ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES INC - 10-Q Quarterly Report

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United States Securities and Exchange Commission
Washington, D.C. 20549

FORM 10-Q

(X) Quarterly Report Pursuant To Section 13 or 15(d)
Of The Securities Exchange Act of 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

Commission File Number 1-10367

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

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

914 NORTH JEFFERSON STREET
SPRINGDALE, ARKANSAS 72764
(Address of Principal Executive Office) (Zip Code)

Registrant's telephone number, including area code:
(479) 756-7400

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 shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
YES: X NO:

As of June 30, 2002, the number of shares outstanding of the Registrant's Class
A Common Stock, which is the class registered under the Securities Exchange Act
of 1934, was 28,315,340 and the number of shares outstanding of the Registrant's
Class B Common Stock was 1,465,530.

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

Form 10-Q Index

PART I - FINANCIAL INFORMATION

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

BALANCE SHEETS

ASSETS

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

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ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS' EQUITY

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

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ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

STATEMENTS OF OPERATIONS (UNAUDITED)

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

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ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC.

STATEMENTS OF CASH FLOWS (UNAUDITED)

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

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NOTES TO FINANCIAL STATEMENTS

NOTE 1: UNAUDITED INFORMATION

Advanced Environmental Recycling Technologies, Inc., has prepared the
financial statements included herein without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). However, all
adjustments have been made to the accompanying financial statements which are,
in the opinion of the Company's management, of a normal recurring nature and
necessary for a fair presentation of the Company's operating results. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are adequate to
make the information presented herein not misleading. It is recommended that
these financial statements be read in conjunction with the financial statements
and the notes thereto included in the Company's latest annual report on Form
10-K. The Company has reclassified certain prior period amounts to conform to
the current period presentation.

NOTE 2: DESCRIPTION OF THE COMPANY

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

NOTE 3: FUTURE OPERATIONS

The financial statements of the Company have been prepared on the basis
of accounting principles applicable to a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. At June 30, 2002, the Company had a working capital deficit of
$4,351,919. Prior to 2001, the Company had incurred net losses in each year
since its inception in 1989. With the profitability of the second quarter ended
June 30, 2002, the Company now has produced five consecutive profitable
quarters. The Company on its own has limited financial resources, and in the
past few years has, in large part, been supported by financing from certain
major shareholders and several accredited investors. As discussed in the
following paragraphs, the Company may require additional financial resources in
order to complete its production plan on a timely basis and fund maturities of
debt and other obligations as they become due.

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The ability of the Company to continue as a going concern is dependent
upon the ongoing support of its stockholders, investors, customers and
creditors, and its ability to continue to successfully mass-produce and market
its products at economically feasible levels however, there is no assurance or
commitment for their ongoing support.

The Company is continuing to refine its production plans, which
management believes will continue to improve operating efficiencies, as compared
to prior periods. The plan includes increasing production capacity, further
automating the production process, improving existing throughputs and
efficiencies, reducing costs and better utilizing raw materials. Implementation
of the full production plan will aid the Company in receiving the proceeds from
the bond financing (discussed below) or in obtaining additional debt or equity
financing beyond those resources currently available to the Company.

In October 1999, the Company entered into an agreement with the City of
Springdale, Arkansas for the issuance of $16.5 million principal amount of
Series 1999 industrial development revenue bonds. The bonds are private activity
bonds issued for a limited number of purposes, including solid waste disposal
projects. Cash deposits sufficient to retire the debt currently secure the
bonds. If the Company is successful in remarketing the bonds, the Company
anticipates reducing its working capital deficit by paying off approximately
$2.0 million of bridge notes and satisfying certain other short-term liabilities
that have been incurred in significant part to purchase equipment for its
Springdale plant or finance other capital assets. The Company is now attempting
to remarket the bonds on terms that it finds acceptable. If the Company is
unsuccessful in remarketing the bonds, and if alternative expansion financing is
also not available, it could slow the Company's expansion plans, limit its
ability to increase decking production to meet customer demand and would require
the Company to make other mutually agreeable provisions for the payment of its
outstanding short-term debts of which there can be no assurance. If the bonds
are not remarketed by October 16, 2003, the Company will be required to buy them
back.

