<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] 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: 000-20997
STERILE RECOVERIES, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its Charter)
FLORIDA 59-3252632
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(State of incorporation) (I.R.S. Employer
Identification No.)
28100 U.S. HIGHWAY 19 NORTH, SUITE 201
CLEARWATER, FLORIDA 33761
----------------------------------------
(Address of Principal Executive Offices)
(727) 726-4421
-------------------------------
(Registrant's Telephone Number)
Indicate by check whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Number of outstanding shares of each class of Registrant's Common Stock as of
May 10, 1999:
Common Stock, par value $.001 - 5,676,794
<PAGE> 2
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C> <C>
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Condensed Consolidated Statements of Earnings for
the three month period ended March 31, 1999
(unaudited) and the three month period ended
March 31, 1998 (unaudited)............................ 1
Condensed Consolidated Balance Sheets as of March
31, 1999 (unaudited) and December 31, 1998............ 2
Condensed Consolidated Statements of Cash Flows
for the three month period ended March 31, 1999
(unaudited) and three month period ended March 31,
1998 (unaudited)...................................... 3
Notes to Condensed Consolidated Financial
Statements (unaudited)................................ 4
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 7
PART II OTHER INFORMATION
Item 1 Legal Proceedings..................................... 14
Item 2 Changes in Securities................................. 14
Item 3 Defaults Upon Senior Securities....................... 14
Item 4 Submission of Matters to a Vote of Security Holders... 14
Item 5 Other Information..................................... 14
Item 6 Exhibits and Reports on Form 8-K...................... 14
SIGNATURE................................................................. 15
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
STERILE RECOVERIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months
Ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Revenues $17,058 $11,732
Cost of revenues 11,498 7,734
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Gross profit 5,560 3,998
Distribution expenses 1,266 887
Selling and administrative expenses 2,267 1,697
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Income from operations 2,027 1,414
Interest expense (income), net 65 (7)
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Income before income tax expense 1,962 1,421
Income tax expense 756 554
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Net income $ 1,206 $ 867
======= =======
Dividends on preferred stock 55 --
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Net income available for common shareholders $ 1,151 $ 867
======= =======
Net income per common share - basic $ 0.20 $ 0.15
======= =======
Net income per common share - diluted $ 0.19 $ 0.15
======= =======
Weighted average common shares outstanding - basic 5,674 5,660
======= =======
Weighted average common shares outstanding - diluted 6,339 5,859
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE> 4
STERILE RECOVERIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
March 31, Dec. 31,
1999 1998
----------- --------
(unaudited)
<S> <C> <C>
ASSETS
Cash $ 343 $ 172
Accounts receivable, net 7,953 7,580
Reimbursable construction costs 2,003 --
Inventories 2,290 2,324
Prepaid expenses and other assets 1,583 1,670
Reusable surgical products, net 14,959 14,705
Property, plant and equipment, net 12,484 12,042
Goodwill, net 5,559 5,127
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Total assets $47,174 $43,620
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable to bank $ 5,814 $ 3,698
Accounts payable 2,247 2,898
Employee related accrued expenses 1,296 974
Other accrued expenses 1,309 786
Deferred tax liability 142 142
------- -------
Total liabilities 10,808 8,498
Commitments and contingencies -- --
Shareholders' equity
Preferred stock 1 1
Common stock 6 6
Additional paid-in capital 27,414 27,321
Retained earnings 8,945 7,794
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Total shareholders' equity 36,366 35,122
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Total liabilities and shareholders' equity $47,174 $43,620
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 5
STERILE RECOVERIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months
Ended
March 31, March 31,
1999 1998
------- -------
<S> <C> <C>
Cash flows from operating activities
Net income $ 1,206 $ 867
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation and amortization 391 203
Amortization of reusable surgical products 971 675
Provision for reusable surgical products shrinkage 457 256
Change in assets and liabilities (net of business combination):
Accounts receivable (223) (71)
Inventories 34 (95)
Prepaid expenses and other assets (244) 560
Accounts payable (603) 91
Other accrued expenses 846 261
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Net cash provided by operating activities 2,835 2,747
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Cash flows from investing activities
Purchases of property, plant and equipment (782) (630)
