**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10 - Q**

 

**(MarkOne)**

 
| **ý**                               |   | **Quarterly Report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                                                               |
|------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                     |   |                                                                                                                                                                                                                                                                                                                       |
|                                     |   | **For the quarterly period ended:  SEPTEMBER 30, 2003**                                                                                                                                                                                                                                                          |
|                                     |   |                                                                                                                                                                                                                                                                                                                       |
| **o**                                    |   | **Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                                                              |
|                                     |   |                                                                                                                                                                                                                                                                                                                       |
|                                     |   | **For  the transition period  from                       to                       ** |
|                                     |
| **Commission File Number:  1-8101** |

 

**SMTEK INTERNATIONAL, INC.**

Exact Name of Registrant asSpecified in Its Charter:

 

| **DELAWARE**                                                    |   | **33-0213512**                      |
|-----------------------------------------------------------------|--------|-------------------------------------|
| State or Other  Jurisdiction of  Incorporation or Organization: |   | I.R.S. Employer  Identification No. |
|                                                            |   |                                |
|                                                            |   |                                |
| Address of Principal Executive Offices:                         |   | **200 Science Drive**               |
|                                                            |   | **Moorpark, CA  93021**        |
|                                                            |   |                                |
| Registrant’s Telephone Number:                             |   | **(805) 532-2800**                  |

 

Indicate by check mark whetherthe registrant:  (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.    Yes ý  No o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934). Yes o No ý

 

The registrant had 2,284,343shares of Common Stock outstanding as of October 28, 2003.

 

 

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**SMTEK INTERNATIONAL,INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATEDBALANCE SHEETS (UNAUDITED)**

**(In thousands exceptshare amounts)**

 
|                                                                                                                                             |   | **September  30,  2003** |   | **June 30,  2003** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|--------------------|--------|
|                                                                                                                                             |   |                     |   |               |   |
| **ASSETS**                                                                                                                                       |   |                     |   |               |   |
| Current assets:                                                                                                                                  |   |                     |   |               |   |
| Cash and cash equivalents                                                                                                                        |   | $                        | 846    |               | $      | 583 |   |
| Accounts receivable, less allowance for  doubtful accounts of $660 and $657, as of September 30, 2003 and  June 30, 2003, respectively |   | 12,403                   |   | 11,096             |   |
| Inventories, net                                                                                                                                 |   | 10,190                   |   | 9,377              |   |
| Prepaid expenses                                                                                                                                 |   | 1,004                    |   | 446                |   |
| Total current assets                                                                                                                             |   | 24,443                   |   | 21,502             |   |
|                                                                                                                                             |   |                     |   |               |   |
| Property, equipment and improvements, net  of accumulated depreciation and amortization                                                          |   | 5,205                    |   | 5,541              |   |
| Other assets                                                                                                                                     |   | 763                      |   | 763                |   |
|                                                                                                                                             |   | $                        | 30,411 |               | $      | 27,806 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                    |   |                     |   |               |   |
| Current liabilities:                                                                                                                             |   |                     |   |               |   |
| Current portion of long-term debt                                                                                                                |   | $                        | 1,697  |               | $      | 2,495 |   |
| Accounts payable                                                                                                                                 |   | 10,948                   |   | 9,598              |   |
| Other accrued liabilities                                                                                                                        |   | 3,717                    |   | 3,708              |   |
| Total current liabilities                                                                                                                        |   | 16,362                   |   | 15,801             |   |
|                                                                                                                                             |   |                     |   |               |   |
| Long-term liabilities:                                                                                                                           |   |                     |   |               |   |
| Long-term bank lines of credit payable                                                                                                           |   | 6,681                    |   | 5,452              |   |
| Long-term debt                                                                                                                                   |   | 4,651                    |   | 5,675              |   |
| Total liabilities                                                                                                                                |   | 27,694                   |   | 26,928             |   |
| Commitments and contingencies                                                                                                                    |   |                     |   |               |   |
|                                                                                                                                             |   |                     |   |               |   |
| Stockholders’ equity:                                                                                                                       |   |                     |   |               |   |
| Preferred stock, $1 par value;  1,000,000 shares authorized; 250,000  shares issued and outstanding at September 30, 2003              |   | 475                      |   | —             |   |
| Common stock, $.01 par value; 3,750,000  shares authorized; 2,284,343 issued and outstanding at September 30,  2003 and June 30, 2003  |   | 23                       |   | 23                 |   |
| Additional paid-in capital                                                                                                                       |   | 37,028                   |   | 37,028             |   |
| Accumulated deficit                                                                                                                              |   | (34,918                  | )      | (36,232            | )      |
| Accumulated other comprehensive loss                                                                                                             |   | 109                      |   | 59                 |   |
| Total stockholders’ equity                                                                                                                  |   | 2,717                    |   | 878                |   |
|                                                                                                                                             |   | $                        | 30,411 |               | $      | 27,806 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

2

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**SMTEK INTERNATIONAL,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONSAND OTHER COMPREHENSIVE INCOME (LOSS) (Unaudited)**

**(In thousands exceptper share amounts)**

 
|                                                                      |   | **Three  Months Ended  September 30,** |   |
|---------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                      |   | **2003**                               |   | **2002** |   |
| Revenues                                                                  |   | $                                      | 20,692 |   | $ | 17,587 |   |
| Cost of goods sold                                                        |   | 18,007                                 |   | 16,050 |   |
| Gross profit                                                              |   | 2,685                                  |   | 1,537 |   |
| Operating expenses:                                                       |   |                                   |   |   |   |
| Administrative and selling                                                |   | 2,027                                  |   | 1,931 |   |
| Total operating expenses                                                  |   | 2,027                                  |   | 1,931 |   |
| Operating income (loss)                                                   |   | 658                                    |   | (394 | ) |
| Non-operating income (expense):                                           |   |                                   |   |   |   |
| Interest expense, net                                                     |   | (215                                   | )      | (254 | ) |
| Other income, net                                                         |   | 908                                    |   | 4 |   |
| Total non-operating income (expense), net                                 |   | 693                                    |   | (250 | ) |
| Income (loss) from continuing operations  before income taxes             |   | 1,351                                  |   | (644 | ) |
| Income tax provision                                                      |   | 37                                     |   | 5 |   |
| Income (loss) from continuing operations                                  |   | 1,314                                  |   | (649 | ) |
| Loss from discontinued operations, net of  tax                            |   | —                                 |   | (134 | ) |
| Income (loss) before cumulative effect of  change in accounting principle |   | 1,314                                  |   | (783 | ) |
| Cumulative effect of change in accounting  principle                      |   | —                                 |   | (420 | ) |
| Net income (loss)                                                         |   | $                                      | 1,314  |   | $ | (1,203 | ) |
| Basic earnings (loss) per share:                                          |   |                                   |   |   |   |
| Income (loss) from continuing operations                                  |   | $                                      | 0.58   |   | $ | (0.29 | ) |
| Loss from discontinued operations                                         |   | —                                 |   | (0.06 | ) |
| Cumulative effect of change in accounting  principle                      |   | —                                 |   | (0.18 | ) |
| Net income (loss) per share                                               |   | $                                      | 0.58   |   | $ | (0.53 | ) |
|                                                                      |   |                                   |   |   |   |
| Diluted earnings (loss) per share:                                        |   |                                   |   |   |   |
| Income (loss) from continuing operations                                  |   | $                                      | 0.56   |   | $ | (0.29 | ) |
| Loss from discontinued operations                                         |   | —                                 |   | (0.06 | ) |
| Cumulative effect of change in accounting  principle                      |   | —                                 |   | (0.18 | ) |
| Net income (loss) per share                                               |   | $                                      | 0.56   |   | $ | (0.53 | ) |
|                                                                      |   |                                   |   |   |   |
| Shares used in computing basic and diluted  earnings (loss) per share:    |   |                                   |   |   |   |
| Basic                                                                     |   | 2,284                                  |   | 2,284 |   |
| Diluted                                                                   |   | 2,362                                  |   | 2,284 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

