<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 September 30, 2000
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)
914 N. Jefferson Street 72764
P. O. Box 1237
Springdale, Arkansas 72765
(Address of Principal Executive Office) (Zip Code)
Registrant's telephone number, including area code: (501) 756-7400
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 September 30, 2000, 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 24,596,525 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
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
Review Report of Independent Public Accountants 1
ITEM 1 Financial Statements
Balance Sheets, September 30, 2000 (unaudited)
and December 31, 1999 2-3
Statements of Operations, (unaudited)
Three Months and Nine Months Ended
September 30, 2000 and 1999 4
Statements of Cash Flows, (unaudited)
Nine Months Ended September 30, 2000 and 1999 5
Notes to Financial Statements 6-12
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-19
ITEM 3 Quantitative and Qualitative Disclosure about Market Risk 20
ITEM 4 Information Systems and the Impact of the Year 2000 20
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings 20
ITEM 6 Exhibits and Reports on Form 8-K 21
Signatures 22
</TABLE>
<PAGE> 3
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Advanced Environmental Recycling Technologies, Inc.
We have reviewed the accompanying balance sheet of Advanced Environmental
Recycling Technologies, Inc. (a Delaware corporation), as of September 30, 2000,
and the related statements of operations and cash flows for the three-month and
nine-month periods ended September 30, 2000 and 1999, and the statements of cash
flows for the nine-month periods ended September 30, 2000 and 1999. 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 accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 3, because of
significant operating losses and other adverse conditions, the Company may be
unable to continue as a going concern. Management's plans to deal with these
conditions are also described in Note 3. The accompanying financial statements
do not include any adjustments that might be necessary should the Company be
unable to continue as a going concern.
/s/ Arthur Andersen LLP
Fayetteville, AR
November 6, 2000
1
<PAGE> 4
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
September 30,
2000 December 31,
(unaudited) 1999
------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 366,335 $ 187,173
Restricted bond escrow fund 17,330,771 16,593,696
Trade receivables, net of allowance of
$20,000 1,952,226 1,587,368
Inventories 1,472,118 1,274,771
Prepaid expenses and other 180,788 93,982
------------- ------------
Total current assets 21,302,238 19,736,990
------------- ------------
Buildings and equipment:
Land 878,028 --
Buildings and leasehold improvements 1,125,037 1,044,096
Machinery and equipment 18,543,317 13,981,153
Transportation equipment 202,321 162,400
Office equipment 284,719 210,024
Construction in progress 760,500 2,747,290
------------- ------------
21,793,922 18,144,963
Less accumulated depreciation
and amortization 8,865,080 7,227,875
------------- ------------
Net buildings and equipment 12,928,842 10,917,088
Other assets, at cost less accumulated
amortization of $321,591 (2000)
and $300,161 (1999) 1,044,684 801,715
------------- ------------
$ 35,275,764 $ 31,455,793
============= ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 5
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
September 30, 2000 December 31,
(unaudited) 1999
------------ ------------
<S> <C> <C>
Current liabilities:
Accounts payable - trade $ 4,421,530 $ 5,110,787
Accounts payable - related parties 1,307,002 1,535,997
Current maturities of long-term debt:
Related parties 265,692 494,265
Other 117,790 46,824
Current maturities of capital lease obligation 32,424 23,189
Accrued liabilities 2,078,016 933,543
Notes payable - related parties 400,000 550,000
Notes payable - other 2,296,274 2,354,944
Bond payable 16,500,000 16,500,000
------------ ------------
Total current liabilities 27,418,728 27,549,549
------------ ------------
Total long-term debt, less current maturities 4,409,512 5,923
------------ ------------
Capital lease obligation 52,387 53,733
------------ ------------
Accrued dividends payable on convertible
preferred stock 555,164 337,890
------------ ------------
Commitments and contingencies (Note 6)
Stockholders' equity:
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;
75,000,000 shares authorized, 24,596,525 (2000)
and 24,251,497 (1999) shares issued and outstanding 245,965 242,515
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 28,695,847 28,459,192
Accumulated deficit (26,119,394) (25,210,564)
------------ ------------
Total stockholders' equity 2,839,973 3,508,698
------------ ------------
Total liabilities and stockholders' equity $ 35,275,764 $ 31,455,793
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 6
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------- -------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales $ 7,537,893 $ 5,794,834 $ 21,352,908 $ 15,135,817
Cost of goods sold 5,907,372 4,593,646 17,091,415 12,221,812
------------ ------------ ------------ ------------
Gross margin 1,630,521 1,201,188 4,261,493 2,914,005
Selling and administrative costs 1,749,610 1,050,311 4,326,474 2,632,635
------------ ------------ ------------ ------------
Operating income (loss) (119,089) 150,877 (64,981) 281,370
Interest expense, net (236,337) (109,539) (626,575) (334,328)
------------ ------------ ------------ ------------
Income (loss) before dividends on
convertible preferred stock (355,426) 41,338 (691,556) (52,958)
Accrued dividends on convertible
preferred stock (72,500) (73,096) (217,274) (216,904)
------------ ------------ ------------ ------------
Net loss applicable to common stock $ (427,926) $ (31,758) $ (908,830) $ (269,862)
============ ============ ============ ============
Net loss per share of common
stock (Basic and Diluted) $ (.02) $ .00 $ (.04) $ (.01)
============ ============ ============ ============
Weighted average number of common shares
outstanding 25,967,462 24,981,027 25,868,487 24,382,523
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 7
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Nine months Nine months
Ended ended
September 30, 2000 September 30, 1999
------------------ ------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (908,830) $ (269,862)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,680,230 1,505,925
Dividends accrued on convertible
preferred stock 217,274 216,904
Expenses paid through issuance of stock options 9,896 --
Provision for doubtful accounts -- (9,850)
(Increase) decrease in other assets 53,245 (44,972)
Changes in current assets and current liabilities (2,043,750) (1,168,183)
------------------ ------------------
Net cash provided by (used in) operating activities (991,935) 229,962
------------------ ------------------
Cash flows from investing activities:
Additions to buildings and equipment (2,898,767) (1,831,719)
------------------ ------------------
Cash flows from financing activities:
Proceeds from issuance of notes 4,500,000 300,000
Payments on notes (462,688) (643,744)
Payments on capital lease obligations (17,303) (14,325)
Increase in accounts payable - related parties 158,885 773,558
Debt acquisition costs (339,239) (37,925)
Interest paid through issuance of Class A common stock -- 124,115
Proceeds from exercise of stock options and
Warrants 230,209 990,608
------------------ ------------------
Net cash provided by financing activities 4,069,864 1,492,287
------------------ ------------------
(Decrease) increase in cash and cash equivalents 179,162 (109,470)
Cash, beginning of period 187,173 614,494
------------------ ------------------
Cash, end of period $ 366,335 $ 505,024
================== ==================
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 8
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. (AERT, the Company or "we"), 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
AERT 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 other
alternative plastic materials for standard door components, windowsills, brick
mould, fascia board, decking and heavy industrial flooring. 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 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. At September 30, 2000, the Company had a substantial working
capital deficit of $6,116,490. The Company has incurred net losses in each year
since its inception and has never operated at successful manufacturing levels
over an extended period. Further, the Company has limited financial resources
available to support its operations and in the past few years has, in large
part, been supported by certain major shareholders in conjunction with several
accredited investors. There is no commitment for such shareholders or accredited
investors to continue such support. As discussed in the following paragraphs,
the Company will require additional financial resources in order to complete its
production plan and fund maturities of debt and other obligations as they become
due.
