<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) Quarterly Report Pursuant To Section 13 Or 15(d)
Of The Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 1996
Commission File Number 1-10367
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
DELAWARE 71-0675758
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
206 1/2 East Emma Avenue
P.O. Box 1237
Springdale, Arkansas 72765
(Address of Principal Executive Office) (Zip Code)
Registrant's telephone number, including area code: (501)750-1299
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
YES: X NO:
As of November 11, 1996, the number of shares outstanding of the Registrant's
Class A Common Stock, which is the class registered under the Securities
Exchange Act of 1934, was 18,198,383 and the number of shares outstanding of the
Registrant's Class B Common Stock was 1,465,530.
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
FORM 10-Q INDEX
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
ITEM 1 Financial Statements
Balance Sheets, September 30, 1996 and December 31, 1995 1-2
Statements of Operations,
Three months and nine months ended September 30, 1996 and 1995 3
Statements of Cash Flows,
Nine months ended September 30, 1996 and 1995 4
Notes to Financial Statements 5-17
Review Report of Arthur Andersen LLP,
Independent Public Accountants 18
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 19-24
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 24-25
Signatures 26
</TABLE>
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
------
September 30, 1996 December 31,
(Unaudited) 1995
----------- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 16,234 $ 15,350
Receivables 481,434 48,463
Inventories 462,505 648,211
Prepaid expenses and other 126,098 108,528
---------- ----------
Total current assets 1,086,271 820,552
---------- ----------
Buildings and equipment,
at cost, including construction
in progress of $794,296 at 9-30-96, and
$22,946 at 12-31-95:
Buildings 687,508 675,420
Machinery and equipment 8,637,867 7,985,870
Transportation equipment 133,527 112,411
Office equipment 172,598 170,659
Leasehold improvements 315,331 315,331
---------- ----------
9,946,831 9,259,691
Less accumulated depreciation
and amortization 3,916,432 3,050,979
---------- ----------
Net buildings and equipment 6,030,399 6,208,712
---------- ----------
Other assets, at cost less accumulated
amortization of $101,606 at 9-30-96, and
$83,058 at 12-31-95 327,500 328,478
---------- ----------
$7,444,170 $7,357,742
========== ==========
</TABLE>
The accompanying notes to the financial statements are an integral part of these
financial statements.
1
<PAGE>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
<CAPTION>
September 30, 1996 December 31,
(Unaudited) 1995
----------- ----
<S> <C> <C>
Current liabilities:
Current maturities of long-term debt $ 663,200 $ 755,576
Accounts payable - trade 1,110,976 1,078,243
Payables to related parties 126,634 362,155
Accrued liabilities 329,399 166,779
Notes payable 95,530 14,604
------------ ------------
Total current liabilities 2,325,739 2,377,357
------------ ------------
Long-term debt, less current maturities -
Related parties 902,257 1,102,554
Other 105,657 164,088
------------ ------------
Total long-term debt 1,007,914 1,266,642
------------ ------------
Stockholders' equity
Preferred stock, $1 par value; 5,000,000
shares authorized, none issued - -
Class A common stock, $.01 par value;
50,000,000 shares authorized, 18,198,383 (1996)
and 15,692,866 (1995) shares issued and outstanding 181,984 156,929
Class B convertible common stock, $.01 par
value; 7,500,000 shares authorized, 1,465,530
shares issued and outstanding 1996 and 1995 14,655 14,655
Common Stock Subscribed 507,920 -
Additional paid in capital 20,850,557 19,282,865
Deficit accumulated (17,444,599) (15,740,706)
------------ ------------
Total stockholders' equity 4,110,517 3,713,743
------------ ------------
$ 7,444,170 $ 7,357,742
============ ============
</TABLE>
The accompanying notes to the financial statements are an integral part of these
financial statements.
2
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Sales $1,901,319 $1,693,444 $5,561,072 $4,260,418
Cost of Goods Sold 2,185,426 1,786,749 5,867,368 4,700,344
---------- ---------- ---------- ----------
Gross Margin (284,107) (93,305) (306,296) (439,926)
Selling and Administrative Costs 533,159 327,869 1,324,596 1,000,438
---------- ---------- ---------- ----------
Operating Loss (817,266) (421,174) (1,630,892) (1,440,364)
Other Income (Expense)
Other Income 0 8 20,399 792
Interest Expense (43,063) (74,070) (160,500) (207,604)
---------- ---------- ---------- ----------
Loss Before Extraordinary Gain (860,329) (495,236) (1,770,993) (1,647,176)
---------- ---------- ---------- ----------
Extraordinary Gain, Net of 0 Income
Tax Effect 67,100 0 67,100 0
---------- ---------- ---------- ----------
Net Loss $ (793,229) $ (495,236) $(1,703,893) $(1,647,176)
============ ============ ============ ============
Net loss per share of common stock
($.04) ($.03) ($.09) ($.11)
=========== =========== =========== ===========
Weighted average number of
common shares outstanding 19,663,913 15,511,477 18,708,340 15,506,233
=========== =========== =========== ===========
</TABLE>
The accompanying notes to the financial statements are an integral part of these
financial statements.
3
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
September 30, September 30,
1996 1995
-------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (1,703,893) $(1,647,176)
Adjustments to reconcile net loss to net
cash used in operating activities:
Extraordinary Gain (67,100)
Depreciation 909,726 771,181
Amortization of other assets 18,548 17,281
Gain on disposition of assets - (734)
Increase in other assets (17,510) (36,151)
Changes in current assets & current liabilities (223,617) 341,671
----------- -----------
Net cash used in operating activities (1,083,906) 553,928)
Cash flows from investing activities:
Additions to buildings and equipment (870,301) (45,598)
Proceeds of insurance reimbursement 124,602 5,000
----------- -----------
Net cash used in investing activities (745,699) (40,598)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of notes 269,155 1,035,696
Payments on notes (539,333) (446,447)
Proceeds from issuance of common stock, net 2,100,669 -
------------- -----------
Net cash provided by financing activities 1,830,491 618,204
------------- -----------
Increase (Decrease) in cash & cash equivalents 886 23,678
Cash and cash equivalents:
Beginning of period 15,350 5,977
----------- -----------
End of period $ 16,236 $ 29,655
=========== ===========
</TABLE>
The accompanying notes to the financial statements are an integral part of these
financial statements.
4
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
Note 1: Unaudited Information
- ------------------------------
The financial statements included herein have been prepared by Advanced
Environmental Recycling Technologies, Inc. (the Company or AERT), without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission
(SEC). However, all adjustments have been made to the accompanying financial
statements which are, in the opinion of the Company's management, necessary for
a fair presentation of the Company's operating results. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to make the information presented herein not
misleading. It is recommended that these financial statements be read in
conjunction with the financial statements and the notes thereto included in the
Company's latest annual report on Form 10-K.
