<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 June 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 July 31, 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, June 30, 1996 and December 31, 1995 1-2
Statements of Operations,
Three months and six months ended June 30, 1996 and 1995 3
Statements of Cash Flows,
Six months ended June 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 19-23
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 23-25
Signatures 26
</TABLE>
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
------
June 30, 1996 December 31,
(Unaudited) 1995
----------- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 13,444 $ 15,350
Receivables 309,919 48,463
Inventories 498,641 648,211
Prepaid expenses and other 261,085 108,528
---------- ----------
Total current assets 1,083,089 820,552
---------- ----------
Buildings and equipment,
at cost, including construction
in progress of $654,811 at 6-30-96, and
$22,946 at 12-31-95:
Buildings 675,420 675,420
Machinery and equipment 8,637,125 7,985,870
Transportation equipment 133,527 112,411
Office equipment 172,598 170,659
Leasehold improvements 315,331 315,331
---------- ----------
9,934,001 9,259,691
Less accumulated depreciation
and amortization 3,629,866 3,050,979
---------- ----------
Net buildings and equipment 6,304,135 6,208,712
---------- ----------
Other assets, at cost less accumulated
amortization of $95,367 at 6-30-96, and
$83,058 at 12-31-95 331,083 328,478
---------- ----------
$7,718,307 $7,357,742
========== ==========
</TABLE>
The accompanying notes to the financial statements should be read in conjunction
with these statements.
1
<PAGE>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
<CAPTION>
June 30, 1996 December 31,
(Unaudited) 1995
----------- ----
<S> <C> <C>
Current liabilities:
Current maturities of long-term debt $ 630,249 $ 755,576
Accounts payable - trade 1,092,439 1,078,243
Payables to related parties 82,364 362,155
Accrued liabilities 216,238 166,779
Notes payable 192,049 14,604
------------ -----------
Total current liabilities 2,213,339 2,377,357
------------ -----------
Long-term debt, less current maturities -
Related parties 954,731 1,102,554
Other 154,410 164,088
------------ -----------
Total long-term debt 1,109,141 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
Additional paid in capital 20,850,557 19,282,865
Deficit accumulated during the
development stage (16,651,369) (15,740,706)
------------ ------------
Total stockholders' equity 4,395,827 3,713,743
------------ -----------
$ 7,718,307 $ 7,357,742
============ ===========
</TABLE>
The accompanying notes to the financial statements should be read in conjunction
with these statements.
2
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
-------------- ------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Sales $ 2,057,337 $ 1,395,664 $ 3,659,116 $ 2,566,974
Cost of Goods Sold 1,943,021 1,541,314 3,689,251 2,913,595
----------- ----------- ----------- -----------
Gross Margin 114,316 (145,650) (30,135) (346,621)
Selling and Administrative Costs 406,118 351,695 783,489 672,569
----------- ----------- ----------- -----------
Operating Income (Loss) (291,802) (497,345) (813,624) (1,019,190)
Other Income (Expense)
Other Income 20,291 760 20,399 784
Interest Expense (56,699) (74,569) (117,438) (133,534)
----------- ----------- ----------- -----------
Net Loss $ (328,210) $ (571,154) $ (910,663) $(1,151,940)
=========== =========== =========== ===========
Net loss per share of common
stock ($.02) ($.04) ($.05) ($.07)
=========== =========== =========== ===========
Weighted average number of
common shares outstanding 18,225,348 15,503,568 18,225,348 15,503,568
=========== =========== =========== ===========
</TABLE>
The accompanying notes to the financial statements should be read in conjunction
with these statements.
