The following discussion and analysis should be read in conjunction with the financial statements and accompanying notes appearing elsewhere in this Form 10-K. This discussion contains forward-looking statements, based on current expectations related to future events and AETI's future financial performance that involves risks and uncertainties. AETI's actual results may differ materially from those anticipated in these forward-looking statements as a result of many important factors, including those set forth in the section entitled "Risk Factors" in this Form 10-K.

Overview

In May 2007, M&I was a party to a reverse merger transaction in which it was legally acquired by American Access Technologies, Inc.("AAT"). The shareholders of M&I were issued stock of AAT in amounts that in aggregate constituted approximately 80% of the total shares outstanding. As a result, the merger has been accounted for as an acquisition of AAT by M&I. Immediately following the merger, AAT's name was changed to American Electric Technologies, Inc. Results of operations of AAT have been consolidated commencing with the merger date. References to operating results prior to the May 2007 merger date solely reflect M&I and its subsidiaries and affiliates.

Our corporate structure currently consists of American Electric Technologies, Inc., which owns 100% of both M&I Electric Industries, Inc. ("M&I") and American Access Technologies, Inc. ("AAT"). We report financial data for three operating segments: the Technical Products and Services ("TP&S") segment and the Electrical and Instrumentation Construction ("E&I") segment which together encompass the operations of M&I including its South Coast Electric Systems, LLC subsidiary and the American Access ("AAT") segment which encompasses the operations of American Access including its Omega Metals division . M&I holds a 40% and 49% interests in Chinese and Singapore joint ventures, respectively. These ventures are stand-alone operating companies and enhance our ability to provide products to these markets. Income from these ventures is reported utilizing the equity method of accounting and is included in the TP&S segment's earnings before taxes.

AETI has experienced a substantial increase in the demand for its products and services over the past several years. In the years ended December 31, 2006, 2007 and 2008, AETI benefited from an improvement in overall market conditions. Although AETI enters 2009 with a relatively strong backlog, it is not possible to predict demand trends for its products and services in 2009 and beyond because of the global recessionary trends and disruptions in financial markets.

Results of Operations

Year ended December 31, 2008 compared to year ended December 31, 2007

Consolidated Comparison

Revenues and Gross Profit. Total consolidated net sales increased $9.7 million, or 17.5%, to $65.4 million for the year ended December 31, 2008 over the prior year. The increase occurred across all segments although the $2.8 million or 52.1% increase in American Access was primarily due to the May 2007 merger described above. Consolidated cost of sales for the year ended December 31, 2008 was $57.0 million, a $5.8 million increase, or 11.4%, over the prior year. The increase in cost of sales is primarily due to increases in net sales over the prior year. As a percentage of net sales, cost of sales in 2008 declined as a percentage of sales by approximately 4.7%. This reflects an increased percentage of higher margin technical services sales and lower warranty and startup costs for the liquid cooled AC drives that negatively impacted 2007. Consolidated gross profit during the year ended December 31, 2008 significantly increased from $4.5 million for 2007 to $8.4 million in 2008. The increase in consolidated gross margin is a result, in part, of increased sales while reducing the percentage of the cost of sales. Consolidated gross profit as a percent of net sales was 12.8% during 2008, compared to 8.1% for the prior year. This improvement reflects the changes in cost of goods sold described above.

Selling, General and Administrative Expenses. Total consolidated selling, general and administrative expenses were $8.2 million during the year ended December 31, 2008, an increase of $2.0 million over the prior year. Approximately $0.7 million of the increase relates to the fact that AAT's overhead expenses were not included prior to May 15, 2007. Selling expenses, primarily compensation , increased by $0.6 million. Charges for incentive plans, stock-based and otherwise increased by $0.2 million, repairs associated with Hurricane Ike approximated $0.1 million and consulting charges related to the ERP system implementation increased $0.1 million. AETI expended approximately $0.2 million in Sarbanes Oxley compliance costs. The balance of the increase in this category was occasioned by the inclusion of a full year of public company compliance costs.

Other Income and Expense. Consolidated other income and expense in 2008 declined by $0.3 million due to the realized gain on sale of marketable securities of $1.0 million in 2007 and increased interest expense($0.1 million) partially offset by increased earnings from the Chinese and Singapore joint ventures aggregating $0.9 million.

