Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)

 

3CI COMPLETE COMPLIANCE CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

YES  ý  NO  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this form 10-Q or any amendment to this Form 10-Q.

 

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

 

 

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

 

The number of shares of Common Stock outstanding as of the close of business on August 4, 2004, was 9,739,611.

 

 

FORWARD-LOOKING STATEMENTS

 

“THIS QUARTERLY REPORT CONTAINS FORWARD-LOOKING STATEMENTS CONCERNING THE COMPANY’S BUSINESS AND OPERATIONS.  ALTHOUGH THE COMPANY BELIEVES THAT THE EXPECTATIONS REFLECTED IN THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, THESE EXPECTATIONS AND THE RELATED STATEMENTS ARE SUBJECT TO RISKS, UNCERTAINTIES, AND OTHER FACTORS THAT COULD CAUSE THE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED.  THESE RISKS, UNCERTAINTIES, AND OTHER FACTORS INCLUDE, BUT ARE NOT LIMITED TO, ADVERSE WEATHER CONDITIONS, FLUCTUATIONS IN CUSTOMER DEMAND, COMPETITIVE ACTIVITY AND PRICING PRESSURE AND GENERAL ECONOMIC CONDITIONS AFFECTING THE BIO-MEDICAL WASTE DISPOSAL INDUSTRY, AS WELL AS OTHER RISKS DETAILED IN THE COMPANY’S FILINGS WITH THE SEC.  THE COMPANY EXPRESSLY DISCLAIMS ANY OBLIGATIONS TO RELEASE PUBLICLY ANY UPDATES OR REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT ANY CHANGES IN THE COMPANY’S EXPECTATIONS.”

 

 

3CI COMPLETE COMPLIANCE CORPORATION

 

I N D E X

 

PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Balance Sheets as of June 30, 2004 and September 30, 2003
	Statements of Operations for the three and nine months ended June 30, 2004 and 2003
	Statements of Cash Flows for the nine months ended June 30, 2004 and 2003
	Notes to Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote Of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
SIGNATURES

 

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PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

3CI COMPLETE COMPLIANCE CORPORATION

BALANCE SHEETS

 

		June 30, 2004			September 30, 2003
		(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents		$	399,666		$	1,057,055
Accounts receivable, net allowances of $401,437 and $622,668 at June 30, 2004 and September 30, 2003, respectively		2,128,551			2,540,388
Inventory		69,502			73,525
Prepaid expenses		761,221			337,314
Deferred income taxes		157,274			157,274
Other current assets		3,582			16,320
Total current assets		3,519,796			4,181,876
Property, plant and equipment, at cost		6,904,561			7,430,398
Accumulated depreciation		(4,845,082		)	(5,186,243		)
Net property, plant and equipment		2,059,479			2,244,155
Excess of cost over net assets acquired, net of accumulated amortization of $174,988 at June 30, 2004 and September 30, 2003		262,243			262,243
Intangibles, net of accumulated amortization of $208,902 and $173,693 at June 30, 2004 and September 31, 2003		415,396			450,607
Deferred income taxes		3,302,592			3,326,342
Other assets		78,923			78,438
Total assets		$	9,638,429		$	10,543,661
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Notes payable		$	403,243		$	22,821
Accounts payable		90,512			332,870
Accounts payable, affiliated companies		96,377			423,602
Accrued liabilities		685,398			600,976
Note payable majority shareholder, current portion		1,587,213			1,123,537
Total current liabilities		2,862,743			2,503,806
Note payable majority shareholder, net of current portion		—			1,302,108
Total liabilities		2,862,743			3,805,914
Shareholders’ Equity:
Common stock, $0.01 par value, authorized 40,450,000 shares; Issued and outstanding 9,739,611		97,742			97,742
Common stock to be issued (Note 5)		7,750,000			7,750,000
Less cost of treasury stock 34,500 shares		(51,595		)	(51,595		)
Additional paid-in capital - common stock		20,519,861			20,519,861
Accumulated deficit		(21,540,322		)	(21,578,261		)
Total shareholders’ equity		6,775,686			6,737,747
Total liabilities and shareholders’ equity		$	9,638,429		$	10,543,661

 

The accompanying notes are an integral part of these financial statements.

 

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3CI COMPLETE COMPLIANCE CORPORATION

STATEMENTS OF OPERATION

(UNAUDITED)

 

		For the three months ended June 30,						For the nine months ended June 30,
		2004			2003			2004			2003
Revenues		$	3,217,564		$	3,439,572		$	9,853,464		$	10,446,375
Expenses:
Cost of services		1,787,659			1,989,164			5,852,913			6,495,219
Depreciation and amortization		106,953			153,909			352,084			511,914
Selling, general and administrative expenses		831,406			1,045,648			3,163,878			2,549,576
Interest expense		49,286			30,417			121,411			138,121
Other expense-net		90,163			(9,255		)	301,489			130,160
Income before income taxes		352,097			229,689			61,689			621,385
Income tax expenses		135,555			—			23,750			—
Net income		$	216,542		$	229,689		$	37,939		$	621,385
Net income applicable to common shareholders		$	216,542		$	229,689		$	37,939		$	621,385
Basic earnings per share:
Basic net income per share		$	0.01		$	0.02		$	—		$	0.05
Diluted earnings per share:
Diluted net income per share		$	0.01		$	0.01		$	—		$	0.04

 

The accompanying notes are an integral part of these financial statements.

