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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 

**x****Annual Report Pursuant to Section 13 or15(d) of the Securities Exchange Act of 1934**

 

**For thefiscal year ended January 3, 2009**

 

**or**

 

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

 
| **Commission File No. 0-19621**                                            |
|---------------------------------------------------------------------------------|
|                                                                            |
| **APPLIANCE RECYCLING CENTERS OF  AMERICA, INC.**                               |
| (Exact name of registrant as specified in its  charter)                         |
| ** **                                                                      | ** ** |
| **Minnesota**                                                                   | **41-1454591** |
| (State or other jurisdiction of  incorporation or organization)                 | (I.R.S. Employer  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) of the Act:          |
|                                                                            |
| **Common Stock, without par value**                                             | **NASDAQ Capital Market** |
| Title of each class                                                             | Name of each exchange on which registered |
|                                                                            |   |
| Securities  registered pursuant to Section 12(g) of the Act: **None** |

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.

 

o Yes    xNo

 

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13or 15(d) of the Act.            o Yes    xNo

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports) and (2) has been subject to such filing requirements for thepast 90 days.

 

x Yes    oNo

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or 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  (Do not check if a smaller reporting company) | Smaller reporting  company | x |

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of theAct).                          oYes    x No

 

The aggregate marketvalue of the voting and non-voting common equity held by non-affiliates of theregistrant, based on the closing price of $7.40 per share, as of June 28,2008 (the last business day of the registrant’s most recently completed secondfiscal quarter) was $33,875,550.

 

As of March 2, 2009,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 2009 Annual Meeting ofShareholders to be held on May 14, 2009 are incorporated by reference intoPart III hereof.

 

 

 

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**TABLE OFCONTENTS**

 
|                   |                                                                                                 | **Page** |
|------------------------|------------------------------------------------------------------------------------------------------|----------|
|                   | **PART I           **                    |     |
| Item  1.               | Business                                                                                             | 3        |
|                   | General                                                                                              | 3        |
|                   | Industry Background                                                                                  | 3        |
|                   | Company Background                                                                                   | 4        |
|                   | Customers  and Source of Supply                                                                      | 7        |
|                   | Company Operations                                                                                   | 8        |
|                   | Principal  Products and Services                                                                     | 8        |
|                   | Sales and Marketing                                                                                  | 9        |
|                   | Seasonality                                                                                          | 9        |
|                   | Competition                                                                                          | 9        |
|                   | Government  Regulation                                                                               | 10       |
|                   | Employees                                                                                            | 11       |
| Item 1A.               | Risk Factors                                                                                         | 11       |
| Item 1B.               | Unresolved Staff Comments                                                                            | 15       |
| Item 2.                | Properties                                                                                           | 15       |
| Item 3.                | Legal Proceedings                                                                                    | 15       |
| Item 4.                | Submission of Matters to a Vote of Security  Holders                                                 | 16       |
|                   |                                                                                                 |     |
|                   | **PART II          **                         |     |
| ** **             |                                                                                                 |     |
| Item 5.                | Market for Our Common Equity, Related  Shareholder Matters and Issuer Purchases of Equity Securities | 17       |
| Item 6.                | Selected Financial Data                                                                              | 18       |
| Item 7.                | Management’s Discussion and Analysis of  Financial Condition and Results of Operations          | 20       |
| Item 7A.               | Quantitative and Qualitative  Disclosures About Market Risk                                          | 27       |
| Item 8.                | Financial Statements and Supplementary  Data                                                         | 28       |
| Item 9.                | Changes in and Disagreements With  Accountants on Accounting and Financial Disclosure                | 48       |
| Item 9A.               | Controls and Procedures                                                                              | 48       |
| Item 9B.               | Other Information                                                                                    | 49       |
|                   |                                                                                                 |     |
|                   | **PART III         **                              |     |
| ** **             |                                                                                                 |     |
| Item 10.               | Directors, Executive Officers,and  Corporate Governance                                              | 50       |
| Item 11.               | Executive Compensation                                                                               | 50       |
| Item 12.               | Security Ownership of Certain  Beneficial Owners and Management and Related Stockholder Matters      | 50       |
| Item 13.               | Certain Relationships and Related Transactions                                                       | 50       |
| Item 14.               | Principal Accounting Fees and Services                                                               | 51       |
|                   |                                                                                                 |     |
|                   | **PART IV         **                               |     |
| ** **             |                                                                                                 |     |
| Item 15.               | Exhibits and Financial Statement  Schedules                                                          | 52       |
|                   |                                                                                                 |     |
| **SIGNATURES**         | 54                                                                                                   |
| **INDEX  TO EXHIBITS** | 55                                                                                                   |

 

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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 also provide turnkey appliance recyclingservices for electric utilities and other sponsors of energy efficiencyprograms.

 

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

 

1.               Retail sales ofappliances at our ApplianceSmart® Factory Outlets.

2.              Feescharged for collecting and recycling appliances for utilities and othersponsors of energy efficiency programs.

3.               Sellingbyproduct materials from appliances that we recycle, including appliancescollected through our ApplianceSmart 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 2008, factoryshipments of major appliances totaled more than 68 million units in theU.S.  Total sales of the top 100 majorappliance retailers in 2007 were over $25 billion, a slight decline compared to2006.

 

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.              Polychlorinatedbiphenyls (“PCBs”), which have toxic effects on humans and animals.  Although the Environmental Protection Agency(“EPA”) banned the production of PCBs in 1979, it allowed manufacturers to usetheir remaining inventories of PCB-containing components.  Consequently, some old room air conditionersand microwave ovens have capacitors that contain PCBs, which can contaminategroundwater when released.

 

2.              Mercury,which easily enters the body through absorption, inhalation or ingestion,potentially causing neurological damage. Freezers and washers may have mercury-containing switches in their lids.

 

3.              Chlorofluorocarbon,hydrochlorofluorocarbon, and hydrofluorocarbon (collectively, “CFC”)refrigerants, which cause long-term damage to the earth’s ozone layer and maycontribute to global climate change. Refrigerators, freezers, room air conditioners and dehumidifierscommonly contain CFC refrigerants.  CFCsare also used as blowing agents in the polyurethane foam insulation ofrefrigeration appliances.

 

4.              Othermaterials, such as oil and sulfur dioxide, that are harmful when released intothe environment.

 

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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, some 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 manufactured in the 1960s andearly 1970s use up to 1,750 kilowatt-hours of electricity each year.  By 2001, federal standards enacted over theyears lowered the average annual energy use per new unit to less than 500kilowatt-hours.

 

To encourage thepermanent removal of energy inefficient appliances from use, many electricutility companies sponsor programs through which their residential customerscan retire working refrigerators, 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 efficient models.

 

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.

 

***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 eighty utilities throughout the U.S. and Canada.  Current programs include:

 

1.               Acontract with Southern California Edison (“Edison”) to handle refrigerator andfreezer recycling operations, extending Edison’s 2006-2008 appliance recyclingprogram, which covers fifty percent of the previous southern and centralCalifornia territories that we handled under Edison’s 2004-2005 program.  The contract runs through December 2009.  Under terms of this agreement, Edison isresponsible for advertising the program. We expect the contract will be renewed for 2010 and 2011.

 

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2.               Abridge contract with San Diego Gas & Electric (“SDG&E”) for their2006-2008 program to provide refrigerator, freezer and room air conditionerrecycling services for their residential and small commercial customers.  The contract runs through December 2009.  Under terms of this agreement, we areresponsible for advertising the program. We expect the contract will be renewed for 2010 and 2011.

 

3.               Anexpansion of our contract with Southern California Public Power Authority (“SCPPA”),which sponsors a program to replace and recycle old, inefficient refrigeratorsowned by low income residents in the city. We currently perform these services for all participating members ofSCPPA, including the Los Angeles Department of Water and Power (“LADWP”).  The contract runs through June 2010.

 

4.               Anagreement with WPPI Energy (“WPPI”) to provide appliance recycling servicesthrough 2009.  WPPI is a regional powercompany owned by 50 municipalities that operate electric utilities.  They supply power to 190,000 homes andbusinesses in Wisconsin, Upper Michigan and Iowa.  WPPI is responsible for advertising thisprogram.

 

5.               Anagreement entered into in December 2004 with Austin Energy in Texas tomanage appliance recycling operations in their service territory during2005.  The contract was initiallyextended through 2006, 2007 and 2008, and was extended again until December 2009with two one-year extensions.  In 2008,Austin Energy initiated a refrigerator replacement program for which wepurchase and install new appliances and recycle the old units.  Austin Energy is the nation’s ninth largestcommunity-owned electric utility, serving 388,000 customers within the City ofAustin and surrounding counties.  AustinEnergy is responsible for advertising this program.

 

6.               A contractannounced in June 2007 with Ontario Power Authority (“OPA”) in Ontario,Canada, to recycle refrigerators, freezers and room air conditioners throughoutthe province.  The program isadministered by OPA and managed by more than seventy local electricdistribution companies.  This contractruns through the end of 2010.  OPA isresponsible for advertising this program.

 

7.               Asubcontracting agreement with Conservation Services Group (“CSG”) to provideappliance recycling services to Ameren Illinois Utilities (AIU) residentialcustomers in Illinois.  The program isadministered by CSG and the contract is through May 2011. We areresponsible for advertising the program at the direction of CSG.

 

8.               InNovember 2008, we entered into contracts with American Electric Power (“AEP”)Texas North Company (“TNC”), Texas Central Company (“TCC”) and SouthwesternElectric Power Company (“SWEPCO”) to manage appliance recycling forapproximately 930,000 residential and 184,000 commercial customers through December 2009.  We are responsible for advertising theprograms.

 

9.               Additionally,we have appliance recycling contracts with Minnesota Power and City Water Lightand Power (“CWLP”) of Springfield, Illinois.

 

In the past two years, wehave seen a heightened interest from electric utilities that recognize theeffectiveness of programs to recycle energy inefficient appliances.  We are aggressively pursuing this segment ofcustomers in 2009 and expect that we will continue to submit proposals forvarious new utility appliance recycling programs throughout the year.  However, we still have a limited ability toproject revenues from new utility programs in 2009.  We cannot predict recycling volumes or if wewill be successful obtaining new contracts.

 

***ApplianceSmart Factory Outlets***

 

When electric utilitiesbegan to scale back or discontinue their programs with us in the mid-1990s dueto the potential of wide-scale industry deregulation, we increased ourmarketing to appliance manufacturers and retailers, waste haulers and propertymanagement companies.  We also concentratedon strengthening our retail appliance operations, and in 1998, we introducedApplianceSmart Factory Outlets to focus on selling new appliances.

 

As of March 2009, ApplianceSmart was operating twenty factoryoutlets: six in the Minneapolis/St. Paul market; one in Rochester, Minn.; fourin the Columbus, Ohio, market; six in the Atlanta market; and three in the SanAntonio, Texas, market.  We believe weare one of the nation’s leading retailers of special-buy household appliances,primarily those manufactured by Whirlpool, General Electric andFrigidaire.  These special-buyappliances—which include close-outs, factory overruns, floor samples, returnedor exchanged items, and scratch-and-dent units—typically are not integratedinto 

 

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manufacturers’ normal distribution channels.  In the appliance industry, these appliancesrequire a different method of management.

 

The appliances we sell atApplianceSmart are new, not used.  Someare in the carton while others are out of the carton.  One example of this type of special-buyproduct involves manufacturer redesign, in which a current model is updated toinclude a few new features and is then assigned a new model number.  Because the manufacturer ships only thelatest models to retailers, a large quantity of the older model remains in themanufacturer’s inventory.

 

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 80 percent of the appliance sales market.  At the same time, the expansion of big-boxretailers that sell appliances has created a dramatic increase in the number ofspecial-buy units, further straining the traditional outlet system for theseappliances.  Because these special-buyappliances have value, manufacturers and retailers need an efficient managementsystem to recover their worth.

 

***ManufacturerSupply***

 

We have entered intoreverse logistics contracts with the following five major manufacturers:

 

1.               Whirlpool

2.               GeneralElectric (“GE”)

3.               Frigidaire

4.               Danby

5.               Bosch

 

These agreements havebeen extended through 2009 and in addition to the reverse logistics contracts,we are also an authorized new-appliance dealer for these five manufacturers.

 

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.               Wehave no guarantees for the number or type of appliances that we have topurchase.

2.               Theagreement may be terminated by either party with 30 days’ prior written notice.

3.               Wehave agreed to indemnify certain manufacturers for certain claims, allegationsor losses concerning the appliances we sell.

4.     In October2008, we signed an agreement to carry appliances manufactured by Bosch.

 

***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 

 

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conditioners from a majormanufacturer was depleted, no longer providing refurbishment opportunities forPDN and revenues for NAACO, which was the basis for our investment in thesebusinesses.  We will not have anycontinuing involvement or significant continuing cash flows in thesebusinesses.

 

***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 store location.

 

We have also seen renewedinterest from sponsors of energy efficiency programs across the country thatrecognize the effectiveness of recycling energy inefficient appliances.  We are aggressively pursuing this segment ofcustomers in 2009 and expect that we will continue to submit proposals forvarious new utility appliance recycling programs.

 

In 2008, we entered intoan agreement to become the exclusive North American distributor for UNTHARecycling Technology (URT), one of the world’s leading manufacturers oftechnologically advanced refrigerator recycling systems and recyclingfacilities for electrical household appliances and electronic scrap.  In addition to marketing these systems to therecycling industry, we intend to install a URT system at one of our highervolume appliance recycling facilities.

 

**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 recyclingprograms as an energy conservation measure.

 

*Appliance Manufacturers:*  We work with appliance manufacturers,including Whirlpool, Frigidaire, GE and Danby, to acquire the product we sellat our ApplianceSmart Factory Outlet stores. We purchase special-buy appliances, such as discontinued models andfactory overruns, and sell the product at a significant discount to full retailprices.  In addition, our participationin a national buying cooperative enables us to purchase new in-the-cartonappliances to fill out our 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 contract with utility companies and othersponsors of energy efficiency programs to provide a full range of appliancerecycling services to help them achieve their energy savings goals.  The contracts usually have terms of one tofour years, with provisions for renewal at the option of the utility.  Under some contracts, we manage all aspectsof the appliance recycling 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 institutedtracking and auditing procedures to assure our customers that those appliancesdo not return to use.

