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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, 2001

                         COMMISSION FILE NUMBER 1-10367

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

<Table>
<S>                                            <C>
                   DELAWARE                                      71-0675758
       (State or other jurisdiction of                        (I.R.S. Employer
        incorporation or organization)                      Identification No.)

          914 NORTH JEFFERSON STREET                               72764
             SPRINGDALE, ARKANSAS                                (Zip Code)
   (Address of principal executive offices)
</Table>

              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: [X]     NO: [ ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  YES: [X]     NO: [ ]

      Number of shares of the common stock outstanding at March 20, 2002:
                             CLASS A -- 27,194,374
                              CLASS B -- 1,465,530
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                                     PART I

ITEM 1.  BUSINESS

     Advanced Environmental Recycling Technologies, Inc. develops, manufactures
and markets composite building materials that can be used as an alternative to
traditional wood products for exterior applications in building and remodeling
homes. We use waste wood fiber and reclaimed polyethylene plastics as our raw
materials. Our products are comprised of approximately equal amounts of wood and
plastic, have been extensively tested and are used by several leading national
companies, such as the Weyerhaeuser Company (Weyerhaeuser) Lowe's Companies,
Inc. (Lowe's) and Therma-Tru Corporation. On April 26, 2001, our decking,
handrails and stair applications received 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. This also allowed our decking products to expand into additional
markets during 2001. Our products are marketed under the trade names
LifeCycle(R), MoistureShield(R), Weyerhaeuser ChoiceDek(R) Classic, Weyerhaeuser
ChoiceDek(R) Plus and Weyerhaeuser ChoiceDek(R) Premium. Our decking
distribution is with Weyerhaeuser Building Materials with 71 customer service
centers across the US and Canada, providing logistics services to manufacturers,
lumber dealers and home centers. We recently introduced ChoiceDek Premium into
Lowe's stores during the first quarter of 2002. During January 2001, we
introduced an exterior trim and fascia system under the trade name
MoistureShield(R) CornerLoc(TM).

     Our sales are primarily in the following markets:

     - Commercial and residential decking surface components and accessories
       such as balusters and handrails,

     - Exterior door, window and housing trim components, and

     - Industrial flooring.

     We currently operate two manufacturing and recycling facilities. Our
Junction, Texas facility currently manufactures primarily decking and decking
components, ChoiceDek Classic and ChoiceDek Premium, on two extruder lines. Our
door, window and housing trim components, (MoistureShield) are manufactured at
our Springdale, Arkansas facility, along with our LifeCycle, ChoiceDek Plus, and
ChoiceDek Premium lines of decking products, and all of our heavy industrial
flooring. We now have three extruder lines and a plastic recycling facility in
operation at our Springdale location. We have focused on improving our
manufacturing efficiencies and reducing our manufacturing costs at the Junction
and Springdale manufacturing facilities. Because of increased demand, two of the
existing extrusion lines at the Springdale manufacturing facility will be
upsized in 2002 and a fourth composite extrusion line will be added. A second
plastic recycling facility and a third composite extrusion facility are also
planned for Springdale. The timeliness of the implementation of the projects are
subject to the availability of financing from either the proceeds of our
industrial development bond financing currently held in escrow or from other
debt or equity financing, of which there can be no assurance in either case (see
Liquidity and Capital Resources and Note 5. Bonds Payable). In 2001, we opened a
plastic recycling warehouse and transfer facility in Springdale, Arkansas, and
increased our collection efforts. This is in advance of and in preparation of
building an additional plastic recycling plant.

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

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

     - They do not require preservative or chemical treatments utilizing toxic
       chemicals such as chromated copper arsenic (CCA), like traditional wood.
       They do not require yearly water sealing or staining, like traditional
       wood, when used as a deck surface.

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

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

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

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

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

MARKETING AND SALES

     The Company directed its initial marketing activities to specialized market
segments in the building industry in which cost and physical characteristics
place AERT's composite products, such as the subsurface component pieces of
standard door and window products, at a competitive advantage over alternative
conventional materials. Also, the current weaknesses of composites (for example,
certain of its initial strength and aesthetic characteristics) were not critical
disadvantages in these market segments. The Company has targeted its composite
products into defined needs in the marketplace, primarily external areas where
wood rots and/or requires substantial yearly maintenance such as staining or
water sealing. The Company also markets a growing line of primed and painted
window and exterior trim parts that substitute for wood and wood clad
components. The Company has developed an extensive customer base in the national
door and window market and with Weyerhaeuser BMD, primarily through members of
management, and strives to maintain strong customer relationships.

     The Company has been selling decking since 1993. Our first major decking
project was installed in 1993 at South Padre Island in Texas. In May 1995, the
Company signed a marketing and distribution agreement with Weyerhaeuser BMD to
distribute decking under the name ChoiceDek, in order to gain a national
presence.

     In 1995, the decking gross sales were $762,179. Gross sales for decking has
risen steadily the last four years from $4.3 million in 1998, $10.4 million in
1999, $20.2 million in 2000 to $27.3 million in 2001. Decking and decking
products are an important part of our growth.

     The Company began a marketing program in 2001 based upon extensive store
testing, intended to increase decking distribution into the home improvement
warehouse market. In December 2001, the Company entered into a three-year,
ongoing renewable agreement with Weyerhaeuser and Lowe's stores for sales of
ChoiceDek Premium, exclusively through Lowe's stores. The agreement calls for
AERT to dedicate production for a minimum of 1,500 truckloads during 2002 and
for Weyerhaeuser to guarantee to purchase said minimum volume for distribution
and sales to Lowe's. The product will be distributed primarily through Lowe's
distribution channels with Weyerhaeuser providing fill-in and back-up
distribution. Lowe's is also providing dedicated retail shelf space in all of
its 740 stores in 42 states for ChoiceDek Premium and has commenced a marketing
campaign in print and television advertising.

     As a condition for being awarded the Lowe's contract the Company was
required to develop and build a new upscale handrail and post system. The new
railing system was developed during the fourth quarter 2001 and commenced
production during the first quarter 2002. It will be available initially to
consumers through Lowe's stores but will not be exclusive to Lowe's.

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     The Company believes that Weyerhaeuser will have the majority of the Lowe's
stores reset with ChoiceDek Premium by the second quarter of 2002. In addition,
the Company intends to begin testing its MoistureShield trim products in
selected Lowe's stores during 2002.

     This contract will strengthen our position in the decking marketplace and
in the remodeling sector. The impact of these agreements will be evident in 2002
and will require additional production capacity in the near future. There will
be significant advertising during the spring and summer of 2002 that will
enhance the name of ChoiceDek to a wide range of consumers, including both home
improvement purchasers and contractors.

     This development will greatly improve the Company's move into the home
improvement markets that started in 2001. The Company will also have decking
products for other distribution channels; ChoiceDek Classic and ChoiceDek Plus,
as well as the ChoiceDek decorative railing system through Weyerhaeuser to
accommodate a wider range of applications through independent contractor
oriented lumber dealers. All decking products are promoted through displays at
regional and local home, lawn and garden shows, as well as store demonstration
displays and marketed on our web site on the Internet at
http://www.choicedek.com. The Company also has print and cable TV advertising
targeted towards the residential decking market and began marketing into home
improvements warehouses during 2001.

     For our MoistureShield marketing efforts for door, window and housing trim
manufacturers, to the extent a prospective customer currently uses wood for
component pieces, the Company emphasizes the "value-added" potential of its
MoistureShield composite product, which, unlike competing wood products, can be
engineered to incorporate certain desired end-product characteristics. The
Company also calls the prospective customer's attention to the savings in time
and expense that can be achieved by designing into the equipment used in the
extrusion process much of the millwork required in the customer's finished
product. Also by using our composite components the customers will avoid the
need for chemical treatments to their final product, which is often necessary to
be added to wood products to avoid rot and sustain durability. Our
MoistureShield composite components have additional durability and performance,
which allow our customers to extend the lifetime or warranties of their products
while reducing or eliminating maintenance costs. The Company will continue to
work on expanding its MoistureShield line of products, and an additional source
of information relating to MoistureShield is available on the Internet at
http://www.moistureshield.com. Our newest product line, which is an exterior
trim system was introduced using the trademark MoistureShield(R) CornerLoc(TM).

     MoistureShield composites have been marketed primarily to companies that
manufacture products for use by the construction industry in new home
construction and home improvement work. The construction industry is subject to
significant fluctuations in activity and periodic downturns caused by general
economic conditions. Increased interest rates can lead to reduced homebuilding
activity. Reductions in construction activity could have an adverse effect on
the demand for AERT composites. The Company places a major emphasis on
components for customers in the home improvement market; however, the Company
has recently expanded its marketing focus to accommodate a wider range of
products and applications, and is continuing to significantly increase market
distribution during 2002.

     In conjunction with expanding its decking towards nationwide distribution
and providing increased customer service, the Company began expanding its sales
group during late 1999. During the first quarter of 2001, the Company added a
new Vice President of Sales and Marketing, Jim Precht, who has 32-years of
experience. The Company over the last year has transferred its sales and
customer service functions to the corporate office in Springdale. With the
recent introduction of ChoiceDek Premium decking line and MoistureShield
CornerLoc exterior trim and fascia system, along with the decking products
moving into Canada and also into approximately 740 Lowe's stores, plus the
expansion plan by Lowe's of over 100 stores each year for the next three years
and along with continued emphasis on the contractor/segment dealer; it is our
intent to expand and improve our sales and customer service group and related
functions. Mr. Precht is working to expand our marketing, sales and customer
service functions, in conjunction with improving the sales focus of the
Weyerhaeuser customer service and/or distribution

                                        3
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centers, in order to handle substantially increased sales. Initially, this was a
one-year effort jointly sponsored by Weyerhaeuser.

SOURCES AND AVAILABILITY OF RAW MATERIALS

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

     Cedar Fiber.  The Junction, Texas composite facility is located near four
cedar mills, which extract cedar oil for perfumes and industrial detergents and
dispose of the cedar fiber as a by-product of their operations. These mills in
the past have sold cedar fiber as a drilling mud bridging agent for the oil
field industry. With the increase in natural gas prices during 2000, competition
for cedar fiber increased. The Company, in the past, had purchased the entire
wood fiber required for its manufacturing purposes from these mills but began a
diversification program during 2001. As the Company's ChoiceDek Classic product
line continues to grow, additional cedar fiber will not be required, as the
Company has arranged alternative wood fiber sources which are more reliable at
this same time. The disruption associated with inadequate cedar fiber supplies
hurt the Texas operation during 2000. The Company has manufactured its composite
material with other types of wood fibers, primarily hardwood. The Company began
a manufacturing program with hardwood waste for a line of hardwood decking in
Texas and has located a number of substitute wood fibers other than cedar, which
are currently available.

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

     Recycled Plastics.  The cost of recycled waste plastics for use in the
composites manufacturing process has been subject to significant market and
quality fluctuations over the past several years and the Company has experienced
supply problems associated with contaminated plastics in the past. In an effort
to reduce its exposure to price volatility, inconsistent quality, and potential
supply disruptions, the Company in 1990 developed its own patented plastic
recycling technologies and established the waste Plastics Reclamation Unit in
Rogers, Arkansas to assure itself of a cleaner, more dependable, and consistent
supply of plastic raw material for its composite manufacturing operations. The
Company currently performs its Low-Density Polyethylene (LDPE) processing
function at its facility in Springdale, Arkansas, as well as with three outside
independent contractors who process plastic for the Company. The Company has
also recently established several additional plastic supply sourcing
relationships in order to broaden its sources of supply. The Company has
recently acquired and/or leased equipment and is preparing to add in-house
plastic grinding and processing capacity. We believe this will help us lower a
portion of our raw material costs when completed. We expect this additional
plastic processing to come
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on-line during the third quarter of 2002, subject to the availability of
financing from either the proceeds of our industrial development bond financing
currently held in escrow or from other debt or equity financing, of which there
can be no assurance in either case (see Liquidity and Capital Resources and Note
5. Bonds Payable).

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

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

     - High Density Polyethylene (HDPE) and Linear Low Density Polyethylene
       (LLDPE) mixed plastic grocery bags from supermarket and store collection
       programs;

     - HDPE ground container material; and

     - LLDPE stretch film from warehouses and packing waste.

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

PATENTED AND PROPRIETARY TECHNOLOGY

     The Company's composite manufacturing process and its development efforts
in connection with waste plastics reclamation technologies involve patents and
many trade secrets which are considered proprietary by the Company, as well as
certain methods, processes and equipment designs for which the Company has
sought additional patent protection. The Company has taken measures that are
designed to safeguard its trade secrets by, among other things, entering into
confidentiality and nondisclosure agreements, and restricting access to its
facilities. The Company has also recently installed advanced security systems at
both facilities, including cameras.

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

     The Company was sued in Delaware, in June 1992, by Mobil Oil Corporation
seeking a declaratory judgment that four composite product patents were invalid
and unenforceable. This was after several members of the Mobil composite
products staff toured the AERT Junction, Texas facility in 1991 and signed
confidentiality agreements. In February 1994, in litigation with Mobil Oil
Corporation, a Delaware jury returned a verdict that four AERT patents on its
composite product technology were invalid. Two

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patents were later restored upon appeal in 1995. A continuation application
related to two of the patents in suit was later allowed and issued in 1998 after
extensive review by the patent office under U.S. Patent No. 5,759,680. There can
be no assurance such additional patents will not be challenged and upheld. The
cost of patent protection, and in particular, patent litigation is extremely
high. It can also strain resources and inhibit growth. AERT intends to take
other steps reasonably necessary in the future to protect its existing
technology and any technology that may be subsequently developed.

INDUSTRY STANDARDS

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

     The Company finalized such initial independent testing and submitted it to
the National Evaluation Service, and received a formal rating under NER-596, for
its decking products in 2001. The Company believes that a NER listing has helped
to further increase sales and market acceptance of its decking products.

