**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

(Mark One)

**x****        ****ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the fiscal year ended June 25, 2004**

**OR**

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

**For the transition period from                  to                     **

**Commission File Number 1-08101**

**SMTEKINTERNATIONAL, INC.**

Exact Name of Registrant as Specified in Its Charter

| **DELAWARE**                    | ** ** | **33-0213512**   |
|---------------------------------|------------|------------------|
| (State or Other Jurisdiction of |       | (I.R.S. Employer |
| Incorporation or Organization)  |       | Identification)  |

 

**200Science Drive, Moorpark, CA 93021(805) 532-2800**

(Address, including zip code, and telephone number,includingarea code, of registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) ofthe Act: **None**

Securities registered pursuant to Section 12(g) ofthe Act:

Common Stock, $0.01Par Value(Title of Class)

 

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.   Yesx   Noo

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.   o

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2).   Yes o   No x

The aggregate market value of the voting and non-votingstock held by non-affiliates of the registrant based on the closing price asreported by The Nasdaq SmallCap Market on December 26, 2003, the last businessday of the registrant’s most recently completed second fiscal quarter, was$17,155,072. The registrant had 2,690,995 shares of Common Stock outstanding asof August 31, 2004.

**DOCUMENTSINCORPORATED BY REFERENCE**

Part III of this Form 10-Kincorporates certain information by reference from our Proxy Statement for our2004 Annual Meeting of Stockholders, which will be filed within 120 days afterthe end of our fiscal year.

 

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**PART I**

**Item1.**  BUSINESS

THIS ANNUAL REPORT ON FORM 10-K,INCLUDING EXHIBITS HERETO, CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THEMEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21EOF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THAT INVOLVE SUBSTANTIALRISKS AND UNCERTAINTIES. ALL STATEMENTS, OTHER THAN STATEMENTS OF HISTORICALFACT, MADE IN THIS ANNUAL REPORT, INCLUDING STATEMENTS REGARDING THE COMPANY’SPROSPECTS AND FUTURE RESULTS OF OPERATIONS OR FINANCIAL CONDITION, AREFORWARD-LOOKING. THESE FORWARD-LOOKING STATEMENTS ARE TYPICALLY IDENTIFIED BYTHE WORDS “ANTICIPATES”, “BELIEVES”, “EXPECTS”, “INTENDS”, “FORECASTS”, “PLANS”,“FUTURE”, “STRATEGY”, OR WORDS OF SIMILAR MEANING. FORWARD-LOOKING STATEMENTSREFLECT MANAGEMENT’S CURRENT EXPECTATIONS, PLANS OR PROJECTIONS AND AREINHERENTLY UNCERTAIN. FORWARD-LOOKING STATEMENTS IN THIS REPORT OR HEREAFTERINCLUDED IN OTHER PUBLICLY AVAILABLE DOCUMENTS FILED WITH THE SEC, REPORTS TOTHE COMPANY’S STOCKHOLDERS, AND OTHER PUBLIC STATEMENTS ISSUED OR RELEASED BYTHE COMPANY INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORSWHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED INTHE FORWARD-LOOKING STATEMENTS. THESE FACTORS INCLUDE, BUT ARE NOT LIMITED TO,THE RISKS SET FORTH HEREIN, INCLUDING THOSE DESCRIBED BELOW IN PART I, “COMPANYRISK FACTORS,” AND IN OTHER DOCUMENTS THE COMPANY HAS FILED AND FILES, FROMTIME TO TIME, WITH THE SEC, EACH OF WHICH COULD ADVERSELY AFFECT OUR BUSINESSAND THE ACCURACY OF THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN. THEFORWARD-LOOKING STATEMENTS EXPRESSED HEREIN ARE BASED UPON MANAGEMENT’S BESTESTIMATES, CURRENT CONDITIONS AND THE MOST RECENT RESULTS OF OPERATIONS ANDSPEAK ONLY AS OF THE TIME SUCH STATEMENTS ARE MADE. OUR ACTUAL RESULTS MAY DIFFERMATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. WEDO NOT INTEND TO UPDATE OR REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECTEVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OFUNANTICIPATED EVENTS. AS A RESULT, READERS ARE CAUTIONED NOT TO UNDULY RELY ONTHESE FORWARD-LOOKING STATEMENTS THAT SPEAK ONLY AS OF THE DATE OF THIS REPORT.

**GENERAL**

SMTEK International, Inc. (the “Company,” “we,” “us”or “our”), a Delaware corporation, is an electronics manufacturing services (“EMS”)provider to original equipment manufacturers (“OEMs”) in the medical,industrial instrumentation, telecommunications, security, financial servicesautomation and aerospace and defense industries, including integrated solutionsacross the entire product life cycle, from design to manufacturing to end-oflife service, for the worldwide high criticality, high reliability, highcomplexity segment of the EMS industry.

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

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We were incorporated in California in 1959 and werereincorporated in Delaware in 1986. We changed our name from Data-DesignLaboratories, Inc. to DDL Electronics, Inc. in December 1993,and in October 1998 we changed our name to SMTEK International, Inc. Ourexecutive office is currently located at 200 Science Drive, Moorpark,California 93021, telephone (805) 532-2800. Our internet address iswww.smtek.com. Our annual reports on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K and any amendmentsto those reports, are available, free of charge, as soon as practicable aftersuch material is electronically filed with, or furnished to, the SEC. Our SECreports as well as our Code of Ethics and Conduct, can be accessed through theinvestor relations section of our web site. The information found on our website is not part of this or any other report of ours filed with or furnished tothe SEC.

On August 31, 2004, ourcurrent Chief Executive Officer and President, Edward J. Smith, announced thathe is resigning from his executive officer positions effective September 20,2004.  Mr. Smith will continue to serveas a member of our Board of Directors. Our Board of Directors has designated Kirk A. Waldron, our Senior VicePresident and Chief Financial Officer, to serve as our interim President.  We do not anticipate that this change willmaterially adversely affect our business.

**Basis ofPresentation**

We utilize a 52-53week fiscal year ending on the Friday closest to June 30 which, for fiscalyears 2004, 2003 and 2002, fell on June 25, June 27, and June 28,respectively. In the accompanying consolidated financial statements, the fiscalyear-end for all years is shown as June 30 for clarity of presentation. Fiscalyears 2004, 2003 and 2002 each consisted of 52 weeks.

**Certain BusinessDevelopments**

On October 24, 2001, we completed a transactionto purchase certain assets, but not assume any liabilities, of CenturyElectronics Manufacturing, Inc. (“Century”), an EMS company that filed forbankruptcy protection. As part of this transaction, we also purchasedsubstantially all of the common stock of Century’s subsidiary in Thailand. Theaggregate purchase price of this transaction was approximately $3.2 million.

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

On April 9, 2003, we sold our facility inNorthern Ireland. The sale is shown in our audited financial statements as adiscontinued operation. The loss from discontinued operations in 2003 was $1.3million, net of taxes, and the net gain on the sale was $106,000.

On January 9, 2004,we sold our subsidiary Jolt Technology, Inc. (aka SMTEK Fort Lauderdale),located in Fort Lauderdale, Florida, for approximately $940,000 in cash. Theloss on the sale of Jolt was approximately $85,000 which was recognized in theyear ended June 30, 2004.

**INDUSTRYOVERVIEW**

**ElectronicsManufacturing Services (EMS) Industry**

SMTEK operates in a single business segment, the EMSindustry. The EMS industry can be classified into two general segments:high-volume/low complexity and low-to-medium volume/high complexity. We focuson the low-to-medium volume/high complexity market. Competition in this marketis highly fragmented and intense. Customer bases tend to be highlyconcentrated, with two or three customers typically accounting for asignificant portion of an EMS provider’s total revenue. By contrast, our topfive customers represented less than 50% of our revenues in fiscal 2004.

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Two principal assemblytechniques are employed in the EMS industry: surface mount technology (“SMT”),which accounts for the majority of manufacturing; and through-hole technology. Webelieve that the low-to-medium volume/high complexity EMS market is continuingto move toward SMT as the preferred manufacturing technique, due in part to thefact that semiconductors have continued to shrink in size, which tightensmanufacturing tolerances and necessitates the use of automation for efficientproduction. Our production processes are predominantly SMT.

**Description of EMSProducts and Services**

Production of electronic assemblies for a customer isonly performed when a firm order is received and accepted. Electronicassemblies are produced based on one of two general methods: either “turnkey”(where we provide all materials, labor and equipment associated with producingthe customers’ product) or “consigned” (where we provide only labor andequipment for manufacturing electronic assemblies and the customer provides thematerials).

Our EMS operations provide both turnkey andconsignment electronics manufacturing services using surface mount andthrough-hole interconnection technologies. We conduct our domestic businessthrough our facilities in Moorpark, Marlborough and Santa Clara and our foreignbusiness, SMTEK International Thailand Limited subsidiary in Ayutthya, Thailand.Our EMS operations do not fabricate any of the components used in theseprocesses.

The materials procurement element of our turnkeyservices consists of the planning, purchasing, expediting, warehousing andfinancing of the components and materials required to assemble a board-level orsystem-level assembly. Customers have increasingly required us and other EMSproviders to purchase some or all components directly from componentmanufacturers or distributors and to finance the components and materials. Thedistribution network for components and materials is comprised of manydistributors and provides us with multiple sources for our raw materials. Wehave consignment programs with six distributors of components and the twolargest of these distributors house consignment warehouses within our facility.These consignment programs and warehouses increase the likelihood of procuringcomponents in a reasonable timeframe to meet our manufacturing schedule.

Customers usually incurcosts in establishing a relationship with an EMS provider and there is alearning curve for both the customer and the EMS provider in terms of producingthe product, redesigns and refinements of products. Once a relationship isestablished, we believe that customers experience difficulty in expeditiouslyand effectively reassigning a turnkey project to a new assembler or in takingon the project themselves. Providing a high level of quality and service to ourcustomers has been a positive contributing factor in the retention andexpansion of business with established customers. The relative difficulty forcustomers to change EMS providers also tends to limit our ability to attractand recruit new customers away from their existing EMS providers or fromin-house assembly operations.

