JanOne Inc. - Quarter Report: 2012 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2012

 

or

 

o         Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission File No. 0-19621

 

APPLIANCE RECYCLING CENTERS OF AMERICA, INC.

(Exact name of registrant as specified in its charter)

 

 

952-930-9000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  x Yes  o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  x Yes  o No

 

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 definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  o Yes  x No

 

As of August 6, 2012, there were outstanding 5,555,927 shares of the registrant’s Common Stock, without par value.

 

 

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APPLIANCE RECYCLING CENTERS OF AMERICA, INC.

 

INDEX TO FORM 10-Q

 

 

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PART I.                 FINANCIAL INFORMATION

 

Item 1.                   Financial Statements

 

APPLIANCE RECYCLING CENTERS OF AMERICA, INC.

CONSOLIDATED BALANCE SHEETS

(In Thousands)

 

		June 30, 2012			December 31, 2011
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	3,734		$	4,401
Accounts receivable, net of allowance of $33 and $18, respectively		6,181			7,445
Inventories, net of reserves of $83 and $85, respectively		21,112			18,456
Other current assets		2,481			1,420
Deferred tax assets		173			173
Total current assets		33,681			31,895
Property and equipment, net		12,614			12,535
Goodwill		1,120			1,120
Other assets		1,127			1,232
Deferred income taxes		27			27
Total assets (a)		$	48,569		$	46,809
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	5,566		$	4,323
Accrued expenses		4,936			4,453
Line of credit		11,903			10,685
Current maturities of long-term obligations		955			989
Total current liabilities		23,360			20,450
Long-term obligations, less current maturities		6,830			7,251
Deferred gain, net of current portion		609			853
Deferred income tax liabilities		875			875
Total liabilities (a)		31,674			29,429
Commitments and contingencies		—			—
Shareholders’ equity:
Common Stock, no par value; 10,000 shares authorized; issued and outstanding: 5,556 shares and 5,527 shares, respectively		20,492			20,338
Accumulated deficit		(5,504		)	(4,797		)
Accumulated other comprehensive loss		(372		)	(361		)
Total shareholders’ equity		14,616			15,180
Noncontrolling interest		2,279			2,200
		16,895			17,380
Total liabilities and shareholders’ equity		$	48,569		$	46,809

 

(a)

Assets of ARCA Advanced Processing, LLC (AAP), our consolidated variable interest entity (VIE) that can only be used to settle obligations of AAP were $11,383 and $11,771 as of June 30, 2012 and December 31, 2011, respectively. Liabilities of AAP for which creditors do not have recourse to the general credit of Appliance Recycling Centers of America, Inc. were $1,928 and $2,186 as of June 30, 2012 and December 31, 2011, respectively.

 

See Notes to Consolidated Financial Statements.

 

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APPLIANCE RECYCLING CENTERS OF AMERICA, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In Thousands, Except Per Share Amounts)

 

		Three Months Ended						Six Months Ended
		June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Revenues:
Retail		$	18,964		$	18,385		$	38,720		$	37,604
Recycling		6,145			9,612			11,410			15,350
Byproduct		4,233			4,894			8,644			9,863
Total revenues		29,342			32,891			58,774			62,817
Costs of revenues		21,771			23,244			43,591			44,181
Gross profit		7,571			9,647			15,183			18,636
Selling, general and administrative expenses		7,764			7,394			15,292			14,855
Operating income (loss)		(193		)	2,253			(109		)	3,781
Other expense:
Interest expense, net		(279		)	(284		)	(533		)	(602		)
Other expense, net		(25		)	(45		)	(9		)	(74		)
Income (loss) before income taxes and noncontrolling interest		(497		)	1,924			(651		)	3,105
Provision for (benefit of) income taxes		54			(152		)	(23		)	292
Net income (loss)		(551		)	2,076			(628		)	2,813
Net income attributable to noncontrolling interest		(90		)	(48		)	(79		)	(111		)
Net income (loss) attributable to controlling interest		$	(641	)	$	2,028		$	(707	)	$	2,702
Income (loss) per common share:
Basic		$	(0.12	)	$	0.37		$	(0.13	)	$	0.49
Diluted		$	(0.12	)	$	0.35		$	(0.13	)	$	0.47
Weighted average common shares outstanding:
Basic		5,555			5,493			5,546			5,493
Diluted		5,555			5,820			5,546			5,801
Net income (loss)		$	(551	)	$	2,076		$	(628	)	$	2,813
Other comprehensive income (loss), net of tax:
Effect of foreign currency translation adjustments		(71		)	17			(11		)	85
Total other comprehensive income (loss), net of tax		(71		)	17			(11		)	85
Comprehensive income (loss)		(622		)	2,093			(639		)	2,898
Comprehensive income attributable to noncontrolling interest		(90		)	(48		)	(79		)	(111		)
Comprehensive income (loss) attributable to controlling interest		$	(712	)	$	2,045		$	(718	)	$	2,787

 

See Notes to Consolidated Financial Statements.

