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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
COMMISSION FILE NO. 000-20997
STERILE RECOVERIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Florida 59-3252632
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(State of Incorporation) (IRS Employer Identification No.)
28100 U.S. HIGHWAY 19 NORTH, SUITE 201, CLEARWATER, FLORIDA 34621
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(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (813) 726-4421
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.001 - 5,521,189
Indicate by check mark 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
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 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 information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant, based upon the closing sale price of the Common Stock on
February 25, 1997, as reported on the Nasdaq National Market, was approximately
$64,082,417. Shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The Registrant had outstanding 5,652,894 shares of Common Stock as of
February 25, 1997.
__________________________
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Proxy Statement for the 1997 Annual Meeting of Shareholders to
be held on April 30, 1997 is incorporated by reference in Part III of this
report to the extent stated herein.
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STERILE RECOVERIES, INC.
FORM 10-K
YEAR ENDED DECEMBER 31, 1996
Section Page
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PART I
Item 1: Business 1
Item 2: Properties 9
Item 3: Legal Proceedings 10
Item 4: Submission of Matters to a Vote of Security Holders 10
PART II
Item 5: Market for the Registrant's Common Equity and Related
Shareholder Matters 11
Item 6: Selected Financial Data 12
Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 8: Financial Statements and Supplementary Data 22
Item 9: Changes In and Disagreements With Accountants On
Accounting and Financial Disclosure 51
PART III
Item 10: Directors and Executive Officers of the Registrant 51
Item 11: Executive Compensation 51
Item 12: Security Ownership of Certain Beneficial Owners
and Management 51
Item 13: Certain Relationships and Related Transactions 51
PART IV
Item 14: Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 51
SIGNATURES 55
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PART I
ITEM 1. BUSINESS
Sterile Recoveries, Inc. ("SRI" or the "Company") provides hospitals
and surgery centers with a comprehensive surgical procedure-based daily
delivery service. The foundations of this service are SRI's reusable surgical
products including gowns, towels, drapes and basins, and its daily delivery and
retrieval of these products for each customer. The Company complements its
reusable products with cost-effective disposable accessory packs to provide a
comprehensive offering for surgical procedures. SRI believes its superior
quality reusable products and its service solutions, including direct delivery
to its customers' departments, differentiate SRI from its competitors. These
solutions enable SRI's customers to outsource to SRI costly and burdensome
processes.
At seven regional facilities, SRI collects, sorts, cleans, inspects,
packages, sterilizes, and delivers its reusable products on a just-in-time
basis. SRI offers an integrated "closed-loop" reprocessing service which 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 which is liquid and bacterial
resistant.
The Company currently serves a growing customer base of over 260
hospitals and surgery centers located in 18 states, including Duke University
Medical Center (Durham), Henry Ford Hospital (Detroit), Johns Hopkins Medical
Center (Baltimore), St. Luke's Episcopal Hospital (Houston), Jackson Memorial
Hospital (Miami), IHC Hospitals, Inc. (Salt Lake City), and Hospital of the
Good Samaritan (Los Angeles). None of the foregoing customers individually
accounts for a material portion of the Company's revenues.
The Company believes that its reusable surgical product delivery and
retrieval service is a superior and competitively priced alternative to
disposable surgical products or to operating an in-house reusable program for
surgical products. The Company's delivery service offers savings to hospitals
by reducing the costs associated with: (i) the disposal of biohazardous wastes,
(ii) carrying an inventory of disposable surgical products, and (iii) in-house
processing of reusable surgical products. In addition to these cost savings,
the Company's liquidproof and liquid resistant gowns offer surgeons and
surgical staff enhanced protection against transmission of blood-borne
pathogens, including the HIV and hepatitis viruses. Also, the Company's
reusable gowns are made with a breathable surgical fabric which is designed for
superior comfort during long procedures.
Through the Company's acquisition of Surgipro in February 1996, SRI
offers its customers disposable accessory packs containing smaller surgical
items which are not reusable, such as needles, syringes, and tubing. The
Company's Disposable Products Division (formerly Surgipro) enables SRI to
complement its reusable surgical product delivery and retrieval service with
disposable surgical products that are not available in reusable form. The
Company believes the flexibility it offers its customers by combining reusable
surgical gowns, towels, drapes, and basins with disposable products have
improved the Company's competitive position in the marketplace.
SRI purchased the assets of its business from Amsco Sterile
Recoveries, Inc. ("Amsco Sterile"), an indirect wholly-owned subsidiary of
Amsco International, Inc., on July 31, 1994 (the "Acquisition").
*GORE(R) Surgical Barrier Fabric is a registered trademark of W.L. Gore &
Associates, Inc.
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THE MARKET
The United States health care system includes approximately 6,500
acute care hospitals, over 2,300 freestanding surgery centers, and a variety of
other health care facilities. According to industry sources, approximately 31
million procedures were performed at hospitals and surgery centers in 1996.
The Company believes between $40-$50 of reusable surgical products service
revenues can be realized from a typical surgical procedure.
In the 1980's, hospitals began using custom procedure trays because
of their convenience, a trend which continued to grow until recently. A custom
procedure tray typically contains, in disposable form, most of the sterile
products used in a particular surgical or other medical procedure. According
to industry sources, total sales of custom procedure trays in the United States
were an estimated $1.5 billion in 1995. However, the Company believes that
custom procedure trays have several shortcomings relative to reusable products,
including costs associated with excessive product content, storage, handling,
and waste disposal, and the working capital requirements required to carry
product inventory.
Most hospitals which converted to custom procedure trays eliminated
the in-house personnel and equipment necessary to process reusable surgical
products. Furthermore, hospitals possessing in-house facilities are
increasingly unwilling to support those personnel and capital requirements.
With the growth of managed care, many hospitals and surgery centers are
seeking significant cost reduction solutions. The Company believes that a
service which provides daily delivery of substantially better quality surgical
products without any capital investment by the hospital, thereby reducing
employee and space needs, should become an attractive managed care option for
hospitals.
Several developments have created a market opportunity for the kind of
cost-competitive, reusable surgical product delivery and retrieval service SRI
offers, including:
Increasing Pressure on Hospitals to Contain Cost and Raise
Productivity. With the growth of managed care, economic constraints continue
to require hospitals to become more efficient by limiting capital investments,
reducing staff and costs. Hospitals are continually seeking to decrease their
cost of supplies and the associated cost of waste disposal. SRI offers a
cost-competitive service which eliminates the need for in-house inventory or
processing facilities or the costs associated with stocking and discarding
disposable products.
Heightened Concern Regarding the Transmission of Infectious Diseases.
The health care industry has experienced a substantial increase in the
transmission of infectious disease through cross-infections. These concerns
have increased the desirability of surgical barrier fabrics that protect
surgeons and surgical staff from patient liquids. SRI's liquidproof gown
prevents liquid and viral strike-through in critical areas during surgical
procedures involving higher risk. The Company's standard gown is specially
designed to resist liquid and bacterial strike-through in most other surgical
procedures.
Concern Regarding the Handling and Disposal of Biohazardous Waste.
The disposal of large volumes of infectious and hazardous solid and liquid
waste generated by the health care industry has attracted increased public
awareness. The increased burdens on hospitals generating biohazardous waste
due to restrictions on incineration and access to dump sites give a competitive
advantage to reprocessing systems, such as SRI's, which replace disposable
surgical products with reusable surgical products. The SRI reprocessing cycle
substantially reduces biohazardous waste and its impact on the environment.
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Increased Outsourcing of Hospital Functions That Do Not Involve
Patient Care. Hospitals with significant staff, capital and space dedicated to
in-house processing of reusable surgical products are increasingly outsourcing
this function to more efficient outside providers. This trend is consistent
with the overall industry focus on efficiency and improved patient care. SRI's
service allows hospitals to outsource to SRI the ownership and reprocessing of
surgical products.
STRATEGY
The Company's objective is to continue its growth and become a leading
provider of reusable surgical products and related delivery and retrieval
services to hospitals and surgery centers. The Company's principal strategies
for achieving this objective are as follows:
Leverage Infrastructure With Increased Penetration in Existing
Markets. The Company believes its existing facilities currently operate at
approximately 50% of their aggregate annual revenue capacity, allowing it to
add a substantial amount of sales without the need for significant additional
capital expenditures for equipment or new facilities. To obtain increased
operating leverage and expand profit margins, the Company intends to grow its
customer base within its existing markets and focus on expanding its
relationships with existing customers by servicing additional surgical
procedures.
Become a Preferred Vendor Through Competitive Pricing and Expanded
Service Solutions. As hospitals seek to contain costs and outsource functions
that do not involve patient care or revenue producing activities, the Company
believes hospitals will seek relationships with vendors who offer a broad range
of products or services at competitive prices. The Company intends to
establish preferred vendor relationships with its customers by providing
high-quality reusable surgical products, related delivery and retrieval
services, and disposable accessory packs containing disposable surgical items.
Through its disposable products division, SRI has expanded its range of
surgical products to include those products typically offered by its
competitors through disposable custom procedure trays, while giving its
customers the added flexibility of using the Company's reusable surgical
products.
Expand National and Regional Agreements. To date, the Company's
service agreements are primarily with individual hospitals. Management
believes that there is a trend toward group purchasing among hospitals. To
address this consolidation, management intends to offer its reusable products
delivery service through agreements with national and regional hospital groups.
Add Facilities in Selected Markets. SRI currently services customers
in 18 states through seven regional facilities. SRI serves several large
metropolitan areas through highway transport and satellite (depots) supported
by a regional facility. To expand geographically, the Company expects to build
additional facilities when needed in markets previously served by highway
transport. For example, the Company plans to re-open its Dallas facility in
April 1997 to better serve its customers in Northern Texas and Southern
Oklahoma who were previously serviced from the Company's facility in Houston,
Texas. From each new facility, SRI will be able to serve new metropolitan
areas which were previously too far from an existing regional facility. The
Company believes this strategy of incremental geographic expansion will allow
the Company to operate these new facilities profitably by beginning operations
with an existing customer base.
Decentralize Operations to Facilities. The Company operates each of
its facilities on a stand alone basis, with the general manager of each
facility accountable to senior management for sales, service, operations, and
profitability within the facility's market area. The Company believes
individual general managers with operational experience in local markets are
best suited to respond to local business opportunities with overall direction
and support from the Company's corporate staff. The Company implemented an
incentive compensation plan in 1995 which provides compensation awards for the
general managers and certain key production, customer service and sales
employees based on individual and facility performance, as well as overall
Company performance. Each general manager also participates in the Company's
stock option plan.
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Utilize Operational Knowledge. The Company's management gained
substantial knowledge in operating Amsco Sterile's facilities. Amsco Sterile
invested approximately $100 million during the period from 1991 to 1994,
allowing management to implement innovative techniques and processes. As a
result, when the Company acquired these facilities, management had developed a
high degree of expertise in operations and was ready to capitalize upon Amsco
Sterile's development efforts. The Company intends to utilize this expertise
to provide superior products and services at a competitive cost.
DELIVERY, RETRIEVAL AND REPROCESSING SYSTEM
SRI's closed-loop reprocessing service picks up soiled reusable
surgical products from its customers and sorts, cleans, inspects, packages,
sterilizes, and redelivers the products. In one trip, SRI's trucks deliver
clean carts of sterilized surgical products to the hospital or surgical center
and retrieve carts containing soiled products and return them to its facility
for reprocessing. The specially designed aluminum carts hold sterile products,
lock to maintain security and sterilization, conveniently roll for delivery
within the hospital and convert into hampers to hold soiled products after the
procedure. The customer avoids the need to maintain secondary stock locations
and the costs of either reprocessing reusable products or stocking and
discarding disposable products.
Upon return to SRI's facility, the contents of the soiled carts are
sorted in a decontamination area. Soiled fabric products are routed through an
automated washing and drying process that delivers clean, dry, and
decontaminated products to a pack room where they are carefully inspected for
damage, repaired if necessary, folded and assembled into packs. The pack is
steam sterilized, sorted, and redelivered to the customer. SRI separately
cleans, dries, and decontaminates its carts, stainless steel basins, and other
hard reusable products through special automatic tunnel washers before
redelivery. Processing through the facility occurs in three to five days.
Because the Company's ability to price competitively with disposable
products depends on maintaining its sewn goods' useful lives, SRI closely
monitors its reprocessing to ensure longevity. SRI uses a bar coding system to
track its reusable surgical products' status, history, and number of uses. SRI
continues to refine the washing and sterilization processes, building on Amsco
Sterile's substantial investments of time and money to initially develop those
operations.
The growth of SRI's business reflects its products' appeal, its
service quality, and general customer resistance to change when the SRI system
is in place. SRI also believes its direct relationship with hospital staff has
been important in attracting and retaining customers. Many of SRI's
competitors use a distributor system which introduces an intermediary between
the competition and their customers which SRI believes adds costs.
The Company's sales process for new customers is typically six to
twelve months in duration from initial contact to a 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 Company believes there is a
tendency to maintain the status quo in many hospitals and this favors its
retention of existing customers.
SRI bills its customers weekly for the previous week's deliveries on a
per-use basis under service contracts or purchase orders. Consistent with
industry custom, these contracts generally are cancelable by either party with
90 days' notice, and customers may unilaterally reduce their use of the
Company's services under such contracts without penalty. The Company does not
have any order backlog because its products are generally delivered daily in
response to customer orders.
