Edgar Filing: ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES INC

f10k_031513.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

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

	For the fiscal year ended December 31, 2012
Or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-10367

Advanced Environmental Recycling Technologies, Inc.

(Exact name of Registrant as specified in its charter)

Delaware	71-0675758
(State of Incorporation)	(I.R.S. Employer Identification No.)

914 N Jefferson Street Springdale, Arkansas	72764
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code:

(479) 756-7400

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Class A common stock, $.01 par value

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) 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. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company þ

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the closing stock price of such common equity as of the last business day of the registrant’s most recently completed second fiscal quarter was $4,970,219 (for the purposes hereof, directors, executive officers and 10% or greater shareholders have been deemed affiliates).

Number of shares of common stock outstanding at March 15, 2013: Class A — 88,165,632; Class B — 1,465,530

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our Definitive Proxy Statement for our 2013 annual meeting scheduled to be held in June 19, 2013, and expected to be filed within 120 days of our fiscal year end, are incorporated by reference into Part III.

Table of Contents

		Page No.
Part I
Item 1.	Business	1
Item 2.	Properties	5
Item 3.	Legal Proceedings	5
Item 4.	Mine Safety Disclosure	5

Part II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	6
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	7
Item 8.	Financial Statements	13
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	14
Item 9A.	Controls and Procedures	14
Item 9B.	Other Information	14

Part III
Item 10.	Directors, Executive Officers and Corporate Governance	15
Item 11.	Executive Compensation	15
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	15
Item 13.	Certain Relationships and Related Transactions, and Director Independence	15
Item 14.	Principal Accountant Fees and Services	15

Part IV
Item 15.	Exhibits and Financial Statement Schedules	16
Signatures		17
Index to Financial Statements		F-1

Part I

Item 1. Business.

Summary

Advanced Environmental Recycling Technologies, Inc. (AERT or the Company), founded in 1988, develops and commercializes technologies to recycle waste polyethylene plastics and develops, manufactures, and markets value-added, green building compounds. Our primary products are composite building materials that are used in place of traditional wood or plastic products for exterior applications in building and remodeling homes and for certain other industrial or commercial building purposes. Our products are made primarily from approximately equal amounts of recycled polyethylene plastic, which has been cleaned, processed, and reformulated and waste wood fiber, which has been cleaned, sized and reprocessed utilizing our patented and proprietary technologies. Our products have been extensively tested, and are sold by leading national companies such as the BlueLinx Corporation (BlueLinx), Lowe’s Companies, Inc. (Lowe’s) and Therma-Tru Corporation. Our products are primarily used in renovation and remodeling by consumers, homebuilders, and contractors as an exterior environmentally responsible (“Green”) building alternative for decking, railing, and trim products.

The Company currently manufactures all of its composite products at extrusion facilities in Springdale, Arkansas. The Company operates a plastic recycling, blending and storage facility in Lowell, Arkansas, where it also leases warehouses and land for inventory storage. In April 2011, the Company started a new green-age recycling, cleaning and reformulation facility at Watts, Oklahoma. The marketing and sale of recycled plastic and filler resins to third parties commenced in late 2011.

Products

Building on our base process and materials, we manufacture the following product lines:

·	Commercial and residential decking planks and accessories such as balusters and handrails under the MoistureShield® and ChoiceDek® brands,

·	Exterior door components,

·	Exterior housing trim (MoistureShield®), and

·	Green recycled plastic resin compounds.

The wood fiber content of our products gives them many properties similar to all-wood products, but we believe that the plastic content renders our products superior to both all-wood or all-plastic alternatives because:

·	Unlike wood, our products do not require preservatives or treatment with toxic chemicals or annual sealing or staining.

·	Our products are less subject to thermal contraction or expansion and have greater dimensional stability than competing all-plastic products.

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

·	Our products are designed and extruded through dies to a desired shape in accordance with customer specifications, which helps the customer to minimize waste.

·	Our products are less subject to rotting, cracking, warping, splintering, insect infestation and water absorption than conventional wood materials.

·	Our products are aesthetically enhanced to provide a wood-like or grained surface appearance.

·	Our products are combined with coloring agents and/or other additives to provide various colors and aesthetics.

Our latest generation of products offers colors to more closely resemble the natural look of wood. We also commenced adding a mildew-cide in our products in 2006 to inhibit the growth of mold.

Based upon our extensive product testing and successful extended field history, we offer a 25-year limited replacement warranty on our ChoiceDek® Foundations™ and a limited lifetime replacement warranty on our MoistureShield® products against rot and fungal decay, and termite and insect damage.

Marketing and Sales

General Market Strategy. Our products are designed for applications where we can add the greatest value and address market needs, i.e., for external applications where wood is prone to rot and/or requires substantial annual maintenance in the form of staining or sealing. Though we believe there are many possible applications for our wood/plastic composite technology, we have focused our resources and personnel on outdoor decking and handrail components and door and other OEM components; that represent the most attractive market opportunities at this time. Within our chosen markets, we are constantly working to develop and improve strong customer relationships.

Sales and Customer Service. We provide sales support and customer service through our own marketing department, contract marketing through outside commissioned representatives, through BlueLinx, and through training programs for our customers and their sales associates. We also promote our decking products through interactive displays at national, regional, and local home and garden shows, as well as through in-store displays. Our in-house sales and customer support team is focused on serving commercial decking contractors and customers, and supporting the sales professionals at our regional building products distributors, as well as BlueLinx and Lowe’s. Information and customer service are provided through the websites www.choicedek.com and www.moistureshield.com, and through a national toll-free customer assistance telephone number: 1-800-951-5117.

Cyclical Nature of Building Products Industry. Our products are used primarily in home improvement and new home construction. The home improvement and housing construction industries are subject to significant fluctuations in activity and periodic downturns caused by general economic conditions. High fuel prices, reduced disposable income, and economic uncertainty in particular can lead to reduced home improvement activity. Reductions in such activity have an adverse effect on the demand for our products. We have focused a large portion of our business on the remodel and repair market segment, which we believe is less cyclical than the new homebuilding market.

Facility Upgrades/Product Innovation. In our ongoing pursuit to satisfy our customers and to keep up with changing trends in the marketplace, we continuously work to develop new products and improve existing products. We have invested significantly in plastic recycling technology and infrastructure over the last several years, which is also a strategic initiative designed to help insulate our raw materials purchasing from wide price swings associated with the petrochemical markets. The aesthetics of our products, which are overwhelmingly composed of recycled materials, have improved with technology advances. The startup of our next-generation Watts, Oklahoma recycling facility allows us to expand into additional customer-driven opportunities.

The composite decking business is continuously evolving. The technology used to manufacture wood/plastic boards has advanced significantly over the last several years, and many contemporary products have much improved aesthetics. Going forward, it will be important for AERT to continue to innovate, keep in close touch with consumer trends and focus on regional market trends while always remaining competitive with wood decking.

Innovation

We are committed to becoming the leader in green building products from recycled plastic materials. In addition, we believe plastic recycling technologies could lead to new opportunities in the future. Our Watts, Oklahoma facility, which is designed to recover, utilize, and convert lower grades of waste plastics into usable feed stocks, is an example of our efforts to continually improve our recycling technology. By utilizing technology, we are upgrading the quality and aesthetics of our products made primarily from recycled raw materials to levels comparable to virgin resin based products.

Green Building Products

We have been recycling plastic and manufacturing green building products since our inception in 1988, and we intend to continue building our brands and differentiating AERT as a green building products company. Listed below are the major categories of products we manufacture and markets we supply.

ChoiceDek® Decking. We currently sell our ChoiceDek® branded decking products in the home improvement warehouse (HIW) market through BlueLinx to Lowe’s. We derived most of our revenue (62%) from BlueLinx (our distributor for ChoiceDek® products) in 2012. This market segment primarily focuses on the do-it-yourself (DIY) market in which homeowners buy, build, and install their own decks. The DIY market is also serviced by The Home Depot, as well as several smaller regional chains. Our decking products are not currently carried in The Home Depot, and the ChoiceDek® brand is sold exclusively to Lowe’s. ChoiceDek® is promoted through in-store displays and an ongoing print and marketing campaign targeting the residential decking market. We maintain a nationwide sales and customer service group. Lowe’s also conducts national print and television ads for the products it carries. In 2012, ChoiceDek® introduced its new line, ChoiceDek® Foundations™. This newly engineered product provides better fade performance than our previous product and features a smaller profile, making it more lightweight and easier to handle.

MoistureShield® Decking. Our MoistureShield® brand line of decking products is currently sold to select primary distributors, who re-sell it to lumber dealers and contractor yards for sale to local deck builders and home builders. Our international distributor accounted for 14% of our sales in 2012. Most of our MoistureShield® customers are regularly purchasing, or have been exposed to, competing brands of composite decking. On this higher end segment, we believe success will require converting customers from competing products to our brands. The MoistureShield® decking line allows us to diversify our customer base.

Door Component Products. We sell our MoistureShield® industrial products to door manufacturers for use as component parts in products. For example, we manufacture door rails built into doors by Therma-Tru Corporation. In marketing these products, we emphasize the value-added feature of the MoistureShield® composite product, which, unlike competing wood products, can be engineered to incorporate certain desired end-product characteristics that save our customers time and expense. Customers also avoid the need for chemical treatments to their final product, which are often otherwise necessary to prevent rot and sustain durability. The durability of our MoistureShield® composite components allows our customers to extend the lifetime or warranties of their products while reducing or eliminating warranty claims costs. We are unable to predict the future size of the markets for MoistureShield® industrial products; however, we believe that the national door and window and commercial and residential trim markets are large and will allow us to diversify our customer base over time as we add production capacity and focus on additional opportunities.

Exterior Trim and Fascia Products. We have marketed an exterior trim and fascia system under the trade names MoistureShield® Trim and MoistureShield® CornerLoc™. Several national homebuilders have been specifying and using the product. We believe this product line has significant growth potential as a green alternative to plastic (i.e., PVC) and wood trims to be distributed and sold in conjunction with our MoistureShield® distributors.

Competition

Our products compete with high-grade western pine, cedar and other premium woods, aluminum, high-performance plastics, and an increasing number of composites and other construction materials. We believe that our products have superior characteristics, which make them a better value for the consumer; however, they are more expensive initially than traditional wood products. Additionally, manufacturers of some competing products have long-established ties to the building and construction industry and have well-accepted products. Some of our competitors are larger and have research and development budgets, marketing staffs, and financial and other resources that surpass our resources.

Sales of non-wood decking products to date represent a small portion of the decking market. Pressure treated pine, cedar, redwood and other traditional woods constitute the vast majority of annual decking sales. We thus view wood decking as our principal competitor. The wood decking industry is highly segmented with many small to medium sized manufacturers. Wood decking is principally a commodity that competes as the low-priced product, whereas the more expensive non-wood products must compete on features and performance.

Among manufacturers of alternative decking materials, we view Trex Company, TimberTech Ltd., Tamko Building Products and Fiber Composites LLC as our primary competitors. The market for door products is highly segmented, with many competitors. We believe that our MoistureShield® industrial products have superior characteristics and are competitively priced. We emphasize durability, which means that manufacturers and homebuilders using our products should see reduced warranty callbacks and higher customer satisfaction. Our product competes not only on durability, but also the ability of the customer to order a product that is custom manufactured to its specifications.

Intellectual Property and Proprietary Technology

Our products are built for hostile external environmental conditions. Our recycling processes focus on intensive cleaning and reformulating of our raw materials prior to extrusion. Our extrusion process is unique and focuses on total encapsulation of the wood fibers. Our composite manufacturing process and our development efforts in connection with waste plastics reclamation technologies involve patents and many trade secrets that we consider to be proprietary. We have also developed certain methods, processes, and equipment designs for which we have sought additional patent protection. We have three new patents that were issued in 2012. Our patents expire between 2013 and 2028.

Our patents cover plastic recycling processes, methods, and apparatus or specially designed equipment as well as the composite product that we manufacture. The composite product patent was issued in 1998 and expires in 2015. This patent covers the unique properties, formulation and processing parameters of our encapsulated wood/polyethylene plastic composite building material. We have also received patents with regard to our mixed recycled plastic resin identification and reformulation technologies.