3
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Six months Six months
ended ended
June 30, June 30,
1996 1995
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (910,663) $(1,151,940)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 578,887 493,684
Amortization of other assets 12,309 11,388
Gain on disposition of assets - (734)
Increase in other assets (14,914) (28,590)
Changes in current assets & current liabilities (480,579) 7,629
---------- -----------
Net cash used in operating activities (814,960) (668,563)
Cash flows from investing activities:
Additions to buildings and equipment (674,311) (15,257)
Proceeds of sale of equipment - 5,000
---------- -----------
Net cash used in investing activities (674,311) (10,257)
---------- -----------
Cash flows from financing activities:
Proceeds from issuance of notes 269,155 953,822
Payments on notes (374,538) (272,281)
Proceeds from issuance of common stock, net 1,592 748 -
---------- -----------
Net cash provided by financing activities 1,487,365 681,541
---------- -----------
Increase (Decrease) in cash & cash equivalents (1,906) 2,721
Cash and cash equivalents:
Beginning of period 15,350 5,977
---------- -----------
End of period $ 13,444 $ 8,698
========== ===========
</TABLE>
The accompanying notes to the financial statements should be read in conjunction
with these 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. (the Company) 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 June 30, 1996, the Company had a working capital deficit of
$1,130,250 and had incurred net losses of $910,663 for the six months ended June
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 June 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 management's belief that
6
<PAGE>
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 six 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 $6,264,411 at June 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>
Six months Six months
ended ended
June 30, 1996 June 30, 1995
(unaudited) (unaudited)
----------- -----------
<S> <C> <C>
Receivables $(261,456) $ 21,263
Inventories 149,570 (9,892)
Prepaid expenses and other (152,557) (95,267)
Accounts payable -
trade & related parties (265,595) 92,044
Accrued liabilities 49,459 (519)
--------- --------
$(480,579) $ 7,629
========= ========
</TABLE>
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
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>
June 30, 1996 December 31,
(Unaudited) 1995
-------------- ------------
<S> <C> <C>
Raw materials $166,534 $ 54,279
Finished goods 332,107 593,932
-------- --------
$498,641 $648,211
======== ========
</TABLE>
Other Assets
------------
Other assets consist primarily of the costs for the preparation of patent
applications ($421,361 and $406,447 at June 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 six months ended June 30, 1996, the Company sold an aggregate of
approximately $3,838,025 in receivables under this agreement. Costs of
approximately $33,781 associated with the factoring agreement are included in
selling and administrative costs for the six 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 June
30, 1996, the entire amount was available to the Company.
9
<PAGE>
Note 7: Long-term debt
- -----------------------
Long-term debt as of June 30, 1996 and December 31, 1995, consisted of the
following:
<TABLE>
<CAPTION>
June 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 June 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. $ 264,034 $ 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. 166,025 213,769
Note payable, to a related party, due in 60-monthly
installments of principal and interest, beginning
April 1, 1995, interest at 9.75%. 1,243,371 1,399,245
Other 65,960 84,234
---------- ----------
Total 1,739,390 2,022,218
630,249 755,576
Less current maturities ---------- ----------
Long-term debt, net of
current maturities $1,109,141 $1,266,642
========== ==========
</TABLE>
The fair value of the Company's outstanding debt is approximately equal to its
carrying value at June 30, 1996.
10
<PAGE>
The aggregate maturities of long-term debt as of June 30, 1996 are as follows:
<TABLE>
<S> <C>
1997 $ 630,249
1998 456,721
1999 362,463
2000 289,957
2001 0
----------
$1,739,390
==========
</TABLE>
Note 8: Interest
- -----------------
Interest incurred, capitalized, expensed and cash payments for interest are
summarized as follows:
<TABLE>
<CAPTION>
Six months Six months
ended ended
June 30, June 30,
1996 1995
(unaudited) (unaudited)
----------- -----------
<S> <C> <C>
Interest incurred $117,438 $133,534
Interest capitalized as
part of the cost of machinery
and equipment - -
-------- --------
Interest expensed $117,438 $133,534
-------- ========
Cash payments for interest $131,862 $106,944
-------- ========
</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 1995, the Company's Board of Directors approved a resolution extending
the expiration date of the outstanding Class B Warrants to September 1, 1996.
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 June 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.
At June 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>
13
<PAGE>
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 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.
14
<PAGE>
A summary of the activity in the Company's Stock Option Plans during the six
months ended June 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
June 30, 1996 2,031,668 $.38 - $3.00
=========
Exercisable
June 30, 1996 1,054,668 $.38 - $3.00
=========
</TABLE>
Note 11: Significant customer
- ------------------------------
During the six months ended June 30, 1996, the Company had $1,333,797 in sales
to a single customer which represented 36% of total sales. Additionally, the
Company had aggregate sales of $1,445,152 to three other customers which
individually represent 22%, 12%, and 5% of total sales. During the six months
ended June 30, 1995, the Company had $974,708 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 (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
15
<PAGE>
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 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. The Company
is currently evaluating its legal options, and has until September 13, 1996 to
further appeal the decision to the U.S. Supreme 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.