Purchases of reusable surgical products (1,682) (1,981)
Reimbursable construction costs (1,673) --
Payment for acquisition of business, net of cash acquired (633) --
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Net cash used in investing activities (4,770) (2,611)
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Cash flows from financing activities
Net change in notes payable to bank 2,115 --
Net proceeds from issuance of common stock 93 --
Dividends paid (102) --
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Net cash provided by financing activities 2,106 --
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Increase (decrease) in cash 171 136
Cash and cash equivalents at beginning of period 172 380
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Cash and cash equivalents at end of period $ 343 $ 516
======= =======
Supplemental cash flow information
Cash paid for interest $ 52 $ 10
======= =======
Cash paid for income taxes $ 144 $ 97
======= =======
Supplemental schedule of non-cash investing activities
Acquisition of businesses
Fair value of assets acquired $ 633
Cash paid $ (633)
=======
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 6
STERILE RECOVERIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial
statements of Sterile Recoveries, Inc. (the "Company") have been
prepared in accordance with the Securities and Exchange Commission's
instructions to Form 10-Q and, therefore, omit or condense footnotes
and certain other information normally included in financial
statements prepared in accordance with generally accepted accounting
principles. The accounting policies followed for quarterly financial
reporting conform with generally accepted accounting principles for
interim financial statements and include those accounting policies
disclosed in the Company's Form 10-K for the year ended December 31,
1998 filed with the Securities and Exchange Commission. In the opinion
of management, all adjustments of a normal recurring nature that are
necessary for a fair presentation of the financial information for the
interim periods reported have been made. The results of operations for
the three months ended March 31, 1999 are not necessarily indicative
of the results that can be expected for the entire year ending
December 31, 1999. The unaudited condensed consolidated financial
statements should be read in conjunction with the consolidated
financial statements and the notes thereto included in the Form 10-K.
2. ACQUISITIONS
On August 31, 1998, the Company acquired all the stock of
RePak Surgical Enterprises, Inc. ("RePak"), a wholly owned subsidiary
of Standard Textile Co., Inc.("Standard Textile"), in exchange for
566,667 shares of its convertible Series A Preferred Stock. The
Company also purchased the RePak facility's real estate for $1.5
million cash from Standard Textile's affiliates. The Company has
accounted for the acquisition as a purchase and RePak's operating
results are included in the Company's operating results for its entire
first quarter of 1999.
The following unaudited pro forma information combines the
Company's results of operations with RePak's results of operations as
if the acquisition had occurred at the beginning of the respective
period.
<TABLE>
<CAPTION>
Three Months Ended
March 31, 1998
----------------------
(In thousands,
except per share data)
<S> <C>
Revenues $13,839
=======
Net income $ 961
=======
Net income available for common
shareholders $ 906
=======
Net income per common share, basic $ 0.16
=======
Net income per common share, diluted $ 0.15
=======
</TABLE>
This pro forma financial information does not necessarily
reflect the Company's actual operating results if the transaction had
been effective during the shown period and does not necessarily
reflect future results.
4
<PAGE> 7
On February 26, 1999, the Company announced its acquisition
of NPAC, the reusable surgical product business of the textile rental
segment of National Service Industries, Inc. The Company purchased the
NPAC customer relationships and certain other assets of the business
exclusive of plant and equipment for cash consideration of
approximately $633,000, of which $483,000 has been allocated to
goodwill. Goodwill will be amortized over 30 years. The Company has
accounted for the acquisition as a purchase and includes NPAC's
operating results in the Company's operating results since March 1,
1999. Pro forma results are not material and therefore are not
presented.
3. LINE OF CREDIT
The Company had approximately $5.8 million outstanding at
March 31, 1999 under its $15.0 million revolving credit facility with
First Union National Bank. This facility is secured by substantially
all of the Company's assets and has a maturity date of February 8,
2002. The facility's interest rate varies between 100 and 150 basis
points over LIBOR (4.94% as of March 31, 1999), depending on the
Company's leverage. The amendments require the Company to maintain (a)
consolidated net worth of $34.9 million plus 75% of cumulative
consolidated net income for each fiscal quarter occurring after
February 24, 1999; (b) a consolidated leverage ratio of not more than
2.5 to 1.0; and (c) a fixed charge coverage ratio of not less than 2.8
to 1.0. The facility restricts the Company's payment of dividends,
acquisition transactions, additional indebtedness, and encumbering of
assets.
4. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
As of February 1, 1999, the Company secured a $10.0 million
lease financing agreement to provide financing for land, building and
equipment for new processing facilities. The lease financing margins
are substantially the same as under the Company's revolving line of
credit. Under the agreement, the lessor purchases land, reimburses the
Company for the facility's construction and equipment costs, and
leases the completed facility to the Company for three years. The
Company guarantees all lease payments and a substantial residual value
for the facility when the lease term ends. Each lease agreement
includes a purchase option for the Company at the original cost of the
leased facility. The Company will account for these leases as
operating leases. Construction of two facilities that will be financed
under this agreement started in the first quarter of 1999 at a
projected cost of $4.5 to $5.0 million for each facility. The Company
anticipates that it will occupy these facilities and begin making
lease payments for them in the third quarter of 1999. The Company had
outstanding construction costs, reimbursable by the lessor, of $2.0
million as of March 31, 1999.
5. WEIGHTED AVERAGE COMMON SHARES
Historical net income per common share is computed by
dividing historical net income by the basic and diluted weighted
average number of shares of common stock outstanding. For diluted
weighted average shares outstanding, the Company used the treasury
stock method to calculate the Common Stock equivalents that the stock
options would represent.
5
<PAGE> 8
The following table sets forth the computation of historical
basic and diluted earnings per share:
<TABLE>
<CAPTION>
March 31,
1999 1998
---- ----
(In thousands, except
per share data)
(Unaudited)
<S> <C> <C>
BASIC
Numerator:
Net income $1,206 $ 867
Less effect of dividends of preferred
stock (55) --
------ ------
Net income available to common
shareholders $1,151 $ 867
====== ======
Denominator:
Weighted average shares outstanding 5,674 5,660
====== ======
Net income per common share - basic $ 0.20 $ 0.15
====== ======
DILUTED
Numerator:
Net income $1,206 $ 867
====== ======
Denominator:
Weighted average shares outstanding 5,674 5,660
Effect of dilutive securities:
Employee stock options 98 199
Convertible preferred stock 567 --
------ ------
6,339 5,859
====== ======
Net income per common share - diluted $ 0.19 $ 0.15
====== ======
</TABLE>
Options to purchase 483,500 and 145,500 shares of common
stock were not included for all or a portion of the 1999 and 1998
computation of diluted net income per common share, respectively,
because the options' exercise prices were greater than the average
market price of the common shares on March 31, 1999, and therefore
their exercise would have an anti-dilutive effect.
6
<PAGE> 9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
OVERVIEW
The Company provides hospitals and surgery centers with a
comprehensive surgical procedure-based delivery and retrieval service
for reusable gowns, towels, drapes, and basins and provides other
disposable products necessary for surgery. At nine regional
facilities, the Company collects, sorts, cleans, inspects, packages,
sterilizes, and delivers its reusable products on a just-in-time
basis. The Company offers an integrated "closed-loop" reprocessing
service that uses two of the most technologically advanced reusable
textiles: (i) a GORE(R) Surgical Barrier Fabric for gowns and drapes
that is breathable yet liquidproof and provides a viral/bacterial
barrier and (ii) an advanced microfiber polyester surgical fabric for
gowns and drapes that is liquid and bacterial resistant. The Company
believes that its reusable surgical products made from these fabrics
provide protection and comfort that are superior to disposable
alternatives.
The Company's two new reprocessing facilities that are under
construction in Stockton, California and Chattanooga, Tennessee are on
schedule to open in the third quarter of 1999. These new facilities
will serve a portion of the customers currently serviced by the Long
Beach, California and Raleigh, North Carolina facilities, which will
increase available capacity in those facilities.
The Company purchased RePak Surgical Enterprises, Inc. on
August 31, 1998 and the NPAC division of National Service Industries
on February 26, 1999. RePak's results of operations are included for
the Company's entire first quarter of 1999 and NPAC's results are
included for March 1999.
RESULTS OF OPERATIONS
The following table sets forth for the periods shown the
percentage of revenues represented by certain items reflected in the
condensed consolidated statements of earnings of the Company.