 

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

 

1.               Total number ofappliances expected to be processed.

2.               Length of thecontract term.

3.               Specific servicesthe utility selects us to provide.

4.               Market factors,including labor rates and transportation costs.

 

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Currently, we havecontracts for 2009 with the following utilities to handle recycling operationsin their service territories:

 

1.               SouthernCalifornia Edison

2.               SanDiego Gas & Electric

3.               WPPIEnergy

4.               AustinEnergy

5.               SouthernCalifornia Public Power Authority

6.               OntarioPower Authority

7.               MinnesotaPower

8.               Oncor

9.               AEPTexas

10.         AmerenIllinois Utilities

11.         CityWater Light & Power

12.         Severalother 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 warranty andcarry a 100 percent money-back guarantee. We also offer extended warranties, appliance delivery, factory-trainedtechnician service and recycling of customers’ old 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 programs for energy efficiency. We enter 2009 serving seven major utility programs and several smallerones.  We are aggressively pursuingadditional utility customers, but have a limited ability to project revenuesfrom new utility programs in 2009.  Wecannot predict recycling volumes or if we will be successful obtaining newcontracts.

 

We have focused on acarefully managed growth plan to strengthen our retail operations.  We opened four new factory outlets in 2008and one in 2009 and will continue to open factory outlet stores in convenient,high-traffic locations.  To supply ourstores with a wide selection of appliances, we will continue to seek additionalsources of product.  We currently operatetwenty factory outlets in strategic markets throughout the U.S., and we believethat the growth of our retail business in the near future will likely occurthrough opening new ApplianceSmart Factory Outlets in our existing markets.

 

**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 

 

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selling scrap materials,such as metal and plastics, and reclaimed CFC refrigerants from appliances wecollect and recycle, including those from our 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.”

 
| ** ** | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------|------------|----------|------------|----------|------------|
| Retail     |       | 68.6     | %          | 72.0     | %          |
| Recycling  |       | 26.7     | %          | 25.3     | %          |
| Byproduct  |       | 4.7      | %          | 2.7      | %          |
|       |       | 100.0    | %          | 100.0    | %          |

 

During fiscal years 2008 and 2007, 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 for utilitiesand other customers and includes byproduct revenue, which is generatedprimarily through the recycling of appliances. Financial information about our segments is included in “Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” and Note 12 of “Notes to Consolidated Financial 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.

 

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 to 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.

 

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.

 

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Many factors, includingobtaining adequate resources to create and support the infrastructure requiredto operate large-scale appliance recycling programs, affect competition in theappliance recycling industry.  We generallycompete 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 recyclingcompanies.

2.               Entrepreneursentering the appliance recycling business.

3.               Energy managementconsultants.

4.               Major waste haulingcompanies.

5.               Scrap metalprocessors.

 

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.

 

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 Best StratosphericOzone Protection Award as part of an appliance recycling team responsible for “themost exceptional global contributions in the first two decades of the MontrealProtocol.”

 

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.

 

Our retail stores obtainall business licenses, sales tax licenses and permits required for theirlocations.  Our delivery and collectionvehicles 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.

 

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**Employees**

 

At March 2, 2009 wehad 413 full-time employees and 16 part-time employees, distributedapproximately as follows:

 

1.               46%of our employees, including management, provide customer service, appliancecollection, transportation and processing services at our recycling centers.

2.               46% of ouremployees, including management, work in our factory outlet stores.

3.               8%of our employees are corporate management and support staff.

 

Our employees have nevercaused our operations to be disrupted by a work stoppage, and we believe thatour employee relations 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 primary growthstrategy is to open new retail stores. We evaluate demographic, economic and financial information in consideringa new store location.  We look primarilyin markets 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.  Weearned income from continuing operations of $1.8 million or $0.41 per dilutedshare for fiscal year 2008 and income from continuing operations of $2.5million or $0.55 per diluted share for fiscal year 2007.  We have experienced improvement in our retailsegment as our stores have become established. As illustrated in Note 12 of “Notes to Consolidated FinancialStatements,” operating income from the retail segment was $0.3 million in fiscal2008 compared to $2.3 million in fiscal 2007. This decline is the result of opening four new factory outlets and aneconomic slowdown that is discussed later in “Risks Relating to Our Business.”  Our full financial information is set out inthe consolidated financial statements and related notes and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.”

 

***Mostof our revenues are derived from retail sales. We expect this dependence on retail sales to continue in the future.***

 

Most of our revenues arederived from retail sales of appliances at our ApplianceSmart Factory Outletstores.  We currently operate twentyApplianceSmart Factory Outlet stores.  Retailrevenues have lower profit margins than recycling revenues.  While we believe that our future economicresults will be heavily dependent on our retail stores, we have seen a renewedinterest in recycling programs and are pursuing opportunities with providers ofenergy efficiency services.  In fiscalyears 2008 and 2007, approximately 69% and 72%, respectively, of our revenueswere from retail sales.

 

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

 

We purchase inventory forresale from three main suppliers.  Whilewe believe that our relationship with our vendors is strong, the loss of one ofthese suppliers could have a negative impact on the amount and mix of productthat we would be able to offer for sale, which could adversely affect ourrevenues and profitability.

 

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***Ourrevenues from recycling contracts increased in 2008, but future revenues fromthis source are very difficult to project.***

 

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 increased to 31% from 28% of totalrevenues for fiscal years 2008 and 2007, respectively.  This slight increase in fiscal 2008 comparedto fiscal 2007 is partially due to increased awareness and regulation ofenvironmental and energy conservation issues, combined with higher byproductrevenues.  However, we are stilldependent on certain customers for a large portion of our revenues.  Generally, recycling revenues have a highergross profit than retail revenues.

 

Three of our majorutility customers, Southern California Edison Company, Ontario Power Authorityand Southern California Public Power Authority, collectively accounted forapproximately 23% and 21% of our total revenues for 2008 and 2007,respectively.  The loss or materialreduction of business from any of these major customers could adversely affectour net revenues and profitability.

 

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.  We expect thatwe will continue to experience such seasonal fluctuations in recyclingrevenues.  We experience less seasonalfluctuation in our retail business.

 

***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 2009.  Currently,we have twenty retail stores and six 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.  Even if we are able to maintain our currentline of credit, we may need additional equity or other capital in thefuture.  Sources of additional financing,if needed in the future, may include further debt financing or the sale ofequity (including the 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 discretionary spending toother products during the fourth quarter of 2008.  These factors may likely cause us to delay or

 

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slow our expansion plans,reduce net sales and potentially result in excess inventories in 2009.  This may, in turn, lead to increasedmerchandise markdowns and related costs associated with higher levels of inventorythat could adversely affect our liquidity and profitability in 2009.

 

***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 therecycling side of our business.  Wegenerally compete with two or three companies based in the geographic area tobe served, and they generally offer some of the services we provide.  We expect our primary competition forcontracts with existing or new customers to come from entrepreneurs enteringthe appliance recycling business, energy management consultants, currentrecycling companies, major waste hauling companies, scrap metal processors andused-appliance dealers.  In addition,some of our customers, such as utility companies, may operate appliancerecycling programs internally rather than contracting with us or other thirdparties.  We cannot assure you that wewill be able to compete 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 our two ownedproperties, substantially all assets have been pledged to secure payments underthe line. 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.  At March 2,2009, borrowings of $12.2 million wereoutstanding under the line of credit, and we had unused borrowing capacity of $0.2 million.

 

***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 presentmanagement.  The loss of services of oneor more members of present management, including Edward R. (“Jack”) Cameron,our founder, Chairman 

 

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of the Board and currentCEO, could adversely affect our business. We do not have employment contracts with present management.  We maintain key person insurance on the lifeof Mr. Cameron in the amount of $1.0 million.

 

***Wehave ongoing litigation surrounding intellectual property issues and havesuccessfully avoided a claim of infringement in a second law suit.***

 

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 we expect that a decision on the appeal will behanded down late in 2009 or early in 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 using refrigeratorrecycling systems and processes covered by two U.S. patents issued to SEG andexclusively licensed to JACO.  JACO and SEG sought an undisclosed amountin damages, in addition to an injunction barring us from continuing to use andmarket the systems and processes upon which we allegedly infringed.  This suit was subsequently dismissedfollowing a transfer of the case to Los Angeles upon the motion of ARCA.

 

**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.

 

***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 7.1% of our Common Stock.  Our officers and directors together beneficiallyhold approximately 9.0% of our CommonStock.  Medallion Capital, Inc.(“Medallion”) owns approximately 10.7%of our outstanding common shares. Medallion also has a non-voting right to attend and participate in allmeetings of our Board of Directors. Perkins Capital Management, Inc. owns approximately 16.1% of our outstanding commonshares.  Because of such ownership, ourmanagement and principal shareholders may be able to significantly affect ourcorporate decisions, including the election of the Board of Directors.

 

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**ITEM 1B.****                                            UNRESOLVEDSTAFF COMMENTS**

 

None.

 

**ITEM 2.****                                                    PROPERTIES**

 

Our executive offices arelocated in Minneapolis, Minnesota, in a Company-owned facility that includesapproximately 11 acres of land.  Thebuilding contains approximately 122,000 square feet, consisting of 27,000square feet of office space, 62,000 square feet of operations and processingspace, and 33,000 square feet of retail space (as identified below with anopening date of June 1998).  We alsoown and use a building in Compton, California, with 11,000 square feet ofoffice space and 35,000 square feet of warehouse and processing space.  Both facilities we own are collateralsecuring outstanding loans.

 

We currently operatetwenty 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)* | * *   |
|       |       | October 2006     |       | 27,000                            |       |                                                           |       |
|       |       | December 2006    |       | 46,000                            |       |                                                           |       |
|       |       | December 2008    |       | 33,000                            |       |                                                           |       |
|       |       | January 2009     |       | 25,000                            |       |                                                           |       |
|       |       |                  |       |                              |       |                                                           |       |
| Texas      |       | October 2004     |       | 36,000                            |       |                                                           |       |
|       |       | October 2005     |       | 37,000                            |       |                                                           |       |
|       |       | September 2008   |       | 30,000                            |       |                                                           |       |

 

We lease all of ourretail store facilities with the exception of the one location we own in Minnesota.  We generally attempt to negotiate lease termsof five to ten years for our retail stores.

 

We operate six processingand recycling centers.  Two are in thefacilities that we own in Minnesota and California.  The other four are leased facilities inOakville, Ontario; Austin, Texas; Arlington, Texas; and Springfield,Illinois.  Our recycling centerstypically range in size from 25,000 to 40,000 square feet.

 

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

 

**ITEM 3.****                                                     LEGALPROCEEDINGS**

 

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 

 

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in serving more thanforty-five electric utility appliance recycling programs up to the time thesuit was filed.  We sought an injunction to prevent JACO from claimingthat it obtained a valid patent on appliance recycling processes that webelieve is based on methods and processes we invented.  In addition, we asked the Court to find thatthe patent obtained by JACO is unenforceable due to inequitable conduct beforethe United States Patent Office.  We also asked the court for unspecifieddamages related to charges that JACO, in using the patent to promote itsservices, engaged in unfair competition and false and misleading advertisingunder 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 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 we expect that a decision on the appeal will behanded down late in 2009 or early in 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.

 

**ITEM 4.****                                                    SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

We did not submitany matters to a vote of security holders during the last quarter of the fiscalyear covered by this report.

 

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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 Stock,which trades under the symbol “ARCI,” began trading on the NASDAQ CapitalMarket on February 22, 2006.  Thefollowing table sets forth, for the periods indicated, the high and low pricesfor our Common Stock, as reported by the NASDAQ Capital Market.  These quotations reflect the daily closeprices.

 
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **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    |       |
| **2007**       |       |     |       |    |       |
| First Quarter  |       | 2.76     |       | 2.10    |       |
| Second Quarter |       | 5.55     |       | 2.20    |       |
| Third Quarter  |       | 9.40     |       | 4.05    |       |
| Fourth Quarter |       | 11.00    |       | 6.29    |       |
|                |            |          |            |         |            |  |  |

 

On March 16,2009, the last reported sale price of the Common Stock on the NASDAQ CapitalMarket was $1.31 per share.  As of March 16,2009, there were approximately 900 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.****                                                     SELECTEDFINANCIAL 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 2008 and 2007 and “Item 8. Financial Statements andSupplementary Data.” All data is in thousands except per common sharedata.  The data for 2004-2007 has beenrestated to reflect the impact of the discontinued operations of our NAACO andPDN subsidiaries.

 
| **Fiscal Years Ended**                                   | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| **Statements  of Operations:**                                     |       |     |       |     |       |     |       |     |       |     |       |
| Total revenues                                                     |       | $        | 110,971    |     | $          | 99,754   |       | $        | 76,857     |     | $          | 74,354 |   | $ | 52,627 |   |
| Gross profit                                                       |       | $        | 35,610     |     | $          | 32,511   |       | $        | 23,613     |     | $          | 22,214 |   | $ | 15,457 |   |
| Operating income  (loss)                                           |       | $        | 4,035      |     | $          | 4,142    |       | $        | (959       | )        | $          | (165 | ) | $ | (961 | ) |
| Income (loss)  from continuing operations                          |       | $        | 1,864      |     | $          | 2,476    |       | $        | (1,257     | )        | $          | (1,014 | ) | $ | (1,206 | ) |
| Net income  (loss)                                                 |       | $        | 360        |     | $          | 2,539    |       | $        | (1,409     | )        | $          | (933 | ) | $ | (1,314 | ) |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Basic income  (loss) from continuing operations per common share   |       | $        | 0.41       |     | $          | 0.56     |       | $        | (0.29      | )        | $          | (0.24 | ) | $ | (0.44 | ) |
| Basic income  (loss) per common share                              |       | $        | 0.08       |     | $          | 0.58     |       | $        | (0.33      | )        | $          | (0.22 | ) | $ | (0.48 | ) |
| Diluted income  (loss) from continuing operations per common share |       | $        | 0.41       |     | $          | 0.55     |       | $        | (0.29      | )        | $          | (0.24 | ) | $ | (0.44 | ) |
| Diluted income  (loss) per common share                            |       | $        | 0.08       |     | $          | 0.57     |       | $        | (0.33      | )        | $          | (0.22 | ) | $ | (0.48 | ) |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Basic weighted  average number of common shares outstanding        |       | 4,571    |       | 4,400    |       | 4,335    |       | 4,261    |       | 2,722    |       |
| Diluted weighted  average number of common shares outstanding      |       | 4,612    |       | 4,475    |       | 4,335    |       | 4,261    |       | 2,722    |       |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| **Balance  Sheet:**                                                |       |     |       |     |       |     |       |     |       |     |       |
| Working capital                                                    |       | $        | 5,772      |     | $          | 5,126    |       | $        | 3,026      |     | $          | 3,879 |   | $ | 4,600 |   |
| Total assets                                                       |       | $        | 37,415     |     | $          | 35,532   |       | $        | 23,913     |     | $          | 24,491 |   | $ | 24,340 |   |
| Long-term  liabilities                                             |       | $        | 5,412      |     | $          | 5,215    |       | $        | 5,377      |     | $          | 5,216 |   | $ | 5,521 |   |
| Shareholders’  equity                                         |       | $        | 7,989      |     | $          | 7,262    |       | $        | 4,142      |     | $          | 5,421 |   | $ | 6,063 |   |

