UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended June 30, 2017 or

For the transition period from             to

Commission File Number 1-37556

 

Stericycle, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

28161 North Keith Drive

Lake Forest, Illinois 60045

(Address of principal executive offices, including zip code)

(847) 367-5910

(Registrant’s telephone number, including area code)

 

 

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 ☒ NO ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES ☒ NO ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "accelerated filer", "large accelerated filer", "smaller reporting company", and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     YES ☐ NO ☒

 

On August 3, 2017, there were 85,338,685  shares of the Registrant’s Common Stock outstanding.

 

 

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Stericycle, Inc.

Table of Contents

 

 

 

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PART I. – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

STERICYCLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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STERICYCLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF (LOSS) INCOME

(Unaudited)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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STERICYCLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF

COMPREHENSIVE (LOSS) INCOME

(Unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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STERICYCLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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STERICYCLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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STERICYCLE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Unless the context requires otherwise, “the Company”, "we," "us" or "our" refers to Stericycle, Inc. and its subsidiaries on a consolidated basis.

NOTE 1 — BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with United States Generally Accepted Accounting Principles (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. However, the Company believes the disclosures included in the accompanying condensed consolidated financial statements are adequate to make the information presented not misleading. In our opinion, all adjustments necessary for a fair presentation for the periods presented have been reflected and are of a normal recurring nature. These condensed consolidated financial statements should be read in conjunction with the Stericycle, Inc. and Subsidiaries consolidated financial statements and notes thereto, as filed with our Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”). The results of operations for the six months ended June 30, 2017 are not necessarily indicative of the results that may be achieved for the entire year ending December 31, 2017.

There were no material changes in the Company’s significant accounting policies since the filing of its 2016 Form 10-K. As discussed in the 2016 Form 10-K, the preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the amount of reported assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the periods reported. Actual results may differ from those estimates.

Certain amounts in previously issued financial statements have been reclassified to conform to the current period presentation.

During the three and six months ended June 30, 2017, we presented certain rent, utility and depreciation expenses in cost of revenues that had historically been recorded in selling, general and administrative expense (“SG&A”). We have reclassified $3.4 million of which $2.0 million was for rent and utility expenses and $1.4 million was for depreciation expenses from SG&A to cost of revenues for the three months ended June 30, 2016, and $6.0 million of which $3.4 million was for rent and utility expenses and $2.6 million was for depreciation expenses from SG&A to cost of revenues for the six months ended June 30, 2016 to conform to the current period presentation.

NOTE 2 – NEW ACCOUNTING STANDARDS

Adoption of New Accounting Standards

Intangibles – Goodwill and Other – Simplifying the Test for Goodwill Impairment

Effective January 1, 2017, the Company early adopted the guidance in Accounting Standards Update (“ASU”) No. 2017-04, “Intangibles – Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment.” This ASU eliminates Step 2 of the goodwill impairment test and requires a goodwill impairment to be measured as the amount by which a reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of its goodwill. The adoption of this standard did not have a material impact on our financial statements.

 

 

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Statement of Cash Flows

Effective January 1, 2017, the Company early adopted the guidance in ASU No. 2016-15 “Statement of Cash Flows” (Topic 230). This ASU clarifies diversity in practice on where in the Statement of Cash Flows to recognize certain transactions, including the classification of payment of contingent consideration for acquisitions between Financing and Operating activities. Based on the results of the Company’s analysis, there is no impact on our financial statements, as our treatment of the relevant affected items on the Condensed Consolidated Statements of Cash Flows is consistent with the requirements of this guidance.

Accounting Standards Issued But Not Yet Adopted

Revenue From Contracts With Customers

In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers" (Topic 606), guidance to provide a single and comprehensive revenue recognition model for all contracts with customers. The revenue guidance contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The amended authoritative guidance associated with revenue recognition is effective for the Company on January 1, 2018. The Company currently anticipates adopting this ASU using the modified retrospective method. The Company continues to assess its various revenue streams to identify performance obligations under this ASU and the key aspects of the standard that will impact the Company's revenue and expense recognition process. Based upon our preliminary assessments, the Company expects that contract acquisition costs of obtaining revenue generating contracts, such as sales commissions paid in connection with multi-year service contracts, will be capitalized and amortized over the economic life of the contracts. Under the current guidance, the Company expenses such costs when incurred. The Company continues to work with third party service providers to assist us in our review of implementing the new revenue recognition standard and implementing an information technology solution. As the Company completes its evaluation of this new standard, new information may arise that could change the Company's current understanding of the impact to revenue and expense recognition. Additionally, the Company will continue to monitor industry activities and any additional guidance provided by regulators, standards setters, or the accounting profession to adjust the Company’s assessment and implementation plans accordingly.

Definition of a Business

On January 5, 2017, the FASB issued ASU No. 2017-01, “Clarifying the Definition of a Business” (Topic ASC 805), guidance to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this ASU provide a screen to determine when an integrated set of assets and activities (collectively referred to as a “set”) is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. If the screen is not met, the amendments require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and remove the evaluation of whether a market participant could replace the missing elements. This ASU is effective for public business entities in annual periods beginning after December 15, 2017, including interim periods therein. Due to the number of acquisitions the Company completes in any year, there may be instances where the acquisition will be determined to be an acquisition of assets instead of a business. The Company believes this will be a minority of the acquisitions completed in any year and that there will not be a material impact to our financial statements.

 

 

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Leases

In February 2016, the FASB issued ASU No. 2016-02, “Leases” (Topic 842). This guidance will require lessees to record a right-of-use asset and lease liability on the balance sheet for all leases with terms of more than 12 months. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. This ASU also requires certain quantitative and qualitative disclosures. Accounting guidance for lessors is largely unchanged. The guidance should be applied on a modified retrospective basis. This ASU is effective for the Company beginning January 1, 2019. During the second quarter of 2017, the Company engaged a third party service provider to assist us in our review of implementing the new leases standard, and we have begun the initial evaluation of the impact that the adoption of ASU 2016-02 will have on our consolidated financial statements and related disclosures.

Intra-Entity Transfers of Assets Other Than Inventory

In October 2016, the FASB issued ASU No. 2016-16, “Intra-Entity Transfers of Assets Other Than Inventory.” This ASU requires the income tax consequences of an intra-entity transfer of an asset other than inventory to be recognized when the transfer occurs, instead of when the asset is sold to an outside party. This ASU is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods, with early adoption permitted. We do not expect the adoption to have a material impact on our financial statements.

Compensation – Stock Compensation

In May 2017, the FASB issued ASU No. 2017-09, “Compensation – Stock Compensation” (Topic 718) - Scope of Modification Accounting. This ASU clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. This ASU is effective prospectively for the annual period ending December 31, 2018 and interim periods within that annual period. Early adoption is permitted. We do not expect the adoption to have a material impact on our financial statements.

NOTE 3 – ACQUISITIONS, DIVESTITURES, AND ASSETS HELD FOR SALE

Acquisitions

During the six months ended June 30, 2017, we completed 19 acquisitions.

Domestically and in Canada, we acquired 100% of the stock of one and selected assets and liabilities of nine secure information destruction businesses. We also acquired selected assets and liabilities of two regulated waste businesses and one communication services business.

Internationally (exclusive of Canada), we acquired selected assets and liabilities of one regulated waste business and one secure information destruction business in the Netherlands, and selected assets and liabilities of two regulated waste businesses in the Republic of Korea. We also acquired 100% of the stock of one regulated waste business in Portugal and one regulated waste business in Spain.

The acquisitions were all considered to be business combinations.

 

 

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The following table summarizes the locations of our acquisitions for the six months ended June 30, 2017:

 

The following table summarizes the acquisition date fair value of consideration transferred for the current period acquisitions and the adjustments to the consideration transferred for prior year acquisitions during the six months ended June 30, 2017:

 

For financial reporting purposes, our acquisitions were accounted for using the acquisition method of accounting. These acquisitions resulted in the recognition of goodwill in our financial statements reflecting the premium paid to acquire businesses that we believe are complementary to our existing operations and fit our growth strategy. During the six months ended June 30, 2017, we recognized an increase in goodwill of $20.5 million related to current period acquisitions, excluding the effect of foreign currency translation. Approximately $18.3 million of the goodwill recognized from current period acquisitions will be deductible for income taxes.

During the six months ended June 30, 2017, we recognized an increase of $13.4 million in the estimated fair value of acquired customer relationships for current period acquisitions, excluding the effect of foreign currency translation, with amortizable lives of 10 to 40 years.

The fair value of consideration transferred in a business combination is allocated to the tangible and intangible assets assumed at the acquisition date, with the remaining unallocated amount recorded as goodwill. The allocations of the acquisition price for recent acquisitions have been prepared on a preliminary basis, pending completion of certain intangible asset valuations and finalization of the respective opening balance sheets. The following table summarizes the preliminary purchase price allocation for current period acquisitions and various adjustments to our prior year acquisitions during the six months ended June 30, 2017:

 

During the three months ended June 30, 2017 and 2016, the Company incurred $23.7 million and $25.2 million, respectively, of acquisition and integration expenses related to acquiring businesses, reported within SG&A on the

 

 

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Condensed Consolidated Statements of (Loss) Income. During the six months ended June 30, 2017 and 2016, these costs were $43.6 million and $47.4 million, respectively. Acquisition-related costs are costs the Company incurs to effect a business combination such as due diligence and legal expenses, costs of maintaining an internal acquisitions department, direct travel expenses related to acquisitions, government fees, and environmental studies. Integration-related costs are costs the Company incurs after an acquisition is completed to integrate the acquired business’ operations with the Company and include, for example, integration of our sales and collection processes and systems to support those efforts, rebranding to the Company’s name, severance expense related to personnel redundancies, and other. The results of operations of these acquired businesses have been included on the Condensed Consolidated Statements of (Loss) Income from the date of the acquisition. Pro forma results of operations for these acquisitions are not presented because the pro forma effects, individually or in the aggregate, were not material to the Company’s results of operations.

Divestitures

During the second quarter of 2017, we sold certain assets and liabilities in the UK for $1.2 million resulting in a pretax loss of $3.6 million ($2.9 million, net of tax) which is included in SG&A on the Condensed Consolidated Statements of (Loss) Income.

