<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 March 31, 1997
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 May 14, 1997, 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 19,201,148 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
PAGE
ITEM 1 Financial Statements
Balance Sheets, March 31, 1997 and December 31, 1996 1-2
Statements of Operations,
Three months ended March 31, 1997 and 1996 3
Statements of Cash Flows,
Three months ended March 31, 1997 and 1996 4
Notes to Financial Statements 5-10
Review Report of Arthur Andersen LLP,
Independent Public Accountants 11
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-16
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 17-18
Signatures 19
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
-----------------------------
<S> <C> <C>
March 31, 1997 December 31,
(Unaudited) 1996
----------- ----
Current assets:
Cash and cash equivalents $ 29,131 $ 82,756
Receivables
Insurance 754,008 1,001,657
Trade 676,201 9,280
Inventories 550,750 593,325
Prepaid expenses and other 100,459 87,381
---------- ----------
Total current assets 2,110,549 1,774,399
---------- ----------
Buildings and equipment,
at cost, including construction
in progress of $838,709 at 3-31-97, and
$838,709 at 12-31-96:
Buildings 687,509 687,509
Machinery and equipment 6,876,974 6,791,709
Transportation equipment 135,527 135,527
Office equipment 174,062 172,597
---------- ----------
7,874,072 7,787,342
Less accumulated depreciation
and amortization 3,447,340 3,182,679
---------- ----------
Net buildings and equipment 4,426,732 4,604,663
---------- ----------
Other assets, at cost less accumulated
amortization of $113,990 (1996), and
$107,798 (1995), respectively 344,680 346,487
---------- ----------
$6,881,961 $6,725,549
========== ==========
</TABLE>
The accompanying notes to the financial statements should be read in conjunction
with these statements.
1
<PAGE>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
<CAPTION>
March 31, 1997 December 31,
(Unaudited) 1996
--------------- -------------
<S> <C> <C>
Current liabilities:
Accounts payable - trade $ 1,100,862 $ 1,224,711
Accounts Payable - related parties 1,192,171 468,715
Current maturities of long-term debt 768,853 705,344
Accrued liabilities 293,872 207,065
Notes payable - 61,559
------------ ------------
Total current liabilities 3,355,758 2,667,394
------------ ------------
Long-term debt, less current maturities - Related parties 719,094 799,554
Other 80,172 156,222
------------ ------------
Total long-term debt 799,266 955,776
------------ ------------
Commitments and contingencies
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, 19,201,148 (1997)
and 19,201,148 (1996) shares issued and outstanding 192,012 192,012
Class B convertible common stock, $.01 par
value; 7,500,000 shares authorized, 1,465,530 (1997)
and 1,465,530 (1996) shares issued and outstanding 14,655 14,655
Additional paid in capital 21,777,450 21,533,450
Accumulated Deficit (19,257,180) (18,637,738)
Total stockholders' equity ------------ ------------
2,726,937 3,102,379
------------ ------------
$ 6,881,961 $ 6,725,549
============ ============
</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 Three months
ended ended
March 31, March 31,
1997 1996
------------- -------------
<S> <C> <C>
Sales $ 1,747,802 $ 1,601,778
Cost of Goods Sold 1,993,546 1,746,229
----------- -----------
Gross Margin
(245,744) (144,451)
Selling and Administrative Costs
338,138 377,269
Operating Loss ----------- -----------
Other Income (Expense) (583,882) (521,720)
Other Income
Interest Expense
- 7
Net loss (35,559) (60,740)
----------- -----------
$ (619,441) $ (582,453)
=========== ===========
Net loss per share of
common stock ($.03) ($.03)
=========== ===========
Weighted average number of
common shares outstanding 20,666,678 17,521,033
=========== ===========
</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>
Three months Three months
ended ended
March 31, March 31,
1997 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (619,441) $(582,453)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 264,661 277,998
Amortization of other assets 6,192 6,117
Increase in other assets (4,385) (14,600)
Changes in operating assets & operating liabilities 46,638 89,837
---------- ---------
Net cash used in operating activities (306,335) (223,101)
---------- ---------
Cash flows from investing activities:
Insurance proceeds 250,000 -
Additions to buildings and equipment (86,730) (9,005)
---------- ---------
Net cash provided by (used in) investing activities 163,270 (9,005)
---------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes - 75,551
Payments on notes (154,560) (158,229)
Proceeds from stock subscriptions 244,000 305,000
---------- ---------
Net cash provided by financing activities 89,440 222,322
---------- ---------
Decrease in cash & cash equivalents (53,625) (9,784)
Cash and cash equivalents:
Beginning of period 82,756 15,350
---------- ---------
End of period $ 29,131 $ 5,566
========== =========
</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. Accordingly, the Company has
reclassified certain prior period amounts to conform to the current period
presentation.