 

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

######  

The followingtable sets forth certain unaudited quarterly financial data for the eightquarters ended January 3, 2009.  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 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 |   |
|                                                               |       |                         |       |   |   |   |   |   |   |
| ** **                                                         | ** ** | **Fiscal 2007**              | ** ** |
| ** **                                                         | ** ** | **1****st**** Quarter** | ** ** | **2****nd**** Quarter** | ** ** | **3****rd**** Quarter** | ** ** | **4****th**** Quarter** | ** ** |
| Total revenues                                                     |       | $                            | 19,845     |   | $ | 22,132 |   | $ | 27,139 |   | $ | 30,638 |   |
| Gross profit                                                       |       | $                            | 6,530      |   | $ | 7,692 |   | $ | 9,196 |   | $ | 9,093 |   |
| Operating income  (loss)                                           |       | $                            | (146       | ) | $ | 858 |   | $ | 1,837 |   | $ | 1,593 |   |
| Income (loss)  from continuing operations                          |       | $                            | (442       | ) | $ | 487 |   | $ | 1,409 |   | $ | 1,022 |   |
| Net income  (loss)                                                 |       | $                            | (472       | ) | $ | 836 |   | $ | 1,404 |   | $ | 771 |   |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Basic income  (loss) from continuing operations per common share   |       | $                            | (0.10      | ) | $ | 0.11 |   | $ | 0.32 |   | $ | 0.23 |   |
| Basic earnings  (loss) per common share                            |       | $                            | (0.11      | ) | $ | 0.19 |   | $ | 0.32 |   | $ | 0.17 |   |
| Diluted income  (loss) from continuing operations per common share |       | $                            | (0.10      | ) | $ | 0.11 |   | $ | 0.31 |   | $ | 0.22 |   |
| Diluted earnings  (loss) per common share                          |       | $                            | (0.11      | ) | $ | 0.19 |   | $ | 0.31 |   | $ | 0.17 |   |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Basic weighted  average number of common shares outstanding        |       | 4,341                        |       | 4,353 |   | 4,409 |   | 4,495 |   |
| Diluted weighted  average number of common shares outstanding      |       | 4,341                        |       | 4,426 |   | 4,511 |   | 4,582 |   |

 

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| **ITEM 7.** | **MANAGEMENT’S  DISCUSSION 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, includinginformation with respect to our plans and strategy for our business and relatedfinancing, includes forward-looking statements that involve risk anduncertainties. In evaluating such statements, you should specifically considerthe various factors identified in this annual report that could cause resultsto differ materially from those expressed in such forward-looking statements,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 recycling services for electricutilities and other sponsors of energy efficiency programs.

 

***Subsidiaries*. **ARCA Canada Inc., a Canadian corporation,is a wholly owned subsidiary.  ARCACanada was formed in September 2006 to provide turnkey recycling servicesfor electric utility energy efficiency programs.  The operating results of ARCA Canada havebeen consolidated in our financial statements. We were a sixty percent 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 sixty percent owner in Productos Duraderos de Norte America (“PDN”),a Mexican corporation.  PDN was acquiredin September 2006 and refurbished room air conditioners for sale throughour NAACO operation in McAllen, Texas, and through our ApplianceSmart FactoryOutlet stores.  The operating results ofPDN have been consolidated in our financial statements.

 

***DiscontinuedOperations*. **Duringthe fourth quarter of 2008, we planned and executed the shutdown of our NAACOand PDN operations.  NAACO and PDN werenot operating 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.  The results ofoperations for 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.

 

***FiscalYear*. **We report ona 52- or 53-week fiscal year.  Our 2008fiscal year (“2008”) ended on January 3, 2009 and included 53 weeks.  Our 2007 fiscal year (“2007”) ended on December 29,2007 and included 52 weeks.

 

**KEYCOMPONENTS OF RESULTS OF OPERATIONS**

 

***Revenues*. **We generate revenues from three sources:retail, recycling and byproduct.  Retail revenuesare generated through the sale of new of appliances at our ApplianceSmartFactory Outlet stores.  Recyclingrevenues are generated by charging fees for collecting and recycling appliancesfor utilities and other sponsors of energy efficiency programs.  Byproduct revenues are generated by sellingrecovered materials, such as metals and plastics, and reclaimedchlorofluorocarbons (“CFC”) refrigerants, from appliances we collect andrecycle, including appliances from our ApplianceSmart Factory Outlet stores.

 

***Costof Revenues*. **Costof revenues includes all costs related to the purchase of inventory, includingfreight, costs related to receiving and distribution of inventory, and costsrelated to delivery and service of inventory after it is sold to theconsumer.  Also, the costs related torecycling appliances, such as customer service, transportation and processing,and the cost of refrigerators used in our replacement programs, are included inthe cost of revenues.  Depreciationexpense related to buildings and equipment from our recycling centers ispresented in cost of revenues.

 

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***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.

 

***InterestExpense*.**  Interestexpense is comprised of interest charges related to borrowings under our lineof credit, mortgages on our Minnesota and California buildings and otherlong-term obligations, primarily capital leases.

 

***Segments*. **We operate two reportable segments:retail and recycling.  The retail segmentis comprised of income generated through our ApplianceSmart Factory Outletstores.  Our recycling segment includesall fees charged and costs incurred for collecting, recycling and installingappliances for utilities and other customers and includes byproduct revenue,which is primarily generated through the recycling of appliances.  Retail revenues typically have lower profitmargins than recycling revenues.

 

*RetailSegment*.  We operatednineteen and fifteen factory outlet stores in 2008 and 2007, respectively.  Our nineteen factory outlet stores arelocated in convenient, high-traffic locations in Georgia, Minnesota, Ohio andTexas.  In 2008, we opened four newfactory outlet stores: our sixth and seventh in Minnesota, third in Texas andsixth in Georgia.  In 2007, we closed ourretail store in California and opened a fourth retail store in Ohio.  In January 2009, we opened our seventhfactory outlet store in Georgia to bring our total number of retail stores totwenty.

 

*RecyclingSegment*.  We operate six processing and recyclingcenters, which are located in Minnesota, California, Texas, Illinois andOntario, Canada.  We are activelypursuing opportunities to support energy efficiency programs run by electricutility companies.  During 2008, wehandled appliance recycling programs for and in the service territories ofSouthern California Edison; San Diego Gas & Electric; SouthernCalifornia Public Power Authority; Austin Energy, AEP Texas and Oncor ElectricDelivery in Texas; Ameren and City Water Light & Power in Illinois;Wisconsin Public Power; Wisconsin Energy Conservation Corporation; OntarioPower Authority; and several Southern California municipal electric utilities.

 

**RESULTS OF OPERATIONS**

 

The following table setsforth our consolidated financial data as a percentage of total revenues for thefiscal years 2008 and 2007:

 
| ** **                                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Revenues                                                          |       | 100.0    | %          | 100.0    | %          |
| Cost of revenues                                                  |       | 67.9     |       | 67.4     |       |
| Gross profit                                                      |       | 32.1     |       | 32.6     |       |
| Selling, general  and administrative expenses                     |       | 28.5     |       | 28.4     |       |
| Operating income                                                  |       | 3.6      |       | 4.2      |       |
| Other income  (expense):                                          |       |     |       |     |       |
| Interest  expense, net                                            |       | (1.2     | )          | (1.5     | )          |
| Other expenses,  net                                              |       | 0.0      |       | (0.1     | )          |
| Income from  continuing operations before income taxes            |       | 2.4      |       | 2.6      |       |
| Provision for  income taxes                                       |       | 0.7      |       | 0.2      |       |
| Income from  continuing operations                                |       | 1.7      |       | 2.4      |       |
| Income (loss)  from discontinued operations, net of income taxes  |       | (0.7     | )          | 0.1      |       |
| Loss on disposal  of discontinued operations, net of income taxes |       | (0.6     | )          | 0.0      |       |
| Net income                                                        |       | 0.4      | %          | 2.5      | %          |

 

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The followingtable sets forth the key results of operations by segment for the fiscal years2008 and 2007 (dollars in millions):

 
| ** **                   | ** ** | **2008** | ** ** | **2007** | ** ** | **% Change** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Revenues:                    |       |     |       |     |       |              |       |
| Retail                       |       | $        | 76.2       |     | $          | 71.9              |       | 5.9 | % |
| Recycling                    |       | 34.8     |       | 27.9     |       | 24.9              | %          |
| Total revenues               |       | $        | 111.0      |     | $          | 99.8              |       | 11.2 | % |
|                         |       |     |       |     |       |              |       |
| Operating income  (loss):    |       |     |       |     |       |              |       |
| Retail                       |       | $        | 0.3        |     | $          | 2.3               |       | (88.0 | )% |
| Recycling                    |       | 6.0      |       | 2.3      |       | 160.4             | %          |
| Unallocated  corporate costs |       | (2.3     | )          | (0.5     | )          | 426.2             | %          |
| Total operating  income      |       | $        | 4.0        |     | $          | 4.1               |       | (2.6 | )% |

 

***Revenues*.**  Revenues for the fiscal years of 2008 and2007 are as follows (dollars in millions):

 
| ** ** | ** ** | **2008** | ** ** | **2007** | ** ** | **% Change** | ** ** |
|------------|------------|----------|------------|----------|------------|-------------------|------------|
| Retail     |       | $        | 76.2       |     | $          | 71.9              |       | 5.9 | % |
| Recycling  |       | 29.6     |       | 25.2     |       | 17.6              | %          |
| Byproduct  |       | 5.2      |       | 2.7      |       | 94.0              | %          |
|       |       | $        | 111.0      |     | $          | 99.8              |       | 11.2 | % |

 

Our total revenues for2008 increased $11.2 million or 11.2% from $99.8 million in 2007.  Retail sales accounted for 69% of total salesfor 2008 compared to 72% in 2007.  Weexperienced growth in all of our revenue streams but do not expect this levelof growth in 2009 due to the economic slowdown and decline in scrap metal pricesfrom the first three quarters of 2008. We expect that scrap metal prices will remain depressed throughout 2009.

 

*Retail Revenues*.  Our retail revenues for 2008 increased $4.3million or 5.9% from $71.9 million in 2007. The increase in retail revenues was primarily due to opening four new factoryoutlet stores in 2008.  These new storescontributed $6.5 million of additional revenues in 2008 compared to 2007.  The revenue growth from our new stores waspartially offset by the closure of our California factory outlet in September 2007.  Our comparable store sales of the fourteenApplianceSmart Factory Outlets that were open during the entire years of 2008and 2007 were down 2.5% or $1.7 million. The primary decrease in comparable store sales occurred in the fourthquarter of 2008.  Prior to the fourthquarter, our comparable sales were up 2.6% for the first three quarters of 2008compared to the same period in 2007.  Inthe fourth quarter of 2008 our comparable store sales were down 16.7% primarilydue to two factors: 1) the fourth quarter of 2007 was positively impacted by alarge close-out purchase from a major manufacturer that resulted in strongcustomer sales.  This purchasingopportunity did not exist in 2008, and 2) the overall retail economy is experiencinga nationwide slowdown and cutback in consumer spending.  We expect the economic slowdown and cutbackin consumer spending to continue through 2009, negatively impacting oursales.  We also plan to slow down theopening of new stores in 2009 or until we see a pickup in consumer spending.

 

Our factory outlets carry a wide range of newin-the-box and special-buy appliances, which include manufacturer closeouts,factory overruns, floor samples, returned or exchanged items, open-cartonitems, and scratch and dent appliances. All these appliances are new. Some are in the carton while others are out of the carton.

 

We continue to purchasethe majority of both new in-the-box and special-buy appliances from Whirlpool,GE and Frigidaire.  We have no minimumpurchase 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.

 

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*Recycling Revenues*.  Our recycling revenues for 2008 increased$4.4 million or 17.6% from $25.2 million in 2007.  The increase was primarily due to recyclingmore appliances under our Ontario Power Authority and Southern CaliforniaPublic Power Authority contracts in 2008 compared to 2007.  We are aggressively pursuing new appliancerecycling programs but cannot predict if we will be successful in signing newcontracts or renewing existing contracts.

 

*Byproduct Revenues*.  Our byproduct revenues for 2008 increased$2.5 million or 94.0% from $2.7 million in 2007.  The increase was due primarily to higherscrap metal prices we received during the first three quarters of 2008 and, toa lesser extent, increased recycling volumes. During the fourth quarter of 2008, there was a significant decline inthe demand and prices we received for scrap materials.  We expect that scrap material prices willstay depressed throughout 2009.

 

***GrossProfit*.**  Ouroverall gross profit increased $3.1 million or 9.5% from $32.5 million in2007.  Our gross profit as a percentageof total revenue was 32% in 2008 compared to 33% in 2007.  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 retailproducts we sell.

2.               The prices at whichwe purchase product from the major manufacturers who supply product to us.

3.               The volume ofappliances we receive through our recycling contracts.

4.               The volume andprice of scrap metals, plastics and reclaimed CFCs.

 

Unless we cansignificantly increase our appliance purchasing volume, resulting in a higherlevel rebates, or sign substantial recycling contracts utilizing our currentrecycling facilities, gross profit percentages will remain flat in 2009.