3

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**SMTEK INTERNATIONAL, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)**

**(In thousands)**

 
|                                                                                                                 |   | **Three  Months Ended  September 30,** |   |
|----------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                                 |   | **2003**                               |   | **2002** |   |
| Cash flows from operating activities:                                                                                |   |                                   |   |   |   |
| Income (loss) from continuing operations                                                                             |   | $                                      | 1,314  |   | $ | (649 | ) |
| Adjustments to reconcile net income (loss)  from continuing operations to net cash provided by operating activities: |   |                                   |   |   |   |
| Depreciation and amortization                                                                                        |   | 454                                    |   | 518 |   |
| Gain on extinguishment of debt                                                                                       |   | (817                                   | )      | — |   |
| (Increase) decrease in accounts receivable                                                                           |   | (1,307                                 | )      | 209 |   |
| (Increase) decrease in inventories                                                                                   |   | (813                                   | )      | 786 |   |
| Increase (decrease) in accounts payable                                                                              |   | 1,350                                  |   | (43 | ) |
| Increase (decrease) in other accrued  liabilities                                                                    |   | (16                                    | )      | (317 | ) |
| Increase in prepaid expense                                                                                          |   | (424                                   | )      | (70 | ) |
| Cash used in operating activities -  discontinued operations                                                         |   | —                                 |   | (185 | ) |
| Net cash (used in) provided by operating  activities                                                                 |   | (259                                   | )      | 249 |   |
|                                                                                                                 |   |                                   |   |   |   |
| Cash flows from investing activities:                                                                                |   |                                   |   |   |   |
| Capital expenditures                                                                                                 |   | (118                                   | )      | (543 | ) |
| Capital expenditures - discontinued  operations                                                                      |   | —                                 |   | (168 | ) |
| Net cash used in investing activities                                                                                |   | (118                                   | )      | (711 | ) |
|                                                                                                                 |   |                                   |   |   |   |
| Cash flows from financing activities:                                                                                |   |                                   |   |   |   |
| Proceeds from bank lines of credit                                                                                   |   | 1,229                                  |   | 418 |   |
| Payments of short-term debt                                                                                          |   | (398                                   | )      | — |   |
| Payments of long-term debt                                                                                           |   | (607                                   | )      | (338 | ) |
| Proceeds from the issuance of preferred  stock                                                                       |   | 500                                    |   | — |   |
| Costs related to new credit facility                                                                                 |   | (134                                   | )      | — |   |
| Cash inflows from financing activities -  discontinued operations                                                    |   | —                                 |   | 343 |   |
| Net cash provided by (used in) financing  activities                                                                 |   | 590                                    |   | 423 |   |
|                                                                                                                 |   |                                   |   |   |   |
| Effect of exchange rate changes on cash                                                                              |   | 50                                     |   | (30 | ) |
| Increase (decrease) in cash and cash  equivalents                                                                    |   | 263                                    |   | (69 | ) |
|                                                                                                                 |   |                                   |   |   |   |
| Cash and cash equivalents at beginning of  period                                                                    |   | 583                                    |   | 816 |   |
| Cash and cash equivalents at end of period                                                                           |   | $                                      | 846    |   | $ | 747 |   |
|                                                                                                                 |   |                                   |   |   |   |
| Supplemental cash flow information:                                                                                  |   |                                   |   |   |   |
| Interest paid                                                                                                        |   | $                                      | 136    |   | $ | 298 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

4

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**SMTEK INTERNATIONAL, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTSThree Months Ended September 30, 2003 and 2002**

 

**NOTE 1 - DESCRIPTION OF BUSINESS AND BASIS OFPRESENTATION**

 

SMTEKInternational, Inc. (the “Company,” “we,” “us” or “our”) is an electronicsmanufacturing services (“EMS”) provider to original equipment manufacturers(“OEMs”) primarily in the medical, industrial controls and instrumentation,telecommunications, security, financial services automation and aerospace anddefense industries.  We provideintegrated solutions to OEMs across the entire product life cycle, from designto manufacturing to end-of-life services, for the worldwide low-to-mediumvolume, high complexity segment of the EMS industry.

 

We have fivewholly owned subsidiaries:  SMTEK, Inc.(dba SMTEK Moorpark), located in Moorpark, California; Jolt Technology, Inc.(aka SMTEK Fort Lauderdale), located in Fort Lauderdale, Florida; SMTEK NewEngland, located in Marlborough, Massachusetts; SMTEK Santa Clara, located inSanta Clara, California; and SMTEK International Thailand Limited, located inAyutthya, Thailand.

 

On November 19, 2002, weannounced that we were consolidating our San Diego facility into our otherCalifornia operations in Moorpark and Santa Clara.  This transition was completed as of March 31, 2003.

 

On April 9,2003, we sold our facility in Northern Ireland.  This is shown in our unaudited condensed financial statements asa discontinued operation.  For furtherdiscussion, see Note 3.

 

The unauditedconsolidated financial information furnished herein has been prepared inaccordance with generally accepted accounting principles and reflects alladjustments, consisting only of normal recurring adjustments, which in theopinion of management, are necessary to fairly state the Company’s financialposition, the results of its operations and its cash flows for the periodspresented.

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the amounts reported in the financial statements and theaccompanying notes.  Actual resultscould differ from those estimates and such differences may be material to thefinancial statements.  The results ofoperations for the three months ended September 30, 2003 are not necessarilyindicative of results for the entire fiscal year ending June 30, 2004.

 

Certain notesand other information are condensed or omitted from the interim financialstatements presented in this Quarterly Report on Form 10-Q.  Therefore, these condensed financialstatements should be read in conjunction with our 2003 Annual Report on Form10-K as filed with the Securities and Exchange Commission on September 25,2003.

 

**Revenue Recognition**

 

All of oursubsidiaries recognize revenues once all of the following conditions have beenmet: a) an authorized purchase order has been received in writing, b) thecustomer’s credit worthiness has been established, c) shipment of the producthas occurred, d) title and risk of ownership has transferred, e) if stipulatedby the contract, customer acceptance has occurred and f) all significant vendorobligations, if any, have been satisfied. We ship products FOB shipping point and, accordingly, title and risk ofownership pass to the customer upon shipment.

 

5

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**Principles of Consolidation**

 

Theaccompanying condensed consolidated financial statements include the accountsof SMTEK International, Inc. and its wholly owned subsidiaries.  All significant intercompany transactionsand accounts have been eliminated in consolidation.

 

**Stock Based Compensation**

 

SFAS No. 123,“Accounting for Stock-Based Compensation” allows entities to continue to applythe provisions of Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees,” and provide pro forma net incomeand pro forma earnings per share disclosures for stock-based awards as if thefair-value-based method defined in SFAS No. 123 had been applied.  In accordance with APB Opinion No. 25 andrelated interpretations, compensation expense would generally be recorded forfixed option grants only if, on the date of grant, the current market price ofthe underlying stock exceeded the exercise price.  We have elected to continue to apply the provisions of APBOpinion No. 25 and provide the pro forma disclosure provisions of SFAS No.123.  Accordingly, no compensationexpense has been recognized for our employee stock option plans and award ofoptions to non-employee directors.  Hadcompensation expense for stock-based awards been determined consistent withSFAS No.123, our results of operation would have been reduced to the pro formaamounts indicated below (in thousands except per share amounts):

 
|                                                                                                             |   | **Three Months  Ended  September 30,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                             |   | **2003**                               |   | **2002** |   |
|                                                                                                             |   |                                   |   |   |   |
| Net income (loss) as reported                                                                                    |   | $                                      | 1,314  |   | $ | (1,203 | ) |
| Deduct total stock-based employee  compensation expense under fair value-based method for all awards, net of tax |   | (65                                    | )      | (88 | ) |
| Pro forma net income (loss)                                                                                      |   | $                                      | 1,249  |   | $ | (1,291 | ) |
|                                                                                                             |   |                                   |   |   |   |
| Pro forma earnings (loss) per share - basic                                                                      |   | $                                      | 0.55   |   | $ | (0.57 | ) |
| Pro forma earnings (loss) per share -  diluted                                                                   |   | $                                      | 0.53   |   | $ | (0.57 | ) |

 

**Recent Accounting Pronouncements**

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Instruments withCharacteristics of Both Liabilities and Equity.”  This standard requires that certain financial instrumentsembodying an obligation to transfer assets or to issue equity securities beclassified as liabilities.  Thisstandard is effective for financial instruments entered into or modified afterMay 31, 2003.  The adoption of SFAS No.150 did not have an effect on the Company’s financial position or results ofoperations.

