ITEM 1. BUSINESS
FORWARD LOOKING INFORMATION
Those statements followed by an asterisk (*) may be perceived to be forward looking statements. 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. The various risks and uncertainties described below in "Risk Factors" and elsewhere in this Annual Report 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 San Bernardino County), fluctuations in commodities prices, changes in environmental regulations or related laws, inability to settle union labor contract disputes, competition, failure to achieve Year 2000 compliance and consequences of the Company's S Corporation election. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on its behalf.
HISTORY AND CERTAIN RECENT DEVELOPMENTS
Norcal Waste Systems, Inc. ("Norcal" or the "Company"), a California corporation, is a vertically integrated waste management company. Norcal provides services to approximately 408,000 residential and 58,000 commercial and industrial customers (as of September 30, 1999) throughout the State of California through 22 operating subsidiaries. The Company's principal activities include refuse collection, recycling and other waste diversion, transfer station and hauling operations, and management of both Company-owned and third party-owned landfills.
The Company traces its roots to the 1920s and, pursuant to a City of San Francisco Ordinance enacted in 1932 (the "Ordinance"), has provided substantially all of the residential and commercial refuse collection in San Francisco since that time. In 1987, the Company's two predecessors merged to form the Company. The Company currently provides waste management services to 50 cities and counties throughout California. The Company operates 14 landfills in California, four of which it owns, and operates 12 transfer stations, six of which it owns, and three material recovery facilities ("MRFs"). Norcal is currently 100% owned by an employee stock ownership plan (the "ESOP").
On November 21, 1995, Norcal issued 12 1/2% Series A Senior Notes ("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 "Offering"). The Company used the proceeds from the 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 the Offering, the Company entered into a new bank credit agreement providing for a revolving credit facility with maximum current availability of $90 million (which maximum amount may be reduced by $2.5 million per quarter), of which up to $25.0 million may be utilized for letters of credit (such credit agreement, as amended, is hereafter referred to as the "Credit Agreement"). The financing provided by the Offering and the Credit Agreement together with the transactions effected through the application of the initial proceeds thereof, are collectively referred to herein as the "Refinancing." The Credit Agreement was amended in November 1996 primarily to provide additional flexibility under the financial covenants contained therein and increase the Company's ability to incur certain types of additional debt (including indebtedness incurred in connection with acquisitions). As of September 30, 1999, the Company had utilized $2.3 million for letters of credit and had availability under the Credit Agreement of approximately $52.9 million, 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 in the Credit Agreement become more restrictive over time. Applying the more
restrictive covenant measures in effect beginning December 31, 1999 to the Company's estimated results of operations for the twelve month period ending December 31, 1999 would result in a decrease in availability under the Credit Agreement of approximately $4.4 million.* The Company's performance relative to the covenant measures is calculated on a quarterly basis.
In September 1996, the Company exchanged all of the outstanding Series A Senior Notes for an identical principal amount of 12 1/2% Series B Senior Notes (the "Senior Notes") registered under the Securities Act of 1933.
The Company currently operates seven landfills, six transfer stations and six community collection centers in San Bernardino County. Since November 1, 1995, with the concurrence of San Bernardino County's Waste System Division, the Company has closed ten of the County's landfills, thereby concentrating the allocation of the County's waste stream among the seven remaining landfills. The San Bernardino County Board of Supervisors has directed the County's Chief Administrative Officer to negotiate an amendment to end its agreement with the Company. For further information see "Item 1. Business -- Landfills -- Operated Landfills -- San Bernardino County."
The Company employs approximately 1,400 employees under union contracts. The Company completed the acquisition of the assets of two small medical waste companies during 1997. In October and November 1998, the Company completed the acquisition of a waste collection company and the acquisitions of the assets of two other waste collection companies in the Los Angeles metropolitan area.
COLLECTION OPERATIONS
The Company provides refuse collection services to residential, commercial and industrial customers in California. Residential customers accounted for approximately 41% of the Company's refuse collection revenues in fiscal year 1999, and commercial and industrial customers accounted for the remaining 59%.
Services to residential customers are typically provided pursuant to municipal contracts or franchises that obligate the Company to collect from all residences in a specified area. At inception, these contracts typically extend for 5 to 20 years. As of September 30, 1999, the Company had 37 franchise agreements with municipalities and served many additional customers through operating contracts.
Commercial services are typically provided under contracts ranging from 1 to 3 years while contracts for the larger "roll-off" container services may provide for either temporary or longer-term services. Fees are negotiated with each customer and are determined by such factors as frequency of collection, type and size of equipment furnished, and the type and volume or weight of the waste collected.
San Francisco Operations. Since 1932, the Company has provided solid waste collection and recycling in San Francisco pursuant to the Ordinance, which provides that, with limited exceptions, only a collector that has been granted a permit for a specified route may collect or transport solid waste on that route. The Company's principal operating subsidiaries have held the only permits for substantially all the routes subject to the Ordinance since 1932, which routes serve virtually all of San Francisco. San Francisco operations represent the single largest portion of the Company's business, accounting for approximately 174,000 of its customers and approximately 39% of its total revenues for fiscal year 1999. The Ordinance permits refuse with "commercial value" (as defined in the Ordinance and interpreted by the courts) to be collected without a permit. In addition, debris boxes at construction sites do not require a permit under the Ordinance. The Company competes for the placement of boxes at construction sites and the collection of refuse with commercial value. Collection of refuse from state agencies is also subject to competition.
The Company's San Francisco permits continue until terminated under the provisions of the Ordinance. Termination, or the award of permits to a competitor, could occur if, among other things,
the Company was to provide inadequate service. None of the Company's permits has been terminated since their initial grant in 1932. A vote to repeal or amend the Ordinance could also adversely affect the status of the Company's permits. The Company defeated two initiatives placed on the San Francisco ballot in 1993 and 1994 that, if enacted, would have repealed or amended the Ordinance and opened residential and commercial refuse collection to competition. See "Risk Factors -- Changes in Legislation and Political Uncertainty -- Ballot Initiatives Affecting Ordinance."
If a similar initiative passes in the future, the Company believes that although a portion of the Company's operations may be immediately affected, California statutory law would not allow the Company to be completely displaced by another exclusive waste collection provider for five years unless a buy-out arrangement were reached between the Company and San Francisco on mutually satisfactory terms or the permits were terminated pursuant to the existing provisions of the Ordinance. Furthermore, the Company believes it would be difficult to create an alternative to its transfer station anywhere in or around San Francisco because of community resistance, permitting requirements and the requirements of the California Environmental Quality Act. See "Risk Factors -- Changes in Legislation and Political Uncertainty -- Potential Flow Control Legislation."
The Company currently deposits solid waste collected in San Francisco at an independently owned landfill at favorable rates. These rates are set by an agreement between San Francisco, the Company and the third party owner of the landfill, and are subject to annual increases for inflation and regulatory costs. This agreement is one of several agreements to which the Company is a party (the "Waste Disposal Agreements") relating to certain operations in San Francisco that clarify the relationships among the City and County of San Francisco, the Company and the third-party owner of the landfill at which all non-hazardous solid waste collected in San Francisco is deposited. The Waste Disposal Agreements continue until the earlier of the year 2053 or the deposit of 15 million tons of waste in the landfill. Although estimates are uncertain, the Company believes, based on historical disposal volumes, the Waste Disposal Agreements are expected to remain in force until at least 2010.*
Franchise and Other Agreements. Outside of San Francisco, the Company provides most collection services pursuant to franchise and other agreements with local governmental entities that obligate the Company to collect from all residences and, often, commercial establishments within a specified area. Such agreements typically grant near-exclusivity, although some expressly allow limited activities by others, such as residential self-hauling and recycling by charitable or non-profit organizations. Certain agreements allow competition for specified categories of commercial waste such as construction debris. A local governmental entity may enter into multiple franchise or other agreements with different collection companies, each covering a distinct territory within its jurisdiction. The Company has multiple agreements with certain governmental entities, in some cases representing the entity's entire jurisdiction and in other cases representing only part of that entity's jurisdiction. The Company's collection agreements typically contain general indemnifications by the applicable operating subsidiary of the Company, as well as, in some cases, indemnification obligations with respect to costs and damages arising from hazardous waste.
At inception, the Company's franchise and other agreements relating to its collection operations typically have terms of between five and 20 years. Although the Company's franchise and other agreements generally provide for termination under specified circumstances, such as failure to provide adequate and continuous service, failure to comply with applicable laws, or insolvency or bankruptcy, the Company has never had an agreement terminated for such causes. For fiscal year 1999, approximately 77% of the Company's collection revenues, excluding San Francisco operations, were generated under franchise and other agreements with remaining terms of five years or more. In the past ten years, the Company has been successful in renewing or extending substantially all of its franchise and other agreements. In light of increasing competitive pressure in the waste industry, and the risks of competitive bidding, there can be no assurance that the Company will be able to renew existing franchise and other agreements, or that such franchise and other agreements will yield levels of profit consistent with past levels.* See "Risk Factors."
Changes in state or local laws could also terminate the exclusivity of these agreements or otherwise subject the Company to greater competition in its collection activities. Under California law, counties may be required to conduct competitive bidding upon the expiration of collection franchise agreements, although under certain conditions counties may extend existing franchise agreements for one additional term (not to exceed 25 years) without such bidding. The majority of the Company's franchise agreements are with municipalities other than counties and are unaffected by this law. However, any laws enacted in the future requiring competitive bidding could have a material adverse effect on the Company's financial condition or results of operations.* In addition, a California Court of Appeal ruled in 1994 that state facilities such as state universities and other schools, correctional facilities, office buildings and parks are free to conduct competitive bidding despite exclusive franchises granted under local ordinances. See "Risk Factors -- Changes in Legislation and Political Uncertainty -- Potential Competitive Bidding."
Rates. Refuse collection customers pay a single rate that is designed to cover not only collection services, but all the services the Company performs as to the material it collects, including transfer, landfill disposal and recycling. In most jurisdictions, rate boards, city councils or other local governmental agencies are authorized to set the rates the Company may charge at a level that allows the Company to recover projected specified costs and realize a profit margin. Such specified costs generally include all direct operating costs, such as direct collection costs (such as personnel and equipment); any applicable recycling costs; operating costs or tipping fees for transfer stations, landfills and other facilities; interest charged on leases; depreciation; trust fund obligations associated with closure and maintenance of landfills; and other costs. In San Francisco, the Ordinance prescribes an involved rate-setting procedure under which a rate board determines rates for residential customers.
The Company generally applies for rate increases every one to three years in each of its franchise areas to reflect changes in its costs of providing services. Although rate increases have generally been satisfactory, at times the Company has not succeeded in fully coordinating the timing and amount of rate increases with increases in its expenses or capital expenditures or has not succeeded in obtaining rate increases to cover increased costs, including ESOP and other corporate-related costs, resulting in reduced margins. Some of the Company's franchise agreements provide for inflation-based adjustments to a negotiated rate. The negotiated rates may be adjusted for specific regulatory and certain other cost increases. See "Risk Factors -- Changes in Legislation and Political Uncertainty -- Problems in Rate-Setting Process" and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Outside of San Francisco, commercial and industrial fees are generally regulated by local governments and vary from customer to customer depending on such factors as frequency of collection, volume or weight of waste, type of equipment furnished by the Company, and distance from the customer site to the Company's disposal facility. Although rates for commercial and industrial customers in San Francisco are subject to negotiation and are not directly regulated, historically the Company's practice has been to raise these rates consistent with percentage increases in residential rates.
Recycling and Waste Diversion. The Company provides a variety of recycling services, including material recovery services and other waste diversion services (collectively, "recycling services"), under arrangements with various local governments and directly with commercial customers. At times a substantial portion of the Company's recycling revenues have been derived from the sale of various grades of recycled paper and paper products. Prices of recyclable commodities are volatile and cause fluctuations in the Company's recycling revenues. In addition, the costs associated with mandated recycling efforts and the resulting increase in supply of, and reduction in sales prices for, recyclable material place pressure on the Company's operating margins in its recycling operations. See "Risk Factors -- Fluctuations in Prices for Recyclable Commodities."
Transfer Stations. The Company currently operates 12 transfer stations, six of which it owns. Transfer station ownership allows the Company to exercise greater control over the waste stream from its collection operations and promotes greater efficiency in its recycling and waste transportation activities. As of September 30, 1999, approximately 80% of the waste delivered to the Company-owned facilities came from the Company's collection operations. As a result of the Waste Disposal Agreements, substantially all of the refuse collected in San Francisco (other than waste diverted for recycling) is deposited in the San Francisco transfer station owned by the Company. Certain generators of waste (including state agencies) and certain types of waste (including construction and demolition debris) are not subject to the Waste Disposal Agreements and as a result waste collected from such generators and such excluded types of waste may be taken to other transfer stations.
LANDFILLS
The Company operates 14 landfills in California, four of which it owns and ten of which are owned by local governmental entities. Each of these landfills generally accepts only non-hazardous waste, with the exception of certain wastes that may be hazardous due to asbestos content.
Owners or operators of landfills face substantial liabilities, including environmental impairment liabilities, closure and post-closure maintenance obligations and corrective action obligations. With respect to all but one of the third party landfills currently managed by the Company, the Company is a contractor and is not the operator under the applicable permits. In those circumstances, the Company is not responsible for closure and post-closure maintenance obligations, corrective action obligations, or environmental impairment under operator liability obligations. In addition, in San Bernardino County, the County has agreed to indemnify the Company for certain other liabilities. See "Risk Factors -- Environmental Regulation and Potential Litigation," and "Risk Factors -- Possible Liability for Environmental Remediation and Damages."
Owned Landfills
The following table sets forth certain information about the four active landfills owned by the Company:
- --------------- (a) Includes all permitted landfill acres. Total landfill area is approximately 2,500 acres, including contiguous areas. Not all contiguous areas are permittable.
(b) Permitted acreage includes approximately 35 acres that can only be used for the disposal of concrete, asphalt and similar inert demolition waste due to the existence of geologic conditions unsatisfactory for landfill siting.
The Company owns landfills with capacity to service markets the Company currently serves with collection operations in Northern California. At such time as a Company-owned landfill no longer has remaining capacity, the Company intends to either redirect waste being deposited at such landfill to another Company-owned landfill with substantial remaining capacity or to a third party-owned landfill. The Company's B&J and Ostrom Road landfills have Class II permits, which allow these landfills to accept non-hazardous waste that is capable of degrading water quality if not properly handled, in addition to municipal solid waste.
In July 1999, the Company and Humboldt Waste Management Authority ("HWMA") entered into an agreement in principal concerning the Cummings Road Landfill and the Company's Eureka
Transfer Station. In November 1999, the Company entered into an agreement with HWMA, pursuant to which the Company would transfer to HWMA ownership of such properties as well as certain operating equipment. As part of the agreement, the Company would receive certain cash payments totaling approximately $4.2 million from the HWMA and HWMA would assume certain closure/post-closure, corrective action and operational responsibilities with respect to the Cummings Road Landfill. The Company would retain liability for its operation of the landfill prior to the closing of the transaction and for any defect in corrective action work performed by the Company at the landfill prior to the closing of the transaction. Under the agreement, the Company would also transfer to HWMA its interest in the closure/post-closure and corrective action trust funds relating to the landfill. The consummation of the agreement is subject to several closing conditions. Provided such conditions are met or waived, the closing is expected to occur before January 15, 2000.*
Of the waste deposited at Company-owned landfills for fiscal year 1999 approximately 67% was received from the Company's collection, waste diversion and transfer station operations and 33% was received from independent third party collectors, hauling companies and self-haulers.
Operated Landfills
The Company currently manages ten third party-owned landfills, nine under contracts with the permitted operators and one under lease from the landfill owner. These landfills are permitted for approximately 13,500 tons-per-day total capacity. Landfill operating agreements with third party owners generally provide for payment to the Company of a fee based on tonnage received.
San Bernardino County. The Company has a contract with San Bernardino County, pursuant to which it operates (through its San Bernardino subsidiary) all active landfills owned by San Bernardino County and is primarily responsible for implementing the County's strategic plan which addresses the County's long-term waste disposal needs (the "1995 Contract"). The Company's other responsibilities include closure and monitoring of non-active landfills and identification, permitting and construction of landfill expansions. Since November 1, 1995, with the concurrence of the County's Waste System Division, the Company has closed 10 of the County's landfills, thereby concentrating the County's waste stream among the seven remaining landfills. The Company currently operates seven landfills, six transfer stations and six community collection centers in San Bernardino County.
The Company's revenues from San Bernardino County are derived from two categories of services. The core service is the performance of ongoing landfill operations activities and transfer station operations. Over the term of the contract the amount of revenues from this core service has varied and will continue to vary primarily as a result of changes in volume of waste and changes in the Company's per ton compensation rate. The other component of revenues represents activities associated with the planning and implementation of the strategic plan to regionalize landfill operations in San Bernardino County. This includes planning, engineering and construction management for landfill expansions, transfer station construction and landfill closures. It is anticipated that San Bernardino County plans to spend approximately $50 million through June 30, 2001, and, if the County elects to complete its current strategic plan, up to an additional $50 million during the subsequent two-to three-year period, at which time the major work in connection with the strategic plan is expected to have been completed.* While revenues generated from these activities are significant, the Company generally earns lower margins than on its collection and disposal operations due to the fact that there is little capital investment required to generate the additional revenues and revenues are provided on a cost plus profit margin basis per the 1995 Contract. In addition, this business involves substantial subcontractor, consulting and other related expenses paid to third parties. Moreover, under the terms of the 1995 Contract, the County and the Company have obligations to negotiate a redetermination of the per ton compensation rate payable to the County every three years, and if the parties cannot agree upon such rate they are subject to an agreement to arbitrate. Additionally, either party may terminate the 1995 Contract if, in good faith, it does not agree with the redetermined rate arrived at in the arbitration. The County and the Company are currently in disagreement with respect to the per ton compensation rate to be paid under the 1995 Contract for services rendered by the Company on or
after July 1, 1999, which dispute arose in the fourth calendar quarter of 1999. Pursuant to the 1995 Contract, the County and Company are currently in arbitration with respect to such dispute. If the County were to prevail in such arbitration and obtain a reduction in the current rate, the Company's future profit margin on the 1995 Contract would be adversely affected, although at this time the Company cannot accurately predict the financial impact of an adverse arbitration decision.
The 1995 Contract with the County is scheduled to terminate on June 30, 2001 (the "Expiration Date"). The 1995 Contract provides that the Company, at its option, may extend the agreement for an additional 15-year period. At the conclusion of this initial extension period, the Company, at its option, may extend the agreement for up to an additional 15 years, so long as the waste stream contractually committed to the landfills meets certain levels. However, each party may terminate the contract for default, failure to reach an agreement regarding the reconfiguration of the landfills and other facilities following a reduction in tonnage, or the bankruptcy or insolvency of the other party. In addition, San Bernardino County may terminate the contract so long as it uses a competitive procedure to select a contractor or municipalizes such operations. The 1995 Contract also contains a clause stating that the County may terminate the agreement at any time if a Company employee is convicted of bribing public officials where the conviction relates to actions taken by the employee in respect to the 1995 Contract.
In October 1999, the United States Attorney for the Central District of California announced criminal indictments of James J. Hlawek, the immediate former Chief Administrative Officer for San Bernardino County, Harry M. Mays, a former consultant of the Company (and Mr. Hlawek's predecessor as Chief Administrative Officer for San Bernardino County), and Kenneth James Walsh, a former employee of the Company. 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.
The Company first learned of this matter when Mr. Walsh reported to the Company in mid-August 1999 that he was facing possible federal criminal charges in a matter that Mr. Walsh claimed was totally unrelated to the Company. The Company immediately made voluntary contact with the United States Attorney's office to determine the nature and substance of the United States Attorney's investigation and to offer the Company's full cooperation. The Company also initiated an internal investigation to determine the nature of Mr. Walsh's acts and any Company involvement in the matter. After learning of the true nature of the United States Attorney's investigation and after Mr. Walsh's refusal to cooperate with the Company's investigation, the Company terminated his employment on August 27, 1999. The Company terminated its consulting arrangement with Mr. Mays on September 3, 1999. The Company also informed the County of the information that had come to its attention concerning this matter and its actions in terminating Messrs. Walsh and Mays.
Messrs. Walsh and Mays have advised the Company that they were the only Company personnel and consultants involved in this matter and that no other Company personnel or consultants were involved in or had knowledge of their illegal conduct. The Company believes that Messrs. Walsh and Mays were acting purely for their own personal gain and that none of the Company's other employees or consultants were aware of or otherwise involved with Messrs. Walsh's and Mays' illegal conduct. After terminating Mr. Walsh, the Company was informed by the United States Attorney that Mr. Walsh had been accepting kickbacks from Mr. Mays and from one of the Company's vendors and had used a portion of such kickbacks along with a portion of the contract fee paid to Mr. Mays to fund the payments to Mr. Hlawek. The Company anticipates that the United States Attorney's office may require additional information in its ongoing investigation. The Company has cooperated with the United States Attorney's investigation and intends to continue to cooperate in the future.
On December 14, 1999, the County Board of Supervisors directed the County's Chief Administrative Officer to negotiate an amendment with the Company to end the 1995 Contract as soon as the County can complete a competitive bidding process through a Request for Proposal, review submitted bids, and negotiate a replacement contract, but in no event later than June 30, 2001. Although the County's Chief Administrative Officer has estimated in his report to the County's Board of Supervisors that the process should take 15 to 18 months, the County's Board of Supervisors has requested that the process be completed more quickly, if possible. In response to this request, the County's Chief Administrative Officer has stated that the process could potentially be accomplished in 12 to 15 months. The Company is currently unable to estimate how much time the County will need to complete these procedures. Moreover, the Company does not know whether it can successfully negotiate such an amendment, what terms may ultimately be negotiated in such an amendment or whether the County's Board of Supervisors will approve any such amendment. Assuming the County is unable to complete the Request for Proposal and enter into a new contract in the next nine months, the Company does not expect an amendment to end the 1995 Contract or the termination of the 1995 Contract to have a significant impact on its cash flows, results of operations or financial condition for fiscal year 2000.* The County has indicated that the Company will be permitted to bid on the new contract, but there can be no assurance that the Company will be awarded the new contract, or if the Company is the successful bidder, how the terms of the new contract will compare to as those contained in the 1995 Contract.
During fiscal years 1999, 1998 and 1997, revenues derived from the services the Company performed for San Bernardino County were approximately $55.1 million (16% of the Company's total revenue), $65.1 million (19% of the Company's total revenue) and $55.1 million (17% 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 were approximately $6.6 million, $7.9 million and $7.4 million, respectively. While the Company's results of operations and cash flows will be adversely impacted if an amendment to end the 1995 Contract is negotiated or the 1995 Contract is terminated and the Company and the County do not enter into a new contract having comparable terms, management believes that such event will not have a material adverse effect on the Company's financial condition or on its ability to maintain its operations and service its debt.
San Diego County. On March 1, 1995, the Company began managing activities of five county-owned landfills in San Diego County. On October 31, 1997, the County of San Diego sold its waste system (including the four landfills operated by the Company at that time) to a third party. On March 31, 1998, the Company ceased operations of the landfills when the new owner assumed operations.
Other Counties. The Company operates two landfills in Kern County, California under contracts expiring in April 2002 and December 2002, respectively, and one landfill in Placer County, California under a contract expiring in August 2001.
Financial Assurance Obligations
Extensive regulation of landfills not only affects their siting and operations but also imposes long-term obligations on landfill owners or operators to make substantial efforts to close landfills and maintain them following closure for at least 30 years. The Company believes that where it operates landfills owned by local governmental entities, those entities, as the holders of the relevant permits, are responsible for closure and post-closure maintenance obligations.
For each landfill it owns, the Company is required to demonstrate financial assurance for closure and post-closure maintenance costs. The Company makes periodic deposits to trust funds intended to provide adequate funding at the time of landfill closure, consistent with the Company's current estimates for all closure costs and, under current California law, at least 30 years of post-closure
maintenance costs. In addition, with respect to one closed landfill, the Company has posted a performance bond to fund post-closure obligations up to $1.1 million. The Company estimates, that as of September 30, 1999, the aggregate current cost of its closure and 30-year post-closure requirements is approximately $52.9 million.* The foregoing estimate of closure and post-closure liabilities is based on currently available information and current environmental and regulatory requirements and may change if applicable regulations or the assumptions relied on or facts and circumstances relating to the Company's landfills change.