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**MARKETS AND CUSTOMERS**

Oursales and the percentage of our consolidated sales to the principal end-usermarkets we serve for the last three fiscal years are as follows (dollars inthousands):
| ** **                 | ** ** | **Year ended June 30,** | ** ** |
|----------------------------|------------|----------------------------------------|------------|
| **Markets**                | ** ** | ** **                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Industrial instrumentation |       | $                                      | 23,707     |   | 25.4 | % | $ | 16,380 |   | 23.2 | % | $ | 18,201 |   | 28.2 | % |
| Medical                    |       | 22,185                                 |       | 23.8 |   | 22,119 |   | 31.3 |   | 22,712 |   | 35.2 |   |
| Telecommunications         |       | 13,125                                 |       | 14.1 |   | 6,868 |   | 9.7 |   | 12,043 |   | 18.7 |   |
| Security                   |       | 11,754                                 |       | 12.6 |   | 6,993 |   | 9.9 |   | 1,461 |   | 2.3 |   |
| Aerospace and  defense     |       | 8,579                                  |       | 9.2 |   | 5,807 |   | 8.2 |   | 7,124 |   | 11.0 |   |
| Consumer                   |       | 6,666                                  |       | 7.1 |   | 5,147 |   | 7.3 |   | 876 |   | 1.4 |   |
| Computers                  |       | 2,596                                  |       | 2.8 |   | 2,895 |   | 4.1 |   | 703 |   | 1.1 |   |
| Other                      |       | 4,671                                  |       | 5.0 |   | 4,514 |   | 6.3 |   | 1,438 |   | 2.1 |   |
| Total                      |       | $                                      | 93,283     |   | 100 | % | $ | 70,723 |   | 100 | % | $ | 64,558 |   | 100.0 | % |
|                            |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our revenues from external customers attributed to theU.S. were $88.0 million, $66.7 million and $63.2 million for our fiscal years2004, 2003 and 2002, respectively. Our revenues from external customersattributable to other countries, which consisted of revenues from a singleexternal customer located in Thailand, were $5.3 million, $4.0 million and $1.4million for our fiscal years 2004, 2003 and 2002, respectively.

See Note 12 to the consolidated financial statementsfor additional information on our revenues and long-lived assets bygeographical area.

Thefollowing table includes net sales to major customers as a percentage ofconsolidated net sales for the last three fiscal years. Our customer base isprimarily domestic and we have no customers outside of the United States thatrepresented 10% or more of our total revenues in the past three fiscal years.
| ** **                    | ** ** | **Year ended June 30,** | ** ** |
|-------------------------------|------------|----------------------------------------|------------|
| **Major Customers**      | ** ** | ** **                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Hass  Automation, Inc.   |       | 12.7                                   | %          | 11.0 | % | * |   |
| Occam  Networks, Inc.    |       | 11.1                                   | %          | * |   | * |   |
| Philips Medical  Systems      |       | *                                      |       | 16.7 | % | 14.8 | % |
| Medtronic  MiniMed, Inc. |       | *                                      |       | * |   | 17.3 | % |
|                               |            |                                        |            |  |  |  |  |  |  |

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*                    less than 10%

Wemarket our EMS services through both direct sales personnel and throughindependent sales representatives. Our marketing strategy is to develop closerelationships with, and to increase sales to, certain existing and new majorOEM customers. This includes becoming involved at an early stage in the designof these customers’ new products. We believe this strategy is necessary to keepabreast of rapidly changing technological needs and to develop new EMSprocesses, so as to enhance our EMS capabilities and our position in theindustry. As a result of this strategy, however, fluctuations experienced byone or more of our customers in demand for their products may have adverseeffects on our sales and profitability. (See “Risk Factors That May AffectOur Business and Results Of Operations”).

**BACKLOG**

At June 30, 2004, 2003 and 2002, our backlog was$44.0 million, $29.5 million and $40.1 million, respectively. Backlog iscomprised of orders believed to be firm for products that have scheduledshipment dates within the next six to twelve months. We expect to ship asubstantial portion of the backlog within 90 

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days, although thecontinuation of current economic conditions or the occurrence of other riskfactors may alter those expectations.

Some orders in the backlog may be cancelled undercertain conditions. In addition, the timing of orders from major customers mayresult in significant fluctuations in our backlog and operating results fromperiod to period.

Accordingly, we believethat backlog may not be a reliable indicator of future operating results.

**RISK FACTORS THAT MAY AFFECT OUR BUSINESS ANDRESULTS OF OPERATIONS**

The following risk factorsand uncertainties could cause our actual results to differ materially from thoseprojected in our forward-looking statements, whether made with this AnnualReport on From 10-K or the other documents we file with the Securities andExchange Commission or in our annual or quarterly reports to shareholders,press releases or orally, whether in presentations, responses to question orotherwise.

**General Industry Conditions and Competition CreateUncertainties that Could Have an Adverse Effect on Our Results of Operationsand Financial Condition.**

The markets in which the EMS industry operates areintensely competitive. Competition in the EMS industry is primarily driven byprice with secondary factors including product quality, technical capabilityand the ability to deliver products on schedule. Both the price of, and thedemand for, EMS are sensitive to economic conditions, changing technologies andother factors. The technology used in EMS is widely available, and there are alarge number of domestic and foreign competitors. Many of these firms arelarger than we are and have significantly greater financial, marketing andother resources.

Many of our competitors have also made substantialcapital expenditures in recent years and operate technologically advanced EMSfacilities. Further, some of our customers have substantial in-house EMS capabilities.There is a risk that, in periods when these customers are operating at lessthan full capacity, they will use their own facilities rather than contractwith us. Despite this risk, we believe we have not recently experienced asignificant loss of business to OEMs’ captive assembly operations. However,there can be no assurance that future losses in this regard will not occur.

Another factor thatpresents a continuing risk is the inability of EMS providers to require thattheir customers take back excess inventories that have no current or knownfuture use in production. (See the risk factor below dealing with “If OurCustomers Vary Their Requirements, Our Results and Our Financial Condition May BeAffected”). We can provide no assurance that we will not be forced to sellexcess inventory. If we sell such excess inventory, we may have to sell all orportions of the inventory for a loss, which may adversely affect our business,operating results and financial condition.

**Our Domestic Line of Credit Agreement and our ThailandCredit Facility Contain Certain Financial Covenants That Must Be Met AndFailure To Do So Could Negatively Affect our Financial Condition.**

Our domestic creditfacility, which matures September 30, 2007, includes certain covenants thatwe are required to comply with. Our bank covenants include requirements relatedto our net income, stockholders’ equity and debt service ratio. On May 6,2004, we entered into a new Thailand credit facility (See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Liquidityand Capital Resources—New Thailand Credit Facility”). In the event of defaultunder these credit agreements, any and all outstanding borrowings could becomeimmediately due and payable which would likely create significant operating andfinancial restrictions on us, further causing an adverse effect upon ourbusiness, operating results and financial condition.

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**Our New Facilities and Strategic Expansion May NotYield the Benefits We Expect and Could Adversely Affect Our FinancialCondition.**

We moved the operations of two of our facilities,SMTEK, Inc. and our San Diego facility, during fiscal year 2002 fromThousand Oaks, California and El Cajon, California, respectively, to largerfacilities in Moorpark, California and Poway, California, respectively. ThePoway and Moorpark leases each have a term of ten years. In fiscal 2003, wetransitioned the operations of the Poway facility to the Moorpark and SantaClara facilities.

We had a subtenant in the Poway facility until April 2004,when the subtenant defaulted on the sublease and vacated the premises. We areliable under the lease and, while a new subtenant is being sought, there can beno assurance that we will find another subtenant at favorable terms.

We also have entered intoa long-term lease for our facility in Marlborough, Massachusetts which is ineffect through October 2009. The lease for our Santa Clara, Californiaoperation expires at the end of July 2005. Any default under theseagreements would likely have an adverse effect on our business, operatingresults and financial condition. In addition, upon the expiration of our SantaClara lease, there can be no assurance that we will be able to enter into a newlease under favorable terms.

**The Reserve Established for the Closure and Transitionof Our San Diego (Poway) Facility Was Based on Estimates and, Therefore, May NotFully Represent All Future Costs For That Facility and Additional  Costs Could Adversely Affect Our OperatingResults and Financial Condition.**

In the second quarter offiscal 2003, we established a reserve for future costs related to the closureand transition to Moorpark of our San Diego (Poway) facility. In estimatingthese future costs, we considered the cost of our lease obligation net ofestimated future proceeds from subleasing the facility. As previously noted,the facility is currently vacant. If the facility were to be vacant for anextended period of time during the remaining term of the lease, we may berequired to increase the reserve and this could negatively impact our operatingresults and financial condition.

**Our Industry is Characterized by Low Profit MarginsWhich May Adversely Affect Our Operating Results and Financial Condition.**

Competition in the EMSindustry is primarily driven by price often resulting in lower profit marginsfor EMS providers. In this regard, customers have sought and continue to seekprice 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 furthermaterial cost reductions, efficiencies and productivity gains, we mayexperience a material adverse effect on our operating results and our financialcondition. There can be no assurance, however, that reductions in materialscosts will be effective or adequate to compensate for such price reductions orthat we will be successful in achieving efficiencies and productivity gains.

**The Loss of Any One of Our Larger Customers May AdverselyAffect Our Results and Financial Condition.**

We had sales to twocustomers which accounted for 12.7% and 11.1% of revenues in fiscal 2004, salesto two customers which accounted for 16.7%, 11.0% of revenues in fiscal 2003,and sales to two customers which accounted for 17.3% and 14.8% of revenues infiscal 2002. The loss of one or more of our larger customers, or a significantreduction in sales to any of our major customers, could have an adverse effecton our business, results of operations and financial condition.