Provision for Income Taxes. Income tax expense increased by $0.6 million consistent with the increase in earnings before income tax. The effective tax rate of 35% was slightly higher than the prior year.

Net Income. Net income for the year ended December 31, 2008 was $1.7 million as compared to $0.6 million for the prior year. The increase in net income is a reflection of increased sales and gross profit partially offset by lower other income and increased selling, general and administrative expenses.

Divisional Comparisons

Technical Products & Services. The Technical Products & Services segment revenues increased $4.0 million from $30.1 million for 2007 to $34.1 million for 2008. The Technical Products & Services segment business enjoyed an approximately $1.5 million increase in its services businesses, some of which was attributable to repair work due to Hurricane Ike. Although overall revenues were strong in 2008, there was a pronounced decline in land and marine drilling rig quotations and as a result the backlog for that segment is negligible as of year end. This decline was offset by marine based drive system sales. This unit entered 2009 with a backlog of $14.4 million, comparable to the prior year, however the outlook in most of its markets is very uncertain. The segment remains committed to development of products for the alternative energy markets and it expects to commercialize some of these products in 2009.

Gross profits for the Technical Products & Services segment for 2008 were $5.2 million, a $1.3 million increase over the prior year. The increase in gross profits is primarily associated with the sales change. Its gross profit percentage increased by 2.3% relating to lower startup and warranty charges on AC drive systems and the increased higher margin services work. Technical Products & Services income before taxes for 2008 was $4.4 million compared to $3.4 million for 2007. This increase in income is a result of higher sales and related gross profit as higher equity income from joint ventures ($0.8 million) was essentially offset by increased selling and general expenses.

Electrical & Instrumentation Construction. The Construction segment reported sales of $23.2 million in 2008, an increase of $2.9 million over the prior year. The increase was due primarily to marine and powerhouse construction contracts. Approximately $10 million in each period related to new school construction projects which will not occur in 2009. The segment expects to replace most of this business with increases in wastewater construction, powerhouse projects and entry into a new market. The backlog for the Construction segment was $7.1 million as of December 31, 2008, an $11 million decline from 2007, the decrease almost exclusively due to the withdrawal from the new school construction market.

Gross profits for the Construction segment for 2008 were $1.4 million, an improvement of $2.0 million from the prior year. A substantial portion of this increase beyond the expected margin on the sales increase occurred because of an industrial contract in 2007 that incurred excess costs of $0.6 million. The Construction

segment loss before taxes for 2008 was $0.6 million compared to a loss of $1.7 million for the previous year period. This improvement was due primarily to the change in gross profits from the prior year . The segment lost approximately $1 million in both 2007 and 2008 due to contracts in the new school construction market. The segment does not expect to incur losses from the remainder of this business in 2009.

American Access Technologies. This segment's sales increased from $5.4 million to $8.2 million due primarily to inclusion of a full year of sales in 2008 since the acquisition became effective May 15, 2007. The segment contributed gross profits of approximately $1.9 million to the consolidated results, an increase of $0.6 million from the prior year which is consistent with the sales increase. Gross profit percentages declined slightly, by 1%, as the unit experienced considerable material price inflation during the middle part of the year. AAT commenced a program to increase its value added manufacturing customer base in 2008 which it believes will lead to enhanced revenues and operating margins in the future. In conjunction with this strategy, AAT sold almost $200,000 in products to the TP&S segment, an amount that should increase in 2009.

Year ended December31, 2007 compared to year ended December 31, 2006

Consolidated Comparison

Revenues and Gross Profit. AETI's sales increased 23% or $10.2 million in 2007 from the prior year levels. The increase was occasioned by a $7.8 million increase in E&I construction revenues, primarily due to the entry into the commercial market in 2007. In addition, the acquisition of AAT contributed $5.4 million of sales that were not present in 2006. The TP&S segment reported a decline of $2.9 million due to sales to China in 2006 of $6 million that did not recur. The 2006 sales to China occurred prior to the start up of the Chinese joint venture. This activity is now conducted by the BOMAY joint venture and reflected as equity income. Gross profits declined by $2.9 million to $4.5 million in 2007 in comparison to prior year levels due to a 34% increase in cost of goods sold. This was due to several factors, the most significant of which was cost overruns at 3 commercial construction projects that aggregated $1.9 million. The overruns occurred primarily due to poor project management, a circumstance that has been rectified by replacement of personnel. In addition, the application of several new technologies, liquid cooled electrical drive systems for the marine industry and alternate current digital electrical drive systems, caused costs to increase over expected levels by $1.6 million. Management believes these additional costs will not be recurring and that gross profits will return to historical levels during the second half of 2008.

