##### Table of Contents



UNITED
    STATES SECURITIES AND EXCHANGE COMMISSIONWashington, 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, 2006
  Commission file number 1-10367
  Advanced Environmental
    Recycling Technologies, Inc.
 (Exact name of Registrant as
    specified in its charter)
  Delaware

71-0675758(State of
    Incorporation)

(I.R.S. Employer
    Identification No.)914 N Jefferson Street
    Post Office Box 1237
    Springdale, Arkansas

72764(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
  o þ
  o þ
  þ o
  Regulation S-K Form 10-K Form 10-K. þ
  Rule 12b-2
  o þ o
  Rule 12b-2 o þ
      Class A  44,812,956;
    Class B  1,465,530
  DOCUMENTS INCORPORATED BY REFERENCE




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##### 



Table of
    Contents
  PageNo.Part IItem 1.

Business


1Item 1A.

Risk
    Factors


7Item 1B.

Unresolved Staff
    Comments


8Item 2.

Properties


8Item 3.

Legal
    Proceedings


9Item 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.


13Item 7A.

Quantitative and
    Qualitative Disclosures About Market Risk


22Item 8.

Financial
    Statements and Supplementary Data


23Item 9.

Changes in and
    Disagreements With Accountants on Accounting and Financial
    Disclosure


23Item 9A.

Controls and
    Procedures


23Item 9B.

Other
    Information


25Part IIIItem 10.

Directors,
    Executive Officers and Corporate Governance


25Item 11.

Executive
    Compensation


29Item 12.

Security Ownership
    of Certain Beneficial Owners and Management and Related
    Stockholder Matters


29Item 13.

Certain
    Relationships and Related Transactions, and Director
    Independence


29Item 14.

Principal
    Accounting Fees and Services


29Part IVItem 15.

Exhibits and
    Financial Statement Schedules


29Signatures


30Index to Financial
    Statements


F-1Accountant's ConsentSection 302 CertificationSection 302 CertificationSection 302 CertificationSection 906 CertificationSection 906 CertificationSection 906 Certification   i




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##### Table of Contents



Item 1.
    Business.  Summary
  ® ® ® ® ® ® ® tm ®
  Products
    
    Commercial and residential decking planks and accessories such
    as balusters and handrails (MoistureShield and Weyerhaeuser
    ChoiceDek),
    Exterior door and window components,
    Exterior housing trim (MoistureShield), and
    Fence boards    
    Unlike wood, our products do not require preservatives or
    treatment with toxic chemicals nor do they require yearly water
    sealing or staining.
    Our products are less subject to thermal contraction or
    expansion and have greater dimensional stability than competing
    all-plastic products.
    Our products are engineered for superior moisture-resistance and
    will not swell or expand like wood.
    Our products can be designed and extruded through dies to a
    desired shape in accordance with customer specifications, which
    helps the customer to minimize waste.
    Our products are less subject to rotting, cracking, warping, and
    splintering, insect infestation and water absorption than
    conventional wood materials.
    Our products can be aesthetically enhanced 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.
    Our products can be combined with coloring agents
    and/or other
    additives to provide different colors and aesthetics. 1




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Marketing
    and Sales
  General Market Strategy. and/or
  Outdoor Decking Systems.
       2




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##### Table of Contents



tm
    Privacy Fencing Systems. tm
  Door and Window Products.
    Exterior Trim and Fascia Products. start-up
  Sales and Customer Service.
 3




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##### Table of Contents



Cyclical Nature of Building Products
    Industry. and/or
  Product Innovation.
  Raw
    Materials
  Wood Fiber. over-the-road
    Recycled Plastics.
  
    Low density polyethylene (LDPE) poly coatings or linings from
    recycled bleached food-board, which are generated from the
    hydro-pulping process;
    High density polyethylene (HDPE) and linear low density
    polyethylene (LLDPE) mixed plastic grocery bags from supermarket
    and store collection programs;
    HDPE ground container material;
    LLDPE stretch film from warehouses and packing waste; and
    Virgin HDPE and LDPE pellets.     4




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##### Table of Contents




    As world political events conspired to raise the price of
    petroleum there was a related rise in the price of virgin
    plastic, which is a petroleum and natural gas derivative. This
    in turn increased the demand for scrap plastics since scrap can
    be substituted for virgin plastics in many manufacturing
    applications. We thus began competing with scrap plastic
    consumers that had not previously been in the market.
    The relative decline in the value of the dollar versus major
    Asian currencies has made it economical for Asian manufactures
    to source scrap plastic in the U.S. for use in their
    countries. We have thus encountered significant competition for
    scrap plastics from foreign consumers that had not previously
    been a factor in the market. Demand for petrochemical products
    from China, India and other rapidly expanding economies is
    expected to increase.
    As annual sales of wood composite decking products have grown,
    we and other composite decking manufacturers have become
    relatively large consumers of scrap plastics, which has created
    increasing competition for raw materials and driven up prices.    Supply Contracts.
  Competition for Raw Materials.
  Patented
    and Proprietary Technology
  on-site
   5




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##### Table of Contents



Industry
    Standards
    Regulation
      Competition
  Competition for Sales.
        Employees
  and/or
 6




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##### Table of Contents



and/or time-to-time,
  Item 1A.
    Risk
    Factors.    We
    have a working capital deficit
    We may
    be unable to secure an adequate quantity and quality of raw
    materials at economical prices
    The
    loss of one or more of our key customers could cause a
    substantial reduction in our revenues and profits
    If we
    are unable to comply with certain debt covenants, our financial
    position and operations could be adversely
    affected
    Restrictions
    regarding increased manufacturing capabilities could restrain
    our business growth
   7




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##### Table of Contents



Our
    growth is limited by the availability of human capital
    resources
    Declines
    in construction activity may adversely affect our
    business
    Fire
    disruptions may adversely affect our business
    Covenants
    in our bond agreements could restrict our ability to borrow,
    which could impair the improvement and expansion of our
    operations
  day-to-day
  Future
    sales of shares could be dilutive and impair our ability to
    raise capital
    Item 1B.
    Unresolved
    Staff Comments.    Item 2.
    Properties.     8




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##### Table of Contents



ten-acres
    seven-acre
              Item 3.
    Legal
    Proceedings.  Lloyds
    of London
   9




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##### Table of Contents



Advanced
    Control Solutions
    Other
    Matters
    Item 4.
    Submission
    of Matters to a Vote of Security Holders.   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.
  High