COMPETITION

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

     Many large competitors also have research and development budgets,
marketing staffs and financial and other resources, which far surpass the
resources of the Company. There can be no assurance that such competitors will
not attempt to develop and introduce similar recycled composite materials. The
Company must also compete in the building materials market with certain other
plastics recyclers currently manufacturing recycled materials intended for
similar building material applications, including decking and fencing. Mobil Oil
Corporation entered the market in 1992, after purchasing the assets and
technology of a company called Rivenite. Mobil formed a composite products
division, opened a plant, and introduced a decking and fencing product called
Timbrex; which was later renamed Trex(R). Mobil initiated a large national
marketing and advertising program aimed at attaining significant distribution in
the decking market. Mobil divested this division in 1996 to a group of Trex
managers who named the new company The Trex Co., LLC. In April 1999, it became
Trex Company, Inc., and began trading on the New York Stock Exchange. Trex(R)
has continued to advertise heavily and generated composite decking sales in
excess of $116.9 million during 2001. Additional competition is emerging from
various sources for decking.

     As the Company has developed its own plastic reclamation technologies, it
has in certain instances been required to compete for raw materials with other
plastic recyclers, or plastic resin producers, most of which are far larger and
better established than the Company. However, management believes that its focus
towards sources of contaminated polyethylene films that it recycles and uses in
its composites business are less attractive to most producers of recycled
plastics, other than plastic lumber producers.

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Additional competitors in the non-wood decking segment of the decking market are
Crane Plastics, Louisiana-Pacific, CertainTeed Corporation and U.S. Plastic
Lumber. As a result, the increasing market demand for composite products is now
changing. Several additional competitors are starting to show interest in
poly-waste and other plastics, and prices for scrap are increasing. Further, the
Company believes that the plastics reclamation processes it has developed for
its composite manufacturing business are targeted to the waste management needs
of particular industrial waste generators, to plastic film wastes and to other
plastic waste generators, whose potential as recycling sources is not being
utilized to a significant extent by current plastics recyclers, as compared to
post-consumer, source-separated plastic containers recycling processes, in which
a substantially greater number of plastics recyclers compete for plastic waste
materials.

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

EMPLOYEES

     On December 31, 2001, the Company employed 382 people at its combined
facilities, which included 120 employees at the Texas facility, of which 4 were
executives and/or office personnel and 116 were full-time factory personnel. At
the Arkansas facility, there were 262 employees, of which 26 were executives
and/or office personnel and 236 were full-time factory personnel. The Company,
from time-to-time, employs additional persons on a part-time basis in its
manufacturing operations. The Company is intent on streamlining and automating
its manufacturing operations and we hope to attain increased outputs and
improved efficiencies without substantially increasing personnel.

OPERATIONS IMPROVEMENTS

     The Company embarked on the cost reduction plan aimed at significantly
reducing duplication, operating and/or extraordinary costs during 2001 and
eliminated or reduced costs $720,142. In addition to improving the desired
efficiencies described above, an example of this is cogeneration units that were
installed during first quarter of 2001, at both facilities and will utilize
waste sawdust or paper for dry fuel. These cogeneration units eliminated natural
gas and propane costs for drying wood fiber at both facilities by $262,618. Such
improvements significantly reduce or eliminate the Company's need for additional
sources of capital to support its operations. Management believes that increased
production and sales, and improved product focus, increased job training,
increased throughputs, and reduced plastics division raw material costs have
allowed it to attain profitability. Additional production volumes and resultant
sales increases from its Springdale plant combined with continued improvements
in production efficiency and capacity, as previously discussed, will be required
for the Company to further increase sales levels to those necessary to continue
to maintain and increase the profitable results from operations, provide funds
to repay the Company's outstanding obligations, meet the requirements to remove
the bond proceeds from escrow, refinance all or a portion of its short term debt
into longer term debt and meet its debt service schedule.

ITEM 2.  PROPERTIES

     The Company conducts its composite products manufacturing operations from
two separate facilities, including a 49,000 square foot manufacturing and
storage facility on a seven-acre site in Junction, Texas. In accordance with the
lease on the Junction facility, the Company exercised its right to purchase this
property from Marjorie S. Brooks, a major shareholder in May 2001. The Company
believes that the Junction facility is currently suitable for its composite
materials manufacturing requirements on a regional

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basis. The Company is upgrading and improving the Junction facility to provide
additional composite capacity and further reduce operating costs.

     The Company's Springdale, Arkansas manufacturing facility consists of
103,000 square feet and is located on 10 acres with a rail siding in the
Springdale Industrial District. The Company added storage sheds of approximately
12,000 square feet during 1999. An additional 18,440 square foot storage shed
was completed in 2001. The facility has dual sprinkler systems, and is leased by
the Company for $19,000 per month with an option to purchase it for $1.8
million. The Company intends to purchase said facility once it breaks escrow,
with a portion of its $16.5 million financing (see Liquidity and Capital
Resources and Note 5. Bonds Payable).

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

     A second plastic recycling facility warehouse has been leased and became
operational during the second quarter of 2001. Additional plastic grinding and
processing equipment has been acquired and is designed to come on-line during
the last half of 2002. The facility is comprised of 55,000 square feet. The
lease is $7,021 per month for two years with a renewal option.

ITEM 3.  LEGAL PROCEEDINGS

     The Company was a counterclaim defendant in a federal action in Texas,
involving allegations from a former employee and officer of the Company that the
Company breached an employment agreement by terminating employment. The Company
believed this action was without merit and vigorously defended itself. The
Company prevailed at trial with no award of damages. The plaintiffs' appeal is
pending.

     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 are 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 and also sued two of our founders personally,
as well as the Company. A bench trial began during the fourth quarter 2001, and
post-trial brief concluded in February 2002, and the case is now awaiting
decision from the court. The Company believes these allegations are unfounded
and without merit and is defending itself accordingly.

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, 2001.

                                        8
<PAGE>

                                    PART II

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

     The Company's Class A common stock is traded in the over-the-counter market
and is listed on The Nasdaq Stock Market(R) under the symbol AERTA. In order to
remain listed on Nasdaq, the Company is required to meet certain criteria as
maintenance standards established by Nasdaq. One such standard is a minimum bid
price of $1.00 per share. A second maintenance standard is to maintain a net
equity position of $2 million. At December 31, 2001, the Company's closing stock
price per share was $1.15 (and $2.15, as of March 20, 2002) and its net asset
value was $4.2 million. There is no guarantee that the Company will maintain
these minimum requirements.

     The following table sets forth the ranges of high and low quarterly sales
prices (as reported by NASDAQ) of the Company's Class A common stock for the
years ended December 31, 2000 and 2001. The quotations represent prices between
dealers, do not include retail markup, markdown or commission, and do not
necessarily represent actual transactions.

<Table>
<Caption>
                                                                 CLASS A
                                                              COMMON STOCK
                                                              -------------
                                                              HIGH     LOW
                                                              -----   -----
<S>                                                           <C>     <C>
Fiscal 2000
  First Quarter.............................................  3.563   2.000
  Second Quarter............................................  2.500   1.906
  Third Quarter.............................................  2.313   1.313
  Fourth Quarter............................................  1.438   0.656
Fiscal 2001
  First Quarter.............................................  1.250   0.719
  Second Quarter............................................  1.090   0.750
  Third Quarter.............................................  1.600   0.710
  Fourth Quarter............................................  1.150   0.850
</Table>

     As of December 31, 2001, there were approximately 1,500 record holders of
Class A common stock and 11 record holders of Class B common stock. The number
of beneficial owners of the Class A common stock at December 31, 2001 is not
known; however, management believes the number of beneficial owners of Class A
common stock at December 31, 2001, was in excess of 5,000.

                                        9
<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA

     The following tables set forth selected historical data for the Company for
the years ended December 31, 1997 through 2001, derived from the Company's
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".

<Table>
<Caption>
                                                        YEAR ENDED DECEMBER 31,
                                  -------------------------------------------------------------------
                                     2001          2000          1999          1998          1997
                                  -----------   -----------   -----------   -----------   -----------
<S>                               <C>           <C>           <C>           <C>           <C>
STATEMENTS OF OPERATIONS DATA:
Net sales.......................  $33,178,982   $27,508,864   $19,917,133   $12,408,591   $ 7,982,381
                                  -----------   -----------   -----------   -----------   -----------
Income (loss) before
  extraordinary gain............      312,864    (2,206,521)   (1,763,736)   (3,653,070)   (1,913,664)
Extraordinary gain..............           --            --            --            --       757,644
                                  -----------   -----------   -----------   -----------   -----------
Income (loss) applicable to
  common stock..................  $   312,864   $(2,206,521)  $(1,763,736)  $(3,653,070)  $(1,156,020)
                                  ===========   ===========   ===========   ===========   ===========
Income (loss) before
  extraordinary gain per common
  share.........................  $       .01   $      (.08)  $      (.07)  $      (.16)  $      (.09)
Extraordinary gain per common
  share.........................           --            --            --            --           .04
                                  -----------   -----------   -----------   -----------   -----------
Net income (loss) per common
  share(1)
  (Basic and Diluted)...........  $       .01   $      (.08)  $      (.07)  $      (.16)  $      (.05)
                                  ===========   ===========   ===========   ===========   ===========
Weighted average number of
  shares outstanding(1).........   27,565,825    26,059,013    24,598,715    22,895,517    21,800,170
BALANCE SHEET DATA:
Working capital (deficit).......  $(4,535,600)  $(6,804,992)  $(7,756,859)  $(4,625,935)  $(3,117,649)
Total assets....................   36,393,071    35,258,304    31,455,793    10,941,927     7,641,328
Long-term debt
  Less current maturities.......    4,303,202     4,486,156        59,656       227,376       588,412
Total liabilities...............   32,194,317    32,548,921    27,947,095     7,164,426     5,290,970
Stockholders' equity............    4,198,754     2,709,383     3,508,698     3,777,501     2,350,358
</Table>

---------------

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

                                        10
<PAGE>

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

RESULTS OF OPERATIONS

  YEAR ENDED DECEMBER 31, 2001, COMPARED TO YEAR ENDED DECEMBER 31, 2000

     Net sales were $33,178,982 for the year ended December 31, 2001, which
represented an increase of $5,670,118 or 21% over sales of $27,508,864 for the
year ended December 31, 2000. Net sales are computed by subtracting from gross
sales early pay discounts, returns, dating discounts, allowances and freight
charges, which together totaled $867,880 for 2001. The 2001 composite sales
consisted of MoistureShield net sales of $6,557,161 and decking (ChoiceDek
Classic, ChoiceDek Plus and ChoiceDek Premium) net sales of $26,621,821. These
figures compare with 2000 MoistureShield net sales of $7,783,256 and ChoiceDek
decking net sales of $19,725,608.

     The Texas plant net sales increased to $13,929,561 in 2001 from
$12,283,451, an increase of $1,646,110 or 13.4%. The Texas plant primarily
produces the ChoiceDek Classic product line. Texas net sales in 2001 for
ChoiceDek Classic were $13,856,638 versus $12,046,741 in 2000, an increase of
$1,809,897 or 15%; net sales of MoistureShield were $72,923 versus $236,710 in
2000, a decrease of $163,787. The change to focus Texas on ChoiceDek Classic was
intended to improve efficiencies. The Texas plant will also produce ChoiceDek
Premium in 2002.

     The Arkansas plant net sales in 2001 increased to $12,765,182, for
ChoiceDek decking and $6,484,239 for MoistureShield, for total net sales of
$19,249,421, an increase of $4,024,008 or 26% over 2000 sales of $15,225,413.
Decking net sales increased from $7,678,865 in 2000 to $12,765,182 in 2001, an
increase of $5,086,317 or 66%. During 2001, MoistureShield net sales were
$6,484,239, which was a decrease of $1,062,309 or 14% from 2000 MoistureShield
net sales of $7,546,548.

     Cost of goods sold increased $1,314,923 from $22,650,739 in 2000 to
$23,965,662 in 2001. However, as a percent of net sales, cost of goods sold
decreased 10.1% in 2001, from 82.3% in 2000 to 72.2% in 2001. All three major
cost components of the cost of goods sold decreased as a percent of sales; raw
materials -3.4%, direct labor -2.3%, and manufacturing overhead -4.3%. In 2001,
the Company started the year with a program to reduce its manufacturing costs
and it was successful. The following manufacturing expenses were reduced by a
total of 4.2% or $720,142 as compared to 2000, repair and maintenance, tooling,
leases/rents, supplies, fuel and oil, and waste disposal. A summary of the cost
of goods sold is presented below.

     Significant cost categories are as follows:

<Table>
<Caption>
EXPENSE CATEGORY                                                2001          2000*
----------------                                             -----------   -----------
<S>                                                          <C>           <C>
Payroll and payroll taxes..................................  $ 7,830,167   $ 7,245,558
Depreciation...............................................    2,668,447     2,333,649
Raw Materials..............................................    7,850,884     7,452,625
Other......................................................    5,616,164     5,618,907
                                                             -----------   -----------
          Total cost of goods sold.........................  $23,965,662   $22,650,739
                                                             ===========   ===========
</Table>

---------------

* Amounts for "Payroll and payroll taxes" and "Other" have been reclassified
  from the prior year's presentation to compare to the current year presentation
  for these cost categories.

     Selling, general, and administrative expenses, excluding extraordinary
litigation expense of $882,644, increased $774,000 to $6.7 million in 2001 up
from $6.0 million in 2000. Including litigation expense, the increase was
$1,656,242 to $7,615,072 in 2001 from $5,958,830 in 2000. As a percent of sales,
SG&A increased 1.3% from 2000 to 2001. Excluding the litigation percent
increase, the following expenses increased as a percent of sales, salaries,
commissions, advertising and promotion, and travel and entertainment. This
increase in selling and administrative expenses was directly attributable to
increased decking sales. All of these expenses related to the buildup of the
sales staff and developmental and

                                        11
<PAGE>

marketing expenses for the build up of the brand awareness of ChoiceDek in
conjunction with Weyerhaeuser.

