<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, 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 March 31, 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 22,725,384 and the number of shares outstanding of the Registrant's
Class B Common Stock was 1,465,530.
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
FORM 10-Q INDEX
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
<S> <C>
ITEM 1 Financial Statements
Balance Sheets, March 31, 1999 (Unaudited)
and December 31, 1998 1-2
Statements of Operations (Unaudited),
Three months ended March 31, 1999 and 1998 3
Statements of Cash Flows (Unaudited),
Three months ended March 31, 1999 and 1998 4
Notes to Financial Statements 5-16
Review Report of Arthur Andersen LLP,
Independent Public Accountants 17
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 18-25
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 25-27
Signatures 28
</TABLE>
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
BALANCE SHEETS
ASSETS
------
<TABLE>
<CAPTION>
March 31, 1999 December 31,
(unaudited) 1998
----------- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 141,164 $ 614,494
Trade receivables, net of allowance of $38,800
(1999) and $20,000 (1998) 1,549,507 712,894
Inventories 878,104 846,571
21,546 89,266
Prepaid expenses and other ------------- -------------
2,590,321 2,263,225
Total current assets ------------- -------------
Buildings and equipment:
Buildings and leasehold improvements 967,463 1,041,035
Machinery and equipment 12,365,156 10,937,425
Transportation equipment 126,997 108,355
Office equipment 166,094 159,295
Construction in progress 1,290,354 1,502,520
------------- -------------
14,916,064 13,748,630
Less accumulated depreciation
and amortization 5,918,616 5,452,638
------------- -------------
Net buildings and equipment 8,997,448 8,295,992
Other assets, at cost less
accumulated amortization of $278,731 (1999)
and $271,570 (1998) 391,544 382,710
------------- -------------
Total assets $ 11,979,313 $ 10,941,927
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
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LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
<CAPTION>
March 31, 1999 December 31,
(unaudited) 1998
---------- ----
<S> <C> <C>
Current liabilities:
Accounts payable - trade $ 3,243,960 $ 2,606,034
Accounts payable - related parties 1,035,574 895,170
Current maturities of long-term debt:
Related parties 664,359 648,425
Other 166,461 199,873
Current maturities of capital lease obligations 19,186 19,263
Accrued liabilities 426,944 435,070
Notes payable, net of debt discount
of $10,000 (1999) and $45,255 (1998) 1,992,848 2,085,325
------------ ------------
Total current liabilities 7,549,332 6,889,160
------------ ------------
Long-term debt, less current maturities:
Related parties - 97,707
Other 26,156 52,747
------------ ------------
Total long-term debt 26,156 150,454
------------ ------------
Capital lease obligation 71,663 76,922
------------ ------------
Accrued dividends payable on convertible
119,397 47,890
preferred stock ------------ ------------
Commitments and contingencies (Note 6)
Stockholders' equity:
Convertible preferred stock, $1 par value;
5,000,000 shares authorized; 2,900 shares issued
and outstanding 2,900 2,900
Class A common stock, $.01 par value;
50,000,000 shares authorized; 22,725,384 (1999)
and 22,245,639 (1998) shares issued and outstanding 227,254 222,456
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 27,407,654 26,984,318
Accumulated deficit (23,439,698) (23,446,828)
------------ ------------
Total stockholders' equity 4,212,765 3,777,501
------------ ------------
Total liabilities and stockholders' equity $ 11,979,313 $ 10,941,927
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
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ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
March 31,
---------
1999 1998
----- ----
<S> <C> <C>
Sales $ 4,534,274 $ 2,507,300
Cost of goods sold 3,624,742 2,222,490
----------- -----------
Gross margin 909,532 284,810
Selling and administrative costs 714,848 645,184
----------- -----------
Operating income (loss) 194,684 (360,374)
----------- -----------
Interest expense, net (116,047) (158,567)
----------- -----------
Income (loss) before dividends on 78,637 (518,941)
convertible preferred stock
Accrued dividends on convertible
preferred stock (71,507) -
----------- -----------
Net income (loss) applicable to
common stock $ 7,130 $ (518,941)
=========== ===========
Net income (loss) per share of
common stock (basic and diluted) $ .00 $(.02)
=========== ===========
Weighted average number of common
shares outstanding-Basic 23,825,255 21,995,434
=========== ===========
Weighted average number of common
shares outstanding-Diluted 30,971,348 21,995,434
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Three months Three months
ended ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) applicable to common stock $ 7,130 $ (518,941)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 465,978 272,993
Amortization of other assets 43,307 87,908
Amortization of debt discount 35,255 80,911
Dividends accrued on convertible preferred stock 71,507 -
Interest paid through issuance of Class A
common stock 43,800 39,867
Provision for doubtful accounts 18,800 -
Loss on disposition of equipment - 1,964
