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UNITED STATES
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 fiscal year ended December 31, 2004 Commission file number 1-10367 Advanced Environmental Recycling Technologies, Inc. Delaware
    
    71-0675758(State or other jurisdiction of incorporation or
    
    (I.R.S. Employer Identification No).organization)914 N Jefferson StreetPost Office Box 1237Springdale, Arkansas
    
    72765(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code:(479) 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 such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past
90 days. YES: þ NO: o 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: þ
NO: o Indicate by check mark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act).
YES: o NO: þ On June 30, 2004, the last business day of the registrants most recently
completed second fiscal quarter, the aggregate market value of the voting and
non-voting common equity beneficially held by non-affiliates computed by reference to
the price at which the common equity was last sold, or the average bid and asked price
of such common equity of the registrant was $38,325,194 (for the purposes hereof,
directors, executive officers and 10% or greater shareholders have been deemed
affiliates). Indicate the number of shares outstanding of each of the registrants classes of
common stock, as of the latest practicable date. Number of shares of common stock
outstanding at April 6, 2005: Class A  32,766,400
Class B - 1,465,530




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Table of Contents PagePart IItem 1.
    
    Business
    
    
    1Item 2.
    
    Properties
    
    
    9Item 3.
    
    Legal Proceedings
    
    
    10Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    10Part IIItem 5.
    
    Market for
Registrants Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.
    
    
    11Item 6.
    
    Selected Financial Data
    
    
    12Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    21Item 8.
    
    Financial Statements and Supplementary Data
    
    
    22Item 9.
    
    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    22Item 9A.
    
    Controls and Procedures
    
    
    22Item 9B.
    
    Other Information
    
    
    22Part IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    23Item 11.
    
    Executive Compensation
    
    
    26Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    29Item 13.
    
    Certain Relationships and Related Transactions
    
    
    32Item 14.
    
    Principal Accountant Fees and Services
    
    
    32Part IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    32Signatures
    
    
    33Index to Financial Statements
    
    
    F-1Accountant's ConsentCertification Pursuant to Section 302 - Chairman, Co-CEO and PresidentCertification Pursuant to Section 302 - Co-CEOCertification Pursuant to Section 302 - CFOCertification Pursuant to Section 906 - Chairman, Co-CEO and PresidentCertification Pursuant to Section 906 - Co-CEOCertification Pursuant to Section 906 - CFO
  i




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PART I 
 Item 1. Business Summary Advanced Environmental Recycling Technologies, Inc. (AERT) develops manufactures and markets
composite building materials that are used in place of traditional wood products for exterior
applications in building and remodeling homes and for certain other industrial or commercial
building purposes. Since inception in 1989, we have sold in excess of
$269 million of products into the North American marketplace.
Our products are made from approximately equal amounts of waste wood fiber and
reclaimed polyethylene plastics, have been extensively tested, and are sold by leading national
companies such as the Weyerhaeuser Company (Weyerhaeuser), Lowes Companies, Inc. (Lowes) and
Therma-Tru Corporation. Our composite building materials are marketed as a substitute for wood and
plastic filler materials for standard door components, windowsills, brick mould, fascia board,
decking and heavy industrial flooring under the trade names LifeCycle®, MoistureShield®,
MoistureShield® CornerLoc, Weyerhaeuser ChoiceDek® Classic, Weyerhaeuser ChoiceDek® Plus,
Weyerhaeuser ChoiceDek® Premium, ChoiceDek® Classic Colors, ChoiceDek® Premium Colors and
MoistureShield® outdoor decking. We operate manufacturing facilities in Springdale, Lowell, and
Tontitown, Arkansas, Junction, Texas and Alexandria, Louisiana. Our customers are primarily
regional and national door and window manufacturers, Weyerhaeuser (our primary decking customer),
and various building product distributors. Products Using the same basic material, we manufacture the following product lines:  
    Commercial and residential decking planks and accessories such as balusters and
handrails (MoistureShield and Weyerhaeuser ChoiceDek), and
    Exterior door, window, and housing trim components (MoistureShield) The wood fiber content of our products gives them many properties similar to all-wood
products, but we believe the plastic content makes our products superior to either all-wood or
all-plastic alternatives because:  
    The primary replacement chemical treatment for lumber is alkaline copper quaternary
(ACQ), and this treated lumber is approximately 20% higher in price than chromated copper arsenic
(CCA) treated lumber
and also requires additional handling and fastening techniques. Unlike wood, our products
do not require preservatives or treatment with toxic chemicals such as CCA or ACQ, nor do
they require yearly water sealing or staining. Beginning January 1, 2004, the wood
industry no longer sells CCA treated lumber
for residential and construction applications.
    They are less subject to thermal contraction or expansion and have greater dimensional
stability than competing all-plastic products.
    They are engineered for superior moisture-resistance and will not swell or expand like
wood.
    They can be designed and extruded through dies to a desired shape in accordance with
customer specifications, which helps the customer to minimize waste.
    They are less subject to rotting, cracking, warping, and splintering, insect infestation
and water absorption than conventional wood materials. 1




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
    They can be embossed to provide a wood-like or grained surface appearance.
    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.
    They can be combined with coloring agents and/or other additives to provide different
colors and aesthetics. Our composites manufacturing process involves proprietary technologies, certain of which are
patented. We also use manufacturing equipment that has been custom-built or modified to our
specifications. Our composite building material became a patented product in June 1998 under U.S.
Patent No. 5,759,680. In 2004, we introduced a line of fade-resistant colored decking products, some of which also
have an embossed wood-grain texture. We introduced a new matching handrail system for the colored
decking during the third quarter of 2004. Based upon our extensive product testing and successful extended field history of over a
decade, we offer a limited lifetime replacement warranty on our products against rot and fungal
decay, and termite and insect damage. AERT is subject to federal, state, and local environmental regulations. Environmental
discharges and impacts from our manufacturing facilities including air, solid waste, and wastewater
discharges must meet the standards set by environmental regulatory authorities in Texas, Arkansas,
and Louisiana. Compliance with environmental laws has not had a material effect on our operating
results or financial condition. Our operations also are subject to work place safety regulation by the U.S. Occupational
Safety and Health Administration, the state of Arkansas, the state of Texas, and the state of
Louisiana. We provide safety awareness and training programs for all associates who work in a
manufacturing environment. Marketing and Sales General Market
Strategy.We have manufactured wood plastic composite products since 1989.
Our products are designed for applications where we can add the
greatest value and address market needs, i.e. for external applications where wood is prone to rot
and/or requires substantial yearly maintenance in the form of staining or water sealing. Though we
believe there are many possible applications for our wood/plastic composite technology, we have
focused our resources and personnel on the outdoor decking and door and window components as in our
view representing the most attractive market opportunity at this time. Within our chosen markets,
we are constantly working to develop and improve strong customer relationships. Outdoor Decking Systems.Since 1995, we have sold our decking products exclusively to
Weyerhaeuser Building Materials. In August 2004, we signed a new contract with Weyerhaeuser that
allows AERT to sell decking products to distributors and dealers other than Weyerhaeuser. Under
the new Weyerhaeuser contract, Weyerhaeuser will purchase all of our ChoiceDek Premium decking products and sell
it exclusively to Lowes Home Improvement Warehouse under the Weyerhaeuser ChoiceDek brand. The
Weyerhaeuser contract requires us to produce, and Weyerhaeuser to purchase, a minimum number of
truckloads of ChoiceDek Premium decking and accessories during 2005. The minimum volume to be
produced for each succeeding year will be determined annually. In addition, Weyerhaeuser and
independent lumber dealers can special order MoistureShield decking from the Weyerhaeuser
distribution network in certain markets. Weyerhaeuser entered into a rolling three year agreement
with Lowes whereby Lowes has the exclusive right to carry the ChoiceDek Premium product line.
Lowes has agreed to provide dedicated retail shelf space in all of its 1,000 plus stores and to
promote ChoiceDek Premium through a national print and advertising campaign. Under the new Weyerhaeuser contract,
the term of the agreement was modified
from a rolling, evergreen 3-year period to a term now expiring December 31, 2006 and renewing on a year-to-year basis thereafter, unless
either party provides prescribed four months advance notice of cancellation. We believe the
Weyerhaeuser contract strengthens our competitive position in the decking marketplace and gives us
the opportunity to develop and sell new products through the same home improvement warehouse
channel. 2




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We promote our decking products through displays and presentations at national, regional, and
local home, lawn, and garden shows, and through in-store displays. We have an on-going print
advertising program that targets the residential decking market. Lowes is also conducting a
national print and television advertising campaign for ChoiceDek Premium. Weyerhaeuser purchased and resold substantially all of our decking products, which represented
about 81% of our 2004 revenues. If Weyerhaeuser were to cancel the Weyerhaeuser contract, we would
have to develop an alternative distribution system for decking products, which could be expensive
and time consuming. Though Weyerhaeuser has purchased substantially all of our decking production
since 1995, there is no assurance that it will continue to do so past the terms of the contract in
2005 (see Note 2 to the financial statements regarding concentration of risk). In October 2004, we began production of our new MoistureShield line of decking products, which
consists of four new colors and a new wood-like embossed surface pattern. We intend to initially sell
MoistureShield decking through a limited number of primary distributors, who will re-sell it to
local builders and lumber dealers. We anticipate that in 2005 MoistureShield decking sales will
represent 10% to 15% of total company sales. The MoistureShield decking line allows us to
diversify our customer base and increase
factory utilization and maintain cash flow, especially during the historically slow fourth quarter. It also allows us to
diversify the risk inherent in selling such a large portion of our production to one customer,
Weyerhaeuser. It is our intent to grow the MoistureShield decking program and diversify our
customer base. Door and Window Products.We sell our MoistureShield industrial line to door and window
manufacturers for use as component parts of their products. For example, we manufacture a
windowsill that is built into products like Portrait windows by Stock Building Supply and other
regional window manufacturers, and we manufacture door rails built into doors by Therma-Tru
Corporation. In marketing, we emphasize the value-added potential of the MoistureShield
composite product, which, unlike competing wood products, can be engineered to incorporate certain
desired end-product characteristics, which saves our customers time and expense. Customers will
also avoid the need for chemical treatments to their final product, which are otherwise often
necessary to prevent rot and sustain durability. The durability of our MoistureShield composite
components allows our customers to extend the lifetime or warranties of their products while
reducing or eliminating warranty claims costs. Therma-Tru and Stock Building Supply each purchase a large portion of our MoistureShield
production. The loss of either customer would negatively impact sales and earnings. We are unable
to predict the future size of the markets for MoistureShield; however, we believe that the national
door and window, commercial and residential trim, and residential decking material markets are
significant and will allow us to diversify our customer base over time as more production capacity
becomes available. Exterior Trim and Fascia Products.We market an exterior trim and fascia system under the
trade name MoistureShield CornerLoc. Three national homebuilders are now using the product. With
our previous limitations on production capacity and focus to meet the demand for our decking
systems, we have had restricted CornerLoc production to date. We believe this product line has significant
growth potential, and we are striving to increase production capacity so that we can begin a full
production and marketing program, but the timetable of a full product launch is dependent upon our
construction and financing timetable. (See Liquidity and Capital Resources in Item 7) Sales and Customer Service.We provide sales support and customer service through our own
marketing department, through Weyerhaeuser, and through training programs for our customers and
their sales associates. Our in-house sales team is focused on serving commercial decking
contractors and supporting the Weyerhaeuser and Lowes sales professionals. Information and
customer service are provided through the website, www.choicedek.com, and through a national
toll-free customer assistance telephone number. We also use independent, outside sales
representatives in some markets to promote and serve door, window, and decking customers. 3




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Cyclical Building Products Industry.Our products are used primarily in home improvement and
new home construction. The home improvement and housing construction industries are subject to
significant fluctuations in activity and periodic downturns caused by general economic conditions.
Increased interest rates and economic uncertainty in particular can lead to reduced homebuilding
and/or home improvement activity. Reductions in such activity could have an adverse effect on the
demand for our products. We have focused a large portion of our business on the remodel and repair
market segment which we believe is less sensitive to interest rate fluctuations. Raw Materials Wood Fiber.The wood fiber we use is waste byproduct generated by hardwood furniture, cabinet, and
flooring manufacturers. The cost of acquiring the waste wood is primarily the handling and
transportation costs involved in getting the product to our facilities. Costs vary with
transportation costs in general, which are related to petroleum prices and the supply and demand
for over-the-road trucking services. Our cost of sourcing waste wood fiber has increased 15% over
the last two years, but remains a small proportion of our total costs. Our gross profit margin is
not materially sensitive to changes in the cost of acquiring wood fiber. Two suppliers accounted individually for more than 10% and collectively for approximately 82%
of our 2004 waste wood fiber purchases. Based on our discussions with other waste wood fiber
suppliers, we believe that if the arrangements with one or both of these suppliers were terminated
we would be able to obtain adequate supplies of waste wood fiber at an acceptable price from new
suppliers.
We are currently evaluating the feasibility of establishing an in-house wood fiber reclamation and cleaning system in northwest Arkansas. Recycled Plastics.We use the following classes of industrial and consumer waste
polyethylene:  
    Low density polyethylene (LDPE) poly coatings or linings from recycled bleached
food-board, which are generated from the hydro-pulping process;
    High density polyethylene (HDPE) and linear low density polyethylene (LLDPE)
mixed plastic grocery bags from supermarket and store collection programs;
    HDPE ground container material; and
    LLDPE stretch film from warehouses and packing waste. The materials we use are highly contaminated with paper and other non-plastic materials, which
lessen their value to other plastic recyclers. Our proprietary recycling process does not require
the purity, extensive cleaning, additional washing, and melt filtration required for conventional
plastics manufacturing, and can be conducted faster and more economically. By using primarily
contaminated plastics, we produce a usable, but lower cost, feedstock for our composite extrusion
lines. We also purchase additional plastic raw materials from outside sources and sometimes virgin
resin producers. These materials are more expensive and more sensitive to price swings related to the
petrochemical industry.
Our goal is to source and process a minimum of 75% of our plastic raw materials in-house.
Currently we are at approximately 55% which still leaves us overly dependent on outside suppliers. Two suppliers accounted individually for more than 10% and collectively for approximately 39%
of our 2004 polyethylene scrap purchases by weight. We discontinued purchasing from one of those
vendors in early 2005. We also are subject to various quality and consistency problems when dealing with third party scrap suppliers, which also increases cost. Thus,
we are utilizing more off spec or virgin resin at higher prices as we further work to increase our in-house infrastructure. Over the last several years, we believe three factors have caused an increase in the demand
for scrap polyethylene and, consequently, the cost to us of acquiring raw materials for our
manufacturing process.  
    As world political events conspired to raise the price of petroleum there was
a related rise in the price of virgin plastics, which is a petroleum derivative. This in
turn increased the demand for scrap plastics since scrap can be substituted for virgin
plastics in many manufacturing applications. We thus began competing with scrap plastic
consumers that had not previously been in the market.  
    The relative decline in the value of the dollar versus major Asian currencies
has made it more economical for Asian manufactures to source scrap plastic in the U.S. for
use in their countries. We have thus encountered significant competition for scrap
plastics from foreign consumers that had not previously been a factor in the market.  
    As annual sales of wood composite decking products have grown and competition has increased, we and other
composite decking manufacturers have become relatively large consumers of scrap plastics,
which has created increasing competition and driven up prices. Looking forward,
we have no way
to accurately assess the future of prices in that market. We also believe that the economics of
recycling are now such that more private and public entities will find it attractive to undertake
removing plastic scrap from the waste stream and make it available to consumers like us. Over time
we expect the increased supply from these sources to ease competitive pressures for our raw
materials acquisition program provided adequate processing infrastructure is developed to continually purchase and sustain these recycling programs. Supply Contracts.We purchase raw materials under both supply contracts and purchase orders.
In 2004, we purchased 68% of our polyethylene scrap and 51% of our waste wood, by weight, via
purchase orders. Purchase order acquisitions are one-time transactions that involve no long-term
obligation. We also have supply contracts, with terms that range from one to three years, which
obligate us to purchase materials. The prices under these contracts are renegotiated semi-annually
or annually. In the past three years, the amounts we have been obligated to purchase under the
supply contracts have been significantly less than the amounts of these materials we have needed
for production. We anticipate that we will continue to acquire most of our raw materials under
purchase orders. Competition for Raw Materials.As the wood/plastic composites industry grows, we sometimes
compete for raw materials with other plastic recyclers or plastic resin producers. We believe that our ability
to use highly contaminated polyethylene limits the number of competitors because most recycling
processes require cleaner waste plastic sources. Nonetheless, we expect to continue to encounter new
entrants into the composites or plastics reclamation business. These new entrants may have greater
financial and other resources than we do, and may include domestic and foreign beverage bottlers,
manufacturers, distributors and retailers, forestry product producers, petrochemical and other
companies. We increased our
capacity for processing waste plastic in 2004, which reduced our dependence on outside suppliers and
reduces our overall costs but it is still not to desired levels. There is no assurance that we will be able to control the effect
that increasing waste plastic costs has on our profitability. (See Managements Discussion and
Analysis  General and Liquidity and Capital Resources.) 4




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Patented and Proprietary Technology Our composite manufacturing process and our development efforts in connection with waste
plastics reclamation technologies involve patents and many trade secrets that we consider to be
proprietary. We have also developed certain methods, processes, and equipment designs for which we
have sought additional patent protection. We have taken measures to safeguard our trade secrets
by, among other things, entering into confidentiality and nondisclosure agreements, and restricting
access to our facilities. We also have installed advanced security systems, including limited
access and cameras, at all facilities including on-site security personnel. Should our trade secrets be disclosed notwithstanding these
efforts, our business and prospects could be materially and adversely affected. We have filed nineteen patent applications and have received issuance from the United States
Patent and Trademark Office for fifteen patents, six of which relate to our composite materials
manufacturing operations and product, and nine of which relate to waste plastics reclamation
technologies. The patents cover our composite product, extrusion process and apparatus, our
continuous down-stream cooling and forming conveyor system and our plastic reclamation process and
equipment. The cost of patent protection and, in particular, patent litigation is extremely high.
It can also strain resources and inhibit growth. Industry Standards Local building codes often require that building materials meet strength and safety standards
developed by the American Society for Testing Materials and that, in order to qualify, the
materials be evaluated by an independent testing organization. Our decking, handrails and stair
applications have a national evaluation report NER code rating under NER-596. The NER rating
provides local building inspectors and code officials with independent testing and installation
information regarding our products. We believe that the NER listing has helped to increase sales
and market acceptance of our decking products. Competition Competition for Sales.Our products compete with high-grade western pine, cedar and other
premium woods, aluminum, high-performance plastics, and an increasing number of composites and
other construction materials. We believe that our products have superior physical characteristics,
which make them a better value for the consumer. Manufacturers of some competing products,
however, have long-established ties to the building and construction industry and have
well-accepted products. Many of our competitors are larger and have research and development
budgets, marketing staffs, and financial and other resources which surpass our resources. Sales of non-wood decking products to date represent a small portion of the decking market.
According to an independent research report the composite market share was 12% in 2003 and continues to grow. Pressure
treated pine, cedar, redwood and other traditional woods constitute the vast majority of annual
decking sales. We thus view wood decking as our principal competitor. The wood decking industry
is highly segmented with many small to medium sized manufacturers. Wood decking is principally a
commodity that competes as the low-priced product, whereas the more-expensive non-wood products
must compete on features and performance. Among manufacturers of alternative decking materials, we view Trex Company, Crane Plastics
TimberTech, Louisiana-Pacific Corporations WeatherBest, CertainTeed Corporations Boardwalk and
Fiber Composites, LLCs Fiberon, as our primary competitors. The market for door, windowsill, and trim products is highly segmented, with many competitors.
We believe that our MoistureShield industrial products have superior characteristics and are
competitively priced. We emphasize durability, which means that manufacturers and homebuilders
using our products should see reduced warranty callbacks and higher customer satisfaction. Our
product competes on durability and the ability of the customer to order a product that is custom
manufactured to their specifications. 5




