**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10 - Q**

 
| **(Mark One)** |
|----------------|
|           |   |   |
| **ý**     |   | **Quarterly  Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|           |   |   |
|           |   | **For the quarterly period  ended:    DECEMBER 31, 2003** |
|           |   |   |
| **o**          |   | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|           |   |   |
|           |   | **For the transition period from             to            ** |
|           |   |   |
|           |   | **Commission File Number:   1-8101** |

 

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

 

Indicate by check mark 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 90 days.         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  o   No  ý

 

The registrant had 2,313,864 shares of Common Stock outstanding as ofFebruary 2, 2004.

 

 

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**PARTI.  FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

**SMTEK INTERNATIONAL, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS(UNAUDITED)**

**(In thousands except share amounts)**

** **
|                                                                                                                                                          |   | **December  31,  2003** |   | **June 30,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
| **ASSETS**                                                                                                                                                    |   |                    |   |                    |   |
| Current assets:                                                                                                                                               |   |                    |   |                    |   |
| Cash and cash equivalents                                                                                                                                     |   | $                       | 581    |                    | $      | 583 |   |
| Marketable securities                                                                                                                                         |   | 620                     |   | —                  |   |
| Accounts receivable, less allowance for doubtful accounts of $669 and  $657, as of December 31, 2003 and June 30, 2003, respectively                |   | 10,967                  |   | 11,096                  |   |
| Inventories, net                                                                                                                                              |   | 8,304                   |   | 9,377                   |   |
| Prepaid expenses                                                                                                                                              |   | 1,137                   |   | 446                     |   |
| Assets held for sale - current                                                                                                                                |   | 1,026                   |   | —                  |   |
| Total current assets                                                                                                                                          |   | 22,635                  |   | 21,502                  |   |
|                                                                                                                                                          |   |                    |   |                    |   |
| Property, equipment and improvements, net of accumulated depreciation  and amortization                                                                       |   | 4,969                   |   | 5,541                   |   |
| Other assets, net                                                                                                                                             |   | 408                     |   | 763                     |   |
| Assets held for sale - non-current                                                                                                                            |   | 78                      |   | —                  |   |
|                                                                                                                                                          |   | $                       | 28,090 |                    | $      | 27,806 |   |
|                                                                                                                                                          |   |                    |   |                    |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                |   |                    |   |                    |   |
| Current liabilities:                                                                                                                                          |   |                    |   |                    |   |
| Current portion of long-term debt                                                                                                                             |   | $                       | 1,692  |                    | $      | 2,495 |   |
| Accounts payable                                                                                                                                              |   | 9,057                   |   | 9,598                   |   |
| Other accrued liabilities                                                                                                                                     |   | 2,952                   |   | 3,708                   |   |
| Liabilities held for sale                                                                                                                                     |   | 79                      |   | —                  |   |
| Total current liabilities                                                                                                                                     |   | 13,780                  |   | 15,801                  |   |
|                                                                                                                                                          |   |                    |   |                    |   |
| Long-term liabilities:                                                                                                                                        |   |                    |   |                    |   |
| Long-term bank line of credit payable                                                                                                                         |   | 6,796                   |   | 5,452                   |   |
| Long-term debt                                                                                                                                                |   | 4,521                   |   | 5,675                   |   |
|                                                                                                                                                          |   |                    |   |                    |   |
| Total liabilities                                                                                                                                             |   | 25,097                  |   | 26,928                  |   |
|                                                                                                                                                          |   |                    |   |                    |   |
| Commitments and contingencies                                                                                                                                 |   |                    |   |                    |   |
|                                                                                                                                                          |   |                    |   |                    |   |
| Stockholders’ equity:                                                                                                                                    |   |                    |   |                    |   |
| Preferred stock, $1 par value;   1,000,000 shares authorized; 250,000 shares issued and outstanding at  December 31, 2003                           |   | 475                     |   | —                  |   |
| Common stock, $.01 par value; 20,000,000 shares authorized; 2,287,343  and 2,284,343 issued and outstanding at December 31, 2003 and  June 30, 2003 |   | 23                      |   | 23                      |   |
| Additional paid-in capital                                                                                                                                    |   | 37,023                  |   | 37,028                  |   |
| Accumulated deficit                                                                                                                                           |   | (34,656                 | )      | (36,232                 | )      |
| Accumulated other comprehensive income                                                                                                                        |   | 128                     |   | 59                      |   |
| Total stockholders’ equity                                                                                                                               |   | 2,993                   |   | 878                     |   |
|                                                                                                                                                          |   | $                       | 28,090 |                    | $      | 27,806 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

2

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**SMTEK INTERNATIONAL, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**AND OTHER COMPREHENSIVE INCOME (LOSS)(Unaudited)**

**(In thousands except per share amounts)**

 
|                                                                      |   | **Three Months Ended  December 31,** |   | **Six Months Ended  December 31,** |   |
|---------------------------------------------------------------------------|--------|-------------------------------------------|--------|-----------------------------------------|--------|
|                                                                      |   | **2003**                                  |   | **2002**                                |   | **2003** |   | **2002** |   |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Revenues                                                                  |   | $                                         | 20,132 |                                    | $      | 15,457 |   | $ | 40,824 |   | $ | 33,044 |   |
| Cost of goods sold                                                        |   | 17,923                                    |   | 14,562                                  |   | 35,930 |   | 30,612 |   |
| Gross profit                                                              |   | 2,209                                     |   | 895                                     |   | 4,894 |   | 2,432 |   |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Operating expenses:                                                       |   |                                      |   |                                    |   |   |   |   |   |
| Administrative and selling                                                |   | 2,035                                     |   | 4,095                                   |   | 4,062 |   | 5,690 |   |
| Total operating expenses                                                  |   | 2,035                                     |   | 4,095                                   |   | 4,062 |   | 5,690 |   |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Operating income (loss)                                                   |   | 174                                       |   | (3,200                                  | )      | 832 |   | (3,258 | ) |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Non-operating income  (expense):                                          |   |                                      |   |                                    |   |   |   |   |   |
| Interest expense, net                                                     |   | (123                                      | )      | (257                                    | )      | (338 | ) | (509 | ) |
| Other income (expense), net                                               |   | 207                                       |   | 325                                     |   | 1,115 |   | (8 | ) |
| Total non-operating income  (expense), net                                |   | 84                                        |   | 68                                      |   | 777 |   | (517 | ) |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Income (loss) from  continuing operations before income tax               |   | 258                                       |   | (3,132                                  | )      | 1,609 |   | (3,775 | ) |
| Income tax provision                                                      |   | —                                    |   | —                                  |   | 37 |   | 6 |   |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Income (loss) from  continuing operations                                 |   | 258                                       |   | (3,132                                  | )      | 1,572 |   | (3,781 | ) |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Loss from discontinued  operations, net of tax                            |   | —                                    |   | (410                                    | )      | — |   | (544 | ) |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Income (loss) before  cumulative effect of change in accounting principle |   | 258                                       |   | (3,542                                  | )      | 1,572 |   | (4,325 | ) |
| Cumulative effect of change  in accounting principle                      |   | —                                    |   | —                                  |   | — |   | (420 | ) |
| Net income (loss)                                                         |   | $                                         | 258    |                                    | $      | (3,542 | ) | $ | 1,572 |   | $ | (4,745 | ) |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Other comprehensive income (loss):                                        |   |                                      |   |                                    |   |   |   |   |   |
| Foreign currency translation adjustments                                  |   | 19                                        |   | (2                                      | )      | 69 |   | (72 | ) |
| Change in unrealized gain/(loss) on forward  contracts                    |   | —                                    |   | (20                                     | )      | — |   | (37 | ) |
| Comprehensive income (loss)                                               |   | $                                         | 277    |                                    | $      | (3,564 | ) | $ | 1,641 |   | $ | (4,854 | ) |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Diluted earnings (loss) per  share:                                       |   |                                      |   |                                    |   |   |   |   |   |
| Income (loss) from  continuing operations                                 |   | $                                         | 0.09   |                                    | $      | (1.37 | ) | $ | 0.60 |   | $ | (1.66 | ) |
| Loss from discontinued  operations                                        |   | —                                    |   | (0.18                                   | )      | — |   | (0.24 | ) |
| Cumulative effect of change  in accounting principle                      |   | —                                    |   | —                                  |   | — |   | (0.18 | ) |
| Net income (loss) per share                                               |   | $                                         | 0.09   |                                    | $      | (1.55 | ) | $ | 0.60 |   | $ | (2.08 | ) |
|                                                                      |   |                                      |   |                                    |   |   |   |   |   |
| Shares used in computing  basic and diluted earnings (loss) per share:    |   |                                      |   |                                    |   |   |   |   |   |
| Basic                                                                     |   | 2,285                                     |   | 2,284                                   |   | 2,285 |   | 2,284 |   |
| Diluted                                                                   |   | 2,785                                     |   | 2,284                                   |   | 2,623 |   | 2,284 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