California regulations also require the Company to provide financial assurance contingency funds for the initiation and completion of corrective action for certain possible releases of contaminants that may occur from its landfills into the groundwater, surface water or unsaturated zone, whether such releases occur before or after closure of the Company-owned landfill. The Company makes periodic deposits to trust funds intended to provide such contingency funds. The Company estimates, that as of September 30, 1999, the aggregate current cost of such remaining corrective action requirements for Company-owned landfills is approximately $7.7 million and remaining funding requirements total approximately $5.6 million.* The foregoing estimates are based on current available information and current environmental and regulatory requirements and may change if applicable regulations or the assumptions relied on or facts and circumstances relating to the Company's landfills change.
Regulations amended in 1992 also require California landfill operators to demonstrate financial assurance to compensate third parties for bodily injury and property damage arising out of landfill operations. Under the method adopted by the Company, the regulations require funding of $1.0 million per landfill to a maximum of $5.0 million Company-wide. To satisfy this requirement for each of the Company-owned landfills the Company has established trust funds, which are fully funded, for each landfill. The Company has obtained an insurance policy for one of its landfills not covered by the method described above.
SPECIAL WASTE AND HAZARDOUS WASTE
The Company provides limited waste management services in connection with five types of special waste: medical waste, waste water sludge, asbestos, non-hazardous contaminated soil and ash.
In addition, the Company operates permanent household hazardous waste collection facilities in four communities and periodically collects household hazardous waste in other communities as part of special programs designed to help reduce deposits of hazardous waste in the solid waste stream. The Company also provides limited hauling and disposal services for asbestos and may also handle hazardous waste from its load checking and/or ancillary to its medical waste activities at its facilities. The Company currently has no other plans to collect or dispose of hazardous or toxic materials.
ENVIRONMENTAL REGULATION
The Company's business activities are subject to extensive and evolving regulation under various complex, and at times overlapping and conflicting, 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's activities. The Company believes that such regulation will increase in the future.
To operate landfills, transfer stations and other waste processing facilities, the Company must possess and maintain various governmental approvals, operating permits and licenses, and in certain instances, must secure various land use approvals. Obtaining approvals and permits to acquire, develop or expand solid waste management facilities is difficult, time-consuming and expensive and is sometimes vigorously opposed by local citizen groups or other private parties. Once obtained, operating permits are subject under certain circumstances to modification or revocation by the issuing agency and may be altered by changing laws and regulations.
In the collection segment of the industry, regulation takes such forms as licensing collection vehicles, health and safety requirements, vehicular weight limitations, and, in certain localities, limitations on weight, area, and time and frequency of collection.
The Company's operation of solid waste management facilities subjects it to certain operational, monitoring, site maintenance, closure and post-closure obligations, as well as financial assurance obligations relating to third party liability, corrective actions, and closure and post-closure maintenance.
In addition to costly and restrictive regulation, other factors, the long-term effects of which are unpredictable, may have a significant effect on the Company's operation of landfills. Increasing public opposition to the siting and operation of landfills is adding to the length of time required to obtain necessary permits and approvals for new landfills and the expansion of existing landfills. Moreover, there is a national trend to attempt to reduce the volume of solid waste and the dependence on landfill disposal by promoting source reduction, waste transformation and recycling programs.
During the ordinary course of its operations, the Company may from time to time receive citations, notices and comments from regulatory authorities that such operations are not in compliance with applicable environmental regulations. Upon receipt of such citations, notices or comments, the Company works with the authorities in an attempt to address the issues identified by such authorities. In some instances, where the Company operates a landfill or transfer station pursuant to an agreement with a county or other governmental body, responsibility for the matters referenced in such citations, notices or comments lies with such governmental body. Failure to correct the problems to the satisfaction of the authorities could lead to fines or a curtailment or cessation of the landfill or transfer station's operations.
Compliance with current or future regulatory requirements may require the Company to make capital and operating expenditures to maintain current operations or to initiate new operations. While the Company intends to apply for rate increases whenever possible to cover such increased costs, there is no assurance that it will be able to pass all or a portion of these costs on to its customers.
Federal Regulation
The principal federal statutes affecting the Company's business operations are:
The Resource Conservation and Recovery Act of 1976 ("RCRA"). RCRA regulates the handling, storage, treatment, transportation and disposal of hazardous and non-hazardous wastes and requires states to develop programs to insure the safe disposal of solid waste. Subtitle D of RCRA establishes a framework for federal, state and local government cooperation in controlling the management of nonhazardous solid waste, and prohibits the operation of municipal solid waste landfills that fail to meet minimum federal standards for protecting human health and the environment. Under these regulations, state and local governments retain primary responsibility for ensuring enforcement and compliance with state and federal minimum standards by landfills within their jurisdictions.
The United States Environmental Protection Agency (the "EPA") adopted regulations under Subtitle D of RCRA that provide minimum standards or criteria establishing landfill location restrictions, design standards, operating criteria, closure and post-closure requirements, financial assurance requirements, groundwater monitoring requirements and corrective action requirements. These regulations establish stringent requirements for liner design, leachate (liquid that has leached from the landfill and become contaminated through contact with solid waste) collection systems, groundwater testing wells and methane gas control systems. A landfill that fails to meet the Subtitle D criteria will be deemed to be engaged in "open dumping" in violation of RCRA. Most of these regulations have been in effect in California for several years. The EPA has approved California's application to operate California's permitting program for solid waste landfills under Subtitle D.
The Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("Superfund" or "CERCLA"). CERCLA imposes liability for the investigation and clean up of, or natural resource
damages from, facilities from which there has been, or is threatened, a release of a hazardous substance into the environment. Current owners and operators of the site, parties who were owners or operators at the time the hazardous substance was disposed of, and all generators or transporters and those who arrange for disposal of a hazardous substance that is released from a site are potentially responsible parties. Liability under CERCLA is strict, joint and several, meaning that it can be imposed upon any potentially responsible party even if such party complied with all laws and regulations in effect at the time of the act giving rise to liability or has generated no more than a very small portion of a facility's contamination. Many of the more than 700 substances listed by the EPA as "hazardous substances" (including asbestos) can be found in household waste.
CERCLA investigation and cleanup costs can be very substantial. Many of the sites addressed under CERCLA are or were municipal solid waste landfills that ostensibly never received hazardous wastes. Even if the Company's landfills never received hazardous wastes as such, one or more hazardous substances may have come to be located at these landfills. The same is true of other industrial properties owned or operated by the Company. If the Company were to be found to be a responsible party for a CERCLA cleanup, the enforcing agency could hold the Company completely responsible for all investigative and remedial costs, even if others were also liable. The Company's ability to obtain reimbursement from others for their allocable share of such costs would be limited by the Company's ability to locate such other responsible parties and to prove the extent of their responsibility and by the financial resources of such other parties. Legislation has been introduced in Congress which, if passed would limit the liability of municipalities and others under CERCLA as generators and transporters of municipal solid waste. If such legislation becomes law, the Company's ability to seek contribution from municipalities for CERCLA cleanup costs would be limited even if the hazardous substances requiring remediation at one of the Company's facilities were generated or transported to the facility by a municipality.
The Federal Water Pollution Control Act (the "Clean Water Act"). The Clean Water Act regulates the discharge of pollutants from a variety of sources, including solid waste disposal sites, into surface waters of the United States. The discharge of runoff or leachate from the Company's landfills into waters of the United States would require the Company to apply for and obtain a discharge permit, conduct sampling and monitoring and, under certain circumstances, reduce the quantity of pollutants in the discharge. Also, under new federal storm water regulations, many landfills, transfer stations and other Company operations are now required to obtain storm water discharge permits and to develop a storm water pollution prevention and monitoring program.
The Clean Air Act. The Clean Air Act, as amended, provides for federal, state and local regulation of emissions of air pollutants into the atmosphere. The EPA has proposed new source performance standards regulating air emissions of certain pollutants (methane and non-methane organic compounds) from municipal solid waste landfills. The EPA may also issue regulations controlling the emissions of particular regulated air pollutants from municipal solid waste landfills. In addition, the EPA has issued standards regulating the handling of asbestos-containing materials.
Occupational Safety and Health Act of 1970 ("OSHA"). OSHA establishes certain health and safety standards for the workers employed by the Company. Certain of these standards, including standards for notices of hazards, safety in evacuation, and the handling of asbestos, may apply to certain of the Company's operations.
State and Local Regulation
Each state in which the Company now operates or may operate in the future has laws and regulations for the protection of human health and the environment that affect various operations of the Company. These laws and regulations govern, among other things, solid waste disposal, water and air pollution and, in most cases, the design, operation, maintenance, closure and post-closure
maintenance of landfills and transfer stations. Among the principal California statutes affecting the Company's business operations are:
The California Integrated Waste Management Act. The California Integrated Waste Management Act of 1989 establishes a framework for the regulation of landfills and other solid waste facilities in California through a system of solid waste facilities permits administered jointly by the California Integrated Waste Management Board (the "Waste Board") and the local enforcement agency (generally a county health or environmental department). Periodic site inspections and permit reviews are undertaken by the local enforcement agency to ensure that the landfill operations comply with current health, safety and environmental regulations. Among those regulations are minimum performance standards for proper operation, closure, post-closure maintenance and ultimate re-use of landfill sites to assure that public health and safety and the environment are protected from pollution due to the disposal of solid waste.
The California Integrated Waste Management Act also requires each local government to divert 25% of its waste from landfill disposal through source reduction, recycling and composting. This required level will increase to 50% by the beginning of calendar year 2000. Attempted compliance with these diversion goals by local governments could substantially reduce the tonnage of waste deposited in the Company's landfills.
Closure/Post-Closure. A part of the California Integrated Waste Management Act known as the Eastin Statute requires landfill owners and operators to (i) develop closure and post-closure maintenance plans and submit plans to both the Waste Board and the applicable Regional Water Quality Control Board for approval, (ii) prepare an estimate of closure and post-closure maintenance costs, and (iii) establish a mechanism acceptable to the Waste Board to demonstrate financial responsibility for such estimated costs.
Regulations promulgated under the Eastin Statute (the "Eastin Regulations") impose closure and post-closure requirements governing the removal of structures, decommissioning of environmental control systems, construction and maintenance of final cover, grading, drainage and site face, slope protection and erosion control (revegetation), leachate control and monitoring systems, groundwater monitoring facilities and landfill gas monitoring and control systems. Landfill owners and operators must submit preliminary closure and post-closure maintenance plans at the time of the application for any existing solid waste facilities permit review or upon the first application for a permit. Existing permit reviews generally occur in connection with modifications for the permit or, if earlier, five years following the most recent permit review. In addition, final closure and post-closure plans must be submitted two years before the anticipated date of landfill closure. The EPA has approved California's application to operate its existing solid waste program under Subtitle D.
The Eastin Regulations require the owner or operator of each landfill to (i) estimate the cost associated with closing the landfill in accordance with the foregoing requirements, including the costs of conducting post-closure maintenance for a period of at least 30 years after closure, (ii) certify such cost estimates to the Waste Board and the local enforcement agency, and (iii) demonstrate that the owner or operator has the financial resources to conduct closure and post-closure maintenance activities. One of the means by which an owner or operator can demonstrate financial assurance is to establish a statutory trust fund whereby the owner or operator is committed to make yearly contributions over the remaining life of the landfill. This is the primary mechanism used by the Company for the Company-owned landfills that it has responsibility for closing. Each year's minimum trust fund deposits are based upon a regulatory formula using the ratio of the landfill's annual capacity filled, to the remaining permitted capacity, multiplied by the remaining cost estimate to be funded. Because these costs can be substantial, the annual trust fund contributions could have a significant impact on the Company's cash flow if the Company were unsuccessful in collecting such costs in tipping or collection fees.
Hazardous Waste Control Law and Carpenter-Presley-Tanner Hazardous Substance Account Act. The California Environmental Protection Agency's Department of Toxic Substances Control has broad
authority under the Hazardous Waste Control Law, similar in many respects to Subtitle C of RCRA, to regulate generators and transporters of hazardous waste and facilities that treat, store or dispose of hazardous waste. California also has enacted the Carpenter-Presley-Tanner Hazardous Substance Account Act, which is the state's "Superfund" law, with provisions similar to those of the federal CERCLA.
The Porter-Cologne Water Quality Control Act ("Porter-Cologne Act"). The Porter-Cologne Act regulates the discharge of waste that may affect waters of California, whether surface or subsurface, and whether by point or non-point sources of discharge. This would include the discharge of waste into a landfill. Each discharger must file a report of waste discharge with the regional water quality control board (the "regional board") having jurisdiction over the location of the proposed discharge, and the regional board issues a permit, known as "waste discharge requirements," that limits the quantity and manner of the discharge to meet water quality standards and to ensure the protection of beneficial use of the receiving waters. Pursuant to the Porter-Cologne Act, in 1984, California adopted regulations imposing design, siting, and operational standards for waste disposal sites to minimize the extent to which landfill runoff and leachate may pose a threat to surface or groundwater quality. These standards also apply to new or expanded waste disposal facilities.
The federal Clean Water Act allows states to assume the EPA's responsibilities over point source discharges of pollutants into surface waters. California has assumed those responsibilities under the Porter-Cologne Act.
California has also adopted regulations requiring owners and operators of landfills to provide financial assurance for the initiation and completion of corrective action for known or reasonably foreseeable releases of contaminants from landfills into the groundwater, surface water or unsaturated zone.
Other States' Regulation. Although almost all of the Company's business is currently conducted in California, the Company has historically and in the future is likely to conduct business in other states with statutes similar to California's that would regulate the Company's handling, transportation and disposal of waste, and the design, operation, maintenance, closure and post-closure care of solid waste disposal facilities and underground storage tanks ("USTs") regulation. These states may have additional rules with which the Company would have to comply.
Underground Storage Tank Regulation. USTs in California are regulated by federal law under RCRA, by a California law that closely parallels the requirements of the federal law and by local regulation. These regulations contain extensive requirements relating to monitoring, leak detection and prevention, permitting, reporting, and other matters, including the required removal or closure of tanks that are no longer in use. In connection with its business operations, the Company maintains five double-walled USTs, all of which are used for the storage of petroleum products, which are hazardous materials.
During 1999, the Company removed the final 10 single-walled USTs previously used in its operations at three sites. With the exception of two sites, at which the Company anticipates that up to an additional $0.5 million may be required to remediate contamination, the Company is not aware of any of the UST sites that will require significant soil or groundwater remediation.* However, in most instances the Company has not conducted soil or groundwater testing sufficient to assess fully the extent and cost of any possible remediation that might be required. These costs, if any, will not be known until such tests are completed, although the Company currently estimates that the cost, if any, of remediating the sites from which the final 10 single-walled USTs were removed may be as much as $0.9 million.
Owners and operators of USTs containing petroleum also must demonstrate financial responsibility to pay for corrective action and third party claims arising from a release from their USTs. The Company has purchased insurance to make this demonstration.
Flow Control. Many states and municipalities attempt to direct the flow of municipal solid waste through a variety of means, including the passage of laws and ordinances requiring solid waste to be processed or disposed of at a particular facility. In addition, some municipalities grant franchises and permits that have the effect of limiting who may collect solid waste and where such waste may be brought for disposal. In 1994, the United States Supreme Court, in the case of Carbone v. Town of Clarkstown, held unconstitutional a local ordinance that required all solid waste generated within or brought into the locality to be disposed of at a particular transfer station that the town had guaranteed a certain minimum tonnage of solid waste, in order to help finance the construction of the transfer station. The Court held that the ordinance discriminated against interstate commerce by allowing only the favored facility to process solid waste from the town and effectively "hoarding" commerce in the service of processing solid waste for the benefit of local economic interests. The Court found that the primarily economic reasons for enacting the ordinance could not justify the law's discrimination against interstate commerce.
Although the Company believes there are many significant differences between the facts in Carbone and the circumstances relating to the collection franchises, permits and agreements held by the Company and to government actions related to such franchises, permits and agreements, it is possible that these franchises, permits and agreements could be challenged under a similar rationale. In that event, the municipalities involved would have to show that their franchises, permits and agreements (i) do not regulate interstate commerce, (ii) do not discriminate against interstate commerce and do not impose an excessive burden on interstate trade in relation to the total benefits conferred; or (iii) are necessary to advance legitimate local interests. There can be no assurance that such franchises, permits and agreements would be upheld.
Bills that would exempt certain ordinances and facilities from the potential impact of Carbone have been presented to the United States Congress. At present, it is impossible to know in what form such a bill, if any, will pass the Congress, but the attempts to pass such a bill have been unsuccessful to date. Although these bills appear to be intended to limit, rather than broaden, the scope of Carbone, there can be no assurance that a bill will not be enacted that will adversely affect the legality of exclusive franchises, agreements or permits under the interstate commerce clause.
COMPETITION
The solid waste services industry is highly competitive and requires substantial capital, technical expertise and human resources. The industry is comprised of three large publicly-traded national waste service companies (Waste Management, Inc., Allied Waste Industries, Inc. and Republic Services, Inc.) and several smaller, publicly-traded regional companies, as well as numerous regional and local companies of varying sizes and competitive resources. Many of the Company's competitors have significantly greater financial and operating resources and a lower cost of capital than the Company and can take advantage of less capital intensive environmental regulatory financial assurance obligations than those with which the Company is required to comply. Additionally, in smaller markets, the Company may be at a competitive disadvantage with respect to regional and local companies which may have significantly lower operating costs. In its landfill activities, the Company also competes with cities and counties that conduct their own waste disposal services. These municipalities may have the advantages of access to tax revenues and tax exempt financings as well as the ability to direct the collection and disposal of waste in their respective jurisdictions.
Most of the Company's collection operations are conducted pursuant to franchise agreements, permits and licenses that make the Company the exclusive provider of most waste services in a specific geographic area. However, each of these arrangements has a specific duration except in San Francisco, and the Company may become subject to competition if these arrangements are not extended prior to maturity. The Company competes for collection services primarily on the basis of service and price. Transfer station activities are often tied to collection operations, so the same competitive considerations apply. Competition among landfills is based upon price, service and the proximity of the landfill to the waste generator. Competition for operation of landfills under contract is based on price and
service. The Company believes that, from time to time, competitors offer substantially lower prices for their services in an effort to maintain or expand market share or win a competitively bid municipal contract.
The industry is continuing to undergo significant consolidation, characterized by the acquisition of smaller regional and local operations by larger entities, mergers, the privatization of operations that local governments no longer wish to conduct and the reduced presence of smaller regional and local operations caused by the ability of larger entities to bid for franchises and contracts at prices such smaller operations cannot match. Because of the difficulty in obtaining approvals to operate in communities that already have established service providers, competition for the acquisition of other companies and price-related competition upon the renewal of existing contracts and franchises are increasingly intense. In addition, the Company believes that a number of its competitors have full-time personnel primarily dedicated to locating, evaluating and securing business expansion opportunities and acquisitions -- including environmental and regulatory experts, engineers, attorneys, lobbyists, financial and accounting personnel and finders. The Company may be at a competitive disadvantage if it is unable to identify, adequately evaluate or respond to acquisition opportunities or incurs higher costs than are borne by its competitors to do so. Accordingly, it may become uneconomical for the Company to make further acquisitions or the Company may be unable to locate suitable acquisition candidates, particularly in markets the Company does not already serve. See "Risk Factors -- Acquisition-Related Risks."
RISK FACTORS
The following is a discussion of certain risks and uncertainties that could cause results to differ materially from predictions, estimates and expectations expressed by the Company in this Annual Report.
Concentration of Business
The Company is dependent on a number of franchise contracts and operating permits for a significant portion of its revenues and operating income. Approximately 39% of the Company's revenues and substantially more of its operating income in fiscal year 1999 were derived from services performed in the City and County of San Francisco. In San Francisco, the Ordinance provides that, with certain limited exceptions, only a collector that has been granted a permit for a specified route may collect or transport solid waste on that route in the City and County of San Francisco. Although the Company holds permits for substantially all routes covered by the Ordinance, a permit may be revoked or additional permits granted to third parties if, among other things, the Company were to provide inadequate service, such as a failure to collect refuse properly or overcharging. The granting of additional permits due to inadequate service is required if 20% or more of the customers on a route sign a petition stating that the Company's service has been inadequate and the Director of the Department of Public Health finds such statement to be correct. Further, the Ordinance could be repealed or amended by the vote of the electorate in a way that is unfavorable to the Company. A change in the Ordinance and the possible loss by the Company of one or more of its permits could have a material adverse effect on the Company's business, financial condition and results of operations. However, the Company believes that California law would not allow it to be completely displaced by another exclusive waste collection provider for five years if the Ordinance were repealed, unless the permits were terminated pursuant to the existing provisions of the Ordinance. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Approximately 16% of the Company's revenues in fiscal year 1999 were derived from services performed for the County of San Bernardino. The Company and the County are currently in the process of negotiating an amendment to their agreement pursuant to which the agreement will end as soon as the County can complete a competitive bidding process through a Request for Proposal, review submitted bids and negotiate a replacement contract, but in no event later than June 30, 2001. The County's Chief Administrative Officer has indicated that the process could potentially be accomplished
in 12 to 15 months. The County has indicated that the Company will be permitted to bid on the new contract, but there can be no assurance that the Company will be awarded the new contract, or if the Company is the successful bidder, how the terms of the new contract will compare to those contained in the 1995 Contract. For further information see "Item 1. Business -- Landfills -- Operated Landfills -- San Bernardino County." The failure of the Company to obtain a new contract will result in the loss of the Company's San Bernardino County operations. Such loss will result in a greater concentration of the Company's revenues and operating income among a limited number of franchises and permitted operations.
Substantially all of the Company's assets and operations are located in California. An economic slowdown in California (such as occurred in the early 1990s) or a change in California's environmental or related regulations that negatively affects the waste management industry could have a material adverse effect on the Company's business, financial condition and results of operations.
Changes in Legislation and Political Uncertainty
The waste management industry is subject to federal, state and local statutes, regulations, ballot initiatives and judicial decisions that impose significant risks and compliance burdens on the Company. The adoption or promulgation of new, or the amendment of existing, legislation and regulations could cause the Company to lose franchises, reduce the value of its existing franchises or require the Company to modify its waste disposal facilities and methods of operation at substantial cost. In addition, because operations of waste management companies are the subject of a high level of public concern, unfavorable publicity may have an adverse effect on the Company.
Ballot Initiatives Affecting Ordinance. In November 1993 and November 1994, initiatives were placed on the San Francisco general ballot which, if passed, would have repealed or amended the Ordinance and would have opened refuse collection in San Francisco to competition. Although these initiatives were defeated (by votes of 76% to 24% and 65% to 35%, respectively), there can be no assurance that other attempts will not be made to implement legislation with a material adverse effect on the Company's operations. The Company incurred costs in connection with its campaigns to defeat the 1993 and 1994 initiatives and may incur significant costs in connection with future ballot initiatives, if any. Future attempts to implement legislation may be financed by persons having greater resources than the Company and may be successful in modifying or repealing the Ordinance. There can be no assurance that the Ordinance will not be modified or repealed in the future.
Potential Competitive Bidding. The Company provides waste collection services in San Francisco pursuant to permits granted under the terms of the Ordinance and in other communities generally pursuant to exclusive franchise or other service agreements. In the event of the amendment or repeal of the Ordinance or upon the expiration or termination of a franchise or service agreement in other communities, the award of a franchise or service contract may be determined by competitive bidding. The waste management industry is intensely competitive and many of the Company's competitors have greater financial and other resources than the Company and therefore there can be no assurance that the Company will succeed in having its bid for such franchise or other service contract accepted or that such franchise or other service contract, if accepted, will be on terms and at prices which result in profit margins similar to those currently earned by the Company.