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**Adverse Changes in the Availability and Expense ofComponents and Materials May Materially Adversely Affect Our Operations.**

For our surface mount assemblies and turnkeyoperations, we purchase components and material from approved suppliers. Anyfailure on the part of these suppliers to deliver required components to us orany failure of such components to meet performance requirements could impairour ability to meet scheduled shipment dates. This in turn could delaycompleting our sales and receipt of payment, which may adversely affect ourbusiness, financial condition and results of operations. From time to time, wehave experienced, and may in the future experience, shortages of certain typesof electronic components. These shortages may increase our costs and may alsocause us to experience delays in deliveries to our customers.

In addition, our customers may specify that wepurchase parts or materials from particular manufacturers of components for usein the assembly process. Certain components used in a number of our customerprograms are obtained from sole source suppliers. To the extent thesecomponents are not available on a timely basis or are in short supply becauseof allocations imposed by the component manufacturer, and the customer isunwilling to accept a substitute component, delays may occur. Such delays areexperienced in the EMS business from time to time and have caused sales andinventory fluctuations in our business.

To the extent ourcustomers do not absorb the costs associated with parts or materials shortagesor price increases, whether by agreement or to maintain a business relationshipwith a customer, we could suffer a material adverse effect on our business,financial condition and results of operations.

**If Our Customers’ Vary Their Requirements, Our ResultsAnd Our Financial Condition May Be Adversely Affected.**

The level and timing of purchase orders placed by ourcustomers are affected by a number of factors, including variation in demandfor the customer’s products, customer attempts to manage inventory and changesin the customer’s manufacturing strategies. Many of these factors are outside ofour control. Generally, customers may cancel, reduce or delay purchase ordersand commitments without penalty, except for payment for services rendered,materials purchased or procured and, in certain circumstances, chargesassociated with such cancellation, reduction or delay. The current economicconditions, however, may adversely affect our ability to recover such costs,penalties and charges.

Significant or numerouscancellations, reductions or delays in orders by customers, or inability bycustomers to pay for services provided or to pay for components and materialspurchased on such customer’s behalf, have in the past adversely affected ourbusiness, financial condition and results of operations. Such events orconditions could have a material adverse effect on our business, financialcondition and results of operations in the future.

**Our Liquidity is CurrentlyLimited and Our Debt Profile May Change Which Could Materially AdverselyAffect Our Financial Condition.**

Ourliquidity is currently limited, and, at June 30, 2004, our debt-to-equityratio was 2.8 to 1.00. Although our debt load has recently decreased and wehave reduced costs, 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 remain profitable, maysignificantly change our debt profile, resulting in an increase in debt to apoint that over-extends our cash-flow capacity. Also, under such circumstances,we may have future capital requirements and our ability to obtain additionalfinancing will be subject to a number of factors, including market conditions,our operating performance and investor sentiment. These factors may make thetiming, amount, terms and conditions of additional 

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financing unavailable or unattractive to us. Any ofthese events or conditions could have a material adverse effect on ourbusiness, financial condition and results of operations.

**Our Foreign Facility in Thailand Faces Unique Challenges That Our Domestic Facilities DoNot Face Which Could Materially Adversely Affect Our Results of Operations andFinancial Condition.**

Our foreignoperation has risks that may materially adversely affect our operating resultsand financial condition. These risks include:

·       thefluctuations of its foreign currency against the U.S. dollar in our reportedresults,

·       importand export duties, and value added taxes,

·       importand export regulations that could increase costs, increase losses or erode anyprofitability that may exist,

·       potentialrestrictions on the transfer or repatriation of funds,

·       inflexibleemployee contracts in the event of business downturns, and

·       difficulties related to thedifferences between foreign and U.S. laws.

**The Expansion of our Foreign Facility in Thailand May NotProceed as Planned and Cost Overruns or Delays May Have a Negative Impacton Our Operating Results.**

We have begun expandingour facility in Thailand and we continue to transition certain production fromthe Moorpark facility to our Thailand facility. If the expansion facessignificant delays or if we do not effectively transition production to makeefficient use of the increased capacity, our fixed costs could increase as apercentage of revenues. Cost overruns in the expansion process could alsonegatively impact our operating results and financial condition.

**Our Success Depends On Our Ability To Retain andRecruit Key Personnel, Including Our Senior Management, And Any Failure To DoSo Could Have a Material Adverse Affect on Our Results of Operations.**

Our success depends in large part on our ability torecruit and retain highly skilled technical, managerial, sales, and otherpersonnel. In spite of the economic slowdown, competition for such personnelremains intense. We have a high degree of dependence on our remainingpersonnel, and we continue to rely on our current personnel to assumeadditional responsibilities. The loss of services of any of our key personnelor our failure to retain and attract qualified personnel in the future couldhave a material adverse effect on our business and operating results.

Our current President and Chief Executive Officer,Edward A. Smith, has announced that he is resigning from his executive officeseffective September 20, 2004.  If we are notable to recruit and retain an appropriate successor, our business and operatingresults could be materially adversely affected.

**Our Use of Hazardous Materials in Our Business May ResultIn Unexpected and Substantial Claims Against Us Relating To the Use, Handling,Storage and Disposal of Such Materials Which Could Adversely Affect Our Resultsof Operations and Financial Condition.**

Our manufacturing activities involve the controlled use ofhazardous chemicals. The risk of accidental contamination or injury from thesematerials cannot be completely eliminated. Federal, state and local laws andregulations govern the use, storage, handling and disposal of hazardoussubstances. Any failure by the Company to comply with present or futureenvironmental laws or regulations could subject the Company to substantialfuture liabilities, result in the suspension of operations, and have an adverseeffect on our financial condition and results of operations.

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**OUR ENVIRONMENTAL CLEAN-UP CONTINUES AT ANAHEIM,CALIFORNIA FACILITY**

Since the early 1990s, wehave continued to be involved in certain remediation and investigative studiesregarding soil and groundwater contamination at the site of a former printedcircuit board manufacturing plant in Anaheim, California. One of our formersubsidiaries, Aeroscientific Corp., leased the Anaheim facility. Under theterms of a cost sharing agreement entered into several years ago, the remainingremediation costs are currently being shared on a 50-50 basis with the landlord.We have paid $6,000, $2,000 and $15,000 as our share of the remediation costsfor fiscal 2004, 2003 and 2002, respectively. There is no environmentalinsurance coverage for this remediation. At June 30, 2004, we had areserve of $416,000 for future remediation costs. 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 actual remediation costs could differ significantlyfrom the estimates. Further, our portion could potentially exceed the amount ofour reserve. Our liability for remediation in excess of our reserve could havea material adverse impact on our business, financial condition and results ofoperations.

**EMPLOYEES**

At June 30, 2004, wehad approximately 549 employees plus 184 skilled temporary workers. Given thegrowth of our business and the quick response-time required by our customers,we seek to maintain labor flexibility to scale up or down our operations asnecessary to maximize efficiency. We also use skilled temporary labor. None ofour employees in the United States and Thailand are covered by a unionagreement. We have no history of labor disputes at any of our facilities. Webelieve that our employee relationships are good.

**Item2.    PROPERTIES**

Thefollowing table lists our principal plants and properties:
| ** **                     | ** ** | ** ** | ** ** | **Owned**   | ** ** | ** **                         | ** ** |
|--------------------------------|------------|------------|------------|-------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **Square** | ** ** | **or**      | ** ** | ** **                         | ** ** |
| **Location**                   | ** ** | ** ** | ** ** | **Footage** | ** ** | **Leased**                         | ** ** | **Use** | ** ** |
| Moorpark,  California(A)       |       | 115,000    |       | Leased      |       | Executive  offices, Assembly plant |       |
| Marlborough,  Massachusetts(B) |       | 69,400     |       | Leased      |       | Assembly  plant/offices            |       |
| Santa Clara,  California(C)    |       | 44,700     |       | Leased      |       | Assembly  plant/offices            |       |
| Ayutthya,  Thailand(D)         |       | 12,000     |       | Owned       |       | Assembly  plant/offices            |       |
| Poway, California(E)           |       | 45,000     |       | Leased      |       | Vacant                             |       |
|                                |            |            |            |             |            |                                    |            |  |  |

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(A)       The operations andcorporate headquarters moved from Thousand Oaks into the Moorpark facility in March 2002.

(B)        An eight-year lease wassigned for the Marlborough facility during fiscal year 2002.

(C)        A three-year lease wassigned for the Santa Clara facility in July 2002.

(D)       An expansion project, whichwill double the capacity of the Thailand facility, is scheduled for completionin October 2004.

(E)        The former subtenant inthe Poway building vacated the premises in May 2004, and a new subtenantfor the Poway building is currently being sought.

For further discussion onour facilities in Moorpark, Poway, Marlborough and Santa Clara, see “CompanyRisk Factors—Our New Facilities and Strategic Expansion May Not Yield theBenefits We Expected and Could Adversely Affect Our Financial Condition.”

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**Item 3.    LEGALPROCEEDINGS**

In the ordinary course ofbusiness, we experience various types of claims which sometimes result inlitigation 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 4.    SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

There were no matters submitted to a vote of thesecurity holders during the three months ended June 30, 2004.

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**PART II**

**Item 5.**            MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

Our Common Stock is tradedon Nasdaq SmallCap Market (ticker symbol “SMTI”). The high and low closingsales prices for our Common Stock, as reported by the Nasdaq SmallCap Market,for the last two fiscal years are set forth in the following table.
| ** **  | ** ** | **Fiscal 2004** | ** ** | **Fiscal 2003** | ** ** |
|-------------|------------|----------------------|------------|----------------------|------------|
| ** **  | ** ** | **High**             | ** ** | **Low**              | ** ** | **High** | ** ** | **Low** | ** ** |
| 1st Quarter |       | $                    | 1.80       |                 | $          | 0.70 |   | $ | 1.80 |   | $ | 0.75 |   |
| 2nd Quarter |       | 9.82                 |       | 2.99                 |       | 1.30 |   | 0.48 |   |
| 3rd Quarter |       | 10.67                |       | 6.83                 |       | 1.12 |   | 0.69 |   |
| 4th Quarter |       | 8.25                 |       | 5.62                 |       | 1.05 |   | 0.52 |   |
|             |            |                      |            |                      |            |  |  |  |  |  |  |  |  |

 

On August 31, 2004, the closing market price ofour Common Stock in the Nasdaq SmallCap Market was $11.07 per share. There wereapproximately 1,200 stockholders of record at August 31, 2004. This numberdoes not give effect to the total number of stockholders who hold their sharesin “street name” or brokerage accounts.