 

6

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In January2003, the FASB issued Interpretation No. 46, “Consolidation of VariableInterest Entities - an Interpretation of ARB No. 51”.  The Interpretation clarifies the applicationof Accounting Research Bulletin No. 51, Consolidated Financial Statements, tocertain entities in which equity investors do not have the characteristics of acontrolling financial interest or do not have sufficient equity at risk for theentity to finance its activities without additional subordinated financialsupport from other parties.  Theprovisions of the Interpretation are effective for all enterprises withvariable interests in variable interest entities created after January 31,2003 and is effective October 9, 2003. The adoption of this Interpretation is not expected to have asignificant impact on the Company’s financial position or results ofoperations.

 

**AccountingPeriod**

 

We utilize a52-53 week fiscal year ending on the Friday closest to June 30, which forfiscal year 2003 fell on June 27, 2003. In the accompanying condensed consolidated financial statements, the2003 fiscal year end is shown as June 30 and the interim period end for bothyears is shown as September 30 for clarity of presentation.  The actual interim periods ended onSeptember 26, 2003 and September 27, 2002.

 

**NOTE 2 - CHANGE IN ACCOUNTING PRINCIPLE**

 

We adoptedStatement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill andOther Intangible Assets,” as of July 1, 2002.  SFAS No. 142 requires that goodwill and intangible assets withindefinite useful lives no longer be amortized, but instead tested forimpairment, at least annually, in accordance with the provisions of SFAS No.142.  SFAS No. 142 also requires thatintangible assets with definite useful lives be amortized over their respectiveestimated useful lives to their estimated residual values, and reviewed forimpairment in accordance with SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets.”  Inaccordance with SFAS No. 142, during the December 2002 quarter we completed ourinitial assessment of impairment and determined that our goodwill was fullyimpaired and have recognized an impairment loss of $420,000, net of taxes, inthe condensed consolidated statement of operations as a change in accountingprinciple, effective July 1, 2002.  Theeffect of the change in accounting principle to the quarter ended September 30,2002 is as follows (dollars in thousands except per share amounts):

 
|                                                         |   | **Three  months ended  September 30, 2002** |   |
|--------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                         |   |                                        |   |
| Net loss from continuing operations, as  originally reported |   | $                                           | (649   | ) |
| Loss from discontinued operations                            |   | (134                                        | )      |
| Change in accounting principle, net of  taxes                |   | (420                                        | )      |
| Net loss as restated                                         |   | $                                           | (1,203 | ) |
|                                                         |   |                                        |   |
| Basic and diluted loss per share:                            |   |                                        |   |
| Net loss from continuing operations, as  originally reported |   | $                                           | (0.29  | ) |
| Loss from discontinued operations                            |   | (0.06                                       | )      |
| Change in accounting principle                               |   | (0.18                                       | )      |
| Net loss as restated                                         |   | $                                           | (0.53  | ) |

 

7

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**NOTE 3 - DISCONTINUED OPERATIONS**

 

On April 9,2003, we sold 100% of the outstanding stock of our Northern Ireland facility,SMTEK Europe.  The purchaser alsoassumed all liabilities of SMTEK Europe. The purchaser was a Northern Ireland investor group, which included adirector from SMTEK Europe.

 

Accordingly, operatingresults for SMTEK Europe for the three months ended September 30, 2002 havebeen presented in the accompanying unaudited Condensed Consolidated Statementsof Operations and Other Comprehensive Income (Loss) as a discontinuedoperation, and are summarized as follows (in thousands):

 
|                                           |   | **Three  Months Ended  September 30, 2002** |   |
|------------------------------------------------|--------|---------------------------------------------|--------|
|                                           |   |                                        |   |
| Net sales                                      |   | $                                           | 3,149  |   |
| Cost of goods sold                             |   | (2,989                                      | )      |
| Operating expenses                             |   | (191                                        | )      |
| Other income (expense), net                    |   | (103                                        | )      |
|                                           |   |                                        |   |
| Loss from discontinued operations, net of  tax |   | $                                           | (134   | ) |

 

Net assets of SMTEK Europeconsisted of the following (in thousands):

 
|                                 |   | **As of  September 30, 2002** |   |
|--------------------------------------|--------|-------------------------------|--------|
| Current assets                       |   | $                             | 6,531  |   |
| Property, equipment and improvements |   | 1,643                         |   |
| Current liabilities                  |   | (6,720                        | )      |
| Long-term debt                       |   | (760                          | )      |
| Net assets                           |   | $                             | 694    |   |

 

**NOTE 4 - EARNINGS PER SHARE**

 

Basic earnings(loss) per share is computed by dividing net income (loss) available to commonstockholders by the weighted average number of common shares outstanding duringthe period.  Diluted earnings (loss) pershare reflects the potential dilution that could occur if securities or othercontracts to issue common stock were exercised or converted into common stockor resulted in the issuance of common stock that then shared in our earnings(losses).

 

Common stockequivalents used in the determination of diluted earnings per share include theeffect, when such effect is dilutive, of our outstanding employee stockoptions, the 8-1/2% Convertible Subordinated Debentures (which are convertibleinto 4,988 shares of common stock at $212.50 per share of common stock) and theSeries A Preferred Stock (which is convertible into 250,000 shares of commonstock at $2.00 per share of common stock). The following is a summary of the calculation of basic and dilutedearnings per share (dollars in thousands, except per share data):

 

8

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|                                                         |   | **Three  Months Ended  September 30,** |   |
|--------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                         |   | **2003**                               |   | **2002** |   |
|                                                         |   |                                   |   |   |   |
| Net income (loss)                                            |   | $                                      | 1,314  |   | $ | (1,203 | ) |
|                                                         |   |                                   |   |   |   |
| Weighted average shares:                                     |   |                                   |   |   |   |
| Basic weighted average number of common  shares outstanding  |   | 2,284,343                              |   | 2,284,343 |   |
| Dilutive effect of outstanding common stock  equivalents     |   | 77,254                                 |   | — |   |
| Diluted weighed average number of common  shares outstanding |   | 2,361,597                              |   | 2,284,343 |   |
|                                                         |   |                                   |   |   |   |
| Earnings (loss) per share - basic                            |   | $                                      | 0.58   |   | $ | (0.53 | ) |
|                                                         |   |                                   |   |   |   |
| Earnings (loss) per share - diluted                          |   | $                                      | 0.56   |   | $ | (0.53 | ) |

 

Options to purchaseapproximately 325,992 shares of common stock at prices ranging from $1.50 to$10.00 which were outstanding at September 30, 2003, are not included in thecomputation of diluted earnings per share for the three months ended September30, 2003, because the exercise price of these options were greater than theaverage market price of our common stock. Options to purchase approximately 22,100 shares of common stock atprices ranging from $1.21 to $10.00 which were outstanding atSeptember 30, 2002, would not have been included in the computation ofdiluted earnings per share for the three months ended September 30, 2002,because the exercise price of these options and warrants were greater than theaverage market price of our common stock.

 

Convertiblesubordinated debentures aggregating $1,060,000, due in 2008 and convertible ata price of $212.50 per share at any time prior to maturity were outstandingduring the three months ended September 30, 2003 but were not included in thecomputation of diluted earnings per share because the conversion price wasgreater than the average market price of the common stock.  Convertible subordinated debenturesaggregating $1,580,000, due in 2008 and convertible at a price of $212.50 pershare at any time prior to maturity were outstanding during the three monthsended September 30, 2002 but were not included in the computation of dilutedearnings per share because the effect would be antidilutive.

