##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (Mark one) þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
 OR o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from __________ to __________ Commission File No. 000-12739 AESP, INC.  FLORIDA
    
    59-2327381(State or other jurisdiction of
incorporation or organization)
    
    (IRS Employer
Identification No.)
 1810 N.E. 144th STREET
NORTH MIAMI, FLORIDA
    
    33181(Address of Principal Executive Offices)
    
    (Zip Code)
 Registrants Telephone Number, Including Area Code: (305) 944-7710 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 past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes o No x On November 8, 2004, the registrant had 6,143,596 outstanding shares of
its common stock, par value $.001 per share.




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AESP, INC. AND SUBSIDIARIES INDEX PagePART I. FINANCIAL INFORMATIONItem 1.
    
    FINANCIAL STATEMENTSCondensed Consolidated Balance Sheets at September 30, 2004 (unaudited) and December 31, 2003
    
    
    3Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003 (unaudited)
    
    
    4Condensed Consolidated Statement of Shareholders Equity for the nine months ended September 30, 2004 (unaudited)
    
    
    5Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003 (unaudited)
    
    
    6Notes to Condensed Consolidated Financial Statements (unaudited)
    
    
    7Item 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    16Item 3.
    
    QUANTITATIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK
    
    
    26Item 4.
    
    CONTROLS AND PROCEDURES
    
    
    27PART II. OTHER INFORMATIONItem 1.
    
    LEGAL PROCEEDINGS
    
    
    28Item 2.
    
    CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
    
    
    28Item 3.
    
    DEFAULTS UPON SENIOR SECURITIES
    
    
    28Item 4.
    
    SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
    
    
    28Item 5.
    
    OTHER INFORMATION
    
    
    28Item 6.
    
    EXHIBITS
    
    
    28
 Forward-looking statements Unless the context otherwise requires, references to AESP, Inc., AESP,
the company, we, our and us in this Quarterly Report on Form 10-Q
includes AESP, Inc. and its subsidiaries. The matters discussed in this
Quarterly Report on Form 10-Q contain or may contain forward-looking statements
about such matters as our operations, our financial performance and our
prospects within the meaning of Section 21E of the Securities Exchange Act of
1934, which are intended to be covered by the safe harbors created thereby.
These forward-looking statements involve risks, uncertainties, and assumptions,
including:  
    
    our ability to generate sufficient cash flow, or to
obtain required incremental capital, to pay our operating expenses
and service our debt as it comes due,
    
    competition from other manufacturers and distributors of
computer networking products both nationally and internationally,
    
    our ability to generate sales of our products at
sufficient gross margins to operate our business on a cash flow
positive and profitable basis,
    
    the balance of the mix between original equipment
manufacturer sales (which have comparatively lower gross profit
margins with lower expenses) and networking sales (which have
comparatively higher gross profit margins with higher expenses)
from period to period,
    
    our dependence on third parties for manufacturing and assembly of products, and
    
    the absence of supply agreements. These and additional factors are discussed herein and in our Annual Report on
Form 10-K for the 2003 fiscal year (the Form 10-K). You should carefully consider the information incorporated by reference
and the information that we file with the Securities and Exchange Commission
(SEC) from time to time. The words may, will, expect, anticipate,
believe, continue, estimate, project, intend, and similar expressions
used in this Form 10-Q are intended to identify forward-looking statements.
You should not place undue reliance on these forward-looking statements, which
speak only as of the date made. We undertake no obligation to publicly release
any revision of these forward-looking statements to reflect events or
circumstances after the date they are made or to reflect the occurrence of
unanticipated events. You should also know that such statements are not
guarantees of future performance and are subject to risks, uncertainties and
assumptions. Should any of these risks or uncertainties materialize, or should
any of our assumptions prove incorrect, actual results may differ materially
from those included within the forward-looking statements. 2




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Part I. Financial Information 
 Item 1. FINANCIAL STATEMENTS AESP, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS  September 30, 2004
    
    December 31, 2003(unaudited)AssetsCurrent AssetsCash
    
    $
    521
    
    
    $
    1,082Accounts receivable, net of allowance for doubtful accounts of $214
    
    
    1,543
    
    
    
    1,967at September 30, 2004 and $246 at December 31, 2003
Due from factor
    
    
    214
    
    
    
    265Inventories, net
    
    
    3,582
    
    
    
    4,194Due from employees
    
    
    106
    
    
    
    8Prepaid expenses and other current assets
    
    
    268
    
    
    
    191Current assets of discontinued operations
    
    
    1,073
    
    
    
    3,200Total current assets
    
    
    7,307
    
    
    
    10,907Property and equipment, net
    
    
    410
    
    
    
    504Goodwill
    
    
    289
    
    
    
    289Deferred tax assets
    
    
    85
    
    
    
    9Assets of business transferred under contractual arrangement
    
    
    
    
    
    
    240Other assets
    
    
    200
    
    
    
    138Non-current assets of discontinued operations
    
    
    145
    
    
    
    741TOTAL ASSETS
    
    $
    8,436
    
    
    $
    12,828Liabilities and Shareholders EquityCurrent LiabilitiesLines of credit
    
    $
    540
    
    
    $
    1,052Accounts payable
    
    
    4,667
    
    
    
    5,330Accrued expenses
    
    
    148
    
    
    
    227Accrued salaries and benefits
    
    
    199
    
    
    
    244Income taxes payable
    
    
    
    
    
    
    7Customer deposits and other
    
    
    332
    
    
    
    460Current portion of long-term debt
    
    
    683
    
    
    
    45Current liabilities of discontinued operations
    
    
    1,322
    
    
    
    3,559Total current liabilities
    
    
    7,891
    
    
    
    10,924Long term debt, less current portion
    
    
    74
    
    
    
    71TOTAL LIABILITIES
    
    
    7,965
    
    
    
    10,995Shareholders EquityPreferred stock, $.001 par value; 1,000 shares authorized; none issued
    
    
    
    
    
    
    Common stock, $.001 par value; 20,000 shares authorized; 6,144 shares
    
    
    6
    
    
    
    6issued at September 30, 2004 and December 31, 2003
Paid-in capital
    
    
    13,546
    
    
    
    13,546(Deficit)
    
    
    (13,313
    )
    
    
    (11,664
    )Accumulated other comprehensive income (loss)
    
    
    232
    
    
    
    (55
    )TOTAL SHAREHOLDERS EQUITY
    
    
    471
    
    
    
    1,833TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    8,436
    
    
    $
    12,828
 See accompanying notes to condensed consolidated financial statements. 3




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AESP, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net sales
    
    $
    6,434
    
    
    $
    5,543
    
    
    $
    17,433
    
    
    $
    15,795Operating expensesCost of sales
    
    
    4,743
    
    
    
    4,099
    
    
    
    12,515
    
    
    
    11,341Selling, general and administrative expenses
    
    
    1,785
    
    
    
    1,513
    
    
    
    5,123
    
    
    
    4,812Total operating expenses
    
    
    6,528
    
    
    
    5,612
    
    
    
    17,638
    
    
    
    16,153Loss from operations
    
    
    (94
    )
    
    
    (69
    )
    
    
    (205
    )
    
    
    (358
    )Other income (expense):Interest, net
    
    
    (77
    )
    
    
    (47
    )
    
    
    (227
    )
    
    
    (118
    )Other, net
    
    
    25
    
    
    
    32
    
    
    
    4
    
    
    
    131(Loss) from continuing operations before income taxes
    
    
    (146
    )
    
    
    (84
    )
    
    
    (428
    )
    
    
    (345
    )Provision for income taxes
    
    
    4
    
    
    
    2
    
    
    
    27
    
    
    
    52(Loss) from continuing operations
    
    
    (150
    )
    
    
    (86
    )
    
    
    (455
    )
    
    
    (397
    )(Loss) from discontinued operations, net of tax
    
    
    (293
    )
    
    
    (380
    )
    
    
    (485
    )
    
    
    (637
    )(Loss) on disposal of discontinued operations, net of tax
    
    
    (583
    )
    
    
    
    
    
    
    (753
    )
    
    
    Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    
    
    
    
    44
    
    
    
    Net (loss)
    
    
    (1,026
    )
    
    
    (466
    )
    
    
    (1,649
    )
    
    
    (1,034
    )Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12Net (loss) applicable to common shareholders
    
    $
    (1,026
    )
    
    $
    (466
    )
    
    $
    (1,649
    )
    
    $
    (1,046
    )Basic and diluted loss per common share:(Loss) from continuing operations
    
    $
    (0.02
    )
    
    $
    (0.02
    )
    
    $
    (0.07
    )
    
    $
    (0.07
    )(Loss) from discontinued operations, net of tax
    
    
    (0.05
    )
    
    
    (0.06
    )
    
    
    (0.08
    )
    
    
    (0.11
    )(Loss) on disposal of discontinued operations, net of tax
    
    
    (0.10
    )
    
    
    
    
    
    
    (0.13
    )
    
    
    Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    
    
    
    
    0.01
    
    
    
    $
    (0.17
    )
    
    $
    (0.08
    )
    
    $
    (0.27
    )
    
    $
    (0.18
    )Weighted average shares, basic and diluted
    
    
    6,144
    
    
    
    5,975
    
    
    
    6,144
    
    
    
    5,880
 See accompanying notes to condensed consolidated financial statements. 4




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AESP, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
(UNAUDITED)  Common Stock
    
    
    
    
    
    
    
    
    
    AccumulatedAdditional
    
    
    
    
    
    Other
    
    Comprehensive
    
    TotalShares
    
    Par
    
    Paid-In
    
    
    
    
    
    Comprehensive
    
    Income
    
    Shareholders'Outstand.
    