The Company also has litigation outstanding against it as described in Notes 7
and 8, the outcome of which is uncertain. If the litigated claims 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 mass-produce and market its products at economically
feasible levels.
The Company is currently implementing a production plan, which management
believes will provide better operating
6
<PAGE> 9
efficiencies and correct the production problems encountered in the past. The
plan includes increasing production capacity, increasing internal plastic
recycling capacity and lowering raw material costs, increasing throughputs,
improving finished yields, and further automating the production process. The
Company anticipates reducing its working capital deficit by refinancing
short-term debt into long-term debt, paying off the bridge notes and acquiring
reimbursement for significant capital expenditures from the bond fund proceeds
discussed below. During April 2000, the Springdale plant's third extrusion line
commenced operation with a new material transfer system. Furthermore, in March
2000, the Company obtained $4.5 million of additional bank financing, the
proceeds of which were used to acquire land adjacent to the Springdale facility
and reduce accounts payable.
The Company closed a $16.5 million tax-exempt industrial bond financing into
escrow in October 1999, which is intended to refinance and shift its
construction related accounts payable into long-term financing. The bonds were
reissued in October 2000, and resold to the original purchaser with a new
repurchase date by the Company of October 1, 2001. In order for the Company to
receive the bond financing out of escrow, the Company must meet certain
financial and operating criteria unless waived by the holder of 100% of the
bonds. These include delivering to the trustee satisfactory evidence that for
any consecutive 12 month period commencing on or after the date of the issuance
of the bonds, the long-term debt service coverage ratio, as defined, has been
not less than 2 to 1, and the projected long-term debt service coverage ratio
for the 24 month period subsequent to the first disbursement shall not be less
than 2 to 1. There is no assurance the Company will be successful in meeting the
standards required to receive the bond financing proceeds or in obtaining
necessary financial resources from other sources.
Completion of the production plan will require that the Company receive the
proceeds from the bond financing or obtain additional debt or equity financing
beyond those resources currently available to the Company. Also, additional
financial resources will be necessary to fund maturities of debt and other
obligations as they come due in 2000. There is no assurance the Company will be
able to correct prior production problems and improve operating efficiencies or
that the Company will be successful in securing capital resources to complete
its production plan, fund maturities of debt and other obligations as they
become due in 2000 or to support the Company until such time, if ever, that the
Company is able to consistently generate income from operations.
NOTE 4: STATEMENTS OF CASH FLOWS
In order to determine net cash provided by (used in) operating activities, net
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, current notes payable
and selected payables to related parties.
7
<PAGE> 10
Those changes, shown as an (increase) decrease in current assets and an increase
(decrease) in current liabilities, are as follows:
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
September 30, 2000 September 30, 1999
(unaudited) (unaudited)
------------ -----------
<S> <C> <C>
Receivables $ (364,858) $ (960,294)
Inventories (197,347) (45,646)
Prepaid expenses and other (86,806) (30,317)
Accounts payable -
trade and related parties (1,802,137) (278,226)
Accrued liabilities 407,398 146,300
------------ -----------
$ (2,043,750) $(1,168,183)
============ ===========
Cash paid for interest $ 376,368 $ 131,131
Cash paid for income taxes -- --
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
September 30, 2000 September 30, 1999
(unaudited) (unaudited)
------------ -----------
<S> <C> <C>
Notes payable for financing of insurance policies $ 278,457 $ 106,788
Accounts / notes payable for equipment 725,000 1,558,989
Capital lease obligation for equipment 25,192 --
Interest on restricted bond escrow fund 737,075 --
</TABLE>
8
<PAGE> 11
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>
September 30, 2000
(unaudited) December 31, 1999
----------- -----------------
<S> <C> <C>
Raw materials $ 664,941 $ 535,034
Parts and supplies 94,067 30,225
Work in process 368,516 323,268
Finished goods 344,594 386,244
----------- ----------
$ 1,472,118 $1,274,771
=========== ==========
</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.
NOTE 6: LONG-TERM DEBT
The Company obtained bridge financing from a bank in the amount of $4.5 million
in March of 2000. The debt is due in 176 equal monthly payments of $49,156
including interest at a fixed rate of 9.75%, beginning June 23, 2000, and
maturing February 23, 2015. The note is collateralized by real estate and
improvements, fixed assets, assignment of a life insurance policy, personal
guarantees of certain stockholders and an 80% USDA Department of Rural
Development guarantee. The note contains certain financial covenants including a
minimum debt to net worth ratio, as defined, of no more than 3 to 1; a minimum
current ratio of 1 to 1 by August 2000; and a minimum current ratio of 2 to 1 by
February 2001 and thereafter. As of September 30, 2000 the covenants had been
waived.
