**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

| **ý** |   | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**                                                                                                                                                                                                                                                                                                                                                                     |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|       |   | **For the quarterly period ended  June 30, 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**                                                                                                                                                                                                                                                                                                                                                                                                                                     |

 

**3CICOMPLETE 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 August 4, 2004, was 9,739,611.

 

 

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**FORWARD-LOOKINGSTATEMENTS**

 

“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, COMPETITIVE ACTIVITYAND PRICING PRESSURE AND GENERAL ECONOMIC CONDITIONS AFFECTING THE BIO-MEDICALWASTE DISPOSAL INDUSTRY, AS WELL AS OTHER RISKS DETAILED IN THE COMPANY’SFILINGS WITH THE SEC.  THE COMPANYEXPRESSLY 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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**3CICOMPLETE COMPLIANCE CORPORATION**

 

**IN D E X**

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

 

2

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**PART I – FINANCIAL INFORMATION**

 

**Item1. Financial Statements**

 

**3CI COMPLETE COMPLIANCE CORPORATION**

**BALANCESHEETS**

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

 

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

 

3

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**3CI COMPLETE COMPLIANCE CORPORATION**

**STATEMENTSOF OPERATION**

**(UNAUDITED)**

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

 

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

 

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

 

5

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**3CICOMPLETE COMPLIANCE CORPORATION**

**NOTESTO FINANCIAL STATEMENTSJune 30, 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. The Company has not issued any shares of Common Stock and has notrecorded any increase in the outstanding Common Stock related to suchconversion.  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 the information andfootnotes required by accounting principles generally accepted in the UnitedStates for complete financial statements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for a fair presentation have beenincluded.  Operating results for thethree and nine month period ended June 30, 2004 are not necessarilyindicative of the results that may be expected for the year endedSeptember 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  June 30,  2004** |    | **Three  months ended  June 30,  2003** |   | **Nine  months ended  June 30,  2004** |   | **Nine  months ended  June 30,  2003** |   |
|-------------------------------------------------------------------|--------|----------------------------------------------|---------|----------------------------------------------|--------|---------------------------------------------|--------|---------------------------------------------|--------|
|                                                              |   |                                         |    |                                         |   |                                        |   |                                        |   |
| Numerator:                                                        |   |                                         |    |                                         |   |                                        |   |                                        |   |
|                                                              |   |                                         |    |                                         |   |                                        |   |                                        |   |
| Net income                                                        |   | $                                            | 216,542 |                                         | $      | 252,575                                     |   | $                                           | 37,939 |   | $ | 621,385 |   |
| Denominator for basic earnings per  share-weighted average shares |   | 17,489,611                                   |    | 9,739,611                                    |   | 17,489,611                                  |   | 9,582,399                                   |   |
| Effect of dilutive shares:                                        |   |                                         |    |                                         |   |                                        |   |                                        |   |
|                                                              |   |                                         |    |                                         |   |                                        |   |                                        |   |
| Preferred Shares                                                  |   | —                                       |    | 7,750,000                                    |   | —                                      |   | 7,750,000                                   |   |
| Warrants                                                          |   |                                         |    |                                         |   |                                        |   | 95,026                                      |   |
| Denominator for diluted earnings per share                        |   | 17,489,611                                   |    | 17,489,611                                   |   | 17,489,611                                  |   | 17,427,425                                  |   |
|                                                              |   |                                         |    |                                         |   |                                        |   |                                        |   |
| Basic net income per share                                        |   | $                                            | 0.01    |                                         | $      | 0.02                                        |   | $                                           | — |   | $ | 0.05 |   |
| Diluted net income per common share                               |   | $                                            | 0.01    |                                         | $      | 0.01                                        |   | $                                           | — |   | $ | 0.04 |   |

 

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 June 30, 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.

 

**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 firstday of each month, which are applied to principal and accrued interestcalculated at the prime lending rate (4% as of June 30, 2004), as such maychange from time to time, published under “Money Rates” in *The Wall Street Journal*(Southwestern Edition) (the “Prime Rate”), not to exceed 13%.  In addition to the term note 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 onOctober 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.  TheCompany and WSI are currently negotiating a modification of the minimum levelof EBITDA that the Company is required to achieve under the Note in accordancewith the Company’s budgeted financial results.

