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ARCI > SEC Filings for ARCI > Form 10-K on 22-Mar-2013All Recent SEC Filings

Show all filings for APPLIANCE RECYCLING CENTERS OF AMERICA INC /MN | Request a Trial to NEW EDGAR Online Pro

Form 10-K for APPLIANCE RECYCLING CENTERS OF AMERICA INC /MN


22-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Item 6. Selected Financial Data" and "Item 8. Financial Statements and Supplementary Data." Certain information contained in the discussion and analysis set forth below and elsewhere in this annual report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risk and uncertainties. In evaluating such statements, you should specifically consider the various factors identified in this annual report that could cause results to differ materially from those expressed in such forward-looking statements, including matters set forth in "Item 1A. Risk Factors."

Overview

Subsidiaries. ApplianceSmart, Inc., a Minnesota corporation, is a wholly owned subsidiary that was formed through a corporate reorganization in July 2011 to hold our business of selling new major household appliances through a chain of Company-owned retail stores. ARCA Canada Inc., a Canadian corporation, is a wholly owned subsidiary that was formed in September 2006 to provide turnkey recycling services for electric utility energy efficiency programs. ARCA Recycling, Inc., a California corporation, is a wholly owned subsidiary that was formed in November 1991 to provide turnkey recycling services for electric utility efficiency programs. The operating results of our wholly owned subsidiaries are consolidated in our financial statements.


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Variable Interest Entity. ARCA Advanced Processing, LLC ("AAP") is a joint venture that was formed in October 2009 between ARCA and 4301 Operations, LLC
("4301") to support ARCA's agreement, as amended, with General Electric ("GE")
acting through its GE Appliances business component. Both ARCA and 4301 have a 50% interest in AAP. AAP commenced operations in February 2010 and services the GE agreement as a subcontractor for ARCA. The financial position and results of operations of AAP are consolidated in our financial statements based on our conclusion that AAP is a variable interest entity and because we have the ability to significantly influence the economic performance of the entity through our contractual agreement with GE.

Reporting Period. We report on a 52- or 53-week fiscal year. Our 2012 fiscal year ("2012") ended on December 29, 2012, and included 52 weeks. Our 2011 fiscal year ("2011") ended on December 31, 2011, and included 52 weeks.

Segments. We operate two reportable segments: retail and recycling. Our retail segment is comprised of income generated from the sale of appliances through ApplianceSmartŪ stores and includes a portion of our byproduct revenues from collected appliances. Our recycling segment includes all income generated from collecting, recycling and installing appliances for utilities and other customers and includes a significant portion of our byproduct revenue, which is primarily generated through the recycling of appliances. Our recycling segment also includes all income generated by AAP and our GE agreement. GE sells its recyclable appliances in certain regions of the United States to us and we collect, process and recycle the appliances. These appliances include units manufactured by GE as well as by other manufacturers. The agreement requires that we will only recycle, and will not sell for re-use or resale, the recyclable appliances purchased from GE. We have established regional processing centers in Philadelphia and Louisville to support our agreement with GE. The regional processing center in Philadelphia is operated by AAP.

Our business components are uniquely positioned in the industry to work together to provide a full array of appliance-related services. ApplianceSmart operates nineteen company-owned stores and sells new appliances directly to consumers and provides affordable ENERGY STARŪ options for energy efficiency appliance replacement programs. Our eleven regional recycling centers process appliances at end of life to remove environmentally damaging substances and produce material byproducts for over 150 utilities in the U.S. and Canada. AAP employs advanced technology to refine traditional appliance recycling techniques to achieve optimal revenue-generating and environmental benefits. We are also the exclusive North American distributor for UNTHA Recycling Technology ("URT"), one of the world's leading manufacturers of technologically advanced refrigerator recycling systems and recycling facilities for electrical household appliances and electronic scrap. AAP operates the only URT refrigerator system in the United States.

We believe the GE contract and AAP model is the future of appliance recycling and expect to open similar centers throughout the United States. We cannot predict when these centers may open or if the appropriate volumes can be obtained to support the AAP model at future locations.

Our retail segment is similar to many other retailers in that it is seasonal in nature. Historically, the fourth quarter is our weakest quarter in terms of both revenues and earnings. We believe this is primarily because the fourth quarter includes several holidays during which consumers tend to focus less on purchasing major household appliances. During fiscal year 2012, we closed two underperforming ApplianceSmart stores in our Georgia market and opened one store in our Minnesota market. Fiscal year 2012 was challenging for retail sales and profitability due to consumer anxiety about the election, economy and government spending cuts. Our total retail store revenues decreased 2.1% compared with fiscal year 2011. By comparison, industry shipments of the six primary appliances sold at ApplianceSmart decreased 2.3% according to the Association of Home Appliance Manufacturers. We are implementing strategies for addressing our underperforming stores, from right-sizing showroom space to closure. We plan to close another one or two underperforming stores in 2013.