LowSales Price Range of
    Class A Common StockFiscal 2005First Quarter

$
1.85


$
1.25Second Quarter


1.59



1.21Third Quarter


1.74



1.19Fourth Quarter


1.79



1.25Fiscal 2006First Quarter


2.56



1.58Second Quarter


3.71



1.95Third Quarter


3.32



2.10Fourth Quarter


2.37



1.48    11




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##### Table of Contents



Item 6.
    Selected
    Financial Data.  Managements Discussion and Analysis of
    Financial Condition and Results of Operations.
  Year Ended December 31,2006


2005


2004


2003


2002Statements of Operations
    Data:Net sales

$
97,840,126


$
87,312,560


$
63,637,285


$
43,520,563


$
41,415,466Income (loss) before extraordinary
    gain, accrued premium on preferred stock and income taxes


968,585



3,583,370



1,369,983



(665,921
)


1,193,333Accrued premium on preferred stock






(235,367
)


(276,000
)


(276,000
)


(278,083
)Income (loss) before extraordinary
    gain and income taxes


968,585



3,348,003



1,093,983



(941,921
)


915,250Net income tax benefit


835,937



4,449,682











Income (loss) before extraordinary
    gain


1,804,522



7,797,685



1,093,983



(941,921
)


915,250Extraordinary gain










173,536



2,962,041



Net income applicable to common
    stock

$
1,804,522


$
7,797,685


$
1,267,519


$
2,020,120


$
915,250Net income (loss) per common share
    before extraordinary gain(1) (Basic)

$
0.04


$
0.22


$
.03


$
(.03
)

$
.03Net income (loss) per common share
    before extraordinary gain(1) (Diluted)

$
0.04


$
0.19


$
.03


$
(.03
)

$
.02Extraordinary gain per common
    share (Basic)









$
.01


$
.10



Extraordinary gain per common
    share (Diluted)









$
.00


$
.10



Net income per common share after
    extraordinary gain (Basic)

$
0.04


$
0.22


$
.04


$
.07


$
.03Net income per common share after
    extraordinary gain (Diluted)

$
0.04


$
0.19


$
.03


$
.07


$
.02Weighted average number of shares
    outstanding (Basic)


41,990,150



35,861,060



31,815,067



30,017,661



29,516,768Weighted average number of shares
    outstanding (Diluted)


45,881,498



40,475,244



41,070,289



30,017,661



42,665,451Balance Sheet Data:Working capital deficit

$
3,466,130


$
687,039


$
3,470,971


$
1,915,695


$
6,557,943Total assets


72,049,966



56,952,673



43,340,793



36,406,601



39,335,948Long-term debt less current
    maturities


16,827,717



17,010,889



15,571,068



16,659,241



4,068,210Total liabilities


44,493,361



35,835,369



31,610,279



27,458,156



33,574,481Stockholders equity


27,556,605



21,117,304



11,730,514



8,948,445



5,761,467     (1)
    
    The net income (loss) per share of common stock is based on the
    combined weighted average number of shares of Class A and
    Class B common stock outstanding during the period. See
    Note 2 to the financial statements for a reconciliation of
    the basic and diluted weighted average number of shares
    outstanding. 12




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##### Table of Contents



Item 7.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations.    2006
    Operations
  Sales
  year-over-year
  tm
  Margins
  run-up
    Current
    Business Environment
    Sales
     13




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TM
            Costs
       14




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##### Table of Contents



Longer
    Term Factors Driving Our Business
          Managements
    Focus for 2007
  
    Introduce three new ChoiceDek products and stock a minimum of
    two colors in all stores.
    Introduce our expanded MoistureShield decking product line into
    nationwide distribution by the end of the first quarter of 2008.
    Introduce LifeCycle Basics deck board and LifeCycle fencing.
    Decrease operating costs relative to sales revenue:  
    Complete modifications to our plastic blending processes to
    increase throughput and increase yield at extrusion factories
    Increase our ability to use more low cost raw materials
    More aggressive raw materials purchasing strategies
    Improve training and associate development
    Increase automation to improve yield and lower labor costs
    Streamline logistics and manufacturing operations
    Install new enterprise resource planning system to improve
    management information
    Balance sales, general and administrative overhead expenses to
    match growth rate  
    Reduce leverage and strengthen the balance sheet.   15




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##### Table of Contents



Results
    of Operations
  Three
    Year Comparison
  2006


% Change


2005


% Change


2004Net sales

$
97,840,126



12.1
%

$
87,312,560



37.2
%

$
63,637,285Cost of goods sold


77,594,965



16.9
%


66,389,964



35.6
%


48,963,166% of net sales


79.3
%


3.3
%


76.0
%


(0.9
)%


76.9
%Gross margin


20,245,161



(3.2
)%


20,922,596



42.6
%


14,674,119% of net sales


20.7
%


(3.3
)%


24.0
%


0.9
%


23.1
%Selling and administrative costs


16,407,400



12.4
%


14,595,854



31.5
%


11,099,911% of net sales


16.8
%


0.1
%


16.7
%


(0.7
)%


17.4
%Research and development


285,858



159.6
%


110,134



13.3
%


97,207Subtotal


16,693,258



13.5
%


14,705,988



31.3
%


11,197,118% of net sales


17.1
%


0.3
%


16.8
%


0.8
%


17.6
%Operating income


3,551,903



(42.9
)%


6,216,608



78.8
%


3,477,001% of net sales


3.6
%


(3.5
)%


7.1
%


1.6
%


5.5
%Other income (expense)Insurance proceeds related to lost
    income






0.0
%






(100.0
)%


8,720Net litigation contingency






(100.0
)%


(610,206
)



*


Gain (loss) on disposition of
    equipment


58,285




*


(26,122
)



*


Net interest expense


(2,641,603
)


32.3
%


(1,996,910
)


(5.6
)%


(2,115,738
)Income before extraordinary item,
    accrued premium on preferred stock and taxes


968,585



(73.0
)%


3,583,370



161.6
%


1,369,983% of net sales


1.0
%


(3.1
)%


4.1
%


1.9
%


2.2
%Accrued premium on preferred stock






(100.0
)%


(235,367
)


(14.7
)%


(276,000
)Income before extraordinary item
    and taxes


968,585



(71.1
)%


3,348,003



206.0
%


1,093,983% of net sales


1.0
%


(2.8
)%


3.8
%


2.1
%


1.7
%Net income tax benefit


835,937



(81.2
)%


4,449,682




*


% of net sales


0.9
%


(4.2
)%


5.1
%


5.1
%


0.0
%Income before extraordinary item


1,804,522



(76.9
)%


7,797,685



612.8
%


1,093,983% of net sales


1.8
%


(7.1
)%


8.9
%


7.2
%


1.7
%Extraordinary gain on involuntary
    conversion of non-monetary assets due to fire






