**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q/A**

 

**Amendment No. 1**

 

**(Mark One)**

| **ý**                         | ** ** | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**                                                                                                                                                                                                                                                                                                                                                    |
|------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| ** **                         | ** ** | **For the quarterly period ended  March 31, 2004**                                                                                                                                                                                                                                                                                                                                                                                               |
|                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| **OR**                             |
|                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| **o**                              | ** ** | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**                                                                                                                                                                                                                                                                                                                                                   |
|                               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| ** **                         |       | **For the transition period from                                     to                                  ** |
| ** **                         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| **Commission file number 1-11097** |

 

**3CI COMPLETE COMPLIANCE CORPORATION**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                       | ** ** | **76-0351992**                        |
|--------------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)    |       | (I.R.S. Employer  Identification No.) |
|                                                               |       |                                  |
| **1517 W North Carrier Parkway #104, Grand  Prairie, Texas 75050** |
| (Address of principal executive offices)                           |
| (Zip Code)                                                         |
|                                                               |
| **(972) 375-0006**                                                 |
| (Registrant’s telephone number, including  area code)         |

 

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

 

YES ý NO o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 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 informationstatements incorporated by reference in Part III of this form 10-Q or anyamendment 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

 

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

 

The number of shares of Common Stock outstanding as of the close ofbusiness on May 3, 2004, was 9,739,611.

 

 

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**Explanatory Note**

 

The Company is filing this Quarterly Report on Form 10-Q/A as AmendmentNo. 1 to the Company’s Form 10-Q, originally filed on May 13, 2004 (the“Original Form 10-Q”), for the purpose of (i) amending the Company’s Statementsof Operations for the three and six-month periods ended March 31, 2004,the Company’s Balance Sheets as of March 31, 2004, and the Company’sStatement of Cash Flows for the six months ended March 31, 2004, and (ii)amending certain disclosures in Note 3 and in Management’s Discussion andAnalysis of Financial Condition and Results of Operations in Item 2 of Part I,in order to account for an overstatement of interest expense ofapproximately $90,457 reported in the Original Form 10-Q, due to the Company’smiscalculation of penalty fees payable by the Company to WasteSystems, Inc. (“WSI”), the Company’s majority stockholder, under anamended and restated revolving promissory note payable to WSI.  Forthe convenience of the reader, the Quarterly Report has been restated in itsentirety.

 

**FORWARD-LOOKING STATEMENTS**

 

“THIS QUARTERLY REPORT CONTAINSFORWARD-LOOKING STATEMENTS CONCERNING THE COMPANY’S BUSINESS ANDOPERATIONS.  ALTHOUGH THE COMPANYBELIEVES THAT THE EXPECTATIONS REFLECTED IN THE FORWARD-LOOKING STATEMENTS AREREASONABLE, THESE EXPECTATIONS AND THE RELATED STATEMENTS ARE SUBJECT TO RISKS,UNCERTAINTIES, AND OTHER FACTORS THAT COULD CAUSE THE ACTUAL RESULTS TO DIFFERMATERIALLY FROM THOSE PROJECTED.  THESERISKS, UNCERTAINTIES, AND OTHER FACTORS INCLUDE, BUT ARE NOT LIMITED TO,ADVERSE WEATHER CONDITIONS, FLUCTUATIONS IN CUSTOMER DEMAND, COMPETITIVEACTIVITY AND PRICING PRESSURE AND GENERAL ECONOMIC CONDITIONS AFFECTING THEBIO-MEDICAL WASTE DISPOSAL INDUSTRY, AS WELL AS OTHER RISKS DETAILED IN THECOMPANY’S FILINGS WITH THE SEC.  THECOMPANY EXPRESSLY DISCLAIMS ANY OBLIGATIONS TO RELEASE PUBLICLY ANY UPDATES ORREVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT ANY CHANGES IN THECOMPANY’S EXPECTATIONS.”

 

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**3CI COMPLETE COMPLIANCE CORPORATION**

 

**I N D E X**

 
| **PART I.**    | **FINANCIAL INFORMATION**                                                                   |   |
|----------------|---------------------------------------------------------------------------------------------|--------|
|           |                                                                                        |   |
| Item 1.        | Financial Statements                                                                        |   |
|           |                                                                                        |   |
|           | Balance  Sheets as of March 31, 2004 and September 30, 2003                       |   |
|           |                                                                                        |   |
|           | Statements of Operations for the three and  six months ended March 31, 2004 and 2003   |   |
|           |                                                                                        |   |
|           | Statements of Cash Flows for the six months  ended March 31, 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** |                                                                                        |   |

 

2

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**Item1.****Financial Statements**

 

