<PAGE>   1

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------

                                   FORM 10-K
                            ------------------------

              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

                      FOR THE YEAR ENDED DECEMBER 31, 2000

                         COMMISSION FILE NUMBER 1-10367

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

<TABLE>
<S>                                            <C>
                   DELAWARE                                      71-0675758
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)

           914 N. JEFFERSON STREET                                 72764
                P.O. BOX 1237                                      72765
             SPRINGDALE, ARKANSAS                                (ZIP CODE)
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
</TABLE>

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (501) 756-7400

        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                             CLASS A COMMON STOCK,
                                 $.01 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 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 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.  Yes [X]  No [ ]

     Number of shares of the common stock outstanding at December 31, 2000:
                             CLASS A -- 25,755,321
                              CLASS B -- 1,465,530

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>   2

                                     PART I

ITEM 1. BUSINESS

THE COMPANY

     Advanced Environmental Recycling Technologies, Inc. (AERT or the Company)
develops, manufactures and markets composite building materials that can be used
as an alternative to traditional wood products for exterior applications in
building and remodeling homes. We use waste wood fiber and reclaimed
polyethylene plastics as our raw materials. Our products are comprised of
approximately equal amounts of wood and plastic, have been extensively tested
and are used by several leading national companies, such as the Weyerhaeuser
Company and Therma-Tru. Our products are marketed under the tradenames
LifeCycle(R), MoistureShield(R), ChoiceDek(R) Classic and ChoiceDek(R) Plus. Our
decking distribution is with Weyerhaeuser Building Materials Distribution (BMD).
We have recently introduced an exterior trim system under the tradename
MoistureShield(R) CornerLoc(TM).

     Our sales are primarily in the following markets:

     - exterior door, window and housing trim components,

     - commercial and residential decking surface components and accessories
       such as handrails, and

     - heavy industrial flooring.

     We currently operate two manufacturing and recycling facilities. Our
Junction, Texas facility currently manufactures primarily decking components,
ChoiceDek(R) Classic on three extruder lines. Our door, window and housing trim
components are manufactured at our Springdale, Arkansas facility, along with our
LifeCycle(R) and ChoiceDek(R) Plus line of decking products, and all of our
heavy industrial flooring. We now have three extruder lines and a plastic
facility in operation at our Springdale location. The initial construction at
this manufacturing facility was completed during the third quarter ended
September 30, 2000, with the third extrusion line becoming operational in July
2000. We have focused on improving our manufacturing efficiencies and reducing
our manufacturing costs with the start-up of the third Springdale line. Two of
the existing extrusion lines can be further upsized and/or a fourth composite
extrusion line may be added at the Springdale manufacturing facility once demand
exceeds the current capacity. This extrusion line can be installed in
approximately three months. A second plastic recycling facility and a third
composite extrusion facility is planned for Springdale once we become
consistently profitable and the bond financing funds become available (see Bond
Financing and Escrow Section).

     Because of their plastic content, our composites exhibit the following
attributes:

     - They are engineered for superior moisture-resistance and will not swell
       or expand like wood.

     - They do not require preservative or chemical treatments utilizing toxic
       chemicals such as chromated copper arsenic (CCA), like traditional wood.

     - They do not require yearly water sealing or staining, like traditional
       wood when used as a deck surface.

     - They can be designed and extruded through dies to a desired shape in
       accordance with customer specifications, minimizing waste.

     - They are less subject to rotting, cracking, warping, splintering, insect
       infestation and water absorption than conventional wood materials.

     - When combined with our unique tie coat primer, the life of exterior paint
       can be greatly enhanced thus creating a low-maintenance non-wood trim and
       fascia system designed to enhance and complement fiber cement siding.

     Because of their wood fiber content, our composites are less subject to
thermal contraction or expansion and display greater dimensional stability than
conventional plastic materials. Our manufactured products maintain many
properties similar to traditional wood materials.

                                        1
<PAGE>   3

     Our composites manufacturing process involves proprietary and patented
technologies and specialized manufacturing equipment, custom-built or modified
for us. The process uses plentiful, lower cost, raw materials, such as recycled
plastics and wood-filler materials and, in certain cases, special additives or
virgin plastics in varying mixtures. The mixtures can be specifically formulated
based on our customers' desired end product specifications. The encapsulation of
wood fibers in plastic creates a consistent material, free of foreign matter,
which can be extruded into a desired shape. Our composite building material
became a patented product in June 1998 (U.S. Patent No. 5,759,680).

     AERT has increased net sales from $12,408,591 in 1998 to $19,917,133 in
1999 and to $27,508,864 in 2000, and has sold in excess of $86 million of
composite building materials since inception. The Company has proven products
today in several million homes in the United States. Proceeds from $16.5 million
in tax-exempt bonds currently in escrow are intended to both refinance completed
construction projects which are now into commercial production, as well as
further increase the manufacturing capacity in Springdale, Arkansas. It is our
intent to convert short-term debt into long-term debt during 2001 for costs
incurred to complete the Springdale plant, subject to the Company meeting
certain requirements described in the Bond Financing and Escrow and Liquidity
and Capital Resources Sections.

BACKGROUND AND HISTORY

     Principals of the Company have been involved in plastic recycling since
1985 and began working on developing processes for re-utilizing and recycling
wood and certain compatible waste plastics in 1987. AERT was founded in 1988, by
the Brooks family and associates of Springdale, Arkansas. Since inception, the
Company has developed, patented, and commercialized several new technologies and
products, which significantly advance state-of-the-art reclamation of
polyethylene plastic scrap and related manufacturing processes. Polyethylene
plastic is the largest segment of the plastic waste stream and is used primarily
for packaging in items ranging from milk carton and frozen food linings to
grocery bags.

     The Company utilizes its proprietary and patented technologies to produce
an innovative and growing line of moisture-resistant and dimensionally stable
engineered composite building materials. The composite materials are hard,
dense, short-grained substances with a dark, speckled surface appearance
depending on the wood fiber. They are manufactured utilizing primarily recycled
polyethylene plastics (both low and high density) and waste wood fibers. A key
advantage of the Company's process is the ability to utilize plentiful, low-cost
raw material components, encapsulate the wood fibers in the plastic and create a
consistent material, free of foreign matter, which can be extruded and/or
machined into a desired shape, while the end product maintains many properties
similar to traditional wood materials. In addition, the Company has developed a
unique tie coat primer which allows for additional aesthetic painted
applications, such as windowsills or exterior trim for the Company's products.

     The Company's initial penetrations into the national building and
construction markets were focused on value added components such as door rails,
door subsills, windowsills and other exterior moisture stress areas. These are
the major problem areas that manufacturers have because of rotting, swelling and
warping with wood applications. Therefore, AERT initially targeted this market
segment to maximize the value of its product line, in addition to addressing a
well-defined need in the marketplace for a wood component replacement that does
not absorb moisture, swell or rot. Currently, these materials are primarily
targeted at the national door and window component market, the
industrial-flooring market, and the residential decking market under the trade
names LifeCycle(R), MoistureShield(R), ChoiceDek(R) Classic and ChoiceDek(R)
Plus. We recently introduced an exterior trim product using the tradename
MoistureShield(R) CornerLoc(TM).

COMPOSITE MANUFACTURING

     The initial composite extrusion production commenced in 1989 at the
Company's Junction, Texas facility. In August 1993, a fire severely damaged the
Junction, Texas composite facility, destroying the raw materials handling and
processing area and one of the two extrusion production lines. Clean up and
reconstruction began immediately and within two weeks, one production line was
operating on a limited basis. As part of the rebuilding, an in-house wood dryer
was incorporated into the raw materials processing area and

                                        2
<PAGE>   4

improvements were made to production lines such that both lines operated more
efficiently than before the fire occurred. The reconstruction of the plant was
completed in August 1994 with restored and improved production capability. In
December 1995, the Company exchanged certain equipment, which was previously
used for plastic sales to third parties at its Rogers, Arkansas plant, for
equipment required to complete a third extrusion line at the Junction, Texas
plant. The third line was installed during the first half of 1996 and commenced
full production in mid 1996, increasing the Company's extrusion capacity.

     The Company initiated sales of its LifeCycle(R) decking components early in
1993, however, the fire at the composite facility severely limited production,
and the decking project was delayed as the plant was rebuilt. In May 1995, the
Company entered into an exclusive marketing and distribution agreement with a
division of Weyerhaeuser, a large forest products company, for sales of its
LifeCycle(R) line of extruded decking components, which are primarily targeted
towards the high-end residential housing market. Weyerhaeuser has marketed this
product under the trade name ChoiceDek(R) through their distribution centers
located throughout the United States. In 2000, they also began introducing
ChoiceDek(R) into their Canadian distribution centers.

     In 2000, gross decking sales increased to $20.2 million from $10.4 million
in 1999 and $4.3 million in 1998. Since our inception in 1988 to December 31,
2000, we have generated net sales of over $86 million, primarily into the U.S.
residential homebuilding market. We believe significant customer demand exists
for substantially higher sales. The Company is now in position with increasing
production and improved efficiencies to aggressively market its products and is
working to increase retail distribution and further increase sales.

THE PLASTICS RECLAMATION UNIT

     The Plastics Reclamation Unit was originally located in Rogers, Arkansas
and was initially established to develop and commercialize plastic recycling
technology primarily to serve as a dependable, cost-effective source of plastic
raw materials for the Composite Manufacturing Unit. The Company began activities
at its Plastics Reclamation Unit in 1990. Since that time, the Company has
further developed and patented its proprietary waste plastics reclamation
technologies which allows it to recover waste plastics from the by-product of
paper recycling mills, as well as certain waste plastic from post-consumer or
industrial plastic films. Secondary fiber recovery mills recycle paper and
polyethylene-coated paperboard to recover the paper fiber through a process
known as hydropulping. The by-product of the hydropulping process is a
water-saturated mixture of polyethylene and unrecovered paper fiber, which most
such mills currently dispose of without further processing. Using certain
plastics recycling technologies, which such paper recycling companies do not
generally have available, the Company has been able to economically recover
polyethylene suitable for use in its composite manufacturing process at prices
below that of virgin plastic.

     In 1991, while continuing to develop its initial plastic recycling
technology, the Company entered into a technology development agreement with The
Dow Chemical Company for the purpose of further developing and commercializing
the Company's plastic reclamation technology for additional applications of
polyethylene films. Dow Chemical was the world's largest producer of
polyethylene plastic and the Company received an initial 10 million pounds
market development order from Dow in 1992 for recycled plastic. However, in 1994
when federal recycling legislation and market development waned for recycled
plastic, that order was restructured allowing the Company to significantly
reduce indebtedness. Pursuant to the restructuring, Dow forgave approximately
$879,000 in debt from the Company in lieu of purchasing the remaining portion of
the recycled plastic. Following the restructuring and completion of the Dow
contract, the Company began utilizing production capacity not required for
processing raw materials for the Composites Manufacturing Unit to produce other
types of materials for sale to manufacturers of grocery bags, trash bags, and
other manufacturers of plastic goods desiring recycled content in their
products.

     Through 1995, the Company's plastic reclamation facility was also involved
in sales of recycled plastics to third party film manufacturers. The materials
desired by these customers required substantial processing beyond that necessary
to produce raw materials for the composites facility, and sufficient
efficiencies of scale and market demands were never attained. Mandatory federal
plastic recycling content legislation also died in

                                        3
<PAGE>   5

1995 and failed to be enacted. These issues, combined with increased sales of
the Company's composite products and the composites division's increased
raw-material requirements, prompted the Company, in the first quarter of 1996,
to discontinue reclamation of plastics for sale to third-parties and dedicate
all of the plastic facility's production to providing materials to its Junction
composites operation. In connection with this restructuring of the plastics
reclamation plant, the Company exchanged certain equipment, previously utilized
to produce plastics for sale to third-parties, for other equipment which was
utilized to process raw-materials and for additional equipment necessary to
complete the installation of a third production line at the Company's composite
facility.

     The Company experienced a series of extensive fires that caused substantial
damage during the last half of 1996 at its Rogers, Arkansas plastic reclamation
facility. These fires in September and December of 1996 set back the Company's
plastic reclamation program and the resulting supply disruption of plastic raw
materials limited composite sales growth. The claim regarding the September fire
was settled in late 1996 for approximately $379,000, and the Rogers plastic
reclamation operation recommenced in late November. In December 1996, the
undamaged portion of the Rogers facility then suffered a second major fire, and
the manufacturing portion experienced extensive damage, causing the facility to
be closed. Both fires were deemed incendiary by independent investigators. The
Company's rebuilding efforts were delayed for most of the first half of 1997 due
to the ongoing fire investigation and insurance settlement delays. The December
fire claim was finally settled in June 1997 for $1.9 million. The Company began
relocating and reestablishing its internal plastic recycling capacity at the
facility in Springdale, Arkansas in late 1997. This project was later completed
in 1999.

     The pattern of continued fires caused the Company's fire insurance to be
cancelled. The Company was able to renew its fire insurance, but at a
substantially higher rate. The Company has increased security and added armed
guards at its facilities. Following the fires, the Company experienced
competition for several of its plastic polywaste sources. Another major fire or
similar disruption could materially adversely affect the Company, and could
cause it to lose its ongoing supply sources from plastic waste generators that
might switch to competitors rather than wait on the Company to again rebuild its
recycling facilities.

PRODUCT TESTING AND FIELD HISTORY

     The Company has completed extensive testing of its products, developed
substantial positive-field history since inception in 1988, and continues to add
original equipment manufacturers (OEM) accounts in the door and window market
for components parts. The Company also works closely and has developed strong
relationships with its customers' research and development departments, which
has allowed the Company to compete against higher-end plastic, wood and
engineered combinations and component systems and avoid from commodity pricing.
Also, AERT set up a millwork and fabrication division and began manufacturing
and selling finished products as component parts to customer specifications.
These customer relationships have also provided the Company access to extensive
experience in long-term 25-year testing, or accelerated aging of materials under
extreme external environmental conditions. An example of this testing was the
Company having to bury its products into termite mounds in Hawaii for 9.5
months. The Company has completed extensive third party independent testing of
its products. The Company is in the final stages of receiving BOCA approval for
its decking products (see Industry Standards Section).

     The Company's rot-proof, moisture-resistant component parts are now in
several million homes and market share is increasing rapidly. We continue to
sell to several OEM's such as Therma-Tru, Carolina Builders, Peachtree and
numerous small and regional shop-built window manufacturers. With the pending
addition of several large customers and Weyerhaeuser increasing demand for
decking, the Company has strong composite sales demand in place. In addition, we
have developed and introduced a new exterior trim and fascia system under the
trademark of MoistureShield(R) CornerLoc(TM).

PATENTED AND PROPRIETARY TECHNOLOGY

     The Company's composite manufacturing process and its development efforts
in connection with waste plastics reclamation technologies involve patents and
many trade secrets which are considered proprietary by

                                        4
<PAGE>   6

the Company, as well as certain methods, processes and equipment designs for
which the Company has sought additional patent protection. The Company has taken
measures that are designed to safeguard its trade secrets by, among other
things, entering into confidentiality and nondisclosure agreements, and
restricting access to its facilities. The Company has also recently installed
advanced security systems at both facilities, including cameras.

     The Company has filed nineteen patent applications and has received
issuance from the United States Patent and Trademark Office for fifteen patents,
six of which relate to the Company's composite materials manufacturing
operations and product, and nine of which relate to its waste plastics
reclamation technologies. The patents issued relate to the Company's composite
product, extrusion process and apparatus, its continuous down stream cooling and
forming conveyor system and its plastic reclamation process and equipment. The
Company received formal issuance of its fourteenth patent in June 1998 and their
fifteenth patent in November of 2000. Should the Company's trade secrets be
disclosed notwithstanding these efforts, the business and prospects of the
Company could be materially and adversely affected.

     The Company was sued in Delaware, in June 1992, by Mobil Oil Corporation
seeking a declaratory judgement that four recently issued composite product
patents were invalid and unenforceable. This was after several members of the
Mobil Composite Products staff toured the AERT Junction, Texas facility in 1991
and signed confidentiality agreements. In February 1994, in litigation with
Mobil Oil Corporation, a Delaware jury returned a verdict that four AERT patents
on its composite product technology were invalid (see Item 3. Legal
Proceedings). Two patents were later restored upon appeal in 1995. There can be
no assurance such additional patents will be allowed, or if allowed that they
will not be challenged and invalidated. The cost of patent protection, and in
particular, patent litigation is extremely high. It can also strain resources
and inhibit growth. AERT intends to take other steps reasonably necessary in the
future to protect its existing technology and any technology that may be
subsequently developed. The Company may license its technologies to industrial
users in the future, and or enter into joint ventures, if licensing terms can be
agreed upon and if the Company believes it can preserve adequate demand for its
own products.

BUSINESS

     Advanced Environmental Recycling Technologies, Inc. is currently comprised
of three separate, yet interrelated manufacturing facilities; the Composites
Manufacturing Units are located in Junction, Texas and Springdale, Arkansas,
which manufacture and market moisture resistant composite building materials
made from waste plastics and by-product wood fibers, and the Plastics
Reclamation Unit located in Springdale, Arkansas, which processes waste
plastics, producing various polyethylene materials that are used as feedstock in
the composite manufacturing process. A second plastic recycling and storage
facility warehouse has been leased and additional plastic grinding and
processing functions will also commence during the third quarter of 2001.

     The Company employs a four-part business strategy: (1) it utilizes low-cost
waste products and internally-produced products as raw materials; (2) it
configures its production facilities so that it can economically manufacture a
broad range of products on the same equipment in short production runs; (3) it
maintains a high level of technical and product support for its customers and
places a major emphasis on quality control and consistency in regard to its
products; and (4) its marketing program identifies and sells to niche markets
with defined needs in which the Company believes it can be prominent or
dominant.

     The Company completed the expansion of its manufacturing capabilities at
its composite manufacturing and millwork facility in Springdale, Arkansas in the
third quarter ended September 30, 2000. The third extrusion line for the
Springdale facility became operational in July 2000. The Company has continued
to streamline and increase its manufacturing efficiencies since that time. Due
to continued and increasing customer demands, a third extrusion facility is
planned on the recently acquired 18.6 acres that adjoin the current Springdale
facility. This construction for this facility will begin with the breaking of
the $16.5 million in bond proceeds from escrow. The additional production
capacity is designed to increase annualized sales to $70 million-plus per year
over the ensuing 18-month period (see Bond Financing and Escrow Section).

                                        5
<PAGE>   7

     The Company's Composites Manufacturing Unit located in Junction, Texas
markets its moisture-resistant composite building materials under the trade name
ChoiceDek(R) Classic. The Composites Manufacturing Unit located in Springdale,
Arkansas markets MoistureShield(R), ChoiceDek(R) Plus and its newest product
line, MoistureShield(R) CornerLoc(TM). The Composite Manufacturing Units are
comprised of wood fiber and plastic raw material processing departments,
composite extrusion departments, and millwork and fabrication departments. The
Springdale facility also has a priming and paint department. The raw material
processing departments consist of wood fiber and plastic cleaning, drying,
grinding and storage equipment; the extrusion departments currently consist of
six extrusion and downstream production lines. The millwork departments
currently consist of five moulding and end-work lines.

     The Company's main focus is utilizing the Plastics Reclamation Unit as a
source of supply for the Composites Manufacturing Unit. Therefore, as sales of
the Company's composite products increase, the composites division's raw
materials requirements will increase and additional supplies of recycled
plastics will be required.

     The Company currently is expanding its existing plastic recycling capacity
in Springdale, Arkansas with the recent leasing of an additional warehouse. We
have acquired and/or leased additional equipment and are starting to install
additional plastic recycling equipment for a second plastic processing function.
We believe this will help reduce a portion of our raw material costs by
processing more plastic internally. In addition, a third larger plastic
recycling plant is planned when the funds from the bond money being held in
escrow are released.

SUPPLY AND PRICING OF RAW MATERIALS

     The Company's composites are currently manufactured from cedar and hardwood
fiber, polyethylene industrial and post-consumer film scrap and ground
industrial and post-consumer high-density polyethylene containers, as well as
other sources of consistent polyethylene waste products. The Arkansas facility
utilizes hardwood fibers as its wood source. AERT has entered into supply
agreements for the cedar fiber and a portion of the waste plastics used in its
composite manufacturing process. It is the Company's intention to enter into
additional supply agreements in the future. The Company currently purchases raw
materials from sources that it believes are dependable and adequate for its
short-term manufacturing requirements, and the Company believes suitable
alternative sources are available. However, the Company during the fourth
quarter of 2000, experienced significant cedar fiber disruptions which limited
production and had a negative impact on Texas operations. The Company currently
has several long-term supply agreements with companies that generate waste
polyethylene at different manufacturing plants. Additional raw material supply
sources of both plastic and wood fiber will be required for the Company to
continue to increase composite production and sales. The Company is also looking
to increase its growth with products that are not manufactured with cedar fiber.
The Company is currently working to enter formal supply agreements for both
additional plastic and fiber supplies. The Company is experiencing increased
competition for waste plastics and raw material prices are increasing. To
partially offset increased raw material costs, the Company is working to
increase the efficiencies of its recycling facilities along with increasing the
amount of raw materials processed internally. A significant disruption of supply
arrangements and/or significant increases in raw material prices could have a
materially adverse effect on AERT's operations.

     Cedar Fiber. The Junction, Texas composite facility is located near four
cedar mills, which extract cedar oil for perfumes and industrial detergents and
dispose of the cedar fiber as a by-product of their operations. It is also sold
by said mills in some instances as a horse-stable bedding or a drilling mud
bridging agent. With the increase in natural gas prices, competition for cedar
fiber has increased. The Company, in the past, has purchased the entire wood
fiber required for its manufacturing purposes from these mills. As the Company's
ChoiceDek(R) Classic product line continues to grow, additional cedar fiber will
be required, of which there is no commitment at this time. Although the Company
believes it has access to sufficient supplies of cedar fiber to supply its
current customer requirements from Texas, the Company has manufactured its
composite material with other types of wood fibers, primarily hardwood. The
Company began a testing program with hardwood waste for a line of hardwood
decking in Texas and believes that a number of substitute wood fibers

                                        6
<PAGE>   8

could be satisfactorily used in its manufacturing process and that other sources
than cedar are currently available.

     Hardwood Fiber. The Springdale facility is located in the Ozark Mountain
area with numerous hardwood mills and manufacturers. The Company has currently
established a minimum of two hardwood suppliers for the Springdale facility. The
Company has not experienced any limitations with regard to hardwood supplies.

     Recycled Plastics. The cost of recycled waste plastics for use in the
composites manufacturing process has been subject to significant market and
quality fluctuations over the past several years and the Company has experienced
supply problems associated with contaminated plastics in the past. In an effort
to reduce its exposure to price volatility, inconsistent quality, and potential
supply disruptions, the Company in 1990 developed its own patented plastic
recycling technologies and established the waste Plastics Reclamation Unit in
Rogers, Arkansas to assure itself of a cleaner, more dependable, and consistent
supply of plastic raw material for its composite manufacturing operations. The
Company currently performs its Low-Density Polyethylene (LDPE) processing
function at its facility in Springdale, Arkansas, as well as with three outside
independent contractors who process plastic for the Company. The Company has
also recently established several additional plastic supply sourcing
relationships in order to broaden its sources of supply. The Company has
recently acquired and/or leased equipment and is preparing to add additional
in-house plastic grinding and processing capacity. We believe this will help us
lower a portion of our raw material costs when completed. We expect this
additional plastic processing to come on-line during the third quarter 2001.

     The Company's plastics manufacturing processes primarily focus on recycling
the following polyethylene films for use in the composites manufacturing
process:

     - LDPE poly coatings or linings from recycled bleached food-board, which
       are generated from the hydropulping 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; and

     - LLDPE stretch film from warehouses and packing waste.

