**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

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**FORM 10-Q**

 

**(MarkOne)**

| **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 its charter)

 

| **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 reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

 

YES ýNO o

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this form 10-Q or any amendment to this Form 10-Q.

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule2b-2 of the Act).  Yes [  ]  No[X]

 

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

 

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

 

 

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**FORWARD-LOOKING STATEMENTS**

 

“THISQUARTERLY REPORT CONTAINS FORWARD-LOOKING STATEMENTS CONCERNING THE COMPANY’SBUSINESS AND OPERATIONS.  ALTHOUGH THECOMPANY BELIEVES THAT THE EXPECTATIONS REFLECTED IN THE FORWARD-LOOKINGSTATEMENTS ARE REASONABLE, THESE EXPECTATIONS AND THE RELATED STATEMENTS ARESUBJECT TO RISKS, UNCERTAINTIES, AND OTHER FACTORS THAT COULD CAUSE THE ACTUALRESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED.  THESE RISKS, UNCERTAINTIES, AND OTHER FACTORS INCLUDE, BUT ARENOT LIMITED TO, ADVERSE WEATHER CONDITIONS, FLUCTUATIONS IN CUSTOMER DEMAND,COMPETITIVE ACTIVITY AND PRICING PRESSURE AND GENERAL ECONOMIC CONDITIONSAFFECTING THE BIO-MEDICAL WASTE DISPOSAL INDUSTRY, AS WELL AS OTHER RISKSDETAILED IN THE COMPANY’S FILINGS WITH THE SEC.  THE COMPANY EXPRESSLY DISCLAIMS ANY OBLIGATIONS TO RELEASEPUBLICLY ANY UPDATES OR REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TOREFLECT ANY CHANGES IN THE COMPANY’S EXPECTATIONS.”

 

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**3CI COMPLETECOMPLIANCE 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**

 

**3CICOMPLETE COMPLIANCE CORPORATION**

**BALANCE SHEETS**

 
|                                                                                                                               |   | **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 $173,693 at March 31, 2004 and September 31, 2003**                |   | **424,467**         | ** **     | **450,607**              | ** ** |
|                                                                                                                               |   |                | ** **     |                     | ** ** |
| **Deferred income taxes**                                                                                                          |   | **3,473,284**       | ** **     | **3,326,342**            | ** ** |
|                                                                                                                               |   |                | ** **     |                     | ** ** |
| **Other assets**                                                                                                                   |   | **78,474**          | ** **     | **78,438**               | ** ** |
| **Total assets**                                                                                                                   |   | **$**               | **10,457,748** | ** **               | **$**      | **10,543,661** | ** ** |
|                                                                                                                               |   |                | ** **     |                     | ** ** |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                     |   |                | ** **     |                     | ** ** |
| **Current Liabilities:**                                                                                                           |   |                | ** **     |                     | ** ** |
| **Notes payable**                                                                                                                  |   | **$**               | **618,136**    | ** **               | **$**      | **22,821** | ** ** |
| **Accounts payable**                                                                                                               |   | **375,632**         | ** **     | **332,870**              | ** ** |
| **Accounts payable, affiliated companies**                                                                                         |   | **214,856**         | ** **     | **423,602**              | ** ** |
| **Accrued liabilities**                                                                                                            |   | **875,775**         | ** **     | **600,976**              | ** ** |
| **Note payable majority shareholder, current portion**                                                                             |   | **1,869,485**       | ** **     | **1,123,537**            | ** ** |
| **Total current liabilities**                                                                                                      |   | **3,953,884**       | ** **     | **2,503,806**            | ** ** |
|                                                                                                                               |   |                | ** **     |                     | ** ** |
| **Note payable majority shareholder, net of current  portion**                                                                     |   | **—**          | ** **     | **1,302,108**            | ** ** |
|                                                                                                                               |   |                | ** **     |                     | ** ** |
| **Total liabilities**                                                                                                              |   | **3,953,884**       | ** **     | **3,805,914**            | ** ** |
|                                                                                                                               |   |                | ** **     |                     | ** ** |
| **Shareholders’ Equity:**                                                                                                     |   |                | ** **     |                     | ** ** |
| **Common stock, $0.01 par value, authorized 40,450,000  shares; Issued and outstanding 9,739,611**                                 |   | **97,742**          | ** **     | **97,742**               | ** ** |
| **Common stock to be issued (Note 5)**                                                                                             |   | **7,750,000**       | ** **     | **7,750,000**            | ** ** |
| **Less cost of treasury stock 34,500 shares**                                                                                      |   | **(51,595**         | **)**          | **(51,595**              | **)**      |
| **Additional paid-in capital - common stock**                                                                                      |   | **20,519,861**      | ** **     | **20,519,861**           | ** ** |
| **Accumulated deficit**                                                                                                            |   | **(21,812,144**     | **)**          | **(21,578,261**          | **)**      |
| **Total shareholders’ equity**                                                                                                |   | **6,503,864**       | ** **     | **6,737,747**            | ** ** |
| **Total liabilities and shareholders’ equity**                                                                                |   | **$**               | **10,457,748** | ** **               | **$**      | **10,543,661** | ** ** |

