Stericycle, Inc.

Table of Contents

PART I. – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

STERICYCLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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

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STERICYCLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

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

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STERICYCLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

June 30, 2010 (Unaudited) and

Year Ended December 31, 2009 (Audited)

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

STERICYCLE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Unless the context requires otherwise, “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 Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations; but the Company believes the disclosures 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. Current amounts in previously issued financial statements were reclassified to conform to the current period presentation. These condensed consolidated financial statements should be read in conjunction with the Consolidated Financial Statements and notes thereto for the year ended December 31, 2008,2009, as filed with our Annual Report on Form 10-K for the year ended December 31, 2008.2009. The results of operations for the six months ended June 30, 20092010 are not necessarily indicative of the results that may be achieved for the entire year ending December 31, 2009.2010.

NOTE 2 – ACQUISITIONS

AND DIVESTITURES

During the quarter ended March 31, 2009,2010, we acquired selected assets of threetwo domestic regulated waste businesses, 100% of the stock of two regulated waste businesses in the UK, 70% of the stock of a regulated waste business in Brazil, and completed100% of the funding onstock of a 2008 acquisition.

regulated waste business in Chile. We also increased our majority share in a previous acquisition in Chile.

During the quarter ended June 30, 2009,2010, we completed sevenfour acquisitions. Domestically, we acquired five regulated waste businesses four of which were selected assets and one was a stock purchase.  Internationally, we acquired all of the stock of two regulated waste businessesbusinesses. Internationally, we acquired all of the stock of one regulated waste business located in the United Kingdom and the otherselected assets of a regulated waste business located in Romania.  

Mexico.

The aggregate purchase price of our acquisitions during the six months ended June 30, 20092010 was approximately $81.3$105.4 million, of which approximately $14.2 million in cash payments related to transactions that closed in 2008 and were disbursed in 2009.  The purchase price of our 2009 acquisitions was approximately $67.1 million, of which $46.3$67.8 million was paid in cash, and $20.8$31.0 million was paid by the issuance of promissory notes.notes, and $6.6 million was recorded as contingent consideration. For financial reporting purposes, our 2009 acquisitions were accounted for using thewe recognized $76.9 million in goodwill, of which $6.5 million is tax deductible. We recognized $49.8 million in intangible assets of which $32.3 million have amortizable lives of 15-40 years, $0.4 million have amortizable lives of 3-5 years, and $17.1 million are indefinite lived. The allocation of acquisition method of accounting.  The purchase prices of these acquisitions, in excess of acquired tangible assets, have been primarily allocated to goodwill and areprice is preliminary pending completion of certain intangible asset valuations.  valuations and completion accounts.

In thousands
		Preliminary Allocation of 2010 Acquisitions				Adjustments During Allocation Period				Total Allocations
Fixed assets		$	8,325			$	195			$	8,520
Intangibles			49,807				2,160				51,967
Goodwill			76,901				(2,681	)			74,220
Net other assets			4,786				(1,022	)			3,764
Debt			(4,079	)			900				(3,179	)
Net deferred tax liabilities			(12,951	)			597				(12,354	)
Noncontrolling interests			(17,457	)			—				(17,457	)
		$	105,332			$	149			$	105,481

The results of operations of these acquired businesses have been included in the consolidated statements

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of income from the dates of acquisition. These acquisitions resulted in recognition of goodwill in our financial statements reflecting the complementary strategic fit that the acquired businesses brought to us. During the six month period ended June 30, 2010 and 2009, the Company incurred $1.4 million and $1.9 million, respectively, of third party acquisition related expenses. These expenses are identified on our Condensed Consolidated Statements of Income as Acquisition related transaction expenses.

Our acquisition of MedServe in December of 2009 required us to divest of certain acquired assets. These assets were sold for $8.0 million resulting in a pre-tax gain of $3.0 million. The following table describes the sold assets:

On May 9, 2009, we and our wholly-owned subsidiary, ATMW Acquisition Corp., entered into an agreement and plan of merger with MedServe, Inc. a Delaware corporation, and Avista Capital Partners, L.P., a Delaware limited partnership, as the stockholders’ representative. Pursuant to the merger agreement and upon completion of the merger, our subsidiary will be merged with and into MedServe and MedServe will become a wholly-owned subsidiary of ours.  MedServe is privately held. It is engaged in the collection, transportation, treatment and disposal of medical waste, hazardous waste, universal waste and other regulated wastes, sharps management services, safety and compliance training services, and other related businesses.

The total merger consideration payable by us is $185 million in cash, subject to reduction for MedServe’s indebtedness as of the closing date, MedServe’s expenses in connection with the transaction, and other expenses related to the transaction. In addition, $27.8 million of the merger consideration will be deposited in escrow to cover indemnification obligations of the MedServe stockholders under the merger agreement.

Concurrently with the parties’ execution of the merger agreement, MedServe stockholders holding a majority of its outstanding shares entitled to vote delivered their written consent approving the merger agreement and the merger.