     These films are highly contaminated with paper and other non-plastic
materials, which makes them less desirable for traditional plastic uses, and
thus lessens their value to producers of recycled plastics. However, plastic
used for the Company's composites manufacturing units does not require the
purity, extensive cleaning, additional washing and melt filtration associated
with conventional plastics, and can be processed faster and more economically.
Further, the contaminated plastics are acquired by the Company at minimal costs,
primarily only handling and freight charges. By focusing on contaminated
plastics, the Company is able to process these materials through its Plastics
Reclamation Unit and produce an acceptable lower-cost feedstock for the
composite facilities. The Company believes that it has adequate and reliable
sources of LDPE hydropulp, additional industrial LDPE and HDPE sources and
HDPE/LLDPE mixed plastic grocery bags for the near future; however, with
increased competition, the Company is experiencing raw material price increases
in regard to scrap polyethylene. The Company also from time to time purchases
plastic, if available at reasonable costs and quality, from outside sources,
such as brokers or other plastic recyclers, to supplement the above-described
sources.

MARKETING AND SALES

     The Company directed its initial marketing activities to specialized market
segments in the building industry in which cost and physical characteristics
place AERT's composite products, such as the subsurface component pieces of
standard door and window products, at a competitive advantage over alternative
conventional materials. Also, the current weaknesses of composites (for example,
certain of its initial strength and aesthetic characteristics) were not critical
disadvantages in these market segments. The Company has targeted its composite
products into defined needs in the marketplace, primarily external areas where
wood

                                        7
<PAGE>   9

rots and/or requires substantial yearly maintenance such as staining or water
sealing. The Company also markets a growing line of primed and painted window
and exterior trim parts that substitute for wood and wood clad components. The
Company has developed an extensive customer base in the national door and window
market and with Weyerhaeuser BMD, primarily through members of management, and
strives to maintain strong customer relationships.

     To the extent a prospective customer currently uses wood for component
pieces, the Company emphasizes the "value-added" potential of its
MoistureShield(R) composite product, which, unlike competing wood products, can
be engineered to incorporate certain desired end-product characteristics. The
Company also calls the prospective customer's attention to the savings in time
and expense that can be achieved by designing into the equipment used in the
extrusion process much of the millwork required in the customer's finished
product. Also using our composite components, the customers will avoid the need
for chemical treatments to their final product, which is often necessary to be
added to wood products to avoid rot and sustain durability. Our
MoistureShield(R) composite components have the additional durability and
performance which allow our customers to extend the lifetime or warranties of
their products.

     MoistureShield(R) composites have been marketed primarily to companies that
manufacture products for use by the construction industry in new home
construction and home improvement work. The construction industry is subject to
significant fluctuations in activity and periodic downturns caused by general
economic conditions. Reductions in construction activity could have an adverse
effect on the demand for AERT composites; however, the Company believes that its
market diversification program will reduce the effects that fluctuations in
construction activity would have on the Company. The Company focuses heavily on
products for the home improvement market, which often tends to increase in
activity when housing starts decline, and the Company is further expanding its
marketing focus and increasing its decking distribution with its ChoiceDek(R)
Classic and ChoiceDek(R) Plus and other decking products through Weyerhaeuser to
accommodate a wider range of applications in order to avoid total dependence on
one industry.

     The Company intends to further increase distribution and expand into
additional markets during 2001, while continuing to increase sales in its
initial decking markets. Weyerhaeuser markets ChoiceDek(R) Classic and
ChoiceDek(R) Plus primarily through independent contractor oriented lumber
dealers, although increased distribution is planned into the home improvement
segments. ChoiceDek(R) Classic, ChoiceDek(R) Plus and other decking products
such as LifeCycle(R) will be increasingly promoted through displays at regional
and local home, lawn and garden shows as well as store demonstration displays
and marketed on a web site on the Internet (www.choicedek.com). The Internet
site targets high-end contractors and architects. For more information, email
sales@choicedek.com. The Company also has print and cable TV advertising
targeted towards the residential decking market, and will begin marketing into
home improvement warehouses during 2001. The Company recently introduced an
exterior trim product using the trademark MoistureShield(R) CornerLoc(TM).

     The Company currently maintains a concentrated customer base. The Company
is unable to predict the future size of the markets for its composite building
products; however, the Company believes that the national door and window,
commercial and residential trim and residential decking material markets are
significant. The Company believes that it can further penetrate these markets
and/or increase sales to its existing customer base if the Company's goals for
increased production capacity and efficiency are achieved. By focusing its
marketing strategy on a limited number of large door and window companies with
large and increasing product requirements, and by sales of decking products
through the Weyerhaeuser marketing and distribution agreement, the Company
believes it can continue to increase market penetration and sales of its
products. With additional production capacity on-line, the Company can now move
towards national market distribution of decking and other value added products,
and has implemented additional marketing and sales personnel into regional
areas. The sales personnel are focused on increasing and sustaining higher
demand for decking and other trim products. To a lesser extent, the Company's
marketing focus also utilizes outside commissioned sales representatives for a
portion of its door, window and decking customers.

     In conjunction with expanding its decking towards nationwide distribution
and providing increased customer service, the Company began expanding its sales
group during late 1999. During the first quarter of

                                        8
<PAGE>   10

2001, the Company added a new Vice President of Sales and Marketing, Jim Precht,
who has 32-years of experience. The Company over the last year has transferred
its sales and customer service functions to the corporate office in Springdale.
With the recent introduction of MoistureShield(R) CornerLoc(TM) trim and fascia,
along with the decking products moving into Canada and also into approximately
500 home improvement warehouse stores, along with continued emphasis on the
contractor/segment dealer; it is our intent to expand and improve our sales and
customer service group and related functions. Mr. Precht is working to upgrade
our marketing and sales group, in conjunction with improving the sales focus of
the Weyerhaeuser customer service and/or distribution centers, in order to
handle substantially increased sales. Initially, this is a one-year effort
jointly sponsored by Weyerhaeuser.

REDUCTIONS IN CONSTRUCTION ACTIVITY; INTEREST RATE SENSITIVITY

     AERT composites are presently marketed primarily to companies that
manufacture products for use by the construction industry in new home
construction and home improvement work. The construction industry is subject to
significant fluctuations in activity and to periodic downturns caused by general
economic conditions. Increased interest rates can lead to reduced homebuilding
activity. Reductions in construction activity could have an adverse effect on
the demand for AERT composites. The Company, therefore, places a major emphasis
on components for customers in the home improvement market. However, the Company
has recently expanded its marketing focus to accommodate a wider range of
products and applications, and is continuing to significantly increase market
distribution during 2001.

INDUSTRY STANDARDS

     The American Society for Testing Materials (ASTM) and certain industry
trade organizations have established general standards and methods for measuring
the characteristics of specific building materials. Users of building materials
(and frequently, issuers of building codes) generally specify that the building
materials comply with such standards relative to the proposed applications. In
regard to decking, many areas require independent testing of specific test
criteria in order to qualify for building code approval. The Company has
generated a substantial amount of independent test data regarding its products
and has developed an extensive field history in conjunction with positive
customer satisfaction for its components through its large OEM customers. The
Company has submitted its decking products to extensive independent testing by
certified laboratories and has made its test data available to the users,
allowing them to determine suitability for the application.

     The Company has finalized such initial independent testing and submitted it
to the National Evaluation Service, in order to receive a formal rating from
Building Officials and Code Administrators International, Inc. (BOCA), for its
decking products. The lack of such a standard (and the independent assurance of
extensive testing, quality control and performance capability, which compliance
with accepted standards typically provides) may limit the market potential of
the Company's decking materials in certain areas and make potential purchasers
of such building materials reluctant to use them until independent certification
is granted by a universally recognized approval agency. The Company believes it
is in the final stages of receiving BOCA approval for its decking products as
extensive review has been completed by the agency. The Company believes that
receiving a BOCA listing will help further increase sales and market acceptance
of its decking products.

COMPETITION

     In seeking to identify MoistureShield(R), ChoiceDek(R) Classic and
ChoiceDek(R) Plus composites as alternative building materials to high grade
western pine and other woods, aluminum, high-performance plastics and other
construction materials, the Company competes with major forestry product
companies, aluminum fabricating companies, and major plastic and petrochemical
companies. The conventional material manufacturers with which the Company must
compete have, in many cases, long-established ties to the building and
construction industry and have proven well-accepted products.

                                        9
<PAGE>   11

     Many large competitors also have research and development budgets,
marketing staffs and financial and other resources, which far surpass the
resources of the Company. There can be no assurance that such competitors will
not attempt to develop and introduce similar recycled composite materials. The
Company must also compete in the building materials market with certain other
plastics recyclers currently manufacturing recycled materials intended for
similar building material applications, including decking and fencing. Mobil Oil
Corporation entered the market in 1992, after purchasing the assets and
technology of a company called Rivenite. Mobil formed a composite products
division, opened a plant, and introduced a decking and fencing product called
Timbrex; which was later renamed Trex(R). Mobil initiated a large national
marketing and advertising program aimed at attaining significant distribution in
the decking market. Mobil divested this division in 1996 to a group of Trex
managers who named the new company The Trex Co., LLC. In April 1999, it became
Trex Company, Inc., and began trading on the New York Stock Exchange. Trex(R)
has continued to advertise heavily and generated composite decking sales in
excess of $117 million during 2000. Additional competition is emerging from
various sources for decking.

     As the Company has developed its own plastic reclamation technologies, it
has in certain instances been required to compete for raw materials with other
plastic recyclers, or plastic resin producers, most of which are far larger and
better established than the Company. However, management believes that its focus
towards sources of contaminated polyethylene films that it recycles and uses in
its composites business are less attractive to most producers of recycled
plastics, other than plastic lumber producers. Additional decking competitors of
wood composite decking are Crane Plastics with a product called TimberTech, U.S.
Plastic Lumber with a product called SmartDeck and Certainteed recently
introduced a (poly vinyl chloride) PVC composite named BoardWalk. As a result,
the increasing market demand for composite products is now changing. Several
additional competitors are starting to show interest in poly waste and other
plastics, and prices for scrap are increasing. Further, the Company believes
that the plastics reclamation processes it has developed for its composite
manufacturing business are targeted to the waste management needs of particular
industrial waste generators, to plastic film wastes and to other plastic waste
generators, whose potential as a recycling source is not being utilized to a
significant extent by current plastics recyclers, as compared to post-consumer,
source-separated plastic containers recycling processes, in which a
substantially greater number of plastics recyclers compete for plastic waste
materials.

     As it grows, the Company expects to encounter new entrants into the
composites or plastics reclamation business, which could affect the Company's
source of raw materials supply. These new entrants may have substantially
greater financial and other resources than the Company, and may include beverage
bottlers, distributors and retailers, as well as forestry product producers,
petrochemical and other companies. For example, competitors are now competing
with the Company for certain raw materials in connection with the production of
their products. This competition may cause the price of the Company's raw
materials to continue to rise somewhat in the future.

EMPLOYEES

     On December 31, 2000, the Company employed 320 people at its combined
facilities, which included 120 employees at the Texas facility, of which 8 were
executives and/or office personnel and 112 were full-time factory personnel. At
the Arkansas facility, there were 200 employees, of which 20 were executives
and/or office personnel and 180 were full-time factory personnel. The Company,
from time-to-time, employs additional persons on a part-time basis in its
manufacturing operations. The Company is intent on streamlining and automating
its manufacturing operations and we hope to attain increased outputs and
improved efficiencies without substantially increasing personnel.

BOND FINANCING AND ESCROW

     The Company received final approval for a $16.5 million bond issue from the
Springdale City Council in October 1999. The bonds are tax-exempt industrial
development revenue bonds, and are the type used to assist companies that
recycle products. The bonds are offered throughout the state of Arkansas, as
well as in Springdale. The bonds were sold to complete the expansion of the
existing manufacturing facility in Springdale and to build another manufacturing
facility in Springdale in order to meet the strong demand for
                                        10
<PAGE>   12

the Company's products. The bonds were sold to a Maryland mutual fund company,
at an interest rate of 5.25%. The proceeds of the bonds have been placed in
escrow, pending the finalization of bond requirements. These requirements
include delivering to the Trustee such general items as project plans and
specifications, cost estimates, construction contracts and insurance coverage.
Furthermore, unless waived by the holder of 100% of the Bonds, the Company must
also deliver to the Trustee satisfactory evidence that for any consecutive 12
month period commencing on or after the date of the issuance of the bonds, the
long-term debt service coverage ratio, as defined, has not been less than 2 to
1, and the projected long-term debt service coverage ratio for the 24 month
period subsequent to the first disbursal from the Project Fund shall be not less
than 2 to 1. Out plan is to have the escrowed bond funds released in segments
when and if the criteria are met. The bonds were subject to mandatory tender for
purchase by the Company in whole on October 13, 2000 (the Reset Date), at which
time the bonds were repurchased by Calvert and a new reset date of October 13,
2001, was established subject to the same terms described above except the
interest rate changed to 6.4%. There are no assurances that the Company will be
successful in re-marketing the bonds, at which time the Company will be required
to buy back the bonds.

     The Company intends to break escrow of the $16.5 million bond financing in
stages as production and subsequent construction progress in the third
manufacturing facility. This breaking of escrow is anticipated in the second
half of 2001. Initial proceeds from the escrowed funds will be used to shift
some short-term debt used to complete the first Springdale plant to long-term
debt, buy the property of the Springdale manufacturing facility now in place and
build a plastic facility (see Liquidity and Capital Resources Section).

     Total completion on the second Springdale manufacturing, with its three
extrusion lines, will be completed 18 months after start-up. The additional
capacity is intended to increase annualized sales to $70 million. At that time,
AERT will be positioned to positively address the ever-increasing demand of the
market place for low-maintenance composite building materials.

RISK FACTORS

     An investment in the Company's securities involves a high degree of risk.
Prior to making an investment, prospective investors should carefully consider
the following factors, among others, and seek professional advice in analyzing
this Company. In addition, this Form 10-K contains certain "forward-looking
statements" within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. Such forward-looking statements, which are often
identified by words such as "believes," "anticipates," "expects," "estimates,"
"should," "may," "will" and similar expressions, represent the Company's
expectations or beliefs concerning future events. Numerous assumptions, risks
and uncertainties, including the factors set forth below, could cause actual
results to differ materially from the results discussed in the forward looking
statements. Prospective purchasers of the Shares should carefully consider the
factors set forth below, as well as the other information contained herein or in
the documents incorporated herein by reference.

     This discussion contains certain estimates, predictions, projections and
other forward-looking statements (within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934)
that involve various risks and uncertainties. While these forward-looking
statements, and any assumptions upon which they are based, are made in good
faith and reflect the Company's current judgment regarding the direction of its
business, actual results will almost always vary, sometimes materially, from any
estimates, predictions, projections, assumptions, or other future performance
suggested herein. Some important factors (but not necessarily all factors) that
could affect the Company's sales volumes, growth strategies, future
profitability and operating results, or that otherwise could cause actual
results to differ materially from those expressed in any forward-looking
statement include the following: market, political or other forces affecting the
pricing and availability of plastics and other raw material accidents or other
unscheduled shutdowns affecting the Company's, its suppliers' or its customers'
plants, machinery, or equipment; competition from products and services offered
by other enterprises; state and federal environmental, economic, safety and
other policies and regulations, any changes therein, and any legal or regulatory
delays or other factors beyond the Company's control; execution of planned
capital projects; weather conditions affecting the Company's operations or the
areas in which the Company's products are marketed; adverse rulings, judgments,
or settlements in litigation or other legal matters. The Company undertakes no
obligation
                                        11
<PAGE>   13

to publicly release the result of any revisions to any such forward-looking
statements that may be made to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.

     The success of the Company's continuing operations will depend upon the
availability of cash flow from operations, sustaining profitability and the
Company's success in managing its debt. The expenses that might be incurred in
manufacturing and further developing and marketing the Company's products cannot
be predicted with certainty. The Company must increase sales and improve its
operating margins in order to achieve profitability. There is no assurance that
further operating improvements or additional financing can be obtained, or
obtained on terms satisfactory to the Company.

ITEM 2. PROPERTIES

     The Company conducts its composite products manufacturing operations from
two separate facilities, including a 49,000 square foot manufacturing and
storage facility on a seven-acre site in Junction, Texas. The grounds and a
10,500 square foot building are leased from Marjorie S. Brooks, a major
shareholder, under an agreement that expires April 30, 2001. Management intends
on renewing the non-cancelable lease in Junction under similar terms. The
Company owns the building improvements located on the site and currently pays a
monthly rent of $1,519 for the lease. The Company believes that the Junction
facility is currently suitable for its composite materials manufacturing
requirements. The Company is upgrading and improving the Junction facility to
provide additional composite capacity.

     The Company's Springdale, Arkansas manufacturing facility consists of
103,000 square feet and is located on 10 acres with a rail siding in the
Springdale Industrial District. The Company added storage sheds of approximately
12,000 square feet during 1999. The facility has dual sprinkler systems, and is
leased by the Company for $19,000 per month with an option to purchase it for
$1.8 million. The Company intends to purchase said facility once it breaks
escrow, with a portion of its $16.5 million financing (see Bond Financing and
Escrow and Liquidity and Capital Resources Sections).

     In March 1999, the Company entered into a lease agreement for an office,
storage building and parking lot adjacent to the manufacturing facility in
Springdale, Arkansas. The lease is for $3,500 per month for two years, renewable
yearly. The Company also leases a parking area for $200 per month. The office
and storage facility is comprised of 10,000 square feet on 2.36 acres and houses
the Company's corporate offices. The Company has an option to purchase this
property for $360,000, with half of the lease payments applicable to the
purchase price. The Company completed its purchase of 18.6 acres of land, south
of and adjoining the existing manufacturing facility, in March 2000. This land
is where the second Springdale manufacturing facility will be built and was
acquired for a price of $785,000.

     A second plastic recycling facility warehouse has been leased and will
become operational during the second quarter of 2001. Additional plastic
grinding and processing equipment has been acquired and is designed to come
on-line during the third quarter of 2001. The facility is comprised of 55,000
square feet. The lease is $7,400 per month for two years with a renewal option.

ITEM 3. LEGAL PROCEEDINGS

     In June 1992, Mobil Oil Corporation (Mobil) commenced an action against the
Company in the United States District Court of the District of Delaware entitled
"Mobil Oil Corporation v. Advanced Environmental Recycling Technologies, Inc."
In the complaint, Mobil sought entry of a declaratory judgment and sought no
monetary damages in that suit, but did seek reimbursement of its attorneys'
fees. The Company denied Mobil's claims and asserted counterclaims against Mobil
and three Mobil Executives, seeking monetary damages, punitive damages and
injunctive relief. After a trial on the patent issues in February 1994, the
court held that four AERT patents on its composite product technology were
invalid and that Mobil had not infringed the patents. The Company filed a motion
in March 1995, alleging prejudicial misconduct by Mobil prior to the trial and
also filed an appeal with the U.S. Court of Appeals in July 1995. In June 1996,
the U.S. Court of Appeals reversed a portion of the earlier ruling, which had
held that two of the patents were invalid, but ruled that Mobil did not infringe
such patents. The Company did not further appeal this ruling.

                                        12
<PAGE>   14

     In August 1994, Mobil filed a motion seeking an award of attorney's fees
and costs of $2.7 million. In September 1999, the Delaware Court dismissed the
Mobil Motion for Attorneys' Fees, for a second time. The Court also dismissed
the Company's motion for new trial upon discovery misconduct and the Company's
motion to supplement the record.

     On a second appeal, arising from an order entered by the district court on
September 30, 1999, Mobil Oil sought an award of attorney's fees again from the
Company in the approximate amount of $2.7 million. The Company also appealed,
seeking a new trial and an opportunity to supplement the record in the trial
court. On December 6, 2000, the Federal Circuit affirmed the district court
decision, thereby denying both the award of the attorneys' fees to Mobil Oil and
the relief requested by the Company.

     The Company's counterclaims against Mobil and individual defendants
alleging violations of the Sherman Act, false and deceptive advertising, breach
of confidential relationship and unfair competition had remained pending in the
District of Delaware, having been bifurcated prior to the trial on the patent
law claims.

     The Company is a counterclaim defendant in a federal action in Texas,
involving allegations from a former employee and officer of the Company that the
Company breached an employment agreement by terminating employment. The Company
believes this action is without merit and will vigorously defend itself.

     Three H. Enterprises sued the Company for breach of contract on May 9,
2000, alleging that unpaid royalties in the amount of $10 per ton of product
produced from the Junction, Texas, facility are purportedly owed to plaintiff.
The alleged contract is from a settlement stipulation entered into between
litigants in a prior Arkansas state court suit in 1987, prior to the formation
of the Company.

     On December 13, 2000, Three H. Enterprises filed an Amended Complaint
adding Juniper Industries, Inc., Southern Minerals, Inc., Joseph G. Brooks and
Marjorie S. Brooks as co-defendants in the litigation. The Company has denied
the allegations and discovery between Three H. Enterprises and the Company
closed on March 31, 2001. No trial date has been set. The Company believes the
allegations and claims are without merit and will vigorously defend itself. The
Company also believes this lawsuit is related to the prior Delaware action which
was recently dismissed.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     There were no matters submitted by the Company to a vote of security
holders during the quarter ended December 31, 2000.

                                        13
<PAGE>   15

                                    PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The Company's Class A common stock is traded in the over-the-counter market
and is listed on The Nasdaq Stock Market(R) under the symbol AERTA. In order to
remain listed on NASDAQ, the Company is required to meet certain criteria
(Maintenance Standards) established by NASDAQ. One such Maintenance Standard is
a minimum bid price of $1.00 per share. The Company's stock price fell below the
$1.00 bid in 1999 and the bid price subsequently increased to over the minimum
$1.00 bid within the correction time and sustained compliance until the recent
downturn. The Company anticipates sustained compliance within a correction time,
should it become necessary, as future events unfold and become public. At
December 31, 2000, the Company's closing stock price per share was $0.75, and
its net asset value was $2,709,383.

     A second maintenance standard is to maintain a net equity position of $2
million. There is no guarantee that the Company will maintain this minimum
requirement. The Company has evaluated the potential financial statement impact
of accounting for its outstanding warrants using the guidelines set forth in
recently released Emerging Issues Task Force Abstract 00-19, "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock" (EITF 00-19). For contracts, such as the Company's
warrants, that existed on September 20, 2000, and remain outstanding June 30,
2001, EITF 00-19 is effective as of June 30, 2001, based on the contract terms
then in place. Had EITF 00-19 been early adopted by the Company as of December
31, 2000, the Company would have recognized an additional $4.6 million in net
loss as a cumulative effect of a change in accounting principle. The increase in
net loss would have caused the Company's net asset value to drop below the $2
million minimum set by NASDAQ for continued listing. The Company plans to amend
its warrant contracts prior to June 30, 2001, to avoid any negative impact on
its net asset position.

     The following table sets forth the ranges of high and low quarterly sales
prices (as reported by NASDAQ) of the Company's Class A common stock for the
years ended December 31, 1998, 1999 and 2000. The quotations represent prices
between dealers, do not include retail markup, markdown or commission, and do
not necessarily represent actual transactions.

<TABLE>
<CAPTION>
                                                   CLASS A COMMON STOCK
                                                   --------------------
                                                    HIGH          LOW
                                                   ------        ------
<S>                                                <C>           <C>
Fiscal 1998
  First Quarter................................    1.938         0.375
  Second Quarter...............................    1.813         1.000
  Third Quarter................................    1.438         0.531
  Fourth Quarter...............................    1.031         0.719
Fiscal 1999
  First Quarter................................    1.063         0.750
  Second Quarter...............................    1.938         0.750
  Third Quarter................................    2.250         1.625
  Fourth Quarter...............................    3.313         1.656
Fiscal 2000
  First Quarter................................    3.563         2.000
  Second Quarter...............................    2.500         1.906
  Third Quarter................................    2.313         1.313
  Fourth Quarter...............................    1.438         0.656
</TABLE>

     The Class B Warrants, which expired in February 1999, were delisted in 1998
due to lack of trading activity.

     As of December 31, 2000, there were 1,574 record holders of Class A common
stock and 11 record holders of Class B common stock. The number of beneficial
owners of the Class A common stock at December 31, 2000 is not known; however,
management believes the number of beneficial owners of Class A common stock at
December 31, 2000, was in excess of 5,000.

