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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
                             ---------------------
 
                                   FORM 10-K
 
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<C>               <S>
   (MARK ONE)
      [X]         ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
                  THE SECURITIES EXCHANGE ACT OF 1934
    FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
                                      OR
      [  ]        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                  SECURITIES EXCHANGE ACT OF 1934
    FOR THE TRANSITION PERIOD FROM ____________ TO ____________
 
                        Commission File Number 0-21926
</TABLE>
 
                           AER ENERGY RESOURCES, INC.
             (Exact name of registrant as specified in its charter)
 
<TABLE>
<S>                                                 <C>
                      GEORGIA                                           34-1621925
          (State or other jurisdiction of                            (I.R.S. Employer
          incorporation or organization)                            Identification No.)
</TABLE>
 
                4600 HIGHLANDS PARKWAY, SUITE G, SMYRNA, GEORGIA
                    (Address of principal executive offices)
 
                                     30082
                                   (Zip Code)
 
       Registrant's telephone number, including area code: (770) 433-2127
 
        Securities registered pursuant to Section 12(b) of the Act: NONE
 
          Securities registered pursuant to Section 12(g) of the Act:
 
                           COMMON STOCK, NO PAR VALUE
 
     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 such 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 [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
     The aggregate market value of the Common Stock held by non-affiliates of
the registrant, based upon the closing sale price of the Common Stock on the
Nasdaq Stock Market's National Market on February 22, 1999, was approximately
$11,025,381.
 
     As of February 22, 1999, the registrant had 24,862,263 shares of Common
Stock outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE:
 
     Certain portions of the Proxy Statement for the registrant's 1999 Annual
Meeting of Shareholders are incorporated by reference to the extent indicated in
Part III of this Form 10-K.
 
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                               TABLE OF CONTENTS
 
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                                                                           PAGE
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<S>   <C>    <C>                                                           <C>
PART I
------
Item    1.   Business....................................................    3
        2.   Properties..................................................    6
        3.   Legal Proceedings...........................................    7
        4.   Submission of Matters to a Vote of Security Holders.........    7
             Executive Officers of the Registrant........................    7
 
PART II
-------
Item    5.   Market for Registrant's Common Equity and Related               8
               Stockholder Matters.......................................
        6.   Selected Financial Data.....................................    8
        7.   Management's Discussion and Analysis of Financial Condition     8
               and Results of Operations.................................
        7A.  Quantitative and Qualitative Disclosures about Market          11
               Risk......................................................
        8.   Financial Statements and Supplementary Data.................   11
        9.   Changes in and Disagreements with Accountants on Accounting    11
               and Financial Disclosure..................................
 
PART III
--------
Item   10.   Directors and Executive Officers of the Registrant..........   12
       11.   Executive Compensation......................................   12
       12.   Security Ownership of Certain Beneficial Owners and            12
               Management................................................
       13.   Certain Relationships and Related Transactions..............   12
 
PART IV
-------
Item   14.   Exhibits, Financial Statement Schedules and Reports on Form    13
               8-K.......................................................
</TABLE>
 
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                                     PART I
 
ITEM 1.  BUSINESS.
 
GENERAL
 
     AER Energy Resources, Inc. (the "Company" or "AER Energy") was incorporated
in 1989 and has been engaged in the development and commercialization of high
energy density zinc-air batteries. The Company's operations until recently were
focused primarily on developing and improving its technology, setting up the
manufacturing process, testing and selling rechargeable zinc-air batteries,
recruiting personnel, and similar activities. The Company began selling its
first product in August 1994, but sales from products have been minimal.
 
     In 1998 the Company changed its focus to research and product development
of zinc-air technology and commercialization of primary (disposable) rather than
rechargeable batteries through alliances with large established battery and
original equipment manufacturers ("OEMs"). The Company announced in September
1998 its Technology Licenses and Services ("TLAS") Agreement with Duracell Inc.,
a subsidiary of The Gillette Company, making Duracell the first licensee of the
Company's primary (non-rechargeable) zinc-air technology. Under the terms of the
TLAS Agreement, the Company agrees to license certain of its primary zinc-air
related battery technology to Duracell. In addition, Duracell is funding certain
joint product development projects with the Company.
 
     Under the TLAS Agreement, Duracell agrees to license the rights to the
Company's currently existing patents. Duracell will own technology developed
under the projects it funds, and the Company will have rights to utilize the
technology. Duracell also has options to obtain certain other license rights.
 
     Prior to this 1998 change in strategy, AER Energy had been engaged in the
development and commercialization of rechargeable zinc-air batteries that
provide long, continuous runtime to users of portable electronic products.
Although the Company will not entirely forsake the rechargeable market, for the
foreseeable future it will be only a secondary emphasis. The major focus will be
on primary batteries, a larger market than rechargeable batteries with a
potential for quicker entry.
 
     The Company continues to be a development stage company and has generated
only minimal revenues from battery sales. Revenues in the form of license fees
and development funds from its new strategy commenced in the fourth quarter of
1998 and are expected to continue. New alliances and license agreements will be
sought which would eventually bring the Company out of the development stage.
 
     In November 1997, the Company was issued a United States patent for its
"Diffusion Air Manager" technology. The Diffusion Air Manager can extend
zinc-air battery storage life by isolating the cells in zinc-air batteries from
exposure to air during periods when the battery is in storage or not in use.
Because of its simplicity, small size and enhanced storage life capability, the
Company believes that the Diffusion Air Manager may allow zinc-air batteries to
be applied to a variety of markets and products that have not been practical in
the past. It is this technology that will be the basis for seeking to attract
more large established battery and consumer electronic equipment manufacturers
into alliances for joint product development, manufacturing, and licensing.
 
     The Company was formed to use technology licensed from Dreisbach
Electromotive, Inc. ("DEMI"). DEMI was formed in 1982 to conduct research and
development on electric vehicles and battery systems utilizing, among others,
zinc-air technology. DEMI's zinc-air development programs included applications
for electric vehicles and portable products. The Company and DEMI entered into a
license agreement (the "DEMI License") in July 1989 whereby DEMI granted to the
Company exclusive worldwide rights to DEMI's zinc-air battery patents and
technology (including trade secrets) for all applications other than motor
vehicles for so long as the Company wishes to use such licensed rights. DEMI has
retained the rights to zinc-air technology for motor vehicle applications and to
its other technologies for motor vehicle applications and batteries producing
over 500 watts of continuous power output.
 
TECHNOLOGY OVERVIEW
 
     The market for batteries is currently being served by a variety of
different battery technologies, some of which were first commercialized
approximately 100 years ago. Each of these battery technologies offers certain
attributes such as energy density, energy storage capacity, cost, configuration
and service life which make it best suited for particular product applications.
Choosing the appropriate battery to serve a given application involves matching
the battery's characteristics to the user's application requirements. The
Company is not aware of any single battery technology that can ideally serve all
applications.
 
     The battery industry is broadly segmented into two types of batteries:
primary and rechargeable. Primary batteries are used until discharged, then
discarded and they typically are priced below rechargeable batteries. In
contrast, rechargeable batteries can be discharged and then recharged to almost
full capacity and discharged again.
 
     The Company believes important battery characteristics include energy
density, energy storage capacity, cell voltage and discharge voltage profile.
Energy density can be calculated based on either the weight or volume of the
battery. For a given amount of energy, higher energy density by weight yields
lighter batteries and higher energy density by volume yields smaller batteries.
Energy storage capacity refers to the limits on a battery's ability to store
energy safely and practically. Batteries with high energy storage capacity may
more easily be configured to deliver increased operating time. Cell voltage
determines the number of individual cells that must be connected in series to
provide the overall voltage required to operate a specific product. Generally,
batteries requiring fewer cells to achieve a given battery voltage are more
reliable and facilitate original equipment product design. The shape of a
battery's discharge voltage profile defines the
 
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range of voltage over which a product must operate to utilize all of the energy
stored in the battery. A battery with a flat discharge profile delivers a more
consistent level of voltage throughout the battery's discharge cycle and may
simplify an OEM product design and contribute to better operating efficiency.
 
     The Company believes its primary zinc-air batteries offer a unique
combination of high energy density by weight, volume, and high-energy storage
capacity. In addition, the Company's primary zinc-air battery cell has a flat
discharge voltage profile.
 
     Zinc-air batteries are known to exhibit superior energy density compared to
other types of batteries due to their ability to absorb oxygen directly from the
atmosphere to fuel the chemical reaction that generates electricity. It is this
superior energy density that provides zinc-air batteries with their long runtime
capability. However, if stored in an open-to-air condition, the storage life of
zinc-air batteries can be greatly effected by the humidity in the air. As a
result, the use of primary zinc-air batteries has been relegated to niche
applications in which the battery operates continuously once it is placed in
service. For this reason, primary zinc-air batteries have been predominantly
used in hearing aids. In order to develop a marketable zinc-air battery, AER
Energy needed to develop an air management system to isolate the battery's
zinc-air cells from exposure to air during customer storage. The Company's early
air manager designs for rechargeable zinc-air batteries were bulky and
relatively expensive since they involved the use of sliding doors or
electromechanical devices to seal the battery case and isolate the zinc-air
cells from exposure to air. In November 1997, the Company was issued a patent on
its Diffusion Air Manager, an air management system which consists of openings
configured as tubes to admit air into the battery enclosure and a small fan to
draw air through the tubes. The Diffusion Air Manager can be applied to both
primary and rechargeable zinc-air batteries. In addition, because of its
simplicity, small size, and improvement in zinc-air battery storage life, the
Diffusion Air Manager is expected to expand the number of applications that are
appropriate for primary and rechargeable zinc-air battery technology. The
Company believes that the market for primary zinc-air batteries is larger and
more easily penetrated than the market for rechargeable batteries and, as a
consequence, will focus on primary batteries.
 
BUSINESS STRATEGY
 
     The Company's strategy is to capitalize on the need for long runtime
batteries by mobile workers and other consumers dissatisfied with the runtime of
their portable electronic devices powered by other batteries. The following are
key elements of the Company's current strategy:
 
          1. Generate revenues from license fees, development contracts and
     royalties.
 
          2. Focus research and development on primary zinc-air battery
     technology.
 
          3. Pursue market opportunities through relationships with major
     battery and electronic product manufacturers.
 
          4. Reduce operating costs consistent with the new business direction.
 
PRODUCTS
 
     Due to the capability of the Diffusion Air Manager to be applied to primary
zinc-air batteries, AER Energy has changed its focus to primary batteries as
opposed to rechargeable batteries. The path to market for the primary battery is
normally faster and the Company's licensees will have the responsibility for
sales and marketing.
 
     The primary batteries produced by the Company's licensees would most likely
be used in hand-held electronic devices, such as cellular telephones, cordless
telephones, camcorders, digital cameras, and hand-held computers. Due to the
long runtime and anticipated low cost of the batteries, they could also be used
in some applications that today call for rechargeable batteries.
 
MARKETING AND SALES
 
     The primary focus of AER Energy's marketing and sales effort will be to
find large established battery and consumer electronic equipment manufacturers
who recognize the advantages of the Company's zinc air technology and wish to
fulfill the manufacturing and sales role of bringing the batteries to market.
 
RESEARCH AND DEVELOPMENT
 
     The Company's primary assets are the patents that its research and
development efforts have produced over the years. The more recent success of the
Company's research and development efforts is the development and patenting of
Diffusion Air Manager technology which is the foundation of AER Energy's entry
into the primary battery market. The Company plans to continue to work to reduce
the size and cost of zinc-air batteries. AER Energy maintains a small assembly
operation to produce prototype batteries for thorough testing.
 
     A majority of the Company's expenses to date have been for research and
development. The Company's research and development expenses for the last three
years averaged over $4.3 million and have aggregated $35.5 million from
inception.
 
