10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

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

For the fiscal year ended December 31, 2005

Commission file Number 1-10367

Advanced Environmental Recycling Technologies, Inc.

(Exact name of Registrant as specified in its charter)

Delaware	71-0675758
(State of Incorporation)	(I.R.S. Employer Identification No.)
914 N Jefferson Street Post Office Box 1237 Springdale, Arkansas (Address of principal executive offices)	72764 (Zip Code)

Registrant’s telephone number, including area code:

(479) 756-7400

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

None

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

Class A common stock, $.01 par value

Indicate by check mark 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

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

Large Accelerated Filer o     Accelerated Filer o     Non-Accelerated Filer þ

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

On June 30, 2005, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity of the registrant was $38,503,743 (for the purposes hereof, directors, executive officers and 10% or greater shareholders have been deemed affiliates).

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. Number of shares of common stock outstanding at March 27, 2006: Class A — 38,137,812; Class B — 1,465,530

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our Definitive Proxy Statement for the 2006 Annual Meeting to be held June 8, 2006, 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 1A.	Risk Factors		6
Item 1B.	Unresolved Staff Comments		8
Item 2.	Properties		8
Item 3.	Legal Proceedings		9
Item 4.	Submission of Matters to a Vote of Security Holders		10
Part II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities		10
Item 6.	Selected Financial Data		11
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		19
Item 8.	Financial Statements and Supplementary Data		20
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure		21
Item 9A.	Controls and Procedures		21
Item 9B.	Other Information		21
Part III
Item 10.	Directors and Executive Officers of the Registrant		21
Item 11.	Executive Compensation		25
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		25
Item 13.	Certain Relationships and Related Transactions		25
Item 14.	Principal Accountant Fees and Services		25
Part IV
Item 15.	Exhibits and Financial Statement Schedules		25
Signatures			26
Index to Financial Statements			F-1
Loan Agreement - Liberty Bank of Arkansas
Promissory Note
Accountant's Consent
Certification Pursuant to Section 302
Certification Pursuant to Section 302
Certification Pursuant to Section 302
Certification Pursuant to Section 906
Certification Pursuant to Section 906
Certification Pursuant to Section 906

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Item 1.   Business

Summary

Advanced Environmental Recycling Technologies, Inc. (AERT) develops, manufactures, and markets composite building materials that are used in place of traditional wood 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 waste wood fiber, which have been cleaned, sized and reprocessed, and recycled polyethylene plastics. Our products have been extensively tested, and are sold by leading national companies such as the Weyerhaeuser Company (Weyerhaeuser), Lowe’s Companies, Inc. (Lowe’s) and Therma-Tru Corporation. Since our inception in 1989, we have sold over $350 million of products into the North American marketplace. Our composite building materials are marketed as a substitute for wood and plastic filler materials for standard door components, windowsills, brick mould, fascia board, decking and heavy industrial flooring under the trade names LifeCycle^®, MoistureShield^®, MoistureShield^® CornerLoc^tm, Weyerhaeuser ChoiceDek^® Premium, ChoiceDek^® Premium Colors and MoistureShield^® outdoor decking. We operate manufacturing facilities in Springdale, Lowell, and Tontitown, Arkansas; Junction, Texas and Alexandria, Louisiana. We also operate a warehouse and reload complex in Lowell, Arkansas. Operations will commence in the second quarter of 2006 at our third composite extrusion plant, which we refer to as “Springdale South”. Our customers are primarily regional and national door and window manufacturers, Weyerhaeuser — our primary decking customer — and regional building product distributors.

Products

Using the same basic process and material, we manufacture the following product lines:

•  Commercial and residential decking planks and accessories such as balusters and handrails (MoistureShield and Weyerhaeuser ChoiceDek),

•  Exterior door and window components, and

•  Exterior housing trim (MoistureShield).

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

•  Unlike wood, our products do not require preservatives or treatment with toxic chemicals nor do they require yearly water sealing or staining.

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

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

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

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

•  Our products can be aesthetically enhanced to provide a wood-like or grained surface appearance.

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

•  Our products can be combined with coloring agents and/or other additives to provide different colors and aesthetics.

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AERT’s composites manufacturing process involves proprietary technologies, certain of which are patented. We also use manufacturing equipment that has been custom-built or modified to our specifications. Our composite building material became a patented product in June 1998 under U.S. Patent No. 5,759,680.

Based upon our extensive product testing and successful extended field history of over a decade, we offer a limited lifetime replacement warranty on our products against rot and fungal decay, and termite and insect damage.

Marketing and Sales

General Market Strategy.  We have manufactured wood plastic composite products since 1989. Our products are designed for applications where we can add the greatest value and address market needs, i.e. for external applications where wood is prone to rot and/or requires substantial yearly maintenance in the form of staining or water sealing. Though we believe there are many possible applications for our wood/plastic composite technology, we have focused our resources and personnel on outdoor decking and door and window components, which in our view represent the most attractive market opportunities at this time. Within our chosen markets, we are constantly working to develop and improve strong customer relationships.

Outdoor Decking Systems.  Initially, beginning in 1995, we sold our decking products exclusively to Weyerhaeuser Building Materials. That changed in 2004, and we currently operate under a contract with Weyerhaeuser whereby Weyerhaeuser purchases all of our ChoiceDek Premium decking products for resale exclusively to Lowe’s Companies under the Weyerhaeuser ChoiceDek brand. Additionally, we are the exclusive producer of composite decking for Lowe’s. The Weyerhaeuser contract requires us to produce, and Weyerhaeuser to purchase, a minimum number of truckloads of ChoiceDek Premium decking and accessories, which amount is set by Weyerhaeuser each year subject to a minimum annual quantity of 1,850 truckloads. Weyerhaeuser and independent lumber dealers can also special order MoistureShield decking from the Weyerhaeuser distribution network in certain markets. Weyerhaeuser has agreed to provide Lowe’s the exclusive right to carry the ChoiceDek Premium product line, which Lowe’s sells in all of its 1,200+ home improvement stores across the U.S. Weyerhaeuser and AERT were named Lowe’s “Vendor of the Year” for lumber products in 2005. Lowe’s promotes ChoiceDek Premium through a national print and advertising campaign and sponsorship of major sporting events such as the NCAA basketball “Final Four” tournament and NASCAR races. The Weyerhaeuser contract is year-to-year and automatically renews each year unless either party provides four months advance notice of cancellation. We believe the Weyerhaeuser contract strengthens our competitive position in the decking marketplace and gives us the opportunity to develop and sell new products through the same home improvement warehouse channel.

We promote our decking products through displays and presentations at national, regional, and local home, lawn, and garden shows, and through in-store displays. We have an on-going print advertising program that targets the residential decking market. Lowe’s is also conducting a national print and television advertising campaign for ChoiceDek Premium.

Weyerhaeuser purchases accounted for about 77% of our 2005 net sales. If Weyerhaeuser were to cancel the Weyerhaeuser contract, we would have to develop an alternative distribution system for decking products, which could be expensive and time consuming. Though Weyerhaeuser has purchased substantially all of our decking production since 1995, there is no assurance that it will continue to do so (see Item 1A. “Risk Factors — The loss of one or more of our key customers could cause a substantial reduction in our revenues and profits” and Note 2 to the financial statements regarding concentration of risk).

In October 2004, we began production of our new MoistureShield brand line of decking products, which consists of four colors and a wood-like embossed surface pattern. MoistureShield decking is currently sold to a limited number of primary distributors, who re-sell it to lumber dealers and contractor yards for sale to local deck builders and home builders. MoistureShield decking sales represented about 9% of total Company sales in 2005. The MoistureShield decking line will allow us to diversify our customer base. It also allows us to diversify the risk inherent in selling such a large portion of our production to one customer, Weyerhaeuser. It is our intent to grow the MoistureShield decking program and diversify our customer base as additional production capacity becomes available during 2006.

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Door and Window Products.  We sell our MoistureShield industrial products to door and window manufacturers for use as component parts of their products. For example, we manufacture a windowsill that is built into products like Portrait windows by Stock Building Supply and we manufacture door rails built into doors by Therma-Tru Corporation. In marketing, we emphasize the “value-added” potential of the MoistureShield composite product, which, unlike competing wood products, can be engineered to incorporate certain desired end-product characteristics that save our customers time and expense. Customers also avoid the need for chemical treatments to their final product, which are otherwise often necessary to prevent rot and sustain durability. The durability of our MoistureShield composite components allows our customers to extend the lifetime or warranties of their products while reducing or eliminating warranty claims costs.

Therma-Tru and Stock Building Supply each purchase a large portion of our industrial products. The loss of either customer would negatively impact sales and earnings. We are unable to predict the future size of the markets for MoistureShield industrial products; however, we believe that the national door and window, commercial and residential trim, and residential decking material markets are large and growing 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 market an exterior trim and fascia system under the trade names MoistureShield Trim and MoistureShield CornerLoc. Three national homebuilders are now specifying and using the product. With our previous limitations on production capacity and focus to meet the demand for our decking systems, we have limited our Trim and CornerLoc production to date. We believe this product line has significant growth potential, and we are striving to increase production capacity so that we can increase production and initiate a marketing program, in conjunction with our MoistureShield distributors. The timetable of a full product launch is dependent upon our construction and financing timetable and the start-up of our Springdale South manufacturing facility (see Item 2 — Properties and Item 7 — Liquidity and Capital Resources).

Sales and Customer Service.  We provide sales support and customer service through our own marketing department, through outside commissioned representatives with an affiliated entity, through Weyerhaeuser, and through training programs for our customers and their sales associates. Our in-house sales and customer support team is focused on serving commercial decking contractors and supporting the Weyerhaeuser and Lowe’s sales professionals. Information and customer service are provided through the websites www.choicedek.com and www.moistureshield.com, and through a national toll-free customer assistance telephone number. We also use independent, outside sales representatives in some markets to serve door, window, and decking customers.

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 interest rates and economic uncertainty in particular can lead to reduced homebuilding and/or home improvement activity. Reductions in such activity could have an adverse effect on the demand for our products. We have focused a large portion of our business on the remodel and repair market segment which we believe is less sensitive to interest rate fluctuations.

Product Innovation.  In our constant pursuit of satisfying our customers, and to keep up with changing trends in the marketplace, we routinely analyze the need to develop new products and improve existing products. We intend to develop several new decking products in late 2006 for introduction to consumers in 2007.

Raw Materials

Wood Fiber.  The wood fiber we use is waste by product generated by hardwood furniture, cabinet, and flooring manufacturers. The cost of acquiring the waste wood is primarily the handling and transportation costs involved in getting the material to our facilities. Costs vary with transportation costs in general, which are related to petroleum prices and the supply and demand for over-the-road trucking services. Our cost of sourcing waste wood fiber has increased over the last three years due to transportation costs, but remains a

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small proportion of our total costs. Our gross profit margin is not materially sensitive to changes in the cost of acquiring wood fiber.

Two suppliers accounted individually for more than 10% and collectively for approximately 80% of our 2005 waste wood fiber purchases. Based on our discussions with other waste wood fiber suppliers, we believe that if the arrangements with one or both of these suppliers were terminated we would be able to obtain adequate supplies of waste wood fiber at an acceptable price from new suppliers. We are currently evaluating the feasibility of establishing an in-house wood fiber reclamation and cleaning system in northwest Arkansas.

Recycled Plastics.  We use the following classes of industrial and consumer waste polyethylene:

•  Low density polyethylene (LDPE) poly coatings or linings from recycled bleached food-board, which are generated from the hydro-pulping process;

•  High density polyethylene (HDPE) and linear low density polyethylene (LLDPE) mixed plastic grocery bags from supermarket and store collection programs;

•  HDPE ground container material;

•  LLDPE stretch film from warehouses and packing waste; and

•  Virgin HDPE and LDPE pellets.

The main materials we use are highly contaminated with paper and other non-plastic materials, which lessen their value to other plastic recyclers. Our proprietary recycling process does not require the purity, extensive cleaning, additional washing, and melt filtration required for conventional plastics manufacturing, and can be conducted faster and more economically. By using primarily contaminated, lower in waste plastics, we produce a usable, but lower cost, feedstock for our composite extrusion lines. We also purchase plastic raw materials from outside sources, including virgin resin producers. These materials are more expensive and more sensitive to price swings related to the petrochemical industry. We also are subject to various quality and consistency problems when dealing with third party scrap suppliers, which also increases our costs. Thus, we are utilizing more virgin resin at higher prices as we further work to increase our in-house infrastructure. Our goal is to source and process a minimum of 75% of our plastic raw materials in-house. In 2005, we processed approximately 55%, which still leaves us overly dependent on outside suppliers.

One supplier accounted for about one third of our 2005 polyethylene scrap purchases by weight. No other of our more than 100 polyethylene suppliers accounted for more than 10% of our purchases by weight.

Over the last several years, we believe four factors have caused an increase in the demand for scrap polyethylene and, consequently, the cost to us of acquiring raw materials for our manufacturing process.

•  As world political events conspired to raise the price of petroleum there was a related rise in the price of virgin plastic, which is a petroleum and natural gas derivative. This in turn increased the demand for scrap plastics since scrap can be substituted for virgin plastics in many manufacturing applications. We thus began competing with scrap plastic consumers that had not previously been in the market.

•  The relative decline in the value of the dollar versus major Asian currencies has made it economical for Asian manufactures to source scrap plastic in the U.S. for use in their countries. We have thus encountered significant competition for scrap plastics from foreign consumers that had not previously been a factor in the market.

•  Demand from economies in China and India for increased petrochemical products.

•  As annual sales of wood composite decking products have grown, we and other composite decking manufacturers have become relatively large consumers of scrap plastics, which has created increasing competition for raw materials and driven up prices.

On the other hand, we believe that the economics of recycling are now such that more private and public entities will find it attractive to undertake removing plastic scrap from the waste stream and make it available to consumers like us.

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Supply Contracts.  We purchase raw materials under both supply contracts and purchase orders. In 2005, we purchased about 40% of our polyethylene scrap and all of our waste wood, by weight, via purchase orders. Purchase order acquisitions are one-time transactions that involve no long-term obligation. We also have supply contracts, with terms that range from one to three years, which obligate us to purchase materials. The prices under these contracts are renegotiated semi-annually or annually. In the past three years, the amounts we have been obligated to purchase under the supply contracts have been significantly less than the amounts of these materials we have needed for production.

Competition for Raw Materials.  As the wood/plastic composites industry grows, we sometimes compete for raw materials with other plastic recyclers or plastic resin producers. We believe that our ability to use highly contaminated polyethylene limits the number of competitors because most recycling processes require “cleaner” waste plastic sources. Nonetheless, we expect to continue to encounter new entrants into the plastics reclamation business. These new entrants may have greater financial and other resources than we do, and may include domestic and foreign beverage bottlers, manufacturers, distributors and retailers, forestry product producers, petrochemical and other companies. We increased our capacity for processing waste plastic in 2005, which reduced our dependence on outside suppliers and reduces our overall costs but it is still not to desired levels. There is no assurance that we will be able to control the effect that increasing waste plastic costs has on our profitability. (See Item 7. Management’s Discussion and Analysis — Liquidity and Capital Resources.)

Patented and Proprietary Technology

Our composite manufacturing process and our development efforts in connection with waste plastics reclamation technologies involve patents and many trade secrets that we consider to be proprietary. We have also developed certain methods, processes, and equipment designs for which we have sought additional patent protection. We have taken measures to safeguard our trade secrets by, among other things, entering into confidentiality and nondisclosure agreements, and restricting access to our facilities. We also have installed advanced security systems, including limited access and cameras, at all facilities including on-site security personnel. Should our trade secrets be disclosed notwithstanding these efforts, our business and prospects could be materially and adversely affected.

We have filed nineteen patent applications and have received issuance from the United States Patent and Trademark Office for fourteen patents, five of which relate to our composite materials manufacturing operations and product, and nine of which relate to waste plastics reclamation technologies. The patents cover our composite product, extrusion process and apparatus, our continuous down-stream cooling and forming conveyor system and our plastic reclamation process and equipment. The cost of patent protection and, in particular, patent litigation is extremely high. It can also strain resources and inhibit growth.

Industry Standards

Local building codes often require that building materials meet strength and safety standards developed by the American Society for Testing Materials and that, in order to qualify, the materials be evaluated by an independent testing organization. Our decking, handrails and stair applications have a national evaluation report “NER” code rating under NER-596. The NER rating provides local building inspectors and code officials with independent testing and installation information regarding our products. We believe that the NER listing has helped to increase sales and market acceptance of our decking products. We have recently renewed our building code listing and are currently in the process of upgrading and increasing the number of products covered for additional building code approval.

Regulation

AERT is subject to federal, state, and local environmental regulations. Environmental discharges and impacts from our manufacturing facilities including air, solid waste, and wastewater discharges must meet the standards set by environmental regulatory authorities in Texas, Arkansas, and Louisiana. Compliance with environmental laws has not had a material effect on our operating results or financial condition.

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Our operations are also subject to work place safety regulation by the U.S. Occupational Safety and Health Administration, the state of Arkansas, the state of Texas, and the state of Louisiana. We provide safety awareness and training programs for all associates who work in a manufacturing environment.

Competition

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

Sales of non-wood decking products to date represent a small portion of the decking market. According to an independent research report the wood-alternative market share was 16% in 2004 and continues to grow. Pressure treated pine, cedar, redwood and other traditional woods constitute the vast majority of annual decking sales. We thus view wood decking as our principal competitor. The wood decking industry is highly segmented with many small to medium sized manufacturers. Wood decking is principally a commodity that competes as the low-priced product, whereas the more-expensive non-wood products must compete on features and performance.

Among manufacturers of alternative decking materials, we view Trex Company, Crane Plastic’s TimberTech, Louisiana-Pacific Corporation’s WeatherBest, and Fiber Composites LLC’s Fiberon, as our primary competitors.

The market for door, windowsill, and trim products is highly segmented, with many competitors. We believe that our MoistureShield industrial products have superior characteristics and are competitively priced. We emphasize durability, which means that manufacturers and homebuilders using our products should see reduced warranty callbacks and higher customer satisfaction. Our product competes on durability and the ability of the customer to order a product that is custom manufactured to its specifications.

Employees

On December 31, 2005, we employed 670 people on a full-time basis, as associates. We had 80 associates at the Texas facility, of which two were executive and/or office personnel and 78 were full-time factory personnel. The Arkansas facilities, including our corporate office, employed 568 associates, of which 101 were executives and/or office personnel and 467 were full-time factory personnel. We had 22 full-time associates at our Louisiana facility. From time-to-time, we hire part-time employees to supplement our workforce.

Item 1A.   Risk Factors

Our business is subject to a number of risks, including but not limited to the following:

We have a working capital deficit

At December 31, 2005, we had a working capital deficit of $687,039 and at December 31, 2004, we had a working capital deficit of $3.5 million. The working capital deficit is the result of previously incurred losses from operations, our decision to finance capital projects with cash generated from operations, and our need to fund rapid growth in sales.

We may be unable to secure an adequate quantity and quality of raw materials at economical prices

The largest component of our raw material costs is scrap polyethylene. The price that we must pay for these materials is related to the market prices of natural gas and petroleum, which have been rising and volatile in recent years. Our future profitability is contingent on us being able to manage raw material costs under these circumstances.

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The loss of one or more of our key customers could cause a substantial reduction in our revenues and profits

We could be materially adversely affected if we were to lose one or more of our large existing customers. Our principal customer for our decking material is Weyerhaeuser, which accounted for 77% and 81% of our sales in 2005 and 2004, respectively. A few large door and window construction companies have historically purchased substantially all of our industrial component products. A loss of any one of our large customers would adversely affect our sales and profitability.

If we are unable to comply with certain debt covenants, our financial position and operations could be adversely affected

The bond agreement contains financial covenants, which include a current ratio of not less than 1.00 to 1.00 and a requirement that not more than 10% of accounts payable be in excess of 75 days past the invoice date. We were not in compliance with these two covenants at December 31, 2005; however, these covenants were waived by the bondholder as of December 31, 2005 through, and including, December 31, 2006. There is no assurance that we will be able to comply with these debt covenants in the future, or that the bondholder will waive or modify the covenants in the future. If we are unable to comply with the covenants or obtain a waiver or modification of the covenants in the future, then the bond debt, currently in the amount of $12.9 million, could immediately become due and payable, the bondholder could foreclose on the property used to secure the debt, and the bondholder could claim our revenues pledged as part of the bond agreement.

Restrictions regarding increased manufacturing capabilities could restrain our business growth

We increased our sales by $23.7 million in 2005, $20.1 million in 2004 and $2.1 million in 2003, the year in which there was a fire that temporarily shut down our Junction, Texas manufacturing facility. Our products have seen significant growth, and our customers have significant established expansion plans. Our primary customers and markets are large, and continued sales growth will require significant capital expenditures for additional production equipment and manufacturing facilities. Although our goal is to become the number one composite producer in North America, there is no assurance that we will be able to secure the necessary financing, attain the necessary operational execution, or that the equipment and facilities will become operational in a timely manner to meet that goal.

Our growth is limited by the availability of human capital resources

Future profitable growth will require us to recruit and retain qualified associates. We compete with many larger companies in the labor market, many of whom offer more attractive compensation packages than we are able to economically provide. Though we have adopted equity compensation plans to aid in our efforts to recruit and retain qualified associates, the accounting treatment for those plans results in a reduction in our earnings.

Declines in construction activity may adversely affect our business

Our products are sold in the home improvement and new home construction markets. These markets are subject to significant fluctuations in activity and to periodic downturns caused by general economic conditions. A slowdown in construction activity could have an adverse effect on the demand for our products.

Fire disruptions may adversely affect our business

Our raw materials and manufacturing processes involve a greater than average risk of fire loss or disruption. Through the Company’s history, we have experienced several fires, some of which severely disrupted our manufacturing operations. There was an accidental fire at our Junction, Texas facility in March 2003, which caused substantial damage and temporarily shut down plant operations. Although we have increased security and increased fire protection equipment at our facilities, another major fire could occur and materially adversely affect our operations.

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Covenants in our bond agreements could restrict our ability to borrow, which could impair the improvement and expansion of our operations

Certain covenants in our bond agreements restrict the types and amounts of additional indebtedness that we may incur, including a requirement that, with certain exceptions, we may only incur additional indebtedness to the extent it would satisfy a debt incurrence coverage ratio of 250% of income before interest, taxes, depreciation and amortization to debt service. Those restrictions could inhibit our ability to improve and expand our current operations. Additionally, our ability to secure adequate working capital to support our day-to-day operations as we grow could be limited by the covenants in our bond agreements.

Future sales of shares could be dilutive and impair our ability to raise capital

The conversion of a significant number of our outstanding derivative securities into Class A common stock could adversely affect the market price of the stock. There are currently warrants outstanding for 9,176,242 shares of Class A common stock at an average exercise price of $1.05, and options outstanding for 3,688,130 shares of Class A common stock at an average exercise price of $1.01. The exercise or conversion of a material amount of such securities will result in a dilution in interest for our other security holders. The convertible securities whether converted into stock or not, could impair our ability to obtain additional capital because of the potential for dilution. Also, the holders of such securities may be expected to exercise their rights at a time when we would in all likelihood be able to obtain needed capital through a new offering of our securities on terms more favorable than those provided by the outstanding securities.

The high growth rate in demand for our products will eventually slow

The demand for our decking products has increased rapidly over the past three years due to growing consumer awareness of the benefits of composite decking and the marketing efforts of our customers who sell our products to end users. As annual sales of composite decking increase, it is likely that the growth rate of our decking sales will slow.

Item 1B.   Unresolved Staff Comments.

We have no unresolved staff comments.

Item 2.   Properties

We operate the following manufacturing and recycling facilities:

We manufacture our MoistureShield and Weyerhaeuser ChoiceDek brand lines of decking products at our Springdale, Arkansas extrusion plant. That facility also produces door, window, and housing trim components. Springdale had four extrusion lines and a plastic recycling facility throughout 2005. The Springdale plant consists of 103,000 square feet under one roof and is located on 10 acres with a rail siding in the Springdale industrial district. Since 1999, we have added 30,440 square feet of shed storage space and installed a dual sprinkler system.

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

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

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

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

In the fall of 2004, we entered into two leases for two 100,000 square foot warehouses under construction in Lowell, Arkansas that are connected by rail spurs. We first occupied these warehouses in the first quarter of 2005. One warehouse is used for raw material storage, and the second is used for both raw material and finished goods storage. We have recently leased a third 125,000 square foot warehouse in the same complex, which will be used for finished goods processing and distribution. We also lease ten acres of land adjacent to our Lowell plastic plant for storage and load-out of finished goods; this operation is designed to load up to five railcars and ten trucks at a time.

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

We began building a new extrusion factory just to the south of our existing Springdale plant in 2005. Construction of this “Springdale South” facility is being financed from a combination of cashflow, operating leases and traditional debt financing, so completion has been subject to some degree to the availability of funds from operations. We believe we can begin the first of Springdale South’s planned four production lines in the second quarter of 2006, but there is no assurance that we will be able to meet our planned schedule. We anticipate installing the other three lines over the course of the next two years, subject to continued growth in demand for our products.

Item 3.   Legal Proceedings

Lloyd’s London

We have been sued by certain underwriters at Lloyd’s, London (“Lloyd’s”) in connection with a pending final settlement of our Junction, Texas fire claim. Lloyd’s filed suit January 19, 2005 in the Circuit Court of Washington County, Arkansas seeking a declaratory judgment that they are not liable to reimburse us for certain costs of rebuilding the AERT Junction, Texas facility. Lloyd’s alleges that we did not rebuild the facility exactly as it had existed prior to the March 2003 fire and seeks to retroactively cancel its portion of the insurance policy. The filing was unexpected by us because we cooperated fully with the claims underwriting process and believed that negotiations toward a final settlement of the claim were progressing.

We believe the Lloyd’s lawsuit is without merit. We filed a counterclaim on January 24, 2005 denying all of Lloyd’s allegations and seeking immediate and full reimbursement for rebuilding of the Junction plant. We seek to recover actual damages in the amount of at least $2.4 million plus attorney and court fees and punitive damages for acts of bad faith committed by Lloyd’s.

The parties participated in an unsuccessful court-ordered mediation on March 13, 2006. The matter will now go to trial, though a trial date has not yet been set by the court.

Advanced Control Solutions

On March 3, 2006, a Benton County Circuit Court jury found AERT liable for $655,769 in damages to Advanced Control Solutions (“ACS”) for future business opportunities that ACS alleges it lost when AERT discontinued using ACS programming and electrical contractor services and for missing equipment. The jury found that AERT also interfered with certain non-compete provisions of an employment agreement between

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ACS and an employee by hiring the employee after he had been terminated by ACS in December 2003. The jury also awarded AERT judgment against ACS for approximately $45,000 for ACS’s failure to complete a programming contract.

We strongly disagree with the jury’s findings and intend to exercise our full legal rights of appeal. We intend to file motions requesting the Judge to set aside the verdicts against AERT as not being supported by the law and facts. If the motions are not granted, AERT will appeal the jury verdicts to the Arkansas Court of Appeals.

Other Matters

AERT is involved in other litigation arising from the normal course of business. In management’s opinion, this litigation is not expected to materially impact the Company’s results of operations or financial condition.

Item 4.   Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2005.

PART II

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

Our Class A common stock is traded on the NASDAQ Capital Market System under the symbol AERTA.  As of March 27, 2006, there were approximately 1,600 holders of record of Class A common stock and 11 holders of record of Class B common stock. The price of our common stock was $1.79 on December 31, 2005. We have not previously paid cash dividends on the common stock and there are currently restrictions under various debt obligations 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 (as reported by NASDAQ) of our Class A common stock for the years ended December 31, 2004 and 2005.

Sales price range of Class A common stock

	High		Low
Fiscal 2004
First Quarter		1.45		1.10
Second Quarter		1.28		1.00
Third Quarter		1.72		1.04
Fourth Quarter		1.67		1.18
Fiscal 2005
First Quarter		1.85		1.25
Second Quarter		1.59		1.21
Third Quarter		1.74		1.19
Fourth Quarter		1.79		1.25

No repurchases of common stock took place during the fiscal year 2005.

Recent Sales of Unregistered Securities

On February 7, 2005, we issued an aggregate of 976,398 shares of our Class A common stock to Zanett Lombardier, Ltd. upon the cashless exercise of 1,253,784 Consulting warrants with an exercise price of $0.375. We believe, due to the nature of the relationship of this firm to us and the isolated nature of the transaction, that the issuance and sale of the shares of Class A common stock underlying such warrants was exempt from registration under the Securities Act of 1933, as amended, as a private placement pursuant to Section 4(2) of that Act.

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Item 6.   Selected Financial Data

The following tables set forth selected historical data for the years ended December 31, 2001 through 2005, derived from our audited financial statements for each such year and should be read in conjunction with such financial statements and the footnotes attached thereto as well as the discussion contained herein in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. Certain prior period amounts have been reclassified to conform to the current period presentation.

	Year Ended December 31,
	2005			2004			2003			2002			2001
Statements of Operations Data:
Net sales	$	87,312,560		$	63,637,285		$	43,520,563		$	41,415,466		$	33,422,959
Income (loss) before extraordinary gain, accrued premium on preferred stock and income taxes		3,583,370			1,369,983			(665,921	)		1,193,333			602,864
Accrued premium on preferred stock		(235,367	)		(276,000	)		(276,000	)		(278,083	)		(290,000	)
Income (loss) before extraordinary gain and income taxes		3,348,003			1,093,983			(941,921	)		915,250			312,864
Net income tax benefit		4,449,682			—			—			—			—
Income (loss) before extraordinary gain		7,797,685			1,093,983			(941,921	)		915,250			312,864
Extraordinary gain		—			173,536			2,962,041			—			—
Net income applicable to common stock	$	7,797,685		$	1,267,519		$	2,020,120		$	915,250		$	312,864
Net income (loss) per common share before extraordinary gain(1) (Basic)	$	0.22		$	.03		$	(.03	)	$	.03		$	.01
Net income (loss) per common share before extraordinary gain(1) (Diluted)	$	0.19		$	.03		$	(.03	)	$	.02		$	.01
Extraordinary gain per common share (Basic)		—		$	.01		$	.10			—			—
Extraordinary gain per common share (Diluted)		—		$	.00		$	.10			—			—
Net income (loss) per common share after extraordinary gain (Basic)	$	0.22		$	.04		$	.07		$	.03		$	.01
Net income (loss) per common share after extraordinary gain (Diluted)	$	0.19		$	.03		$	.07		$	.02		$	.01
Weighted average number of shares outstanding (Basic)		35,861,060			31,815,067			30,017,661			29,516,768			27,565,825
Weighted average number of shares outstanding (Diluted)		40,475,244			41,070,289			30,017,661			42,665,451			37,176,751
Balance Sheet Data:
Working capital deficit	$	687,039		$	3,470,971		$	1,915,695		$	6,557,943		$	4,535,600
Total assets		56,952,673			43,340,793			36,406,601			39,335,948			36,393,071
Long-term debt less current maturities		17,010,889			15,571,068			16,659,241			4,068,210			4,303,202
Total liabilities		35,835,369			31,610,279			27,458,156			33,574,481			32,194,317
Stockholders’ equity		21,117,304			11,730,514			8,948,445			5,761,467			4,198,754

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

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

Executive Overview

For the year ended December 31, 2005, our income before income taxes was $3.35 million, compared to income of $1.09 million before income taxes and extraordinary gain for 2004, a 207% increase. Net sales for 2005 increased 37% over 2004 to $87.3 million. This continued growth in our business is a result of our strategy to provide our customers with the best product and the best service at the best price. Net income was $7.8 million or $0.19 per fully diluted share. Net income includes a $4.6 million tax benefit for the elimination of the valuation allowance.

Now that AERT has been profitable from operations for the past two years and expects to be profitable in the future, we removed the valuation allowance we had provided for our deferred tax assets in the fourth quarter and recognized a net $4.6 million non-cash income tax benefit, which significantly increased net income for the quarter and year. The deferred tax asset is comprised of net operating losses (NOLs) accumulated in the Company’s developmental years. In future periods, AERT will apply a combined federal and state effective income tax rate of approximately 40% to pre-tax income, even though the taxes recorded will be primarily non-cash charges. We will continue to use the NOLs to reduce actual income tax payments, which will benefit our cash flow.

Sales growth in 2005 was driven by continued strong demand for all three of our product lines and enabled by higher factory output resulting from increased productivity and price increases. In order to meet expected future demand, we are building a third extrusion factory and expanding our plastic recycling facilities, which resulted in a total capital investment of $9.6 million during 2005. We plan to continue to increase our production capacity in step with growing demand for our products. As industry-wide sales of composite decking increases, it is likely that the annual rate of sales growth will decelerate.