We have made no dividend payments on our common stockfor the three most recent fiscal years and dividend payments are notanticipated in the foreseeable future. In addition, our bank covenants prohibitus from paying cash dividends on our common stock.

On March 1, 2004, weissued warrants to purchase 15,000 shares of common stock at an exercise price of$7.95 per share to Silverman Heller Associates in consideration of investorrelations services to be rendered over the following 14 months. The warrantswill be exercisable after May 1, 2005 and expire five years from theissuance date. Silverman Heller Associates has represented that it is an “accreditedinvestor” within the meaning of Rule 501(a) under the Securities Actof 1933, as amended. In issuing these securities, we relied on an exemptionfrom the registration requirements pursuant to Rule 506 under Section 4(2) ofthe Securities Act.

**Item 6.**            SELECTEDFINANCIAL DATA

The selected consolidated financial data for the yearsended June 30, 2000 through 2004 set forth below are derived from ourconsolidated financial statements and notes thereto. The consolidated balancesheets as of June 30, 2004 and 2003 and the related consolidatedstatements of operations, stockholders’ equity and comprehensive income (loss)and cash flows for each of the years in the three-year period ended June 30,2004, appear elsewhere in this Report. The Selected Consolidated Financial Dataare qualified in their entirety by reference to, and should be read inconjunction with, the consolidated financial statements and related notes and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included elsewhere in this Report.

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**SMTEK INTERNATIONAL, INC. AND SUBSIDIARIESFIVE-YEAR FINANCIAL SUMMARY(In thousands except per share amounts)**
| ** **                                                                | ** ** | **Year ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------|------------|
| **OPERATING DATA**                                                   | ** ** | ** **                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| Revenues                                                                  |       | $                                      | 93,283     |   | $ | 70,723 |   | $ | 64,558 |   | $ | 73,772 |   | $ | 50,107 |   |
| Cost of goods  sold                                                       |       | 81,819                                 |       | 63,720 |   | 59,902 |   | 64,366 |   | 43,380 |   |
| Gross profit                                                              |       | 11,464                                 |       | 7,003 |   | 4,656 |   | 9,406 |   | 6,727 |   |
| Operating expenses:                                                       |       |                                   |       |   |   |   |   |   |   |   |   |
| Administrative and selling                                                |       | 8,457                                  |       | 9,774 |   | 9,246 |   | 5,612 |   | 4,592 |   |
| Goodwill amortization                                                     |       | —                                 |       | — |   | 37 |   | 670 |   | 1,304 |   |
| Total operating  expenses                                                 |       | 8,457                                  |       | 9,774 |   | 9,283 |   | 6,282 |   | 5,896 |   |
| Operating income  (loss)                                                  |       | 3,007                                  |       | (2,771 | ) | (4,627 | ) | 3,124 |   | 831 |   |
| Non-operating income  (expense):                                          |       |                                   |       |   |   |   |   |   |   |   |   |
| Interest income                                                           |       | 2                                      |       | 4 |   | 7 |   | 20 |   | 154 |   |
| Interest expense                                                          |       | (734                                   | )          | (945 | ) | (999 | ) | (1,179 | ) | (768 | ) |
| Other income, net                                                         |       | 789                                    |       | 710 |   | 236 |   | 7 |   | 281 |   |
| Total  non-operating income (expense)                                     |       | 57                                     |       | (231 | ) | (756 | ) | (1,152 | ) | (333 | ) |
| Income (loss)  from continuingoperations before income taxes              |       | 3,064                                  |       | (3,002 | ) | (5,383 | ) | 1,972 |   | 498 |   |
| Income tax  provision (benefit)                                           |       | 111                                    |       | — |   | (225 | ) | (42 | ) | 100 |   |
| Income (loss)  from continuing operations                                 |       | 2,953                                  |       | (3,002 | ) | (5,158 | ) | 2,014 |   | 398 |   |
| Loss from  discontinued operations                                        |       | —                                 |       | (1,300 | ) | (826 | ) | (216 | ) | (378 | ) |
| Gain (loss) on  sale of discontinued operations                           |       | —                                 |       | 106 |   | — |   | — |   | (661 | ) |
| Income (loss)  before cumulative effect of change in accounting principle |       | 2,953                                  |       | (4,196 | ) | (5,984 | ) | 1,798 |   | (641 | ) |
| Cumulative effect of change in accounting principle                       |       | —                                 |       | (420 | ) | — |   | — |   | — |   |
| Net income (loss)                                                         |       | $                                      | 2,953      |   | $ | (4,616 | ) | $ | (5,984 | ) | $ | 1,798 |   | $ | (641 | ) |
| Basic earnings  (loss) per share:                                         |       |                                   |       |   |   |   |   |   |   |   |   |
| Income (loss) from continuing operations                                  |       | $                                      | 1.17       |   | $ | (1.31 | ) | $ | (2.26 | ) | $ | 0.88 |   | $ | 0.18 |   |
| Loss from discontinued operations                                         |       | —                                 |       | (0.57 | ) | (0.36 | ) | (0.09 | ) | (0.17 | ) |
| Gain (loss) on sale of discontinued operations                            |       | —                                 |       | 0.04 |   | — |   | — |   | (0.29 | ) |
| Cumulative effect of change in accounting principle                       |       | —                                 |       | (0.18 | ) | — |   | — |   | — |   |
| Basic earnings (loss) per share                                           |       | $                                      | 1.17       |   | $ | (2.02 | ) | $ | (2.62 | ) | $ | 0.79 |   | $ | (0.28 | ) |
| Diluted earnings (loss)  per share:                                       |       |                                   |       |   |   |   |   |   |   |   |   |
| Income (loss) from continuing operations                                  |       | $                                      | 1.07       |   | $ | (1.31 | ) | $ | (2.26 | ) | $ | 0.85 |   | $ | 0.18 |   |
| Loss from discontinued operations                                         |       | —                                 |       | (0.57 | ) | (0.36 | ) | (0.09 | ) | (0.17 | ) |
| Gain (loss) on sale of discontinued operations                            |       | —                                 |       | 0.04 |   | — |   | — |   | (0.29 | ) |
| Cumulative effect of change in accounting principle                       |       | —                                 |       | (0.18 | ) | — |   | — |   | — |   |
| Diluted earnings(loss) per share                                          |       | $                                      | 1.07       |   | $ | (2.02 | ) | $ | (2.62 | ) | $ | 0.76 |   | $ | (0.28 | ) |
|                                                                           |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Included in net loss for fiscal 2003 are costsincurred in connection with the closure and transition of our San Diegofacility of approximately $1.6 million consisting of severance cost of$287,000, write-off of leasehold improvements of $370,000 and accrual ofremaining lease obligation of $4,011,000, less projected sublease income of$3,038,000.

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Included in the net lossfor fiscal 2002 were severance costs of $575,000, expenses of $785,000 relatedto the lease at our vacated Thousand Oaks facility and the recognition of$342,000 bad debt provision.
| ** **                                           | ** ** | **Year ended June 30,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------|------------|
| **BALANCE SHEET DATA**                     | ** ** | ** **                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| Current assets                                       |       | $                                      | 27,929     |   | $ | 21,502 |   | $ | 25,253 |   | $ | 27,672 |   | $ | 30,429 |   |
| Current  liabilities                                 |       | $                                      | 17,850     |   | $ | 15,801 |   | $ | 19,338 |   | $ | 14,294 |   | $ | 24,056 |   |
| Working capital                                      |       | $                                      | 10,079     |   | $ | 5,701 |   | $ | 5,915 |   | $ | 13,378 |   | $ | 6,373 |   |
| Current ratio                                        |       | 1.6                                    |       | 1.4 |   | 1.3 |   | 1.9 |   | 1.3 |   |
| Total assets                                         |       | $                                      | 34,503     |   | $ | 27,806 |   | $ | 34,834 |   | $ | 35,932 |   | $ | 38,528 |   |
| Long-term debt,  excluding current maturities        |       | $                                      | 11,912     |   | $ | 11,127 |   | $ | 10,071 |   | $ | 10,418 |   | $ | 4,997 |   |
| Stockholders’  equity (without preferred stock) |       | $                                      | 4,291      |   | $ | 878 |   | $ | 5,425 |   | $ | 11,220 |   | $ | 9,475 |   |
| Preferred stock                                      |       | 450                                    |       | — |   | — |   | — |   | — |   |
| Stockholders’  equity                           |       | $                                      | 4,741      |   | $ | 878 |   | $ | 5,425 |   | $ | 11,220 |   | $ | 9,475 |   |
| Equity per share                                     |       | $                                      | 1.99       |   | $ | 0.38 |   | $ | 2.38 |   | $ | 4.92 |   | $ | 4.17 |   |
| Shares outstanding  (000s)                           |       | 2,386                                  |       | 2,284 |   | 2,284 |   | 2,282 |   | 2,272 |   |
|                                                      |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 7.**            MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**BASIS OF PRESENTATION**

We utilize a 52-53 week fiscal year ending onthe Friday closest to June 30 which, for fiscal years 2004, 2003 and 2002,fell on June 25, June 27 and June 28, respectively. In theaccompanying consolidated financial statements, the fiscal year-end for allyears is shown as June 30 for clarity of presentation. Fiscal years 2004,2003 and 2002 each consisted of 52 weeks.

