NOTES
TO FINANCIAL STATEMENTS
Note 1: Unaudited Information
Advanced Environmental Recycling Technologies, Inc. (the Company or AERT) has prepared the financial statements included herein 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 accounting principles generally accepted in the United States of America 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
Advanced Environmental Recycling Technologies, Inc. (AERT or the Company), founded in 1988, recycles polyethylene plastic and develops, manufactures, and markets composite building materials that are used in place of traditional wood or plastic products for exterior applications in building and remodeling homes and for certain other industrial or commercial building purposes. The Company’s products are made primarily from approximately equal amounts of waste wood fiber, which have been cleaned, sized and reprocessed, and recycled polyethylene plastics which have been cleaned, processed, and reformulated utilizing our patented and proprietary technologies. Its products have been extensively tested, and are sold by leading national companies such as BlueLinx Corporation (BlueLinx), Lowe’s Companies, Inc. (Lowe’s) and Therma-Tru Corporation. The Company’s products are primarily used in renovation and remodeling by consumers, homebuilders, and contractors as an exterior environmentally responsible building alternative for decking, railing, and trim products.
The Company’s distributor for its ChoiceDek
®
products is BlueLinx Corporation. All ChoiceDek
®
products are sold by BlueLinx exclusively to Lowe’s.
The Company currently manufactures all of its composite products at extrusion facilities in Springdale, Arkansas. The Company operates a plastic recycling, blending and storage facility in Lowell, Arkansas, where it also leases warehouses and land for inventory storage. The Company also maintains a facility at Watts, Oklahoma where it cleans, reformulates, and recycles polyethylene plastic scrap as a means to reduce the Company’s costs of recycled plastics. The Company also leases warehouse space for inventory storage in Westville, Oklahoma.
Note 3: Statements of Cash Flows
In order to determine net cash provided by (used in) operating activities, net income (loss) has been adjusted by, among other things, changes in current assets and current liabilities, excluding changes in cash, current maturities of long-term debt and current notes payable. Those changes, shown as an (increase) decrease in current assets and an increase (decrease) in current liabilities, are as follows (in thousands):
|
|
Quarters ended
|
|
|
|
|
|
|
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Receivables - trade and related parties
|
|
$
|
95
|
|
|
$
|
(87
|
)
|
Inventories
|
|
|
(317
|
)
|
|
|
(2,308
|
)
|
Prepaid expenses
|
|
|
(254
|
)
|
|
|
209
|
|
Accounts payable - trade and related parties
|
|
|
871
|
|
|
|
781
|
|
Accrued liabilities
|
|
$
|
447
|
|
|
$
|
(649
|
)
|
|
|
$
|
842
|
|
|
$
|
(2,054
|
)
|
Cash paid for interest
|
|
$
|
165
|
|
|
$
|
152
|
|
Supplemental Disclosures of Non-Cash Investing and Financing Activities
(in thousands):
|
|
Quarters ended
|
|
|
|
|
|
|
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Notes payable for financing insurance policies
|
|
|
-
|
|
|
|
105
|
|
Note 4: Significant Accounting Policies
Revenue Recognition Policy
The Company recognizes revenue when the title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, shipment has occurred or services have been rendered, the sales price is determinable and collectability is reasonably assured. The Company typically recognizes revenue at the time product is shipped or when segregated and billed under a bill and hold arrangement. Sales are recorded net of discounts, rebates and returns, which were $0.8 million and $0.5 million for the quarters ended March 31, 2014 and 2013, respectively.
Estimates of expected sales discounts are calculated by applying the appropriate sales discount rate to all unpaid invoices that are eligible for the discount. The Company’s sales prices are determinable given that its sales discount rates are fixed and given the predictability with which customers take sales discounts.
Shipping and Handling
The Company records shipping fees billed to customers in net sales and records the related expenses in cost of goods sold.
