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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 March 31, 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.

(Exact Name of Registrant as Specified in Its Charter)
     
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 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

             
        Page
  PART I. FINANCIAL INFORMATION        
 
            
  FINANCIAL STATEMENTS.        
 
            
  Condensed Consolidated Balance Sheets at March 31, 2004 (unaudited) and December 31, 2003     3  
 
            
  Condensed Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003 (unaudited)     4  
 
            
  Condensed Consolidated Statement of Shareholders’ Equity for the three months ended March 31, 2004 (unaudited)     5  
 
            
  Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003 (unaudited)     6  
 
            
  Notes to Condensed Consolidated Financial Statements (unaudited)     7  
 
            
  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS     14  
 
            
  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK     21  
 
            
  CONTROLS AND PROCEDURES.     21  
 
            
  PART II. OTHER INFORMATION        
 
            
  LEGAL PROCEEDINGS.     22  
 
            
  CHANGES IN SECURITIES AND USE OF PROCEEDS.     22  
 
            
  DEFAULTS UPON SENIOR SECURITIES.     22  
 
            
  SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.     22  
 
            
  OTHER INFORMATION.     22  
 
            
  EXHIBITS AND REPORTS ON FORM 8-K.     22  
 Sec 302 Chief Executive Officer Certification
 Sec 302 Chief Financial Officer Certification
 Sec 906 Chief Executive Officer Certification
 Sec 906 Chief Financial Officer Certification

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.

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Part I. Financial Information

Item 1. FINANCIAL STATEMENTS

AESP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                 
    March 31, 2004
   December 31, 2003
    (unaudited)        
Assets
                
Current Assets
                
Cash
   $ 692     $ 1,082  
Accounts receivable, net of allowance for doubtful accounts of $349
at March 31, 2004 and $345 at December 31, 2003
     3,239       3,581  
Due from factor
     292       265  
Inventories
     5,571       5,700  
Due from employees
     18       21  
Prepaid expenses and other current assets
     244       258  
 
    
 		      
 		  
Total current assets
     10,056       10,907  
Property and equipment, net
     571       535  
Goodwill
     643       643  
Deferred tax assets
     162       161  
Assets of business transferred under contractual arrangement
     —       240  
Other assets
     413       422  
 
    
 		      
 		  
TOTAL ASSETS
   $ 11,845     $ 12,908  
 
    
 		      
 		  
 
                
Liabilities and Shareholders’ Equity
                
Current Liabilities
                
Lines of credit
   $ 1,854     $ 1,888  
Accounts payable
     6,252       6,588  
Accrued expenses
     281       667  
Accrued salaries and benefits
     642       703  
Income taxes payable
     4       118  
Customer deposits and other
     898       995  
Current portion of long-term debt
     76       45  
 
    
 		      
 		  
Total current liabilities
     10,007       11,004  
Long term debt, less current portion
     43       71  
 
    
 		      
 		  
TOTAL LIABILITIES
     10,050       11,075  
Shareholders’ Equity
                
Preferred stock, $.001 par value; 1,000 shares authorized; none issued
     —       —  
Common stock, $.001 par value; 20,000 shares authorized; 6,144 shares issued at March 31, 2004 and December 31, 2003
     6       6  
Paid-in capital
     13,546       13,546  
(Deficit)
     (11,728 )     (11,664 )
Accumulated other comprehensive loss
     (29 )     (55 )
 
    
 		      
 		  
TOTAL SHAREHOLDERS’ EQUITY
     1,795       1,833  
 
    
 		      
 		  
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
   $ 11,845     $ 12,908  
 
    
 		      
 		  

See accompanying notes to condensed consolidated financial statements.

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AESP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                 
    Three Months Ended
    March 31,
    2004
   2003
Net sales
   $ 8,583     $ 8,103  
Operating expenses
                
Cost of sales
     5,871       5,392  
Selling, general and administrative expenses
     2,683       2,729  
 
    
 		      
 		  
Total operating expenses
     8,450       8,121  
 
    
 		      
 		  
Income (loss) from operations
     29       (18 )
Other income (expense):
                
Interest, net
     (90 )     (38 )
Other, net
     (19 )     39  
 
    
 		      
 		  
(Loss) before income taxes
     (80 )     (17 )
Provision for income taxes
     28       52  
 
    
 		      
 		  
Net (loss) before cumulative effect of change in accounting principle
     (108 )     (69 )
Cumulative effect of a change in accounting principle
     44       —  
 
    
 		      
 		  
Net (loss)
     (64 )     (69 )
Preferred stock dividends
     —       12  
 
    
 		      
 		  
Net (loss) applicable to common shareholders
   $ (64 )   $ (81 )
 
    
 		      
 		  
Net loss per common share — basic
   $ (0.01 )   $ (0.01 )
 
    
 		      
 		  
Net loss per common share — diluted
   $ (0.01 )   $ (0.01 )
 
    
 		      
 		  

See accompanying notes to condensed consolidated financial statements.