Assets and Liabilities Held for Sale

As of June 30, 2017, we have certain of our international operations classified as held for sale. No material changes to the fair value of these assets and liabilities held for sale were recorded during the three and six months ended June 30, 2017. Fair value of these assets and liabilities held for sale is subject to changes in estimates as a result of evolving market conditions, negotiations, and other matters. The assets and liabilities of the disposal groups are presented in Assets held for sale and Liabilities held for sale on the Condensed Consolidated Balance Sheets.

The following table presents information related to the major classes of assets and liabilities that were classified as held for sale on the Condensed Consolidated Balance Sheet at June 30, 2017:

 

 

NOTE 4 – RESTRUCTURING, CONTRACT EXIT AND PLANT CONVERSION EXPENSES

During the first quarter of 2017, management began executing a realignment of our operations to reduce labor redundancies and facility costs in our Latin American countries. Various operating locations, primarily in Brazil, have been consolidated to increase efficiency while reducing headcount. For the three months ended June 30, 2017, the Company recorded $5.9 million of restructuring expenses of which $2.0 million related to employee severance, $3.6 million was long-lived assets and operating permits impairment charges, and $0.3 million was other related expenses. For the six months ended June 30, 2017, the Company recorded $6.6 million of restructuring expenses of which $2.6 million related to employee severance, $3.6 million was long-lived assets and operating permits impairment charges, and $0.4 million was other related expenses. These expenses are reflected as part of SG&A on the Condensed Consolidated Statements of (Loss) Income. The recorded restructuring liabilities

 

 

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are expected to be paid within the current year. While the Company believes the recorded restructuring liabilities are adequate, revisions to current estimates may be recorded in future periods based on new information as it becomes available. There could be additional initiatives in the future to further streamline our operations. As such, the Company expects further expenses related to workforce reductions and other facility rationalization costs when those restructuring plans are finalized and related expenses are estimable.

For the three and six months ended June 30, 2017, the Company recorded $1.1 million and $2.5 million, respectively, of expenses to exit certain of our patient transportation services contracts in the UK which are reflected as part of SG&A on the Condensed Consolidated Statements of (Loss) Income.

For the three months ended June 30, 2017, the Company recorded $7.2 million of plant conversion and other related expenses of which $5.5 million was operating permits and customer relationships impairment charges and $1.7 million was other costs due to rationalizing our operations and environmental liabilities primarily in our Latin America countries. For the six months ended June 30, 2017, the Company recorded $8.0 million of plant conversion and other related expenses of which $5.9 million was operating permits and customer relationships impairment charges and $2.1 million was other costs due to rationalizing our operations and environmental liabilities primarily in our Latin America countries. These expenses are reflected as part of SG&A on the Condensed Consolidated Statements of (Loss) Income.

NOTE 5 – INCOME TAXES

We file income tax returns in the U.S., in various states and in certain foreign jurisdictions.

The Company has recorded liabilities to cover certain uncertain tax positions. Such uncertain tax positions relate to additional taxes that the Company may be required to pay in various tax jurisdictions. During the course of examinations by various taxing authorities, proposed adjustments may be asserted. The Company evaluates such items on a case-by-case basis and adjusts the liability for uncertain tax positions as deemed necessary.

The effective tax rates for the three months ended June 30, 2017 and 2016 were 33.8% and 36.9%, respectively. The decrease in the current period tax rate, when compared to the prior period, is primarily due to the tax impact of the charge associated with the proposed settlement, in the amount of $295.0 million, of the small quantity customer class action lawsuit in the U.S. (see Note 14 – Legal Proceedings) resulting in a lower proportion of U.S. pre-tax income which has a higher statutory tax rate when compared to international operations.

NOTE 6 – STOCK-BASED COMPENSATION

At June 30, 2017, we had the following incentive stock plans:

 

 

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Stock Based Compensation Expense:

The following table presents the total stock-based compensation expense resulting from stock option awards, restricted stock units (“RSUs”), performance-based restricted stock units (“PSUs”), and the ESPP included on the Condensed Consolidated Statements of (Loss) Income:

 

Stock Options:

Options granted to directors vest in one year and options granted to officers and employees generally vest over five years. Expense related to options with graded vesting is recognized using the straight-line method over the vesting period. Stock option activity during the six months ended June 30, 2017, is summarized as follows:

 

At June 30, 2017, there was $37.0 million of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted average period of 3.11 years.

The following table sets forth the intrinsic value of options exercised for the three and six months ended June 30:

 

The intrinsic value represents the total pre-tax intrinsic value (the difference between the fair value on the trading day the option was exercised and the exercise price associated with the respective option).

 

 

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The Company uses historical data to estimate expected life and volatility. The estimated fair value of stock options at the time of the grant using the Black-Scholes option pricing model was as follows:

 

Restricted Stock Units:

The fair value of RSUs is based on the closing price of the Company's common stock on the date of grant and is amortized to expense over the service period. Our 2017 Plan includes a share reserve for RSUs granted at a 1-1 ratio while our 2008, 2011, and 2014 Plans reserve at a 2-1 ratio.

A summary of our RSU activity during the six months ended June 30, 2017, is summarized as follows:

 

At June 30, 2017, there was $23.0 million of total unrecognized compensation expense related to RSUs, which is expected to be recognized over a weighted average period of 4.03 years.

Performance-Based Restricted Stock Units:

In February 2017 under the incentive stock plan, our executive officers were granted PSUs. PSUs vest, or not, in three equal annual installments based on the achievement of pre-determined annual earnings per share performance goals as approved by the Compensation Committee. Each of the units granted represent the right to receive one share of the Company’s common stock at a specified future date. The maximum number of common shares issuable upon vesting of these PSUs under the first installment is 10,348 shares. The grant date fair value was $83.35 per share and the total grant date fair value of the shares for which the performance conditions are expected to be met for 2017 was $0.9 million.

NOTE 7 – PREFERRED STOCK

At June 30, 2017, we had 1,000,000 authorized shares of preferred stock and 694,380 shares issued and outstanding of mandatory convertible preferred stock.

Series A Mandatory Convertible Preferred Stock Offering: On September 15, 2015, we completed a registered public offering of 7,700,000 depositary shares, each representing a 1/10th interest in a share of our 5.25% Series A mandatory convertible preferred stock, par value $0.01 per share (the "Series A Preferred Stock"), at a public offering price of $100.00 per depository share for total gross proceeds of $770.0 million.

 

 

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Unless earlier converted or redeemed, each share of the Series A Preferred Stock will automatically convert into between 5.8716 and 7.3394 shares of our common stock, subject to anti-dilution and other adjustments, on the mandatory conversion date, which is expected to be September 15, 2018. The number of shares of our common stock issuable on conversion will be determined based on the volume-weighted average price of our common stock over the 20 trading day period commencing on and including the 23rd scheduled trading day prior to September 15, 2018. Subject to certain restrictions, at any time prior to September 15, 2018, holders of the Series A Preferred Stock may elect to convert all or a portion of their shares into common stock at the minimum conversion rate of 5.8716 shares of common stock per share of Series A Preferred Stock, subject to adjustment.

Dividends on shares of the Series A Preferred Stock are payable on a cumulative basis when, as and if declared by our board of directors, or an authorized committee thereof, at an annual rate of 5.25% on the liquidation preference of $1,000 per share (and, correspondingly, $100.00 per share with respect to the depositary shares). The dividends may be payable in cash, or subject to certain limitations, in shares of our common stock, or any combination of cash and shares of our common stock, on March 15, June 15, September 15 and December 15 of each year, commencing on December 15, 2015, and to, and including, September 15, 2018.

We declared and paid dividends of $9.2 million and $10.0 million to the preferred stock shareholders during the three months ended June 30, 2017 and 2016, respectively, and $18.5 million and $20.1 million for the six months ended June 30, 2017 and 2016, respectively.

The following table provides information about our repurchases of depository shares of mandatory convertible preferred stock during the six months ended June 30, 2017:

 

Repurchases of our mandatory convertible preferred stock resulted in a $9.0 million increase to retained earnings, because we redeemed the preferred stock at a discount. The 321,200 depository shares are equivalent to 32,120 units of preferred stock.

NOTE 8 – (LOSS) EARNINGS PER COMMON SHARE

Basic (loss) earnings per share is computed by dividing (loss) income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted (loss) earnings per share is computed by dividing (loss) income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding stock options, shares to be purchased under the Company’s employee stock purchase plan, RSUs, PSUs, and the assumed conversion of mandatory convertible preferred stock. The effect of potentially dilutive securities is reflected in diluted earnings per share by application of the "treasury stock method" for outstanding stock-based compensation awards. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities. For the issue of the mandatory convertible preferred stock, we use the "if-converted method." Under the if-converted method, the preferred dividend applicable to convertible preferred stock is added back as an adjustment to the numerator. The mandatory convertible preferred shares are assumed to be converted to

 

 

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common shares at the beginning of the period or, if later, at the time of issuance, and the resulting common shares are included in the denominator. In applying the if-converted method, conversion shall not be assumed for purposes of computing diluted EPS if the effect would be anti-dilutive. The numerator is also adjusted for any premium or discount arising from redemption of the preferred stock.

The following table sets forth the computation of basic and diluted (loss) earnings per share:

 

For the three and six months ended June 30, 2017, options to purchase shares of 4,776,294 and 4,713,228, respectively, were not included in the computation of diluted earnings per share because the effect would have been anti-dilutive. For the three and six months ended June 30, 2017, 327,336 and 328,984, respectively, incremental shares related to stock options were not included in the computation of diluted loss per share because of the net loss during the three and six months ended June 30, 2017.

For the three and six months ended June 30, 2016, options to purchase shares of 2,961,595 and 2,662,834, respectively, were not included in the computation of diluted earnings per share because the effect would have been anti-dilutive.

For the three and six months ended June 30, 2017, RSUs of 45,597 and 47,617 respectively, were not included in the computation of diluted earnings per share because the effect would have been anti-dilutive. For the three and six months ended June 30, 2017, 20,729 and 19,709, respectively, incremental shares related to RSUs were not included in the computation of diluted loss per share because of the net loss during the three and six months ended June 30, 2017.