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Employees On December 31, 2004, we employed 585 people on a full-time basis, as associates. We had 101
associates at the Texas facility, of which two were executive and/or office personnel and 99 were
full-time factory personnel. The Arkansas facilities, including our corporate office, employed 456
associates, of which 59 were executives and/or office personnel and 397 were full-time factory
personnel. We had 28 full-time associates at our Louisiana facility. From time-to-time, we hire
part-time employees to supplement our factory workforce. Risk Factors Our business is subject to a number of risks, including but not limited to the following: We have a working capital deficit At December 31, 2004, we had a working capital deficit of $3.5 million and at December 31,
2003, we had a working capital deficit of $1.9 million. The working capital deficit is the result
of previously incurred losses from operations, our decision to finance capital projects with
cash generated from operations, and our need to fund rapid growth in
sales. Additionally, pursuant to our bond agreement, we are required to
maintain a debt service reserve fund in the amount of approximately $2 million, which is classified as a
non-current asset in our balance sheet. Our limited manufacturing capabilities could restrain our business growth The long-term success of our operations will depend upon the manufacture of our composite
products on a substantially greater commercial scale and at lower costs than we have engaged in to date or have the
current production capacity to engage in. Our primary customers and markets are large, and
continued increased sales growth will require significant capital expenditures. Although we
believe financing can be obtained to add production equipment further
increase efficiencies and build additional manufacturing
facilities, there is no assurance that we will secure the necessary financing, attain the necessary operational
execution required or that the equipment
and facilities will become operational in a timely manner. We currently have one composite
manufacturing facility in Junction, Texas, and a second composite manufacturing facility in
Springdale, Arkansas, but plan to increase production capacity at both facilities, and plan to
build a third composite manufacturing facility adjacent to our current facility in Springdale in
2005. Declines in construction activity may adversely affect our business Our engineered 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 to periodic downturns
caused by general economic conditions. Increases in long-term interest rates can have a negative
effect by slowing housing starts due to increased financing costs. Reductions in construction
activity could have an adverse effect on the demand for our composites in the door and window
market. The loss of one or more of our key customers could cause a substantial reduction in our revenues We could be materially adversely affected if we were to lose one or more of our large existing
customers. We have limited our marketing to major industrial companies with large market shares
nationwide in the building material, door, and window construction industries. Our principal
marketing and distribution channel for our decking material is Weyerhaeuser, which accounted for
81% and 82% of our sales in 2004 and 2003, respectively. Since inception, a few large door and
window construction companies have historically purchased substantially our entire MoistureShield
product line. Most of our key door and window customers are not contractually obligated to
purchase additional products. 6




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Fire disruptions may adversely affect our business Our raw materials and manufacturing processes involve a greater than average risk of fire loss
or disruption. We experienced a series of fires in 1996, which severely disrupted our
manufacturing operations, although these were determined to be instances of arson. The pattern of
fires caused our fire insurance to be cancelled, but we were subsequently able to renew it. There
was an accidental fire at our Junction, Texas facility in March 2003, which caused substantial
damage and temporarily shut down plant operations. Although we have increased security and
increased fire protection equipment at our facilities, another major fire could occur and
materially adversely affect our operations. Covenants in our bond agreements could restrict our ability to borrow, which could impair the
improvement and expansion of our operations Certain covenants in our bond agreements restrict the types and amounts of additional
indebtedness that we may incur, including a requirement that, with certain exceptions, we may only
incur additional indebtedness to the extent it would satisfy a debt incurrence coverage ratio of
250% of income before interest, taxes, depreciation and amortization to debt service. Those
restrictions could inhibit our ability to improve and expand our current operations.
Additionally, our ability to secure adequate working capital to support our day-to-day operations
as we grow could be limited by the covenants in our bond agreements. If we are unable to comply with certain debt covenants, our financial position and operations could
be adversely affected The bond agreement contains financial covenants, which include a current ratio of not less
than 1.00 to 1.00 and a requirement that not more than 10% of accounts payable be in excess of 75
days past the invoice date. We were not in compliance with these two covenants at December 31,
2004, however, these covenants were waived by the bondholder as of
December 31, 2004 through, and including, December 31, 2005. There is no assurance that we will be able to comply
with these debt covenants in the future, or that the bondholder will waive or modify the covenants
in the future. If we are unable to comply with the covenants or obtain a waiver or modification of
the covenants in the future, then the bond debt in the amount of $14.4 million could immediately
become due and payable, the bondholder could foreclose on the property used to secure the debt, and
the bondholder could claim our revenues pledged as part of the bond agreement. Our common stock could be diluted or otherwise adversely affected by additional issuances of
preferred stock Additional issuances of preferred stock may provide for rights that adversely affect the Class
A common stock or may be convertible into shares of Class A common stock on a basis which would
cause dilution. We are authorized to issue up to 5,000,000 shares of preferred stock, 2,900 shares
of which have been issued. Our board of directors is empowered to fix the terms of the preferred
stock without stockholder approval, which terms may adversely affect the rights of holders of the
Class A common stock. We could be required to pay liquidated damages on preferred stock If we default under certain obligations with respect to our outstanding preferred stock, we
may be required to pay liquidated damages to the holders of the preferred stock. Our outstanding
Series A, B and C convertible preferred stock (total stated value of $2,760,000) has a 10% per
annum accreting premium for conversion, 7




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redemption and liquidation purposes. Although the preferred stock is not mandatorily
redeemable, we could be required to pay as liquidated damages an amount equal to 10% of the stated
value of the preferred stock if we default under certain provisions of the preferred stock agreements.
The liquidated damages amount is payable at our option in either cash or shares of Class A common
stock. The redemption price is generally equal to the greater of (a) the aggregate market value of
the Class A common stock into which the preferred stock could be converted and (b) 115% of the sum
of (i) the stated value, (ii) the 10% per annum premium, and (iii) any unpaid conversion default
payment. Payment of the liquidated damages amount in common stock would result in substantial
dilution to existing holders of common stock. The floating conversion feature of our convertible preferred stock could cause a drop in our stock
price Conversion of a material amount of our convertible preferred stock into Class A common stock,
which would increase the total number of Class A common stock in the marketplace, could cause a
drop in our stock price. Our convertible preferred stock is convertible into common stock at the
holders option at any time at a conversion price equal to the lower of a fixed $1.20 conversion
price or the 10-trading day average closing bid price immediately prior to the date of conversion.
At December 31, 2004, the applicable conversion price was $1.20.
If any shares of preferred stock have not been converted prior to
November 10, 2005, then those shares are scheduled to automatically convert on that date, subject to certain conditions. Based on these conversion price formulae, whenever the prevailing market price of the common
stock is below $1.20, the convertible preferred stock will be convertible into a proportionately
greater number of shares of common stock. The number of shares we could be required to issue in
payment of the premium on the preferred stock would also increase whenever the market price of the
common stock is below $1.20. In that event, the lower the price of our common stock at the time of
conversion, the more shares into which the convertible preferred stock will be convertible. There
is no minimum conversion price for the preferred stock. These increases in the number of shares
issuable upon conversion of the convertible preferred stock and upon payment of the premium on the
preferred stock could result in a substantial dilution to other holders of Class A common stock and
could cause a decline in the market price of the Class A common stock due to the added number of
shares in the market. In addition, substantial sales by the holders of the convertible preferred
stock could place further downward pressure on our stock price and permit holders of our
convertible preferred stock to convert additional shares at a lower price, which would further add
to the number of shares in the market and cause the price to fall further. An additional reduction
of the price of Class A common stock shares may occur if shareholders or others begin to sell the
Class A common stock short to take advantage of the falling stock price caused by preferred stock
holders converting material amounts of their preferred stock. Future sales of shares could be dilutive and impair our ability to raise capital The conversion of a significant number of our outstanding derivative securities into Class A
common stock could adversely affect the market price of the stock.
There are currently warrants outstanding for 14,890,867 shares of Class A
common stock at an average exercise price of $1.05. The exercise or conversion of a
material amount of such securities will result in a dilution in interest for our other security
holders. Such convertible securities, whether converted into stock or not, could impair our
ability to obtain additional capital because of the potential for dilution. Also, the holders of
such securities may be expected to exercise their rights at a time when we would in all likelihood
be able to obtain needed capital through a new offering of our securities on terms more favorable
than those provided by the outstanding securities. 8




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##### Table of Contents






Item 2. Properties

Manufacturing Facilities

We operate the following manufacturing and recycling facilities:

We manufacture our MoistureShield and Weyerhaeuser ChoiceDek brand lines of decking products at
our Springdale, Arkansas extrusion plant. That facility also produces door, window, and housing
trim components. Springdale had four extrusion lines and a plastic recycling facility
throughout 2004. The Springdale plant consists of 103,000 square feet under one roof and is
located on 10 acres with a rail siding in the Springdale industrial district. We have added
30,440 square feet of shed storage space since 1999 and installed a dual sprinkler system.

We lease an office, storage building, and parking lot adjacent to the Springdale facility. The
lease is for two years, renewable yearly. We also lease an adjacent parking area. The office
and storage facility is comprised of 10,000 square feet on 2.36 acres and houses our corporate
offices.

Our Junction, Texas facility manufactures primarily MoistureShield and Weyerhaeuser ChoiceDek
decking. A fire in March 2003 reduced production capacity for the rest of 2003. Production
increased through 2003 and 2004 as fire damage was repaired. Full restoration has been slowed
by litigation with one of the insurance carriers responsible for paying for fire damage. (See
Item 3. Legal Proceedings.) The Junction plant consists of a 49,000 square foot manufacturing
and storage facility on a seven-acre site. We believe that the Junction facility is currently
suitable for composite materials manufacturing requirements on a regional basis.

During the first quarter of 2004, we relocated and expanded our paint system and added some
finishing and packaging operations to a 50,000 square foot facility near Tontitown, Arkansas.
This allowed for additional extrusion production at the Springdale facility.

In late 2003, we began construction on a plastics processing facility in Lowell, Arkansas. Work
was completed in the fourth quarter of 2004. The facility is used for plastic recycling, blending, and
storage, and includes a railroad loading/unloading spur, truck scale, receiving station, and
finished goods storage.

In the fall of 2004, we entered into two leases for two 100,000 square foot warehouses under
construction in Lowell, Arkansas that are connected by rail spurs. We occupied these warehouses
in the first quarter of 2005. One warehouse will be used for raw material storage, the second
for finished goods storage. In addition, we lease ten acres of land for storage and load-out of
finished goods designed to load up to five railcars and ten trucks at a time. All this property
is adjacent and immediately to the south of the Lowell plastic plant.

We lease plastic recycling equipment and factory space in Alexandria, Louisiana that commenced
operations in June 2003. The lease is for five years from June 2003 through June 2008. We have made improvements and installed additional equipment to
increase the facilitys throughput. The upgrades provide flexibility to economically process
different types of scrap plastic and to provide plastic feedstock of a quality and consistency necessary to efficiently operate our extrusion facilities.

9



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##### Table of Contents



During the first quarter of 2003, we began road and bridge infrastructure work on an 18.8-acre
tract that adjoins the existing Springdale, Arkansas facility. In 2004, we continued to build
the civil infrastructure. We plan to build a new extrusion factory on the site in 2005. The
second stage currently underway involves building a new raw material system that will service
both the existing and new plants. Construction of this Springdale South facility is being
financed primarily from cashflow, so completion is subject to the availability of funds from
operations. We may seek to finance the new building and warehouse. We believe we can complete
work in 2005, but there is no assurance that we will have adequate funds available to meet our
planned schedule. We believe construction of the Springdale South site could allow us to further
consolidate some operations in the future and reduce costs versus building a third extrusion facility
in another location. 
 Item 3. Legal Proceedings Lloyds London We have been sued by certain underwriters at Lloyds, London (Lloyds) in connection with a
pending final settlement of our Junction, Texas fire claim. Lloyds filed suit January 19, 2005 in the Circuit Court of Washington County, Arkansas
seeking a declaratory judgment that they are not liable to reimburse us for certain costs of
rebuilding the AERT Junction, Texas facility. Lloyds alleges that we did not rebuild the facility
exactly as it had existed prior to the March 2003 fire and that we committed fraud in seeking
reimbursement for alleged improvements made to the facility. Lloyds also seeks to retroactively
cancel its portion of the insurance policy. The filing was unexpected by us because we have
cooperated fully with the claims underwriting process and negotiations toward a final settlement of
the claim seemed to be progressing prior to the lawsuit. We believe the Lloyds lawsuit is without merit. We filed a counterclaim on January 24, 2005
denying all of Lloyds allegations and seeking immediate and full reimbursement for rebuilding of
the Junction plant. We seek to recover actual damages in the amount of at least $1.8 million plus
attorney and court fees and punitive damages for acts of bad faith committed by Lloyds. 
 Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the fourth quarter of the
fiscal year ended December 31, 2004. 10




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##### Table of Contents



PART II 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters, and Issuer Purchases
of Equity Securities AERTs Class A common stock is traded on the NASDAQ in the SmallCap Market and is listed under
the symbol AERTA. In order to remain listed on NASDAQ, we are required to meet certain
criteria as maintenance standards established by NASDAQ. One such standard is a minimum bid price
of $1.00 per share. At December 31, 2004, our closing stock price per share was $1.27 (and $1.38,
as of April 6, 2005). There is no assurance that our stock price will continue to be greater than
the minimum required for NASDAQ listing. The following table sets forth the ranges of high and low quarterly sales prices (as reported
by NASDAQ) of our Class A common stock for the years ended December 31, 2003 and 2004. The
quotations represent prices between dealers, do not include retail markup, markdown, or commission,
and do not necessarily represent actual transactions. Class A Common StockHigh
    
    
    LowFiscal 2003First Quarter
    
    
    1.400
    
    
    
    1.140Second Quarter
    
    
    1.330
    
    
    
    1.017Third Quarter
    
    
    1.600
    
    
    
    1.303Fourth Quarter
    
    
    1.610
    
    
    
    1.207Fiscal 2004First Quarter
    
    
    1.400
    
    
    
    1.160Second Quarter
    
    
    1.220
    
    
    
    1.030Third Quarter
    
    
    1.540
    
    
    
    1.200Fourth Quarter
    
    
    1.530
    
    
    
    1.210
 As of December 31, 2004, there were approximately 1,600 record holders of Class A common stock
and 11 record holders of Class B common stock. We have not previously paid cash dividends on the
common stock and there are currently restrictions under various debt obligations and preferred
securities that would prevent the payment of such dividends for the foreseeable future. Recent Sales of Unregistered Securities On January 16, 2004, we sold an aggregate of 225,000 shares of our Class A common stock to ten
middle manager associates and one of our officers upon the exercise of stock options at an exercise
price of $0.469 per share. We believe, due to the nature of the relationship of these persons to
us and the isolated nature of the transactions, that each issuance and sale of the shares of Class
A common stock underlying such options was exempt from registration under the Securities Act of
1933, as amended, as a private placement pursuant to Section 4(2) of that Act. On March 31, 2004, Marjorie Brooks, our largest shareholder and one of our current directors,
exercised options to purchase 400,000 shares of our Class A common stock at an exercise price of
$1.00 per share, and received restricted stock. We believe, due to her position as a director of
our company and the isolated nature of the transaction, that the issuance and sale of the shares of
Class A common stock underlying such options was exempt from registration under the Securities Act
of 1933, as amended, as a private placement pursuant to Section 4(2) of that Act. On April 7, 2004, Sal Miwa, one of our current directors, exercised options to purchase 25,000
shares of our Class
A common stock at an exercise price of $0.72 per share. We believe, due to his position as a
director of our company and the isolated nature of the transaction, that the issuance and sale of
the shares of Class A common stock underlying such 11




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##### Table of Contents



options was exempt from registration under the
Securities Act of 1933, as amended, as a private placement pursuant to Section 4(2) of that Act. On September 16, 2004, we sold an aggregate of 100,000 shares of our Class A common stock to
three middle management associates upon the exercise of stock options at an exercise price of
$0.813. We believe, due to the nature of the relationship of these persons to us and the isolated
nature of the transactions, that each issuance and sale of the shares of Class A common stock
underlying such options was exempt from registration under the Securities Act of 1933, as amended,
as a private placement pursuant to Section 4(2) of that Act. In October 2004, four holders of consulting warrants exercised 1,573,333 warrants at an
exercise price of $0.375 per share, and received restricted stock. We believe that each issuance
and sale of the shares of Class A common stock underlying such warrants was exempt from
registration under the Securities Act of 1933, as amended, as a private placement pursuant to
Section 4(2) of that Act. 
 Item 6. Selected Financial Data The following tables set forth selected historical data for the years ended December 31, 2000
through 2004, derived from our audited financial statements for each such year and should be read
in conjunction with such financial statements and the footnotes attached thereto as well as the
discussion contained herein in Managements Discussion and Analysis of Financial Condition and
Results of Operations. Certain prior period amounts have been reclassified to 12




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##### Table of Contents



conform to the current period presentation. Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Statements of Operations Data:Net sales
    
    $
    63,637,285
    
    
    $
    43,520,563
    
    
    $
    41,415,466
    
    
    $
    33,422,959
    
    
    $
    27,707,491Income (loss) before extraordinary gain
and
accrued premium on preferred stock
    
    
    1,369,983
    
    
    
    (665,921
    )
    
    
    1,193,333
    
    
    
    602,864
    
    
    
    (1,916,521
    )Accrued premium on preferred stock
    
    
    (276,000
    )
    
    
    (276,000
    )
    
    
    (278,083
    )
    
    
    (290,000
    )
    
    
    (290,000
    )Income (loss) before extraordinary gain
    
    
    1,093,983
    
    
    
    (941,921
    )
    
    
    915,250
    
    
    
    312,864
    
    
    
    (2,206,521
    )Extraordinary gain
    
    
    173,536
    
    
    
    2,962,041
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss) applicable to common
stock
    
    $
    1,267,519
    
    
    $
    2,020,120
    
    
    $
    915,250
    
    
    $
    312,864
    
    
    $
    (2,206,521
    )Net income (loss) per common share
before extraordinary gain(1)(Basic)
    
    $
    .03
    
    
    $
    (.03
    )
    
    $
    .03
    
    
    $
    .01
    
    
    $
    (.08
    )Net income (loss) per common share
before extraordinary gain (1) (Diluted)
    
    $
    .03
    
    
    $
    (.03
    )
    
    $
    .02
    
    
    $
    .01
    
    
    $
    (.08
    )Extraordinary gain per common share (Basic)
    
    $
    .01
    
    
    $
    .10
    
    
    
    
    
    
    
    
    
    
    
    Extraordinary gain per common share (Diluted)
    
    $
    .00
    
    
    $
    .10
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss) per common share
after extraordinary gain (Basic)
    
    $
    .04
    
    
    $
    .07
    
    
    $
    .03
    
    
    $
    .01
    
    
    $
    (.08
    )Net income (loss) per common share
after extraordinary gain (Diluted)
    
    $
    .03
    
    
    $
    .07
    
    
    $
    .02
    
    
    $
    .01
    
    
    $
    (.08
    )Weighted average number of shares
outstanding (Basic)
    
    
    31,815,067
    
    
    
    30,017,661
    
    
    
    29,516,768
    
    
    
    27,565,825
    
    
    
    26,059,013Weighted average number of shares
outstanding (Diluted)
    
    
    41,070,289
    
    
    
    30,017,661
    
    
    
    42,665,451
    
    
    
    37,176,751
    
    
    
    26,059,013Balance Sheet Data:Working capital deficit
    
    $
    3,470,971
    
    
    $
    1,915,695
    
    
    $
    6,557,943
    
    
    $
    4,535,600
    
    
    $
    6,804,992Total assets
    
    
    43,340,793
    
    
    