 

4

 

3CI COMPLETE COMPLIANCE CORPORATION

STATEMENT OF CASH FLOWS

(UNAUDITED)

 

		For the nine months ended June 30,
		2004			2003
Cash flow from operating activities:
Net income		$	37,939		$	621,385
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on disposal of fixed assets		(1,225		)	(64,139		)
Depreciation and amortization		352,084			511,914
Deferred tax asset		23,750			—
Changes in operating assets and liabilities:
Decrease in accounts receivable, net		411,837			993,365
Decrease (Increase) in inventory		4,023			(8,595		)
Increase in prepaid expenses		(423,907		)	(154,429		)
Decrease in other assets		12,253			27,879
Decrease in accounts payable		(242,358		)	(90,447		)
Decrease in accounts payable, affiliated companies		(327,225		)	(407,623		)
Increase in insurance note payable		380,422			275,067
Increase (Decrease) in accrued liabilities		84,422			(5,975		)
Total adjustments to net income		274,076			1,077,017
Net cash provided by operating activities		312,015			1,698,402
Cash flow from investing activities:
Acquisition of intangible assets from Air N Sea		—			(504,300		)
Proceeds from sale of property, plant and equipment		81,375			—
Purchase of property, plant and equipment		(212,348		)	(181,903		)
Net cash used in investing activities		(130,973		)	(686,203		)
Cash flow from financing activities:
Proceeds from issuance of common stock		—			54,129
Reduction of note payable to majority shareholders		(838,432		)	(865,172		)
Net cash used in financing activities		(838,432		)	(811,043		)
Net (decrease) increase in cash and cash equivalents		(657,389		)	201,156
Cash and cash equivalents, beginning of period		1,057,055			898,720
Cash and cash equivalents, end of period		$	399,666		$	1,099,896

 

The accompanying notes are an integral part of these financial statements.

 

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3CI COMPLETE COMPLIANCE CORPORATION

NOTES TO FINANCIAL STATEMENTS
June 30, 2004

 

NOTE 1—DESCRIPTION OF BUSINESS

 

Organization and Basis of Presentation

 

3CI Complete Compliance Corporation (the “Company” or “3CI”), a Delaware corporation, is engaged in the collection and transportation of biomedical waste in the southwestern and southeastern United States.

 

Effective October 1, 1998, Stericycle Inc., a Delaware corporation (“Stericycle”), acquired 100% of the common stock of Waste Systems, Inc. (“WSI”). Stericycle directly and indirectly through WSI owns (i) 67.5% or 6,578,504 shares of the Company’s outstanding common stock, par value $0.01 per share (“Common Stock”), and (ii) 100% of the Company’s Series B Preferred Stock, par value $0.01 per share (“Series B Preferred Stock”), and 100% of the Company’s Series C Preferred Stock, par value $0.01 per share (“Series C Preferred Stock,” and together with the Series B Preferred Stock, the “Preferred Stock”), all of which shares of Preferred Stock were converted into Common Stock on April 6, 2003.  The Company has not issued any shares of Common Stock and has not recorded any increase in the outstanding Common Stock related to such conversion.  See Note 5.

 

The accompanying unaudited condensed financials statements have been prepared in accordance with accounting principles generally accepted in the United States, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three and nine month period ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ended September 30, 2004.

 

For further information, refer to the consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended September 30, 2003.

 

Certain amounts in the financial statements for 2003 have been reclassified to conform to the 2004 presentation. For the Statement of Cash Flows, proceeds and payments on the Insurance Notes Payable have been reclassified for 2003 from cash flow from financing activities to cash flow from operating activities. The Company believes that the notes are an operating liability and that the reclassification in the Statement of Cash Flows better reflects their nature.

 

NOTE 2—NET (LOSS) INCOME PER SHARE

 

The following table sets forth the computation of net income (loss) per common share:

 

		Three months ended June 30, 2004			Three months ended June 30, 2003			Nine months ended June 30, 2004			Nine months ended June 30, 2003
Numerator:
Net income		$	216,542		$	252,575		$	37,939		$	621,385
Denominator for basic earnings per share-weighted average shares		17,489,611			9,739,611			17,489,611			9,582,399
Effect of dilutive shares:
Preferred Shares		—			7,750,000			—			7,750,000
Warrants											95,026
Denominator for diluted earnings per share		17,489,611			17,489,611			17,489,611			17,427,425
Basic net income per share		$	0.01		$	0.02		$	—		$	0.05
Diluted net income per common share		$	0.01		$	0.01		$	—		$	0.04

 

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The effect of the conversion of the preferred shares on the above basic and diluted net income per share calculations is based upon (i) the Company’s interpretation that the appropriate conversion rate is the per share market value of the Common Stock on the conversion notice date, less $1.00 per share, but in no event is the conversion rate less than $1.00 per share and (ii) the fact that the preferred shares were converted on April 6, 2003 (See Notes 5 and 7).

 

Stock options were not included in the June 30, 2004 and 2003 computations as they were antidilutive since the exercise prices ranging from $0.28 to $0.59 were greater than the average price of the common stock.

 

NOTE 3—PROMISSORY NOTE

 

The Company has historically financed its working capital needs, capital expenditures and acquisitions primarily using advances from WSI and internally generated funds.  The Company’s borrowed indebtedness currently consists only of amounts owed under an amended and restated revolving promissory note payable to WSI (the “Note”), which had an original aggregate principal amount of $5,487,308 as of October 1, 1998.

 

The Note is payable in monthly payments of $100,000, due on the first day of each month, which are applied to principal and accrued interest calculated at the prime lending rate (4% as of June 30, 2004), as such may change from time to time, published under “Money Rates” in The Wall Street Journal (Southwestern Edition) (the “Prime Rate”), not to exceed 13%.  In addition to the term note facility described above, the Note includes a revolving credit agreement under which the Company can borrow up to and including $100,000; the Company has no borrowings outstanding under the revolving credit agreement.  Borrowings under the Note may be prepaid at any time without penalty.  The Note matures on October 1, 2004.