(Increase) decrease in other assets (15,995) 2,417
Changes in current assets & current liabilities (85,168) 204,190
----------- -----------
Net cash provided by operating activities 584,614 171,309
----------- -----------
Cash flows from investing activities:
Additions to buildings and equipment (1,167,434) (1,097,181)
Insurance recoveries, net of fire related expenses - 4,722
----------- -----------
Net cash used in investing activities (1,167,434) (1,092,459)
----------- -----------
Cash flows from financing activities:
Prepaid stock subscriptions - 53,750
Proceeds from issuance of notes - 885,000
Payments on notes (269,508) (101,381)
Payments on capital lease obligations (5,335) -
Proceeds from exercise of stock options and warrants, net 384,333 63,750
----------- -----------
Net cash provided by financing activities 109,490 901,119
----------- -----------
Decrease in cash and cash equivalents (473,330) (20,031)
Cash and cash equivalents:
Beginning of period 614,494 45,428
----------- -----------
End of period $ 141,164 $ 25,397
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
Note 1: Unaudited Information
- -----------------------------
The financial statements included herein have been prepared by Advanced
Environmental Recycling Technologies, Inc. (the Company or AERT), without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission
(SEC). However, all adjustments have been made to the accompanying financial
statements, which are, in the opinion of the Company's management, necessary for
a fair presentation of the Company's operating results. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to make the information presented herein not
misleading. It is recommended that these financial statements be read in
conjunction with the financial statements and the notes thereto included in the
Company's latest annual report on Form 10-K.
Note 2: Description of the Company
- ----------------------------------
The Company manufacturers 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 over an extended period. The
losses
5
<PAGE>
were primarily caused by problems in maintaining significant production volumes
of products and in producing products at economically feasible operating cost
levels. There is no assurance that the Company will be able to improve its
manufacturing process and operating costs to the extent necessary to reach
successful operating levels. Furthermore, the Company is subject to delisting of
its common stock from Nasdaq, which would cause $2.9 million of preferred stock
to be reclassified to a current liability because delisting of the Company's
stock renders to the holders of the Company's preferred stock the right to
present the preferred stock for redemption to the Company. At March 31, 1999,
the Company had a working capital deficit of $4,959,011.
In the past few years the Company has, in large part, been supported by certain
major shareholders in conjunction with several accredited investors. As of March
31, 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 May 18,
1999 ($287,500) and June 1, 1999 ($1,619,963). 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
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 require that the Company files a registration
statement by June 1, 1999, to register the preferred stock and the common stock
6
<PAGE>
required in relation to the warrants. The Company will be required to pay
certain penalties to the holders of the preferred stock and warrants if the
registration statement is not filed by June 1, 1999 and/or effective by August
1, 1999. 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 agreements state that if a redemption event occurs, the Company must
pay each holder of preferred stock an amount equal to ten percent of the
aggregate stated value of the shares of preferred stock then outstanding.
The Company has also received an increase on its factor agreement from its major
shareholder up to $2 million. The Company is currently pursuing an $18,000,000
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 also
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
first half 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. 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.
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 completion of the initial production
plan is nearing completion once the third Springdale extrusion line becomes
operational, it may require additional debt or equity financing beyond those
resources currently available to the Company to finish this phase. 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 $18 million bond
issue is not successfully completed in a timely manner. The Company is working
on a contingency plan that would allow refinancing and paying down its
7
<PAGE>
construction payables if this happens. This includes increasing production,
sales and margins through better utilization of existing assets (i.e.,
streamlining production) in conjunction with start-up of the additional
extrusion line in Springdale. The Company expects this line to increase cash
flows and sales. 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 current
production plan during the second quarter 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 and fund maturities of debt and other obligations as they become due.