3

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**SMTEKINTERNATIONAL, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS (Unaudited)**

**(In thousands)**

 
|                                                                                                                        |   | **Six Months Ended  December 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                                                                        |   | **2003**                                |   | **2002** |   |
| Cash flows  from operating activities:                                                                                      |   |                                    |   |   |   |
| Income (loss)  from continuing operations                                                                                   |   | $                                       | 1,572  |   | $ | (3,781 | ) |
| Adjustments  to reconcile income (loss) from continuing operations to net cash (used in)  provided by operating activities: |   |                                    |   |   |   |
| Depreciation  and amortization                                                                                              |   | 906                                     |   | 1,072 |   |
| Gain on  extinguishment of debt                                                                                             |   | (817                                    | )      | — |   |
| Unrealized  gain on marketable securities                                                                                   |   | (284                                    | )      | — |   |
| Provision  for estimated 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                                                                                            |   | (504                                    | )      | (250 | ) |
| Decrease in  inventories                                                                                                    |   | 713                                     |   | 820 |   |
| Decrease in  accounts payable                                                                                               |   | (508                                    | )      | (416 | ) |
| (Decrease)  increase in other accrued liabilities                                                                           |   | (833                                    | )      | 1,625 |   |
| Increase in  other current assets                                                                                           |   | (593                                    | )      | (134 | ) |
| Cash  provided by operating activities - discontinued operations                                                            |   | —                                  |   | 820 |   |
| Net cash  (used in) provided by operating activities                                                                        |   | (263                                    | )      | 815 |   |
| Cash flows  from investing activities:                                                                                      |   |                                    |   |   |   |
| Capital  expenditures                                                                                                       |   | (392                                    | )      | (637 | ) |
| Capital  expenditures - discontinued operations                                                                             |   | —                                  |   | (270 | ) |
| Net cash  used in investing activities                                                                                      |   | (392                                    | )      | (907 | ) |
| Cash flows  from financing activities:                                                                                      |   |                                    |   |   |   |
| Proceeds  from bank lines of credit                                                                                         |   | 1,344                                   |   | 1,186 |   |
| Payments of  long-term debt                                                                                                 |   | (1,137                                  | )      | (659 | ) |
| Proceeds  from the issuance of preferred stock                                                                              |   | 500                                     |   | — |   |
| Costs  related to new credit facility                                                                                       |   | (134                                    | )      | — |   |
| Proceeds  from the exercise of stock options                                                                                |   | 11                                      |   | — |   |
| Cash  outflows from financing activities - discontinued operations                                                          |   | —                                  |   | (588 | ) |
| Net cash  provided by (used in) financing activities                                                                        |   | 584                                     |   | (61 | ) |
|                                                                                                                        |   |                                    |   |   |   |
| Effect of  exchange rate changes on cash                                                                                    |   | 69                                      |   | (35 | ) |
| Decrease in  cash and cash equivalents                                                                                      |   | (2                                      | )      | (188 | ) |
|                                                                                                                        |   |                                    |   |   |   |
| Cash and  cash equivalents at beginning of period                                                                           |   | 583                                     |   | 816 |   |
| Cash and  cash equivalents at end of period                                                                                 |   | $                                       | 581    |   | $ | 628 |   |
|                                                                                                                        |   |                                    |   |   |   |
| Supplemental  cash flow information:                                                                                        |   |                                    |   |   |   |
| Interest  paid                                                                                                              |   | $                                       | 354    |   | $ | 501 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

4

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**SMTEKINTERNATIONAL, INC. AND SUBSIDIARIES**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Six Months Ended December 31, 2003 and2002**

 

**NOTE1 - DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION**

 

SMTEK International, Inc. (the “Company,”“we,” “us” or “our”) is an electronics manufacturing services (“EMS”) providerto original equipment manufacturers (“OEMs”) primarily in the medical,industrial controls and 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 low-to-medium volume, high complexitysegment of the EMS industry.

 

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

 

On January 9, 2004, we sold oursubsidiary Jolt Technology, Inc. (aka SMTEK Fort Lauderdale), located in FortLauderdale, Florida, for approximately $940,000 in cash to the president ofJolt and an affiliated investor of the Company.  The estimated loss on the sale of Jolt is approximately $85,000and has been recognized for the six months ended December 31, 2003 in theaccompanying unaudited Condensed Consolidated Statements of Operations and OtherComprehensive Income (Loss).  The assetsand liabilities of Jolt as of December 31, 2003 and June 30, 2003have been included in the accompanying unaudited Condensed Consolidated BalanceSheets as assets and liabilities held for sale.  The results of operations of Jolt for the three and six monthsended December 31, 2003 and 2002 are included in the accompanyingunaudited Condensed Consolidated Statements of Operations and OtherComprehensive Income (Loss).  Forfurther discussion, see Note 3.

 

On April 9, 2003, we sold our facilityin Northern Ireland.  This is shown inour unaudited condensed financial statements as a discontinued operation.  For further discussion, see Note 4.

 

On November 19, 2002, we announced that we wereconsolidating our San Diego facility into our other California operations inMoorpark and Santa Clara.  Thistransition was completed as of March 31, 2003.

 

The unaudited consolidated financialinformation furnished herein has been prepared in accordance with generallyaccepted accounting principles and reflects all adjustments, consisting only ofnormal recurring adjustments, which in the opinion of management, are necessaryto fairly state the Company’s financial position, the results of its operationsand its cash flows for the periods presented.

 

The preparation of financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the amounts reported in thefinancial statements and the accompanying notes.  Actual results could differ from those estimates and suchdifferences may be material to the financial statements.  The results of operations for the three andsix months ended December 31, 2003 are not necessarily indicative ofresults for the entire fiscal year ending June 30, 2004.

