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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 

**x Annual ReportPursuant to Section 13 or 15(d) of the Securities Exchange Act of1934**

 

**For thefiscal year ended January 2, 2010**

 

**or**

 

**o TransitionReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**Commission File No. 000-19621**

 

**APPLIANCE RECYCLING CENTERS OF AMERICA, INC.**

(Exact name of registrant as specified in its charter)

 

| **Minnesota**                                        | ** ** | **41-1454591**      |
|------------------------------------------------------|------------|---------------------|
| (State or other jurisdiction of                      | ** ** | (I.R.S. Employer    |
| incorporation or organization)                       | ** ** | Identification No.) |
| ** **                                           | ** ** | ** **          |
| **7400 Excelsior Boulevard, Minneapolis, Minnesota** | ** ** | **55426-4517**      |
| (Address of principal executive offices)             | ** ** | (Zip Code)          |

 

Registrant’s telephone number, including area code:  **952-930-9000**

 

Securities registered pursuant to Section 12(b) ofthe Act:

 

| **Common Stock, without par value** | ** ** | **NASDAQ Capital Market**                 |
|-------------------------------------|------------|-------------------------------------------|
| Title of each class                 |       | Name of each exchange on which registered |

 

Securitiesregistered pursuant to Section 12(g) of the Act:  **None**

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act. o Yes  x No

 

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or 15(d) of the Act. o Yes  xNo

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports) and (2) has been subject tosuch filing requirements for the past 90 days. xYes  o No

 

Indicateby check mark whether the registrant has submitted electronically and posted onits Website, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such file). o Yes  o No

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definition of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

| Large  accelerated filer o                |   | Accelerated  filer o         |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer o                  |   | Smaller  reporting company x |
| (Do not check if  a smaller reporting company) |   |                              |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act).  o Yes   xNo

 

Theaggregate market value of the voting and non-voting common equity held bynon-affiliates of the registrant, based on the closing price of $1.67 pershare, as of July 4, 2009 (the last business day of the registrant’s mostrecently completed second fiscal quarter) was $7,644,888.

 

As of March 1, 2010,there were outstanding 4,577,777 shares of the registrant’s Common Stock,without par value.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of theregistrant’s definitive Proxy Statement for its 2010 Annual Meeting ofShareholders to be held on May 13, 2010 are incorporated by reference intoPart III hereof.

 

 

 

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**TABLE OF CONTENTS**

 
| ** **             | ** **                                                                                            | **Page**   |
|------------------------|-------------------------------------------------------------------------------------------------------|------------|
| ** **             | ** **                                                                                            | ** ** |
|                   | **PART I**                                                                                       |       |
|                   | ** **                                                                                            |       |
| Item 1.                | Business                                                                                              | 3          |
|                   | General                                                                                               | 3          |
|                   | Industry Background                                                                                   | 3          |
|                   | Company Background                                                                                    | 4          |
|                   | Customers and Source of Supply                                                                        | 8          |
|                   | Company Operations                                                                                    | 9          |
|                   | Principal Products and Services                                                                       | 10         |
|                   | Sales and Marketing                                                                                   | 10         |
|                   | Seasonality                                                                                           | 10         |
|                   | Competition                                                                                           | 11         |
|                   | Government Regulation                                                                                 | 11         |
|                   | Employees                                                                                             | 12         |
| Item 1A.               | Risk Factors                                                                                          | 12         |
| Item 2.                | Properties                                                                                            | 17         |
| Item 3.                | Legal Proceedings                                                                                     | 18         |
|                   |                                                                                                  |       |
|                   | **PART II**                                                                                      |       |
|                   | ** **                                                                                            |       |
| Item 5.                | Market for  Our Common Equity, Related Shareholder Matters and Issuer Purchases of Equity  Securities | 19         |
| Item 6.                | Selected  Financial Data                                                                              | 20         |
| Item 7.                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations           | 22         |
| Item 7A.               | Quantitative  and Qualitative Disclosures About Market Risk                                           | 32         |
| Item 8.                | Financial Statements and Supplementary Data                                                           | 33         |
| Item 9.                | Changes in  and Disagreements With Accountants on Accounting and Financial Disclosure                 | 57         |
| Item 9A.               | Controls and  Procedures                                                                              | 57         |
| Item 9B.               | Other Information                                                                                     | 58         |
|                   |                                                                                                  |       |
|                   | **PART III**                                                                                     |       |
|                   | ** **                                                                                            |       |
| Item 10.               | Directors,  Executive Officers, and Corporate Governance                                              | 59         |
| Item 11.               | Executive  Compensation                                                                               | 59         |
| Item 12.               | Security  Ownership of Certain Beneficial Owners and Management and Related Shareholder  Matters      | 59         |
| Item 13.               | Certain  Relationships and Related Transactions                                                       | 59         |
| Item 14.               | Principal  Accountant Fees and Services                                                               | 60         |
|                   |                                                                                                  |       |
|                   | **PART IV**                                                                                      |       |
|                   | ** **                                                                                            |       |
| Item 15.               | Exhibits  and Financial Statement Schedules                                                           | 61         |
|                   |                                                                                                  |       |
| **SIGNATURES**         | 63                                                                                                    |
| **INDEX  TO EXHIBITS** | 64                                                                                                    |

 

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**PART I**

 

**ITEM 1.****                                                   ****BUSINESS**

 

**General**

 

Appliance RecyclingCenters of America, Inc. and Subsidiaries (“we,” the “Company” or “ARCA”)are in the business of selling new major household appliances through a chainof Company-owned factory outlet stores under the name ApplianceSmart®.  We alsoprovide turnkey appliance recycling and replacement services for electricutilities and other sponsors of energy efficiency programs.

 

We are a leading retailerand recycler of major household appliances and generate revenues from:

 

1.                    Retail sales of appliances at our ApplianceSmart® FactoryOutlets.

2.                    Fees charged for collecting and recycling appliancesfor utilities and other sponsors of energy efficiency programs.

3.                    Fees charged for recycling and replacing oldrefrigerators with new energy efficient refrigerators for low-income housingprograms sponsored by electric utilities.

4.                    Selling byproduct materials, such as metals, fromappliances that we recycle, including appliances collected through ourApplianceSmart Factory Outlets.

 

Wewere incorporated in Minnesota in 1983, although through our predecessors webegan our appliance retail and recycling business in 1976.  Our principal office is located at 7400Excelsior Boulevard, Minneapolis, Minnesota, 55426-4517.  References herein to our Company include ouroperating subsidiaries.  (See “Exhibits.”)

 

**IndustryBackground**

 

In the United States,more than 700 million major household appliances are currently in use.  These appliances include:

 
| Refrigerators   |   | Washers                     |
|-----------------|--------|-----------------------------|
| Freezers        |   | Dryers                      |
| Ranges/ovens    |   | Room air  conditioners |
| Dishwashers     |   | Dehumidifiers               |
| Microwave ovens |   | Humidifiers                 |

 

In 2009, factoryshipments of major appliances totaled more than 59 million units in the U.S.,which was down 13% from 2008 shipments.

 

With every new appliancesale comes the potential for disposal of the unit that was replaced.  Improper disposal of old appliances threatensair, ground and water resources because many types of major appliances containsubstances that can damage the environment. These harmful materials include:

 

1.                    Polychlorinated biphenyls (“PCBs”), which have toxiceffects on humans and animals.  Althoughthe U.S. Environmental Protection Agency (“EPA”) banned the production of PCBsin 1979, it allowed manufacturers to use their remaining inventories ofPCB-containing components.  Consequently,some old room air conditioners and microwave ovens have capacitors that containPCBs, which can contaminate groundwater when released.

 

2.                    Mercury, which easily enters the body throughabsorption, inhalation or ingestion, potentially causing neurologicaldamage.  Freezers and washers may havemercury-containing switches in their lids.

 

3.                    Chlorofluorocarbon, hydrochlorofluorocarbon, andhydrofluorocarbon (collectively, “CFC”) refrigerants, which cause long-termdamage to the earth’s ozone layer and may contribute to global climatechange.  Refrigerators, freezers, roomair conditioners and dehumidifiers commonly contain CFC refrigerants.

 

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4.                    CFCs having a very high ozone-depletion potential thatmay also be used as blowing agents in the polyurethane foam insulation ofrefrigeration appliances.

 

5.                    Other materials, such as oil and sulfur dioxide, thatare harmful when released into the environment.

 

The federal governmentrequires the recovery of CFC refrigerants upon appliance disposal and alsoregulates the management of hazardous materials found in appliances.  Most state and local governments have alsoenacted laws affecting how their residents dispose of unwanted appliances.  For example, many areas restrict landfillsand scrap metal processors from accepting appliances unless the units have beenprocessed to remove environmentally harmful materials.  As a result, old appliances usually cannot bediscarded directly through ordinary solid waste systems.

 

In addition to thesesolid waste management and environmental issues, energy conservation is anothercompelling reason for proper disposal of old appliances.  Refrigerators manufacturedtoday consume about one-third as much electricity as those manufactured 30years ago and about half as much as the typical unit manufactured before 1993.Additionally, the use of second refrigerators has grown steadily in the pasttwo decades, leading to an increase in household energy consumption. Everyyear, approximately 10 percent of households purchasing new refrigerators keeptheir old units, increasing the base of second units by 800,000 to 1 millionunits annually.  Currentlytwenty-six percent of all U.S households have a second refrigerator, a ratethat is growing at 1 percent per year.

 

Utilities have becomeimportant participants in dealing with energy inefficient appliances as a wayof reducing peak demand on their systems and avoiding the capital andenvironmental costs of adding new generating capacity.  To encourage the permanent removal of energyinefficient appliances from use, many electric utility companies sponsorprograms through which their residential customers can retire workingrefrigerators, freezers and room air conditioners.  Utility companies often provide assistanceand incentives for consumers to discontinue use of a surplus appliance or toreplace their old, inefficient appliances with newer, more efficientmodels.  To help accomplish this, someutilities offer appliance replacement programs for their low-income customers,through which older model refrigerators or room air conditioners are recycledand new highly efficient ENERGY STAR® units are installed.

 

The EPA has been supportive of efforts by electric utilities and otherentities that sponsor appliance recycling programs to ensure that the collectedunits are managed in an environmentally sound manner.  In October 2006, the EPA launched theResponsible Appliance Disposal (“RAD”) Program, a voluntary partnership programdesigned to help protect the ozone layer and reduce emissions of greenhousegases.  Through the RAD program, partnersuse best practices to recover ozone-depleting chemicals and other harmfulmaterials from old refrigerators, freezers, room air conditioners anddehumidifiers. We were active participants in helping to design the RAD programand currently collect and submit annual reports to the EPA to document theenvironmental benefits our utility customers have achieved through theirrecycling programs.

 

**CompanyBackground**

 

We started our businessin 1976 as a used-appliance retailer that reconditioned old appliances to sellat our stores.  Under contract withnational and regional retailers of new appliances, such as Sears and MontgomeryWard, we collected the replaced appliance from the customer’s residence whenone of their stores delivered a new appliance in the Minneapolis/St. Paul,Miami or Atlanta market.  The oldappliances that we could not sell in our stores were sold to scrap metalprocessors.

 

In the late 1980s,stricter environmental regulations began to affect the disposal of unwantedappliances, and we were no longer able to take appliances that containedhazardous components to a scrap metal processor.  At that time, we began to develop systems andequipment to remove the harmful materials so that metal processors would acceptthe appliance shells for processing.

 

We then offered ourservices for disposing of appliances in an environmentally sound manner toappliance manufacturers and retailers, waste hauling companies, rental propertymanagers, local governments and the public.

 

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***ApplianceRecycling for Energy Efficiency Programs***

 

In 1989, we begancontracting with electric utility companies to provide turnkey appliancerecycling services to support their energy conservation efforts.  Since that time, we have provided ourservices to more than 150 utilities throughout the U.S. and Canada.  Current programs include:

 

1.                    A bridge contract through March 2010 withSouthern California Edison (“Edison”) to handle refrigerator and freezerrecycling operations, extending Edison’s 2006-2008 appliance recycling program,which covers fifty percent of the previous southern and central Californiaterritories that we handled under Edison’s 2004-2005 program.  Under terms of this agreement, Edison isresponsible for advertising the program. We are negotiating a three-year contract extension, gaining backtwenty-five percent of our previously reduced territory to now serve seventy-fivepercent of Edison’s territory.

 

2.                    A contract with San Diego Gas & Electric (“SDG&E”)for their 2010-2012 program to provide refrigerator, freezer and room airconditioner recycling services for their residential and small commercialcustomers.  Under terms of this agreement,we are responsible for advertising the program.

 

3.                    A contract with Southern California Public PowerAuthority (“SCPPA”), which sponsors a program to replace and recycle old,inefficient refrigerators owned by low-income residents.  We currently perform these services for allparticipating members of SCPPA, including the Los Angeles Department of Waterand Power (“LADWP”).  The contract runsthrough June 2010.

 

4.                    An agreement with WPPI Energy (“WPPI”) to provideappliance recycling services through 2010. WPPI is a regional power company serving 51 customer-owned electricutilities.  They supply power to 195,000homes and businesses in Wisconsin, Upper Michigan and Iowa.  WPPI is responsible for advertising thisprogram.

 

5.                    An agreement entered into in December 2004 withAustin Energy in Texas to manage appliance recycling operations in theirservice territory during 2005.  Thecontract has been extended annually and currently runs through September 2010,with an additional one-year extension at the option of Austin Energy.  In 2008, Austin Energy initiated an appliancereplacement program for which we purchase and install new units and recycle theold ones.  Austin Energy is the nation’sninth largest community-owned electric utility, serving 388,000 customerswithin the City of Austin and surrounding counties.  Austin Energy is responsible for advertisingthis program.

 

6.                    A contract announced in June 2007 withOntario Power Authority (“OPA”) in Ontario, Canada, to recycle refrigerators,freezers and room air conditioners throughout the province.  The program is administered by OPA andmanaged by more than seventy local electric distribution companies.  This contract runs through the end of2010.  OPA is responsible for advertisingthis program.

 

7.                    A subcontracting agreement with Conservation ServicesGroup (“CSG”) to provide appliance recycling services to Ameren IllinoisUtilities (“AIU”) residential customers in Illinois.  The program is administered by CSG and thecontract is through May 2011.  CSGis responsible for advertising the program.

 

8.                    Subcontracting agreements with ICF International toprovide appliance recycling services for Southern Maryland ElectricalCooperative through December 2010 and for Baltimore Gas &Electric through February 2011.  Weare responsible for advertising these programs.

 

9.                    A contract to recycle refrigerators and freezersthrough January 2012 for Puget Sound Energy, which serves more than onemillion customers in the state of Washington. Puget Sound Energy is responsible for advertising the program.

 

10.              A contract with Xcel Energy to provide refrigeratorrecycling services for their customers in Minnesota, Colorado and New Mexicothrough December 2010.  Under termsof this agreement, we are responsible for advertising the program.

 

11.              Additionally, we have appliance recycling contractswith Minnesota Power; City Water Light and Power (“CWLP”); Great River Energy;Santee Cooper; Otter Tail Power Company; and several smaller municipal utilitycompanies.

 

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In the past three years,we have seen a heightened interest from electric utilities that recognize theeffectiveness of programs to recycle and replace energy inefficientappliances.  We are aggressively pursuingthis segment of customers in 2010 and expect that we will continue to submitproposals for various new utility appliance recycling and replacement programsthroughout the year.  However, we stillhave a limited ability to project revenues from new utility programs in2010.  We cannot predict recyclingvolumes or if we will be successful obtaining new contracts.

 

***ApplianceSmart Factory Outlets***

 

As of March 2010, ApplianceSmart was operating nineteen factoryoutlets: six in the Minneapolis/St. Paul market; one in Rochester, Minn.; fourin the Columbus, Ohio, market; six in the Atlanta market; and two in the SanAntonio, Texas, market.  We are a majorhousehold appliance retailer with two main channels: new, in-the-box productand new, out-of-the-box product, which we call special-buy appliances.  These special-buy household appliances,primarily those manufactured by Whirlpool, General Electric and Electrolux,include close-outs, factory overruns, floor samples, returned or exchangeditems, and scratch-and-dent units.  Oneexample of this type of special-buy product involves manufacturer redesign, inwhich a current model is updated to include a few new features and is thenassigned a new model number.  Because themanufacturer ships only the latest models to retailers, a large quantity of theolder model remains in the manufacturer’s inventory.  Special-buy appliances typically are notintegrated into manufacturers’ normal distribution channels and require adifferent method of management.

 

For many years,manufacturers relied on small appliance dealers to buy this product to sell intheir stores.  However, today these smallretailers are struggling to compete with large appliance chains: the top 10retailers are estimated to control 84 percent of the appliance salesmarket.  At the same time, the expansionof big-box retailers that sell appliances has created a dramatic increase inthe number of special-buy units, further straining the traditional outletsystem for these appliances.  Becausethese special-buy appliances have value, manufacturers and retailers need anefficient management system to recover their worth.

 

***ManufacturerSupply***

 

We have entered intopurchasing contracts for new, in-the box and new, out-of-the-box appliances,which have been extended through 2010, with the following five majormanufacturers:

 

1.               Whirlpool

2.               General Electric (“GE”)

3.               Electrolux

4.               Danby

5.               Bosch

 

There are no guaranteeson the number of units that any of the manufacturers will sell us; however, webelieve that purchases from these five manufacturers will provide an adequatesupply of high-quality appliances for our ApplianceSmart Factory Outlets.

 

Key components of ourcurrent agreements include:

 

1.               We have no guarantees for the number ortype of appliances that we have to purchase.

2.               The agreements may be terminated byeither party with 30 days’ prior written notice.

3.               We have agreed to indemnify certainmanufacturers for certain claims, allegations or losses concerning theappliances we sell.

 

***RegionalProcessing Centers***

 

On October 21,2009, we entered into an Appliance Sales and Recycling Agreement (the “Agreement”)with General Electric Company (“GE”) acting through its GE Consumer &Industrial business.  Under theAgreement, GE will sell all of its recyclable appliances generated in thenortheastern United States to us, and we will collect, process and recycle suchrecyclable 

 

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appliances.  The Agreement requires that we will onlyrecycle, and will not sell for re-use or resale, the recyclable appliancespurchased from GE.  We plan to establisha regional processing center (“RPC”) located in the northeastern United Statesat which the recyclable appliances will be processed.  The term of the Agreement is for a period ofsix years from the first date of collection of recyclable appliances.  We expect the first date of collection willbe early in the second quarter of 2010.

 

In connection withthe Agreement described above, we entered into a Joint Venture Agreement with4301 Operations, LLC, to establish and operate the northeastern RPC.  4301 Operations has substantial experience inthe recycling of major household appliances and will contribute their existingbusiness to the joint venture.  Under theJoint Venture Agreement, the parties will form a new entity to be known as ARCAAdvanced Processing, LLC (“AAP”) and each party will be a 50% owner ofAAP.  If additional RPCs are established,AAP will establish the next two RPCs and will have a right of first refusal toestablish subsequent RPCs.  We plan toraise debt and/or equity financing to fund our share of the capital required toform the joint venture.  We plan tocontribute approximately $2.0 million, including the Appliance Sales andRecycling Agreement, to the joint venture, and 4301 Operations plans tocontribute their equipment and existing business to the joint venture.  The joint venture plans to commenceoperations early in the second quarter of 2010; however, there is no assurancethat operations will commence or that financing will be available on termssatisfactory to us or permitted by our current debt agreement.  As of January 2, 2010, we loaned 4301Operations $0.4 million that will be considered as a portion of our capitalcontribution when the joint venture commences operations.

 

The Agreement iscontingent on the ability of the joint venture to raise additional financing topurchase and install UNTHA Recycling Technology (“URT”) equipment, enhancingthe capabilities of the RPC.  We are theexclusive distributor of URT equipment for North America**. **The joint venture plans to raiseadditional debt financing to purchase the URT equipment, but there is noassurance that the financing will be available or on terms acceptable to thejoint venture.

 

***Subsidiaries***

 

ARCA Canada Inc., aCanadian corporation, is a wholly-owned subsidiary.  ARCA Canada was formed in September 2006to provide turnkey appliance recycling services for electric utility energyefficiency programs.

 

We were a sixty percentowner in North America Appliance Company, LLC (“NAACO”).  NAACO was formed and commenced operations in June 2003and was a retailer of special-buy appliances in Texas.

 

We were a sixty percentowner in Productos Duraderos de Norte America (“PDN”), a Mexicancorporation.  PDN was acquired in September 2006and refurbished room air conditioners for sale through our NAACO operation inMcAllen, Texas, and through our ApplianceSmart Factory Outlet stores.

 

During the fourth quarterof 2008, we planned and executed the shutdown of our NAACO and PDNsubsidiaries.  NAACO and PDN were notoperating as planned and were no longer economically viable.  In 2008, our supply of room air conditionersfrom a major manufacturer was depleted, no longer providing refurbishmentopportunities for PDN and revenues for NAACO, which was the basis for ourinvestment in these businesses.  We willnot have any continuing involvement or significant continuing cash flows inthese businesses.

 

***GrowthStrategy***

 

Larger factory outletfacilities offer consumers a wider selection of appliances than smaller storesdo and are more efficient for us to operate. For these reasons, we intend to continue to focus our retail salesoperations on larger facilities.  Wewould consider opening new stores primarily in markets in which we currentlyhave operations to benefit from operational and marketing efficiencies ofscale.  However, we will study othermajor consumer markets throughout the United States with the possibility ofexpanding our retail stores to new markets. We evaluate demographic, economic and financial information as well asthe facility and proposed lease terms when considering a new storelocation.  At the end of August 2009,we closed one store in San Antonio, Texas, when the facility lease expired, andclosed and vacated our ApplianceSmart Factory Outlet store in Stockbridge,Georgia.  We continue to evaluate factoryoutlet stores and markets and address underperforming stores with a range ofoutcomes from expense reductions to store closings.  We do not anticipate opening any additionalfactory outlet stores in 2010.

 

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We have also seen renewedinterest from sponsors of energy efficiency programs across the country thatrecognize the effectiveness of recycling energy inefficient appliances.  At times, program sponsors may also choose toassist their customers in replacing these inefficient appliances with new,highly efficient ENERGY STAR® models.  Weare aggressively pursuing this segment of customers in 2010 and expect that wewill continue to submit proposals for various new utility appliance recyclingand replacement programs.

 

In 2008, we entered intoan agreement to become the exclusive North American distributor for UNTHA RecyclingTechnology (URT), one of the world’s leading manufacturers of technologicallyadvanced refrigerator recycling systems and recycling facilities for electricalhousehold appliances and electronic scrap. In addition to marketing these systems to the recycling industry, weintend to install a URT system at one of our higher volume appliance recyclingfacilities. We expect our first installation to be at our northeastern RPC.

 

**Customersand Source of Supply**

 

We offer reverselogistics services to manufacturers and retailers that need an efficient way tomanage appliances that fall outside their normal distribution and saleschannels.  We also provide services forelectric utility companies that offer their customers appliance recycling andreplacement programs as energy conservation measures.

 

*Appliance Manufacturers**:*  We work withappliance manufacturers, including Whirlpool, Electrolux, GE, Bosch and Danby,to acquire the product we sell at our ApplianceSmart Factory Outletstores.  We purchase new, special-buyappliances, such as discontinued models and factory overruns, and sell theproduct at a significant discount to full retail prices.  In addition, our participation in a nationalbuying cooperative enables us to purchase new in-the-box appliances to fill outour mix of product.

 

Although we believe thatour current sources for appliances are adequate to supply our retail stores andallow us to grow our sales, we face the risk that one or more of these sourcescould be lost.

 

*Electric Utility Companies**:*  We contractwith utility companies and other sponsors of energy efficiency programs toprovide a full range of appliance recycling and replacement services to helpthem achieve their energy savings goals. The contracts usually have terms of one to four years, with provisionsfor renewal at the option of the utility. Under some contracts, we manage all aspects, including advertising, ofthe appliance recycling or replacement program. Under other contracts, we provide only specified services, such ascollection and recycling.

 

Our contracts withelectric utility customers prohibit us from repairing and selling appliances wereceive through their programs.  Becausethe intent of the program is to conserve electricity, we have instituted trackingand auditing procedures to assure our customers that those appliances do notreturn to use.

 

Our pricing for energyefficiency program contracts is on a per-appliance basis and depends uponseveral factors, including:

 

1.                    Total number of appliances expected to be processedand/or replaced.

2.                    Length of the contract term.

3.                    Specific services the utility selects us to provide.

4.                    Market factors, including labor rates andtransportation costs.

 

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Currently, we havecontracts for 2010 with the following utilities to handle recycling operationsin their service territories:

 
| 1.  |   | Southern California  Edison                 |
|-----|--------|---------------------------------------------|
| 2.  |   | San Diego  Gas & Electric          |
| 3.  |   | WPPI Energy                                 |
| 4.  |   | Austin Energy                               |
| 5.  |   | Southern California  Public Power Authority |
| 6.  |   | Ontario Power Authority                     |
| 7.  |   | Minnesota Power                             |
| 8.  |   | Ameren Illinois  Utilities                  |
| 9.  |   | City Water  Light & Power          |
| 10. |   | Xcel Energy                                 |
| 11. |   | Santee Cooper                               |
| 12. |   | Great River Energy                          |
| 13. |   | Southern Maryland  Electrical Cooperative   |
| 14. |   | Puget Sound Energy                          |
| 15. |   | Baltimore  Gas & Electric          |
| 16. |   | Otter Tail Power  Company                   |
| 17. |   | Several smaller  municipal utilities        |

 

**CompanyOperations**

 

We provide a full rangeof appliance recycling support services for energy efficiency programs in theU.S. and Canada.  We also purchase majorappliances, primarily from appliance manufacturers, to sell through ourApplianceSmart Factory Outlets.

