**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10 - Q**

 

**(Mark One)**

 

**ý****        ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF**

 

**For the quarterly periodended:          MARCH 31,2004**

 

**o****        ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition periodfrom                    to                    **

 

**Commission File Number:  1-08101**

 

**SMTEK INTERNATIONAL, INC.**

(Exact name of registrant as specified in itscharter)

 

| **DELAWARE**                                                    |   | **33-0213512**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **200 Science Drive, Moorpark, CA  93021**                 |
| (Address of principal executive offices)                        |
|                                                            |   |                                  |
| **805-532-2800**                                                |
| (Registrant’s telephone number, including  area code)      |

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90days.                    Yes ý  No o

 

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

 

The registrant had 2,383,516 shares of Common Stock outstanding as ofMay 6, 2004.

 

 

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**PART I.  FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

 

**SMTEKINTERNATIONAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**(Inthousands, except share amounts)**

 
|                                                                                                                                                     |   | **March 31,  2004** |   | **June 30,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
| **ASSETS**                                                                                                                                               |   |                     |   |                    |   |
| Current assets:                                                                                                                                          |   |                     |   |                    |   |
| Cash and cash equivalents                                                                                                                                |   | $                        | 501    |                    | $      | 583 |   |
| Marketable securities                                                                                                                                    |   | 364                      |   | —                  |   |
| Accounts receivable, less allowance for  doubtful accounts of $438 and $657, as of March 31,                                                        |   |                     |   |                    |   |
| 2004 and June 30, 2003, respectively                                                                                                                |   | 13,030                   |   | 11,096                  |   |
| Inventories                                                                                                                                              |   | 13,932                   |   | 9,377                   |   |
| Prepaid expenses                                                                                                                                         |   | 1,061                    |   | 446                     |   |
| Total current assets                                                                                                                                     |   | 28,888                   |   | 21,502                  |   |
|                                                                                                                                                     |   |                     |   |                    |   |
| Property, equipment and improvements, net  of accumulated depreciation and amortization                                                                  |   | 5,071                    |   | 5,541                   |   |
| Other assets, net                                                                                                                                        |   | 407                      |   | 763                     |   |
|                                                                                                                                                     |   | $                        | 34,366 |                    | $      | 27,806 |   |
|                                                                                                                                                     |   |                     |   |                    |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                           |   |                     |   |                    |   |
| Current liabilities:                                                                                                                                     |   |                     |   |                    |   |
| Current portion of long-term debt                                                                                                                        |   | $                        | 1,515  |                    | $      | 2,495 |   |
| Accounts payable                                                                                                                                         |   | 15,656                   |   | 9,598                   |   |
| Other accrued liabilities                                                                                                                                |   | 3,332                    |   | 3,708                   |   |
| Total current liabilities                                                                                                                                |   | 20,503                   |   | 15,801                  |   |
|                                                                                                                                                     |   |                     |   |                    |   |
| Long-term liabilities:                                                                                                                                   |   |                     |   |                    |   |
| Long-term bank line of credit payable                                                                                                                    |   | 6,264                    |   | 5,452                   |   |
| Long-term debt                                                                                                                                           |   | 4,098                    |   | 5,675                   |   |
|                                                                                                                                                     |   |                     |   |                    |   |
| Total liabilities                                                                                                                                        |   | 30,865                   |   | 26,928                  |   |
|                                                                                                                                                     |   |                     |   |                    |   |
| Commitments and contingencies                                                                                                                            |   |                     |   |                    |   |
|                                                                                                                                                     |   |                     |   |                    |   |
| Stockholders’ equity:                                                                                                                               |   |                     |   |                    |   |
| Preferred stock, $1 par value; 1,000,000  shares authorized; 250,000 shares issued and outstanding at March 31,  2004                               |   | 475                      |   | —                  |   |
| Common stock, $.01 par value; 20,000,000  shares authorized; 2,383,516 and 2,284,343 issued and outstanding at  March 31,2004 and June 30,2003 |   | 24                       |   | 23                      |   |
| Additional paid-in capital                                                                                                                               |   | 37,383                   |   | 37,028                  |   |
| Accumulated deficit                                                                                                                                      |   | (34,508                  | )      | (36,232                 | )      |
| Accumulated other comprehensive income                                                                                                                   |   | 127                      |   | 59                      |   |
| Total stockholders’ equity                                                                                                                          |   | 3,501                    |   | 878                     |   |
|                                                                                                                                                     |   | $                        | 34,366 |                    | $      | 27,806 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

2

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**SMTEKINTERNATIONAL, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**ANDOTHER COMPREHENSIVE INCOME (LOSS) (Unaudited)**

**(Inthousands, except per share amounts)**

 
|                                                                      |   | **Three  Months Ended  March 31,** |   | **Nine  Months Ended  March 31,** |   |
|---------------------------------------------------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|
|                                                                      |   | **2004**                                |   | **2003**                               |   | **2004** |   | **2003** |   |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Revenues                                                                  |   | $                                       | 22,556 |                                   | $      | 17,430 |   | $ | 63,380 |   | $ | 50,474 |   |
| Cost of goods sold                                                        |   | 20,168                                  |   | 15,510                                 |   | 56,098 |   | 46,122 |   |
| Gross profit                                                              |   | 2,388                                   |   | 1,920                                  |   | 7,282 |   | 4,352 |   |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Operating expenses:                                                       |   |                                    |   |                                   |   |   |   |   |   |
| Administrative and selling                                                |   | 1,860                                   |   | 2,216                                  |   | 5,922 |   | 7,906 |   |
| Total operating expenses                                                  |   | 1,860                                   |   | 2,216                                  |   | 5,922 |   | 7,906 |   |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Operating income (loss)                                                   |   | 528                                     |   | (296                                   | )      | 1,360 |   | (3,554 | ) |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Non-operating income (expense):                                           |   |                                    |   |                                   |   |   |   |   |   |
| Interest expense, net                                                     |   | (207                                    | )      | (267                                   | )      | (545 | ) | (776 | ) |
| Other income (expense), net                                               |   | (170                                    | )      | 269                                    |   | 945 |   | 261 |   |
| Total non-operating income (expense), net                                 |   | (377                                    | )      | 2                                      |   | 400 |   | (515 | ) |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Income (loss) from continuing operations  before income tax               |   | 151                                     |   | (294                                   | )      | 1,760 |   | (4,069 | ) |
| Income tax provision                                                      |   | 3                                       |   | —                                 |   | 40 |   | 6 |   |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Income (loss) from continuing operations                                  |   | 148                                     |   | (294                                   | )      | 1,720 |   | (4,075 | ) |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Loss from discontinued operations, net of  tax                            |   | —                                  |   | (756                                   | )      | — |   | (1,300 | ) |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Income (loss) before cumulative effect of  change in accounting principle |   | 148                                     |   | (1,050                                 | )      | 1,720 |   | (5,375 | ) |
| Cumulative effect of change in accounting  principle                      |   | —                                  |   | —                                 |   | — |   | (420 | ) |
| Net income (loss)                                                         |   | $                                       | 148    |                                   | $      | (1,050 | ) | $ | 1,720 |   | $ | (5,795 | ) |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Other comprehensive income (loss):                                        |   |                                    |   |                                   |   |   |   |   |   |
| Foreign currency translation adjustments                                  |   | (2                                      | )      | (28                                    | )      | 71 |   | (9 | ) |
| Change in unrealized gain/(loss) on forward  contracts                    |   | —                                  |   | —                                 |   | — |   | (72 | ) |
| Comprehensive income (loss)                                               |   | $                                       | 146    |                                   | $      | (1,078 | ) | $ | 1,791 |   | $ | (5,876 | ) |
| Basic earnings (loss) per share:                                          |   |                                    |   |                                   |   |   |   |   |   |
| Income (loss) from continuing operations                                  |   | $                                       | 0.06   |                                   | $      | (0.13 | ) | $ | 0.69 |   | $ | (1.79 | ) |
| Loss from discontinued operations                                         |   | —                                  |   | (0.33                                  | )      | — |   | (0.57 | ) |
| Cumulative effect of change in accounting  principle                      |   | —                                  |   | —                                 |   | — |   | (0.18 | ) |
| Net income (loss) per share                                               |   | $                                       | 0.06   |                                   | $      | (0.46 | ) | $ | 0.69 |   | $ | (2.54 | ) |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Diluted earnings (loss) per share:                                        |   |                                    |   |                                   |   |   |   |   |   |
| Income (loss) from continuing operations                                  |   | $                                       | 0.05   |                                   | $      | (0.13 | ) | $ | 0.63 |   | $ | (1.79 | ) |
| Loss from discontinued operations                                         |   | —                                  |   | (0.33                                  | )      | — |   | (0.57 | ) |
| Cumulative effect of change in accounting  principle                      |   | —                                  |   | —                                 |   | — |   | (0.18 | ) |
| Net income (loss) per share                                               |   | $                                       | 0.05   |                                   | $      | (0.46 | ) | $ | 0.63 |   | $ | (2.54 | ) |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Shares used in computing basic and diluted  earnings (loss) per share:    |   |                                    |   |                                   |   |   |   |   |   |
| Basic                                                                     |   | 2,595                                   |   | 2,284                                  |   | 2,488 |   | 2,284 |   |
| Diluted                                                                   |   | 2,912                                   |   | 2,284                                  |   | 2,721 |   | 2,284 |   |

 

See accompanying notes to unaudited condensed consolidated financialstatements.