Our gross profit margin improved to 24% in 2005 from 23.1% in 2004. Volatility in worldwide pricing of polyethylene — the largest component of our raw material costs — continues to present a challenge as we reach for higher and more stable margins. We believe polyethylene prices will continue to be unstable and so we are focused on further developing our capability to use types of polyethylene waste that are in abundant supply and low demand.

Our operating margin improved to 6.4% of net sales in 2005 from 5.5% of net sales in 2004 due to our improved gross margin and because we were able to increase sales at a faster rate than we increased our overhead costs, which we expect to continue. General and administrative costs for 2005 included substantial legal expenses, and we also took a one-time net charge in the fourth quarter of 2005 of $610,206 as a reserve against a recent jury award in a contract dispute with a former supplier.

We generated $7.3 million of cash flow from operations in 2005 versus $5.4 million in 2004, a 35% increase. Cash used for capital improvements was approximately $5.9 million, cash used in financing activities was $836,000 (primarily to reduce debt), and we increased our cash balance by $670,000. At December 31, 2005, our current ratio was 0.96 and our long-term debt to equity ratio was 0.81. That compares to 0.78 and 1.33, respectively, at December 31, 2004. We believe that funds generated from operations will be sufficient to pay our operating costs and fixed obligations for 2006 and into the future.

For 2006 and beyond we are focused on adding production capacity and improving manufacturing efficiencies. For example,

•  We are investing heavily in in-house plastic recycling capacity and advanced recycling technologies;

•  We expect to start one production line at our new Springdale South extrusion facility in the second quarter of 2006 and plan to add a second line in early 2007, with two more lines — for a total of four — anticipated by the end of 2007.

•  We are continually evaluating, improving and implementing manufacturing efficiencies;

•  We continue to aggressively recruit new AERT associates for senior and middle management levels.

•  We continue to build brand recognition and our company’s reputation with the quality of our products and customer service.

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We believe the selected sales data, the percentage relationship between net sales and major categories in the Statements of Operations and the percentage change in the dollar amounts of each of the items presented below is important in evaluating the performance of our business operations. We operate in one business segment and believe the information presented in our Management’s Discussion and Analysis of Results of Operations and Financial Condition provides an understanding of our business segment, our operations and our financial condition.

Results of Operations

Three Year Comparison

	2005			% Change			2004			% Change			2003
Net sales	$	87,312,560			37.2	%	$	63,637,285			46.2	%	$	43,520,563
Cost of goods sold		66,389,964			35.6	%		48,963,166			42.5	%		34,361,984
% of net sales		76.0	%		(0.9	)%		76.9	%		(2.1	)%		79.0	%
Gross margin		20,922,596			42.6	%		14,674,119			60.2	%		9,158,579
% of net sales		24.0	%		0.9	%		23.1	%		2.1	%		21.0	%
Selling and administrative costs		14,595,854			31.5	%		11,099,911			23.3	%		9,001,261
% of net sales		16.7	%		(0.7	)%		17.4	%		(3.3	)%		20.7	%
Research and development		110,134			13.3	%		97,207			24.8	%		77,900
Subtotal		14,705,988			31.3	%		11,197,118			23.3	%		9,079,161
% of net sales		16.8	%		0.8	%		17.6	%		(3.3	)%		20.9	%
Operating income		6,216,608			78.8	%		3,477,001			4278.1	%		79,418
% of net sales		7.1	%		1.6	%		5.5	%		5.3	%		0.2	%
Other income (expense)
Insurance proceeds related to lost income		—			(100.0	)%		8,720			(99.2	)%		1,125,372
Net litigation contingency		(610,206	)		—			—			0.0	%		—
Loss on disposition of equipment		(26,122	)		—			—			0.0	%		—
Net interest expense		(1,996,910	)		(5.6	)%		(2,115,738	)		13.1	%		(1,870,711	)
Income (loss) before extraordinary item accrued premium on preferred stock and taxes		3,583,370			161.6	%		1,369,983			—			(665,921	)
% of net sales		4.1	%		1.9	%		2.2	%		3.7	%		(1.5	)%
Accrued premium on preferred stock		(235,367	)		(14.7	)%		(276,000	)		0.0	%		(276,000	)
Income (loss) before extraordinary item and taxes		3,348,003			206.0	%		1,093,983			—			(941,921	)
% of net sales		3.8	%		2.1	%		1.7	%		3.9	%		(2.2	)%
Net income tax benefit		4,449,682			—			—			0.0	%		—
% of net sales		5.1	%		5.1	%		0.0	%		0.0	%		0.0	%
Income (loss) before extraordinary item		7,797,685			612.8	%		1,093,983			—			(941,921	)
% of net sales		8.9	%		7.2	%		1.7	%		3.9	%		(2.2	)%
Extraordinary gain on involuntary conversion of non-monetary assets due to fire		—			(100.0	)%		173,536			(94.1	)%		2,962,041
Net income applicable to common stock	$	7,797,685			515.2	%	$	1,267,519			(37.3	)%	$	2,020,120
% of net sales		8.9	%		6.9	%		2.0	%		(2.6	)%		4.6	%

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Net Sales	2005		% Change			2004		% Change			2003
Springdale facility	$	67,823,259		41.6	%	$	47,902,106		40.1	%	$	34,203,234
Junction facility		19,489,301		23.9	%		15,735,179		68.9	%		9,317,329
Total net sales	$	87,312,560		37.2	%	$	63,637,285		46.2	%	$	43,520,563

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

Net Sales

Net sales for the year ended December 31, 2005 grew 37.2% compared to 2004. Our challenge, as in recent prior years, was to make enough of our products to satisfy customer demand. Approximately 95% of the sales gain was the result of productivity increases at our plastic recycling and extrusion plants, with the balance attributable to price increases. We have recently increased prices of our products by an average of 8.5% versus the average price prevailing in 2005.

Cost of Goods Sold and Gross Margin

Cost of goods sold, as a percent of sales, decreased to 76% for the year ended December 31, 2005 from 76.9% for 2004. Labor costs and manufacturing overhead were down, as a percent of sales, due to increased automation and efficiency initiatives. Our manufacturing improvement programs also resulted in higher output per manufacturing line in 2005 versus 2004, thus reducing overhead costs as a percent of sales. Material costs, however, were up significantly due to higher costs of polyethylene scrap prices resulting from instability in world petroleum and natural gas markets and disruptions in the supply of polyethylene resulting from hurricane damage along the Gulf Coast in August and September.

Our strategy for managing raw material costs is to expand our internal plastic processing capacity and to seek new sources of lower cost waste plastic materials. We are also focused on better material handling techniques and efficiencies to further reduce manufacturing waste and handling costs. Volatility of raw material costs continues to be one of our greatest challenges and sustained upward price movement of our raw materials has an adverse effect on our profitability.

Gross profit margin improved to 24% for 2005 from 23.1% in 2004 as efficiency gains and price increases outweighed the effects of higher raw material costs.

Selling and Administrative Expenses

Selling and administrative costs increased in 2005 compared to 2004 as a result of increases in sales, customer service, and corporate personnel expenses, along with general increases in corporate costs to manage our growing business. As a percentage of net sales, selling and administrative costs decreased to 16.7% in 2005 compared to 17.4% in 2004. The categories of salaries and benefits, professional fees, advertising and promotion, travel and entertainment, and commissions together make up 75% of total selling and administrative expenses. Professional fees included substantial legal expenses (see Item 3. Legal Proceedings). We expect to continue to grow sales at a faster rate than overhead expenses in 2006.

Operating Income

Operating income was 6.4% of net sales for 2005 versus 5.5% of net sales for 2004. Operating income was negatively impacted by a one-time litigation loss charge of $655,769 in the fourth quarter of 2005 pertaining to a recent jury award in a contract dispute with a former supplier (see Item 3. Legal Proceedings).

Net Income

We removed the valuation allowance we had provided for our deferred tax assets in the fourth quarter and recognized a net $4.6 million non-cash income tax benefit, which significantly increased net income for the quarter and year. The deferred tax asset is comprised of net operating losses (NOLs) accumulated during

14

AERT’s developmental years. In future periods, we will apply a combined federal and state effective income tax rate of approximately 40% to pre-tax income, even though the taxes recorded will be primarily non-cash charges. We will continue to use the NOLs to reduce actual income tax payments, which will benefit our cash flow.

Net income increased to $7,797,685 in 2005 from $1,267,519 in 2004. Income before income taxes for 2005 was $3,348,003, up substantially from income of $1,093,983 in 2004. Continued profitable operations depends on, among other things, our ability to manage raw material costs and to grow our sales faster than our overhead expenses (see Item 1A. Risk Factors — We may be unable to secure an adequate quantity and quality of raw materials at economical prices).

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

Net Sales

Net sales for the year ended December 31, 2004 grew 46.2% compared to 2003 due to:

•  A product mix that included a higher percentage of value added products, including the new ChoiceDek Premium Embossed, which accounted for 15% of the increase;

•  Restoration of the Junction plant to its pre-fire capacity, which accounted for 23% of the increase; and

•  Increased productivity, which resulted from various capital projects that increased output and reduced manufacturing waste. Productivity gains account for the remaining 62% of the increase.

In 2004, demand for our products exceeded our manufacturing capacity.

Cost of Goods Sold

Our cost of goods sold increased 42.5% in 2004 versus 2003. Cost of goods sold is directly related to sales, which increased 46.2%. Cost of goods sold as a percent of sales thus decreased from 79% of sales to 76.9% of sales, which raised our gross margin from 21% to 23.1%.

All three accounting components of cost of goods sold — cost of materials, direct labor, and manufacturing overhead — decreased as a percent of sales. Direct labor costs decreased as a result of automation projects and from more emphasis on training and productivity improvement programs. Manufacturing overhead decreased as we increased output at a faster rate than we increased overhead spending.

The cost of materials in 2004 was lower, as a percent of sales, than in 2003 because we expanded our plastic processing capacity at the Lowell, Arkansas and Alexandria, Louisiana facilities and sought new sources of lower cost waste plastic materials. Also during 2004, we used a substantial amount of plastic inventory that was acquired in earlier periods at less than 2004 market prices. This helped to offset rising material costs through the year by lessening our dependence on outside suppliers. Our in-house plastic processing capacity went from 25% in 2003 to 55% in the first quarter of 2005. We focused on better material handling techniques and efficiencies in order to further reduce manufacturing waste and handling costs.

Increasing our in-house plastic processing facilities lowered our variable cost of purchasing recycled plastic scrap, but also increased our manufacturing overhead and additional processing costs. With increased fixed overhead for recycling and processing infrastructure, sufficient volumes and throughputs are required to lower overall costs. Lower-cost, poor-quality plastic scrap can cause decreased throughputs and significant increases in overall cost. This effect contributed somewhat to higher overall manufacturing costs and lower gross margin in the fourth quarter of 2004.

Overall, we were successful in reducing cost of goods sold as a percent of sales by improved focus and investing in new facilities; i.e. productivity gains offset rising material costs, which helped us to achieve an increase in 2004 operating income to $3.5 million from $79,000 in 2003.

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Selling and Administrative Expenses

Selling and administrative cost increased in 2004 compared to 2003 as a result of increases in sales, customer service, and corporate personnel expenses, along with general increases in corporate costs to manage our growing business. However, as a percentage of net sales, selling and administrative costs decreased. Some of the major components of selling, general, and administrative costs were salaries, commissions, advertising and promotion, travel and entertainment and professional fees. The preceding cost categories as a percent of sales were lower in 2004 (17.6%) when compared to 2003 (20.9%).

Net Income

Net income before extraordinary item in 2004 was $1.09 million compared to a net loss before extraordinary item of $941,921 in 2003, an improvement of $2.03 million. Compared to 2003, net income before extraordinary item increased due to increased sales, lower manufacturing costs as a percentage of sales, and lower selling and administrative costs as a percentage of sales.

Net income after extraordinary item was $1.26 million compared to $2.02 million in 2003, a decrease of $760,000 or 38%. Insurance proceeds received to reimburse costs of reconstructing the Junction facility following a March 2003 fire resulted in a $173,536 extraordinary gain for 2004 compared to an extraordinary gain of $2.96 million in 2003.

Extraordinary Item

There was a major fire at the Junction, Texas facility in 2003. The Junction facility was fully insured. Damage caused by the fire required us to write down gross assets by approximately $4.91 million. We simultaneously adjusted accumulated depreciation on those assets by $3.96 million, resulting in a net book value decrease in assets of about $950,000. At December 31, 2004, we had invested approximately $6.4 million in reconstructing the Junction facility. Insurance proceeds received to reimburse costs incurred to reconstruct the facility resulted in a gain of $173,536 for the year ended December 31, 2004. Through December 31, 2004, the total extraordinary gain recorded as a result of the fire was $3,135,577. Total insurance proceeds in connection with the fire were $6 million received through December 31, 2004. We had initially booked a receivable of approximately $864,000 and related income in the first quarter of 2004 for additional amounts we expected to collect from the insurers related to such matter. However, such claims are now being contested by the insurer and, although we intend to vigorously pursue the collection of such claims, we have, in accordance with generally accepted accounting principles, reversed any receivable or income for the 2004 fiscal year attributable to such disputed claims unless and until such claims are collected.

Contingencies

Liquidity and Capital Resources

At December 31, 2005, we had a working capital deficit of $687,039 compared to a working capital deficit of $3.5 million at December 31, 2004. At December 31, 2005, the working capital deficit included total current liabilities of approximately $18.59 million, of which $3.04 million was for accrued payroll expense and other accrued liabilities, $13.51 million was in payables and $2.04 million was a combination of short-term notes payable and the current portion of long-term debt. Our rapid growth and current cash flow from operations is restricting the growth of our working capital. The working capital deficit is the result of previously incurred losses from operations, our decision to pay for our capital expansion using cash generated from operations, our need to fund rapid growth in sales, and our need to use working capital to pay for a portion of the rebuild of our Junction, Texas facility after the fire, as our insurance claim was contested by our insurer, Lloyd’s London (see Item 3. Legal Proceedings). Additionally, pursuant to our bond agreement, we are required to maintain a debt service reserve fund in the amount of approximately $2 million, which is classified as a non-current asset in our balance sheet.

Cash increased $669,487 to $1.75 million at December 31, 2005 from $1.08 million at December 31, 2004. Significant components of that increase were: (i) cash provided by operating activities of $7.3 million,

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which consisted of the net income for the period of $7.8 million increased by depreciation and amortization of $4.2 million and decreased by other uses of cash of approximately $4.7 million; (ii) cash used in investing activities of $5.8 million; and (iii) cash used in financing activities of approximately $836,000. Payments on notes during the period were $4.2 million, and proceeds from the issuances of notes amounted to $1.9 million. At December 31, 2005, we had bonds and notes payable in the amount of $19.0 million, of which $2.0 million was current notes payable and the current portion of long-term debt.

Our expansion plans currently are prioritized around adding extrusion capacity at Springdale South, increasing plastic recycling capacity to lower raw material costs, and further automating our production processes to improve efficiencies and increase margins. New capital projects are funded primarily from cash flow, and there is no assurance as to when additional funds will be available or as to when the projects will be completed. Our capital improvement budget for 2006 is currently estimated at $12.0 million, of which we believe we can finance $6.0 million through long-term debt and operating leases; the balance of required funds must come from cash flow. There is no assurance that we will generate sufficient cash flow to meet our objectives. If we are unable to complete our 2006 capital expansion program as planned, it will affect our ability to grow sales and profit margins in 2006 and future years.

During the first quarter of 2006, we entered into a new $15.0 million bank line of credit, replacing the factoring arrangement with Brooks Investment Co. that is currently in use. The line is a one year revolving credit facility maturing January 7, 2007, secured by our inventory, accounts receivable, chattel paper, general intangibles and other current assets, as well as by fixtures and equipment, and is provided by Liberty Bank of Arkansas at a variable interest rate of prime plus one hundred basis points. The maximum amount that may be drawn on the line at any one time is $15.0 million. The full amount of the line is guaranteed as to payment by our largest stockholder, Marjorie Brooks. The credit facility includes debt service coverage ratio, current ratio, and accounts payable and accounts receivable aging covenants substantially similar to those under our 2003 bond agreements and customary restrictions on dividends and the incurrence of additional debt or liens, among other matters.

Under the 2003 bond agreement, AERT covenants that it will maintain certain financial ratios. If we fail to comply with the covenants, or to secure a waiver of the covenants, the bond trustee would have the option of demanding immediate repayment of the bonds. In such an event, we would be unable to repay the bonds from current or reasonably foreseeable cash resources, and there can be no assurance we would be able to refinance the bonds.

We were not in compliance with two of the bond covenants as of December 31, 2005. The bond trustee waived these covenants as of December 31, 2005 through, and including, December 31, 2006. We expect to be in compliance with all bond covenants by December 31, 2006.

Bonds Payable and Allstate Notes Payable Debt Covenants	December 31, 2005			Compliance
Long-term debt service coverage ratio for last four quarters of at least 2.00 to 1.00		3.25		Yes
Current ratio of not less than 1.00 to 1.00 (as adjusted)(1)		1.08		No-Waived
Debt to equity ratio of not more than 3.00 to 1.00		0.90		Yes
Not more than 10% of accounts payable in excess of 75 days past invoice date		10.3	%	No-Waived
Not more than 20% of accounts receivable in excess of 90 days past invoice date		0.0	%	Yes

(1) The current ratio calculation was modified by the waiver to include the debt service reserve fund of $2,110,881 in current assets.

Critical Accounting Policies and Estimates

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

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Accounts Receivable

Trade accounts receivable are stated at the amount management expects to collect from outstanding balances. Delinquency fees are not assessed. Payments of accounts receivable are allocated to the specific invoices identified on the customers’ remittance advice. Accounts receivable are carried at the original invoice amount less an estimated reserve made for returns and discounts based on quarterly review of historical rates of returns and expected discounts to be taken. The carrying amount of accounts receivable is reduced, if needed, by a valuation allowance that reflects management’s best estimate of the amounts that will not be collected. Management individually reviews all accounts receivable balances that exceed thirty days from the invoice date, and based on an assessment of current creditworthiness, estimates the portion, if any, of the balance that may not be collected. Management provides for probable uncollectible amounts through a charge to earnings and a credit to a valuation based on its assessment of the current status of the individual accounts. Balances that remain outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to trade accounts receivable. Changes in the valuation allowance have not been material to the financial statements. Recoveries of trade receivables previously written off are recorded when received. Due to the nature of our business and our association with large national corporations, our collection of receivables has stayed at a constant level with very few uncollectible accounts.

Buildings and Equipment

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

We account for the impairment or disposal of long-lived assets in accordance with the provisions of the Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144). SFAS 144 requires an assessment of the recoverability of our investment in long-lived assets to be held and used in operations whenever events or circumstances indicate that their carrying amounts may not be recoverable. Such assessment requires that the future cash flows associated with the long-lived assets be estimated over their remaining useful lives. An impairment loss may be required when the future cash flows are less than the carrying value of such assets.

Stock-Based Compensation

We have to date accounted for our stock option plans and other stock-based compensation under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which allows us to use the “intrinsic value” method of accounting set forth in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations (see Note 2 to the financial statements). Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of our common stock at the date of the grant over the amount an employee must pay to acquire the stock.

Revenue Recognition

The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (SAB 104). Under SAB 104, revenue is recognized when the title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable and collectibility is reasonably assured. The Company typically recognizes revenue at the time of shipment or segregated and billed under a bill and hold agreement. The terms of this agreement qualify for revenue recognition under SAB 104. Sales are recorded net of discounts, rebates, and returns.

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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.

Contractual Obligations

The following table represents our contractual obligations outstanding as of December 31, 2005:

	Payments Due by Period
			Less Than		1 to 3		3 to 5		More Than
	Total		1 Year		Years		Years		5 Years
Long-term debt	$	17,949,593	$	938,704	$	2,188,743	$	4,022,146	$	10,800,000
Operating leases		7,157,697		1,816,437		2,978,500		1,541,495		821,265
Total	$	25,107,290	$	2,755,141	$	5,167,243	$	5,563,641	$	11,621,265

Our waste wood and scrap polyethylene supply contracts have varying terms and pricing structures. The contracts generally obligate us to take whatever waste the supplier generates as long as the waste meets our standards. Pricing for these contracts can be renegotiated every six or twelve months, however, so determining our precise future liability is not reasonably estimable.

Uncertainties, Issues and Risks

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

Item 7A.   Quantitative and Qualitative Disclosures about Market Risk

We have no material exposures relating to our long-term debt because all of our long-term debt bears interest at fixed rates. See Note 4 to the financial statements for a discussion of outstanding debt. We depend on the market for favorable long-term mortgage rates to help generate sales of our product for use in the residential construction industry. Should mortgage rates increase substantially, our business could be impacted by a reduction in the residential construction industry. Important raw materials that we purchase are recycled plastic and wood fiber, which are subject to price fluctuations. We attempt to limit the impact of price increases on these materials by negotiating with each supplier on a term basis.

Forward-looking Information

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

The foregoing discussion contains certain estimates, predictions, projections and other forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) that involve various risks and uncertainties. While these forward-looking statements,

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

Item 8.   Financial Statements and Supplementary Data

Summary Quarterly Financial Data

	2004										2005
	First			Second		Third		Fourth			First		Second		Third		Fourth
	Quarter(1)			Quarter		Quarter		Quarter(1)			Quarter		Quarter		Quarter		Quarter
Net sales	$	13,221,121		$	16,162,575	$	18,975,717	$	15,277,872		$	19,943,530	$	20,954,211	$	23,099,857	$	23,314,962
Gross margin		2,588,210			4,184,501		5,695,745		2,205,663			4,319,620		4,734,626		6,266,274		5,602,076
Income (loss) before extraordinary item		(463,313	)		857,142		1,500,498		(800,344	)		665,477		918,938		1,651,945		4,561,325
Net income (loss) after extraordinary item		574,264			857,142		1,500,498		(1,664,385	)		665,477		918,938		1,651,945		4,561,325
Income (loss) per share before extraordinary item (Basic)	$	0.00		$	0.03	$	0.05	$	(0.03	)	$	0.02	$	0.03	$	0.05	$	0.12
Income (loss) per share before extraordinary item (Diluted)	$	0.00		$	0.02	$	0.04	$	(0.03	)	$	0.01	$	0.02	$	0.04	$	0.11
Income (loss) per share after extraordinary item (Basic)	$	0.00		$	0.03	$	0.05	$	(0.05	)	$	0.02	$	0.03	$	0.05	$	0.12
Income (loss) per share after extraordinary item (Diluted)	$	0.00		$	0.02	$	0.04	$	(0.05	)	$	0.01	$	0.02	$	0.04	$	0.11

(1) In the first quarter of 2004, we booked an insurance receivable of $864,000 and recognized related additional income of such amount related to additional insurance claims we expect to collect with respect to a 2003 fire at our Junction, Texas facility. Pursuant to litigation filed by the insurer in January 2005, such claims are now being contested. As a result, we have reversed the receivable and related income for these additional claims by means of an $864,000 adjustment taken in the fourth quarter of 2004.

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

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

None.

Item 9A.   Controls and Procedures

Each of our Co-Chief Executive Officers, Joe G. Brooks and Stephen W. Brooks, and our Chief Financial Officer, Robert A. Thayer, have reviewed and evaluated the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) that we have in place as of December 31, 2005 with respect to, among other things, the timely accumulation and communication of information to management and the recording, processing, summarizing and reporting thereof for the purpose of preparing and filing this annual report on Form 10-K. Based upon their review, these executive officers have concluded that, as of December 31, 2005, we have an effective system of disclosure controls and procedures and an effective means for timely communication of information required to be disclosed in this Report. During the fourth quarter of the fiscal year ended December 31, 2005, there have been no changes in our internal controls over financial reporting that have materially affected, or that are reasonably likely to materially affect, our internal controls over financial reporting. Similarly, there were no such changes in our internal controls over financial reporting that materially affected or that are reasonably likely to materially affect our controls over financial reporting for the fiscal quarters ended December 31, 2004, March 31, 2005, June 30, 2005 and September 30, 2005.

Item 9B.   Other Information

None.

PART III

Item 10.

Certain information required by Item 10 is incorporated herein by reference to the Company’s definitive proxy statement for its 2006 annual meeting of stockholders.

Directors and Executive Officers of the Registrant (Item 401)

The directors and executive officers of the Company as of December 31, 2005, are as follows:

Name	Age		Position
Joe G. Brooks		50	Chairman of the board of directors, co-chief executive officer and president
Sal Miwa		49	Vice-chairman of the board of directors
Stephen W. Brooks		49	Co-chief executive officer and director
Marjorie S. Brooks		70	Secretary, treasurer and director
J. Douglas Brooks		46	Senior vice-president — raw materials
Alford Drinkwater		54	Senior vice president — plastic operations
Jim Precht		60	Senior vice-president — sales and marketing
Robert A. Thayer		54	Senior vice-president and Chief financial officer
Eric E. Barnes		32	Controller and Chief accounting officer
Jerry B. Burkett		49	Director
Edward P. Carda		65	Director
Melinda Davis		63	Director
Tim W. Kizer		40	Director
Samuel L. ‘‘Tony” Milbank		65	Director
Jim Robason		68	Director
Michael M. Tull		51	Director

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The Company’s board of directors elected Joe G. Brooks as its chairman and the Company’s co-chief executive officer in December 1998, and he has served as president since February 2000. Mr. Brooks has served as president or in other executive office capacities and has been a director since the Company’s inception in December 1988, including service as chairman and CEO from inception until August 1993. He was a member of Clean Texas 2000, appointed by then Governor George W. Bush in 1995.

Sal Miwa has been an outside director of the Company since January 1994. He served as chairman of the board between December 1995 and December 1998, and as vice chairman from December 1998 through July 2005. From January 2005 to present, Mr. Miwa has been CEO and chairman of Greenstone Holdings, Inc.(OTC “GSHG”), a chemical technology company located in New York City primarily serving the building and construction industry. From July 2004 to December 2005, he was CEO of Greenstone Inc. of Delaware, a predecessor of Greenstone Holdings, Inc. From April 2000 to June 2004, he was COO and director of RealRead Inc., an online document service company. For more than 20 years Mr. Miwa has been engaged in various international businesses and serves on boards of several closely held family businesses around the world. He received his master’s degree in Aerospace Engineering from the Massachusetts Institute of Technology in 1981.

The Company’s board of directors elected Stephen W. Brooks as co-chief executive officer in December 1998. Mr. Brooks has served as its chief executive officer and has been a director since January 1996. Mr. Brooks has served as CEO and chairman of the board of Razorback Farms, Inc. from January 1996 to the present. Razorback Farms is a Springdale, Arkansas based firm that specializes in vegetables processing. Mr. Brooks also serves on the board of the Ozark Food Processors Association.

Marjorie S. Brooks has been secretary, treasurer and a director since the Company’s inception in December 1988. Mrs. Brooks has served as secretary and treasurer of Brooks Investment Co., a holding company for the Brooks’ family investments, for more than thirty years.

J. Douglas Brooks has served as executive vice-president from inception to September 2003, has been in charge of raw material sourcing and strategic relationships since 1998, and has been a senior vice president since September 2003. Mr. Brooks was vice-president of plastics from 1995 through 1998, was previously project manager for AERT’s polyethylene recycling program with The Dow Chemical Company, and is a joint inventor on several of AERT’s process patents for recycling polyethylene film for composites.

Robert A. Thayer was named by the board of directors to succeed Edward J. Lysen as chief financial officer in September 2005. Since October 2002, Mr. Thayer has served as the assistant to AERT chairman Joe G. Brooks, during which time he has had executive assignments in all aspects of AERT’s business including finance, operations, and administration. From January 1997 to October 2002, Mr. Thayer was a principal at Madison Research, Denison, Texas where he conducted independent financial research under contract to banks and financial publishers. From January 2001 to July 2002 he also served as Vice President of Finance for Asia Teletech Company, Ltd., a Thailand headquartered voice-over-internet company where he was responsible for raising the company’s startup capital. Prior to 1997, Mr. Thayer spent twenty-one years in the software and investment banking industries with financial, systems and executive responsibilities. He received a BA in Economics from the University of Colorado and studied graduate economics at the University of Wisconsin, Madison. Mr. Thayer is a Chartered Financial Analyst.

Alford Drinkwater has served as senior vice president of logistics, laboratories, and plastic operations since September 2003. Prior to joining the Company in May 2000, Mr. Drinkwater had been the Assistant Director for the Established Industries Division of the Arkansas Department of Economic Development and was on the Advocacy Team from November 1988 until January 2000. From September 1986 until July 1988, he owned and operated Town and Country Waste Services, Inc. a waste services company engaging in the development of waste recycling, energy recovery, and disposal systems. From April 1981 until January 1987, Mr. Drinkwater was the Resource Recovery Manager for Metropolitan Trust Company, and was primarily involved in waste-to-energy systems development. From July 1974 until April 1981, Mr. Drinkwater worked for the State of Arkansas as Assistant to the Chief of the Solid Waste Control Division of the Arkansas Department of Pollution Control & Ecology and as the Manager of the Biomass and Resource Recovery Program of the Arkansas Department of Energy.

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Jim Precht has served as executive vice-president of sales and marketing for the Company since February 2001, and senior vice president since September 2003. Mr. Precht was formerly general manager of Weyerhaeuser Building Materials’ Pittsburgh Customer Service Center with 32-years of industry experience.

AERT’s accounting and control team is headed by Eric E. Barnes, who the board of directors appointed as chief accounting officer in September 2005. Mr. Barnes joined AERT’s accounting department in November 1997 after graduating from the University of Arkansas with a BS in Accounting and an MA in Economics. He was named AERT’s controller in January 2000. Mr. Barnes is a Certified Public Accountant.

Jerry B. Burkett has served on the board of directors of the Company since May 1993. Mr. Burkett has been a rice and grain farmer since 1979 and has been a principal in other closely held businesses. He is the past president of the Arkansas County Farm Bureau. In April 2002, Mr. Burkett was elected to serve as a director of the Ag Heritage Farm Credit Services board.

Edward P. Carda was elected to the board of directors in July 2005. Mr. Carda began his 37-year business career with Weyerhaeuser Company in June 1967, ending with his retirement in December 2003. While at Weyerhaeuser, he served in various management positions, including statutory reporting, heading large accounting departments, interacting with external and internal auditors and all types of management. Mr. Carda spent the last 10 years of his career as the business controller for the distribution business of Weyerhaeuser. While in this capacity, he received many awards for his performance for profit and working capital improvement initiatives. Mr. Carda attended the University of Montana and graduated with a degree in accounting. He has served for 25 years on the board of directors of the Woodstone Credit Union in Federal Way, Washington and is currently its Vice Chairman. He also serves on the credit union’s audit committee.

Melinda Davis has served on the board of directors since July 2001. From December 2000 to the present, Ms. Davis has provided professional consulting services in the areas of financial management and cost accounting for manufacturing operations. Ms. Davis retired as senior vice-president and treasurer from Allen Canning Co. in December 2000, after serving for 39 years in various accounting and financial management positions.

Tim W. Kizer was elected to the board of directors in July 2005. Since December 2004, Mr. Kizer has served as president and partner of Bentonville Global Associates, a global consultancy firm specializing in collaborative commerce. Mr. Kizer is executive director of the Doing Business in Bentonville Series — seminar level program series in Bentonville Arkansas. From April 2001 to December 2004, Mr. Kizer was director of the Center for Management and Executive Development and the Donald W. Reynolds Center for Enterprise Development, Sam M. Walton College of Business, University of Arkansas. From January 2000 to April 2001, Mr. Kizer was managing director of Information Technology Research Center, Sam M. Walton College of Business, University of Arkansas. Mr. Kizer was a business and industry specialist for the Division of Continuing Education at the University of Arkansas from October 1996 until January 2000. He has a BA from the University of Louisville and is a member of the Board of Advisors of RFID Global Solution in Bentonville, Arkansas.

Samuel L. Milbank has served on the board of directors since July 2000. Mr. Milbank is a co-founder and owner of Milbank Roy and Co., LLC, an investment bank founded in February 2005 and focused on M&A, advisory as well as funding of middle market companies. Prior to that, from April 1997 to February 2005, Mr. Milbank was a managing director of Zanett Securities Corporation, a company also focusing on investment banking services to the middle market. From February 1992 to January 1996, Mr. Milbank was a senior vice-president and sales manager with Lehman Brothers, Inc. in New York, where he managed a team that provided interest rate and currency risk management for central banks and other official institutions. From March 1973 to February 1992, Mr. Milbank worked with Salomon Brothers, Inc. as a director and manager of the international department. Since January 1990, Mr. Milbank has served as chairman of Milbank Memorial Fund, a private operating foundation (established in 1905), concerned with environmental and public health issues. He has a BS from Columbia University and a MBA in Finance from The Amos Tuck School of Business Administration at Dartmouth College.

