<PAGE> 1
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, 1999
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)
801 N. Jefferson Street
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 June 30, 1999 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 23,515,497 and the number of shares outstanding of the Registrant's
Class B Common Stock was 1,465,530.
<PAGE> 2
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
FORM 10-Q INDEX
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
PAGE
----
<S> <C>
ITEM 1 Financial Statements
Balance Sheets, June 30, 1999 (Unaudited)
and December 31, 1998 1-2
Statements of Operations, (Unaudited)
Three Months and Six Months Ended June 30, 1999 and 1998 3
Statements of Cash Flows, (Unaudited)
Six Months Ended June 30, 1999 and 1998 4
Notes to Financial Statements 5-15
Review Report of Independent Public Accountants 16
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 17-25
ITEM 3 Quantitative and Qualitative Disclosure about Market Risk 25
ITEM 4 Year 2000 Update 25
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 26-27
Signatures 28
</TABLE>
<PAGE> 3
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
June 30, 1999 December 31,
(unaudited) 1998
----------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 543,364 $ 614,494
Trade receivables, net of allowance of
$10,000 (1999) and $20,000 (1998) 1,408,704 712,894
Inventories 875,867 846,571
Prepaid expenses and other 200,755 89,266
----------- -----------
Total current assets 3,028,690 2,263,225
----------- -----------
Buildings and equipment:
Buildings and leasehold improvements 994,981 1,041,035
Machinery and equipment 12,950,947 10,937,425
Transportation equipment 162,017 108,355
Office equipment 178,060 159,295
Construction in progress 2,058,040 1,502,520
----------- -----------
16,344,045 13,748,630
Less accumulated depreciation
and amortization 6,369,305 5,452,638
----------- -----------
Net buildings and equipment 9,974,740 8,295,992
Other assets, at cost less accumulated
amortization of $285,874 (1999)
and $271,570 (1998) 435,598 382,710
----------- -----------
$13,439,028 $10,941,927
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE> 4
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
June 30, 1999 December 31,
(unaudited) 1998
------------ ------------
<S> <C> <C>
Current liabilities:
Accounts payable - trade $ 3,704,825 $ 2,606,034
Accounts payable - related parties 1,293,834 895,170
Current maturities of long-term debt:
Related parties 625,836 648,425
Other 138,970 199,873
Current maturities of capital lease obligation 20,436 19,263
Accrued liabilities 432,078 435,070
Notes payable - related parties 300,000 --
Notes payable - other, net of debt discount
of $45,255 (1998) 2,003,054 2,085,325
------------ ------------
Total current liabilities 8,519,033 6,889,160
------------ ------------
Long-term debt, less current maturities:
Related parties -- 97,707
Other 8,117 52,747
------------ ------------
Total long-term debt 8,117 150,454
------------ ------------
Capital lease obligation 66,060 76,922
------------ ------------
Accrued dividends payable on convertible
preferred stock 191,698 47,890
------------ ------------
Commitments and contingencies (Note 6)
Stockholders' equity:
Preferred stock, $1 par value; 5,000,000
shares authorized, 2,900 shares issued and 2,900 2,900
outstanding
Class A common stock, $.01 par value;
50,000,000 shares authorized, 23,515,497 (1999)
and 22,245,639 (1998) shares issued and 235,155 222,456
outstanding
Class B convertible common stock, $.01 par
value; 7,500,000 shares authorized, 1,465,530
shares issued and outstanding 14,655 14,655
Additional paid-in capital 28,086,342 26,984,318
Accumulated deficit (23,684,932) (23,446,828)
------------ ------------
Total stockholders' equity 4,654,120 3,777,501
------------ ------------
Total liabilities and stockholders' equity $ 13,439,028 $ 10,941,927
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 5
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
---------------------------- ----------------------------
1999 1998 1999 1998
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales $4,806,709 $ 2,793,323 $ 9,340,983 $ 5,300,623
Cost of goods sold 4,003,424 2,821,617 7,628,166 5,044,107
---------- ----------- ----------- -----------
Gross margin 803,285 (28,294) 1,712,817 256,516
Selling and administrative costs 867,476 821,847 1,582,324 1,467,031
---------- ----------- ----------- -----------
Operating income (loss) (64,191) (850,141) 130,493 (1,210,515)
Interest expense, net (108,742) (345,316) (224,789) (503,883)
---------- ----------- ----------- -----------
Loss before dividends on
convertible preferred stock (172,933) (1,195,457) (94,296) (1,714,398)
Accrued dividends on convertible
preferred stock (72,301) -- (143,808) --
---------- ----------- ----------- -----------
Net loss applicable to common stock $ (245,234) $(1,195,457) $ (238,104) $(1,714,398)
========== =========== =========== ===========
Net loss per share of common
stock (Basic and Diluted) $ (.01) $ (.05) $ (.01) $ (.08)
========== =========== =========== ===========
Weighted average number of common shares
outstanding 24,328,586 22,320,249 24,078,311 22,173,620
========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 6
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Six Months Six Months
Ended Ended
June 30, 1999 June 30, 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (238,104) $(1,714,398)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization 916,667 608,513
Amortization of other assets 61,441 220,097
Amortization of debt discount 45,255 324,038
Dividends accrued on convertible
preferred stock 143,808 --
Interest paid through issuance of Class A
common stock 124,115 102,867
Provision for doubtful accounts (10,000) --
Loss on disposition of equipment -- 1,964
(Increase) decrease in other assets (67,192) 1,817
Changes in current assets and current liabilities 727,519 824,646
----------- -----------
Net cash provided by operating activities 1,703,509 369,544
----------- -----------
Cash flows from investing activities:
Additions to buildings and equipment (2,595,415) (2,398,964)
Insurance proceeds -- 4,722
----------- -----------
Net cash used in investing activities (2,595,415) (2,394,242)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of notes 300,000 1,138,342
Payments on notes (460,143) (133,600)
Payments on capital lease obligations (9,689) (7,740)
Proceeds from exercise of stock options and
warrants 990,608 988,571
----------- -----------
Net cash provided by financing activities 820,776 1,985,573
----------- -----------
Decrease in cash and cash equivalents (71,130) (39,125)
Cash, beginning of period 614,494 45,428
----------- -----------
Cash, end of period $ 543,364 $ 6,303
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 7
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. The Company has reclassified
certain prior period amounts to conform to the current period presentation.