     The operating profit for 2001 was $1,598,248, up from an operating loss of
$1,100,705 in 2000, a $2.708 million improvement and a significant turnaround
over prior periods. The profit was attained by reducing operating costs, even as
SG&A increased. Net interest increased to $995,384 in 2001 up $179,568 from
$815,816 in 2000.

     The Texas plant recorded a net loss of $294,624 in 2001, a decrease of
$376,553 from the net loss of $671,177 in 2000. The Texas plant experienced
significant downtime and efficiency reductions associated with capital
improvements, combined with reduced fourth quarter sales of ChoiceDek Classic.
The Texas plant also carried a significant amount of corporate overhead that may
be reduced in future periods as sales continue to increase at other AERT
locations. This reflects improvements made in reducing targeted manufacturing
overhead expenses by $220,730.

     The Springdale, Arkansas plant recorded a net profit of $607,488 in 2001 as
compared to a net loss of $1,535,344 in 2000. This is a positive change of
$2,142,832. The earnings improvement resulted from efficiencies implemented in
operations and the increase in sales volume while holding expenses at a slower
growth rate than the sales increase and, as previously mentioned, the programs
to reduce manufacturing overhead expenses which resulted in a savings of
$499,412 in 2001.

     The net profit for 2001, the first profitable year in the history of the
Company, was $312,864. This compares to a net loss in 2000 of $2,206,521, or an
increase in earnings of $2,519,385 over last year.

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

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

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

     The third extrusion line for the Springdale plant was completed and
operational in July of 2000. The net sales in 2000 at the Springdale plant were
$7,678,865 for ChoiceDek Plus and $6,725,080 for MoistureShield, for total net
sales of $15,225,413, an increase of $6,031,513 or 65.6% over 1999 sales of
$9,193,900. Decking sales increased from $896,695 in 1999 to $7,678,865 in 2000,
an increase of $6,782,170 or 756%. During 2000, MoistureShield sales were
$7,546,548, which was a decrease of $755,657 or 9% from 1999 sales of
$8,302,205. This decrease in OEM sales was attributable to three factors: (i) a
slow down of sales of door and window components in the fourth quarter of 2000,
(ii) a

                                        12
<PAGE>

decline in purchases during the last half of 2000 by a major door component
customer, and (iii) production limitations associated with starting up the new
MoistureShield CornerLoc system.

     Cost of goods sold increased $5,484,715 from $17,166,024 in 1999 to
$22,650,739 in 2000. As a percent of sales, cost of goods sold decreased 4% in
2000, from 86% in 1999 to 82%. Significant improvement was made in spite of the
problems with the Texas plant during the fourth quarter and higher raw material
costs. The major cost of goods component that increased as a percent of sales
was raw materials, up $2,273,130. As a percent of sales, raw materials increased
from 26.6% in 1999 to 27.1% in 2000 (.5%). Fuel and propane gas costs also
increased significantly over 1999. This increase in raw material costs was
primarily due to the continued increase in plastic costs. Payroll and payroll
related expenses remained at 30% of sales. The payroll remained constant, as a
percent of sales, because of the staffing required streamlining and bringing the
Springdale facility closer to full operating capacity. The other manufacturing
expenses decreased as a percent of sales by 3%. This resulted in a net decrease
of 4% for the overall cost of goods as a percent of sales. A summary of the cost
of goods sold is presented below:

     Significant cost categories are as follows:

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

     Selling, general and administrative expenses, excluding extraordinary
litigation expenses of $583,000, increased $1.64 million to $5.4 million from
$3.76 million in 1999. Including the litigation expenses, the increase was
$2.192 million to $5,958,830 in 2000 from $3,766,779, in 1999. As a percent of
sales, SG&A increased 2.7%, of which the majority was due to litigation costs.
Staffing was increased, primarily in marketing and sales, although as a percent
of sales, staffing costs decreased slightly from 6.8% to 6.3%. The major SG&A
expenses of $1.08 million was advertising and commission expenses for ChoiceDek
decking and the Weyerhaeuser distribution arrangements for such projects.
Additional promotional expenses were incurred to increase brand awareness of the
ChoiceDek and MoistureShield products. Commissions and factoring fees increased
as sales increased. The operating loss for year ended December 31, 2000, was
$517,705, excluding the litigation costs of $583,000, which brought it to
$1,100,705. This loss compares to an operating loss of $1,015,670, for the
comparable period a year ago. Net interest expense increased to $815,816 for the
year ended December 31, 2000, up $357,750 from $458,066 for the comparable
period a year ago. Of such interest expense, $143,379 was for factoring expense
and $225,594 was interest on $1.8 million in outstanding bridge notes.

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

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

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

                                        13
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 2001, the Company had a working capital deficit of
$4,535,600 compared to a working capital deficit of $6,804,992 at December 31,
2000. The Company expended approximately $1.5 million on capital expansion
during the year ended 2001, primarily on improving our equipment at both
production facilities in the areas of extrusion and raw material processing and
plastic production. The reduction in the working capital deficit is primarily
attributable to the Company's improving its production processes, reducing
costs, paying down the note payables and making a profit. Management's decision
to finance significant capital expenditures with short-term bridge loans
continues to contribute to the working capital deficit. Of such deficit,
involving total liabilities of approximately $32.2 million as of December 31,
2001, $16.5 million was for bonds payable, which is currently escrowed and
offset by a $16.5 million restricted bond escrow fund, $3.3 million was to the
Company's major shareholder or companies controlled by her, $1.65 million was in
short term bridge loans, and approximately $4.1 million was in payables. The
$4.5 million working capital deficit reflects management's decision to enter
into short-term debt financing, while the Company has expanded, built and
improved its production and sales capacities to increase cash flows from
operations. The Company's plan was to issue short-term debt and refinance in the
future, rather than enter into what it felt would have been more expensive and
dilutive equity financing at that time. The Company generated sufficient cash
flow to more than cover debt service. Cash flow available for debt service for
the year ended December 31, 2001, was approximately $4.5 million, up from $1.36
million, for the year ended December 31, 2000.

     The Company closed a $16.5 million tax-exempt bond financing into escrow
during the fourth quarter of 1999, intended to refinance existing obligations
and shift construction and expansion related accounts payable into long-term
financing. The Company started up the third Springdale composite extrusion line,
further increased production and intends to significantly increase positive cash
flows, attain profitability and then break escrow on a portion or possibly all
of the bonds. In addition, the bonds were subject to mandatory tender for
purchase by the Company in whole on October 13, 2000 (the Reset Date), at which
time the bonds were repurchased by the bond holder and a new reset date of
October 13, 2001 was established.

     Following the events of the September 11 tragedy the bonds were rolled over
on October 13, 2001, January 16, 2002 and March 15, 2002. The bonds are
currently due for reset on July 16, 2002. Since October 2001, discussions with
potential buyers for the bonds have commenced. Currently the terms and covenants
of the bonds in regard to the Company's needs are being reexamined and
negotiated with potential buyers. The Company will continue to actively attempt
to remarket the bonds. If the Company is unsuccessful in remarketing the bonds,
it could slow the Company's expansion plans and limit its ability to increase
decking production in a timely manner for sale to Weyerhaeuser for Lowe's. As
such, alternative construction or expansion financing would have to be arranged
of which there is no assurance. There are no assurances that the Company will be
successful in re-marketing the bonds. If unsuccessful, the Company will be
required to buy back the bonds. Should the Company be successful in its efforts
to break escrow, the Company believes it will have more than adequate debt
service coverage for its long-term bond debt.

     The Company believes that if it is successful in completing its pending
escrowed bond financing it will reduce and later eliminate its working capital
deficit by paying off the remaining bridge note balance of $1.8 million during
the remainder of 2002. In addition, the Company will be reimbursed for
approximately $4.9 million of working capital used to pay vendors for costs
eligible to be paid from bond proceeds. The Company will also receive
approximately $174,000 for unpaid costs eligible for reimbursement that are
reflected in the Company's accounts payable total. The bond funds will greatly
improve the working capital position, and will restructure a significant portion
of the Company's short-term indebtedness into long-term debt with more favorable
interest rates, if the Company is able to meet the requirements of the bond
indenture previously described and break escrow. Purchasing the existing
manufacturing site over a longer term should also help improve operating costs
by eliminating the monthly lease payments. By having substantial funds allocated
and available for capital expansion, the Company believes that increasing cash
flows generated from operations can be used for working capital and to further
reduce debt and the deficit.
                                        14
<PAGE>

     Cash and cash equivalents increased $151,972 in 2001. Significant
components of that increase were: (i) cash provided by operating activities of
$3,051,168, which consisted of the net income for the period of $312,864
increased by depreciation and amortization of $2,859,874 and reduced by other
uses of cash of $121,570; (ii) cash used in investing activities of $1,075,395,
and (iii) cash used in financing activities of $1,823,801. Payments on notes
during the period were $650,267, and proceeds from the issuances of notes
amounted to $200,000. At December 31, 2001, the Company had bonds and notes
payable in the amount of $23,631,961, of which $19,328,759 was current bonds and
notes payable and the current portion of long-term debt. Of the current bonds
and notes payable, $2,457,463 or 13% was to Marjorie S. Brooks, a major
shareholder and other investors closely associated with the Company. The Company
intends to pay down the remaining $1.8 million in other notes from cash flow
and/or refinancing during 2002 and the final balance upon successful completion
of the bond financing.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

FORWARD-LOOKING INFORMATION

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

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

                                        15
<PAGE>

statements. Prospective purchasers of the Shares should carefully consider the
information contained herein or in the documents incorporated herein by
reference.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

     There have been no disagreements on accounting and financial disclosures
with accountants during the quarter ended December 31, 2001.

     There was a change in accountants on March 4, 2002. See Form 8K and 8-K/A
filed with the SEC in March 2002.

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

               DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

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

<Table>
<Caption>
NAME                                   AGE                      POSITION
----                                   ---                      --------
<S>                                    <C>   <C>
Joe G. Brooks........................  46    Chairman of the board of directors, co-chief
                                             executive officer and president
Sal Miwa.............................  45    Vice-chairman of the board of directors
Stephen W. Brooks....................  45    Co-chief executive officer and director
J. Douglas Brooks....................  42    Executive vice-president -- plastics
Jim Precht...........................  55    Executive vice-president -- sales and marketing
Marjorie S. Brooks...................  66    Secretary, treasurer and director
Edward J. Lysen......................  64    Chief financial officer
Jerry B. Burkett.....................  45    Director
Michael M. Tull......................  47    Director
Samuel L. "Tony" Milbank.............  61    Director
Delbert E. "Pete" Allen, Jr. ........  60    Director
Melinda Davis........................  59    Director
</Table>

     The Company's board of directors elected Joe G. Brooks as its chairman and
the Company's co-chief executive officer in December 1998 and he is serving as
president. Mr. Brooks has previously served as president and has been a director
since the Company's inception in December 1988. He was also previously chairman
and CEO from inception until August 1993. Mr. Brooks is a director and chairman
of the standing committee of the Arkansas Recycling Coalition for Buy Recycled
Business Alliance for the State of Arkansas and serves on its executive
committee. He was a member of Clean Texas 2000, appointed by Governor George
Bush in 1995.

     In December 1998, the Company's board of directors elected Sal Miwa as its
vice-chairman. He has been an outside director of the Company since January
1994. Sal Miwa is COO and director of RealRead Inc., an online book sampling
service company located in New York, NY. For the past 20 years, he has been
engaged in various international businesses located in North America, Japan and
Europe. He received his master's degree in Aerospace Engineering from the
Massachusetts Institute of Technology.

     The Company's board of directors elected Stephen W. Brooks as co-chief
executive officer in December 1998. Mr. Brooks has served as its chief executive
officer and has been a director since January 1996. Mr. Brooks is CEO and
chairman of the board of Razorback Farms, Inc., a Springdale, Arkansas

                                        16
<PAGE>

based firm that specializes in vegetables for processing. Mr. Brooks also serves
on the board of the Ozark Food Processors Association.

     J. Douglas Brooks has served as executive vice-president of Plastics. Mr.
Brooks serves on the Executive Committee and is in charge of technical services,
which includes quality assurance, R&D, raw material processing, development and
sourcing. Mr. Brooks was previously project manager for AERT's polyethylene
recycling program with The Dow Chemical Company and is a joint inventor on
several of AERT's process patents for recycling polyethylene film for
composites.

     Jim Precht has served as executive vice-president of sales and marketing
for the Company since February 2001. Mr. Precht was formerly general manager of
Weyerhaeuser Building Materials' Pittsburgh Customer Service Center with
32-years of industry experience and has a dual reporting relationship to both
AERT and Weyerhaeuser Building Materials.

     Marjorie S. Brooks has 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. Lysen joined AERT in April 1999 as chief financial officer. Mr.
Lysen has over 30 years experience in financial management. Prior to entering
the private sector, Mr. Lysen was a consultant in the Management Consulting
Group, KPMG-Peat Marwick from 1966 to 1979. From 1979 to 1992, Mr. Lysen was
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. In 1998 to 1999, he was
the CFO of Hairston Roberson, a leading designer and manufacturer of women's
fashion apparel. He has an MBA in Finance from Northwestern University and is a
certified public accountant.

     Jerry B. Burkett was appointed a director to the board of directors of the
Company in 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.

     Michael M. Tull was appointed a director to the board of directors of the
Company in 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 sales and marketing of those companies' window and door related
components in the southeastern Unites States. Mr. Tull serves on boards of
several closely held family businesses and is the 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. Milbank was elected to the board of directors in July 2000. From
1997 to the present, Mr. Milbank has been a managing director of Zanett
Securities Corporation, an investment advisory company focusing on small and
microcap companies. From 1992 to 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 1973 to 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 issues. He has a BS from Columbia University and
a MBA in Finance from The Amos Tuck School of Business Administration at
Dartmouth College.