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Jim Robason has served on the board of directors since July 2003. Since January 2005, Mr. Robason has been a consultant to and supervisor of the Company’s plant operations on an interim basis. Mr. Robason joined Allen Canning Co. in 1967. Mr. Robason served as senior vice-president-operations of Allen Canning Co. from 1974 until his retirement in 2002. As senior vice-president of operations with Allen Canning Co., he was responsible for the operation of twelve plants with plant managers and raw product procurement managers, as well as special projects engineering, reporting to him. He has a vast amount of knowledge in all phases of manufacturing including infrastructure, building, equipment, and engineering; with a focus on the full production arena from product procurement through the production process. Mr. Robason is a graduate of West Texas State University. He has served on Allen Canning’s executive committee and profit sharing/retirement plan committee in addition to his operations responsibilities.

Michael M. Tull has served on the board of directors of the Company since December 1998. Mr. Tull has served since 1990 as the president and majority owner of Tull Sales Corporation, a manufacturer’s representative company, which professionally represents eight manufacturing companies and is responsible for the sales and marketing of those companies’ window and door related components in the southeastern United States. Mr. Tull serves on boards of several closely held family businesses and is the chairman and a board of director member of the National Wild Turkey Federation, which is one of the largest North American conservation organizations.

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

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

The audit committee of the board of directors consists of outside directors: Melinda Davis (chairman), Edward P. Carda, Jerry B. Burkett, and Sal Miwa. The audit committee is directly responsible for the engagement of the Company’s independent accountants and is responsible for approving the services performed by the Company’s independent accountants and for reviewing and evaluating the Company’s accounting principles and its system of internal accounting controls. The board of directors has determined that Melinda Davis qualifies as an audit committee financial expert; as such term is defined in rules of the SEC implementing requirements of the Sarbanes-Oxley Act of 2002. In addition, Melinda Davis, and the other members of the audit committee are independent, as that term is defined under the listing standards of the National Association of Securities Dealers.

The compensation committee consists of Samuel L. Milbank (chairman), Sal Miwa, Edward Carda and Jim Robason. The compensation committee establishes and administers the Company’s compensation and equity incentive plans on behalf of the board of directors and approves restricted stock grants thereunder.

The nominating committee consists of Jerry B. Burkett (chairman), Linda Davis, and Tim Kizer. The nominating committee evaluates the efforts of AERT and its board of directors to maintain effective corporate governance practices. The committee identifies candidates for election to the board of directors.

Code of Ethics

We adopted a Code of Business Conduct and Ethics applicable to all our directors and associates, including our chief executive officers, chief financial officer and principal accounting officer or controller, which is a “code of ethics” as defined by applicable rules of the SEC. This code has been filed with the SEC as an exhibit to our Form 10-K for the fiscal year ended December 31, 2003, and is publicly available on our website at www.aertinc.com. A copy may also be obtained upon written request to our secretary, Marjorie S. Brooks, Post Office Box 1237, Springdale, Arkansas 72765. If we make any amendments to this code other than technical, administrative or other non-substantive amendments or grant any waivers, including implicit waivers, from a provision of this code that applies to our chief executive officers, chief financial officer or principal accounting officer or controller and relates to an element of the SEC’s “code of ethics” definition, we will disclose the nature of the amendment or waiver, its effective date and to whom it applies on our website or in a report on Form 8-K filed with the SEC.

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Item 11.   Executive Compensation

The information required by Item 11 is incorporated herein by reference to the Company’s definitive proxy statement for its 2006 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 2006 annual meeting of stockholders.

Item 13.   Certain Relationships and Related Transactions

The information required by Item 13 is incorporated herein by reference to the Company’s definitive proxy statement for its 2006 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 2006 annual meeting of stockholders.

Part IV

Item 15.   Exhibits, Financial Statement Schedules

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

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

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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.

By:  /s/  JOE G. BROOKS

Joe G. Brooks,

Chairman, Co-Chief Executive Officer and President

/s/  STEPHEN W. BROOKS

Stephen W. Brooks,

Co-Chief Executive Officer

/s/  ROBERT A. THAYER

Robert A. Thayer,

Chief Financial Officer

Date: March 31, 2006

POWER OF ATTORNEY

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

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

Signature	Title	Date
/s/  JOE G. BROOKS Joe G. Brooks	Chairman of the board, co-CEO and president	March 31, 2006
/s/  SAL MIWA Sal Miwa	Vice-chairman of the board	March 31, 2006
/s/  STEPHEN W. BROOKS Stephen W. Brooks	Co-CEO and director	March 31, 2006
/s/  MARJORIE S. BROOKS Marjorie S. Brooks	Secretary, treasurer and director	March 31, 2006

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Signature	Title	Date
/s/  JERRY B. BURKETT Jerry B. Burkett	Director	March 31, 2006
/s/  MICHAEL M. TULL Michael M. Tull	Director	March 31, 2006
/s/  SAMUEL L. ‘TONY” MILBANK Samuel L. ‘‘Tony” Milbank	Director	March 31, 2006
/s/  MELINDA DAVIS Melinda Davis	Director	March 31, 2006
/s/  JIM ROBASON Jim Robason	Director	March 31, 2006
/s/  EDWARD P. CARDA Edward P. Carda	Director	March 31, 2006
/s/  TIM W. KIZER Tim W. Kizer	Director	March 31, 2006

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ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

INDEX TO FINANCIAL STATEMENTS

	Page
Financial Statements:
Report of Independent Registered Public Accounting Firm		F-2
Balance Sheets		F-3
Statements of Operations		F-4
Statements of Stockholders’ Equity		F-5
Statements of Cash Flows		F-6
Notes to Financial Statements		F-7 - F-29

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Advanced Environmental Recycling Technologies, Inc.

We have audited the accompanying balance sheets of Advanced Environmental Recycling Technologies, Inc. as of December 31, 2005 and 2004, and the related statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. 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 audit 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Advanced Environmental Recycling Technologies, Inc. as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.

/s/  TULLIUS TAYLOR SARTAIN & SARTAIN LLP

Fayetteville, Arkansas

March 30, 2006

F-2

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

BALANCE SHEETS

	December 31,			December 31,
	2005			2004
ASSETS
Current assets:
Cash and cash equivalents	$	1,748,023		$	1,078,536
Restricted cash		668,344			679,635
Trade accounts receivable, net of allowance of $420,319 at December 31, 2005 and $153,526 at December 31, 2004		2,993,701			2,554,594
Inventories		9,748,743			7,392,838
Prepaid expenses		706,301			586,637
Deferred tax asset		2,036,962			—
Total current assets		17,902,074			12,292,240
Land, buildings and equipment:
Land		1,986,033			1,612,243
Buildings and leasehold improvements		5,717,054			5,413,115
Machinery and equipment		35,647,614			33,524,077
Transportation equipment		970,204			775,669
Office equipment		770,803			755,000
Construction in progress		8,997,223			2,363,936
		54,088,931			44,444,040
Less accumulated depreciation		23,002,809			18,963,479
Net land, buildings and equipment		31,086,122			25,480,561
Other assets:
Deferred tax asset		2,597,920			—
Debt issuance costs, net of accumulated amortization of $549,256 at December 31, 2005 and $373,336 at December 31, 2004		3,055,666			3,211,766
Debt service reserve fund		2,110,881			2,057,792
Other assets, net of accumulated amortization of $364,163 at December 31, 2005 and $335,590 at December 31, 2004		200,010			298,434
Total other assets		7,964,477			5,567,992
	$	56,952,673		$	43,340,793
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable — trade	$	10,508,451		$	8,486,792
Accounts payable — related parties		3,006,306			2,280,781
Current maturities of long-term debt		938,704			1,133,168
Accrued payroll expense		668,485			401,183
Litigation loss payable		655,769			—
Other accrued liabilities		1,595,017			2,533,605
Income taxes payable		117,200			—
Notes payable — related parties		746,775			600,000
Notes payable — other		352,406			327,682
Total current liabilities		18,589,113			15,763,211
Long-term debt, less current maturities		17,010,889			15,571,068
Accrued premium on convertible preferred stock		235,367			276,000
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $1 par value; 5,000,000 shares authorized, 2,760 shares issued and outstanding at December 31, 2004		—			2,760
Class A common stock, $.01 par value; 75,000,000 shares authorized; 37,651,369 and 32,032,123 shares issued and outstanding at December 31, 2005 and 2004, respectively		376,514			320,322
Class B convertible common stock, $.01 par value; 7,500,000 shares authorized; 1,465,530 shares issued and outstanding at December 31, 2005 and 2004		14,655			14,655
Warrants outstanding; 9,176,242 at December 31, 2005 and 14,890,867 at December 31, 2004		4,489,419			6,917,544
Additional paid-in capital		31,340,363			27,376,565
Accumulated deficit		(15,103,647	)		(22,901,332	)
Total stockholders’ equity		21,117,304			11,730,514
Total liabilities and stockholders’ equity	$	56,952,673		$	43,340,793

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

F-3

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

STATEMENTS OF OPERATIONS

	Year Ended December 31,
	2005			2004			2003
Net sales	$	87,312,560		$	63,637,285		$	43,520,563
Cost of goods sold		66,389,964			48,963,166			34,361,984
Gross margin		20,922,596			14,674,119			9,158,579
Selling and administrative costs		14,595,854			11,099,911			9,001,261
Research and development		110,134			97,207			77,900
		14,705,988			11,197,118			9,079,161
Operating income		6,216,608			3,477,001			79,418
Other income (expense):
Insurance proceeds related to lost income		—			8,720			1,125,372
Net litigation contingency		(610,206	)		—			—
Loss on disposition of equipment		(26,122	)		—			—
Interest income		90,908			5,324			160,659
Interest expense		(2,087,818	)		(2,121,062	)		(2,031,370	)
		(2,633,238	)		(2,107,018	)		(745,339	)
Income (loss) before extraordinary item, accrued premium on preferred stock and income taxes		3,583,370			1,369,983			(665,921	)
Accrued premium on preferred stock		(235,367	)		(276,000	)		(276,000	)
Income (loss) before extraordinary item and income taxes		3,348,003			1,093,983			(941,921	)
Net income tax benefit		(4,449,682	)		—			—
Income (loss) before extraordinary item		7,797,685			1,093,983			(941,921	)
Extraordinary gain on involuntary conversion of non-monetary assets due to fire		—			173,536			2,962,041
Net income applicable to common stock	$	7,797,685		$	1,267,519		$	2,020,120
Income (loss) per share of common stock before extraordinary item (Basic)	$	0.22		$	0.03		$	(0.03	)
Income (loss) per share of common stock before extraordinary item (Diluted)	$	0.19		$	0.03		$	(0.03	)
Extraordinary gain per share of common stock (Basic)		—		$	0.01		$	0.10
Extraordinary gain per share of common stock (Diluted)		—		$	0.00		$	0.10
Income per share of common stock after extraordinary item (Basic)	$	0.22		$	0.04		$	0.07
Income per share of common stock after extraordinary item (Diluted)	$	0.19		$	0.03		$	0.07
Weighted average number of common shares outstanding (Basic)		35,861,060			31,815,067			30,017,661
Weighted average number of common shares outstanding (Diluted)		40,475,244			41,070,289			30,017,661

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

F-4

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

STATEMENTS OF STOCKHOLDERS’ EQUITY

																					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, 2002		2,760		$	2,760			28,331,312	$	283,313		1,465,530	$	14,655		16,590,122		$	7,824,206		$	23,825,504		$	(26,188,971	)	$	5,761,467
Issuance of stock in payment of accrued premium on preferred stock		—			—			179,586		1,796		—		—		—			—			213,722			—			215,518
Issuance of stock in payment of interest		—			—			309,849		3,099		—		—		—			—			429,296			—			432,395
Exercise of stock options		—			—			95,000		950		—		—		—			—			48,410			—			49,360
Exercise of Placement warrants		—			—			9,400		94		—		—		(9,400	)		(5,372	)		8,803			—			3,525
Issuance of stock in payment of debt issuance costs		—			—			350,000		3,500		—		—		—			—			462,560			—			466,060
Net income		—			—			—		—		—		—		—			—			—			2,020,120			2,020,120
Balance — December 31, 2003		2,760		$	2,760			29,275,147	$	292,752		1,465,530	$	14,655		16,580,722		$	7,818,834		$	24,988,295		$	(24,168,851	)	$	8,948,445
Issuance of stock in payment of accrued premium on preferred stock		—			—			229,994		2,300		—		—		—			—			273,700			—			276,000
Exercise of stock options		—			—			837,400		8,374		—		—		—			—			560,751			—			569,125
Exercise of Consulting warrants		—			—			1,573,333		15,733		—		—		(1,573,606	)		(849,741	)		1,423,964			—			589,956
Exercise of Class I warrants								116,249		1,163		—		—		(116,249	)		(51,549	)		129,855			—			79,469
Net income		—			—			—		—		—		—		—			—			—			1,267,519			1,267,519
Balance — December 31, 2004		2,760		$	2,760			32,032,123	$	320,322		1,465,530	$	14,655		14,890,867		$	6,917,544		$	27,376,565		$	(22,901,332	)	$	11,730,514
Issuance of stock in payment of accrued premium on preferred stock		—			—			229,994		2,300		—		—		—			—			273,700			—			276,000
Exercise of stock options		—			—			387,600		3,876		—		—		—			—			203,200			—			207,076
Exercise of Consulting warrants		—			—			1,738,946		17,389		—		—		(2,016,332	)		(1,120,815	)		1,389,382			—			285,956
Expiration of Consulting warrants		—			—			—		—		—		—		(1,379,926	)		(784,532	)		784,532			—			—
Exercise of Class C warrants		—			—			325,000		3,250		—		—		(325,000	)		(96,098	)		442,223			—			349,375
Exercise of Series X warrants		—			—			6,564		66		—		—		(6,564	)		(3,485	)		11,296			—			7,877
Exercise of Class I warrants		—			—			21,142		211		—		—		(21,142	)		(8,220	)		24,604			—			16,595
Expiration of Class I warrants		—			—			—		—		—		—		(42,997	)		(13,478	)		13,478			—			—
Exercise of Series Z warrants		—			—			300,000		3,000		—		—		(300,000	)		(106,898	)		403,898			—			300,000
Exercise of Extension warrants		—			—			310,000		3,100		—		—		(310,000	)		(183,310	)		296,460			—			116,250
Expiration of Bonus warrants		—			—			—		—		—		—		(1,312,664	)		(111,289	)		111,289			—			—
Conversion of preferred stock		(2,760	)		(2,760	)		2,300,000		23,000		—		—		—			—			(20,240	)		—			—
Deferred equity compensation — restricted stock		—			—			—		—		—		—		—			—			29,976			—			29,976
Net income		—			—			—		—		—		—		—			—			—			7,797,685			7,797,685
Balance — December 31, 2005		—		$	—			37,651,369	$	376,514		1,465,530	$	14,655		9,176,242		$	4,489,419		$	31,340,363		$	(15,103,647	)	$	21,117,304

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

F-5

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2005			2004			2003
Cash flows from operating activities:
Net income applicable to common stock	$	7,797,685		$	1,267,519		$	2,020,120
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,176,523			4,086,811			3,671,512
Premium accrued on preferred stock		235,367			276,000			276,000
Interest paid through issuance of common stock		—			—			432,395
Loss on disposition of equipment		26,122			—			—
Provision for returns and allowances		266,793			61,319			(6,000	)
Extraordinary gain on involuntary conversion of non-monetary assets due to fire		—			(173,536	)		(2,962,041	)
Deferred tax benefit		(4,634,882	)		—			—
(Increase) decrease in other assets		192,683			67,765			(766,446	)
(Increase) decrease in cash restricted for letter of credit and interest costs		42,708			(224,014	)		(277,835	)
Changes in current assets and current liabilities		(784,790	)		65,361			(161,255	)
Net cash provided by operating activities		7,318,209			5,427,225			2,226,450
Cash flows from investing activities:
Purchases of land, buildings and equipment		(5,907,695	)		(5,868,218	)		(11,257,967	)
Proceeds from disposition of equipment		94,596			—			—
Insurance proceeds from involuntary disposition of property and equipment		—			669,012			3,681,904
Net cash used in investing activities		(5,813,099	)		(5,199,206	)		(7,576,063	)
Cash flows from financing activities:
Proceeds from issuance of notes		1,900,000			2,050,000			17,000,000
Payments on notes		(4,200,749	)		(3,804,520	)		(9,112,156	)
Increase in cash restricted for payment of long-term debt		(31,417	)		(2,708	)		(175,078	)
Increase (decrease) in outstanding advances on factored receivables		353,235			301,884			(187,112	)
Debt acquisition costs		(19,821	)		11,100			(1,677,080	)
Proceeds from exercise of stock options and warrants, net		1,163,129			1,238,550			52,885
Net cash provided by (used in) financing activities		(835,623	)		(205,694	)		5,901,459
Increase in cash		669,487			22,325			551,846
Cash and cash equivalents, beginning of period		1,078,536			1,056,211			504,365
Cash and cash equivalents, end of period	$	1,748,023		$	1,078,536		$	1,056,211

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

F-6

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

Note 1:   Description of the Company

Advanced Environmental Recycling Technologies, Inc. (AERT) develops, manufactures and markets composite building materials that are used in place of traditional wood products for exterior applications in building and remodeling homes and for certain other industrial or commercial building purposes. Our products are made from approximately equal amounts of waste wood fiber and reclaimed polyethylene plastics. They have been extensively tested, and are sold by leading national companies such as the Weyerhaeuser Company (Weyerhaeuser), Lowe’s Companies, Inc. (Lowe’s) and Therma-Tru Corporation. Our composite building materials are marketed as a substitute for wood and plastic filler materials for decking, standard door components, windowsills, brick mould, fascia board, and heavy industrial flooring under the trade names LifeCycle^®, MoistureShield^®, MoistureShield^® CornerLoc^tm, Weyerhaeuser ChoiceDek^® Classic, Weyerhaeuser ChoiceDek^® Plus, Weyerhaeuser ChoiceDek^® Premium, ChoiceDek^® Classic Colors, ChoiceDek^® Premium Colors and MoistureShield^® outdoor decking. We operate manufacturing facilities in Springdale, Lowell, and Tontitown, Arkansas; Junction, Texas and Alexandria, Louisiana. Our customers are primarily regional and national door and window manufacturers, Weyerhaeuser, our primary decking customer, and various building product distributors.

Note 2:   Summary of Significant Accounting Policies

Revenue Recognition

The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (SAB 104). Under SAB 104, revenue is recognized when the title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable and collectibility is reasonably assured. The Company typically recognizes revenue at the time of shipment or segregated and billed under a bill and hold agreement. The terms of this agreement qualify for revenue recognition under SAB 104. Sales are recorded net of discounts, rebates, and returns, which were $2,211,835 in 2005, $1,519,811 in 2004 and $1,439,101 in 2003.

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

Shipping and Handling

In accordance with Emerging Issues Task Force (EITF) Issue 00-10, Accounting for Shipping and Handling Fees and Costs, the Company records shipping fees billed to customers in net sales and records the related expenses in cost of goods sold.

Operating Costs

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

F-7

Statements of Cash Flows

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

	Year Ended December 31,
	2005			2004			2003
Receivables	$	(705,900	)	$	(402,405	)	$	213,444
Inventories		(2,355,905	)		(3,521,570	)		(1,186,932	)
Prepaid expenses and other		1,219,421			1,151,327			844,929
Accounts payable —
Trade and related parties		835,910			1,858,857			(321,085	)
Accrued liabilities		104,484			1,040,471			282,389
Accrued income taxes		117,200			—			—
	$	(784,790	)	$	126,680		$	(167,255	)
Cash paid for interest	$	2,458,323		$	1,898,373		$	1,125,238
Cash paid for income taxes	$	68,000		$	—		$	—

Supplemental Disclosures of Non-cash Investing and Financing Activities

	Year Ended December 31,
	2005		2004		2003
Notes payable for financing of insurance policies	$	1,339,084	$	1,158,801	$	1,080,683
Accounts/notes payable for equipment		3,936,561		1,546,631		928,023
Accrued premium on preferred stock paid with Class A common stock		276,000		276,000		215,518

Cash Equivalents and Restricted Cash

The Company considers all highly liquid investments, those with a maturity of three months or less when purchased, to be cash equivalents. At December 31, 2005 and 2004, restricted cash included $426,984 and $451,591, respectively, that was restricted for payment of principal and interest on the Company’s bond payable. (See Note 4: Notes Payable and Long-term Debt.) Additionally, restricted cash at December 31, 2005 and 2004 included $241,360 and $228,044, respectively, which served as collateral for letters of credit with respect to purchases on credit from certain vendors.

Buildings and Equipment

Buildings and equipment are stated at cost and depreciated over the estimated useful life of each asset using the straight-line method. Estimated useful lives are: buildings — 15 to 30 years, leasehold improvements — 2 to 6 years, transportation equipment — 3 to 5 years, office equipment — 3 to 6 years and machinery and equipment — 3 to 10 years. Depreciation expense recognized by the Company for the years ended December 31, 2005, 2004 and 2003 was approximately $4.1 million, $4.1 million and $3.6 million, respectively.

F-8

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

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.

The Company accounts for the impairment or disposal of long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144). SFAS 144 requires an assessment of the recoverability of the Company’s investment in long-lived assets to be held and used in operations whenever events or circumstances indicate that their carrying amounts may not be recoverable. Such assessment requires that the future cash flows associated with the long-lived assets be estimated over their remaining useful lives. 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. Inventories consisted of the following at December 31:

	2005		2004
Raw materials	$	6,541,443	$	5,479,344
Work in process		1,256,121		891,473
Finished goods		1,951,179		1,022,021
	$	9,748,743	$	7,392,838

Other Assets

Debt issuance costs are amortized over the term of the related debt. Amortization of debt issuance costs charged to interest expense was $175,920 for 2005 and $174,269 for 2004. The net costs for the preparation of patent applications of $121,586 and $150,159 as of December 31, 2005 and 2004, respectively, are amortized using the straight-line method over 17 years. Amortization expense for patents was $28,573 for each of 2005 and 2004. The amortization of intangible assets resulted in aggregate expense of $204,493 for 2005 and $202,842 for 2004. The debt service reserve fund is restricted for the life of the bonds payable (see Note 4: Notes Payable and Long-term Debt) for payment of principal and interest on the bonds in the case the Company is unable to make those payments.

As of December 31, 2005 and December 31, 2004, the Company had the following amounts related to intangible assets:

	December 31, 2005				December 31, 2004
	Gross Carrying		Accumulated		Gross Carrying		Accumulated
	Amount		Amortization		Amount		Amortization
Debt issuance costs	$	3,604,922	$	549,256	$	3,585,102	$	373,336
Patents		485,749		364,163		485,749		335,590
	$	4,090,671	$	913,419	$	4,070,851	$	708,926

F-9

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

The following table represents the total estimated amortization of intangible assets for the five succeeding years:

	Estimated
	Amortization
2006		209,449
2007		209,449
2008		207,797
2009		202,842
2010		181,563

Accounts Receivable

Accounts receivable are uncollateralized customer obligations due under normal trade terms generally requiring payment within thirty days from the invoice date. Trade accounts are stated at the amount management expects to collect from outstanding balances. Delinquency fees are not assessed. Payments of accounts receivable are allocated to the specific invoices identified on the customers’ remittance advice.

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

Earnings Per Share

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

In computing Diluted EPS, only potential common shares that are dilutive — those that reduce earnings per share or increase loss per share — are included. Exercise of options and warrants or conversion of convertible securities is not assumed if the result would be antidilutive, such as when a loss from continuing operations is reported. The “control number” for determining whether including potential common shares in the Diluted EPS computation would be antidilutive is income from continuing operations. As a result, if there is a loss from continuing operations, Diluted EPS would be computed in the same manner as Basic EPS is computed, even if an entity has net income after adjusting for discontinued operations, an extraordinary item or the cumulative effect of an accounting change. The Company incurred a loss from continuing operations for the year ended December 31, 2003. Therefore, Basic EPS and Diluted EPS are computed in the same manner for that year.

F-10

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

	2005			2004						2003
				Before Extra-			After Extra-			Before Extra-			After Extra-
				Ordinary Item			Ordinary Item			Ordinary Item			Ordinary Item
Net income (loss) applicable to common stock (A)	$	7,797,685		$	1,093,983		$	1,267,519		$	(941,921	)	$	2,020,120
Assumed exercise of stock options and warrants		11,160,603			18,196,164			18,196,164			—			—
Application of assumed proceeds toward repurchase of stock at average market price		(6,546,419	)		(8,940,942	)		(8,940,942	)		—			—
Net additional shares issuable		4,614,184			9,255,222			9,255,222			—			—
Adjustment of shares outstanding:
Weighted average common shares outstanding		35,861,060			31,815,067			31,815,067			30,017,661			30,017,661
Net additional shares issuable		4,614,184			9,255,222			9,255,222			—			—
Adjusted shares outstanding (B)		40,475,244			41,070,289			41,070,289			30,017,661			30,017,661
Net income (loss) per common share — Diluted (A) divided by (B)	$	0.19		$	0.03		$	0.03		$	(0.03	)	$	0.07
Antidilutive and/or non-exercisable options		682,500			1,256,000			1,256,000			N/A			N/A
Antidilutive and/or non-exercisable warrants		1,021,269			2,333,933			2,333,933			N/A			N/A

The Company has additional options and warrants that were not included in the calculation of diluted earnings per share for the years ended December 31, 2005 and 2004, as indicated in the above table. Those options and warrants were antidilutive and/or not exercisable during those periods. Although the above financial instruments were not included due to being antidilutive and/or not exercisable, such financial instruments may become dilutive and would then need to be included in future calculations of Diluted EPS.

Concentration Risk

Credit Risk

The Company’s revenues are derived principally from a number of regional and national door and window manufacturers, regional building materials dealers and Weyerhaeuser, the Company’s primary decking customer. 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 customers. Weyerhaeuser is the only

F-11

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

customer from which the Company derived more than 10% of its revenue. The following table presents sales to Weyerhaeuser and the percentage of total sales that those sales represent.

	2005			2004			2003
Sales (in millions)	$	67.4		$	51.7		$	35.6
% of total sales		77	%		81	%		82	%

Cash

The Company maintains bank accounts which are insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000. At times, cash balances may be in excess of the FDIC insurance limit. The Company believes no significant concentrations of risk exist with respect to its cash.

Disclosure about Fair Value of Financial Instruments

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

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

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

Stock-Based Compensation

The Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). The following table illustrates the effect on net income (loss) and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation for the years ended December 31, 2005, 2004, and 2003.

	2005		2004				2003
			Before		After		Before			After
			Extra-Ordinary		Extra-Ordinary		Extra-Ordinary			Extra-Ordinary
			Item		Item		Item			Item
Net income (loss) applicable to common stock, as reported	$	7,797,685	$	1,093,983	$	1,267,519	$	(941,921	)	$	2,020,120
Deduct: Total stock-based compensation expense determined under fair value based method for all awards		20,913		263,328		263,328		396,958			396,958
Net income (loss) applicable to common stock, pro forma	$	7,776,772	$	830,655	$	1,004,191	$	(1,338,879	)	$	1,623,162
Net income (loss) per share of common stock:
Basic — as reported	$	0.22	$	0.03	$	0.04	$	(0.03	)	$	0.07
Basic — pro forma	$	0.22	$	0.03	$	0.03	$	(0.04	)	$	0.05
Diluted — as reported	$	0.19	$	0.03	$	0.03	$	(0.03	)	$	0.07
Diluted — pro forma	$	0.19	$	0.02	$	0.02	$	(0.04	)	$	0.05

F-12

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 2004 and 2003, respectively (no options were granted in 2005): risk-free interest rates of 4.2 and 4.0 percent; expected lives of 10 and 10 years; and expected volatilities of 67 and 91 percent. Since no dividends are expected to be paid by the Company during the expected lives of the options, a dividend yield of zero was used for purposes of computing the fair value of the options. The weighted-average fair value of options granted during 2004 and 2003 was $0.93 and $0.98, respectively.

Use of Estimates

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

Advertising Costs

Advertising costs are charged to expense in the period incurred. Advertising expense was approximately $1,481,000, $1,086,000, and $1,277,000, in 2005, 2004, and 2003, respectively.

Research and Development Costs

Expenditures for research activities relating to product development and improvement are charged to expense as incurred. Such expenditures amounted to $110,134, $97,207, and $77,900 in 2005, 2004, and 2003, respectively.

Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Additionally, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Company adopted the provisions of this statement effective January 1, 2006. The adoption of SFAS 151 did not have a material effect on the Company’s financial statements and related disclosures.

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, Share-Based Payment (SFAS 123R). SFAS 123R is a revision of SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions) and requires that cost to be recognized in the financial statements. The Company adopted the provisions of this statement effective January 1, 2006. The adoption of SFAS 123R did not have a material effect on the Company’s financial statements and related disclosures.

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29 (SFAS 153). The guidance in APB Opinion 29, Accounting for Nonmonetary Transactions, is based on the principle that

F-13

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. SFAS 153 amends APB Opinion 29 to eliminate an exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. The Company adopted the provisions of this statement effective January 1, 2006. The adoption of SFAS 153 did not have any effect on the Company’s financial statements and related disclosures.

In May 2005, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections (SFAS 154), which replaces APB Opinion No. 20, Accounting Changes, and FASB Statement 3, Reporting Accounting Changes in Interim Financial Statements. This statement changes the requirements for the accounting for and reporting of a change in accounting principle, including all voluntary changes in accounting principles. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires voluntary changes in accounting principles be recognized retrospectively to prior periods’ financial statements, rather than recognition in the net income of the current period. Retrospective application requires restatements of prior period financial statements as if that accounting principle had always been used. This statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. The provisions of SFAS No. 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

Reclassifications

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

Note 3:   Related Party Transactions

Transfer of Receivables

The Company accounts for transfers of receivables, with recourse, to a related party (Brooks Investment Co.) under the guidelines of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140). This statement provides accounting and reporting standards for, among other things, the transfer and servicing of financial assets, such as transfers of receivables with recourse, and provides standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. Based on the requirements of SFAS 140, the receivables transferred to the related party with recourse are accounted for as a secured borrowing because the Company is not considered to have surrendered control over the transferred assets. Accounts payable-related parties and trade accounts receivable at December 31, 2005 and 2004, include $2,450,788 and $2,097,553, respectively, to reflect these requirements. The Company plans to discontinue the agreement with Brooks Investment Co. on March 31, 2006.

The terms of the agreement with Brooks Investment Co., controlled by Marjorie S. Brooks, allows the Company to transfer certain of its trade receivables as collateral, which Brooks Investment Co. deems acceptable, up to $4.0 million at any one time. Upon acceptance of a transfer of a receivable, Brooks Investment Co. remits to the Company 85% of the receivable, as defined in the agreement. Upon collection of the receivable, the Company remits to Brooks Investment Co. 1.25% of the receivable as a factoring charge, and the remaining receivable, less interest costs, which are based on the time period over which the receivable is outstanding is remitted to the Company. The Company indemnifies Brooks Investment Co. for any loss arising out of rejections or returns of any merchandise, or any claims asserted by the Company’s customers. During 2005, the Company transferred an aggregate of approximately $89.5 million in receivables under this agreement, of which $3.0 million remained to be collected as of December 31, 2005. During 2004 and 2003, the Company transferred an aggregate of approximately $65.9 million and $45.0 million, respectively, in

F-14

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

receivables under this agreement, none of which remains to be collected. During 2005, Brooks Investment Co. provided a rebate of factoring costs in the amount of $450,000, resulting in total factoring costs of $669,718, which were included in selling and administrative costs at December 31, 2005. Costs of $826,248 and $512,233 associated with the factoring agreement were included in selling and administrative costs at December 31, 2004 and 2003, respectively.

Commissions

The Company employs the services of a related party, Tull Sales, Inc., as an outside sales representative. Tull Sales is owned by Michael M. Tull, one of our directors. Commissions paid to Tull Sales were $677,794 in 2005, $643,570 in 2004 and $351,032 in 2003.

In addition to the related transactions discussed above, members of the Brooks family provide the following to the Company without receiving any financial consideration:

•  Marjorie S. Brooks personally guaranteed repayment of up to $4 million of the 2003 bonds;

•  Joe G. Brooks personally guarantees repayment of the Company’s American Express account, the outstanding balance of which is sometimes in excess of $100,000; and,

•  Joe G. Brooks personally guarantees repayment of the Company’s automobile loans, which had a balance of $71,068 at December 31, 2005.

At December 31, 2005, accounts payable-related parties included the following amounts:

•  Advances on factored receivables of approximately $2.45 million assigned to Brooks Investment Co.,

•  Sales commissions of approximately $84,000 owed to Tull Sales Co., which is owned by Michael M. Tull, one of our directors, and director compensation of $3,750 owed to Mr. Tull,

•  Deferred compensation of $90,500 owed to Steve Brooks, one of our Co-CEO’s,

•  Deferred compensation of $169,622 and out-of-pocket expenses of $15,000 owed to Joe Brooks, our Chairman and Co-CEO,

•  Director compensation of $3,750 and consulting fees of $112,000 owed to Jim Robason, one of our directors, and

•  Other items owed to related parties of approximately $77,000.