Revenues and earnings in our recycling segment are impacted by seasonal variances, with both the second and third quarters generally having higher levels of revenues and earnings. During fiscal year 2012, we experienced an unanticipated decline in energy efficiency program volumes throughout most of our contracts as compared with fiscal year 2011. We believe this was due to economic uncertainty and tighter budgets at electric utilities. Seasonality in the recycling segment is due primarily to our utility customers supporting more marketing and advertising during the spring and summer months. Our customers tend to promote the recycling programs more aggressively during the warmer months because they believe more people want to clean up their garages and basements during that time of the year. However, the addition of the GE agreement and some customers shifting to marketing their appliance recycling programs year-round has helped to mitigate some seasonality. We are seeing a shift from straight recycling programs to weatherization programs that include replacing old inefficient refrigerators and washers with new ENERGY STARŪ models and recycling the old appliances. We expect this trend to continue in 2013.

We monitor specific economic factors such as retail trends, consumer confidence, manufacturing by the major appliance companies, sales of existing homes and mortgage interest rates as key indicators of industry demand, particularly in our retail segment. Competition in the home appliance industry is intense in the four retail markets we serve. This includes competition not only from independent retailers, but also from such major retailers as Sears, Best Buy, The Home Depot and Lowe's. We also closely


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monitor the metals and various other scrap markets because of the type of components recovered in our recycling process. This includes monitoring the American Metal Market and the regions throughout the U.S. where we have recycling centers.

We derive revenues from the sale of carbon offsets created by the destruction of ozone-depleting CFCs generated at our ARCA and AAP recycling centers. In 2011, we sold carbon offsets on the voluntary market and recognized $1.2 million in revenues. In 2012, our carbon offset revenues declined by $1.1 million due to uncertainty during 2012 regarding California's nascent carbon market. We elected to delay the destruction and sale of the majority of our accumulated CFCs until this market stabilized. In January 2013, the California Superior Court rejected a major challenge to California's cap-and-trade program for reducing greenhouse gases. We cannot predict the impact of this legal case, nor other pending lawsuits, but we believe this court decision indicates growing momentum and stability in this market. In the future, we believe it will become easier and more profitable to monetize our existing and future inventory of carbon offsets created by the destruction of CFCs.

Results of Operations

The following table sets forth our consolidated financial data as a percentage of total revenues for fiscal years 2012 and 2011:

                                                                2012      2011
Revenues:
Retail                                                         62.3  %    57.5 %
Recycling                                                      22.1       26.1
Byproduct                                                      15.6       16.4
Total revenues                                                100.0      100.0
Cost of revenues                                               75.5       71.0
Gross profit                                                   24.5       29.0
Selling, general and administrative expenses                   26.3       23.3
Impairment charge                                               0.9          -
Operating income (loss)                                        (2.7 )      5.7
Other income (expense):
Interest expense, net                                          (1.0 )     (0.9 )
Other income (expense), net                                       -          -
Income (loss) before income taxes and noncontrolling interest  (3.7 )      4.8
Provision for income taxes                                      0.1        1.1
Net income (loss)                                              (3.8 )      3.7
Net loss (income) attributable to noncontrolling interest       0.5       (0.2 )
Net income (loss) attributable to controlling interest         (3.3 )%     3.5 %

The following table sets forth the key results of operations by segment for fiscal years 2012 and 2011 (dollars in millions):

                               2012      2011     % Change
Revenues:
Retail                         72.4      74.5       (2.8 )%
Recycling                      41.9      52.2      (19.6 )%
Total revenues                114.3     126.7       (9.8 )%
Operating income (loss):
Retail                         (2.7 )    (0.3 )   (997.5 )%
Recycling                      (0.2 )     6.9     (103.5 )%
Unallocated corporate costs    (0.3 )     0.6     (160.1 )%
Total operating income (loss)  (3.2 )     7.2     (144.4 )%


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Our total revenues of $114.3 million for 2012 decreased $12.4 million or 9.8% from $126.7 million in 2011. The decrease in revenues was attributed primarily to our recycling segment and the following three factors:
1. A 27% decline in utility recycling volumes compared with 2011, resulting in lower revenues of approximately $6.3 million.