 

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

 

3

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**3CICOMPLETE 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**                                     |   | **140,153**                               | ** **    | **55,273**                              | ** ** | **162,539** | ** ** | **107,705** | ** ** |
| **Other expense-net**                                    |   | **80,474**                                | ** **    | **69,000**                              | ** ** | **142,370** | ** ** | **138,000** | ** ** |
| **Income (loss) before income taxes**                    |   | **(189,883**                              | **)**         | **37,393**                              | ** ** | **(380,825** | **)** | **391,696** | ** ** |
|                                                     |   |                                      | ** **    |                                    | ** ** |   | ** ** |   | ** ** |
| **Income taxes**                                         |   | **73,105**                                | ** **    | **—**                              | ** ** | **146,942** | ** ** | **—** | ** ** |
|                                                     |   |                                      | ** **    |                                    | ** ** |   | ** ** |   | ** ** |
| **Net income (loss)**                                    |   | **$**                                     | **(116,778**  | **)**                                   | **$**      | **37,393** | ** ** | **$** | **(233,883** | **)** | **$** | **391,696** | ** ** |
|                                                     |   |                                      | ** **    |                                    | ** ** |   | ** ** |   | ** ** |
| **Net income (loss) applicable to common  shareholders** |   | **$**                                     | **(116,778**  | **)**                                   | **$**      | **37,393** | ** ** | **$** | **(233,883** | **)** | **$** | **391,696** | ** ** |
|                                                     |   |                                      | ** **    |                                    | ** ** |   | ** ** |   | ** ** |
| **Basic earnings per share:**                            |   |                                      | ** **    |                                    | ** ** |   | ** ** |   | ** ** |
| **Basic net income (loss) per share**                    |   | **$**                                     | **(0.01**     | **)**                                   | **$**      | **—** | ** ** | **$** | **(0.01** | **)** | **$** | **0.04** | ** ** |
|                                                     |   |                                      | ** **    |                                    | ** ** |   | ** ** |   | ** ** |
| **Diluted earnings per share:**                          |   |                                      | ** **    |                                    | ** ** |   | ** ** |   | ** ** |
| **Diluted net income (loss) per share**                  |   | **$**                                     | **(0.01**     | **)**                                   | **$**      | **—** | ** ** | **$** | **(0.01** | **)** | **$** | **0.02** | ** ** |

 

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

 

4

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**3CICOMPLETE COMPLIANCE CORPORATION**