    Value
    
    Capital
    
    (Deficit)
    
    Income (Loss)
    
    (Loss)
    
    EquityBalance at December 31, 2003
    
    
    6,144
    
    
    $
    6
    
    
    $
    13,546
    
    
    $
    (11,664
    )
    
    $
    (55
    )
    
    
    
    
    
    $
    1,833Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,649
    )
    
    
    
    
    
    
    (1,649
    )
    
    
    (1,649
    )Other comprehensive income
(loss):Foreign currency
translation
adjustment, net of
tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    287
    
    
    
    287
    
    
    
    287(1,362
    )Balance at September 30, 2004
    
    
    6,144
    
    
    $
    6
    
    
    $
    13,546
    
    
    $
    (13,313
    )
    
    $
    232
    
    
    
    
    
    
    $
    471
 See accompanying notes to condensed consolidated financial statements. 5




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AESP, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)  Nine months ended September 30,2004
    
    2003Operating Activities:Net loss
    
    $
    (1,649
    )
    
    $
    (1,034
    )Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:Provision, net of losses on accounts receivable
    
    
    
    
    
    
    6(Income) loss from discontinued operations
    
    
    485
    
    
    
    637Loss on disposal of discontinued operations
    
    
    753
    
    
    
    Cumulative effect of a change in accounting principle
    
    
    (44
    )
    
    
    Depreciation and amortization
    
    
    168
    
    
    
    118Amortization of deferred compensation
    
    
    
    
    
    
    79Deferred income taxes
    
    
    (84
    )
    
    
    (Increase) decrease in:Accounts receivable
    
    
    633
    
    
    
    60Due from factor
    
    
    51
    
    
    
    Inventories, net
    
    
    646
    
    
    
    596Prepaid expenses and other current assets
    
    
    (65
    )
    
    
    100Other assets
    
    
    181
    
    
    
    Increase (decrease) in:Accounts payable and accrued expenses
    
    
    (541
    )
    
    
    (269
    )Accrued salaries and benefits
    
    
    (28
    )
    
    
    40Income taxes payable
    
    
    (9
    )
    
    
    (82
    )Customer deposits and other
    
    
    (195
    )
    
    
    (227
    )Net cash provided by operating activities of continuing operations
    
    
    302
    
    
    
    24Net cash (used in) operating activities of discontinued operations
    
    
    (327
    )
    
    
    (1,137
    )Investing Activities:Additions, net to property and equipment
    
    
    (83
    )
    
    
    (137
    )Grant of loans to employees
    
    
    (97
    )
    
    
    (7
    )Collection on note receivable from sale of Ukrainian subsidiary
    
    
    
    
    
    
    45Net cash (used in) investing activities of continuing operations
    
    
    (180
    )
    
    
    (99
    )Net cash provided by (used in) investing activities of discontinued operations
    
    
    (17
    )
    
    
    34Financing Activities:Increase in long-term debt
    
    
    633
    
    
    
    Net proceeds from (payments on) lines of credit
    
    
    (521
    )
    
    
    (281
    )Payment of preferred stock dividends
    
    
    
    
    
    
    (12
    )Net cash provided by (used in) financing activities of continuing operations
    
    
    112
    
    
    
    (293
    )Net cash provided by (used in) financing activities of discontinued operations
    
    
    (505
    )
    
    
    815Net decrease in cash
    
    
    (615
    )
    
    
    (656
    )Effect of exchange rate changes on cash of continuing operations
    
    
    6
    
    
    
    4Effect of exchange rate changes on cash of discontinued operations
    
    
    48
    
    
    
    (26
    )Cash, at beginning of period
    
    
    1,082
    
    
    
    1,226Cash, at end of period
    
    $
    521
    
    
    $
    548Supplemental information:Cash paid for:Interest
    
    $
    217
    
    
    $
    164Taxes
    
    
    116
    
    
    
    114Non-cash transactions:Conversion of common stock to preferred stock
    
    
    
    
    
    
    230Conversion of preferred stock to common stock
    
    
    
    
    
    
    230
 See accompanying notes to condensed consolidated financial statements. 6




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AESP, INC. AND SUBSIDIARIES 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 1. Basis of Presentation
    
    The accompanying unaudited condensed
consolidated financial statements have been
prepared in accordance with accounting
principles generally accepted in the U.S.
for interim financial information and with
the instructions to Form 10-Q promulgated
by the Securities & Exchange Commission.
Accordingly, they do not include all of the
information and footnotes required by
accounting principles generally accepted in
the U.S. for complete financial statements.
In the opinion of management, all
adjustments (consisting of normal recurring
adjustments) considered necessary for a
fair presentation have been included.
Operating results for the three and nine
month periods ended September 30, 2004 are
not necessarily indicative of the results
that may be expected for the year ended
December 31, 2004. The condensed
consolidated balance sheet information as
of December 31, 2003 was derived from the
audited consolidated financial statements
included in the Companys Annual Report on
Form 10-K for 2003 (the Form 10-K). For
further information, refer to the
consolidated financial statements and
footnotes thereto included in the Form
10-K. Certain prior period balances have
been reclassified in the unaudited
condensed consolidated financial statements
in order to provide a presentation
consistent with the current period. AESP,
Inc. (AESP) and its subsidiaries and
variable interest entities (see Note 4) are
collectively referred to herein as the
Company.2. U.S. Line of Credit
    
    On October 31, 2003, the Company signed two
agreements, one an amendment with
Commercebank, N.A. (the Bank) to extend
the maturity date on its $1.9 million U.S.
based line of credit to April 20, 2004, and
a second agreement with Marquette
Commercial Finance, Inc. (formerly KBK
Financial, Inc.) (Marquette). The initial
funding from Marquette was used to fund a
permanent reduction in the Companys line
of credit with the Bank. The initial
funding under the Marquette agreement was
$1,220,000, with $70,000 utilized to cover
closing expenses and $1,150,000 applied to
the Banks line of credit. An additional
payment of $100,000 from proceeds of the
Marquette agreement, was made in December
2003, to permanently reduce the available
balance under the Banks line of credit to
$631,000 (which was due and payable on
April 20, 2004). This balance was paid in
full on April 26, 2004 through the proceeds
received by the Company under a new
one-year term loan agreement with Bendes
Investment Ltd (Bendes).The Bendes loan is a $631,000 one-year term
loan due in April 2005. However, the Bendes
loan is payable earlier from the net
proceeds of any sale of the Companys
equity securities. The loan bears interest
at the prime rate plus 8% per annum,
payable monthly. The Bendes loan is
guaranteed by the Companys principal
shareholders. Under the term of the Bendes
loan, the Company is required to comply
with certain affirmative and negative
covenants. At September 30, 2004, the
Company was in compliance with these
covenants. The Bendes loan is secured by a
lien on substantially all of the Companys
assets.
 7




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AESP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) The Marquette agreement advances funds to the Company at a rate of 82.5% of the
invoice amount purchased by Marquette. The portion of the invoices not advanced
to the Company are recorded as a due from factor until the invoice is paid by
the customer, at which point the Company receives the remaining proceeds, less
fees. Substantially all of the Companys invoices to U.S. customers are
available for sale under this agreement and may be offered to Marquette on a
daily basis, subject to a $2,000,000 funding limit. Marquette can accept or
reject offered invoices and is not obligated to purchase any invoices.
Marquette exercises control over incoming lockbox receipts to ensure that cash
received on purchased invoices is collected. The Marquette agreement contains
fixed and variable discount rate pricing components. The fixed discount is
1.25% of the invoice amount and is payable at the time of funding. The variable
rate is Marquettes base rate as established by Marquette from time to time
(generally the prime rate), plus 2% per annum and is payable based on the
number of days from the sale of the invoice until collection. The agreement is
terminable by either party upon 30 days notice and immediately by Marquette
upon default by the Company. In the event of termination by the Company prior
to November 2005, a termination fee of up to $20,000 may be due. Bendes and
Marquette have entered into an intercreditor agreement governing their
respective priorities in the assets of the Company securing their respective
financings. Because funds advanced under this facility are considered a sale of
the particular invoices sold, the Company reports funds advanced as a reduction
of accounts receivable in the Condensed Consolidated Financial Statements. The
Marquette factoring agreement is guaranteed, on a limited basis, with respect
to matters related to the existence and validity of purchased receivables, by
the Companys principal shareholders. Under the terms of the Marquette
agreement, the Company is required to comply with certain affirmative and
negative covenants and to maintain certain financial benchmarks and ratios on a
monthly basis. As of September 30, 2004, the Company was not in compliance with
the tangible net worth covenant under the Marquette agreement, however
Marquette has waived compliance with this covenant. Further, as of September
30, 2004, Marquette had purchased accounts receivables aggregating $1,135,000.The Company incurred net losses in each of the last three fiscal years and in
the first three quarters of fiscal 2004 and the Companys working capital is
extremely limited. The Company may not meet its financial covenants in future
periods unless its results of operations substantially improve. While there can
be no assurance, the Company expects that Marquette will continue to waive
covenant violations during future periods. The Company believes that its
internally generated cash flow from operations combined with funds available
under the Marquette agreement, will be sufficient to fund current operations
through the end of 2004. The Company may also consider selling debt or equity
securities, or one or more of its operations, in order to meet current and
future working capital requirements. However, such fundings or transactions may
not be available. If the Company is unable to generate sufficient cash flow
from operations to meet its operating costs, or is otherwise unable to raise
the required funds or reduce expenses sufficiently to overcome any shortfall,
its operations would be materially and adversely affected.
 8




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AESP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 3. Earnings (loss) per
    share
    
    Options to purchase
3,610,000 shares of
common stock at
$0.81  $3.69 per
share, were
outstanding at
September 30, 2004,
but were not
included in the
computation of
diluted EPS for the
three and nine
months ended
September 30, 2004,
as they are
anti-dilutive due to
the Companys loss.Options to purchase 2,961,000 shares of common stock at $0.81  $3.69 per
share, were outstanding at September 30, 2003, but were not included in the
computation of diluted EPS for the three and nine months ended September 30,
2003, as they are anti-dilutive due to the Companys loss.4. Variable Interest
    Entities
    