    36,406,601
    
    
    
    39,335,948
    
    
    
    36,393,071
    
    
    
    35,258,304Long-term debt less current maturities
    
    
    15,571,068
    
    
    
    16,659,241
    
    
    
    4,068,210
    
    
    
    4,303,202
    
    
    
    4,486,156Total liabilities
    
    
    31,610,279
    
    
    
    27,458,156
    
    
    
    33,574,481
    
    
    
    32,194,317
    
    
    
    32,548,921Stockholders equity
    
    
    11,730,514
    
    
    
    8,948,445
    
    
    
    5,761,467
    
    

    
    4,198,754
    
    
    
    2,709,383
   (1)
    
    The net income (loss) per share of common stock is based on the combined weighted average
number of shares of Class A and Class B common stock outstanding during the period. See Note
2 to the financial statements for reconciliation of basic and diluted weighted average number
of shares outstanding. 13




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and Results of
Operations General As a growing business in an expanding market, we faced many challenges in 2004, including:  
    We were overly dependent on outside plastic recycling companies and virgin resin
producers and in some cases the resultant product quality. As some of our suppliers faced their own challenges in the face
of rapidly rising plastic scrap prices, AERT was increasingly left short of adequate input and quality
materials for our composite board extrusion lines
to keep up with continued customer requirements and substantial sales growth. This forced us to purchase alternative
feedstock, such as virgin polyethylene, to keep our factories running and meet our
obligations to our customers. The higher priced input materials pushed up our cost of
goods sold and depressed our gross margin.
    Attempting to use lower cost and lower quality feedstock in some cases caused a substantial decrease in efficiencies and higher overall costs.
    We were overly dependent on one customer. Since 1995, we have sold our decking products
exclusively to Weyerhaeuser, who resold it through their distribution system. Over time,
Weyerhaeusers business strategy has shifted and we believed that their distribution system
was not allowing us to grow and adequately compete in all market segments.
In particular, their reluctance to take and hold inventory during the fourth quarter for
sale to independent lumber dealers over the last several years has limited our growth and restricted our working capital.
    As a rapidly growing company, we require increasing amounts of working capital. We
suffered from a lack of adequate working capital during 2004, the effect of which was to
hold back our capital expansion and efficiency programs. A major contributor to this inadequacy was the
failure to receive the full amount of our fire insurance claim in 2004. (See Item 3.
Legal Proceedings)
    Our aggressive growth objectives have strained our human capital resources and we
are working to hire, train, and staff additional supervisory and management personnel; and,
    We believe that an excessive overhang of common stock warrants limits institutional
participation in the market for our stock in the near term, which depress our stock price and limits
access to additional equity capital  (see Note 5: Stockholder Equity). Looking to 2005 and beyond, we are focused on alleviating these structural impediments to our
growth and profitability. For example:  
    We are investing heavily in adding in-house plastic recycling capacity;
    We are further automating our manufacturing facilities;
    We continue to focus on increasing gross margins through price increases and increased efficiencies;
    We have renegotiated the distribution arrangements with Weyerhaeuser to allow us to sell
decking products to other customers, though Weyerhaeuser retains an exclusive right to
purchase ChoiceDek products for re-sale to Lowes Home Improvement stores. Over 80%
of Weyerhaeusers 2004 purchases from us for re-sale to
Lowes. For 2005, we have introduced our
MoistureShield line of decking and will have more focus on its production and sale in this
and coming years;
    We are in discussions with additional sources of working capital. We expect to finalize
at least one new working capital arrangement in 2005;
    We are aggressively recruiting new AERT associates for senior and middle management
levels. Some highly 14




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##### Table of Contents



qualified new people have already joined the AERT team in 2005.
    Many of the outstanding stock warrants will expire in 2005 and 2006, with the balance
expiring in 2007. (See Note 5. to the accompanying financial statements.)
    In 2004, we invested $7.4 million in manufacturing infrastructure (plant and equipment)
and plan to spend $8 million in 2005. Most of the capital expansion was, and will be, funded
through cashflow. (See Liquidity and Capital Resources.)
    We continue to build brand recognition and our reputation with the quality of our
products. Results of Operations Three Year Comparison 2004
    
    
    % Change
    
    
    2003
    
    
    % Change
    
    
    2002Net sales
    
    $
    63,637,285
    
    
    
    46.2
    %
    
    $
    43,520,563
    
    
    
    5.1
    %
    
    $
    41,415,466Cost of goods sold
    
    
    48,963,166
    
    
    
    42.5
    %
    
    
    34,361,984
    
    
    
    15.3
    %
    
    
    29,800,939% of net sales
    
    
    76.9
    %
    
    
    -2.1
    %
    
    
    79.0
    %
    
    
    7.0
    %
    
    
    72.0
    %Gross margin
    
    
    14,674,119
    
    
    
    60.2
    %
    
    
    9,158,579
    
    
    
    -21.1
    %
    
    
    11,614,527% of net sales
    
    
    23.1
    %
    
    
    2.1
    %
    
    
    21.0
    %
    
    
    -7.0
    %
    
    
    28.0
    %Selling and administrative costs
    
    
    11,099,911
    
    
    
    23.3
    %
    
    
    9,001,261
    
    
    
    15.0
    %
    
    
    7,823,826% of net sales
    
    
    17.4
    %
    
    
    -3.3
    %
    
    
    20.7
    %
    
    
    1.8
    %
    
    
    18.9
    %Legal settlement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    -100.0
    %
    
    
    1,100,000Research and development
    
    
    97,207
    
    
    
    24.8
    %
    
    
    77,900
    
    
    
    -64.6
    %
    
    
    220,354Subtotal
    
    
    11,197,118
    
    
    
    23.3
    %
    
    
    9,079,161
    
    
    
    -0.7
    %
    
    
    9,144,180% of net sales
    
    
    17.6
    %
    
    
    -3.3
    %
    
    
    20.9
    %
    
    
    -1.2
    %
    
    
    22.1
    %Operating income
    
    
    3,477,001
    
    
    
    4278.1
    %
    
    
    79,418
    
    
    
    -96.8
    %
    
    
    2,470,347% of net sales
    
    
    5.5
    %
    
    
    5.3
    %
    
    
    0.2
    %
    
    
    -5.8
    %
    
    
    6.0
    %Other income (expense)Insurance proceeds related to lost income
    
    
    8,720
    
    
    
    -99.2
    %
    
    
    1,125,372
    
    
    
    
    
    
    
    Gain (loss) on disposition of equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    -100.0
    %
    
    
    (134,413
    )Net interest expense
    
    
    (2,115,738
    )
    
    
    13.1
    %
    
    
    (1,870,711
    )
    
    
    63.7
    %
    
    
    (1,142,601
    )Income (loss) before extraordinary item
and accrued premium on preferred stock
    
    
    1,369,983
    
    
    
    
    
    
    
    (665,921
    )
    
    
    -155.8
    %
    
    
    1,193,333% of net sales
    
    
    2.2
    %
    
    
    3.7
    %
    
    
    -1.5
    %
    
    
    -4.4
    %
    
    
    2.9
    %Accrued premium on preferred stock
    
    
    (276,000
    )
    
    
    
    
    
    
    (276,000
    )
    
    
    -0.7
    %
    
    
    (278,083
    )Income (loss) before extraordinary item
    
    
    1,093,983
    
    
    
    
    
    
    
    (941,921
    )
    
    
    
    
    
    
    915,250% of net sales
    
    
    1.7
    %
    
    
    3.9
    %
    
    
    -2.2
    %
    
    
    -4.4
    %
    
    
    2.2
    %Extraordinary gain on involuntary conversion
of non-monetary assets due to fire
    
    
    173,536
    
    
    
    -94.1
    %
    
    
    2,962,041
    
    
    
    
    
    
    
    Net income applicable to common stock
    
    $
    1,267,519
    
    
    
    -37.3
    %
    
    $
    2,020,120
    
    
    
    120.7
    %
    
    $
    915,250% of net sales
    
    
    2.0
    %
    
    
    -2.6
    %
    
    
    4.6
    %
    
    
    2.4
    %
    
    
    2.2
    %
 Net Sales 2004
    
    
    % Change
    
    
    2003
    
    
    % Change
    
    
    2002Springdale facility
    
    $
    47,902,106
    
    
    
    40.1
    %
    
    $
    34,203,234
    
    
    
    27.1
    %
    
    $
    26,901,808Junction facility
    
    $
    15,735,179
    
    
    
    68.9
    %
    
    $
    9,317,329
    
    
    
    -35.8
    %
    
    $
    14,513,658Total net sales
    
    $
    63,637,285
    
    
    
    46.2
    %
    
    $
    43,520,563
    
    
    
    5.1
    %
    
    $
    41,415,466
 15




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##### Table of Contents



Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 Net Sales  Net sales for the year ended December 31, 2004 grew
46.2% compared to 2003 due to:
    A product mix that included a higher percentage of value added
products, including the new ChoiceDek Premium
Embossed, which accounts for 15% of the increase;
    Restoration of the Junction plant to its pre-fire capacity, which accounts for 23% of
the increase; and
    Increased productivity, which resulted from various capital projects that increased
output and reduced manufacturing waste. Productivity gains account for the remaining 62%
of the increase. In 2004, demand for our products exceeded our manufacturing capacity. Cost of Goods Sold Our cost of goods sold, increased 42.5% in 2004 versus 2003.
Cost of goods sold is directly related to sales, which increased 46.2%. Cost of
goods sold as a percent of sales thus decreased from 79% of sales to 76.9% of sales, which raised
our gross margin from 21% to 23.1%. All three
accounting components of cost of goods sold  cost of materials, direct labor, and manufacturing
overhead  decreased as a percent of sales. Direct labor costs decreased as a result of
automation projects and from more emphasis on training and productivity improvement programs.
Manufacturing overhead decreased as we increased output at a faster rate than we increased overhead
spending. We believe further gains in both direct labor and manufacturing are possible as we
expand output. The cost of materials in 2004 was lower, as a percent of sales, than in 2003 because we
expanded our plastic processing capacity at the Lowell, Arkansas and Alexandria, Louisiana
facilities and are continually seeking new sources of lower cost waste plastic materials.
Also during 2004, we used a substantial amount of plastic inventory that was acquired in earlier periods at less than 2004 market prices. This
helped to offset rising material costs through the year by lessening our dependence on outside
suppliers. We are working to further increase our in-house plastic processing capacity, which has
gone from 25% in 2003 to 55% in the first quarter 2005. Our goal is to reach 75% in-house
capacity. We also focused on better material handling techniques and efficiencies in order to
further reduce manufacturing waste and handling costs. Increasing our in-house plastic processing facilities is
intended to lower our variable cost of purchasing recycled plastic scrap, but also increases our
manufacturing overhead and additional processing costs. With increased fixed overhead for
recycling and processing infrastructure, sufficient volumes, and throughputs are required to lower
overall costs. Lower-cost poor-quality plastic scrap can thus cause decreased throughputs and
significant increases in overall cost. This effect contributed somewhat to higher overall
manufacturing costs and lower gross margin in the fourth quarter of 2004. Overall, we were successful in reducing cost of goods sold as a percent of
sales by improved focus and investing in new facilities; i.e. productivity gains offset rising
material costs, which helped us to achieve an increase in operating
income of $3.4 million versus 2003. Over the next two years  2005 and 2006  we expect further increases in our cost of raw materials as a percent of sales before the market reaches equilibrium and prices stabilize.
There is no assurance that our assessment of future market conditions is correct, however, and sustained increases in the cost of acquiring raw materials would have a negative impact on our
profitability and ability to increase shareholder value. Selling and Administrative Expenses Selling and administrative cost increased in 2004 compared to 2003 as a result of increases in
sales, customer service, and corporate personnel expenses, along with general increases in
corporate costs to manage our growing business. However, as a percentage of net sales, selling and
administrative costs decreased. Some of the major components of selling, general, and
administrative costs are salaries, commissions, advertising and promotion, travel and 16




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##### Table of Contents



entertainment and professional fees. Overall, as a percent of sales the preceding cost categories
were lower in 2004 (17.6%) when compared to 2003 (20.9%) Net Income Net income before extraordinary item was $1.09 million
compared to a net loss before extraordinary item of $941,921 for the prior year an improvement of $2.03 million.
Compared to 2003, net income before extraordinary item increased due to increased sales, lower manufacturing
costs as a percentage of sales, and lower selling and administrative costs as a percentage of
sales. Net income after extraordinary item was $1.26 million compared to
$2.02 million for the prior year, a decrease of $760,000 or 38%. Insurance proceeds received to reimburse costs of reconstructing the Junction facility
following a March 2003 fire resulted in a $173,536 extraordinary gain for 2004 compared to an extraordinary gain of $2.96 million
in 2003. See Extraordinary Item below. Extraordinary Item There was a major fire at the Junction, Texas facility in 2003. The Junction facility was
fully insured. Damage caused by the fire required us to write down gross assets by approximately
$4.91 million. We simultaneously adjusted accumulated depreciation on those assets by $3.96
million, resulting in a net book value decrease in assets of about $950,000. At December 31, 2004,
we had invested approximately $6.4 million in reconstructing the Junction facility. Insurance
proceeds received to reimburse costs incurred to reconstruct the facility resulted in a gain of
$173,536 for the year ended December 31, 2004. Through December 31, 2004, the total extraordinary gain recorded
as a result of the fire was $3,135,577. Total insurance proceeds
received through December 31, 2004 in connection with the fire
was $6 million. In addition, we had initially booked an additional receivable of approximately $864,000 and
related income in the first quarter of 2004 for additional amounts we expect to collect from the
insurers related to such matter. However, such claims are now being contested by the insurer and,
although we intend to vigorously pursue the collection of such claims, we have, in accordance with
generally accepted accounting principles, reversed any receivable or income for the 2004 fiscal
year attributable to such disputed claims unless and until such claims are collected.
(See Item 3. Legal Proceedings) Contingencies We are in dispute with Zanett Lombardier, Ltd.
over $187,856 in penalty interest on a
$350,000 bridge loan that we repaid in 2003. Repayment included nominal interest from the date
of the loan at 12% per annum, but we dispute the additional penalty interest that Zanett
Lombardier is seeking, which Zanett Lombardier asserts should be accruing at 24% per annum.
Nonetheless, we have accrued a liability for this entire amount. See Note 4 to the financial statements. Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Net Sales Increased
national demand for our ChoiceDek Premium products and investment in
plant automation and efficiency projects caused net sales at the
Springdale facility to increase 27.1% in 2003. Net sales from the
Junction facility decreased 35.8% versus 2002 due to the
March 2003 fire that temporarily shut down
plant operations. The initial restoration project completed in
May 2003, included the rebuilding of
one extrusion line that had been partially damaged, electrical system replacement, and roof
replacement. The second extrusion line began operations in April 2004. Cost of Goods Sold Our
cost of goods sold increased significantly versus 2002 to 79% of sales from 72% of
sales, which decreased our gross margin by seven
percentage points. 70% of the increase was due to the rising cost of acquiring recyclable plastics. A sharp increase in
petroleum prices early in the year drove up virgin resin prices, which caused industrial consumers
to turn to recycled plastics, which then forced up the price that we
had to pay for the plastic scrap that we use in our manufacturing
process. Higher manufacturing overhead caused the other 30% of the
decrease in gross margin. Most of the relative cost increase is a
result of reduced sales over which to allocate fixed operating
expenses, which drives up the cost of manufacturing each unit. Direct
labor, as percent of sales, was constant from 2002 to 2003. To help offset rising material costs, we expanded the plastic recovery process capacity at our
Lowell, Arkansas facility and are testing new sources of scrap
polyethylene that could reduce our materials cost. Selling and Administrative Expenses The increase in selling and administrative costs as a percentage of sales in 2003 was the
result of the decrease in revenue at the Junction facility and the additional sales staff and
increased marketing and brand building expenses related to decking
sales. These items resulted in higher unit costs and lower absorption
of overhead expenses. Income Income before the extraordinary gain decreased from 2002 to 2003 primarily because we had to
pay more for raw materials and Junction sales decreased significantly due to the fire. Additionally, net interest expense increased
approximately $728,000 in 2003 over 2002, due primarily to the completion of the bond financing in
the fourth quarter of 2003, which resulted in higher interest costs and the write-off of $299,855 in debt
issuance costs related to the Arkansas State Bank loan. 17




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##### Table of Contents



Extraordinary Item There was a major fire at the Junction, Texas facility in 2003. The Junction facility was
fully insured. Damage caused by the fire required us to write down gross assets by approximately
$4.91 million. We simultaneously adjusted accumulated depreciation on those assets by $3.96
million, resulting in a net book value decrease in assets of about $950,000. At December 31, 2003,
we had invested approximately $3.9 million in reconstructing the Junction facility. Insurance
proceeds received to reimburse costs incurred to reconstruct the facility resulted in a gain of
$2,962,041 through December 31, 2003. Additionally, we received $1,366,682 in business
interruption insurance during 2003, including $1,125,372 to replace lost income and $241,310 to
cover fixed expenses. At December 31, 2003, approximately $484,000 was included in accounts
receivable for expected insurance reimbursements, as these proceeds had been received subsequent to year end. Liquidity and Capital Resources At December 31, 2004, we had a working capital deficit of $3.5 million compared to a working
capital deficit of $1.9 million at December 31, 2003. Excluding the $2.5 million spent to
reconstruct the Junction facility, we spent approximately $4.9 million on capital expansion during
2004. Expenditures were primarily for increasing our plastic processing capacity at our Lowell and
Alexandria facilities in order to better control our raw material costs, and for automation
equipment in our extrusion plants. At December 31, 2004, the working capital deficit included
total current liabilities of approximately $15.8 million, of which $2.9 million was for accrued
payroll expense and other accrued liabilities, $10.8 million was in payables and $2.1 million was a
combination of short-term notes payable and the current portion of long-term debt. The working
capital deficit reflects managements decision to pay for its capital expansion using cash
generated from operations. Additionally, pursuant to our bond agreement, we are required to
maintain a debt service reserve fund in the amount of approximately $2 million, which is classified as a
non-current asset in our balance sheet. Cash increased $249,000 to $1.76 million at December 31, 2004 from December 31, 2003.
Significant components of that increase were: (i) cash provided by operating activities of $5.7
million, which consisted of the net income for the period of $1.3 million increased by depreciation
and amortization of $4.1 million and decreased by other uses of cash of approximately $300,000;
(ii) cash used in investing activities of $5.2 million; and (iii) cash used in financing activities
of approximately $200,000. Payments on notes during the period were $3.8 million, and proceeds
from the issuances of notes amounted to $2.1 million. At December 31, 2004, we had bonds and notes
payable in the amount of $17.6 million, of which $2.1 million was current notes payable and the
current portion of long-term debt. On October 9, 2003, we finalized a long-term financing package with the City of Springdale,
Arkansas and Allstate Insurance Company that resulted in the release to us of most of the funds
previously held in the restricted bond escrow fund. The package consisted of $14.4 million
tax-exempt industrial development bonds and a $2.6 million loan that is subordinated to the bonds. Net proceeds from the financing were used to repay short-term loans, pay down accounts payable
incurred to develop qualified solid waste disposal facilities, purchase the Springdale, Arkansas
extrusion facility, purchase the Lowell, Arkansas plastic facility, pay issuance fees, and provide
limited capital for further expansion. The obligations are secured by substantially all of our
real estate assets and personal property, although provision is made for us to incur additional
working capital lines of credit (subject to compliance with financial covenants) that would be
secured by accounts receivable and inventory on a basis senior to obligations. Marjorie S. Brooks,
our largest shareholder, personally guaranteed repayment of up to $4 million of the tax-exempt
bonds. Through December 31, 2004,
we had received $6.0 million in insurance proceeds related
to the March 2003 Junction plant fire, including amounts for lost income reimbursement, and had
invested approximately $6.4 million in reconstructing the Junction facility.
We recorded $11,213 in business interruption insurance during 2004, including $8,720 to replace lost income and $2,493 to cover fixed expenses.
Insurance proceeds
received to reimburse costs incurred to reconstruct the facility resulted in a gain of $173,536
for the year ended December 31, 2004. We believe the insurance
claim of $1.8 million for the
replacement of the building and contents will be settled by the end of 2005. (See Item 3. Legal
Proceedings) Since the 18