     Delbert E. "Pete" Allen, Jr. was elected to the board of directors in July
2001. Currently, Mr. Allen is President of Allen Holding, Inc., an investment,
finance and ranching enterprise. From 1970 to 1999, Mr. Allen was President and
CEO of Allen Canning Co. He also served as a director of Allen Canning Co. from
1967 to 1999. Mr. Allen has served as director of Arkansas State Bancshares Inc.
and Arkansas State Bank in Siloam Springs since 1971, and was recently named its
Chairman of the Board. Mr. Allen is presently Chairman Emeritus and director of
the National Food Processors Association (NFPA). He
                                        17
<PAGE>

served the NFPA as chairman in 1983-1984 and has been a director in excess of
thirty years. He is a past member of the NFPA's executive committee. Mr. Allen
is a director on the Agricultural Development Council-University of Arkansas. He
served from 1994 to present. Mr. Allen is also past president and director of
the Siloam Springs Hospital Board.

     Melinda Davis was elected to the board of directors in July 2001. Since
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.

     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 of Melinda Davis (chairman), Jerry B. Burkett, and Sal Miwa. The audit
committee recommends engagement of the Company's independent accountants and is
primarily responsible for approving the services performed by the Company's
independent accountants and for reviewing and evaluating the Company's
accounting principles and its system of internal accounting controls.

     The compensation and stock option committee consists of Jerry B. Burkett
(chairman), Sal Miwa, Marjorie S. Brooks and Michael M. Tull. The compensation
and stock option committee establishes and administers the Company's
compensation and stock option plans on behalf of the board of directors and
approves stock options granted thereunder.

     The executive committee consists of three board members with Joe G. Brooks
(chairman), Sal Miwa and Delbert E. "Pete" Allen, Jr. and three executive
management members of Stephen W. Brooks and J. Douglas Brooks and Alford
Drinkwater. The executive committee establishes corporate policies, manpower,
technology, cost accounting and day-to-day operations of the Company.

     The litigation committee consists of Joe G. Brooks (chairman), Sal Miwa and
Jerry B. Burkett. The litigation committee establishes and administers the
Company's litigation plans on behalf of the board of directors.

     The nominating committee consists of Michael M. Tull (chairman), Samuel L.
"Tony" Milbank, Marjorie S. Brooks and Joe G. Brooks. The nominating committee
evaluates the efforts of AERT and board of directors to maintain effective
corporate governance practices. The committee identifies candidates for election
to the board of directors.

                                        18
<PAGE>

ITEM 11.  EXECUTIVE COMPENSATION.

     The following table sets forth the aggregate cash compensation paid by the
Company during the three years ended December 31, 2001, to each executive
officer of the Company whose aggregate cash compensation earned exceeded
$100,000, and to the chief executive officer.

                           SUMMARY COMPENSATION TABLE

<Table>
<Caption>
                                       ANNUAL
                                    COMPENSATION         LONG-TERM COMPENSATION AWARDS       PAYOUTS
                                  -----------------   -----------------------------------   ---------
                                                       RESTRICTED    SECURITIES             LONG-TERM
NAME AND                                      OTHER   ANNUAL STOCK   UNDERLYING             INCENTIVE    ALL OTHER
PRINCIPAL POSITION         YEAR   SALARY      BONUS   COMPENSATION     AWARDS     OPTIONS    PAYOUTS    COMPENSATION
------------------         ----   -------     -----   ------------   ----------   -------   ---------   ------------
<S>                        <C>    <C>         <C>     <C>            <C>          <C>       <C>         <C>
Stephen W. Brooks........  2001         0       0          0             0           0          0            0
  Co-CEO                   2000         0       0          0             0           0          0            0
                           1999         0       0          0             0           0          0            0
Joe G. Brooks............  2001   105,000       0          0             0           0          0            0
  Co-CEO                   2000   105,000       0          0             0           0          0            0
                           1999   105,000       0          0             0           0          0            0
</Table>

          AGGREGATED OPTION EXERCISES IN YEAR ENDED DECEMBER 31, 2001
                     AND OPTION VALUES AT DECEMBER 31, 2001

<Table>
<Caption>
                                                                    NUMBER OF         VALUE OF UNEXERCISED
                                       NUMBER OF               UNEXERCISED OPTIONS    IN-THE-MONEY OPTIONS
                                        SHARES                 AT DECEMBER 31, 2001   AT DECEMBER 31, 2001
                                       ACQUIRED      VALUE         EXERCISABLE/           EXERCISABLE/
NAME                                  ON EXERCISE   REALIZED      UNEXERCISABLE          UNEXERCISABLE
----                                  -----------   --------   --------------------   --------------------
<S>                                   <C>           <C>        <C>                    <C>
Stephen W. Brooks...................          0     $     0       475,000/     0          $295,050/$0
Joe G. Brooks.......................          0     $     0       246,667/     0          $149,292/$0
</Table>

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     The board of directors, as a whole, reviews and acts upon personnel
policies and executive compensation matters. Joe G. Brooks and Stephen W. Brooks
serve as executive officers of the Company; however, such individuals do not
participate in compensation decisions or in forming compensation policies in
which they have a personal interest, nor do they vote on any such matters.

LIMITED LIABILITY OF OFFICERS AND DIRECTORS

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

                                        19
<PAGE>

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth, as of December 31, 2001, certain
information with regard to the beneficial ownership of the Company's capital
stock by each holder of 5% or more of the outstanding stock, by each director of
the Company, and by all officers and directors as a group:

<Table>
<Caption>
                                                      NUMBER OF          PERCENTAGE        PERCENTAGE
NAME AND ADDRESS                                      SHARES OF           OF CLASS         OF VOTING
OF BENEFICIAL OWNER           TITLE OF CLASS(1)    COMMON STOCK(2)   OUTSTANDING(2)(15)   POWER(2)(16)
-------------------           -----------------    ---------------   ------------------   ------------
<S>                           <C>                  <C>               <C>                  <C>
Marjorie S. Brooks                 Class A           11,818,998(3)          24.2%             31.8%
  P. O. Box 1237                   Class B              837,588(4)          57.2%
  Springdale, AR 72765        Preferred-Series A            850(5)          29.3%
                                   Series B                 400(5)          13.8%
Joe G. Brooks                      Class A              938,397(6)           1.9%              3.9%
  P. O. Box 1237                   Class B              284,396             19.4%
  Springdale, AR 72765
J. Douglas Brooks                  Class A              941,573(7)           1.9%              2.7%
  P. O. Box 1237                   Class B              131,051              8.9%
  Springdale, AR 72765
Jerry B. Burkett                   Class A              215,000(8)             *                 *
  P. O. Box 1237                   Class B               33,311              2.3%
  Springdale, AR 72765
Sal Miwa                           Class A              456,963(9)             *                 *
  P. O. Box 1237
  Springdale, AR 72765
Stephen W. Brooks                  Class A              895,116(10)          1.8%              2.2%
  P. O. Box 1237                   Class B               89,311              6.1%
  Springdale, AR 72765
Delbert E. "Pete" Allen, Jr.       Class A              983,900(11)          2.0%              1.6%
  P. O. Box 1237
  Springdale, AR 72765
Melinda Davis                      Class A                   --                *                 *
  P. O. Box 1237
  Springdale, AR 72765
Michael M. Tull                    Class A              146,000(12)            *               1.9%*
  P. O. Box 1237              Preferred-Series B            400             13.8%
  Springdale, AR 72765
Samuel L. "Tony" Milbank           Class A              521,897(13)          1.1%                *
  P. O. Box 1237              Preferred-Series A             15                *
  Springdale, AR 72765
Officers and directors as a
  group (nine persons)             Class A           16,917,844             34.6%             46.4%
                                   Class B            1,375,657             93.9%
                              Preferred-Series A            865             29.8%
                                   Series B                 800             27.6%
</Table>

---------------

  *  Less than 1%

 (1) The Class B common stock is substantially identical to the Class A common
     stock, except that each share of Class B common stock has five votes per
     share and each share of Class A common stock has one vote per share. Each
     share of Class B common stock is convertible into one share of Class A
     common stock. Each share of Preferred Stock is convertible 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 971 shares of Class A common stock,
     based upon the trading price prevailing at December 31, 2001.

                                        20
<PAGE>

     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, 2002) of December 31, 2001.

 (3) Includes 2,837,148 shares owned directly, 643,645 in trusts or corporations
     controlled by Mrs. Brooks, 1,125,000 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, 646,000 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 and J. Douglas Brooks, as
     to which she disclaims a beneficial interest.

 (5) Includes 850 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 370,932 shares owned directly, 33,021 shares owned indirectly,
     7,620 shares issuable upon exercise of bonus warrants and 530,000 shares
     issuable upon exercise of stock options.

 (8) Includes 13,000 shares owned directly, 2,000 shares owned by Mr. Burkett as
     custodian for his minor child, 10,000 shares owned by a partnership
     controlled by Mr. Burkett and 190,000 shares issuable upon exercise of
     stock options.

 (9) Includes 3,000 shares owned directly and 453,963 shares issuable upon
     exercise of stock options.

(10) Includes 370,116 shares owned directly and 525,000 shares issuable upon
     exercise of stock options.

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

(12) Includes 71,000 shares owned directly and 75,000 shares issuable upon
     exercise of stock options.

(13) Includes 335,710 shares owned directly 112,697 shares issuable upon
     exercise of Series X Warrants, 41,604 shares issuable upon exercise of
     Series Y Warrants, and 31,886 shares issuable upon exercise of Class I
     Warrants.

(14) Class A common stock beneficial ownership is calculated based on 48,906,678
     shares outstanding as of December 31, 2001, which includes 21,738,904
     shares which may be acquired through the exercise of outstanding options
     and warrants within 60 days of December 31, 2001. Class B common stock
     beneficial ownership is calculated based on 1,465,530 shares outstanding on
     December 31, 2001. Preferred stock beneficial ownership is calculated based
     on 2,900 shares outstanding on December 31, 2001.

(15) Calculated based on 60,150,995 shares outstanding on December 31, 2001,
     which includes voting rights on all classes of stock, options and warrants
     which can be acquired within 60 days of December 31, 2001.

                                        21
<PAGE>

     At December 31, 2001, there were 27,167,774 shares of Class A common stock
and 1,465,530 shares of Class B common stock issued and outstanding. The
previous table sets forth that directors, officers and 5% shareholders, as a
group, beneficially owned shares representing approximately 46.4% 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 31.8% of the votes entitled
to be cast and may be in a position to control the Company.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     During 2001, the Company had an agreement with an affiliate, Brooks
Investment Co., controlled by Marjorie S. Brooks (Brooks Investment Co.) whereby
the Company agreed to transfer certain of its trade receivables as collateral,
which the affiliate deemed acceptable, up to $2.5 million at any one time. Upon
acceptance of a transfer of a receivable, the affiliate remitted to the Company
85% of the receivable, as defined in the agreement. Through September 30, 2001,
upon collection of the receivable, the Company remitted to the affiliate 1.75%
of the receivable as a factoring charge and the additional 13.25% of the
receivable was remitted to the Company, less interest costs, which were based on
the time period over which the receivable was outstanding. On October 1, 2001,
the factoring charge decreased to 0.8%. The Company indemnified the affiliate
for any loss arising out of rejections or returns of any merchandise, or any
claims asserted by the Company's customers. During 2001, the Company transferred
an aggregate of approximately $34 million in receivables under this agreement,
of which $3.3 million remained to be collected as of December 31, 2001. During
2000 and 1999, the Company transferred an aggregate of approximately $28.2
million and $20.5 million, respectively, in receivables under this agreement,
none of which remains to be collected. Costs of approximately $517,349, $470,794
and $202,034 associated with the factoring agreement were included in selling
and administrative costs at December 31, 2001, 2000 and 1999, respectively.

     At December 31, 2001, accounts payable-related parties included advances on
factored receivables of approximately $2.9 million and $388,000 relating to
other items owed to related parties.

                                    PART IV

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

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

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

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

     On March 4, 2002, the Corporation filed a Current Report on Form 8-K under
Item 4. Changes in Registrant's Certifying Accountant and subsequent Exhibit 16
on March 8, 2002.

     On March 18, 2002, the Corporation filed a Current Report on Form 8-K/A
under Item 4. Changes in Registrant's Certifying Accountant. The report amended
the Corporations' Current Report on Form 8-K dated March 4, 2002, for the
purpose of clarifying the language of the filing and included Exhibit 16.

                                        22
<PAGE>

                                   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 ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

<Table>
<S>     <C>                                         <C>


 By:                /s/ JOE G. BROOKS                             /s/ EDWARD J. LYSEN
        -----------------------------------------      -----------------------------------------
                      Joe G. Brooks,                                Edward J. Lysen,
                  Chairman and Co-Chief                  Chief Financial and Accounting Officer
                    Executive Officer


               Date: March 29, 2002                                  March 29, 2002
</Table>

     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.

<Table>
<Caption>
                    SIGNATURE                                      TITLE                       DATE
                    ---------                                      -----                       ----
<S>     <C>                                          <C>                                  <C>

                /s/ JOE G. BROOKS                      Chairman of the board, co-CEO      March 29, 2002
 ------------------------------------------------               and director
                  Joe G. Brooks


                   /s/ SAL MIWA                          Vice-chairman and director       March 29, 2002
 ------------------------------------------------
                     Sal Miwa


              /s/ STEPHEN W. BROOKS                         Co-CEO and director           March 29, 2002
 ------------------------------------------------
                Stephen W. Brooks


                /s/ JOE G. BROOKS                                President                March 29, 2002
 ------------------------------------------------
                  Joe G. Brooks


              /s/ MARJORIE S. BROOKS                 Secretary, treasurer and director    March 29, 2002
 ------------------------------------------------
                Marjorie S. Brooks


               /s/ JERRY B. BURKETT                               Director                March 29, 2002
 ------------------------------------------------
                 Jerry B. Burkett


               /s/ MICHAEL M. TULL                                Director                March 29, 2002
 ------------------------------------------------
                 Michael M. Tull


           /s/ SAMUEL L. "TONY" MILBANK                           Director                March 29, 2002
 ------------------------------------------------
             Samuel L. "Tony" Milbank


         /s/ DELBERT E. "PETE" ALLEN, JR.                         Director                March 29, 2002
 ------------------------------------------------
           Delbert E. "Pete" Allen, Jr.