**3CI COMPLETE COMPLIANCE CORPORATION**

**BALANCESHEETS**

 
| ** **                                                                                                                                    | ** ** | **March 31,  2004** | ** **     | **September 30,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|----------------|------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **(unaudited)**          | ** **     | ** **                   | ** ** |
| **ASSETS**                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Current Assets:**                                                                                                                           | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Cash and cash equivalents**                                                                                                                 | ** ** | **$**                    | **920,816**    | ** **                   | **$**      | **1,057,055** | ** ** |
| **Accounts receivable, net  allowances of $402,476 and $622,668 at March 31, 2004 and  September 30, 2003, respectively**           | ** ** | **2,116,337**            | ** **     | **2,540,388**                | ** ** |
| **Inventory**                                                                                                                                 | ** ** | **61,285**               | ** **     | **73,525**                   | ** ** |
| **Prepaid expenses**                                                                                                                          | ** ** | **851,714**              | ** **     | **337,314**                  | ** ** |
| **Deferred income taxes**                                                                                                                     | ** ** | **157,274**              | ** **     | **157,274**                  | ** ** |
| **Other current assets**                                                                                                                      | ** ** | **5,596**                | ** **     | **16,320**                   | ** ** |
| **Total current assets**                                                                                                                      | ** ** | **4,113,022**            | ** **     | **4,181,876**                | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Property, plant and equipment, at  cost**                                                                                                   | ** ** | **7,070,604**            | ** **     | **7,430,398**                | ** ** |
| **Accumulated depreciation**                                                                                                                  | ** ** | **(4,964,346**           | **)**          | **(5,186,243**               | **)**      |
| **Net property, plant and equipment**                                                                                                         | ** ** | **2,106,258**            | ** **     | **2,244,155**                | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Excess of cost over net assets  acquired, net of accumulated amortization of $174,988 at March 31, 2004  and September 30, 2003** | ** ** | **262,243**              | ** **     | **262,243**                  | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Intangibles, net of accumulated  amortization of $199,833 and $173,693 at March 31, 2004 and  September 31, 2003**                | ** ** | **424,467**              | ** **     | **450,607**                  | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Deferred income taxes**                                                                                                                     | ** ** | **3,438,150**            | ** **     | **3,326,342**                | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Other assets**                                                                                                                              | ** ** | **78,474**               | ** **     | **78,438**                   | ** ** |
| **Total assets**                                                                                                                              | ** ** | **$**                    | **10,422,614** | ** **                   | **$**      | **10,543,661** | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                 | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Current Liabilities:**                                                                                                                      | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Notes payable**                                                                                                                             | ** ** | **$**                    | **618,136**    | ** **                   | **$**      | **22,821** | ** ** |
| **Accounts payable**                                                                                                                          | ** ** | **375,632**              | ** **     | **332,870**                  | ** ** |
| **Accounts payable, affiliated  companies**                                                                                                   | ** ** | **124,442**              | ** **     | **423,602**                  | ** ** |
| **Accrued liabilities**                                                                                                                       | ** ** | **875,775**              | ** **     | **600,976**                  | ** ** |
| **Note payable majority shareholder,  current portion**                                                                                       | ** ** | **1,869,485**            | ** **     | **1,123,537**                | ** ** |
| **Total current liabilities**                                                                                                                 | ** ** | **3,863,470**            | ** **     | **2,503,806**                | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Note payable majority shareholder,  net of current portion**                                                                                | ** ** | **—**               | ** **     | **1,302,108**                | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Total liabilities**                                                                                                                         | ** ** | **3,863,470**            | ** **     | **3,805,914**                | ** ** |
| ** **                                                                                                                                    | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Shareholders’ Equity:**                                                                                                                | ** ** | ** **               | ** **     | ** **                   | ** ** |
| **Common stock, $0.01 par value,  authorized 40,450,000 shares; Issued and outstanding 9,739,611**                                            | ** ** | **97,742**               | ** **     | **97,742**                   | ** ** |
| **Common stock to be issued (Note 5)**                                                                                                        | ** ** | **7,750,000**            | ** **     | **7,750,000**                | ** ** |
| **Less cost of treasury stock 34,500  shares**                                                                                                | ** ** | **(51,595**              | **)**          | **(51,595**                  | **)**      |
| **Additional paid-in capital -  common stock**                                                                                                | ** ** | **20,519,861**           | ** **     | **20,519,861**               | ** ** |
| **Accumulated deficit**                                                                                                                       | ** ** | **(21,756,864**          | **)**          | **(21,578,261**              | **)**      |
| **Total shareholders’ equity**                                                                                                           | ** ** | **6,559,144**            | ** **     | **6,737,747**                | ** ** |
| **Total liabilities and  shareholders’ equity**                                                                                          | ** ** | **$**                    | **10,422,614** | ** **                   | **$**      | **10,543,661** | ** ** |

 

**The accompanying notes are an integral partof these financial statements.**

 

3

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**3CI COMPLETE COMPLIANCE CORPORATION**

**STATEMENTSOF OPERATION**

**(UNAUDITED)**

 
| ** **                                               | ** ** | **For the three months ended March 31,** | ** **    | **For the six months ended March 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------|---------------|---------------------------------------------|------------|
| ** **                                               | ** ** | **2004**                                      | ** **    | **2003**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                     |       |                                          |          |                                        |       |   |   |   |   |
| **Revenues**                                             | ** ** | **$**                                         | **3,276,258** | ** **                                  | **$**      | **3,412,417** | ** ** | **$** | **6,635,900** | ** ** | **$** | **7,006,803** | ** ** |
| **Expenses:**                                            | ** ** | ** **                                    | ** **    | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Cost of services**                                     | ** ** | **2,011,040**                                 | ** **    | **2,217,809**                               | ** ** | **4,135,260** | ** ** | **4,506,055** | ** ** |
| **Depreciation and  amortization**                       | ** ** | **119,022**                                   | ** **    | **182,126**                                 | ** ** | **245,097** | ** ** | **358,005** | ** ** |
| **Selling, general  and administrative expenses**        | ** ** | **1,115,452**                                 | ** **    | **850,816**                                 | ** ** | **2,331,459** | ** ** | **1,505,342** | ** ** |
| **Interest expense**                                     | ** ** | **49,739**                                    | ** **    | **55,273**                                  | ** ** | **72,125** | ** ** | **107,705** | ** ** |
| **Other expense-net**                                    | ** ** | **80,474**                                    | ** **    | **69,000**                                  | ** ** | **142,370** | ** ** | **138,000** | ** ** |
| **Income (loss)  before income taxes**                   | ** ** | **(99,469**                                   | **)**         | **37,393**                                  | ** ** | **(290,411** | **)** | **391,696** | ** ** |
| ** **                                               | ** ** | ** **                                    | ** **    | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income taxes**                                         | ** ** | **37,971**                                    | ** **    | **—**                                  | ** ** | **111,808** | ** ** | **—** | ** ** |
| ** **                                               | ** ** | ** **                                    | ** **    | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net income (loss)**                                    | ** ** | **$**                                         | **(61,498**   | **)**                                       | **$**      | **37,393** | ** ** | **$** | **(178,603** | **)** | **$** | **391,696** | ** ** |
| ** **                                               | ** ** | ** **                                    | ** **    | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net income (loss)  applicable to common shareholders** | ** ** | **$**                                         | **(61,498**   | **)**                                       | **$**      | **37,393** | ** ** | **$** | **(178,603** | **)** | **$** | **391,696** | ** ** |
| ** **                                               | ** ** | ** **                                    | ** **    | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic earnings per  share:**                           | ** ** | ** **                                    | ** **    | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic net income  (loss) per share**                   | ** ** | **$**                                         | **—**    | ** **                                  | **$**      | **—** | ** ** | **$** | **(0.01** | **)** | **$** | **0.04** | ** ** |
| ** **                                               | ** ** | ** **                                    | ** **    | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Diluted earnings  per share:**                         | ** ** | ** **                                    | ** **    | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Diluted net income  (loss) per share**                 | ** ** | **$**                                         | **—**    | ** **                                  | **$**      | **—** | ** ** | **$** | **(0.01** | **)** | **$** | **0.02** | ** ** |