Note 2: Organization and Description of the Company
- ----------------------------------------------------
Advanced Environmental Recycling Technologies, Inc. has developed and commenced
the manufacture of a composite building material from waste plastic and wood
fiber waste for certain specialized applications in the construction industry.
The Company has initially marketed this material as a substitute for wood and
plastic filler materials for standard door frames, window sills, and decking.
The Company is comprised of two separate, yet interrelated manufacturing
facilities located in Junction, Texas and Rogers, Arkansas. The Company's
customers primarily consist of a number of regional and national door and window
manufacturers and Weyerhaeuser, the Company's primary decking customer.
The Company was initially capitalized on December 2, 1988, with a contribution
of machinery and equipment, plant facilities and technology, most of which were
used by certain members of management in an unsuccessful prior business. The
prior business was organized in June 1985 to manufacture artificial firelogs
using certain technology somewhat similar to that used in the Company's
manufacturing process. By 1986, the prior business had incurred substantial
losses from operations, had no further working capital resources and
discontinued its business. The initial contribution consisted of approximately
$3,000,000 in buildings, machinery and equipment, supplies and other tangible
assets, as well as technological rights and expertise. In connection with such
initial organization, the Company assumed $795,000 in bank indebtedness secured
by certain of the contributed assets. All amounts are reflected in the
accompanying financial statements at the contributor's book value.
Prior to March 31, 1995, the Company was a development stage enterprise whose
operations consisted primarily of design development and improvement of the
equipment and production process and initial marketing and determination of
product markets. Accordingly, the Company has reclassified certain prior period
amounts to conform to the current period presentation.
5
<PAGE>
Note 3: Future operations
- --------------------------
The financial statements of the Company have been prepared on the basis of
accounting principles applicable to a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. At September 30, 1996, the Company had a working capital deficit
of $1,239,468 and had incurred net losses of $1,703,893 for the nine months
ended September 30, 1996. The Company, since inception, has not achieved a
successful level of operations nor is there any assurance that the Company will
be able to achieve future revenue levels sufficient to support existing
operations, generate positive cash flow from operations or recover its
investment in its property, plant and equipment. Management believes that the
Company's currently available borrowing capacity under its line of credit with a
major shareholder is adequate to support its operations until successful
production and sales levels are attained, but that it is likely the Company will
need additional financing to fund payment of the Company's current maturities of
long-term debt due in 1996. The Company has recently restructured its business
in order to reduce its plastics division losses and is continuing in its efforts
to increase composite sales to a level sufficient to obtain positive cash-flows
and overall profitability. However, there can be no assurance that such
production and sales levels will actually be reached. The Company is currently
negotiating financing to allow for additional composite expansion and working
capital which would be in addition to existing support from its major
shareholders. The Company has limited additional financial resources available
to support its operations and in the past few years has, in large part, been
supported by certain major shareholders. There is no commitment for such
shareholders to continue such support beyond the current line of credit. The
Company also has claims in litigation outstanding against it as described in
Note 13, the outcome of which is uncertain. There can be no assurance that the
Company's financial resources (which at present are limited to a $433,097 line
of credit as described in Note 6) will be adequate to support existing
operations until such time, if ever, sales levels are sufficient to generate
positive cash flow from operations. Further, if the litigated claims discussed
in Note 13 were to be assessed against the Company, the Company would likely be
unable to pay such claims. These factors, among others, raise substantial doubt
concerning the ability of the Company to continue as a going concern. The
ability of the Company to continue as a going concern is dependent upon the
ongoing support of its stockholders, investors, customers and creditors and its
ability to successfully mass produce and market its product at economically
feasible levels.
Effective October 1, 1995, the Company adopted Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, (SFAS 121). SFAS 121 requires an
assessment of the recoverability of the Company's investment in long-lived
assets to be held and used in operations whenever events or circumstances
indicate that their carrying amounts may not be recoverable. Such assessment
requires that the future cash-flows associated with the long-lived assets be
estimated over their remaining useful lives and an impairment loss recognized
when the future cash-flows are less than the carrying value of such assets.
The Company has assessed the recoverability of its investment in long-lived
assets to be held and used in operations under the guidelines set forth in SFAS
121 and determined that no impairment loss was required as of September 30,
1996. Such assessment required the Company to make certain estimates of future
production volumes and costs and future sales volumes and prices which are
expected to occur over the remaining useful lives of its long-lived assets.
(Such long-lived assets primarily consist of the Company's Rogers and Junction
manufacturing facilities.) The Company's estimates of these factors are based
upon
6
<PAGE>
management's belief that future production volumes will significantly increase
over previous historical production levels achieved by the Company's
manufacturing facilities and that future production costs per unit will also
significantly decrease below previous historical cost levels. The Company has
restructured its Rogers plastics reclamation facility and believes that no
significant production problems will recur at its Junction composite
manufacturing facility. As such, management of the Company believes a
reasonable basis exists for the use of such future estimates which are
significantly better than past historical performance.
Although the Company believes it has a reasonable basis for its estimates of
future production volumes and costs and future sales volumes and prices, it is
reasonably possible that the Company's actual performance could materially
differ from such estimates. Management expects that the Company's performance
during the last three months of 1996 will provide additional evidence to confirm
or disprove such future estimates. Management also believes that if such
estimates are not confirmed, revisions to such estimates could result in a
material impairment loss on its long-lived assets constituting all or a material
portion of the carrying value of the Company's Rogers and Junction manufacturing
facilities which was $5,954,602 at September 30, 1996.
Note 4: Significant Accounting Policies
- ----------------------------------------
Statements of Cash Flows
------------------------
In order to determine net cash used in operating activities, loss from
continuing operations has been adjusted by, among other things, changes in
current assets and current liabilities, excluding changes in cash and cash
equivalents, current maturities of long-term debt and advances from affiliates
included in notes payable - related parties. Those changes, shown as an
(increase) decrease in current assets and an increase (decrease) in current
liabilities, are as follows:
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
September 30, 1996 September 30, 1995
(unaudited) (unaudited)
----------- -----------
<S> <C> <C>
Receivables $(294,083) $ 15,987
Inventories 128,204 183,037
Prepaid expenses and other (17,570) (60,080)
Accounts payable -
trade & related parties (202,788) 196,339
Accrued liabilities 162,620 6,388
--------- --------
$(223,617) $341,671
========= ========
</TABLE>
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
In connection with the Rogers facility fire insurance proceeds the Company
experienced an extraordinary gain of $67,100 and established a receivable from
the insurance company of $138,888 (See note 14 to Financial Statements.)
7
<PAGE>
Buildings and Equipment
-----------------------
Buildings and equipment contributed to the Company in exchange for Class B
Common Stock are carried at the contributor's historical book value. Property
additions and betterments include capitalized interest, and acquisition,
construction and administrative costs allocable to construction projects and
property purchases. Gains or losses on sales or other disposition of property
are credited or charged to income.