    The Company has evaluated its
relationship with AESP Ukraine
(Ukraine), an entity created before
February 1, 2003 and has determined
that it is a variable interest
entity under the provisions of FASB
Interpretation No. 46, Consolidation
of Variable Interest Entities
(Revised December 2003)
(Interpretation No. 46). Ukraine was
a wholly-owned subsidiary, which the
Company sold to a then thinly
capitalized entity in January 2001.
The Company has determined that it
is the primary beneficiary (as
defined in Interpretation No. 46) of
Ukraine and as such, under
Interpretation No. 46 was required
to consolidate Ukraines assets,
liabilities and noncontrolling
interests as of March 31, 2004 at
their respective carrying values, as
if it were a subsidiary of the
Company. As of September 30, 2004,
Ukraine has total assets of $649,000
and total debt and other payables of
$544,000, of which $460,000 is
payable to the Company. The amount
payable to the Company consists of a
gross note receivable of $603,000
and trade accounts receivable of
$238,000 at September 30, 2004. As
of December 31, 2003, the Company
recorded a $381,000 impairment
against the note receivable, based
on the Companys assessment that it
is probable that the note is not
fully collectible. Ukraines
operations are not material to the
Company. Therefore, in accordance
with Interpretation No. 46, the
Company has reported the difference
of $44,000 in Ukraines assets and
liabilities, including the reversal
of the note receivable impairment
due to the Ukraine consolidation, as
a cumulative effect of a change in
accounting principle in its
Condensed Consolidated Statement of
Operations for the nine months ended
September 30, 2004.The Company also considered whether RSB Holdings, Inc. (RSB),
a related party, is a variable interest entity. RSB, which is
owned by the Companys principal shareholders, is the lessor
on the Companys corporate headquarters in Miami, Florida.
Under the provisions of Interpretation No. 46, the Company
has determined that RSB is not a variable interest entity.
 9




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##### 



AESP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 5. Operating Segments
    
    The Companys operations, consisting primarily of
sales of computer networking products, are handled by each of its
subsidiaries operating in their respective countries. Accordingly,
management operates its business based on a geographic basis, whereby
sales and related data are attributed to the AESP entity that generates
such revenues. United States includes Signamax, Advanced Electronic
Manufacturing and sales of products to the Companys Russian distributor.
Western Europe includes Intelek, the Companys Czech Republic subsidiary
and the operations of the Company Ukrainian distributor, which is
consolidated in accordance with Interpretation No. 46 (see Note 4). All
other European operations (Jotec and Lanse in Norway, AESP Sweden and AESP
GmbH and Signamax GmbH in Germany) have been or are in the process of
being disposed and are therefore, reflected as discontinued operations.
Segment information is presented below for each significant geographic
region (in thousands).
 United States
    
    Western Europe
    
    Elimination
    
    TotalThree months ended Sept. 30, 2004:Sales to unaffiliated customers
    
    $
    4,159
    
    
    $
    2,275
    
    
    $
    
    
    
    $
    6,434Transfers between geographical areas
    
    
    328
    
    
    
    
    
    
    
    (328
    )
    
    
    Total sales
    
    
    4,487
    
    
    
    2,275
    
    
    
    (328
    )
    
    
    6,434Operating income (loss)
    
    
    29
    
    
    
    (84
    )
    
    
    (39
    )
    
    
    (94
    )Income (loss) before income taxes
from continuing operations
    
    
    (31
    )
    
    
    (76
    )
    
    
    (39
    )
    
    
    (146
    )Identifiable assets at September
30, 2004
    
    
    4,415
    
    
    
    5,324
    
    
    
    (1,303
    )
    
    
    8,436Three months ended Sept. 30, 2003:Sales to unaffiliated customers
    
    $
    4,049
    
    
    $
    1,494
    
    
    $
    
    
    
    $
    5,543Transfers between geographic areas
    
    
    366
    
    
    
    
    
    
    
    (366
    )
    
    
    Total sales
    
    
    4,415
    
    
    
    1,494
    
    
    
    (366
    )
    
    
    5,543Operating income (loss)
    
    
    (105
    )
    
    
    (9
    )
    
    
    45
    
    
    
    (69
    )Income (loss) before income taxes
from continuing operations
    
    
    (135
    )
    
    
    6
    
    
    
    45
    
    
    
    (84
    )Identifiable assets at December 31,
2003
    
    
    6,774
    
    
    
    7,430
    
    
    
    (1,376
    )
    
    
    12,828Nine months ended Sept. 30, 2004:Sales to unaffiliated customers
    
    $
    11,414
    
    
    $
    6,019
    
    
    $
    
    
    
    $
    17,433Transfers between geographical areas
    
    
    1,499
    
    
    
    
    
    
    
    (1,499
    )
    
    
    Total sales
    
    
    12,913
    
    
    
    6,019
    
    
    
    (1,499
    )
    
    
    17,433Operating income (loss)
    
    
    (261
    )
    
    
    95
    
    
    
    (39
    )
    
    
    (205
    )Income (loss) before income taxes
from continuing operations
    
    
    (445
    )
    
    
    56
    
    
    
    (39
    )
    
    
    (428
    )Identifiable assets at September
30, 2004
    
    
    4,415
    
    
    
    5,324
    
    
    
    (1,303
    )
    
    
    8,436Nine months ended Sept. 30, 2003:Sales to unaffiliated customers
    
    $
    11,742
    
    
    $
    4,053
    
    
    $
    
    
    
    $
    15,795Transfers between geographic areas
    
    
    1,769
    
    
    
    
    
    
    
    (1,769
    )
    
    
    Total sales
    
    
    13,511
    
    
    
    4,053
    
    
    
    (1,769
    )
    
    
    15,795Operating income (loss)
    
    
    (370
    )
    
    
    12
    
    
    
    24
    
    
    
    (358
    )Income (loss) before income taxes
from continuing operations
    
    
    (415
    )
    
    
    46
    
    
    
    24
    
    
    
    (345
    )Identifiable assets at December 31,
2003
    
    
    6,774
    
    
    
    7,430
    
    
    
    (1,376
    )
    
    
    12,828
 10




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##### 



AESP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) Identifiable assets are those assets that are identified
with the operations based in each geographic area.
Foreign sales, including foreign sales of AESP, for the
three months ended September 30, 2004 and 2003,
approximated 56% and 47%, respectively, of consolidated
revenues. Foreign sales, including foreign sales of AESP,
for the nine months ended September 30, 2004 and 2003,
approximated 53% and 46%, respectively, of consolidated
revenues.For the three months ended September 30, 2004,
purchases from an electrical cabinet vendor in the Czech
Republic amounted to approximately 17% of cost of sales.
For the three months ended September 30, 2003, no vendor
accounted for greater than 10% of cost of sales. For the
nine months ended September 30, 2004, purchases from this
cabinet vendor were approximately 12% of cost of sales.
For the nine months ended September 30, 2003, purchases
from a Far East manufacturer amounted to approximately
11% of cost of sales.Sales by the Companys United States business segment to
its exclusive distributor in Russia, AESP-Russia,
amounted to approximately 20% and 17% of net sales for
the three months ended September 30, 2004 and 2003,
respectively and approximately 18% and 18% of net sales
for the nine months ended September 30, 2004 and 2003,
respectively.6. Warrant Dividend
    
    In June 2003, the Company distributed to the
holders of its outstanding common stock (the
Warrant Dividend), as of the record date of
April 10, 2003, on a pro-rata basis, common
stock purchase warrants to purchase one share of
common stock for each share owned as of the
record date (the Warrants). Warrants to
purchase 5,984,000 shares were issued in the
Warrant Dividend. The Warrants are
non-transferable. The Warrant exercise period
commenced on September 23, 2003, which is the
date following the date of effectiveness of a
registration statement registering the sale of
the shares of common stock underlying the
Warrants. The warrants were scheduled to expire
on September 23, 2004, however, the Companys
Board of Directors extended the expiration date
for an additional six months. Until March 23,
2005 (the extended expiration date of the
warrants), the Warrants are exercisable at an
exercise price of $5.50 per share.Any proceeds received by the Company from the
exercise of the Warrants will be used to repay
the Bendes note (which is due in April 2005, but
must be paid sooner from the net proceeds of any
sales by the Company of its equity securities),
for general working capital purposes or for
acquisitions.
 11




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##### 



AESP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 7. Stock Based    Compensation
    
    The Company has granted stock options to key
employees and directors under stock option plans.
The Company accounts for these plans under the
recognition and measurement principles of Accounting
Principles Board Opinion No. 25, Accounting For
Stock Issued to Employees, as amended and
interpreted. Stock-based employee compensation cost
is not reflected in net loss as all options granted
under those plans had an exercise price greater than
or equal to the market value of the underlying
common stock on the date of grant. The following
table illustrates the effect on net loss and
earnings per share if the Company had applied the
fair value recognition provisions of SFAS No. 123,
Accounting For Stock-Based Compensation, as
amended and interpreted, to stock-based employee
compensation (in thousands, except per share
amounts):
 THREE MONTHS ENDED SEPTEMBER 30,
    
    2004
    
    2003Net loss, as reported
    
    $
    (1,026
    )
    
    $
    (466
    )Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax benefits
    
    
    (43
    )
    
    
    (32
    )Pro forma net loss
    
    $
    (1,069
    )
    
    $
    (498
    )Basic loss per share, as reported
    
    $
    (.17
    )
    
    $
    (.08
    )Basic loss per share  pro forma
    
    $
    (.17
    )
    
    $
    (.08
    )Diluted loss per share, as reported
    
    $
    (.17
    )
    
    $
    (.08
    )Diluted loss per share  pro forma
    
    $
    (.17
    )
    
    $
    (.08
    )
 NINE MONTHS ENDED SEPTEMBER 30,
    
    2004
    
    2003Net loss, as reported
    
    $
    (1,649
    )
    
    $
    (1,046
    )Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax benefits
    
    
    (273
    )
    
    
    (245
    )Pro forma net loss
    
    $
    (1,922
    )
    
    $
    (1,291
    )Basic loss per share, as reported
    
    $
    (.27
    )
    
    $
    (.18
    )Basic loss per share  pro forma
    
    $
    (.31
    )
    
    $
    (.22
    )Diluted loss per share, as reported
    
    $
    (.27
    )
    
    $
    (.18
    )Diluted loss per share  pro forma
    
    $
    (.31
    )
    
    $
    (.22
    )
 SFAS No. 123 requires the Company to provide pro forma
information regarding net income (loss) and net income
(loss) per share as if compensation cost for the
Companys employee stock options had been determined in
accordance with the fair value based method in SFAS No.
123. The Company estimates the fair value of each stock
option by using the Black-Scholes option-pricing model
with the following weighted average assumptions used for
grants in the nine months ended September 30, 2004 and
2003, respectively: no dividend yield percent; expected
volatility of 65% and 112%; weighted average risk-free
interest rates of approximately 4.8% and 4.8%; and
expected lives of 10 and 10 years. There were no stock
option grants in the three months ended September 30,
2004 and 2003.
 12




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##### 



AESP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 8. Recent Accounting    Pronouncements
    
