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ARCI > SEC Filings for ARCI > Form 10-Q on 8-Aug-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-Q for APPLIANCE RECYCLING CENTERS OF AMERICA INC /MN


8-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking and Cautionary Statements

This quarterly report contains statements that are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended and
Section 21E of the Securities Act of 1934, as amended. Any statements contained in this quarterly report that are not purely historical or relate to our future operations, performance and results, and anticipated liquidity are forward looking. These forward-looking statements are based on information available to us on the date of this quarterly report, but are subject to risks and uncertainties, including, but not limited to, those discussed herein. Our actual results could differ materially from those discussed in this quarterly report.

The forward-looking statements contained in this quarterly report, and other written and oral forward-looking statements made by us from time to time, are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. Any forward-looking information regarding our operations will be affected primarily by individual retail stores' profitability, the volume of appliance sales, the strength of energy conservation recycling programs and general economic conditions affecting consumer demand for appliances. Any forward-looking information will also be affected by our continued ability to purchase product from our suppliers at acceptable prices, the ability of individual retail stores to meet planned revenue levels, the number of retail stores, costs and expenses being realized at higher than expected levels, our ability to secure an adequate supply of special-buy appliances for resale, the ability to secure appliance recycling and replacement contracts with sponsors of energy efficiency programs, the ability of customers to supply units under their recycling contracts with us, the performance of our consolidated variable interest entity and the continued availability of our current line of credit. Other factors that might cause such a difference include, but are not limited to, those discussed in Item 1A "Risk Factors" in our annual report on Form 10-K for the year ended December 29, 2012.

The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our operations and financial condition. This discussion should be read with the consolidated financial statements appearing in Item 1.

Overview

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 small 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 from our agreement with General Electric ("GE") acting through its GE Appliances business component. 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 ARCA Advanced Processing, LLC ("AAP") through a joint venture agreement between ARCA and 4301 Operations, LLC ("4301").

Our business components are uniquely positioned in the industry to work together to provide a full array of appliance-related services. ApplianceSmart operates eighteen company-owned stores, sells new appliances directly to consumers and provides affordable ENERGY STARŪ options for energy efficiency appliance replacement programs. Our eleven regional centers process appliances at end of life to remove environmentally damaging substances and produce material byproducts for recycling 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.

We believe the GE contract and AAP model are 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.


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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. This seasonality 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. Our recycling segment typically operates two types of programs:
1. Fees charged for collecting and recycling appliances for utilities and other sponsors of energy efficiency programs.

2. Fees charged for recycling and replacing old appliances with new ENERGY STARŪ appliances for energy efficiency programs sponsored by electric and gas utilities.

Over the last twelve months recycling-only programs continue to report declining revenues and volumes, while we have experienced strong revenues and volumes from our replacement programs. We believe factors impacting this shift include a declining number of pre-1993 refrigerators eligible for recycling programs and a greater emphasis by utilities on promoting ENERGY STARŪ appliances.

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. Through the six months ended June 29, 2013, we did not recognize any carbon offset revenues. In 2012, we sold carbon offsets on the voluntary market and recognized $0.1 million in revenues compared with $1.2 million in 2011. The decline in 2012 and 2013 is due to uncertainty 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; other legal challenges are still pending. In April 2013, California's Air Resources Board approved linking the state's program with a similar program in Quebec beginning in 2014, which we consider an important step toward a more efficient, liquid market. We cannot predict the impact of any legal cases nor future market expansion, but we believe there is growing momentum in the carbon offset 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. We expect to create carbon offsets throughout 2013 and derive revenues through California's market in the second half of 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 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 our recycling centers.

Reporting Period. Operating results for the three and six months ended June 29, 2013, and June 30, 2012, are presented using 13-week and 26-week periods, respectively. The results of operations for any interim period are not necessarily indicative of the results for the year.


