Stericycle
Annual Report 2008

Plain-text annual report

Annual Report Dear Fellow Shareholders: In 2008, Stericycle continued to set new Company financial records, to expand our range of service offerings in the U.S. and to grow internationally. Revenues in 2008 grew to $1.1 billion, a 16.2% increase over 2007. Gross margins remained the same as 2007 at 44.8%. Operating income rose 22.1% to $274.2 million from $224.5 million in 2007. Operating margins were 25.3% versus 24.1% in 2007. Under generally accepted accounting principles (“GAAP”), net income for 2008 increased 25.6%, from $118.4 million to $148.7 million, and diluted earnings per share increased 27.9%, from $1.32 to $1.68 per diluted share. Our 2008 results include the effect of a partially adverse award in an arbitration settlement in Australia that reduced 2008 net income by $3.5 million or $0.04 per diluted share. Our 2007 results included several one-time events that had a combined effect of reducing 2007 net income by $9.3 million or $0.10 per diluted share due to the net impact of the following events: a partially adverse award in arbitration proceedings in Australia, the write-down of a joint venture investment in Argentina, and the write-down of impaired intangibles and impaired fixed assets partially offset by the receipt of insurance proceeds related to the 2005 3CI class action litigation settlement and the gain recognized on the divestiture of selected business operations in the United Kingdom. Excluding the impact of these one-time events and other items on our results in both 2007 and 2008, our non-GAAP net income in 2008 increased 21.6% over our non-GAAP net income in 2007. Accomplishments in 2008 We continued to generate strong free cash flow from operations, which we used to fund growth and improve our balance sheet. During 2008, we invested $47.5 million of the $210.6 million in cash generated from operations to expand our capabilities, drive innovation and better serve the evolving needs of our customers. In addition, we used $84.9 million for acquisitions and we repurchased $167.3 million in stock on the open market. Domestically: We continued to strengthen Stericycle’s leadership position in regulated waste management and healthcare safety and compliance services. We successfully increased the penetration of Steri•SafeSM, our OSHA safety and compliance solution, helping even more healthcare providers throughout the United States to create a safer, more compliant workplace. We continued to achieve strong customer adoption of our Sharps Management Service that not only reduces the risk of needle sticks for hospital staff, but also prevents thousands of tons of plastic and corrugated material from accumulating in landfills. We achieved strong growth in new accounts for our Returns Management Services business. In 2008, we completed 14 domestic acquisitions and began their integration into our existing operations. Internationally: We continued to establish and strengthen our position in international markets. We acquired eight businesses internationally, including entering a country where we had not previously operated (Chile). We added business that strengthened our capabilities in Mexico, the United Kingdom, Ireland, Argentina and Canada. Priorities for 2009 By building on Stericycle’s industry leadership position in 2008, we are confident that we have the operating platform that we need to drive future growth and explore opportunities to serve our customers better. Our priorities for 2009 are: Domestic Growth: Our focus will be on our Steri•SafeSM, Bio Systems and Return Management Services offerings. Our marketing efforts to small quantity generators will concentrate on our Steri•SafeSM OSHA safety and compliance services and regulated waste management services. Our marketing focus for large quantity generators will be on extending the momentum of our Sharps Management Service solution and expanding our Return Management Services. We will focus overall on creating best-in-class customer service and meeting customer needs with additional service offerings. International Growth: We will remain focused on integrating the acquisitions completed and on pursuing attractive international market opportunities directed to providing value to our shareholders over the course of the next several years. Profit Growth: We are committed to extending our track record of improving our operating margins. We will seek to make further improvements to our collection route densities, reduce our long-haul transportation costs and improve efficiency in our processing plants. Our culture of continuous improvement is focused on streamlining how we serve customers and encourages the sharing of best practices and productivity improvement ideas across our entire organization. Service Innovation and Environmental Leadership: During 2009, we will maintain our dual commitments to being both responsive to our customers’ needs and an environmental leader by offering services suited to the needs of our customers. Our innovative Steri•SafeSM OSHA safety and compliance services will continue to help our customers enjoy a safer, more compliant workplace in a cost-effective manner. The breadth of our Return Management Services offerings will help our customers protect their brands and reduce liability. Our other innovative outsourcing programs, such as our Sharps Management Service featuring reusable containers, offer significant environmental benefits by reducing waste volume and conserving valuable natural resources. • • • We are excited and confident about our future. Through our many service offerings, we help our customers protect the safety of their workforce and reduce risk. We are a clear leader in providing regulated waste management, safety compliance, sharps management and return management services. We will focus on the many growth opportunities that our leadership position affords us. We will continue to refine the efficiency of our operations and improve our customers’ experience while maintaining our strong focus on safety and regulatory compliance. We thank you for your support. Mark C. Miller Chairman, President and CEO Jack W. Schuler Lead Director UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K È ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2008 or ‘ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 0-21229 Stericycle, Inc. (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 36-3640402 (IRS Employer Identification Number) 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) Securities registered pursuant to Section 12(b) of the Act: Common stock, par value $.01 per share (Title of each class) NASDAQ Stock Market (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes È No ‘ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act of 1934. Yes ‘ No È 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 reports), and (2) has been subject to such filing requirements for the past 90 days. Yes È No ‘ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. È Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one) Large accelerated filer È Accelerated filer ‘ Non-accelerated filer ‘ Smaller reporting company ‘ Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the Exchange Act). Yes ‘ No È State the aggregate market value of voting and non-voting common equity held by non-affiliates computed by reference to the price at which common equity was last sold as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2008) was: $4,422,093,531. On February 13, 2008, there were 85,288,466 shares of the Registrant’s Common Stock outstanding. Information required by Items 10, 11, 12 and 13 of Part III of this Report is incorporated by reference from the Registrant’s definitive Proxy Statement for the 2009 Annual Meeting of Stockholders to be held on May 28, 2009. DOCUMENTS INCORPORATED BY REFERENCE Protecting People. Reducing Risk.™ Stericycle, Inc. 2008 ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS PART I. Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4. Business Risk Factors Unresolved Staff Comments Properties Legal Proceedings Submission of Matters to a Vote of Security Holders PART II. Item 5. Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters Item 6. Item 7. Selected Consolidated Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Item 8. Item 9. Quantitative and Qualitative Disclosures about Market Risk Consolidated Financial Statements and Supplemental Data Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Item 9B. Controls and Procedures Other Information PART III. Item 10. Item 11. Item 12. Directors and Executive Officers of the Registrant Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Item 14. Certain Relationships and Related Transactions Principal Accountant Fees and Services PART IV. Item 15. Exhibits and Financial Statement Schedules Signature Page No. 1 9 12 12 13 13 15 18 19 27 29 58 58 58 59 59 59 59 59 61 64 Item 1. Business PART I. Unless the context requires otherwise, “we,” “us” or “our” refers to Stericycle, Inc. and its subsidiaries on a consolidated basis. Overview We are in the business of managing regulated waste and providing an array of related services. We operate in the United States, Canada, Mexico, Argentina, Chile, the United Kingdom and Ireland. For large-quantity generators of regulated waste such as hospitals and for pharmaceutical companies and distributors, we offer: • • • • our institutional regulated waste management services; our Bio Systems® sharps management services to reduce the risk of needle sticks; a variety of products and services for infection control; and our regulated returns management services for expired or recalled healthcare products. For small-quantity generators of regulated waste such as doctors’ offices and for retail pharmacies, we offer: • • • • our regulated waste management services; our Steri-Safe® Occupational Safety and Health Act and Health Insurance Portability and Accountability Act (“HIPAA”) compliance programs; a variety of products and services for infection control; and our regulated returns management services for expired or recalled healthcare products. We operate integrated national regulated waste management networks in the United States, Canada, Mexico, Argentina, Chile, the United Kingdom and Ireland. Our national networks include a total of 89 processing or combined processing and collection sites and 97 additional transfer, collection or combined transfer and collection sites. Our regulated waste processing technologies include autoclaving, our proprietary electro-thermal- deactivation system (“ETD”), chemical treatment and incineration. We serve approximately 418,000 customers worldwide, of which approximately 11,000 are large-quantity generators, such as hospitals, blood banks and pharmaceutical manufacturers, and approximately 407,000 are small-quantity generators, such as outpatient clinics, medical and dental offices, long-term and sub-acute care facilities and retail pharmacies. We benefit from significant customer diversification. No one customer accounts for more than 2% of our total revenues, and our top 10 customers account for approximately 7% of total revenues. Industry Overview Governmental legislation and regulation increasingly requires the proper handling and disposal of regulated waste which includes such items as medical waste and pharmaceutical waste. Regulated medical waste is generally any medical waste that can cause an infectious disease and includes: single-use disposable items, such as needles, syringes, gloves and other medical supplies; cultures and stocks of infectious agents; and blood and blood products. Regulated pharmaceutical waste consists of expired or recalled pharmaceuticals. 1 During 2008, we believe the size of the global regulated waste market for the services we provide was approximately $10.5 billion. We estimate that our global market share increased to 10.3% in 2008 from 9.3% in 2007. Industry growth is driven by a number of factors. These factors include: • Aging of Population: The average age of the population in the countries we operate in is rising. As people age, they typically require more medical attention and a wider variety of tests, procedures and medications, leading to an increase in the quantity of regulated waste generated. • Pressure to Reduce Healthcare Costs: The healthcare industry is under pressure to reduce costs. We believe that our services can help healthcare providers to reduce their handling and compliance costs and to reduce their potential liability for employee exposure to blood-borne pathogens and other infectious agents. • Environmental and Safety Regulation: We believe that many businesses that are not currently using third party regulated waste services are unaware either of the need for proper training of employees or of the requirements of the Occupational Safety and Health Administration (“OSHA”) regarding the handling of regulated waste. These businesses include manufacturing facilities, schools, restaurants, hotels and other businesses where employees may come into contact with blood-borne pathogens. Similarly, the proper handling of expired or recalled pharmaceuticals requires an expertise that many retail pharmacies lack or find inefficient to provide. • Shift to Off-Site Treatment: We believe that patient care is continuing to shift from institutional higher-cost acute-care settings to less expensive, smaller, off-site treatment alternatives, with a resulting increase in the number of regulated waste generators that cannot treat their own regulated waste. • Control of Drug Diversion: The U.S. Drug Enforcement Administration (“DEA”) has recently emphasized improved control of the handling and shipment of controlled substances to prevent diversion and counterfeiting, thus increasing the utility to pharmaceutical manufacturers and distributors of a returns service for expired or recalled pharmaceuticals. Competitive Strengths We believe that we benefit from the following competitive strengths, among others: • Broad Range of Services: We offer our customers a broad range of services to help them develop systems and processes to manage their regulated waste safely and efficiently. For example, we have developed programs to help our customers ensure and maintain compliance with OSHA and HIPAA regulations. • Established Network of Treatment and Transportation Locations in Each Country: We believe that networks like ours would be very expensive and time-consuming for a competitor to develop. • Diverse Customer Base and Revenue Stability: We have a very diverse customer base in all the markets in which we operate. We are also generally protected from the cost of regulatory changes and increases in fuel, insurance and other operating costs because our regulated waste contracts typically allow us to adjust our prices to reflect these cost increases. • Strong Sales Network and Proprietary Database: We use both telemarketing and direct sales efforts to obtain new regulated waste customers. In addition, we have a large database of potential new small- quantity customers, which we believe gives us a competitive advantage in identifying and reaching this higher-margin sector. • Experienced Senior Management Team: We have experienced leadership. Our six most senior executives collectively have over 150 years of management experience in the health care, consumer and waste management industries. 2 • Ability to Integrate Acquisitions: We have completed 157 acquisitions since 1993 and have demonstrated a consistent ability to integrate our acquisitions into our operations successfully. Our goals are to strengthen our position as a leading provider of regulated waste and compliance services and to continue to improve our profitability. Components of our strategy to achieve these goals include: • Expand Range of Services and Products: We believe that we continue to have opportunities to expand our business by increasing the range of products and services that we offer our existing regulated waste customers. For example, through our Steri-Safe® program, we now offer OSHA compliance services to small-quantity customers, and an acquisition in 2003 enabled us to market the Bio Systems® sharps management program to large-quantity customers in new geographic areas. We have expanded our regulated waste services to pharmaceutical companies and other large-quantity generators through a series of acquisitions beginning in 2005 of nine businesses engaged in regulated returns and recall management or related services. • • Improve Margins: We intend to continue working to improve our margins by increasing our base of small-quantity customers and focusing on service strategies that more efficiently meet the needs of our large-quantity customers. We have succeeded in raising the percentage of our revenues from small- quantity customers from 33% of domestic regulated waste revenues at the fourth quarter of 1996 to 63% for the year ended 2008. Seek Complementary Acquisitions: We intend to continue to seek opportunities to acquire businesses that expand our networks in the United States and internationally and increase our customer base. We believe that selective acquisitions can enable us to improve our operating efficiencies through increased utilization of our service infrastructure. Acquisitions We have substantial experience in evaluating potential acquisitions and determining whether a particular waste business can be integrated into our operations with minimal disruption. Once a business is acquired, we implement programs and procedures to improve customer service, sales, marketing, routing, equipment utilization, employee productivity, operating efficiency and overall profitability. We completed 157 acquisitions from 1993 through 2008, with 114 in the United States and 43 internationally. During 2008, we completed 22 acquisitions, of which 12 were domestic regulated waste businesses, two were domestic return management businesses and eight were international regulated waste businesses in Canada, Latin America and Europe. Effective for the month ended March 31, 2008, we dissolved our relationship in a United Kingdom joint venture, White Rose Sharpsmart Limited, which was formed in October 2001 prior to our acquisition of White Rose Environmental Limited in June 2004. This joint venture was previously consolidated in our financial statements. Services and Operations Collection and Transportation: In many respects, our regulated waste business is one of logistics. Efficiency of collection and transportation of regulated waste is a critical element of our operations because it represents the largest component of our operating costs. For regulated waste, we supply specially designed reusable leak-and puncture-resistant plastic containers to most of our large-quantity customers and many of our larger small-quantity customers. To assure regulatory compliance, we will not accept regulated waste from customers unless it is properly packaged in containers that we have either supplied or approved. 3 We collect containers or corrugated boxes of regulated waste from our customers at intervals depending upon customer requirements, contract terms and volume of waste generated. The waste is then transported directly to one of our processing facilities or to one of our transfer stations where it is combined with other regulated waste and transported to a processing facility. Transfer stations allow us to temporarily hold small loads of waste until they can be consolidated into full truckloads and transported to a processing facility. Our use of transfer stations in a “hub and spoke” configuration improves the efficiency of our collection and transportation operations by expanding the geographic area that a particular processing facility can serve and thereby increasing utilization of the facility by increasing the volume of waste that it processes. We collect some expired or recalled pharmaceuticals from pharmacy shelves, but more typically, pharmacies ship them directly to our processing facilities. Processing and Disposal: Upon arrival at a processing facility, containers or boxes of regulated waste are typically scanned to verify that they do not contain any unacceptable substances like radioactive material. Any container or box that is discovered to contain unacceptable waste is returned to the customer and the appropriate regulatory authorities are informed. The regulated waste is then processed using one of our various treatment technologies. Upon completion of the particular process, the resulting waste or incinerator ash is transported for resource recovery, recycling or disposal in a landfill operated by an unaffiliated third party. We do not own any landfills. After plastic containers such as our Steri-Tub® or Bio Systems® containers have been emptied, they are washed, sanitized and returned to customers for re-use. Upon receipt at a processing facility, expired or recalled pharmaceuticals are counted and logged, and controlled substances are stored securely. In accordance with the manufacturer’s instructions, expired or recalled pharmaceuticals are then returned to the manufacturer or destroyed in compliance with applicable regulations. Documentation: We provide complete documentation to our customers for all regulated waste that we collect in accordance with applicable regulations and customer requirements. Marketing and Sales Marketing Strategy: We use both telemarketing and direct sales efforts to obtain new customers. In addition, our drivers may also participate in our regulated waste marketing efforts by actively soliciting small- quantity customers they service. Small-Quantity Customers: We target small-quantity customers as a growth area of our regulated waste business. We believe that small-quantity regulated waste customers view the potential risks of failing to comply with applicable state and federal regulated waste regulations as disproportionate to the cost of the services that we provide. We believe that this factor has been the basis for the significantly higher gross margins that we have achieved with our small-quantity customers relative to our large-quantity customers. We believe that the same potential exists in processing returns of expired pharmaceuticals for smaller retail pharmacies. Steri-Safe®: Our Steri-Safe® OSHA compliance program provides an integrated regulated waste management and compliance-assistance service for small-quantity customers who typically lack the internal personnel and systems to comply with OSHA blood-borne regulations. Customers for our Steri-Safe® service pay a predetermined subscription fee in advance for regulated waste collection and processing services and can also choose from available packages of training and education services and products designed to help them to comply with OSHA regulations. Approximately 132,000 small-quantity customers are enrolled in this program. We believe that the implementation of our Steri-Safe® service provides us with an enhanced opportunity to leverage our existing customer base through the program’s prepayment structure and diversified product and service offerings. 