As previously indicated, the Company had a working capital deficit of
$4,351,919 at June 30, 2002. This is primarily due to the investment of cash
from operations to fund ongoing expansion, as well as the incurrence of
short-term loans from related parties and vendor financing assistance for such
purposes. Since January 1, 2002, commitments for expansion projects completed or
that are underway have amounted to approximately $2.1 million. This expansion,
as well as other proposed expansion, will continue to result in a negative
working capital position until proceeds of the bonds are released. There is no
assurance the Company will be able to further improve operating efficiencies and
meet its production plan goals or that the Company will be successful in
remarketing the bonds.

NOTE 4: 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 and cash equivalents, current
maturities of long-term debt and current notes payable.

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Those changes, shown as an (increase) decrease in current assets and an
increase (decrease) in current liabilities for the six months ended June 30, are
as follows:

Supplemental Disclosure of Non-Cash Investing and Financing Activities:

NOTE 5: SIGNIFICANT ACCOUNTING POLICIES

REVENUE RECOGNITION POLICY

Revenue is recognized at the time of shipment.

INVENTORIES

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

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USE OF ESTIMATES

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

RESEARCH AND DEVELOPMENT

Expenditures relating to the development of new products and processes,
including significant improvements to existing products, are expensed as
incurred.

NOTE 6: INCOME TAXES

No income tax provision was recorded for the six months ended June 30,
2002 and 2001, due to the realization of previously unrecognized net operating
loss carryforwards.

NOTE 7: COMMITMENTS AND CONTINGENCIES

The Company was sued by Three H Enterprises, LLC, (3-H) an entity
specifically established to acquire the rights to a previous dispute, in May
2000 in the Western District of Texas for breach of contract, seeking royalties
allegedly owed but unpaid from a 1987 settlement of prior litigation against a
predecessor entity and two members of the Brooks family. Following the trial
during the fourth quarter of 2001, the court rendered a judgment on July 16,
2002, ordering the Company to pay $820,000 for past royalties on production from
the Junction plant, $240,000 in prejudgment interest and post judgment interest
at two percent per annum until paid, if the judgment is upheld on appeal. 3-H
has moved to amend the judgment seeking recovery of its attorneys' fees. This
issue remains pending before the district court. The Company has appealed the
judgment to the Fifth Circuit Court of Appeals and plans to post a bond pending
the outcome of the appeal. Although the district court declined to grant 3-H's
request for an order requiring ongoing royalty payments from the Texas plant,
there can be no assurance that 3-H will not file suit again and attempt to seek
ongoing royalty payments. There is also no assurance that the Company will be
successful upon appeal or that all or a portion of the plaintiff's attorneys'
fees will not be awarded. The Company believes these actions are without merit
and will continue to defend itself appropriately.

NOTE 8: 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:

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

o Whose operating results are regularly reviewed by the
enterprise's chief operating decision-maker; and,

o For which discrete financial information is available.

As of June 30, 2002, 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:

NOTE 9: 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 replaces
the presentation of Primary EPS with Basic EPS and requires dual presentation of
Basic and Diluted EPS on the face of the statements of operations and requires a
reconciliation of the numerator and denominator of the

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Basic EPS computation to the numerator and denominator of the Diluted EPS
computation. Basic EPS excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that then shared in the earnings of the Company. Diluted EPS is computed
similarly to Fully Diluted EPS pursuant to Accounting Principles Board Opinion
No. 15, "Earnings Per Share".

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

The Company has additional options and warrants that were not included
in the calculation of diluted earnings per share (EPS). Those options (for
525,000 shares and for 675,000 shares) and warrants (for 2,333,933 shares) were
either antidilutive and/or not exercisable during the three and six

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months ended June 30, 2002, respectively. 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.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