 

The shares ofthe Series A Preferred Stock which are initially convertible into 250,000shares of common stock at a price of $2.00 per share and outstanding atSeptember 30, 2003 are not included in the computation of diluted earnings pershare for the three months ended September 30, 2003 because the conversionprice was greater than the average market price of our common stock.

 

**NOTE 5 - INVENTORIES**

 

Inventoriesconsist of the following (in thousands):

 

9

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|               |   | **September  30,  2003** |   | **June 30,  2003** |   |
|--------------------|--------|--------------------------|--------|--------------------|--------|
| Raw  materials     |   | $                        | 6,232  |               | $      | 5,810 |   |
| Work in process    |   | 3,512                    |   | 3,298              |   |
| Finished goods     |   | 446                      |   | 269                |   |
| Total  inventories |   | $                        | 10,190 |               | $      | 9,377 |   |

 

**Note 6 - PROPERTY, EQUIPMENT AND IMPROVEMENTS**

 

Property,equipment and improvements consist of the following (in thousands):

 
|                                            |   | **September  30,  2003** |   | **June 30,  2003** |   |
|-------------------------------------------------|--------|--------------------------|--------|--------------------|--------|
| Buildings and improvements                      |   | $                        | 1,450  |               | $      | 1,450 |   |
| Plant equipment                                 |   | 13,157                   |   | 13,075             |   |
| Office and other equipment                      |   | 1,616                    |   | 1,581              |   |
| Less accumulated depreciation and  amortization |   | (11,018                  | )      | (10,565            | )      |
| Total property, equipment and improvements      |   | $                        | 5,205  |               | $      | 5,541 |   |

 

**NOTE 7 - CREDIT AGREEMENTS AND DEBTRESTRUCTURING**

 

In September2003, we entered into a new credit facility which consists of a $10 millionworking capital line, a term credit facility in the amount of up to $1.0million and a capital expenditure facility of $1 million.  The $10 million working capital line iscollateralized by accounts receivable, inventory and equipment.  Borrowings under the credit agreement bearinterest at either the bank’s prime rate (4.0% at September 30, 2003) plus 1.0%or a Libor-base rate (1.12% at September 30, 2003) plus 3.75%.  The credit facility contains certainfinancial covenants and matures September 19, 2006.  Accordingly, amounts outstanding at September 30, 2003 under ourcredit facility have been classified as long-term. In addition, in September2003 we borrowed $1 million on our term credit facility.  This advance has a maturity date ofSeptember 19, 2006 and bears interest at either the bank’s prime rate (4.0% atSeptember 30, 2003) plus 1.0% or a Libor-base rate (1.12% at September 30,2003) plus 3.75%.  At September 30,2003, the balance outstanding was $1 million and the effective interest ratewas 5.0%.  The capital expenditurecredit facility of $1 million will be used to finance our capitalexpenditures.  Each advance under thecapital expenditure credit facility will have a three year term at either theBank’s prime rate or at a fixed rate equal to the Libor rate plus 3.75%.  We were in compliance with all covenants atSeptember 30, 2003.

 

Also duringthe three months ended September 30, 2003, we settled obligations to formerofficers, employees and directors under consulting and deferred fee agreementsby paying an aggregate of $430,000 to fully retire an aggregate of $889,000 indebt resulting in an aggregate $459,000 recognition of gain from extinguishmentof debt. We also reached settlement with certain sub-debt holders by paying anaggregate of $172,000 to fully retire an aggregate of $520,000 in debtresulting in an aggregate $348,000 gain from extinguishment of debt. Theapproximately $800,000 gain on extinguishment of debt is a component of Otherincome, net in the unaudited condensed consolidated statements of operations.

 

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**NOTE 8 - PREFERRED STOCK**

 

In September 2003, we sold in aprivate placement 250,000 shares of non-redeemable, convertible Series APreferred Stock for $500,000.  Theshares are convertible into common stock initially on a one-to-one basis andare redeemable, solely at the Company’s option, at 1.5 times the purchase priceafter 180 days from the date of issuance. Holders of Series A Preferred Stock have voting rights equal to holdersof common stock on an as converted basis and enjoy a liquidation preference toany junior stock whereby preferred holders receive 1.5 times their initialinvestment plus any accrued dividends before any distributions to juniorstockholders.

 

**NOTE 9 - BUSINESS SEGMENT AND GEOGRAPHICINFORMATION**

 

We operate ina single business segment - the EMS industry. Our revenues and long-lived assets, net of accumulated depreciation, bygeographic area are as follows (in thousands):

 
|           |   | **Three  Months Ended  September 30,** |   |
|----------------|--------|----------------------------------------|--------|
|           |   | **2003**                               |   | **2002** |   |
| Revenues:      |   |                                   |   |   |   |
| United States  |   | $                                      | 18,742 |   | $ | 16,832 |   |
| Thailand       |   | 1,950                                  |   | 755 |   |
| Total revenues |   | $                                      | 20,692 |   | $ | 17,587 |   |

 
|                    |   | **September 30,  2003** |   | **June 30,  2003** |   |
|-------------------------|--------|-------------------------|--------|--------------------|--------|
| Long-lived assets:      |   |                    |   |               |   |
| United States           |   | $                       | 4,993  |               | $      | 5,324 |   |
| Thailand                |   | 212                     |   | 217                |   |
| Total long-lived assets |   | $                       | 5,205  |               | $      | 5,541 |   |

 

**NOTE 10 - FOREIGN CURRENCY FORWARD CONTRACTS**

 

It is ourpolicy not to enter into derivative financial instruments for speculativepurposes.  We may, from time to time,enter into foreign currency forward exchange contracts in an effort to protectus from adverse currency rate fluctuations on foreign currency commitmentsentered into in the ordinary course of business.  These commitments are generally for terms of less than oneyear.  The foreign currency forwardexchange contracts are executed with banks believed to be creditworthy and aredenominated in currencies of major industrial countries.  In accordance with SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” all derivative financialinstruments are measured at fair value and are recognized as either assets orliabilities in the balance sheet.  Theaccounting treatment of changes in fair value is dependent upon whether or nota derivative financial instrument is designated as a hedge and, if so, the typeof hedge.  Changes in fair value arerecognized in current results of operations for fair value hedges and in othercomprehensive income for cash flow hedges. Derivative financial instruments not qualifying for hedge accountingtreatment under SFAS No. 133 are recognized as assets or liabilities with gainsor losses recognized in current results of operations.  At September 30, 2003 and 2002, we did not haveany open forward foreign currency contracts.

 

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**NOTE 11 - COMMITMENTS AND CONTINGENCIES -ENVIRONMENTAL MATTERS**

 

**Environmental Matters**

 

Sincethe early 1990s, we continue to be involved in certain remediation andinvestigative studies regarding soil and groundwater contamination at the siteof a former printed circuit board manufacturing plant in Anaheim,California.  One of our formersubsidiaries, Aeroscientific Corp., leased the Anaheim facility.  Under the terms of a cost sharing agreement,the remaining remediation costs are currently being shared on a 50-50 basiswith the landlord.  There is noenvironmental insurance coverage for this remediation.  At September 30, 2003, we had a reserve of$416,000 for future remediation costs. Management, based in part on consultations with outside environmentalengineers and scientists, believes that this reserve is adequate to cover itsshare of future remediation costs at this site.  However, the future actual remediation costs could differ significantlyfrom the estimates.  Further, ourportion could potentially exceed the amount of our reserve.  Our liability for remediation in excess ofour reserve could have a material adverse impact on our business, financialcondition and results of operations.