 

As permitted under applicable rules andregulations of the Securities and Exchange Commission, certain notes and otherinformation are condensed or 

 

5

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omitted from the interim financial statements presented in thisQuarterly Report on Form 10-Q. Therefore, these condensed financial statements should be read inconjunction with our 2003 Annual Report on Form 10–K as filed with theSecurities and Exchange Commission on September 25, 2003.

 

**MarketableSecurities**

 

Our marketable securities consist of aninvestment in common stock of a public company which, for accounting purposes,is classified as trading securities. Accordingly, the investment is marked to market quarterly with thechange in value being recorded in the statement of operations.  In the current quarter, this resulted in a$283,000 unrealized gain.  Management’sintention is to sell off the stock over the next 12 months.

 

**RestructuringCosts**

 

In connection with the closure and transitionof the Company’s San Diego facility in the second quarter of 2003, we incurredapproximately $1.6 million in expenses consisting of severance costs of$287,000, write-off of leasehold improvements of $370,000 and accrual of remaininglease obligation of $4,011,000 less sublease income of $3,038,000.  All severance costs were paid out and, ofthe $973,000 lease related commitments, $350,000 has been paid out leaving areserve at December 31, 2003 of $623,000.

 

**RevenueRecognition**

 

All of our subsidiaries recognize revenuesonce all of the following conditions have been met: a) an authorized purchaseorder has been received in writing, b) the customer’s credit worthiness hasbeen established, c) shipment of the product has occurred, d) title and risk ofownership has transferred, e) if stipulated by the contract, customeracceptance has occurred and f) all significant vendor obligations, if any, havebeen satisfied.  We ship products FOBshipping point and, accordingly, title and risk of ownership pass to thecustomer upon shipment.

 

**Principlesof Consolidation**

 

The accompanying condensed consolidatedfinancial statements include the accounts of SMTEK International, Inc. and itswholly owned subsidiaries.  Allsignificant intercompany transactions and accounts have been eliminated inconsolidation.

 

**StockBased Compensation**

 

SFAS No. 123, “Accounting for Stock-BasedCompensation” allows entities to continue to apply the provisions of AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees,” and provide pro forma net income and pro forma earnings per sharedisclosures for stock-based awards as if the fair-value-based method defined inSFAS No. 123 had been applied.  Inaccordance with APB Opinion No. 25 and related interpretations, compensationexpense would generally be recorded for fixed option grants only if, on thedate of grant, the current market price of the underlying stock exceeded theexercise price.  We have elected tocontinue to apply the provisions of APB Opinion No. 25 and provide the proforma disclosure provisions of SFAS No. 123. Accordingly, no compensation expense has been recognized for ouremployee stock option plans and award of options to non-employeedirectors.  Had compensation expense forstock-based awards been determined consistent with SFAS No.123, our results ofoperation would have been reduced to the pro forma amounts indicated below (inthousands except per share amounts):

 

6

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|                                                                                                              |   | **Three Months Ended  December 31,** |   | **Six Months Ended  December 31,** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|-----------------------------------------|--------|
|                                                                                                              |   | **2003**                                  |   | **2002**                                |   | **2003** |   | **2002** |   |
| Net income  (loss) as reported                                                                                    |   | $                                         | 258    |                                    | $      | (3,542 | ) | $ | 1,572 |   | $ | (4,745 | ) |
| Deduct total  stock-based employee compensation expense under fair value-based method for  all awards, net of tax |   | (269                                      | )      | (88                                     | )      | (334 | ) | (176 | ) |
| Pro forma  net income (loss)                                                                                      |   | $                                         | (11    | )                                       | $      | (3,630 | ) | $ | 1,238 |   | $ | (4,921 | ) |
|                                                                                                              |   |                                      |   |                                    |   |   |   |   |   |
| Pro forma  earnings (loss) per share:                                                                             |   |                                      |   |                                    |   |   |   |   |   |
| Basic                                                                                                             |   | $                                         | (0.01  | )                                       | $      | (1.59 | ) | $ | 0.54 |   | $ | (2.15 | ) |
| Diluted                                                                                                           |   | $                                         | (0.01  | )                                       | $      | (1.59 | ) | $ | 0.47 |   | $ | (2.15 | ) |

 

**RecentAccounting Pronouncements**

 

In May 2003, the FASB issued SFAS No.150, “Accounting for Certain Instruments with Characteristics of BothLiabilities and Equity.”  This standardrequires that certain financial instruments embodying an obligation to transferassets or to issue equity securities be classified as liabilities.  This standard is effective for financialinstruments entered into or modified after May 31, 2003.  The adoption of SFAS No. 150 did not have aneffect on the Company’s financial position or results of operations.

 

In January 2003, the FASB issuedInterpretation No. 46, “Consolidation of Variable Interest Entities – anInterpretation of ARB No. 51”.  TheInterpretation clarifies the application of Accounting Research Bulletin No.51, Consolidated Financial Statements, to certain entities in which equityinvestors do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance its activitieswithout additional subordinated financial support from other parties.  The provisions of the Interpretation areeffective for all enterprises with variable interests in variable interestentities created after January 31, 2003 and is effective October 9,2003.  The adoption of thisinterpretation did not have a significant impact on the Company’s financialposition or results of operations.

 

**AccountingPeriod**

 

We utilize a 52-53 week fiscal year ending onthe Friday closest to June 30, which for fiscal year 2003 fell onJune 27, 2003.  In the accompanyingcondensed consolidated financial statements, the 2003 fiscal year end is shownas June 30 and the interim period end for both years is shown as December 31for clarity of presentation.  The actualinterim periods ended on December 26, 2003 and December 27, 2002.

 

**NOTE2 - CHANGE IN ACCOUNTING PRINCIPLE**

 

We adopted Statement of Financial AccountingStandards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” as ofJuly 1, 2002.  SFAS No. 142 requiresthat goodwill and intangible assets with indefinite useful lives no longer beamortized, but instead tested for impairment, at least annually, in accordancewith the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with definite usefullives be amortized over their 

 

7

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respective estimated useful lives to their estimated residual values,and reviewed for impairment in accordance with SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets.”  In accordance with SFAS No. 142, during the December 2002quarter we completed our initial assessment of impairment and determined thatour goodwill was fully impaired and have recognized an impairment loss of $420,000,net of taxes, in the condensed consolidated statement of operations as a changein accounting principle, effective July 1, 2002.

 

**NOTE3 - SALE OF SUBSIDIARY**

 

On January 9, 2004, we sold oursubsidiary Jolt Technology, Inc. (aka SMTEK Fort Lauderdale), located in FortLauderdale, Florida, for approximately $940,000 in cash to the president ofJolt and an affiliated investor of the Company.  The estimated loss on the sale of Jolt is approximately $85,000and has been recognized for the six months ended December 31, 2003 in theaccompanying unaudited Condensed Consolidated Statements of Operations andOther Comprehensive Income (Loss).  Theassets and liabilities of Jolt as of December 31, 2003 and June 30,2003 have been included in the accompanying unaudited Condensed ConsolidatedBalance Sheets as assets and liabilities held for sale.  The results of operations of Jolt for thethree and six months ended December 31, 2003 and 2002 are included in theaccompanying unaudited Condensed Consolidated Statements of Operations andOther Comprehensive Income (Loss).