ENVIRONMENTAL MATTERS
 
     The Company is subject to various United States federal, state and local
standards that govern the storage, use and disposal of various chemicals used in
and waste materials produced in the manufacture of its zinc-air batteries,
including zinc, carbon, potassium hydroxide, solvents and adhesives. These
standards include the Environmental Protection
 
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<PAGE>   5
 
Agency's regulations governing the amount of zinc in the manufacturing waste
stream and state and local regulations governing fire protection, air quality
standards and employee safety, training and preparedness.
 
     During 1996, the Company eliminated the addition of mercury to its zinc-air
cells and batteries without sacrificing size, weight or power. Under federal
regulations, the Company's zinc-air batteries with no added mercury are not
considered hazardous waste and can be disposed of as household garbage. However,
some of the chemicals currently used in its batteries, such as zinc metal and
potassium hydroxide, may subject its batteries to regulation in the future.
 
COMPETITION
 
     The development and marketing of battery products is highly competitive.
The industry consists primarily of major domestic and international companies,
the vast majority of which have financial, technical, marketing, sales,
manufacturing, distribution and other resources and name recognition
substantially greater than those of the Company as well as established positions
in the market and established ties with OEMs. This competitive situation is one
reason AER Energy has changed its strategy to one which anticipates licensing
large established battery and consumer electronic equipment manufacturers.
 
     The Company has at least one competitor currently developing primary
zinc-air batteries for portable electronic products. Electric Fuel Corporation
has announced that it is beginning the manufacture of primary zinc-air batteries
for cellular telephones and that it has received at least one order for delivery
in 1999. In addition to Electric Fuel Corporation, the Company believes that its
major competitors will also be makers of nickel-cadmium, nickel-metal hydride
and lithium-based batteries, some, if not all, of whom are candidates to be AER
Energy licensees. Such competitors and potential licensees include Ralston
Purina's Eveready Battery Company, Sanyo Electric Co., Ltd., Toshiba
Corporation, Matsushita Electric Industrial Co., Ltd., SAFT and Varta Batterie
AG, who, among others, currently manufacture nickel-cadmium or nickel-metal
hydride batteries or both. Sony Corporation, Sanyo Electric Co., Ltd. and
Matsushita Electric, among others, are marketing a lithium-ion battery that is
designed for use with portable computers, video cameras and cellular telephones.
Sony Corporation and Matsushita Electric have announced that they will begin
production of lithium polymer batteries in 1999. Valence Technology, Inc.,
Ultralife Batteries, Inc., Hydro-Quebec, Dowty Battery Company and Asahi
Chemical Industry Company, Ltd. are also engaged in the research and development
of lithium-polymer batteries, most of which are not yet commercially available.
In addition, companies such as Sony, Matsushita Electric, Sanyo, SAFT, Rayovac,
Tadiran Electronic Industries, Eveready, Duracell and Toshiba, and possibly
other companies, may have active research and development programs to develop
new high energy density batteries. No assurance can be given that such companies
will not develop batteries similar or superior to the Company's zinc-air
batteries.
 
PATENTS AND LICENSES
 
     The Company relies on certain technology for which either the Company or
DEMI has sought patent protection, including certain patents licensed to the
Company by DEMI. The Company has sought to protect certain technology that the
Company believes to be proprietary, filing patent applications for such
technology both in the United States and in certain countries abroad. The
Company plans to prosecute infringements to its patent rights, where
appropriate. However, there can be no assurance that any particular infringement
will be prosecuted, or if prosecuted, that it will be successful. The Company
also plans to rely upon trade secrets, know-how, continuing technological
innovations and its ability to exploit new opportunities to develop and maintain
its competitive position.
 
     Through the DEMI License, the Company has exclusive rights to ten DEMI
patents (except for motor vehicle applications) which have been issued in the
United States and two that have issued in Japan. The DEMI patents relate to air
manager systems, an electrolyte recirculating system, a flexible cell case which
allows for zinc anode volume change during charge and discharge, a continuous
consumable anode, a coated air electrode and a method for attaching zinc-air
batteries to electronic products. The Company is not currently utilizing any of
the technology embodied in the DEMI patents.
 
     During the last nine years, the Company has been granted 19 United States
patents, five European patents, and four Japanese patents. In addition, the
Company has filed 27 United States and 28 foreign patent applications and has 14
patent disclosures in review as of December 31, 1998. It is the Company's
intention to continue filing new patent applications in the United States,
Japan, Europe and Canada as appropriate for the technology, products and product
improvements developed through its research and product development activities.
 
     The Company believes that its most significant intellectual property
benefits are derived from its air manager patents and pending applications. The
air manager system regulates the flow of air within the battery during use and
isolates the zinc-air cells from air during storage, both critical variables
affecting zinc-air battery performance and storage life. The Company has been
issued five United States patents on its air manager system. The Company also
has 17 United States patent applications pending on its designs relating to its
air manager system. The Company believes its most significant air manager patent
is No. 5,691,074, which covers the Company's Diffusion Air Manager and expires
in 2015. AER Energy has also received a Notice of Allowance from the United
States Patent and Trademark Office on a continuation application that
significantly broadens the coverage of the Company's Diffusion Air Manager
patent. The Company's early air manager designs were bulky and relatively
expensive since they involved the use of sliding doors or electromechanical
devices. The Company's Diffusion Air Manager consists of openings that are
configured as tubes to admit air into the battery enclosure and a small fan to
draw air through the tubes. The Company believes the Diffusion Air Manager is a
simple, low cost solution to the storage life problems encountered by both
rechargeable and primary zinc-air battery designs.
 
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     United States patents, either issued to or applied for by DEMI, Mr. Mike
Cheiky, DEMI's former principal scientist, or the Company, and in each case
subject to the DEMI License, relate to some of the operating parameters of the
zinc-air battery system. The Company and DEMI entered into the DEMI License in
July 1989 whereby DEMI granted to the Company the exclusive worldwide rights to
DEMI's zinc-air battery patents and technology (including trade secrets) for all
applications other than motor vehicles for so long as the Company wishes to use
such licensed rights. The DEMI License includes the right to sublicense and it
covers any new zinc-air technology developed or acquired by DEMI, or by Mr.
Cheiky, prior to expiration of his employment agreement with DEMI. For these
rights, the Company has agreed to pay DEMI royalties of 4% of net sales through
July 19, 2004, subject to certain minimum amounts and possible increases or
decreases to a maximum of 4% and a minimum of 2%, as specified in the DEMI
License (except for sales by Duracell which are set at 4%). The applicable
percentage of royalties is currently 4% of net sales. After July 19, 2004, the
Company may continue to use such licensed technology without payment of further
royalties. In order to maintain exclusive rights to the technology covered by
the DEMI License, the Company must pay minimum royalties to DEMI for the first
ten years of the DEMI License (through 1999). Effective in 1993, the DEMI
License was amended so that, under certain circumstances, some or all of the
royalties due under the DEMI License are payable to the shareholders of DEMI
rather than to DEMI. DEMI has also agreed to the terms of a proposed OEM air
manager license agreement to be entered into by the Company and any OEMs
licensing the air manager system, which provides that 4% of the royalties the
Company receives from sublicensing the air manager system will be payable to
DEMI, subject to the reduction as provided in the proposed agreement. Pursuant
to the DEMI License, a relationship for the exchange of technology exists
between the Company and DEMI.
 
     In order to manufacture air electrodes for its zinc-air batteries, the
Company purchased production equipment and licensed the accompanying air
electrode and process technology pursuant to a 1993 agreement (the "Westinghouse
License") with Westinghouse Electric Corporation ("Westinghouse"). Under the
Westinghouse License, the Company is obligated to pay royalties of 1% of its
revenues from sales of zinc-air battery products up to $300,000, followed by
royalties of 0.5% of such revenues up to an additional $350,000, at which time
no further royalties for product sales will be due. In addition, for ten years
the Company will pay Westinghouse the greater of (i) 50% of any sublicense fees
it receives if it sublicenses the technology licensed from Westinghouse, or (ii)
0.5% of sublicensee product sales. The Company is not using the Westinghouse
technology in its primary zinc-air batteries.
 
     In September 1998 the Company executed the TLAS Agreement with Duracell
Inc., a wholly-owned subsidiary of The Gillette Company, pursuant to which the
Company's zinc-air battery technology has been licensed to Duracell on primarily
a non-exclusive basis. Under the agreement, Duracell will provide funding to the
Company for certain product development projects; in return, Duracell will own
the technology developed under the product development projects funded by
Duracell. The Company has certain royalty-bearing and royalty-free rights to
utilize the technology funded by Duracell. Duracell also has certain
non-exclusive rights to the Company's currently existing technology and certain
option rights to obtain an exclusive license of the Company's technology to
manufacture and sell certain battery cells.
 
     In addition to potential patent protection, the Company attempts to protect
its trade secrets and other proprietary information through secrecy agreements
with customers, suppliers, employees and consultants and other security
measures. Although the Company intends to protect its rights vigorously, there
can be no assurance that these measures will be successful.
 
EMPLOYEES
 
     At December 31, 1998, the Company had 39 employees. Of the total number of
personnel, 11 were engaged in research and development, 19 were engaged in
product development, assembly and prototype operations, and 9 were in marketing
and general and administrative functions. In implementing its new strategy, the
Company reduced the number of employees from 85 at the beginning of 1998. The
Company's success will depend in large part on its ability to retain skilled and
experienced employees. None of the Company's employees are covered by a
collective bargaining agreement, and the Company considers its relations with
its employees to be good.
 
FORWARD LOOKING STATEMENTS
 
     This report contains statements which, to the extent that they are not
recitations of historical fact, may constitute "forward looking statements"
within the meaning of applicable federal securities laws and are based on the
Company's current expectations and assumptions. These expectations and
assumptions are subject to a number of risks and uncertainties which could cause
actual results to differ materially from those anticipated, which include but
are not limited to the following: ability of the Company to achieve development
goals, ability of the Company to commercialize its battery technology, ability
of the Company to license its technology, ability of the Company to implement
its new strategy, development of competing battery technologies, ability of the
Company to protect its proprietary rights to its technology, improvements in
conventional battery technologies, demand for and acceptance of the Company's
products in the marketplace, ability to obtain commitments from battery
manufacturers and OEMs, impact of any future governmental regulations, impact of
pricing or material costs, ability of the Company to raise additional funds and
other factors affecting the Company's business that are beyond the Company's
control. All forward looking statements contained in this report are intended to
be subject to the safe harbor protection provided by applicable federal
securities laws.
 
ITEM 2.  PROPERTIES.
 
     The Company currently leases 35,400 square feet of office administration,
engineering, testing and product development space in Smyrna, Georgia. This
space will be reduced to 24,840 square feet in May 1999. The Company
 
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believes that its existing facilities (at the May 1999 reduced level) and
equipment, together with any equipment to be purchased with existing cash, will
be adequate to conduct its operations. Management does not anticipate needing
additional space in the near future, but believes that if needed, the Company
would be able to secure additional space at reasonable rates.
 
ITEM 3.  LEGAL PROCEEDINGS.
 
     The Company is not currently a party to, and no property of the Company is
presently the subject of, any pending legal proceeding.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1998.
 
EXECUTIVE OFFICERS OF THE REGISTRANT.
 
