ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion provides information which management believes is relevant to an assessment and understanding of the operations and financial condition of Avalon Holdings Corporation and its subsidiaries. As used in this report, the term “Avalon” means Avalon Holdings Corporation and its wholly owned subsidiaries, taken as a whole, unless the context indicates otherwise.
Statements included in Management’s Discussion and Analysis of Financial Condition and Results of Operations which are not historical in nature are intended to be, and are hereby identified as, “forward looking statements’. Avalon cautions readers that forward looking statements, including, without limitation, those relating to Avalon’s future business prospects, revenues, working capital, liquidity, capital needs, interest costs, and income, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward looking statements, due to risks and factors identified herein and from time to time in Avalon’s reports filed with the Securities and Exchange Commission.
Liquidity and Capital Resources
For the first six months of 2014, Avalon utilized existing cash, cash provided from operations and cash provided through a private placement offering related to the salt water injection wells to fund capital expenditures and meet operating needs. On July 22, 2014 Avalon increased its unsecured line of credit agreement with The Huntington National Bank from $1 million to $5 million. On August 1, 2014 Avalon borrowed $2.9 million under the line of credit. These monies were utilized to purchase The Magnuson Grand Hotel, formerly The Avalon Inn.
In October 2013, AWMS Holdings, LLC, which was formed to act as a holdings company and own a series of wholly owned subsidiaries that will own and operate salt water injection wells and facilities, began accepting subscriptions, through a private placement offering to accredited investors, for the purchase of membership units in AWMS Holdings, LLC. The private placement offering is expected to raise $3.5 million. At June 30, 2014, AWMS Holdings, LLC had received $3.45 million from the sale of membership units to accredited investors. Per the operating agreement, Avalon had committed to purchase any unsold membership units or loan money to AWMS Holdings, LLC to complete the construction. Avalon purchased the one remaining membership unit from the original offer. In June 2014, it was determined that an additional $.6 million were needed to complete the construction of the facilities. In order to maintain its percentage of ownership, Avalon purchased half of the units offered for $.3 million. In July 2014, AWMS Holdings, LLC offered additional membership units in order to raise the additional $.3 million for the construction costs. As of July 31, 2014, all of the additional units offered have been sold. The monies raised through the private placement offering plus cash contributed by Avalon were used to construct the facilities necessary for the operation of two salt water injection wells. As a result of the private placement offerings, Avalon may not be the majority owner of AWMS Holdings, LLC; however, due to the managerial control of Avalon, the financial statements of AWMS Holdings, LLC and subsidiaries will be included in the Avalon consolidated financial statements. At June 30, 2014, Avalon owned approximately 49% of AWMS Holdings, LLC. For the first six months of 2014, AWMS Holdings, LLC incurred $3.0 million in capital expenditures relating to the drilling and construction of the two salt water injection wells and related facilities. The wells began accepting a limited amount of brine water for disposal in April 2014, while the final construction of the related facilities was being completed.
For the first six months of 2014, Avalon incurred capital expenditures of $3.7 million and paid vendors $3.5 million for such expenditures. Such expenditures related principally to the drilling of two salt water injection wells and the construction of related facilities, building improvements and equipment for the golf and related operations segment. Avalon’s aggregate capital expenditures in 2014 are expected to be in the range of $4.0 million to $4.5 million, which will principally relate to completing the drilling and construction of the salt water injection wells and related facilities, building improvements and equipment purchases. On August 1, 2014, Avalon acquired
The Magnuson Grand Hotel, formerly The Avalon Inn, which is located adjacent to
Avalon’s corporate headquarters and its Avalon Lakes Golf Course. The amount of capital expenditures relating to the renovation of the hotel has not yet been determined.
Avalon entered into a long-term agreement with Squaw Creek Country Club to lease and operate its golf course and related facilities. The lease, which commenced November 1, 2003, has an initial term of ten (10) years with four (4) consecutive ten (10) year renewal term options unilaterally exercisable by Avalon. Under the lease, Avalon is obligated to pay $15,000 in annual rent and make leasehold improvements of $150,000 per year. Amounts expended by Avalon for leasehold improvements during a given year in excess of $150,000 will be carried forward and applied to future leasehold improvement obligations. Based upon the amount of leasehold improvements already made and leasehold improvements anticipated to be made in the future, Avalon expects to exercise all of its renewal options.
Working capital was $6.4 million at June 30, 2014 compared with $9.5 million at December 31, 2013.
The decline is primarily the result of monies expended for capital expenditures, a decrease in accounts receivable and an increase in deferred revenues, partially offset by decreased accounts payable.