    In January 2003, the Financial
Accounting Standards Board
(FASB) issued FASB
Interpretation No. 46,
Consolidation of Variable
Interest Entities
(Interpretation No. 46).
Interpretation No. 46 clarifies
the application of Accounting
Research Bulletin No. 51,
Consolidated Financial
Statements, to certain
entities in which equity
investors do not have the
characteristics of a
controlling financial interest
or do not have sufficient
equity at risk for the entity
to finance its activities
without additional subordinated
financial support from other
parties. Interpretation No. 46
applies immediately to variable
interest entities (VIEs)
created after January 31, 2003,
and to VIEs in which an
enterprise obtains an interest
after that date. The FASB
previously deferred the
effective date for variable
interests in VIEs created
before February 1, 2003, to the
quarter ending March 30, 2004.
See Note 4 to Condensed
Consolidated Financial
Statements for the Companys
evaluation of the impact of the
adoption of Interpretation No.
46. The Companys involvement
with these entities began prior
to February 1, 2003.In May 2003, the FASB issued
SFAS No. 150 Accounting for
Certain Financial Instruments
with Characteristics of both
Liabilities and Equity (SFAS
No. 150). SFAS No. 150
requires that an issuer
classify a financial instrument
that is within its scope as a
liability (or asset in some
circumstances). This Statement
is effective for financial
instruments created or modified
after May 31, 2003, and
otherwise is effective at the
beginning of the first interim
period beginning after June 15,
2003. The Company has adopted
the provisions of SFAS No. 150
that are effective as of March
31, 2004. The adoption of SFAS
No. 150 did not have a material
effect on the Companys results
of operations or financial
position.In December 2003, the SEC
issued Staff Accounting
Bulletin No. 104, Revenue
Recognition(SAB No. 104),
which codifies, revises and
rescinds certain sections of
SAB No. 101, Revenue
Recognition,in order to make
this interpretive guidance
consistent with current
authoritative guidance. The
changes noted in SAB No. 104
did not have a material impact
upon the Companys results of
operations or financial
position.
 13




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##### 



AESP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 9. Discontinued    Operations
    
    In May 2004, the management of
Lanse AS, one of the Companys
Norwegian subsidiaries,
informed the Company that they
intended to terminate their
employment relationship with
Lanse. Thereafter, these
managers and the Company
entered into negotiations to
sell Lanse to these managers.
These negotiations were
concluded in July 2004, when
Lanse signed an agreement to
sell certain of its assets to a
company jointly owned by the
former managers of Lanse and
several of Lanses major
vendors. The assets sold were
(1) a majority of Lanses
inventory, with an original
cost of approximately $157,000,
sold at cost with the proceeds
required to be used to retire
current accounts payable due to
the vendors and (2) the
ownership of certain trade
names sold for $237,000,
payable $145,000 at closing in
the form of additional credits
from the vendors, $48,000 in
cash due in one year and the
remainder, $44,000 in cash due
in two years. The Company is
currently winding down the
operations of Lanse, primarily
through sales of its remaining
inventory, collection of
accounts receivable and payment
of remaining liabilities. The
Company expects to realize
approximately $100,000 in net
proceeds through this process.In July 2004, the Company
determined that its German
subsidiary, AESP GmbH, which
has recorded losses from
operations for the last three
years, most likely met the
criteria for insolvency under
German law. In response, an
attorney designated by the
German government met with the
management of AESP GmbH and
reviewed its financial
position, specifically to
assess its ability to pay bills
when due and the level of
shareholders equity. On
September 1, 2004, the German
court adjudged AESP GmbH to be
insolvent and at that point,
management control of the
assets and liabilities of AESP
GmbH passed from the Company to
the attorney, acting on behalf
of the German government. As
such, the Company has ceased
consolidating AESP GmbH
subsequent to August 31, 2004,
due to the Company no longer
controlling the entity. Due to
the relatively insignificant
amount of assets and
liabilities of AESP GmbH, it is
expected that this liquidation
of the net assets will not have
a significant impact on the
results of operations or the
financial position of the
Company.In August 2004, the Company
signed an agreement with an
unrelated third party to sell
100% of the outstanding common
stock in its other Norwegian
subsidiary, Jotec AS, for a
nominal sum. In connection with
this sale, the Company
collected approximately
$285,000 in overdue accounts
receivable from Jotec and was
relieved of any further
liability under Jotecs bank
line of credit and its facility
lease, which had approximately
seven years remaining.In September 2004, the Company
entered into negotiations with
an unrelated third party to
sell 100% of the outstanding
common stock of its Swedish
subsidiary, AESP Sweden. These
negotiations were completed in
early October 2004, when the
Company signed an agreement to
sell AESP Sweden for a nominal
sum. In connection with this
sale, the Company was relieved
of any liability under AESP
Swedens bank line of credit.
As a condition to the sale, the
Company will not collect
approximately $130,000 in
accounts receivable that AESP
Sweden owed Jotec, which when
paid by AESP Sweden, was to be
transferred to the Company by
the new owners of Jotec.
Further, the Company expects to
realize a gain on the sale of
its Swedish operations of
approximately $50,000, which
will be recorded in the fourth
quarter of 2004.
 14




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##### 



AESP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) In September 2004, the Company decided to phase out the operations of its second German subsidiary, Signamax GmbH, by
transferring its customer base and sales operations, along with its inventory, to the operations of the Companys Czech
Republic subsidiary, Intelek. The Company is currently winding down the operations of Signamax GmbH, primarily through the
collection of accounts receivable and the payment of remaining liabilities.As a result of these transactions, the Company has reflected the operating results of Lanse, AESP GmbH, Jotec, AESP Sweden
and Signamax GmbH, as well as the estimated losses on disposal, as discontinued operations in the Condensed Consolidated
Financial Statements for all periods presented. Results of these operations, as presented in the accompanying Condensed
Consolidated Statements of Operations, are as follows (in thousands):
 Three months ended
    
    Nine months endedSept. 30, 2004
    
    Sept. 30, 2003
    
    Sept. 30, 2004
    
    Sept. 30, 2003Net sales
    
    $
    1,246
    
    
    $
    2,163
    
    
    $
    6,242
    
    
    $
    7,415(Loss) from operations, net of tax
    
    $
    (293
    )
    
    $
    (380
    )
    
    $
    (485
    )
    
    $
    (637
    )Loss on disposal, net of tax
    
    $
    (583
    )
    
    
    
    
    
    $
    (753
    )
    
    
    
 The remaining assets and liabilities of the discontinued operations, as presented in the accompanying Condensed Consolidated
Balance Sheets, are as follows (in thousands):
 Sept. 30, 2004
    
    December 31, 2003Accounts receivable, net
    
    $
    701
    
    
    $
    1,594Inventories
    
    
    339
    
    
    
    1,507Due from employees
    
    
    
    
    
    
    67Prepaid expenses and other current assets
    
    
    33
    
    
    
    32Current assets
    
    $
    1,073
    
    
    $
    3,200Property and equipment, net
    
    $
    51
    
    
    $
    31Goodwill
    
    
    
    
    
    
    362Deferred tax assets
    
    
    
    
    
    
    72Other assets
    
    
    94
    
    
    
    276Non-current assets
    
    $
    145
    
    
    $
    741Lines of credit
    
    $
    319
    
    
    $
    836Accounts payable
    
    
    489
    
    
    
    1,258Accrued expenses
    
    
    343
    
    
    
    440Accrued salaries and benefits
    
    
    100
    
    
    
    459Income taxes payable
    
    
    
    
    
    
    31Customer deposits and other
    
    
    39
    
    
    
    535Current portion of long-term debt
    
    
    32
    
    
    
    Current liabilities
    
    $
    1,322
    
    
    $
    3,559
 15




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##### 



Item 2.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
THE INFORMATION SET FORTH IN MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS IN THE FORM 10-K. Recent Developments We have recently experienced several significant changes in our business. For
details, see Note 9 to the Condensed Consolidated Financial Statements and
Liquidity and Capital Resources below. Critical Accounting Policies Our discussion and analysis of financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States of America. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
liabilities. We base these estimates on our experience and on various other
assumptions that we believe to be reasonable under the circumstances, and these
estimates form the basis for our judgments concerning the carrying values of
assets and liabilities that are not readily apparent from other sources. We
periodically evaluate these estimates and judgments based on available
information and experience. Actual results could differ materially from our
estimates under different assumptions and conditions. If actual results
significantly differ from our estimates, our financial condition and results of
operations could be materially impacted. We believe that the accounting policies described below are critical to
understanding our business, results of operations and financial condition
because they involve more significant judgments and estimates used in the
preparation of our consolidated financial statements. An accounting policy is
deemed to be critical if it requires an accounting estimate to be made based on
assumptions about matters that are highly uncertain at the time the estimate is
made, and if different estimates that could have been used, or changes in the
accounting estimates that are reasonably likely to occur periodically, could
materially impact our consolidated financial statements. We have discussed the
development, selection and application of our critical accounting policies with
the audit committee of our board of directors, and our audit committee has
reviewed our disclosure relating to our critical accounting policies in this
Managements Discussion and Analysis of Financial Condition and Results of
Operations. Other significant accounting policies, primarily those with lower levels of
uncertainty than those discussed below, are also critical to understanding our
consolidated financial statements. The notes to our consolidated financial
statements contain additional information related to our accounting policies
and should be read in conjunction with this discussion. Revenue Recognition We recognize revenue when earned and realized or realizable, which is generally
at the time of product shipment to our customer. At the time of product
shipment to our customer, the customer has already agreed to purchase the
product, is obligated to pay a fixed, reasonably collectible sales price and
ownership and risk of loss has transferred to the customer. Warranties are provided on certain of our networking products for periods
ranging from five years to lifetime. We establish provisions for estimated
returns, as well as other sales allowances, concurrently with the recognition
of revenue. Warranty claims and sales allowances have historically been
nominal. The provisions are established based upon consideration of a variety
of factors, including, among other things, recent and historical return rates,
estimated customer inventory levels by product, the impact of any new product
releases and projected economic conditions. Actual product returns are,
however, dependent upon future events, including the amount of stock balancing
activity by our customers and the level of customer inventories. We continually
monitor the factors that influence the pricing of our products and customer
inventory levels and make adjustments to these provisions when we believe
actual returns and other allowances could differ from established reserves. Our
ability to recognize revenue upon shipment to our customers is predicated on
our ability to reliably estimate future returns. If actual experience or
changes in market condition impairs our ability to estimate returns, we would
be required to defer the recognition of revenue until the delivery of the
product to the end-user. If market conditions were to decline, we could take
actions to increase our customer incentive offerings, which could result in an
incremental reduction to our revenue at the time the incentive is offered. 16