We have updated and continue to refine our recycling processes, procedures, and technologies, and included these in later issued patents or pending patent applications. We have taken additional measures to protect our intellectual property and trade secrets by restricting access to our facilities and maintaining a policy of nondisclosure among our associates, which includes requiring confidentiality and nondisclosure agreements.

Raw Materials

Wood Fiber. The wood fiber we use is primarily waste byproduct generated by hardwood furniture, cabinet, and flooring manufacturers. However, we see competition for scrap wood fiber for use as a fuel to replace other fuels for both residential and industrial applications.

Recycled Plastics. We use primarily post-consumer waste polyethylene. The largest portion of the plastic materials we use is mixed with paper and other non-plastic materials, which lessen its value to other plastic recyclers. By principally sourcing these contaminated waste plastics prior to processing; we produce a usable but lower-cost feedstock for our composite extrusion lines. We believe our investments in recycling technology and infrastructure will create a significant raw material cost advantage compared to several of our virgin resin-based competitors while offering a more competitive green building product.

Competition for Raw Materials. As the wood/plastic composites industry grows, we sometimes compete for raw materials with other plastic recyclers or plastic resin producers. We believe that our ability to use more contaminated polyethylene limits the number of competitors. Nonetheless, we expect to continue to encounter new entrants into the plastics reclamation business. We increased our capacity for processing waste plastic in recent years, which reduced our dependence on outside suppliers and gave us more control over our costs.

Industry Standards

Building codes exist to provide for safe and effective structures and consistency of structures and construction practices. Our decking and railing products comply with the International Building Code and the International Residential Code as well as the 1997 Uniform Building Code™ (UBC) and the BOCA® National Building Code/1999 (BNBC). The International Code Council – Evaluation Service (ICC-ES) publishes evaluation reports for building products. These reports tell the consumer, commercial or residential, that the products listed in the report comply with code when they are used in the prescribed application and installed according to the manufacturer’s installation instructions. In 2009, we converted from the legacy evaluation report, NER-596, to ESR-2388 from ICC-ES. In Canada, compliance of our products to code is documented in evaluation report CCMC 13191-R from the Canadian Construction Materials Center. We utilize an independent third-party to ensure continuing compliance of our products to code.

The Company has also received from ICC-ES a Verification of Attributes Report (VAR-1015) that verifies the content of recycled materials in our decking, railing and OEM products.

Employees

Due to the seasonality of our business and timing of orders received from our largest customer, the numbers of permanent employees is adjusted throughout the course of the year. At December 31, 2011 and 2012 we had 427 and 371 employees, respectively, reflecting, in part, process efficiencies identified and implemented during 2012.

Available Information

We post on our website (www.aert.com) our periodic reports filed with the SEC on Forms 10-K, 10-Q, and 8-K and amendments to these reports filed pursuant to Section 13(a) of the Securities Exchange Act as soon as reasonably practicable after we electronically file such material with the SEC.

Item 2. Properties.

We currently manufacture all of our composite products at extrusion facilities in Springdale, Arkansas where we also lease our corporate office space.

We suspended extrusion operations at our Junction, Texas facility in October 2007. In 2012, we transferred all of the remaining extrusion and other equipment from the Texas facility to our Arkansas and Oklahoma facilities for additional surge capacity and new product development work. The land and buildings located at Junction are being offered for sale.

We operate a facility in Lowell, Arkansas that is used for plastic recycling, blending, and storage. Additionally, we lease warehouses and land in Lowell for inventory storage.

In December 2007, we entered into a related party lease for the use of 60 acres in Watts, Oklahoma where we constructed an additional plastics recycling facility that commenced operations in February 2010.

We lease a warehouse in Westville, Oklahoma for inventory storage.

Item 3. Legal Proceedings. – See Note 11: Commitments and Contingencies

Item 4. Mine Safety Disclosure. – Not applicable

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The Company’s stock is currently listed with the OTC Bulletin Board and trades under the symbol of AERT. As of December 31, 2012, there were approximately 1,414 holders of record of our Class A common stock and 5 holders of record of our Class B common stock. The closing price of our common stock was $0.09 on December 30, 2012. We have not previously paid cash dividends on our common stock and there are currently restrictions under various debt obligations and our Series E preferred stock designation that would prevent the payment of such dividends for the foreseeable future. The following table sets forth the range of high and low quarterly sales prices of our Class A common stock for the years ended December 31, 2011 and 2012.

Sales Price Range of Class A Common Stock
Fiscal 2011	High		Low
First Quarter		0.24		0.16
Second Quarter		0.25		0.10
Third Quarter		0.18		0.10
Fourth Quarter		0.17		0.06

Fiscal 2012
First Quarter		0.09		0.07
Second Quarter		0.10		0.06
Third Quarter		0.15		0.05
Fourth Quarter		0.12		0.08

No repurchases of common stock took place during 2011 or 2012.

Equity Compensation Plan Information

The following table provides information as of December 31, 2012, regarding shares outstanding and available for issuance under the Company’s equity compensation plans. With the H.I.G. recapitalization in 2011 (See Note 5), the remaining 1,540,673 shares that were authorized to be issued were withdrawn from the 1997 plan. No awards were made in 2012 pursuant to the Company’s 2012 Stock Incentive Plan, which was approved by security holders at the Company’s annual shareholders’ meeting on June 27, 2012.

Number of securities

remaining available for

Number of securities

future issuance under

to be issued

Weighted average

compensation plans

upon exercise of

exercise price of

(excluding securities

outstanding options,

reflected in the first

Plan Category

warrants and rights

column of this table)*

1997 Equity compensation plans approved by security holders

350,000

1.17

2012 Equity compensation plans approved by security holders

N/A

40,000,000

Equity compensation plans not approved by security holders

N/A

Total

350,000

1.17

40,000,000

____________________

* The amount in this column represents the sum of restricted stock units available for grant or available to be issued.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

2012 Summary

Results of Operations

Two Year Comparison (in thousands)


	2011			2012			% Change
Net sales	$	59,259		$	74,611			25.9	%
Cost of goods sold		55,331			61,328			10.8	%
% of net sales		93.4	%		82.2	%
Gross margin		3,928			13,283			238.2	%
% of net sales		6.6	%		17.8	%

Gain (loss) from asset disposition		(195	)		38			(119.5	%)
Selling and administrative costs		10,733			11,070			3.1	%
% of net sales		18.1	%		14.8	%
Operating income (loss)		(7,000	)		2,251			(132.2	%)
% of net sales		(11.8	%)		3.0	%

Other Income:
Other Income		40			52			30	%
Gain on Recapitalization		3,029			-			*
Other expenses:
Net interest expense		(2,996	)		(2,972	)		(0.8	%)
Loss before dividends		(6,927	)		(669	)		90.3	%
% of net sales		(11.7	%)		(0.9	%)
Dividends on preferred stock		(1,119	)		(1,320	)		18.0	%
Net loss applicable to common stock	$	(8,046	)	$	(1,989	)		75.3	%
% of net sales		(13.6	%)		(2.7	%)

____________

* Not meaningful as a percentage change

Sales

Net sales for the year ended December 31, 2012 were up 25.9% from the year ended December 31, 2011 due primarily to increased MoistureShield® sales, attributed to the increase in international sales and the additions of new MoistureShield® customers. ChoiceDek® sales also increased in 2012 over 2011. In 2011, sales were reduced by a $4.6 million inventory refresh that entailed the replacement of ChoiceDek® product at Lowe’s stores with a newly designed ChoiceDek® Foundations™ product.

Cost of Goods Sold and Gross Margin

Cost of goods sold increased by 10.8% for the year ended December 31, 2012 compared to 2011. As a percentage of sales, 2012 cost of goods sold decreased 11.2 percentage points from 2011. Gross margin increased reflecting increased manufacturing efficiencies primarily associated with economies of scale relating to increased production.

Selling and Administrative Costs

Selling and administrative costs were up 3.1% in 2012 compared to 2011. The increase is primarily due to an increase in advertising, promotions, and commissions related to increased sales. As a percentage of sales, selling and administrative costs were down 3.3% from 2011. The primary components of selling and administrative costs are compensation and benefits, advertising and promotion, travel, professional fees, and commissions.

Asset Impairment, Disposition and Other Expenses

During 2012, AERT disposed of fully depreciated assets, which were no longer of service to the Company. These assets were once located in the Company’s Junction, Texas facility.

Infrequent charges recorded during 2011 include the following:

·	Gain on restructure due to H.I.G. recapitalization of $3.0 million

·	Accrual for returns of product from Lowe’s relating to an inventory refresh of $4.6 million

·	Equity compensation expense of $0.5 million relating to shares becoming fully vested as a result of change of control.

Net Income (Loss)

AERT generated operating income of $2.3 million for 2012 versus an operating loss of $7.0 million for 2011. After the gain on recapitalization in 2011 and the deduction for interest and dividends, the Company had a net loss of $2.0 million, an improvement of $6.0 million in net income over the 2011 $8.0 million net loss.

Liquidity and Capital Resources

Liquidity refers to the liquid financial assets available to fund our business operations and pay for near-term obligations as well as unused borrowing capacity under our revolving credit facility. Our cash requirements have historically been satisfied through a combination of cash flows from operations and debt financings.

On November 15, 2012, AERT entered into a $15.0 million Loan and Security Agreement (the Agreement) with AloStar Bank of Commerce (AloStar), a state banking institution organized under the laws of the State of Alabama; $8 million as a Revolver Loan and $7.0 million as an asset-based loan (Term Loan).

Upon execution of the Agreement, AloStar advanced funds from the Term Loan in full payment of the Liberty Bank Revolving Line of Credit and the Mortgage, Security Agreement. The Revolver Loan will be used to cover operating expenses as needed. At December 31, 2012, $2.5 million was available for drawdown.

The Term Loan requires that AloStar hold first security interest to the majority of AERT’s plant, property, and equipment; as well as, real estate. Payments on the principal portion of the loan commenced on December 1, 2012 and will be made in 36 equal monthly installments of $0.08 million plus interest. The final installment $4.1 million shall be due and payable on the commitment termination date. Interest is calculated at 4.5% plus the greater of (a) 1.0% and (b) the LIBOR Rate as shown in the Wall Street Journal on such day for United States dollar deposits for the one month delivery of funds in amounts approximately equal to the principal amount of the Loan for which such rate is being determined or, if such day is not a Business Day on the immediately preceding Business Day. Interest accrued on the principal balance of the Term Loan shall be due and payable on the first day of each month, computed through the last day of the preceding month. Interest, expressed in simple interest terms as of December 31, 2012, is 5.5%.

The Revolver Loan is subject to a reserve of $1.0 million plus a maximum reserve of $1.0 million for class action claims. Interest is assessed at the greater of (a) 1.0% and (b) the LIBOR rate as shown in the Wall Street Journal on such day for United States dollar deposits for the one month delivery of funds in an amount approximately equal to the principal amount of the Loan for which such rate is being determined plus 4% as of December 31, 2012. If the LIBOR cannot be determined, the interest will be calculated using the prime lending rate plus 2%. The Revolver Loan is secured by 85% of accounts receivable after a reduction for amounts owed by international customers. The Revolver Loan is also secured by 60% of the eligible inventory or 85% of the net orderly liquidation value of the inventory. The line of credit at AloStar had a balance of $2.3 million at December 31, 2012.

The Company continues to improve on liquidity by increasing plant efficiencies, decreasing our overhead costs, negotiating longer payment terms with vendors and increasing profitability within our product sector. Our Junction, Texas facility, which is currently unused, is available for sale.

On October 20, 2011, AERT and H.I.G. amended their Credit Agreement on the Series B Senior Term Note with H.I.G. With the addition of PIK interest, as of December, 2012, the Company had $0.4 million available to be drawn, as needed.

Cash Flows

Cash Flows from Operations

Cash provided by operations in 2012 was $0.8 million compared to cash used in operations of $8.0 million in 2011. The $8.0 million used in operations in 2011 was primarily due to the changes relating to the recapitalization (See Note 3) offset by increased accrued liabilities for the inventory refresh.

