, the Company also
used $9.9 million to purchase the stock of one solid waste collection company
and substantially all of the assets of two other solid waste collection
companies in Southern California. In June 2000, the Company completed the sale
of its landfill and transfer station in Eureka, California from which it
received cash proceeds of approximately $3.5 million. See Note 8 of Notes to
Consolidated Financial Statements.
Cash Flow from Financing Activities. Cash used in financing activities was
$0.8 million for the nine months ended June 30, 2000 compared to $1.4 million
for the nine months ended June 30, 1999. Activity in both periods consisted
primarily of scheduled note and capital lease payments.
Certain Other Cash Requirements. The Company is in discussions with the
City of San Francisco regarding plans for increased diversion of waste from
disposal at landfills as well as the construction and/or relocation of materials
recovery and other facilities for use in connection with the Company's San
Francisco operations and to facilitate compliance with mandated recycling
requirements. The Company cannot predict the timing or outcome of these
discussions. Over the term of the Senior Notes, the Company may need to invest
substantial capital to acquire or construct waste processing facilities,
household hazardous waste facilities, maintenance and administrative complexes,
and equipment.* The Company intends to seek continued rate recovery for amounts
expended on any projects and may seek to finance such capital expenditures
through additional secured borrowings, including up to $30.0 million of
borrowing for certain "Designated Capital Expenditures" (as defined in the
Indenture).* On August 4, 2000, under terms of the settlement agreement with San
Bernardino County, the Company paid approximately $6.6 million to San Bernardino
County. See Note 7 of Notes to Consolidated Financial Statements.
18
<PAGE>
Environmental Regulations
The Company's business activities are subject to extensive and evolving
regulation under complex federal, state and local laws for the protection of
public health and the environment. These laws, and the numerous regulatory
bodies responsible for interpreting and enforcing them, impose significant
restrictions and requirements on the Company and also impact the municipalities
the Company serves and operators of non-owned landfills used by the Company. The
Company believes that this regulation will continue in the future.*
Various federal and state regulations require owners or operators of solid
waste landfill sites to provide financial assurances for the closure and
post-closure monitoring and maintenance of these sites. The Company uses
independent engineers to assist it in assessing the estimates of future costs of
complying with such regulations. A significant portion of the landfill closure
and post-closure liability relates to the leachate and groundwater management
and remediation. There are many unknown and uncertain factors including
regulatory requirements, incomplete data with respect to projected volumes,
quality and cost of treatment among others. Accordingly, estimates for closure
and post-closure management and remediation of leachate and contaminated
groundwater could be subject to periodic and substantial revision as the
Company's knowledge increases concerning these factors.
Inflation
Historically, the Company has experienced cost increases due to the effects
of inflation on its operating expenses, particularly the cost of compensation
and benefits, and the replacement of or additions to property and equipment.
Fuel costs which fluctuate with inflation and other market conditions may also
affect operating results. Most of the Company's operations are subject to rate
setting processes which allow for the recovery of certain costs including labor
and fuel. However, inflationary increases in operating costs may cause the
Company to incur lower operating margins, at least until such time as new rates
can be implemented. Rate adjustments, if approved, can take several months.
Due to the Company's concentration in California, cyclical economic
conditions in California will have an impact on the Company's results.* A
significant economic downturn in California could have an adverse impact on the
Company's results of operations.*
San Francisco Pension
On April 24, 1997, employees represented by the Sanitary Truck Drivers and
Helpers Union Local 350 International Brotherhood of Teamsters ("Local 350")
initiated a strike against certain San Francisco operations of the Company. The
strike was resolved on April 26, 1997 when Local 350 voted to accept a five-year
contract. A provision of the new contract related to an increase in pension
benefits. The effect of the provision has been subject to dispute between the
Company and Local 350. The Company believes that it was agreed that the increase
to certain pension benefits was to be prospective.
On June 28, 2000, the Company announced that effective October 1, 2000, the
Company will make changes to the pension benefits through plan amendments
consistent with the Local 350 interpretation of the 1997 contract. As a result
of this change, the Company estimates that the accumulated benefit obligation
("ABO") as of September 30, 2000 will increase by an additional $9.7 million.