Note 2: Description of the Company
The Company manufactures a line of composite building materials from reclaimed
plastic and wood fiber waste for certain specialized applications in the
construction industry. The Company markets this material as a substitute for
wood and plastic filler materials for standard door components, windowsills,
industrial flooring and decking. The Company is comprised of two manufacturing
facilities located in Junction, Texas and Springdale, Arkansas. The Company's
customers primarily consist of a number of regional and national door and window
manufacturers, industrial flooring companies and Weyerhaeuser, the Company's
primary decking customer.
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. Up until and through December 31, 1998, the Company had incurred
operating losses in each year since its inception and through that date had
never operated at successful manufacturing levels until 1999. The losses have
primarily been caused by problems in maintaining significant production volumes
of products and in producing products at economically feasible operating cost
levels. There is no assurance the Company will be able to improve its
manufacturing process and
5
<PAGE> 8
operating costs to the extent necessary to reach successful operating levels. At
June 30, 1999, the Company had a working capital deficit of $5,490,343.
In July 1999, Nasdaq sent the Company correspondence stating its "concerns over
the Company's ability to sustain compliance with the Nasdaq's continuing
inclusion requirements" and asked the Company about the bond closing delays, its
negative working capital position, its plans to remedy its auditor's going
concern opinion and concerns about potential issuance of more shares. Nasdaq
also requested certain information from the Company for it to evaluate. The
Company submitted information in late July, and awaits further correspondence
from Nasdaq.
Delisting of the Company's common stock results in a redemption event under the
preferred stock agreements. However, the holders of the preferred stock have no
right to deliver a redemption notice following the occurrence of a redemption
event relating to delisting of the Company's stock, if the Company pays to each
preferred stock holder within five business days after the occurrence of such
redemption event, as liquidated damages for the decrease in the value of the
preferred stock, which will result from the occurrence of such event, an amount
equal to 10% of the aggregate stated value of the shares of preferred stock
then held by each holder. The amount shall be payable, at the Company's option,
in cash or shares of common stock (based upon a price per share of common stock
equal to 90% of the variable conversion price in effect (or which would have
been in effect if a milestone failure had previously occurred) as of the date
of such redemption event.) If such a redemption event were to occur, it is the
Company's intention to pay the above penalty in shares of the Company's common
stock. Holders of the Company's preferred stock have the right to present the
preferred stock for redemption to the Company in the amount of $2.9 million, if
the above payments are not made, and would result in the immediate
reclassification of the preferred stock out of stockholders' equity, reducing
the Company's net assets below the threshold of $2 million for both continued
and initial listing of the stock. A preferred stock redemption would result in
a $2.9 million decrease in the Company's net assets. Delisting of the Company's
stock also results in an event of default under the bridge financing
agreements. An event of default results in all the then outstanding principal
amounts and unpaid interest becoming due and payable immediately. It is
unlikely that the Company would have the financial resources to redeem the
preferred stock if the holders were to present such stock for redemption or
have the ability to pay its obligations under the bridge financing agreements.
Delisting would result in the Company's stock being moved to over-the-counter
bulletin board, which could result in less liquidity for the holders of the
Company's stock.
In the past few years, the Company has been supported, in large part, by certain
major shareholders in conjunction with several accredited investors. As of June
30, 1999, approximately $3.16 million had been initially borrowed in a series of
bridge loans, and the Company had converted and/or repaid approximately
$1,050,000 of said amount as of November 10, 1998, through a placement of
preferred stock. The Company paid down an additional $104,615 as of March 31,
1999, and an additional $95,385 in April 1999, in lieu of any penalty warrants.
The bridge note holders have extended the remaining $1.9 million until September
30, 1999. During the second quarter, the majority shareholder loaned the Company
$300,000, which is due on demand. There is no commitment for such shareholders
to continue such support or for the bridge holders to restructure their
remaining notes.
The Company also has claims in litigation outstanding against it as described in
Note 6. The outcome of the litigation is still uncertain. 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
6
<PAGE> 9
adjustments relating to the recoverability and classification of asset carrying
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 continue to improve efficiencies and mass produce and market its
products at economically feasible levels, while sustaining positive cash flows
and increasing profitability.