NOTE 7: 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 the complaint, Mobil sought entry of a declaratory
judgment that:
o AERT was without right or authority to threaten suit against Mobil or
our customers for alleged infringement of AERT patents;
o certain AERT patents were invalid and unenforceable; and
o Mobil had not infringed the AERT patents through any products or method.
Mobil sought no monetary damages in that suit, but did seek reimbursement of its
attorneys' fees.
The Company denied Mobil's claims and asserted counterclaims against Mobil and
three Mobil executives for:
9
<PAGE> 12
o an illegal combination or contract in restraint of trade in violation of
federal antitrust laws;
o a pattern of intentional misconduct constituting an attempt to
monopolize in violation of federal antitrust laws;
o breach of a confidential relationship between Mobil and AERT; and
o unfair competition.
The Company sought monetary damages, punitive damages and injunctive relief.
In February 1994, after a trial on the patent issues, the court held that four
AERT patents on its composite product technology were invalid and that Mobil had
not infringed the patents.
In March 1995, the Company filed a motion with the Court alleging prejudicial
misconduct by Mobil prior to the trial. The Company also filed an appeal with
the U.S. Court of Appeals in July 1995. In June 1996, the U.S. Court of Appeals
reversed a portion of the earlier ruling, which had held that two of the patents
were invalid, but nevertheless ruled that Mobil did not infringe such patents.
The Company did not further appeal this ruling.
In August 1994, Mobil filed a motion seeking an award of attorneys' fees and
costs for $2.7 million. In September 1999, the Delaware Court dismissed the
Mobil Motion for Attorneys' Fees, for a second time. The Court also dismissed
the Company's motion for new trial based upon discovery misconduct and the
Company's motion to supplement record.
Mobil recently filed an appeal brief regarding denial and dismissal of the
attorneys' fees motion by the Delaware Court. The Company recently answered
Mobil's appeal and cross-appealed the dismissal of its prejudicial misconduct
motion by the Delaware Court in March of 2000. The Company retained new legal
counsel for said appeal, which has extensive experience and specializes in
appellate actions. The Company's cross-appeal involves allegations of tampering
with, altering and withholding critical evidence by Mobil prior to trial. It
seeks a final denial of Mobil's request for attorneys' fees and a new trial for
prejudicial discovery misconduct. The oral arguments for appeal have been set by
the U.S. Court of Appeals for the Federal Circuit for oral argument on December
5, 2000, in Washington, D.C. The Company's counterclaims are still pending,
although Mobil is no longer in the composite products business.
The Company has accrued $40,000 for anticipated court costs related to the Mobil
litigation. There can be no assurance that the Company can prevail on these
issues or that if it prevails, Mobil will not further appeal to a higher court.
Furthermore, there can be no assurance that the Company will be awarded a new
trial upon appeal, or if it receives a new trial that the outcome will be
favorable to the Company.
NOTE 8: OTHER LITIGATION
The Company is a counterclaim 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 will vigorously defend itself.
We were also sued in May 2000 in federal court in Texas for back royalty
payments allegedly due to a successor to a licensor of firelog extrusion
technology. That licensor licensed technology to a firelog manufacturing company
operated by our founders in 1986-1987. A dispute and lawsuit arose at that time
between our founders and that licensor that was settled by an agreement that our
founders and their affiliates would pay the licensor a royalty of $10.00 per ton
of material, if any material was produced using the licensor's technology. As
described in our December 1989 IPO prospectus and for many years thereafter, we
have always contended that we did not use such technology and no royalty was
paid nor, prior to this year, did that licensor ever pursue any claim for such
royalties. We believe numerous defenses are available and intend to vigorously
defend ourselves against what we consider a
10
<PAGE> 13
matter related to the current suit in Delaware. Mobil was also a successor and
licensee from affiliates of that firelog technology licensor.
NOTE 9: NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", (SFAS 133), as
amended by Statement of Financial Accounting Standards No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133". SFAS No. 133 establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting
for qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement. Companies must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. SFAS No. 133 is effective for fiscal years beginning after
June 15, 2000; however, companies may implement the statement as of the
beginning of any fiscal quarter beginning on or after June 16, 1998.
SFAS No. 133 cannot be applied retroactively and must be applied to (a)
derivative instruments and (b) certain derivative instruments embedded in hybrid
contracts that were issued, acquired, or substantively modified after December
31, 1997 (and, at the Company's election, before January 1, 1998). The Company
is in the process of quantifying impact of adopting SFAS No. 133 on its
financial statements and does not believe the impact will be material to the
financial statements.
NOTE 10: SEGMENT INFORMATION
SFAS No. 131 "Disclosures About Segments of an Enterprise and Related
Information", (SFAS 131), establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. SFAS 131
requires that a public business enterprise report financial and descriptive
information about its reportable operating segments. Reportable operating
segments are defined as a component of an enterprise:
o That engages in business activities from which it may earn revenues and
expenses,
o Whose operating results are regularly reviewed by the enterprise's chief
operating decision maker,
o For which discrete financial information is available.