                                        14
<PAGE>   16

ITEM 6. SELECTED FINANCIAL DATA

     The following tables set forth-selected historical data for the Company for
the years ended December 31, 1996 through 2000. For the years ended December 31,
2000, 1999 and 1998, the data was obtained from the Company financial statements
contained in this document at pages F-1 through F-24. Data for the periods prior
to December 31, 1997 was obtained from Item 6 of the Company's Annual Report or
Form 10-K for the year ended December 31, 1997.

<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                              -------------------------------------------------------------------
                                 2000          1999          1998          1997          1996
                              -----------   -----------   -----------   -----------   -----------
<S>                           <C>           <C>           <C>           <C>           <C>
STATEMENTS OF OPERATIONS
  DATA:
Sales.......................  $27,508,864   $19,917,133   $12,408,591   $ 7,982,381   $ 6,950,219
                              -----------   -----------   -----------   -----------   -----------
Loss before extraordinary
  gain......................   (1,916,521)   (1,473,736)   (3,605,180)   (1,913,664)   (2,933,698)
Extraordinary gain..........           --            --            --       757,644        36,666
Accrued premium on preferred
  stock.....................     (290,000)     (290,000)      (47,890)           --            --
                              -----------   -----------   -----------   -----------   -----------
Loss applicable to common
  stock.....................  $(2,206,521)  $(1,763,736)  $(3,653,070)  $(1,156,020)  $(2,897,032)
                              ===========   ===========   ===========   ===========   ===========
Loss before extraordinary
  gain per common share.....  $      (.08)  $      (.07)  $      (.16)  $      (.09)  $      (.15)
Extraordinary gain per
  common share..............           --            --            --           .04            --
                              -----------   -----------   -----------   -----------   -----------
Net Loss per common share(1)
  (Basic and Diluted).......  $      (.08)  $      (.07)  $      (.16)  $      (.05)  $      (.15)
                              ===========   ===========   ===========   ===========   ===========
Weighted Average Number of
  Shares Outstanding(1).....   26,059,013    24,598,715    22,895,517    21,800,170    19,134,484

BALANCE SHEET DATA:
</TABLE>

<TABLE>
<CAPTION>
                              DECEMBER 31,   DECEMBER 31,   DECEMBER 31,   DECEMBER 31,   DECEMBER 31,
                                  2000           1999           1998           1997           1996
                              ------------   ------------   ------------   ------------   ------------
<S>                           <C>            <C>            <C>            <C>            <C>
Working Capital (Deficit)...  $(6,804,992)   $(7,756,859)   $(4,625,935)   $(3,117,649)    $ (892,995)
Total Assets................   35,258,304     31,455,793     10,941,927      7,641,328      6,725,549
Long-Term Debt Less Current
  Maturities................    4,486,156         59,656        227,376        588,412        955,776
  Total Liabilities.........   32,548,921     27,947,095      7,164,426      5,290,970      3,623,170
  Stockholders' Equity......    2,709,383      3,508,698      3,777,501      2,350,358      3,102,379
</TABLE>

------------------------
(1) The net loss per share of common stock is based on the combined weighted
    average of shares of Class A and Class B common stock outstanding during the
    period.

                                        15
<PAGE>   17

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2000, COMPARED TO YEAR ENDED DECEMBER 31, 1999

     Net sales increased to $27,508,864 for the year ended December 31, 2000,
which represented an increase of $7,591,731 or 38% over sales of $19,917,133 for
the year ended December 31, 1999. Net sales are computed by subtracting from
gross sales early pay discounts, returns, dating discounts, allowances and
freight charges, which together totaled $783,329 for 2000. The 2000 composite
sales consisted of MoistureShield(R) net sales of $7,783,256 and decking
(ChoiceDek(R) Classic and ChoiceDek(R) Plus) net sales of $19,725,608. These
figures compare with 1999 MoistureShield(R) net sales of $9,602,405 and
ChoiceDek(R) decking net sales of $10,314,728.

     The Texas plant net sales increased to $12,283,451 in 2000 from $10,723,233
in 1999, an increase of $1,580,267 or 14.5%. The Texas plant primarily produces
the ChoiceDek(R) Classic product line. Texas net sales in 2000 for ChoiceDek(R)
Classic were $12,046,741 versus $9,423,033 in 1999. Net sales of
MoistureShield(R) were $236,710 in 2000 versus $1,300,200 in 1999, a decrease of
$1,063,490. This decrease in MoistureShield sales was due to the plan to have
the Texas plant focus on production of ChoiceDek(R) Classic. Focusing on this
major product line provided Texas the opportunity to be more efficient. However,
during the fourth quarter of 2000, the Texas plant experienced operational
problems associated with raw material disruptions regarding its supplies of
cedar fiber. Due to weather related problems, there was a shortage of cedar
fiber, which was due to severe, prolonged rainy weather in the area that stopped
the harvesting and delivery of the cedar to the cedar mills from which our
supply of fiber is generated. In addition, the Texas plant experienced some
mechanical problems which were repaired during the downtime, also associated
with inadequate fiber supplies. AERT lost an estimated $1.6 million in sales
because of these problems. We believe the Texas plant can produce at an
annualized capacity of $17 million.

     The third extrusion line for the Springdale plant was completed and
operational in July of 2000. The net sales in 2000 at the Springdale plant were
$7,678,865 for ChoiceDek(R) Plus and $6,725,080 for MoistureShield(R), for total
net sales of $15,225,413, an increase of $6,031,513 or 65.6% over 1999 sales of
$9,193,900. Decking sales increased from $896,695 in 1999 to $7,678,865 in 2000,
an increase of $6,782,170 or 756%. During 2000, MoistureShield(R) sales were
$7,546,548 which was a decrease of $755,657 or 9% from 1999 sales of $8,302,205.
This decrease in OEM sales was attributable to three factors; a slow down of
sales of door and window components in the fourth quarter of 2000, a decline in
purchases during the last half of 2000 by a major door component customer, and
production limitations associated with starting up the new MoistureShield(R)
CornerLoc(TM) system. Based on the operating efficiencies recently achieved and
an appropriate mix of decking and OEM orders, 60% and 40%, respectively, we
believe Springdale can currently produce at an annualized capacity of $25
million and ramp-up to $33 million in the future.

     Cost of goods sold increased $5,484,715 from $17,166,024 in 1999 to
$22,650,739 in 2000. As a percent of sales, cost of goods sold decreased 4% in
2000, from 86% in 1999 to 82%. Significant improvement was made in spite of the
problems with the Texas plant during the fourth quarter and higher raw material
costs. The major cost of goods component that increased as a percent of sales
was raw materials, up $2,273,130. As a percent of sales, raw materials increased
from 26.6% in 1999 to 27.1% in 2000 (.5%). Fuel and propane gas costs also
increased significantly over 1999. This increase in raw material costs was
primarily due to the continued increase in plastic costs. Payroll and payroll
related expenses remained at 30% of sales. The payroll remained constant, as a
percent of sales, because of the staffing required to streamline and bring the
Springdale facility closer to full operating capacity. The other manufacturing
expenses decreased as a percent

                                        16
<PAGE>   18

of sales by 3%. This resulted in the net decrease of 4% for the overall cost of
goods as a percent of sales. A summary of the cost of goods sold is presented
below:

     Significant cost categories are as follows:

<TABLE>
<CAPTION>
EXPENSE CATEGORY                               2000           1999
----------------                            -----------    -----------
<S>                                         <C>            <C>
Payroll and payroll taxes.................  $ 8,144,107    $ 5,997,364
Depreciation..............................    2,333,649      1,820,152
Raw Materials.............................    7,452,625      5,301,905
Other.....................................    4,720,358      4,046,603
                                            -----------    -----------
Total cost of goods sold..................  $22,650,739    $17,166,024
                                            ===========    ===========
</TABLE>

     Selling, general and administrative expenses, excluding extraordinary
litigation expenses of $583,000, increased $1.64 million to $5.4 million from
$3.76 million in 1999. Including the litigation expenses, the increase was
$2.192 million to $5,958,830 in 2000 from $3,766,779, in 1999. As a percent of
sales, SG&A increased 2.7%, of which the majority was due to existing litigation
costs. Staffing was increased, primarily in marketing and sales, although as a
percent of sales, staffing costs decreased slightly from 6.8% to 6.3%. The major
SG&A expenses of $1.08 million was advertising and commission expenses in regard
to ChoiceDek(R) decking with Weyerhaeuser. Additional promotional expenses were
incurred to increase brand awareness of the ChoiceDek(R) and MoistureShield(R)
products. Commissions and factoring fees increased as sales increased. The
operating loss for year ended December 31, 2000, was $517,705, excluding the
litigation costs of $583,000, which brought it to $1,100,705. This loss compares
to an operating loss of $1,015,670, for the comparable period a year ago. Net
interest expense increased to $815,816 for the year ended December 31, 2000, up
$357,750 from $458,066 for the comparable period a year ago. Of said interest
expense, $143,379 was for factoring expense and $225,594 was interest on $1.8
million in outstanding bridge notes. The Company intends to work towards
eliminating its factoring expense and move toward a bank line-of-credit if it
can demonstrate sustained profitability over the next year.

     The Texas plant recorded a net loss in 2000 of $671,177, a decrease of
$1,241,185 from the $570,008 profit in 1999. The decrease resulted from the
result of the circumstances previously described that affected the fourth
quarter and overall results from the Texas plant.

     The Springdale plant recorded a net loss of $1,535,344 in 2000 as compared
to a net loss of $2,043,744 in 1999. This reduction of the net loss of over
$500,000 reflects the improvement of the Springdale plant as several
construction phases were completed and its transition into a more efficient
operating facility.

     The net loss for 2000 was $2,206,521 or a net loss per weighted average
common shares outstanding of $.08. This compares to a 1999 loss of $1,763,736,
or a net loss per weighted average common shares outstanding of $.07. Of the net
loss in 2000, $1,298,992 or 59% was experienced in the fourth quarter. Over
$850,000 of the loss was attributable to the Texas plant and its weather-related
and operational problems previously described in this section.

YEAR ENDED DECEMBER 31, 1999, COMPARED TO YEAR ENDED DECEMBER 31, 1998

     Net sales were $19,917,133 for the year ended December 31, 1999, which
represented an increase of $7,508,542 or 61% over the year ended December 31,
1998. Net sales were attained by subtracting from gross sales early pay
discounts, returns, allowances, and freight charges, which together totaled
$583,332 for 1999. The 1999 composite sales consisted of MoistureShield(R) net
sales of $9,602,405 and decking (ChoiceDek(R) and DreamWorks(TM)) net sales of
$10,314,728. These figures compare with 1998 MoistureShield(R) sales of
$8,148,422 and ChoiceDek(R) sales of $4,260,169.

     The Texas plant increased net sales to $10,723,233 in 1999 from $9,530,654
in 1998, a 12.5% increase. The Texas plant now produces primarily the
ChoiceDek(R) product line. Texas sold $9,423,033 of ChoiceDek(R) and $1,300,200
of MoistureShield(R) during 1999. The DreamWorks(TM) decking product line, now
marketed under the name ChoiceDek(R) Plus, is produced in the Springdale plant.
This move streamlined and focused the

                                        17
<PAGE>   19

products produced at the Texas plant and made it more efficient. We believe that
in 2000, with the investment made at the end of 1999 and in the first quarter of
2000 to the extruding equipment, the Texas plant will be producing its increased
annualized capacity of $17 million. The Springdale plant reported composite
sales of $9,193,900 in 1999 compared to $2,877,937 in 1998, a 219% increase. The
Springdale plant sold $8,302,205 of MoistureShield(R) and $891,695 of
DreamWorks(TM) decking in 1999, as the decking projects experienced startup
delays during the fourth quarter of 1999. The Springdale plant was not in full
operation in 1998 and only had two of its three extrusion lines in operation in
1999. The Springdale plant produces the Company's MoistureShield(R) lines for
its door, window and industrial flooring customers, as well as the
DreamWorks(TM) line of decking.

     Cost of goods sold increased $5,477,576 from $11,688,448 in 1998 to
$17,166,024 in 1999. This increase in cost of goods sold was primarily
attributed to increased payroll and payroll expenses, raw material costs and
utility and operating costs associated with operating the Company's composites
manufacturing units, even though direct labor costs as a percent of net sales
decreased 3% from 1998 to 1999. The Company also experienced significant
inefficiencies with an air transfer loading system, which would not attain its
manufacturer delivery objectives for speed or accuracy. This situation delayed
increased production on the initial lines and startup of the third line. When
this problem became apparent and well documented at the start of the fourth
quarter, the Company elected to modify and upgrade portions of the system to
increase accuracy and speed in conjunction with increasing capacity to
accommodate a new higher output extrusion design. Also, the Company incorporated
additional blending and mixing capabilities to allow it to utilize a wider range
of recycled plastic materials. The Company has expended approximately $1.1
million on this project, in addition to taking a fourth quarter net write-down
of approximately $84,089 for non-performing assets. The new material transfer
system started up on March 15, 2000. Springdale was in both an operational mode
and a construction mode in 1999, installing an air quality environmental system,
refining the second extrusion line, rebuilding the material transfer system and
working on the installation of the third line for this plant.

     Significant cost categories are as follows:

<TABLE>
<CAPTION>
             EXPENSE CATEGORY                  1999           1998
             ----------------               -----------    -----------
<S>                                         <C>            <C>
Payroll and payroll taxes.................  $ 5,997,364    $ 4,094,877
Depreciation..............................    1,820,152      1,412,692
Raw Materials.............................    5,301,905      2,976,338
Other.....................................    4,046,603      3,204,541
                                            -----------    -----------
Total cost of goods sold..................  $17,166,024    $11,688,448
                                            ===========    ===========
</TABLE>

     Payroll and payroll taxes increased due to the increase in the number of
personnel required to operate the Springdale plant in 1999 as production
capacity increased. Raw material costs increased as a result of the increase in
sales and an increase in raw material plastic costs. To offset the higher raw
material costs, the Company implemented price increases on its products in early
2000. Other manufacturing costs increased $842,062 to $4,046,603 in 1999, up
from $3,204,541 in 1998. The increase in costs was due to the increase in sales
and the continued buildup of the Springdale facility to a fully operational
plant. As a percentage of net sales, manufacturing overhead decreased to 37% in
1999 from 45% in 1998, an 8% decrease. The manufacturing overhead grew at a
slower rate than sales.

     Selling, general and administrative expenses increased $546,546 in 1999 to
$3,766,779, compared to $3,220,233 for 1998. The increase was due to an increase
in salaries, professional fees and commissions. These expenses are normally
associated with growing sales. As a percentage of net sales, SG&A decreased to
19% from 26% in 1998, a 27% decrease. This decrease indicates that while
production and sales grew, the SG&A increased at a lower rate. The Company
initiated a national advertising program for decking in 1999, which included
print, trade shows and limited cable television advertising. Of the Company's
$10,314,728 in decking sales, $309,442 or 3% was targeted at creating brand
awareness and increased market acceptance for ChoiceDek(R). In 1999, these
marketing expenses amounted to 49% of the increase in SG&A. This marketing
strategy was initiated with the goal of significantly increasing sales of its
ChoiceDek(R) decking products into national distribution in conjunction with
Weyerhaeuser, its North American decking distributor.

                                        18
<PAGE>   20

     The net loss for 1999 was $1,763,736, or a net loss per weighted average
common share outstanding of $.07. This compares to a 1998 loss of $3,653,070, or
a net loss per weighted average common share outstanding of $.16. Of the 1999
loss, $1,493,874 or 85% was experienced in the fourth quarter, and was
attributable to delays associated with starting up the DreamWorks(TM) product
line in Springdale and with shutting down the Texas plant for extended periods
for maintenance and production upgrade work.

     The Texas plant recorded a profit of $570,008 in 1999, an increase of
$758,546, from a net loss of $188,538 in 1998. This was the first profitable
year for that plant, although it had positive cash flow in 1998. The Springdale
plant recorded a net loss of $2,043,744, a reduction of $1,363,553, from the net
loss of $3,407,297 in 1998. As previously stated, Springdale was in an
operational mode and in a construction mode, however it moved significantly
toward profitability.

     In addition, the Company increased its plastics recycling and processing
capacity during the second half of the year by adding more cleaning and
production equipment. These additions were designed and intended to allow the
Company's plastic recycling machinery to utilize and blend lower cost recycled
plastics. During 1999, the Company invested approximately $4.5 million in
capital expenditures at the Springdale facility.

     There can be no assurance that the Company can attain its anticipated
continued operating improvements, that raw material costs will not continue to
increase, or that its additional production efficiencies and resultant unit cost
reductions required for profitability will occur.

LIQUIDITY AND CAPITAL RESOURCES

     The Company, in conjunction with its major shareholder, contractors and
suppliers, completed the major portion of the Springdale capital expansion
during the third quarter ended September 30, 2000. At December 31, 2000, the
Company had a working capital deficit of $6,804,992 compared to a working
capital deficit of $7,756,859 at December 31, 1999. The Company expended
approximately $3.5 million on capital expansion during the year ended 2000,
primarily on completing the Springdale Arkansas facility. The deficit is
primarily attributable to the Company's delays in completing construction and
starting up its additional extrusion lines in a timely manner, and the resultant
negative cash flow from the Springdale plant during the majority of the year.
The weather related problems experienced by the Texas plant during the fourth
quarter, also contributed to the deficit. Management's decision to finance
significant capital expenditures with short-term bridge loans also contributed
to the increased deficit. Of such deficit, involving total liabilities of
approximately $27.8 million as of December 31, 2000, $16.5 million was for bonds
payable, which is currently escrowed and offset by a $16.5 million restricted
bond escrow fund, $2.3 million was to the Company's major shareholder, $1.8
million was in short term bridge loans, and approximately $5.2 million was in
payables of which a significant portion reflects the ongoing construction
completed at the Springdale facility. The $6.8 million working capital deficit
reflects management's decision to enter into short-term debt financing, while
the Company has expanded, built and improved its production and sales capacities
to increase cash flows from operations. The Company's plan was to acquire
short-term debt and refinance in the future, rather than enter into what it felt
would have been more expensive and dilutive equity financing at that time. Even
with the Texas plant's fourth quarter problems, that substantially reduced sales
and negatively impacted operations, the working capital deficit and loss in
2000, the Company generated sufficient cash flow to more than cover debt
service. Cash flow available for debt service for the period ended December 31,
2000, was approximately $1.36 million.

     The Company successfully closed a $16.5 million tax-exempt bond financing
into escrow during the fourth quarter of 1999, which is intended to refinance
and shift its construction and expansion related accounts payable into long-term
financing. The Company started up the third Springdale production line, further
increased production and intends to significantly increase positive cash flows,
attain profitability and then break escrow of a portion or possibly all of the
bonds. Certain requirements must be met in order for the Company to break
escrow. These include delivering to the Trustee such general items as project
plans and specifications, cost estimates, construction contracts and insurance
coverage. Furthermore, unless waived by the holder of 100% of the Bonds, the
Company must also deliver to the Trustee satisfactory evidence that for any
consecutive 12 month period commencing on or after the date of the issuance of
the bonds, the long-term

                                        19
<PAGE>   21

debt service coverage ration, as defined, has been not less than 2 to 1, and the
projected long-term debt service coverage ratio for the 24 month period
subsequent to the first disbursal from the Project Fund shall be not less than 2
to 1. In addition, the bonds were subject to mandatory tender for purchase by
the Company in whole on October 13, 2000 (the Reset Date), at which time the
bonds were repurchased by the bond holder and a new reset date of October 13,
2001 was established subject to the same terms and covenants previously
described above except the interest rate changed to 6.4%. If the Company has not
achieved the above mentioned progress by said date, the Company will attempt to
re-market the bonds. There are no assurances that the Company will be successful
in re-marketing the bonds. If unsuccessful, the Company will be required to buy
back the bonds. Should the Company be successful in its efforts to break escrow,
the Company believes it will have more than adequate debt service coverage for
its long-term bond debt. As of December 31, 2000, the Company had not met the
aforementioned criteria and there are no assurances the Company will be
successful in meeting the standards required to receive the bond financing
proceeds.

     On February 29, 2000, the Company closed a bank financing with an Arkansas
based bank totaling $4.5 million. This demand loan with a 15-year amortization
is 80% guaranteed by the U.S. Government and carries a 9.75% interest rate. The
major shareholder and members of her family also personally guarantee this loan.
The loan proceeds were used to acquire the 18.6 acres of land that adjoins the
plant in Springdale, Arkansas. This land will be the site of the third
manufacturing facility and an additional plastic plant, as previously mentioned.
In addition, the loan proceeds reduced the Company's accounts payable and
provided cash for liquidity of $600,000. The Company believes that if it is
successful in completing its pending escrowed bond financing it will reduce and
later eliminate its working capital deficit by paying off the remaining bridge
note balance of $1.9 million during the remainder of 2001. In addition, the
Company will be reimbursed for approximately $4.7 million of working capital
used to pay vendors for costs eligible to be paid from bond proceeds. The
Company will also receive approximately $700,000 for unpaid costs eligible for
reimbursement that are reflected in the Company's accounts payable total. The
bond funds will greatly improve the working capital position, and will
restructure a significant portion of the Company's short-term indebtedness into
long-term debt with more favorable interest rates, if the Company is able to
meet the requirements of the bond indenture previously described and break
escrow. Purchasing the existing manufacturing site over a longer term should
also help improve operating costs by eliminating the monthly lease payment. By
having substantial funds allocated and available for capital expansion, the
Company believes that increasing cash flows generated from operations can be
used for working capital and to further reduce the deficit.

     The Company recapitalized from June 1998 to February 1999 through a
voluntary conversion of Class B and Class C warrants in conjunction with a
private placement of preferred stock. The Company received voluntary conversions
of 1,312,664 warrants at prices ranging from $1.075 to $1.20 per warrant,
yielding net proceeds of $1,541,374. On February 12, 1999, all Class B and C
warrants not exercised (3,549,776) were allowed to expire by the Board of
Directors, with the exception of 325,000 Class C warrants that were previously
extended for every warrant exercised. In connection with the voluntary warrant
conversion, a bonus warrant exercisable for $3.00 per share was issued for every
warrant exercised. The Company issued 1,312,664 bonus warrants, which will
expire two years after a pending S-3 registration statement becomes effective.
In addition, 2,900 shares of preferred stock were issued to the major
shareholder and several close accredited investors for $1,000 per share. Classes
were issued in Series A, B and C with Series B having voting rights for the
underlying shares and warrants. On the 7th anniversary date of the issuance of
the preferred stock, the preferred stock will automatically be converted into
shares of common stock with the conversion price equal to the lower of the
average of the closing bid prices for the common stock for the 5 trading days
immediately preceding the 7th anniversary of the issuance or the fixed
conversion price. The fixed conversion price is $1.20. If the preferred stock is
converted prior to the 7th anniversary of its date of issuance, the conversion
price is the lower of $1.20 and the variable conversion price. The variable
conversion price is the average of the closing bid prices for the common stock
during the 10 consecutive trading days ending on the trading date immediately
preceding the date of determination. A 10% premium on the stated value of the
preferred stock ($2.9 million) is payable per year. Series X and Y warrants were
issued in connection with the preferred stock and are exercisable at $1.20 and
$2.50 per warrant, respectively. Each of the warrants has cashless exercise
features that are based on various conversion amounts and terms. The preferred
stock agreements require that the Company register with the SEC the common stock
underlying the convertible preferred stock and
                                        20
<PAGE>   22

warrants with an effective registration statement by July 15, 2001. The Company
may be required to pay certain penalties to the holders of the preferred stock
and warrants if the registration statement is not declared effective by the SEC
by July 15, 2001. The penalties increase over time until the registration
statement is effective. The preferred stock agreements contain potential
redemption events, which would cause the Company to have to redeem the preferred
stock all of which are events within the Company's control. The Company filed an
initial registration statement for the preferred stock in December 1999, and
expects to have it declared effective by the SEC prior to July 15, 2001.