During 1998, the Company issued a series of voting and non-voting, convertible
preferred stock, which raised an additional $2.9 million in equity. The
preferred stock agreements required that the Company file a registration
statement by June 1, 1999, to register the preferred stock and the common stock
required in relation to the attached warrants. The Company has not yet filed the
necessary registration statement, but the holders of the preferred stock and
warrants have waived any penalties due from the Company for not filing the
registration statement by the June 1 deadline through September 30, 1999. If the
registration statement is not filed and effective by September 30, 1999, the
Company may be required to pay certain penalties to the holders of the preferred
stock and warrants. The penalties increase over time until the registration
statement is filed and/or effective. The preferred stock agreements contain
potential redemption events, which would cause the Company to have to redeem the
preferred stock.
The Company is currently pursuing a $19,500,000 bond-financing package through
the City of Springdale, Arkansas, in conjunction with the Arkansas Development
Finance Authority for acquisition and further expansion of the Arkansas
facility. The financing package was recently approved by the City Council of
Springdale, Arkansas. Bond proceeds of $10.4 million are dedicated to be used to
expand output capacity. The expansion will involve the Company acquiring
approximately 18 acres adjacent to the existing Springdale facility,
construction of a three building campus and installation of additional
manufacturing lines and other equipment. Bond proceeds of $1,750,000 must be
used to acquire the existing Springdale plant, which is currently leased. Bond
proceeds are also allocated to be used to refinance up to $2,000,000 of bridge
financing. The remaining proceeds would be used for a debt service reserve fund,
one year of construction period interest and financing costs. The Company is
working to finalize and close this bond-financing package during the third
quarter of 1999. There is no assurance that the Company will be successful in
its efforts to complete the above described bond financing in a timely manner,
and the Company may request an allocation extension with the State of Arkansas
if necessary. The Company does not intend to further expand and continue
construction beyond the third extrusion line in Springdale without the
successful completion of the pending bond financing.
7
<PAGE> 10
The Company began implementing a production plan in 1998, which was designed to
focus and streamline production at two plants and increase sales to levels
sufficient to support operations. Although the Company is nearing completion of
its initial production plan as it works to finish construction of the third
Arkansas extrusion line and implement additional plastic recycling equipment, it
will require an additional $600,000 to complete this work, of which management
has a plan to accomplish this and bring it online. Also, additional financial
resources will be necessary to fund maturities of debt and other obligations as
they come due late in 1999, if the pending $19.5 million bond issue is not
successfully completed in a timely manner. The Company could also be assessed
penalty warrants by its bridge lender, which could result in a charge against
earnings, if assessed. The Company is working on a contingency plan that would
allow refinancing and paying down its construction payables if this happens,
which includes increasing production, sales and margins through better
utilization of existing assets (i.e. streamlining production) in conjunction
with the start-up of the additional extrusion line in Springdale. The Company
expects this line to increase cash flows and sales. Cash flows from operations
for the first six months of 1999 exceeded $1.7 million. Management believes
further operations improvements during the subsequent quarters will continue to
increase cash flows. Thus, the Company believes successful completion of its
plan combined with increased production capacity will allow it to attain its
financial objectives, reduce payables and eliminate its negative working capital
during 1999. There is no assurance that the Company will be able to further
improve operating efficiencies and attain its desired profitability level. The
Company believes it has sufficient capital resources to complete its initial
production plan including completion of the third extrusion line during the
second half of 1999.
The Company also believes it can restructure debt and other obligations, as they
become due in 1999, if necessary, although the terms may be more expensive.
There is no assurance that the Company will be able to successfully complete the
above mentioned refinancing plan or continue to improve and sustain operating
efficiencies beyond current levels. There is no assurance that the Company will
be successful in securing sufficient capital resources to support the Company
until such time as the Company is able to generate positive cash flow sufficient
to support its operations for a sustained period of time, reduce its current
payables or fund maturities of debt and other obligations as they become due.
8
<PAGE> 11
Note 4: Statements of Cash Flows
In order to determine net cash provided by operating activities, net loss has
been adjusted by, among other things, changes in operating assets and operating
liabilities, excluding changes in cash and cash equivalents, current maturities
of long-term debt and current notes payable. 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, 1999 June 30, 1998
(unaudited) (unaudited)
------------- -------------
<S> <C> <C>
Receivables $ (685,810) $ (223,335)
Note receivable -- 14,000
Inventories (29,296) 116,141
Prepaid expenses and other (51,838) (158,369)
Accounts payable -
trade and related parties 1,497,455 913,848
Accrued liabilities (2,992) 162,361
----------- -----------
$ 727,519 $ 824,646
=========== ===========
Cash paid for interest $ 59,879 $ 13,076
Cash paid for income taxes -- --
</TABLE>
The Company considers all highly liquid investments, with a maturity of three
months or less when purchased, to be cash equivalents.