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REUSABLE PRODUCTS
SRI's principal reusable surgical products are its liquidproof and
liquid resistant surgical gowns, towels, drapes, and stainless steel basin
sets. SRI offers these products in a variety of packs configured to the
hospital's specific needs. Packs are comprised of various combinations of
gowns, absorbent towels, liquidproof backtable covers, mayo stand covers, and
stainless components.
The Company's liquidproof gown has GORE(R) Surgical Barrier Fabric in
critical areas to provide protection for procedures which present a higher risk
of liquid strike-through and provide more comfort. This protection is critical
to SRI's customers given current concerns of doctors, staff, and regulatory
authorities regarding transmission of blood-borne pathogens, including the HIV
and hepatitis viruses. The Company's liquid resistant gown is made of an
advanced microfiber polyester fabric designed to resist liquid and bacterial
strike-through in most surgical procedures. All of SRI's gowns and drapes
offer the wearer both comfort and breathability, combined with a high level of
protection from liquid penetration that SRI believes is superior to that
offered by disposable products.
SRI contracts with third-party vendors for the weaving of microfiber
fabric and the cutting and sewing of garments, wraps and drapes. The other
components of the Company's products are currently available at reasonable
costs from a variety of suppliers.
DISPOSABLE PRODUCTS
To complement its reusable surgical products, the Company offers
disposable accessory packs containing smaller surgical products, such as
needles, syringes, and tubing. The Company develops these packs with its
customers' cooperation to assure a desirable and cost effective product mix.
SRI purchases the products from major manufacturers, assembles the products in
packs, arranges for ethylene oxide sterilization by a third party, and delivers
them to customers on its carts with its reusable products.
EMPLOYEES
As of December 31, 1996, SRI employed approximately 690 people,
consisting of approximately 35 persons in management, administration and
finance at its corporate office and approximately 655 people in various
positions at the Company's facilities. The Company's employees are not covered
by a collective bargaining agreement, and the Company considers its employee
relations to be good.
COMPETITION
SRI competes principally with sellers of both reusable and disposable
gowns, drapes, utensils, and other products for surgical procedures. The
market is dominated by disposables, especially custom procedure trays. SRI
believes it is the leading provider of high quality reusable surgical gowns and
drapes. With the acquisition of Surgipro, SRI competes directly with suppliers
of disposable custom procedure trays.
Unlike SRI, many of SRI's competitors can offer full national coverage
and have much greater resources than the Company. The Company's principal
competitor is the Convertors division of Allegiance Corporation, which has a
substantial market share.
*GORE(R) Surgical Barrier Fabric is a registered trademark of W.L. Gore &
Associates, Inc.
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The Company competes based primarily on price, service, quality, and
its ability to save its customers waste disposal costs. The changing
healthcare environment in recent years has led to increasingly intense
competition among health care suppliers based on price, service, and product
performance. Hospitals are seeking cost reductions in response to pressure
from governments, insurance companies, and health maintenance organizations.
The Company believes its high degree of expertise in operations significantly
assists it in offering a superior product at a competitive cost. In addition,
hospitals are increasingly seeking buying leverage by purchasing in integrated
networks. SRI believes that competitive pressure in these areas will continue.
REGULATION
Substantially all of the Company's products and services are subject
to extensive government regulation in the United States by federal, state and
local governmental agencies, including the Food and Drug Administration (the
"FDA"), the Department of Transportation ("DOT"), and the Occupational Safety
and Health Administration ("OSHA"). The Company's products are subject to
regulation by the FDA as medical devices. The regulated devices include the
Company's gowns, towels, drapes, basins, boots, surgical wraps, surgical packs,
and delivery blankets. The FDA regulates the development, production,
distribution, and promotion of medical devices in the United States. Various
states in which the Company's products are being sold or may be sold in the
future might impose additional regulatory requirements. Pursuant to the
Federal Food Drug and Cosmetics Act (the "FDA Act"), a medical device is
subject to general controls regarding FDA inspections of facilities, "Good
Manufacturing Practices," labeling, maintenance of records, and filings with
the FDA. FDA pre-market approval of these devices is obtained under Section
510(k) of regulations issued under the FDA Act, which provides for FDA approval
on an expedited basis for products that can be shown to be substantially
equivalent to devices legally marketed before May 1976 (the month and year of
enactment of the FDA Act). Products must be produced in registered
establishments and be manufactured in accordance with "Good Manufacturing
Practices," as defined under the FDA Act. In addition, all medical devices
must be periodically listed with the FDA. Labeling and promotional activities
are subject to scrutiny by the FDA and, in certain instances, by the Federal
Trade Commission. If the Company fails to comply with the applicable
provisions of the FDA Act, the FDA can institute proceedings to detain or seize
products, enjoin future violations, impose product labeling restrictions or
enforce product recalls or withdrawals from the market. The Medical Device
Reporting ("MDR") regulation obligates the Company to provide information to
the FDA on injuries alleged to have been associated with the use of a product
or in connection with certain product failures which could cause serious injury
or death. SRI and its hospital customers also must comply with regulations of
OSHA, including the blood-borne pathogen rule requiring that "universal
precautions" be observed to minimize exposure to blood and other bodily fluids.
To comply with these requirements, SRI's employees wear protective gear in
handling soiled linens in the facility's decontamination area. Properly used,
SRI's products allow its hospital customers to protect their employees in
compliance with these regulations. The Company must comply with local
regulations governing the discharge of water used in its operations. SRI uses
local licensed contractors to dispose of any biohazardous waste generated by
the hospital and received by SRI and therefore does not need to obtain permits
for biohazardous waste disposal. The Company must comply with DOT and OSHA
regulations governing the transportation of hazardous materials. These
regulations concern, among other things, labeling, marketing, placarding, using
proper containers, and reporting discharges. The Company complies with these
regulations by putting soiled products in marked liquidproof bags and locked,
marked transfer carts. Sterilization of the Company's disposable accessory
packs is provided under contract by a third-party. The use of ethylene oxide
by that third-party in the sterilization of the Company's disposable accessory
packs is subject to regulation by OSHA and the Environmental Protection Agency.
In addition to the foregoing, numerous other federal, state and local
regulatory authorities, including those enforcing laws which relate to the
environment, fire hazard control, and working conditions, have jurisdiction to
take actions which could have a material adverse effect on the Company. SRI
makes expenditures from time to time to comply with environmental regulations,
but does not expect any material capital expenditures for environmental
compliance in the current or next fiscal year.
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CERTAIN CONSIDERATIONS
From time to time, the Company may publish forward-looking statements
relating to such matters as anticipated financial performance,
business prospects, new products, and similar matters. These
statements are based on current expectations and actual results might
differ materially. Among the factors which could cause actual results
and experience to differ are the following:
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. SRI'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. SRI'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. See
"Business--The Market."
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. To adequately service a new customer, SRI makes an investment
in new reusable surgical products and carts equal to approximately 50% of the
projected first year revenue from the customer. SRI estimates that its capital
expenditures for new carts and reusable surgical products will be approximately
$475,000 per month in the next twelve months, although the amount will
fluctuate depending on the growth rate of SRI's business. The Company also
expects to make additional expenditures of approximately $350,000 in each of
its four largest facilities to increase the aggregate capacity of those
facilities. 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 "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
Dependence on a Significant Customer and Market Consolidation. During
1996, Columbia/HCA Healthcare Corporation ("Columbia") hospitals, with which
the Company currently does business, accounted for approximately 15% of SRI's
sales. 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 sales, 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 SRI 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.
Dependence on a Key Supplier. A significant percentage of the
Company's business is dependent upon its ability to obtain the GORE(R) Surgical
Barrier Fabric from W.L. Gore & Associates, Inc. This material is a key
component of SRI's liquidproof surgical gowns, which accounted for
approximately 13% of its revenues in fiscal year 1996. The Company does not
have a long-term commitment from W.L. Gore & Associates, Inc. for the supply
of this fabric and is currently unaware of any equivalent substitute for the
GORE(R) product. Sustained loss of this supply relationship would have a
material adverse effect on the Company. See "Business--Reusable Products."
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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. See "Business--Competition."
Dependence on Key Executives. The Company is largely dependent upon
the management expertise and experience of Richard T. Isel, Wayne R. Peterson,
James T. Boosales, and Bertram T. Martin, Jr., its principal officers. Mr.
Isel underwent heart bypass surgery in March 1996, and although he has returned
to work on a full-time basis, there is no assurance his condition will permit
him to provide the same level of service to the Company he provided before his
surgery. The loss of the services of one or more of these key employees could
have a material adverse effect on the Company.
Protection of Operating Knowledge. The Company's success will depend
in part on its ability to protect the operating knowledge associated with
operation of its closed-loop system. The Company relies on a combination of
trade secret law, proprietary know-how, non-disclosure and other contractual
provisions to protect its knowledge associated with operation of the
closed-loop system. The Company does not hold any patents. Failure to
adequately protect its operating knowledge could have a material adverse effect
on the Company.
Increasing Replacement and Amortization Costs. SRI 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, SRI 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, SRI'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 (see "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Overview" and Note B of Notes
to Financial Statements).
Health Care Reform. Numerous proposals have been debated in Congress
and in several state legislatures regarding health care legislation intended to
control the cost and availability of health care services. It is not possible
to determine what health care reform legislation will be adopted by Congress or
any state legislature, or if and when any such legislation will be adopted and
implemented by regulations. In that event, there can be no assurance the
Company will be able to adjust effectively to any regulatory changes made by
future health care reform legislation and remain profitable. The Company is
unable to predict accurately the nature and effect, if any, that the adoption
of health care legislation or regulations or changing interpretations at the
federal or state level would have upon the Company. See "Business--The
Market."
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Product Liability and Insurance Coverage. The use of the Company's
products entails a risk of liability from injuries suffered by patients,
hospital staff, and the Company's employees. The Company's products are used
in connection with surgery, which exposes all of the above persons to risks of
transmission of blood-borne pathogens, including the HIV and hepatitis viruses.
Although no claims have been asserted to date, product liability or other
claims might be asserted against the Company by persons who allege that the use
of the Company's products resulted in injury or other adverse effects, and the
claims might involve large amounts of alleged damages and significant defense
costs. Although the Company currently maintains product liability and workers
compensation insurance, the liability limits or the scope of the Company's
insurance policies might be inadequate to protect against potential claims.
In addition, the Company's insurance policies must be renewed annually. The
Company has been able to obtain product liability insurance in the past;
however this insurance varies in cost, might be difficult to obtain, and might
not be available on commercially reasonable terms in the future. A successful
claim against the Company in excess of its available insurance coverage could
have a material adverse effect on the Company. In addition, the Company's
business reputation could be adversely affected by product liability claims,
regardless of their merit or eventual outcome.
ITEM 2: PROPERTIES
SRI operates seven processing facilities of approximately 23,000 to
32,000 square feet each in Baltimore, Detroit, Houston, Los Angeles, Raleigh,
Salt Lake City, and Tampa. Each facility contains a uniform set of
computerized and fully automated heavy washers, dryers, and sterilizers to
achieve consistent cleaning and sterilization cycles for reusable surgical
products. The Company uses standard operating procedures at each facility, and
regularly implements at all facilities efficiencies which are developed and
tested at one location.
The Company's properties and the major markets which they serve are
summarized below. All the properties are leased, with the exception of the
Houston processing facility. SRI believes its existing facilities adequately
serve its current requirements.
SQUARE FEET
FACILITY AND LOCATION (APPROX.) LEASE EXPIRATION(1) SELECTED MARKETS SERVED
- --------------------- --------- ------------------- -----------------------
Processing facilities:
Baltimore, Maryland 32,000 February 1, 2003 Baltimore, Philadelphia,
Pittsburgh, Washington, D.C.
Detroit, Michigan 23,000 September 30, 2002 Chicago, Detroit, Louisville,
Milwaukee, Toledo
Houston, Texas 30,000 Owned Dallas, Houston, San Antonio, Oklahoma City,
Austin
Los Angeles, California 30,000 November 30, 2002 San Diego, Sacramento, Los Angeles,
San Francisco
Raleigh, North Carolina 31,500 April 30, 2002 Richmond, Atlanta, South Carolina, North
Carolina
Salt Lake City, Utah 24,000 November 30, 2003 Utah
Tampa, Florida 29,000 January 24, 2002 Tampa, Miami, Orlando, Jacksonville
Depots:
Chicago, Illinois 3,000 September 30, 1998 --
Dallas, Texas (2) 20,000 March 31, 2002 --
Louisville, Kentucky 3,000 December 31, 1997 --
Miami, Florida 4,000 January 31, 1998 --
San Francisco, California 6,000 May 31, 1997 --
Warehouse:
Houston, Texas 5,000 September 30, 1997 --
Disposable products facility:
Orlando, Florida 18,500 February 28, 1999 --
Corporate office:
Clearwater, Florida 10,000 October 31, 2001 --
(1) Excludes renewal options in the leases which range from one to 10
years.
(2) The Dallas facility is fully equipped to operate as a processing
facility. After its re-opening in April, 1997, this facility will
serve the Dallas and Oklahoma City markets.
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ITEM 3: LEGAL PROCEEDINGS
Neither the Company nor any of its property is subject to any
litigation or other legal proceeding expected to have a material effect on the
Company or its business.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 1996 covered by this report.