Inventories
Inventories are stated at the lower of cost
(first-in, first-out method)
or market. Material, labor, and factory overhead necessary to produce the inventories are included at their cost. Inventories consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(unaudited)
|
|
|
|
|
Raw materials
|
|
|
6,012
|
|
|
|
5,100
|
|
Work in process
|
|
|
2,125
|
|
|
|
2,337
|
|
Finished goods
|
|
|
5,330
|
|
|
|
5,713
|
|
|
|
$
|
13,467
|
|
|
$
|
13,150
|
|
Accounts Receivable
Accounts receivable are uncollateralized customer obligations due under normal trade terms generally requiring payment within thirty days from the invoice date. Trade accounts are stated at the amount management expects to collect from outstanding balances. Payments of accounts receivable are allocated to the specific invoices identified on the customers’ remittance advice.
Accounts receivable are carried at original invoice amounts less an estimated reserve provided for returns and discounts based on a review of historical rates of returns and expected discounts. The carrying amount of accounts receivable is reduced, if needed, by a valuation allowance that reflects management’s best estimate of the amounts that will not be collected. Management individually reviews all overdue accounts receivable balances and, based on an assessment of current creditworthiness, estimates the portion, if any, of the balance that will not be collected. Management provides for probable uncollectible amounts through a charge to earnings and a credit to an allowance account based on its assessment of the current status of the individual accounts. Balances which remain outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to trade accounts receivable. Recoveries of trade receivables previously written off are recorded when received.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.
Concentration Risk
Credit Risk
The Company’s revenues are derived principally from national and regional building products distributors and BlueLinx, the Company’s primary decking customer. The ChoiceDek
®
brand of decking products sold to BlueLinx are in turn sold exclusively to Lowe’s. BlueLinx is also one of the Company’s MoistureShield
®
decking customers. The Company extends unsecured credit to its customers. The Company’s concentration in the building materials industry has the potential to impact its exposure to credit risk because changes in economic or other conditions in the construction industry may similarly affect the Company’s customers. The Company derived most of its revenue from BlueLinx, its distributor of ChoiceDek
®
products.
M
ajor Customers
The Company’s revenues are derived principally from national and regional building products distributors. BlueLinx is the Company’s largest single customer, distributing both the ChoiceDek
®
brand of decking products sold exclusively at Lowe’s as well as the Company’s MoistureShield
®
decking products in select geographies. For quarter ended March 31, 2014, BlueLinx represented more than 60% of the Company’s revenue. A loss of this customer, or a major reduction in their business, could cause a significant reduction in our liquidity. We are currently working to increase our distribution network that will reduce this customer’s concentration.
The Company has significant customer concentration, with one customer representing more than 40% of our accounts receivable for the quarter ended March 31, 2014 as compared to 73% for the quarter ended March 31, 2013. A loss of this customer, or a major reduction in their business, could cause a significant reduction in our liquidity. We are currently working to expand our distribution network, which will reduce this customer’s concentration.
Cash
The Company maintains bank accounts that are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. At times, cash balances may be in excess of the FDIC limit. The Company believes no significant concentrations of risk exist with respect to its cash.
Note 5: Income Taxes
As of March 31, 2014, the Company had net operating loss (NOL) carryforwards for federal income tax purposes, which are available to reduce future taxable income. If not utilized, the NOL carryforwards will expire between 2017 and 2031. In March 2011, H.I.G. AERT, LLC acquired a controlling interest in the Company, which resulted in a significant restriction on the utilization of the Company’s net operating loss carryforwards. It is estimated that the utilization of future NOL carryforwards will be limited (per IRC 382) to approximately $0.8 million per year for the next 18 years. The impact of this limitation is approximately $27.0 million in NOL’s, which will expire before the Company can use them.
As there is insufficient evidence that the Company will be able to generate adequate future taxable income to enable it to realize its net operating loss carryforwards prior to expiration, the Company maintains a valuation allowance to recognize its deferred tax assets only to the extent of its deferred tax liabilities.
Based upon a review of its income tax filing positions, the Company believes that its positions would be sustained upon an audit and does not anticipate any adjustments that would result in a material change to its financial position. Therefore, no reserves for uncertain income tax positions have been recorded. The Company recognizes interest related to income taxes as interest expense and recognizes penalties as operating expense.
The Company is subject to routine audits by various taxing jurisdictions. The recent examination by the Internal Revenue Service of the Company’s 2010 federal tax return yielded changes that did not affect the tax that was reported on the return; therefore, the Service has accepted the return. The Company is no longer subject to income tax examinations by taxing authorities for years before 2010, except in the States of California and Texas, for which the 2009 tax year is still subject to examination.