 

3

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SMTEK INTERNATIONAL, INC. AND SUBSIDIARIES

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

**(Inthousands)**

 
|                                                                                                                       |   | **Nine  Months Ended  March 31,** |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                                       |   | **2004**                               |   | **2003** |   |
|                                                                                                                       |   |                                   |   |   |   |
| Cash flows from operating activities:                                                                                      |   |                                   |   |   |   |
| Income (loss) from continuing operations                                                                                   |   | $                                      | 1,720  |   | $ | (4,075 | ) |
| Adjustments to reconcile income (loss) from  continuing operations to net cash (used in) provided by operating activities: |   |                                   |   |   |   |
| Depreciation and amortization                                                                                              |   | 1,353                                  |   | 1,648 |   |
| Gain on extinguishment of debt                                                                                             |   | (880                                   | )      | — |   |
| Unrealized gain on marketable securities                                                                                   |   | (28                                    | )      | — |   |
| Loss on sale of subsidiary                                                                                                 |   | 85                                     |   | — |   |
| Equity securities received in settlement of  claim against prior customer                                                  |   | —                                 |   | (336 | ) |
| Charge for leasehold abandonment                                                                                           |   | —                                 |   | 1,025 |   |
| Write-off of leasehold improvements                                                                                        |   | —                                 |   | 370 |   |
| Increase in accounts receivable                                                                                            |   | (2,563                                 | )      | (3,143 | ) |
| (Increase) decrease in inventories                                                                                         |   | (4,915                                 | )      | 484 |   |
| Increase in accounts payable                                                                                               |   | 6,132                                  |   | 1,996 |   |
| (Decrease) increase in other accrued  liabilities                                                                          |   | (423                                   | )      | 1,316 |   |
| Increase in other current assets                                                                                           |   | (488                                   | )      | (33 | ) |
| Cash provided by operating activities -  discontinued operations                                                           |   | —                                 |   | 2,080 |   |
| Net cash (used in) provided by operating  activities                                                                       |   | (7                                     | )      | 1,332 |   |
|                                                                                                                       |   |                                   |   |   |   |
| Cash flows from investing activities:                                                                                      |   |                                   |   |   |   |
| Capital expenditures                                                                                                       |   | (941                                   | )      | (756 | ) |
| Capital expenditures - discontinued operations                                                                             |   | —                                 |   | (275 | ) |
| Proceeds from sale of subsidiary                                                                                           |   | 940                                    |   | — |   |
| Net cash used in investing activities                                                                                      |   | (1                                     | )      | (1,031 | ) |
|                                                                                                                       |   |                                   |   |   |   |
| Cash flows from financing activities:                                                                                      |   |                                   |   |   |   |
| Proceeds from bank lines of credit                                                                                         |   | 812                                    |   | 2,625 |   |
| Payments of long-term debt                                                                                                 |   | (1,673                                 | )      | (1,253 | ) |
| Proceeds from the issuance of preferred  stock                                                                             |   | 500                                    |   | — |   |
| Costs related to new credit facility                                                                                       |   | (164                                   | )      | — |   |
| Proceeds from the exercise of stock options                                                                                |   | 383                                    |   | — |   |
| Cash outflows from financing activities -  discontinued operations                                                         |   | —                                 |   | (1,929 | ) |
| Net cash used in financing activities                                                                                      |   | (142                                   | )      | (557 | ) |
|                                                                                                                       |   |                                   |   |   |   |
| Effect of exchange rate changes on cash                                                                                    |   | 68                                     |   | (14 | ) |
|                                                                                                                       |   |                                   |   |   |   |
| Decrease in cash and cash equivalents                                                                                      |   | (82                                    | )      | (270 | ) |
|                                                                                                                       |   |                                   |   |   |   |
| Cash and cash equivalents at beginning of  period                                                                          |   | 583                                    |   | 816 |   |
|                                                                                                                       |   |                                   |   |   |   |
| Cash and cash equivalents at end of period                                                                                 |   | $                                      | 501    |   | $ | 546 |   |
|                                                                                                                       |   |                                   |   |   |   |
| Supplemental cash flow information:                                                                                        |   |                                   |   |   |   |
| Interest paid                                                                                                              |   | $                                      | 598    |   | $ | 862 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

4

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**SMTEKINTERNATIONAL, INC. AND SUBSIDIARIES**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**NineMonths Ended March 31, 2004 and 2003**

 

**NOTE 1 - DESCRIPTIONOF BUSINESS AND BASIS OF PRESENTATION**

 

SMTEK International, Inc. (the “Company,” “we,” “us” or “our”),headquartered in Moorpark, California, is an electronics manufacturing services(“EMS”) provider serving original equipment manufacturers (“OEMs”) in themedical, industrial instrumentation, telecommunications, security, financialservices automation and aerospace and defense industries.  We provide integrated solutions to OEMsacross the entire product life cycle, from design to manufacturing toend-of-life services, for the worldwide high criticality, high reliability,high complexity segment of the EMS industry.

 

We have four wholly owned subsidiaries:  SMTEK, Inc. (dba SMTEK Moorpark), located in Moorpark,California; SMTEK New England, located in Marlborough, Massachusetts; SMTEKSanta Clara, located in Santa Clara, California; and SMTEK InternationalThailand Limited, located in Ayutthya, Thailand.

 

On January 9, 2004, we sold our subsidiary Jolt Technology, Inc.(aka SMTEK Fort Lauderdale), located in Fort Lauderdale, Florida, forapproximately $940,000 in cash to the president of Jolt and an affiliatedinvestor of the Company.  The loss onthe sale of Jolt was approximately $85,000 and has been recognized for the ninemonths ended March 31, 2004 in the accompanying unaudited CondensedConsolidated Statements of Operations and Other Comprehensive Income(Loss).  The results of operations ofJolt through the date of sale and for the nine months ended March 31, 2003are included in the accompanying unaudited Condensed Consolidated Statements ofOperations and Other Comprehensive Income (Loss).  For further discussion, see Note 3.

 

On April 9, 2003, we sold our facility in Northern Ireland.  This is shown in our unaudited condensedfinancial statements as a discontinued operation.  For further discussion, see Note 4.

 

On November 19, 2002, we announced that we were consolidating ourSan Diego facility into our other California operations in Moorpark and SantaClara.  This transition was completed asof March 31, 2003.

 

The unaudited consolidated financial information furnished herein hasbeen prepared in accordance with generally accepted accounting principles andreflects all adjustments, consisting only of normal recurring adjustments,which in the opinion of management, are necessary to fairly state the Company’sfinancial position, the results of its operations and its cash flows for theperiods presented.

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the amounts reported in the financial statements andthe accompanying notes.  Actual resultscould differ from those estimates and such differences may be material to thefinancial statements.  The results ofoperations for the three and nine months ended March 31, 2004 are notnecessarily indicative of results for the entire fiscal year endingJune 30, 2004.

 

As permitted under applicable rules and regulations of the Securitiesand Exchange Commission, certain notes and other information are condensed oromitted from the interim financial statements presented in this QuarterlyReport on Form 10-Q.  Therefore, thesecondensed financial statements should be read in conjunction with our AnnualReport on Form 10-K for the year ended

 

5

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June 30, 2003, as filed with the Securities and ExchangeCommission on September 25, 2003.

 

**Marketable Securities**

 

Our marketable securities consist of an investment in common stock of apublic company which, for accounting purposes, is classified as tradingsecurities.  Accordingly, the investmentis marked to market quarterly with the change in value being recorded in thestatement of operations.  For the threeand nine months ended March 31, 2004, we recognized an unrealized gain(loss) on marketable securities of ($255,000) and $28,000, respectively.  Management’s intention is to sell off theshares of such public company over the next 12 months.

 

**Restructuring Costs**

 

In connection with the closure and transition of the Company’s SanDiego facility in the second quarter of 2003, we incurred approximately $1.6million in expenses consisting of severance costs of $287,000, write-off ofleasehold improvements of $370,000 and accrual of remaining lease obligation of$4,011,000 less sublease income of $3,038,000. All severance costs were paid out and, of the $973,000 lease-relatedcommitments, $448,000 has been paid out, resulting in a reserve atMarch 31, 2004 of $525,000.

 

**Revenue Recognition**

 

All of our subsidiaries recognize revenues once all of the followingconditions have been met: a) an authorized purchase order has been received inwriting, b) the customer’s credit worthiness has been established, c) shipmentof the product has occurred, d) title and risk of ownership has transferred, e)if stipulated by the contract, customer acceptance has occurred and f) allsignificant vendor obligations, if any, have been satisfied.  We ship products FOB shipping point and,accordingly, title and risk of ownership pass to the customer upon shipment.