 

The Note is subordinated to all security interests under a certain Settlement Agreement effective January 10, 1996, by and among the Company, James H. Shepherd, James Michael Shepherd, Richard T. McElhannon (collectively, the “Shepherd Parties”), WSI and certain former directors and officers of the Company (the “Shepherd Settlement Agreement”), which was assigned to Stericycle on May 1, 2002, but otherwise is secured by substantially all of the Company’s assets.  Pursuant to the Note, the Company is required to achieve each fiscal quarter a minimum level of $900,000 of EBITDA (earnings before interest, taxes, depreciation and amortization) for the then trailing six-month period, excluding certain expenses associated with the dispute regarding the conversion rate of the Preferred Stock.  If the minimum EBITDA level is not achieved at the end of any such six-month period, the Note requires the Company to pay to WSI a fee equal to 3% per annum of the outstanding principal balance of the Note at the end of such period.  The Company and WSI are currently negotiating a modification of the minimum level of EBITDA that the Company is required to achieve under the Note in accordance with the Company’s budgeted financial results.

 

Total interest expense under the Note was $100,816 and $138,121 for the nine months ended June 30, 2004 and 2003, respectively. The Company was not in compliance under the EBITDA covenant of the Note at June 30, 2004, March 31, 2004 and December 31, 2003.  On March 17, 2004, the Company paid to WSI a penalty fee of approximately $64,469 in connection with such non-compliance as of December 31, 2003.  The Company has recently notified WSI that it has determined that the Company overpaid this penalty fee by approximately $48,352.  The overpayment resulted from the Company not calculating the amount of the penalty fee on a per annum basis, as required by the Note.  The Company will request that WSI refund the full amount of the overpayment to the Company. The Company had also previously accrued approximately $56,084 as interest expense in connection with its failure to comply with the EBITDA covenant of the Note as of March 31, 2004, but has not yet paid this penalty fee to WSI.  Similarly, the Company has recently determined that it overstated this $56,084 accrual by approximately $42,064 because of a failure to calculate the amount of the penalty fee on a per annum basis.  The Company has accrued approximately $11,904 in connection with its failure to comply with the EBITDA covenant of the Note as of June 30, 2004, and has not yet paid this penalty fee to WSI.  This $11,904 accrual has been calculated on a per annum basis in accordance with the Note.  The Company is determining whether it has overpaid any other penalty fees previously paid to WSI pursuant to the Note and has amended the March 31, 2004 10-Q to account for the overstatement of interest expense in the approximate amount of $90,414.

 

The Company has requested an additional amendment to the Note, which would exclude from its EBITDA covenant calculation not only certain expenses associated with the dispute regarding the conversion rate of the Company’s Preferred Stock, which has previously been agreed to by WSI, but also certain expenses primarily associated with the allegations of the Company’s minority stockholders in Robb et al. v. Stericycle, Inc. et al. and the Special Committee’s investigation of those allegations.  See Part II, Item I, Legal Proceedings.

 

NOTE 4—INCOME TAXES

 

At September 30, 2003 the Company had eligible net operating loss carryforwards for federal income tax purposes of approximately $10,555,000 which will begin expiring in 2004. The Company also had state net operating losses at September 30, 2003. Based on Section 382 of the Internal Revenue Code relating to changes in ownership of the Company, utilization of the net operating loss carryforwards is subject to an annual limitation of approximately

 

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$995,000 for net operating losses created prior to September 30, 1998. All net operating losses created after September 30, 1998 are not subject to any limitations and are available to be used for 20 years after they are produced. As such, the deferred tax asset and the related valuation allowance for net operating loss carryforwards were reduced at September 30, 2003 to account for the portion of the net operating loss carryforwards the Company will not be able to utilize.

 

During the fourth quarter of the Company’s 2003 fiscal year, the Company reevaluated the estimated amount of valuation allowance required in light of the profitability achieved during 2003 and 2002 as well as profitability expected in future years. As a result, the Company decreased the valuation allowance on deferred tax assets in accordance with SFAS No. 109, “Accounting for Income Taxes,” to an amount that the Company believes is more likely than not of being recovered based upon the Company’s assessment of the likelihood of near term operating income.

 

NOTE 5—PREFERRED STOCK

 

Preferred Stock Conversion

 

Pursuant to the Certificates of Designation governing the Preferred Stock, all 7,750,000 shares of Preferred Stock automatically converted on April 6, 2003. The Company has not issued any shares of Common Stock and has not recorded any increase in the outstanding Common Stock related to the conversion of the Preferred Stock.

 

Prior to April 6, 2003, WSI and Stericycle asserted that the conversion rate of the Preferred Stock is such that each share of Preferred Stock is convertible into that number of shares of Common Stock determined by dividing $7,000,000 (with respect to the Series B Preferred Stock) or $750,000 (with respect to the Series C Preferred Stock) by the market value of the Common Stock on the date of conversion. On April 6, 2003, the per share closing price of the Common Stock was $0.21. Accordingly, the Company would have issued 36,904,761 shares of Common Stock upon conversion of the Preferred Stock under this interpretation, which would have increased WSI’s ownership percentage to approximately 91.2% of the outstanding shares of Common Stock and the combined WSI and Stericycle ownership percentage to approximately 93.2%.

 

WSI and Stericycle’s interpretation of the conversion rate is contrary to the Company’s interpretation of the conversion rate. Based on the Certificates of Designations governing the Preferred Stock, certain documents executed contemporaneously with the issuance of the Preferred Stock, and the intent of the parties at the time of issuance of the Preferred Stock and the execution of these documents, the Company believes that the appropriate conversion rate is the per share market value of the Common Stock on the conversion notice date, less $1.00 per share, but that the conversion rate shall not be less than $1.00 per share (the “Agreed Maximum Conversion Rate”). Under this interpretation, since the per share market value of the Common Stock was less than $1.00 on April 6, 2003, the Company would have issued 7,750,000 shares of Common Stock upon conversion of the Preferred Stock, which would have increased WSI’s ownership percentage to approximately 76.6% of the outstanding shares of Common Stock and the combined WSI and Stericycle ownership percentage to approximately 81.9%.