 

Net assets of Jolt consisted of the following(in thousands):

 
|                                  |   | **As of December 31, 2003** |   |
|---------------------------------------|--------|----------------------------------|--------|
| Current  assets                       |   | $                                | 1,026  |   |
| Property,  equipment and improvements |   | 58                               |   |
| Other assets                          |   | 20                               |   |
| Current  liabilities                  |   | (79                              | )      |
| Net assets                            |   | $                                | 1,025  |   |

 

Jolt revenues were $0.8 million and $1.7 million,respectively, for the three and six months ended December 31, 2003.  Operating income was $62,000 and $109,000,respectively, for the three and six months ended December 31, 2003.

 

**NOTE4 - DISCONTINUED OPERATIONS**

 

On April 9, 2003, we sold 100% of theoutstanding stock of our Northern Ireland facility, SMTEK Europe.  The purchaser also assumed all liabilitiesof SMTEK Europe.  The purchaser was aNorthern Ireland investor group, which included a director from SMTEK Europe.

 

Accordingly,operating results for SMTEK Europe for the six months ended December 31,2002 have been presented in the accompanying unaudited Condensed ConsolidatedStatements of Operations and Other Comprehensive Income (Loss) as discontinuedoperations, and are summarized as follows (in thousands):

 
|                                           |   | **Six Months Ended  December 31, 2002** |   |
|------------------------------------------------|--------|----------------------------------------------|--------|
|                                           |   |                                         |   |
| Net sales                                      |   | $                                            | 4,991  |   |
| Cost of  goods sold                            |   | (4,929                                       | )      |
| Operating  expenses                            |   | (406                                         | )      |
| Other income  (expense), net                   |   | (200                                         | )      |
| Loss from  discontinued operations, net of tax |   | $                                            | (544   | ) |

 

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Net assets of SMTEK Europe consisted of the following (in thousands):

 
|                                  |   | **As of December 31, 2002** |   |
|---------------------------------------|--------|----------------------------------|--------|
| Current  assets                       |   | $                                | 5,098  |   |
| Property, equipment  and improvements |   | 1,672                            |   |
| Current  liabilities                  |   | (6,388                           | )      |
| Long-term  debt                       |   | (743                             | )      |
| Net  liabilities                      |   | $                                | (361   | ) |

** **

**NOTE5 - EARNINGS PER SHARE**

 

Basic earnings (loss) per share is computedby dividing net income (loss) available to common stockholders by the weightedaverage number of common shares outstanding during the period.  Diluted earnings (loss) per share reflectsthe potential dilution that could occur if securities or other contracts toissue common stock were exercised or converted into common stock or resulted inthe issuance of common stock that then shared in our earnings (losses).

 

Common stock equivalents used in thedetermination of diluted earnings per share include the effect, when sucheffect is dilutive, of our outstanding employee stock options, the 8-1/2%Convertible Subordinated Debentures (which are convertible into 4,988 shares ofcommon stock at $212.50 per share of common stock) and the Series A PreferredStock (which is convertible into 250,000 shares of common stock at $2.00 pershare of common stock).  The followingis a summary of the calculation of basic and diluted earnings per share(dollars in thousands, except per share data):

 
|                                                         |   | **Three Months Ended  December 31** |   | **Six Months Ended  December 31** |   |
|--------------------------------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
|                                                         |   | **2003**                                 |   | **2002**                               |   | **2003** |   | **2002** |   |
|                                                         |   |                                     |   |                                   |   |   |   |   |   |
| Net income (loss)                                            |   | $                                        | 258    |                                   | $      | (3,542 | ) | $ | 1,572 |   | $ | (4,745 | ) |
|                                                         |   |                                     |   |                                   |   |   |   |   |   |
| Weighted average shares:                                     |   |                                     |   |                                   |   |   |   |   |   |
| Basic weighted average number of common shares outstanding   |   | 2,285,134                                |   | 2,284,343                              |   | 2,284,739 |   | 2,284,343 |   |
| Dilutive effect of outstanding common stock equivalents      |   | 499,827                                  |   | —                                 |   | 338,702 |   | — |   |
|                                                         |   |                                     |   |                                   |   |   |   |   |   |
| Diluted weighted average number of common shares outstanding |   | 2,784,961                                |   | 2,284,343                              |   | 2,623,441 |   | 2,284,343 |   |
|                                                         |   |                                     |   |                                   |   |   |   |   |   |
| Earnings (loss) per share - basic                            |   | $                                        | 0.11   |                                   | $      | (1.55 | ) | $ | 0.69 |   | $ | (2.08 | ) |
|                                                         |   |                                     |   |                                   |   |   |   |   |   |
| Earnings (loss) per share - diluted                          |   | $                                        | 0.09   |                                   | $      | (1.55 | ) | $ | 0.60 |   | $ | (2.08 | ) |

 

Options to purchase approximately 36,230 shares ofcommon stock at prices ranging from $7.47 to $10.00 which were outstanding atDecember 31, 2003, are not included in the computation of diluted earningsper share for the three 

 

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andsix months ended December 31, 2003, because the exercise price of theseoptions was greater than the average market price of our common stock.  Because we had a net loss for the three andsix months ended December 31, 2002, there were no common stock equivalentswhich had a dilutive effect on earnings per share.  However, if we had reported net income rather than a loss for thethree and six months ended December 31, 2002, the additional dilutedshares outstanding would have been 3,704 and 3,002, for the three and sixmonths ended December 31, 2002, respectively. Further, options to purchaseapproximately 657,200 shares of common stock at prices ranging from $1.05 to$10.00 which were outstanding at December 31, 2002, would not have beenincluded in the computation of diluted earnings per share for the three and sixmonths ended December 31, 2002, because the exercise price of theseoptions and warrants were greater than the average market price of our commonstock.

 

Convertible subordinated debenturesaggregating $1,060,000, due in 2008 and convertible at a price of $212.50 pershare at any time prior to maturity, were outstanding during the three and sixmonths ended December 31, 2003 but were not included in the computation ofdiluted earnings per share because the conversion price was greater than theaverage market price of the common stock. Convertible subordinated debentures aggregating $1,580,000, due in 2008and convertible at a price of $212.50 per share at any time prior to maturitywere outstanding during the three and six months ended December 31, 2002but were not included in the computation of diluted earnings per share becausethe effect would be antidilutive.

 

**NOTE6 - INVENTORIES**

 

Inventories consist of the following (inthousands):

 
|              |   | **December 31,2003** |   | **June 30,2003** |   |
|-------------------|--------|---------------------------|--------|-----------------------|--------|
| Raw materials     |   | $                         | 4,922  |                  | $      | 5,810 |   |
| Work in  process  |   | 3,000                     |   | 3,298                 |   |
| Finished goods    |   | 382                       |   | 269                   |   |
| Total inventories |   | $                         | 8,304  |                  | $      | 9,377 |   |

 

**Note7 - PROPERTY, EQUIPMENT AND IMPROVEMENTS**

 

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

 
|                                            |   | **December 31,  2003** |   | **June 30,  2003** |   |
|-------------------------------------------------|--------|-----------------------------|--------|-------------------------|--------|
| Buildings  and improvements                     |   | $                           | 1,469  |                    | $      | 1,450 |   |
| Plant  equipment                                |   | 12,220                      |   | 13,075                  |   |
| Office and  other equipment                     |   | 1,558                       |   | 1,581                   |   |
| Less  accumulated depreciation and amortization |   | (10,278                     | )      | (10,565                 | )      |
| Total  property, equipment and improvements     |   | $                           | 4,969  |                    | $      | 5,541 |   |

 