 

**Principles ofConsolidation**

 

The accompanying condensed consolidated financial statements includethe accounts of SMTEK International, Inc. and its wholly ownedsubsidiaries.  All significantintercompany transactions and accounts have been eliminated in consolidation.

 

**Stock BasedCompensation**

 

SFAS No. 123, “Accounting for Stock-Based Compensation” allows entitiesto continue to apply the provisions of Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees,” and provide proforma net income and pro forma earnings per share disclosures for stock-basedawards as if the fair-value-based method defined in SFAS No. 123 had beenapplied.  In accordance with APB OpinionNo. 25 and related interpretations, compensation expense would generally berecorded for fixed option grants only if, on the date of grant, the currentmarket price of the underlying stock exceeded the exercise price.  We have elected to continue to apply theprovisions of APB Opinion No. 25 and provide the pro forma disclosureprovisions of SFAS No. 123. Accordingly, no compensation expense has been recognized for ouremployee stock option plans and award of options to non-employee directors.  Had compensation expense for stock-based awardsbeen determined consistent with SFAS No.123, our results of operation wouldhave been reduced to the unaudited pro forma amounts indicated below (inthousands, except per share amounts):

 

6

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|                                                                                                              |   | **Three Months Ended  March 31** |   | **Nine Months Ended  March 31** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                                                              |   | **2004**                              |   | **2003**                             |   | **2004** |   | **2003** |   |
|                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Net income  (loss) as reported                                                                                    |   | $                                     | 148    |                                 | $      | (1,050 | ) | $ | 1,720 |   | $ | (5,795 | ) |
|                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Deduct total  stock-based employee compensation expense under fair value-based method for  all awards, net of tax |   | (204                                  | )      | (99                                  | )      | (538 | ) | (297 | ) |
|                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Pro forma net  income (loss)                                                                                      |   | $                                     | (56    | )                                    | $      | (1,149 | ) | $ | 1,182 |   | $ | (6,092 | ) |
|                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Pro forma  earnings (loss) per share:                                                                             |   |                                  |   |                                 |   |   |   |   |   |
| Earnings  (loss) per share - basic                                                                                |   | $                                     | (0.02  | )                                    | $      | (0.50 | ) | $ | 0.48 |   | $ | (2.67 | ) |
| Earnings  (loss) per share - diluted                                                                              |   | $                                     | (0.02  | )                                    | $      | (0.50 | ) | $ | 0.43 |   | $ | (2.67 | ) |

 

For purposes of the pro forma disclosure under SFAS No. 123, the “fairvalue” of each option and warrant is estimated on the date of grant using theBlack-Scholes option-pricing model with the following assumptions used forgrants in 2004 and 2003:  dividend yieldof 0.0% for all years; expected volatility of 120% and 100% for 2004 and 2003,respectively; risk-free interest rates ranging from 2.75% to 3.38% for 2004 and2.24% to 3.11% for 2003, and expected lives of five years for both years.

 

The weighted average fair value of options granted during the ninemonths ended March 31, 2004 and 2003 was $4.98 and $1.19, respectively.

 

**Recent Accounting Pronouncements**

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainInstruments with Characteristics of Both Liabilities and Equity.”  This standard requires that certainfinancial instruments embodying an obligation to transfer assets or to issueequity securities be classified as liabilities.  This standard is effective for financial instruments entered intoor modified after May 31, 2003.  Theadoption of SFAS No. 150 did not have an effect on the Company’s financialposition or results of operations.

 

In January 2003, the FASB issued Interpretation No. 46,“Consolidation of Variable Interest Entities — an Interpretation of ARB No.51”.  The Interpretation clarifies theapplication of Accounting Research Bulletin No. 51, Consolidated FinancialStatements, to certain entities in which equity investors do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  The provisions of the Interpretation are effective for allenterprises with variable interests in variable interest entities created afterJanuary 31, 2003 and is effective October 9, 2003.  The adoption of this interpretation did nothave an impact on the Company’s financial position or results of operations.

 

**Accounting Period**

 

We utilize a 52-53 week fiscal year ending on the Friday closest toJune 30, which for fiscal year 2003 fell on June 27, 2003.  In the accompanying condensed consolidatedfinancial statements, the 2003 fiscal year end is shown as June 30 and theinterim period end for both years is shown as March 31 for clarity ofpresentation.  The actual interimperiods ended on March 26, 2004 and March 28, 2003.

 

7

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**NOTE 2 – CHANGE INACCOUNTING PRINCIPLE**

 

We adopted Statement of Financial Accounting Standards (“SFAS”) No.142, “Goodwill and Other Intangible Assets,” as of July 1, 2002.  SFAS No. 142 requires that goodwill andintangible assets with indefinite useful lives no longer be amortized, butinstead tested for impairment, at least annually, in accordance with theprovisions of SFAS No. 142.  SFAS No.142 also requires that intangible assets with definite useful lives beamortized over their respective estimated useful lives to their estimatedresidual values, and reviewed for impairment in accordance with SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets.”  In accordance with SFAS No. 142, during theDecember 2002 quarter we completed our initial assessment of impairmentand determined that our goodwill was fully impaired and have recognized animpairment loss of $420,000, net of taxes, in the condensed consolidatedstatement of operations as a change in accounting principle, effectiveJuly 1, 2002.

 

**NOTE 3 – SALE OFSUBSIDIARY**

 

On January 9, 2004, we sold our subsidiary Jolt Technology, Inc.(aka SMTEK Fort Lauderdale), located in Fort Lauderdale, Florida, forapproximately $940,000 in cash to the president of Jolt and an affiliatedinvestor of the Company.  The loss onthe sale of Jolt was approximately $85,000 and has been recognized for the ninemonths ended March 31, 2004 in the accompanying unaudited CondensedConsolidated Statements of Operations and Other Comprehensive Income(Loss).  The results of operations ofJolt through the date of sale and for the nine months ended March 31, 2003are included in the accompanying unaudited Condensed Consolidated Statements ofOperations and Other Comprehensive Income (Loss).

 

Net assets of Jolt as of the sale date of January 9, 2004consisted of the following (in thousands):

 
| Current assets                       |   | $   | 1,026  |   |
|--------------------------------------|--------|-----|--------|--------|
| Property, equipment and improvements |   | 58  |   |
| Other assets                         |   | 20  |   |
| Current liabilities                  |   | (79 | )      |
| Net assets                           |   | $   | 1,025  |   |

 

There were no results of operations for Jolt in the current quarterended March 31, 2004. Revenues were $1.7 million for the nine months endedMarch 31, 2004 and operating income was $109,000 for the nine months endedMarch 31, 2004.

 

**NOTE 4 - DISCONTINUEDOPERATIONS**

 

On April 9, 2003, we sold 100% of the outstanding stock of ourNorthern Ireland facility, SMTEK Europe. The purchaser also assumed all liabilities of SMTEK Europe.  The purchaser was a Northern Irelandinvestor group, which included a director from SMTEK Europe.

 

Accordingly, operating results for SMTEK Europe for the nine monthsended March 31, 2003 have been presented in the accompanying unauditedCondensed Consolidated Statements of Operations and Other Comprehensive Income(Loss) as discontinued operations, and are summarized as follows (inthousands):

 

8

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|                                           |   | **Nine  Months Ended  March 31, 2003** |   |
|------------------------------------------------|--------|---------------------------------------------|--------|
| Net sales                                      |   | $                                           | 6,277  |   |
| Cost of goods sold                             |   | (6,542                                      | )      |
| Operating expenses                             |   | (867                                        | )      |
| Other income (expense), net                    |   | (168                                        | )      |
| Loss from discontinued operations, net of  tax |   | $                                           | (1,300 | ) |

 

Net assets of SMTEK Europe as of the sale date of April 9, 2003consisted of the following (in thousands):

 
| Current assets                       |   | $      | 3,516  |   |
|--------------------------------------|--------|--------|--------|--------|
| Property, equipment and improvements |   | 1,486  |   |
| Current liabilities                  |   | (5,312 | )      |
| Long-term debt                       |   | (65    | )      |
| Net liabilities                      |   | $      | (375   | )      |

 

**NOTE 5 – EARNINGS PERSHARE**

 

Basic earnings (loss) per share is computed by dividing net income(loss) available to common stockholders by the weighted average number ofcommon shares and participating preferred shares on an as converted basisoutstanding during the period.  Dilutedearnings (loss) per share reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock or resulted in the issuance of common stock that then sharedin our earnings (losses).