     Cash and cash equivalents increased $416,456 in 2000. Significant
components of that increase were: (i) cash used in operating activities of
$951,477, which consisted of the net loss for the period of $2,206,521 reduced
by depreciation and amortization of $2,463,645 and increased by other uses of
cash of $1,208,601; (ii) cash used in investing activities of $2,826,230, and
(iii) cash provided by financing activities of $4,194,163. Payments on notes
during the period were $742,220, and proceeds from the issuances of notes
amounted to $4,500,000. At December 31, 2000, the Company had bonds and notes
payable in the amount of $23,677,213, of which $19,191,057 was current bonds and
notes payable or the current portion of long-term debt. Of the current bonds and
notes payable, $2,693,430 or 14% was to the major shareholder and other
investors closely associated with the Company. During the fourth quarter of
1998, the Company reduced the indebtedness of its $3.16 million bridge loans by
$1 million through the issuance of preferred stock. During the first quarter of
1999, the loan was further reduced by $200,000, and during the second quarter of
2000, the loans were reduced by $100,000. The Company intends to pay down the
remaining $1.8 million from cash flow and/or refinancing during 2001 and the
final balance upon successful completion of the bond financing.

     The Company has five bridge financing agreements. The date of the first
agreement was October 30, 1997. The Company issued notes payable totaling $1.3
million that were originally due and payable on July 27, 1998, but the maturity
date was extended. During 1998, $1,050,000 of the notes were converted to
preferred stock (see Note 6), and the balance of the notes was paid off in
installments, the last of which was April 2000. Interest on the notes was
payable every three months at 12% in the Company's Class A common stock. In
connection with the notes, the Company issued 2,600,000 consulting warrants and
156,000 placement warrants and paid loan origination costs of $169,000 to the
placement agent. The warrants expire October 30, 2002, and are exercisable at a
price of $0.375 per share of Class A common stock for each warrant exercised.
Per the agreement, if the notes were extended, an additional 650,000 consulting
warrants and 78,000 placement warrants would be issued. In connection with the
extension of the notes, 310,000 penalty warrants were issued to one of the note
holders and an agreement was entered into for voluntary selling restrictions of
the Company's stock by the Company's officers and certain shareholders without
prior approval from the issuer of the note.

     The second bridge financing was completed on February 5, 1998. The Company
issued notes payable totaling $800,000 which were originally due and payable on
November 2, 1998, but have since been extended without penalty warrants to May
15, 2001. Interest on the notes is payable every three months at 12% in either
cash or the Company's Class A common stock, at the option of the Company. In
connection with the notes, the Company issued 1,600,000 consulting warrants and
96,000 placement warrants and paid loan origination costs of $104,000 to the
placement agent. If the notes are extended beyond May 15, 2001, the Company may
be required to issue 448,000 penalty warrants (400,000 consulting warrants and
48,000 placement warrants). The warrants expire February 5, 2003, and are
exercisable at a price of $0.375 per share of Class A common stock for each
warrant exercised. In June 2000, $50,000 was paid on the notes bringing the note
balance to $750,000 at December 31, 2000.

     A third bridge financing was completed on April 7, 1998. The Company issued
notes payable totaling $410,000 which were originally due and payable on January
2, 1999, but have since been extended without penalty warrants to May 15, 2001.
Interest on the notes is payable every three months at 12% in either cash or the
Company's Class A common stock, at the option of the Company. In connection with
the notes, the Company issued 820,000 consulting warrants and 49,200 placement
warrants and paid loan origination costs of $53,300 to the placement agent. If
the notes are extended beyond May 15, 2001, an additional 205,000 consulting
warrants and 24,600 placement warrants may be issued. The warrants expire April
7, 2003, and are exercisable at a price of $0.375 per share of Class A common
stock for each warrant exercised.
                                        21
<PAGE>   23

     A fourth bridge financing was completed on June 3, 1998. The Company issued
notes payable totaling $359,963 which were originally due and payable on
February 28, 1999, but have since been extended without penalty warrants to May
15, 2001. Interest on the notes is payable every three months at 12% in either
cash or the Company's Class A common stock, at the option of the Company. In
connection with the notes, the Company issued 719,926 consulting warrants and
43,195 placement warrants and paid loan origination costs of $46,795 to the
placement agent. If the notes are extended beyond May 15, 2001, an additional
179,981 consulting warrants and 21,597 placement warrants may be issued. The
warrants expire June 3, 2003, and are exercisable at a price of $0.375 per share
of Class A common stock for each warrant exercised.

     A fifth bridge financing was completed on August 21, 1998. The Company
issued notes payable totaling $287,500, which were originally due and payable on
May 18, 1999, but have since been extended without penalty warrants to May 15,
2001. Interest on the notes is payable every three months at 12% in either cash
or the Company's Class A common stock, at the option of the Company. In
connection with the notes, the Company issued 575,000 consulting warrants and
34,500 placement warrants and paid loan origination costs of $37,375 to the
placement agent. If the notes are extended beyond May 15, 2001, an additional
143,750 consulting warrants and 17,250 placement warrants may be issued. The
warrants expire August 21, 2003, and are exercisable at a price of $0.375 per
share of Class A common stock for each warrant exercised.

     Delisting of the Company's stock would result in an event of default under
the bridge financing agreements. An event of default results in all the then
outstanding principal amounts and unpaid interest becoming due and payable
immediately.

     During January 2000, the Company had an agreement with an affiliate whereby
the Company agreed to transfer certain of its trade receivables as collateral,
which the affiliate deemed acceptable, up to $2 million at any one time. In
February 2000, the Company's major shareholder increased the Company's factoring
line to $2.5 million. The Company believes that the current terms of its
factoring agreement with its major shareholder are competitive with, if not
better than, terms that might be obtained from outside sources. Upon acceptance
of a transfer of a receivable, the affiliate remitted to the Company 85% of the
receivable, as defined in the agreement. Upon collection of the receivable, the
Company remitted to the affiliate 1.75% of the receivable as a factoring charge,
and the additional 13.25% of the receivable was remitted to the Company, less
interest costs, which were based on the time period over which the receivable
was outstanding. The Company indemnified the affiliate for any loss arising out
of rejections or returns of any merchandise, or any claims asserted by the
Company's customers. During 2000, the Company transferred an aggregate of
approximately $28,292,000 in receivables under this agreement, of which
$1,817,544 remained to be collected as of December 31, 2000. During 1999 and
1998, the Company transferred an aggregate of approximately $20,500,000 and
$12,863,000, respectively, in receivables under this agreement, none of which
remains to be collected. Costs of approximately $470,794, $202,034 and $113,189
associated with the factoring agreement were included in selling and
administrative costs at December 31, 2000, 1999 and 1998, respectively.

     The Company believes that further improvement and streamlining of its
manufacturing rates and efficiencies along with the additional production
capacity at its Springdale facility will allow it to further reduce costs and
improve gross margins. The ability to significantly lower unit production costs
while further increasing sales will enable the Company to achieve a level of
operations in periods subsequent to the first quarter of 2001, which will allow
for increased cash flows from operations.

     The Company has also embarked on a cost reduction plan aimed at
significantly reducing duplication, operating and/or extraordinary costs during
2001 and has targeted excess of $1.75 million of costs which it intends to
eliminate during 2001. In addition to improving the desired efficiencies
described above, an example of this is cogeneration units that have been
installed during first quarter of 2001, at both facilities and will utilize
waste sawdust or paper for dry fuel. These cogeneration units will eliminate
and/or reduce natural gas and propane costs for drying wood fiber at both
facilities. We believe these improvements will significantly reduce or eliminate
the Company's need for additional sources of capital to support its operations.
Management believes that increased production and sales, and improved product
focus, increased throughputs, and reduced plastics division raw material costs
will allow it to attain profitability. Additional production volumes and
resultant sales increases from its Springdale plant combined with continued

                                        22
<PAGE>   24

improvements in production efficiency and capacity, as previously discussed,
will be required for the Company to further increase sales levels to those
necessary to attain profitable results from operations, provide funds to repay
the Company's outstanding obligations, meet the requirements to remove the bond
proceeds from escrow, refinance all or a portion of its short term debt into
longer term debt and meet its debt service schedule.

     The foregoing plan assumes that the Company will increase operating cash
flows throughout the future and that the bond proceeds will be released from
escrow. There can be no assurance that the Company will be able to maintain its
current operating levels or achieve increased production volumes and sales
levels required for increasing cash flows and profitability, or that the Company
will be successful in remarketing the bonds, or that the Company will be able to
release the funds from escrow after a successful remarketing of the bonds.

     During the second half of 2000, the Company greatly improved the
technological capability of its facilities and staff with the installation of
three servers for accounting, communication and production systems. At the same
time, AERT added 34 personal computers to support the new systems being
implemented. The computer capability enhanced the development of reports and
data in all departments of the Company. While the computer equipment was being
brought in, a local area network (LAN) was developed to support the Company's
information systems and provide for efficiencies and accuracy with the sharing
of data. The final phase of the LAN system has been completed during the first
quarter of 2001, with the hook-up of satellite communication equipment into the
Junction plant. With that final link in place, AERT now has more complete and
continuing communication with all our locations.

     Currently, standard operating procedures are being reviewed, improved and
upgraded, as necessary, for each production facility as we strive for continued
operations improvement and lower production costs. These standard operating
procedures improve efficiencies while at the same time provide for the sharing
of data so that daily monitoring occurs in the production processes at both the
plant locations. This responsive capability has helped improve efficiencies and
reduce problem areas. As AERT moves forward and the systems information flow
continues, less downtime and improved efficiencies are expected.

     The Company has recently begun introducing its decking products into the
home improvement market and initially into approximately 500 home improvement
warehouses or Big Box stores in select markets. This is in addition to its
existing contractor oriented decking dealer base through Weyerhaeuser. We
believe that this market segment is targeted towards the home improvement and
remodel market, which allows us more diversification during periods of economic
slowdowns or uncertainty. In conjunction with our diversification program we
have also introduced a new exterior trim and fascia product called
MoistureShield(R) CornerLoc(TM) which is designed to compliment fiber cement
siding. We have recently hired a new V.P. of Marketing and Sales, who joins us
after 32-years of industry experience, including Weyerhaeuser. Mr. Precht is
working to upgrade our marketing and sales group, in conjunction with improving
the sales focus of the Weyerhaeuser customer service and/or distribution
centers, in order to handle substantially increased sales. Initially, this is a
one-year effort jointly sponsored by Weyerhaeuser. These increased sales and
customer service efforts are designed to maximize our existing production
facilities to the $50 million sales range and position us to further increase
and time distribution and/or demand for our third composite extrusion facility.
As production and sales volume increase, we believe we can continue to improve
efficiencies and substantially reduce our overhead as a percentage of sales,
thus improving cash flows and profitability.

     The foregoing discussion contains certain estimates, predictions,
projections and other forward-looking statements (within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934) that involve various risks and uncertainties. While these
forward-looking statements, and any assumptions upon which they are based, are
made in good faith and reflect the Company's current judgment regarding the
direction of its business, actual results will almost always vary, sometimes
materially, from any estimates, predictions, projections, assumptions, or other
future performance suggested herein. Some important factors (but not necessarily
all factors) that could affect the Company's sales volumes, growth strategies,
future profitability and operating results, or that otherwise could cause actual
results to differ materially from those expressed in any forward-looking
statement include the following: market, political or other forces affecting the
pricing and availability of plastics and other raw material

                                        23
<PAGE>   25

accidents or other unscheduled shutdowns affecting the Company's, its suppliers'
or its customers' plants, machinery, or equipment; competition from products and
services offered by other enterprises; state and federal environmental,
economic, safety and other policies and regulations, any changes therein, and
any legal or regulatory delays or other factors beyond the Company's control;
execution of planned capital projects; weather conditions affecting the
Company's operations or the areas in which the Company's products are marketed;
adverse rulings, judgments, or settlements in litigation or other legal matters.
The Company undertakes no obligation to publicly release the result of any
revisions to any such forward-looking statements that may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.

INFORMATION SYSTEMS AND THE IMPACT OF THE YEAR 2000

     Through the date of this report, the Company completed the transition from
calendar year 2000 to calendar year 2001 without any major problems or
disruptions because of year 2000 issues. Additionally, no problems are expected
to arise because of any year 2000 related failure in the future.

ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     The Company has no material exposures relating to its long-term debt, due
to virtually all of the Company's long-term debt bearing interest at fixed
rates. See Note 5 to the financial statements for a discussion of the Company's
debt. The Company depends on the market for favorable long-term mortgage rates
to help generate sales of its product to its customers for use in the
residential construction industry. Should mortgage rates increase substantially,
the Company could be impacted by a reduction in the residential construction
industry. Important raw materials purchased by the Company are recycled plastic
and wood fiber, which are subject to price fluctuations. The Company attempts to
limit the impact of price increases on these materials by negotiating with each
of its suppliers on a term basis.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The response to this item is submitted in a separate section of this
report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

     There have been no disagreements on accounting and financial disclosures
with accountants during the periods reported upon herein.

                                        24
<PAGE>   26

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The directors and executive officers of the Company are as follows:

<TABLE>
<CAPTION>
             NAME                AGE                        POSITION
             ----                ---                        --------
<S>                              <C>    <C>
Joe G. Brooks..................  45     Chairman of the Board of Directors, Co-Chief
                                        Executive Officer and Interim President
Sal Miwa.......................  44     Vice-Chairman of the Board of Directors
Stephen W. Brooks..............  44     Co-Chief Executive Officer and Director
J. Douglas Brooks..............  41     Executive Vice-President
Marjorie S. Brooks.............  65     Secretary, Treasurer and Director
Edward J. Lysen................  63     Chief Financial Officer
Jerry B. Burkett...............  43     Director
James H. Culp..................  55     Director
Peter S. Lau...................  47     Director
Michael M. Tull................  47     Director
Samuel L. (Tony) Milbank.......  60     Director
</TABLE>

     The Company's Board of Directors elected Joe G. Brooks as its Chairman and
the Company's Co-Chief Executive Officer on December 11, 1998 and he is serving
as Interim President. Mr. Brooks has previously served as President and has been
a director since the Company's inception in December 1988. He was also
previously Chairman and CEO from inception until August 1993. Mr. Brooks is a
director and Chairman of the Standing Committee of the Arkansas Recycling
Coalition for Buy Recycled Business Alliance for the State of Arkansas and
serves on their Executive Committee. He is a member of Clean Texas 2000,
appointed by Governor George Bush in 1995. He is a past President, director and
independent consultant of Juniper Products, Inc., from July 1985 until December
1988, which was an artificial firelog manufacturing entity in Junction, Texas.
Mr. Brooks has been past President of Southern Minerals and Fibers, Inc. (SMF),
a producer of drilling mud and fluid additives.

     On December 11, 1998, the Company's Board of Directors elected Sal Miwa as
its Vice-Chairman. Mr. Miwa has served as its Chairman for 3 years before this
election. He has been an outside director of the Company since January 1994. Sal
Miwa is COO and Director of RealRead Inc., an online book sampling service
company located in New York, NY. For the past 20 years, he has been engaged in
various international businesses located in the North America, Japan and Europe.
He received his Masters degree in Aerospace Engineering from the Massachusetts
Institute of Technology.

     The Company's Board of Directors elected Stephen W. Brooks as Co-Chief
Executive Officer on December 11, 1998. Mr. Brooks has served as its Chief
Executive Officer and has been a director since January 1996. Mr. Brooks is CEO
and Chairman of the Board of Razorback Farms, Inc.; a Springdale, Arkansas based
firm that specializes in vegetables for processing. Mr. Brooks also serves on
the Board of the Ozark Food Processors Association.

     J. Douglas Brooks is Executive Vice-President and a previous board member.
Mr. Brooks serves on the Executive Committee and is in charge of Technical
Services, which includes Quality Assurance, R&D, Raw Material Processing,
Development and Sourcing. Mr. Brooks was previously Project Manager for AERT's
polyethylene recycling program with The Dow Chemical Company and is a joint
inventor on several of AERT's process patents for recycling polyethylene film
for composites. Mr. Brooks has previously served as an independent consultant to
Juniper Industries, Inc. and as Vice President of SMF.

     Marjorie S. Brooks has been Secretary, Treasurer and a director since the
Company's inception in December 1988. Mrs. Brooks also serves as a director of
Juniper Industries, Inc. and Razorback Farms, Inc., and has served as Secretary
and Treasurer of Brooks Investment Co., a holding company for the Brooks' family
investments, for more than the past thirty years.

                                        25
<PAGE>   27

     Edward J. Lysen joined AERT in April 1999 as Chief Financial Officer. Mr.
Lysen has over 30 years experience in financial management. Prior to entering
the private sector, Mr. Lysen was a consultant in the Management Consulting
Group, KPMG-Peat Marwick from 1966 to 1979. From 1979 to 1992, Mr. Lysen was Sr.
V.P, CFO and on the Board of Tuesday Morning, Inc., a publicly traded retailer.
From 1993 to 1996, he served as Chairman of the Board and CFO of Distribution
Data Management Systems, a computer service provider in the office products
industry. In 1996, Mr. Lysen entered the financial planning industry with AAL, a
leading fraternal benefits society. In 1998 to 1999, he was the CFO of Hairston
Roberson, a leading designer and manufacturer of women's fashion apparel. He has
an MBA in Finance from Northwestern University and is a Certified Public
Accountant.

     Jerry B. Burkett was appointed to the Board of Directors of the Company on
May 17, 1993. Mr. Burkett has been a rice and grain farmer since 1979 and has
been a principal in other closely held businesses. He is the past President of
the Arkansas County Farm Bureau.

     Dr. James H. Culp joined the AERT Board as Director of Technology in July
1996 and served as special board assistant to the CEO in October 1996. Dr. Culp
received a B.S. Degree in Chemistry from the University of Alabama and Ph.D.
Degree in Analytical and Nuclear Chemistry from Texas A&M University. Dr. Culp
was an Assistance Professor at Texas A&M University Chemical Oceanography for
two years before joining The Dow Chemical Company. Dr. Culp worked at Dow in
research, manufacturing, business development, and supply chain for 24 years.
His last responsibility at Dow was North American Supply Chain Director for
Engineering Thermoplastics and North American Recycle Plastics Director. Dr.
Culp retired from Dow in April 1996.

     Peter S. Lau was appointed an outside director to the Board of Directors of
the Company in April 1997. Mr. Lau is currently a director and Chief Executive
Officer of Cathay One, Inc. and he is the former CFO of Cathay Online, Inc. He
former managing director of corporate finance of American Fronteer Financial
Corporation (AFFC), formerly known as RAF Financial Corporation and a former
associate of Heng Fung Capital Inc., a merchant-banking group out of Hong Kong.
Mr. Lau is a graduate of the University of Hartford with a B.S. and M.S. in
accounting and is a Certified Public Accountant.

     Michael M. Tull was appointed a director to the Board of Directors of the
Company in December 1998. Mr. Tull is the President and majority owner of Tull
Sales Corporation, a manufacturer's representative company, which professionally
represents nine manufacturing companies and is responsible for sales and
marketing of those companies' window and door related components in the
southeastern Unites States. Mr. Tull serves on boards of several closely held
family businesses and is the President and a Board of Director member of the
National Wild Turkey Federation, which is one of the largest North American
conservation organizations with membership of 315,000.

     Samuel L. Milbank was elected to the Board of Directors as a director by
the shareholders at the July 2000 Annual Meeting. From 1997 to the present, Mr.
Milbank has been the Managing Director of Zanett Securities Corporation; an
investment bank advisory company focusing on small and micro capitalization
companies. From 1992 to 1996, Mr. Milbank was a Senior Vice President and Sales
Manager with Lehman Brothers, Inc. in New York, and managed and coordinated a
global sales coverage of central banks and official institutions. From 1973 to
1992, Mr. Milbank worked with Salomon Brothers, Inc. as a Director of Fixed
Income Sales. He has a BS from Columbia University and a MBA in Finance from The
Amos Tuck School of Business Administration at Dartmouth College.

     Joe G. Brooks, Stephen W. Brooks and J. Douglas Brooks are brothers and are
sons of Marjorie S. Brooks. There are no other familial relationships between
the current directors and executive officers.

     Each of the Company's directors has been elected to serve until the next
annual meeting of stockholders or until there successors are elected and
qualified. Officers serve at the discretion of the Board of Directors.

     The Audit Committee of the Board of Directors consists of three outside
directors of Peter S. Lau (Chairman), Jerry B. Burkett, and Sal Miwa. The Audit
Committee recommends engagement of the Company's independent accountants and is
primarily responsible for approving the services performed by the

                                        26
<PAGE>   28

Company's independent accountants and for reviewing and evaluating the Company's
accounting principles and its system of internal accounting controls.

     The Compensation and Stock Option Committee consists of Jerry B. Burkett
(Chairman), Sal Miwa, Marjorie S. Brooks and Michael M. Tull. The Compensation
and Stock Option Committee establishes and administers the Company's
compensation and stock option plans on behalf of the Board of Directors and
approves stock options granted thereunder.

     The Executive Committee consists of three outside board members with Sal
Miwa (Chairman), James H. Culp and Michael M. Tull and three executive
management members of Joe G. Brooks, Stephen W. Brooks, and J. Douglas Brooks.
The Executive Committee establishes corporate policies, manpower, technology,
cost accounting and day-to-day operations of the Company.

     The Litigation Committee consists of Joe G. Brooks (Chairman), James H.
Culp and Sal Miwa. The Litigation Committee establishes and administers the
Company's litigation plans on behalf of the Board of Directors.

     The Nominating Committee consists of Michael M. Tull (Chairman), Samuel L.
Milbank, Peter S. Lau and Marjorie S. Brooks. The Nominating Committee evaluates
the efforts of AERT and Board of Directors to maintain effective corporate
governance practices. The committee identifies candidates for election to the
Board of Directors.

ITEM 11. EXECUTIVE COMPENSATION

     The following table sets forth the aggregate cash compensation paid by the
Company during the three years ended December 31, 2000, to each executive
officer of the Company whose aggregate cash compensation earned exceeded
$100,000, and to the chief executive officer.

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                    LONG-TERM COMPENSATION
                                                                            AWARDS                               PAYOUTS
                                                                   -------------------------             ------------------------
                                       ANNUAL COMPENSATION          RESTRICTED    SECURITIES             LONG-TERM
            NAME AND              ------------------------------   ANNUAL STOCK   UNDERLYING             INCENTIVE    ALL OTHER
       PRINCIPAL POSITION         YEAR    SALARY     OTHER BONUS   COMPENSATION     AWARDS     OPTIONS    PAYOUTS    COMPENSATION
       ------------------         ----   --------    -----------   ------------   ----------   -------   ---------   ------------
<S>                               <C>    <C>         <C>           <C>            <C>          <C>       <C>         <C>
Stephen W. Brooks...............  2000          0         0             0             0           0          0            0
  Co-CEO                          1999          0         0             0             0           0          0            0
                                  1998          0         0             0             0           0          0            0
Joe G. Brooks...................  2000   $105,000(*)      0             0             0           0          0            0
  Co-CEO                          1999    105,000(*)      0             0             0           0          0            0
                                  1998     75,000         0             0             0           0          0            0
</TABLE>

---------------
* Accrued $30,000, which Joe G. Brooks did not receive as of December 31, 1999
  or 2000.

          AGGREGATED OPTION EXERCISES IN YEAR ENDED DECEMBER 31, 2000
                     AND OPTION VALUES AT DECEMBER 31, 2000

<TABLE>
<CAPTION>
                                                                                         VALUE OF UNEXERCISED
                                                                       NUMBER OF             IN-THE-MONEY
                                          NUMBER OF               UNEXERCISED OPTIONS          OPTIONS
                                           SHARES                 AT DECEMBER 31, 2000   AT DECEMBER 31, 2000
                                          ACQUIRED      VALUE         EXERCISABLE/           EXERCISABLE/
                 NAME                    ON EXERCISE   REALIZED      UNEXERCISABLE          UNEXERCISABLE
                 ----                    -----------   --------   --------------------   --------------------
<S>                                      <C>           <C>        <C>                    <C>
Stephen W. Brooks......................          0     $     0       475,000/50,000           $86,625/0
Joe G. Brooks..........................    120,000     $40,000       246,667/     0           $50,625/0
</TABLE>

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     The Board of Directors, as a whole, reviews and acts upon personnel
policies and executive compensation matters. Joe G. Brooks and Stephen W. Brooks
serve as executive officers of the Company; however, such

                                        27
<PAGE>   29

individuals do not participate in compensation decisions or in forming
compensation policies in which they have a personal interest, nor do they vote
on any such matters.