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##### Table of Contents



Junction facility has reached the production level at which it operated prior to the fire,
we will no longer receive business interruption insurance proceeds for lost income
reimbursement. We are currently adding plastic recycling equipment in Lowell, which is designed to increase
our internal capability of processing scrap plastic. In addition, we have completed the site work
for the addition of a production facility on the property adjacent to our Springdale plant, and
construction on a second raw material system to service both plants has commenced and is intended
to become operational starting in phases during the second quarter of 2005. The building program
will provide the capacity necessary to achieve higher sales levels and sustain our growth. Our expansion plans currently are prioritized around increasing plastic recycling capacity and
lowering raw material costs, in conjunction with further automating our production processes to
improve efficiencies and increase margins. New capital projects are funded primarily from cash
flow, and there is no assurance as to when additional funds will be available or as to when the
projects will be completed. Our capital improvement budget for 2005 is currently estimated at
$8 million, of which we believe we can finance $2 million through long-term debt and operating leases; the balance of required
funds must come from cash flow. There is no assurance that we will generate sufficient cash flow
to meet our objectives. If we are unable to complete our 2005 capital expansion program as
planned, it will affect our ability to grow sales and profit margins in 2005 and future years. Under the 2003 bond agreement, AERT covenants that it will maintain certain financial ratios.
If we fail to comply with the covenants, or to secure a waiver there from, the bond trustee would
have the option of demanding immediate repayment of the bonds. In such an event, it could be
difficult for us to refinance the bonds, which would give the bond trustee the option to take us
into bankruptcy. We were not in compliance with two covenants as of December 31, 2004. The bond trustee has
waived these covenants as of December 31, 2004 through, and including, December 31, 2005. We
expect to be in compliance with all bond covenants by December 31, 2005. Bonds payable and Allstate Notes Payable DebtCovenants
    
    December 31, 2004
    
    ComplianceLong-term debt service coverage ratio for last four
quarters of at least 2.00 to 1.00
    
    
    2.46
    
    
    YesCurrent ratio of not less than 1.00 to 1.00
(as adjusted1)
    
    
    0.91
    
    
    No-WaivedDebt to equity ratio of not more than 3.00 to
1.00
    
    
    1.50
    
    
    YesNot more than 10% of accounts payable in excess of 75
days past invoice date
    
    
    15.3
    %
    
    No-WaivedNot more than 20% of accounts receivable in excess
of 90
days past invoice date
    
    
    4.0
    %
    
    Yes
 (1) The current ratio calculation was modified to include the debt service reserve fund
of $2,057,792 in current assets. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that
affect the amounts reported on our financial statements. The estimates made in applying the
accounting policies described below are material to the financial statements and notes thereto due
to the level of judgment involved in arriving at those estimates. Accounts Receivable Trade accounts receivable are stated at the amount management expects to collect from
outstanding balances. Delinquency fees are not assessed. Payments of accounts receivable are
allocated to the specific invoices identified on the customers remittance advice. Accounts
receivable are carried at the original invoice amount less an estimated reserve 19




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##### Table of Contents



made for returns
and discounts based on quarterly review of historical rates of returns and expected discounts to be
taken. The carrying amount of accounts receivable is reduced, if needed, by a valuation allowance
that reflects managements best estimate of the amounts that will not be collected. Management
individually reviews all accounts receivable balances that exceed sixty days from invoice date and
based on an assessment of current creditworthiness, estimates the portion, if any, of the balance
that will not be collected. Management provides for probable uncollectible amounts through a
charge to earnings and a credit to a valuation based on its assessment of the current status of the
individual accounts. Balances that remain outstanding after management has used reasonable
collection efforts are written off through a charge to the valuation allowance and a credit to
trade accounts receivable. Changes in the valuation allowance have not been material to the
financial statements. Recoveries of trade receivables previously written off are recorded when
received. Due to the nature of our business and our association with
large national corporations,
our collection of receivables has stayed at a constant level with very little uncollectible
accounts. Buildings and Equipment Property additions and betterments include capitalized interest and acquisition, construction
and administrative costs allocable to construction projects and property purchases. Provision for
depreciation of buildings and equipment is provided on a straight-line basis over the estimated
useful lives of the assets. 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. We account for the impairment or disposal of long-lived assets in accordance with the
provisions of the Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets(SFAS 144). SFAS 144 requires an assessment of the
recoverability of our 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. Stock-Based Compensation We have to date accounted for our stock option plans and other stock-based compensation under Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which allows us to use 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 (see Note 2 to the financial statements).
Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted
market price of our common stock at the date of the grant over the amount an employee must pay to
acquire the stock. Revenue recognition The Company recognizes
revenue in accordance with SEC Staff Accounting Bulletin No. 104,
Revenue Recognition in Financial Statements (SAB 104). Under SAB 104, revenue is recognized when the title and risk of loss have passed to the
customer, there is persuasive evidence of an arrangement; delivery has occurred or services have been rendered, the sales price is determinable
and collectibility is reasonably assured. The Company typically recognizes revenue at the time of shipment. Sales are recorded net of discounts,
rebates, and returns. Estimates of expected sales discounts are calculated by applying the appropriate sales discount
rate to all unpaid invoices that are eligible for the discount. The
Companys sales prices are determinable given that the Companys sales discount rates are fixed and given the predictability with which
customers take sales discounts. 20




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##### Table of Contents



Contractual Obligations The following table represents our contractual obligations outstanding as of December 31,
2004: Payments Due by PeriodLess than
    
    
    1 to 3
    
    
    3 to 5
    
    
    More thanTotal
    
    
    1 year
    
    
    years
    
    
    years
    
    
    5 yearsLong-term debt
    
    $
    30,387,908
    
    
    $
    2,617,340
    
    
    $
    4,549,947
    
    
    $
    4,440,621
    
    
    $
    18,780,000Operating leases
    
    
    2,618,088
    
    
    
    797,146
    
    
    
    1,221,876
    
    
    
    599,066
    
    
    
    Total
    
    $
    33,005,996
    
    
    $
    3,414,486
    
    
    $
    5,771,823
    
    
    $
    5,039,687
    
    
    $
    18,780,000
 Our waste wood and scrap polyethylene supply contracts have varying terms and pricing
structures. The contracts generally obligate us to take whatever waste the supplier generates as
long as the waste meets our standards. Pricing for these contracts can be renegotiated every six or
twelve months, however, so determining our precise future liability is not possible. Uncertainties, Issues and Risks There are many factors that could adversely affect our business and results of operations.
These factors include, but are not limited to, general economic conditions, decline in demand,
business or industry changes, critical accounting policies, government rules and regulations,
environmental concerns, litigation, new products / product transition, competition, acts of war,
terrorism, public health issues, concentration of customer base, availability of raw material
(plastic) at a reasonable price, managements failure to execute effectively, inability to obtain
adequate financing (i.e. working capital), equipment breakdowns, low stock price, and fluctuations
in quarterly performance. 
 Item 7A. Quantitative and Qualitative Disclosures about Market Risk We have no material exposures relating to our long-term debt because all of our long-term debt
bears interest at fixed rates. See Note 4 to the financial statements for a discussion of
outstanding debt. We depend on the market for favorable long-term mortgage rates to help generate
sales of our product for use in the residential construction industry. Should mortgage rates
increase substantially, our business could be impacted by a reduction in the residential
construction industry. Important raw materials that we purchase are recycled plastic and wood
fiber, which are subject to price fluctuations. We attempt to limit the impact of price increases
on these materials by negotiating with each supplier on a term basis. Forward-looking Information An investment in our 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 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
our expectations or beliefs concerning future events. Numerous assumptions, risks, and
uncertainties could cause actual results to differ materially from the results discussed in the
forward-looking statements. Prospective purchasers of our securities should carefully consider the
information contained herein or in the documents incorporated herein by reference. 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 managements current judgment regarding the direction of the business,
actual results will almost always vary, sometimes materially, from any estimates, predictions,
projections, or other future performance suggested herein. Some important factors (but not
necessarily all factors) that could affect the 21




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##### Table of Contents



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 materials; accidents or other unscheduled shutdowns
affecting us, our suppliers or their 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 our control; execution of planned capital projects; weather conditions
affecting our operations or the areas in which our products are marketed; adverse rulings,
judgments, or settlements in litigation or other legal matters. We undertake 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. 
 Item 8. Financial Statements and Supplementary Data Summary Quarterly Financial Data 2003
    
    
    2004First
    
    
    Second
    
    
    Third
    
    
    Fourth
    
    
    First
    
    
    Second
    
    
    Third
    
    
    FourthQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter(1)
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter(1)Net sales
    
    $
    11,109,782
    
    
    $
    10,086,456
    
    
    $
    11,379,799
    
    
    $
    10,944,526
    
    
    $
    13,221,121
    
    
    $
    16,162,575
    
    
    $
    18,975,717
    
    
    $
    15,277,872Gross margin
    
    
    2,480,400
    
    
    
    2,352,704
    
    
    
    2,356,494
    
    
    
    1,968,981
    
    
    
    2,588,210
    
    
    
    4,184,501
    
    
    
    5,695,745
    
    
    
    2,205,663Income (loss) before
extraordinary item
    
    
    108,233
    
    
    
    514,036
    
    
    
    (256,959
    )
    
    
    (1,307,231
    )
    
    
    (463,313
    )
    
    
    857,142
    
    
    
    1,500,498
    
    
    
    (800,344
    )Net income (loss) after
extraordinary item
    
    
    108,233
    
    
    
    2,392,257
    
    
    
    (204,033
    )
    
    
    (276,337
    )
    
    
    574,264
    
    
    
    857,142
    
    
    
    1,500,498
    
    
    
    (1,664,385
    )Income (loss) per share
before extraordinary item (Basic)
    
    $
    (0.01
    )
    
    $
    0.02
    
    
    $
    (0.01
    )
    
    $
    (0.04
    )
    
    $
    0.00
    
    
    $
    0.03
    
    
    $
    0.05
    
    
    $
    (0.03
    )Income (loss) per share
before extraordinary item
(Diluted)
    
    $
    (0.01
    )
    
    $
    0.01
    
    
    $
    (0.01
    )
    
    $
    (0.04
    )
    
    $
    0.00
    
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    (0.03
    )Income (loss) per share
after extraordinary item (Basic)
    
    $
    0.02
    
    
    $
    0.08
    
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    0.00
    
    
    $
    0.03
    
    
    $
    0.05
    
    
    $
    (0.05
    )Income (loss) per share
after extraordinary item (Diluted)
    
    $
    0.02
    
    
    $
    0.06
    
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    0.00
    
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    (0.05
    )
  (1)
    In the first quarter of 2004, we booked an insurance receivable of $864,000 and recognized
related additional income of such amount related to additional insurance claims we expect to
collect with respect to a 2003 fire at our Junction, Texas facility. Pursuant to litigation
filed by the insurer in January 2005, such claims are now being contested. As a result, we
have reversed the receivable and related income for these additional claims by means of an
$864,000 adjustment taken in the fourth quarter of 2004. The financial statements portion of this item is submitted in a separate section of this report. 
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 
 Item 9A. Controls and Procedures Each of our Co-Chief Executive Officers, Joe G. Brooks and Stephen W. Brooks, and our Chief
Financial Officer, Edward J. Lysen, have reviewed and evaluated the disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934)
that we have in place as of December 31, 2004 with respect to, among other things, the timely
accumulation and communication of information to management and the recording, processing,
summarizing and reporting thereof for the purpose of preparing and filing this annual report on
Form 10-K. Based upon their review, these executive officers have concluded that, as of December
31, 2004, we have an effective system of disclosure controls and procedures and an effective means
for timely communication of information required to be disclosed in this Report. During the fourth
quarter of the fiscal year ended December 31, 2004, there have been no changes in our internal
controls over financial reporting that have materially affected, or that are reasonably likely to
materially affect, our internal controls over financial reporting. Similarly, there were no such
changes in our internal controls over financial reporting that materially affected or that are
reasonably likely to materially affect our controls over financial reporting for the fiscal
quarters ended December 31, 2003, March 31, 2004, June 30, 2004 and September 30, 2004. 
 Item 9B. Other Information None. 22




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##### Table of Contents



PART III 
 Item 10. Directors and Executive Officers of the Registrant The directors and executive officers of the Company are as follows: Name
    
    Age
    
    PositionJoe G. Brooks
    
    
    49
    
    
    Chairman of the board of directors, co-chief executive
officer and presidentSal Miwa
    
    
    48
    
    
    Vice-chairman of the board of directorsStephen W. Brooks
    
    
    48
    
    
    Co-chief executive officer and directorJ. Douglas Brooks
    
    
    45
    
    
    Senior vice-president  raw materialsJim Precht
    
    
    59
    
    
    Senior vice-president  sales and marketingMarjorie S. Brooks
    
    
    69
    
    
    Secretary, treasurer and directorEdward J. Lysen
    
    
    67
    
    
    Senior vice president and chief financial officerAlford Drinkwater
    
    
    53
    
    
    Senior vice president  plastic operationsJerry B. Burkett
    
    
    48
    
    
    DirectorMichael M. Tull
    
    
    50
    
    
    DirectorSamuel L. Tony Milbank
    
    
    64
    
    
    DirectorMelinda Davis
    
    
    62
    
    
    DirectorJim Robason
    
    
    67
    
    
    Director
 The Companys board of directors elected Joe G. Brooksas its chairman and the Companys
co-chief executive officer in December 1998, and he has served as president since February 2000.
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. He
was a member of Clean Texas 2000, appointed by then Governor George W. Bush in 1995. In December 1998, the Companys board of directors elected Sal Miwaas its vice-chairman. Mr.
Miwa also served as chairman of the board between December 1995 and December 1998. He has been an
outside director of the Company since January 1994. From July 2004 to present, Mr. Miwa has been CEO and director of
Greenstone Inc., a chemical technology company located in New York City primarily serving the building and construction industry.
From April 2000 to June 2004, he was COO
and director of RealRead Inc., an online document service company. For more than 20 years Mr. Miwa
has been engaged in various international businesses and serves on boards of several closely held
family businesses around the world. He received his masters degree in Aerospace Engineering from
the Massachusetts Institute of Technology. The Companys board of directors elected Stephen W. Brooksas co-chief executive officer in
December 1998. Mr. Brooks has served as its chief executive officer and has been a director since
January 1996. Mr. Brooks has served as CEO and chairman of the board of Razorback Farms, Inc. from
January 1996 to the present. Razorback Farms is a Springdale, Arkansas based firm that specializes
in vegetables processing. Mr. Brooks also serves on the board of the Ozark Food Processors
Association. J. Douglas Brookshas served as executive vice-president, has been in charge of raw material
sourcing and strategic relationships since 1998, and has been a senior vice president since
September 2003. Mr. Brooks was vice-president of plastics from 1995 through 1998, 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. 23




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##### Table of Contents



Jim Prechthas served as executive vice-president of sales and marketing for the Company since
February 2001, and senior vice president since September 2003. Mr. Precht was formerly general
manager of Weyerhaeuser Building Materials Pittsburgh Customer Service Center with 32-years of
industry experience. Marjorie S. Brookshas been secretary, treasurer and a director since the Companys inception
in December 1988. Mrs. Brooks has served as secretary and treasurer of Brooks Investment Co., a
holding company for the Brooks family investments, for more than thirty years. Edward J. Lysenjoined AERT in April 1999 as chief financial officer and has been a senior
vice president since September 2003. 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 senior
vice-president, 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. From 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. Alford Drinkwaterhas served as senior vice president of logistics, laboratories, and plastic
operations since September 2003. Prior to joining the Company in May 2000, Mr. Drinkwater had been
the Assistant Director for the Established Industries Division of the Arkansas Department of
Economic Development and was on the Advocacy Team from November 1988 until January 2000. From
September 1986 until July 1988, he owned and operated Town and Country Waste Services, Inc. a waste
services company engaging in the development of waste recycling, energy recovery, and disposal
systems. From April 1981 until January 1987, Mr. Drinkwater was the Resource Recovery Manager for
Metropolitan Trust Company, and was primarily involved in waste-to-energy systems development.
From July 1974 until April 1981, Mr. Drinkwater worked for the State of Arkansas as Assistant to
the Chief of the Solid Waste Control Division of the Arkansas Department of Pollution Control &
Ecology and as the Manager of the Biomass and Resource Recovery Program of the Arkansas Department
of Energy. Jerry B. Burketthas served on the board of directors of the Company since May 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. In April 2002, Mr.
Burkett was elected to serve as a director of the Ag Heritage Farm Credit Services board. Michael M. Tullhas served on the board of directors of the Company since December 1998. Mr.
Tull has served since 1990 as the president and majority owner of Tull Sales Corporation, a
manufacturers representative company, which professionally represents eight manufacturing
companies and is responsible for the sales and marketing of those companies window and door
related components in the southeastern United States. Mr. Tull serves on boards of several closely
held family businesses and is the chairman and a board of director member of the National Wild
Turkey Federation, which is one of the largest North American conservation organizations. Samuel L. Tony Milbankhas served on
the board of directors since July 2000. Mr. Milbank is a co-founder and owner of Milbank Roy Zanett and Company, an investment
bank focused on M&A advisory as well as funding of middle market companies founded on February 1, 2005.
Prior to that, from April 1997 to February 2005, Mr. Milbank was a managing director of Zanett Securities Corporation, a
company also focusing on investment banking services to the middle market. From February 1992 to January 1996, Mr.
Milbank was a senior vice-president and sales manager with Lehman Brothers, Inc. in New York, where
he managed a team that provided interest rate and currency risk management for central banks and
other official institutions. From March 1973 to February 1992, Mr. Milbank worked with Salomon Brothers, Inc. as
a director and manager of the international department. Since 1990, Mr. Milbank has served as
chairman of Milbank Memorial Fund, a private operating foundation (established in 1905), concerned
with environmental and public health 24




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##### Table of Contents



issues. He has a BS from Columbia University and a MBA in Finance from The Amos Tuck School of
Business Administration at Dartmouth College. Melinda Davishas served on the board of directors since July 2001. From December 2000 to the
present, Ms. Davis has provided professional consulting services in the areas of financial
management and cost accounting for manufacturing operations. Ms. Davis retired as senior
vice-president and treasurer from Allen Canning Co. in December 2000, after serving for 39 years in
various accounting and financial management positions. Jim Robasonhas served on the board of directors since July 2003. Mr. Robason joined Allen
Canning Co. in 1967. Mr. Robason served as senior vice-president-operations of Allen Canning Co.
from 1974 until his retirement in 2002. As senior vice-president of operations with Allen Canning
Co., he was responsible for the operation of twelve plants with plant managers and raw product
procurement managers, as well as special projects engineering, reporting to him. He has a vast
amount of knowledge in all phases of manufacturing including infrastructure, building, equipment
and engineering; with a focus on the full production arena from product procurement through the
production process. Mr. Robason is a graduate of West Texas State University. He has served on
the executive committee and the Allen Canning profit sharing/retirement plan committee in addition
to his operations responsibilities. Joe G. Brooks, Stephen W. Brooks, and J. Douglas Brooks are brothers and 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 their 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: Melinda
Davis (chairman), Jerry B. Burkett, and Sal Miwa. The audit committee is directly responsible for
the engagement of the Companys independent accountants and is responsible for approving the
services performed by the Companys independent accountants and for reviewing and evaluating the
Companys accounting principles and its system of internal accounting controls. The board of directors has determined that Melinda Davis qualifies as an audit committee
financial expert; as such term is defined in rules of the SEC implementing requirements of the
Sarbanes-Oxley Act of 2002. In addition, Melinda Davis, and the other members of the audit
committee are independent, as that term is defined under the listing standards of the National
Association of Securities Dealers. The compensation and stock option committee consists of Samuel L. Tony Milbank (chairman),
Sal Miwa, and Jim Robason. 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 nominating committee consists of Jerry B. Burkett (chairman), Linda Davis, and Jim
Robason. The nominating committee evaluates the efforts of AERT and its board of directors to
maintain effective corporate governance practices. The committee identifies candidates for
election to the board of directors. 25