2. A summer refrigerator replacement initiative in 2011 from a California utility program that resulted in replacing over 10,000 refrigerators that did not occur in 2012, resulting in lower revenues of approximately $2.9 million.

3. A decline in carbon offset revenues of $1.1 million compared with 2011.

We expect to generate carbon offset revenues in 2013 but cannot predict the amount or frequency of carbon offset sales. Retail segment revenues accounted for 63% of total revenues in 2012 compared with 59% in 2011. Recycling segment revenues and retail segment revenues each include a portion of byproduct revenues. The decline in recycling volumes and lower carbon offset revenues impacted the overall mix of revenues between the retail and recycling segments in 2012 compared with 2011.

Our operating income (loss) of $(3.2) million for 2012 decreased $10.4 million or 144.4% compared with $7.2 million in 2011. The change in operating income
(loss) was attributed to several factors, including the following:
1. The combination of lower retail segment revenues and gross profit percentage compared with 2011 resulted in a $1.8 million decline in operating income.

2. An increase in retail segment sales, general and administrative expenses of $1.0 million related to operating two new ApplianceSmart stores that did not exist in 2011, offset by $0.4 million in lower advertising expenses.

3. The combination of lower recycling segment volumes, lower scrap metal prices and higher transportation costs per unit compared with 2011 resulted in a $5.8 million decline in operating income.

4. A $1.1 million decline of carbon offset revenues in our recycling segment that drop directly to operating income.

5. A $1.1 million non-cash goodwill impairment charge related to AAP in our recycling segment.

Revenues. Revenues for the fiscal years of 2012 and 2011 were as follows (dollars in millions):

            2012       2011     % Change
Retail    $  71.2    $  72.8      (2.1 )%
Recycling    25.3       33.1     (23.5 )%
Byproduct    17.8       20.8     (14.6 )%
          $ 114.3    $ 126.7      (9.8 )%

Retail Revenues. Our retail revenues of $71.2 million for 2012 decreased $1.6 million or 2.1% from $72.8 million in 2011. Comparable store appliance revenues from ApplianceSmart stores operating during the entire fiscal years of 2012 and 2011 decreased $3.8 million compared with 2011. We believe the decline in comparable store revenues was driven by consumer anxiety about the election, economy and government spending cuts. In November 2011, we opened an ApplianceSmart store in St. Cloud, Minnesota. In August 2012, we opened a store in Eden Prairie, Minnesota. These two new stores generated $3.0 million in revenues that did not occur in 2011. We closed two underperforming stores in our Georgia market, one in September 2012 and one in December 2012, resulting in a $0.8 million decline in revenues compared with 2011. We are implementing strategies for addressing our underperforming stores, from right-sizing showroom space to closure. We plan to close another one or two underperforming stores in 2013.

The table below illustrates our retail revenues by quarter for fiscal years 2012 and 2011 (dollars in millions):

           2012      2011     % Change
Quarter 1 $ 19.7    $ 19.2       2.8  %
Quarter 2   19.0      18.4       3.1  %
Quarter 3   17.3      18.8      (7.8 )%
Quarter 4   15.2      16.4      (7.3 )%
          $ 71.2    $ 72.8      (2.1 )%


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Our stores carry a wide range of innovative, new appliances as well as other affordable options such as close-outs, factory overruns, discontinued models and other special-buy appliances, including out-of-carton merchandise. All of these appliances are new; we do not sell used appliances.

We continue to purchase the majority of our appliances from Whirlpool, GE and Electrolux. We have no minimum purchase requirements with any of these manufacturers. We believe purchases from these three manufacturers will provide an adequate supply of high-quality appliances for our retail stores; however, there is a risk that one or more of these sources could be curtailed or lost.

Recycling Revenues. Our recycling revenues of $25.3 million for 2012 decreased $7.8 million or 23.5% from $33.1 million in 2011. Recycling revenues are comprised of two components: (1) appliance recycling revenues generated by collecting and recycling appliances for utilities and other sponsors of energy efficiency programs and (2) replacement program revenues generated by recycling and replacing old appliances with new energy efficient models for programs sponsored by utility companies. Appliance recycling revenues decreased 26.5% to $13.6 million in 2012 compared with $18.6 million in 2011, due primarily to 27% decline in recycling volumes. Replacement program revenues decreased 19.7% to $11.7 million in 2012 compared with $14.5 million in 2011. The decrease was primarily the result of a summer refrigerator replacement initiative from a California utility program that resulted in replacing over 10,000 refrigerators in 2011 that did not occur in 2012, resulting in a $2.9 million decline in revenues. We are aggressively pursuing new appliance recycling and replacement programs along with renewing our current contracts throughout North America but cannot predict if we will be successful in signing new contracts or renewing existing contracts.