0.0
%






(100.0
)%


173,536Net income applicable to common
    stock

$
1,804,522



(76.9
)%

$
7,797,685



515.2
%

$
1,267,519% of net sales


1.8
%


(7.1
)%


8.9
%


6.9
%


2.0
%     *
    
    Not meaningful as a percentage change 16




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##### Table of Contents



Year
    Ended December 31, 2006 Compared to Year Ended
    December 31, 2005
  Net
    Sales
    Cost of
    Goods Sold and Gross Margin
      Selling
    and Administrative Expenses
    Operating
    Income
    Net
    Income
    Year
    Ended December 31, 2005 Compared to Year Ended
    December 31, 2004
  Net
    Sales
    Cost of
    Goods Sold and Gross Margin
   17




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##### Table of Contents



Selling
    and Administrative Expenses
    Net
    Income
      Extraordinary
    Item
    Contingencies
  Liquidity
    and Capital Resources
     18




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##### Table of Contents



and/or
         19




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##### Table of Contents



December 31,2006


ComplianceBonds Payable and Allstate
    Notes Payable Debt CovenantsLong-term debt service coverage
    ratio for last four quarters of at least 2.00 to 1.00


2.01


YesCurrent ratio of not less than
    1.00 to 1.00 (as adjusted)(1)


0.95


No - WaivedDebt to equity ratio of not more
    than 3.00 to 1.00


1.09


YesNot more than 10% of accounts
    payable in excess of 75 days past invoice date


25
%

No - WaivedNot more than 20% of accounts
    receivable in excess of 90 days past invoice date


1
%

Yes     (1)
    
    The current ratio calculation was modified by the waiver to
    include the debt service reserve fund of $2,040,000 in current
    assets.  Critical
    Accounting Policies and Estimates
    Accounts
    Receivable
   20




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##### Table of Contents



Buildings
    and Equipment
    Accounting for the
    Impairment or Disposal of Long-Lived Assets
  Revenue
    Recognition
  Revenue Recognition in
    Financial Statements
    Contractual
    Obligations
    Payments Due by PeriodLess Than


1 to 3


3 to 5


More ThanTotal


1 Year


Years


Years


5 YearsLong-term debt

$
18,501,329


$
1,673,612


$
4,918,481


$
2,309,236


$
9,600,000Operating leases


8,587,614



2,308,399



3,281,659



2,237,638



759,918Total

$
27,088,943


$
3,982,011


$
8,200,140


$
4,546,874


$
10,359,918      21




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##### Table of Contents



Uncertainties,
    Issues and Risks
    Item 7A.
    Quantitative
    and Qualitative Disclosures about Market Risk.    Forward-looking
    Information
  Form 10-K
   22




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##### Table of Contents



Item 8.
    Financial
    Statements and Supplementary Data.  Summary
    Quarterly Financial Data
  2005


2006First


Second


Third


Fourth


First


Second


Third


FourthQuarter


Quarter


Quarter


Quarter


Quarter


Quarter


Quarter


QuarterNet sales

$
19,943,530


$
20,954,211


$
23,099,857


$
23,314,962


$
27,665,249


$
28,105,770


$
20,800,859


$
21,268,248Gross margin


4,319,620



4,734,626



6,266,274



5,602,076



5,954,316



8,480,538



4,132,310



1,677,997Net income


665,477



918,938



1,651,945



4,561,325



905,942



1,723,097



(305,595
)


(518,922
)Income (loss) per share (Basic)

$
0.02


$
0.03


$
0.05


$
0.12


$
0.02


$
0.04


$
(0.01
)

$
(0.01
)Income (loss) per share (Diluted)

$
0.01


$
0.02


$
0.04


$
0.11


$
0.02


$
0.04


$
(0.01
)

$
(0.01
)     Item 9.
    Changes
    in and Disagreements with Accountants on Accounting and
    Financial Disclosure.    Item 9A.
    Controls
    and Procedures.  Rules 13a-15(e) 15d-15(e)
  Managements
    Report on Internal Control Over Financial Reporting
     23




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##### Table of Contents



/s/  JOE
    G. BROOKS   Chairman, Chief Executive Officer and President
  STEPHEN
    W. BROOKS
   Vice Chairman and Chief Operating Officer
  ROBERT
    A. THAYER
   Senior Vice President and Chief Financial Officer
 24




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##### Table of Contents



Remediation
    of Material Weakness in Internal Control Over Financial
    Reporting
    Changes
    in Internal Control Over Financial Reporting
    Item 9B.
    Other
    Information.   PART III  Item 10.
    Directors,
    Executive Officers and Corporate Governance.    Name

Age

PositionJoe G. Brooks


51


Chairman, chief executive officer
    and presidentStephen W. Brooks


50


Chief operating officer and
    directorMarjorie S. Brooks


71


Secretary, treasurer and directorJ. Douglas Brooks


47


Senior vice presidentAlford Drinkwater


55


Senior vice presidentJim Precht


61


Senior vice president 
    sales and marketingRobert A. Thayer


55


Senior vice president and chief
    financial officerEric E. Barnes


33


Chief accounting officer and
    controllerJerry B. Burkett


50


DirectorEdward P. Carda


66


DirectorMelinda Davis


64


DirectorTim W. Kizer


41


DirectorSamuel L. Tony Milbank


66


DirectorSal Miwa


50


DirectorJim Robason


69


DirectorMichael M. Tull


52


Director   Joe G. Brooks
  Stephen W.
    Brooks
 25




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##### Table of Contents



Marjorie S. Brooks
  J. Douglas Brooks
  Robert A. Thayer voice-over-internet
  Alford Drinkwater waste-to-energy
  Jim Precht 32-years
  Eric E. Barnes
  Jerry B. Burkett
  Edward P. Carda 37-year
 26




---



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Melinda Davis
  Tim W. Kizer Doing Business in
    Bentonville Series
  Samuel L. Milbank
  Sal Miwa
  Jim Robason
 27




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##### Table of Contents



Michael M. Tull
            Code of
    Ethics
  Form 10-K Form 8-K
  Compliance
    with Section 16(a) of the Exchange Act
   28