<TABLE>
<CAPTION>
Three Months Ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Revenues 100.0% 100.0%
Cost of revenues 67.4 65.9
----- -----
Gross profit 32.6 34.1
Distribution expense 7.4 7.6
Selling and administrative expenses 13.3 14.4
----- -----
Income from operations 11.9 12.1
Interest expense (income),net 0.4 0.0
----- -----
Income before income taxes 11.5 12.1
Income tax expense 4.4 4.7
----- -----
Net income 7.1% 7.4%
===== =====
</TABLE>
GORE(R) Surgical Barrier Fabric is a registered trademark of W.L. Gore &
Associates, Inc.
7
<PAGE> 10
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
REVENUES. The Company's revenues increased $5.3 million, or
45.4%, to $17.1 million in the first quarter of 1999 from $11.7
million in the first quarter of 1998. The revenue increases were
attributable in roughly equal amounts to new customers, increased
revenues from current customers, and added revenues from the RePak and
NPAC acquisitions.
GROSS PROFIT. Gross profit increased $1.6 million, or 39.1%,
to $5.6 million in the first quarter of 1999 from $4.0 million in the
first quarter of 1998. The Company continues to benefit from labor
efficiencies in the pack room and the economies of scale associated
with spreading fixed costs over more revenues. These benefits were
partially offset by higher amortization and shrinkage expense of
reusable surgical products. As a percentage of revenues, gross profit
decreased to 32.6% in the first quarter of 1999, compared to 34.1% in
the first quarter of 1998, because of higher amortization and
shrinkage expense.
DISTRIBUTION EXPENSES. Distribution expenses increased
$379,000, or 42.7%, to $1.3 million in the first quarter of 1999 from
$887,000 in the first quarter of 1998. Distribution expenses as a
percentage of revenues decreased by 0.2% to 7.4% in the first quarter
of 1999 from 7.6% in the first quarter of 1998. The improvement in
distribution expenses as a percentage of revenues resulted primarily
from efficiencies derived from delivering more volume over existing
routes and from adding routes and equipment at a slower pace than
revenue growth.
SELLING AND ADMINISTRATIVE EXPENSES. Selling and
administrative expenses increased $570,000, or 33.6%, to $2.3 million
in the first quarter of 1999, from $1.7 million in the first quarter
of 1998. As a percentage of revenues, selling and administrative
expenses decreased by 1.1% to 13.3% during the first quarter of 1999
from 14.4% during the first quarter of 1998. Expenses increased in
support of increased revenues and the acquisition of RePak. The
decline in selling and administrative expenses as a percentage of
revenues resulted primarily from the increases in revenues.
INCOME FROM OPERATIONS. Income from operations increased
$613,000, or 43.4%, to $2.0 million in the first quarter of 1999, from
$1.4 million in the first quarter of 1998. Income from operations as a
percentage of revenues decreased 0.2% to 11.9% in the first quarter of
1999, from 12.1% in the first quarter of 1998.
INTEREST EXPENSE (INCOME), NET. Interest income changed from
$7,000 in the first quarter of 1998 to interest expense of $65,000 in
the first quarter of 1999, due to higher borrowings under the
Company's revolving credit facility.
INCOME TAX EXPENSE. Income tax expense increased $202,000 to
$756,000 in the first quarter of 1999, compared to $554,000 in the
first quarter of 1998. The Company's effective tax rate decreased to
38.5% in the first quarter of 1999, compared to 39.0% in the first
quarter of 1998.
NET INCOME PER SHARE. The Company recorded a net income per
share of $0.20 on a basic per share basis and $0.19 on a diluted per
share basis for the first quarter of 1999, compared with $0.15 basic
and diluted per share net income in the first quarter of 1998.
8
<PAGE> 11
LIQUIDITY AND CAPITAL RESOURCES
The Company's positive cash flow from operating activities
was $2.8 million during the first three months of 1999, compared to
$2.7 million during the first three months of 1998. The increase in
cash flows from operating activities resulted primarily from increased
net income before amortization, shrinkage, and depreciation expense.
The Company's positive cash flow from operating activities exceeded
the required purchases of reusable surgical products during the first
quarter of 1999.