 

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APPLIANCE RECYCLING CENTERS OF AMERICA, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

 

		Six Months Ended
		June 30,			July 2,
		2012			2011
Operating activities
Net income (loss)		$	(628	)	$	2,813
Adjustments to reconcile net income (loss) to net cash and cash equivalents (used in) provided by operating activities:
Depreciation and amortization		609			667
Share-based compensation		68			213
Amortization of deferred gain		(244		)	(244		)
Amortization of debt issuance costs		99			93
Reversal of deferred tax asset valuation allowance		—			(917		)
Excess tax benefits related to share-based compensation		—			(36		)
Other		35			(4		)
Changes in assets and liabilities:
Accounts receivable		1,256			(4,405		)
Inventories		(2,656		)	240
Other current assets		(1,064		)	(713		)
Other assets		(34		)	31
Accounts payable and accrued expenses		1,726			1,822
Income taxes payable		—			803
Net cash flows (used in) provided by operating activities		(833		)	363
Investing activities
Purchases of property and equipment		(625		)	(1,316		)
Decrease in restricted cash		—			701
Proceeds from sale of property and equipment		—			9
Net cash flows used in investing activities		(625		)	(606		)
Financing activities
Checks issued in excess of cash in bank		—			(42		)
Net borrowings under line of credit		1,218			621
Payments on debt obligations		(503		)	(7,771		)
Proceeds from issuance of debt obligations		—			9,400
Proceeds from issuance of Common Stock		86			—
Payment of debt issuance costs		—			(669		)
Excess tax benefits related to share-based compensation		—			36
Net cash flows provided by financing activities		801			1,575
Effect of changes in exchange rate on cash and cash equivalents		(10		)	80
Increase (decrease) in cash and cash equivalents		(667		)	1,412
Cash and cash equivalents at beginning of period		4,401			3,065
Cash and cash equivalents at end of period		$	3,734		$	4,477

 

See Notes to Consolidated Financial Statements.

 

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APPLIANCE RECYCLING CENTERS OF AMERICA, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(In Thousands)

 

		Six Months Ended
		June 30,			July 2,
		2012			2011
Supplemental disclosures of cash flow information
Cash payments for interest		$	431		$	502
Cash payments for income taxes		$	123		$	407
Non-cash investing and financing activities
Equipment acquired under capital leases and other financing obligations		$	146		$	33
Repayment of debt from trade-in of equipment		$	87		$	—

 

See Notes to Consolidated Financial Statements.

 

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APPLIANCE RECYCLING CENTERS OF AMERICA, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Per Share Amounts)

 

1.                                      Nature of Business and Basis of Presentation

 

Appliance Recycling Centers of America, Inc. and subsidiaries (“we,” the “Company” or “ARCA”) are in the business of providing turnkey appliance recycling and replacement services for electric utilities and other sponsors of energy efficiency programs.  We also sell new major household appliances through a chain of Company-owned stores under the name ApplianceSmart®.  In addition, we have a 50% interest in a joint venture operating under the name ARCA Advanced Processing, LLC (“AAP”), which recycles appliances from twelve states in the Northeast and Mid-Atlantic regions of the United States for General Electric Company (“GE”) acting through its GE Appliances business component.  These appliances include units manufactured by GE as well as by other manufacturers.

 

The accompanying consolidated financial statements of the Company are unaudited and have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States of America for interim financial information and Article 8 of Regulation S-X promulgated by the United States Securities and Exchange Commission (the “SEC”).  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  In the opinion of management, normal and recurring adjustments and accruals considered necessary for a fair presentation for the periods indicated have been included.  Operating results for the three-month and six-month periods ended June 30, 2012 and July 2, 2011 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.