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13
PART II
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The Company's Common Stock trades publicly on The Nasdaq National
Market tier of the Nasdaq Stock Market under the symbol "STRC." The table
below sets forth the high and low bid quotations for the Company's Common Stock
from July 18, 1996 (the date on which trading commenced on the NASDAQ National
Market) through December 31, 1996. These bid prices represent prices between
dealers without adjustment for retail mark-ups, mark-downs, or commissions and
may not necessarily represent actual transactions.
COMMON STOCK PRICE RANGE
1996 HIGH LOW
Third Quarter (From July 18, 1996) $14.75 $ 9.50
Fourth Quarter $15.25 $13.875
The Company has never declared or paid cash dividends on its Common
Stock. The Company currently expects all of its earnings will be retained for
development and expansion, and does not anticipate paying dividends on its
Common Stock in the foreseeable future. Additionally, financial covenants in
the Company's credit facility prohibit the payment of cash dividends. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Notes to Financial
Statements."
-11-
14
ITEM 6: SELECTED FINANCIAL DATA
The following table contains certain selected financial data and is
qualified by the more detailed Financial Statements and Notes thereto included
elsewhere in this report. The selected financial data for the years ended
December 31, 1996 and December 31, 1995 and the five-months ended December 31,
1994, have been derived from the Company's audited financial statements. The
selected financial data (statement of income data only) set forth below for the
seven months ended July 31, 1994 and the year ended December 31, 1993, have
been derived from audited financial statements of Amsco Sterile (the
predecessor company). The Balance Sheet data as of July 31, 1994 and December
31, 1993, and the selected financial data for the year ended December 31, 1992
have been derived from the unaudited statements of operations and balance
sheets of Amsco Sterile exclusive of notes thereto, which include all
adjustments that Amsco Sterile considers necessary for a fair presentation of
its results of operation and financial position for the period presented. The
following information should be read in conjunction with the Financial
Statements and Notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere in this
report.
Sterile Recoveries, Inc. Predecessor Company (1)
-------------------------------------------- --------------------------------------------
Years Ended Five Months Seven Months Years Ended
----------------------------- Ended Ended ---------------------------
December 31, December 31, December 31, July 31, December 31, December 31,
1996 1995 1994 1994 1993 1992
------------ ------------ ------------- ---------- ------------ ------------
(In thousands, except per share data) (In thousands)
STATEMENT OF OPERATIONS DATA:
Revenues $ 32,168 $25,320 $ 9,285 $ 12,069 $ 7,988 $ 1,132
Cost of revenues 21,764 17,659 6,550 14,091 15,090 684
-------- ------- --------- --------- ---------- --------
Gross profit (loss) 10,404 7,661 2,735 (2,022) (7,102) 448
Distribution expenses 3,000 2,801 1,032 1,309 981 --
Selling and administrative
expenses 4,734 3,975 2,162 7,375 12,132 7,638
Restructuring expenses -- -- -- -- 1,550 --
-------- ------- --------- --------- ---------- --------
Income (loss) from
operations 2,670 885 (459) (10,706) (21,765) (7,190)
Interest expense 648 1,489 735 4,791 5,727 1,536
-------- ------- --------- --------- ---------- --------
Income (loss) before
income taxes 2,022 (604) (1,194) (15,497) (27,492) (8,726)
Income tax expense (2) 190 -- -- -- -- --
-------- ------- --------- --------- ---------- --------
Net income (loss) $ 1,832 $ (604) $ (1,194) $ (15,497) $ (27,492) $ (8,726)
======== ======= ========= ========= ========== ========
UNAUDITED PRO FORMA INFORMATION (2):
Historical net income (loss) $ 1,832 $ (604) $(1,194)
Reduction to historical income
tax expense 74 -- --
-------- -------- -------
Pro forma net income (loss) $ 1,906 $ (604) $(1,194)
======== ======== =======
Pro forma net income (loss) per
common share, primary (3) $ 0.43 $ (0.17) $ (0.34)
======== ======== =======
Pro forma net income (loss) per
common share, fully
dilutive (3) $ 0.42 $ (0.17) $ (0.34)
======== ======== =======
Weighted average common shares
outstanding, primary 4,473 3,513 3,513
======== ======== =======
Weighted average common shares
outstanding, fully
dilutive 4,574 3,513 3,513
======== ======== =======
BALANCE SHEET DATA:
Reusable surgical products $ 6,915 $ 4,924 $ 4,867 $ 32,836 $ 31,226 $ 18,344
Total assets 25,006 13,493 13,388 67,651 63,871 43,999
Total indebtedness 1,000 10,891 11,942 115,841 96,088 49,156
Shareholders' equity
(deficit) 20,756 214 (182) (50,293) (34,796) (7,304)
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15
STERILE RECOVERIES, INC.
SELECTED FINANCIAL DATA - (CONTINUED)
(1) The table covers periods before and after the Company acquired its
business from Amsco Sterile on July 31, 1994. A comparison of the
Company's operating results for the periods after the Acquisition to the
operating results before the Acquisition is not meaningful. See
"Management's Discussion and Analysis of Financial Condition and Results
of Operations--Overview."
(2) As an S Corporation for federal income tax purposes, the Company had not
been subject to income tax until the date of the Offering at which time
the Company became a C Corporation. On a pro forma basis, assuming the
Company had been subject to income tax for all periods presented, the
Company would not have recognized any corporate income tax expense prior
to 1996. See Notes B and L of Notes to Financial Statements.
(3) Supplemental pro forma net income per common share for the years ended
December 31, 1996 and 1995, giving effect to the payment of debt from a
portion of the proceeds from the Company's initial public offering in
July 1996 and the increased number of shares, is $0.47 and $0.17 per
common share (assuming 5,103,246 and 4,664,623 weighted average common
shares outstanding).
-13-
16
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Company's Financial Statements and the Notes thereto included
elsewhere in this report. This discussion and analysis contains trend analysis
and might contain forward-looking statements. These statements are based on
current expectations and actual results might differ materially. Among the
factors that could cause actual results to vary are those described in this
"Overview" section and in "Business--Certain Considerations."
OVERVIEW
The financial statements in this report and this discussion and
analysis cover periods before and after the Company acquired its business from
Amsco Sterile on July 31, 1994. The Company's operating results for the
periods after the Acquisition are not comparable to the operating results of
Amsco Sterile for the periods before the Acquisition for several reasons.
Amsco Sterile incurred a significant amount of debt, costs, and losses in
starting up, equipping, and developing the business from its inception in 1991
through the Acquisition. SRI purchased eight of the nine facilities and all of
Amsco Sterile's depreciated equipment and surgical products inventory for
approximately 17% of Amsco Sterile's net book value. Consequently, SRI has
one fewer facility, less debt, and considerably lower depreciation and
amortization expense than Amsco Sterile. In addition, the Company has
significantly changed the business operations since the Acquisition (see Note D
of Notes to Financial Statements).
The Company completed its initial public offering (the "Offering") of
2,150,000 shares of its Common Stock (including shares sold in the
overallotment) in July and August 1996. The net proceeds of the Offering
received by the Company after payment of expenses were $17.9 million, of which
approximately $11 million was used to retire acquisition debt and working
capital facility.
The Company's revenues are derived from providing hospitals and
surgery centers with reusable gowns, towels, drapes, and basins for use in
surgical procedures through a daily comprehensive surgical procedure-based
delivery and retrieval system, and also from the sale of disposable surgical
products that supplement its reusable surgical product service. The Company's
revenue growth is primarily affected by the number of customers, the number and
type of surgical procedures it services for each customer, and the pricing by
type of surgical pack.
As of December 31, 1996, the Company believes its facilities operated
at approximately 50% of their estimated aggregate annual revenue capacity of
approximately $65 million at current prices. Estimated annual revenue capacity
is based on the Company's estimate of revenues that would be derived from the
full utilization of the facilities at current prices and without addition of
equipment. SRI believes the aggregate revenue capacity can be further
increased to approximately $80 million (at current prices) with additional
equipment expenditures of approximately $350,000 to add washing, drying and
sterilization capabilities in each of its four larger facilities. Variations
in maximum revenue potential by facility result from differences in product mix
and pricing for each facility. The Company's ability to use this excess
revenue capacity will depend on its success in substantially increasing its
volume of business. A primary strategy of the Company is to increase its
operating leverage by expanding revenues within existing markets.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (CONTINUED)
The Company amortizes its reusable surgical products on a per-use
basis, based on estimates of the products' useful lives. SRI's purchase of
used reusable surgical products in the Acquisition at approximately 17% of
Amsco Sterile's net book value has resulted in lower amortization expense since
the Acquisition. The Company's purchases of new reusable surgical products at
current replacement cost increased amortization expense in 1996 and will
increase future amortization expense. However, the Company's current
replacement cost is substantially less than Amsco Sterile's original cost due
to significantly improved sourcing of fabrics. See "Business--Certain
Considerations - Increasing Replacement and Amortization Costs" and Note B of
Notes to Financial Statements.
Before the Offering, the Company was an S Corporation for state and
federal income tax purposes and not subject to corporate income taxes. Upon
completion of the Offering, the Company's S Corporation status terminated and
the Company became subject to corporate income taxes. See Notes B and L of
Notes to Financial Statements.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of
revenues represented by certain items reflected in the statements of operations
of the Company and Amsco Sterile.
FIVE SEVEN
YEARS ENDED MONTHS MONTHS YEAR
DECEMBER 31, ENDED ENDED ENDED
------------------------ DEC. 31, JULY 31, DEC.31,
1996 1995 1994 1994 1993
------ ------ ------ ------ ------
Revenues 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues 67.7 69.7 70.5 116.7 188.9
----- ----- ----- ------ ------
Gross profit 32.3 30.3 29.5 (16.7) (88.9)
Distribution expense 9.3 11.1 11.1 10.9 12.3
Selling and administrative expenses 14.7 15.7 23.3 61.1 151.9
Restructuring expense -- -- -- -- 19.4
----- ----- ----- ------ ------
Income (loss) from operations 8.3 3.5 (4.9) (88.7) (272.5)
Interest expense 2.0 5.9 7.9 39.7 71.7
----- ----- ----- ------ ------
Income (loss) before income taxes 6.3 (2.4) (12.8) (128.4) (344.2)
Income tax expense 0.6 -- -- -- --
----- ----- ----- ------ ------
Historical net income (loss) 5.7 (2.4) (12.8) (128.4) (344.2)
Reduction to historical income tax
expense .2 -- -- -- --
----- ----- ----- ------ ------
Pro forma net income (loss) 5.9% (2.4)% (12.8)% (128.4)% (344.2)%
===== ===== ===== ====== ======
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18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (CONTINUED)
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Revenues
Revenues increased $6.9 million, or 27.0%, to $32.2 million in
1996 from $25.3 million in 1995. The revenue increases for the period were
equally attributable to new customers and increased revenues from current
customers.
Gross Profit
Gross profit increased $2.7 million, or 35.8%, to $10.4 million in
1996 from $7.7 million in 1995. The improvement in gross profit is largely
attributable to labor efficiencies and the economies of scale associated with
spreading fixed costs over increased revenues. These favorable factors were
partially offset by higher amortization of reusable surgical products as the
Company supplements the products purchased in the Acquisition with products
purchased at current higher replacement cost. Increased revenues from
relatively lower margin disposable surgical products also offset some of the
efficiency gains.
Distribution Expenses
Distribution expenses increased $200,000, or 7.1%, to $3.0 million
in 1996 from $2.8 million in 1995. As a percentage of revenues, distribution
expenses decreased to 9.3% in 1996 from 11.1% in 1995. The improvement in
distribution expenses as a percentage of revenues resulted primarily from
efficiencies derived from delivering more volume over existing routes.
Selling and Administrative Expenses
Selling and administrative expenses increased $759,000, or 19.1%,
to $4.7 million in 1996 from $4.0 million in 1995. This increase was largely
attributable to additional sales personnel, the addition of an executive
officer after the Offering, and the expense associated with being a public
company. As a percentage of revenues, selling and administrative expenses
decreased to 14.7% in 1996 from 15.7% in 1995, primarily due to leveraging of
fixed administrative expenses over additional revenues.
Interest Expense, Net
Interest expense decreased by $841,000, or 56.5%, to $648,000 in
1996 from $1.5 million in 1995, primarily due to the elimination of the
acquisition debt to Amsco Sterile repaid from the Offering proceeds, and the
interest and other income earned in the amount of $181,000 since the Offering.
Income Before Income Tax Expense
As a result of the foregoing, the Company's income before taxes
increased to $2.0 million in 1996, from a loss before taxes of $604,000 in
1995. As a percentage of revenues, income before taxes in 1996 was 6.3% of
revenues compared to a loss before taxes of 2.4% in 1995.
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19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (CONTINUED)
Historical Income Tax Expense
During 1996, the Company changed from an S Corporation to a C
Corporation for federal income tax purposes. This change resulted in an
effective tax rate for the Company of 9.4% compared to the statutory income tax
rate of 38.5%. The lower effective tax rate reflects the recording of a
deferred tax asset and the benefit from the allocation of the year's earnings
between the C Corporation and the S Corporation (see Note L of the Financial
Statements).