Note 4: Statements of Cash Flows
- --------------------------------
In order to determine net cash provided by operating activities, net income
(loss) 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, capital lease obligations and current notes
8
<PAGE>
payable. 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, 1999 March 31, 1999
(unaudited) (unaudited)
----------- -----------
<S> <C> <C>
Receivables $(855,413) $(267,128)
Note receivable - 14,000
Inventories (31,533) 41,831
Prepaid expenses and other 31,574 (66,944)
Accounts payable -
trade & related parties 778,330 427,196
Accrued liabilities (8,126) 55,235
----------- -----------
$ (85,168) $ 204,190
=========== ===========
Cash paid for interest $ 40,800 $ 22,291
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, 1999 December 31,
(unaudited) 1998
----------- ----
<S> <C> <C>
Raw materials $427,244 $486,068
Work in process 386,127 263,573
Finished goods 64,733 96,930
----------- ----------
$878,104 $846,571
=========== ==========
</TABLE>
9
<PAGE>
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 March 31,
1999 and December 31, 1998. Such assessment required the Company to make
certain estimates of future production volumes, costs, 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 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
10
<PAGE>
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 $8,997,448 at March 31, 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 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
11
<PAGE>
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. 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 attorney's 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 Attorney's 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 attorney's
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
attorney's 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 March 31, 1999. Mobil Oil divested
its composites business in 1996 and no longer directly competes with the
Company.
In June 1998, the Company received a formal notice of allowance 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.
Note 7: NASDAQ Listing Requirements
- -----------------------------------
12
<PAGE>
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. The Company's
Class B warrants AERTZ are no longer listed. 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 April 19, 1999, after the review of the
Company's 10-K, the Company was asked by Nasdaq to provide additional
information on its plans. The Company must respond by May 4, 1999 and has
requested another meeting in order to present its plans regarding how the
Company believes it can satisfy and maintain the increased Nasdaq listing
requirements. A negative decision could result in the immediate delisting of the
Company's securities from The Nasdaq Small Cap Market. Should the Company's
securities be delisted, the Company will not be notified of the decision until
after the securities have been removed from The Nasdaq Stock Market. The Company
has a right to appeal the decision, should that occur, although there can be no
assurance that an appeal would be successful. The minimum bid price must be
above $1.00 for 10 trading days. The Company is also considering implementing a
1 for 2 or 1 for 3 reverse stock split in order to attain compliance. As of
March 31, 1999, the Company's bid price per share was below $1.00. As of March
31, 1999, the Company's net asset value was $4.2 million. The Company has
initially implemented and is currently finalizing initial phases of its
production plan to increase profitability and further expand its business, as
well as to maintain its minimum Nasdaq listing.
If the Company is delisted, it would be required to meet the new listing
standards to be listed on The Nasdaq SmallCap Market. The standards for initial
listing require, among other things, that an issuer have total assets of $4
million and capital and surplus of at least $2 million; that the minimum bid
price for the listed securities be $3.00 per share; that the minimum market
value of the public float (the shares held by non-insiders) be at least $2
million; and that there be at
13
<PAGE>
least two market makers for the issuer's securities. As mentioned above, the
Company is currently not in compliance with the minimum bid price requirement
for continued listing and, therefore, also does not meet the minimum bid price
for initial listing. Delisting of the Company's common stock renders to holders
of the Company's preferred stock the right to present the preferred stock for
redemption to the Company in the amount of $2.9 million 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 interests 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 the over-the-
counter bulletin board, which could result in less liquidity for the holders of
the Company's stock.
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 intends to counter-claim and ask that the manufacturer refund its money
or make the equipment function properly. The Company is also a defendant in a
federal action in Texas, involving allegations from a former employee and
officer of the Company that the Company breached an employment agreement by
terminating employment. The Company believes this action is without merit and
has filed a motion to dismiss this suit for lack of jurisdiction. 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.
Note 9: Bond Financing
- ----------------------
If the Company completes the bond financing it will incur associated fees of
approximately $1,080,000 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.
14
<PAGE>
Note 10: Earnings Per Share
- ---------------------------
<TABLE>
<CAPTION>
March 31, March 31,
1999 1998
---- ----
<S> <C> <C>
Net income (loss) (A) $ 7,130 $ (518,941)
=========== ===========
Assumed exercise of stock options
and warrants 16,625,475 -
Application of assumed proceeds
($9,119,165) toward repurchase of
stock at an average market price of
$0.962 per share (9,479,382) -
----------- -----------
Net additional shares issuable 7,146,093 -
=========== ===========
Adjustment of shares outstanding:
Weighted average common shares outstanding 23,825,255 21,995,434
Net additional shares issuable 7,146,093 -
----------- -----------
Adjusted shares outstanding (B) 30,971,348 21,995,434
=========== ===========
Net income (loss) per common share (A) divided by (B)
$ .00 $ (.02)
=========== ===========
</TABLE>
The Company has additional options and warrants that were not included in the
calculation of diluted earnings per share (EPS). Those options (2,125,500) and
warrants (8,603,081) are either antidilutive and/or not exercisable at March 31,
1999. The Company's preferred stock is automatically convertible into shares of
common stock on the 7th anniversary date of the issuance of the preferred stock.