**STATEMENT OF CASH FLOWS**

**(UNAUDITED)**

 
|                                                                                          |   | **For the  six months ended March 31,** |         |
|-----------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------------|
|                                                                                          |   | **2004**                                |         | **2003** |   |
|                                                                                          |   |                                    |         |   |   |
| **Cash flow from operating activities:**                                                      |   |                                    | ** **   |   | ** ** |
| **Net income (loss)**                                                                         |   | **$**                                   | **(233,883** | **)** | **$** | **391,696** | ** ** |
| **Adjustments to reconcile net income (loss)  to net cash provided by operating activities:** |   |                                    | ** **   |   | ** ** |
|                                                                                          |   |                                    | ** **   |   | ** ** |
| **Gain on disposal of fixed assets**                                                          |   | **4,921**                               | ** **   | **—** | ** ** |
| **Depreciation and amortization**                                                             |   | **245,097**                             | ** **   | **358,005** | ** ** |
| **Deferred tax asset**                                                                        |   | **(146,942**                            | **)**        | **—** | ** ** |
| **Changes in operating assets and liablilites:**                                              |   |                                    | ** **   |   | ** ** |
| **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**                                       |   | **(208,746**                            | **)**        | **(385,384** | **)** |
| **Increase in accrued liabilities**                                                           |   | **274,799**                             | ** **   | **(143,286** | **)** |
|                                                                                          |   |                                    | ** **   |   | ** ** |
| **Total adjustments to net income**                                                           |   | **739,787**                             | ** **   | **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 activites**                                                      |   | **(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** | ** ** |

 

**The accompanying notes are an integral partof 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 southwestern and southeastern United States.

 

Effective October 1, 1998, Stericycle Inc., a Delawarecorporation (“Stericycle”), acquired 100% of the common stock of WasteSystems, Inc. (“WSI”). Stericycle directly and indirectly through WSI owns(i) 67.5% or 6,578,504 shares of the Company’s outstanding common stock, parvalue $0.01 per share (“Common Stock”), and (ii) 100% of the Company’s Series BPreferred Stock, par value $0.01 per share (“Series B Preferred Stock”), and100% of the Company’s Series C Preferred Stock, par value $0.01 per share(“Series C Preferred Stock,” and together with the Series B Preferred Stock,the “Preferred Stock”), all of which shares of Preferred Stock were convertedinto Common 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 the UnitedStates, for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States forcomplete financial statements.  In theopinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation have been included.  Operating results for the three and sixmonth period ended March 31, 2004 are not necessarily indicative of the resultsthat may be expected 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)                                                 |   | $                                        | (116,778 | )                                        | $      | 37,393                                 |   | $                                      | (233,883 | ) | $ | 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    | )                                        | $      | —                                 |   | $                                      | (0.01    | ) | $ | 0.04 |   |
| Diluted net income (loss) per common share                        |   | $                                        | (0.01    | )                                        | $      | —                                 |   | $                                      | (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 as theywere 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 of October 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 change fromtime to time, published under “Money Rates” in *The Wall Street Journal*(Southwestern Edition) (the “Prime Rate”), not to exceed 13%.  In addition to the term note facilitydescribed above, the Note includes a revolving credit agreement under which theCompany can borrow up to and including $100,000; the Company has no borrowingsoutstanding under the revolving credit agreement.  Borrowings under the Note may be prepaid at any time withoutpenalty.  The Note matures 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 obtainedat the end of any such six-month period, the agreement requires the Company topay to WSI a fee equal to 3% of the outstanding principal balance of the Noteat the end of such period.

 

Total interest expense under the Note was $140,153 and $55,273 for thesix months ended March 31, 2004 and 2003, respectively. The Company was not incompliance under the EBITDA covenant of the Note at March 31, 2004 and atDecember 31, 2003.  On March 17, 2004,the Company paid to WSI a penalty fee of approximately $64,000 in connectionwith such non-compliance as of December 31, 2003.  The Company accrued approximately $56,000 in connection with suchnon-compliance as of March 31, 2004. These penalties were included in the financial statements with interestexpense.

 

The Company has requested an additional amendment to the Note, whichwould exclude from its EBITDA covenant calculation 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.