 

Many of the appliances wereceive from manufacturers are still in the factory carton and ready tosell.  Other appliances need repair orcosmetic work before we deliver them to our ApplianceSmart retail outlets.  All appliances we sell are under factorywarranty and carry a 100 percent money-back guarantee.  We also offer extended warranties, appliancedelivery, factory-trained technician service and free recycling of customers’replaced appliances.

 

Appliances that do notmeet our quality standards for sale at our ApplianceSmart Factory Outlets andappliances collected through utility customers’ energy conservation programsmust be recycled to prevent re-use.  Weprocess and recycle these units using environmentally sound systems andtechniques.

 

In our recyclingoperation, our Company-trained technicians first inspect and categorize eachappliance to identify the types of hazardous materials it contains.  We then process the appliances to remove andmanage the environmentally hazardous substances according to all federal, stateand local regulations.  We deliver theprocessed appliances to local scrap processing facilities, where they shred andrecycle the metals.

 

Although the potential ofindustry deregulation negatively affected our business with electric utilitiesin the middle to late 1990s, we are seeing renewed interest in appliancerecycling and replacement programs for energy efficiency.  We enter 2010 serving seven major utilityprograms and several smaller ones.  Weare aggressively pursuing additional utility customers, but have a limitedability to project revenues from new utility programs in 2010.  We cannot predict recycling or replacementvolumes or if we will be successful obtaining new contracts.

 

We have focused on acarefully managed growth plan to strengthen our retail segment.  We opened four new factory outlets in 2008and one in 2009.  In the third quarter2009, we closed one underperforming factory outlet in the Atlanta market andone store in San Antonio when the facility lease expired.  To supply our stores with a wide selection ofappliances, we will continue to seek additional sources of product.  We currently operate nineteen factory outletsin strategic markets throughout the U.S. We continue to evaluate factory outlet stores and markets and addressunderperforming stores with a range of outcomes from expense reductions tostore closings.  We do not anticipateopening any additional factory outlet stores in 2010.

 

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**PrincipalProducts and Services**

 

We generate revenues fromthree sources: retail, recycling and byproduct. Retail revenues are generated through the sale of new appliances at ourApplianceSmart Factory Outlets. Recycling revenues are generated by charging fees for collecting andrecycling appliances for utilities and other sponsors of energy efficiencyprograms.  Byproduct revenues aregenerated by selling scrap materials, such as metal and plastics, and reclaimedCFC refrigerants from appliances we collect and recycle, including those fromour ApplianceSmart stores.

 

The table belowreflects the percentage of total revenues from continuing operations from eachsource for the past two fiscal years. See also “Management’s Discussion and Analysis of Financial Conditionand Results of Operations.”

 
| ** ** | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------|------------|----------|------------|----------|------------|
| Retail     |       | 74.1     | %          | 68.6     | %          |
| Recycling  |       | 22.5     | %          | 26.7     | %          |
| Byproduct  |       | 3.4      | %          | 4.7      | %          |
|       |       | 100.0    | %          | 100.0    | %          |

 

During fiscal years 2009 and 2008, we operated two reportable segments:retail and recycling.  The retail segmentis comprised of sales generated through our ApplianceSmart FactoryOutlets.  Our recycling segment includesall fees charged for collecting, recycling and installing appliances forutilities and other customers and includes byproduct revenue, which isgenerated primarily through the recycling of appliances.  Financial information about our segments isincluded in “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” and Note 15 of “Notes to ConsolidatedFinancial Statements.”

 

**Sales andMarketing**

 

We use a variety ofmethods to promote awareness of our products and services.  We believe that we are recognized as a leaderin the recycling industry and in special-buy appliance retailing.

 

Our ApplianceSmartFactory Outlet store concept includes establishing large showrooms inmetropolitan locations where we can offer consumers a selection of hundreds ofappliances at each of our stores.  Ourvisual branding consists of ample display of product, manufacturers’ signageand custom-designed ApplianceSmart materials in red, white and blue.  We advertise our stores through print media,television, radio and direct mail. Through www.ApplianceSmart.com, consumers can also learn more about uson the Internet.

 

To evaluate theeffectiveness of ApplianceSmart’s current advertising venues and messages, wehave engaged a consulting group to help us analyze our branding and marketingefforts that will allow ApplianceSmart to explore new directions in reachingconsumers. We expect this analysis to yield valuable results by helpingApplianceSmart to expand on its current message and advertising methods.

 

We market our services toelectric utility companies and other sponsors of energy efficiency programs bycontacting prospective customers directly, delivering educational presentationsat conferences for energy efficiency professionals, participating in utilityindustry trade shows, networking with key affiliates of electric power andenvironmental associations, and promoting our corporate website atwww.arcainc.com.  We submit salesproposals for our services to interested parties and in response toutility-issued requests for bid.

 

**Seasonality**

 

We experience someseasonality in retail revenues, with revenues in the second and third calendarquarters being slightly higher than revenues in the first and fourth calendarquarters.

 

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Traditionally, ourelectric utility customers with multi-year programs have rolled out theirprograms towards the end of the first calendar quarter.  Promotional activities are strong during thesecond and third calendar quarters, leading to higher customer demand forservices during that time period.  As aresult, we experience a surge in business during the second and third calendarquarters, which declines through the fourth and first calendar quarters untiladvertising activities resume.

 

**Competition**

** **

Our retail competitioncomes mainly from new-appliance and other special-buy retailers.  Each ApplianceSmart Factory Outlet competeswith local and national retail appliance chains, as well as with independentlyowned retailers.  Many of these retailershave been in business longer than we have and may have significantly greaterassets.

 

Many factors, includingobtaining adequate resources to create and support the infrastructure requiredto operate large-scale appliance recycling programs, affect competition in theappliance recycling industry.  Wegenerally compete for contracts with several other national appliance recyclingbusinesses and energy services management companies.  We also compete with small hauling orrecycling companies based in the program’s service territory; however, thesecompanies generally are not able to offer the full range of services that weprovide.

 

We expect our primarycompetition for appliance recycling contracts with existing and new customersto come from a variety of sources, including:

 

1.                     Existing recycling companies.

2.                     Entrepreneurs entering the appliancerecycling business.

3.                     Energy management consultants.

4.                     Major waste hauling companies.

5.                     Scrap metal processors.

 

In addition, utilitycompanies and other customers may choose to provide all or some of the servicesrequired to operate their appliance recycling programs internally rather thancontracting with outside vendors.  Wehave no assurance that we will be able to compete profitably in any of ourchosen markets.

 

**GovernmentRegulation**

 

Federal, state and localgovernments regulate appliance collection, recycling and sales activities.  While some requirements apply nationwide,others vary by market.  The many laws andregulations that affect appliance recycling include landfill disposalrestrictions, hazardous waste management requirements and air qualitystandards.  For example, the 1990Amendments to the Clean Air Act prohibit the venting of CFC and CFC-substituterefrigerants while servicing or disposing of appliances.

 

Each of our recyclingfacilities maintains the appropriate registrations, permits and licenses foroperating at its location.  We registerour recycling centers as hazardous waste generators with the EPA and obtain allappropriate regional and local licenses for managing hazardous wastes.  Licensed hazardous waste companies transportand recycle or dispose of the hazardous materials we generate.  Our collection vehicles and ourtransportation employees comply with all Department of Transportation licensingrequirements.

 

We have been recognizedfor our work in protecting the environment from the harmful effects of improperappliance disposal.  In 2004, the EPAawarded us, along with our customer Southern California Edison, theStratospheric Ozone Protection Award for the environmentally responsible mannerin which we collect and dispose of appliances. In 2007, we were again recognized by the EPA with a Best of the BestStratospheric Ozone Protection Award as part of an appliance recycling teamresponsible for “the most exceptional global contributions in the first twodecades of the Montreal Protocol.”

 

In 2007, we became afounding reporter of The Climate Registry, an organization that providesinformation regarding the measurement and reporting of greenhouse gas emissionsto various governmental and private agencies and businesses.

 

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In 2009, our Presidentand Chief Executive Officer, Jack Cameron, was selected to represent theappliance recycling industry in the Climate Action Reserve’s 23-memberworkgroup that was tasked with developing the U.S. Ozone-Depleting Substances(ODS) Project Protocol for the Destruction of Domestic High Global WarmingPotential (GWP) Ozone-Depleting Substances. The Climate Action Reserve is a national offsets program working toensure integrity, transparency and financial value in the U.S. carbonmarket.  The protocol, which was issuedon February 3, 2010, provides guidance to account for, report and verifygreenhouse gas (GHG) emission reductions associated with destruction of highglobal warming potential ODS that would have otherwise been released to theatmosphere, including ODS used in both foam and refrigerant applications.

 

Our retail stores obtainall business licenses, sales tax licenses and permits required for theirlocations.  Our delivery and servicevehicles comply with all Department of Transportation licensing requirements.

 

Although we believe thatfurther governmental regulation of the appliance recycling industry could havea positive effect on us, we cannot foretell the direction of futurelegislation.  Under some circumstances,for example, further regulation could materially increase our operationalcosts.  In addition, under somecircumstances we may be subject to contingent liabilities because we handlehazardous materials.  We believe we arein compliance with all government regulations regarding the handling ofhazardous materials, and we have environmental insurance to mitigate the impactof any potential contingent liability.

 

**Employees**

 

At March 1, 2010 wehad 360 full-time employees and 18 part-time employees, distributedapproximately as follows:

 

1.       30% of our employees, includingmanagement, provide customer service, appliance collection, transportation andprocessing services at our recycling centers.

2.       60% of our employees, includingmanagement, work in our factory outlet stores.

3.       10% of our employees are corporatemanagement and support staff.

 

We have no union orcollective bargaining agreements covering any of our employees.  Our employees have never caused ouroperations to be disrupted by a work stoppage, and we believe that our employeerelations are good.

 

**ITEM 1A.               RISKFACTORS**

 

*An investment in our Common Stockinvolves a high degree of risk.  Youshould carefully consider the risks described below with respect to aninvestment in our shares.  If any of thefollowing risks actually occur, our business, financial condition, operatingresults or cash provided by operations could be materially harmed.  As a result, the trading price of our CommonStock could decline, and you might lose all or part of your investment.  When evaluating an investment in our CommonStock, you should also refer to the other information in this report, includingour financial statements and related notes.*

 

**Risks Relating to Our Business**

 

***Ourstrategy of opening new retail stores may result in net losses.***

 

Our growth strategyincludes opening new retail stores.  Weevaluate demographic, economic and financial information in considering a newstore location.  We look primarily inmarkets where we currently have operations to benefit from additionaloperational and marketing efficiencies of scale.  New stores take time to become profitable; wecannot assure you that any individual current or future store will attain ormaintain projected profitability.  Weincurred a loss from continuing operations of $3.3 million or $0.73 per sharein fiscal 2009 compared to income from continuing operations of $1.9 million or$0.41 per share in fiscal 2008.  We havehistorically experienced improvement in our retail segment as our stores havebecome established.  As illustrated inNote 15 of “Notes to Consolidated Financial Statements,” our operating lossfrom the retail segment was $4.2 million in fiscal 2009 compared to operatingincome of $0.8 million in fiscal 2008. This decline was the result of opening new factory outlets and aneconomic slowdown that is discussed later in “Risks Relating to Our 

 

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Business.” Our fullfinancial information is set out in the consolidated financial statements andrelated notes and “Management’s Discussion and Analysis of Financial Conditionand Results of Operations.”

 

***Mostof our revenues are derived from retail sales. However, we expect recycling revenues as a percentage of total revenueswill continue to rise in the future.***

 

Most of our revenues arederived from retail sales of appliances at our ApplianceSmart Factory Outletstores.  We currently operate nineteenApplianceSmart Factory Outlet stores. Retail revenues have lower profit margins than recycling revenues. Whilewe believe that our future economic results will be heavily dependent on ourretail stores, we have seen a renewed interest in recycling and replacementprograms and are pursuing opportunities with providers of energy efficiencyservices.  In fiscal years 2009 and 2008,approximately 74% and 69%, respectively, of our revenues were from retailsales.  We believe that recyclingrevenues will grow faster than retail revenues as we continue to add newrecycling contracts.

 

***Wecurrently purchase product for resale from a limited number of suppliers.***

 

We purchase inventory forresale from three main suppliers.  Whilewe believe that our relationships with our vendors are strong, the loss of oneof these suppliers could have a negative impact on the amount and mix ofproduct that we would be able to offer for sale, which could adversely affectour revenues and profitability.

 

***Ourrevenues from recycling contracts decreased in 2009 due a planned reduction inone of our contracts and future revenues from this source are very difficult toproject.***

 

In the past, our businesswas dependent largely upon our ability to obtain new contracts and continueexisting contracts for appliance recycling services with utilitycompanies.  Contracts with these entitiesgenerally have initial terms of one to four years, with renewal options andearly termination clauses.  The recyclingand byproducts portion of our business decreased to 26% from 31% of totalrevenues for fiscal years 2009 and 2008, respectively.  This decrease in fiscal 2009 compared tofiscal 2008 was partially due to a planned reduction in one of ourcontracts.  Although we have experiencedan increase in the number of utility companies requesting bids for upcomingappliance recycling programs, we are still dependent on certain customers for alarge portion of our revenues. Generally, recycling revenues have a higher gross profit than retailrevenues.

 

Three of our majorutility customers, Southern California Edison Company, Ontario Power Authorityand Southern California Public Power Authority, collectively accounted forapproximately 17% and 23% of our total revenues for 2009 and 2008,respectively.  The loss or materialreduction of business from any of these major customers could adversely affectour net revenues and profitability.  However,we believe we will continue to add new recycling contracts in 2010 and beyond.

 

We cannot assure you thatour existing recycling contracts will continue, existing customers willcontinue to use our services at current levels or we will be successful inobtaining new recycling contracts.

 

***Ourrevenues from recycling contracts are subject to seasonal fluctuations and aredependent on the utilities’ advertising and promotional activities forcontracts in which we do not provide advertising services.***

 

In our business withutility companies, we experience seasonal fluctuations that impact ouroperating results.  Our recyclingrevenues are generally higher during the second and third calendar quarters andlower in the first and fourth calendar quarters, due largely to the promotionalactivity schedules over which we have no control in advertising programsmanaged by the utilities.  Our staffcommunicates client-driven advertising activities internally in an effort toachieve an operational balance.  We expectthat we will continue to experience such seasonal fluctuations in recyclingrevenues.  We experience less seasonalfluctuation in our retail business.

 

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***Thejoint venture we have formed does not have an operating history upon which itcan be evaluated.  It may never achieveprofitable operations.***

 

We have formed a 50/50joint venture, ARCA Advanced Processing, LLC (“AAP”), to operate the initialRegional Processing Center (“RPC”) under our contract with GE.  AAP was recently formed and has not commencedoperations.  AAP is subject to all of therisks associated with a new venture, including the potential for unanticipatedexpenses, difficulties and delays frequently encountered in connection with thestart-up of new businesses, and the competitive environment in which AAP willoperate.  There is no assurance that AAPwill achieve profitable operations.  Eachadditional RPC that may be established in the future will also be subject tothe risks associated with a new venture.

 

***AAP’sfinancial performance will be dependent on market prices for recoveredmaterials.***

 

AAP’s total revenues willbe driven by the market prices for various recovered materials, which includesteel, copper, aluminum, other non-ferrous metals, glass, plastic, oil, andcertain types of refrigerants.  Marketprices for such materials may vary significantly.  If market prices for such materials are lessthan projected, AAP may be unable to achieve profitable operations.

 

***The volumeof appliances under the contract with GE is not guaranteed.  The contract with GE is terminable on 60-daynotice if a material breach occurs and is not cured.***

 

Theoperations of AAP and the initial RPC will be materially dependent on thevolume of appliances from GE.  However,GE has not guaranteed any specific volume of appliances under thecontract.  Also, the RPC will need significant volume inaddition to the volume from GE to operate successfully.  Thecontract with GE is for a period of six years from the first date of collectionof recyclable appliances from GE’s northeast delivery area, but may beterminated earlier by either party if the other party is in material breach ofthe contract and does not cure the breach within sixty (60) days afterreceiving written notice from the other party. A delay in commencing operations at the RPC, or in installing the URTsystem, could result in a material breach of the contract by us.

 

***Wemay need new capital to fully execute our growth strategy.***

 

Our business involvesproviding comprehensive, integrated appliance recycling services and developinga chain of retail stores.  Thiscommitment will require a significant continuing investment in capitalequipment and leasehold improvements and could require additional investment inreal estate.

 

Our total capitalrequirements will depend, among the other things discussed in this annualreport, on the number of recycling centers and the number and size of retailstores operating during 2010.  Currently,we have nineteen retail stores and seven recycling centers in operation.  If our revenues are lower than anticipated,our expenses are higher than anticipated or our current line of credit cannotbe maintained, we will require additional capital to finance our operations.  In addition, we may need to provideadditional capital to AAP to establish and fund its operation.  Even if we are able to maintain our currentline of credit, we may need additional equity or other capital in the future.  Sources of additional financing, if needed inthe future, may include further debt financing or the sale of equity (includingthe issuance of Preferred Stock) or other securities.  We cannot assure you that any additionalsources of financing or new capital will be available to us, available onacceptable terms, or permitted by the terms of our current debt.  In addition, if we sell additional equity toraise funds, all outstanding shares of Common Stock will be diluted.

 

***Adecline in general economic conditions has led to reduced consumer demand forour products and had an adverse effect on our liquidity and profitability.***

 

Since purchases of ourmerchandise are dependent upon discretionary spending by our retail customers,our financial performance is sensitive to changes in overall economicconditions that affect consumer spending. Consumer spending habits are affected by, among other things, prevailingeconomic conditions, levels of employment, salaries and wage rates, gasolineprices, consumer confidence, and consumer perception of economicconditions.  A slowdown in the UnitedStates economy or uncertainty as to the economic outlook has reduceddiscretionary spending or caused a shift in consumer 

 

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discretionary spending toother products during fiscal year 2009. These factors may likely cause us to delay or slow our expansion plans,may result in reduced sales and potentially result in excess inventories in2010.  This may, in turn, lead toincreased merchandise markdowns and related costs associated with higher levelsof inventory that could adversely affect our liquidity and profitability in 2010.

 

***Ourmarket share may be adversely impacted at any time by a significant number ofcompetitors.***

 

Competition for ourretail stores comes primarily from retailers of new and special-buyappliances.  Each of our locations willcompete not only with local and national chains of new appliance retailers,many of whom have been in business longer than we have and who may havesignificantly greater assets, but will also be required to compete withnumerous independently owned retailers of used appliances.  A number of our retail operations have beenopened within the past 24 months; therefore, we cannot assure you that we willbe able to compete effectively in any such market.

 

Many factors, includingexisting and proposed governmental regulation, may affect competition in theappliance recycling and replacement side of our business.  We generally compete with two or threecompanies based in the geographic area to be served, and they generally offersome of the services we provide.  Weexpect our primary competition for contracts with existing or new customers tocome from entrepreneurs entering the appliance recycling business, energymanagement consultants, current recycling companies, major waste haulingcompanies, scrap metal processors and new- and used-appliance dealers.  In addition, some of our customers, such asutility companies, may operate appliance recycling programs internally ratherthan contracting with us or other third parties.  We cannot assure you that we will be able tocompete profitably in any of our chosen markets.

 

***Changesin governmental regulations relating to our recycling business could increaseour costs of operations and adversely affect our business.***

 

Our appliance recyclingcenters are subject to various federal, state and local laws, regulations andlicensing requirements related to providing turnkey services for energyefficiency programs.  These requirementsmay vary by market location and include, for example, laws concerning themanagement of hazardous materials and the 1990 Amendments to the Clean Air Act,which require us to recapture CFC refrigerants from appliances to prevent theirrelease into the atmosphere.

 

We have registered ourcenters with the EPA as hazardous waste generators and have obtained requiredlicenses from appropriate state and local authorities.  We have agreements with approved and licensedhazardous waste companies for transportation and recycling or disposal ofhazardous materials generated through our recycling processes.  As is the case with all companies handlinghazardous materials, under some circumstances we may be subject to contingentliability.  We believe we are incompliance with all government regulations regarding the handling of hazardousmaterials, and we have environmental insurance to mitigate the impact of anypotential contingent liability.

 

***Ourlender has the right to demand payment in full of the borrowings under our lineof credit at any time.  If it were to doso, we would not be able to pursue our growth strategy and our operations wouldbe severely limited unless and until new financing was obtained.***

 

We have an $18.0 million line of credit, basedon the loan amendment dated February 5, 2008, with a stated maturity dateof December 31, 2010.  The line of credit also provides that thelender may demand payment in full of the entire outstanding balance of the loanat any time.  Except for the one propertywe own, substantially all assets have been pledged to secure payments under theline. The line requires that we meet certain financial covenants, providespayment penalties for noncompliance and prepayment, limits the amount of otherdebt we can incur, limits the amount of spending on fixed assets, and limitspayments of dividends.  On March 1,2010, borrowings of $10.6 million wereoutstanding under the line of credit, and we had unused borrowing capacity of $0.8 million.  As of January 2, 2010, we were not incompliance with certain financial covenants and received a waiver from ourlender.  On March 10, 2010, theinterest rate on the line increased to 6.75% (the greater of prime plus 3.50percentage points or 6.75%).  In 2010, weplan to renegotiate and extend our line of credit.

 

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***Wemay not be able to operate successfully if we lose key personnel, are unable tohire qualified personnel or experience turnover of our management team.***

 

We believe our operationsare materially dependent upon the continued services of our present management.  The loss of services of one or more membersof present management, including Edward R. (Jack) Cameron, our founder,Chairman of the Board and current CEO, could adversely affect our business.  We do not have employment contracts withpresent management.  We maintain keyperson life insurance on Mr. Cameron in the amount of $1.0 million.

 

***Wehave ongoing litigation surrounding intellectual property issues and have had aclaim of infringement in a second law suit dismissed.***

 

In December 2004, wefiled suit in the U.S. District Court for the Central District of Californiaalleging that JACO Environmental, Inc. (“JACO”) and one of our formerconsultants fraudulently obtained U.S. Patent No. 6,732,416 in May 2004covering appliance recycling methods and systems which were originallydeveloped by us beginning in 1987 and used in serving more than forty-fiveelectric utility appliance recycling programs up to the time the suit wasfiled.  We sought an injunction to prevent JACO from claiming that it obtaineda valid patent on appliance recycling processes that we believe is based onmethods and processes we invented.  Inaddition, we asked the Court to find that the patent obtained by JACO isunenforceable due to inequitable conduct before the United States PatentOffice.  We also asked the court for unspecified damages related tocharges that JACO, in using the patent to promote its services, engaged inunfair competition and false and misleading advertising under federal andCalifornia statutes.

 

In September 2005,we received a legally binding document in which JACO stated it would not sue usor any of our customers for violating the JACO patent.  Further, the defendants in the case did notassert any counterclaims against ARCA.

 

In January 2009, theCourt granted JACO a summary judgment in ARCA’s lawsuit against theparties.  The ruling was made by the samejudge who had earlier denied summary judgment to the defendants.  Even though the Court’s ruling will have noimpact on ARCA’s method of recycling or ability to conduct existing and futurebusiness, we filed an appeal with the Ninth Circuit Court of Appeals inCalifornia in February 2009 seeking to have the court set aside thesummary judgment.  We believe thedecision by the trial judge was in error and contrary to the law relating tounfair competition and false advertising. We believe we are entitled to our day in court against JACO for damagescaused by their actions, and our case is scheduled to be argued before theNinth Circuit Court of Appeals on April 9, 2010.

 

On October 24, 2006,JACO and SEG Umwelt-Service/Basis of Mettlach, Germany (SEG) filed a patentinfringement lawsuit in Federal Court in San Francisco against us.  The suit claimed that we had been usingrefrigerator recycling systems and processes covered by two U.S. patents issuedto SEG and exclusively licensed to JACO.  JACO and SEG sought anundisclosed amount in damages, in addition to an injunction barring us fromcontinuing to use and market the systems and processes upon which we allegedlyinfringed.  This suit was subsequentlydismissed following a transfer of the case to Los Angeles upon the motion ofARCA.

 

**Risks Relating to Our CommonStock**

 

***If anactive trading market for our Common Stock does not develop, the value andliquidity of your investment in our Common Stock could be adversely affected.***

 

The trading volumes inour Common Stock on the NASDAQ Capital Market are highly variable.  At any given time, there may be only alimited market for any shares of Common Stock that you purchase.  Sales of substantial amounts of Common Stockinto the public market at the same time could adversely affect the market priceof our Common Stock.