 

On April 2, 2003, the Company, WSI and Stericycle entered into an Agreement to Defer Conversion of Preferred Stocks (the “Agreement to Defer Conversion”), pursuant to which all parties agreed that the Company will not issue any Common Stock upon conversion of the Preferred Stock until a judicial judgment as to the appropriate conversion rate has become final and non-appealable.

 

On May 9, 2003, the Company filed a declaratory judgment action seeking a judicial determination of the appropriate conversion rate of the Preferred Stock. On August 22, 2003, the Company filed an original petition for declaratory judgment and to enforce the Settlement Agreement, dated July 17, 1997, pursuant to which the Preferred Stock was issued. In its petition, the Company requests the Court establish the conversion rate of the Preferred Stock to be the Agreed Maximum Conversion Rate and confirm the issuance of no more than 7,750,000 shares of Common Stock to WSI as of April 6, 2003. WSI subsequently filed a motion to have the Court declare that the Preferred Stock is convertible into 36,704,761 shares of Common Stock.  The parties are currently conducting discovery in this proceeding.   See Part II, Item 1, Legal Proceedings.

 

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Preferred Stock Dividends

 

There are unanimous written consents of the Board of Directors declaring dividends on the Series B Preferred Stock and Series C Preferred Stock totaling $161,158, $637,623, $907,387 and $497,550 for each of the years 2003, 2002, 2001, 2000, respectively.  Each of these resolutions for the dividends called for payment in cash from funds legally available for the payment of dividends, as and when the Board of Directors may direct by further resolution. However, none of these unanimous consents are executed by all of the individuals who were members of the Board of Directors at the date of such unanimous consents, and none of the dividends have been paid.

 

On December 22, 2003, the independent and disinterested members of the Board of Directors, relying on an opinion of counsel expert in Delaware corporate law and acting on behalf of the Board, determined that (i) the previous declarations of dividends on the Preferred Stock in the aggregate amount of $2,203,717 (collectively, the “Preferred Stock Dividends”) had not been effective to declare and obligate the Company to pay such dividends, and (ii) the Preferred Stock Dividends cannot now be lawfully declared and paid on the Preferred Stock. As a consequence of these determinations, the Company reversed the Preferred Stock Dividend entries on the Company’s books and records and restated its financial statements for the years ended September 30, 2001, 2002 and 2003.  These restatements reflect for the quarter ended December 31, 2002, a removal of (a) dividends payable on the Preferred Stock as a current liability on the Company’s balance sheets and as an adjustment of net income (loss) applicable to common shareholders on the statements of operations, and (b) the Preferred Stock Dividends as a line item on the Company’s statements of shareholders’ equity and statements of cash flows.

 

WSI was the holder of the Preferred Stock. The Company has been advised by WSI, Stericycle and the members of the Board who are affiliates of WSI and Stericycle that they believe the Company remains obligated to pay the Preferred Stock Dividends as previously declared in the Board resolutions and as previously recorded on the Company’s books. If WSI and Stericycle’s position is correct, the Preferred Stock Dividends would be paid by the Company in cash from funds legally available for the payment of dividends as and when the Board may direct by further resolution. Due to WSI, Stericycle and their affiliates’ announced position on the Preferred Stock Dividends, the Company has determined the amount of such dividends to be a contingent liability of $2,203,717.  See Part II, Item 1, Legal Proceedings.

 

NOTE 6—NOTE PAYABLE

 

During the quarter ended June 30, 2004, the Company financed its annual insurance premium over a 12-month period of time at a 5% per annum interest rate.

 

NOTE 7—COMMITMENTS AND CONTINGENCIES

 

See Note 5 of the Notes to the Financial Statements above for a discussion of certain contingent liabilities of the Company related to the Preferred Stock.

 

On June 20, 2002, a suit was filed by Larry F. Robb, individually, on behalf of a class comprised of the Company’s minority stockholders, and derivatively on behalf of the Company, in the First Judicial District Court in Shreveport, Louisiana against Stericycle, certain of the Company’s directors and the Company’s President and Chief Executive Officer which alleged minority stockholder oppression, breach of fiduciary duty and unjust enrichment. On or about October 27, 2003, the plaintiffs in this suit filed their First Amended Petition adding the Company as a derivative defendant. The Company has contacted its insurance carrier and has hired counsel to assist the Company in this litigation.  See Part II, Item 1, Legal Proceedings.

 

The Company is a defendant in Medical Waste Services of America LLC v. American 3CI Complete Compliance Corporation, cause no. 02-65105, in the 151st Judicial District Court of Harris County, Texas.  In this suit, the plaintiff seeks approximately $818,800 in damages, interest and attorney’s fees for failure to pay for treatment of medical waste and for breach of contract.  Plaintiff alleges that the Company has failed to pay for the treatment and disposal of medical waste at the plaintiff’s Birmingham, Alabama facility.  Further, plaintiff alleges that the Company agreed to deliver an additional amount of medical waste to plaintiff’s facility for treatment and disposal at a predetermined price, which the Company has failed to do.  3CI contends that the plaintiff has breached the contract by unilaterally increasing the contract price.  The parties are currently in discovery, and the Company cannot at this time predict the outcome of this litigation.