LIMITED LIABILITY OF OFFICERS AND DIRECTORS

     The Delaware Supreme Court has held that a director's duty of care to a
corporation and its stockholders requires the exercise of an informed business
judgment. Having become informed of all material information reasonably
available to them, directors must act with requisite care in the discharge of
their duties. The Delaware General Corporation law permits a corporation through
its Certificate of Incorporation to exonerate its directors from personal
liability to the corporation or its stockholders for monetary damages for breach
of the fiduciary duty of care as a director, with certain exceptions. The
exceptions include a breach of the director's duty of loyalty, acts or omissions
not in good faith or which involve intentional misconduct or knowing violations
of law, improper declarations of dividends and transactions from which the
directors derived an improper personal benefit. The Company's Certificate of
Incorporation exonerates its directors, acting in such capacity, from monetary
liability to the extent permitted by this statutory provision. The limitation of
liability provision does not eliminate a stockholder's right to seek
non-monetary, equitable remedies such as injunction or rescission to redress an
action taken by directors. However, as a practical matter, equitable remedies
may not be available in all situations and there may be instances in which no
effective remedy is available.

                                        28
<PAGE>   30

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth, as of December 31, 2000, certain
information with regard to the beneficial ownership of the Company's capital
stock by each holder of 5% or more of the outstanding stock, by each director of
the Company, and by all officers and directors as a group:

<TABLE>
<CAPTION>
        NAME AND ADDRESS           TITLE OF   NUMBER OF SHARES OF   PERCENTAGE OF CLASS      PERCENTAGE OF
      OF BENEFICIAL OWNER          CLASS(1)     COMMON STOCK(2)     OUTSTANDING(2)(15)    VOTING POWER(2)(16)
      -------------------         ----------  -------------------   -------------------   -------------------
<S>                               <C>         <C>                   <C>                   <C>
Marjorie S. Brooks..............  Class A         11,147,998(3)            23.4%                 27.8%
  P. O. Box 1237                  Class B            837,588(4)            57.2%
  Springdale, AR 72765            Preferred-
                                  Series B               400(5)            13.8%
Joe G. Brooks...................  Class A            938,397(6)             2.0%                  4.0%
  P. O. Box 1237                  Class B            284,396               19.4%
  Springdale, AR 7276
J. Douglas Brooks...............  Class A            941,573(7)             2.0%                  2.7%
  P. O. Box 1237                  Class B            131,051                8.9%
  Springdale, AR 72765
Jerry B. Burkett................  Class A            190,000(8)               *                     *
  P. O. Box 1237                  Class B             33,311                2.3%
  Springdale, AR 72765
Sal Miwa........................  Class A            431,963(9)               *                     *
  P. O. Box 1237
  Springdale, AR 72765
Stephen W. Brooks...............  Class A            845,116(10)            1.8%                  2.2%
  P. O. Box 1237                  Class B             89,311                6.1%
  Springdale, AR 72765
James H. Culp, Ph.D. ...........  Class A            425,000(11)              *                     *
  P. O. Box 1237
  Springdale, AR 72765
Peter S. Lau....................  Class A            129,715(12)              *                     *
  P. O. Box 1237
  Springdale, AR 72765
Michael M. Tull.................  Class A            121,000(13)              *                   1.9%
  P. O. Box 1237                  Preferred-
  Springdale, AR 72765            Series B               400               13.8%
Samuel L. (Tony) Milbank........  Class A            499,899(14)            1.1%                    *
  P. O. Box 1237                  Preferred-
  Springdale, AR 72765            Series A                15                  *
Officers and directors..........  Class A         15,670,661               32.9%                 41.7%
  as a group (nine persons)       Class B          1,375,657               93.9%
                                  Preferred-
                                  Series A                15
                                  Series B               800               27.6%
</TABLE>

---------------
  *  Less than 1%

 (1) The Class B common stock is substantially identical to the Class A common
     stock, except that each share of Class B common stock has five votes per
     share and each share of Class A common stock has one vote per share. Each
     share of Class B common stock is convertible into one share of Class A
     common stock. Each share of Preferred Stock is convertible into 833 1/3
     shares of Class A common stock. The Series B Preferred Stock (900 shares)
     has voting rights of 2,500 votes per share. No other Preferred Stock
     carries any voting rights.

 (2) Beneficial ownership of shares was determined in accordance with Rule
     13d-3(d)(1) of the Exchange Act and included shares underlying outstanding
     warrants and options which the named individual had the right to acquire
     within sixty days of December 31, 2000.

 (3) Includes 2,608,940 shares owned directly, 493,645 in trusts controlled by
     Mrs. Brooks, 1,100,000 shares issuable upon exercise of stock options,
     3,000 shares issuable upon exercise of Bonus Warrants, 325,000

                                        29
<PAGE>   31

shares issuable upon exercise of Class C Warrants, 3,974,080 shares issuable
upon exercise of Class F and Class G Warrants issued in connection with a
private placement of Class A common stock in May of 1994, 2,000,000 shares
     issuable upon exercise of Class H Warrants, and 493,333 shares issuable
     upon exercise of Series X and Series Y Warrants owned indirectly through
     two corporations controlled by Mrs. Brooks.

 (4) Includes 403,946 shares owned directly by Mrs. Brooks and 433,642 shares
     owned by two corporations controlled by Mrs. Brooks. (Razorback Farms, Inc.
     is the record owner of 312,320 shares and SMF is the record owner of
     121,322 shares, representing approximately 21.3% and 8.3%, respectively, of
     the Class B common stock). Excludes additional shares owned by adult
     children of Mrs. Brooks, including Joe G. Brooks and J. Douglas Brooks, as
     to which she disclaims a beneficial interest.

 (5) Includes Series B Preferred Stock owned indirectly by Mrs. Brooks.
     Razorback Farms, Inc. is the record owner of 165 shares. Brooks Investment
     Company is the record owner of 235 shares.

 (6) Includes 354,067 shares owned directly, 4,500 shares owned as custodian for
     Joe G. Brooks' minor child, 38,205 shares owned as custodian for Brooks'
     Children's Trust, 1,500 shares issuable upon exercise of Bonus Warrants
     owned as custodian for Mr. Brook's minor child, 38,250 shares issuable upon
     exercise of Bonus Warrants owned as custodian for Brook's Children's Trust,
     1,875 shares issuable upon exercise of Bonus Warrants owned directly and
     400,000 shares issuable upon exercise of stock options.

 (7) Includes 370,932 shares owned directly, 33,021 shares owned indirectly,
     7,620 shares issuable upon exercise of Bonus Warrants and 420,000 shares
     issuable upon exercise of stock options.

 (8) Includes 13,000 shares owned directly, 2,000 shares owned by Mr. Burkett as
     custodian for his minor child, 10,000 shares owned by a partnership
     controlled by Mr. Burkett and 140,000 shares issuable upon exercise of
     stock options.

 (9) Includes 3,000 shares owned directly and 425,000 shares issuable upon
     exercise of stock options.

(10) Includes 370,116 shares owned directly and 375,000 shares issuable upon
     exercise of stock options.

(11) Represents shares issuable upon exercise of stock options.

(12) Includes 75,000 shares issuable upon exercise of stock options and 29,715
     shares issuable upon exercise of Class I Warrants.

(13) Includes 71,000 shares owned directly and 25,000 shares issuable upon
     exercise of stock options.

(14) Includes 142,946 shares owned directly or indirectly, 80,000 shares
     issuable upon exercise of consulting warrants, 45,150 shares issuable upon
     exercise of placement warrants, 112,697 shares issuable upon exercise of
     Series X warrants, 41,604 shares issuable upon exercise of Series Y
     Warrants, and 77,502 shares issuable upon exercise of Class I Warrants.

(15) Class A common stock beneficial ownership is calculated based on 47,580,718
     shares outstanding as of December 31, 2000, which includes 21,825,397
     shares which any person has the right to acquire through the exercise of
     options and warrants within 60 days of December 31, 2000. Class B common
     stock beneficial ownership is calculated based on 1,465,530 shares
     outstanding on December 31, 2000. Preferred stock beneficial ownership is
     calculated based on 2,900 shares outstanding on December 31, 2000.

(16) Calculated based on 57,855,029 shares outstanding on December 31, 2000,
     which includes voting rights on all classes of stock, options and warrants
     which can be acquired within 60 days of December 31, 2000.

     At December 31, 2000, there were 25,755,321 shares of Class A common stock
and 1,465,530 shares of Class B common stock issued and outstanding. The
previous table sets forth that directors, officers and 5% shareholders, as a
group, directly owned shares representing approximately 41.7% of the votes
entitled to be cast upon matters submitted to a vote of the Company's
stockholders, and Marjorie S. Brooks and corporations controlled by her owned
shares representing approximately 27.8% of the votes entitled to be cast and may
be in a position to control the Company.

                                        30
<PAGE>   32

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     During January 2000, the Company had an agreement with an affiliate whereby
the Company agreed to transfer certain of its trade receivables as collateral,
which the affiliate deemed acceptable, up to $2 million at any one time. In
February 2000, the Company's major shareholder increased the Company's factoring
line to $2.5 million. The Company believes that the current terms for its
factoring agreement with its major shareholder is competitive with, if not
better than, terms that might be obtained from outside sources. Upon acceptance
of a transfer of a receivable, the affiliate remitted to the Company 85% of the
receivable, as defined in the agreement. Upon collection of the receivable the
Company remitted to the affiliate 1.75% of the receivable as a factoring charge,
and the additional 13.25% of the receivable was remitted to the Company, less
interest costs, which were based on the time period over which the receivable
was outstanding. The Company indemnified the affiliate for any loss arising out
of rejections or returns of any merchandise, or any claims asserted by the
Company's customers. During 2000, the Company transferred an aggregate of
approximately $28,231,000 in receivables under this agreement, of which
$1,817,544 remained to be collected as of December 31, 2000. During 1999 and
1998, the Company transferred an aggregate of approximately $20,500,000 and
$12,863,000, respectively, in receivables under this agreement, none of which
remains to be collected. Costs of approximately $470,794, $202,034 and $113,189
associated with the factoring agreement were included in selling and
administrative costs at December 31, 2000, 1999 and 1998, respectively.

     At December 31, 2000, accounts payable-related parties included advances on
factored receivables of approximately $1,639,351 and $224,937 relating to other
items owed to related parties.

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

     (a1), (a2), and (d). The Financial Statements listed in the accompanying
Index to Financial Statements are filed as part of this report and such Index is
hereby incorporated by reference. All schedules for which provision is made in
the applicable accounting regulation on the Securities and Exchange Commission
are not required under the related instructions or are inapplicable, and
therefore have been omitted.

     (a3) and (c). The exhibits listed in the accompanying Index to Exhibits are
filed or incorporated by reference as part of this report and such Index is
hereby incorporated by reference.

     (b) No reports on Form 8-K were filed during the last quarter of the period
covered by this report.

                                        31
<PAGE>   33

                                   SIGNATURES

     PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF
BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED, IN THE CITY OF SPRINGDALE, STATE
OF ARKANSAS, ON THE 12TH DAY OF APRIL, 2001.

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

<TABLE>
<S>                                                    <C>
                By: /s/ JOE G. BROOKS                                   /s/ EDWARD J. LYSEN
  -------------------------------------------------    -----------------------------------------------------
                   Joe G. Brooks,                                        Edward J. Lysen,
                      Chairman                                        Chief Financial Officer

                Date: April 12, 2001                                      April 12, 2001
</TABLE>

     PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.

<TABLE>
<CAPTION>
                      SIGNATURE                                     TITLE                     DATE
                      ---------                                     -----                     ----
<C>                                                    <C>                               <S>
                  /s/ JOE G. BROOKS                         Chairman of the Board,       April 12, 2001
-----------------------------------------------------        Co-CEO and Director
                    Joe G. Brooks

                    /s/ SAL MIWA                          Vice-Chairman and Director     April 12, 2001
-----------------------------------------------------
                      Sal Miwa

                /s/ STEPHEN W. BROOKS                        Co-CEO and Director         April 12, 2001
-----------------------------------------------------
                  Stephen W. Brooks

                  /s/ JOE G. BROOKS                           Interim-President          April 12, 2001
-----------------------------------------------------
                    Joe G. Brooks

               /s/ MARJORIE S. BROOKS                      Secretary, Treasurer and      April 12, 2001
-----------------------------------------------------              Director
                 Marjorie S. Brooks

                /s/ JERRY B. BURKETT                               Director              April 12, 2001
-----------------------------------------------------
                  Jerry B. Burkett

                  /s/ JAMES H. CULP                                Director              April 12, 2001
-----------------------------------------------------
                    James H. Culp

                  /s/ PETER S. LAU                                 Director              April 12, 2001
-----------------------------------------------------
                    Peter S. Lau

                 /s/ MICHAEL M. TULL                               Director              April 12, 2001
-----------------------------------------------------
                   Michael M. Tull

                /s/ SAMUEL L. MILBANK                              Director              April 12, 2001
-----------------------------------------------------
                  Samuel L. Milbank
</TABLE>

                                        32
<PAGE>   34

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                 PAGE
                                                                 ----
<S>                                                           <C>
Financial Statements:
  Report of Independent Public Accountants..................         F-2
  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 - F-27
</TABLE>

                                       F-1
<PAGE>   35

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of
Advanced Environmental Recycling Technologies, Inc.:

     We have audited the accompanying balance sheets of Advanced Environmental
Recycling Technologies, Inc. (a Delaware corporation) as of December 31, 2000
and 1999, and the related statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 2000.
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 auditing standards generally
accepted in the United States. 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 Advanced Environmental
Recycling Technologies, Inc., as of December 31, 2000 and 1999, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States.

     The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has incurred net losses since inception, has a
working capital deficit at December 31, 2000, and is subject to certain claims
in litigation as discussed in Note 10. These factors, among others, as discussed
in Note 2, raise substantial doubt concerning the ability of the Company to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 2. The financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result should
the Company be unable to continue as a going concern.

                                          /s/ ARTHUR ANDERSEN LLP

Fayetteville, Arkansas
March 30, 2001

                                       F-2
<PAGE>   36

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                                 BALANCE SHEETS

                                     ASSETS

<TABLE>
<CAPTION>
                                                              DECEMBER 31,    DECEMBER 31,
                                                                  2000            1999
                                                              ------------    ------------
<S>                                                           <C>             <C>
Current assets:
  Cash......................................................  $    603,629    $    187,173
  Restricted bond escrow fund...............................    16,661,330      16,593,696
  Accounts receivable, net of allowance of $84,858 in 2000
     and $20,000 in 1999....................................     1,925,969       1,587,368
  Inventories...............................................     1,657,666       1,274,771
  Prepaid expenses..........................................       118,775         149,682
                                                              ------------    ------------
          Total current assets..............................    20,967,369      19,792,690
                                                              ------------    ------------
Land, buildings and equipment:
  Land......................................................       889,528              --
  Buildings and leasehold improvements......................     1,129,609       1,044,096
  Machinery and equipment...................................    18,741,162      13,981,153
  Transportation equipment..................................       175,385         162,400
  Office equipment..........................................       338,501         210,024
  Construction in progress..................................     1,143,301       2,747,290
                                                              ------------    ------------
                                                                22,417,486      18,144,963
Less accumulated depreciation and amortization..............     9,608,669       7,227,875
                                                              ------------    ------------
Net land, buildings and equipment...........................    12,808,817      10,917,088
                                                              ------------    ------------
Other assets, at cost less accumulated amortization of
  $352,364 in 2000 and
  $300,161 in 1999..........................................     1,482,118         746,015
                                                              ------------    ------------
                                                              $ 35,258,304    $ 31,455,793
                                                              ============    ============
                           LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable -- trade.................................  $  5,175,326    $  5,110,787
  Accounts payable -- related parties.......................     2,109,350       2,030,262
  Current maturities of long-term debt......................       242,689          70,013
  Accrued liabilities.......................................     1,296,628         933,543
  Notes payable -- related parties..........................       250,000         550,000
  Notes payable -- other....................................     2,198,368       2,354,944
  Bonds payable.............................................    16,500,000      16,500,000
                                                              ------------    ------------
          Total current liabilities.........................    27,772,361      27,549,549
                                                              ------------    ------------
Long-term debt, less current maturities.....................     4,486,156          59,656
                                                              ------------    ------------
Accrued premium on convertible preferred stock..............       290,404         337,890
                                                              ------------    ------------
Commitments and contingencies
Stockholders' equity, per accompanying statements:
  Preferred stock, $1 par value; 5,000,000 shares
     authorized; 2,900 shares issued and outstanding as of
     December 31, 2000 and 1999, respectively...............         2,900           2,900
  Class A common stock, $.01 par value; 75,000,000 shares
     authorized; 25,755,321 and 24,251,497 shares issued and
     outstanding as of December 31, 2000 and 1999,
     respectively...........................................       257,553         242,515
  Class B convertible common stock, $.01 par value;
     7,500,000 shares authorized; 1,465,530 shares issued
     and outstanding as of December 31, 2000 and 1999,
     respectively...........................................        14,655          14,655
  Additional paid-in capital................................    29,851,360      28,459,192
  Accumulated deficit.......................................   (27,417,085)    (25,210,564)
                                                              ------------    ------------
          Total stockholders' equity........................     2,709,383       3,508,698
                                                              ------------    ------------
          Total liabilities and stockholders' equity........  $ 35,258,304    $ 31,455,793
                                                              ============    ============
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                       F-3
<PAGE>   37

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31,
                                                      -----------------------------------------
                                                         2000           1999           1998
                                                      -----------    -----------    -----------
<S>                                                   <C>            <C>            <C>
Net sales...........................................  $27,508,864    $19,917,133    $12,408,591
Cost of goods sold..................................   22,650,739     17,166,024     11,688,448
                                                      -----------    -----------    -----------
Gross margin........................................    4,858,125      2,751,109        720,143
Selling and administrative costs....................    5,958,830      3,766,779      3,220,233
                                                      -----------    -----------    -----------
Operating loss......................................   (1,100,705)    (1,015,670)    (2,500,090)
                                                      -----------    -----------    -----------
Other income (expense)
  Interest income...................................      960,048        187,508             --
  Interest expense..................................   (1,775,864)      (645,574)    (1,105,090)
                                                      -----------    -----------    -----------
                                                         (815,816)      (458,066)    (1,105,090)
                                                      -----------    -----------    -----------
Loss before accrued premium on preferred stock......   (1,916,521)    (1,473,736)    (3,605,180)
Accrued premium on preferred stock..................     (290,000)      (290,000)       (47,890)
                                                      -----------    -----------    -----------
Net loss applicable to common stock.................  $(2,206,521)   $(1,763,736)   $(3,653,070)
                                                      -----------    -----------    -----------
Loss per share of common stock (Basic and
  Diluted)..........................................  $      (.08)   $      (.07)   $      (.16)
                                                      ===========    ===========    ===========
Weighted average number of common shares outstanding
  (Basic and Diluted)...............................   26,059,013     24,598,715     22,895,517
                                                      ===========    ===========    ===========
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                       F-4
<PAGE>   38

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                       STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                                CLASS A                CLASS B
                                       PREFERRED STOCK       COMMON STOCK           COMMON STOCK       ADDITIONAL
                                       ---------------   ---------------------   -------------------     PAID-IN     ACCUMULATED
                                       SHARES   AMOUNT     SHARES      AMOUNT     SHARES     AMOUNT      CAPITAL       DEFICIT
                                       ------   ------   ----------   --------   ---------   -------   -----------   ------------
<S>                                    <C>      <C>      <C>          <C>        <C>         <C>       <C>           <C>
BALANCE -- DECEMBER 31, 1997.........     --    $  --    20,312,969   $203,130   1,465,530   $14,655   $21,926,331   $(19,793,758)
Issuance of shares for payment of
  interest on bridge financings......     --       --       260,708      2,607          --        --       282,803             --
Exercise of stock options............     --       --       493,333      4,933          --        --       148,267             --
Exercise of Class B Warrants.........     --       --       779,670      7,797          --        --       926,233             --
Exercise of Class C Warrants.........     --       --       275,000      2,750          --        --       327,250             --
Exercise of Consultant Warrants......     --       --        60,000        600          --        --        21,900             --
Cashless exercise of Placement
  Warrants...........................     --       --        40,434        404          --        --          (404)            --
Issuance of Class A Common Stock to
  Vendor.............................     --       --        23,525        235          --        --        10,798             --
Issuance of extension warrants
  relating to extension of first
  bridge financing...................     --       --            --         --          --        --        19,685             --
Debt discount on consulting and
  Placement Warrants.................     --       --            --         --          --        --       619,355             --
Net proceeds from issuance of
  Preferred Stock....................  2,900    2,900            --         --          --        --     2,702,100             --
Net loss.............................     --       --            --         --          --        --            --     (3,653,070)
                                       -----    ------   ----------   --------   ---------   -------   -----------   ------------
BALANCE -- DECEMBER 31, 1998.........  2,900    2,900    22,245,639    222,456   1,465,530    14,655    26,984,318    (23,446,828)
Issuance of shares for payment of
  interest on bridge financings......     --       --       124,823      1,248          --        --       122,867             --
Issuance of options in payment of
  expenses...........................     --       --            --         --          --        --        12,347             --
Exercise of stock options............     --       --       132,500      1,325          --        --       160,600             --
Exercise of Class B Warrants.........     --       --       257,994      2,580          --        --       274,763             --
Exercise of Class F Warrants.........     --       --       350,864      3,509          --        --       210,518             --
Exercise of Class G Warrants.........     --       --       481,810      4,818          --        --       437,138             --
Exercise of Class I Warrants.........     --       --        29,367        294          --        --        27,238             --
Exercise of Consulting Warrants......     --       --       600,000      6,000          --        --       219,000             --
Exercise of Placement Warrants.......                        28,500        285          --        --        10,403             --
Net loss.............................     --       --            --         --          --        --            --     (1,763,736)
BALANCE -- DECEMBER 31, 1999.........  2,900    2,900    24,251,497    242,515   1,465,530    14,655    28,459,192    (25,210,564)
                                       -----    ------   ----------   --------   ---------   -------   -----------   ------------
Exercise of stock options............     --       --       465,000      4,650          --        --       275,559             --
Exercise of Class H Warrants.........     --       --       228,208      2,282          --        --        97,718             --
Exercise of Class J Warrants.........     --       --       100,000      1,000          --        --        49,000             --
Exercise of Placement Warrants.......     --       --       129,574      1,296          --        --        47,295             --
Issuance of stock in payment of debt
  acquisition expenses...............     --       --       150,000      1,500          --        --       429,750             --
Issuance of stock in payment of
  debt...............................     --       --       150,000      1,500          --        --       148,500             --
Compensation expense on non-employee
  options............................     --       --            --         --          --        --         9,896             --
Issuance of shares in payment of
  accrued premium on preferred
  stock..............................                       281,042      2,810          --        --       334,450             --
Net loss.............................     --       --            --         --          --        --            --     (2,206,521)
                                       -----    ------   ----------   --------   ---------   -------   -----------   ------------
BALANCE -- DECEMBER 31, 2000.........  2,900    $2,900   25,755,321   $257,553   1,465,530   $14,655   $29,851,360   $(27,417,085)
                                       =====    ======   ==========   ========   =========   =======   ===========   ============