 

**Theaccompanying notes are an integral part of these financial statements.**

 

4

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**3CI COMPLETE COMPLIANCE CORPORATION**

**STATEMENTOF CASH FLOWS**

**(UNAUDITED)**

 
| ** **                                                                                    | ** ** | **For the six months ended March 31,** | ** **   |
|-----------------------------------------------------------------------------------------------|------------|---------------------------------------------|--------------|
| ** **                                                                                    | ** ** | **2004**                                    | ** **   | **2003** | ** ** |
|                                                                                          |       |                                        |         |   |   |
| **Cash flow from  operating activities:**                                                     | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Net income (loss)**                                                                         | ** ** | **$**                                       | **(178,603** | **)** | **$** | **391,696** | ** ** |
| **Adjustments to  reconcile net income (loss) to net cash provided by operating activities:** | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| ** **                                                                                    | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Gain on disposal of  fixed assets**                                                         | ** ** | **4,922**                                   | ** **   | **—** | ** ** |
| **Depreciation and  amortization**                                                            | ** ** | **245,097**                                 | ** **   | **358,005** | ** ** |
| **Deferred tax asset**                                                                        | ** ** | **(111,808**                                | **)**        | **—** | ** ** |
| **Changes in  operating assets and liabilities:**                                             | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Decrease in  accounts receivable, net**                                                     | ** ** | **424,051**                                 | ** **   | **762,700** | ** ** |
| **Decrease in  inventory**                                                                    | ** ** | **12,240**                                  | ** **   | **3,897** | ** ** |
| **Increase in prepaid  expenses**                                                             | ** ** | **(514,400**                                | **)**        | **(252,200** | **)** |
| **Decrease in other  current assets**                                                         | ** ** | **10,688**                                  | ** **   | **10,218** | ** ** |
| **Increase in  insurance notes payable**                                                      | ** ** | **595,315**                                 | ** **   | **354,276** | ** ** |
| **Increase in  accounts payable**                                                             | ** ** | **42,764**                                  | ** **   | **62,624** | ** ** |
| **Decrease in  accounts payable, affiliated companies**                                       | ** ** | **(299,160**                                | **)**        | **(385,384** | **)** |
| **Increase in accrued  liabilities**                                                          | ** ** | **274,799**                                 | ** **   | **(143,286** | **)** |
| ** **                                                                                    | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Total adjustments  to net income**                                                          | ** ** | **684,506**                                 | ** **   | **770,850** | ** ** |
| **Net cash provided  by operating activities**                                                | ** ** | **505,904**                                 | ** **   | **1,162,546** | ** ** |
| ** **                                                                                    | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Cash flow from  investing activities:**                                                     | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Proceeds from sale  of property, plant and equipment**                                      | ** ** | **48,201**                                  | ** **   | **—** | ** ** |
| **Purchase of  property, plant and equipment**                                                | ** ** | **(134,183**                                | **)**        | **(82,226** | **)** |
| **Net cash used in  investing activities**                                                    | ** ** | **(85,982**                                 | **)**        | **(82,226** | **)** |
| ** **                                                                                    | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Cash flow from  financing activities:**                                                     | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Proceeds from  issuance of common stock**                                                   | ** ** | **—**                                  | ** **   | **54,129** | ** ** |
| **Reduction of note  payable to majority shareholders**                                       | ** ** | **(556,160**                                | **)**        | **(498,143** | **)** |
| **Net cash used in  financing activities**                                                    | ** ** | **(556,160**                                | **)**        | **(444,014** | **)** |
| ** **                                                                                    | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Net (decrease)  increase in cash and cash equivalents**                                     | ** ** | **(136,238**                                | **)**        | **636,306** | ** ** |
| ** **                                                                                    | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Cash and cash  equivalents, beginning of period**                                           | ** ** | **1,057,054**                               | ** **   | **898,720** | ** ** |
| ** **                                                                                    | ** ** | ** **                                  | ** **   | ** ** | ** ** |
| **Cash and cash  equivalents, end of period**                                                 | ** ** | **$**                                       | **920,816**  | ** ** | **$** | **1,535,026** | ** ** |

 

**Theaccompanying notes are an integral part of these financial statements.**

 

5

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**3CICOMPLETE COMPLIANCE CORPORATIONNOTES TO FINANCIAL STATEMENTSMarch 31, 2004**

 

**NOTE 1—DESCRIPTION OF BUSINESS**

 

**Organization and Basis of Presentation**

 

3CI Complete Compliance Corporation (the “Company” or “3CI”), aDelaware corporation, is engaged in the collection and transportation ofbiomedical waste in the south and southeastern United States.

 

Effective October 1, 1998, Stericycle Inc., a Delawarecorporation (“Stericycle”), acquired 100% of the common stock of Waste Systems,Inc. (“WSI”). Stericycle directly and indirectly through WSI owns (i) 67.5% or6,578,504 shares of the Company’s outstanding common stock, par value $0.01 pershare (“Common Stock”), and (ii) 100% of the Company’s Series B PreferredStock, par value $0.01 per share (“Series B Preferred Stock”), and 100% of theCompany’s Series C Preferred Stock, par value $0.01 per share (“Series CPreferred Stock,” and together with the Series B Preferred Stock, the“Preferred Stock”), all of which shares of Preferred Stock were converted intoCommon Stock on April 6, 2003.  TheCompany has not issued any shares of Common Stock and has not recorded anyincrease in the outstanding Common Stock related to such conversion.  See Note 5.

 

The accompanying unaudited condensed financials statements have beenprepared in accordance with accounting principles generally accepted in theUnited States, for interim financial information and with the instructions toForm 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States for complete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for a fairpresentation have been included. Operating results for the three and six month period endedMarch 31, 2004 are not necessarily indicative of the results that may beexpected for the year ended September 30, 2004.