The table below illustrates our recycling revenues by quarter for fiscal years 2012 and 2011 (dollars in millions):

           2012      2011     % Change
Quarter 1 $  5.3    $  5.7      (8.2 )%
Quarter 2    6.2       9.6     (36.0 )%
Quarter 3    7.0      11.4     (38.1 )%
Quarter 4    6.8       6.4       7.6  %
          $ 25.3    $ 33.1     (23.5 )%

Byproduct Revenues. Our byproduct revenues of $17.8 million for 2012 decreased $3.0 million or 14.6% from $20.8 million in 2011. The decrease in byproduct revenues was primarily the result of a decline in overall recycling volumes, lower carbon offset revenues and lower scrap metal prices. The decline in overall recycling volumes and scrap metal prices resulted in lower byproduct revenues of $1.9 million. In 2011, we recognized $1.2 million in carbon offset revenues, of which $0.4 million was generated at AAP. In 2012, carbon offset revenues declined by $1.1 million compared with 2011. Byproduct revenues include all of the revenues generated by AAP. Revenues from AAP of $11.3 million was consistent with 2011. In 2012, AAP's recycling volume increased but was offset by lower scrap metal prices and lower carbon offset revenues. We cannot predict byproduct material prices. We expect to generate carbon offset revenues in 2013 but cannot predict the amount or frequency of carbon offset sales.

The table below illustrates our byproduct revenues by quarter for fiscal years 2012 and 2011 (dollars in millions):

           2012      2011     % Change
Quarter 1 $  4.4    $  5.0     (11.2 )%
Quarter 2    4.2       4.9     (13.5 )%
Quarter 3    4.7       5.7     (18.9 )%
Quarter 4    4.5       5.2     (13.8 )%
          $ 17.8    $ 20.8     (14.6 )%

Gross Profit. Our gross profit of $28.0 million in 2012 decreased $8.7 million or 23.9% compared with $36.7 million in 2011. Gross profit as a percentage of total revenues decreased to 24.5% in 2012 compared with 29.0% in 2011.

Gross profit for the retail segment decreased to $18.5 million in 2012 compared with $20.2 million in 2011. The year-over-year decrease was due primarily to a shift in sales mix. In 2012, our product sales consisted of 72% new (in-the-box) product compared with 58% new (in-the-box) product in 2011. New (in-the-box) product typically has lower profit margins than special buy (out-of-the-box) product. Also, in 2012, we recorded an additional $0.6 million non-cash inventory charge related to aged inventory compared with 2011.


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Our recycling segment gross profit decreased to $9.5 million in 2012 compared with $16.5 million in 2011, driven primarily by lower overall recycling volumes, higher transportation costs per unit, lower scrap metal prices and lower carbon offset revenues. The combination of a decline in our overall recycling volumes and increase in utility transportation costs per unit resulted in a $5.1 million reduction in gross profit. AAP's gross profit declined by $0.8 million compared with 2011 due primarily to lower scrap metal prices. The decline in carbon offset revenue of $1.1 million mentioned previously had a direct impact on our decline in gross profit.

Our gross profit for future periods can be affected favorably or unfavorably by numerous factors, including:

1. The mix of retail products we sell.
2. The prices at which we purchase product from the major manufacturers who supply product to us.
3. The volume of appliances we receive through our recycling contracts.
4. The volume and price of byproduct materials.
5. The volume and price of carbon offset sales created by the destruction of ozone-depleting refrigerants.

Selling, General and Administrative Expenses. Our selling, general and administrative ("SG&A") expenses of $30.1 million for 2012 increased $0.6 million or 2.0% compared with $29.5 million in 2011. Our SG&A expenses as a percentage of total revenues increased to 26.3% in 2012 compared with 23.3% in 2011. Selling expenses increased $0.3 million to $18.9 million in 2012 compared with $18.6 million in 2011. The increase in selling expenses was due primarily to opening two ApplianceSmart stores in 2012, partially offset by a $0.4 million reduction to advertising expense to promote our ApplianceSmart stores. General and administrative expenses increased $0.3 million to $11.2 million in 2012 compared with $10.9 million in 2011. The increase in general and administrative expenses was due primarily to higher health care costs under our self-funded plan.