 

Common stock equivalents used in the determination of diluted earningsper share include the effect, when such effect is dilutive, of our outstandingemployee stock options, the 8-1/2% Convertible Subordinated Debentures (thatare convertible into 4,988 shares of common stock at $212.50 per share ofcommon stock) and warrants to purchase 15,000 shares of common stock at $7.95per share.  The following is a summaryof the calculation of basic and diluted earnings per share (dollars inthousands, except per share data):

 
|                                                          |   | **Three  Months ended March 31,** |   | **Nine  Months Ended March 31,** |   |
|---------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                          |   | **2004**                               |   | **2003**                              |   | **2004** |   | **2003** |   |
|                                                          |   |                                   |   |                                  |   |   |   |   |   |
| Net income (loss)                                             |   | $                                      | 148    |                                  | $      | (1,050 | ) | $ | 1,720 |   | $ | (5,795 | ) |
|                                                          |   |                                   |   |                                  |   |   |   |   |   |
| Weighted average shares:                                      |   |                                   |   |                                  |   |   |   |   |   |
| Basic weighted average number of common  shares outstanding   |   | 2,594,527                              |   | 2,284,343                             |   | 2,487,818 |   | 2,284,343 |   |
| Dilutive effect of outstanding common stock  equivalents      |   | 317,337                                |   | —                                |   | 233,601 |   | — |   |
| Diluted weighted average number of common  shares outstanding |   | 2,911,864                              |   | 2,284,343                             |   | 2,721,419 |   | 2,284,343 |   |
| Earnings (loss) per share - basic                             |   | $                                      | 0.06   |                                  | $      | (0.46 | ) | $ | 0.69 |   | $ | (2.54 | ) |
| Earnings (loss) per share - diluted                           |   | $                                      | 0.05   |                                  | $      | (0.46 | ) | $ | 0.63 |   | $ | (2.54 | ) |

 

Options to purchase approximately 18,542 shares of common stock atprices ranging from $8.36 to $10.00 that were outstanding at March 31,2004, are not included in the computation of diluted earnings per share for thethree months

 

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ended March 31, 2004, because the exercise prices of these optionswere greater than the average market price of our common stock.  Options to purchase approximately 197,884shares of common stock at prices ranging from $5.78 to $10.00 that wereoutstanding at March 31, 2004, are not included in the computation ofdiluted earnings per share for the nine months ended March 31, 2004,because the exercise prices of these options were greater than the averagemarket price of our common stock. Warrants to purchase 15,000 shares of common stock at $7.95 per sharewhich were outstanding at March 31, 2004, are not included in the computationof diluted earnings per share for the nine months ended March 31, 2004,because the exercise price of these warrants was greater than the averagemarket price of our common stock. Because we had a net loss for the three and nine months ended March 31,2003, there were no common stock equivalents that had a dilutive effect onearnings per share.  However, if we hadreported net income rather than a loss for the three and nine months endedMarch 31, 2003, the additional diluted shares outstanding would have been6,430 and 4,145 shares for the three and nine months ended March 31, 2003,respectively.  Further, options topurchase approximately 613,900 shares of common stock at prices ranging from$1.05 to $10.00 that were outstanding at March 31, 2003, would not havebeen included in the computation of diluted earnings per share for the threeand nine months ended March 31, 2003, because the exercise price of theseoptions and warrants were greater than the average market price of our commonstock.

 

Convertible subordinated debentures aggregating $1,060,000, due in 2008and convertible at a price of $212.50 per share at any time prior to maturity,were outstanding during the three and nine months ended March 31, 2004 butwere not included in the computation of diluted earnings per share because theconversion price was greater than the average market price of the commonstock.  Convertible subordinateddebentures aggregating $1,580,000, due in 2008 and convertible at a price of$212.50 per share at any time prior to maturity were outstanding during the threeand nine months ended March 31, 2003 but were not included in thecomputation of diluted earnings per share because we had a net loss and becausethe conversion price was greater than the average market price of the commonstock.

 

**NOTE 6 - INVENTORIES**

 

Inventories consist of the following (in thousands):

 
|              |   | **March 31,  2004** |   | **June 30,  2003** |   |
|-------------------|--------|--------------------------|--------|-------------------------|--------|
| Raw materials     |   | $                        | 8,445  |                    | $      | 5,810 |   |
| Work in process   |   | 5,192                    |   | 3,298                   |   |
| Finished goods    |   | 295                      |   | 269                     |   |
| Total inventories |   | $                        | 13,932 |                    | $      | 9,377 |   |

 

**Note 7 – PROPERTY,EQUIPMENT AND IMPROVEMENTS**

 

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

 
|                                            |   | **March 31,  2004** |   | **June 30,  2003** |   |
|-------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
| Buildings and improvements                      |   | $                        | 1,475  |                    | $      | 1,450 |   |
| Plant equipment                                 |   | 12,719                   |   | 13,075                  |   |
| Office and other equipment                      |   | 1,602                    |   | 1,581                   |   |
| Less accumulated depreciation and  amortization |   | (10,725                  | )      | (10,565                 | )      |
| Total property, equipment and improvements      |   | $                        | 5,071  |                    | $      | 5,541 |   |

 

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**NOTE 8 – CREDITAGREEMENTS AND DEBT RESTRUCTURING**

 

At March 31, 2004, as one component of our credit facility, wehave a $10 million working capital line collateralized by accounts receivable,inventory and equipment for our domestic operating units that maturesSeptember 19, 2006.  Borrowingsunder the working capital line bear interest, at our option, at either thebank’s prime rate (4.0% at March 31, 2004) plus 1.0% or a Libor-base rate(1.125% at March 31, 2004) plus 3.75%. At March 31, 2004, borrowings under our working capital lineamounted to $6.3 million and the effective weighted average interest rate was4.91%.  Borrowings under our workingcapital line at March 31, 2004 have been classified as long-term.  In addition, in September 2003 weborrowed $1 million on our term credit facility, the second component of ourcredit facility.  This advance has amaturity date of September 19, 2006 and bears interest, at our option, ateither the bank’s prime rate (4.0% at March 31, 2004) plus 1.0% or aLibor-base rate (1.125% at March 31, 2004) plus 3.75%.  At March 31, 2004, the balanceoutstanding was $833,000 and the effective interest rate was 4.89%.  The third component of our credit facility,the capital expenditure credit facility of $1 million, will be used to financeour capital expenditures.  Each advanceunder the capital expenditure credit facility will have a three year term ateither the Bank’s prime rate or, at our option, at a fixed rate equal to theLibor rate plus 3.75%.  There were noborrowings under the capital expenditure credit facility as of March 31,2004.  We were in compliance with allcovenants on the above credit facilities at March 31, 2004.

 

Also during the nine months ended March 31, 2004, we settledobligations to former officers, employees and directors under consulting anddeferred fee agreements by paying approximately $440,000 and fully retiring$972,000 in debt resulting in a $532,000 gain from extinguishment of debt.  We also reached settlement with certainsubordinated debt holders by paying an aggregate of $172,000 to fully retire anaggregate of $520,000 in debt resulting in a $348,000 gain from extinguishmentof debt.  The aggregate $880,000 gain onextinguishment of debt is a component of other income (expense), net in theunaudited condensed consolidated statements of operations.

 

**NOTE 9 – PREFERREDSTOCK**

 

In September 2003, we sold in a private placement 250,000 sharesof convertible Series A Preferred Stock at $2.00 per share for gross offeringproceeds of $500,000.  The shares areconvertible into common stock initially on a one-to-one basis and areredeemable, 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.  Preferred holders areentitled to receive, on January 1 of each year, out of any assets legallyavailable therefor, payable when, as and if declared by the Board, prior and inpreference to any declaration or payment of any dividend on Junior Securities,dividends at the rate of 9% of the Purchase Price plus any accrued an unpaiddividends per annum.  Such dividendsshall accrue annually in arrears whether or not

 

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declared by the Board of Directors and shall be cumulative.  If the Company declares and pays dividendsor distributions on common stock then the holders of shares of Series APreferred Stock are entitled to share in such dividends or distributions on apro rata basis as if their shares had been converted into shares of commonstock.  Dividends accrued on thepreferred stock amounted to $26,000 at March 31, 2004.

 

**NOTE 10 – GEOGRAPHICINFORMATION**

 

We operate in a single business segment – the EMS industry.  Our revenues and long-lived assets, net ofaccumulated depreciation, by geographic area are as follows (in thousands):

 
|           |   | **Three  Months Ended  March 31,** |   | **Nine  Months Ended  March 31,** |   |
|----------------|--------|-----------------------------------------|--------|----------------------------------------|--------|
|           |   | **2004**                                |   | **2003**                               |   | **2004** |   | **2003** |   |
|           |   |                                    |   |                                   |   |   |   |   |   |
| Revenues:      |   |                                    |   |                                   |   |   |   |   |   |
| United States  |   | $                                       | 20,132 |                                   | $      | 15,973 |   | $ | 56,270 |   | $ | 47,331 |   |
| Thailand       |   | 2,424                                   |   | 1,457                                  |   | 7,110 |   | 3,143 |   |
| Total revenues |   | $                                       | 22,556 |                                   | $      | 17,430 |   | $ | 63,380 |   | $ | 50,474 |   |

 
|                    |   | **March 31,  2004** |   | **June 30,  2003** |   |
|-------------------------|--------|--------------------------|--------|-------------------------|--------|
| Long-lived assets:      |   |                     |   |                    |   |
| United States           |   | $                        | 4,537  |                    | $      | 5,324 |   |
| Thailand                |   | 534                      |   | 217                     |   |
| Total long-lived assets |   | $                        | 5,071  |                    | $      | 5,541 |   |

 

**NOTE 11 – SUBSEQUENTEVENT**

 

On May 6, 2004, we finalized a Credit Facility Agreement between SMTEKInternational Thailand Company Limited (our Thailand subsidiary) and BankThaiPublic Company Limited and an unconditional guarantee by SMTEK International,Inc. for the purpose of funding the growth and expansion of our Thailandfacility.  The credit facility includesa $725,000 mortgage loan for the purchase of the building and land at ourThailand facility.  The mortgage has aseven year term with an initial interest rate of 5.75%, based on Thailand PrimeRate, and a monthly payment of approximately $9,000.  The Credit Facility Agreement also includes a $440,000construction loan for the expansion of the Thailand facility.  The construction loan has a 78 month termwith interest at Thailand Prime Rate and a monthly payment of approximately$5,000.  The Credit Facility Agreementalso includes a working capital line of approximately $500,000 with interest atThailand Prime rate, a one year term and it is secured by all the assets of theThailand facility.  All liabilities andobligation under the Credit Facility are denominated in Baht, the currency ofThailand.