For the three and six months ended June 30, 2016, RSUs of 650 and 500, respectively, were not included in the computation of diluted earnings per share because the effect would have been anti-dilutive.

The Company had outstanding PSUs during the three and six months ended June 30, 2017 that were eligible to vest into a maximum of 10,348 shares of common stock subject to the achievement of specified performance

 

 

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conditions. Contingently issuable shares are excluded from the computation of diluted earnings per share if, based on current period results, the shares would not be issuable if the end of the reporting period were the end of the contingency period. These outstanding PSUs have been excluded from the loss per share calculation for the three and six months ended June 30, 2017 as the performance conditions were not satisfied as of the end of the period.

NOTE 9 – FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels as described below:

Level 1 – Quoted prices in active markets for identical assets or liabilities (highest priority).

Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability (lowest priority).

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of assets and liabilities and their placement within the fair value hierarchy levels. The impact of our creditworthiness and non-performance risk has been considered in the fair value measurements noted below. There were no movements of items between fair value hierarchies in the periods presented.

The following table summarizes the bases used to measure financial assets and liabilities that are carried at fair value on a recurring basis on the Condensed Consolidated Balance Sheets:

 

 

 

 

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For our derivative financial instruments, we use a market approach valuation technique based on observable market transactions of spot and forward rates.

We recorded a $0.5 million asset related to the fair value of the U.S. dollar-Canadian dollar foreign currency swap which was classified as Other assets at June 30, 2017. The objective of the swap is to offset the foreign exchange risk to the U.S. dollar equivalent cash outflows for our Canadian subsidiary.

Our contingent consideration liabilities are recorded using Level 3 inputs and were $23.0 million as of June 30, 2017, of which $6.8 million was classified as Current liabilities. Contingent consideration liabilities were $24.1 million at December 31, 2016, of which $8.1 million was classified as Current liabilities. Contingent consideration represents amounts expected to be paid as part of acquisition consideration only if certain future events occur. These events are usually targets for revenues, earnings, or other milestones related to the business acquired. We arrive at the fair value of contingent consideration by applying a weighted probability of potential payment outcomes. The calculation of these potential outcomes is dependent on both past financial performance and management assumptions about future performance. If the financial performance measures were all fully met, our maximum liability would be $25.7 million at June 30, 2017. Contingent consideration liabilities are reassessed each reporting period and are reflected on the Condensed Consolidated Balance Sheets as part of Other current liabilities and Other liabilities.

Changes to contingent consideration are reflected in the table below:

 

At June 30, 2017, the fair value of the Company’s debt obligations was estimated, using Level 2 inputs, at $2.87 billion, which was also equal to the carrying amount. At December 31, 2016, the fair value of the Company’s debt obligations was estimated, using Level 2 inputs, at $2.97 billion compared to a carrying amount of $2.96 billion. The fair values were estimated using an income approach by applying market interest rates for comparable instruments.

Accounts receivable, Accounts payable and Accrued liabilities are financial assets and liabilities, respectively, with carrying values that approximate fair value. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy.

 

 

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NOTE 10 – GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill:

The changes in the carrying amount of goodwill since January 1, 2016, by reportable segment and for the “Other” category (see Note 13 – Segment Reporting), were as follows:

 

Current period adjustments to goodwill for certain 2016 acquisitions are primarily due to the finalization of intangible asset valuations.

Other Intangible Assets:

At June 30, 2017 and December 31, 2016, the values of other intangible assets were as follows:

 

 

 

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The changes in the carrying amount of intangible assets since January 1, 2016 were as follows:

 

Our indefinite-lived intangible assets include permits and certain tradenames. We have determined that our permits and certain tradenames have indefinite lives due to our ability to renew them with minimal additional cost, and therefore these are not amortized.

Our finite-lived intangible assets are amortized over their useful lives. We have determined that our customer relationships have useful lives ranging from 5 to 40 years based upon the type of customer and a weighted average remaining useful life of 15.0 years. We have covenants not-to-compete intangibles with useful lives ranging from 5 to 14 years and a weighted average remaining useful life of 3.0 years. We have tradename intangibles with useful lives ranging from 10 to 40 years and a weighted average remaining useful life of 15.9 years. Other intangibles mainly consist of landfill air rights and have a weighted average remaining useful life of 17.0 years.

For the three and six months ended June 30, 2017, we recognized $5.8 million and $6.2 million, respectively, of impairment charge as part of SG&A on the Consolidated Statements of (Loss) Income. For more details, see Note 4 – Restructuring, Contract Exit and Plant Conversion Expenses.

During the three months ended June 30, 2017 and 2016, the aggregate intangible amortization expense was $29.5 million and $50.9 million, respectively. For the six months ended June 30, 2017 and 2016, the aggregate intangible amortization expense was $58.6 million and $69.2 million, respectively.

The estimated amortization expense for each of the next five years, assuming no additional amortizable intangible assets, is as follows for the years ended December 31:

 

The estimates for amortization expense noted above are based upon foreign exchange rates at June 30, 2017.

 

 

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NOTE 11 – DEBT

Long-term debt consisted of the following:

 

Our senior credit facility, term loan, and the private placement notes all require us to comply with the same financial, reporting and other covenants and restrictions, including a restriction on dividend payments. At June 30, 2017, we were in compliance with all of our financial debt covenants. Our senior credit facility, term loan, and the private placement notes rank pari passu to each other and all other unsecured debt obligations.

At June 30, 2017 and December 31, 2016, we had $133.6 million and $138.0 million, respectively, committed to outstanding letters of credit under our senior credit facility. The unused portion of the revolving credit facility was $675.8 million and $654.9 million at June 30, 2017 and December 31, 2016, respectively.

We classified our $175.0 million private placement notes that mature in October 2017 as long-term debt due to our intent to settle this obligation by borrowing on the available and unused capacity of our $1.2 billion senior credit facility due in 2019.

As disclosed in our current report on Form 8-K filed on August 2, 2017, we entered into amendments to the agreements governing our senior credit facility, term loan and private placement notes, which amend the financial covenants therein to modify the definition of Consolidated EBITDA and provisions relating to permissible Consolidated Leverage Ratio to permit the Company to make the payment contemplated by the Proposed MDL Settlement (see Note 14 – Legal Proceedings). If at the end of any fiscal quarter, the Consolidated Leverage Ratio, on a pro forma basis as of such date and immediately after giving effect to the settlement payment of the Proposed MDL Settlement  is greater than 3.50 to 1.00, the Company may, in its sole discretion, elect to increase the maximum Consolidated Leverage Ratio to 4.00 to 1.00 as of the end of the fiscal quarter in which the full payment for the Proposed MDL Settlement occurred and in any subsequent fiscal quarter ending on or prior to September 30, 2018; provided, however, in no event shall the elevated ratio permitted by the immediately preceding clause extend after September 30, 2018.

The August 2, 2017 amendments referenced above further provide that, if at the end of any fiscal quarter of the Company, the Consolidated Leverage Ratio exceeded 3.75 to 1.00 but is at or below 4.00 to 1.00, the per annum interest rate (including any Default Rate, if applicable) otherwise applicable shall be increased by 50 basis points (.50%) from the date of such Leverage Increase to but not including the date that the Consolidated Leverage Ratio is 3.75 to 1.00 or less.

 

 

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NOTE 12 – ENVIRONMENTAL REMEDIATION LIABILITIES

We record a liability for environmental remediation when such liability becomes probable and the costs or damages can be reasonably estimated. We accrue environmental remediation costs, on an undiscounted basis, associated with identified sites where an assessment has indicated that cleanup costs are probable and can be reasonably estimated, but the timing of such payments is not fixed and determinable. Such accruals are based on currently available information, estimated timing of remediation actions, existing technology, and enacted laws and regulations. The liability for environmental remediation is included on the Condensed Consolidated Balance Sheets in current liabilities within Accrued liabilities and in noncurrent liabilities within Other liabilities.

At June 30, 2017 and December 31, 2016, the total environmental remediation liabilities recorded were $32.9 million and $30.9 million of which $5.7 million and $2.4 million were presented in Accrued liabilities on the Condensed Consolidated Balance Sheets, respectively. We project costs over approximately 30 years.

As discussed in Note 14 – Legal Proceedings, in the second quarter of 2017 we recorded an environmental liability of $2.0 million related to a portion of a hazardous waste facility in Mexico based upon our initial assessment. We are continuing to assess the level of required remediation, as well as other potentially responsible parties, and will adjust our estimate in the future as appropriate.

 

NOTE 13 – SEGMENT REPORTING

Our three operating segments are:

Domestic CRS does not meet the quantitative criteria to be a separate reportable segment and therefore is included in All other. Costs related to our corporate headquarter functions are also included in All other.

Our Domestic and Canada and International Regulated Waste and Compliance Services segments include medical waste disposal, pharmaceutical waste disposal, hazardous waste management, sustainability solutions for expired or unused inventory, secure information destruction of documents and e-media, training and consulting through our Steri-Safe® and Clinical Services programs, and other regulatory compliance services.

Our Domestic Communication and Related Services segment consists of inbound/outbound communication, automated patient reminders, online scheduling, notifications, product retrievals, product returns, and quality audits.

Our two reportable segments are:

 

 

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The following tables show financial information for the Company's reportable segments:

 

The following table reconciles the Company's primary measure of segment profitability (EBITA) to income from operations:

 

 

 

 

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The following table shows consolidated revenues by service:

 

 

NOTE 14 – LEGAL PROCEEDINGS

We operate in highly regulated industries and must deal with regulatory inquiries or investigations from time to time that may be initiated for a variety of reasons. We are also involved in a variety of civil litigation from time to time.

The Company establishes an accrued liability for loss contingencies related to legal and regulatory matters when the loss is both probable and reasonably estimable. If a loss is not probable or a probable loss is not reasonably estimable, no liability is recorded. These accruals represent management’s best estimate of probable losses and, in such cases, there may be an exposure to loss in excess of the amounts accrued. Legal and regulatory matters inherently involve significant uncertainties based on, among other factors, the stage of the proceedings, developments in the applicable facts or law, and the unpredictability of the ultimate determination of the merits of any claim, any defenses the Company may assert against that claim and the amount of any damages that may be awarded. The Company’s accrued liabilities for loss contingencies related to legal and regulatory matters may change in the future as a result of new developments, including, but not limited to, the occurrence of new legal matters, changes in the law or regulatory environment, adverse or favorable rulings, newly discovered facts relevant to the matter, or changes in the strategy for the matter. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources and other factors.