                /s/ MELINDA DAVIS                                 Director                March 29, 2002
 ------------------------------------------------
                  Melinda Davis
</Table>

                                        23
<PAGE>

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                         INDEX TO FINANCIAL STATEMENTS

<Table>
<Caption>
                                                                 PAGE
                                                                 ----
<S>                                                           <C>
Financial Statements:
  Report of Independent Auditors' Report....................         F-2
  Balance Sheets............................................         F-3
  Statements of Operations..................................         F-4
  Statements of Stockholders' Equity........................         F-5
  Statements of Cash Flows..................................         F-6
  Notes to Financial Statements.............................  F-7 - F-26
</Table>

                                       F-1
<PAGE>

                          INDEPENDENT AUDITORS' REPORT

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

     We have audited the accompanying balance sheet of Advanced Environmental
Recycling Technologies, Inc. as of December 31, 2001, and the related statements
of operations, stockholders' equity and cash flows for the year then ended.
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 audit. The financial statements of Advanced Environmental Recycling
Technologies, Inc. for the years ended December 31, 2000 and 1999 were audited
by other auditors whose report, dated March 30, 2001, on those financial
statements included an explanatory paragraph that expressed substantial doubt
about the Company's ability to continue as a going concern.

     We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. 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 audit provides a
reasonable basis for our opinion.

     In our opinion, the 2001 financial statements referred to above present
fairly, in all material respects, the financial position of Advanced
Environmental Recycling Technologies, Inc. as of December 31, 2001, and the
results of its operations and its cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America.

     The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has incurred significant net losses since
inception, has a working capital deficit at December 31, 2001, and is subject to
certain claims in litigation as discussed in Note 10. These factors, among
others, as discussed in Note 2, raise substantial doubt concerning the ability
of the Company to continue as a going concern. Management's plans in regard to
these matters are also described in Note 2. The financial statements do not
include any adjustments relating to the recoverability and classification of
asset carrying amounts or the amount and classification of liabilities that
might result should the Company be unable to continue as a going concern.

                                       /s/ TULLIUS TAYLOR SARTAIN & SARTAIN LLP

March 15, 2002

                                       F-2
<PAGE>

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                                 BALANCE SHEETS

<Table>
<Caption>
                                                              DECEMBER 31,   DECEMBER 31,
                                                                  2001           2000
                                                              ------------   ------------
<S>                                                           <C>            <C>

                                         ASSETS

Current assets:
     Cash...................................................  $   755,601    $   603,629
     Restricted bond escrow fund............................   16,603,068     16,661,330
     Accounts receivable, net of allowance of $71,849 in
      2001 and $84,858 in 2000..............................    3,278,473      1,925,969
     Inventories............................................    2,232,712      1,657,666
     Prepaid expenses.......................................      195,257        118,775
                                                              -----------    -----------
          Total current assets..............................   23,065,111     20,967,369
                                                              -----------    -----------
Land, buildings and equipment:
     Land...................................................      889,528        889,528
     Buildings and leasehold improvements...................    1,468,525      1,129,609
     Machinery and equipment................................   19,744,082     18,741,162
     Transportation equipment...............................      439,673        175,385
     Office equipment.......................................      467,471        338,501
     Construction in progress...............................      831,193      1,143,301
                                                              -----------    -----------
                                                               23,840,472     22,417,486
Less accumulated depreciation...............................   12,366,249      9,608,669
                                                              -----------    -----------
Net land, buildings and equipment...........................   11,474,223     12,808,817
                                                              -----------    -----------
Other assets, at cost less accumulated amortization of
  $357,308 in 2001 and $352,364 in 2000.....................    1,853,737      1,482,118
                                                              -----------    -----------
                                                              $36,393,071    $35,258,304
                                                              ===========    ===========
                          LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable -- trade.................................  $ 4,113,105    $ 5,175,326
  Accounts payable -- related parties.......................    3,290,847      2,109,350
  Current maturities of long-term debt......................      313,182        242,689
  Accrued liabilities.......................................      868,000      1,296,628
  Notes payable -- related parties..........................      450,000        250,000
  Notes payable -- other....................................    2,065,577      2,198,368
  Bonds payable.............................................   16,500,000     16,500,000
                                                              -----------    -----------
          Total current liabilities.........................   27,600,711     27,772,361
                                                              -----------    -----------
Long-term debt, less current maturities.....................    4,303,202      4,486,156
                                                              -----------    -----------
Accrued premium on convertible preferred stock..............      290,404        290,404
                                                              -----------    -----------
Stockholders' equity, per accompanying statements:
  Preferred stock, $1 par value; 5,000,000 shares
     authorized, 2,900 shares issued and outstanding as of
     December 31, 2001 and 2000, respectively...............        2,900          2,900
  Class A common stock, $.01 par value; 75,000,000 shares
     authorized; 27,167,774 and 25,755,321 shares issued and
     outstanding as of December 31, 2001 and 2000,
     respectively...........................................      271,678        257,553
  Class B convertible common stock, $0.01 par value;
     7,500,000 shares authorized; 1,465,530 shares issued
     and outstanding as of December 31, 2001 and 2000,
     respectively...........................................       14,655         14,655
  Warrants outstanding; 17,298,501..........................    8,203,154             --
  Additional paid-in capital................................   22,810,588     29,851,360
  Accumulated deficit.......................................  (27,104,221)   (27,417,085)
                                                              -----------    -----------
          Total stockholders' equity........................    4,198,754      2,709,383
                                                              -----------    -----------
          Total liabilities and stockholders' equity........  $36,393,071    $35,258,304
                                                              ===========    ===========
</Table>

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

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                            STATEMENTS OF OPERATIONS

<Table>
<Caption>
                                                                YEAR ENDED DECEMBER 31,
                                                        ---------------------------------------
                                                           2001          2000          1999
                                                        -----------   -----------   -----------
<S>                                                     <C>           <C>           <C>
Net sales.............................................  $33,178,982   $27,508,864   $19,917,133
Cost of goods sold....................................   23,965,662    22,650,739    17,166,024
                                                        -----------   -----------   -----------
Gross margin..........................................    9,213,320     4,858,125     2,751,109
Selling and administrative costs......................    7,615,072     5,958,830     3,766,779
                                                        -----------   -----------   -----------
Operating income (loss)...............................    1,598,248    (1,100,705)   (1,015,670)
                                                        -----------   -----------   -----------
Other income (expense)
  Interest income.....................................      906,736       960,048       187,508
  Interest expense....................................   (1,902,120)   (1,775,864)     (645,574)
                                                        -----------   -----------   -----------
                                                           (995,384)     (815,816)     (458,066)
                                                        -----------   -----------   -----------
Income (loss) before accrued premiums on preferred
  stock...............................................      602,864    (1,916,521)   (1,473,736)
Accrued premium on preferred stock....................     (290,000)     (290,000)     (290,000)
                                                        -----------   -----------   -----------
Net income (loss) applicable to common stock..........  $   312,864   $(2,206,521)  $(1,763,736)
                                                        ===========   ===========   ===========
Income (loss) per share of common stock (Basic and
  Diluted)............................................  $       .01   $      (.08)  $      (.07)
                                                        ===========   ===========   ===========
Weighted average number of common shares outstanding
  (Basic).............................................   27,565,825    26,059,013    24,598,715
                                                        ===========   ===========   ===========
Weighted average number of common shares outstanding
  (Diluted)...........................................   37,176,751    26,059,013    24,598,715
                                                        ===========   ===========   ===========
</Table>

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

                                       F-4
<PAGE>

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                       STATEMENTS OF STOCKHOLDERS' EQUITY
<Table>
<Caption>
                                                       CLASS A               CLASS B
                               PREFERRED STOCK       COMMON STOCK          COMMON STOCK       WARRANTS OUTSTANDING    ADDITIONAL
                               ---------------   --------------------   ------------------   ----------------------    PAID-IN
                               SHARES   AMOUNT     SHARES     AMOUNT     SHARES     AMOUNT     SHARES       VALUE      CAPITAL
                               ------   ------   ----------   -------   ---------   ------   ----------   ---------   ----------
<S>                            <C>      <C>      <C>          <C>       <C>         <C>      <C>          <C>         <C>
Balance -- December 31,
  1998.......................  2,900    2,900    22,245,639   222,456   1,465,530   14,655                            26,984,318
                               -----    -----    ----------   -------   ---------   ------   ----------   ---------   ----------
Issuance of shares for
  payment of interest on
  bridge financings..........     --       --       124,823     1,248          --      --                                122,867
Issuance of options in
  payment of expenses........     --       --            --        --          --      --                                 12,347
Exercise of stock options....     --       --       132,500     1,325          --      --                                160,600
Exercise of Class B
  Warrants...................     --       --       257,994     2,580          --      --                                274,763
Exercise of Class F
  Warrants...................     --       --       350,864     3,509          --      --                                210,518
Exercise of Class G
  Warrants...................     --       --       481,810     4,818          --      --                                437,138
Exercise of Class I
  Warrants...................     --       --        29,367       294          --      --                                 27,238
Exercise of Consulting
  Warrants...................     --       --       600,000     6,000          --      --                                219,000
Exercise of Placement
  Warrants...................                        28,500       285          --      --                                 10,403
Net loss.....................     --       --            --        --          --      --                                     --
                               -----    -----    ----------   -------   ---------   ------   ----------   ---------   ----------
Balance -- December 31,
  1999.......................  2,900    2,900    24,251,497   242,515   1,465,530   14,655                            28,459,192
                               -----    -----    ----------   -------   ---------   ------   ----------   ---------   ----------
Exercise of stock options....     --       --       465,000     4,650          --      --                                275,559
Exercise of Class H
  Warrants...................     --       --       228,208     2,282          --      --                                 97,718
Exercise of Class J
  Warrants...................     --       --       100,000     1,000          --      --                                 49,000
Exercise of Placement
  Warrants...................     --       --       129,574     1,296          --      --                                 47,295
Issuance of stock in payment
  of debt acquisition
  expenses...................     --       --       150,000     1,500          --      --                                429,750
Issuance of stock in payment
  of debt....................     --       --       150,000     1,500          --      --                                148,500
Compensation expense on non-
  employee options...........     --       --            --        --          --      --                                  9,896
Issuance of shares in payment
  of accrued premium on
  preferred stock............                       281,042     2,810          --      --                                334,450
Net loss.....................     --       --            --        --          --      --                                     --
                               -----    -----    ----------   -------   ---------   ------   ----------   ---------   ----------
Balance -- December 31,
  2000.......................  2,900    2,900    25,755,321   257,553   1,465,530   14,655                            29,851,360
                               -----    -----    ----------   -------   ---------   ------   ----------   ---------   ----------
Issuance of shares in payment
  of accrued premium on
  preferred stock............     --       --       358,239     3,582          --      --                                286,418
Issuance of stock in payment
  of interest................     --       --       409,114     4,092          --      --                                515,906
Exercise of stock options....     --       --        75,000       750          --      --                                 46,531
Warrants outstanding recorded
  due to the adoption of EITF
  00-19......................                                                                17,818,601   8,419,345   (8,419,345)
Exercise of Class J
  Warrants...................     --       --       150,000     1,500          --      --      (100,000)    (38,241)     137,241
Exercise of Class K
  Warrants...................     --       --       150,000     1,500          --      --      (150,000)    (27,663)     138,663
Exercise of Class I
  Warrants...................     --       --        45,616       456          --      --       (45,616)    (24,040)      45,632
Exercise of Consulting
  Warrants...................     --       --       199,334     1,993          --      --      (199,334)   (112,166)     184,922
Exercise of Placement
  Warrants...................                        25,150       252                  --       (25,150)    (14,081)      23,260
Net income...................     --       --            --        --          --      --            --          --           --
                               -----    -----    ----------   -------   ---------   ------   ----------   ---------   ----------
Balance -- 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
                               =====    =====    ==========   =======   =========   ======   ==========   =========   ==========

<Caption>

                               ACCUMULATED
                                 DEFICIT       TOTAL
                               -----------   ----------
<S>                            <C>           <C>
Balance -- December 31,
  1998.......................  (23,446,828)   3,777,501
                               -----------   ----------
Issuance of shares for
  payment of interest on
  bridge financings..........           --      124,115
Issuance of options in
  payment of expenses........           --       12,347
Exercise of stock options....           --      161,925
Exercise of Class B
  Warrants...................           --      277,343
Exercise of Class F
  Warrants...................           --      214,027
Exercise of Class G
  Warrants...................           --      441,956
Exercise of Class I
  Warrants...................           --       27,532
Exercise of Consulting
  Warrants...................           --      225,000
Exercise of Placement
  Warrants...................           --       10,688
Net loss.....................   (1,763,736)  (1,763,736)
                               -----------   ----------
Balance -- December 31,
  1999.......................  (25,210,564)   3,508,698
                               -----------   ----------
Exercise of stock options....           --      280,209
Exercise of Class H
  Warrants...................           --      100,000
Exercise of Class J
  Warrants...................           --       50,000
Exercise of Placement
  Warrants...................           --       48,591
Issuance of stock in payment
  of debt acquisition
  expenses...................           --      431,250
Issuance of stock in payment
  of debt....................           --      150,000
Compensation expense on non-
  employee options...........           --        9,896
Issuance of shares in payment
  of accrued premium on
  preferred stock............           --      337,260
Net loss.....................   (2,206,521)  (2,206,521)
                               -----------   ----------
Balance -- December 31,
  2000.......................  (27,417,085)   2,709,383
                               -----------   ----------
Issuance of shares in payment
  of accrued premium on
  preferred stock............           --      290,000
Issuance of stock in payment
  of interest................           --      519,998
Exercise of stock options....           --       47,281
Warrants outstanding recorded
  due to the adoption of EITF
  00-19......................                        --
Exercise of Class J
  Warrants...................           --      100,500
Exercise of Class K
  Warrants...................           --      112,500
Exercise of Class I
  Warrants...................           --       22,048
Exercise of Consulting
  Warrants...................           --       74,749
Exercise of Placement
  Warrants...................           --        9,431
Net income...................      312,864      312,864
                               -----------   ----------
Balance -- December 31,
  2001.......................  (27,104,221)   4,198,754
                               ===========   ==========
</Table>