Problems in Rate-Setting Process. The Company generally seeks to recover all of its operating costs, including the costs of recycling services, landfill closure and post-closure obligations and tipping fees in the rate-setting proceedings that determine many of its collection, transfer station and landfill rates. However, rate-setting bodies sometimes have been reluctant to allow all of the Company's operating and related costs, including capital expenditures, to be reflected in its rates. Political pressure has occasionally inhibited local governments from allowing large rate increases and caused them instead to increase rates gradually. Lack of public understanding of new regulatory requirements which can significantly affect the Company's operating costs, especially relating to recycling mandates and landfill closure and post-closure maintenance, has sometimes made it difficult for the Company to
obtain rate increases to cover such costs. In addition, certain municipalities, including San Francisco, have not allowed the Company to recover through its rates some or all ESOP or other corporate-related expenses. Given these difficulties, there can be no assurance that the Company will succeed in obtaining timely rate increases sufficient to cover all costs or sufficient to maintain profit margins at historic levels. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Potential Flow Control Legislation. Many states and municipalities attempt to direct the flow of municipal solid waste through a variety of means, including the passage of laws and ordinances requiring solid waste to be processed or disposed of at a particular facility. In addition, some municipalities grant franchises and permits that have the effect of limiting who may collect solid waste and where such waste may be brought for disposal. In 1994, the United States Supreme Court, in the case of Carbone v. Town of Clarkstown, held unconstitutional a local ordinance that required all solid waste generated within or brought into the locality to be disposed of at a particular transfer station for which the town had guaranteed a certain minimum tonnage of solid waste in order to help finance the construction of the transfer station. Although there are many significant differences between the facts in Carbone and the circumstances relating to the collection franchises, permits and agreements held by the Company and to government actions related to such franchises, permits and agreements, it is possible that these franchises, permits and agreements could be challenged under a similar rationale. There can be no assurance such a challenge would not be successful or would not adversely affect the enforceability of the Company's exclusive franchises, permits and agreements. Bills that would exempt certain ordinances and facilities from the potential impact of Carbone have been presented to the United States Congress but the attempts to pass such bills have been unsuccessful to date. At present, it is impossible to predict the form in which such a bill, if any, will pass. There can be no assurance that a bill will not be enacted that will adversely affect the enforceability of exclusive franchise agreements or permits under the interstate commerce clause of the U.S. Constitution.
Adverse Publicity. Because the Company's business is dependent on approvals of political bodies, unfavorable publicity affecting public attitudes or perceptions of the Company could result in political pressure, including government action, which may have an adverse effect on the Company's business. For example, the recent guilty pleas by a former employee and a former consultant of the Company with respect to federal charges of conspiring to pay and accept bribes to influence or reward a former San Bernardino County official in connection with such person's official duties have generated significant unfavorable publicity for the Company in San Bernardino County. Moreover, the Company has in the past and may from time to time in the future receive unfavorable publicity relating to litigation, regulatory actions and other claims, including those involving environmental issues and employment practices. Also, in the ordinary course of its business, the Company makes political contributions to various state and local elected officials or candidates for elective office and pays substantial compensation to consultants, lobbyists and business opportunity finders, including persons who are former officials or were formerly employed by officials of municipalities with which the Company does business or may seek to do business. These activities could become the subject of unfavorable publicity. There can be no assurance that unfavorable publicity relating to Norcal or its affiliates will not have an adverse effect on the Company's business or prospects.
Environmental Regulation and Potential Litigation
The Company's operations are subject to, and substantially affected by, numerous federal, state and local laws and regulations that govern environmental protection, zoning, public health and safety and other matters. In recent years, these regulations have become increasingly stringent (particularly in California).
These requirements and standards change and, to comply with new requirements, the Company may from time to time be required to make significant capital and operating expenditures. These expenditures may be necessary to modify, replace or supplement equipment and facilities at substantial cost and without any resulting increase in revenues. In addition, the Company will be required to
make substantial expenditures to satisfy statutory obligations concerning closure and post-closure maintenance of the landfills it owns. The Company may be unable to pass some or all of these expenditures on to its customers through rate increases. Even if such expenditures can be passed on, the Company may experience significant delays in recovering these expenditures. Moreover, the cost of closure and post-closure monitoring may exceed the amount the Company has set aside in trust funds and reserves to satisfy its regulatory obligations.
Environmental regulations may also impose restrictions on the Company's operations. In order to develop and operate a landfill or other solid waste management facility, for example, the Company usually must obtain, maintain in effect and periodically renew several permits and often must obtain zoning, environmental or other land use approvals. These permits and approvals are difficult and time consuming to obtain or renew and may, under certain circumstances, be modified or revoked by the issuing agency. Additionally, from time to time, the Company may be subjected to actions brought by citizens' groups or other private parties in connection with the grant of permits or alleging violations of permits or other regulatory requirements. There can be no assurance that the Company will successfully obtain and maintain in effect the permits and approvals required for the successful operation and growth of its business. The Company's failure to obtain or maintain in effect a significant permit could adversely affect the Company's business and financial condition.
In the normal course of its business, the Company may become subject to various judicial and administrative proceedings involving federal, state or local agencies, or private parties. These proceedings may seek to impose fines on the Company, to revoke or deny renewal of an operating permit or license held by the Company, or to require the Company to remediate environmental problems. The Company could incur substantial legal expenses during the course of such proceedings and the outcome of one or more of these proceedings could have an adverse impact on the Company's business.
Possible Liability for Environmental Remediation and Damages
With limited exceptions, federal and state laws impose joint, several and strict liability upon present and former owners, operators and users of facilities that release certain hazardous substances into the environment and the generators and transporters of those substances, regardless of the care exercised by such persons and regardless of when the hazardous substance is first detected in the environment. All such persons may be liable for the costs of site investigation, clean up and natural resource damage. Many of such hazardous substances can be found in household waste. The Company may face claims for remediation of environmental contamination, personal injury, property damage or damage to natural resources with respect to facilities it currently or formerly owned, operated or used. Costs for remediation of, and damages and penalties for, environmental contamination can be substantial and if incurred by the Company such liability could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company expects to grow in part by acquiring existing landfills, transfer stations, and collection operations. There can be no assurance that the Company will identify all problems or risks in connection with the businesses it acquires, including environmental problems or risks. As a result, the Company may have acquired, or may in the future acquire, landfills or other properties that have unknown environmental problems and related liabilities. The Company will be subject to similar risks and uncertainties in connection with the acquisition of facilities that formerly had been operated or owned by businesses acquired by the Company.
A subsidiary of the Company has indemnification obligations to the City and County of San Francisco and the owner of the landfill at which such subsidiary deposits a substantial amount of waste with respect to damages, removal and remedial costs associated with the deposit of hazardous and certain other types of waste. Neither the Company nor the subsidiary maintains insurance with respect to these indemnification obligations, although certain costs resulting from such obligations may be reimbursed through a reserve fund maintained by the City and County of San Francisco or through
rate increases. There can be no assurance that the reserve fund or rate increases will be adequate to satisfy such indemnification obligations. The Company's collection agreements typically contain general indemnifications by the applicable operating subsidiary of the Company, as well as, in some cases, indemnification obligations with respect to costs and damages arising from hazardous waste.
Insurance, Bonding and Letters of Credit
The Company has environmental impairment liability insurance, which covers the sudden or gradual onset of environmental damage to third parties, on all owned and operated facilities. The current policy has a limit of $15.0 million per loss with an annual aggregate limit for all losses of $15.0 million, covering pollution conditions that result in bodily injury or property damage to third parties, including clean-up costs. Liability for environmental damage significantly in excess of these limits could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to obtain such insurance in the future.
The Company carries a broad range of insurance coverage that it considers adequate to protect its assets and operations from "risk of loss." The Company's commercial general liability, general business automobile liability, and umbrella and excess liability policies provide an aggregate of $50.0 million coverage for any single occurrence, subject to a variety of exclusions and a self-insurance requirement of $0.5 million. Substantially all of the Company's present workers' compensation liabilities are self-insured and some of its pre-existing workers' compensation liabilities are self-insured; however, this liability is capped at a maximum of $0.5 million per claim with workers' compensation insurance covering liabilities in excess of this amount. In addition, certain employee and retiree healthcare liabilities are self-insured. Norcal also provides director and officer and ERISA fiduciary insurance.
The Company is required to post performance bonds in connection with certain contracts on which it bids. In addition, the Company is usually required to post a performance bond or a bank letter of credit at the time of execution of a municipal collection contract. Some of these performance bonds are secured by letters of credit posted by the Company. At September 30, 1999, the Company had performance bonds outstanding in the aggregate amount of $25.1 million, and had provided letters of credit of approximately $0.5 million to secure the Company's obligations to indemnify the surety companies. If the Company were to be unable to obtain surety bonds or letters of credit in sufficient amounts or at reasonable rates, it might be precluded from bidding on certain contracts, entering into additional municipal collection contracts or obtaining or retaining landfill operating permits. See "Risk Factors -- Competitive Industry."
As of September 30, 1999, the Company had a $1.0 million letter of credit outstanding pertaining to workers' compensation deferred premiums.
Required Payments for ESOP Participant Benefits
To the extent Norcal contributes funds to the ESOP in order for the ESOP to pay cash benefits due to retired, terminated or withdrawing ESOP participants, or to the extent Norcal is obligated to repurchase common stock distributed to participants, Norcal will have less cash available to make payments on its outstanding indebtedness or for other reasons. The amount Norcal may contribute to the ESOP to fund such ESOP distribution obligations (or may use to repurchase common stock distributed by the ESOP) will increase significantly in the future as the Company's workforce ages and retires, as additional shares of common stock are allocated to participants, if eligible participants elect to receive in-service withdrawals or if the value of the common stock increases.
Union Matters
As of September 30, 1999, about 73% of the Company's approximately 2,000 employees were represented by unions. While the Company believes that it generally has had good relations with its union employees, the Company was the subject of a work stoppage during 1997. 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. While this strike was resolved quickly, there can be no assurances that the Company will not be subject to future work stoppages or that such stoppages will not continue for extended periods. In the event that the Company is subjected to an extended strike or other work stoppage, there could be a material adverse effect on the Company's business, financial condition and results of operations.
In connection with the resolution of the San Francisco strike, a provision of the new contract effects an increase in pension benefits. 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. The Company has served upon Local 350 a demand to arbitrate this dispute under the terms of the collective bargaining agreement between the parties. Representatives of the Company and Local 350 have entered into a Memorandum of Understanding (the "Memorandum"), which provides that the parties will suspend the arbitration and that when the Company files its next rate application with the San Francisco Department of Public Works, which application may be filed at such time as the Company reasonably determines is appropriate, such application will include a request for sufficient money to cover the funding of costs of the pension benefit increases requested by Local 350 (the "Local 350 Amounts"). The Memorandum further provides that, if the Company's rate applications are granted and become effective, including the Local 350 Amounts, the arbitration will be terminated with prejudice; but if such request is denied, in whole or in part, for any reason and the Company does not put into effect the pension increases requested by Local 350, either party may reinstate the arbitration. The Company has not determined when it will submit a rate application. The ultimate outcome of this matter cannot be determined at this time and the results of the rate application process or the arbitration proceeding, if reinstated, cannot be predicted with certainty. If the arbitration is reinstated, the arbitrator could find in favor of the Company or Local 350, or could conclude that there has been no meeting of the minds on this provision of the contract and the provision could have to be renegotiated. If the matter is not satisfactorily renegotiated, the Company could be subject to another work stoppage. Such events could have a material adverse effect on the financial condition or results of operations of the Company.
If either party was to reinstate the arbitration and if Local 350 was to prevail in the arbitration discussed above or if the Company is successful in obtaining funding for the Local 350 amounts, the Company estimates that the accumulated benefit obligation ("ABO") as of September 30, 1999 would increase by an additional $8.2 million and reduce stockholder's equity by $1.8 million. In addition, if the increased pension benefits are provided, the Company's estimated incremental increase in its annual expense for employee benefits would be approximately $3.1 million for pension and medical costs. Such incremental increase in expense would be mostly offset by higher revenue if the Company is successful in obtaining increased rates to cover the additional funding. 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.
Dependence on Senior Management
The Company is highly dependent on the efforts of its senior management team. The loss of services of any member of senior management may have a material adverse effect on the business, financial condition and results of operations of the Company. The Company's success may also be dependent on its ability to hire and retain additional qualified management personnel. There can be no assurance that the Company will be able to hire and retain such personnel. The Company does not maintain "key man" life insurance.
Competitive Industry
The solid waste industry is highly competitive. Operations require substantial technical, managerial and financial resources. The Company competes with large publicly-traded national solid waste companies, including Waste Management, Inc., Allied Waste Industries, Inc. and Republic Services, Inc. and their affiliates, several smaller publicly-traded regional companies and other regional and local companies, some of which have significantly greater financial and other resources, lower cost of capital and more established market positions than the Company. Additionally, in smaller markets, the Company may be at a competitive disadvantage with respect to regional and local companies, which may have significantly lower operating costs. The Company's competitors also may not be subject to restrictions on their ability to incur new indebtedness, obtain necessary performance bonds or letters of credit, or make capital expenditures, strategic acquisitions or engage in certain expansions of their businesses such as those imposed on the Company by the Credit Agreement and the indenture relating to the Senior Notes (the "Indenture"). As a result, competitors of the Company may be better able to compete more aggressively for new permits and franchises (including those held by the Company), pay higher prices for acquisition candidates, withstand economic downturns and volatility in prices for recyclable commodities and bear the costs of new regulations.
Acquisition-Related Risks
The Company intends to grow, in part, through the acquisition of additional franchises, contracts, permits and other businesses. Such growth, if any, may place significant strain on the Company's management, working capital and financial control systems. As a result, the Company's future operating results will depend, in part, on its ability to make acquisitions at appropriate purchase prices and integrate successfully such acquisitions, including its ability to recruit, if necessary, qualified management and other personnel to supervise such operations and improve financial controls. There can be no assurance that the Company will be able to locate suitable acquisition candidates, make and manage any such acquisitions successfully or that such acquisitions will not materially and adversely affect the Company's financial condition or results of operations. To fund significant expansion, the Company may require financing for amounts which exceed the amount of its internally generated cash and borrowing capacity under existing credit facilities. There can be no assurance that such financing will be available. Moreover, the Company's lack of a publicly traded equity security and its alternative cost of financing, which may be higher than that of its competitors, could limit the amount the Company could prudently pay for acquisition candidates. Also, the Credit Agreement and the Indenture restrict the Company's ability to make acquisitions.
Substantial Leverage
As of September 30, 1999, the Company had outstanding long-term debt of $177.3 million and stockholder's equity of $65.0 million. This level of indebtedness and the debt service obligations arising therefrom may have one or more of the following effects on the Company: (i) the Company's ability to obtain additional financing in the future may be limited; (ii) a significant portion of the Company's cash provided from operations is and will be dedicated to servicing the Company's indebtedness, thereby reducing the funds available to the Company for operations and capital expenditures; and (iii) the Company may be more vulnerable to economic downturns or other adverse developments than less leveraged competitors and thus may be limited in its ability to withstand competitive pressures. Furthermore, the Credit Agreement currently provides for total maximum borrowing availability of $90 million (subject to certain limitations imposed by certain financial ratios and such maximum amount may be reduced by $2.5 million per calendar quarter), $25.0 million of which may be utilized for letters of credit, all of which indebtedness is scheduled to become due prior to the time any principal payments may be made on the Senior Notes (except for certain optional redemptions). As of September 30, 1999, the Company had availability under the Credit Agreement of approximately $52.9 million, 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 in the Credit Agreement become more restrictive over time. Applying the more restrictive covenant measures in effect beginning December 31, 1999 to the Company's estimated results of operations for the twelve month period ending December 31, 1999 would result in a decrease in availability under the Credit Agreement of approximately $4.4 million.* The Company's performance relative to the covenant measures is calculated on a quarterly basis. The Company is also subject to certain limitations on incurring additional indebtedness in the Indenture.
Possible Inability to Service Debt
The Company's ability to make scheduled payments on its indebtedness, including interest payments on the Senior Notes, depends on its financial and operating performance (including its ability to generate sufficient cash flow), which, in turn, is subject to prevailing economic conditions and to financial, business and other events, many of which are beyond its control (including delays in obtaining rate increases, the ability to renew franchises at historical profit margin levels, and fluctuations in prices for recyclable commodities). Moreover, the Company may incur additional indebtedness in the future. There can be no assurances that the Company's cash flow will be sufficient to repay its debt. The Company's ability to make scheduled payments also may be affected by its obligations to provide cash to fund ESOP distributions to retired, terminated or withdrawing participants. For information relating to the possible loss of the Company's contract with San Bernardino County and the impact of such loss on the Company's ability to service its debt, see "Item 1. Business -- Landfills -- Operated Landfills -- San Bernardino County."
Effect of Holding Company Structure
Norcal has no operations other than those relating to its subsidiaries and depends on the earnings and cash flows of, and dividends from, such subsidiaries to pay its obligations, including payments of principal and interest on its indebtedness. The ability of Norcal's subsidiaries to pay such dividends will be subject to, among other things, state law and contractual restrictions. Substantially all of the assets of Norcal's wholly-owned subsidiaries (the "Subsidiary Guarantors") have been pledged as collateral for their guarantees of Norcal's obligations under the Credit Agreement and the capital stock of (or partnership interests in) all the Subsidiary Guarantors has been pledged as collateral for Norcal's obligations under the Credit Agreement. In the event of a default under the Credit Agreement, the rights of Norcal with respect to the liquidation of these assets would be subject to the prior claims of the lenders under the Credit Agreement. A default under the Senior Notes constitutes an event of default under the Credit Agreement. Similarly, certain defaults (including the failure to pay principal or interest or defaults resulting in acceleration) under other indebtedness in an outstanding principal amount of at least $5.0 million constitute an event of default under the Indenture.
Seasonality
The Company's revenues tend to be higher during the spring and summer months (third and fourth fiscal quarters) due to higher volumes of certain types of waste, such as construction and demolition debris. Such increased volumes result in higher revenues and earnings from the Company's transfer stations, waste collection, and landfill operations during such months. In addition, project management revenues are highest in the fourth quarter as a result of the favorable construction conditions. Unusual changes in weather patterns can also affect the operating results on a quarter to quarter basis.
Fluctuations in Prices for Recyclable Commodities
The Company's operating results are affected by variations in its recycling revenues from the sale of recyclable commodities. The Company's recycling revenues are volatile and fluctuate in accordance with changes in prices of recyclable commodities which in turn are, in many cases, dependent on changes in worldwide supply of, and demand for, such recyclable commodities. However, costs (including significant capital costs) related to recycling do not fluctuate in accordance with changes in
prices for recyclables. As a result, the Company may experience increases in profitability with increases in commodity prices, or reduced profitability (or losses) at times of low commodity prices. A substantial portion of the Company's recycling revenues are derived from the sale of various grades of recycled paper and paper products, the prices for which, in recent years, have suffered declines from their historical highs.
Year 2000 Compliance
Many computer systems and software applications may experience problems handling dates beyond the year 1999. Computer systems and other equipment with embedded chips or processors have historically used two digits, rather than four, to define a specific year. These systems would be unable to determine whether the digits "00" referred to the year 1900 or 2000. This could result in system failures or miscalculations as a result of systems being unable to process accurately certain data before, during or after the year 2000. This could potentially cause disruptions to the Company's various activities and operations.
Projects. The Company has established a corporate level Year 2000 project team to coordinate the efforts in the Company's operating units and corporate departments to address the Year 2000 issue in three major areas: information technology, supply chain and embedded systems. Information technology is the computer hardware, systems and software used throughout the company's facilities. Supply chain includes the third parties with which the Company conducts business. Embedded systems can exist in the automated equipment and associated software, which are used in the Company's operations. Progress reports on the Year 2000 project are presented regularly to the Company's senior management and periodically to the Board of Directors.
The Company has addressed and continues to address Year 2000 compliance in three overlapping stages: (i) the identification and assessment of all critical equipment, software systems and business relationships requiring modification or replacement prior to 2000; (ii) the renovation and testing of modifications to all significant systems, including embedded systems; and, (iii) the development of contingency and business continuation plans to mitigate the extent of any disruption to the Company's operations arising from the Year 2000 problem.
The Company believes that it has replaced all operating equipment and computer hardware which was not Year 2000 compliant or which could not be modified to be Year 2000 compliant.
The Company has implemented a new third-party package of integrated financial applications which the vendor has represented is Year 2000 compliant. As a result of the vendors representation and the Company's internal testing, the Company believes that its general ledger, accounts payable, fixed assets, inventory management, human resources, payroll, contract management, job costing, purchasing and equipment management systems are Year 2000 compliant. In addition, the Company has renovated its remaining legacy systems which include customer billing and customer service support systems to be Year 2000 compliant.
The Company has investigated the Year 2000 compliance efforts of suppliers, contractors, financial institutions and other third parties with whom the Company does business and has material relationships to attempt to mitigate any adverse impact on the Company's operations from significant compliance problems that may be experienced by such parties. The Company continues to monitor this through periodic discussions with suppliers, customers and other third parties. The Company has surveyed its mission critical suppliers, customers and third parties. The Company has received responses from nearly all of these mission critical entities and believes that most of the entities are currently compliant or have Year 2000 compliance programs in progress. Based on current information, the Company believes that it will not experience any significant Year 2000 related problems as a direct consequence of its relationships with such third parties.
The Company has developed contingency plans which are intended to mitigate the impact on its operations, if any, of potential failures of mission-critical systems arising from the Year 2000 issue.
These plans are designed to protect the company's assets, continue safe operations, and enable the resumption of any interrupted operations in a timely and efficient manner. However, contingency planning for Year 2000 issues is complicated by the possibility of multiple and simultaneous incidents, which could significantly impede efforts to respond to emergencies and resume normal business functions. Such incidents may be outside of the Company's control, for example, if third parties with whom the Company does business and has material relationships do not successfully address their own material Year 2000 problems.
Costs. To date, the Company has charged to expense under $0.5 million in effecting Year 2000 compliance. The Company anticipates that its remaining costs in effecting such compliance will not be material.*
Risks. Factors, many of which are outside the control of the Company, that could affect the Company's ability to be Year 2000 compliant by the end of 1999 include: the failure of suppliers, contractors, customers, governmental entities and others to achieve compliance; the continued availability of the internal and external resources necessary for the Company to complete Year 2000 compliance; and the inability or failure to identify all critical Year 2000 issues or to develop appropriate contingency plans for all Year 2000 issues that ultimately may arise.
The foregoing disclosure is based on the Company's current expectation, estimates and projections, which could ultimately prove to be inaccurate. Because of uncertainties, the actual effects of the Year 2000 issues to the Company may be different from the Company's current assessment. While the Company believes that its Year 2000 project will adequately address its internal issues, the failure of the Company's suppliers, customers and other third parties to adequately address the issue could result in disruption to the Company's operations and have a material adverse impact on its results of operations, cash flow and financial condition, the extent of which the Company cannot yet determine.
EMPLOYEES
The Company employed approximately 2,000 persons as of September 30, 1999. Seventy-three percent of the Company's employees are covered under union contracts with varying terms and expiration dates. 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 of the Company's San Francisco operations. On April 26, 1997, employees represented by Local 350 voted to accept a five-year contract which provides for an aggregate 13.4% wage increase and certain amendments to provide early retirement and increase other benefits. The first-year cost of the contract was included in the most recent rate increase approved in San Francisco and the Company intends to seek rate recovery of scheduled future cost increases through the rate setting process. There can be no assurance that the Company will succeed in obtaining timely rate increases sufficient to cover all costs or sufficient to maintain profit margins at historical levels. For a discussion of outstanding issues related to the union contract, see "Risk Factors -- Union Matters."
ITEM 2.
ITEM 2. PROPERTIES
The principal properties of the Company consist of landfills, transfer stations, waste recovery, administrative and maintenance facilities and other land and improvements. The Company owns an aggregate of 302 acres of property on which its California operations, maintenance, storage, warehousing and administration facilities are situated. It owns six transfer stations, five of which are located at the Company's collection sites. The Company also operates three MRFs. The Company owns four active landfills in California consisting of approximately 2,500 acres, including contiguous areas.
The Company's headquarters are located in approximately 25,000 square feet of leased office space in San Francisco, California, pursuant to a lease that expires April 30, 2009. Under a lease expiring in October 2000, the Company leases 62,000 square feet of industrial space in the Los Angeles metropolitan area for its newly acquired Southern California operations. Under a lease expiring in July 2023, the Company leases 309,000 square feet of industrial space in San Francisco for recycling operations. Under a lease expiring in 2007, the Company leases 29,000 square feet of industrial space in Oakland, California, where the Company's medical waste treatment and disposal subsidiary conducts business.