Contract Class Action Lawsuits. We were served on March 12, 2013 with a class action complaint filed in the U.S. District Court for the Western District of Pennsylvania by an individual plaintiff for itself and on behalf of all other “similarly situated” customers of ours. The complaint alleges, among other things, that we imposed unauthorized or excessive price increases and other charges on our customers in breach of our contracts and in violation of the Illinois Consumer Fraud and Deceptive Business Practices Act. The complaint sought certification of the lawsuit as a class action and the award to class members of appropriate damages and injunctive relief.

The Pennsylvania class action complaint was filed in the wake of a settlement with the State of New York of an investigation under the New York False Claims Act which arose out of the qui tam (or “whistle blower”) action captioned United States of America ex rel. Jennifer D. Perez v. Stericycle, Inc., Case No. 1:08-cv-2390, which was settled in the fourth quarter of 2015 as previously disclosed.

Following the filing of the Pennsylvania class action complaint, we were served with class action complaints filed in federal and state courts in several jurisdictions. These complaints asserted claims and allegations substantially similar to those made in the Pennsylvania class action complaint. All of these cases appear to be follow-on litigation to our settlement with the State of New York. On August 9, 2013, the Judicial Panel on Multidistrict Litigation granted our Motion to Transfer these related actions to the United States District Court for the Northern District of Illinois for centralized pretrial proceedings (the “MDL Action”). On December 10, 2013, we filed our answer to the Amended Consolidated Class Action Complaint in the MDL Action, generally denying the allegations therein. Plaintiffs subsequently filed a Second Amended Consolidated Complaint on March 8, 2016, and we filed an

 

 

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answer to that pleading on March 25, 2016, generally denying the allegations therein and asserting a variety of affirmative defenses.

Plaintiffs filed a motion for class certification on January 29, 2016. On February 16, 2017, the Court entered an order granting Plaintiffs’ motion for class certification. The Court certified a class of “[a]ll persons and entities that, between March 8, 2003 through the date of trial resided in the United States (except Washington and Alaska), were identified by Stericycle as ‘Small Quantity’ or ‘SQ’ customer, and were charged and paid more than their contractually-agreed price for Stericycle’s medical waste disposal goods and services pursuant to Stericycle’s automated price increase policy. Governmental entities whose claims were asserted in United States ex rel. Perez v. Stericycle Inc. shall be excluded from the class.” On March 2, 2017, Stericycle filed a motion for reconsideration and clarification relating to the Court’s class certification decision, which motion remains pending. The parties engaged in discussions through and overseen by a mediator regarding a potential resolution of the matter and reached an agreement in principle for settlement in July 2017 (the “Proposed MDL Settlement”).

As we disclosed in a current report on Form 8-K filed on August 2, 2017, under the terms of the Proposed MDL Settlement that will be submitted to the Court for approval, we will establish a common fund of $295.0 million from which will be paid all compensation to members of the settlement class, attorneys’ fees to class counsel, incentive awards to the named class representatives and all costs of notice and administration. Our existing contracts with customers will remain in force, while we will also establish as part of the Proposed MDL Settlement guidelines for future price increases and provide customers additional transparency regarding such increases. The Proposed MDL Settlement will also address additional matters, including the availability of alternative dispute resolution for members of the settlement class. The Proposed MDL Settlement is not yet final and remains subject to Court approval of a final agreement. In the Proposed MDL Settlement, we are admitting no fault or wrongdoing whatsoever, and are entering into the Proposed MDL Settlement in order to avoid the cost and uncertainty of litigation.

In view of the Proposed MDL Settlement, we recorded a pre-tax accrual of $295.0 million in accrued liabilities on the Condensed Consolidated Balance Sheet as of June 30, 2017 and a pre-tax charge of $295.0 million in SG&A on the Consolidated Statements of (Loss) Income for three and six months ended June 30, 2017.

Securities Class Action Lawsuit. On July 11, 2016, two purported stockholders filed a putative class action complaint in the U.S. District Court for the Northern District of Illinois. The plaintiffs purported to sue for themselves and on behalf of all purchasers of our publicly traded securities between February 7, 2013 and April 28, 2016, inclusive, and all those who purchased securities in our public offering of depositary shares, each representing a 1/10th interest in a share of our mandatory convertible preferred stock, on or around September 15, 2015. The complaint named as defendants the Company, our directors and certain of our current and former officers, and certain of the underwriters in the public offering. The complaint purports to assert claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as well as SEC Rule 10b-5, promulgated thereunder. The complaint alleges, among other things, that the Company imposed unauthorized or excessive price increases and other charges on its customers in breach of its contracts, and that defendants failed to disclose those alleged practices in public filings and other statements issued during the proposed class period beginning February 7, 2013 and ending April 28, 2016.

On August 4, 2016, plaintiffs filed an Amended Complaint that purports to assert additional misrepresentations in public statements through July 28, 2016, and therefore to change the putative class period to the period from February 7, 2013 to July 28, 2016, inclusive. On October 21, 2016, plaintiffs filed a Corrected Amended Complaint adding the Company as a named defendant in plaintiff’s claim under Section 11 of the Securities Act, which had previously been asserted only against the Underwriters and certain officers and directors.

On November 1, 2016, the Court appointed the Public Employees’ Retirement System of Mississippi and the Arkansas Teacher Retirement System as Lead Plaintiffs and their counsel as Lead Counsel. On February 1, 2017, Lead Plaintiff filed a Consolidated Amended Complaint with additional purported factual material supporting the same legal claims from the prior complaints for a class period from February 7, 2013 through September 18, 2016.    

 

 

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Defendants filed a motion to dismiss the Consolidated Amended Complaint on April 1, 2017. On May 19, 2017, Plaintiffs filed a response in opposition to the motion to dismiss and on June 19, 2017, Defendants filed a reply brief in support of their motion  The motion to dismiss is currently pending.

We intend to vigorously defend ourselves against this lawsuit.

We have not accrued any amounts in respect of this lawsuit, and we cannot estimate the reasonably possible loss or the range of reasonably possible losses that we may incur. We are unable to make such an estimate because (i) litigation is by its nature uncertain and unpredictable, (ii) we do not know whether the court will certify any class of plaintiffs or, if any class is certified, how the class would be defined, and (iii) in our judgment, the factual and legal allegations asserted by plaintiffs are sufficiently unique that we are unable to identify other proceedings with circumstances sufficiently comparable to provide guidance in making estimates.

Shareholder Derivative Lawsuits. On September 1, 2016, a purported stockholder filed a putative derivative action complaint in the Circuit Court of Cook County, Illinois against certain officers and directors of the Company, naming the Company as nominal defendant. The complaint alleges that defendants breached their fiduciary duties to the Company and its stockholders by causing the Company to allegedly overcharge certain customers in breach of those customers’ contracts, otherwise provide unsatisfactory customer service and injure customer relationships, and make materially false and misleading statements and omissions regarding the Company’s business, operational and compliance policies between February 7, 2013 and the present. On March 1, 2017, another purported stockholder filed a putative derivative action complaint containing substantially similar allegations in the Circuit Court of Cook County, Illinois against certain officers and directors of the Company, naming the Company as nominal defendant. The Company notes, among other things, that, in addition to failing to make the required demand on the board of directors, both of these filings are in violation of the Company’s Bylaws, which require any such actions to be brought in a court in Delaware. On June 29, 2017, the Court entered an agreed order consolidating the two putative derivative actions for all purposes under the caption Kausal Shah v. Charles A. Alutto, et al. On July 11, 2017, the Court entered a further agreed order appointing lead counsel for plaintiffs and staying the action pending resolution of the motion to dismiss the securities class action discussed above. Pursuant to the agreed order, defendants reserve all potential defenses to both actions, should the stay be lifted.

We intend to vigorously defend ourselves against this lawsuit.

We have not accrued any amounts in respect of these lawsuits, and we cannot estimate the reasonably possible loss or the range of reasonably possible losses that we may incur. We are unable to make such an estimate because (i) litigation is by its nature uncertain and unpredictable and (ii) in our judgment, the factual and legal allegations asserted by plaintiffs are sufficiently unique that we are unable to identify other proceedings with circumstances sufficiently comparable to provide guidance in making estimates.

Shareholder Demand Letter. On October 18, 2016, the Company received a letter from an attorney purporting to represent a current stockholder of the Company demanding, pursuant to Del. Ct. Ch. R. 23.1, that the Company’s Board of Directors take action to remedy alleged breaches of fiduciary duties by certain officers and directors of the Company. The factual allegations set forth in the letter are similar to those asserted in the Securities Class Action Lawsuit and the Shareholder Derivative Lawsuit. The letter asserts breaches of fiduciary duty in connection with the management, operation and oversight of the Company’s business and in connection with alleged false, misleading and/or incomplete statements regarding the Company’s business practices.

The Company’s Board of Directors has constituted a Special Demand Review Committee to investigate the claims made in the demand letter and the Committee has retained independent counsel to assist with the investigation. The Committee’s investigation is ongoing.

TCPA Lawsuit. On June 3, 2016, a plaintiff filed a putative class action, captioned Ibrahim v. Stericycle, Inc., No. 16-cv-4294 (N.D. Ill.), against us and our wholly-owned subsidiary, Stericycle Communication Solutions, Inc., under the Telephone Consumer Protection Act (“TCPA”), asserting that the defendants called plaintiff and others in violation

 

 

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of that statute. Plaintiff challenges our use of pre-recorded messages that urge the owners of recalled products to return or obtain repairs for those products.

Plaintiff seeks certification of two nationwide classes. One class includes people who received one or more cellular telephone calls from Stericycle featuring a prerecorded or artificial voice message relating to a product recall, where the called party was not the same individual who, according to Stericycle’s records, was the intended recipient of the call. The second class includes people who received one or more cellular telephone calls from Stericycle featuring a prerecorded or artificial voice message relating to a product recall after such person had communicated to Stericycle that Stericycle did not have consent to make any such calls to their cellular telephone number.