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AESP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2004
(UNAUDITED)
(IN THOUSANDS)
                                                         
    Common Stock
                            
                                    Accumulated        
                    Additional           Other   Comprehensive   Total
    Shares   Par   Paid-In           Comprehensive   Income   Shareholders'
    Outstand.
   Value
   Capital
   (Deficit)
   Income (Loss)
   (Loss)
   Equity
Balance at December 31, 2003
     6,144     $ 6     $ 13,546     $ (11,664 )   $ (55 )           $ 1,833  
Net (loss)
                             (64 )             (64 )     (64 )
Other comprehensive income (loss):
                                                        
Foreign currency translation adjustment, net of tax
                                     26       26       26  
 
                                            
 		          
 
                                             (38 )        
 
    
 		      
 		      
 		      
 		      
 		      
 		      
 		  
Balance at March 31, 2004
     6,144     $ 6     $ 13,546     $ (11,728 )   $ (29 )           $ 1,795  
 
    
 		      
 		      
 		      
 		      
 		      
 		      
 		  

See accompanying notes to condensed consolidated financial statements.

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AESP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)
(IN THOUSANDS)
                 
    Three months ended March 31,
    2004
   2003
Operating Activities:
                
Net (loss)
   $ (64 )   $ (69 )
Adjustments to reconcile net (loss) to net cash used in operating activities:
                
Provision, net for losses on accounts receivable
     7       10  
Depreciation and amortization
     77       65  
Amortization of deferred compensation
     —       32  
Deferred income taxes
     1       10  
(Increase) decrease in:
                
Accounts receivable
     189       252  
Due from factor
     (27 )     —  
Inventories, net
     100       (108 )
Prepaid expenses and other current assets
     (73 )     37  
Other assets
     (6 )     —  
Increase (decrease) in:
                
Accounts payable and accrued expenses
     (520 )     118  
Accrued salaries and benefits
     (61 )     (82 )
Income taxes payable
     (113 )     (74 )
Customer deposits and other
     (146 )     (505 )
 
    
 		      
 		  
Net cash (used in) operating activities
     (636 )     (314 )
 
                
Investing Activities:
                
(Additions), deletions, net to property and equipment
     (112 )     14  
Effect of implementation of FASB Interpretation No. 46
     390       —  
Collection of loans due from employees
     3       3  
Collection on note receivable from sale of Ukrainian subsidiary
     —       25  
 
    
 		      
 		  
Net cash provided by investing activities
     281       42  
 
                
Financing Activities:
                
Net (payments on) lines of credit
     (12 )     (67 )
 
    
 		      
 		  
 
                
Net cash (used in) financing activities
     (12 )     (67 )
 
                
Net decrease in cash
     (367 )     (339 )
Effect of exchange rate changes on cash
     (23 )     (25 )
Cash, at beginning of period
     1,082       1,226  
 
    
 		      
 		  
Cash, at end of period
   $ 692     $ 862  
 
    
 		      
 		  
 
                
Supplemental information:
                
Cash paid for:
                
Interest
   $ 91     $ 56  
Taxes
     34       104  
 
                
Non-cash transactions:
                
Conversion of common stock to preferred stock
     —       230  
Conversion of preferred stock to common stock
     —       230  
Preferred stock cash dividends accrued
     —       12  

See accompanying notes to condensed consolidated financial statements.

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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 month period ended March 31, 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”.
 
    
 
  Certain amounts in the 2003 financial statements have been reclassified to conform to the 2004 presentation.
 
    
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 KBK Financial, Inc. (“KBK”). The initial funding from KBK was used to fund a permanent reduction in the Company’s 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 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 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.

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AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

     
 
  The KBK agreement advances funds to the Company at a rate of 82.5% of the invoice amount purchased by KBK. 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 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 the Company. In the event of termination by the Company 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 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 KBK 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 KBK 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 February 29, 2004, the Company was 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, the Company was in compliance with the applicable covenants.
 
    
  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 its financing institutions will continue to waive covenant violations during future periods. The Company believes that its internally generated cash flow from operations including anticipated operating cost reductions, combined with funds available under the KBK agreement, will be sufficient to fund current operations for the next twelve months. The Company may also consider selling debt or equity securities in order to meet current and future working capital requirements or to fund future acquisitions. If the Company is unable to generate sufficient cash flow from operations or in some other fashion, or reduce expenses, its operations will be materially and adversely affected.