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
<TABLE>
<CAPTION>
Six Months Ended Six Months Ended
June 30, 1999 June 30, 1998
unaudited unaudited
---------------- ----------------
<S> <C> <C>
Notes payable for financing
of insurance policies $106,788 $104,027
Notes payable for equipment -- 140,006
Capital lease obligation for equipment -- 110,000
</TABLE>
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<PAGE> 12
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>
June 30, 1999 December 31,
(unaudited) 1998
------------- ------------
<S> <C> <C>
Raw materials $549,588 $486,068
Work in process 215,005 263,573
Finished goods 111,274 96,930
-------- --------
$875,867 $846,571
======== ========
</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.
SFAS No. 121
The Company has 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
No. 121 and has determined that no impairment loss was required as of June 30,
1999. 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 Springdale and Junction
manufacturing facilities. The Company's estimates of these factors are based
upon
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<PAGE> 13
management's belief that future production volumes will significantly increase
over previous historical production levels achieved by the Company's
manufacturing facilities and that future production costs per unit will also
significantly decrease below previous historical cost levels.
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
subsequent to the completion of its production plan 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 Springdale and
Junction manufacturing facilities, which was $9,974,740 at June 30, 1999.
Note 6: Commitments and Contingencies
In June 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.
In December 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
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<PAGE> 14
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.
In March 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
that 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. In 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. 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 at present cannot predict when the Mobil Motion for
Attorneys' Fees and the AERT Prejudicial Misconduct Motion for a New Trial will
be addressed, or if ever, by the Delaware Court. The Company has not recorded
any liability related to such litigation at June 30, 1999. Mobil Oil divested
its composites business in 1996, and no longer directly competes with the
Company.
In June 1998, the Company received formal issuance from the United States Patent
and Trademark Office concerning a related product by process patent application,
which had been pending throughout the litigation. This is an application, which
was filed on the same date as those currently in litigation, although
substantial additional disclosures have been made.
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<PAGE> 15
Note 7: NASDAQ Listing Requirements
The Company's Class A Common Stock is traded in the over-the-counter market and
is listed on The Nasdaq Stock Market(R) under the symbol AERTA. In order to
remain listed on Nasdaq, the Company is required to meet certain criteria
(maintenance standards) established by Nasdaq. One such maintenance standard is
a minimum bid price of $1.00 per share. The Company has been formally notified
by Nasdaq of increased listing and maintenance standards for both the Nasdaq
National and Small Cap Markets. The increased Nasdaq listing standards went into
effect on February 23, 1998. The increased listing and maintenance standards
include a minimum bid $1.00 common stock price and a $2 million net asset value.
On October 13, 1998, the Company was notified that it did not meet the $1.00
minimum bid price for continued listing. The Company was given ninety days,
until January 13, 1999, to regain compliance. The Company did not achieve
compliance during the grace period and subsequently requested a hearing. On
March 12, 1999, the Company attended a hearing in the matter of the continued
listing of the Company's stock in The Nasdaq Stock Market, presented its plan to
regain compliance, and requested additional time to comply. On May 7, 1999,
after a review of the Company, Nasdaq decided to continue listing the Company's
stock if the Company could maintain a closing bid price of at least $1 per share
beginning May 17, 1999, and for the ten subsequent trading days. The Company was
also required to file its first quarter report on Form 10-Q by May 17, 1999. In
June 1999, Nasdaq informed the Company that it had complied with all of the
necessary terms, and that its stock will continue to be listed on the Nasdaq
SmallCap Market.
Based upon this Nasdaq notification, the Board of Directors have recently voted
unanimously to cancel a pending proposed reverse stock split. In July 1999,
Nasdaq sent the Company correspondence stating its concerns over the Company's
ability to sustain compliance with the Nasdaq's continuing inclusion
requirements. Nasdaq also requested certain information from the Company for it
to evaluate. The Company submitted information in late July, and awaits further
correspondence from Nasdaq.
Note 8: Other Litigation
The Company is currently involved in litigation in North Carolina involving
payment for equipment in its paint facility. The issue involves a dispute over a
final $70,000 payment for equipment, which has yet to operate effectively. The
Company has counter-claimed and asked that the manufacturer refund its money or
make the equipment function properly. The Company is also involved in an action
whereby it is the plaintiff seeking to recover approximately $200,000 for
merchandise sold for which it was not paid. This action is currently pending.
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<PAGE> 16
In a separate lawsuit, the Company was sued by a former employee who complained
of his termination and the non-payment of relocation expenses. The company had
previously accrued, in 1998, $30,000 related to this lawsuit. During the second
quarter of 1999, the Company reversed $20,000 of such accrual based upon
favorable findings in the case. The positive effect of the $20,000 reversal is
included in selling and administrative costs on the statement of operations.
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<PAGE> 17
Note 9: Bond Financing
If the Company completes the bond financing it will incur associated fees of
approximately $1,080,000, which will be paid from bond proceeds, and the
underwriter will be entitled to 300,000 shares of Class A Common Stock at $.01
per share under terms of the financing agreement. The underwriter will then also
have a right of first refusal for any future tax-exempt bond financings for up
to 5 years.
Note 10: Preferred Stock Milestone Failure
The preferred stock agreements require that the Company meet certain milestones
relating to sales volume and cash flows. The sales volume required for the first
quarter of 1999 was $4,500,000 and sales for the first quarter were $4,534,274.