 

**ITEM 2.****                             MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

References in this report to “the Company”, “SMTEK”, “we”, “our”, or“us” mean SMTEK International, Inc. together with its subsidiaries, exceptwhere the context otherwise requires. This Quarterly Report on Form 10-Qcontains

 

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certain statements that are, or may be deemed to be, forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933and Section 21E of the Securities Exchange Act of 1934, and are made inreliance upon the protections provided by such acts for forward-lookingstatements. These forward-looking statements (such as when we describe what“will,” “may” or “should” occur, what we “plan,” “intend,” “estimate,”“believe,” “expect” or “anticipate” will occur, and other similar statements)include, but are not limited to, statements regarding future sales andoperating results, future prospects, anticipated benefits of proposed (orfuture) acquisitions and new facilities, growth, the capabilities andcapacities of business operations, any financial or other guidance and allstatements that are not based on historical fact, but rather reflect ourcurrent expectations concerning future results and events. We make certainassumptions when making forward-looking statements, any of which could prove inaccurate,including, but not limited**to, statements about our future operatingresults and business plans. The**ultimate correctness of theseforward-looking statements is dependent upon a number of known and unknownrisks and events, and is subject to various uncertainties and other factorsthat may cause our actual results, performance or achievements to be differentfrom any future results, performance or achievements expressed or implied bythese statements.

 

The following important factors, among others, could affect futureresults and events, causing those results and events to differ materially fromthose expressed or implied in our forward-looking statements: businessconditions and growth in our customers’ industries, the electronicmanufacturing services industry and the general economy, variability ofoperating results, our dependence on a limited number of major customers, thepotential consolidation of our customer base, availability of components,dependence on certain industries, seasonality, variability of customerrequirements, our ability to successfully negotiate definitive agreements andconsummate acquisitions, and to integrate operations following consummation ofacquisitions, our ability to take advantage of our restructuring to improve utilizationand realize savings, other economic, business and competitive factors affectingour customers, our industry and business generally and other factors that wemay not have currently identified or quantified. For a further list anddescription of various risks, relevant factors and uncertainties that couldcause future results or events to differ materially from those expressed orimplied in our forward-looking statements, see “Factors that May Affect ourResults” below, as well as in our Annual Report on Form 10-K for the fiscalyear ended June 30, 2003, any subsequent Reports on Form 10-Q and Form 8-Kand other filings with the Securities and Exchange Commission.

 

All forward-looking statements included in this Quarterly Report onForm 10-Q are made only as of the date of this Quarterly Report on Form 10-Q,and we do not intend to publicly update or correct any forward-lookingstatements to reflect events or circumstances that subsequently occur or whichwe hereafter become aware of. You should read this document and the documents,if any, that we incorporate by reference into this Quarterly Report on Form10-Q completely and with the understanding that our actual future results maybe materially different from what we expect. We may not update these forward-lookingstatements, even if our situation changes in the future. All forward-lookingstatements attributable to us are expressly qualified by these cautionarystatements.

 

The following discussion and analysis should be read in conjunctionwith the condensed consolidated financial statements and related notes includedelsewhere in this report.

 

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**FACTORS THAT MAYAFFECT OUR RESULTS**

 

The following factors update certain risk factors identified in our2003 Annual Report on Form 10-K which was filed with the SEC onSeptember 25, 2003.  We directreaders to the documents we file with the SEC, including our most recentReports on Forms 10-K, 10-Q and 8-K, each as it may be amended from time totime, for a more complete description of important risk factors affecting ourCompany.

 

**OurIndustry is Characterized by Low Profit Margins.**

 

Competition in the EMS industry is primarily driven by price oftenresulting in lower profit margins for EMS providers. In this regard, customershave sought and continue to seek price reductions.  In addition, designing and manufacturing products for newcustomers can result in higher costs and lower profit margins than we typicallyexperience with our established customers since initial production runs do notreflect full production efficiencies. Unless we successfully achieve further material cost reductions,efficiencies and productivity gains, we may experience a material adverse effecton our operating results and our financial condition.  There can be no assurance, however, whether reductions inmaterials costs will be effective or adequate to compensate for such pricereductions or that we will be successful in furthering efficiencies andproductivity gains.

 

**TheLoss of Any One of Our Larger Customers May Adversely Affect Our Results andFinancial Condition.**

 

Sales to three customers accounted for 12.1%, 11.5% and 10.1% ofrevenues in the nine months ended March 31, 2004.  The loss of one or more of our largercustomers, or a significant reduction in sales to any of our major customers,could have an adverse effect on our business, results of operations andfinancial condition.

 

**Our Liquidity is Currently Limited and OurDebt Profile May Change and May Affect Our Operations and Financial Condition.**

 

Our cash is currently limited, and, atMarch 31, 2004, our debt-to-equity ratio, excluding bank letter of creditclassified as long-term, was 1.6 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.

 

**OurLines of Credit Contain Certain Financial Covenants That Must Be Met.**

 

In September 2003, we entered into a new domestic credit facility(See Note 8 to the unaudited condensed consolidated financial statements for amore detailed discussion of the new credit facility).  This new credit facility matures September 19, 2006 andincludes certain covenants that we are required to comply with.  On May 6, 2004, we entered into a newThailand credit facility (See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations – Liquidity and Capital Resources– New Thailand Credit

 

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Facility”). In the event of default under our line of creditagreements, any and all outstanding borrowings could become immediately due andpayable which would likely create significant operating and financialrestrictions on us, further causing an adverse effect upon our business,operating results and financial condition.

 

**OurStock Price Has Been And Continues To Be Volatile.**

 

The market price for our common stock continues to be volatile due tovarious factors.  These factors include,but are not limited to:

 

•                  the public floatbeing relatively small and thinly traded;

 

•                  announcements byus or our competitors of new contracts or technological innovations;

 

•                  fluctuations inour quarterly and annual operating results;

 

•                  acquisition-relatedannouncements; and

 

•                  general marketconditions.

 

In addition, our stock price in recent years has experiencedsignificant price fluctuations for a variety of reasons, including conditionsthat are both internal and external to us.

 

**TheExpansion of our Foreign Facility in Thailand May Not Proceed as Planned andCost Overruns or Delays May Have a Negative Impact on Our Operating Results.**

 

We are beginning a process of expanding our facility in Thailand andare also transitioning certain production from the Moorpark facility to theThailand facility.  If the expansionfaces significant delays or if we do not effectively transition production tomake efficient use of the increased capacity, our fixed costs could increase asa percentage of revenues.  Cost overrunsin the expansion process could also negatively impact our operating results andfinancial condition.

 

**The****ReserveEstablished for the Closure and Transition of Our San Diego Facility Was Basedon Estimates and, Therefore, May Not Fully Represent All Future Costs For ThatFacility.**

 

In the second quarter of fiscal 2003, we established a reserve forfuture costs related to the closure and transition to Moorpark of our San Diegofacility.  In estimating these futurecosts, we considered the cost of our lease obligation net of estimated futureproceeds from subleasing the facility. If the facility were to be vacant for an extended period of time duringthe remaining term of the lease, we may be required to increase the reserve andthis could negatively impact our operating results and financial condition.

 

**DESCRIPTION OF THEBUSINESS**

 

We are an electronics manufacturing services (“EMS”) provider tooriginal equipment manufacturers (“OEMs”) in the medical, industrialinstrumentation, 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 worldwidehigh criticality, high reliability, high complexity segment of the EMSindustry.

 

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We have four wholly-owned subsidiaries:  SMTEK, Inc. (dba SMTEK Moorpark), located in Moorpark,California; SMTEK New England, located in Marlborough, Massachusetts; SMTEKSanta Clara, located in Santa Clara, California; and SMTEK InternationalThailand Limited, located in Ayutthya, Thailand.