<CAPTION>

                                          TOTAL
                                       -----------
<S>                                    <C>
BALANCE -- DECEMBER 31, 1997.........  $ 2,350,358
Issuance of shares for payment of
  interest on bridge financings......      285,410
Exercise of stock options............      153,200
Exercise of Class B Warrants.........      934,030
Exercise of Class C Warrants.........      330,000
Exercise of Consultant Warrants......       22,500
Cashless exercise of Placement
  Warrants...........................           --
Issuance of Class A Common Stock to
  Vendor.............................       11,033
Issuance of extension warrants
  relating to extension of first
  bridge financing...................       19,685
Debt discount on consulting and
  Placement Warrants.................      619,355
Net proceeds from issuance of
  Preferred Stock....................    2,705,000
Net loss.............................   (3,653,070)
                                       -----------
BALANCE -- DECEMBER 31, 1998.........    3,777,501
Issuance of shares for payment of
  interest on bridge financings......      124,115
Issuance of options in payment of
  expenses...........................       12,347
Exercise of stock options............      161,925
Exercise of Class B Warrants.........      277,343
Exercise of Class F Warrants.........      214,027
Exercise of Class G Warrants.........      441,956
Exercise of Class I Warrants.........       27,532
Exercise of Consulting Warrants......      225,000
Exercise of Placement Warrants.......       10,688
Net loss.............................   (1,763,736)
BALANCE -- DECEMBER 31, 1999.........    3,508,698
                                       -----------
Exercise of stock options............      280,209
Exercise of Class H Warrants.........      100,000
Exercise of Class J Warrants.........       50,000
Exercise of Placement Warrants.......       48,591
Issuance of stock in payment of debt
  acquisition expenses...............      431,250
Issuance of stock in payment of
  debt...............................      150,000
Compensation expense on non-employee
  options............................        9,896
Issuance of shares in payment of
  accrued premium on preferred
  stock..............................      337,260
Net loss.............................   (2,206,521)
                                       -----------
BALANCE -- DECEMBER 31, 2000.........  $ 2,709,383
                                       ===========
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                       F-5
<PAGE>   39

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31,
                                                      -----------------------------------------
                                                         2000           1999           1998
                                                      -----------    -----------    -----------
<S>                                                   <C>            <C>            <C>
Cash flows from operating activities:
  Net loss applicable to common stock...............  $(2,206,521)   $(1,763,736)   $(3,653,070)
  Adjustments to reconcile net loss to net cash
     provided by (used in) operating activities:
     Depreciation and amortization..................    2,463,645      1,968,508      2,500,350
     Premium accrued on preferred stock.............      290,000        290,000         47,890
     Expenses paid through issuance of stock                9,896         12,347             --
       options......................................
     Loss on disposition of equipment...............           --         82,052          1,964
     Provision for discounts and doubtful                  64,858             --             --
       accounts.....................................
     (Increase) decrease in other assets............       18,860        (31,374)       271,527
     Changes in current assets and current             (1,592,215)      (221,188)       870,066
       liabilities..................................
                                                      -----------    -----------    -----------
Net cash provided by (used in) operating                 (951,477)       336,609         38,727
  activities........................................
                                                      -----------    -----------    -----------
Cash flows from investing activities:
  Additions to land, buildings and equipment........   (2,826,230)    (2,552,511)    (3,674,969)
  Proceeds from sale of equipment...................           --         35,000          4,722
                                                      -----------    -----------    -----------
Net cash used in investing activities...............   (2,826,230)    (2,517,511)    (3,670,247)
                                                      -----------    -----------    -----------
Cash flows from financing activities:
  Proceeds from issuance of notes...................    4,500,000        950,000      1,380,842
  Payments on notes.................................     (767,313)      (779,677)      (384,750)
  Increase in accounts payable -- related parties...      456,337        487,568        161,651
  Debt acquisition costs............................     (423,434)      (360,521)      (276,542)
  Interest paid through issuance of Class A common             --        124,115        285,410
     stock..........................................
  Proceeds from issuance of preferred stock.........           --             --      1,155,000
  Proceeds from exercise of stock options and             428,573      1,332,096      1,878,975
     warrants, net..................................
                                                      -----------    -----------    -----------
Net cash provided by financing activities...........    4,194,163      1,753,581      4,200,586
                                                      -----------    -----------    -----------
Increase (decrease) in cash and cash equivalents....      416,456       (427,321)       569,066
Cash, beginning of period...........................      187,173        614,494         45,428
                                                      -----------    -----------    -----------
Cash, end of period.................................  $   603,629    $   187,173    $   614,494
                                                      ===========    ===========    ===========
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                       F-6
<PAGE>   40

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                         NOTES TO FINANCIAL STATEMENTS

NOTE 1: DESCRIPTION OF THE COMPANY

     Advanced Environmental Recycling Technologies, Inc. (the Company or AERT)
manufactures a line of composite building materials from reclaimed plastic and
wood fiber waste for certain specialized applications in the construction
industry. The Company markets this material as a substitute for wood and plastic
filler materials for standard door components, windowsills, brick mould, fascia
board, decking and heavy industrial flooring. The Company is comprised of two
manufacturing facilities located in Junction, Texas and Springdale, Arkansas.
The Company's customers primarily consist of a number of regional and national
door and window manufacturers, industrial-flooring companies and Weyerhaeuser,
the Company's primary decking customer.

NOTE 2: FUTURE OPERATIONS

     The financial statements of the Company have been prepared on the basis of
accounting principles applicable to a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. At December 31, 2000, the Company had a working capital deficit of
$6.8 million and had incurred net losses of approximately $2.2 million, $1.8
million and $3.7 million for the years ended December 31, 2000, 1999 and 1998,
respectively. The Company has incurred net losses in each year since its
inception and has never operated at successful manufacturing levels over an
extended period. Further, the Company has limited additional financial resources
available to support its operations and in the past few years has, in large
part, been supported by certain major shareholders and several accredited
investors. There is no commitment for such shareholders or accredited investors
to continue such support. As discussed in the following paragraphs, the Company
will require additional financial resources in order to complete its production
plan and fund maturities of debt and other obligations as they become due.
Additionally, the Company's stock price and net equity positions are at risk of
not meeting the minimum Nasdaq requirements for continued listing of the
Company's stock. If the Company's stock were to be delisted, certain debt could
become immediately due and payable.

     The Company also has claims and litigation outstanding against it as
described in Note 10, the outcome, of which is uncertain. If the litigated
claims were to be assessed against the Company, the Company would likely be
unable to pay such claims. These factors, among others, raise substantial doubt
concerning the ability of the Company to continue as a going concern. The
financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might result should the Company be unable to
continue as a going concern. The ability of the Company to continue as a going
concern is dependent upon the ongoing support of its stockholders, investors,
customers and creditors, maintaining listing of its common stock, and its
ability to successfully mass produce and market its products at economically
feasible levels.

     The Company is currently implementing a production plan, which management
believes will provide better operating efficiencies and correct the production
problems encountered in the past. The plan includes increasing production
capacity, further automating the production process and better utilizing
regrindable scrap. If the Company is successful in breaking escrow of the $16.5
million bond proceeds, as discussed below, the Company anticipates reducing its
working capital deficit by paying off the bridge notes payable and being
reimbursed for significant working capital for qualifying expenditures already
incurred. During 2000, the Springdale plant put its third extrusion line in
operation with a new material transfer system.

     As discussed in Note 5, the Company closed a $16.5 million tax-exempt
industrial bond financing into escrow in October 1999, intended to refinance and
shift its construction related accounts payable into long-term financing. In
order for the Company to receive the bond financing the Company must meet
certain financial and operating criteria unless waived by the holder of 100% of
the Bonds. These include delivering to the Trustee satisfactory evidence that
for any consecutive 12 month period commencing on or after the date of the
issuance of the bonds, the long-term debt service coverage ratio, as defined,
has been not less than 2 to 1,
                                       F-7
<PAGE>   41
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

and the projected long-term debt service coverage ratio for the 24 month period
subsequent to the first disbursement shall not be less than 2 to 1. There is no
assurance the Company will be successful in meeting the standards required to
receive the bond financing proceeds or in obtaining necessary financial
resources from other sources (see Note 5).

     Completion of the production plan will require that the Company receive the
proceeds from the bond financing or obtain additional debt or equity financing
beyond those resources currently available to the Company. Also, additional
financial resources will be necessary to fund maturities of debt and other
obligations as they come due in 2001. There is no assurance the Company will be
able to correct prior production problems and improve operating efficiencies or
that the Company will be successful in securing capital resources to complete
its production plan, fund maturities of debt and other obligations as they
become due in 2001 or to support the Company until such time, if ever, that the
Company is able to consistently generate income from operations.

NOTE 3: SIGNIFICANT ACCOUNTING POLICIES

  Revenue Recognition Policy

     Revenue is recognized at the time of shipment.

  Statements of Cash Flows

     In order to determine net cash provided by (used in) operating activities,
net loss has been adjusted by, among other things, changes in current assets and
current liabilities, excluding changes in cash and cash equivalents, current
maturities of long-term debt and current notes payable. Those changes, shown as
an (increase) decrease in current assets and an increase (decrease) in current
liabilities, are as follows:

<TABLE>
<CAPTION>
                                               YEAR ENDED DECEMBER 31,
                                        --------------------------------------
                                           2000          1999          1998
                                        -----------    ---------    ----------
<S>                                     <C>            <C>          <C>
Receivables...........................  $  (403,459)   $(824,752)   $ (172,155)
Note receivable.......................           --           --        81,571
Inventories...........................     (382,895)    (428,200)     (110,874)
Prepaid expenses and other............       94,561      (69,135)      (95,581)
Accounts payable --
  Trade and related parties...........   (1,263,507)     602,426     1,042,716
Accrued liabilities...................      363,085      498,473       124,389
                                        -----------    ---------    ----------
                                        $(1,592,215)   $(221,188)   $  870,066
                                        ===========    =========    ==========
Cash paid for interest................  $ 1,437,703    $ 218,296    $   52,395
                                        ===========    =========    ==========
</TABLE>

                                       F-8
<PAGE>   42
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

     Supplemental Disclosures of Non-cash Investing and Financing Activities:

<TABLE>
<CAPTION>
                                                   2000          1999           1998
                                                ----------    -----------    ----------
<S>                                             <C>           <C>            <C>
Notes payable for financing of insurance
  policies....................................  $  186,988    $   133,038    $  104,027
Accounts/notes payable for equipment..........   1,348,530      2,125,547       280,248
Bond financing proceeds received in escrow....          --     16,500,000            --
Class A Common Stock issued in payment of debt
  acquisition costs...........................     431,250             --            --
Receivable from exercise of stock options.....          --         26,375            --
Capital lease obligation for equipment........      25,192             --       110,000
Class A Common Stock issued in payment of
  account payable.............................          --             --        11,033
Series B Preferred Stock issued in payment of
  accounts payable -- related parties.........          --             --       400,000
Series B Preferred Stock issued in payment of
  notes payable...............................          --             --       100,000
Series A Preferred Stock issued in payment of
  notes payable...............................          --             --     1,050,000
Stock issued in payment of notes payable......     200,000             --            --
Non-cash payment for financing costs..........          --             --        19,685
</TABLE>

  Buildings and Equipment

     Buildings and equipment contributed to the Company in exchange for Class B
common stock are carried at the contributor's historical book value. Property
additions and betterments include capitalized interest and acquisition,
construction and administrative costs allocable to construction projects and
property purchases.

     Gains or losses on sales or other dispositions of property are credited or
charged to income in the period incurred. Repairs and maintenance costs are
charged to income in the period incurred, unless it is determined that the
useful life of the respective asset has been extended.

     Provision for depreciation of buildings and equipment is provided on a
straight-line basis for buildings, leasehold improvements, machinery,
transportation equipment and office equipment over the lesser of the estimated
useful life of the asset or the term of the lease. Depreciation expense
recognized by the Company for the years ended December 31, 2000, 1999 and 1998
was approximately $2.3 million, $1.8 million and $1.4 million, respectively.
Estimated useful lives are: buildings -- 5 to 19 years, leasehold
improvements -- 6 years, transportation equipment -- 3 to 5 years, office
equipment -- 5 years and machinery and equipment -- 3 to 8 years. The Company
had $3,859,677 of fully depreciated assets as of December 31, 2000.

     The Company has adopted Statement of Financial Accounting Standards (SFAS)
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." SFAS No. 121 requires an assessment of the
recoverability of the Company's investment in long-lived assets to be held and
used in operations whenever events or circumstances indicate that their carrying
amounts may not be recoverable. Such assessment requires that the future cash
flows associated with the long-lived assets be estimated over their remaining
useful lives and an impairment loss recognized when the future cash flows are
less than the carrying value of such assets.

     The Company has assessed the recoverability of its investment in long-lived
assets to be held and used in operations under the guidelines set forth in SFAS
No. 121 and has determined that no impairment loss was required as of December
31, 2000. Such assessment required the Company to make certain estimates of
future production volumes, costs, sales volumes and prices, which are expected
to occur over the remaining useful lives of its long-lived assets. Such
long-lived assets primarily consist of the Company's Springdale and

                                       F-9
<PAGE>   43
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

Junction manufacturing facilities. The Company's estimates of these factors are
based upon management's belief that future production volumes will significantly
increase over previous historical production levels achieved by the Company's
manufacturing facilities and that future production costs per unit will also
decrease below previous historical cost levels.

     Although the Company believes it has a reasonable basis for its estimates
of future production volumes and costs and future sales volumes and prices, it
is reasonably possible that the Company's actual performance could materially
differ from such estimates. Management expects that the Company's performance
subsequent to the completion of its production plan will provide additional
evidence to confirm or disprove such future estimates. Management also believes
that if such estimates are not confirmed, revisions to such estimates could
result in a material impairment loss on its long-lived assets constituting all
or a material portion of the carrying value of the Company's Springdale and
Junction manufacturing facilities, which was approximately $12.8 million at
December 31, 2000.

  Inventories

     Inventories are stated at the lower of cost (first-in, first-out method) or
market. Inventories consisted of the following at December 31:

<TABLE>
<CAPTION>
                                                 2000          1999
                                              ----------    ----------
<S>                                           <C>           <C>
Raw materials...............................  $  682,841    $  565,259
Work in process.............................     508,688       323,268
Finished goods..............................     466,137       386,244
                                              ----------    ----------
                                              $1,657,666    $1,274,771
                                              ==========    ==========
</TABLE>

  Other Assets

     At December 31, 2000 and 1999, respectively, other assets consisted
primarily of debt acquisition costs in the amount of $1,158,802 and $302,697,
net, which are amortized over the term of the related debt, and the costs for
the preparation of patent applications of $264,453 and $293,026, net, which are
amortized using the straight-line method over 17 years.

  Use of Estimates

     The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

  SFAS No. 125

     The Company accounts for transfers of receivables, with recourse, to a
related party under the guidelines of SFAS No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities", (SFAS
125). This statement provides accounting and reporting standards for, among
other things, the transfer and servicing of financial assets, such as transfers
of receivables with recourse, and provides standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings. Based on the requirements of SFAS No. 125, the receivables
transferred to the related party with recourse are accounted for as a secured
borrowing because the Company is not considered to have surrendered control over
the transferred assets. Accounts receivable and accounts payable-related parties
at December 31, 2000 and 1999, include $1,639,351, and $1,183,015, respectively,
to reflect these requirements (see Note 4).

                                       F-10
<PAGE>   44
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

  SFAS No. 128

     The Company calculates and discloses earnings per share (EPS) in accordance
with SFAS No. 128, "Earnings Per Share" (SFAS 128). SFAS 128 replaces the
presentation of Primary EPS with Basic EPS and requires dual presentation of
Basic and Diluted EPS on the face of the statements of operations and requires a
reconciliation of the numerator and denominator of the Basic EPS computation to
the numerator and denominator of the Diluted EPS computation. Basic EPS excludes
dilution and is computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
Company. Diluted EPS is computed similarly to Fully Diluted EPS pursuant to
Accounting Principles Board Opinion No. 15, "Earnings Per Share".

     In computing Diluted EPS, only potential common shares that are
dilutive -- those that reduce earnings per share or increase loss per
share -- are included. Exercise of options and warrants or conversion of
convertible securities is not assumed if the result would be antidilutive, such
as when a loss from continuing operations is reported. The "control number" for
determining whether including potential common shares in the Diluted EPS
computation would be antidilutive is income from continuing operations. As a
result, if there is a loss from continuing operations, Diluted EPS would be
computed in the same manner as Basic EPS is computed, even if an entity has net
income after adjusting for discontinued operations, an extraordinary item or the
cumulative effect of an accounting change. The Company has incurred losses from
continuing operations and net losses for the years ended December 31, 2000, 1999
and 1998. Therefore, Basic EPS and Diluted EPS are computed in the same manner.
Although such financial instruments were not included due to being antidilutive,
the Company does have potentially dilutive financial instruments in the form of
warrants and options (see Notes 6 and 7). The number of shares of common stock
subject to issuance under options and warrants at December 31, 2000 and not
included due to antidilutive effects was approximately 22.4 million.

  Concentrations of Credit Risk

     The Company's revenues are derived principally from a number of regional
and national door and window manufacturers, industrial-flooring companies and
Weyerhaeuser, the Company's primary decking customer. The Company extends
unsecured credit to its customers. This industry concentration has the potential
to impact the Company's exposure to credit risk because changes in economic or
other conditions in the construction industry may similarly affect the
customers. The Company derived more than 10% of its revenue from the following
customers:

<TABLE>
<CAPTION>
                                                  2000    1999    1998
                                                  ----    ----    ----
<S>                                               <C>     <C>     <C>
Weyerhaeuser....................................   72%     50%     34%
Therma-Tru......................................   12%     21%     24%
</TABLE>

  Disclosure about Fair Value of Financial Instruments

     The following methods and assumptions were used to estimate the fair value
of each class of financial instrument held by the Company:

          Current assets and current liabilities -- The carrying value
     approximates fair value due to the short maturity of those items.

          Long-term debt -- The fair value of the Company's long-term debt has
     been estimated by the Company based upon each obligation's characteristics,
     including remaining maturities, interest rate, credit rating, collateral
     and amortization schedule. The carrying amount approximates fair value.

                                       F-11
<PAGE>   45
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

  Reclassifications

     Certain reclassifications have been made to prior years' financial
statements to conform to the current year presentation. These reclassifications
had no effect on the Company's net loss.

NOTE 4: RELATED PARTY TRANSACTIONS

     During 2000, the Company had an agreement with an affiliate whereby the
Company agreed to transfer certain of its trade receivables as collateral, which
the affiliate deemed acceptable, up to $2 million at any one time. In February
2000, the Company's major shareholder increased the Company's factoring line to
$2.5 million. Upon acceptance of a transfer of a receivable, the affiliate
remitted to the Company 85% of the receivable, as defined in the agreement. Upon
collection of the receivable, the Company remitted to the affiliate 1.75% of the
receivable as a factoring charge and the additional 13.25% of the receivable was
remitted to the Company, less interest costs, which were based on the time
period over which the receivable was outstanding. The Company indemnified the
affiliate for any loss arising out of rejections or returns of any merchandise,
or any claims asserted by the Company's customers. During 2000, the Company
transferred an aggregate of approximately $28,292,000 in receivables under this
agreement, of which $1,817,544 remained to be collected as of December 31, 2000.
During 1999 and 1998, the Company transferred an aggregate of approximately
$20,500,000 and $12,863,000, respectively, in receivables under this agreement,
none of which remains to be collected. Costs of approximately $470,794, $202,034
and $113,189 associated with the factoring agreement were included in selling
and administrative costs at December 31, 2000, 1999 and 1998, respectively.

     At December 31, 2000, accounts payable-related parties included advances on
factored receivables of approximately $1,639,351 and $469,999 relating to other
items owed to related parties.

NOTE 5: NOTES PAYABLE AND LONG-TERM DEBT

  Notes Payable -- Other

     Notes payable -- other, consisted of the following at December 31:

<TABLE>
<CAPTION>
                                                                 2000          1999
                                                              ----------    ----------
<S>                                                           <C>           <C>
12% notes payable, due on demand............................  $  350,000    $  400,000
12% notes payable (the bridge financing), interest payable
  quarterly in shares of the Company's Class A common stock
  or cash, principal was paid in full at December 31, 2000.
  The effective interest rate on the debt, including the
  effects on debt discounts from stock warrant issuances,
  was 33.0%.................................................          --        50,000
12% notes payable (the bridge financing), interest payable
  quarterly in shares of the Company's Class A common stock
  or cash, principal due in cash on May 15, 2001. The
  effective interest rate on the debt, including the effects
  on debt discounts from stock warrant issuances, was
  61.8%.....................................................     750,000       800,000
12% notes payable (the bridge financing), interest payable
  quarterly in shares of the Company's Class A common stock
  or cash, principal due in cash on May 15, 2001. The
  effective interest rate on the debt, including the effects
  on debt discounts from stock warrant issuances, was
  188.9%....................................................     410,000       410,000
12% notes payable (the bridge financing), interest payable
  quarterly in shares of the Company's Class A common stock
  or cash, principal due in cash on May 15, 2001. The
  effective interest rate on the debt, including the effects
  on debt discounts from stock warrant issuances, was
  57.8%.....................................................     359,963       359,963
</TABLE>

                                       F-12
<PAGE>   46
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

<TABLE>
<CAPTION>
                                                                 2000          1999
                                                              ----------    ----------
<S>                                                           <C>           <C>
12% notes payable (the bridge financing), interest payable
  quarterly in shares of the Company's Class A common stock
  or cash, principal due in cash on May 15, 2001. The
  effective interest rate on the debt, including the effects
  on debt discounts from stock warrant issuances, was
  37.1%.....................................................     287,500       287,500
Other.......................................................      40,905        47,481
                                                              ----------    ----------
Total.......................................................  $2,198,368    $2,354,944
                                                              ==========    ==========
</TABLE>

     The Company has five bridge financing agreements. The date of the first
agreement was October 30, 1997. The Company issued notes payable totaling $1.3
million that were originally due and payable on July 27, 1998, but the maturity
date was extended. During 1998, $1,050,000 of the notes was converted to
preferred stock (see Note 6), and the balance of the note was paid off in
installments, the last of which was April 2000. Interest on the notes was
payable every three months at 12% in the Company's Class A common stock. In
connection with the notes, the Company issued 2,600,000 consulting warrants and
156,000 placement warrants and paid loan origination costs of $169,000 to the
placement agent. The warrants expire October 30, 2002, and are exercisable at a
price of $0.375 per share of Class A common stock for each warrant exercised.
Per the agreement, if the notes were extended, an additional 650,000 consulting
warrants and 78,000 placement warrants would be issued. In connection with the
extension of the notes, 310,000 penalty warrants were issued to one of the note
holders and an agreement was entered into for voluntary selling restrictions of
the Company's stock by the Company's officers and certain shareholders, without
prior approval from the issuer of the note.

     The second bridge financing was completed on February 5, 1998. The Company
issued notes payable totaling $800,000 which were originally due and payable on
November 2, 1998, but have since been extended without penalty warrants to May
15, 2001. Interest on the notes is payable every three months at 12% in either
cash or the Company's Class A common stock, at the option of the Company. In
connection with the notes, the Company issued 1,600,000 consulting warrants and
96,000 placement warrants and paid loan origination costs of $104,000 to the
placement agent. If the notes are extended beyond May 15, 2001, the Company may
be required to issue 448,000 penalty warrants (400,000 consulting warrants and
48,000 placement warrants). The warrants expire February 5, 2003, and are
exercisable at a price of $0.375 per share of Class A common stock for each
warrant exercised. In June 2000, $50,000 was paid on the notes bringing the note
balance to $750,000 at December 31, 2000.

     A third bridge financing was completed on April 7, 1998. The Company issued
notes payable totaling $410,000 which were originally due and payable on January
2, 1999, but have since been extended without penalty warrants to May 15, 2001.
Interest on the notes is payable every three months at 12% in either cash or the
Company's Class A common stock, at the option of the Company. In connection with
the notes, the Company issued 820,000 consulting warrants and 49,200 placement
warrants and paid loan origination costs of $53,300 to the placement agent. If
the notes are extended beyond May 15, 2001, an additional 205,000 consulting
warrants and 24,600 placement warrants may be issued. The warrants expire April
7, 2003, and are exercisable at a price of $0.375 per share of Class A common
stock for each warrant exercised.