The sales volume required for the second quarter of 1999 was $6,000,000. Sales
for the second quarter were $4,806,709. Therefore, a milestone failure has
occurred. The other milestone relates to a requirement for positive cash flow
from operations beginning with the fourth quarter of 1998. The Company met this
requirement for the fourth quarter of 1998 and the first two quarters of 1999.
The above milestone failure gives the holders of the preferred stock the right
to convert the preferred stock at the lower of the fixed conversion price or the
variable conversion price.
Note 11: Issuance of Options
During the second quarter, the Company granted 750,000 options at an exercise
price of $1.00 per share to a non-paid associate/officer of the Company and a
major shareholder who is the Secretary of the Company. Such options expire five
years from their date of issuance and are vested based upon continued
association and non-paid employment. No compensation expense has been recognized
as the market price of the related common stock on the date of grant was less
than or equal to the granted exercise price.
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<PAGE> 18
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, 1999, and
the related statements of operations for the three-month and six-month periods
ended June 30, 1999 and 1998, and the statement of cash flows for the six-month
periods ended June 30, 1999 and 1998. 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 principles.
/s/ Arthur Andersen LLP
Dallas, Texas
August 6, 1999
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<PAGE> 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC., (AERT or the Company) has
commercialized and manufactures a growing line of low-maintenance composite
building materials which are increasingly sold into several significant segments
of the $190 billion plus U. S. Homebuilding Industry. AERT is a unique customer
driven entity, which utilizes low cost waste materials such as recycled
polyethylene plastics and waste wood fibers as its primary raw material sources,
to produce several value added products, which favorably compete in the national
door and window, industrial flooring and residential decking markets. The
products are marketed under the trade names MoistureShield(R), LifeCycle(TM),
ChoiceDek(TM) and DreamWorks(TM) and exhibit superior moisture-resistance and
dimensional stability when compared to traditional wood products. AERT products
do not require toxic chemical or preservative treatments and have been
extensively tested.
The Company's impressive and growing customer base includes such national brands
as Therma Tru Doors, Peach Tree Doors and Windows, Crestline and Vetter Windows,
Carolina Builders and Weyerhaeuser BMD. Since inception (1988) to June 30, 1999,
AERT has sold in excess of $48.6 million of composite building materials into
the U. S. market. A second composite extrusion and manufacturing plant is
currently nearing initial completion, which has resulted in increased quarterly
sales to a level of $4.8 million. With two manufacturing plants, AERT is
positively positioned to grow and meet the ever-increasing needs of the
marketplace for low-maintenance building materials.
With two extrusion plants in operation, the Company is focusing production and
product lines, in order to attain improved efficiencies and increased
production. With a pending Industrial Revenue Bond financing nearing completion,
the Company intends to further expand its production capabilities with the
upcoming additions of a second plastic recycling facility to be followed by a
third composite manufacturing facility over the next 18 months. This additional
recycling and manufacturing capacity consisting of initially four additional
extrusion lines (designed for up to six) is designed to further increase
production and sales over the next 18 months to the $75 million annualized level
and yield net income once completed.
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<PAGE> 20
Results of Operations
Quarter Ended June 30, 1999 Compared To Quarter Ended June 30, 1998
The Company's production plan implemented during 1998 began to yield results and
substantially increased production during the quarter and resulted in an
all-time quarterly net sales record of $4.8 million for the quarter ended June
30, 1999.
Sales increased for ChoiceDek(TM) decking products from $753,716 for the quarter
ended June 30, 1998 to $2,103,845 for the quarter ended June 30, 1999.
MoistureShield(R) industrial component sales increased from $2,039,607 for the
quarter ended June 30, 1998 to $2,702,864 in the comparable period in 1999
representing a $2,013,386 increase overall. This increase was accomplished with
construction still ongoing and not yet completed at the Springdale plant.
The Company believes that as additional ChoiceDek(TM) and decking production
increases in Texas and as the MoistureShield(R) production switch to Arkansas is
completed during the third quarter 1999, sales for both product lines will
continue to increase, gross margins will continue to improve and positive cash
flows and profitability will further improve during subsequent quarters.
Cost of goods sold was $4,003,424 for the quarter ended June 30, 1999 versus
$2,821,617 for the comparable period in 1998. Gross margin increased to a
positive $803,285 in 1999 versus a negative $28,294 for 1998, an $831,579
improvement. The overall gross margin as a percent of sales increased
significantly in 1999 versus 1998. Further operations improvement was restricted
due to increased administrative costs and production problems experienced at
both plants early during the quarter. The Company also experienced raw material
cost increases during the quarter.
Gross margin improved to a positive 16.7% of net sales for the second quarter of
1999. However, the Company reported an operating loss of $64,191 for 1999 versus
an $850,141 operating loss for the second quarter of 1998, an improvement of
$785,950. With interest costs of $108,742, the loss before dividends on
convertible preferred stock for the quarter was $172,933 or ($.01) per share
versus a net loss of $1,195,457 or ($.05) per share for the comparable period in
1998. Accrued dividends for preferred stock totaled $72,301 for the quarter.
This accrual increased the net loss to $245,234 for the quarter. Interest
expense for the quarter ended June 30, 1999, was reduced to $108,742 compared to
$345,316 for the comparable period in 1998. The decreased interest expense was
attributable to a reduction in debt discount amortization related to the bridge
financing, as well as a principal reduction by the Company in regard to the
bridge notes.