 

On January 9, 2004, we sold our subsidiary Jolt Technology, Inc.(aka SMTEK Fort Lauderdale), located in Fort Lauderdale, Florida, forapproximately $940,000 in cash to the president of Jolt and an affiliatedinvestor of the Company.  The loss onthe sale of Jolt was approximately $85,000 and has been recognized for the ninemonths ended March 31, 2004 in the accompanying unaudited CondensedConsolidated Statements of Operations and Other Comprehensive Income(Loss).  The results of operations ofJolt through the date of sale and for the nine months ended March 31, 2003are included in the accompanying unaudited Condensed Consolidated Statements ofOperations and Other Comprehensive Income (Loss).

 

The EMS industry experienced rapid change and growth over most of thepast decade as an increasing number of OEMs outsourced an increasing portion,and, in some cases, all of their manufacturing requirements. In mid-2001, theindustry’s revenue declined as a result of significant cut-backs in itscustomers’ production requirements, which was consistent with the overallglobal economic downturn. In response to this industry and global economicdownturn, we implemented restructuring programs to reduce our cost structureand further align our manufacturing capacity with the geographic productiondemands of our customers. Our restructuring activities included reductions inworkforce, closure and re-sizing of certain facilities and the transition ofcertain facilities into new customer development sites. Additionally, we havemade concentrated efforts to diversify our customer base through organicgrowth. Industry revenues have slowly increased over the last year as customerproduction requirements generally began to stabilize.

 

**CRITICAL ACCOUNTINGPOLICIES AND ESTIMATES**

 

The preparation of our financial statements and related disclosures inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and judgments that affect ourreported amounts of assets and liabilities, revenues and expenses, and relateddisclosures of contingent assets and liabilities. On an on-going basis, weevaluate our estimates and assumptions based upon historical experience andvarious other factors and circumstances. Management believes that our estimatesand assumptions are reasonable under the circumstances; however, actual resultsmay vary from these estimates and assumptions under different futurecircumstances. We have identified the following critical accounting policiesthat affect the more significant judgments and estimates used in thepreparation of our consolidated financial statements.

 

Allowance for Doubtful Accounts

 

We maintain an allowance for doubtful accounts related to receivablesnot expected to be collected from our customers. This allowance is based onmanagement’s assessment of specific customer balances, considering the age ofreceivables and financial stability of the customer. If there is an adversechange in the financial condition of our customers, or if actual defaults arehigher than provided for, an addition to the allowance may be necessary.

 

Inventory Valuation

 

We purchase inventory based on forecasted demand and record inventoryat the lower of cost or market. Management regularly assesses inventoryvaluation based on current and forecasted usage and other lower of cost ormarket

 

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considerations. If actual market conditions or our customers’ productdemands are less favorable than those projected, additional valuationadjustments may be necessary.

 

Long-Lived Assets

 

We review property, plant and equipment for impairment whenever eventsor changes in circumstances indicate that the carrying amount of an asset maynot be recoverable. Recoverability of property, plant and equipment is measuredby comparing its carrying value to the projected cash flows the property, plantand equipment are expected to generate. If such assets are considered to beimpaired, the impairment to be recognized is measured as the amount by whichthe carrying value of the property exceeds its fair market value. Theimpairment analysis is based on significant assumptions of future results madeby management, including revenue and cash flow projections. Circumstances thatmay lead to impairment of property, plant and equipment include unforeseendecreases in future performance or industry demand and the restructuring of ouroperations resulting from a change in our business strategy.

 

Restructuring and Impairment Charges

 

We recognized restructuring and impairment charges in fiscal year 2003related to reductions in workforce, re-sizing and closure of facilities. Thesecharges were recorded pursuant to formal plans developed and approved bymanagement. The recognition of restructuring and impairment charges requiresthat we make certain judgments and estimates regarding the nature, timing andamount of costs associated with these plans. The estimates of futureliabilities may change, requiring additional restructuring and impairmentcharges or the reduction of liabilities already recorded. At the end of eachreporting period, we evaluate the remaining accrued balances to ensure that noexcess accruals are retained and the utilization of the provisions are fortheir intended purpose in accordance with the restructuring programs. Forfurther discussion of our restructuring programs, refer to Note 1 — “Descriptionof Business and Basis of Presentation - Restructuring Costs” and Note 2 —“Change in Accounting Principle” to the Consolidated Financial Statements.

 

**RESULTS OF OPERATIONS– THREE AND NINE MONTHS ENDED MARCH 31, 2004**

 

We utilize a 52-53 week fiscal year ending on the Friday closest toJune 30, which for fiscal year 2003 fell on June 27, 2003.  In the accompanying condensed consolidatedfinancial statements, the 2003 fiscal year end is shown as June 30 and theinterim period end for both years is shown as March 31 for clarity ofpresentation. The actual interim periods ended on March 26, 2004 andMarch 28, 2003.

 

**Revenues**

(dollars in thousands)

 
|                |   | **Three  Months Ended  March 31** |   | **Nine  Months Ended  March 31** |   |
|---------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                |   | **2004**                               |   |                                  |   | **2003** |   | **2004** |   |   |   | **2003** |   |
| Revenues            |   | **$**                                  | 22,556 |                                  |   |   | $ | 17,430 | ** ** | **$** | 63,380 |   |   |   | $ | 50,474 |   |
| Percentage Increase |   |                                   |   | 29.4                                  | %      |   |   |   |   | 25.6 | % |   |   |
|                     |        |                                        |        |                                       |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in revenues primarily represents stronger demand fromexisting programs.  We experiencedcontinuing strong demand particularly in the medical, industrial instrumentation,telecommunications and security industries. Revenues attributable to new customers represent approximately 8%

 

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of the total revenue increase and occurred most significantly in themedical and security industries.

 

**Gross profit**

(dollars in thousands)

 
|         |   | **Three  Months Ended  March 31** |      | **Nine  Months Ended  March 31** |   |
|--------------|--------|----------------------------------------|-----------|---------------------------------------|--------|
|         |   | **2004**                               |      | **2003**                              |   | **2004** |   | **2003** |   |
| Gross Profit |   | **$**                                  | **2,388** |                                  | $      | 1,920 | ** ** | **$** | **7,282** |   | $ | 4,352 |   |
| Gross Margin |   | **10.6**                               | **%**     | 11.0                                  | %      | **11.5** | **%** | 8.6 | % |
|              |        |                                        |           |                                       |        |  |  |  |  |  |  |  |  |

 

The fluctuations in the Company’s gross profit margin for the three andnine month periods are the result of a number of factors including labor costand overhead efficiencies, customer mix, increased capacity utilization andcomponent pricing.  The increase in grossprofit margin for the nine month period of fiscal 2004, as compared to the ninemonth period in fiscal 2003, is largely attributable to the decrease in excesscapacity which resulted from the closure and subsequent transition of the SanDiego facility and the sale of our European manufacturing facility in the prioryear.  The relatively flat gross marginfor the comparable three month periods ended March 31 resulted from anincrease in material cost as a percentage of sales counteracting our improved variableand fixed cost margins related to better utilization of excess capacity.  We cannot be sure that our capacityutilization will remain at its current level and any decrease in revenues withthe resultant under-utilization of capacity could negatively impact our grossprofit margin.

 

**Administrative andselling expense**

(dollars in thousands)

 
|                                               |   | **Three  Months Ended  March 31** |      | **Nine  Months Ended  March 31** |   |
|----------------------------------------------------|--------|----------------------------------------|-----------|---------------------------------------|--------|
|                                               |   | **2004**                               |      | **2003**                              |   | **2004** |   | **2003** |   |
| Administrative and selling expense                 |   | **$**                                  | **1,860** |                                  | $      | 2,216 | ** ** | **$** | **5,922** |   | $ | 7,906 |   |
| Percent of sales                                   |   | **8.2**                                | **%**     | 12.7                                  | %      | **9.3** | **%** | 15.7 | % |
|                                               |   |                                   |      |                                  |   |   |   |   |   |
| Expenses related to closure of San Diego  facility |   |                                   |      |                                  |   |   |   | $ | (1,630 | ) |
| Nine months ended March 2003 as  adjusted     |   |                                   |      |                                  |   |   |   | $ | 6,276 |   |
|                                               |   |                                   |      |                                  |   |   |   | 12.4% |   |
|                                                    |        |                                        |           |                                       |        |  |  |  |  |  |  |  |  |

 

Administrative and selling expenses have decreased as a percentage ofsales as we continue to closely monitor our expenditures even as sales volumeincreases.  (Note that the $1.6 millionrestructuring costs related to the closure and transition of our San Diegofacility in the second quarter of fiscal 2003 consisted of severance cost of$287,000, write-off of leasehold improvements of $370,000 and accrual ofremaining lease obligation of $4,011,000 less sublease income of $3,038,000.)

 

**Interest expense**

(dollars in thousands)

 
|                 |   | **Three  Months Ended  March 31** |    | **Nine  Months Ended  March 31** |   |
|----------------------|--------|----------------------------------------|---------|---------------------------------------|--------|
|                 |   | **2004**                               |    |                                  |   | **2003** |   | **2004** |   |   |   | **2003** |   |
| Interest expense     |   | **$**                                  | **207** |                                  |   |   | $ | 267 | ** ** | **$** | **545** |   |   |   | $ | 776 |   |
| Percentage reduction |   |                                   |    | 22.5                                  | %      |   |   |   |   | 29.8 | % |   |   |
|                      |        |                                        |         |                                       |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

The decrease in interest expense was the result of lower levels of debtoutstanding during the three and nine months ended March 31, 2004 ascompared to the three and nine months ended March 31, 2003.  The reduction in debt included thesettlement of approximately $1.5 million of obligations at a discount (see Note8 to the Unauditied Condensed Consolidated Financial Statements).