     A fourth bridge financing was completed on June 3, 1998. The Company issued
notes payable totaling $359,963 which were originally due and payable on
February 28, 1999, but have since been extended without penalty warrants to May
15, 2001. Interest on the notes is payable every three months at 12% in either
cash or the Company's Class A common stock, at the option of the Company. In
connection with the notes, the Company issued 719,926 consulting warrants and
43,195 placement warrants and paid loan origination costs of $46,795 to the
placement agent. If the notes are extended beyond May 15, 2001, an additional
179,981 consulting warrants and 21,597 placement warrants may be issued. The
warrants expire June 3, 2003, and are exercisable at a price of $0.375 per share
of Class A common stock for each warrant exercised.

                                       F-13
<PAGE>   47
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

     A fifth bridge financing was completed on August 21, 1998. The Company
issued notes payable totaling $287,500 which were originally due and payable on
May 18, 1999, but have since been extended without penalty warrants to May 15,
2001. Interest on the notes is payable every three months at 12% in either cash
or the Company's Class A common stock, at the option of the Company. In
connection with the notes, the Company issued 575,000 consulting warrants and
34,500 placement warrants and paid loan origination costs of $37,375 to the
placement agent. If the notes are extended beyond May 15, 2001, an additional
143,750 consulting warrants and 17,250 placement warrants may be issued. The
warrants expire August 21, 2003, and are exercisable at a price of $0.375 per
share of Class A common stock for each warrant exercised.

     Delisting of the Company's stock results in an event of default under the
bridge financing agreements. An event of default results in all of the then
outstanding principal amounts and unpaid interest becoming due and payable
immediately.

     In regard to the warrant shares issued under the bridge financing
agreements, if the resale of the warrant shares by the holders is not then
registered pursuant to an effective registration statement under the Securities
Act, the warrant holders may effect a cashless exercise at any time after the
first anniversary of the respective dates of the note agreements until the end
of the respective exercise periods. In the event of a cashless exercise, in lieu
of paying the exercise price in cash, the warrant holder shall surrender his
warrant to the Company for a certain number of shares of Class A common stock,
based on the market value of the stock at the time of exercise.

     Under a placement agency agreement entered into concurrently with the
October 30, 1997 bridge financing agreement, for a two-year period the placement
agent has the right, but not the obligation, to offer and place on behalf of the
Company up to an additional $342,537 aggregate principal amount of notes to the
Company. This two-year period has been extended in conjunction with the
extension of the bridge financing. If the additional notes are issued, then the
Company will issue 685,074 consulting warrants and 41,104 placement warrants in
connection with the notes. If the notes are extended, an additional 171,268
consulting warrants and 20,552 placement warrants may be issued. Both the
additional notes and related consulting and placement warrants will have terms
and provisions similar to those of previous bridge financings.

  Notes Payable -- Related Parties

     Notes payable to related parties consisted of two notes payable to an
investment company owned by a significant shareholder. During 2000, $150,000 of
the outstanding principal balance on one of these notes was converted to Class A
common stock at a conversion price of $1 per share, which approximated fair
value. This transaction is considered a non-cash financing activity for
statement of cash flows purposes. The outstanding principal balance at December
31, 2000 on each note was $100,000 and $150,000, respectively. The notes are due
on demand and include interest at a fixed rate of 10%.

                                       F-14
<PAGE>   48
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

  Long-term Debt

     Long-term debt, net of debt discount consisted of the following at December
31:

<TABLE>
<CAPTION>
                                                                 2000         1999
                                                              ----------    --------
<S>                                                           <C>           <C>
13.25% notes payable, due in monthly installments of $6,030,
  secured by certain manufacturing equipment, maturing
  January 1, 2003...........................................  $  126,530    $     --
9.75% note payable to Arkansas State Bank, due in monthly
  installments of $49,156, secured by real estate and
  improvements, fixed assets, assignment of life insurance
  policy, personal guarantee of certain stockholders and an
  80% USDA Department of Rural Development guarantee,
  maturing February 23, 2015(a).............................   4,500,000          --
Other.......................................................     102,315     129,669
                                                              ----------    --------
Total.......................................................   4,728,845     129,669
Less current maturities.....................................    (242,689)    (70,013)
                                                              ----------    --------
Long-term debt, net of current maturities...................  $4,486,156    $ 59,656
                                                              ==========    ========
</TABLE>

---------------
(a) The note contains certain financial covenants including a minimum debt to
    net worth ratio, as defined, of no more than 3 to 1; a minimum current ratio
    of 1 to 1 by August 2000; and a minimum current ratio of 2 to 1 by February
    2001 and thereafter. The Company was not in compliance as of December 31,
    2000, and the bank granted a waiver of the financial covenants discussed
    above.

     The aggregate maturities of long-term debt, net of debt discount, as of
December 31, 2000, are as follows:

<TABLE>
<CAPTION>
                  YEAR                       AMOUNT
                  ----                     ----------
<S>                                        <C>
2001.....................................  $  242,690
2002.....................................     274,424
2003.....................................     215,683
2004.....................................     219,267
2005.....................................     233,372
Thereafter...............................   3,543,410
                                           ----------
                                           $4,728,846
                                           ==========
</TABLE>

Bonds Payable

     In October 1999, the Company entered into an agreement with the City of
Springdale, Arkansas for the issuance of Series 1999 Industrial Development
Revenue Bonds (the Bonds). The Bonds are private activity bonds issued for a
limited number of purposes, including solid waste disposal projects. The Company
received the Bond allocation; however, given their current cash flow position,
the Bonds are not marketable. As a result, the Bonds have been issued and
retained in escrow until such time in which the Company meets certain criteria
as defined in the Bond agreement. As of December 31, 2000, the Company has debt
with the City of Springdale, Arkansas, secured by cash deposits sufficient to
retire the debt.

     Proceeds of the Bonds were deposited as follows: $112,814 of the proceeds
were deposited in the Issuance Expense Fund while the remaining $16,387,186 were
deposited in the Project Fund and invested until the Reset Date (October 13,
2000). The Company did not break escrow by October 13, 2000. However, the
investment company repurchased the Bonds on October 13, 2000, and a new reset
date of October 13, 2001, was set subject to the aforementioned terms and
conditions. The interest rate changed to 6.4%. Concurrent with the closing, the
funds were transferred to an investment company and invested in selected low
risk investment types as defined in the Indenture of Trust. Any interest or
other gain realized as a result of any

                                       F-15
<PAGE>   49
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

investments of monies from the Project Fund shall be retained in or transferred
to the Project Fund. Should the escrow funds be devalued by the Reset Date, the
Company is liable for any deficiencies.

     The Bonds carry an initial interest rate of 5.25%, a maturity date of
October 1, 2029 and an original issue date of October 14, 1999. The Bonds shall
be dated as of October 14, 1999 with interest from the original interest date
payable semiannually on April 1 and October 1 of each year, commencing April 1,
2002. The Bonds will bear interest at 5.25% from the date of issuance until the
Reset Date. Interest from the Reset Date to the maturity date will be calculated
at a variable rate equal to the lesser of (i) 9.75% per annum and (ii) a
variable rate of interest certified by a remarketing agent appointed by the
Company. If a remarketing agent fails to properly certify a new variable rate,
the rate shall be the same as the rate preceding the Reset Date until the
variable rate is so certified.

     In October 1999, an investment company agreed to purchase the Bonds from
the City of Springdale. The Bonds are issuable only as fully registered bonds in
the minimum denominations of $100,000 and in any integral multiple of $5,000 in
excess thereof. At or prior to disbursement of proceeds from the Project Fund,
assuming proceeds of the Bonds have not been used to redeem the Bonds, the
Company must deliver to the Trustee such general items as project plans and
specifications, cost estimates, construction contracts and insurance coverage.
Furthermore, unless waived by the holder of 100% of the Bonds, the Company must
also deliver to the Trustee satisfactory evidence that for any consecutive 12
month period commencing on or after the date of the issuance of the Bonds, the
long-term debt service coverage ratio, as defined, has been not less than 2 to
1, and the projected long-term debt service coverage ratio for the 24 month
period subsequent to the first disbursement from the Project Fund shall be not
less than 2 to 1. Although the Bonds will be called if the Company does not
break escrow by the Reset Date, if a negative arbitrage position does not exist,
it is possible that the bondholder will waive/roll the call for another year or
sell to another investor. However, the risk does exist that if another investor
cannot be identified, the Company will be required to buy back the Bonds at the
Reset Date.

     All advancements under this agreement are secured by the Company's interest
in the land purchased in Springdale, Arkansas in March 2000, the improvements,
the plans and specifications, and any fixtures or appurtenances now or hereafter
erected thereon. In addition, the Company granted the Issuer a present security
interest in the pledged accounts, the funds, any trust accounts referred to in
the agreement, all tangible personal property, furniture, and machinery and
equipment located on the site.

     The Bonds are subject to mandatory redemption under various circumstances
including, but not limited to, casualty loss or condemnation and occurrence of a
determination of taxability as defined in the Indenture of Trust. Furthermore,
the Bonds shall be subject to mandatory tender for purchase by the Company in
whole on the Reset Date, at a purchase price equal to the principal amount of
Series 1999 Bonds so tendered plus accrued interest to the Reset Date.

     The Bonds are subject to mandatory sinking fund redemption at a redemption
price equal to 100 percent of the principal amount thereof and accrued interest
to the redemption date. As of October 1 of each year,

                                       F-16
<PAGE>   50
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

there shall be deposited in the Bond Principal Fund and Bond Interest Fund a sum
which is sufficient to redeem the following principal amounts and accrued
interest to the redemption date:

<TABLE>
<CAPTION>
                  YEAR                      AMOUNT
                  ----                    -----------
<S>                                       <C>
2001....................................  $         0
2002....................................      200,000
2003....................................      170,000
2004....................................      185,000
2005....................................      200,000
Thereafter..............................   15,745,000
                                          -----------
                                          $16,500,000
                                          ===========
</TABLE>

     The Company will incur certain costs related to remarketing the Bonds.
During 1999, the Company entered an agreement with an investment company whereby
the Company has committed to pay the investment company 5% of Bond proceeds plus
495,000 shares of common stock upon satisfactory completion of the Bond
remarketing.

NOTE 6: STOCKHOLDERS' EQUITY

  Preferred Stock

     During 1998, the Company issued a series of voting and non-voting,
convertible preferred stock, which raised an additional $2.9 million in equity
(including $1,050,000 from the conversion of certain notes payable, see Note 5).
The Company has reserved 6,196,656 shares of Class A common stock for conversion
under the preferred stock agreement. The Company issued 1,500 Series A preferred
shares, 900 Series B preferred shares and 500 Series C preferred shares at a
price of $1,000 per share. Such stock was purchased by the major stockholder, a
5% holder and accredited institutional investors. The preferred stock bears an
interest premium of 10% per year and is payable in cash or common stock. During
2000, the Company converted $337,260 of accrued premiums to common stock at a
conversion price of $1.20 per share. This transaction is considered a non-cash
financing activity for statement of cash flow purposes.

     On the 7th anniversary date of the issuance of preferred stock, the
preferred stock will automatically be converted into shares of common stock with
the conversion price equal to the lower of the average of the closing bid prices
for the common stock for the 5 trading days immediately preceding the 7th
anniversary of the issuance or the fixed conversion price. The fixed conversion
price is $1.20. If the preferred stock is converted prior to the 7th anniversary
of its date of issuance, the conversion price is the lower of $1.20 or the
variable conversion price. The variable conversion price is the average of the
closing bid prices for the common stock during the 10 consecutive trading days
ending on the trading date immediately preceding the date of determination. The
Company, at its option and two years from the issuance date, can redeem the
stock prior to conversion at a premium of 150 percent. The stock was issued with
a series of X and Y warrants, which can be exercised at $1.20 and $2.50 per
share, respectively, as described in the warrants section below.

     The preferred stock agreements have been amended to extend the date by
which the Company is required to have an effective registration statement that
registers the common stock underlying the convertible preferred stock and
warrants to July 15, 2001. The Company may be required to pay certain penalties
to the holders of the preferred stock and warrants if the registration statement
is not declared effective by the SEC by July 15, 2001. The penalties increase
over time until the registration statement is declared effective. The preferred
stock agreements contain potential redemption events which would cause the
Company to have to redeem the preferred stock, all of which are within the
control of the Company. The agreements state that if a redemption event occurs,
the Company must pay each holder of preferred stock an amount equal to ten
percent of the aggregate stated value of the shares of preferred stock then
outstanding.

                                       F-17
<PAGE>   51
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

     The Class A common stock and the Class B common stock are substantially
similar in all respects except that the Class B common stock has five votes per
share while the Class A common stock has one vote per share. Each share of Class
B common stock is convertible at any time at the holder's option to one share of
Class A common stock and, except in certain instances, is automatically
converted into one share of Class A common stock upon any sale or transfer.

  Warrants

     The Company has reserved 17,818,601 shares of the Company's Class A common
stock for issuance under the following warrant agreements.

  Class B Warrants

     Each Class B Warrant entitled the holder to purchase one share of Class A
common stock at an exercise price of $1.075. In addition, one Bonus Warrant
(described below) was granted to the holder for each warrant exercised. During
1998, the Company received net proceeds of $934,032 from the exercise of 779,670
Class B Warrants. An additional 257,994 warrants were exercised in 1999,
resulting in proceeds to the Company of $277,343. The remaining warrants were
not exercised, and expired on February 12, 1999.

  Class C Warrants

     Each Class C Warrant is exercisable into one share of Class A common stock
at an exercise price of $1.075 per share. During 1998, the Company received net
proceeds of $330,000 from the exercise of 275,000 Class C Warrants. One Bonus
Warrant (described below) was granted to the holder for each warrant exercised.
On February 12, 1999, 50,000 Class C Warrants expired. The remaining 325,000
Class C Warrants expire in June 2003.

  Class F Warrants

     In 1999, 350,864 Class F Warrants were exercised at a price of $0.61 per
share, resulting in proceeds of $214,027. The remaining 987,040 Class F Warrants
expire in June 2004, and are exercisable at a price of $0.61 per share of Class
A common stock for each Class F Warrant exercised.

  Class G Warrants

     In 1999, 481,810 Class G Warrants were exercised at prices ranging from
$0.91 to $0.92 per share, resulting in proceeds of $441,956. The remaining
2,987,040 Class G Warrants expire in June 2004, and are exercisable at a price
of $0.92 per share of Class A common stock for each Class G Warrant exercised.

  Class H Warrants

     In 1995, in connection with the note payable to Marjorie S. Brooks and the
accounts payable-related parties (see Notes 4 and 5), the Company's Board of
Directors authorized the issuance of up to 2,000,000 Class H Warrants on a
one-for-one basis for each dollar advanced under the agreement and having an
exercise price equal to the per share market value of the Company's Class A
common stock on the date of such advances. The warrants are exercisable at
prices from $0.39 to $.48 per share of Class A common stock for each Class H
Warrant exercised. In 2000, 228,208 shares of Class H Warrants were exercised at
prices ranging from $0.39 to $0.48 per share, resulting in proceeds of $100,000.
The remaining 1,771,792 Class H Warrants expire in February 2005, and are
exercisable at prices from $0.46 to $0.48 per share of Class A common stock for
each Class H Warrant exercised.

                                       F-18
<PAGE>   52
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

  Class I Warrants

     In June 1996, the Company completed an offering to qualified foreign
investors under Regulation S of the Securities Act of 1933 with the issuance of
1,666,893 shares of Class A common stock. Net offering proceeds consisted of
$1,146,000 in cash. As part of the offering, the Company issued 242,878 Class I
Warrants to the Stock Placement Distributor. The Class I Warrants were to expire
three years from the date of issue and were exercisable at prices ranging from
$0.9375 to $1.125 per share of Class A common stock for each Class I Warrant
exercised. In May 1997, an additional 150,466 Class I warrants were issued in
connection with the December 1996 Regulation S Offering, as described below, at
exercise prices ranging from $0.31 to $0.56 per share of Class A common stock
for each Class I Warrant exercised.

     In 1999, 29,367 Class I Warrants were exercised at a price of $0.9375 per
share, resulting in proceeds of $27,532, and 42,866 Class I Warrants expired.
Also in 1999, 321,111 Class I Warrants were extended two years from the
effective date of the S-3 registration statement which will register the shares
underlying these warrants.

     In December 1996, the Company received $185,000 in cash relating to an
offering to qualified foreign investors under Regulation S of the Securities Act
of 1933 with the issuance of 228,571 and 134,454 shares of Class A common stock
in 1996 and 1997, respectively. Also, in 1997, $228,999 was received and 977,367
shares of Class A common stock were issued.

  Class J and K Warrants

     In December 1996, in connection with a note payable of $100,000, the
Company authorized and issued two sets of Warrants, Class J for 200,000 and
Class K for 150,000. Each Class J and Class K Warrant is exercisable on a
one-for-one basis into common stock. Each Class J Warrant is exercisable at
$0.50 per share and each Class K Warrant is exercisable at $0.75 per share. Both
Class J and Class K Warrants expire five years from the date of issuance. In
2000, 100,000 shares of Class J Warrants were exercised at a price of $0.50 per
share, through the conversion of a note payable to the warrant holder of
$50,000. This transaction is considered a non-cash financing transaction for
statement of cash flow purposes. The remaining 100,000 Class J Warrants and
150,000 Class K Warrants expire December 2001.

  X and Y Warrants Issued in Connection with Preferred Stock

     The preferred stock carries a series of X and Y Warrants, which will
convert at $1.20 and $2.50 per share. In connection with the 2,900 preferred
shares, the Company issued 2,900 X Warrants and 2,900 Y Warrants. Each of the
Series X Warrants entitles the holder the right to acquire 555 shares (for X
Warrants issued with Series A shares) and 833.33 shares (for X Warrants issued
with Series B and C shares) of the Company's common stock (1,999,162 shares).
Each of the Series Y Warrants entitles the holder the right to acquire 205
shares (for Y Warrants issued with Series A shares) and 400 shares (for Y
Warrants issued with Series B and C shares) of the Company's common stock
(867,500 shares). Each of the warrants has cashless exercise features that are
based on various conversion amounts and terms.

  X and Y Warrants to Placement Agent

     The Series A preferred stock shares were placed through a placement agent.
The placement agent and certain officers of the placement agent were given
Series X Warrants to purchase, in the aggregate, 278.33 shares of the Company's
common stock for each $1,000 of purchase price (417,495 shares) and Series Y
Warrants to purchase, in the aggregate, 102.7 shares of the Company's common
stock for each $1,000 of Purchase Price (154,050 shares). The Series X Warrants
are exercisable for a period of six years from the first anniversary of the date
of issuance at a price per share equal to $1.20 and the Series Y Warrants

                                       F-19
<PAGE>   53
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

are exercisable for a period of five years from the second anniversary of the
date of issuance at a price per share equal to $2.50. No placement agent was
used for the Series B and C shares.

  Bonus Warrants

     In connection with the exercise of the Class B and C Warrants during 1998
and 1999, the Company granted a new warrant on a one-for-one basis for each
Class B and C Warrant exercised. The Bonus Warrants, 1,054,670 and 257,994
issued in 1998 and 1999, respectively, were originally to expire February 12,
2001, but were extended to two years from the effective date of the S-3
registration statement which will register the shares underlying these warrants
and are exercisable at a price of $3.00 per share of Class A common stock for
each Bonus Warrant exercised.

  Consulting and Placement Warrants

     In October 1997, the Company obtained bridge financing of $1.3 million (see
Note 5). In connection with the financing obtained, 2,756,000 stock warrants
were issued. The stock warrants expire on October 30, 2002, and are exercisable
at a price of $0.375 per share of Class A common stock for each warrant
exercised. The debt and stock warrants were recorded at their estimated fair
market value at the date of the transaction. The value of the stock warrants was
treated as a debt discount and amortized over the initial life of the loan as
interest expense. In 1998 and 1999, 120,000 and 628,500, Consulting and
Placement Warrants were exercised at a price of $0.375 per share, resulting in
proceeds of $45,000 and $235,688, respectively. In 2000, 39,000 placement
warrants were exercised at a price of $0.375 resulting in proceeds of $14,625.

     In February 1998, the Company obtained bridge financing of $800,000 (see
Note 5). In connection with the financing obtained, 1,696,000 stock warrants
were issued. The stock warrants expire on February 5, 2003, and are exercisable
at a price of $0.375 per share of Class A common stock for each warrant
exercised. The debt and stock warrants were recorded at their estimated fair
market value at the date of the transaction. The value of the stock warrants was
treated as a debt discount and amortized over the life of the loan as interest
expense. In 2000, 69,334 consulting warrants were exercised at a price of $0.375
resulting in proceeds of $26,000. In 2000, 21,240 placement warrants were
exercised at a price of $0.375 per share resulting in proceeds of $7,965.

     In April 1998, the Company obtained bridge financing of $410,000 (see Note
5). In connection with the financing obtained, 869,200 stock warrants were
issued. The stock warrants expire on April 7, 2003, and are exercisable at a
price of $0.375 per share of Class A common stock for each warrant exercised.
The debt and stock warrants were recorded at their estimated fair market value
at the date of the transaction. The value of the stock warrants was treated as a
debt discount and amortized over the life of the loan as interest expense.

     In June 1998, the Company obtained bridge financing of $359,963 (see Note
5). In connection with the financing obtained, 763,121 stock warrants were
issued. The stock warrants expire on June 3, 2003, and are exercisable at a
price of $0.375 per share of Class A common stock for each warrant exercised.
The debt and stock warrants were recorded at their estimated fair market value
at the date of the transaction. The value of the stock warrants was treated as a
debt discount and amortized over the life of the loan as interest expense.

     In August 1998, the Company obtained bridge financing of $287,500 (see Note
5). In connection with the financing obtained, 609,500 stock warrants were
issued. The stock warrants expire on August 21, 2003, and are exercisable at a
price of $0.375 per share of Class A common stock for each warrant exercised.
The debt and stock warrants were recorded at their estimated fair market value
at the date of the transaction. The value of the stock warrants was treated as a
debt discount and amortized over the life of the loan as interest expense.

                                       F-20
<PAGE>   54
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

  Extension Warrants

     In connection with the extension of the October 30, 1997 bridge financing,
310,000 extension warrants were issued. The stock warrants expire on November 5,
2003, and are exercisable at a price of $0.375 per share of Class A common stock
for each warrant exercised.

  Series Z Placement Warrants

     In 1998, the Company issued 300,000 Placement Warrants in connection with
the issuance of the Series C Preferred Stock. These warrants are exercisable at
a price of $1.00 per share of Class A common stock for each warrant exercised,
and expire on November 12, 2003.