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**NOTE8 - CREDIT AGREEMENTS AND DEBT RESTRUCTURING**

 

At December 31, 2003, as one componentof our credit facility, we have a $10 million working capital linecollateralized by accounts receivable, inventory and equipment for our domesticoperating units which matures September 19, 2006.  Borrowings under the working capital linebear interest at either the bank’s prime rate (4.0% at December 31, 2003)plus 1.0% or a Libor-base rate (1.25% at December 31, 2003) plus3.75%.  At December 31, 2003,borrowings under our working capital line amounted to $6.8 million and havebeen classified as long-term. In addition, in September 2003 we borrowed$1 million on our term credit facility, the second component of our creditfacility.  This advance has a maturitydate of September 19, 2006 and bears interest at either the bank’s primerate (4.0% at December 31, 2003) plus 1.0% or a Libor-base rate (1.25% atDecember 31, 2003) plus 3.75%.  AtDecember 31, 2003, the balance outstanding was $944,000 and the effectiveinterest rate was 5.0%.  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 year term at either the Bank’s prime rate orat a fixed rate equal to the Libor rate plus 3.75%.  We were in compliance with all covenants on the above creditfacilities at December 31, 2003.

 

Also during the six months endedDecember 31, 2003, we settled obligations to former officers, employeesand directors under consulting and deferred fee agreements by paying anaggregate of $430,000 to fully retire an aggregate of $899,000 in debtresulting in an aggregate $469,000 recognition of gain from extinguishment ofdebt. We also reached settlement with certain sub-debt holders by paying anaggregate of $172,000 to fully retire an aggregate of $520,000 in debtresulting in an aggregate $348,000 gain from extinguishment of debt. Theapproximately $817,000 gain on extinguishment of debt is a component of otherincome, net in the unaudited condensed consolidated statements of operations.

 

**NOTE9 - PREFERRED STOCK**

 

In September 2003, we sold in a privateplacement 250,000 shares of convertible Series A Preferred Stock for$500,000.  The shares are convertibleinto common stock initially on a one-to-one basis and are redeemable, solely atthe Company’s option, at 1.5 times the purchase price after 180 days from thedate of issuance.  Holders of Series APreferred Stock have voting rights equal to holders of common stock on an asconverted basis and enjoy a liquidation preference to any junior stock wherebypreferred holders receive 1.5 times their initial investment plus any accrueddividends before any distributions to junior stockholders.  Dividends accrued on the preferred stockamounted to $15,000 at December 31, 2003.

 

**NOTE10 - BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION**

 

We operate in a single business segment - theEMS industry.  Our revenues andlong-lived assets, net of accumulated depreciation, by geographic area are asfollows (in thousands):

 
|            |   | **Three Months Ended  December 31,** |   | **Six Months Ended  December 31,** |   |
|-----------------|--------|-------------------------------------------|--------|-----------------------------------------|--------|
|            |   | **2003**                                  |   | **2002**                                |   | **2003** |   | **2002** |   |
| Revenues:       |   |                                      |   |                                    |   |   |   |   |   |
| United  States  |   | $                                         | 17,636 |                                    | $      | 14,526 |   | $ | 36,138 |   | $ | 31,358 |   |
| Thailand        |   | 2,496                                     |   | 931                                     |   | 4,686 |   | 1,686 |   |
| Total  revenues |   | $                                         | 20,132 |                                    | $      | 15,457 |   | $ | 40,824 |   | $ | 33,044 |   |

 

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|                     |   | **December 31,  2003** |   | **June 30,  2003** |   |
|--------------------------|--------|-----------------------------|--------|-------------------------|--------|
| Long-lived  assets:      |   |                        |   |                    |   |
| United States            |   | $                           | 4,772  |                    | $      | 5,324 |   |
| Thailand                 |   | 197                         |   | 217                     |   |
| Total  long-lived assets |   | $                           | 4,969  |                    | $      | 5,541 |   |

 

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

 

THIS QUARTERLY REPORT ON FORM 10-Q, INCLUDING THEDISCLOSURES BELOW, CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIALRISKS AND UNCERTAINTIES.  WHEN USEDHEREIN, THE TERMS “ANTICIPATES,” “EXPECTS,” “ESTIMATES,” “BELIEVES,” “WILL” ANDSIMILAR EXPRESSIONS, AS THEY RELATE TO US OR OUR MANAGEMENT, ARE INTENDED TOIDENTIFY SUCH FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS IN THIS REPORT OR HEREAFTER INCLUDED IN OTHERPUBLICLY AVAILABLE DOCUMENTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION(“SEC”), REPORTS TO OUR STOCKHOLDERS AND OTHER PUBLICLY AVAILABLE STATEMENTSISSUED OR RELEASED BY US INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES ANDOTHER FACTORS WHICH COULD CAUSE OUR ACTUAL RESULTS, PERFORMANCE (FINANCIAL OROPERATING) OR ACHIEVEMENTS TO DIFFER MATERIALLY FROM THE FUTURE RESULTS,PERFORMANCE (FINANCIAL OR OPERATING) OR ACHIEVEMENTS EXPRESSED OR IMPLIED BYSUCH FORWARD-LOOKING STATEMENTS.  THESERISKS INCLUDE, BUT ARE NOT LIMITED TO, THE RISKS SET FORTH HEREIN AND IN OTHERDOCUMENTS FILED WITH THE SEC, EACH OF WHICH COULD ADVERSELY AFFECT OUR BUSINESSAND THE ACCURACY OF THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN.  FUTURE EXPECTED RESULTS ARE BASED UPONMANAGEMENT’S BEST ESTIMATES, CURRENT CONDITIONS AND THE MOST RECENT RESULTS OFOPERATIONS.  OUR ACTUAL RESULTS,PERFORMANCE OR ACHIEVEMENTS MAY DIFFER MATERIALLY FROM THOSE EXPRESSED ORIMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. WE DO NOT UNDERTAKE, AND SPECIFICALLY DISCLAIM, ANY OBLIGATION TO UPDATETHESE FORWARD-LOOKING STATEMENTS.

 

THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ INCONJUNCTION WITH THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND RELATEDNOTES INCLUDED ELSEWHERE IN THIS REPORT.

 

**UPDATEOF RISK FACTORS**

 

The following risk factors update certain risk factorsidentified in our 2003 Annual Report on Form 10-K which was filed with the SECon September 25, 2003.  Readers arereferred to the documents filed by us 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.

 

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

 

Competition in the EMS industry is primarilydriven by price often resulting in lower profit margins for EMS providers. Inthis regard, customers have sought and continue to seek price reductions. Inaddition, engaging with new customers can result in higher costs and lowerprofit margins than are typical with established customers as initialproduction runs may not reflect full production efficiencies which are attainedwith established customers. Unless we successfully achieve further materialcost reductions, efficiencies and productivity gains, we may experience amaterial adverse effect on our operating results and our financial condition.There can be no assurance, however, whether reductions in materials costs willbe effective or adequate to compensate for such price reductions or that wewill be successful in furthering efficiencies and productivity gains.

 

**TheLoss of Any One of Our Larger Customers MayAdversely Affect Our Results and Financial Condition.**

 

We had sales to three customers whichaccounted for 12.1%, 11.6% and 11.6% of revenues in the six months endedDecember 31, 2003.  The loss of oneor more of our larger customers, or a significant reduction in sales to any of

 

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our major customers, could have an adverse effect on our business,results of operations and financial condition.