 

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***Ourprincipal shareholders own a large percentage of our voting stock, which willallow them to control substantially all matters requiring shareholder approval.***

 

Currently, Jack Cameron,Chairman and Chief Executive Officer, beneficially owns approximately 7.6% of our Common Stock.  Our officers and directors togetherbeneficially hold approximately 10.5%of our Common Stock.  MedallionCapital, Inc. (“Medallion”) owns approximately 10.7% of our outstanding common shares.  Medallion also has a non-voting right toattend and participate in all meetings of our Board of Directors.  Perkins Capital Management, Inc. ownsapproximately 16.2% of ouroutstanding common shares.  Because ofsuch ownership, our management and principal shareholders may be able tosignificantly affect our corporate decisions, including the election of theBoard of Directors.

 

**ITEM 2.                 PROPERTIES**

 

Our executive offices arelocated in Minneapolis, Minnesota, in a leased facility that includes approximately11 acres of land.  The building containsapproximately 126,000 square feet, consisting of 27,000 square feet of officespace, 66,000 square feet of operations and processing space, and 33,000 squarefeet of retail space (as identified below with an opening date of June 1998).We also own and use a building in Compton, California, with 11,000 square feetof office space and 35,000 square feet of warehouse and processing space.  Our building in Compton, California, servesas collateral securing the outstanding mortgage loan.

 

We currently operatenineteen retail stores in the following locations:

 
| **Market** | ** ** | **Opening Date**    | ** ** | **Retail  Space   (Sq. Ft.)** | ** ** | ** **                                                     |
|------------|------------|---------------------|------------|-------------------------------|------------|----------------------------------------------------------------|
| Minnesota  |       | June 1998      |       | 33,000                        |       |                                                           |
|       |       | January 2001   |       | 24,000                        |       |                                                           |
|       |       | October 2001   |       | 49,000                        |       |                                                           |
|       |       | February 2003  |       | 33,000                        |       |                                                           |
|       |       | December 2004  |       | 30,000                        | * *   | *(Also has 29,000 square feet of warehouse space)*             |
|       |       | May 2008       |       | 23,000                        |       |                                                           |
|       |       | December 2008  |       | 31,000                        |       |                                                           |
|       |       |                |       |                          |       |                                                           |
| Ohio       |       | June 1997      |       | 20,000                        |       |                                                           |
|       |       | May 2001       |       | 32,000                        |       |                                                           |
|       |       | March 2002     |       | 30,000                        |       |                                                           |
|       |       | December 2007  |       | 30,000                        |       |                                                           |
|       |       |                |       |                          |       |                                                           |
| Georgia    |       | December 2003  |       | 30,000                        |       |                                                           |
|       |       | November 2004  |       | 30,000                        | * *   | *(Also has 58,000 square feet of  production/warehouse space)* |
|       |       | December 2006  |       | 46,000                        |       |                                                           |
|       |       | December 2008  |       | 33,000                        |       |                                                           |
|       |       | January 2009   |       | 25,000                        |       |                                                           |
|       |       | November 2009  |       | 28,000                        |       |                                                           |
|       |       |                |       |                          |       |                                                           |
| Texas      |       | October 2005   |       | 37,000                        |       |                                                           |
|       |       | September 2008 |       | 30,000                        |       |                                                           |

 

We lease all of ourretail store facilities.  We generallyattempt to negotiate lease terms of five to ten years for our retail stores.

 

We operate sevenprocessing and recycling centers.  One islocated in the facility that we own in California.  The other six are leased facilities inOakville, Ontario; St. Louis Park, Minnesota; Austin, Texas; Springfield,Illinois; Commerce City, Colorado; and Kent, Washington.  Our recycling centers typically range in sizefrom 6,000 to 42,000 square feet.

 

We believe that all ofthe facilities we occupy currently are adequate for our future needs.

 

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**ITEM 3.                 LEGAL PROCEEDINGS**

 

In December 2004, wefiled suit in the U.S. District Court for the Central District of Californiaalleging that JACO Environmental, Inc. (JACO) and one of our formerconsultants fraudulently obtained U.S. Patent No. 6,732,416 in May 2004covering appliance recycling methods and systems which were originallydeveloped by us beginning in 1987 and used in serving more than forty-fiveelectric utility appliance recycling programs up to the time the suit wasfiled.  We sought an injunction to prevent JACO from claiming that itobtained a valid patent on appliance recycling processes that we believe isbased on methods and processes we invented. In addition, we asked the Court to find that the patent obtained by JACOis unenforceable due to inequitable conduct before the United States PatentOffice.  We also asked the court for unspecified damages related tocharges that JACO, in using the patent to promote its services, engaged inunfair competition and false and misleading advertising under federal andCalifornia statutes.

 

In September 2005,we received a legally binding document in which JACO stated it would not sue usor any of our customers for violating the JACO patent.  Further, the defendants in the case did notassert any counterclaims against ARCA.

 

In January 2009, theCourt granted JACO a summary judgment in ARCA’s lawsuit against theparties.  The ruling was made by the samejudge who had earlier denied summary judgment to the defendants.  Even though the Court’s ruling will have noimpact on ARCA’s method of recycling or ability to conduct existing and futurebusiness, we filed an appeal with the Ninth Circuit Court of Appeals inCalifornia in February 2009 seeking to have the court set aside thesummary judgment.  We believe thedecision by the trial judge was in error and contrary to the law relating tounfair competition and false advertising. We believe we are entitled to our day in court against JACO for damagescaused by their actions, and our case is scheduled to be argued before theNinth Circuit Court of Appeals on April 9, 2010.

 

On October 24, 2006,JACO and SEG Umwelt-Service/Basis of Mettlach, Germany (SEG) filed a patentinfringement lawsuit in Federal Court in San Francisco against us.  The suit claimed that we had been usingrefrigerator recycling systems and processes covered by two U.S. patents issuedto SEG and exclusively licensed to JACO.  JACO and SEG sought anundisclosed amount in damages, in addition to an injunction barring us fromcontinuing to use and market the systems and processes upon which we allegedlyinfringed.  This suit was subsequentlydismissed following a transfer of the case to Los Angeles upon the motion ofARCA.

 

In December 2009,a lawsuit in the Fourth Judicial District Court of Hennepin County, Minnesotahas been commenced by RKL Landholdings, LLC and Emad Y. Abed relating to thepotential sale of our St. Louis Park, Minnesota property.  This property has been sold to a third partyand all proceeds from the sale have been received by us. The claims made by thePlaintiffs in this matter have been alleged against both Appliance RecyclingCenters of America, Inc. and Edward Cameron, individually.  The claims relate to an originally executedPurchase Agreement and extensions thereto executed between the parties, whichPurchase Agreement and extensions all expired by their own terms.  The Plaintiffs have alleged various facts andclaims, including promissory estoppel, unjust enrichment, conversion, fraud,tortuous interference with prospective advantage, and breach of contract.  We plan to vigorously defend these claims andbelieve that any outcome will not have a material impact on our results ofoperations or financial position.

 

We are party from time totime to other ordinary course disputes that we do not believe to be material.

 

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**PART II**

 

**ITEM 5.****                ****MARKET FOR OUR COMMON EQUITY,RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

**Marketfor Common Stock**

 

Our Common Stocktrades under the symbol “ARCI” on the NASDAQ Capital Market.  The following table sets forth for theperiods indicated the high and low prices for our Common Stock, as reported bythe NASDAQ Capital Market.  Thesequotations reflect the daily close prices.

 
| ** **      | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------|------------|----------|------------|---------|------------|
| **2009**        |       |     |       |    |       |
| First  Quarter  |       | $        | 3.65       |    | $          | 1.06 |   |
| Second  Quarter |       | 2.74     |       | 1.62    |       |
| Third  Quarter  |       | 2.80     |       | 1.36    |       |
| Fourth  Quarter |       | 2.32     |       | 1.93    |       |
| **2008**        |       |     |       |    |       |
| First  Quarter  |       | 8.95     |       | 4.86    |       |
| Second  Quarter |       | 7.40     |       | 4.85    |       |
| Third  Quarter  |       | 7.24     |       | 4.62    |       |
| Fourth  Quarter |       | 4.40     |       | 2.21    |       |
|                 |            |          |            |         |            |  |  |

 

On March 12,2010, the last reported sale price of our Common Stock on the NASDAQ CapitalMarket was $2.21 per share.  As of March 12,2010, there were approximately 800 beneficial holders of our Common Stock.

 

We have not paiddividends on our Common Stock and do not presently plan to pay dividends on ourCommon Stock for the foreseeable future. Our line of credit prohibits payment of dividends.

 

Informationconcerning securities authorized for issuance under equity compensation plansis included in Part III, Item 12 of this report.

 

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**ITEM 6.****                ****SELECTED FINANCIAL DATA**

 

The selectedfinancial information set forth below has been derived from our consolidatedfinancial statements and should be read in conjunction with “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations” forthe fiscal years of 2009 and 2008 and “Item 8. Financial Statements andSupplementary Data.” All data is in thousands except per common sharedata.  The data for 2005-2007 has beenrestated to reflect the impact of the discontinued operations of our NAACO andPDN subsidiaries.

 
| **Fiscal  Years Ended**                                            | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                                         |       |     |       |     |       |     |       |     |       |     |       |
| **Statements of Operations:**                                      |       |     |       |     |       |     |       |     |       |     |       |
| Total  revenues                                                    |       | $        | 101,269    |     | $          | 110,971  |       | $        | 99,754     |     | $          | 76,857 |   | $ | 74,354 |   |
| Gross  profit                                                      |       | $        | 28,377     |     | $          | 35,610   |       | $        | 32,511     |     | $          | 23,613 |   | $ | 22,214 |   |
| Operating  income (loss)                                           |       | $        | (2,161     | )        | $          | 4,035    |       | $        | 4,142      |     | $          | (959 | ) | $ | (165 | ) |
| Income  (loss) from continuing operations                          |       | $        | (3,338     | )        | $          | 1,864    |       | $        | 2,476      |     | $          | (1,257 | ) | $ | (1,014 | ) |
| Net  income (loss)                                                 |       | $        | (3,338     | )        | $          | 360      |       | $        | 2,539      |     | $          | (1,409 | ) | $ | (933 | ) |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Basic  income (loss) from continuing operations per common share   |       | $        | (0.73      | )        | $          | 0.41     |       | $        | 0.56       |     | $          | (0.29 | ) | $ | (0.24 | ) |
| Basic  income (loss) per common share                              |       | $        | (0.73      | )        | $          | 0.08     |       | $        | 0.58       |     | $          | (0.33 | ) | $ | (0.22 | ) |
| Diluted  income (loss) from continuing operations per common share |       | $        | (0.73      | )        | $          | 0.41     |       | $        | 0.55       |     | $          | (0.29 | ) | $ | (0.24 | ) |
| Diluted  income (loss) per common share                            |       | $        | (0.73      | )        | $          | 0.08     |       | $        | 0.57       |     | $          | (0.33 | ) | $ | (0.22 | ) |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Basic  weighted average number of common shares outstanding        |       | 4,578    |       | 4,571    |       | 4,400    |       | 4,335    |       | 4,261    |       |
| Diluted  weighted average number of common shares outstanding      |       | 4,578    |       | 4,612    |       | 4,475    |       | 4,335    |       | 4,261    |       |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| **Balance Sheet:**                                                 |       |     |       |     |       |     |       |     |       |     |       |
| Working  capital                                                   |       | $        | 3,719      |     | $          | 5,772    |       | $        | 5,126      |     | $          | 3,026 |   | $ | 3,879 |   |
| Total  assets                                                      |       | $        | 31,450     |     | $          | 37,415   |       | $        | 35,532     |     | $          | 23,913 |   | $ | 24,491 |   |
| Long-term  liabilities                                             |       | $        | 4,481      |     | $          | 5,412    |       | $        | 5,215      |     | $          | 5,377 |   | $ | 5,216 |   |
| Shareholders’  equity                                         |       | $        | 5,643      |     | $          | 7,989    |       | $        | 7,262      |     | $          | 4,142 |   | $ | 5,421 |   |

 

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###### **SELECTED QUARTERLY FINANCIAL DATA**

######  

The followingtable sets forth certain unaudited quarterly financial data for the eightquarters ended January 2, 2010.  Inour opinion, the unaudited information set forth below has been prepared on thesame basis as the audited information and includes all adjustments necessary topresent fairly the information set forth herein.  The operating results for any quarter are notindicative of results for any future period. All data is in thousands except per common share data.  The data for all quarters presented has beenrestated to reflect the impact of the discontinued operations of our NAACO andPDN subsidiaries.

 
| ** **                                                         | ** ** | **Fiscal 2009**              | ** ** |
|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                         | ** ** | **1****st**** Quarter** | ** ** | **2****nd**** Quarter** | ** ** | **3****rd**** Quarter** | ** ** | **4****th**** Quarter** | ** ** |
| Total  revenues                                                    |       | $                            | 26,158     |   | $ | 25,392 |   | $ | 26,005 |   | $ | 23,714 |   |
| Gross  profit                                                      |       | $                            | 6,329      |   | $ | 7,585 |   | $ | 8,493 |   | $ | 5,970 |   |
| Operating  income (loss)                                           |       | $                            | (1,682     | ) | $ | (144 | ) | $ | 855 |   | $ | (1,190 | ) |
| Income  (loss) from continuing operations                          |       | $                            | (1,962     | ) | $ | (411 | ) | $ | 416 |   | $ | (1,381 | ) |
| Net  income (loss)                                                 |       | $                            | (1,962     | ) | $ | (411 | ) | $ | 416 |   | $ | (1,381 | ) |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Basic  income (loss) from continuing operations per common share   |       | $                            | (0.43      | ) | $ | (0.09 | ) | $ | 0.09 |   | $ | (0.30 | ) |
| Basic  earnings (loss) per common share                            |       | $                            | (0.43      | ) | $ | (0.09 | ) | $ | 0.09 |   | $ | (0.30 | ) |
| Diluted  income (loss) from continuing operations per common share |       | $                            | (0.43      | ) | $ | (0.09 | ) | $ | 0.09 |   | $ | (0.30 | ) |
| Diluted  earnings (loss) per common share                          |       | $                            | (0.43      | ) | $ | (0.09 | ) | $ | 0.09 |   | $ | (0.30 | ) |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Basic  weighted average number of common shares outstanding        |       | 4,578                        |       | 4,578 |   | 4,578 |   | 4,578 |   |
| Diluted  weighted average number of common shares outstanding      |       | 4,578                        |       | 4,578 |   | 4,578 |   | 4,578 |   |

** **
| ** **                                                         | ** ** | **Fiscal 2008**              | ** ** |
|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                         | ** ** | **1****st**** Quarter** | ** ** | **2****nd**** Quarter** | ** ** | **3****rd**** Quarter** | ** ** | **4****th**** Quarter** | ** ** |
| Total  revenues                                                    |       | $                            | 25,702     |   | $ | 29,662 |   | $ | 29,414 |   | $ | 26,193 |   |
| Gross  profit                                                      |       | $                            | 8,061      |   | $ | 9,646 |   | $ | 10,162 |   | $ | 7,741 |   |
| Operating  income (loss)                                           |       | $                            | 607        |   | $ | 1,540 |   | $ | 2,145 |   | $ | (257 | ) |
| Income  (loss) from continuing operations                          |       | $                            | 327        |   | $ | 920 |   | $ | 1,277 |   | $ | (660 | ) |
| Net  income (loss)                                                 |       | $                            | 117        |   | $ | 837 |   | $ | 1,141 |   | $ | (1,735 | ) |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Basic  income (loss) from continuing operations per common share   |       | $                            | 0.07       |   | $ | 0.20 |   | $ | 0.28 |   | $ | (0.14 | ) |
| Basic  earnings (loss) per common share                            |       | $                            | 0.03       |   | $ | 0.18 |   | $ | 0.25 |   | $ | (0.38 | ) |
| Diluted  income (loss) from continuing operations per common share |       | $                            | 0.07       |   | $ | 0.20 |   | $ | 0.28 |   | $ | (0.14 | ) |
| Diluted  earnings (loss) per common share                          |       | $                            | 0.03       |   | $ | 0.18 |   | $ | 0.25 |   | $ | (0.38 | ) |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Basic  weighted average number of common shares outstanding        |       | 4,556                        |       | 4,571 |   | 4,578 |   | 4,578 |   |
| Diluted  weighted average number of common shares outstanding      |       | 4,624                        |       | 4,632 |   | 4,608 |   | 4,578 |   |

 

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**ITEM 7.**             **MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*Thefollowing discussion and analysis of our financial condition and results ofoperations should be read in conjunction with the “Selected Financial Data” andthe Consolidated Financial Statements and Notes to Consolidated FinancialStatements included elsewhere in this annual report.  Certain information contained in thediscussion and analysis set forth below and elsewhere in this annual report,including information with respect to our plans and strategy for our businessand related financing, includes forward-looking statements that involve riskand uncertainties. In evaluating such statements, you should specificallyconsider the various factors identified in this annual report that could causeresults to differ materially from those expressed in such forward-lookingstatements, including matters set forth in the section entitled “Risk Factors.”*

 

**OVERVIEW**

 

We are in the business ofselling new major household appliances through a chain of Company-owned factoryoutlet stores under the name ApplianceSmart®.  We also provide turnkey appliance recyclingand replacement services for electric utilities and other sponsors of energyefficiency programs.

 

***Subsidiaries*****. **ARCACanada Inc., a Canadian corporation, is a wholly-owned subsidiary.  ARCA Canada was formed in September 2006to provide turnkey recycling services for electric utility energy efficiencyprograms.  The operating results of ARCACanada have been consolidated in our financial statements.  We were a sixty percent owner in NorthAmerica Appliance Company, LLC (“NAACO”). NAACO was formed and commenced operations in June 2003 and was aretailer of special-buy appliances in Texas. The operating results of NAACO have been consolidated in our financialstatements.  We were a sixty percentowner in Productos Duraderos de Norte America (“PDN”), a Mexicancorporation.  PDN was acquired in September 2006and refurbished room air conditioners for sale through our NAACO operation inMcAllen, Texas, and through our ApplianceSmart Factory Outlet stores.  The operating results of PDN have beenconsolidated in our financial statements.

 

***DiscontinuedOperations*****. **During the fourth quarter of 2008, weplanned and executed the shutdown of our NAACO and PDN operations.  NAACO and PDN were not operating as plannedand were no longer economically viable. In 2008, our supply of room air conditioners from a major manufacturerwas depleted, no longer providing refurbishment opportunities for PDN andrevenues for NAACO, which was the basis for our investment in thesebusinesses.  We will not have anycontinuing involvement or significant continuing cash flows in thesebusinesses.  The results of operationsfor NAACO and PDN were included in our retail segment.  All results of operations for periodspresented prior to the abandonment date have been reclassified as discontinuedoperations.

 

***Investments.*** On June 1, 2009, we completed a $0.3 million investment inDiagnostico y Administracion de Logistica Inversa, S.A. de C.V. (“DALI”), aMexican company.  DALI is a joint venturethat operates a refrigerator recycling program sponsored by the Mexicangovernment.  Our investment represents a46.3% ownership in the joint venture. The DALI joint venture is accounted for under the equity method and ispresented in the consolidated balance sheets as a component of otherassets.  The results of the joint venturewere immaterial for the fiscal year ended January 2, 2010.

 

On October 21,2009, we entered into an Appliance Sales and Recycling Agreement (the “Agreement”)with General Electric Company (“GE”) acting through its GE Consumer &Industrial business.  Under theAgreement, GE will sell all of its recyclable appliances generated in thenortheastern United States to us, and we will collect, process and recycle suchrecyclable appliances.  The Agreementrequires that we will only recycle, and will not sell for re-use or resale, therecyclable appliances purchased from GE. We plan to establish a regional processing center (“RPC”) located in thenortheastern United States at which the recyclable appliances will beprocessed.  The term of the Agreement isfor a period of six years from the first date of collection of recyclableappliances.  We expect the first date ofcollection will be early in the second quarter of 2010.

 

In connection withthe Agreement described above, we entered into a Joint Venture Agreement with4301 Operations, LLC, to establish and operate the northeastern RPC.  4301 Operations has substantial experience inthe recycling of major household appliances and will contribute their existingbusiness to the joint venture.  Under theJoint Venture Agreement, the parties will form a new entity to be known as ARCAAdvanced Processing, LLC (“AAP”) and each party will be a 50% owner ofAAP.  If 

 

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additional RPCsare established, AAP will establish the next two RPCs and will have a right offirst refusal to establish subsequent RPCs. We plan to raise debt and/or equity financing to fund our share of thecapital required to form the joint venture. We plan to contribute approximately $2.0 million, including theAppliance Sales and Recycling Agreement, to the joint venture, and 4301Operations plans to contribute their equipment and existing business to thejoint venture.  The joint venture plansto commence operations early in the second quarter of 2010; however, there isno assurance that operations will commence or that financing will be availableon terms satisfactory to us or permitted by our current debt agreement.  As of January 2, 2010, we loaned 4301Operations $0.4 million that will be considered a portion of our capitalcontribution when the joint venture commences operations.

 

The Agreement iscontingent on the ability of the joint venture to raise additional financing topurchase and install UNTHA Recycling Technology (“URT”) equipment, enhancingthe capabilities of the RPC.  We are theexclusive distributor of URT equipment for North America**. **The joint venture plans to raiseadditional debt financing to purchase the URT equipment, but there is noassurance that the financing will be available or on terms acceptable to thejoint venture.

 

***ApplianceSmartFactory Outlets.***  On November 16, 2009, we opened a27,900-square-foot ApplianceSmart Factory Outlet in Cumming, Georgia, to servethe northeast suburbs of the Atlanta metropolitan area.  At the end of August 2009, we closed onestore in San Antonio, Texas, when the facility lease expired, and closed andvacated our ApplianceSmart Factory Outlet store in Stockbridge, Georgia.  The Stockbridge store was underperforming andmanagement executed a plan to close the store with six-and-a-half yearsremaining on the lease; we subsequently recognized a lease termination chargeof $0.3 million in 2009.  Through eightmonths of operation in 2009, these two stores combined generated $3.2 millionin retail revenues and reported an operating loss of $0.3 million.

 

***Sale-LeasebackTransaction.***  In September 2009, we completed anagreement to sell and lease back our St. Louis Park, Minnesota, facility.  The building is a 126,458-square-footfacility that includes our executive offices, a processing and recyclingcenter, and a retail store.  Pursuant tothe agreement entered into on August 11, 2009, we sold our St. Louis Parkbuilding to the purchaser for $4.6 million and leased the building back over aninitial term of five years.  The sale ofthe building resulted in $2.0 million cash after payment of the outstandingmortgage and closing costs.  We used thenet cash proceeds to pay down our line of credit.  In connection with the transaction, werecognized a deferred gain on transaction of $2.4 million that will beamortized over the initial lease term.

 

***FiscalYear*****. **We report on a 52- or 53-week fiscal year.  Our 2009 fiscal year (“2009”) ended on January 2,2010 and included 52 weeks.  Our 2008fiscal year (“2008”) ended on January 3, 2009 and included 53 weeks.

 

**KEYCOMPONENTS OF RESULTS OF OPERATIONS**

 

***Revenues*****. **Wegenerate revenues from three sources: retail, recycling and byproduct.  Retail revenues are generated through thesale of new of appliances at our ApplianceSmart Factory Outlet stores.  Recycling revenues are generated by chargingfees for collecting and recycling appliances for utilities and other sponsorsof energy efficiency programs.  Recyclingrevenues also include fees charged for recycling and replacing old refrigeratorswith new energy efficient refrigerators for two low income housing programssponsored by electric utilities. Byproduct revenues are generated by selling recovered materials, such asmetals and plastics, and reclaimed chlorofluorocarbons (“CFC”) refrigerants,from appliances we collect and recycle, including appliances from ourApplianceSmart Factory Outlet stores.

 

***Costof Revenues*****. **Cost of revenues includes all costsrelated to the purchase of inventory, including freight, costs related toreceiving and distribution of inventory, and costs related to delivery andservice of inventory after it is sold to the consumer.  Also, the costs related to recyclingappliances, such as customer service, transportation and processing, and thecost of refrigerators purchased for our replacement programs, are included inthe cost of revenues.  Depreciationexpense related to buildings and equipment from our recycling centers ispresented in cost of revenues.

 

***Selling,General and Administrative Expenses*****. **Selling, general and administrativeexpenses are comprised primarily of employee compensation and benefits(including share-based compensation), occupancy costs, advertising, bankprocessing charges, professional services and depreciation.

 

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***InterestExpense*****.**  Interest expense is comprised of interestcharges related to borrowings under our line of credit, mortgages on our Minnesotaand California buildings and other long-term obligations, primarily capitalleases.  In 2009, we paid off themortgage on our Minnesota building.

 

***Segments*****. **We operatetwo reportable segments: retail and recycling. The retail segment is comprised of income generated through ourApplianceSmart Factory Outlet stores. Our recycling segment includes all fees charged and costs incurred forcollecting, recycling and installing appliances for utilities and other customersand includes byproduct revenue, which is primarily generated through therecycling of appliances.  Retail revenuestypically have lower profit margins than recycling revenues.

 

*RetailSegment*.  We operated nineteen factory outlet stores atthe end of both 2009 and 2008.  Ournineteen factory outlet stores are located in convenient, high-trafficlocations in Georgia, Minnesota, Ohio and Texas.  In 2009, we opened one new factory outletstore in Cumming, Georgia, terminated the lease and closed one store inStockbridge, Georgia, and closed one store in San Antonio, Texas, when thelease expired.