The decrease in accounts receivable at June 30, 2014 compared with December 31, 2013 is primarily due to improved collections and lower net operating revenues of the waste management services segment in the second quarter of 2014 compared with the fourth quarter of 2013. Such decrease was partially offset by an increase in the accounts receivable of the golf and related operations segment as a result of higher revenues in the second quarter of 2014 compared with the fourth quarter of 2013.
The increase in other current assets at June 30, 2014 compared with December 31, 2013 is primarily due to higher food and beverage and merchandise inventories for the golf and related operations segment during the summer months.
The decrease in accounts payable at June 30, 2014 compared with December 31, 2013 is primarily due to a decrease in amounts due disposal facilities and transportation carriers of the waste brokerage and management services as a result of significantly lower net operating revenues of the waste brokerage and management services business in the second quarter of 2014 compared with the fourth quarter of 2013 and the timing of payments to vendors in the ordinary course of business.
The increase in accrued payroll and other compensation is primarily due to the amount of accrued bonuses and incentives at June 30, 2014 compared with those accrued at December 31, 2013. This increase is primarily due to the timing of such payments.
In addition, the accrued payroll for the golf and related operations at June 30, 2014 was higher compared with December 31, 2013 due to the increased seasonal employment during the golf season.
The increase in deferred revenues at June 30, 2014 compared with December 31, 2013 is a result of an increase in the number of members of the Avalon Golf and Country Club. Revenues related to membership dues are recognized proportionately over twelve months based upon the anniversary date of each membership. Such deferred revenues increased to $3.1 million at June 30, 2014 compared with $2.3 million at December 31, 2013.
Management believes that anticipated cash provided from future operations, existing working capital, as well as Avalon’s ability to incur indebtedness, will be, for the foreseeable future, sufficient to meet operating requirements and fund capital expenditure programs.
Growth Strategy:
Our growth strategy for the waste management services segment will focus on increasing revenue, gaining market share and enhancing shareholder value through internal growth. Although we are a waste management services company, we do not own any landfills or provide waste collection services. However, because of our many relationships with various disposal facilities and transporters, we are able to be more flexible and provide alternative solutions to a customer’s waste disposal or recycling needs. We intend to capitalize on our management and sales staff which has extensive experience in all aspects of the waste business. As such, we intend to manage our internal growth as follows:
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Sales and Marketing Activities
. We will focus on retaining existing customers and obtaining new business through our well-managed sales and marketing activities. We seek to manage our sales and marketing activities to enable us to capitalize on our position in many of the markets in which we operate. We provide a tailored program to all of our customers in response to their particular needs. We accomplish this by centralizing services to effectively manage their needs, such as minimizing their procurement costs.
We currently have a number of professional sales and marketing employees in the field who are compensated using a commission structure that is focused on generating high levels of quality revenue. For the most part, these employees directly solicit business from existing and prospective customers. We emphasize our rate and cost structures when we train new and existing sales personnel. We intend to hire additional qualified professional sales personnel to expand into different geographical areas.
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Pricing Activities
. We seek to secure price increases necessary to offset increased costs, and when possible, to increase prices to improve our operating margins.
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Development Activities
. We will seek to identify opportunities to further position us as an integrated service provider in markets where we provide services. In addition, we will continue to utilize the extensive experience of our management and sales staff to bid on significant one-time projects and those that require special expertise. Where appropriate, we may seek to obtain permits that would provide vertically integrated waste services or expand the service offerings or leverage our existing volumes with current vendors to provide for long term, cost competitive strategic positioning within our existing markets.
For the golf and related operations, several private country clubs in the northeast Ohio area are experiencing economic difficulties. Avalon believes some of these clubs may represent an attractive investment opportunity. While Avalon has not entered into any pending agreements for acquisitions, it may do so at any time and will continue to consider acquisitions that make economic sense. Such potential acquisitions could be financed by existing working capital, utilizing its line of credit, secured or unsecured debt, issuance of common stock, or issuance of a security with characteristics of both debt and equity, any of which could impact liquidity in the future.
Results of Operations
Overall performance
Net operating revenues in the second quarter of 2014 decreased to $13.0 million from $15.7 million in the prior year’s second quarter. The decrease is primarily the result of a decrease in the net operating revenues of the waste management services segment. Costs of operations decreased to $10.8 million in the second quarter of 2014 compared with $13.0 million in the prior year’s second quarter. Such decrease is primarily due to the lower net operating revenues of the waste management services segment, which resulted in less transportation and disposal costs, as these costs vary directly with the associated net operating revenues. Fixed costs relating to depreciation and amortization expense were $.6 million in the second quarter of 2014 compared to $.4 million in the second quarter of 2013. The increase is primarily the result of depreciation expense associated with the salt water injections wells which began accepting brine water in April 2014. Consolidated selling, general and administrative expenses were to $1.9 million in both the second quarter of 2014 and 2013. Avalon incurred a net loss of $.1 million in the second quarter of 2014 compared with net income of $.5 million in the second quarter of 2013.