 

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

 

Our cash iscurrently limited, and, at December 31, 2003, our debt-to-equity ratio was2.1 to 1.00.  Although our debt loadrecently decreased and we have taken certain cost reduction measures, severalfactors, including but not limited to, a continued prolonged economic downturn,capital investment to increase production, acquisitions of other EMS companiesor our inability to move the Company toward profitability, may significantlychange our debt profile, resulting in an increase in debt to a point thatover-extends our cash-flow capacity. Also, under such circumstances, we may have future capital requirementsand our ability to obtain additional financing will be subject to a number offactors, including market conditions, our operating performance and investorsentiment.  These factors may make thetiming, amount, terms and conditions of additional financing unavailable orunattractive to us.  Any of these eventsor conditions could have a material adverse effect on our business, financialcondition and results of operations.

 

**OurDomestic Line of Credit Agreement Contains Certain FinancialCovenants That Must Be Met.**

 

In September 2003, we entered into a newcredit facility (See Note 8 to the unaudited condensed consolidated financialstatements for a more detailed discussion of the new credit facility).  This new credit facility maturesSeptember 19, 2006 and includes certain covenants that we are required tocomply with.  In the event of defaultunder our line of credit agreement, any and all outstanding borrowings couldbecome immediately due and payable which would likely create significantoperating and financial restrictions on us, further causing an adverse effectupon our business, operating results and financial condition.

 

**OurStock Price Has Been And Continues To Be Volatile.  Based Upon ANumber of Factors, We May Face Future Delisting Proceedings From Nasdaq.**

 

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

 

•     the public float beingrelatively small and thinly traded;

 

•      announcements by us or our competitors ofnew contracts or technological innovations;

 

•     fluctuations in our quarterlyand annual operating results;

 

•     acquisition-relatedannouncements; and

 

•     general market conditions.

 

In addition, our stock price in recent yearshas experienced significant price fluctuations for a variety of reasons,including conditions that are both internal and external to us.

 

Although we currently satisfy Nasdaq’sconditions for continued listing on The Nasdaq SmallCap Market, there can be noassurance that we will be able to maintain such listing in the future.  If our common stock were delisted from TheNasdaq SmallCap Market, it may become eligible immediately thereafter forquotation on the Over-The-Counter Market on the NASD Electronic Bulletin Boardor in the “pink sheets” maintained by the National Quotation Bureau,

 

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Inc., which are generally considered to be less efficient systems thanmarkets such as Nasdaq or other national exchanges, and which may also causedifficulty in conducting trades and difficulty in obtaining future financing.  Further, for companies whose securities aretraded in the Over-The-Counter Market, it is more difficult: (i) to obtainaccurate quotations, (ii) to obtain coverage for significant news eventsbecause major wire services, such as the Dow Jones News Service, generally donot publish press releases about such companies, and (iii) to obtain neededcapital.

 

**DESCRIPTIONOF THE BUSINESS**

 

We are an electronics manufacturing services(“EMS”) provider to original equipment manufacturers (“OEMs”) primarily in themedical, industrial controls and instrumentation, telecommunications, security,financial services 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 low-to-medium volume, high complexitysegment of the EMS industry.

 

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

 

On January 9, 2004, we sold oursubsidiary Jolt Technology, Inc. (aka SMTEK Fort Lauderdale), located in FortLauderdale, Florida, for approximately $940,000 in cash to the president ofJolt and an affiliated investor of the Company.  The estimated loss on the sale of Jolt is approximately $85,000and has been recognized for the six months ended December 31, 2003 in theaccompanying unaudited Condensed Consolidated Statements of Operations andOther Comprehensive Income (Loss).  Theassets and liabilities of Jolt as of December 31, 2003 and June 30,2003 have been included in the accompanying unaudited Condensed ConsolidatedBalance Sheets as assets and liabilities held for sale.  The results of operations of Jolt for thethree and six months ended December 31, 2003 and 2002 are included in theaccompanying unaudited Condensed Consolidated Statements of Operations andOther Comprehensive Income (Loss).

 

**RESULTSOF OPERATIONS**

 

We utilize a 52-53 week fiscal year ending onthe Friday closest to June 30, which for fiscal year 2003 fell onJune 27, 2003.  In the accompanyingcondensed consolidated financial statements, the 2003 fiscal year end is shownas June 30 and the interim period end for both years is shown asDecember 31 for clarity of presentation. The actual interim periods endedon December 26, 2003 and December 27, 2002.

 

Consolidatedrevenues for the three and six months ended December 31, 2003 were $20.1million and $40.8 million, respectively, compared to $15.5 million and $33.0million, respectively, for the three and six months ended December 30,2002.  The increase in revenues isattributable to continued shipment of product for existing customers as well asshipments to new customers.

 

Consolidatedgross profit for the three and six months ended December 31, 2003 was $2.2million (10.9% of sales) and $4.9 million (12.0% of sales), respectively,compared to $895,000 (5.8% of sales) and $2.4 million (7.3% of sales),respectively, for the three and six months ended December 31, 2002.  Gross profit margin is impacted by customermix, and the variance in gross 

 

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profit margin inthe current fiscal year is primarily related to a high percentage of shipmentsto lower margin customers in the second quarter of fiscal 2004.  The increase in gross profit margin infiscal 2004, as compared to the comparable periods in fiscal 2003, is largelyattributable to the decrease in excess capacity which resulted from the closureand transition of our San Diego facility and the sale of our Europeanmanufacturing facility in the prior year. There can be no assurance that capacity utilization will remain at itscurrent level and any decrease in revenues with the resultant under-utilizationof capacity could negatively impact our gross profit margin.

 

Administrativeand selling expenses were $2.0 million and $4.1 million, respectively, for thethree months and six months ended December 31, 2003 as compared to $4.1million and $5.7 million, respectively, for the three and six months endedDecember 31, 2002. Administrative and selling expenses in the secondquarter of fiscal 2003 ending December 31, 2002 included the recognitionof approximately $1.6 million in expenses related to the closing of our SanDiego facility. These restructuring costs 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.  As adjusted for thesenon-recurring charges, administrative and selling expenses would have been $2.5million and $4.1 million, respectively, for the three and six months endedDecember 31, 2002. As a percentage of sales, administrative and sellingexpense has decreased as compared to the same periods in fiscal 2003 as wecontinue to closely monitor our expenditures.

 

Totalnet non-operating income was $84,000 and $777,000, respectively, for the threeand six months ended December 31, 2003. The six-month non-operating income of $777,000 includes $817,000 gain onextinguishment of debt, $284,000 unrealized gain on marketable securitiesclassified as trading securities, $87,000 currency translation gain and anestimated loss on the sale of our Florida subsidiary of $85,000.  Without these four items, the netnon-operating expense for the six months ended December 31, 2003 wouldhave been approximately $326,000.  Totalnet non-operating income was $68,000 for the three months endedDecember 31, 2002 and the net non-operating loss was $517,000 for the sixmonths ended December 31, 2002.  Onthis basis, the decrease in the six months ended December 31, 2003 isprimarily attributable to a decrease in interest expense reflecting thedecreased debt load.

 

We hadan income tax provision of $37,000 for the six months ended December 31,2003, as compared to $6,000 for the six months ended December 31,2002.  The income tax provision isprimarily related to state franchise taxes.