 

The Company operates within the regulated medical waste disposal industry, which is subject to intense governmental regulation at the federal, state and local levels. The Company believes it is currently in compliance in all material respects with all applicable laws and regulations governing the medical waste disposal business. However, continuing expenditures may be required in order for the Company to remain in compliance with existing and changing regulations. Furthermore, because the medical waste disposal industry is predicated upon the existence of strict

 

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governmental regulation, any material relaxation of regulatory requirements governing medical waste disposal or of their enforcement could result in a reduced demand for the Company’s services and have a material adverse effect on the Company’s revenues and financial condition. The scope and duration of existing and future regulations affecting the medical waste disposal industry cannot be anticipated and are subject to changing political and economic pressures.

 

The Company is subject to certain other litigation and claims arising in the ordinary course of business.  In the opinion of management of the Company, the amounts ultimately payable, if any, as a result of such claims and assessments will not have a material adverse effect on the Company’s financial position, results of operations or net cash flows.

 

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

 

The Company is engaged in the business of medical waste management services in the south and southeastern United States.  The Company’s customers include regional medical centers, major hospitals, clinics, medical and dental offices, veterinarians, pharmaceutical companies, retirement homes, medical testing laboratories and other medical waste generators.  The following is a discussion of some events that may allow a better understanding of the progression of the Company’s financial position and operating results.

 

The Company has historically financed its working capital needs, capital expenditures and acquisitions primarily using borrowings from WSI and internally generated funds. Currently, the Company’s only borrowed indebtedness consists of money borrowed from WSI under the Note and annual insurance premium financing.  As of June 30, 2004, March 31, 2004, September 30, 2003 and March 31, 2003, the outstanding balances under the WSI Note were in the aggregate principal amounts of approximately $1,587,213, $1,869,485, $2,425,645 and $3,392,492, respectively.   See Liquidity and Capital Resources herein and Note 3 to the Company’s financial statements.

 

See Note 5 to the Company’s financial statements above for a discussion of the reversal of the Company’s Preferred Stock Dividends on its books and records and the restatement of its financial statements for the years ended September 30, 2001, 2002 and 2003.

 

During the fourth quarter of the Company’s 2003 fiscal year, the Company reevaluated the estimated amount of valuation allowance required in light of the profitability achieved during 2003 and 2002 as well as profitability expected in future years. As a result, the Company increased the valuation allowance on deferred tax assets in accordance with SFAS No. 109, “Accounting for Income Taxes,” to an amount that the Company believes is more likely than not of being recovered. Accordingly, an income tax benefit of approximately $3,483,616 was reflected in the fourth quarter of the Company’s 2003 fiscal year. The amount of net deferred tax assets estimated to be recoverable was based upon the Company’s assessment of the likelihood of near term operating income.

 

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RESULTS OF OPERATIONS

 

The following summarizes (in thousands) the Company’s operations:

 

		Three Months Ended June 30,						Nine Months Ended June 30,
		2004			2003			2004			2003
Revenues		$	3,218		$	3,440		$	9,853		$	10,446
Cost of services		1,788			1,989			5,853			6,495
Depreciation and amortization		107			154			352			512
Selling, general and administrative expenses		831			1,046			3,164			2,550
Income from operations		492			251			484			889
Interest expense		49			30			121			138
Other expense, net		90			(9		)	301			130
Income taxes		136			—			24			—
Net Income		$	217		$	230		$	38		$	621

 

Three months ended June 30, 2004 compared to three months ended June 30, 2003:

 

Revenues decreased by $222,008, or 6.5%, to $3,217,564 during the three-month period ended June 30, 2004, from $3,439,572 for the three-month period ended June 30, 2003. This decrease is primarily related to a reduction in the volume of waste handled.  Substantially all of this reduction in volume was attributable to the Company’s efforts to focus on small quantity generators which provide higher margins at lower volumes while reducing the focus on less profitable larger quantity generators.

 

Cost of services decreased by $201,505, or 10.1%, to $1,787,659 during the three months ended June 30, 2004, compared to $1,989,164 for the three-month period ended June 30, 2003.  This decrease was primarily attributable to a decrease in processing and a decrease in transportation costs due to increased route efficiency.  Cost of services as a

 

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percentage of revenues decreased to 55.6% compared to 57.8% during the three months ended June 30, 2004 and June 30, 2003 respectively.  This percentage decrease was primarily attributable to a decrease in processing and a decrease in transportation costs due to increased route efficiency.

 

Depreciation and amortization expense for the three months ended June 30, 2004 decreased $46,957 or 30.5% to $106,952 compared to $153,909 for the three months ended June 30, 2003. This decrease was primarily attributable to the depreciable useful lives of assets still employed in the Company’s operations having expired during the quarter.

 

Selling, general and administrative expenses for the three months ended June 30, 2004 decreased 20.5% or $214,241 to $831,407 from $1,045,648 during the three months ended June 30, 2003.  Selling, general and administrative expenses decreased as a percentage of revenue to 25.8% for the three months ended June 30, 2004, as compared to 30.4% for the three months ended June 30, 2003 due primarily to timing issues related to legal expenses.

 

Interest expense for the three months ended June 30, 2004 increased by $18,869 or 62.0%, to $49,286 from $30,417 during the three months ended June 30, 2003.  This increase was due to the penalties paid and accrued due to the Company’s failure to meet the EBITDA covenant of the Note at December 31, 2003, March 31, 2004 and June 30, 2004, which is currently 3% per annum of the outstanding principal balance of the Note.

 

Nine months ended June 30, 2004 compared to nine months ended June 30, 2003:

 

Revenues decreased by $592,911 or 5.7%, to $9,853,464 during the nine-month period ended June 30, 2004, from $10,446,375 for the nine-month period ended June 30, 2003. This decrease is primarily related to a reduction in the volume of waste handled.  Substantially all of this reduction in volume was attributable to the Company’s efforts to focus on small quantity generators which provide higher margins at lower volumes while reducing the focus on less profitable larger quantity generators.