General

ADVANCED ENVIRONMENTAL RECYCLING TECHNOLOGIES, INC. develops,
manufactures and markets composite building materials that can be used as an
alternative to traditional wood products for exterior applications in building
and remodeling homes. We use waste wood fiber and reclaimed polyethylene
plastics as our raw materials. Our products are comprised of approximately equal
amounts of wood and plastic, have been extensively tested and are used by
several leading national companies, such as the Weyerhaeuser Company
(Weyerhaeuser), Lowe's Companies, Inc. (Lowe's) and Therma-Tru Corporation. On
April 26, 2001, our decking, handrails and stair applications received a
national evaluation report "NER" code rating under NER-596. The NER rating
provides local building inspectors and code officials with independent testing
and installation information regarding our products. The receipt of this rating
also allowed our decking products to expand into additional markets during 2001.
Our products are marketed under the trade names LifeCycle(R), MoistureShield(R),
Weyerhaeuser ChoiceDek(R) Classic, Weyerhaeuser ChoiceDek(R) Plus and
Weyerhaeuser ChoiceDek(R) Premium. Our decking distribution is with Weyerhaeuser
Building Materials with 71 customer service centers across the US and Canada,
providing logistics services to manufacturers, lumber dealers and home centers.
During January 2001, we introduced an exterior trim and fascia system under the
trade name MoistureShield(R) CornerLoc(TM). In the first quarter of 2002, we
introduced ChoiceDek Premium into Lowe's and introduced a new composite handrail
and deck post system.

Our sales are primarily in the following markets:

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

o Exterior door, window and housing trim components.

We currently operate two manufacturing and recycling facilities. Our
Junction, Texas facility currently manufactures primarily decking and decking
components, ChoiceDek Classic and ChoiceDek Premium, on two extruder lines. Our
door, window and housing trim components (MoistureShield) are manufactured at
our Springdale, Arkansas facility, along with our LifeCycle, ChoiceDek Plus, and
ChoiceDek Premium lines of decking products, and our heavy industrial flooring.
We now have three extruder lines and a plastic recycling facility in operation
at our Springdale, Arkansas location. We have focused on improving our
manufacturing efficiencies and reducing our manufacturing costs at the Junction
and Springdale manufacturing facilities. Because of increased demand for our
products, two of the existing extrusion lines at the Springdale manufacturing
facility were upsized during the second quarter of 2002, and a fourth composite
extrusion line will be added during the third quarter of 2002. A second plastic

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recycling facility and a third composite extrusion facility are also planned for
Springdale. The timeliness of the implementation of the projects are subject to
the availability of financing from either the proceeds of our industrial
development bond financing currently held in escrow or from other debt or equity
financing; however, there is no assurance that additional financing can be
acquired (see Liquidity and Capital Resources). In 2001, we opened a plastic
recycling warehouse and transfer facility in Springdale, Arkansas, and increased
our plastic collection efforts, in preparation for building the additional
plastic recycling plant.

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

RESULTS OF OPERATIONS

QUARTER ENDED JUNE 30, 2002 COMPARED TO QUARTER ENDED JUNE 30, 2001

Net sales increased to $10,289,049 for the quarter ended June 30, 2002,
which represented an increase of $2,003,166 or 24.2% over the quarter ended June
30, 2001. The second quarter 2002 composite net sales consisted of decking
product (ChoiceDek) sales of $8,160,258, and door, window and housing trim
component (MoistureShield) sales of $2,128,791. These figures compare with
second quarter 2001 ChoiceDek sales of $6,473,567 and MoistureShield sales of
$1,812,316.

The Springdale plant reported composite net sales of $6,646,898 in the
second quarter of 2002, compared to $4,364,850 in the second quarter of 2001, a
52% increase. The Junction, Texas plant net sales decreased to $3,642,151 in the
second quarter of 2002, from $3,921,033 in the second quarter of 2001, a 7%
decrease. As a result of upgrades made in the extrusion department, the Texas
plant now has two larger extrusion lines. This move streamlined and focused the
products produced at the Texas plant and helped make it more efficient.