 

**Other income(expense)**

(dollars in thousands)

 
|                   |   | **Three  Months Ended  March 31** |     | **Nine  Months Ended  March 31** |   |
|------------------------|--------|----------------------------------------|----------|---------------------------------------|--------|
|                   |   | **2004**                               |     | **2003**                              |   | **2004** |   | **2003** |   |
| Other income (expense) |   | **$**                                  | **(170** | **)**                                 | $      | 269 | ** ** | **$** | **945** |   | $ | 261 |   |
|                        |        |                                        |          |                                       |        |  |  |  |  |  |  |  |  |

 

Other expense of $170,000 for the three months ended March 31,2004 consists primarily of an unrealized loss on marketable securitiesclassified as trading securities of $255,000 offset by a gain on extinguishmentof debt of $63,000 and other income of $22,000.  During the nine months ended March 31, 2004, we recognized again on extinguishment of debt of $880,000, an unrealized gain on marketablesecurities classified as trading securities of $28,000, a currency transactiongain of $85,000 and other income of $37,000, offset by the loss on the sale ofour Florida subsidiary of $85,000. Other income for the three and nine months ended March 31, 2003,consists primarily of a gain on the extinguishment of debt of $175,000 and incomeof $96,000 from the settlement of contingent liabilities.

 

**Income tax provision**

(dollars in thousands)

 
|                 |   | **Three  Months Ended  March 31** |   | **Nine  Months Ended  March 31** |   |
|----------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                 |   | **2004**                               |   | **2003**                              |   | **2004** |   | **2003** |   |
| Income tax provision |   | **$**                                  | **3**  |                                  | $      | — | ** ** | **$** | **40** |   | $ | 6 |   |
|                      |        |                                        |        |                                       |        |  |  |  |  |  |  |  |  |

 

The income tax provision is primarily related to state franchise taxes.

 

**Net income (loss)**

(dollars in thousands)

 
|              |   | **Three  Months Ended  March 31** |    | **Nine  Months Ended  March 31** |   |
|-------------------|--------|----------------------------------------|---------|---------------------------------------|--------|
|              |   | **2004**                               |    | **2003**                              |   | **2004** |   | **2003** |   |
| Net income (loss) |   | **$**                                  | **148** |                                  | $      | (1,050 | ) | **$** | **1,720** |   | $ | (5,795 | ) |
|                   |        |                                        |         |                                       |        |  |  |  |  |  |  |  |  |

 

Our net income increases are primarily attributable to higher revenuesand control of our expenses.  Asdiscussed above under the heading “Other income (expense)”, there were alsocertain non-recurring items contributing to net income for the nine monthsended March 31, 2004, most significantly, a $880,000 gain onextinguishment of debt. This gain is non-recurring.  In addition, we cannot assure that we will maintain our currentrevenue and gross profit margin levels.

 

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**LIQUIDITY AND CAPITALRESOURCES**

 

Our primary sources of liquidity are our cash and cash equivalents,which amounted to $501,000 at March 31, 2004, and amounts available underour bank lines of credit, which provided approximately $3.7 million ofavailability in excess of current borrowings at March 31, 2004.

 

**Current assets,current liabilities and long-term debt**

The following table sets forth certain debt and liquidity measurements(dollars in thousands):

 
|                                             |   | **At  March 31, 2004** |   | **At  June 30, 2003** |   |
|--------------------------------------------------|--------|-----------------------------|--------|----------------------------|--------|
|                                             |   |                        |   |                       |   |
| Working capital                                  |   | $                           | 8,385  |                       | $      | 5,701 |   |
| Long-term borrowings, including current  portion |   | $                           | 5,613  |                       | $      | 8,170 |   |
| Ratio of current assets to current  liabilities  |   | 1.41                        |   | 1.36                       |   |

 

The increase in the working capital and decrease in debt are related toour improved earnings as well as the settlement of certain debt obligations asdescribed below.  The outstandingbalance of our bank line of credit, classified as long-term, increased by$812,000 during the first nine months of fiscal 2004.

 

During the nine months ended March 31, 2004, we settled obligationsto former officers, employees and directors under consulting and deferred feeagreements by paying approximately $440,000 and fully retiring $972,000 in debtresulting in a $532,000 gain from extinguishment of debt.  We also reached settlement with certainsub-debt holders by paying an aggregate of $172,000 to fully retire anaggregate of $520,000 in debt resulting in a $348,000 gain from extinguishmentof debt.  During the current quarterended March 31, 2004, we also paid approximately $190,000 as acceleratedpayoff of several equipment notes with interest rates of 5.4% to 8.9%.

 

**Cash flows providedby /(used for):**

The following table sets forth, for the periods indicated, selectedconsolidated cash flow information (dollars in thousands):

 
|                                                  |   | **Nine Months  Ended  March 31** |   |
|-------------------------------------------------------|--------|---------------------------------------|--------|
|                                                  |   | **2004**                              |   | **2003** |   |
| Operating Activities                                  |   | $                                     | (7     | ) | $ | 1,332 |   |
| Investing Activities                                  |   | (1                                    | )      | (1,031 | ) |
| Financing Activities                                  |   | (142                                  | )      | (557 | ) |
| Effect of exchange rate changes on cash               |   | 68                                    |   | (14 | ) |
| Net (decrease) increase in cash and cash  equivalents |   | $                                     | (82    | ) | $ | (270 | ) |

 

March 2004 revenues resulted in a significant increase in accountsreceivable for the nine months ended March 31, 2004.  In addition, our inventories are higher inpreparation for our fourth quarter production. An increase in accounts payable did not entirely compensate for theseuses of operating funds and the $1.7 million in income from continuingoperations before depreciation and amortization of $1.4 million was partiallyoffset by the non-cash gain on extinguishment of debt of $880,000.  Although inventory

 

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levels are higher compared to 2003, inventory turns have improved dueto increased revenue.

 

Net cash used in investing activities for the nine months endedMarch 31, 2004 includes capital expenditures of $941,000.  In addition to ongoing upgrades tomanufacturing and computer equipment, approximately $354,000 of the capitalequipment investment is attributable to equipment upgrades in our Thailandfacility.  Investing activities alsoinclude proceeds of $940,000 from the sale of our Florida subsidiary.

 

The most significant use of funds for financing purposes was therepayment of debt as described in more detail above and in Note 8 to theUnaudited Condensed Consolidated Financial Statements.  In-flows included borrowing against our bankline of credit at a lower rate than the debt retired, proceeds from the firstquarter issuance of preferred stock and proceeds from the exercise of stockoptions.

 

**New Thailand creditfacility**

 

Subsequent to March 31, 2004, on May 6, 2004, we finalized aCredit Facility Agreement between our subsidiary SMTEK International ThailandLimited (“SMTEK Thailand”) and BankThai Public Company Limited and weunconditionally guaranteed SMTEK Thailand’s liabilities and obligations underthe Credit Facility Agreement for the purpose of funding the growth andexpansion of our Thailand facility.  Thecredit facility includes a $725,000 mortgage loan for the purchase of thebuilding and land at our Thailand facility. The mortgage has a seven year term with an initial interest rate of5.75%, based on Thailand Prime Rate, and a monthly payment of approximately$9,000.  The Credit Facility Agreementalso includes a $440,000 construction loan for the expansion of the Thailandfacility.  The construction loan has a78 month term with interest at Thailand Prime Rate and a monthly payment ofapproximately $5,000.  The CreditFacility Agreement also includes a working capital line of approximately$500,000 with interest at Thailand Prime rate, a one year term and it issecured by all the assets of the Thailand facility.  All liabilities and obligations under the Credit Facility aredenominated in Baht, the currency of Thailand, and therefore the aboveestimates fluctuate with changes in the Baht exchange rate.

 

**Wells Fargo creditfacility and other liquidity and capital resources issues**

 

In September 2003, we entered into a new long-term creditfacility.  This new credit facilityconsists of a $10 million working capital line, a term credit facility in theamount of up to $1.0 million and a capital expenditure facility of $1.0million.  The $10 million workingcapital line is collateralized by accounts receivable, inventory and equipmentand matures September 19, 2006. Borrowings under the working capital line bear interest, at our option,at either the bank’s prime rate (4.0% at March 31, 2004) plus 1.0% or aLibor-base rate (1.125% at March 31, 2004) plus 3.75%.  At March 31, 2004, borrowings under ourworking capital line amounted to $6.3 million and the effective weightedaverage interest rate was 4.91%. Borrowings under our working capital line at March 31, 2004 havebeen classified as long-term.  Inaddition, in September 2003 we borrowed $1 million on our term creditfacility, the second component of our credit facility.  This advance has a maturity date ofSeptember 19, 2006 and bears interest, at our option. at either the bank’sprime rate (4.0% at March 31, 2004) plus 1.0% or a Libor-base rate (1.125%at March 31, 2004) plus 3.75%.  AtMarch 31, 2004, the balance outstanding was $833,000 and the effectiveinterest rate was 4.89%.  The thirdcomponent of our credit facility, the capital expenditure credit facility of $1million, will be used to finance our capital expenditures.  Each advance under the capital expenditurecredit facility will have a three

 

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year term at either the Bank’s prime rate or, at our option, at a fixedrate equal to the Libor rate plus 3.75%. There were no borrowings under the capital expenditure credit facilityas of March 31, 2004.  We were incompliance with all covenants on the above credit facilities at March 31,2004 and as of the date of this filing on Form 10Q.