On July 28, 2016, we answered the complaint, denying the material allegations and raising certain affirmative defenses. Among the asserted defenses is the “emergency” exception to the TCPA, which exempts calls made to promote public health and safety. On December 19, 2016, before any substantial discovery in the case, we filed a motion for summary judgment primarily on the basis of the “emergency” exception. On February 1, 2017, plaintiff responded to our motion by requesting additional discovery. The court permitted plaintiff to obtain some but not all of the requested discovery, and we have provided additional documents in response to that order.

On April 5, 2017, plaintiff sought leave to file an amended complaint which would add a claim under the Illinois Automatic Telephone Dialers Act (which does not include an “emergency” exception) and certain additional allegations. We filed an opposition to this motion on April 28, 2017, contending that the proposed amendments are futile and that we are entitled to summary judgment. On June 27, 2017, the court permitted plaintiff to file the amended complaint. We have answered plaintiff’s amended complaint, denying liability, and in light of the amended complaint, have withdrawn our motion for summary judgment without prejudice.

We intend to vigorously defend ourselves against this lawsuit.

We have not accrued any amounts in respect of this lawsuit, and we cannot estimate the reasonably possible loss or the range of reasonably possible losses that we may incur. We are unable to make such an estimate because (i) litigation is by its nature uncertain and unpredictable, (ii) we do not know whether the court will certify any class of plaintiffs or, if any class is certified, how the class would be defined, and (iii) in our judgment, the factual and legal allegations asserted by plaintiff are sufficiently unique that we are unable to identify other proceedings with circumstances sufficiently comparable to provide guidance in making estimates.

FCPA Investigation. On June 12, 2017, the SEC issued a subpoena to the Company, requesting documents and information relating to the Company’s compliance with the Foreign Corrupt Practices Act (“FCPA”) or other foreign or domestic anti-corruption laws with respect to certain of the Company’s operations in Latin America. In addition, the Department of Justice has notified the Company that it is investigating this matter in parallel with the SEC. The Company is cooperating with these agencies. The Company is also conducting an internal investigation of these matters, under the oversight of the Audit Committee of the Board of Directors and with the assistance of outside counsel, and this investigation has found evidence of improper conduct. We have not accrued any amounts in respect of this matter, as we cannot estimate any reasonably possible loss or any range of reasonably possible losses that we may incur. We are unable to make such an estimate because, based on what we know now, in our judgment, the factual and legal issues presented in this matter are sufficiently unique that we are unable to identify other circumstances sufficiently comparable to provide guidance in making estimates.

Environmental Matters. Our Environmental Solutions business is regulated by federal, state and local laws enacted to regulate the discharge of materials into the environment, remediate contaminated soil and groundwater or otherwise protect the environment. As a result of this continuing regulation, we frequently become a party to legal or administrative proceedings involving various governmental authorities and other interested parties. The issues involved in these proceedings generally relate to alleged violations of existing permits and licenses or alleged responsibility under federal or state Superfund laws to remediate contamination at properties owned either by us or by other parties to which either we or the prior owners of certain of its facilities shipped wastes. From time to

 

 

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time, we may be subject to fines or penalties in regulatory proceedings relating primarily to waste treatment, storage or disposal facilities.

North Salt Lake, Utah. On February 29, 2016, we entered into a statute of limitations tolling agreement with the United States Attorney’s Office for the District of Utah (the “USAO”) relating to an investigation by the USAO and the Criminal Investigation Division of the U.S. Environmental Protection Agency (the “EPA”) of the same facts underlying the notice of violation (the “NOV”) issued by the State of Utah Division of Air Quality (the “DAQ”) that resulted in our December 2014 settlement with the DAQ that we have previously disclosed. The USAO and EPA are investigating whether the matters forming the basis of the NOV constitute criminal or civil violations of the Clean Air Act and other federal statutes. On July 24, 2017, we extended the tolling agreement to August 31, 2017. Under the tolling agreement as extended, the period from March 1, 2016 through August 31, 2017 will be excluded from any calculation of time for the purpose of determining the statute of limitations concerning any charges that we violated federal statutes. The agreement does not constitute an admission of guilt or wrongdoing on our part and cannot be construed as a waiver of any other rights or defenses that we may have in any resulting action or proceeding. We continue to cooperate with the investigation and have engaged in discussions with the USAO and EPA regarding the parties’ current factual and legal positions. We will continue to evaluate the USAO’s position and to explore a number of potential alternatives, including a negotiated resolution and potential litigation.

We have not accrued any amounts in respect of this investigation, and we cannot estimate the reasonably possible loss or the range of reasonably possible losses that we may incur. We are unable to make such an estimate because (i) the Company and the USAO and EPA continue to exchange information and develop their respective factual and legal positions, and (ii) in our judgment, the factual and legal issues raised in the investigation are sufficiently unique that we are unable to identify other investigations with circumstances sufficiently comparable to provide guidance in making estimates.

Rancho Cordova, California. The California Department of Toxic Substances Control (“DTSC”) has alleged violations of California’s Hazardous Waste Control Law for our hazardous waste facility in Rancho Cordova, California for the years 2011 through 2017. DTSC has referred the matter to the California Attorney General’s office. We have entered into a tolling agreement with the Attorney General’s office and intend to engage in discussions with that office concerning the alleged violations and the proposed penalty.

We have not accrued any amounts in respect of this matter, and we cannot estimate the reasonably possible loss or the range of reasonably possible losses that we may incur. We are unable to make such an estimate because (i) we are still in the process of evaluating the alleged violations and developing our factual and legal position, and (ii) in our experience, similar matters have resulted in a broad range of outcomes, with each case being dependent on its own unique facts and circumstances.

Tabasco, Mexico. The National Agency for Industrial Security and the Protection of the Environment for the Hydrocarbon Sector in Mexico (“ASEA”) has conducted a permit compliance inspection at a hazardous waste treatment facility acquired by one of our subsidiaries in Dos Bocas, Tabasco, Mexico. ASEA has claimed that the contaminated soil treatment process described in the treatment permit had not been followed properly and has issued an order imposing a fine and directing that the facility be closed and that alleged contamination on a certain portion of the facility be remediated. Our subsidiary has engaged a firm of environmental technicians to assess the contamination in the portion of the facility reviewed by ASEA and to determine if any further contamination exists on the premises. In late July 2017, the environmental firm presented the preliminary findings from its initial survey which indicate that remediation of the portion of the facility identified by ASEA could cost approximately $2.0 million. Our review and assessment of ASEA’s position and the scope and cost of any remediation at the facility is ongoing.

As described in Note 12 - Environmental Remediation Liabilities, we have recorded a pre-tax accrual of $2.0 million for this matter in accrued liabilities on our Condensed Consolidated Balance Sheet as of June 30, 2017.

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We are a business-to-business services provider with a focus on regulated and compliance solutions for healthcare, retail, and commercial businesses. This includes the collection and processing of regulated and specialized waste for disposal and the collection of personal and confidential information for secure destruction, plus a variety of training, consulting, recall/return, communication, and compliance services. We were incorporated in 1989 and presently serve a diverse customer base of more than 1,000,000 customers throughout the U.S., Argentina, Austria, Australia, Belgium, Brazil, Canada, Chile, France, Germany, Ireland, Japan, Luxembourg, Mexico, the Netherlands, Portugal, Romania, Republic of Korea, Singapore, South Africa, Spain, and the UK.

More specifically, our services and products include:

There were no material changes in the Company’s critical accounting policies since the filing of its Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”). As discussed in the 2016 Form 10-K, the preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the amount of reported assets and liabilities and disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and revenues and expenses during the periods reported. Actual results may differ from those estimates.

 

 

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Results of Operations for Three Months Ended June 30, 2017 Compared to

Three Months Ended June 30, 2016

Highlights for the three months ended June 30, 2017 included the following:

 

 

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The following summarizes the Company’s operations:

 

Revenues: In analyzing our Company’s performance, it is necessary to understand that our various regulated services share a common infrastructure and customer base. We market our regulated and compliance services by offering various pricing options to meet our customers’ preferences, and customers move between these different billing paradigms. For example, our customers may contract with us for "Medical Waste Disposal" services that are billed based on the weight of waste collected, processed and disposed during a particular period, and in a subsequent period, the same customer could move to our standard service ("Steri-Safe OSHA Compliance Program"), which packages the same regulated medical waste services with training and education services for a contracted subscription fee. Another example is a customer that purchases our "Medical Waste Disposal" and "Sharps Disposal Management" services which provides the customer with the same regulated services under a different pricing and billing arrangement. We do not track the movement of customers between the various types of regulated services we offer. Although we can identify directional trends in our services, because the regulated services are similar in nature and there are inherent inaccuracies in disaggregation, we believe that aggregating these revenues communicates the appropriate metric. We analyze our revenue by identifying changes related to organic growth, acquisitions and divestitures, and changes due to currency exchange fluctuations.

Our consolidated revenues increased $26.1 million, or 2.9%, in the second quarter of 2017 to $917.7 million from $891.6 million in the second quarter of last year. Overall organic revenue growth contributed $30.4 million, or 3.4%. Organic growth excludes the effect of foreign exchange and acquisitions and divestitures with less than a full year of revenues in the comparative period. Revenues from acquisitions contributed $8.6 million to the increase in revenues in the second quarter of 2017. Divestiture activity decreased current period revenues by $0.8 million. The net effect of acquisitions and divestiture activity resulted in a 0.9% increase in revenues in the second quarter of

 

 

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2017. The effect of foreign exchange rates unfavorably impacted total revenues in the second quarter of 2017 by $12.1 million, or 1.3%, as foreign currencies declined against the U.S. dollar.

Domestic and Canada Regulated Waste and Compliance Services (“Domestic and Canada RCS”) revenues increased $18.5 million, or 2.9%, in the second quarter of 2017 to $649.1 million from $630.7 million in the second quarter of last year. Organic revenue growth contributed $14.6 million, or 2.3%, and acquisitions contributed $5.6 million, or 0.9%, in revenues. Our Secure Information Destruction revenues were strong due to higher sales activity for both reoccurring and one-time purge services combined with higher recycling revenue. The weakening of the Canadian dollar unfavorably impacted 2017 revenues by $1.7 million, or 0.3%. Revenues related to Manufacturing and Industrial (“M&I”) waste services continued to experience a decline of $5.1 million reducing overall organic growth by 2.7%. This decline was due to fewer on-call services related to softness in the U.S. industrial market. In addition, we have experienced pricing pressure on our small quantity regulated waste and compliance customers resulting from hospital consolidation of physician practices and increased competitive activities in the market.