The Company owns a 302-acre site situated in San Benito and Santa Clara Counties in California that formerly was used to spread waste water sludge. The soil quality suffered from such activities but was returned to normal agricultural condition in 1993. The Company may use the site again to spread waste water sludge on a more limited basis and for other waste diversion activities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
LITIGATION REGARDING THE ESOP NOTES
In 1995, the Company and the ESOP settled litigation by certain former holders of the prior notes issued by the ESOP that had been brought against them, together with (among others) certain financial institutions, as to which Norcal and/or the ESOP have certain indemnification obligations (the "Settlement"). The litigation was Abraham, et al. v. Norcal Waste Systems, Inc., et al., No. C94-3076 CAL, in the United States District Court for the Northern District of California. Pursuant to the Settlement, the claims against all defendants, including Norcal and the ESOP, were dismissed with prejudice, with the exception of certain of plaintiffs' claims against one of the named financial institutions, as to which the litigation proceeded and judgment ultimately was entered against the plaintiff and in favor of the financial institution. The court ruled that the Settlement was fair and made in good faith, and barred any claims by that financial institution, among others, against Norcal and the ESOP for equitable indemnity or contribution relating to the plaintiffs' released claims. That financial institution later made claims against Norcal and the ESOP related to the Settlement and alleging that Norcal and the ESOP have post-Settlement indemnity obligations to the institution. The court rejected those claims, and ultimately entered judgment in favor of Norcal and the ESOP in connection with the claims of the financial institution. The financial institution also brought a second lawsuit against the ESOP alone, raising the same indemnity issues that were at issue in the previously described action. The Court rejected those claims as well, and entered judgement for the ESOP. The financial institution is appealing the adverse judgments. The plaintiffs in the Abraham matter, in turn, are appealing from the judgement entered against them in favor of that financial institution; however, such plaintiffs have no remaining claims against Norcal or the ESOP, having settled those claims in 1995. Norcal and the ESOP believe that the financial institution's claims against them are without merit and that the Court's rulings will be affirmed on appeal. However, in the event that these judgments are overturned on appeal, it is unlikely, given the terms of the Settlement, that Norcal's and the ESOP's financial exposure to the financial institution would materially exceed the amount of the financial institution's legal fees and expenses.
SAN FRANCISCO UNION ARBITRATION
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 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. On February 10, 1998, the Company filed a petition for order compelling arbitration in U.S. District Court for the Northern District of California entitled Norcal Waste Systems, Inc., Golden Gate Disposal and Recycling, Inc. and Sunset Scavenger Company v. Sanitary Truck Drivers and Helpers Union Local 350, IBT. On April 23, 1998 the Company filed a motion for order compelling such arbitration. On May 29, 1998, the Court ruled in the Company's favor and directed the parties to proceed with arbitration.
Representatives of the Company and Local 350 have entered into a Memorandum of Understanding (the "Memorandum"), which provides that the parties will suspend the arbitration and that when the Company files its next rate application with the San Francisco Department of Public Works, which application may be filed at such time as the Company reasonably determines is appropriate, such application will include a request for sufficient money to cover the funding of costs of the pension benefit increases requested by Local 350 (the "Local 350 Amounts"). The Memorandum further provides that, if the Company's rate applications are granted and become effective, including the Local 350 Amounts, the arbitration will be terminated with prejudice; but if such request is denied, in whole or in part, for any reason and the Company does not put into effect the pension increases requested by Local 350, either party may reinstate the arbitration. The Company has not determined when it will submit a rate application. The ultimate outcome of this matter cannot be determined at this time and the results of the rate application process or the arbitration proceeding, if reinstated, cannot be predicted with certainty. If the arbitration is reinstated, the arbitrator could find in favor of the Company or Local 350, or could conclude that there has been no meeting of the minds on this provision of the contract and the provision could have to be renegotiated. If the matter is not satisfactorily renegotiated, the Company could be subject to another work stoppage. Such events could have a material adverse effect on the financial condition or results of operations of the Company. See "Risk Factors -- Union Matters."
If either party was to reinstate the arbitration and if Local 350 was to prevail in the arbitration discussed above or if the Company is successful in obtaining funding for the Local 350 amounts, the Company estimates that the accumulated benefit obligation ("ABO") as of September 30, 1999 would increase by an additional $8.2 million and reduce stockholder's equity by $1.8 million. In addition, if the increased pension benefits are provided, the Company's estimated incremental increase in its annual expense for employee benefits would be approximately $3.1 million for pension and medical costs. Such incremental increase in expense would be mostly offset by higher revenue if the Company is successful in obtaining increased rates to cover the additional funding. 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.
DIR DETERMINATION LETTER
On February 3, 1998, the Company received a determination letter from the Department of Industrial Relations of the State of California ("DIR") adverse to the Company. The DIR ruled that the operation of San Bernardino County Landfills is a public work within the meaning of the labor code and therefore subject to prevailing wage laws for construction. This determination was in response to a request by the Company for a determination after the Southern California Labor/ Management Operating Engineers Contract Compliance Committee (the "Compliance Committee") filed a Complaint (Case No. 4002639001) with the Long Beach office of the Division of Labor
Standards Enforcement. The Complaint alleged that the Company is not paying prevailing wages and benefits required for a public work by the Labor Code to those persons employed by the Company to operate the landfills in San Bernardino County.
The Company filed an appeal of the DIR's ruling with the Director of the DIR (the "Director") on March 4, 1998. On July 27, 1998, the Director issued a decision affirming the DIR's initial determination that the operation of the San Bernardino County landfills is a public work and is therefore subject to prevailing wage laws. However, the Director rejected the automatic adoption of general construction industry prevailing wage rates for landfill operators and referred the matter to the Labor Commissioner of the Division of Labor Standards Enforcement (the "Commissioner") for a determination as to the prevailing wage for landfill operators such as those employed by the Company in San Bernardino County. On July 25, 1999, the Company and the International Union of Operating Engineers, Local Union No. 12 ("Local 12") completed a three year collective bargaining agreement covering substantially all the operating personnel at the San Bernardino landfills and transfer stations operated by the Company. After the collective bargaining agreement was entered into, the Compliance Committee requested that the DIR withdraw the complaint. On September 24, 1999, the DIR accepted the Compliance Committee's request and issued a notice that the case had been closed.
HUMBOLDT COUNTY DISPOSAL AGREEMENT
The Company's subsidiary, City Garbage Company of Eureka, Inc., is currently in discussion with the County of Humboldt over sums due under the Solid Waste Disposal Agreement which expired on September 28, 1998 (the "Humboldt Agreement"). The Humboldt Agreement provides for payments relating to the final period of operations and for long-term environmental contingencies such as certain corrective action costs and closure and post-closure maintenance costs. The proposed actions and projected expenses were developed by independent consulting engineers and have been approved or submitted for approval to the applicable California regulatory agencies. The items in the termination payment and interim closure/post-closure payment which are disputed by the County of Humboldt total approximately $1 million. If the matter cannot be resolved informally, it will be subject to arbitration pursuant to the agreement between the parties. Although the outcome of any arbitration is inherently uncertain, the Company believes that it is likely to recover a substantial portion of the disputed amount.
ENVIRONMENTAL LIABILITIES
Cummings Road Landfill. In 1987, contamination was confirmed in the groundwater underlying and in the vicinity of the Company's Cummings Road Landfill in Humboldt County, California. Investigations indicated that the landfill was the source of the contamination. In response to civil claims, the Company made cash payments, restricted use of certain property, exchanged property and provided an alternative water supply to certain residents and businesses affected or potentially affected by the impacted groundwater. As part of a revised corrective action plan submitted to, and in 1994 approved by, the Regional Water Quality Control Board, various landfill improvements have been made including a trench to intercept upgradient groundwater to divert it away from the landfill. In July 1999, the Company and Humboldt Waste Management Authority ("HWMA") entered into an agreement in principal concerning the Cummings Road Landfill and the Company's Eureka Transfer Station. In November 1999, the Company entered into an agreement with HWMA, pursuant to which the Company would transfer to HWMA ownership of such properties as well as certain operating equipment. As part of the agreement, the Company would receive certain cash payments totaling approximately $4.2 million from the HWMA and HWMA would assume certain closure/post-closure, corrective action and operational responsibilities with respect to the Cummings Road Landfill. The Company would retain liability for its operation of the landfill prior to the closing of the transaction and for any defect in corrective action work performed by the Company at the landfill prior to the closing of the transaction. Under the agreement, the Company would also transfer to HWMA its interest in the closure/post-closure and corrective action trust funds relating to the landfill. The
consummation of the agreement is subject to several closing conditions. Provided such conditions are met or waived, the closing is expected to occur before January 15, 2000.
In the ordinary course of its business, the Company has incurred environmental liabilities at some of its other sites including soil and water contamination. Although the Company believes the environmental liabilities at these sites will not have a material adverse effect on the Company, there can be no assurance that such liabilities will not be material or that other material liabilities will not arise in the future at these or other sites.
OTHER MATTERS
From time to time, in the normal course of its business, the Company may become subject to various judicial and administrative proceedings involving federal, state or local agencies. The Company could incur substantial legal expenses during the course of such proceedings and the outcome of one or more of these proceedings could have an adverse impact on the Company's business. From time to time, the Company also may be subjected to actions brought by individuals or citizens' groups in connection with the grant or permits for its operations or alleging violations of permits or other regulatory requirements pursuant to which the Company operates, which, if successful, could have a material adverse effect on the Company's business. See "Risk Factors -- Environmental Regulation and Potential Litigation."
The Company is involved in various other legal actions in the normal course of business. It is the Company's opinion that these matters relating to the normal course of business are adequately provided for or that resolution of such matters will not have a material adverse impact on the financial condition of the Company; however, there can be no assurance that the impact of such matters on its results of operations or cash flows for any given reporting period will not be material.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is 100% owned by the ESOP and is not publicly traded.
The Company has declared no cash dividends on its common stock since 1988. The Indenture relating to the Senior Notes provides that the Company may not, and may not permit any of its subsidiaries to, directly or indirectly, declare or pay any dividend or make any distribution on account of, or any contribution in respect of, its capital stock, other than dividends or distributions payable in capital stock (other than stock, or any security convertible into common stock, with certain mandatory dividend or redemption provisions) of the Company or dividends or distributions payable from a subsidiary to the Company or any wholly-owned subsidiary of the Company, if at the time of and after giving effect to such dividend, distribution or contribution, certain conditions are not met. This provision does not prohibit certain purchases of capital stock distributed by the ESOP, certain contributions or dividends paid to the ESOP, or certain loans to the ESOP.
Pursuant to the Credit Agreement, neither the Company nor any of its subsidiaries may declare or pay any distributions (including dividends) on or in respect of any class of capital stock other than (i) distributions payable solely in its capital stock; (ii) distributions of cash by a subsidiary of the Company to a Subsidiary Guarantor or to the Company; (iii) certain distributions made to the ESOP; (iv) distributions made by the Company to repurchase any capital stock of the Company distributed by the ESOP, to the extent made under certain circumstances; and (v) other distributions not to exceed $1,000,000 in the aggregate per fiscal year, subject to certain events of default.
The Company has no present intention to pay a dividend. Any future determination to pay dividends will be at the discretion of the Board of Directors and will be dependent upon the Company's results of operations, financial condition, tax benefits and applicable contractual and legal restrictions and other factors deemed relevant by the Board of Directors.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES SELECTED FINANCIAL DATA
The following is a summary of certain consolidated financial information regarding the Company for the five years ended September 30, 1999.
- --------------- (a) Non-cash ESOP compensation expense is calculated under the shares allocated method based upon repayment on the ESOP's indebtedness to the Company, funded by contributions from the Company.
(b) Data for 1996 represent non-recurring expenses incurred in connection with the settlement of litigation involving the ESOP Notes.
(c) Includes indebtedness of the ESOP in fiscal year 1995 as required to be reflected on the Company's balance sheet by GAAP.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless otherwise indicated, references in the discussion below to a particular year are references to the Company's fiscal year ended September 30.
FORWARD LOOKING INFORMATION
Those statements followed by an asterisk (*) may be perceived to be forward looking statements. 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. The various risks and uncertainties described earlier (see "Risk Factors" in Item 1) and elsewhere in this Annual Report 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 San Bernardino County), fluctuations in commodities prices, changes in environmental regulations or related laws, inability to settle union labor contract disputes, competition, failure to achieve Year 2000 compliance and consequences of the Company's S Corporation election. The Company does not undertake to update any forward-looking statement that may be made from time to time by it or on its behalf.
GENERAL
The Company's revenues are comprised primarily of fees charged to residential, commercial and industrial customers for the collection and disposal of solid waste, disposal fees charged to third parties who dispose at the Company's transfer stations and landfills, fees charged for landfill operations and solid waste systems management activities for third party landfill owners, and revenues generated from the sale of recyclable materials.
Collection and disposal revenues are subject to pressures from a variety of sources, including increased competition, reductions and diversion of solid waste and regulatory changes. Revenues are generated through rates charged to customers. Residential rates are generally covered by formal rate setting mechanisms as established by rate boards or other local government jurisdictions, which provide a specified return on allowable costs. Commercial and industrial rates are generally subject to competitive considerations if not covered by formal rate setting mechanisms. The rate setting process may result in the exclusion of certain costs and/or delays in cost recovery. To the extent that certain operating costs are excluded from the allowable costs to be recovered, operating margins will be negatively impacted.* The Company believes the trend of increasing pressure on collection rates, and therefore profit margins, will continue in the future.*
Approximately 39% of the Company's revenues and substantially more of its operating income in fiscal year 1999 were derived from services performed in the City and County of San Francisco.
During 1996, the Company commenced management of the operations in San Bernardino County under a new contract. In addition to the operations and engineering activities with respect to all active landfill sites, the contract includes the opportunity to generate substantial revenues through the development and implementation of the County's Solid Waste Strategic Plan. Approximately 16% of the Company's revenues for fiscal year 1999 were derived from services performed for San Bernardino County. The Company's revenues from San Bernardino County are derived from two categories of services. The core service is the performance of ongoing landfill operations activities. Revenues from this component accounted for approximately 35% of total revenues generated in San Bernardino County in 1998. Over the term of the contract the amount of revenues from this core service has varied and will continue to vary primarily as a result of changes in volume of waste deposited at landfills and changes in the Company's per ton compensation rate. The other component of revenues represents activities associated with the planning and implementation of the strategic plan to regionalize landfill operations in San Bernardino County. This includes planning, engineering and construction management for landfill expansions, transfer station construction and landfill closures. It is anticipated that San
Bernardino County plans to spend approximately $50 million through June 30, 2001, and, if the County elects to complete its current strategic plan, up to an additional $50 million during the subsequent two-to three-year period, at which time the major work in connection with the strategic plan is expected to be completed.* See "Item 1. Business -- Landfills -- Operated Landfills -- San Bernardino County."
As a consequence of a former Company employee's and a former Company consultant's guilty pleas to federal charges of conspiring to pay and accept bribes to influence or reward a former San Bernardino County official in connection with such person's official duties, the County has alleged a default under the 1995 Contract. On December 14, 1999, the County Board of Supervisors directed the County's Chief Administrative Officer to negotiate an amendment with the Company to end the 1995 Contract as soon as the County can complete a competitive bidding process through a Request for Proposal, review submitted bids, and negotiate a replacement contract, but in no event later than June 30, 2001. Although the County's Chief Administrative Officer has estimated in his report to the County's Board of Supervisors that the process should take 15 to 18 months, the County's Board of Supervisors has requested that the process be completed more quickly, if possible. In response to this request, the County's Chief Administrative Officer has stated that the process could potentially be accomplished in 12 to 15 months. The Company is currently unable to estimate how much time the County will need to complete these procedures. Moreover, the Company does not know whether it can successfully negotiate such an amendment, what terms may ultimately be negotiated in such an amendment or whether the County's Board of Supervisors will approve any such amendment. Assuming the County is unable to complete the Request for Proposal and enter into a new contract in the next nine months, the Company does not expect an amendment to end the 1995 Contract or the termination of the 1995 Contract to have a significant impact on its cash flows, results of operations or financial condition for fiscal year 2000. The County has indicated that the Company will be permitted to bid on the new contract, but there can be no assurance that the Company will be awarded the new contract, or if the Company is the successful bidder, how the terms of the new contract will compare to those contained in the 1995 Contract.
During fiscal years 1999, 1998 and 1997, revenues derived from the services the Company performed for San Bernardino County were approximately $55.1 million (16% of the Company's total revenue), $65.1 million (19% of the Company's total revenue) and $55.1 million (17% 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 were approximately $6.6 million, $7.9 million and $7.4 million, respectively. While the Company's results of operations and cash flows will be adversely impacted if an amendment to end the 1995 Contract is negotiated or the 1995 Contract is terminated and the Company and the County do not enter into a new contract having comparable terms, management believes that such event will not have a material adverse effect on the Company's financial condition or on its ability to maintain its operations and service its debt. For further information see "Item 1. Business -- Landfills -- Operated Landfills -- San Bernardino County."
The revenues derived from the sale of recyclable materials are volatile and fluctuate in accordance with changes in prices of recyclable commodities which in turn are, in many cases, dependent on worldwide supply of and demand for such recyclable commodities. In the aggregate, the costs related to recycling operations do not fluctuate in accordance with changes in the prices of recyclable commodities and as a result the Company may experience increases or decreases in profitability depending on changes in the prices for recyclable commodities.
Operating expenses include labor, landfill project and subcontractor costs, disposal fees paid to third parties, fuel, equipment maintenance and rentals, engineering, consulting and other professional services and other direct costs of operations. Also included are accruals for 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 repay its intercompany loans to the Company along with amounts to fund distributions 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. Distribution payments are made by the ESOP to retired, terminated or withdrawing participants based on their vested allocated shares of Company common stock. The Company expects future contributions to the ESOP to fund distributions to increase significantly as additional employees reach retirement age, as additional shares are allocated to employee accounts, if eligible participants elect to receive in-service withdrawals and if the appraised value of the Company common stock increases.* During 1998, the Company made contributions to the ESOP that, in addition to funding the distribution obligation and the scheduled loan repayment, allowed the ESOP to prepay approximately $10.2 million of inter-company loans. The additional contribution for the prepayment resulted in substantial tax savings and additional ESOP compensation expense of approximately $7.4 million related to the additional shares allocated. On June 24, 1999, the Company and the ESOP executed an amendment to the Fourth Amended and Restated ESOP Loan Agreement related to the Company's S Corporation election. The amendment allows the ESOP to pay interest only during the period the Company remains an S Corporation, provided that the entire principal balance is still repaid by fiscal year 2008 (the final due date of the ESOP Agreement). As a result of the amendment, the Company's ESOP compensation expense of $1.0 million in 1999 related to the intercompany loans was based on a contribution of interest only. The Company expects the ESOP to pay interest only as long as the Company continues to be an S Corporation, however the total remaining balance of principal and interest payable must be repaid no later than September 30, 2008.* See "Accounting and Other Matters."
The Company has no present intention to pay a dividend. Any future determination to pay dividends will be at the discretion of the Board of Directors and will be dependent upon the Company's results of operations, financial condition, tax benefits and applicable contractual and legal restrictions and other factors deemed relevant by the Board of Directors.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES SUMMARY STATEMENTS OF OPERATIONS PERCENTAGE RELATIONSHIP TO TOTAL REVENUES
FISCAL YEAR 1999 COMPARED WITH FISCAL YEAR 1998
Revenues. Revenues in 1999 increased $5.3 million (1.6%) to $343.2 million from $337.9 million in 1998. Waste collection and disposal revenues increased by $18.0 million; approximately $6.8 million was due to operations acquired in Los Angeles in October and November 1998, approximately $5.0 million due to general volume increases and the remainder due to rate increases in several service areas. Third party landfill management services revenues decreased by $12.5 million due primarily to lower revenues of $9.9 million in San Bernardino County as a result of lower project management activities in 1999 and reduced landfill operations revenues due to reduced volumes 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. Additionally, with respect to its landfill management operations, the Company experienced a reduction of $2.6 million from 1998 in San Diego as the Company ceased operations of the San Diego County landfills on March 31, 1998, when the new owner assumed operations.
Operating Expenses. Operating expenses in 1999 increased $1.3 million (0.6%) to $242.1 million from $240.8 million in 1998. As a percentage of revenues, operating expenses decreased to 70.6% in 1999 from 71.3% in 1998. Disposal costs increased $5.2 million due to operations acquired in October and November 1998, higher volumes and tipping fee increases. Payroll and related costs increased $3.4 million due primarily to operations acquired in October and November 1998, as well as scheduled union wage increases. Fuel costs increased $0.9 million due to higher prices in 1999 and operations acquired in October and November 1998. Health care costs increased $0.9 million due to higher medical costs and operations acquired in October and November 1998. These increased costs were partially offset by lower project and subcontractor related costs of $7.6 million and lower landfill operating costs of $1.3 million. Both of these reductions were due primarily to lower project management activities during 1999 and reduced volumes in San Bernardino County compared to 1998.
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, along with contributions to fund distributions to retired, terminated and withdrawing participants. ESOP compensation expense in 1999 decreased $12.0 million (78.9%) to $3.2 million from $15.2 million in 1998. The decrease in expense can be attributed to lower contributions made to the ESOP based upon a revised payment schedule that does not currently include repayments of principal related to the Company's S Corporation election.
General and Administrative. General and administrative expenses in 1999 increased $3.2 million (9.4%) to $37.4 million from $34.2 million in 1998. As a percentage of revenues, general and administrative expenses increased to 10.9% in 1999 from 10.1% in 1998. The increased costs were primarily due to general wage increases of $2.0 million and higher professional services of $0.4 million.
Operating Income. Operating income in 1999 increased $11.5 million (41.7%) to $39.1 million from $27.6 million in 1998. The primary cause of the increase in operating income was the lower ESOP compensation expense described above.
Interest Income. Interest income in 1999 decreased $0.5 million (12.3%) to $3.3 million from $3.8 million in 1998. The decrease is due to lower cash balances during 1999 which resulted from higher capital expenditures and acquisitions of businesses compared to 1998.
Gain (Loss) on Dispositions. The gain on dispositions in 1999 of $0.6 million represents the net impact of asset disposals and decreased $3.1 million (83.8%) from 1998. The gain on dispositions in 1998 was primarily from the sale of real estate in San Francisco and Kansas City.
Other Income (Expense). Other income in 1999 increased $0.5 million (100.0%) to $1.0 million from $0.5 million in 1998. Other income in 1999 includes royalty income of $0.5 million related to an asset sold in 1995.
Income Tax Expense. Income tax expense of $0.3 million in 1999 was based primarily on the state tax rate of 1.5% for S Corporations 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 which did not elect to become divisions of the S Corporation. The Company experienced an effective tax rate of zero in 1998 as a result of realizing certain of its deferred tax assets for which a valuation allowance had previously been established.
Net Income. Net income in 1999 increased $8.1 million to $17.6 million from $9.5 million in 1998. The increase was primarily attributable to higher operating income partially offset by lower gains on dispositions discussed above.
FISCAL YEAR 1998 COMPARED WITH FISCAL YEAR 1997
Revenues. Revenues in 1998 increased $18.1 million (5.7%) to $337.9 million from $319.8 million in 1997. Third party landfill management services revenues increased by $9.3 million due primarily to expanded landfill operations and solid waste management activities in San Bernardino County as a result of higher project management revenues of $13.2 million from landfill closure and expansion project activities, partially offset by a temporary reduction of volumes to the San Bernardino County landfills during the first half of the 1998 fiscal year and reduced revenues in San Diego as the Company ceased operations of the San Diego County landfills on March 31, 1998, when the new owner assumed operations. Waste collection and disposal revenues increased by $8.6 million, $5.5 million due to rate increases in several service areas (primarily an 11.0% increase in San Francisco, effective March 1, 1997), with the remaining increase due to general volume increases.
Operating Expenses. Operating expenses in 1998 increased $13.3 million (5.9%) to $240.8 million from $227.5 million in 1997. As a percentage of revenues, operating expenses increased slightly to 71.3% in 1998 from 71.1% in 1997. Project and subcontractor related costs increased $11.4 million due to increased landfill closure and expansion project activities in San Bernardino County. Payroll and
related costs increased $5.8 million due to scheduled union wage increases (primarily a 2.0% increase in San Francisco, effective January 1, 1998), higher employee benefit costs in San Francisco as a result of the April 1997 union agreement and higher health care costs. Disposal costs increased $1.5 million due to higher volumes and tipping fee increases. In 1998, the Company accrued $1.0 million for estimated losses to be incurred on certain contractual obligations. These increased costs were partially offset by lower landfill related costs of $3.3 million due to the substantial completion of corrective action activities at one of the Company's landfills and reductions for estimated closure costs. Professional services decreased $2.9 million reflecting lower engineering services for recycling facilities as well as reduced consulting services.
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, along with contributions to fund distributions to retired, terminated and withdrawing participants. ESOP compensation expense in 1998 increased $2.1 million (16.0%) to $15.2 million from $13.1 million in 1997. The increase in expense can be attributed to higher contributions made to the ESOP that allowed the ESOP to make scheduled loan payments and prepayment of additional principal along with an increase in contributions related to the funding of distributions due to a higher share value and an increased number of shares repurchased.