Cost of goods sold increased $1,692,089, from $5,921,014 for the
quarter ended June 30, 2001, to $7,613,103 in 2002. As a percentage of sales,
cost of goods sold increased 2.5% to 74.0% for the quarter ended June 30, 2002,
as compared to 71.5% for the same period in 2001. The major changes in cost of
goods sold were as follows: raw materials, as a percentage of sales, decreased
3% to 20.8% in 2002 from 23.8% in the second quarter of 2001; direct labor
increased 1% as a percentage of sales to 17.3% in 2002 from 16.3% in the second
quarter of 2001; and manufacturing overhead increased 4.7% as a percentage of
sales to 36% in 2002 from 31.3% for the second quarter of 2001. The Springdale
plant cost of goods sold increased as a percentage of sales by 3% to 72% in
2002, from 69% in 2001. The Texas plant cost of goods sold increased 3.9% to
77.7% in 2002, from 73.8% in 2001.

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The increase in manufacturing overhead costs in the second quarter of
2002 was primarily due to outsourcing charges from third party vendors required
to finish components for a new railing system while additional equipment to
perform this work in-house was being installed during the quarter. The
outsourcing was required in order to meet customer deadlines, and cost
approximately $478,000. The Company is installing the required equipment to
bring these additional processes in-house in order to reduce the outsourcing
expenses during the third quarter of 2002.

Significant cost categories were as follows for the quarter ended June
30:

Selling, general and administrative expenses decreased $36,080 in the
second quarter of 2002 to $1,951,405, compared to $1,987,485 for 2001. The
decrease was due to decreases in travel and meals, professional fees, factoring
fees and commissions. Professional fees decreased $215,938. Some of the
decreases were offset by increases in salaries and wages. As a percentage of
sales, selling and administrative expenses decreased to 19% from 24% in 2001.

Net income for the quarter ended June 30, 2002 was $413,391. This is an
earnings improvement of $343,625 when compared to the net income of $69,766 for
the second quarter of 2001. There can be no assurance that the Company can
attain its anticipated continued operating improvements, that raw material costs
will not increase and that additional sales price increases will be possible or
that its additional production efficiencies and resultant unit cost reductions
required for sustained profitability will occur.

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SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001

Net sales increased to $19,571,728 for the six months ended June 30,
2002, which represented an increase of $3,419,843 or 21.2% over the same period
a year ago. The six months composite net sales consisted of decking product
(ChoiceDek) net sales of $15,939,531, and door, window and housing trim
components (MoistureShield) net sales of $3,632,197. These figures compare to
the same period a year ago of ChoiceDek net sales of $12,887,909 and
MoistureShield net sales of $3,263,976.

The Springdale, Arkansas plant reported composite net sales of
$12,723,411 for the six month period ended June 30, 2002, compared to $8,731,524
for the same period a year ago, which represented a 46% increase. The Junction,
Texas plant net sales decreased to $6,848,317 for the six month period ended
June 30, 2002, from $7,420,360 for the same period a year ago, an 8% decrease.
This decrease in sales was the result of limited plant downtime and making
improvements and upgrades in Junction. As a result of upgrades made in the
extrusion department, the Texas plant now has two larger extrusion lines. This
move streamlined and focused the products produced at the Texas plant and helped
make it more efficient.

Cost of goods sold increased $2,645,370 from $11,786,660 for the six
month period ended June 30, 2001, to $14,432,030. As a percentage of sales, cost
of goods sold increased 0.7% to 73.7% for the six month period ended June 30,
2002, as compared to 73.0% for the same period a year ago. The major changes in
cost of goods sold were as follows: as a percentage of sales, raw material
decreased 3.2%, direct labor increased 0.8%, and manufacturing overhead
increased 3.2%. The Springdale plant cost of goods sold increased 0.4% as a
percentage of sales to 70.2% for the six month period in 2002, from 69.8% for
the same period in 2001. The Junction plant cost of goods sold increased 3.7%
for the six month period in 2002, from 76.7% for the same period in 2001.

The increase in manufacturing overhead costs in the six month period
ended June 30, 2002 was outsourcing charges from third party vendors to finish
components for a new railing system while additional equipment to perform this
work in-house was being installed. The outsourcing was required to meet customer
deadlines, and cost approximately $903,000, which was 4.6% of net sales. The
Company is installing the required equipment to bring these additional processes
in-house during the third quarter.