Note 2: Organization and Description of the Company
- ----------------------------------------------------
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 was
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.
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 March 31, 1997, the Company had a working capital deficit of
$1,245,209 and had incurred net losses of $619,441 for the three months ended
March 31, 1997. The Company, since inception,
5
<PAGE>
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. Further, 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 6, the outcome
of which is uncertain. There can be no assurance that the Company's financial
resources will be adequate to support existing operations until such time, if
ever, sales and manufacturing levels are sufficient to generate positive cash
flow from operations. Further, if the litigated claims discussed in Note 6 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 financial statements
do not include any adjustments relating to the recoverability and classification
of recorded asset amounts or the amount and classification of liabilities that
might result should the Company be unable 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 products at economically
feasible levels.
The Company has developed, and is currently implementing, a production plan
which Management believes will provide for better operating efficiencies and
correct the production problems encountered in the past. Such plan includes
increasing production capacity, changes to production management, further
automation of the production process and better utilization of regrindable
scrap. The Company is also seeking to raise approximately $2.2 million in an
offering of preferred stock, and believes that such capital will be sufficient
to support the Company until such time as the Company achieves positive cash
flow from operations. However, it is possible additional financial resources
may be necessary to fund maturities of debt and other obligations as they come
due. There is no assurance the Company will be able to correct prior production
problems and, improve operating efficiencies or that the Company will be
successful in securing sufficient capital resources to support the Company until
such time, if ever, the Company is able to generate positive cash flow.
Effective October 1, 1995, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of. SFAS No. 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 March 31, 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 future production volumes will significantly
increase over previous historical production levels achieved by the
6
<PAGE>
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 nine months of 1997 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 $4,426,732 at March 31, 1997.
Note 4: Statement 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, 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>
Three months Three months
ended ended
March 31, 1997 March 31, 1996
(unaudited) (unaudited)
-------------- --------------
<S> <C> <C>
Receivables $(669,273) $(100,927)
Inventories 42,575 171,279
Prepaid expenses and other (13,078) 60,477
Accounts payable -
trade & related parties 599,607 (63,104)
Accrued liabilities 86,807 22,112
--------- ---------
46,638 $ 89,837
========= =========
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
Three months Three months
ended ended
March 31, 1997 March 31, 1996
(unaudited) (unaudited)
-------------- --------------
<S> <C> <C>
Cash paid for interest $35,522 $52,763
Cash paid for taxes - -
</TABLE>
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Note 5: Significant Accounting Policies
- ---------------------------------------
Inventories
-----------
Inventories are stated at the lower of cost (first-in, first-out method) or
market. Inventories consisted of the following:
<TABLE>
<CAPTION>
March 31, 1997 December 31,
(Unaudited) 1996
--------------- ------------
<S> <C> <C>
Raw materials $191,084 $210,483
Work in process 319,457 351,477
Finished goods 40,209 31,365
-------- --------
$550,750 $593,325
======== ========
</TABLE>
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.
Recently Issued Accounting Standards
------------------------------------
In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". This statement provides accounting and
reporting standards for, among other things, the transfer and servicing of
financial assets, such as factoring receivables with recourse and will require
the Company to classify its financial assets pledged as collateral separately in
the financial statements. This statement is effective for transactions
occurring after December 31, 1996, and is to be applied prospectively. Earlier
or retroactive application is not permitted. In
8
<PAGE>
December 1996, the FASB issued SFAS No. 127, "Deferral of the Effective Date of
Certain Provisions of SFAS No. 125," SFAS No. 127 moves forward some, but not
all, of the provisions of SFAS No. 125 to December 31, 1997. The Company
presently factors, with recourse, receivables to a related party. Effective
January 1, 1997, the Company adopted SFAS No. 125.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." SFAS No.