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##### Table of Contents



Code of Ethics We adopted a Code of Business Conduct and Ethics applicable to all our directors and
associates, including our chief executive officers, chief financial officer and principal
accounting officer or controller, which is a code of ethics as defined by applicable rules of the
SEC. This code has been filed with the SEC as an exhibit to our Form 10-K for the fiscal year
ended December 31, 2003, and is publicly available on our website at www.aertinc.com. A copy may
also be obtained upon request to our secretary, Marjorie S. Brooks at our mailing address on the
cover of this Form 10-K. If we make any amendments to this code other than technical,
administrative or other non-substantive amendments or grant any waivers, including implicit
waivers, from a provision of this code that applies to our chief executive officers, chief
financial officer or principal accounting officer or controller and relates to an element of the
SECs code of ethics definition, we will disclose the nature of the amendment or waiver, its
effective date and to whom it applies on our website or in a report on Form 8-K filed with the SEC. Section 16(a) of the Exchange Act Section 16(a) of the Securities Exchange Act of 1934 requires AERTs executive officers and
directors, and persons who own more than ten-percent of a registered class of the Companys
securities to file reports of ownership and changes in ownership with the Securities and Exchange
Commission and National Association of Securities Dealers. Officers, directors and greater than
ten-percent shareholders are required by SEC regulation to furnish the Company with copies of all
forms filed pursuant to Section 16(a). Based on a review of the copies of such forms received by
it and written representations from certain reporting persons that no
Forms 4 or Forms 5 were required for those persons, the Company believes that during the fiscal year ended December 31, 2004, all Section 16(a)
filing requirements were met. 
 Item 11. Executive Compensation Director Compensation Non-employee directors are entitled to receive cash compensation for serving on the Companys
board of directors, as follows: board meeting fee $1,000 per diem, $500 for 1/2 day, committee
meeting fee  $500 and teleconference fee  $250. Directors are reimbursed for out-of-pocket
expenses in connection with their attendance at meetings. In addition the Company may from time to time request that directors perform special services for the Company
or engage in special studies for the Company in their capacity as a director, such as meeting
with third parties with whom the Company does or proposes to do business and in such event, the
Company pays such members a per diem rate of $1,000. Directors are paid long-term compensation in the form of stock option grants under the
Companys Non-Employee Director Stock Option Plan. Such plan provides for annual grants of options
to purchase 25,000 shares of Class A common stock at the fair market value of such stock on the
date of such grant. Also, certain directors are hired on a contract basis from time to time by the
board of directors to perform services for the Company. Executive Compensation The following table sets forth the aggregate compensation paid by the Company during the three
years ended December 31, 2004, to each executive officer of the Company whose aggregate annual
salary and bonus in 2004 exceeded 26




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##### Table of Contents



$100,000, and to the chief executive officers. SUMMARY COMPENSATION TABLE
Annual Compensation (a)
    
    
    
    
    
    
    
    
    
    
    (e)Name
    
    
    
    
    
    
    
    
    
    
    
    
    
    Otherand
    
    
    
    
    
    (c)
    
        
    
    
    
    
    AnnualPrincipal
    
(b)

    
    
Salary
    
    
    (d)
    

Compen-Position
    
    Year
    
    

($)
    
    
    Bonus ($)
    
    
    sation ($)(1)Stephen W. Brooks
    
    
    2004
    
    
    
    52,000
    (2)
    
    
    0Co-CEO
    
    
    2003
    
    
    
    52,000
    (2)
    
    
    02002
    
    
    
    0
    
    
    
    0Joe G. Brooks
    
    
    2004
    
    
    
    157,500
    
    
    
    193,500
    (3)
    
    
    48,775
    (4)Co-CEO
    
    
    2003
    
    
    
    157,500
    
    
    
    15,0002002
    
    
    
    201,154
    
    
    
    51,500Jim Precht
    
    
    2004
    
    
    
    102,521
    
    
    
    30,000
    
    
    
    20,188
    (6)Senior-vice president
    
    
    2003
    
    
    
    73,750
    (5)
    
    
    10,000
    
    
    
    16,590
    (7)- sales and marketing
    
    
    2002
    
    
    
    49,500
    (5)
    
    
    68,915
    
    
    
    12,000
    (8)J. Douglas Brooks
    
    
    2004
    
    
    
    87,288
    
    
    
    16,570Senior-vice president
    
    
    2003
    
    
    
    84,000
    
    
    
    5,000- raw materials
    
    
    2002
    
    
    
    82,769
    
    
    
    17,500Edward J. Lysen
    
    
    2004
    
    
    
    85,000
    
    
    
    16,570Senior-vice president
    
    
    2003
    
    
    
    85,000
    
    
    
    5,000and chief financial
    
    
    2002
    
    
    
    85,000
    
    
    
    12,500officer
   (1)
    
    Excludes perquisites less than $50,000 and that do not exceed 10% of salary and bonus.(2)
    
    Paid pursuant to a non-employee consulting agreement with the Company.(3)
    
    Includes $130,000 awarded to Mr. Brooks by the
Board of Directors and $63,500 in quarterly performance incentives which Mr. Brooks voluntarily
did not take until 2004.(4)
    
    Includes 48 months of $1,000 a month for non-accountable expense allowance which Mr. Brooks voluntarily did not
take until 2004.(5)
    
    In 2002 and the first six months of 2003 there was an agreement between AERT and Weyerhaeuser where each paid one-half of Mr. Prechts
salary. The amounts above account for AERTs portion of the annual salary.(6)
    
    Includes $14,000 for a non-accountable expense allowance and $6,188 for the value of a company-provided vehicle.(7)
    
    Includes $12,000 for a non-accountable expense allowance and $4,590 for the value of a company-provided vehicle.(8)
    
    Represents a non-accountable expense allowance. Aggregated Option/SAR Exercises in Last Fiscal Year
and FY-End Option/SAR Values Value of UnexercisedShares
    
    
    
    
    
    
    Number of Securities Underlying
    
    
    In-the-MoneyAcquired
    
    
    Value
    
    
    Unexercised Options/SAR at
    
    
    Options/SAR atOn Exercise
    
    
    Realized
    
    
    December 31, 2004 (%)
    
    
    December 31, 2004 ($)Name
    
    ($)
    
    
    ($)
    
    
    Exercisable/Unexercisable
    
    
    Exercisable/UnexercisableStephen W. Brooks
    
    
    0
    
    
    
    0
    
    
    
    525,000 / 0
    
    
    
    350,175 / 0Joe G. Brooks
    
    
    0
    
    
    
    0
    
    
    
    246,667 / 0
    
    
    
    175,192 / 0
 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 individuals do not participate in compensation decisions or in forming
compensation policies in which they have a personal interest or in any deliberations of the board
of directors concerning such matters, nor do they vote on any such
matters, although Messrs Joe
G. and Stephen W. Brooks did participate in compensation deliberations and decisions with respect
to other executive officers. 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 27




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##### Table of Contents



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




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##### Table of Contents



Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth, as of December 31, 2004, 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 officer and director of the Company, and by all officers and directors
as a group: Name and Address
    
    Title of
    
    Number of Shares of
    
    
    Percentage of Class
    
    
    Percentage of Totalof Beneficial Owner
    
    Class(1)
    
    Common Stock (2)
    
    
    Outstanding (2)(17)
    
    
    Voting Power (2)(18)Marjorie S. Brooks
    
    Class A
    
    
    11,339,159
    (3)
    
    
    28.8
    %
    
    
    33.8
    %Class B
    
    
    837,588
    (4)
    
    
    57.2
    %Preferred-Series A
    
    
    425
    (5)
    
    
    15.4
    %Series B
    
    
    400
    (5)
    
    
    14.5
    %Joe G. Brooks
    
    Class A
    
    
    938,397
    (6)
    
    
    2.9
    %
    
    
    5.6
    %Class B
    
    
    284,396
    
    
    
    19.4
    %J. Douglas Brooks
    
    Class A
    
    
    935,573
    (7)
    
    
    2.9
    %
    
    
    3.8
    %Class B
    
    
    131,051
    
    
    
    8.9
    %Jerry B. Burkett
    
    Class A
    
    
    290,000
    (8)
    
    
    *
    
    
    
    1.1
    %Class B
    
    
    33,311
    
    
    
    2.3
    %Sal Miwa
    
    Class A
    
    
    531,963
    (9)
    
    
    1.6
    %
    
    
    1.3
    %Stephen W. Brooks
    
    Class A
    
    
    821,112
    (10)
    
    
    2.5
    %
    
    
    3.0
    %Class B
    
    
    89,311
    
    
    
    6.1
    %Jim Robason
    
    Class A
    
    
    106,282
    (11)
    
    
    *
    
    
    
    *Preferred-Series A
    
    
    80
    
    
    
    2.9
    %Melinda Davis
    
    Class A
    
    
    142,466
    (12)
    
    
    *
    
    
    
    *Preferred-
    
    
    
    
    
    
    2.9
    %Series A
    
    
    80Michael M. Tull
    
    Class A
    
    
    622,447
    (13)
    
    
    1.9
    %
    
    
    3.8
    %Preferred-Series B
    
    
    400
    
    
    
    13.8
    %Samuel L. Tony Milbank
    
    Class A
    
    
    551,067
    (14)
    
    
    1.7
    %
    
    
    1.3
    %Preferred-Series A
    
    
    15
    
    
    
    *Jim Precht
    
    Class A
    
    
    407,700
    (15)
    
    
    1.3
    %
    
    
    1.0
    %Edward J. Lysen
    
    Class A
    
    
    302,000
    (16)
    
    
    *
    
    
    
    *Officers and directors
    
    Class A
    
    
    16,998,166
    
    
    
    39.4
    %
    
    
    49.1
    %as a group (thirteen persons):
    
    Class B
    
    
    1,375,657
    
    
    
    93.9
    %P. O. Box 1237
    
    Preferred-Springdale, AR 72765
    
    Series A
    
    
    600
    
    
    
    21.7
    %Series B
    
    
    800
    
    
    
    29.0
    %
   *
    
    Less than 1% 29




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##### Table of Contents



(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 at the lower
of $1.20 and the ten-trading day average of the Companys Class A common stock, and would be
convertible into 833 shares of Class A common stock, based upon the trading price prevailing
at December 31, 2004. 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 (March 1, 2005) of December 31, 2004. (3)

    Includes 3,272,564 shares owned directly, 726,390 in trusts or corporations controlled by
Mrs. Brooks, 450,000 shares issuable upon exercise of stock options, 3,000 shares issuable
upon exercise of bonus warrants, 325,000 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, 1,771,792 shares issuable
upon exercise of Class H Warrants, 323,000 shares issuable upon exercise of Series X and Y
warrants owned directly 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, Stephen W. Brooks and J. Douglas
Brooks, as to which she disclaims a beneficial interest. (5)

    Includes 425 shares of Series A preferred stock owned directly and 400 shares of 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 607,400 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
246,667 shares issuable upon exercise of stock options. (7)

    Includes 343,212 shares owned directly, 84,741 shares owned indirectly, 7,620 shares
issuable upon exercise of bonus warrants and 500,000 shares issuable upon exercise of stock
options. (8)

    Includes 38,000 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 240,000
shares issuable upon exercise of stock options. (9)

    Includes 28,000 shares owned directly and 503,963 shares issuable upon exercise of stock
options. (10)

    Includes 296,112 shares owned directly and 525,000 shares issuable upon exercise of
stock options. (11)

    Includes 20,482 shares owned directly, 60,800 shares issuable upon exercise of Series X
and Series Y warrants, and 25,000 shares issuable upon exercise of stock options. (12)

    Represents 6,666 shares owned directly, 75,000 shares issuable upon exercise of stock
options, and 60,800 30




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##### Table of Contents



shares issuable upon exercise of Series X and Series Y warrants. (13) Includes 79,114 shares owned directly, 100,000 shares issuable upon exercise of stock
options and 443,333 shares issuable upon exercise of Series X and Series Y warrants. (14)
Includes 289,880 shares owned directly, 112,697 shares issuable upon exercise of Series
X Warrants, 41,604 shares issuable upon exercise of Series Y Warrants, 31,886 shares issuable
upon exercise of Class I Warrants, and 75,000 shares issuable upon exercise of stock options. (15)
Includes 7,700 shares owned directly and 400,000 shares issuable upon the exercise of
stock options. (16)
Includes 2,000 shares owned directly and 300,000 shares issuable upon the exercise of
stock options. (17)
Class A common stock beneficial ownership was calculated by dividing the beneficial
ownership of each individual by the sum of: (i) the total shares of Class A common stock
outstanding at December 31, 2004, and (ii) the total shares underlying outstanding warrants
and options which the named individual had the right to acquire within 60 days (March 1,
2005) of December 31, 2004. Class B common stock beneficial ownership is calculated based on
1,465,530 shares outstanding on December 31, 2004. Preferred stock beneficial ownership is
calculated based on 2,760 shares outstanding on December 31, 2004. (18)
Calculated by dividing the voting rights of the beneficial ownership of each individual
by the sum of: (i) the total votes available to be cast at December 31, 2004, and (ii) in
footnote (18) above. At December 31, 2004, there were 32,032,123 shares of Class A common stock and 1,465,530
shares of Class B common stock issued and outstanding. The previous table indicates that those
directors, officers and 5% shareholders, as a group, beneficially owned shares representing
approximately 49.1% 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 beneficially
owned shares representing approximately 33.8% of the votes entitled to be cast and may be in a
position to control the Company. Equity Compensation Plan Information The following table provides information as of December 31, 2004, regarding shares outstanding
and available for issuance under the Companys existing stock option plans. Number ofsecurities to beissued upon
    
    
    Weighted-exercise of
    
    
    average exerciseoutstanding
    
    
    price ofoptions,
    
    
    outstanding
    
    
    Number of securitieswarrants and
    
    
    options, warrants
    
    
    remaining availablerights
    
    
    and rights
    
    
    for future issuancePlan Category
    
    (a)
    
    
    (b)
    
    
    (c)Equity compensation plans approved by security holders
    
    
    4,595,230
    
    
    $
    1.06
    
    
    
    13,537Equity compensation plans not approved by security holders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    4,595,230
    
    
    $
    1.06
    
    
    
    13,537
 31




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##### Table of Contents



Item 13. Certain Relationships and Related Transactions During 2004, the Company had an agreement
with Brooks Investment Co., controlled
by Marjorie S. Brooks, allows the Company to transfer as collateral, certain of its trade
receivables, which Brooks Investment Co. deemed acceptable, up to $4.0 million at any one time.
Upon acceptance of a transfer of a receivable, Brooks Investment Co. remits to the Company 85% of
the receivable. Upon collection of the receivable, the Company remits to Brooks Investment Co.
1.25% of the receivable as a factoring charge, and the remaining receivable, less interest costs, which are based on the time period over which the
receivable is outstanding is remitted to the Company. The Company indemnifies Brooks Investment Co. for any loss arising out
of rejections or returns of any merchandise, or any claims asserted by the Companys customers.
During 2004, the Company transferred an aggregate of approximately $65.9 million in receivables
under this agreement, of which $2.5 million remained to be collected as of December 31, 2004.
During 2003 and 2002 the Company transferred an aggregate of approximately $45 million and $42.8
million, respectively, in receivables under this agreement, none of which remains to be collected.
Costs of $826,248, $512,233, and $343,752 associated with the factoring agreement were included in
selling and administrative costs at December 31, 2004, 2003, and
2002, respectively. In addition, members of the Brooks family provide the following
to the Company without receiving any financial consideration:  
    Marjorie S. Brooks personally guaranteed repayment of up to
    $4 million of the 2003 bonds;
    Joe G. Brooks personally guarantees repayment of the
    Companys American Express account, the outstanding balance
    of which is sometimes in excess of $100,000; and,
    Joe G. Brooks personally guarantees repayment of the
Companys automobile loans, which have a current balance of $116,563. At December 31, 2004, accounts payable-related parties included advances on factored
receivables of approximately $2.1 million and $183,228 relating to other items owed to related
parties. 
 Item 14. Principal Accounting Fees and Services The information below sets forth the fees charged by Tullius Taylor Sartain & Sartain LLP
(TTS&S) during 2004 and 2003 for services provided to the Company in the following categories and amounts: 2004
    
    
    2003Audit fees
    
    $
    81,500
    
    
    $
    80,250Audit-related fees
    
    
    8,500
    
    
    
    7,500Tax fees
    
    
    
    
    
    
    All other fees
    
    
    
    
    
    
    Total
    
    $
    90,000
    
    
    $
    87,750
 All of TTS&Ss fees for
2004 and 2003 were pre-approved by the audit committee
through a formal engagement letter with TTS&S. The audit committees policy is to
pre-approve all services by AERTs independent accountants. 
 Part IV 
 Item 15. Exhibits, Financial Statement Schedules (a1) and (a2).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. 32




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. ADVANCED ENVIRONMENTALRECYCLING TECHNOLOGIES, INC.By: /s/ JOE G. BROOKSJoe G. Brooks,Chairman, Co-Chief Executive Officer and President/s/ STEPHEN W. BROOKSStephen W. Brooks,Co-Chief Executive Officer/s/ EDWARD J. LYSENEdward J. Lysen,Senior Vice President and Chief Financial Officer
 Date: April 14, 2005 POWER OF ATTORNEY The undersigned directors and officers of Advanced Environmental Recycling Technologies, Inc.
hereby constitute and appoint Joe G. Brooks our true and lawful attorney-in-fact and agent with
full power to execute in our name and behalf in the capacities indicated below any and all
amendments to this report on Form 10-K to be filed with the Securities and Exchange
Commission and hereby ratify and confirm all that such attorney-in-fact and agent shall lawfully do
or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated. Signature
    
    Title
    Date/s/ JOE G. BROOKS
    
    Chairman of the board, co-CEO
    
    April 14, 2005and presidentJoe G. Brooks/s/ SAL MIWA
    
    Vice-chairman of the board
    
    April 14, 2005Sal Miwa/s/ STEPHEN W. BROOKS
    
    Co-CEO and director
    
    April 14, 2005Stephen W. Brooks/s/ MARJORIE S. BROOKS
    
    Secretary, treasurer and director
    
    April 14, 2005Marjorie S. Brooks/s/ JERRY B. BURKETT
    
    Director
    
    April 14, 2005Jerry B. Burkett/s/ MICHAEL M. TULL
    
    Director
    
    April 14, 2005Michael M. Tull/s/ SAMUEL L. TONY MILBANK
    
    Director
    
    April 14, 2005Samuel L. Tony Milbank/s/ MELINDA DAVIS
    
    Director
    
    April 14, 2005Melinda Davis/s/ JIM ROBASON
    
    Director
    
    April 14, 2005Jim Robason
 33




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Signature
    
    Title
    Date/s/ JIM ROBASON
    
    Director
    
    April 14, 2005Jim Robason
 31




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ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC. 
 INDEX TO FINANCIAL STATEMENTS PageFinancial Statements:Report of Independent Registered Public Accounting Firm
    
