##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2007
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 Commission file number 1-10367
 Advanced Environmental Recycling Technologies, Inc.
 (Exact name of Registrant as specified in its charter)
 Delaware(State of Incorporation)
    
    71-0675758(I.R.S. Employer Identification No.)914 N Jefferson Street 
Post Office Box 1237
Springdale, Arkansas(Address of principal executive offices)
    
    72764(Zip Code)
 (479) 756-7400
  Title of Each Class:
    
    Name of Each Exchange on Which Registered:Class A common stock, $.01 par value
    
    The Nasdaq Stock Market
 
 o þ
 o þ
 þ o
 þ
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer o
    
    Smaller reporting company o(Do not check if a smaller reporting company)
 o þ
  Class A  46,314,250; Class B 
1,465,530
 DOCUMENTS INCORPORATED BY REFERENCE




---



##### 



Table of Contents
 Page No.Part IItem 1.
    
    Business
    
    
    2Item 1A.
    
    Risk Factors
    
    
    11Item 1B.
    
    Unresolved Staff Comments
    
    
    16Item 2.
    
    Properties
    
    
    16Item 3.
    
    Legal Proceedings
    
    
    17Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    18Part IIItem 5.
    
    Market for Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
    
    
    18Item 6.
    
    Selected Financial Data
    
    
    19Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    30Item 8.
    
    Financial Statements and Supplementary Data
    
    
    31Item 9.
    
    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    31Item 9A.
    
    Controls and Procedures
    
    
    31Item 9B.
    
    Other Information
    
    
    32Part IIIItem 10.
    
    Directors, Executive Officers and Corporate Governance
    
    
    33Item 11.
    
    Executive Compensation
    
    
    36Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
    
    
    37Item 13.
    
    Certain Relationships and Related Transactions, and Director Independence
    
    
    37Item 14.
    
    Principal Accountant Fees and Services
    
    
    37Part IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    37Signatures
    
    
    38Index to Financial Statements
    
    
    F-1Consent of Independent Registered Public Accounting FirmCertification Per Section 302 by the Company's Chairman, Chief Executive Officer and PresidentCertification Per Section 302 by the Company's Chief Financial OfficerCertification Per Section 906 by the Company's Chairman, Chief Executive Officer and PresidentCertification Per Section 906 by the Company's Chief Financial Officer
  i




---



##### Table of Contents



Disclaimer
  
 Item 1. Business.
 Summary
   Intellectual Property
  2




---



##### Table of Contents



Facilities
 www.aert.com
 Market Overview
        
    
    80% of consumers believe it is important to buy from
green companies and a majority say they
would spend more on green products. PBS Internet Survey Group, 2007
    
    62% of Americans would buy more eco-friendly products when there is no price difference
    
    68% of Americans feel recycling at home has an impact on the environment
 3




---



##### Table of Contents




    
    47% of Americans say they feel like a smart consumer when they buy environmentally
friendly products
  AERT Mission Statement
  Green Building Products
  MoistureShield Decking.
 Privacy Fencing Systems
 Door Component Products.
  4




---



##### Table of Contents



Marketing and Sales
 General Market Strategy.
 Exterior Trim and Fascia Products.
 Sales and Customer Service.
 Cyclical Nature of Building Products Industry.
 Facility Upgrades/Product Innovation
  5




---



##### Table of Contents



Sales and Innovation
      Advanced Recycling Technologies  Mining the Plastic Waste Stream
   6




---



##### Table of Contents



Raw Materials
 Wood Fiber.
 7




---



##### Table of Contents



Cedar Fiber.
 Recycled Plastics.
 
    
    Low density polyethylene (LDPE) poly coatings or linings from recycled bleached
food-board, which are generated from the hydro-pulping process;
    
    High density polyethylene (HDPE) and linear low density polyethylene (LLDPE) mixed
plastic grocery bags from supermarket and store collection programs;
    
    HDPE ground container material;
    
    LLDPE stretch film from warehouses and packing waste;
    
    Virgin HDPE and LDPE pellets; and
    
    Mixed PE films from industrial and municipal sources.
    
    
    As global political and economic factors have caused an
increase in the price of petroleum, there was a
related rise in the price of virgin plastic, which is a petroleum and natural gas
derivative. This in turn increased the demand for scrap plastics since scrap can be
substituted for virgin plastics in many manufacturing applications. We thus began
competing with scrap plastic consumers that had not previously been in the market.
 8




---



##### Table of Contents




    
    The relative decline in the value of the dollar versus major Asian currencies has
made it economical for Asian manufactures to source scrap plastic in the U.S. for use
in their countries. We have thus encountered significant competition for scrap
plastics from foreign consumers that had not previously been a factor in the market.
Demand for petrochemical products from China, India and other rapidly expanding
economies is expected to increase.
    
    As annual sales of wood composite decking products have grown, we and other
composite decking manufacturers have become relatively large consumers of scrap
plastics, which has created increasing competition for raw materials and driven up
prices.
  Supply Contracts.
 Competition for Raw Materials.
 Patented and Proprietary Technology
   9




---



##### Table of Contents



Industry Standards
  Regulation
   Competition
 Competition for Sales.
    Employees
  10




---



##### Table of Contents



Available Information
 (www.aert.com
 
 Item 1A. Risk Factors.
  Risks Related to Operating Our Business
 The demand for our products is influenced by general economic conditions and may be adversely
affected by general economic downturns or declines in construction activity.
  The loss of one or more of our key customers could cause a substantial reduction in our revenues
and profits.
  We may be unable to secure an adequate quantity of quality raw materials at economical prices.
  Weather
  High
fuel prices
  11




---



##### Table of Contents



We are highly leveraged and if we are unable to comply with certain debt covenants, our financial
position and operations could be adversely affected.
    If we do not effectively manage our growth, our business resources may become strained and our
results of operations may be adversely affected.
  Our growth is limited by the availability of human capital resources.
  12




---



##### Table of Contents



We have recently been sued by plaintiffs alleging defects in our decking products
 See Item 103  Legal Proceedings.
 Fire disruptions may adversely affect our ability to operate our business.
  Our strategy of using recycled plastic and waste wood to create a competitive cost advantage
involves significant risks, the occurrence of which may materially adversely affect our
profitability.
  
    
    Our profitability may be materially diminished. The intrinsic variability of our raw
material sources can result in considerable reduction in our operating rates and yields,
which may more than offset any savings we realize from the purchase price of the materials.
    
    We may not produce a sustainable return on investment. Because our production model
requires backward integration in plastic recycling operations, as well as customized
solutions for material preparation, compounding and extrusion, our model is significantly
more capital intensive on a per-unit-basis than the models of our typical competitors. Our
plants must convert our raw materials at high rates and net yields to generate the profit
margins and cash flows necessary to sustain our business.
    
    We may be limited in the markets in which we can effectively compete. Successfully
expanding our business beyond decking would require applying our formulation and process
technology to increasingly more challenging applications, such as high-end railing systems
and fencing. The greater complexity and tighter design tolerances of such profiles require
a level of process control that is more stringent than the level involved in deck board
production. Our raw materials and process technology may not permit us to develop new
applications on a cost-effective basis.
 Environmental regulation exposes us to potential liability for response costs and damages to
natural resources.
  Identification of certain weaknesses in our internal controls.
  13




---



##### Table of Contents



Maintaining product innovation at competitive costs
  Maintaining product quality and performance at acceptable costs
 See Item 103  Legal Proceedings.
 Lack of Product Diversification
  Risks Related to Financing Our Business
 Our
indebtedness could adversely affect our ability to compete and
produce net income
  We may have insufficient working capital to achieve our growth objectives.
  We will likely need to raise additional capital in the future. If we need additional funding, but
fail to obtain it, we may not be able to adequately develop and commercialize our products or
improve or expand our operations.
  Our failure to maintain Nasdaq listing requirements could cause our common stock to be delisted.
  14




---



##### Table of Contents



We currently have a significant number of derivative
equity securities outstanding, the conversion
of which could adversely impact the market price of our Class A common stock and our ability to
obtain additional needed outside capital.
  If we raise additional funding, the terms
of such transactions may cause dilution to existing
shareholders or contain terms that are not favorable to us.
  Covenants in our bond agreements could
restrict our ability to borrow, which could impair our
ability to execute our business plan.
  Management may be in a position to control the Company.
  15




---



##### Table of Contents



Risks Related to Our Intellectual Property
 Our proprietary rights may not adequately protect our technologies or products.
   
 Item 1B. Unresolved Staff Comments.
  
 Item 2. Properties.
      16




---



##### Table of Contents



Item 3. Legal Proceedings.
 Class Action Lawsuits
   17




---



##### Table of Contents



Energy
Unlimited, Inc. vs. AERT, Inc.
  Other Matters
  
 Item 4. Submission of Matters to a Vote of Security Holders.
  
 PART II
 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities.
 AERT
 Sales price range of Class A common stock
    
    High
    
    LowFiscal 2006First Quarter
    
    $
    2.56
    
    
    $
    1.58Second Quarter
    
    
    3.71
    
    
    
    1.95Third Quarter
    
    
    3.32
    
    
    
    2.10Fourth Quarter
    
    
    2.37
    
    
    
    1.48Fiscal 2007First Quarter
    
    
    2.07
    
    
    
    1.38Second Quarter
    
    
    1.82
    
    
    
    1.31Third Quarter
    
    
    1.72
    
    
    
    1.27Fourth Quarter
    
    
    1.34
    
    
    
    .70
  18




---



##### Table of Contents



Item 6.
    