 

Cost of services decreased $642,306, or 9.9%, to $5,852,913, during the nine months ended June 30, 2004, compared to $6,495,219 for the nine-month period ended June 30, 2003.  This decrease was primarily attributable to a decrease in processing and a decrease in transportation costs due to increased route efficiency.  Cost of revenues as a percentage of revenues decreased to 59.4% during the nine months ended June 30, 2004, as compared to 62.2% during the nine months ended June 30, 2003.  This decrease was primarily attributable to a decrease in processing and a decrease in transportation costs due to increased route efficiency.

 

Depreciation and amortization expense for the nine months ended June 30, 2004 decreased $159,830 or 31.2% to $352,084 compared to $511,914 for the nine months ended June 30, 2003. This decrease was primarily attributable to the depreciable useful lives of assets still employed in the Company’s operations having expired during the nine months ended June 30, 2004.

 

Selling, general and administrative expenses for the period increased 24.1% or $614,302 to $3,163,878 during the nine months ended June 30, 2004 from $2,549,576 during the nine months ended June 30, 2003.  Selling, general and administrative expenses increased as a percentage of revenue to 32.1% for the nine months ended June 30, 2004 as compared to 24.4% for the nine months ended June 30, 2003 due primarily to increases in legal expenses and information technology consulting fees.  Substantially all of these increased legal fees are related to the legal proceedings described in Part II, Item 1, Legal Proceedings below.

 

Interest expense decreased by $16,710 or 12.1% to $121,411 during the nine months ended June 30, 2004 as compared to $138,121 during the nine months ended June 30, 2003.  This decrease was due to a lower principal balance on the Note to majority shareholder.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The Company has historically financed its working capital needs, capital expenditures and acquisitions primarily using advances from WSI and internally generated funds. The Company’s borrowed indebtedness currently consists only of amounts owed to WSI under the Note and financed annual insurance premiums.

 

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The Note is payable in monthly payments of $100,000, due on the first day of each month, which are applied to principal and accrued interest calculated at the prime lending rate (4% as of March 31, 2004), as such may change from time to time, published under “Money Rates” in The Wall Street Journal (Southwestern Edition) (the “Prime Rate”), not to exceed 13%. As of June 30, 2004, and June 30, 2003, the outstanding balances under the Note were in the aggregate principal amounts of approximately $1,587,213 and $3,890,635, respectively. In addition to the term note facility described above, the Note includes a revolving credit agreement under which the Company can borrow up to and including $100,000; the Company has no borrowings outstanding under the revolving credit agreement. Borrowings under the Note may be prepaid at any time without penalty. The Note matures on October 1, 2004.

 

The Note is subordinated to all security interests under the Shepherd Settlement Agreement, which were assigned to Stericycle on May 1, 2002, but otherwise is secured by substantially all of the Company’s assets. Pursuant to the Note, the Company is required to achieve each fiscal quarter a minimum level of $900,000 of EBITDA (earnings before interest, taxes, depreciation and amortization) for the then trailing six-month period, excluding certain expenses associated with the dispute regarding the conversion rate of the Preferred Stock.  If the minimum EBITDA level is not obtained at the end of any such six-month period, the Note requires the Company to pay to WSI a fee equal to 3% per annum of the outstanding principal balance of the Note at the end of such period.  The Company and WSI are currently negotiating a modification of the minimum level of EBITDA that the Company is required to achieve under the Note in accordance with the Company’s budgeted financial results.

 

The Company was not in compliance under the EBITDA covenant of the Note at June 30, 2004, March 31, 2004 and December 31, 2003.  On March 17, 2004, the Company paid to WSI a penalty fee of approximately $64,469 in connection with such non-compliance as of December 31, 2003.  The Company has recently notified WSI that it has determined that the Company overpaid this penalty fee by approximately $48,352.  The overpayment resulted from the Company not calculating the amount of the penalty fee on a per annum basis, as required by the Note.  The Company will request that WSI refund the full amount of the overpayment to the Company. The Company had also previously accrued approximately $56,084 as interest expense in connection with its failure to comply with the EBITDA covenant of the Note as of March 31, 2004, but has not yet paid this penalty fee to WSI.  Similarly, the Company has recently determined that it overstated this $56,084 accrual by approximately $42,062 because of a failure to calculate the amount of the penalty fee on a per annum basis.  The Company has accrued approximately $11,904 in connection with its failure to comply with the EBITDA covenant of the Note as of June 30, 2004, and has not yet paid this penalty fee to WSI.  This $11,904 accrual has been calculated on a per annum basis in accordance with the Note.  The Company is determining whether it has overpaid any other penalty fees previously paid to WSI pursuant to the Note and has amended the March 31, 2004 10-Q to account for the overstatement of interest expense in the approximate amount of $90,414.

 

The Company has requested an additional amendment to the Note, which would exclude from its EBITDA covenant calculation not only certain expenses associated with the dispute regarding the conversion rate of the Company’s Preferred Stock, which has previously been agreed to by WSI, but also certain expenses primarily associated with the allegations of the Company’s minority stockholders in Robb et al. v. Stericycle, Inc. et al. and the Special Committee’s investigation of those allegations.  See Part II, Item I, Legal Proceedings.

 

Since June 2003, the Company has not attempted to arrange credit from third-party sources, but believes that if such funds were available, they would be at higher interest rates and could require additional operating and financing restrictions from those under the WSI Note.

 

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At September 30, 2003, the Company had net operating loss carryforwards for federal income tax purposes of approximately $10,555,000 which will begin expiring in 2004. The Company also had state net operating losses at September 30, 2003. Based on Section 382 of the Internal Revenue Code relating to changes in ownership of the Company, utilization of the net operating loss carryforwards is subject to an annual limitation of approximately $995,000 for net operating losses created prior to September 30, 1998. All net operating losses created after September 30, 1998 are not subject to any limitations and are available to be used for 20 years after they are produced. As such, the deferred tax asset and the related valuation allowance for net operating loss carryforwards were reduced to account for the portion of the net operating loss carryforwards the Company will not be able to utilize.

 

During the fourth quarter of the Company’s 2003 fiscal year, the Company reevaluated the estimated amount of valuation allowance required in light of the profitability achieved during 2003 and 2002 as well as profitability expected in future years. As a result, the Company increased the valuation allowance on deferred tax assets in accordance with SFAS No. 109, “Accounting for Income Taxes,” to an amount that the Company believes is more likely than not of being recovered. Accordingly, an income tax benefit of approximately $3,483,616 was reflected in the fourth quarter of the Company’s 2003 fiscal year. The amount of net deferred tax assets estimated to be recoverable was based upon the Company’s assessment of the likelihood of near term operating income.

 

At June 30, 2004, the Company had net working capital, exclusive of the Note, of $2,244,266 compared to a net working capital exclusive of the Note of $2,801,607 at September 30, 2003.  This decrease in net working capital of $557,341 was due primarily to the decrease in accounts receivable.

 

Net cash provided by operating activities was $312,015 during the nine-month period ended June 30, 2004, compared to $1,698,402 for the nine-month period ended June 30, 2003.  The difference is due to a decrease in net income.

 

Net cash used in investing activities for the nine months ended June 30, 2004, was $130,973 compared to $686,203 for the same period in 2003.  The $555,230 increase reflected increased investment in equipment net of proceeds from the sale of equipment.

 

Net cash used in financing activities was $838,432 for the nine-month period ended June 30, 2004, compared to $811,043 during the nine-month period ended June 30, 2003.  The $27,389 net decrease was due to the principal reduction of the Note.

 

Item 3.   Qualitative Disclosure about Market Risk

 

The Company’s exposure to market risk includes the possibility of rising interest rates in connection with the Note, thereby increasing its debt service obligation, which could adversely affect the Company’s cash flows.  The interest rate on the Note is variable and tied to the Prime Rate not to exceed 13%.  An increase in the prime rate of 1% would have the effect of increasing interest expense by approximately $15,872 over 12 months.  The Company does not utilize derivative financial instruments to mitigate the risks of changes in interest rates.

 

Item 4.   Controls and Procedures

 

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Securities and Exchange Commission.  This information is accumulated and communicated to the Company’s management including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.  The Company’s management, including the Chief Executive Officer and the Chief Financial Officer,

 

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recognizes that any set of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

 

Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, the Company conducted an evaluation of its disclosure controls and procedures within 90 days of the filing date of this report.  Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosures controls and procedures are effective in alerting them on a timely basis to material information required to be disclosed in the Company’s periodic filings.

 

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in the foregoing paragraph.

 

PART II - OTHER INFORMATION

 

Item 1.           Legal Proceedings

 

Judicial Filings Regarding the Conversion Rate of the Preferred Stock

 

On May 9, 2003, the Company filed a declaratory judgment action in the 269th District Court in Harris County, Texas (the “Court”) seeking a judicial determination of the appropriate conversion rate of the Preferred Stock. The Company filed the declaratory judgment action in connection with James T. Rash, et. al. v. Waste Systems, Inc., the Company and certain of the Company’s former directors and officers (the “1995 Action”), which was the original proceeding pursuant to which the Preferred Stock was issued by the Company.

 

Following a hearing in the 1995 Action and for jurisdictional reasons, the Company elected to initiate a new action (the “2003 Action”), and on August 22, 2003, filed an original petition for declaratory judgment and to enforce the Settlement Agreement, dated July 17, 1997, pursuant to which the Preferred Stock was issued. In this petition, the Company requests the Court establish the conversion rate of the Preferred Stock to be the Agreed Maximum Conversion Rate and confirm the issuance of no more than 7,750,000 shares of Common Stock to WSI as of April 6, 2003.

 

On October 3, 2003, WSI filed a motion to enforce judgment in the 1995 Action and to have the Court declare that the Preferred Stock is convertible into 36,904,761 shares of Common Stock. The Company opposed WSI’s motion to enforce the judgment. Following a hearing, the Court abated WSI’s motion on November 10, 2003.

 

On October 24, 2003, Don Smith, Ghere-Smith Interests, Inc., Tidel Technologies, Inc. f/k/a American Medical Technologies, Inc., Jim Rash, individually and in his capacity as representative of the certified class of minority shareholders of 3CI, and Larry Robb, individually and as proposed co-representative of the same certified class (collectively, the “Minority Stockholders”), answered and/or intervened in the 2003 Action, cross- claimed against WSI and filed a third-party petition against Stericycle.

 

The Minority Stockholders have asserted, on behalf of all minority stockholders of 3CI, many of the same claims of fraud, breach of fiduciary duty, unjust enrichment and other acts of minority stockholder oppression, as they have alleged in the Louisiana Suit (as defined and discussed below). In addition, the Minority Stockholders have asked the Court to deny 3CI’s request for declaratory relief, find that Stericycle and WSI have abused their duties to the minority stockholders and declare that Stericycle and WSI, among other things, (i) forfeit all fees, payments, dividends, warrants, preferred stock, common stock, profit shares and all other forms of value which Stericycle and WSI have extracted from 3CI and its minority owners, (ii) pay actual damages of at least $28 million and reasonable punitive damages, and (iii) buy the capital stock of the minority stockholders of the Company at the relative value of 3CI’s shares to Stericycle’s shares at the time Stericycle gained control over 3CI, i.e. one share of Stericycle common stock for every five shares of Common Stock.

 

On December 3, 2003, Stericycle filed its original answer to the Minority Stockholders’ third-party petition, and on December 24, 2003, WSI filed its answer and counter-petition in the 2003 Action. In their respective filings, Stericycle and WSI have denied all material allegations and reasserted their claims that the Preferred Stock is

 

15

 

convertible into 36,904,761 shares of Common Stock. The parties are currently conducting discovery in the 2003 Action.