As of September 30, 2000, the Company does not have available discrete financial
information to disclose gross margin by product line. All operating expenses are
allocated primarily on capacity. Corporate overhead is not allocated by product
line, neither are selected assets. Net revenue is segregated by product line as
follows:
<TABLE>
<CAPTION>
Three months Three months
ended ended
Sept. 30, 2000 Sept. 30, 1999
-------------- --------------
<S> <C> <C>
Exterior door, window and housing trim components $ 1,626,568 $ 2,678,866
Commercial and residential decking surface components 5,555,868 2,824,658
Industrial flooring 355,457 291,310
-------------- --------------
$ 7,537,893 $ 5,794,834
============== ==============
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
Sept. 30, 2000 Sept. 30, 1999
-------------- --------------
<S> <C> <C>
Exterior door, window and housing trim components $ 5,653,218 $ 7,801,916
Commercial and residential decking surface components 15,117,604 7,042,591
Industrial flooring 582,086 291,310
-------------- --------------
$ 21,352,908 $ 15,135,817
============== ==============
</TABLE>
Revenues, cost of goods sold and gross margin by plant were as follows:
<TABLE>
<CAPTION>
Three months Three months
ended ended
Sept. 30, 2000 Sept. 30, 1999
-------------- --------------
Springdale Junction Springdale Junction
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net revenues $ 4,071,128 $ 3,466,765 $ 2,723,546 $ 3,071,288
Cost of goods sold 3,081,552 2,825,820 2,454,637 2,139,009
------------ ------------ ------------ ------------
Gross margin $ 989,576 $ 640,945 $ 268,909 $ 932,279
============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
Sept. 30, 2000 Sept. 30, 1999
-------------- --------------
Springdale Junction Springdale Junction
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net revenues $ 11,195,408 $ 10,157,500 $ 6,912,863 $ 8,222,954
Cost of goods sold 9,421,406 7,670,009 6,124,969 6,096,843
------------ ------------ ------------ ------------
Gross margin $ 1,774,002 $ 2,487,491 $ 787,894 $ 2,126,111
============ ============ ============ ============
</TABLE>
12
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC. (AERT, the Company or "we")
manufactures and markets composite building materials that can be used as an
alternative to traditional wood products for exterior applications in building
and remodeling homes. We use waste wood fiber and reclaimed polyethylene plastic
as our raw materials. Our products are comprised of approximately equal amounts
of wood and plastic, have been extensively tested and have been used by several
leading national companies, such as the Weyerhaeuser Company and Therma Tru
Corporation. Our products are marketed under the LifeCycle(R),
MoistureShield(R), and ChoiceDek(R) tradenames. We recently introduced a new
decking line called DreamWorks(TM), which is marketed as ChoiceDek(R) Plus.
Our sales are primarily in the following markets:
o exterior door, window and housing trim components,
o commercial and residential decking surface components, and
o heavy industrial flooring.
We currently operate two manufacturing and recycling facilities. We recently
expanded into nationwide decking distribution with Weyerhaeuser BMD. Our
Junction, Texas facility currently manufactures primarily decking components on
three extruder lines. Our door, window and housing trim components are
manufactured at our Springdale, Arkansas facility, along with most of our
ChoiceDek(R) Plus line of decking products, and all of our heavy industrial
flooring. We now have three extruder lines and a plastic facility in operation
at our Springdale location. The third extrusion line became operational in April
2000, and the initial construction at this manufacturing facility was mostly
completed during the quarter ended June 30, 2000. A fourth composite extrusion
line may be added at our initial Springdale manufacturing facility in the first
half of 2001. A second plastic recycling facility and a third composite
extrusion facility are planned for Springdale later in 2000 or the first half of
2001, once financing becomes available.
Because of their wood fiber content, our composites are less subject to thermal
contraction or expansion and display greater dimensional stability than
conventional plastic materials. Because of their plastic content, our composites
will not absorb moisture, rot or swell like wood and do not require preservative
treatments, such as yearly sealing or staining, however our manufactured
products maintain many properties similar to traditional wood materials.
The composites manufacturing process involves proprietary and patented
technologies and specialized manufacturing equipment, custom-built or modified
for us. The process uses plentiful, lower cost, raw materials, such as recycled
plastics and wood-filler materials and, in certain cases, special additives or
virgin plastics in varying mixtures. The mixtures can be specifically formulated
based on our customers' desired end-product specifications. The encapsulation of
wood fibers in plastic creates a consistent material, free of foreign matter,
which can be extruded into a desired shape. Our composite building material
became a patented product in June 1998 (U. S. Patent No. 5,759,680).
13
<PAGE> 16
RESULTS OF OPERATIONS
Quarter Ended September 30, 2000 Compared To Quarter Ended September 30, 1999
Net sales increased to $7,537,893 for the quarter ended September 2000, which
represented an increase of $1,743,059 or 30% over the quarter ended September
30, 1999. Further increases were attainable but not achieved due to a temporary
order reduction in September by a major customer. The third quarter 2000
composite sales consisted of MoistureShield(R) net sales of $1,982,025 and
decking products (ChoiceDek(R) Classic and ChoiceDek(R) Plus) net sales of
$5,555,868. These figures compare with third quarter 1999 MoistureShield(R)
sales of $2,970,176 and decking product sales of $2,824,658. MoistureShield(R)
sales growth was limited due to reduction in certain OEM order activity
associated with reduced housing activity in certain parts of the country, in
conjunction with the Company placing its major focus on honoring its decking
contract with Weyerhaeuser BMD. The Company has several large MoistureShield(R)
projects pending that it intends to initiate during the fourth quarter of 2000,
with additional capacity now becoming available.
The Texas plant increased net sales to $3,466,765 in the third quarter of 2000
from $3,071,288 in the third quarter of 1999, a 13% increase. The Texas plant
now produces primarily the ChoiceDek(R) Classic product line. The production
upgrades initiated late last year helped boost productivity. This move
streamlined and focused the products produced at the Texas plant and helped make
it more efficient. However, the Texas plant also experienced significant raw
material price increases during the quarter, which also significantly reduced
the effects of other efficiency improvements and negatively affected the
performance, as compared to the quarter ended September 30, 1999. The Texas
facility is currently evaluating, designing and planning to add additional
plastic processing and recycling equipment during the first quarter of 2001, in
order to offset and/or eliminate higher priced plastic raw materials required
from third parties and reduce its costs, increase its margins and profitability.
The Springdale plant reported composite sales of $4,071,128 in the third quarter
of 2000 compared to $2,723,546 in the third quarter of 1999, a 49% increase.