The changes in our revenue and cost of raw materials significantly impact the Company’s liquidity. We are in the remodeling industry that has been depressed as a result of the reduction in home prices in recent years. While improvements in the Company’s sales improved, our business is still dependent upon the economy and we cannot accurately predict cyclical economic changes or the impact on consumer buying.

The Company has significant customer concentration, with one customer representing approximately 62% of our revenue. A loss of this customer, or a major reduction in their business, would cause a significant reduction in our liquidity. We are currently working to increase our distribution network, which will reduce this customer’s concentration.

The change in current assets and current liabilities was primarily due to the reduction of $4.6 million accrued product returns at 2011 year end for the Lowe’s inventory refresh. The process of refreshing the inventory at over 2,000 Lowe’s locations proved to be very successful and resulted in increased sales of the new ChoiceDek® Foundations™ product.

Cash Flows from Investing Activities

Cash used in investing activities in 2012 increased only slightly from 2011, by $0.7 million. This increase in cash used resulted from additional capital expenditures at our Watts, Oklahoma plastic recycling facility and increased capital expenditures to improve our extrusion operations in Springdale, Arkansas.

Cash Flows from Financing Activities

Cash provided by financing activities was $1.5 million in 2012 compared to cash provided by financing activities of $9.8 million in 2011, which was primarily proceeds from the issuance of notes associated with the H.I.G. recapitalization. In 2012, the proceeds from the Term Loan from AloStar were used to pay the outstanding loans with Liberty Bank.

Working Capital

At December 31, 2012, the Company had working capital of $0.2 million compared to a working capital deficit of $9.9 million at December 31, 2011. The increase in working capital for 2012 was primarily due to the completion of the inventory refresh in the Lowe’s stores, which reduced the $4.6 million accrual recorded in 2011; and, the new loan with AloStar that paid the Liberty line of credit and real estate loan. An increase in international sales and sales to new customers in new markets increased accounts receivable. Components of working capital that fluctuated significantly include accounts receivable, inventory, accruals related to class action, accrued product returns and current maturities of long term debt.

Property, Plant and Equipment

The changes in our property, plant and equipment for 2012 are due primarily to fixed asset additions to our Watts, Oklahoma plastic recycling facility and at our extrusion facilities in Springdale, Arkansas. The depreciation of buildings and equipment is provided on a straight-line basis over the estimated useful lives of the assets. Gains or losses on sales, or other dispositions of property, are credited or charged to income in the period incurred. Repairs and maintenance costs are charged to income in the period incurred, unless it is determined that the useful life of the respective asset has been extended.

Arkansas Loan Program

On March 30, 2010, the Company entered into a grant agreement with the City of Springdale and the Arkansas Economic Development Commission (AEDC) in the amount of $170,000. Part of the grant funds have been used to pay for a new packaging line in the Springdale North plant. On June 4, 2010, the Company accepted an offer of additional grant funding in the amount of $150,000 that would be combined with and become a part of the initial grant provided by AEDC, bringing the total amount of that grant to $320,000. In 2011, $70,000 of the grant fund was used to purchase a hammermill for the Springdale South location. The remainder of the grant funding was used when we removed and relocated equipment from AERT’s plant at Junction, Texas to the Springdale South Plant. AERT expects to create 84 jobs in its operations in Arkansas as a result of the grant funding from AEDC.

Debt

In addition to the H.I.G. transaction on March 18, 2011, as discussed in Note 5, and the recent obligations pledged to AloStar on November 15, 2012, also discussed in Note 5, the Company continues to explore financing options, including various financial assistance programs sponsored by state and federal governments.

Line of Credit

On November 15, 2012, the Revolving Line of Credit with the Liberty Bank was paid in full using funds provided by a new term loan (Term Loan) with AloStar Bank of Commerce (AloStar). A new Revolver Loan (Revolver) was established with AloStar as well. The Revolver Loan with AloStar does not require a guarantee.

Oklahoma Energy Program Loan

On July 14, 2010, the Company entered into a loan agreement with the Oklahoma Department of Commerce (ODOC) whereby ODOC agreed to a 15-year, $3.0 million loan to AERT at a fixed interest rate of 3.0%. The loan is being made pursuant to the American Recovery and Reinvestment Act State Energy Program for the State of Oklahoma, and is funding the second phase of AERT’s new recycling facility in Watts, Oklahoma. Payments on the loan commenced on May 1, 2012. The balance on the loan at December 31, 2012 was $2.9 million.

ODOC, under award number 14215 SSEP09, advanced $3.0 million to AERT between 2010 and 2012. As of December 31, 2012, a total of $3.0 million was spent on contract labor, contract materials, and equipment. In addition, as of December 31, 2012, matching funds of $9.2 million have been contributed (in-kind) to the project by AERT.

Debt Covenants

Our debt covenants per the Company’s agreements with AloStar Bank of Commerce and H.I.G. are as follows:

	For the period of
	November 16, 2012
	through
	December 31, 2012			Compliance
	Actual		Required
AloStar Bank of Commerce Debt Covenants
Capital Expenditures	$	0	<$0.5 million	Yes

Fixed Charge Coverage Ratio		2.9	> 1.10:1.00	Yes
Adjusted Consolidated EBITDA / Consolidated Fixed Charges
Adjusted EBITDA	$8.3 million		= >$5.25 million	Yes

	Year Ended
	December 31, 2012			Compliance
H.I.G. Debt Covenants	Actual		Required
Leverage Ratio		4.2	= < 4.0:1.00	No, Waived
Consolidated Indebtedness / Consolidated EBITDA
Fixed Charge Coverage Ratio		3.4	> 1.25:1.00	Yes
Adjusted Consolidated EBITDA / Consolidated Fixed Charges
Consolidated EBITDA	$8.9 million		=>$6.5 million	Yes

On January 25, 2013, H.I.G. AERT LLC, the holder of all of the issued and outstanding shares of Series E Convertible Preferred Stock, waived the Specified Events of Default as a result of AERT failing to have a Leverage Ratio (as defined in that certain Credit Agreement, dated as of March 18, 2011, as amended by that certain First Amendment to Credit Agreement, dated as of May 12, 2011, and as further amended by that certain Second Amendment to Credit Agreement, dated as of October 20, 2011 and as further amended, restated, supplemented or otherwise modified from time to time, the Credit Agreement, by and among AERT, the lenders from time to time parties thereto and H.I.G. AERT, LLC) of below 4.0 to 1.0 for four Fiscal Quarters (as defined in the Credit Agreement) ending December 31, 2012 and (collectively, the Specified Events of Default). On February 20, 2013, H.I.G. AERT LLC, waived its right to deliver a Triggering Event Redemption Notice solely as a result of the Specified Events of Default.

H.I.G. Long Term Debt

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported on our financial statements. The estimates made in applying the accounting policies described below are material to the financial statements and notes thereto due to the level of judgment involved in arriving at those estimates.

Accounts Receivable

Trade accounts receivable are stated at the amount management expects to collect from outstanding balances. Payments of accounts receivable are allocated to the specific invoices identified on the customers’ remittance advice. Accounts receivable are carried at the original invoice amount less an estimated reserve. Management reviews all overdue accounts receivable balances and estimates the portion, if any, of the balance that may not be collected and provides an allowance. Balances that remain outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a reduction in trade accounts receivable. Recoveries of trade receivables previously written off are recorded when received.

Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or market. Material, labor, and factory overhead necessary to produce the inventories are included in their cost.

Buildings and Equipment

Property additions and betterments include capitalized interest and acquisition, construction and administrative costs allocable to construction projects and property purchases. The depreciation of buildings and equipment is provided on a straight-line basis over the estimated useful lives of the assets. Gains or losses on sales or other dispositions of property are credited or charged to income in the period incurred. Repairs and maintenance costs are charged to income in the period incurred, unless it is determined that the useful life of the respective asset has been extended.

We assess the impairment of long-lived assets, consisting of property, plant, and equipment, whenever events or circumstances indicate that the carrying value may not be recoverable.

Examples of such events or circumstances include:

·	an asset group's inability to continue to generate income from operations and positive cash flow in future periods;

·	loss of legal ownership or title to an asset;

·	significant changes in our strategic business objectives and utilization of the asset(s); and

·	the impact of significant negative industry or economic trends.

We evaluate our assets on a quarterly basis during periods when we suffer operating losses. The last evaluation was prepared as of December 31, 2011. For the year ending December 31, 2012, the Company had operating profit of $2.3 million.

For purposes of testing impairment, we group our long-lived assets at the same level for which there are identifiable cash flows independent of other asset groups. Currently, there is only one level of aggregation for our assets. We assess the impairment of long-lived assets, primarily consisting of property, plant, and equipment related to the extrusion and rendering of plastic materials, whenever events or circumstances indicate that the carrying value may not be recoverable. The Company believes the assets which most significantly drive the cash-flow-generating capacity at our facilities are the assets resulting in property, plant and equipment.

Recoverability of assets to be held and used in operations is measured by a comparison of the carrying amount of our assets to the undiscounted future net cash flows expected to be generated by the assets. The factors used to evaluate the future net cash flows, while reasonable, require a high degree of judgment and the results could vary if the actual results are materially different than the forecasts. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less selling costs.

As stated in Note 2, buildings and equipment are stated at cost and depreciated over the estimated useful life of each asset using the straight-line method. Estimated useful lives are: buildings — 15 to 30 years, leasehold improvements — 2 to 6 years, office equipment — 3 to 6 years, and machinery and equipment — 3 to 10 years. We also periodically review the lives assigned to our assets to ensure that our initial estimates do not exceed any revised estimated periods from which we expect to realize cash flows from the asset.

Revenue Recognition

The Company recognizes revenue when the title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable and collectability is reasonably assured. The Company typically recognizes revenue at the time product is shipped or when segregated and billed under a bill and hold agreement. Sales are recorded net of discounts, rebates, and returns.

Estimates of expected sales discounts are calculated by applying the appropriate sales discount rate to all unpaid invoices that are eligible for the discount. The Company’s sales prices are determinable given that the Company’s sales discount rates are fixed and given the predictability with which customers take sales discounts.

Uncertainties, Issues and Risks

There are many factors that could adversely affect our business and results of operations. These factors include, but are not limited to, general economic conditions, decline in demand for our products, business or industry changes, critical accounting policies, government rules and regulations, environmental concerns, litigation, new products / product transition, product obsolescence, competition, acts of war, terrorism, public health issues, concentration of customer base, loss of a significant customer, availability of raw material (plastic) at a reasonable price, management’s failure to execute effectively, manufacturing inefficiencies, high scrap rates, inability to obtain adequate financing (i.e. working capital), equipment breakdowns, low stock price, and fluctuations in quarterly performance.

The Company voluntarily reported several wastewater exceedances in the summer of 2012 during a period of plant expansion and was fined seventeen thousand dollars by the Oklahoma Department of Environmental Quality relating to wastewater issues at its Watts, OK facility and is currently operating under an agreed consent agreement. If the Company fails to correct and resolve these issues it could incur further fines and or harsher penalties.

Forward-looking Information

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

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

Item 8. Financial Statements.

The financial statements portion of this item is submitted in a separate section of this report.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None

Item 9A. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer, Joe G. Brooks, who is our principal executive officer, and our Chief Financial Officer, J. R. Brian Hanna, who is our principal financial and accounting officer, have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of December 31, 2012. Based upon this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of December 31, 2012, the end of the period covered by this report, AERT’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by AERT in the reports that it files or submits under the Exchange Act and are effective in ensuring that information required to be disclosed by AERT in the reports that it files or submits under the Exchange Act is accumulated and communicated to AERT’s management, including AERT’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Management’s Report on Internal Control Over Financial Reporting

We, as members of the management of Advanced Environmental Recycling Technologies, Inc. (the Company), are responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

We assessed the Company’s internal control over financial reporting as of December 31, 2012, based on criteria for effective internal control over financial reporting established in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we have concluded that such internal control over financial reporting was effective as of December 31, 2012.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by its registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit it to provide only management’s report in this annual report.