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##### 



Inventory We provide a provision for inventory obsolescence based on excess and obsolete
inventories identified through a review of the past 12 months usage and
determined primarily by future demand forecasts. The process to estimate the
inventory provision involves the review of the Companys inventories, in
detail, by operations personnel and the Companys management. At the point of the loss recognition, a new, lower-cost basis for that
inventory is established, and subsequent changes in facts and circumstances do
not result in the restoration or increase in that newly established cost basis. If there were to be a sudden and significant decrease in demand for our
products, or if there were a higher incidence of inventory obsolescence because
of rapidly changing technology and customer requirements, we could be required
to charge our inventory provision and our gross margin could be adversely
affected. Inventory management remains an area of focus as we balance the need
to maintain strategic inventory levels to ensure competitive lead times versus
the risk of inventory obsolescence because of rapidly changing technology and
customer requirements. Goodwill We review annually, or more frequently if indicators of impairment arise, the
carrying value of our goodwill using the terminal value method. At September
30, 2004, we had $289,000 in indefinite lived goodwill related to our
acquisition of Intelek (Czech Republic). We operate in two markets, the U.S.
and Western Europe. These two geographic regions constitute our reportable
segments. See Notes 5 and 9 of Notes to our Condensed Consolidated Financial
Statements for additional information regarding our geographic segments and the
sale of certain Lanse assets which required a writedown during the second
quarter of 2004 of the goodwill related to Lanse. All of our remaining goodwill
is contained in our Western Europe reportable segment. We evaluate goodwill at
the respective reporting unit level. Related Party Transactions We lease our principal executive offices from a related party, RSB Holdings,
Inc. (RSB). RSB is a partnership owned by Slav Stein, our President, Chief
Executive Officer and Director and Roman Briskin, our Executive Vice President,
Secretary/Treasurer and Director. We have determined that RSB is not a variable
interest entity under the provision of FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, as further interpreted
(Interpretation No. 46). We do not guarantee the mortgage on the property. Loss Contingencies We are subject to the possibility of various loss contingencies arising in the
ordinary course of business. We consider the likelihood of loss or impairment
of an asset or the incurrence of a liability, as well as our ability to
reasonably estimate the amount of loss in determining loss contingencies. An
estimated loss contingency is accrued when it is probable that an asset has
been impaired or a liability has been incurred and the amount of loss can be
reasonably estimated. We regularly evaluate current information available to us
to determine whether such accruals should be adjusted and whether new accruals
are required. 17




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##### 



Results of Operations As discussed in Note 9 to the Condensed Consolidated Financial Statements,
our Norwegian subsidiaries, Jotec and Lanse, along with our German
subsidiaries, AESP GmbH and Signamax GmbH and our Swedish subsidiary, AESP
Sweden
have been accounted for as discontinued operations as of September 30, 2004.
Accordingly, the results of operations for each of the periods presented have
been restated to reflect the results of operations of these entities as
discontinued operations. As a result, our Western European segment now includes
only our Czech Republic subsidiary, Intelek and the operations of our Ukrainian
distributor, which is consolidated in accordance with Interpretation No. 46
(see Note 4 to the Condensed Consolidated Financial Statements). Three months ended September 30, 2004 and 2003 For the quarter ended September 30, 2004, we recorded net sales of $6.4
million, compared to net sales of $5.5 million for the quarter ended September
30, 2003. Approximately 2.4% or $155,000 of the sales in the third quarter of
2004 was due to the declining value of the U.S. dollar which increased sales in
our Western European segment when converted from local currency to U.S.
dollars. The following table illustrates our sales by location and the exchange
rate effect on our sales in 2004 (in thousands): 3rd Quarter 2004Constant dollarNet sales
    
    Currency effect (a)
    
    sales
    
    3rd Quarter 2003
    
    Percent ChangeU.S.
    
    $
    4,161
    
    
    $
    
    
    
    $
    4,161
    
    
    $
    4,050
    
    
    
    2.7
    %Czech Rep.
    
    
    1,779
    
    
    
    (155
    )
    
    
    1,624
    
    
    
    1,493
    
    
    
    8.8
    %Ukraine
    
    
    494
    
    
    
    
    
    
    
    494
    
    
    
    
    
    
    
    
    %Total
    
    $
    6,434
    
    
    $
    (155
    )
    
    $
    6,279
    
    
    $
    5,543
    
    
    
    13.3
    %
   (a)
    
    calculated based on the conversion of 2004 local currency sales at the 2003
average currency exchange rate into U.S. dollars. Without the impact of the foreign currency change, revenues would have
increased from $5.5 million in 2003 to $6.3 million in 2004, an increase of $.8
million or approximately 13.3%. In the U.S., sales were up slightly, due
primarily to three items (1) an increase of $470,000 in sales to our exclusive
distributor in Russia, AESP Russia, based upon sales growth and a strong
economy in their sector. This increase was offset by (2) a drop in sales
recorded by our Signamax computer networking product line due to a steep
decline in purchases by a major customer and (3) the elimination in
consolidation of $225,000 of U.S. sales to AESP Ukraine in 2004. Our former
subsidiary in the Ukraine was determined to be a variable interest entity in
2004 in accordance with our adoption of FASB Interpretation No. 46,
Consolidation of Variable Interest Entitiesand, as a result, was consolidated
in our financial statements for 2004, as if it were a subsidiary. Since AESP
Ukraine was not consolidated in the third quarter of 2003, U.S. sales to AESP
Ukraine during that quarter were not eliminated. Further, in conjunction with
the required consolidation of AESP Ukraine in the first quarter of 2004, sales
of AESP Ukraine to third parties of $494,000 were added to consolidated sales.
See Note 4 to the Condensed Consolidated Financial Statements. Czech Republic
sales increased in the current quarter as a result of several large projects
with existing customers. Cost of sales for the three months ended September 30, 2004, increased to
$4.7 million, compared to cost of sales of $4.1 million for the three months
ended September 30, 2003. Consistent with sales, the weakening U.S. dollar
affected the cost of sales for the current quarter. As the following table
illustrates, the exchange rate difference resulted in an increase to cost of
sales of approximately $121,000 in 2004, when compared to 2003, however it had
only a minimal effect on the resulting gross profit percentages (in thousands): 18




---



##### 



3rd Quarter 2004Constant dollarCost of sales
    
    Currency effect (a)
    
    cost of sales
    
    3rd Quarter 2003
    
    Percent ChangeU.S.
    
    $
    2,970
    
    
    $
    
    
    
    $
    2,970
    
    
    $
    2,918
    
    
    
    1.8
    %Czech Rep.
    
    
    1,392
    
    
    
    (121
    )
    
    
    1,271
    
    
    
    1,181
    
    
    
    7.6
    %Ukraine
    
    
    381
    
    
    
    
    
    
    
    381
    
    
    
    
    
    
    
    
    %Total
    
    $
    4,743
    
    
    $
    (121
    )
    
    $
    4,622
    
    
    $
    4,099
    
    
    
    12.8
    %Gross profit
    
    $
    1,691
    
    
    $
    (34
    )
    
    $
    1,657
    
    
    $
    1,444
    
    
    
    14.8
    %Gross profit %
    
    
    26.3
    %
    
    
    
    
    
    
    26.4
    %
    
    
    26.1
    %
   (a)
    
    calculated based on the conversion of 2004 local currency cost of sales at
the 2003 average currency exchange rate into U.S. dollars. The increase in cost of sales is primarily due to the increase in sales, as the
gross profit percent remained relatively constant from quarter to quarter,
26.1% in the third quarter of 2003 compared to 26.4% in the third quarter of
2004. Our former subsidiary in the Ukraine was determined to be a variable
interest entity in 2004 and, as a result, was consolidated as if it were a
subsidiary for 2004. See Note 4 to the Condensed Consolidated Financial
Statements. Selling, general and administrative (S,G & A) expenses increased for the
quarter ended September 30, 2004, compared to the quarter ended September 30,
2003. Again, consistent with sales and cost of sales, the level of S,G & A
expenses were impacted by the change in value of the U.S. dollar compared to
foreign currencies and the effect of that change when converting to U.S. dollar
equivalents: 3rd Quarter 2004Constant dollarS,G & A
    
    Currency effect (a)
    
    S,G & A
    
    3rd Quarter 2003
    
    Percent ChangeU.S.
    
    $
    1,179
    
    
    $
    
    
    
    $
    1,179
    
    
    $
    1,191
    
    
    
    -0.1
    %Czech Rep.
    
    
    486
    
    
    
    (42
    )
    
    
    444
    
    
    
    322
    
    
    
    37.9
    %Ukraine
    
    
    120
    
    
    
    
    
    
    
    120
    
    
    
    
    
    
    
    
    %Total
    
    $
    1,785
    
    
    $
    (42
    )
    
    $
    1,743
    
    
    $
    1,513
    
    
    
    15.2
    %
   (a)
    
    calculated based on the conversion of 2004 local currency S,G & A expenses
at the 2003 average currency exchange rate into U.S. dollars. The flat level of U.S. expenses was primarily a combination of cost cuts offset
by increases in several expense categories. Personnel and other cost
reductions instituted in July 2003, which included certain employee
terminations, mandatory salary reductions for a significant number of remaining
employees and cuts in other expenses deemed non-essential reduced our U.S.
overhead by approximately $500,000 per annum. These cuts have been partially
offset by increases in employee health costs and planned increases in sales and
marketing costs, primarily in our Signamax line. Additional sales
representatives have been added and spending on product catalogs and other
promotional literature has been increased to cover our entire product line. In
the Czech Republic, additional funds were expended for high profile trade shows
and for sales and marketing assistance in preparing bid packages for several
potentially significant projects. Our former subsidiary in the Ukraine was
determined to be a variable interest entity in 2004 and, as a result, was
consolidated as if it were a subsidiary in 2004. See Note 4 to the Condensed
Consolidated Financial Statements. On a worldwide basis, we are continuing to
closely monitor our S,G & A expenses and may make additional headcount
reductions if consolidated sales levels (net of currency effects) do not begin
to increase in future periods. We believe that if sales increase in the future,
we will see a reduction in S,G & A expenses as a percentage of net sales, since
many of our S,G & A expenses are relatively fixed. 19