     The executive officers of the Company as of February 22, 1999 were as
follows:
 
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          NAME             AGE                          POSITION
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<S>                        <C>   <C>
David W. Dorheim           49    President, Chief Executive Officer and Director
R. Dennis Bentz            48    Vice President -- Product and Process Development
Frank M. Harris            46    Vice President -- Marketing and Licensing
J. T. Moore                59    Vice President -- Chief Financial Officer, Treasurer
                                 and Secretary
Lawrence A. Tinker, Ph.D   46    Vice President -- Advanced Technology
</TABLE>
 
     David W. Dorheim joined the Company in 1989 as President, Chief Executive
Officer and a director. From 1985 to 1989, Mr. Dorheim was Vice President,
Battery Assembly Division, Gates Energy Products, Inc., with responsibility for
assembly operations in Juarez, Mexico, Newcastle, England and Hong Kong as well
as a design center in El Paso, Texas. Prior to 1985, Mr. Dorheim held various
marketing and sales positions with the General Electric Battery Division in
Gainesville, Florida, including Regional Sales Manager and Manager of Marketing
Programs. Mr. Dorheim is a director of DEMI.
 
     R. Dennis Bentz joined the Company in 1990 as Vice
President -- Manufacturing. His title was recently changed to Vice
President -- Product and Process Development to reflect his role in the
Company's new strategy. Mr. Bentz was employed from 1978 to 1990 by Duracell
International, Inc., a battery manufacturer. Mr. Bentz's last four years at
Duracell were spent as Product Engineering Manager, with responsibility for
product and process design of alkaline, lithium and primary zinc-air batteries.
Prior to 1987, Mr. Bentz managed the Duracell development and testing facility
in Tarrytown, New York and served as Engineering Manager and Product Engineer.
 
     Frank M. Harris joined the Company in 1990 as Vice President -- Marketing
and Sales. His title was recently changed to Vice President -- Marketing and
Licensing to reflect his role in the Company's new strategy. From 1987 through
1989, Mr. Harris was employed by International Components Corporation, a
Chicago-based manufacturer of battery chargers, as Vice President of Engineering
and Director of Sales. From 1986 to 1987, Mr. Harris served as Manager of
Marketing Programs for a lighting product line of the General Electric Lighting
Business Group. From 1981 to 1986, Mr. Harris worked with the battery business
of General Electric where he held positions in market research and served as
manager of private label battery marketing.
 
     J. T. Moore joined the Company in September 1998 as Vice President -- Chief
Financial Officer, Treasurer and Secretary. He previously served as Chief
Financial Officer of Dyad Corporation, a computer software developer, from 1997
to 1998, Executive Vice President of Eastern European Capital, an international
investment company, from 1995 to 1997, and International Chief Financial
Officer/Director of Finance for Turner Broadcasting Company, an international
broadcasting company, from 1993 to 1995. His experience also includes Arthur
Andersen, LLP and Marriott Corporation. Mr. Moore is a certified public
accountant.
 
     Lawrence A. Tinker, Ph.D joined the Company in January 1993 as Vice
President -- Engineering. His title was recently changed to Vice
President -- Advanced Technology to reflect his role in the Company's new
strategy. During the prior five years, Dr. Tinker was employed by Gates Energy
Products, Inc., where his most recent position was Manager, Technology for
aerospace batteries. In this position, Dr. Tinker managed a group of scientists
responsible for developing nickel-cadmium, nickel-metal hydride and
nickel-hydrogen aerospace battery systems. Prior to 1988, Dr. Tinker was
employed by Ballard Research Inc. for six years, where he managed the research
and development effort for rechargeable lithium battery systems.
 
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                                    PART II
 
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
     The Company's common stock is traded under the symbol "AERN" on the Nasdaq
National Market ("Nasdaq").
 
     The following table sets forth, for the quarters indicated, the high and
low sales prices for the Company's common stock on Nasdaq. Nasdaq quotations are
based on actual transactions and not bid prices.
 
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                                                                  PRICE
                                                              --------------
QUARTER ENDED:                                                HIGH       LOW
--------------                                                ----       ---
<S>                                                           <C>        <C>
March 31, 1997..............................................  3 9/16     2 1/4
June 30, 1997...............................................  3 1/4      2
September 30, 1997..........................................  2 13/16    2 1/16
December 31, 1997...........................................  2 7/16     1 1/8
March 31, 1998..............................................  1 7/8      1 1/8
June 30, 1998...............................................  1 23/32    11/16
September 30, 1998..........................................  1 5/16     17/32
December 31, 1998...........................................  1 3/16     9/16
</TABLE>
 
     On December 31, 1998, the closing price of the common stock as reported on
Nasdaq was $0.788 per share. On February 22, 1999, there were 283 holders of
record of the Company's common stock. This number excludes shareholders holding
stock under nominee or street name accounts with brokers.
 
     The Company has not declared a cash dividend on its common stock since
inception. The Company has incurred operating losses since inception and expects
to incur operating losses at least through 1999. Thus, the Company anticipates
that for the foreseeable future, earnings, if any, will be retained for the
operation and growth of its business. Accordingly, the Company does not
anticipate paying any dividends in the foreseeable future.
 
ITEM 6.  SELECTED FINANCIAL DATA.
 
<TABLE>
<CAPTION>
                                                                                                     PERIOD FROM
                                                                                                    JULY 17, 1989
                                                                                                      (DATE OF
                                                            YEAR ENDED DECEMBER 31,                 INCEPTION) TO
                                               --------------------------------------------------   DECEMBER 31,
        STATEMENT OF OPERATIONS DATA:           1998      1997       1996       1995       1994         1998
        -----------------------------          -------   -------   --------   --------   --------   -------------
                                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                            <C>       <C>       <C>        <C>        <C>        <C>
License fees and research and development
  revenues...................................  $   350   $    --   $     --   $     --   $     --     $    350
Product sales................................        2       108         23        159         49          340
Cost of product sales........................       (2)   (2,674)    (1,311)    (2,179)      (595)      (6,761)
                                               -------   -------   --------   --------   --------     --------
                                                   350    (2,566)    (1,288)    (2,020)      (546)      (6,071)
Costs and expenses:
  Research and development...................    4,747     4,024      4,207      4,696      6,341       35,463
  Marketing, general, and administrative.....    2,613     2,999      3,123      4,174      3,766       23,180
                                               -------   -------   --------   --------   --------     --------
          Total costs and expenses...........    7,360     7,023      7,330      8,870     10,107       58,643
                                               -------   -------   --------   --------   --------     --------
Operating loss...............................   (7,010)   (9,589)    (8,618)   (10,890)   (10,653)     (64,714)
Interest income (expense), net...............      378       823      1,059        692        464        3,624
                                               -------   -------   --------   --------   --------     --------
Net loss.....................................  $(6,632)  $(8,766)  $ (7,559)  $(10,198)  $(10,189)    $(61,090)
                                               -------   -------   --------   --------   --------     --------
Net loss per share (basic and diluted).......  $ (0.27)  $ (0.36)  $  (0.33)  $  (0.59)  $  (0.68)    $  (4.01)
                                               =======   =======   ========   ========   ========     ========
Weighted average shares outstanding (basic
  and diluted)...............................   24,839    24,617     22,673     17,229     14,905       15,238
</TABLE>
 
<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                                        ----------------------------------------------------
BALANCE SHEET DATA:                                       1998       1997       1996       1995       1994
-------------------                                     --------   --------   --------   --------   --------
                                                                           (IN THOUSANDS)
<S>                                                     <C>        <C>        <C>        <C>        <C>
Cash and cash equivalents.............................  $  4,250   $ 10,207   $ 18,728   $ 16,417   $ 16,030
Working capital.......................................     4,069     10,155     18,502     16,125     15,953
  Total assets........................................     5,335     12,057     20,688     18,895     19,007
  Total liabilities...................................       285        494        512        703        665
Deficit accumulated during the development stage......   (61,427)   (54,795)   (46,008)   (38,223)   (27,936)
          Total stockholders' equity..................     5,050     11,563     20,176     18,192     18,342
</TABLE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
 
GENERAL
 
     The Company was incorporated in 1989 and has been engaged in the
development and commercialization of high energy density zinc-air batteries. The
Company's operations until recently were focused primarily on developing and
 
                                        8
<PAGE>   9
 
improving its technology, setting up the manufacturing process, testing and
selling zinc-air batteries, recruiting personnel, and similar activities. The
Company began selling its first product in August 1994, but sales from products
have been minimal.
 
     In 1998, the Company changed its focus to research and product development
of zinc-air technology and commercialization of primary (disposable) rather than
rechargeable batteries through alliances with large established battery and
original equipment manufacturers ("OEMs"). This change allows AER Energy to
capitalize on the capability of its patented Diffusion Air Manager technology
and opportunities in hand-held electronic products like camcorders, cellular
telephones, cordless telephones, digital cameras, and hand-held computers. The
Diffusion Air Manager is a simplified method of isolating the cells in zinc-air
batteries from exposure to air during periods when the battery is in storage or
not in use. The Company has ceased marketing its rechargeable battery products
and canceled all outstanding orders for its rechargeable battery products.
 
     In September 1998, the Company announced its Technology Licenses and
Services ("TLAS") Agreement with Duracell Inc., a subsidiary of The Gillette
Company, making Duracell the first licensee of the Company's zinc-air
technology. Under the TLAS Agreement, Duracell agrees to license the rights to
the Company's currently existing patents. In addition, Duracell is funding
certain joint product development projects with the Company. Duracell will own
technology developed under the projects it funds, and the Company will have
rights to utilize the technology. Duracell also has options to obtain certain
other license rights.
 
     As of January 1999, Duracell has paid the Company $1.875 million which will
be recognized as revenue when it is earned ($350,000 was recognized in 1998).
Additional monies are anticipated for product development funding in 1999.
 
     Throughout 1999, the Company plans to work with Duracell under the TLAS
Agreement, seek additional license agreements for its patented zinc-air
technology with other companies, focus on the development of prototype primary
zinc-air batteries that utilize Diffusion Air Manager technology, and maintain a
small research and development effort in rechargeable zinc-air technology.
 
RESULTS OF OPERATIONS
 
     Revenues for 1998, 1997, and 1996 were $352,000, $108,000, and $23,000,
respectively. Virtually all of the 1998 revenues arose from the TLAS Agreement
with Duracell and were for product development. Revenues during 1997 and 1996
were attributable to battery product sales.
 
     The Company's cost of product sales for 1997 and 1996 were $2.7 million and
$1.3 million, respectively. There were virtually no products produced for sale
in 1998. The high cost of sales in 1997 and 1996 was due primarily to
manufacturing inefficiencies and high material costs resulting from low
production volumes and start up of production processes.
 
     Research and development expenses increased to $4.7 million in 1998 from
$4.0 million in 1997 in line with the increased emphasis on research and
development. The 4% decrease from 1996 ($4.2 million) to 1997 is attributable to
the higher level of manufacturing in 1997 versus 1996, causing less overhead to
be charged to research and development.
 
     Marketing, general and administrative expenses decreased to $2.6 million in
1998 from $3.0 million in 1997 and $3.1 million in 1996. In 1998, the 13%
decrease resulted primarily from lower personnel related costs ($207,000),
advertising and similar marketing expenses ($168,000), and travel ($69,000). In
1997, the 4% decrease arose from decreases in professional fees ($118,000),
obsolete inventory ($108,000), warranty costs ($85,000), facility costs
($63,000), and royalty expense ($54,000), offset by increases in personnel
related costs ($230,000) and travel costs ($65,000).
 
     Interest income decreased in both 1998 and 1997 as a result of lower cash
and cash equivalents balances throughout each year in comparison with the
previous year.
 
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
 
     The Company financed its operations from inception through July 1993 with
debt and private placements of common stock. In July 1993, the Company received,
net of underwriting discounts and commissions but before deducting expenses,
proceeds of $16.3 million from its initial public offering of 2,500,000 shares
of common stock. In August 1993, the Company issued 311,700 additional shares
pursuant to the exercise of the underwriters' over-allotment option, and
received additional proceeds of $2.0 million, net of underwriting discounts and
commissions. In November 1994, the Company closed a second public offering of
2,500,000 shares of its common stock, generating proceeds of $12.3 million, net
of underwriting discounts and commissions but before deducting expenses. In
December 1994, 150,000 additional shares were issued pursuant to the
underwriters' overallotment option, generating additional proceeds of $736,500,
net of underwriting discounts and commissions.
 