    Selected Financial Data.
 Managements Discussion and Analysis of Financial Condition and
Results of Operations.
 Year Ended December 31,2007
    
    
    2006
    
    
    2005
    
    
    2004
    
    
    2003Statements of Operations Data:Net sales
    
    $
    82,209,963
    
    
    $
    97,840,126
    
    
    $
    87,312,560
    
    
    $
    63,637,285
    
    
    $
    43,520,563Income (loss) before extraordinary gain, accrued
dividends on preferred stock and income taxes
    
    
    (12,530,850
    )
    
    
    968,585
    
    
    
    3,583,370
    
    
    
    1,369,983
    
    
    
    (665,921
    )Preferred
stock dividends from beneficial conversion feature
    
    
    (943,838
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accrued
dividends on preferred stock
    
    
    (136,957
    )
    
    
    
    
    
    
    (235,367
    )
    
    
    (276,000
    )
    
    
    (276,000
    )Income (loss) before extraordinary gain and income
taxes
    
    
    (13,611,645
    )
    
    
    968,585
    
    
    
    3,348,003
    
    
    
    1,093,983
    
    
    
    (941,921
    )Net income tax benefit
    
    
    3,662,082
    
    
    
    835,937
    
    
    
    4,449,682
    
    
    
    
    
    
    
    Income (loss) before extraordinary gain
    
    
    (9,949,563
    )
    
    
    1,804,522
    
    
    
    7,797,685
    
    
    
    1,093,983
    
    
    
    (941,921
    )Extraordinary gain, net of income tax
    
    
    432,403
    
    
    
    
    
    
    
    
    
    
    
    173,536
    
    
    
    2,962,041Net income (loss) applicable to common stock
    
    $
    (9,517,160
    )
    
    $
    1,804,522
    
    
    $
    7,797,685
    
    
    $
    1,267,519
    
    
    $
    2,020,120Net income (loss) per common share
before extraordinary gain(1)(Basic)
    
    $
    (0.21
    )
    
    $
    0.04
    
    
    $
    0.22
    
    
    $
    0.03
    
    
    $
    (0.03
    )Net income (loss) per common share
before extraordinary gain (1) (Diluted)
    
    $
    (0.21
    )
    
    $
    0.04
    
    
    $
    0.19
    
    
    $
    0.03
    
    
    $
    (0.03
    )Extraordinary gain per common share
(Basic)
    
    $
    0.01
    
    
    
    
    
    
    
    
    
    
    $
    0.01
    
    
    $
    0.10Extraordinary gain per common share (Diluted)
    
    $
    0.01
    
    
    
    
    
    
    
    
    
    
    $
    0.00
    
    
    $
    0.10Net income (loss) per common share
after extraordinary gain (Basic)
    
    $
    (0.20
    )
    
    $
    0.04
    
    
    $
    0.22
    
    
    $
    0.04
    
    
    $
    0.07Net income (loss) per common share
after extraordinary gain (Diluted)
    
    $
    (0.20
    )
    
    $
    0.04
    
    
    $
    0.19
    
    
    $
    0.03
    
    
    $
    0.07Weighted average number of shares
outstanding (Basic)
    
    
    47,030,850
    
    
    
    41,990,150
    
    
    
    35,861,060
    
    
    
    31,815,067
    
    
    
    30,017,661Weighted average number of shares
outstanding (Diluted)
    
    
    47,030,850
    
    
    
    45,881,498
    
    
    
    40,475,244
    
    
    
    41,070,289
    
    
    
    30,017,661Balance Sheet Data:Working
capital surplus (deficit)
    
    $
    2,226,615
    
    
    $
    (3,466,130
    )
    
    $
    (687,039
    )
    
    $
    (3,470,971
    )
    
    $
    (1,915,695
    )Total assets
    
    
    93,758,803
    
    
    
    72,049,966
    
    
    
    56,952,673
    
    
    
    43,340,793
    
    
    
    36,406,601Long-term debt less current maturities.
    
    
    26,504,264
    
    
    
    16,827,717
    
    
    
    17,010,889
    
    
    
    15,571,068
    
    
    
    16,659,241Total liabilities
    
    
    63,683,674
    
    
    
    44,493,361
    
    
    
    35,835,369
    
    
    
    31,610,279
    
    
    
    27,458,156Stockholders equity
    
    
    30,075,129
    
    
    
    27,556,605
    
    
    
    21,117,304
    
    
    
    11,730,514
    
    
    
    8,948,445
 
 (1)
    
    The net income (loss) per share of common stock is based on the combined weighted average
number of shares of Class A and Class B common stock outstanding during the period. See Note
2 to the financial statements for a reconciliation of the basic and diluted weighted average
number of shares outstanding. 19




---



##### Table of Contents



Item 7.  Managements Discussion and Analysis of Financial Condition and Results of
Operations.
 2007 Summary
  Current Business Environment
  Sales
    TM
     20




---



##### Table of Contents



Costs
    Longer Term Factors Driving Our Business
     Managements Focus for 2008
 
    
    Complete the expansion of the distribution network for our MoistureShield decking
product line to nationwide distribution by the summer of 2008
 21




---



##### Table of Contents




    
    Expand our business in China and explore opportunities in other growing international
markets
    
    Continue to expand sales in the HIW segment through Lowes
    
    Decrease operating costs relative to sales revenue:
 
    
    Complete modifications to our plastic blending processes to increase throughput
and increase yield at extrusion factories
    
    Increase our ability to use more low cost raw materials
    
    More aggressive raw materials purchasing strategies
    
    Improve training and associate development
    
    Increase automation to improve yield and lower labor costs
    
    Streamline logistics and manufacturing operations
    
    Complete installation of the new enterprise resource planning system to improve
management information
    
    Balance sales, general and administrative overhead expenses to match growth rate
 
    
    Reduce leverage and strengthen the balance sheet
 Growth Objectives
  1.
    
    Technological InnovationInvestments in leading edge recycling technologies have now entered the commercial phase with
recent additions at our Lowell, Arkansas and Springdale, Arkansas manufacturing facilities.
Additional technology is also underway with the Companys Watts, Oklahoma facility which is
designed to recover, utilize, and convert lower grades of waste plastics into usable
feedstocks. By utilizing technology, we are upgrading the quality and aesthetics of our
products to levels equal to or better than virgin resin based materials from primarily a
low end stream base of raw materials.2.
    
    Green Marketing and Branding FocusWe have been recycling plastic and building green building products since our inception in
1988. We have recently retained the services of a national advertising and marketing firm,
Nicholson-Kovac of Kansas City, Missouri to help build brand awareness for our MoistureShield
product line. This involves expanded internet marketing, trade publications, and consumer
and media marketing. We intend to continue building our brands and differentiating AERT as a
green building products company.3.
    
    Quality and Continuous ImprovementOur products are built for hostile, external environmental conditions. Our recycling
processes focus on intensive cleaning and reformulating of our raw materials prior to
extrusion. Our extrusion process is unique and focuses on total encapsulation of the wood
fibers. Our products are covered under U.S. Patent #5759680.Since inception, we have focused on continuous improvement in our processes, products, and
customer service.
 22




---



##### Table of Contents



With our latest technological advances in plastic recycling, we are taking recycled plastics
up to performance levels of new plastics, while also continuing to improve the surface
aesthetics and other properties of our finished products. In the
future, commercial implementation of our latest plastic recycling
technologies may provide additional revenue opportunities beyond
composites.4.
    
    Distribution, Sales, and New ProductsWe are broadening our distribution and sales beyond the HIW market in 2008 and further
expanding into the commercial contractor and international markets. In addition to
increased MoistureShield distribution, we have added several new tropical hardwood colors and
are prepared to introduce a new line of matching embossed handrail kits. We are also
finalizing field testing of a new line of exterior fencing which we intend to launch in the
second half of 2008.We have recently begun exporting decking products beyond North America with shipments to
China and the Middle East. Exportation of our green building product is a major focus for
our future.5.
    
    Cost ImprovementsWe have invested substantially over the last several years in facilities and equipment in
order to attain increased sales capabilities. In addition, we have implemented several cost
reduction programs involving process and automation improvements and the consolidation or
closing of less efficient facilities. We have recently hired a new
President and named a V.P. of
Operations, both of whom are focused on the implementation of lean manufacturing and other efficiency
processes while attaining improved cost efficiencies. Our focus is to utilize technology and
infrastructure to convert low cost waste materials in to high
quality, outdoor green building
products with a significant cost advantage.
 23




---



##### Table of Contents



Results of Operations
 Three Year Comparison
 2007
    
    
    % Change
    
    
    2006
    
    
    % Change
    
    
    2005Net sales
    
    $
    82,209,963
    
    
    
    -16.0
    %
    
    $
    97,840,126
    
    
    
    12.1
    %
    
    $
    87,312,560Cost of goods sold
    
    
    74,340,601
    
    
    
    -4.2
    %
    
    
    77,594,965
    
    
    
    16.9
    %
    
    
    66,389,964% of net sales
    
    
    90.4
    %
    
    
    11.1
    %
    
    
    79.3
    %
    
    
    3.3
    %
    
    
    76.0
    %Gross margin
    
    
    7,869,362
    
    
    
    -61.1
    %
    
    
    20,245,161
    
    
    
    -3.2
    %
    
    
    20,922,596% of net sales
    
    
    9.6
    %
    
    
    -11.1
    %
    
    
    20.7
    %
    
    
    -3.3
    %
    
    
    24.0
    %Selling and administrative costs
    
    
    16,368,725
    
    
    
    -0.2
    %
    
    
    16,407,400
    
    
    
    12.4
    %
    
    
    14,595,854% of net sales
    
    
    19.9
    %
    
    
    3.1
    %
    
    
    16.8
    %
    
    
    0.1
    %
    
    
    16.7
    %Research and development
    
    
    265,881
    
    
    
    -7.0
    %
    
    
    285,858
    
    
    
    159.6
    %
    
    
    110,134Subtotal
    
    
    16,634,606
    
    
    
    -0.4
    %
    
    
    16,693,258
    
    
    
    13.5
    %
    
    
    14,705,988% of net sales
    
    
    20.2
    %
    
    
    3.2
    %
    
    
    17.1
    %
    
    
    0.3
    %
    
    
    16.8
    %Operating income (loss)
    
    
    (8,765,244
    )
    
    
    *
    
    
    
    3,551,903
    
    
    
    -42.9
    %
    
    
    6,216,608% of net sales
    
    
    -10.7
    %
    
    
    -14.3
    %
    
    
    3.6
    %
    
    
    -3.5
    %
    
    
    7.1
    %Other income (expense)Net litigation contingency
    
    
    
    
    
    
    0.0
    %
    
    
    
    
    