 

***Selling, General andAdministrative Expenses*****.** Our selling, general and administrative (“SG&A”) expenses for 2008increased $3.2 million or 11.3% from $28.4 million in 2007.  Our SG&A expenses as a percentage oftotal revenues remained unchanged at 28% in 2008 compared to 2007.  Selling expenses increased $1.4 million to$19.9 million in 2008 from $18.5 million in 2007.  The increase in selling expenses was dueprimarily to opening four new factory outlet stores in 2008 and the full-yearimpact of opening our factory outlet store in Ohio in December 2007.  General and administrative expenses increased$1.9 million to $11.7 million in 2008 from $9.8 million in 2007.  The increase was due primarily to additionalemployee compensation, share-based compensation and legal fees associated withthe legal proceedings discussed in Part I, Item 3, “Legal Proceedings,”and Note 8 of “Notes to Consolidated Financial Statements.”  We expect SG&A expenses to decreaseslightly as a percentage of total revenues in 2009 due to cost saving initiatives.

 

***InterestExpense*****.**  Interest expense decreased $0.1 million to$1.4 million in 2008 compared to $1.5 million in 2007.  The decrease was primarily due to the declinein the weighted average interest rate on our line of credit from 10.58% in 2007to 6.83% in 2008.  We cannot predict whatwill happen with interest rates in 2009.

 

***Provisionfor Income Taxes*.** Our provision for income taxes for 2008 increased $0.5 million to $0.7million in 2008 compared to $0.2 million in 2007.  The increase is primarily due to taxableincome from our Canadian subsidiary.  Asof January 3, 2009 and December 29, 2007, we recorded cumulativevaluation allowances of $2.2 million and $2.3 million, respectively, againstour U.S. net deferred tax assets due to the uncertainty of theirrealization.  The realization of deferredtax assets is dependent upon sufficient future taxable income during theperiods when deductible temporary differences and carryforwards are expected tobe available to reduce taxable income. We do not expect a significant increase or decrease in our provision forincome taxes in 2009.

 

***DiscontinuedOperations*.**  Duringthe fourth quarter of 2008, we planned and executed the shutdown of our NAACOand PDN operations.  NAACO and PDN werenot operating 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.  The results ofoperations for NAACO and PDN were included in our retail segment and have beenreclassified as discontinued operations. During the fiscal years ended January 3, 2009 and December 29,2007, NAACO and PDN had revenues of $0.8 million and $1.0 million,respectively, and income (loss) before taxes of ($0.9) million and $0.1million, respectively.  We recorded aloss on the 

 

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disposal of NAACOand PDN of $0.7 million, net of taxes in 2008, which consisted of terminationcosts and the write-down of certain assets to fair value upon the abandonmentof 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 3,2009 were $3.5 million compared to $2.8 million as of December 29,2007.  Our working capital increased to$5.8 million for the year ended January 3, 2009 compared to $5.1 millionfor the year ended December 29, 2007.

 

***Net Cash Provided by (Used in)Operating Activities*****.**  Our net cash provided by operating activitieswas $1.6 million in 2008 compared to net cash used in operating activities of$6.2 million in 2007.  During 2008,inventories increased by $5.0 million, primarily due to opening four newfactory outlet stores, compared to a $3.1 million increase in 2007.  During 2008, accounts receivable decreased$3.6 million, primarily due to the timing of collections of recyclingreceivables which was largely the cause of the increase of $7.7 million in2007.

 

***NetCash Used in Investing Activities*.**  Our net cash used in investing activities was$0.8 million in 2008 compared to $0.9 million in 2007.  The net cash used in investing activities in2008 and 2007 was primarily related to the purchase of computer equipment,phone systems, leasehold improvements to support our new store openings andrecycling equipment to support recycling contracts.  We did not have any material purchasecommitments for assets as of January 3, 2009 or through March 2,2009.

 

***NetCash Provided by Financing Activities*.**  Our net cash provided by financing activitieswas $0.4 million in 2008 compared to $7.1 million in 2007.  The net cash provided by financing activitiesin 2008 was primarily due to borrowings under our line of credit, partiallyoffset by payments on our long-term debt obligations.  The net cash provided by financing activitiesin 2007 was primarily due to increased borrowings under the line of credit forinventory purchases and stock option exercises, offset by payments on long-termdebt obligations.

 

***OutstandingIndebtedness*.**  Asof January 3, 2009, we had an $18.0 million line of credit with alender.  The line was increased from$16.0 million to $18.0 million on February 5, 2008.  The interest rate on the line as of January 3,2009 was 6.25% (the greater of prime plus 1.50 percentage points or 6.25%).  The amount of borrowings available under theline of credit is based on a formula using receivables and inventories.  We may not have access to the full $18.0million line of credit due to the formula using our receivables andinventories.  The outstanding balance andunused borrowing capacity were $14.5 million and $0.4 million, respectively, asof January 3, 2009.  At March 2,2009, borrowings of $12.2 million wereoutstanding under the line of credit, and we had unused borrowing capacity of $0.2 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.  As of January 3, 2009 we were not incompliance with certain financial covenants and received a waiver from thelender.

 

In September 2008, we enteredinto a master equipment lease with a lender providing up to $0.3 million inavailable funds.  As of January 3,2009, we had utilized the entire lease line to fund equipment for the newretail outlets opened in December 2008 and January 2009.

 

As of January 3, 2009, we hadlong-term obligations of $5.5 million consisting of mortgages on our Minnesotaand California buildings along with various financings, primarily consisting ofcapital leases.

 

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

 
| 2009   |   | $   | 0.6    |   |
|--------|--------|-----|--------|--------|
| 2010   |   | 0.6 |   |
| 2011   |   | 0.5 |   |
| 2012   |   | 2.5 |   |
| 2013   |   | 1.3 |   |
|   |   | $   | 5.5    |   |

 

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 December 2009. Our total capital requirements for 2009 will depend upon, among otherthings as discussed below, the number and size of retail stores operatingduring the fiscal year and the recycling volumes generated from recyclingcontracts in 2009.  Currently, we havetwenty retail stores and six recycling centers in operation.  We may need additional capital to finance ouroperations if our revenues are lower than anticipated or our expenses arehigher 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.

 

**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.***  Werecognize revenue from appliance sales in the period the consumer purchases andpays for the appliance, net of an allowance for estimated returns.  We recognize revenue from appliance recyclingwhen we collect and process a unit.  Werecognize byproduct revenue upon shipment. We recognize revenue on extended warranties with retained serviceobligations on a straight-line basis over the period of the warranty inaccordance with FASB Technical Bulletin 90-1, *Accountingfor Separately Priced Extended Warranty and Product Maintenance Contracts*.  On extended warranty arrangements that wesell but others service for a fixed portion of the warranty sales price, werecognize revenue for the net amount retained at the time of sale of theextended warranty to the consumer.  Weinclude shipping and handling charges to customers in revenue, which isrecognized in the period the consumer purchases and pays for delivery.  Shipping and handling costs that we incur areincluded in cost of revenues.** **The application of our revenuerecognition policy does not involve significant uncertainties and is notsubject to accounting estimates or assumptions having significant sensitivityto change.

 

***ProductWarranty*.**  Weprovide a warranty for the replacement or repair of certain defectiveunits.  Our standard warranty policyrequires us to repair or replace certain defective units at no cost to ourcustomers.  We estimate the costs thatmay be incurred under our warranty and record an accrual in the amount of suchcosts at the time 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.** **Historically, our actualexperience has not differed significantly from our estimates.

 

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***Trade Receivables*.**** **We carry trade receivables at theoriginal invoice amount less an estimate made for doubtful accounts based on amonthly review of all outstanding amounts. Management determines the allowance for doubtful accounts by regularlyevaluating individual customer receivables and considering a customer’sfinancial condition, credit history and current economic conditions.  We write off trade receivables when we deemthem uncollectible.  We record recoveriesof trade receivables previously written off when we receive them.  We consider a trade receivable to be past dueif any portion of the receivable balance is outstanding for more than ninetydays.  We do not charge interest on pastdue receivables.

 

***Inventories*.**  Our inventories, consisting principally ofappliances, are stated at the lower of cost, determined on a specificidentification basis, or market.  Weprovide estimated 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.  Historically, our actual experience has notdiffered significantly from our estimates.

 

***IncomeTaxes*.*** *We account for income taxes underthe liability method in accordance with SFAS No. 109, *Accountingfor Income Taxes*.  Deferredtax liabilities are recognized for temporary differences that will result intaxable 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 are measuredusing the enacted tax rates expected to apply to taxable income in the periodsin which the deferred tax asset or liability is expected to be realized orsettled.  We assess the likelihood thatour deferred tax assets will be recovered from future taxable income and recorda valuation allowance to reduce our deferred tax assets to the amounts webelieve to be realizable.  We concludedthat a full valuation allowance against our U.S. deferred tax assets was appropriateas of January 3, 2009.

 

***Share-BasedCompensation*.**  Weaccount for share-based compensation in accordance with SFAS No. 123(revised 2004), *Share Based Payment*, using themodified prospective method.  Under thismethod, we recognize compensation expense on a straight-line basis over the vestingperiod for all share-based awards granted on or after January 1, 2006, andfor previously granted awards not yet vested as of January 1, 2006.  We use the Black-Scholes option pricing modelto 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 will continueto review these estimates in future periods. The risk-free rates for the expected terms of the stock options arebased on the U.S. Treasury yield curve in effect at the time of the grant.  The expected life represents the period thatthe stock option awards are expected to be outstanding.  The expected dividend yield is zero as wehave not paid or declared any cash dividends on our Common Stock.

 

**RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

** **

In May 2008, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 162, *TheHierarchy of Generally Accepted Accounting Principles*.  This standard is intended to improvefinancial reporting by identifying a consistent framework, or hierarchy, forselecting accounting principles to be used in preparing financial statementsthat are presented in conformity with generally accepted accounting principlesin the United States for non-governmental entities.  SFAS No. 162 is effective 60 daysfollowing approval by the SEC of the Public Company Accounting Oversight Board’samendments to AU Section 411, *TheMeaning of**Present Fairly inConformity with Generally Accepted Accounting Principles*.  We do not expect SFAS No. 162 to have amaterial impact on the preparation of our consolidated financial statements.

 

In March 2008, theFASB issued SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities*.  SFAS No. 161 is intended to improvefinancial reporting about derivative instruments and hedging activities byrequiring enhanced disclosures to enable investors to better understand theireffects on an entity’s financial position, financial performance and cashflows.  SFAS No. 161 also improvestransparency about the location and amounts of derivative instruments in anentity’s financial statements; how derivative instruments and related hedgeditems are accounted for under SFAS No. 133; and how derivative instrumentsand related hedged items affect its financial position, financial performanceand cash flows.  SFAS No. 161 iseffective for financial statements issued for fiscal years and interim periodsbeginning after November 15, 2008, with early application encouraged.  We do not believe the adoption of SFAS No. 161will have a material effect on our results of operations or financial position.

 

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In December 2007,the FASB issued SFAS No. 160, *Noncontrolling Interestsin Consolidated Financial Statements, an amendment of ARB No. 51*.  This statement establishes accounting andreporting standards for noncontrolling interests in subsidiaries and for thedeconsolidation of subsidiaries and clarifies that a noncontrolling interest ina subsidiary is an ownership interest in the consolidated entity that should bereported as equity in the consolidated financial statements.  This statement also requires expandeddisclosures that clearly identify and distinguish between the interests of theparent owners and the interests of the noncontrolling owners of a subsidiary.  SFAS No. 160 is effective for fiscalyears beginning on or after December 15, 2008.  We do not believe the adoption of SFAS No. 160will have a material effect on our results of operations or financial position.

 

In December 2007,the FASB issued SFAS No. 141 (Revised 2007), *BusinessCombinations*.  While thisstatement retains the fundamental requirement of SFAS No. 141 that theacquisition method of accounting (which SFAS No. 141 called the purchasemethod) be used for all business combinations, SFAS No. 141 (Revised 2007)now establishes the principles and requirements for how an acquirer in abusiness combination: recognizes and measures in its financial statements, theidentifiable assets acquired, the liabilities assumed, and any noncontrollinginterests in the acquiree; recognizes and measures the goodwill acquired in thebusiness combination 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.  SFAS No. 141(Revised 2007) is effective for fiscal years beginning on or after December 15,2008.  We do not believe the adoption ofSFAS No. 141 will have a material effect on our results of operations orfinancial position.

 

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*.  This statement permits entities to choose tomeasure many financial instruments and certain other items at fair value.  SFAS No. 159 is effective for fiscalyears beginning after November 15, 2007. The adoption of SFAS No. 159 on December 30, 2007 had noimpact on our consolidated financial statements.

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*.  This statement defines fair value,establishes a framework for measuring fair value under generally acceptedaccounting principles and expands disclosures about fair value measurements.  SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007;however, during February 2008, the FASB issued FASB Staff Position (“FSP”)No. 157-2 which deferred the effective date of certain provisions of SFAS No. 157until fiscal years beginning after November 15, 2008.  We adopted the provisions of SFAS No. 157that were not deferred under FSP No. 157-2 effective December 30,2007.  The adoption had no impact on ourconsolidated financial statements.

 

**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.  Anyforward-looking information regarding our operations will be affected primarilyby the speed at which individual retail outlets reach profitability, the volumeof appliance retail sales and the strength of energy conservation recyclingprograms.  Any forward-lookinginformation will also be affected by our continued ability to purchase productfrom our suppliers at acceptable prices, the ability of individual retailstores to meet planned revenue levels, the rate of growth in the number ofretail stores, costs and expenses being realized at higher than expectedlevels, our ability to secure an adequate supply of special-buy appliances forresale, the ability to secure appliance recycling contracts with sponsors ofenergy efficiency programs, the ability of customers to supply units undertheir recycling contracts with us, and the continued availability of ourcurrent line of credit.

 

**ITEM 7A.               QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

**Market Risk and Impact of Inflation**

** **

***InterestRate Risk*.**  We donot believe there is any significant risk related to interest rate fluctuationson our long-term fixed-rate debt.  Thereis interest rate risk on the line of credit, since our interest rate floatswith prime.  The outstanding balance on 

 

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our line of creditas of January 3, 2009 was approximately $14.5 million.  There is also interest rate risk onapproximately $2.7 million in long-term debt entered into in September 2002,since our interest rate is based on the 30-day LIBOR rate.  Although the $14.5 million line of credit issubject to a minimum interest rate of 6.25%, based on average floating rateborrowings of $17.2 million, a hypothetical 100 basis point change in theapplicable interest rate would have caused our interest expense to change byapproximately $0.2 million.