The merger is subject to customary closing conditions and regulatory reviews, including clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (See Note 10 – Legal Proceedings).

NOTE 3 – INCOME TAXESNEW ACCOUNTING STANDARDS

Accounting Standards Recently Adopted

WeConsolidation

On January 1, 2010, Stericycle adopted changes issued by the FASB related to amendments to previous guidance on the consolidation of variable interest entities (“VIE”). This standard clarifies the characteristics that identify a VIE and our subsidiaries file U.S. federal income tax returnschanges how a reporting entity identifies a primary beneficiary that would consolidate the VIE from a quantitative risk and income tax returnsrewards calculation to a qualitative approach based on which variable interest holder has controlling financial interest and the ability to direct the most significant activities that impact the VIE’s economic performance. This statement requires the primary beneficiary assessment to be performed on a continuous basis. It also requires additional disclosures about an entity’s involvement with a VIE, restrictions on the VIE’s assets and liabilities that are included in various statesthe reporting entity’s consolidated balance sheet, significant risk exposures due to the entity’s involvement with the VIE, and foreign jurisdictions.  Withhow its involvement with a few exceptions, we are no longer subject to U.S. federal, state, local, or non-U.S. income tax examinations by tax authorities for years before 2002.  The Internal Revenue Service (“IRS”) concluded an examinationVIE impacts the reporting entity’s consolidated financial statements. Our adoption of the Company's U.S. income tax returnstandard did not have an impact to our financial statements.

Accounting Standards not yet adopted

Revenue Recognition

In October 2009, the FASB issued an update to existing guidance on revenue recognition for 2004; subsequent tax years remain openarrangements with multiple deliverables. This update will allow companies to allocate consideration received for qualified separate deliverables using estimated selling price for both delivered and subject to examination byundelivered items when vendor-specific objective evidence or third-party evidence is unavailable. Additional disclosures discussing the IRS. Our subsidiaries in foreign countries have tax years open ranging from 2002 through 2008.

The total amountnature of unrecognized tax benefits asmultiple element arrangements, the types of June 30, 2009 and 2008 was $8.2 million and $3.7 million, respectively, which included immaterial amounts of interest and penalties reflected as a liability on the balance sheet. The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is approximately $8.2 million. We recognize interest and penalties accrued related to income tax reserves in income tax expense.  This method of accounting is consistent with prior years.

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The following table summarizes the changes in unrecognized tax positions during the six months ended June 30, 2009:

NOTE 4 – STOCK BASED COMPENSATION

At June 30, 2009, we had stock options outstandingdeliverables under the following plans:

·

arrangements, the 2008 Incentive Stock Plan, whichgeneral timing of their delivery, and significant factors and estimates used to determine estimated selling prices are required. We will adopt this update for new revenue arrangements entered into or materially modified beginning January 1, 2011. We do not generally have arrangements with multiple deliverables and therefore do not expect any material impact to our stockholders approved in May 2008;

·

the 2005 Incentive Stock Plan, which our stockholders approved in April 2005;

·

the 2000 Nonstatutory Stock Option Plan, which our Board of Directors adopted in February 2000;

·

the 1997 Stock Option Plan, which expired in January 2007;

·

the Directors Stock Option Plan, which expired in May 2006;

·

the 1995 Incentive Compensation Plan, which expired in July 2005;

·

and our Employee Stock Purchase Plan, which our stockholders approved in May 2001.

The following table sets forth the expense related to stock compensation:

The following table sets forth the tax benefits related to stock compensation:

The Black-Scholes option-pricing model is used in determining the fair value of each option grant using the assumptions noted in the table below.  The expected term of options granted is based on historical experience and represents the period of time that awards granted are expected to be outstanding.  Expected volatility is basedfinancial statements upon historical volatility of the company’s stock.  The expected dividend yield is zero.  The risk-free interest rate is based upon the U.S. Treasury yield rates of a comparable period.adoption.

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The assumptions that we used in the Black-Scholes model are as follows:

The weighted average grant date fair value of the stock options granted during the three and six months ended June 30, 2009 and 2008, was $13.87 and $16.33, and $11.89 and $13.51, respectively.

Stock option activity for the six months ended June 30, 2009, was as follows:

The total intrinsic value of options exercised for the three and six months ended June 30, 2009 and 2008 was $4.7 million and $14.7 million, and $8.9 million and $21.2 million, respectively.  Intrinsic value is measured using the fair market value at the date of the exercise (for options exercised) or at June 30, 2009 (for outstanding options), less the applicable exercise price.

As of June 30, 2009, there was $26.7 million of total unrecognized compensation expense, related to non-vested stock options, which is expected to be recognized over a weighted average period of 1.93 years.

NOTE 5 – COMMON STOCK

During the quarters ended March 31, 2009 and 2008, we repurchased on the open market, and subsequently cancelled, 536,346 and 1,482,185 shares of common stock, respectively.  The weighted average repurchase price was $47.59 and $53.56 per share, respectively.