The Company used approximately $2.2 million more net cash in
investing activities in the first three months of 1999 than in the
first three months of 1998. The Company has made capital expenditures
in the first three months of 1999 for equipment and computers of
$782,000 and for reusable surgical products of $1.7 million compared
to $630,000 for equipment and computers, and $2.0 million for reusable
surgical products during the first three months of 1998. The Company
also paid reimbursable construction costs of $1.7 million in the three
month period ended March 31, 1999. These expenditures were funded
primarily by cash provided by operating activities and the balance
from borrowings under the Company's revolving credit facility.
The Company continues to invest in more reusable surgical
products, primarily to support anticipated increases in business. The
Company's business is capital intensive and will require substantial
capital expenditures for additional surgical products and equipment
during the next several years to achieve its operating and expansion
plans. To adequately service a new customer, the Company estimates
that it makes an investment in new reusable surgical products and
carts equal to approximately 50% of the projected first year revenue
from the customer. The Company estimates capital expenditures for new
carts and reusable surgical products will be approximately $800,000
per month for the next 12 months, although the amount will fluctuate
with the growth of its business. The Company also expects to make
additional expenditures of approximately $4.0 million during the last
three quarters of 1999 for equipment upgrades and maintenance to
increase the aggregate capacity of its facilities, including
approximately $3.0 million to expand and equip its Cincinnati, Ohio
facility. The Company spent $400,000 in the first quarter of 1999 for
new technology software and related hardware and expects to spend
$300,000 more during the rest of 1999. The Company expects to fund
these expenditures primarily by cash provided by operating activities
and borrowings under its revolving credit facility.
The Company had approximately $5.8 million outstanding at
March 31, 1999 under its $15.0 million revolving credit facility with
First Union National Bank. This facility is secured by substantially
all of the Company's assets and has a maturity date of February 28,
2002. The facility's interest rate varies between 100 and 150 basis
points over LIBOR (4.94% as of March 31, 1999), depending on the
Company's leverage. The amendments require the Company to maintain (a)
consolidated net worth of $34.9 million plus 75% of cumulative
consolidated net income for each fiscal quarter occurring after
February 24, 1999; (b) a consolidated leverage ratio of not more than
2.5 to 1.0; and (c) a fixed charge coverage ratio of not less than 2.8
to 1.0. The facility restricts the Company's payment of dividends,
acquisition transactions, additional indebtedness, and encumbering of
assets.
As of February 1, 1999, the Company secured a $10.0 million
lease financing arrangement to finance land, building, and equipment
for its two new reprocessing facilities in Stockton, California and
Chattanooga, Tennessee, each estimated to cost approximately $5.0
million. The lease financing margins are substantially the same as
under the Company's credit facility. Under the arrangement, a lessor
purchases land, reimburses the Company for the facility's construction
and
9
<PAGE> 12
equipment costs, and leases the completed facility to the Company for
three years. The Company guarantees all lease payments and a
substantial residual value for the facility when the lease term ends.
The lease agreement includes a purchase option for the Company at the
original cost of the leased facility. The Company will account for
these leases as operating leases. The Company anticipates that it will
occupy these new facilities and begin making lease payments for them
in the third quarter of 1999.
As of March 31, 1999, the Company had cash of approximately
$343,000. The Company believes this current cash balance, combined
with its cash flow from operating activities and funds available under
its credit facility, will be sufficient to fund its growth and
anticipated capital requirements for the next twelve months. The
Company expects to fund additional capital expenditures from a
combination of internal cash flow, its credit facility, and other
capital sources.
YEAR 2000 COMPLIANCE
The Company has developed and is implementing a comprehensive
program to address year 2000 issues for its information technology and
non-information technology systems. The program consists of
identification, compliance, and post-implementation phases, and
considers the effects of the year 2000 on the Company's internal
systems, customers, products, and services, as well as its effects on
suppliers and other critical business partners.
The Company is replacing its financial and operational
systems with enterprise-wide software that is year 2000 compliant. The
Company will incur staff, consulting, and other expenses to prepare
its computer systems and applications for this implementation. The
Company does not expect year 2000 related expense will materially
impact its financial position. The Company had spent $1.5 million for
this software implementation project through March 31, 1999, and
estimates that it will spend an additional $300,000 for this project
by its estimated completion time of the third quarter end.
The Company has also distributed questionnaires and scheduled
follow-up meetings with critical suppliers and other business partners
to determine the extent that year 2000 issues affecting these third
parties might affect the Company. The Company cannot be assured that
these parties will achieve timely year 2000 compliance, and their
failure to achieve timely compliance could have a material adverse
affect on the Company.