    
    -100.0
    %
    
    
    (610,206
    )Gain (loss) on disposition of equipment
    
    
    7,920
    
    
    
    -86.4
    %
    
    
    58,285
    
    
    
    *
    
    
    
    (26,122
    )Net interest expense
    
    
    (3,773,526
    )
    
    
    42.8
    %
    
    
    (2,641,603
    )
    
    
    32.3
    %
    
    
    (1,996,910
    )Income (loss) before extraordinary item,
accured premium on preferred stock
and taxes
    
    
    (12,530,850
    )
    
    
    *
    
    
    
    968,585
    
    
    
    -73.0
    %
    
    
    3,583,370% of net sales
    
    
    -15.2
    %
    
    
    -16.2
    %
    
    
    1.0
    %
    
    
    -3.1
    %
    
    
    4.1
    %Preferred stock dividends from beneficial conversion feature
    
    
    (943,838
    )
    
    
    *
    
    
    
    
    
    
    
    0.0
    %
    
    
    Accrued premium on preferred stock
    
    
    (136,957
    )
    
    
    *
    
    
    
    
    
    
    
    -100.0
    %
    
    
    (235,367
    )Income (loss) before extraordinary item
and taxes
    
    
    (13,611,645
    )
    
    
    *
    
    
    
    968,585
    
    
    
    -71.1
    %
    
    
    3,348,003% of net sales
    
    
    -16.6
    %
    
    
    -17.6
    %
    
    
    1.0
    %
    
    
    -2.8
    %
    
    
    3.8
    %Net income tax benefit
    
    
    3,662,082
    
    
    
    338.1
    
    
    
    835,937
    
    
    
    -81.2
    %
    
    
    4,449,682% of net sales
    
    
    4.5
    %
    
    
    3.6
    %
    
    
    0.9
    %
    
    
    -4.2
    %
    
    
    5.1
    %Income (loss) before extraordinary item
    
    
    (9,949,563
    )
    
    
    *
    
    
    
    1,804,522
    
    
    
    -76.9
    %
    
    
    7,797,685% of net sales
    
    
    -12.1
    %
    
    
    -13.9
    %
    
    
    1.8
    %
    
    
    -7.1
    %
    
    
    8.9
    %Extraordinary gain on involuntary conversion
of non-monetary assets due to fire
    
    
    432,403
    
    
    
    *
    
    
    
    
    
    
    
    0.0
    %
    
    
    Net income (loss) applicable to common
stock
    
    $
    (9,517,160
    )
    
    
    *
    
    
    $
    1,804,522
    
    
    
    -76.9
    %
    
    $
    7,797,685% of net sales
    
    
    -11.6
    %
    
    
    -13.4
    %
    
    
    1.8
    %
    
    
    -7.1
    %
    
    
    8.9
    %
 
 *
    
    Not meaningful as a percentage change 24




---



##### Table of Contents



Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
 Net Sales
    Cost of Goods Sold and Gross Margin
   Selling and Administrative Expenses
  25




---



##### Table of Contents



Income (loss)
  Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
 Net Sales
  Cost of Goods Sold and Gross Margin
   Selling and Administrative Expenses
   Operating Income
  Net Income
  26




---



##### Table of Contents



Contingencies
 Liquidity and Capital Resources
       27




---



##### Table of Contents



December 31,Bonds payable and Allstate Notes Payable Debt Covenants
    
    2007
    
    ComplianceLong-term debt service coverage ratio for last four quarters of at least 2.00
to 1.00
    
    
    -1.48
    
    
    No  WaivedCurrent ratio of not less than 1.00 to 1.00
    
    
    1.06
    
    
    YesDebt to equity ratio of not more than 3.00 to 1.00
    
    
    1.63
    
    
    YesNot more than 10% of accounts payable in excess of 75 days past invoice date
    
    
    23.2
    %
    
    No  WaivedNot more than 20% of accounts receivable in excess of 90 days past invoice date
    
    
    5.4
    %
    
    Yes
 Critical Accounting Policies and Estimates
  Accounts Receivable
  Buildings and Equipment
  28




---



##### Table of Contents



Accounting for the
Impairment or Disposal of Long-Lived Assets
 Revenue Recognition
 Revenue Recognition in Financial Statements
  Contractual Obligations
  Payments Due by PeriodLess than
    
    1 to 3
    
    3 to 5
    
    More thanTotal
    
    1 year
    
    years
    
    years
    
    5 yearsLong-term
debt and capital lease obligations
    
    $36,311,249
    
    $9,806,985
    
    $5,470,339
    
    $3,963,925
    
    $17,070,000Operating leases
    
    12,337,256
    
    2,873,535
    
    4,378,243
    
    3,323,289
    
    1,762,189Total
    
    $48,648,505
    
    $12,680,520
    
    $9,848,582
    
    $7,287,214
    
    $18,832,189
   29




---



##### Table of Contents



Uncertainties, Issues and Risks
  
 Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
  Forward-looking Information
   
 30




---



##### Table of Contents



Item 8. Financial Statements and Supplementary Data.
 Summary Quarterly Financial Data
 2006
    
    2007First
    
    Second
    
    Third
    
    Fourth
    
    First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    QuarterNet sales
    
    $
    27,665,249
    
    
    $
    28,105,770
    
    
    $
    20,800,859
    
    
    $
    21,268,248
    
    
    $
    22,367,040
    
    
    $
    25,342,796
    
    
    $
    24,797,778
    
    
    $
    9,702,349Gross margin
    
    
    5,954,316
    
    
    
    8,480,538
    
    
    
    4,132,310
    
    
    
    1,677,997
    
    
    
    2,838,452
    
    
    
    3,989,802
    
    
    
    2,065,163
    
    
    
    (1,024,055
    )Net income
(loss)
    
    
    905,942
    
    
    
    1,723,097
    
    
    
    (305,595
    )
    
    
    (518,922
    )
    
    
    (1,171,659
    )
    
    
    (383,919
    )
    
    
    (1,529,444
    )
    
    
    (6,432,138
    )Income (loss) per share (Basic)
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    (0.03
    )
    
    $
    (0.01
    )
    
    $
    (0.03
    )
    
    $
    (0.13
    )Income (loss) per share (Diluted)
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    (0.03
    )
    
    $
    (0.01
    )
    
    $
    (0.03
    )
    
    $
    (0.13
    )
  
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.
  
 Item 9A. Controls and Procedures.
  Managements Report on Internal Control Over Financial Reporting
    31




---



##### Table of Contents



/s/ JOE G. BROOKSJoe G. Brooks,Chairman, Chief Executive Officer and President/s/ STEPHEN W. BROOKSStephen W. Brooks,Vice Chairman and Chief Operating Officer/s/ ROBERT A. THAYERRobert A. Thayer,Senior Vice President and Chief Financial Officer Remediation of Material Weakness in Internal Control Over Financial Reporting
  Changes in Internal Control Over Financial Reporting
  
 Item 9B. Other Information.
  32




---



##### Table of Contents



PART III
 
 Item 10. Directors, Executive Officers and Corporate Governance.
  Name
    
    Age
    
    PositionJoe G. Brooks
    
    
    52
    
    
    Chairman, chief executive officer and presidentStephen W. Brooks
    
    
    51
    
    
    Vice chairman and chief operating officerMarjorie S. Brooks
    
    
    72
    
    
    Secretary, treasurer and directorJ. Douglas Brooks
    
    
    48
    
    
    Senior vice presidentAlford Drinkwater
    
    
    56
    
    
    Senior vice presidentJim Precht
    
    
    62
    
    
    Senior vice president  sales and marketingRobert A. Thayer
    
    
    56
    
    
    Senior vice president and chief financial officerEric E. Barnes
    
    
    34
    
    
    Chief accounting officer and controllerJerry B. Burkett
    
    
    51
    
    
    DirectorEdward P. Carda
    
    
    67
    
    
    DirectorMelinda Davis
    
    
    65
    
    
    DirectorTim W. Kizer
    
    
    42
    
    
    DirectorPeter S. Lau
    
    
    54
    
    
    DirectorSal Miwa
    
    
    51
    
    
    DirectorJim Robason
    
    
    70
    
    
    DirectorMichael M. Tull
    
    
    53
    
    
    Director
 Joe G. Brooks
 Stephen W. Brooks
 Marjorie
S. Brooks
 J.
Douglas Brooks
 Robert
A. Thayer
 33




---



##### Table of Contents



Alford Drinkwater
 Jim Precht
 Eric E. Barnes
 Jerry B. Burkett
 Edward P. Carda
 Melinda Davis
 Tim W. Kizer
 34




---



##### Table of Contents



Doing Business in Bentonville Series
 Peter S. Lau
 Sal Miwa
 Jim Robason
 Michael M. Tull
  35




---



##### Table of Contents



Code of Ethics
  Compliance with Section 16(a) of the Exchange Act
  
 Item 11. Executive Compensation.
  36




---



##### Table of Contents



Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.
  
 Item 13. Certain Relationships and Related Transactions, and Director Independence.
  
 Item 14. Principal Accountant Fees and Services.
  