General and Administrative. General and administrative expenses in 1998 increased $1.7 million (5.2%) to $34.2 million from $32.5 million in 1997. As a percentage of revenues, general and administrative expenses decreased to 10.1% in 1998 from 10.2% in 1997. The increased costs were primarily due to general wage increases.
Operating Income. Operating income in 1998 increased $0.6 million (2.2%) to $27.6 million from $27.0 million in 1997. The primary cause of the increase in operating income was increased revenues.
Interest Expense. Interest expense in 1998 increased $0.6 million (2.3%) to $26.2 million from $25.6 million in 1997. The increase is due to a higher effective interest rate on the Senior Notes in the current period.
Interest Income. Interest income in 1998 increased $1.3 million (52.0%) to $3.8 million from $2.5 million in 1997. The increase is due to higher cash balances which earned interest in 1998.
Gain (Loss) on Dispositions. The gain on dispositions in 1998 of $3.7 million represents the net impact of asset disposals, primarily real estate in San Francisco and Kansas City.
Other Income (Expense). Other income in 1998 decreased $2.1 million (80.3%) to $0.5 million from $2.6 million in 1997. Other income in 1997 included gains of $1.4 million from the sale of marketable securities and a $1.0 million settlement with a third party in connection with a dispute over a landfill engineering matter at one of its landfills.
Income Tax Expense. There was no income tax expense in 1998 or 1997. The Company has experienced an effective tax rate of zero in 1998 and 1997 as a result of realizing certain of its deferred tax assets for which a valuation allowance had previously been established.
Net Income. Net income in 1998 increased $3.0 million to $9.5 million from $6.5 million in 1997. The increase was primarily attributable to higher gains on dispositions and higher interest income partially offset by lower other income discussed 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. As of September 30, 1999, the Company had working capital of $29.9 million. As part of the Refinancing the Company entered into the Credit Agreement which currently provides for up to $90 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 September 30, 1999, 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 $52.9 million, 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 in the Credit Agreement become more restrictive over time. Applying the more restrictive covenant measures in effect beginning December 31, 1999 to the Company's estimated results of operations for the twelve month period ending December 31, 1999 would result in a decrease in availability under the Credit Agreement of approximately $4.4 million. The Company's performance relative to the covenant measures is calculated on a quarterly basis.
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 additional debt.
The Senior Notes mature in November 2005. As of September 30, 1999, 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 as 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 Norcal's option, upon not less than 30 nor more than 60 days' notice. Any such voluntary redemptions by Norcal through November 14, 2003 will include a redemption premium payment that declines annually over such period. For any redemptions made by Norcal 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 Operations. Cash flow from operations in 1999 increased 79.7% to $46.0 million from $25.6 million in 1998. The increase was due to a smaller reduction in accounts payable in 1999 compared to 1998 of $5.2 million, a $4.1 million decrease in accounts receivable and a $3.9 million decrease in tax payments.
Cash Flow from Investing Activities. Cash used by investing activities in 1999 increased 150.0% to $42.0 million from $16.8 million in 1998. The Company used $33.7 million on capital expenditures during 1999, primarily vehicles, construction projects, containers and other equipment and $9.9 million to purchase the stock of solid waste collection company and substantially all of the assets of two other solid waste collection companies in Los Angeles. In 1998, the Company generated $7.3 million from the sale of miscellaneous assets, primarily real estate in San Francisco and Kansas City.
Cash Flow from Financing Activities. Cash used by financing activities was $1.7 million in 1999 and $1.3 million in 1998; consisting primarily of principal payments on long term debt and capital leases in both years.
OTHER CASH REQUIREMENTS
The Company has material financial obligations related to closure and post-closure costs with respect to landfills it owns. While the amount of these future obligations cannot be determined definitively at this time, the Company estimates the costs in current dollars for final closure of landfills it owns, as well as related post-closure activities for an estimated period of thirty years after the closure of each respective landfill, at approximately $52.9 million.* The Company recognizes an expense and
liability for such costs based on units of production and makes contributions to trust funds to satisfy financial assurance requirements and fund the landfill costs. As of September 30, 1999, the Company had recorded a liability of $25.9 million for such projected costs in accordance with generally accepted accounting principles ("GAAP") and had on deposit $25.0 million in trust accounts consistent with regulatory requirements. The Company estimates its 2000 funding requirement at approximately $0.5 million, although the actual requirements could vary with changes in cost estimates and/or regulatory requirements.*
The Company also has significant financial obligations with respect to certain environmental statutes and regulations protecting the groundwater and surface water in the vicinity of its landfills. The Company estimates the remaining funding associated with this issue to be approximately $5.6 million and is satisfying that obligation through deposits made to trust funds.* The Company estimates its 2000 funding requirement at approximately $0.3 million, although the actual requirement could vary with changes in cost estimates and/or regulatory requirements.* The Company also has recorded a liability of $2.6 million for potential costs associated with other environmental matters.
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 material 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).*
The Company is obligated to provide, subject to certain conditions, post-retirement health and welfare benefits to certain former employee-shareholders (as well as their spouses and dependents) of two of its predecessors. Although the Company's obligation with respect to some of its former employee-shareholders will terminate upon the earlier of October 1, 2000 or the final resolution of legal claims against third parties reserved pursuant to the settlement of litigation, most of the Company's obligations extend for the lifetime of such former employee-shareholders. The accrued post-retirement medical benefit liability as of September 30, 1999 was $35.5 million and the Company made cash payments during 1999 totaling approximately $1.3 million. Payments at rates similar to those made in 1999 or greater, depending on medical inflation rates and the aging of the persons entitled to benefits, are expected for a significant number of years.*
The Company anticipates future increases in the ESOP contributions related to funding the distributions to retired, terminated or withdrawing participants based on their vested allocated shares of Company common stock.* The Company expects the contributions to increase as additional employees reach retirement age, as additional shares are allocated to employee accounts, if eligible participants elect to receive in-service withdrawals and if the value of the Company common stock increases. While Norcal may consider a public offering of its common stock as a potentially desirable way to eliminate the ESOP-related requirements to either repurchase stock or fund cash distributions for retired, terminated or withdrawing employees, there can be no assurance that Norcal would be able to effect such an offering or otherwise create a trading market for its stock.*
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 upward revision as the Company's knowledge increases concerning these factors.
INFLATION AND PREVAILING ECONOMIC CONDITIONS
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 also have affected 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.
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 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. On February 10, 1998, the Company filed a petition for order compelling arbitration in U.S. District Court for the Northern District of California entitled Norcal Waste Systems, Inc., Golden Gate Disposal and Recycling, Inc. and Sunset Scavenger Company v. Sanitary Truck Drivers and Helpers Union Local 350, IBT. On April 23, 1998 the Company filed a motion for order compelling such arbitration. On May 29, 1998, the Court ruled in the Company's favor and directed the parties to proceed with arbitration.
Representatives of the Company and Local 350 have entered into a Memorandum of Understanding (the "Memorandum"), which provides that the parties will suspend the arbitration and that when the Company files its next rate application with the San Francisco Department of Public Works, which application may be filed at such time as the Company reasonably determines is appropriate, such application will include a request for sufficient money to cover the funding of costs of the pension benefit increases requested by Local 350 (the "Local 350 Amounts"). The Memorandum further provides that, if the Company's rate applications are granted and become effective, including the Local 350 Amounts, the arbitration will be terminated with prejudice; but if such request is denied, in whole or in part, for any reason and the Company does not put into effect the pension increases requested by Local 350, either party may reinstate the arbitration. The Company has not determined when it will submit a rate application. The ultimate outcome of this matter cannot be determined at this time and the results of the rate application process or the arbitration proceeding, if reinstated, cannot be predicted with certainty. If the arbitration is reinstated, the arbitrator could find in favor of the Company or Local 350, or could conclude that there has been no meeting of the minds on this provision of the contract and the provision could have to be renegotiated. If the matter is not satisfactorily renegotiated, the Company could be subject to another work stoppage. Such events
could have a material adverse effect on the financial condition or results of operations of the Company. See "Risk Factors -- Union Matters."
If either party was to reinstate the arbitration and if Local 350 was to prevail in the arbitration discussed above or if the Company is successful in obtaining funding for the Local 350 amounts, the Company estimates that the accumulated benefit obligation ("ABO") as of September 30, 1999 would increase by an additional $8.2 million and reduce stockholder's equity by $1.8 million. In addition, if the increased pension benefits are provided, the Company's estimated incremental increase in its annual expense for employee benefits would be approximately $3.1 million for pension and medical costs. Such incremental increase in expense would be mostly offset by higher revenue if the Company is successful in obtaining increased rates to cover the additional funding. 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.
Included in the five-year contract referred to above was an aggregate 13.4% wage increase. The first year cost of the contract is included in the current rate in San Francisco and the Company intends to seek rate recovery of cost increases through the rate setting process.* There can be no assurance that the Company will succeed in obtaining timely rate increases sufficient to cover all costs or sufficient to maintain profit levels at historical levels.
Due to the Company's concentration in California, cyclical economic conditions in California will have an impact on the Company's results.* The Company is unable to determine the significance a California economic downturn would have on its operations.
SEASONALITY
The Company's revenues tend to be higher during spring and summer (third and fourth fiscal quarters) due to higher volumes of certain types of waste, such as construction and demolition debris. Such increased volumes result in higher revenues and earnings from the Company's transfer stations, waste collection, and landfill operations during such months. In addition, project management revenues are highest in the fourth quarter as a result of favorable construction conditions. Unusual changes in weather patterns can also affect the operating results on a quarter to quarter basis.
ACCOUNTING AND OTHER MATTERS
The Internal Revenue Service's (the "IRS") audit of the Company's income tax returns for the fiscal years ended September 30, 1992 through 1994, which was initiated in 1996, has been completed. The IRS is currently auditing the Company's tax returns for the fiscal years ended September 30, 1995 through 1997. The California Franchise Tax Board's audit of the Company's state income tax returns for the fiscal years ended September 30, 1993 through 1997 is ongoing.
The Company elected to become taxable as an S Corporation effective with the tax year beginning October 1, 1998. In connection with the 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 (each a Qualified Subchapter S Subsidiary). 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. 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 is not subject to tax on its allocable share of the Company's taxable income. Although S Corporations generally are not subject to corporate-level income taxes, the Company, for so long as it retains its status as an S Corporation, will be subject to (a) potential income taxes related to the disposition of, or the realization of income with respect to, certain built-in gain assets (that is, any asset, such as real estate or securities, with a fair market value greater than its tax basis as of October 1, 1998 or income reported which relates to taxable periods prior to the Company becoming an S Corporation, including, for example, income subsequently reported by reason of a pre-existing change in accounting method) and
(b) state income taxes at a rate of 1.5%. Deferred tax assets and liabilities are eliminated when a taxable enterprise becomes a non-taxable enterprise and the effect of recognizing or eliminating deferred tax assets or liabilities is charged or credited to income tax expense within income from continuing operations. Corporations that elect S Corporation status generally are subject to tax under built-in gains provisions as previously discussed and thus would be required to continue to recognize deferred taxes associated with built-in gains. Deferred taxes related to built-in gains for the Company include deferred taxes for anticipated sales of real estate and other assets. In addition, for subsidiaries of the Company that do not elect to become Qualified Subchapter S Subsidiaries, deferred taxes must be maintained for existing tax liabilities. The Company currently maintains deferred taxes related to anticipated built-in gains and existing tax liabilities for those subsidiaries that did not elect to become Qualified Subchapter S Subsidiaries.
ITEM 7A.
ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not believe that there is any material market risk exposure with respect to derivative or other financial instruments which would require disclosure under this item. The Company does not engage in financial transactions for trading or speculative purposes.
ITEM 8.
ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
INDEPENDENT AUDITORS' REPORT
The Board of Directors Norcal Waste Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Norcal Waste Systems, Inc. (the Company) and subsidiaries as of September 30, 1999 and 1998, and the related consolidated statements of income, stockholder's equity and cash flows for each of the years in the three year period ended September 30, 1999. In connection with our audits of the consolidated financial statements, we have also audited financial statement schedule II. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Norcal Waste Systems, Inc. and subsidiaries as of September 30, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three year period ended September 30, 1999, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule II, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
San Francisco, California December 17, 1999
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1999 AND 1998 (IN THOUSANDS)
ASSETS
See accompanying notes to consolidated financial statements.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997 (IN THOUSANDS)
See accompanying notes to consolidated financial statements.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997 (IN THOUSANDS)
See accompanying notes to consolidated financial statements.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997 (IN THOUSANDS)
See accompanying notes to consolidated financial statements.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 AND 1998
(1) NATURE OF BUSINESS
Through its subsidiaries, Norcal Waste Systems, Inc. (the Company) provides integrated waste services to residential, commercial, municipal and industrial customers in California. The Company's services include refuse collection, recycling and other waste diversion, transfer station and hauling operations, 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 (note 15).
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation
The consolidated financial statements include the accounts of Norcal Waste Systems, Inc. and its subsidiaries, all of which are wholly owned. The Company uses the equity method for its investments in companies which are 50% or less owned and are not consolidated. All significant intercompany accounts and transactions have been eliminated.
The Company's outstanding common stock is 100% owned by the Norcal Waste Systems, Inc. Employee Stock Ownership Plan and Trust (the Norcal ESOP or the ESOP).
(b) Revenue Recognition
The Company recognizes revenue when services are performed. Revenues billed in advance are deferred and recorded as income in the period in which the related services are rendered. A significant amount of the Company's revenue is subject to rate regulation by local jurisdictions under franchise agreements and permits.
The Company performs project services on certain managed landfills relating to landfill closure, landfill expansion and various regulatory compliance tasks. Revenues are recognized on the percentage-of-completion method. Determination of the percentage complete is based on estimates of subcontractors of actual job progress and expenses incurred. Project costs include all direct and indirect costs related to contract performance including subcontractors, materials and internal labor. General and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.
(c) Parts and Supplies
The Company's parts and supplies are recorded at cost (first-in, first-out).
(d) Property and Equipment
Property and equipment, including major renewals and betterments, are stated at cost. Property and equipment under capital leases are stated at the present value of minimum lease payments at the inception of the lease. Ordinary maintenance and repairs are charged directly to operations. The Company capitalizes interest costs for significant projects under development. The amount capitalized and netted against interest expense in the consolidated statements of income was $0.4 million in 1999 and $0.2 million in both 1998 and 1997. Certain properties available for sale have been written down to their estimated net realizable value.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Depreciation is calculated on the straight-line method over the estimated useful lives of assets as follows: buildings and improvements, 3 to 40 years; and vehicles and equipment, 6 to 9 years. Property and equipment held under capital leases and leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the asset.
Landfills are carried at cost which includes acquisition, engineering and permitting costs related to landfills which are currently in operation. These costs are amortized as the landfill is used, based on engineering estimates of the available capacity. Engineering, legal and other costs associated with the development of new landfills and expansion at existing landfills are deferred pending receipt of all necessary operating permits, at which time they are capitalized as landfill costs. The Company is required to close, monitor, and maintain landfill sites for a period of thirty years or more after closure. The estimated costs and changes thereto in current dollars attributable to future closure and post-closure costs are accrued in landfill closure liabilities for each site based upon the capacity used in the current year in relation to the total remaining capacity as of the beginning of the year.
(e) Intangible Assets
The excess of cost over net assets of acquired businesses is amortized on the straight-line method over periods not exceeding 40 years. Franchises, permits and contracts are amortized on the straight-line method over their estimated lives ranging from 3 to 40 years. In accordance with Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for Impairment of Long Lived Assets and for Long Lived Assets to be Disposed Of, the Company's policy is to review the estimated undiscounted future cash flows for each operation on an annual basis and to compare it to the remaining net book value to ascertain if a provision for impairment is necessary.
(f) Income Taxes
The Company utilizes the liability method of accounting for income taxes prescribed by SFAS No. 109, Accounting for Income Taxes. Under the liability method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Deferred taxes are provided on financial statement and income tax basis differences relating to business acquisitions, except that no deferred taxes are provided on amounts related to operating permit rights and excess of costs over net assets of businesses acquired. Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. This standard requires that the Company recognize income tax benefits for loss carryforwards and certain temporary differences for which tax benefits have not previously been recorded. The likelihood of realizing the tax benefits related to a potential deferred tax asset is evaluated, and a valuation allowance is recognized to reduce that deferred tax asset to an amount that more likely than not will be realized. Effective October 1, 1998, the Company elected to change its tax status to become an S Corporation (note 8).
(g) ESOP Accounting
The Company recognizes ESOP compensation expense using the shares allocated method whereby the expense is based upon contributions by the Company to the ESOP relating to ESOP debt service payments, the historical cost of the shares and the number of shares allocated by reason of such payments. Shares allocable to participants for a given year are determined based on the ratio of the current year's debt service payments to the total of the current year's and estimated remaining debt
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
service. Shares to be allocated to individual participants are based upon the participants' relative compensation.
(h) Cash and Cash Equivalents
Cash and cash equivalents include all cash balances and highly liquid investments with a remaining maturity at the time of purchase of three months or less. Cash and cash equivalents are principally comprised of cash invested in demand accounts and money market instruments and are stated at cost plus accrued interest.
(i) Marketable Securities and Trust Accounts
Marketable securities represent primarily investments in fixed income securities of federal government entities which are considered as available for sale securities and are recorded at market value using the closing price as quoted on a national securities exchange. The available for sale securities mature at various dates from October 1999 to July 2009. Unrealized gains and losses, which occur when the cost basis differs from the fair value, are included as a separate component of stockholder's equity, in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. During fiscal 1999, $1.3 million of available for sale securities were sold for proceeds of $1.3 million. During fiscal 1998, $5.1 million of available for sale securities were sold for proceeds of $5.2 million. The cost of securities sold is based on the specific identification method. The gross unrealized holding gains and gross unrealized holding losses for available for sale securities at September 30, 1999 were $0.1 million and $0.3 million, respectively, and at September 30, 1998 were $0.4 million and $0.1 million, respectively.
The Company has established restricted and unrestricted trust accounts principally in connection with financial assurance for closure and post-closure liabilities related to landfill operations, financial assurance for the initiation and completion of corrective action and liabilities to third parties for bodily injury/property damage. Amounts are principally invested in fixed income securities of federal government entities with maturities from two to ten years. The Company considers certain of its trust accounts to be held to maturity and, consequently, has stated these investments at amortized cost in accordance with SFAS No. 115. To the extent that the Company expects the closure/post-closure cash requirements to change, it will periodically modify the maturity profiles of such investments. The remainder of all trust accounts are considered available for sale. During fiscal 1999, $0.1 million of held to maturity securities were sold for proceeds of $0.1 million. During fiscal 1998, $10.0 million of held to maturity securities were sold for $10.2 million, which was reinvested in similar fixed income securities with maturities more closely aligned with current landfill closure projections. The gross unrealized holding gains and gross unrealized holding losses for held to maturity securities at September 30, 1999 were $0.1 million and $0.1 million, respectively, and at September 30, 1998 were $0.2 million and $0.3 million, respectively.
The maturity dates for the Company's investments are as follows (in millions):
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(j) Stock Options
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 establishes accounting and reporting standards for stock-based compensation plans. This Statement allows companies to choose between the "fair value based method of accounting" as defined in this Statement and the "intrinsic value based method of accounting" as prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. The Company has elected to remain with the accounting requirements under APB 25. The pro forma disclosures of net income required by SFAS No. 123, as if the fair value based method of accounting had been applied, are included in note 9.
(k) Use of Estimates
Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
(l) Reclassifications
Certain prior year balances have been reclassified to conform to the current year presentation.
(3) BUSINESS ACQUISITIONS
On November 18, 1996, the Company completed the acquisition of substantially all of the assets of a solid waste business in Butte County. Results of operations of this entity have been included in the consolidated financial statements from the acquisition date. The Company paid $2.6 million in cash and issued a note with a face value of $2.0 million repayable over 20 years at 6.5% interest. The note was discounted to $1.7 million to yield an imputed rate of 8.75%. The acquisition was accounted for under the purchase method of accounting; accordingly, the purchase price was allocated to the assets acquired (principally operating permits) based on estimates of their relative fair value.
In February and April 1997, the Company acquired certain assets for $1.1 million in cash from businesses operating in the collection and disposal of medical wastes.
On October 14, 1998, the Company completed the acquisition of a waste collection company in the Los Angeles metropolitan area. The Company paid $2.2 million in cash, assumed liabilities of $0.2 million and issued two convertible notes with face values of $1.0 million each repayable over 5 years at 5.5% interest. The combined notes were discounted to $1.8 million to yield an imputed interest rate of 8.5%. In November 1998, the Company acquired certain assets of two waste collection companies in the Los Angeles metropolitan area for $7.6 million, primarily in cash.
(4) FRANCHISES, PERMITS AND OTHER INTANGIBLES
When the Company acquires businesses with definitive franchise or other agreements with specific terms, a portion of the purchase price is allocated to the franchise based upon its estimated fair value at the date of acquisition. In certain instances, permits or other legal documents evidence the Company's right to do business for an indefinite period and are similar to goodwill. Any amounts in excess of amounts allocated to franchises and permits are included in excess of cost over net assets of
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
businesses acquired. A summary of intangible assets, net of accumulated amortization at September 30, is as follows:
(5) INVESTMENTS IN UNCONSOLIDATED AFFILIATES
The investments in unconsolidated affiliates are included in other assets in the accompanying consolidated balance sheets. The Company's equity in earnings of unconsolidated affiliates included in other income in the consolidated statements of income, was $0.6 million, $0.4 million and $0.2 million for the years ended 1999, 1998 and 1997, respectively.
(6) LONG-TERM DEBT
Long-term debt at September 30, 1999 and 1998 is summarized as follows:
On November 21, 1995, the Company completed a private debt offering, (the Refinancing) of $175.0 million in Series A Senior Notes. The Series A Senior Notes were to mature in November 2005 with interest payable semi-annually. The Series A Senior Notes were redeemable at the option of the Company, in whole or in part, at any time during or after November 2000. Prior to this date, the Series A Senior Notes were partially redeemable in the event of a public offering, or would have been required to be redeemed in the event of a change in control of the Company. The Series A Senior Notes were unsecured and ranked pari passu in right of payment to all existing and future senior indebtedness of the Company. The Series A Senior Notes were guaranteed on a senior unsecured basis by the Company's wholly-owned subsidiaries. The Indenture governing the Series A Senior Notes contained provisions which, among other things, (i) limited 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) limited the purchase, redemption or retirement of capital stock and (iii) limited the incurrence of additional debt. In September 1996, the Company completed the exchange of all of its outstanding Series A Senior Notes for Series B Senior Notes
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Senior Notes) with an identical principal balance and terms. The exchange was completed under the Securities Act of 1933. The interest rate on the Senior Notes at September 30, 1999 was 13.5%. The interest rate reverts back to 12.5% if Norcal (in one or more transactions) offers to purchase at 110% (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.
The Company received net proceeds from the private debt offering of $170.2 million (after original issuance discount of $4.8 million). Deferred financing costs at September 30, 1999 include commissions and other costs related to the offering and the new credit agreement (see below) and are being amortized over the life of the Senior Notes and the new credit agreement. The Company used the proceeds from the Series A Senior Notes, proceeds from the liquidation of indemnification trusts and cash balances to repay $94.0 million of long-term debt, $2.2 million of capital leases, redeem and cancel subordinated notes for $73.4 million and settle litigation for $3.6 million. The recorded value and associated accrued interest of the subordinated notes that the Company redeemed was $103.3 million. The Company recognized an extraordinary gain in 1996 of $31.4 million in connection with the redemption.
Total debt outstanding at September 30, 1999, matures as follows: 2000, $0.4 million; 2001, $0.3 million; 2002, $1.6 million; 2003, $1.2 million; 2004, $0.1 million; and thereafter, $172.8 million, net of unamortized discount of $3.6 million. Included in accrued expenses at September 30, 1999 and 1998 is accrued interest amounting to $9.0 million for both years.
Concurrent with the private debt offering, the Company entered into a new Credit Agreement with a group of lenders and the First National Bank of Boston as Agent. The agreement, which expires on November 21, 2000, established a revolving credit facility in an amount currently of up to $90 million, up to $25 million of which can be used for letters of credit. Substantially all of the assets of the Company and its wholly owned subsidiaries are pledged to secure the obligations of the Company and such subsidiaries. Subsidiaries of the Company have guaranteed the debt under the Credit Agreement on a joint and several basis (note 16). The Credit Agreement provides for certain positive and negative covenants including restrictions on indebtedness, investments, and distributions among others, and financial covenants including leverage ratio, interest coverage ratio, consolidated net worth, and debt service ratio. The credit facility may be reduced by $2.5 million each quarter beginning with the quarter ending December 31, 1998 until the maturity date. There are no compensating balance requirements or any informal arrangements in connection with any of the loans. The Company must pay to the lenders a commitment fee on the daily average amount of the unused credit commitment at an annual rate per annum equal to 0.05%, plus an amount equal to 2.25% of the face amount of each letter of credit. Except as set forth below, there were no borrowings outstanding under the Credit Agreement at September 30, 1999.