The conversion price is equal to the lower of the average of the closing bid
prices for the common stock for the five trading days immediately preceding the
7th anniversary of the issuance or the fixed conversion price. The fixed
conversion price is $1.20. At the current fixed conversion price of $1.20,
conversion of the Company's preferred stock would result in the issuance of
2,416,667 shares of the Company's common stock. The preferred stock, at March
31, 1999, is antidilutive and is, therefore, not included in the calculation of
Diluted EPS. Although the above financial instruments were not included due to
being antidilutive and/or not exercisable, such financial instruments may become
dilutive and would then need to be included in future calculations of Diluted
EPS.
SFAS No. 128, "Earnings Per Share" requires dual presentation of Basic and
Diluted EPS on the face of the statements of operations and requires a
15
<PAGE>
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 stockholders 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.
In computing Diluted EPS, only potential common shares that are dilutive--those
that reduce earnings per share or increase loss per share--are included.
Exercise of options and warrants or conversion of convertible securities is not
assumed if the result would be antidilutive, such as when a loss from continuing
operations is reported. The "control number" for determining whether including
potential common shares in the Diluted EPS computation would be antidilutive is
income from continuing operations. As a result, if there is a loss from
continuing operations, Diluted EPS would be computed in the same manner as Basic
EPS is computed, even if an entity has net income after adjusting for
discontinued operations, an extraordinary item or the cumulative effect of an
accounting change. The Company incurred a loss from continuing operations for
the quarter ended March 31, 1998. Therefore, Basic EPS and Diluted EPS are
computed in the same manner for the quarter ended March 31, 1998.
16
<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, 1999, and
the related statements of operations and cash flows for the three-month periods
ended March 31, 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
April 27, 1999
17
<PAGE>
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 and 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 March 31,
1999, AERT has sold in excess of $43.8 million of composite building materials
into the U. S. market. A second manufacturing plant is currently coming up to
speed, which has resulted in record quarterly sales of $4.53 million and posting
the Company's first profitable quarter. With a pending $18 million Arkansas
Industrial Development Revenue Bond financing nearing completion, AERT is
positioned to meet the ever increasing needs of the marketplace for low-
maintenance building materials.
With profitability at hand in addition to completion of its second composite
manufacturing facility; the Company is now positively positioned to further
expand with the upcoming additions of a second plastic recycling facility and a
third composite manufacturing facility over the next 18 months. This additional
recycling and manufacturing capacity consisting of four additional extrusion
lines is designed to further increase production and sales over the next 18
months to the $75 million annualized level and yield increased net income once
completed.
18
<PAGE>
Results of Operations
- ---------------------
Quarter ended March 31, 1999 compared to quarter ended March 31, 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 $4.53 million for the quarter ended March 31,
1999.
Based upon strong customers demands and purchase commitments the Company
initiated a production plan during 1998 designed to 1) increase overall
production capacity; 2) focus and dedicate plant and line production to specific
product lines; 3) reduce changeovers and eliminate line downtime; 4) streamline
product manufacturing for improved efficiencies of scale and lower production
costs; and 5) increase gross margins and attain respectable profitability. The
benefits of this plan, although not yet fully implemented and operational as of
March 31, 1999, yielded significant operations improvement during the first
quarter and resulted in a small overall profit for the Company.
Sales increased for ChoiceDek(TM) decking products from $713,924 for the quarter
ended March 31, 1998 to $2,114,088 for the quarter ended March 31, 1999.
MoistureShield(R) industrial component sales increased from $1,793,376 for the
quarter ended March 31, 1998 to $2,420,186 in the comparable period in 1999.
This represented a $2,026,974 increase overall and yielded the first operating
profit in the history of the Company. This was also 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 second 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 $3,624,742 for the quarter ended March 31, 1999 vs.
$2,222,490 for the comparable period in 1998. Gross margin increased to a
positive $909,532 in 1999 vs. a positive $284,810 for 1998, a $624,722
improvement. The overall gross margin as a percent of sales increased
significantly in 1999 vs. 1998.