 Part IV
 
 Item 15. Exhibits and Financial Statement Schedules.
 (a1) and (a2).
 (a3) and (c).
 37




---



##### Table of Contents



SIGNATURES
  ADVANCED ENVIRONMENTAL
RECYCLING TECHNOLOGIES, INC./s/ JOE G. BROOKSJoe G. Brooks,Chairman, Chief Executive Officer
and President (principal executive officer)/s/ STEPHEN W. BROOKSStephen W. Brooks,Vice Chairman and Chief Operating
Officer/s/ ROBERT A. THAYERRobert A. Thayer,Senior Vice President and Chief Financial Officer (principal financial officer)/s/ ERIC E. BARNESEric E. Barnes,Chief Accounting Officer and Controller (principal accounting officer)  POWER OF ATTORNEY
   Signature
    
    Title
    
    Date/s/ JOE G. BROOKS

Joe G. Brooks
    
    Chairman, Chief Executive Officer
and President
    
    April 7, 2008/s/ STEPHEN W. BROOKS

Stephen W. Brooks
    
    Vice Chairman and Chief Operating Officer
    
    April 7, 2008/s/ MARJORIE S. BROOKS

Marjorie S. Brooks
    
    Secretary, Treasurer and Director
    
    April 7, 2008/s/ JERRY B. BURKETT

Jerry B. Burkett
    
    Director
    
    April 7, 2008/s/ EDWARD P. CARDA

Edward P. Carda
    
    Director
    
    April 7, 2008/s/ MELINDA DAVIS

Melinda Davis
    
    Director
    
    April 7, 2008
 38




---



##### Table of Contents



Signature
    
    Title
    
    Date/s/ TIM W. KIZER

Tim W. Kizer
    
    Director
    
    April 7, 2008/s/ SAL MIWA

Sal Miwa
    
    Director
    
    April 7, 2008/s/ JIM ROBASON

Jim Robason
    
    Director
    
    April 7, 2008/s/ MICHAEL M. TULL

Michael M. Tull
    
    Director
    
    April 7, 2008/s/
PETER S. LAU

Peter S. Lau
    
    Director
    
    April 7, 2008
 39




---



##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
 
 INDEX TO FINANCIAL STATEMENTS
 PageFinancial Statements:Reports of Independent Registered Public Accounting Firm
    
    F-2  F-3Balance Sheets
    
    F-4  F-5Statements of Operations
    
    F-6Statements of Stockholders Equity
    
    F-7Statements of Cash Flows
    
    F-8Notes to Financial Statements
    
    F-9  F-29
 F-1




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
    Internal
ControlIntegrated Framework Internal ControlIntegrated Framework
 /s/ TULLIUS TAYLOR SARTAIN & SARTAIN LLP 
 F-2




---



##### Table of Contents



Internal
ControlIntegrated Framework .
     Internal
ControlIntegrated Framework
   
 F-3




---



##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
 
 Balance Sheets
 December 31,
    
    
    December 31,2007
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    1,716,481
    
    
    $
    2,164,532Restricted cash
    
    
    11,461,950
    
    
    
    787,191Restricted certificate of deposit
    
    
    871,468
    
    
    
    Trade accounts receivable, net of allowance of $1,162,500 at December 31, 2007 and
$374,894 at December 31, 2006
    
    
    640,668
    
    
    
    3,789,302Other accounts receivable
    
    
    63,453
    
    
    
    760,970Inventories
    
    
    23,622,586
    
    
    
    14,515,845Prepaid expenses
    
    
    892,462
    
    
    
    1,018,657Deferred tax asset
    
    
    
    
    
    
    1,163,017Total current assets
    
    
    39,269,068
    
    
    
    24,199,514Land, buildings and equipment:Land
    
    
    1,988,638
    
    
    
    1,988,638Buildings and leasehold improvements
    
    
    10,008,257
    
    
    
    5,979,223Machinery and equipment
    
    
    51,690,169
    
    
    
    39,475,682Transportation equipment
    
    
    1,148,046
    
    
    
    1,243,556Office equipment
    
    
    1,169,213
    
    
    
    801,231Construction in progress
    
    
    4,218,303
    
    
    
    14,762,153Total land, buildings and equipment
    
    
    70,222,626
    
    
    
    64,250,483Less accumulated depreciation
    
    
    31,380,005
    
    
    
    26,728,540Net land, buildings and equipment
    
    
    38,842,621
    
    
    
    37,521,943Other assets:Deferred tax asset
    
    
    8,851,412
    
    
    
    4,293,912Debt issuance costs, net of accumulated amortization of $1,052,949 at December 31, 2007
and $790,532 at December 31, 2006
    
    
    3,042,645
    
    
    
    2,814,390Debt service reserve fund
    
    
    3,391,500
    
    
    
    2,040,000Restricted certificate of deposit
    
    
    
    
    
    
    829,961Other assets, net of accumulated amortization of $421,310 at December 31, 2007 and
$392,736 at December 31, 2006
    
    
    361,557
    
    
    
    350,246Total other assets
    
    
    15,647,114
    
    
    
    10,328,509Total assets
    
    $
    93,758,803
    
    
    $
    72,049,966
  F-4




---



##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
 Balance Sheets
 December 31,
    
    
    December 31,2007
    
    
    2006LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable  trade
    
    $
    9,274,134
    
    
    $
    10,861,648Accounts payable  related parties
    
    
    350,882
    
    
    
    494,831Current maturities of long-term debt
    
    
    9,582,145
    
    
    
    1,580,357Current
maturities of capital lease obligations
    
    
    224,840
    
    
    
    93,255Accrued payroll expense
    
    
    553,376
    
    
    
    575,782Litigation loss payable
    
    
    655,769
    
    
    
    655,769Other accrued liabilities
    
    
    3,712,700
    
    
    
    1,933,821Working capital line of credit
    
    
    12,303,378
    
    
    
    10,060,000Notes payable  related parties
    
    
    
    
    
    
    1,000,000Notes payable  other
    
    
    385,229
    
    
    
    410,181Total current liabilities
    
    
    37,042,453
    
    
    
    27,665,644Long-term debt, less current maturities
    
    
    25,707,959
    
    
    
    16,803,644Capital
lease obligations, less current maturities
    
    
    796,305
    
    
    
    24,07326,504,264
    
    
    
    16,827,717Accrued dividends on convertible preferred stock
    
    
    136,957
    
    
    
    Commitments and contingenciesStockholders equity:Preferred stock, $.01 par value; 5,000,000 shares authorized, 757,576 shares issued
and outstanding at December 31, 2007
    
    
    7,576
    
    
    
    Class A common stock, $.01 par value; 75,000,000 shares authorized; 46,314,250 and
43,041,164 shares issued and outstanding at December 31, 2007 and 2006, respectively
    
    
    463,143
    
    
    
    430,412Class B convertible common stock, $.01 par value; 7,500,000 shares authorized;
1,465,530 shares issued and outstanding at December 31, 2007 and 2006
    
    
    14,655
    
    
    
    14,655Warrants outstanding; 3,787,880 at December 31, 2007 and 4,606,132 at December 31, 2006
    
    
    1,533,578
    
    
    
    2,519,389Additional paid-in capital
    
    
    50,872,462
    
    
    
    37,891,274Accumulated deficit
    
    
    (22,816,285
    )
    
    
    (13,299,125
    )Total stockholders equity
    
    
    30,075,129
    
    
    
    27,556,605Total liabilities and stockholders equity
    
    $
    93,758,803
    
    
    $
    72,049,966
  F-5




---



##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
 
 STATEMENTS OF OPERATIONS
 Year Ended December 31,2007
    
    
    2006
    
    
    2005Net sales
    
    $
    82,209,963
    
    
    $
    97,840,126
    
    
    $
    87,312,560Cost of goods sold
    
    
    74,340,601
    
    
    
    77,594,965
    
    
    
    66,389,964Gross margin
    
    
    7,869,362
    
    
    
    20,245,161
    
    
    
    20,922,596Selling and administrative costs
    
    
    16,368,725
    
    
    
    16,407,400
    
    
    
    14,595,854Research and development
    
    
    265,881
    
    
    
    285,858
    
    
    
    110,13416,634,606
    
    
    
    16,693,258
    
    
    
    14,705,988Operating income (loss)
    
    
    (8,765,244
    )
    
    
    3,551,903
    
    
    
    6,216,608Other income (expense):Net litigation contingency
    
    
    
    
    
    
    
    
    
    
    (610,206
    )Gain (loss) on disposition of equipment
    
    
    7,920
    
    
    
    58,285
    
    
    
    (26,122
    )Interest income
    
    
    183,409
    
    
    
    202,724
    
    
    
    90,908Interest expense
    
    
    (3,956,935
    )
    
    
    (2,844,327
    )
    
    
    (2,087,818
    )Net other expense
    
    
    (3,765,606
    )
    
    
    (2,583,318
    )
    
    
    (2,633,238
    )Income (loss) before extraordinary item, income taxes and accrued
dividends on preferred stock
    
    
    (12,530,850
    )
    
    
    968,585
    
    
    
    3,583,370Preferred stock dividends from beneficial conversion feature
    
    
    (943,838
    )
    
    
    
    
    
    
    Accrued dividends on preferred stock
    
    
    (136,957
    )
    
    
    
    
    
    
    (235,367
    )Income (loss) before extraordinary item and income taxes
    
    
    (13,611,645
    )
    
    
    968,585
    
    
    
    3,348,003Income tax benefit
    
    
    (3,662,082
    )
    
    
    (835,937
    )
    
    
    (4,449,682
    )Income (loss) before extraordinary item
    
    
    (9,949,563
    )
    
    
    1,804,522
    
    
    
    7,797,685Extraordinary gain on involuntary conversion of non-monetary assets
due to fire (net of income tax)
    
    
    432,403
    
    
    
    
    
    
    
    Net income (loss) applicable to common stock
    
    $
    (9,517,160
    )
    
    $
    1,804,522
    
    
    $
    7,797,685Income (loss) per share of common stock before extraordinary item (Basic)
    
    $
    (0.21
    )
    
    $
    0.04
    
    
    $
    0.22Income (loss) per share of common stock before extraordinary item (Diluted)
    
    $
    (0.21
    )
    
    $
    0.04
    
    
    $
    0.19Extraordinary gain per share of common stock (Basic)
    
    $
    0.01
    
    
    
    
    
    
    
    Extraordinary gain per share of common stock (Diluted)
    
    $
    0.01
    
    
    
    
    
    
    
    Income (loss) per share of common stock after extraordinary item (Basic)
    
    $
    (0.20
    )
    
    $
    0.04
    
    
    $
    0.22Income (loss) per share of common stock after extraordinary item (Diluted)
    
    $
    (0.20
    )
    
    $
    0.04
    
    
    $
    0.19Weighted average number of common shares outstanding (Basic)
    
    
    47,030,850
    
    
    
    41,990,150
    
    
    
    35,861,060Weighted average number of common shares outstanding (Diluted)
    
    
    47,030,850
    
    
    
    45,881,498
    
    
    
    40,475,244
  F-6




---



##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
 STATEMENTS OF STOCKHOLDERS EQUITY
 Class A
    