As more fully described in the accompanyingconsolidated financial statements and notes thereto, on October 24, 2001,we completed a transaction to purchase certain assets, but not assume anyliabilities, of Century Electronics Manufacturing, Inc. (“Century”), anEMS company that filed for bankruptcy. As part of this transaction, we alsopurchased substantially all of the common stock of Century’s subsidiary inThailand. The aggregate purchase price of this transaction was approximately$3.2 million.

As more fully described in the accompanyingconsolidated financial statements and notes thereto, on November 19, 2002we announced that we were consolidating our San Diego facility into our otherCalifornia operations in Moorpark and Santa Clara. This transition wascompleted by the end of our third quarter, March 31, 2003. On April 9,2003, we sold our facility in Northern Ireland. This is shown in ourconsolidated financial statements as a discontinued operation.

As more fully described in the accompanyingconsolidated financial statements and notes thereto, on January 9, 2004,we sold our subsidiary Jolt Technology, Inc. (aka SMTEK Fort Lauderdale),located in Fort Lauderdale.

The following discussionand analysis should be read in conjunction with the consolidated financialstatements and related notes included elsewhere in this Report.

**CRITICAL ACCOUNTING POLICIES**

The following information describes our accountingpolicies in regards to risks, estimates and subjective assessments whoseapplication may have an impact on our reported results of operations andfinancial condition.

REVENUE RECOGNITION—All of our subsidiaries recognizerevenues once all of the following conditions have been met: a) anauthorized purchase order has been received in writing, b) the customer’s 

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credit worthiness has beenestablished, c) shipment of the product has occurred, d) title andrisk of ownership has transferred, e) if stipulated by the contract,customer acceptance has occurred and f) all significant vendorobligations, if any, have been satisfied. The majority of our products ship FOBshipping point and, accordingly, in these cases title and risk of ownershippass to the customer upon shipment.

In years prior to fiscal 2003, our Moorpark subsidiaryhistorically used the percentage of completion method to recognize revenues andcost of sales on certain of its long-term contracts with suppliers ofelectronic components and products. Percentage of completion is determined onthe basis of costs incurred to total estimated costs. Contract costs includeddirect material and direct labor costs and those indirect costs related to theassembly process, such as indirect labor, supplies, tools, repairs anddepreciation costs. Selling and administrative costs were charged to expense asincurred. In the period in which it is determined that a loss will result fromthe performance of a contract, the entire amount of the estimated loss wascharged to cost of goods sold. Other changes in contract price and estimates ofcosts and profits at completion were recognized prospectively. A portion of theasset “costs and estimated earnings in excess of billings on uncompletedcontracts” contains revenues recognized in excess of amounts billed.

During fiscal 2002, our Moorpark facility entered intosales contracts consistent with our other locations, and as such, recognizesrevenue on these new arrangements upon shipment of products rather than on apercentage of completion method. As a result, during fiscal 2002, the Moorparkfacility was recognizing revenue upon shipment of products as well as under thepercentage of completion method. At June 30, 2002 there were no existingsales contracts with customers under the percentage of completion method ofaccounting.

ACCOUNTS RECEIVABLE—We perform ongoing creditevaluations of our customers and adjust credit limits based upon each customer’spayment history and current credit worthiness, as determined by creditinformation available at that time. We continuously monitor collections andpayments from our customers and we maintain allowances for doubtful accountsfor estimated losses resulting from the inability of our customers to makerequired payments. If the financial condition of our customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances may be required.

INVENTORIES—Inventories are stated at the lower ofcost or net realizable value, with cost determined by use of the first-in,first-out method. We write down inventory for slow-moving and obsoleteinventory based on assessments of future demands, market conditions andcustomers which may be experiencing financial difficulties. If these factorsare less favorable than those projected, additional inventory write downs maybe required.

LONG-LIVED ASSETS—Property,equipment and improvements are stated at cost. Depreciation and amortizationare computed on the straight-line method. The principal estimated useful livesare: buildings—20years; improvements—5to 10 years; and plant, office and other equipment—3 to 7 years. The recoverabilityof long-lived assets is evaluated whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. If futureundiscounted cash flows expected to result from the use of such assets arebelieved insufficient to recover the carrying value of the asset, the carryingvalue is written down to fair value in the period the impairment is identified.Factors we consider important which could trigger an impairment review include,but are not limited to, the following:

·       theasset’s ability to continue to generate income;

·       lossof legal ownership or title to the asset;

·       significantchanges in our strategic business objectives and utilization of the asset;

·       theimpact of significant negative industry or economic trends; or

·       asignificant decrease in the market value of the asset

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ACCOUNTINGFOR STOCK OPTIONS—SFASNo. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148,allows entities to continue to apply the provisions of Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,”and provide pro forma net income and pro forma earnings per share disclosuresfor stock-based awards as if the fair-value-based method defined in SFAS No. 123had been applied. In accordance with APB Opinion No. 25 and relatedinterpretations, compensation expense would generally be recorded for fixedoption grants only if, on the date of grant, the current market price of theunderlying stock exceeded the exercise price. We have elected to continue toapply the provisions of APB Opinion No. 25 and provide the pro formadisclosure provisions of SFAS No. 123. Accordingly, no compensationexpense has been recognized for our employee stock option plans and award ofoptions to non-employee directors. Had compensation expense for stock-basedawards 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):
| ** **                          | ** ** | **Year ended June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|
| ** **                          | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income (loss):                  |       |                                   |       |   |   |   |   |
| As reported                         |       | $                                      | 2,953      |   | $ | (4,616 | ) | $ | (5,984 | ) |
| Stock option compensation expense   |       | (717                                   | )          | (351 | ) | (387 | ) |
| Pro forma                           |       | $                                      | 2,236      |   | $ | (4,967 | ) | $ | (6,371 | ) |
| Basic earnings (loss)  per share:   |       |                                   |       |   |   |   |   |
| As reported                         |       | $                                      | 1.17       |   | $ | (2.02 | ) | $ | (2.62 | ) |
| Pro forma                           |       | $                                      | 0.89       |   | $ | (2.17 | ) | $ | (2.79 | ) |
| Diluted earnings (loss)  per share: |       |                                   |       |   |   |   |   |
| As reported                         |       | $                                      | 1.07       |   | $ | (2.02 | ) | $ | (2.62 | ) |
| Pro forma                           |       | $                                      | 0.81       |   | $ | (2.17 | ) | $ | (2.79 | ) |

 

For purposes of the pro forma disclosure under SFAS No. 123,the “fair value” of each option is estimated on the date of grant using theBlack-Scholes option-pricing model with the following assumptions used forgrants in 2004, 2003 and 2002:   dividendyield of 0.0% for all years; expected volatility of 120%, 100% and 90% for2004, 2003 and 2002, respectively; risk-free interest rates ranging from 2.8%to 3.8% for 2004, 2.2% to 3.1% for 2003 and 3.5% to 5.3% for 2002; and expectedlives of five years for all years.

The weighted average fair value of options grantedduring the years ended June 30, 2004, 2003 and 2002 was $4.94, $1.03 and$3.50, respectively.

VALUATION ALLOWANCEAGAINST DEFERRED TAX ASSETS—Inassessing the realizability of net deferred tax assets, management considerswhether it is more likely than not that some portion or all of the net deferredtax assets will be realized. The ultimate realization of net deferred taxassets is dependent upon the generation of future income. Based on the level ofhistorical losses, management believes that it does not have the basis toconclude that it is more likely than not that the deferred tax assets will berealized, and therefore, has recorded a 100% valuation allowance to offset thenet deferred tax assets.

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**RESULTS OF OPERATIONS**

Thefollowing table sets forth our comparative revenues and other operating data aspercentages of revenues:
| ** **                                                    | ** ** | **Year Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues                                                      |       | 100.0                                  | %          | 100.0 | % | 100.0 | % |
| Cost of goods  sold                                           |       | 87.7                                   |       | 90.1 |   | 92.8 |   |
| Gross profit                                                  |       | 12.3                                   |       | 9.9 |   | 7.2 |   |
| Administrative  and selling expenses                          |       | 9.1                                    |       | 13.8 |   | 14.4 |   |
| Operating income  (loss)                                      |       | 3.2                                    |       | (3.9 | ) | (7.2 | ) |
| Net interest  expense                                         |       | (0.8                                   | )          | (1.3 | ) | (1.5 | ) |
| Other income, net                                             |       | 0.9                                    |       | 1.0 |   | 0.4 |   |
| Income (loss)  from continuing operations before income taxes |       | 3.3                                    |       | (4.2 | ) | (8.3 | ) |
| Income tax  provision (benefit)                               |       | .1                                     |       | — |   | (0.3 | ) |
| Income (loss)  from continuing operations                     |       | 3.2                                    |       | (4.2 | ) | (8.0 | ) |
| Loss from discontinued  operations                            |       | —                                 |       | (1.8 | ) | (1.3 | ) |
| Gain on sale of  discontinued operations                      |       | —                                 |       | 0.1 |   | — |   |
| Cumulative effect  of change in accounting principle          |       | —                                 |       | (0.6 | ) | — |   |
| Net income (loss)                                             |       | 3.2                                    | %          | (6.5 | )% | (9.3 | )% |

 

**FISCAL 2004 VS. 2003**

**Revenues**(dollars in thousands)
| ** **           | ** ** | **Year ended June 30,** | ** ** |
|----------------------|------------|----------------------------------------|------------|
| ** **           | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| Revenues             |       | $                                      | 93,283     |   | $ | 70,723 |   |
| Percentage  Increase |       | 31.9%                                  |       |
|                      |            |                                        |            |  |  |  |  |

 

More than half of theincrease in revenues was attributable to new customers or existing customersexpanding into new products. The remainder of the increase was attributable toalready established customers’ increasing demand for existing products.