 

**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 Internal Revenue CodeSection 382 relating to changes in ownership of the Company, utilizationof the net operating loss carryforwards is subject to an annual limitation ofapproximately

 

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

 

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 as profitabilityexpected in future years. As a result, the Company increased the valuationallowance on deferred tax assets in accordance with SFAS No. 109,“Accounting for Income Taxes,” to an amount that the Company believes is morelikely than not of being recovered based upon the Company’s assessment of thelikelihood 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, theper share closing price of the Common Stock was $0.21. Accordingly, the Companywould have issued 36,904,761 shares of Common Stock upon conversion of thePreferred Stock under this interpretation, which would have increased WSI’sownership percentage to approximately 91.2% of the outstanding shares of CommonStock and the combined WSI and Stericycle ownership percentage to approximately93.2%.

 

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 andnon-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 CommonStock.  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 ended September30, 2001, 2002 and 2003.  Theserestatements reflect for the quarter ended December 31, 2002, a removal of (a)dividends payable on the Preferred Stock as a current liability on theCompany’s balance sheets and as an adjustment of net income (loss) applicableto common shareholders on the statements of operations, and (b) the PreferredStock Dividends as a line item on the Company’s statements of shareholders’equity and statements of cash flows.

 

WSI was the holder of the Preferred Stock. The Company has been advisedby WSI, Stericycle and the four 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, Legal Proceedings.

 

**NOTE 6—NOTE PAYABLE**

 

During the quarter ended March 31, 2004 the Company financed its annualinsurance premium over a 12 month period of time at 5% per annum interest 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 3CI’s directors and theCompany’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 plaintiffseeks approximately $818,800 in damages, interest and attorney’s fees forfailure to pay for treatment of medical waste and for breach of contract.  Plaintiff alleges that the Company hasfailed to pay for 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 andchanging regulations. Furthermore, because the medical waste disposal industryis predicated upon the existence of strict

 

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governmental regulation, anymaterial relaxation of regulatory requirements governing medical waste disposalor of their enforcement could result in a reduced demand for the Company’sservices and have a material adverse effect on the Company’s revenues andfinancial condition. The scope and duration of existing and future regulationsaffecting the medical waste disposal industry cannot be anticipated and aresubject to changing political and economic pressures.

 

The Company is subject to certain other litigation and claims arisingin the ordinary course of business.  Inthe opinion of management of the Company, the amounts ultimately payable, ifany, as a result of such claims and assessments will not have a materiallyadverse effect on the Company’s financial position, results of operations ornet cash flows.

 

**Item2.  ****Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

The Company is engaged in the business of medical waste managementservices in the southwestern 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 events that may allow abetter understanding of the progression of the Company’s financial position andoperating 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 under the WSINote were in the aggregate principal amounts of approximately $1,869,485,  $2,425,645 and $3,392,492,respectively.   See Liquidity andCapital Resources herein and Note 3 to the Company’s financial statements.

 

See Note 5 and 7 to the Company’s financial statements above for adiscussion of the reversal of the Company’s Preferred Stock Dividends on itsbooks and records and the restatement of its financial statements for the yearsended September 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. Theamount of net deferred tax assets estimated to be recoverable was based uponthe Company’s assessment of the likelihood of near term operating income.

 

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**RESULTSOF OPERATIONS**

 

The following summarizes (inthousands) 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                              |   | 140                                   |   | 55                                 |   | 163 |   | 108 |   |
| Other expense, net                            |   | 80                                    |   | 69                                 |   | 142 |   | 138 |   |
| Income taxes                                  |   | (73                                   | )      | —                             |   | (147 | ) | — |   |
| Net (Loss) Income                             |   | $                                     | (117   | )                                  | $      | 37 |   | $ | (234 | ) | $ | 392 |   |

 

**Three months ended March 31, 2004 compared tothree months ended March 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 ended March 31,2003. This decrease is primarily related to a reduction in the volume of wastehandled.  Substantially all of thisreduction in volume was attributable to the Company’s efforts to focus on smallquantity generators which provide higher margins at lower volumes whilereducing the focus on less profitable larger quantity generators.

 

***Costof services*** decreased by $206,769, or 9.3%, to$2,011,040 during the three months ended March 31, 2004, compared to $2,217,809for the three month period ended March 31, 2003.  This decrease was primarily attributable to a decrease inprocessing and a decrease in transportation costs due to increased routeefficiency.  Cost of services as a

 

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percentage of revenuesdecreased to 61.4% compared to 65.0% during the three months ended March 31,2004 and March 31, 2003 respectively. This percentage decrease was primarily attributable to a decrease inprocessing and a decrease in transportation costs due to increased routeefficiency.