 

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

 

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

 

**NOTE 2—NET (LOSS) INCOME PER SHARE**

 

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

 
| ** **                                                        | ** ** | **Three  months ended  March 31,  2004** | ** ** | **Three  months ended  March 31,  2003** | ** ** | **Six  months ended  March 31,  2004** | ** ** | **Six  months ended  March 31,  2003** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
|                                                              |       |                                          |       |                                          |       |                                        |       |                                        |       |
| Numerator:                                                        |       |                                          |       |                                          |       |                                        |       |                                        |       |
|                                                              |       |                                          |       |                                          |       |                                        |       |                                        |       |
| Net income (loss)                                                 |       | $                                             | (61,498    | )                                             | $          | 37,393                                      |       | $                                           | (178,603   | ) | $ | 391,696 |   |
| Denominator for basic earnings per  share-weighted average shares |       | 17,489,611                                    |       | 9,739,611                                     |       | 17,489,611                                  |       | 9,505,941                                   |       |
| Effect of dilutive shares:                                        |       |                                          |       |                                          |       |                                        |       |                                        |       |
|                                                              |       |                                          |       |                                          |       |                                        |       |                                        |       |
| Preferred Shares                                                  |       | —                                        |       | 7,750,000                                     |       | —                                      |       | 7,750,000                                   |       |
|                                                              |       |                                          |       |                                          |       |                                        |       |                                        |       |
| Warrants                                                          |       | —                                        |       | —                                        |       | —                                      |       | 140,202                                     |       |
| Denominator for diluted earnings per share                        |       | 17,489,611                                    |       | 17,303,691                                    |       | 17,489,611                                  |       | 17,396,143                                  |       |
|                                                              |       |                                          |       |                                          |       |                                        |       |                                        |       |
| Basic net income (loss) per share                                 |       | $                                             | —     |                                          | $          | —                                      |       | $                                           | (0.01      | ) | $ | 0.04 |   |
| Diluted net income (loss) per common share                        |       | $                                             | —     |                                          | $          | —                                      |       | $                                           | (0.01      | ) | $ | 0.02 |   |

 

6

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The effect of the conversion of the preferred shares on the above basicand diluted net income per share calculations is based upon (i) theCompany’s interpretation that the appropriate conversion rate is the per sharemarket value of the Common Stock on the conversion notice date, less $1.00 pershare, 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 March 31, 2004 and 2003computations 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.Preferred shares are not included in the March 31, 2004 computations asthey were antidilutive since the Company has a loss in that period.

 

**NOTE 3—PROMISSORY NOTE**

 

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

 

The Note is payable in monthly payments of $100,000, due on the first dayof each month, which are applied to principal and accrued interest calculatedat the prime lending rate (4% as of March 31, 2004), as such may changefrom time to time, published under “Money Rates” in *The WallStreet Journal* (Southwestern Edition) (the “Prime Rate”), not toexceed 13%.  In addition to the term notefacility described above, the Note includes a revolving credit agreement underwhich the Company can borrow up to and including $100,000; the Company has noborrowings outstanding under the revolving credit agreement.  Borrowings under the Note may be prepaid atany time without penalty.  The Notematures on October 1, 2004.

 

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

 

Total interest expense under the Note was $49,739 and $72,125 for thesix months ended March 31, 2004 and 2003, respectively. The Company wasnot in compliance with the EBITDA covenant of the Note at March 31, 2004and at December 31, 2003.  OnMarch 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 also previouslyaccrued approximately $56,084 in connection with such non-compliance as ofMarch 31, 2004, but has not yet paid this penalty fee to WSI.  During the third quarter of the Company’s2004 fiscal year, the Company discovered that it had incorrectly calculated thepenalty fees owed to WSI with respect to the six-month periods endedDecember 31, 2003 and March 31, 2004. The Company miscalculated the penalties as 3% of the outstandingprincipal balance of Note as of December 31, 2003 and March 31, 2004,instead of 3% per annum of the Note’s outstanding principal balance as of suchdates.  As a result, the Companyoverstated interest expense by an aggregate amount of approximately $90,457, ofwhich approximately $48,373 was due to the Company’s overpayment of the penaltydue to WSI in connection with the Company’s non-compliance at December 31,2002, and approximately $42,085 was due to the Company’s over-accrual of thepenalty due to WSI in connection with the Company’s non-compliance atMarch 31, 2004.  Based onthese determinations, a penalty fee of $16,069 for the Company’s non-complianceat December 31, 2003 and a penalty accrual of $13,999 for itsnon-compliance at March 31, 2004 have been included in the financial statements aspart of interest expense.

 

The Company has recently notified WSI that it has determined that itoverpaid the penalty fee paid to WSI on March 17, 2004, and has requestedthat WSI refund the full amount of the $48,373 overpayment to the Company. The Company is determining whether it has overpaid anyother penalty fees previously paid to WSI pursuant to the Note.  

 

TheCompany has requested an additional amendment to the Note, which would excludefrom its EBITDA covenant calculation not only certainexpenses associated with the dispute regarding the conversion rate of theCompany’s Preferred Stock, which has previously been agreed to by WSI, but alsocertain expenses primarily associated with the allegations of the minoritystockholders in the *Robb et al. v.Stericycle, Inc. et al.* in Louisiana and the Special Committee’sinvestigation of those allegations.  SeePart II, Item I, Legal Proceedings.

 

**NOTE 4—INCOME TAXES**

 

At September 30, 2003 the Company had eligible net operating losscarryforwards for federal income tax purposes of approximately $10,555,000which will begin expiring in 2004. The Company also had state net operatinglosses at September 30, 2003. Based on Section 383 of the InternalRevenue Code relating to changes in ownership of the Company, utilization ofthe net operating loss carryforwards is subject to an annual limitation ofapproximately

 

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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 notsubject to any limitations and are available to be used for 20 years afterthey are produced. As such, the deferred tax asset and the related valuationallowance for net operating loss carryforwards were reduced atSeptember 30, 2003 to account for the portion of the net operating losscarryforwards the Company will not be able to utilize.

 

During the fourth quarter of the Company’s 2003 fiscal year, theCompany reevaluated the estimated amount of valuation allowance required inlight of the profitability achieved during 2003 and 2002 as well asprofitability expected in future years. As a result, the Company decreased thevaluation allowance on deferred tax assets in accordance with SFASNo. 109, “Accounting for Income Taxes,” to an amount that the Companybelieves is more likely than not of being recovered based upon the Company’sassessment of the likelihood of near term operating income.

 

**NOTE 5—PREFERRED STOCK**

 

**Preferred Stock Conversion**

 

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

 

Prior to April 6, 2003, WSI and Stericycle asserted that theconversion rate of the Preferred Stock is such that each share of PreferredStock is convertible into that number of shares of Common Stock determined bydividing $7,000,000 (with respect to the Series B Preferred Stock) or$750,000 (with respect to the Series C Preferred Stock) by the marketvalue 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 Stockupon conversion of the Preferred Stock under this interpretation, which wouldhave increased WSI’s ownership percentage to approximately 91.2% of theoutstanding shares of Common Stock and the combined WSI and Stericycleownership percentage to approximately 93.2%.