Note 4:   Notes Payable and Long-Term Debt

Notes Payable — Related Parties

Notes Payable to Related Parties Consisted of the Following at December 31:	2005		2004
7% notes payable to Brooks Investment Company, which is controlled by Marjorie S. Brooks, an officer and director of the Company; unsecured; due on demand	$	746,775	$	600,000

Notes Payable — Other

Notes Payable Other, Consisted of the Following at December 31:	2005		2004
Various notes payable to finance insurance policies bearing interest at rates of 11.5%and 13.25% at December 31, 2005; secured by insurance policies	$	352,406	$	327,682

F-15

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

Long-term Debt

Long-Term Debt, Less Current Maturities Consisted of the Following at December 31:	2005			2004
7% bonds payable to Regions Bank; principal payable annually; interest payable semi-annually; subject to mandatory sinking fund redemption; secured by real estate and improvements, fixed assets, patents and trademarks, inventory, pledged revenues, and a personal guarantee by Marjorie S. Brooks, the major shareholder; maturing on October 1, 2017(a)	$	12,900,000		$	13,700,000
19.75% note payable to Allstate Insurance Company, secured by subordinated interest in the collateral securing the bonds payable; interest payable semiannually; principal due on October 1, 2017		2,600,000			2,600,000
Variable rate note payable bearing interest at the Wall Street Journal prime rate plus 1% (8.25% at December 31, 2005); secured by certain real estate and equipment purchased with proceeds from the note; maturing on September 28, 2009		1,932,000			—
Variable rate note payable bearing interest at LIBOR plus 3.1% (7.32% at December 31, 2005); secured by equipment purchased with proceeds from the note; maturity to be negotiated upon completion of draws on $2,000,000 equipment loan, of which this amount is the first draw		446,522			—
5% note payable with weekly principal payments of $6,540 plus interest; unsecured; maturing October 14, 2005		—			267,980
Other		71,071			136,256
Total		17,949,593			16,704,236
Less current maturities		(938,704	)		(1,133,168	)
Long-term debt, less current maturities	$	17,010,889		$	15,571,068

(a) The bond agreement contains financial covenants, which include a current ratio of not less than 1.00 to 1.00 and a requirement that not more than 10% of accounts payable be in excess of 75 days past the invoice date. The Company was not in compliance with these two covenants at December 31, 2005; however, the bond trustee waived these covenants as of December 31, 2005 through, and including, December 31, 2006.

The aggregate maturities of long-term debt, net of debt discount, as of December 31, 2005, are as follows:

Year	Amount
2006	$	938,704
2007		1,096,927
2008		1,091,816
2009		2,922,146
2010		1,100,000
Thereafter		10,800,000
	$	17,949,593

F-16

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

Note 5:   Stockholders’ Equity

Preferred Stock

The Company issued 1,500 Series A preferred shares, 900 Series B preferred shares and 500 Series C preferred shares at a price of $1,000 per share in 1998. Such stock was purchased by the major stockholder, a 5% holder and accredited institutional investors. The preferred stock had an interest premium of 10% per year payable in cash or common stock. The Company converted $276,000 of accrued premiums to common stock in each of 2005 and 2004. These transactions are considered non-cash financing activities for statement of cash flow purposes.

On November 7, 2005, the seventh anniversary date of the issuance of the preferred stock, the remaining 2,760 shares of preferred stock were automatically converted into shares of common stock according to the mandatory conversion feature of the preferred stock. The conversion price was $1.20, the lower of the average of the closing bid prices for the common stock for the five trading days immediately preceding the conversion date and the fixed conversion price of $1.20. The preferred stock was originally issued with two classes of warrants, Series X and Y, which can be exercised at $1.20 and $2.50 per share, respectively, as described in the warrants section below.

Common Stock

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

Warrants

The Company has reserved 9,176,242 shares of the Company’s Class A common stock for issuance under warrant agreements.

Class C Warrants

In June 1993, 650,000 detachable Class C warrants were issued to Marjorie S. Brooks, an officer and director of the Company, and four other individuals, in connection with the issuance of bridge notes in the amount of $650,000. Each Class C warrant was exercisable into one share of Class A common stock at an exercise price of $1.075 per share. During 1998, the Company received net proceeds of $330,000 from the exercise of 275,000 Class C warrants. One Bonus warrant (described below) was granted to the holder for each warrant exercised. On February 12, 1999, 50,000 Class C warrants expired. The remaining 325,000 Class C warrants were set to expire in June 2003, but the expiration date was extended to June 2005. In June 2005, the remaining 325,000 Class C warrants were exercised for proceeds of $349,375.

Class F Warrants

In May 1994, the Company completed a private placement offering at market price to certain bridge note holders and affiliated stockholders, including Marjorie S. Brooks, an officer and director of the Company. As part of the private placement, 3,468,400 shares of Class A common stock, 3,468,400 Class F warrants, and 3,468,400 Class G warrants (see below) were issued. Net offering proceeds of approximately $2,065,000 consisted of $2,020,000 conversion of debt and accrued interest and $45,000 in cash. In 1999, 350,864 Class F warrants were exercised at a price of $0.61 per share, resulting in proceeds of $214,027. The remaining 987,040 Class F warrants were set to expire in June 2004, but the expiration date was extended to June 2006.

F-17

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

The warrants are exercisable at a price of $0.61 per share of Class A common stock for each Class F warrant exercised.

Class G Warrants

In 1999, 481,810 Class G warrants were exercised at prices ranging from $0.91 to $0.92 per share, resulting in proceeds of $441,956. The remaining 2,987,040 Class G warrants were set to expire in June 2004, but the expiration date was extended to June 2006. The warrants are exercisable at a price of $0.92 per share of Class A common stock for each Class G warrant exercised. See the paragraph above for additional information on the original issuance of the Class G warrants.

Class H Warrants

In 1995, in connection with a note payable to Marjorie S. Brooks and accounts payable to a company controlled by her (see Note 3), the Company’s Board of Directors authorized the issuance of up to 2,000,000 Class H warrants on a one-for-one basis for each dollar advanced under the agreement and having an exercise price equal to the per share market value of the Company’s Class A common stock on the date of such advances. The warrants were exercisable at prices from $0.39 to $0.49 per share of Class A common stock for each Class H warrant exercised. In 2000, 228,208 shares of Class H warrants were exercised at prices ranging from $0.39 to $0.49 per share, resulting in proceeds of $100,000. The remaining 1,771,792 Class H warrants were set to expire in February 2005, but the expiration date was extended to February 2007. The warrants are exercisable at prices from $0.46 to $0.48 per share of Class A common stock for each Class H warrant exercised.

Class I Warrants

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

In December 1996, the Company received $185,000 in cash relating to an offering to qualified foreign investors under Regulation S of the Securities Act of 1933 with the issuance of 228,571 and 134,454 shares of Class A common stock in 1996 and 1997, respectively. Also, in 1997, $228,999 was received and 977,367 shares of Class A common stock were issued. In 1999, the remaining Class I warrants were extended to June 22, 2003, and were later extended again to June 22, 2005. All Class I warrants were either exercised or expired in June 2005.

F-18

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

The following table sets forth the exercises and expirations of Class I warrants and the proceeds received for those exercises:

	Class I						Class I
	Warrants		Range of Exercise		Proceeds		Warrants
	Exercised		Prices		Received		Expired
2005		21,142	$	0.5613 to $0.9375	$	16,596		42,997
2004		116,249	$	0.31 to $ 1.125		79,469		—
2002		95,107	$	0.31 to $ 1.125		62,881		—
2001		56,727	$	0.31 to $ 1.125		34,548		—
1999		29,367	$	0.9375		27,532		42,866

Series X and Series Y Warrants Issued in Connection with Preferred Stock

In connection with the issuance of preferred stock in 1998, 2,416,665 Series X warrants and 1,021,269 Series Y warrants were issued. The warrants are exercisable at $1.20 and $2.50 per share, respectively. Each of the warrants has cashless exercise features that are based on various conversion amounts and terms. The expiration date of the warrants was extended from November 2005 to November 2007. In 2002, 1,000 Series X warrants were exercised at $1.20, resulting in proceeds of $1,200.

Series X and Series Y Warrants to Placement Agent

The Series A preferred stock shares were placed through a placement agent. The placement agent and certain officers of the placement agent were given Series X warrants to purchase, in the aggregate, 278.33 shares of the Company’s common stock for each $1,000 of purchase price (417,495 shares) and Series Y warrants to purchase, in the aggregate, 102.7 shares of the Company’s common stock for each $1,000 of purchase price (154,050 shares). The Series X warrants were originally exercisable for a period of six years from the first anniversary of the date of issuance at a price per share equal to $1.20 and the Series Y warrants were originally exercisable for a period of five years from the second anniversary of the date of issuance at a price per share equal to $2.50. The exercise period for both the Series X and Series Y warrants was extended by two years. No placement agent was used for the Series B and C preferred stock. In 2005, 6,564 Series X warrants were exercised at $1.20, resulting in proceeds of $7,877.

Bonus Warrants

In connection with the exercise of the Class B and C Warrants during 1998 and 1999, the Company granted a new warrant on a one-for-one basis for each Class B and C Warrant exercised. The Bonus warrants, 1,054,670 and 257,994 issued in 1998 and 1999, respectively, were originally to expire February 12, 2001, but were extended to June 22, 2003, and later extended to June 22, 2005. They were exercisable at a price of $3.00 per share of Class A common stock for each Bonus warrant exercised. All of the Bonus warrants expired unexercised in June 2005.

F-19

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

Consulting and Placement Warrants

In 1997 and 1998, the Company obtained bridge financing of $3.2 million (see Note 4). In connection with the financing, 6,314,926 Consulting warrants and 378,895 Placement warrants were issued at an exercise price of $0.375. The expiration dates for all warrants were extended by two years in 2002. Since the issuance of the warrants, all of the Consulting and Placement warrants were either exercised or expired, as shown in the table below.

	Exercised				Expired
	Consulting		Placement		Consulting		Placement
Year Exercised/Expired	Warrants		Warrants		Warrants		Warrants
2005		2,016,332		—		1,379,926		—
2004		1,573,333		—		—		—
2003		—		9,400		—		—
2002		416,667		195,605		—		—
Prior to 2002		928,668		173,890		—		—
		4,935,000		378,895		1,379,926		—

Extension Warrants

In connection with the extension of an October 30, 1997 bridge financing, 310,000 extension warrants were issued at an exercise price of $0.375 per share of Class A common stock for each warrant exercised. The stock warrants were originally to expire on November 5, 2003, but the expiration date was extended to November 5, 2005. All 310,000 warrants were exercised in November 2005 for proceeds of $116,250.

Series Z Placement Warrants

In 1998, the Company issued 300,000 Series Z Placement warrants in connection with the issuance of the Series C preferred stock. These warrants are exercisable at a price of $1.00 per share of Class A common stock for each warrant exercised, and were originally to expire on November 12, 2003, but the expiration date was extended to November 12, 2005. All 300,000 warrants were exercised in October 2005 for proceeds of $300,000.

F-20

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

At December 31, 2005, the Company had warrants outstanding as follows:

	Warrants Outstanding		Weighted				Warrants		Warrants
	for Class A		Average		Expiration		Exercised		Expired
	Common Stock		Exercise Price		Date		in 2005		in 2005
Class C warrants		—	$	1.08		06/15/05		325,000		—
Class F warrants		987,040		0.61		06/06/06		—		—
Class G warrants		2,987,040		0.92		06/06/06		—		—
Class H warrants		1,771,792		0.47		02/21/07		—		—
Class I warrants		—		0.94		06/22/05		21,142		42,997
Series X warrants		1,998,165		1.20		11/10/07		—		—
Series Y warrants		867,500		2.50		11/10/07		—		—
Series X warrants — placement agent		410,936		1.20		11/10/07		6,564		—
Series Y warrants — placement agent		153,769		2.50		11/10/07		—		—
Bonus warrants		—		3.00		06/22/05		—		1,312,664
Consulting warrants		—		0.38		02/05/05		1,441,332		—
Consulting warrants		—		0.38		04/06/05		—		760,000
Consulting warrants		—		0.38		06/03/05		—		619,926
Consulting warrants		—		0.38		08/21/05		575,000		—
Extension warrants		—		0.38		11/05/05		310,000		—
Series Z Placement warrants		—		1.00		11/12/05		300,000		—
Totals		9,176,242	$	1.05				2,979,038		2,735,587

Effective June 30, 2001, the Company adopted Financial Accounting Standards Board SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), with no effects on its financial statements except for warrants that are indexed to and potentially settled in the Company’s common stock, which includes all of the Company’s warrants. These warrants have been accounted for under the provisions of Emerging Issues Task Force abstract 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (EITF 00-19). The Company modified certain of its warrant related registration rights agreements as of June 30, 2001, so that those warrants would be classified as equity rather than debt in its balance sheet under the provisions of EITF 00-19. As a result of these modifications, there was no impact on earnings.

In accounting for its derivative contracts at June 30, 2001, the Company recorded $8,419,345 in warrants outstanding in the equity section of its balance sheet and decreased its additional paid-in capital by the same amount, leaving its total stockholder’s equity amount unaffected. The warrant valuation was determined as of June 30, 2001 using the Black-Scholes option-pricing model, with the following details and assumptions. The underlying stock price was $0.87. Exercise prices of the warrants ranged from $0.31 to $3.00. The volatility of the stock underlying the warrants ranged from 46.42% to 87.27%, and the risk-free rates of return ranged from 3.63% to 4.82%.

Note 6:   Stock Option Plans

The Company’s stock option plans (the 1997 Plan, 1994 Plan, Director Plan, Chairman Plan and the 1989 Plan, collectively “the Plans”) authorize the issuance of 7,600,000 shares of the Company’s Class A common stock to its directors, employees and outside consultants. The option price of the stock options awarded must be at least equal to the market value of the Class A common stock on the date of grant. Stock options may not be granted to an individual to the extent that in any calendar year in which options first become exercisable, the shares subject to options first exercisable in such year have a fair market value on the date of grant in

F-21

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

excess of $100,000. No option may be outstanding for more than ten years after its grant. The purpose of the Plans is to enable the Company to encourage key employees, directors and outside consultants to contribute to the success of the Company by granting such persons incentive stock options (ISOs) and/or non-incentive stock options (nonqualified stock options). The ISOs are available for employees only. In order to provide for disinterested administration of the Plans for purposes of Rule 16b-3 under the Securities Exchange Act of 1934, the Director Plan also provides that outside directors will automatically receive annual awards of nonqualified stock options; however, no more options will be issued from the Director Plan, as all options authorized for issuance under the Director Plan have been issued, and the Company has adopted a separate non-employee director equity incentive plan (see Note 7).

The Company’s stockholders approved the Non-Employee Director Stock Option Plan (the Director Plan), in June 1994. The Director Plan provides for the issuance of options to purchase up to an aggregate of 500,000 shares of the Company’s Class A common stock to eligible outside directors of the Company. Each eligible outside director was granted options to purchase 25,000 shares of common stock annually commencing in 1995 and each year thereafter through 2004. The plan expired in 2004, and options can no longer be issued under this plan.

In June 1994, stockholders of the Company approved the adoption of the Amended and Restated Stock Option Plan (the 1994 Plan), which superseded and replaced the Company’s 1990 Stock Option Plan. The 1994 Plan provides for the granting of options to purchase up to 1,000,000 shares of the Company’s Class A common stock by recipients of incentive stock options or nonqualified stock options as granted by the Company’s Board of Directors. The 1994 Plan has expired, and no more stock options can be issued under that plan.

Also, in June 1994, stockholders of the Company approved the Chairman Stock Option Plan. This plan provided for a grant of options to purchase up to 500,000 shares of the Company’s Class A common stock.

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

F-22

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

A summary of the activity in the Company’s stock option plans during the years ended December 31, 2005, 2004, and 2003, follows:

	2005					2004					2003
				Weighted					Weighted					Weighted
				Average					Average					Average
				Exercise					Exercise					Exercise
	Shares			Price		Shares			Price		Shares			Price
Outstanding, beginning of year		4,595,230		$	1.06		5,742,630		$	1.01		5,667,630		$	1.00
Granted		—			—		175,000			1.22		215,000			1.13
Exercised		(377,600	)		0.49		(837,400	)		0.76		(95,000	)		0.52
Forfeited		(529,500	)		1.79		(485,000	)		1.06		(45,000	)		1.03
Outstanding, end of year		3,688,130		$	1.01		4,595,230		$	1.06		5,742,630		$	1.01
Exercisable, end of year		3,638,130		$	1.01		4,395,230		$	1.02		5,215,130		$	0.92

The following table summarizes information about stock options outstanding under the Company’s stock option plans as of December 31, 2005:

	Options Outstanding						Options Exercisable
	Number		Wtd. Avg.		Wtd. Avg.		Number		Wtd. Avg.
	Outstanding		Remaining		Exercise		Exercisable		Exercise
Range of Exercise Prices	at 12/31/05		Contract Life		Price		at 12/31/05		Price
$0.38 - $0.48		486,667		1.40 years	$	0.44		486,667	$	0.44
$0.56 - $1.00		1,833,963		1.73 years	$	0.66		1,833,963	$	0.66
$1.10 - $1.34		735,000		4.87 years	$	1.17		685,000	$	1.17
$1.75 - $2.75		632,500		3.15 years	$	2.32		632,500	$	2.32
		3,688,130		2.56 years	$	1.01		3,638,130	$	1.01

The weighted-average fair value of options granted during 2004 and 2003 was $0.93, and $0.98, respectively.

Note 7:   Equity Incentive Plans

2005 Key Associate and Management Equity Incentive Plan

The purpose of the Associate Plan is to further the growth and development of the Company by providing, through ownership of stock of the Company, an incentive to officers and other key “associates” (each of whom are employees of the Company for tax purposes) who are in a position to contribute materially to the prosperity of the Company including, but not limited to, all salaried personnel of the Company, to increase such persons’ interests in the Company’s welfare, to encourage them to continue their services to the Company, and to attract individuals of outstanding ability to enter the employment of the Company.

The Associate Plan is currently administered by the compensation committee (the Administrator) of the board of directors. The Administrator has the power and authority to select and grant to participants restricted stock awards pursuant to the terms of the Associate Plan. Any employee of the Company is eligible to receive an award under the 2005 Associate Plan. No director who is not also an employee will be eligible to receive an award under the Associate Plan.

The stock available for awards under the Associate Plan are shares of the Company’s authorized but unissued, or reacquired, common stock. The aggregate number of shares which may be issued pursuant to awards granted under the Associate Plan may not exceed 1,500,000 shares of common stock. In the event that

F-23

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

any outstanding award for any reason expires, is forfeited or is terminated, the shares of common stock allocable to the unvested portion of the award will again be available for awards under the Associate Plan as if no award had been granted with respect to such shares.

The terms and conditions of the restricted stock purchase agreements or award may change from time to time, and the terms and conditions of separate restricted stock purchase agreements need not be identical, but each restricted stock purchase agreement will include the substance of each of the following provisions:

(a) Purchase Price.  The purchase price of restricted stock awards shall be determined by the Administrator, and may be stated as cash, property or prior services performed.

(b) Consideration.  The consideration for common stock acquired pursuant to the restricted stock purchase agreement will be paid either: (i) in cash at the time of purchase; or (ii) in any other form of legal consideration that may be acceptable to the Administrator in its discretion including, without limitation, a recourse promissory note, property or a stock-for-stock exchange or prior services that the Administrator determines have a value at least equal to the fair market value of such common stock.

(c) Vesting.  Shares of common stock acquired under the restricted stock purchase agreement or awards may, but need not, be subject to a restricted period that specifies a right of repurchase in favor of the Company in accordance with a vesting schedule to be determined by the Administrator, or forfeiture in the event the consideration was in the form of prior services. In general, it is anticipated that, except as the Administrator may otherwise determine in its discretion, awards will vest (and prior thereto shall be subject to such a restricted period) over a three-year period, with 20% of a particular award vesting on the first anniversary thereof, an additional 30% of such award (50% cumulatively) vesting on the second anniversary of the award, and the 50% balance of the award vesting on the third anniversary of the award.

No stock has yet been awarded pursuant to the Key Associate and Management Equity Incentive Plan.

2005 Non-Employee Director Equity Incentive Plan

The purpose of the Director Plan is to further the growth and development of the Company by providing, through ownership of stock of the Company, an incentive to non-employee directors to encourage them to continue their director services to the Company, and to attract individuals of outstanding ability to accept director positions for the Company. The Director Plan will initially be administered by the compensation committee (the Administrator) 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).

Each director of the Company who is not also an employee of the Company is eligible to receive, and will automatically receive, an annual award under the Director Plan. There were, as of December 31, 2005, nine non-employee directors who are eligible to participate in the Director Plan (including non-employee directors who are not independent directors). The stock available for awards under the Director Plan are shares of the Company’s authorized but unissued, or reacquired, common stock. The aggregate number of shares which may be issued pursuant to awards granted under the Director Plan will not exceed 500,000 shares of common stock. In the event that any outstanding award under the Director Plan for any reason expires, is forfeited or is terminated, the shares of common stock allocable to the unexercised portion of the award shall again be available for awards under the Director Plan as if no award had been granted with respect to such shares.

The major terms of the restricted stock awards are as follows:

(a) Restricted Stock Awards.  Effective as of the third business day each year following the earlier of (i) the Company’s announcement by press release or other widely disseminated means of its results of operations (including both definitive revenue, net income, and earnings per share data) for the preceding

F-24

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

fiscal year of the Company, or (ii) the Company’s filing with the Securities and Exchange Commission of its Annual Report on Form 10-K for the preceding fiscal year of the Company, each eligible director then serving shall be granted pursuant hereto, in consideration of his or her services as a director to that point and as an inducement to further services in such capacity, a restricted stock award equal to the number of shares of common stock determined by dividing thirty thousand dollars ($30,000) by the fair market value, which for such purposes shall be deemed to be the average closing sale price of the common stock over the 50-business day period immediately preceding the effective date of such awards, to vest (and prior thereto shall be subject to a restricted period as defined herein) over a three-year period, with 20% of a particular award vesting on the first anniversary thereof, an additional 30% of such award (50% cumulatively) vesting on the second anniversary of the award, and the 50% balance of the award vesting on the third anniversary of the award; provided, however, as an inducement for new directors to serve, in the event new non-employee directors are elected or added to the board after the date of the annual award in any fiscal year, such new directors will be entitled to an initial restricted stock award equal to a pro rated (by fiscal quarters) portion of the usual $30,000 annual award, such that the new director will be credited for such pro rating purposes with one fiscal quarter of service for every fiscal quarter of the Company, or any portion thereof, during which such person will serve as a director in such initial fiscal year of service, divided in such case by the average closing sale price of the common stock over the 50-business day period immediately preceding such new director’s election or appointment to the board of directors. Such initial restricted stock awards to new directors shall vest over a three-year period in the same manner as other awards pursuant to the Director Plan.

(b) Termination of Participant’s Continuous Service.  In the event a participant’s continuous service as a director terminates for any reason, the Company may exercise its right of repurchase or otherwise reacquire, or the participant shall forfeit unvested shares acquired in consideration of services performed or performable.

In 2005, seven directors were each granted 20,848 shares of restricted stock pursuant to the Director Plan, for a total of 145,936 shares. The total dollar value of the awards was $210,000, and was initially recorded as deferred equity compensation. The value of the awards is amortized over the vesting period of the awards and charged to director compensation expense.

Note 8:   Leases

At December 31, 2005, the Company was obligated under various operating leases covering certain buildings and equipment. Rent expense under operating leases for the years ended December 31, 2005, 2004, and 2003 was $3,381,404, $2,053,051, and $1,602,788, 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 a duration of less than one year.

Future minimum lease payments required under operating leases as of December 31, 2005, are as follows:

Year	Amount
2006	$	1,816,437
2007		1,645,404
2008		1,333,096
2009		841,328
2010		700,167
Thereafter		821,265
Total minimum payments required	$	7,157,697

F-25

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

Note 9:  Income Taxes

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

The Company’s income tax provision (benefit) consisted of the following:

	Year Ended December 31,
	2005			2004		2003
Current:
Federal	$	80,000		$	—	$	—
State		105,200			—		—
		185,200			—		—
Deferred:
Federal		(4,823,917	)		—		—
State		189,035			—		—
		(4,634,882	)		—		—
Net income tax benefit	$	(4,449,682	)	$	—	$	—

The Company generated net operating losses for income tax purposes in 2004 and 2003, so there were no current tax provisions for those years. Additionally, the excess of our deferred tax assets over our deferred tax liabilities was offset by a valuation allowance, resulting in no deferred tax benefit for those years.

The income tax provision for 2004 and 2003 differs from the amount computed by applying the US federal statutory rate of 34% to income before income taxes due primarily to changes in the valuation allowance. The income tax benefit for 2005 differs from the amount computed by applying the US federal statutory rate of 34% to income before income taxes as a result of the following:

	Amount			Percent
Income tax at the U.S. federal statutory rate	$	1,138,321			34.0	%
Net operating loss carryforwards		(1,024,489	)		(30.6	)
State income taxes		105,200			3.1
Net reversal of valuation allowance		(4,634,882	)		(138.4	)
Other		(33,832	)		(1.0	)
	$	(4,449,682	)		(132.9	%)

F-26

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

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

	Year Ended December 31,
	2005
	Current		Long-Term		2004			2003
Deferred tax assets:
Net operating loss carryforwards	$	2,036,962	$	5,193,366	$	8,794,000		$	7,637,000
Other		—		64,000		—			—
Valuation allowance		—		—		(8,121,000	)		(7,567,000	)
Total deferred tax assets		2,036,962		5,257,366		673,000			70,000
Deferred tax liability: Depreciation		—		2,659,446		673,000			70,000
Net deferred tax assets	$	2,036,962	$	2,597,920	$	—		$	—

As of December 31, 2005, the Company had net operating loss carryforwards of approximately $21.3 million for federal income tax purposes, which are available to reduce future taxable income and will expire beginning in 2015 through 2024. As the Company generated net operating losses from its inception through 2000, and there was no assurance that it would be able to utilize its net operating loss carryforwards, a valuation allowance was established in 2003 and 2004 to recognize its deferred tax assets only to the extent of its deferred tax liabilities, as discussed above. The Company evaluated the need for a valuation allowance as of December 31, 2005, and determined it is more likely than not that it will generate enough taxable income to fully utilize the net operating loss carryforwards prior to their expiration. In eliminating the valuation allowance, the Company has recorded a deferred tax asset of approximately $7.3 million for its net operating loss carryforwards, reduced by a deferred tax liability of approximately $2.7 million for the difference between its net property, plant and equipment for income tax purposes and financial reporting purposes. The current portion of the deferred tax assets represents the portion of the net operating loss carryforwards that we expect to utilize in 2006. The net impact of eliminating the valuation allowance is reflected as an income tax benefit on the statement of operations for the year ended December 31, 2005.

Note 10:   Extraordinary Item

On March 28, 2003, the Company had an accidental fire at the Junction, Texas plant. The Company was given permission to begin demolition and the rebuilding of a portion of the production facility in April 2003. The initial restoration project, completed in May 2003, included the rebuild of one extrusion line that had been partially damaged, electrical system replacement, and roof replacement. The rebuild of the second extrusion line was completed in April 2004. The Junction plant is fully insured for fire damage and business interruption. Through December 31, 2004 and 2003, the Company had received $6.0 million and $5.4 million, respectively, in insurance proceeds related to this incident.

Due to the Junction facility fire, gross assets were written down by approximately $4.91 million, along with the associated accumulated depreciation on those assets in the amount of $3.96 million, resulting in a net book value decrease in assets of about $950,000. At December 31, 2004 and 2003, approximately $6.4 million and $3.9 million, respectively, had been invested in reconstructing the Junction facility. Insurance proceeds received to reimburse costs incurred to reconstruct the facility resulted in gains of $173,536 and $2,962,041 for the years ended December 31, 2004 and 2003, respectively. Additionally, the Company recorded $11,213 in business interruption insurance during 2004, including $8,720 to replace lost income and $2,493 to cover fixed expenses. During 2003, the Company recorded $1,366,682 in business interruption insurance, including $1,125,372 to replace lost income and $241,310 to cover fixed expense.

F-27

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

Note 11:   Commitments and Contingencies

Lloyd’s London

We have been sued by certain underwriters at Lloyd’s, London (“Lloyd’s”) in connection with a pending final settlement of our Junction, Texas fire claim. Lloyd’s filed suit January 19, 2005 in the Circuit Court of Washington County, Arkansas seeking a declaratory judgment that they are not liable to reimburse us for certain costs of rebuilding the AERT Junction, Texas facility. Lloyd’s alleges that we did not rebuild the facility exactly as it had existed prior to the March 2003 fire and seeks to retroactively cancel its portion of the insurance policy. The filing was unexpected by us because we cooperated fully with the claims underwriting process and believed that negotiations toward a final settlement of the claim were progressing.

We believe the Lloyd’s lawsuit is without merit. We filed a counterclaim on January 24, 2005 denying all of Lloyd’s allegations and seeking immediate and full reimbursement for rebuilding of the Junction plant. We seek to recover actual damages in the amount of at least $2.4 million plus attorney and court fees and punitive damages for acts of bad faith committed by Lloyd’s.

The parties participated in an unsuccessful court-ordered mediation on March 13, 2006. The matter will now go to trial, though a trial date has not yet been set by the court.

Advanced Control Solutions

On March 3, 2006, a Benton County Circuit Court jury found AERT liable for $655,769 in damages to Advanced Control Solutions (“ACS”) for future business opportunities that ACS alleges it lost when AERT discontinued using ACS programming and electrical contractor services and for missing equipment. The jury found that AERT also interfered with certain non-compete provisions of an employment agreement between ACS and an employee by hiring the employee after he had been terminated by ACS in December 2003. The jury also awarded AERT judgment against ACS for approximately $45,000 for ACS’s failure to complete a programming contract.

We intend to file motions requesting the Judge to set aside the verdicts against AERT as not being supported by the law and facts. If the motions are not granted, AERT will appeal the jury verdicts to the Arkansas Court of Appeals.

Other Matters

AERT is involved in other litigation arising from the normal course of business. In management’s opinion, this litigation is not expected to materially impact the Company’s results of operations or financial condition.

Note 12:   Segment Information

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

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

•  Whose operating results are regularly reviewed by the enterprise’s chief operating decision maker,

•  For which discrete financial information is available.

F-28

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS — (Continued)

As of December 31, 2005, the Company does not have available discrete financial information to disclose gross margin by product line. All operating expenses are allocated primarily on capacity. Corporate overhead is not allocated by product line, neither are selected assets. Net sales segregated by product line and gross margin by plant location are as follows:

	Year Ended December 31,
	2005		2004		2003
Net Sales —
Commercial and residential decking surface components	$	73,361,707	$	51,885,985	$	35,646,315
Exterior door, window, and housing trim components		13,950,853		11,751,300		7,874,248
	$	87,312,560	$	63,637,285	$	43,520,563

	Year Ended December 31,
	2005				2004				2003
	Springdale		Junction		Springdale		Junction		Springdale		Junction
Gross Margin —
Net revenues	$	67,823,259	$	19,489,301	$	47,902,106	$	15,735,179	$	34,203,234	$	9,317,329
Cost of goods sold		50,661,941		15,728,023		35,883,623		13,079,543		26,779,482		7,582,502
Gross margin	$	17,161,318	$	3,761,278	$	12,018,483	$	2,655,636	$	7,423,752	$	1,734,827

Note 13:   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. Profit sharing contributions to the Plan can range from 0% to 15% of participants’ annual compensation. The Company has never made any matching or profit sharing contributions to the Plan.

Note 14:   Subsequent Events

During the first quarter of 2006, we entered into a new $15.0 million bank line of credit, replacing the factoring arrangement with Brooks Investment Co. that is currently in use. The line is a one year revolving credit facility maturing January 7, 2007, secured by our inventory, accounts receivable, chattel paper, general intangibles and other current assets, as well as by fixtures and equipment, and is provided by Liberty Bank of Arkansas at a variable interest rate of prime plus one hundred basis points. The maximum amount that may be drawn on the line at any one time is $15.0 million. The full amount of the line is guaranteed as to payment by our largest stockholder, Marjorie Brooks. The credit facility includes debt service coverage ratio, current ratio, and accounts payable and accounts receivable aging covenants substantially similar to those under our 2003 bond agreements and customary restrictions on dividends and the incurrence of additional debt or liens, among other matters.