 

**ITEM2.****               MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

THIS QUARTERLY REPORT ONFORM 10-Q, INCLUDING THE DISCLOSURES BELOW, CONTAINS FORWARD-LOOKING STATEMENTSTHAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES.  WHEN USED HEREIN, THE TERMS “ANTICIPATES,” “EXPECTS,”“ESTIMATES,” “BELIEVES,” “WILL” AND SIMILAR EXPRESSIONS, AS THEY RELATE TO USOR OUR MANAGEMENT, ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKINGSTATEMENTS.  FORWARD-LOOKING STATEMENTSIN THIS REPORT OR HEREAFTER INCLUDED IN OTHER PUBLICLY AVAILABLE DOCUMENTSFILED WITH THE SECURITIES AND EXCHANGE COMMISSION (“SEC”), REPORTS TO OURSTOCKHOLDERS AND OTHER PUBLICLY AVAILABLE STATEMENTS ISSUED OR RELEASED BY USINVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH COULDCAUSE OUR ACTUAL RESULTS, PERFORMANCE (FINANCIAL OR OPERATING) OR ACHIEVEMENTSTO DIFFER FROM THE FUTURE RESULTS, PERFORMANCE (FINANCIAL OR OPERATING) ORACHIEVEMENTS EXPRESSED OR IMPLIED BY FORWARD-LOOKING STATEMENTS.  THESE RISKS INCLUDE, BUT ARE NOT LIMITED TO,THE RISKS SET FORTH HEREIN AND IN OTHER DOCUMENTS FILED WITH THE SEC, EACH OFWHICH COULD ADVERSELY AFFECT OUR BUSINESS AND THE ACCURACY OF THEFORWARD-LOOKING STATEMENTS CONTAINED HEREIN. FUTURE EXPECTED RESULTS ARE BASED UPON MANAGEMENT’S BEST ESTIMATES,CURRENT CONDITIONS AND THE MOST RECENT RESULTS OF OPERATIONS.  OUR ACTUAL RESULTS, PERFORMANCE ORACHIEVEMENTS MAY DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKINGSTATEMENTS.  WE DO NOT UNDERTAKE, ANDSPECIFICALLY DISCLAIM, ANY OBLIGATION TO UPDATE THESE FORWARD-LOOKINGSTATEMENTS.

 

THE FOLLOWING DISCUSSIONAND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS REPORT.

 

**UPDATEOF RISK FACTORS**

 

The following riskfactors update certain risk factors identified in our 2003 Annual Report onForm 10-K which was filed with the SEC on September 25, 2003.  Readers are referred to the documents filedby us with the SEC, including our most recent Reports on Forms 10-K, 10-Q and8-K, each as it may be amended from time to time, for a more completedescription of important risk factors.

 

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**General IndustryConditions and Competition**

 

The markets inwhich the EMS industry operates are intensely competitive.  Competition in the EMS industry is primarilydriven by price with secondary factors including product quality, technicalcapability and the ability to deliver products on schedule.  Both the price of, and the demand for, EMSare sensitive to economic conditions, changing technologies and otherfactors.  The technology used in EMS iswidely available, and there are a large number of domestic and foreigncompetitors.  Many of these firms arelarger than we are and have significantly greater financial, marketing andother resources.

 

Many of ourcompetitors have also made substantial capital expenditures in recent years andoperate technologically advanced EMS facilities.  Further, some of our customers have substantial in-house EMScapabilities.  There is a risk that, inperiods when these customers are operating at less than full capacity, theywill use their own facilities rather than contract with us.  Despite this risk, we believe we have notrecently experienced a significant loss of business to OEMs’ captive assemblyoperations.  However, there can be noassurance that future losses in this regard will not occur.

 

Another factorthat presents a continuing risk is the inability of EMS providers to requirethat their customers take back excess inventories that have no current or knownfuture use in production.  (See the riskfactor below dealing with “If Our Customers Vary Their Requirements, OurResults and Our Financial Condition May Be Affected”).  This factor has also affected us and mayoccur more frequently if the current electronic industry production slowdowndoes not appreciably improve.  We canprovide no assurance that we will not be forced to sell excess inventory.  Further, if we sell such excess inventory,we may have to sell all or portions of the inventory for a loss, which mayadversely affect our business, operating results and financial condition.

 

**Our Domestic Line ofCredit Agreement Contains Certain Financial Covenants That Must Be Met.**

 

In September2003, we entered into a new credit facility (See Note 7 to the unauditedcondensed consolidated financial statements for a more detailed discussion ofthe new credit facility).  This newcredit facility matures September 19, 2006 and includes certain covenants thatwe are required to comply with.  In theevent of default under our line of credit agreement, any and all outstandingborrowings could become immediately due and payable which would likely createsignificant operating and financial restrictions on us, further causing anadverse effect upon our business, operating results and financial condition.

 

**Our Industry isCharacterized by Low Profit Margins.**

 

Competition inthe EMS industry is primarily driven by price often resulting in lower profitmargins for EMS providers. In this regard, customers have sought and continueto seek price reductions.  Unless wesuccessfully achieve further material cost reductions, efficiencies andproductivity gains, we may experience a material adverse effect on ouroperating results and our financial condition. There can be no assurance, however, whether reductions in materialscosts will be effective or adequate to compensate for such price reductions orthat we will be successful in furthering efficiencies and productivity gains.

 

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**The Loss of Any Oneof Our Larger Customers May Adversely Affect Our Results and FinancialCondition.**

 

We had salesto three customers which accounted for 16.8%, 11.1% and 8.8% of revenues infiscal 2003.  The loss of one or more ofour larger customers, or a significant reduction in sales to any of our majorcustomers, could have an adverse effect on our business, results of operationsand financial condition.

 

**Our Operating ResultsFluctuate and May Continue to Materially Fluctuate.**

 

Our operatingresults fluctuate and may continue to materially fluctuate from period toperiod.  Our operating results may varysignificantly depending on a number of factors, several of which are beyond ourcontrol.  These include:

 

•              thetiming of orders from and shipments to major customers,

 

•              theavailability and cost of materials and components,

 

•              thevolume of orders relative to our capacity,

 

•              thetiming of expenditures in anticipation of future sales,

 

•              thegain or loss of significant customers,

 

•              variationsin the mix between consignment and turnkey arrangements with customers,

 

•              variationsin the demand for products in the industries we serve,

 

•              qualityissues and general economic conditions, and

 

•                                          thedevelopment and introduction of new products and technologies by our customersand our customers’ competitors.

 

In addition tofluctuations from day to day operations, our operating results will also beaffected by the following risks:

 

•                                          excesscapacity at the various subsidiary plants, which may entail attempts to limitliabilities of leases, selling or subleasing equipment, and other measures ofthat nature for which we might not be successful,

 

**•****                                         **ourdebt load, though recently decreased, could rise to a point that over-extends our cash-flow capacity, and

 

•                                          ourinability to maintain compliance with certain financial covenants in ourdomestic line of credit agreement. (See risk factor entitled “Our Domestic Lineof Credit Agreement Contains Certain Financial Covenants That Must Be Met”).

 

A significantportion of our expenses are relatively fixed in nature and planned expendituresare based in part on anticipated orders. Our inability to timely adjust expenditures to compensate for a declinein net sales may magnify the adverse impact of a decline in our results ofoperations.

 

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**Our Stock Price HasBeen And Continues To Be Volatile. Based Upon A Number of Factors, We May Face Delisting Proceedings FromNasdaq.**

 

The marketprice for our common stock continues to be volatile due to variousfactors.  These factors include, but arenot limited to:

 

•                                          thepublic float being relatively small and thinly traded;

 

•                                          announcementsby us or our competitors of new contracts or technological innovations;

 

•                                          fluctuationsin our quarterly and annual operating results;

 

•                                          acquisition-relatedannouncements; and

 

•                                          generalmarket conditions.

 

In addition,our stock price in recent years has experienced significant price fluctuationsfor a variety of reasons, including conditions that are both internal andexternal to us.