With the additional capacity now increasing from its third extrusion line, the
Springdale plant will initially have a first year capacity in 2000 of $20
million. This capacity is intended to increase to $33 million as improved
efficiencies are realized. The Springdale plant will produce the Company's
MoistureShield(R) lines for its door, window, housing trim and industrial OEM
customers, as well as most of the ChoiceDek(R) Plus line of decking. A new
decking product may also be introduced in 2001.
Cost of goods sold increased $1,313,726, from $4,593,646 for the quarter ended
September 30, 1999 to $5,907,372 in 2000. This increase in cost of goods sold
was primarily attributed to increased raw material costs, payroll and payroll
related expenses, and utility and operating costs associated with operating the
Company's composites manufacturing units and increasing sales. The Company
completed start-up of an upgraded material handling and blending system during
the first half of July 2000. As a result of start-up of the third extrusion
line, combined with the raw material and blending system, Springdale
depreciation charges increased to $465,811 vs $285,170, for the quarter ended
September 30, 1999 an increase of $180,641 for the quarter.
14
<PAGE> 17
Significant cost categories were as follows for the quarter ended September 30:
<TABLE>
<CAPTION>
Expense Category 2000 1999
---------------- ----------- -----------
<S> <C> <C>
Payroll and payroll taxes $ 1,952,897 $ 1,625,621
Depreciation 629,951 475,019
Raw Materials 2,007,288 1,475,763
Other 1,317,236 1,017,243
----------- -----------
Total $ 5,907,372 $ 4,593,646
=========== ===========
</TABLE>
Payroll and payroll taxes increased due to additional production capacity, and
consequently production, at the Springdale plant in the third quarter of 2000 as
compared to the third quarter of 1999. Raw material costs increased as a result
of the increase in sales. A significant increase in Texas was due to raw
material plastic costs. In particular, raw material costs as a percent of sales
increased 1.2% for the third quarter of 2000 as compared to the same period a
year ago. The overall effect was limited primarily because of efficiencies
attained at the Springdale plastic recycling facility. As a percentage of sales,
the cost of materials at the Springdale facility decreased 7.2% as compared to
the third quarter of 1999, and the cost of materials at the Junction facility
increased 7% as compared to the third quarter of 1999. The overall increase in
materials costs accounted for approximately $87,622 of the $2 million in raw
material costs for the third quarter 2000. To partially offset the higher raw
material costs the Company implemented price increases on its products. As a
percentage of sales, manufacturing overhead increased to 32% in 2000 from 31% in
1999.
Selling, general and administrative expenses increased $699,299 in the third
quarter of 2000 to $1,749,610, compared to $1,050,311 for 1999. The increase was
due to increases in salaries, legal fees, advertising, commissions, and
factoring fees. Legal fees made up approximately $93,543 of the increase, and
costs associated with conducting testing for and filing the BOCA application
were approximately $21,000. The increases in commissions and factoring fees,
which totaled approximately $156,207, were directly attributable to increased
sales. The Company incurred additional marketing expenses associated with
increasing decking into nationwide distribution and into Canada. Other than the
additional legal and marketing expenses, these expenses are normally associated
with growing sales. As a percentage of sales, SG&A increased to 23% from 18% in
1999.
The Company initiated a limited national advertising program for decking in late
1999, which included print, trade shows and limited cable television
advertising. This marketing strategy was initiated with the goal of
significantly increasing sales of its ChoiceDek(R) Classic and ChoiceDek(R) Plus
decking products into national distribution in conjunction with Weyerhaeuser
BMD, its North American decking distributor.
The loss for the quarter ended September 30, 2000 was $427,926 or a loss per
weighted average common share outstanding of $.02. This compares to a net loss
of $31,758 for the third quarter of 1999. Of the increase in the third quarter
2000 expenses, approximately $87,622 was directly attributable to increased raw
material costs and $144,474 was attributable to the corporate support and
litigation when compared on a percentage basis to the third quarter of 1999.
Depreciation expenses also increased to $629,951 from $463,953 for the Company
with the start-up of the third line and Springdale raw material system.
Marketing expenses increased to $68,895 for the quarter ended September 30, 2000
as compared to $43,301 for the quarter ended September 30, 1999.
15
<PAGE> 18
Nine Months Ended September 30, 2000 Compared to Nine Months Ended
September 30, 1999
Net sales for the nine months ended September 30, 2000 increased by $6,217,091,
or 41%, over the same period a year ago. The increase in sales was attributable
to the addition of a third extrusion line at the Company's Springdale facility
and production upgrades at the Company's Junction facility. Cost of goods sold
for the nine months ended September 30, 2000 increased $4,869,603, or 40%, over
the same period a year ago. The increase in cost of goods sold was attributable
to increases in raw materials costs, payroll expenses, utilities and
depreciation expense.
Significant cost categories were as follows for the nine months ended
September 30:
<TABLE>
<CAPTION>
Expense Cateogory 2000 1999
----------------- ---- ----
<S> <C> <C>
Payroll and payroll taxes $ 5,877,245 $ 4,312,916
Depreciation 1,604,776 1,383,152
Raw materials 5,766,396 3,578,982
Other 3,842,998 2,946,762
------------ ------------
Total $ 17,091,415 $ 12,221,812
</TABLE>
Payroll expenses increased due to the increase in production capacity at the
Springdale facility. Raw material costs increased as a result of increased sales
and increased plastic prices. The depreciation expense increase came as a result
of the addition of the third Springdale extrusion line and the upgrade of the
Springdale raw material and blending systems.
Selling and administrative costs for the nine months ended September 30, 2000
increased by $1,693,839, or 64%, over the same period a year ago. The increase
in selling and administrative costs was due to increases in salaries,
professional fees, advertising, commissions, and factoring fees. The addition of
customer service and marketing personnel contributed to the salaries and
advertising increases. The increases in commissions and factoring fees were
attributable to increased sales and the increase in factoring charges from 1% of
sales to 1.75% of sales. Interest costs increased $292,247 over the nine months
ended September 30, 1999, due mainly to the addition of the $4.5 million
Arkansas State Bank loan, which is 80% guaranteed by the USDA.