 

*RecyclingSegment*.  We operate seven processing and recyclingcenters, which are located in Minnesota, California, Texas, Illinois, Colorado,Washington and Ontario, Canada.  We areactively pursuing opportunities to support energy efficiency programs run byelectric utility companies.

 

**RESULTS OF OPERATIONS**

 

The following table setsforth our consolidated financial data as a percentage of total revenues for thefiscal years 2009 and 2008:

 
| ** **                                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Revenues                                                          |       | 100.0    | %          | 100.0    | %          |
| Cost of revenues                                                  |       | 72.0     |       | 67.9     |       |
| Gross profit                                                      |       | 28.0     |       | 32.1     |       |
| Selling, general  and administrative expenses                     |       | 30.2     |       | 28.5     |       |
| Operating income                                                  |       | (2.2     | )          | 3.6      |       |
| Other income  (expense):                                          |       |     |       |     |       |
| Interest  expense, net                                            |       | (1.1     | )          | (1.2     | )          |
| Income (loss)  from continuing operations before income taxes     |       | (3.3     | )          | 2.4      |       |
| Provision for  income taxes                                       |       | 0.0      |       | 0.7      |       |
| Income (loss)  from continuing operations                         |       | (3.3     | )          | 1.7      |       |
| Income (loss)  from discontinued operations, net of income taxes  |       | 0.0      |       | (0.7     | )          |
| Loss on disposal  of discontinued operations, net of income taxes |       | 0.0      |       | (0.6     | )          |
| Net (loss)  income                                                |       | (3.3     | )%         | 0.4      | %          |

 

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The following tablesets forth the key results of operations by segment for the fiscal years 2009and 2008 (dollars in millions):

 
| ** **                    | ** ** | **2009** | ** ** | **2008** | ** ** | **% Change** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|--------------|------------|
| Revenues:                     |       |     |       |     |       |         |       |
| Retail                        |       | $        | 75.5       |     | $          | 77.9         |       | (3.0 | )% |
| Recycling                     |       | 25.8     |       | 33.1     |       | (22.2        | )%         |
| Total revenues                |       | $        | 101.3      |     | $          | 111.0        |       | (8.7 | )% |
|                          |       |     |       |     |       |         |       |
| Operating income (loss):      |       |     |       |     |       |         |       |
| Retail                        |       | $        | (4.2       | )        | $          | 0.8          |       | (613.4 | )% |
| Recycling                     |       | 1.8      |       | 5.3      |       | (66.8        | )%         |
| Unallocated corporate costs   |       | 0.2      |       | (2.1     | )          | 111.5        | %          |
| Total operating income (loss) |       | $        | (2.2       | )        | $          | 4.0          |       | (153.6 | )% |

 

***Revenues*****.**  Revenues forthe fiscal years of 2009 and 2008 were as follows (dollars in millions):

 
| ** ** | ** ** | **2009** | ** ** | **2008** | ** ** | **% Change** | ** ** |
|------------|------------|----------|------------|----------|------------|--------------|------------|
| Retail     |       | $        | 75.0       |     | $          | 76.2         |       | (1.5 | )% |
| Recycling  |       | 22.8     |       | 29.6     |       | (23.0        | )%         |
| Byproduct  |       | 3.5      |       | 5.2      |       | (33.2        | )%         |
|       |       | $        | 101.3      |     | $          | 111.0        |       | (8.7 | )% |

 

Our total revenues for2009 decreased $9.7 million or 8.7% from $111.0 million in 2008.  Retail segment revenues accounted for 75% oftotal revenues in 2009 compared to 70% in 2008. The decline in 2009 revenues is attributed primarily to the recyclingsegment. In 2009, recycling segment revenues declined $7.3 million or 22.2%compared to 2008.  Retail segmentrevenues were down $2.4 million or 3.0% in 2009 compared to 2008.  Recycling segment revenues and retail segmentrevenues each include a portion of byproduct revenues.

 

*Retail Revenues*. Our retail revenues for 2009 decreased $1.2 million or 1.5% from $76.2million in 2008.  The decline in retailrevenues was due primarily to price compression, lower store traffic and thefour-month impact of closing two ApplianceSmart Factory Outlets, which waspartially offset by the new factory outlet stores opened during the past twelvemonths.  New-store revenues were $9.4million while comparable-store revenues were down 12.1% or $8.5 millioncompared to the same period in 2008. Fiscal 2009 included 52 weeks compared to 53 weeks in 2008.  Normalizing for the additional week in fiscal2008, comparable-store revenues decreased 10.5%.  The closing of two factory outlet storescontributed to a decline in retail revenues of $1.8 million compared to thesame period of 2008.  We believe retailrevenues will increase in the first quarter of 2010 as a result of thegovernment stimulus rebates to purchase ENERGY STAR® appliances.  We cannot predict the extent and length ofthe current economic slowdown and cutback in consumer spending or the potentialimpact of the appliance stimulus rebates in 2010.  We continue to evaluate factory outlet storesand markets and address underperforming stores with a range of outcomes fromexpense reductions to store closings.

 

Our factory outlets carry a wide range of newin-the-box and new out-of-the-box appliances, including manufacturer closeouts,factory overruns, floor samples, returned or exchanged items, open-cartonitems, and scratch and dent appliances.

 

We continue to purchasethe majority of new in-the-box and new out-of-the-box appliances fromWhirlpool, GE and Electrolux.  We have nominimum purchase requirements with any of these manufacturers.  We believe purchases from these threemanufacturers will provide an adequate supply of high-quality appliances forour retail factory outlets; however, there is a risk that one or more of thesesources could be curtailed or lost.

 

*Recycling Revenues*.  Our recyclingrevenues for 2009 decreased $6.8 million or 23.0% from $29.6 million in2008.  The decrease was due primarily toa planned volume reduction for one contract in California and lower recyclingvolumes on other contracts, combined with a later-than-anticipated start and alower level of sign-ups from a major utility’s annual 

 

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appliancereplacement program in 2009.  In 2009, weadded several new recycling contracts and our Illinois recycling center wasoperating for the entire year compared to 2008, which partially offset theplanned volume reduction in California. We are aggressively pursuing new appliance recycling programs but cannotpredict if we will be successful in signing new contracts or renewing existingcontracts.

 

*Byproduct Revenues*. Our byproduct revenues for 2009 decreased $1.7 million or 33.2% from$5.2 million in 2008.  The decrease wasdue primarily to depressed scrap metal prices during the first three quartersof 2009 compared to the same period of 2008 and, to a lesser extent, lowerrecycling volumes.  In the fourth quarterof 2009, scrap metal prices did start to increase but were still below prioryear weighted-average market prices for the full year compared to 2008.  We do not expect scrap metal prices tofluctuate significantly in 2010 as compared to fourth quarter 2009 levels.

 

***GrossProfit*****.**  Our overall gross profit in 2009 decreased$7.2 million or 20.3% from $35.6 million in 2008.  Our gross profit as a percentage of totalrevenues was 28% in 2009 compared to 32% in 2008.  The decline was due primarily to pricecompression on product in our retail segment to remain competitive with otherretailers during the current economic downturn. Gross profit in 2009 for the retail segment was 25.4% of the relatedrevenues compared to 31.8% in 2008. Gross profit in 2009 for the recyclingsegment was 35.6% of the related revenues compared to 32.6% in 2008.  The increase in gross profit for therecycling segment was due to cost-saving efforts in several areas, includinglabor, transportation, various operating costs, non-renewal of two off-sitewarehouse leases, improving revenues and profitability for some of therecycling contracts that existed in both 2008 and 2009, and improving theeconomic model for some of the new recycling contracts.  Recycling gross profit percentages aretypically higher than retail gross profit percentages. Our gross profit as apercentage of total revenues for future periods can be affected favorably orunfavorably by numerous factors, including:

 

1.               The mix of retail products we sell.

2.               The prices at which we purchase product from the majormanufacturers who supply product to us.

3.               The volume of appliances we receive through our recyclingcontracts.

4.               The volume and price of scrap metals, plastics andreclaimed CFCs.

 

Unless we cansignificantly increase our appliance purchasing and sales volume, resulting inhigher level rebates, or sign substantial recycling contracts utilizing our currentrecycling facilities, we believe gross profit percentages in 2010 will remainconsistent with 2009 for our recycling segment with moderate improvement in ourretail segment.

 

***Selling, General andAdministrative Expenses*****.** Our selling, general and administrative (“SG&A”) expenses for 2009decreased $1.0 million or 3.3% from $31.6 million in 2008.  Our SG&A expenses as a percentage oftotal revenues increased to 30% in 2009 compared to 29% in 2008.  Selling expenses increased $1.2 million to$21.1 million in 2009 from $19.9 million in 2008.  The increase in selling expenses was dueprimarily to operating costs related to having more factory outlet stores openthroughout 2009 compared to 2008.  Wealso recorded a $0.3 million lease termination charge in 2009 related toclosing our factory outlet store in Stockbridge, Georgia.  General and administrative expenses decreased$2.2 million to $9.5 million in 2009 from $11.7 million in 2008.  The decrease in general and administrativeexpenses was due primarily to cost-containment initiatives implementedthroughout 2009, including reducing corporate expenses over $1.0 million as aresult of cost-cutting in various areas, including process improvements, salaryreductions and headcount eliminations. We expect SG&A expenses to remain consistent in 2010 as a percentageof total revenues compared to 2009.

 

***InterestExpense*****.**  Interest expense decreased $0.2 million to$1.2 million in 2009 compared to $1.4 million in 2008.  The decrease was due primarily to reducing theweighted average balance on our line of credit and, to a lesser extent, adecline in the weighted average interest rate from 6.83% in 2008 to 6.25% in2009.  We used the $2.0 million net cashproceeds from the selling and leasing back of our St. Louis Park, Minnesota,facility to pay down our line of credit. The annual interest expense savings from paying off our St. Louis Parkfacility mortgage is approximately $0.1 million.  We cannot predict our 2010 borrowings or whatwill happen with interest rates in 2010.

 

***Provisionfor Income Taxes*****.**  Our provision for income taxes for 2009decreased $0.7 million from $0.7 million in 2008.  The decline is partly the result of recordinga discrete item in the second quarter of 2009 related to additional Canadian taxdeductions determined by completing a detailed transfer pricing study andpartly the result of lower taxable income from our Canadian operations in 2009in comparison to 2008.  We recognized atax benefit of approximately $0.2 million related 

 

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solely to our Canadianoperations compared to the original tax provision estimate for fiscal2008.  We also recorded a provision forincome taxes of $0.2 million in 2009 related to taxable income generated by ourCanadian operations.  As of January 2,2010 and January 3, 2009, we recorded cumulative valuation allowances of$2.4 million and $2.2 million, respectively, against our U.S. net deferred taxassets due to the uncertainty of their realization.  The realization of deferred tax assets isdependent upon sufficient future taxable income during the periods whendeductible temporary differences and carryforwards are expected to be availableto reduce taxable income.

 

***DiscontinuedOperations*****.**  During the fourth quarter of 2008, we plannedand executed the shutdown of our NAACO and PDN operations.  NAACO and PDN were not operating as plannedand were no longer economically viable. In 2008, our supply of room air conditioners from a major manufacturerwas depleted, no longer providing refurbishment opportunities for PDN andrevenues for NAACO, which was the basis for our investment in thesebusinesses.  We will not have any continuinginvolvement or significant continuing cash flows in these businesses.  The results of operations for NAACO and PDNwere included in our retail segment and have been reclassified as discontinuedoperations.  During the fiscal year endedJanuary 3, 2009, NAACO and PDN had revenues of $0.8 and a loss beforetaxes of $0.9 million.  We recorded aloss on the disposal of NAACO and PDN of $0.7 million, net of taxes in 2008,which consisted of termination costs and the write-down of certain assets tofair value upon the abandonment of the operations in December.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

***Principal Sources and Uses of Liquidity.******  ***Our principal sources of liquidity are cash fromoperations and borrowings under our line of credit.  Our principal liquidity requirements consistof long-term debt obligations, capital expenditures and working capital.  Our cash and cash equivalents as of January 2,2010 were $2.8 million compared to $3.5 million as of January 3,2009.  The reduction in our cash and cashequivalents balance is related primarily to restricted cash required by ourcredit card processor in 2009.  Ourworking capital decreased to $3.7 million for the year ended January 2,2010 compared to $5.8 million for the year ended January 3, 2009.

 

***Net Cash Provided by OperatingActivities*****.**  Our net cash provided by operating activitieswas $1.3 million in 2009 compared to $1.6 million in 2008.  The $0.3 million decline in net cash providedby operating activities was primarily the result of our net loss, which wasalmost entirely offset by reductions in inventory and accounts receivable.

 

***NetCash Provided by (Used in) Investing Activities*****.**  Our net cashprovided by investing activities was $2.8 million in 2009 compared to net cashused in investing activities of $0.8 million in 2008.  In July 2009, we were required by ourcredit card processor to maintain a deposit of $0.7 million to coverchargebacks, adjustments, fees and other charges that may be due from us.  The deposit is included in restricted cash onthe consolidated balance sheet.  The netcash provided by investing activities in 2009 was due primarily to proceedsfrom selling our St. Louis Park, Minnesota, facility and was partially offsetby the credit card processor deposit, capital expenditure purchases of $0.5million and joint venture investments of $0.6 million.  The net cash used in investing activities for2008 was related primarily to the purchase of computer equipment, phonesystems, leasehold improvements to support our new store openings and recyclingequipment to support recycling contracts. We did not have any material purchase commitments for assets as of January 2,2010 or through March 1, 2010. However, we expect to require additional capital of $2.0 million tosupport our investment in the joint venture with 4301 Operations, LLC.

 

***NetCash Provided by (Used in) Financing Activities*****.**  Our net cashused in financing activities was $4.9 million in 2009 compared to net cashprovided by financing activities of $0.4 million in 2008.  The net cash used in financing activities for2009 resulted primarily from using the $4.6 million proceeds from the sale ofour St. Louis Park, Minnesota, building to pay off the $2.6 million mortgage onthe building, and the remaining $2.0 million was used to pay down our line ofcredit.  The net cash provided byfinancing activities in 2008 was due primarily to borrowings under our line ofcredit, partially offset by payments on our long-term debt obligations.

 

***OutstandingIndebtedness*****.**  As of January 2, 2010, we had an $18.0million line of credit with a lender. The line was increased from $16.0 million to $18.0 million on February 5,2008.  The interest rate on the line asof January 2, 2010 was 6.25% (the greater of prime plus 3.00 percentagepoints or 6.25%).  The amount ofborrowings available under the line of credit is based on a formula usingreceivables and inventories.  We may nothave access to the full $18.0 million line of 

 

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credit due to a borrowingbase formula determined using our receivables and inventories.  The outstanding balance and unused borrowingcapacity were $12.4 million and $0.1 million, respectively, as of January 2,2010.  On March 1, 2010, borrowingsof $10.6 million wereoutstanding under the line of credit, and we had unused borrowing capacity of $0.8 million. The line of credit has a stated maturity date of December 31,2010, if not renewed, and provides that the lender may demand payment in fullof the entire outstanding balance of the loan at any time.  The line of credit is secured bysubstantially all our assets and requires minimum monthly interest payments of$58,000, regardless of the outstanding principal balance.  The lender is also secured by an inventoryrepurchase agreement with Whirlpool Corporation for purchases from Whirlpoolonly.  The line requires that we meetcertain financial covenants, provides payment penalties for noncompliance andprepayment, limits the amount of other debt we can incur, limits the amount ofspending on fixed assets and prohibits payments of dividends.  On March 10, 2010, the interest rate onthe line increased to 6.75% (the greater of prime plus 3.50 percentage pointsor 6.75%).  As of January 2, 2010,we were not in compliance with certain financial covenants and received awaiver from the lender.  In 2010, we planto renegotiate and extend our line of credit.

 

In 2008, we entered into a masterequipment lease with a lender providing up to $0.3 million in availablefunds.  As of January 3, 2009, wehad utilized the entire lease line to fund equipment for factory outletsstores.  In 2009, we entered into amaster equipment lease with a lender providing up to $0.2 million in availablefunds.  As of January 2, 2010, wehad utilized the entire lease line to fund equipment and displays for factoryoutlets stores.

 

As of January 2, 2010, we hadlong-term obligations of $2.5 million, consisting of mortgages on ourCalifornia building along with various financings, primarily consisting ofcapital leases.

 

The future annualmaturities of long-term obligations are as follows (in millions):

 
| 2010   |   | $   | 0.5    |   |
|--------|--------|-----|--------|--------|
| 2011   |   | 0.4 |   |
| 2012   |   | 0.2 |   |
| 2013   |   | 1.4 |   |
|   |   | $   | 2.5    |   |

 

***Contractual Obligations.***  The following table represents ourcontractual obligations including interest, except for the potential intereston the line of credit (in millions):

 
| ** **                                     | ** ** | **Total** | ** ** | **Less Than  One Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than  Five Years** | ** ** |
|------------------------------------------------|------------|-----------|------------|-------------------------|------------|---------------|------------|---------------|------------|---------------------------|------------|
| Line of credit                                 |       | $         | 12.4       |                    | $          | 12.4          |       | $             | —     |                      | $          | — |   | $ | — |   |
| Mortgage                                       |       | 1.9       |       | 0.2                     |       | 0.4           |       | 1.3           |       | —                    |       |
| Capital lease  and other financing obligations |       | 1.0       |       | 0.5                     |       | 0.5           |       | —        |       | —                    |       |
| Operating lease  obligations                   |       | 26.2      |       | 4.5                     |       | 8.9           |       | 7.1           |       | 5.7                       |       |
|                                                |            |           |            |                         |            |               |            |               |            |                           |            |  |  |  |  |  |

 

We believe, based on theanticipated sales per retail store, the anticipated revenues from our recyclingcontracts and our anticipated gross profit, that our cash balance, anticipatedfunds generated from operations and our current line of credit will besufficient to finance our operations, long-term debt obligations and capitalexpenditures through at least December 2010.  Our total capital requirements for 2010 willdepend upon, among other things as discussed below, the number and size ofretail stores operating during the fiscal year, the recycling volumes generatedfrom recycling contracts in 2010 and our needs related to the establishment ofour joint venture with 4301 Operations, LLC. Currently, we have nineteen retail stores and seven recycling centers inoperation.  We may need additionalcapital to finance our operations if our revenues are lower than anticipated,our expenses are higher than anticipated or we pursue new opportunities.  Sources of additional financing, if needed inthe future, may include further debt financing or the sale of equity (Common orPreferred Stock) or other financing opportunities.  There can be no assurance that suchadditional sources of financing will be available on terms satisfactory to usor permitted by our current debt agreement.

 

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**APPLICATION OF CRITICALACCOUNTING POLICIES**

 

Our discussion of thefinancial condition and results of operations is based upon our consolidatedfinancial statements, which have been prepared in conformity with accountingprinciples generally accepted in the United States.  The preparation of our consolidated financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, revenues and expenses, andrelated disclosure of any contingent assets and liabilities at the date of thefinancial statements.  Managementregularly reviews its estimates and assumptions, which are based on historicalfactors and other factors that are believed to be relevant under thecircumstances.  Actual results may differfrom these estimates under different assumptions, estimates or conditions.

 

Critical accountingpolicies are defined as those that are reflective of significant judgments anduncertainties, and potentially result in materially different results underdifferent assumptions and conditions. See Note 3 of “Notes to Consolidated Financial Statements” foradditional disclosure of the application of these and other accountingpolicies.

 

***RevenueRecognition.***  We recognize revenue from appliance sales inthe period the consumer purchases and pays for the appliance, net of anallowance for estimated returns.  Werecognize revenue from appliance recycling when we collect and process aunit.  We recognize byproduct revenueupon shipment.  We recognize revenue onextended warranties with retained service obligations on a straight-line basisover the period of the warranty.  Onextended warranty arrangements that we sell but others service for a fixedportion of the warranty sales price, we recognize revenue for the net amountretained at the time of sale of the extended warranty to the consumer.  We include shipping and handling charges tocustomers in revenue, which is recognized in the period the consumer purchasesand pays for delivery.  Shipping andhandling costs that we incur are included in cost of revenues.** **The application ofour revenue recognition policy does not involve significant uncertainties andis not subject to accounting estimates or assumptions having significantsensitivity to change.

 

***ProductWarranty*****.**  We provide a warranty for the replacement orrepair of certain defective units.  Ourstandard warranty policy requires us to repair or replace certain defectiveunits at no cost to our customers.  Weestimate the costs that may be incurred under our warranty and record anaccrual in the amount of such costs at the time we recognize product revenue.  Factors that affect our warranty accrual forcovered units include the number of units sold, historical and anticipatedrates of warranty claims on these units, and the cost of such claims.  We periodically assess the adequacy of ourrecorded warranty accrual and adjust the amounts as necessary.** **Historically, ouractual experience has not differed significantly from our estimates.

 

***Trade Receivables*****.**** **We carrytrade receivables at the original invoice amount less an estimate made fordoubtful accounts based on a monthly review of all outstanding amounts.  Management determines the allowance fordoubtful accounts by regularly evaluating individual customer receivables andconsidering a customer’s financial condition, credit history and currenteconomic conditions.  We write off tradereceivables when we deem them uncollectible. We record recoveries of trade receivables previously written off when wereceive them.  We consider a tradereceivable to be past due if any portion of the receivable balance isoutstanding for more than ninety days. We do not charge interest on past due receivables.

 

***Inventories*****.**  Ourinventories, consisting principally of appliances, are stated at the lower ofcost, determined on a specific identification basis, or market.  We provide estimated provisions for theobsolescence of our appliance inventories, including adjustments to market,based on various factors, including the age of such inventory and ourmanagement’s assessment of the need for such provisions.  We look at historical inventory agings andmargin analysis in determining our provision estimate.  Historically, our actual experience has notdiffered significantly from our estimates.

 

***IncomeTaxes*****.*** *We accountfor income taxes under the liability method. Deferred tax liabilities are recognized for temporary differences thatwill result in taxable amounts in future years. Deferred tax assets are recognized for deductible temporary differencesand tax operating loss and tax credit carryforwards.  Deferred tax assets and liabilities aremeasured using the enacted tax rates expected to apply to taxable income in theperiods in which the deferred tax asset or liability is expected to be realizedor settled.  We assess the likelihoodthat our deferred tax assets will be recovered from future taxable income andrecord a valuation allowance to reduce our deferred tax assets to the amountswe believe to be realizable.  Weconcluded that a full valuation allowance against our U.S. deferred tax assetswas appropriate as of January 2, 2010.

 

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***Share-BasedCompensation*****.**  We recognize compensation expense on astraight-line basis over the vesting period for all share-based awards grantedon or after January 1, 2006, and for previously granted awards not yetvested as of January 1, 2006.  Weuse the Black-Scholes option pricing model to determine the fair value ofawards at the grant date.  We calculatethe expected volatility for stock options and awards using historicalvolatility.  We estimate a 0%-5%forfeiture rate for stock options issued to all employees and Board ofDirectors members, but will continue to review these estimates in futureperiods.  The risk-free rates for theexpected terms of the stock options are based on the U.S. Treasury yield curvein effect at the time of the grant.  Theexpected life represents the period that the stock option awards are expectedto be outstanding. The expected dividend yield is zero as we have not paid ordeclared any cash dividends on our Common Stock.

 

**RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

** **

*AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples*

 

On October 3, 2009,we adopted new accounting guidance related to accounting standards codificationand the hierarchy of generally accepted accounting principles (“GAAP”).  The new guidance will become the source ofauthoritative non-SEC authoritative GAAP. The guidance establishes a two-level GAAP hierarchy for nongovernmentalentities: authoritative guidance and nonauthoritative guidance.  Authoritative guidance consists of theCodification and, for SEC registrants, rules and interpretative releasesof the Commission.  Nonauthoritativeguidance consists of non-SEC accounting literature that is not included in theCodification and has not been grandfathered. The new guidance, including the Codification, is effective for financialstatements of interim and annual periods ending after September 15,2009.  As the Codification was notintended to change or alter existing GAAP, it did not have any impact on ourconsolidated financial statements.

 

*Consolidationof Variable Interest Entities*

 

On January 3, 2010,we plan to adopt new accounting guidance related to consolidation of variableinterest entities.  The new guidanceaddresses the effects of eliminating the qualified special purpose entityconcept and responds to concerns about the application of accounting guidancerelated to the consolidation of variable interest entities, including concernsover the transparency of enterprises’ involvement with variable interestentities. The new guidance is effective for fiscal years beginning after November 15,2009.  We do not expect the new guidance to have a material impact on thepreparation of our consolidated financial statements.

 

*Accountingfor Transfers of Financial Assets*

 

On January 3, 2010,we plan to adopt new accounting guidance related to accounting for transfers offinancial assets.  The new guidanceeliminates the concept of a “qualified special-purpose entity,” changes therequirements for derecognizing financial assets and requires additionaldisclosures in order to enhance information reported to users of financialstatements by providing greater transparency about transfers of financialassets, including securitization transactions, and an entity’s continuinginvolvement in and exposure to the risks related to transferred financialassets.  The new guidance is effectivefor fiscal years beginning after November 15, 2009.  We do not expect the new guidance to have amaterial impact on the preparation of our consolidated financial statements.