In the event of a default under the Credit Agreement, the rights of Norcal with respect to the liquidation of all of the assets of Norcal's wholly owned subsidiaries and the capital stock of the wholly owned subsidiaries would be subject to the prior claims of the lenders under the Credit Agreement. A NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
default under the Senior Notes constitutes an event of default under the Credit Agreement. Similarly, certain defaults under other indebtedness in excess of $5.0 million (including indebtedness under the Credit Agreement) constitute an event of default under the Indenture.
At September 30, 1999, the Company had utilized $2.3 million of the credit facility provided by the Credit Agreement for the letters of credit and had availability under the Credit Agreement of approximately $52.9 million, 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.
(7) LEASES
The Company leases certain land, buildings, vehicles and equipment under lease agreements. Certain of these leases are accounted for as capital leases. The Company is responsible for all maintenance costs, taxes and insurance on the buildings, vehicles and equipment. At September 30, the gross amount of property and equipment and related accumulated amortization recorded under capital leases were as follows:
Future minimum lease payments under noncancelable operating leases and the present value of future minimum capital lease payments at September 30, 1999 are as follows:
Rental expense charged to operations under all operating leases was approximately $4.8 million, $4.6 million and $4.4 million for the years ended 1999, 1998, and 1997, respectively, including amounts under short-term rental agreements.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) INCOME TAXES
Income tax expense (benefit) for the fiscal years ended September 30 is as follows:
Total income tax expense differed from the amount computed by applying the federal statutory income tax rate of 35% to income as a result of the following:
The deferred tax liability at September 30, 1999 and 1998 primarily relates to financial statement carrying amounts in excess of the tax basis in certain land investments that will not be disposed of in
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the foreseeable future. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at September 30 are summarized below:
The total valuation allowance decreased for the years ended September 30, 1999 and 1998 by $3.7 million and $5.2 million, respectively.
The Internal Revenue Service (the Service) has completed examinations of the Company's income tax returns for the fiscal years ended September 30, 1988 through September 30, 1991 and the fiscal years ended September 30, 1992 through September 30, 1994. The Service has begun an examination of the Company's income tax returns for the fiscal years ended September 30, 1995 through September 30, 1997. The California Franchise Tax Board is examining the Company's state income tax returns for the fiscal years ended September 30, 1993 through 1997.
It is the Company's opinion that the matters relating to these examinations are adequately provided for or that the resolution of such matters will not have a material adverse impact on the financial condition of the Company; however, there can be no assurance that the impact of such matters on its results of operations or cash flows for any given reporting period will not be material.
The Company elected to become an S Corporation effective October 1, 1998 and to treat a number of its subsidiaries as divisions for income tax purposes. Under S Corporation rules, taxable income and losses are passed through to the ESOP, the Company's sole shareholder, which is exempt from income tax.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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). In addition, for subsidiaries of the Company that did not elect to become Qualified Subchapter S Subsidiaries and treated as a division of the Company, deferred taxes will continue to be maintained for existing corporate level tax liabilities.
Deferred tax assets and liabilities are eliminated when a taxable enterprise becomes a non-taxable enterprise and the effect of recognizing or eliminating deferred tax assets or liabilities is charged or credited to income tax expense in income from continuing operations. However, corporations that elect S Corporation status generally are subject to tax under built-in gains provisions as previously discussed and thus would be required to continue to recognize deferred taxes associated with built-in gains and the California 1.5% franchise tax. At September 30, 1999, the Company provided deferred taxes associated with anticipated built-in gains.
(9) STOCKHOLDER'S EQUITY
(a) Capital Structure
The Company's Articles of Incorporation allow for the issuance of Preferred Stock in one or more series, at such designations, rates of dividends, redemption prices, liquidation payments, voting rights and conversion, exchange or other special rights to be determined at the time of issuance. None is presently issued or outstanding.
(b) Stock Options
The Company has four stock option plans that provide for the granting of Incentive Stock Options and Non-Qualified Stock Options for the purchase of Common Stock. The options may be granted to officers, employees, directors and independent contractors of the Company. Participation in the Stock Option Plans is determined by the Compensation Committee of the Board of Directors, based on the parameters of each respective plan. The term of an option granted under any of the option plans cannot exceed ten years and may be further limited by the specific restrictions as detailed in the individual plans. The options generally are exercisable pursuant to any vesting requirements imposed by the Compensation Committee upon the grant of the options.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table sets out specific details of the respective stock option plans and status as of September 30, 1999, 1998 and 1997:
- --------------- (a) To the extent shares are granted under the 1990 Stock Option Plan, the 1996 Executive Stock Incentive Plan, the Deferred Compensation and Stock Option Plan (defined below) or the 1996 Non-Employee Director Stock Option Plan, the number of shares available under the 1996 Employee Stock Incentive Plan is reduced by a corresponding amount.
In addition to the plans summarized above, the Company has granted a nonqualified stock option pursuant to a plan (the Deferred Compensation and Stock Option Plan) to a former officer to purchase up to 300,000 shares of common stock at an exercise price of $4.89 per share. At September 30, 1999, 300,000 shares were vested.
The Company applies APB 25 in accounting for its Plans. Had the Company determined compensation cost using the fair value based method of accounting, as defined by SFAS No. 123, for its
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
stock options, the Company's net income would have been reduced to the pro forma amounts indicated below:
Pro forma net income has been computed using the Black-Scholes option pricing model and the following assumptions:
The full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because the estimated compensation cost will be recognized over the options' vesting periods.
(c) Employee Stock Ownership Plan
In 1986, one of the Company's predecessors (Old Norcal) established an employee stock ownership plan and trust (the ESOP) which purchased all of the Company's outstanding stock. Old Norcal borrowed funds from a lender group and in turn Old Norcal loaned funds to the ESOP which were used together with certain subordinated notes (the ESOP Notes) for the purpose of purchasing the stock. In addition, in connection with two other transactions, the Company borrowed funds from lender groups and in turn loaned funds to the ESOP.
The ESOP will obtain funds to repay the Company loans, including interest, primarily through the receipt of tax deductible contributions made by the Company. For financial statement purposes, the Company's future scheduled contribution to the ESOP, as described below, is reflected as a reduction of stockholder's equity.
The ESOP covers most of the employees of the Company and is noncontributory. The benefits are based on the employee's account balance which is a function of contributions, forfeitures, income and appreciation or depreciation in the value of assets allocated to the accounts based on years of service and compensation.
In connection with the Refinancing (note 6) the ESOP's indebtedness reflects, among other things, Norcal's funding of the ESOP's retirement of the ESOP Notes, repayment of all amounts owed under the Old Credit Agreement, and incurrence of new indebtedness by the Company pursuant to the Refinancing. At September 30, 1999, the outstanding principal balance owed to Norcal was $38.6 million. The ESOP and Norcal entered into a Fourth Amended and Restated ESOP Loan Agreement, (the ESOP Agreement), effective as of October 1, 1995, whereby the ESOP will repay such outstanding indebtedness, plus unpaid accrued interest at the rate of 7.0% per annum, in installments of approximately $9.8 million each as of September 30 of each year, beginning in 1996. In addition, the ESOP will prepay such outstanding indebtedness, without penalty, to the extent that Norcal makes contributions to the ESOP for the purpose of making such prepayments subject to certain limitations.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company made an additional contribution of $10.2 million in 1998 to the ESOP which amount has been applied as a prepayment of the loans from the Company to the ESOP. During 1999, the Company and the ESOP amended the ESOP Agreement to allow the ESOP to pay interest only during the period the Company remained an S Corporation, provided that the entire principal balance was still repaid by fiscal year 2008, the final due date of the ESOP Agreement.
The scheduled contribution to the ESOP presented in the accompanying balance sheets as a reduction in equity represents the aggregate principal amounts which the Company has scheduled to contribute to the ESOP in future years attributable to the original loans and is summarized as follows:
Following is a summary of shares as of September 30:
The Company has an obligation to make cash contributions to the ESOP or to repurchase shares from participants as described below. The cash contributions made for purposes of funding ESOP benefit payments were $2.2 million, $2.0 million and $1.7 million for the years ended September 30, 1999, 1998, and 1997, respectively. The amount of the repurchase obligation will increase significantly in the future as the Company's workforce ages and retires, as additional shares are allocated to participants, if eligible participants elect to receive in-service withdrawals and if the value of common stock increases. The fair value of the shares as established by the ESOP Administrative Committee based on the valuation of independent appraisers was $6.05 and $6.26 as of September 30, 1999 and 1998, respectively.
The Company's common stock is not traded on an established market. Presently, all shares are held by the ESOP, and all benefit distributions from the ESOP are intended to be made in cash which is received from Norcal or trust income. A participant who is vested is entitled to begin receiving a distribution of his or her ESOP accounts at a future date following his or her termination of employment. Distributions may be made in a lump sum, equal annual installments over a period generally not to exceed five years or a combination of the foregoing, generally as determined by the ESOP Administrative Committee (the Committee). The Committee also generally determines the time and manner of distributions, subject to the following limitations: (1) in the event of a participant's retirement, disability or death, distribution must begin prior to September 30th of the Plan Year following the Plan Year in which employment terminates; (2) if a participant's employment terminates for any other reason, distribution must begin prior to September 30th of the sixth Plan Year following the Plan Year in which employment terminates, although the Committee may (a) further defer distributions that are attributable to shares of Common Stock purchased with loan proceeds until after NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
such loan has been repaid, and (b) further defer distributions that are not attributable to post-1986 shares until the participant reaches the age that he or she would be required to reach in order to qualify for retirement under the ESOP.
(10) EMPLOYEE BENEFIT PLANS
Effective October 1, 1998, the Company adopted SFAS No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. Information for prior years has been restated to conform to the requirements of this statement.
The Company has two noncontributory funded defined benefit pension plans covering a portion of their employees. Benefits are based on a formula which includes years of service and average compensation. Nonparticipating employees generally are covered under one of several multi-employer union plans to which the Company contributes.
It is the Company's current policy to contribute at least the minimum statutory amounts. Actual contributions to the pension plans were $5.1 million, $4.0 million and $3.1 million during 1999, 1998 and 1997, respectively.
Certain of the Company's union employees are participants in multi-employer union defined benefit pension plans. Pension cost charged to expense under these plans for the years ended September 30, 1999, 1998, and 1997, was $2.0 million, $1.7 million and $1.5 million, respectively. The Company's portion of the actuarially computed value of the vested and nonvested benefits of the plans and the net assets of the pension funds have not been determined.
Assets of the pension plans include marketable equity securities, money market funds, U.S. government obligations, fixed income securities and other investments.
In connection with the ESOP's purchase of stock from the former Old Norcal employee-shareholders, the Company has agreed to provide certain post-retirement health and welfare benefits to certain settling plaintiffs until the earlier of the resolution of certain claims against third parties or October 1, 2000. In connection with the ESOP's purchase of stock from the former Envirocal employee-shareholders, the Company has agreed to provide certain former Envirocal employee-shareholders with certain lifetime post-retirement health and welfare benefits subject to certain conditions.
The Company recognizes postretirement medical benefits in the financial statements over the term of the affected employee's service with the Company as required by SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The postretirement medical benefit plan is unfunded.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes the balance sheet impact, as well as the benefit obligations, assets, funded status, periodic benefit costs and rate assumptions associated with the Company's pension and postretirement medical benefit plans.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company expects its health care cost trend for postretirement benefits to decrease from 8.0% in 2000 to 5.5% in 2005, after which the rate is expected to stabilize. A one percentage point change in the assumed health care cost trend rate would have the following effects:
In addition, the Company sponsors an unfunded deferred compensation and stock option plan for one of its former executives. The accumulated benefit obligation and projected benefit obligation for this plan were $342,000 and $301,000 as of September 30, 1999 and 1998, respectively. The unfunded amount for this plan as of September 30, 1999 is included in accrued payroll and other benefits in the Consolidated Balance Sheet. The Company recorded an additional minimum pension liability for this plan of $62,000 as of September 30, 1998. After recognizing an intangible asset related to the net transition obligation, the reduction to stockholders' equity at September 30, 1998 totaled $18,000, net of tax benefit of $13,000.
The Company is currently in a dispute with one of its unions with respect to an increase in pension benefits. If the union were to prevail the Company estimates that the accumulated benefit obligation would increase by an additional $8.2 million as of September 30, 1999 (note 12).
(11)LANDFILL CLOSURE, POST-CLOSURE LIABILITIES, ENVIRONMENTAL LIABILITIES, TRUST ACCOUNTS, COMMITMENTS AND FUNDING
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.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Compliance with current or future regulatory requirements will require the Company to make capital and operating expenditures to maintain current operations or to initiate new operations. It is not possible to quantify with certainty the potential impact of actions regarding environmental matters, particularly any future remediation and other compliance efforts. The Company has made and may continue to make substantial expenditures relating to environmental conditions primarily on its landfill properties. In the opinion of management, compliance with present environmental protection laws will not have a material adverse effect on the results of operations of the Company provided costs are substantially covered in the Company's rates on a timely basis. The Company continues to monitor these matters; however, there is no assurance that material costs or liabilities related to environmental matters will not be incurred 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 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.
At September 30, 1999 and 1998, the Company has recorded closure and post-closure liabilities on its owned landfills of approximately $25.9 million and $25.3 million, respectively, based on the total estimated closure costs and post-closure maintenance and monitoring at each date, in current dollars, and the percentage of estimated landfill capacity remaining. The current portion of landfill closure liability at September 30, 1999 and 1998, amounting to approximately $0.5 million and $0.9 million, respectively, is included in accrued expenses and is determined by the amount of required funding of various trust funds in accordance with various jurisdictional requirements along with the estimate of closure/post-closure work to be performed in the next year. Amounts (credited) charged to operating expenses for landfill closure in 1999, 1998 and 1997, net of interest income earned on related trust accounts, were approximately $(0.4) million, $(0.4) million and $0.2 million, respectively. Included in each year's expense are amounts that represent the effects of changes in cost and capacity estimates that are being recognized over the remaining life of each site. At September 30, 1999 and 1998, the future closure and post-closure obligation remaining to be recognized over the remaining lives of the applicable landfills is estimated to be approximately $27.0 million and $29.3 million, respectively. While the Company believes its estimates of closure and post-closure costs are reasonable, such amounts are based upon current laws, technology and information available on the properties. Accordingly, the Company's estimates may be subject to substantial upward revision.
In accordance with State of California legislation, and other governmental jurisdictions, the Company has established restricted and unrestricted trust funds for each owned landfill which are funded annually in amounts designed to provide the resources to accomplish closure and post-closure maintenance and monitoring. The estimated funding requirements are $0.5 million for 2000 and approximately $2.8 million due over the subsequent 5 year period based upon volume used at the landfill and regulatory requirements. At September 30, 1999 and 1998, $25.0 million and $25.4 million, respectively, have been deposited in restricted and unrestricted trust accounts for this purpose. In addition, at September 30, 1999, the Company had deposited $2.1 million in a trust fund maintained by Humboldt County which is included in other assets. Withdrawals of funds from certain restricted trust accounts may require approval of regulatory agencies. In addition to establishing trust funds, the NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Company also provides financial assurance for one of its landfills through the issuance of a bond for $1.1 million.
In addition, in accordance with State of California legislation, the Company is required to provide financial assurance for the initiation and completion of corrective action for potential releases of contaminants from its landfills. The Company has on deposit $2.1 million in trust funds as of September 30, 1999 and estimates that future contributions to trust funds of approximately $5.6 million over the remaining lives of the respective landfills will be required to satisfy these obligations. In the event of a release prior to full funding, the Company may be required to pay for the corrective action or to accelerate funding of the trust funds.
The Company has environmental impairment liability insurance, which covers the sudden or gradual onset of environmental damage to third parties, on all owned and operated facilities. The current policy has a limit of $15.0 million per loss with an annual aggregate limit for all losses of $15.0 million, covering pollution conditions that result in bodily injury or property damage to third parties, including clean-up costs. The Company also carries an underground tank policy to satisfy financial assurance requirements mandated under federal law.
California landfill operators must demonstrate financial assurance to compensate third parties for bodily injury and property damage arising out of landfill operations. Under the method adopted by the Company, the regulations require funding of $1.0 million per landfill to a maximum of $5.0 million Company-wide. To satisfy this requirement the Company has established financial assurance mechanisms for each landfill. As of September 30, 1999, the Company has approximately $3.4 million in three separate trust funds and has secured an insurance policy for the other landfill.
In July 1999, the Company and Humboldt Waste Management Authority (HWMA) entered into an agreement in principal concerning the Cummings Road Landfill and the Company's Eureka Transfer Station. In November 1999, the Company entered into an agreement with HWMA, pursuant to which the Company would transfer to HWMA ownership of such properties as well as certain operating equipment. As part of the agreement, the Company would receive certain cash payments totaling $4.2 million from the HWMA and HWMA would assume certain closure/post-closure, corrective action and operational responsibilities with respect to the Cummings Road Landfill. The Company would retain liability for its operation of the landfill prior to the closing of the transaction and for any defect in corrective action work performed by the Company at the landfill prior to the closing of the transaction. Under the agreement, the Company would also transfer to HWMA its interest in the closure/post-closure and corrective action trust funds relating to the landfill. The consummation of the agreement is subject to several closing conditions. Provided such conditions are met or waived, the closing is expected to occur before January 15, 2000.
(12) COMMITMENTS AND CONTINGENCIES
The Company has arranged stand-by letters of credit with various expiration dates totaling $2.3 million and $2.1 million at September 30, 1999 and 1998, respectively. These letters of credit are provided primarily to secure insurance and self-insurance obligations and for bond requirements. As of September 30, 1999, the Company has $22.7 million in stand-by letters of credit availability.
The Company is self-insured for various risks of loss related to general liability, automobile liability, property damage, employee and certain retiree healthcare, and workers' compensation. The establishment of reserves and claim payment activity include estimates of the ultimate costs of claims that have been reported but not settled and of claims that have been incurred but not reported.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Adjustments to the reserve are charged or credited to expense in the periods in which they are determined to be necessary. At September 30, 1999 and 1998, the Company's accrued liability for self-insured claims was approximately $18.0 million and $17.3 million, respectively. The current portion of self-insured claims at September 30, 1999 and 1998, amounting to approximately $6.9 million and $8.1 million, respectively, is included in accrued expenses.
At September 30, 1999, the Company and the other unrelated investors were jointly and severally liable as guarantors of affiliates' (note 5) indebtedness totaling $0.2 million.
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 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. The Company has served upon Local 350 a demand to arbitrate this dispute under the terms of the collective bargaining agreement between the parties. Representatives of the Company and Local 350 have entered into a Memorandum of Understating (the Memorandum), which provides that the parties will suspend the arbitration and that when the Company files its next rate application with the San Francisco Department of Public Works, which application may be filed at such time as the Company reasonably determines is appropriate, such application will include a request for sufficient money to cover the funding of costs of the pension benefit increases requested by Local 350 (the Local 350 Amounts). The Memorandum further provides that, if the Company's rate applications are granted and become effective, including the Local 350 Amounts, the arbitration will be terminated with prejudice; but if such request is denied, in whole or in part, for any reason and the Company does not put into effect the pension increases requested by Local 350, either party may reinstate the arbitration. The Company has not determined when it will submit a rate application.
If either party was to reinstate the arbitration and if Local 350 was to prevail in the arbitration discussed above or if the Company is successful in obtaining funding for the Local 350 amounts, the Company estimates that the accumulated benefit obligation (ABO) as of September 30, 1999 would increase by an additional $8.2 million and reduce stockholder's equity by $1.8 million. In addition, if the increased pension benefits are provided, the Company's estimated incremental increase in its annual expense for employee benefits would be approximately $3.1 million for pension and medical costs. Such incremental increase in expense would be mostly offset by higher revenue if the Company is successful in obtaining increased rates to cover the additional funding. 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.
(13) LITIGATION
The Company and the ESOP were defendants in litigation brought by certain previous noteholders of the ESOP against them and, among others, certain financial institutions as to which the Company and/or the ESOP have certain indemnification obligations. In 1995, the litigation was settled, except for continuing claims by the noteholders against one of those financial institutions. That institution has claimed, among other things, that the Company and the ESOP have continuing indemnity obligations to it in connection with the litigation. The Court has rejected those claims, and ultimately entered judgment in favor of Norcal and the ESOP in connection with the claims of the financial institution.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The financial institution also brought a second lawsuit against the ESOP alone, raising the same indemnity issues that were at issue in the previously described action. The Court rejected those claims as well, and entered judgment for the ESOP. The financial institution is appealing the adverse judgments. The Company and the ESOP believe that such claims are without merit. In any case, given the terms of the settlement agreement, the Company believes it is unlikely that Norcal's and the ESOP's financial exposure to the claims would materially exceed the amount of the financial institution's legal fees and expenses.
The Company is involved in various other legal actions in the normal course of business. It is the Company's opinion that all such matters relating to litigation are adequately provided for or that resolution of such matters will not have a material adverse impact on the financial condition of the Company; however, there can be no assurance that the impact of such matters on its results of operations or cash flows for any given reporting period will not be material.
(14) FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company is required under Statement of Financial Accounting Standards (SFAS) No. 107, Fair Value of Financial Instruments, to disclose fair value for all of its financial instruments. The carrying value of cash and cash equivalents, trade accounts receivable, accounts payable and accrued expenses approximate fair value because of the short maturity of these instruments. Estimates for the fair value of the Company's other financial instruments at September 30, are detailed below:
Trust accounts and marketable securities -- The fair value of the trust accounts and marketable securities has been estimated based on market values provided by the respective trustees and quoted market prices.
Senior Notes -- The fair value of the senior notes at September 30, 1999 and September 30, 1998 has been estimated using the quoted market price for the Notes based upon a limited number of transactions.
(15) BUSINESS SEGMENT, GEOGRAPHICAL AND OTHER INFORMATION
The Company operates in one business segment -- solid waste management services primarily consisting of collection, transfer, disposal and landfill management to industrial, commercial, residential and municipal customers. The Company's San Francisco operations represents approximately 39% of revenues for each of the years 1999, 1998 and 1997; however, the Company does not believe that it is exposed to credit risk.
The Company has a contract with San Bernardino County, pursuant to which it operates (through its San Bernardino subsidiary) all active landfills owned by San Bernardino County and is primarily
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
responsible for implementing the County's strategic plan which addresses the County's long-term waste disposal needs (the 1995 Contract). The Company's other responsibilities include closure and monitoring of non-active landfills, and identification, permitting and construction of landfill expansions. The Company's contract with the County is scheduled to terminate on June 30, 2001 (the Expiration Date). The 1995 Contract provides that the Company, at its option, may extend the agreement for an additional 15-year period. At the conclusion of this initial extension period, the Company, at its option, may extend the agreement for up to an additional 15 years, so long as the waste stream contractually committed to the landfills meets certain levels. However, each party may terminate the contract for default, failure to reach an agreement regarding the reconfiguration of the landfills and other facilities following a reduction in tonnage, or the bankruptcy or insolvency of the other party. In addition, San Bernardino County may terminate the contract so long as it uses a competitive procedure to select a contractor or municipalizes such operations and either party may terminate the 1995 Contract for failure to reach an agreement regarding the redetermination of the Company's per ton compensation rate (which rate must be redetermined every three years, and is currently the subject of an arbitration between the County and the Company). The contract also contains a clause stating that the County may terminate the agreement at any time if a Company employee is convicted of bribing public officials where the conviction relates to actions taken by the employee in respect to the 1995 Contract.
In October 1999, the United States Attorney for the Central District of California announced criminal indictments of James J. Hlawek, the immediate former Chief Administrative Officer for San Bernardino County, Harry M. Mays, a former consultant of the Company (and Mr. Hlawek's predecessor as Chief Administrative Officer for San Bernardino County), and Kenneth James Walsh, a former employee of the Company. 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.