For the first six months of 2014, net operating revenues decreased to $23.0 million from $30.4 million for the first six months of 2013. The decrease is primarily the result of a decrease in the net operating revenues of the waste management services segment. Costs of operations were $19.3 million for the first six months of 2014 compared with $25.6 million for the first six months of 2013. Such decrease is primarily due to the lower net operating revenues of the waste management services segment, which resulted in less transportation and disposal costs as these costs vary directly with the associated net operating revenues. Fixed costs relating to depreciation and amortization expense were $1.0 million for the first six months of 2014 compared with the $.8 million for the first six months of 2013. The increase is primarily the result of depreciation expense associated with the salt water injections wells which began accepting brine water in April 2014. Consolidated selling, general and administrative expenses decreased to $3.7 million for the first six months of 2014 compared with $3.8 million for the first six months of 2013. Avalon incurred a net loss of $.8 million for the first six months of 2014 compared with net income of $.3 million for the first six months of 2013.
Performance in the Second Quarter of 2014 compared with the Second Quarter of 2013
Segment performance
Segment performance should be read in conjunction with Note 8 to the Condensed Consolidated Financial Statements.
Net operating revenues of the waste management services segment decreased approximately 23% to $9.3 million in the second quarter of 2014 compared with $12.1 million in the second quarter of the prior year. For the second quarter of 2014, net operating revenues of the waste brokerage and management services business were $8.5 million compared with $11.5 million in the second quarter of 2013, while the net operating revenues of the captive landfill management operations were $.6 million in both the second quarter of 2014 and 2013. The net operating revenues of the salt water injection wells, which began operating in the second quarter of 2014, were $.2 million.
The decrease in net operating revenues of the waste brokerage and management operations was primarily due to a 40% decrease in net operating revenues associated with event work and a 58% decrease in the net operating revenues from managerial, consulting and clerical services that are provided for a single customer. Event work is defined as bid projects under contract that occurs on a one-time basis over a short period of time and can fluctuate significantly from quarter to quarter. The managerial, consulting and clerical services provided are entirely dependent upon such customer’s needs. The net operating revenues from managerial, consulting and clerical services that are provided for a single customer declined from $2.5 million in the second quarter of 2013 to $1.05 million in the second quarter of 2014. The gross margins associated with this type of work are much lower than our traditional waste management services’ margins. The overall average gross margins of the waste brokerage and management services business increased to 19.7% in the second quarter of 2014 compared with 16.4 % in the second quarter of the prior year. The improvement was primarily due to a lower percentage of the total net operating revenues being associated with the managerial, consulting and clerical services. The net operating revenues of the captive landfill are dependent upon the amount of waste generated by the owner of the landfill for whom Avalon manages and operates the facility. During the second quarter of 2014, the volume of waste disposed of at the landfill decreased, however, this decrease was offset by an increase in construction mat sales.
Income before taxes for the waste management services segment declined to $.7 million in the second quarter of 2014 compared with $1.0 million in the second quarter of the prior year. The decrease is primarily due to the decreased net operating revenues of the waste brokerage and management services business, partially offset by improved gross margins. Income before taxes of the waste brokerage and management services business decreased to $.7 million for the second quarter of 2014 compared with $.9 million for the second quarter of 2013 primarily due to the aforementioned items. Income before taxes of the captive landfill operations was $.1 million in both the second quarter of 2014 and in the prior year quarter. The salt water injection wells, which began operating in the second quarter, incurred a loss before taxes of $.1 million due to the limited amount water accepted for disposal during the second quarter. Depreciation expense for the salt water injection wells was $.1 million during the second quarter of 2014.
Avalon’s golf and related operations segment consists primarily of golf courses, clubhouses which provide dining and banquet facilities, and a travel agency. Although the golf courses will continue to be available for use by the general public, the primary source of revenues for golf will be generated by the members of the Avalon Golf and Country Club. The average number of members during the second quarter of 2014 increased to 3,770 compared with 3,653 in the prior year’s second quarter. Net operating revenues for the golf and related operations were $3.7 million in both in the second quarter of 2014 and 2013. Net operating revenues relating to membership dues and food and beverage sales increased, while the net operating revenues for greens fees, cart rentals and merchandise sales decreased. The golf and related operations segment incurred a loss before taxes of $.2 million in the second quarter of 2014 compared with income before taxes of $.2 million in the second quarter of 2013. The decrease was primarily due to higher employee costs and increased operating expenses, including operating supplies and utilities.