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##### Table of Contents



Item 11.
    Executive
    Compensation.    Item 12.
    Security
    Ownership of Certain Beneficial Owners and Management and
    Related Stockholder Matters.    Item 13.
    Certain
    Relationships and Related Transactions, and Director
    Independence.    Item 14.
    Principal
    Accounting Fees and Services.   Part IV  Item 15.
    Exhibits
    and Financial Statement Schedules.  (a1) and (a2).
  (a3) and (c).
 29




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##### Table of Contents



SIGNATURES    ADVANCED ENVIRONMENTAL
 RECYCLING TECHNOLOGIES, INC.
  /s/  JOE
    G. BROOKS   Chairman, Chief Executive Officer and President
  STEPHEN
    W. BROOKS
   Vice Chairman and Chief Operating Officer
  ROBERT
    A. THAYER
   Senior Vice President and Chief Financial Officer
    POWER OF
    ATTORNEY
  attorney-in-fact Form 10-K attorney-in-fact
    Signature

Title

Date/s/  JOE
    G. BROOKSJoe
    G. Brooks

Chairman, Chief Executive Officer
    and president

March 16, 2007/s/  STEPHEN
    W. BROOKSStephen
    W. Brooks

Vice Chairman and Chief Operating
    Officer

March 16, 2007/s/  MARJORIE
    S. BROOKSMarjorie
    S. Brooks

Secretary, treasurer and director

March 16, 2007/s/  JERRY
    B. BURKETTJerry
    B. Burkett

Director

March 16, 2007 30




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##### Table of Contents



Signature

Title

Date/s/  EDWARD
    P. CARDAEdward
    P. Carda

Director

March 16, 2007/s/  MELINDA
    DAVISMelinda
    Davis

Director

March 16, 2007/s/  TIM
    W. KIZERTim
    W. Kizer

Director

March 16, 2007/s/  SAMUEL
    L. TONY
    MILBANKSamuel
    L. Tony Milbank

Director

March 16, 2007/s/  SAL
    MIWASal
    Miwa

Director

March 16, 2007/s/  JIM
    ROBASONJim
    Robason

Director

March 16, 2007/s/  MICHAEL
    M. TULLMichael
    M. Tull

Director

March 16, 2007  31




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##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  INDEX
    TO FINANCIAL STATEMENTS
  PageFinancial Statements:Reports of
    Independent Registered Public Accounting Firm


F-2-F-4Balance
    Sheets


F-5Statements of
    Operations


F-6Statements of
    Stockholders Equity


F-7Statements of Cash
    Flows


F-8Notes to Financial
    Statements


F-9-F-30  F-1




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM           Internal ControlIntegrated Framework Internal ControlIntegrated Framework
  
    F-2




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
     Internal Control  Integrated
    Framework
         F-3




---



##### Table of Contents



Internal
    ControlIntegrated Framework Internal ControlIntegrated
    Framework
  
    F-4




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  BALANCE
    SHEETS
  December 31,


December 31,2006


2005ASSETSCurrent assets:Cash and cash equivalents

$
2,164,532


$
1,748,023Restricted cash


787,191



668,344Trade accounts receivable, net of
    allowance of $374,894 at December 31, 2006 and $420,319 at
    December 31, 2005


3,789,302



2,865,386Other accounts receivable


760,970



128,315Inventories


14,515,845



9,748,743Prepaid expenses


1,018,657



706,301Deferred tax asset


1,163,017



2,036,962Total current assets


24,199,514



17,902,074Land, buildings and equipment:Land


1,988,638



1,986,033Buildings and leasehold improvements


5,979,223



5,717,054Machinery and equipment


39,475,682



35,647,614Transportation equipment


1,243,556



970,204Office equipment


801,231



770,803Construction in progress


14,762,153



8,997,22364,250,483



54,088,931Less accumulated depreciation


26,728,540



23,002,809Net land, buildings and equipment


37,521,943



31,086,122Other assets:Deferred tax asset


4,293,912



2,597,920Debt issuance costs, net of
    accumulated amortization of $790,532 at December 31, 2006
    and $549,256 at December 31, 2005


2,814,390



3,055,666Debt service reserve fund


2,040,000



2,110,881Restricted certificate of deposit


829,961



Other assets, net of accumulated
    amortization of $392,736 at December 31, 2006 and $364,163
    at December 31, 2005


350,246



200,010Total other assets


10,328,509



7,964,477Total assets

$
72,049,966


$
56,952,673LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable  trade

$
10,861,648


$
10,508,451Accounts payable 
    related parties


494,831



3,006,306Current maturities of long-term debt


1,673,612



938,704Accrued payroll expense


575,782



668,485Litigation loss payable


655,769



655,769Other accrued liabilities


1,933,821



1,712,217Line of credit


10,060,000



Notes payable  related
    parties


1,000,000



746,775Notes payable  other


410,181



352,406Total current liabilities


27,665,644



18,589,113Long-term debt, less current
    maturities


16,827,717



17,010,889Accrued premium on convertible
    preferred stock






235,367Commitments and contingenciesStockholders equity:Class A common stock,
    $.01 par value; 75,000,000 shares authorized;43,041,164 and
    37,651,369 shares issued and outstanding at
    December 31, 2006 and 2005, respectively


430,412



376,514Class B convertible common
    stock, $.01 par value; 7,500,000 shares authorized;
    1,465,530 shares issued and outstanding at
    December 31, 2006 and 2005


14,655



14,655Warrants outstanding; 4,606,132 at
    December 31, 2006 and 9,176,242 at December 31, 2005


2,519,389



4,489,419Additional paid-in capital


37,891,274



31,340,363Accumulated deficit


(13,299,125
)


(15,103,647
)Total stockholders equity


27,556,605



21,117,304Total liabilities and
    stockholders equity

$
72,049,966


$
56,952,673    F-5




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  STATEMENTS
    OF OPERATIONS
  Year Ended December 31,2006


2005


2004Net sales

$
97,840,126


$
87,312,560


$
63,637,285Cost of goods sold


77,594,965



66,389,964



48,963,166Gross margin


20,245,161



20,922,596



14,674,119Selling and administrative costs


16,407,400



14,595,854



11,099,911Research and development


285,858



110,134



97,20716,693,258



14,705,988



11,197,118Operating income


3,551,903



6,216,608



3,477,001Other income (expense):Insurance proceeds related to lost
    income










8,720Net litigation contingency






(610,206
)


Gain (loss) on disposition of
    equipment


58,285



(26,122
)


Interest income


202,724



90,908



5,324Interest expense


(2,844,327
)


(2,087,818
)


(2,121,062
)(2,583,318
)


(2,633,238
)