19
<PAGE>
Gross margin improved to a positive 20% of net sales for the first quarter of
1999. Thus, the Company reported an operating income of $194,684 for 1999 vs. a
($360,374) operating loss for the first quarter of 1998, an improvement of
$555,058. Income before dividends on convertible preferred stock for the
quarter was $78,637 or $.00 per share vs. a net loss of ($518,941) or ($.02) per
share for the comparable period in 1998, which was a significant milestone and
turning point for the Company. Accrued dividends for preferred stock totaled
$71,507 for the quarter. This reduced the net income to $7,130 for the quarter.
Interest expense for the quarter ended March 31, 1999, was $116,047 compared to
$158,567 for the comparable period in 1998. The decreased interest expense was
attributable to a reduction in debt discount amortization related to the bridge
financing.
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 manufacturing facility for $1.75 million (assuming
successful completion of the pending bond financing) during the second quarter
of 1999. This is intended to 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 Company
believes completion of these transactions will greatly reduce its current
working capital deficit 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 $4.53 million for the quarter ended March 31, 1999, represented
a significant increase over the first quarter of 1998, up $2 million or 81% and
affirms that the Company continues to have strong customer demand for its
products and that the Company's plan in regard to the addition of the Springdale
plant is beginning to demonstrate overall increased production, margins,
positive cash flows and overall profitability.
Cost of goods sold was $3,624,742 for the first quarter of 1999 compared to
$2,222,490 for the first quarter of 1998. Overall cost of goods as a percentage
of sales decreased. Increases were experienced in all major expense categories
due to increased production volumes 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.
20
<PAGE>
The overall cost of goods sold to sales ratio decreased from 1998 due to
increased emphasis on production efficiencies, cost controls and execution of
the production plan.
21
<PAGE>
Significant categories are as follows:
<TABLE>
<CAPTION>
Expense Category 1999 1998
---------------- ---- ----
<S> <C> <C>
Payroll and payroll taxes $ 1,262,921 $ 771,215
Depreciation 465,978 270,021
Direct material costs 1,011,247 483,854
Other 884,596 697,400
----------- ------------
Total $ 3,624,742 $ 2,222,490
=========== ============
</TABLE>
Selling, general and administrative expenses were $714,848 compared to $645,184
for the first quarter of 1998. Although sales increased approximately
$2,026,974 or 81%, SG&A expenses rose only 11% or $69,664 in the quarter ended
March 31, 1999 over 1998. Most of the increase was attributable to increased
sales commission and factoring costs, which were a direct result of the
increased sales levels of $4.53 million for the quarter.
Operating income for the quarter ended March 31, 1999, was $194,684, a
significant change from the ($360,374) loss reported for the comparable period
in 1998. Net income (basic and diluted) per weighted average common share
outstanding was $.00 for the quarter ended March 31, 1999. This compares to a
net loss (basic and diluted) per weighted average common share outstanding of
($.02) for the quarter ended March 31, 1998. The Company is currently refining
the production plan which Management implemented last year to provide for better
operating efficiencies and streamlining and increasing the production of the
original facility. As part of the production plan, the Company added a second
composite facility in conjunction with rebuilding its internal plastic
reclamation capabilities. The plastic reclamation facility allows the Company
to internally produce a large portion of its recycled plastic feed stocks. The
plan included increasing production capacity, streamlining production runs and
reducing line change overs, additional automation and process control of the
production processes, improving plastic raw material sourcing, obtaining lower
raw material costs, and increasing security. The Company believes it can finish
and successfully complete the initial production plan, including the addition of
the third extrusion line at the Springdale facility by the end of the second
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.
22
<PAGE>
The Company's operations remain subject to numerous risks associated with the
continued establishment of its business, including lack of financing sources and
competition from numerous large, well-established and well-capitalized
competitors who manufacture products for the same applications. In addition,
the Company has in the past and may again in the future, encounter unanticipated
problems, including manufacturing, distribution, and marketing difficulties,
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.
Liquidity and Capital Resources
- -------------------------------
At March 31, 1999, the Company had a working capital deficit of $4,959,011
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 in addition to ongoing
work underway to finish installation of extrusion lines and complete the initial
phases of its Springdale plant. The Company increased production utilizing
short-term financing in order to maintain its diversified customer base and
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
during the first quarter of 1999. This was intended 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
initial bridge loan was converted or paid down with the remaining balances
extended until May 18, 1999 ($287,500) and until June 1, 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. The
Company has also purchased a key-man life insurance policy for $4 million on Joe
G. Brooks during this interim
23
<PAGE>
construction period and intends to maintain it until the corporate refinancing
is complete.