    
    Class B
    
    
    Warrants
    
    
    AdditionalPreferred Stock
    
    
    Common Stock
    
    
    Common Stock
    
    
    Outstanding
    
    
    Paid-in
    
    
    AccumulatedShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Number
    
    
    Value
    
    
    Capital
    
    
    Deficit
    
    
    TotalBalance  December 31, 2004
    
    $
    2,760
    
    
    $
    2,760
    
    
    $
    32,032,123
    
    
    $
    320,322
    
    
    $
    1,465,530
    
    
    $
    14,655
    
    
    $
    14,890,867
    
    
    $
    6,917,544
    
    
    $
    27,376,565
    
    
    $
    (22,901,332
    )
    
    $
    11,730,514Issuance of stock in payment of accrued premium
on preferred stock
    
    
    
    
    
    
    
    
    
    
    229,994
    
    
    
    2,300
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    273,700
    
    
    
    
    
    
    
    276,000Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    387,600
    
    
    
    3,876
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    203,200
    
    
    
    
    
    
    
    207,076Exercise of Consulting warrants
    
    
    
    
    
    
    
    
    
    
    1,738,946
    
    
    
    17,389
    
    
    
    
    
    
    
    
    
    
    
    (2,016,332
    )
    
    
    (1,120,815
    )
    
    
    1,389,382
    
    
    
    
    
    
    
    285,956Expiration of Consulting warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,379,926
    )
    
    
    (784,532
    )
    
    
    784,532
    
    
    
    
    
    
    
    Exercise of Class C warrants
    
    
    
    
    
    
    
    
    
    
    325,000
    
    
    
    3,250
    
    
    
    
    
    
    
    
    
    
    
    (325,000
    )
    
    
    (96,098
    )
    
    
    442,223
    
    
    
    
    
    
    
    349,375Exercise of Series X warrants
    
    
    
    
    
    
    
    
    
    
    6,564
    
    
    
    66
    
    
    
    
    
    
    
    
    
    
    
    (6,564
    )
    
    
    (3,485
    )
    
    
    11,296
    
    
    
    
    
    
    
    7,877Exercise of Class I warrants
    
    
    
    
    
    
    
    
    
    
    21,142
    
    
    
    211
    
    
    
    
    
    
    
    
    
    
    
    (21,142
    )
    
    
    (8,220
    )
    
    
    24,604
    
    
    
    
    
    
    
    16,595Expiration of Class I warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (42,997
    )
    
    
    (13,478
    )
    
    
    13,478
    
    
    
    
    
    
    
    Exercise of Series Z warrants
    
    
    
    
    
    
    
    
    
    
    300,000
    
    
    
    3,000
    
    
    
    
    
    
    
    
    
    
    
    (300,000
    )
    
    
    (106,898
    )
    
    
    403,898
    
    
    
    
    
    
    
    300,000Exercise of Extension warrants
    
    
    
    
    
    
    
    
    
    
    310,000
    
    
    
    3,100
    
    
    
    
    
    
    
    
    
    
    
    (310,000
    )
    
    
    (183,310
    )
    
    
    296,460
    
    
    
    
    
    
    
    116,250Expiration of Bonus warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,312,664
    )
    
    
    (111,289
    )
    
    
    111,289
    
    
    
    
    
    
    
    Conversion of preferred stock
    
    
    (2,760
    )
    
    
    (2,760
    )
    
    
    2,300,000
    
    
    
    23,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,240
    )
    
    
    
    
    
    
    Deferred equity compensation for restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,976
    
    
    
    
    
    
    
    29,976Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,797,685
    
    
    
    7,797,685Balance  December 31, 2005
    
    
    
    
    
    
    
    
    
    
    37,651,369
    
    
    
    376,514
    
    
    
    1,465,530
    
    
    
    14,655
    
    
    
    9,176,242
    
    
    
    4,489,419
    
    
    
    31,340,363
    
    
    
    (15,103,647
    )
    
    
    21,117,304Issuance of stock in payment of accrued premium
on preferred stock
    
    
    
    
    
    
    
    
    
    
    195,965
    
    
    
    1,960
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    233,407
    
    
    
    
    
    
    
    235,367Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    741,000
    
    
    
    7,410
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    443,245
    
    
    
    
    
    
    
    450,655Exercise of Class F warrants
    
    
    
    
    
    
    
    
    
    
    987,040
    
    
    
    9,870
    
    
    
    
    
    
    
    
    
    
    
    (987,040
    )
    
    
    (485,637
    )
    
    
    1,077,861
    
    
    
    
    
    
    
    602,094Exercise of Class G warrants
    
    
    
    
    
    
    
    
    
    
    2,987,040
    
    
    
    29,870
    
    
    
    
    
    
    
    
    
    
    
    (2,987,040
    )
    
    
    (1,167,901
    )
    
    
    3,886,107
    
    
    
    
    
    
    
    2,748,076Exercise of Series X warrants
    
    
    
    
    
    
    
    
    
    
    478,750
    
    
    
    4,788
    
    
    
    
    
    
    
    
    
    
    
    (596,030
    )
    
    
    (316,492
    )
    
    
    711,704
    
    
    
    
    
    
    
    400,000Deferred equity compensation for restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    198,587
    
    
    
    
    
    
    
    198,587Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,804,522
    
    
    
    1,804,522Balance  December 31, 2006
    
    
    
    
    
    
    
    
    
    
    43,041,164
    
    
    
    430,412
    
    
    
    1,465,530
    
    
    
    14,655
    
    
    
    4,606,132
    
    
    
    2,519,389
    
    
    
    37,891,274
    
    
    
    (13,299,125
    )
    
    
    27,556,605Issuance of
Series D preferred stock, net of issuance costs
    
    
    757,576
    
    
    
    7,576
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,186,044
    
    
    
    
    
    
    
    9,193,620Issuance of
Series W stock warrants, net of issuance costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,787,880
    
    
    
    1,533,578
    
    
    
    (1,533,578
    )
    
    
    
    
    
    
    Issuances of restricted stock
    
    
    
    
    
    
    
    
    
    
    160,641
    
    
    
    1,607
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,607
    )
    
    
    
    
    
    
    Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    1,333,130
    
    
    
    13,331
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    662,038
    
    
    
    
    
    
    
    675,369Exercise of Series H warrants
    
    
    
    
    
    
    
    
    
    
    1,771,792
    
    
    
    17,718
    
    
    
    
    
    
    
    
    
    
    
    (1,771,792
    )
    
    
    (1,142,060
    )
    
    
    1,958,448
    
    
    
    
    
    
    
    834,106Exercise of Series X warrants
    
    
    
    
    
    
    
    
    
    
    7,523
    
    
    
    75
    
    
    
    
    
    
    
    
    
    
    
    (508,989
    )
    
    
    (270,251
    )
    
    
    270,176
    
    
    
    
    
    
    
    Expiration of Series X warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,304,082
    )
    
    
    (692,412
    )
    
    
    692,412
    
    
    
    
    
    
    
    Expiration of Series Y warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,021,269
    )
    
    
    (414,666
    )
    
    
    414,666
    
    
    
    
    
    
    
    Deferred equity compensation for restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    388,751
    
    
    
    
    
    
    
    388,751Preferred stock dividends from beneficial conversion feature
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    943,838
    
    
    
    
    
    
    
    943,838Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,517,160
    )
    
    
    (9,517,160
    )Balance  December 31, 2007
    
    
    757,576
    
    
    $
    7,576
    
    
    
    46,314,250
    
    
    $
    463,143
    
    
    
    1,465,530
    
    
    $
    14,655
    
    
    
    3,787,880
    
    
    $
    1,533,578
    
    
    $
    50,872,462
    
    
    $
    (22,816,285
    )
    
    $
    30,075,129
  F-7




---



##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
 STATEMENTS OF CASH FLOWS
 Year Ended December 31,2007
    
    
    2006
    
    
    2005Cash flows from operating activities:Net income (loss) applicable to common stock
    
    $
    (9,517,160
    )
    
    $
    1,804,522
    
    
    $
    7,797,685Adjustments
to reconcile net income (loss) to net cash provided by (used in)
operating activities:Depreciation and amortization
    
    
    5,331,206
    
    
    
    4,324,913
    
    
    
    4,352,445Preferred
stock dividends from beneficial conversion feature
    
    
    943,838
    
    
    
    
    
    
    
    Dividends accrued on preferred stock
    
    
    136,957
    
    
    
    
    
    
    
    235,367Provisions for returns
    
    
    787,606
    
    
    
    
    
    
    
    266,793Deferred tax benefit
    
    
    (3,662,082
    )
    
    
    (822,047
    )
    
    
    (4,634,882
    )Extraordinary gain on involuntary conversion of non-monetary assets due
to fire
    
    
    (432,403
    )
    
    
    
    
    
    
    (Gain) loss on disposition of equipment
    
    
    (7,920
    )
    
    
    (58,285
    )
    
    
    26,122(Increase) decrease in other assets
    
    
    (1,432,889
    )
    
    
    (937,889
    )
    
    
    16,761(Increase) decrease in cash restricted for letter of credit and interest costs
    
    
    (450,067
    )
    
    
    (88,157
    )
    
    
    42,708Changes in current assets and current liabilities
    
    
    (4,792,670
    )
    
    
    (6,202,868
    )
    
    
    (784,790
    )Net cash provided by (used in) operating activities
    
    
    (13,095,584
    )
    
    
    (1,979,811
    )
    
    
    7,318,209Cash flows from investing activities:Purchases of land, buildings and equipment
    
    
    (4,526,559
    )
    
    
    (6,841,889
    )
    
    
    (5,907,695
    )Proceeds from disposition of equipment
    
    
    
    
    
    
    17,400
    
    
    
    94,596Insurance proceeds from involuntary conversion of non-monetary assets
due to fire
    
    
    700,000
    
    
    
    
    
    
    
    Net cash used in investing activities
    
    
    (3,826,559
    )
    
    
    (6,824,489
    )
    
    
    (5,813,099
    )Cash flows from financing activities:Net borrowings on line of credit
    
    
    2,243,378
    
    
    