128 replaces the presentation of Primary Earnings Per Share (EPS) with Basic EPS
and requires dual presentation of Basic and Diluted EPS on the face of the
statements of operations and requires a reconciliation of the numerator and
denominator of the Basic EPS computation to the numerator and denominator of the
Diluted EPS computation. Basic EPS excludes dilution and is computed by
dividing income available to common shareholders by the weighted-average number
of common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the Company. Diluted EPS is
computed similarly to Fully Diluted EPS pursuant to Accounting Principles Board
Opinion No. 15, "Earnings Per Share." SFAS No. 128 is effective for financial
statements of issued after December 15, 1997, and earlier application is not
permitted. SFAS No. 128 requires restatement of all prior-period EPS data
presented.
Note 6: 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.
9
<PAGE>
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. The
March 14, 1995 motion is currently stayed 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, 1996, the U.S. Court of Appeals reversed a
portion of the earlier ruling that two of the patents were invalid, and that
Mobil did not infringe. The Company did not further appeal this issue to the
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.
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. The Motion is currently
stayed. With the recent appeals court ruling upholding the invalidity of two
patents and the ruling of inequitable conduct, the Company has been advised that
if and when the court decides to entertain Mobil's motion for the attorney's
fees, and if and when Mobil decides to submit documentation and substantiate its
claim, that the Company could face possible risk from an adverse decision from
the court by awarding a portion of said fees to Mobil. The Company has been
advised in a worse case scenario that it could face an aggressive challenge
against it for a significant portion of the said $2.7 million attorney's fees in
an attempt to end this litigation prior to the company's prejudicial misconduct
motion or pending counterclaims against Mobil being heard. 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
believes that the Mobil motion for attorney's fees and the AERT prejudicial
misconduct motion for a new trial could be addressed sometime during 1997 by the
Delaware Court. The Company has not recorded any liability related to such
litigation at March 31, 1997.
10
<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 March 31, 1997, and
the related statements of operations and cash flows for the three-month periods
ended March 31, 1997 and 1996. 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
San Antonio, Texas
May 6, 1997
11
<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 (the
"Rogers Facility") and a composites manufacturing facility in Junction, Texas
(the "Junction 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: (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 experienced a series of
extensive fires that caused substantial damage during the last half of 1996 at
its Rogers, Arkansas plastic reclamation facility. These fires in September and
December of 1996 halted the Company,s plastic reclamation program and limited
composite sales growth. As of this date, the Company has received notification
that the insurance company has concluded the property claim of $1.95 million is
compensable under the terms and conditions of the policy and there are some
differences in the measure of loss which the Company plans to resolve in the
second quarter. The Company to date has received $1.1 million in advances from
the insurance carrier. The Company is currently rebuilding said facility and
intends to resume operations during the second quarter of 1997. Although the
Company has established alternate supply sources and is currently meeting its
customers minimum requirements, it will require the Rogers facility to come back
on line to provide the quality, consistency, and volume of plastic required for
the Company to continue to increase composite sales to a level required to
attain profitability.
The Company, in conjunction with the fires at the Rogers facility mentioned
above, has also experienced production difficulties associated with raw material
problems with its plastic supplies, created when the Company had to purchase all
plastic from outside vendors due to the above mentioned fires. The Company was
also restrained in its efforts to further increase sales due to production
limitations and inefficiences at the Junction,
12
<PAGE>
Texas composites facility. The Company currently operates three extrusion lines
at the Junction facility and due to increased composite sales demands is working
to expand its composite manufacturing capacity by the addition of a fourth
extrusion line in the near future. The Company is also working to establish an
additional composite manufacturing capability with Sutton Engineered Wood
Products near Harrison, Arkansas.
Due to the significant amount of loss from the two Rogers, Arkansas fires
experienced during the second half of 1996, the Company was notified that its
fire insurance carrier had chosen not to renew the policy when it expired on May
1997. The Company has been able to secure coverage for another year through a
different carrier with an increase in premium and the deductible but with no
lapse in coverage.
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 expands
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.
Also, the Company's marketing focus utilizes outside commissioned sales
representatives for a portion of its door and window accounts.