4 Mail-Back Program: We also operate a “mail-back” program by which we can reach small-quantity regulated waste customers located in outlying areas that would be inefficient to serve using our regular route structure. Our mail-back program has allowed us to service customers as far away as Hawaii, Alaska, Guam and the Virgin Islands. Mail-back programs are also used in home care patient settings. Large-Quantity Customers: Our marketing efforts to large-quantity customers are conducted by account executives who are also able to provide consulting services to assist our large-quantity customers in training their employees on safety issues and implementing programs to improve waste segregation. Our Bio Systems® sharps management offering can enhance our revenue and margins per large-quantity account. The Bio Systems® service can help our large-quantity customers eliminate plastic and cardboard from their waste stream while providing a safe and cost-effective way for them to deal with the disposal of their sharp objects (such as needles, syringes, etc.). We offer hospital pharmacies an onsite collection service to assist them in accounting for and segregating expired or recalled pharmaceuticals. National Accounts: As a result of our extensive geographic coverage, we are capable of servicing national account customers (i.e., customers requiring regulated waste services at various geographically dispersed locations). Contracts: We have multi-year contracts with a large majority of our customers. We negotiate individual contracts with each large-quantity and small-quantity customer. Although we have a standard form of contract, particularly for small-quantity customers, terms may vary depending upon the customer’s service requirements and the volume of regulated waste generated and, in some jurisdictions, statutory and regulatory requirements. Substantially all of our contracts with small-quantity customers contain automatic renewal provisions. International We conduct regulated waste operations in Canada, Mexico, Argentina, Chile, the United Kingdom and Ireland. We began our operations in Canada and Mexico in 1998, Argentina in 1999, the United Kingdom in 2004, Ireland in 2006 and Chile in 2008. We also have technology licensing agreements in Japan, Brazil and South Africa. Processing Technologies We currently use both non-incineration technologies (autoclaving, chemical treatment and our proprietary ETD technology) and incineration technologies for treating regulated waste. Stericycle was founded on the belief that there was a need for safe, secure and environmentally responsible management of regulated waste. From our beginning we have championed the use of non-incineration treatment technologies such as our ETD process. While we recognize that some state regulations currently in force mandate that some types of regulated waste must be incinerated, we also know from years of experience working with our customers that there are ways to reduce the amount of regulated waste that is ultimately incinerated. The most effective strategy that we have seen involves comprehensive education of our customers in waste minimization and segregation. Autoclaving: Autoclaving treats regulated waste with steam at high temperature and pressure to kill pathogens. Autoclaving alone does not change the appearance of waste, and some landfill operators may not accept recognizable regulated waste, but autoclaving may be combined with a shredding or grinding process to render the regulated waste unrecognizable. 5 ETD: Our ETD treatment process includes a system for grinding regulated waste. After grinding, ETD uses an oscillating field of low-frequency radio waves to heat regulated waste to temperatures that destroy pathogens such as viruses, bacteria, fungi and yeast without melting the plastic content of the waste. ETD does not produce regulated air or water emissions. Incineration: Incineration burns regulated waste at elevated temperatures and reduces it to ash. Incineration reduces the volume of waste, and it is the recommended treatment and disposal option for some types of regulated waste such as anatomical waste or residues from chemotherapy procedures. Air emissions from incinerators can contain certain byproducts that are subject to federal, state and, in some cases, local regulation. In some circumstances, the ash byproduct of incineration may be regulated. Chem-Clav: Chemclaving treats regulated waste using high heat, pressure, and a steam auger to kill pathogens. The waste is treated in a sealed container while the auger shreds the waste, making it unrecognizable while exposing more surface area of the waste to the steam. After shredding and treatment, the waste residue is sterile and safe for landfill. Competition The regulated waste industry is highly competitive, and barriers to entry into the regulated waste collection and disposal business and the pharmaceutical returns business are very low. Our competitors consist of many different types of service providers, including a large number of regional and local companies. In the regulated waste industry, another major source of competition is the on-site treatment of regulated waste by some large- quantity generators, particularly hospitals. In addition, in the regulated waste industry we face potential competition from businesses that are attempting to commercialize alternate treatment technologies or products designed to reduce or eliminate the generation of regulated waste, such as reusable or degradable medical products. Governmental Regulation The regulated waste industry is subject to extensive and frequently changing federal, state and local laws and regulations. This statutory and regulatory framework imposes a variety of compliance requirements, including requirements to obtain and maintain government permits. These permits grant us the authority, among other things: • • • to construct and operate collection, transfer and processing facilities; to transport regulated waste within and between relevant jurisdictions; and to handle particular regulated substances. Our permits must be periodically renewed and are subject to modification or revocation by the issuing authority. We are also subject to regulations that govern the definition, generation, segregation, handling, packaging, transportation, treatment, storage and disposal of regulated waste. We are also subject to extensive regulations designed to minimize employee exposure to regulated waste. Domestic Federal Regulation: Five U.S. federal agencies have authority over regulated waste. These agencies are the U.S. Environmental Protection Agency (“EPA”), OSHA, U.S. Department of Transportation (“DOT”), the U.S. Postal Service (“USPS”) and DEA. These agencies supervise regulated waste under a variety of statutes and regulations. The principal statutes and regulations are: • Medical Tracking Act of 1988. In the late 1980s, the EPA outlined a two-year demonstration program to the Medical Waste Tracking Act (“MWTA”), which was added to the Resource pursuant 6 Conservation and Recovery Act of 1976. In regulations implementing the MWTA, the EPA defined medical waste and established guidelines for its segregation, handling, containment, labeling and transport. The MWTA demonstration program expired in 1991, but the MWTA established a model followed by many states in developing their specific medical waste regulatory framework. • Occupational Safety and Health Act of 1970. The Occupational Safety and Health Act of 1970 authorizes OSHA to issue occupational safety and health standards. Various standards apply to certain aspects of our operations and govern such matters as exposure to blood borne pathogens and other potentially infectious materials. • Resource Conservation and Recovery Act of 1976. The Resource Conservation and Recovery Act of 1976 (“RCRA”) created standards for the generation, transportation, treatment, storage and disposal of solid and hazardous wastes. Medical wastes are currently considered non-hazardous solid wastes under including RCRA. However, some substances collected by us from some of our customers, photographic fixer developer solutions, lead foils and dental amalgam, are considered hazardous wastes. • Clean Air Act Regulations. In August 1997, the EPA adopted regulations under the Clean Air Act Amendments of 1990 that limit the discharge into the atmosphere of pollutants released by regulated waste incineration. These regulations required every state to submit to the EPA for approval a plan to meet minimum emission standards for these pollutants. We currently operate seven incinerators in the United States. We believe these incinerators are in compliance with applicable state requirements. • DOT Regulations. DOT has adopted regulations under the Hazardous Materials Transportation Authorization Act of 1994 that require us to package and label regulated waste in compliance with designated standards, and which incorporate blood borne pathogens standards issued by OSHA. Under these standards, we must, among other things, identify our packaging with a “biohazard” marking on the outer packaging, and our regulated waste container must be sufficiently rigid and strong to prevent tearing or bursting. It must also be puncture-resistant, leak-resistant, properly sealed and impervious to moisture. Expired or recalled pharmaceuticals are subject to substantially the same DOT regulations as medical waste. We identify these products by their National Drug Code number and classify them by their handling, transportation and disposal requirements. • Comprehensive Environmental Response, Compensation and Liability Act of 1980. The Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”) established a regulatory and remedial program to provide for the investigation and cleanup of facilities that have released or threaten to release hazardous substances into the environment. CERCLA and state laws similar to it may impose strict, joint and several liability on the current and former owners and operators of facilities from which releases of hazardous substances have occurred and on the generators and transporters of the hazardous substances that come to be located at these facilities. • USPS Regulations. We have obtained permits from the USPS to conduct our “mail-back” program, pursuant to which customers mail approved containers of “sharps” (needles, knives, broken glass and the like) directly to our treatment facilities. • Controlled Substances Act. Our returns service for expired and recalled pharmaceuticals is required to comply with DEA regulations relating to the approval and permitting of processing facilities, management of employees engaged in the collection, processing and disposal of controlled substances, proper documentation and reporting to the DEA. We use landfills owned and operated by unrelated third parties for the disposal of waste from our processing facilities. Domestic State and Local Regulation: We conduct business in all 50 states and Puerto Rico. Each state has its own regulations related to the handling, treatment and storage of regulated waste. Although there are many 7 differences among the various state laws and regulations, for regulated waste many states have followed the model under the MWTA and have implemented programs under RCRA. In each state where we operate a processing facility or a transfer station, we are required to comply with numerous state and local laws and regulations as well as our operating plan for each site. In addition, many local governments have ordinances and regulations, such as zoning and health regulations that affect our operations. We maintain numerous governmental permits and licenses to conduct our business. Our permits vary from state to state based upon our activities within that state and on the applicable state and local laws and regulations. Foreign Regulation: We are subject to substantial regulation by the governments of the foreign jurisdictions in which we conduct regulated waste operations. The statutory and regulatory requirements vary from jurisdiction to jurisdiction. Patents and Proprietary Rights We consider the protection of our technology to be important to our business. Our policy is to protect our technology by a variety of means, including applying for patents in the United States and in other foreign countries. We hold seven current United States patents relating to the ETD treatment process and other aspects of processing regulated waste. We have filed or have been assigned patent applications in several foreign countries and we have received patents in Australia, Canada, Denmark, France, Ireland, Italy, Japan, Mexico, South Africa, South Korea, Spain, Sweden and the United Kingdom. The term of the first-to-end of our existing United States patents relating to our ETD treatment process will currently end in May 2009 and the term of the last-to-end will currently end in January 2019. We own federal registrations of the trademarks “Steri-Fuel®”, “Steri-Plastic®”, “Steri-Tub®”, “Direct Return®”, “Steri-Safe®”, the service mark Stericycle® and a service mark consisting of a nine-circle design. Potential Liability and Insurance The regulated waste industry involves potentially significant risks of statutory, contractual, tort and common law liability claims. Potential liability claims could involve, for example: • • • • • • cleanup costs; personal injury; damage to the environment; employee matters; property damage; or alleged negligence or professional errors or omissions in the planning or performance of work. We could also be subject to fines or penalties in connection with violations of regulatory requirements. We carry $35 million of liability insurance (including umbrella coverage), and under a separate policy, $10 million of aggregate pollution and legal liability insurance ($5 million per incident), which we consider sufficient to meet regulatory and customer requirements and to protect our employees, assets and operations. Employees As of December 31, 2008, we had 6,567 full-time and 316 part-time employees, of which 4,920 were employed in the United States and 1,963 internationally. Approximately 381 of our U.S. drivers, transportation 8 helpers and plant workers are covered by a total of seven collective bargaining agreements with local unions of the International Brotherhood of Teamsters. These agreements expire at various dates from June 2009 to October 2013. We also have approximately 586 employees in Latin America under various collective bargaining agreements. We consider our employee relations to be satisfactory. Website Access We maintain an Internet website, www.stericycle.com, providing a variety of information about us. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K that we file with the Securities and Exchange Commission are available, as soon as reasonably practicable after filing, at the investors’ page on our website, or by a direct link to our filings on the SEC’s free website, www.sec.gov. Item 1A. Risk Factors We are subject to extensive governmental regulation, which is frequently difficult, expensive and time- consuming to comply with. industry is subject The regulated waste management to extensive federal, state and local laws and regulations relating to the collection, transportation, packaging, labeling, handling, documentation, reporting, treatment and disposal of regulated waste. Our business requires us to obtain many permits, authorizations, approvals, certificates and other types of governmental permission from every jurisdiction where we operate. We believe that we currently comply in all material respects with all applicable permitting requirements. State and local regulations change often, however, and new regulations are frequently adopted. Changes in the regulations could require us to obtain new permits or to change the way in which we operate under existing permits. We might be unable to obtain the new permits that we require, and the cost of compliance with new or changed regulations could be significant. Many of the permits that we require, especially those to build and operate processing plants and transfer facilities, are difficult and time-consuming to obtain. They may also contain conditions or restrictions that limit our ability to operate efficiently, and they may not be issued as quickly as we need them (or at all). If we cannot obtain the permits that we need when we need them, or if they contain unfavorable conditions, it could substantially impair our operations and reduce our revenues. The handling and treatment of regulated waste carries with it the risk of personal injury to employees and others. Our business requires us to handle materials that may be infectious or hazardous to life and property in other ways. While we try to handle such materials with care and in accordance with accepted and safe methods, the possibility of accidents, leaks, spills, and acts of God always exists. Examples of possible exposure to such materials include: • • • • truck accidents; damaged or leaking containers; improper storage of regulated waste by customers; improper placement by customers of materials into the waste stream that we are not authorized or able to process, such as certain body parts and tissues; or • malfunctioning treatment plant equipment. Human beings, animals or property could be injured, sickened or damaged by exposure to regulated waste. This in turn could result in lawsuits in which we are found liable for such injuries, and substantial damages could be awarded against us. 9 While we carry liability insurance intended to cover these contingencies, particular instances may occur that are not insured against or that are inadequately insured against. An uninsured or underinsured loss could be substantial and could impair our profitability and reduce our liquidity. The handling of regulated waste exposes us to the risk of environmental liabilities, which may not be covered by insurance. As a company engaged in regulated waste management, we face risks of liability for environmental contamination. The federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, or CERCLA, and similar state laws impose strict liability on current or former owners and operators of facilities that release hazardous substances into the environment as well as on the businesses that generate those substances and the businesses that transport them to the facilities. Responsible parties may be liable for substantial investigation and clean-up costs even if they operated their businesses properly and complied with applicable federal and state laws and regulations. Liability under CERCLA may be joint and several, which means that if we were found to be a business with responsibility for a particular CERCLA site, we could be required to pay the entire cost of the investigation and clean-up even though we were not the party responsible for the release of the hazardous substance and even though other companies might also be liable. Our pollution liability insurance excludes liabilities under CERCLA. Thus, if we were to incur liability under CERCLA and if we could not identify other parties responsible under the law whom we are able to compel to contribute to our expenses, the cost to us could be substantial and could impair our profitability and reduce our liquidity. Our customer service agreements make clear that the customer is responsible for making sure that only appropriate materials are disposed of. If there were a claim against us that a customer might be legally liable for, we might not be successful in recovering our damages from the customer. The level of governmental enforcement of environmental regulations has an uncertain effect on our business and could reduce the demand for our services. We believe that the government’s strict enforcement of laws and regulations relating to regulated waste collection and treatment has been good for our business. These laws and regulations increase the demand for our services. A relaxation of standards or other changes in governmental regulation of regulated waste could increase the number of competitors or reduce the need for our services. If we are unable to acquire other regulated waste businesses, our revenue and profit growth may be slowed. Historically our growth strategy has been based in substantial part on our ability to acquire other regulated waste businesses. We do not know whether in the future we will be able to: • • • • identify suitable businesses to buy; complete the purchase of those businesses on terms acceptable to us; improve the operations of the businesses that we do buy and successfully integrate their operations into our own; or avoid or overcome any concerns expressed by regulators. We compete with other potential buyers for the acquisition of other regulated waste companies. This competition may result in fewer opportunities to purchase companies that are for sale. It may also result in higher purchase prices for the businesses that we want to purchase. We also do not know whether our growth strategy will continue to be effective. Our business is significantly larger than before, and new acquisitions may not have the desired benefits that we have obtained in the past. 10 The implementation of our acquisition strategy could be affected in certain instances by the concerns of state regulators, which could result in our not being able to realize the full synergies or profitability of particular acquisitions. We may become subject to inquiries and investigations by state antitrust regulators from time to time in the course of completing acquisitions of other regulated waste businesses. In order to obtain regulatory clearance for a particular acquisition, we could be required to modify certain operating practices of the acquired business or to divest ourselves of one or more assets of the acquired business. Changes in the terms of our acquisitions required by regulators or agreed to by us in order to settle regulatory investigations could impede our acquisition strategy or reduce the anticipated synergies or profitability of our acquisitions. The likelihood and outcome of inquiries and investigations from state regulators in the course of completing acquisitions cannot be predicted. Aggressive pricing by existing competitors and the entrance of new competitors could drive down our profits and slow our growth. The regulated waste industry is very competitive because of low barriers to entry, among other reasons. This competition has required us in the past to reduce our prices, especially to large account customers, and may require us to reduce our prices in the future. Substantial price reductions could significantly reduce our earnings. We face direct competition from a large number of small, local competitors. Because it requires very little money or technical know-how to compete with us in the collection and transportation of regulated waste, there are many regional and local companies in the industry. We face competition from these businesses, and competition from them is likely to exist in the new locations to which we may expand in the future. In addition, large national companies with substantial resources may decide to enter the regulated waste industry. For example, Waste Management, Inc., a major solid waste company, has begun offering regulated waste management services to hospitals and possibly other large quantity generators of regulated waste. Our competitors could take actions that would hurt our growth strategy, including the support of regulations that could delay or prevent us from obtaining or keeping permits. They might also give financial support to citizens’ groups that oppose our plans to locate a treatment or transfer facility at a particular location. Restrictions in our senior unsecured credit facility may limit our ability to pay dividends, incur additional debt, make acquisitions and make other investments. Our senior unsecured credit facility contains covenants that restrict our ability to make distributions to stockholders or other payments unless we satisfy certain financial tests and comply with various financial ratios. It also contains covenants that limit our ability to incur additional indebtedness, acquire other businesses and make capital expenditures, and imposes various other restrictions. These covenants could affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. The loss of our senior executives could affect our ability to manage our business profitably. We depend on a small number of senior executives. Our future success will depend upon, among other things, our ability to keep these executives and to hire other highly qualified employees at all levels. We compete with other potential employers for employees, and we may not be successful in hiring and keeping the executives and other employees that we need. We do not have written employment agreements with any of our executive officers, and officers and other key employees could leave us with little or no prior notice, either individually or as part of a group. Our loss of or inability to hire key employees could impair our ability to manage our business and direct its growth. 