    10,060,000
    
    
    
    Proceeds from issuance of notes-related party
    
    
    750,000
    
    
    
    3,303,225
    
    
    
    1,900,000Proceeds from issuance of notes  other
    
    
    18,515,000
    
    
    
    
    
    
    
    Payments on notes-related party
    
    
    (1,750,000
    )
    
    
    (3,050,000
    )
    
    
    (1,753,225
    )Payments on notes  other
    
    
    (3,150,627
    )
    
    
    (2,734,847
    )
    
    
    (2,447,524
    )Payments on capital lease obligations
    
    
    (121,390
    )
    
    
    (76,916
    )
    
    
    Increase in cash restricted for payment of long-term debt
    
    
    (10,224,692
    )
    
    
    (30,691
    )
    
    
    (31,417
    )Increase (decrease) in outstanding advances on factored receivables
    
    
    
    
    
    
    (2,450,788
    )
    
    
    353,235Debt acquisition costs
    
    
    (490,672
    )
    
    
    
    
    
    
    (19,821
    )Proceeds
from preferred stock placement, net
    
    
    9,193,620
    
    
    
    
    
    
    
    Proceeds from exercise of stock options and warrants, net
    
    
    1,509,475
    
    
    
    4,200,826
    
    
    
    1,163,129Net cash provided by (used in) financing activities
    
    
    16,474,092
    
    
    
    9,220,809
    
    
    
    (835,623
    )Increase (decrease) in cash and cash equivalents
    
    
    (448,051
    )
    
    
    416,509
    
    
    
    669,487Cash and cash equivalents, beginning of period
    
    
    2,164,532
    
    
    
    1,748,023
    
    
    
    1,078,536Cash and cash equivalents, end of period
    
    $
    1,716,481
    
    
    $
    2,164,532
    
    
    $
    1,748,023
  F-8




---



##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
 
 NOTES TO FINANCIAL STATEMENTS
 Note 1: Description of the Company
 ® ® ® ® ® ®
   Note 2: Summary of Significant Accounting Policies
 Revenue Recognition Policy
 Revenue Recognition in Financial Statements
  Shipping and Handling
 Accounting for Shipping and
Handling Fees and Costs
 F-9




---



##### Table of Contents



Operating Costs
  Statements of Cash Flows
  Year Ended December 31,2007
    
    
    2006
    
    
    2005Receivables
    
    $
    3,058,545
    
    
    $
    (1,556,571
    )
    
    $
    (705,900
    )Inventories
    
    
    (9,106,741
    )
    
    
    (4,767,102
    )
    
    
    (2,355,905
    )Prepaid expenses and other
    
    
    1,654,972
    
    
    
    1,257,433
    
    
    
    1,219,421Accounts payable  trade and related parties
    
    
    (2,155,919
    )
    
    
    (1,265,529
    )
    
    
    835,910Accrued income taxes
    
    
    
    
    
    
    (116,754
    )
    
    
    117,200Accrued liabilities
    
    
    1,756,473
    
    
    
    245,655
    
    
    
    104,484$
    (4,792,670
    )
    
    $
    (6,202,868
    )
    
    $
    (784,790
    )Cash paid for interest
    
    $
    3,380,690
    
    
    $
    2,573,679
    
    
    $
    2,458,323Cash paid for income taxes
    
    $
    
    
    
    $
    285,824
    
    
    $
    68,000
 Supplemental Disclosures of Non-cash Investing and Financing Activities
 Year Ended December 31,2007
    
    2006
    
    2005Notes payable for financing of insurance policies
    
    $
    1,528,777
    
    
    $
    1,569,789
    
    
    $
    1,339,084Accounts / notes payable for equipment
    
    
    1,437,664
    
    
    
    3,409,523
    
    
    
    3,936,561Accrued dividends on preferred stock paid with
Class A common stock
    
    
    
    
    
    
    235,367
    
    
    
    276,000
 Cash Equivalents and Restricted Cash
  F-10




---



##### Table of Contents



Buildings and Equipment
   Accounting for the
Impairment or Disposal of Long-Lived Assets
 Inventories
  2007
    
    
    2006Parts and supplies
    
    $
    2,423,766
    
    
    $
    2,007,535Raw materials
    
    
    7,182,551
    
    
    
    5,072,734Work in process
    
    
    3,906,810
    
    
    
    3,928,442Finished goods
    
    
    10,109,459
    
    
    
    3,507,134$
    23,622,586
    
    
    $
    14,515,845
 Other Assets
    F-11




---



##### Table of Contents



2007
    
    
    2006Gross Carrying
    
    
    Accumulated
    
    
    Gross Carrying
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    Amount
    
    
    AmortizationDebt issuance costs
    
    $
    4,095,594
    
    
    $
    1,052,949
    
    
    $
    3,604,922
    
    
    $
    790,532Patents
    
    
    485,748
    
    
    
    421,310
    
    
    
    485,748
    
    
    
    392,736$
    4,581,342
    
    
    $
    1,474,259
    
    
    $
    4,090,670
    
    
    $
    1,183,268
  EstimatedAmortization2008
    
    $
    318,9982009
    
    
    314,0432010
    
    
    292,7622011
    
    
    285,4702012
    
    
    285,470
 Accounts Receivable
   Earnings Per Share
 Earnings Per Share
 F-12




---



##### Table of Contents



2007Before
    
    
    AfterExtraordinary
    
    
    ExtraordinaryItem
    
    
    Item
    
    
    2006
    
    
    2005Net income (loss) applicable to common stock (A)
    
    $
    (9,949,563
    )
    
    $
    (9,517,160
    )
    
    $
    1,804,522
    
    
    $
    7,797,685Assumed exercise of stock options and warrants
    
    
    
    
    
    
    
    
    
    
    6,231,993
    
    
    
    11,160,603Application of assumed proceeds toward repurchase
of stock at average market price
    
    
    
    
    
    
    
    
    
    
    (2,340,645
    )
    
    
    (6,546,419
    )Net additional shares issuable
    
    
    
    
    
    
    
    
    
    
    3,891,348
    
    
    
    4,614,184Adjustment of shares outstanding:Weighted average common shares outstanding
    
    
    47,030,850
    
    
    
    47,030,850
    
    
    
    41,990,150
    
    
    
    35,861,060Net additional shares issuable
    
    
    
    
    
    
    
    
    
    
    3,891,348
    
    
    
    4,614,184Adjusted shares outstanding (B)
    
    
    47,030,850
    
    
    
    47,030,850
    
    
    
    45,881,498
    
    
    
    40,475,244Net income (loss) per common share  Diluted (A)
divided by (B)
    
    $
    (0.21
    )
    
    $
    (0.20
    )
    
    $
    0.04
    
    
    $
    0.19Antidilutive and/or non-exercisable options
    
    
    1,521,500
    
    
    
    1,521,500
    
    
    
    275,000
    
    
    
    682,500Antidilutive and/or non-exercisable warrants
    
    
    3,787,880
    
    
    
    3,787,880
    
    
    
    1,021,269
    
    
    
    1,021,269
  Concentration Risk
 Credit Risk
  F-13




---



##### Table of Contents



2007
    
    2006
    
    2005Sales (in millions)
    
    $
    64.4
    
    
    $
    81.1
    
    
    $
    68.5% of total sales
    
    
    75
    %
    
    
    81
    %
    
    
    77
    %
 Cash and Cash Equivalents
  Disclosure about Fair Value of Financial Instruments
  Current assets and current liabilities
 Long-term debt
 Stock-Based Compensation
 Share-Based Payment Accounting for Stock-Based Compensation Accounting for
Stock Issued to Employees
 Use of Estimates
  F-14




---



##### Table of Contents



Advertising Costs
  Research and Development Costs
  Recent Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109 Accounting for Income
Taxes.
 Fair Value Measurements
 F-15




---



##### Table of Contents



The Fair Value Option for Financial Assets and Financial Liabilities
 Disclosures about Derivative Instruments and Hedging Activities  an
amendment of FASB Statement No. 133
 Reclassifications
  Note 3: Related Party Transactions
 Transfer of Receivables
   Lease
   F-16




---



##### Table of Contents



Commissions
    
    
    Sales commissions of $63,501 owed to Tull Sales Co., which is owned by Michael M.
Tull, one of our directors,
    
    Loan guarantee fees of $155,268, equipment rental of $27,344 and miscellaneous
charges of $70,101 owed to Marjorie S. Brooks, one of our directors, or companies
controlled by her, and
    
    Deferred compensation of $20,667 and out-of-pocket expenses of $15,000 owed to Joe G.
Brooks
 Note 4: Line of Credit
  Note 5: Notes Payable and Long-Term Debt
 Notes Payable  Related Parties
 Notes payable to related parties consisted of the following at December 31:
    
    2007
    
    
    20069.25% note payable to Brooks Investment Company, which is controlled by
Marjorie S. Brooks, an officer and director of the Company; unsecured; due
on demand; no periodic principal or interest payments required; paid
in 2007
    
    
    
    
    
    $
    1,000,000
 Notes Payable  Other
 Notes payable other, consisted of the following at December 31:
    
    2007
    
    
    2006Various notes payable to finance insurance policies bearing interest at rates of 10.5%
and 11.25%; secured by insurance policies; principal and interest payable monthly
    
    $
    385,229
    
    
    $
    398,181Other
    
    
    
    
    
    
    12,000$
    385,229
    
    
    $
    410,181
 F-17




---



##### Table of Contents



Long-term Debt
 Long-term debt, less current maturities consisted of the following at December 31:
    
    2007
    
    
    20068% bonds payable to Bank of Oklahoma; principal payable annually beginning December 15,
2009; interest payable semi-annually; subject to mandatory sinking fund redemption;
secured by real estate and improvements, fixed assets, patents and trademarks,
inventory, and pledged revenues; maturing on December 15, 2023(a)
    
    $
    13,515,000
    
    
    
    7% bonds payable to Regions Bank; principal payable annually; interest payable
semi-annually; subject to mandatory sinking fund redemption; secured by real estate and
improvements, fixed assets, patents and trademarks, inventory, pledged revenues, and a
personal guarantee on $4 million of the outstanding balance by Marjorie S. Brooks, the
major shareholder; maturing on October 1, 2017(a)
    