16
<PAGE>
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. As of this date,
these Motions are still stayed before the Delaware Court. 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.
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 June 30, 1996, and
the related statements of operations for the three-month and six-month periods
ended June 30, 1996 and 1995, and the statements of cash flows for the six-month
periods ended June 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/ ARTHUR ANDERSEN LLP
-----------------------------
Arthur Andersen LLP
San Antonio, Texas
August 7, 1996
18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
- -------
During the second quarter of 1995, the Company substantially completed
development of its commercial manufacturing processes and further defined the
principal markets for certain of the Company's products. The Company,
therefore, exited the development stage and has reclassified certain prior
period amounts to conform to current period reporting presentation. While the
Company will continue to expend amounts related to the research and development
of new products, such amounts are not expected to be material in relation to
prior periods. The Company's efforts are now primarily directed towards
increasing production capacity and efficiency and profitability, expanding its
customer base, and promptly attaining positive cash-flows.
In May 1995, the Company entered into an exclusive marketing and distribution
agreement with a division of Weyerhaeuser, Inc. ("Weyerhaeuser") for sales of
its Lifecycle(TM) line of extruded decking components, which are primarily
targeted towards the high-end residential housing market. Weyerhaeuser will
market the product under the Company's trade-name, ChoiceDek(TM), initially in a
limited number of its 80 distribution and reload centers throughout the United
States and Canada. To date, the Company has experienced a substantial backlog
for its residential decking products with Weyerhaeuser Distribution and has
recently commenced a production expansion program intended to increase
production capacity for Weyerhaeuser and its other customers.
As a result of the Weyerhaeuser agreement, the Company's sales efforts are now
primarily focused towards the following three market areas which are 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 a source of raw materials supply for the
Junction Facility. The Company has increased the production capacity of its
composites manufacturing operation, during the second quarter, to levels that
will require substantially all of the Rogers Facility's production to be
dedicated thereto. However, as additional product demand warrants, the Rogers
Facility can increase production by extending such facility's operating hours or
by adding additional equipment.
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.
19
<PAGE>
Results of Operations
- ---------------------
Quarter ended June 30, 1996 compared to quarter ended June 30, 1995
- -------------------------------------------------------------------
Net sales of $2,057,337 for the quarter ended June 30, 1996 represented an
increase in sales of 47% or $661,673 over the second quarter of 1995. Sales by
the composite products division increased from $997,965 in the second quarter of
1995 to $2,057,337 in the second quarter of 1996; an increase of 106%. This
increase was due to increased production focus on composites in conjunction with
partial start-up of a third extrusion line and increased product demand from a
larger customer base. The Company phased out of plastic sales to third parties
and completed re-deploying assets of the Rogers plastic division during the
second quarter. As part of that restructuring, certain plastics equipment, no
longer required, was traded for equipment required for a third composite line at
Junction, Texas and equipment for a second plastics reclamation line at the
Rogers facility. The plastics division focused on producing for composites and
set a production record during the second quarter of 1996.
Cost of goods sold was $1,943,021 for the second quarter of 1996 compared to
$1,541,314 for the second quarter of 1995. The overall cost of goods sold to
sales ratio showed improvement over 1995 and posted a positive gross margin of
$114,316 for the second quarter of 1996 vs. a negative $145,650 for the second
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. Significant categories are as follows:
<TABLE>
<CAPTION>
Expense Category 1996 1995
---------------- ---- ----
<S> <C> <C>
Payroll and payroll taxes $ 873,030 $ 491,782
Depreciation 296,410 221,303
Direct material costs 183,770 401,381
Other 589,811 426,848
---------- ----------
Total $1,943,021 $1,541,314
========== ==========
</TABLE>
Selling, general and administrative expenses were $406,118 vs. $351,695 during
the second quarter of 1995. The net loss for the quarter ended June 30, 1996
was $328,210, or a net loss per weighted average common share outstanding of
$.02. The loss compares to a loss of $571,154, or a net loss per weighted
average common share outstanding of $.04 for the three months ended June 30,
1995. The loss was attributable to costs associated with less than desired
operating efficiencies in conjunction with increased labor and marketing costs.