**Gross profit**(dollars in thousands)
| ** **   | ** ** | **Year ended June 30,** | ** ** |
|--------------|------------|----------------------------------------|------------|
| ** **   | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| Gross Profit |       | $                                      | 11,464     |   | $ | 7,003 |   |
| Gross Margin |       | 12.3                                   | %          | 9.9 | % |
|              |            |                                        |            |  |  |  |  |

 

The improvement in thegross margin was primarily attributable to decreased indirect costs as apercentage of sales. We now operate in four facilities, a decrease from seventhroughout much of fiscal 2003 and five through the first two quarters offiscal 2004. The reduction in excess capacity and the more efficient use of thecapacity in the remaining facilities has allowed us to spread fixed costs andapply variable costs over a larger production volume. In addition, we areexperiencing more efficiency in direct labor usage. These factors have morethan offset increases in material costs that we have experienced. We cannot besure that our capacity utilization will remain at its current level and anydecrease in revenues with the resultant under-utilization of capacity couldnegatively impact our gross profit margin.

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**Administrative and selling expense**(dollars in thousands)
| ** **                  | ** ** | **Year ended June 30,** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|
| ** **                  | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| Admin and selling  expense  |       | $                                      | 8,457      |   | $ | 9,774 |   |
| Percent of sales            |       | 9.1                                    | %          | 13.8 | % |
| One time expenses           |       |                                   |       | (2,200 | ) |
| One time bad debt  recovery |       |                                   |       | 336 |   |
| As adjusted                 |       |                                   |       | 7,910 |   |
| Adjusted percent of  sales  |       |                                   |       | 11.2 | % |
|                             |            |                                        |            |  |  |  |  |

 

Administrative and selling expenses have decreased asa percentage of sales as we continue to closely control our expendituresdespite sales volume increases.

In fiscal 2003,approximately $1.6 million in expense was recognized due to the closure andtransition of our San Diego facility and a $600,000 loss was recognized on thelease commitment for our vacated Thousand Oaks facility. Partially offsettingthose costs, we recognized a recovery of bad debt of $336,000 due to the receiptof restricted equity securities in settlement of our outstanding claim againsta prior customer.

**Interest expense (net)**(dollars in thousands)
| ** **             | ** ** | **Year ended June 30,** | ** ** |
|------------------------|------------|----------------------------------------|------------|
| ** **             | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| Interest expense (net) |       | $                                      | 732        |   | $ | 941 |   |
|                        |            |                                        |            |  |  |  |  |

 

The decrease in interestexpense was the result of lower levels of debt outstanding during fiscal 2004as compared to fiscal 2003. The reduction in debt included the settlement ofapproximately $1.5 million of obligations at a discount (see Note 6 to theConsolidated Financial Statements).

**Other income (net)**(dollars in thousands)
| ** **          | ** ** | **Year ended June 30,** | ** ** |
|---------------------|------------|----------------------------------------|------------|
| ** **          | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| Other income  (net) |       | $                                      | 789        |   | $ | 710 |   |
|                     |            |                                        |            |  |  |  |  |

 

Other income (net) infiscal 2004 included gain on extinguishment of debt of $880,000 and otherincome of $120,000 partially offset by unrealized loss on marketable securitiesof $126,000 and loss on sale of our Jolt subsidiary of $85,000. Other income infiscal 2003 included gain on extinquishment of debt of $514,000.

**Income tax provision**(dollars in thousands)
| ** **            | ** ** | **Year ended June 30,** | ** ** |
|-----------------------|------------|----------------------------------------|------------|
| ** **            | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| Income tax  provision |       | $                                      | 111        |   | — |   |
|                       |            |                                        |            |  |  |  |

 

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The fiscal 2004 income tax provision is primarilyrelated to state franchise taxes as the ability to apply net operating lossesto current pre-tax profits has been suspended by the state of California.

**Fiscal 2003 itemsnot from continuing operations**

Items not from continuing operations for fiscal 2003aggregated to a loss of $1.6 million and included loss from discontinuedoperations (Europe) of $1.3 million, net gain on the sale of the Europeanfacility in Ireland of $106,000 and the change in accounting principle for thegoodwill impairment charge of $420,000.

**Net income (loss)**(dollars in thousands except earnings per share)
| ** **                             | ** ** | **Year ended June 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| Net income (loss)                      |       | $                                      | 2,953      |   | (4,616 | ) |
| Earnings (loss) per share—basic   |       | $                                      | 1.17       |   | $ | (2.02 | ) |
| Earnings (loss) per share—diluted |       | $                                      | 1.07       |   | $ | (2.02 | ) |

 

The increase in net incomewas primarily attributable to higher revenues, improvement in labor costs andcontrol of our indirect expenses. As discussed above under the heading “Otherincome (net)”, there were also certain non-recurring items contributing to netincome in fiscal 2004, most significantly, a $880,000 gain on extinguishment ofdebt. This gain is non-recurring. In addition, we cannot be certain that wewill maintain our current revenue and gross profit margin levels.

**FISCAL 2003 VS. 2002**

**Revenues**(dollars in thousands)

| ** **          | ** ** | **Year ended June 30,** | ** ** |
|---------------------|------------|----------------------------------------|------------|
| ** **          | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| Revenues            |       | $                                      | 70,723     |   | $ | 64,558 |   |
| Percentage Increase |       | 9.5%                                   |       |
|                     |            |                                        |            |  |  |  |  |

 

Revenuein our Moorpark facility, which represents 65% of our fiscal 2003 revenues,increased 19.9% compared to fiscal 2002 as continued shipments to existingcustomers were complimented by shipments to new customers.

**Gross profit**(dollars in thousands)

| ** **   | ** ** | **Year ended June 30,** | ** ** |
|--------------|------------|----------------------------------------|------------|
| ** **   | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| Gross Profit |       | $                                      | 7,003      |   | $ | 4,656 |   |
| Gross Margin |       | 9.9                                    | %          | 7.2 | % |
|              |            |                                        |            |  |  |  |  |

 

Gross profit in theMoorpark facility was 13.4% in fiscal 2003 as compared to 9.5% in fiscal 2002as the Company began to more efficiently use the capacity of its new facility,spreading fixed costs and applying variable costs over a larger productionvolume.

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**Administrative andselling expense**(dollars in thousands)

| ** **                 | ** ** | **Year ended June 30,** | ** ** |
|----------------------------|------------|----------------------------------------|------------|
| ** **                 | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| Admin and selling  expense |       | $                                      | 9,774      |   | $ | 9,246 |   |
| Percent of sales           |       | 13.8                                   | %          | 14.4 | % |
| One time expenses          |       | (2,200                                 | )          | (1,700 | ) |
| One time debt  recovery    |       | 336                                    |       | — |   |
| As adjusted                |       | 7,910                                  |       | 7,546 |   |
| Adjusted percent of  sales |       | 11.2                                   | %          | 11.7 | % |
|                            |            |                                        |            |  |  |  |  |

 

The increase in expense infiscal 2003 was primarily related to the closure and transition of the SanDiego facility in December 2002. Approximately $1.6 million of the fiscal2003 expenses were recognized due to the closure and transition of the SanDiego facility and a $600,000 loss was recognized on the lease commitment forthe vacated Thousand Oaks facility. Partially offsetting those costs, werecognized a recovery of bad debt of $336,000 due to the receipt of restrictedequity securities from a prior customer in settlement of our outstanding claim.Similar expenses in fiscal 2002 aggregated to $1.7 million and consisted of baddebt expense of $342,000, severance expense of $575,000 and a $785,000 lossrelated to the lease at the former Thousand Oaks facility.

**Interest expense (net)**(dollars in thousands)

| ** **              | ** ** | **Year ended June 30,**                   | ** ** |
|-------------------------|------------|----------------------------------------------------------|------------|
| ** **              | ** ** | **    2003    ** | ** ** | **    2002    ** | ** ** |
| Interest expense  (net) |       |                                                     | $          | 941 |   |   |   | $ | 992 |   |   |
|                         |            |                                                          |            |  |  |  |  |  |  |  |  |

 

The decrease in interestexpense was primarily related to decrease in debt related to the operatinglosses from the discontinuation of the Ireland facility and the closure andtransition of the San Diego facility in fiscal 2003.

**Other income (net)**(dollars in thousands)

| ** **          | ** ** | **Year ended June 30,**                   | ** ** |
|---------------------|------------|----------------------------------------------------------|------------|
| ** **          | ** ** | **    2003    ** | ** ** | **    2002    ** | ** ** |
| Other income  (net) |       |                                                     | $          | 710 |   |   |   | $ | 236 |   |   |
|                     |            |                                                          |            |  |  |  |  |  |  |  |  |

 

The primary reason for thenet increase in other income was gain on extinquishment of debt of $514,000during fiscal 2003.

**Income tax provision (benefit)**(dollars in thousands)

| ** **                      | ** ** | **Year ended June 30,**                   | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|
| ** **                      | ** ** | **    2003    ** | ** ** | **    2002    ** | ** ** |
| Income tax  provision (benefit) |       |                                                     | $          | — |   |   |   | $ | (225 | ) |   |
|                                 |            |                                                          |            |  |  |  |  |  |  |  |  |

 

The fiscal 2002 income taxbenefit reflected a $164,000 income tax benefit resulting from passage of thefederal government’s 2003 Stimulus Package providing for the recovery of ouralternative minimum taxes paid in fiscal years 2000 and 2001 and a refund of$78,000 from the State of California for fiscal 2001. Without these items, wewould have reported an income tax expense of $17,000 for fiscal 2002. Our tax 

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benefitrate was lower than the statutory income tax rate due the valuation allowanceplaced on our net deferred tax assets. Based on the level of historical losses,management believes that it does not have the basis to conclude that it is morelikely than not that the deferred tax assets will be realized, and therefore,has recorded a 100% valuation allowance to offset the net deferred assets.

**Items not from continuing operations**

Items not from continuingoperations for fiscal 2003 aggregated to a loss of $1.6 million and includedloss from discontinued operations (Europe) of $1.3 million, net gain on the saleof the European facility in Ireland of $106,000 and the change in accountingprinciple for the goodwill impairment charge of $420,000. The fiscal 2002 netloss included loss from discontinued operations of $826,000.