Provision for depreciation and amortization of buildings and equipment is
provided on a straight-line basis for buildings and leasehold improvements,
transportation equipment and office equipment over the estimated useful lives of
these facilities. Machinery and equipment is depreciated on a straight line
basis over the estimated useful life of the related equipment or on a units of
production basis over the estimated useful production lives of the related
assets. Estimated useful lives are; buildings and leasehold improvements 6 to
20 years, transportation equipment - 3 to 5 years, office equipment - 5 years
and machinery and equipment - 7 to 12 years or 120 million units (pounds).
Inventories
-----------
Inventories are stated at the lower of cost (first-in, first-out method) or
market. Inventories consisted of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
(Unaudited) ------------
--------------
<S> <C> <C>
Raw materials $137,200 $ 54,279
Finished goods 325,305 593,932
-------- --------
$462,505 $648,211
======== ========
</TABLE>
Other Assets
------------
Other assets consist primarily of the costs for the preparation of patent
applications ($424,017 and $406,447 at September 30, 1996 and December 31, 1995,
respectively) which are amortized using the straight-line method over 17 years.
Also included in Other Assets are deposits of $5,089.
Use of estimates
----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
8
<PAGE>
Recently Issued Accounting Standards
- ------------------------------------
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation." This statement encourages entities to adopt the fair value
method of accounting for employee stock compensation plans for fiscal years
beginning after December 15, 1995, but allows an entity to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." The Company intends to continue to
measure compensation cost for its employee stock compensation plans in
accordance with APB Opinion No. 25.
Note 5: Receivables
- --------------------
In April 1993, the Company entered into an agreement with an affiliate whereby
the Company agreed to sell certain of its trade receivables which the affiliate
deems acceptable. Upon the acceptance of a sale of a receivable, the affiliate
will remit to the Company 100% of the receivable, as defined in the agreement,
and the Company shall remit to the affiliate .88% as a factoring charge. The
Company will indemnify the affiliate for any loss arising out of rejections or
returns of any merchandise, or any claims asserted by the Company's customers.
During the nine months ended September 30, 1996, the Company sold an aggregate
of approximately $6,031,298 in receivables under this agreement. Costs of
approximately $53,455 associated with the factoring agreement are included in
selling and administrative costs for the nine month period.
Note 6: Notes payable - related parties
- ----------------------------------------
In July 1994, the Company obtained a $1,000,000 line of credit financing
agreement with Jim G. and Marjorie S. Brooks. The credit line is secured by
substantially all of the assets of the Company and accrues interest at a rate of
8.5% per annum. Proceeds from the line of credit were used to redeem notes
payable to related parties and provide working capital for Company operations.
At December 31, 1994, the outstanding balance on the line of credit was
$1,411,903. In February 1995, the line of credit was increased to $2,000,000 of
which approximately $1,566,903 was converted to a term note to be amortized at 9
3/4% over five years beginning April 1, 1995. The balance of $433,097 is a
revolving credit line to be available as needed by the Company and as of
September 30, 1996, the entire amount was available to the Company.
9
<PAGE>
Note 7: Long-term debt
- -----------------------
Long-term debt as of September 30, 1996 and December 31, 1995, consisted of the
following:
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
---- ----
<S> <C> <C>
Note payable, due in monthly installments
of $10,156 plus interest at prime plus two
percent (10.25% at September 30, 1996) through
August 1, 1996 and beginning September 1, 1996,
monthly installments of $15,354 including interest
at 10.75%; secured by certain manufacturing equipment,
inventories and receivables. $ 240,824 $ 324,970
Note payable, due in monthly installments of accrued
interest from January 1, 1995 through April 1, 1995,
and monthly installments of principal and interest
beginning May 1, 1995 with the remaining balance
due March 1, 1997, interest at eight percent, secured
by unescrowed shares of Class B Common Stock
owned by certain officers of the Company and certain
manufacturing equipment. 151,971 213,769
Note payable, to a related party, due in 60-monthly
installments of principal and interest, beginning
April 1, 1995, interest at 9.75%. 1,220,185 1,399,245
Other 58,134 84,234
---------- ----------
Total 1,671,114 2,022,218
Less current maturities 663,200 755,576
---------- ----------
Long-term debt, net of
current maturities $1,007,914 $1,266,642
========== ==========
</TABLE>
The fair value of the Company's outstanding debt is approximately equal to its
carrying value at September 30, 1996.
10
<PAGE>
The aggregate maturities of long-term debt as of September 30, 1996 are as
follows:
<TABLE>
<S> <C>
1997 $ 663,200
1998 421,804
1999 363,363
2000 222,747
2001 0
----------
$1,671,114
==========
</TABLE>
Note 8: Interest
- -----------------
Interest incurred, capitalized, expensed and cash payments for interest are
summarized as follows:
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
September September
30, 1996 30, 1995
(unaudited) (unaudited)
------------ ------------
<S> <C> <C>
Interest incurred $160,500 $207,604
Interest capitalized as
part of the cost of machinery
and equipment - -
-------- --------
Interest expensed $160,500 $207,604
======== ========
Cash payments for interest $131,862 $163,983
======== ========
</TABLE>
Note 9: Stockholders' equity
- -----------------------------
The Class A Common Stock and the Class B Common Stock are substantially similar
in all respects except that the Class B Common Stock has five votes per share
while the Class A Common Stock has one vote per share. Each share of Class B
Common Stock is convertible at any time at the holder's option to one share of
Class A Common Stock and, except in certain instances, is automatically
converted into one share of Class A Common Stock upon any sale or transfer.
On November 9, 1989, the Company completed a public offering of 1,250,000 units,
at a price to the public of $4.00 per unit. In December 1989, the Company sold
an additional 100,000 units to the underwriter at the same price. Each unit
consists of three shares of Class A Common Stock and three redeemable Class A
Warrants, which are separable and transferable immediately upon issuance. Each
Class A Warrant entitles the holder to purchase a unit consisting of one share
of Class A Common Stock and one Class B Warrant at an exercise price of $2.00.
Each Class B Warrant entitles the holder to purchase one share of Class A Common
Stock at an exercise price of $3.00. The Class A and Class B Warrants are
redeemable at $.05 per Warrant
11
<PAGE>
at the option of the Company if certain public stock trading prices are achieved
and were scheduled to expire in November 1995.
In connection with the public offering, the Class B Stockholders placed in
escrow, on a pro rata basis, an aggregate of 5,625,000 shares of Class B Common
Stock. The Class B Stockholders continue to vote the escrow shares unless such
shares are canceled. Upon the occurrence of certain events, escrow shares were
to be released from escrow and returned to the Class B Stockholders if during
the calendar year ended December 31, 1994 (1) the Company's minimum pretax
income was at least $16 million or (2) the market price of the Company's Class A
Common Stock averages in excess of $6.50 per share for 20 consecutive trading
days. The Company did not achieve any of the above requirements, and, as such,
the escrowed shares were contributed to the Company's treasury on March 31, 1995
and then canceled.