Changes in Internal Control over Financial Reporting

During the fourth quarter ended December 31, 2012, there have been no changes in our internal controls over financial reporting that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information.

None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance.

The information required by Item 10 is incorporated herein by reference to the Company’s definitive proxy statement for its 2013 annual meeting of stockholders.

Item 11. Executive Compensation.

The information required by Item 11 is incorporated herein by reference to the Company’s definitive proxy statement for its 2013 annual meeting of stockholders.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information required by Item 12 is incorporated herein by reference to the Company’s definitive proxy statement for its 2013 annual meeting of stockholders.

Item 13. Certain Relationships and Related Transactions, and Director Independence.

The information required by Item 13 is incorporated herein by reference to the Company’s definitive proxy statement for its 2013 annual meeting of stockholders.

Item 14. Principal Accountant Fees and Services.

The information required by Item 14 is incorporated herein by reference to the Company’s definitive proxy statement for its 2013 annual meeting of stockholders.

PART IV

Item 15. Exhibits and Financial Statement Schedules.

(a1) and (a2). The Financial Statements listed in the accompanying Index to Financial Statements are filed as part of this report and such Index is hereby incorporated by reference. All schedules for which provision is made in the applicable accounting regulation of 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.

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.

/s/ JOE G. BROOKS

Joe G. Brooks,

Chairman and Chief Executive Officer

(principal executive officer)

/s/ J. R. BRIAN HANNA

J. R. Brian Hanna,

Chief Financial Officer and Principal Accounting Officer

Date: March 15, 2013

POWER OF ATTORNEY

The undersigned directors and officers of Advanced Environmental Recycling Technologies, Inc. hereby constitute and appoint Joe G. Brooks our true and lawful attorney-in-fact and agent with full power to execute in our name and behalf in the capacities indicated below any and all amendments to this report on Form 10-K to be filed with the Securities and Exchange Commission and hereby ratify and confirm all that such attorney-in-fact and agent shall lawfully do or cause to be done by virtue thereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/ JOE G. BROOKS	Chairman and Chief Executive Officer	March 15, 2013
Joe G. Brooks

/s/TIMOTHY D. MORRISON	President and Director	March 15, 2013
Timothy D. Morrison

/s/BOBBY J. SHETH	Secretary and Director	March 15, 2013
Bobby J. Sheth

/s/ JACKSON S. CRAIG	Director	March 15, 2013
Jackson S. Craig

/s/ TODD J. OFENLOCH	Director	March 15, 2013
Todd J. Ofenloch

/s/ MICHAEL R. PHILLIPS	Director	March 15, 2013
Michael R. Phillips

/s/ VERNON J. RICHARDSON	Director	March 15, 2013
Vernon J. Richardson

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

INDEX TO FINANCIAL STATEMENTS

	Page

Report of Independent Registered Public Accounting Firm	F-2
Balance Sheets	F-3 – F-4
Statements of Operations	F-5
Statements of Stockholders’ Deficit	F-6
Statements of Cash Flows	F-7
Notes to Financial Statements	F-8 – F24

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Advanced Environmental Recycling Technologies, Inc.

We have audited the accompanying balance sheets of Advanced Environmental Recycling Technologies, Inc. as of December 31, 2012 and 2011, and the related statements of operations, stockholders' deficit, and cash flows for the years 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 audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Advanced Environmental Recycling Technologies, Inc. as of December 31, 2012 and 2011, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/ HOGANTAYLOR LLP

Fayetteville, Arkansas

March 15, 2013

F-2

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

BALANCE SHEETS

(in thousands)


	December 31,		December 31,
	2011		2012
Assets
Current assets:
Cash	$	1,083	$	346
Restricted cash		454		-
Trade accounts receivable, net of allowance of $137 at December 31, 2011 and $46 at December 31, 2012		1,868		3,747
Inventories		11,120		9,468
Prepaid expenses		536		557
Total current assets		15,061		14,118

Land, buildings and equipment:
Land		1,989		1,989
Buildings and leasehold improvements		16,995		16,995
Machinery and equipment		42,838		45,013
Office equipment		2,168		2,166
Construction in progress		822		1,719
Total land, buildings and equipment		64,812		67,882
Less accumulated depreciation		32,700		38,145
Net land, buildings and equipment		32,112		29,737

Other assets:
Debt issuance costs, net of accumulated amortization of $97 at December 31, 2011 and $262 at December 31, 2012		654		1,193
Other assets		722		413
Total other assets		1,376		1,606
Total assets	$	48,549	$	45,461

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

F-3

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

BALANCE SHEETS

(in thousands)


	December 31,			December 31,
	2011			2012
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable – trade	$	4,847		$	4,105
Accounts payable – related parties		646			591
Current maturities of long-term debt		1,680			1,195
Accruals related to expected settlement of class action lawsuit		3,059			1,268
Other accrued liabilities		3,720			4,422
Accrued product returns		4,726			-
Working capital line of credit		6,125			2,327
Total current liabilities		24,803			13,908

Long-term debt, less current maturities		25,454			33,800

Commitments and Contingencies (See Note 11)

Series E cumulative convertible preferred stock, $0.01 par value; 30,000 shares authorized, 20,524 shares issued and outstanding at December 31, 2011 and 2012, including accrued unpaid dividends of $988 and $2,308 at December 31, 2011 and 2012, respectively		21,512			22,832

Stockholders' deficit:
Class A common stock, $.01 par value; 525,000,000 shares authorized; 88,165,632 shares issued and outstanding at at December 31, 2011 and 2012		882			882
Class B convertible common stock, $.01 par value; 7,500,000 shares authorized; 1,465,530 shares issued and outstanding at December 31, 2011 and 2012		15			15
Additional paid-in capital		53,347			53,660
Accumulated deficit		(77,647	)		(79,636	)
Total stockholders' deficit		(23,403	)		(25,079	)
Total liabilities and stockholders' deficit	$	48,549		$	45,461

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

F-4

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

	Year Ended
	December 31,			December 31,
	2011			2012
Net sales	$	59,259		$	74,611
Cost of goods sold		55,331			61,328
Gross margin		3,928			13,283

Selling and administrative costs		10,733			11,070
(Gain) Loss from asset impairment and disposition		195			(38	)

Operating income (loss)		(7,000	)		2,251

Other income and expenses:
Other income		40			52
Gain on recapitalization		3,029			-
Net interest expense		(2,996	)		(2,972	)
Net loss		(6,927	)		(669	)
Dividends on preferred stock		(1,119	)		(1,320	)
Net loss applicable to common stock	$	(8,046	)	$	(1,989	)

Loss per share of common stock (basic and diluted)	$	(0.10	)	$	(0.02	)

Weighted average common shares outstanding (basic and diluted)		81,142,729			89,631,162

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

F-5

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

STATEMENTS OF STOCKHOLDERS’ DEFICIT

(in thousands, except share data)

																					Additional
	Preferred Stock						Class A Common Stock				Class B Common Stock				Warrants Outstanding						Paid-in			Accumulated
	Shares			Amount			Shares		Amount		Shares		Amount		Number			Value			Capital			Deficit			Total
Balance - December 31, 2010		748,772		$	7			48,800,531	$	488		1,465,530	$	15		3,787,880		$	1,533		$	53,209		$	(69,601	)	$	(14,349	)
Issuances of Class A common stock pursuant to employee stock award program		-			-			2,551,725		26		-		-		-			-			(24	)		-			2
Issuance of Class A common stock in payment of services		-			-			500,000		5		-		-		-			-			100			-			105
HIG Restructuring (See Note 6)
Changes to Class A Common Stock		-			-			36,313,376		363		-		-		-			-			6,900			-			7,263
Changes to Preferred Stock / Warrants		(748,772	)		(7	)		-		-		-		-		(3,787,880	)		(1,533	)		(8,057	)		-			(9,597	)
Related party forgiveness of debt		-			-			-		-		-		-		-			-			731			-			731
Deferred equity compensation for restricted stock		-			-			-		-		-		-		-			-			488			-			488
Net loss applicable to common stock		-			-			-		-		-		-		-			-			-			(8,046	)		(8,046	)
Balance - December 31, 2011		-			-			88,165,632	$	882		1,465,530	$	15		-			-		$	53,347		$	(77,647	)	$	(23,403	)
Related party forgiveness of debt		-			-			-		-		-		-		-			-			313			-			313
Net income (loss) applicable to common stock		-			-			-		-		-		-		-			-			-			(1,989	)		(1,989	)
Balance - December 31, 2012		-			-			88,165,632	$	882		1,465,530	$	15		-		$	-		$	53,660		$	(79,636	)	$	(25,079	)

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

F-6

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

STATEMENT OF CASH FLOWS

(in thousands)

	Year Ended
	December 31,			December 31,
	2011			2012
Cash flows from operating activities:
Net loss applicable to common stock	$	(8,046	)	$	(1,989	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		5,782			5,610
Gain on recapitalization		(3,029	)		-
Issuance of stock in payment of expenses		105			-
Dividends on preferred stock		1,119			1,320
Accrued interest converted to long-term debt		1,368			2,158
(Gain) loss from fixed asset impairment and disposition		195			(38	)
Increase (decrease) in accounts receivable allowance		27			(91	)
Increase (decrease) in other assets		(2,015	)		961
Changes in other current assets and current liabilities		(3,534	)		(6,416	)
Net cash provided by (used in) operating activities		(8,028	)		1,515

Cash flows from investing activities:
Purchases of land, buildings and equipment		(2,430	)		(3,069	)
Proceeds from disposition of equipment		112			18
Net cash used in investing activities		(2,318	)		(3,051	)

Cash flows from financing activities:
Proceeds from the issuance of notes		11,481			972
Proceeds from Term Loan		-			7,000
Net payments on line of credit		(1,704	)		(3,798	)
Payments on notes		(387	)		(2,938	)
Payments on capital lease obligations		(218	)		(187	)
Releases from restricted cash		2,393			881
Increase in restricted cash for payment of debt and construction costs		(1,981	)		(427	)
Debt issuance costs		-			(704	)
Proceeds from Arkansas ARRA grant		190			-
Net cash provided by financing activities		9,774			799

Decrease in cash		(572	)		(737	)
Cash, beginning of period		1,655			1,083
Cash, end of period	$	1,083		$	346

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

F-7

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS

Note 1: Description of the Company

Advanced Environmental Recycling Technologies, Inc. (AERT or the Company), founded in 1988, recycles polyethylene plastic and develops, manufactures, and markets composite building materials that are used in place of traditional wood or plastic products for exterior applications in building and remodeling homes and for certain other industrial or commercial building purposes. The Company’s products are made primarily from approximately equal amounts of waste wood fiber, which have been cleaned, sized and reprocessed, and recycled polyethylene plastics which have been cleaned, processed, and reformulated utilizing our patented and proprietary technologies. Its products have been extensively tested, and are sold by leading national companies such as BlueLinx Corporation (BlueLinx), Lowe’s Companies, Inc. (Lowe’s) and Therma-Tru Corporation. The Company’s products are primarily used in renovation and remodeling by consumers, homebuilders, and contractors as an exterior green (environmentally responsible) building alternative for decking, railing, and trim products.

The Company’s distributor for its ChoiceDek® products is BlueLinx Corporation. All ChoiceDek® products are sold by BlueLinx exclusively to Lowe’s.

The Company currently manufactures all of its composite products at extrusion facilities in Springdale, Arkansas. The Company operates a plastic recycling, blending and storage facility in Lowell, Arkansas, where it also leases warehouses and land for inventory storage. In April 2011, the Company started a new Green Age recycling, cleaning and reformulation facility at Watts, Oklahoma, which currently recycles polyethylene plastic scrap in order to reduce the Company’s costs of recycled plastics as well as for sales to third parties. The marketing and sale of recycled plastic and filler resins to third parties commenced in late 2011.