 

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

 

The Company has requested an additional amendment to the Note, whichwould exclude from its EBITDA covenant calculation not only certain expensesassociated with the dispute regarding the conversion rate of the Company’sPreferred Stock, which has previously been agreed to by WSI, but also certainexpenses primarily associated with the allegations of the Company’s minoritystockholders in *Robb et al. v. Stericycle,Inc. et al.* and the Special Committee’s investigation of thoseallegations.  See Part II, Item I, LegalProceedings.

 

**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 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

 

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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 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 currentlyconducting discovery in this proceeding.  See Part II, Item 1, Legal Proceedings.

 

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**Preferred Stock Dividends**

 

There are unanimous written consents of the Board of 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 members of the Board who are affiliates of WSI andStericycle that they believe the Company remains obligated to pay the PreferredStock Dividends as previously declared in the Board resolutions and aspreviously recorded on the Company’s books. If WSI and Stericycle’s position iscorrect, 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 June 30, 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.

 

TheCompany is a defendant in *Medical WasteServices 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 the treatment and disposal of medical waste at theplaintiff’s Birmingham, Alabama facility. Further, plaintiff alleges that the Company agreed to deliver an additionalamount of medical 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.

 

TheCompany operates within the regulated medical waste disposal industry, which issubject to intense governmental regulation at the federal, state and locallevels. The Company believes it is currently in compliance in all materialrespects with all applicable laws and regulations governing the medical wastedisposal business. However, continuing expenditures may be required in orderfor the Company to remain in compliance with existing and changing regulations.Furthermore, because the medical waste disposal industry is predicated upon theexistence of strict

 

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governmental regulation, any material relaxation of regulatoryrequirements governing medical waste disposal or of their enforcement couldresult in a reduced demand for the Company’s services and have a materialadverse effect on the Company’s revenues and financial condition. The scope andduration of existing and future regulations affecting the medical wastedisposal industry cannot be anticipated and are subject to changing politicaland 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 materialadverse 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 south and southeastern United States.  The Company’s customers include regional medical centers, majorhospitals, clinics, medical and dental offices, veterinarians, pharmaceuticalcompanies, retirement homes, medical testing laboratories and other medicalwaste generators.  The following is adiscussion of some events that may allow a better understanding of theprogression of the Company’s financial position and operating results.

 

The Company has historically financed its working capital needs,capital expenditures and acquisitions primarily using borrowings from WSI andinternally generated funds. Currently, the Company’s only borrowed indebtednessconsists of money borrowed from WSI under the Note and annual insurance premiumfinancing.  As of June 30, 2004,March 31, 2004, September 30, 2003 and March 31, 2003, theoutstanding balances under the WSI Note were in the aggregate principal amountsof approximately $1,587,213, $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 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  June 30,** |   | **Nine  Months****Ended  June 30,** |   |
|-----------------------------------------------|--------|-------------------------------------------|--------|------------------------------------------|--------|
|                                          |   | **2004**                                  |   | **2003**                                 |   | **2004** |   | **2003** |   |
|                                          |   |                                      |   |                                     |   |   |   |   |   |
| Revenues                                      |   | $                                         | 3,218  |                                     | $      | 3,440 |   | $ | 9,853 |   | $ | 10,446 |   |
| Cost of services                              |   | 1,788                                     |   | 1,989                                    |   | 5,853 |   | 6,495 |   |
| Depreciation and amortization                 |   | 107                                       |   | 154                                      |   | 352 |   | 512 |   |
| Selling, general and administrative  expenses |   | 831                                       |   | 1,046                                    |   | 3,164 |   | 2,550 |   |
| Income from operations                        |   | 492                                       |   | 251                                      |   | 484 |   | 889 |   |
| Interest expense                              |   | 49                                        |   | 30                                       |   | 121 |   | 138 |   |
| Other expense, net                            |   | 90                                        |   | (9                                       | )      | 301 |   | 130 |   |
| Income taxes                                  |   | 136                                       |   | —                                   |   | 24 |   | — |   |
| Net Income                                    |   | $                                         | 217    |                                     | $      | 230 |   | $ | 38 |   | $ | 621 |   |

 

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

 

***Revenues***decreased by $222,008, or 6.5%, to $3,217,564 during the three-month periodended June 30, 2004, from $3,439,572 for the three-month period endedJune 30, 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 $201,505, or 10.1%, to $1,787,659 during the three months endedJune 30, 2004, compared to $1,989,164 for the three-month period endedJune 30, 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 55.6% compared to 57.8% during thethree months ended June 30, 2004 and June 30, 2003 respectively.  This percentage decrease was primarilyattributable to a decrease in processing and a decrease in transportation costsdue to increased route efficiency.