In March 1992, the Company issued notice of redemption of the aforementioned
Class A Warrants, of which approximately 4.3 million were outstanding on the
redemption date of April 27, 1992. Prior to the redemption date, holders of
4,212,740 Class A Warrants exercised their warrants at $2.00 per warrant which
totalled $8,425,480 in warrant exercise proceeds. Accordingly, the Company
issued 4,212,740 shares of Class A Common Stock and 4,212,740 Class B Warrants
to the exercisers of the Class A Warrants. The remaining unexercised Class A
Warrants were redeemed at $0.05 per warrant. During the fourth quarter of 1992,
holders of 300 Class B Warrants exercised their warrants at $3.00 per warrant.
In August 1996, the Company's Board of Directors approved a resolution extending
the expiration date of the outstanding Class B Warrants to January 1, 1998.
In July 1993, in connection with the increase of $650,000 in Bridge Notes which
matured June 29, 1994, the Company issued 650,000 Class C Warrants which are
exercisable ratably into one share of Class A Common Stock at an exercise price
of $3.00 per share. The Warrants expire on June 29, 1998.
In September 1993, the Company initiated an offering of up to $2,000,000 of
discounted gross offering proceeds of Class A Common Stock to qualified foreign
investors under Regulation S of the Securities Act of 1933. At December 31,
1993, 736,135 shares of such stock had been issued resulting in approximately
$602,000 net offering proceeds to the Company. In January 1994, an additional
450,000 shares were issued, resulting in approximately $344,000 net offering
proceeds to the Company. As a part of the offering, the Company has issued
206,751 Class D Warrants to the Stock Placement Distributor. The Class D
Warrants expire five years from the date of issue and are exercisable at a price
of $1.50 per share of Class A Common Stock for each Class D Warrant exercised.
Also in connection with the Regulation S offering, the Company has reserved for
issuance one Class E Warrant for each two shares of Class A Common Stock
purchased by the aforementioned qualified foreign investors. The Class E
Warrants were issued six months after the Class A Common stockholders' stock
acquisition date, provided that the shares of Class A Common Stock were still
owned by and registered in the name of the original purchaser as of such date.
The Class E Warrant will expire two years from the date of issue and will be
exercisable at $1.50 per share of Class A Common Stock for each Class E Warrant
exercised. As of September 30, 1996 no Class E Warrants have been exercised and
all such Warrants have expired.
12
<PAGE>
In May 1994, the Company completed a Private Placement Offering at market price
to certain affiliated stockholders and bridge note holders with the issuance of
3,468,400 shares of Class A Common Stock, 3,468,400 Class F Warrants, and
3,468,400 Class G Warrants. Net offering proceeds of approximately $2,065,000
consisted of $2,020,000 conversion of debt and accrued interest and $45,000 in
cash. The Class F and Class G Warrants expire five years from the date of
issuance and are exercisable at a price of $.61 and $.92 per share of Class A
Common Stock for each Class F or Class G Warrants exercised.
In 1995, in connection with an extension of a line of credit to the Company by a
related party (see Note 6), the Company's Board of Directors authorized the
issuance of up to 2,000,000 Class H Warrants on a one-for-one basis for each
dollar advanced under the loan agreement and having an exercise price equal to
the per share market value of the Company's Class A Common Stock on the date of
such advances. While no warrants have been issued as of the date of this filing,
all authorized Class H Warrants are currently issuable. Upon issue, the warrants
will be exercisable at prices from $.39 to $.49 per share of Class A Common
Stock for each Class H Warrant exercised. The Class H Warrants will expire in
February 2005.
In May 1996, the Company completed a Private Placement Offering with the
issuance of 338,624 shares of Class A Common Stock. Net offering proceeds
consisted of $200,000 in cash.
In June 1996, the Company completed an offering to qualified foreign investors
under Regulation S of the Securities Act of 1933 with the issuance of 1,666,893
shares of Class A Common Stock. Net offering proceeds consisted of $1,146,000 in
cash. As a part of the offering, the Company has issued 166,688 Class I Warrants
to the Stock Placement Distributor. The Class I Warrants expire three years from
the date of issue and are exercisable at prices from $0.9375 to $1.125 per share
of Class A Common Stock for each Class I Warrant exercised.
In September 1996 the Company received $500,000 cash relating to an offering to
qualified foreign investors under Regulation S of the Securities Act of 1933
with the issuance of the 762,194 shares of Class A common stock to be completed
in October 1996.
13
<PAGE>
At September 30, 1996, the Company had Class A Common Stock reserved for
issuance as follows:
<TABLE>
<CAPTION>
Class A
Common Stock
equivalent shares
-----------------
<S> <C>
Class B Warrants 4,212,440
Stock option plans (Note 10) 3,050,000
Class C Warrants 650,000
Class D Warrants 206,751
Class F Warrants 1,337,904
Class G Warrants 3,468,400
Class H Warrants 2,000,000
Class I Warrants 166,688
----------
15,092,183
==========
</TABLE>
Note 10: Stock option plans
- ---------------------------
The Company's Stock Option Plans (the "1990 Plan" and the "1989 Plan") authorize
the issuance of a total of 1,500,000 shares of the Company's Class A Common
Stock to its directors, employees, and outside consultants. The option price of
the stock options awarded must be at least equal to the market value of the
Class A Common Stock on the date of grant. Stock options may not be granted to
an individual to the extent that in any calendar year in which options first
become exercisable, the shares subject to options first exercisable in such year
have a fair market value on the date of grant in excess of $100,000. Stock
options may not be granted after March 2000 and May 1999 for the 1990 Plan and
the 1989 Plan, respectively. No option may be outstanding for more than ten
years after its grant. The purpose of the Plans is to enable the Company to
encourage key employees, directors and outside consultants to contribute to the
success of the Company by granting such persons incentive stock options ("ISOs")
and/or non-incentive stock options ("nonqualified stock options"). The ISOs are
available for employees only.
In order to provide for disinterested administration of the Plans for purposes
of Rule 16b-3 under the Securities Exchange Act of 1934, the 1990 Plan also
provides that outside directors will automatically receive annual awards of
nonqualified stock options.
In June 1994, stockholders of the Company approved the adoption of the Amended
and Restated Stock Option Plan which superceded and replaced the Company's 1990
Stock Option Plan. The new Plan provides for the granting of options to
purchase up to 1,000,000 shares of the Company's Class A Common Stock by
recipients of incentive stock options or non-qualified stock options as granted
by the Company's Board of Directors. 406,000 options were granted from this
plan during 1995.
The Company's stockholders also approved the Non-Employee Director Stock Option
Plan. The Director Plan provides for the issuance of options to purchase up to
an aggregate of 500,000 shares of the Company's Class A Common Stock to eligible
outside directors of the Company. Each eligible outside director will be
granted
14
<PAGE>
options to purchase 25,000 shares of common stock annually commencing in 1995
and each year thereafter. In April 1996, 25,000 such options were granted to
each of the four outside directors serving on the Board at that time.
