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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 JUNE 30, 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
------- ----------
(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
August 4, 1999:
Common Stock, par value $.001 - 5,676,794
<PAGE> 2
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements
Condensed Consolidated Statements of
Earnings for the three months and six
months ended June 30, 1999 (unaudited) and
the three months and six months ended June
30, 1998 (unaudited)............................................... 1
Condensed Consolidated Balance Sheets as of
June 30, 1999 (unaudited) and December 31, 1998.................... 2
Condensed Consolidated Statements of Cash
Flows for the six months ended June 30,
1999 and June 30, 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 Six Months Ended
June 30, June 30,
1999 1998 1999 1998
------- -------- ------- --------
<S> <C> <C> <C> <C>
Revenues $17,170 $ 12,283 $34,228 $ 24,015
Cost of revenues 11,396 8,134 22,894 15,868
------- -------- ------- --------
Gross profit 5,774 4,149 11,334 8,147
Distribution expenses 1,292 859 2,558 1,746
Selling and administrative expenses 2,349 1,768 4,616 3,465
------- -------- ------- --------
Income from operations 2,133 1,522 4,160 2,936
Interest expense (income), net 78 (5) 143 (12)
------- -------- ------- --------
Income before income tax expense 2,055 1,527 4,017 2,948
Income tax expense 795 595 1,551 1,150
------- -------- ------- --------
Net income $ 1,260 $ 932 $ 2,466 $ 1,798
======= ======== ======= ========
Dividends on preferred stock 51 -- 106 --
------- -------- ------- --------
Net income available for common
shareholders $ 1,209 $ 932 $ 2,360 $ 1,798
======= ======== ======= ========
Net income per common share - basic $ 0.21 $ 0.16 $ 0.42 $ 0.32
======= ======== ======= ========
Net income per common share - diluted $ 0.20 $ 0.16 $ 0.39 $ 0.31
======= ======== ======= ========
Weighted average common shares
outstanding - basic 5,677 5,660 5,676 5,660
======= ======== ======= ========
Weighted average common shares
outstanding - diluted 6,335 5,902 6,337 5,879
======= ======== ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements
1
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STERILE RECOVERIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
June 30, Dec. 31,
1999 1998
----------- -------
(unaudited)
<S> <C> <C>
ASSETS
Cash $ 81 $ 172
Accounts receivable, net 8,733 7,580
Reimbursable construction costs 3,042 331
Inventories 2,572 2,324
Prepaid expenses and other assets 752 1,339
Reusable surgical products, net 14,971 14,705
Property, plant and equipment, net 12,884 12,042
Goodwill, net 5,679 5,127
------- -------
Total assets $48,714 $43,620
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Note payable to bank $ 5,350 $ 3,698
Accounts payable 3,279 2,898
Employee related accrued expenses 1,382 974
Other accrued expenses 986 786
Deferred tax liability 142 142
------- -------
Total liabilities 11,139 8,498
Shareholders' equity
Preferred stock 1 1
Common stock 6 6
Additional paid-in capital 27,414 27,321
Retained earnings 10,154 7,794
------- -------
Total shareholders' equity 37,575 35,122
------- -------
Total liabilities and shareholders' equity $48,714 $43,620
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements
2
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STERILE RECOVERIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30, June 30,
1999 1998
------- -------
<S> <C> <C>
Cash flows from operating activities
Net income $ 2,466 $ 1,798
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 767 415
Amortization of reusable surgical products 1,965 1,364
Provision for reusable surgical products shrinkage 944 584
Change in assets and liabilities (net of business combination):
Accounts receivable (1,004) (270)
Inventories (248) 25
Prepaid expenses and other assets 587 651
Accounts payable 420 172
Other accrued expenses 636 (41)
------- -------
Net cash provided by operating activities 6,533 4,698
------- -------
Cash flows from investing activities
Purchases of property, plant and equipment (1,690) (1,225)
Purchases of reusable surgical products (3,172) (3,802)
Reimbursable construction costs (2,712) --
Payment for acquisition of business, net of cash
acquired (641) --
------- -------
Net cash used in investing activities (8,215) (5,027)
------- -------
Cash flows from financing activities
Net change in note payable to bank 1,651 --
Net proceeds from issuance of common stock 93 9
Dividends paid (153) --
------- -------
Net cash provided by financing activities 1,591 9
------- -------
Decrease in cash (91) (320)
Cash and cash equivalents at beginning of period 172 380
------- -------
Cash and cash equivalents at end of period $ 81 $ 60
======= =======
Supplemental cash flow information
Cash paid for interest $ 134 $ 19
======= =======
Cash paid for income taxes $ 1,304 $ 1,151
======= =======
</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 six months ended June 30, 1999 are
not necessarily indicative of the results that can be expected for the entire
year ending December 31, 1999. The unaudited financial statements should be
read in conjunction with the financial statements and the notes thereto
included in the Form 10-K.