 

WSI and Stericycle’s interpretation of the conversion rate is contraryto the Company’s interpretation of the conversion rate. Based on theCertificates of Designations governing the Preferred Stock, certain documentsexecuted contemporaneously with the issuance of the Preferred Stock, and theintent of the parties at the time of issuance of the Preferred Stock and theexecution of these documents, the Company believes that the appropriateconversion rate is the per share market value of the Common Stock on theconversion notice date, less $1.00 per share, but that the conversion rateshall 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 Stockwas less than $1.00 on April 6, 2003, the Company would have issued7,750,000 shares of Common Stock upon conversion of the Preferred Stock, whichwould have increased WSI’s ownership percentage to approximately 76.6% of theoutstanding shares of Common Stock and the combined WSI and Stericycleownership percentage to approximately 81.9%.

 

On April 2, 2003, the Company, WSI and Stericycle entered into anAgreement to Defer Conversion of Preferred Stocks (the “Agreement to DeferConversion”), pursuant to which all parties agreed that the Company will notissue any Common Stock upon conversion of the Preferred Stock until a judicialjudgment as to the appropriate conversion rate has become final and non-appealable.

 

On May 9, 2003, the Company filed a declaratory judgment actionseeking a judicial determination of the appropriate conversion rate of thePreferred Stock. On August 22, 2003, the Company filed an originalpetition for declaratory judgment and to enforce the Settlement Agreement,dated July 17, 1997, pursuant to which the Preferred Stock was issued. Inits petition, the Company requests the Court establish the conversion rate ofthe Preferred Stock to be the Agreed Maximum Conversion Rate and confirm theissuance of no more than 7,750,000 shares of Common Stock to WSI as ofApril 6, 2003. WSI subsequently filed a motion to have the Court declarethat the Preferred Stock is convertible into 36,704,761 shares of Common Stock.  The parties are currently conductingdiscovery in this proceeding.   See PartII, Item 1, Legal Proceedings.

 

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**Preferred Stock Dividends**

 

There are unanimous written consents of the Board of Directorsdeclaring dividends on the Series B Preferred Stock and Series C PreferredStock totaling $161,158, $637,623, $907,387 and $497,550 for each of the years2003, 2002, 2001, 2000, respectively. Each of these resolutions for the dividends called for payment in cashfrom funds legally available for the payment of dividends, as and when theBoard of Directors may direct by further resolution. However, none of theseunanimous consents are executed by all of the individuals who were members ofthe Board of Directors at the date of such unanimous consents, and none of thedividends have been paid.

 

On December 22, 2003, the independent and disinterested members ofthe Board of Directors, relying on an opinion of counsel expert in Delawarecorporate law and acting on behalf of the Board, determined that (i) theprevious declarations of dividends on the Preferred Stock in the aggregateamount of $2,203,717 (collectively, the “Preferred Stock Dividends”) had notbeen effective to declare and obligate the Company to pay such dividends, and(ii) the Preferred Stock Dividends cannot now be lawfully declared andpaid on the Preferred Stock. As a consequence of these determinations, theCompany reversed the Preferred Stock Dividend entries on the Company’s booksand records and restated its financial statements for the years endedSeptember 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 currentliability 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 ofshareholders’ equity and statements of cash flows.

 

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

 

**NOTE 6—NOTE PAYABLE**

 

During the quarter ended March 31, 2004 the Company financed itsannual insurance premium over a 12 month period of time at a 5% per annuminterest rate.

 

**NOTE 7—COMMITMENTS AND CONTINGENCIES**

 

See Note 5 of the Notes tothe Financial Statements above for a discussion of certain contingentliabilities 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, andderivatively on behalf of the Company, in the First Judicial District Court inShreveport, Louisiana against Stericycle, certain of the Company’s directorsand the Company’s President and Chief Executive Officer which alleged minoritystockholder oppression, breach of fiduciary duty and unjust enrichment. On orabout October 27, 2003, the plaintiffs in this suit filed their FirstAmended Petition adding the Company as a derivative defendant. The Company hascontacted its insurance carrier and has hired counsel to assist the Company inthis litigation.  See Part II, Item 1, Legal Proceedings.

 

The Company is a defendant in *MedicalWaste 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 seeksapproximately $818,800 in damages, interest and attorney’s fees for failure topay for treatment of medical waste and for breach of contract.  Plaintiff alleges that the Company has failedto pay for the treatment and disposal of medical waste at the plaintiff’sBirmingham, Alabama facility.  Further,plaintiff alleges that the Company agreed to deliver an additional amount ofmedical waste to plaintiff’s facility for treatment and disposal at apredetermined price, which the Company has failed to do.  3CI contends that the plaintiff has breachedthe contract by unilaterally increasing the contract price.  The parties are currently in discovery, andthe Company cannot at this time predict the outcome of this litigation.

 

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

 

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governmental regulation, any materialrelaxation of regulatory requirements governing medical waste disposal or oftheir enforcement could result in a reduced demand for the Company’s servicesand have a material adverse effect on the Company’s revenues and financialcondition. The scope and duration of existing and future regulations affectingthe medical waste disposal industry cannot be anticipated and are subject tochanging political and economic pressures.

 

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

 

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

 

The Company is engaged in the business of medical waste managementservices in the south and southeastern United States.  The Company’s customers include regionalmedical centers, major hospitals, clinics, medical and dental offices,veterinarians, pharmaceutical companies, retirement homes, medical testinglaboratories and other medical waste generators.  The following is a discussion of some eventsthat may allow a better understanding of the progression of the Company’sfinancial position and operating results.

 

The Company has historically financed its working capital needs,capital expenditures and acquisitions primarily using borrowings from WSI andinternally generated funds. Currently, the Company’s only borrowed indebtednessconsists of money borrowed from WSI under the Note and annual insurance premiumfinancing.  As of March 31, 2004,September 30, 2003 and March 31, 2003, the outstanding balances underthe WSI Note were in the aggregate principal amounts of approximately$1,869,485,  $2,425,645and $3,392,492, respectively.   SeeLiquidity and Capital Resources herein and Note 3 to the Company’s financialstatements.