Pro Forma Income Tax Expense
In conjunction with the completion of the Offering, the Company
terminated its S Corporation status. For pro forma income tax purposes only,
the S Corporation's cumulative net operating losses as of December 31, 1995, of
approximately $1.6 million have been treated as C Corporation losses, and,
accordingly, used to reduce pretax earnings in 1996. (See Note L of the
Financial Statements.)
Net Income Per Share
The Company recorded a pro forma net income per share of $0.42 on a
fully diluted per share basis, and $0.43 on a primary per share basis for 1996,
compared with ($0.17) for both diluted and primary pro forma per share net
income in 1995.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
The following discussion and analysis pertains to operations both
before and after the Acquisition. The stated amounts for 1995 are for the
Company's operations. The stated amounts for 1994 include the combined
operations in that year of both the Company (August 1 and after) and Amsco
Sterile (before August 1). For reasons stated above, the operations of Amsco
Sterile are not comparable to the Company. See "--Overview."
Revenues
Revenues increased $3.9 million, or 18.6%, to $25.3 million in 1995
from $21.4 million in 1994. In 1994 and early 1995, the revenue growth of the
business slowed because of marketplace concerns regarding AMSCO's sale or
closure of Amsco Sterile, SRI's financial condition after the Acquisition, and
SRI management's focus on retaining existing customers and implementing
operating efficiencies to generate operating profits.
Gross Profit
Gross profit increased $7.0 million, or 1,000%, to $7.7 million in
1995 from $713,000 in 1994. Gross margin increased to 30.3% in 1995 from 3.3%
in 1994. The comparison of gross profit for 1994 and 1995 is not meaningful
because of Amsco Sterile's significantly higher depreciation and amortization
expenses associated with higher book asset values. In particular, SRI's
purchase of used reusable surgical products in the Acquisition at approximately
17% of Amsco Sterile's net book value resulted in lower amortization expense
since the Acquisition. See "--Overview."
Distribution Expenses
Distribution expenses increased $460,000, or 19.6%, to $2.8 million in
1995 from $2.3 million in 1994. As a percentage of revenues, distribution
expenses increased slightly to 11.1% in 1995 from 11.0% in 1994. The Company
did not experience any economies in distribution expense on the year to year
revenue increase.
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20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (CONTINUED)
Selling and Administrative Expenses
Selling and administrative expenses decreased $5.5 million, or 58.3%,
to $4.0 million in 1995 from $9.5 million in 1994. As a percentage of
revenues, selling and administrative expenses decreased to 15.7% in 1995 from
44.7% in 1994 primarily due to reductions in corporate overhead following the
Acquisition, the reduction of sales expense, and the leveraging of fixed
administrative expenses over additional revenues. Management significantly
reduced personnel and expenses after the Acquisition.
Interest Expense
Interest expense decreased by $4.0 million, or 73.1%, to $1.5 million
in 1995. As a percentage of revenues, interest expense decreased to 5.9% in
1995 from 25.9% in 1994. Amsco Sterile incurred significant intercompany debt
to AMSCO in connection with its start up and development of the business that
was replaced following the Acquisition by a significantly lower level of debt
incurred to finance the Acquisition and the Company's cash flow requirements.
Net Loss
As a result of the foregoing, the net loss decreased $16.1 million, or
96.4%, to $604,000 for 1995 from $16.7 million in 1994. As a percentage of
revenues, the net loss in 1995 was 2.4% of revenues compared to a net loss of
78.2% of revenues in 1994.
YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993
The following discussion pertains to operations both before and after
the Acquisition. The stated amounts for 1993 are for Amsco Sterile's
operations. The stated amounts for 1994 include the combined results of
operations of both the Company (August 1 and after) and Amsco Sterile (before
August 1). For reasons stated above, the operations of Amsco Sterile are not
comparable to the Company. See "--Overview."
Revenues
Revenues for 1994 increased $13.4 million, or 167.3%, to $21.4 million
from $8.0 million in 1993, primarily as a result of the continued marketing
efforts of Amsco Sterile.
Gross Profit (Deficit)
Gross profit increased $7.8 million to $713,000 in 1994 from a deficit
of $7.1 million in 1993. The comparison of gross profit for 1994 and 1993 is
not meaningful because of Amsco Sterile's significantly higher depreciation and
amortization expenses associated with its relatively higher book asset values.
Distribution Expenses
Distribution expenses increased $1.4 million, or 139%, to $2.3 million
in 1994 from $981,000 in 1993. As a percentage of revenues, distribution
expenses decreased to 11.0% in 1994 from 12.3% in 1993 as more deliveries were
made over the same routes.
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21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (CONTINUED)
Selling and Administrative Expenses
Selling and administrative expenses decreased $2.6 million, or 21.4%,
to $9.5 million in 1994 from $12.1 million in 1993. As a percentage of
revenues, selling and administrative expenses decreased to 44.7% in 1994 from
151.9% in 1993 due to the leveraging of fixed administrative expenses over
additional revenues. Management significantly reduced personnel and related
expenses after the Acquisition.
Interest Expense
Interest expense decreased slightly by $201,000, or 3.5%, to $5.5
million in 1994 from $5.7 million in 1993. As a percentage of revenues,
interest expense decreased to 25.9% in 1994 from 71.7% in 1993. Amsco Sterile
incurred significant intercompany debt to AMSCO in connection with its start up
and development of the business which was replaced following the Acquisition by
a significantly lower level of debt incurred to finance the Acquisition and the
Company's working capital requirements.
Net Loss
As a result of the foregoing, the net loss decreased $10.8 million, or
39.3%, to $16.7 million for 1994 from $27.5 million in 1993. As a percentage
of revenues, the net loss in 1994 was 78.2% of revenues compared to a net loss
of 344.2% of revenues in 1993.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of capital have been sales of its debt
and equity securities, including the Offering, cash flows from operations,
operating leases for facilities and distribution vehicles, and borrowings under
its working capital loan facility.
The Company's positive cash flow from operating activities was $1.7
million in 1996, compared to $1.1 million in 1995. The increase in cash from
operating activities from 1995 to 1996 resulted primarily from increased net
income before amortization and depreciation expense. This increase was
partially offset by cash used for increased accounts receivable and
inventories. Accounts receivable increased by $1.8 million as the result of
revenue growth and some slowing of turnover, mainly in the fourth quarter.
Inventories at December 31, 1996 were $1.2 million, compared to $306,000 at
December 31, 1995. The increase in inventory reflects the introduction and
continued growth of disposable surgical products to supplement the Company's
delivery and retrieval service for reusable surgical products.
The Company used approximately $3.9 million more net cash in investing
activities in 1996 than in 1995. The Company has made capital expenditures in
1996 for equipment of $1.3 million and for reusable surgical products of $3.7
million to support sales growth, as compared to $278,000 for equipment and
$820,000 for reusable surgical products in 1995. These expenditures were
funded primarily by cash provided by financing activities, including net
proceeds of approximately $17.9 million from the Offering after commissions and
expenses, $300,000 from a private sale of common stock, and $1,000,000 from a
loan from a director pursuant to a partially secured convertible note. These
funds were used to retire debt of approximately $11.1 million, to purchase
additional assets, and for a cash reserve to fund future capital needs. The
debt retirement eliminated principal and interest payments of approximately
$2.5 million on an annualized basis.
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22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - (CONTINUED)
As of December 31, 1996, the Company had cash of approximately $5.2
million, reflecting primarily the remaining proceeds of the Offering. Excess
cash and cash generated from operations will be used to fund purchases of
additional stocks of reusable surgical products, primarily to support
anticipated growth in revenues, and other capital expenditures as necessary to
support additional facility capacity.
During 1996, the Company established with First Union National Bank of
Florida a $15.0 million unsecured revolving credit facility that will expire in
August 1999. The facility imposes certain financial covenants. Beginning
January 1, 1997, total outstanding borrowings under the facility are limited to
three times the Company's earnings before interest, taxes, depreciation, and
amortization (EBITDA) for the previous four quarters (declining to two and
one-half times by the third year). The Company must maintain a minimum
tangible net worth of $18,750,000 during 1997, increasing to $20,745,000 for
1998 and $23,745,000 for the balance of the loan term, and the Company may
elect to convert up to $5.0 million of the available facility into term loans
for capital expenditures that are repayable ratably over five years and
secured by equipment acquired with the loan proceeds. All borrowings accrue
interest at the London Interbank Offering Rate (LIBOR) plus 200 basis points
(7.45% as of December 31, 1996). The facility restricts the declaration of
dividends and prohibits the Company from encumbering its assets. Currently,
there are no borrowings under this credit facility.
During 1996, the Company substantially increased its expenditures for
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. Until the beginning
of 1996, the Company minimized its new purchases of reusable surgical products
by using excess stocks of reusable surgical fabrics and products included in
the Acquisition at a relatively low cost. With excess stocks almost fully
utilized, SRI's capital expenditures for new carts and reusable surgical
products were approximately $4.0 million in 1996, compared to $800,000 for all
of fiscal year 1995. The Company estimates capital expenditures for new carts
and reusable surgical products will be approximately $475,000 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 equipment expenditures
of approximately $350,000 in each of its four largest facilities to increase
the aggregate capacity of those facilities. The Company will also require
working capital to continue growing its inventory of disposable surgical
products.
The Company believes its 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. In the longer term, the Company expects its capital
requirements will be substantial and will depend on its growth and
opportunities. The Company expects to fund additional capital expenditures
from a combination of internal cash flow, its credit facility, and other
capital sources. See "Certain Considerations--Need for Capital."
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23
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Sterile Recoveries, Inc.
We have audited the accompanying balance sheets of Sterile Recoveries,
Inc. as of December 31, 1995 and 1996 and the related statements of operations,
shareholders' equity and cash flows for the five months ended December 31,
1994, and years ended December 31, 1995 and 1996. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Sterile Recoveries,
Inc., as of December 31, 1995, and 1996 and the results of operations and cash
flows for the five months ended December 31, 1994 and years ended December 31,
1995 and 1996, in conformity with generally accepted accounting principles.
GRANT THORNTON LLP
Tampa, Florida
February 14, 1997
-21-
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
STERILE RECOVERIES, INC.
STATEMENTS OF OPERATIONS
(in thousands, except per share data)
YEARS ENDED FIVE MONTHS
DECEMBER 31, ENDED
---------------------------- DECEMBER 31,
1996 1995 1994
--------- -------- ------------
Revenues $ 32,168 $ 25,320 $ 9,285
Cost of revenues 21,764 17,659 6,550
-------- -------- --------
Gross profit 10,404 7,661 2,735
Distribution expenses 3,000 2,801 1,032
Selling and administrative expenses 4,734 3,975 2,162
-------- -------- --------
Income (loss) from operations 2,670 885 (459)
Interest expense 648 1,489 735
-------- -------- --------
Income (loss) before income taxes 2,022 (604) (1,194)
Income tax expense 190 -- --
-------- -------- --------
Net income (loss) $ 1,832 $ (604) $ (1,194)
======== ======== ========
Unaudited pro forma information
Historical net income (loss) $ 1,832 $ (604) $ (1,194)
Reduction to historical income
tax expense 74 -- --
-------- -------- --------
Pro forma net income (loss) $ 1,906 $ (604) $ (1,194)
======== ======== ========
Pro forma net income (loss) per
common share - primary $ 0.43 $ (0.17) $ (0.34)
======== ======== ========
Pro forma net income (loss) per
common share - fully dilutive $ 0.42 $ (0.17) $ (0.34)
======== ======== ========
The accompanying notes are an integral part of these financial statements.
-22-
25
STERILE RECOVERIES, INC.
BALANCE SHEETS
(in thousands, except share data)
December 31,
-----------------------------------------
1996 1995
----------- ----------
ASSETS
Cash $ 5,199 $ 252
Accounts receivable, net 5,253 3,389
Inventories 1,240 306
Prepaid expenses and other assets 530 303
Reusable surgical products, net of accumulated amortization of
$2,388 and $1,138, respectively 6,915 4,924
Property, plant and equipment, net 5,102 4,319
Goodwill, net 550 ---
Deferred income taxes 217 ---
-------- --------
Total assets $ 25,006 $ 13,493
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable--working capital facility $ -- $ 1,810
Notes payable--related parties 1,000 --
Accounts payable 1,360 1,167
Employee related accrued expenses 901 653
Other accrued expenses 989 568
Acquisition debt --- 9,081
-------- --------
Total liabilities 4,250 13,279
Commitments and contingencies --- ---
Shareholders' equity
Preferred stock--authorized 5,000,000 shares of $.001
par value; no shares issued and outstanding --- ---
Common stock--authorized 30,000,000 shares of $.001
par value; issued and outstanding 5,521,189 and
3,225,807 shares, respectively 6 3
Additional paid-in capital 19,376 2,009
Retained earnings (deficit) 1,374 (1,798)
-------- --------
Total shareholders' equity 20,756 214
-------- --------
Total liabilities and shareholders' equity $ 25,006 $ 13,493
======== ========
The accompanying notes are in integral part of these financial statements.
-23-
26
STERILE RECOVERIES, INC.
STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands, except for share data)
Common Stock Additional Retained
----------------------- Paid-in Earnings
Shares Amount Capital (Deficit) Total
------ ------ ------- --------- -----
Initial cash capitalization of
the Company 3,000,000 $ 3 $ 1,009 $ --- $ 1,012
Net loss ---- --- --- (1,194) (1,194)
--------- ------- --------- -------- --------
BALANCE AT DECEMBER 31, 1994 3,000,000 3 1,009 (1,194) (182)
Conversion of note payable 225,807 --- 1,000 --- 1,000
Net loss --- --- --- (604) (604)
--------- ------- --------- -------- --------
BALANCE AT DECEMBER 31, 1995 3,225,807 3 2,009 (1,798) 214
Issuance of common stock for cash 51,282 --- 300 --- 300
Acquisition of Surgipro 90,000 1 526 --- 527
Initial Public Offering net of
offering costs of
$1.1 million 2,150,000 2 17,926 --- 17,928
S Corp Shareholder Distribution --- --- (52) --- (52)
Recapitalization of Company for
change from S Corporation to
C Corporation --- --- (1,340) 1,340 ---
Exercise of stock options 4,100 --- 7 --- 7
Net income --- --- --- 1,832 1,832
---------- ------- ------- -------- --------
BALANCE AT DECEMBER 31, 1996 5,521,189 $ 6 $ 19,376 $ 1,374 $ 20,756
========== ======= ========= ======== ========
The accompanying notes are an integral part of this financial statement.
-24-
27
STERILE RECOVERIES, INC.
STATEMENTS OF CASH FLOW
(In thousands)
FIVE MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31,
------------------------- ------------
1996 1995 1994
-------- --------- ------------
Increase (decrease) in cash
Cash flows from operating activities
Net income (loss) $ 1,832 $ (604) $ (1,194)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 512 421 170
Amortization of reusable surgical products 1,258 764 274
Provision for reusable surgical products shrinkage 457 --- 100
Deferred income taxes (217) --- ---
Change in assets and liabilities (net of
business combination)
Accounts receivable (1,800) (94) 551
Inventories (728) (88) (90)
Prepaid expenses and other assets (94) (45) (258)
Accounts payable 71 487 401
Accrued expenses 439 272 820
-------- ---------- --------
Net cash provided by operating activities 1,730 1,113 774
-------- ---------- --------
Cash flows from investing activities
Proceeds from sale of assets from acquired company --- --- 1,530
Purchases of property, plant, and equipment (1,261) (278) (62)
Purchases of reusable surgical products (3,705) (820) (15)
Payment for acquisition of business, net of cash acquired 6 --- (5,012)
-------- ---------- ---------
Net cash used in investing activities (4,960) (1,098) (3,559)
-------- ---------- ---------
Cash flows from financing activities
Proceeds from initial capitalization of the Company --- --- 1,012
Proceeds from convertible demand notes 1,000 --- 1,000
Payments on related party debt (167) --- ---
Payments on acquisition debt (9,081) (800) ---
Net proceeds from working capital facility (1,810) 749 1,061
Proceeds from issuance of common stock 18,235 --- ---
-------- ---------- ---------
Net cash provided by (used in) financing activities 8,177 (51) 3,073
-------- ---------- ---------
Increase (decrease) in cash 4,947 (36) 288
Cash and cash equivalents at beginning of period 252 288 ---
-------- ---------- ---------
Cash and cash equivalents at end of period $ 5,199 $ 252 $ 288
======== ========== =========
Supplemental cash flow information
Cash paid for interest $ 697 $ 1,419 $ ---
======== ========== =========
Cash paid for income taxes $ 96 $ --- $ ---
======== ========== =========
Supplemental schedule of non-cash investing
activities:
Purchase of Surgipro (1996) and Amsco Sterile (1994)
Fair value of assets acquired $ 986 $ --- $ 15,300
Cash (paid) received 6 --- (5,012)
Common stock issued (526) --- ---
-------- ---------- ---------
Liabilities incurred or assumed $ 466 $ --- $ 10,288
======== ========== =========
Conversion of Convertible Demand Note into
225,407 shares of common stock $ --- $1,000,000 $ ---
======== ========== =========
The accompanying notes are an integral part of these financial statements.
-25-
28
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A--DESCRIPTION OF ORGANIZATION AND BUSINESS
Sterile Recoveries, Inc. ("SRI" or the "Company") was incorporated in
June 1994 in Florida to acquire all of the assets of its predecessor, AMSCO
Sterile Recoveries, Inc. ("Amsco Sterile") on July 31, 1994 (see Note D) (the
"Acquisition"). The Company's corporate office is located in Clearwater,
Florida.
SRI provides hospitals and surgery centers with a comprehensive
surgical procedure-based delivery and retrieval service for reusable gowns,
towels, drapes and basins, and, additionally provides disposable products
necessary for surgery. At seven regional facilities located in various states,
SRI collects, sorts, cleans, inspects, packages, sterilizes, and delivers its
reusable products on a just-in-time basis. While its emphasis is providing a
reusable surgical product delivery and retrieval service, the Company also
earns revenues from the sale of disposable surgical products, representing 7%
or less of total revenues for all periods presented herein. On February 26,
1996, the Company acquired Surgipro, Inc. ("Surgipro"), which became its
disposable products division, in order to expand its revenues from disposable
accessory packs containing small surgical items such as needles and sutures.
SRI contracts with third-party vendors for the weaving of microfiber
fabric and the cutting and sewing of gowns, wraps and drapes. A significant
percentage of the Company's business is dependent on its ability to obtain a
key component of its liquid-proof surgical products from one principal vendor.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial statement presentation
The statements of operations, cash flows and shareholders' equity
present the Company's initial five month period from August 1, 1994 through
December 31, 1994, as the Company had no assets or operations from June 1994
until the Acquisition, except for the Company's initial cash capitalization by
its three shareholders in July 1994.
The Company operates on a 52-53 week fiscal year ending the Sunday
nearest December 31. The financial statements reflect the Company's year-end
as December 31 for presentation purposes.
Use of estimates in financial statements
In preparing financial statements in conformity with generally
accepted accounting principles, management makes estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements, as
well as the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Cash equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. The Company has no
cash equivalents for any of the periods presented.
Inventories
Inventories consist principally of consumables, supplies, and
disposable surgical products since the acquisition of Surgipro (see Note D) and
are stated at the lower of cost or market; cost being determined on the
first-in, first-out method.
-26-
29
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Reusable surgical products
Reusable surgical products are stated at historical cost, net of
amortization. The products are amortized on a basis similar to the units of
production method. Estimated useful lives are based on the estimated total
number of available uses for each product. The expected total available usage
for its products using the three principal fabrics (accounting for 85% of its
products) are 75, 100, and 125 uses based on several factors including studies
performed by management. Based on current inventory (product) turnover, the
expected total available usage equates to a time period of approximately three
to seven years. The estimates, however, are subject to revision if actual
experience differs from the estimated available uses.
The Company has experienced minor amounts of shrinkage since August 1,
1994, with actual shrinkage currently ranging 1% - 1.5% of revenues. As of
December 31, 1996 and 1995, the Company has established a reserve for shrinkage
of $135,000 and $100,000, respectively, to account for the estimated amount of
product at customer locations which will not be returned to the Company. The
Company will continue to evaluate, at least quarterly, the actual shrinkage
experience and trends, and will review the shrinkage provision if deemed
necessary.
Property, plant and equipment
Property, plant and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets, or the term
of the related leases for leasehold improvements, if less than the useful
lives.
Goodwill
Goodwill, which resulted from the acquisition of Surgipro, is stated
at cost less accumulated amortization which is provided using the straight-line
method over 20 years.
Impairment of long-lived and intangible assets
On a quarterly basis, the Company evaluates the projected undiscounted
cash flows of each business unit (reusable and disposable) to determine, when
indicators of impairment are present, whether or not there has been permanent
impairment of its long-lived assets , and accrues expenses for the amount, if
any, determined to be permanently impaired. No impairment exists as of
December 31, 1996.
Revenues
Revenues are recognized as the agreed upon services (as described in
Note A of Notes to Financial Statements) which are delivered, generally daily.
The Company's revenues are principally generated from service agreements with
varying terms of one to three years, which are cancelable by either party,
generally with a 90-day notice. All reusable surgical products provided to a
customer under these agreements are used by the customer, but remain the
Company's property.
Income taxes
At the time of completion of the Offering in July 1996 (see Note C),
the Company terminated its S Corporation status, and became subject to
corporate income taxes. Accordingly, the financial statements present
historical income tax expense for 1996 and pro forma income tax expense for all
years presented (see Note L).
-27-
30
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Collectibility of accounts receivable
The Company grants credit to customers who meet pre-established credit
requirements. The Company does not require collateral when trade credit is
granted to customers. Credit losses have been less than $25,000 for each
period presented herein. The allowance for doubtful accounts at December 31,
1996 and 1995 is $35,000 and $21,000 respectively.
Fair value of financial instruments
The carrying amounts of cash, receivables, payables, accrued expenses
and notes payable approximate fair value because of the short-term nature of
the items.
Earnings per common share
Earnings per share for 1996 are computed using the weighted average
number of common shares plus common stock equivalents, consisting of options,
using the treasury stock method subsequent to the completion of the Offering
(prior to the Offering, all the common stock equivalents were deemed
outstanding) (see Note M).
Accounting for Stock-Based Compensation
Effective January 1, 1996, management elected to continue using the
method under Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," to account for stock option awards granted to employees.
As a result, Statement of Accounting Standards No. 123 (SFAS No. 123),
"Accounting for Stock-Based Compensation" proforma disclosures are required in
these financial statements. The adoption of SFAS No. 123's accounting and
reporting provisions had an insignificant effect on the Company's financial
statements (see Note K).
NOTE C-- PUBLIC OFFERING
On July 24, 1996, the Company completed the Offering of 2,000,000
shares of its Common Stock priced at $9.50 per share. The net proceeds of the
Offering, after deducting commissions of approximately $1,330,000 and
approximately $1,100,000 in expenses, were approximately $16,570,000. In
addition, the underwriters on August 9, 1996 exercised their overallotment
option to purchase 150,000 additional shares of the Company's Common Stock.
Proceeds to the Company of the underwriters' purchase of shares pursuant to
their exercise of the overallotment option were $1,325,250 after commissions.
The Company used approximately $11,000,000 of the proceeds to retire debt,
including $8,380,832 of debt owed to AMSCO Sterile and $2,139,759 of debt owed
to a lender, Metro Factors, Inc. The supplementary pro forma income per common
share for the period ending December 31, 1996 and December 31, 1995,
respectively, as if this debt has been retired at the beginning of the
respective period, would be $0.47 and $0.17 per share, assuming 5,103,246 and
4,664,623 primary weighted average common shares outstanding.
The underwriters also on August 9, 1996, exercised their overallotment
option to purchase 150,000 additional shares of Common Stock granted to them by
the Company's three founding shareholders. The Company did not receive any
proceeds from these transactions with its shareholders.
-28-
31
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE D--BUSINESS COMBINATIONS
Amsco Sterile Recoveries, Inc.
Effective July 31, 1994, the Company acquired from Amsco Sterile in
the Acquisition substantially all of its assets, principally reusable surgical
products, property, plant and equipment, and accounts receivable. Amsco
Sterile's parent was American Sterilizer Company, a subsidiary of AMSCO
International, Inc. Two of the Company's officers and major shareholders were
formerly executive officers of Amsco Sterile. The total consideration of
approximately $15,300,000 consisted of:
Cash $ 5,012,000
Acquisition debt to Amsco Sterile 9,871,000
Liabilities assumed 265,000
Direct acquisition costs 152,000
-----------
$15,300,000
===========
The cash was provided from: (i) $1,012,000 contributed by the
Company's three shareholders; (ii) $1,000,000 from a convertible note agreement
with an individual who became a director of the Company (see Note G); (iii)
$1,470,000 from the concurrent factoring of certain acquired accounts
receivable; and (iv) $1,530,000 from the concurrent sale of one of the
facilities acquired from Amsco Sterile, including reusable surgical products,
to an unrelated third party.
The acquisition was accounted for as a purchase transaction. The
purchase cost was allocated based on the fair value of the net assets acquired
or estimated amounts expected to be received upon disposal, as follows:
Accounts receivable $ 3,847,000
Inventories 127,000
Reusable surgical products 5,226,000
Property, plant and equipment 4,570,000
-----------
13,770,000
Assets sold concurrently 1,530,000
-----------
$15,300,000
===========
The Company's active operations commenced upon the acquisition of
Amsco Sterile's business on July 31, 1994; therefore, the statement of
operations includes the acquired business' operating results from August 1,
1994.
Surgipro
In February 1996, the Company purchased the operations of Surgipro.
The Company paid consideration of approximately $600,000, consisting of 90,000
shares of the Company's Common Stock valued at $526,500 and a note payable of
approximately $109,000, which was paid at the completion of the offering, for
approximately $500,000 of assets and the assumption of approximately $400,000
of liabilities. This acquisition was accounted for as a purchase transaction
and, accordingly, the purchase price was allocated to the assets and
liabilities based upon their estimated fair values at the time of the
acquisition, with the excess of approximately $574,000 being allocated to
goodwill. The results of operations are included in the accompanying Statement
of Operations from the acquisition date.
-29-
32
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following unaudited pro forma financial information assumes the
purchase had occurred at the beginning of the respective periods after the
effect of certain pro forma adjustments including, among others, adjustments to
reflect amortization of goodwill. The pro forma information is presented for
informational purposes only and may not be indicative of actual results had the
purchase occurred at the beginning of the respective periods.