 

These financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes thereto for the year ended December 31, 2011 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2012.

 

Principles of consolidation:  The consolidated financial statements include the accounts of Appliance Recycling Centers of America, Inc. and our subsidiaries.  All significant intercompany accounts and transactions have been eliminated in consolidation.

 

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 California, 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.

 

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 GE acting through its GE Appliances business component.  Both ARCA and 4301 have a 50% interest in AAP.  GE sells its recyclable appliances generated from twelve states in the Northeast and Mid-Atlantic regions of the United States to ARCA, which collects, processes and recycles the appliances.  These appliances include units manufactured by GE as well as by other manufacturers.  The agreement requires that ARCA will only recycle, and will not sell for re-use or resale, the recyclable appliances purchased from GE.  AAP established a regional processing center in Philadelphia, Pennsylvania, at which the recyclable appliances are processed.  The term of the agreement is for six years from the first date of appliance collection, which was March 31, 2010.  AAP commenced operations in February 2010 and has the exclusive rights to service 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.

 

Fair value of financial instruments:  The following methods and assumptions are used to estimate the fair value of each class of financial instrument:

 

Cash and cash equivalents, accounts receivable and accounts payable:  Due to their nature and short-term maturities, the carrying amounts approximate fair value.

 

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Short- and long-term debt:  The fair value of short- and long-term debt approximates carrying value and has been estimated based on discounted cash flows using interest rates being offered for similar debt having the same or similar remaining maturities and collateral requirements.

 

No separate comparison of fair values versus carrying values is presented for the aforementioned financial instruments since their fair values are not significantly different than their balance sheet carrying amounts.  In addition, the aggregate fair values of the financial instruments would not represent the underlying value of our Company.

 

2.                                Recent Accounting Pronouncements

 

Presentation of Comprehensive Income

 

In June 2011, the FASB issued an Accounting Standards Update (“ASU”) related to the presentation of comprehensive income.  This ASU amends the FASB Accounting Standards Codification (“Codification”) to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income.  This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity.  The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  This ASU is effective for fiscal years beginning after December 15, 2011.  The adoption of this ASU did not have a material effect on our results of operations, financial position or cash flows.

 

Testing for Goodwill Impairment

 

In September 2011, the FASB issued an ASU that permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. This ASU is effective for fiscal years beginning after December 15, 2011. The adoption of this ASU did not have a significant impact on our consolidated results of operations, financial position, or cash flows.

 

3.                                      Significant Accounting Policies

 

Trade receivables:  We carry unsecured trade receivables at the original invoice amount less an estimate made for doubtful accounts based on a monthly review of all outstanding amounts.  Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition, credit history and current economic conditions.  We write off trade receivables when we deem them uncollectible.  We record recoveries of trade receivables previously written off when we receive them.  We consider a trade receivable to be past due if any portion of the receivable balance is outstanding for more than ninety days.  We do not charge interest on past due receivables.  Our management considers the allowance for doubtful accounts of $33 and $18 to be adequate to cover any exposure to loss at June 30, 2012 and December 31, 2011, respectively.

 

Inventories:  Inventories, consisting principally of appliances, are stated at the lower of cost, determined on a specific identification basis, or market and consist of:

 

		June 30, 2012			December 31, 2011
Appliances held for resale		$	20,657		$	18,291
Processed metals from recycled appliances held for resale		538			250
Less provision for inventory obsolescence		(83		)	(85		)
		$	21,112		$	18,456

 

We provide estimated provisions for the obsolescence of our appliance inventories, including adjustments to market, based on various factors, including the age of such inventory and our management’s assessment of the need for such provisions.  We look at historical inventory agings and margin analysis in determining our provision estimate.  A revised cost basis is used once a provision for obsolescence is recorded.

 

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Property and equipment:  Property and equipment consists of the following:

 

		June 30, 2012			December 31, 2011
Land		$	1,140		$	1,140
Buildings and improvements		3,393			3,303
Equipment (including computer software)		19,951			19,472
Projects under construction		96			35
		24,580			23,950
Less accumulated depreciation and amortization		(11,966		)	(11,415		)
		$	12,614		$	12,535

 

Software development costs:  We capitalize software developed for internal use and are amortizing such costs over their estimated useful lives of three to five years.  Costs capitalized were $36 and $47 for the three months ended June 30, 2012 and July 2, 2011, respectively.  Costs capitalized were $85 and $76 for the six months ended June 30, 2012 and July 2, 2011, respectively.