 

*SubsequentEvents*

 

On July 4, 2009, weadopted new guidance related to subsequent events.  The new guidance requires all public entitiesto evaluate subsequent events through the date that the financial statementsare available to be issued and disclose in the notes the date through which theCompany has evaluated subsequent events and whether the financial statementswere issued or were available to be issued on the disclosed date.  The new guidance defines two types ofsubsequent events, as follows: the first type consists of events ortransactions that provide additional evidence about conditions that existed atthe date of the balance sheet and the second type consists of events thatprovide evidence about conditions that did not exist at the date of the balancesheet but arose after that date.  The newguidance is effective for interim and annual periods ending after June 15,2009 and must be applied prospectively. In February 2010, the new guidance related to subsequent events wasamended for SEC filers to delete the requirement to disclose the date throughwhich we evaluated 

 

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subsequent events.  The adoption and the relatedamendment thereto of the new guidance did not have a material effect on ourresults of operations or financial position.

 

*Disclosures About DerivativeInstruments and Hedging Activities*

 

On January 4, 2009,we adopted new accounting guidance related to disclosures about derivativeinstruments and hedging activities.  Thenew guidance is intended to improve financial reporting about derivativeinstruments and hedging activities by requiring enhanced disclosures to enableinvestors to better understand their effects on an entity’s financial position,financial performance and cash flows. The new guidance also improves transparency about the location andamounts of derivative instruments in an entity’s financial statements; howderivative instruments and related hedged items are accounted for; and howderivative instruments and related hedged items affect its financial position,financial performance and cash flows. The new guidance is effective for financial statements issued for fiscalyears and interim periods beginning after November 15, 2008, with earlyapplication encouraged.  The adoption ofthe new guidance did not have a material effect on our results of operations orfinancial position.

 

*Noncontrolling Interests inConsolidated Financial Statements*

 

On January 4, 2009,we adopted new accounting guidance related to noncontrolling interests onconsolidated financial statements.  Thenew guidance establishes accounting and reporting standards for noncontrollinginterests in subsidiaries and for the deconsolidation of subsidiaries andclarifies that a noncontrolling interest in a subsidiary is an ownership interestin the consolidated entity that should be reported as equity in theconsolidated financial statements.  Thenew guidance also requires expanded disclosures that clearly identify anddistinguish between the interests of the parent owners and the interests of thenoncontrolling owners of a subsidiary. The new guidance is effective for fiscal years beginning on or after December 15,2008.  The adoption of the new guidancedid not have a material effect on our results of operations or financialposition.

 

*Business Combinations*

 

On January 4, 2009,we adopted new accounting guidance related to business combinations.  The new accounting guidance establishes theprinciples and requirements for how an acquirer in a business combination:recognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, and any noncontrolling interests in theacquiree; recognizes and measures the goodwill acquired in the businesscombination or the gain from a bargain purchase; and determines whatinformation should be disclosed in the financial statements to enable users ofthe financial statements to evaluate the nature and financial effects of thebusiness combination.  The new guidanceis effective for fiscal years beginning on or after December 15,2008.  The adoption of the new guidancedid not have a material effect on our results of operations or financialposition.

 

**FORWARD-LOOKING STATEMENTS**

 

Statements contained inthis annual report regarding our future operations, performance and results,and anticipated liquidity discussed herein are forward-looking and, therefore,are subject to certain risks and uncertainties, including, but not limited to,those discussed herein.  Any forward-lookinginformation regarding our operations will be affected primarily by the speed atwhich individual retail outlets reach profitability, the volume of applianceretail sales and the strength of energy conservation recycling programs.  Any forward-looking information will also beaffected by our continued ability to purchase product from our suppliers atacceptable prices, the ability of individual retail stores to meet plannedrevenue levels, the rate of growth in the number of retail stores, costs andexpenses being realized at higher than expected levels, our ability to securean adequate supply of special-buy appliances for resale, the ability to secureappliance recycling contracts with sponsors of energy efficiency programs, theability of customers to supply units under their recycling contracts with us,and the continued availability of our current line of credit.

 

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**ITEM 7A.               QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**Market Risk and Impact of Inflation**

** **

***InterestRate Risk*****.**  We do not believe there is any significantrisk related to interest rate fluctuations on our long-term fixed-ratedebt.  There is interest rate risk on theline of credit, since our interest rate floats with prime.  The outstanding balance on our line of creditas of January 2, 2010 was approximately $12.4 million.  Although the borrowings on the line of creditare subject to a minimum interest rate of 6.25% (amended to 6.75% on March 10,2010), based on average floating rate borrowings, a hypothetical 100 basispoint change in the applicable interest rate would have caused our interestexpense to change by approximately $0.1 million.

 

***Foreign Currency Exchange Rate Risk.***  We currently generaterevenues in Canada.  The reportingcurrency for our consolidated financial statements is U.S. dollars.  It is not possible to determine the exactimpact of foreign currency exchange rate changes; however, the effect onreported revenue and net earnings can be estimated.  We estimate that theoverall strength of the U.S. dollar against the Canadian dollar had anunfavorable impact on revenue of approximately $1.0 million in fiscal2009.  In addition, we estimate that such strength had an unfavorableimpact of approximately $0.4 million on our net income in the fiscal year2009.  We do not currently hedge foreigncurrency fluctuations and do not intend to do so for the foreseeable future.

 

We do not hold anyderivative financial instruments; nor do we hold any securities for trading orspeculative purposes.

 

Also, we believethe decline in the housing and credit markets could continue to adverselyaffect buying habits of our retail segment customers in 2010.

 

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**ITEM 8.                  FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 
| **Description**                                                                                                                                        | ** ** | **Page** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                                                                   |       |     |
| Report  of Independent Registered Public Accounting Firm                                                                                               |       | 34       |
| Consolidated  Balance Sheets as of January 2, 2010 and January 3, 2009                                                                       |       | 35       |
| Consolidated  Statements of Operations for the fiscal years ended January 2, 2010 and  January 3, 2009                                       |       | 36       |
| Consolidated  Statements of Shareholders’ Equity and Comprehensive Loss for the fiscal  years ended January 2, 2010 and January 3, 2009 |       | 37       |
| Consolidated  Statements of Cash Flows for the fiscal years ended January 2, 2010 and  January 3, 2009                                       |       | 38       |
| Notes to Consolidated Financial Statements                                                                                                             |       | 39       |
|                                                                                                                                                   |       |     |
| Schedule II, Valuation and Qualifying Accounts is  included in Part IV, Item 15 of this Annual Report on Form 10-K.                          |

 

Selected QuarterlyFinancial Data is presented in Item 6 of this Annual Report on Form 10-K.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM

 

To the Shareholders,Audit Committee and Board of Directors

Appliance RecyclingCenters of America, Inc. and Subsidiaries

Minneapolis, Minnesota

 

We have audited theaccompanying consolidated balance sheets of Appliance Recycling Centers ofAmerica, Inc. and Subsidiaries (the Company) as of January 2, 2010and January 3, 2009, and the related consolidated statements ofoperations, shareholders’ equity and comprehensive loss and cash flows for thefiscal years then ended.  Theseconsolidated financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the consolidated financial statements are free of materialmisstatement.  The Company is notrequired to have, nor were we engaged to perform, an audit of its internalcontrol over financial reporting. Our audits included consideration of itsinternal control over financial reporting as a basis for designing auditprocedures that are appropriate in the circumstances, but not for the purposeof expressing an opinion on the effectiveness of the Company’s internal controlover financial reporting.  Accordingly,we express no such opinion.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management as wellas evaluating the overall consolidated financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Appliance Recycling Centers ofAmerica, Inc. and Subsidiaries as of January 2, 2010 and January 3,2009 and the results of their operations and cash flows for the fiscal yearsthen ended, in conformity with U.S. generally accepted accounting principles.

 

 

/s/ Baker Tilly VirchowKrause, LLP

 

Minneapolis, MN

March 17, 2010

 

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**APPLIANCE RECYCLING CENTERS OF AMERICA, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(In Thousands)**

 
| ** **                                                                                  | ** ** | **January 2,** | ** ** | **January 3,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                                                  | ** ** | **2010**            | ** ** | **2009**            | ** ** |
| **ASSETS**                                                                                  |       |                |       |                |       |
| Current assets:                                                                             |       |                |       |                |       |
| Cash and cash equivalents                                                                   |       | $                   | 2,799      |                | $          | 3,498 |   |
| Accounts receivable, net of allowance of $41 and  $292, respectively                        |       | 4,252               |       | 6,056               |       |
| Inventories, net of reserves of $519 and $115,  respectively                                |       | 16,785              |       | 18,834              |       |
| Deferred income taxes                                                                       |       | 677                 |       | 448                 |       |
| Other current assets                                                                        |       | 532                 |       | 950                 |       |
| Total current assets                                                                        |       | 25,045              |       | 29,786              |       |
| Property and equipment, net                                                                 |       | 4,139               |       | 6,967               |       |
| Restricted cash                                                                             |       | 700                 |       | —              |       |
| Deferred income taxes                                                                       |       | —              |       | 177                 |       |
| Other assets                                                                                |       | 1,566               |       | 485                 |       |
| Total assets                                                                                |       | $                   | 31,450     |                | $          | 37,415 |   |
|                                                                                        |       |                |       |                |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                               |       |                |       |                |       |
| Current liabilities:                                                                        |       |                |       |                |       |
| Accounts payable                                                                            |       | $                   | 3,364      |                | $          | 4,473 |   |
| Checks issued in excess of bank balance                                                     |       | 410                 |       | —              |       |
| Accrued expenses                                                                            |       | 4,401               |       | 4,073               |       |
| Line of credit                                                                              |       | 12,419              |       | 14,527              |       |
| Current maturities of long-term obligations                                                 |       | 544                 |       | 579                 |       |
| Income taxes payable                                                                        |       | 188                 |       | 362                 |       |
| Total current liabilities                                                                   |       | 21,326              |       | 24,014              |       |
|                                                                                        |       |                |       |                |       |
| Long-term obligations, less current maturities                                              |       | 1,963               |       | 4,892               |       |
| Deferred gain, net of current portion                                                       |       | 1,827               |       | —              |       |
| Deferred income tax liabilities                                                             |       | 691                 |       | 520                 |       |
| Total liabilities                                                                           |       | 25,807              |       | 29,426              |       |
|                                                                                        |       |                |       |                |       |
| Commitments and contingencies                                                               |       | —              |       | —              |       |
|                                                                                        |       |                |       |                |       |
| Shareholders’ equity:                                                                  |       |                |       |                |       |
| Common Stock, no par value; 10,000 shares  authorized; issued and outstanding: 4,578 shares |       | 17,278              |       | 16,221              |       |
| Accumulated deficit                                                                         |       | (11,267             | )          | (7,929              | )          |
| Accumulated other comprehensive loss                                                        |       | (368                | )          | (303                | )          |
| Total shareholders’ equity                                                             |       | 5,643               |       | 7,989               |       |
| Total liabilities and shareholders’ equity                                             |       | $                   | 31,450     |                | $          | 37,415 |   |

 

See Notes toConsolidated Financial Statements.

 

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**APPLIANCE RECYCLING CENTERS OF AMERICA, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(In Thousands, Except Per Share Amounts)**

 
| ** **                                                                  | ** ** | **For the fiscal year ended** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                  | ** ** | **January 2,**           | ** ** | **January 3,** | ** ** |
| ** **                                                                  | ** ** | **2010**                      | ** ** | **2009** | ** ** |
| Revenues:                                                                   |       |                          |       |   |   |
| Retail                                                                      |       | $                             | 75,022     |   | $ | 76,179 |   |
| Recycling                                                                   |       | 22,799                        |       | 29,628 |   |
| Byproduct                                                                   |       | 3,448                         |       | 5,164 |   |
| Total revenues                                                              |       | 101,269                       |       | 110,971 |   |
| Cost of revenues                                                            |       | 72,892                        |       | 75,361 |   |
| Gross profit                                                                |       | 28,377                        |       | 35,610 |   |
| Selling, general and administrative expenses                                |       | 30,538                        |       | 31,575 |   |
|                                                                        |       |                          |       |   |   |
| Operating income (loss)                                                     |       | (2,161                        | )          | 4,035 |   |
|                                                                        |       |                          |       |   |   |
| Other expense:                                                              |       |                          |       |   |   |
| Interest expense, net                                                       |       | (1,158                        | )          | (1,377 | ) |
| Other expense                                                               |       | (14                           | )          | (55 | ) |
| Income (loss) from continuing operations before  provision for income taxes |       | (3,333                        | )          | 2,603 |   |
| Provision for income taxes                                                  |       | 5                             |       | 739 |   |
| Income (loss) from continuing operations                                    |       | (3,338                        | )          | 1,864 |   |
| Loss from discontinued operations, net of tax                               |       | —                        |       | (812 | ) |
| Loss on disposal of discontinued operations, net of  tax                    |       | —                        |       | (692 | ) |
| Net income (loss)                                                           |       | $                             | (3,338     | ) | $ | 360 |   |
|                                                                        |       |                          |       |   |   |
| Basic income (loss) per common share:                                       |       |                          |       |   |   |
| Continuing operations                                                       |       | $                             | (0.73      | ) | $ | 0.41 |   |
| Discontinued operations                                                     |       | —                        |       | (0.33 | ) |
| Net income (loss)                                                           |       | $                             | (0.73      | ) | $ | 0.08 |   |
|                                                                        |       |                          |       |   |   |
| Diluted income (loss) per common share:                                     |       |                          |       |   |   |
| Continuing operations                                                       |       | $                             | (0.73      | ) | $ | 0.41 |   |
| Discontinued operations                                                     |       | —                        |       | (0.33 | ) |
| Net income (loss)                                                           |       | $                             | (0.73      | ) | $ | 0.08 |   |
|                                                                        |       |                          |       |   |   |
| Weighted average common shares outstanding:                                 |       |                          |       |   |   |
| Basic                                                                       |       | 4,578                         |       | 4,571 |   |
| Diluted                                                                     |       | 4,578                         |       | 4,612 |   |

 

See Notes toConsolidated Financial Statements.

 

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**APPLIANCE RECYCLING CENTERS OF AMERICA, INC.**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY**

**AND COMPREHENSIVE LOSS**

**(In Thousands)**

 
| ** **                           | ** ** | ** **       | ** ** | ** **        | ** ** | **Accumulated**   | ** ** | ** **  | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------------|------------|-------------------|------------|-------------------|------------|-------------|------------|------------|------------|
| ** **                           | ** ** | ** **       | ** ** | ** **        | ** ** | **Other**         | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Accumulated**   | ** ** | ** **  | ** ** |
| ** **                           | ** ** | **Shares**       | ** ** | **Amount**        | ** ** | **Income (loss)** | ** ** | **Deficit** | ** ** | **Total**  | ** ** |
| Balance at December 29, 2007    |       | 4,509            |       | $                 | 15,475     |              | $          | 76          |       | $          | (8,289     | ) | $ | 7,262 |   |
| Net income                           |       | —           |       | —            |       | —            |       | 360         |       | 360        |       |
| Other comprehensive loss, net of tax |       | —           |       | —            |       | (379              | )          | —      |       | (379       | )          |
| Exercise of stock options            |       | 69               |       | 217               |       | —            |       | —      |       | 217        |       |
| Share-based compensation             |       | —           |       | 529               |       | —            |       | —      |       | 529        |       |
| Balance at January 3, 2009      |       | 4,578            |       | 16,221            |       | (303              | )          | (7,929      | )          | 7,989      |       |
| Net loss                             |       | —           |       | —            |       | —            |       | (3,338      | )          | (3,338     | )          |
| Other comprehensive loss, net of tax |       | —           |       | —            |       | (65               | )          | —      |       | (65        | )          |
| Issuance of warrant                  |       | —           |       | 479               |       | —            |       | —      |       | 479        |       |
| Share-based compensation             |       | —           |       | 578               |       | —            |       | —      |       | 578        |       |
| Balance at January 2, 2010      |       | 4,578            |       | $                 | 17,278     |              | $          | (368        | )          | $          | (11,267    | ) | $ | 5,643 |   |

 

Comprehensive lossis as follows:

 
| ** **                                                                                                                | ** ** | **For the fiscal year ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                | ** ** | **January 2,**           | ** ** | **January 3,** | ** ** |
| ** **                                                                                                                | ** ** | **2010**                      | ** ** | **2009** | ** ** |
| Net income (loss)                                                                                                         |       | $                             | (3,338     | ) | $ | 360 |   |
| Foreign currency translation adjustments, net of tax                                                                      |       | (65                           | )          | (452 | ) |
| Reclassification of foreign currency translation adjustments  related to discontinued operations recognized in net income |       | —                        |       | 73 |   |
| Comprehensive loss                                                                                                        |       | $                             | (3,403     | ) | $ | (19 | ) |

 

See Notes toConsolidated Financial Statements.

 

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**APPLIANCE RECYCLING CENTERS OF AMERICA, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In Thousands)**

 
| ** **                                                                                                      | ** ** | **For the fiscal year ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                      | ** ** | **January 2,**           | ** ** | **January 3,** | ** ** |
| ** **                                                                                                      | ** ** | **2010**                      | ** ** | **2009** | ** ** |
| **Operating activities**                                                                                        |       |                          |       |   |   |
| Net income (loss)                                                                                               |       | $                             | (3,338     | ) | $ | 360 |   |
| Adjustments to reconcile  net income (loss) to net cash and cash equivalents provided by operating  activities: |       |                          |       |   |   |
| Loss on disposal of  discontinued operations                                                                    |       | —                        |       | 692 |   |
| Depreciation and  amortization                                                                                  |       | 1,287                         |       | 1,123 |   |
| Amortization of deferred  gain                                                                                  |       | (122                          | )          | — |   |
| Provision for bad debts                                                                                         |       | 69                            |       | 264 |   |
| Share-based compensation                                                                                        |       | 578                           |       | 529 |   |
| Deferred income taxes                                                                                           |       | (58                           | )          | 72 |   |
| Other                                                                                                           |       | 88                            |       | — |   |
| Changes in assets and  liabilities:                                                                             |       |                          |       |   |   |
| Accounts receivable                                                                                             |       | 1,735                         |       | 3,570 |   |
| Inventories                                                                                                     |       | 2,094                         |       | (5,041 | ) |
| Other current assets                                                                                            |       | 418                           |       | 45 |   |
| Other assets                                                                                                    |       | 12                            |       | (4 | ) |
| Accounts payable and  accrued expenses                                                                          |       | (1,268                        | )          | (164 | ) |
| Income taxes payable                                                                                            |       | (159                          | )          | 203 |   |
| Net cash flows provided by  operating activities                                                                |       | 1,336                         |       | 1,649 |   |
|                                                                                                            |       |                          |       |   |   |
| **Investing activities**                                                                                        |       |                          |       |   |   |
| Purchase of property and  equipment                                                                             |       | (509                          | )          | (812 | ) |
| Increase in restricted cash                                                                                     |       | (700                          | )          | — |   |
| Proceeds from sale of  building and equipment                                                                   |       | 4,635                         |       | — |   |
| Investment in DALI                                                                                              |       | (263                          | )          | — |   |
| Loan to 4301 Operations                                                                                         |       | (375                          | )          | — |   |
| Net cash flows provided by  (used in) investing activities                                                      |       | 2,788                         |       | (812 | ) |
|                                                                                                            |       |                          |       |   |   |
| **Financing activities**                                                                                        |       |                          |       |   |   |
| Checks issued in excess of  cash in bank                                                                        |       | 410                           |       | (310 | ) |
| Net borrowings (payments)  under line of credit                                                                 |       | (2,108                        | )          | 942 |   |
| Payments on long-term  obligations                                                                              |       | (3,214                        | )          | (482 | ) |
| Proceeds from stock option  exercises                                                                           |       | —                        |       | 217 |   |
| Net cash flows provided by  (used in) financing activities                                                      |       | (4,912                        | )          | 367 |   |
|                                                                                                            |       |                          |       |   |   |
| Effect of changes in  exchange rate on cash and cash equivalents                                                |       | 89                            |       | (483 | ) |
|                                                                                                            |       |                          |       |   |   |
| Increase in cash and cash  equivalents                                                                          |       | (699                          | )          | 721 |   |
| Cash and cash equivalents  at beginning of period                                                               |       | 3,498                         |       | 2,777 |   |
| Cash and cash equivalents  at end of period                                                                     |       | $                             | 2,799      |   | $ | 3,498 |   |
|                                                                                                            |       |                          |       |   |   |
| **Supplemental disclosures of  cash flow information**                                                          |       |                          |       |   |   |
| Cash payments for interest                                                                                      |       | $                             | 1,161      |   | $ | 1,385 |   |
| Cash payments for income  taxes, net                                                                            |       | $                             | 220        |   | $ | 397 |   |
|                                                                                                            |       |                          |       |   |   |
| **Non-cash investing and  financing activities**                                                                |       |                          |       |   |   |
| Equipment acquired under  capital lease                                                                         |       | $                             | 259        |   | $ | 518 |   |
| Deferred gain on  sale-leaseback of building                                                                    |       | $                             | 2,436      |   | $ | — |   |
| Issuance of warrant in connection with recycling  contract                                                      |       | $                             | 479        |   | $ | — |   |

 

See Notes to Consolidated Financial Statements.

 

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**APPLIANCERECYCLING CENTERS OF AMERICA, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(InThousands, Except Per Share Amounts)**

 

**1.****             ****Nature of Business and Basis ofPresentation**

 

*Nature ofbusiness**:*** **Appliance Recycling Centers of America, Inc. andSubsidiaries (“we,” the “Company” or “ARCA”) are in the business of selling newmajor household appliances through a chain of Company-owned factory outletstores under the name ApplianceSmart®.  We also provide turnkey appliance recyclingand replacement services for electric utilities and other sponsors of energyefficiency programs.

 

*Principlesof consolidation**:*  The consolidated financial statements includethe accounts of Appliance Recycling Centers of America, Inc. and oursubsidiaries.  All significantintercompany accounts and transactions have been eliminated in consolidation.

 

ARCA Canada Inc.,a Canadian corporation, is a wholly-owned subsidiary.  ARCA Canada was formed in September 2006to provide turnkey recycling services for electric utility energy efficiencyprograms.  The operating results of ARCACanada have been consolidated in our financial statements.

 

We were a sixtypercent owner in North America Appliance Company, LLC (“NAACO”).  NAACO was formed and commenced operations in June 2003and was a retailer of special-buy appliances in Texas.  The operating results of NAACO have beenconsolidated in our financial statements.

 

We were a sixtypercent owner in Productos Duraderos de Norte America (“PDN”), a Mexicancorporation.  PDN was acquired in September 2006and refurbished room air conditioners for sale through our NAACO operation inMcAllen, Texas, and through our ApplianceSmart Factory Outlet stores.  The operating results of PDN have beenconsolidated in our financial statements.

 

*Discontinuedoperations*:  During the fourth quarter of 2008, we plannedand executed the shutdown of our NAACO and PDN businesses.  NAACO and PDN were not operating as plannedand were no longer economically viable.

 

*Reclassifications**:*  Certain prioryear items have been reclassified to conform to current year presentation.  We reclassified the results of ourdiscontinued operations below income (loss) from continuing operations in theconsolidated statements of operations. In Note 15, we reclassified certain assets, revenue and operating incomeitems between our retail, recycling and unallocated corporate segments.

 

*Fairvalue of financial instruments**:***** The following methods and assumptions are usedto estimate the fair value of each class of financial instrument:

 

*Cash andcash equivalents, accounts receivable and accounts payable:* Due to their nature and short-term maturities, the carrying amountsapproximate fair value.

 

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

 

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

 

*Estimates**:*  Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires our management tomake estimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported 

 

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amounts ofrevenues and expenses during the reporting period.  Significant items subject to estimates andassumptions include the valuation allowances for accounts receivable,inventories and deferred tax assets, accrued expenses, and the assumptions weuse to value share-based compensation. Actual results could differ from those estimates.

 

*Fiscalyear**:* We report on a 52- or 53-week fiscal year.  Our 2009 fiscal year (“2009”) ended on January 2,2010 and included 52 weeks.  Our 2008fiscal year (“2008”) ended on January 3, 2009 and included 53 weeks.

 

**2.****             ****Recent Accounting Pronouncements**

 

*AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples*

 

On October 3, 2009,we adopted new accounting guidance related to accounting standards codificationand the hierarchy of generally accepted accounting principles (“GAAP”).  The new guidance will become the source ofauthoritative non-SEC authoritative GAAP. The guidance establishes a two-level GAAP hierarchy for nongovernmentalentities: authoritative guidance and nonauthoritative guidance.  Authoritative guidance consists of theCodification and, for SEC registrants, rules and interpretative releasesof the Commission.  Nonauthoritativeguidance consists of non-SEC accounting literature that is not included in theCodification and has not been grandfathered. The new guidance, including the Codification, is effective for financialstatements of interim and annual periods ending after September 15,2009.  As the Codification was notintended to change or alter existing GAAP, it did not have any impact on ourconsolidated financial statements.