    F-2Balance Sheets
    
    F-3 - F-4Statements of Operations
    
    F-5Statements of Stockholders Equity
    
    F-6Statements of Cash Flows
    
    F-7Notes to Financial Statements
    
    F-8 - F-26
 F-1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 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. as of December 31, 2004 and 2003, and the related statements of operations, stockholders
equity and cash flows for each of the three years in the period ended December 31, 2004. 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
the standards of the Public Company Accounting Oversight Board (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, 2004 and 2003, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America. /s/ TULLIUS TAYLOR SARTAIN & SARTAIN LLP Fayetteville, Arkansas
March 29, 2005 F-2




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##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC. 
 BALANCE SHEETS ASSETS December 31,
    
    
    December 31,2004
    
    
    2003Current assets:Cash and cash equivalents
    
    $
    1,078,536
    
    
    $
    1,056,211Restricted cash
    
    
    679,635
    
    
    
    452,913Trade accounts receivable, net of allowance of $153,526 at December
31, 2004 and $92,207 at December 31, 2003
    
    
    2,554,594
    
    
    
    2,163,402Insurance claim receivable
    
    
    
    
    
    
    484,263Inventories
    
    
    7,392,838
    
    
    
    3,871,268Prepaid expenses
    
    
    586,637
    
    
    
    579,163Total current assets
    
    
    12,292,240
    
    
    
    8,607,220Land, buildings and equipment:Land
    
    

    1,612,243
    
    
    
    1,612,243Buildings and leasehold improvements
    
    
    5,413,115
    
    
    
    4,943,462Machinery and equipment
    
    
    33,524,077
    
    
    
    25,753,179Transportation equipment
    
    
    775,669
    
    
    
    675,208Office equipment
    
    
    755,000
    
    
    
    698,802Construction in progress
    
    
    2,363,936
    
    
    
    3,346,29844,444,040
    
    
    
    37,029,192Less accumulated depreciation
    
    
    18,963,479
    
    
    
    14,905,242Net land, buildings and equipment
    
    
    25,480,561
    
    
    
    22,123,950Other Assets:Debt issuance costs, net of accumulated amortization of $373,336 at
December 31, 2004 and $199,067 at December 31, 2003
    
    
    3,211,766
    
    
    
    3,397,134Debt service reserve fund
    
    
    2,057,792
    
    
    
    1,946,643Other assets, net of accumulated amortization of $335,590 at
December 31, 2004 and $307,017 at December 31, 2003
    
    
    298,434
    
    
    
    331,654Total other assets
    
    
    5,567,992
    
    
    
    5,675,431$
    43,340,793
    
    
    $
    36,406,601
 The accompanying notes are an integral part of these financial statements. F-3




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##### Table of Contents



LIABILITIES AND STOCKHOLDERS EQUITY December 31,
    
    
    December 31,2004
    
    
    2003Current liabilities:Accounts payable  trade
    
    $
    8,486,792
    
    
    $
    5,321,317Accounts payable  related parties
    

    
    2,280,781
    
    
    
    1,799,405Current maturities of long-term debt
    


    
    1,133,168
    
    
    
    1,142,525Accrued payroll expense
    



    
    401,183
    
    
    
    603,134Other accrued liabilities
    
    
    2,533,605
    
    
    
    1,291,183Notes payable  related parties
    
    
    600,000
    
    
    
    Notes payable  other
    


    
    327,682
    
    
    
    365,351Total current liabilities
    
    
    15,763,211
    
    
    
    10,522,915Long-term debt, less current maturities
    
    
    15,571,068
    
    
    
    16,659,241Accrued premium on convertible preferred stock
    
    
    276,000
    
    
    
    276,000Commitments and contingenciesStockholders equity:Preferred stock, $1 par value; 5,000,000 shares authorized,
2,760 shares issued and outstanding at
December 31, 2004 and 2003
    
    
    2,760
    
    
    
    2,760Class A common stock, $.01 par value; 75,000,000 shares
authorized; 32,032,123 and 29,275,147 shares issued and
outstanding at December 31, 2004 and 2003,
respectively
    
    
    320,322
    
    
    
    292,752Class B convertible common stock, $.01 par value;
7,500,000 shares authorized; 1,465,530 shares issued and
outstanding at December 31, 2004 and 2003
    
    
    14,655
    
    
    
    14,655Warrants outstanding; 14,890,867 at December 31, 2004 and
16,580,722 at December 31, 2003
    
    
    6,917,544
    
    
    
    7,818,834Additional paid-in capital
    
    
    27,376,565
    
    
    
    24,988,295Accumulated deficit
    
    
    (22,901,332
    )
    
    
    (24,168,851
    )Total stockholders equity
    
    
    11,730,514
    
    
    
    8,948,445Total liabilities and stockholders
equity
    
    $
    43,340,793
    
    
    $
    36,406,601
 The accompanying notes are an integral part of these financial statements. F-4




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##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC. 
 STATEMENTS OF OPERATIONS Year Ended December 31,2004
    
    
    2003
    
    
    2002Net
sales
    
    $
    63,637,285
    
    
    $
    43,520,563
    
    
    $
    41,415,466Cost of goods
sold
    
    
    48,963,166
    
    
    
    34,361,984
    
    
    
    29,800,939Gross
margin
    
    
    14,674,119
    
    
    
    9,158,579
    
    
    
    11,614,527Selling and
administrative
costs
    
    
    11,099,911
    
    
    
    9,001,261
    
    
    
    7,823,826Legal
settlement
    
    
    
    
    
    
    
    
    
    
    1,100,000Research and
development
    
    
    97,207
    
    
    
    77,900
    
    
    
    220,35411,197,118
    
    
    
    9,079,161
    
    
    
    9,144,180Operating
income
    
    
    3,477,001
    
    
    
    79,418
    
    
    
    2,470,347Other income (expense):Insurance proceeds
related to lost
income
    
    
    8,720
    
    
    
    1,125,372
    
    
    
    Loss on
disposition of
equipment
    
    
    
    
    
    
    
    
    
    
    (134,413
    )Interest
income
    
    
    5,324
    
    
    
    160,659
    
    
    
    321,955Interest
expense
    
    
    (2,121,062
    )
    
    
    (2,031,370
    )
    
    
    (1,464,556
    )(2,107,018
    )
    
    
    (745,339
    )
    
    
    (1,277,014
    )Income (loss) before
extraordinary item and
accrued premium on
preferred
stock
    
    
    1,369,983
    
    
    
    (665,921
    )
    
    
    1,193,333Accrued premium on
preferred stock
    
    
    (276,000
    )
    
    
    (276,000
    )
    
    
    (278,083
    )Income (loss) before
extraordinary
item
    
    
    1,093,983
    
    
    
    (941,921
    )
    
    
    915,250Extraordinary gain on
involuntary conversion of
non-monetary assets due
to fire
    
    
    173,536
    
    
    
    2,962,041
    
    
    
    Net income applicable to
common stock
    
    $
    1,267,519
    
    
    $
    2,020,120
    
    
    $
    915,250Income (loss) per share
of common stock before
extraordinary item
(Basic)
    
    $
    0.03
    
    
    $
    (0.03
    )
    
    $
    0.03Income (loss) per share
of common stock before
extraordinary item
(Diluted)
    
    $
    0.03
    
    
    $
    (0.03
    )
    
    $
    0.02Extraordinary gain per
share of common stock
(Basic)
    
    $
    0.01
    
    
    $
    0.10
    
    
    
    Extraordinary gain per
share of common stock
(Diluted)
    
    $
    0.00
    
    
    $
    0.10
    
    
    
    Income per share of
common stock after
extraordinary item
(Basic)
    
    $
    0.04
    
    
    $
    0.07
    
    
    $
    0.03Income per share of
common stock after
extraordinary item
(Diluted)
    
    $
    0.03
    
    
    $
    0.07
    
    
    $
    0.02Weighted average number
of common shares
outstanding
(Basic)
    
    
    31,815,067
    
    
    
    30,017,661
    
    
    
    29,516,768Weighted average number
of common shares
outstanding
(Diluted)
    
    
    41,070,289
    
    
    
    30,017,661
    
    
    
    42,665,451
 The accompanying notes are an integral part of these financial statements. F-5




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##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC. 
 STATEMENTS OF STOCKHOLDERS EQUITY Class A
    
    
    Class BPreferred Stock
    
    
    Common Stock
    
    
    Common Stock
    
    
    Warrants Outstanding
    
    
    AdditionalPaid-in
    
    
    AccumulatedShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Shares
    
    
    Value
    
    
    Capital
    
    
    Deficit
    
    
    TotalBalance  December 31, 2001
    
    
    2,900
    
    
    $
    2,900
    
    
    
    27,167,774
    
    
    $
    271,678
    
    
    
    1,465,530
    
    
    $
    14,655
    
    
    
    17,298,501
    
    
    $
    8,203,154
    
    
    $
    22,810,588
    
    
    $
    (27,104,221
    )
    
    $
    4,198,754Issuance of shares in payment
of accrued premium on preferred stock
    
    
    
    
    
    
    
    
    
    
    338,492
    
    
    
    3,385
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    350,393
    
    
    
    
    
    
    
    353,778Conversion of preferred stock
    
    
    (140
    )
    
    
    (140
    )
    
    
    116,667
    
    
    
    1,166
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,026
    )
    
    
    
    
    
    
    Exercise of Series X Warrants
    
    
    
    
    
    
    
    
    
    
    1,000
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    (1,000
    )
    
    
    (531
    )
    
    
    1,721
    
    
    
    
    
    
    
    1,200Exercise of Class I Warrants
    
    
    
    
    
    
    
    
    
    
    95,107
    
    
    
    951
    
    
    
    
    
    
    
    
    
    
    
    (95,107
    )
    
    
    (43,328
    )
    
    
    105,258
    
    
    
    
    
    
    
    62,881Exercise of Consulting Warrants
    
    
    
    
    
    
    
    
    
    
    416,667
    
    
    
    4,167
    
    
    
    
    
    
    
    
    
    
    
    (416,667
    )
    
    
    (225,631
    )
    
    
    377,716
    
    
    
    
    
    
    
    156,252Exercise of Placement Warrants
    
    
    
    
    
    
    
    
    
    
    195,605
    
    
    
    1,956
    
    
    
    
    
    
    
    
    
    
    
    (195,605
    )
    
    
    (109,458
    )
    
    
    180,854
    
    
    
    
    
    
    
    73,352Net income applicable to common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    915,250
    
    
    
    915,250Balance  December 31, 2002
    
    
    2,760
    
    
    $
    2,760
    
    
    
    28,331,312
    
    
    $
    283,313
    
    
    
    1,465,530
    
    
    $
    14,655
    
    
    
    16,590,122
    
    
    $
    7,824,206
    
    
    $
    23,825,504
    
    
    $
    (26,188,971
    )
    
    $
    5,761,467Issuance of shares in payment
of accrued premium on preferred stock
    
    
    
    
    
    
    
    
    
    
    179,586
    
    
    
    1,796
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    213,722
    
    
    
    
    
    
    
    215,518Issuance of shares in payment of interest
    
    
    
    
    
    
    
    
    
    
    309,849
    
    
    
    3,099
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    429,296
    
    
    
    
    
    
    
    432,395Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    95,000
    
    
    
    950
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48,410
    
    
    
    
    
    
    
    49,360Exercise of Placement Warrants
    
    
    
    
    
    
    
    
    
    
    9,400
    
    
    
    94
    
    
    
    
    
    
    
    
    
    
    
    (9,400
    )
    
    
    (5,372
    )
    
    
    8,803
    
    
    
    
    
    
    
    3,525Issuance of shares in payment of debt
issuance costs
    
    
    
    
    
    
    
    
    
    
    350,000
    
    
    
    3,500
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    462,560
    
    
    
    
    
    
    
    466,060Net income applicable to common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,020,120
    
    
    
    2,020,120Balance  December 31, 2003
    
    
    2,760
    
    
    $
    2,760
    
    
    
    29,275,147
    
    
    $
    292,752
    
    
    
    1,465,530
    
    
    $
    14,655
    
    
    
    16,580,722
    
    
    $
    7,818,834
    
    
    $
    24,988,295
    
    
    $
    (24,168,851
    )
    
    $
    8,948,445Issuance of shares in payment
of accrued premium on preferred stock
    
    
    
    
    
    
    
    
    
    
    229,994
    
    
    
    2,300
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    273,700
    
    
    
    
    
    
    
    276,000Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    837,400
    
    
    
    8,374
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    560,751
    
    
    
    
    
    
    
    569,125Exercise of Consulting Warrants
    
    
    
    
    
    
    
    
    
    
    1,573,333
    
    
    
    15,733
    
    
    
    
    
    
    
    
    
    
    
    (1,573,606
    )
    
    
    (849,741
    )
    
    
    1,423,964
    
    
    
    
    
    
    
    589,956Exercise of Class I Warrants
    
    
    
    
    
    
    
    
    
    
    116,249
    
    
    
    1,163
    
    
    
    
    
    
    
    
    
    
    
    (116,249
    )
    
    
    (51,549
    )
    
    
    129,855
    
    
    
    
    
    
    
    79,469Net income applicable to common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,267,519
    
    
    
    1,267,519Balance  December 31, 2004
    
    
    2,760
    
    
    $
    2,760
    
    
    
    32,032,123
    
    
    $
    320,322
    
    
    
    1,465,530
    
    
    $
    14,655
    
    
    
    14,890,867
    
    
    $
    6,917,544
    
    
    $
    27,376,565
    
    
    $
    (22,901,332
    )
    
    $
    11,730,514
 The accompanying notes are an integral part of these financial statements. F-6




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ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC. 
 STATEMENTS OF CASH FLOWS Year Ended December 31,2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net income applicable to common stock
    
    $
    1,267,519
    
    
    $
    2,020,120
    
    
    $
    915,250Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    4,086,811
    
    
    
    3,671,512
    
    
    
    2,985,050Premium accrued on preferred stock
    
    
    276,000
    
    
    
    276,000
    
    
    
    278,083Interest paid through issuance of common stock
    
    
    
    
    
    
    432,395
    
    
    
    Loss on disposition of equipment
    
    
    
    
    
    
    
    
    
    
    134,413Extraordinary gain on involuntary conversion of non-
monetary assets due to fire
    
    
    (173,536
    )
    
    
    (2,962,041
    )
    
    
    (Increase) decrease in other assets
    
    
    67,765
    
    
    
    (766,446
    )
    
    
    54,053Increase in restricted cash
    
    
    (226,722
    )
    
    
    (452,913
    )
    
    
    Changes in current assets and current liabilities
    
    
    126,680
    
    
    
    (167,255
    )
    
    
    505,297Net cash provided by operating activities
    
    
    5,424,517
    
    
    
    2,051,372
    
    
    
    4,872,146Cash flows from investing activities:Purchases of land, buildings and equipment
    
    
    (5,868,218
    )
    
    
    (11,257,967
    )
    
    
    (4,837,311
    )Insurance proceeds from involuntary disposition of
property and equipment
    
    
    669,012
    
    
    
    3,681,904
    
    
    
    Net cash used in investing activities
    
    
    (5,199,206
    )
    
    
    (7,576,063
    )
    
    
    (4,837,311
    )Cash flows from financing activities:Proceeds from issuance of notes
    
    
    2,050,000
    
    
    
    17,000,000
    
    
    
    1,415,000Payments on notes
    
    
    (3,804,520
    )
    
    
    (9,112,156
    )
    
    
    (769,302
    )Increase (decrease) in outstanding advances on
factored receivables
    
    
    301,884
    
    
    
    (187,112
    )
    
    
    (920,143
    )Debt acquisition costs
    
    
    11,100
    
    
    
    (1,677,080
    )
    
    
    (305,309
    )Proceeds from exercise of stock options
and warrants, net
    
    
    1,238,550
    
    
    
    52,885
    
    
    
    293,683Net cash provided by (used in) financing activities
    
    
    (202,986
    )
    
    
    6,076,537
    
    
    
    (286,071
    )Increase (decrease) in cash
    
    
    22,325
    
    
    
    551,846
    
    
    
    (251,236
    )Cash and cash equivalents, beginning of period
    
    
    1,056,211
    
    
    
    504,365
    
    
    
    755,601Cash and cash equivalents, end of period
    
    $
    1,078,536
    
    
    $
    1,056,211
    
    
    $
    504,365
 The accompanying notes are an integral part of these financial statements. F-7




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##### Table of Contents



ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC. 
 NOTES TO FINANCIAL STATEMENTS Note 1: Description of the Company Advanced Environmental Recycling Technologies, Inc. (AERT) develops manufactures and markets
composite building materials that are used in place of traditional wood products for exterior
applications in building and remodeling homes and for certain other industrial or commercial
building purposes. Our products are made from approximately equal amounts of waste wood fiber and
reclaimed polyethylene plastics, have been extensively tested, and are sold by leading national
companies such as the Weyerhaeuser Company (Weyerhaeuser), Lowes Companies, Inc. (Lowes) and
Therma-Tru Corporation. Our composite building materials are marketed as a substitute for wood and
plastic filler materials for standard door components, windowsills, brick mould, fascia board,
decking and heavy industrial flooring under the trade names LifeCycle®, MoistureShield®,
MoistureShield® CornerLoc, Weyerhaeuser ChoiceDek® Classic, Weyerhaeuser ChoiceDek® Plus,
Weyerhaeuser ChoiceDek® Premium, ChoiceDek® Classic Colors, ChoiceDek® Premium Colors and
MoistureShield® outdoor decking. We operate manufacturing facilities in Springdale, Lowell, and
Tontitown, Arkansas; Junction, Texas and Alexandria, Louisiana. Our customers are primarily
regional and national door and window manufacturers, Weyerhaeuser, our primary decking customer,
and various building product distributors. Note 2: Summary of Significant Accounting Policies Revenue Recognition The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104,
Revenue Recognition in Financial Statements(SAB 104). Under SAB 104, revenue is recognized when
the title and risk of loss have passed to the customer, there is persuasive evidence of an
arrangement, delivery has occurred or services have been rendered, the sales price is determinable
and collectibility is reasonably assured. The Company typically recognizes revenue at the time of
shipment or segregated and billed under a bill and hold agreement. The terms of this agreement
qualify for revenue recognition under SAB 104. Sales are recorded net of discounts, rebates, and returns. Estimates of expected sales discounts are calculated by applying the appropriate sales
discount rate to all unpaid invoices that are eligible for the discount. The Companys sales prices are
determinable given that the Companys sales discount rates are fixed and given the predictability
with which customers take sales discounts. Shipping and Handling In accordance with Emerging Issues Task Force (EITF) Issue 00-10, Accounting for Shipping and
Handling Fees and Costs, the Company records shipping fees billed to customers in net sales and
records the related expenses in cost of goods sold. Operating Costs The cost of goods sold line item in the Companys statements of operations includes costs
associated with the manufacture of our products, such as labor, depreciation, repair and
maintenance, utilities, leases, and raw materials, including the costs of raw material delivery,
warehousing and other distribution related costs. The selling and administrative costs line item
in the Companys statements of operations includes costs associated with sales, marketing, and
support activities like accounting and information technology. The types of costs incurred in
those areas include labor, advertising, travel, commissions, outside professional services, and
factoring fees. F-8




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##### Table of Contents



Statements of Cash Flows In order to determine net cash provided by operating activities, net income has been adjusted
by, among other things, changes in current assets and current liabilities, excluding changes in
cash, current maturities of long-term debt and current notes payable. Those changes, shown as an
(increase) decrease in current assets and an increase (decrease) in current liabilities, are as
follows: Year Ended December 31,2004
    
    
    2003
    
    
    2002Receivables
    
    $
    (402,405
    )
    
    $
    213,444
    
    
    $
    642,513Inventories
    
    
    (3,521,570
    )
    
    
    (1,186,932
    )
    
    
    (451,624
    )Prepaid expenses and other
    
    
    1,151,327
    
    
    
    844,929
    
    
    
    290,012Accounts payable -
Trade and related parties
    
    
    1,858,857
    
    
    
    (321,085
    )
    