The loss for the nine months ended September 30, 2000 was $908,830, or $.04 per
weighted average common share. The loss for the nine months ended September 30,
1999 was $269,862, or $.01 per weighted average common share. The increased loss
was due primarily to the increases in selling and administrative costs, raw
material costs and interest costs. Sales did not increase enough to cover these
overhead expenses. Selling and administrative costs and interest costs together
increased to 23% of sales over 20% of sales a year ago.
There can be no assurance that the Company can attain its anticipated continued
operating improvements, that raw material costs will not continue to increase,
and that additional sales price increases will be possible or that its
additional production efficiencies and resultant unit cost reductions required
for sustained profitability will occur.
RECENT DEVELOPMENTS
AERT entered into a purchase agreement with Weyerhaeuser for 1,200 trucks of its
residential and commercial decking products, which are marketed under the brand
name ChoiceDek(R), for the year 2000. This purchase agreement will approximate
$22,000,000 in gross sales for the year, providing the Company can reach this
volume of production. Through the first nine months of 2000, decking sales
amounted to $15,117,604. That sales amount is an increase over the comparable
period in 1999 of approximately 115%. AERT's focus on honoring and meeting its
Weyerhaeuser purchase agreement in 2000 has led to significant increases in
sales and increased distribution during the year. This increase in sales
opportunities for the Company is driven primarily by the increasing market
acceptance of low-maintenance decking materials by consumers over traditional
decking materials like wood that require maintenance and can rot, splinter and
warp over time when exposed to external environments.
Additionally, in the first quarter of 2000, AERT and Weyerhaeuser started a
national TV advertising campaign on TNN Outdoors. The ads ran four times per
week with an exposure to over 72 million households. These ads were to build
product identification and brand awareness. Limited print advertising in
contractor and builder magazines was also initiated over the year. During the
third quarter, additional cable TV advertising was initiated on the Outdoor
Channel. The Company began additional print and TV advertising during the third
quarter, and focused on exhibiting at many fall home and garden shows.
During October and early November 2000, Kimble County Texas where the Junction
facility is located experienced an excessive period of heavy rainfall and a
series of floods. One of the floods wiped out one of the roads (FM 2169) between
the Junction plant and Interstate 10. Although the plant was not damaged, raw
material supplies of cedar fiber were significantly reduced to the Company as
the surrounding cedar mills wood harvesting and transportation activities were
disrupted by the unusually prolonged period of wet weather. Accordingly, the
Company reduced operations to two production lines during this period and
believes it will resume full operations in Texas around the first week of
December 2000.
LIQUIDITY AND CAPITAL RESOURCES
The Company, in conjunction with its major shareholder, contractors and
suppliers, conducted a major capital expansion during 1999 at the Springdale
plant. Although this capital expansion contributed to the working capital
deficit, the completion of the $4.5 million government guaranteed loan helped to
reduce the deficit to $5,340,760 from $7,756,859 at December 31, 1999. The
deficit is primarily attributable to the Company's delays in completing
construction and starting up its additional extrusion lines in a timely manner,
and the resultant negative cash flow from the Springdale plant. Management's
decision to finance significant capital expenditures with short-term bridge
loans also contributed to the increased deficit. Of such deficit, involving
total liabilities of approximately $27.4 million as of September 30, 2000, $16.5
million was for bonds payable, which is currently escrowed and offset by a $16.5
million restricted bond escrow fund, $2 million was payable to the Company's
major shareholder, $2.3 million was in short term bridge loans, and
approximately $4.4 million was in payables of which a significant portion
reflects the construction at the Springdale facility. At September 30, 2000, net
assets had decreased to $2.8 million from $3.5 million at December 31, 1999.
Construction payables were approximately $1 million at September 30, 2000,
primarily due to Springdale construction.
The Company also successfully closed a $16.5 million tax-exempt bond financing
into escrow during the fourth quarter of 1999, which is intended to refinance
and shift its construction and expansion related accounts payable into long-term
financing. The Company started up the third Springdale production line in April
2000 and it commenced commercial production in July 2000. The Company plans to
further increase production on its additional lines through efficiency
increases. It also plans to significantly increase positive cash flows, and then
work to break a portion of the bonds from escrow once sufficient debt service
coverage can be consistently maintained. Certain requirements must be met in
order for the Company to break escrow. These include delivering to the trustee
such general items as project plans and specifications, cost estimates,
construction contracts and insurance coverage.
16
<PAGE> 19
Furthermore, unless waived by the holder of 100% of the Bonds, the Company must
also deliver to the trustee satisfactory evidence that for any consecutive 12
month period commencing on or after the date of the issuance of the bonds, the
long-term debt service coverage ratio, as defined, has been not less than 2 to
1, and the projected long-term debt service coverage ratio for the 24 month
period subsequent to the first disbursement from the project fund shall be not
less than 2 to 1. At September 30, 2000, the Company had not met the
aforementioned criteria and there are no assurances the Company will be
successful in meeting the standards required to receive the bond financing
proceeds. The bonds were reissued in October 2000, and resold to the original
purchaser with a new repurchase date by the Company of October 1, 2001. There
are no assurances that the Company will be successful in re-marketing the bonds,
at which time the Company will be required to buy back the bonds. Should the
Company be successful in its efforts to break escrow the Company believes it
will have more than adequate debt service coverage for its pending long-term
bond debt. Currently the interest expense accrued on the bonds is offset by the
interest income earned on the escrowed bond proceeds.
On February 29, 2000, the Company closed a bank financing with an Arkansas based
bank totaling $4.5 million. This loan has a 15-year amortization, is 80%
guaranteed by the U.S. Government and carries a 9.75% interest rate.