 

***Depreciationand amortization*** expense for the three months ended March 31,2004 decreased $63,104 or 34.6% to $119,022 compared to $182,126 for the threemonths ended March 31, 2003. This decrease was primarily attributable to thedepreciable useful lives of assets still employed in our operations havingexpired during the quarter.

 

***Selling,general and administrative***expenses for the threemonths 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.  Sales, general and administrative expensesincreased as a percentage of revenue to 34.0% for the three months ended March31, 2004, as compared to 24.9% for the three months ended March 31, 2003 dueprimarily to increases in legal expenses and information technology consultingfees.   Substantially all of theincreased legal fees are related to the legal proceedings described in Part II,Item 1, Legal Proceedings below.

 

***Interest expense***for the three months ended March 31, 2004 increased by $84,880 or 153.6%, to$140,153 from $55,273 during the three months ended March 31, 2003.  This increase was due to the penalties paidand accrued due to the company’s failure to meet the EBITDA covenant at December31, 2003 and March 31, 2004, under the Note, currently at 3% of the outstandingprincipal balance of the Note.

 

***Earnings before interest taxes depreciationand amortization (“EBITDA”)*** totaled $69,292 or 2.1% of revenue comparedto $274,792 or 8.1% of revenue for the quarter ended March 31, 2003.  The difference was primarily reflective ofthe increase in legal and professional fees.

 

**Six months ended March 31, 2004 compared tosix months ended March 31, 2003:**

 

***Revenues***decreased by $370,903 or 5.3%, to $6,635,900 during the six months period endedMarch 31, 2004, from $7,006,803 for the six month period ended March 31, 2003.This decrease is primarily related to a reduction in the volume of wastehandled.  Substantially all of thisreduction in volume was attributable to the Company’s efforts to focus on smallquantity generators which provide higher margins at lower volumes whilereducing the focus on less profitable larger quantity generators.

 

***Costof services*** decreased $370,795, or 8.2%, to$4,135,260, during the six months ended March 31, 2004, compared to $4,506,055for the six month period ended March 31, 2003. This decrease was primarily attributable to a decrease in processing anda decrease in transportation 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 compared to64.3% during the six months ended March 31, 2003.  This decrease was primarily attributable to a decrease inprocessing and a decrease in transportation costs due to increased routeefficiency.

 

***Depreciationand amortization*** expense for the six months ended March 31,2004 decreased $112,908 or 31.5% to $245,097 compared to $358,005 for the sixmonths ended March 31, 2003. This decrease was primarily attributable to thedepreciable useful lives of assets still employed in our operations havingexpired during the quarter.

 

***Selling,general and administrative***expenses for the periodincreased 54.9% or $826,117 to $2,331,459 from $1,505,342 during the six monthsended March 31, 2004.  Sales, generaland administrative expenses increased as a percentage of revenue to 35.1% forthe six months ended March 31, 2004 as compared to 21.5% for the six monthsended March 31, 2003 due primarily to increases in legal expenses andinformation technology consulting fees. Substantially all of these increased legal fees are related to the legalproceedings described in Part II, Item 1, Legal Proceedings below.

 

***Interest expense***increased by $54,834 or 50.9% to $162,539 during the six months ended March 31,2004 as compared to $107,705 during the six months ended March 31, 2003.  This increase was due to the penalties paidand accrued due to the company’s failure to meet the EBITDA covenant atDecember 31, 2003 and March 31, 2004, under the Note, currently at 3% of theoutstanding principal balance of the Note.

 

***Earnings before interest taxes depreciationand amortization (“EBITDA”)***totaled $(26,811) or (0.4)% of revenue for thesix months ended March 31, 2004 compared to $857,406 or 12.2% of revenue forthe six months ended March 31, 2003. The difference was primarily reflective of the increase in legal andprofessional 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 thePreferred Stock.  If the minimum EBITDAlevel is not obtained at the end of any such six-month period, the agreementrequires the Company to pay to WSI a fee equal to 3% of the outstandingprincipal balance of the Note at the end of such period.