Years Ended
December 31, December 31,
------------ -------------
1996 1995
------------ -------------
(Unaudited)
Revenues $ 32,281,858 $ 26,315,051
Net income (loss) $ 1,875,019 $ (683,968)
Net income (loss) per common share - primary $ 0.42 $ (0.19)
NOTE E--PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
December 31,
Useful Lives -------------------------------------
in Years 1996 1995
------------- ------------ -----------
Land and buildings 38 $ 324,474 $ 314,369
Leasehold improvements 2-18 1,323,655 1,300,698
Machinery and equipment 3-12 4,035,436 2,928,415
Office furniture and equipment 5-10 497,593 366,390
-------------- --------------
6,181,158 4,909,872
Less: Accumulated depreciation and amortization 1,078,890 591,032
-------------- --------------
$ 5,102,268 $ 4,318,840
============== ==============
NOTE F--LINE OF CREDIT
The Company has established with First Union National Bank of Florida
a $15 million unsecured revolving credit facility that will expire in August
1999. The facility imposes certain financial covenants. Beginning January 1,
1997, total outstanding borrowings under the facility are limited to three
times the Company's earnings before interest, taxes, depreciation, and
amortization (EBITDA) for the previous four quarters (declining to two and
one-half times by the third year). The facility also imposes a covenant
concerning the maintenance during the 1996 year of minimum tangible net worth
of $18,750,000. The minimum net worth requirement increases to $19,245,000 for
1997 and to $20,745,000 for 1998. Thereafter, the minimum net worth
requirement will be $23,745,000. Pursuant to the terms of the credit facility,
the Company may elect to convert up to $5 million of the available facility
into term loans for capital expenditures that are ratably payable over five
years, and are secured by the equipment acquired with these loans. All
borrowings accrue interest at the London Interbank Offering Rate (LIBOR) plus
200 basis points (7.45% as of December 31, 1996). The facility restricts the
declaration of dividends and prohibits the Company from encumbering its assets.
Currently, there are no borrowings under this credit facility.
-30-
33
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE G--NOTES PAYABLE--RELATED PARTIES
Convertible Demand Promissory Notes
In conjunction with the Acquisition, the Company borrowed $1,000,000
from a director of the Company pursuant to a secured Convertible Demand
Promissory Note which accrued interest at 12% per annum. In September, 1995,
the note was converted into 225,807 shares of Common Stock at an effective
conversion price of $4.43 per share.
In March 1996, the Company borrowed $1,000,000 from a director
pursuant to an 8.5% Convertible Demand Promissory Note secured by a first lien
on the Company's Houston, Texas facility and the equipment located at the
facility. Beginning on March 1, 1997, the Convertible Note becomes payable on
demand and may be redeemed by the Company for face value. At any time before
that date, $750,000 of the Convertible Note is convertible to Common Stock at
$5.85 per share. The $250,000 balance is not convertible and is payable on
maturity. The Convertible Note has a stated interest rate of 8.5%. Seven
hundred fifty thousand dollars ($750,000) of the note was converted on February
24, 1997.
The Company incurred interest expense related to the demand notes of
approximately $71,000, $70,000 and $50,000, respectively, for the years ended
December 31, 1996 and 1995 and the five-months ended December 31, 1994.
NOTE H--ACQUISITION DEBT
Acquisition debt consisted of a Purchase Money Note with Amsco Sterile
in the amount of $9,080,832 as of December 31, 1995, collateralized by all
Company assets, excluding accounts receivable and real and personal property at
the Houston, Texas facility. The note required monthly principle payments of
$100,000 through July 1997 with a balloon payment due August 1997, and monthly
interest payments at a bank's prime rate plus 1.5% (8.75% as of December 31,
1995). The Purchase Money Security Agreement with Amsco Sterile contained
various financial related covenants, including, among other things, limiting in
1996 the Company's total allowed capital expenditures and general indebtedness
to approximately $4,400,000 and $18,600,000, respectively. In addition,
certain limitations existed as to the permitted amount of Common Stock
dividends and distributions. The entire debt to Amsco Sterile was paid in 1996
from proceeds of the Offering and Amsco Sterile released its lien on the
Company's assets.
Interest expense for the years ended December 31, 1996 and 1995, and
the five months ended December 31, 1994 totaled $499,409, $977,711 and
$378,758, respectively.
NOTE I--COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases offices, facilities and distribution vehicles under
non-cancelable operating leases with terms ranging from one year to nine years.
The office and processing facility leases contain various renewal options and
escalating payments. At present, the Company intends to exercise certain
aspects of these renewal options when the initial term expires. The vehicle
leases contain contingent rentals based on mileage.
-31-
34
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease payments as of December 31, 1996 under leases in
excess of one year are as follows:
Year ending
1997 $1,388,636
1998 1,210,752
1999 1,033,894
2000 970,504
2001 915,110
Thereafter 627,399
----------
Total $6,146,295
==========
Rental expense for years ended December 31, 1996 and 1995 and the
five-month period ended December 31, 1994 totaled $1,960,346, $1,866,246 and
$815,235 (including contingent rentals of approximately $228,000, $230,000, and
$100,000), respectively.
Legal Proceedings
Neither the Company nor any of its property is subject to any
litigation or other legal proceedings expected to have a material effect on the
Company or its business.
Management Incentive Plan
In 1995, the Company established a Management Incentive Plan. The
incentives were based on various performance factors and are adjusted to
reflect the Company's overall performance as determined by the Board of
Directors. Payment of the cash incentives is made at the end of the second
month after the end of the incentive year. The participant must still be an
employee of the Company at that time. Approximately $375,000 and $195,000 of
estimated incentives were recognized during the years ended December 31, 1996
and 1995, respectively.
Financial Consultant Agreement
In accordance with a financial consulting agreement dated October 18,
1995 with an individual who later became a director, upon the successful
completion of the offering, approximately $227,000 cash remuneration was paid
to the director. Because payment for the consultation services was contingent
upon successful completion of the offering, which was uncertain, no amounts
were recognized until July 1996, when the Offering was completed.
Management Employment Agreements
In 1996, the Board approved employment agreements with four
executives and one other employee in which each person would receive severance
pay equal to two years of base salary in the event that the executive or
employee is terminated following a change in control of the Company.
NOTE J--SHAREHOLDERS' EQUITY
Common Stock
Subject to preferences which might be applicable to any outstanding
Preferred Stock, the holders of the Common Stock are entitled to receive
dividends when, as, and if declared from time to time by the Board of Directors
out of funds legally
-32-
35
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
available. In the event of liquidation, dissolution, or winding-up of the
Company, holders of the Common Stock are entitled to share ratably in all
assets remaining after payment of liabilities subject to prior distribution
rights of any Preferred Stock then outstanding. The Common Stock has no
preemptive or conversion rights and is not subject to call or assessment by the
Company. There are no redemption or sinking fund provisions applicable to the
Common Stock.
Preferred Stock
The Company is authorized to issue 5,000,000 shares of Preferred
Stock, $.001 par value per share. The Board of Directors has the authority,
without any further vote or action by the Company's shareholders, to issue
Preferred Stock in one or more series and to fix the number of shares,
designations, relative rights (including voting rights), preferences, and
limitations of those series to the full extent now or hereafter permitted by
Florida law. The Company believes that this power to issue Preferred Stock
will provide flexibility in connection with possible corporate transactions.
The issuance of Preferred Stock, however, could adversely affect the voting
power of holders of Common Stock and restrict their rights to receive payments
upon liquidation and could have the effect of delaying, deferring, or
preventing a change in control of the Company. The Company has no present
intention to issue shares of Preferred Stock, although it may determine to do
so in the future.
NOTE K--STOCK OPTIONS
The Company maintains two stock option plans, the 1995 Stock Option
Plan (the "Employee Plan") and the Company's 1996 Non-Employee Director Plan
(the "Non-Employee Plan").
The Employee Plan
The Employee Plan provides employees with incentive or non-qualified
options to purchase up to 500,000 shares of Common Stock. On December 21,
1995, the Company granted non-qualified stock options covering a total of
94,000 shares of Common Stock to various employees at an exercise price of
$5.85 per share. The exercise price represented the estimated fair value of
the Company's Common Stock at the time of the grant, as approved by the Board
of Directors based upon various factors including an independent third-party
firm's valuation. None of the options vested until completion of the
Offering, and are then vested ratably over the four-year period following the
completed Offering. At the completion of the Offering, all employees as a
group who participated in the Employee Plan were also granted options to
purchase a total of 219,500 shares of Common Stock at the initial offering
price per share of $9.50. Included in these options are 70,000 options to an
employee who is also a director of the Company. On August 22, 1996, 15,000
shares at $12.69 per share were granted to an employee. Each of these options
vests ratably over the five-year period. All outstanding options vest upon the
change in control of the Company. Options granted under the Employee Plan
expire no later than ten years after the date granted or sooner in the event of
death, disability, retirement or termination of employment.
The Non-Employee Plan
The Non-Employee Plan provides for the grant of non-qualified stock
options to purchase up to 100,000 shares of Common Stock to members of the
Board of Directors who are not employees of the Company. As of the date of
these financial statements, such members held no options under the Non-Employee
Plan. At the completion of the Offering, each non-employee director was
granted options to purchase 4,000 shares of Common Stock for each full
remaining year of the director's term at the offering price of $9.50 per share.
Thereafter, on the date on which a new non-employee director is first elected
or appointed, he will automatically be granted options to purchase 4,000 shares
of Common Stock for each year of his initial term. Each non-employee director
will be granted options to purchase 4,000 shares of Common Stock for each year
of any subsequent term to which he is elected. All options become
-33-
36
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
exercisable ratably over the director's term and have an exercise price equal
to the fair market value of the Common Stock on the date of grant.
Other Stock Options
In March 1995, in conjunction with an employment termination and the
potential that the former employee may be a future independent sales
representative for the Company, 12,500 options at $1.00 a share exercise price
were granted to the individual. The option term is for 10 years and includes a
put option whereby the Company could be required to buy back the option at the
net book value per share of the Company's Common Stock at the preceding year
end value, less $1.00 a share. The value of the buy back is insignificant to
the financial statements.
In October 1995, in conjunction with a financial consulting
arrangement with an individual who has become a director and an officer of the
Company, the Company granted the individual a non-qualified stock option for
66,000 shares of its Common Stock at an exercise price of $4.43 a share which
were exercisable as follows: (1) 22,000 shares upon the completion of an
interim financing (completed in March 1996); and (2) 44,000 at the completion
of an initial public offering. The exercise price was determined by the
Board of Directors to approximate the estimated fair value of the Company's
Common Stock at the date of grant based on various factors, including the
Company's history of operating losses.
On May 2, 1996, the Company issued to a recently appointed director,
an option to purchase 7,500 shares of the Company's Common Stock for $8.00 per
share, which vests one-third on completion of the offering, one-third at the
1997 annual meeting of shareholders, and one-third at the 1998 annual meeting
of shareholders.
The Company has adopted only the disclosure provisions of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation," as it
relates to employment awards. It applies APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
plans and does not recognize compensation expense for its stock-based
compensation plans other than for restricted stock. If the Company had elected
to recognize compensation expense based upon the fair value at the grant date
for awards under these plans consistent with the methodology prescribed by SFAS
123, the Company's net income (loss) and earnings (loss) per share would be
reduced to the pro forma amounts indicated below:
1996 1995
---- ----
Net income (loss) As reported $1,906 $ (604)
Pro forma (unaudited) $1,731 $ (608)
Primary earnings (loss) per share As reported $ 0.43 $ (0.17)
Pro forma (unaudited) $ 0.39 $ (0.17)
Fully diluted earnings (loss) per share As reported $ 0.42 $ (0.17)
Pro forma (unaudited) $ 0.38 $ (0.17)
The fair value of each option grant is estimated on the date of grant using the
Binomial options-pricing model with the following weighted-average assumptions
used for grants in 1996 and 1995, respectively, no dividend yield for all
years, expected volatility of 32 and 38 percent; risk-free interest rates of
5.64 and 6.52 percent, and expected lives of 3.8 and 3.7 years.
-34-
37
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the status of the Company's fixed stock option plan as of December
31, 1996 and 1995, and changes during the years ending on those dates is
presented below:
Weighted
Average
Exercise
Shares Price
------ -------
Balance as of July 31, 1994 and December 31, 1994 --- ---
Granted 172,500 $4.96
Exercised --- ---
Forfeited --- ---
-------
Outstanding as of December 31, 1995 172,500 $4.96
Granted 258,000 $9.64
Exercised (4,100) $1.71
Forfeited (2,400) $5.85
-------
Outstanding as of December 31, 1996 424,000 $7.83
=======
The following table summarizes information concerning currently outstanding
and exercisable stock options:
OUTSTANDING SHARES
Weighted Average
Remaining
Range of Number Contractual Life Weighted Average
Exercise Prices Outstanding (years) Exercise Price
--------------- ----------- ---------------- --------------
$1.00 9,000 8.3 $1.00
$4.43 - 5.85 157,000 8.9 $5.25
$8.00 - 9.50 243,000 9.5 $9.45
$12.69 15,000 9.6 $12.69
EXERCISABLE SHARES
$ 1.00 9,000 $1.00
$ 4.43 - 5.85 84,200 $4.74
$ 8.00 - 9.50 2,500 $8.00
$12.69 --- ---
NOTE L--INCOME TAX
Historical Income Taxes
In accordance with the provisions of the Internal Revenue Code, upon
the conversion to a C Corporation, a portion of the income earned after the
conversion was allocated to the S Corporation. As a result of this allocation,
the effective rate for calculating income taxes is lower than the statutory
rates. In addition, the accounting rules require the establishment of deferred
-35-
38
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
taxes for all existing temporary differences in the Company's assets' and
liabilities' basis for income and financial reporting purposes at the date of
conversion to a C Corporation. The Company recorded deferred tax assets of
approximately $200,000 at the date of conversion.