F-29

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
	3	.2	Certificate of Designation of Class B common stock. (a)
	3	.3	Bylaws of Registrant. (a)
	3	.4	Form of Class A common stock Certificate. (c)
	4	.2	Form of Class B common stock Certificate. (a)
	4	.8	Form of Class C Warrant Certificate. (h)
	4	.9	Form of Class D Warrant Certificate. (h)
	4	.10	Form of Class E Warrant Certificate. (h)
	4	.11	Form of Class F Warrant Certificate. (i)
	4	.12	Form of Class G Warrant Certificate. (i)
	4	.13	Form of Class H Warrant Certificate. (j)
	4	.14	Form of Class I Warrant Certificate. (j)
	4	.15	Form of Class J Warrant Certificate. (j)
	4	.16	Form of Class K Warrant Certificate. (j)
	10	.1	Private Placement Agreement. (l)
	10	.2	Consulting Agreement. (l)
	10	.3	Note Purchase Agreement. (l)
	10	.4	Form of Notes. (l)
	10	.5	Form of Private Placement Warrants. (l)
	10	.6	Form of Consulting Warrants. (l)
	10	.9	Form of Right of Refusal Agreement among Class B common stockholders. (a)
	10	.10	1989 Stock Option plan. (a)
	10	.11	Form of Escrow Agreement with American Stock Transfer & Trust Company. (c)
	10	.15	Lease Agreement dated June 1, 1990 between the Registrant and J’s Feed, Inc. for the Registrant’s plastics reclamation facility. (e)
	10	.18	Loan Agreement with City of Rogers, arranged through Arkansas Industrial Development Commission. (f)
	10	.19	Lease Agreement dated June 15, 1992 between the Registrant and George’s, Inc. for the Registrant’s corporate office facility. (g)
	10	.20	Factoring Agreement dated April 30, 1993 between the Registrant and Brooks Investment Company. (g)
	10	.21	Private Placement Distribution Agreement dated September 23, 1993 between the Registrant and Berkshire International Finance, Inc. (g)
	10	.22	Lease Agreement dated June 16, 1994 between Registrant and Marjorie S. Brooks. (i)
	10	.27	Line of Credit Promissory Note payable to Jim G. Brooks and Marjorie S. Brooks. (i)
	10	.28	Amended and Restated Stock Option Plan. (i)
	10	.29	Non-Employee Director Stock Option Plan. (i)
	10	.30	Chairman Stock Option Plan. (i)
	10	.31	Factoring Agreement dated April 30, 1994 between the Registrant and Brooks Investment Company.(i)
	10	.32	Lease agreement dated July 29, 1997 between Registrant and Dwain A. Newman, et ux., and National Home Center, Inc. (k)
	10	.33	Securities Purchase Agreement. (m)
	10	.34	Certificate of Designation of Series A Preferred Convertible Stock. (m)

Exhibit
No.			Description of Exhibit
	10	.35	Certificate of Designation of Series B Preferred Convertible Stock. (m)
	10	.36	Certificate of Designation of Series C Preferred Convertible Stock. (m)
	10	.37	Form of Series X Warrants. (m)
	10	.38	Form of Series Y Warrants. (m)
	10	.39	Registration Rights Agreement. (m)
	10	.40	Placement Agency Agreement. (m)
	10	.41	Indenture of Trust between City of Springdale and Regions Bank, Trustee, as of October 1, 2003. (n)
	10	.42	Mortgage and Loan Agreement between City of Springdale and Company, as of October 1, 2003.(n)
	10	.43	Assignment of Mortgage and Loan Agreement between City of Springdale and Regions Bank. (n)
	10	.44	Note Purchase Agreement between Company and Allstate Insurance Company dated October 9, 2003. (n)
	10	.45	Promissory Note made by Company dated October 9, 2003. (n)
	10	.46	Wood-Plastic Composite Decking Agreement between AERT and Weyerhaeuser Company, et al. effective October 12, 2004.* (Redacted in accordance with confidential treatment request, as filed October 18, 2005) (o) (p)
	10	.46.1	Wood-Plastic Composite Decking Agreement between AERT and Weyerhaeuser Company, et al. effective October 12, 2004.* (Redacted in accordance with confidential treatment request, as filed October 15, 2005) (q)
	10	.47	Loan Agreement. (r)
	10	.48	Promissory Note. (r)
	10	.49	Loan Agreement.***
	10	.50	Promissory Note.***
	23	.1	Accountant’s Consent. ***
	31	.1	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, by the Company’s chairman, co-chief executive officer and president. ***
	31	.2	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, by the Company’s co-chief executive officer. ***
	31	.3	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, by the Company’s chief financial officer. ***
	32	.1	Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, by the Company’s chairman, co-chief executive officer and president. ***
	32	.2	Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, by the Company’s co-chief executive officer. ***
	32	.3	Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, by the Company’s chief financial officer. ***

*	Confidential treatment was granted by the Securities and Exchange Commission for certain portions of this agreement. The confidential portions were filed separately with the Commission.
	The Registrant has no exhibits corresponding to Exhibits 1, 2, 5, 6, 7, 8, 9, 11, through 23, or 26 through 29.
***	Filed herewith.
(a)	Contained in Exhibits to Registration Statement on Form S-1, No. 33-29595, filed June 28, 1989.
(b)	Contained in Exhibits to Amendment No. 1 to Registration Statement on Form S-1, No. 33-29595, filed August 24, 1989.
(c)	Contained in Exhibits to Amendment No. 2 to Registration Statement on Form S-1, No. 33-29595, filed November 8, 1989.
(d)	Filed with Form 10-K for December 31, 1989.
(e)	Filed with Form 10-K for December 31, 1990.

(f)	Contained in Exhibits to Post Effective Amendment No. 1 to Registration Statement on Form S-1, No. 33-29593, filed December 24, 1991.
(g)	Filed with Form 10-K for December 31, 1992.
(h)	Filed with Form 10-K for December 31, 1994.
(j)	Filed with Form 10-K for December 31, 1996. [EX-4.13, 4.14, 4.15, and 4.16]
(k)	Filed with Form 10-K for December 31, 1997. [EX-10.32]
(l)	Contained in Exhibits to Registration Statement on Form S-3, No. 333-42555 filed December 18, 1997. [EX-10.1, 10.2, 10.3, 10.4, 10.5, 10.6]
(m)	Filed with Form 10-K for December 31, 1998. [EX-10.33, 10.34, 10.35, 10.36, 10.37, 10.38, 10.39 and 10.40]
(n)	Filed with Form 10-Q for September 30, 2003.
(o)	Filed with Form 10-Q for September 30, 2004.
(p)	Filed with Form 10-Q for June 30, 2005.
(q)	Filed with Form 10-Q/A for September 30, 2004.
(r)	Filed with Form 10-Q for September 30, 2005.

EX-10.49

Exhibit 10.49

LOAN AGREEMENT

Dated as of January 16, 2006

between

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

a Delaware corporation

and

LIBERTY BANK OF ARKANSAS

LOAN AGREEMENT

     THIS LOAN AGREEMENT (the “Agreement”), dated as of January 16, 2006, is between ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC., a Delaware corporation (the “Borrower”), and LIBERTY BANK OF ARKANSAS, an Arkansas state chartered bank (the “Lender”).

RECITALS:

     The Borrower has requested that the Lender extend credit to the Borrower as described in this Agreement. The Lender is willing to make such credit available to the Borrower upon and subject to the provisions, terms and conditions hereinafter set forth.

     NOW THEREFORE, in consideration of the premises and the mutual covenants herein contained, the parties hereto agree as follows:

ARTICLE I
DEFINITIONS

     1.1 Definitions. As used in this Agreement, all exhibits, appendices and schedules hereto and in any note, certificate, report or other Loan Documents made or delivered pursuant to this Agreement, the following terms will have the meanings given such terms in this Section 1 or in the provision, section or recital referred to below:

          (a) “AAA” has the meaning for such term set forth in Section 11.20 of the Agreement.

          (b) “Adjusted EBITDA” means an amount equal to (i) EBITDA less (ii) taxes minus the sum of distributions, dividends and maintenance capital expenditures.

          (c) “Advance” means an advance by the Lender to the Borrower pursuant to Article II.

          (d) “Advance Request Form” means a certificate, in a form approved by the Lender, properly completed and signed by the Borrower requesting a Revolving Credit Advance.

          (e) “Affiliate” means, as to any Person, any other Person (i) that directly or indirectly, through one or more intermediaries, controls or is controlled by, or is under common control with, such Person; (ii) that directly or indirectly beneficially owns or holds five percent (5%) or more of any class of voting stock of such Person; or (iii) five percent (5%) or more of the voting stock of which is directly or indirectly beneficially owned or held by the Person in question. The term “control” means the possession, directly or indirectly, of the power to direct or cause direction of the management and policies of a Person, whether through the ownership of voting securities, by contract, or otherwise; provided, however, in no event shall the Lender be deemed an Affiliate of the Borrower.

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          (f) “Agreement” has the meaning set forth in the Introductory Paragraph hereto, as the same may, from time to time, be amended, modified, restated, renewed, waived, supplemented, or otherwise changed, and includes all schedules, exhibits and appendices attached or otherwise identified therewith.

          (g) “Borrowing Base” means, at any time, an amount equal to the sum of (i) eighty-five percent (85%) of the value of Eligible Accounts of which Weyerhaeuser Company (“Weyerhaeuser”) is the account debtor, (ii) eighty-five percent (85%) of the value of Eligible Accounts of which Therma-Tru Corporation (“Therma-Tru”) is the account debtor, (iii) seventy-five percent (75%) of all other Eligible Accounts, (iv) seventy-five percent (75%) of the value of Eligible Inventory that constitutes finished goods, including Eligible Inventory that is finished goods held in a Therma-Tru warehouse, and (v) fifty percent (50%) of all other Eligible Inventory.

          (h) “Borrowing Base Report” means, as of any date of preparation, a certificate setting forth the Borrowing Base (in a form acceptable to the Lender in substantially the form of Exhibit A attached hereto) prepared by and certified by the chief financial officer of the Borrower.

          (i) “Borrower” means the Person identified as such in the Introductory Paragraph hereof, and its successors and assigns.

          (j) “Business Day” has the meaning assigned to it in the Note.

          (k) “Capital Expenditure” shall mean any expenditure by a Person for (i) an asset which will be used in a year or years subsequent to the year in which the expenditure is made and which asset is properly classified in relevant financial statements of such Person as equipment, real property, a fixed asset or a similar type of capitalized asset in accordance with GAAP or (ii) an asset relating to or acquired in connection with an acquired business, and any and all acquisition costs related to (i) or (ii) above.

          (l) “Capitalized Lease Obligation” shall mean the amount of Debt under a lease of Property by a Person that would be shown as a liability on a balance sheet of such Person prepared for financial reporting purposes in accordance with GAAP.

          (m) “Code” means the Internal Revenue Code of 1986, as amended, and the regulations promulgated and rulings issued thereunder.

          (n) “Collateral” has the meaning for such term set forth in Section 4.1 of this Agreement.

          (o) “Commitment” means the obligation of the Lender to make Revolving Credit Advances pursuant to Section 2.1 in an aggregate principal amount at any time outstanding up to but not exceeding Fifteen Million and no/100 Dollars ($15,000,000.00), subject, however, to termination pursuant to Section 10.2.

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          (p) “Compliance Certificate” means a certificate, substantially in the form of Exhibit B attached hereto, prepared by and executed by the chief financial officer of the Borrower.

          (q) “Constituent Documents” means Borrower’s articles or certificate of incorporation and bylaws.

          (r) “Consultant” means a firm or firms designated in a certificate of the Borrower which is not, and no member, stockholder, director, officer, trustee or employee of which is, an officer, director, trustee or employee of the Borrower, and which is a professional management consultant of national repute for having the skill and experience necessary to render the particular report required by the Section 9.1 herein.

          (s) “Current Maturities of Long-Term Indebtedness” shall mean, in respect of a Person and as of any applicable date of determination thereof, that portion of Long-Term Indebtedness that should be classified as current in accordance with GAAP.

          (t) “Current Ratio” means the ratio of current assets to current liabilities. For purposes of calculating the Current Ratio, Borrower may include as a current asset that certain Two Million and No/100 Dollars ($2,000,000.00) debt service reserve fund created in connection with Borrower’s bond indebtedness with Allstate Insurance Company.

          (u) “Debt” means as to any Person at any time (without duplication): (i) all obligations of such Person for borrowed money, (ii) all obligations of such Person evidenced by bonds, notes, debentures, or other similar instruments, (iii) all obligations of such Person to pay the deferred purchase price of property or services, except trade accounts payable of such Person arising in the ordinary course of business that are not past due by more than ninety (90) days, (iv) all Capital Lease Obligations of such Person, (v) all Debt or other obligations of others Guaranteed by such Person, (vi) all obligations secured by a Lien existing on property owned by such Person, whether or not the obligations secured thereby have been assumed by such Person or are non-recourse to the credit of such Person, (vii) any other obligation for borrowed money or other financial accommodations which in accordance with GAAP would be shown as a liability on the balance sheet of such Person, (viii) any repurchase obligation or liability of a Person with respect to accounts, chattel paper or notes receivable sold by such Person, (ix) any liability under a sale and leaseback transaction that is not a Capital Lease Obligation, (x) any obligation under any so called “synthetic leases”, (xi) any obligation arising with respect to any other transaction that is the functional equivalent of borrowing but which does not constitute a liability on the balance sheets of a Person, (xii) all reimbursement obligations of such Person (whether contingent or otherwise) in respect of letters of credit, bankers’ acceptances, surety or other bonds and similar instruments, and (xiii) all liabilities of such Person in respect of unfunded vested benefits under any Plan.

          (v) “Debt Service Coverage Ratio” shall mean, in respect of a Person and for any period of determination, the ratio, computed on a rolling four quarter basis, of (i) Adjusted EBITDA to (ii) Current Maturities of Long-Term Indebtedness plus interest expense.

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          (w) “Default” means an Event of Default or the occurrence of an event or condition which with notice or lapse of time or both would become an Event of Default.

          (x) “Default Interest Rate” has the meaning assigned to it in the Notes.

          (y) “Dispute” means any action, dispute, claim or controversy of any kind, whether in contract or tort, statutory or common law, legal or equitable, now existing or hereafter arising under or in connection with, or in any way pertaining to, this Agreement and each other document, contract and instrument required hereby or now or hereafter delivered to Lender in connection herewith, or any past, present or future extensions of credit and other activities, transactions or obligations of any kind related directly or indirectly to any of the foregoing documents, including without limitation, any of the foregoing arising in connection with the exercise of any self-help, ancillary or other remedies pursuant to any of the foregoing documents.

          (z) “Disclosure Schedule” means the schedule of the same name attached hereto.

          (aa) “Dollars” and “$” mean lawful money of the United States of America.

          (bb) “EBITDA” means an amount equal to net income plus the sum of interest, taxes, depreciation and amortization.

          (cc) “Eligible Accounts” means, at any time, all accounts receivable of the Borrower created in the ordinary course of business that are acceptable to the Lender and satisfy the following conditions:

               (i) The account complies with all applicable laws, rules, and regulations, including, without limitation, usury laws, the Federal Truth in Lending Act, and Regulation Z of the Board of Governors of the Federal Reserve System;

               (ii) The account has not been outstanding for more than the lesser of (1) sixty (60) days past the date the invoice was issued or the underlying obligation was incurred and (2) thirty (30) days past the first date the account was due;

               (iii) The account does not represent a commission and the account was created in connection with (i) the sale of goods by the Borrower in the ordinary course of business and such sale has been consummated and such goods have been shipped and delivered and received by the account debtor (except for goods that are normally and ordinarily shipped by rail, and which are freight-on-board shipping point), or (ii) the performance of services by the Borrower in the ordinary course of business and such services have been completed and accepted by the account debtor;

               (iv) The account arises from an enforceable contract, the performance of which has been completed by the Borrower;

               (v) The account does not arise from the sale of any good that is on a guaranteed sale, sale-or-return, sale on approval, consignment, or any other repurchase or return basis;

4

               (vi) The Borrower has good and indefeasible title to the account and the account is not subject to any Lien except Liens in favor of the Lender (except for any permitted liens identified on the Disclosure Schedule);

               (vii) The account does not arise out of a contract with or order from, an account debtor that, by its terms, prohibits or makes void or unenforceable the grant of a security interest by the Borrower to the Lender in and to such account;

               (viii) The account is not subject to any setoff, counterclaim, defense, dispute, recoupment, or adjustment other than normal discounts for prompt payment;

               (ix) The account debtor is not insolvent or the subject of any bankruptcy or insolvency proceeding and has not made an assignment for the benefit of creditors, suspended normal business operations, dissolved, liquidated, terminated its existence, ceased to pay its debts as they become due, or suffered a receiver or trustee to be appointed for any of its assets or affairs;

               (x) The account is not evidenced by chattel paper or an instrument;

               (xi) No default exists under the account by any party thereto;

               (xii) The account debtor has not returned or refused to retain, or otherwise notified the Borrower of any dispute concerning, or claimed nonconformity of, any of the goods from the sale of which the account arose;

               (xiii) The account is not owed by an Affiliate, employee, officer, director or shareholder of the Borrower;

               (xiv) The account is payable in Dollars by the account debtor;

               (xv) The account is not owed by an account debtor whose accounts the Lender in its sole discretion has chosen to exclude from Eligible Accounts;

               (xvi) The account shall be ineligible if the account debtor is domiciled in any country other than the United States of America, Mexico, or Canada;

               (xvii) The account shall be ineligible if the account debtor is the United States of America or any department, agency, or instrumentality thereof, and the Federal Assignment of Claims Act of 1940, as amended, shall not have been complied with; and

               (xviii) The Account is otherwise acceptable in the sole good faith discretion of the Lender; provided that the Lender shall have the right to create and adjust eligibility standards and related reserves from time to time in its good faith credit judgment.

     The amount of the Eligible Accounts owed by an account debtor to the Borrower shall be reduced by the amount of all “contra accounts” and other obligations owed by the Borrower to such account debtor.

5

          (dd) “Eligible Inventory” means, at any time, or unless otherwise stated in this Agreement, all inventory of raw materials, work in process and finished goods then owned by (and in the possession or under the control of) the Borrower and held for sale or disposition in the ordinary course of the Borrower’s business, in which the Lender has a perfected, first priority security interest, valued at the lower of actual cost or fair market value. Except as otherwise provided in this Agreement, Eligible Inventory shall not include (i) inventory that has been shipped or delivered to a customer on consignment, a sale-or-return basis, or on the basis of any similar understanding, (ii) inventory with respect to which a claim exists disputing the Borrower’s title to or right to possession of such inventory, (iii) inventory that is not in good condition or does not comply with any applicable law, rule, or regulation or any standard imposed by any Governmental Authority with respect to its manufacture, use, or sale, (iv) inventory that is damaged, obsolete or otherwise not readily saleable, (v) inventory covered by negotiable warehouse or other document of title (unless the same is in the possession of the Lender); (vi) inventory held for rental or lease, (vii) inventory that the Lender, in its sole discretion, has determined to be unmarketable, (viii) inventory subject to third-party intellectual property agreements and (ix) inventory that requires consent of a third-party for manufacture or sale.

          (ee) “Environmental Laws” means any and all federal, state, and local laws, regulations, judicial decisions, orders, decrees, plans, rules, permits, licenses, and other governmental restrictions and requirements pertaining to health, safety, or the environment, including, without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, 42 U.S.C. § 9601 et seq., the Resource Conservation and Recovery Act of 1976, 42 U.S.C. § 6901 et seq., the Occupational Safety and Health Act, 29 U.S.C. § 651 et seq., the Clean Air Act, 42 U.S.C. § 7401 et seq., the Clean Water Act, 33 U.S.C. § 1251 et seq., and the Toxic Substances Control Act, 15 U.S.C. § 2601 et seq., as the same may be amended or supplemented from time to time.

          (ff) “Environmental Liabilities” means, as to any Person, all liabilities, obligations, responsibilities, Remedial Actions, losses, damages, punitive damages, consequential damages, treble damages, costs, and expenses, (including, without limitation, all reasonable fees, disbursements and expenses of counsel, expert and consulting fees and costs of investigation and feasibility studies), fines, penalties, sanctions, and interest incurred as a result of any claim or demand, by any Person, whether based in contract, tort, implied or express warranty, strict liability, criminal or civil statute, including any Environmental Law, permit, order or agreement with any Governmental Authority or other Person, arising from environmental, health or safety conditions or the Release or threatened Release of a Hazardous Material into the environment, resulting from the past, present, or future operations of such Person or its Affiliates.

          (gg) “ERISA” means the Employee Retirement Income Security Act of 1974, as amended from time to time, and the regulations and published interpretations thereunder.

          (hh) “ERISA Affiliate” means any corporation or trade or business which is a member of the same controlled group of corporations (within the meaning of Section 414(b) of the Code) as the Borrower or is under common control (within the meaning of Section 414(c) of the Code) with the Borrower.

6

          (ii) “Event of Default” has the meaning specified in Section 10.1.

          (jj) “Funded Debt” means Debt described in clauses (i), (ii), (iv), (vii), (ix), (x) and (xi) of the definition of “Debt.”

          (kk) “GAAP” means generally accepted accounting principles, applied on a consistent basis, as set forth in Opinions of the Accounting Principles Board of the American Institute of Certified Public Accountants and/or in statements of the Financial Accounting Standards Board and/or their respective successors and which are applicable in the circumstances as of the date in question. Accounting principles are applied on a “consistent basis” when the accounting principles applied in a current period are comparable in all material respects to those accounting principles applied in a preceding period.

          (ll) “Governmental Authority” means any nation or government, any state or political subdivision thereof and any entity exercising executive, legislative, judicial, regulatory, or administrative functions of or pertaining to government.

          (mm) “Guarantee” by any Person means any obligation, contingent or otherwise, of such Person directly or indirectly guaranteeing any Debt or other obligation of any other Person as well as any obligation or liability, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt or other obligation or liability (whether arising by virtue of partnership arrangements, by agreement to keep-well, to purchase assets, goods, securities or services, to operate Property, to take-or-pay, or to maintain net worth or working capital or other financial statement conditions or otherwise) or (ii) entered into for the purpose of indemnifying or assuring in any other manner the obligee of such Debt or other obligation or liability of the payment thereof or to protect the obligee against loss in respect thereof (in whole or in part), provided that the term Guarantee shall not include endorsements for collection or deposit in the ordinary course of business. The term “Guarantee” used as a verb has a corresponding meaning.

          (nn) “Guarantor” means any Person who from time to time guarantees all or any part of the Obligations, including Marjorie S. Brooks.

          (oo) “Guaranty” means a written guaranty of each Guarantor in favor of the Lender, in form and substance satisfactory to Lender, as the same may be amended, modified, restated, renewed, replaced, extended, supplemented or otherwise changed from time to time.

          (pp) “Hazardous Material” means any substance, product, waste, pollutant, material, chemical, contaminant, constituent, or other material which is or becomes listed, regulated, or addressed under any Environmental Law, including, without limitation, asbestos, petroleum, and polychlorinated biphenyls.

          (qq) “Leverage Ratio” means, at any particular time, the ratio of Consolidated Liabilities to Consolidated Tangible Net Worth.

          (rr) “Liabilities” means, at any particular time, all amounts which, in conformity with GAAP, would be included as liabilities on a balance sheet of a Person.

7

          (ss) “Lien” means any lien, mortgage, security interest, tax lien, pledge, charge, hypothecation, assignment, preference, priority, or other encumbrance of any kind or nature whatsoever (including, without limitation, any conditional sale or title retention agreement), whether arising by contract, operation of law, or otherwise.

          (tt) “Loan Documents” means this Agreement and all promissory notes, security agreements, deeds of trust, assignments, letters of credit, guaranties, and other instruments, documents, and agreements executed and delivered pursuant to or in connection with this Agreement, as such instruments, documents, and agreements may be amended, modified, renewed, restated, extended, supplemented, replaced, consolidated, substituted, or otherwise changed from time to time.

          (uu) “Long-Term Indebtedness” shall mean, in respect of a Person and as of any applicable date of determination thereof, all Debt (other than the aggregate outstanding principal balance of the Revolving Credit Note) which should be classified as “funded indebtedness” or “long term indebtedness” on a balance sheet of such Person as of such date in accordance with GAAP and Long-Term Indebtedness includes Capital Lease Obligations.

          (vv) “Maximum Lawful Rate” means, at any time, the maximum rate of interest which may be charged, contracted for, taken, received or reserved by the Lender in accordance with applicable Arkansas law (or applicable United States federal law to the extent that such law permits Lender to charge, contract for, receive or reserve a greater amount of interest than under Arkansas law). The Maximum Lawful Rate shall be calculated in a manner that takes into account any and all fees, payments, and other charges in respect of the Loan Documents that constitute interest under applicable law. Each change in any interest rate provided for herein based upon the Maximum Lawful Rate resulting from a change in the Maximum Lawful Rate shall take effect without notice to the Borrower at the time of such change in the Maximum Lawful Rate.

          (ww) “Multiemployer Plan” means a multiemployer plan defined as such in Section 3(37) of ERISA to which contributions have been made by the Borrower or any ERISA Affiliate and which is covered by Title IV of ERISA.

          (xx) “Note” means any promissory note executed at any time by the Borrower and payable to the order of the Lender, as amended, renewed, replaced, extended, supplemented, consolidated, restated, modified, otherwise changed and/or increased from time to time.

          (yy) “Obligated Party” means the Guarantor or any other Person who is or becomes party to any agreement that guarantees or secures payment and performance of the Obligations or any part thereof.

          (zz) “Obligations” means all obligations, indebtedness, and liabilities of the Borrower, each Guarantor and any other Obligated Party to the Lender or Affiliates of the Lender, or both, now existing or hereafter arising, whether direct, indirect, related, unrelated, fixed, contingent, liquidated, unliquidated, joint, several, or joint and several, including, without limitation, the obligations, indebtedness, and liabilities under this Agreement, any Swap Contract, the other Loan Documents, any cash management or treasury services agreements and

8

all interest accruing thereon (whether a claim for post-filing or post-petition interest is allowed in any insolvency, reorganization or similar proceeding) and all attorneys’ fees and other expenses incurred in the enforcement or collection thereof.

          (aaa) “Operating Lease” means any lease (other than a lease constituting a Capital Lease Obligation) of real or personal Property.

          (bbb) “PBGC” means the Pension Benefit Guaranty Corporation or any entity succeeding to all or any of its functions under ERISA.

          (ccc) “Person” means any individual, corporation, limited liability company, business trust, association, company, partnership, joint venture, Governmental Authority, or other entity, and shall include such Person’s heirs, administrators, personal representatives, executors, successors and assigns.

          (ddd) “Plan” means any employee benefit or other plan established or maintained by the Borrower or any ERISA Affiliate and which is covered by Title IV of ERISA.

          (eee) “Principal Office” means the principal office of the Lender, presently located at 4706 South Thompson, Suite 101, Springdale, Arkansas 72764.

          (fff) “Prohibited Transaction” means any transaction set forth in Section 406 of ERISA or Section 4975 of the Code.

          (ggg) “Property” of a Person means any and all property, whether real, personal, tangible, intangible or mixed, of such Person, or any other assets owned, operated or leased by such Person.

          (hhh) “Related Indebtedness” has the meaning set forth in Section 11.21 of this Agreement.

          (iii) “Release” means, as to any Person, any release, spill, emission, leaking, pumping, injection, deposit, disposal, disbursement, leaching, or migration of Hazardous Materials into the indoor or outdoor environment or into or out of property owned by such Person, including, without limitation, the movement of Hazardous Materials through or in the air, soil, surface water, ground water, or property.

          (jjj) “Remedial Action” means all actions required to (i) clean up, remove, treat, or otherwise address Hazardous Materials in the indoor or outdoor environment, (ii) prevent the Release or threat of Release or minimize the further Release of Hazardous Materials so that they do not migrate or endanger or threaten to endanger public health or welfare or the indoor or outdoor environment, or (iii) perform pre-remedial studies and investigations and post-remedial monitoring and care.

          (kkk) “Reportable Event” means any of the events set forth in Section 4043 of ERISA.

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          (lll) “Revolving Credit Advance” means any Advance made by the Lender to the Borrower pursuant to Section 2.1(a) of this Agreement.

          (mmm) “Revolving Credit Note” means the promissory note of the Borrower payable to the order of the Lender, in substantially the form of Exhibit C hereto, and all amendments, extensions, renewals, replacements, and modifications thereof.

          (nnn) “Security Agreement” means the Security Agreement of the Borrower in favor of the Lender, in form and substance satisfactory to the Lender, as the same may be amended, restated, supplemented, modified, or changed from time to time.

          (ooo) “Security Documents” means each and every Security Agreement, Guaranty, pledge, mortgage, deed of trust or other collateral security agreement required by or delivered to the Lender from time to time to secure the Obligations or any portion thereof.

          (ppp) “Senior Funded Debt” means Funded Debt minus Subordinated Debt.

          (qqq) “Subordinated Debt” means any Debt of the Borrower (other than the Obligations) that has been subordinated to the Obligations by written agreement, in form and content satisfactory to the Lender.

          (rrr) “Subsidiary” means (i) any corporation of which at least a majority of the outstanding shares of stock having by the terms thereof ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether or not at the time stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time directly or indirectly owned or controlled by the Borrower or one or more of the Subsidiaries or by the Borrower and one or more of the Subsidiaries; and (ii) any other entity (1) of which at least a majority of the ownership, equity or voting interest is at the time directly or indirectly owned or controlled by one or more of the Borrower and the Subsidiaries and (2) which is treated as a subsidiary in accordance with GAAP.

          (sss) “Swap Contract” means any agreement (including related confirmations and schedules) between the Borrower and the Lender or any Affiliate of the Lender now existing or hereafter entered into which is, or relates to, a rate swap, basis swap, forward rate transaction, cap transaction, floor transaction, collar transaction or any other similar transactions (including any option with respect to any of these transactions) or any combination thereof.

          (ttt) “Tangible Net Worth” means, at any particular time, all amounts which, in conformity with GAAP, would be included as stockholders’ equity on a balance sheet of a Person; provided, however, there shall be excluded therefrom: (i) any amount at which the equity of such Person appears as an asset on such Person’s balance sheet, (ii) goodwill, including any amounts, however designated, that represent the excess of the purchase price paid for assets or stock over the value assigned thereto, (iii) patents, trademarks, trade names, and copyrights, (iv) deferred expenses, (v) loans and advances to any stockholder, director, officer, or employee of the Person or any Affiliate of Person, Borrower, and (vi) all other assets which are properly classified as intangible assets.

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          (uuu) “Termination Date” means 11:00 A.M. Springdale, Arkansas time on January 16, 2007, or such earlier date on which the Commitment terminates as provided in this Agreement.

          (vvv) “UCC” means the Uniform Commerce Code as enacted in any State or jurisdiction which may govern the liens and security interests granted to Lender, as amended from time to time.

          (www) “Working Capital” means, at any particular time, the amount by which Current Assets exceed Current Liabilities.

     1.2 Accounting Matters. Any accounting term used in this Agreement or the other Loan Documents shall have, unless otherwise specifically provided therein, the meaning customarily given such term in accordance with GAAP, and all financial computations thereunder shall be computed, unless otherwise specifically provided therein, in accordance with GAAP consistently applied; provided, that all financial covenants and calculations in the Loan Documents shall be made in accordance with GAAP as in effect on the date of this Agreement unless the Borrower and the Lender shall otherwise specifically agree in writing. That certain items or computations are explicitly modified by the phrase “in accordance with GAAP” shall in no way be construed to limit the foregoing.

     1.3 Other Definitional Provisions. All definitions contained in this Agreement are equally applicable to the singular and plural forms of the terms defined. The words “hereof”, “herein”, and “hereunder” and words of similar import referring to this Agreement refer to this Agreement as a whole and not to any particular provision of this Agreement. Unless otherwise specified, all Article and Section references pertain to this Agreement. Terms used herein that are defined in the UCC, unless otherwise defined herein, shall have the meanings specified in the UCC.

ARTICLE II
ADVANCES

     2.1 Revolving Credit Advances. Subject to the terms and conditions of this Agreement, the Lender agrees to make one or more Revolving Credit Advances to the Borrower from time to time from the date hereof to and including the Termination Date in an aggregate principal amount at any time outstanding up to but not exceeding the amount of the Commitment, provided that the aggregate amount of all Revolving Credit Advances at any time outstanding shall not exceed the lesser of (i) the amount of the Commitment or (ii) the Borrowing Base. Subject to the foregoing limitations, and the other terms and provisions of this Agreement, the Borrower may borrow, repay, and reborrow hereunder.

          (a) The Revolving Credit Note. The obligation of the Borrower to repay the Revolving Credit Advances and interest thereon shall be evidenced by the Revolving Credit Note executed by the Borrower, payable to the order of the Lender, in the principal amount of the Commitment as originally in effect, and dated the date hereof.

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          (b) Repayment of Revolving Credit Advances. The Borrower shall repay the unpaid principal amount of all Advances on the Termination Date, unless sooner due by reason of acceleration by the Lender as provided in this Agreement.