Also in June 1994, stockholders of the Company approved the Chairman Stock
Option Plan. The Chairman Plan provides that Jim G. Brooks, the Company's
Chairman and Chief Executive Officer be awarded a one-time grant, effective May
1, 1994, to purchase 500,000 shares of the Company's Class A Common Stock. The
options granted are exercisable at $.63 per share and are vested at the rate of
20% per year commencing on the first anniversary of the grant date.
A summary of the activity in the Company's Stock Option Plans during the nine
months ended September 30, 1996 is as follows:
<TABLE>
<CAPTION>
Shares Per Share
------ ---------
<S> <C> <C>
Outstanding
December 31, 1995 1,931,668 $.38 - $3.00
Granted 100,000 $.81
Forfeited - -
Exercised - -
---------
Outstanding
September 30, 1996 2,031,668 $.38 - $3.00
=========
Exercisable
September 30, 1996 1,054,668 $.38 - $3.00
=========
</TABLE>
Note 11: Significant customer
- ------------------------------
During the nine months ended September 30, 1996, the Company had $1,866,272 in
sales to a single customer which represented 34% of total sales. Additionally,
the Company had aggregate sales of $2,276,774 to three other customers which
individually represent 24%, 12%, and 6% of total sales. During the nine months
ended September 30, 1995, the Company had $1,605,229 in sales to a single
customer which represented 38% of total sales.
Note 12: Net loss per share of common stock
- --------------------------------------------
The net loss per share of common stock was based on the combined weighted
average number of shares of Class A and Class B Common Stock outstanding during
the period. For purposes of such calculation, the 5,625,000 shares of Class B
Common Stock which were placed in escrow in connection with the public offering
were not considered as outstanding after the date of the public offering as the
effect of such inclusion would be dilutive to the net loss per share
calculation. Further, the Company's other common stock equivalents
15
<PAGE>
(options which accompanied the subordinated notes, Class B, C, D, F, G, H and I
Warrants issued or contingently issuable, and the stock options) have a dilutive
effect on the loss per share calculation and, accordingly, were also excluded.
Note 13: Commitments and contingencies
- --------------------------------------
On June 9, 1992, Mobil Oil Corporation ("Mobil") commenced an action against the
Company in the United States District Court for the District of Delaware
entitled Mobil Oil Corporation v. Advanced Environmental Recycling Technologies,
-----------------------------------------------------------------------
Inc. In its complaint, Mobil sought entry of a declaratory judgment that: (a)
- ----
AERT is without right or authority to threaten suit against Mobil or its
customers for alleged infringement of AERT patents; (b) The AERT patents are
invalid and unenforceable, and (c) Mobil has not infringed the AERT patents
through any products or method. Mobil seeks no monetary damages in this suit,
but does seek reimbursement of its attorneys' fees.
On December 8, 1992, the Company answered Mobil's Complaint. In its Answer, the
Company denied Mobil's claims and asserted counterclaims against Mobil and three
Mobil executives for: (1) an illegal combination or contract in restraint of
trade in violation of federal antitrust laws; (2) a pattern of intentional
misconduct constituting an attempt to monopolize in violation of federal
antitrust laws; (3) breach of a confidential relationship between Mobil and the
Company; and (4) unfair competition. The Company sought monetary damages,
punitive damages and injunctive relief. Mobil filed an answer to AERT's
counterclaims, denying any liability. The Delaware Court then bifurcated the
trial into patent and non-patent issues and ordered the patent issues tried
first.
In February 1994, after a trial on the patent issues, a Delaware jury returned a
verdict that four AERT patents on its composite product technology were invalid.
The jury also determined that Mobil had not infringed two of the four patents
which AERT had asserted against Mobil. The jury verdict answered a number of
interrogatories on the factual issues, and rendered advisory findings for the
Court on Mobil's allegation that AERT had obtained its patents by inequitable
conduct. Thereafter, the Judge adopted the jury's advisory findings on
inequitable conduct and held that each of the four AERT patents were
unenforceable for failure to disclose certain alleged prior art to the patent
office during patent prosecution.
Because of the nature of certain of the jury verdict interrogatory responses,
AERT's counsel concluded that the verdict was adversely affected by improper
conduct by Mobil counsel during trial, and false statements of law and fact made
during closing argument, that caused the jury to misapply the law on inequitable
conduct and to render clearly erroneous findings. Consequently, AERT moved for a
new trial. That motion was denied. The Company's additional post-trial motions
were also denied by the Delaware Court. On March 14, 1995, the Company filed a
sealed motion with the Court based upon newly discovered evidence which alleges
prejudicial misconduct by Mobil prior to the trial. The motion also brings to
the Court's attention evidence which the Company believes was intentionally
withheld from it in direct defiance of the Delaware Court's January 4, 1994
Motion to Compel, prior to the trial. It also brings to the Court's attention,
an official government safety approval document which was altered prior to
submission to AERT during pre-trial discovery, which also relates to a portion
of the alleged withheld discovery documentation. The motion seeks further
discovery into Mobil's misconduct, and a new trial. In December 1995, the
Company also moved to
16
<PAGE>
supplement its pending March 14, 1995 Motion with additional tampered evidence
and discovery misconduct by Mobil. Although the March 14, 1995 Motion is still
pending before the Delaware Court, the Company filed an appeal with the U.S.
Court of Appeals on July 10, 1995 on the initial trial arguments. In January
1996, oral arguments were presented before the U.S. Court of Appeals. On June
13, 1996, the U.S. Court of Appeals issued a decision which vacated the judgment
of invalidity against two AERT patents and upheld and affirmed the invalidity of
two AERT patents. In August 1994, Mobil filed a motion seeking an award of
attorneys' fees and costs in the amount of $2.7 million. On November 1, 1994,
the Court ruled that the motion was premature and will not be considered at the
present time. In January 1995, Mobil renewed its Motion for Attorneys' Fees. In
April 1995, the Court requested AERT to respond to Mobil's Motion. In March
1996, the Court entered an Order which stayed Mobil's Motion for Attorneys' Fees
and AERT's Motion for a New Trial, pending disposition of the appeal. On
September 30, 1996, the Delaware Court stayed AERT's Motion to Supplement the
Record on its Motion for a New Trial. As of this date, these Motions are still
stayed before the Delaware Court. Should the Delaware Court deny the Company's
pending Prejudicial Misconduct Motion, the Company intends to follow-up with an
additional appeal on these issues. Should the Court not rule in favor of the
Company on such motions, all appellate processes available will be pursued.
There can be no assurance that the Company will receive a more favorable outcome
upon appeal. The Company will vigorously defend against Mobil's claim for
attorneys' fees and costs, however, there can be no assurances as to the outcome
of this litigation.
The Company's counterclaims against Mobil and other defendants are to be heard
in a separate trial which has not yet been scheduled.