 

Product warranty:  We provide a warranty for the replacement or repair of certain defective units which varies based on the product sold.  Our standard warranty policy requires us to repair or replace certain defective units at no cost to our customers.  We estimate the costs that may be incurred under our warranty and record an accrual in the amount of such costs at the time we recognize product revenue.  Factors that affect our warranty accrual for covered units include the number of units sold, historical and anticipated rates of warranty claims on these units, and the cost of such claims.  We periodically assess the adequacy of our recorded warranty accrual and adjust the amounts as necessary.

 

Changes in our warranty accrual are as follows:

 

		Three Months Ended						Six Months Ended
		June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Beginning Balance		$	66		$	37		$	71		$	36
Standard accrual based on units sold		12			36			24			51
Actual costs incurred		(4		)	(4		)	(8		)	(8		)
Periodic accrual adjustments		(13		)	(10		)	(26		)	(20		)
Ending Balance		$	61		$	59		$	61		$	59

 

Share-based compensation:  We recognize share-based compensation expense on a straight-line basis over the vesting period for all share-based awards granted.  We use the Black-Scholes option pricing model to determine the fair value of awards at the grant date.  We calculate the expected volatility for stock awards using historical volatility.  We estimate a 0%-5% forfeiture rate for stock awards issued to all employees and members of the Board of Directors, but will continue to review these estimates in future periods.  The risk-free rates for the expected terms of the stock awards are based on the U.S. Treasury yield curve in effect at the time of the grant.  The expected life represents the period that the stock awards are expected to be outstanding.  The expected dividend yield is zero as we have not paid or declared any cash dividends on our Common Stock.  Based on these valuations, we recognized share-based compensation expense of $32 and $114 for the three months ended June 30, 2012 and July 2, 2011, respectively, and $68 and $213 for the six months ended June 30, 2012 and July 2, 2011, respectively.  We estimate that the remaining expense for fiscal 2012 will be approximately $80 based on the value of stock awards outstanding as of June 30, 2012.  This estimate does not include any expense for additional awards that may be granted and vest during 2012.

 

Comprehensive income (loss):  Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income but are excluded from net income as these amounts are recorded directly as an adjustment to shareholders’ equity.  Our other comprehensive income (loss) is comprised of foreign currency translation adjustments.

 

Basic and diluted income (loss) per share:  Basic income per common share is computed based on the weighted average number of common shares outstanding.  Diluted income (loss) per common share is computed based on the weighted average number of common shares outstanding adjusted by the number of additional shares that would have been outstanding had the potentially dilutive common shares been issued.  Potentially dilutive shares of Common Stock include unexercised stock options and warrants.  Basic per share amounts are computed, generally, by dividing net income (loss) attributable to controlling

 

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interest by the weighted average number of common shares outstanding.  Diluted per share amounts assume the conversion, exercise or issuance of all potential Common Stock instruments unless their effect is anti-dilutive, thereby reducing the loss or increasing the income per common share.  In calculating diluted weighted average shares and per share amounts, we included stock options and warrants with exercise prices below average market prices, for the respective reporting periods in which they were dilutive, using the treasury stock method.  We calculated the number of additional shares by assuming the outstanding stock options were exercised and that the proceeds from such exercises were used to acquire Common Stock at the average market price during the quarter.  For the three and six months ended June 30, 2012, we excluded 798 and 790, respectively, options and warrants from the diluted weighted average share outstanding calculation as the effect of these options and warrants is anti-dilutive due to the net loss incurred.  For the three and six months ended July 2, 2011, we excluded 232 and 251, respectively, options and warrants from the diluted weighted average share outstanding calculation as the effect of these options and warrants is anti-dilutive.

 

A reconciliation of the denominator in the basic and diluted income or loss per share is as follows:

 

		Three Months Ended						Six Months Ended
		June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Numerator:
Net income (loss) attributable to controlling interest		$	(641	)	$	2,028		$	(707	)	$	2,702
Denominator:
Weighted average shares outstanding — basic		5,555			5,493			5,546			5,493
Employee stock options		—			117			—			101
Stock warrants		—			210			—			207
Weighted average shares outstanding - diluted		5,555			5,820			5,546			5,801
Income (loss) per share:
Basic		$	(0.12	)	$	0.37		$	(0.13	)	$	0.49
Diluted		$	(0.12	)	$	0.35		$	(0.13	)	$	0.47

 

4.                                      Variable Interest Entity

 

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.