 

Netincome was $258,000 and $1.6 million, respectively, for the three and sixmonths ended December 31, 2003, or $0.09 and $0.60,respectively, perdiluted share, compared to net loss of $3.5 million and $4.7 million,respectively, for the three and six months ended December 31, 2002, or($1.55) and ($2.08),respectively, per diluted share.  The increase in net income is attributable primarily to higherrevenues, better gross profit and gains as a component of non-operatingincome.  The gains are non-recurring. Inaddition, there can be no assurance that we will maintain the current levels ofrevenue or the improved gross profit margin.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Ourprimary sources of liquidity are our cash and cash equivalents, which amountedto $581,000 at December 31, 2003, and amounts available under our banklines of credit, which provided approximately $2.7 million of availability inexcess of current borrowings at December 31, 2003.  During the six months endedDecember 31, 2003, cash and cash equivalents decreased by $2,000.  This resulted from cash provided byfinancing activities of $584,000 

 

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offset by cashused in operating activities of $263,000 and capital expenditures of $392,000.

 

Netcash used in operating activities of $263,000 for the six months endedDecember 31, 2003 was attributable primarily to the income from continuingoperations before depreciation of $2.5 million, increased by a $713,000reduction in inventories, reduced by an $817,000 gain from extinguishment ofdebt and a $284,000 unrealized gain on marketable securities and further offsetby an increases in accounts receivable and prepaid expenses of an aggregate$1.1 million and decreases in accounts payable and accrued liabilities of anaggregate $1.3 million.  The increase inworking capital accounts was primarily attributable to increased revenue andassociated increased cost.

 

Netcash used in investing activities was $392,000 for the six months ended December 31,2003 compared to $907,000 for the six months ended December 31, 2002.  The cash used was for the purchase ofcapital expenditures, primarily for IT infrastructure and software.

 

Netcash provided by financing activities was $584,000 for the six months endedDecember 31, 2003 compared to net cash used in financing activities of$61,000 for the six months ended December 31, 2002.  The borrowings on the line of credit tofinance inventory and the proceeds from the sale of preferred stock were partiallyoffset by cash used to retire debt at a discount, as discussed in more detailin Note 8 to the Unaudited Condensed Consolidated Financial Statements.

 

In September 2003, we entered into a newlong-term credit facility.  This newcredit facility consists of a $10 million working capital line, a term creditfacility in the amount of up to $1.0 million and a capital expenditure facilityof $1.0 million.  The $10 millionworking capital line is collateralized by accounts receivable, inventory andequipment.  Borrowings under the workingcapital line bear interest at either the bank’s prime rate (4.0% atDecember 31, 2003) plus 1.0% or a Libor-base rate (1.25 atDecember 31, 2003) plus 3.75%.  Theworking capital credit facility contains various financial covenants andmatures September 19, 2006. In addition, in September, 2003 we borrowed $1million on our term credit facility. This advance has a maturity date of September 19, 2006 and bearsinterest at either the bank’s prime rate (4.0% at December 31, 2003) plus1.0% or a Libor-base rate (1.25% at December 31, 2003) plus 3.75%.  At December 31, 2003, the balanceoutstanding was $944,000 and the effective interest rate was 5.0%.   The capital expenditure credit facility of$1 million will be used to finance our capital expenditures.  Each advance under the capital expenditurecredit facility will have a three year term at either the Bank’s prime rate orat a fixed rate equal to the Libor rate plus 3.75%.  We were in compliance with all covenants in our long-term creditfacility at December 31, 2003.

 

Weanticipate that additional expenditures of as much as $1.4 million may beincurred during the remainder of fiscal 2004, primarily to improve productionefficiency at all our subsidiaries.  Asubstantial portion of these capital expenditures are expected to be financedby our new line of credit or other notes/leases payable.

 

AtDecember 31, 2003, the ratio of current assets to current liabilities was1.6 to 1.0 compared to 1.4 to 1.0 at June 30, 2003.  At December 31, 2003, we had $8.9million of working capital compared to $5.7 million at June 30, 2003.  At December 31, 2003, we had long-termborrowings, including short-term portion of long-term debt, of $6.2 millioncompared to $8.2 million at June 30, 2003.  The increase in the working capital and decrease in debt arerelated to the settlement of certain debt obligations as described below.  Related to the decrease in debt, theoutstanding balance of our line of

 

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 credit, classified as long-term, increased by$1.3 million during the first six months of fiscal 2004.

 

During the six-month period endingDecember 31, 2003, we settled notes payable to former officers, employeesand directors by paying an aggregate of $430,000 to fully retire an aggregateof $889,000 in debt. We also reached settlement with certain sub-debt holdersby paying an aggregate of $172,000 to fully retire an aggregate of $520,000 indebt.  Also during the first quarter offiscal 2004, we sold in a private placement 250,000 shares of convertibleSeries A Preferred Stock for $500,000. The shares are initially convertible into Common Stock on a one to onebasis and are redeemable, solely at the Company’s option, at 1.5 times thepurchase price after 180 days from issuance.

 

Although we currently satisfy Nasdaq’sconditions for continued listing on The Nasdaq SmallCap Market, there can be noassurance that we will be able to maintain such listing in the future.  If our common stock were delisted from TheNasdaq SmallCap Market, it may become eligible immediately thereafter forquotation on the Over-The-Counter Market on the NASD Electronic Bulletin Boardor in the “pink sheets” maintained by the National Quotation Bureau, Inc.,which are generally considered to be less efficient systems than markets suchas Nasdaq or other national exchanges, and which may also cause difficulty inconducting trades and difficulty in obtaining future financing.  Further, for companies whose securities aretraded in the Over-The-Counter Market, it is more difficult: (i) to obtainaccurate quotations, (ii) to obtain coverage for significant news eventsbecause major wire services, such as the Dow Jones News Service, generally donot publish press releases about such companies, and (iii) to obtain neededcapital.

 

We previously recorded a liability for afederal tax assessment, including accrued interest, of $2.5 million per aDecember 2001 settlement with the Appeals division of the IRS.  We finalized a payment plan inJuly 2003 and at December 31, 2003 have a total liability, includingaccrued interest, of $2.2 million to be paid in monthly installment payments of$45,000 through July 2008.

 

We may experience an adverse effect on ouroperating results and in our financial condition at our operatingsubsidiaries.  For further discussion,see section entitled “Company Risk Factors” in our 2003 Form 10-K as wellas the updated risk factors set forth herein.

 

We may continue to experience an adverseeffect on our operating results and our financial condition if current economicconditions continue for an extended period of time, despite our cost reductionmeasures and efficiency improvements made at our operating subsidiaries.  For further discussion, seesection entitled “Risk Factors That May Affect Your Decision toInvest in Us” in our 2003 Form 10-K, which was filed with the SEC onSeptember 25, 2003.

 

Management believes that our cash resources,cash from operations and available borrowing capacity on our working capitallines of credit are sufficient to fund operations for at least the next 12months.  Long term, however, if economicconditions weaken for an extended period of time, despite our cost reductionmeasures and efficiency improvements or if we are unable to maintainprofitability, we may have to obtain additional debt or equity financing.  There can be no assurance that the Companywill be able to obtain additional debt or equity financing, if and when needed,on terms acceptable to the Company.

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

In May 2003, the FASB issued SFAS No.150, “Accounting for Certain Instruments with Characteristics of BothLiabilities and Equity.”  This

 

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standard requires that certain financial instruments embodying anobligation to transfer assets or to issue equity securities be classified asliabilities.  This standard is effectivefor financial instruments entered into or modified after May 31, 2003.  The adoption of SFAS No. 150 did not have aneffect on the Company’s financial position or results of operations.