(2,107,018
)Income before extraordinary item,
    accrued premium on preferred stock and income taxes


968,585



3,583,370



1,369,983Accrued premium on preferred stock






(235,367
)


(276,000
)Income before extraordinary item
    and income taxes


968,585



3,348,003



1,093,983Net income tax benefit


(835,937
)


(4,449,682
)


Income before extraordinary item


1,804,522



7,797,685



1,093,983Extraordinary gain on involuntary
    conversion of non-monetary assets due to fire










173,536Net income applicable to common
    stock

$
1,804,522


$
7,797,685


$
1,267,519Income per share of common stock
    before extraordinary item (Basic)

$
0.04


$
0.22


$
0.03Income per share of common stock
    before extraordinary item (Diluted)

$
0.04


$
0.19


$
0.03Extraordinary gain per share of
    common stock (Basic)









$
0.01Extraordinary gain per share of
    common stock (Diluted)









$
0.00Income per share of common stock
    after extraordinary item (Basic)

$
0.04


$
0.22


$
0.04Income per share of common stock
    after extraordinary item (Diluted)

$
0.04


$
0.19


$
0.03Weighted average number of common
    shares outstanding (Basic)


41,990,150



35,861,060



31,815,067Weighted average number of common
    shares outstanding (Diluted)


45,881,498



40,475,244



41,070,289    F-6




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  STATEMENTS
    OF STOCKHOLDERS EQUITY
  AdditionalPreferred Stock


Class A Common Stock


Class B Common Stock


Warrants Outstanding


Paid-in


AccumulatedShares


Amount


Shares


Amount


Shares


Amount


Number


Value


Capital


Deficit


TotalBalance 
    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 stock 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






































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
)

$
11,730,514Issuance of stock in payment of
    accrued premium on preferred stock










229,994



2,300



















273,700







276,000Exercise of stock options










387,600



3,876



















203,200







207,076Exercise of Consulting warrants










1,738,946



17,389











(2,016,332
)


(1,120,815
)


1,389,382







285,956Expiration of Consulting warrants


























(1,379,926
)


(784,532
)


784,532







Exercise of Class C warrants










325,000



3,250











(325,000
)


(96,098
)


442,223







349,375Exercise of Series X warrants










6,564



66











(6,564
)


(3,485
)


11,296







7,877Exercise of Class I warrants










21,142



211











(21,142
)


(8,220
)


24,604







16,595Expiration of Class I warrants


























(42,997
)


(13,478
)


13,478







Exercise of Series Z warrants










300,000



3,000











(300,000
)


(106,898
)


403,898







300,000Exercise of Extension warrants










310,000



3,100











(310,000
)


(183,310
)


296,460







116,250Expiration of Bonus warrants


























(1,312,664
)


(111,289
)


111,289







Conversion of preferred stock


(2,760
)


(2,760
)


2,300,000



23,000



















(20,240
)






Deferred equity compensation for
    restricted stock


































29,976







29,976Net income






































7,797,685



7,797,685Balance 
    December 31, 2005





$




37,651,369


$
376,514



1,465,530


$
14,655



9,176,242


$
4,489,419


$
31,340,363


$
(15,103,647
)

$
21,117,304Issuance of stock in payment of
    accrued premium on preferred stock










195,965



1,960



















233,407







235,367Exercise of stock options










741,000



7,410



















443,245







450,655Exercise of Class F warrants










987,040



9,870











(987,040
)


(485,637
)


1,077,861







602,094Exercise of Class G warrants










2,987,040



29,870











(2,987,040
)


(1,167,901
)


3,886,107







2,748,076Exercise of Series X warrants










478,750



4,788











(596,030
)


(316,492
)


711,704







400,000Deferred equity compensation for
    restricted stock


































198,587







198,587Net income






































1,804,522



1,804,522Balance 
    December 31, 2006





$




43,041,164


$
430,412



1,465,530


$
14,655



4,606,132


$
2,519,389


$
37,891,274


$
(13,299,125
)

$
27,556,605    F-7




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  STATEMENTS
    OF CASH FLOWS
  Year Ended December 31,2006


2005


2004Cash flows from operating
    activities:Net income applicable to common
    stock

$
1,804,522


$
7,797,685


$
1,267,519Adjustments to reconcile net
    income to net cash provided by (used in) operating activities:Depreciation and amortization


4,083,638



4,176,523



4,086,811Premium accrued on preferred stock






235,367



276,000Provisions for returns






266,793



61,319Deferred tax benefit


(822,047
)


(4,634,882
)


Extraordinary gain on involuntary
    conversion of non-monetary assets due to fire










(173,536
)(Gain) loss on disposition of
    equipment


(58,285
)


26,122



(Increase) decrease in other assets


(696,614
)


192,683



67,765(Increase) decrease in cash
    restricted for letter of credit and interest costs


(328,050
)


42,708



(224,014
)Changes in current assets and
    current liabilities


(6,202,868
)


(784,790
)


65,361Net cash provided by (used in)
    operating activities


(2,219,704
)


7,318,209



5,427,225Cash flows from investing
    activities:Purchases of land, buildings and
    equipment


(6,841,889
)


(5,907,695
)


(5,868,218
)Proceeds from disposition of
    equipment


17,400



94,596



Insurance proceeds from
    involuntary disposition of property and equipment










669,012Net cash used in investing
    activities


(6,824,489
)


(5,813,099
)


(5,199,206
)Cash flows from financing
    activities:Net borrowings on line of credit


10,060,000







Proceeds from issuance of notes


3,303,225



1,900,000



2,050,000Payments on notes


(5,861,763
)


(4,200,749
)


(3,804,520
)(Increase) decrease in cash
    restricted for payment of long-term debt


209,202



(31,417
)


(2,708
)Increase (decrease) in outstanding
    advances on factored receivables


(2,450,788
)


353,235



301,884Debt acquisition costs






(19,821
)


11,100Proceeds from exercise of stock
    options and warrants, net


4,200,826



1,163,129



1,238,550Net cash provided by (used in)
    financing activities


9,460,702



(835,623
)


(205,694
)Increase in cash and cash
    equivalents


416,509



669,487



22,325Cash and cash equivalents,
    beginning of period


1,748,023



1,078,536



1,056,211Cash and cash equivalents, end of
    period

$
2,164,532


$
1,748,023


$
1,078,536    F-8




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS
  Note 1:
    Description
    of the Company  ® ® ® ® ® ® ® tm
  Note 2:
    Summary
    of Significant Accounting Policies  Revenue
    Recognition Policy
  Revenue Recognition in
    Financial Statements
    Shipping
    and Handling
  00-10, Accounting for Shipping and Handling Fees and Costs
  Operating
    Costs
   F-9