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

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                            STATEMENTS OF CASH FLOWS

<Table>
<Caption>
                                                                YEAR ENDED DECEMBER 31,
                                                        ---------------------------------------
                                                           2001          2000          1999
                                                        -----------   -----------   -----------
<S>                                                     <C>           <C>           <C>
Cash flows from operating activities:
  Net income (loss) applicable to common stock........  $   312,864   $(2,206,521)  $(1,763,736)
  Adjustments to reconcile net income (loss) to net
     cash provided by (used in) operating activities:
     Depreciation and amortization....................    2,859,874     2,463,645     1,968,508
     Premium accrued on preferred stock...............      290,000       290,000       290,000
     Provision for allowances and doubtful accounts...           --        64,858            --
     Expenses paid through issuance of stock
       options........................................           --         9,896        12,347
     (Gain) loss on disposition of equipment..........           --            --        82,052
     (Increase) decrease in other assets..............        2,557        18,860       (31,374)
     Changes in current assets and current
       liabilities....................................     (396,435)   (1,592,215)      (97,073)
                                                        -----------   -----------   -----------
Net cash provided by (used in) operating activities...    3,068,860      (951,477)      460,724
                                                        -----------   -----------   -----------
Cash flows from investing activities:
  Purchases of land, buildings and equipment..........   (1,093,087)   (2,826,230)   (2,552,511)
  Proceeds from sale of equipment.....................           --            --        35,000
                                                        -----------   -----------   -----------
Net cash used in investing activities.................   (1,093,087)   (2,826,230)   (2,517,511)
                                                        -----------   -----------   -----------
Cash flows from financing activities:
  Proceeds from issuance of notes.....................      200,000     4,500,000       950,000
  Payments on notes...................................     (650,267)     (767,313)     (779,677)
  (Increase) decrease in outstanding advances on
     factored receivables.............................   (1,263,573)      456,337       487,568
  Debt acquisition costs..............................     (476,470)     (423,434)     (360,521)
  Proceeds from exercise of stock options and
     warrants, net....................................      366,509       428,573     1,332,096
                                                        -----------   -----------   -----------
Net cash provided by (used in) financing activities...   (1,823,801)    4,194,163     1,629,466
                                                        -----------   -----------   -----------
Increase in cash......................................      151,972       416,456      (427,321)
Cash, beginning of period.............................      603,629       187,173       614,494
                                                        -----------   -----------   -----------
Cash, end of period...................................  $   755,601   $   603,629   $   187,173
                                                        ===========   ===========   ===========
</Table>

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

                                       F-6
<PAGE>

              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                         NOTES TO FINANCIAL STATEMENTS

NOTE 1:  DESCRIPTION OF THE COMPANY

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

NOTE 2:  FUTURE OPERATIONS

     The financial statements of the Company have been prepared on the basis of
accounting principles applicable to a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. At December 31, 2001, the Company had a working capital deficit of
$4.5 million and had incurred net losses of approximately $2.2 million and $1.8
million for the years ended December 31, 2000 and 1999, respectively. With the
exception of 2001, the Company has incurred net losses in each year since its
inception and has never operated at successful manufacturing levels over an
extended period. Further, the Company has limited additional financial resources
available to support its operations, and in the past few years has, in large
part, been supported by certain major shareholders and several accredited
investors. There is no commitment for such shareholders or accredited investors
to continue such support. As discussed in the following paragraphs, the Company
will require additional financial resources in order to complete its production
plan and fund maturities of debt and other obligations as they become due.

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

     The Company is continuing to implement a production plan, which management
believes will continue to provide better operating efficiencies and correct the
production problems encountered in the past. The plan includes increasing
production capacity, further automating the production process and better
utilizing regrindable scrap. If the Company is successful in breaking escrow of
the $16.5 million bond proceeds, as discussed in Note 5, the Company anticipates
reducing its working capital deficit by paying off the bridge notes payable and
being reimbursed for significant working capital used to purchase equipment for
its Springdale plant. There is no assurance the Company will be successful in
meeting the standards required to receive the bond financing proceeds or in
obtaining necessary financial resources from other sources.

     Completion of the production plan will require that the Company receive the
proceeds from the bond financing or obtain additional debt or equity financing
beyond those resources currently available to the Company. Also, additional
financial resources will be necessary to fund maturities of debt and other
obligations as they come due in 2002. There is no assurance the Company will be
able to correct prior production problems and improve operating efficiencies or
that the Company will be successful in securing capital resources to complete
its production plan, fund maturities of debt and other obligations as they
                                       F-7
<PAGE>
              ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

become due in 2002 or to support the Company until such time, if ever, that the
Company is able to consistently generate income from operations.

NOTE 3:  SIGNIFICANT ACCOUNTING POLICIES

  REVENUE RECOGNITION POLICY

     Revenue is recognized at the time of shipment.

  STATEMENTS OF CASH FLOWS

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

<Table>
<Caption>
                                                        YEAR ENDED DECEMBER 31,
                                                 -------------------------------------
                                                    2001          2000         1999
                                                 -----------   -----------   ---------
<S>                                              <C>           <C>           <C>
Receivables....................................  $(1,352,504)  $  (403,459)  $(824,752)
Inventories....................................     (575,046)     (382,895)   (428,200)
Prepaid expenses and other.....................      231,896        94,561     (69,135)
Accounts payable --
  Trade and related parties....................    1,207,849    (1,263,507)    602,426
Accrued liabilities............................       91,370       363,085     498,473
                                                 -----------   -----------   ---------
                                                 $  (396,435)  $(1,592,215)  $(221,188)
                                                 ===========   ===========   =========
Cash paid for interest.........................  $ 2,323,597   $ 1,437,703   $ 218,296
                                                 ===========   ===========   =========
</Table>

     Supplemental Disclosures of Non-cash Investing and Financing Activities:

<Table>
<Caption>
                                                         YEAR ENDED DECEMBER 31,
                                                   -----------------------------------
                                                     2001        2000         1999
                                                   --------   ----------   -----------
<S>                                                <C>        <C>          <C>
Notes payable for financing of insurance
  policies.......................................  $250,116   $  186,988   $   133,038
Accounts/notes payable for equipment.............   329,899    1,348,530     2,125,547
Bond financing proceeds received in escrow.......        --           --    16,500,000
Class A common stock issued in payment of debt...        --
  acquisition costs..............................        --      431,250            --
Capital lease obligation for equipment...........        --       25,192
Stock issued in payment of notes payable.........        --      200,000            --
Receivable from exercise of stock options........        --           --        26,375
</Table>

  BUILDINGS AND EQUIPMENT

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

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

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

     Provision for depreciation of buildings and equipment is provided on a
straight-line basis for buildings, leasehold improvements, machinery,
transportation equipment and office equipment over the lesser of the estimated
useful life of the asset or the term of the lease. Depreciation expense
recognized by the Company for the years ended December 31, 2001, 2000 and 1999
was approximately $2.8 million, $2.3 million and $1.8 million, respectively.
Estimated useful lives are: buildings -- 5 to 19 years, leasehold
improvements -- 6 years, transportation equipment -- 3 to 5 years, office
equipment -- 5 years and machinery and equipment -- 3 to 8 years. The Company
had $4,212,984 of fully depreciated assets as of December 31, 2001.

     The Company has adopted Statement of Financial Accounting Standards (SFAS)
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets and for
Long-Lived Assets". SFAS 144 addresses the financial accounting and reporting
for the impairment or disposal of long-lived assets. SFAS supersedes FASB
Statement No. 121 but retains Statement 121's fundamental provisions for (a)
recognition/measurement of impairment of long-lived assets to be held and used
and (b) measurement of long-lived assets to be disposed of by sale. SFAS No. 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.

     The Company has assessed the recoverability of its investment in long-lived
assets to be held and used in operations under the guidelines set forth in SFAS
No. 144 and has determined that no impairment loss was required as of December
31, 2001. Such assessment required the Company to make certain estimates of
future production volumes, costs, sales volumes and prices, which are expected
to occur over the remaining useful lives of its long-lived assets. Such
long-lived assets primarily consist of the Company's Springdale and Junction
manufacturing facilities. The Company's estimates of these factors are based
upon management's belief that future production volumes will significantly
increase over previous historical production levels achieved by the Company's
manufacturing facilities and that future production costs per unit will also
decrease below previous historical cost levels. Actual performance could
materially differ from these estimates.

  INVENTORIES

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

<Table>
<Caption>
                                                                 2001         2000
                                                              ----------   ----------
<S>                                                           <C>          <C>
Raw materials...............................................  $1,221,419   $  682,841
Work in process.............................................     639,907      508,688
Finished goods..............................................     371,386      466,137
                                                              ----------   ----------
                                                              $2,232,712   $1,657,666
                                                              ==========   ==========
</Table>

  OTHER ASSETS

     At December 31, 2001 and 2000, respectively, other assets consisted
primarily of debt acquisition costs in the amount of $1,557,761 and $1,158,802,
net, which are amortized over the term of the related debt, and the costs for
the preparation of patent applications of $235,879 and $264,453, net, which are
amortized using the straight-line method over 17 years.

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

  USE OF ESTIMATES

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

  SFAS NO. 125

     The Company accounts for transfers of receivables, with recourse, to a
related party under the guidelines of SFAS No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities", (SFAS
125). This statement provides accounting and reporting standards for, among
other things, the transfer and servicing of financial assets, such as transfers
of receivables with recourse, and provides standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings. Based on the requirements of SFAS No. 125, the receivables
transferred to the related party with recourse are accounted for as a secured
borrowing because the Company is not considered to have surrendered control over
the transferred assets. Accounts receivable and accounts payable-related parties
at December 31, 2001 and 2000, include $2,902,925 and $1,639,351, respectively,
to reflect these requirements (see Note 4).

  SFAS NO. 128

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

     In computing Diluted EPS, only potential common shares that are
dilutive -- those that reduce earnings per share or increase loss per
share -- are included. Exercise of options and warrants or conversion of
convertible securities is not assumed if the result would be antidilutive, such
as when a loss from continuing operations is reported. The "control number" for
determining whether including potential common shares in the Diluted EPS
computation would be antidilutive is income from continuing operations. As a
result, if there is a loss from continuing operations, Diluted EPS would be
computed in the same manner as Basic EPS is computed, even if an entity has net
income after adjusting for discontinued operations, an extraordinary item or the
cumulative effect of an accounting change. The

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Company has incurred losses from continuing operations and net losses for the
years ended December 31, 2000 and 1999. Therefore, Basic EPS and Diluted EPS are
computed in the same manner for those years.

<Table>
<Caption>
                                                          YEAR ENDED DECEMBER
                                                ---------------------------------------
                                                   2001          2000          1999
                                                -----------   -----------   -----------
<S>                                             <C>           <C>           <C>
Net income (loss) (A).........................  $   312,864   $(2,206,521)  $(1,763,736)
                                                ===========   ===========   ===========
Assumed exercise of stock options and
  warrants....................................   19,026,734            --
Application of assumed proceeds of $9,509,966
  toward repurchase of stock at average market
  prices of $1.01 per share for the year ended
  December 31, 2001...........................   (9,415,808)           --
                                                -----------   -----------   -----------
Net additional shares issuable................    9,610,926            --
                                                ===========   ===========   ===========
Adjustment of shares outstanding:
  Weighted average common shares
     outstanding..............................   27,565,825    26,059,013    24,598,715
  Net additional shares issuable..............    9,610,926            --
                                                -----------   -----------   -----------
  Adjusted shares outstanding (B).............   37,176,751    25,059,013    24,598,715
                                                ===========   ===========   ===========
Net income (loss) per common share
  -- Diluted (A) divided by (B)...............  $      0.01   $     (0.08)  $     (0.07)
                                                ===========   ===========   ===========
</Table>

     The Company has additional options and warrants that were not included in
the calculation of diluted earnings per share (EPS). Those options (1,168,500
for the year ended December 31, 2001) and warrants (5,109,204 for the year ended
December 31, 2001) were either antidilutive and/or not exercisable at December
31, 2001. 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.

  CONCENTRATIONS OF CREDIT RISK

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

<Table>
<Caption>
                                                              2001    2000    1999
                                                              ----    ----    ----
<S>                                                           <C>     <C>     <C>
Weyerhaeuser................................................   82%     72%     50%
Therma-Tru..................................................    6%     12%     21%
</Table>

  DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

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

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

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

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

  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 4:  RELATED PARTY TRANSACTIONS

     During 2001, the Company had an agreement with an affiliate, Brooks
Investment Co., controlled by Marjorie S. Brooks whereby the Company agreed to
transfer certain of its trade receivables as collateral, which the affiliate
deemed acceptable, up to $2.5 million at any one time. Upon acceptance of a
transfer of a receivable, the affiliate remitted to the Company 85% of the
receivable, as defined in the agreement. Through September 30, 2001, upon
collection of the receivable, the Company remitted to the affiliate 1.75% of the
receivable as a factoring charge and the additional 13.25% of the receivable was
remitted to the Company, less interest costs, which were based on the time
period over which the receivable was outstanding. On October 1, 2001, the
factoring charge decreased to 0.8%. The Company indemnified the affiliate for
any loss arising out of rejections or returns of any merchandise, or any claims
asserted by the Company's customers. During 2001, the Company transferred an
aggregate of approximately $34 million in receivables under this agreement, of
which $3.3 million remained to be collected as of December 31, 2001. During 2000
and 1999, the Company transferred an aggregate of approximately $28.2 million
and $20.5 million, respectively, in receivables under this agreement, none of
which remains to be collected. Costs of approximately $517,349, $470,794 and
$202,034 associated with the factoring agreement were included in selling and
administrative costs at December 31, 2001, 2000 and 1999, respectively.