The Company expanded its Springdale plant in 1998 with $3.1 million in
short-term debt and intends to restructure the remaining $1.9 million debt, plus
purchase its existing
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<PAGE> 21
manufacturing facility for $1.75 million (assuming successful completion of the
pending bond financing) during the third quarter of 1999. Legal issues delayed
completion of the bond financing until the third quarter. The bond financing is
intended to further reduce the current interest expenses associated with the
bridge notes in conjunction with reducing monthly lease payments by purchasing
the existing Springdale facility over a longer term. The new Springdale
extrusion facility consists of two lines with a third nearing completion. These
lines are in addition to three extrusion lines at the original Texas facility.
The Company believes successful completion of these transactions will greatly
reduce its current working capital deficit by shifting short-term payables and
debt into long-term debt in subsequent periods while continuing to increase and
improve gross margins in order to further increase positive cash flows and
profitability from operations.
The net sales of $4.8 million for the quarter ended June 30, 1999, represented a
significant increase over the second quarter of 1998, up $2 million or 72%. This
increase affirms that the Company continues to have strong customer demand for
its products and that the Company's plan, in regards to the addition of the
Springdale plant, is beginning to demonstrate overall increased production,
improved gross margins, and positive cash flows from operations.
Cost of goods sold was $4,003,424 for the second quarter of 1999 compared to
$2,821,617 for the second quarter of 1998. Overall cost of goods sold as a
percentage of sales decreased. Increases were experienced in all major expense
categories, due to increased production volumes, increased sales and operating
costs associated with the second plant. Payroll costs and depreciation increased
due to the start-up of the new plant in Springdale, Arkansas. Material costs
increased primarily due to increased production and sales volumes and some
increased raw materials costs. The overall cost of goods sold to sales ratio
decreased significantly from 1998 due to increased emphasis on production
efficiencies, cost controls and execution of the production plan.
Significant categories are as follows:
<TABLE>
<CAPTION>
Expense Category 1999 1998
---------------- ---------- ----------
<S> <C> <C>
Payroll and payroll taxes $1,424,374 $ 629,672
Depreciation 442,155 260,660
Direct material costs 1,091,972 441,001
Other 1,044,923 431,308
---------- ----------
Total $4,003,424 $1,762,641
========== ==========
</TABLE>
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<PAGE> 22
Selling, general and administrative expenses were $867,476 compared to $821,847
for the second quarter of 1998. The Company leased and opened an administrative
office in Springdale during the quarter. Although sales increased approximately
$2 million or 72%, SG&A expenses rose only 5.6% or $45,629 in the quarter ended
June 30, 1999 over 1998. Approximately $100,000 of the increase was attributable
to increased sales commission and factoring costs, which was a direct result of
the increased sales of $4.8 million for the quarter. Therefore, the total of all
other SG&A expenses actually declined in the second quarter of 1999 as compared
to the second quarter of 1998.
Operating loss for the quarter ended June 30, 1999, was reduced to $64,191; a
$785,950 improvement from the $850,141 loss reported for the comparable period
in 1998. Net loss (basic and diluted) per weighted average common share
outstanding was $.01 for the quarter ended June 30, 1999. This compares to a net
loss (basic and diluted) per weighted average common share outstanding of $.05
for the quarter ended June 30, 1998. The Company is currently completing
construction on the initial phases of the Springdale plant implemented last year
to provide for better operating efficiencies, streamlining and increasing the
production of both facilities.
With the Company's initial production plan nearing completion and assuming
successful completion of the pending bond financing, the Company could soon be
in a rapid expansion and growth mode. Building plants, starting up machinery,
hiring and training qualified people is a difficult task. In preparation of and
in order to accomplish this, the Company has retained several experienced
professionals to help manage its aggressive construction schedule, as well as
streamline and train additional people for its operations. Hiring, training and
retaining quality people will be an essential part of the Company's success. The
ability to manage growth, while also attaining positive earnings will also be
crucial to success.
The initial plastic reclamation facility is also being expanded and is designed
to allow the Company to internally produce a substantial portion of its recycled
plastic feed stocks. With these improvements primarily completed, the Company
believes it can further increase production capacity, attain further efficiency
improvements, streamline production runs and reduce line changeovers. In
addition, further automation and process control of the production processes,
increased plastic raw material sourcing, increased plastic throughputs and
increased security is planned. The Company believes it will successfully
complete the initial phases of its production plan, including the addition of
the third extrusion line at the Springdale facility in the third quarter of
1999. Management currently believes the Company is in a sustainable positive
cash flow position from operations and should continue to improve during
subsequent periods.
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
20
<PAGE> 23
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, marketing difficulties, construction
delays and/or construction cost overruns, 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 further
anticipated efficiencies and manufacturing sales levels.