 

***Foreign Currency Exchange Rate Risk.***  Wecurrently generate revenues in Canada. The reporting currency for our consolidated financial statements isU.S. dollars.  It is not possible todetermine the exact impact of foreign currency exchange rate changes; however,the effect on reported revenue and net earnings can be estimated.  Weestimate that the overall strength of the U.S. dollar against the Canadiandollar had an unfavorable impact on revenue of approximately $0.6 million infiscal 2008.  In addition, we estimate that such strength had an unfavorableimpact of approximately $0.2 million on our net income in the fiscal year2008.  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 adversely affect buyinghabits of our customers in 2009.

 

**ITEM 8.                  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 
| **Description**                                                                                                                                                    | ** ** | **Page** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                                                                               |       |     |
| Report  of Independent Registered Public Accounting Firm                                                                                                           |       | 29       |
|                                                                                                                                                               |       |     |
| Consolidated Balance  Sheets as of January 3, 2009  and December 29, 2007                                                                                |       | 30       |
|                                                                                                                                                               |       |     |
| Consolidated  Statements of Operations for the fiscal years  ended January 3, 2009 and December 29, 2007                                                 |       | 31       |
|                                                                                                                                                               |       |     |
| Consolidated  Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the  fiscal years  ended January 3, 2009 and December 29, 2007 |       | 32       |
|                                                                                                                                                               |       |     |
| Consolidated  Statements of Cash Flows for the fiscal years  ended January 3, 2009 and December 29, 2007                                                 |       | 33       |
|                                                                                                                                                               |       |     |
| Notes to Consolidated Financial Statements                                                                                                                         |       | 34       |
|                                                                                                                                                               |       |     |
| Schedule  II, Valuation and Qualifying Accounts is included in Part IV, Item 15 of  this Annual Report on Form 10-K.                                     |       |     |
|                                                                                                                                                               |       |     |
| Selected  Quarterly Financial 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 3, 2009and December 29, 2007, and the related consolidated statements ofoperations, shareholders’ equity and comprehensive income (loss) and cash flowsfor the fiscal years then ended.  Theseconsolidated financial statements are the responsibility of the company’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audits.

 

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 3, 2009 and December 29,2007 and the results of their operations and cash flows for the fiscal yearsthen ended, in conformity with U.S. generally accepted accounting principles.

 

 

/s/ Virchow, Krause &Company, LLP

 

Minneapolis, MN

March 19, 2009

 

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**APPLIANCERECYCLING CENTERS OF AMERICA, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(InThousands)**

 
| ** **                                                                                                           | ** ** | **January 3,** | ** ** | **December 29,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------|------------|
| ** **                                                                                                           | ** ** | **2009**            | ** ** | **2007**              | ** ** |
| **ASSETS**                                                                                                           |       |                |       |                  |       |
| Current assets:                                                                                                      |       |                |       |                  |       |
| Cash and cash  equivalents                                                                                           |       | $                   | 3,498      |                  | $          | 2,777 |   |
| Accounts  receivable, net of allowance of $292 and $152, respectively                                                |       | 6,056               |       | 10,086                |       |
| Inventories, net  of reserves of $115 and $84, respectively                                                          |       | 18,834              |       | 14,064                |       |
| Deferred income  taxes                                                                                               |       | 448                 |       | 259                   |       |
| Other current  assets                                                                                                |       | 950                 |       | 995                   |       |
| Total current  assets                                                                                                |       | 29,786              |       | 28,181                |       |
| Property and  equipment, net                                                                                         |       | 6,967               |       | 6,762                 |       |
| Deferred income  taxes                                                                                               |       | 177                 |       | —                |       |
| Other assets                                                                                                         |       | 485                 |       | 589                   |       |
| Total assets                                                                                                         |       | $                   | 37,415     |                  | $          | 35,532 |   |
|                                                                                                                 |       |                |       |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                       |       |                |       |                  |       |
| Current  liabilities:                                                                                                |       |                |       |                  |       |
| Accounts payable                                                                                                     |       | $                   | 4,473      |                  | $          | 4,350 |   |
| Checks issued in  excess of cash in bank                                                                             |       | —              |       | 310                   |       |
| Accrued expenses                                                                                                     |       | 4,073               |       | 4,113                 |       |
| Line of credit                                                                                                       |       | 14,527              |       | 13,585                |       |
| Current  maturities of long-term obligations                                                                         |       | 579                 |       | 479                   |       |
| Income taxes  payable                                                                                                |       | 362                 |       | 218                   |       |
| Total current  liabilities                                                                                           |       | 24,014              |       | 23,055                |       |
|                                                                                                                 |       |                |       |                  |       |
| Long-term  obligations, less current maturities                                                                      |       | 4,892               |       | 4,956                 |       |
| Deferred income  tax liabilities                                                                                     |       | 520                 |       | 259                   |       |
| Total  liabilities                                                                                                   |       | 29,426              |       | 28,270                |       |
|                                                                                                                 |       |                |       |                  |       |
| Commitments and  contingencies                                                                                       |       | —              |       | —                |       |
|                                                                                                                 |       |                |       |                  |       |
| Shareholders’  equity:                                                                                          |       |                |       |                  |       |
| Common Stock, no  par value; 10,000 shares authorized; issued and outstanding: 4,578 and 4,509  shares, respectively |       | 16,221              |       | 15,475                |       |
| Accumulated  deficit                                                                                                 |       | (7,929              | )          | (8,289                | )          |
| Accumulated  other comprehensive income (loss)                                                                       |       | (303                | )          | 76                    |       |
| Total  shareholders’ equity                                                                                     |       | 7,989               |       | 7,262                 |       |
| Total  liabilities and shareholders’ equity                                                                     |       | $                   | 37,415     |                  | $          | 35,532 |   |

 

See Notes toConsolidated Financial Statements.

 

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**APPLIANCERECYCLING CENTERS OF AMERICA, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                           | ** ** | **For the fiscal year ended** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                           | ** ** | **January 3,**                               | ** ** | **December 29,** | ** ** |
| ** **                                                           | ** ** | **2009**                                          | ** ** | **2007** | ** ** |
| Revenues:                                                            |       |                                              |       |   |   |
| Retail                                                               |       | $                                                 | 76,179     |   | $ | 71,904 |   |
| Recycling                                                            |       | 29,628                                            |       | 25,188 |   |
| Byproduct                                                            |       | 5,164                                             |       | 2,662 |   |
| Total revenues                                                       |       | 110,971                                           |       | 99,754 |   |
| Cost of revenues                                                     |       | 75,361                                            |       | 67,243 |   |
| Gross profit                                                         |       | 35,610                                            |       | 32,511 |   |
| Selling, general  and administrative expenses                        |       | 31,575                                            |       | 28,369 |   |
|                                                                 |       |                                              |       |   |   |
| Operating income                                                     |       | 4,035                                             |       | 4,142 |   |
|                                                                 |       |                                              |       |   |   |
| Other expense:                                                       |       |                                              |       |   |   |
| Interest  expense, net                                               |       | (1,377                                            | )          | (1,450 | ) |
| Other expense                                                        |       | (55                                               | )          | (53 | ) |
| Income from  continuing operations before provision for income taxes |       | 2,603                                             |       | 2,639 |   |
| Provision for  income taxes                                          |       | 739                                               |       | 163 |   |
| Income from  continuing operations                                   |       | 1,864                                             |       | 2,476 |   |
| Income (loss)  from discontinued operations, net of tax              |       | (812                                              | )          | 63 |   |
| Loss on disposal  of discontinued operations, net of tax             |       | (692                                              | )          | — |   |
| Net income                                                           |       | $                                                 | 360        |   | $ | 2,539 |   |
|                                                                 |       |                                              |       |   |   |
| Basic income  (loss) per common share:                               |       |                                              |       |   |   |
| Continuing  operations                                               |       | $                                                 | 0.41       |   | $ | 0.56 |   |
| Discontinued  operations                                             |       | (0.33                                             | )          | 0.02 |   |
| Net income                                                           |       | $                                                 | 0.08       |   | $ | 0.58 |   |
|                                                                 |       |                                              |       |   |   |
| Diluted income  (loss) per common share:                             |       |                                              |       |   |   |
| Continuing  operations                                               |       | $                                                 | 0.41       |   | $ | 0.55 |   |
| Discontinued  operations                                             |       | (0.33                                             | )          | 0.02 |   |
| Net income                                                           |       | $                                                 | 0.08       |   | $ | 0.57 |   |
|                                                                 |       |                                              |       |   |   |
| Weighted average  common shares outstanding:                         |       |                                              |       |   |   |
| Basic                                                                |       | 4,571                                             |       | 4,400 |   |
| Diluted                                                              |       | 4,612                                             |       | 4,475 |   |

 

See Notes toConsolidated Financial Statements.

 

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**APPLIANCERECYCLING CENTERS OF AMERICA, INC.**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY**

**ANDCOMPREHENSIVE INCOME (LOSS)**

**(InThousands)**

 
| ** **                              | ** ** | ** **            | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** **  | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|-------------------|------------|------------------------|------------|-------------|------------|------------|------------|
| ** **                              | ** ** | ** **            | ** ** | ** **        | ** ** | **Other**              | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Common Stock** | ** ** | **Comprehensive** | ** ** | **Accumulated**        | ** ** | ** **  | ** ** |
| ** **                              | ** ** | **Shares**            | ** ** | **Amount**        | ** ** | **Income (Loss)** | ** ** | **Deficit** | ** ** | **Total**  | ** ** |
| Balance at  December 30, 2006      |       | 4,341                 |       | $                 | 14,970     |                   | $          | —      |       | $          | (10,828    | ) | $ | 4,142 |   |
| Net income                              |       | —                |       | —            |       | —                 |       | 2,539       |       | 2,539      |       |
| Other  comprehensive income, net of tax |       | —                |       | —            |       | 76                     |       | —      |       | 76         |       |
| Exercise of  stock options              |       | 168                   |       | 398               |       | —                 |       | —      |       | 398        |       |
| Share-based  compensation               |       | —                |       | 107               |       | —                 |       | —      |       | 107        |       |
| 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 |   |

 

Comprehensiveincome (loss) is as follows:

 
| ** **                                                                                                                 | ** ** | **For the fiscal year ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **January 3,**                               | ** ** | **December 29,** | ** ** |
| ** **                                                                                                                 | ** ** | **2009**                                          | ** ** | **2007** | ** ** |
| Net income                                                                                                                 |       | $                                                 | 360        |   | $ | 2,539 |   |
| Foreign currency  translation adjustments, net of tax                                                                      |       | (452                                              | )          | 76 |   |
| Reclassification  of foreign currency translation adjustments related to discontinued  operations recognized in net income |       | 73                                                |       | — |   |
| Comprehensive  income (loss)                                                                                               |       | $                                                 | (19        | ) | $ | 2,615 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In Thousands)**

 
| ** **                                                                                                         | ** ** | **For the fiscal year ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **January 3,**                               | ** ** | **December 29,** | ** ** |
| ** **                                                                                                         | ** ** | **2009**                                          | ** ** | **2007** | ** ** |
| **Operating  activities**                                                                                          |       |                                              |       |   |   |
| Net income                                                                                                         |       | $                                                 | 360        |   | $ | 2,539 |   |
| Adjustments to  reconcile net income to net cash and cash equivalents provided by (used in)  operating activities: |       |                                              |       |   |   |
| Loss on disposal  of discontinued operations                                                                       |       | 692                                               |       | — |   |
| Depreciation and  amortization                                                                                     |       | 1,123                                             |       | 873 |   |
| Provision for  bad debts                                                                                           |       | 264                                               |       | — |   |
| Share-based  compensation                                                                                          |       | 529                                               |       | 107 |   |
| Deferred income  taxes                                                                                             |       | 72                                                |       | — |   |
| Changes in  assets and liabilities:                                                                                |       |                                              |       |   |   |
| Accounts  receivable                                                                                               |       | 3,570                                             |       | (7,675 | ) |
| Inventories                                                                                                        |       | (5,041                                            | )          | (3,066 | ) |
| Other current  assets                                                                                              |       | 45                                                |       | (338 | ) |
| Other assets                                                                                                       |       | (4                                                | )          | (156 | ) |
| Accounts payable  and accrued expenses                                                                             |       | (164                                              | )          | 1,308 |   |
| Income taxes  payable                                                                                              |       | 203                                               |       | 160 |   |
| Net cash flows  provided by (used in) operating activities                                                         |       | 1,649                                             |       | (6,248 | ) |
|                                                                                                               |       |                                              |       |   |   |
| **Investing  activities**                                                                                          |       |                                              |       |   |   |
| Purchase of  property and equipment                                                                                |       | (812                                              | )          | (932 | ) |
| Net cash flows  used in investing activities                                                                       |       | (812                                              | )          | (932 | ) |
|                                                                                                               |       |                                              |       |   |   |
| **Financing  activities**                                                                                          |       |                                              |       |   |   |
| Checks issued in  excess of cash in bank                                                                           |       | (310                                              | )          | 310 |   |
| Net borrowings  under line of credit                                                                               |       | 942                                               |       | 6,713 |   |
| Payments on  long-term obligations                                                                                 |       | (482                                              | )          | (293 | ) |
| Proceeds from  stock option exercises                                                                              |       | 217                                               |       | 398 |   |
| Net cash flows  provided financing activities                                                                      |       | 367                                               |       | 7,128 |   |
|                                                                                                               |       |                                              |       |   |   |
| Effect of  changes in exchange rate on cash and cash equivalents                                                   |       | (483                                              | )          | 76 |   |
|                                                                                                               |       |                                              |       |   |   |
| Increase in cash  and cash equivalents                                                                             |       | 721                                               |       | 24 |   |
| Cash and cash  equivalents at beginning of period                                                                  |       | 2,777                                             |       | 2,753 |   |
| Cash and cash  equivalents at end of period                                                                        |       | $                                                 | 3,498      |   | $ | 2,777 |   |
|                                                                                                               |       |                                              |       |   |   |
| **Supplemental  disclosures of cash flow information**                                                             |       |                                              |       |   |   |
| Cash payments  for interest                                                                                        |       | $                                                 | 1,385      |   | $ | 1,471 |   |
| Cash payments  for income taxes, net                                                                               |       | $                                                 | 397        |   | $ | 3 |   |
|                                                                                                               |       |                                              |       |   |   |
| **Non-cash  investing and financing activities**                                                                   |       |                                              |       |   |   |
| Equipment  acquired under capital lease                                                                            |       | $                                                 | 518        |   | $ | 525 |   |
| Equipment  acquired for long-term debt                                                                             |       | $                                                 | —     |   | $ | 118 |   |

 

See Notes toConsolidated Financial Statements.