Messrs. Walsh and Mays have advised the Company that they were the only Company personnel and consultants involved in this matter and that no other Company personnel or consultants were involved in or had knowledge of their illegal conduct. The Company believes that Messrs. Walsh and Mays were acting purely for their own personal gain and that none of the Company's other employees or consultants were aware of or otherwise involved with Messrs. Walsh's and Mays' illegal conduct. The Company terminated Mr. Walsh on August 27, 1999 and its arrangement with Mr. Mays on September 3, 1999. After terminating Mr. Walsh, the Company was informed by the United States Attorney that Mr. Walsh had been accepting kickbacks from Mr. Mays and from one of the Company's vendors and had used a portion of such kickbacks along with a portion of the contract fee paid to Mr. Mays to fund the payments to Mr. Hlawek. The Company anticipates that the United States Attorney's office may require additional information in its ongoing investigation. The Company has cooperated with the United States Attorney's investigation and intends to continue to cooperate in the future. The Company has also initiated its own internal investigation of the matter.
On December 14, 1999, the County Board of Supervisors directed the County's Chief Administrative Officer to negotiate an amendment with the Company to end the 1995 Contract as soon as the County can complete a competitive bidding process through a Request for Proposal, review submitted bids, and negotiate a replacement contract, but in no event later than June 30, 2001. Although the County's Chief Administrative Officer has estimated in his report to the County's Board of Supervisors NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
that the process should take 15 to 18 months, the County's Board of Supervisors has requested that the process be completed more quickly, if possible. In response to this request, the County's Chief Administrative Officer has stated that the process could potentially be accomplished in 12 to 15 months. The Company is currently unable to estimate how much time the County will need to complete these procedures. Moreover, the Company does not know whether it can successfully negotiate such an amendment, what terms may ultimately be negotiated in such an amendment or whether the County's Board of Supervisors will approve any such amendment. Assuming the County is unable to complete the Request for Proposal and enter into a new contract in the next nine months, the Company does not expect an amendment to end the 1995 Contract or the termination of the 1995 Contract to have a significant impact on its cash flows, results of operations or financial condition for fiscal year 2000. The County has indicated that the Company will be permitted to bid on the new contract, but there can be no assurance that the Company will be awarded the new contract, or if the Company is the successful bidder, how the terms of the new contract will compare to those contained in the 1995 Contract.
During fiscal years 1999, 1998 and 1997, revenues derived from the services the Company performed for San Bernardino County were approximately $55.1 million (16% of the Company's total revenue), $65.1 million (19% of the Company's total revenue) and $55.1 million (17% 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 were approximately $6.6 million, $7.9 million and $7.4 million, respectively. While the Company's results of operations and cash flows will be adversely impacted if an amendment to end the 1995 Contract is negotiated or the 1995 Contract is terminated and the Company and the County do not enter into a new contract having comparable terms, management believes that such event will not have a material adverse effect on the Company's financial condition or on its ability to maintain its operations and service its debt.
As of September 30, 1999, approximately 73% of the Company's employees were represented by unions. Of this total, approximately 9% are covered under contracts that will expire by September 30, 2000.
The Company's operating results are affected by variations in its recycling revenues from the sale of recyclable commodities. The Company's recycling revenues are volatile and fluctuate in accordance with changes in prices of recyclable commodities which in turn are, in many cases, dependent on changes in worldwide supply of, and demand for, such recyclable commodities.
(16) 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 certain direct and indirect subsidiaries of Norcal. The guarantor subsidiaries are all wholly owned subsidiaries and the guarantees of the guarantors are full, unconditional and joint and several. The direct and indirect nonguarantor subsidiaries of Norcal are individually and in the aggregate inconsequential. Separate financial statements of each guarantor have not been presented since management has determined such separate financial statements are not material to noteholders.
NORCAL WASTE SYSTEMS, INC. AND SUBSIDIARIES (WHOLLY OWNED BY THE NORCAL WASTE SYSTEMS, INC. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(17) COMPREHENSIVE INCOME
Effective October 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income. Comprehensive income consists of net income and other gains and losses affecting stockholders' equity, that under generally accepted accounting principles are excluded from net income. The components of comprehensive income for the years ended September 30, 1999, 1998 and 1997 are as follows:
(18) SELECTED QUARTERLY FINANCIAL DATA, UNAUDITED
The following table summarizes the unaudited quarterly results of operations:
ITEM 9.
ITEM 9.CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
PART III
ITEM 10.
ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages and positions and offices with Norcal of the current executive officers and directors of Norcal are set forth below.
- --------------- (a) Audit Committee member
(b) Compensation Committee member
MICHAEL J. SANGIACOMO has served as a director of Norcal since November 1990 and as Chief Executive Officer and President since January 1991. From November 1990 to January 1991, Mr. Sangiacomo served as Acting Chief Executive Officer and President of Norcal. From August 1988 until November 1990, he served as Chief Financial Officer of Norcal, and held the additional title of Senior Vice President from January to November 1990. Mr. Sangiacomo serves as a director and an executive officer of all of Norcal's subsidiaries. He also serves as an executive officer of Nortech Waste LLC, a joint venture in which the Company is a minority investor ("Nortech"). Mr. Sangiacomo holds a B.S. in Business Administration from the University of San Francisco and practiced as a certified public accountant from 1971 to 1978.
ARCHIE L. HUMPHREY was appointed Executive Vice President and Chief Operating Officer of Norcal in August 1999. Mr. Humphrey serves as an executive officer and director of all of Norcal's subsidiaries, and as an executive officer and a members' representative of Nortech. Mr. Humphrey also serves as a director of NorthBay Healthcare Group, a not for profit healthcare organization. From November 1996 to August 1999, Mr. Humphrey served as Division Manager for all Northern California operations except San Francisco operations and Integrated Environmental Systems, Inc., and was a Vice President of 13 subsidiaries of the Company. Mr. Humphrey has also been a member of the Administrative Committee of the ESOP since 1986 and its Secretary since 1992. From August 1995 to November 1996, Mr. Humphrey served as Division Manager for North Coast operations of the Company. Mr. Humphrey served as a Regional Manager for the Company's Solano County operations from October 1992 until August 1995 and as a director of the Company from November 1991 until February 1996. Mr. Humphrey holds a B.A. in Sociology from California State University at Sacramento.
MARK R. LOMELE has served as Senior Vice President, Chief Financial Officer and Treasurer of Norcal since January 1997 and as a Vice President since November 1990. He also serves as an officer and a members' representative of Nortech. From September 1988 to July 1996, Mr. Lomele served as Norcal's Corporate Controller and from July 1996 to January 1997 as Acting Chief Financial Officer. Mr. Lomele serves as an executive officer of all of Norcal's subsidiaries. From April 1996 to September 1996 he also served as General Manager of Nortech. Mr. Lomele has been a member of the ESOP's Administrative Committee since 1991 and has served as its Chair since February 1, 1995. He holds a B.S. in Business Administration from the University of San Francisco.
GEORGE P. MCGRATH has served as Senior Vice President, Chief Information Officer of Norcal since October 1998, responsible for all of the Company's information systems. From July 1996 to June 1997, Mr. McGrath served as Vice President and General Manager of Alta Environmental Services, Inc., a subsidiary that markets certain types of landfill space to third parties. Prior to joining Norcal in October 1995, Mr. McGrath served as Vice President and Area General Manager for Chemical Waste Management in the Western Region of the United States from October 1990 to February 1995. Mr. McGrath holds a B.S. in Psychology from Western Michigan University.
JON D. BRASLAW has served as Vice President, Corporate Controller since January 1997. Mr. Braslaw served as Controller from August to December 1996, as Assistant Controller from April to July 1996, as Manager of Financial Reporting from January 1995 to March 1996, and as a Financial Analyst from November 1989 to December 1994. He holds a B.A. in Economics from the University of California at Santa Barbara.
BENNIE J. ANSELMO, JR. has served as Vice President -- Equipment Procurement and Maintenance and Vice President of Alta Leasing Co., Inc. since November 1990. Mr. Anselmo served as Director of Equipment Procurement for Golden Gate Disposal Company from January 1988 until his transfer to Norcal in November 1990. Mr. Anselmo began his career with Golden Gate Disposal Company in 1962, serving as shop foreman and shop superintendent, among other capacities.
DAVID A. COCHRANE has served since February 1995 as Vice President -- Facilities Management and Technical Services of Norcal. Prior to that Mr. Cochrane served Norcal as Director of Technical Services since October 1994, and as Corporate Manager for Landfill Engineering since April 1993. From November 1996 to April 1998, Mr. Cochrane served as Vice President of Alta Environmental Services, Inc., a subsidiary that markets certain types of landfill space to third parties, and as Vice President of B&J Drop Box, subsidiary that owns a landfill in Vacaville, CA, and Western Placer Recovery, Inc., a subsidiary that operates a landfill in Roseville, CA. Before joining Norcal in April 1993, Mr. Cochrane served since April 1990 as an executive manager for Emcon Associates, an environmental and engineering consulting firm that provided services to the waste industry, including Norcal and its subsidiaries. He holds a B.A. in Geology from Humboldt State University.
DENISE DELMATIER has served as Vice President -- Governmental & Regulatory Affairs since March 1999. Prior to joining Norcal, Ms. Delmatier represented Norcal in legislative and regulatory matters for the past twelve years with the lobbying firms of Heron, Burchette, Ruckert & Rothwell and the Gualco Group. Ms. Delmatier's most recent public employment position was a legislative assistant for the California State Assemblyman Dan Hauser. She holds a B.A. in English from California State University, Chico.
GALE R. KAUFMAN became a director of Norcal in July 1996. Since 1987, Ms. Kaufman has been the president of Kaufman Campaign Consultants, a political campaign and consulting firm. From 1992 to 1995, she was the Director of the Speaker's Office of Majority Services of the California State Assembly. Since May 1993, she has provided certain consulting services to Norcal, including overall campaign responsibility in connection with Norcal's defeat of certain City of San Francisco ballot initiatives. Ms. Kaufman has a B.A. in Political Science from George Washington University.
JOHN B. MOLINARI has served as a director of Norcal and its predecessor since 1986 and as Chairman of the Board since December 1990. From 1948 to 1953, Mr. Molinari served as a judge of the
San Francisco Municipal Court; from 1953 to 1962, he served as a judge of the San Francisco Superior Court; and from 1962 to 1977, he served as a Justice on the California Court of Appeal. He has been an attorney in private practice since 1977.
H. WELTON FLYNN has served as a director of Norcal since December 1991. From 1949 until the present, Mr. Flynn has been the sole proprietor of an accounting firm located in San Francisco. Since January 1996, he has served as a member of The Public Transportation Commission of the City and County of San Francisco and currently serves as its President. Mr. Flynn was appointed to the Public Utilities Commission for the City and County of San Francisco in 1970 and served as its President for more than five terms before retiring in 1991.
Each executive officer of Norcal is appointed by, and serves at the pleasure of, the Board of Directors. There are no family relationships among executive officers or directors of Norcal.
BOARD OF DIRECTORS
Number of Directors and Term of Office. Norcal's Bylaws currently fix the authorized number of directors of Norcal at five. All directors hold office until the next annual meeting of shareholders and until their successors have been elected. The ESOP (as shareholder) has the power to remove directors at any time. There is currently one vacancy on the Board of Directors.
Committees of the Board. The Compensation Committee recommends to the Board of Directors the salary, benefit and incentive compensation levels of Norcal's executive officers as well as the contractual provisions of their employment contracts, and administers Norcal's 1990 Stock Option Plan (the "1990 Option Plan"), the 1996 Employee Stock Incentive Plan (the "1996 Employee Plan"), the Deferred Compensation and Stock Option Plan (the "Deferred Compensation Stock Option Plan") and the 1996 Executive Stock Incentive Plan (the "1996 Stock Plan"), including determination of grants of options, prescribing the terms and provisions of the options, construing and interpreting the 1990 Option Plan, the 1996 Employee Plan and the 1996 Stock Plan and establishing and amending rules and regulations related thereto. The members of the Compensation Committee are Messrs. Molinari and Flynn. The Audit Committee recommends the firm of independent certified public accountants to be appointed to audit Norcal's financial statements, reviews the scope and results of the audit, reviews with management Norcal's interim and year-end operating results, considers the adequacy of the internal accounting controls and audit procedures of Norcal and reviews the non-audit services to be performed by the independent accountants. The members of the Audit Committee are Messrs. Molinari and Flynn.
Compensation of Directors. Directors who are employees of Norcal or its subsidiaries do not receive additional compensation for their services as directors of Norcal. For services as a non-employee director during fiscal year 1999, John B. Molinari, H. Welton Flynn and Gale R. Kaufman were each paid $38,000, $33,000 and $28,000, respectively. Each non-employee director receives an annual retainer of $18,000 and a payment of $1,000 plus expenses for each board meeting attended and $1,000 plus expenses for each committee meeting attended that is held at a different time or place than a board meeting. Non-employee directors are also eligible to receive option grants under the 1996 Non-Employee Director Stock Option Plan. All directors are eligible to receive option grants under the 1996 Stock Plan and the 1996 Employee Plan.
Compensation Committee. Interlocks and Insider Participation in Compensation Decisions. Messrs. Molinari and Flynn were appointed to the Compensation Committee in May 1992. Neither has ever been an officer or employee of Norcal or any of its subsidiaries. Mr. Sangiacomo, President and Chief Executive Officer of Norcal, participates fully with the committee members in recommending to Norcal's Board of Directors the salaries, benefits and incentive compensation for Norcal's executive officers, excluding his own.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table provides certain summary information concerning the compensation paid or accrued during the three fiscal years ended September 30, 1999 to Norcal's Chief Executive Officer and to each of the four other most highly compensated executive officers of Norcal who received compensation in excess of $100,000 during the last completed fiscal year (the "Named Executive Officers"):
- --------------- (a) Bonuses are indicated for the fiscal year in which they were earned based on the achievement of certain business plan targets.
(b) Unless otherwise indicated in a note to this table, this amount consists primarily of increases in the value of the individual's ESOP account as a result of an allocation of additional shares of Norcal's Common Stock to such account as well as changes in the estimated fair market value per share of such stock. This figure also includes premiums paid by Norcal on behalf of the Named Executive Officers for group life insurance during each of the years indicated, pro-rated for partial years of service.
(c) Represents amounts earned with respect to a deferred annuity to be paid as part of the Deferred Compensation Stock Option Plan (as hereinafter defined), along with compensation relating to the increase in the value of his ESOP account (see footnote (b)).
(d) Mr. Moriel served as the Company's Executive Vice President and Chief Operating Officer from June 1994 to October 1998. He served as the Company's Vice President, Special Projects from October 1998 to May 1999.
Employment Contracts and Termination of Employment and Change-in-Control Arrangements. Norcal has employment contracts with various executive officers and key employees.
In April 1996, Norcal entered into an employment agreement with Mr. Sangiacomo, its President and Chief Executive Officer. Under the agreement, Mr. Sangiacomo is entitled to receive a salary of at least $350,000 per year and is eligible to participate in the Short-Term Incentive Bonus Plan. In addition, Mr. Sangiacomo receives insurance and other benefits and perquisites generally available to Norcal's executive employees.
Mr. Sangiacomo is entitled to certain severance payments (i) if his employment is terminated constructively or without cause after a change in control of Norcal or (ii) if he resigns at any time more than 12 months but less than 13 months after a change in control of Norcal. Such severance benefits would, under certain circumstances, include payment of an amount equal to twice his average total annual compensation for the two previous years.
Norcal has granted Mr. Sangiacomo a nonqualified stock option pursuant to its 1996 Stock Plan (as defined below) to purchase Common Stock consisting of three series, with each series being for 320,000 shares. The initial exercise price for all shares was $4.89. The exercise price for the Series B shares was adjusted to $5.18, the fair value of the stock on October 1, 1996. The exercise price for the Series C shares was adjusted to $5.59, the fair value of the stock on October 1, 1997. Each Series generally will vest over four years, with the first vesting to occur for Series A, B and C options on September 30 of 1996, 1997 and 1998, respectively. This vesting schedule will be partially accelerated if Norcal achieves certain financial, operational and strategic objectives, including an initial public offering. Under certain circumstances, the option will vest completely if there is a change in control (a "Control Event") of Norcal. Generally, a Control Event will be deemed to have occurred if: (i) a third party (other than an employee benefit plan or an entity controlled by the Company) acquires 25% or more of Norcal's voting securities (or 35% or more if Norcal has not had an initial public offering of Common Stock; (ii) persons who are directors of Norcal as of the date of adoption of the 1996 Stock Plan (the "Incumbent Board") cease to constitute a two-thirds majority of Norcal's board of directors (provided that any director whose nomination or election is approved by a two-thirds majority of the Incumbent Board shall be considered a member of the Incumbent Board); (iii) at any time prior to an initial public offering, the ESOP no longer owns more than 50% of the Company's then outstanding voting securities; (iv) a merger or like event involving Norcal is consummated unless, among other things, Norcal shareholders immediately before such event own immediately following such event at least 75% of the voting securities of the resulting corporation; (v) Norcal is liquidated or dissolved; or (vi) substantially all of Norcal's assets are sold.
As long as Mr. Sangiacomo remains employed by Norcal, he may exercise any option in a Series any time within seven years after the exercise price has been fixed for that Series with respect to shares that have vested.
In October 1998, Norcal entered into an employment agreement with Mr. Coyle, then its Chief Operating Officer. Under the agreement, Mr. Coyle was entitled to receive a salary of at least $240,000 per year, a hiring bonus of $40,000 and a relocation allowance of $50,000. Mr. Coyle was eligible to participate in the Short-Term Incentive Bonus Plan. In addition, Mr. Coyle received insurance and other benefits and perquisites generally available to Norcal's executive employees. Mr. Coyle was entitled to severance benefits of $120,000 if his employment is terminated without cause before October 1999 and $240,000 after October 1999. In July 1999, Mr. Coyle voluntarily terminated his employment with the Company.
In June 1996, Norcal entered into an employment agreement with Mr. Moriel, then the Company's Executive Vice President and Chief Operating Officer and most recently its Vice President, Special Projects. Under the agreement, Mr. Moriel was entitled to receive a salary of at least $275,000 per year, with $50,000 of such annual salary deferred pursuant to the Deferred Compensation Stock Option Plan. Mr. Moriel was eligible to participate in the Short-Term Incentive Bonus Plan. In addition, Mr. Moriel received insurance and other benefits and perquisites generally available to Norcal's executive employees.
Pursuant to the agreement, Mr. Moriel retired in 1999 and will receive a retirement annuity pursuant to the Deferred Compensation Stock Option Plan which, together with certain pension payments, will result in aggregate payments of $50,000 per year. In March 1999, Mr. Moriel designated the Donald M. Moriel and Janet Allad Moriel 1992 Family Revocable Trust (the "Moriel Trust") as the primary beneficiary of deferred compensation under the aforementioned plan. Mr. Moriel has agreed to enter into a consulting agreement with Norcal. The terms of that consulting agreement are under
negotiation, but it is expected that it shall have a term of five years and a minimum annual payment of $50,000.
Norcal granted Mr. Moriel a nonqualified stock option under the Deferred Compensation Stock Option Plan to purchase up to 300,000 shares of Common Stock at an exercise price of $4.89 per share. As of September 30, 1999, all 300,000 shares were vested. In March 1999, Mr. Moriel and his wife assigned their interest in this option to the Moriel Trust. Subject to certain provisions of the Deferred Compensation Stock Option Plan, the Moriel Trust may exercise its option at any time on or before September 30, 2002.
In April 1996, the Board of Directors adopted a severance pay policy (the "Severance Policy") which would be triggered by a change in control of Norcal. The program covers up to ten key employees of the Company (but not Mr. Sangiacomo). Each employee covered by the Severance Policy will receive an amount equal to his current base salary if there is a change in control of Norcal and the employee is constructively terminated or terminated without cause within 13 months after such change in control. The Company has not designated any specific employees to be covered by the Severance Policy at this time.
Short-Term Incentive Bonus Plan. In April 1996, the Company adopted a Short-Term Incentive Bonus Plan, which was amended by the Company on October 29, 1998 (as amended, the "1996 Bonus Plan"), providing variable cash bonuses for up to approximately 90 of the Company's executive and management employees (including the Named Executive Officers). Under the 1996 Bonus Plan, cash bonuses will be based on a percentage of each participant's base salary, with such percentages varying depending on how closely Norcal (or its regional operations, as the case may be) achieves specific financial, operational and strategic objectives. No bonuses will be paid unless the Company's profit before taxes exceeds the aggregate amount of bonuses due to be paid pursuant to the 1996 Bonus Plan. Depending on the employee, cash bonuses will range from 5% to 30% of base salary if 85% of the target is achieved to between 20% and 120% of base salary if 120% of the target is achieved. The Company has retained the discretion to modify such bonuses as it deems appropriate. The Board of Directors may, from time to time, modify the 1996 Bonus Plan.
1996 Executive Stock Incentive Plan ("1996 Stock Plan"). Pursuant to Norcal's 1996 Stock Plan, up to 2,887,500 shares of Common Stock have been set aside to satisfy awards that may be granted to officers, employees or directors of the Company or its affiliates. Awards may consist of incentive or nonqualified stock options, restricted stock, stock appreciation rights, performance awards and dividend equivalent rights. The 1996 Stock Plan will expire in January 2006. The 1996 Stock Plan is administered by a committee of non-employee directors (currently, the Compensation Committee), which has the power to determine when and to whom awards will be granted and the terms of each award. The terms of any award will be set forth in an award agreement, which may modify or delete provisions of the 1996 Stock Plan that would otherwise apply to such award or which may contain other terms and restrictions not set forth in the 1996 Stock Plan.
With respect to awards of options, the committee has authority to determine (i) the number of shares of Common Stock that may be purchased pursuant to each option, (ii) the option's vesting provisions, (iii) the exercise price (provided in general that the exercise price for shares must be at least 85% of the fair market value of the shares as of the grant date), (iv) the term of such option and (v) such other terms as the committee determines.
The 1996 Stock Plan generally provides that, upon a Control Event (as defined in the Plan), all outstanding options will become immediately and fully exercisable, and optionholders may surrender any option to the extent not yet exercised in exchange for a cash payment.
With limited exceptions, transfers of shares of Common Stock acquired pursuant to the 1996 Stock Plan are subject to the Company's right of first refusal, which right will terminate upon the consummation of the Company's first public offering of Common Stock. In addition, upon termination
of a participant's employment, the Company will have an assignable option to repurchase any shares of Common Stock awarded to a participant pursuant to the 1996 Stock Plan.
Unless a particular award agreement provides otherwise, participants who violate certain noncompetition and confidentiality provisions in the 1996 Stock Plan are subject to certain forfeiture provisions with respect to their options or shares.
Effective April 1996, Messrs. Molinari and Flynn, who are non-employee directors, were each awarded an option to purchase up to 15,000 shares of Common Stock under the 1996 Stock Plan at an exercise price of $4.89 per share.
1996 Employee Stock Incentive Plan (the "1996 Employee Plan"). Pursuant to the 1996 Employee Plan, up to 5,260,500 shares of Common Stock (less any such shares set forth in awards granted pursuant to the 1996 Stock Plan, the 1990 Option Plan, the Non-Employee Director Plan and the Deferred Compensation Stock Option Plan) have been set aside to satisfy awards that may be granted to officers, employees or directors of the Company or its affiliates. Awards may consist of incentive or nonqualified stock options, restricted stock, stock appreciation rights, performance awards and dividend equivalent rights. The 1996 Employee Plan will expire in April 2006. The 1996 Employee Plan is administered by a committee of non-employee directors (currently, the Compensation Committee), which has the power to determine when and to whom awards will be granted and the terms of each award. The terms of any award will be set forth in an award agreement, which may modify or delete provisions of the 1996 Employee Plan that would otherwise apply to such award or which may contain other terms and restrictions not set forth in the 1996 Employee Plan.
With respect to the awards of options, the committee has authority to determine (i) the number of shares of Common Stock that may be purchased pursuant to each option, (ii) the option's vesting provisions (provided that the rate of vesting must be at least 20% per year over five years from the date the option is granted), (iii) the exercise price (provided in general that the exercise price for shares must be at least 85% of the fair market value of the shares as of the grant date), (iv) the term of such option (provided that the term of an option may not be greater than ten years from the date of grant thereof) and (v) such other terms as the committee determines.
The 1996 Employee Plan generally provides that, in the event of certain changes in control, the committee, in its sole discretion, may take a variety of actions (including acceleration of unvested options) with respect to outstanding awards that it considers to be in the best interests of the Company.
With limited exceptions, transfers of shares of Common Stock acquired pursuant to the 1996 Employee Plan are subject to the Company's right of first refusal, which right will terminate upon the consummation of the Company's first public offering of Common Stock. In addition, upon termination of a participant's employment, the Company will have an assignable option to repurchase any shares of Common Stock awarded to a participant pursuant to the 1996 Employee Plan, which option will terminate upon the consummation of the Company's first public offering of Common Stock.