11 Our expansion into foreign countries exposes us to unfamiliar regulations and may expose us to new obstacles to growth. We plan to grow both in the United States and in foreign countries. We have established operations in Argentina, Canada, Chile, Ireland, Mexico and the United Kingdom. Foreign operations carry special risks. Although our business in foreign countries has not yet been affected, our business in the countries in which we currently operate and those in which we may operate in the future could be limited or disrupted by: • • • • • • • • • exchange rate fluctuations; government controls; import and export license requirements; political or economic instability; trade restrictions; changes in tariffs and taxes; our unfamiliarity with local laws, regulations, practices and customs; restrictions on repatriating foreign profits back to the United States or movement of funds to other countries; difficulties in staffing and managing international operations. Foreign governments and agencies often establish permit and regulatory standards different from those in the United States. If we cannot obtain foreign regulatory approvals, or if we cannot obtain them when we expect, our growth and profitability from international operations could be limited. Fluctuations in currency exchange could have similar effects. Our earnings could decline if we write-off intangible assets, such as goodwill. As a result of purchase accounting for our various acquisitions, our balance sheet at December 31, 2008 contains goodwill of $1,135.8 million and other intangible assets, net of accumulated amortization, of $170.6 million (including indefinite lived intangibles of $48.1 million). In accordance with Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS No. 142”), we evaluate on an ongoing basis whether facts and circumstances indicate any impairment of the value of indefinite-lived intangible assets such as goodwill. As circumstances after an acquisition can change, we may not realize the value of these intangible assets. If we were to determine that a significant impairment has occurred, we would be required to incur non-cash write-offs of the impaired portion of goodwill and other unamortized intangible assets, which could have a material adverse effect on our results of operations in the period in which the write-off occurs. Item 1B. Unresolved Staff Comments None. Item 2. Properties We lease office space for our corporate offices in Lake Forest, Illinois. Domestically, we own or lease two ETD processing facilities, ten incineration processing facilities, 28 autoclave processing facilities and six other processing facilities. All of our processing facilities also serve as collection sites. We own or lease 80 additional transfer and collection sites and nine additional sales/administrative sites. Internationally, we own or lease two ETD processing facilities, 38 facilities that have autoclave and incineration processing and three other type processing facilities. We also lease or own 17 transfer and collection sites and 13 additional sales/administrative sites. We consider that these processing facilities are adequate for our present and anticipated needs. 12 We do not own or operate any landfills or any other type of disposal site. After processing, all remaining waste materials are transported to unaffiliated third parties for permanent disposal. Item 3. Legal Proceedings We operate in a highly regulated industry and must deal with regulatory inquiries or investigations from time to time that may be instituted for a variety of reasons. We are also involved in a variety of civil litigation from time to time. In April 2008, Stericycle and Daniels Corporation (UK) Limited (“Daniels UK”), a subsidiary of Daniels Sharpsmart Pty Limited (“Daniels”), and certain affiliated companies entered into a settlement of arbitration proceedings in the United Kingdom prior to any award by the arbitrator. At the same time, we entered into settlements with other subsidiaries of Daniels resolving various disputes, and we finalized the payment of the legal fees that SteriCorp Limited had been awarded under a November 2007 arbitrator’s award. In connection with these net settlements, we recognized a total pre-tax expense of $5.6 million, or an after-tax expense of $3.5 million for the year-ended December 31, 2008. In November 2007, the arbitrator issued a final award in arbitration proceedings in Australia with SteriCorp Limited that we have previously reported. The arbitrator awarded Stericycle $8.2 million USD on our claim against SteriCorp for payments due under certain convertible notes and awarded SteriCorp $14.5 million USD on its claim that we failed to supply SteriCorp with equipment conforming to specifications under an equipment supply agreement. The final award also required us to pay two-thirds of SteriCorp’s arbitration costs. An estimate of those amounts was made and accrued for in our consolidated financial statements for the year-ended December 31, 2007. The net effect of the various components of the final arbitration award was a charge of $13.9 million to our income statement identified as “Arbitration award and related costs.” Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of our stockholders during the fourth quarter of 2008. Supplemental Information Executive Officers of the Registrant The following table contains certain information regarding our six current executive officers: Name Mark C. Miller Richard T. Kogler Frank J.M. ten Brink Richard L. Foss Michael J. Collins Richard J. Marasco Position Chairman, President and Chief Executive Officer Executive Vice President and Chief Operating Officer Executive Vice President and Chief Financial Officer Executive Vice President, International President, Return Management Services Executive Vice President, Mergers and Acquisitions Age 53 49 52 54 52 52 Mark C. Miller has served as our Chairman, President and Chief Executive Officer since joining us in May 1992. From May 1989 until he joined us, Mr. Miller served as vice president for the Pacific, Asia and Africa in the International Division of Abbott Laboratories, which he joined in 1976 and where he held a number of management and marketing positions. Mr. Miller received a B.S. degree in computer science from Purdue University, where he graduated Phi Beta Kappa. Richard T. Kogler joined us as Chief Operating Officer in December 1998. From May 1995 through October 1998, Mr. Kogler was vice president and chief operating officer of American Disposal Services, Inc., a 13 solid waste management company. From October 1984 through May 1995, Mr. Kogler served in a variety of management positions with Waste Management, Inc. Mr. Kogler received a B.A. degree in chemistry from St. Louis University. Frank J.M. ten Brink has served as our Executive Vice President, Finance and Chief Financial Officer since June 1997. From 1991 until 1996 he served as chief financial officer of Hexacomb Corporation, and from 1996 until joining us, he served as chief financial officer of Telular Corporation. Prior to 1991, he held various financial management positions with Interlake Corporation and Continental Bank of Illinois. Mr. ten Brink received a B.B.A. degree in international business and a M.B.A. degree in finance from the University of Oregon. Richard L. Foss has served as our Executive Vice President for Corporate Development since February 2003. From 1999 to 2002, Mr. Foss was a vice president and director of worldwide product marketing in the personal communication sector at Motorola Inc., and from 1977 until 1999, he held a number of management and marketing positions at The Procter & Gamble Company, including serving as a vice president and general manager in the health care segment. Mr. Foss received a B.S. degree in chemistry and an M.B.A degree from Rensselear Polytechnic Institute. Michael J. Collins has served as President of our Return Management Services Division since June 2006. Prior to joining us, he served at Abbott Laboratories, a diversified health care company, which he joined in 1982 and where he held a number of management and marketing positions, most recently as vice president, medical products group health systems. Mr. Collins received a B.A. degree in business and education from the University of New Haven and a M.B.A. degree in business administration from National University. Richard J. Marasco served as Corporate Vice President, Mergers & Acquisitions upon joining us in September 2007 and became Executive Vice President, Mergers & Acquisitions in July 2008. Prior to joining us, he served at Abbott Laboratories, which he joined in 1981 and where he served in various management positions, most recently as Vice President, Europe and Canada and Vice President Pediatric Nutrition with Ross Products. He holds a B.S. degree in accounting from Drake University and is a licensed certified public accountant. 14 PART II. Item 5. Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters As of February 13, 2009, we had approximately 177 stockholders of record. The Company’s stock trades on the NASDAQ National Market under the ticker symbol SRCL. During the quarter ended June 30, 2007 our shareholders approved an increase in our authorized shares of common stock from 80,000,000 shares to 120,000,000 shares. In addition, our Board of Directors authorized a 2-for-1 stock split. The stock split was in the form of a stock dividend of one share payable on May 31, 2007 in respect of each share of common stock outstanding on the record date of May 17, 2007. Historic share and per share amounts have been adjusted to reflect the stock split. The following table provides the high and low sales prices of our Common Stock for each calendar quarter during our two most recent fiscal years: Quarter First quarter 2007 Second quarter 2007 Third quarter 2007 Fourth quarter 2007 First quarter 2008 Second quarter 2008 Third quarter 2008 Fourth quarter 2008 High $41.12 45.59 57.16 $61.87 $62.13 58.91 64.77 $61.13 Low $36.59 40.78 43.27 $52.04 $50.38 50.82 49.72 $48.83 We did not pay any cash dividends during 2008 and have never paid any dividends on our common stock. We currently expect that we will retain future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In May 2002 our Board of Directors authorized the Company to repurchase up to 6,000,000 shares of our common stock, in the open market or through privately negotiated transactions, at times and in amounts in the Company’s discretion. In February 2005, at a time when we had purchased a total of 2,956,860 shares, the Board authorized us to purchase an additional 2,956,860 shares. In February 2007, at a time when we had purchased an additional 3,142,080 shares since the prior increase in authorization, the Board authorized us to purchase up to an additional 3,142,080 shares. In May 2007, at a time when we had purchased an additional 1,187,142 shares since the prior increase in authorization, the Board authorized us to purchase up to an additional 1,187,142 shares. In May 2008, at a time when we had purchased an additional 2,938,496 shares since the prior increase in authorization, the Board authorized us to purchase up to an additional 2,938,496 shares, thereby again giving the Company the authority to purchase up to a total of 6,000,000 additional shares. 15 The following table provides information about our purchases of shares of our common stock during the year ended December 31, 2008: Issuer Purchase of Equity Securities Total Number of Share (or Units) Purchased 198,218 891,224 392,743 23,498 231,684 729,351 179,073 — — 184,257 — 350,511 Average Price Paid per Share (or Unit) $54.91 54.10 51.65 53.26 52.23 52.54 50.53 — — 51.17 — $50.94 Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs 198,218 891,224 392,743 23,498 231,684 729,351 179,073 — — 184,257 — 350,511 Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs 4,600,653 3,709,429 3,316,686 3,293,188 6,000,000 5,270,649 5,091,576 5,091,576 5,091,576 4,907,319 4,907,319 4,556,808 Period January 1 - January 31, 2008 February 1 - February 29, 2008 March 1 - March 31, 2008 April 1 - April 30, 2008 May 1 - May 31, 2008 June 1 - June 30, 2008 July 1 - July 31, 2008 August 1 - August 31, 2008 September 1 - September 30, 2008 October 1 - October 31, 2008 November 1 - November 30, 2008 December 1 - December 31, 2008 Equity Compensation Plans The following table summarizes information as of December 31, 2008 relating to our equity compensation plans pursuant to which stock option grants, restricted stock awards or other rights to acquire shares of our common stock may be made or issued: Equity Compensation Plan Information Plan Category Equity compensation plans approved by our security holders(1) Equity compensation plans not approved by our security holders(2) Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (a) 5,212,871 2,084,528 Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights (b) Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a)) (c) $34.25 $22.76 5,025,888 410,674 (1) These plans consist of our 2008 Incentive Stock Plan, 2005 Incentive Stock Plan, 1997 Stock Option Plan, Directors Stock Option Plan, 1995 Incentive Compensation Plan and the Employee Stock Purchase Plan. (2) The only plan in this category is our 2000 Nonstatutory Stock Option Plan. In 2000, our Board of Directors approved the 2000 Nonstatutory Stock Option Plan (the “2000 Plan”), which authorized the granting of nonstatutory stock options for 7,000,000 shares of our common stock to employees (but not to officers or directors). See Note 13 to the Consolidated Financial Statements for a description of this plan. 16 Performance Graph The following graph compares the cumulative total return (i.e., stock price appreciation plus dividends) on our common stock over the five-year period ending December 31, 2008 with the cumulative total return for the same period on the NASDAQ National Market Composite Index, the S&P 500 Index and an index of a peer group of companies that we selected consisting of Republic Services, Inc., SRI/Surgical Express, Inc. (formerly Sterile Recoveries, Inc.), Steris Corporation and Waste Management, Inc. The graph assumes that $100 was invested on December 31, 2003 in our common stock and in the stock represented by each of the three indexes, and that all dividends were reinvested. The stock price performance of our common stock reflected in the following graph is not necessarily indicative of future performance. Stericycle, Inc. Nasdaq NM Composite S&P 500 Index Peer Group $270.00 $255.00 $240.00 $225.00 $210.00 $195.00 $180.00 $165.00 $150.00 $135.00 $120.00 $105.00 $90.00 $75.00 $60.00 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 17 Item 6. Selected Consolidated Financial Data In thousands, except per share data Statement of Income Data(1) Revenues Income from operations Net income Net income applicable to common stock Diluted net income per share of common stock(2) Depreciation and amortization Other Data Cash provided by operating activities Cash used in investing activities Cash (used in)/ provided by financing activities Balance Sheet Data(1) Cash, cash equivalents and short-term investments Total assets Long-term debt, net of current portion Convertible redeemable preferred stock Shareholders’ equity Years Ended December 31, 2008 2007 2006 (3) 2005 2004 $1,083,679 274,239 148,708 148,708 $ 932,767 224,544 118,378 118,378 $ 789,637 201,762 105,270 105,270 $ 609,457 166,532 67,154 67,154 $ 516,228 145,655 78,178 78,178 1.68 34,148 1.32 31,137 1.16 27,036 0.74 21,431 0.85 21,803 $ 210,555 (132,930) $ 174,042 (135,261) $ 160,162 (201,425) $ 94,327 (156,001) $ 114,611 (105,093) (77,882) (32,635) 52,547 59,500 (6,941) $ 10,503 1,759,298 753,846 — $ 670,480 $ 18,364 1,608,159 613,781 — $ 714,075 $ 16,040 1,327,906 443,115 — $ 625,081 $ 8,545 1,047,660 348,841 — $ 521,634 $ 7,949 834,141 190,431 — $ 495,372 (1) See Note 4 to the Consolidated Financial Statements for information concerning our acquisitions during the three years ended December 31, 2008. (2) See Note 12 to the Consolidated Financial Statements for information concerning the computation of net income per common share. • In 2008, net income includes nonrecurring costs (net of tax) of $3.5 million related to a business dispute settlement and related costs and a fixed asset write-down of equipment of $0.3 million. These costs negatively impacted diluted earnings per share (“EPS”) by $0.05. In 2007, net income includes nonrecurring costs (net of tax) of $9.3 million, of which $7.7 million were net non-cash items. These costs negatively impacted EPS by $0.10, related to the following: i. We recognized legal settlement expense related to the arbitration award in Australia, including • expected arbitration cost reimbursements to be paid in 2008; ii. We wrote down our investment in Medam, B.A., an Argentine joint venture. The write down of our investment in Argentina was a result of the legal restructuring of the business operations; iii. We wrote down the White Rose Environmental tradename as a result of the name change of our subsidiary in the United Kingdom; iv. We wrote down the permit intangible for a treatment facility in the United Kingdom that was no longer being used; v. We wrote down equipment that had been permanently idled; vi. We recorded a gain on the divestiture of selected assets of Sterile Technologies, Ltd., one of our subsidiaries in the United Kingdom; vii. We received proceeds from two of our insurance carriers for coverage related to the 3CI Complete Compliance Corporation (“3CI”) class action litigation settlement; viii. We divested the over the counter products portion of our Scherer Labs assets which resulted in a gain. • In 2006, net income includes costs (net of tax) related to a fixed asset write-down of equipment of $0.2 million, write-down of an investment in securities of $0.6 million, partially offset by income recorded 18 • • from insurance proceeds related to the 3CI settlement of $0.6 million. The net amount of $0.2 million did not affect EPS. In 2005, net income includes costs (net of tax) related to the 3CI preliminary settlement of class action litigation of $23.4 million, South Africa note receivable write-down of $1.5 million, fixed asset impairments of $0.5 million, settlement of licensing litigation of $1.1 million, and items related to debt restructuring of $0.3 million which negatively impacted EPS by $0.30 per share. Of the total of $26.8 million of such items, $3.4 million were non-cash items. In 2004, net income includes fixed asset write-offs of $0.7 million, and items related to debt restructuring and redemption of senior subordinated debt of $2.8 million that negatively impacted EPS by $0.04 per share. (3) On January 1, 2006, we adopted the provisions of SFAS No. 123R, “Share-Based Payment” (“SFAS No. 123R”) using the modified prospective method to account for stock compensation costs. SFAS No. 123R requires the measurement and recognition of compensation expense for all stock-based payment awards made to our employees and directors. During the years ended December 31, 2008, 2007, and 2006, we recognized stock compensation expense (net of tax) of $7.3 million, $6.6 million and $6.5 million, respectively. See Note 13 to the Consolidated Financial Statements for additional information related to stock compensation expense. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and related notes in Item 8 of this Report. Introduction We are in the business of managing regulated waste and providing an array of related services. We operate in the United States, Canada, Mexico, Argentina, Chile, the United Kingdom and Ireland. For large-quantity generators of regulated waste such as hospitals and for pharmaceutical companies and institutional medical waste management services; our Bio Systems® sharps distributors, we offer: our management services to reduce the risk of needle sticks; a variety of products and services for infection control; and our regulated returns management services for expired or recalled products. For small-quantity generators of regulated waste such as doctors’ offices and for retail pharmacies, we offer: our medical waste management services; our Steri-Safe® Occupational Safety and Health Act and HIPAA compliance programs; a variety of products and services for infection control; and our regulated returns services for expired or recalled products. We operate integrated national regulated waste management networks in the United States, Canada, Mexico, Argentina, Chile, the United Kingdom and Ireland. Our national networks include a total of 89 processing or combined processing and collection sites and 97 additional transfer, collection or combined transfer and collection sites. Our regulated waste processing technologies include autoclaving, our proprietary ETD, chemical treatment and incineration. As of December 31, 2008, we served approximately 418,000 customers worldwide, of which approximately 407,000 were small quantity customers and 11,000 were large quantity customers. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally 19 accepted in the United States. The preparation of these financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We believe that of our significant accounting policies (see Note 2 to the Consolidated Financial Statements), the following ones may involve a higher degree of judgment on our part and greater complexity of reporting. Revenue Recognition: We recognize revenues for our regulated waste services at the time of waste collection. Payments received in advance are deferred and recognized as services are provided. Revenues from regulated returns management services are recorded at the time services are performed. Royalty revenues are calculated based on measurements specified in each contract or license and revenues are recognized at the end of each reporting period when the activity being measured has been completed. Revenues from product sales are recognized at the time the goods are shipped to the customer. Software licensing revenues are recognized on a prorated basis over the term of the license agreement. We do not have any contracts in a loss position. Losses would be recorded when known and estimable for any contracts that should go into a loss position. Goodwill and Other Identifiable Intangible Assets: Goodwill associated with the excess purchase price over the fair value of assets acquired is not amortized. We have determined that our permits have indefinite lives and, accordingly, are not amortized. This position is in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). See Note 10 to the Consolidated Financial Statements for additional information. Our balance sheet at December 31, 2008 contains goodwill of $1,135.8 million. In accordance with SFAS No. 142, we evaluate on at least an annual basis, using the fair value of reporting units, whether goodwill is impaired. If we were to determine that a significant impairment has occurred, we would be required to incur non-cash write-offs of the impaired portion of goodwill that could have a material adverse effect on our results of operations in the period in which the write-off occurs. We use the market value of our stock compared to book as the current measurement of total fair value of our company. The performance of each of our reporting units is compared to that fair value ratio, and any unforeseen material drop in our stock price may be an indicator of a potential impairment of goodwill. The results of the 2008 impairment test conducted in June 2008 did not show any impairment of goodwill, and no events have occurred since that time that indicates that an impairment situation exists. Our permits are currently tested for impairment annually at December 31 or more frequently if circumstances indicate that they may be impaired. We use a discounted income approach model as the current measurement of the fair value of the permits. The estimate of income is based upon, among other things, certain assumptions about expected future operating performance and an appropriate discount rate determined by management. Our estimates of discounted income may differ from actual income due to, among other things, inaccuracies in economic estimates. The results of the 2008 impairment test did not show any impairment of our permits and no events have occurred since that time that would indicate an impairment situation exists. Other identifiable intangible assets, tradenames and covenants such as customer not-to-compete, are currently amortized using the straight-line method over their estimated useful lives. We have determined that our regulated waste customer relationships have between 20-year and 40-year lives based on the specific type of relationship. This determination was based on an independent study performed on our customer relationships. Although the regulated waste management business is highly competitive, we have been able to maintain high customer retention through contracts with automatic renewal provisions and excellent customer service. relationships, The valuation of our contractual customer relationships was derived using a discounted income approach valuation model similar to the method used for permit impairment testing mentioned earlier. These assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may be less than its undiscounted estimated future cash flows. There have been no indicators of impairment of these intangibles (see Note 10 to the Consolidated Financial Statements). 20 Income Taxes: Deferred income tax liabilities and assets are determined based on the differences between the financial statement and income tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. To provide for certain potential tax exposures, we maintain a reserve for specific tax contingencies, the balance of which management believes is adequate, in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). Accounts Receivable: Accounts receivable consist primarily of amounts due to us from our normal business activities. Accounts receivable balances are determined to be delinquent when the amount is past due based on the contractual terms with the customer. We maintain an allowance for doubtful accounts to reflect the expected uncollectibility of accounts receivable based on past collection history and specific risks identified among uncollected accounts. Accounts receivable are charged to the allowance for doubtful accounts when we have determined that the receivable will not be collected and/or when the account has been referred to a third party collection agency. No single customer accounts for more than 2% of our revenues. Insurance: Our insurance for worker’s compensation, vehicle liability and physical damage, and employee- related health care benefits is obtained using high deductible insurance polices. A third-party administrator is used to process all such claims. We require all workers’ compensation, vehicle liability and physical damage claims to be reported within 24 hours. As a result, we accrue our worker’s compensation, vehicle and physical damage liability based upon the claim reserves established by the third-party administrator at the end of each reporting period. Our employee health insurance benefit liability is based on our historical claims experience rate. Our earnings would be impacted to the extent that actual claims vary from historical experience. We review our accruals associated with the exposure to these liabilities for adequacy at the end of each reporting period. Litigation: We operate in a highly regulated industry and deal with regulatory inquiries or investigations from time to time that may be instituted for a variety of reasons. We are also involved in a variety of civil litigation from time to time. Settlements from litigation would be recorded when known, probable and estimable. Stock Option Plans: We have issued stock options to employees and directors as an integral part of our compensation programs. On January 1, 2006, we adopted the provisions of SFAS No. 123R, “Share-Based Payment” (“SFAS No. 123R”) using the modified prospective method to account for stock compensation costs. SFAS No. 123R requires the measurement and recognition of compensation expense for all stock-based payment awards made to our employees and directors. Under the fair value recognition provisions of SFAS No. 123R, stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of stock-based awards at the grant date requires considerable judgment, including estimating expected volatility, expected term and risk-free rate. Our expected volatility is based upon historical experience. The expected term of the stock options is based upon a measure of historical volatility of our stock price. The risk-free interest rate assumption is based upon the U.S. Treasury yield rates of a comparable period. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. New Accounting Pronouncements: For information about recently issued accounting pronouncements (see Note 2 to the Consolidated Financial Statements). Fair Value Considerations: As required by SFAS No. 157, 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, under SFAS No. 157, the fair value measurement of a liability must reflect the nonperformance risk of an entity. At December 31, 2008, we have $9.1 million in cash and cash equivalents and $1.4 million of short-term investments that we carry on our books at fair value using Level 1 inputs. 21 We have a cash flow hedge with an objective to offset foreign currency exchange risk to the U.S. dollar equivalent cash inflows on the settlement of a GBP denominated intercompany loan. The fair value of the hedge was calculated using Level 2 inputs and was recorded as a current asset of $2.3 million as of December 31, 2008. In October 2008, Stericycle entered into three interest rate swap contracts, covering $225 million of our borrowings outstanding under our senior credit facility. The objective of the swap is to reduce the risk of volatile interest expense by fixing the rate. The fair value of the hedge is calculated using Level 2 inputs and is recorded as a liability of $4.8 million, of which $2.1 million is current as of December 31, 2008. 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 three hedges. There were no movements of items between fair value hierarchies. Year Ended December 31, 2008 Compared to Year Ended December 31, 2007 The following summarizes the Company’s operations: In thousands, except per share data Revenues Cost of revenues Depreciation Total cost of revenues Gross profit Selling, general and administrative expenses Depreciation Amortization Total selling, general and administrative expenses Gain on sale of assets Impairment of intangible assets Impairment of fixed assets Arbitration award and related costs Acquisition integration expenses Income from operations Write-down of investment Insurance proceeds Net interest expense Income tax expense Net income Earnings per share – Diluted Years Ended December 31, 2008 2007 $ $1,083,679 573,554 25,096 % $ 100.0 $932,767 52.9 491,789 2.3 23,057 % 100.0 52.7 2.5 598,650 485,029 194,158 5,013 4,039 203,210 — — 472 5,595 1,513 274,239 — — 32,174 90,296 $ 148,708 1.68 $ 55.2 44.8 17.9 0.5 0.4 18.8 — — 0.0 0.5 0.1 25.3 — — 3.0 8.3 13.7 514,846 417,921 168,657 4,423 3,657 176,737 (2,099) 2,269 1,261 13,904 1,305 224,544 2,930 (3,300) 32,375 72,862 $118,378 1.32 $ 55.2 44.8 18.1 0.5 0.4 18.9 (0.2) 0.2 0.1 1.5 0.1 24.1 0.3 (0.4) 3.5 7.8 12.7 Revenues: Our revenues increased $150.9 million, or 16.2%, to $1,083.7 million in 2008 from $932.8 million in 2007. Domestic revenues increased $109.4 million, or 15.2%, to $830.8 million from $721.4 million in 2007 as internal growth for domestic small account customers increased by approximately $52.5 million, over 13%, driven by an increase of Steri-Safe customers. Revenues from domestic large account customers increased approximately $21.9 million, or over 9% as we increased the total number of accounts. Returns Management Services decreased revenues compared to 2007 by over $10.8 million due to lower than expected recall volumes. Domestic acquisitions less than one year old added an additional $45.8 million in revenues compared to 2007. 22 International revenues in 2008 were $252.9 million, compared to $211.4 million in 2007, an increase of $41.5 million or 19.6%. Internal growth, currency rate fluctuations, acquisitions, and the divestiture of some plants in the United Kingdom, impact the comparison of 2008 to 2007. Internal growth was $30.8 million. The effect of exchange rates negatively impacted international 2008 revenues by $11.3 million as foreign currencies depreciated against the U.S. dollar, acquisitions less than one year old favorably impacted revenues by $23.9 million. The divestiture of selected Sterile Technologies Group, Ltd., (“STG”) plants in the first quarter of 2007 negatively impacted the comparison to 2008 by $1.9 million. Cost of Revenues: Our 2008 cost of revenues increased $83.8 million, or $16.3%, to $598.6 million compared to $514.8 million in 2007. Domestic cost of revenues increased $65.1 million, or 17.6%, to $435.0 million in 2008 compared to $369.9 million for 2007. International cost of revenues increased $18.7 million, or 12.9%, to $163.6 million in 2008 compared to $144.9 million in 2007. Our gross margin percentage remained at 44.8% during 2008 and 2007. Domestic gross margin percentage decreased 1.1% to 47.6% during 2008 from 48.7% in 2007. Our domestic gross margin decrease was primarily the result of energy and transportation costs increases in 2008, which were partially offset by higher revenues related to energy surcharges. International gross margin increased 3.9% in 2008 compared to 2007, primarily due to integration of acquisitions and related efficiencies. In general, international gross margins are lower than domestic gross margins because the international operations have less penetration into the small quantity generator market, which has a better gross margin. Historically, the international operations have had most of their revenues from large national healthcare hospitals. As the international segment increases, consolidated gross margins receive downward pressure due this “business mix” shift, which can be offset by additional international small quantity market penetration, integration savings and domestic business expansion. Selling, General and Administrative Expenses: In 2008, our selling, general and administrative (“SG&A”) expenses increased $26.5 million, or 15.0%, to $203.2 million from $176.7 million in 2007. Amortization and depreciation expense, as a percentage of revenue, did not change from 2007 to 2008. Domestically, 2008 SG&A increased $18.1 million, or 12.6%, to $161.2 million from $143.1 million in 2007. The increase was primarily due to spending related to acquisitions, market penetration for our Bio Systems® sharps management program and investments in the Steri-Safe and returns management services. Internationally, our SG&A increased $8.4 million, or 25.0%, in 2008 to $42.0 million from $33.6 million in 2007, mostly due to acquisitions. Income from Operations: Income from operations increased by $49.7 million, or 22.1%, to $274.2 million in 2008 from $224.5 million in 2007. Comparisons of income from operations between 2008 and 2007 are affected by various charges not considered part of our day-to-day operations. During the year ended December 31, 2008, we recorded expenses of $5.6 million related a business dispute settlement and related costs and $0.5 million related to fixed asset write-offs. During the year ended December 31, 2007 we had charges totaling $17.4 million related to permit write-offs, fixed asset write-offs and settlement of arbitration proceedings in Australia. Those charges were partially offset by gains of $2.1 million from the sale of assets of STG and of Scherer Labs. Domestically, our income from operations increased $40.6 million, or 21.1%, to $233.4 million from $192.8 million in 2007. Internationally, our income from operations increased $9.1 million, or 28.7%, to $40.8 million from $31.7 million in 2006. Interest Expense and Interest Income: Interest expense slightly decreased to $33.1 million during 2008 from $34.0 million during 2007. The decrease is related to lower interest rates. Interest income was $0.9 million during 2008 and $1.6 million during 2007. 23 Write-down of Investment: During 2007 we had a $2.9 million non-cash write-down of our investment in Medam B.A., an Argentine medical waste processing company. The write-down was due to a legal restructuring of the Medam B.A. operations. Stericycle now is the sole owner of Medam B.A. Proceeds from Insurance: During 2007 we received $3.3 million of insurance proceeds related to the 3CI litigation settled in 2005. Income Tax Expense: Income tax expense for the years 2008 and 2007 reflects an effective tax rate of approximately 37.8% and 38.1%, respectively, for federal and state income taxes. Year Ended December 31, 2007 Compared to Year Ended December 31, 2006 The following summarizes the Company’s operations: In thousands, except per share data Revenues Cost of revenues Depreciation Total cost of revenues Gross profit Selling, general and administrative expenses Depreciation Amortization Total selling, general and administrative expenses Gain on sale of assets Impairment of intangible assets Impairment of fixed assets Arbitration award and related costs Acquisition integration expenses Income from operations Write-down of investment Insurance proceeds Net interest expense Income tax expense Net income Earnings per share – Diluted Years Ended December 31, 2007 2006 $ $932,767 491,789 23,057 % 100.0 52.7 2.5 $ $789,637 419,689 20,081 % 100.0 53.1 2.5 514,846 417,921 168,657 4,423 3,657 176,737 (2,099) 2,269 1,261 13,904 1,305 224,544 2,930 (3,300) 32,375 72,862 $118,378 1.32 $ 55.2 44.8 18.1 0.5 0.4 18.9 (0.2) 0.2 0.1 1.5 0.1 24.1 0.3 (0.4) 3.5 7.8 12.7 439,770 349,867 137,411 3,989 2,966 144,366 — — 300 — 3,439 201,762 1,000 (1,025) 27,061 67,304 $105,270 1.16 $ 55.7 44.3 17.4 0.5 0.4 18.3 — — 0.0 — 0.4 25.6 0.1 (0.1) 3.4 8.5 13.3 Revenues: Our revenues increased $143.1 million, or 18.1%, to $932.8 million in 2007 from $789.6 million in 2006. Domestic revenues increased $105.0 million, or 17.0%, to $721.4 million from $616.4 million in 2006 as internal growth for domestic small account customers increased by approximately $37.1 million, over 10%, driven by an increase of Steri-Safe customers. Revenues from domestic large account customers increased approximately $13.1 million, or over 6% as we increased the total number of accounts and grew Bio Systems® services. Returns Management Services increased revenues compared to 2006 by over $22.3 million from internal growth due to larger than expected recall volumes. Domestic acquisitions less than one year old added an additional $32.5 million in revenues compared to 2006. International revenues in 2007 were $211.4 million, compared to $173.2 million in 2006, an increase of $38.1 million or 22.0%. Internal growth, currency rate fluctuations, acquisitions, and the divestiture of some plants in the United Kingdom, impact the comparison of 2007 to 2006. Internal growth was $16.2 million. The 24 effect of exchange rates favorably impacted international 2007 revenues by $11.8 million as foreign currencies appreciated against the U.S. dollar, acquisitions less than one year old favorably impacted revenues by $24.5 million, while the divestiture at a gain of selected STG plants in the first quarter of 2007 negatively impacted the comparison to 2006 by $14.4 million. Cost of Revenues: Our 2007 cost of revenues increased $75.1 million, or $17.1%, to $514.8 million compared to $439.8 million in 2006. Domestic cost of revenues increased $47.4 million, or 14.7%, to $369.9 million in 2007 compared to $322.6 million for 2006. International cost of revenues increased $27.7 million, or 23.6%, to $144.9 million in 2007 compared to $117.2 million in 2006. Our gross margin percentage increased to 44.8% during 2007 from 44.3% during 2006. Domestic gross margin percentage improved 1.0% to 48.7% during 2007 from 47.7% in 2006. Our gross margin increase was primarily the result of increased number of small quantity customers, which have a better gross margin. Domestic energy and transportation costs increased in 2007, which were partially offset by higher revenues related to energy surcharges. International gross margin decreased 0.9% in 2007 compared to 2006, primarily due to acquisitions whose margins are lower. In general, international gross margins are lower than domestic gross margins because the international operations have less penetration into the small quantity generator market, which has a better gross margin. Historically, the international operations have had most of their revenues from large national healthcare hospitals. As the international segment increases, consolidated gross margins receive downward pressure due this “business mix”, which can be offset by additional international small quantity market penetration, integration savings and domestic business expansion. Selling, General and Administrative Expenses: In 2007, our SG&A expenses increased $32.4 million, or 22.4%, to $176.7 million from $144.4 million in 2006. Amortization and depreciation expense, as a percentage of revenue, did not change from 2006 to 2007. Domestically, 2007 SG&A increased $26.6 million, or 22.8%, to $143.1 million from $116.6 million in 2006. The increase was primarily due to spending related to market penetration for our Bio Systems® sharps management program and investments in the Steri-Safe and returns management services and acquisitions. Internationally, our SG&A increased $5.8 million, or 20.7%, in 2007 to $33.6 million from $27.8 million in 2006, mostly due to foreign exchange fluctuations (higher dollar costs as the dollar weakened versus other currencies) and acquisitions. As a percentage of revenue, international SG&A decreased 0.2%. This decrease reflects the ongoing efforts to integrate our businesses in the United Kingdom and Argentina. Income from Operations: Income from operations increased by $22.8 million, or 11.3%, to $224.5 million in 2007 from $201.8 million in 2006. Comparisons of income from operations between 2007 and 2006 are affected by various charges not considered part of our day-to-day operations. During the year ended December 31, 2007 we had charges totaling $17.4 million related to permit write-offs, fixed asset write-offs and settlement of arbitration proceedings in Australia. Those charges were partially offset by gains of $2.1 million from the sale of assets of STG and of Scherer Labs. During the year ended December 31, 2006, we recorded expenses of $0.3 million related to fixed asset write downs. Domestically, our income from operations increased $17.7 million, or 10.1%, to $192.8 million from $175.1 million in 2006. Internationally, our income from operations increased $5.1 million, or 19.1%, to $31.7 million from $26.7 million in 2006. Interest Expense and Interest Income: Interest expense increased to $34.0 million during 2007 from $28.4 million during 2006. The increase of $5.6 million is related to higher debt levels incurred to finance acquisitions and stock repurchases. Interest income was $1.6 million during 2007 and $1.4 million during 2006. 