 

As of September 4, 2003, the full Board unanimously appointed a Special Committee comprised of the independent Directors on the Company’s Board of Directors who are not affiliated with Stericycle or WSI.  The Special Committee was initially established to act on behalf of the Company in connection with the Company’s dispute with WSI and Stericycle as to the appropriate conversion rate of the Preferred Stock.  See Part II, Item 1, Legal Proceedings - Louisiana Minority Stockholder Litigation for a further description of the authority of the Special Committee.

 

Louisiana Minority Stockholder Litigation

 

On June 20, 2002, Larry F. Robb, individually, on behalf of a class comprised of the Company’s minority stockholders, and derivatively on behalf of the Company (collectively, the “Louisiana Plaintiffs”), filed cause no. 467704-A, Robb et al. v. Stericycle, Inc. et al., in the First Judicial District Court, Caddo Parish, Louisiana (the “Louisiana Suit”). In this suit, the Louisiana Plaintiffs assert numerous claims of minority stockholder oppression, breach of fiduciary duty and unjust enrichment against Stericycle, the four affiliates of Stericycle who are or were directors of the Company, and the President and Chief Executive Officer of the Company (collectively, the “Louisiana Defendants”).

 

The Louisiana Plaintiffs contend that since Stericycle’s acquisition of WSI in September 1998, Stericycle has unfairly and improperly exercised control over 3CI to the detriment of the Company’s minority stockholders in contravention of various contractual, common law and statutory duties. Among other things, the Louisiana Plaintiffs allege that the Louisiana Defendants have (i) deprived the Company of revenues by imposing unfavorable loan obligations and avoidable expenses on the Company; (ii) usurped 3CI’s business and business opportunities and diverted its assets for Stericycle’s benefit; and (iii) depressed the value of the Common Stock. The Louisiana Plaintiffs further allege that Stericycle has breached an agreement entered into for the protection of 3CI’s minority stockholders in connection with Stericycle’s acquisition of WSI.

 

Based on these and other allegations, the Louisiana Plaintiffs seek to recover actual and punitive damages and a variety of equitable and other relief, including forfeiture or rescission of various disputed transactions, a constructive trust of all benefits Stericycle has derived on business usurped from the Company or not offered to the Company and an order requiring Stericycle to buy the capital stock of the minority stockholders of the Company at the relative value of the Company’s shares to Stericycle’s shares at the time Stericycle gained control over the Company, i.e. one share of Stericycle common stock for every five shares of the Company’s Common Stock.

 

On or about October 27, 2003, the Louisiana Plaintiffs filed their First Amended Petition adding the Company as a derivative defendant. The Company has not yet answered this petition.

 

As of January 8, 2004, the Board expanded the authority of the Special Committee such that the Special Committee now has the exclusive power and authority on behalf of the Company to (i) make all inquiries, conduct all investigations and gather all information related to the Louisiana Suit, the 1995 Action and the 2003 Action, or any actions or proceedings related to any of the foregoing; (ii) make or approve all decisions of the Company related to the Louisiana Suit, the 1995 Action and the 2003 Action, including the Company’s filing, amending, maintaining, prosecuting or settling of any legal proceedings related to such suits; and (iii) exercise such other power and authority that may be exercised by the full Board with regard to the foregoing. The Special Committee is composed of Stephen B. Koenigsberg and Kevin J. McManus, who are the independent directors on the Board not affiliated with Stericycle or WSI.  Robert M. Waller, previously a member of the Special Committee, for personal reasons, resigned from the Board of Directors on March 11, 2004.  The Special Committee has appointed legal counsel to assist it in its investigation of the Louisiana Plaintiffs’ allegations and to gather all information related to the Louisiana Suit.

 

In June 2004, the Louisiana Plaintiffs filed a motion to certify the Louisiana Suit as a class action and served discovery relating to the request for class certification on all parties, including the Company.  In response, the Company, at the direction of the Special Committee, filed a motion with the Louisiana court to stay all proceedings in the litigation (including discovery) pending the completion of the Special Committee’s investigation.  After a hearing on the motion in June 2004, the court extended the Company’s deadline for responding to the Louisiana Plaintiffs’ discovery pending completion of the Special Committee’s investigation, but allowed the other parties to proceed with discovery in the interim.  The Company does not have sufficient information to predict the outcome of the Louisiana Suit.

 

Item 2.           Changes in Securities

 

None.

 

16

 

Item 3.    Defaults upon Senior Securities

 

The Company failed to achieve the minimum EBITDA level under the Note at the end of the six-month periods ended March 31, 2004 and June 30, 2004, and has not yet paid to WSI the required penalty fees thereunder.  Therefore, the Company could be deemed to be in default under the Note.  See Note 3 and Part I, Item 2, Management Discussion & Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources for a description of the Note and the required penalty fees thereunder.

 

Item 4.    Submission of Matters to a Vote of Security Holders

 

None.

 

Item 5.    Other Information

 

None.

 

Item 6.    Exhibits and Reports on Form 8-K

 

a)  Exhibits.  The following is a list of the exhibits filed with this Form 10-Q.

 

Exhibit Number		Description
31.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley act of 2002.
32.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley act of 2002.

 

b)  Reports on Form 8-K

 

None.

 

17

 

SIGNATURES

 

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

 

 

		3CI COMPLETE COMPLIANCE
		CORPORATION
		(Registrant)
Dated: August 16, 2004		By:	/s/ Donald P. Zima
			Donald P. Zima
	Chief Financial Officer, Secretary and Treasurer
			(Principal Financial Officer and Principal Accounting Officer)

 

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