Unless a particular award agreement provides otherwise, participants who violate certain noncompetition, confidentiality and other provisions in the 1996 Employee Plan are subject to certain forfeiture provisions with respect to their options or shares.
Ms. Delmatier, who is an employee of the Company, was awarded options with respect to her employment during fiscal year 1999 to purchase up to 30,000 shares of Common Stock under the 1996 Employee Plan. These options were issued at an exercise price of $6.05 per share. These options have a seven-year term (commencing on the date of grant) and vest over four years from the date of grant.
Deferred Compensation Stock Option Plan. Pursuant to Norcal's Deferred Compensation Stock Option Plan, (i) up to 300,000 shares of Common Stock have been set aside to satisfy the award of an unqualified stock option to Mr. Moriel; (ii) Mr. Moriel will defer $50,000 per year of his annual salary (as described above) (the "Deferred Compensation"); and (iii) Mr. Moriel will be entitled to receive
a retirement annuity (the "Retirement Annuity"), payable quarterly until his death, in the amount of $50,000 per year, less the aggregate amount of benefits he receives from other retirement plans of Norcal, excluding the ESOP benefit. In March 1999, Mr. Moriel designated the Moriel Trust as the primary beneficiary of the Deferred Compensation and assigned the stock option to the Moriel Trust.
The Deferred Compensation Stock Option Plan is currently administered by the Compensation Committee, which has the power to interpret the plan.
Generally, in the event that (i) there is a merger, consolidation or other reorganization in which Norcal is not the surviving entity or becomes a subsidiary of another corporation, (ii) there is a sale of all or substantially all of Norcal's assets, (iii) there is a sale of more than 50 percent of Norcal's outstanding stock to one or more persons who are not shareholders of Norcal or (iv) there is a dissolution or liquidation of Norcal (the transactions referred to in clauses (i)-(iv) are each referred to herein as a "Corporate Transaction"), Norcal is obligated to (i) require the successor entity to (A) assume Mr. Moriel's option now held by the Moriel Trust or (B) substitute a comparable option of such successor entity (or any of, its affiliated entities), or (ii) notify the Moriel Trust at least 30 days before a Corporate Transaction occurs so that he will have an opportunity to purchase all or part of his vested shares prior to the consummation of such Corporate Transaction, at which time Mr. Moriel's option will be cancelled. Shares acquired pursuant to the exercise of the option granted under the Deferred Compensation Stock Option Plan are subject to certain restrictions on transfers. In addition, with certain exceptions, transfers of such shares are subject to Norcal's right of first refusal, which right will terminate upon the consummation of Norcal's first public offering of Common Stock. Upon the later of Mr. Moriel's termination of employment and the term of his option, Norcal will have an assignable option to repurchase shares of Common Stock awarded to Mr. Moriel pursuant to the Deferred Compensation Stock Option Plan.
The Deferred Compensation Stock Option Plan provides that if Mr. Moriel violates certain noncompetition and confidentiality provisions in such plan, he will be subject to forfeiture provisions with respect to his options, shares purchased thereunder and the Retirement Annuity.
Mr. Moriel's Deferred Compensation will accrue interest at the rate of 8 percent per year, compounded quarterly. Norcal will distribute such Deferred Compensation to the Moriel Trust at the rate of $30,000 per year beginning with the first day of the calendar quarter following termination of his employment with Norcal for any reason.
1996 Non-Employee Director Stock Option Plan. Pursuant to Norcal's 1996 Non-Employee Director Stock Option Plan (the "Non-Employee Director Plan"), up to 175,000 shares of Common Stock have been set aside to satisfy awards to nonemployee directors of Norcal. Upon becoming a director, each future participant will be awarded an option to purchase 35,000 shares of Common Stock, which option will become exercisable in three equal, annual installments, beginning on the first anniversary of the date of grant. Each such option will have a term of seven years and an exercise price equal to the Common Stock's fair market value on the date of grant. Unless otherwise provided in the applicable award agreement, options granted under the Non-Employee Director Plan will become immediately exercisable upon a Control Event (as defined therein). Effective January 1996, Messrs. Molinari and Flynn, who are non-employee directors, were each awarded an option to purchase up to 35,000 shares of Common Stock under the Non-Employee Director Plan at an exercise price of $4.89 per share. In July 1996, Ms. Kaufman, a non-employee director, was also granted an option to purchase up to 35,000 shares of Common Stock under the Non-Employee Director Plan at an exercise price of $4.89 per share. The Non-Employee Director Plan is administered by Norcal's Board of Directors.
1990 Stock Option Plan ("1990 Option Plan"). Pursuant to Norcal's 1990 Option Plan, options to purchase a maximum of 1,898,000 shares of Common Stock may be issued to officers, employees, independent contractors and directors of Norcal, its subsidiaries and/or its affiliates. Of that amount, options to purchase a maximum of 600,000 shares of Common Stock may be granted to directors of Norcal, including directors who are also employees of Norcal. Under the 1990 Option Plan, incentive stock options that meet the requirements of Section 422 of the Code may be granted to the officers and
employees of Norcal, its subsidiaries and/or certain of its affiliates. The 1990 Option Plan is currently administered by the Compensation Committee of the Board of Directors, which has the power to determine to whom options will be granted, the terms of each option and to interpret the plan.
The exercise price of any stock option may not be less than 100% of the fair market value of the Common Stock on the date the option is granted. If the Common Stock is not publicly traded on the date of grant of an option, fair market value may be computed in good faith by the Board of Directors or a Committee thereof, but shall not be less than the fair market value reflected in the most recent year-end independent appraiser's valuation report received by the ESOP Administrative Committee. Unless otherwise provided in the option grant, shares acquired pursuant to the exercise of options become vested over a period of five years from the date of grant and are subject to certain restrictions on transfer, unvested shares may be repurchased by Norcal upon termination of the optionee's employment or engagement with Norcal (or its subsidiaries) at the exercise price the optionee originally paid for such shares and all shares purchased pursuant to the exercise of options are subject to repurchase by Norcal under certain circumstances. Generally, in the event (i) there is a merger, consolidation or other reorganization as a result of which Norcal is not the surviving corporation or becomes a subsidiary of another corporation and (ii) the surviving corporation does not agree to assume all options granted under the 1990 Option Plan (or to issue options equivalent thereto), then such options will become immediately exercisable and shares purchased pursuant to them will immediately vest.
As of September 30, 1999, options to purchase 188,000 shares of Common Stock were outstanding under the 1990 Option Plan, at an exercise price of $7.04 per share. No options were granted or exercised under the 1990 Option Plan during fiscal year 1999. The following table provides certain information with respect to options outstanding during fiscal year 1999 for the Named Executive Officers. No stock appreciation rights ("SARs") were outstanding during such period.
OPTION GRANTS IN FISCAL 1999
- --------------- (a) Options granted to Mr. Coyle and Ms. Delmatier were granted pursuant to the 1996 Employee Plan. Each of the options is a non-qualified option and expires on September 30, 2006. Each option will vest as follows: 20% will vest on each of September 30, 2000 and 2001, and 30% will vest on each of September 30, 2002 and 2003. In the event of a change in control, the Compensation Committee, in its sole discretion, may take a variety of actions with respect to the options that it considers to be in the best interests of the Company. The Company will have an assignable option upon termination of an individual's employment to repurchase any such shares. The Company's repurchase option with respect to vested shares will terminate upon an initial public offering. Mr. Coyle's options were canceled when he voluntarily terminated his employment with the Company in July 1999.
(b) Grant Date Present Value was computed using the Black-Scholes option pricing model. The calculations utilize certain assumptions, including the following:
(i) the volatility is assumed to be zero as the Company's Common Stock is not publicly traded as of the date hereof;
(ii) the risk-free rate of return for each grant is assumed to be the U.S. Treasury zero-coupon bond rate for bonds with maturities consistent with the expected time of exercise of each grant;
(iii) the dividend yield is assumed to be zero;
(iv) the stock price is assumed to be $6.05, which is as of September 30, 1999, the effective date of the most recently completed valuation;
(v) the value of the options is discounted by 5% per year to account for assumed for forfeitures.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION & SAR VALUES
Pension Plans. The Norcal Waste Systems, Inc. Defined Benefit Pension Plan (the "Norcal Pension Plan") is a defined benefit pension plan maintained for certain employees of Norcal and its subsidiaries. Most of the other employees of Norcal and its subsidiaries are covered by certain collective bargaining agreements or by the Envirocal, Inc. Retirement Plan (the "Envirocal Retirement Plan"), the plan covering certain former employees of Envirocal, Inc., one of Norcal's predecessors, and certain of Envirocal's subsidiaries. The Norcal Pension Plan is funded as required by ERISA and does not require employee contributions. Full vesting generally is obtained after five years of vesting service. The calculation of annual retirement benefits is generally based upon years of service and average annual compensation for the five consecutive calendar years that produce the highest such average. Compensation used in determining retirement benefits generally consists of an employee's total annual earnings, including overtime pay and bonuses limited to $160,000.
The following table shows the estimated annual retirement benefit payable on normal retirement at age 62 for unmarried employees (or a married employee who elects a single life annuity) at specified compensation levels with various years of service for the Norcal Pension Plan:
NORCAL PENSION PLAN TABLE
Covered compensation is total cash compensation but not including any payment for automobile, moving or living allowances, or employee expense reimbursements, which corresponds to the amounts listed in the Summary Compensation Table set forth above under the columns "Salary" and "Bonus" plus certain payouts by the Company in respect of accrued vacation. Any amounts in excess of limitations pursuant to Section 401(a)(17) of the Code are excluded. The annual benefit estimates computed for this table are Single Life Benefits and are not subject to deductions for Social Security or other offset amounts.
As of September 30, 1999, the Named Executive Officers had the following estimated credited years of service under the Norcal Pension Plan: Mr. Sangiacomo, 11.0 years; Mr. Humphrey, 14.0 years; Mr. Lomele, 11.0 years; Mr. McGrath, 4.0 years; Mr. Braslaw 10.0 years; and Mr. Moriel, 6.0 years.
Mr. Sangiacomo is eligible also to receive a retirement benefit from the Envirocal Retirement Plan, due to his past employment with Envirocal. The Envirocal Retirement Plan also is funded as required by ERISA and does not require employee contributions. The calculation of monthly retirement benefits is generally based upon years of service and average monthly compensation for the 60 months (whether or not consecutive) that produce the highest such average. Compensation used in determining retirement benefits generally consists of an employee's total earnings, including overtime pay and bonuses. Covered compensation is total cash compensation but not including any payment for automobile, moving or living allowances, employee expense reimbursements, or payment in lieu of unused vacation or sick leave. Any amounts in excess of limitations pursuant to Section 401(a)(17) of the Code are excluded.
As of September 30, 1999, Mr. Sangiacomo had an estimated 5.17 years of credited services under the Envirocal Retirement Plan. The estimated annual retirement benefit to which he will be entitled under the Envirocal Retirement Plan is $16,383. That estimate is computed as a Single Life Benefit and is not subject to deduction for Social Security or other offset amounts.
ITEM 12.
ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to the beneficial ownership of Norcal's Common Stock as of December 27, 1999 by (i) each person known to Norcal to beneficially own 5% or more of Norcal's Common Stock, (ii) each director of Norcal, (iii) the Named Executive Officers, and (iv) all directors and executive officers of Norcal as a group.
- --------------- * Less than 1%.
(a) Except as otherwise indicated in the notes to this table, the address of each beneficial owner of more than 5% of the Common Stock is c/o Norcal Waste Systems, Inc., 160 Pacific Avenue, Suite 200 San Francisco, California 94111.
(b) As ESOP participants, the individuals named in the table have shared voting power, but no investment power, over the shares of Common Stock allocated to such individuals' ESOP account, unless they are members of the ESOP Administrative Committee. See note (c) below. The ESOP account includes allocated shares as of September 30, 1999.
(c) The Trustee of the ESOP is Union Bank of California Company (the "ESOP Trustee"), 475 Sansome Street, 12th Floor, San Francisco, California 94111. An aggregate of 24,134,973 shares of Common Stock were held by the ESOP Trustee as of September 30, 1999, of which approximately 20,526,298 had been allocated to the accounts of individual ESOP participants, including officers of Norcal. All of the shares held by the ESOP Trustee are currently voted in most matters as determined by the Administrative Committee of the ESOP. However, in certain matters the ESOP participants direct the ESOP Trustee to vote the shares allocated to their respective accounts. Therefore, the members of the Administrative Committee currently have shared voting and investment power with respect to all shares held by the ESOP Trustee. None of the members of the Administrative Committee has sole voting power over any shares, but as ESOP participants they have shared voting power over the shares allocated to their individual ESOP accounts. The members of the Administrative Committee, and the number of shares of Common Stock that were allocated to their respective ESOP accounts as of September 30, 1999 are as follows: Archie L. Humphrey, 41,623 shares; John A. Legnitto, 15,138 shares; and Mark R. Lomele, 30,464 shares. In addition, Messrs. Humphrey and Lomele hold options to purchase 10,000 and 10,000 shares of
Common Stock, respectively, that are exercisable within 60 days, with an exercise price of $7.04 per share, which is higher than the fair market value of Norcal's Common Stock as of September 30, 1999, along with options to purchase 52,500 and 45,500, respectively, that are exercisable within 60 days at $4.89 per share, options to purchase 16,000 and 16,000, respectively, that are exercisable within 60 days at $5.18 per share and options to purchase 8,000 and 8,000, respectively, that are exercisable within 60 days at $5.59 per share. With respect to each member of the ESOP Administrative Committee, the number of such shares in the member's individual ESOP account, together with those subject to stock options exercisable within 60 days, represent less than 1% of the outstanding shares of Common Stock as of September 30, 1999.
(d) Excludes all shares of Common Stock held by the ESOP Trustee deemed to be beneficially owned by Messrs. Lomele, Humphrey and Legnitto as a result of their membership on the ESOP Administrative Committee which exercises shared voting and investment power with respect to such shares (see notes (c) above and (e) below), but includes those shares of Common Stock held by the ESOP Trustee for the benefit of Messrs. Lomele, Humphrey and Legnitto as ESOP participants (see note (b) above).
(e) ESOP shares not vested as of September 30, 1999.
(f) Includes all shares of Common Stock held by the ESOP Trustee because Mark R. Lomele and Archie L. Humphrey are executive officers of Norcal as well as members of the Administrative Committee of the ESOP with shared voting and investment power with respect to such shares (see note (c) above).
THE ESOP
The Norcal Waste Systems, Inc. Employee Stock Ownership Plan and Trust (the "ESOP") owns all of Norcal's outstanding shares of common stock. The ESOP is an employee stock ownership plan intended to qualify under Sections 401(a) and 4975(e)(7) of the Code. The ESOP was adopted effective as of October 1, 1985 and acquired the outstanding shares of Norcal in three separate transactions.
TRUSTEE AND ADMINISTRATIVE COMMITTEE; CONTROL OF NORCAL BY THE ESOP
The assets of the ESOP are held in trust under a trust agreement with the ESOP Trustee. An Administrative Committee (the "Committee") that is appointed by and serves at the pleasure of the Board of Directors is responsible for the operation and administration of the ESOP, including the ESOP's activities as sole shareholder of Norcal. Under ERISA, the Committee members are fiduciaries and as such must act for the exclusive benefit of the employee participants under the ESOP. The current members of the Committee are Archie L. Humphrey, John A. Legnitto and Mark R. Lomele. Mr. Lomele, Chair of the Committee, is an officer of Norcal. Mr. Humphrey, Secretary of the Committee, is also an officer of Norcal. All of the Committee members are employees of the Company. Norcal has agreed to indemnify members of the Committee against any liability arising out of an alleged breach by a member in the performance of his or her fiduciary duties, except those resulting from a member's own gross negligence or willful misconduct. Norcal also carries insurance against costs and liability arising from a member's breach or alleged breach of fiduciary duty.
The ESOP Trustee has granted the Committee a proxy to vote all shares held by the ESOP. The Committee elects Norcal's Board of Directors, may remove these directors, and votes with respect to certain corporate transactions requiring or presented for shareholder approval. However, with respect to any corporate matter that requires a shareholder vote and constitutes a merger, consolidation, recapitalization, reclassification, liquidation, dissolution, sale of substantially all assets of a trade or business or such similar transactions as may be specified in U.S. Treasury Department regulations, voting instructions are to be solicited from ESOP participants with respect to shares allocated to their accounts. The Committee determines the voting of any unallocated shares and any allocated shares for which ESOP participants do not provide voting instructions. Because a significant number of shares are
unallocated (3,608,675 shares or 15.0% of outstanding stock), currently the Committee may be able to exercise a significant influence over such matters. If Norcal's capital stock becomes registered under the Exchange Act, each ESOP participant will be able to direct voting of those shares allocated to his or her account and the Committee will have responsibility for voting only unallocated or undirected shares. The sale of any shares of Norcal Common Stock by the ESOP requires the approval of the Board of Directors.
DISTRIBUTIONS
In-Service Withdrawals. Each participant who has attained age 55 and has participated in the ESOP for at least ten years is entitled to make in-service withdrawals with respect to common stock acquired by the ESOP after December 31, 1986, and allocated to his or her ESOP account ("Post-1986 Shares"). An eligible participant will be entitled to withdraw up to a total of 25% of his or her Post-1986 Shares during the first five years of the election period and will be entitled to withdraw up to a total of 50% of his or her Post-1986 Shares during the sixth year of the election period. It is expected that withdrawals will be paid in cash. As of the date hereof, the ESOP held 11,654,973 Post-1986 Shares.
Post-Termination Distributions. Except for the in-service withdrawals described above, a vested participant is not entitled to begin receiving a distribution of his or her ESOP accounts until after his or her employment has terminated. The Committee generally determines the time and manner of distributions, subject to certain limitations. Distributions may be made in a lump sum or in substantially equal annual installments over a period not exceeding five years. Norcal expects that the ESOP's distributions will continue to be paid in cash. Norcal is obligated to repurchase any shares of its common stock that may be distributed by the ESOP to participants following withdrawal, retirement or termination.
NORCAL CONTRIBUTIONS AND ALLOCATIONS
Norcal may make contributions to the ESOP in the form of cash, cancellation of indebtedness (on the various loans that Norcal has made to the ESOP (the "ESOP Loans"), or newly issued shares of common stock, in such amounts as may be determined annually by the Board of Directors. The ESOP may use cash contributions to make payments on the ESOP Loans, to make distributions of benefits to participants (or beneficiaries) or to invest in investments other than common stock of Norcal. Contributions to the ESOP are allocated each plan year to those participants who complete at least 1,000 hours of service during the plan year and are employed on September 30 (or who retire, become disabled or die during the plan year). Of 24,134,973 total shares, 3,608,675 shares were unallocated as of September 30, 1999.
To the extent that the ESOP utilizes cash contributions from Norcal to repay the ESOP Loans, the contribution will result in no net cash outlay by Norcal. Moreover, such contributions to the ESOP are generally tax-deductible.
The Credit Agreement and the Indenture relating to the Senior Notes expressly permit Norcal to pay dividends or make contributions or loans to the ESOP in order for the ESOP to pay cash benefits due to retired, terminated or withdrawing ESOP participants and/or to repurchase Norcal common stock distributed to such participants. To the extent Norcal contributes funds to the ESOP for this purpose or is obligated to repurchase common stock distributed to participants, Norcal will have less cash available to make payments on its outstanding indebtedness. Furthermore, the amount Norcal may contribute to the ESOP to fund such ESOP distribution obligations (or may use to repurchase common stock distributed by the ESOP) will increase significantly in the future as the Company's workforce ages and retires, as additional shares of common stock are allocated to participants, if eligible participants elect to receive in-service withdrawals or if the value of the common stock increases. Such an increase in contributions would reduce the amount of cash available for other purposes, including to make debt service payments.
THE ESOP LOANS
In 1986 and 1987 Norcal's predecessors lent a total of $127.7 million to their respective employee stock ownership plans in connection with the acquisition of each of the predecessors by their respective ESOPs and merger of the two predecessor companies. In 1990, in connection with the Excel Transaction, Norcal loaned $10.7 million to the Excel ESOP pursuant to a loan agreement, which amount became indebtedness of the ESOP upon the merger of the Excel ESOP into the ESOP. At September 30, 1995 the Company reflected on its balance sheet amounts owed by the ESOP to Norcal of $47.8 million.
In connection with the Refinancing, the ESOP's indebtedness reflects, among other things, Norcal's funding of the ESOP's retirement of the ESOP Notes, repayment of all amounts owed under the Old Credit Agreement, and incurrence of new indebtedness by the Company pursuant to the Refinancing. At September 30, 1999, the outstanding principal balance owed to Norcal was $22.6 million. The ESOP and Norcal have entered into a Fourth Amended and Restated ESOP Loan Agreement, effective as of October 1, 1995, whereby the ESOP will repay such outstanding indebtedness, plus unpaid accrued interest at the rate of seven percent (7.0%) per annum, in installments of approximately $9.8 million each as of September 30 of each year, beginning in 1996. In addition, the ESOP will prepay such outstanding indebtedness, without penalty, to the extent that Norcal makes contributions to the ESOP for the purpose of making such prepayments. The ESOP's repayment of principal and interest on such outstanding indebtedness may not exceed the sum of Norcal's contributions to the ESOP for the purpose of making such repayments, plus any cash dividends paid on Norcal's common stock held by the ESOP and earnings on Norcal contributions to the ESOP, less any repayments made by the ESOP in prior years. On June 24, 1999, the Company and the ESOP executed an amendment to the Fourth Amended and Restated ESOP Loan Agreement related to the Company's S Corporation election. The amendment allows the ESOP to pay interest only during the period the Company remains an S Corporation, provided that the entire principal balance is still repaid by fiscal year 2008 (the final due date of the ESOP Agreement). See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CONSULTING ARRANGEMENTS WITH KAUFMAN CAMPAIGN CONSULTANTS
Kaufman Campaign Consultants ("KCC"), of which Ms. Kaufman, a director of Norcal, is President and sole shareholder, is party to a consulting agreement with the Company, effective May 16, 1996, pursuant to which KCC has agreed to provide the Company with certain consulting services in the areas of political affairs, public affairs, media and public relations. The agreement, which had an original term of one year, has been extended by the Company and KCC through September 30, 2000. Under the agreement, KCC receives a monthly fee of $9,500. KCC received an aggregate of $114,000 in fees during fiscal year 1999.
DIRECTORS AND OFFICERS INSURANCE
Norcal carries insurance indemnifying its directors and officers against certain liabilities that may arise by reason of their status or service as directors or officers of Norcal and its affiliates and as ERISA fiduciaries, to the extent they may so act.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Report of KPMG LLP, Independent Auditors
Consolidated balance sheets as of September 30, 1999 and 1998
Consolidated statements of income for each of the three years in the period ended September 30, 1999
Consolidated statements of stockholder's equity for each of the three years in the period ended September 30, 1999
Consolidated statements of cash flows for each of the three years in the period ended September 30, 1999
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Included in Part IV of this report:
Schedule II Valuation and Qualifying Accounts and Reserves
All other schedules are omitted because they are not required, or are not applicable, or the information is included in the consolidated financial statements or notes to consolidated financial statements.
3. Exhibits
Exhibits available upon request to the Company. - --------------- + Incorporated by reference to the identically numbered exhibit to the Company's Registration Statement on Form S-4 (File No. 33-80777), as amended and declared effective on August 16, 1996.
++ Incorporated by reference to the identically numbered exhibit to the Company's Annual Report for the fiscal year ended September 30, 1997, filed December 24, 1997.
+++ Incorporated by reference to the Company's Annual Report for the fiscal year ended September 30, 1998, filed December 21, 1998.
++++ Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report for the quarter ended June 30, 1997, filed August 14, 1997.
+++++ Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report for the quarter ended December 31, 1997, filed February 13, 1998.
++++++ Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report for the quarter ended June 30, 1998, filed August 17, 1998.
+++++++ Incorporated by reference to the identically numbered exhibit to the Company's Quarterly Report for the quarter ended June 30, 1999, filed August 13, 1999.
* Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
None.
SIGNATURES
Dated: December 28, 1999.
NORCAL WASTE SYSTEMS, INC.
By: /s/ MICHAEL J. SANGIACOMO ------------------------------------ Michael J. Sangiacomo President, Chief Executive Officer and Director
NORCAL WASTE SYSTEMS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Supporting schedules other than the above have been omitted because they are not applicable or not required or because the information to be set forth therein is included in the financial statements or notes thereto herein.
EXHIBIT INDEX