On March 18, 2011, the Company entered into a Securities Exchange Agreement, Credit Agreement, and related other agreements with H.I.G., AERT, LLC, and affiliates of H.I.G. Capital, LLC (H.I.G), referred to as the “Recapitalization.” The recapitalization has been accounted for as a troubled debt restructuring (ASC 470-60), resulting in a gain of $3.0 million. (See Notes 5 and 6.)

Note 2: Summary of Significant Accounting Policies

Revenue Recognition

Accrued Product Returns

An inventory refresh entails replacing existing deck boards at Lowe’s stores with newly designed product that is expected to enhance future sales. This is accounted for as an adjustment to revenue in the period in which the refresh agreement is reached.

Revenue adjustment estimates are based on the original sales price of the product expected to be returned, transportation to AERT’s facility in Springdale, Arkansas, labor and repackaging materials, and costs to dispose of unsalable product. The accrual is reduced by the per pound cost of any unsalable product that can be re-used in the manufacturing process. The replacement deck boards were accounted for as a sale in accordance with our revenue recognition policy.

F-8

Shipping and Handling

The Company records shipping fees billed to customers in net sales and records the related expenses in cost of goods sold.

Operating Costs

The cost of goods sold line item in the Company’s statements of operations includes costs associated with the manufacture of our products, such as labor, depreciation, repairs and maintenance, utilities, leases, and raw materials, including the costs of raw material delivery, warehousing and other distribution related costs. The selling and administrative costs line item in the Company’s statements of operations includes costs associated with sales, marketing, and support activities like accounting and information technology. The types of costs incurred in those areas include labor, advertising, travel, commissions, outside professional services, leases and depreciation.

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, 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 (in thousands):

	Year Ended
	December 31,
	2011			2012
Receivables	$	602		$	(1,787	)
Inventories		(2,950	)		1,652
Prepaid expenses		109			-
Accounts payable - trade and related parties		(4,914	)		(464	)
Accrued liabilities	$	3,619		$	(5,817	)
	$	(3,534	)	$	(6,416	)
Cash paid for interest	$	798		$	819
Cash paid for income taxes		-			-

Supplemental Disclosures of Non-cash Investing and Financing Activities (in thousands):

	Year Ended
	December 31,
	2011		2012
Notes payable for financing insurance policies	$	227	$	673
Note payable for equipment		-		45
Unpaid dividends on preferred stock		2,858		-
Forgiven related party loan guarantee fees		731		313
Accrued interest exchanged for equity/notes		2,237		-
Accrued interest converted to long term debt		1,368		2,158
Exchange of debt for new debt and Series E Cumulative Convertible Stock		30,631		-

F-9

Restricted Cash

At December 31, 2012, AERT had no restricted cash. The remainder of the funds received from the Oklahoma Energy Program Loan unexpended at December 31, 2011 were expended on construction and equipment costs at the Watts, Oklahoma plastic recycling facility in 2012.

Buildings and Equipment

Buildings and equipment are stated at cost and depreciated over the estimated useful life of each asset using the straight-line method. Estimated useful lives are: buildings — 15 to 30 years, leasehold improvements — 2 to 6 years, office equipment — 3 to 6 years, and machinery and equipment — 3 to 10 years. Depreciation expense recognized by the Company for each of the years ended December 31, 2011 and 2012 was $5.7 million and $5.6 million, respectively. Assets under capital leases are reported in buildings and equipment and office equipment and depreciated over the shorter of the primary lease term or estimated future lives.

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. Interest costs incurred during periods of construction of facilities are capitalized as part of the project cost. There was no capitalized interest for the years ended December 31, 2011 and 2012.

The Company assesses the recoverability of its 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. An impairment loss may be required when the future cash flows are less than the carrying value of such assets.

Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or market. Material, labor, and factory overhead necessary to produce the inventories are included in their cost. Inventories consisted of the following at December 31 (in thousands):

	2011		2012
Parts and supplies	$	743	$	648
Raw materials		5,960		3,935
Work in progress		2,164		2,034
Finished goods		2,253		2,851
	$	11,120	$	9,468

Other Assets

Debt issuance costs are amortized over the term of the related debt. Debt issuance cost amortization charged to interest expense was $0.1 million for 2011. Debt issuance costs of $0.16 million for 2012 were charged to amortization expense. As a result of the H.I.G. recapitalization the unamortized debt issuance costs existing at the time were written off.

As of December 31, the Company had the following amounts related to intangible assets (in thousands):

	2011				2012
	Gross Carrying		Accumulated		Gross Carrying		Accumulated
	Amount		Amortization		Amount		Amortization
Debt issuance costs	$	751	$	97	$	1,455	$	262

F-10

In 2013, the Company incurred an additional $23 thousand of debt issuance costs related to the AloStar Term and Revolver Loans, which will be amortized. The following table represents the total estimated amortization of intangible assets for the five succeeding years (in thousands):

	Estimated Amortization
2013	$	367
2014		367
2015		327
2016		125
2017		27

Accounts Receivable

Accounts receivable are uncollateralized customer obligations due under normal trade terms generally requiring payment within thirty days from the invoice date. Trade accounts are stated at the amount management expects to collect from outstanding balances. Payments of accounts receivable are allocated to the specific invoices identified on the customers’ remittance advice.

Accounts receivable are carried at original invoice amounts less an estimated reserve provided for returns and discounts based on a review of historical rates of returns and expected discounts. The carrying amount of accounts receivable is reduced, if needed, by a valuation allowance that reflects management’s best estimate of the amounts that will not be collected. Management individually reviews all overdue accounts receivable balances and, based on an assessment of current creditworthiness, estimates the portion, if any, of the balance that will not be collected. Management provides for probable uncollectible amounts through a charge to earnings and a credit to an allowance account based on its assessment of the current status of the individual accounts. Balances that remain outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to trade accounts receivable. Recoveries of trade receivables previously written off are recorded when received.

The table below presents a rollforward of our allowance for sales returns and bad debts for 2011 and 2012 (in thousands).

	Balance at		Charged to		Charged to				Balance at
	Beginning		Costs and		Other				End of
	of Period		Expenses		Accounts		Deductions1		Period
2011	$	110		1,862		84		1,919	$	137
2012	$	137		935		302		1,327	$	47

_____________________

1Charges to the accounts are for the purposes for which the reserve was created.

Warranty Estimates

The Company offers a limited warranty on its products. Estimates of expected warranty claims are recorded as liabilities and charged to income in the period revenue is recognized. Amounts accrued for warranty claims totaled $0.6 million at December 31, 2011 and 2012.

Earnings Per Share

The Company utilizes the two-class method for computing and presenting earnings per share. The Company currently has two classes of common stock (the Common Stock) and one class of cumulative participating preferred stock, Series E (the Preferred Stock). Pursuant to the Series E Designation, holders of the Series E Preferred Stock are entitled to receive per share dividends equal to 6% per annum of the stated value of $1,000 per share of Series E Preferred Stock when declared by the Company’s Board of Directors. In addition, holders of the Series E Preferred Stock are entitled to participate in any dividends declared on shares of the Company’s Common Stock on an as-converted basis. Therefore, the Preferred Stock is considered a participating security requiring the two-class method for the computation and presentation of net income per share – basic.

F-11

The two-class computation method for each period segregates basic earnings per common and participating share into two categories: distributed earnings per share (i.e., the Preferred Stock stated dividend) and undistributed earnings per share, which allocates earnings after subtracting the Preferred Stock dividend to the total of weighted average common shares outstanding plus equivalent converted common shares related to the Preferred Stock. Basic earnings per common and participating share exclude the effect of Common Stock equivalents, and are computed using the two-class computation method.

In computing diluted EPS, only potential common shares that are dilutive—those that reduce earnings per share or increase loss per share—are included. The exercise of options or conversion of convertible securities is not assumed if the result would be antidilutive, such as when a loss from continuing operations is reported. As a result, if there is a loss from continuing operations, diluted EPS would be computed in the same manner as basic EPS is computed, even if an entity has net income after adjusting for discontinued operations, an extraordinary item or the cumulative effect of an accounting change. The Company incurred losses from continuing operations for years ended December 31, 2011 and 2012. Therefore, basic EPS and diluted EPS were computed in the same manner. The following table presents the two-class method for the years ended December 31, 2011 and 2012.

BASIC EARNINGS PER SHARE

(in thousands, except share data)

	Year Ended
	December 31,
	2011			2012
Net income (loss) applicable to common stock	$	(8,046	)	$	(1,989	)
Preferred stock dividend		1,119			1,320
Income (loss) before dividends		(6,927	)		(669	)

Per share information:
Basic earnings per common and participating share:
Distributed earnings per share:
Common	$	0.00		$	0.00
Preferred	$	0.00		$	0.00

Earned, unpaid dividends per share
Preferred	$	54.54		$	64.32

Undistributed earnings (loss) per share:
Common	$	(0.10	)	$	(0.02	)
Preferred		-			-

Total basic earnings (loss) per common and participating share:
Common	$	(0.10	)	$	(0.02	)
Preferred	$	54.54		$	64.32

Basic weighted average common shares:
Common weighted average number of shares		81,142,729			89,631,162
Participating preferred shares - if converted		220,578,220			294,850,030
Total weighted average number of shares		301,720,949			384,481,192

Total weighted average number of preferred shares		20,524			20,524

F-12

Although not included in a diluted EPS calculation due to being antidilutive, the Company had potentially dilutive securities outstanding at December 31, 2011 and 2012. The following schedule presents antidilutive securities for the years ended December 31.

	2011		2012
Options		525,000		350,000
Series E preferred stock		286,823,146		304,423,633

Although these financial instruments were not included due to being antidilutive, such financial instruments may become dilutive and would then need to be included with future calculations of diluted EPS.

Concentration Risk

Credit Risk

The Company’s revenues are derived principally from national and regional building products distributors and BlueLinx, the Company’s primary decking customer. The ChoiceDek® brand of decking products sold to BlueLinx are in turn sold exclusively to Lowe’s. BlueLinx is also one of the Company’s MoistureShield® decking customers. The Company extends unsecured credit to its customers. The Company’s concentration in the building materials industry has the potential to impact its exposure to credit risk because changes in economic or other conditions in the construction industry may similarly affect the Company’s customers. The Company derived most of its revenue from BlueLinx, its distributor of ChoiceDek® products.

Major Customers

One customer accounted for 68% of accounts receivable at December 31, 2011. At December 31, 2012, one customer accounted for 62% and a second customer accounted for 22% of the accounts receivables. The Company regularly monitors the creditworthiness of its customers and believes that it has adequately provided for exposure to potential credit losses.

One customer accounted for 62% and a second customer, our Canadian distributor, accounted for 14% of gross revenue for the year ended December 31, 2012.

Cash

The Company maintains bank accounts which are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. At times, cash balances may be in excess of the FDIC insurance limit. The Company believes no significant concentrations of risk exist with respect to its cash.

Disclosure about Fair Value of Financial Instruments

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

Share-Based Payments

The Company measures the cost of employee and director service received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognizes that cost in the financial statements. Compensation cost is recognized as the awards vest. Since 2005, the Company has used restricted stock awards as its exclusive form of stock-based compensation. On March 18, 2011, with the change of control, all stock awards were vested.

Use of Estimates

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

F-13

Advertising Costs

Advertising costs are expensed in the period incurred. Advertising expense was $0.7 million for the year ended December 31, 2011 and $1.1 million for the year ended December 31, 2012.

Research and Development Costs

Expenditures for research activities relating to product development and improvement are charged to expense as incurred. Such expenditures amounted to $0.7 million and $0.2 million in 2011 and 2012, respectively.

Recent Accounting Pronouncements

Accounting standards that have been issued or proposed that do not require adoption until a future date are not expected to have a material impact on our financial statements upon adoption.

Note 3: Related Party Transactions

Leases

In December 2007, the Company entered into a 20-year lease for an existing 16-building complex on 60 acres in Adair County, Oklahoma near the town of Watts, for the construction of a waste plastic washing, recycling, and reclamation facility. The property is being leased from Razorback Farms, a corporation controlled by Marjorie S. Brooks, a former director, with payments of $0.0075 per pound of plastic recycled, commencing on January 1, 2009, on a pounds of production, or net throughput of recycled plastic produced, basis with a minimum rent of $1,000 per month. The throughput or production rent is due quarterly and is capped throughout the term of the lease not to exceed $450,000 per year. Rent expense recorded under this lease totaled $181,351 in 2011 and $188,143 in 2012.