 

On June 27, 2003, we received notice from Nasdaqof its decision to continue listing our common stock on The Nasdaq SmallCapMarket via an exception to a number of listing requirements.  The terms ofthis temporary exception require that we satisfy a number of conditions forcontinued listing.  On October 3, 2003,Nasdaq notified us that we had met the requirements for continued listing onthe Nasdaq SmallCap Market. Nonetheless, Nasdaq notified us that its Listing Qualifications Panelwould continue to monitor our compliance with Nasdaq’s shareholders’ equity requirementand, in this regard, we must file this quarterly report on Form 10-Q on orbefore November 14, 2003 reporting shareholders’ equity of at least $2,500,000.

 

Although webelieve that we have currently satisfied Nasdaq’s conditions for continuedlisting on The Nasdaq SmallCap Market, there can be no assurance that ourcommon stock will continue to be currently listed on The Nasdaq SmallCap Marketor, if it continues to be listed, that we will be able to maintain such listingin the future.  If our common stock weredelisted from The Nasdaq SmallCap Market, it may become eligible immediatelythereafter for quotation on the Over-The-Counter Market on the NASD ElectronicBulletin Board or in the “pink sheets” maintained by the National QuotationBureau, Inc., which are generally considered to be less efficient systems thanmarkets such as Nasdaq or other national exchanges, and which may also causedifficulty in conducting trades and difficulty in obtaining futurefinancing.  Further, for companies whosesecurities are traded in the Over-The-Counter Market, it is more difficult: (i)to obtain accurate quotations, (ii) to obtain coverage for significant newsevents because major wire services, such as the Dow Jones News Service,generally do not publish press releases about such companies, and (iii) toobtain needed capital.

 

**The Availability andExpense of Components and Materials May Affect Our Operations.**

 

For oursurface mount assemblies and turnkey operations, we purchase components andmaterials from approved suppliers.  Anyfailure on the part of these suppliers to deliver required components to us orany failure of such components to meet performance requirements could impairour ability to meet scheduled shipment dates. This in turn could delay consummating sales and receipt of payment, whichmay adversely affect our business, financial condition and results ofoperations.  From time to time, we haveexperienced, and may in the future experience, shortages of certain types ofelectronic

 

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components.  These shortages may increase our costs andmay also cause us to experience delays in deliveries to our customers.

 

In addition,our customers may specify that we purchase parts or materials from particularcomponent manufacturers for use in the assembly process.  Certain components used in a number of ourcustomer programs are obtained from sole source suppliers.  To the extent these components are notavailable on a timely basis or are in short supply because of allocationsimposed by the component manufacturer, and the customer is unwilling to accepta substitute component, delays may occur. Such delays are experienced in the EMS business from time to time andhave caused sales and inventory fluctuations in our business.

 

To the extentour customers do not absorb the costs associated with parts or materialsshortages or price increases, whether by agreement or to maintain a businessrelationship with a customer, we could suffer a material adverse effect on ourbusiness, financial condition and results of operations.

 

**If Our Customers’Vary Their Requirements, Our Results And Our Financial Condition May BeAffected.**

 

The level andtiming of purchase orders placed by our customers are affected by a number offactors, including variation in demand for the customer’s products, customerattempts to manage inventory and changes in the customer’s manufacturingstrategies.  Many of these factors areoutside of our control.  Generally,customers may cancel, reduce or delay purchase orders and commitments withoutpenalty, except for payment for services rendered, materials purchased orprocured and, in certain circumstances, charges associated with suchcancellation, reduction or delay.  Thecurrent economic conditions, however, may adversely affect our ability torecover such costs, penalties and charges.

 

Significant ornumerous cancellations, reductions or delays in orders by customers, orinability by customers to pay for services rendered or to pay for componentsand materials purchased on such customer’s behalf, have in the past adverselyaffected our business, financial condition and results of operations.  Such events or conditions could have amaterial adverse effect on our business, financial condition and results ofoperations in the future.

 

**OurLiquidity is Currently Limited and Our Debt Profile May Change and May AffectOur Operations and Financial Condition.**

 

Our cash is currently limited, and, at September 30, 2003, ourdebt-to-equity ratio was 2.3 to 1.00. Although our debt load recently decreased and we have taken certain costreduction measures, several factors, including but not limited to, a continuedprolonged economic downturn, capital investment to increase production,acquisitions of other EMS companies or our inability to move the Company towardprofitability, may significantly change our debt profile, resulting in anincrease in debt to a point that over-extends our cash-flow capacity.  Also, under such circumstances, we may havefuture capital requirements and our ability to obtain additional financing willbe subject to a number of factors, including market conditions, our operatingperformance and investor sentiment. These factors may make the timing, amount, terms and conditions ofadditional financing unavailable or unattractive to us.  Any of these events or conditions could havea material adverse effect on our business, financial condition and results ofoperations.

 

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**DESCRIPTIONOF THE BUSINESS**

 

We are anelectronics manufacturing services (“EMS”) provider to original equipmentmanufacturers (“OEMs”) primarily in the medical, industrial controls andinstrumentation, telecommunications, security, financial services automationand aerospace and defense industries. We provide integrated solutions to OEMs across the entire product lifecycle, from design to manufacturing to end-of-life services, for the worldwidelow-to-medium volume, high complexity segment of the EMS industry.

 

We have fivewholly owned subsidiaries:  SMTEK, Inc.(dba SMTEK Moorpark), located in Moorpark, California; Jolt Technology, Inc.(aka SMTEK Fort Lauderdale), located in Fort Lauderdale, Florida; SMTEK NewEngland, located in Marlborough, Massachusetts; SMTEK Santa Clara, located inSanta Clara, California; and SMTEK International Thailand Limited, located inAyutthya, Thailand.

 

**RESULTS OF OPERATIONS**

 

We utilize a52-53 week fiscal year ending on the Friday closest to June 30, which forfiscal year 2003 fell on June 27, 2003. In the accompanying condensed consolidated financial statements, the2003 fiscal year end is shown as June 30 and the interim period end for bothyears is shown as September 30 for clarity of presentation. The actual interimperiods ended on September 26, 2003 and September 27, 2002.

 

Consolidatedrevenues for the three months ended September 30, 2003 were $20.7 millioncompared to $17.6 million for the three months ended September 30, 2002, anincrease of approximately 17.6%.  Theincrease in revenues was primarily due to the continued shipment of product forexisting customers.

 

Consolidatedgross profit for the three months ended September 30, 2003 was $2.7 million(13.0% of sales) compared to $1.5 million (8.7% of sales) for the three monthsended September 30, 2002.  The decreasein excess capacity which resulted from the closure of the San Diego andEuropean manufacturing facilities in fiscal 2003 was a significant factor inthe increase in gross profit.  There canbe no assurance that capacity utilization will remain at its current level andany decrease in revenues with the resultant under-utilization of capacity couldnegatively impact our gross profit margin.

 

Administrativeand selling expenses increased 5% to $2.0 million for the three months endedSeptember 30, 2003 from $1.9 million for the three months ended September 30,2002 as a parallel to the increase in the Company’s revenues.  As a percentage of sales, administrative andselling expense decreased to 9.8% of sales in the first quarter of fiscal 2004as compared to 11.0% of sales in the same period in fiscal 2003 as we continueto closely monitor our expenditures.

 

Total netnon-operating income was $693,000 for the three months ended September 30,2003.  This non-operating incomeincludes $817,000 gain on extinguishment of debt and currency translation gainof $70,000.  Without these two items,the net non-operating expense for the first quarter of fiscal 2004 would havebeen $194,000 as compared to a net non-operating expense of $250,000 for thethree months ended September 30, 2002. The decrease, on this basis, is primarily attributable to a decrease ininterest expense reflecting the decreased debt load.

 

We had anincome tax provision of $37,000 for the three months ended September 30, 2003,as compared to $5,000 for the three months ended September 30, 2002.  The income tax provision is primarilyrelated to the State of

 

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California which has suspendedthe use of net operating losses as carryforwards against current taxableincome.