     At December 31, 2001, accounts payable-related parties included advances on
factored receivables of approximately $2.9 million and $388,000 relating to
other items owed to related parties.

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5:  NOTES PAYABLE AND LONG-TERM DEBT

  NOTES PAYABLE -- OTHER

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

<Table>
<Caption>
                                                                 2001         2000
                                                              ----------   ----------
<S>                                                           <C>          <C>
12% notes payable, due on demand............................  $  350,000   $  350,000
12% notes payable (the bridge financing), interest payable
  quarterly in shares of the Company's Class A common stock
  or cash, principal due in cash on December 31, 2002. The
  effective interest rate on the debt, including the effects
  on debt discounts from stock warrant issuances, was
  61.8%.....................................................     600,000      750,000
12% notes payable (the bridge financing), interest payable
  quarterly in shares of the Company's Class A common stock
  or cash, principal due in cash on December 31, 2002. The
  effective interest rate on the debt, including the effects
  on debt discounts from stock warrant issuances, was
  188.9%....................................................     410,000      410,000
12% notes payable (the bridge financing), interest payable
  quarterly in shares of the Company's Class A common stock
  or cash, principal due in cash on December 31, 2002. The
  effective interest rate on the debt, including the effects
  on debt discounts from stock warrant issuances, was
  57.8%.....................................................     359,963      359,963
12% notes payable (the bridge financing), interest payable
  quarterly in shares of the Company's Class A common stock
  or cash, principal due in cash on December 31, 2002. The
  effective interest rate on the debt, including the effects
  on debt discounts from stock warrant issuances, was
  37.1%.....................................................     287,500      287,500
Other.......................................................      58,114       40,905
                                                              ----------   ----------
Total.......................................................  $2,065,577   $2,198,368
                                                              ==========   ==========
</Table>

     The Company has had five-bridge financing agreements. The first was
completed on October 30, 1997, and was paid off in 2001. The second bridge
financing was completed on February 5, 1998. The Company issued notes payable
totaling $800,000 which were originally due and payable on November 2, 1998, but
have since been extended without penalty warrants to the earlier of December 31,
2002 and the release of at least $9 million of the escrowed bond funds. Interest
on the notes is payable every three months at 12% in either cash or the
Company's Class A common stock, at the option of the Company. In connection with
the notes, the Company issued 1,600,000 consulting warrants and 96,000 placement
warrants and paid loan origination costs of $104,000 to the placement agent. If
the notes are extended beyond December 31, 2002, the Company may be required to
issue 448,000 penalty warrants (400,000 consulting warrants and 48,000 placement
warrants). The warrants expire February 5, 2003, and are exercisable at a price
of $0.375 per share of Class A common stock for each warrant exercised. In 2000
and 2001, $50,000 and $150,000, respectively, was paid on the notes bringing the
note balance to $600,000 at December 31, 2001.

     A third bridge financing was completed on April 7, 1998. The Company issued
notes payable totaling $410,000 which were originally due and payable on January
2, 1999, but have since been extended without penalty warrants to the earlier of
December 31, 2002 and the release of at least $9 million of the escrowed bond
funds. Interest on the notes is payable every three months at 12% in either cash
or the Company's Class A common stock, at the option of the Company. In
connection with the notes, the Company issued 820,000 consulting warrants and
49,200 placement warrants and paid loan origination costs of $53,300 to

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

the placement agent. If the notes are extended beyond December 31, 2002, an
additional 205,000 consulting warrants and 24,600 placement warrants may be
issued. The warrants expire April 7, 2003, and are exercisable at a price of
$0.375 per share of Class A common stock for each warrant exercised.

     A fourth bridge financing was completed on June 3, 1998. The Company issued
notes payable totaling $359,963 which were originally due and payable on
February 28, 1999, but have since been extended without penalty warrants to the
earlier of December 31, 2002 and the release of at least $9 million of the
escrowed bond funds. Interest on the notes is payable every three months at 12%
in either cash or the Company's Class A common stock, at the option of the
Company. In connection with the notes, the Company issued 719,926 consulting
warrants and 43,195 placement warrants and paid loan origination costs of
$46,795 to the placement agent. If the notes are extended beyond December 31,
2002, an additional 179,981 consulting warrants and 21,597 placement warrants
may be issued. The warrants expire June 3, 2003, and are exercisable at a price
of $0.375 per share of Class A common stock for each warrant exercised.

     A fifth bridge financing was completed on August 21, 1998. The Company
issued notes payable totaling $287,500 which were originally due and payable on
May 18, 1999, but have since been extended without penalty warrants to the
earlier of December 31, 2002 and the release of at least $9 million of the
escrowed bond funds. Interest on the notes is payable every three months at 12%
in either cash or the Company's Class A common stock, at the option of the
Company. In connection with the notes, the Company issued 575,000 consulting
warrants and 34,500 placement warrants and paid loan origination costs of
$37,375 to the placement agent. If the notes are extended beyond December 31,
2002, an additional 143,750 consulting warrants and 17,250 placement warrants
may be issued. The warrants expire August 21, 2003, and are exercisable at a
price of $0.375 per share of Class A common stock for each warrant exercised.

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

  NOTES PAYABLE -- RELATED PARTIES

     Notes payable to related parties consisted of two notes payable to an
investment company owned by a significant shareholder, a note payable directly
to that significant shareholder and a note payable to an investment holding
company controlled by one of the Company's directors. During 2000, $150,000 of
the outstanding principal balance on one of these notes was converted to Class A
common stock at a conversion price of $1 per share, which approximated fair
value. This transaction is considered a non-cash financing activity for
statement of cash flows purposes. The outstanding principal balance at December
31, 2001 on each note was $100,000, $150,000, $100,000 and $100,000,
respectively. The first two notes are due on demand and include interest at a
fixed rate of 10%. The second two notes are due June 3, 2002 and include
interest at a fixed rate of 8.5%.

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

  LONG-TERM DEBT

     Long-term debt, less current maturities consisted of the following at
December 31:

<Table>
<Caption>
                                                                 2001         2000
                                                              ----------   ----------
<S>                                                           <C>          <C>
13.25% notes payable, due in monthly installments of $6,030,
  secured by certain manufacturing equipment, maturing
  January 1, 2003...........................................  $   72,655   $  126,530
9.75% note payable to Arkansas State Bank, due in monthly
  installments of $49,156, secured by real estate and
  improvements, fixed assets, assignment of life insurance
  policy, personal guarantee of certain stockholders and an
  80% USDA Department of Rural Development guarantee,
  maturing February 23, 2015.(a)............................   4,349,459    4,500,000
Other.......................................................     194,270      102,315
                                                              ----------   ----------
Total.......................................................   4,616,384    4,728,845
Less current maturities.....................................    (313,182)    (242,689)
                                                              ----------   ----------
Long-term debt, net of current maturities...................  $4,303,202   $4,486,156
                                                              ==========   ==========
</Table>

---------------

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

     The aggregate maturities of long-term debt, net of debt discount, as of
December 31, 2001, are as follows:

<Table>
<Caption>
YEAR                                                             AMOUNT
----                                                           ----------
<S>                                                            <C>
2002........................................................   $  313,182
2003........................................................      270,353
2004........................................................      250,503
2005........................................................      238,936
2006........................................................      255,643
Thereafter..................................................    3,287,767
                                                               ----------
                                                               $4,616,384
                                                               ==========
</Table>

  BONDS PAYABLE

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

     Proceeds of the Bonds were deposited as follows: $112,814 of the proceeds
were deposited in the Issuance Expense Fund while the remaining $16,387,186 were
deposited in the Project Fund and invested until the Reset Date (July 16, 2002).
Any interest or other gain realized as a result of any investments of monies
from the Project Fund shall be retained in or transferred to the Project Fund.
Should the escrow funds be devalued by the Reset Date, the Company is liable for
any deficiencies.

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

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

     The Bonds are issuable only as fully registered bonds in the minimum
denominations of $100,000 and in any integral multiple of $5,000 in excess
thereof. At or prior to disbursement of proceeds from the Project Fund, assuming
proceeds of the Bonds have not been used to redeem the Bonds, the Company must
deliver to the Trustee such general items as project plans and specifications,
cost estimates, construction contracts and insurance coverage. Although the
Bonds will be called if the Company does not break escrow by the Reset Date, if
a negative arbitrage position does not exist, it is possible that the bondholder
will waive/roll the call for another year or sell to another investor. However,
the risk does exist that if another investor cannot be identified, the Company
will be required to buy back the Bonds at the Reset Date.

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

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

     The Bonds are subject to mandatory sinking fund redemption at a redemption
price equal to 100 percent of the principal amount thereof and accrued interest
to the redemption date. As of October 1 of each year, subsequent to the year the
bonds break escrow, there shall be deposited in the Bond Principal Fund and Bond
Interest Fund a sum which is sufficient to redeem the following principal
amounts and accrued interest to the redemption date:

<Table>
<Caption>
YEAR                                                             AMOUNT
----                                                           -----------
<S>                                                            <C>
2002........................................................   $         0
2003........................................................       200,000
2004........................................................       170,000
2005........................................................       185,000
2006........................................................       200,000
Thereafter..................................................    15,745,000
                                                               -----------
                                                               $16,500,000
                                                               ===========
</Table>

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

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 6:  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. 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
6,196,656 shares of Class A common stock for conversion under the preferred
stock agreement. During 2001, the Company converted $290,000 of accrued premiums
to common stock at a conversion price of $0.81 per share. This transaction is
considered a non-cash financing activity for statement of cash flow purposes.

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

     The preferred stock agreements 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.

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

  WARRANTS

     The Company has reserved 17,298,501 shares of the Company's Class A common
stock for issuance under the following warrant agreements.

  Class B Warrants

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

  Class C Warrants

     Each Class C Warrant is exercisable into one share of Class A common stock
at an exercise price of $1.075 per share. During 1998, the Company received net
proceeds of $330,000 from the exercise of

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

275,000 Class C Warrants. One Bonus Warrant (described below) was granted to the
holder for each warrant exercised. On February 12, 1999, 50,000 Class C Warrants
expired. The remaining 325,000 Class C Warrants expire in June 2003.

  Class F Warrants

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

  Class G Warrants

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

  Class H Warrants

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

  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, 29,367 Class I Warrants were exercised at a price of $0.9375 per
share, resulting in proceeds of $27,532, and 42,866 Class I Warrants expired.
Also in 1999, 321,111 Class I Warrants were extended to June 22, 2003. In 2001,
45,616 Class I Warrants were exercised at prices ranging from $0.31 to $0.9375
per share, resulting in proceeds of $22,048.

  Class J and K Warrants

     In December 1996, in connection with a note payable of $100,000, the
Company authorized and issued two sets of Warrants, Class J for 200,000 and
Class K for 150,000. Each Class J and Class K

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Warrant is exercisable on a one-for-one basis into common stock. Each Class J
Warrant is exercisable at $0.50 per share and each Class K Warrant is
exercisable at $0.75 per share. In 2000, 100,000 shares of Class J Warrants were
exercised at a price of $0.50 per share, through the conversion of a note
payable to the warrant holder of $50,000. This transaction is considered a
non-cash financing transaction for statement of cash flow purposes. The
remaining 100,000 Class J Warrants and 150,000 Class K Warrants were exercised
in 2001.

  X and Y Warrants Issued in Connection with Preferred Stock

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

  X and Y Warrants to Placement Agent

     The Series A preferred stock shares were placed through a placement agent.
The placement agent and certain officers of the placement agent were given
Series X Warrants to purchase, in the aggregate, 278.33 shares of the Company's
common stock for each $1,000 of purchase price (417,495 shares) and Series Y
Warrants to purchase, in the aggregate, 102.7 shares of the Company's common
stock for each $1,000 of Purchase Price (154,050 shares). The Series X Warrants
are exercisable for a period of six years from the first anniversary of the date
of issuance at a price per share equal to $1.20 and the Series Y Warrants are
exercisable for a period of five years from the second anniversary of the date
of issuance at a price per share equal to $2.50. No placement agent was used for
the Series B and C shares.

  Bonus Warrants

     In connection with the exercise of the Class B and C Warrants during 1998
and 1999, the Company granted a new warrant on a one-for-one basis for each
Class B and C Warrant exercised. The Bonus Warrants, 1,054,670 and 257,994
issued in 1998 and 1999, respectively, were originally to expire February 12,
2001, but were extended to June 22, 2003, and are exercisable at a price of
$3.00 per share of Class A common stock for each Bonus Warrant exercised.

  Consulting and Placement Warrants

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

     In February 1998, the Company obtained bridge financing of $800,000 (see
Note 5). In connection with the financing obtained, 1,696,000 stock warrants
were issued. The stock warrants expire on February 5, 2003, and are exercisable
at a price of $0.375 per share of Class A common stock for each

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

warrant exercised. The debt and stock warrants were recorded at their estimated
fair market value at the date of the transaction. The value of the stock
warrants was treated as a debt discount and amortized over the life of the loan
as interest expense. In 2000 and 2001, 69,334 and 59,334 consulting warrants
were exercised at a price of $0.375 resulting in proceeds of $26,000 and
$22,250, respectively. In 2000 and 2001, 21,240 and 13,427 placement warrants
were exercised at a price of $0.375 per share resulting in proceeds of $7,965
and $5,035, respectively.

     In April 1998, the Company obtained bridge financing of $410,000 (see Note
5). In connection with the financing obtained, 869,200 stock warrants were
issued. The stock warrants expire on April 7, 2003, and are exercisable at a
price of $0.375 per share of Class A common stock for each warrant exercised.
The debt and stock warrants were recorded at their estimated fair market value
at the date of the transaction. The value of the stock warrants was treated as a
debt discount and amortized over the life of the loan as interest expense. In
2001, 60,000 consulting warrants and 3,099 placement warrants were exercised at
a price of $0.375 per share resulting in proceeds of $23,662.