Guaranty Agreement

In connection with the execution of the Credit Agreement, Marjorie S. Brooks entered into a Second Amended and Restated Guaranty Agreement in favor of H.I.G., dated March 18, 2011 (the H.I.G. Guaranty), pursuant to which Ms. Brooks agreed to guarantee the Company’s obligations under the Credit Agreement up to a maximum guaranteed amount of $6.0 million (plus certain potential expenses), replacing a prior guaranty Ms. Brooks had agreed to with respect to certain of the Prior Debt. In consideration for Ms. Brooks entering into the H.I.G. Guaranty and continuing to perform her obligations under a January 16, 2006 Guaranty Agreement, as amended, in favor of Liberty Bank (the Liberty Guaranty), the Company entered into a Guaranty Fee Agreement with Ms. Brooks, dated March 18, 2011 and February 15, 2012 (the Guaranty Fee Agreement), pursuant to which the Company agreed to pay to Ms. Brooks, for as long as the Liberty Guaranty remained in effect, a guaranty fee equal to 4.0% per annum multiplied by the average daily balance of the Company’s obligations under its Loan Agreement with Liberty Bank, as amended, for the month in which the fee is calculated. Ms. Brooks agreed to accept a payment of $0.3 million on or before July 31, 2011 in full satisfaction of previously accrued and unpaid guaranty fees, subject to the terms and conditions set forth in the Guaranty Fee Agreement, which included a $6.0 million guaranty of AERT’s obligation under the Credit Agreement dated March 18, 2011 between AERT and H.I.G. AERT, LLC. In May 2012, AERT received a release from Ms. Brooks, in which she forgave AERT the $0.3 million in loan guarantee fees due. In return, Ms. Brooks was released from her obligation under the H.I.G. Guaranty. Previously accrued loan guaranty fees of $731,000 payable to Ms. Brooks were cancelled in connection with the restructuring transaction.

Concurrently to the execution of the AloStar Term Loan on November 15, 2012, the Liberty Note was paid in full and the Liberty Guaranty was cancelled. The Company recorded loan guaranty fees of $0.3 million in 2011 and $0.2 million in 2012.

F-14

Advisory Services Agreement

The Company also entered into an Advisory Services Agreement between H.I.G. Capital, L.L.C., an affiliate of H.I.G., and the Company (the Advisory Services Agreement) on March 18, 2011 that provides for an annual monitoring fee between $250,000 and $500,000 (the Monitoring Fee) and reimbursement of all other out of pocket fees and expenses incurred by H.I.G. Capital, L.L.C.. In addition, pursuant to the terms of the Advisory Services Agreement, H.I.G. Capital, L.L.C. will be entitled to a financial advisory fee and a supplemental management fee in connection with any acquisition, disposition or material public or private debt or equity financing of the Company, in each case which has been introduced, arranged, managed and/or negotiated by H.I.G. Capital, L.L.C. or its affiliates. H.I.G. Capital, L.L.C. was paid a $500,000 transaction fee under the Advisory Services Agreement in connection with the recapitalization.

The Company recorded advisory services fees of $0.2 million and $0.25 million in 2011 and 2012, respectively, which were related to the Advisory Services Agreement.

Other

The balance of related party accounts payable included the following amounts:

•

Loan guaranty fees of $0.3 million and $0 at December 31, 2011 and 2012, respectively, owed to Marjorie S. Brooks.

•

Lease and other charges of $0.2 million at December 31, 2011 and $0.4 million at December 31, 2012, respectively, owed to Razorback Farms.

•

Accrued board of directors’ fees of $9 thousand at December 31, 2011 and $14 thousand at December 31, 2012.

•

Advisory services fees of $0.1 and $0.2 million at December 31, 2011 and 2012, respectively, owed to H.I.G.

Note 4: Line of Credit

The Revolving Line of Credit agreement with Liberty Bank was secured by inventory, accounts receivable, chattel paper, general intangibles and other current assets, as well as by fixtures and equipment, and bore an interest rate that was reduced from 7.5% to 7.15% effective February 15, 2012. In November, 2012 the Revolving Line of Credit with Liberty Bank was paid in full with the proceeds of a new loan with AloStar Bank of Commerce (AloStar), a state banking institution organized under the laws of the State of Alabama.

On November 15, 2012, AERT entered into a $15.0 million Loan and Security Agreement (the Agreement) with AloStar; $8 million as a Revolver Loan and $7.0 million as an asset-based loan (Term Loan).

The $8.0 million Revolver Loan is subject to a reserve of $1.0 million plus a maximum reserve of $1.0 million for class action claims. Interest is assessed at the greater of (a) 1.0% and (b) the LIBOR rate as shown in the Wall Street Journal on such day for United States dollar deposits for the one month delivery of funds in an amount approximately equal to the principal amount of the Loan for which such rate is being determined plus 4% as of December 31, 2012. If the LIBOR cannot be determined, the interest will be calculated using the prime lending rate plus 2%. The Revolver Loan is secured by 85% of accounts receivable after a reduction for amounts owed by international customers. The Revolver Loan is also secured by 60% of the eligible inventory or 85% of the net orderly liquidation value of the inventory. The Revolver at AloStar had a balance of approximately $2.3 million at December 31, 2012.

F-15

Note 5: Long-Term Debt

Long-Term Debt

	Year Ended
	December 31,			December 31,
	2011			2012
	(in thousands)
Long-term debt, less current maturities consisted of the following at December 31:
6.5% note payable to Liberty Bank of Arkansas. This note was paid in full using funds from the AloStar Term Loan listed below.		1,536			-
3% note payable to the Oklahoma Department of Commerce; secured by assets purchased / constructed with the loan proceeds; matures April 1, 2027		2,580			2,886
H.I.G. Series A Note (a)		10,643			11,519
H.I.G. Series B Note (b)		12,322			13,603
AloStar Bank of Commerce Term Loan bearing interest at 5.5%; secured by a continuing security interest in and lien upon all personal proerty, including all goods, inventory, equipment, all instruments, chattel paper, documents, general intangibles, intellectual property, deposit accounts, and investment property		-			6,917
Other		53			70
Total		27,134			34,995
Less Current Maturities		(1,680	)		(1,195	)
Long-term debt, less current maturities	$	25,454		$	33,800

______________________________

(a)	Cash interest of 4% plus 4% paid-in-kind interest added quarterly to principal. Addition occurs after quarter-end. To date all cash interest on H.I.G. Series A Note has been added to principal.

(b)	Cash interest of 4% plus 6% paid-in-kind interest added quarterly to principal. Addition occurs after quarter-end. To date, all cash interest on H.I.G. Series B Note has been added to principal.

The aggregate maturities of long-term debt as of December 31, 2012 were as follows:

(in thousands)
Year	Amount
2013		1,173
2014		1,179
2015		5,092
2016		180
2017		25,308
Thereafter		2,011
		34,943

Oklahoma Energy Program Loan

On July 14, 2010, we entered into a loan agreement with the Oklahoma Department of Commerce (ODOC) whereby ODOC agreed to a 15-year, $3.0 million loan to AERT at a fixed interest rate of 3.0%. The loan was made pursuant to the American Recovery and Reinvestment Act State Energy Program for the State of Oklahoma, and is funding the second phase of AERT’s new recycling facility in Watts, Oklahoma. Payments on the loan began May 1, 2012.

ODOC, under award number 14215 SSEP09, advanced $3.0 million to AERT throughout 2010, 2011 and 2012. As of December 31, 2012, a total of $3.0 million has been spent on contract labor, contract materials, and equipment. In addition, as of December 31, 2012, matching funds of $9.2 million have been contributed (in-kind) to the project by AERT.

F-16

AloStar Bank of Commerce Term Loan

The Term Loan contains certain covenants, including restrictions on: (1) fundamental changes in ownership, (2) conduct of business, (3) declaration of distributions, (4) amendments or modifications to existing agreements, (5) property acquisitions, (6) affiliated party transactions, and (7) hedging agreements. The proceeds of the loan were used to pay the Liberty Bank obligations.

Recapitalization Agreement - H.I.G. Long Term Debt

On March 18, 2011, the Company consummated related recapitalization transactions (the Transactions) with H.I.G. AERT, L.L.C., an affiliate of H.I.G. Capital L.L.C. (H.I.G.) and with other existing preferred stockholders, pursuant to which, among other things, H.I.G. exchanged $32,620,816 of its secured debt in the Company, including interest accrued through March 17, 2011, for a combination of new debt and equity. Prior to the consummation of the Transactions, H.I.G. was the sole owner of four distinct obligations representing the Company’s debt: (i) $6,806,656 of principal plus accrued interest owed under that certain Promissory Note, dated July 1, 2009, issued by the Company in favor of H.I.G.; (ii) $13,281,084 of principal plus accrued interest owed under the Adair County Industrial Authority Solid Waste Recovery Facilities Revenue Bonds issued in 2007; (iii) $10,436,409 of principal plus accrued interest owed under the City of Springdale Arkansas, Industrial Development Refunding Revenue Bonds issued in 2008; and (iv) $2,096,667 of principal plus accrued interest owed under the Secured Promissory Note (2010 Note) issued on December 20, 2010. Items (i)-(iv) above are collectively referred to herein as the “Prior Debt.”

In connection with the consummation of the Transactions, the Company entered into a Securities Exchange Agreement with H.I.G. (the Exchange Agreement), and a Credit Agreement with H.I.G. (the Credit Agreement), each dated March 18, 2011. Pursuant to the Exchange Agreement and the Credit Agreement, in exchange for the Prior Debt and H.I.G. making approximately $6.9 million in additional new capital available to the Company, H.I.G. was issued (i) a Series A Term Note (Series A Note) in the aggregate principal amount of $10,000,000, (ii) a Series B Senior Term Note (Series B Note, and collectively with the Series A Note, the Notes) in the aggregate principal amount of $9,000,000 (or such lesser amount as is actually borrowed thereunder), and (iii) 20,524.149 shares of Series E Convertible Preferred Stock, par value $0.01 per share, of the Company (the Series E Preferred Stock). As a result, upon consummation of the Transactions (including the Series D Exchange Agreement described hereunder), H.I.G. held $17,596,667 outstanding principal of senior secured debt of the Company and owned approximately 80% of the outstanding common equity securities of the Company on a fully diluted, as converted basis. Pursuant to the Exchange Agreement, until such time as H.I.G. no longer owns at least 20% of the Company’s outstanding Common Stock on a fully diluted basis, H.I.G. has the right to purchase securities in any subsequent issuance or sale of securities by the Company in an amount equal to the greater of (i) H.I.G.’s ownership percentage as of the business day prior to its receipt of notice of the proposed issuance or sale by the Company or (ii) 51%.

Pursuant to the Credit Agreement, the Company issued to H.I.G. the Notes, which are secured by a grant of a security interest in all of the Company’s assets in accordance with the terms of a Security Agreement, Patent Security Agreement, Copyright Security Agreement and Trademark Security Agreement, each dated March 18, 2011. The Series A Note matures six years after the closing of the Transactions (the Closing) and, at the Company’s option, either (i) bears cash interest at 8.0% per annum or (ii) bears cash interest at 4.0% per annum, plus a rate of interest equal to 4.0% per annum payable in kind and added to the outstanding principal amount of the Series A Note (with the latter option only being available for the first 24 months following the Closing, after which the Series A Note will bear cash interest at 8.0% per annum).