General corporate expenses
General corporate expenses were $.7 million in both the second quarter of 2014 and 2013.
Net income
Avalon incurred a net loss of $.1 million in the second quarter of 2014 compared with net income of $.5 million in the second quarter of 2013. Avalon recorded a state income tax provision in both the second quarter of 2014 and 2013, which was related entirely to the waste management and brokerage operations. Excluding the effect of this state tax provision, Avalon’s overall effective tax rate was 0% in the second quarter of 2014 and 2013. The income tax benefit recorded for the second quarter of 2014 and income tax provision for the second quarter of 2013 were offset by a change in the valuation allowance. The overall effective tax rate is different than statutory rates primarily due to a change in the valuation allowance. A valuation allowance is provided when it is more likely than not that deferred tax assets relating to certain federal and state loss carryforwards will not be realized. Avalon continues to maintain a valuation allowance against the majority of its deferred tax amounts until it is evident that the deferred tax asset will be utilized in the future.
Performance in the first six months of 2014 compared with the first six months of 2013
Segment performance
Segment performance should be read in conjunction with Note 8 to the Condensed Consolidated Financial Statements.
Net operating revenues of the waste management services segment decreased to $17.2 million in the first six months of 2014 compared with $24.7 million in the first six months of the prior year. For the first six months of 2014, net operating revenues of the waste brokerage and management services business were $15.8 million compared with $23.5 million for the first six months of 2013, while the net operating revenues of the captive landfill management operations were $1.2 million in both the first six months of 2014 and 2013. The net operating revenues of the salt water injection wells, which began operating in the second quarter of 2014, were $.2 million.
The decrease in net operating revenues of the waste brokerage and management operations was primarily due to a 46% decrease in net operating revenues associated with event work and a 60% decrease in the net operating revenues relating to managerial, consulting and clerical services that are provided for a single customer. The managerial, consulting and clerical services provided are entirely dependent upon such customer’s needs. The net operating revenues from managerial, consulting and clerical services that are provided for a single customer declined from $4.9 million for the first six months of 2013 to $2.0 million for the first six months of 2014. The gross margins associated with this type of work are much lower than our traditional waste management services’ margins. Event work is defined as bid projects under contract that occurs on a one-time basis over a short period of time and can fluctuate significantly from quarter to quarter and year to year. During the first six months of 2013, the waste management and brokerage business was able to secure a number of very large event work projects. The overall average gross margins of the waste brokerage and management services business increased to 18.9% for the first six months of 2014 compared with
15.6 % in for the first six months of the prior year. The improvement was primarily due to a lower percentage of the total net operating revenues being associated with the managerial, consulting and clerical services.
Income before taxes for the waste management services segment decreased to $1.2 million in the first six months of 2014 compared with $1.9 million in the first six months of the prior year. The decrease is primarily due to the decreased net operating revenues of the waste brokerage and management services business, partially offset by improved gross margins. Income before taxes of the waste brokerage and management services business decreased to $1.1 million for the first six months of 2014 compared with $1.6 million for the first six months of 2013 primarily as a result of the aforementioned items. Income before taxes of the captive landfill operations was $.2 million in the first six months of 2014 compared with $.3 million in the first six months of 2013. The decrease was primarily due an increase in employee costs. The salt water injection wells, which began operating in the second quarter, incurred a loss before taxes of $.1 million due to the limited amount water accepted for disposal during the second quarter. Depreciation expense for the salt water injection wells was $.1 million for the first six months of 2014.
Net operating revenues of the golf and related operations segment were $5.9 million in the first six months of 2014 compared with $5.8 million in the first six months of 2013. Due to adverse weather conditions, net operating revenues relating to the golf courses, which are located in northeast Ohio and western Pennsylvania, were minimal during the first three months of 2014 and 2013. The higher net operating revenues were primarily attributed to an increase in the net operating revenues from membership dues and food and beverage sales, partially offset by a decrease in the net operating revenues from greens fees, cart rentals and merchandise sales. The average number of members during the first six months of 2014 was 3,729 compared with 3,550 in the prior year’s first six months. The golf and related operations segment incurred a loss before taxes of $.7 million for the six months ended June 30, 2014 compared with a loss before taxes of $.2 million for the six months ended June 30, 2013. The increased loss was primarily due to significantly higher employee costs, substantially higher utility costs as a result of the inclement weather and higher costs for operating supplies.