The Company operates on a 52-53 week fiscal year ending the Sunday
nearest December 31. There are 27 weeks and 26 weeks included for the six month
periods ended June 30, 1999 and June 30, 1998, respectively.
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 since
the date of acquisition.
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 Six Months Ended
June 30,1998 June 30, 1998
---------- --------
(In thousands,
except per share data)
(unaudited)
<S> <C> <C>
Revenues $ 14,557 $28,396
========= =======
Net income $ 1,122 $ 2,108
========= =======
Net income available for common
shareholders $ 1,071 $ 2,002
========= =======
Net income per common share, basic $ 0.19 $ 0.36
========= =======
Net income per common share, diluted $ 0.17 $ 0.33
========= =======
</TABLE>
4
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This pro forma financial information does not necessarily reflect the
Company's actual operating results if the transaction had been effective during
the periods shown and does not necessarily reflect future results.
On February 26, 1999, the Company acquired 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 property, plant and equipment for cash
consideration of approximately $641,000, of which $483,000 has been allocated
to goodwill. Goodwill is amortized over 30 years. The Company has accounted for
the acquisition as a purchase and NPAC's operating results are included in the
Company's operating results since the date of acquisition. Pro forma results
are not material and therefore are not presented.
3. LINE OF CREDIT
The Company had approximately $5.4 million outstanding at June 30,
1999 under its $15.0 million revolving credit facility with First Union
National Bank. This credit facility is secured by substantially all of the
Company's assets and has a maturity date of February 28, 2002. The credit
facility's interest rate varies between 100 and 150 basis points over LIBOR
(5.24% as of June 30, 1999), depending on the Company's leverage. The credit
facility requires 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 credit 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 approximately $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 $3.0 million
as of June 30, 1999. The lease payment and purchase option amounts will be
ascertained in the third quarter of 1999, after completion of construction.
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>
Three Months Six Months
Ended June 30, Ended June 30,
1999 1998 1999 1998
------- ------ ------- ------
(In thousands, except
per share data)
(Unaudited)
<S> <C> <C> <C> <C>
BASIC
Numerator:
Net income $ 1,260 $ 932 $ 2,466 $1,798
Less effect of dividends of
preferred stock (51) -- (106) --
------- ------ ------- ------
Net income available to
common shareholders $ 1,209 $ 932 $ 2,360 $1,798
======= ====== ======= ======
Denominator:
Weighted average shares
outstanding 5,677 5,660 5,676 5,660
======= ====== ======= ======
Net income per common share
- basic $ 0.21 $ 0.16 $ 0.42 $ 0.32
======= ====== ======= ======
DILUTED
Numerator:
Net income $ 1,260 $ 932 $ 2,466 $1,798
======= ====== ======= ======
Denominator:
Weighted average shares
outstanding 5,677 5,660 5,676 5,660
Effect of dilutive securities:
Employee stock options 91 242 94 219
Convertible preferred stock 567 -- 567 --
------- ------ ------- ------
6,335 5,902 6,337 5,879
======= ====== ======= ======
Net income per common share
- diluted $ 0.20 $ 0.16 $ 0.39 $ 0.31
======= ====== ======= ======
</TABLE>
Options to purchase 506,000 and 2,000 shares of common stock for the
three month periods ended June 30, 1999 and June 30, 1998, respectively, and
options to purchase 506,000 and 255,000 shares of common stock for the six
month periods ended June 30, 1999 and June 30, 1998, respectively, were not
included for all or a portion of the computation of diluted net income per
common share because the options' exercise prices were greater than the average
market price of the common shares on June 30, 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 and NPAC's results of operations are included in the Company's results
of operations since the date of acquisition.
RESULTS OF EARNINGS
The following table sets forth for the periods shown the percentage of
revenues represented by certain items reflected in the statement of earnings of
the Company.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
----- ----- ----- -----
(In thousands, except
per share data)
(Unaudited)
<S> <C> <C> <C> <C>
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 66.4 66.2 66.9 66.1
----- ----- ----- -----
Gross profit 33.6 33.8 33.1 33.9
Distribution expenses 7.5 7.0 7.4 7.3
Selling and administrative expenses 13.7 14.4 13.5 14.4
----- ----- ----- -----
Income from operations 12.4 12.4 12.2 12.2
Interest expense (income),net .4 0 .5 (0.1)
----- ----- ----- -----
Income before income taxes 12.0 12.4 11.7 12.3
Income tax expense 4.7 4.8 4.5 4.8
----- ----- ----- -----
Net income 7.3% 7.6% 7.2% 7.5%
===== ===== ===== =====
</TABLE>
GORE(R) Surgical Barrier Fabric is a registered trademark of W.L. Gore &
Associates, Inc.