 

The following table summarizes the assets and liabilities of AAP as of June 30, 2012 and December 31, 2011:

 

		June 30, 2012			December 31, 2011
Assets
Current assets		$	881		$	1,134
Property and equipment, net		9,265			9,419
Goodwill		1,082			1,082
Other assets		155			136
		$	11,383		$	11,771
Liabilities
Accounts Payable		$	652		$	858
Accrued Expenses		250			250
Current maturities of long-term debt obligations		614			593
Long-term debt obligations, net of current maturities		4,760			5,022
Other liabilities (a)		549			647
		$	6,825		$	7,370

 

(a)          Other liabilities represent loans between ARCA and AAP that are eliminated in consolidation.

 

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The following table summarizes the operating results of AAP for the three and six months ended June 30, 2012 and July 2, 2011:

 

		Three Months Ended						Six Months Ended
		June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Revenues		$	2,725		$	2,583		$	5,433		$	5,236
Gross profit		360			269			551			542
Operating income		290			185			355			379

 

5.                                      Other Assets

 

Other assets as of June 30, 2012 and December 31, 2011 consist of the following:

 

		June 30,  2012			December 31, 2011
Deposits		$	429		$	400
Recycling contract, net		299			339
Debt issuance costs, net		379			476
Patent Costs		20			17
		$	1,127		$	1,232

 

For both the three and six months ended June 30, 2012 and July 2, 2011, we recorded amortization expense of $20 and $40, respectively, related to our recycling contract.  For the three and six months ended June 30, 2012, we recorded non-cash interest expense of $50 and $99, respectively, related to debt issuance costs.  For the three and six months ended July 2, 2011, we recorded non-cash interest expense of $47 and $93, respectively, related to debt issuance costs.

 

6.                                      Accrued Expenses

 

Accrued expenses as of June 30, 2012 and December 31, 2011 consist of the following:

 

		June 30, 2012			December 31, 2011
Compensation and benefits		$	1,077		$	1,023
Accrued incentive and rebate checks		582			728
Accrued rent		1,275			1,336
Warranty expense		61			71
Accrued payables		740			408
Current portion of deferred gain on sale-leaseback of building		487			487
Deferred revenue		152			96
Other		562			304
		$	4,936		$	4,453

 

7.                                      Line of Credit

 

On January 24, 2011, we entered into a Revolving Credit, Term Loan and Security Agreement (“Revolving Credit Agreement”) with PNC Bank, National Association (“PNC”) that provides us with a $15,000 revolving line of credit.  See Note 9 for further discussion regarding the Term Loan entered into with PNC.  The Revolving Credit Agreement has a stated maturity date of January 24, 2014, if not renewed.  The Revolving Credit Agreement includes a lockbox agreement and a subjective acceleration clause and as a result we have classified the revolving line of credit as a current liability.  The Revolving Credit Agreement is collateralized by a security interest in substantially all of our assets and PNC is also secured by an inventory repurchase agreement with Whirlpool Corporation for Whirlpool purchases only.  We also issued a $750 letter of credit in favor of Whirlpool Corporation.  The Revolving Credit Agreement requires, starting with the fiscal quarter ending April 2, 2011 and continuing at the end of each quarter thereafter, that we meet a minimum fixed charge coverage ratio of 1.10 to 1.00, measured on a trailing twelve month basis.  The Revolving Credit Agreement limits investments we can purchase, the amount of other debt and leases we can incur, the amount of loans we can issue to our affiliates and the amount we can spend on fixed assets along with prohibiting the payment of dividends.  As of June 30, 2012, we were in compliance with all the covenants of the

 