Results of Operations
- ---------------------
Quarter ended March 31, 1997 compared to quarter ended March 31, 1996
- ---------------------------------------------------------------------
Net sales of $1,747,802 for the quarter ended March 31, 1997 represented an
increase in sales of 9% or $146,024 over the first quarter of 1996. Although
there was an increase over the first quarter of 1996 and the Company continued
to have a backlog of orders for its products, the Company was restrained in its
efforts to further increase sales primarily due to the limited supply and
quality of the raw material plastic. Sales during the quarter show a further
correlation with this problem, with monthly sales of $409,038, $640,112, and
$708,863 for January, February and March, respectively as the Company dealt with
the problem of securing additional plastic vendors after the December 1996 fire
at the Rogers facility.
Cost of goods sold was $1,993,546 for the first quarter of 1997 compared to
$1,746,229 for the first quarter of 1996. Real dollars and the overall cost of
goods sold to sales ratio increased from 1996 due to increased sales and less
than desirable operating efficiencies at the Junction facility. The Company,s
material and labor costs were adversely impacted by the quality and consistency
of the outside vendor raw material plastic. In addition, these costs increased
due to excessive scrap rates and inefficient utilization of the regrindable
scrap primarily occurring in the month of January. Significant categories are
as follows:
13
<PAGE>
<TABLE>
<CAPTION>
Expense Category 1997 1996
---------------- ---- ----
<S> <C> <C>
Payroll and payroll taxes $ 684,354 $ 622,532
Depreciation 260,158 273,519
Direct material costs 428,699 308,125
Other 620,335 542,053
---------- ----------
Total $1,993,546 $1,746,229
========== ==========
</TABLE>
Selling, general and administrative expenses were $338,138 vs. $377,269 during
the first quarter of 1996. The decrease in selling, general, and administrative
expenses is primarily attributed to decreased professional fees and the
Company,s efforts to reduce overhead and streamline operations.
The net loss for the quarter ended March 31, 1997 was $619,441, or a net loss
per weighted average common share outstanding of $.03. The loss compares to a
loss of $582,433, or a net loss per weighted average common share outstanding of
$.03 for the three months ended March 31, 1996. The losses by month were
$408,521, $132,913, and $78,007 for January, February, and March, respectively.
The loss can be attributed to less than anticipated sales due to limited supply
and quality of raw material plastic and less than desirable operating
efficiencies at the Junction facility primarily occurring in the month of
January.
The Company has developed, and is currently implementing, a production plan
which Management believes will provide for better operating efficiencies and
correct the production problems encountered in the past. Such plan includes
increasing production capacity, changes to production management, further
automation of the production process and better utilization of regrindable
scrap. The Company has restructured its operations management regarding the
composites division bringing in a new chief operating officer in February of
1997, and believes that with the planned additional production line, as well as
resuming plastic production at the Rogers facility, the Company should be able
to reduce its existing backlog, thereby significantly increasing sales 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 financial 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.
Liquidity and Capital Resources
- -------------------------------
At March 31, 1997, the Company had a working capital deficit of $1,245,209
compared to a working capital deficit of $1,781,768 at December 31, 1996. The
decrease is primarily attributable to the Company's 1996 recording of a
receivable from the insurance company regarding the Rogers fire. Cash and cash
equivalents decreased $53,625 in the first quarter of 1997. Significant
components of that decrease were: (I) cash used in
14
<PAGE>
operating activities of $306,335, which consisted of the net loss for the period
of $619,441, reduced by depreciation and amortization of $271,101 and other uses
of cash of $46,638; (ii) cash provided by investing activities of $163,270, and
(iii) cash provided by financing activities of $89,440. Payments on notes during
the period were $154,560 and there were no proceeds from the issuances of notes.
At March 31, 1997, the Company had notes payable in the amount of $1,568,119, of
which $768,853 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
$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 March 31, 1997, approximately $102,389 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 $1,355,607 at March 31, 1997, and a $433,097 revolving
line of credit to be available as needed. As of March 31, 1997, 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. 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. To
finance existing operations and required capital expenditures, the following
transactions were completed during or subsequent to the first quarter: (I) the
Company received $244,000 cash relating to an offering to qualified foreign
investors under Regulation S of the Securities Act of 1933.