Significant cost categories were as follows for the six months ended
June 30:

Selling, general and administrative expenses increased $120,804 for the
six month period ended June 30, 2002 to $3,850,062 when compared to $3,729,258.
However, this was a decrease of 3.4% as a percentage of sales to 19.7% for the
six month period in 2002 from 23.1% for the same period in 2001. The percentage
decrease was due to decreases in travel and meal expenses, professional fees,
factoring fees, and commissions. Some of the decreases were offset by increases
in salaries and wages.

Net income for the six month period ended June 30, 2002 was $621,834.
This is an earnings improvement of $583,220 when compared to net income of
$38,614 for the same period in 2001. There can be no assurance that the Company
can attain its anticipated continued operating improvements, that the raw
material costs will not increase and that sales price increases will be
possible, or that its additional production efficiencies and resultant unit cost
reductions required for sustained profitability will occur.

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LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2002, the Company had a working capital deficit of $4.35
million compared to a working capital deficit of $4.54 million at December 31,
2001. The reduction in the working capital deficit is primarily attributable to
the Company improving its production processes, reducing costs, paying down its
notes payable and consistently making a profit. The Company's continued capital
expansion for customer requirements contributed to the deficit not being further
reduced during the period. The Company expended approximately $1.3 million on
capital projects during the quarter ended June 30, 2002. Management's decision
in recent years to finance significant capital expenditures with short-term
bridge loans continues to contribute to the working capital deficit. Of such
deficit, involving liabilities of approximately $27.5 million as of June 30,
2002, $16.5 million was for bonds payable, which is currently escrowed and
offset by a $16.5 million restricted bond escrow fund, $2.9 million was to the
Company's major shareholder or companies controlled by her, $2.0 million was in
short term bridge loans, and approximately $4.1 million was in payables. The
$4.35 million working capital deficit reflects management's decision to enter
into short-term debt financing, while the Company has expanded, built and
improved its production and sales capacities to increase cash flows from
operations. The Company's plan was to issue short-term debt and refinance in the
future, rather than enter into what it felt would have been more expensive and
dilutive equity financing at that time. The Company generated sufficient cash
flow to more than cover debt service in the second quarter of 2002. Cash flow
available for debt service was approximately $1.5 million, up 36% from $1.1
million for the quarter ended June 30, 2001.

The Company closed a $16.5 million tax-exempt bond financing into
escrow during the fourth quarter of 1999, intended to refinance existing
obligations and shift construction and expansion related accounts payable into
long-term financing. The bonds were subject to mandatory tender for purchase by
the Company in whole on October 13, 2000, at which time the bonds were
repurchased by the bondholder and a new reset date of October 13, 2001 was
established. Following the events of the September 11 tragedy, the bonds were
rolled over on October 13, 2001, January 16, 2002, March 15, 2002 and July 16,
2002. The Company is now attempting to remarket the bonds on terms that it finds
acceptable. If the Company is unsuccessful in remarketing the bonds, and if
alternative expansion financing is also not available, it could slow the
Company's expansion plans, limit its ability to increase decking production to
meet customer demand and would require the Company to make other mutually
agreeable provisions for the payment of its outstanding short-term debts, of
which there can be no assurance. If the bonds are not remarketed by October 16,
2003, the Company will be required to buy them back.

The Company believes that if it is successful in remarketing its bonds
and breaking the current escrow on bond proceeds it will reduce and later
eliminate its working capital deficit, in part by paying off the remaining
bridge note balance of $2.0 million during the remainder of 2002. In addition,
the Company would be effectively reimbursed for approximately $7.1 million of
working capital used to pay vendors for capital expenditures and other costs
eligible to be paid from bond proceeds. The Company would also receive
approximately $209,000 for unpaid costs eligible for reimbursement that are
reflected in the Company's accounts payable total. The bond funds would greatly
improve the working capital position, and would restructure a significant
portion of the Company's short-term indebtedness into long-term debt with more
favorable interest rates, if the Company is able to meet the requirements of the
bond indenture and break escrow. Purchasing the existing manufacturing site over
a longer term should also help improve operating costs by eliminating the
monthly lease payments. By having substantial funds allocated and available for
capital expansion, the Company believes that increasing cash flows generated
from operations could be used for working capital and to further reduce debt and
the working capital deficit.