Note 14: Extraordinary gain
- ---------------------------
In September 1996 the Company experienced an extraordinary gain of $67,100
relating to the insurance proceeds for the loss of finished goods inventory
destroyed in the Rogers facility fire. The Company was reimbursed for the
inventory at a historical total cost which was greater than the book carrying
value. In addition, capital equipment was destroyed having a net book value of
$138,888 and a receivable was set-up as the Company expects to be fully
reimbursed for the total fire loss. The impact of the extraordinary gain on the
net loss per share of common stock was insignificant.
17
<PAGE>
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Advanced Environmental Recycling Technologies, Inc.
We have reviewed the accompanying balance sheet of Advanced Environmental
Recycling Technologies, Inc. (a Delaware corporation), as of September 30, 1996,
and the related statements of operations for the three-month and nine-month
periods ended September 30, 1996 and 1995, and the statements of cash flows for
the nine-month periods ended September 30, 1996 and 1995. These financial
statements are the responsibility of the company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principals.
s/s Arthur Andersen LLP
ARTHUR ANDERSEN LLP
San Antonio, Texas
November 7, 1996
18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
- -------
The Company has developed technologies to reclaim polyethylene plastics and
manufacture engineered composite products that exhibit superior moisture
resistance and dimensional stability. To-date, the Company has received 13
United States Patents on its technologies and additional patent applications are
currently pending. (Note: Legal Proceedings) The Company has built and currently
operates a plastics reclamation facility in Rogers, Arkansas and a composites
manufacturing facility in Junction, Texas. The Company is currently doubling the
production capacity of the composites facility and has recently entered into
agreements to establish an additional plastic reclamation facility for high-
density polyethylene and a second composite manufacturing facility. The Company
has experienced increased customer demand for its engineered composite products
that are marketed under the trade-names, Moistureshield(TM) and CHOICEDEK(TM).
The Company's efforts are now primarily directed towards increasing production
capacity and increasing its production to supply its existing customer base, and
promptly attaining positive cash-flows and profitability.
To-date, the Company has experienced a substantial backlog for its CHOICEDEK(TM)
line of residential decking products through Weyerhaeuser Distribution and has
commenced an expansion program intended to increase production capacity for
Weyerhaeuser and its other OEM customers. To-date, the Company has been limited
in its ability to supply the residential decking market and has only been able
to supply its CHOICEDEK(TM) line to a limited number of distribution centers.
The Company's sales are now primarily focused towards the following three market
areas which are currently supplied by the Company's composites manufacturing
facility in Junction, Texas (the "Junction Facility"): (1) components for the
national door and window market, (2) the heavy industrial flooring market as
floor blocks for industrial applications, and (3) as decking components for
commercial and residential applications through Weyerhaeuser. The Company will
continue to primarily utilize production capacity of its plastics reclamation
facility in Rogers, Arkansas (the "Rogers Facility") as its main source of
plastic raw materials supply for the Junction facility. The Rogers facility
experienced a fire during the third quarter that disrupted the operations at the
Arkansas facility and intends to have it back in full production shortly. The
Company has increased the production capacity of its composites manufacturing
operation to levels that require substantially all of the Rogers Facility's
production. In addition to purchasing additional plastics from outside vendors,
the Company has also entered into an agreement to establish a second plastic
reclamation facility, of which the Company intends to purchase the plastic
output.
The Company, in addition to the fire at the Rogers facility mentioned above, has
also experienced production difficulties and expansion delays during the last
quarter, that limited its efforts to increase production and sales for its
customers. The Company has recently added a third composite line and is
awaiting back-ordered production equipment, which is required to finish and
start up its fourth composite line at its Junction, Texas facility. The Company
must establish and maintain increased composite production from its third and
fourth lines in order to obtain positive cash-flows and profitability. The
Company also believes it can obtain improved operating efficiencies and
increased efficiencies of scale once the Junction, Texas expansion is complete.
It is currently estimated that the fourth extrusion line will become operational
during December.
19
<PAGE>
The Company currently maintains a concentrated customer base with approximately
70% of its sales directed to three customers. (See Note 11 to Financial
Statements.) The Company is currently unable to predict the future size of the
markets for its composite building products, however, the Company believes that
the national door and window and residential decking material markets are
significant. The Company believes that it can further penetrate these markets
and/or expand sales to its existing customer base if the Company's goals for
increased production capacity and efficiency are achieved. By focusing its
marketing strategy on a limited number of large door and window companies, and
by initiating sales of its new decking products through the Weyerhaeuser
marketing and distribution agreement, the Company believes it can increase
market penetration and sales without significantly increasing administrative
overhead. To a lesser extent, the Company's marketing focus also utilizes
outside commissioned sales representatives for a portion of its door and window
accounts.
Results of Operations
- ---------------------
Quarter ended September 30, 1996 compared to quarter ended September 30, 1995
- -----------------------------------------------------------------------------
Net sales of $1,901,319 for the quarter ended September 30, 1996 represented an
increase in sales of 12% or $207,875 over the third quarter of 1995. Sales by
the composite products division increased from $1,612,106 in the third quarter
of 1995 to $1,901,319 in the third quarter of 1996; an increase of 18%. This
increase was due to increased production focus on composites in conjunction with
partial start-up of a third extrusion line. The Company experienced production
difficulties with the startup of its third extrusion line, and equipment delays
for the completion of its fourth line during the quarter. Thus, unanticipated
production problems limited the Company's ability to increase sales to its
customers. The third line has recently been brought back on-line and the Company
is intent on further increasing its production to supply the increased
requirements of its existing customers.
Cost of goods sold was $2,185,426 for the third quarter of 1996 compared to
$1,786,749 for the third quarter of 1995. The increase in cost of goods sold
was primarily attributable to increased raw material, labor costs, and start-up
of the third extrusion line, which resulted in less than desired operating
efficiencies. Significant categories are as follows:
<TABLE>
<CAPTION>
Expense Category 1996 1995
---------------- ---- ----
<S> <C> <C>
Payroll and payroll taxes $ 911,371 $ 686,186
Depreciation 326,360 277,842
Direct material costs 317,093 340,576
Other 631,602 482,145
--------- ----------
Total $2,185,426 $1,786,749
========== ==========
</TABLE>
Selling, general and administrative expenses were $533,159 for the quarter ended
September 30, 1996 compared to $327,867 during the third quarter of 1995. A
portion of the increase was attributable to increasing sales and distribution of
CHOICEDEK(TM) Professional fees for the third quarter were $107,030. The net
loss for the quarter ended September 30, 1996 was $793,229, or a net loss per
weighted average common share outstanding of $.04. The loss compares to a loss
of
20
<PAGE>
$495,236, or a net loss per weighted average common share outstanding of $.03
for the three months ended September 30, 1995. The loss was attributable to
costs associated with less than desired operating efficiencies in conjunction
with increased labor and marketing costs. The fire at the Rogers facility and
the change-over in raw materials also contributed to increased costs. The
Company commenced limited operation of a third extrusion line during the quarter
which experienced equipment problems that required warranty work by the
manufacturer. The machinery was recently fixed and came back on line. The
composites division has experienced unanticipated manufacturing difficulties
during the last three quarters that resulted in poor operating efficiencies and
higher costs. Local, state, and federal agencies are currently investigating
whether these problems are intentional, and with the recent Rogers facility
fire; related. The Company has recently added additional cleaning equipment and
security equipment, including video surveillance cameras throughout the
composite manufacturing facility in an attempt to prevent and stop these
problems that appear to be of an ongoing nature. Management intends to continue
to take such action as it deems necessary to resolve and eliminate these
problems.