          (c) Interest. The unpaid principal amount of the Revolving Credit Note shall, subject to the following sentence, bear interest as provided in the Revolving Credit Note. If at any time the rate of interest specified in the Revolving Credit Note would exceed the Maximum Lawful Rate but for the provisions thereof limiting interest to the Maximum Lawful Rate, then any subsequent reduction shall not reduce the rate of interest on the Revolving Credit Advances below the Maximum Lawful Rate until the aggregate amount of interest accrued on the Revolving Credit Advances equals the aggregate amount of interest which would have accrued on the Revolving Credit Advances if the interest rate had not been limited by the Maximum Lawful Rate. Accrued and unpaid interest on the Revolving Credit Advances shall be payable as provided in the Revolving Credit Note and on the Termination Date.

          (d) Borrowing Procedure. The Borrower shall give the Lender notice of each Revolving Credit Advance by means of an Advance Request Form containing the information required therein and delivered (by hand or by mechanically confirmed facsimile) to the Lender no later than 1:00 p.m. (Springdale, Arkansas time) on the day on which the Revolving Credit Advance is desired to be funded. There shall not be a minimum amount for any advance hereunder. The Lender at its option may accept telephonic requests for such Advances, provided that such acceptance shall not constitute a waiver of the Lender’s right to require delivery of an Advance Request Form in connection with subsequent Advances. Any telephonic request for a Revolving Credit Advance by the Borrower shall be promptly confirmed by submission of a properly completed Advance Request Form to the Lender, but failure to deliver an Advance Request Form shall not be a defense to payment of the Advance. The Lender shall have no liability to the Borrower for any loss or damage suffered by the Borrower as a result of the Lender’s honoring of any requests, execution of any instructions, authorizations or agreements or reliance on any reports communicated to it telephonically, by facsimile or electronically and purporting to have been sent to the Lender by the Borrower and the Lender shall have no duty to verify the origin of any such communication or the identity or authority of the Person sending it. Subject to the terms and conditions of this Agreement, each Revolving Credit Advance shall be made available to the Borrower by depositing the same, in immediately available funds, in an account of the Borrower designated by an agent or representative of Borrower (such agent or representative being Bob Thayer, Steve Brooks, Doug Brooks, or Joe Brooks) maintained with the Lender at the Principal Office.

     2.2 General Provisions Regarding Interest; Etc.

          (a) Any outstanding principal of any Advance and (to the fullest extent permitted by law) any other amount payable by the Borrower under this Agreement or any other Loan Document that is not paid in full when due (whether at stated maturity, by acceleration, or otherwise) shall bear interest at the Default Interest Rate for the period from and including the due date thereof to but excluding the date the same is paid in full. Additionally, upon the occurrence of an Event of Default (and from the date of such occurrence) all outstanding and unpaid principal amounts of all of the Obligations shall, to the extent permitted by law, bear interest at the Default Interest Rate until such time as the Lender shall waive in writing the

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application of the Default Interest Rate to such Event of Default situation. Interest payable at the Default Interest Rate shall be payable from time to time on demand.

          (b) Interest on the Advances and all other amounts payable by the Borrower hereunder shall be computed on the basis of a year of 360 days and the actual number of days elapsed (including the first day but excluding the last day) unless such calculation would result in a usurious rate, in which case interest shall be calculated on the basis of a year of 365 or 366 days, as the case may be.

     2.3 Unused Facility Fee. [Intentionally omitted.]

     2.4 Use of Proceeds. The proceeds of the Revolving Credit Advances shall be used by the Borrower for working capital in the ordinary course of business.

ARTICLE III
PAYMENTS

     3.1 Method of Payment. All payments of principal, interest, and other amounts to be made by the Borrower under this Agreement and the other Loan Documents shall be made to the Lender at the Principal Office in Dollars and immediately available funds, without setoff, deduction, or counterclaim, and free and clear of all taxes at the time and in the manner provided in the Notes.

     3.2 Prepayments.

          (a) Voluntary Prepayments. The Borrower may prepay all or any portion of the Revolving Credit Note to the extent and in the manner provided for therein.

          (b) Mandatory Prepayment. The Borrower must pay on DEMAND the amount by which at any time the unpaid principal balance of the Revolving Credit Note exceeds the Borrowing Base.

     3.3 Lockbox and Account Collections. The Borrower will maintain under such written agreements as the Lender requires, as security for the Obligations, a lockbox (“Lockbox”) and depository account in the name of the Lender (“Depository Account”). All payments from account debtors of the Borrower will be deposited directly into the Depository Accounts, and the Lender is authorized to transfer to the Depository Account any funds which are account debtor payments but which have been deposited into any other depository account of the Borrower at the Lender. The Borrower agrees that the Lender will have all right, title and interest in and to all items and funds from time to time in the Depository Account. Checks received into the Depository Account will not be considered good funds until the Lender’s depository bank has effected final settlement with respect thereto by irrevocable credit to the Lender. The Lender is authorized to apply any and all funds in the Depository Account at any time, and from time to time, to the Obligations in any order the Lender may elect.

     Upon written notice to the Borrower from the Lender, the Borrower will advise all of its Account debtors to direct their payments to the Lockbox, at the address established by the

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Lockbox arrangements. All payments received into the Lockbox will be deposited into the Depository Account for disposition as set forth above in this section.

ARTICLE IV
SECURITY

     4.1 Collateral. To secure full and complete payment and performance of the Obligations, the Borrower shall execute and deliver or cause to be executed and delivered all of the Security Documents required by the Lender covering the Property and collateral described in such Security Documents (which, together with any other Property and collateral described in the Security Agreement, and any other property which may now or hereafter secure the Obligations or any part thereof, is sometimes herein called the “Collateral”). The Borrower shall execute and cause to be executed (or, to the extent applicable, hereby authorizes Lender to execute and/or file) such further documents and instruments, including without limitation, Uniform Commercial Code financing statements, as the Lender, in its sole discretion, deems necessary or desirable to create, evidence, preserve, and perfect its liens and security interests in the Collateral.

     4.2 Setoff. If an Event of Default shall have occurred and be continuing, the Lender shall have the right to set off and apply against the Obligations in such manner as the Lender may determine, at any time and without notice to the Borrower, any and all deposits (general or special, time or demand, provisional or final) or other sums at any time credited by or owing from the Lender to the Borrower whether or not the Obligations are then due. As further security for the Obligations, the Borrower hereby grants to the Lender a security interest in all money, instruments, and other property of the Borrower now or hereafter held by the Lender, including, without limitation, property held in safekeeping. In addition to the Lender’s right of setoff and as further security for the Obligations, the Borrower hereby grants to the Lender a security interest in all deposits (general or special, time or demand, provisional or final) and other accounts of the Borrower now or hereafter on deposit with or held by the Lender and all other sums at any time credited by or owing from the Lender to the Borrower. The rights and remedies of the Lender hereunder are in addition to other rights and remedies (including, without limitation, other rights of setoff) which the Lender may have.

ARTICLE V
CONDITIONS PRECEDENT

     5.1 Initial Extension of Credit. The obligation of the Lender to make the initial Advance under the Revolving Credit Note is subject to the condition precedent that the Lender shall have received on or before the day of such Advance all of the following, each dated (unless otherwise indicated) the date hereof, in form and substance satisfactory to the Lender:

          (a) Resolutions. Resolutions of the Board of Directors (or other governing body) of the Borrower certified by the Secretary or an Assistant Secretary (or other custodian of records) of the Borrower which authorize the execution, delivery, and performance by the Borrower of this Agreement and the other Loan Documents to which the Borrower is or is to be a party;

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          (b) Incumbency Certificate. A certificate of incumbency certified by an authorized officer or representative certifying the names of the individuals or other Persons authorized to sign this Agreement and each of the other Loan Documents to which the Borrower is or is to be a party (including the certificates contemplated herein) on behalf of the Borrower together with specimen signatures of such Persons;

          (c) Constituent Documents. The Constituent Documents for the Borrower as of a date acceptable to the Lender;

          (d) Governmental Certificates. Certificates of the appropriate government officials of the state of incorporation or organization of the Borrower as to the existence and good standing of the Borrower, each dated within ten (10) days prior to the date of the initial Advance;

          (e) Revolving Credit Note. The Revolving Credit Note executed by the Borrower;

          (f) Security Documents. The Security Documents executed by the Borrower and other Obligated Parties;

          (g) Financing Statements. Uniform Commercial Code financing statements covering such Collateral as the Lender may request;

          (h) Guaranty. The Guaranty executed by the Guarantor;

          (i) Landlord Waivers. Landlord waivers executed by any landlord of Borrower identified by Lender in its sole and reasonable discretion; provided, however, pending receipt by Lender of all such waiver and/or subordination agreements and provided that all other conditions herein have been satisfied, Lender may make Advances hereunder based on a Borrowing Base composed only of Eligible Accounts;

          (j) Insurance Matters. Copies of insurance certificates describing all insurance policies required by Section 7.5, together with loss payable and lender endorsements in favor of the Lender with respect to all insurance policies covering Collateral;

          (k) UCC Search. The results of a Uniform Commercial Code search showing all financing statements and other documents or instruments on file against the Borrower in the office of the Secretaries of State of Delaware, Arkansas, and any other jurisdiction deemed necessary in the discretion of Lender, such search to be as of a date no more than ten (10) days prior to the date of the initial Advance;

          (l) Opinion of Counsel. A favorable opinion of Hahn, Smith, Walsh & Mancuso, P.C., legal counsel to the Borrower and the Guarantor, as to such other matters as the Lender may reasonably request;

          (m) Attorneys’ Fees and Expenses. Evidence that the costs and expenses (including reasonable attorneys’ fees) referred to in Section 11.1, to the extent incurred, shall have been paid in full by the Borrower; and

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          (n) Additional Items. The additional items, if any, set forth on Schedule 5.1(n).

     5.2 All Extensions of Credit. The obligation of the Lender to make any Advance (including the initial Advance) is subject to the following additional conditions precedent:

          (a) Request for Advance. The Lender shall have received in accordance with this Agreement, as the case may be, an Advance Request Form pursuant to the Lender’s requirements dated the date of such Advance and executed by an authorized officer of the Borrower;

          (b) No Default, Etc. No Default or material adverse change or effect shall have occurred and be continuing, or would result from or after giving effect to such Advance or Letter of Credit;

          (c) Representations and Warranties. All of the representations and warranties contained in Article VI hereof and in the other Loan Documents shall be true and correct on and as of the date of such Advance with the same force and effect as if such representations and warranties had been made on and as of such date; and

          (d) Additional Documentation. The Lender shall have received such additional approvals, opinions, or documents as the Lender or its legal counsel may reasonably request.

ARTICLE VI
REPRESENTATIONS AND WARRANTIES

     To induce the Lender to enter into this Agreement, and except as set forth on the Disclosure Schedule, the Borrower represents and warrants to the Lender that:

     6.1 Corporate Existence. The Borrower (a) is a corporation duly organized, validly existing, and in good standing under the laws of the jurisdiction of its incorporation or formation; (b) has all requisite power and authority to own its assets and carry on its business as now being or as proposed to be conducted; and (c) is qualified to do business in all jurisdictions in which the nature of its business makes such qualification necessary and where failure to so qualify would have a material adverse effect on its business, condition (financial or otherwise), operations, prospects, or properties. The Borrower has the power and authority to execute, deliver, and perform its obligations under this Agreement and the other Loan Documents to which it is or may become a party.

     6.2 Financial Statements; Etc. The Borrower has delivered to the Lender audited financial statements of the Borrower as at and for the fiscal year ended December 31, 2004 and such other unaudited financial statements of the Borrower requested by Lender. Such financial statements are true and correct, have been prepared in accordance with GAAP, and fairly and accurately present the financial condition of the Borrower and its Subsidiaries as of the respective dates indicated therein and the results of operations for the respective periods indicated therein. The Borrower does not have any material contingent liabilities, liabilities for

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taxes, unusual forward or long-term commitments, or unrealized or anticipated losses from any unfavorable commitments except as referred to or reflected in such financial statements. There has been no material adverse change in the business, condition (financial or otherwise), operations, prospects, or properties of the Borrower since the effective date of the most recent financial statements referred to in this Section. All projections delivered by the Borrower to the Lender have been prepared in good faith, with care and diligence and use assumptions that are reasonable under the circumstances at the time such projections were prepared and delivered to the Lender and all such assumptions are disclosed in the projections.

     6.3 Action; No Breach. The execution, delivery, and performance by the Borrower of this Agreement and the other Loan Documents to which the Borrower is or may become a party and compliance with the terms and provisions hereof and thereof have been duly authorized by all requisite action on the part of the Borrower and do not and will not (a) violate or conflict with, or result in a breach of, or require any consent under (i) Constituent Documents of the Borrower, (ii) any applicable law, rule, or regulation or any order, writ, injunction, or decree of any Governmental Authority or arbitrator, or (iii) any agreement or instrument to which the Borrower is a party or by which any of them or any of their Properties is bound or subject, or (b) constitute a default under any such agreement or instrument, or result in the creation or imposition of any Lien upon any of the revenues or assets of the Borrower.

     6.4 Operation of Business. The Borrower possess all licenses, permits, franchises, patents, copyrights, trademarks, and tradenames, or rights thereto, necessary to conduct its business substantially as now conducted and as presently proposed to be conducted, and the Borrower is not in violation of any valid rights of others with respect to any of the foregoing.

     6.5 Litigation and Judgments. There is no action, suit, investigation, or proceeding before or by any Governmental Authority or arbitrator pending, or to the knowledge of the Borrower, threatened against or affecting the Borrower, that would, if adversely determined, have a material adverse effect on the business, condition (financial or otherwise), operations, prospects, or properties of the Borrower or the ability of the Borrower to pay and perform the Obligations. There are no outstanding judgments against the Borrower of the Borrower.

     6.6 Rights in Properties; Liens. The Borrower has good and indefeasible title to or valid leasehold interests in their respective Properties, including the Properties reflected in the financial statements described in Section 6.2, and none of the Properties of the Borrower or any Subsidiary is subject to any Lien, except as permitted by Section 8.2.

     6.7 Enforceability. This Agreement constitutes, and the other Loan Documents to which the Borrower is party, when delivered, shall constitute legal, valid, and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms, except as limited by bankruptcy, insolvency, or other laws of general application relating to the enforcement of creditors’ rights.

     6.8 Approvals. No authorization, approval, or consent of, and no filing or registration with, any Governmental Authority or third party is or will be necessary for the execution, delivery, or performance by the Borrower of this Agreement and the other Loan Documents to which the Borrower is or may become a party or the validity or enforceability thereof.

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     6.9 Debt. Except as identified on Schedule 6.9.1, the Borrower has no Debt.

     6.10 Taxes. The Borrower has filed all tax returns (federal, state, and local) required to be filed, including all income, franchise, employment, property, and sales tax returns, and has paid all of its respective liabilities for taxes, assessments, governmental charges, and other levies that are due and payable. The Borrower knows of no pending investigation of the Borrower by any taxing authority or of any pending but unassessed tax liability of the Borrower.

     6.11 Use of Proceeds; Margin Securities. The Borrower is not engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulations G, T, U, or X of the Board of Governors of the Federal Reserve System), and no part of the proceeds of any Advance will be used to purchase or carry any margin stock or to extend credit to others for the purpose of purchasing or carrying margin stock.

     6.12 ERISA. The Borrower is in compliance in all material respects with all applicable provisions of ERISA. Neither a Reportable Event nor a Prohibited Transaction has occurred and is continuing with respect to any Plan. No notice of intent to terminate a Plan has been filed, nor has any Plan been terminated. No circumstances exist which constitute grounds entitling the PBGC to institute proceedings to terminate, or appoint a trustee to administer, a Plan, nor has the PBGC instituted any such proceedings. Neither the Borrower nor any ERISA Affiliate has completely or partially withdrawn from a Multiemployer Plan. The Borrower and each ERISA Affiliate have met their minimum funding requirements under ERISA with respect to all of their Plans, and the present value of all vested benefits under each Plan do not exceed the fair market value of all Plan assets allocable to such benefits, as determined on the most recent valuation date of the Plan and in accordance with ERISA. Neither the Borrower nor any ERISA Affiliate has incurred any liability to the PBGC under ERISA.

     6.13 Disclosure. No statement, information, report, representation, or warranty made by the Borrower in this Agreement or in any other Loan Document or furnished to the Lender in connection with this Agreement, including any and all filings with the Securities and Exchange Commission, or any of the transactions contemplated hereby contains any untrue statement of a material fact or omits to state any material fact necessary to make the statements herein or therein not misleading. There is no fact known to the Borrower which has a material adverse effect, or which might in the future have a material adverse effect, on the business, condition (financial or otherwise), operations, prospects, or properties of the Borrower or any Subsidiary that has not been disclosed in writing to the Lender.

     6.14 Subsidiaries, Ventures, Etc. The Borrower has no Subsidiaries, Affiliates or joint ventures or partnerships other than those listed on the Disclosure Schedule and the Disclosure Schedule sets forth the jurisdiction of incorporation or organization of each such Person and the percentage of the Borrower’s ownership interest in such Person. All of the outstanding capital stock or other ownership interest of Person described in the Disclosure Schedule has been validly issued, is fully paid, and is nonassessable.

     6.15 Agreements. The Borrower is not a party to any indenture, loan, or credit agreement, or to any lease or other agreement or instrument, or subject to any charter or

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corporate or other organizational restriction which could have a material adverse effect on the business, condition (financial or otherwise), operations, prospects, or properties of the Borrower or any Subsidiary, or the ability of the Borrower to pay and perform its obligations under the Loan Documents to which it is a party. The Borrower is not in default in any respect in the performance, observance, or fulfillment of any of the obligations, covenants, or conditions contained in any agreement or instrument material to its business to which it is a party.

     6.16 Compliance with Laws. The Borrower is not in violation in any material respect of any law, rule, regulation, order, or decree of any Governmental Authority or arbitrator.

     6.17 Inventory. All inventory of the Borrower has been and will hereafter be produced in compliance with all applicable laws, rules, regulations, and governmental standards, including, without limitation, the minimum wage and overtime provisions of the Fair Labor Standards Act, as amended (29 U.S.C. §§ 201-219), and the regulations promulgated thereunder.

     6.18 Investment Company Act. The Borrower is not an “investment company” within the meaning of the Investment Company Act of 1940, as amended.

     6.19 Public Utility Holding Company Act. The Borrower is not a “holding company” or a “subsidiary company” of a “holding company” or an “affiliate” of a “holding company” or a “public utility” within the meaning of the Public Utility Holding Company Act of 1935, as amended.

     6.20 Environmental Matters.

          (a) The Borrower and all of its respective properties, assets, and operations are in full compliance with all Environmental Laws. The Borrower is not aware of, nor has the Borrower received notice of, any past, present, or future conditions, events, activities, practices, or incidents which may interfere with or prevent the compliance or continued compliance of the Borrower and the Subsidiaries with all Environmental Laws;

          (b) The Borrower has obtained all permits, licenses, and authorizations that are required under applicable Environmental Laws, and all such permits are in good standing and the Borrower is in compliance with all of the terms and conditions of such permits;

          (c) No Hazardous Materials exist on, about, or within or have been used, generated, stored, transported, disposed of on, or Released from any of the properties or assets of the Borrower. The use which the Borrower makes and intends to make of its respective properties and assets will not result in the use, generation, storage, transportation, accumulation, disposal, or Release of any Hazardous Material on, in, or from any of their properties or assets;

          (d) The Borrower nor any of its respective currently or previously owned or leased properties or operations is subject to any outstanding or threatened order from or agreement with any Governmental Authority or other Person or subject to any judicial or docketed administrative proceeding with respect to (i) failure to comply with Environmental Laws, (ii) Remedial Action, or (iii) any Environmental Liabilities arising from a Release or threatened Release;

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          (e) There are no conditions or circumstances associated with the currently or previously owned or leased properties or operations of the Borrower that could reasonably be expected to give rise to any Environmental Liabilities;

          (f) The Borrower is not a treatment, storage, or disposal facility requiring a permit under the Resource Conservation and Recovery Act, 42 U.S.C. § 6901 et seq., regulations thereunder or any comparable provision of state law. The Borrower is in compliance with all applicable financial responsibility requirements of all Environmental Laws;

          (g) The Borrower has not filed or failed to file any notice required under applicable Environmental Law reporting a Release; and

          (h) No Lien arising under any Environmental Law has attached to any property or revenues of the Borrower.

     6.21 Intellectual Property. All material Intellectual Property owned or used by the Borrower, or any Obligated Party is listed, together with application or registration numbers, where applicable, in the Disclosure Schedule. Each Person identified on the Disclosure Schedule owns, or is licensed to use, all Intellectual Property necessary to conduct its business as currently conducted except for such Intellectual Property the failure of which to own or license could not reasonably be expected to have a material adverse effect. Each Person identified on the Disclosure Schedule will maintain the patenting and registration of all Intellectual Property with the United States Patent and Trademark Office, the United States Copyright Office, or other appropriate Governmental Authority and each Person identified on the Disclosure Schedule will promptly notify the Lender in writing five (5) Business Days prior to filing any such new patent or registration.

     6.22 Depository Relationship. To induce the Lender to establish the interest rates provided for in the Revolving Credit Note, the Borrower will use the Lender as its principal depository bank and, except as otherwise disclosed on the Disclosure Schedule, the Borrower covenants and agrees to maintain the Lender as its principal depository bank, including for the maintenance of business, cash management, operating and administrative deposit accounts.

ARTICLE VII
AFFIRMATIVE COVENANTS

     The Borrower covenants and agrees that, as long as the Obligations or any part thereof are outstanding or the Lender has any Commitment hereunder, the Borrower will perform and observe the following positive covenants, unless the Lender shall otherwise consent in writing:

     7.1 Reporting Requirements. The Borrower will furnish to the Lender:

          (a) Annual Financial Statements. As soon as available, and in any event within ninety (90) days after the end of each fiscal year of the Borrower unless (i) otherwise consented to in writing by Lender or (ii) Borrower receives an extension of the applicable filing date from the Securities and Exchange Commission, in which case such reports shall be provided to Lender contemporaneous with the provision of the same to the Securities and Exchange

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Commission, beginning with the fiscal year ending December 31, 2005, (x) a copy of the audited annual financial statements of Borrower and its 10-K report filed with the Securities and Exchange Commission for such fiscal year containing balance sheets and statements of income, retained earnings, and cash flow as at the end of such fiscal year and for the 12-month period then ended, in each case setting forth in comparative form the figures for the preceding fiscal year, all in reasonable detail and audited and certified by the independent auditors of Borrower, Tullius Taylor Sartain and Sartain LLP, or other independent certified public accountants of recognized standing acceptable to the Lender, to the effect that such report has been prepared in accordance with GAAP and containing no material qualifications or limitations on scope; and (y) a certificate of such independent certified public accountants to the Lender (A) stating that to their knowledge no Default has occurred and is continuing, or if in their opinion a Default has occurred and is continuing, a statement as to the nature thereof, and (B) confirming the calculations set forth in the officer’s certificate delivered simultaneously therewith;

          (b) Quarterly Financial Statements. As soon as available, and in any event within forty-five (45) days after the end of each of the quarters of each fiscal year of the Borrower, unless (i) otherwise consented to in writing by Lender or (ii) Borrower receives an extension of the applicable filing date from the Securities and Exchange Commission, in which case such reports shall be provided to Lender contemporaneous with the provision of the same to the Securities and Exchange Commission, a copy of an unaudited financial report of the Borrower and a copy of Borrower’s 10-Q report filed with the Securities and Exchange Commission for the same period as of the end of such fiscal quarter and for the portion of the fiscal year then ended, containing balance sheets and statements of income, and cash flow, in each case setting forth in comparative form the figures for the corresponding period of the preceding fiscal year, all in reasonable detail certified by the chief financial officer of the Borrower to have been prepared in accordance with GAAP and to fairly and accurately present (subject to year-end audit adjustments) the financial condition and results of operations of the Borrower and its Subsidiaries at the date and for the periods indicated therein;

          (c) Other Filings with the Securities and Exchange Commission. As soon as available, and in any event within ten (10) days after the filing of the same, a copy of any and all documents, statements, reports, or any other filing with the Securities and Exchange Commission, or a state equivalent or counterpart to the same within the state of Borrower’s incorporation or any state in which it conducts business.

          (d) Monthly Financial Statements. As soon as available, and in any event within thirty (30) days after the end of each month of each fiscal year of the Borrower, a copy of an unaudited statement of income which shall be in reasonable detail certified by the chief financial officer of the Borrower to have been prepared in accordance with GAAP and to fairly and accurately present (subject to year-end audit adjustments) the financial condition and results of operations of the Borrower at the date and for the periods indicated therein;

          (e) Borrowing Base Report. Along with the submission of each Advance Request Form and within forty-five (45) days after the end of each of the quarters of each fiscal year of the Borrower, a Borrowing Base Report, in a form identical to the same annexed hereto as Exhibit A, certified by the chief financial officer of the Borrower;

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          (f) Compliance Certificate. Concurrently with the delivery of each of the financial statements referred to in subsections 8.1(a) and 8.1(b), a certificate of the chief financial officer of the Borrower identical to the form annexed hereto as Exhibit B (i) stating that to the best of such officer’s knowledge, no Default has occurred and is continuing, or if a Default has occurred and is continuing, a statement as to the nature thereof and the action which is proposed to be taken with respect thereto, and (ii) showing in reasonable detail the calculations demonstrating compliance with Article IX;

          (g) Management Letters. Promptly upon receipt thereof, a copy of any management letter or written report submitted to the Borrower by independent certified public accountants with respect to the business, condition (financial or otherwise), operations, prospects, or properties of the Borrower;

          (h) Notice of Litigation. Promptly after the commencement thereof, notice of all actions, suits, and proceedings before any Governmental Authority or arbitrator affecting the Borrower which, if determined adversely to the Borrower, could have a material adverse effect on the business, condition (financial or otherwise), operations, prospects, or properties of the Borrower;

          (i) Notice of Default. As soon as possible and in any event within three (3) days after the occurrence of each Default, a written notice setting forth the details of such Default and the action that the Borrower has taken and proposes to take with respect thereto;

          (j) ERISA Reports. Promptly after the filing or receipt thereof, copies of all reports, including annual reports, and notices which the Borrower files with or receives from the PBGC or the U.S. Department of Labor under ERISA; and as soon as possible and in any event within five (5) days after the Borrower knows or has reason to know that any Reportable Event or Prohibited Transaction has occurred with respect to any Plan or that the PBGC or the Borrower has instituted or will institute proceedings under Title IV of ERISA to terminate any Plan, a certificate of the chief financial officer of the Borrower setting forth the details as to such Reportable Event or Prohibited Transaction or Plan termination and the action that the Borrower proposes to take with respect thereto;

          (k) Reports to Other Creditors. Promptly after the furnishing thereof, copies of any statement or report furnished to any other party pursuant to the terms of any indenture, loan, or credit or similar agreement and not otherwise required to be furnished to the Lender pursuant to any other clause of this Section;

          (l) Notice of Material Adverse Change. As soon as possible and in any event within five (5) days after the occurrence thereof, written notice of any matter that could have a material adverse effect on the business, condition (financial or otherwise), operations, prospects, or properties of the Borrower or any Subsidiary;

          (m) Accounts Receivable and Accounts Payable Aging. Along with the submission of each Advance Request Form and within forty-five (45) days after the end of each of the quarters of each fiscal year of the Borrower, an account receivable aging, classifying the Borrower’s domestic and export accounts receivable in categories of 0-30, 31-60, 61-90 and over

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90 days from date of invoice, and in such form and detail as the Lender shall require, and account payable aging by categories of 0-30, 31-60 and over 60, from date of invoice, also in such detail as the Lender shall reasonably require, and in each case certified by the chief financial officer of the Borrower;

          (n) Inventory Report. Along with the submission of each Advance Request Form and within forty-five (45) days after the end of each of the quarters of each fiscal year of the Borrower, an inventory report, in such form and detail as the Lender shall reasonably require, certified by the chief financial officer of the Borrower;

          (o) Contracts in Progress. Within forty-five (45) days after the end of each of the quarters of each fiscal year of the Borrower, a contracts in progress report, in such form and detail as the Lender shall require, certified by the chief financial officer of the Borrower;

          (p) Guarantor Financial Statement. Guarantor shall provide an annual financial statement, in such form and detail as the Lender shall reasonably require, within one hundred twenty (120) days after the end of each calendar year and a copy of the Guarantor’s filed tax return, within thirty (30) days of the day it is filed with the Internal Revenue Service;

          (q) Proxy Statements, Etc. As soon as available, one copy of each financial statement, report, notice or proxy statement sent by the Borrower to its stockholders generally and one copy of each regular, periodic or special report, registration statement, or prospectus filed by the Borrower with any securities exchange or the Securities and Exchange Commission or any successor agency; and

          (r) General Information. Promptly, such other information concerning the Borrower or any Subsidiary as the Lender may from time to time reasonably request.

     7.2 Maintenance of Existence; Conduct of Business. The Borrower will preserve and maintain its existence and all of its leases, privileges, licenses, permits, franchises, qualifications, and rights that are necessary or desirable in the ordinary conduct of its business. The Borrower will conduct its business in an orderly and efficient manner in accordance with good business practices. Without limitation, the Borrower will not make any material change in its credit collection policies if such change would materially impair the collectibility of any Account, nor will it rescind, cancel or modify any Account except in the ordinary course of business.

     7.3 Maintenance of Properties. The Borrower will maintain, keep, and preserve all of its Properties (tangible and intangible) necessary or useful in the proper conduct of its business in good working order and condition.

     7.4 Taxes and Claims. The Borrower will pay or discharge at or before maturity or before becoming delinquent (a) all taxes, levies, assessments, and governmental charges imposed on it or its income or profits or any of its property, and (b) all lawful claims for labor, material, and supplies, which, if unpaid, might become a Lien upon any of its property; provided, however, that the Borrower shall not be required to pay or discharge any tax, levy, assessment, or governmental charge which is being contested in good faith by appropriate proceedings diligently pursued, and for which adequate reserves have been established.

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     7.5 Insurance. The Borrower will maintain insurance with financially sound and reputable insurance companies in such amounts and covering such risks as is usually carried by corporations engaged in similar businesses and owning similar properties in the same general areas in which the Borrower operates, provided that in any event the Borrower will maintain workmen’s compensation insurance, property insurance, comprehensive general liability insurance, products liability insurance, and business interruption insurance reasonably satisfactory to the Lender. Each insurance policy covering Collateral shall name the Lender as loss payee and shall provide that such policy will not be cancelled or reduced without thirty (30) days prior written notice to the Lender.

     7.6 Inspection Rights. At any reasonable time and from time to time, the Borrower will permit representatives of the Lender to examine the Collateral and conduct Collateral audits, to examine, copy, and make extracts from its books and records, to visit and inspect its properties, and to discuss its business, operations, and financial condition with its officers, employees, and independent certified public accountants.

     7.7 Keeping Books and Records. The Borrower will maintain proper books of record and account in which full, true, and correct entries in conformity with GAAP shall be made of all dealings and transactions in relation to its business and activities.

     7.8 Compliance with Laws. The Borrower will comply in all material respects with all applicable laws, rules, regulations, orders, and decrees of any Governmental Authority or arbitrator.

     7.9 Compliance with Agreements. The Borrower will comply in all material respects with all agreements, contracts, and instruments binding on it or affecting its properties or business.

     7.10 Further Assurances. The Borrower will execute and deliver such further agreements and instruments and take such further action as may be requested by the Lender to carry out the provisions and purposes of this Agreement and the other Loan Documents and to create, preserve, and perfect the Liens of the Lender in the Collateral.

     7.11 ERISA. The Borrower will comply with all minimum funding requirements, and all other material requirements, of ERISA, if applicable, so as not to give rise to any liability thereunder.

ARTICLE VIII
NEGATIVE COVENANTS

     The Borrower covenants and agrees that, as long as the Obligations or any part thereof are outstanding or the Lender has any Commitment hereunder, the Borrower will perform and observe the following negative covenants, unless the Lender shall otherwise consent in writing:

     8.1 Debt. The Borrower will not incur, create, assume, or permit to exist, any Debt, except:

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          (a) Debt to the Lender;

          (b) Existing Debt described on the Disclosure Schedule hereto;

          (c) Subordinated Debt; and

          (d) Purchase money Debt not to exceed $250,000.00 in the aggregate.