 

***Depreciation andamortization*** expense for the three months ended June 30, 2004 decreased$46,957 or 30.5% to $106,952 compared to $153,909 for the three months endedJune 30, 2003. This decrease was primarily attributable to the depreciableuseful lives of assets still employed in the Company’s operations having expiredduring the quarter.

 

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

 

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

 

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

 

***Revenues***decreased by $592,911 or 5.7%, to $9,853,464 during the nine-month period endedJune 30, 2004, from $10,446,375 for the nine-month period endedJune 30, 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 $642,306, or 9.9%, to $5,852,913, during the nine months endedJune 30, 2004, compared to $6,495,219 for the nine-month period endedJune 30, 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 59.4% during the nine months ended June 30, 2004, as comparedto 62.2% during the nine months ended June 30, 2003.  This decrease was primarily attributable toa decrease in processing and a decrease in transportation costs due toincreased route efficiency.

 

***Depreciation andamortization*** expense for the nine months ended June 30, 2004 decreased$159,830 or 31.2% to $352,084 compared to $511,914 for the nine months endedJune 30, 2003. This decrease was primarily attributable to the depreciableuseful lives of assets still employed in the Company’s operations havingexpired during the nine months ended June 30, 2004.

 

***Selling, general andadministrative***expenses for the period increased24.1% or $614,302 to $3,163,878 during the nine months ended June 30, 2004from $2,549,576 during the nine months ended June 30, 2003.  Selling, general and administrative expensesincreased as a percentage of revenue to 32.1% for the nine months endedJune 30, 2004 as compared to 24.4% for the nine months ended June 30,2003 due primarily to increases in legal expenses and information technologyconsulting fees.  Substantially all ofthese increased legal fees are related to the legal proceedings described inPart II, Item 1, Legal Proceedings below.

 

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

 

**LIQUIDITY AND CAPITALRESOURCES**

 

TheCompany has historically financed its working capital needs, capitalexpenditures and acquisitions primarily using advances from WSI and internallygenerated funds. The Company’s borrowed indebtedness currently consists only ofamounts owed to WSI under the Note and financed annual insurance premiums.

 

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The Note is payable in monthly payments of $100,000, due on the 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 June 30, 2004, andJune 30, 2003, the outstanding balances under the Note were in theaggregate principal amounts of approximately $1,587,213 and $3,890,635,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, which were assigned to Stericycle on May 1, 2002, butotherwise is 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 Noterequires the Company to pay to WSI a fee equal to 3% per annum of theoutstanding principal balance of the Note at the end of such period.  The Company and WSI are currentlynegotiating a modification of the minimum level of EBITDA that the Company isrequired to achieve under the Note in accordance with the Company’s budgetedfinancial results.

 

The Company was not in compliance under the EBITDA covenant of the Noteat June 30, 2004, March 31, 2004 and December 31, 2003.  On March 17, 2004, the Company paid toWSI a penalty fee of approximately $64,469 in connection with suchnon-compliance as of December 31, 2003. The Company has recently notified WSI that it has determined that theCompany overpaid this penalty fee by approximately $48,352.  The overpayment resulted from the Companynot calculating the amount of the penalty fee on a per annum basis, as requiredby the Note.  The Company will requestthat WSI refund the full amount of the overpayment to the Company. The Companyhad also previously accrued approximately $56,084 as interest expense inconnection with its failure to comply with the EBITDA covenant of the Note asof March 31, 2004, but has not yet paid this penalty fee to WSI.  Similarly, the Company has recentlydetermined that it overstated this $56,084 accrual by approximately $42,062because of a failure to calculate the amount of the penalty fee on a per annumbasis.  The Company has accruedapproximately $11,904 in connection with its failure to comply with the EBITDAcovenant of the Note as of June 30, 2004, and has not yet paid thispenalty fee to WSI.  This $11,904accrual has been calculated on a per annum basis in accordance with theNote.  The Company is determiningwhether it has overpaid any other penalty fees previously paid to WSI pursuantto the Note and has amended the March 31, 2004 10-Q to account for theoverstatement of interest expense in the approximate amount of $90,414.