Impairment charge. We recorded a $1.1 million impairment charge in the fourth quarter of 2012. AAP concluded, as a result of its goodwill impairment test, that a full impairment of its goodwill was appropriate in accordance with Financial Accounting Standards Board Accounting Standards Codification No. 350-20.

Provision for Income Taxes. For 2012, we recorded a provision for income taxes of $0.1 million. The tax provision recorded in 2012 is primarily related to the tax effect of the cumulative undistributed earnings from our Canadian subsidiary as it was determined that our investment in Canada is no longer permanent in duration. In 2012, we recognized a net deferred tax liability of $0.1 million consisting of a deferred liability of $1.0 million for undistributed earnings and a deferred tax assets of $0.9 million for foreign tax credits related to the undistributed earnings. In 2012, we recorded a valuation allowance of $1.2 million primarily against the NOLs generated during the year as it was determined to be more-likely-than-not that we will not recognize the benefit of the net loss incurred in 2012.

For 2011, we recorded a provision for income taxes of $1.4 million. At January 1, 2011, we recorded a full valuation allowance against our U.S. net deferred tax assets due to the uncertainty of their realization. During the second quarter of 2011, we concluded, based on the assessment of all available evidence, including previous three-year cumulative income before infrequent and unusual items, a history of generating income before taxes for six consecutive quarters and estimates of future profitability, that it was more-likely-than-not that we would be able to realize a portion of our deferred tax assets in the future and recorded a $0.9 million non-cash reversal of our deferred tax asset valuation allowance. In 2011, we recorded $2.0 million and $0.3 million tax provisions related to taxable income from our U.S. and Canadian operations, respectively, which were partially offset by the non-cash reversal of a portion of our deferred tax asset valuation allowance.

Noncontrolling Interest. Noncontrolling interest represents 4301's share of AAP's net (income) loss. Under the AAP joint venture agreement, ARCA and 4301 each have a 50% interest in AAP. AAP reported net loss of $1,208,000 that included a goodwill impairment charge of $1,082,000 for 2012, of which $604,000 represented the loss attributable to noncontrolling interest. AAP reported a net income of $522,000 for 2011, of which $261,000 represented the income attributable to noncontrolling interest.

Liquidity and Capital Resources

Summary. Cash and cash equivalents as of December 29, 2012, were $3.2 million compared with $4.4 million as of December 31, 2011. Net working capital, the excess of current assets over current liabilities, decreased to $7.6 million as of December 29, 2012 compared with $11.4 million as of December 31, 2011. The decline was primarily the result of carrying $1.2 million less in cash and cash equivalents, $1.2 million less in appliance inventory and $1.1 million in lower receivables.


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The following table summarizes our cash flows for the fiscal years ended December 29, 2012 and December 31, 2011 (in millions):

                                                         2012      2011
Total cash and cash equivalents provided by (used in):
Operating activities                                   $  0.5     $ 1.4
Investing activities                                     (0.8 )    (1.1 )
Financing activities                                     (1.0 )     1.1
Effect of exchange rates on cash and cash equivalents     0.1      (0.1 )
Increase (decrease) in cash and cash equivalents       $ (1.2 )   $ 1.3

Operating Activities. Our net cash provided by operating activities was $0.5 million in 2012 compared with $1.4 million in 2011. The decrease in net cash provided by operating activities for the year ended December 29, 2012, was related primarily to our net loss, offset by cash provided by accounts receivable, appliance inventories and accounts payable.

Investing Activities. Our net cash used in investing activities was $0.8 million in 2012 compared with $1.1 million in 2011. Net cash used in investing activities for the year ended December 29, 2012, was entirely related to the purchase of property and equipment. Net cash used in investing activities for the year ended December 31, 2011, was related primarily to capital expenditures needed to complete the installation of AAP's URT materials recovery system in Philadelphia, Pennsylvania, that began in 2010. The net cash used in investing activities in 2011 was partially offset by the release of a $0.7 million deposit required by our credit card processor in 2009. On December 31, 2012, our bankcard processor informed us that it was exercising its rights under the merchant contract and requiring a $0.5 million reserve. The reserve will accumulate daily by garnishing 10% of our daily collections.

Financing Activities. Our net cash used in financing activities was $1.0 million in 2012 compared with cash provided by financing activities of $1.1 million in 2011. Net cash used in financing activities for the year ended December 29, 2012, was related primarily to payments on our long-term borrowings and revolving line of credit. Net cash provided by financing activities for the year ended December 31, 2011, was related primarily to $9.4 million in proceeds from issuance of debt offset by the payment of $8.3 million on our borrowings.

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