 

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**APPLIANCERECYCLING CENTERS OF AMERICA, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

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

 

**1.****              Nature of Businessand Basis of Presentation**

 

*Nature ofbusiness:*** **Appliance Recycling Centers ofAmerica, Inc. and Subsidiaries (“we,” the “Company” or “ARCA”) are in thebusiness of selling new major household appliances through a chain ofCompany-owned factory outlet stores under the name ApplianceSmart®. We also provide turnkey appliance recycling services for electricutilities and other sponsors of energy efficiency programs.

 

*Principlesof consolidation:* The consolidated financial statements include the accounts of ApplianceRecycling Centers of America, Inc. and our subsidiaries.  All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

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.

 

During the fourthquarter of 2008, we planned and executed the shutdown of our NAACO and PDN businesses.  NAACO and PDN were not operating as plannedand were no longer economically viable. See Note 4 of “Notes to Consolidated Financial Statements” for moredetail.

 

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.

 

*Reclassifications:*  Certain prior year items have beenreclassified to conform to current year presentation.  We reclassified interest income from otherincome (expense) to offset interest expense in the consolidated statements ofoperations.  We reclassified the resultsof our discontinued operations below income from continuing operations in theconsolidated statements of operations. In Note 12 to “Notes to Consolidated Financial Statements,” wereclassified certain assets between our retail, recycling and unallocatedcorporate 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 amounts approximate fair value.

 

*Short-and long-term debt: *Thefair value of short- and long-term debt approximates carrying value and hasbeen estimated based on discounted cash flows using interest rates beingoffered for similar debt having the same or similar remaining maturities andcollateral 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.

 

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*Estimates:*  The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires our management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues 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 stock-based compensation. Actual results could differ from those estimates.

 

*Fiscalyear:*  We report ona 52- or 53-week fiscal year.  Our 2008fiscal year (“2008”) ended on January 3, 2009 and included 53 weeks.  Our 2007 fiscal year (“2007”) ended on December 29,2007 and included 52 weeks.

 

**2.****              RecentAccounting Pronouncements**

 

In May 2008, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 162, *TheHierarchy of Generally Accepted Accounting Principles*.  This standard is intended to improvefinancial reporting by identifying a consistent framework, or hierarchy, forselecting accounting principles to be used in preparing financial statementsthat are presented in conformity with generally accepted accounting principlesin the United States for non-governmental entities.  SFAS No. 162 is effective 60 daysfollowing approval by the SEC of the Public Company Accounting Oversight Board’samendments to AU Section 411, *TheMeaning of**Present Fairly inConformity with Generally Accepted Accounting Principles*.  We do not expect SFAS No. 162 to have amaterial impact on the preparation of our consolidated financial statements.

 

In March 2008, theFASB issued SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities*.  SFAS No. 161 is intended to improvefinancial reporting about derivative instruments and hedging activities byrequiring enhanced disclosures to enable investors to better understand theireffects on an entity’s financial position, financial performance and cashflows.  SFAS No. 161 also improves transparencyabout the location and amounts of derivative instruments in an entity’sfinancial statements; how derivative instruments and related hedged items areaccounted for under SFAS No. 133; and how derivative instruments andrelated hedged items affect its financial position, financial performance andcash flows.  SFAS No. 161 iseffective for financial statements issued for fiscal years and interim periodsbeginning after November 15, 2008, with early application encouraged.  We do not believe the adoption of SFAS No. 161will have a material effect on our results of operations or financial position.

 

In December 2007,the FASB issued SFAS No. 160, *Noncontrolling Interestsin Consolidated Financial Statements, an amendment of ARB No. 51*.  This statement establishes accounting andreporting standards for noncontrolling interests in subsidiaries and for thedeconsolidation of subsidiaries and clarifies that a noncontrolling interest ina subsidiary is an ownership interest in the consolidated entity that should bereported as equity in the consolidated financial statements.  This statement also requires expandeddisclosures that clearly identify and distinguish between the interests of theparent owners and the interests of the noncontrolling owners of a subsidiary.  SFAS No.160 is effective for fiscal yearsbeginning on or after December 15, 2008. We do not believe the adoption of SFAS No. 160 will have a materialeffect on our results of operations or financial position.

 

In December 2007,the FASB issued SFAS No. 141 (Revised 2007), *BusinessCombinations*.  While thisstatement retains the fundamental requirement of SFAS No. 141 that theacquisition method of accounting (which SFAS No. 141 called the purchasemethod) be used for all business combinations, SFAS No. 141 (Revised 2007)now establishes the principles and requirements for how an acquirer in abusiness combination: recognizes and measures in its financial statements, theidentifiable assets acquired, the liabilities assumed, and any noncontrollinginterests in the acquiree; recognizes and measures the goodwill acquired in thebusiness combination 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.  SFAS No. 141(Revised 2007) is effective for fiscal years beginning on or after December 15,2008.  We do not believe the adoption ofSFAS No. 141 will have a material effect on our results of operations orfinancial position.

 

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*.  This statement permits entities to choose tomeasure many financial instruments and certain other items at fair value.  

 

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SFAS No. 159 iseffective for fiscal years beginning after November 15, 2007.  The adoption of SFAS No. 159 on December 30,2007 had no impact on our consolidated financial statements.

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*.  This statement defines fair value,establishes a framework for measuring fair value under generally acceptedaccounting principles and expands disclosures about fair valuemeasurements.  SFAS No. 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007; however, during February 2008, the FASB issued FASB Staff Position (“FSP”)No. 157-2 which deferred the effective date of certain provisions of SFAS No. 157until fiscal years beginning after November 15, 2008.  We adopted the provisions of SFAS No. 157that were not deferred under FSP No. 157-2 effective December 30,2007.  The adoption had no impact on ourconsolidated financial statements.

 

**3.****              SignificantAccounting Policies**

 

*Cash and cash equivalents:*  We consider all highly liquid investmentspurchased with original maturity dates of three months or less to be cashequivalents.  We maintain our cash inbank deposit and money-market accounts which, at times, exceed federallyinsured limits.  We have not experiencedany losses in such accounts.

 

*Trade receivables:*** **We carry trade receivables at theoriginal invoice amount less an estimate made for doubtful accounts based on amonthly review of all outstanding amounts. Management determines the allowance for doubtful accounts by regularly evaluatingindividual customer receivables and considering a customer’s financialcondition, credit history and current economic conditions.  We write off trade receivables when we deemthem uncollectible.  We record recoveriesof trade receivables previously written off when we receive them.  We consider a trade receivable to be past dueif any portion of the receivable balance is outstanding for more than ninetydays.  We do not charge interest on pastdue receivables.  Our managementconsiders the allowance for doubtful accounts of $292 and $152 to be adequateto cover any exposure to loss as of January 3, 2009 and December 29,2007, respectively.

 

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

 
| ** **                                 | ** ** | **January 3,  2009** | ** ** | **December 29,  2007** | ** ** |
|--------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| Finished goods                             |       | $                         | 18,949     |                        | $          | 14,148 |   |
| Less provision  for inventory obsolescence |       | (115                      | )          | (84                         | )          |
|                                       |       | $                         | 18,834     |                        | $          | 14,064 |   |

 

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 and equipment are stated atcost.  We compute depreciation usingstraight-line and accelerated methods over the following estimated usefullives:

 
| ** **                               | ** ** | **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.

 

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Property and equipmentconsists of the following:

 
| ** **                               | ** ** | **January 3,  2009** | ** ** | **December 29,  2007** | ** ** |
|------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| Land                                     |       | $                         | 2,050      |                        | $          | 2,050 |   |
| Buildings and  improvements              |       | 5,249                     |       | 4,952                       |       |
| Equipment  (including computer software) |       | 9,161                     |       | 8,152                       |       |
|                                     |       | 16,460                    |       | 15,154                      |       |
| Less accumulated  depreciation           |       | (9,493                    | )          | (8,392                      | )          |
|                                     |       | $                         | 6,967      |                        | $          | 6,762 |   |

 

*Depreciationand amortization expense*: Depreciation and amortization expense related to buildings and equipmentfrom our recycling centers is presented in cost of revenues and depreciationand amortization expense related to buildings and equipment from ourApplianceSmart Factory Outlet stores and corporate assets, such as furnitureand computers, is presented in selling, general and administrative expenses inthe consolidated statements of operations. Depreciation and amortization expense was $1,123 and $873 for the fiscalyears ended January 3, 2009 and December 29, 2007, respectively.

 

*Software development costs:*  We capitalizesoftware developed for internal use in accordance with Statement of Position98-1, *Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use,* and are amortizing suchcosts over their estimated useful lives of three to five years.  Costs capitalized were $262 and $231 for theyears ended January 3, 2009 and December 29, 2007, respectively.  Amortization expense on software developmentcosts was $256 and $260 for the fiscal years 2008 and 2007, respectively.  Estimated amortization expenses are $263,$177, $71, $8, and $3 for the fiscal years 2009, 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 basedon the estimated future net undiscounted cash flows expected to result from theuse of the assets, including cash flows from disposition.  Should the sum of the expected future netcash flows be less than the carrying value, we recognize an impairment loss atthat time.  We measure an impairment lossby comparing the amount by which the carrying value exceeds the fair value(estimated discounted future cash flows or appraisal of assets) of thelong-lived assets.  We recognized noimpairment charges during the fiscal years ended January 3, 2009 and December 29,2007.

 

*Deferred financing fees:*  Deferred financing fees are presented in theconsolidated balance sheets as a component of other assets and are reported netof accumulated amortization.  We recordamortization expense on a straight-line basis over the term of the underlyingdebt.  Deferred financing fees, net ofaccumulated amortization, were $38 and $51 as of January 3, 2009 and December 29,2007, respectively.

 

*Accounting for leases*:  We conduct the majority of our retail andrecycling operations from leased facilities. The majority of our leases require payment of real estate taxes,insurance and common area maintenance in addition to rent.  The terms of our lease agreements typicallyrange from five to ten years.  Most ofthe leases contain renewal clauses and escalation clauses, and certain storeleases require contingent rents based on factors such as revenue.  For leases that contain predetermined fixedescalations of the minimum rent, we recognize the related rent expense on astraight-line basis from the date we take possession of the property to the endof the initial lease term.  We record anydifference between straight-line rent amounts and amounts payable under theleases as part of deferred rent in accrued expenses.  Cash or lease incentives (tenant allowances)received upon entering into certain store leases are recognized on astraight-line basis as a reduction to rent from the date we take possession ofthe property through the end of the initial lease term.

 

*Product warranty:*  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 productrevenue.  Factors that affect ourwarranty accrual for covered units include the number of units sold, historicaland anticipated rates of 

 

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warranty claims on theseunits, and the cost of such claims.  Weperiodically assess the adequacy of our recorded warranty accrual and adjustthe amounts as necessary.

 

Changes in our warrantyaccrual for the fiscal years ending January 3, 2009 and December 29,2007 are as follows:

 
| ** **                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Beginning  Balance                    |       | $        | 80         |     | $          | 28 |   |
| Standard accrual  based on units sold |       | 87       |       | 93       |       |
| Actual costs  incurred                |       | (4       | )          | (4       | )          |
| Periodic accrual  adjustments         |       | (72      | )          | (37      | )          |
| Ending Balance                        |       | $        | 91         |     | $          | 80 |   |

 

*Income taxes: *We account for income taxes under theliability method in accordance with SFAS No. 109, *Accountingfor Income Taxes*.  Deferredtax liabilities are recognized for temporary differences that will result intaxable 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 3, 2009.

 

*Share-basedcompensation:*  Weaccount for share-based compensation in accordance with SFAS No. 123(revised 2004), *Share Based Payment*, using themodified prospective method.  Under thismethod, we recognize compensation expense on a straight-line basis over thevesting period for all share-based awards granted.  We use the Black-Scholes option pricing modelto 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 $529 and $107 for the fiscalyears ending January 3, 2009 and December 29, 2007,respectively.  We estimate that theexpense for fiscal 2009 will be approximately $527, based on the value ofoptions outstanding as of January 3, 2009. This estimate does not include any expense for additional options thatmay be granted and vest during 2009.

 

*Comprehensiveincome:*  We reportcomprehensive income or loss in accordance with the provisions of SFAS No. 130,*Reporting Comprehensive Income*.  SFAS No. 130 establishes standardsfor the reporting and display of comprehensive income and its components.  Other comprehensive income refers torevenues, expenses, gains and losses that under generally accepted accounting principlesare included in comprehensive income but are excluded from net income as theseamounts are recorded directly as an adjustment to shareholders’ equity.  Our other comprehensive income is comprisedof foreign currency translation adjustments. The effect of the foreign currency translation adjustments, net of tax,was a loss of $452 for the fiscal year ending January 3, 2009 and incomeof $76 for the fiscal year ending December 29, 2007.

 

*Revenuerecognition:*  Werecognize revenue from appliance sales in the period the consumer purchases andpays for the appliance, net of an allowance for estimated returns.  We recognize revenue from appliance recyclingwhen we collect and process a unit.  Werecognize byproduct revenue upon shipment. We recognize revenue on extended warranties with retained serviceobligations on a straight-line basis over the period of the warranty inaccordance with FASB Technical Bulletin 90-1, *Accountingfor Separately Priced Extended Warranty and Product Maintenance Contracts*.  On extended warranty arrangements that wesell but others service for a fixed portion of the warranty sales price, werecognize revenue for the net amount retained at the time of sale of theextended warranty to the consumer.  Weinclude shipping and handling charges to 

 

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customers in revenue, which is recognized in the period the consumerpurchases and pays for the delivery. Shipping and handling costs that we incur are included in cost ofrevenues.