    
    (785,890
    )Accrued liabilities
    
    
    1,040,471
    
    
    
    282,389
    
    
    
    810,286$
    126,680
    
    
    $
    (167,255
    )
    
    $
    505,297Cash paid for interest
    
    $
    1,898,373
    
    
    $
    1,125,238
    
    
    $
    1,126,496
 Supplemental Disclosures of Non-cash Investing and Financing Activities Year Ended December 31,2004
    
    
    2003
    
    
    2002Notes payable for financing of insurance policies
    
    $
    1,158,801
    
    
    $
    1,080,683
    
    
    $
    400,644Accounts / notes payable for equipment
    
    
    1,546,631
    
    
    
    928,023
    
    
    
    1,305,264Accrued premium on preferred stock paid with Class
A common stock
    
    
    276,000
    
    
    
    215,518
    
    
    
    353,778
 Cash Equivalents and Restricted Cash The Company considers all highly liquid investments, those with a maturity of three months or
less when purchased, to be cash equivalents. At December 31, 2004 and 2003, restricted cash
included $451,591 and $427,155, respectively, that was restricted for payment of the 2005 and 2004 principal and interest on
the Companys bond payable. (See Note 4: Notes Payable and Long-term Debt.) Additionally, restricted cash at December 31, 2004 and 2003 included
$228,044 and $25,758, respectively, which served as collateral for letters of credit with
respect to purchases on credit from certain vendors. Buildings and Equipment Buildings and equipment are stated at cost and depreciated over the estimated useful life of
each asset using the straight-line method. Estimated useful lives are: buildings  15 to 30
years, leasehold improvements  2 to 6 years, transportation equipment  3 to 5 years, office
equipment  5 to 6 years and machinery and equipment  3 to 10 years. Depreciation expense
recognized by the Company for the years ended December 31, 2004, 2003 and 2002 was approximately
$4.1 million, $3.6 million and $3.0 million, respectively. 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. F-9




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The Company accounts for the impairment or disposal of long-lived assets in accordance with
the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets(SFAS 144). SFAS 144 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. Inventories Inventories are stated at the lower of cost (first-in, first-out method) or market.
Inventories consisted of the following at December 31: 2004
    
    
    2003Raw materials
    
    $
    5,479,344
    
    
    $
    2,722,682Work in process
    
    
    891,473
    
    
    
    566,503Finished goods
    
    
    1,022,021
    
    
    
    582,083$
    7,392,838
    
    
    $
    3,871,268
 Other Assets Debt
issuance costs are amortized over the term of the related debt. Accumulated amortization was $373,336 and $199,067
at December 31, 2004 and 2003, respectively. Amortization of debt issuance costs charged to
interest expense was $174,269 for 2004 and $496,427 for 2003. The net costs for the
preparation of patent applications of $150,159 and $178,733 as of
December 31, 2004 and 2003, respectively, are amortized using the
straight-line method over 17 years. The debt service reserve fund is restricted for the life of
the bonds payable (see Note 4: Notes Payable and Long-term Debts) for payment of principal and
interest on the bonds in the case the Company is unable to make those payments. Accounts Receivable Accounts receivable are uncollateralized customer obligations due under normal trade terms
generally requiring payment within thirty days from the invoice date. Trade accounts are stated at
the amount management expects to collect from outstanding balances. Delinquency fees are not
assessed. Payments of accounts receivable are allocated to the specific invoices identified on the
customers remittance advice. Accounts receivable are carried at original invoice amount less an estimated reserve made for
returns and discounts based on quarterly review of historical rates of returns and expected
discounts to be taken. The carrying amount of accounts receivable is reduced, if needed, by a
valuation allowance that reflects managements best estimate of the amounts that will not be
collected. Management individually reviews all accounts receivable balances that exceed sixty days
from invoice date and based on an assessment of current creditworthiness, estimates the portion, if
any, of the balance that will not be collected. Management provides for probable uncollectible
amounts through a charge to earnings and a credit to a valuation account based on its assessment of the
current status of the individual accounts. Balances that remains outstanding after management has
used reasonable collection efforts are written off through a charge to the valuation allowance and
a credit to trade accounts receivable. Changes in the valuation allowance have not been material
to the financial statements. Recoveries of trade receivables previously written off are recorded
when received. Earnings Per Share The Company calculates and discloses earnings per share (EPS) in accordance with SFAS No. 128,
Earnings Per Share(SFAS 128). SFAS 128 requires dual presentation of F-10




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##### Table of Contents



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. 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 incurred a loss from continuing operations for the year ended
December 31, 2003. Therefore, Basic EPS and Diluted EPS are computed in the same manner for that
year. Year Ended December 31,2004
    
    
    
    
    
    
    2003
    
    
    2002Before Extra-
    
    
    After Extra-
    
    
    Before Extra-
    
    
    After Extra-ordinary Item
    
    
    ordinary Item
    
    
    ordinary Item
    
    
    ordinary ItemNet income (loss) applicable to
common stock (A)
    
    $
    1,093,983
    
    
    $
    1,267,519
    
    
    $
    (941,921
    )
    
    $
    2,020,120
    
    
    $
    915,250Assumed exercise of stock options
and warrants
    
    
    18,196,164
    
    
    
    18,196,164
    
    
    
    
    
    
    
    
    
    
    
    20,821,319Application of assumed proceeds
toward repurchase of stock at
average market price
    
    
    (8,940,942
    )
    
    
    (8,940,942
    )
    
    
    
    
    
    
    
    
    
    
    (7,672,636
    )Net additional shares issuable
    
    
    9,255,222
    
    
    
    9,255,222
    
    
    
    
    
    
    
    
    
    
    
    13,148,683Adjustment of shares outstanding:Weighted average common shares
outstanding
    
    
    31,815,067
    
    
    
    31,815,067
    
    
    
    30,017,661
    
    
    
    30,017,661
    
    
    
    29,516,768Net additional shares issuable
    
    
    9,255,222
    
    
    
    9,255,222
    
    
    
    
    
    
    
    
    
    
    
    13,148,683Adjusted shares outstanding (B)
    
    
    41,070,289
    
    
    
    41,070,289
    
    
    
    30,017,661
    
    
    
    30,017,661
    
    
    
    42,665,451Net income (loss) per common share
 Diluted (A) divided by
(B)
    
    $
    0.03
    
    
    $
    0.03
    
    
    $
    (0.03
    )
    
    $
    0.07
    
    
    $
    0.02Antidilutive and/or
non-exercisable
options
    
    
    1,256,000
    
    
    
    1,256,000
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    1,402,500Antidilutive and/or
non-exercisable
warrants
    
    
    2,333,933
    
    
    
    2,333,933
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    2,333,933
 The Company has additional options and warrants that were not included in the calculation
of diluted earnings per share for the years ended December 31, 2004 and 2002, as indicated in the
above table. Those options and warrants were antidilutive and/or not exercisable during those
periods. Although the above financial instruments were not included due to being antidilutive
and/or not exercisable, such financial instruments may become
dilutive and would then need to be included in future calculations of Diluted EPS. Except in the case the Company incurs a loss from
continuing operations, the conversion of all series of preferred stock is assumed in calculating
Diluted EPS. F-11




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Concentration Risk 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. Weyerhaeuser is the only customer from which the Company
derived more than 10% of its revenue. The following table presents sales to
Weyerhaeuser and the percentage of total sales that those sales
represent. 2004
    
    
    2003
    
    
    2002Sales
    
    $
    51,725,413
    
    
    $
    35,619,110
    
    
    $
    33,983,190% of total
sales
    
    
    81%
    
    
    
    82%
    
    
    
    82%
 Cash The Company maintains bank accounts which are insured by the Federal Deposit Insurance
Corporation (FDIC) up to $100,000. At times, cash balances may be in excess of the FDIC insurance
limit. The Company believes no significant concentrations of risk exist with respect to its cash. 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 these 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, and collateral and amortization schedule. The carrying amount approximates fair value. Stock-Based Compensation The Company adopted the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation(SFAS 123). The following table
illustrates the effect on net income (loss) and earnings per share if the Company had applied the
fair value recognition provisions of SFAS 123 to stock-based F-12




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##### Table of Contents



employee compensation for the years ended December 31, 2004, 2003, and 2002. 2004
    
    
    2003
    
    
    2002Before
    
    
    After
    
    
    Before
    
    
    AfterExtra-
    
    
    Extra-
    
    
    Extra-
    
    
    Extra-ordinary
    
    
    ordinary
    
    
    ordinary
    
    
    OrdinaryItem
    
    
    Item
    
    
    Item
    
    
    ItemNet income (loss) applicable to
common stock, as
reported
    
    $
    1,093,983
    
    
    $
    1,267,519
    
    
    $
    (941,921
    )
    
    $
    2,020,120
    
    
    $
    915,250Deduct: Total stock-based
compensation expense determined
under fair value based method for
all awards
    
    
    263,328
    
    
    
    263,328
    
    
    
    396,958
    
    
    
    396,958
    
    
    
    628,795Net income (loss) applicable to
common stock, pro forma
    
    $
    830,655
    
    
    $
    1,004,191
    
    
    $
    (1,338,879
    )
    
    $
    1,623,162
    
    
    $
    286,455Net income (loss) per share of
common stock:Basic  as reported
    
    $
    0.03
    
    
    $
    0.04
    
    
    $
    (0.03
    )
    
    $
    0.07
    
    
    $
    0.03Basic  pro forma
    
    $
    0.03
    
    
    $
    0.03
    
    
    $
    (0.04
    )
    
    $
    0.05
    
    
    $
    0.01Diluted  as reported
    
    $
    0.03
    
    
    $
    0.03
    
    
    $
    (0.03
    )
    
    $
    0.07
    
    
    $
    0.02Diluted  pro forma
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    (0.04
    )
    
    $
    0.05
    
    
    $
    0.01
 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 2004, 2003
and 2002, respectively: risk-free interest rates of 4.2, 4.0, and 4.3 percent; expected lives of
10, 10, and 8 years; and expected volatilities of 67, 91, and 74 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. The weighted-average fair
value of options granted during 2004, 2003 and 2002 was $0.93, $0.98, and $1.19, respectively. Use of Estimates The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates. Advertising Costs Advertising costs are charged to expense in the period incurred. Advertising expense was
approximately $1,086,000, $1,277,000, and $1,129,000 in 2004, 2003, and 2002, respectively. Research and Development Costs Expenditures
for research activities relating to product development and
improvement are charged to expense as incurred. Such expenditures
amounted to $97,207, $77,900 and $220,354 in 2004, 2003, and 2002,
respectively. Recent Accounting Pronouncements F-13




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##### Table of Contents



In December 2003, the Financial Accounting Standards Board issued Interpretation 46R
Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No.
51(FIN 46R), which replaces FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, and clarifies the application of Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to certain entities in which equity investors do not have the characteristics
of a controlling financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support. The Company is required
to adopt the provisions of this Interpretation no later than the end of the first reporting period
that ends after March 15, 2004. The Company does not have an interest in an entity that is subject
to the Interpretation, therefore, the adoption of FIN 46R did not have any effect on the
Companys financial statements and related disclosures. In
November 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 151,
Inventory Costs, an amendment of ARB No. 43,
Chapter 4 (SFAS 151). SFAS 151 amends the guidance
in ARB No. 43, Chapter 4, Inventory Pricing, to
clarify the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage).
Additionally, this statement requires that allocation of fixed
production overheads to the costs of conversion be based on the
normal capacity of the production facilities. The Company is required
to adopt the provisions of this statement no later than the beginning
of the first fiscal year beginning after June 15, 2005. The
Company does not expect the adoption of SFAS 151 to have a
material effect on the Companys financial statements and
related disclosures. In
December 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123R,
Share-Based Payment (SFAS 123R). SFAS 123R is a
revision of SFAS 123, Accounting for Stock-Based
Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and its related
implementation guidance. This statement requires a public entity to
measure the cost of employee services received in exchange for an
award of equity instruments based on the grand-date fair value of the
award (with limited exceptions) and requires that cost to be
recognized in the financial statements. The Company is required to
adopt the provisions of this statement no later than the beginning of
the first interim or annual reporting period that begins after
June 15, 2005. The Company does not expect the adoption of
SFAS 123R to have a material effect on the Companys
financial statements and related disclosures. In December 2004, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29
(SFAS153). The guidance in APB Opinion 29, Accounting for Nonmonetary Transactions, is based on
the principle that exchanges of nonmonetary assets should be measured based on the fair value of
the assets exchanged. SFAS 153 amends APB Opinion 29 to eliminate an exception for nonmonetary
exchanges of similar productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. The Company is required to adopt the
provisions of this statement no later than the beginning of the first fiscal period beginning after
June 15, 2005. The Company does not expect the adoption of SFAS 153 to have any effect on the
Companys financial statements and related disclosures. 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 income. Note 3: Related Party Transactions The Company accounts for transfers of receivables, with recourse, to a related
party (Brooks Investment Company) under the
guidelines of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities(SFAS 140). 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 140, 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 payable-related parties and trade accounts
receivable at December 31, 2004 and 2003, include $2,097,553 and $1,795,670, respectively, to
reflect these requirements. The terms of the agreement with Brooks Investment Co., controlled
by Marjorie S. Brooks allows the Company to transfer certain of its trade receivables as
collateral, which Brooks Investment Co. deemed acceptable, up to
$4.0 million at any one time.
Upon acceptance of a transfer of a receivable, Brooks Investment Co. remits to the Company 85% of
the receivable, as defined in the agreement. Upon collection of the receivable, the Company
remits to Brooks Investment Co. 1.25% of the receivable as a factoring charge, and the
remaining receivable, less interest costs, which are based on the
time period over which the receivable is outstanding is remitted to the Company. The Company indemnifies Brooks Investment
Co. for any loss arising out of rejections or returns of any merchandise, or any claims asserted by
the Companys customers. During 2004, the Company transferred an aggregate of approximately $65.9
million in receivables under this agreement, of which $2.5 million remained to be collected as of
December 31, 2004. During 2003 and 2002 the Company transferred an aggregate of approximately $45
million and $42.8 million, respectively, in receivables under this agreement, none of which remains
to be collected. Costs of $826,248, $512,233, and $343,752 associated with the factoring agreement
were included in selling and administrative costs at December 31, 2004, 2003, and 2002,
respectively. In addition, members of the Brooks family provide the following
to the Company without receiving any financial consideration:  
    Marjorie S. Brooks personally guaranteed repayment of up to
    $4 million of the 2003 bonds;
    Joe G. Brooks personally guarantees repayment of the
    Companys American Express account, the outstanding balance
    of which is sometimes in excess of $100,000; and
    Joe G. Brooks personally guarantees
    repayment of the
    Companys automobile loans, which have a current balance of $116,563. F-14




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##### Table of Contents



At December 31, 2004, accounts payable-related parties included advances on factored
receivables of approximately $2.1 million and $183,228 relating to other items owed to related
parties. Note 4: Notes Payable and Long-Term Debt Notes Payable  Related Parties Notes payable to related parties consisted of the following at December 31:
    
    2004
    
    
    20037% notes payable to Brooks Investment Company, which is controlled by
Marjorie S. Brooks, an officer and director of the
Company; unsecured; due on demand
    
    $
    600,000
    
    
    $
    
 Notes Payable  Other Notes payable  other, consisted of the following at December 31:
    
    2004
    
    
    2003Various notes with interest at 11.5% at December 31, 2004
    
    $
    327,682
    
    
    $
    365,351
 The Company has had five bridge financing agreements. The first was completed on October 30,
1997, and was paid off in 2001. The remaining four financings were completed in 1998, and paid off
in 2003 with proceeds from the $17 million financing discussed in the long-term debt section of
this note. In connection with the repayment of one of the bridge financings, the Company is in dispute with Zanett Lombardier, Ltd. over
penalty interest on that financing, which amounted to $187,856 at December 31, 2004. The Company has accrued a liability for this entire amount. Long-term Debt Long-term debt, less current maturities consisted of the following at December 31:
    
    2004
    
    
    20037% bonds payable to Regions Bank; principal payable annually; interest payable
semi-annually; subject to mandatory sinking fund redemption; secured by real estate
and improvements, fixed assets, patents and trademarks, inventory, pledged revenues,
and a personal guarantee by Marjorie S. Brooks, the major shareholder; maturing on
October 1, 2017 (a)
    
    $
    13,700,000
    
    
    $
    14,400,00019.75% note payable to Allstate Insurance Company, secured by subordinated interest in
the collateral securing the bonds payable; interest payable semiannually; principal
due on October 1, 2017
    
    
    2,600,000
    
    
    
    2,600,0005% note payable with weekly principal payments of $6,540 plus interest; unsecured;
maturing October 14, 2005
    
    
    267,980
    
    
    
    614,600Other
    
    
    136,256
    
    
    
    187,166Total
    
    
    16,704,236
    
    
    
    17,801,766Less current maturities
    
    
    (1,133,168
    )
    
    
    (1,142,525
    )Long-term debt, less current maturities
    
    $
    15,571,068
    
    
    $
    16,659,241
   (a)
    
    The bond agreement contains financial covenants, which include a current ratio of not
less than 1.00 to 1.00 and a requirement that not more than 10% of accounts payable be in
excess of 75 days past the invoice date. The Company was not in compliance with these two
covenants at December 31, 2004; however, the bond trustee has waived these
covenants as of December 31, 2004 through, and including, December 31, 2005. F-15




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##### Table of Contents



The aggregate maturities of long-term debt, net of debt discount, as of December 31, 2004, are
as follows: Year
    
    Amount2005
    
    $
    1,133,1682006
    
    
    841,2982007
    
    
    924,1492008
    
    
    905,6212009
    
    
    1,000,000Thereafter
    
    
    11,900,000$
    16,704,236
 Notes and Bonds Payable On October 9, 2003, the Company finalized a long-term financing package with the City of
Springdale, Arkansas and Allstate Insurance Company that resulted in the Company borrowing the
funds previously in the restricted bond escrow fund on a long-term basis and terminating such
escrow agreement. The package consists of $14.4 million tax-exempt industrial development bonds
and $2.6 million subordinated debt. Net proceeds from the financing were used to repay short-term loans, pay down accounts payable
incurred to develop qualified solid waste disposal facilities, purchase the Springdale, Arkansas
extrusion facility, purchase the Lowell, Arkansas plastic facility, pay issuance fees, and provide
limited capital for further expansion. The obligations are secured by substantially all of the
Companys real estate assets and personal property, although provision is made for the Company to
incur additional working capital lines of credit (subject to compliance with financial covenants)
that would be secured by accounts receivable and inventory on a basis senior to the existing
obligations. In addition, there is a $4 million personal guarantee from Marjorie S. Brooks, the
major shareholder. Note 5: Stockholders Equity Preferred Stock 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 in 1998. 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. The Company has
reserved 6,079,989 shares of Class A common stock for conversion under the preferred stock
agreement. During 2002, 140 shares of the Series A preferred stock was converted into 116,667
shares of Class A common stock. The Company converted $276,000 and $215,518 of accrued premiums to
common stock in 2004 and 2003, respectively. These transactions are considered non-cash financing
activities for statement of cash flow purposes. On the 7th
anniversary date of the issuance of preferred stock (November 2005), 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 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. F-16