 

We anticipate that we may incur additional capital expenditures of asmuch as $300,000 during the remainder of fiscal 2004, primarily to improveproduction efficiency at all our subsidiaries. A substantial portion of these capital expenditures are expected to befinanced by our new line of credit or other notes and leases payable.

 

We previously recorded a liability for a federal tax assessment,including accrued interest, of $2.5 million per a December 2001 settlementwith the Appeals division of the IRS. We finalized a payment plan in July 2003 and at March 31,2004, the note payable to the IRS is $2.1 million, payable in monthlyinstallments of $45,000 through July 2008.

 

Management believes that our cash resources, cash from operations andavailable borrowing capacity on our working capital lines of credit aresufficient to fund operations for at least the next 12 months.  Long term, however, if economic conditionsweaken for an extended period of time or if we are unable to maintain profitability,we may have to obtain additional debt or equity financing.  There can be no assurance that we will beable to obtain additional debt or equity financing, if and when needed, onterms acceptable to us.

 

**RECENT ACCOUNTINGPRONOUNCEMENTS**

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainInstruments with Characteristics of Both Liabilities and Equity.”  This standard requires that certainfinancial instruments embodying an obligation to transfer assets or to issueequity securities be classified as liabilities.  This standard is effective for financial instruments entered intoor modified after May 31, 2003.  Theadoption of SFAS No. 150 did not have an effect on the Company’s financialposition or results of operations.

 

In January 2003, the FASB issued Interpretation No. 46,“Consolidation of Variable Interest Entities — an Interpretation of ARB No.51”.  The Interpretation clarifies theapplication of Accounting Research Bulletin No. 51, Consolidated FinancialStatements, to certain entities in which equity investors do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  The provisions of the Interpretation are effective for allenterprises with variable interests in variable interest entities created afterJanuary 31, 2003 and is effective October 9, 2003.  The adoption of this Interpretation did nothave an impact on the Company’s financial position or results of operations.

 

**ENVIRONMENTAL MATTERS**

 

Since the early 1990s, we have been and continue to be involved incertain remediation and investigative studies regarding soil and groundwatercontamination at the site of a former printed circuit board manufacturing plantin Anaheim, California.  One of ourformer subsidiaries, Aeroscientific Corp., leased the Anaheim facility.  Under the terms of a cost sharing agreemententered into several years ago, the remaining remediation costs are currentlybeing shared on a 50-50 basis with the landlord.  There is no environmental insurance coverage for thisremediation.  At March 31, 2004, wereserved $421,000 for future remediation costs.  Management, based in part on

 

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consultations with outside environmental engineers and scientists,believes that this reserve is adequate to cover its share of future remediationcosts at this site.  However, the futureactual remediation costs could differ significantly from the estimate.  Further, our portion could potentiallyexceed the amount of our reserve.  Ourliability for remediation in excess of our reserve could have a materialadverse impact on our business, financial condition, results of operations andcash flows.

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Our financial instruments include cash and cash equivalents, accountsreceivable and short-term and long-term debt. At March 31, 2004, the carrying amount of long-term debt (includingcurrent portion thereof but excluding bank lines of credit) was $5.6 millionand the fair value was $5.1 million. The carrying values of our other financial instruments approximatedtheir fair values.  The fair value ofour financial instruments is estimated based on quoted market prices for thesame or similar issues.  A change ininterest rates of one percent would result in an annual impact on interestexpense of approximately $120,000.

 

It is our policy not to enter into derivative financial instruments forspeculative purposes.  We may, from timeto time, enter into foreign currency forward exchange contracts in an effort toprotect us from adverse currency rate fluctuations on foreign currencycommitments entered into in the ordinary course of business.  These commitments are generally for terms ofless than one year.  The foreigncurrency forward exchange contracts are executed with banks believed to becreditworthy and are denominated in currencies of major industrialcountries.  In accordance with SFAS No.133, “Accounting for Derivative Instruments and Hedging Activities,” allderivative financial instruments are measured at fair value and are recognizedas either assets or liabilities in the balance sheet.  The accounting treatment of changes in fair value is dependentupon whether or not a derivative financial instrument is designated as a hedgeand, if so, the type of hedge.  Changesin fair value are recognized in current results of operations for fair valuehedges and in other comprehensive income for cash flow hedges.  Derivative financial instruments notqualifying for hedge accounting treatment under SFAS No. 133, as amended by FAS149, are recognized as assets or liabilities with gains or losses recognized incurrent results of operations.  At March 31,2004, we had no forward foreign currency contracts.

 

Our operations include investments in a foreign operating unit.  Our foreign subsidiary representsapproximately 11% of our revenues and 9% of our total assets.  As a result, our financial results have beenand may continue to be affected by changes in foreign currency exchange rates.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

**Evaluation ofdisclosure controls and procedures**.

 

Based on management’s evaluation (with the participation of ourprincipal executive officer and principal financial officer), as of the end ofthe period covered by this report, our principal executive officer andprincipal financial officer have concluded that our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensurethat information required to be disclosed by us in reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in SEC rules and regulations.

 

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**Changes in internalcontrol over financial reporting**.

 

There was no change in our internal control over financial reportingduring our third fiscal quarter of 2004 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

**Limitation on theEffectiveness of Controls**

 

Our management, including our Chief Executive Officer and ChiefFinancial Officer, does not expect that our disclosure controls and internalcontrols will prevent all error and all fraud. A control system, no matter howwell conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met. Further, thedesign of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the company have been detected. Theseinherent limitations include the realities that judgments in decision-making canbe faulty, and that breakdowns can occur because of simple error or mistake.Additionally, controls can be circumvented by the individual acts of somepersons, by collusion of two or more people, or by management override of thecontrol.

 

The design of any system of controls also is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions.

 

**PART II.****                        OTHERINFORMATION**

 

**ITEM 1.****                             LEGALPROCEEDINGS**

 

In the ordinary course of business, we experience various types ofclaims that sometimes 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.****                             CHANGESIN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

On March 1, 2004, we agreed to issue a warrant to purchase 15,000shares of our Common Stock at an exercise price of $7.95 per share to oneentity, Silverman Heller Associates. The warrant becomes exercisable on and after May 1, 2005 and expires onApril 1, 2010.  In issuing thewarrants, we relied on an exemption from registration pursuant toSection 4(2) of the Securities Act of 1933, as amended.

 

**ITEM 6.****                             EXHIBITSAND REPORTS ON FORM 8-K**

 

a. Exhibits:

 
| 2.1    |   | Stock Purchase Agreement (incorporated by reference to Exhibit 2.1 of  the Company’s current report on Form 8-K filed with the SEC on  January 20, 2004). |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                |
| 10.1   |   | Credit Facility Agreement, dated May 6, 2004, by and between                                                                                                        |

 

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|   |   | BankThai Public Company Limited and SMTEK International (Thailand)  Company Limited.                                  |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                  |
| 10.2   |   | Guarantee Agreement, dated May 6, 2004, by and between BankThai  Public Company Limited and SMTEK International, Inc. |
|   |   |                                                                                                                  |
| 31.1   |   | Rule 13a-14(a)/15a-14(a) Certification of Chief Executive Officer.                                                    |
|   |   |                                                                                                                  |
| 31.2   |   | Rule 13a-14(a)/15a-14(a) Certification of Chief Financial Officer.                                                    |
|   |   |                                                                                                                  |
| 32.1   |   | Section 1350 Certification of Chief Executive Officer.                                                           |
|   |   |                                                                                                                  |
| 32.2   |   | Section 1350 Certification of Chief Financial Officer.                                                           |

 

 

b.  Current reports on Form 8-K:

 

On January 20, 2004, we filed a current report on Form 8-Kannouncing that we sold our Florida facility, Jolt Technology, Inc.

 

On February 10, 2004, we filed a current report on Form 8-Kannouncing our financial results for the second fiscal quarter endedDecember 31, 2003.

 

 

**SIGNATURE**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
| May 10, 2004 |   | /s/ Kirk A. Waldron                                                               |
|--------------|--------|-----------------------------------------------------------------------------------|
| Date         |   | Kirk A. Waldron                                                                   |
|         |   | Senior Vice President and Chief  Financial Officer (Principal  Financial Officer) |

 

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