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Revolving Credit Agreement.  The interest rate on the revolving line of credit is PNC Base Rate plus 1.75%, or 1-, 2- or 3-month PNC LIBOR Rate plus 2.75%.  The PNC Base Rate shall mean, for any day, a fluctuating per annum rate of interest equal to the highest of (i) the interest rate per annum announced from time to time by PNC at its prime rate, (ii) the Federal Funds Open Rate plus ½ of 1%, and (iii) the one month LIBOR rate plus 100 basis points (1%).  As of June 30, 2012, the outstanding balance under the Revolving Credit Agreement was $11,903 with a weighted average interest rate of 3.73%, which included both PNC LIBOR Rate and PNC Base Rate loans.  As of December 31, 2011, the outstanding balance under the Revolving Credit Agreement was $10,685 with a weighted average interest rate of 3.72%, which included both PNC LIBOR Rate and PNC Base Rate loans.  The amount of revolving borrowings under the Revolving Credit Agreement is based on a formula using accounts receivable and inventories.  We may not have access to the full $15,000 revolving line of credit due to the formula using accounts receivable and inventories, the amount of the letter of credit issued in favor of Whirlpool Corporation and the amount of outstanding loans between PNC and our AAP joint venture.  As of June 30, 2012 and December 31, 2011, our available borrowing capacity under the Revolving Credit Agreement was $2,228 and $3,505, respectively.

 

8.                                      Deferred Gain

 

In connection with the September 25, 2009 sale-leaseback of our St. Louis Park, Minnesota, building, we recorded a deferred gain of $2,436.  The deferred gain is being amortized over the initial lease period of five years.  For both the three and six months ended June 30, 2012 and July 2, 2011, we amortized $122 and $244, respectively, of the deferred gain.  The deferred gain amortization is netted against rent expense as a component of selling, general and administrative expenses in the consolidated statements of operations.

 

9.                                      Borrowings

 

Long-term debt, capital lease and other financing obligations as of June 30, 2012 and December 31, 2011 consist of the following:

 

		June 30, 2012			December 31, 2011
Floating rate term loan, due in monthly installments of $21, plus interest, due February 2021, collateralized by land and building		$	2,168		$	2,295
Floating rate term loans, due in monthly installments of $54, including interest, due March 2021, collateralized by equipment		4,348			4,537
2.75% note, due in monthly installments of $3, including interest, due October 2024, collateralized by equipment		426			440
10.00% note, due in monthly installments of $10, including interest, due December 2014		341			400
Capital leases and other financing obligations		502			568
		7,785			8,240
Less current maturities		955			989
		$	6,830		$	7,251

 

On January 24, 2011, we entered into a $2,550 term loan with PNC Bank to refinance the existing mortgage on our California facility.  The term loan is payable as follows, subject to acceleration upon the occurrence of an event of default or termination of the Revolving Credit Agreement: 119 consecutive monthly principal payments of $21 plus interest commencing on February 1, 2011 and continuing on the first day of each month thereafter followed by a 120th payment of all unpaid principal, interest and fees on February 1, 2021. The term loan is collateralized with our California facility located in Compton, California. The term loan bears interest at PNC Base Rate plus 2.25%, or 1-, 2- or 3-month PNC LIBOR Rate plus 3.25%.  As of June 30, 2012 and December 31, 2011, the interest rate was 5.50%.

 

On March 10, 2011, ARCA Advanced Processing, LLC entered into three separate commercial term loans (“Term Loans”) with Susquehanna Bank, pursuant to the guidelines of the U.S. Small Business Administration 7(a) Loan Program.  The total amount of the Term Loans is $4,750, split into three separate loans for $2,100; $1,400; and $1,250.  The Term Loans mature in ten years and bear an interest rate of Prime plus 2.75%.  As of June 30, 2012 and December 31, 2011, the interest rate was 6.00%.  Borrowings under the Term Loans are secured by substantially all of the assets of AAP along with liens on the business assets and certain personal assets of the owners of 4301 Operations, LLC. We are a guarantor of the Term Loans along with 4301 Operations, LLC and its owners.

 

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Capital leases and other financing obligations:  We acquire certain equipment under capital leases and other financing obligations.  The cost of the equipment was approximately $1,946 and $1,940 at June 30, 2012 and December 31, 2011, respectively.  Accumulated amortization at June 30, 2012 and December 31, 2011 was approximately $1,514 and $1,458, respectively.  Depreciation and amortization expense is included in cost of revenues and selling, general and administrative expenses.

 

10.                               Commitments and Contingencies

 

Contracts:  We have entered into material contracts with three appliance manufacturers.  Under the agreements there are no minimum purchase commitments; however, we have agreed to indemnify the manufacturers for certain claims, allegations or losses with respect to appliances we sell.

 

Litigation:  We are party from time to time to ordinary course disputes that we do not believe to be material or have merit.  We intend to vigorously defend ourselves against these ordinary course disputes.