25 Write-down of Investment: During 2007 we had a $2.9 million non-cash write-down of our investment in Medam B.A., an Argentine medical waste processing company. The write-down was due to a legal restructuring of the Medam B.A. operations. Stericycle now is the sole owner of Medam B.A. During 2006 we had a $1.0 million non-cash write-down of an investment in securities. Proceeds from Insurance: During 2007 we received $3.3 million of insurance proceeds related to the 3CI litigation settled in 2005. During 2006 we received $1.0 million of insurance proceeds related to the 3CI litigation settled in 2005. Income Tax Expense: Income tax expense for the years 2007 and 2006 reflects an effective tax rate of approximately 38.1% and 39.0%, respectively, for federal and state income taxes. Liquidity and Capital Resources Our senior credit facility of $850.0 million maturing in August 2012 requires us to comply with various financial, reporting and other covenants and restrictions, including a restriction on dividend payments. At December 31, 2008, we were in compliance with all of our financial debt covenants. At December 31, 2008 the margin for interest rates on borrowings under our new credit facility was 0.0% on base rate loans (at higher of (i) the federal funds rate plus 0.5% or (ii) the prime rate) and 0.75% on LIBOR loans. As of December 31, 2008, we had $439.8 million of borrowings outstanding under our senior unsecured credit facility, which includes foreign currency borrowings of $11.3 million. In addition, we had $212.3 million committed to outstanding letters of credit. The weighted average rate of interest on the unsecured revolving credit facility was 2.70% per annum which includes the amounts under our interest rate hedge. At December 31, 2008 we had $352.9 million in other debt outstanding, which includes promissory notes issued in connection with acquisitions during 2004 through 2008, seven-year $100 million private placement notes at a fixed rate of 5.64%, other foreign subsidiary bank debt and capital leases. On April 15, 2008, we entered into a note purchase agreement with nine institutional purchasers pursuant to which we issued and sold to the purchasers $100 million of our 5.64% senior notes due April 15, 2015 (the “notes”). The notes bear interest at the fixed rate of 5.64% per annum. Interest is payable in arrears semi- annually on April 15 and October 15 beginning on October 15, 2008, and principal is payable at the maturity of the notes on April 15, 2015. The notes are unsecured obligations and rank pari passu with our obligations under our senior unsecured credit facility pursuant to our credit agreement with Bank of America, N.A. and the other lenders party to the credit agreement. We applied the proceeds from the sale of the notes to reduce our borrowings under our revolving credit facility under our senior unsecured credit facility. The notes contain customary events of default, including our failure to pay any principal, interest or other amount when due, our violation of our affirmative or negative covenants or a breach of our representations and warranties. Upon the occurrence of an event of default, payment of the notes may be accelerated by the holders of the notes. Working Capital: At December 31, 2008, our working capital decreased $15.8 million to $44.8 million compared to $60.6 million at December 31, 2007. Current assets increased by $14.2 million primarily due to an $11.6 million increase in accounts receivable from increased revenues year over year. Current liabilities increased $29.9 million primarily due to an increase in accrued liabilities of $17.9 million and debt of $16.9 million. The major components contributing to the increase in accrued liabilities is a $12.0 million acquisition purchase accrual and a $2.5 million accrual for stock repurchases that settled after December 31, 2008. The major component to the increase in short-term debt is notes issued for acquisitions made in 2008. Net Cash Provided or Used: Net cash provided by operating activities increased $36.5 million, or 21.0%, to $210.6 million during 2008 compared to $174.0 million for 2007. The increase in operating cash was primarily due to collections on higher revenues, which increased 16.2%. 26 Net cash used in investing activities during 2008 was $132.9 million compared to $135.3 million used in 2007. The difference is due to $26.5 million received from the divestiture of selected plants in the United Kingdom completed in February 2007, offset by $29.8 million less paid for acquisitions in 2008. Net cash used in financing activities was $77.9 million during 2008 compared to $32.6 million used in 2007. As described above, in 2008, we completed the private placement of $100 million in unsecured seven-year notes, primarily used to pay down our revolver debt. Three was $16.6 million less in repayment of other long-term debt during 2008 compared to 2007. Offsetting the decrease in debt repayment was an additional $63.7 million for the purchase of treasury stock in 2008. Contractual Obligations: The following table summarizes our significant contractual obligations and cash commitments as of December 31, 2008: Payments due by period (dollars in thousands) Long-term debt (1) Capital lease obligations (1) Operating leases Purchase obligations Other long-term liabilities (1)(2) Total $ 881,330 1,312 137,087 2,156 2,070 2009 $58,053 688 37,067 2,146 772 2010-2011 $101,832 618 54,666 10 1,001 2012-2013 $518,341 6 24,924 — 264 2014 and After $203,104 — 20,430 — 33 Total contractual cash obligations $1,023,955 $98,726 $158,127 $543,535 $223,567 (1) The long-term debt, capital leases and other long-term liabilities items include both the future principal payment amount as well as an amount calculated for expected future interest payments. For long-term debt with floating rate of interest, management used judgment to estimate the future rate of interest. (2) Other long-term liabilities include amounts related to non-compete agreements. Excludes payments for unrecognized tax benefits. Based on the contingent and uncertain nature of our liability for unrecognized tax benefits, we are unable to make an estimate of the period of potential settlement, if any, with respective taxing authorities. At December 31, 2008 we had $212.3 million in stand-by letters of credit issued. We anticipate that our operating cash flow, together with borrowings under our senior secured credit facility, will be sufficient to meet our anticipated future operating expenses, capital expenditures and debt service obligations as they become due during the next 12 months and the foreseeable future. Guarantees: We have guaranteed a loan to JPMorganChase Bank N.A. on behalf of Shiraishi-Sogyo Co. Ltd (“Shiraishi”). Shiraishi is a customer in Japan that is expanding their regulated waste management business and has a one year loan with a current balance of $5.4 million with JPMorgan Chase Bank N.A. that expires in May 2009. Management currently believes no amount will be paid under the guarantee. Item 7A. Quantitative and Qualitative Disclosures 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 $2.5 million on a pre-tax basis. 27 In October 2008, we entered into three interest rate derivative transactions that effectively fix the interest rate on the applicable notional amounts of our variable rate debt as follows: In thousands Notional Amount $125,000 $ 75,000 $ 25,000 Fixed Interest Rate 2.79% 2.79% 2.94% Variable Interest Rate 1 Month Libor 1 Month Libor 1 Month Libor Expiration Date October 2009 April 2010 October 2010 The interest rate swaps are designated as cash flow hedges; the notional amounts and all other significant terms of the swap agreement are matched to the provisions and terms of the variable rate debt hedged. We apply hedge accounting to account for these instruments. We have exposure to currency exchange rate fluctuations between the U.S. dollar and U.K. pound sterling (“GBP”) related to an eight million GBP inter-company loan to Stericycle International, Ltd., the parent company of White Rose Environmental, which we hedge with a forward contract. We use cash flow hedge accounting treatment on our forward contract. Both the inter-company loan balance and the forward contract are marked to market at the end of each reporting period and the impact on the balances is recorded on the balance sheet to other comprehensive income. The forward contract expires in July 2009. We have exposure to commodity pricing for gas and diesel fuel for our trucks and for the purchase of containers and boxes. We do not hedge these items to manage the exposure. 28 Item 8. Consolidated Financial Statements and Supplemental Data Management’s Report on Internal Control Over Financial Reporting The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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. The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control–Integrated Framework. Based on this assessment and those criteria, management concludes that the Company maintained effective internal control over financial reporting as of December 31, 2008. The Company’s independent auditors have issued an attestation report on the Company’s internal control over financial reporting. That report appears on page 30. Stericycle, Inc. Lake Forest, IL February 26, 2009 29 Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting The Board of Directors and Shareholders of Stericycle, Inc. We have audited Stericycle, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Stericycle, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s 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 purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. 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. In our opinion, Stericycle, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Stericycle, Inc. and Subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008 and our report dated February 26, 2009 expressed an unqualified opinion thereon. Chicago, Illinois February 26, 2009 Ernst & Young LLP 30 Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders of Stericycle, Inc. We have audited the accompanying consolidated balance sheets of Stericycle, Inc. and Subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Stericycle, Inc. and Subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth herein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Stericycle, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2009 expressed an unqualified opinion thereon. Ernst & Young LLP Chicago, Illinois February 26, 2009 31 STERICYCLE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS In thousands, except share and per share data ASSETS Current Assets: December 31, 2008 2007 Cash and cash equivalents Short-term investments Accounts receivable, less allowance for doubtful accounts of $6,616 in 2008 and $ $ 9,095 1,408 17,108 1,256 $6,157 in 2007 Deferred income taxes Prepaid expenses and other current assets Total Current Assets Property, Plant and Equipment, net Other Assets: Goodwill Intangible assets, less accumulated amortization of $14,116 in 2008 and $12,230 in 2007 Other Total Other Assets Total Assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities: Current portion of long-term debt Accounts payable Accrued liabilities Deferred revenues Total Current Liabilities Long-term debt, net of current portion Deferred income taxes Other liabilities Common Shareholders’ Equity: Common stock (par value $.01 per share, 120,000,000 shares authorized, 85,252,879 issued and outstanding in 2008, 87,410,653 issued and outstanding in 2007) Additional paid-in capital Accumulated other comprehensive income Retained earnings Total Shareholders’ Equity Total Liabilities and Shareholders’ Equity 168,598 16,821 28,508 224,430 207,144 157,435 13,510 20,967 210,276 193,039 1,135,778 1,033,333 170,624 21,322 152,689 18,822 1,327,724 1,204,844 $1,759,298 $1,608,159 $ 38,880 33,612 93,487 13,663 179,642 753,846 147,287 8,043 $ 22,003 40,049 75,571 12,095 149,718 613,781 125,041 5,544 852 67,776 (32,075) 633,927 670,480 874 197,462 30,520 485,219 714,075 $1,759,298 $1,608,159 The accompanying notes are an integral part of these financial statements. 32 STERICYCLE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME In thousands, except share and per share data Revenues Costs and Expenses: Cost of revenues Selling, general and administrative expenses Gain on sale of assets Impairment of intangible assets Impairment of fixed assets Arbitration award and related costs Acquisition integration expenses Total Costs and Expenses Income from Operations Other Income (Expense): Interest income Interest expense Write-down of investment Proceeds from insurance Other expense, net Total Other Expense 2008 Years Ended December 31, 2007 932,767 $ $ 1,083,679 $ 598,650 203,210 — — 472 5,595 1,513 809,440 274,239 930 (33,104) — — (3,061) (35,235) 514,846 176,737 (2,099) 2,269 1,261 13,904 1,305 708,223 224,544 1,590 (33,965) (2,930) 3,300 (1,299) (33,304) 2006 789,637 439,770 144,366 — — 300 — 3,439 587,875 201,762 1,358 (28,419) (1,000) 1,025 (2,152) (29,188) Income Before Income Taxes 239,004 191,240 172,574 Income Tax Expense Net Income Earnings Per Common Share: Basic Diluted 90,296 72,862 67,304 $ 148,708 $ 118,378 $ 105,270 $ $ 1.73 1.68 $ $ 1.35 1.32 $ $ 1.19 1.16 Weighted Average Number of Common Shares Outstanding: Basic Diluted 85,950,192 88,335,832 87,578,650 89,933,242 88,466,990 90,529,998 The accompanying notes are an integral part of these financial statements. 33 STERICYCLE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS In thousands Years Ended December 31, 2007 2008 2006 OPERATING ACTIVITIES: Net income Adjustments to reconcile net income to net cash provided by operating activities: $ 148,708 $ 118,378 $ 105,270 Gain on sale of assets Loss on sale and impairment of fixed assets Impairment of intangibles Write-down of investment Write-off of note receivable related to joint venture Stock compensation expense Excess tax benefit of stock options exercised Depreciation Amortization Deferred income taxes Changes in operating assets and liabilities, net of effect of acquisitions and divestitures: Accounts receivable Accounts payable Accrued liabilities Deferred revenues Other assets and liabilities Net cash provided by operating activities INVESTING ACTIVITIES: Payments for acquisitions and international investments, net of cash acquired Proceeds from maturity/(purchase) of short-term investments Proceeds from sale of assets Proceeds from sale of property and equipment Capital expenditures Net cash used in investing activities FINANCING ACTIVITIES: Proceeds from issuance of note payable Repayment of long-term debt Borrowings on senior credit facility Repayments of senior credit facility Proceeds from private placement of long-term note Principal payments on capital lease obligations Payments of deferred financing costs Purchase/ cancellation of treasury stock Proceeds from other issuance of common stock Excess tax benefit of stock options exercised Net cash (used in)/ provided by financing activities Effect of exchange rate changes on cash Net (decrease)/ increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year NON-CASH ACTIVITIES: Net issuance of notes payable for certain acquisitions Net issuance of common stock for certain acquisitions — 472 — — 798 11,755 (9,319) 30,109 4,039 26,522 (2,099) 1,261 2,269 2,930 — 10,714 (8,054) 27,480 3,657 17,265 — 300 — 1,000 — 10,610 (8,427) 24,070 2,966 12,937 (12,998) (7,041) 19,517 1,597 (3,604) (11,400) 6,987 1,566 537 2,551 (14,742) (6,003) 28,107 280 3,794 210,555 174,042 160,162 (84,947) (463) — — (47,520) (114,781) 1,301 26,616 — (48,397) (164,015) (1,828) — 832 (36,414) (132,930) (135,261) (201,425) — (13,866) 977,352 (1,000,425) 100,000 (527) (236) (167,338) 17,839 9,319 (77,882) (7,756) (8,013) 17,108 — (30,447) 506,472 (428,786) — (212) (606) (103,679) 16,569 8,054 (32,635) (2,530) 3,616 13,492 5,953 (30,735) 362,452 (265,988) — (816) (453) (42,757) 16,464 8,427 52,547 (5,617) 5,667 7,825 $ $ 9,095 $ 17,108 $ 13,492 106,074 — $ 112,509 13,667 $ 30,157 750 The accompanying notes are an integral part of these financial statements. 34 STERICYCLE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY Years Ended December 31, 2008, 2007 and 2006 In thousands Balance at December 31, 2005 Issuance of common stock for exercise of options and warrants and employee stock purchases Purchase/ Cancellation of treasury stock Stock compensation expense Excess tax benefit of disqualifying dispositions of stock options and exercise of non-qualified stock options Currency translation adjustment Change in fair value of cash flow hedge Net income Comprehensive income Issued and Outstanding Shares 88,300 Amount $884 Additional Paid-In Capital $ 258,633 Retained Earnings $261,571 Accumulated Other Comprehensive Income (Loss) $ 546 Total Equity $ 521,634 1,540 (1,336) — 16 (14) — 17,198 (42,743) 10,610 — — — — — — — — 8,427 — — — — — — — — — 105,270 — — — — 4,350 333 — 17,214 (42,757) 10,610 8,427 4,350 333 105,270 109,953 Balance at December 31, 2006 88,504 $886 $ 252,125 $366,841 $ 5,229 $ 625,081 Issuance of common stock for exercise of options and warrants and employee stock purchases Issuance of common stock for acquisitions Purchase/ Cancellation of treasury stock Stock compensation expense Excess tax benefit of disqualifying dispositions of stock options and exercise of non-qualified stock options Currency translation adjustment Change in fair value of cash flow hedge Net income Comprehensive income 1,067 228 (2,388) — 10 2 (24) — 16,559 13,665 (103,655) 10,714 — — — — — — — — 8,054 — — — — — — — — — — 118,378 — — — — — 25,125 166 — 16,569 13,667 (103,679) 10,714 8,054 25,125 166 118,378 143,669 Balance at December 31, 2007 87,411 $874 $ 197,462 $485,219 $ 30,520 $ 714,075 Issuance of common stock for exercise of options and warrants and employee stock purchases Purchase/ Cancellation of treasury stock Stock compensation expense Excess tax benefit of disqualifying dispositions of stock options and exercise of non-qualified stock options Currency translation adjustment Change in fair value of cash flow hedge, net of $1.9 million tax Net income Comprehensive income 1,064 (3,222) — 10 (32) — 19,049 (169,809) 11,755 — — — — — — — — 9,319 — — — — 148,708 — — — — — — — — 19,059 (169,841) 11,755 — (59,301) (3,294) — 9,319 (59,301) (3,294) 148,708 86,113 Balance at December 31, 2008 85,253 $852 $ 67,776 $633,927 $(32,075) $ 670,480 The accompanying notes are an integral part of these financial statements. 35 STERICYCLE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008 Unless the context requires otherwise, “we”, “us” or “our” refers to Stericycle, Inc. and its subsidiaries on a consolidated basis. NOTE 1—DESCRIPTION OF BUSINESS We were incorporated in 1989 and presently serve approximately 418,000 customers throughout the United States, Canada, Mexico, Argentina, Chile, the United Kingdom, Ireland and Puerto Rico. Domestically, we have a fully integrated, national network that includes 46 processing centers and 80 additional transfer and collection sites. We use this network to provide a broad range of services to our customers related to regulated waste management services and regulated return management services. Regulated waste management services include servicing a variety of customers to remove and process waste while regulated return management services are physical services provided to companies and individual businesses that assist with the handling of products that are being removed from the supply chain due to recalls and expiration. These services also included advanced notification technology that is used to communicate specific instructions to the users of the product. Our waste treatment technologies include autoclaving, incineration, chemical treatment and our proprietary electro-thermal- deactivation system. Internationally, we have fully integrated networks, which includes 43 processing/collection centers and 17 additional transfer and collection sites. In addition, we have technology licensing agreements with companies located in Japan, South Africa and Brazil. NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: The consolidated financial statements include the accounts of Stericycle, Inc. and its wholly owned subsidiaries. Revenue Recognition: We recognize revenues for our regulated waste services at the time of waste collection. Payments received in advance are deferred and recognized as services are provided. Revenues from regulated returns management services are recorded at the time services are performed. Royalty revenues, which are not material, are calculated based on measurements specified in each contract or license and revenues are recognized at the end of each reporting period when the activity being measured has been completed. Revenues from product sales are recognized at the time the goods are shipped to the ordering customer. Software licensing revenues, which are not material, are recognized on a prorated basis over the term of the license agreement. We do not have any contracts in a loss position. Losses would be recorded when known and estimable for any contracts that should go into a loss position. Cash Equivalents and Short-Term Investments: We consider all highly liquid investments with a maturity of less than three months when purchased to be cash equivalents. Short-term investments consist of certificates of deposit, which mature in less than one year. 36 Property, Plant and Equipment: Property, plant and equipment are stated at cost. Depreciation and amortization, which include the depreciation of assets recorded under capital leases, are computed using the straight-line method over the estimated useful lives of the assets as follows: Building and improvements Machinery and equipment Containers Transportation equipment Office equipment and furniture Software 5 to 30 years 10 to 20 years 2 to 20 years 3 to 7 years 3 to 10 years 1 to 7 years Our containers have a weighted average useful life of 10.0 years. During the years ended December 31, 2008, 2007 and 2006 we wrote down $0.5 million, $1.3 million and $0.3 million, respectively, related to equipment that had been permanently idled. Goodwill and Identifiable Intangibles: Goodwill and identifiable indefinite lived intangibles are not amortized, but are subject to an annual impairment test according to Statement of Financial Accounting Standards (“SFAS”) No. 142. Other intangible assets will continue to be amortized over their useful lives. We have determined that our customer relationships have useful lives from 20 to 40 years based upon the type of customer, with a weighted average useful life of 38.1 years. We have non-compete intangibles with useful lives from one to ten years, with a weighted average useful life of 7.9 years. We have tradename intangibles with useful lives from 20 to 40 years, with a weighted average useful life of 38.3 years. We have software technology intangibles with useful lives from three to five years, with a weighted average useful life of 4.4 years. We have determined that our permits have indefinite lives and therefore are not amortized. Valuation of our intangible customer relationships and permits is derived using a discounted income approach. Financial information such as revenues, costs, assets and liabilities related to the intangible asset are input into a standard valuation model to determine a stream of income attributable to that intangible. The income stream is then discounted to the present to arrive at a valuation. We perform annual impairment tests, in accordance with SFAS No. 142, on our indefinite lived intangible assets. Valuation of Intangibles: Our permits are currently tested for impairment annually at December 31, or more frequently if circumstances indicate that they may be impaired. We use a discounted income approach model as the current measurement of the fair value of the permits. The estimate of income is based upon, among other things, certain assumptions about expected future operating performance and an appropriate discount rate determined by management. Our estimates of discounted income may differ from actual income due to, among other things, inaccuracies in economic estimates. Amortizable identifiable intangible assets, such as customer relationships, tradenames and covenants not-to-compete, are currently amortized using the straight-line method over their estimated useful lives. We have determined that our regulated waste customer relationships have between 20-year and 40-year lives based on the specific type of relationship. The valuation of our contractual customer relationships was derived using a discounted income approach valuation model similar to the method used for permit testing mentioned earlier. These assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may be less than its undiscounted estimated future cash flows (see Note 10 to the Consolidated Financial Statements). impairment 37 Income Taxes: Deferred income tax liabilities and assets are determined based on the differences between the financial statement and income tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Accounts Receivable: Accounts receivable consist primarily of amounts due to us from our normal business activities. We do not require collateral as part of our standard trade credit policy. Accounts receivable balances are determined to be past due when the amount is overdue based on the contractual terms with the customer. We maintain an allowance for doubtful accounts to reflect the expected uncollectibility of accounts receivable based on past collection history and specific risks identified among uncollected accounts. Accounts receivable are written off against the allowance for doubtful accounts when we have determined that the receivable will not be collected and/or when the account has been referred to a third party collection agency. Bad debt expense was $5.0 million, $4.4 million and $4.