International Regulated Waste and Compliance Services (“International RCS”) revenues decreased $14.8 million, or 7.6%, in the second quarter of 2017 to $180.1 million from $194.9 million in the second quarter of last year. Organic decline in the International RCS segment was $5.3 million, or 2.7%, primarily due to exiting certain patient transport service contracts in the UK and M&I waste services. Acquisitions in the International RCS segment increased revenues by $1.6 million in the second quarter of 2017. Divestiture activity decreased current period revenues by $0.8 million. The net effect of acquisitions and divestiture activity resulted in a 0.4% increase in revenues in the second quarter of 2017. The effect of foreign exchange rates unfavorably impacted international revenues in the second quarter of 2017 by $10.4 million, or 5.3%, as foreign currencies declined against the U.S. dollar.

Other revenues related to Domestic Communication and Related Services increased $22.5 million, or 34.0%, in the second quarter of 2017 to $88.6 million from $66.1 million in the second quarter of last year, primarily due to several larger non-recurring recall events in the quarter.

Cost of Revenues: Our consolidated 2017 cost of revenues increased $22.0 million, or 4.3%, in the second quarter of 2017 to $536.0 million from $514.0 million in the second quarter of last year. As a percentage of revenues, consolidated gross profit decreased to 41.6% in the second quarter of 2017 from 42.4% in the second quarter of last year. In general, international gross profit is lower than domestic gross profit because our international operations have fewer small account customers, which tend to generate higher gross profit. Historically, our international operations generate most of their revenues from large account customers, such as hospitals. As our international revenues increase as a percentage of consolidated revenues, consolidated gross profit percentages experience downward pressure due to this "business mix" shift, which may be offset by additional international small account market penetration, integration savings, and domestic business expansion.

Domestic and Canada RCS cost of revenues increased $19.0 million, or 5.5%, in the second quarter of 2017 to $364.2 million from $345.2 million in the second quarter of last year. Gross profit as a percentage of revenues decreased to 43.9% in the second quarter of 2017 from 45.3% in the second quarter of last year primarily due to lower revenues from our M&I customers, which have a higher fixed cost structure. Pricing pressure on our small quantity regulated waste and compliance customers negatively impacted our gross profit as a percentage of revenues. We also experienced higher costs related to wages and disposal costs.

International RCS cost of revenues decreased $10.4 million, or 7.8%, in the second quarter of 2017 to $123.6 million from $134.0 million in the second quarter of last year, primarily driven by the impact of foreign exchange movements as the U.S. dollar strengthened in 2017. Gross profit as a percentage of revenues slightly increased to 31.4% in the second quarter of 2017 from 31.3% in the second quarter of last year.

Selling, General and Administrative Expenses Exclusive of Adjusting Items, Depreciation and Intangible Amortization ("Adjusted SG&A"): Our consolidated Adjusted SG&A expenses increased $12.8 million, or 7.1%, in the second quarter of 2017 to $192.2 million from $179.4 million in the second quarter of last year primarily due

 

 

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to investments to support our sales and marketing activities to address pricing pressure on our small quantity regulated waste and compliance customers as well as an increase in our performance compensation expenses.

Domestic and Canada RCS Adjusted SG&A expenses decreased $3.1 million, or 3.5%, in the second quarter of 2017 to $86.5 million from $89.6 million in the second quarter of last year. As a percentage of revenues, Adjusted SG&A decreased to 13.3% in the second quarter of 2017 compared to 14.2% in the second quarter of last year.

International RCS Adjusted SG&A expenses decreased $7.0 million, or 16.0%, in the second quarter of 2017 to $36.5 million from $43.5 million in the second quarter of last year, primarily related to the exit of certain UK patient transport services contracts as well as the impact of foreign exchange movements as the U.S. dollar strengthened in 2017. As a percentage of revenues, Adjusted SG&A decreased to 20.3% in the second quarter of 2017 compared to 22.3% in the second quarter of last year.

(Loss) Income from Operations: Consolidated income from operations decreased $292.1 million in the second quarter of 2017 to a loss of ($192.4) million from income of $99.7 million in the second quarter of last year. The comparison of (loss) income from operations between 2017 and 2016 was affected by the following items:

During the second quarter of 2017, we recognized $23.7 million of expenses related to acquisition and integration activities, $304.4 million in certain litigation and professional services expenses (primarily due to a charge of $295.0 million related to the Proposed MDL Settlement), $5.1 million in restructuring, plant conversion and other related expenses, and contract exit expenses, and $12.7 million of asset impairment charges and loss on disposal of assets held for sale.

During the second quarter of 2016, we recognized $25.2 million of expenses related to acquisition and integration activities, $2.7 million in certain litigation and professional services expenses, and $13.6 million in restructuring, plant conversion and other related expenses, and contract exit expenses.

Consolidated depreciation and amortization expense decreased $24.0 million, or 29.0%, in the second quarter of 2017 to $58.7 million from $82.6 million in the second quarter of last year, primarily due to an update of the intangible valuations related to the Shred-it acquisition resulting in a catch-up of amortization expense from the acquisition date in 2016. As a percentage of revenues, depreciation and amortization expense decreased to 6.4% in the second quarter of 2017 compared to 9.3% in the second quarter of last year.

Domestic and Canada RCS income from operations decreased $274.7 million in the second quarter of 2017 to a loss of ($132.4) million from income of $142.2 million in the second quarter of last year.

During the second quarter of 2017, we recognized $308.0 million of expenses related to acquisition and integration activities, certain litigation and professional services expenses (primarily due to a charge of $295.0 million related to the Proposed MDL Settlement), and asset impairment charges.

During the second quarter of 2016, we recognized $13.6 million of expenses related to acquisition and integration activities.

Domestic and Canada RCS depreciation and amortization expense decreased $18.8 million, or 33.1%, in the second quarter of 2017 to $37.9 million from $56.6 million in the second quarter of last year, primarily due to an update of the intangible valuations related to the Shred-it acquisition resulting in a catch-up of amortization expense from the acquisition date in 2016. As a percentage of revenues, depreciation and amortization expense decreased to 5.8% in the second quarter of 2017 compared to 9.0% in the second quarter of last year.

International RCS loss from operations decreased $3.3 million in the second quarter of 2017 to ($8.3) million from ($11.6) million in the same period of last year.

During the second quarter of 2017, we recognized $21.1 million of expenses related to acquisition and integration activities, certain litigation and professional services expenses, restructuring, plant conversion and other related

 

 

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expenses, contract exit expenses, asset impairment charges, and loss on disposal of assets held for sale. These charges are primarily due to an initiative to realign our operations and reduce labor redundancies in our Latin American countries and exiting certain of our UK patient transport services contracts.

During the second quarter of 2016, we recognized $15.8 million of expenses related to acquisition and integration activities, plant conversion and other related expenses and contract exit expenses related to exiting certain contracts in our patient transport services in the UK.

International RCS depreciation and amortization expense decreased $7.6 million, or 36.4%, in the second quarter of 2017 to $13.3 million from $20.9 million in the second quarter of last year, primarily due to an update of the intangible valuations related to the Shred-it acquisition resulting in a catch-up of amortization expense from the acquisition date in 2016. As a percentage of revenues, depreciation and amortization expense decreased to 7.4% in the second quarter of 2017 compared to 10.7% in the second quarter of last year.

Net Interest Expense: Net interest expense decreased to $23.7 million in the second quarter of 2017 from $24.4 million in the second quarter of last year due to a reduction of our average outstanding debt balance, partially offset by increase in interest rates in the U.S.

Income Tax (Benefit) Expense: Income tax (benefit) was ($73.5) million in the second quarter of 2017 compared to income tax expense of $27.0 million in the second quarter of last year. This change to a benefit is primarily due to the tax impact of the charge associated with the proposed settlement of the small quantity customer class action lawsuit in the U.S. The effective tax rates for the second quarter of 2017 and 2016 were 33.8% and 36.9%, respectively. The decrease in the current period tax rate, when compared to the prior year, is primarily related to the aforementioned charge.

Results of Operations for Six Months Ended June 30, 2017 Compared to

Six Months Ended June 30, 2016

Highlights for the six months ended June 30, 2017 included the following:

 

 

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The following summarizes the Company’s operations:

 

Revenues: Our consolidated revenues increased $44.3 million, or 2.5%, for the six months ended June 30, 2017 to $1.81 billion from $1.77 billion in the same period of last year. Overall organic revenue growth contributed $49.0 million, or 2.8%. Organic growth excludes the effect of foreign exchange and acquisitions and divestitures with less than a full year of revenues in the comparative period. Revenues from acquisitions contributed $18.6 million to the increase in revenues in the first six months of 2017. Divestiture activity decreased current period revenues by $1.5 million. The net effect of acquisitions and divestiture activity resulted in a 1.0% increase in revenues in the first six months of 2017. The effect of foreign exchange rates unfavorably impacted total revenues in 2017 by $21.8 million, or 1.2%, as foreign currencies declined against the U.S. dollar.

 

 

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Domestic and Canada RCS revenues increased $36.1 million, or 2.9%, for the six months ended June 30, 2017 to $1.28 billion from $1.25 billion in the same period of last year. Organic revenue growth contributed $23.7 million, or 1.9%, and acquisitions contributed $12.6 million, or 1.0%, in revenues. Our Secure Information Destruction revenues were strong due to higher sales activity for both reoccurring and one-time purge services combined with higher recycling revenue. The strengthening of the Canadian dollar had a slight unfavorable impact on 2017 revenues by $0.2 million. M&I waste services continued to experience a decline of $9.9 million reducing overall organic growth by 1.1%. This decline was due to fewer on-call services related to softness in the U.S. industrial market. In addition, we have experienced pricing pressure on our small quantity regulated waste and compliance customers resulting from hospital consolidation of physician practices and increased competitive activities in the market.