Cash and cash equivalents increased $384,405 in the first half of 2002.
Significant components of that increase were: (i) cash provided by operating
activities of $1,141,935, which consisted of the net income for the period of
$621,834 increased by depreciation and amortization of $1,447,657 and reduced by
other uses of cash of $927,556; (ii) cash used in investing activities of
$1,804,036, and (iii) cash provided by financing activities of $1,046,506.
Payments on notes during the period were $346,913, and proceeds from the
issuances of notes amounted to $250,000. At June 30, 2002, the Company had bonds
and notes payable in the amount of

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$23,982,611, of which $19,764,313 was current bonds and notes payable and the
current portion of long-term debt. Of the current bonds and notes payable,
$2,657,463 or 13.4% was payable to Marjorie S. Brooks, a major shareholder, and
other investors closely associated with the Company. The Company intends to pay
down or refinance the remaining $2.0 million in bridge notes during 2002 and the
final balance upon successful completion of the bond financing.

FORWARD-LOOKING INFORMATION

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

The foregoing discussion contains certain estimates, predictions,
projections and other forward-looking statements (within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934) that involve various risks and uncertainties. While these
forward-looking statements, and any assumptions upon which they are based, are
made in good faith and reflect the Company's current judgment regarding the
direction of its business, actual results will almost always vary, sometimes
materially, from any estimates, predictions, projections, or other future
performance suggested herein. Some important factors (but not necessarily all
factors) that could affect the Company's sales volumes, growth strategies,
future profitability and operating results, or that otherwise could cause actual
results to differ materially from those expressed in any forward-looking
statement include the following: success in remarketing its $16.5 million
principal amount of bonds without further escrow requirements; market, political
or other forces affecting the pricing and availability of plastics and other raw
materials; accidents or other unscheduled shutdowns affecting the Company's, its
suppliers' or its customers' plants, machinery, or equipment; competition from
products and services offered by other enterprises; state and federal
environmental, economic, safety and other policies and regulations, any changes
therein, and any legal or regulatory delays or other factors beyond the
Company's control; execution of planned capital projects; weather conditions
affecting the Company's operations or the areas in which the Company's products
are marketed; adverse rulings, judgments, or settlements in litigation or other
legal matters. The Company undertakes no obligation to publicly release the
result of any revisions to any such forward-looking statements that may be made
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

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

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

The Company was sued by Three H Enterprises, LLC, (3-H) an entity
specifically established to acquire the rights to a previous dispute, in May
2000 in the Western District of Texas for breach of contract, seeking royalties
allegedly owed but unpaid from a 1987 settlement of prior litigation against a
predecessor entity and two members of the Brooks family. Following the trial
during the fourth quarter of 2001, the court rendered a judgment on July 16,
2002, ordering the Company to pay $820,000 for past royalties on production from
the Junction plant, $240,000 in prejudgment interest and post judgment interest
at two percent per annum until paid, if the judgment is upheld on appeal. 3-H
has moved to amend the judgment seeking recovery of its attorneys' fees. This
issue remains pending before the district court. The Company has appealed the
judgment to the Fifth Circuit Court of Appeals and plans to post a bond pending
the outcome of the appeal. Although the district court declined to grant 3-H's
request for an order requiring ongoing royalty payments from the Texas plant,
there can be no assurance that 3-H will not file suit again and attempt to seek
ongoing royalty payments. There is also no assurance that the Company will be
successful upon appeal or that all or a portion of the plaintiff's attorneys'
fees will not be awarded. The Company believes these actions are without merit
and will continue to defend itself appropriately.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) The following exhibits are filed as part of this report:

99.1 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 by
the Company's chairman and co-chief executive
officer,

99.2 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, and

99.3 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

(b) No reports on Form 8-K were filed during the second quarter
2002

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SIGNATURES

Pursuant to the requirements 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 By: /s/ Edward J. Lysen
--------------------------------------- -------------------------
Joe G. Brooks Edward J. Lysen
Chairman and co-chief executive officer Chief financial officer

Date: August 14, 2002 Date: August 14, 2002

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INDEX TO EXHIBITS