     In November 1995, the Company issued $10,675,000 principal amount of 8%
convertible subordinated debentures due November 17, 1997. Through November 17,
1997, a holder of a debenture could have elected to convert the debenture into
common stock of the Company at a conversion price equal to the lesser of $3.60
per share or a percentage ranging from 85% to 100% of the average closing bid
price for the five trading days immediately prior to the conversion. In
connection with the transaction, the Company paid to a placement agent $840,500
in fees and delivered warrants to purchase 225,590 shares of the Company's
common stock at an exercise price of $4.32 per share. The warrants expired in
1998. During 1996, $9,775,000 in principal plus accrued interest was converted
into 5,394,992 shares of common stock at an average conversion price of $1.86
per share. During 1997, the remaining $900,000 in principal plus accrued
interest was converted into 518,683 shares of common stock at an average
conversion price of $1.93 per share.
 
                                        9
<PAGE>   10
 
     In May 1996, the Company issued 1,584,158 shares of its common stock, and
warrants to purchase 835,000 additional shares, in a private placement at an
aggregate purchase price of $10 million. The transaction generated proceeds of
$9.4 million, net of expenses. The warrants have an exercise price of $6.3125
per share and expire in 2001. The value of the warrants is included in common
stock on the balance sheet.
 
     The Company plans to use the remaining net proceeds from these financings
to fund research and product development efforts, marketing and licensing
activities, production of prototype zinc-air battery products, working capital
and general corporate purposes as determined by management. In the interim, the
Company invests the net proceeds in government securities and other short-term,
investment grade, interest bearing investments.
 
     The TLAS Agreement with Duracell will also provide cash to fund operating
needs of the Company.
 
     As of December 31, 1998 the Company had cash and cash equivalents of $4.25
million.
 
     Net cash used in operating activities decreased to $5.9 million in 1998
from $8.2 million in 1997, and increased in 1997 from $6.9 million in 1996. The
changes in net cash used in operating activities are primarily due to the
changes in costs and expenses discussed above in "Results of Operations."
 
     During the years ended December 31, 1998, 1997 and 1996, cash used in
investing activities was $39,000, $280,000, and $158,000, respectively, which
primarily reflected the purchase of manufacturing and battery testing equipment.
 
     Financing activities during 1998 and 1997 provided no significant cash. In
1996, cash provided by financing activities of $9.4 million came from the
private placement sale of the Company's common stock and warrants.
 
     As discussed in Note 7 to the Financial Statements, the Company has agreed
to pay DEMI royalties pursuant to the DEMI License. The Company recorded royalty
expense related to the DEMI License for the years ended December 31, 1998, 1997,
and 1996 and for the period from inception to December 31, 1998 of $100,000,
$100,000, $150,000, and $1,350,000, respectively.
 
     As discussed in Note 8 to the Financial Statements, under the Westinghouse
License the Company would pay 1% of revenues up to $300,000 followed by 0.5% of
revenues up to $350,000, at which time no further royalties for product sales
will be due. The Company is not using the Westinghouse technology in its primary
zinc-air batteries.
 
     At December 31, 1998, the Company had available net operating loss
carryforwards for income tax purposes of approximately $54.7 million and
research and development credit carryforwards of approximately $1.3 million.
These carryforward items will both begin to expire in 2004. Both of these
carryforward items are subject to certain limitations on annual utilization
related to changes in ownership of the Company. These limitations could
significantly reduce the amount of the net operating loss and credit
carryforwards available to the Company in the future.
 
     The Company currently anticipates that its existing cash balances, along
with cash to be received in 1999 under the TLAS Agreement, will fund operations
and continue technology development at the current level of activity through the
end of 1999 and into early 2000. However, it may be necessary for the Company to
increase its research and product development expenses as it continues to work
to improve its primary zinc-air technology and to explore markets for its
rechargeable zinc-air batteries. It may also be necessary for the Company to
expend greater than expected funds on its facilities to produce prototypes of
its primary zinc-air battery products. The Company will continue to need working
capital beyond its current levels, and depending on the Company's results of
operations, the Company may find it necessary to obtain additional working
capital on an accelerated basis or in amounts greater than currently
anticipated. There can be no assurance that additional equity or debt financing
will be available when needed or on terms acceptable to the Company. To date,
both costs and development times have substantially exceeded the Company's
forecasts. The Company has also encountered greater difficulty in
commercializing its technology than originally expected. In addition, the
battery business is a chemical processing business and, as such, the Company
will require specialized equipment to develop its zinc-air batteries. Future
equipment additions could exceed current Company estimates in cost, complexity
and development time.
 
     The market price of the Company's common stock has fluctuated significantly
since it began to be publicly traded in July 1993 and may continue to be highly
volatile. Factors such as the ability of the Company to achieve development
goals, ability of the Company to commercialize its battery technology, ability
of the Company to license its technology, development of competing battery
technologies, ability of the Company to protect its proprietary rights to its
technology, improvements in conventional battery technologies, demand for and
acceptance of the Company's products in the marketplace, ability to obtain
commitments from battery companies and OEMs, impact of any future governmental
regulations, impact of pricing or material costs, ability of the Company to
raise additional funds, general market conditions and other factors affecting
the Company's business that are beyond the Company's control may cause
significant fluctuations in the market price of the Company's common stock. The
market prices of the stock of many high technology companies have fluctuated
substantially, often unrelated to the operating or research and development
performance of the specific companies. Such market fluctuations could adversely
affect the market price for the Company's common stock.
 
     On September 3, 1998, Nasdaq notified the Company that it was not in
compliance with the Nasdaq National Market Continued Listing Requirements due to
the bid price for shares of the Company's common stock closing below $1 per
share for thirty consecutive trading days. On February 4, 1999, the Company
appeared at a hearing before a Nasdaq Review Panel to present its business case
and to disclose the Company's intention to effect a reverse stock split at its
April 7, 1999 Annual Meeting of Shareholders in order to meet the minimum bid
price requirement for continued listing on Nasdaq. Questions were raised by the
Nasdaq Review Panel concerning the Company's net tangible assets, as another
requirement for continued listing on the Nasdaq National Market is a minimum of
$4 million in net tangible assets. In
 
                                       10
<PAGE>   11
 
response to the questions raised at its hearing, the Company prepared a plan and
submitted it to Nasdaq on February 12, 1999, showing the projected net tangible
assets for the Company throughout the coming twelve months. The Company is
awaiting a decision from the Nasdaq Review Panel. There is no assurance that the
Nasdaq Review Panel's ruling will result in the Company's continued listing on
the Nasdaq National Market.
 
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
     As of December 31, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." The Statement
establishes standards for the reporting and display of comprehensive income and
its components in a full set of general purpose financial statements. The
adoption of this Statement did not have any effect on the Company's financial
position or results of operations.
 
     In June 1997, FASB issued Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information".
Management has determined that the Company does not have separate reportable
operating segments as defined by this Statement.
 
     In March 1998, the AICPA issued SOP 98-1, "Accounting For the Costs of
Computer Software Developed For or Obtained For Internal Use." The SOP requires
capitalization of certain costs incurred in connection with developing or
obtaining internal use software. This SOP is not anticipated to have a material
effect on the financial position or results of operations of the Company.
 
     As of December 31, 1998, the Company adopted Statement of Financial
Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities." Because the Company does not have any
derivative instruments or hedging activities, the adoption of the new Statement
did not have any effect on the financial position or results of operations of
the Company.
 
YEAR 2000 DISCLOSURE
 
     The "Year 2000" issue is the result of some computer programs being written
using two digits instead of four digits to define an applicable year.
Time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000 which could potentially result in miscalculations or system
failure. The Year 2000 issue is believed to affect all companies and
organizations, including the Company. The Company has been assessing its
exposure to the Year 2000 issue by reviewing all internal business, network and
testing systems and by identifying key areas of exposure related to outside
third parties.
 
     The Company has determined that its major operational and accounting
programs that control its purchasing, inventory, billing, accounts payable and
general accounting systems are designed to be Year 2000 compliant, and the
Company has received outside certification of this compliance. In addition to
its operational programs, the Company has several software programs that test
product performance and quality. These programs have been tested internally as
Year 2000 compliant, and the Company does not anticipate any material
modifications. The Company did determine that its network server was not Year
2000 compliant and has already ordered and received the required upgrades that
will be installed internally. Most of the Company's user workstations are Year
2000 compliant with the remaining scheduled to be upgraded by December 31, 1999
at a cost of approximately $4,000 to $5,000.
 
     Currently the Company has no critical interfacing systems to third parties.
However, it is very difficult to predict the Year 2000 impact on third parties
with which the Company has business transactions, and while the Company does not
anticipate any significant problems, there can be no assurance that problems
will not occur or have a material adverse effect on the Company.
 
     Management is continuing to examine the Year 2000 issues as they
potentially impact the Company and is developing contingency plans as necessary.
While the Company believes that the cost of completing the assessment and
contingency plans will not be material and the risks to the Company with respect
to Year 2000 issues are manageable, the Company cannot at this time fully assess
the potential impact.
 
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
     The Company has invested a portion of its cash and cash equivalents in
financial instruments that mature in 90 days or less, and are therefore
classified as cash equivalents. The Company has historically held, and plans in
the future to hold, all such instruments until maturity. If the instruments
were, for some reason not anticipated, redeemed earlier than their maturity,
there might be a gain or loss on the transaction. As noted immediately above,
the Company has no transactions which qualify for treatment under SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities".
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
     Reference is made to the Index to Financial Statements on Page F-1 of the
Financial Statements of the Company filed as part of this report.
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
 
     None.
 
                                       11
<PAGE>   12
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
 
     The information concerning the nominees for Directors of the Company set
forth under "Election of Directors" in the Company's Proxy Statement for its
1999 Annual Meeting of Shareholders is incorporated herein by reference in
response to the information required by this Item 10.
 
     Information concerning compliance with Section 16(a) of the Securities
Exchange Act of 1934 set forth under the heading "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's Proxy Statement for its 1999
Annual Meeting of Shareholders is incorporated herein by reference in response
to the information required by this Item 10.
 
     Information concerning the Executive Officers of the Company is contained
in a separate section captioned "Executive Officers of the Registrant" in Part I
of this report and is incorporated herein by reference in response to the
information required by this Item 10.
 
ITEM 11. EXECUTIVE COMPENSATION.
 
     The information set forth under "Executive Compensation" in the Company's
Proxy Statement for its 1999 Annual Meeting of Shareholders is incorporated
herein by reference in response to the information required by this Item 11.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
     The information set forth under "Voting Securities" in the Company's Proxy
Statement for its 1999 Annual Meeting of Shareholders is incorporated herein by
reference in response to the information required by this Item 12.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
     The information set forth under "Certain Transactions" and "Compensation
Committee Interlocks and Insider Participation" in the Company's Proxy Statement
for its 1999 Annual Meeting of Shareholders is incorporated herein by reference
in response to the information required by this Item 13.
 
                                       12
<PAGE>   13
 
                                    PART IV
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
 
(a) Documents:
 
     (1) The following financial statements of the Company and Report of
Independent Auditors are filed as part of this Report.
 