---



##### 



Pursuant to a License Agreement signed in December 2003, the Company
granted options to purchase 300,000 shares of its common stock to
Daidone-Steffens LLC, an entity affiliated with one of our directors, at an
exercise price of $0.90 per share.
The options vest over a five year period, beginning on the date the licensed
technology is transferred to the Company and a production line is installed. In
accordance with EITF No. 96-18, Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling
Goods or Services, the value of the options will be determined on the
measurement date, which is the earlier of the commitment date or the date at
which the counterpartys performance is complete, neither of which has occurred
as of September 30, 2004. In such future periods, the value of the options will
be expensed. We do not currently anticipate that the measurement date will
occur in 2004. As a result of the above factors, the loss from operations for the three
months ended September 30, 2004 was $94,000, compared to a loss from operations
of $69,000 for the three months ended September 30, 2003, an increase in the
loss from operations of $25,000. Interest expense, net, increased from $47,000 in the quarter ended
September 30, 2003 to $77,000 in the quarter ended September 30, 2004 primarily
due to an increase in interest expense of $42,000. The increase in interest
expense was focused in the U.S., where the average interest rate rose
approximately 6% due to higher rates on the Bendes note, along with the upfront
fee of 1.25% and an interest rate of 7% currently on the KBK financing
arrangement, compared to the Bank line of credit outstanding in 2003. See Note
2 to the Notes to Condensed Consolidated Financial Statements for further
information on these U.S. financing agreements. Other income (expense) varied from income of $32,000 in 2003 to income of
$25,000 in 2004. We recorded $3,000 in foreign currency losses in the third
quarter of 2003 compared to foreign currency gains of $17,000 in the third
quarter of 2004. These gains and losses arise from the transactions between our
operating units and their vendors and customers in foreign countries and are
the results of movements in the respective currencies. Further, in 2003, our
Czech Republic subsidiary posted $30,000 in income relating to advertising
credits and rental income. The loss from continuing operations before income taxes was $146,000 in
the three months ended September 30, 2004, compared to a loss of $84,000 in
the three months ended September 30, 2003, as a result of the factors mentioned
above. The provision for income taxes recorded for the three months ended
September 30, 2004 and 2003 consists of income taxes recorded on those
consolidated entities that realized profitable operations for each period.
Realization of substantially all of our deferred tax assets resulting from the
available net operating loss carryforwards and other net temporary differences
is not considered more likely than not and accordingly a valuation allowance
has been provided for the full amount of such assets. We anticipate that our
consolidated effective tax rate in future periods will be impacted by which of
our businesses are profitable in any such future period and if we will be able
to take advantage of our U.S. net operating loss carryforwards to affect
taxable income in such periods. As a result of the foregoing factors, we incurred a net loss from
continuing operations of $150,000 for the quarter ended September 30, 2004,
compared to a net loss of $86,000 recorded for the quarter ended September 30,
2003. For the third quarter of 2004, the loss from continuing operations per
common share, both basic and diluted, was $.02. For the third quarter of 2003,
the loss from continuing operations per common share, both basic and diluted,
was also $.02. Weighted average shares outstanding (basic and diluted) were
6,144,000 in 2004 and 5,975,000 in 2003. The
results of discontinued operations, net of tax associated with the discontinued
operations were a loss of $293,000 for the three months ended September 30,
2004 compared to a loss of $380,000 for the three months ended September 30,
2003. For 2004 and 2003, the primary contributor to the losses was our
Norwegian operations, which posted losses of $164,000 and $283,000,
respectively, primarily due to a significant drop in sales as a result of
competitive pressures and adverse market conditions. The loss on disposal of $583,000 recorded in the third quarter of 2004 was
primarily due to (1) a disposal loss recorded on the sale of Jotec of
approximately $140,000, (2) the write-off of $130,000 in accounts receivable
related to amounts due from Jotec, (3) accruals of $80,000 to cover attorneys
fees and bank guarantees and (4) reserves and accruals of $200,000 recorded on
Signamax GmbH due to the phase-out of those product lines not transferred to
Intelek (Czech Republic). 20




---



##### 



Nine months ended September 30, 2004 and 2003 For the nine months ended September 30, 2004, we recorded net sales of
$17.4 million, compared to net sales of $15.8 million for the nine months ended
September 30, 2003, an increase of $1.6 million or approximately 10.1%. A
portion of the increase in sales was due to the declining value of the U.S.
dollar which increased sales in our Western European segment
when converted from local currency to U.S. dollars. The following table
illustrates our sales by location and the exchange rate effect on our sales in
2004 (in thousands): Nine Months 2004Constant dollarNet sales
    
    Currency effect (a)
    
    sales
    
    Nine Months 2003
    
    Percent ChangeU.S.
    
    $
    11,415
    
    
    $
    
    
    
    $
    11,415
    
    
    $
    11,743
    
    
    
    -2.8
    %Czech Rep.
    
    
    5,074
    
    
    
    (428
    )
    
    
    4,646
    
    
    
    4,052
    
    
    
    14.7
    %Ukraine
    
    
    944
    
    
    
    
    
    
    
    944
    
    
    
    
    
    
    
    
    %Total
    
    $
    17,433
    
    
    $
    (428
    )
    
    $
    17,005
    
    
    $
    15,795
    
    
    
    7.7
    %
   (a)
    
    calculated based on the conversion of 2004 local currency sales at the 2003
average currency exchange rate into U.S. dollars. Without the impact of the foreign currency change, revenues would have
increased from $15.8 million in 2003 to $17.0 million in 2004, a rise of almost
8%. In the U.S. sales declined 2.8% from 2003 to 2004, due primarily to three
items (1) an increase of $495,000 in sales to our exclusive distributor in
Russia, AESP Russia, based upon sales growth and a strong economy in their
sector. This increase was offset by (2) a drop in sales recorded by our
Signamax computer networking product line due to a steep decline in purchases
by a major customer and (3) the elimination in consolidation of $567,000 of
U.S. sales to AESP Ukraine in 2004. Our former subsidiary in the Ukraine was
determined to be a variable interest entity in 2004 in accordance with our
adoption of FASB Interpretation No. 46, Consolidation of Variable Interest
Entitiesand, as a result, was consolidated in our financial statements for
2004, as if it were a subsidiary. Since AESP Ukraine was not consolidated in
2003, U.S. sales to AESP Ukraine during that quarter were not eliminated.
Further, in conjunction with the required consolidation of AESP Ukraine in the
first quarter of 2004, sales of AESP Ukraine to third parties of $944,000 were
added to consolidated sales. See Note 4 to the Condensed Consolidated Financial
Statements. Czech Republic sales increased in the current year as a result of
several large projects with existing customers. Cost of sales for the nine months ended September 30, 2004, increased to
$12.5 million, compared to cost of sales of $11.3 million for the nine months
ended September 30, 2003. Consistent with sales, the weakening U.S. dollar
affected the cost of sales for the current period. As the following table
illustrates, the exchange rate difference resulted in an increase to cost of
sales of approximately $324,000 in 2004, when compared to 2003, however it had
only a minimal effect on the resulting gross profit percentages (in thousands): Nine Months 2004Constant dollarCost of sales
    
    Currency effect (a)
    
    cost of sales
    
    Nine Months 2003
    
    Percent ChangeU.S.
    
    $
    7,999
    
    
    $
    
    
    
    $
    7,999
    
    
    $
    8,231
    
    
    
    -2.8
    %Czech Rep.
    
    
    3,840
    
    
    
    (324
    )
    
    
    3,516
    
    
    
    3,110
    
    
    
    13.1
    %Ukraine
    
    
    676
    
    
    
    
    
    
    
    676
    
    
    
    
    
    
    
    
    %Total
    
    $
    12,515
    
    
    $
    (324
    )
    
    $
    12,191
    
    
    $
    11,341
    
    
    
    7.5
    %Gross profit
    
    $
    4,918
    
    
    $
    (104
    )
    
    $
    4,814
    
    
    $
    4,454
    
    
    
    8.1
    %Gross profit %
    
    
    28.2
    %
    
    
    
    
    
    
    28.3
    %
    
    
    28.2
    %
   (a)
    
    calculated based on the conversion of 2004 local currency cost of sales at
the 2003 average currency exchange rate into U.S. dollars. The gross profit percentages were consistent from the first nine months of
2003 to the same period in 2004. Our former subsidiary in the Ukraine was
determined to be a variable interest entity in 2004 and, as a result, was
consolidated as if it were a subsidiary for 2004. See Note 4 to the Condensed
Consolidated Financial Statements. 21




---



##### 



Selling, general and administrative (S,G & A) expenses increased for the
nine months ended September 30, 2004, compared to the nine months ended
September 30, 2003. Again, consistent with sales and cost of sales, the level
of S,G & A expenses were impacted by the change in value of the U.S. dollar
compared to foreign currencies and the effect of that change when converting to
U.S. dollar equivalents: Nine Months 2004Constant dollarS,G & A
    
    Currency effect (a)
    
    S,G & A
    
    Nine Months 2003
    
    Percent ChangeU.S.
    
    $
    3,677
    
    
    $
    
    
    
    $
    3,677
    
    
    $
    3,859
    
    
    
    -4.7
    %Czech Rep.
    