International RCS revenues decreased $21.2 million, or 5.5%, for the six months ended June 30, 2017 to $361.6 million from $382.9 million in the same period of last year. Organic decline in the International RCS segment was $1.8 million, or 0.5%, in the 2017 period, primarily due to exiting certain patient transport service contracts in the UK and a decline in M&I waste services. Acquisitions in the International RCS segment increased revenues by $3.6 million in the 2017 period. Divestiture activity decreased current period revenues by $1.5 million. The net effect of acquisitions and divestiture activity resulted in a 0.6% increase in revenues in the 2017 period. The effect of foreign exchange rates unfavorably impacted international revenues in 2017 by $21.5 million, or 5.6%, as foreign currencies declined against the U.S. dollar.

Other revenues related to Domestic Communication and Related Services increased $29.5 million, or 21.7%, for the six months ended June 30, 2017 to $165.7 million from $136.1 million in the same period of last year, primarily due to serving new brands across many industries and several larger non-recurring recall events in 2017.

Cost of Revenues: Our consolidated 2017 cost of revenues increased $38.1 million, or 3.7%, for the six months ended June 30, 2017 to $1.06 billion from $1.02 billion in the same period of last year. As a percentage of revenues, consolidated gross profit decreased to 41.5% for the six months ended June 30, 2017 from 42.1% in the same period of last year.

Domestic and Canada RCS cost of revenues increased $32.4 million, or 4.7%, for the six months ended June 30, 2017 to $719.8 million from $687.4 million in the same period of last year. Gross profit as a percentage of revenues decreased to 43.9% for the six months ended June 30, 2017 from 44.9% in the same period of last year, primarily due to lower revenues from our M&I customers, which have a higher fixed cost structure. Pricing pressure on our small quantity regulated waste and compliance customers negatively impacted our gross profit as a percentage of revenues. We also experienced higher costs related to fuel, utilities and wages.

International RCS cost of revenues decreased $14.6 million, or 5.6%, for the six months ended June 30, 2017 to $246.7 million from $261.2 million in the same period of last year, primarily driven by the impact of foreign exchange movements as the U.S. dollar strengthened in 2017. Gross profit as a percentage of revenues was at 31.8% for both the six months ended June 30, 2017 and 2016.

Adjusted SG&A: Our consolidated Adjusted SG&A expenses increased $24.7 million, or 6.9%, for the six months ended June 30, 2017 to $384.3 million from $359.5 million in the same period of last year to support our increase in revenues.

Domestic and Canada RCS Adjusted SG&A expenses slightly increased $0.3 million, or 0.2%, for the six months ended June 30, 2017 to $175.7 million from $175.4 million in the same period of last year. As a percentage of revenues, Adjusted SG&A decreased to 13.7% for the six months ended June 30, 2017 compared to 14.1% in the same period of last year.

International RCS Adjusted SG&A expenses decreased $10.7 million, or 12.7%, for the six months ended June 30, 2017 to $73.6 million from $84.4 million in the same period of last year, primarily related to the exit of certain UK patient transport services contracts as well as the impact of foreign exchange movements as the U.S. dollar

 

 

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strengthened in 2017. As a percentage of revenues, Adjusted SG&A decreased to 20.4% for the six months ended June 30, 2017 compared to 22.0% in the same period of last year.

(Loss) Income from Operations: Consolidated income from operations decreased $318.4 million for the six months ended June 30, 2017 to a loss of ($77.8) million from income of $240.6 million in the same period of last year. The comparison of (loss) income from operations between 2017 and 2016 was affected by the following items:

During the six months ended June 30, 2017, we recognized $43.6 million of expenses related to acquisition and integration activities, $308.1 million in certain litigation and professional services expenses (primarily due to a charge of $295.0 million related to the Proposed MDL Settlement), $7.5 million in restructuring, plant conversion and other related expenses, and contract exit expenses, $13.2 million of asset impairment charges and loss on disposal of assets held for sale in the UK, and a $0.4 million unfavorable change in fair value of contingent consideration.

During the six months ended June 30, 2016, we recognized $47.4 million of expenses related to acquisition and integration activities (mainly Shred-it), $4.0 million in litigation expenses, $13.9 million in restructuring, plant conversion and other related expenses, and contract exit expenses related to exiting certain contracts in our patient transport services in the UK, and a $2.6 million favorable change in the fair value of contingent consideration.

Consolidated depreciation and amortization expense decreased $14.2 million, or 10.8%, for the six months ended June 30, 2017 to $116.8 million from $131.0 million in the same period of last year, primarily due to an update of the intangible valuations related to the Shred-it acquisition resulting in a catch-up of amortization expense from the acquisition date in 2016. As a percentage of revenues, depreciation and amortization expense decreased to 6.5% compared to 7.4% in in the same period of last year.

Domestic and Canada RCS income from operations decreased $282.8 million for the six months ended June 30, 2017 to $22.2 million from $305.0 million in the same period of last year.

During the six months ended June 30, 2017, we recognized $318.1 million of expenses related to acquisition and integration activities, certain litigation and professional services expenses (primarily due to a charge of $295.0 million related to the Proposed MDL Settlement), plant conversion and other related expenses, and asset impairment charges.

During the six months ended June 30, 2016, we recognized $24.4 million of expenses related to acquisition and integration activities.

Domestic and Canada RCS depreciation and amortization expense decreased $10.9 million, or 12.4%, for the six months ended June 30, 2017 to $76.8 million from $87.6 million in the same period of last year, primarily due to an update of the intangible valuations related to the Shred-it acquisition resulting in a catch-up of amortization expense from the acquisition date in 2016. As a percentage of revenues, depreciation and amortization expense decreased to 6.0% for the six months ended June 30, 2017 compared to 7.0% in the same period of last year.

International RCS income from operations increased $1.2 million for the six months ended June 30, 2017 to $3.5 million from $2.3 million in the same period of last year.

During the six months ended June 30, 2017, we recognized $23.9 million of expenses related to acquisition and integration activities, certain litigation and professional services expenses, restructuring, plant conversion and other related expenses, contract exit expenses, asset impairment charges, and loss on disposal of assets held for sale. These charges are primarily due to an initiative to realign our operations and reduce labor redundancies in our Latin American countries and exiting certain of our UK patient transport services contracts.

During the six months ended June 30, 2016, we recognized $15.8 million of expenses related to acquisition and integration activities, plant conversion and other related expenses and contract exit expenses related to exiting

 

 

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certain contracts in our patient transport services in the UK, and a favorable change in the fair value of contingent consideration.

International RCS depreciation and amortization expense decreased $7.1 million, or 21.1%, for the six months ended June 30, 2017 to $26.5 million from $33.6 million in the same period of last year, primarily due to an update of the intangible valuations related to the Shred-it acquisition resulting in a catch-up of amortization expense from the acquisition date in 2016. As a percentage of revenues, depreciation and amortization expense decreased to 7.3% for the six months ended June 30, 2017 compared to 8.8% in the same period of last year.

Net Interest Expense: Net interest expense decreased to $47.0 million for the six months ended June 30, 2017 from $48.4 million in the same period of last year due to a reduction of our average outstanding debt balance, partially offset by increase in interest rates in the U.S.

Income Tax (Benefit) Expense: Income tax (benefit) was ($42.4) million for the six months ended June 30, 2017 compared to income tax expense of $65.0 million in the same period of last year. This change to a benefit is primarily due to the tax impact of the charge associated with the proposed settlement of the small quantity customer class action lawsuit in the U.S. The effective tax rates for the six months ended June 30, 2017 and 2016 were 33.1% and 34.4%, respectively. The decrease in the current period tax rate, when compared to the prior year, is primarily related to the aforementioned charge.

Liquidity and Capital Resources:

The following senior credit facility, term loan, and the private placement notes require us to comply with various financial, reporting, and other covenants and restrictions, including a restriction on dividend payments:

 

The financial debt covenants are the same for the senior credit facility, term loan, and the private placement notes. At June 30, 2017, we were in compliance with all of our financial debt covenants. Our senior credit facility, term loan, and the private placement notes rank pari passu to each other and all other unsecured debt obligations.

At June 30, 2017, we had $390.6 million of borrowings outstanding under our $1.2 billion senior unsecured credit facility, which includes foreign currency borrowings of $127.1 million. We also had $133.6 million outstanding letters of credit under this facility. The unused portion of the revolving credit facility at June 30, 2017 was $675.8 million. At June 30, 2017, our interest rates on borrowings under our revolving credit facility were as follows:

The weighted average rate of interest on the unsecured revolving credit facility was 2.36% per annum, which includes the 0.2% facility fee at June 30, 2017.

 

 

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As of June 30, 2017, we had $950.0 million outstanding under our term loan credit facility. The weighted average rate of interest on the unsecured term loan facility was 2.53% per annum.

As of June 30, 2017, we had $175.0 million of seven-year 3.89% unsecured senior notes and $225.0 million of 10-year 4.47% unsecured senior notes outstanding issued to 39 institutional purchasers in a private placement completed in October 2010. Interest is payable in arrears semi-annually on April 15 and October 15 beginning on April 15, 2011, and principal is payable on October 15, 2017 for the seven-year notes and October 15, 2020 for the 10-year notes. We have classified our $175.0 million private placement notes that mature in October 2017 as long-term debt due to our intent and ability to settle this obligation by borrowing on our $1.2 billion senior credit facility due in 2019.

As of June 30, 2017, we had $125.0 million of seven-year 2.68% unsecured senior notes and $125.0 million of 10-year 3.26% unsecured senior notes outstanding issued to 46 institutional purchasers in a private placement completed in December 2012. Interest is payable in arrears semi-annually on June 12 and December 12 beginning on June 12, 2013, and principal is payable on December 12, 2019 for the seven-year notes and December 12, 2022 for the 10-year notes.

As of June 30, 2017, we had $200.0 million of seven-year 2.72% unsecured senior notes and $100.0 million of eight-year 2.79% unsecured senior notes outstanding issued to several institutional purchasers in a private placement completed in July 2015. Interest is payable in arrears semi-annually on January 1 and July 1 beginning on January 1, 2016, and principal is payable on July 1, 2022 for the seven-year notes and July 1, 2023 for the eight-year notes.