The Company also estimates that the increase in its annual accruals for pension
and other post-retirement costs, directly attributable to this change, will be
19
<PAGE>
approximately $2.0 million. The Company believes that future increases in
expense will most likely be offset by higher revenue, if the Company is
successful in obtaining increased rates to cover the additional expense. The
Company has not determined when it will submit a rate application and the timing
and ultimate outcome of the rate application cannot be predicted with certainty.
The above estimates are based on a discount rate of 7.5%. The discount rate
applied under generally accepted accounting principles ("GAAP") fluctuates with
market conditions. A change in the discount rate can result in significant
adjustments to the ABO as well as changes in annual accruals for pension costs.
San Bernardino Contract
Effective as of July 26, 2000, Norcal and Norcal/San Bernardino, Inc.
("Norcal/SB" and together with Norcal, the "Norcal Parties") entered into a
settlement, expressly denying any wrongdoing or legal liability of any kind,
with San Bernardino County (the "County"), its current County Administrative
Officer and certain County-related entities (collectively the "County Parties")
to settle all of the claims asserted against the Norcal Parties in a lawsuit
filed by the County Parties on June 8, 2000 in San Bernardino County (the
"Action"). The lawsuit also includes claims unrelated to the Norcal Parties
against various other defendants, against which the Action will proceed. In the
claims against the Norcal Parties, the complaint generally also names as
additional defendants James J. Hlawek, the immediate former County
Administrative Officer, Harry M. Mays, Mr. Hlawek's predecessor as County
Administrative Officer and a former consultant to Norcal, Bio-Reclamation
Technologies, Inc., a company affiliated with Mays ("Bio-Reclamation"), and
Kenneth James Walsh, a former employee of Norcal. The County Parties' complaint
alleged against the Norcal Parties claims for breach of fiduciary duty, fraud,
unjust enrichment and constructive trust, as well as certain claims under
California statutes, including alleged violations of the Political Reform Act,
the Unfair Competition law and the False Claims Act. The complaint also alleged
that the County was entitled to restitution of all payments made to the Norcal
Parties under Norcal's 1995 contract with the County (the "1995 Contract"),
based on Section 1090 of the California Government Code, which prohibits
government officials from being "financially interested in any contract made by
them in their official capacity, or by any body or board of which they are
members," and Section 1092 of the California Government Code, which provides
that contracts violating Section 1090 "may be avoided." The complaint was based
on allegations of, inter alia, a conspiracy to influence and reward Hlawek in
connection with procuring and obtaining solid waste management work connected
with the 1995 Contract, pursuant to which Norcal operates (through Norcal/SB)
all active landfills owned by the County and is primarily responsible for
implementing the County's strategic plan concerning the County's long-term waste
disposal needs. The complaint further alleged that money was paid to Hlawek by
Mays and/or Walsh out of proceeds of payments Norcal made to Bio-Reclamation
under a consulting agreement and kickbacks Walsh allegedly received from a
Norcal/SB subcontractor.
The Norcal Parties have vigorously contested each and every claim alleged
against them. Based on its own internal investigation, Norcal believes that
Messrs. Walsh and Mays were acting purely for their own personal gain and that
no other employees or consultants of the Company were aware of or otherwise
involved with Messrs. Walsh's and May's illegal conduct. While the Norcal
Parties believe that they have meritorious defenses to the County Parties'
claims, they also believe that the settlement agreement is in their best
interest because, among other reasons, it resolves this litigation and thereby
avoids the further investment by the Company of significant time and expense,
management distraction, continuing adverse publicity and uncertainties inherent
in litigation, particularly where extraordinary damages are sought.