 

The Company has requested an additional amendment to the Note, whichwould exclude from its EBITDA covenant calculation not only certain expensesassociated with the dispute regarding the conversion rate of the Company’sPreferred Stock, which has previously been agreed to by WSI, but also certainexpenses primarily associated with the allegations of the Company’s minoritystockholders in *Robb et al. v. Stericycle,Inc. et al.* and the Special Committee’s investigation of thoseallegations.  See Part II, Item I, LegalProceedings.

 

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 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 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 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 of nearterm operating income.

 

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

 

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

 

Net cash used in investing activities for the nine months endedJune 30, 2004, was $130,973 compared to $686,203 for the same period in2003.  The $555,230 increase reflectedincreased investment in equipment net of proceeds from the sale of equipment.

 

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

 

**Item3.   Qualitative Disclosure about MarketRisk**

 

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 variableand tied 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 $15,872 over 12 months.  The Company does not utilize derivativefinancial instruments to mitigate the risks of changes in interest rates.

 

**Item4.   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 management,including the Chief Executive Officer and the Chief Financial Officer,

 

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recognizes that any set of controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired 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’sChief Executive Officer and Chief Financial Officer concluded that theCompany’s disclosures controls and procedures are effective in alerting them ona timely basis to material information required to be disclosed in theCompany’s periodic 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 District Courtin Harris County, Texas (the “Court”) seeking a judicial determination of theappropriate 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.

 

On October 3,2003, WSI filed a motion to enforce judgment in the 1995 Action and to have theCourt declare that the Preferred Stock is convertible into 36,904,761 shares ofCommon Stock. The Company opposed WSI’s motion to enforce the judgment.Following a hearing, the Court abated WSI’s motion on November 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) 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) buy the capital stock of the minority stockholders of the Company atthe relative value of 3CI’s shares to Stericycle’s shares at the time Stericyclegained control over 3CI, i.e. one share of Stericycle common stock for everyfive shares of Common 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 respectivefilings, Stericycle and WSI have denied all material allegations and reassertedtheir claims that the Preferred Stock is

 

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convertible into 36,904,761 shares of CommonStock. The parties are currently 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 affiliates ofStericycle who are or were directors of the Company, and the President andChief Executive Officer of the Company (collectively, the “LouisianaDefendants”).

 

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.

 

As ofJanuary 8, 2004, the Board expanded the authority of the Special Committeesuch that the Special Committee now has the exclusive power and authority onbehalf of the Company to (i) make all inquiries, conduct allinvestigations and gather all information related to the Louisiana Suit, the1995 Action and the 2003 Action, or any actions or proceedings related to anyof the foregoing; (ii) make or approve all decisions of the Company relatedto the Louisiana Suit, the 1995 Action and the 2003 Action, including theCompany’s filing, amending, maintaining, prosecuting or settling of any legalproceedings related to such suits; and (iii) exercise such other power andauthority that may be exercised by the full Board with regard to the foregoing.The Special Committee is composed of Stephen B. Koenigsberg and KevinJ. McManus, who are the independent directors on the Board not affiliatedwith Stericycle or WSI.  Robert M.Waller, previously a member of the Special Committee, for personal reasons,resigned from the Board of Directors on March 11, 2004.  The SpecialCommittee has appointed legal counsel to assist it in its investigation of theLouisiana Plaintiffs’ allegations and to gather all information related to theLouisiana Suit.

 

In June 2004, the Louisiana Plaintiffs filed a motion to certifythe Louisiana Suit as a class action and served discovery relating to therequest for class certification on all parties, including the Company.  In response, the Company, at the directionof the Special Committee, filed a motion with the Louisiana court to stay allproceedings in the litigation (including discovery) pending the completion ofthe Special Committee’s investigation. After a hearing on the motion in June 2004, the court extended theCompany’s deadline for responding to the Louisiana Plaintiffs’ discoverypending completion of the Special Committee’s investigation, but allowed theother parties to proceed with discovery in the interim.  The Company does not havesufficient information 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 periods ended March 31, 2004 and June 30,2004, and has not yet paid to WSI the required penalty fees thereunder.  Therefore, the Company could be deemed to 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 for a description ofthe Note and the required penalty fees thereunder.

 

**Item 4.****    Submission of Matters to a Voteof Security Holders**

 

None.

 

**Item5.****    Other Information**

 

None.

 

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

 

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

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

 

b) Reports on 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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