 

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

 

During the fourth quarter of the Company’s 2003 fiscal year, theCompany reevaluated the estimated amount of valuation allowance required inlight of the profitability achieved during 2003 and 2002 as well asprofitability expected in future years. As a result, the Company increased thevaluation allowance on deferred tax assets in accordance with SFASNo. 109, “Accounting for Income Taxes,” to an amount that the Companybelieves is more likely than not of being recovered. Accordingly, an income taxbenefit of approximately $3,483,616 was reflected in the fourth quarter of theCompany’s 2003 fiscal year. The amount of net deferred tax assets estimated tobe recoverable was based upon the Company’s assessment of the likelihood ofnear term operating income.

 

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**RESULTS OF OPERATIONS**

 

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

 
| ** **                                    | ** ** | **Three Months****Ended  March 31,** | ** ** | **Six Months****Ended  March 31,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                    | ** ** | **2004**                                  | ** ** | **2003**                                | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                          |       |                                      |       |                                    |       |   |   |   |   |
| Revenues                                      |       | $                                         | 3,276      |                                    | $          | 3,412 |   | $ | 6,636 |   | $ | 7,007 |   |
| Cost of services                              |       | 2,011                                     |       | 2,218                                   |       | 4,135 |   | 4,506 |   |
| Depreciation and amortization                 |       | 119                                       |       | 182                                     |       | 245 |   | 358 |   |
| Selling, general and administrative  expenses |       | 1,116                                     |       | 851                                     |       | 2,331 |   | 1,505 |   |
| (Loss) income from operations                 |       | 30                                        |       | 161                                     |       | (76 | ) | 638 |   |
| Interest expense                              |       | 49                                        |       | 55                                      |       | 72 |   | 108 |   |
| Other expense, net                            |       | 80                                        |       | 69                                      |       | 142 |   | 138 |   |
| Income taxes                                  |       | (38                                       | )          | —                                  |       | (111 | ) | — |   |
| Net (Loss) Income                             |       | $                                         | (61        | )                                       | $          | 37 |   | $ | (179 | ) | $ | 392 |   |

 

**Three months ended March 31, 2004 compared to three months endedMarch 31, 2003:**

 

***Revenues***decreased by $136,159, or 4%, to $3,276,258 during the three-month period endedMarch 31, 2004, from $3,412,417 for the three month period endedMarch 31, 2003. This decrease is primarily related to a reduction in thevolume of waste handled.  Substantiallyall of this reduction in volume was attributable to the Company’s efforts tofocus on small quantity generators which provide higher margins at lowervolumes while reducing the focus on less profitable larger quantity generators.

 

***Cost of services***decreased by $206,769, or 9.3%, to $2,011,040 during the three months endedMarch 31, 2004, compared to $2,217,809 for the three month period endedMarch 31, 2003.  This decrease wasprimarily attributable to a decrease in processing and a decrease intransportation costs due to increased route efficiency.  Cost of services as a

 

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percentage of revenues decreased to 61.4%compared to 65.0% during the three months ended March 31, 2004 andMarch 31, 2003 respectively.  Thispercentage decrease was primarily attributable to a decrease in processing anda decrease in transportation costs due to increased route efficiency.

 

***Depreciation and amortization*** expense for the three monthsended March 31, 2004 decreased $63,104 or 34.6% to $119,022 compared to$182,126 for the three months ended March 31, 2003. This decrease wasprimarily attributable to the depreciable useful lives of assets still employedin the Company’s operations having expired during the quarter.

 

***Selling, general and administrative***expensesfor the three months ended March 31, 2004 increased 31.1% or $264,636 to$1,115,452 from $850,816 during the three months ended March 31,2003.  Selling, general andadministrative expenses increased as a percentage of revenue to 34.0% for the threemonths ended March 31, 2004, as compared to 24.9% for the three monthsended March 31, 2003 due primarily to increases in legal expenses andinformation technology consulting fees.  Substantially all of the increased legal fees are related to the legalproceedings described in Part II, Item 1, LegalProceedings below.

 

***Interestexpense*** for the three months ended March 31,2004 decreased by $5,534 or 10.0%, to $49,739 from $55,273 during the threemonths ended March 31, 2003.  Thisdecrease was due to a decrease in the principal under the Note.

 

***Earningsbefore interest taxes depreciation and amortization (“EBITDA”)*** totaled $69,292 or 2.1% ofrevenue compared to $274,792 or 8.1% of revenue for the quarter endedMarch 31, 2003.  The difference wasprimarily reflective of the increase in legal and professional fees.

 

**Six months ended March 31, 2004 compared to six months endedMarch 31, 2003:**

 

***Revenues***decreased by $370,903 or 5.3%, to $6,635,900 during the six-month period endedMarch 31, 2004, from $7,006,803 for the six-month period endedMarch 31, 2003. This decrease is primarily related to a reduction in thevolume of waste handled.  Substantiallyall of this reduction in volume was attributable to the Company’s efforts tofocus on small quantity generators which provide higher margins at lowervolumes while reducing the focus on less profitable larger quantity generators.

 

***Cost of services***decreased $370,795, or 8.2%, to $4,135,260, during the six months endedMarch 31, 2004, compared to $4,506,055 for the six-month period endedMarch 31, 2003.  This decrease wasprimarily attributable to a decrease in processing and a decrease intransportation costs due to increased route efficiency.  Cost of revenues as a percentage of revenuesdecreased to 62.3% during the six months ended March 31, 2004, as comparedto 64.3% during the six months ended March 31, 2003.  This decrease was primarily attributable to adecrease in processing and a decrease in transportation costs due to increasedroute efficiency.

 

***Depreciation and amortization*** expense for the six months endedMarch 31, 2004 decreased $112,908 or 31.5% to $245,097 compared to$358,005 for the six months ended March 31, 2003. This decrease wasprimarily attributable to the depreciable useful lives of assets still employedin the Company’s operations having expired during the quarter endedMarch 31, 2004.

 

***Selling, general and administrative***expensesfor the period increased 54.9% or $826,117 to $2,331,459 from $1,505,342 duringthe six months ended March 31, 2004. Selling, general and administrative expenses increased as a percentageof revenue to 35.1% for the six months ended March 31, 2004 as compared to21.5% for the six months ended March 31, 2003 due primarily to increasesin legal expenses and information technology consulting fees.  Substantially all of these increased legalfees are related to the legal proceedings described in Part II, Item 1, Legal Proceedings below.

 

***Interestexpense*** decreased by $35,580 or 49.3% to $72,125during the six months ended March 31, 2004 as compared to $107,705 duringthe six months ended March 31, 2003. This decrease was due to a decrease in the principal of the Note.