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   Statements
    of Cash Flows
    Year Ended December 31,2006


2005


2004Receivables

$
(1,556,571
)

$
(705,900
)

$
(463,724
)Inventories


(4,767,102
)


(2,355,905
)


(3,521,570
)Prepaid expenses and other


1,257,433



1,219,421



1,151,327Accounts payable  trade
    and related parties


(1,265,529
)


835,910



1,858,857Accrued income taxes


(116,754
)


117,200



Accrued liabilities


245,655



104,484



1,040,471$
(6,202,868
)

$
(784,790
)

$
65,361Cash paid for interest

$
2,573,679


$
2,458,323


$
1,898,373Cash paid for income taxes

$
285,824


$
68,000


$
   Supplemental
    Disclosures of Non-cash Investing and Financing
    Activities
  Year Ended December 31,2006


2005


2004Notes payable for financing of
    insurance policies

$
1,569,789


$
1,339,084


$
1,158,801Accounts / notes payable for
    equipment


3,409,523



3,936,561



1,546,631Accrued premium on preferred stock
    paid with Class A common stock


235,367



276,000



276,000   Cash
    Equivalents and Restricted Cash
    Buildings
    and Equipment
     F-10




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   Accounting
    for the Impairment or Disposal of Long-Lived Assets
  Inventories
  (first-in,
  2006


2005Parts and supplies

$
2,007,535


$
1,694,867Raw materials


5,072,734



4,846,576Work in process


3,928,442



1,256,121Finished goods


3,507,134



1,951,179$
14,515,845


$
9,748,743   Other
    Assets
      December 31, 2006


December 31, 2005Gross Carrying


Accumulated


Gross Carrying


AccumulatedAmount


Amortization


Amount


AmortizationDebt issuance costs

$
3,604,922


$
790,532


$
3,604,922


$
549,256Patents


485,748



392,736



485,749



364,163$
4,090,670


$
1,183,268


$
4,090,671


$
913,419  F-11




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
    EstimatedAmortization2007

$
289,9832008


288,3312009


283,3762010


262,0942011


254,803   Accounts
    Receivable
      Earnings
    Per Share
  Earnings Per Share
    F-12




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
  2006


2005


2004Before


AfterExtraordinary


ExtraordinaryItem


ItemNet income applicable to common
    stock(A)

$
1,804,522


$
7,797,685


$
1,093,983


$
1,267,519Assumed exercise of stock options
    and warrants


6,231,993



11,160,603



18,196,164



18,196,164Application of assumed proceeds
    toward repurchase of stock at average market price


(2,340,645
)


(6,546,419
)


(8,940,942
)


(8,940,942
)Net additional shares issuable


3,891,348



4,614,184



9,255,222



9,255,222Adjustment of shares outstanding:Weighted average common shares
    outstanding


41,990,150



35,861,060



31,815,067



31,815,067Net additional shares issuable


3,891,348



4,614,184



9,255,222



9,255,222Adjusted shares outstanding(B)


45,881,498



40,475,244



41,070,289



41,070,289Net income (loss) per common
    share  Diluted(A) divided by(B)

$
0.04


$
0.19


$
0.03


$
0.03Antidilutive
    and/or
    non-exercisable options


275,000



682,500



1,256,000



1,256,000Antidilutive
    and/or
    non-exercisable warrants


1,021,269



1,021,269



2,333,933



2,333,933   and/or and/or
  Concentration
    Risk
  Credit
    Risk
    2006

2005

2004Sales (in millions)

$
81.1


$
68.5


$
54.2% of total sales


81
%


77
%


82
%   Cash and
    Cash Equivalents
   F-13




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   Disclosure
    about Fair Value of Financial Instruments
    Current assets and current liabilities
  Long-term debt
  Stock-Based
    Compensation
  Share-Based Payment Accounting for
    Stock-Based Compensation Accounting for Stock Issued to Employees
  Use of
    Estimates
    Advertising
    Costs
    Research
    and Development Costs
   F-14




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   Recent
    Accounting Pronouncements
  Inventory Costs, an Amendment of ARB No. 43,
    Chapter 4
  Exchanges of Nonmonetary Assets, an Amendment of APB Opinion
    No. 29 Accounting for Nonmonetary Transactions
  Accounting for Uncertainty
    in Income Taxes  an interpretation of FASB Statement
    No. 109 Accounting for Income Taxes.
  Fair Value Measurements
  Considering the
    Effects of Prior Year Misstatements When Quantifying
    Misstatements in Current Year Financial Statements
  The Fair Value Option for Financial Assets and Financial
    Liabilities
 F-15




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   Reclassifications
    Note 3:
    Related
    Party Transactions  Transfer
    of Receivables
      Commissions
        
    Sales commissions of $93,476 owed to Tull Sales Co., which is
    owned by Michael M. Tull, one of our directors, and director
    compensation of $3,750 owed to Mr. Tull,  
    Loan guarantee fees of $140,883, director fees of $3,750,
    equipment rental of $52,310 and miscellaneous charges of $20,216
    owed to Marjorie S. Brooks, one of our directors, or companies
    controlled by her,  
    Deferred compensation of $42,038 and
    out-of-pocket
    expenses of $15,000 owed to Joe G. Brooks, our Chairman and CEO, F-16




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   
    Director compensation of $3,750 and consulting fees of $88,000
    owed to Jim Robason, one of our directors, and
    Other items owed to related parties of approximately $31,658.  Note 4:  Line
    of Credit
    Note 5:  Notes
    Payable and Long-Term Debt
  Notes Payable 
    Related Parties
  2006

2005Notes payable to related
    parties consisted of the following at
    December 31:7% to 9.25% notes payable to
    Brooks Investment Company, which is controlled by Marjorie S.
    Brooks, an officer and director of the Company; unsecured; due
    on demand

$
1,000,000


$
746,775   Notes Payable 
    Other
  2006

2005Notes payable 
    other, consisted of the following at December 31:Various notes payable to finance
    insurance policies bearing interest at rates of 11.5% and 13.5%;
    secured by insurance policies

$
398,181


$
352,406Other


12,000



  F-17




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
  Long-term
    Debt
  2006


2005Long-term debt, less current
    maturities consisted of the following at
    December 31:7% bonds payable to Regions Bank;
    principal payable annually; interest payable semi-annually;
    subject to mandatory sinking fund redemption; secured by real
    estate and improvements, fixed assets, patents and trademarks,
    inventory, pledged revenues, and a personal guarantee on
    $4 million of the outstanding balance by Marjorie S.
    Brooks, the major shareholder; maturing on October 1,
    2017(a)