Note 6: Earnings Per Share
The Company utilizes the two-class method for computing and presenting earnings per share. The Company currently has two classes of common stock (the Common Stock) and one class of cumulative participating preferred stock, Series E (the Preferred Stock). Pursuant to the Series E Designation, holders of the Series E Preferred Stock are entitled to receive per share dividends equal to 6% per annum of the stated value of $1,000 per share of Series E Preferred Stock when declared by the Company’s Board of Directors. In addition, holders of the Series E Preferred Stock are entitled to participate in any dividends declared on shares of the Company’s Common Stock on an as-converted basis. Therefore, the Preferred Stock is considered a participating security requiring the two-class method for the computation and presentation of net income per share – basic.
The two-class computation method for each period segregates basic earnings per common and participating share into two categories: distributed earnings per share (i.e., the Preferred Stock stated dividend) and undistributed earnings per share, which allocates earnings after subtracting the Preferred Stock dividend to the total of weighted average common shares outstanding plus
equivalent converted common shares related to the Preferred Stock. Basic earnings per common and participating share exclude the effect of Common Stock equivalents, and are computed using the two-class computation method.
In computing diluted EPS, only potential common shares that are dilutive—those that reduce earnings per share or increase loss per share—are included. The exercise of options or conversion of convertible securities is not assumed if the result would be antidilutive, such as when a loss from continuing operations is reported. 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 following presents the two-class method for the three months ended March 31, 2014 and 2013:
BASIC EARNINGS PER SHARE
(in thousands, except share and per share data)
|
|
Quarters ended
|
|
|
|
|
|
|
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Net income (loss) applicable to common stock
|
|
$
|
(1,799
|
)
|
|
$
|
646
|
|
Preferred stock dividend
|
|
$
|
363
|
|
|
$
|
342
|
|
Income (loss) before dividends
|
|
$
|
(1,436
|
)
|
|
$
|
988
|
|
|
|
|
|
|
|
|
|
|
Per share information:
|
|
|
|
|
|
|
|
|
Basic earnings per common and participating share:
|
|
|
|
|
|
|
|
|
Distributed earnings per share:
|
|
|
|
|
|
|
|
|
Common
|
|
$
|
0.00
|
|
|
$
|
0.00
|
|
Preferred
|
|
$
|
0.00
|
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
Earned, unpaid dividends per share:
|
|
|
|
|
|
|
|
|
Preferred
|
|
$
|
17.71
|
|
|
$
|
16.69
|
|
|
|
|
|
|
|
|
|
|
Undistributed earnings (loss) per share:
|
|
|
|
|
|
|
|
|
Common
|
|
$
|
(0.02
|
)
|
|
$
|
0.00
|
|
Preferred
|
|
|
-
|
|
|
$
|
24.33
|
|
|
|
|
|
|
|
|
|
|
Total basic earnings (loss) per common and participating share:
|
|
|
|
|
|
|
|
|
Common
|
|
$
|
(0.02
|
)
|
|
$
|
0.00
|
|
Preferred
|
|
$
|
17.71
|
|
|
$
|
41.02
|
|
|
|
|
|
|
|
|
|
|
Basic weighted average common shares:
|
|
|
|
|
|
|
|
|
Common weighted average number of shares
|
|
|
89,631,162
|
|
|
|
89,631,162
|
|
Participating preferred shares - if converted
|
|
|
-
|
|
|
|
305,945,751
|
|
Total weighted average number of shares
|
|
|
89,631,162
|
|
|
|
395,576,913
|
|
Although not included in the basic earnings per share calculation under the two-class method, due to a period of loss, the Company had participating securities outstanding at March 31, 2014. The following schedule presents these securities for the quarter ended March 31, 2014.
|
|
2014
|
|
Series E preferred stock
|
|
|
327,950,710
|
|
Although these financial instruments were not included due to a period of loss for the three months ended March 31, 2014, such financial instruments would need to be included with future calculations of basic EPS under the two-class method in periods of income.