        Balance Sheets as of December 31, 1998 and 1997
 
        Statements of Operations for the years ended December 31, 1998, 1997,
and 1996, and for the period from July 17, 1989 (date of inception) to December
31, 1998
 
        Statements of Stockholders' Equity for the years ended December 31,
1998, 1997, and 1996, and for the period from July 17, 1989 (date of inception)
to December 31, 1998
 
        Statements of Cash Flows for the years ended December 31, 1998, 1997,
and 1996, and for the period from July 17, 1989 (date of inception) to December
31, 1998
 
        Notes to Financial Statements
 
        Report of Independent Auditors
 
     (2) Financial Statement Schedules.
 
     Financial statement schedules have been omitted either because they are not
applicable or because the information that would be included in such schedules
is included elsewhere in the financial statements or the notes thereto.
 
     (3) Exhibits:
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                          DESCRIPTION OF EXHIBITS
-------                         -----------------------
<C>      <C>  <S>
  3.1     --  Articles of Incorporation of the Company, as amended.(1)
  3.2     --  Bylaws of the Company, as amended.(1)
  4.1     --  See Articles II and VII of the Company's Articles of
              Incorporation located within Exhibit 3.1.
  4.2     --  See Articles 2, 3 and 4 of the Company's Bylaws located
              within Exhibit 3.2.
 10.1     --  License Agreement dated July 19, 1989 among the Company,
              Dreisbach Electromotive, Inc. and Mike Cheiky.(2)
 10.2*    --  AER Energy Resources, Inc. 1992 Stock Option Plan, as
              amended.(2)
 10.3*    --  Form of Non-Qualified Stock Option Agreement.(3)
 10.4*    --  Form of Incentive Stock Option Agreement.(3)
 10.5     --  Agreement dated May 12, 1993 between the Company and
              Westinghouse Electric Corporation.(2)
 10.6*    --  Form of Indemnity Agreement with Directors.(2)
 10.7     --  Consent to Partial Assignment of Royalties and Amendment No.
              2 to License Agreement dated as of October 15, 1993 among
              the Company, Dreisbach Electromotive, Inc. and Mike
              Cheiky.(4)
 10.8     --  Amended and Restated DEMI/AER Air Manager Agreement dated
              October 15, 1993 among the Company, Dreisbach Electromotive,
              Inc. and Mike Cheiky. (4)
 10.9*    --  AER Energy Resources, Inc. 1993 Non-Employee Directors'
              Restricted Stock Award Plan. (4)
 10.10*   --  Form of Director's Restricted Stock Award Agreement. (5)
 10.11*   --  Stock Option Agreement dated November 2, 1989 by and between
              David W. Dorheim and Aerobic Power Systems, Inc. (now AER
              Energy Resources, Inc.). (6)
 10.12*   --  Stock Option Agreement dated February 8, 1991 by and between
              R. Dennis Bentz and AER Energy Resources, Inc. (6)
 10.13*   --  Stock Option Agreement dated July 1, 1990 by and between
              Frank M. Harris and Aerobic Power Systems, Inc. (now AER
              Energy Resources, Inc.).(6)
 10.14    --  Lease Agreement dated November 15, 1993 between AER Energy
              Resources, Inc. and Highlands Park Associates.(7)
 10.15    --  Lease Agreement dated March 25, 1994 between AER Energy
              Resources, Inc. and Highlands Park Associates.(7)
 10.16*   --  Stock Option Agreement dated December 20, 1994 between H.
              Douglas Johns and AER Energy Resources, Inc.(8)
 10.17*   --  Consulting Agreement dated December 20, 1994 between H.
              Douglas Johns and AER Energy Resources, Inc.(9)
 10.18    --  Form of Convertible Debenture Subscription Agreement.(10)
 10.19    --  Form of 8% Convertible Debenture due November 17, 1997.(10)
 10.20    --  Registration Rights Agreement.(10)
</TABLE>
 
                                       13
<PAGE>   14
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                          DESCRIPTION OF EXHIBITS
-------                         -----------------------
<C>      <C>  <S>
 10.21    --  Warrant to Purchase Common Stock.(10)
 10.22    --  Amendment No. 3 to License Agreement and Termination of
              Technology Assignment Agreement dated December 26, 1995.(11)
 10.23    --  Securities Purchase Agreement, dated as of May 20, 1996, by
              and between FW AER Partners, L.P. and AER Energy Resources,
              Inc.(12)
 10.24    --  Warrant to Purchase Common Stock.(12)
 10.25*   --  Agreement between H. Douglas Johns and AER Energy Resources,
              Inc. dated November 7, 1996, amending Mr. Johns' Consulting
              Agreement and Stock Option Agreement.(13)
 10.26    --  Technology Licenses and Services Agreement, dated as of
              September 24, 1998, by and between Duracell Inc. and AER
              Energy Resources, Inc.(14)
 21       --  Subsidiaries of the Company.(2)
 23       --  Consent of Ernst & Young LLP, Independent Auditors.
 27       --  Financial Data Schedule (for SEC use only).
</TABLE>
 
---------------
 
  * Indicates management contract or compensatory plan or arrangement.
 (1) Filed on June 17, 1993 as an Exhibit to Amendment No. 2 to the Registrant's
     Registration Statement on Form S-1 (File No. 33-62668) and incorporated
     herein by reference.
 (2) Filed on May 14, 1993 as an Exhibit to the Registrant's Registration
     Statement on Form S-1 (File No. 33-62668) and incorporated herein by
     reference.
 (3) Filed on October 5, 1993 as an Exhibit to the Registrant's Registration
     Statement on Form S-8 (File No. 33-69982) and incorporated herein by
     reference.
 (4) Filed on October 29, 1993 as an Exhibit to the Registrant's Quarterly
     Report on Form 10-Q (File No. 0-21926) for the quarter ended September 30,
     1993 and incorporated herein by reference.
 (5) Filed on September 24, 1993 as an Exhibit to the Registrant's Registration
     Statement on Form S-8 (File No. 33-69462) and incorporated herein by
     reference.
 (6) Filed on March 25, 1994 as an Exhibit to the Registrant's Annual Report on
     Form 10-K (File No. 0-21926) for the year ended December 31, 1993 and
     incorporated herein by reference.
 (7) Filed on September 23, 1994 as an Exhibit to the Registrant's Registration
     Statement on Form S-1 (File No. 33-84300) and incorporated herein by
     reference.
 (8) Filed on February 2, 1995 as an Exhibit to the Registrant's Registration
     Statement on Form S-8 (File No. 33-89068) and incorporated herein by
     reference.
 (9) Filed on March 23, 1995 as an Exhibit to the Registrant's Annual Report on
     Form 10-K (File No. 0-21926) for the year ended December 31, 1994 and
     incorporated herein by reference.
(10) Filed on December 13, 1995 as an Exhibit to the Registrant's Form 8-K (File
     No. 0-21926) and incorporated herein by reference.
(11) Filed on March 28, 1996 as an Exhibit to the Registrant's Annual Report on
     Form 10-K (File No. 0-21926) for the year ended December 31, 1995 and
     incorporated herein by reference.
(12) Filed on May 20, 1996 as an Exhibit to the Registrant's Form 8-K (File No.
     0-21926) and incorporated herein by reference.
(13) Filed on March 27, 1997 as an Exhibit to the Registrant's Annual Report on
     Form 10-K (File No. 0-21926) for the year ended December 31, 1996 and
     incorporated herein by reference.
(14) Filed on September 24, 1998 as an Exhibit to the Registrant's Form 8-K
     (File No. 0-21926) and incorporated herein by reference.
 
(b) Reports on Form 8-K filed in the fourth quarter of 1998:
 
     The registrant did not file any reports on Form 8-K during the quarter
ended December 31, 1998.
 
                                       14
<PAGE>   15
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) 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 on February 23, 1999.
 
                                      AER ENERGY RESOURCES, INC.
 
                                      By:       /s/ DAVID W. DORHEIM
                                        ----------------------------------------
                                        David W. Dorheim,
                                        President and Chief Executive Officer
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                      SIGNATURE                                         TITLE                         DATE
                      ---------                                         -----                         ----
<C>                                                    <S>                                      <C>
                 /s/ JON A. LINDSETH                   Chairman                                 February 23, 1999
-----------------------------------------------------
                   Jon A. Lindseth
 
                /s/ DAVID W. DORHEIM                   Director, President and Chief Executive  February 23, 1999
-----------------------------------------------------    Officer
                  David W. Dorheim
 
                   /s/ J. T. MOORE                     Vice President -- Chief Financial        February 23, 1999
-----------------------------------------------------    Officer, Treasurer and Secretary
                     J. T. Moore                         (Principal Accounting Officer and
                                                         Principal Financial Officer)
 
                 /s/ DAVID G. BROWN                    Director                                 February 23, 1999
-----------------------------------------------------
                   David G. Brown
 
                 /s/ JAMES W. DIXON                    Director                                 February 23, 1999
-----------------------------------------------------
                   James W. Dixon
 
               /s/ WILLIAM L. JACKSON                  Director                                 February 23, 1999
-----------------------------------------------------
                 William L. Jackson
 
                /s/ H. DOUGLAS JOHNS                   Director                                 February 23, 1999
-----------------------------------------------------
                  H. Douglas Johns
 
                 /s/ JOHN L. WILKES                    Director                                 February 23, 1999
-----------------------------------------------------
                   John L. Wilkes
</TABLE>
 
                                       15
<PAGE>   16
 
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Report of Independent Auditors..............................  F-2
 
Financial Statements
 
  Balance Sheets............................................  F-3
 
  Statements of Operations..................................  F-4
 
  Statements of Stockholders' Equity........................  F-5
 
  Statements of Cash Flows..................................  F-6
 
  Notes to Financial Statements.............................  F-7
</TABLE>
 
                                       F-1
<PAGE>   17
 
                         REPORT OF INDEPENDENT AUDITORS
 
The Stockholders and Board of Directors
AER Energy Resources, Inc.
 
     We have audited the accompanying balance sheets of AER Energy Resources,
Inc. (a development stage company) as of December 31, 1998 and 1997, and the
related statements of operations, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1998 and for the period from
July 17, 1989 (date of inception) to December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of AER Energy Resources, Inc.
(a development stage company) as of December 31, 1998 and 1997, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1998 and for the period from July 17, 1989 (date of
inception) to December 31, 1998, in conformity with generally accepted
accounting principles.
 
                                      /s/ ERNST & YOUNG LLP
                                      ------------------------------------------
                                      Ernst & Young LLP
 
Atlanta, Georgia
January 22, 1999
 
                                       F-2
<PAGE>   18
 
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                                 BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                                     DECEMBER 31,
                                                              --------------------------
                                                                  1998          1997
                                                              ------------   -----------
<S>                                                           <C>            <C>
                                         ASSETS
Current assets:
  Cash and cash equivalents (Note 1)........................  $  4,249,868   $10,206,870
  Trade accounts receivable.................................            --           116
  Inventories (Notes 1 and 2)...............................        52,729       291,278
  Prepaid expenses..........................................        51,414       149,474
                                                              ------------   -----------
Total current assets........................................     4,354,011    10,647,738
Equipment and improvements:
  Machinery and equipment...................................     3,228,772     3,207,603
  Office equipment..........................................       479,061       469,537
  Leasehold improvements....................................       262,856       254,766
                                                              ------------   -----------
                                                                 3,970,689     3,931,906
  Less accumulated depreciation.............................     3,006,211     2,539,020
                                                              ------------   -----------
                                                                   964,478     1,392,886
Other assets................................................        16,841        16,841
                                                              ------------   -----------
Total assets................................................  $  5,335,330   $12,057,465
                                                              ============   ===========
 
                          LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
  Accounts payable..........................................  $     79,089   $   219,230
  Accrued royalties -- related party (Note 7)...............        30,000        30,000
  Deferred revenue..........................................        50,000            --
  Other accrued expenses....................................       125,901       243,046
                                                              ------------   -----------
Total current liabilities...................................       284,990       492,276
Deferred rental expense.....................................            --         2,112
Stockholders' equity:
  Preferred stock, no par value:
     Authorized -- 10,000,000 shares; no shares issued and
      outstanding...........................................            --            --
  Common stock, no par value:
     Authorized -- 100,000,000 shares; issued and
      outstanding -- 24,862,263 shares at December 31, 1998
      and 24,791,013 shares at December 31, 1997............    66,593,140    66,519,348
  Notes receivable from common stock sales (Note 5).........            --       (35,938)
  Unearned stock compensation (Note 4)......................      (115,840)     (124,882)
  Deficit accumulated during the development stage..........   (61,426,960)  (54,795,451)
                                                              ------------   -----------
Total stockholders' equity..................................     5,050,340    11,563,077
                                                              ------------   -----------
Total liabilities and stockholders' equity..................  $  5,335,330   $12,057,465
                                                              ============   ===========
</TABLE>
 
See accompanying notes.
 