Approximately $800,000 of the loan proceeds were used to acquire 18.6 acres of
land that adjoins the plant in Springdale, Arkansas. This land will be the site
of the third manufacturing facility and an additional plastic plant, as
previously mentioned. Also, the loan proceeds were used to pay debt acquisition
costs of approximately $346,000, reduced the Company's accounts payable by
approximately $2,000,000 and provided working capital of approximately
$1,350,000. Said financing also required personal guarantees by the major
shareholder and two family members. The Company has initiated an outside third
party fairness opinion regarding this transaction, and may, but is not required
to, compensate these individuals in the future for use of their guarantees. The
Company believes that with the successful completion of its pending escrowed
bond financing it will reduce and later eliminate its working capital deficit by
paying off the remaining bridge note balance of $1.8 million during 2001. The
Company since November 1998, its bond inducement date, has expended $7.7
million on construction and expansion allocation of its Springdale facility, of
said expenditures $4.7 million are reimbursable to the Company. In addition,
$774,000 of construction payables are for bond related expenses bringing the
total to $5.47 million. If and when the bond financing were to break escrow,
payables would be reduced by approximately $1 million and the working capital
deficit would be decreased by approximately $2.1 million. Purchasing the
existing manufacturing site over a longer term should also help improve
operating costs by reducing the monthly lease payment cash requirement. By
having substantial amounts allocated for capital expansion, the Company believes
that increasing cash flows generated from operations can be used for working
capital and to further reduce the working capital deficit.
In 1998, 2,900 shares of preferred stock were issued to the major shareholder
and several close accredited investors for $1,000 per share. Classes were issued
in Series A, B and C with Series B having voting rights for the underlying
shares and warrants. On the 7th anniversary date of the issuance of the
preferred stock, the preferred stock will automatically be converted into shares
of common stock with the conversion price equal to the lower of the average of
the closing bid prices for the common stock for the 5 trading days immediately
preceding the 7th anniversary of the issuance or the fixed conversion price. The
fixed conversion price is $1.20. Under the terms of the preferred stock
agreements, certain continuing performance criteria are required of the Company,
including: (1) minimum sales of $6 million per quarter and (2) positive
quarterly cash flow from operations each quarter. If a milestone failure occurs,
the conversion price is the lower of the fixed conversion price or the variable
conversion price. The variable conversion price is the average of the closing
bid prices for the common stock during the 10 consecutive trading days ending on
the trading date immediately preceding the date of determination. A 10% premium
is payable per year. Series X and Y warrants were issued in connection with the
preferred stock and are exercisable at $1.20 and $2.50 per
17
<PAGE> 20
share, respectively. Each of the warrants has cashless exercise features that
are based on various conversion amounts and terms. Series X warrants could not
be exercised for one year from date of issuance. The preferred stock agreements
require that the Company register with the SEC the common stock underlying the
convertible preferred stock and warrants with an effective registration
statement by December 15, 2000. The Company may be required to pay certain
penalties to the holders of the preferred stock and warrants if the registration
statement is not declared effective by the SEC by December 15, 2000. The
penalties increase over time until the registration statement is 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. As a condition of this financing, the
Company filed an initial registration statement for the preferred stock in
December 1999, and expects to have it either declared effective by the SEC prior
to December 15, 2000, or have the date by which the registration statement must
be declared effective extended.
Cash and cash equivalents increased $179,162 for the first nine months of 2000.
Significant components of that increase were: (i) cash used in operating
activities of $991,935, which consisted of the net loss for the period of
$908,830 reduced by depreciation and amortization of $1,680,230 and increased by
other uses of cash of $1,763,335; (ii) cash used in investing activities of
$2,898,767, and (iii) cash provided by financing activities of $4,069,864.
Payments on notes during the period were $462,688, and proceeds from the
issuances of notes amounted to $4,500,000. At September 30, 2000, the Company
had bonds and notes payable in the amount of $24,074,079, of which $19,612,180
were current bonds and notes payable or current portion of long-term debt. Of
the current bonds and notes payable, $2,961,966 or 15% was to the major
shareholder and other investors closely associated with the Company. During the
fourth quarter of 1998, the Company reduced the indebtedness of its $3.16
million bridge loan by $1 million through the issuance of preferred stock.
During the first quarter of 1999, the loan was further reduced by $200,000 to
$1.9 million. The Company paid $100,000 in the second quarter of 2000 and
intends to pay down the remaining $1.8 million from cash flow and/or refinancing
during 2001 and the final balance upon successful completion of the bond
financing.
FUTURE PLANS
With the startup and commercial implementation of the third Springdale extrusion
line, management believes the Arkansas facility has sufficient production
capacity to support its customer base and maintain positive cash flows and
respectable profitability. The Company's objectives are to now restructure and
solidify its balance sheet,
18
<PAGE> 21
eliminate its "going concern" issue and attain a clean audit opinion. These
objectives are to be attained in four ways.
o Debt restructuring
o Cash flow
o Profitability
o Potential voluntary warrant exercise
Debt restructuring: Once both plants are in a sustainable profit mode, the
Company intends to break escrow on a portion of the bonds, with which AERT can
purchase the Springdale plant, refinance a significant portion of the bridge
loans, pay open account balances on remaining construction payables and increase
working capital by obtaining reimbursement from the bond proceeds for capital
expenditures by AERT out of working capital, which totaled approximately $4.7 at
September 30, 2000. The Company will also receive approximately $774,000 for
unpaid costs eligible for reimbursement, which are reflected in the Company's
accounts payable total. This debt restructuring is estimated to reduce
short-term payables and debt by approximately $5 million, and will greatly
improve the Company's short-term debt position. The purchase of the existing
Springdale plant will eliminate $228,000 in annual lease payments.
Cash flow: With the third Springdale extrusion line now up and running, both of
the plants should produce a consolidated amount of $900,000 of gross sales
weekly when efficiencies of scale are attained. That amount of gross sales
annualizes to $46,800,000, which management believes will generate enough cash
to pay operating expenses on a current basis. Additional plastic recycling
capacity will shortly be added to help reduce raw material costs. Additional
MoistureShield(R) product lines are also being introduced to balance and broaden
the product offering. When the bond funds break from escrow, designated bond
funds will be dedicated for construction and expansion, and cash flows generated
will then begin to increase our working capital balances.