Note 7: Line of Credit
The Company has an $8.0 million line of credit (Revolver) loan with the AloStar Bank of Commerce, subject to a reserve of $1.0 million. Interest is assessed at the greater of (a) 1.0% and (b) the LIBOR rate as shown in the
Wall Street Journal
on such day for United States dollar deposits for the one month delivery of funds in an amount approximately equal to the principal amount of the Revolver Loan for which such rate is being determined plus 4% at March 31, 2014. If the LIBOR cannot be determined, the interest will be calculated using the prime lending rate plus 2%. The interest rate at March 31, 2014 was 5%. The Revolver is secured by 85% of accounts receivable after a reduction for amounts owed by international customers. The Revolver is also secured by 60% of the eligible inventory or 85% of the net orderly liquidation value of the inventory. The Revolver at AloStar had a balance of $5.6 million at March 31, 2014. The proceeds available to draw down on the Revolver loan at March 31, 2013 were $1.4 million.
Note 8: Related Party Transactions
Leases
In December 2007, the Company entered into a 20-year lease for an existing 16-building complex on 60 acres in Adair County, Oklahoma near the town of Watts, for the construction of a waste plastic washing, recycling, and reclamation facility. The property was leased from Razorback Farms, a corporation controlled by Marjorie S. Brooks, a former director, with payments of $0.0075 per pound of plastic recycled, commencing on January 1, 2009, on a pounds of production, or net throughput of recycled plastic produced, basis with a minimum rent of $1,000 per month. The throughput or production rent was due quarterly and was capped throughout the term of the lease not to exceed $450,000 per year. Rent expense recorded under this lease totaled $188,143 in 2012.
In March 2013, the Company purchased the 60 acres in Adair County from Razorback Watts. As a result of this transaction, no rent expense was recognized in 2013 for this property.
Recapitalization
In 2011, the Company consummated related recapitalization transactions with H.I.G. AERT, LLC. In exchange for making approximately $6.9 million of additional capital available to the Company, H.I.G. was issued (i) a Series A Term Note in the aggregate principal amount of $10 million and (ii) a Series B Senior Term Note in the aggregate principal amount of $9 million and (iii) 20,524.149 shares of Series E convertible preferred stock, par value $0.01 per share. As a result, H.I.G. owns approximately 80% of the outstanding common equity securities of the Company on a fully diluted, as converted basis.
The recapitalization agreements have been accounted for as a troubled debt restructuring (ASC 470-60). The Credit Agreement contains provisions requiring mandatory payments upon the Notes equal to 50% of the Company’s “Excess Cash Flow” and equal to 100% of proceeds from most non-ordinary course asset dispositions, additional debt issuances or equity issuances (subject to certain exceptions in each case or as H.I.G. otherwise agrees), and contains covenant restrictions on the incurrence of additional debt, liens, leases or equity issuances (subject to certain exceptions in each case or as H.I.G. otherwise agrees).
Advisory Services
The Company entered into an Advisory Services Agreement between H.I.G. Capital, L.L.C. and the Company (the Advisory Services Agreement) on March 18, 2011 that provides for an annual monitoring fee between $250,000 and $500,000 (the Monitoring Fee) and reimbursement of all other out-of-pocket fees and expenses incurred by H.I.G. Capital, L.L.C.
Note 9: Commitments and Contingencies
AERT is involved from time to time in litigation arising from the normal course of business that is not disclosed in its filings with the SEC. In management's opinion, this litigation is not expected to materially impact the Company's results of operations or financial condition.
Class Action Lawsuits
The U.S. District Court, Western District of Washington (Seattle Division) approved a class action settlement in January 2009 related to a purported class action lawsuit seeking to recover on behalf of purchasers of ChoiceDek® composite decking for damages allegedly caused by mold and mildew stains on their decks. The settlement includes decking material purchased from January 1, 2004 through December 31, 2007, along with decking material purchased after December 31, 2007 that was manufactured before October 1, 2006, the date a mold inhibitor was introduced into the manufacturing process.
In 2008, the Company accrued an estimated $2.9 million for resolving claims. In the third quarter of 2009, the Company increased its estimate of costs to be incurred in resolving claims under the settlement by $5.1 million. The estimate was revised due to events that occurred and information that became available after the second quarter of 2009 concerning primarily the number of claims received. The deadline for submitting new claims has now passed. The claim resolution process had an annual net cost limitation to the Company of $2.0 million. The claims resolution process is now completed.