 

Net income was$1.3 million for the three months ended September 30, 2003, or $0.56 perdiluted share, compared to net loss of $1.2 million for the three months endedSeptember 30, 2002, or ($0.53) per diluted share, due mainly to higher revenues,better gross profit and gains as a component of non-operating income.  The gains are non-recurring. In addition,there can be no assurance that we will maintain the current levels of revenueor the improved gross profit margin.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Our primarysources of liquidity are our cash and cash equivalents, which amounted to$846,000 at September 30, 2003, and amounts available under our bank lines ofcredit, which provided approximately $2.3 million of availability in excess ofcurrent borrowings at September 30, 2003. During the three months ended September 30, 2003, cash and cashequivalents increased by $263,000.  Thisincrease resulted from cash provided by financing activities of $590,000 offsetby cash used in operating activities of $259,000 and capital expenditures of$118,000.

 

Net cash usedin operating activities of $259,000 for the three months ended September 30,2003 was attributable primarily to the income from continuing operations beforedepreciation of $1.8 million reduced by the $817,000 gain from extinguishmentof debt and offset by an increase in inventories of $0.8 million and anincrease in prepaid expenses, of $0.4 million. There were also offsetting increases of $1.3 million in accountsreceivable and accounts payable.  Theincrease in working capital accounts was primarily attributable to increasedrevenue and associated increased cost.

 

Net cash usedin investing activities was $118,000 for the three months ended September 30,2003 compared to $711,000 for the three months ended September 30, 2002.  The cash used was for the purchase ofcapital expenditures, primarily for IT infrastructure and software.

 

Net cashprovided by financing activities was $590,000 for the three months endedSeptember 30, 2003 compared to net cash provided by financing activities of$423,000 for the three months ended September 30, 2002.  The borrowings on the line of credit tofinance inventory and the proceeds from the sale of preferred stock werepartially offset by cash used to retire debt at a discount, as discussed inmore detail in Note 7 to the unaudited condensed consolidated financialstatements.

 

In September2003, we entered into a new long-term credit facility.  This new credit facility consists of a $10million working capital line, a term credit facility in the amount of up to$1.0 million and a capital expenditure facility of $1.0 million.  The $10 million working capital line iscollateralized by accounts receivable, inventory and equipment.  Borrowings under the credit agreement bearinterest at either the bank’s prime rate (4.0% at September 26, 2003) plus 1.0%or a Libor-base rate (1.12 at September 26, 2003) plus 3.75%.  The working capital credit facility containsvarious financial covenants and matures September 19, 2006. In addition, inSeptember, 2003 we borrowed $1 million on our term credit facility.  This advance has a maturity date ofSeptember 19, 2006 and bears interest at either the bank’s prime rate (4.0% atSeptember 30, 2003) plus 1.0% or a Libor-base rate (1.12% at September 30,2003) plus 3.75%.  At September 30,2003, the balance outstanding was $1 million and the effective interest ratewas 5.0%.   The capital expenditurecredit facility of $1 million will be used to finance our capital expenditures.  Each advance under the capital expenditurecredit facility will have a three year term at either the Bank’s prime rate orat a

 

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fixed rate equal to the Liborrate plus 3.75%.  We were in compliancewith all covenants at September 30, 2003.

 

We anticipatethat additional expenditures of as much as $2.0 million may be incurred duringfiscal 2004, primarily to improve production efficiency at all oursubsidiaries.  A substantial portion ofthese capital expenditures are expected to be financed by our new line ofcredit or other notes/leases payable.

 

At September30, 2003, the ratio of current assets to current liabilities was 1.5 to 1.0compared to 1.4 to 1.0 at June 30, 2003. At September 30, 2003, we had $8.1 million of working capital comparedto $5.7 million at June 30, 2003.  AtSeptember 30, 2003, we had long-term borrowings of $6.3 million compared to$8.2 million at June 30, 2003.  Theincrease in the working capital and decrease in debt are related to thesettlement of certain debt obligations as described below.  Related to the decrease in debt, theoutstanding balance of our line of credit, classified as long-term, increasedby $1.2 million during the first quarter of fiscal 2004.

 

During thethree month period ending September 30, 2003, we settled notes payable toformer officers, employees and directors by paying an aggregate of $430,000 tofully retire an aggregate of $889,000 in debt. We also reached settlement withcertain sub-debt holders by paying an aggregate of $172,000 to fully retire anaggregate of $520,000 in debt.  Alsoduring the first quarter of fiscal 2004, we sold in a private placement 250,000shares of non-redeemable, convertible Series A Preferred Stock for$500,000.  The shares are initiallyconvertible into Common Stock on a one to one basis and are redeemable, solelyat the Company’s option, at 11⁄2 times the purchase price after 180 days fromissuance.

 

On June 27,2003, we received notice from Nasdaq of its decision to continue listing ourcommon stock on The Nasdaq SmallCap Market via an exception to a number oflisting requirements.  The terms of this temporary exception require thatwe satisfy a number of conditions for continued listing.  On October 3, 2003, Nasdaq notified us thatwe had met the requirements for continued listing on the Nasdaq SmallCapMarket.  Nonetheless, Nasdaq notified usthat its Listing Qualifications Panel would continue to monitor our compliancewith Nasdaq’s shareholders’ equity requirement and, in this regard, we mustfile this quarterly report on Form 10-Q on or before November 14, 2003reporting shareholders’ equity of at least $2,500,000.

 

Although webelieve that we have currently satisfied Nasdaq’s conditions for continuedlisting on The Nasdaq SmallCap Market, there can be no assurance that ourcommon stock will continue to be currently listed on The Nasdaq SmallCap Marketor, if it continues to be listed, that we will be able to maintain such listingin the future.  If our common stock weredelisted from The Nasdaq SmallCap Market, it may become eligible immediatelythereafter for quotation on the Over-The-Counter Market on the NASD ElectronicBulletin Board or in the “pink sheets” maintained by the National QuotationBureau, Inc., which are generally considered to be less efficient systems thanmarkets such as Nasdaq or other national exchanges, and which may also causedifficulty in conducting trades and difficulty in obtaining futurefinancing.  Further, for companies whosesecurities are traded in the Over-The-Counter Market, it is more difficult: (i)to obtain accurate quotations, (ii) to obtain coverage for significant newsevents because major wire services, such as the Dow Jones News Service,generally do not publish press releases about such companies, and (iii) toobtain needed capital.

 

We previouslyrecorded a liability for a federal tax assessment, including accrued interest,of $2.5 million per a December 2001 settlement with the Appeals division of theIRS.  We finalized a payment plan in

 

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July 2003 and at September30, 2003 have a total liability, including accrued interest, of $2.3 million tobe paid in monthly installment payments of $45,000 through July 2008.

 

We may experiencean adverse effect on our operating results and in our financial condition atour operating subsidiaries.  For furtherdiscussion, see section entitled “Company Risk Factors” in our 2003 Form 10-Kas well as the updated risk factors set forth herein.

 

We maycontinue to experience an adverse effect on our operating results and ourfinancial condition if current economic conditions continue for an extendedperiod of time, despite our cost reduction measures and efficiency improvementsmade at our operating subsidiaries.  Forfurther discussion, see section entitled “Risk Factors That May Affect YourDecision to Invest in Us” in our 2003 Form 10-K, which was filed with the SECon September 25, 2003.

 

Managementbelieves that our cash resources, cash from operations and available borrowingcapacity on our working capital lines of credit are sufficient to fundoperations for at least the next 12 months. Long term, however, if current economic conditions continue for anextended period of time, despite our cost reduction measures and efficiencyimprovements or if we are unable to maintain profitability, we may have toobtain additional debt or equity financing. There can be no assurance that the Company will be able to obtainadditional debt or equity financing, if and when needed, on terms acceptable tothe Company.

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Instruments withCharacteristics of Both Liabilities and Equity.”  This standard requires that certain financial instrumentsembodying an obligation to transfer assets or to issue equity securities beclassified as liabilities.  Thisstandard is effective for financial instruments entered into or modified afterMay 31, 2003.  The adoption of SFAS No.150 did not have an effect on the Company’s financial position or results ofoperations.