    
    11,200,000
    
    
    
    12,100,00010% note payable to Allstate Insurance Company, secured by subordinated interest in the
collateral securing the bonds payable; principal and interest due October 1, 2008
    
    
    5,000,000
    
    
    
    19.75% note payable to Allstate Insurance Company, secured by subordinated interest in
the collateral securing the bonds payable; interest payable semiannually; principal due
on October 1, 2017
    
    
    2,600,000
    
    
    
    2,600,000Variable rate note payable bearing
interest at the Wall Street Journal prime rate plus 1% (8.25% at
December 31, 2007);
secured by certain real estate and equipment purchased
with proceeds from the note; principal and interest payable monthly; maturing on
September 28, 2009
    
    
    1,900,799
    
    
    
    1,925,679Variable rate note payable bearing
interest at LIBOR plus 3.1% (7.6% at
December 31, 2007); secured by equipment
purchased with proceeds from the note;
principal and interest payable monthly;
maturing on May 1, 2009
    
    
    997,416
    
    
    
    1,623,092Other
    
    
    76,889
    
    
    
    135,230Total
    
    
    35,290,104
    
    
    
    18,384,001Less current maturities
    
    
    (9,582,145
    )
    
    
    (1,580,357
    )Long-term debt, less current maturities
    
    $
    25,707,959
    
    
    $
    16,803,644
 
 (a)
    
    Our 2007 bonds have substantially the same covenants as our
2003 bonds, except that the accounts payable percentage is 20% and
the debt service coverage ratio requirement is 1.5 to 1 through
December 31, 2008, and moves to 2 to 1 beginning with the
quarter ended March 31, 2009. We were not in compliance with the
accounts payable and debt service coverage covenants at
December 31, 2007; however, the debt service coverage covenant
was waived by the bondholder as of December 31, 2007 through,
and including, March 31, 2008, and the accounts payable covenant
was waived by the bondholder as of December 31, 2007 through,
and including, December 31, 2008. F-18




---



##### Table of Contents



Year
    
    Amount2008
    
    $
    9,582,1452009
    
    
    3,383,7232010
    
    
    1,647,8632011
    
    
    1,781,3732012
    
    
    1,825,000Thereafter
    
    
    17,070,000$
    35,290,104
       Note 6: Stockholders Equity
 Preferred Stock
 Series A, B and C
   Series D
         Common Stock
  Warrants
  Class C Warrants
  F-19




---



##### Table of Contents



Class F Warrants
  Class G Warrants
  Class H Warrants
  Class I Warrants
    Class I
    
    
    
    
    
    
    
    
    
    
    Class IWarrants
    
    
    Range of Exercise
    
    
    Proceeds
    
    
    WarrantsExercised
    
    
    Prices
    
    
    Received
    
    
    Expired2005
    
    
    21,142
    
    
    $
    0.5613 to $0.9375
    
    
    $
    16,596
    
    
    
    42,9972004
    
    
    116,249
    
    
    $
    0.31 to $1.125
    
    
    
    79,469
    
    
    
    2002
    
    
    95,107
    
    
    $
    0.31 to $1.125
    
    
    
    62,881
    
    
    
    2001
    
    
    56,727
    
    
    $
    0.31 to $1.125
    
    
    
    34,548
    
    
    
    1999
    
    
    29,367
    
    
    $
    0.9375
    
    
    
    27,532
    
    
    
    42,866
 F-20




---



##### Table of Contents



Series X and Series Y Warrants Issued in Connection with Preferred Stock
  Series X and Series Y Warrants to Placement Agent
  Bonus Warrants
  Consulting and Placement Warrants
  F-21




---



##### Table of Contents



Exercised
    
    ExpiredConsulting
    
    Placement
    
    Consulting
    
    PlacementYear Exercised/Expired
    
    Warrants
    
    Warrants
    
    Warrants
    
    Warrants2005
    
    
    2,016,332
    
    
    
    
    
    
    
    1,379,926
    
    
    
    2004
    
    
    1,573,333
    
    
    
    
    
    
    
    
    
    
    
    2003
    
    
    
    
    
    
    9,400
    
    
    
    
    
    
    
    2002
    
    
    416,667
    
    
    
    195,605
    
    
    
    
    
    
    
    Prior to 2002
    
    
    928,668
    
    
    
    173,890
    
    
    
    
    
    
    
    4,935,000
    
    
    
    378,895
    
    
    
    1,379,926
    
    
    
    
 Extension Warrants
  Series Z Placement Warrants
  Series W Warrants Issued in Connection with Preferred Stock
   Warrants Outstanding
    
    Weighted
    
    
    
    
    
    Warrantsfor Class A
    
    Average
    
    Expiration
    
    ExercisedCommon Stock
    
    Exercise Price
    
    Date
    
    in 2007Class H warrants
    
    
    
    
    
    
    0.47
    
    
    
    02/21/07
    
    
    
    1,771,792Series X warrants
    
    
    
    
    
    
    1.20
    
    
    
    11/10/07
    
    
    
    352,425Series Y warrants
    
    
    
    
    
    
    2.50
    
    
    
    11/10/07
    
    
    
    Series X warrants  placement agent
    
    
    
    
    
    
    1.20
    
    
    
    11/10/07
    
    
    
    156,564Series Y warrants  placement agent
    
    
    
    
    
    
    2.50
    
    
    
    11/10/07
    
    
    
    Series W warrants
    
    
    3,787,880
    
    
    
    1.38
    
    
    
    10/29/12
    
    
    
    Totals
    
    
    3,787,880
    
    
    $
    1.38
    
    
    
    
    
    
    
    2,280,781
 Accounting for Derivative Instruments and Hedging Activities Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Companys Own Stock
 F-22




---



##### Table of Contents



Note 7: Stock Option Plans
      F-23




---



##### Table of Contents



2007
    
    
    2006
    
    
    2005Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceOutstanding, beginning of year
    
    
    2,872,130
    
    
    $
    1.09
    
    
    
    3,688,130
    
    
    $
    1.01
    
    
    
    4,595,230
    
    
    $
    1.06Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercised
    
    
    (1,333,130
    )
    
    
    0.49
    
    
    
    (791,000
    )
    
    
    0.60
    
    
    
    (377,600
    )
    
    
    0.49Forfeited
    
    
    (17,500
    )
    
    
    1.06
    
    
    
    (25,000
    )
    
    
    2.00
    
    
    
    (529,500
    )
    
    
    1.79Outstanding, end of year
    
    
    1,521,500
    
    
    $
    1.59
    
    
    
    2,872,130
    
    
    $
    1.09
    
    
    
    3,688,130
    
    
    $
    1.01Exercisable, end of year
    
    
    1,521,500
    
    
    $
    1.59
    
    
    
    2,872,130
    
    
    $
    1.09
    
    
    
    3,638,130
    
    
    $
    1.01
  Options Outstanding and ExercisableWtd. Avg.
    
    
    Wtd. Avg.Number
    
    
    Remaining
    
    
    ExerciseRange of Exercise Prices
    
    at 12/31/07
    
    
    Contract Life
    
    
    Price$0.86  $0.94
    
    
    224,000
    
    
    2.42 years
    
    $
    0.89$1.10  $1.75
    
    
    790,000
    
    
    3.55 years
    
    
    1.24$2.25  $2.75
    
    
    507,500
    
    
    3.26 years
    
    
    2.451,521,500
    
    
    3.29 years
    
    $
    1.59
  Note 8: Equity Incentive Plans
 2005 Key Associate and Management Equity Incentive Plan
   F-24




---



##### Table of Contents



(a)
    
    Purchase Price.The purchase price of restricted stock awards shall be
determined by the Administrator, and may be stated as cash, property or prior services
performed.(b)
    
    Consideration.The consideration for common stock acquired pursuant to the
restricted stock purchase agreement will be paid either: (i) in cash at the time of
purchase; or (ii) in any other form of legal consideration that may be acceptable to the
Administrator in its discretion including, without limitation, a recourse promissory
note, property or a stock-for-stock exchange or prior services that the Administrator
determines have a value at least equal to the fair market value of such common stock.(c)
    
    Vesting.Shares of common stock acquired under the restricted stock purchase
agreement or awards may, but need not, be subject to a restricted period that specifies
a right of repurchase in favor of the Company in accordance with a vesting schedule to
be determined by the Administrator, or forfeiture in the event the consideration was in
the form of prior services. In general, it is anticipated that, except as the
Administrator may otherwise determine in its discretion, awards will vest (and prior
thereto shall be subject to such a restricted period) over a three-year period, with 20%
of a particular award vesting on the first anniversary thereof, an additional 30% of
such award (50% cumulatively) vesting on the second anniversary of the award, and the
50% balance of the award vesting on the third anniversary of the award.
  2005 Non-Employee Director Equity Incentive Plan
   F-25




---



##### Table of Contents



Restricted Stock
Awards.
 Termination of Participants Continuous Service.
  Note 9: Leases
    F-26




---



##### Table of Contents



Capital


OperatingYear

Leases


Leases2008

$
285,610


$
2,873,5352009


261,330



2,366,4482010


256,161



2,011,7952011


199,303



1,926,4552012


182,695



1,396,834Thereafter






1,762,189Total minimum payments required


1,185,099


$
12,337,255Less amount representing interest


163,954Present value of future minimum lease payments


1,021,145Less current obligations under capital leases


224,840Long-term obligations under capital leases

$
796,305
 Note 10: Income Taxes
 Accounting for Income Taxes
  Year Ended December 31,2007
    
    
    2006
    
    
    2005Current:Federal
    
    $
    
    
    
    $
    14,639
    
    
    $
    80,000State
    
    $
    
    
    
    
    
    
    
    
    105,200$
    
    
    
    
    14,639
    
    
    
    185,200Deferred:Federal
    
    $
    (2,824,724
    )
    
    
    (645,696
    )
    
    
    (4,823,917
    )State
    
    $
    (569,761
    )
    
    
    (204,880
    )
    
    
    189,035(3,394,485
    )
    