Recorded income tax expense for the twelve-months ended December 31,
1996 is as follows:
Income taxes currently payable $ 407,000
Income tax benefit deferred (217,000)
---------
Income tax expense $ 190,000
=========
Reconciliation of the federal statutory income tax rate of 34.0% to
the effective income tax rate for the year ended December 31, 1996, is as
follows:
Federal statutory income tax rate 34.0%
State income taxes, net of federal 4.5
Net earnings allocated to the S Corporation period (21.3)
Deferred tax asset previously not recognized (10.7)
Other, net 2.9
------
9.4%
======
Deferred tax asset and liability components were as follows as of December 31,
1996:
Deferred tax assets:
Inventory shrinkage reserve $ 52,000
Health insurance reserve 64,000
Vacation pay accrued 56,000
Other 45,000
---------
217,000
Deferred tax liabilities ---
---------
Net deferred income taxes $ 217,000
=========
The deferred tax asset was established upon the completion of the Offering (see
Note B). No valuation allowance has been established as management considers
the utilization of the deferred tax asset probable.
Pro forma income taxes
In conjunction with the completion of the Offering, the Company
terminated its S Corporation status. For pro forma income tax purposes only,
the S Corporation's cumulative net operating losses as of December 31, 1995 of
approximately $1.6 million have been treated as C Corporation net operating
losses, and accordingly, used to reduce pretax earnings in 1996. For all
periods presented, the Company chose to recognize only the tax benefit
equivalent to the amount used to eliminate the pro forma income tax expense,
and no additional tax benefits (deferred tax assets) for the remaining or
unused net operating loss carryforward have been recognized for any of the
periods presented, because the Company's operating profit history has been
limited.
-36-
39
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Reconciliation of the income tax expense (benefit) calculated using
the federal statutory income tax rate of 34% to the income tax expense recorded
is as follows:
Five Months
Years Ended Ended
December 31, December 31,
--------------------- ------------
1996 1995 1994
-------- ------- -------------
Federal income taxes (benefit) at statutory rate $ 687,000 $(205,000) $ (406,000)
State income taxes, net of federal benefit 91,000 (27,000) (54,000)
Net operating losses not currently utilizable --- 229,000 454,000
Utilization of net operating loss carryforwards (683,000) --- ---
Other 21,000 3,000 6,000
--------- --------- ----------
Income tax expense $ 116,000 $ --- $ ---
========= ========= ==========
NOTE M--WEIGHTED AVERAGE COMMON SHARES
Pro forma net income (loss) per common share is computed by dividing
pro forma net income (loss) by the weighted average number of shares of common
stock and common stock equivalents outstanding. Pro forma net income (loss)
includes a pro forma provision for income taxes assuming the Company had been
subject to income taxes during the period it was an S Corporation for income
tax purposes. All Common Stock and options issued within one year prior to the
Company's offering are deemed outstanding for all periods prior to becoming a
publicly-held company. In addition, the Company assumed that the Convertible
Demand Promissory Note issued March 1996 (see Notes F and L) would be converted
prior to or concurrently with the Offering and accordingly, the resulting
shares of Common Stock are included in the net income (loss) per common share
calculation (actually converted on February 24, 1997 (unaudited)). The Company
used the treasury stock method to calculate the Common Stock equivalents that
the stock options would represent. The additional shares assumed outstanding
in the calculation of income (loss) per common share, relate primarily to the
Common Stock issued as described in the Statement of Shareholders' Equity and
Notes C, D and K of the financial statements and the previously described
convertible notes.
-37-
40
STERILE RECOVERIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1995 1994
------------ ----------- ------------
PRIMARY
- -------
Actual weighted average shares outstanding 4,300,125 3,094,086 3,000,000
Additional shares 173,165 418,729 512,815
--------- --------- ---------
Weighted average shares used in income per share
calculation - primary 4,473,290 3,512,815 3,512,815
========= ========= =========
FULLY DILUTED
- -------------
Actual weighted average shares outstanding 4,300,125 3,094,086 3,000,000
Additional shares 274,361 418,729 512,815
--------- --------- ---------
Weighted average shares used in income per share
calculation - fully diluted 4,574,486 3,512,815 3,512,815
========= ========= =========
NOTE N--RELATED PARTY TRANSACTIONS
The Company paid $55,807, $8,000 and $4,000 in 1996, 1995 and 1994 to
a company, which is owned by a director and shareholder of the Company, to
design and supply the components for water reclamation systems for two Company
facilities, and expects to pay an additional $190,000 in 1997 to design and
supply components for its remaining five facilities.
During 1996, 1995 and 1994, the Company paid approximately $257,000,
$22,000 and $93,000, respectively, to the Company's corporate law firm, a
member of which is a shareholder of the Company.
-38-
41
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Sterile Recoveries, Inc.
We have audited the accompanying statement of operations of Amsco
Sterile Recoveries, Inc. (a wholly-owned subsidiary of American Sterilizer
Company and predecessor to Sterile Recoveries, Inc.) and the related statement
of cash flows for the seven months ended July 31, 1994. These financial
statements are the responsibility of management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the results of operations of Amsco Sterile
Recoveries, Inc. and cash flows for the seven months ended July 31, 1994, in
conformity with generally accepted accounting principles.
GRANT THORNTON LLP
Tampa, Florida
May 10, 1996
-39-
42
AMSCO STERILE RECOVERIES, INC.
(PREDECESSOR TO STERILE RECOVERIES, INC.)
STATEMENT OF OPERATIONS
SEVEN MONTHS ENDED JULY 31, 1994
Revenues
Reusable surgical products service $12,069,411
Cost of revenues 14,091,339
-----------
Gross profit (deficit) (2,021,928)
Distribution expenses 1,309,603
Selling and administrative expenses 7,374,720
-----------
Loss from operations (10,706,251)
Interest expense 4,790,888
-----------
Loss before income taxes (15,497,139)
Income taxes ---
------------
Net loss $(15,497,139)
============
The accompanying notes are an integral part of this financial statement.
-40-
43
AMSCO STERILE RECOVERIES, INC.
(PREDECESSOR TO STERILE RECOVERIES, INC.)
STATEMENT OF CASH FLOWS
SEVEN MONTHS ENDED JULY 31, 1994
Increase (decrease) in cash
Cash flows from operating activities
Net loss $(15,497,139)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,388,032
Amortization of reusable surgical products 2,564,912
Provision for reusable surgical product shrinkage 950,747
Change in assets and liabilities:
Accounts receivable (1,609,963)
Prepaid expenses and other assets (450,646)
Accounts payable 49,955
Accrued expenses 23,804
Accrued restructuring (549,014)
------------
Net cash used in operating activities (13,129,312)
------------
Cash flows from investing activities
Purchases of property, plant and equipment (1,390,265)
Purchases of reusable surgical products (5,125,698)
------------
Net cash used in investing activities (6,515,963)
Cash flows from financing activities
Advances and loans (net) from parent 19,752,400
------------
Net cash provided by financing activities 19,752,400
------------
Increase in cash 107,125
Cash at beginning of period 40,189
------------
Cash at end of period $ 147,314
============
Supplemental cash flow information
Cash paid for interest (accrued through intercompany charges) $ 4,790,888
============
The accompanying notes are an integral part of this financial statement.
-41-
44
AMSCO STERILE RECOVERIES, INC.
(PREDECESSOR TO STERILE RECOVERIES, INC.)
NOTES TO FINANCIAL STATEMENTS
NOTE A--DESCRIPTION OF ORGANIZATION AND BUSINESS
AMSCO Sterile Recoveries, Inc. ("Amsco Sterile") was a wholly-owned
subsidiary of American Sterilizer Company, a Pennsylvania corporation whose
parent, AMSCO International, Inc. ("AMSCO"), was a Delaware corporation. The
Amsco Sterile corporate headquarters were located in Clearwater, Florida.
Amsco Sterile commenced business in September 1991 when it acquired
Amsco Sterile's predecessor, a Delaware corporation, which at that time had no
assets or liabilities, except for exclusive rights under a distribution
agreement with a manufacturer of certain fabric material used in Amsco
Sterile's products.
Amsco Sterile provided hospitals and surgery centers with a
comprehensive surgical procedure-based delivery and retrieval service for
reusable gowns, towels, drapes and basins, necessary for surgery. At regional
facilities located in various states, Amsco Sterile collected, sorted, cleaned,
inspected, packaged, sterilized, and delivered its reusable products on a
just-in-time basis.
Amsco Sterile contracted with third-party vendors for the weaving of
microfiber fabric and the cutting and sewing of gowns, wraps, and drapes.
Amsco Sterile's business was substantially dependent on its ability to obtain a
key component of its surgical products from two principal vendors.
Effective July 31, 1994, Amsco Sterile consummated a sale of all its
assets to Sterile Recoveries, Inc. (see Note B).
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial statement presentation
Amsco Sterile maintained separate books and records as its operations
were generally on the stand-alone basis as it related to its affiliated group,
except that Amsco Sterile was solely dependent on its parent to finance its
operations through intercompany loans and advances, and Amsco Sterile and its
parent had many common customers. The accompanying financial statements
therefore may not necessarily be indicative of the results of operations which
would be obtained if Amsco Sterile had operated exclusively as an independent
entity.
The statement of operations reflects the interest charged by AMSCO on
the intercompany debt. The other services provided by AMSCO that are material
have been included in the financial statements (see below). While Amsco
Sterile was part of AMSCO's consolidated income tax return, Amsco Sterile's
income tax provision herein is determined on the separate return basis (see
note E).
AMSCO's Board of Directors, on June 23, 1994, approved a plan to
divest or wind-down Amsco Sterile's business and engaged a nationally
recognized investment banking firm to solicit bids to purchase Amsco Sterile.
AMSCO's decision was based on the difficulties encountered in achieving Amsco
Sterile's growth objectives in the healthcare environment existing at that
time. In connection with this divestment plan, Amsco Sterile consummated the
sale of substantially all of its assets on July 31, 1994 to a newly formed
company, Sterile Recoveries, Inc. (the "Successor"), a Florida corporation,
owned by two former executive officers of Amsco Sterile and another individual.
These two former executive officers were also the founders and stockholders of
Amsco Sterile's predecessor in September 1991 (see Note A). The purchase price
totaled approximately $14,883,000 (exclusive of assumed liabilities of
$265,000), consisting of cash of $5,012,000 and a purchase money note of
$9,871,000. The purchase price was substantially less than the recorded cost
of the assets disposed.
-42-
45
AMSCO STERILE RECOVERIES, INC.
(PREDECESSOR TO STERILE RECOVERIES, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The accompanying financial statements do not contain any adjustments
such as writedown of assets or establishment of reserves resulting from AMSCO's
decision to discontinue Amsco Sterile's operations and/or to sell most of the
assets effective July 31, 1994.
Use of estimates in financial statements
In preparing financial statements in conformity with generally
accepted accounting principles, management made estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements, as
well as the reported amounts of revenues and expenses during the reporting
period. Actual results could have differed from those estimates.
Revenues
Revenues were recognized as the agreed upon services, as described in
Note A to the financial statements, were delivered, which is generally daily.
Amsco Sterile's revenues were principally generated from service agreements
with varying terms of one to three years, which were cancelable by either
party, generally with a 90-day notice. All reusable surgical products provided
to the customers under these agreements, were used by the customer, but
remained Amsco Sterile's property.
Depreciation of property, plant and equipment
Depreciation and amortization is provided using the straight-line
method over the estimated useful lives of the assets: 40 years for buildings;
5-20 years for leasehold improvements; 3-12 years for machinery and equipment;
and 5-10 years for office furniture and equipment. Leasehold improvements are
amortized using the lesser of the asset's useful lives or the lease term.
Management on a quarterly basis reviewed the Company's actual and
projected operations and cash flows on an overall basis and by facility to
ascertain whether or not any permanent impairment in the carrying value of its
assets should be recognized. No impairment has been recognized in the
financial statements.
Amortization of reusable surgical products
The products were amortized on a basis similar to the unit of
production method. Estimated useful lives were based on the estimated total
number of available uses for each product. The expected total available usage
for its products using the three principal fabrics (accounting for 85% of its
products) are 75, 100, and 125 uses based on several factors including studies
performed by management. Based on current inventory (product) turnover, the
expected total available usage equates to a time period of approximately three
to seven years. The estimates, however, are subject to revision if actual
experience differs from the estimated available uses.
In addition to the amortization of the reusable surgical products,
Amsco Sterile provided for shrinkage of the product. The provision was
generally 8% of revenues and was based on management estimates.