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. Financial Instruments: Our financial instruments consist of cash and cash equivalents, short-term investments, derivatives, accounts receivable and payable and long-term debt. At December 31, 2008, the fair value of the Company’s debt obligations was estimated at $771.5 million, compared to a carrying amount of $792.7 million. This fair value was estimated using market interest rate for comparable instruments. The Company has no current plans to retire a significant amount of its debt prior to maturity. Financial instruments, which potentially subject us to concentrations of credit risk, consist principally of accounts receivable. Credit risk on trade receivables is minimized as a result of the large size of our customer base. No single customer represents greater than 2% of total accounts receivable. We perform ongoing credit evaluation of our customers and maintain allowances for potential credit losses. For any contracts in loss positions, losses are recorded when known and estimable. These losses, when incurred, have been within the range of our expectations. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires the amounts reported in the financial statements and us to make estimates and assumptions that affect accompanying notes. Some areas where we make estimates include allowance for doubtful accounts, credit memo reserve, accrued employee health and welfare benefits, income tax liabilities and accrued auto and workers’ compensation insurance claims. Such estimates are based on historical trends and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from our estimates. Future estimated expenses may fluctuate depending on changes in foreign currency rates. The estimates for payments due on long-term debt, lease payments under capital leases, amortization expense and rental payments are based upon foreign exchange rates as of December 31, 2008 (see Notes 7, 10 and 11 to the Consolidated Financial Statements). Derivative Instruments: We have one forward contract for the purchase of Sterling (GBP) as hedging instruments for an intercompany loan from the parent company to our subsidiary in the United Kingdom, Stericycle International Ltd, which is described more fully in Note 9 to the Consolidated Financial Statements. The subsidiary borrowed the funds for the purchase of all the common stock of White Rose Environmental, Ltd. The forward contract aligns with the anticipated repayment schedule of the loan and expires in July 2009. 38 In October 2008, Stericycle entered into three interest rate swap contracts, covering $225 million of our borrowings outstanding under our senior credit facility. The objective of the swap is to reduce the risk of volatile interest expense by fixing the rate. The fair market of the three hedges is recorded as a liability of $4.8 million, of which $2.1 million is current (see Note 9 to the Consolidated Financial Statements for more information). 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 three hedges. Stock-Based Compensation: On January 1, 2006, we adopted the provisions of SFAS No. 123R, Share-Based Payment (“SFAS No. 123R”) using the modified prospective method to account for stock compensation costs. SFAS No. 123R requires the measurement and recognition of compensation expense for all stock-based payment awards made to our employees and directors. Under the fair value recognition provisions of SFAS No. 123R, stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of stock-based awards at the grant date requires considerable judgment, including estimating expected volatility, expected term and risk-free rate. Our expected volatility is based upon historical experience. The expected term of the stock options is based upon the historical volatility of our stock price. The risk-free interest rate assumption is based upon the U.S. Treasury yield rates for a comparable period. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. Foreign Currency Translation: Assets and liabilities of foreign affiliates that use the local currency as their functional currency are translated at the exchange rate on the last day of the accounting period, and income statement accounts are translated at the average rates during the period. Related translation adjustments are reported as a component of comprehensive income in shareholders’ equity. Environmental Matters: We record a liability for environmental remediation or damages when a cleanup program becomes probable and the costs or damages can be reasonably estimated. We do not have any environmental liabilities recorded at December 31, 2008 nor are we aware of any issues at our facilities that could initiate the need for environmental remediation. New Accounting Standards: Effective January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), for all financial assets and liabilities and for nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) No. 157-2 delayed the adoption date for nonfinancial assets and liabilities that are measured at fair value on a non-recurring basis, such as goodwill and identifiable intangible assets until January 1, 2009. We do not believe the adoption of SFAS No. 157 for our non-financial assets and liabilities, effective January 1, 2009, will have a material impact on our consolidated financial statements. Our adoption of SFAS No. 157 did not require a cumulative effect adjustment to the opening balance of our retained earnings (see Note 3 to the Consolidated Financial Statements). In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 allows measurement at fair value of eligible financial assets and liabilities that are not otherwise measured at fair value. If the fair value option for an eligible item is elected, unrealized gains and losses for that item are reported 39 in current earnings at each subsequent reporting date. SFAS No. 159 also establishes presentation and disclosure requirements designed to draw comparisons between the different measurement attributes that we elect for similar types of assets and liabilities. SFAS No. 159 became effective for fiscal years beginning after November 15, 2007. We do not have any financial assets or liabilities for which we elected the fair value option under SFAS No. 159. In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) replaces SFAS No. 141, Business Combinations. SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction; requires certain contingent assets and liabilities acquired to be recognized at their fair values on the acquisition date; requires contingent consideration to be recognized at its fair value on the acquisition date and changes in the fair value to be recognized in earnings until settled; requires the expensing of most transaction and restructuring costs; and generally requires the reversals of valuation allowances related to acquired deferred tax assets and changes to acquired income tax uncertainties to also be recognized in earnings. This new accounting standard will require the company to recognize expenses to the income statement that were previously accounted for as purchase accounting and reflected on the balance sheet. This accounting standard is effective for financial statements issued for fiscal years beginning after December 15, 2008. Amounts capitalized in anticipation of a business combination that was not completed by December 31, 2008 will be expensed in January of 2009. These expenses are approximately $0.6 million. Because of the inherent uncertainty of the number, structure and complexity of the acquisitions that we may complete in the future and the magnitude of the transaction expenses that we may incur in completing these acquisitions, the impact of the adoption of SFAS 141(R) is not reasonably estimable. In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”), to enhance the disclosure regarding the Company’s derivative and hedging activities to improve the transparency of financial reporting. This statement is effective for fiscal years beginning after November 15, 2008. As SFAS No. 161 only requires enhanced disclosures, this standard has no impact on the financial position, results of operations, or cash flows of the Company. NOTE 3—FAIR VALUE MEASUREMENTS We adopted SFAS No. 157 on January 1, 2008, which clarifies that fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. Under SFAS No. 157, fair value should be based on the assumptions market participants would use when pricing the asset or liability and establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of our company. Unobservable inputs are those that reflect the company’s assumptions about what market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The three levels of the fair value hierarchy defined by SFAS No. 157 are as follows: • Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access. • Level 2—Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities. • Level 3—Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. As required by SFAS No. 157, 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 40 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, under SFAS No. 157, the fair value measurement of a liability must reflect the nonperformance risk of an entity. At December 31, 2008, we have $9.1 million in cash and cash equivalents and $1.4 million of short-term investments that we carry on our books at fair value using Level 1 inputs. We have a cash flow hedge with an objective to offset foreign currency exchange risk to the U.S. dollar equivalent cash inflows on the settlement of a GBP denominated intercompany loan. The fair value of the hedge was calculated using Level 2 inputs and was recorded as a current asset of $2.3 million as of December 31, 2008. We have three cash flow hedges with the objective to offset variable interest rate expense on a portion of our revolver debt with fixed rate expense. The notional amount of our three hedges is $225.0 million. The fair value of the hedge is calculated using Level 2 inputs and is recorded as a liability of $4.8 million, of which $2.1 million is current as of December 31, 2008. There were no movements of items between fair value hierarchies. NOTE 4—ACQUISITIONS AND DIVESTITURE During 2008, we completed 22 acquisitions, of which 12 were domestic regulated waste businesses, two domestic return management businesses and eight were international regulated waste businesses in Canada, Latin America and Europe. The aggregate net purchase price of all our acquisitions, including adjustments for purchase accounting was approximately $191.0 million, of which $84.9 million was paid in cash and $106.1 million was paid by the issuance of promissory notes. The purchase prices of these acquisitions have been primarily allocated to identifiable intangible assets and goodwill, reflecting the complementary strategic fit that the acquired businesses brought to us. During 2007, we completed 19 acquisitions, of which ten were domestic regulated waste businesses, one was a domestic assembler and distributor of containers that we use in our mail-back program and eight were international regulated waste businesses in Canada, Latin America and Europe. The two largest acquisitions were in the United States. In addition, we acquired the remaining minority interest of our Medam S.A. de C.V. subsidiary in Mexico and became the sole owner of our Medam B.A. subsidiary in Argentina, previously accounted for as a minority interest using the equity method of accounting. The aggregate net purchase price of all our 2007 acquisitions, including adjustments for purchase accounting, was approximately $241.0 million, of which $114.8 million was paid in cash, $112.5 million was paid by the issuance of promissory notes and $13.7 million was paid by the issuance of shares of our common stock. In February 2007, we sold three incinerators and associated customer contracts in the United Kingdom to comply with a remedy accepted by United Kingdom Competition Commission, as we reported in our Form 10-K for 2006. The sales price was $26.5 million and resulted in a gain of approximately $1.9 million. During the year ended December 31, 2006, we completed 16 acquisitions, of which seven were domestic and nine were international. The largest of our acquisitions during the year was The Sterile Technologies Group Limited in Ireland (“STG”). We acquired all of the stock of STG for approximately $131.0 million, of which $114.0 million was paid in cash and $17.0 million was paid by the assumption of debt. The aggregate net purchase price of these acquisitions was approximately $194.9 million, of which approximately $164.0 million was paid in cash, $30.1 million was paid by the issuance of promissory notes and $0.8 million was paid by the issuance of shares of our common stock. 41 For financial reporting purposes these acquisitions were accounted for using the purchase method of accounting. The total purchase price for 2008, 2007 and 2006 of $191.0 million, $241.0 million and $194.9 million, respectively, net of cash acquired, was allocated to the assets acquired and liabilities assumed based on the estimated fair market value at the date of acquisition. In certain cases, the purchase price is or was subject to downward adjustment if revenues from customer contracts acquired failed to reach certain specified levels. The excess of the purchase price over the fair market value of the net assets acquired is reflected in the accompanying consolidated balance sheets as goodwill. Some allocations are pending completion of certain intangible asset valuations. Goodwill was recorded in the amounts of $148.9 million, $203.8 million and $119.3 million during the years 2008, 2007 and 2006, respectively. Tax deductible goodwill, pending final purchase accounting, was approximately $107.8 million, $84.4 million, and $26.9 million for the years 2008, 2007, and 2006, respectively. The results of operations of these acquired businesses have been included in the consolidated statements of income from the date of the acquisition. We intend to continue to seek opportunities to acquire businesses that expand our national networks in the United States and internationally and increase our customer base. We believe that our acquisitions will enable us to improve our operating efficiencies through increased utilization of our service infrastructure. NOTE 5—PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at December 31 consist of the following items: In thousands Land Building and improvements Machinery and equipment Office equipment and furniture Internally developed software Construction in progress Total property, plant & equipment Less: Accumulated depreciation and amortization Property, plant and equipment, net 2008 $ 14,322 66,810 211,153 41,811 6,015 13,610 2007 $ 12,879 59,447 207,145 32,913 4,061 16,648 353,721 (146,577) 333,093 (140,054) $ 207,144 $ 193,039 Significant components of our income tax expense for the years ended December 31, 2008, 2007 and 2006 NOTE 6—INCOME TAXES are as follows: In thousands Current U.S. federal U.S. state Foreign countries Deferred U.S. federal U.S. state Foreign countries Total provision 2008 2007 2006 $49,635 8,053 10,094 $39,440 8,042 3,298 $40,764 7,857 5,235 67,782 50,780 53,856 19,279 4,722 (1,487) 22,514 14,275 2,805 5,002 22,082 9,131 2,534 1,783 13,448 $90,296 $72,862 $67,304 42 A reconciliation of the income tax provision computed at the federal statutory rate to the effective tax rate for the years ended December 31, 2008, 2007 and 2006 are as follows: Federal statutory income tax rate Effect of: State taxes, net of federal tax effect Other Effective tax rate 2008 2007 35.0% 35.0% 35.0% 2006 3.5% 3.7% 3.9% (0.8%) (0.6%) 0.1% 37.7% 38.1% 39.0% Cash payments for income taxes were $52.4 million, $45.9 million and $30.1 million for the years ended December 31, 2008, 2007 and 2006, respectively. Our deferred tax liabilities and assets as of December 31, 2008 and 2007 are as follows: In thousands Deferred tax liabilities: Property, plant and equipment Goodwill and other intangibles Total deferred tax liabilities Deferred tax assets: Accrued liabilities Other Net operating tax loss carry forward Total deferred tax assets Net deferred tax liabilities 2008 2007 $ (36,610) $ (20,265) (116,817) (104,776) (153,427) (125,041) $ $ 9,158 5,053 8,750 9,146 2,930 1,434 22,961 13,510 $(130,466) $(111,531) At December 31, 2008, net operating loss carry forwards for U.S. federal and state income tax purposes have been fully utilized, excluding net operating loss carry forwards related to our acquisitions. The remaining net operating loss carry forwards from acquisitions are approximately $25.4 million that begin to expire in 2009 and 2016. We expect to fully utilize the net operating losses that would otherwise expire in 2009. Undistributed earnings of foreign subsidiaries are considered permanently invested, and therefore no U.S. deferred taxes are recorded thereon. The cumulative amounts of such earnings are $83.5 million at December 31, 2008, and it was not practicable to estimate the U.S. withholding tax thereon assuming repatriation. In September 2006, FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted the provisions of FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material impact on our consolidated financial statements. We and our subsidiaries file consolidated 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 43 non-U.S. income tax examinations by tax authorities for years before 2002. Subsequent tax years remain open and subject to examination by the IRS. In addition, our subsidiaries in foreign countries have tax years open ranging from 2002 through 2007. The total amount of unrecognized tax positions as of December 31, 2008 is $5.3 million, which includes immaterial amounts of interest and penalties and is reflected as a liability on the balance sheet. The amount of unrecognized tax positions that, if recognized, would affect the effective tax rate is approximately $5.3 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 summarizes the changes in unrecognized tax positions during the year ended December 31, 2008: In thousands Unrecognized tax positions, January 1, 2007 Gross increases- tax positions in prior period Gross decreases- tax positions in prior period Gross increase- current period tax positions Settlement Lapse of statute of limitations Unrecognized tax positions, December 31, 2007 Gross increases- tax positions in prior period Gross decreases- tax positions in prior period Gross increase- current period tax positions Settlement Lapse of statute of limitations Unrecognized tax positions, December 31, 2008 Long-term debt consists of the following at December 31: NOTE 7—LONG-TERM DEBT In thousands Obligations under capital leases Senior credit facility Notes payable and other foreign debt Private placement Less: Current portion Total $ 4,400 1,228 (188) — (925) (840) $ 3,675 786 (99) 2,461 (1,414) (91) $ 5,318 $ 2008 1,182 439,794 251,750 100,000 792,726 38,880 $ 2007 1,709 465,434 168,641 — 635,784 22,003 $753,846 $613,781 44 Payments due on long-term debt, excluding capital lease obligations, during each of the five years subsequent to December 31, 2008 are as follows: In thousands 2009 2010 2011 2012 2013 Thereafter $ 38,274 39,502 27,598 478,405 18,635 189,130 $791,544 We paid interest of $29.1 million, $31.8 million and $27.6 million for the years ended December 31, 2008, 2007 and 2006, respectively. Property under capital leases included with property, plant and equipment in the accompanying consolidated balance sheets is as follows at December 31: In thousands Buildings Machinery and equipment Office equipment Vehicles Less: Accumulated depreciation and amortization Amortization related to these capital leases is included with depreciation expense. Minimum future lease payments under capital leases are as follows: In thousands 2009 2010 2011 2012 2013 Total minimum lease payments Less: Amounts representing interest Present value of net minimum lease payments Less: Current portion Long-term obligations under capital leases $ 2008 114 176 111 2,760 (1,472) $ 2007 138 456 62 2,227 (1,198) $ 1,689 $ 1,685 $ 688 449 169 6 — 1,312 (130) 1,182 (606) $ 576 Senior Credit Facility Our senior credit facility of $850.0 million maturing in August 2012 requires us to comply with various financial, reporting and other covenants and restrictions, including a restriction on dividend payments. At 45 December 31, 2008, we were in compliance with all of our financial debt covenants. At December 31, 2008 the margin for interest rates on borrowings under our new credit facility was 0.0% on base rate loans (at higher of (i) the federal funds rate plus 0.5% or (ii) the prime rate) and 0.75% on LIBOR loans. As of December 31, 2008, we had $439.8 million of borrowings outstanding under our senior unsecured credit facility, which includes foreign currency borrowings of $11.3 million. In addition, we had $212.3 million committed to outstanding letters of credit. The weighted average rate of interest on the unsecured revolving credit facility was 2.70% per annum which includes the amounts under our interest rate hedge. At December 31, 2008 we had $352.9 million in other debt outstanding, which includes promissory notes issued in connection with acquisitions during 2004 through 2008, seven-year $100 million private placement notes at a fixed rate of 5.64%, other foreign subsidiary bank debt and capital leases. On April 15, 2008, we entered into a note purchase agreement (the “note purchase agreement”) with nine institutional purchasers pursuant to which we issued and sold to the purchasers $100 million of our 5.64% senior notes due April 15, 2015 (the “notes”). The notes bear interest at the fixed rate of 5.64% per annum. Interest is payable in arrears semi-annually on April 15 and October 15 beginning on October 15, 2008, and principal is payable at the maturity of the notes on April 15, 2015. The notes are unsecured obligations and rank pari passu with our obligations under our senior unsecured credit facility pursuant to our credit agreement with Bank of America, N.A. and the other lenders party to the credit agreement. We applied the proceeds from the sale of the notes to reduce our borrowings under our revolving credit facility under our senior unsecured credit facility. The notes contain customary events of default, including our failure to pay any principal, interest or other amount when due, our violation of our affirmative or negative covenants or a breach of our representations and warranties. Upon the occurrence of an event of default, payment of the notes may be accelerated by the holders of the notes. In August 2007, we entered into a new credit agreement. The new credit agreement was in substance an amendment of our existing credit agreement. The amended credit facility (i) reduced the interest rates that we were charged by reducing the applicable margin that was added to the relevant interest rate; (ii) increased our revolving credit facility from $650 million to $850 million, with an additional capacity available up to $200 million upon request; (iii) increased both the letter of credit sublimit and alternative currency sublimit to $300 million from $200 million each; and (iv) the maturity date was extended from July 2011 to August 2012. As of December 31, 2007, we had $465.4 million of borrowings outstanding under our senior unsecured credit facility, which includes foreign currency borrowings of $16.0 million. In addition, we had $139.4 million committed to outstanding letters of credit. As of December 31, 2007 the weighted average rate of interest on the unsecured revolving credit facility was 5.53% per annum. Notes Payable and Foreign Subsidiary Debt At December 31, 2008 we had promissory notes and foreign subsidiary bank debt, primarily issued as a result of acquisitions, totaling $351.8 million. Of the $351.8 million, $212.3 million of promissory notes was secured with letters of credit. Of the $351.8 million, $317.4 million had a fixed interest rate and $34.4 million had a floating interest rate. The weighted average interest rate was 5.05% and the weighted average maturity was approximately 6.1 years. At December 31, 2007 we had promissory notes and foreign subsidiary bank debt, primarily issued as a result of acquisitions, totaling $168.6 million. Of the $168.6 million, $139.4 million of promissory notes was secured with letters of credit. Of the $168.6 million, $138.6 million had a fixed interest rate and $30.0 million had a floating interest rate. The weighted average interest rate was 5.79% and the weighted average maturity was approximately 5.9 years. 