7
<PAGE> 10
THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE MONTHS ENDED JUNE 30, 1998
REVENUES. The Company's revenues increased $4.9 million, or 39.8%, to
$17.2 million in the three months ended June 30, 1999, from $12.3 million in
the three months ended June 30, 1998. In the six months ended June 30, 1999,
the Company's revenues increased $10.2 million, or 42.5%, to $34.2 million,
from $24.0 million in the six months ended June 30, 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 39.2%, to $5.8
million in the three months ended June 30, 1999 from $4.1 million in the three
months ended June 30, 1998; and $3.2 million, or 39.1%, to $11.3 million in the
six months ended June 30, 1999, from $8.1 million in the six months ended June
30, 1998. The Company continues to benefit from labor efficiencies in the pack
room. These benefits were partially offset by higher amortization and shrinkage
expense of reusable surgical products. Gross profit as a percentage of revenues
decreased by 0.2% to 33.6% in the three months ended June 30, 1999, from 33.8%
in the three months ended June 30, 1998; and decreased 0.8% to 33.1% in the six
months ended June 30, 1999, from 33.9% in the six months ended June 30, 1998,
because of higher amortization and shrinkage expense.
DISTRIBUTION EXPENSES. Distribution expenses increased $433,000, or
50.4%, to $1.3 million in the three months ended June 30, 1999, from $859,000
in the three months ended June 30, 1998; and $812,000, or 46.5%, to $2.6
million in the six months ended June 30, 1999, from $1.7 million in the six
months ended June 30, 1998. Distribution expenses as a percentage of revenues
increased by 0.5% to 7.5% in the three months ended June 30, 1999 from 7.0% in
the three months ended June 30, 1998; and increased 0.1% to 7.4% in the six
months ended June 30, 1999, from 7.3% in the six months ended June 30, 1998.
Distribution expense increased due to the addition of new truck routes to new
customers as the Company continues to expand its geographic reach.
SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative
expenses increased $581,000, or 32.9%, to $2.3 million in the three months
ended June 30, 1999, from $1.8 million in the three months ended June 30, 1998;
and increased $1.2 million, or 33.2%, to $4.6 million in the six months ended
June 30, 1999, from $3.5 million in the six months ended June 30, 1998. As a
percentage of revenues, selling and administrative expenses decreased 0.7% to
13.7% in the three months ended June 30, 1999 from 14.4% in the three months
ended June 30, 1998; and decreased 0.9% to 13.5% in the six months ended June
30, 1999, from 14.4% in the six months ended June 30, 1998. The decline in
selling and administrative expenses as a percentage of revenues resulted
primarily from leverage due to increases in revenues.
INCOME FROM OPERATIONS. Income from operations increased $611,000, or
40.1%, to $2.1 million in the three months ended June 30, 1999, from $1.5
million in the three months ended June 30, 1998; and increased $1.2 million, or
41.7%, to $4.2 million in the six months ended June 30, 1999, from $2.9 million
in the six months ended June 30, 1998. Income from operations as a percentage
of revenues remained the same at 12.4% and 12.2% for the three and six month
periods ended June 30, 1999 compared to the three and six month periods ended
June 30, 1998, respectively.
8
<PAGE> 11
INTEREST EXPENSE (INCOME), NET. Interest income changed from $5,000 in
the three months ended June 30, 1998, to interest expense of $78,000 in the
three months ended June 30, 1999, and from interest income of $12,000 in the
six months ended June 30, 1998 to interest expense of $143,000 in the six
months ended June 30, 1999, due to higher borrowings under the Company's
revolving credit facility.
INCOME TAX EXPENSE. Income tax expense increased $200,000 to $795,000
in the three months ended June 30, 1999, compared to $595,000 in the three
months ended June 30, 1998; and increased $401,000 to $1.6 million in the six
months ended June 30, 1999, compared to $1.2 million in the six months ended
June 30, 1998. The Company's effective tax rate is 39.0%.
NET INCOME PER SHARE. The Company's net income per share is $0.21 on a
basic per share basis and $0.20 on a diluted per share basis for the three
months ended June 30, 1999, compared with $0.16 basic and diluted per share net
income for the three months ended June 30, 1998; and net income per share of
$0.42 on a basic per share basis and $0.39 on a diluted per share basis for the
six months ended June 30, 1999, compared with a net income per share of $0.32
on a basic per share basis and $0.31 on a diluted per share basis for the six
months ended June 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's positive cash flow from operating activities was $6.5
million during the six months ended June 30, 1999, compared to $4.7 million
during the six months ended June 30, 1998. The increase in cash flows from
operating activities resulted primarily from increased net income before
amortization, shrinkage, and depreciation expense, partially offset by an
increase in accounts receivable. The Company's positive cash flow from
operating activities exceeded its purchases of reusable surgical products
during the six months ended June 30, 1999.