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AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

     
3. Earnings (loss) per share
   The following reconciles the components of the (loss) per share (“EPS”) computation (in thousands, except per share amount):
                                                 
FOR THE THREE MONTHS ENDED MARCH 31,
   2004
   2003
    Loss   Shares   Per-Share   Loss   Shares   Per-Share
    (Numerator)
   (Denominator)
   Amount
   (Numerator)
   (Denominator)
   Amount
(Loss) per common share:
                                                
Net (loss)
   $ (64 )     6,144     $ (0.01 )   $ (69 )     5,723     $ (0.01 )
Preferred stock dividends
     —       —       —       (12 )     —       —  
 
    
 		      
 		      
 		      
 		      
 		      
 		  
Net (loss) applicable to common shareholders
     (64 )     6,144       (0.01 )   $ (81 )     5,723     $ (0.01 )
Effect of dilutive securities:
                                                
Stock options
     —       —       —       —       —       —  
 
    
 		      
 		      
 		      
 		      
 		      
 		  
Net (loss) applicable to common shareholders plus assumed conversions
   $ (64 )     6,144     $ (0.01 )   $ (81 )     5,723     $ (0.01 )
 
    
 		      
 		      
 		      
 		      
 		      
 		  
     
  Vested options to purchase 3,028,000 shares of common stock at $0.81 — $3.69 per share, were outstanding at March 31, 2004, but were not included in the computation of diluted EPS for the three months ended March 31, 2004, as they are anti-dilutive due to the Company’s loss.
 
    
  Vested options to purchase 2,483,000 shares of common stock at $0.81 — $3.69 per share, were outstanding at March 31, 2003, but were not included in the computation of diluted EPS for the three months ended March 31, 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 it is 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 March 31, 2004, Ukraine has total assets of $472,000 and total debt and other payables of $805,000, of which $771,000 is payable to the Company. (Ukraine has negative equity.) The amount payable to the Company consists of a gross note receivable of $621,000 and trade accounts receivable of $150,000 at March 31, 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 is reporting the difference of $44,000 in Ukraine’s assets and liabilities as a cumulative effect of a change in accounting principle in its Condensed Consolidated Statement of Operations for the three months ended March 31, 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.

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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. Segment information is presented below for each significant geographic region (in thousands).
                                 
    United States
   Western Europe
   Elimination
   Total
Three months ended March 31, 2004:
                                
Sales to unaffiliated customers
   $ 4,039     $ 4,544     $ —     $ 8,583  
Transfers between geographical areas
     598       —       (598 )     —  
 
    
 		      
 		      
 		      
 		  
Total sales
     4,637       4,544       (598 )     8,583  
 
    
 		      
 		      
 		      
 		  
Operating income (loss)
     (34 )     84       (21 )     29  
Income (loss) before income taxes
     (97 )     38       (21 )     (80 )
Identifiable assets
     6,737       7,685       (2,577 )     11,845  
 
                                
Three months ended March 31, 2003:
                                
Sales to unaffiliated customers
   $ 4,030     $ 4,073     $ —     $ 8,103  
Transfers between geographic areas
     715       —       (715 )     —  
 
    
 		      
 		      
 		      
 		  
Total sales
     4,745       4,073       (715 )     8,103  
 
    
 		      
 		      
 		      
 		  
Operating income (loss)
     67       (77 )     (8 )     (18 )
Income (loss) before income taxes
     54       (63 )     (8 )     (17 )
Identifiable assets
     7,134       7,444       (1,456 )     13,122  
     
 
  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 March 31, 2004 and 2003, approximated 66% and 65%, respectively, of consolidated revenues.
 
    
  No supplier accounted for more than 10% of consolidated purchases in the three months ended March 31, 2004 and 2003.
 
    
  Sales by the Company’s United States business segment to its exclusive distributor in Russia, AESP-Russia, amounted to approximately 12% and 14% of net sales for the three months ended March 31, 2004 and 2003, respectively.

10

Table of Contents

AESP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

     
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 and will continue for a period of one-year thereafter, unless the Company’s Board of Directors extends the period further. In March 2004 the Company reduced the exercise price of the warrants from $2.50 per share. The current exercise price of the Warrants is as follows:
         
 
   •   Until June 15, 2004, the Warrants are exercisable at an exercise price of $1.25 per share, and
 
        
  •   Thereafter, until September 23, 2004 (the current 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