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Results of Operations

The following table sets forth our consolidated financial data as a percentage
of total revenues for the three and six months ended June 29, 2013, and June 30,
2012:

                                     Three Months Ended                  Six Months Ended
                                 June 29,           June 30,         June 29,         June 30,
                                   2013               2012             2013             2012
Revenues:
Retail                               55.1  %            64.2  %          57.2  %          65.7  %
Recycling                            31.8  %            20.8  %          29.6  %          19.3  %
Byproduct                            13.1  %            15.0  %          13.2  %          15.0  %
Total revenues                      100.0  %           100.0  %         100.0  %         100.0  %
Cost of revenues                     73.7  %            73.1  %          73.8  %          73.1  %
Gross profit                         26.3  %            26.9  %          26.2  %          26.9  %
Selling, general and
administrative expenses              22.6  %            27.5  %          23.6  %          27.1  %
Operating income (loss)               3.7  %            (0.6 )%           2.6  %          (0.2 )%
Other income expense:
Interest expense, net                (1.0 )%            (0.9 )%          (1.0 )%          (0.9 )%
Other expense, net                      -  %            (0.1 )%             -  %             -  %
Income (loss) before income
taxes and noncontrolling
interest                              2.7  %            (1.6 )%           1.6  %          (1.1 )%
Provision for (benefit of)
income taxes                          0.4  %             0.2  %           0.2  %             -  %
Net income (loss)                     2.3  %            (1.8 )%           1.4  %          (1.1 )%
Net loss (income)
attributable to
noncontrolling interest               0.1  %            (0.3 )%           0.2  %          (0.1 )%
Net income (loss)
attributable to controlling
interest                              2.4  %            (2.1 )%           1.6  %          (1.2 )%

For the Three Months Ended June 29, 2013, and June 30, 2012

The following table sets forth the key results of operations by segment for the
three months ended June 29, 2013, and June 30, 2012 (dollars in millions):

                                      Three Months Ended
                               June 29,      June 30,        %
                                 2013          2012       Change
Revenues:
Retail                        $    18.1     $    19.3       (6 )%
Recycling                          14.2          10.2       39  %
Total revenues                $    32.3     $    29.5        9  %

Operating income (loss):
Retail                        $     0.1     $    (0.6 )    123  %
Recycling                           1.2           0.4      182  %
Unallocated corporate costs        (0.1 )        (0.0 )   (125 )%
Total operating income (loss)       1.2          (0.2 )    723  %

Our total revenues of $32.3 million for the second quarter of 2013 increased $2.8 million or 9% from $29.5 million in the second quarter of 2012. The increase in revenues was attributed to our recycling segment. Replacement program revenues increased by $4.4 million compared with the prior year, which was partially offset by a decline in recycling-only revenues of $0.2 million, a decline of AAP revenues of $0.2 million and a 4% decline in ApplianceSmart same-store sales. Retail segment revenues accounted for 56% of total revenues in the second quarter of 2013 compared with 65% in the same period of 2012. Recycling segment


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revenues and retail segment revenues each include a portion of byproduct revenues. The recycling segment accounts for approximately 93% of the byproduct revenues. The increase in replacement program revenues impacted the overall mix of revenues between the retail and recycling segments for the second quarter of 2013 compared with same period of 2012.

Our total operating income of $1.2 million for the second quarter of 2013 increased $1.4 million compared with an operating loss of $(0.2) million in the second quarter of 2012. The increase was related primarily to the increase in replacement revenues and improvement in our ApplianceSmart gross margin, which included an inventory reserve reversal of $0.4 million. These factors were partially offset by a decline in AAP's gross margin, due primarily to lower steel scrap prices and higher depreciation.

Revenues. Revenues for the three months ended June 29, 2013, and June 30, 2012, were as follows (dollars in millions):

Three Months Ended

           June 29,     June 30,
             2013         2012       % Change
Retail    $    17.8    $     19.0      (6 )%
Recycling      10.3           6.1      67  %
Byproduct       4.2           4.4      (5 )%
          $    32.3    $     29.5       9  %

Retail Revenues. Our retail revenues of $17.8 million for the second quarter of 2013 decreased $1.2 million or 6% from $19.0 million in the second quarter of 2012. The decrease in retail revenues was due primarily to a 4% decrease in same-store sales along with the closure of three underperforming stores that were operating in the second quarter of 2012. We believe the factors leading to the decline in same-store sales included increased competition from national chains with expanded product offerings and continued economic softness. We closed one underperforming store in May 2013 as a result of not renewing the lease.

Recycling Revenues. Our recycling revenues of $10.3 million for the second quarter of 2013 increased $4.2 million or 67% from $6.1 million in the second quarter of 2012. 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% to $3.2 million in the second quarter of 2013 compared with $3.4 million in the second quarter of 2012, due primarily to lower volumes and price compression within certain contracts. The number of units driving our appliance recycling revenues declined 14% and the average revenue per unit declined by $2 compared with the same quarter last year. Replacement program revenues increased 160% to $7.1 million in the second quarter of 2013 compared with $2.7 million in the second quarter of 2012, due primarily to higher volumes and the mix of appliance replacements.