**Net loss**(dollars in thousands except earnings pershare)

| ** **                  | ** ** | **Year ended June 30,** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|
| ** **                  | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| Net loss                    |       | $                                      | (4,616     | ) | $ | (5,984 | ) |
| Loss per  share—basic  |       | $                                      | (2.02      | ) | $ | (2.62 | ) |
| Loss per share—diluted |       | $                                      | (2.02      | ) | $ | (2.62 | ) |

 

The decline in operatingloss was primarily related to the better gross margins as discussed above.

**MAJORCUSTOMERS**

Netsales to major customers as a percentage of consolidated net sales for the lastthree fiscal years were:

| ** **                    | ** ** | **Year ended June 30,** | ** ** |
|-------------------------------|------------|----------------------------------------|------------|
| ** **                    | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| Hass  Automation, Inc.   |       | 12.7                                   | %          | 11.0 | % | * |   |
| Occam  Networks, Inc.    |       | 11.1                                   | %          | * |   | * |   |
| Philips Medical  Systems      |       | *                                      |       | 16.7 | % | 14.8 | % |
| Medtronic  MiniMed, Inc. |       | *                                      |       | * |   | 17.3 | % |

 

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*                    lessthan 10%

**CHANGE IN ACCOUNTING PRINCIPLE**

We adopted SFAS No. 142,“Goodwill and Other Intangible Assets,” as of July 1, 2002. SFAS No 142requires that goodwill and intangible assets with indefinite useful lives nolonger be amortized, but instead tested for impairment, at least annually, inaccordance with the provisions of SFAS No. 142. SFAS No. 142 alsorequires that intangible assets with definite useful lives be amortized overtheir respective estimated useful lives to their estimated residual values, andreviewed for impairment in accordance with SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to BeDisposed Of”. In accordance with SFAS No. 142, during fiscal 2003, wecompleted our initial assessment of the impairment and determined that ourgoodwill was fully impaired and recognized an impairment loss of $420,000 inthe condensed consolidated statement of operations as a change in accountingprinciple, effective July 1, 2002.

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**RECENT ACCOUNTING PRONOUNCEMENTS**

In November 2002, the Financial AccountingStandards Board issued Interpretation No. 45, Guarantor s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees OfIndebtedness Of Others, an Interpretation of FASB Statements No. 5, 57,and 107 and Rescission of FASB Interpretation No. 34. FIN 45 relates tothe accounting for and disclosure of guarantees. FIN 45 excludes certain typesof guarantees from its initial recognition and measurement, includingguarantees between parents and their subsidiaries or between corporations undercommon control. The disclosure requirements of FIN 45 are effective forfinancial statements of interim and annual periods ending after December 15,2002. The initial recognition and initial measurement provisions should beapplied only on a prospective basis to guarantees issued or modified after December 31,2002. The guarantor s previous accounting for guarantees issued prior to theinitial application date of FIN 45 should not be revised or restated to reflectthe effect of the new recognition and measurement provisions. The Company sadoption of FIN 45 has not had a material impact on its consolidated financialstatements.

In January 2003, the Financial AccountingStandards Board issued Interpretation No. 46, Consolidation of VariableInterest Entities, an interpretation of ARB No. 51. The objective of FIN46 is to improve financial reporting by companies involved with variableinterest entities. This new model for consolidation applies to an entity inwhich either (1) the powers or rights of the equity holders do not givethem sufficient decision making powers or (2) the equity investment atrisk is insufficient to finance that entity s activities without receivingadditional subordinated financial support from other parties. FIN 46 requires avariable interest entity to be consolidated into the company that is subject toa majority of the risk of loss from the variable interest entity s activitiesor that is entitled to receive a majority of the entity s residual returns orboth. The consolidation requirements of FIN 46 apply immediately to variableinterest entities created after January 31, 2003. The Company adopted theprovisions of FIN 46 in 2003 and such adoption did not have a material impacton the Company s consolidated financial statements since the Company currentlyhas no variable interest entities. In December 2003, the FASB issued FIN46R with respect to variable interest entities created before January 31,2003, which, among other things, revised the implementation date to the firstfiscal year or interim period ending after March 15, 2004, with theexception of Special Purpose Entities ( SPE ). The consolidation requirementsapply to all SPE s in the first fiscal year or interim period ending after December 15,2003. The Company has adopted the provisions of FIN 46R effective December 31,2003, and such adoption did not have a material impact on the Company sconsolidated financial statements since the Company currently has no SPE s.

In March 2004, theEmerging Issues Task Force finalized its consensus on EITF Issue 03-6, “ParticipatingSecurities and the Two-Class Method Under FASB Statement No. 128,Earnings Per share” (EITF 03-6). EITF 03-6 clarifies whatconstitutes a participating security and requires the use of the two-classmethod for computing basic earnings per share when participating convertiblesecurities exist. EITF 03-6 is effective for fiscal periods beginningafter March 31, 2004. Adoption of EITF 03-6 is not expected to havea material effect on our consolidated financial statements.

**LIQUIDITY AND CAPITAL RESOURCES**

Our primary sources ofliquidity are our cash and cash equivalents, which amounted to $406,000 at June 30,2004, and amounts available under our bank lines of credit, which providedapproximately $3.5 million of availability in excess of current borrowingsat June 30, 2004.

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

The following table setsforth certain debt and liquidity measurements (dollars in thousands):
| ** **                                       | ** ** | **At June 30,  2004** | ** ** | **At June 30,  2003** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| Working capital                                  |       |                            | $          | 10,079                          |       |   |   | $ | 5,701 |   |   |
| Long-term borrowings,  including current portion |       |                            | $          | 4,635                           |       |   |   | $ | 8,170 |   |   |
| Borrowings under bank  line of credit            |       |                            | $          | 8,648                           |       |   |   | $ | 5,452 |   |   |
| Ratio of current assets  to current liabilities  |       |                            | 1.56       |                            |       |   | 1.36 |   |   |

 

The increase in theworking capital and decrease in debt are related to our improved earnings aswell as the settlement of certain debt obligations as described below. Theoutstanding balance of our bank line of credit, classified as long-term,increased by $3.2 million in fiscal 2004. Our availability in excess ofborrowings on the working capital line of credit increased by $200,000.

During fiscal 2004, wesettled obligations to former officers, employees and directors underconsulting and deferred fee agreements by paying approximately $465,000 andfully retiring $996,000 in debt and accrued interest resulting in a $531,000gain from extinguishment of debt. We also reached settlement with certainsub-debt holders by paying an aggregate of $171,000 to fully retire anaggregate of $520,000 in debt resulting in a $349,000 gain from extinguishmentof debt. We also paid approximately $190,000 as accelerated payoff of severalequipment notes with interest rates of 5.4% to 8.9%.

**Cash flows provided by /(used in)**

The following table sets forth, for the periodsindicated, selected consolidated cash flow information (dollars in thousands):
| ** **                                 | ** ** | **Fiscal Year Ended  June 30 ** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                 | ** ** | **2004**                                            | ** ** | **2003** | ** ** |
| Operating  Activities                      |       | $                                                   | 91         |   | $ | 1,562 |   |
| Investing  Activities                      |       | (870                                                | )          | (1,036 | ) |
| Financing  Activities                      |       | 605                                                 |       | (808 | ) |
| Effect of  exchange rate changes on cash   |       | (3                                                  | )          | 49 |   |
| Net decrease in cash and  cash equivalents |       | $                                                   | (177       | ) | $ | (233 | ) |

 

The increase in sales and production levels in fiscal2004 has resulted in an increase in accounts receivables and inventories ascompared to fiscal 2003. An increase in accounts payable did not entirelycompensate for these uses of operating funds and the $2.9 million inincome from continuing operations before depreciation and amortization of $1.8 millionwas partially offset by the non-cash gain on extinguishment of debt of $880,000.Although inventory levels are higher compared to 2003, inventory turns haveimproved due to increased revenue. Note that in fiscal 2003 cash fromdiscontinued operations of approximately $2.2 million was a significantcomponent of cash from operating activities and primarily represents a decreasein accounts receivables at our European facility prior to its sale in thefourth quarter of fiscal 2003.

Net cash used in investing activities for fiscal 2004includes capital expenditures of $1.8 million. These expenditures areprimarily related to ongoing upgrades to manufacturing and computer equipment. Infiscal 2004 we financed approximately $637,000 of capital expenditures by notespayable and capital leases. We expect our subsidiaries will require continuinginvestment in plant and equipment to remain competitive as technology evolvesand to increase production capacity to accommodate business growth andexpansion and we have budgeted $2.7 million for capital expenditures infiscal 2005 and approximately 

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$400,000 for the Thailandfacility expansion. Investing activities also include proceeds of $940,000 fromthe sale of our Jolt subsidiary.

The most significant useof funds for financing purposes was the repayment of debt as described in moredetail above and in Note 6 to the Consolidated Financial Statements. Proceedsfrom financing activities included borrowings against our bank line of creditat a lower rate than the debt retired, proceeds from the first quarter fiscal2004 issuance of preferred stock and proceeds from the exercise of stockoptions.

**New Thailand credit facility**

In May 2004, wefinalized a Credit Facility Agreement between our subsidiary SMTEKInternational Thailand Limited (“SMTEK Thailand”) and BankThai Public CompanyLimited and we unconditionally guaranteed SMTEK Thailand’s liabilities andobligations under the Credit Facility Agreement for the purpose of funding thegrowth and expansion of our Thailand facility. The credit facility includes a $678,000mortgage loan for the purchase of the building and land at our Thailandfacility. 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 Agreement also includes a $440,000 constructionloan for the expansion of the Thailand facility. The construction loan has a 78month term with interest at Thailand Prime Rate and a monthly payment ofapproximately $5,000. The Credit Facility Agreement also includes a workingcapital line of approximately $500,000 with interest at Thailand Prime Rate, aone year term and it is collateralized by all the assets of the Thailandfacility. 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 to U.S. dollar exchange rate.