 

The Company was not in compliance under the EBITDA covenant of the Noteat March 31, 2004 and at December 31, 2003. On March 17, 2004, the Company paid to WSI a penalty fee ofapproximately $64,000 in connection with such non-compliance as of December 31,2003.  In addition, the Company accruedapproximately $56,000 in connection with such non-compliance as of March 31,2004. The Company has requested an additional amendment to the Note, whichwould exclude from its EBITDA covenant calculation 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 asfollows:

 

The reconciliation of EBITDA tonet income is reflected in the following table (in thousands):

 
|                          |   | **Three  Months Ended March 31,** |   | **Six Months  Ended March 31,** |   |
|-------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                          |   | **2004**                          |   | **2003**                        |   | **2004** |   | **2003** |   |
| Net income                    |   | $                                 | (117   | )                               | $      | 37 |   | $ | (234 | ) | $ | 392 |   |
| Increase expense              |   | 140                               |   | 55                              |   | 163 |   | 108 |   |
| Income tax benefit            |   | (73                               | )      | —                          |   | (147 | ) | — |   |
| Depreciation and amortization |   | 119                               |   | 182                             |   | 245 |   | 358 |   |
| EBITDA                        |   | $                                 | 69     |                            | $      | 274 |   | $ | 27 |   | $ | 858 |   |

 

EBITDA is calculated as the sum of netincome, plus interest expense, income tax expense, depreciation expense, andamortization expense to the extent deducted in calculating net income.  The Company considers EBITDA to be a widelyaccepted financial indicator of a company’s operating performance and abilityto service debt, fund capital expenditures and expand its business.  EBITDA is not calculated in the same way byall companies and therefore may not be comparable to similarly titled measuresreported by other companies.  EBITDA isnot a measure in accordance with accounting principles generally accepted inthe United States.  EBITDA should not beconsidered as an alternative to net income, as an indicator of operatingperformance or as an alternative 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 credit fromthird-party sources, but believes that if such funds were available, they wouldbe at higher interest rates and could require additional operating andfinancing restrictions from those under the WSI 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 Internal Revenue CodeSection 382 relating to changes in ownership of the Company, utilizationof the 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 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. Theamount of net deferred tax assets estimated to be recoverable was based uponthe Company’s assessment of the likelihood of near term operating income.

 

At March 31, 2004, the Company had net working capital, exclusive ofthe note payable to its majority shareholder, of $2,028,623 compared to a networking capital exclusive of the note payable to its majority shareholder of$2,366,924 at September 30, 2003.  Thisdecrease in net working capital of $338,301 was due primarily to the decreasein accounts receivable and an increase in prepaid insurance.

 

Net cashprovided by operating activities was $505,904 during the six month period endedMarch 31, 2004, compared to $1,162,546 for the six month period ended March 31,2003.  The difference is due to adecrease in accounts receivable.

 

Net cash usedin investing activities for the six months ended March 31, 2004, was $85,982compared to $82,226 for the same period in 2003.  The $3,756 increase reflected increased investment in equipmentnet of proceeds from the sale of equipment.

 

Net cash usedin financing activities was $556,160 for the six month period ended March 31,2004, compared to $444,014 during the six month period ended March 31,2003.  The $112,146 net change was dueto the principal reduction of the WSI note coupled with proceeds from CommonStock issuance in 2003.

 

**Item3.   Qualitative Disclosure about MarketRisk**

 

The Company’sexposure to market risk includes the possibility of rising interest rates inconnection with the Note, thereby increasing its debt service obligation, whichcould adversely affect the Company’s cash flows.  The interest rate on the Note is variable and tied to the primerate not to exceed 13%.  An increase inthe prime rate of 1% would have the effect of increasing interest expense byapproximately $18,695 over 12 months. The Company does not utilize derivative financial instruments tomitigate the risks of changes in interest rates.