 

*Consolidationof Variable Interest Entities*

 

On January 3, 2010,we plan to adopt new accounting guidance related to consolidation of variableinterest entities.  The new guidanceaddresses the effects of eliminating the qualified special purpose entityconcept and responds to concerns about the application of accounting guidancerelated to the consolidation of variable interest entities, including concernsover the transparency of enterprises’ involvement with variable interestentities. The new guidance is effective for fiscal years beginning after November 15,2009.  We do not expect the new guidance to have a material impact on thepreparation of our consolidated financial statements.

 

*Accountingfor Transfers of Financial Assets*

 

On January 3, 2010,we plan to adopt new accounting guidance related to accounting for transfers offinancial assets.  The new guidanceeliminates the concept of a “qualified special-purpose entity,” changes therequirements for derecognizing financial assets and requires additionaldisclosures in order to enhance information reported to users of financialstatements by providing greater transparency about transfers of financialassets, including securitization transactions, and an entity’s continuinginvolvement in and exposure to the risks related to transferred financialassets.  The new guidance is effectivefor fiscal years beginning after November 15, 2009.  We do not expect the new guidance to have amaterial impact on the preparation of our consolidated financial statements.

 

*SubsequentEvents*

 

On July 4, 2009, weadopted new guidance related to subsequent events.  The new guidance requires all public entitiesto evaluate subsequent events through the date that the financial statementsare available to be issued and disclose in the notes the date through which theCompany has evaluated subsequent events and whether the financial statementswere issued or were available to be issued on the disclosed date.  The new guidance defines two types of subsequentevents, as follows: the first type consists of events or transactions thatprovide additional evidence about conditions that existed at the date of thebalance sheet, and the second type consists of events that provide evidenceabout conditions that did not exist at the date of the balance sheet but aroseafter that date.  The new guidance iseffective for interim and annual periods ending after June 15, 2009 andmust be applied prospectively.  In February 2010,the new guidance related to subsequent events was amended for SEC filers to deletethe requirement to disclose the date through which the Company has to evaluatesubsequent events.  The adoption ofthe new guidance and related amendment thereto did not have a material effecton our results of operations or financial position.

 

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*Disclosures about DerivativeInstruments and Hedging Activities*

 

On January 4, 2009,we adopted new accounting guidance related to disclosures about derivativeinstruments and hedging activities.  Thenew guidance is intended to improve financial reporting about derivativeinstruments and hedging activities by requiring enhanced disclosures to enableinvestors to better understand their effects on an entity’s financial position,financial performance and cash flows. The new guidance also improves transparency about the location andamounts of derivative instruments in an entity’s financial statements; howderivative instruments and related hedged items are accounted for; and howderivative instruments and related hedged items affect its financial position,financial performance and cash flows. The new guidance is effective for financial statements issued for fiscalyears and interim periods beginning after November 15, 2008, with earlyapplication encouraged.  The adoption ofthe new guidance did not have a material effect on our results of operations orfinancial position.

 

*Noncontrolling Interests inConsolidated Financial Statements*

 

On January 4, 2009,we adopted new accounting guidance related to noncontrolling interests onconsolidated financial statements.  Thenew guidance establishes accounting and reporting standards for noncontrollinginterests in subsidiaries and for the deconsolidation of subsidiaries andclarifies that a noncontrolling interest in a subsidiary is an ownershipinterest in the consolidated entity that should be reported as equity in theconsolidated financial statements.  Thenew guidance also requires expanded disclosures that clearly identify anddistinguish between the interests of the parent owners and the interests of thenoncontrolling owners of a subsidiary. The new guidance is effective for fiscal years beginning on or after December 15,2008.  The adoption of the new guidancedid not have a material effect on our results of operations or financialposition.

 

*Business Combinations*

 

On January 4, 2009,we adopted new accounting guidance related to business combinations.  The new accounting guidance establishes theprinciples and requirements for how an acquirer in a business combination:recognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, and any noncontrolling interests in the acquiree;recognizes and measures the goodwill acquired in the business combination orthe gain from a bargain purchase; and determines what information should bedisclosed in the financial statements to enable users of the financialstatements to evaluate the nature and financial effects of the businesscombination.  The new guidance iseffective for fiscal years beginning on or after December 15, 2008.  The adoption of the new guidance did not havea material effect on our results of operations or financial position.

 

**3.     Significant Accounting Policies**

 

*Cash and cash equivalents**:*  We considerall highly liquid investments purchased with original maturity dates of threemonths or less to be cash equivalents. We maintain our cash in bank deposit and money-market accounts which, attimes, exceed federally insured limits. We have determined that the fair value of the money-market accounts fallwithin level 1 of the fair value hierarchy. We have not experienced any losses in such accounts.

 

*Trade receivables**:*** **We carryunsecured trade receivables at the original invoice amount less an estimatemade for doubtful accounts based on a monthly review of all outstandingamounts.  Management determines theallowance for doubtful accounts by regularly evaluating individual customerreceivables and considering a customer’s financial condition, credit historyand current economic conditions.  Wewrite off trade receivables when we deem them uncollectible.  We record recoveries of trade receivablespreviously written off when we receive them. We consider a trade receivable to be past due if any portion of thereceivable balance is outstanding for more than ninety days.  We do not charge interest on past duereceivables.  In 2009, we wrote off $320of uncollectible receivables primarily reserved for in 2008.  Our management considers the allowance fordoubtful accounts of $41 and $292 to be adequate to cover any exposure to lossas of January 2, 2010 and January 3, 2009, respectively.

 

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*Inventories**:* Inventories, consisting principally of appliances, are stated at thelower of cost, determined on a specific identification basis, or market andconsist of:

 
| ** **                                 | ** ** | **January 2,  2010** | ** ** | **January 3,  2009** | ** ** |
|--------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| Finished  goods                            |       | $                         | 17,304     |                      | $          | 18,949 |   |
| Less  provision for inventory obsolescence |       | (519                      | )          | (115                      | )          |
|                                       |       | $                         | 16,785     |                      | $          | 18,834 |   |

 

We provideestimated provisions for the obsolescence of our appliance inventories,including adjustments to market, based on various factors, including the age ofsuch inventory and our management’s assessment of the need for suchprovisions.  We look at historicalinventory agings and margin analysis in determining our provision estimate.

 

*Propertyand equipment**:*  Property andequipment are stated at cost.  We computedepreciation using straight-line and accelerated methods over the followingestimated useful lives:

 
| ** **                               | ** ** | **Years** | ** ** |
|------------------------------------------|------------|-----------|------------|
| Buildings  and improvements              |       | 18-30     |       |
| Equipment  (including computer software) |       | 3-8       |       |

 

We amortize leaseholdimprovements on a straight-line basis over the shorter of their estimateduseful lives or the underlying lease term. Repair and maintenance costs are charged to operations as incurred.

 

Property and equipmentconsists of the following:

 
| ** **                                      | ** ** | **January 2,  2010** | ** ** | **January 3,  2009** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| Land                                            |       | $                         | 1,140      |                      | $          | 2,050 |   |
| Buildings  and improvements                     |       | 2,990                     |       | 5,249                     |       |
| Equipment  (including computer software)        |       | 9,082                     |       | 9,161                     |       |
|                                            |       | 13,212                    |       | 16,460                    |       |
| Less  accumulated depreciation and amortization |       | (9,073                    | )          | (9,493                    | )          |
|                                            |       | $                         | 4,139      |                      | $          | 6,967 |   |

 

In 2009, we wrote off $597 of fully depreciated assets that were nolonger in use, which did not have an impact on our operating results.  In 2009, we also reduced land, building andimprovements and accumulated depreciation by $910, $2,317 and $1,036,respectively, as a result of the sale-leaseback transaction described in Note4.

 

*Depreciationand amortization expense*:  Depreciationand amortization expense related to buildings and equipment from our recyclingcenters is presented in cost of revenues and depreciation and amortizationexpense related to buildings and equipment from our ApplianceSmart FactoryOutlet stores and corporate assets, such as furniture and computers, ispresented in selling, general and administrative expenses in the consolidatedstatements of operations.  Depreciationand amortization expense was $1,287 and $1,123 for the fiscal years ended January 2,2010 and January 3, 2009, respectively.

 

*Software development costs**:*  We capitalizesoftware developed for internal use and are amortizing such costs over theirestimated useful lives of three to five years. Costs capitalized were $207 and $262 for the fiscal years ended January 2,2010 and January 3, 2009, respectively. Amortization expense on software development costs was $314 and $256 forthe fiscal years 2009 and 2008, respectively. Estimated amortization expenses are $249, $141, $30 and $2 for thefiscal years 2010, 2011, 2012 and 2013, respectively.

 

*Impairmentof long-lived assets**:*** **We evaluate long-lived assets such asproperty and equipment for impairment whenever events or changes incircumstances indicate the carrying value of an asset may not berecoverable.  We assess impairment 

 

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based on the estimatedfuture net undiscounted cash flows expected to result from the use of theassets, including cash flows from disposition. Should the sum of the expected future net cash flows be less than thecarrying value, we recognize an impairment loss at that time.  We measure an impairment loss by comparingthe amount by which the carrying value exceeds the fair value (estimateddiscounted future cash flows or appraisal of assets) of the long-livedassets.  We recognized no impairmentcharges during the fiscal years ended January 2, 2010 and January 3,2009.

 

*Restrictedcash**:*  Restricted cash consists of a reserve account required by our bankcard processorto cover chargebacks, adjustments, fees and other charges that may be due fromus.

 

*Accounting for leases*: We conduct the majority of our retail and recycling operations fromleased facilities.  The majority of ourleases require payment of real estate taxes, insurance and common areamaintenance in addition to rent.  Theterms of our lease agreements typically range from five to ten years.  Most of the leases contain renewal andescalation clauses, and certain store leases require contingent rents based onfactors such as revenue.  For leases thatcontain predetermined fixed escalations of the minimum rent, we recognize therelated rent expense on a straight-line basis from the date we take possessionof the property to the end of the initial lease term.  We record any difference betweenstraight-line rent amounts and amounts payable under the leases as part ofdeferred rent in accrued expenses.  Cashor lease incentives (tenant allowances) received upon entering into certainstore leases are recognized on a straight-line basis as a reduction to rentfrom the date we take possession of the property through the end of the initiallease term.

 

*Product warranty**:*  We provide awarranty for the replacement or repair of certain defective units.  Our standard warranty policy requires us torepair or replace certain defective units at no cost to our customers.  We estimate the costs that may be incurredunder our warranty and record an accrual in the amount of such costs at thetime we recognize product revenue. Factors that affect our warranty accrual for covered units include thenumber of units sold, historical and anticipated rates of warranty claims onthese units, and the cost of such claims. We periodically assess the adequacy of our recorded warranty accrual andadjust the amounts as necessary.

 

Changes in our warrantyaccrual for the fiscal years ended January 2, 2010 and January 3,2009 are as follows:

 
| ** **                            | ** ** | **For the fiscal year ended** | ** ** |
|---------------------------------------|------------|-------------------------------|------------|
| ** **                            | ** ** | **January 2,  2010**     | ** ** | **January 3,  2009** | ** ** |
| Beginning  Balance                    |       | $                             | 91         |   | $ | 80 |   |
| Standard  accrual based on units sold |       | 79                            |       | 87 |   |
| Actual  costs incurred                |       | (16                           | )          | (4 | ) |
| Periodic  accrual adjustments         |       | (87                           | )          | (72 | ) |
| Ending  Balance                       |       | $                             | 67         |   | $ | 91 |   |

 

*Income taxes**: *We accountfor income taxes under the liability method. Deferred tax liabilities are recognized for temporary differences thatwill result in taxable amounts in future years. Deferred tax assets are recognized for deductible temporary differencesand tax operating loss and tax credit carryforwards.  Deferred tax assets and liabilities aremeasured using the enacted tax rates expected to apply to taxable income in theperiods in which the deferred tax asset or liability is expected to be realizedor settled.  We assess the likelihoodthat our deferred tax assets will be recovered from future taxable income andrecord a valuation allowance to reduce our deferred tax assets to the amountswe believe to be realizable.  Weconcluded that a full valuation allowance against our U.S. deferred tax assetswas appropriate as of January 2, 2010.

 

*Share-basedcompensation**:*  We recognize compensation expense on astraight-line basis over the vesting period for all share-based awardsgranted.  We use the Black-Scholes optionpricing model to determine the fair value of awards at the grant date.  We calculate the expected volatility forstock options and awards using historical volatility.  We estimate a 0%-5% forfeiture rate for stockoptions issued to all employees and Board of Directors members, but willcontinue to review these estimates in future periods.  The risk-free rates for the expected terms ofthe stock options are based on the U.S. Treasury yield curve in effect at thetime of the grant.  The expected liferepresents the period that the stock option awards are expected to beoutstanding.  The expected dividend yieldis zero as we have not paid or declared any cash dividends on our CommonStock.  Based on these valuations, werecognized share-based compensation expense of $578 and $529 for the fiscalyears ending January 2, 2010 and January 3, 2009, respectively.  We estimate that the expense for fiscal 2010will be 

 

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approximately $177and immaterial thereafter, based on the value of options outstanding as of January 2,2010.  This estimate does not include anyexpense for additional options that may be granted and vest during 2010.

 

*Comprehensiveincome (loss)**:*  Other comprehensive income (loss) refers torevenues, expenses, gains and losses that under generally accepted accountingprinciples are included in comprehensive income (loss) but are excluded fromnet income (loss) as these amounts are recorded directly as an adjustment toshareholders’ equity.  Our othercomprehensive income (loss) is comprised of foreign currency translationadjustments.  The effect of the foreigncurrency translation adjustments, net of tax, was a loss of $65 and $452 forthe fiscal years ending January 2, 2010 and January 3, 2009,respectively.

 

*Revenuerecognition**:*  We recognize revenue from appliance sales inthe period the consumer purchases and pays for the appliance, net of anallowance for estimated returns.  Werecognize revenue from appliance recycling when we collect and process aunit.  We recognize byproduct revenueupon shipment.  We recognize revenue onextended warranties with retained service obligations on a straight-line basisover the period of the warranty.  Onextended warranty arrangements that we sell but others service for a fixedportion of the warranty sales price, we recognize revenue for the net amountretained at the time of sale of the extended warranty to the consumer.  We include shipping and handling charges tocustomers in revenue, which are recognized in the period the consumer purchasesand pays for delivery.  Shipping andhandling costs that we incur are included in cost of revenues.

 

*Taxescollected from customers**:*** **We account for taxes collected from customers on a netbasis.

 

*Advertisingexpense**:***** Our policy is to expense advertising costs asincurred.  Advertising expense was $3,746and $4,258 for the fiscal years ended January 2, 2010 and January 3,2009, respectively.

 

*Basic anddiluted net income (loss) per common share:*  Basic income(loss) per common share is computed based on the weighted average number ofcommon shares outstanding.  Dilutedincome (loss) per common share is computed based on the weighted average numberof common shares outstanding adjusted by the number of additional shares thatwould have been outstanding had the potentially dilutive common shares beenissued.  Potentially dilutive shares ofCommon Stock include unexercised stock options and warrants.  Basic per share amounts are computed,generally, by dividing net income (loss) by the weighted average number ofcommon shares outstanding.  Diluted pershare amounts assume the conversion, exercise or issuance of all potentialCommon Stock instruments unless their effect is anti-dilutive, thereby reducingthe loss or increasing the income per common share.  In calculating diluted weighted averageshares and per share amounts, we included stock options with exercise pricesbelow average market prices, for the respective fiscal years in which they weredilutive, using the treasury stock method. We calculated the number of additional shares by assuming theoutstanding stock options were exercised and that the proceeds from suchexercises were used to acquire Common Stock at the average market price duringthe year.  We excluded 303 options infiscal 2008 from the diluted weighted average share outstanding calculation asthe effect of these options is anti-dilutive. The effect of all options and warrants outstanding in fiscal year 2009 wasanti-dilutive due to the net loss incurred.

 

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A reconciliationof the denominator in the basic and diluted income or loss per share is asfollows:

 
| ** **                                               | ** ** | **For the fiscal year ended** | ** ** |
|----------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                               | ** ** | **January 2,**           | ** ** | **January 3,** | ** ** |
| ** **                                               | ** ** | **2010**                      | ** ** | **2009** | ** ** |
| **Numerator:**                                           |       |                          |       |   |   |
| Income (loss) from continuing operations                 |       | $                             | (3,338     | ) | $ | 1,864 |   |
| Loss from discontinued operations, net of tax            |       | —                        |       | (812 | ) |
| Loss on disposal of discontinued operations, net of  tax |       | —                        |       | (692 | ) |
| Net income (loss)                                        |       | $                             | (3,338     | ) | $ | 360 |   |
|                                                     |       |                          |       |   |   |
| **Denominator:**                                         |       |                          |       |   |   |
| Weighted average common shares outstanding - basic       |       | 4,578                         |       | 4,571 |   |
| Stock options                                            |       | —                        |       | 41 |   |
| Weighted average common shares outstanding - diluted     |       | 4,578                         |       | 4,612 |   |
|                                                     |       |                          |       |   |   |
| **Basic income (loss) per common share:**                |       |                          |       |   |   |
| Continuing operations                                    |       | $                             | (0.73      | ) | $ | 0.41 |   |
| Discontinued operations                                  |       | —                        |       | (0.33 | ) |
| Net income (loss)                                        |       | $                             | (0.73      | ) | $ | 0.08 |   |
|                                                     |       |                          |       |   |   |
| **Diluted income (loss) per common share:**              |       |                          |       |   |   |
| Continuing operations                                    |       | $                             | (0.73      | ) | $ | 0.41 |   |
| Discontinued operations                                  |       | —                        |       | (0.33 | ) |
| Net income (loss)                                        |       | $                             | (0.73      | ) | $ | 0.08 |   |

 

**4.****             ****Sale-Leaseback Transaction**

 

On September 25,2009, we completed the sale-leaseback of our St. Louis Park building.  The building is a 126,458-square-footfacility that includes our corporate office, a processing and recycling center,and an ApplianceSmart Factory Outlet store. Pursuant to the agreement entered into on August 11, 2009, we soldthe St. Louis Park building for $4,627, net of fees, and leased the buildingback over an initial lease term of five years. The sale of the building provided the Company with $2,032 in cash afterrepayment of the $2,595 mortgage.  Thesale-leaseback transaction resulted in an adjustment of $2,191 to the net bookvalue related to the land and building, and we recorded a deferred gain of$2,436.  Under the terms of the leaseagreement, we are classifying the lease as an operating lease and amortizingthe gain on a straight-line basis over five years.

 

**5.****             ****Discontinued Operations**

 

During the fourthquarter of 2008, we planned and executed the shutdown of our NAACO and PDNoperations.  NAACO and PDN were notoperating as planned and were no longer economically viable.  In 2008, our supply of room air conditionersfrom a major manufacturer was depleted, no longer providing refurbishmentopportunities for PDN and revenues for NAACO, which was the basis for ourinvestment in these businesses.  We havenot had any continuing involvement or significant continuing cash flows inthese businesses.  The results ofoperations for NAACO and PDN were included in our retail segment.  During the fiscal year ended January 3,2009, NAACO and PDN had revenues of $792 and a loss before taxes of $882.  All results of operations for periodspresented prior to the abandonment date have been reclassified as discontinuedoperations.  We recorded a loss on thedisposal of NAACO and PDN of $692, net of tax, for the year ended January 3,2009, which consisted of termination costs and the write-off of certain assetsto fair value upon the abandonment of the operations in December 2008.

 

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**6.****             ****Investments**

 

On June 1,2009, we completed a $263 investment in Diagnostico y Administracion deLogistica Inversa, S.A. de C.V. (“DALI”), a Mexican company.  DALI is a joint venture that operates arefrigerator recycling program sponsored by the Mexican government.  Our investment represents a 46.3% ownershipin the joint venture.  The DALI jointventure is accounted for under the equity method and is presented in theconsolidated balance sheets as a component of other assets.  The results of the joint venture wereimmaterial for the fiscal year ended January 2, 2010.

 

On October 21,2009, we entered into an Appliance Sales and Recycling Agreement (the “Agreement”).  Under the Agreement, our client will sell allof its recyclable appliances generated in the northeastern United States to us,and we will collect, process and recycle such recyclable appliances.  The Agreement requires that we will onlyrecycle, and will not sell for re-use or resale, the recyclable appliancespurchased from our client.  We plan toestablish a regional processing center (“RPC”) located in the northeasternUnited States at which the recyclable appliances will be processed.  The term of the Agreement is for a period ofsix years from the first date of collection of recyclable appliances, which weexpect will be early in the second quarter of 2010. We issued a warrant inconjunction with the Agreement asdescribed in Note 13.  The fairmarket value of the warrant was recorded as an intangible asset and will beamortized over the initial term of the Agreement.  The recycling contract intangible asset ispresented in the consolidated balance sheets as a component of other assets.

 

In connection withthe Agreement described above, we entered into a Joint Venture Agreement with4301 Operations, LLC, to establish and operate the northeastern RPC.  4301 Operations has substantial experience inthe recycling of major household appliances and will contribute their existingbusiness to the joint venture.  Under theJoint Venture Agreement, the parties will form a new entity to be known as ARCAAdvanced Processing, LLC (“AAP”) and each party will be a 50% owner ofAAP.  If additional RPCs are established,AAP will establish the next two RPCs and will have a right of first refusal toestablish subsequent RPCs.  We plan toraise debt and/or equity financing to fund our share of the capital required toform the joint venture.  We plan tocontribute approximately $2,000, including the Appliance Sales and RecyclingAgreement, to the joint venture, and 4301 Operations plans to contribute theirequipment and existing business to the joint venture.  The joint venture plans to commenceoperations early in the second quarter of 2010; however, there is no assurancethat operations will commence or that financing will be available on termssatisfactory to us or permitted by our current debt agreement.  As of January 2, 2010, we loaned 4301Operations $375 that will be considered as a portion of our capitalcontribution when the joint venture commences operations.  The loan to 4301 Operations is presented inthe consolidated balance sheets as a component of other assets.

 

The Agreement iscontingent on the ability of the joint venture to raise additional financing topurchase and install UNTHA Recycling Technology (“URT”) equipment, which willenhance the capabilities of the RPC.  Weare the exclusive distributor of URT equipment for North America**. **The joint ventureplans to raise additional debt financing to purchase the URT equipment, butthere is no assurance that the financing will be available or on terms acceptableto the joint venture.

 

**7.****             ****Other Assets**

 

Other assets as ofJanuary 2, 2010 and January 3, 2009 consist of the following:

 
| ** **                   | ** ** | **January 2,  2010** | ** ** | **January 3,  2009** | ** ** |
|------------------------------|------------|---------------------------|------------|---------------------------|------------|
| Deposits                     |       | $                         | 407        |                      | $          | 408 |   |
| Investment in DALI           |       | 263                       |       | —                    |       |
| Loan to 4301 Operations, LLC |       | 375                       |       | —                    |       |
| Recycling contract, net      |       | 479                       |       | —                    |       |
| Other                        |       | 42                        |       | 77                        |       |
|                         |       | $                         | 1,566      |                      | $          | 485 |   |

 

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**8.****             ****Accrued Expenses**

 

Accrued expensesas of January 2, 2010 and January 3, 2009 consist of the following:

 
| ** **                                                      | ** ** | **January 2,  2010** | ** ** | **January 3,   2009** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------|------------|----------------------------|------------|
| Compensation and benefits                                       |       | $                         | 868        |                       | $          | 1,565 |   |
| Accrued recycling incentive checks                              |       | 1,232                     |       | 1,110                      |       |
| Accrued rent                                                    |       | 1,176                     |       | 461                        |       |
| Warranty expense                                                |       | 67                        |       | 91                         |       |
| Accrued payables                                                |       | 350                       |       | 509                        |       |
| Current portion of deferred gain on sale-leaseback  of building |       | 488                       |       | —                     |       |
| Other                                                           |       | 220                       |       | 337                        |       |
|                                                            |       | $                         | 4,401      |                       | $          | 4,073 |   |

 

**9.****             ****Line of Credit**

 

We have an $18,000line of credit with a lender.  The linewas increased from $16,000 to $18,000 on February 5, 2008.  The interest rate on the line was 6.25% (thegreater of prime plus 3.00 percentage points or 6.25%) as of January 2,2010 and January 3, 2009.  Theweighted average interest rate for fiscal years 2010 and 2009 was 6.25% and6.83%, respectively.  The amount ofborrowings available under the line of credit is based on a formula usingreceivables and inventories.  Our unusedborrowing capacity under this line was $56 as of January 2, 2010.  We may not have access to the full $18.0 millionline of credit due to the formula using our receivables and inventories.  The line of credit has a stated maturity dateof December 31, 2010, if not renewed, and provides that the lender maydemand payment in full of the entire outstanding balance of the loan at anytime.  The line of credit iscollateralized by substantially all our assets and requires minimum monthlyinterest payments of $58, regardless of the outstanding principal balance.  The lender is also secured by an inventoryrepurchase agreement with Whirlpool Corporation for purchases from Whirlpoolonly.  The loan requires that we meetcertain financial covenants, provides payment penalties for noncompliance andprepayment, limits the amount of other debt we can incur, limits the amount ofspending on fixed assets and prohibits payments of dividends.  As of January 2, 2010, we were not incompliance with certain financial covenants of the loan agreement and receiveda waiver from the lender.  On March 10,2010, the interest rate on the line increased to 6.75% (the greater of primeplus 3.50 percentage points or 6.75%).