 

***Earningsbefore interest taxes depreciation and amortization (“EBITDA”)***totaled $(26,811) or (0.4)% ofrevenue for the six months ended March 31, 2004 compared to $857,406 or12.2% of revenue for the six months ended March 31, 2003.  The difference was primarily reflective ofthe increase in legal and professional fees.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

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

 

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The Note is payable in monthly payments of $100,000, due on the firstday of each month, which are applied to principal and accrued interestcalculated at the prime lending rate (4% as of March 31, 2004), as suchmay change from time to time, published under “Money Rates” in *The Wall Street Journal* (SouthwesternEdition) (the “Prime Rate”), not to exceed 13%. As of March 31, 2004, andMarch 31, 2003, the outstanding balances under the Note were in theaggregate principal amounts of approximately $1,869,485 and $3,392,492,respectively. In addition to the term note facility described above, the Noteincludes a revolving credit agreement under which the Company can borrow up toand including $100,000; the Company has no borrowings outstanding under therevolving credit agreement. Borrowings under the Note may be prepaid at anytime without penalty. The Note matures on October 1, 2004.

 

The Note is subordinated to all security interests under the ShepherdSettlement Agreement, in which were assigned to Stericycle on May 1, 2002, butotherwise are secured by substantially all of the Company’s assets. Pursuant tothe Note, the Company is required to achieve each fiscal quarter a minimumlevel of $900,000 of EBITDA (earnings before interest, taxes, depreciation andamortization) for the then trailing six-month period, excluding certainexpenses associated with the dispute regarding the conversion rate of the PreferredStock.  If the minimum EBITDA level isnot obtained at the end of any such six-month period, the agreement requiresthe Company to pay to WSI a fee equal to 3% of the outstanding principalbalance of the Note at the end of such period.

 

Total interest expense under the Note was $49,739 and $72,125 for thesix months ended March 31, 2004 and 2003, respectively. The Company wasnot in compliance with the EBITDA covenant of the Note at March 31, 2004and at December 31, 2003.  OnMarch 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 also previouslyaccrued approximately $56,084 in connection with such non-compliance as ofMarch 31, 2004, but has not yet paid this penalty fee to WSI.  During the third quarter of the Company’s2004 fiscal year, the Company discovered that it had incorrectly calculated thepenalty fees owed to WSI with respect to the six-month periods endedDecember 31, 2003 and March 31, 2004. The Company miscalculated the penalties as 3% of the outstandingprincipal balance of Note as of December 31, 2003 and March 31, 2004,instead of 3% per annum of the Note’s outstanding principal balance as of suchdates.  As a result, the Company overstatedinterest expense by an aggregate amount of approximately $90,457, of whichapproximately $48,373 was due to the Company’s overpayment of the penalty dueto WSI in connection with the Company’s non-compliance at December 31,2002, and approximately $42,085 was due to the Company’s over-accrual of thepenalty due to WSI in connection with the Company’s non-compliance atMarch 31, 2004.  Based onthese determinations, a penalty fee of $16,069 for the Company’s non-complianceat December 31, 2003 and a penalty accrual of $13,999 for itsnon-compliance at March 31, 2004 have been included in the financial statements as part of interestexpense.

 

The Company has recentlynotified WSI that it has determined that it overpaid the penalty fee paid toWSI on March 17, 2004, and has requested that WSI refund the full amountof the $48,373 overpayment to the Company. The Company is determining whetherit has overpaid any other penalty fees previously paid to WSI pursuant to theNote.  

 

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

 

EBITDA is calculated as follows:

 

The reconciliation of EBITDA to net income is reflected in thefollowing table (in thousands):

 
| ** **                    | ** ** | **Three Months Ended March 31,** | ** ** | **Six Months Ended March 31,** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                    | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                    |       | $                                     | (61        | )                                   | $          | 37 |   | $ | (179 | ) | $ | 392 |   |
| Increase expense              |       | 49                                    |       | 55                                  |       | 73 |   | 108 |   |
| Income tax benefit            |       | (38                                   | )          | —                              |       | (112 | ) | — |   |
| Depreciation and amortization |       | 119                                   |       | 182                                 |       | 245 |   | 358 |   |
| EBITDA                        |       | $                                     | 69         |                                | $          | 274 |   | $ | 27 |   | $ | 858 |   |

 

EBITDA is calculated as the sum of net income, plus interest expense, incometax expense, depreciation expense, and amortization expense to the extentdeducted in calculating net income.  TheCompany considers EBITDA to be a widely accepted financial indicator of acompany’s operating performance and ability to service debt, fund capitalexpenditures and expand its business. EBITDA is not calculated in the same way by all companies and thereforemay not be comparable to similarly titled measures reported by other companies.  EBITDA is not a measure in accordance withaccounting principles generally accepted in the United States.  EBITDA should not be considered as analternative to net income, as an indicator of operating performance or as analternative to cash flow as a measure of liquidity.  The funds depicted by the measure may not beavailable for management’s discretionary use due to legal or functionalrequirements, debt service, other commitments and uncertainties.

 

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

 

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

 

During the fourth quarter of the Company’s 2003 fiscal year, theCompany reevaluated the estimated amount of valuation allowance required inlight of the profitability achieved during 2003 and 2002 as well asprofitability expected in future years. As a result, the Company decreased thevaluation allowance on deferred tax assets in accordance with SFASNo. 109, “Accounting for Income Taxes,” to an amount that the Companybelieves is more likely than not of being recovered. Accordingly, an income taxbenefit of approximately $3,483,616 was reflected in the fourth quarter of theCompany’s 2003 fiscal year. The amount of net deferred tax assets estimated tobe recoverable was based upon the Company’s assessment of the likelihood ofnear term operating income.

 

At March 31, 2004, the Company had net working capital, exclusiveof the Note, of $2,119,037 compared to a net working capital exclusive of theNote of $2,366,924 at September 30, 2003. This decrease in net working capital of $247,887 was due primarily tothe decrease in accounts receivable and an increase in prepaid insurance.

 

Net cash provided by operating activities was $505,904 during thesix-month period ended March 31, 2004, compared to $1,162,546 for thesix-month period ended March 31, 2003. The difference is due to a decrease in accounts receivable.

 

Net cash used in investing activities for the six months endedMarch 31, 2004, was $85,982 compared to $82,226 for the same period in2003.  The $3,756 increase reflectedincreased investment in equipment net of proceeds from the sale of equipment.