     At December 31, 2000, the Company had outstanding warrants as follows:

<TABLE>
<CAPTION>
                                                   WARRANTS FOR       WEIGHTED
                                                     CLASS A          AVERAGE
                                                   COMMON STOCK    EXERCISE PRICE
                                                   ------------    --------------
<S>                                                <C>             <C>
Class C Warrants.................................      325,000         $1.075
Class F Warrants.................................      987,040          0.61
Class G Warrants.................................    2,987,040          0.92
Class H Warrants.................................    1,771,792          0.47
Class I Warrants.................................      321,111          0.75
Class J Warrants.................................      100,000          0.50
Class K Warrants.................................      150,000          0.75
Series X Warrants................................    1,999,162          1.20
Series Y Warrants................................      867,500          2.50
Series X Warrants -- Placement Agent.............      417,495          1.20
Series Y Warrants -- Placement Agent.............      154,050          2.50
Bonus Warrants...................................    1,312,664          3.00
Consulting Warrants..............................    5,585,592          0.375
Placement Warrants...............................      230,155          0.375
Extension Warrants...............................      310,000          0.375
Series Z Placement Warrants......................      300,000          1.00
                                                    ----------         ------
                                                    17,818,601         $0.98
                                                    ==========         ======
</TABLE>

     In order to remain listed on the NASDAQ SmallCap Market, all publicly held
companies must meet certain criteria (maintenance standards) established by the
NASDAQ. Increased listing and maintenance standards include a minimum bid of
$1.00 common stock price and a $2 million net asset value. On March 12, 1999,
the Company attended a hearing in the matter of the continued listing of the
Company's stock on the NASDAQ SmallCap Market. The hearing was in regards to the
Company being notified on October 13, 1998, that it did not meet the $1.00
minimum bid price for continued listing. The Company was given ninety days,
until January 13, 1999, to regain compliance. The Company did not achieve
compliance during the grace period and requested the hearing. Subsequent to the
hearing, the Company was given an additional waiver to regain compliance and
meet minimum listing standards. The NASDAQ Listing Qualifications Panel notified
the Company in June 1999 that it had regained full compliance regarding listing
qualifications, and that the Company's Class A common stock (AERTA) would
continue to be listed on the NASDAQ SmallCap Market. As of December 31, 2000,
the Company's closing stock price was $0.75, and its net asset value was
$2,709,383. There is no guarantee that in the future the stock price will
increase above the $1.00 minimum bid price or that the net assets will not fall
below the $2 million amount required by NASDAQ.

                                       F-21
<PAGE>   55
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

NOTE 7: STOCK OPTION PLANS

     The Company's Stock Option Plans (the 1997 Plan, 1994 Plan, Director Plan,
Chairman Plan and the 1989 Plan, collectively "the Plans") authorize the
issuance of a total of 7,600,000 shares of the Company's Class A common stock to
its directors, employees and outside consultants. The option price of the stock
options awarded must be at least equal to the market value of the Class A common
stock on the date of grant. Stock options may not be granted to an individual to
the extent that in any calendar year in which options first become exercisable,
the shares subject to options first exercisable in such year have a fair market
value on the date of grant in excess of $100,000. No option may be outstanding
for more than ten years after its grant. The purpose of the Plans is to enable
the Company to encourage key employees, directors and outside consultants to
contribute to the success of the Company by granting such persons incentive
stock options (ISOs) and/or non-incentive stock options (nonqualified stock
options). The ISOs are available for employees only. In order to provide for
disinterested administration of the Plans for purposes of Rule 16b-3 under the
Securities Exchange Act of 1934, the Director Plan also provides that outside
directors will automatically receive annual awards of nonqualified stock
options.

     The Company's stockholders approved the Non-Employee Director Stock Option
Plan (the Director Plan), in June 1994. The Director Plan provides for the
issuance of options to purchase up to an aggregate of 500,000 shares of the
Company's Class A common stock to eligible outside directors of the Company.
Each eligible outside director will be granted options to purchase 25,000 shares
of common stock annually commencing in 1995 and each year thereafter.

     In June 1994, stockholders of the Company approved the adoption of the
Amended and Restated Stock Option Plan (the 1994 Plan), which superseded and
replaced the Company's 1990 Stock Option Plan. The new Plan provides for the
granting of options to purchase up to 1,000,000 shares of the Company's Class A
common stock by recipients of incentive stock options or nonqualified stock
options as granted by the Company's Board of Directors.

     Also, in June 1994, stockholders of the Company approved the Chairman Stock
Option Plan. The Plan provided for a grant of 500,000 shares of the Company's
Class A common stock.

     In July 1997, stockholders of the Company approved the adoption of the
Advanced Environmental Recycling Technologies, Inc. 1997 Securities Plan (the
1997 Plan). The 1997 Plan provides for certain awards to be given to senior and
executive management of the Company to encourage and reward superior
performance. The awards can be in the form of stock options, restricted stock
and other performance awards to be given. The aggregate number of shares which
may be offered pursuant to incentive stock options under the 1997 Plan
originally was not to exceed 3,000,000, but this amount was increased by
approval of the stockholders to 5,000,000 in July 1999. The aggregate number of
shares which may be offered for purchase pursuant to non-qualified stock options
shall not exceed 500,000 shares. The stock options may not be granted with an
exercise price less than the fair market value of a share on the date the option
is granted, unless granted to a 10% shareholder, then the exercise price must be
at least 110% of the fair market value per share on the date such option is
granted. The Incentive Stock Options may not be exercised after ten years from
the date the option is granted unless the option is given to a 10% shareholder,
and then the expiration date is five years from the date the option is granted.
The options must be exercised within three months after termination of
employment.

     During June 1989, stockholders of the Company approved the adoption of the
Advanced Environmental Recycling Technologies, Inc. 1989 Stock Option Plan (the
1989 Plan). The 1989 Plan was designed to increase the interest of the directors
and executives and other employees of the Company. The total number of shares of
the Company's Class A common stock which may be issued under options granted
pursuant to the Plan shall not exceed 600,000. The option price will be the fair
market value of the shares on the date on which the respective shares are
granted unless granted to a 10% stockholder, then the exercise price must be at

                                       F-22
<PAGE>   56
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

least 110% of the fair market value per share on the date such option is
granted. Each option's expiration date can not exceed ten years from the date
such option was granted, unless the option is granted to a 10% shareholder, and
then the expiration date is five years from the date the option is granted. The
1989 Plan terminated June 4, 1999 and no additional options can be granted after
such date.

     A summary of the activity in the Company's Stock Option Plans during the
years ended December 31, 2000, 1999 and 1998, as follows:

<TABLE>
<CAPTION>
                                              2000                   1999                   1998
                                      --------------------   --------------------   --------------------
                                                  WEIGHTED               WEIGHTED               WEIGHTED
                                                  AVERAGE                AVERAGE                AVERAGE
                                                  EXERCISE               EXERCISE               EXERCISE
                                       SHARES      PRICE      SHARES      PRICE      SHARES      PRICE
                                      ---------   --------   ---------   --------   ---------   --------
<S>                                   <C>         <C>        <C>         <C>        <C>         <C>
Outstanding, beginning of year......  5,484,500    $0.77     4,473,000    $0.67     4,103,000    $0.68
Granted.............................    200,000    $2.02     1,350,000    $1.29     1,055,000    $0.89
Exercised...........................   (465,000)   $ .55      (132,500)   $1.22      (493,333)   $0.42
Forfeited...........................   (654,370)   $ .80      (206,000)   $1.73      (191,667)   $1.48
                                      ---------    -----     ---------    -----     ---------    -----
Outstanding, end of year............  4,565,130    $ .84     5,484,500    $0.77     4,473,000    $0.67
</TABLE>

     The following table summarizes information about stock options outstanding
under the Company's Stock Option Plans as of December 31, 2000:

<TABLE>
<CAPTION>
                              OPTIONS OUTSTANDING                OPTIONS EXERCISABLE
                    ---------------------------------------   --------------------------
                                    WEIGHTED      WEIGHTED                     WEIGHTED
                      NUMBER         AVERAGE       AVERAGE        NUMBER        AVERAGE
     RANGE OF       OUTSTANDING     REMAINING     EXERCISE     EXERCISABLE     EXERCISE
  EXERCISE PRICES   AT 12/31/00   CONTRACT LIFE     PRICE      AT 12/31/00       PRICE
  ---------------   -----------   -------------   ---------   --------------   ---------
  <S>               <C>           <C>             <C>         <C>              <C>
   $0.38 - $0.48     1,192,667     5.15 years       $0.44       1,067,667        $0.44
   $0.56 - $1.00     2,603,963     5.32 years       $0.75       1,770,629        $0.64
   $1.19 - $1.47       143,500     5.13 years       $1.29         143,500        $1.29
   $1.75 - $2.63       625,000     5.59 years       $1.91         150,000        $2.21
                    ----------    -----------       -----     -----------        -----
                     4,565,130     5.30 years       $0.84       3,131,796        $0.68
</TABLE>

     The weighted-average fair value of options granted during 2000, 1999 and
1998 was $1.77, $0.94 and $0.53, respectively. SFAS No. 123, "Accounting for
Stock-Based-Compensation", issued by the FASB in October 1995, encourages but
does not require companies to measure and recognize in their financial
statements a compensation cost for stock-based employee compensation plans based
on the "fair value" method of accounting set forth in the statement. The Company
continues to account for its stock option plans and other stock-based
compensation using the "intrinsic value" method of accounting set forth in
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees", and related interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the Company's common stock at the date of the grant over the amount an employee
must pay to acquire the stock. Had compensation cost for the Company's stock
option plans and other stock-based compensation been determined consistent with
SFAS No. 123, the Company's net loss and net loss per share of common stock
would have been increased to the following pro forma amounts:

<TABLE>
<CAPTION>
                                                         2000           1999           1998
                                                      -----------    -----------    -----------
<S>                                                   <C>            <C>            <C>
Net loss applicable to common stock
  As Reported.......................................  $(2,206,521)   $(1,763,736)   $(3,653,070)
  Pro Forma.........................................   (2,549,574)    (2,445,990)    (3,915,670)
Net loss per share of common stock (Basic and
  Diluted)
  As Reported.......................................  $      (.08)   $      (.07)   $      (.16)
  Pro Forma.........................................         (.10)          (.10)          (.17)
</TABLE>

                                       F-23
<PAGE>   57
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

     The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 2000, 1999 and 1998, respectively: risk-free
interest rates of 5.8, 5.4 and 5.3 percent; expected lives of 9, 5 and 10 years;
and expected volatilities of 94.6, 90.5 and 87.4 percent. Since no dividends are
expected to be paid by the Company during the expected lives of the options, a
dividend yield of zero was used for purposes of computing the fair value of the
options.

NOTE 8: LEASES

     At December 31, 2000, the Company was obligated under a non-cancelable
lease with a principal stockholder for land and a building where a production
facility is located. This lease has an expiration date of April 30, 2001, and
rental payments of $1,519 per month. Management intends on renewing the non-
cancelable lease in Junction under similar terms. In 1997, the Company entered
into a non-cancelable sublease for a production facility which expires August
31, 2002. Lease payments on the facility are $19,000 per month. The sublease
contains an option to purchase the facility for $1.8 million, exercisable at any
time during the sublease, and a renewal option to lease the property for an
additional five years at an increased rate. At December 31, 2000, the Company
was obligated under various operating leases covering certain equipment. Rent
expense under operating leases for the years ended December 31, 2000, 1999 and
1998 was $695,478, $609,586 and $432,356, respectively. Future minimum lease
payments required under operating leases as of December 31, 2000, are as
follows:

<TABLE>
<CAPTION>
                  YEAR                       AMOUNT
                  ----                     ----------
<S>                                        <C>
2001.....................................  $  515,496
2002.....................................     428,065
2003.....................................     221,467
2004.....................................     199,627
Total minimum payments required..........  $1,364,655
                                           ==========
</TABLE>

NOTE 9: INCOME TAXES

     The Company records income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes". Under this method, deferred income taxes reflect
the net tax effects of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes. The Company has generated book and tax losses for the
period and since inception.

     As of December 31, 2000, the Company had net operating loss carryforwards
of approximately $22.6 million for federal income tax purposes, which are
available to reduce future taxable income and will expire in 2004 through 2020,
if not utilized.

     The tax effects of significant temporary differences representing deferred
tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31,
                                              -----------------------------------------
                                                 2000           1999           1998
                                              -----------    -----------    -----------
<S>                                           <C>            <C>            <C>
Deferred tax assets --
  Net operating loss carryforwards..........  $ 8,014,219    $ 7,509,146    $ 7,311,702
  Valuation allowance.......................   (7,449,992)    (6,961,445)    (7,155,941)
                                              -----------    -----------    -----------
          Total deferred tax assets.........      564,227        547,701        155,761
Deferred tax liability --
  Depreciation..............................      564,227        547,701        155,761
                                              -----------    -----------    -----------
          Net deferred tax..................  $        --    $        --    $        --
                                              ===========    ===========    ===========
</TABLE>

                                       F-24
<PAGE>   58
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

     As the Company has generated net operating losses since its inception and
there is no assurance of future income, a valuation allowance of $7,449,992 has
been established at December 31, 2000, to recognize its deferred tax assets only
to the extent of its deferred tax liabilities. The Company will continue to
evaluate the need for such valuation allowance in the future.

NOTE 10: COMMITMENTS AND CONTINGENCIES

     In June 1992, Mobil Oil Corporation (Mobil) commenced an action against the
Company in the United States District Court of the District of Delaware entitled
"Mobil Oil Corporation v. Advanced Environmental Recycling Technologies, Inc."
In the complaint, Mobil sought entry of a declaratory judgment and sought no
monetary damages in that suit, but did seek reimbursement of its attorneys'
fees. The Company denied Mobil's claims and asserted counterclaims against Mobil
and three Mobil Executives, seeking monetary damages, punitive damages and
injunctive relief. After a trial on the patent issues in February 1994, the
court held that four AERT patents on its composite product technology were
invalid and that Mobil had not infringed the patents. The Company filed a motion
in March 1995, alleging prejudicial misconduct by Mobil prior to the trial and
also filed an appeal with the U.S. Court of Appeals in July 1995. In June 1996,
the U.S. Court of Appeals reversed a portion of the earlier ruling, which had
held that two of the patents were invalid, but ruled that Mobil did not infringe
such patents. The Company did not further appeal this ruling.

     In August 1994, Mobil filed a motion seeking an award of attorney's fees
and costs of $2.7 million. In September 1999, the Delaware Court dismissed the
Mobil Motion for Attorneys' Fees, for a second time. The Court also dismissed
the Company's motion for new trial upon discovery misconduct and the Company's
motion to supplement the record.

     On a second appeal, arising from an order entered by the district court on
September 30, 1999, Mobil Oil sought an award of attorney's fees again from the
Company in the approximate amount of $2.7 million. The Company also appealed,
seeking a new trial and an opportunity to supplement the record in the trial
court. On December 6, 2000, the Federal Circuit affirmed the district court
decision, thereby denying both the award of the attorneys' fees to Mobil Oil and
the relief requested by the Company.

     The Company's counterclaims against Mobil and individual defendants
alleging violations of the Sherman Act, false and deceptive advertising, breach
of confidential relationship and unfair competition had remained pending in the
District of Delaware, having been bifurcated prior to the trial on the patent
law claims.

     The Company is a counterclaim defendant in a federal action in Texas,
involving allegations from a former employee and officer of the Company that the
Company breached an employment agreement by terminating employment. The Company
believes this action is without merit and will vigorously defend itself.

     Three H. Enterprises sued the Company for breach of contract on May 9,
2000, alleging that unpaid royalties in the amount of $10 per ton of product
produced from the Junction, Texas, facility are purportedly owed to plaintiff.
The alleged contract is from a settlement stipulation entered into between
litigants in a prior Arkansas state court suit in 1987, prior to the formation
of the Company.

     On December 13, 2000, Three H. Enterprises filed an Amended Complaint
adding Juniper Industries, Inc., Southern Minerals, Inc., Joseph G. Brooks and
Marjorie S. Brooks as co-defendants in the litigation. The Company has denied
the allegations and discovery between Three H. Enterprises and the Company
closed on March 31, 2001. No trial date has been set. The Company believes the
allegations and claims are without

                                       F-25
<PAGE>   59
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

merit and will vigorously defend itself. The Company also believes this lawsuit
is related to the prior Delaware action which was recently dismissed.

NOTE 11: NEW ACCOUNTING PRONOUNCEMENT

     In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", (SFAS 133), as
amended by Statement of Financial Accounting Standards No. 137 and No. 138,
"Accounting for Derivative Instruments and Hedging Activities -- Deferral of the
Effective Date of FASB Statement No. 133". SFAS 133 establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. SFAS
No. 133 requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement. Companies
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. SFAS 133 is effective for fiscal years beginning
after June 15, 2000.

     The Company adopted SFAS 133 with no effects with the exception of warrants
that are indexed to and potentially settled in the Company's common stock. These
warrants will be accounted for under the provisions of Emerging Issues Task
Force 00-19, "Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock" (EITF 00-19). EITF 00-19 is
effective for all new contracts and contract modifications entered into after
September 20, 2000, of which the Company had none. For contracts that existed on
September 20, 2000, and remain outstanding June 30, 2001, the EITF is effective
as of June 30, 2001, based on the contract terms then in place. Had EITF 00-19
been early adopted by the Company as of December 31, 2000, the Company would
have recognized an additional $4.6 million in net loss as a cumulative effect of
a change in accounting principle. The ultimate impact to the Company will not be
known until the adoption of EITF 00-19 on June 30, 2001. The impact will be
based on the values and conditions which exist at that time.

NOTE 12: SEGMENT INFORMATION

     SFAS No. 131 "Disclosures About Segments of an Enterprise and Related
Information", (SFAS 131), establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. SFAS 131
requires that a public business enterprise report financial and descriptive
information about its reportable operating segments. Reportable operating
segments are defined as a component of an enterprise:

     - That engages in business activities from which it may earn revenues and
       expenses,

     - Whose operating results are regularly reviewed by the enterprise's chief
       operating decision maker,

     - For which discrete financial information is available.

     As of December 31, 2000, the Company does not have available discrete
financial information to disclose gross margin by product line. All operating
expenses are allocated primarily on capacity. Corporate overhead is

                                       F-26
<PAGE>   60
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

not allocated by product line, neither are selected assets. Net sales segregated
by product line and gross margin by plant location are as follows:

<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31,
                                                      -----------------------------------------
                                                         2000           1999           1998
                                                      -----------    -----------    -----------
<S>                                                   <C>            <C>            <C>
Net Sales --
  Commercial and residential decking surface
     components.....................................  $19,725,608    $10,314,728    $ 4,260,169
  Exterior door, window and housing trim
     components.....................................    6,896,334      9,311,095      7,749,049
  Industrial flooring...............................      886,922        291,310        399,373
                                                      -----------    -----------    -----------
                                                      $27,508,864    $19,917,133    $12,408,591
                                                      ===========    ===========    ===========
</TABLE>

<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                         ------------------------------------------------------------------------------
                                   2000                        1999                      1998
                         -------------------------   ------------------------   -----------------------
                         SPRINGDALE     JUNCTION     SPRINGDALE    JUNCTION     SPRINGDALE    JUNCTION
                         -----------   -----------   ----------   -----------   ----------   ----------
<S>                      <C>           <C>           <C>          <C>           <C>          <C>
Gross Margin --
  Net revenues.........  $15,225,413   $12,283,451   $9,193,900   $10,723,233   $2,877,937   $9,530,654
  Cost of goods sold...   12,680,692     9,970,047    8,632,047     8,533,978    3,184,830    8,503,618
                         -----------   -----------   ----------   -----------   ----------   ----------
  Gross margin.........  $ 2,544,721   $ 2,313,404   $  561,853   $ 2,189,255   $ (306,893)  $1,027,036
                         ===========   ===========   ==========   ===========   ==========   ==========
</TABLE>

NOTE 13: 401(k) PLAN

     During December 2000, the Company initiated the A.E.R.T. 401(k) Plan (the
Plan) for the benefit of all eligible employees. The plan qualifies under
Section 401(k) of the Internal Revenue Code thereby allowing eligible employees
to make tax-deductible contributions to the Plan. The Plan provides that the
Company may elect to make employer-matching contributions equal to a percentage
of each participant's voluntary contribution. The Company may also elect to make
a profit sharing contribution to the Plan. Profit sharing contributions to the
Plan can range from 0% to 15% of participants' annual compensation. During 2000,
no matching or profit sharing contributions were made to the Plan.

                                       F-27
<PAGE>   61

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                        DESCRIPTION OF EXHIBIT
-------                       ----------------------
<C>        <S>
  3.1      Certificate of Incorporation, including Certificate of
           Amendment filed on June 12, 1989(a), and Certificate of
           Amendment filed on August 22, 1989.(b)
  3.2      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)
  4.2      Form of Class B common stock Certificate.(a)
  4.3      Form of Warrant Agreement with American Stock Transfer &
           Trust Company, including Class A and Class B common stock
           Purchase Warrants.(a)
  4.7      Form of Redeemable Class B Warrant Certificate.(c)
  4.8      Form of Class C Warrant Certificate.(h)
  4.9      Form of Class D Warrant Certificate.(h)
  4.10     Form of Class E Warrant Certificate.(h)
  4.11     Form of Class F Warrant Certificate.(i)
  4.12     Form of Class G Warrant Certificate.(i)
  4.13     Form of Class H Warrant Certificate.(j)
  4.14     Form of Class I Warrant Certificate.(k)
  4.15     Form of Class J Warrant Certificate.(l)
  4.16     Form of Class K Warrant Certificate.(m)
 10.1.1    Private Placement Agreement.(o)
 10.1.2    Consulting Agreement.(o)
 10.1.3    Note Purchase Agreement.(o)
 10.1.4    Form of Note.(o)
 10.1.5    Form of Private Placement Warrants.(o)
 10.1.6    Form of Consulting Warrants.(o)
 10.9      Form of Right of Refusal Agreement among Class B common
           stockholders.(a)
 10.10     1989 Stock Option plan.(a)
 10.11     Form of Escrow Agreement with American Stock Transfer &
           Trust Company.(c)
 10.15     Lease Agreement dated June 1, 1990 between the Registrant
           and J's Feed, Inc. for the Registrant's plastics reclamation
           facility.(e)
 10.16     Loan Agreement dated June 13, 1991 with Dow Credit
           Corporation.(f)
 10.17     Loan Agreement dated October 22, 1991 with Dow Credit
           Corporation.(f)
 10.18     Loan Agreement with City of Rogers, arranged through
           Arkansas Industrial Development Commission.(f)
 10.19     Lease Agreement dated June 15, 1992 between the Registrant
           and George's, Inc. for the Registrant's corporate office
           facility.(g)
 10.20     Factoring Agreement dated April 30, 1993 between the
           Registrant and Brooks Investment Company.(h)
 10.21     Private Placement Distribution Agreement dated September 23,
           1993 between the Registrant and Berkshire International
           Finance, Inc.(h)
 10.22     Lease Agreement dated June 16, 1994 between Registrant and
           Marjorie S. Brooks.(i)
</TABLE>
<PAGE>   62

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                        DESCRIPTION OF EXHIBIT
-------                       ----------------------
<C>        <S>
 10.27     Line of Credit Promissory Note payable to Jim G. Brooks and
           Marjorie S. Brooks.(i)
 10.28     Amended and Restated Stock Option Plan.(i)
 10.29     Non-Employee Director Stock Option Plan.(i)
 10.30     Chairman Stock Option Plan.(i)
 10.31     Factoring Agreement dated April 30, 1994 between the
           Registrant and Brooks Investment Company.(i)
 10.32     Lease agreement dated July 29, 1997 between Registrant and
           Dwain A. Newman, et ux., and National Home Center, Inc.(n)
 10.33     Securities Purchase Agreement.(p)
 10.34     Certificate of Designation of Series A Preferred Convertible
           Stock.(p)
 10.35     Certificate of Designation of Series B Preferred Convertible
           Stock.(p)
 10.36     Certificate of Designation of Series C Preferred Convertible
           Stock.(p)
 10.37     Form of Series X Warrants.(p)
 10.38     Form of Series Y Warrants.(p)
 10.39     Registration Rights Agreement.(p)
 10.40     Placement Agency Agreement.(p)
</TABLE>

---------------
 *  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 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, 1989.

(e) Filed with Form 10-K for December 31, 1990.

(f) Contained in Exhibits to Post Effective Amendment No. 1 to Registration
    Statement on Form S-1, No. 33-29593, filed December 24, 1991.

(g) Filed with Form 10-K for December 31, 1992.

(h) Filed with Form 10-K for December 31, 1992.

(i) Filed with Form 10-K for December 31, 1994.

(j) Filed with Form 10-K for December 31, 1996.

(k) Filed with Form 10-K for December 31, 1996.

(l) Filed with Form 10-K for December 31, 1996.

(m) Filed with Form 10-K for December 31, 1996.

(n) Filed with Form 10-K for December 31, 1997.

(o) Contained in Exhibits to Registration Statement on Form S-3, No. 333-42555
    filed December 18, 1997.

(p) Filed with Form 10-K for December 31, 1998.