 

*Taxescollected from customers:*** **We account for taxes collectedfrom customers on a net basis in accordance with Emerging Issues Task ForceIssue No. 06-3, *How Taxes Collected fromCustomers and Remitted to Governmental Authorities Should Be Presented in theIncome Statement (That Is, Gross versus Net Presentation)*.

 

*Advertisingexpense:***** Our policy is to expense advertising costs asincurred.  Advertising expense was $4,258and $4,447 for the fiscal years ending January 3, 2009 and December 29,2007, respectively.

 

*Basic anddiluted net income (loss) per share:*  We calculate net income (loss) per share inaccordance with SFAS No. 128, *EarningsPer Share* (SFAS 128). Basic earnings per share is computed based on the weighted averagenumber of common shares outstanding. Diluted earnings per share is computed based on the weighted averagenumber of common shares outstanding adjusted by the number of additional sharesthat would have been outstanding had the potentially dilutive common sharesbeen issued.  Potentially dilutive sharesof Common Stock include unexercised stock options.  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 antidilutive, thereby reducingthe loss or increasing the income per common share.  In calculating diluted weighted averageshares and per share amounts, we included stock options (see Note 10) withexercise prices below average market prices, for the respective fiscal years inwhich they were dilutive, using the treasury stock method.  We calculated the number of additional sharesby assuming the outstanding stock options were exercised and that the proceedsfrom such exercises were used to acquire Common Stock at the average marketprice during the year.  As of January 3,2009, we excluded 303 options from the diluted weighted average shareoutstanding calculation as the effect of these options is anti-dilutive.  The effect of all options outstanding infiscal year 2007 was dilutive.

 

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

 
| ** **                                               | ** ** | **For the fiscal year ended** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                               | ** ** | **January 3,**                               | ** ** | **December 29,** | ** ** |
| ** **                                               | ** ** | **2009**                                          | ** ** | **2007** | ** ** |
| **Numerator:**                                           |       |                                              |       |   |   |
| Income from  continuing operations                       |       | $                                                 | 1,864      |   | $ | 2,476 |   |
| Income (loss)  from discontinued operations, net of tax  |       | (812                                              | )          | 63 |   |
| Loss on disposal  of discontinued operations, net of tax |       | (692                                              | )          | — |   |
| Net income                                               |       | $                                                 | 360        |   | $ | 2,539 |   |
|                                                     |       |                                              |       |   |   |
| **Denominator:**                                         |       |                                              |       |   |   |
| Weighted average  common shares outstanding - basic      |       | 4,571                                             |       | 4,400 |   |
| Stock options                                            |       | 41                                                |       | 75 |   |
| Weighted average  common shares outstanding - diluted    |       | 4,612                                             |       | 4,475 |   |
|                                                     |       |                                              |       |   |   |
| **Basic  income (loss) per share:**                      |       |                                              |       |   |   |
| Continuing  operations                                   |       | $                                                 | 0.41       |   | $ | 0.56 |   |
| Discontinued  operations                                 |       | (0.33                                             | )          | 0.02 |   |
| Net income                                               |       | $                                                 | 0.08       |   | $ | 0.58 |   |
|                                                     |       |                                              |       |   |   |
| **Diluted  income (loss) per share:**                    |       |                                              |       |   |   |
| Continuing  operations                                   |       | $                                                 | 0.41       |   | $ | 0.55 |   |
| Discontinued  operations                                 |       | (0.33                                             | )          | 0.02 |   |
| Net income                                               |       | $                                                 | 0.08       |   | $ | 0.57 |   |

 

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**4.****              DiscontinuedOperations**

 

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 willnot have 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 years ended January 3,2009 and December 29, 2007, NAACO and PDN had revenues of $792 and $1,011,respectively, and income (loss) before taxes of ($882) and $63,respectively.  All results of operationsfor periods presented prior to the abandonment date have been reclassified asdiscontinued operations.  We recorded aloss on the disposal 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.

 

**5.****              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 as of January 3,2009 was 6.25% (the greater of prime plus 1.50 percentage points or 6.25%)compared to 9.25% as of December 29, 2007. The weighted average interest rate for fiscal years 2008 and 2007 was6.83% and 10.58%, respectively.  Theamount of borrowings available under the line of credit is based on a formulausing receivables and inventories.  Ourunused borrowing capacity under this line was $384 as of January 3,2009.  We may not have access to the full$18.0 million line of credit due to the formula using our receivables andinventories.  The line of credit has astated maturity date of December 31, 2010, if not renewed, and providesthat the lender may demand payment in full of the entire outstanding balance ofthe loan at any time.  The line of creditis collateralized 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 3, 2009, we were not incompliance with certain financial covenants of the loan agreement and receiveda waiver from the lender.

 

**6.****              Long-Term DebtObligations**

 

Long-term debt andcapital lease obligations consisted of the following:

 
| ** **                                                                                                                                                                                                                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| 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      |     | $          | 2,902 |   |
|                                                                                                                                                                                                                                                |       |     |       |     |       |
| 6.85% mortgage,  due in monthly installments of $15, including interest, due January 2013,  collateralized by land and building                                                                                                                |       | 1,659    |       | 1,721    |       |
|                                                                                                                                                                                                                                                |       |     |       |     |       |
| Capital leases  and other financing obligations (see below)                                                                                                                                                                                         |       | 1,065    |       | 812      |       |
|                                                                                                                                                                                                                                                |       | 5,471    |       | 5,435    |       |
| Less current  maturities                                                                                                                                                                                                                            |       | 579      |       | 479      |       |
|                                                                                                                                                                                                                                                |       | $        | 4,892      |     | $          | 4,956 |   |

 

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

 
| 2009   |   | $     | 579    |   |
|--------|--------|-------|--------|--------|
| 2010   |   | 592   |   |
| 2011   |   | 478   |   |
| 2012   |   | 2,480 |   |
| 2013   |   | 1,342 |   |
|   |   | $     | 5,471  |   |

 

*Capital leases and other financing obligations**:*  We acquire certain equipment under capitalleases and other financing obligations. The cost of the equipment was approximately $1,396 and $966 at January 3,2009 and December 29, 2007, respectively. Accumulated amortization at January 3, 2009 and December 29,2007 was approximately $387 and $256, respectively.  Depreciation and amortization expense for2008 and 2007 is included in cost of revenue and selling, general andadministrative expenses.

 

InSeptember 2008, we entered into a master equipment lease with a lenderproviding up to $250 in available funds. As of January 3, 2009, we had utilized the entire lease line tofund equipment for the new retail outlets opened in December 2008 and January 2009.

 

The following is aschedule by fiscal year of the approximate remaining minimum payments requiredunder the leases and other financing obligations, together with the presentvalue at January 3, 2009:

** **
| 2009                                                                   |   | $     | 461    |   |
|------------------------------------------------------------------------|--------|-------|--------|--------|
| 2010                                                                   |   | 430   |   |
| 2011                                                                   |   | 264   |   |
| 2012                                                                   |   | 81    |   |
| 2013                                                                   |   | 9     |   |
| Total minimum  lease and other financing obligation payments           |   | 1,245 |   |
| Less amount  representing interest                                     |   | 180   |   |
| Present value of  minimum payments                                     |   | 1,065 |   |
| Less current  portion                                                  |   | 365   |   |
| Capital lease  and other financing obligations, net of current portion |   | $     | 700    |   |

 

**7.****              Accrued Expenses**

 

Accrued expenses were asfollows:

 
| ** **                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Compensation and  benefits          |       | $        | 1,565      |     | $          | 2,113 |   |
| Accrued  recycling incentive checks |       | 1,110    |       | 1,110    |       |
| Accrued rent                        |       | 461      |       | 433      |       |
| Warranty expense                    |       | 91       |       | 80       |       |
| Accrued payables                    |       | 509      |       | 190      |       |
| Other                               |       | 337      |       | 187      |       |
|                                |       | $        | 4,073      |     | $          | 4,113 |   |

 

**8.****              Commitments andContingencies**

 

*Operating leases:*** **We lease themajority of our retail stores and recycling centers under noncancelableoperating leases.  The leases typicallyrequire the payment of taxes, maintenance, utilities and insurance.

 

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Minimum future rentalcommitments under noncancelable operating leases as of January 3, 2009 areas follows:

 
| 2009                 |   | $     | 3,877  |   |
|----------------------|--------|-------|--------|--------|
| 2010                 |   | 3,605 |   |
| 2011                 |   | 3,420 |   |
| 2012                 |   | 3,246 |   |
| 2013                 |   | 2,840 |   |
| 2014 and  thereafter |   | 7,063 |   |
|                 |   | $     | 24,051 |   |

 

Rent expense for theyears ending January 3, 2009 and December 29, 2007 was $4,710 and$4,069, respectively.

 

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

 

*Litigation:*** **In December 2004, we filed suitin the 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 we expect that a decision on the appeal will behanded down late in 2009 or early in 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.

 

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**9.****              Income Taxes**

 

The provision for incometaxes consisted of the following:

 
| ** **                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
| Current tax  expense:       |       |     |       |     |       |
| Federal                     |       | $        | 128        |     | $          | 40 |   |
| State                       |       | 44       |       | 24       |       |
| Foreign                     |       | 495      |       | 99       |       |
| Current tax  expense        |       | $        | 667        |     | $          | 163 |   |
| Deferred tax  expense       |       | 72       |       | —   |       |
| Provision for  income taxes |       | $        | 739        |     | $          | 163 |   |
|                             |            |          |            |          |            |  |  |  |

 

A reconciliation of ourprovision for income taxes with the federal statutory tax rate is shown below:

 
| ** **                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Income tax  expense at statutory rate |       | $        | 885        |     | $          | 918 |   |
| State tax, net  of federal tax effect |       | 71       |       | 100      |       |
| Permanent  differences                |       | 275      |       | (121     | )          |
| Changes in  valuation allowance       |       | (657     | )          | (734     | )          |
| Foreign rate  differential            |       | 54       |       | —   |       |
| Other                                 |       | 111      |       | —   |       |
|                                  |       | $        | 739        |     | $          | 163 |   |

 

The components of netdeferred tax assets are as follows:

 
| ** **                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  assets:             |       |     |       |     |       |
| Net operating  loss carryforwards |       | $        | 1,734      |     | $          | 1,986 |   |
| Federal and  state tax credits    |       | 312      |       | 309      |       |
| Reserves                          |       | 322      |       | 205      |       |
| Accrued expenses                  |       | 278      |       | 168      |       |
| Share-based  compensation         |       | 82       |       | 80       |       |
| Foreign currency  translation     |       | 177      |       | —   |       |
| Other                             |       | —   |       | 26       |       |
|                              |       | 2,905    |       | 2,774    |       |
| Valuation  allowance              |       | (2,187   | )          | (2,324   | )          |
| Deferred tax  assets              |       | 718      |       | 450      |       |
|                              |       |     |       |     |       |
| Deferred tax  liabilities:        |       |     |       |     |       |
| Prepaid expenses                  |       | 152      |       | 140      |       |
| Property and  equipment           |       | 452      |       | 264      |       |
| Foreign currency  translation     |       | —   |       | 30       |       |
| Other                             |       | 9        |       | 16       |       |
| Deferred tax  liabilities         |       | 613      |       | 450      |       |
| Net deferred tax  assets          |       | $        | 105        |     | $          | — |   |

 

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The deferred tax amountsmentioned above have been classified in the accompanying balance sheet asfollows:

 
| ** **               | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Current assets           |       | $        | 448        |     | $          | 259 |   |
| Non-current assets       |       | 177      |       | —   |       |
| Non-current  liabilities |       | (520     | )          | (259     | )          |
|                     |       | $        | 105        |     | $          | — |   |

 

At January 3, 2009,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 whendeductible temporary differences and carryforwards are expected to be availableto reduce taxable income.  The valuation allowancedecreased in the current year primarily as a result of taxable income generatedduring the year from U.S. sources.  Inthe future, when we believe we can reasonably estimate future operating resultsand those estimated results reflect taxable income, the amount of deferred taxassets considered reasonable could be adjusted by a reduction of the valuationallowance.

 

We have not recognized adeferred tax liability relating to cumulative undistributed earnings ofcontrolled foreign subsidiaries that are essentially permanent in duration.  If some or all of the undistributed earningsof the controlled foreign subsidiaries are remitted to us in the future, incometaxes, if any, after the application of foreign tax credits will be provided atthat 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.

 

At January 3, 2009,we had federal NOL carryforwards of approximately $8,650 ($6,695 of which issubject 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 $299.  We also had stateNOL carryforwards of $20,025 ($3,241 of which is subject to IRC section 382limitations).  The NOL carryforwards areavailable to offset future taxable income or reduce taxes payable through2027.  These loss carryforwards willbegin expiring in 2016.  The generalbusiness credits will expire in 2013.  Wepreviously wrote off NOLs related to IRC section 382 limits against thevaluation allowance.

 

A portion of our netoperating loss carryforwards (approximately $930 of tax deductions) resultedfrom the exercise of stock options.  Whenthese loss carryforwards are realized, the corresponding change in valuationallowance will be recorded as additional paid-in capital.  We have adopted the “with and without”approach to determine tax benefits under FAS 123R.  Under this approach, windfall tax benefitsare used last to offset taxable income and a benefit is recorded in additionalpaid-in capital only if an incremental benefit is provided after consideringall other tax attributes (including NOLs) presently available to us.  This treatment results in are-characterization of the NOL carryforward and a difference in the NOL assetbetween the financial statements and tax returns.  The difference in the federal NOL deferredtax asset is $316.

 

At January 3, 2009,we had NOL carryforwards not subject to IRC section 382 limitations, expiringas follows:

 
| 2025 |   | $ | 66    |   |
|------|--------|---|-------|--------|
| 2026 |   | $ | 1,889 |   |

 

We account for uncertaintax positions in accordance with the provisions of FASB Interpretation 48 (“FIN48”), *Accounting for Uncertainty in Income Taxes*.  As required by FIN 48, which clarifies FASB No. 109,*Accounting for Income Taxes*, werecognize the financial statement benefit of a tax position only afterdetermining that the relevant tax authority would more likely than not sustainthe position.  For tax positions meetingthe more-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 3, 2009,we did not have any material uncertain tax positions.

 

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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 3, 2009, 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 before2005.  We are not currently underexamination by any taxing jurisdiction.