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 will be able to 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 for ongoing operations, or were it to be assessed
the Mobil legal claims described in Note 6 to the financial statements, it is
likely the Company would be unable to continue as a going concern.
The foregoing discussion contains certain estimates, predictions, projections
and other "forward-looking statements" (within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934)
that involve various risks and uncertainties. While these forward-looking
statements, and
15
<PAGE>
any assumptions upon which they are based, are made in good faith and reflect
the Company's current judgment regarding the direction of its business, actual
results will almost always vary, sometimes materially, from any estimates,
predictions, projections, assumptions, or other future performance suggested
herein. Some important factors (but not necessarily all factors) that could
affect the Company's sales volumes, growth strategies, future profitability and
operating results, or that otherwise could cause actual results to differ
materially from those expressed in any forward-looking statement include the
following: market, political or other forces affecting the pricing and
availability of plastics and other raw material accidents or other unscheduled
shutdowns affecting the Company's, its suppliers' or its customers' plants,
machinery, or equipment; competition from products and services offered by other
enterprises; state and federal environmental, economic, safety and other
policies and regulations, any changes therein, and any legal or regulatory
delays or other factors beyond the Company's control; execution of planned
capital projects; weather conditions affecting the Company's operations or the
areas in which the Company's products are marketed; adverse rulings, judgments,
or settlements in litigation or other legal matters. The Company undertakes no
obligation to publicly release the result of any revisions to any such forward-
looking statements that may be made to reflect events or circumstances after the
date hereof or to reflect the occurrence of unanticipated events.
16
<PAGE>
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 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. The
March 14, 1995 motion is currently stayed before the Delaware Court. The
Company filed an appeal with the U.S. Court of
17
<PAGE>
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, 1996, the
U.S. Court of Appeals reversed a portion of the earlier ruling that two of the
patents were invalid, and that Mobil did not infringe. The Company did not
further appeal this issue to the 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.
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. The Motion is currently
stayed. With the recent appeals court ruling upholding the invalidity of two
patents and the ruling of inequitable conduct, the Company has been advised that
if and when the court decides to entertain Mobil's motion for the attorney's
fees, and if and when Mobil decides to submit documentation and substantiate its
claim, that the Company could face possible risk from an adverse decision from
the court by awarding a portion of said fees to Mobil. The Company has been
advised in a worse case scenario that it could face an aggressive challenge
against it for a significant portion of the said $2.7 million attorney's fees in
an attempt to end this litigation prior to the companies prejudicial misconduct
motion or pending counterclaims against Mobil being heard. The Company will
vigorously defend against Mobil's claim for attorney's fees and costs, however,
there can be no assurances as to the outcome of this litigation. The Company
believes that the Mobil motion for attorney's fees and the AERT prejudicial
misconduct motion for a new trial could be addressed sometime during 1997 by the
Delaware Court. The Company has not recorded any liability related to such
litigation as of March 31, 1997.
18
<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.
BY: /s/ Joe G. Brooks BY: /s/ Jake M. Bushey
- ----------------------- ----------------------
JOE G. BROOKS JAKE M. BUSHEY
President Corporate Controller
Date: May 14, 1997 May 14, 1997
------------ ------------
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 29,131
<SECURITIES> 0
<RECEIVABLES> 1,430,209
<ALLOWANCES> 0
<INVENTORY> 550,750
<CURRENT-ASSETS> 2,110,549
<PP&E> 7,874,072
<DEPRECIATION> 3,447,340
<TOTAL-ASSETS> 6,881,961
<CURRENT-LIABILITIES> 3,355,758
<BONDS> 0
0
0
<COMMON> 206,667
<OTHER-SE> 2,520,270
<TOTAL-LIABILITY-AND-EQUITY> 6,881,961
<SALES> 1,747,802
<TOTAL-REVENUES> 1,747,802
<CGS> 1,993,546
<TOTAL-COSTS> 2,331,684
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 35,559
<INCOME-PRETAX> (619,441)
<INCOME-TAX> 0
<INCOME-CONTINUING> (619,441)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (619,441)
<EPS-PRIMARY> (.03)
<EPS-DILUTED> (.03)
</TABLE>