 

**10.****      ****Long-Term Debt Obligations**

 

Long-term debt andcapital lease obligations as of January 2, 2010 and January 3, 2009consist of the following:

 
| ** **                                                                                                                                                                                                                                          | ** ** | **January 2,  2010** | ** **  | **January 3,   2009** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|-------------|----------------------------|------------|
|                                                                                                                                                                                                                                                |       |                      |        |                       |       |
| 6.85 % mortgage, due in monthly installments of $15,  including interest, due January 2013, collateralized by land and  building                                                                                                               |       | $                         |  1,586 |                       | $          |  1,659 |   |
|                                                                                                                                                                                                                                                |       |                      |        |                       |       |
| Adjustable rate mortgage, due in monthly  installments, adjusted weekly based on 30-day LIBOR plus 2.70 percentage  points (3.38% as of January 3, 2009) on a 20-year amortization due  October 2012, collateralized by land and building |       | —                    |        | 2,747                      |       |
|                                                                                                                                                                                                                                                |       |                      |        |                       |       |
| Capital leases and other financing obligations                                                                                                                                                                                                      |       | 921                       |        | 1,065                      |       |
|                                                                                                                                                                                                                                                |       | 2,507                     |        | 5,471                      |       |
| Less current maturities                                                                                                                                                                                                                             |       | 544                       |        | 579                        |       |
|                                                                                                                                                                                                                                                |       | $                         |  1,963 |                       | $          |  4,892 |   |

 

In September 2009, we paid off our adjustable rate mortgage as aresult of the sale-leaseback transaction described in Note 4.

 

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The future annualmaturities of long-term debt obligations are as follows:

 
| 2010   |   | $     |  544   |   |
|--------|--------|-------|-------------|--------|
| 2011   |   | 412   |        |
| 2012   |   | 197   |        |
| 2013   |   | 1,350 |        |
| 2014   |   | 4     |        |
|   |   | $     |  2,507 |   |

 

*Capital leases and other financing obligations**:*  We acquire certain equipment under capitalleases and other financing obligations. The cost of equipment was approximately $1,615 and $1,396 at January 2,2010 and January 3, 2009, respectively. Accumulated amortization at January 2, 2010 and January 3,2009 was approximately $802 and $387, respectively.  Depreciation and amortization expense forequipment under capital leases and other financing obligations is included incost of revenue and selling, general and administrative expenses.

 

In 2008, we entered intoa master equipment lease with a lender providing up to $250 in availablefunds.  As of January 3, 2009, wehad utilized the entire lease line to fund equipment for factory outletstores.  In 2009, we entered into amaster equipment lease with a lender providing up to $188 in availablefunds.  As of January 2, 2010, wehad utilized the entire lease line to fund equipment and displays for factoryoutlet stores.

 

The followingschedule by fiscal year is the approximate remaining minimum payments requiredunder the leases and other financing obligations, together with the presentvalue at January 2, 2010:

 
| 2010                                                                   |   | $     | 537    |   |
|------------------------------------------------------------------------|--------|-------|--------|--------|
| 2011                                                                   |   | 358   |   |
| 2012                                                                   |   | 114   |   |
| 2013                                                                   |   | 13    |   |
| 2014                                                                   |   | 4     |   |
| Total minimum lease and other financing obligation  payments           |   | 1,026 |   |
| Less amount representing interest                                      |   | 105   |   |
| Present value of minimum payments                                      |   | 921   |   |
| Less current portion                                                   |   | 466   |   |
| Capital lease and other financing obligations, net  of current portion |   | $     | 455    |   |

 

**11.****      ****Commitments and Contingencies**

 

*Operatingleases**:*** **We leasethe majority of our retail stores and recycling centers under noncancelableoperating leases.  The leases typicallyrequire the payment of taxes, maintenance, utilities and insurance.

 

Minimum futurerental commitments under noncancelable operating leases as of January 2,2010 are as follows:

 
| 2010                |   | $     | 4,534  |   |
|---------------------|--------|-------|--------|--------|
| 2011                |   | 4,541 |   |
| 2012                |   | 4,349 |   |
| 2013                |   | 3,966 |   |
| 2014                |   | 3,130 |   |
| 2015 and thereafter |   | 5,734 |   |
|                |   | $     | 26,254 |   |

 

Rent expense forthe fiscal years ended January 2, 2010 and January 3, 2009 was $4,960and $4,710, respectively.

 

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*Contracts**:* We have entered into material contracts with three appliancemanufacturers.  Under the agreementsthere are no minimum purchase commitments; however, we have agreed to indemnifythe manufacturers for certain claims, allegations or losses with respect toappliances we sell.

 

*Litigation**:*** **In December 2004, we filed suit inthe U.S. District Court for the Central District of California alleging thatJACO Environmental, Inc. (JACO) and one of our former consultantsfraudulently obtained U.S. Patent No. 6,732,416 in May 2004 coveringappliance recycling methods and systems which were originally developed by usbeginning in 1987 and used in serving more than forty-five electric utilityappliance recycling programs up to the time the suit was filed.  We soughtan injunction to prevent JACO from claiming that it obtained a valid patent onappliance recycling processes that we believe is based on methods and processeswe invented.  In addition, we asked theCourt to find that the patent obtained by JACO is unenforceable due toinequitable conduct before the United States Patent Office.  We also askedthe court for unspecified damages related to charges that JACO, in using thepatent to promote its services, engaged in unfair competition and false andmisleading advertising under federal and California statutes.

 

In September 2005,we received a legally binding document in which JACO stated it would not sue usor any of our customers for violating the JACO patent.  Further, the defendants in the case did notassert any counterclaims against ARCA.

 

In January 2009, theCourt granted JACO a summary judgment in ARCA’s lawsuit against theparties.  The ruling was made by the samejudge who had earlier denied summary judgment to the defendants.  Even though the Court’s ruling will have noimpact on our method of recycling or ability to conduct existing or futurebusiness, we filed an appeal with the Ninth Circuit Court of Appeals inCalifornia in February 2009 seeking to have the court set aside thesummary judgment.  We believe thedecision by the trial judge was in error and contrary to the law relating tounfair competition and false advertising. We believe we are entitled to our day in court against JACO for damagescaused by their actions, and our case is scheduled to be argued before theNinth Circuit Court of Appeals on April 9, 2010.

 

On October 24, 2006,JACO and SEG Umwelt-Service/Basis of Mettlach, Germany (SEG) filed a patentinfringement lawsuit in Federal Court in San Francisco against us.  The suit claimed that we had been usingrefrigerator recycling systems and processes covered by two U.S. patents issuedto SEG and exclusively licensed to JACO.  JACO and SEG sought anundisclosed amount in damages, in addition to an injunction barring us fromcontinuing to use and market the systems and processes upon which we allegedlyinfringed.  This suit was subsequentlydismissed following a transfer of the case to Los Angeles upon the motion ofARCA.

 

In December 2009,a lawsuit in the Fourth Judicial District Court of Hennepin County, Minnesotahas been commenced by RKL Landholdings, LLC and Emad Y. Abed relating to thepotential sale of our St. Louis Park, Minnesota property.  This property has been sold to a third partyand all proceeds from the sale have been received by us. The claims made by thePlaintiffs in this matter have been alleged against both Appliance RecyclingCenters of America, Inc. and Edward Cameron, individually.  The claims relate to an originally executedPurchase Agreement and extensions thereto executed between the parties, whichPurchase Agreement and extensions all expired by their own terms.  The Plaintiffs have alleged various facts andclaims, including promissory estoppel, unjust enrichment, conversion, fraud,tortuous interference with prospective advantage, and breach of contract.  We plan to vigorously defend these claims andbelieve that any outcome will not have a material impact on our results ofoperations or financial position.

 

We are party from time totime to other ordinary course disputes that we do not believe to be material.

 

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**12.****      ****Income Taxes**

 

The provision forincome taxes for the fiscal years ended January 2, 2010 and January 3,2009 consisted of the following:

 
| ** **                 | ** ** | **For the fiscal year ended** | ** ** |
|----------------------------|------------|-------------------------------|------------|
| ** **                 | ** ** | **January 2,   2010**    | ** ** | **January 3,   2009** | ** ** |
| Current tax expense:       |       |                          |       |   |   |
| Federal                    |       | $                             | —     |   | $ | 128 |   |
| State                      |       | 39                            |       | 44 |   |
| Foreign                    |       | 24                            |       | 495 |   |
| Current tax expense        |       | $                             | 63         |   | $ | 667 |   |
| Deferred tax expense       |       | (58                           | )          | 72 |   |
| Provision for income taxes |       | $                             | 5          |   | $ | 739 |   |

 

A reconciliationof our provision for income taxes with the federal statutory tax rate for thefiscal years ended January 2, 2010 and January 3, 2009 is shownbelow:

 
| ** **                                              | ** ** | **For the fiscal year ended** | ** ** |
|---------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                              | ** ** | **January 2,   2010**    | ** ** | **January 3,   2009** | ** ** |
| Income tax expense (benefit) at statutory rate          |       | $                             | (1,133     | ) | $ | 885 |   |
| State tax expense (benefit), net of federal tax  effect |       | (110                          | )          | 71 |   |
| Permanent differences                                   |       | 242                           |       | 275 |   |
| Changes in valuation allowance                          |       | 192                           |       | (657 | ) |
| Reversal of deferred tax asset for change in tax law    |       | 962                           |       | — |   |
| Foreign income tax payable true-up                      |       | (206                          | )          | — |   |
| Foreign rate differential                               |       | (3                            | )          | 54 |   |
| Other                                                   |       | 61                            |       | 111 |   |
|                                                    |       | $                             | 5          |   | $ | 739 |   |

 

We recorded adiscrete item in the second quarter of 2009 related to additional Canadian taxdeductions determined by completing a detailed transfer pricing study.  We recognized a tax benefit of approximately$206 related solely to our Canadian operations compared to the original taxprovision estimate for fiscal 2008.

 

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The components ofnet deferred tax assets as of January 2, 2010 and January 3, 2009 areas follows:

 
| ** **                       | ** ** | **January 2,   2010** | ** ** | **January 3,   2009** | ** ** |
|----------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Deferred tax assets:             |       |                       |       |                       |       |
| Net operating loss carryforwards |       | $                          | 868        |                       | $          | 1,734 |   |
| Federal and state tax credits    |       | 323                        |       | 312                        |       |
| Reserves                         |       | 367                        |       | 322                        |       |
| Accrued expenses                 |       | 229                        |       | 278                        |       |
| Share-based compensation         |       | 107                        |       | 82                         |       |
| Deferred gain                    |       | 913                        |       | —                     |       |
| Foreign currency translation     |       | —                     |       | 177                        |       |
|                             |       | 2,807                      |       | 2,905                      |       |
| Valuation allowance              |       | (2,379                     | )          | (2,187                     | )          |
| Deferred tax assets              |       | 428                        |       | 718                        |       |
|                             |       |                       |       |                       |       |
| Deferred tax liabilities:        |       |                       |       |                       |       |
| Prepaid expenses                 |       | (112                       | )          | (152                       | )          |
| Property and equipment           |       | (330                       | )          | (452                       | )          |
| Other                            |       | —                     |       | (9                         | )          |
| Deferred tax liabilities         |       | (442                       | )          | (613                       | )          |
| Net deferred tax assets          |       | $                          | (14        | )                          | $          | 105 |   |

 

The deferred taxamounts mentioned above have been classified in the accompanying consolidatedbalance sheets as follows:

 
| ** **              | ** ** | **January 2,   2010** | ** ** | **January 3,   2009** | ** ** |
|-------------------------|------------|----------------------------|------------|----------------------------|------------|
| Current assets          |       | $                          | 677        |                       | $          | 448 |   |
| Non-current assets      |       | —                     |       | 177                        |       |
| Non-current liabilities |       | (691                       | )          | (520                       | )          |
|                    |       | $                          | (14        | )                          | $          | 105 |   |

 

At January 2,2010, we had a full valuation allowance against our U.S. deferred tax assets toreduce the total to an amount our management believes is appropriate.  Realization of deferred tax assets isdependent upon sufficient future taxable income during the periods when deductibletemporary differences and carryforwards are expected to be available to reducetaxable income.  The valuation allowanceincreased in the current year primarily as a result of taxable losses generatedduring the year from U.S. sources and was partially offset by the reversal ofdeferred tax assets as a result of a change in state tax law.  In the future, when we believe we canreasonably estimate future operating results and those estimated resultsreflect taxable income, the amount of deferred tax assets considered reasonablecould be adjusted by a reduction of the valuation allowance.

 

We have notrecognized a deferred tax liability relating to cumulative undistributedearnings of controlled foreign subsidiaries that are essentially permanent induration.  If some or all of theundistributed earnings of the controlled foreign subsidiaries are remitted tous in the future, income taxes, if any, after the application of foreign taxcredits will be provided at that time.

 

Future utilization of netoperating loss (“NOL”) and tax credit carryforwards is subject to certainlimitations under provisions of Section 382 of the Internal RevenueCode.  This section relates to a 50percent change in control over a three-year period.  We believe that the issuance of Common Stockduring 1999 resulted in an “ownership change” under Section 382.  Accordingly, our ability to use NOL and taxcredit carryforwards generated prior to February 1999 is limited toapproximately $56 per year.

 

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At January 2,2010, we had federal NOL carryforwards of approximately $8,707 ($6,639 of whichis subject to IRC section 382 limitations) and credits for general businesscredits of $13.  In addition to generalbusiness credits we also had alternative minimum tax credits carried forward ofapproximately $310.  We also had stateNOL carryforwards of $8,862 ($2,642 of which is subject to IRC section 382 limitations).  The NOL carryforwards are available to offsetfuture taxable income or reduce taxes payable through 2027.  These loss carryforwards will begin expiringin 2016.  The general business creditswill expire in 2013.  We previously wroteoff NOLs related to IRC section 382 limits against the valuation allowance.

 

A portion of ournet operating loss carryforwards (approximately $930 of tax deductions)resulted from the exercise of stock options. When these loss carryforwards are realized, the corresponding change invaluation allowance will be recorded as additional paid-in capital.  We have adopted the “with and without”approach to determine tax benefits. Under this approach, windfall tax benefits are used last to offsettaxable income and a benefit is recorded in additional paid-in capital only ifan incremental benefit is provided after considering all other tax attributes(including NOLs) presently available to us. This treatment results in a re-characterization of the NOL carryforwardand a difference in the NOL asset between the financial statements and taxreturns.  The difference in the federalNOL deferred tax asset is $316.

 

At January 2,2010, we had NOL carryforwards not subject to IRC section 382 limitations,expiring as follows:

 
| 2026 |   | 1,357 |   |
|------|--------|-------|--------|
| 2029 |   | 711   |   |

 

We recognize thefinancial statement benefit of a tax position only after determining that therelevant tax authority would more likely than not sustain the position.  For tax positions meeting themore-likely-than-not threshold, the amount recognized in the financialstatements is the largest benefit that has a greater than 50 percent likelihoodof being realized upon ultimate settlement with the relevant taxauthority.  As of January 2, 2010,we did not have any material uncertain tax positions.

 

It is our practice torecognize interest related to income tax matters as a component of interestexpense and penalties as a component of selling, general and administrativeexpense.  As of January 2, 2010, wehad an immaterial amount of accrued interest and penalties.

 

We are subject to incometaxes in the U.S. federal jurisdiction, foreign jurisdictions and various statejurisdictions.  Tax regulations from eachjurisdiction are subject to the interpretation of the related tax laws and regulationsand 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 before2006.  We are not currently underexamination by any taxing jurisdiction.

 

We had no significantunrecognized tax benefits as of January 2, 2010 that would reasonably beexpected to affect our effective tax rate during the next twelve months.

 

**13.****      ****Shareholders’ Equity**

 

*Stockoptions*:  Our 2006 Stock Option Plan (the “2006 Plan”)permits the granting of incentive stock options meeting the requirements of Section 422of the Internal Revenue Code of 1986, as amended, and nonqualified options thatdo not meet the requirements of Section 422.  The 2006 Plan has 600 shares available forgrant.  As of January 2, 2010, 380options were outstanding to employees and non-employee directors and 15 optionshave been exercised under the 2006 Plan. Our Restated 1997 Stock Option Plan (the “1997 Plan”) has expired, butthe options outstanding under the expired 1997 Plan continue to be exercisablein accordance with their terms.  As of January 2,2010, options to purchase an aggregate of 33 shares were outstanding under the1997 Plan.  Options granted to employeestypically vest over two years while grants to non-employee directors vest insix months.

 

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The fair value of eachoption grant is estimated on the date of grant using the Black-Scholes optionpricing model with the following weighted-average assumptions for the fiscalyears ended January 2, 2010 and January 3, 2009:

 
| ** **                       | ** ** | **For the fiscal year ended** | ** ** |
|----------------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | **January 2,   2010**    | ** ** | **January 3,   2009** | ** ** |
| Expected dividend yield          |       | —                        |       | — |   |
| Expected stock price volatility  |       | 105.39                        | %          | 104.72 | % |
| Risk-free interest rate          |       | 2.77                          | %          | 3.39 | % |
| Expected life of options (years) |       | 7.00                          |       | 6.88 |   |

 

Additionalinformation relating to all outstanding options is as follows (in thousands,except per share data):

 
| ** **                        | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|-----------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                        | ** ** | ** **      | ** ** | **Average**  | ** ** |
| ** **                        | ** ** | **Options**     | ** ** | **Exercise** | ** ** |
| ** **                        | ** ** | **Outstanding** | ** ** | **Price**    | ** ** |
| Balance at December 29, 2007 |       | 144             |       | $            | 3.34       |   |
| Granted                           |       | 282             |       | 5.02         |       |
| Exercised                         |       | (69             | )          | 3.21         |       |
| Cancelled/expired                 |       | (2              | )          | 2.53         |       |
| Forfeited                         |       | (16             | )          | 5.86         |       |
| Balance at January 3, 2009   |       | 339             |       | 4.65         |       |
| Granted                           |       | 102             |       | 2.04         |       |
| Cancelled/expired                 |       | (9              | )          | 4.68         |       |
| Forfeited                         |       | (19             | )          | 2.55         |       |
| Balance at January 2, 2010   |       | 413             |       | 4.10         |       |
|                                   |            |                 |            |              |            |  |

 

The weightedaverage fair value per option of options granted during fiscal years 2009 and2008 was $1.74 and $4.26, respectively.

 

The followingtable summarizes information about stock options outstanding as of January 2,2010 (in thousands, except per share data):

 
| ** **                   | ** ** | ** **      |   | **Weighted Average** |   | ** **           |   | ** **          |   |
|------------------------------|------------|-----------------|--------|----------------------|--------|----------------------|--------|---------------------|--------|
| ** **                   | ** ** | ** **      |   | **Remaining**        |   | ** **           |   | ** **          |   |
| ** **                   | ** ** | **Options**     |   | **Contractual Life** |   | **Weighted Average** |   | **Aggregate**       |   |
| **Range of Exercise Prices** | ** ** | **Outstanding** |   | **In Years**         |   | **Exercise Price**   |   | **Intrinsic Value** |   |
| $5.05 to $6.41               |       | 219             |   | 5.46                 |   | $                    | 5.48   |                |   |   |
| $3.81 to $4.32               |       | 30              |   | 4.58                 |   | 4.06                 |   |                |   |
| $2.38 to $2.80               |       | 127             |   | 5.61                 |   | 2.39                 |   |                |   |
| $1.50 to $2.00               |       | 37              |   | 8.77                 |   | 1.87                 |   |                |   |
|                         |       | 413             |   | 5.74                 |   | 4.10                 |   | $                   | 20     |   |
|                              |            |                 |        |                      |        |                      |        |                     |        |  |  |

 

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The followingtable summarizes information about stock options exercisable as of January 2,2010 (in thousands, except per share data):

 
| ** **                   | ** ** | **Options**     | ** ** | **Weighted Average** | ** ** | **Aggregate**       | ** ** |
|------------------------------|------------|-----------------|------------|----------------------|------------|---------------------|------------|
| **Range of Exercise Prices** | ** ** | **Exercisable** | ** ** | **Exercise Price**   | ** ** | **Intrinsic Value** | ** ** |
| $5.05 to $6.41               |       | 122             |       | $                    | 5.51       |                |       |   |
| $3.81 to $4.32               |       | 30              |       | 4.06                 |       |                |       |
| $2.38 to $2.80               |       | 57              |       | 2.51                 |       |                |       |
| $1.50 to $2.00               |       | 30              |       | 1.87                 |       |                |       |
|                         |       | 239             |       | 4.16                 |       | $                   | 13         |   |
|                              |            |                 |            |                      |            |                     |            |  |  |

 

The aggregateintrinsic value in the preceding tables represents the total pre-tax intrinsicvalue, based on our closing stock price of $2.30 on January 2, 2010, whichtheoretically could have been received by the option holders had all optionholders exercised their options as of that date.  The total number of in-the-money optionsexercisable as of January 2, 2010 was 30. No stock options were exercised during the fiscal year ended January 2,2010.  The intrinsic value of stockoptions exercised during the fiscal year ended January 3, 2009 was $291.

 

*Warrant**:*** **Inconjunction with the Agreement entered into on October 21, 2009 as described in Note 6, we issued awarrant to purchase 248 shares of Common Stock at a price of $0.75 pershare.  The fair market value of thewarrant issued was $479 and is exercisable in full at any time during a term often years.  The exercise price may bereduced and the number of shares of Common Stock that may be purchased underthe warrant may be increased if the Company issues or sells additional sharesof Common Stock at a price lower than the then-current warrant exercise priceor the then-current market price of the Common Stock.  The shares underlying the warrant includelegal restrictions regarding the transfer or sale of the shares.

 

The following tablesummarizes the assumptions used to estimate the fair value of the warrantissued on October 21, 2009 using the Black-Scholes Model:

 
| Expected  dividend yield          |   | 0.0    | %      |
|-----------------------------------|--------|--------|--------|
| Expected  stock price volatility  |   | 128.27 | %      |
| Risk-free  interest rate          |   | 3.42   | %      |
| Expected  life of options (years) |   | 10.00  |   |

 

The fair value pershare of Common Stock underlying the warrant issued was $1.93 based on ourclosing stock price of $1.97.

 

*PreferredStock**:*** **Our amendedArticles of Incorporation authorize two million shares of Preferred Stock thatmay 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 beenissued.

 

**14.****      ****Major Customers and Suppliers**

 

For the fiscal year ended January 2, 2010, no single customerrepresented 10% or more of our total revenues. As of January 2, 2010, two customers each represented more than 10%of our total trade receivables.  For thefiscal year ended January 3, 2009, one customer represented 10% of ourtotal revenues.  As of January 3,2009, three customers each represented more than 10% of our total tradereceivables.

 

During the twofiscal years ended January 2, 2010 and January 3, 2009, we purchaseda vast majority of appliances for resale from three suppliers.  We have and are continuing to secure othervendors from which to purchase appliances. However, the curtailment or loss of one of these suppliers or anyappliance supplier could adversely affect our operations.

 

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**15.****      ****Segment Information**

 

We operate withintargeted markets through two reportable segments: retail and recycling.  Theretail operation is comprised of income generated through our ApplianceSmartFactory Outlet stores, which includes appliance sales and byproduct revenuesfrom collected appliances.  Therecycling operation includes all fees charged and costs incurred forcollecting, recycling and installing appliances for utilities and othercustomers and includes byproduct revenue, which is primarily generated throughthe recycling of appliances.  The nature of products, services and customersfor both segments varies significantly. As such, the segments are managed separately.  Our Chief Executive Officer has beenidentified as the Chief Operating Decision Maker (“CODM”).  The CODM evaluates performance and allocatesresources based on sales and income from operations of each segment.  Income from operations represents revenuesless cost of revenues and operating expenses, including certain allocatedselling, general and administrative costs. There are no inter-segment sales or transfers.  During 2009, we modified the way we reportbyproduct revenues, recycling revenues and recycling costs in order to moreaccurately report the activity within our two reportable segments.  Although not material, comparable periodrevenue and operating income items have been reclassified between our retailand recycling segments to conform to our current year presentation.