Selling, general and administrative expenses. These expenses were $6.2 million in 2007 or 51% higher than 2006. Consolidating the expenses from the AAT business caused an increase of $1.6 million and the additional costs associated with becoming a publicly traded company contributed an additional $0.5 million in expense. The addition of a senior marketing executive in conjunction with higher marketing and promotion expenses aggregated $0.3 million in 2007. Partially offsetting these cost increases was a reduction in management bonuses of $0.4 million due to the reduction in operating performance.

Other Income (Expense). Other Income was higher by $1.9 million in 2007 due to a $0.6 million increase in gains from the disposal of marketable securities. All such securities have been sold as of December 31, 2007. In addition, AETI's equity in income from its joint venture affiliates increased $1.5 million in 2007 from the prior year, primarily due to the successful start up of its Chinese venture, BOMAY. This venture reported sales of $49 million (that are not consolidated). AETI reduced the reported net income from this joint venture based on the uncertainties of the operating environment and its belief that warranty and electrical system start up costs have been underestimated. The Company had increased interest expense of $0.1 million in 2007 due to increased borrowings.

Taxes on Income. Income tax expense was reduced by $1.2 million in 2007 due to reduced pretax income.

Net Income. Net income was reduced by $1.8 million in 2007 due to the reduced gross profits and higher selling, general and administrative expenses explained above.

Divisional Comparisons

Technical Products & Services. The Technical Products & Services segment revenues decreased $2.9 million from $32.9 million for 2006 to $30.0 million for 2007. The Technical Products & Services segment business has been bolstered by the strength of the overall world economy and improvements in global drilling activity discussed above although activity in the North American drilling markets reflected a reduction in activity during the latter part of 2007. Approximately $6.0 million of the Technical Products & Services segment revenues during 2006 were derived from sales to a Chinese land drilling rig manufacturer. Sales to this customer in 2007 were recorded by BOMAY, the Chinese joint venture company. As reported above, BOMAY reported sales of $49 million in 2007 that are not consolidated.

Gross profits for the Technical Products & Services segment for 2007 were $3.9 million, a $2.4 million decrease over the prior year. This reduction is a result of reduced revenues but additionally reflected start up costs associated with two new product offerings, marine liquid cooled drives and drilling system alternate current digital drives. Technical Products & Services income before taxes for 2007 was $3.4 million compared to $ 6.3 million for 2006. This decrease in income is a result of lower sales and related gross profits partially offset by the improvement in equity income. In addition, $1.6 million of corporate overheads that had previously not been allocated were charged to the segment.

Electrical & Instrumentation Construction. The Construction segment reported sales of $20.3 million in 2007, an increase of $7.8 million over the prior year. The increase was due primarily to the Company's increased activity in commercial markets. The commercial market increase primarily related to public school construction. The segment's sales to the industrial, commercial and energy markets remained strong during 2007 as well. The backlog for the Construction segment was $18.7 million as of December 31, 2007, an increase of $7.0 million over the previous year.

Gross profits for the Construction segment for 2007 reflected a loss of $0.6 million, a decrease of $2.2 million from the prior year. The decline was due to losses of $1.2 million on three commercial construction contracts that resulted from poor project management. The expected gross profit on these contracts was approximately $1.0 million. The personnel associated with these contracts have been replaced and the contracts were substantially completed as of December 31, 2007. The Company expects its gross profits to return to historical levels in 2008. The Construction segment loss before taxes for 2007 was $1.7 million compared to income of $1.6 million for the previous year period. This decrease was due primarily to contract cost overruns referred to previously and the allocation of $1.1 million in corporate overheads that was not reflected in the prior year.