Management on a quarterly basis reviewed the Company's actual and
projected operations and cash flows on an overall basis and by facility to
ascertain whether or not any permanent impairment in the carrying value of its
assets should be recognized. No impairment has been recognized in the
financial statements.
-43-
46
AMSCO STERILE RECOVERIES, INC.
(PREDECESSOR TO STERILE RECOVERIES, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Goodwill amortization
Goodwill amortization is provided using the straight-line method over
40 years. The goodwill is related to the purchase of Amsco Sterile's
predecessor and is accounted for at the subsidiary level using push-down
accounting by AMSCO.
Management on a quarterly basis reviewed the Company's actual and
projected operations and cash flows on an overall basis and by facility to
ascertain whether or not any permanent impairment in the carrying value of its
assets should be recognized. No impairment has been recognized in the
financial statements.
NOTE C--RELATED PARTY TRANSACTIONS
Administrative costs
AMSCO charged fees to Amsco Sterile to develop certain computer
software for Amsco Sterile's use. Such fees allocated by AMSCO, based on
estimates of actual time incurred, which management believed to be a reasonable
allocation method, aggregated approximately $400,000 for the seven months
ended July 31, 1994. AMSCO also processed payroll, collected Amsco Sterile's
accounts receivable and performed computer processing for Amsco Sterile at no
charge to Amsco Sterile. No estimate of these costs has been reflected in
these financial statements as management believed that the amounts were not
material to the financial statements.
Interest expense
AMSCO charged Amsco Sterile interest monthly on borrowings made by
Amsco Sterile based upon the average balance owed to AMSCO at a rate comparable
to that which is paid by AMSCO on its borrowings (approximately 9% at July 31,
1994). Amsco Sterile's management believed the interest allocation method was
reasonable.
NOTE D--RESTRUCTURING
Amsco Sterile decided by December 31, 1993 to close three of its
facilities and reduce some of its workforce in 1994, consequently Amsco Sterile
recorded a $1,550,000 restructuring provision in 1993 consisting of (1)
$900,000 for lease termination charges; (2) $300,000 for severance and
relocation costs; and (3) $350,000 for various other matters. Through July 31,
1994, approximately $550,000 of these items were paid.
NOTE E--INCOME TAXES
Amsco Sterile's tax provision was determined on a separate return
basis.
Amsco Sterile incurred substantial losses since inception. In
addition, substantially all of Amsco Sterile's assets were sold on July 31,
1994 for an amount which was less than the assets' carrying values. The
statements of operations do not reflect any income tax benefits for Amsco
Sterile's losses as, under the circumstances described above and in Note B to
the financial statements, none have been realized.
-44-
47
AMSCO STERILE RECOVERIES, INC.
(PREDECESSOR TO STERILE RECOVERIES, INC.)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE F--COMMITMENTS
The terms of the acquisition agreement with Amsco Sterile's
predecessor also included additional consideration under the terms of an
earn-out provision based on net profits of the Company through December 31,
1996. Because of the substantial losses incurred since the original
acquisition in September 1991 through July 31, 1994, there have been no
adjustments to the original purchase price.
NOTE G--OPERATING LEASES
Amsco Sterile leased offices, facilities and distribution vehicles
under non-cancelable operating leases with terms ranging from one year to 10
years. The office and processing facility leases contained various renewal
options and escalating payments. The vehicle leases contained contingent
rentals based on mileage.
Total rental expense for the seven months ended July 31, 1994
aggregated approximately $670,000 (including contingent rentals of
approximately $155,000).
NOTE H--EMPLOYEE BENEFIT PLANS
Employees of Amsco Sterile were entitled to participate in the benefit
plans of AMSCO. AMSCO's plans consisted of the following:
AMSCO Employees' Retirement Account
AMSCO administered the AMSCO Employees' Retirement Account (the
"Plan"), which is a qualified employee stock ownership plan.
The Plan enabled eligible employees, including Amsco Sterile's
management, to receive an equity participation in AMSCO. Contributions
declared by the Board of Directors, up to a maximum of 25% of eligible
employee compensation, were made to the Plan. The Plan in turn used
the funds to purchase shares of the AMSCO's stock or make investments
in certain other securities.
AMSCO Pension Plan
AMSCO had a defined benefit pension plan which covered substantially
all domestic union employees and provided pension benefits of stated
amounts for each year of the employee's service. The following table
sets forth the pension plan's funded status at December 31, 1993
(date of last available data).
Actuarial present value of benefit obligations
Vested $(29,421,000)
Nonvested (982,000)
-------------
Projected benefit obligation (equal to the
accumulated benefit obligation) (30,403,000)
Plan assets at fair value 26,462,000
-------------
Plan assets less than projected
benefit obligation $ (3,941,000)
=============
-45-
48
AMSCO STERILE RECOVERIES, INC.
(PREDECESSOR TO STERILE RECOVERIES, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Amsco Sterile's expenses relating to these benefit plans were
approximately $243,000 in 1994, and were based on the allocation of the expense
directly related to Amsco Sterile's participating employees. Management
believes that the allocation method is reasonable.
-46-
49
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
ON FINANCIAL SCHEDULE
Board of Directors
Sterile Recoveries, Inc.
In connection with our audit of the financial statements of Sterile
Recoveries, Inc., referred to in our report dated February 14, 1997, which is
included in this Annual Report on SEC Form 10-K for the year ended December
31, 1996, we have also audited Schedule II for the five months ended
December 31, 1994 and the years ended December 31, 1995 and 1996. In our
opinion, this schedule presents fairly, in all material respects, the
information required to be set forth therein.
GRANT THORNTON LLP
Tampa, Florida
February 14, 1997
-47-
50
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
STERILE RECOVERIES, INC.
BALANCE CHARGED TO BALANCE
BEGINNING COSTS AND DEDUCTIONS AT END
DESCRIPTION OF PERIOD EXPENSES (DESCRIBE) OF PERIOD
----------- --------- ---------- ---------- ---------
Five months ended December 31, 1994:
Allowance for doubtful
accounts $ --- $ 6,000 $ --- $ 6,000
Year ended December 31, 1995:
Allowance for doubtful
accounts $ 6,000 $25,000 $(10,000) (1) $ 21,000
Year ended December 31, 1996:
Allowance for doubtful
accounts $ 21,000 $34,000 $(20,000) (1) $ 35,000
(1) Write-offs of uncollectible accounts
-48-
51
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
ON FINANCIAL SCHEDULE
Board of Directors
Sterile Recoveries, Inc.
In connection with our audit of the financial statements of Amsco
Sterile Recoveries, Inc., referred to in our report dated May 10, 1996, which
is included in this annual report on SEC Form 10-K for the year ended December
31, 1996, we have also audited Schedule II for the seven months ended July 31,
1994. In our opinion, this schedule presents fairly, in all material respects,
the information required to be set forth therein.
GRANT THORNTON LLP
Tampa, Florida
May 10, 1996
-49-
52
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
AMSCO STERILE RECOVERIES, INC.
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND DEDUCTIONS AT END
DESCRIPTION OF PERIOD EXPENSES (DESCRIBE) OF PERIOD
----------- --------- ---------- ---------- ---------
Seven Months ended July 31, 1994:
Allowance for doubtful accounts $ 25,000 $ 125,000 -- $ 150,000
-50-
53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item concerning the Company's
executive officers and directors is incorporated by reference to the
information set forth under the captions "Proposal No. 1: Election of
Directors" and "Other Information" in the Company's Proxy Statement for the
1997 Annual Meeting of Shareholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
the information set forth under the caption "Executive Officer Compensation" in
the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to
the information set forth under the caption "Other Information" in the
Company's Proxy Statement for the 1997 Annual Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to
the information set forth under the caption "Certain Relationships" in the
Company's Proxy Statement for the 1997 Annual Meeting of Shareholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
The Company did not file a Report on Form 8-K during the last quarter
of 1996.
Exhibits
The following exhibits are filed as part of this report:
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54
EXHIBITS INDEX
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------ -------------------
2.1(1) Asset Purchase Agreement dated July 31, 1994, between the Company and
Amsco Sterile Recoveries, Inc.
2.2(1) Agreement and Plan of Merger dated as of February 26, 1996, between Surgipro,
Inc. and the Company.
2.3(1) Articles of Merger dated as of February 26, 1996, between Surgipro, Inc. and
the Company.
3.1(1) Restated Articles of Incorporation of the Company.
3.2(1) Bylaws of the Company.
4.3(1) Specimen certificate for Common Stock.
10.1(1) 1995 Stock Option Plan, as amended.
10.2(1) Form of Stock Option Agreement between the Company and participants under
the 1995 Stock Option Plan.
10.3(1) Form of Indemnity Agreement between the Company and each of its executive
officers.
10.4(1) Stock Option Agreement dated March 20, 1995, between the Company and
Robert Normyle.
10.5(1) Form of Registration Rights Agreement executed in connection with the private
placement of Common Stock.
10.6(3) Employment Agreement between the Company and each of Messrs. Isel,
Peterson, Boosales and Martin:
(a) Isel
(b) Peterson
(c) Boosales
(d) Martin
10.7(1) Employment Agreement dated as of February 26, 1996, between Clayton W. Page
and the Company.
10.8(1) Lease Agreement dated August 16, 1991, between Coastal 2920 Corporation and
Amsco Sterile Recoveries, Inc., as amended and assigned to the Company.
10.9(1) Lease dated August 28, 1992, among Winchester Homes, Inc. and Weyerhaeuser
Real Estate Company and Amsco Sterile Recoveries, Inc., as assigned to the Company.
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55
EXHIBITS INDEX
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------ -------------------
10.10(1) Texas Industrial Net Lease dated March 19, 1992, between the Trustees of the
Estate of James Campbell, Deceased, and Amsco Sterile Recoveries, Inc., as assigned
to the Company.
10.11(1) Lease dated March 30, 1992, between Walter D'Aloisio and Amsco Sterile
Recoveries, Inc., as assigned to the Company.
10.12(1) Standard Industrial Lease -- Multi-Tenant (American Industrial Real Estate
Association) dated February 24, 1992, between Borstein Enterprises and Amsco
Sterile Recoveries, Inc., as assigned to the Company.
10.13(1) Carolina Central Industrial Center Lease dated April 22, 1992, between Industrial
Development Associates and Amsco Sterile Recoveries, Inc., as assigned to the
Company.
10.14(1) Lease Agreement dated September 2, 1993, between Price Pioneer Company, Ltd.,
and Amsco Sterile Recoveries, Inc., as assigned to the Company.
10.15(1) Service Center Lease dated December 4, 1991, between QP One Corporation
and Amsco Sterile Recoveries, Inc., as assigned to the Company.
10.16(1) Lease Agreement dated January 31, 1996, between Florida Conference
Association of Seventh-Day Adventists and Surgipro, Inc., as assigned to the
Company.
10.17(1) License Agreement dated July 31, 1994, between the Company and Amsco
Sterile Recoveries, Inc.
10.18(1) Stock Option Agreement dated as of October 18, 1996, between Bertram T.
Martin, Jr. and the Company.
10.19(3) Stock Option Agreement dated as of May 2, 1996, between James M. Emanuel
and the Company.
10.20(1) 1996 Non-Employee Director Stock Option Plan.
10.21(3) Retention Agreements between the Company and each of Messrs. Isel,
Peterson, Boosales and Martin:
(a) Isel
(b) Peterson
(c) Boosales
(d) Martin
10.21(4) Loan Agreement dated October 15, 1996, between First Union National Bank of
Florida and the Company.
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56
EXHIBITS INDEX
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------ -------------------
10.22(4) Revolving Line of Credit Promissory Note dated October 15, 1996, executed by
the Company in favor of First Union National Bank of Florida.
10.23(4) Security Agreement dated October 15, 1996, executed by the Company in favor
of First Union National Bank of Florida.
10.24 Amendments No. 2 and 3 to the 1995 Stock Option Plan.
27 Financial Data Schedules (for SEC use only).
____________
(1) Incorporated by reference to the Registration Statement on Form S-1 filed
by the Registrant on May 15, 1996.
(2) Incorporated by reference to Amendment No. 2 to the Registration Statement
on Form S-1 filed by the Registrant on July 15, 1996.
(3) Incorporated by reference to Amendment No. 3 to the Registration Statement
on Form S-1 filed by the Registrant on July 18, 1996.
(4) Incorporated by reference to the Quarterly Report on Form 10-Q filed by the
registrant on November 12, 1996.
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57
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES AND
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.
BY: /s/ RICHARD T. ISEL
---------------------------------
Richard T. Isel
President and Chairman of the Board
Dated: March 24, 1997
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ RICHARD T. ISEL President and Chief Executive Officer March 24, 1997
- ------------------------------ and Director
Richard T. Isel
/s/ WAYNE R. PETERSON Executive Vice President and March 24, 1997
- ------------------------------ Director
Wayne R. Peterson
/s/ JAMES T. BOOSALES Executive Vice President, March 24, 1997
- ------------------------------ Chief Financial Officer and
James T. Boosales Director
/s/ BERTRAM T. MARTIN, JR. Executive Vice President, March 24, 1997
- ------------------------------ Chief Operating Officer and
Bertram T. Martin, Jr. Director
/s/ JAMES M. EMANUEL Director March 24, 1997
- ------------------------------
James M. Emanuel
/s/ LEE KEMBERLING Director March 24, 1997
- ------------------------------
Lee Kemberling
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