The Company's limited production capacity and delays associated with its
composites plant expansion limited its ability to increase sales, primarily of
CHOICEDEK(TM) during the quarter. To address the Company's current production
backlog and further increase sales to its customers, the Company is increasing
its composites manufacturing capacity through the recent addition of a third
production line at the Junction, Texas composites manufacturing facility and has
started construction of a fourth line which is scheduled for completion December
1996. The Company is currently gearing up its marketing and distribution to
substantially increase sales of CHOICEDEK(TM) over previous periods. The
increased production of the Company's composite products and accordingly, the
composites division's increased raw-material requirements prompted the Company,
in early 1996, to discontinue reclamation of plastics for sale to third-parties
and dedicate all of the plastic facility's production to providing materials to
the Junction operation. In connection with this restructuring of the plastics
reclamation plant, the Company exchanged certain equipment, previously utilized
to produce plastics for sale to third-parties, for other equipment which will be
utilized in a second plastics reclamation line to produce raw-materials and
which was used in the installation of the third production line at the Company's
composite facility. The Company has also entered into a letter of intent with an
Arkansas based manufacturing company to establish a new composites manufacturing
facility in northern Arkansas. An entity has been established as Sutton
Engineered Wood Products, and the target date for start-up of the first phase of
the new facility is currently estimated during the second quarter of 1997. The
Company is currently rebuilding its Rogers plant that was damaged during the
fire and is working to further improve its efficiency of operation and reduce
costs through the rebuilding. The Company has also entered into an agreement to
establish an additional production facility for HDPE.
The Company believes that the additional production lines at Junction and Rogers
should allow the Company to improve and increase its production volumes, thereby
significantly increasing sales and service to its existing customer base. The
Company is also intent on improving existing operating efficiencies in order to
reduce its composite manufacturing costs and has brought in outside expertise to
assist management in obtaining its production objectives. However, the
Company's operations remain subject to numerous risks associated with the
continued establishment of its business, including lack of financing sources and
competition from numerous large, well-established and well-capitalized
competitors who manufacture products for the same applications. In addition,
the Company has in the past and may again in the future, encounter unanticipated
problems, including manufacturing, distribution, and marketing difficulties,
some of which may be beyond the Company's
21
<PAGE>
financial and technical abilities to resolve. The occurrence of, or failure to
adequately address such difficulties could have a material adverse effect on the
Company's prospects, including its ability to achieve anticipated sales levels,
positive cash-flows from operations and profitability.
The Company experienced an extraordinary gain for the third quarter which was
the result of insurance proceeds for finished goods inventory lost due to the
fire at the Rogers facility. The Company currently estimates the damages from
the fire at $128,000 for inventory and $208,000 for equipment and installation,
which will be fully covered by insurance.
Nine-months ended September 30, 1996 compared to nine-months ended September 30,
- --------------------------------------------------------------------------------
1995
- ----
Cost of goods sold was $5,867,368 for the nine-months ended September 30, 1996
compared to $4,700,344 for the three quarters of 1995. The overall cost of
goods sold to sales ratio showed an improvement over 1995. The increase in cost
of goods sold was primarily attributable to increased raw material, labor costs,
and start-up of the third extrusion line that resulted in less than desired
operating efficiencies. Significant categories are as follows:
<TABLE>
<CAPTION>
Expense Category 1996 1995
---------------- ---- ----
<S> <C> <C>
Payroll and payroll taxes $2,372,882 $1,986,432
Depreciation 896,289 772,827
Direct material costs 665,112 684,947
Other 1,933,085 1,256,138
---------- ----------
Total $5,867,368 $4,700,344
========== ==========
</TABLE>
Liquidity and Capital Resources
- -------------------------------
At September 30, 1996, the Company had a working capital deficit of $1,239,468
compared to a working capital deficit of $1,566,805 at December 31, 1995. The
decreased deficit is primarily attributable to the Company's 1996 operating loss
and a decrease in current maturities of long-term debt. Cash and cash
equivalents increased for the three quarters of 1996. Significant components of
that decrease were: (i) cash used in operating activities of $1,083,906, which
consisted of the net loss for the period of $1,703,893, reduced by depreciation
and amortization of $909,726, and other uses of cash of $289,739; (ii) cash used
in investing activities of $745,699, and (iii) cash provided by financing
activities of $1,830,491. Payments on notes during the period were $571,358 and
proceeds from the issuances of notes amounted to $269,155. At September 30,
1996, the Company had notes payable in the amount of $1,766,644, of which
$758,730 were current notes payable or current portion of long-term debt. In
January 1996, a major stockholder, Marjorie S. Brooks (the "Major Stockholder"),
exercised 500,000 Class F Warrants. The proceeds from the exercise of these
warrants, which amounted to $305,000, reduced the working capital deficit of the
Company and were used to reduce current liabilities.
In September 1996 the Company received $500,000 cash relating to an offering to
qualified foreign investors under Regulation S of the Securities Act of 1933
(See note 9 to Financial Statements.)
22
<PAGE>
The Company maintains an accounts receivable factoring agreement for up to
$700,000 through an affiliated company of a related party. The terms of this
agreement call for the factor to advance 99.12% of the total of invoices
presented by the Company and for the Company to indemnify the factor against
loss of the amounts advanced. At September 30, 1996, approximately $304,189 was
available to factor additional receivables. The Company also maintains a line
of credit from the Major Stockholder which consists of a long-term note payable,
which had a balance of $1,224,511 at September 30, 1996, and a $433,097
revolving line of credit to be available as needed. As of September 30, 1996,
the total amount of the line was available.
Since the completion of the first quarter, the Company has received additional
sources of capital as described below, which have been primarily used to add
additional manufacturing capacity for composite production. Historically,
revenues have not been sufficient to support the Company's current operational
needs. However, the Company continues to attempt to improve production rates and
efficiencies in an effort to reduce or eliminate the need for additional future
capital to support existing operations. Further, continued improvements in
production efficiency and capacity will be required for the Company to increase
sales to a level that will allow the Company to attain profitability. There can
be no assurance that such improvements in production efficiency or capacity will
be achieved.