American Access Technologies

Revenues and Gross Profit. This segment's sales increased $5.4 million over the prior year period due to its acquisition, effective May 15, 2007. The segment contributed gross profits of approximately $1.0 million to the consolidated results. When viewed on an annualized basis, this segment operated at essentially the same level of volume and profitability as it did in the prior year on a stand alone basis.

Liquidity and Capital Resources

As of December 31, 2008, AETI's cash and cash equivalents were $0.1 million as compared to $0.6 million as of December 31, 2007. It is AETI's operating practice to maintain cash balances as low as feasible while it has long term debt outstanding. Working capital was $14.8 and $14.0 million as of December 31, 2008 and December 31, 2007, respectively. Primarily as a result of this moderation in growth in working capital, AETI was

able to repay $1.0 million on its revolving credit facility during the year. As of December 31, 2008, AETI's current ratio is 2.34 and debt to total capitalization ratio is 16.5%. The comparable ratios for December 31, 2007 were 2.3 and 19.1%.

AETI's long-term debt declined $0.5 million during 2008 from $5.0 million in 2007. Interest payments are current on all funded debt. At 2008 year end, AETI had a $10.0 million revolving credit facility which expires in June, 2010. This facility replaced an $8.0 million line with essentially the same terms and conditions except the maturity was extended from September, 2009. For further information regarding the terms of AETI's indebtedness, see Notes 9 and 10 to the Consolidated Financial Statements contained elsewhere in this report.

Operating Activities

During 2008, AETI generated cash from operations in the amount of $0.5 million, a substantial increase over the $5.5 million utilization in 2007. Income from operations plus depreciation generated $1.3 million. This amount was augmented by a refund of income taxes of $0.6 million and increases in accounts payable and accrued liabilities of $0.9 million. Cash was utilized for increases in accounts receivable and inventories of $0.8 million and $1.4 million respectively. In 2007, the operating loss, net of depreciation consumed $0.9 million in cash flow. In addition, increases in accounts receivable and tax expenditures of $5.9 and $1.5 million, respectively utilized operating cash flow. Partially offsetting this utilization was reduced inventories of $0.5 million, increased accounts payable and accrued liabilities of $1.4 million, decreases in cost and estimated earnings in excess of billings, $0.5 million, and deferred income tax benefits of $0.5 million and non-cash charges to operating income of $0.1 million.

Investing Activities

During 2008, AETI generated $0.6 million in cash flow from investing activities as compared to utilization of $1.3 million in 2007. Principal elements of these investing activities included capital expenditures of $0.6 million offset by $1.2 million in dividends from joint ventures in 2008. In 2007, capital expenditures of $1.1 million and a $1.0 million investment in the China joint venture were partially offset by proceeds from the sale of marketable securities, $1.2 million. Disposals of equipment were not significant in any period.

Financing Activities

During 2008 the Company utilized cash for financing activities in connection with the payment of long term debt of $1.5 million. In addition, payments on a long term capital lease aggregated $76,430 and AETI received proceeds on common stock issuances of $21,687. In 2007, cash was generated from financing activities in the amount of $5.3 million due to an increase in long term debt, $5 million and the balance provided by proceeds from the exercise of stock options.

Contractual Obligations

As of December 31, 2008, AETI had the following contractual obligations (in
thousands):



                                                Payments Due by Period
                                          Less than                           More than
   Contractual Obligation        Total     1 year     2-3 years   3-5 years    5 years
   Capital Lease                $   648         127         253         268
   Long-Term Debt Obligations   $ 4,000           0       4,000          -           -

   Total                        $ 4,648         127       4,253         268          -

Outlook for Fiscal 2009

AETI will enter 2009 with a backlog of $21.5 million and this will provide a sound revenue base through the early part of the second quarter. After that time, the short term demand for our products and services is very

uncertain due to global recessionary conditions and the disruptions in the financial markets. We took aggressive action in the latter part of 2008 to improve our cost structure and reduce our breakeven levels by approximately 15% to an annual run rate of $50 million. We will closely monitor our backlog and order activity and continue to adjust our cost structure and expenditures accordingly as conditions change. We expect our service businesses, including the E&I Construction segment to be able to moderate some of the expected activity decline. In addition we expect to benefit from some of our recent product and business development activities, including alternative energy markets. We will continue our initiatives in these markets. Our joint ventures have reported slow-downs in their primary markets but we continue to believe that opportunities exist for alternative energy products, particularly in China to replace the traditional decline.