$
12,100,000


$
12,900,00019.75% 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



2,600,000Variable rate note payable bearing
    interest at the Wall Street Journal prime rate plus 1% (9.25% at
    December 31, 2006); secured by certain real estate and
    equipment purchased with proceeds from the note; maturing on
    September 28, 2009


1,925,679



1,932,000Variable rate note payable bearing
    interest at LIBOR plus 3.1% (8.4% at December 31, 2006);
    secured by equipment purchased with proceeds from the note;
    maturing on May 1, 2009


1,623,092



446,522Other


252,558



71,071Total


18,501,329



17,949,593Less current maturities


(1,673,612
)


(938,704
)Long-term debt, less current
    maturities

$
16,827,717


$
17,010,889     (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, 2006;
    however, the bond trustee waived these covenants as of
    December 31, 2006 through, and including, December 31,
    2007.    Year

Amount2007

$
1,673,6122008


1,675,3732009


3,243,1082010


1,107,8632011


1,201,373Thereafter


9,600,000$
18,501,329  F-18




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
  Note 6:
    Stockholders
    Equity  Preferred
    Stock
      Common
    Stock
    Warrants
    Class C
    Warrants
    Class F
    Warrants
   F-19




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
  Class G
    Warrants
    Class H
    Warrants
  one-for-one
  Class I
    Warrants
     F-20




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
     Class I







Class IWarrants


Range of Exercise

Proceeds


WarrantsExercised


Prices

Received


Expired2005


21,142


$0.5613 to $0.9375

$
16,596



42,9972004


116,249


$0.31 to $1.125


79,469



2002


95,107


$0.31 to $1.125


62,881



2001


56,727


$0.31 to $1.125


34,548



1999


29,367


$0.9375


27,532



42,866   Series X
    and Series Y Warrants Issued in Connection with Preferred
    Stock
    Series X
    and Series Y Warrants to Placement Agent
    Bonus
    Warrants
  one-for-one
 F-21




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   Consulting
    and Placement Warrants
    Exercised


ExpiredConsulting


Placement


Consulting


PlacementYear Exercised/Expired

Warrants


Warrants


Warrants


Warrants2005


2,016,332







1,379,926



2004


1,573,333











2003






9,400







2002


416,667



195,605







Prior to 2002


928,668



173,890







4,935,000



378,895



1,379,926



   Extension
    Warrants
    Series Z
    Placement Warrants
      WarrantsOutstanding


Weighted





Warrantsfor Class A


Average


Expiration


ExercisedCommon Stock


Exercise Price


Date


in 2006Class F warrants





$
0.61



06/06/06



987,040Class G warrants






0.92



06/06/06



2,987,040Class H warrant


1,771,792



0.47



02/21/07



Series X warrants


1,664,832



1.20



11/10/07



333,333Series Y warrants


867,500



2.50



11/10/07



Series X warrants 
    placement agent


148,239



1.20



11/10/07



262,697Series Y warrants 
    placement agent


153,769



2.50



11/10/07



Totals


4,606,132


$
1.21







4,570,110   Accounting
    for Derivative Instruments and Hedging Activities
 F-22




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##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
  00-19, Accounting for Derivative Financial Instruments Indexed to,
    and Potentially Settled in, a Companys Own Stock 00-19). 00-19.
    Note 7:
    Stock
    Option Plans  and/or Rule 16b-3
         F-23




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##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
      2006


2005


2004Weighted





Weighted





WeightedAverage





Average





AverageExercise





Exercise





ExerciseShares


Price


Shares


Price


Shares


PriceOutstanding, beginning of year


3,688,130


$
1.01



4,595,230


$
1.06



5,742,630


$
1.01Granted


















175,000



1.22Exercised


(791,000
)


0.60



(377,600
)


0.49



(837,400
)


0.76Forfeited


(25,000
)


2.00



(529,500
)


1.79



(485,000
)


1.06Outstanding, end of year


2,872,130


$
1.09



3,688,130


$
1.01



4,595,230


$
1.06Exercisable, end of year


2,872,130


$
1.09



3,638,130


$
1.01



4,395,230


$
1.02     Options Outstanding and ExercisableWtd. Avg.


Wtd. Avg.Number


Remaining


ExerciseRange of Exercise Prices

at
    12/31/06


Contract Life


Price$0.38 - $0.47


511,667



0.40 years


$
0.42$0.56 - $1.00


1,052,963



1.05 years



0.66$1.10 - $1.75


800,000



3.50 years



1.24$2.25 - $2.75


507,500



2.68 years


$
2.452,872,130



1.91 years


$
1.09     Note 8:
    Equity
    Incentive Plans  2005
    Key Associate and Management Equity Incentive Plan
   F-24




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
         Purchase Price.
  Consideration. stock-for-stock
  Vesting.
    2005
    Non-Employee Director Equity Incentive Plan
     F-25




---



##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
      Restricted Stock Awards. Form 10-K
  Termination of Participants Continuous
    Service.
    Note 9:
    Leases   F-26




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##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
        Year

Amount2007

$
2,308,3992008


1,920,1462009


1,361,5132010


1,128,0962011


1,109,542Thereafter


759,918Total minimum payments required

$
8,587,614   Note 10:
    Income
    Taxes  Accounting for Income
    Taxes.
    Year Ended December 31,2006


2005


2004Current:Federal

$
14,639


$
80,000


$
State






105,200



14,639



185,200



Deferred:Federal


(645,696
)


(4,823,917
)


State


(204,880
)


189,035



(850,576
)


(4,634,882
)


Net income tax benefit

$
(835,937
)

$
(4,449,682
)

$
      F-27




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##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
    2006


2005Amount


Percent


Amount


PercentIncome tax at the
    U.S. federal statutory rate

$
329,319



34.0


$
1,138,321



34.0Net operating loss carryforwards


(25,664
)


(2.6
)


(1,024,489
)


(30.6
)State income taxes






0.0



105,200



3.1Net reversal of valuation allowance






0.0



(4,634,882
)


(138.4
)Update estimate for 2005 deferred
    taxes


(796,907
)


(82.3
)Stock option exercises


(349,561
)


(36.1
)Other


6,876



0.7



(33,832
)


(1.0
)$
(835,937
)


(86.3
)

$
(4,449,682
)