 

11.                               Income Taxes

 

For the three and six months ended June 30, 2012, we recorded a provision for (benefit of) income taxes of $54 and $(23), respectively, related to our Canadian operations. We are not projecting a taxable loss in 2012 due to expatriating foreign earnings, however, as a result of limitations on the ability to utilize foreign tax credits expected to be generated in 2012, we have not recorded a tax benefit for U.S. losses incurred for the six months ended June 30, 2012.  For the three and six months ended July 2, 2011, we recorded a provision for (benefit of) income taxes of $(152) and $292, respectively.  We regularly evaluate both positive and negative evidence related to retaining a valuation allowance against our deferred tax assets.  The realization of deferred tax assets is dependent upon sufficient future taxable income during the periods when deductible temporary differences and carryforwards are expected to be available to reduce taxable income.  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 is more-likely-than-not that we would be able to realize a portion of our deferred tax assets in the future and recorded a $917 non-cash reversal of our deferred tax asset valuation allowance.   As a result of generating taxable income for the six months ended July 2, 2011, we recorded a provision for income taxes of $1,209 that was partially offset by the reversal of the deferred tax asset valuation allowance.

 

We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position.  For tax positions meeting the more-likely-than-not threshold, the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.  As of June 30, 2012 and December 311, 2011, we did not have any material uncertain tax positions.

 

It is our practice to recognize interest related to income tax matters as a component of interest expense and penalties as a component of selling, general and administrative expense.  As of June 30, 2012 and December 31, 2011, we had an immaterial amount of accrued interest and penalties.

 

We are subject to income taxes in the U.S. federal jurisdiction, foreign jurisdictions and various state jurisdictions.  Tax regulations from each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply.  With few exceptions, we are no longer subject to U.S. federal, foreign, state or local income tax examinations by tax authorities for the years before 2008.  We are not currently under examination by any taxing jurisdiction.

 

We had no significant unrecognized tax benefits as of June 30, 2012 and December 31, 2011 that would reasonably be expected to affect our effective tax rate during the next twelve months.

 

12.                               Shareholders’ Equity

 

Stock options:  On May 12, 2011, our shareholders approved and adopted the 2011 Stock Compensation Plan (the “2011 Plan”).  The 2011 Plan authorizes the granting of awards in any of the following forms: (i) stock options, (ii) stock appreciation rights, and (iii) other share-based awards, including but not limited to restricted stock, restricted stock units or performance shares and expires on the earlier of May 12, 2021 or the date that all shares reserved under the 2011 Plan are issued or no longer available.  The 2011 Plan provides for the issuance of up to 700 shares of Common Stock pursuant to awards granted under the 2011 Plan.  Options granted to employees typically vest over two years while grants to non-employee directors vest in six months.  As of June 30, 2012, 45 options were outstanding under the 2011 Plan.  On May 10, 2012, we granted 30 options to non-employee directors with an exercise price $4.05 per share, a vesting period of six months

 

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and a weighted average fair value of $3.57 per share.  Our 2006 Stock Option Plan (the “2006 Plan”) expired on June 30, 2011, but the options outstanding under the 2006 Plan continue to be exercisable in accordance with their terms.  As of June 30, 2012, 481 options were outstanding to employees and non-employee directors under the 2006 Plan.  Our Restated 1997 Stock Option Plan (the “1997 Plan”) has expired, but the options outstanding under the expired 1997 Plan continue to be exercisable in accordance with their terms.  As of June 30, 2012, options to purchase an aggregate of 8 shares were outstanding under the 1997 Plan.

 

The following table summarizes the assumptions used to estimate the fair value of stock options granted on May 10, 2012 using the Black-Scholes Model:

 

		May 10, 2012
Expected dividend yield		—
Expected stock price volatility		95.5	%
Risk-free interest rate		1.87	%
Expected life of options		10 years

 

Preferred Stock:  Our amended Articles of Incorporation authorize two million shares of Preferred Stock that may be issued from time to time in one or more series having such rights, powers, preferences and designations as the Board of Directors may determine.  To date no such preferred shares have been issued.