 

In January2003, the FASB issued Interpretation No. 46, “Consolidation of VariableInterest Entities - an Interpretation of ARB No. 51”.  The Interpretation clarifies the application of AccountingResearch Bulletin No. 51, Consolidated Financial Statements, to certainentities in which equity investors do not have the characteristics of acontrolling financial interest or do not have sufficient equity at risk for theentity to finance its activities without additional subordinated financialsupport from other parties.  Theprovisions of the Interpretation are effective for all enterprises withvariable interests in variable interest entities created after January 31,2003 and is effective October 9, 2003. The adoption of this Interpretation is not expected to have asignificant impact on the Company’s financial position or results ofoperations.

 

**ENVIRONMENTAL MATTERS**

 

Since theearly 1990s, we continue to be involved in certain remediation andinvestigative studies regarding soil and groundwater contamination at the siteof a former printed circuit board manufacturing plant in Anaheim,California.  One of our former subsidiaries,Aeroscientific Corp., leased the Anaheim facility.  Under the terms of a cost sharing agreement entered into severalyears ago, the remaining remediation costs are currently being shared on a50-50 basis with the landlord.  There isno environmental insurance coverage for this remediation.  At September 30, 2003, we had a reserve of$416,000 for future remediation costs. Management, based in part on consultations with outside environmentalengineers and scientists, believes

 

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that this reserve is adequateto cover its share of future remediation costs at this site.  However, the future actual remediation costscould differ significantly from the estimates. Further, our portion could potentially exceed the amount of ourreserve.  Our liability for remediationin excess of our reserve could have a material adverse impact on our business,financial condition, results of operations and cash flows.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Our financialinstruments include cash and cash equivalents, accounts receivable andshort-term and long-term debt.  AtSeptember 30, 2003, the carrying amount of long-term debt (including currentportion thereof but excluding bank lines of credit) was $6.3 million and thefair value was $5.8 million.  Thecarrying values of our other financial instruments approximated their fairvalues.  The fair value of our financialinstruments is estimated based on quoted market prices for the same or similarissues.  A change in interest rates ofone percent would result in an annual impact on interest expense ofapproximately $60,000.

 

It is ourpolicy not to enter into derivative financial instruments for speculativepurposes.  We may, from time to time,enter into foreign currency forward exchange contracts in an effort to protectus from adverse currency rate fluctuations on foreign currency commitmentsentered into in the ordinary course of business.  These commitments are generally for terms of less than oneyear.  The foreign currency forwardexchange contracts are executed with banks believed to be creditworthy and aredenominated in currencies of major industrial countries.  In accordance with SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” all derivative financialinstruments are measured at fair value and are recognized as either assets orliabilities in the balance sheet.  Theaccounting treatment of changes in fair value is dependent upon whether or nota derivative financial instrument is designated as a hedge and, if so, the typeof hedge.  Changes in fair value arerecognized in current results of operations for fair value hedges and in othercomprehensive income for cash flow hedges. Derivative financial instruments not qualifying for hedge accountingtreatment under SFAS No. 133, as amended by FAS 149, are recognized as assetsor liabilities with gains or losses recognized in current results ofoperations.  At September 30, 2003, wehad no forward foreign currency contracts.

 

Our operationsinclude investments in a foreign operating unit.  Our foreign subsidiary represents approximately 9% of ourrevenues and 9% of our total assets.  Asa result, our financial results have been and may continue to be affected bychanges in foreign currency exchange rates.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**Evaluationof disclosure controls and procedures.**

 

Based onmanagement’s evaluation (with the participation of our principal executiveofficer and principal financial officer), as of the end of the period coveredby this report, our principal executive officer and principal financial officerhave concluded that our disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended,(the “Exchange Act”)) are effective to ensure that information required to bedisclosed by us in reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin SEC rules and regulations.

 

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**Changesin internal control over financial reporting.**

 

There was nochange in our internal control over financial reporting during our first fiscalquarter of 2004 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

In theordinary course of business, we experience various types of claims whichsometimes result in litigation or other legal proceedings.  We do not anticipate that any of theseclaims or proceedings that are currently pending will have a material adverseeffect on us.

 

**ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS**

 

**Sale of Unregistered Securities**

 

On September8, 2003, we sold 250,000 shares of our Series A Preferred Stock for $500,000 toThe Gene Haas Trust in a private placement transaction.  The proceeds from the sale of the Series APreferred Stock is expected to be used for general corporate purposes.  The shares of the Series A Preferred Stockare convertible into our common stock initially on a one-to-one basis and areredeemable, solely at our option, at 1.5 times the purchase price after 180days from the date of issuance.  Theissuance of the shares of the Series A Preferred Stock was exempt fromregistration pursuant to Regulation D of the Securities Act of 1933, asamended.

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

On August 25,2003 we held a special meeting of stockholders to approve an amendment to ouramended and restated certificate of incorporation to decrease the number ofissued and outstanding shares of our common stock by means of a reverse stocksplit with a ratio of not less than two-for-three and not more thanone-for-two.

 

The totalnumber of shares voting on the proposed reverse stock split was 2,142,887, ofwhich 975,634 shares were voted for the proposal, 1,166,185 shares were votedagainst the proposal and 1,068 abstained. A primary purpose behind the reverse stock split proposal was tomaintain the eligibility of our common stock for continued listing on TheNasdaq SmallCap Market, in seeking to comply with Nasdaq’s $1.00 minimum bidprice requirement.  Despite the voteagainst the reverse stock split proposal, Nasdaq has since notified us that theprice of our common stock currently complies with Nasdaq’s minimum bid pricerequirements.

 

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

 
| a.     | Exhibits: |
|--------|-----------|
|   |      |
| 4.1    |      | Certificate  of Designations (incorporated by reference to Exhibit 4.1 of the Company’s  current report on Form 8-K filed on September 8, 2003). |
|   |      |   |
| 10.1   |      | Credit and  security Agreement dated September 19, 2003, by and among Wells Fargo  Business Credit, Inc., SMTEK International, Inc., Jolt Technology, Inc.,  SMTEK New England, Inc., SMTEK Santa Clara, Inc. and Technetics, Inc. |
|   |      |   |
| 10.2   |      | Series A  Preferred Stock Purchase Agreement, dated as of September 8, 2003 by and  between the Company and The Gene Haas Trust |
|        |           |  |  |

 

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|   |   | (incorporated  by reference to Exhibit 10.1 of the Company’s current report on From 8-K  filed on September 8, 2003).                                                                                                                        |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                              |
| 10.3   |   | Registration  Rights Agreement, dated as of September 8, 2003, by and between the Company  and The Gene Haas Trust (incorporated by reference to Exhibit 10.2 of the  Company’s current report on Form 8-K filed on September 8, 2003). |
|   |   |                                                                                                                                                                                                                                              |
| 31.1   |   | Section 302  Certification of Principal Executive Officer.                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                              |
| 31.2   |   | Section 302  Certification of Principal Financial Officer.                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                              |
| 32.1   |   | Section 906  Certification of Principal Executive Officer.                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                              |
| 32.2   |   | Section 906  Certification of Principal Financial Officer.                                                                                                                                                                                        |

 

b.  Current reports on Form 8-K:

 

On July 1, 2003, we fileda current report on Form 8-K announcing that we had received notice from theNasdaq Qualifications Hearings Panel of its decision to continue listing ourcommon stock on the Nasdaq Small Cap Market via a temporary exception to anumber of listing requirements.

 

On September 8, 2003, wefiled a current report on Form 8-K announcing that we had met the requirementsfor continued listing on the Nasdaq Small Cap Market.

 

 

**SIGNATURE**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the regis-trant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
| October 31, 2003 |   |   | /s/ Kirk A. Waldron                                                               |
|------------------|--------|--------|-----------------------------------------------------------------------------------|
| Date             |   |   | Kirk A. Waldron                                                                   |
|             |   |   | Senior Vice President and Chief  Financial Officer (Principal  Financial Officer) |

 

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