 

**Item4.   Controls and Procedures**

 

The Companymaintains disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in the Company’s filings under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the periods specified in the rules and forms of the Securities andExchange Commission.  This informationis accumulated and communicated to the Company’s management including the ChiefExecutive Officer and the Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosures.  The Company’s management including the Chief Executive Officerand the Chief Financial Officer

 

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

 

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

 

There havebeen no significant changes in the Company’s internal controls or in otherfactors that could significantly affect these controls subsequent to the dateof the evaluation referenced in the foregoing paragraph.

 

**PARTII - OTHER INFORMATION**

 

**Item 1.    LegalProceedings**

 

**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. Waste Systems, Inc.*, the Company andcertain of the Company’s former directors and officers (the “1995 Action”),which was the original proceeding pursuant to which the Preferred Stock wasissued 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., Tidel Technologies, Inc.f/k/a American Medical Technologies, Inc., Jim Rash, individually and inhis capacity as representative of the certified class of minority shareholdersof 3CI, and Larry Robb, individually and as proposed co-representative of thesame certified class (collectively, the “Minority Stockholders”), answeredand/or intervened in the 2003 Action, cross- claimed against WSI and filed athird-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) forfeit all fees, payments, dividends, warrants, preferred stock,common stock, profit shares and all other forms of value which Stericycle andWSI have extracted from 3CI and its minority owners, (ii) pay actualdamages of at least $28 million and reasonable punitive damages, and (iii) buythe capital stock of the minority stockholders of the Company at the relativevalue of 3CI’s shares to Stericycle’s shares at the time Stericycle gainedcontrol over 3CI, i.e. one share of Stericycle common stock for every fiveshares of Common Stock.

 

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

 

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convertible into 36,904,761 shares of Common Stock. The parties arecurrently conducting discovery 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 Stockholder Litigation for a furtherdescription 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”). In this suit, the LouisianaPlaintiffs assert numerous claims of minority stockholder oppression, breach offiduciary duty and unjust enrichment against Stericycle, the four directors of3CI who are also affiliates of Stericycle, and the President and ChiefExecutive 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 loanobligations and avoidable expenses on the Company; (ii) usurped 3CI’sbusiness and business opportunities and diverted its assets for Stericycle’sbenefit; and (iii) depressed the value of the Common Stock. The LouisianaPlaintiffs further allege that Stericycle has breached an agreement enteredinto for the protection of 3CI’s minority stockholders in connection withStericycle’s acquisition 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.

 

On or aboutOctober 27, 2003, the Louisiana Plaintiffs filed their First AmendedPetition adding the Company as a derivative defendant. The Company has not yetanswered this petition. However, the other parties in the Louisiana Suitcurrently are proceeding with discovery. The Company does not have sufficientinformation to predict the outcome of the Louisiana Suit.

 

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.  TheSpecial Committee has appointed legal counsel to assist it in its investigationof the Louisiana Plaintiffs’ allegations and to gather all information relatedto the Louisiana Suit.

 

**Item2.    Changes in Securities**

 

None.

 

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**Item3.    Defaults upon Senior Securities**

 

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 paid therequired penalty fee.  Therefore theCompany could be deemed to be in default under the Note.  See Footnote 3- Promissory Note and Part I-Item II. Management Discussion & Analysis of Financial Condition andResults of Operations, Liquidity and Capital Resources above for a descriptionof the Note and the required penalty fee.

 

**Item4.    Submission of Matters to a Vote ofSecurity Holders**

 

None.

 

**Item 5. Other Information**

 

None.

 

**Item6.    Exhibits and Reports on Form 8-K**

 

a)  Exhibits. The following is a list of the exhibits filed with 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 Form 8-K

 

None.

 

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SIGNATURES

 

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

 

 
|                |   | 3CI COMPLETE COMPLIANCE                                                                                           |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------|
|                |   | CORPORATION                                                                                                       |
|                |   | (Registrant)                                                                                                      |
|                |   |                                                                                                              |
|                |   |                                                                                                              |
| Dated: May 13, 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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