21
<PAGE> 24
Liquidity and Capital Resources
At June 30, 1999, the Company had a working capital deficit of $5,490,343
compared to a working capital deficit of $4,625,935 at December 31, 1998. The
deficit is mainly attributable to the Company's expansion and construction
program of the Springdale facility with short-term debt and its efforts to
complete and start-up their third extrusion line at that facility. The Company
increased production by utilizing short-term financing to maintain its
diversified customer base in order to increase its production and manufacturing
capabilities above the $30 million annualized sales levels for the 1999 summer
building and construction season. The Company expended approximately $3.7
million in construction and plant expansion costs during 1998. The Company
expended an additional $1.1 million for construction and plant expansion during
the first quarter of 1999. The Company expended $1.35 million during the second
quarter of 1999. These expansions were designed to substantially complete the
new Springdale facility and add additional extrusion and moulding capacity.
Construction delays occurred resulting in delayed production and revenues during
the third and fourth quarters of 1998. The initial construction was financed in
part by short-term bridge loans of $3.1 million, of which approximately $1.2
million had been repaid or converted to preferred stock by March 31, 1999. In
addition, the Company received $1.54 million from the voluntary B and C warrant
exercises and $2.9 million from the issuance of preferred stock to close
associates of the Company. Of said preferred stock issuance, $1,050,000 of the
bridge loan was converted or paid down with the remaining balances extended
until May 18, 1999 ($287,500) and until September 30, 1999 ($1,619,963). The
Board of Directors allowed a voluntary warrant conversion period until February
12, 1999, at which time 3,224,776 B and C Warrants were allowed to expire. In
addition, 42,866 Class I warrants were allowed to expire as of June 30, 1999.
The Company has also purchased a key-man life insurance policy for $4 million on
Joe G. Brooks during this interim construction period and is seeking an
additional $2.5 million policy on J. Douglas Brooks. The Company intends to
maintain these policies as a condition of the corporate financing package.
Cash and cash equivalents were $543,364 as of June 30, 1999, a decrease of
$71,130 compared to December 31, 1998. Significant components of that decrease
were: (i) cash provided by operating activities of $1,703,509, which consisted
of a net loss for the period of $238,104, increased by depreciation and
amortization of $916,667, and other sources of cash of $1,024,946; (ii) cash
used in investing activities of $2,595,415; and (iii) cash provided by financing
activities of $820,776, which consisted of proceeds from the exercise of options
and warrants of $990,608 and payments on notes and capital lease obligations of
$469,832. At June 30, 1999, the Company had notes payable in the amount of
$3,075,977, of which $3,067,860 were current notes payable or current portion of
long-term debt. Of said notes, $1,907,464 were to the bridge noteholders and
$925,836 was to the majority shareholder.
22
<PAGE> 25
The Company received a formal inducement resolution from the City Council of
Springdale, Arkansas for the issuance of up to $20 million in tax exempt
industrial revenue waste minimization and recycling bonds in early November
1998. No tax-exempt allocation became available during the end of 1998.
Therefore, the project rolled into 1999 and the Springdale City Council enacted
the formal bond ordinance in March 1999. In addition to the bond ordinance, the
Company received formal allocation of $16.5 million from the State of Arkansas
on July 7, 1999. The Company was able to secure the support and assistance of
several of its major contractors to commence construction with payments to be
received out of proceeds. During November and December 1998, approximately
$669,000 was expended towards the expansion program and during the six months
ended June 30, 1999, an additional $2.45 million was expended on Springdale
facility construction. With the addition of two additional operating production
lines at the Springdale facility, in addition to the one that operated for 8
months in 1998, the Company believes it can attain profitability and cash flows
from operations during subsequent quarters. In fact, positive cash flows from
operations, exceeded $1.7 million for the six months ended June 30, 1999, an
improvement of $1,333,965 or 361% over the $369,544 attained during the first
six months of 1998. *Excluding the increases and decreases in assets and
liabilities the cash provided by operating activities approximated $1 million.
Based upon this, and upon increased extrusion operating efficiencies and
throughputs, which are currently meeting management's expectations the Company
believes that sufficient sales and earnings capacity is in place to reduce
payables and restructure debt conventionally if the bond issue were to be
delayed. This would require refinancing the remaining $1.9 million in bridge
notes along with approximately $2 million in construction payables as of June
30, 1999.
Therefore, management is currently working to successfully finalize the bond
offering currently estimated at $16.5 million tax-exempt and $3 million taxable.
Of said $19.5 million, $1.75 million is to be used to purchase the existing 10
acre and 103,000 sq. ft. Springdale site, $2 million to refinance existing
equipment and repay the remaining bridge notes and $1.78 million for current
construction in progress. In addition, of said bond proceeds $1,270,150 has been
allocated for acquisition of an additional 18.6 acres plus site improvements,
$2,802,450 for additional plastic recycling equipment and capacity and
$7,910,625 for additional extrusion and manufacturing capacity.
A significant portion of the new extrusion capacity is planned for the new
DreamWorks(TM) decking line. Management has increased production capacity in
order to address the Company's customers' demands. With what it believes will be
a successful bond completion during the third quarter of 1999, a significant
amount of short-term debt ($1.9 million) plus interim construction payables of
$2 million as of June 30, 1999, will be restructured into longer-term
obligations. The aforementioned conditions combined with the Company's improved
operating status has the Company working to eliminate the negative working
capital deficit in the near future. Successful completion of the bond financing
would significantly reduce the current working capital deficit by up to $5
million dollars.