     In June 1998, the Company obtained bridge financing of $359,963 (see Note
5). In connection with the financing obtained, 763,121 stock warrants were
issued. The stock warrants expire on June 3, 2003, and are exercisable at a
price of $0.375 per share of Class A common stock for each warrant exercised.
The debt and stock warrants were recorded at their estimated fair market value
at the date of the transaction. The value of the stock warrants was treated as a
debt discount and amortized over the life of the loan as interest expense. In
2001, 80,000 consulting warrants were exercised at a price of $0.375 per share
resulting in proceeds of $30,000.

     In August 1998, the Company obtained bridge financing of $287,500 (see Note
5). In connection with the financing obtained, 609,500 stock warrants were
issued. The stock warrants expire on August 21, 2003, and are exercisable at a
price of $0.375 per share of Class A common stock for each warrant exercised.
The debt and stock warrants were recorded at their estimated fair market value
at the date of the transaction. The value of the stock warrants was treated as a
debt discount and amortized over the life of the loan as interest expense. In
2001, 8,624 placement warrants were exercised at a price of $0.375 per share
resulting in proceeds of $3,234.

  Extension Warrants

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

  Series Z Placement Warrants

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

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

     At December 31, 2001, the Company had outstanding warrants as follows:

<Table>
<Caption>
                                                          WARRANTS FOR
                                                            CLASS A      WEIGHTED AVERAGE
                                                          COMMON STOCK    EXERCISE PRICE
                                                          ------------   ----------------
<S>                                                       <C>            <C>
Class C Warrants........................................      325,000         $1.075
Class F Warrants........................................      987,040           0.61
Class G Warrants........................................    2,987,040           0.92
Class H Warrants........................................    1,771,792           0.47
Class I Warrants........................................      275,495           0.70
Series X Warrants.......................................    1,999,162           1.20
Series Y Warrants.......................................      867,500           2.50
Series X Warrants -- Placement Agent....................      417,503           1.20
Series Y Warrants -- Placement Agent....................      153,769           2.50
Bonus Warrants..........................................    1,312,664           3.00
Consulting Warrants.....................................    5,386,258          0.375
Placement Warrants......................................      205,278          0.375
Extension Warrants......................................      310,000          0.375
Series Z Placement Warrants.............................      300,000           1.00
                                                           ----------         ------
                                                           17,298,501         $ 0.96
                                                           ==========         ======
</Table>

     In order to remain listed on the Nasdaq SmallCap Market, all publicly held
companies must meet certain criteria (maintenance standards) established by the
Nasdaq. Increased listing and maintenance standards include a minimum bid of
$1.00 common stock price and a $2 million net asset value. As of December 31,
2001, the Company's closing stock price was $1.15, and its net asset value was
$4,198,754. There is no guarantee that in the future the stock price will
continue above the $1.00 minimum bid price or that the net assets will not fall
below the $2 million amount required by Nasdaq.

     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 with the exception of warrants that are
indexed to and potentially settled in the Company's common stock. 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 from the cumulative effect
of a change in accounting principle.

     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%.

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 7:  STOCK OPTION PLANS

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

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

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

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

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

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

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

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

     A summary of the activity in the Company's Stock Option Plans during the
years ended December 31, 2001, 2000 and 1999, follows:

<Table>
<Caption>
                                         2001                   2000                   1999
                                 --------------------   --------------------   --------------------
                                             WEIGHTED               WEIGHTED               WEIGHTED
                                             AVERAGE                AVERAGE                AVERAGE
                                             EXERCISE               EXERCISE               EXERCISE
                                  SHARES      PRICE      SHARES      PRICE      SHARES      PRICE
                                 ---------   --------   ---------   --------   ---------   --------
<S>                              <C>         <C>        <C>         <C>        <C>         <C>
Outstanding, beginning of
  year.........................  4,690,130    $0.84     5,484,500    $0.77     4,473,000    $0.67
Granted........................    575,000     1.13       200,000     2.02     1,350,000     1.29
Exercised......................    (75,000)    0.66      (465,000)    0.55      (132,500)    1.22
Forfeited......................         --       --      (529,370)    0.80      (206,000)    1.73
                                 ---------    -----     ---------    -----     ---------    -----
Outstanding, end of year.......  5,190,130    $0.93     4,690,130    $0.84     5,484,500    $0.77
</Table>

     The following table summarizes information about stock options outstanding
under the Company's Stock Option Plans as of December 31, 2001:

<Table>
<Caption>
                                          OPTIONS OUTSTANDING               OPTIONS EXERCISABLE
                                ---------------------------------------   -----------------------
                                  NUMBER        WTD. AVG.     WTD. AVG.     NUMBER      WTD. AVG.
                                OUTSTANDING     REMAINING     EXERCISE    EXERCISABLE   EXERCISE
RANGE OF EXERCISE PRICES        AT 12/31/01   CONTRACT LIFE     PRICE     AT 12/31/01     PRICE
------------------------        -----------   -------------   ---------   -----------   ---------
<S>                             <C>           <C>             <C>         <C>           <C>
$0.38-$0.48...................   1,192,667     4.15 years       $0.44      1,192,667      $0.44
$0.56-$1.00...................   2,828,963     4.61 years       $0.75      2,828,963      $0.75
$1.19-$1.47...................     543,500     4.84 years       $1.27        143,500      $1.29
$1.75-$2.75...................     625,000     4.59 years       $2.02        175,000      $2.18
                                 ---------     ----------       -----      ---------      -----
                                 5,190,130     4.52 years       $0.93      4,340,130      $0.74
</Table>

     The weighted-average fair value of options granted during 2001, 2000 and
1999 was $0.87, $1.77 and $0.94, respectively. SFAS No. 123, "Accounting for
Stock-Based-Compensation", issued by the FASB in October 1995, encourages but
does not require companies to measure and recognize in their financial
statements a compensation cost for stock-based employee compensation plans based
on the "fair value" method of accounting set forth in the statement. The Company
continues to account for its stock option plans and other stock-based
compensation using the "intrinsic value" method of accounting set forth in
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees", and related interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the Company's common stock at the date of the grant over the amount an employee
must pay to acquire the stock. Had compensation cost for the Company's stock
option plans and other stock-based compensation been determined consistent with
SFAS No. 123, the Company's net

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

income (loss) and net income (loss) per share of common stock would have been
reduced (increased) to the following pro forma amounts:

<Table>
<Caption>
                                                   2001          2000          1999
                                                -----------   -----------   -----------
<S>                                             <C>           <C>           <C>
Net income (loss) applicable to common stock
  As Reported.................................  $   312,864   $(2,206,521)  $(1,763,736)
  Pro-Forma...................................     (184,819)   (2,549,574)   (2,445,990)
Net income (loss) per share of common stock
  (Basic and Diluted)
  As Reported.................................  $       .01   $      (.08)  $      (.07)
  Pro Forma...................................         (.01)         (.10)         (.10)
</Table>

     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 2001, 2000 and 1999, respectively: risk-free
interest rates of 4.9, 5.8 and 5.4 percent; expected lives of 7, 9 and 5 years;
and expected volatilities of 103, 94.6 and 90.5 percent. Since no dividends are
expected to be paid by the Company during the expected lives of the options, a
dividend yield of zero was used for purposes of computing the fair value of the
options.

NOTE 8:  LEASES

     During 2001, the Company was obligated under a non-cancelable lease with a
principal stockholder for land and a building where a production facility is
located. This lease had an expiration date of April 30, 2001, and rental
payments of $1,519 per month. Upon the expiration of the lease, the Company
exercised its rights to purchase the facility. In 1997, the Company entered into
a non-cancelable sublease for a production facility which expires August 31,
2002. Lease payments on the facility are $19,000 per month. The sublease
contains an option to purchase the facility for $1.8 million, exercisable at any
time during the sublease, and a renewal option to lease the property for an
additional five years at an increased rate. At December 31, 2001, the Company
was obligated under various operating leases covering certain equipment. Rent
expense under operating leases for the years ended December 31, 2001, 2000 and
1999 was $671,762, $695,478 and $609,586, respectively. Future minimum lease
payments required under operating leases as of December 31, 2001, are as
follows:

<Table>
<Caption>
YEAR                                                             AMOUNT
----                                                           ----------
<S>                                                            <C>
2002........................................................   $  588,211
2003........................................................      325,449
2004........................................................      275,527
2005........................................................      257,995
2006........................................................      257,995
                                                               ----------
Total minimum payments required.............................   $1,705,177
                                                               ==========
</Table>

NOTE 9:  INCOME TAXES

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

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

     As of December 31, 2001, the Company had net operating loss carryforwards
of approximately $23 million for federal income tax purposes, which are
available to reduce future taxable income and will expire in 2004 through 2021,
if not utilized.

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

<Table>
<Caption>
                                                        YEAR ENDED DECEMBER 31,
                                                ---------------------------------------
                                                   2001          2000          1999
                                                -----------   -----------   -----------
<S>                                             <C>           <C>           <C>
Deferred tax assets --
  Net operating loss carryforwards............  $ 8,125,000   $ 8,014,000   $ 7,509,000
  Valuation allowance.........................   (7,301,000)   (7,450,000)   (6,961,000)
                                                -----------   -----------   -----------
     Total deferred tax assets................      824,000       564,000       548,000
Deferred tax liability --
  Depreciation................................      824,000       564,000       548,000
                                                -----------   -----------   -----------
     Net deferred tax.........................  $        --   $        --   $        --
                                                ===========   ===========   ===========
</Table>

     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, a valuation allowance of approximately $7.3 million has
been established at December 31, 2001, to recognize its deferred tax assets only
to the extent of its deferred tax liabilities. The Company will continue to
evaluate the need for such valuation allowance in the future.

NOTE 10:  COMMITMENTS AND CONTINGENCIES

     The Company was a counterclaim defendant in a federal action in Texas,
involving allegations from a former employee and officer of the Company that the
Company breached an employment agreement by terminating employment. The Company
believed this action was without merit and vigorously defended itself. The
Company prevailed at trial with no award of damages and plaintiff's appeal was
dismissed for lack of prosecution as of October 24, 2001. The plaintiffs appeal
was subsequently reinstated and is pending.

     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 are 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 and also sued two of our founders personally,
as well as the Company. A bench trial began during the fourth quarter 2001, and
post-trial brief concluded in February 2002, and the case is now awaiting
decision from the court. The Company believes these allegations are unfounded
and without merit and is defending itself accordingly.

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

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

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

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, 2001, 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:

<Table>
<Caption>
                                                        YEAR ENDED DECEMBER 31,
                                                ---------------------------------------
                                                   2001          2000          1999
                                                -----------   -----------   -----------
<S>                                             <C>           <C>           <C>
Net Sales --
  Commercial and residential decking surface
     components...............................  $26,621,821   $19,725,608   $10,314,728
  Exterior door, window and housing trim
     components...............................    5,977,555     6,896,334     9,311,095
  Industrial flooring.........................      579,606       886,922       291,310
                                                -----------   -----------   -----------
                                                $33,178,982   $27,508,864   $19,917,133
                                                ===========   ===========   ===========
</Table>

<Table>
<Caption>
                                                    YEAR ENDED DECEMBER 31,
                        --------------------------------------------------------------------------------
                                  2001                        2000                        1999
                        -------------------------   -------------------------   ------------------------
                        SPRINGDALE     JUNCTION     SPRINGDALE     JUNCTION     SPRINGDALE    JUNCTION
                        -----------   -----------   -----------   -----------   ----------   -----------
<S>                     <C>           <C>           <C>           <C>           <C>          <C>
Gross Margin --
  Net revenues........  $19,249,421   $13,929,561   $15,225,413   $12,283,451   $9,193,900   $10,723,233
  Cost of goods
     sold.............   13,210,982    10,754,680    12,680,692     9,970,047    8,632,047     8,533,978
                        -----------   -----------   -----------   -----------   ----------   -----------
  Gross margin........  $ 6,038,439   $ 3,174,881   $ 2,544,721   $ 2,313,404   $  561,853   $ 2,189,255
                        ===========   ===========   ===========   ===========   ==========   ===========
</Table>

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-deductible contributions to the Plan. The Plan provides that the
Company may elect to make employer-matching contributions equal to a percentage
of each participant's voluntary contribution. The Company may also elect to make
a profit sharing contribution to the Plan. Profit sharing contributions to the
Plan can range from 0% to 15% of participants' annual compensation. During 2001,
no matching or profit sharing contributions were made to the Plan.

                                       F-26
<PAGE>

                               INDEX TO EXHIBITS

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

<Table>
<Caption>
EXHIBIT
NUMBER                                DESCRIPTION
-------                               -----------
<C>      <C>  <S>
 10.31    --  Factoring Agreement dated April 30, 1994 between the
              Registrant and Brooks Investment Company.(i)
 10.32    --  Lease agreement dated July 29, 1997 between Registrant and
              Dwain A. Newman, et ux., and National Home Center, Inc.(n)
 10.33    --  Securities Purchase Agreement.(p)
 10.34    --  Certificate of Designation of Series A Preferred Convertible
              Stock.(p)
 10.35    --  Certificate of Designation of Series B Preferred Convertible
              Stock.(p)
 10.36    --  Certificate of Designation of Series C Preferred Convertible
              Stock.(p)
 10.37    --  Form of Series X Warrants.(p)
 10.38    --  Form of Series Y Warrants.(p)
 10.39    --  Registration Rights Agreement.(p)
 10.40    --  Placement Agency Agreement.(p)
</Table>

---------------

 *   The Registrant has no exhibits corresponding to Exhibits 1, 2, 5, 6, 7, 8,
     9, 11, through 23, or 26 through 29.

**   Filed herewith.

(a)  Contained in Exhibits to Registration Statement on Form S-1, No. 33-29595,
     filed June 28, 1989.

(b)  Contained in Exhibits to Amendment No. 1 to Registration Statement on Form
     S-1, No. 33-29595, filed August 24, 1989.

(c)  Contained in Exhibits to Amendment No. 2 to Registration Statement on Form
     S-1, No. 33-29595, filed November 8, 1989.

(d)  Filed with Form 10-K for December 31, 1989.

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

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

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

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

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

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

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

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

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

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

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

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