The Company cannot at this time quantify the potential
adverse effects of year 2000 non-compliance, or plan for worst case
scenarios. As it completes its year 2000 project during the third
quarter of 1999, the Company will develop contingency plans and
implement them if necessary. There can be no assurances that these
contingency plans will address the Company's risk of year 2000
non-compliance, and significant interruption in its business due to
year 2000 non-compliance could materially adversely affect the
Company.
10
<PAGE> 13
CERTAIN CONSIDERATIONS
This report, other documents that are publicly disseminated
by the Company, and oral statements that are made on behalf of the
Company contain or might contain both statements of historical fact
and forward-looking statements. Examples of forward-looking statements
include: (a) projections of revenue, earnings, capital structure, and
other financial items, (b) statements of the plans and objectives of
the Company and its management, (c) statements of future economic
performance, and (d) assumptions underlying statements regarding the
Company or its business. The cautionary statements set forth below
discuss important factors that could cause actual results to differ
materially from any forward-looking statements.
SALES PROCESS AND MARKET ACCEPTANCE OF PRODUCTS AND SERVICES.
The Company's future performance depends on its ability to increase
revenues to new and existing customers. The Company's sales process
for new customers is typically between six and twelve months in
duration from initial contact to purchase commitment. The extended
sales process is typically due to the complicated approval process
within hospitals for purchases from new suppliers, the long duration
of existing supply contracts, and implementation delays pending
termination of a hospital's previous supply relationships. The long
sales process inhibits the ability of the Company to quickly increase
revenues from new and existing customers or enter new markets. The
Company's future performance will also depend on market acceptance of
its combination of reusable surgical products, disposable accessory
packs, and direct delivery and retrieval service. The Company's market
is now dominated by disposable products, and the Company's primary
strategic emphasis on reusable surgical products and reprocessing
services requires its customers to change their customary purchasing
patterns. There is no assurance that a significant portion of the
market will shift from disposable products to the Company's reusable
surgical products and reprocessing services. The Company's inability
to gain wider market acceptance of its reusable products and
reprocessing services would have a material adverse effect on the
Company's operating and expansion plans.
NEED FOR CAPITAL. The Company's business is capital intensive
and will require substantial capital expenditures for additional
surgical products and equipment during the next several years to
achieve its operating and expansion plans. In the longer term, the
Company expects that its needs for capital expenditures will be
substantial and will depend on its growth and opportunities. The
Company's inability to obtain adequate capital could have a material
adverse effect on the Company. See -- "Liquidity and Capital
Resources."
DEPENDENCE ON A SIGNIFICANT CUSTOMER AND MARKET
CONSOLIDATION. During the first quarter of 1999, Columbia/HCA
Healthcare Corporation ("Columbia") hospitals, with which the Company
currently does business, accounted for approximately 11% of the
Company's revenues, compared to 15% in the first quarter of 1998.
Although each Columbia hospital currently makes its purchasing
decisions on an individual basis, and no single hospital accounted for
more than 3% of the Company's revenues, the Company believes the
executive management of Columbia has the ability to influence the
selection of particular vendors. The loss of a substantial portion of
the Columbia hospitals' business would have a material adverse effect
on the Company. Additionally, hospitals are increasingly buying
products and services in groups to improve efficiency and lower costs.
Although the Company is increasingly targeting these groups for its
sales efforts, a change of its customers' purchasing patterns could
have a material adverse effect on the Company.
11
<PAGE> 14
COMPETITION. The Company's business is highly competitive.
The Company's competitors include a number of distributors and
manufacturers, as well as the in-house reprocessing operations of
hospitals. Certain of the Company's existing and potential competitors
possess substantially greater resources than the Company, and the
Company's market is dominated by their disposable products. Some of
the Company's competitors, including the Convertors division of
Allegiance Corporation, serve as the sole supplier of a wide
assortment of products to a significant number of hospitals. The
Company does not provide an array of products as complete as those
provided by some of its competitors, which in some instances is a
competitive disadvantage. There is no assurance that the Company will
be able to compete effectively with existing or potential competitors.
DEPENDENCE ON KEY EXECUTIVES. The Company is largely
dependent upon the management expertise and experience of Richard T.