46 Guarantees We have guaranteed a loan to JPMorganChase Bank N.A. on behalf of Shiraishi-Sogyo Co. Ltd (“Shiraishi”). Shiraishi is a customer in Japan that is expanding their regulated waste management business and has a one year loan with a current balance of $5.4 million with JPMorgan Chase Bank N.A. that expires in May 2009. Management currently believes no amount will be paid under the guarantee. Accrued liabilities at December 31 consist of the following items: NOTE 8—ACCRUED LIABILITIES In thousands Accrued compensation Accrued insurance Accrued income tax Accrued interest Accrued professional liabilities Accrued acquisition payment Accrued liabilities- other Total accrued liabilities 2008 $19,676 19,524 7,397 4,505 1,364 12,000 29,021 2007 $16,898 16,770 11,446 3,214 5,489 — 21,754 $93,487 $75,571 NOTE 9—DERIVATIVE INSTRUMENTS In July 2004, we entered into four forward contracts, of which three have settled, to hedge a GBP Sterling- based intercompany loan between our US-based subsidiary, Stericycle International L.L.C. and our subsidiary in the United Kingdom, Stericycle International Ltd. The subsidiary borrowed the funds for the purchase of White Rose. The remaining forward contract aligns with the anticipated repayment schedule of the loan and expires in July 2009. Initially, we did not elect hedge accounting on the forward contracts and had recognized the change in value of the hedges through other income (expense). This amount was generally offset by the currency adjustment to the intercompany receivable. On October 1, 2005, we prospectively designated these existing forward contracts as cash flow hedges and are using hedge accounting. The objective of our cash flow hedges is to offset the foreign exchange risk to the U.S. dollar equivalent cash inflows on the settlement of the GBP denominated intercompany loan. At December 31, 2008, the fair market value of the hedge was recorded as a current asset of $2.3 million. As of December 31, 2008, the total notional amount of hedges outstanding is GBP 8.0 million. At December 31, 2008 the hedges were determined to be 100% effective. In October 2008, Stericycle entered into three interest rate swap contracts covering $225 million of our borrowings outstanding under our senior credit facility. The objective of the swap is to reduce the risk of volatile interest expense by fixing the rate. The contracts are as follows: In thousands Notional Amount $125,000 $ 75,000 $ 25,000 Fixed Interest Rate 2.79% 2.79% 2.94% Variable Interest Rate 1 Month Libor 1 Month Libor 1 Month Libor Expiration Date October 2009 April 2010 October 2010 We entered into the interest rate swaps in order to manage the risk of interest rate changes to our interest expense. The interest rate swaps are designated as cash flow hedges; the notional amounts and all other 47 significant terms of the swap 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 liability of $4.8 million, of which $2.1 million is current. At December 31, 2008 the hedges were determined to be 100% effective. Gains or losses on hedges are recognized in other income or expense when realized. 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 three hedges. NOTE 10—GOODWILL AND OTHER INTANGIBLE ASSETS Under SFAS No. 142, goodwill and other indefinite lived intangibles are no longer amortized and are subject to an annual impairment test, or to more frequent testing if circumstances indicate that they may be impaired. We have two geographical reporting segments, “United States” and “Foreign Countries”, both of which have goodwill. The changes in the carrying amount of goodwill for the years ended December 31, 2008 and 2007 was as follows: In thousands Balance as of December 31, 2006 Goodwill acquired during year Changes due to currency fluctuation Balance as of December 31, 2007 Goodwill acquired during year Changes due to currency fluctuation Balance as of December 31, 2008 United States $647,524 195,454 — 842,978 129,497 — Foreign Countries $166,449 8,362 15,544 Total $ 813,973 203,816 15,544 190,355 19,405 (46,457) 1,033,333 148,902 (46,457) $972,475 $163,303 $1,135,778 During the quarter ended June 30, 2008 we performed our annual goodwill impairment evaluation for our three reporting units, Domestic Regulated Waste, Domestic Regulated Returns Management and Foreign Countries, and determined that none of our recorded goodwill was impaired. In 2007 we wrote off $2.0 million for the White Rose Environmental tradename as a result of the name change of our subsidiary in the United Kingdom, and we wrote off $0.2 million for the permit intangible for a treatment facility in the United Kingdom that was no longer being used. These intangibles were part of the Foreign Countries segment and the write off is reported in our Statement of Income as impairment of intangible assets. At December 31, 2008 and 2007, we had $48.1 million and $52.8 million, respectively, of indefinite lived intangibles that consist of environmental permits. In 2008 and 2007 we performed our annual permit impairment evaluation and determined that, other than noted above, there was no impairment. According to SFAS No. 142, other intangible assets will continue to be amortized over their useful lives. In 2008, we assigned $35.6 million to customer relationships with amortization periods of 20 to 40 years, $3.4 million to facility environmental permits with indefinite lives and we $0.3 million to non-compete agreements with amortization periods of one to ten years. In 2007, we assigned $15.9 million to customer relationships with amortization periods of 20 to 40 years, $16.7 million to facility environmental permits with indefinite lives, $2.5 million to non-compete agreements with amortization periods of one to ten years, and $0.1 million to proprietary technology with an amortization periods of three to five years. 48 As of December 31, the value of the amortizing intangible assets were as follows: In thousands Non-compete Customer relationships Tradenames License agreements Other Gross Carrying Amount Accumulated Amortization Net Carrying Amounts $ 2008 3,292 129,069 1,200 2,655 441 $ 2007 4,423 103,249 1,200 2,779 441 2008 $ 1,082 9,849 188 2,655 342 2007 $ 1,825 7,349 156 2,687 213 $ 2008 2,210 119,220 1,012 — 99 2007 $ 2,598 95,900 1,044 92 228 Total $136,657 $112,092 $14,116 $12,230 $122,541 $99,862 During the years ended December 31, 2008, 2007 and 2006 the aggregate amortization expense was $4.0 million, $3.7 million and $3.0 million, respectively. The estimated amortization expense for each of the next five years is as follows for the years ended December 31: In thousands 2009 2010 2011 2012 2013 $3,999 3,976 3,859 3,828 3,774 NOTE 11—LEASE COMMITMENTS We lease various plant equipment, office furniture and equipment, motor vehicles and office and warehouse space under operating lease agreements, which expire at various dates over the next 16 years. The leases for most of the properties contain renewal provisions. Rent expense for 2008, 2007 and 2006 was $41.2 million, $32.4 million and $28.7 million, respectively. Minimum future rental payments under non-cancelable operating leases that have initial or remaining terms in excess of one year as of December 31, 2008 for each of the next five years and in the aggregate are as follows: In thousands 2009 2010 2011 2012 2013 Thereafter $ 37,067 31,022 23,644 16,280 8,644 20,430 $137,087 NOTE 12—NET INCOME PER COMMON SHARE During the quarter ended June 30, 2007 our shareholders approved the increase in our authorized shares of common stock from 80,000,000 shares to 120,000,000 shares. In addition, the Board of Directors authorized a 2-for-1 stock split. The stock split was in the form of a stock dividend of one share payable on May 31, 2007 in 49 respect of each share of common stock outstanding on the record date of May 17, 2007. Historic share and per share amounts have been adjusted to reflect the stock split. The following table sets forth the computation of basic and diluted net income per share: In thousands, except share and per share data Numerator: Numerator for basic earnings per share net income Denominator: Denominator for basic earnings per share-weighted average shares Effect of diluted securities: Employee stock options Warrants Dilutive potential shares Denominator for diluted earnings per share-adjusted weighted Years Ended December 31, 2008 2007 2006 $ 148,708 $ 118,378 $ 105,270 85,950,192 87,578,650 88,466,990 2,385,640 — 2,348,589 6,003 2,062,444 564 2,385,640 2,354,592 2,063,008 average shares and after assumed exercises 88,335,832 89,933,242 90,529,998 Earnings per share – Basic Earnings per share – Diluted $ $ 1.73 1.68 $ $ 1.35 1.32 $ $ 1.19 1.16 For additional information regarding outstanding employee stock options and outstanding warrants, see Note 13 to the Consolidated Financial Statements. In 2008, 2007 and 2006, options and warrants to purchase 993,352 shares, 279,081 shares and 1,565,864 shares, respectively, at exercise prices of $47.32-$60.53, $38.57-$59.70 and $17.53-$36.26, respectively, were not included in the computation of diluted earnings per share (“EPS”) because the effect would be antidilutive. At December 31, 2008 we had no warrants outstanding. NOTE 13—STOCK BASED COMPENSATION Stock Plans: We have adopted six stock option plans: (i) the 2008 Incentive Stock Plan, which our stockholders approved in May 2008; (ii) the 2005 Incentive Stock Plan, which our stockholders approved in April 2005; (iii) the 2000 Nonstatutory Stock Option Plan, which our Board of Directors adopted in February 2000; (iv) the 1997 Stock Option Plan, which expired in January 2007; (v) the Directors Stock Option Plan, which expired in May 2006; (vi) the 1995 Incentive Compensation Plan, which expired in July 2005. The 2008 Plan authorized awards of stock options and stock appreciation rights for a total of 3,500,000 shares; the 2005 Plan authorizes awards of stock options and stock appreciation rights for a total of 4,800,000 shares; as amended, the 2000 Plan authorizes stock option grants for a total of 7,000,000 shares; the 1997 and 1995 Plans each authorized stock option grants for a total of 6,000,000 shares; and as amended, the Directors Plan authorized stock option grants for a total of 2,340,000 shares. 50 Both the 2008 Plan and 2005 Plan provide for the grant of nonstatutory stock options (“NSOs”) and incentive stock options intended to qualify under section 422 of the Internal Revenue Code (“ISOs”) as well as stock appreciation rights. In addition, the 2008 Plan provides for the grant of Restricted Stock Awards and RSU Awards; the 2000 Plan provides for the grant of NSOs; the 1997 and 1995 Plans each provided for the grant of NSOs and ISOs; and the Directors Plan provided for the grant of NSOs. The 2008 and 2005 Plans authorize awards to our officers, employees and consultants and, following the expiration of the Directors Plan in May 2006, to our directors; the 2000 Plan authorizes stock option grants to our employees and consultants, but not to our officers and directors; the 1997 and 1995 Plans each authorized stock option grants to our officers, directors, employees and consultants; and the Directors Plan authorized stock option grants to our outside directors. As of December 31, 2008, we reserved the following shares for issuance, consisting of both shares available for option grants under the 2008 Plan, 2005 Plan, 2000 Plan, 1997 Plan and shares granted as options under all five of our plans, but not yet exercised: 1995 Plan options 1996 Directors Plan options 1997 Plan options 2000 Plan options 2005 Plan options 2008 Plan options Warrants Total shares reserved Employee Stock Purchase Plan: 354,786 258,767 1,218,146 2,084,528 3,381,172 3,500,000 — 10,797,399 In October 2000, our Board of Directors adopted the Employee Stock Purchase Plan (“ESPP”) effective as of July 1, 2001. Our stockholders approved the ESPP in May 2001. The ESPP authorizes 600,000 shares of our common stock to be purchased by employees at a 15% discount from the market price of the stock through payroll deductions during two six-month offerings each year. An employee who elects to participate in an offering is granted an option on the first day of the offering for a number of shares equal to the employee’s payroll deductions under the ESPP during the offering period (which may not exceed $5,000) divided by the option price per share. The option price per share is the lower of 85% of the closing price of a share of our common stock on the first trading day of the offering period or 85% of the closing price on the last trading day of the offering period. We recognize compensation expense for the ESPP, which is reflected in the statement of income. Every employee who has completed six months employment as of the first day of an offering and who is a full-time employee, or a part-time employee who customarily works at least 20 hours per week, is eligible to participate in the offering. During 2008, 2007 and 2006, 48,836 shares, 43,777 shares and 40,996, respectively, were issued through the ESPP. Stock Based Compensation Expense: We recognized stock compensation expense in accordance with SFAS No. 123R which we adopted January 1, 2006. Since the adoption of SFAS No. 123R, there have been no changes to our stock compensation plans or modifications to outstanding stock-based awards which would change the value of any awards outstanding. Compensation expense for all stock-based compensation awards granted subsequent to January 1, 2006 was based on the grant-date fair value determined in accordance with the provisions of SFAS No. 123R. During the years ended December 31, 2008 and 2007, we recognized compensation expense of $11.2 million and $10.3 million, respectively, for stock options, and $0.6 million and $0.4 million, respectively, for the ESPP, which is reflected in the statement of income. There were no significant capitalized stock-based compensation costs at December 31, 2008 and 2007. 51 The following table presents the total stock-based compensation expense resulting from stock option awards and the ESPP included in the consolidated statements of income: In thousands Cost of revenues—stock option plan Selling, general and administrative—stock option plan Selling, general and administrative—ESPP Total Years Ended December 31, 2008 $ 403 10,768 584 $ 2007 477 9,818 419 $ 2006 784 9,521 305 $11,755 $10,714 $10,610 As of December 31, 2008, there were $20.1 million of total unrecognized compensation expense, related to non-vested option awards, which is expected to be recognized over a weighted-average period of 1.56 years. The following table sets forth the tax benefits related to stock compensation: In thousands Tax benefit recognized in income statement Excess tax benefit realized Stock Options: Years Ended December 31, 2008 $4,341 9,319 2007 $4,207 8,054 Options granted to officers and employees generally vest over five years. During 2008, 2007 and 2006, options granted to officers and employees generally vested at the rate of 20% of the option shares on each of the first five anniversaries of the option grant date. Expense related to the graded vesting options is recognized using the straight-line method over the vesting period. The exercise price per share of an option granted under any of our stock option plans may not be less than the closing price of a share of our common stock on the date of grant. The maximum term of an option granted under any plan may not exceed 10 years. An option may be exercised only when it is vested and, in the case of an option granted to an employee (including an officer), only while he or she remains an employee and for a limited period following the termination of his or her employment. New shares are issued upon exercise of stock options. Option activity for the years ended December 31, 2008, 2007 and 2006 is summarized as follows: Outstanding at beginning of year Granted Exercised Forfeited Cancelled or expired 2008 2007 2006 Weighted Average Exercise Price per Share $25.44 53.85 17.38 34.39 5.89 Number of Options 7,258,795 1,202,964 (987,284) (175,734) (1,342) Weighted Average Exercise Price per Share $20.96 40.24 14.86 29.78 26.68 Weighted Average Exercise Price per Share $16.62 30.46 10.48 24.57 9.24 Number of Options 7,185,698 1,744,536 (1,513,216) (370,100) (9,608) Number of Options 7,037,310 1,472,403 (1,013,290) (232,533) (5,095) Outstanding at end of year 7,297,399 $30.97 7,258,795 $25.44 7,037,310 $20.96 Exercisable at end of year Available for future grant 3,815,882 5,136,621 $23.36 3,526,237 2,655,845 $18.62 3,348,190 3,899,020 $15.39 52 The total intrinsic value of options exercised for the years ended December 31, 2008 and 2007 was $39.4 million and $34.6 million, respectively. The total intrinsic value represents the total pre-tax intrinsic value (the difference between our closing stock price on the last day of trading for the year ended December 31, 2008 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders assuming all option holders had exercised their options on December 31, 2008; this amount changes based on the fair market value of our stock. Outstanding options at December 31, 2008 and 2007 had a weighted average remaining contractual life of 6.6 years and 6.8 years, respectively, with an aggregate intrinsic value of $156.3 million and $246.5 million, respectively. Exercisable options at December 31, 2008 and 2007 had a weighted average remaining contractual life of 5.3 years and 5.4 years, respectively, with an aggregate intrinsic value of $109.7 million and $143.8 million, respectively. Options outstanding and exercisable as of December 31, 2008 by price range are presented below: Options Outstanding Options Exercisable Range of Exercise Price $3.188-$17.235 $17.525-$20.500 $20.900-$22.110 $22.485-$22.700 $22.775-$22.900 $22.925-$24.230 $24.300-$29.540 $29.590-$35.590 $35.780-$38.565 $38.905-$60.530 Outstanding Average Remaining Life in Years 2.72 4.06 5.13 5.82 6.12 5.60 7.04 7.33 8.08 9.04 6.57 Weighted Average Exercise Price $11.44 17.85 22.09 22.66 22.90 23.63 29.35 31.98 38.51 52.24 $30.97 Shares 753,564 600,755 734,015 77,554 903,136 175,474 1,001,055 530,545 1,034,184 1,487,117 7,297,399 Shares 753,564 600,755 674,715 62,006 489,686 172,154 382,203 242,188 196,925 241,686 3,815,882 Weighted Average Exercise Price $11.44 17.85 22.10 22.66 22.90 23.64 29.24 31.95 38.47 48.49 $23.36 The Black-Scholes option-pricing model was used in determining the fair value of each option grant. The expected term of options granted is based on historical experience. Expected volatility is based upon historical volatility. The expected dividend yield is zero. The risk-free interest rate is based upon the U.S. Treasury yield rates of a comparable period. The assumptions that we used in the Black-Scholes model are as follows: Stock options granted Weighted average grant date fair value Expected term (in years) Expected volatility Expected dividend yield Risk free interest rate Years Ended December 31, $ 2008 1,202,964 13.53 5.5 26.29% 0.00% 2.76% $ 2007 1,472,403 11.43 5.0 27.07% 0.00% 4.52% $ 2006 1,744,536 8.91 4.5 28.87% 0.00% 4.83% Preferred Stock: NOTE 14—PREFERRED STOCK AND WARRANTS At December 31, 2008 and 2007 we had 1,000,000 authorized shares of preferred stock and no shares issued or outstanding. Warrants: At December 31, 2008 we had no warrants outstanding. 