Byproduct Revenues. Our byproduct revenues of $4.2 million for the second quarter of 2013 decreased $0.2 million or 5% from $4.4 million in the second quarter of 2012. The decrease in byproduct revenues was primarily the result of a decline in steel scrap prices generating revenues at AAP. Byproduct revenues include all of the revenues generated by AAP. AAP revenues of $2.7 million decreased $0.2 million compared with the second quarter of 2012, due primarily to a decline in average steel scrap prices of 11% per gross ton and partially offset by a 5% increase in volume compared with the same period last year. During the second quarter of 2013, we did not recognize any carbon offset revenues.

Gross Profit. During the first quarter of 2013, we reclassified certain revenues, cost of revenues and sales, general and administrative expenses due to further industry analysis and conformed the 2012 presentation. The reclassification is related primarily to facilities costs and certain other costs not directly related to the production of recycled materials within the recycling segment. Our gross profit of $8.5 million in the second quarter of 2013 increased 0.6 million or 7% from $7.9 million in the second quarter of 2012. Gross profit as a percentage of total revenues decreased to 26% for the second quarter of 2013 compared with 27% in the second quarter of 2012. The decline in overall gross profit percentage was due primarily to lower byproduct revenues, including the decline in steel scrap prices generating AAP revenues described above. Gross profit percentage for the recycling segment decreased to 24% for the second quarter of 2013 compared with 29% for the second quarter of 2012. Gross profit percentage for the retail segment increased to 28% for the second quarter of 2013 compared with 26% for the second quarter of 2012. The increase for the retail segment was due primarily to a favorable $0.4 million adjustment to our inventory reserve.

Selling, General and Administrative Expenses. Our selling, general and administrative ("SG&A") expenses for the second quarter of 2013 decreased $0.8 million to $7.3 million compared with $8.1 million for the same period of the prior year. Our SG&A expenses as a percentage of total revenues decreased to 23% in the second quarter of 2013 compared with 27% in the second quarter of 2012. Selling expenses decreased $0.6 million to $4.4 million or 14% of total revenues in the second quarter of 2013


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compared with $5.0 million or 17% of total revenues for the second quarter of 2012. The decrease in selling expenses was due primarily to closing the three ApplianceSmart stores mentioned previously. General and administrative expenses decreased $0.2 million to $2.9 million for the second quarter of 2013 compared with $3.1 million in the second quarter of the prior year. The decrease was due primarily to lower corporate administrative expenses as a result of cost reduction initiatives we implemented in the first quarter of 2013.

For the Six Months Ended June 29, 2013, and June 30, 2012

The following table sets forth the key results of operations by segment for the
six months ended June 29, 2013, and June 30, 2012 (dollars in millions):

                                        Six Months Ended
                               June 29,      June 30,        %
                                 2013          2012        Change
Revenues:
Retail                        $    36.4     $    39.4        (7 )%
Recycling                          26.3          19.6        34  %
Total revenues                $    62.7     $    59.0         6  %

Operating income (loss):
Retail                        $    (0.1 )   $    (0.5 )      88  %
Recycling                           2.0           0.4       404  %
Unallocated corporate costs        (0.3 )        (0.0 )    (560 )%
Total operating income (loss)       1.6          (0.1 )   1,591  %

Our total revenues of $62.7 million for the six months ended June 29, 2013, increased $3.7 million or 6% from $59.0 million for the six months ended June 30, 2012. The increase in revenues was attributed to our recycling segment. Replacement program revenues increased by $8.1 million compared with the same period of the prior year, which was partially offset by a decline in recycling-only revenues of $1.0 million, a decline in AAP revenues of $0.4 million and a 6% decline in ApplianceSmart same-store sales. Retail segment revenues accounted for 58% of total revenues in the six months ended June 29, 2013, compared with 67% in the same period of the prior year. Recycling segment revenues and retail segment revenues each include a portion of byproduct revenues. The recycling segment accounts for approximately 93% of the byproduct revenues. The increase in replacement program revenues impacted the overall mix of revenues between the retail and recycling segments for the six months ended June 29, 2013, compared with same period of the prior year.