As of June 30, 2017, we had $150.0 million of six-year 2.89% unsecured senior notes and $150.0 million of eight-year 3.18% unsecured senior notes outstanding issued to several institutional purchasers in a private placement completed in October 2015. Interest is payable in arrears semi-annually on April 1 and October 1 beginning on April 1, 2016, and principal is payable on October 1, 2021 for the six-year notes and October 1, 2023 for the eight-year notes.

As of June 30, 2017, we had $173.5 million in promissory notes and deferred consideration outstanding issued in connection with acquisitions during 2008 through 2017, $95.1 million in foreign subsidiary bank debt outstanding, and $10.0 million in capital lease obligations.

As disclosed in our current report on Form 8-K filed on August 2, 2017, we entered into amendments to the agreements governing our senior credit facility, term loan and private placement notes which amend the financial covenants therein to modify the definition of Consolidated EBITDA and provisions relating to permissible Consolidated Leverage Ratio to permit the Company to make the payment contemplated by the Proposed MDL Settlement. If at the end of any fiscal quarter, the Consolidated Leverage Ratio, on a pro forma basis as of such date and immediately after giving effect to the settlement payment of the Proposed MDL Settlement (see Note 14 – Legal Proceedings) is greater than 3.5 to 1.00, the Company may, in its sole discretion, elect to increase the maximum Consolidated Leverage Ratio to 4.00 to 1.00 as of the end of the fiscal quarter in which the full payment for the Proposed MDL Settlement occurred and in any subsequent fiscal quarter ending on or prior to September 30, 2018; provided, however, in no event shall the elevated ratio permitted by the immediately preceding clause extend after September 30, 2018.

Each Private Placement Amendment further provides that, if at the end of any fiscal quarter of the Company, the Consolidated Leverage Ratio exceeded 3.75 to 1.00 but is at or below 4.00 to 1.00, the per annum interest rate (including any Default Rate, if applicable) otherwise applicable shall be increased by 50 basis points (.50%) from the date of such Leverage Increase to but not including the date that the Consolidated Leverage Ratio is 3.75 to 1.00 or less.

Working Capital: At June 30, 2017, our working capital decreased $349.9 million to $(119.1) million compared to $230.8 million at December 31, 2016.

 

 

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Current assets increased $22.5 million, primarily driven by a $19.3 million increase in prepaid income taxes due to making current year tax payments at a previously forecasted rate which is now lower. Accounts receivables increased $4.7 million due to an increase in revenues. Days sales outstanding was 63 days and 64 days at June 30, 2017 and December 31, 2016, respectively.

Current liabilities increased $372.4 million, primarily due to an accrual of $295.0 million related to the Proposed MDL Settlement and a $41.0 million reclassification of term loan debt from long-term to current.

Net Cash Change: Net cash provided by operating activities decreased $8.4 million, or 3.4%, to $237.1 million for the six months ended June 30, 2017 from $245.4 million in 2016.

Net cash used in investing activities during the six months ended June 30, 2017 was $83.8 million compared to $107.9 million in 2016. We used $20.9 million less cash for acquisitions during the six months ended June 30, 2017 than during the same period of last year. Our capital expenditures decreased $4.0 million in 2017 and, as percentage of revenues, were at 3.5% and 3.8% in 2017 and 2016, respectively.

Net cash used in financing activities was $157.1 million for the six months ended June 30, 2017 compared to $149.2 million in the same period of last year. In 2017, we repaid $75.9 million, net, of our senior credit facility and term loan facility compared to $62.8 million in 2016. We had preferred share repurchases of $22.1 million in 2017 compared to $40.8 million of common and $5.0 million of preferred shares repurchases in 2016. Dividends of $18.5 million and $20.1 million were paid to holders of our Series A Preferred Stock in 2017 and 2016, respectively.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We are subject to market risks arising from changes in interest rates. Our potential additional interest expense over one year that would result from a hypothetical, instantaneous and unfavorable change of 100 basis points in the interest rate on all of our variable rate obligations would be approximately $14.4 million on a pre-tax basis.

We have exposure to commodity pricing for gas and diesel fuel for our trucks, for the purchases of containers and boxes, and for the price we receive for shredded office paper. We do not hedge these items to manage the exposure.

We have exposure to foreign currency fluctuations. We have subsidiaries in multiple foreign countries whose functional currency is the local currency. Our international subsidiaries use local currency denominated lines of credit for their funding needs which has no exposure to currency fluctuations. We translate the results of our international operations using an average monthly exchange rate. Changes in foreign currency exchange rates could unfavorably impact our consolidated results of operations.

We operate in a highly competitive market. We have exposure to other service providers providing cheaper solutions. As physician practices are consolidated by larger hospital groups we have exposure related to negotiating leverage that large quantity generators have through professional purchasing departments, which may have a negative impact to our revenues as contracts renew.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures.

The term "disclosure controls and procedures" is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) as "controls and other procedures of an issuer that are designed to ensure that information

 

 

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required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms." Our disclosure controls and procedures are designed to ensure that material information relating to us and our consolidated subsidiaries is accumulated and communicated to our management, including our President and Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding our required disclosures.

Our management, with the participation of our President and Chief Executive Officer and our Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q. Based upon that evaluation, our President and Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this quarterly report on Form 10-Q, because of material weaknesses in internal control over financial reporting described below.

Internal control over financial reporting.

Management of Stericycle is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d(f) under the Exchange Act). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.

 

Stericycle conducted an assessment of the effectiveness of its internal control over financial reporting as of December 31, 2016 based on the criteria established by the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO Framework”).

 

During 2016, the Company’s assessment included the global Shred-it business. Shred-it was acquired late in 2015 and resulted in significant integration activities throughout 2016 with a broad impact across the organization. While the Company made progress in certain of the areas identified in the prior year, additional material weaknesses were identified. As a result, as of December 31, 2016, Stericycle management has identified material weaknesses related to: a lack of a framework to identify risks of material misstatement to the organization’s financial statements and appropriately designed controls to mitigate those risks; a lack of robust accounting policies to assist our finance organization with accounting for transactions appropriately and on a timely basis; insufficient design and communication of general information technology controls to support the effective operation of financial controls; and an insufficiently staffed finance organization with the requisite skills and ability to focus on internal control over financial reporting matters to respond to the risks to the financial statements. These material weaknesses in the control environment, risk assessment, and control activity components of the COSO framework as of December 31, 2016 and June 30, 2017 are pervasive across our internal control processes.

Planned Remediation of Material Weaknesses

 

Since 2016, Stericycle has invested considerable time and resources towards redesigning our internal control over financial reporting. This effort can be summarized as follows:

 

 

 

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Remediation of control deficiencies that gave rise to the material weaknesses described above can be a multi-year process. We remain committed to continue investing significant time and resources and taking actions to remediate the material weaknesses in our internal control over financial reporting as we work to further integrate acquisitions, streamline disparate information technology systems, and enhance our control environment.

Below we have described the remediation actions we are taking to address the identified material weaknesses and enhance our overall control environment, risk assessment, and control activities.

 

Control Environment

 

Risk Assessment

 

Control Activities

 

 

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When fully implemented and operational, we believe the measures described above will remediate the control deficiencies that have led to the material weaknesses we have identified and strengthen our internal control over financial reporting. We are committed to continuing to improve our internal control processes and we will continue to review our financial reporting controls and procedures. As we continue to evaluate and work to improve our internal control over financial reporting, we may determine to take additional measures to address control deficiencies or modify certain activities of the remediation measures described above.

Notwithstanding the existence of the material weaknesses as described above, we believe that the Condensed Consolidated Financial Statements in this quarterly report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows as of the dates, and for the periods, presented, in conformity with U.S. GAAP.

Changes in internal control over financial reporting.

We have undertaken strategic remediation actions to address the material weaknesses in our internal controls over financial reporting. These remediation actions continued throughout the quarter ended June 30, 2017 but have not materially affected our internal control over financial reporting.

Safe Harbor Statement: This quarterly report on Form 10-Q may contain forward-looking statements that involve risks and uncertainties, some of which are beyond our control (for example, general economic and market conditions). Our actual results could differ significantly from the results described in the forward-looking statements. Factors that could cause such differences include changes in governmental regulation of the collection, transportation, treatment and disposal of regulated waste or the proper handling and protection of personal and confidential information, completion and court approval of the proposed resolution of the small quantity customer class action litigation, increases in transportation and other operating costs, the level of governmental enforcement of regulations governing regulated waste collection and treatment or the proper handling and protection of personal and confidential information, our obligations to service our substantial indebtedness and to comply with the covenants and restrictions contained in our private placement notes, term loan credit facility and revolving credit facility, our ability to execute our acquisition strategy and to integrate acquired businesses, competition and demand for services in the regulated waste and secure information destruction industries, political, economic and currency risks related to our foreign operations, impairments of goodwill, intangibles or other long-lived assets, variability in the demand for services we provide on a project or non-recurring basis, exposure to environmental liabilities, fluctuations in the price we receive for the sale of paper, the outcome of pending or future litigation, disruptions in or attacks on our information technology systems, compliance with existing and future legal and regulatory requirements, as well as other factors described in our filings with the U.S. Securities and Exchange Commission, including our most recently filed Annual Report on Form 10-K and subsequent quarterly reports on Forms 10-Q. As a result, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate future results or trends. We make no commitment to disclose any subsequent revisions to forward-looking statements.

 

 

 

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Note 14 - Legal Proceedings in the Notes to the Condensed Consolidated Financial Statements (Item 1 of Part I).

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Under resolutions that our Board of Directors has adopted, we have been authorized to purchase a cumulative total of 24,621,640 shares of our common stock on the open market. As of June 30, 2017, we had purchased a cumulative total of 21,251,733 shares.

There were no repurchases of shares of our common stock during the three and six months ended June 30, 2017.

ITEM 6. EXHIBITS

See the Exhibit Index following the signature page to this Quarterly Report on Form 10-Q for a list of exhibits filed or furnished with this report, which Exhibit Index is incorporated herein by reference.

 

 

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: August 9, 2017

 

 

 

 

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EXHIBIT INDEX

 

 

 

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