     8.2 Limitation on Liens. The Borrower will not incur, create, assume, or permit to exist, any Lien upon any of its property, assets, or revenues, whether now owned or hereafter acquired, except:

          (a) Liens disclosed on the Disclosure Schedule hereto;

          (b) Liens in favor of the Lender;

          (c) Encumbrances consisting of minor easements, zoning restrictions, or other restrictions on the use of real property that do not (individually or in the aggregate) materially affect the value of the assets encumbered thereby or materially impair the ability of the Borrower to use such assets in its business, and none of which is violated in any material respect by existing or proposed structures or land use;

          (d) Liens for taxes, assessments, or other governmental charges which are not delinquent or which are being contested in good faith and for which adequate reserves have been established;

          (e) Liens of mechanics, materialmen, warehousemen, carriers, or other similar statutory Liens securing obligations that are not yet due and are incurred in the ordinary course of business;

          (f) Liens resulting from good faith deposits to secure payments of workmen’s compensation or other social security programs or to secure the performance of tenders, statutory obligations, surety and appeal bonds, bids, or contracts (other than for payment of Debt), or leases made in the ordinary course of business;

          (g) Liens on specific property to secure Subordinated Debt to the extent permitted by Section 8.1(c); and

          (h) Purchase money Liens on specific property to secure Debt used to acquire such property to the extent permitted in Section 8.1(d).

     8.3 Mergers, Etc. The Borrower will not become a party to a merger or consolidation, or purchase or otherwise acquire all or any part of the assets of any Person or any shares or other evidence of beneficial ownership of any Person, or wind-up, dissolve, or liquidate.

     8.4 Restricted Payments. The Borrower will not declare or pay any dividends or make any other payment or distribution (in cash, property, or obligations) on account of its

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equity interests, or redeem, purchase, retire, or otherwise acquire any of its equity interests, or set apart any money for a sinking or other analogous fund for any dividend or other distribution on its equity interests or for any redemption, purchase, retirement, or other acquisition of any of its equity interests.

     8.5 Loans and Investments. The Borrower will not make any advance, loan, extension of credit, or capital contribution to or investment in, or purchase any stock, bonds, notes, debentures, or other securities of, any Person, except:

          (a) readily marketable direct obligations of the United States of America or any agency thereof with maturities of one year or less from the date of acquisition;

          (b) fully insured certificates of deposit with maturities of one year or less from the date of acquisition issued by any commercial bank operating in the United States of America having capital and surplus in excess of $50,000,000.00; and

          (c) commercial paper of a domestic issuer if at the time of purchase such paper is rated in one of the two highest rating categories of Standard and Poor’s Corporation or Moody’s Investors Service.

     8.6 Limitation on Issuance of Equity. [Intentionally omitted].

     8.7 Transactions With Affiliates. The Borrower will not enter into any transaction, including, without limitation, the purchase, sale, or exchange of property or the rendering of any service, with any Affiliate of the Borrower, except in the ordinary course of and pursuant to the reasonable requirements of the Borrower’s business and upon fair and reasonable terms no less favorable to the Borrower than would be obtained in a comparable arm’s-length transaction with a Person not an Affiliate of the Borrower.

     8.8 Disposition of Assets. The Borrower will not sell, lease, assign, transfer, or otherwise dispose of any of its assets, except (a) dispositions of inventory in the ordinary course of business or (b) dispositions, for fair value, of worn-out and obsolete equipment not necessary or useful to the conduct of business.

     8.9 Sale and Leaseback. The Borrower will not enter into any arrangement with any Person pursuant to which it leases from such Person real or personal property that has been or is to be sold or transferred, directly or indirectly, by it to such Person.

     8.10 Prepayment of Debt. The Borrower will not prepay any Debt, except the Obligations.

     8.11 Nature of Business. The Borrower will not engage in any business other than the businesses in which it is engaged as of the date hereof.

     8.12 Environmental Protection. The Borrower will not, (a) use (or permit any tenant to use) any of its properties or assets for the handling, processing, storage, transportation, or disposal of any Hazardous Material, (b) generate any Hazardous Material, (c) conduct any activity that is likely to cause a Release or threatened Release of any Hazardous Material, or (d)

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otherwise conduct any activity or use any of their respective properties or assets in any manner that is likely to violate any Environmental Law or create any Environmental Liabilities for which the Borrower would be responsible.

     8.13 Accounting. The Borrower will not change its fiscal year or make any change (a) in accounting treatment or reporting practices, except as required by GAAP and disclosed to the Lender, or (b) in tax reporting treatment, except as required by law and disclosed to the Lender; provided, however, Borrower has disclosed to Lender that it shall be changing its tax reporting fiscal year and Lender has consented to the same.

     8.14 No Negative Pledge. The Borrower will not enter into or permit to exist any arrangement or agreement, other than pursuant to this Agreement or any Loan Document, which directly or indirectly prohibits the Borrower from creating or incurring a Lien on any of its assets.

ARTICLE IX
FINANCIAL COVENANTS

     The Borrower covenants and agrees that, as long as the Obligations or any part thereof are outstanding or the Lender has any Commitment hereunder, the Borrower will, at all times, observe and perform the following financial covenants, unless the Lender shall otherwise consent in writing.

     9.1 The Borrower shall calculate quarterly the Debt Service Coverage Ratio for the four quarters prior to the date of any such calculation, and shall provide a copy of such calculation for such period to the Lender at the time of delivery of the quarterly financial statements delivered in accordance with Section 7.1(b) hereof. If the Debt Service Coverage Ratio computation delivered at the time of delivery of any such statement indicates that the Debt Service Coverage Ratio of the Borrower for such previous four fiscal quarters shall be less than 2.00 to 1.00, the Borrower covenants to retain a Consultant at the expense of the Borrower, within 30 days, to make recommendations to increase such Debt Service Coverage Ratio in the fiscal year following delivery of such recommendations to such level or, if in the opinion of the Consultant the attainment of such level is impracticable, to the highest level attainable in such fiscal year. Any Consultant so retained shall be required to submit such recommendations to the Lender within 90 days after being so retained. The Borrower agrees that it will, to the extent permitted by law, follow the recommendations of the Consultant. The Borrower shall not be obligated to retain such a Consultant more often than once during any twenty-four month period.

     (b) The Borrower covenants and agrees that it shall maintain a Current Ratio, calculated as of the last day of each calendar quarter, of not less than 1.00 to 1.00. The Borrower shall provide a copy of such calculation to the Lender at the time of delivery of the quarterly financial statements delivered in accordance with Section 7.1(b) hereof.

     (d) The Borrower covenants and agrees that not more than 10% of its accounts payable (for the deferred purchase price of property or services) from time to time incurred in the ordinary course of operations and activities shall be in excess of 75 day past the invoice or billing date, or, if greater than 75 days, are being contested in good faith by the Borrower.

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     (e) The Borrower covenants and agrees that not more than 20% of its accounts receivable (for the deferred purchase price of property or services) from time to time shall be in excess of 90 day past the invoice or billing date, excluding from such calculation (i) amounts being contested in good faith by the obligated party, and (ii) amounts which the Borrower has determined, in good faith, are not likely to be collected and are to be treated as losses in accordance with generally accepted accounting principles.

ARTICLE X
DEFAULT

     10.1 Events of Default. Each of the following shall be deemed an “Event of Default”:

          (a) The Borrower shall fail to pay the Obligations or any part thereof shall not be paid within ten (10) days of when due or declared due.

          (b) The Borrower shall fail to provide to the Lender timely any notice of Default as required by Section 7.1(i) of this Agreement or the Borrower shall breach any provision of Article VIII or Article IX of this Agreement.

          (c) Any representation or warranty made or deemed made by the Borrower or any Obligated Party (or any of their respective officers) in any Loan Document or in any certificate, report, notice, or financial statement furnished at any time in connection with this Agreement shall be false, misleading, or erroneous in any material respect when made or deemed to have been made.

          (d) Unless otherwise provided herein, the Borrower or any Obligated Party shall fail to perform, observe, or comply with any covenant, agreement, or term contained in this Agreement or any other Loan Document (other than as covered by Section 10.1(a) and (b) above), and such failure continues for more than 30 days following the date that is the earlier to occur of (i) notice thereof provided by Borrower to Lender and (ii) notice thereof provided by Lender to Borrower.

          (e) The Borrower or any Obligated Party shall commence a voluntary proceeding seeking liquidation, reorganization, or other relief with respect to itself or its debts under any bankruptcy, insolvency, or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian, or other similar official of it or a substantial part of its property or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it or shall make a general assignment for the benefit of creditors or shall generally fail to pay its debts as they become due or shall take any corporate action to authorize any of the foregoing.

          (f) The Borrower or any Obligated Party shall fail to pay when due any principal of or interest on any Debt (other than the Obligations), or the maturity of any such Debt shall have been accelerated, or any such Debt shall have been required to be prepaid prior to the stated maturity thereof, or any event shall have occurred that permits (or, with the giving of notice or lapse of time or both, would permit) any holder or holders of such Debt or any Person

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acting on behalf of such holder or holders to accelerate the maturity thereof or require any such prepayment.

          (g) This Agreement or any other Loan Document shall cease to be in full force and effect or shall be declared null and void or the validity or enforceability thereof shall be contested or challenged by the Borrower or any Obligated Party or any of their respective shareholders, or the Borrower or any Obligated Party shall deny that it has any further liability or obligation under any of the Loan Documents, or any lien or security interest created by the Loan Documents shall for any reason cease to be a valid, first priority perfected security interest in and lien upon any of the Collateral purported to be covered thereby.

          (h) Any of the following events shall occur or exist with respect to the Borrower or any ERISA Affiliate: (i) any Prohibited Transaction involving any Plan; (ii) any Reportable Event with respect to any Plan; (iii) the filing under Section 4041 of ERISA of a notice of intent to terminate any Plan or the termination of any Plan; (iv) any event or circumstance that might constitute grounds entitling the PBGC to institute proceedings under Section 4042 of ERISA for the termination of, or for the appointment of a trustee to administer, any Plan, or the institution by the PBGC of any such proceedings; or (v) complete or partial withdrawal under Section 4201 or 4204 of ERISA from a Multiemployer Plan or the reorganization, insolvency, or termination of any Multiemployer Plan; and in each case above, such event or condition, together with all other events or conditions, if any, have subjected or could in the reasonable opinion of the Lender subject the Borrower to any tax, penalty, or other liability to a Plan, a Multiemployer Plan, the PBGC.

          (i) The Guarantor or any other Obligated Party shall have died or have been declared incompetent by a court of proper jurisdiction and a replacement Guarantor or Obligated Party has not been accepted by Lender in its reasonable discretion; or if the Guarantor or any other Obligated Party is a corporation, partnership or other entity, such Person shall be the subject of a bankruptcy or receivership proceeding or shall have dissolved, liquidated or otherwise ceased doing business.

          (j) Thirty (30) days following the date any of Borrower’s officers and/or directors shall cease to be active in the management of the Borrower, unless Borrower shall have appointed a successor acceptable to Lender, in Lender’s sole and reasonable discretion.

          (k) The Borrower or any Obligated Party, or any of their properties, revenues, or assets, shall become subject to an order of forfeiture, seizure, or divestiture (whether under RICO or otherwise) and the same shall not have been discharged within thirty (30) days from the date of entry thereof.

          (l) More than a ten percent (10%) reduction in the aggregate record or beneficial ownership of the Borrower held by Joe G. Brooks, Stephen W. Brooks, J. Douglas Brooks, and Marjorie S. Brooks (collectively, the “Brooks Shareholders”) shall have been transferred, assigned or hypothecated to any Person (other than a Brooks Shareholder), when compared to such ownership as of the date of this Agreement.

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          (m) An involuntary proceeding shall be commenced against the Borrower or any Obligated Party seeking liquidation, reorganization, or other relief with respect to it or its debts under any bankruptcy, insolvency, or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian, or other similar official for it or a substantial part of its property, and such involuntary proceeding shall remain undismissed and unstayed for a period of thirty (30) days.

          (n) The Borrower or any Obligated Party shall fail to discharge within a period of thirty (30) days after the commencement thereof any attachment, sequestration, or similar proceeding or proceedings involving an aggregate amount in excess of one hundred thousand and no/100 Dollars ($100,000.00) against any of its assets or properties.

          (o) A final judgment or judgments for the payment of money in excess of one hundred thousand and no/100 Dollars ($100,000.00) in the aggregate shall be rendered by a court or courts against the Borrower or any Obligated Party and the same shall not be discharged (or provision shall not be made for such discharge), or a stay of execution thereof shall not be procured, within thirty (30) days from the date of entry thereof and the Borrower or Obligated Party shall not, within said period of thirty (30) days, or such longer period during which execution of the same shall have been stayed, appeal therefrom and cause the execution thereof to be stayed during such appeal.

          (p) Guarantor delivers a Cessation Notice (as defined in the Guaranty) to Lender, or if for any other reason Guarantor is no longer obligated to guaranty any portion of the Loan.

     10.2 Remedies Upon Default. If any Event of Default shall occur and be continuing past any applicable cure period, the Lender may after notice terminate the Commitment and declare the Obligations or any part thereof to be immediately due and payable, and the same shall thereupon become immediately due and payable, without notice, demand, presentment, notice of dishonor, notice of acceleration, notice of intent to accelerate, notice of intent to demand, protest, or other formalities of any kind, all of which are hereby expressly waived by the Borrower; provided, however, that upon the occurrence of an Event of Default under Section 10.1(e), Section 10.1(m), or Section 10.1(p) the Commitment shall automatically terminate, and the Obligations shall become immediately due and payable without notice, demand, presentment, notice of dishonor, notice of acceleration, notice of intent to accelerate, notice of intent to demand, protest, or other formalities of any kind, all of which are hereby expressly waived by the Borrower. If any Event of Default shall occur and be continuing, the Lender may exercise all rights and remedies available to it in law or in equity, under the Loan Documents, or otherwise.

     10.3 Performance by the Lender. If the Borrower shall fail to perform any covenant or agreement contained in any of the Loan Documents, the Lender may perform or attempt to perform such covenant or agreement on behalf of the Borrower. In such event, the Borrower shall, at the request of the Lender, promptly pay any amount expended by the Lender in connection with such performance or attempted performance to the Lender, together with interest thereon at the Default Rate from and including the date of such expenditure to but excluding the date such expenditure is paid in full. Notwithstanding the foregoing, it is expressly agreed that

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the Lender shall not have any liability or responsibility for the performance of any obligation of the Borrower under this Agreement or any other Loan Document.

ARTICLE XI
MISCELLANEOUS

     11.1 Expenses. The Borrower hereby agrees to pay on demand: (a) all costs, expenses, and attorneys’ fees of the Lender in connection with the preparation, negotiation, execution, and delivery of this Agreement and the other Loan Documents and any and all amendments, modifications, renewals, extensions, and supplements thereof and thereto, including, without limitation, the reasonable fees and expenses of legal counsel, advisors, consultants, and auditors for the Lender, (b) all costs and expenses of the Lender in connection with any Default and the enforcement of this Agreement or any other Loan Document, including, without limitation, the fees and expenses of legal counsel, advisors, consultants, and auditors for the Lender, (c) all transfer, stamp, documentary, or other similar taxes, assessments, or charges levied by any Governmental Authority in respect of this Agreement or any of the other Loan Documents, (d) all costs, expenses, assessments, and other charges incurred in connection with any filing, registration, recording, or perfection of any security interest or Lien contemplated by this Agreement or any other Loan Document, and (e) all other costs and expenses incurred by the Lender in connection with this Agreement or any other Loan Document, any litigation, dispute, suit, proceeding or action; the enforcement of its rights and remedies, protection of its interests in bankruptcy, insolvency or other legal proceedings, including, without limitation, all costs, expenses, and other charges (including the Lender’s internal charges) incurred in connection with evaluating, observing, collecting, examining, auditing, appraising, selling, liquidating, or otherwise disposing of the Collateral or other assets of the Borrower.

     11.2 INDEMNIFICATION. THE BORROWER SHALL INDEMNIFY THE LENDER AND EACH AFFILIATE THEREOF AND THEIR RESPECTIVE OFFICERS, DIRECTORS, EMPLOYEES, ATTORNEYS, AND AGENTS FROM, AND HOLD EACH OF THEM HARMLESS AGAINST, ANY AND ALL LOSSES, LIABILITIES, CLAIMS, DAMAGES, PENALTIES, JUDGMENTS, DISBURSEMENTS, COSTS, AND EXPENSES (INCLUDING ATTORNEYS’ FEES) TO WHICH ANY OF THEM MAY BECOME SUBJECT WHICH DIRECTLY OR INDIRECTLY ARISE FROM OR RELATE TO (A) THE NEGOTIATION, EXECUTION, DELIVERY, PERFORMANCE, ADMINISTRATION, OR ENFORCEMENT OF ANY OF THE LOAN DOCUMENTS, (B) ANY OF THE TRANSACTIONS CONTEMPLATED BY THE LOAN DOCUMENTS, (C) ANY BREACH BY THE BORROWER OF ANY REPRESENTATION, WARRANTY, COVENANT, OR OTHER AGREEMENT CONTAINED IN ANY OF THE LOAN DOCUMENTS, (D) THE PRESENCE, RELEASE, THREATENED RELEASE, DISPOSAL, REMOVAL, OR CLEANUP OF ANY HAZARDOUS MATERIAL LOCATED ON, ABOUT, WITHIN, OR AFFECTING ANY OF THE PROPERTIES OR ASSETS OF THE BORROWER OR ANY SUBSIDIARY, (E) THE USE OR PROPOSED USE OF ANY LETTER OF CREDIT, (F) ANY AND ALL TAXES, LEVIES, DEDUCTIONS, AND CHARGES IMPOSED ON THE LENDER OR ANY OF THE LENDER’S CORRESPONDENTS IN RESPECT OF ANY LETTER OF CREDIT, OR (G) ANY INVESTIGATION, LITIGATION, OR OTHER PROCEEDING, INCLUDING, WITHOUT LIMITATION, ANY THREATENED INVESTIGATION,

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LITIGATION, OR OTHER PROCEEDING, RELATING TO ANY OF THE FOREGOING. WITHOUT LIMITING ANY PROVISION OF THIS AGREEMENT OR OF ANY OTHER LOAN DOCUMENT, IT IS THE EXPRESS INTENTION OF THE PARTIES HERETO THAT EACH PERSON TO BE INDEMNIFIED UNDER THIS SECTION SHALL BE INDEMNIFIED FROM AND HELD HARMLESS AGAINST ANY AND ALL LOSSES, LIABILITIES, CLAIMS, DAMAGES, PENALTIES, JUDGMENTS, DISBURSEMENTS, COSTS, AND EXPENSES (INCLUDING ATTORNEYS’ FEES) ARISING OUT OF OR RESULTING FROM THE SOLE CONTRIBUTORY OR ORDINARY NEGLIGENCE OF SUCH PERSON.

     11.3 Limitation of Liability. Neither the Lender nor any Affiliate, officer, director, employee, attorney, or agent of the Lender shall have any liability with respect to, and the Borrower hereby waives, releases, and agrees not to sue any of them upon, any claim for any special, indirect, incidental, or consequential damages suffered or incurred by the Borrower in connection with, arising out of, or in any way related to, this Agreement or any of the other Loan Documents, or any of the transactions contemplated by this Agreement or any of the other Loan Documents. The Borrower hereby waives, releases, and agrees not to sue the Lender or any of the Lender’s Affiliates, officers, directors, employees, attorneys, or agents for punitive damages in respect of any claim in connection with, arising out of, or in any way related to, this Agreement or any of the other Loan Documents, or any of the transactions contemplated by this Agreement or any of the other Loan Documents.

     11.4 No Duty. All attorneys, accountants, appraisers, and other professional Persons and consultants retained by the Lender shall have the right to act exclusively in the interest of the Lender and shall have no duty of disclosure, duty of loyalty, duty of care, or other duty or obligation of any type or nature whatsoever to the Borrower or any of the Borrower’s shareholders or any other Person.

     11.5 Lender Not Fiduciary. The relationship between the Borrower and the Lender is solely that of debtor and creditor, and the Lender has no fiduciary or other special relationship with the Borrower, and no term or condition of any of the Loan Documents shall be construed so as to deem the relationship between the Borrower and the Lender to be other than that of debtor and creditor.

     11.6 Equitable Relief. The Borrower recognizes that in the event the Borrower fails to pay, perform, observe, or discharge any or all of the Obligations, any remedy at law may prove to be inadequate relief to the Lender. The Borrower therefore agrees that the Lender, if the Lender so requests, shall be entitled to temporary and permanent injunctive relief in any such case without the necessity of proving actual damages.

     11.7 No Waiver; Cumulative Remedies. No failure on the part of the Lender to exercise and no delay in exercising, and no course of dealing with respect to, any right, power, or privilege under this Agreement shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power, or privilege under this Agreement preclude any other or further exercise thereof or the exercise of any other right, power, or privilege. The rights and remedies provided for in this Agreement and the other Loan Documents are cumulative and not exclusive of any rights and remedies provided by law.

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     11.8 Successors and Assigns. This Agreement is binding upon and shall inure to the benefit of the Lender and the Borrower and their respective successors and assigns, except that the Borrower may not assign or transfer any of its rights or obligations under this Agreement without the prior written consent of the Lender.

     11.9 Survival. All representations and warranties made in this Agreement or any other Loan Document or in any document, statement, or certificate furnished in connection with this Agreement shall survive the execution and delivery of this Agreement and the other Loan Documents, and no investigation by the Lender or any closing shall affect the representations and warranties or the right of the Lender to rely upon them. Without prejudice to the survival of any other obligation of the Borrower hereunder, the obligations of the Borrower under Sections 11.1, and 11.2 shall survive repayment of the Note and termination of the Commitment.

     11.10 ENTIRE AGREEMENT; AMENDMENT. THIS AGREEMENT, THE NOTE, AND THE OTHER LOAN DOCUMENTS REFERRED TO HEREIN EMBODY THE FINAL, ENTIRE AGREEMENT AMONG THE PARTIES HERETO AND SUPERSEDE ANY AND ALL PRIOR COMMITMENTS, AGREEMENTS, REPRESENTATIONS, AND UNDERSTANDINGS, WHETHER WRITTEN OR ORAL, RELATING TO THE SUBJECT MATTER HEREOF AND MAY NOT BE CONTRADICTED OR VARIED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OR DISCUSSIONS OF THE PARTIES HERETO. THERE ARE NO ORAL AGREEMENTS AMONG THE PARTIES HERETO. The provisions of this Agreement and the other Loan Documents to which the Borrower is a party may be amended or waived only by an instrument in writing signed by the parties hereto.

     11.11 Notices. Unless otherwise expressly provided herein, all notices and other communications provided for hereunder shall be in writing (including by facsimile transmission) and mailed, faxed or delivered, to the address, facsimile number or subject to the last sentence hereof electronic mail address specified for notices below the signatures hereon or to such other address as shall be designated by such party in a notice to the other parties. All such other notices and other communications shall be deemed to have been given or made upon the earliest to occur of (i) actual receipt by the intended recipient or (ii) (A) if delivered by hand or courier, when signed for by the designated recipient; (B) if delivered by mail, four business days after deposit in the mail, postage prepaid; (C) if delivered by facsimile when sent and receipt has been confirmed by telephone; and (D) if delivered by electronic mail (which form of delivery is subject to the provisions of the last sentence below) when delivered; provided, however, that notices and other communications pursuant to Article II shall not be effective until actually received by the Lender. Electronic mail and intranet websites may be used only to distribute only routine communications, such as financial statements and other information, and to distribute Loan Documents for execution by the parties thereto, and may not be used for any other purpose.

     11.12 Governing Law; Venue; Service of Process. This Agreement shall be governed by and construed in accordance with the laws of the State of Arkansas and the applicable laws of the United States of America. This Agreement has been entered into in Washington County, Arkansas, and it shall be performable for all purposes in Washington County, Arkansas. Any action or proceeding against the Borrower under or in connection with any of the Loan

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Documents may be brought in any state or federal court in Washington County, Arkansas. The Borrower hereby irrevocably (a) submits to the nonexclusive jurisdiction of such courts, and (b) waives any objection it may now or hereafter have as to the venue of any such action or proceeding brought in any such court or that any such court is an inconvenient forum. The Borrower agrees that service of process upon it may be made by certified or registered mail, return receipt requested, at its address specified or determined in accordance with the provisions of Section 11.11. Nothing herein or in any of the other Loan Documents shall affect the right of the Lender to serve process in any other manner permitted by law or shall limit the right of the Lender to bring any action or proceeding against the Borrower or with respect to any of its property in courts in other jurisdictions. Any action or proceeding by the Borrower against the Lender shall be brought only in a court located in Washington County, Arkansas.

     11.13 Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.

     11.14 Severability. Any provision of this Agreement held by a court of competent jurisdiction to be invalid or unenforceable shall not impair or invalidate the remainder of this Agreement and the effect thereof shall be confined to the provision held to be invalid or illegal.

     11.15 Headings. The headings, captions, and arrangements used in this Agreement are for convenience only and shall not affect the interpretation of this Agreement.

     11.16 Participations; Etc. The Lender shall have the right at any time and from time to time to grant participations in, and sell and transfer, the Obligations and any Loan Documents. Each actual or proposed participant or assignee, as the case may be, shall be entitled to receive all information received by the Lender regarding the Borrower, including, without limitation, information required to be disclosed to a participant or assignee pursuant to Banking Circular 181 (Rev., August 2, 1984), issued by the Comptroller of the Currency (whether the actual or proposed participant or assignee is subject to the circular or not).

     11.17 Construction. The Borrower and the Lender acknowledge that each of them has had the benefit of legal counsel of its own choice and has been afforded an opportunity to review this Agreement and the other Loan Documents with its legal counsel and that this Agreement and the other Loan Documents shall be construed as if jointly drafted by the Borrower and the Lender.

     11.18 Independence of Covenants. All covenants hereunder shall be given independent effect so that if a particular action or condition is not permitted by any of such covenants, the fact that it would be permitted by an exception to, or be otherwise within the limitations of, another covenant shall not avoid the occurrence of a Default if such action is taken or such condition exists.

     11.19 WAIVER OF JURY TRIAL. TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, BORROWER HEREBY IRREVOCABLY AND EXPRESSLY WAIVES ALL RIGHT TO A TRIAL BY JURY IN ANY ACTION, PROCEEDING, OR COUNTERCLAIM (WHETHER BASED UPON CONTRACT, TORT, OR OTHERWISE)

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ARISING OUT OF OR RELATING TO ANY OF THE LOAN DOCUMENTS OR THE TRANSACTIONS CONTEMPLATED THEREBY OR THE ACTIONS OF LENDER IN THE NEGOTIATION, ADMINISTRATION, OR ENFORCEMENT THEREOF.

     11.20 Arbitration.

          (a) Upon the demand of any party, any dispute shall be resolved by binding arbitration (except as set forth in Section 11.20(e) below) in accordance with the terms of this Agreement or the other Loan Documents. Any party may by summary proceedings bring an action in court to compel arbitration of a Dispute. Any party who fails or refuses to submit to arbitration following a lawful demand by any other party shall bear all costs and expenses incurred by such other party in compelling arbitration of any Dispute.

          (b) Arbitration proceedings shall be administered by the American Arbitration Association (“AAA”) or such other administrator as the parties shall mutually agree upon in accordance with the AAA Commercial Arbitration Rules. All Disputes submitted to arbitration shall be resolved in accordance with the Federal Arbitration Act (Title 9 of the United States Code), notwithstanding any conflicting choice of law provision in any of the foregoing documents. The arbitration shall be conducted at a location in Arkansas selected by the AAA or other administrator. If there is any inconsistency between the terms hereof and any such rules, the terms and procedures set forth herein shall control. All statutes of limitation applicable to any Dispute shall apply to any arbitration proceeding. All discovery activities shall be expressly limited to matters directly relevant to the Dispute being arbitrated. Judgment upon any award rendered in an arbitration may be entered in any court having jurisdiction; provided however, that nothing contained herein shall be deemed to be a waiver by any party that is a bank of the protections afforded to it under Section 91 of Title 12 of the United States Code or any similar applicable state law.

          (c) No provision hereof shall limit the right of any party to exercise self-help remedies such as setoff, foreclosure against or sale of any real or personal property collateral or security, or to obtain provisional or ancillary remedies, including without limitation, injunctive relief, sequestration, attachment, garnishment or the appointment of a receiver from a court of competent jurisdiction before, after or during the pendency of any arbitration or other proceeding. The exercise of any such remedy shall not waive the right of any party to compel arbitration hereunder.

          (d) Arbitrators must be active members of the Arkansas State Bar with expertise in the substantive law applicable to the subject matter of the Dispute. Arbitrators are empowered to resolve Disputes by summary rulings in response to motions filed prior to the final arbitration hearing. Arbitrators (i) shall resolve all Disputes in accordance with the substantive law of the State of Arkansas, (ii) may grant any remedy or relief that a court of the State of Arkansas could order or grant within the scope hereof and such ancillary relief as is necessary to make effective any award, and (iii) shall have the power to award recovery of all costs and fees, to impose sanctions and to take such other actions as they deem necessary to the same extent a judge could pursuant to the Federal Rules of Civil Procedure, the Arkansas Rules of Civil Procedure or other applicable law. Any Dispute in which the amount in controversy is $5,000,000 or less shall be decided by a single arbitrator who shall not render an award of

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greater than $5,000,000 (including damages, costs, fees and expenses). By submission to a single arbitrator, each party expressly waives any right or claim to recover more than $5,000,000. Any Dispute in which the amount in controversy exceeds $5,000,000 shall be decided by majority vote of a panel of three arbitrators; provided however, that all three arbitrators must actively participate in all hearings and deliberations.

          (e) Notwithstanding anything herein to the contrary, in any arbitration in which the amount in controversy exceeds $25,000,000, the arbitrators shall be required to make specific, written findings of fact and conclusions of law. In such arbitrations (i) the arbitrators shall not have the power to make any award which is not supported by substantial evidence or which is based on legal error, (ii) an award shall not be binding upon the parties unless the findings of fact are supported by substantial evidence and the conclusions of law are not erroneous under the substantive law of the State of Arkansas, and (iii) the parties shall have in addition to the grounds referred to in the Federal Arbitration Act for vacating, modifying or correcting an award the right to judicial review of (1) whether the findings of fact rendered by the arbitrators are supported by substantial evidence, and (2) whether the conclusions of law are erroneous under the substantive law of the State of Arkansas. Judgment confirming an award in such a proceeding may be entered only if a court determines the award is supported by substantial evidence and not based on legal error under the substantive law of the State of Arkansas.

          (f) To the maximum extent practicable, the AAA, the arbitrators and the parties shall take all action required to conclude any arbitration proceeding within 180 days of the filing of the Dispute with the AAA. No arbitrator or other party to an arbitration proceeding may disclose the existence, content or results thereof, except for disclosures of information by a party required in the ordinary course of its business, by applicable law or regulation, or to the extent necessary to exercise any judicial review rights set forth herein. If more than one agreement for arbitration by or between the parties potentially applies to a Dispute, the arbitration provision most directly related to the foregoing documents or the subject matter of the Dispute shall control. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or any remaining provisions of this Agreement. This arbitration provision shall survive termination, amendment or expiration of any of the foregoing documents or any relationship between the parties.

          (g) Lender and Borrower hereby agree to keep all Disputes and arbitration proceedings strictly confidential, provided, however, that Lender and Borrower may disclose such confidential information as is necessary in any litigation between Lender and Borrower or as required by applicable law and, on a confidential basis, to accountants, attorneys and other consultants in the ordinary course of business.