Our total operating income of $1.6 million for the six months ended June 29, 2013, increased $1.7 million compared with an operating loss of $(0.1) million for the six months ended June 30, 2012. The increase was related primarily to the increase in replacement revenues and improvement in our ApplianceSmart gross margin. These factors were partially offset by a decline in AAP's gross margin, due primarily to lower steel scrap prices and higher depreciation.

Revenues. Revenues for the six months ended June 29, 2013, and June 30, 2012, were as follows (dollars in millions):

Six Months Ended
           June 29,      June 30,
             2013          2012       % Change
Retail    $     35.9    $     38.7      (7 )%
Recycling       18.5          11.4      63  %
Byproduct        8.3           8.9      (7 )%
          $     62.7    $     59.0       6  %

Retail Revenues. Our retail revenues of $35.9 million for the six months ended June 29, 2013, decreased $2.9 million or 7% from $38.7 million for the six months ended June 30, 2012. The decrease in retail revenues was due primarily to a 6% decline in same-store sales along with the closure of three underperforming stores that were operating for the entire six-month period in the second quarter of 2012. We are developing strategies for other underperforming stores and stores with expiring leases that have a range of outcomes from right-sizing the showroom space to closure. We closed one underperforming store in May 2013 as a result of not renewing the lease.


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Recycling Revenues. Our recycling revenues of $18.5 million for the six months ended June 29, 2013, increased $7.2 million or 63% from $11.4 million in the six months ended June 30, 2012. 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 15% to $5.4 million for the six months ended June 29, 2013, compared with $6.4 million in the same period of the prior year, due primarily to lower volumes and price compression within certain contracts. The number of units driving our appliance recycling revenues declined 11% and the average revenue per unit declined by $4 compared with the same period of the prior year. Replacement program revenues increased 164% to $13.1 million in the six months ended June 29, 2013, compared with $5.0 million in the same period of the prior year, due primarily to higher volumes and the mix of appliance replacements.

Byproduct Revenues. Our byproduct revenues of $8.3 million for the six months ended June 29, 2013, decreased $0.6 million or 7% from $8.9 million in the same period of the prior year. The decrease in byproduct revenues was primarily the result of a decline in steel scrap prices generating revenues at AAP. Byproduct revenues include all of the revenues generated by AAP. AAP revenues of $5.2 million decreased $0.4 million compared with the same period of the prior year, due primarily to a decline in average steel scrap prices of 11% per gross ton and partially offset by a 5% increase in volume compared with the same period of the prior year. During the six months ended June 29, 2013, we did not recognize any carbon offset revenues. ARCA, combined with AAP, expects to recognize approximately $0.8 million in carbon offset revenues later in 2013 pending the transfer and verification of the carbon offsets in the California system. We continue to reclaim and store refrigerants and expect to generate carbon offset revenues in the future although the frequency of these transactions will vary based on volume levels and market conditions.

Gross Profit. During fiscal 2013, we reclassified certain revenues, cost of revenues and sales, general and administrative expenses due to further industry analysis and conformed the 2012 presentation. The reclassification is related primarily to facilities costs and certain other costs not directly related to the production of recycled materials within the recycling segment. Our gross profit of $16.4 million in the six months ended June 29, 2013, increased 0.5 million or 3% from 15.9 million in the six months ended June 30, 2012. Gross profit as a percentage of total revenues decreased to 26% for the six months ended June 29, 2013, compared with 27% in the same period of the prior year. The decline in overall gross profit percentage was due primarily to lower byproduct revenues, including the decline in steel scrap prices generating AAP revenues described above. Gross profit percentage for the recycling segment decreased to 24% for the six months ended June 29, 2013, compared with 28% in the same period of the prior year. Gross profit percentage for the retail segment increased to 28% for the six months ended June 29, 2013, compared with 27% in the same period of the prior year. The increase for the retail segment was due primarily to a favorable $0.5 million adjustment to our inventory reserve for the six months ended June 29, 2013.

Our gross profit as a percentage of total revenues 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 that 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 for the six months ended June 29, 2013, decreased $1.2 million to $14.8 million compared with $16.0 million for the same period of the prior year. Our SG&A expenses as a percentage of total revenues decreased to 24% in the six months ended June 29, 2013, compared with 27% in the same period last year. Selling expenses decreased $0.7 million to $9.0 million or 14% of total revenues in the six months ended June 29, 2013, compared with $9.7 million or 17% of total revenues in the same period of the prior year. The decrease in selling expenses was due primarily to closing the three . . .

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