 

In January 2003, the FASB issuedInterpretation No. 46, “Consolidation of Variable Interest Entities - anInterpretation of ARB No. 51”.  TheInterpretation clarifies the application of Accounting Research Bulletin No.51, Consolidated Financial Statements, to certain entities in which equityinvestors do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties.  The provisions of theInterpretation are effective for all enterprises with variable interests invariable interest entities created after January 31, 2003 and is effectiveOctober 9, 2003.  The adoption ofthis Interpretation did not have a significant impact on the Company’sfinancial position or results of operations.

 

**ENVIRONMENTALMATTERS**

 

Since the early 1990s, we have been and continue to beinvolved in certain remediation and investigative studies regarding soil andgroundwater contamination at the site of a former printed circuit boardmanufacturing plant in Anaheim, California. One of our former subsidiaries, Aeroscientific Corp., leased the Anaheimfacility.  Under the terms of a costsharing agreement entered into several years ago, the remaining remediationcosts are currently being shared on a 50-50 basis with the landlord.  There is no environmental insurance coveragefor this remediation.  AtDecember 31, 2003, we had a reserve of $421,000 for future remediationcosts.  Management, based in part onconsultations with outside environmental engineers and scientists, believesthat this reserve is adequate to cover its share of future remediation costs atthis site.  However, the future actualremediation costs could differ significantly from the estimates.  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.

 

**ITEM3.****     QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Our financial instruments include cash andcash equivalents, accounts receivable and short-term and long-term debt.  At December 31, 2003, the carryingamount of long-term debt (including current portion thereof but excluding banklines of credit) was $6.2 million and the fair value was $5.7 million.  The carrying values of our other financialinstruments approximated their fair values. The fair value of our financial instruments is estimated based on quotedmarket prices for the same or similar issues. A change in interest rates of one percent would result in an annualimpact on interest expense of approximately $125,000.

 

It is our policy not to enter into derivativefinancial instruments for speculative purposes.  We may, from time to time, enter into foreign currency forwardexchange contracts in an effort to protect us from adverse currency rate fluctuationson foreign currency commitments entered into in the ordinary course ofbusiness.  These commitments aregenerally for terms of less than one year. The foreign currency forward exchange contracts are executed with banksbelieved to be creditworthy and are denominated in currencies of majorindustrial countries.  In accordancewith SFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities,” all derivative financial instruments are measured at fair valueand are recognized as either assets or

 

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liabilities in the balance sheet. The accounting treatment of changes in fair value is dependent uponwhether or not a derivative financial instrument is designated as a hedge and,if so, the type of hedge.  Changes infair 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.  AtDecember 31, 2003, we had no forward foreign currency contracts.

 

Our operations include investments in aforeign operating unit.  Our foreignsubsidiary represents approximately 9% of our revenues and 9% of our totalassets.  As a result, our financialresults have been and may continue to be affected by changes in foreigncurrency exchange rates.

 

**ITEM4.****     CONTROLS AND PROCEDURES**

 

**Evaluation of disclosure controls andprocedures**.

 

Based on management’s evaluation (with theparticipation of our principal executive officer and principal financialofficer), as of the end of the period covered by this report, our principalexecutive officer and principal financial officer have concluded that ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”))are effective to ensure that information required to be disclosed by us inreports that we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in SEC rules andregulations.

 

**Changes in internal control overfinancial reporting**.

 

There was no change in our internal control overfinancial reporting during our second fiscal quarter of 2004 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PARTII.  OTHER INFORMATION**

 

**ITEM1.   LEGAL PROCEEDINGS**

 

In the ordinary course of business, weexperience various types of claims which sometimes result in litigation orother legal proceedings.  We do notanticipate that any of these claims or proceedings that are currently pendingwill have a material adverse effect on us.

 

**ITEM4.   SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

We held our 2003 Annual Meeting ofStockholders on November 13, 2003 (see the Company’s proxy statement filedwith the Securities and Exchange Commission on October 17, 2003).  There were 2,284,343 shares of common stockand 250,000 shares of preferred stock outstanding and entitled to vote at the2003 Annual Meeting.  Following is asummary of the results of the voting for the 2003 Annual Meeting:

 

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| **Proposal**                                                                                                                                                                       |   | **Votes For** |   | **Votes  Against** |   | **Non-votes** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|--------|--------------------|--------|---------------|--------|
|                                                                                                                                                                               |   |          |   |               |   |          |   |
| Election of  Director Steven M.Waszak                                                                                                                                              |   | 2,391,881     |   | 3,138              |   |          |   |
|                                                                                                                                                                               |   |          |   |               |   |          |   |
| Election of  Director Kimon Anemogiannis                                                                                                                                           |   | 2 391 906     |   | 3,113              |   |          |   |
|                                                                                                                                                                               |   |          |   |               |   |          |   |
| Amendment of  the Company’s certificate of incorporation to declassify the Company’s board  of directors.                                                                |   | 2,339,169     |   | 52,075             |   | 3,775         |   |
|                                                                                                                                                                               |   |          |   |               |   |          |   |
| Amendment of  the Company’s Certificate of Incorporation to increase the number of  authorized shares of the Company’s common stock from 3,750,000 to 20,000,000  shares |   | 2,324,774     |   | 67,498             |   | 2,747         |   |
|                                                                                                                                                                               |   |          |   |               |   |          |   |
| Adoption of  the SMTEK International, Inc. 2003 Equity Incentive Plan under which 450,000  shares of the Company’s common stock will be reserved for issuance                 |   | 1,429,163     |   | 76,332             |   | 889,523       |   |
|                                                                                                                                                                               |   |          |   |               |   |          |   |
| Ratification  of the appointment of PricewaterhouseCoopers LLP as the Company’s independent  auditor for the fiscal year ending June 25, 2004                            |   | 2,392,488     |   | 2,101              |   | 429           |   |

 

**ITEM6.****     EXHIBITS AND REPORTS ON FORM8-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). |
|   |                         |   |
| 31.1   |                         | Section 302 Certification of Principal  Executive Officer. |
|   |                         |   |
| 31.2   |                         | Section 302 Certification of Principal  Financial Officer. |
|   |                         |   |
| 32.1   |                         | Section 906 Certification of Principal  Executive Officer. |
|   |                         |   |
| 32.2   |                         | Section 906 Certification of Principal  Financial Officer. |
|   |                         |   |
| b.     | Current reports on Form 8-K: |

 

On October 1, 2003, we filed a current report onForm 8-K announcing our earnings for fiscal year 2003.

 

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On October 7, 2003, we filed a current report onForm 8-K announcing that we had received written notice that we had met therequirements for continued listing on The Nasdaq SmallCap Market. We alsoannounced the corresponding change in our Nasdaq trading symbol from “SMTIC” to“SMTI”.

 

On October 29, 2003, we filed a current report onForm 8-K announcing our financial results for the first fiscal quarter endedSeptember 30, 2003.

 

 

**SIGNATURE**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
| February 6, 2004 |                            | /s/ Kirk A. Waldron |   |
|-----------------------|---------------------------------|---------------------|--------|
| Date                  |                            | Kirk A. Waldron     |
|                  | Senior Vice President and Chief |
|                  | Financial  Officer (Principal   |
|                  | Financial  Officer)             |

 

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