                                       F-3
<PAGE>   19
 
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                            STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                                                 PERIOD FROM
                                                                                                JULY 17, 1989
                                                                                                  (DATE OF
                                                             YEARS ENDED DECEMBER 31,           INCEPTION) TO
                                                      ---------------------------------------   DECEMBER 31,
                                                         1998          1997          1996           1998
                                                      -----------   -----------   -----------   -------------
<S>                                                   <C>           <C>           <C>           <C>
License fees and research and development
  revenues..........................................  $   350,000   $        --   $        --   $    350,000
Product sales.......................................        1,636       108,399        22,633        339,810
  Cost of product sales.............................       (1,405)   (2,675,098)   (1,310,360)    (6,760,390)
                                                      -----------   -----------   -----------   ------------
  Gross margin on product sales.....................          231    (2,566,699)   (1,287,727)    (6,070,580)
                                                      -----------   -----------   -----------   ------------
                                                          350,231    (2,566,699)   (1,287,727)    (6,070,580)
Costs and expenses:
  Research and development
  -- related party (Note 7).........................           --            --            --      1,145,913
  -- other..........................................    4,746,681     4,023,876     4,207,551     34,317,424
Marketing, general and administrative
  -- related party (Note 7).........................       99,931        95,663       149,317      1,338,695
  -- other..........................................    2,513,446     2,902,998     2,973,899     21,841,483
                                                      -----------   -----------   -----------   ------------
Total costs and expenses............................    7,360,058     7,022,537     7,330,767     58,643,515
                                                      -----------   -----------   -----------   ------------
Operating loss......................................   (7,009,827)   (9,589,236)   (8,618,494)   (64,714,095)
Interest income.....................................      378,318       823,422     1,059,173      3,888,138
Interest expense
  -- related parties................................           --            --            --       (264,445)
                                                      -----------   -----------   -----------   ------------
Net loss............................................  $(6,631,509)  $(8,765,814)  $(7,559,321)  $(61,090,402)
                                                      ===========   ===========   ===========   ============
Basic and diluted loss per share....................  $     (0.27)  $     (0.36)  $     (0.33)  $      (4.01)
                                                      ===========   ===========   ===========   ============
Weighted average shares outstanding (basic and
  diluted)..........................................   24,839,403    24,616,762    22,673,126     15,238,489
</TABLE>
 
See accompanying notes.
 
                                       F-4
<PAGE>   20
 
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                       STATEMENTS OF STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                                                                       DEFICIT
                                                                           NOTES                     ACCUMULATED
                                                   COMMON STOCK         RECEIVABLE                    DURING THE        TOTAL
                               CONVERTIBLE   ------------------------   FROM COMMON     UNEARNED     DEVELOPMENT    STOCKHOLDERS'
                               DEBENTURES      SHARES       AMOUNT      STOCK SALES   COMPENSATION      STAGE          EQUITY
                               -----------   ----------   -----------   -----------   ------------   ------------   -------------
<S>                            <C>           <C>          <C>           <C>           <C>            <C>            <C>
Issuance of common stock:
    For cash ranging from
      $0.02 to $1.89 per
      share, inception to
      November 1992..........  $        --    8,421,750   $11,257,075    $      --     $      --     $         --   $ 11,257,075
    For cash in public
      offerings for $5.25 and
      $7.00 per share, June
      1993 to December
      1994...................           --    5,461,700    30,257,263           --            --               --     30,257,263
    For promissory notes
      ranging from $0.89 to
      $1.89 per share,
      February 1990 to
      January 1993...........           --      135,450       169,675     (169,675)           --               --             --
    For exchange of debt
      ranging from $1.22 to
      $1.89 per share, May
      1991 to July 1992......           --    3,079,305     4,438,934           --            --               --      4,438,934
  Exercise of stock options
    ranging from $0.89 to
    $1.89 per share, May 1994
    to October 1995..........           --      104,600       121,105           --            --               --        121,105
  Payments received on
    promissory notes.........           --           --            --       57,425            --               --         57,425
  Shares granted under
    Restricted Stock Award
    Plan (Note 4)............           --       99,750       993,750           --      (993,750)              --             --
  Shares canceled under
    Restricted Stock Award
    Plan (Note 4)............           --      (12,000)      (96,000)          --        96,000               --             --
  Compensation under
    Restricted Stock Award
    Plan.....................           --           --      (195,750)          --       555,750               --        360,000
  Cancellation of promissory
    note.....................           --      (21,375)      (40,375)      40,375            --               --             --
  Sale of convertible
    debentures for cash,
    November 1995............    9,834,500           --            --           --            --               --      9,834,500
  Interest payable on
    convertible debentures...       89,573           --            --           --            --          (89,573)            --
  Net loss, inception to
    December 31, 1995........           --           --            --           --            --      (38,133,758)   (38,133,758)
                               -----------   ----------   -----------    ---------     ---------     ------------   ------------
Balance at December 31,
  1995.......................    9,924,073   17,269,180    46,905,677      (71,875)     (342,000)     (38,223,331)    18,192,544
  Issuance of common stock:
    For cash at $6.31 per
      share, May 1996........           --    1,584,158     9,365,217           --            --               --      9,365,217
  Exercise of stock options
    ranging from $1.22 to
    $5.00 per share, June
    1996.....................           --        4,000        12,441           --            --               --         12,441
  Conversion of debentures
    into common stock........   (9,240,423)   5,394,992     9,240,423           --            --               --             --
  Interest payable on
    convertible debentures...      225,548           --            --           --            --         (225,548)            --
  Shares granted under
    Restricted Stock Award
    Plan.....................           --       29,750       185,922           --      (185,922)              --             --
  Shares canceled under
    Restricted Stock Award
    Plan.....................           --       (6,000)      (48,000)          --        48,000               --             --
  Compensation under
    Restricted Stock Award
    Plan.....................           --           --            --           --       151,467               --        151,467
  Grant of Compensatory Stock
    Options..................           --           --        14,063           --            --               --         14,063
  Net loss and comprehensive
    loss.....................           --           --            --           --            --       (7,559,321)    (7,559,321)
                               -----------   ----------   -----------    ---------     ---------     ------------   ------------
Balance at December 31,
  1996.......................      909,198   24,276,080    65,675,743      (71,875)     (328,455)     (46,008,200)    20,176,411
  Conversion of debentures
    into common stock........     (930,635)     518,683       930,635           --            --               --             --
  Interest payable on
    convertible debentures...       21,437           --            --           --            --          (21,437)            --
  Shares granted under
    Restricted Stock Award
    Plan.....................           --       14,250        29,783           --       (29,783)              --             --
  Shares canceled under
    Restricted Stock Award
    Plan.....................           --      (18,000)     (116,813)          --       116,813               --             --
  Compensation under
    Restricted Stock Award
    Plan.....................           --           --            --           --       116,543               --        116,543
  Forgiveness of promissory
    notes....................           --           --            --       35,937            --               --         35,937
  Net loss and comprehensive
    loss.....................           --           --            --           --            --       (8,765,814)    (8,765,814)
                               -----------   ----------   -----------    ---------     ---------     ------------   ------------
Balance at December 31,
  1997.......................           --   24,791,013    66,519,348      (35,938)     (124,882)     (54,795,451)    11,563,077
  Exercise of stock options
    at $0.89 per share,
    January 1998.............           --       11,250        10,012           --            --               --         10,012
  Shares granted under
    Restricted Stock Award
    Plan.....................           --       60,000        63,780           --       (63,780)              --             --
  Compensation under
    Restricted Stock Award
    Plan.....................           --           --            --           --        72,822               --         72,822
  Payments received on
    promissory notes.........           --           --            --        2,000            --               --          2,000
  Forgiveness of promissory
    notes....................           --           --            --       33,938            --               --         33,938
  Net loss and comprehensive
    loss.....................           --           --            --           --            --       (6,631,509)    (6,631,509)
                               -----------   ----------   -----------    ---------     ---------     ------------   ------------
Balance at December 31,
  1998.......................  $        --   24,862,263   $66,593,140    $      --     $(115,840)    $(61,426,960)  $  5,050,340
                               ===========   ==========   ===========    =========     =========     ============   ============
</TABLE>
 
See accompanying notes.
 
                                       F-5
<PAGE>   21
 
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                            STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                                                         PERIOD FROM
                                                                                                        JULY 17, 1989
                                                                                                          (DATE OF
                                                                     YEARS ENDED DECEMBER 31,           INCEPTION) TO
                                                              ---------------------------------------   DECEMBER 31,
                                                                 1998          1997          1996           1998
                                                              -----------   -----------   -----------   -------------
<S>                                                           <C>           <C>           <C>           <C>
OPERATING ACTIVITIES:
Net loss....................................................  $(6,631,509)  $(8,765,814)  $(7,559,321)  $(61,090,402)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Depreciation and amortization.............................      467,191       519,212       547,530      3,415,802
  Amortization of unearned stock compensation...............       72,822       116,543       151,467        700,832
  Grant of compensatory stock options.......................           --            --        14,063         14,063
  Forgiveness of promissory notes...........................       33,938        35,937            --         69,875
  Loss on disposal of equipment.............................           --        28,679         7,390         67,270
  Deferred rental expense...................................       (2,112)         (845)       (4,099)            --
  Accretion of discount on marketable securities............           --            --            --       (187,407)
  Changes in operating assets and liabilities:
    Trade accounts receivable...............................          116         3,359         4,550             --
    Inventories.............................................      238,549      (190,879)      153,609        (52,729)
    Prepaid expenses and other assets.......................       98,060        28,663       (37,005)       (51,724)
    Accounts payable........................................     (140,141)       50,319      (162,524)        79,089
    Accrued royalties -- related party......................           --            --       (30,000)        30,000
    Deferred revenue........................................       50,000            --            --         50,000
    Other accrued expenses..................................     (117,145)      (66,809)        5,540        284,835
                                                              -----------   -----------   -----------   ------------
Net cash used in operating activities.......................   (5,930,231)   (8,241,635)   (6,908,800)   (56,670,496)
 
INVESTING ACTIVITIES:
Purchases of equipment and improvements.....................      (38,783)     (279,922)     (157,583)    (4,073,877)
Purchase of marketable securities...........................           --            --            --    (11,512,296)
Purchase of license agreement...............................           --            --            --       (250,000)
Proceeds from marketable securities.........................           --            --            --     11,700,000
Changes in other assets.....................................           --            --            --       (140,501)
                                                              -----------   -----------   -----------   ------------
Net cash used in investing activities.......................      (38,783)     (279,922)     (157,583)    (4,276,674)
 
FINANCING ACTIVITIES:
Proceeds from revolving credit note to related parties......           --            --            --      5,430,000
Issuance of convertible debentures, net of issuance costs...           --            --            --      9,834,500
Payments on notes payable to related parties................           --            --            --     (1,150,000)
Payments received on promissory notes.......................        2,000            --            --         59,425
Issuance of common stock upon exercise of stock options.....       10,012            --        12,441        143,558
Issuance of common stock, net of issuance costs.............           --            --     9,365,217     50,879,555
                                                              -----------   -----------   -----------   ------------
Net cash provided by financing activities...................       12,012            --     9,377,658     65,197,038
                                                              -----------   -----------   -----------   ------------
(Decrease) increase in cash and cash equivalents............   (5,957,002)   (8,521,557)    2,311,275      4,249,868
Cash and cash equivalents at beginning of period............   10,206,870    18,728,427    16,417,152             --
                                                              -----------   -----------   -----------   ------------
Cash and cash equivalents at end of period..................  $ 4,249,868   $10,206,870   $18,728,427   $  4,249,868
                                                              ===========   ===========   ===========   ============
</TABLE>
 
See accompanying notes.
 