Upon the Closing, H.I.G. converted the $2,000,000 principal amount of the 2010 Note and accrued interest thereon into borrowings under the Series B Note. In addition, an additional $5.5 million was funded and drawn under the Series B Note at Closing. On October 20, 2011 AERT and H.I.G. amended this Credit Agreement to provide the Company with an additional $3.0 million to be drawn, as needed. The Company drew down $1.0 million on May 23, 2011, $2.0 million on October 21, 2011, and $1.0 million on November 18, 2011 to help fund operations. The Company drew down $0.5 million on November 5, 2012, which was repaid on November 15, 2012 with the closing of the AloStar term loan. The remaining principal balance is available to be drawn down from time to time in the future upon request by the Company, subject to H.I.G.’s approval in its sole discretion. The Series B Note matures six years after the Closing and, at the Company’s option, either (i) bears cash interest at 10.0% per annum or (ii) bears cash interest at 4.0% per annum, plus a rate of interest equal 6.0% per annum payable in kind and added to the outstanding principal amount of the Series B Term Note. The Series B Note ranks pari passu to the Series A Note.

F-17

As of December 31, 2012, AERT did not comply with fixed charge coverage ratio covenant required by the Series A and B Term Notes. The debt covenant has been waived by H.I.G. per the Waiver of Specified Events of Default as of January 25, 2013.

The recapitalization agreements have been accounted for as a troubled debt restructuring (ASC 470-60). The term notes, Series E Convertible Preferred Stock and Class A common stock issued have an estimated fair value of $45.4 million. The sum of cash proceeds and the recorded value of debt, accrued interest, Series D Preferred Stock, Warrants and certain other liabilities exchanged totaled $48.1 million, resulting in a gain on troubled debt restructuring of $3.0 million.

The Credit Agreement contains provisions requiring mandatory payments upon the Notes equal to 50% of the Company’s “Excess Cash Flow” (as defined in the Credit Agreement) and equal to 100% of proceeds from most non-ordinary course asset dispositions, additional debt issuances or equity issuances (subject to certain exceptions in each case or as H.I.G. otherwise agrees), and contains covenant restrictions on the incurrence of additional debt, liens, leases or equity issuances (subject to certain exceptions in each case or as H.I.G. otherwise agrees).

Note 6: Equity

Series D Preferred Stock and Warrant Exchange For Class A Common Stock

On March 18, 2011, immediately prior to the closing under the Exchange Agreement and Credit Agreement, the Company and the holders of the Company’s Series D Preferred Stock consummated the transactions contemplated by a Series D Preferred Stock Exchange Agreement (Series D Exchange Agreement), under which 748,772 shares of Series D Preferred Stock and Warrants exercisable for 3,787,880 shares of the Company’s Common Stock were exchanged for 36,313,376 shares of the Company’s Class A Common Stock (the Series D Converted Shares), equal to approximately 10% of the outstanding common shares of the Company on a fully diluted basis. At the date of the Series D Preferred Stock Exchange, H.I.G. owned 315,273 shares of Series D Preferred Stock and 1,515,155 warrants exercisable for shares of the Company Class A common stock.

The Company also terminated the Series D Preferred Stock Purchase Agreement, the Series D Preferred Stock Registration Rights Agreement and the Warrants issued in connection with the Series D Preferred Stock purchase transaction, and terminated all rights and obligations of the parties thereunder except for any indemnification rights and obligations under the Series D Preferred Stock Registration Rights Agreement. No early termination penalties were paid or incurred by the Company in connection with such terminations.

The Company issued (i) 36,313,376 shares of Common Stock to seven existing Series D Preferred Stockholders, including H.I.G., in exchange for (A) all of the previously outstanding 748,772 shares of Series D Preferred Stock and (B) Warrants exercisable for an aggregate of 3,787,880 shares of Common Stock, and (ii) 20,524.149 shares of Series E Preferred Stock to H.I.G. in exchange for a portion of the Prior Debt held by H.I.G. All of such issuances in clauses (i) and (ii) above were done on an unregistered private placement basis pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 thereunder and pursuant to the exemption for exchanges with existing stockholders under Section 3(a)(9) of the Securities Act of 1933, as amended.

All of the Series D Preferred Stock of the Company was retired and the contractual rights associated with it were extinguished and, pursuant to the Board designation rights conferred upon the Series E Preferred Stock, the rights of holders of Common Stock with respect to the election of directors was materially limited.

Series E Cumulative Convertible Preferred Stock

Pursuant to the Exchange Agreement, the Company issued 20,524.149 shares of newly authorized Series E Preferred Stock to H.I.G. at the Closing. The Series E Preferred Stock was authorized by the filing of a Certificate of Designations, Preferences and Rights of the Series E Convertible Preferred Stock of the Company filed on March 17, 2011 with the Delaware Secretary of State (the Series E Designation). Pursuant to the Series E Designation, holders of the Series E Preferred Stock are entitled to receive per share dividends equal to 6% per annum of the stated value of $1,000 per share of Series E Preferred Stock when declared by the Company’s Board of Directors. In addition, holders of the Series E Preferred Stock are entitled to participate in any dividends declared on shares of the Company’s Common Stock on an as-converted basis. Shares of the Series E Preferred Stock and all accrued dividends thereon are convertible at any time at the holder’s election into shares of the Company’s Class A Common Stock (the Conversion Shares) at a conversion price of $0.075 per share, subject to customary anti-dilution adjustments. The Series E Preferred Stock ranks senior to all other equity securities of the Company. Holders of the Series E Preferred Stock have the right to vote their ownership interests in the Series E Preferred Stock on an as-converted basis. In addition, holders of the Series E Preferred Stock also have the right to elect four of the Company’s seven directors while they hold outstanding shares of Series E Preferred Stock representing at least 20% of the outstanding shares of Common Stock on an as-converted basis. If the outstanding shareholding of Series E Preferred Stock at any time represents less than 20% of the outstanding shares of Common Stock on an as-converted basis, the holders of the Series E Preferred Stock will have the right to elect one of the Company’s seven directors. The Series E Designation contains customary protective voting provisions and other rights customarily granted to holders of preferred equity securities.

F-18

Also, on March 18, 2011, the Company and H.I.G. entered into a Registration Rights Agreement under which, among other things, the Company granted to H.I.G. certain demand and “piggyback” registration rights with regard to its Conversion Shares and Series D Converted Shares. The Registration Rights Agreement provides for the payment of reasonable expenses in connection with such registrations (including the payment of fees of counsel up to $10,000 for each registration statement) and contains other customary provisions.

In order to satisfy its obligations under the Exchange Agreement with regard to the reservation of the Conversion Shares, the Company was contractually obligated to present for stockholder approval an amendment to the Company’s Certificate of Incorporation to authorize 400,000,000 additional shares of the Company’s Class A Common Stock which was subsequently voted on July 14, 2011 with stockholder approval. On March 18, 2011, the Company, H.I.G., all of the prior Series D Preferred Stockholders, certain management stockholders and certain other stockholders, including Marjorie S. Brooks, entered into a Voting Agreement undertaking to vote in favor of such increase in authorized capital stock.

The Series E Convertible Preferred Stock is not redeemable except under certain conditions which may be out of the control of the Company. An event of default under the Series A and B Term notes, for example, the failure to meet specified financial covenants, may trigger a redemption right to the holders of the Series E Convertible Preferred stockholders. As a result, the carrying value of the Series E Convertible Preferred Stock is reported in temporary equity.

On January 25, 2013, H.I.G. AERT LLC, the holder of all of the issued and outstanding shares of Series E Convertible Preferred Stock, waived its right to deliver a Triggering Event Redemption Notice as a result of AERT failing to have a Leverage Ratio as defined in that certain Credit Agreement, dated as of March 18, 2011, as amended by that certain First Amendment to Credit Agreement, dated as of May 12, 2011, and as further amended by that certain Second Amendment to Credit Agreement, dated as of October 20, 2011 (as further amended, restated, supplemented or otherwise modified from time to time, the Credit Agreement), by and among AERT, the lenders from time to time parties thereto and H.I.G. AERT, LLC) of below 4.0 to 1.0 for four Fiscal Quarters (as defined the Credit Agreement) ending December 31, 2012.

The initial conversion price of the Series E Preferred Stock is fixed and will remain the conversion price subject to the anti-dilution adjustments described below. The conversion price of the Series E Preferred Stock is subject to customary weighted-average anti-dilution adjustments, which will be made (subject to certain exceptions) in the event that AERT:

·	issues or sells common stock for consideration per share less than a price equal to the current market price in effect immediately prior to such issue or sale;

·	pays dividends or other distributions on the common stock in shares of common stock;

·	subdivides, splits or combines the shares of common stock;

·	subject to certain exceptions and limitations, issues options, rights or warrants entitling the holders to purchase common stock at less than the then-current market price (as defined in the certificate of designations for the Series E Preferred Stock);

·	issues or sells any securities that are convertible into or exercisable or exchangeable for common stock and the lowest price per share for which one share of common stock is issuable upon the conversion, exercise or exchange thereof is less than the then-current market price;

makes changes to the terms of outstanding options, warrants, or convertible securities (including those that were outstanding as of March 18, 2011, the original issue date of the Series E Preferred Stock) and that would result in a dilutive effect on the Series E Preferred Stock; in general, in such event the adjustment shall be calculated as if the changed terms had been in effect from the initial issuance of such securities and such securities issued before March 18, 2011 shall be treated as if newly issued as of the date of such change; provided that no adjustment will be made in such case if such adjustment would result in an increase in the conversion price then in effect; and

F-19

takes any action that would result in dilution of the Series E Preferred Stock but is not specifically provided for in the Series E Preferred Stock certificate of designations (including granting of stock appreciation rights, phantom stock rights or other rights with equity features), in which case the Company’s Board of Directors shall in good faith determine and implement an appropriate adjustment in the conversion price so as to protect the rights of the holders of the Series E Preferred Stock, subject to certain qualifications.

Common Stock

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

Note 7: Stock Option Plans

Additional stock options are not issuable under the Company’s stock option plans, as the plans have expired. However, there are options outstanding that were previously issued under the plans.

	2011					2012
											Aggregate
				Weighted					Weighted		Intrinsic
				Average					Average		Value at
				Exercise					Exercise		December 31,
	Shares			Price		Shares			Price			2012
Outstanding, beginning of year		1,049,000		$	1.68		525,000		$	1.62
Granted		-			-		-			-
Exercised		-			-		-			-
Forfeited		(524,000	)		1.73		(175,000	)		2.53
Outstanding, end of year		525,000		$	1.62		350,000		$	1.17	$	-
Exercisable, end of year		525,000		$	1.62		350,000		$	1.17	$	-

The following table summarizes information about stock options outstanding under the Company’s stock option plans as of December 31, 2012. All options were exercisable at December 31, 2012.

Options Outstanding and Exercisable
	Wtd. Avg.	Wtd. Avg.
Number at	Remaing	Exercise
12/31/12	Contract Life	Price
350,000	0.78 years	1.17

F-20

Note 8: Equity Incentive Plans

The Company’s 2012 Stock Incentive Plan (Plan) is an equity-based incentive compensation plan that is used to distribute Awards to qualified employees, thereby fulfilling the following objectives of the Company:

1.	To enhance the Company’s ability to attract highly qualified personnel

2.	To strengthen the Company’s retention capabilities

3.	To enhance the long-term performance and competitiveness of the Company

4.	To align the interest of Plan participants with those of the Company’s shareholders.

The Plan was approved by the Board of Directors on March 3, 2012 and by the Shareholders at the 2012 Shareholders’ Meeting held in Springdale, Arkansas on June 27, 2012.

Administration

The 2012 Plan is administered by the Compensation Committee (Committee) of the Board of Directors, and thereafter by such committee as the board may from time to time designate, or by the board itself, if it shall so designate. Except when the entire board is acting as the 2012 Plan Administrator, the Committee administering the 2012 Plan shall consist solely of two or more persons all of whom are both “non-employee directors” within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934.

Plan Basics

A total of 40,000,000 shares are available for issuance under the Plan. The shares deliverable pursuant to Awards shall be authorized but unissued shares, or shares that the Company otherwise holds in treasury or trust. Participants are solely responsible for taxes due on Awards. Awards may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of decent or distribution. In the event of a change of control, shares will be equitably adjusted. Awards will be assumed by the successor company; the Awards Committee may accelerate vesting, arrange for cash payment, terminate all or some Awards, or make other modifications. Pursuant to the Awards Agreement, the Company may terminate, rescind, or recapture any outstanding, unexercised, unexpired, unpaid, or deferred Awards. The Company may require that any Participant reimburse the Company for all or any portion of the Awards granted under this Plan. No Participant shall have any rights as a shareholder of the Company until the date of issuance of a share certificate. The Plan will be valid for a period of 10 years.