 

We had no significantunrecognized tax benefits as of January 3, 2009 that would reasonably beexpected to affect our effective tax rate during the next twelve months.

 

**10.****       Shareholders’ Equity**

 

*Stock options*:  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 3, 2009, 300options 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 3,2009, options to purchase an aggregate of 39 shares were outstanding under the1997 Plan.  Options granted to employeestypically vest over two years while grants to non-employee directors vest insix months.

 

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:

 
| ** **                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Expected  dividend yield          |       | —   |       | —   |       |
| Expected stock  price volatility  |       | 104.72   | %          | 100.98   | %          |
| Risk-free  interest rate          |       | 3.39     | %          | 4.91     | %          |
| Expected life of  options (years) |       | 6.88     |       | 6.05     |       |

 

Additional informationrelating to all outstanding options is as follows (in thousands, except pershare data):

 
| ** **                         | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|------------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                         | ** ** | ** **      | ** ** | **Average**  | ** ** |
| ** **                         | ** ** | **Options**     | ** ** | **Exercise** | ** ** |
| ** **                         | ** ** | **Outstanding** | ** ** | **Price**    | ** ** |
| Balance at  December 30, 2006 |       | 264             |       | $            | 2.72       |   |
| Granted                            |       | 48              |       | 3.06         |       |
| Exercised                          |       | (168            | )          | 2.37         |       |
| Balance at  December 29, 2007 |       | 144             |       | 3.26         |       |
| Granted                            |       | 282             |       | 5.02         |       |
| Exercised                          |       | (69             | )          | 3.21         |       |
| Cancelled/Expired                  |       | (18             | )          | 4.68         |       |
| Balance at  January 3, 2009   |       | 339             |       | $            | 4.65       |   |

 

The weighted average fairvalue per option of options granted during fiscal years 2008 and 2007 was $4.26and $2.45, respectively.

 

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The following tablesummarizes information about stock options outstanding as of January 3,2009 (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                              |       | 226             |       | 6.44                      |       | $                         | 5.47       |                     |       |   |
| $3.81 to $4.32                              |       | 35              |       | 4.79                      |       | $                         | 4.09       |                     |       |   |
| $2.38 to $2.80                              |       | 78              |       | 5.81                      |       | $                         | 2.50       |                     |       |   |
|                                        |       | 339             |       | 6.13                      |       | $                         | 4.65       |                     | $          | 45 |   |
|                                             |            |                 |            |                           |            |                           |            |                          |            |  |  |

 

The following tablesummarizes information about stock options exercisable as of January 3,2009 (in thousands, except per share data):

 
| ** **                                  | ** ** | **Options**     | ** ** | **Weighted Average** | ** ** | **Aggregate**            | ** ** |
|---------------------------------------------|------------|-----------------|------------|---------------------------|------------|--------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Exercisable** | ** ** | **Exercise Price**   | ** ** | **Intrinsic Value** | ** ** |
| $5.05 to $6.41                              |       | 26              |       | $                         | 5.84       |                     |       |   |
| $3.81 to $4.32                              |       | 35              |       | $                         | 4.09       |                     |       |   |
| $2.38 to $2.80                              |       | 23              |       | $                         | 2.60       |                     |       |   |
|                                        |       | 84              |       | $                         | 4.20       |                     | $          | 11 |   |
|                                             |            |                 |            |                           |            |                          |            |  |  |

 

The aggregate intrinsicvalue in the preceding tables represent the total pre-tax intrinsic value,based on our closing stock price of $3.07 on January 3, 2009, 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 3, 2009 was 23. The intrinsic value of stock options exercised during the fiscal yearsending January 3, 2009 and December 29, 2007 was $291 and $797,respectively.

 

*Preferred stock:*** **Our amended Articles of Incorporationauthorize two million shares of Preferred Stock that may be issued from time totime in one or more series having such rights, powers, preferences anddesignations as the Board of Directors may determine.  To date no such preferred shares have beenissued.

 

**11.****       Major Customers andSuppliers**

 

Forthe fiscal year ended January 3, 2009, one customer represented 10% of ourtotal revenues and had outstanding receivables of $2,121.  For the fiscal year ended December 29,2007, one customer represented 12% of our total revenues and had outstandingreceivables of $5,934.

 

During the two fiscalyears ended January 3, 2009, we purchased a vast majority of appliancesfor resale from three suppliers.  We haveand are continuing to secure other vendors from which to purchaseappliances.  However, the curtailment orloss of one of these suppliers or any appliance supplier could adversely affectour operations.

 

**12.****       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.  The recyclingoperation is comprised of all fees charged and costs incurred for collecting,recycling and installing appliances for utilities and other customers.  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. The accounting policies of thereportable segments are the same as those described in Note 3, “SignificantAccounting Policies.”  There are nointersegment sales or transfers.

 

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Thefollowing tables present our segment information for fiscal years 2008 and2007:

 
| ** **                                   | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Revenues:                                    |       |     |       |     |       |
| Retail                                       |       | $        | 76,179     |     | $          | 71,904 |   |
| Recycling                                    |       | 34,792   |       | 27,850   |       |
| Total revenues                               |       | $        | 110,971    |     | $          | 99,754 |   |
|                                         |       |     |       |     |       |
| Operating income  (loss):                    |       |     |       |     |       |
| Retail                                       |       | $        | 270        |     | $          | 2,256 |   |
| Recycling                                    |       | 6,033    |       | 2,317    |       |
| Unallocated  corporate costs                 |       | (2,268   | )          | (431     | )          |
| Total operating  income                      |       | $        | 4,035      |     | $          | 4,142 |   |
|                                         |       |     |       |     |       |
| Assets:                                      |       |     |       |     |       |
| Retail                                       |       | $        | 20,453     |     | $          | 15,750 |   |
| Recycling                                    |       | 9,213    |       | 12,903   |       |
| Corporate assets  not allocable              |       | 7,749    |       | 6,879    |       |
| Total assets                                 |       | $        | 37,415     |     | $          | 35,532 |   |
|                                         |       |     |       |     |       |
| Cash capital  expenditures:                  |       |     |       |     |       |
| Retail                                       |       | $        | 362        |     | $          | 378 |   |
| Recycling                                    |       | 135      |       | 323      |       |
| Corporate                                    |       | 315      |       | 231      |       |
| Total cash  capital expenditures             |       | $        | 812        |     | $          | 932 |   |
|                                         |       |     |       |     |       |
| Depreciation and  amortization expense:      |       |     |       |     |       |
| Retail                                       |       | $        | 290        |     | $          | 389 |   |
| Recycling                                    |       | 291      |       | 105      |       |
| Corporate                                    |       | 542      |       | 379      |       |
| Total  depreciation and amortization expense |       | $        | 1,123      |     | $          | 873 |   |
|                                         |       |     |       |     |       |
| Interest  expense:                           |       |     |       |     |       |
| Retail                                       |       | $        | 850        |     | $          | 944 |   |
| Recycling                                    |       | 275      |       | 241      |       |
| Corporate                                    |       | 260      |       | 286      |       |
| Total interest  expense                      |       | $        | 1,385      |     | $          | 1,471 |   |

 

**13.****       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 $30 and $26 for the fiscal years ending January 3, 2009 and December 29,2007, respectively.

 

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| **ITEM 9.** | **CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE** |
|-------------|-------------------------------------------------------------------------------------------|

 

None.

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

 

***Evaluation of Disclosure Controlsand Procedures***

 

Disclosure controls andprocedures and other procedures that are designed to ensure that informationrequired to be disclosed in our reports filed or submitted under the SecuritiesExchange Act of 1934 (the “Exchange Act”), as amended, is recorded,processed, summarized and reported within the time period specified in the SEC’srules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed in our reports filed under the Exchange Act is accumulatedand communicated to management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.  Our management, with the participation of our Chief ExecutiveOfficer and Chief Financial Officer, has evaluated the effectiveness of ourdisclosure controls and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act), as of the end of the period covered bythis report.  Based on such evaluation, our Chief Executive Officerand Chief Financial Officer have concluded that as of the end of such periodour disclosure 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 over financialreporting 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 3, 2009.

 

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 in Internal Control OverFinancial Reporting***

 

In its assessment ofinternal control over financial reporting as of December 29, 2007,management determined that our internal control was not effective due to thefollowing material weakness:

 

Controls surrounding theprocess of reconciling a specific receivable related to credits due frominventory vendors and intercompany accounts were found to be inadequate as of December 29,2007.  These deficiencies in the designand implementation of our internal control over financial reporting causedpost-closing adjustments to be recorded in the fourth quarter of 2007.  These adjustments were limited to 2007 andwere not material to previously reported interim periods or the fourth quarter,but could have grown to be material had they not been detected on audit.

 

The material weaknessrelated to controls surrounding the process of reconciling a specificreceivable related to credits due from inventory vendors and intercompanyaccounts have been remediated in 2008. The remediation consisted of account reconciliations and a change ofprocedures, including management’s review of key account reconciliations.  Management continues to implement, documentand test new controls and procedures related to internal control over financialreporting.

 

**ITEM 9B.****                                            OTHERINFORMATION**

 

None.

 

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**PART III**

 

**ITEM 10.****                                             DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE 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 2009 Annual Meeting ofShareholders to be held May 14, 2009 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 officers and employees in accordancewith applicable rules and regulations of the SEC and The NASDAQ StockMarket.  A copy of the code of ethics maybe obtained upon request, without charge, by addressing a request to InvestorRelations, 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.****                                             EXECUTIVECOMPENSATION**

 

Informationregarding executive compensation is set forth under the headings “CompensationCommittee Report” and “Executive Compensation” in our Proxy Statement for our2009 Annual Meeting of Shareholders to be held May 14, 2009 and isincorporated herein by reference.

 
| **ITEM 12.** | **SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS  AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS** |
|--------------|-----------------------------------------------------------------------------------------------------|

 

Informationregarding security ownership of certain beneficial owners and management is setforth under the heading “Common Stock Ownership” in our Proxy Statement for our2009 Annual Meeting of Shareholders to be held May 14, 2009 and isincorporated herein by reference.

 

The followingtable gives aggregate information under our equity compensation plans as of January 3,2009:

 
| ** **                                          | ** ** | **(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 |       | 338,500                            |       | $                                 | 4.65       |                                       | 285,000    |   |
|                                                     |            |                                    |            |                                   |            |                                            |            |  |

 

**ITEM 13.****                                             CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

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 2009 Annual Meeting of Shareholders to be held May 14,2009 and is incorporated herein by reference.

 

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**ITEM 14.****                                             PRINCIPALACCOUNTING FEES AND SERVICES**

 

Informationregarding principal accounting fees and services is set forth under the heading“Independent Registered Public Accounting Firm” in our Proxy Statement for our2009 Annual Meeting of Shareholders to be held May 14, 2009 and isincorporated herein by reference.

 

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**PART IV**

 

**ITEM 15.****                                             EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**

 

**(a)****                                  FinancialStatements, Financial Statement Schedules and Exhibits**

 

**1.****                                     FinancialStatements**

 

See Index toFinancial Statements under Item 8 of this report.

 

**2.****                                     FinancialStatement 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 were conductedin accordance with the standards of the Public Company Accounting OversightBoard (United States) and were made for the purpose of forming an opinion onthe basic consolidated financial statements of Appliance Recycling Centers ofAmerica, Inc. and Subsidiaries taken as a whole.  The supplemental Schedule II as of January 3,2009 and December 29, 2007 and for the fiscal years then ended ispresented for purposes of complying with the Securities and Exchange Commission’srules and is not a part of the basic consolidated financialstatements.  This schedule has been subjectedto the auditing procedures applied in our audits of the basic consolidatedfinancial statements and in our opinion, is fairly stated in all materialrespects in relation to the basic consolidated financial statements taken as awhole.

 

/s/ Virchow, Krause &Company, LLP

 

Minneapolis,Minnesota

March 19,2009

 

**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 30, 2006 |       | $                                                      | 152        |                                                       | $          | 207                                                                  |       | $ | 2,760 |   |
| Additional  allowance              |       | 3                                                      |       | 9                                                          |       | —                                                               |       |
| Write-offs and  adjustments        |       | (3                                                     | )          | (132                                                       | )          | (436                                                                 | )          |
| 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 |   |

 

----

(1)          The change in valuationallowance for deferred income tax assets related to continuing operations is$657 offset by $520 related to discontinued operations.

 

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**3.****                                     Exhibits**

 

See Index toExhibits on page 55 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 20,  2009 | 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 20,  2009 |
| Edward R. Cameron      |       | Chief Executive Officer                                   |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Peter P. Hausback  |       | Executive Vice  President,                                |       | March 20,  2009 |
| Peter P. Hausback      |       | Chief Financial Officer  and Principal Accounting Officer |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Duane S. Carlson   |       | Director                                                  |       | March 20,  2009 |
| Duane S. Carlson       |       |                                                      |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Thomas F. Hunt Jr. |       | Director                                                  |       | March 20,  2009 |
| Thomas F. Hunt Jr.     |       |                                                      |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Morgan J. Wolf     |       | Director                                                  |       | March 20,  2009 |
| Morgan J. Wolf         |       |                                                      |       |                 |
|                   |       |                                                      |       |                 |
| /s/ Glynnis A. Jones   |       | Director                                                  |       | March 20,  2009 |
| Glynnis A. Jones       |       |                                                      |       |                 |

 

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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 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       |       | 1997 Stock Option Plan  and Amendment [filed as Exhibits 28.1 and 28.2 to the Company’s Registration  Statement on Form S-8 (Registration No. 333-28571) 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 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 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 year ended  January 2, 1999 (File No. 0-19621) and incorporated herein by  reference].           |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                             |
| 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].        |

 

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| 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 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 dated December 23, 2004 of the Company 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 dated  September 10, 1998 of the Company 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].                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                           |
| 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].                                |

 

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| 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  dated September 19, 2002 of the Company 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  dated December 27, 2002 of the Company 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].                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                  |
| 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].                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                  |
| +23.1  |   | Consent of Virchow  Krause & Company, LLP, Independent Registered Public Accounting  Firm.                                                                                                                                                                                                                                                                                                   |

 

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| +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 aremanagement contracts or compensatory plans or arrangements required to be filedas an exhibit pursuant to Item 14(a)3 of this Form 10-K.

+                  Filed herewith.

 

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