General corporate expenses
General corporate expenses were $1.4 million in both the first six months of 2014 and 2013.
Net income
Avalon incurred a net loss of $.8 million in the first six months of 2014 compared with net income of $.3 million in the first six months of the prior year. Avalon recorded a state income tax provision in the first six months of 2014 and 2013, which was related entirely to the waste management and brokerage operations. Excluding the effect of this state tax provision, Avalon’s overall effective tax rate was 0% in both the first six months of 2014 and 2013. The income tax benefit for the first six months of 2014 and the income tax provision for the first six months of 2013 were offset by a change in the valuation allowance. A valuation allowance is provided when it is more likely than not that deferred tax assets relating to certain federal and state loss carryforwards will not be realized. The overall effective tax rate differs from statutory rates primarily due to the change in the valuation allowance.
T
rends and Uncertainties
In the ordinary course of conducting its business, Avalon becomes involved in lawsuits, administrative proceedings and governmental investigations, including those relating to environmental matters. Some of these proceedings may result in fines, penalties or judgments being assessed against Avalon which, from time to time, may have an impact on its business and financial condition. Although the outcome of such lawsuits or other proceedings cannot be predicted with certainty, management assesses the probability of loss and accrues a liability as appropriate. Avalon does not believe that any uninsured ultimate liabilities, fines or penalties resulting from such pending proceedings, individually or in the aggregate, will have a material adverse effect on its liquidity, financial position or results of operations.
The federal government and numerous state and local governmental bodies are continuing to consider legislation or regulations to either restrict or impede the disposal and/or transportation of waste. A portion of Avalon’s waste brokerage and management services revenues is derived from the disposal and/or transportation of out-of-state waste. Any law or regulation restricting or impeding the transportation of waste or the acceptance of out-of-state waste for disposal could have a negative effect on Avalon.
Avalon’s waste brokerage and management services business obtains and retains customers by providing services and identifying cost-efficient disposal options unique to a customer’s needs. Consolidation within the solid waste industry has resulted in reducing the number of disposal options available to waste generators and may cause disposal pricing to increase. Avalon’s waste brokerage and management services business may not be able to pass these price increases onto some of its customers, which, in turn, may adversely impact Avalon’s future financial performance.
A significant portion of Avalon’s business is generated from waste brokerage and management services provided to customers and is not subject to long-term contracts. In light of current economic, regulatory and competitive conditions, there can be no assurance that Avalon’s current customers will continue to transact business with Avalon at historical levels. Failure by Avalon to retain its current customers or to replace lost business could adversely impact the future financial performance of Avalon.
Avalon’s captive landfill management business is dependent upon a single customer as its sole source of revenue. If the captive landfill management business is unable to retain this customer, Avalon’s future financial performance could be adversely impacted.
Economic challenges throughout the industries served by Avalon have resulted in payment defaults by customers. While Avalon continuously endeavors to limit customer credit risks, customer-specific financial downturns are not controllable by management. Significant customer payment defaults would have a material adverse impact upon Avalon’s future financial performance.
The Avalon Golf and Country Club has golf courses and clubhouses at each of its three facilities. The Squaw Creek and Sharon facilities each have a swimming pool, a fitness center and dining and banquet facilities. The Squaw Creek facility also has tennis courts. The Avalon Golf and Country Club competes with many public courses and country clubs in the area. Although the golf courses continue to be available for use by the general public, the primary source of revenues will be generated by the members of the Avalon Golf and Country Club. Avalon believes that the combination of these three facilities will result in additional memberships in the Avalon Golf and Country Club. Due to the state of the economy, the ability to retain current members and attract new members has been difficult. Although Avalon has been able to retain and increase the number of members of the Avalon Golf and Country Club, as of June 30, 2014, Avalon has not attained its membership goals. There can be no assurance as to when such goals will be attained and when the golf and related operations will ultimately become profitable. Avalon is continually using different marketing strategies to attract new members, such as local television advertising and various membership promotions. A significant decline in members could adversely affect the future financial performance of Avalon.
All three of Avalon’s golf course operations currently hold liquor licenses for their respective facilities. If, for some reason, any one of these facilities were to lose its liquor license, the financial performance of the golf and related operations would be adversely affected.
Avalon’s operations are somewhat seasonal in nature since a significant portion of those operations are primarily conducted in selected northeastern and midwestern states. Additionally, Avalon’s golf courses are located in northeast Ohio and western Pennsylvania and are significantly dependent upon weather conditions during the golf season. As a result, Avalon’s financial performance is adversely affected by adverse weather conditions.