53 NOTE 15—EMPLOYEE BENEFIT PLAN We have a 401(k) defined contribution retirement savings plan covering substantially all employees. Each participant may elect to defer a portion of his or her compensation subject to certain limitations. We may contribute up to 50% of the first 5% of compensation contributed to the plan by each employee up to a maximum of $1,500 per annum. Our contributions for the years ended December 31 2008, 2007 and 2006 were approximately $1.7 million, $1.6 million and $1.5 million, respectively. The Company has several foreign defined contribution plans, which require the Company to contribute a regulations. For the years ended total contributions made by the Company for these plans were percentage of December 31, 2008, 2007 and 2006, approximately $0.7 million, $0.5 million and $0.5 million, respectively. the participating employee’s salary according to local The Company has no additional postretirement or postemployment benefit plans. NOTE 16—JOINT VENTURES In 2007 we became the 100% owner of the former joint venture, Medam, B.A. Srl, an Argentine corporation. As part of a legal restructuring of the business operations of Medam, B.A. we recognized a $2.9 million charge related to the impairment of that investment and write-off of an intercompany loan. In 2006 we recorded $0.5 million of equity losses related to the above joint venture, which were recorded in the other income (expense). NOTE 17—LEGAL PROCEEDINGS We operate in a highly regulated industry and must deal with regulatory inquiries or investigations from time to time that may be instituted for a variety of reasons. We are also involved in a variety of civil litigation from time to time. In April 2008, Stericycle and Daniels Corporation (UK) Limited (“Daniels UK”), a subsidiary of Daniels Sharpsmart Pty Limited (“Daniels”), and certain affiliated companies entered into a settlement of arbitration proceedings in the United Kingdom prior to any award by the arbitrator. At the same time, we entered into settlements with other subsidiaries of Daniels resolving various disputes, and we finalized the payment of the legal fees that SteriCorp Limited had been awarded under a November 2007 arbitrator’s award. In connection with these net settlements, we recognized a total pre-tax expense of $5.6 million, or an after-tax expense of $3.5 million for the year-ended December 31, 2008. In November 2007, the arbitrator issued a final award in arbitration proceedings in Australia with SteriCorp Limited. The arbitrator awarded Stericycle $8.2 million USD on our claim against SteriCorp for payments due under certain convertible notes and awarded SteriCorp $14.5 million USD on its claim that we failed to supply SteriCorp with equipment conforming to specifications under an equipment supply agreement. The final award also requires us to pay two-thirds of SteriCorp’s arbitration costs. An estimate of those amounts was made and accrued for in our consolidated financial statements for the year-ended December 31, 2007. The net effect of the various components of the final arbitration award was a charge of $13.9 million to our income statement identified as “Arbitration award and related costs.” NOTE 18 —PRODUCTS AND SERVICES AND GEOGRAPHIC INFORMATION SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires segment information to be reported based on information utilized by executive management to internally assess performance and make operating decisions. We have determined that we have three operating segments based on the organizational structure of our company and information reviewed. These operating segments are Foreign Regulated Waste Management Services (“Foreign Countries”), Domestic Regulated Waste Management Services 54 (“United States”) and Domestic Returns Management Services. We have aggregated Domestic Regulated Waste Management Services and Domestic Returns Management Services into one reportable segment, United States, based on our consideration of the following aggregation criteria: • • • • • • they have similar economic characteristics; the same services are provided; the same types of customers are serviced; the same types of waste collection, transportation and treatment methods are utilized; their regulatory environments are similar, but vary based upon country specific regulations; and they employ the same sales and marketing techniques and activities. Our two operating segments are United States and Foreign Countries. Our foreign operations have material revenues and long lived assets in the United Kingdom and Ireland, (referred to as “Europe” in the following table). Summary information for our reportable segments is as follows: In thousands Revenues: United States Europe Other foreign countries Total foreign countries Total Income before income taxes: United States Foreign countries Total Total assets: United States Foreign countries Total Long-lived assets: United States Europe Other foreign countries Total foreign countries Total 2008 2007 2006 $ 830,813 156,309 96,557 $ 721,408 149,467 61,892 $ 616,436 128,743 44,458 252,866 211,359 173,201 $1,083,679 $ 932,767 $ 789,637 $ 205,183 33,821 $ 167,603 23,637 $ 150,820 21,754 $ 239,004 $ 191,240 $ 172,574 $1,377,486 381,812 $1,304,248 303,911 $1,016,146 311,760 $1,759,298 $1,608,159 $1,327,906 $1,236,160 200,535 98,173 298,708 $1,165,419 132,445 100,019 232,464 $ 895,299 168,007 45,998 214,005 $1,534,868 $1,397,883 $1,109,304 Revenues are attributed to countries based on the location of customers. Intercompany revenues recorded by the United States for work performed in Canada are eliminated prior to reporting United States revenues. The same accounting principles and critical accounting policies are used in the preparation of the financial statements for both reporting segments. 55 Detailed information for our United States reporting segment is as follows: In thousands Regulated waste management services Regulated returns management services Total revenues Net interest expense Write-down of investment Proceeds from insurance Income before income taxes Income taxes Net income Depreciation and amortization Capital expenditures 2008 $756,893 73,920 2007 $637,731 83,677 2006 $557,927 58,509 830,813 26,097 — — 205,183 81,689 721,408 616,436 27,347 — (3,300) 167,603 64,562 23,406 1,000 (1,025) 150,820 63,524 $123,494 $103,041 $ 87,296 $ 24,296 34,353 $ 22,204 37,222 $ 19,893 25,556 Detailed information for our Foreign Countries reporting segment is as follows: In thousands Regulated waste management services Net interest expense Write-down of investment Income before income taxes Income taxes Net income Depreciation and amortization Capital expenditures 2008 $252,866 6,077 — 33,821 8,607 2007 $211,359 5,028 2,930 23,637 8,300 2006 $173,201 3,655 — 21,754 3,780 $ 25,214 $ 15,337 $ 17,974 $ 9,852 13,167 $ 8,933 11,175 $ 7,143 10,858 NOTE 19—ACCUMULATED OTHER 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 2008, 2007 and 2006: In thousands Beginning balance January 1, 2006 Fiscal 2006 change Ending balance December 31, 2006 Fiscal 2007 change Ending balance December 31, 2007 Fiscal 2008 change Ending balance December 31, 2008 Unrealized Gains (Losses) on Cash Flow Hedges $ (101) 333 $ 232 166 $ 398 (3,294) Currency Translation Adjustments 647 $ 4,350 $ 4,997 25,125 $ 30,122 (59,301) $(29,179) $(2,896) Total Accumulated Other Comprehensive Income $ 546 4,683 $ 5,229 25,291 $ 30,520 (62,595) $(32,075) The tax impact of the unrealized loss on cash flow hedges in accumulated other comprehensive income at December 31, 2008 was $1.9 million. The tax impact at December 31, 2006 and 2007 was immaterial. Translation adjustments are not tax-effected as the Company’s net investment in foreign subsidiaries and all related foreign earnings are deemed permanently invested. 56 NOTE 20—SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The following table summarizes our unaudited consolidated quarterly results of operations as reported for 2008 and 2007: In thousands, except per share data Revenues Gross profit Impairment of fixed assets Arbitration award and related costs Net Income * Basic earnings per common share * Diluted earnings per common share In thousands, except per share data Revenues Gross profit Gain on sale of assets Impairment of intangible assets Impairment of fixed assets Arbitration award and related costs Write-down of investment Insurance proceeds Net Income * Basic earnings per common share * Diluted earnings per common share First Quarter 2008 $254,784 113,590 — (5,352) 31,664 0.36 0.35 $ $ Second Quarter 2008 $277,786 123,154 — (147) 38,685 0.45 0.44 $ $ Third Quarter 2008 $277,098 123,029 — (96) 39,227 0.46 0.45 $ $ Fourth Quarter 2008 $274,011 125,256 (472) — 39,132 0.46 0.45 $ $ Year 2008 $1,083,679 485,029 (472) (5,595) 148,708 1.73 1.68 $ $ First Quarter 2007 $211,049 94,236 823 — (650) — — 500 29,387 0.33 0.32 $ $ Second Quarter 2007 $232,845 104,517 1,075 (228) (611) — — — 31,998 0.37 0.36 $ $ Third Quarter 2007 $237,323 106,814 — — — — — — 32,895 0.38 0.37 $ $ Fourth Quarter 2007 $251,550 112,354 201 (2,041) — (13,904) (2,930) 2,800 24,098 0.27 0.27 $ $ Year 2007 $932,767 417,921 2,099 (2,269) (1,261) (13,904) (2,930) 3,300 118,378 1.35 $ 1.32 $ * EPS calculated on a quarterly basis, and, as such, the amounts may not total the calculated full-year EPS. 57 STERICYCLE, INC. AND SUBSIDIARIES SCHEDULE II—VALUATION AND ALLOWANCE ACCOUNTS In thousands Allowance for doubtful accounts Allowance for doubtful accounts Allowance for doubtful accounts Balance 12/31/05 $4,810 Balance 12/31/06 $5,411 Balance 12/31/07 $6,157 Charges to Expenses $4,194 Other Charges (1) $ 48 Write-offs/ Payments $(3,641) Balance 12/31/06 $5,411 Charges to Expenses $4,392 Other Charges (1) $293 Write-offs/ Payments $(3,939) Balance 12/31/07 $6,157 Charges to Expenses $5,006 Other Charges (1) $ 30 Write-offs/ Payments $(4,577) Balance 12/31/08 $6,616 (1) Amounts consist primarily of valuation allowances assumed from acquired companies and currency translation adjustments. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Statement Disclosure None. Item 9A. Controls and Procedures (a) Evaluation of disclosure controls and procedures. 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 fiscal year covered by this Report. On the basis of this evaluation, our President and Chief Executive Officer and our Chief Financial Officer each concluded that our disclosure controls and procedures were effective. The term “disclosure controls and procedures” is defined in Rule 13a-14(e) of the Securities Exchange Act of 1934 as “controls and other procedures designed to ensure that information required to be disclosed by the issuer in the reports, files or submits under the 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. (b) Internal control over financial reporting. Management’s Report on Internal Control over Financial Reporting and our Independent Registered Public Accounting Firm’s Attestation Report are included in Item 8. (c) Changes in internal controls. There were no significant changes in our internal controls or in other factors that could materially affect those controls during the quarter ended December 31, 2008. Item 9B. Other Information None. 58 Item 10. Directors and Executive Officers of the Registrant PART III The information required by this Item regarding our directors is incorporated by reference to the information contained under the caption “Election of Directors” in our definitive proxy statement for our 2009 Annual Meeting of Stockholders to be held on May 28, 2009, to be filed pursuant to Regulation 14A. The information required by this Item regarding our executive officers is contained under the caption “Executive Officers of the Registrant” in Part I of this Report. The information required by this Item regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to the information contained under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement for our 2009 Annual Meeting of Stockholders to be held on May 28, 2009, to be filed pursuant to Regulation 14A. We have adopted a code of business conduct that applies generally to all of our employees and, in addition, we have a adopted a finance department code of ethics that applies specifically to our Chairman, President and Chief Executive Officer, Chief Financial Officer, Vice President-Finance and the members of our finance department. Both codes are available on our website, www.stericycle.com, under “About Us/Corporate Overview,” Any amendment to or waiver of the finance department code of ethics will be posted on our website within five business days after the date of the amendment or waiver. Item 11. Executive Compensation The information required by this Item is incorporated by reference to the information contained under the caption “Compensation Discussion and Analysis” and following sections (up to Item 2) in our definitive proxy statement for our 2009 Annual Meeting of Stockholders to be held on May 28, 2009, to be filed pursuant to Regulation 14A. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by this Item is incorporated by reference to the information contained under the captions “Stock Ownership” and “Compensation Discussion and Analysis” and following sections (up to Item 2) in our definitive proxy statement for our 2009 Annual Meeting of Stockholders to be held on May 28, 2009 to be filed pursuant to Regulation 14A. Item 13. Certain Relationships and Related Transactions The information required by this Item regarding our policies and procedures for the review, approval or ratification transactions with related persons is incorporated by reference to the information contained under the caption “Policy and Related Party Transactions” in Item 1 of our definitive proxy statement for our 2009 Annual Meeting of Stockholders to be held on May 28, 2009, to be filed pursuant to Regulation 14A. The information required by this Item regarding director independence is incorporated by reference to the information contained in Item 1 of our definitive proxy statement for our 2009 Annual Meeting of Stockholders to be held on May 28, 2009, to be field pursuant to Regulation 14A. Item 14. Principal Accountant Fees and Services Audit Fees: The aggregate fees billed by our independent public accountants, Ernst & Young LLP, for professional services rendered in connection with the audit of our annual financial statements and the audit of our internal 59 controls over financial reporting, and review of our interim financial statements included in our quarterly reports on Form 10-Q for the fiscal years ended December 31, 2008 and 2007 were approximately $1.0 million and $1.2 million, respectively. Audit Related Fees: In the years ended December 31, 2008 and 2007 Ernst & Young LLP did not bill us for any audit related fees. Ernst & Young LLP did not perform any other assurance or related services during either of these two fiscal years. Tax Fees: Ernst & Young LLP provided project based tax services to us during 2008 at cost of $350,000. The firm did not provide any in fiscal year 2007. All Other Fees: In 2008, we subscribed to the Ernst & Young online research tool at cost of $1,790. Ernst & Young LLP did not provide any other services to us during the fiscal years ended December 31, 2008 and 2007. In accordance with policies adopted by the Audit Committee of our Board of Directors, all audit and non-audit related services to be performed for us by our independent public accountants must be approved in advance by the Committee. 60 Item 15. Exhibits and Financial Statement Schedules (a) List of Financial Statements, Financial Statement Schedule and Exhibits PART IV We have filed the following financial statements and financial statement schedule as part of this report: Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Report of Independent Registered Public Accounting Firm Consolidated Financial Statements—Stericycle, Inc. and Subsidiaries Consolidated Balance Sheets as of December 31, 2008 and 2007 Consolidated Statements of Income for Each of the Years in the Three-Year Period Ended December 31, 2008 Consolidated Statements of Cash Flows for Each of the Years in the Three-Year Period Ended December 31, 2008 Consolidated Statements of Changes in Shareholders’ Equity for Each of the Years in the Three-Year Period Ended December 31, 2008 Notes to Consolidated Financial Statements Schedule II—Valuation and Allowance Accounts Page 30 31 32 33 34 35 36 58 All other financial statement schedules have been omitted because they are not applicable to us or the required information is shown in the consolidated financial statements or notes thereto. 61 Filed with Electronic Submission We have filed the following exhibits with this report: Exhibit Index 3.1* 3.2* 3.3* 3.4* 3.5 3.6 4.1* 10.1* 10.2 Description Amended and restated certificate of incorporation (incorporated by reference to Exhibit 3.1 to our 1996 Form S-1) First certificate of amendment to amended and restated certificate of incorporation (incorporated by reference to Exhibit 3.1 to our current report on Form 8-K filed November 29, 1999) Second certificate of amendment to amended and restated certificate of incorporation (incorporated by reference to Exhibit 3.4 to our annual report on Form 10-K for 2002) Third certificate of amendment to amended and restated certificate of incorporation (incorporated by reference to Exhibit 3.4 to our registration statement on Form S-4 as declared effective on October 10, 2007 (Registration No. 333-144613) Amended and restated bylaws (incorporated by reference to Exhibit 3(ii).1 to our current report on Form 8-K filed February 22, 2008) Amended to bylaws (incorporated by reference to Exhibit 3(ii).1 to our current report on Form 8-K filed August 20, 2008) Specimen certificate for shares of our common stock, par value $.01 per share (incorporated by reference to Exhibit 4.1 to our 1996 Form S-1) Credit Agreement dated as of August 24, 2007 entered into by Stericycle, Inc. and certain of its subsidiaries as borrowers, Bank of America, N.A., as administrative agent, swing line lender, a lender and a letter of credit issuer, other lenders party to the Credit Agreement, JPMorgan Chase Bank, N.A., as syndication agent, and Citibank, N.A., Fortis Capital Corp. and The Royal Bank of Scotland plc, as co-documentation agents, with Banc of America Securities LLC and J.P. Morgan Securities Inc., as joint lead arrangers and joint book managers (incorporated by reference to our current report on Form 8-K filed August 28, 2007) Note Purchase Agreement dated as of April 15, 2008 entered into by Stericycle, Inc., as issuer and seller, and The Northwestern Mutual Life Insurance Company, American United Life Insurance Company, The State Life Insurance Company, Pioneer Mutual Life Insurance Company, Knights of Columbus, Principal Life Insurance Company, CUNA Mutual Insurance Society, CUMIS Insurance Society, Inc. and Modern Woodmen of America, as purchasers (incorporated by reference to Exhibit 10.1 to our current report on Form 8-K filed April 18, 2008) 10.3*† Directors Stock Option Plan (Amended and Restated) (“Directors Plan”) (incorporated by reference to Exhibit 4.1 to our registration statement on Form S-8 filed August 2, 2001 (Registration No. 333-66542)) 10.4*† 10.5*† 10.6*† 10.7*† 10.8*† First amendment to Directors Plan (incorporated by reference to Exhibit 10.9 to our annual report on Form 10-K for 2001) Form of stock option agreement for option grant under Directors Plan (incorporated by reference to Exhibit 10.1 to our quarterly report on Form 10-Q for the quarter ended September 30, 2004) 1997 Stock Option Plan (“1997 Plan”) (incorporated by reference to Exhibit 10.3 to our annual report on Form 10-K for 1997) First amendment to 1997 Plan (incorporated by reference to Exhibit 10.9 to our 1999 Form S-3) Second amendment to 1997 Plan (incorporated by reference to Exhibit 10.12 to our annual report on Form 10-K for 2001) 62 Exhibit Index 10.9*† 10.10*† 10.11*† 10.12*† 10.13*† Description Third amendment to 1997 Plan (incorporated by reference to Exhibit 10.16 to our annual report on Form 10-K for 2003) 2000 Nonstatutory Stock Option Plan (“2000 Plan”) (incorporated by reference to Exhibit 10.13 to our annual report on Form 10-K for 2001) First amendment to 2000 Plan (incorporated by reference to Exhibit 10.14 to our annual report on Form 10-K for 2001) Second amendment to 2000 Plan (incorporated by reference to Exhibit 10.15 to our annual report on Form 10-K for 2001) Third amendment to 2000 Plan (incorporated by reference to Exhibit 4.2 to our registration statement on Form S-8 filed December 20, 2002 (Registration No. 333-102097)) 10.14*† 2005 Incentive Stock Plan (“2005 Plan”) (incorporated by reference to Exhibit 4.1 to our registration statement on Form S-8 filed August 9, 2005 (Registration No. 333-127353) 10.15† First amendment to 2005 Plan 10.16*† Form of stock option agreement for option grant under 1997 Plan, 2000 Plan and 2005 Plan (incorporated by reference to Exhibit 10.5 to our annual report on Form 10-K for 2005) 10.17*† 2008 Incentive Stock Plan (incorporated by reference to Exhibit 4.1 to our registration statement on Form S-8 filed August 8, 2008 (Registration No. 333-152877)) 10.18† Bonus conversion program (2009 plan year) 10.19*† 10.20*† 10.21*† 10.22*† 10.23*† 14 21 23 31.1 31.2 32 Form of stock option agreement for option grant under bonus conversion program (incorporated by reference to Exhibit 10.16 to our annual report on Form 10-K for 2007) Employee Stock Purchase Plan (“ESPP”) (incorporated by reference to Exhibit 4.1 to our registration statement on Form S-8 filed August 2, 2001 (Registration No. 333-66544) First amendment to ESPP (incorporated by reference to Exhibit 10.21 to our annual report on Form 10-K for 2002) Plan of Compensation for Outside Directors (incorporated by reference to Exhibit 10.1 to our current report on Form 8-K filed August 11, 2006) First amendment to Plan of Compensation for Outside Directors (incorporated by reference to Exhibit 10.19 to our annual report on Form 10-K for 2006) Code of ethics (incorporated by reference to Exhibit 10.14 to our annual report on Form 10-K for 2003) Subsidiaries Consent of Independent Registered Public Accounting Firm Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer Section 1350 Certification of Chief Executive Officer and Chief Financial Officer Filed with Electronic Submission x x x x x x x Previously filed * † Management contract or compensatory plan required to be filed pursuant to Item 601 of Regulation S-K References to our “1996 Form S-1” are to our registration statement on Form S-1 as declared effective on August 22, 1996 (Registration No. 333-05665); and references to our “1999 Form S-3” are to our registration statement on Form S-3 as declared effective on February 4, 1999 (Registration No. 333-60591). 63 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: February 27, 2009 Name Title Date /s/ JACK W. SCHULER Jack W. Schuler /s/ MARK C. MILLER Mark C. Miller /s/ FRANK J.M. TEN BRINK Frank J.M. ten Brink /s/ ROD F. DAMMEYER Rod F. Dammeyer /s/ WILLIAM K. HALL William K. Hall /s/ JONATHAN T. LORD, M.D Jonathan T. Lord, M.D. /s/ JOHN PATIENCE John Patience Lead Director of the Board of Directors February 27, 2009 Chairman, President and Chief Executive Officer February 27, 2009 Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) February 27, 2009 Director Director Director Director February 27, 2009 February 27, 2009 February 27, 2009 February 27, 2009 /s/ THOMAS R. REUSCHÉ Director February 27, 2009 Thomas R. Reusché /s/ THOMAS D. BROWN Director February 27, 2009 Thomas Brown /s/ RONALD G. SPAETH Director February 27, 2009 Ronald Spaeth 64 C O R P O R A T E I N F O R M A T I O N E x e c u t i v e O f f i c e r s Mark C. Miller Richard L. Foss Chairman, President and Chief Executive Officer Executive Vice President, International Frank J.M. ten Brink Richard J. Marasco Executive Vice President, Chief Financial Officer/CAO Executive Vice President, Mergers and Acquisitions Richard Kogler Michael Collins Executive Vice President, Chief Operating Officer President, Return Management Services B o a r d o f D i r e c t o r s Mark C. Miller • Chairman, President & CEO Jack W. Schuler • Lead Director Chairman – Nominating and Governance Committee Member – Audit Committee John Patience Member – Nominating and Governance Committee Member – Audit Committee Jonathan T. Lord, M.D. Chairman – Compensation Committee Member – Nominating and Governance Committee Thomas D. Brown Member – Audit Committee William K. Hall Member – Compensation Committee Rodney F. Dammeyer Chairman – Audit Committee Member – Nominating and Governance Committee Thomas R. Reusché Member – Audit Committee Ronald G. Spaeth Member – Compensation Committee I n d e p e n d e n t A u d i t o r s F o r m 1 0 - K Ernst & Young LLP Sears Tower 233 S. Wacker Drive Chicago, Illinois 60606 L e g a l C o u n s e l Johnson and Colmar 300 S. Wacker Drive, Suite 1000 Chicago, Illinois 60606 T r a n s f e r A g e n t Wells Fargo Bank N.A. Shareowner Services 161 N. Concord Exchange South St. Paul, MN 55075 Additional copies of this Annual Report or Form 10-K filed with the Securities and Exchange Commission are available, without charge, upon request from the company, Investor@stericycle.com or (800) 643-0240 ext. 2012. A n n u a l M e e t i n g The annual meeting of stockholders will be held on Thursday, May 28, 2009 at 11:00 AM at Hilton Garden Inn 26225 N. Riverwoods Boulevard Mettawa, Il 60045 N a s d a q ® S y m b o l SRCL (800) 643-0240 www.stericycle.com 

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