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##### Table of Contents



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. Common Stock 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 14,890,867 shares of the Companys Class A common stock for issuance
under the following warrant agreements. Class C Warrants In June 1993, 650,000 detachable Class C Warrants were issued to Marjorie S. Brooks, an officer
and director of the Company, and four other individuals, in connection with the issuance of bridge
notes in the amount of $650,000. 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 were set to expire in June 2003, but the
expiration date was extended to June 2005. Class F Warrants In May 1994, the Company completed a private placement offering at market price to certain
bridge note holders and affiliated stockholders, including Marjorie S. Brooks, an officer and
director of the Company. As part of the private placement, 3,468,400 shares of Class A common
stock, 3,468,400 Class F Warrants, and 3,468,400 Class G Warrants (see below) were issued. Net
offering proceeds of approximately $2,065,000 consisted of $2,020,000 conversion of debt and
accrued interest and $45,000 in cash. 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 were
set to expire in June 2004, but the expiration date was extended to June 2006. The Warrants 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 were set to
expire in June 2004, but the expiration date was extended to June 2006. The Warrants are
exercisable at a price of $0.92 per share of Class A common stock for each Class G Warrant
exercised. See paragraph above for additional information on the original issuance of the Class G
Warrants. Class H Warrants In 1995, in connection with a note payable to Marjorie S. Brooks and accounts payable to a
company controlled by her (see Note 3), 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 F-17




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##### Table of Contents



value of the Companys Class A common stock on the date of such advances. The warrants were
exercisable at prices from $0.39 to $0.49 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 $0.49 per share, resulting in proceeds of $100,000. The remaining 1,771,792 Class H
Warrants were set to expire in February 2005, but the expiration date was extended to February
2007. The Warrants are exercisable at prices from $0.46 to $0.48 per share of Class A common stock
for each Class H Warrant exercised. 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 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. In 1999, 321,111 Class I Warrants
were extended to June 22, 2003, and have since been extended to June 22, 2005. The following table sets forth the exercises of Class I Warrants and the proceeds received for
those exercises: Class I
    
    
    
    
    
    
    
    
    Class IWarrants
    
    
    Range of exercise
    
    Proceeds
    
    
    Warrantsexercised
    
    
    prices
    
    received
    
    
    expired2004
    
    
    116,249
    
    
    $0.31 to $1.125
    
    $
    79,469
    
    
    
    2002
    
    
    95,107
    
    
    $0.31 to $1.125
    
    
    62,881
    
    
    
    2001
    
    
    56,727
    
    
    $0.31 to $1.125
    
    
    34,548
    
    
    
    1999
    
    
    29,367
    
    
    $0.9375
    
    
    27,532
    
    
    
    42,866
 X and Y Warrants Issued in Connection with Preferred Stock The preferred stock carries a series of X and Y Warrants, which are exercisable at $1.20 and
$2.50 per share. In connection with the 2,900 preferred shares, the Company issued 2,416,665 X
Warrants and 1,021,269 Y Warrants. Each of the warrants has cashless exercise
features that are based on various conversion amounts and terms. The expiration date of the
warrants was extended from November 2005 to November 2007. In 2002, 1,000 Series X Warrants were
exercised at $1.20, resulting in proceeds of $1,200. F-18




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##### Table of Contents



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 were originally
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 were originally 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. The
exercise period for both the Series X and Series Y Warrants was extended by two years. 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 June 22, 2003, and later extended to June 22, 2005,
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 1997 and 1998, the Company obtained bridge financing of $3.2 million (see Note 4). In
connection with the financing, 6,314,926 Consulting warrants and 378,895 Placement warrants were
issued at an exercise price of $0.375. The expiration dates for all warrants were extended by two
years in 2002. Since the issuance of the warrants, 2,918,668 Consulting warrants and all of the
Placement warrants have been exercised, as shown in the table below, leaving 3,396,258 Consulting
warrants outstanding at December 31, 2004. Year
    
    Consulting
    
    
    PlacementExercised
    
    Warrants
    
    
    Warrants2004
    
    
    1,573,333
    
    
    
    2003
    
    
    
    
    
    
    9,4002002
    
    
    416,667
    
    
    
    195,605Prior to 2002
    
    
    928,668
    
    
    
    173,8902,918,668
    
    
    
    378,895
 F-19




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##### Table of Contents



The number of Consulting warrants outstanding and their current expiration dates are shown in
the following table. Consulting
    

    ExpirationWarrants
    

    Date1,441,332
    
    
    
    02/05/05760,000
    
    
    
    04/06/05619,926
    
    
    
    06/03/05575,000
    
    
    
    08/21/053,396,258
 Extension Warrants In connection with the extension of the October 30, 1997 bridge financing, 310,000 extension
warrants were issued. The stock warrants were originally to expire on November 5, 2003, but the
expiration date was extended to November 5, 2005, and is 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 were originally to expire on November 12, 2003, but
the expiration date was extended to November 12, 2005. At December 31, 2004, the Company had outstanding warrants as follows: Warrants Outstanding
    
    
    Weighted
    
    
    
    
    
    
    Warrantsfor Class A
    
    
    Average
    
    
    Expiration
    
    
    ExercisedCommon Stock
    
    
    Exercise Price
    
    
    Date
    
    
    in 2004Class C warrants
    
    
    325,000
    
    
    $
    1.08
    
    
    
    06/15/05
    
    
    
    Class F warrants
    
    
    987,040
    
    
    
    0.61
    
    
    
    06/06/06
    
    
    
    Class G warrants
    
    
    2,987,040
    
    
    
    0.92
    
    
    
    06/06/06
    
    
    
    Class H warrants
    
    
    1,771,792
    
    
    
    0.47
    
    
    
    02/21/07
    
    
    
    Class I warrants
    
    
    64,139
    
    
    
    0.94
    
    
    
    06/22/05
    
    
    
    116,249Series X warrants
    
    
    1,998,165
    
    
    
    1.20
    
    
    
    11/10/07
    
    
    
    Series Y warrants
    
    
    867,500
    
    
    
    2.50
    
    
    
    11/10/07
    
    
    
    Series X warrants  Placement Agent
    
    
    417,500
    
    
    
    1.20
    
    
    
    11/10/07
    
    
    
    Series Y warrants  Placement Agent
    
    
    153,769
    
    
    
    2.50
    
    
    
    11/10/07
    
    
    
    Bonus warrants
    
    
    1,312,664
    
    
    
    3.00
    
    
    
    06/22/05
    
    
    
    Consulting warrants
    
    
    1,441,332
    
    
    
    0.38
    
    
    
    02/05/05
    
    
    
    1,573,333Consulting warrants
    
    
    760,000
    
    
    
    0.38
    
    
    
    04/06/05
    
    
    
    Consulting warrants
    
    
    619,926
    
    
    
    0.38
    
    
    
    06/03/05
    
    
    
    Consulting warrants
    
    
    575,000
    
    
    
    0.38
    
    
    
    08/21/05
    
    
    
    Extension warrants
    
    
    310,000
    
    
    
    0.38
    
    
    
    11/05/05
    
    
    
    Series Z Placement warrants
    
    
    300,000
    
    
    
    1.00
    
    
    
    11/12/05
    
    
    
    Totals
    
    
    14,890,867
    
    
    $
    1.05
    
    
    
    
    
    
    
    1,689,582
 Effective June 30, 2001, the Company adopted Financial Accounting Standards Board SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities(SFAS 133), with no effects on
its financial statements except for F-20




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##### Table of Contents



warrants that are indexed to and potentially settled in the Companys common stock, which includes
all of the Companys warrants. These warrants have been accounted for under the provisions of
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). The Company modified certain
of its warrant related registration rights agreements as of June 30, 2001, so that those warrants
would be classified as equity rather than debt in its balance sheet under the provisions of EITF
00-19. As a result of these modifications, there was no impact on earnings. In accounting for its derivative contracts at June 30, 2001, the Company recorded $8,419,345
in warrants outstanding in the equity section of its balance sheet and decreased its additional
paid-in capital by the same amount, leaving its total stockholders equity amount unaffected. The
warrant valuation was determined as of June 30, 2001 using the Black-Scholes option-pricing model,
with the following details and assumptions. The underlying stock price was $0.87. Exercise prices
of the warrants ranged from $0.31 to $3.00. The volatility of the stock underlying the warrants
ranged from 46.42% to 87.27%, and the risk-free rates of return ranged from 3.63% to 4.82%. Note 6: 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 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 1994 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.
This plan provided for a grant of options to purchase up to 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 F-21




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##### Table of Contents



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. A summary of the activity in the Companys stock option plans during the years ended December
31, 2004, 2003 and 2002, follows: 2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceOutstanding,
beginning of year
    
    
    5,742,630
    
    
    $
    1.01
    
    
    
    5,667,630
    
    
    $
    1.00
    
    
    
    5,190,130
    
    
    $
    0.93Granted
    
    
    175,000
    
    
    
    1.22
    
    
    
    215,000
    
    
    
    1.13
    
    
    
    530,000
    
    
    
    1.72Exercised
    
    
    (837,400
    )
    
    
    0.76
    
    
    
    (95,000
    )
    
    
    0.52
    
    
    
    
    
    
    
    Forfeited
    
    
    (485,000
    )
    
    
    1.06
    
    
    
    (45,000
    )
    
    
    1.03
    
    
    
    (52,500
    )
    
    
    1.00Outstanding, end of
year
    
    
    4,595,230
    
    
    $
    1.06
    
    
    
    5,742,630
    
    
    $
    1.01
    
    
    
    5,667,630
    
    
    $
    1.00Exercisable, end of
year
    
    
    4,395,230
    
    
    $
    1.02
    
    
    
    5,215,130
    
    
    $
    0.92
    
    
    
    4,840,130
    
    
    $
    0.87
 The following table summarizes information about stock options outstanding under the
Companys stock option plans as of December 31, 2004: Options Outstanding
    
    
    Options ExercisableNumber
    
    
    Wtd. Avg.
    
    
    Wtd. Avg.
    
    
    Number
    
    
    Wtd. Avg.Range of Exercise
    
    Outstanding
    
    
    Remaining
    
    
    Exercise
    
    
    Exercisable
    
    
    ExercisePrices
    
    at 12/31/04
    
    
    Contract Life
    
    
    Price
    
    
    at 12/31/04
    
    
    Price$0.38-$0.48
    
    
    780,267
    
    
    1.89 years
    
    $
    0.44
    
    
    
    780,267
    
    
    $
    0.44$0.56-$1.00
    
    
    1,923,963
    
    
    2.77 years
    
    $
    0.66
    
    
    
    1,923,963
    
    
    $
    0.66$1.10-$1.34
    
    
    783,500
    
    
    5.43 years
    
    $
    1.18
    
    
    
    683,500
    
    
    $
    1.19$1.75-$2.75
    
    
    1,107,500
    
    
    2.63 years
    
    $
    2.10
    
    
    
    1,007,500
    
    
    $
    2.044,595,230
    
    
    3.04 years
    
    $
    1.06
    
    
    
    4,395,230
    
    
    $
    1.02
 The weighted-average fair value of options granted during 2004, 2003 and 2002 was $0.93,
$0.98, and $1.19, respectively. F-22




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##### Table of Contents



Note 7: Leases At December 31, 2004, the Company was obligated under various operating leases covering
certain buildings and equipment. Rent expense under operating leases for the years ended December
31, 2004, 2003, and 2002 was $2,053,051, $1,602,788, and $958,883, respectively. These amounts for
rent expense are considerably higher than the future minimum lease payments shown in the table below
due to many of our operating equipment leases having a duration of less than one year. Future minimum lease
payments required under operating equipment leases as of December 31, 2004, are as follows: Year
    
    Amount2005
    
    $
    797,1462006
    
    
    641,3522007
    
    
    580,5242008
    
    
    435,1262009
    
    
    163,940Total minimum payments required
    
    $
    2,618,088
 Note 8: 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. As of December 31, 2004, the Company had net operating loss carryforwards of approximately
$25 million for federal income tax purposes, which are available to reduce future taxable income
and will expire in 2008 through 2019, if not utilized. The tax effects of significant temporary differences representing deferred tax assets and
liabilities are as follows: Year Ended December 31,2004
    
    
    2003
    
    
    2002Deferred tax assetsNet operating loss carryforwards
    
    $
    8,794,000
    
    
    $
    7,637,000
    
    
    $
    8,464,000Valuation allowance
    
    
    (8,121,000
    )
    
    
    (7,567,000
    )
    
    
    (7,551,000
    )Total deferred tax assets
    
    
    673,000
    
    
    
    70,000
    
    
    
    913,000Deferred tax liabilityDepreciation
    
    
    673,000
    
    
    
    70,000
    
    
    
    913,000Net deferred tax
    
    $
    
    
    
    $
    
    
    
    $
    
 As the Company generated net operating losses from its inception through 2000 and there is no
assurance of the Companys ability to generate adequate future taxable income to enable the Company
to realize these carryforwards prior to expiration, a valuation allowance of approximately $8.1
million has been established at December 31, 2004, 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. The income tax provision for each year differs from the amount computed by applying
the US Federal statutory rate of 34% to income before income taxes due primarily to changes in the valuation allowance. F-23




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##### Table of Contents



Note 9: Extraordinary Item On March 28, 2003, the Company had an accidental fire at the Junction, Texas plant. The
Company was given permission to begin demolition and the rebuilding of a portion of the production
facility in April 2003. The initial restoration project, completed in May 2003, included the
rebuild of one extrusion line that had been partially damaged, electrical system replacement, and
roof replacement. The rebuild of the second extrusion line was completed in April 2004. The
Junction plant is fully insured for fire damage and business interruption. Through December 31,
2004 and 2003, the Company had received $6.0 million and
$5.4 million, respectively, in insurance proceeds related to this incident. Due to the Junction facility fire, gross assets were written down by approximately $4.91
million, along with the associated accumulated depreciation on those assets in the amount of $3.96
million, resulting in a net book value decrease in assets of about
$950,000. At December 31, 2004 and 2003, approximately $6.4 million and $3.9 million, respectively, had been invested in reconstructing the Junction facility. Insurance
proceeds received to reimburse costs incurred to reconstruct the facility resulted in gains of
$173,536 and $2,962,041 for the years ended December 31, 2004 and 2003, respectively. Additionally, the Company recorded $11,213 in
business interruption insurance during 2004, including $8,720 to replace lost income and $2,493 to
cover fixed expenses.
During 2003, the Company recorded $1,366,682 in business
interruptions insurance, including $1,125,372 to replace lost income
and $241,310 to cover fixed expenses. At December 31, 2003,
approximately $484,000 was included in accounts receivable for expected insurance reimbursements. Note 10: Commitments and Contingencies The Company was sued in May 2000, in a federal action in the Western District of Texas, for
breach of contract seeking royalties allegedly owed but unpaid from a 1987 settlement of prior
litigation against a predecessor entity and two of our founders in the United States District Court
for the Western District. The plaintiffs were seeking approximately $1.2 million in past
royalties, plus attorneys fees, any applicable pre-judgment and post-judgment interest, and a
declaration that the Company pay an ongoing royalty in the amount of $10 per ton on future sales
from the Companys Junction, Texas facility on production utilizing cedar fiber and recycled
plastic. In 2001, the plaintiffs amended the complaint to include two of our founders as
co-defendants. At trial, the plaintiffs obtained a judgment for past royalties in the amount of
approximately $821,000, plus prejudgment and post-judgment interest and attorneys fees. The
Company settled the lawsuit in December 2002 for $1,100,000. The court, in May 2002, declined to
enter a declaratory judgment requested by the plaintiff requiring the Company to pay a royalty on a
monthly basis in the future on the Companys products, and the release executed in connection with
the December 2002 settlement does not release any potential claims for royalties after January 1,
2002. As to the requested declaratory judgment, the court noted that the plaintiffs had not
properly sought a declaratory judgment from a procedural standpoint and also took note that the
changes to the initial process developed over the years by the Company have brought the Companys
manufacturing operations farther away from the plaintiffs technology. The Company
has been sued by certain underwriters at Lloyds, London (Lloyds) in connection with a
pending final settlement of our Junction, Texas fire claim. Lloyds filed suit January 19, 2005 in the Circuit Court of Washington County, Arkansas
seeking a declaratory judgment that they are not liable to reimburse us for certain costs of
rebuilding the AERT Junction, Texas facility. Lloyds alleges that the Company did not rebuild the facility
exactly as it had existed prior to the March 2003 fire and that the Company committed fraud in seeking
reimbursement for alleged improvements made to the facility. Lloyds also seeks to retroactively
cancel its portion of the insurance policy. The filing was unexpected because management believes the Company has
cooperated fully with the claims underwriting process and negotiations toward a final settlement of
the claim were progressing. Management believes the Lloyds
lawsuit is without merit. The Company filed a counterclaim on January 24, 2005
denying all of Lloyds allegations and seeking immediate and full reimbursement for rebuilding of
the Junction plant. The Company seeks to recover actual damages in the amount of at least $1.8 million plus
attorney and court fees and punitive damages for acts of bad faith committed by Lloyds.
No amount has been recorded in connection with this claim. F-24




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##### Table of Contents



Note 11: 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, 2004, the Company does not have available discrete financial information to
disclose gross margin by product line. All operating expenses are allocated primarily on capacity.
Corporate overhead is not allocated by product line, neither are selected assets. Net sales
segregated by product line and gross margin by plant location are as follows: Year Ended December 31,2004
    
    
    2003
    
    
    2002Net Sales Commercial and
residential decking
surface
components
    
    $
    51,885,985
    
    
    $
    35,646,315
    
    
    $
    33,996,864Exterior door,
window, and housing
trim
components
    
    
    11,592,307
    
    
    
    7,418,157
    
    
    
    7,058,653Industrial
flooring
    
    
    158,993
    
    
    
    456,091
    
    
    
    359,949$
    63,637,285
    
    
    $
    43,520,563
    
    
    $
    41,415,466
 F-25




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##### Table of Contents



Year Ended December 31,2004
    
    
    2003
    
    
    2002Springdale
    
    
    Junction
    
    
    Springdale
    
    
    Junction
    
    
    Springdale
    
    
    JunctionGross Margin Net revenues
    
    $
    47,902,106
    
    
    $
    15,735,179
    
    
    $
    34,203,234
    
    
    $
    9,317,329
    
    
    $
    26,901,808
    
    
    $
    14,513,658Cost of goods sold
    
    
    35,883,623
    
    
    
    13,079,543
    
    
    
    26,779,482
    
    
    
    7,582,502
    
    
    
    18,851,046
    
    
    
    10,949,893Gross margin
    
    $
    12,018,483
    
    
    $
    2,655,636
    
    
    $
    7,423,752
    
    
    $
    1,734,827
    
    
    $
    8,050,762
    
    
    $
    3,563,765
 Note 12: 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-deferred 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. The Company has never made any matching or profit sharing
contributions to the Plan. F-26




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##### Table of Contents



INDEX TO EXHIBITS Exhibit No.
    
    Description of Exhibit3.1
    
    Certificate of Incorporation, including Certificate of Amendment filed
on June 12, 1989 (a), and Certificate of Amendment filed on August 22,
1989. (b)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)4.8
    
    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)10.18
    
    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)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)




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##### Table of Contents



Exhibit No.
    
    Description of Exhibit10.36
    
    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)10.41
    
    Indenture of Trust between City of Springdale and Regions Bank,
Trustee, as of October 1, 2003. (r)10.42
    
    Mortgage and Loan Agreement between City of Springdale and Company,
as of October 1, 2003.(r)10.43
    
    Assignment of Mortgage and Loan Agreement between City of Springdale
and Regions Bank.(r)10.44
    
    Note Purchase Agreement between Company and Allstate Insurance Company
dated October 9, 2003.(r)10.45
    
    Promissory Note made by Company dated October 9, 2003.(r)10.46
    
    Wood-Plastic Composite Decking Agreement (s)23.1
    
    Accountants consent**31.1
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350, by the Companys chairman, co-chief
executive officer and president. **31.2
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350, by the Companys co-chief executive
officer. **31.3
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350, by the Companys chief financial officer.
**32.1
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350, by the Companys chairman, co-chief
executive officer and president. **32.2
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350, by the Companys co-chief executive
officer. **32.3
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350, by the Companys chief financial officer.
**
   *
    
    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.(q)
    
    Filed with Form 10-K for December 31, 2002.(r)
    
    Filed with Form 10-Q for September 30, 2003.(s)
    
    Filed with Form 8-K on October 15, 2004 for October 12, 2004.