(132.9
)     2006


2005


2004Deferred tax assets 


Current



Long-Term



Current



Long-TermNet operating loss carryforwards

$
1,394,000


$
6,068,918


$
2,036,962


$
5,193,366


$
8,794,000Alternative minimum tax credit
    carryforward






70,308







64,000



Allowance for sales returns


147,408















Accrued expenses


22,145



239,933











Valuation allowance


















(8,121,000
)Total deferred tax assets


1,563,553



6,379,159



2,036,962



5,257,366



673,000Deferred tax liability Depreciation






2,085,247







2,659,446



673,000Prepaid expenses


400,536















Total deferred tax liabilities


400,536



2,085,247







2,659,446



673,000Net deferred tax

$
1,163,017


$
4,293,912


$
2,036,962


$
2,597,920


$
    F-28




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##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   Note 11:
    Extraordinary
    Item      Note 12:
    Commitments
    and Contingencies  Lloyds
    of London
        Advanced
    Control Solutions
   F-29




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##### Table of Contents



ADVANCED
    ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
    Other
    Matters
    Note 13:
    401(k)
    Plan   F-30




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##### Table of Contents



INDEX TO
    EXHIBITS
  ExhibitNo.

Description of Exhibit3
.1

Certificate of Incorporation,
    including Certificate of Amendment filed on June 12,
    1989(a), and Certificate of Amendment filed on August 22,
    1989(b), and Certificate of Amendment filed on December 29,
    19993
.2

Certificate of Designation of
    Class B common stock.(a)3
.3

Bylaws of Registrant.(a)3
.4

Form of Class A common stock
    Certificate.(c)4
.2.1

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.(j)4
.15

Form of Class J Warrant
    Certificate.(j)4
.16

Form of Class K Warrant
    Certificate.(j)10
.1

Private Placement Agreement.(l)10
.2

Consulting Agreement.(l)10
.3

Note Purchase Agreement.(l)10
.4

Form of Notes.(l)10
.5

Form of Private Placement
    Warrants.(l)10
.6

Form of Consulting Warrants.(l)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.(g)10
.21

Private Placement Distribution
    Agreement dated September 23, 1993 between the Registrant
    and Berkshire International Finance, Inc.(g)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.(k)10
.33

Securities Purchase Agreement.(m)10
.34

Certificate of Designation of
    Series A Preferred Convertible Stock.(m)10
.35

Certificate of Designation of
    Series B Preferred Convertible Stock.(m)




---



##### Table of Contents



ExhibitNo.

Description of Exhibit10
.36

Certificate of Designation of
    Series C Preferred Convertible Stock.(m)10
.37

Form of Series X Warrants.(m)10
.38

Form of Series Y Warrants.(m)10
.39

Registration Rights Agreement.(m)10
.40

Placement Agency Agreement.(m)10
.41

Indenture of Trust between City of
    Springdale and Regions Bank, Trustee, as of October 1,
    2003.(n)10
.42

Mortgage and Loan Agreement
    between City of Springdale and Company, as of October 1,
    2003.(n)10
.43

Assignment of Mortgage and Loan
    Agreement between City of Springdale and Regions Bank.(n)10
.44

Note Purchase Agreement
    between Company and Allstate Insurance Company dated
    October 9, 2003.(n)10
.45

Promissory Note made by Company
    dated October 9, 2003.(n)10
.46

Wood-Plastic Composite Decking
    Agreement between AERT and Weyerhaeuser Company, et al.
    effective October 12, 2004.* (Redacted in accordance with
    confidential treatment request, as filed October 18,
    2005)(o)(p)10
.46.1

Wood-Plastic Composite Decking
    Agreement between AERT and Weyerhaeuser Company, et al.
    effective October 12, 2004.* (Redacted in accordance with
    confidential treatment request, as filed October 15,
    2005)(q)10
.47

Loan Agreement.(r)10
.48

Promissory Note.(r)10
.49

Loan Agreement.(s)10
.50

Promissory Note.(s)23
.1

Consent of Independent Registered
    Public Accounting Firm.***31
.1

Certification per Sarbanes-Oxley
    Act of 2002 (Section 302) by the Companys
    chairman, chief executive officer and president.***31
.2

Certification per Sarbanes-Oxley
    Act of 2002 (Section 302) by the Companys chief
    operating officer.***31
.3

Certification per Sarbanes-Oxley
    Act of 2002 (Section 302) by the Companys chief
    financial officer.***32
.1

Certification per Sarbanes-Oxley
    Act of 2002 (Section 906) by the Companys
    chairman, chief executive officer and president.***32
.2

Certification per Sarbanes-Oxley
    Act of 2002 (Section 906) by the Companys chief
    operating officer.***32
.3

Certification per Sarbanes-Oxley
    Act of 2002 (Section 906) by the Companys chief
    financial officer.***     *
    
    Confidential treatment was granted by the Securities and
    Exchange Commission for certain portions of this agreement. The
    confidential portions were filed separately with the Commission.The Registrant has no exhibits corresponding to
    Exhibits 1, 2, 5, 6, 7, 8, 9, 11,
    through 23, or 26 through 29.***
    
    Filed herewith.(a)
    
    Contained in Exhibits to Registration Statement on
    Form S-1,
    No. 33-29595,
    filed June 28, 1989.(b)
    
    Contained in Exhibits to Amendment No. 1 to Registration
    Statement on
    Form S-1,
    No. 33-29595,
    filed August 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, 1994.(j)
    
    Filed with
    Form 10-K
    for December 31, 1996. [EX-4.13, 4.14, 4.15, and 4.16]




---



##### Table of Contents



(k)
    
    Filed with
    Form 10-K
    for December 31, 1997. [EX-10.32](l)
    
    Contained in Exhibits to Registration Statement on
    Form S-3,
    No. 333-42555
    filed December 18, 1997. [EX-10.1, 10.2, 10.3, 10.4, 10.5,
    10.6](m)
    
    Filed with
    Form 10-K
    for December 31, 1998. [EX-10.33, 10.34, 10.35, 10.36,
    10.37, 10.38, 10.39 and 10.40](n)
    
    Filed with
    Form 10-Q
    for September 30, 2003.(o)
    
    Filed with
    Form 10-Q
    for September 30, 2004.(p)
    
    Filed with
    Form 10-Q
    for June 30, 2005.(q)
    
    Filed with
    Form 10-Q/A
    for September 30, 2004.(r)
    
    Filed with
    Form 10-Q
    for September 30, 2005.(s)
    
    Filed with
    Form 10-Q
    for September 30, 2006.