 

Net cash used in financing activities was $556,160 for the six monthperiod ended March 31, 2004, compared to $444,014 during the six monthperiod ended March 31, 2003.  The$112,146 net change was due to the principal reduction of the WSI note coupledwith proceeds from Common Stock issuance in 2003.

 

**Item 3.****   QualitativeDisclosure about Market Risk**

 

The Company’s exposure to market risk includes the possibility ofrising interest rates in connection with the Note, thereby increasing its debtservice obligation, which could adversely affect the Company’s cash flows.  The interest rate on the Note is variable andtied to the prime rate not to exceed 13%. An increase in the prime rate of 1% would have the effect of increasinginterest expense by approximately $18,695 over 12 months.  The Company does not utilize derivativefinancial instruments to mitigate the risks of changes in interest rates.

 

**Item 4.****   Controls and Procedures**

 

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

 

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

 

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

 

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

 

**PART II - OTHER INFORMATION**

 

**Item1.****    Legal Proceedings**

 

**JudicialFilings Regarding the Conversion Rate of the Preferred Stock**

 

On May 9,2003, the Company filed a declaratory judgment action in the 269th DistrictCourt in Harris County, Texas (the “Court”) seeking a judicial determination ofthe appropriate conversion rate of the Preferred Stock. The Company filed thedeclaratory judgment action in connection with *JamesT. Rash, et. al. v. WasteSystems, Inc.*, the Company and certain of the Company’s formerdirectors and officers (the “1995 Action”), which was the original proceedingpursuant to which the Preferred Stock was issued by the Company.

 

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

 

OnOctober 3, 2003, WSI filed a motion to enforce judgment in the 1995 Actionand to have the Court declare that the Preferred Stock is convertible into36,904,761 shares of Common Stock. The Company opposed WSI’s motion to enforcethe judgment. Following a hearing, the Court abated WSI’s motion onNovember 10, 2003.

 

OnOctober 24, 2003, Don Smith, Ghere-Smith Interests, Inc., TidelTechnologies, Inc. f/k/a American Medical Technologies, Inc., JimRash, individually and in his capacity as representative of the certified classof minority shareholders of 3CI, and Larry Robb, individually and as proposedco-representative of the same certified class (collectively, the “MinorityStockholders”), answered and/or intervened in the 2003 Action, cross- claimedagainst WSI and filed a third-party petition against Stericycle.

 

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

 

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

 

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convertible into36,904,761 shares of Common Stock. The parties are currently conductingdiscovery in the 2003 Action.

 

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

 

**Louisiana Minority StockholderLitigation**

 

OnJune 20, 2002, Larry F. Robb, individually, on behalf of a class comprisedof the Company’s minority stockholders, and derivatively on behalf of theCompany (collectively, the “Louisiana Plaintiffs”), filed causeno. 467704-A, *Robb et al. v.Stericycle, Inc. et al.*, in theFirst Judicial District Court, Caddo Parish, Louisiana (the “Louisiana Suit”). Inthis suit, the Louisiana Plaintiffs assert numerous claims of minoritystockholder oppression, breach of fiduciary duty and unjust enrichment againstStericycle, the affiliates of Stericycle who are or were directors of the Company, and thePresident and Chief Executive Officer of the Company (collectively, the“Louisiana Defendants”).

 

The LouisianaPlaintiffs contend that since Stericycle’s acquisition of WSI inSeptember 1998, Stericycle has unfairly and improperly exercised controlover 3CI to the detriment of the Company’s minority stockholders incontravention of various contractual, common law and statutory duties. Amongother things, the Louisiana Plaintiffs allege that the Louisiana Defendantshave (i) deprived the Company of revenues by imposing unfavorable loan obligationsand avoidable expenses on the Company; (ii) usurped 3CI’s business andbusiness opportunities and diverted its assets for Stericycle’s benefit; and(iii) depressed the value of the Common Stock. The Louisiana Plaintiffsfurther allege that Stericycle has breached an agreement entered into for theprotection of 3CI’s minority stockholders in connection with Stericycle’sacquisition of WSI.

 

Based on theseand other allegations, the Louisiana Plaintiffs seek to recover actual andpunitive damages and a variety of equitable and other relief, includingforfeiture or rescission of various disputed transactions, a constructive trustof all benefits Stericycle has derived on business usurped from the Company ornot offered to the Company and an order requiring Stericycle to buy the capitalstock of the minority stockholders of the Company at the relative value of theCompany’s shares to Stericycle’s shares at the time Stericycle gained controlover the Company, i.e. one share of Stericycle common stock for every fiveshares of the Company’s Common Stock.

 

Onor about October 27, 2003, the Louisiana Plaintiffs filed their FirstAmended Petition adding the Company as a derivative defendant. The Company hasnot yet answered this petition. 

 

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

 

### **In June 2004, theLouisiana Plaintiffs filed a motion to certify the Louisiana Suit as a classaction and served discovery relating to the request for class certification onall parties, including the Company.  Inresponse, the Company, at the direction of the Special Committee, filed amotion with the Louisiana court to stay all proceedings in the litigation(including discovery) pending the completion of the Special Committee’sinvestigation.  After a hearing on themotion in June 2004, the court extended the Company’s deadline forresponding to the Louisiana Plaintiffs’ discovery pending completion of theSpecial Committee’s investigation, but allowed the other parties to proceedwith discovery in the interim.** The Company does not have sufficientinformation to predict the outcome of the Louisiana Suit.

 

 

**Item2.****    Changes in Securities**

 

None.

 

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**Item 3.****    Defaults upon SeniorSecurities**

 

The Company failed to achieve the minimum EBITDA level under the Noteat the end of the six-month period ended March 31, 2004, and has not yetpaid to WSI the required penalty fees thereunder.  Therefore, the Company could be deemed to bein default under the Note.  See Note 3and Part I, Item 2. Management Discussion & Analysis of Financial Conditionand Results of Operations, Liquidity and Capital Resources above for adescription of the Note and the required penalty fees thereunder.

 

**Item 4.****    Submission of Matters to aVote of Security Holders**

 

None.

 

**Item5.****  OtherInformation**

 

None.

 

**Item 6.****    Exhibits and Reports on Form8-K**

 

a)  Exhibits.  The following is a list of the exhibits filedwith this form 10Q.

 
| **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 Form8-K

 

None.

 

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SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly 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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