Isel, Bertram T. Martin, Jr., Wayne R. Peterson, and James T.
Boosales, its principal officers. The loss of the services of one or
more of these key executives could have a material adverse effect on
the Company.
INCREASED REPLACEMENT AND AMORTIZATION COSTS. The Company
acquired its equipment and surgical products at a cost substantially
below both their original cost and current replacement cost, which has
resulted in lower depreciation, amortization, and shrinkage expense
for those assets since the Amsco Sterile Acquisition, as compared to
the expenses incurred by Amsco Sterile. Since the Amsco Sterile
Acquisition, the Company has purchased equipment and surgical products
at current replacement cost, resulting in increased depreciation,
amortization, and shrinkage expense. The Company amortizes its
reusable surgical products on a per use basis. If the products' actual
number of uses proves to be shorter than the Company's current
estimates, the Company's annual product amortization expense would
increase, which would adversely affect its profitability. The amount
of shrinkage (loss and scrap of reusable surgical products)
experienced by the Company is influenced by a variety of factors
including the customers' surgical product rotation and operating room
control procedures, the Company's internal tracking of reusable
surgical products through bar coding and the Company's increased use
of standardized surgical packs.
RECENT ACQUISITIONS AND IMPLEMENTATION OF ACQUISITION
STRATEGY. The Company acquired RePak Surgical Enterprises, Inc., a
surgical products reprocessing company located in the Cincinnati, Ohio
area, on August 31, 1998, and NPAC, the reusable surgical product
business of the textile rental segment of National Service Industries,
Inc., on February 26, 1999. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Overview". The
Company might make other acquisitions in the future. Acquisitions
involve risks to the Company, including (a) diversion of management's
attention to identifying and negotiating the acquisitions and
integrating the acquired businesses; (b) costs incurred in integrating
the acquired company's financial, operating, and other systems; (c)
unforeseen liabilities or operating difficulties of the acquired
businesses; (d) the adverse earnings impact of amortizing goodwill and
other acquired intangible assets; and (e) the potentially dilutive
effect on per share earnings of any new issuance of equity securities
to the seller.
NEW FACILITIES. The Company is constructing two new
reprocessing facilities in Stockton, California and Chattanooga,
Tennessee. These new facilities will serve a portion of the customers
currently serviced by Long Beach, California and Raleigh, North
Carolina, which should increase available capacity in those
facilities. The Company might in the future construct other new
facilities. This expansion program involves risks that could
materially adversely affect the Company, including (a) diversion of
management's attention;
12
<PAGE> 15
(b) unforeseen costs or delays in construction; (c) customers lost in
their transition to new facilities; (d) unanticipated (although
non-recurring) start-up expenses; and (e) unforeseen operating
difficulties of the facilities.
GOVERNMENT REGULATION. Significant aspects of the Company's
businesses are subject to state and federal statutes and regulations
governing, among other things, medical waste-disposal and workplace
health and safety. In addition, most of the products furnished or sold
by the Company are subject to regulation as medical devices by the
U.S. Food and Drug Administration (FDA), as well as by other federal
and state agencies. The FDA has the power to enjoin future violations,
seize adulterated or misbranded devices, and require the manufacturer
to remove them from the market. The Company's facilities have been
subject to regular inspections by FDA officials and the Company has
received warning letters regarding its compliance with the FDA's
Current Good Manufacturing Practices. The Company has either
adequately addressed these concerns or is actively working with the
FDA to resolve these issues. There can be no assurance that federal or
state governments will not impose additional restrictions or adopt
interpretations of existing laws that could materially adversely
affect the Company's business, results of operations, or financial
conditions.
13
<PAGE> 16
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Neither the Company nor any of its property is subject to any
litigation or other legal proceeding that is expected to have a
material effect on the Company or its business.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
EXHIBITS
27 - Financial Data Schedule (for SEC use only).
REPORTS ON FORM 8-K
On April 5, 1999, the Company filed a current report on Form 8-K
to report a change in its certifying accountants.
14
<PAGE> 17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act
of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
STERILE RECOVERIES, INC.
Date: May 13, 1999 By: /s/ James T. Boosales
-----------------------------------------
James T. Boosales
Executive Vice President and
Chief Financial Officer
15
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