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<PAGE> 26
Once the bond offering is completed, this expansion will continue through fourth
quarter 1999, as a fourth extrusion line is added and the Springdale composite
plant is completed. This expansion is designed and intended to increase overall
manufacturing capabilities and sales above the $50 million annualized sales
level. The Company does not intend to further expand beyond the third extrusion
line in Springdale until the pending bond financing is complete.
The Company previously maintained an accounts receivable factoring agreement for
up to $900,000 through an affiliated company of a related party. The terms of
this initial agreement called 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. In March 1999, the Company's majority
shareholder increased the Company's factoring line to $2 million. The new terms
allow the factor to charge up to 2% per invoice, and the Company must guarantee
the receivables. It is currently estimated that the factor charges will average
around 1.5% during 1999. The Company has three notes payable to the majority
shareholder, which had a total balance of $925,836 at June 30, 1999.
The Company has continued to improve and has generated positive cash flows from
operations during the first and second quarters. Furthermore, 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, consistent and reliable raw material supplies, and hiring,
training and retaining qualified people will be required for the Company to
increase and to maintain sales levels that will allow the Company to grow and
increase sales. There can be no assurance that such improvements in production
efficiencies or capacities will continue to improve or can be sustained.
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 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 materials; accidents, other
unscheduled shutdowns affecting the Company, its suppliers or its customers'
plants, machinery or
24
<PAGE> 27
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; or 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company has no material exposures relating to its long-term debt due to
virtually all of the Company's long-term debt bearing interest at fixed rates.
The Company depends on the market for favorable long-term mortgage rates to help
generate sales of its product to its customers for use in the residential
construction industry. Should mortgage rates increase substantially, the Company
could be impacted by a reduction in the residential construction industry.
Important raw materials purchased by the Company are recycled plastic and wood
fiber, which are subject to price fluctuations. The Company attempts to limit
the impact of price increases on these materials by negotiating with each of its
suppliers on a term basis.
ITEM 4. YEAR 2000 UPDATE
The Company has been and is currently conducting an evaluation of the potential
effects of the Year 2000 issue on its operations. The evaluation is ongoing,
however at this time, management of the Company is not aware of any problems
that will occur within the Company's plant operations. The Company has contacted
the two major manufacturers of its operating equipment and has been informed by
them that they are not aware of Year 2000 issues with the equipment. The Company
plans to finalize contacting the remaining equipment manufacturers during the
third quarter of 1999. The Company has been in contact with some of its
significant vendors and customers to determine their Year 2000 status and plans
to continue to contact others during the third quarter of 1999. In assessing the
impact of the Year 2000 on administration, including accounting and financial
reporting, the Company has updated its financial accounting software and was
provided documentation that the software is Year 2000 compliant. The Company
upgraded its telephone system in Springdale and it is now Year 2000 compliant.
Based on the information above, the Company does not anticipate a material
financial impact as a result of the Year 2000 issue. However, the Company has no
control over Year 2000 compliance by its customers and vendors. If the Company's
customers and vendors are not prepared for the Year 2000 issue, this could
result in a material adverse financial impact to the Company, however, the
Company believes it is unlikely based on the nature of its business, customers
and vendors. The Company will be developing a contingency plan in the third
quarter to deal with any Year 2000 issues that may occur.
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<PAGE> 28
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In June 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.
In December 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.
In March 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
that 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
26
<PAGE> 29
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. In 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. 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 at present cannot predict when the Mobil Motion for
Attorneys' Fees and the AERT Prejudicial Misconduct Motion for a New Trial will
be addressed, or if ever, by the Delaware Court. The Company has not recorded
any liability related to such litigation at June 30, 1999. Mobil Oil divested
its composites business in 1996, and no longer directly competes with the
Company.
In June 1998, the Company received formal issuance from the United States Patent
and Trademark Office concerning a related product by process patent application,
which had been pending throughout the litigation. This is an application, which
was filed on the same date as those currently in litigation, although
substantial additional disclosures have been made.
27
<PAGE> 30
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/ Edward J. Lysen
------------------------------ -----------------------------
JOE G. BROOKS EDWARD J. LYSEN
Chairman Chief Financial Officer
Date: August 16, 1999 Date: August 16, 1999
<PAGE> 31
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 543,364
<SECURITIES> 0
<RECEIVABLES> 1,408,704
<ALLOWANCES> 10,000
<INVENTORY> 875,867
<CURRENT-ASSETS> 3,028,690
<PP&E> 16,344,045
<DEPRECIATION> 6,369,305
<TOTAL-ASSETS> 13,439,028
<CURRENT-LIABILITIES> 8,519,033
<BONDS> 74,177
0
2,900
<COMMON> 249,810
<OTHER-SE> 4,401,410
<TOTAL-LIABILITY-AND-EQUITY> 13,439,028
<SALES> 9,340,983
<TOTAL-REVENUES> 9,340,983
<CGS> 7,628,166
<TOTAL-COSTS> 9,210,490
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 10,000
<INTEREST-EXPENSE> 224,789
<INCOME-PRETAX> (238,104)
<INCOME-TAX> 0
<INCOME-CONTINUING> (238,104)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (238,104)
<EPS-BASIC> (.01)
<EPS-DILUTED> (.01)
</TABLE>