The settlement agreement, among other terms, provides for a mutual release
by the County and the Norcal Parties of all claims asserted in the Action and
various other claims and counterclaims related to the subject matter of the
Action, preserving, however, any claims that may arise out of acts occurring
after a future date specified in the settlement agreement and certain claims to
enforce obligations under the 1995 Contract. The releases generally extend, with
certain exceptions, to the parties' officers, directors, employees, agents and
others, as well as to any affiliated parties that control, are controlled by or
under common control with the parties. On July 27, 2000, the Superior Court of
the State of California entered the order required by the settlement agreement
and on August 4, 2000 the County Parties dismissed with prejudice the Action as
against the Norcal Parties. Pursuant to the settlement, Norcal has paid to the
County $6,561,000, and has agreed to pay 50% of any net proceeds of certain
claims that the Norcal Parties, or either of them, may choose, in their sole
discretion, to assert against certain other defendants in the Action. It is
Norcal's current intention to pursue these claims. The Company has recorded the
$6,561,000 settlement amount as a litigation expense for the quarterly period
ending June 30, 2000. The settlement agreement also provides that the Norcal
Parties may not bid on any successor contract with the County until five years
after the expiration of the 1995 Contract. Further, the settlement agreement
requires both the Norcal Parties and the County Parties to continue to perform
their obligations under the 1995 Contract until its final termination.
20
<PAGE>
During fiscal years 1999, 1998, and 1997 and the nine months ended June 30,
2000, revenues derived from the services the Company performed in the County
were approximately $55.1 million (16% of the Company's total revenue), $65.1
million (19% of the Company's total revenue), $55.1 million (17% of the
Company's total revenue), and $22.8 million (9% of the Company's total revenue),
respectively. Revenues less direct expenses including consulting fees (excluding
allocable corporate management fees, lease charges, interest expense and the
non-cash portion of ESOP expense, and depreciation and amortization), related to
the Company's San Bernardino operations for fiscal years 1999, 1998, and 1997
and the nine months ended June 30, 2000 were approximately $6.6 million, $7.9
million, $7.4 million and $2.8 million, respectively.
Pursuant to a January 2000 amendment to the 1995 Contract, the 1995
Contract will end no later than 90 days from Norcal's receipt of written notice
of termination by the County after identification of the successful proposer
under the Request for Proposal process for a new contract, and in any event no
later than June 30, 2001. Although the Company's results of operations and cash
flows will be adversely impacted by the termination of the 1995 Contract, based
on its belief that revenues and expenses from its operations, exclusive of
San Bernardino, will remain comparable to the Company's 1999 fiscal year,
management believes that such termination will not have a material adverse
effect on the Company's financial condition or on its ability to maintain its
other operations and service its debt.*
In October 1999, the United States Attorney for the Central District of
California announced criminal indictments of Messrs. Hlawek, Mays and Walsh. All
three defendants have pled guilty to federal charges of conspiring to pay and
accept bribes to influence or reward Mr. Hlawek in connection with his official
duties. Although the United States Attorney has advised the Company that its
investigation is ongoing and that the Company is one of its targets, neither the
Company nor any of its affiliates has been charged. If the Company is charged
and held responsible for the conduct of its employee, it may become subject to
penalties and fines.
Seasonality
The Company's revenues tend to be higher during the second half of its
fiscal year due to increased volume at the Company's transfer stations, waste
collection, and landfill operations than during fall and winter (first and
second fiscal quarters) when lower volumes of certain types of waste, such as
construction and demolition debris are generated.* Unusual changes in weather
patterns can also affect the operating results on a quarter to quarter basis.
Industry Developments
The Company's solid waste collection income is largely derived from
providing services pursuant to exclusive arrangements with local governments. In
C&A Carbone, Inc. v. Town of Clarkstown, 511 U.S. 383 (1994), the United States
Supreme Court first cast some doubt on the validity of exclusive solid waste
collection arrangements under the Commerce Clause of the United States
Constitution. In the six years since Carbone, the lower federal courts that have
considered the constitutionality of exclusive collection arrangements under
Carbone and generally rejected constitutional challenges to exclusive collection
arrangements. On May 31, 2000, the Sixth Circuit Court of Appeals entered a
decision at odds with this general trend. In Huish Detergents, Inc. v. Warren
County, 214 F.3d 707 (6th Cir. 2000), the Sixth Circuit became the first federal
appellate court to suggest that Carbone rendered exclusive collection
arrangements unconstitutional. Although the Huish court did not actually
invalidate the exclusive collection arrangement under consideration, it
expressly noted that the logic of Carbone would appear to require this result.