Cash and cash equivalents decreased to $473,330 in the first three months of
1999. Significant components of that decrease were: (i) cash provided by
operating activities of $584,614, which consisted of a net income for the period
of $7,130, increased by depreciation and amortization of $465,978, and other
sources of cash of $111,506 (ii) cash used in investing activities of
$1,167,434, and (iii) cash provided by financing activities of $109,490, which
consisted of proceeds from the exercise of warrants of $384,333 and payments on
notes and capital lease obligations of $274,843. At March 31, 1999, the Company
had notes payable in the amount of $2,849,824, of which $2,823,688 were current
notes payable or current portion of long-term debt.
The Company received a formal inducement resolution from the City Council of
Springdale, Arkansas for the issuance of up to $15 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, so the
project rolled into 1999 and the Springdale City Council enacted the formal bond
ordinance in March 1999. With the support and approval of its bond underwriter,
and in order to positively address its customers increasing purchasing
requirements; the Company commenced a plan aimed at both refinancing a portion
of its existing Springdale facility, in addition to financing additional
production and manufacturing expansion from bond proceeds. In addition, 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 three months ended March
31, 1999, an additional $1.1 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 significantly increase profitability and cash
flows from operations during subsequent quarters. Based upon this, and upon
increased extrusion operating efficiencies and throughputs, which are currently
meeting management's original 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
$2.0 million in construction payables as of March 31, 1999.
24
<PAGE>
Therefore, management is currently working to successfully finalize this bond
offering currently estimated at $15 million tax-exempt and $3 million taxable.
Of said $18 million, $1.75 million is to be used to purchase the existing 10
acre and 103,000 sq. ft. 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 construction in order to address the Company's
customers demands and with what it believes will be a successful bond completion
during May 1999, a significant amount of short-term debt ($1.9 million) plus
interim construction payables of $1.1 million as of March 31, 1999, will be
restructured into longer term obligations. This, combined with the Company's
improved operating status, combined with what management believes will be
improved profitability and cash flows during subsequent quarters, has the
Company working to eliminate the negative working capital deficit in the near
future.
The Company commenced a substantial expansion program at its Springdale facility
to substantially increase composite manufacturing capabilities and production
through the addition of a second extrusion plant and millwork facility. The
majority of the payables increase during the quarter ended March 31, 1999, is
directly attributable to this expansion program. This expansion will continue
through third quarter 1999, as a fourth larger 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 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 major
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 a note payable to the major
shareholder, which had a balance of $664,359 at March 31, 1999.
25
<PAGE>
The Company has continued to improve and has generated positive cash flows and
profitability from operations during the first quarter. Furthermore, the
Company continues to attempt to further 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 along with consistent and reliable raw
material supplies will be required for the Company to increase and maintain
sales to levels that will allow the Company to continue to grow and increase
sales. There can be no assurance that such improvements in production
efficiency or capacity 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 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.
PART II. Other Information
Item 1. Legal Proceedings
--------------------------
26
<PAGE>
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
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
27
<PAGE>
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 attorney's 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 Attorney's 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 attorney's
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
attorney's 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 March 31, 1999. Mobil Oil divested
its composites business in 1996 and no longer directly competes with the
Company.
In June 1998, the Company received a formal notice of allowance 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.
28
<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/ David Sparks
- ----------------------------- ------------------------------
JOE G. BROOKS DAVID SPARKS
Chairman Corporate Controller
Date: May 4, 1999 Date: May 4, 1999
29
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 141,164
<SECURITIES> 0
<RECEIVABLES> 1,588,307
<ALLOWANCES> 38,800
<INVENTORY> 878,104
<CURRENT-ASSETS> 2,590,321
<PP&E> 14,916,064
<DEPRECIATION> 5,918,616
<TOTAL-ASSETS> 11,979,313
<CURRENT-LIABILITIES> 7,549,332
<BONDS> 0
0
2,900
<COMMON> 241,909
<OTHER-SE> 27,407,654
<TOTAL-LIABILITY-AND-EQUITY> 11,979,313
<SALES> 4,534,274
<TOTAL-REVENUES> 4,534,274
<CGS> 3,624,742
<TOTAL-COSTS> 4,339,590
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 116,047
<INCOME-PRETAX> 7,130
<INCOME-TAX> 0
<INCOME-CONTINUING> 7,130
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,130
<EPS-PRIMARY> 0.00
<EPS-DILUTED> 0.00
</TABLE>