    
    1,189
    
    
    
    (100
    )
    
    
    1,089
    
    
    
    953
    
    
    
    14.3
    %Ukraine
    
    
    257
    
    
    
    
    
    
    
    257
    
    
    
    
    
    
    
    
    %Total
    
    $
    5,123
    
    
    $
    (100
    )
    
    $
    5,023
    
    
    $
    4,812
    
    
    
    4.4
    %
   (a)
    
    calculated based on the conversion of 2004 local currency S,G & A expenses
at the 2003 average currency exchange rate into U.S. dollars. The decrease in U.S. expenses was primarily a combination of cost cuts offset
by increases in several expense categories. Personnel and other cost
reductions instituted in July 2003, which included certain employee
terminations, mandatory salary reductions for a significant number of remaining
employees and cuts in other expenses deemed non-essential will reduce our U.S.
overhead by approximately $500,000 per annum. These cuts have been partially
offset by increases in employee health costs and planned increases in sales and
marketing costs, primarily in our Signamax line. Additional sales
representatives have been added and spending on product catalogs and other
promotional literature has been increased to cover our entire product line. In
the Czech Republic, additional funds were expended for high profile trade shows
and for sales and marketing assistance in preparing bid packages for several
potentially significant projects. Our former subsidiary in the Ukraine was
determined to be a variable interest entity in 2004 and, as a result, was
consolidated as if it were a subsidiary in 2004. See Note 4 to the Condensed
Consolidated Financial Statements. On a worldwide basis, we are continuing to
closely monitor our S,G & A expenses and may make additional headcount
reductions if consolidated sales levels (net of currency effects) do not begin
to increase in future periods. We believe that if sales increase in the future,
we will see a reduction in S,G & A expenses as a percentage of net sales, since
many of our S,G & A expenses are relatively fixed. As a result of the above factors, the loss from operations for the nine
months ended September 30, 2004 was $205,000, compared to a loss from
operations of $358,000 for the nine months ended September 30, 2003, a decrease
in the loss from operations of $153,000. Interest expense, net, increased from $118,000 in the nine months ended
September 30, 2003 to $227,000 in the nine months ended September 30, 2004
primarily due to an increase in interest expense of $113,000. The increase in
interest expense was focused in the U.S., where the average interest rate rose
approximately 6% due to higher rates on the new Bendes note, along with the
upfront fee of 1.25% and an interest rate of 7% currently on the KBK financing
arrangement, compared to the Bank line of credit outstanding in 2003. See Note
2 to the Notes to Condensed Consolidated Financial Statements for further
information on these U.S. financing agreements. Other income (expense) varied from income of $52,000 in 2003 to income of
$27,000 in 2004. We recorded $37,000 in foreign currency gains in the first
nine months of 2003 compared to foreign currency losses of $10,000 in the first
nine months of 2004. These gains and losses arise from the transactions between
our operating units and their vendors and customers in foreign countries and
are the results of movements in the respective currencies. The loss from continuing operations before income taxes was $428,000 in
the nine months ended September 30, 2004, compared to $345,000 in the nine
months ended September 30, 2003, as a result of the factors mentioned above. 22




---



##### 



The provision for income taxes recorded for the nine months ended
September 30, 2004 and 2003 consists of income taxes recorded on those
consolidated entities that realized profitable operations for each period.
Realization of substantially all of our deferred tax assets resulting from the
available net operating loss carryforwards and other net temporary differences
is not considered more likely than not and accordingly a valuation allowance
has been provided for the full amount of such assets. We
anticipate that our consolidated effective tax rate in future periods will be
impacted by which of our businesses are profitable in any such future period
and if we will be able to take advantage of our U.S. net operating loss
carryforwards to affect taxable income in such periods. As a result of the foregoing factors, we incurred a net loss from
continuing operations of $455,000 for the nine months ended September 30, 2004,
compared to a net loss of $397,000 recorded for the nine months ended September
30, 2003. For the first nine months of 2004, the loss from continuing
operations per common share, both basic and diluted, was $.07. For the first
nine months of 2003, the loss from continuing operations per common share, both
basic and diluted, was also $.07. Weighted average shares outstanding (basic
and diluted) were 6,144,000 in 2004 and 5,880,000 in 2003. The
results of discontinued operations, net of tax associated with the discontinued
operations were a loss of $485,000 for the nine months ended September 30, 2004
compared to a loss of $637,000 for the nine months ended September 30, 2003.
For 2004 and 2003, the primary contributors to the losses were our Norwegian
operations, which posted losses of $125,000 and $492,000, respectively,
primarily due to a significant drop in sales as a result of competitive
pressures and adverse market conditions, and AESP GmbH, which recorded losses
of $278,000 and $222,000, respectively, due mainly to sales and margin
reductions in the depressed German economy. The loss on disposal of $753,000 recorded in the third quarter of 2004 was
primarily due to (1) a disposal loss recorded on the sale of Jotec of
approximately $140,000, (2) the write-off of $130,000 in accounts receivable
related to amounts due from Jotec, (3) accruals of $80,000 to cover attorneys
fees and bank guarantees, (4) reserves and accruals of $200,000 recorded on
Signamax GmbH due to the phase-out of those product lines not transferred to
Intelek (Czech Republic) and (5) a $119,000 writedown to its net realizable
value of goodwill associated with Lanse. We recorded a cumulative effect of a change in accounting principle in the
nine months ended September 30, 2004 of $44,000. This cumulative effect was
derived from the adoption of FASB Interpretation No. 46, which resulted in the
initial consolidation in the first quarter of 2004 our former subsidiary, AESP
Ukraine, which was determined to be a variable interest entity. See Note 4 to
the Condensed Consolidated Financial Statements for further information. Liquidity & Capital Resources Historically, the Company has primarily financed its operations with cash
flow from operations, borrowings under available lines of credit and sales of
equity securities. At September 30, 2004, we had a working capital deficit of $584,000,
compared to a working capital deficit of $17,000 at December 31, 2003. Our
current ratio was .93 at September 30, 2004 and .99 at December 31, 2003. The
balance sheet line items with the most significant changes from December 31,
2003 to September 30, 2004 were the following: 2004
    
    2003Cash
    
    $
    521,000
    
    
    $
    1,082,000
 Cash declined, as funds at December 31, 2003, along with funds generated from
the decrease in accounts receivable and inventory, were used in the first nine
months of 2004 to make net reductions in accounts payable and customer deposits
and other and to fund our operating losses. 23




---



##### 



2004
    
    2003Accounts receivable
    
    $
    1,543,000
    
    
    $
    1,967,000
 The decrease of approximately $400,000 is due to two factors: (1) Higher sales
in the last quarter of 2003, which increased accounts receivable at December
31, 2003, which were primarily collected in the first quarter of 2004. As a
result, accounts receivable was lower at September 30, 2004, as sales in the
third quarter of 2004 were lower than the fourth quarter of 2003 and (2) due to
the initial consolidation of AESP Ukraine in 2004, $238,000 in accounts
receivable on sales from our U.S operations to AESP Ukraine are eliminated in
consolidation at September 30, 2004. AESP Ukraines accounts receivable, which
were added to our consolidated balance sheet as of January 1, 2004, totaled
$93,000 at September 30, 2004. At December 31, 2003, $130,000 in accounts
receivable from AESP Ukraine remained on our consolidated balance sheet. 2004
    
    2003Inventory
    
    $
    3,582,000
    
    
    $
    4,194,000
 Net of the addition of $458,000 in inventory from the initial consolidation of
AESP Ukraine, inventory worldwide decreased by approximately $1,000,000 as the
result of efforts begun in late 2003 to increase cash flow through improved
inventory management. Funds generated from this program were used to pay down
certain liabilities and fund operating losses. 2004
    
    2003Assets of business transferred under contractual
arrangement
    
    $
    
    
    
    $
    240,000
 This asset is a note receivable (gross note of $603,000 net of impairment
reserve of $381,000 at September 30, 2004) received from the buyer of our
former subsidiary, AESP Ukraine. As a result of the required consolidation of
AESP Ukraine in 2004, in accordance with Interpretation No. 46, this note is
eliminated as of September 30, 2004 in our consolidation. As AESP Ukraine was
not consolidated at December 31, 2003, this note, net of the reserve, remained
on our consolidated balance sheet at December 31, 2003. 2004
    
    2003Current assets of discontinued operations
    
    $
    1,073,000
    
    
    $
    3,200,000Non-current assets of discontinued operations
    
    $
    145,000
    
    
    $
    741,000Current liabilities of discontinued operations
    
    $
    1,322,000
    
    
    $
    3,559,000
 The decrease is primarily due to the sale of certain assets of our Norwegian
subsidiary, Lanse, in July, 2004, the sale of 100% of the common stock of our
other Norwegian subsidiary, Jotec in August 2004 and the insolvency filing of
our German subsidiary, AESP GmbH in August 2004. As a result, assets and
liabilities relating to these entities were not consolidated at September 30,
2004. See Note 9 to the Condensed Consolidated Financial Statements. 2004
    
    2003Lines of credit
    
    $
    540,000
    
    
    $
    1,052,000Current portion of long-term debt
    
    $
    683,000
    
    
    $
    45,000
 In April, 2004 the balance remaining of $631,000 under our line of credit with
Commercebank N.A. was paid in full through the proceeds received under a new
one-year term loan agreement with Bendes. The Bendes loan, which is also
$631,000, is classified as a current portion of long-term debt in our Condensed
Consolidated Balance Sheets. 2004
    
    2003Accounts payable
    
    $
    4,667,000
    
    
    $
    5,330,000Customer deposits and other
    
    $
    332,000
    
    
    $
    460,000
 As described above, cash generated from the decrease in receivables and
inventory, along with funds on hand were utilized during the first nine months
of 2004 to make additional payments to vendors and other creditors, thereby
reducing those balances as of September 30, 2004. 24




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For the nine months ended September 30, 2004, $302,000 of cash was
provided by operating activities of continuing operations. The primary reasons
for this change in cash in 2004 were the net loss of $1,649,000 and reductions
in accounts payable and accrued expenses of $541,000 offset by the add back to
net loss of the loss from discontinued operations of $485,000 and loss on
disposal of discontinued operations of $753,000, along with a decrease in
accounts receivable of $633,000 and
inventory of $646,000. Net cash used in investing activities of continuing
operations was $180,000. Cash of $112,000 was provided by financing activities,
primarily due to the funding from the Bendes note offset by the payoff of the
U.S. line of credit. As a result of the foregoing, our cash position decreased
$615,000 between December 31, 2003 and September 30, 2004. That decrease,
combined with an increase of $54,000 attributable to the effects of exchange
rate changes on cash, produced an overall decrease in cash of $561,000. We are
continuing efforts to improve our cash position through personnel and other
expense reductions, increasing sales and collections of accounts receivable and
selected inventory reductions. On October 31, 2003, we signed two agreements, one an amendment with
Commercebank, N.A. (the Bank) to extend the maturity date on our $1.9 million
U.S. based line of credit to April 20, 2004, and a second agreement with
Marquette Commercial Finance Inc. (formerly KBK Financial, Inc.) (Marquette).
The initial funding from Marquette was used to fund a permanent reduction in
our line of credit with the Bank. The initial funding under the Marquette
agreement was $1,220,000, with $70,000 utilized to cover closing expenses and
$1,150,000 applied to the Banks line of credit. An additional payment of
$100,000 from proceeds of the Marquette agreement, was made in December 2003,
to permanently reduce the available balance under the Banks line of credit to
$631,000 (which was due and payable on April 20, 2004). This balance was paid
in full on April 26, 2004 through the proceeds received by us under a new
one-year term loan agreement with Bendes Investment Ltd (Bendes). The Bendes loan is a $631,000 one-year term loan due April 2005. The loan
bears interest at the prime rate plus 8% per annum, payable monthly. The Bendes
loan is guaranteed by the Companys principal shareholders. Under the term of
the Bendes loan, the Company is required to comply with certain affirmative and
negative covenants and is required to prepay the note, in whole or in part,
from the net proceeds of any sale of our equity securities. The Bendes loan is
secured by a lien on substantially all of our assets. The Marquette agreement advances funds to us at a rate of 82.5% of the
invoice amount purchased by Marquette. The portion of the invoices not advanced
to us are recorded as a due from factor until the invoice is paid by the
customer, at which point we receive the remaining proceeds, less fees.
Substantially all of our invoices to U.S. customers are available for sale
under this agreement and may be offered to Marquette on a daily basis, subject
to a $2,000,000 funding limit. Marquette can accept or reject offered invoices
and is not obligated to purchase any invoices. Marquette exercises control over
incoming lockbox receipts to ensure that cash received on purchased invoices is
collected. The Marquette agreement contains fixed and variable discount rate
pricing components. The fixed discount is 1.25% of the invoice amount and is
payable at the time of funding. The variable rate is Marquettes base rate as
established by Marquette from time to time (generally the prime rate), plus 2%
per annum and is payable based on the number of days from the sale of the
invoice until collection. The agreement is terminable by either party upon 30
days notice and immediately by Marquette upon default by us. In the event of
termination by us prior to November 2005, a termination fee of up to $20,000
may be due. Bendes and Marquette have entered into an intercreditor agreement
governing their respective priorities in our assets securing their respective
financings. Because funds advanced under this facility are considered a sale of the
particular invoices sold, we report funds advanced as a reduction of accounts
receivable in the Condensed Consolidated Financial Statements. The Marquette
factoring agreement is guaranteed, on a limited basis, with respect to matters
related to the existence and validity of purchased receivables, by our
principal shareholders. Under the terms of the Marquette agreement, we are
required to comply with certain affirmative and negative covenants and to
maintain certain financial benchmarks and ratios during future periods. As of
September 30, 2004, we were not in compliance with the current ratio and
tangible net worth covenants under the Marquette agreement. However, Marquette
has waived compliance with these financial covenants as of September 30, 2004.
As of November 10, 2004, Marquette had paid funds on $1,013,000 of purchased
invoices, subject to a $2,000,000 funding limit. We had net losses in each of the last three fiscal years and in the first
three quarters of fiscal 2004 and our working capital is extremely tight. We
may not meet our financial covenants in future periods unless our results of
operations substantially improve. While there can be no assurance, we expect
that Marquette will continue to waive covenant violations during future
periods. We believe that our internally generated cash flow from operations
combined with funds available under the Marquette agreement, will be sufficient
to fund current operations through April 2005 (when the Bendes loan is due). We
may also consider selling debt or equity securities, or one or more of our
operations, in order to meet current and future working capital requirements.
At current prices, any equity raise at this time (or any conversion to equity
of any of our debt) would likely be highly dilutive to our existing equity
holders. However, such fundings or transactions may not be available. If we
are unable to generate sufficient cash flow from operations to meet our
operating costs, or are otherwise unable to raise the required funds or reduce
expenses sufficiently to overcome any shortfall, our operations would be
materially and adversely affected. 25




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Our Czech Republic subsidiary, Intelek has two lines of credit available
for their operations. At September 30, 2004, an aggregate of $540,000 was
outstanding under these lines of credit and $21,000 was available for borrowing
under these
agreements. These lines of credit are renewable annually at the creditors
option. We believe that these, or substantially similar lines of credit will
remain available to us for borrowings through mid 2005. We have experienced net losses and diminished working capital for the nine
months ended September 30, 2004 and for each of the years ended December 31,
2003, 2002 and 2001. As of September 30, 2004, our working capital was
negative. We are dependent upon generating sufficient cash flow from operations
or financings to meet our operating expenses and to repay our liabilities.
While we expect to be able to meet our obligations and service our debt, there
can be no assurance that we will be able to do so. As a result of these uncertainties, the audit report accompanying our
financial statements for the year ended December 31, 2003 notes that there is
substantial doubt about our ability to continue as a going concern. The
Condensed Consolidated Financial Statements for September 30, 2004, do not
contain any adjustments that might result from the outcome of this uncertainty. We do not believe that inflation has had a material effect on our
financial condition or operating results for the last several years, as we have
historically been able to pass along increased costs in the form of adjustments
to the prices we charge to our customers. Recent Accounting Pronouncements In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46, Consolidation of Variable Interest Entities
(Interpretation No. 46). Interpretation No. 46 clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements, to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. We adopted Interpretation No. 46 in the first
quarter of 2004. See Note 4 to the Condensed Consolidated Financial Statements
for further discussion. In May 2003, the FASB issued SFAS No. 150 Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS No. 150). SFAS No. 150 requires that an issuer classify a financial
instrument that is within its scope as a liability (or asset in some
circumstances). This Statement is effective for financial instruments created
or modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. In November 2003, the
FASB deferred the effective date for the classification and measurement
provisions of certain mandatorily redeemable noncontrolling interests under
SFAS No. 150. We have adopted the provisions of SFAS No. 150 that are effective
as of March 31, 2004. The adoption of SFAS No. 150 did not have a material
effect on our results of operations or financial position. In December 2003, the SEC issued Staff Accounting Bulletin No. 104,
Revenue Recognition(SAB No. 104),which codifies, revises and rescinds
certain sections of SAB No. 101, Revenue Recognition,in order to make this
interpretive guidance consistent with current authoritative guidance. The
changes noted in SAB No. 104 did not have a material impact upon the Companys
results of operations and financial position. 
  Item 3.
    QUANTITIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risk from changes in interest rates, and
as a global company, the Company also faces exposure to adverse movements in
foreign currency exchange rates. The Companys earnings are affected by changes in short-term interest
rates as a result of its lines of credit, long-term debt and factoring
agreement. If short-term interest rates averaged 2% more in the three months
ended September 30, 2004 and 2003, the Companys interest expense and loss
before taxes would have increased by $11,000 and $11,000, respectively. If
short-term interest rates averaged 2% more in the nine months ended September
30, 2004 and 2003, the Companys interest expense and loss before taxes would
have increased by $36,000 and $34,000, respectively. 26




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The Companys revenues and net worth have been affected by foreign
currency exchange rates due to having subsidiaries in Norway, Sweden, Germany
and the Czech Republic. Further, effective in the first quarter of 2004, the
Company consolidates the
operations of AESP Ukraine. See Note 4 of Notes to Condensed Consolidated
Financial Statements. While the Companys sales to its subsidiaries are
denominated in U.S. dollars, each subsidiary owns assets and conducts business
in its local currency. Upon consolidation, the subsidiaries financial results
are impacted by the value of the U.S. dollar compared to the value of the
currency in the jurisdiction where the subsidiaries do business. A uniform 10%
strengthening as of September 30, 2004 and 2003 in the value of the dollar
would have resulted in reduced revenues of $227,000 and $149,000 for the three
months ended September 30, 2004 and 2003, respectively. A uniform 10%
strengthening as of September 30, 2004 and 2003 in the value of the dollar
would have resulted in reduced revenues of $602,000 and $405,000 for the nine
months ended September 30, 2004 and 2003, respectively A uniform 10%
strengthening as of September 30, 2004 and 2003 in the value of the dollar
would have resulted in a reduction of the Companys consolidated net worth of
$154,000 and $121,000, respectively. The Company finds it impractical to
hedge foreign currency exposure and, as a result, will continue to experience
foreign currency gains and losses. 
  Item 4.
    CONTROLS AND PROCEDURES In order to ensure that the information we must disclose in our filings
with the Securities and Exchange Commission is recorded, processed, summarized
and reported on a timely basis, we have formalized our disclosure controls and
procedures. Our principal executive officer and principal financial officer
have reviewed and evaluated the effectiveness of our disclosure controls and
procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of
September 30, 2004 (the Evaluation Date). Based on such evaluation, such officers
have concluded that, as of the Evaluation Date, our disclosure controls and
procedures were effective in timely alerting them to material information
relating to our Company (and its consolidated subsidiaries) required to be
included in our periodic SEC filings. Since the Evaluation Date, there have not
been any significant changes in our internal controls, or in other factors that
could significantly affect these controls subsequent to the Evaluation Date. 27




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##### 



PART II. OTHER INFORMATION 
 Item 1. LEGAL PROCEEDINGS None 
  Item 2.
    CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES Not applicable 
  Item 3.
    DEFAULTS UPON SENIOR SECURITIES None 
  Item 4.
    SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS None. 
  Item 5.
    OTHER INFORMATION None. 
  Item 6.
    EXHIBITS 10.1
    
    Agreement  Regarding the Transfer of Parts of Undertaking (i.e. the
Sales Business) from Lanse AESP AS to 3-Play AS, dated July 16, 2004.10.2
    
    Share Purchase Agreement relating to all shares representing the
total share capital of Jotec AESP AS, dated August 25, 2004.10.3
    
    Sale and purchase Agreement by and between AESP, Inc. and Intronics
Barneveld B.V. in respect of the shares in Advanced Electronic
Support Products Computertillbehor I Sweden AB, dated October 14,
2004.31.1
    
    Certification of Slav Stein, President and Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
302 of Sarbanes-Oxley Act of 2002.31.2
    
    Certification of John F. Wilkens, Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 302 of
Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Slav Stein, President and Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of Sarbanes-Oxley Act of 2002.32.2
    
    Certification of John F. Wilkens, Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 28




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##### 



SIGNATURES In accordance with 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. AESP, INC.By:
    /s/ SLAV STEINSlav SteinPresident and Chief Executive Officer By:
    /s/ JOHN F. WILKENSJohn F. WilkensChief Financial and Accounting Officer Dated: November 17, 2004 29