The Company used approximately $3.2 million more net cash in investing
activities in the six months ended June 30, 1999 than in the six months ended
June 30, 1998. The Company has made capital expenditures in the six months
ended June 30, 1999 for equipment and computers of $1.7 million and for
reusable surgical products of $3.2 million compared to $1.2 million for
equipment and $3.8 million for reusable surgical products during the six months
ended June 30, 1998. 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 45% of the projected first
year revenue from the customer. The Company estimates capital expenditures for
new carts and reusable surgical products will be approximately $1.0 million 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 two quarters of 1999
and the first quarter of 2000 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
$700,000 in the six months ended
9
<PAGE> 12
June 30, 1999 for new technology software and related hardware and expects to
spend $200,000 more during the balance of 1999, which the Company expects will
substantially complete its current upgrade of its management information
systems. See "Year 2000 Compliance" below. The Company expects to fund these
expenditures primarily from cash provided by operating activities and
borrowings under its revolving credit facility.
The Company had approximately $5.4 million outstanding at June 30,
1999 under its $15.0 million revolving credit facility with First Union
National Bank. This credit facility is secured by substantially all of the
Company's assets and has a maturity date of February 28, 2002. The credit
facility's interest rate varies between 100 and 150 basis points over LIBOR
(5.24% as of June 30, 1999), depending on the Company's leverage. The credit
facility requires 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 credit 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 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. The lease
payment and purchase option amounts will be ascertained in the third quarter of
1999, after completion of construction.
As of June 30, 1999, the Company had cash of approximately $81,000.
The Company believes this current cash balance, combined with its cash flows
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 flows, 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 in the process of replacing its financial and
operational systems with enterprise-wide software that is year 2000 compliant.
The Company has and will continue to incur staff, consulting, and other
expenses to prepare its computer systems and applications for this
implementation, which the Company expects will not materially adversely affect
its financial position. The Company had spent $1.9 million for this software
implementation project through June 30,
10
<PAGE> 13
1999, and estimates that it will spend an additional $200,000 for this project
by its estimated completion time of the end of October 1999.
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. These parties' timely year 2000 compliance is beyond the
Company's control, 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.
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.
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<PAGE> 14
The Company's inability to obtain adequate capital could have a material
adverse effect on the Company. See -- "Liquidity and Capital Resources."
DEPENDENCE ON SIGNIFICANT CUSTOMERS AND MARKET CONSOLIDATION. During
the second quarter of 1999, Columbia/HCA Healthcare Corporation ("Columbia")
and Premier, Inc. ("Premier") hospitals, with which the Company currently does
business, accounted for approximately 13% and 20% of the Company's revenues
respectively, compared to 15.4% and 22.0% respectively in the second quarter of
1998. Although each Columbia and Premier 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
managements of Columbia and Premier have the ability to influence the selection
of particular vendors. The loss of a substantial portion of the Columbia or
Premier 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.
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
Acquisition, as compared to the expenses incurred by Amsco Sterile. Since the
Acquisition, the Company has purchased equipment and surgical products at
current replacement cost, resulting in increased depreciation, amortization,
and shrinkage expense. SRI amortizes its reusable surgical products on a per
use basis. If the products' actual number of uses proves to be shorter than
SRI'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.
12
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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; (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 Company's facilities are
subject to regular inspections by FDA officials. The FDA has the power to
enjoin future violations, seize adulterated or misbranded devices, require the
manufacturer to remove products from the market, and publicize relevant facts.
Federal or state governments might impose additional restrictions or adopt
interpretations of existing laws that could materially adversely affect the
Company.
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<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
At the annual meeting of the Company's shareholders on May 19, 1999,
the shareholders voted on a proposal to elect Richard T. Isel and James M.
Emanuel as directors of the Company to serve until the 2002 annual meeting. The
holders of the Company's Common Stock and Series A Preferred Stock vote
together as a class in the election of directors. The following sets forth the
votes in this election:
<TABLE>
<CAPTION>
Votes For
Series A Votes Against
Director Common Preferred or Withheld
-------- ------ --------- -------------
<S> <C> <C> <C>
Richard T. Isel 5,149,559 566,667 25,200
James M. Emanuel 5,169,559 566,667 5,200
</TABLE>
Bertram T. Martin, Jr., James T. Boosales, Wayne R. Peterson, Lee R.
Kemberling, and Gary Heiman continue to serve as directors. The shareholders
also approved the appointment of Ernst & Young LLP as the Company's independent
certified public accountants.
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: August 12, 1999 By: /s/ James T. Boosales
------------------------------------
James T. Boosales
Executive Vice President and
Chief Financial Officer
15
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