                                       F-6
<PAGE>   22
 
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                         NOTES TO FINANCIAL STATEMENTS
                               DECEMBER 31, 1998
 
1. SIGNIFICANT ACCOUNTING POLICIES
 
DESCRIPTION OF BUSINESS
 
     AER Energy Resources, Inc. (the "Company") was incorporated on July 17,
1989 and has been engaged in the development and commercialization of high
energy density, zinc-air batteries. The Company's operations, until recently,
were focused primarily on developing and improving its technology, setting up
the manufacturing process, testing and selling rechargeable zinc-air batteries,
recruiting personnel, and similar activities. The Company began selling its
first product in August 1994, but sales from products have been minimal.
 
     In 1998, the Company changed its focus to research and product development
of zinc-air technology and commercialization of primary (disposable) rather than
rechargeable batteries through alliances with large established battery and
original equipment manufacturers ("OEMs"). As discussed in Note 8, an agreement
with Duracell Inc., supporting this new focus, was executed in 1998.
 
USE OF ESTIMATES
 
     The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
 
     In accordance with FASB Statement No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company
records impairment losses on long-lived assets used in operations when events
and circumstances indicate that the assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amounts of those assets. Based on the Company's estimate of future
undiscounted cash flows, the Company expects to recover the carrying amounts of
its remaining fixed assets. The Company's estimates of future undiscounted cash
flows have taken into consideration its change in focus during the past year.
Such estimates contemplate the Company entering into agreements, similar to the
1998 agreement with Duracell, throughout the remaining life of the Company's
fixed assets. If the Company is unable to enter into such agreements or if it is
unable to perform as anticipated, a writedown of such assets to fair value may
be required. During the years ended December 31, 1997 and 1996, the Company
recorded write-offs of obsolete equipment with a net book value of $28,679 and
$7,890, respectively, as part of marketing, general and administrative expenses.
 
CONCENTRATIONS OF CREDIT RISK
 
     Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents.
As of December 31, 1998 and 1997, the Company maintained approximately 76% and
97%, respectively, of its cash and cash equivalents (short duration, high-rated
corporate debt securities) under the management of a high credit quality, third
party financial institution custodian.
 
CASH AND CASH EQUIVALENTS
 
     Cash and cash equivalents consist of cash, bank deposits and highly liquid
investments with maturities of three months or less when purchased and are
stated at cost, which approximates market.
 
INVENTORIES
 
     Inventories are valued at lower of cost or market, using the first-in,
first-out (FIFO) method.
 
EQUIPMENT AND IMPROVEMENTS
 
     Equipment and improvements are stated at cost. Depreciation of equipment
and improvements is computed using the straight-line method over their estimated
useful lives. Certain equipment is used to advance the development of production
processes, refine product designs for production and produce batteries for
laboratory and field testing. Amortization of leasehold improvements is recorded
over the shorter of the lives of the related assets or the lease terms.
 
REVENUE RECOGNITION
 
     Revenues from product sales are recognized when the products are shipped.
License fee revenues are recognized over the period earned and research and
development revenues are recognized over the period the services are performed.
 
INCOME TAXES
 
     The liability method is used in accounting for income taxes. Under this
method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
 
                                       F-7
<PAGE>   23
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
RESEARCH AND DEVELOPMENT
 
     Research and development costs are charged to expense as incurred.
 
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
     As of December 31, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income." The
Statement establishes standards for the reporting and display of comprehensive
income and its components in a full set of general purpose financial statements.
The adoption of this Statement did not have any effect on the Company's
financial position or results of operations.
 
     As of December 31, 1998, the Company adopted Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." Because the Company does not have any derivative instruments or
hedging activities, the adoption of the new Statement did not have an impact on
the financial position or results of operations of the Company.
 
2. INVENTORIES
 
     Inventories are summarized below.
 
<TABLE>
<CAPTION>
                                                                AT DECEMBER 31,
                                                              -------------------
                                                                1998       1997
                                                              --------   --------
<S>                                                           <C>        <C>
Raw material................................................  $ 52,729   $233,997
Work in progress............................................         -     34,818
Finished goods..............................................         -     22,463
                                                              --------   --------
                                                              $ 52,729   $291,278
                                                              ========   ========
</TABLE>
 
3. LEASES
 
     The Company leases office and manufacturing space under operating leases
that expire in 2001. Rent expense under the operating leases for the years ended
December 31, 1998, 1997, and 1996 and for the period from inception to December
31, 1998 was $221,899, $213,431, $201,253, and $1,265,084, respectively. Future
minimum lease payments by year and in the aggregate under the operating leases
consist of the following at December 31, 1998:
 
<TABLE>
<S>                                                           <C>
Year ended December 31,
1999........................................................  $187,277
2000........................................................   159,931
2001........................................................   124,555
                                                              --------
                                                              $471,763
                                                              ========
</TABLE>
 
4. 1993 NON-EMPLOYEE DIRECTORS' RESTRICTED STOCK AWARD PLAN
 
     The Company's 1993 Non-Employee Directors' Restricted Stock Award Plan
provides for the grant of up to an aggregate of 240,000 shares of the Company's
common stock to directors of the Company who are not officers or employees of
the Company. In general, the plan provides for awards of 15,000 shares of common
stock to each non-employee director, with 3,000 shares vesting after each year
of his or her service as a director. As of December 31, 1998, the Company issued
167,750 shares of the Company's common stock pursuant to this plan.
 
     The weighted-average fair values of restricted shares granted for the years
ending December 31, 1998, 1997 and 1996 were $1.06, $2.09 and $6.25,
respectively.
 
5. STOCKHOLDERS' EQUITY
 
     On May 20, 1996, the Company issued 1,584,158 shares of its common stock,
and warrants to purchase an additional 835,000 shares, in a private placement at
an aggregate purchase price of $10,000,000, as discussed in Note 10.
 
     On November 29, 1995, the Company reserved 225,590 shares of common stock
for issuance in connection with a warrant delivered to the placement agent of
$10,675,000 principal amount of 8% convertible subordinated debentures, as
discussed in Note 11. The warrants expired unexercised in 1998.
 
     During the period from inception to December 31, 1994, the Company issued
shares of stock to officers and employees of the Company in exchange for notes
receivable. These notes were secured by the shares of common stock issued and
bear interest at 10%. The notes required payments of interest only through 1993.
In December 1994, the notes
 
                                       F-8
<PAGE>   24
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
were amended to include full recourse against the borrowers in the event of
nonpayment with principal and accrued interest payable in equal annual
installments in 1997 and 1998. The amended notes also included a forgiveness
provision for the entire indebtedness contingent on the continued employment of
the makers of the notes. Pursuant to the forgiveness provision, $33,938 and
$35,937 of outstanding principal were forgiven and recorded as compensation
expense in the Statement of Operations on December 1, 1998 and 1997,
respectively.
 
     During 1991, a major stockholder and another stockholder exchanged notes
due from the Company in the amount of $2,400,000 plus accrued interest of
$125,545 for 2,066,355 shares of the Company's common stock. During 1992, a
major stockholder of the Company advanced $1,880,000 to the Company under a
revolving credit note bearing interest at prime plus 2%. During 1992, the
stockholder exchanged the outstanding balance plus accrued interest of $33,389
for 1,012,950 shares of the Company's common stock.
 
     At December 31, 1998, the Company had reserved 2,605,750 shares of common
stock for the future issuance of restricted stock awards and the future exercise
of stock options and warrants.
 
6. STOCK OPTIONS
 
     Under a stock option agreement with a member of the Board of Directors, the
Company granted the Director an option to acquire 25,000 shares of the Company's
common stock at an exercise price of $2.125 per share. The option is 100% vested
and expires in 2004.
 
     During 1992, the Company adopted the 1992 Stock Option Plan whereby options
may be granted to key employees to purchase shares of common stock at prices not
less than the fair value of the shares on the date of the grant for incentive
stock options and not less than 50% of the fair value of the shares on the date
of the grant for non-qualified stock options. Options become vested 20% per year
not earlier than 12 months from the date of the grant and are exercisable for a
period of ten years from the grant date. On May 9, 1996, the Company amended the
1992 Stock Option Plan to increase the number of shares reserved for future
issuance to 1,500,000.
 
     On March 1, 1996, the Compensation Committee of the Company's Board of
Directors approved a plan to reprice certain options to purchase shares of the
Company's common stock granted to employees pursuant to the 1992 Stock Option
Plan. The options were repriced effective March 22, 1996. Options originally
priced from $4.63 to $8.00 per share were repriced at $3.19 per share, the
closing market price of the common stock on March 22, 1996. Each of the repriced
options, whether or not vested, could not be exercised for a period of one year
ending February 28, 1997. Options to purchase a total of 795,000 shares of
common stock were repriced, of which 71,000 were fully vested prior to
repricing.
 
     The Company has elected to follow APB Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25") and related Interpretations in accounting for
its employee stock options because, as discussed below, the alternative fair
value accounting provided for under FASB Statement No. 123 ("Statement 123"),
"Accounting for Stock-Based Compensation," requires use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB 25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
 
     Pro forma information regarding net loss and net loss per share is required
by Statement 123, which also requires that the information be determined as if
the Company has accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1997
and 1996, respectively: risk-free interest rate of 5.4% and 5.0%; a dividend
yield of 0%; volatility factors of the expected market price of the Company's
common stock of 82% and 91%; and a weighted-average expected life of the option
of five years. No employee stock options were granted during the year ended
December 31, 1998.
 
     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
measure of the fair value of its employee stock options.
 