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During the quarters ended June 30, 2009 and 2008, we repurchased on the open market, and subsequently cancelled, 40,162 and 984,533 shares of common stock, respectively.  The weighted average repurchase price was $48.51 and $52.49 per share, respectively.  

During the quarter ended March 31, 2009, we settled in cash $2.5 million of share repurchases that were executed in December 2008.  

NOTE 4 – 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, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

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 has been considered in the fair value measurements noted below. In addition, the fair value measurement of a liability must reflect the nonperformance risk of an entity.

Level 1: At June 30, 2010, we have $8.3 million in cash and cash equivalents, and $2.2 million of short-term investments that we carry on our books at fair value using Level 1 inputs. At December 31, 2009, we had $15.8 million in cash and cash equivalents and $1.1 million of short-term investments on our books at fair value using market price inputs.

Level 2: At June 30, 2010, we have an interest rate swap contract covering $25 million of our variable interest debt. The objective of the swaps is to reduce the risk of volatile interest expense by fixing the rate. We also have a Treasury rate lock covering $150 million of our expected private debt placement. The objective of the Treasury rate lock is to reduce the risk of volatile interest expense by fixing a portion of the fixed rate. The interest rate hedges are designated as cash flow hedges; the notional amount and all other significant terms of the hedge agreements are matched to the provisions and terms of the debt hedged. We apply hedge accounting to these instruments with changes in the fair value of the hedge agreements recorded as a component of accumulated other comprehensive income. The fair value was determined using market data inputs to calculate expected future interest rates. The cash streams attributable to the difference between expected future rates and the fixed rate payable is discounted to arrive at the fair value of the two hedges. At June 30, 2010 and December 31, 2009 the fair value of the interest rate hedges was recorded as a current liability of $3.8 million and $1.2 million, respectively.

Level 3: We had no assets or liabilities measured at fair value using Level 3 inputs at June 30, 2010 or December 31, 2009.

Fair Value of Debt: At June 30, 2010, the fair value of the Company’s debt obligations was estimated at $949.4 million, compared to a carrying amount of $951.9 million. At December 31, 2009, the fair value of the Company’s debt obligations was estimated at $985.0 million, compared to a carrying amount of $988.9 million. This fair value was estimated using market interest rates for comparable instruments.

There were no movements of items between fair value hierarchies.

NOTE 5 – DERIVATIVE INSTRUMENTS

As of June 30, 2010, we have one interest rate swap contract covering $25 million of our borrowings outstanding under our senior credit facility, and two Treasury rate locks covering $150 million of our expected private debt placement. The objective of the hedges is to reduce the risk of volatile interest expense by fixing the rate. The details of the contracts are as follows:

We entered into the interest rate hedges in order to manage the risk of interest rate changes to our interest expense. The interest rate hedges are designated as cash flow hedges; the notional amounts and all other significant terms of the hedge agreement are matched to the provisions and terms of the variable rate debt hedged. The fair market of the three hedges is recorded as a current liability of $3.8 million at June 30, 2010. At June 30, 2010, the hedges were determined to be 100% effective. Gains or losses on hedges are reclassified into interest expense when the effect of the hedged item is recognized in earnings. The fair market value was determined using market data inputs to calculate expected future interest rates. The cash streams attributable to the difference between expected future rates and the fixed rate payable is discounted to arrive at the fair value of the hedges.

NOTE 6 – NET INCOME PER COMMON SHARETAXES

We and our subsidiaries file U.S. federal income tax returns and income tax returns in various states and foreign jurisdictions. With a few exceptions, we are no longer subject to U.S. federal, state, local, or non-U.S. income tax examinations by tax authorities for years before 2003. The Internal Revenue Service (“IRS”) concluded an examination of the Company’s U.S. income tax return for 2004. Tax years after 2005 remain open and subject to examination by the IRS. In addition, our subsidiaries in foreign countries have tax years open ranging from 2003 through 2009.

The Company has recorded accruals to cover certain unresolved tax issues. Such contingent liabilities relate to additional taxes and interest 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 accrual for contingent liabilities as deemed necessary.

The total amount of unrecognized tax benefits as of June 30, 2010 and December 31, 2009 was $9.0 million and $7.6 million, respectively, which included immaterial amounts of interest and penalties reflected as a liability on the balance sheet. The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is approximately $9.0 million. We recognize interest and penalties accrued related to income tax reserves in income tax expense. This method of accounting is consistent with prior years.

The following table sets forthsummarizes the computation of basic and diluted net income per share:

NOTE 7 – COMPREHENSIVE INCOME

The components of total comprehensive income are net income, the change in cumulative currency translation adjustments and gains and losses on derivative instruments qualifying as cash flow hedges.The following table sets forth the components of total comprehensive income for the three and six months ended June 30, 2009 and 2008: