UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark one)

OR

For the transition period from __________ to __________

Commission File No. 000-12739

AESP, INC.

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 May 10, 2004, the registrant had 6,143,596 outstanding shares of its common stock, par value $.001 per share.

AESP, INC. AND SUBSIDIARIES

INDEX

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:

•

competition from other manufacturers and distributors of computer networking products both nationally and internationally,

•

our ability to pay our operating expenses and service our debt from our available working capital,

•

our ability to generate sales of our products at sufficient gross margins to operate our business on a cash flow 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 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

Part I. Financial Information

Item 1. FINANCIAL STATEMENTS

AESP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to condensed consolidated financial statements.

3

AESP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to condensed consolidated financial statements.

4

AESP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

See accompanying notes to condensed consolidated financial statements.

5

AESP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to condensed consolidated financial statements.

6

AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

7

AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

8

AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

9

AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

10

AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

11

AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

12

AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

13

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.

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.

14

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 March 31, 2004, we had $643,000 in indefinite lived goodwill primarily related to our acquisitions of Intelek (Czech Republic) and Lanse (Norway). We operate in two markets, the U.S. and Western Europe. These two geographic regions constitute our reportable segments. See Note 5 of Notes to our Condensed Consolidated Financial Statements for additional information regarding our geographic segments. All of our goodwill is associated with two reporting units, both part of 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. For instance, at March 31, 2004 we have maintained an accrual for severance payments to the former managing director in Norway in connection with a dispute over his termination.

15

Results of Operations

Three months ended March 31, 2004 and 2003

     For the quarter ended March 31, 2004, we recorded net sales of $8.6 million, compared to net sales of $8.1 million for the quarter ended March 31, 2003, an increase of $.5 million or approximately 6.2%. A significant 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):

(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 $8.1 million in 2003 to $8.2 million in 2004, an increase of $.1 million or approximately 1.2%. In the U.S. sales were relatively flat from quarter to quarter, however a sales increase of $340,000 was achieved by our Advanced Electronic Manufacturing group from several new customers added in late 2003. This increase was offset by three items (1) a $67,000 decline in sales to our exclusive distributor in Russia, who purchased additional product in the first quarter of 2003 due to a planned build up of inventory, (2) a decline in U.S. sales of our Signamax product line due to the negative impact of the loss of a significant customer in the second quarter of 2003 and (3) the elimination in consolidation of $130,000 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 Entities and, as a result, was consolidated in our financial statements for the first quarter ended March 31, 2004 as if it was a subsidiary. Since AESP Ukraine was not consolidated for the first 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 $196,000 were added to consolidated sales. See Note 4 to the Condensed Consolidated Financial Statements. Sales in Germany decreased in the first quarter of 2004 due to a drop in purchasing from certain customers based on competitive conditions. 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 March 31, 2004, increased to $5.9 million, compared to cost of sales of $5.4 million for the three months ended March 31, 2003. Consistent with the rise in sales, this increase of $.5 million was primarily the result of the weakening U.S. dollar. As the following table illustrates, the exchange rate difference resulted in an increase to cost of sales of approximately $.3 million in 2004, when compared to 2003, however it had only a minimal effect on the resulting gross profit percentages (in thousands):

(a) calculated based on the conversion of 2004 local currency cost of sales at the 2003 average currency exchange rate into U.S. dollars.

16

The decline in gross profit percentage, from 33.5% in the first quarter of 2003 to 32.1% in the first quarter of 2004, was due primarily to operations in the U.S. While a portion of the increase in cost of sales in the U.S. can be attributed to the rise in sales, approximately $150,000 is due to a combination of pricing pressures in our markets and an increase in material costs. Increases in certain materials, such as copper have negatively impacted our product costs, while at the same time, competitive market conditions have not allowed us to pass all of the cost increases along to our customers. 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 the first quarter ended March 31, 2004. See Note 4 to the Condensed Consolidated Financial Statements.

     Selling, general and administrative (“S,G & A”) expenses decreased slightly for the quarter ended March 31, 2004, compared to the quarter ended March 31, 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:

(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 Germany, headcount reductions accounted for the bulk of the decrease in S,G & A expenses in 2004. Facility consolidations, including the move of their warehouse from Munich, Germany to Vienna, Austria in early 2004 will further reduce expenses at our German subsidiaries over the balance of 2004. Headcount reductions have also been the prime factor behind the reduction in expenses at our Norwegian and Swedish operations. 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 the first quarter ended March 31, 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.

     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, 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 March 31, 2004. In such future periods, the value of the options will be expensed.

     As a result of the above factors, income from operations for the three months ended March 31, 2004 was $29,000, compared to a loss from operations of $18,000 for the three months ended March 31, 2003, a increase in income from operations of $47,000.

     Interest expense, net, increased from $38,000 in the quarter ended March 31, 2003 to $90,000 in the quarter ended March 31, 2004 as we experienced an increase in interest expense of $32,000 and a decrease in interest income of $20,000. The increase in interest expense was focused in the U.S., where the average interest rate rose approximately 6% due to rate hikes included in several extensions on the Bank line of credit in 2003, along with the upfront fee of .8% and an interest rate of 7% currently on the KBK financing arrangement. See Note 2 to the Notes to Condensed Consolidated Financial Statements for further information on these U.S. financing agreements. The drop in interest income was primarily due to the 2003 conversion of our Norwegian operations from an investor of excess cash to a net borrower, as cash was required to fund its operating losses in 2003.

17

     Other income (expense) varied from income of $39,000 in 2003 to expense of $19,000 in 2004. We recorded $23,000 in foreign currency gains in the first quarter of 2003 compared to foreign currency losses of $31,000 in the first 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.

     The loss before income taxes was $80,000 in the three months ended March 31, 2004, compared to $17,000 in the three months ended March 31, 2003, as a result of the factors mentioned above.

     For the three months ended March 31, 2004 and 2003, a tax provision was recorded on those European subsidiaries that recorded profitable operations for that period, primarily the Czech Republic for both quarters. 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 its U.S. net operating loss carryforwards to affect taxable income in such periods.

     We recorded a cumulative effect of a change in accounting principle in the quarter ended March 31, 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 current quarter of 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.

     As a result of the foregoing factors, we incurred a net loss of $64,000 for the quarter ended March 31, 2004, compared to a net loss of $69,000 recorded for the quarter ended March 31, 2003. For both quarterly periods, the loss per common share, both basic and diluted, was $.01. Weighted average shares outstanding (basic and diluted) were 6,144,000 in 2004 and 5,723,000 in 2003.

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 March 31, 2004, the Company had working capital of $49,000, compared to a working capital deficit of $97,000 at December 31, 2003. The Company’s current ratio was 1.00 at March 31, 2004 and .99 at December 31, 2003. The balance sheet line items with the most significant changes from December 31, 2003 to March 31, 2004 were the following:

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 quarter of 2004 to make net reductions in accounts payable and accrued expenses.

The decrease of approximately $340,000 is due to two factors: (1) Significant sales at our Czech Republic subsidiary in the last two months of 2003, which increased accounts receivable at December 31, 2003 and were collected in the first quarter of 2004. As a result, accounts receivable declined at March 31, 2004, as sales in the first quarter of 2004 were lower than the fourth quarter of 2003, (2) Due to the initial consolidation of AESP Ukraine at March 31, 2004, $150,000 in accounts receivable on sales from our U.S operations to AESP Ukraine were eliminated in consolidation at March 31, 2004. AESP Ukraine’s accounts receivable, which were added to our consolidated balance sheet at March 31, 2004, totaled $13,000. At December 31, 2003, $130,000 in accounts receivable from AESP Ukraine remained on the consolidated balance sheet.

18

Net of the addition of $400,000 in inventory from the initial consolidation of AESP Ukraine, inventory worldwide decreased by approximately $500,000 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.

This asset is a note receivable (gross note of $621,000 net of impairment reserve of $381,000) received from the buyer of our former subsidiary, AESP Ukraine. As a result of the required consolidation of AESP Ukraine at March 31, 2004, in accordance with Interpretation No. 46, this note is eliminated as of March 31, 2004 in our consolidation . As AESP Ukraine was not consolidated at December 31, 2003, this note remains on our consolidated balance sheet at December 31, 2003.

As described above, cash generated from the decrease in receivables and inventory, along with funds on hand were utilized during the first quarter of 2004 to make additional payments to vendors and other creditors, thereby reducing those balances as of March 31, 2004.

     For the three months ended March 31, 2004, $636,000 of cash was used in operations. The primary reason for the use of cash in 2004 were reductions in accounts payable and accrued expenses of $520,000 and customer deposits and other of $146,000 offset by a decrease in inventory of $100,000. Net cash provided by investing activities was $281,000, primarily due to the effect of the implementation of FASB Interpretation No. 46 of $390,000, offset by additions, net to property and equipment of $112,000. Cash of $12,000 was used by financing activities, primarily due to line of credit paydowns by the our Norwegian subsidiary. As a result of the foregoing, our cash position decreased $367,000 between December 31, 2003 and March 31, 2004. That decrease, combined with a decline of $23,000 attributable to the effects of exchange rate changes on cash, produced an overall decrease in cash of $390,000. 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 KBK Financial, Inc. (“KBK”). The initial funding from KBK was used to fund a permanent reduction in our line of credit with the Bank. The initial funding under the KBK 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 KBK 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 KBK agreement advances funds to us at a rate of 82.5% of the invoice amount purchased by KBK. 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 KBK on a daily basis, subject to a $2,000,000 funding limit. KBK can accept or reject offered invoices and is not obligated to purchase any invoices. KBK exercises control over incoming lockbox receipts to ensure that cash received on purchased invoices is collected. The KBK agreement contains fixed and variable discount rate pricing components. The fixed discount is 0.8% of the invoice amount and is payable at the time of funding. The variable rate is KBK’s base rate as established by KBK 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 KBK upon default by us. In the event of termination by us prior to November 2005, a termination fee of up to $40,000 may be due. Bendes and KBK have entered into an intercreditor agreement governing their respective priorities in our assets securing their respective financings.

19

     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 KBK 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 KBK 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 February 29, 2004, we were not in compliance with the current ratio and tangible net worth covenants under the KBK agreement. However, KBK has waived compliance with these financial covenants as of February 29, 2004. As of March 31, 2004, we were in compliance with the applicable covenants. As of March 31, 2004, KBK had paid funds on $1,551,000 of purchased invoices, subject to a $2,000,000 funding limit.

     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 our financing institutions will continue to waive covenant violations during future periods. We believe that our internally generated cash flow from operations including operating cost reductions, combined with the KBK agreement, will be sufficient to fund current operations for the next twelve months, provided efforts to increase working capital are successful. We may also consider selling debt or equity securities in order to meet current and future working capital requirements or to fund future acquisitions. If we are unable to generate sufficient cash flow from operations or in some other fashion, or reduce expenses, our operations will be materially and adversely affected.

     Our foreign subsidiaries also have various lines of credit available for their operations. At March 31, 2004, an aggregate of $1,223,000 was outstanding under these lines of credit and $725,000 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 for at least the next 12 months.

     We have experienced net losses and diminished working capital for the three months ended March 31, 2004 and for each of the years ended December 31, 2003, 2002 and 2001. As of March 31, 2004, our working capital was negligible. 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.

     We believe that internally generated cash flow from operations combined with funds available under the KBK agreement and our subsidiaries’ lines of credit, will be sufficient to meet our financial obligations for the next twelve months. Additionally, our plans for 2004 and beyond include a gradual increase in sales, reductions in inventories, and continuing cost reductions, all designed to enhance cash flow from operations and liquidity. However, we are continuing to incur losses and can offer no assurance of returning to profitability. We are also considering selling debt or equity securities, including shares issuable upon the exercise of the Warrants issued in the Warrant Dividend, in order to pay our debt, meet current and future working capital requirements or to fund future acquisitions. There can be no assurance, however, that such debt or equity financing would be available to us on favorable terms or at all. If we are unable to generate sufficient cash flow from operations or in some other fashion, our operations and financial position will be materially and adversely affected.

     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.

20

     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. QUANTITATIVE AND QUALITATIVE 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. If short-term interest rates averaged 2% more in the three months ended March 31, 2004 and 2003, the Company’s interest expense and loss before taxes would have increased by $17,000 and $12,000, respectively.

     The Company’s revenues and net worth are 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 March 31, 2004 and 2003 in the value of the dollar would have resulted in reduced revenues of $435,000 and $413,000 for the three months ended March 31, 2004 and 2003, respectively. A uniform 10% strengthening as of March 31, 2004 and 2003 in the value of the dollar would have resulted in a reduction of the Company’s consolidated net worth of $169,000 and $185,000, 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 March 31, 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.

21

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

     None

Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

     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

     On April 22, 2004, the Company received a letter from the NASDAQ SmallCap Market advising the Company that as a consequence of its common stock having traded below $1.00 for a consecutive 30-day trading period, the Company was not in compliance with the NASDAQ continued listing maintenance standards. Under the NASDAQ rules, the Company is subject to delisting of its common stock if the closing bid price of its common stock is not $1.00 per share or more for a minimum of ten consecutive trading days between this date and October 19, 2004. As a result, there can be no assurance that the Company will be able to maintain its listing on the NASDAQ SmallCap Market.

Item 6. EXHIBITS AND REPORTS ON FORM 8-K

     (a) Exhibits

     (b) Reports on Form 8-K

     The Company filed a Form 8-K on April 2, 2004, to report the Company issued a press release announcing its financial results for the fiscal year ended December 31, 2003.

     The Company filed a Form 8-K on April 30, 2004 reporting the funding of the Bendes loan and reporting that the Company’s auditors had included a going concern qualification in their audit report on the Company’s fiscal 2003 financial statements.

22

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 STEIN
		Slav Stein
		President and Chief Executive Officer

	By:	/s/ JOHN F. WILKENS
		John F. Wilkens
		Chief Financial and Accounting Officer

Dated: May 14, 2004

23