Profitability: At the aforementioned sales level, we believe AERT will be
generating profits on a consistent basis. The Company is currently holding
monthly meetings at both plants to increase communications between the plant
associates and management and to identify specific areas for improving the
efficiency of the operations and reducing costs. We are implementing a new
accounting and reporting system in order to monitor operating performance in a
more timely manner.
The Company is now in a position under normal working conditions to make profits
each month. This of course does not anticipate major breakdowns or consistent
underutilization of the equipment due to poor operating procedures. The Company
has the infrastructure to move to consistent profitability.
Raw materials: The Company intends to immediately build a second plastic
recycling facility, and further improve and increase its internal raw material
processing capacity with an additional facility once the bond financing breaks
escrow. Management believes and has demonstrated that substantial cost savings
can be realized by processing waste plastic internally rather than relying on
outside brokers or processors. With substantial extrusion capacity now in place,
management believes lowering raw material costs can shortly result in improved
financial performance and profitability.
Potential voluntary warrant exercises: The Company has a series of warrants
outstanding, including those covered by a recent S-3 registration statement
filing, which was filed by the Company as a condition of the preferred stock
offering. This offering of $2.9 million helped the Company complete the
Springdale plant. Although outstanding warrants are voluntarily convertible by
the warrant holders, management believes that when the Company demonstrates that
the Springdale plant can be profitable and that the Company as a whole can
sustain profitability, shareholders may decide to exercise warrants, which could
bring additional equity into the Company. There can be no assurance that
shareholders may decide to voluntarily convert their warrants. Certain
shareholders, including the major shareholder, have expressed interest in
converting existing warrants, on a voluntary basis, during the fourth quarter
of 2000 to help the Company.
19
<PAGE> 22
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. INFORMATION SYSTEMS AND THE IMPACT OF THE YEAR 2000
Through the date of this report, the Company completed the transition from
calendar year 1999 to calendar year 2000 without any major problems or
disruptions because of year 2000 issues. Additionally, no problems are expected
to arise as a result of any year 2000 related failure in the future.
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 the complaint, Mobil sought entry of a declaratory
judgment that:
o AERT was without right or authority to threaten suit against Mobil or our
customers for alleged infringement of AERT patents;
o certain AERT patents were invalid and unenforceable; and
o Mobil had not infringed the AERT patents through any products or method.
Mobil sought no monetary damages in that suit, but did seek reimbursement of its
attorneys' fees.
The Company denied Mobil's claims and asserted counterclaims against Mobil and
three Mobil executives for:
o an illegal combination or contract in restraint of trade in violation of
federal antitrust laws;
o a pattern of intentional misconduct constituting an attempt to monopolize
in violation of federal antitrust laws;
o breach of a confidential relationship between Mobil and AERT; and
o unfair competition.
The Company sought monetary damages, punitive damages and injunctive relief.
In February 1994, after a trial on the patent issues, the court held that four
AERT patents on its composite product technology were invalid and that Mobil had
not infringed the patents.
In March 1995, the Company filed a motion with the Court alleging prejudicial
misconduct by Mobil prior to the trial. The Company also filed an appeal with
the U.S. Court of Appeals in July 1995. In June 1996, the U. S. Court of Appeals
reversed a portion of the earlier ruling, which had held that two of the patents
were invalid, but nevertheless ruled that Mobil did not infringe such patents.
The Company did not further appeal this ruling.
20
<PAGE> 23
In August 1994, Mobil filed a motion seeking an award of attorneys' fees and
costs for $2.7 million. In September 1999, the Delaware Court dismissed the
Mobil Motion for Attorneys' Fees, for a second time. The Court also dismissed
the Company's motion for new trial based upon discovery misconduct and the
Company's motion to supplement record.
Mobil recently filed an appeal brief regarding denial and dismissal of the
attorneys' fees motion by the Delaware Court. The Company recently answered
Mobil's appeal and cross-appealed the dismissal of its prejudicial misconduct
motion by the Delaware Court in March of 2000. The Company retained new legal
counsel for said appeal, which has extensive experience and specializes in
appellate actions. The Company's cross-appeal involves allegations of tampering
with, altering and withholding critical evidence by Mobil prior to trial. It
seeks a final denial of Mobil's request for attorneys' fees and a new trial for
prejudicial discovery misconduct. The Mobil appeal has been set by the U.S.
Court of Appeals for the Federal Circuit for oral argument on December 5, 2000,
in Washington, D.C. The Company's counterclaims are still pending, although
Mobil is no longer in the composite products business.
There can be no assurance that the Company can prevail on these issues or that
if it prevails, Mobil will not further appeal to a higher court. Furthermore,
there can be no assurance that the Company will be awarded a new trial upon
appeal. The Company has $40,000 accrued for any legal fees that could arise as a
result of this litigation.
The Company is a counterclaim 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.
We were also sued in May 2000 in federal court in Texas for back royalty
payments allegedly due to a successor to a licensor of firelog extrusion
technology. That licensor licensed technology to a firelog manufacturing Company
operated by our founders in 1986-1987. A dispute and lawsuit arose at that time
between our founders and that licensor that was settled by an agreement that our
founders and their affiliates would pay the licensor a royalty of $10.00 per ton
of material, if any produced using the licensor's technology. As described in
our December 1989 IPO prospectus and for many years thereafter, we have always
contended that we did not use such technology and no royalty was paid nor, prior
to this year, did that licensor ever pursue any claim for such royalties. We
believe numerous defenses are available and intend to vigorously defend
ourselves against what we consider a matter related to the current suit in
Delaware. Mobil was also a successor and licensee from affiliates of that
firelog technology licensor.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBIT 27 - FINANCIAL DATA SCHEDULE
No reports on Form 8-K were filed during the quarter ended September 30, 2000.
21
<PAGE> 24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
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: November 20, 2000 Date: November 20, 2000
22