    
    (850,576
    )
    
    
    (4,634,882
    )Net income tax benefit
    
    
    (3,394,485
    )
    
    $
    (835,937
    )
    
    $
    (4,449,682
    )
  2007
    
    

2006
    
    

2005Amount
    
    

Percent
    
    

Amount
    
    

Percent
    
    

Amount
    
    

PercentIncome tax at the U.S.
federal statutory rate
    
    $
    (4,389,959
    )
    
    
    (34.0
    )
    
    $
    329,319
    
    
    
    34.0
    
    
    $
    1,138,321
    
    
    
    34.0Net operating loss carryforwards
    
    
    
    
    
    
    
    
    
    
    (25,664
    )
    
    
    (2.6
    )
    
    
    (1,024,489
    )
    
    
    (30.6
    )State income taxes
    
    
    (570,834
    )
    
    
    (4.4
    )
    
    
    
    
    
    
    0.0
    
    
    
    105,200
    
    
    
    3.1Dividends on
preferred stock
    
    
    423,672
    
    
    
    3.3
    
    
    
    
    
    
    
    0.0
    
    
    
    276,000
    
    
    
    8.2Change in
valuation allowance
    
    
    1,486,354
    
    
    
    11.5
    
    
    
    
    
    
    
    0.0
    
    
    
    (4,634,882
    )
    
    
    (138.4
    )Update
estimate for prior year deferred taxes
    
    
    
    )
    
    
    0.0
    
    
    
    (796,907
    )
    
    
    (82.3
    )
    
    
    
    
    
    
    0.0Stock option exercises
    
    
    (251,184
    )
    
    
    (1.9
    )
    
    
    (349,561
    )
    
    
    (36.1
    )
    
    
    
    
    
    
    0.0Other
    
    
    (92,534
    )
    
    
    (0.7
    )
    
    
    6,876
    
    
    
    0.7
    
    
    
    (309,832
    )
    
    
    (9.3
    )$
    (3,394,485
    )
    
    
    (26.3
    )
    
    $
    (835,937
    )
    
    
    (86.3
    )
    
    $
    (4,449,682
    )
    
    
    (133.0
    )
 F-27




---



##### Table of Contents



2007
    
    
    2006
    
    
    2005Current
    
    
    Long-Term
    
    
    Current
    
    
    Long-Term
    
    
    Current
    
    
    Long-TermDeferred tax assets-Net operating loss carryforwards
    
    $
    146,702
    
    
    $
    11,476,946
    
    
    $
    1,394,000
    
    
    $
    6,068,918
    
    
    $
    2,036,962
    
    
    $
    5,193,366Alternative minimum tax credit carryforward
    
    
    
    
    
    
    75,838
    
    
    
    
    
    
    
    70,308
    
    
    
    
    
    
    
    64,000Allowance for sales returns
    
    
    455,700
    
    
    
    
    
    
    
    147,408
    
    
    
    
    
    
    
    
    
    
    
    Accrued expenses
    
    
    12,434
    
    
    
    239,201
    
    
    
    22,145
    
    
    
    239,933
    
    
    
    
    
    
    
    Deferred compensation
    
    
    150,553
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Charitable contribution
    
    
    47,966
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Inventory overhead capitalization
    
    
    107,299
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Valuation allowance
    
    
    (570,809
    )
    
    
    (915,545
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total deferred tax assets
    
    
    349,845
    
    
    
    10,876,440
    
    
    
    1,563,553
    
    
    
    6,379,159
    
    
    
    2,036,962
    
    
    
    5,257,366Deferred tax liability-Depreciation
    
    
    
    
    
    
    2,025,028
    
    
    
    
    
    
    
    2,085,247
    
    
    
    
    
    
    
    2,659,446Prepaid expenses
    
    
    349,845
    
    
    
    
    
    
    
    400,536
    
    
    
    
    
    
    
    
    
    
    
    Total deferred tax liabilities
    
    
    349,845
    
    
    
    2,025,028
    
    
    
    400,536
    
    
    
    2,085,247
    
    
    
    
    
    
    
    2,659,446Net deferred tax
    
    $
    
    
    
    $
    8,851,412
    
    
    $
    1,163,017
    
    
    $
    4,293,912
    
    
    $
    2,036,962
    
    
    $
    2,597,920
   
    
    Future reversals of existing taxable temporary differences
    
    Recent historical utilization of net operating loss carryforwards
    
    The timing and extent of expected net margin increase from
recently implemented and planned changes to operations and projected sales growth
    
    Current and expected future economic conditions
 Note 11: Extraordinary Item
  Note 12: Commitments and Contingencies
 Legal Proceedings
 Lloyds of London
  F-28




---



##### Table of Contents



Advanced Control Solutions
   Class Action Lawsuits
   Energy
Unlimited, Inc. vs. AERT, Inc.
  Other Matters
  Construction Agreement
  Marketing Agreement
  Note 13: 401(k) Plan
  F-29




---



##### Table of Contents



INDEX TO EXHIBITS
 ExhibitNo.
    
    Description of Exhibit3.1
    
    Certificate of Incorporation, including Certificate of Amendment filed on June 12, 1989 (a), and Certificate
of Amendment filed on August 22, 1989 (b), and Certificate of Amendment filed on December 29, 19993.2
    
    Certificate of Designation of Class B common stock. (a)3.3
    
    Bylaws of Registrant. (a)3.4
    
    Form of Class A common stock Certificate. (c)3.5
    
    Certificate of Designation of
Series D Preferred Stock filed October 29, 2007 (i)4.2.1
    
    Form of Class B common stock Certificate. (a)10.1
    
    Form of Right of Refusal Agreement among Class B common stockholders. (a)10.2
    
    Amended and Restated Stock Option
Plan. (d)




---



##### Table of Contents



ExhibitNo.
    
    Description of Exhibit10.3
    
    Non-Employee Director Stock Option Plan. (d)10.4
    
    Chairman Stock Option Plan. (d)10.5
    
    2005 Key Associate and Management
Equity Incentive Plan (l)10.6
    
    2005 Non-Employee Director Equity
Incentive Plan (l)10.7
    
    Indenture of Trust between City of Springdale and Regions Bank, Trustee, as of October 1, 2003. (n)10.8
    
    Mortgage and Loan Agreement between City of Springdale and Company, as of October 1, 2003.(n)10.9
    
    Assignment of Mortgage and Loan Agreement between City of Springdale and Regions Bank. (n)10.10
    
    Note Purchase Agreement between Company and Allstate Insurance Company dated October 9, 2003. (n)10.11
    
    Promissory Note made by Company dated October 9, 2003. (n)10.12
    
    Wood-Plastic Composite Decking Agreement between AERT and Weyerhaeuser Company, et al.
effective October 12, 2004.* (Redacted in accordance with confidential treatment request, as
filed October 15, 2005) (q)10.13
    
    Loan Agreement. (r)10.14
    
    Promissory Note. (r)10.15
    
    Loan Agreement. (s)10.16
    
    Promissory Note. (s)10.17
    
    Series D Convertible Preferred
Stock Purchase Agreement dated October 29, 2007 (i)10.17
    
    Form of Warrants to Purchase Common Stock issued October 29, 2007 (i)10.17
    
    Registration Rights Agreement (i)10.18
    
    Loan Agreement dated
December 19, 2007 related to Series 2007 8% Bonds. (j)10.18
    
    Indenture of Trust dated
December 19, 2007 related to Series 2007 8% bonds. (j)10.19
    
    Indenture of Trust between City of
Springdale, Arkansas, and Bank of Oklahoma, N.A., Trustee, relating
to the issuance of $10,610,000 City of Springdale, Arkansas
Industrial Development Refunding Revenue Bonds (Advanced
Environmental Recycling Technologies, Inc. Project) Series 2008;
dated as of February 1, 2008. (k)10.19
    
    Loan Agreement between City of
Springdale, Arkansas, and Advanced Environmental Recycling
Technologies, Inc., related to $10,610,000 City of Springdale, Arkansas
Industrial Development Refunding Revenue Bonds (Advanced
Environmental Recycling Technologies, Inc. Project) Series 2008;
dated as of February 1, 2008. (k)23.1
    
    Consent of Independent Registered Public Accounting Firm. ***31.1
    
    Certification per Sarbanes-Oxley Act of 2002 (Section 302) by the Companys chairman, chief executive
officer and president.***31.2
    
    Certification per Sarbanes-Oxley Act of 2002 (Section 302) by the Companys
chief financial officer.***32.1
    
    Certification per Sarbanes-Oxley Act of 2002 (Section 906) by the Companys chairman, chief executive
officer and president.***32.2
    
    Certification per Sarbanes-Oxley Act of 2002 (Section 906) by the Companys chief financial officer.***
 
 *
    
    Confidential treatment was granted by the Securities and Exchange
Commission for certain portions of this agreement. The confidential
portions were filed separately with the Commission.The Registrant has no exhibits corresponding to Exhibits 1, 2, 5, 6, 7, 8, 9, 11, through 23,
or 26 through 29.***
    
    Filed herewith.(a)
    
    Contained in Exhibits to Registration Statement on Form S-1, No. 33-29595, filed June 28, 1989.(b)
    
    Contained in Exhibits to Amendment No. 1 to Registration Statement on Form S-1, No. 33-29595,
filed August




---



##### Table of Contents



24, 1989.(c)
    
    Contained in Exhibits to Amendment No. 2 to Registration Statement on Form S-1, No. 33-29595,
filed
November 8, 1989.(d)
    
    Filed with Form 10-K for December 31, 1994.(e)
    
    Filed with Form 10-Q for September 30, 2003.(f)
    
    Filed with Form 10-Q/A for September 30, 2004.(g)
    
    Filed with Form 10-Q for September 30, 2005.(h)
    
    Filed with Form 10-Q for September 30, 2006.(i)
    
    Contained in exhibits to Form 8-K filed November 1,
2007.(j)
    
    Contained in exhibits to Form 8-K filed December 21,
2007.(k)
    
    Contained in exhibits to Form 8-K filed February 29,
2008.(l)
    
    Contained in exhibits to DEFR14A  filed July 11,
2005.