The Committee will have the power and authority to select and grant to participants the following types of Awards:

Options give the Participant the right to purchase Company stock at a given price over an extended period of time. Incentive Stock Options (ISOs) are within the definition of IRS §422. In the case of an ISO granted to a Participant who is a 10% shareholder on the grant date, the exercise price shall be at least 110% of the fair market value.

Share Appreciation Rights (SARs) provide the Participant with a cash (or shares) payment based on the increase in the value of a stated number of shares over a specific period of time. A participant may wish to use an IRS §83(b) election, which will allow the Participant to recognize the value of the SARs as income upon the purchase of the stock.

Restricted Shares and Restricted Share Units (RSUs) are shares of stock for which a Participant is eligible after certain restrictions are fulfilled. Restrictions are pursuant to the Awards Agreement. The Participant shall receive unrestricted shares (or cash) in settlement of the Award. Restricted Shares, RSUs and Unrestricted Shares are not inconsistent with the Plan. If the shares are purchased and forfeited for any reason, the purchase price is refunded to the Participant and the shares of stock remain with the Company.

Deferred Stock Units (DSUs) are permitted within the Plan guidelines. The Committee may permit select eligible persons who are Directors or members of a select group of management or highly compensated employees (within the meaning of ERISA) to irrevocably elect to forego the receipt of cash or other compensation in lieu thereof to have the Company credit to an internal Plan account the number of DSUs deferred. DSUs are 100% vested at all times.

5.	Performance and cash-settled Awards are based on achievement of performance measures for a performance period in relation to a performance formula. The maximum Award will be 10,000,000 shares or $1.0 million. The Committee may defer the Award.

F-21

6.	Dividend Equivalent Rights give the Participant the right to receive a payment, in shares or in cash that is equivalent to the value of dividends declared on shares as of all dividend payment dates. The Award is paid on the record date of dividends and is pursuant to the Awards Agreement.

As of December 31, 2012, no awards have been made.

Note 9: Leases

At December 31, 2012, the Company was obligated under various operating leases covering certain buildings and equipment. Rent expense under operating leases for the years ended December 31, 2011 and 2012 was $3.2 million and $3.1 million, respectively. These amounts for rent expense are considerably higher than the future minimum lease payments each year shown in the table below due to many of our operating equipment leases having durations of less than one year.

During 2010, the Company also leased certain ERP software, computer equipment, and production equipment under three individual, non-cancelable capital leases. The leases have various terms but all include a bargain purchase option upon expiration. The computer equipment lease expired in 2010 while the software and production equipment leases expired in 2012. The principal portion of lease payments for capital lease obligations totaled $0.2 million in each of 2011 and 2012.

Future minimum lease payments required under operating leases as of December 31, 2012, are as follows (in thousands):

	Operating
Year	Leases
2013	$	1,465
2014		906
2015		189
2016		68
2017		33
Thereafter		-
Total minimum payments required	$	2,661

Note 10: Income Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

The Company had no income tax provision for State and Federal income for the years ended December 31, 2011 and 2012.

The income tax provisions for 2011 and 2012 differ from the amounts computed by applying the US federal statutory rate of 34% to income as a result of the following (in thousands):

	2011						2012
	Amount			Percent			Amount			Percent
Income tax at the U.S. federal statutory rate	$	(2,355	)		34.0		$	(227	)		34.0
Permanent differences		200			(3.0	)		17			(3.0	)
Change in valuation allowance		2,155			(31.0	)		210			(31.0	)
	$	-			0.0		$	-			0.0

F-22

The tax effects of significant temporary differences representing deferred tax assets and liabilities were as follows (in thousands):

	2011						2012
	Current			Long-Term			Current			Long-Term
Deferred tax assets —
Net operating loss carryforwards	$	-		$	6,926		$	-		$	8,757
Allowance for sales returns		1,853			-			-			-
Accrued expenses		1,514						956			-
Valuation allowance		(3,384	)		(4,981	)		(1,101	)		(7,827	)
Other		227			54			363			51
Total deferred tax assets		210			1,999			218			981
Deferred tax liability —
Depreciation		-			1,999			-			981
Prepaid expenses		210			-			218			-
Total deferred tax liabilities		210			1,999			218			981
Net deferred tax	$	-		$	-		$	-		$	-

As of December 31, 2012, the Company had net operating loss (NOL) carryforwards for federal income tax purposes, which are available to reduce future taxable income. If not utilized, the NOL carryforwards will expire between 2017 and 2031. In March 2011, H.I.G. AERT, LLC acquired a controlling interest in the Company, which will result in a significant restriction on the utilization of the Company’s net operating loss carryforwards. It is estimated that the utilization of future NOL carryforwards will be limited (per IRC 382) to approximately $0.8 million per year for the next 19 years. The impact of this limitation is approximately $27.0 million in NOL’s, which will expire before the Company can use them.

As there is insufficient evidence that the Company will be able to generate adequate future taxable income to enable it to realize its net operating loss carryforwards prior to expiration, the Company maintains a valuation allowance to recognize its deferred tax assets only to the extent of its deferred tax liabilities.

Based upon a review of its income tax filing positions, the Company believes that its positions would be sustained upon an audit and does not anticipate any adjustments that would result in a material change to its financial position. Therefore, no reserves for uncertain income tax positions have been recorded. The Company recognizes interest related to income taxes as interest expense and recognizes penalties as operating expense.

The Company is subject to routine audits by various taxing jurisdictions. The recent examination by the Internal Revenue Service of the Company’s 2010 federal tax return yielded changes that did not affect the tax that was reported on the return; therefore, the Service has accepted the return. The Company is no longer subject to income tax examinations by taxing authorities for years before 2009, except in the States of California and Texas, for which the 2008 tax year is still subject to examination.

Note 11: Commitments and Contingencies

Long Term Contracts

The Company has two agreements for the purchase of raw materials. One agreement expires in four years. The other agreement expired in mid-January 2013, at which time the agreement reverted to a month-to-month obligation.

Legal Proceedings

AERT is involved from time to time in litigation arising from the normal course of business that is not disclosed in its filings with the SEC. In management's opinion, this litigation is not expected to materially impact the Company's results of operations or financial condition.

F-23

Advanced Environmental Recycling Technologies, Inc. v. Ross Systems, Inc.

The Company and Ross Systems, Inc. settled the cause of action that was brought by the Company against Ross Systems, Inc. The parties agreed to keep the terms of the settlement confidential and the Company continues to use Ross software with maintenance from Ross Systems, Inc. The net settlement recovery was offset against manufacturing and administrative costs previously incurred.

Note 12: 401(k) Plan

The Company sponsors the A.E.R.T. 401(k) Plan (the Plan) for the benefit of all eligible employees. The Plan qualifies under Section 401(k) of the Internal Revenue Code thereby allowing eligible employees to make tax-deferred contributions to the Plan. The Plan provides that the Company may elect to make employer-matching contributions equal to a percentage of each participant’s voluntary contribution. The Company may also elect to make a profit sharing contribution to the Plan. The Company has never made any matching or profit sharing contributions to the Plan.

F-24

INDEX TO EXHIBITS

Exhibit
No.		Description of Exhibit
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), and Certificate of Amendment filed on December 29, 1999, Certificate of Amendment filed September 23, 2010, Certificate of Amendment filed July 14, 2011, and Certificate of Correction of the Certificate of Amendment filed on April 27, 2012
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)
4.2.1		Form of Class B common stock Certificate (a)
10.1		Form of Right of Refusal Agreement among Class B common stockholders (a)
10.2		Liberty Bank Real Estate Loan Agreement (g)
10.3		Liberty Bank Real Estate Promissory Note (d)
10.4		Liberty Bank Line of Credit Loan Agreement (g)
10.5		Liberty Bank Line of Credit Promissory Note (e)
10.6		Form of Warrants to Purchase Common Stock issued October 29, 2007 (e)
10.7		Registration Rights Agreement (e)
10.10		Loan Agreement between Oklahoma Department of Commerce and Advanced Environmental Recycling Technologies, Inc. dated July 1, 2010 (h)
10.11		Promissory Note between Oklahoma Department of Commerce and Advanced Environmental Recycling Technologies, Inc. dated July 1, 2010 (h)
10.12		Securities Exchange Agreement between Registrant and Investors named therein (H.I.G. AERT, L.L.C.) dated March 18, 2011 (f)
10.13		Series D Preferred Stock Exchange Agreement between Registrant and Stockholders named therein dated March 18, 2011 (f)
10.14		Advisory Services Agreement between Registrant and H.I.G. Capital, L.L.C. dated March 18, 2011 (f)
10.15		Voting Agreement by and among Registrant and the persons named therein, dated March 18, 2011 (f)
10.16		Indemnity Agreement between the Registrant and Michael Phillips dated March 18, 2011 (f)
10.17		Credit Agreement between the Registrant and H.I.G. AERT, L.L.C. as Administrative Agent (f)
10.18		Series A Term Note of Registrant payable to H.I.G. AERT, L.L.C. dated March 18, 2011 (f)
10.19		Series B Term Note of Registrant payable to H.I.G. AERT, L.L.C dated March 18.2011 (f)
10.20		Security Agreement between Registrant and H.I.G. AERT, L.L.C. as Administrative Agent dated March 18, 2011 (f)
10.21		Lease Reinstatement, Settlement and Waiver Agreement between Registrant and Banc of America Leasing & Capital, LLC dated March 17, 2011 (f)
10.22		Fifteenth Loan Modification Agreement between Registrant and Liberty Bank of Arkansas dated March 18, 2011 (f)
10.23		Registration Rights Agreement between Registrant and H.I.G. AERT, L.L.C. (f)
10.24		H.I.G. Series E Waiver dated February 20, 2012 (h)
10.25		H.I.G. Waiver of Default dated February 29, 2012 (h)
10.26		Loan Agreement between AloStar Bank of Commerce and AERT dated November 15, 2012 (i)
10.27		Subordination Agreement between AloStar Bank of Commercer and H.I.G. AERT, L.L.C. **
10.28		H.I.G Waiver of Default dated January 25, 2013 **
10.29		H.I.G. Waiver of Triggering Event dated February 20, 2013**
23.1		Consent of Independent Registered Public Accounting Firm**
31.1		Certification per Sarbanes-Oxley Act of 2002 (Section 302) by the Company’s chairman and chief executive officer**
31.2		Certification per Sarbanes-Oxley Act of 2002 (Section 302) by the Company’s chief financial officer**
32.1		Certification per Sarbanes-Oxley Act of 2002 (Section 906) by the Company’s chairman and chief executive officer**
32.2		Certification per Sarbanes-Oxley Act of 2002 (Section 906) by the Company’s chief financial officer**

Exhibit
No.		Description of Exhibit
100		XBRL related documents
101		Interactive data file
____________


**		Filed herewith.

(a)		Incorporated by reference to exhibits to Registration Statement on Form S-1, No. 33-29595, filed June 28, 1989.

(b)		Incorporated by reference to exhibits to Amendment No. 1 to Registration Statement on Form S-1, No. 33-29595, filed August 24, 1989.

(c)		Incorporated by reference to exhibits to Amendment No. 2 to Registration Statement on Form S-1, No. 33-29595, filed November 8, 1989.

(d)		Incorporated by reference to exhibits filed with Form 10-Q for September 30, 2005.

(e)		Incorporated by reference to exhibits filed with Form 10-K for December 31, 2005.

(f)		Incorporated by reference to exhibits to Form 8-K March 18, 2011

(g)		Amendments Incorporated by reference to exhibits to Form 8-K filed February 22, 2012

(h)		Incorporated by reference to exhibits to Form 10-K filed March 30, 2012

(i)		Incorporated by reference to exhibits to Form 8-K filed November 16, 2012