All of the Company's exclusive collection arrangements are located in
California, which is located within the Ninth federal appellate circuit. The
impact of Carbone on exclusive collection arrangements has never been ruled upon
by the Ninth Circuit Court of Appeals or a California state appellate court.
Should a California state appellate court or the Ninth Circuit Court of Appeals
adopt the reasoning of the Huish decision, it could result in the invalidation
of the Company's exclusive solid waste collection arrangements with local
governments. Whether such a decision will ever be rendered by the Ninth Circuit
or the California Court of Appeals and the impact of such a decision, if any,
cannot be predicted at this time. In the event of a ruling delivered by such
courts invalidating exclusive collection arrangements, the Company would no
longer be able to rely on those arrangements to exclude its competitors from
solid waste collection in the communities it currently serves under those
arrangements, but such a judicial ruling would also open other communities
currently having exclusive arrangements with the Company's competitors.
Accounting and Other Matters
The Internal Revenue Service is auditing the Company's income tax returns
for the fiscal years ended September 30, 1995 through 1997. The California
Franchise Tax Board is auditing the Company's state income tax returns for the
fiscal years ended September 30, 1993 though 1997.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133, as amended by SFAS No. 137,
establishes accounting and reporting standards for derivative financial
instruments and hedging activities related to those instruments, as well as
other hedging activities. Because the Company does not currently hold any
derivative instruments and does not engage in hedging activities, the Company
expects that the adoption of SFAS No. 133, as amended, will not have a material
impact on its cash flows, results of operations or financial position. SFAS No.
133, as amended, is effective for fiscal periods beginning after June 15, 2000.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements", as amended by SAB 101A, which provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements filed with the
SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue
and provides guidance for disclosures related to revenue recognition policies.
In June 2000, the SEC issued SAB 101B which deferred the effective date of SAB
101 until the last quarter of fiscal years beginning after December 15, 1999.
The Company does not expect the adoption of SAB 101, as amended, to have a
material effect on its cash flows, results of operations or financial position.
21
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In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25". This Interpretation clarifies the application of Opinion 25 for
certain issues: (a) the definition of employee for purposes of applying Opinion
25, (b) the criteria for determining whether a plan qualifies as a
noncompensatory plan, (c) the accounting consequence of various modifications to
the terms of a previously fixed stock option or award, and (d) the accounting
for an exchange of stock compensation awards in a business combination.
Generally, this Interpretation is effective July 1, 2000. The Company does not
expect the adoption of Interpretation No. 44 to have a material effect on its
cash flows, results of operations or financial position.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
None
22
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
San Francisco Pension.
See Note 9 of Notes to Consolidated Financial Statements in Part 1
hereof and incorporated herein by reference.
San Bernardino Contract.
See Note 7 of Notes to Consolidated Financial Statements in Part 1
hereof and incorporated herein by reference.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
On April 27, 2000, the Administrative Committee of the Norcal Waste
Systems, Inc. Employee Stock Ownership Plan, representing the ESOP as
the Company's sole shareholder, approved the amendment of the Norcal
Waste Systems, Inc. 1996 Non-Employee Director Stock Option Plan
("Non-Employee Director Plan"). The amendment provides for an
increase of 150,000 shares available under the Non-Employee Director
Plan by transfer of 150,00 shares from the 1996 Employee Stock
Incentive Plan.
Item 5. Other Information
None
Item 6. Exhibits and Certain Reports
(a) Exhibits:
10.51 Settlement Agreement, dated July 25, 2000 (Incorporated by reference
to exhibit 99.1 to the Company's Current Report, filed July 26, 2000)
27.0 Financial Data Schedule (EDGAR version only)
(b) Reports on Form 8-K:
On July 26, 2000, the Company filed a current report relating to the
settlement of litigation between San Bernardino County and the Company.
23
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SIGNATURES
NORCAL WASTE SYSTEMS, INC.
(Company)
/s/ Mark R. Lomele
------------------
Mark R. Lomele
Senior Vice President and
Chief Financial Officer
Dated: August 11, 2000
24