 

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The following tables present our segment information for fiscal years2009 and 2008:

 
| ** **                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Revenues:                                    |       |     |       |     |       |
| Retail                                       |       | $        | 75,517     |     | $          | 77,886 |   |
| Recycling                                    |       | 25,752   |       | 33,085   |       |
| Total revenues                               |       | $        | 101,269    |     | $          | 110,971 |   |
|                                         |       |     |       |     |       |
| Operating income (loss):                     |       |     |       |     |       |
| Retail                                       |       | $        | (4,184     | )        | $          | 815 |   |
| Recycling                                    |       | 1,777    |       | 5,356    |       |
| Unallocated corporate  costs                 |       | 246      |       | (2,136   | )          |
| Total operating income  (loss)               |       | $        | (2,161     | )        | $          | 4,035 |   |
|                                         |       |     |       |     |       |
| Assets:                                      |       |     |       |     |       |
| Retail                                       |       | $        | 18,300     |     | $          | 20,453 |   |
| Recycling                                    |       | 6,380    |       | 9,213    |       |
| Corporate assets not  allocable              |       | 6,770    |       | 7,749    |       |
| Total assets                                 |       | $        | 31,450     |     | $          | 37,415 |   |
|                                         |       |     |       |     |       |
| Cash capital expenditures:                   |       |     |       |     |       |
| Retail                                       |       | $        | 189        |     | $          | 362 |   |
| Recycling                                    |       | 40       |       | 135      |       |
| Corporate                                    |       | 280      |       | 315      |       |
| Total cash capital  expenditures             |       | $        | 509        |     | $          | 812 |   |
|                                         |       |     |       |     |       |
| Depreciation and  amortization expense:      |       |     |       |     |       |
| Retail                                       |       | $        | 425        |     | $          | 290 |   |
| Recycling                                    |       | 314      |       | 291      |       |
| Corporate                                    |       | 548      |       | 542      |       |
| Total depreciation and  amortization expense |       | $        | 1,287      |     | $          | 1,123 |   |
|                                         |       |     |       |     |       |
| Interest expense:                            |       |     |       |     |       |
| Retail                                       |       | $        | 782        |     | $          | 850 |   |
| Recycling                                    |       | 220      |       | 275      |       |
| Corporate                                    |       | 159      |       | 260      |       |
| Total interest expense                       |       | $        | 1,161      |     | $          | 1,385 |   |

 

**16.****      ****Benefit Contribution Plan**

 

We have a definedcontribution salary deferral plan covering substantially all employees under Section 401(k) ofthe Internal Revenue Code.  We contributean amount equal to 10 cents for each dollar contributed by each employee up toa maximum of 5% of each employee’s compensation.  We recognized expense for contributions tothe plan of $27 and $30 for the fiscal years ended January 2, 2010 and January 3,2009, respectively.

 

**17.****      ****Subsequent Events**

 

The Company hasevaluated subsequent events and has appropriately included all mattersrequiring disclosure herein.  There wereno subsequent events requiring recognition in these consolidated financialstatements.

 

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**ITEM 9.****                            ****CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A.****                   ****CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

We have establisheddisclosure controls and procedures and other procedures that are designed toensure that information required to be disclosed in our reports filed orsubmitted under the Securities Exchange Act of 1934 (the “Exchange Act”),as amended, is recorded, processed, summarized and reported within the timeperiod specified in the SEC’s rules and forms.  Disclosurecontrols and procedures include, without limitation, controls and proceduresdesigned to ensure that information required to be disclosed in our reportsfiled under the Exchange Act is accumulated and communicated to management,including our Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure.  Ourmanagement, with the participation of our Chief Executive Officer and ChiefFinancial Officer, has evaluated the effectiveness of our disclosure controlsand procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act), as of the end of the period covered by thisreport.  Based on such evaluation, our Chief Executive Officer andChief Financial Officer have concluded that as of the end of such period ourdisclosure controls and procedures were effective.

 

***Management’s Report on InternalControls Over Financial Reporting***

 

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting, as such term is defined in Exchange Act Rules 13a-15(f).  The Company’s internal control over financialreporting includes those policies and procedures that (i) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles and that receipts and expenditures of the Company arebeing made only in accordance with authorizations of management and directorsof the Company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof the Company’s assets that could have a material effect on the financialstatements.

 

Internal control overfinancial reporting is designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples. Because of its inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements.  Also**,**projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions or thatthe degree of compliance with the policies or procedures may deteriorate.

 

Under the supervision andwith the participation of management, including our Chief Executive Officer andChief Financial Officer, we conducted an evaluation of the effectiveness of ourinternal control over financial reporting based on the framework in *Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).  Management concluded that our internalcontrol over financial reporting was effective as of January 2, 2010.

 

This annual report doesnot include an attestation report of the Company’s independent registeredpublic accounting firm regarding internal control over financialreporting.  Management’s report was notsubject to attestation by the Company’s registered public accounting firmpursuant to temporary rules of the Securities and Exchange Commission thatpermit the Company to provide only management’s report in this annual report.

 

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***Changes inInternal Control Over Financial Reporting***

 

There have been nochanges in our internal control over financial reporting during the fourthquarter of the fiscal year ended January 2, 2010, that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

**ITEM 9B.****                                           ****OTHER INFORMATION**

 

None.

 

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** **

**PART III**

 

**ITEM 10.****                                            ****DIRECTORS, EXECUTIVE OFFICERS ANDCORPORATE GOVERNANCE**

 

Informationregarding directors and executive officers of the Company is set forth underthe headings “Nominees” and “Information Concerning Officers and Key EmployeesWho Are Not Directors” and “Section 16 (a) Beneficial OwnershipReporting Compliance” in our Proxy Statement for our 2010 Annual Meeting ofShareholders to be held May 13, 2010 and is incorporated herein byreference.

 

***Code of Ethics***

 

Our AuditCommittee has adopted a code of ethics applicable to our directors and officers(including our Chief Executive Officer, Chief Financial Officer and PrincipalAccounting Officer) and other of our senior executives and employees inaccordance with applicable rules and regulations of the SEC and The NASDAQStock Market.  A copy of the code ofethics may be obtained upon request, without charge, by addressing a request toInvestor Relations, ARCA, Inc., 7400 Excelsior Boulevard, Minneapolis, MN55426.  The code of ethics is also postedon our website at www.arcainc.com under “Investor Relations — CorporateGovernance.”

 

We intend tosatisfy the disclosure requirement under Item 10 of Form 8-K regarding theamendment to, or waiver from, a provision of the code of ethics by posting suchinformation on our website at the address and location specified above and, tothe extent required by the listing standards of the NASDAQ Capital Market, byfiling a Current Report on Form 8-K with the SEC disclosing suchinformation.

 

**ITEM 11.****                                            ****EXECUTIVE COMPENSATION**

 

Informationregarding executive compensation is set forth under the headings “CompensationCommittee Report” and “Executive Compensation” in our Proxy Statement for our2010 Annual Meeting of Shareholders to be held May 13, 2010 and isincorporated herein by reference.

 

**ITEM 12.****                                            ****SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERMATTERS**

 

Informationregarding security ownership of certain beneficial owners and management is setforth under the heading “Common Stock Ownership” in our Proxy Statement for our2010 Annual Meeting of Shareholders to be held May 13, 2010 and isincorporated herein by reference.

 

The followingtable gives aggregate information under our equity compensation plans as of January 2,2010:

 
| ** **                                         | ** ** | **(a)**                  | ** ** | **(b)**                  | ** ** | **(c)**                     | ** ** |
|----------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                         | ** ** | ** **               | ** ** | ** **               | ** ** | **Number of Securities**    | ** ** |
| ** **                                         | ** ** | ** **               | ** ** | ** **               | ** ** | **Available for Future**    | ** ** |
| ** **                                         | ** ** | **Number of Securities** | ** ** | **Weighted Average**     | ** ** | **Issuance Under Equity**   | ** ** |
| ** **                                         | ** ** | **to be Issued**         | ** ** | **Exercise Price of**    | ** ** | **Compensation Plans,**     | ** ** |
| ** **                                         | ** ** | **Upon Exercise of**     | ** ** | **Outstanding Options,** | ** ** | **Excluding Securities**    | ** ** |
| ** **                                         | ** ** | **Outstanding Options**  | ** ** | **Warrants and Rights**  | ** ** | **Reflected in Column (a)** | ** ** |
| Equity compensation plans approved by shareholders |       | 413,200                  |       | $                        | 4.10       |                        | 205,300    |   |
|                                                    |            |                          |            |                          |            |                             |            |  |

 

**ITEM 13.****                                            ****CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

Informationregarding certain relationships and related transactions is set forth under theheadings “Director Independence” and “Review,Approval or Ratification of Transactions with Related Persons” in ourProxy Statement for our 2010 Annual Meeting of Shareholders to be held May 13,2010 and is incorporated herein by reference.

 

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**ITEM 14.****                                            ****PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

Informationregarding principal accounting fees and services is set forth under the heading“Independent Registered Public Accounting Firm” in our Proxy Statement for our2010 Annual Meeting of Shareholders to be held May 13, 2010 and isincorporated herein by reference.

 

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** **

**PART IV**

 

**ITEM 15.****                                            ****EXHIBITS AND FINANCIAL STATEMENTSCHEDULES**

 

**(a)****                                 ****Financial Statements, FinancialStatement Schedules and Exhibits**

 

**1.****                                    ****Financial Statements**

 

See Index toFinancial Statements under Item 8 of this report.

 

**2.****                                    ****Financial Statement Schedule**

 

REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON SUPPLEMENTARY INFORMATION

 

To theShareholders, Audit Committee and Board of Directors

ApplianceRecycling Centers of America, Inc. and Subsidiaries

Minneapolis,Minnesota

 

Our audits wereconducted in accordance with the standards of the Public Company AccountingOversight Board (United States) and were made for the purpose of forming anopinion on the basic consolidated financial statements of Appliance RecyclingCenters of America, Inc. and Subsidiaries taken as a whole.  The supplemental Schedule II as of January 2,2010 and January 3, 2009 and for the fiscal years then ended is presentedfor purposes of complying with the Securities and Exchange Commission’s rules andis not a part of the basic consolidated financial statements.  This schedule has been subjected to theauditing procedures applied in our audits of the basic consolidated financialstatements and in our opinion, is fairly stated in all material respects inrelation to the basic consolidated financial statements taken as a whole.

 

/s/ Baker TillyVirchow Krause, LLP

 

Minneapolis,Minnesota

March 17,2010

 

**ScheduleII - Valuation and Qualifying Accounts**

**(InThousands)**

** **
| ** **                        | ** ** | **Allowance for   Doubtful   Accounts   Receivable** | ** ** | **Valuation   Allowance for   Inventory   Obsolescence** | ** ** | **Valuation   Allowance for   Deferred   Income Tax   Assets** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| Balance at December 29, 2007 |       | $                                                    | 152        |                                                     | $          | 84                                                             |       | $ | 2,324 |   |
| Additional allowance              |       | 264                                                  |       | 31                                                       |       | —                                                         |       |
| Write-offs and adjustments (1)    |       | (124                                                 | )          | —                                                   |       | (137                                                           | )          |
| Balance at January 3, 2009   |       | 292                                                  |       | 115                                                      |       | 2,187                                                          |       |
| Additional allowance              |       | 69                                                   |       | 404                                                      |       | —                                                         |       |
| Write-offs and adjustments (2)    |       | (320                                                 | )          | —                                                   |       | 192                                                            |       |
| Balance at January 2, 2010   |       | $                                                    | 41         |                                                     | $          | 519                                                            |       | $ | 2,379 |   |

 

----

| (1) |   | The change in valuation  allowance for deferred income tax assets related to continuing operations is  $657 offset by $520 related to discontinued operations. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | The change in the  valuation allowance was reduced by the loss of state deferred tax assets  related to a change in tax law.                                   |

 

 

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**3.****                                    ****Exhibits**

 

See Index toExhibits on page 64 of this report.

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or Section 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this Report to be signedon our behalf by the undersigned, thereunto duly authorized.

 
| Dated: March 18,  2010 | APPLIANCE RECYCLING  CENTERS OF AMERICA, INC. |
|-----------------------------|-----------------------------------------------|
|                        | (Registrant)                                  |
|                        |                                          |
|                        | By                                            | /s/ Edward R. Cameron |
|                        |                                          | Edward R. Cameron |
|                        |                                          | President and Chief  Executive Officer |
|                        |                                          |
|                        | By                                            | /s/ Peter P. Hausback |
|                        |                                          | Peter P. Hausback |
|                        |                                          | Executive Vice  President, Chief Financial Officer |
|                        |                                          | and Principal  Accounting Officer |

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this Report has beensigned by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

 
| **Signature**          | ** ** | **Title**                                                 | ** ** | **Date**             |
|------------------------|------------|-----------------------------------------------------------|------------|----------------------|
|                   |       |                                                      |       |                 |
| /s/ Edward R. Cameron  |       | Chairman of the Board,  President and                     |       | March 18,  2010 |
| Edward R. Cameron      |       | Chief Executive Officer                                   |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Peter P. Hausback  |       | Executive Vice  President,                                |       | March 18,  2010 |
| Peter P. Hausback      |       | Chief Financial Officer  and Principal Accounting Officer |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Duane S. Carlson   |       | Director                                                  |       | March 18,  2010 |
| Duane S. Carlson       |       |                                                      |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Thomas F. Hunt Jr. |       | Director                                                  |       | March 18,  2010 |
| Thomas F. Hunt Jr.     |       |                                                      |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Glynnis A. Jones   |       | Director                                                  |       | March 18,  2010 |
| Glynnis A. Jones       |       |                                                      |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Morgan J. Wolf     |       | Director                                                  |       | March 18,  2010 |
| Morgan J. Wolf         |       |                                                      |       |                 |

 

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**INDEX TO EXHIBITS**

 
| **Exhibit   No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                      |
|------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                    |       | Restated Articles of  Incorporation of Appliance Recycling Centers of America, Inc. [filed as  Exhibit 3.1 to the Company’s Form 10-K for the fiscal year ended  January 2, 1999 (File No. 0-19621) and incorporated herein by reference].                                                                                                                                             |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.2                    |       | Bylaws of Appliance  Recycling Centers of America, Inc. as amended December 26, 2007  [filed as Exhibit 3.2 to the Company’s Form 8-K filed on  January 2, 2008 (File No. 0-19621) and incorporated herein by  reference].                                                                                                                                                        |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *10.1                  |       | 2006 Stock Option Plan  [filed as Appendix B to the Company’s Schedule 14A filed on March 31,  2006 and incorporated herein by reference].                                                                                                                                                                                                                                                                 |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *10.2                  |       | 2006 Stock Option Plan  [filed as Appendix B to the Company’s Schedule 14A filed on March 31,  2006 and incorporated herein by reference].                                                                                                                                                                                                                                                                 |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *10.3                  |       | Amendment  effective April 26, 2001 to 1997 Stock Option Plan [filed as  Exhibit 10.2 to the Company’s Form 10-Q for the quarter ended  March 31, 2001 (File No. 0-19621) and incorporated herein by  reference].                                                                                                                                                                      |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| *10.4                  |       | Amendment  effective April 25, 2002 to 1997 Stock Option Plan [filed as  Exhibit 10.2 to the Company’s Form 10-Q for the quarter ended  March 30, 2002 (File No. 0-19621) and incorporated herein by  reference].                                                                                                                                                                      |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.5                   |       | Line of credit  dated August 30, 1996, between Appliance Recycling Centers of  America, Inc. and Spectrum Commercial Services, a division of Lyons  Financial Services, Inc. [filed as exhibit 10.15 to the Company’s  Form 10-Q for the quarter ended September 28, 1996 (File  No. 0-19621) and incorporated herein by reference].                                              |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.6                   |       | First Amendment  to General Credit and Security Agreement and Waiver dated November 8,  1996, between Spectrum Commercial Services, a division of Lyons Financial  Services, Inc., and the Company, and related agreement [filed as exhibit  10.16 to the Company’s Form 10-Q for the quarter ended  September 28, 1996 (File No. 0-19621) and incorporated herein by  reference].     |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.7                   |       | Second Amendment  to General Credit and Security Agreement and Waiver dated February 12,  1998 between Spectrum Commercial Services, a division of Lyons Financial  Services, Inc., and the Company, and related agreements [filed as  Exhibit 10.10 to the Company’s Form 10-K for fiscal year ended  January 3, 1998 (File No. 0-19621) and incorporated herein by  reference]. |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.8                   |       | Fourth Amendment  to General Credit and Security Agreement dated September 10, 1998  between Spectrum Commercial Services, a division of Lyons Financial  Services, Inc., and the Company, and related agreement [filed as  Exhibit 10.15 to the Company’s Form 10-K for the fiscal year ended  January 2, 1999 (File No. 0-19621) and incorporated herein by  reference].        |
|                   |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.9                   |       | Fifth Amendment  to General Credit and Security Agreement dated September 17, 1998  between Spectrum Commercial Services, a division of Lyons Financial  Services, Inc., and the Company, and related agreements [filed as  Exhibit 10.16 to the Company’s Form 10-K for the fiscal year ended  January 2, 1999 (File No. 0-19621) and incorporated herein by  reference].        |

 

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| 10.10  |   | Eighth Amendment  to General Credit and Security Agreement dated August 30, 2000 between  Spectrum Commercial Services, a division of Lyons Financial  Services, Inc., and the Company, and related agreements [filed as  Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended  September 30, 2000 (File No. 0-19621) and incorporated herein by  reference]. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.11  |   | Ninth Amendment  to General Credit and Security Agreement dated June 18, 2001 between  Spectrum Commercial Services Company and the Company, and related agreements  [filed as Exhibit 10.2 to the Company’s Form 10-Q for the quarter  ended June 30, 2001 (File No. 0-19621) and incorporated herein by  reference].                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.12  |   | Tenth Amendment  to General Credit and Security Agreement dated July 26, 2001 between  Spectrum Commercial Services Company and the Company, and related agreements  [filed as Exhibit 10.3 to the Company’s Form 10-Q for the quarter  ended June 30, 2001 (File No. 0-19621) and incorporated herein by  reference].                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.13  |   | Eleventh  Amendment to General Credit and Security Agreement dated August 24, 2001  between Spectrum Commercial Services and the Company, and related agreements  [filed as Exhibit 10.1 to the Company’s Form 10-Q for the quarter  ended September 29, 2001 (File No. 0-19621) and incorporated herein  by reference].                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.14  |   | Twelfth  Amendment to General Credit and Security Agreement dated April 11, 2002  between Spectrum Commercial Services Company and the Company, and related  agreements [filed as Exhibit 10.1 to the Company’s Form 10-Q for  the quarter ended March 30, 2002 (File No. 0-19621) and  incorporated herein by reference].                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.15  |   | Thirteenth  Amendment to General Credit and Security Agreement dated January 23,  2003 between Spectrum Commercial Services Company and the Company, and  related agreements [filed as Exhibit 10.34 to the Company’s  Form 10-K for the fiscal year ended December 28, 2002 (File  No. 0-19621) and incorporated herein by reference].                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.16  |   | Fourteenth  Amendment to General Credit and Security Agreement dated July 1, 2004  between Spectrum Commercial Services Company and the Company [filed as  Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended  July 3, 2004 (File No. 0-19621) and incorporated herein by  reference].                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.17  |   | Sixteenth  Amendment to General Credit and Security Agreement dated December 23,  2004 between Spectrum Commercial Services Company and the Company, and  related Guarantor Acknowledgment [filed as Exhibit 10.18 to the  Company’s Registration Statement on Form S-2 and incorporated herein by  reference].                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.18  |   | Tenth Amended  and Restated Revolving Note of the Company dated December 23, 2004 in  favor of Spectrum Commercial Services Company [filed as Exhibit 10.19 to  the Company’s Registration Statement on Form S-2 and incorporated herein  by reference].                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.19  |   | Seventeenth  Amendment to General Credit and Security Agreement dated January 12,  2005 between Spectrum Commercial Services Company and the Company [filed as  Exhibit 10.20 to the Company’s Registration Statement on Form S-2  and incorporated herein by reference].                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.20  |   | Loan Agreement  dated September 10, 1998 between Medallion Capital, Inc. and the  Company [filed as Exhibit 10.1 to the Company’s Form 10-Q for the  quarter ended October 3, 1998 (File No. 0-19621) and incorporated  herein by reference].                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.21  |   | Note of the  Company dated September 10, 1998 in favor of Medallion  Capital, Inc. [filed as Exhibit 10.2 to the Company’s  Form 10-Q for the quarter ended October 3, 1998 (File  No. 0-19621) and incorporated herein by reference].                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.22  |   | Security  Agreement dated September 10, 1998 between Medallion Capital, Inc.  and the Company [filed as Exhibit 10.3 to the Company’s Form 10-Q  for the quarter ended October 3, 1998 (File No. 0-19621) and  incorporated herein by reference].                                                                                                                      |

 

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| 10.23  |   | Stock Purchase  Warrant of the Company for the Purchase of 700,000 shares of Common Stock in  favor of Medallion Capital, Inc. [corrected copy] [filed as  Exhibit 10.14 to the Company’s Form 10-K for the year ended  January 2, 1999 (File No. 0-19621) and incorporated herein by  reference].                                                                     |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.24  |   | Amendment  No. 1 to Loan Agreement and Security Agreement dated December 23,  2004 between Medallion Capital, Inc. and the Company, and related  Consent and Amendment and Promissory Note [filed as Exhibit 10.25 to the  Company’s Registration Statement on Form S-2 and incorporated herein by  reference].                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.25  |   | Balloon  Promissory Note of the Company dated September 19, 2002 in favor of  General Electric Capital Business Asset Funding Corp. and related agreement  [filed as Exhibit 10.1 to the Company’s Form 10-Q for the quarter  ended September 28, 2002 (File No. 0-19621) and incorporated herein  by reference].                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.26  |   | Balloon  Promissory Note of the Company dated December 27, 2002 in favor of General  Electric Capital Business Asset Funding Corp. and related agreement [filed as  Exhibit 10.33 to the Company’s Form 10-K for the year ended  December 28, 2002 (File No. 0-19621) and incorporated herein by  reference].                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.27  |   | Reverse  Logistics Master Service Agreement between Whirlpool Corporation and the  Company [filed as Exhibit 10 to the Company’s Form 10-Q for the  quarter ended July 4, 1998 (File No. 0-19621) and incorporated  herein by reference].                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.28  |   | Retail Dealer  Sales Agreement dated October 12, 2001 between Maytag Corporation and  the Company [filed as Exhibit 10.2 to the Company’s Form 10-Q for  the quarter ended September 29, 2001 (File No. 0-19621) and  incorporated herein by reference].                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.29  |   | 2003 Statewide  Residential Appliance Recycling Program Agreement dated September 2,  2003 between Southern California Edison Company and ARCA  California, Inc., a wholly-owned subsidiary of the Company [filed as  Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended September 27,  2003 (File No. 0-19621) and incorporated herein by reference]. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.30  |   | 2004-05  Statewide Residential Appliance Recycling Program Agreement dated  January 21, 2004 between Southern California Edison Company and ARCA  California, Inc., a wholly-owned subsidiary of the Company [filed as  Exhibit 10.34 to the Company’s Form 10-K for the year ended  January 3, 2004 (File No. 0-19621) and incorporated herein by  reference].   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.31  |   | Agreements dated  September 24, 2002 between the Company and the Department of Water and Power  of the City of Los Angeles [filed as Exhibit 10.32 to the Company’s  Form 10-K for the year ended December 28, 2002 (File  No. 0-19621) and incorporated herein by reference].                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.32  |   | Agreement dated  March 1, 2004 between San Diego Gas & Electric and the Company  [filed as Exhibit 10.35 to the Company’s Form 10-K for the year  ended January 3, 2004 (File No. 0-19621) and incorporated herein by  reference].                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.33  |   | Agreement dated  May 24, 2006 between San Diego Gas & Electric and the Company  [filed as Exhibit No. 10.1 to the Company’s Form 8-K dated  July 5, 2006 (File No. 0-19621) and incorporated herein by  reference].                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.34  |   | Agreement dated  June 14, 2006 between Southern California Edison Company and the Company  [filed as Exhibit No. 10.1 to the Company’s Form 8-K dated  July 6, 2006 (File No. 0-19621) and incorporated herein by  reference].                                                                                                                                    |

 

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| 10.35        |   | Form of  Securities Purchase Agreement dated as of December 31, 2004, between the  Company and certain investors [filed as Exhibit No. 99.2 to the  Company’s Form 8-K dated December 31, 2004 (File No. 0-19621)  and incorporated herein by reference]. |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                                                                                                                                                              |
| 10.36        |   | Purchase  Agreement for Sale of St. Louis Park Building [filed as  Exhibit No. 10.36 to the Company’s Form 10-Q for the quarter  ended October 3, 2009 (File No. 0-19621) and incorporated herein by  reference].                                                   |
|         |   |                                                                                                                                                                                                                                                                                              |
| 10.37        |   | Lease Agreement  for Leaseback of St. Louis Park Building [filed as  Exhibit No. 10.37 to the Company’s Form 10-Q for the quarter  ended October 3, 2009 (File No. 0-19621) and incorporated herein by  reference].                                                 |
|         |   |                                                                                                                                                                                                                                                                                              |
| +10.38‡ |   | Appliance Sales  and Recycling Agreement dated October 21, 2009 between General Electric  Company and the Company.                                                                                                                                                                           |
|         |   |                                                                                                                                                                                                                                                                                              |
| +10.39       |   | Warrant to  Purchase Common Stock of the Company for the Purchase of 248,189 shares of  Common Stock in favor of General Electric Company, dated October 21,  2009.                                                                                                                          |
|         |   |                                                                                                                                                                                                                                                                                              |
| +23.1        |   | Consent of Baker  Tilly Virchow Krause, LLP, Independent Registered Public Accounting Firm.                                                                                                                                                                                                       |
|         |   |                                                                                                                                                                                                                                                                                              |
| +31.1        |   | Certification by  the Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                    |
|         |   |                                                                                                                                                                                                                                                                                              |
| +31.2        |   | Certification by  the Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                    |
|         |   |                                                                                                                                                                                                                                                                                              |
| +32.1        |   | Certifications  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                              |

 

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*                  Items that are management contracts or compensatoryplans or arrangements required to be filed as an exhibit pursuant to Item14(a)3 of this Form 10-K.

 

+                  Filed herewith.

 

‡                   Confidential treatment has been requested for portionsof this agreement, which portions have been filed separately with the SEC.

 

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