     11.21 Additional Interest Provision. It is expressly stipulated and agreed to be the intent of the Borrower and the Lender at all times to comply strictly with the applicable Arkansas law governing the maximum rate or amount of interest payable on the indebtedness evidenced by any Note, any Loan Document, and the Related Indebtedness (or applicable United States federal law to the extent that it permits the Lender to contract for, charge, take, reserve or receive a greater amount of interest than under Arkansas law). If the applicable law is ever judicially interpreted

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so as to render usurious any amount (i) contracted for, charged, taken, reserved or received pursuant to any Note, any of the other Loan Documents or any other communication or writing by or between the Borrower and the Lender related to the transaction or transactions that are the subject matter of the Loan Documents, (ii) contracted for, charged, taken, reserved or received by reason of the Lender’s exercise of the option to accelerate the maturity of any Note and/or any and all indebtedness paid or payable by the Borrower to the Lender pursuant to any Loan Document other than any Note (such other indebtedness being referred to in this Section as the “Related Indebtedness”), or (iii) the Borrower will have paid or the Lender will have received by reason of any voluntary prepayment by the Borrower of any Note and/or the Related Indebtedness, then it is the Borrower’s and the Lender’s express intent that all amounts charged in excess of the Maximum Lawful Rate shall be automatically canceled, ab initio, and all amounts in excess of the Maximum Lawful Rate theretofore collected by the Lender shall be credited on the principal balance of any Note and/or the Related Indebtedness (or, if any Note and all Related Indebtedness have been or would thereby be paid in full, refunded to the Borrower), and the provisions of any Note and the other Loan Documents shall immediately be deemed reformed and the amounts thereafter collectible hereunder and thereunder reduced, without the necessity of the execution of any new document, so as to comply with the applicable law, but so as to permit the recovery of the fullest amount otherwise called for hereunder and thereunder; provided, however, if any Note has been paid in full before the end of the stated term of any such Note, then the Borrower and the Lender agree that the Lender shall, with reasonable promptness after the Lender discovers or is advised by the Borrower that interest was received in an amount in excess of the Maximum Lawful Rate, either refund such excess interest to the Borrower and/or credit such excess interest against such Note and/or any Related Indebtedness then owing by the Borrower to the Lender. The Borrower hereby agrees that as a condition precedent to any claim seeking usury penalties against the Lender, the Borrower will provide written notice to the Lender, advising the Lender in reasonable detail of the nature and amount of the violation, and the Lender shall have sixty (60) days after receipt of such notice in which to correct such usury violation, if any, by either refunding such excess interest to the Borrower or crediting such excess interest against the Note to which the alleged violation relates and/or the Related Indebtedness then owing by the Borrower to the Lender. All sums contracted for, charged, taken, reserved or received by the Lender for the use, forbearance or detention of any debt evidenced by any Note and/or the Related Indebtedness shall, to the extent permitted by applicable law, be amortized or spread, using the actuarial method, throughout the stated term of such Note and/or the Related Indebtedness (including any and all renewal and extension periods) until payment in full so that the rate or amount of interest on account of any Note and/or the Related Indebtedness does not exceed the Maximum Lawful Rate from time to time in effect and applicable to such Note and/or the Related Indebtedness for so long as debt is outstanding. Notwithstanding anything to the contrary contained herein or in any of the other Loan Documents, it is not the intention of the Lender to accelerate the maturity of any interest that has not accrued at the time of such acceleration or to collect unearned interest at the time of such acceleration.

[Remainder of page intentionally left blank; Signatures to follow.]

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     IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first above written.

BORROWER:
Advanced Environmental Recycling Technologies, Inc.
By:
	Stephen W. Brooks, Co-CEO and Member of Board
	of Directors

Address for Notices:
Post Office Box 1237
Springdale, Arkansas 72765

LENDER:
Liberty Bank of Arkansas
By:
	P. Douglas Lynch, President

Address for Notices:
4706 South Thompson
Suite 101
Springdale, Arkansas 72764

INDEX TO EXHIBITS

Exhibit	Description of Exhibit	Section
A	Borrowing Base Report		1.1
B	Compliance Certificate		1.1
C	Revolving Credit Note		2.1

INDEX TO SCHEDULES

Description of Schedules	Article/Section
Conditions Precedent		5.1	(h)
Debt		6.9.1
Disclosure Schedule	VI

EXHIBIT A

BORROWING BASE REPORT

FOR MONTH ENDED                                                             (THE “SUBJECT MONTH”)

LENDER:	Liberty Bank of Arkansas
BORROWER:	Advanced Environmental Recycling Technologies, Inc.

     This certificate is delivered under the Loan Agreement (the “Agreement”) dated as of January 16, 2006, between Borrower and Lender. Capitalized terms used in this certificate shall, unless otherwise indicated, have the meanings set forth in the Agreement. On behalf of Borrower, the undersigned certifies to Lender on the date hereof that (a) no Default or Event of Default has occurred and is continuing, (b) a review of the activities of Borrower during the Subject Month has been made under my supervision with a view to determining the amount of the current Borrowing Base, (c) the accounts receivable and inventory included in the Borrowing Base below meet all conditions to qualify for inclusion therein as set forth in the Agreement, and all representations and warranties set forth in the Agreement with respect thereto are true and correct in all material respects, and (d) the information set forth below hereto is true and correct as of the last day of the Subject Month.

1.		ACCOUNTS RECEIVABLE (Less Discounts)
	a.	Total Accounts Receivable (less discounts) of which Weyerhaeuser is the account debtor
	b.	Total Accounts Receivable (less discounts) of which Therma-Tru is the account debtor
	c.	Total Other Accounts Receivable (less discounts)
	d.	TOTAL ACOUNTS RECEIVABLE
2.		Less Ineligible Accounts:
	a.	Accounts that have been outstanding for more than the lesser of (1) sixty (60) days past the original date of invoice or the date the obligation was incurred and (2) thirty (30) days past the first date the Account was due
	b.	Accounts not in compliance with applicable laws, rules, and regulations
	c.	Accounts for consignments and non final sales
	d.	Accounts evidenced by chattel paper or an instrument
	e.	Foreign accounts
	f.	Accounts due from the U.S. Government or

		subdivision thereof (with respect to which the Federal Assignment of Claims Act of 1940 has not been complied with)
	g.	Accounts subject to specific assignment restrictions
	h.	Accounts representing commissions or not created in the ordinary course of business or not arising from an enforceable contract, the performance of which has been completed by the Borrower
	i.	Accounts to which the Borrower does not have good and indefeasible title or which are subject to any Lien except Liens in favor of the Lender
	j.	Accounts subject to setoff, counterclaim, defense, dispute, recoupment, or adjustment other than normal discounts for prompt payment
	k.	Accounts with respect to which the account debtor is insolvent or the subject of any bankruptcy or insolvency proceeding or has made an assignment for the benefit of creditors, suspended normal business operations, dissolved, liquidated, terminated its existence, ceased to pay its debts as they become due, or suffered a receiver or trustee to be appointed for any of its assets or affairs
	l.	Accounts with respect to which any default exists
	m.	Accounts with respect to which the account debtor has returned or refused to retain, or otherwise notified the Borrower of any dispute concerning, or claimed nonconformity of, any of the goods from the sale of which the account arose
	n.	Accounts owed by an Affiliate, employee, officer, director or shareholder of the Borrower
	o.	Accounts not payable in Dollars
	p.	The amount of all “contra accounts” and other obligations owed by the Borrower to account debtors
	q.	Other Ineligible Accounts disallowed by Lender in its sole discretion
3.
	a.	Net Total Ineligible Accounts of Which Weyherhauser is the Account Debtor
	b.	Net Total Ineligible Accounts of Which Therma-Tru is the Account Debtor

	c.	Net Total Other Ineligible Accounts
	d.	NET TOTAL INELIGIBLE ACCOUNTS (Sum of Lines 3(a) through 3(c))
4.
	a.	Total Eligible Accounts of Which Weyherhauser is the Account Debtor, multiplied by 85%
	b.	Total Eligible Accounts of Which Therma-Tru is the Account Debtor, multiplied by 85%
	c.	Total Other Eligible Accounts, multiplied by 75%
	d.	TOTAL ACCOUNTS COMPONENT OF BORROWING BASE (Sum of Lines 4(a) through 4(c)
		INVENTORY
5.		Total Finished Goods Inventory, Including Finished Goods Inventory Held at Therma-Tru Facility
		Less the following:
	a.	Finished Goods Inventory not in the possession or under the control of the Borrower
	b.	Finished Goods Inventory not subject to a perfected, first priority security interest in favor of the Lender
	c.	Finished Goods Inventory that has been shipped or delivered to a customer on consignment, a sale-or-return basis, or on the basis of any similar understanding
	d.	Finished Goods Inventory with respect to which a claim exists disputing the Borrower’s title to or right to possession of such inventory
	e.	Finished Goods Inventory that is not in good condition or does not comply with any applicable law, rule, or regulation or any standard imposed by any Governmental Authority with respect to its manufacture, use, or sale
	f.	Other Finished Goods Inventory disallowed by Lender in its sole discretion
	g.	TOTAL NET ELIGIBLE FINISHED GOODS INVENTORY (Sum of Lines 5(a) through 5(f)), multiplied by 75%
6.		Total Other Inventory
		Less the following:
	a.	Inventory not in the possession or under the control of the Borrower
	b.	Inventory not subject to a perfected, first priority security interest in favor of the Lender
	c.	Inventory that has been shipped or delivered to a

		customer on consignment, a sale-or-return basis, or on the basis of any similar understanding
	d.	Inventory with respect to which a claim exists disputing the Borrower’s title to or right to possession of such inventory
	e.	Inventory that is not in good condition or does not comply with any applicable law, rule, or regulation or any standard imposed by any Governmental Authority with respect to its manufacture, use, or sale
	f.	Other Inventory disallowed by Lender in its sole discretion
	g.	TOTAL NET OTHER ELIGIBLE INVENTORY (Sum of Lines 6(a) through 6(f)), multiplied by 50%
7.		BORROWING BASE (Sum of Lines 4(d), 5(g), and 6(g))
8.		AMOUNT OF COMMITMENT
9.		PRINCIPAL BALANCE OF OUTSTANDING REVOLVING CREDIT ADVANCES
10.		LESSOR OF LINE 7 OR 8
11.		AMOUNT AVAILABLE FOR REVOLVING CREDIT ADVANCES IF POSITIVE, OR AMOUNT TO BE REPAID, IF NEGATIVE (Line 10 minus Line 9)

BORROWER:
Advanced Environmental Recycling Technologies, Inc
By:
	Print Name:
	Title: Chief Financial Officer

EXHIBIT B

COMPLIANCE CERTIFICATE

FOR MONTH/QUARTER ENDED                                                                                 (THE “SUBJECT PERIOD”)

LENDER:      Liberty Bank of Arkansas

BORROWER:  Advanced Environmental Recycling Technologies, Inc.

     This certificate is delivered under the Loan Agreement (the “Agreement”) dated as of January 16, 2006, between Borrower and Lender. Capitalized terms when used in this certificate shall, unless otherwise indicated, have the meanings set forth in the Agreement. I certify to Lender that, on the date of this certificate, (a) the financial Statements of Borrower attached to this certificate were prepared in accordance with GAAP, and present fairly the financial condition and results of operations of Borrower as of the end of and for the Subject Period, (b) no Default or Event of Default currently exists or has occurred which has not been cured or waived by Lender, and (c) the status of compliance by Borrower with certain covenants of the Agreement at the end of the Subject Period is as set forth below:

		In Compliance as of
		End of Subject Period
		(Please Indicate)
1.	Financial Statements and Reports
(a) Provide annual audited FYE financial statements within 90 days after the last day of each year, or when otherwise due.		Yes	No
(b) Provide quarterly financial statements within 45 days after the last day of each quarter.		Yes	No
(c) Provide monthly statement of income within 30 days after the last day of each month.		Yes	No
(d) Provide a monthly Compliance Certificate, Borrowing Base Report, and summary accounts receivable aging, within 45 days after the last day of each quarter.		Yes	No
(e) Provide other required reporting timely.		Yes	No
2.	Subsidiaries
	None except as listed on Disclosure Schedule	Yes	No

		In Compliance as of
		End of Subject Period
		(Please Indicate)
3.	Additional Indebtedness
	None, except Indebtedness permitted by Section 8.1 of the Agreement.	Yes	No
4.	Liens and Encumbrances; Negative Pledge Agreements
	None at any time, except Liens permitted by Section 8.2 of the Agreement.	Yes	No
5.	Limitation of Acquisitions and Mergers
	None except those permitted by Section 8.3 of the Agreement.	Yes	No
6.	Dividends and Stock Repurchase
	None, except as permitted by Section 8.4 of the Agreement.	Yes	No
7.	Loans and Investments
	None, except those permitted by Section 8.5 of the Agreement.	Yes	No
8.	Issuance of Equity
	None, except issuances permitted by Section 8.6 of the Agreement.	Yes	No
9.	Affiliate Transactions
	None, except issuances permitted by Section 8.7 of the Agreement.	Yes	No
10.	Disposal of Assets other than in the Ordinary Course of Business
	(Section 8.8 of the Agreement). None at any time without prior
	written consent of Lender.	Yes	No
11.	Sale and Leaseback Transactions (Section 8.9 of the Agreement).
	None at any time without prior written consent of Lender.	Yes	No
12.	Prepayment of Debt (Section 8.10 of the Agreement).
	None at any time without prior written consent of Lender.	Yes	No
13.	Changes in Nature of Business (Section 8.11 of the Agreement).
	None at any time without prior written consent of Lender.	Yes	No
14.	Environmental Laws (Section 8.12 of the Agreement).
	No activity likely to cause violations.	Yes	No
15.	Changes in Fiscal Year; Accounting Practices
	(Section 8.13 of the Agreement).
	None at any time without prior written consent of Lender.	Yes	No
16.	No Negative Pledge (Section 8.14 of the Agreement).
	None.	Yes	No

		In Compliance as of
		End of Subject Period
		(Please Indicate)
18.	Compliance with all Financial Covenants (Article IX):	Yes	No
	(if “No”, explain)

BORROWER:
Advanced Environmental Recycling Technologies, Inc
By:
	Print Name:
	Title: Chief Financial Officer

SCHEDULE 6.9.1
SECURED INDEBTEDNESS SCHEDULE (PREPARED BY BORROWER)

The $14,400,000 City of Springdale, Arkansas Industrial Development Refunding Revenue Bonds (Advanced Environmental Recycling Technologies, Inc. Project) Series 2003 (the “Series 2003 Bonds”) were issued to refund the outstanding City of Springdale, Arkansas Industrial Development Revenue Bonds (Advanced Environmental Recycling Technologies, Inc. Project) Series 1999A (the “Series 1999 Bonds”). The Series 2003 Bonds are issued and secured pursuant to an Indenture of Trust (the “Indenture”), dated as of October 1, 2003, by and between the City of Springdale, Arkansas (the “Issuer”) and Regions Bank, as trustee (the “Trustee”). The proceeds received from the sale of the Series 2003 Bonds were loaned by the Issuer to Advanced Environmental Recycling Technologies, Inc., pursuant to the terms of a Mortgage and Loan Agreement, dated as of October 1, 2003 (the “Loan Agreement”), between AERT and the Issuer. The Bonds are held by Allstate Insurance Company.

At substantially the same time as the issuance of the Bonds, the Company delivered a Promissory Note (the “Taxable Note”) to Allstate in the principal amount of $2,600,000 and bearing interest at the rate of 19.75%,. Proceeds of the Taxable Note shall be applied to the repayment of certain related-party indebtedness of the Company and to the payment of certain capital improvements of the Company.

In order to secure the payment of the Bonds, the Company granted to the City a mortgage and security interest in the real property of the Company in Springdale, Arkansas (the “Site”) and the improvements located thereon (the “Improvements”) and any fixtures or appurtenances now or hereafter erected thereon. The Company also granted a security interest in all rents and leases, profits, royalties, minerals, geothermal resources, oil and gas rights and profits, easements and access rights, used, belonging to, or in any way connected with the Property, the property of the Company in Lowell, Arkansas and the property of the Company in Junction, Texas and in Company revenues, and in all of its right, title and interest, if any, in the trust accounts referred to in the Loan Agreement or in the Indenture, in all tangible personal property, furniture, machinery and equipment of the Company, owned by the Company as of the date of the Loan Agreement and located on the Site, the Lowell Property or the Junction Property (the “Equipment”), and in inventory of the Company located on the Site the Lowell Property or the Junction Property. The mortgage and security interest of the City were assigned to the Trustee pursuant to the Assignment and the Indenture. The Company also grants a security interest to the Trustee in all patents, trademarks and similar properties, pursuant to the Patent and Trademark Security Agreement

In December 2001, the Company executed a supply contract with Weyerhaeuser for the purchase of ChoiceDek ® product over a three-year period (the “Weyerhaeuser Agreement”). As additional security for the Bonds, the Company executed a collateral assignment of the Weyerhaeuser Agreement for the benefit of the Trustee.

To secure the Taxable Note, the Company provided subordinate lien instruments in all collateral pledged for the benefit of the Bonds.

The Company has also executed a Promissory Note for the benefit of Liberty Bank with respect to and secured by certain Springdale property.

DISCLOSURE SCHEDULE TO LOAN AGREEMENT

I.	Subsidiaries – AERT has no subsidiaries.
II.	Intellectual property – All AERT patents are listed below:

Patent No.	Title
6,526,712	Extruded composite interlocking corner assembly
6,149,012	System and method for cleaning and recovering plastic from coated fiber polywaste
5,540,244	Method and apparatus for cleaning and recycling post-consumer plastic films
5,351,895	Separating device for cellulosic and thin plastic materials
5,285,973	Close tolerance shredder
5,277,758	Method for recycling plastic coated paper product waste and polymeric film
5,268,074	Method for recycling polymeric film
5,213,021	Reciprocating cutter assembly
5,100,545	Separation tank
5,096,406	Extruder assembly for composite materials
5,096,046	System and process for making synthetic wood products from recycled materials
5,088,910	System for making synthetic wood products from recycled materials
5,084,135	Recycling plastic coated paper product waste
5,082,605	Method for making composite material

III. Existing debt

	Note Amount
Note Holder	Availability		Maturity Date	Collateral
Brooks Investment Company	$	1,146,775	Due on demand	Unsecured
JRF		53,071	August 5, 2006	Insurance policies
JRF		146,757	February 5, 2006	Insurance policies
Liberty Bank		1,932,000	September 28, 2009	Real estate and equipment
Regions Bank		2,000,000	March 1, 2006	Equipment
Ford Motor Credit		66,777	Various	Vehicles
Allstate — Note		2,600,000	October 1, 2017	Subordinated interest in the collateral securing the bonds payable
Regions/Allstate — Bonds		12,900,000	October 1, 2017	All real estate and improvements, fixed assets and inventory not pledged under a separate loan, patents and trademarks, pledged revenues, personal guarantee of Marjorie Brooks

IV. Depository Banks

First Security Bank	PO Box 1009, 314 North Spring, Searcy, AR 72143
First State Bank	2002 Main, PO Box 105, Junction, TX 76849
Regions Bank	400 West Capitol, 7th Floor, Little Rock, AR 72201
Liberty Bank of Arkansas	PO Box 7514, Jonesboro, AR 72403

EX-10.50

Exhibit 10.50

PROMISSORY NOTE
(Revolving Line of Credit)

Springdale, Arkansas January 16, 2006

$15,000,000.00 or so much thereof
as may have been advanced, to or for
the benefit of Maker

     FOR VALUE RECEIVED, ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC., a Delaware corporation whose local mailing address is Post Office Box 1237, Springdale, Arkansas 72765, (“Maker”), promises to pay LIBERTY BANK OF ARKANSAS, an Arkansas state chartered bank whose local mailing address is 4706 South Thompson, Suite 101, Springdale, Arkansas 72764, Attn: P. Douglas Lynch, its successors and/or assigns (“Holder”), or to order, a principal sum not to exceed the lessor of (i) Fifteen Million and No/100 Dollars ($15,000,000.00) and (ii) an amount that would be in excess of the Borrowing Base (as defined in the Loan Agreement (as defined below)), together with interest thereon from the date hereof, calculated at the Interest Rate as payable as set forth below. Maker agrees and acknowledges that Holder is obligated to advance funds to Maker pursuant to this Note only for the sole, absolute and limited purpose of providing a revolving line of credit for Maker for working capital in connection with the operation of its business. Holder shall have no obligation to advance funds under this Note for any other purpose.

     1. Definitions. The following definitions are applicable to the words, phrases or terms used in this Note:

          (a) The term “Default Rate” shall mean the highest rate of interest permitted under Arkansas law at the time of the occurrence of the Event of Default or immediately following Maturity.

          (b) The term “Event of Default” shall mean the occurrence of any of the following:

               (i) A failure by Maker to make any payment of principal or interest on the Note within ten (10) days after such payment is due;

               (ii) The failure of Maker to comply with any condition or covenant set forth herein or in any of the Loan Instruments after the expiration of any applicable notice and cure period; or

               (iii) The occurrence of any Event of Default, as that term is defined in the Loan Agreement.

          (c) The term “Guarantor” shall mean Marjorie S. Brooks, an individual and resident of the State of Arkansas.

          (d) The term “Guaranty” shall mean that certain Guaranty Agreement, of even date herewith, executed by the Guarantor for the benefit of Holder, guaranteeing, as set forth therein, among other things, this Note.

          (e) The term “Interest Rate” shall mean:

               (1) From the date hereof through and until January 16, 2007, that being Scheduled Maturity, a rate equal to the Wall Street Journal Prime Rate plus one hundred (100) basis points, adjusted daily; and

               (2) On and after Maturity, the Default Rate.

          (f) The term “Loan Agreement” shall mean that certain Loan Agreement executed of even date herewith by Maker as borrower and Holder as lender.

          (g) The term “Loan Instruments” shall mean this Note, the Guaranty, the Loan Agreement, the Security Agreement executed of even date herewith with Maker as grantor and Holder as lender (the “Security Agreement”), and any and all other documents, instruments, agreements or certificates relating to the indebtedness evidenced by this Note, whether any such documents presently exist or are hereafter created.

          (h) The term “Maturity” shall mean the earlier to occur of:

               (1) January 16, 2007 (“Scheduled Maturity”); or

               (2) the date on which Holder declares all sums due and payable hereunder after an Event of Default.

          (i) The term “Note” shall mean this Promissory Note.

          (j) The term “Per Annum” with respect to the Interest Rate shall mean a year consisting of three hundred sixty (360) days.

          (k) The term “Wall Street Journal Prime Rate” shall mean the rate of interest equal to the prime rate on corporate loans posted by at least seventy-five percent (75%) of the nation’s thirty (30) largest banks as published daily in the Wall Street Journal, Southwest Edition, or, in the absence of such published rate, such other reference or benchmark rate of interest that is established by the Holder as its index rate to be in effect from time to time, whether or not such rate is otherwise published, and which is used for its customers previously tied to a Wall Street Journal Prime Rate of interest.

     2. Advancement Terms. Advances under this Note shall be made consistent with the procedures set forth in the Loan Agreement, up to an aggregate principal balance not to exceed the lessor (i) Fifteen Million and No/100 Dollars ($15,000,000.00) and (ii) an amount that would be in excess of the Borrowing Base (as defined in the Loan Agreement), it being expressly understood, acknowledged, and agreed that Lender shall have the sole and absolute discretion to approve or disapprove of applications for advances made by Maker

2

     3. Repayment Terms. Maker promises to pay all sums advanced to or for the benefit of Maker under this Note as follows:

          (a) Commencing on February 16, 2006, and continuing on the same day of each successive month thereafter until Scheduled Maturity, consecutive payments of accrued but unpaid interest calculated on principal advanced and outstanding hereunder from time to time, said interest to be calculated at the Interest Rate;

          (b) The Borrower must pay upon DEMAND the amount by which at any time the unpaid principal balance of this Note, plus all accrued but unpaid interest, cost, fees, and other charges, exceeds the Borrowing Base (as defined in the Loan Agreement); and

          (c) The balance of unpaid principal of this Note with all accrued but unpaid interest and all other fees, costs, charges and expenses shall be due and payable on Scheduled Maturity. It is understood that a balloon payment of all outstanding principal, plus accrued interest, will be due at Scheduled Maturity, and that Holder is not obligated to finance that balloon payment.

     4. Acceleration of Scheduled Maturity. Notwithstanding the terms and conditions of this Note in respect to the payment of principal and interest to the contrary, Holder shall have the right to accelerate Scheduled Maturity for the payment of the indebtedness of this Note, and the unpaid principal and interest due Holder shall become due and payable at once and without notice in the event Maker shall commit any Event of Default under this Note or any of the Loan Instruments, including the Loan Agreement, and such failure is not cured within any applicable notice and cure period.

     5. Prepayment. Maker may prepay this Note in whole or in part at any time without penalty.

     6. Limitation on Interest. In no contingency, whether by reason of acceleration of the Scheduled Maturity of this Note or otherwise, shall the interest contracted for, charged or received by Holder exceed the maximum amount permissible under applicable law. If, from any circumstance whatsoever, interest would otherwise be payable to Holder in excess of the maximum lawful amount, the interest payable to Holder shall be reduced to the maximum amount permitted under applicable law; and, if from any circumstance the Holder shall ever receive anything of value deemed interest by applicable law in excess of the maximum lawful amount, an amount equal to any excessive interest shall be applied to the reduction of the principal of this Note and not to the payment of interest, or if such excessive interest exceeds the unpaid balance of principal of the Note such excess shall be refunded to Maker. All interest paid or agreed to be paid to Holder shall, to the extent permitted by applicable law, be amortized, pro-rated, allocated, and spread throughout the full period until payment in full of the principal of the Note (including the period of any renewal or extension thereof) so that interest thereon for such full period shall not exceed the maximum amount permitted by applicable law.

     7. Remedies; Nonwaiver. Failure of Holder to exercise any right or remedy available to Holder upon the occurrence of an Event of Default shall not constitute a waiver on the part of Holder of the right to exercise any such right or remedy for that Event of Default or

3

any subsequent Event of Default. The exercise of any remedy by Holder shall not constitute an election of any such remedy to the exclusion of any other remedy afforded Holder at law or in equity, all such remedies being nonexclusive and cumulative. If an Event of Default occurs under this Note and this Note is referred to an attorney at law for collection, Maker agrees to pay all costs incurred by Holder incident to collection, including but not limited to reasonable attorneys’ fees in an amount not to exceed ten percent (10%) of the principal and accrued interest then due hereunder, enforceable as a contract of indemnity, plus all court costs and other expenses incurred at or prior to trial and in connection with any and all appeals. If reasonable attorneys’ fees exceed the amount for which Maker is liable under this contract of indemnity, a court may, in its discretion, award Holder additional attorneys fees pursuant to A.C.A. § 16-22-308, and such will also be secured by all liens given as security for this Note.

     8. Application of Payments. Payments received on this Note shall be applied first to accrued interest, then to reimburse Holder for any advances made to preserve or protect any property given as security for this Note or to protect or maintain the priority of Holder’s lien on or security interest therein, and any costs and expenses related thereto, and the balance shall be applied to principal. If any sum owed by Maker to Holder is unsecured, the unsecured portion of the indebtedness shall be completely paid prior to the payment of the secured portion of such indebtedness, and all payments made on account of the indebtedness shall be considered to have been paid on and applied first to the complete payment of the unsecured portion of the indebtedness. Similarly, if any sum advanced by Holder to or for the benefit of Maker, or to protect Holder’s security for this Note, shall not be used for construction of improvements on the land described in the Mortgage, or shall otherwise not be secured by a lien entitled to the special priority accorded by A.C.A. § 18-44-110, that portion of the indebtedness shall be completely paid prior to the payment of any portion of the indebtedness which is entitled to such priority, and all payments made on account of the indebtedness shall be considered to have been paid on and applied first to the complete payment of that portion of the indebtedness not entitled to special priority.

     9. Place for Payment. Unless otherwise designated in writing mailed or delivered to Maker, the place for payment of the indebtedness evidenced by this Note shall be as follows:

Liberty Bank of Arkansas
Attention: P. Douglas Lynch, President
4706 South Thompson, Suite 101
Springdale, Arkansas 72764

     10. Waivers. Except as otherwise specifically provided herein, the Maker, endorsers, sureties and guarantors hereof, if any, severally waive presentment, protest and demand, notice of protest, demand, dishonor and nonpayment of this Note, and expressly agree that this Note may be renewed in whole or in part, or any nonpayment hereunder may be extended, or a new note of different form may be substituted for this Note, or the rate of interest may be changed, or changes may be made in consideration of the extension of the Scheduled Maturity date hereof, or any combination thereof, from time to time, but, in such events, neither Maker nor any guarantor will be released from liability by reason of the occurrence of any such event, nor shall Holder hereof be deemed by the occurrence of any such event to have waived or surrendered, either in whole or in part, any right it otherwise might have.

4

     11. Waiver of Jury Trial. EACH PARTY HERETO HEREBY IRREVOCABLY WAIVES ANY AND ALL RIGHTS IT MAY HAVE TO DEMAND THAT ANY ACTION, PROCEEDING, OR COUNTERCLAIM ARISING OUT OF OR IN ANY WAY RELATED TO THIS AGREEMENT OR THE RELATIONSHIPS OF THE PARTIES HERETO BE TRIED BY JURY. THIS WAIVER EXTENDS TO ANY AND ALL RIGHTS TO DEMAND A TRIAL BY JURY ARISING FROM ANY SOURCE INCLUDING, BUT NOT LIMITED TO, THE CONSTITUTION OF THE UNITED STATES OF OR ANY STATE THEREIN, COMMON LAW OR ANY APPLICABLE STATUTE OR REGULATIONS. EACH PARTY HERETO ACKNOWLEDGES THAT IT IS KNOWINGLY AND VOLUNTARILY WAIVING ITS RIGHT TO DEMAND TRIAL BY JURY.

     12. Security. Payment of the indebtedness evidenced by this Note is secured by (1) the liens and encumbrances set forth in the Security Agreement; (2) the other Loan Instruments; and (3) any UCC Financing Statements to be filed by Holder. Additionally, Maker grants Holder a continuing lien to secure payment of the indebtedness evidenced by this Note upon any and all deposits, monies or other property of value owned or belonging to Maker, and the proceeds thereof, now or hereafter held or received by, or in transit to, Holder from or for the account or benefit of Maker, whether for safekeeping, custody, pledge, transmission, collection or otherwise, and also upon any and all credits or other property of value due or to become due from Maker, and any and all claims of Maker against Holder, at any time existing. Upon an Event of Default, Holder shall have the right and privilege, without the necessity or requirement of notice to Maker or any endorsers or guarantors hereof, to set off, appropriate and apply any and all property of Maker generally referred to in this Note against the outstanding indebtedness evidenced by this Note.

     13. Controlling Law. This entire transaction and all terms and provisions in this Note shall be governed by the laws of the State of Arkansas; provided however, notwithstanding anything to the contrary herein, the interest rate to be charged by Holder, including any fees or other charges which may be deemed to be interest, shall be governed by federal law, specifically Section 731 of the Gramm-Leach-Bliley Act, Codified as 12 U.S.C. § 1831u(f), and the law of the state having the highest permissible interest rate which, as of the date hereof, is the home state to an insured depository institution that has a branch in Arkansas.

     14. Late Charge. If any payment by Maker shall be received by Holder more than ten (10) calendar days after it shall be due, Maker shall pay a late charge for each such late payment equal to five percent (5%) of the late payment.

[Remainder of page intentionally left blank; Signatures to follow.]

5

EXECUTED AND EFFECTIVE as of the day and year first above written.

MAKER:
Advanced Environmental Recycling Technologies, Inc
By:
	Stephen W. Brooks, Co-CEO and Director

This instrument was prepared by:
Jason Bramlett
Friday, Eldredge & Clark, LLP
3425 N Futrall Drive, Suite 103
Fayetteville, Arkansas 72703

6

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Advanced Environmental Recycling Technologies, Inc. Registration Statements on Form S-3 (No. 333-42555) and on Form S-3 (No. 333-93763) and on Form S-8 (No. 333-120604) of our report, dated March 30, 2006, on the financial statements of Advanced Environmental Recycling Technologies, Inc. at December 31, 2005 and 2004, and for each of the three years ended December 31, 2005.

/s/ TULLIUS TAYLOR SARTAIN & SARTAIN LLP

Fayetteville, Arkansas
March 30, 2006

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Joe G. Brooks, the chairman, co-chief executive officer, and president, certify that:

1.	I have reviewed this annual report on Form 10-K of Advanced Environmental Recycling Technologies, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 31, 2006

/s/ JOE G. BROOKS

Joe G. Brooks

Chairman, Co-Chief Executive Officer and

President

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Stephen W. Brooks, the co-chief executive officer, certify that:

1.	I have reviewed this annual report on Form 10-K of Advanced Environmental Recycling Technologies, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 31, 2006

/s/ STEPHEN W. BROOKS

Stephen W. Brooks

Co-Chief Executive Officer

EX-31.3

Exhibit 31.3

CERTIFICATION

I, Robert A. Thayer, the chief financial officer, certify that:

1.	I have reviewed this annual report on Form 10-K of Advanced Environmental Recycling Technologies, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 31, 2006

/s/ ROBERT A. THAYER

Robert A. Thayer

Chief Financial Officer

EX-32.1

Exhibit 32.1

OFFICER CERTIFICATION

PURSUANT TO 18 U.S.C. 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Advanced Environmental Recycling Technologies, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Joe G. Brooks, chairman, co-chief executive officer and president of the Company, certify pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 31, 2006

/s/ JOE G. BROOKS

Joe G. Brooks

Chairman, Co-Chief Executive Officer and President

EX-32.2

Exhibit 32.2

OFFICER CERTIFICATION

PURSUANT TO 18 U.S.C. 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Advanced Environmental Recycling Technologies, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Stephen W. Brooks, co-chief executive officer of the Company, certify pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 31, 2006

/s/ STEPHEN W. BROOKS

Stephen W. Brooks

Co-Chief Executive Officer

EX-32.3

Exhibit 32.3

OFFICER CERTIFICATION

PURSUANT TO 18 U.S.C. 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Advanced Environmental Recycling Technologies, Inc. (the “Company”) on Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Robert A. Thayer, chief financial officer of the Company, certify pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 31, 2006

/s/ ROBERT A. THAYER

Robert A. Thayer

Chief Financial Officer