As previously disclosed, Management is currently undertaking steps to increase
sales to its existing customer base by expanding its production capacity. The
Company has recently added a third production line at its Composites
Manufacturing Facility and intends to add a fourth production line by the end of
December 1996. The Company expended approximately $155,116 during the third
quarter for a fourth extrusion line and for additional building and site work at
the Junction plant. To finance existing operations and the required capital
expenditures, the following transactions were completed during or subsequent to
the first quarter: (i) the Company traded assets for additional equipment which
was deployed as part of the third production line; (ii) the Company received
$305,000 from Warrant Conversions from the Major Stockholder as described above;
(iii) the Company sold an aggregate of 2,429,087 shares of Class A Common Stock
to accredited overseas investors in a transactions exempt under Regulation S of
the Securities Act of 1933 as amended for an aggregate purchase price of
$1,646,000 and (iv) the Company sold 338,624 shares to an existing non-
affiliated AERT shareholder for a purchase price of $200,000.
The Company also restructured and refinanced an existing Note with the Dow
Credit Corporation. (See note: Financial Statement) In addition to the
foregoing, the Company has currently outstanding, approximately 4.2 million
Class B Warrants with an exercise price of $3.00. The expiration date of the
Class B Warrants is January 1, 1998. The Company also has outstanding 1,530,663
Private Placement Warrants held by non-affiliated entities, which, if exercised
by holders, could generate equity capital for the Company (See Note 9 to the
Financial Statements). The receipt of additional funds by the Company upon
exercise of any such warrants, however, is subject to a number of contingencies,
including, but not limited to, (i) compliance with applicable federal and state
securities laws, (ii) the desire and ability of the holders to exercise their
warrants, and (iii) the market price of the Company's stock.
There can be no assurance that the Company will be able to maintain its current
operating levels or achieve increased production volumes and sales levels or
that the Company could obtain additional capital resources to support
manufacturing operations if required.
23
<PAGE>
If the Company is unable to achieve and maintain a successful level of
operations in the near future or unable to secure additional debt or equity
financing to provide support to ongoing operations, or were it to be assessed
the Mobil legal claims described in Note 13 to the financial statements, it is
likely the Company will be unable to continue as a going concern.
PART II. Other Information
Item 1. Legal Proceedings
--------------------------
On June 9, 1992, Mobil Oil Corporation ("Mobil") commenced an action against the
Company in the United States District Court for the District of Delaware
entitled Mobil Oil Corporation v. Advanced Environmental Recycling Technologies,
-----------------------------------------------------------------------
Inc. In its complaint, Mobil sought entry of a declaratory judgment that: (a)
- ----
AERT is without right or authority to threaten suit against Mobil or its
customers for alleged infringement of AERT patents; (b) The AERT patents are
invalid and unenforceable, and (c) Mobil has not infringed the AERT patents
through any products or method. Mobil seeks no monetary damages in this suit,
but does seek reimbursement of its attorneys' fees.
On December 8, 1992, the Company answered Mobil's Complaint. In its Answer, the
Company denied Mobil's claims and asserted counterclaims against Mobil and three
Mobil executives for: (1) an illegal combination or contract in restraint of
trade in violation of federal antitrust laws; (2) a pattern of intentional
misconduct constituting an attempt to monopolize in violation of federal
antitrust laws; (3) breach of a confidential relationship between Mobil and the
Company; and (4) unfair competition. The Company sought monetary damages,
punitive damages and injunctive relief. Mobil filed an answer to AERT's
counterclaims, denying any liability. The Delaware Court then bifurcated the
trial into patent and non-patent issues and ordered the patent issues tried
first.
In February 1994, after a trial on the patent issues, a Delaware jury returned a
verdict that four AERT patents on its composite product technology were invalid.
The jury also determined that Mobil had not infringed two of the four patents
which AERT had asserted against Mobil. The jury verdict answered a number of
interrogatories on the factual issues, and rendered advisory findings for the
Court on Mobil's allegation that AERT had obtained its patents by inequitable
conduct. Thereafter, the Judge adopted the jury's advisory findings on
inequitable conduct and held that each of the four AERT patents were
unenforceable for failure to disclose certain alleged prior art to the patent
office during patent prosecution.
Because of the nature of certain of the jury verdict interrogatory responses,
AERT's counsel concluded that the verdict was adversely affected by improper
conduct by Mobil counsel during trial, and false statements of law and fact made
during closing argument, that caused the jury to misapply the law on inequitable
conduct and to render clearly erroneous findings. Consequently, AERT moved for a
new trial. That motion was denied. The Company's additional post-trial motions
were also denied by the Delaware Court. On March 14, 1995, the Company filed a
sealed motion with the Court based upon newly discovered evidence which alleges
prejudicial misconduct by Mobil prior to the trial. The motion also brings to
the Court's attention,evidence which the Company believes was intentionally
withheld from it in direct defiance of the Delaware Court's January 4, 1994
Motion to Compel, prior to the trial. It also brings to the Court's attention,
an official
24
<PAGE>
government safety approval document which was altered prior to submission to
AERT during pre-trial discovery, which also relates to a portion of the alleged
withheld discovery documentation. The motion seeks further discovery into
Mobil's misconduct, and a new trial. In December 1995, the Company also moved to
supplement its pending March 14, 1995 Motion with additional tampered evidence
and discovery misconduct by Mobil. Although the March 14, 1995 Motion is still
pending before the Delaware Court, the Company filed an appeal with the U.S.
Court of Appeals on July 10, 1995 on the initial trial arguments. In January
1996, oral arguments were presented before the U.S. Court of Appeals. On June
13, 1996, the U.S. Court of Appeals issued a decision which vacated the judgment
of invalidity against two AERT patents and upheld and affirmed the invalidity of
two AERT patents. In August 1994, Mobil filed a motion seeking an award of
attorneys' fees and costs in the amount of $2.7 million. On November 1, 1994,
the Court ruled that the motion was premature and will not be considered at the
present time. In January 1995, Mobil renewed its Motion for Attorneys' Fees. In
April 1995, the Court requested AERT to respond to Mobil's Motion. In March
1996, the Court entered an Order which stayed Mobil's Motion for Attorneys' Fees
and AERT's Motion for a New Trial, pending disposition of the appeal. On
September 30, 1996, the Delaware Court stayed AERT's Motion to Supplement the
Record on its Motion for a New Trial. As of this date, these Motions are still
stayed before the Delaware Court. Should the Delaware Court deny the Company's
pending Prejudicial Misconduct Motion, the Company intends to follow-up with an
additional appeal on these issues. Should the Court not rule in favor of the
Company on such motions, all appellate processes available will be pursued.
There can be no assurance that the Company will receive a more favorable outcome
upon appeal. The Company will vigorously defend against Mobil's claim for
attorneys' fees and costs, however, there can be no assurances as to the outcome
of this litigation.
The Company's counterclaims against Mobil and other defendants are to be heard
in a separate trial which has not yet been scheduled.
25
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
/s/ Joe G. Brooks
------------------------
Joe G. Brooks, President
/s/ Jake M. Bushey
-------------------------------------
Jake M. Bushey, Corporate Controller
DATE: November 14, 1996
26
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