 

13.                         Segment Information

 

We operate within targeted markets through two reportable segments: retail and recycling.  The retail segment is comprised of income generated through our ApplianceSmart stores, which includes appliance sales and byproduct revenues from collected appliances.  The recycling segment includes all fees charged and costs incurred for collecting, recycling and installing appliances for utilities and other customers and includes byproduct revenue, which is primarily generated through the recycling of appliances.  We have included the results from consolidating AAP in our recycling segment.  The nature of products, services and customers for both segments varies significantly.  As such, the segments are managed separately.  Our Chief Executive Officer has been identified as the Chief Operating Decision Maker (“CODM”).  The CODM evaluates performance and allocates resources based on revenues and income from operations of each segment.  Income from operations represents revenues less cost of revenues and operating expenses, including certain allocated selling, general and administrative costs.  There are no inter-segment sales or transfers.

 

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The following tables present our segment information for periods indicated:

 

		Three Months Ended						Six Months Ended
		June 30, 2012			July 2, 2011			June 30, 2012			July 2, 2011
Revenues:
Retail		$	19,273		$	18,809		$	39,344		$	38,428
Recycling		10,069			14,082			19,430			24,389
Total revenues		$	29,342		$	32,891		$	58,774		$	62,817
Operating income (loss):
Retail		$	(559	)	$	91		$	(458	)	$	283
Recycling		436			2,204			401			3,638
Unallocated corporate		(70		)	(42		)	(52		)	(140		)
Total operating income (loss)		$	(193	)	$	2,253		$	(109	)	$	3,781
Assets:
Retail		$	22,399		$	17,352		$	22,399		$	17,352
Recycling		19,699			22,830			19,699			22,830
Corporate assets not allocable		6,471			7,416			6,471			7,416
Total assets		$	48,569		$	47,598		$	48,569		$	47,598
Cash capital expenditures:
Retail		$	131		$	21		$	170		$	42
Recycling		152			285			202			1,132
Corporate assets not allocable		(8		)	83			253			142
Total cash capital expenditures		$	275		$	389		$	625		$	1,316
Depreciation and amortization:
Retail		$	54		$	85		$	112		$	181
Recycling		155			119			299			235
Unallocated corporate		97			98			198			251
Total depreciation and amortization		$	306		$	302		$	609		$	667
Interest expense:
Retail		$	98		$	62		$	178		$	164
Recycling		118			143			240			301
Unallocated corporate		64			81			117			140
Total interest expense		$	280		$	286		$	535		$	605

 

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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 the speed at which individual retail stores reach profitability, the volume of appliance sales and the strength of energy conservation recycling programs.  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 31, 2011.

 

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 retail 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 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, Inc.® operates twenty-one company-owned stores and sells new appliances directly to consumers and provides affordable ENERGY STAR® options for energy efficiency appliance replacement programs.  Our twelve regional centers process appliances at end of life to remove environmentally damaging substances and produce material byproducts for recycling for over 200 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 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.

 

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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.

 

Revenues and earnings in our recycling segment are impacted by seasonal variances, with the 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.

 

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 30, 2012 and July 2, 2011 are presented using 13- and 26-week periods, respectively.  The results of operations for any interim period are not necessarily indicative of the results for the year.

 

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 30, 2012 and July 2, 2011:

 

		Three Months Ended				Six Months Ended
		June 30, 2012		July 2, 2011		June 30, 2012		July 2, 2011
Revenues:
Retail		64.7	%	55.9	%	65.9	%	59.9	%
Recycling		20.9		29.2		19.4		24.4
Byproduct		14.4		14.9		14.7		15.7
Total revenues		100.0		100.0		100.0		100.0
Cost of revenues		74.2		70.7		74.2		70.3
Gross profit		25.8		29.3		25.8		29.7
Selling, general and administrative expenses		26.5		22.5		26.0		23.6
Operating income (loss)		(0.7	)	6.8		(0.2	)	6.1
Other expense:
Interest expense, net		(1.0	)	(0.9	)	(0.9	)	(1.0	)
Other expense, net		(0.1	)	(0.1	)	(0.0	)	(0.1	)
Income (loss) before income taxes and noncontrolling interest		(1.8	)	5.8		(1.1	)	5.0
Provision for (benefit of) income taxes		0.2		(0.5	)	(0.0	)	0.5
Net income (loss)		(2.0	)	6.3		(1.1	)	4.5
Net income attributable to noncontrolling interest		(0.3	)	(0.1	)	(0.1	)	(0.2	)
Net income (loss) attributable to controlling interest		(2.3	)%	6.2	%	(1.2	)%	4.3	%

 

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