We expect to be able to finance 2009's capital expenditures and working capital needs primarily through operating cash flows. AETI believes its existing cash, working capital and unused capacity under its credit facility combined with operating earnings will be sufficient to meet its working capital needs in the immediate future.

Effects of Inflation

The significant price increases in its crucial raw materials, particularly copper and steel, and electrical components that occurred in recent years declined significantly in the latter part of 2008. The Company had been generally successful in recovering these increases from its customers in the form of increased prices. As a result, AETI has not experienced margin erosion due to inflationary pressures. Future inflationary pressures will likely be largely dependent on the worldwide demand for these basic materials which cannot be predicted at this time.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States inherently involves judgments and estimates that directly impact the reported values of assets, liabilities, income and expenses. In addition, these assumptions affect the disclosures of AETI's commitments and contingencies. The company estimates rely upon historical experience and other assumptions that management believes to be reasonable under the existing circumstances. Actual results may differ from these estimates with the benefit of hindsight. The following crucial accounting policies and estimates are important in the preparation of the company's financial statements.

Revenue Recognition

AETI reports earnings from fixed-price and modified fixed- price long-term contracts on the percentage-of-completion method. Earnings are accrued based on the ratio of costs incurred to total estimated costs. Costs include direct material, direct labor, and job related overhead. Losses expected to be incurred on contracts are charged to operations in the period such losses are determined. A contract is considered complete when all costs except insignificant items have been incurred and the facility has been accepted by the customer. Revenue from non-time and material jobs of a short-term nature (typically less than one month) is recognized on the completed-contract method after considering the attributes of such contract. This method is used because these contracts are typically completed in a short period of time and the financial position and results of operations do not vary materially from those which would result from use of the percentage-of-completion method. The asset, "Work-in-process," which is included in inventories, represents the cost of labor, material, and overheads on jobs accounted for under the completed-contract method. For contracts accounted for under the percentage-of-completion method, the asset, "Costs and estimated earnings in excess of billing on uncompleted contracts," represents revenue recognized in excess of amounts billed and the liability, "Billings in excess of costs and estimated earnings on uncompleted contracts," represents billings in excess of revenue recognized.

Concentration of Market Risk and Geographic Operations

Financial instruments which potentially subject AETI to concentrations of credit risk consist primarily of trade accounts receivable. Our market risk is dependent primarily on the strength of the oil and gas and energy

related industries. We grant credit to customers and generally do not require collateral. Procedures are in effect to monitor the credit worthiness of its customers. During 2008 or 2007, no customers accounted for more than 10% of consolidated revenues. During 2006, one customer accounted for 13% of revenues, almost all of which was paid by year-end.

As previously described, AETI has investments in China and Singapore that aggregated $4.9 million and $1.0 million, respectively as of December 31, 2008.

Foreign Currency Gains and Losses

Foreign currency translations are included as a separate component of comprehensive income. We have determined the local currency of our foreign joint ventures to be the functional currency. In accordance with Statement of Financial Accounting Standard No. 52, Foreign Currency Translation, the assets and liabilities of our foreign equity investees, denominated in foreign currency, are translated into United States dollars at exchange rates in effect at the consolidated balance sheet date; revenues and expenses are translated at the average exchange rate for the period. Related translation adjustments are reported as comprehensive income which is a separate component of stockholders' equity, whereas gains and losses resulting from foreign currency transactions are included in results of operations.

Federal Income Taxes

The liability method is used in accounting for federal income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The realizability of deferred tax assets are evaluated annually and a valuation allowance is provided if it is more likely than not that the deferred tax assets will not give rise to future benefits in the company's tax returns. AETI's federal income tax returns through December 31, 2004 have been audited by the Internal Revenue Service. As a result of the reverse merger referred to above, the company recognized a deferred tax asset of $2,852,000 based on an estimate of the extent to which net operating loss carry forwards will be realizable.

Bad Debts

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