The Company commenced limited operation of a third extrusion line and ramped it
up to full production late in the second quarter, while also cross-training
additional employees for the start-up of a fourth extrusion line which is
scheduled for the third quarter of 1996. The composites division has
experienced unanticipated manufacturing difficulties over the last two quarters
which resulted in poor operating efficiencies and higher costs. As previously
disclosed, local and state law enforcement agencies are currently investigating
whether these problems are intentional. 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 which appear to be of an ongoing
nature. Management intends to continue to take such action as it deems
necessary to resolve and eliminate these manufacturing problems.
20
<PAGE>
The Company's limited production capacity and output had resulted in a
significant order backlog. To address the Company's current production backlog,
in addition to taking the various above described measures, the Company
has increased its manufacturing capacity through the addition of a third
production line at the Junction, Texas composites manufacturing unit and has
started construction of a fourth line which is scheduled for completion by
September 1996. The increased production of the Company's composite products
and accordingly, the composites division's increased raw-material requirements
has prompted the Company, in the first quarter of 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 Company anticipates contributing certain manufacturing
assets for a minority interest in the Company. The Company intends to license
its technologies to the new entity and it is anticipated that said entity will
manufacture composites materials under an exclusive contract with the Company.
The target date for start-up of the first phase of the new facility is the first
quarter of 1997.
The Company believes that the additional production lines at Junction and
Rogers, as well as the construction of the new composites facility should allow
the Company to reduce its existing backlog, thereby significantly increasing
sales and service to its existing customer base and to improve existing
operating efficiencies as a result of increased economies of scale. 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 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.
21
<PAGE>
Six-months ended June 30, 1996 compared to six-months ended June 30, 1995
- -------------------------------------------------------------------------
Cost of goods sold was $3,689,251 for the six-months ended June 30, 1996
compared to $2,913,595 for the first half of 1995. The overall cost of goods
sold to sales ratio showed a significant 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. Significant categories are as
follows:
<TABLE>
<CAPTION>
Expense Category 1996 1995
---------------- ---- ----
<S> <C> <C>
Payroll and payroll taxes $1,495,562 $1,028,176
Depreciation 569,929 466,012
Direct material costs 491,915 535,075
Other 1,131,845 884,332
---------- ----------
Total $3,689,251 $2,913,595
========== ==========
</TABLE>
Liquidity and Capital Resources
- -------------------------------
At June 30, 1996, the Company had a working capital deficit of $1,130,250
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 decreased in the first half of 1996. Significant components of that
decrease were: (i) cash used in operating activities of $814,960, which
consisted of the net loss for the period of $910,663, reduced by depreciation
and amortization of $591,196, and other uses of cash of $495,493; (ii) cash used
in investing activities of $674,311, and (iii) cash provided by financing
activities of $1,487,365. Payments on notes during the period were $374,538 and
proceeds from the issuances of notes amounted to $269,155. At June 30, 1996,
the Company had notes payable in the amount of $1,931,439, of which $822,298
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.
The Company maintains an accounts receivable factoring agreement for up to
$650,000 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 June 30, 1996, approximately $66,000 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 $1,243,371 at June 30, 1996, and a $433,097 revolving
line of credit to be available as needed. As of June 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
22
<PAGE>
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
June 1996. The Company expended approximately $788,416 during the second
quarter for a third and 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 1,666,893 shares of
Class A Common Stock to accredited overseas investors in a transactions exempt
under Regulation S of the Securities Act of 1933 for an aggregate purchase price
of $1,146,000 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.
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 September 1, 1996. 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.
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
23
<PAGE>
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 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. The Company
is currently evaluating its legal options, and has until September 13, 1996 to
further appeal the decision to the U.S. Supreme 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.
24
<PAGE>
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. As of this date,
these Motions are still stayed before the Delaware Court. 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/ David C. Chapman
-------------------------------------------
David C. Chapman, Chief Financial Officer
DATE: August 14, 1996
26
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