     For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Because
Statement 123 is applicable only to options granted subsequent to December 31,
1994, its pro forma effect will not be fully reflected until the year 1999. The
Company's pro forma information follows (in thousands except for loss per share
information):
 
<TABLE>
<CAPTION>
                                                              FOR THE YEARS ENDED DECEMBER 31,
                                                              --------------------------------
                                                                1998        1997        1996
                                                              --------    --------    --------
<S>                                                           <C>         <C>         <C>
Pro forma net loss..........................................  $(6,751)    $(9,428)    $(7,996)
Pro forma net loss per share:
  Basic and diluted.........................................  $ (0.27)    $ (0.38)    $ (0.35)
</TABLE>
 
                                       F-9
<PAGE>   25
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     A summary of option activity related to the 1992 Stock Option Plan follows:
 
<TABLE>
<CAPTION>
                                                                             WEIGHTED
                                                               OPTION    AVERAGE EXERCISE
                                                               SHARES    PRICE PER SHARE
                                                              --------   ----------------
<S>                                                           <C>        <C>
Outstanding at December 31, 1995............................   867,625        $5.93
  Granted...................................................    85,000         4.83
  Canceled..................................................   (50,000)        6.04
  Exercised.................................................    (2,000)        5.00
                                                              --------        -----
Outstanding at December 31, 1996(1).........................   900,625         3.37
  Granted...................................................    60,000         2.38
  Canceled..................................................   (59,000)        4.39
                                                              --------        -----
  Outstanding at December 31, 1997..........................   901,625         3.26
  Canceled..................................................  (236,000)        3.42
                                                              --------        -----
Outstanding at December 31, 1998............................   665,625        $3.21
                                                              ========        =====
Outstanding at December 31, 1998:
  Exercise price ranging from $1.89 to $3.19 with a
     weighted-average remaining contractual life of 5.9
     years..................................................   627,625        $3.10
  Exercise price ranging from $3.20 to $6.19 with a
     weighted-average remaining contractual life of 7.3
     years..................................................    38,000         5.03
                                                              --------        -----
                                                               665,625        $3.21
                                                              ========        =====
Options exercisable at December 31, 1998:
  Exercise price ranging from $1.88 to $3.19................   434,625        $3.08
  Exercise price ranging from $3.20 to $6.19................    16,000         5.02
                                                              --------        -----
                                                               450,625        $3.15
                                                              ========        =====
Options exercisable at December 31, 1997:
  Exercise price ranging from $1.88 to $3.19................   391,100        $3.10
  Exercise price ranging from $3.20 to $6.19................    18,000         4.90
                                                              --------        -----
                                                               409,100        $3.18
                                                              ========        =====
Options exercisable at December 31, 1996(1):
  Exercise price ranging from $1.89 to $2.19(2).............    19,575        $1.89
  Exercise price ranging from $2.20 to $6.19................   222,000         3.25
                                                              --------        -----
                                                               241,575        $3.14
                                                              ========        =====
</TABLE>
 
---------------
 
(1) Exercise price reflects repricing to $3.19 per share on March 22, 1996.
(2) $2.19 reflects the market price for the Company's common stock at December
    31, 1996.
 
     The weighted-average fair values of options granted during 1997 and 1996
were $1.49 and $3.51, respectively.
 
     Prior to adoption of the 1992 Stock Option Plan, the Company entered into
stock option agreements with key employees to purchase common stock of the
Company. Options granted under these stock option agreements were immediately
100% vested and expire in 1999. A summary of option activity related to these
agreements follows:
 
<TABLE>
<CAPTION>
                                                                              WEIGHTED
                                                                               AVERAGE
                                                                              EXERCISE
                                                                 OPTION       PRICE PER
                                                                 SHARES         SHARE
                                                              -------------   ---------
<S>                                                           <C>             <C>
Outstanding at December 31, 1995............................     214,000        $ .91
  Exercised.................................................      (2,000)        1.22
                                                                 -------        -----
Outstanding at December 31, 1996 and 1997...................     212,000          .90
  Canceled..................................................      (9,500)        1.22
  Exercised.................................................     (11,250)         .89
                                                                 -------        -----
Outstanding at December 31, 1998............................     191,250        $ .89
                                                                 =======        =====
Options exercisable at December 31, 1998....................     191,250        $ .89
                                                                 =======        =====
</TABLE>
 
7. RELATED PARTY TRANSACTIONS
 
     The Company has a license agreement with Dreisbach Electromotive, Inc.
("DEMI"). Certain of the beneficiaries of this license agreement are also
shareholders of the Company. Under DEMI's agreement, the Company has an
 
                                      F-10
<PAGE>   26
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
exclusive license to use the patent rights for the purpose of manufacturing and
marketing certain batteries and other products employing similar technology. In
addition, the Company agreed to pay DEMI royalties, beginning in 1991, of 4% of
net sales subject to certain minimum amounts and possible increases or decreases
to a maximum of 4% and a minimum of 2%, as specified in the agreement. The
applicable percentage of royalties is currently 4% of net sales. The Company
recorded royalty expense related to the DEMI license for the years ended
December 31, 1998, 1997, and 1996 and for the period from inception to December
31, 1998 of $100,000, $100,000, $150,000, and $1,350,000, respectively. Minimum
royalty expenses are included in marketing, general and administrative expenses
in the statements of operations. Actual royalties due as a percentage of sales
are included in the cost of sales. As of December 31, 1998 and 1997, $30,000 of
these royalty payments remained unpaid. The minimum royalty payments remaining
to be paid total $50,000 and are due in the year ending December 31, 1999.
 
     The Company recorded research and development expenses as a part of the
agreement for the period from inception to December 31, 1998 of approximately
$1,146,000, all of which were recorded prior to 1993. No additional amounts of
research and development expenses were required under the agreement after 1992.
 
8. LICENSE AND RESEARCH AND DEVELOPMENT AGREEMENTS
 
     On September 24, 1998, the Company executed its Technology Licenses and
Services Agreement (TLAS Agreement) with Duracell Inc., a subsidiary of the
Gillette Company. Under the terms of the TLAS Agreement, the Company agrees to
license certain of its zinc-air battery technology to Duracell. In addition,
Duracell is funding certain joint product development projects with the Company.
Under the agreement, Duracell will own technology developed under the projects
it funds which the Company will have rights to utilize. Duracell also has
options to obtain certain other license rights. The Company's license fee and
research and development revenues reflected in the Statements of Operations and
deferred revenues reflected in the Balance Sheets relate to the TLAS Agreement.
 
     On May 12, 1993, the Company executed an agreement with Westinghouse
Electric Corporation ("Westinghouse") whereby the Company obtained exclusive
license and sublicense rights to use Westinghouse's air electrode technology for
portable computer products and non-exclusive license and sublicense rights for
all other portable products. The agreement entitles the Company to improvements
developed or acquired by Westinghouse prior to May 1, 1995. Pursuant to the
agreement, the Company paid an initial license fee of $250,000 and pays 1% of
revenues up to $300,000 followed by 0.5% of revenues up to $350,000, at which
time no further royalties for product sales will be due. In addition, for ten
years the Company will pay Westinghouse the greater of (i) 50% of any sublicense
fees it receives if it sublicenses the technology licensed from Westinghouse, or
(ii) 0.5% of sublicensee product sales. The Company purchased specific
production equipment for $325,000 from Westinghouse. The agreement also includes
certain provisions requiring additional payments to Westinghouse if the Company
sublicenses the technology. Currently, the Company is not using technology
obtained from Westinghouse in its primary batteries.
 
9. INCOME TAXES
 
     A reconciliation of the provision for income taxes to the federal statutory
rate of 34% is as follows:
 
<TABLE>
<CAPTION>
                                                                                       PERIOD FROM JULY,
                                                                                         1989 (DATE OF
                                                    YEARS ENDED DECEMBER 31,             INCEPTION) TO
                                             ---------------------------------------     DECEMBER 31,
                                                1998          1997          1996             1998
                                             -----------   -----------   -----------   -----------------
<S>                                          <C>           <C>           <C>           <C>
Tax at statutory rate......................  $(2,254,713)  $(2,978,246)  $(2,570,161)    $(20,768,597)
Research and development credits...........     (112,687)      (43,402)      (80,319)      (1,296,106)
Other......................................        8,153         5,217         4,329           37,152
Valuation reserve..........................    2,359,247     3,016,431     2,646,151       22,027,551
                                             -----------   -----------   -----------     ------------
                                             $        --   $        --   $        --     $         --
                                             ===========   ===========   ===========     ============
</TABLE>
 
                                      F-11
<PAGE>   27
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     The tax effects of temporary differences and carryforwards that give rise
to significant portions of deferred tax assets consist of the following:
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                              -------------------------
                                                                 1998          1997
                                                              -----------   -----------
<S>                                                           <C>           <C>
Deferred tax assets:
  Net operating loss carryforwards..........................  $18,587,479   $16,015,904
  Depreciation..............................................      176,272       144,103
  Start-up costs............................................    1,861,777     2,192,760
  Research and development credits..........................    1,296,106     1,183,419
  Warranty reserve..........................................       25,978        39,100
  License agreement.........................................       54,439        64,118
  Inventory obsolescence....................................       25,500        28,900
                                                              -----------   -----------
  Gross deferred assets.....................................   22,027,551    19,668,304
  Valuation allowance.......................................   22,027,551    19,668,304
                                                              -----------   -----------
Net deferred tax assets.....................................  $        --   $        --
                                                              ===========   ===========
</TABLE>
 
     At December 31, 1998, the Company had available net operating loss
carryforwards for income tax purposes of approximately $54.7 million and
research and development credit carryforwards of approximately $1.3 million.
These carryforward items will both begin to expire in 2004. Both of these
carryforward items are subject to certain limitations on annual utilization
related to changes in ownership of the Company. These limitations could
significantly reduce the amount of the net operating loss and credit
carryforwards available to the Company in the future.
 
10. PROCEEDS FROM THE SALE OF COMMON STOCK
 
     On May 20, 1996, in a private placement at an aggregate purchase price of
$10,000,000, the Company issued 1,584,158 shares of its common stock and
warrants to purchase 835,000 additional shares. The transaction generated
proceeds of $9.4 million, net of expenses. The warrants have an exercise price
of $6.3125 per share and expire in 2001. The value of the warrants is included
in common stock on the balance sheet.
 
     On November 9, 1994, the Company closed a public offering of 2.5 million
shares of its common stock, generating proceeds of $12.3 million, net of
underwriting discounts and commissions but before deducting expenses. On
December 7, 1994, 150,000 additional shares of common stock were issued pursuant
to the underwriters' over-allotment option, generating additional proceeds of
$736,500, net of underwriting discounts and commissions.
 
     On July 9, 1993, the Company closed an initial public offering of 2.5
million shares of its common stock, generating proceeds of $16.3 million, net of
underwriting discounts and commissions but before deducting expenses. On August
6, 1993, 311,700 additional shares of common stock were issued pursuant to the
underwriters' over-allotment option, generating additional proceeds of $2.0
million, net of underwriting discounts and commissions.
 
     The net proceeds from the common stock sales have been and continue to be
used to fund capital equipment purchases, research and development efforts,
sales and marketing activities, working capital and general corporate purposes
at the Company's discretion.
 
11. PROCEEDS FROM THE SALE OF CONVERTIBLE DEBENTURES
 
     On November 29, 1995, the Company issued $10,675,000 principal amount of 8%
convertible subordinated debentures due November 17, 1997. Through November 17,
1997, a holder of a debenture could have elected to convert the debenture into
common stock of the Company at a conversion price equal to the lesser of $3.60
per share or a percentage ranging from 85% to 100% of the average closing bid
price for the five trading days immediately prior to the conversion. In
connection with the transaction, the Company paid to a placement agent $840,500
in fees and delivered warrants to purchase 225,590 shares of the Company's
common stock at an exercise price of $4.32 per share. The warrants expired in
1998. During 1996, $9,775,000 in principal plus accrued interest converted into
5,394,992 shares of common stock at an average conversion price of $1.86 per
share. During 1997, the remaining $900,000 in principal plus accrued interest
converted into 518,683 shares of common stock at an average conversion price of
$1.93 per share. Assuming the 1997 debenture conversions occurred at January 1,
1997, net loss per share for the year ended December 31, 1997 was $(0.35).
 
12. DEFINED CONTRIBUTION BENEFIT PLAN
 
     Effective February 1, 1993, the Company adopted the AER Energy Resources
401(k) Plan, a defined contribution benefit plan which qualifies under Section
401(k) of the Internal Revenue Code. All employees of the Company as of February
1, 1993 were eligible to participate in the plan. Employees hired after February
1, 1993 who have completed six
 
                                      F-12
<PAGE>   28
                           AER ENERGY RESOURCES, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
months of service with the Company may participate in the plan. Participants may
contribute up to 15% of their base salary to the plan and any employer matching
contribution is discretionary. There was no employer matching contribution
during the years ended December 31, 1998, 1997 or 1996.
 
                                      F-13