**Wells Fargo credit facility and other liquidity andcapital resources issues**

In September 2003, we entered into a newlong-term credit facility with Wells Fargo Business Credit to replace a creditfacility with Comerica Bank that had been in effect at June 30, 2003. In June 2004the Wells Fargo credit facility was amended to the form under which we areoperating as of June 30, 2004. This new credit facility consists of a $15million working capital line, a term credit facility in the amount of up to$1.0 million and a capital expenditure facility of $2.5 million. The$15 million working capital line is collateralized by accounts receivable,inventory and equipment. Borrowings under the credit agreement bear interest ateither the bank’s prime rate (4.0% at June 30, 2004) plus 0.75% or a Liborrate (1.36% at June 30, 2004) plus 3.50%. The working capital creditfacility contains various financial covenants and matures September 30,2007. The financial covenants include requirements related to debt servicecoverage, net worth and net income. We believe we were in compliance with allcovenants at June 30, 2004. The term credit facility has a three year termand will be used to repay the outstanding balance on our equipment line ofcredit. The capital expenditure credit facility of $2.5 million will beused to finance our capital expenditures. Each advance under the capitalexpenditure credit facility will have a three year term at either the Bank’sprime rate or at a fixed rate equal to the Libor rate plus 3.50%.

We anticipate thatadditional capital expenditures of as much as $2.7 million may be incurredduring fiscal 2004, primarily to improve production efficiency at all oursubsidiaries. A substantial portion of these capital expenditures are expectedto be financed by our new line of credit or other notes/leases payable.

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**Contractual Obligations**

Thefollowing table summarizes our future estimated cash payments under existingcontractual obligations as of June 30, 2004, including estimated cashpayments due by period (in thousands):
| ** **                  | ** ** | **Payment due by period** | ** ** |
|-----------------------------|------------|------------------------------------------|------------|
| ** **                  | ** ** | ** **                               | ** ** | **Less than** | ** ** | **1-3** | ** ** | **3-5** | ** ** | **More than** | ** ** |
| ** **                  | ** ** | **Total**                                | ** ** | **1 year** | ** ** | **years** | ** ** | **years** | ** ** | **5 years** | ** ** |
| **Contractual  Obligation** |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Long-term Debt              |       | 3,781                                    |       |   | 931 |   |   | 1,025 |   | 1,430 |   |   | 395 |   |   |
| Capital Leases              |       | 854                                      |       |   | 440 |   |   | 414 |   | — |   |   | — |   |   |
| Operating Leases            |       | 14,987                                   |       |   | 2,473 |   |   | 4,091 |   | 4,230 |   |   | 4,193 |   |   |

 

We previously recorded a liability for a federal taxassessment, including accrued interest, of $2.5 million per a December 2001settlement with the Appeals division of the IRS. We finalized a payment plan inJuly 2003 and began making monthly payments of $45,000. In June 2004,we paid approximately $2.0 million to fully retire the IRS liability.

Management believes thatour cash resources, cash from operations and available borrowing capacity onour working capital lines of credit are sufficient to fund operations for atleast the next 12 months. Long term, however, despite our cost reductionmeasures and efficiency improvements, if we are unable to continue to increasesales and maintain profitability, we may have to obtain additional debt orequity financing. There can be no assurance that we will be able to obtainadditional debt or equity financing, if and when needed, on terms acceptable tous.

**ITEM 7A.**   QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our financialinstruments include cash and cash equivalents, accounts receivable, andshort-term and long-term debt. At June 30, 2004, the carrying amount oflong-term debt (including the current portion thereof, but excluding the banklines of credit) was $4.6 million and the fair value was $4.1 million. Thecarrying values of our other financial instruments approximated their fairvalues. The fair value of our financial instruments is estimated based onquoted market prices for the same or similar issues. See Note 6 to theaccompanying consolidated financial statements for maturities of long-term debtfor the next five years. A change in interest rates of one percent would resultin an annual impact on interest expense of approximately $130,000.

It is our policy not toenter into derivative financial instruments for speculative purposes. We may,from time to time, enter into foreign currency forward exchange contracts in aneffort to protect us from adverse currency rate fluctuations on foreigncurrency commitments entered into in the ordinary course of business. Thesecommitments are generally for terms of less than one year. The foreign currencyforward exchange contracts are executed with banks believed to be creditworthyand are denominated in currencies of major industrial 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 liabilities in the balance sheet. Theaccounting treatment of changes in fair value is dependent upon whether or nota derivative financial instrument is designated as a hedge and, if so, the typeof hedge. Changes in fair value are recognized in current results of operationsfor fair value hedges and in other comprehensive income for cash flow hedges. Derivativefinancial instruments not qualifying for hedge accounting treatment under SFAS No. 133,as amended by FAS 149, are recognized as assets or liabilities with gainsor losses recognized in current results of operations. At June 30, 2004,we had no forward foreign currency contracts.

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Our operations includeinvestments in a foreign operating unit. Our foreign subsidiary representsapproximately 7% of our revenues and 13% of our total assets. As a result, ourfinancial results have been and may continue to be affected by changes inforeign currency exchange rates.

**Item 8.**  FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

See the Index to FinancialStatements attached hereto.

**Item9.**  CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

On October 14, 2002,our Board of Directors and Audit Committee dismissed KPMG LLP as our principalindependent auditors and engaged PricewaterhouseCoopers LLP as our principalindependent auditors.

The report of KPMG LLP forthe fiscal year ended June 30, 2002 did not contain an adverse opinion ordisclaimer of opinion and was not qualified or modified as to uncertainty,audit scope or accounting principles. During the fiscal years ended June 30,2002 and 2001, and the interim period from July 1, 2002 through October 14,2002, there were no disagreements between us and KPMG LLP on any matter ofaccounting principles or practices, financial statement disclosure or auditingscope or procedure, which, if not resolved to the satisfaction of KPMG LLP,would have caused it to make reference to the subject matter of thedisagreement in connection with its report.

During the fiscal yearsended June 30, 2002 and 2001, and the interim period from July 1,2002 through October 14, 2002, we did not consult withPricewaterhouseCoopers LLP on (i) either the application of accountingprinciples to a specified transaction, either completed or proposed, or thetype of audit opinion that might be rendered on our financial statements; or (ii) thesubject of any disagreement, as defined in Item 304(a)(1)(iv) ofRegulation S-K and related instructions, or a reportable event, asdescribed in Item 304(a)(1)(v) of Regulation S-K.

We provided KPMG LLP witha copy of the foregoing disclosures and we filed a copy of KPMG LLP’s letterdated October 21, 2002 as an exhibit to our current report on Form 8-Kfiled on October 22, 2002 with the SEC.

**Item 9A.**   CONTROLS AND PROCEDURES

**Evaluation ofdisclosure controls and procedures.**

Based on management’sevaluation (with the participation of our principal executive officer andprincipal financial officer), as of the end of the period covered by thisreport, our principal executive officer and principal financial officer haveconcluded that our disclosure 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 bedisclosed by us in reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms.

**Changes in internal control over financial reporting.**

There was no change in ourinternal control over financial reporting during our fourth fiscal quarter thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

**Item 9B**.   OTHER INFORMATION

None

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**PART III**

**Item 10.**   DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT

This information is incorporated by reference to ourproxy statement for our 2004 Annual Meeting of Stockholders, to be filed withthe SEC, within 120 days of June 30, 2004, or if not filed by such date,as an amendment to this Report to be filed on or before such date.

We have adopted a Code ofConduct and Ethics that applies in varying respects to our officers andemployees. This Code of Conduct and Ethics is posted on our website in thesection entitled “Investor Relations”. We intend to satisfy the disclosurerequirements under Item 10 of Form 8-K regarding an amendmentto, or waiver from, a provision of the Code of Conduct and Ethics by postingsuch amendment or waiver on our website.

**Item 11.**   EXECUTIVE COMPENSATION

This information isincorporated by reference to our proxy statement for our 2004 Annual Meeting ofStockholders, to be filed with the SEC, within 120 days following June 30,2004, or if not filed by such date, as an amendment to this Report to be filedon or before such date.

**Item 12.**   SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information required bythis item, including information regarding our equity compensation plans, isincorporated by reference to our proxy statement for our 2004 Annual Meeting ofStockholders, to be filed with the SEC, within 120 days following June 30,2004, or if not filed by such date, as an amendment to this Report to be filedon or before such date.

**Item 13.**   CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS

This information isincorporated by reference to our proxy statement for our 2004 Annual Meeting ofStockholders, to be filed with the SEC, within 120 days following June 30,2004, or if not filed by such date, as an amendment to this Report to be filedon or before such date.

**Item 14.**   PRINCIPAL ACCOUNTANT FEES AND SERVICES

This information is incorporated by reference to ourproxy statement for our 2004 Annual Meeting of Stockholders, to be filed withthe SEC, within 120 days of our fiscal year end, or if not filed by such date,as an amendment to this report on Form 10-K to be filed on or beforesuch date.

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**PART IV**

**Item 15.**   EXHIBITS, FINANCIAL STATEMENT SCHEDULESAND REPORTS OF FORM 8-K

(a)(1)               CONSOLIDATEDFINANCIAL STATEMENTS

The following documents are contained in Part II,Item 8 of the Annual Report on Form 10-K:

Report of Independent Registered Public AccountingFirm, PricewaterhouseCoopers LLP on consolidated financial statements as of andfor the years ended June 30, 2004 and 2003

Report of Independent Registered Public AccountingFirm, KPMG LLP on consolidated financial statements for the year ended June 30,2002

Consolidated balance sheets as of June 30, 2004and 2003

Consolidated statements of operations for the yearsended June 30, 2004, 2003 and 2002

Consolidated statements of cash flows for the yearsended June 30, 2004, 2003 and 2004

Consolidated statements of stockholders’equity andcomprehensive income (loss) for the years ended June 30, 2004, 2003, and2002

Notes toconsolidated financial statements

(a)(2)               Financial StatementSchedules

The financialstatement schedules are omitted because they are either not applicable or theinformation is included in the notes to consolidated financial statements.

(a)(3)               EXHIBITS:         Form 10-K
| Exhibit    | ** ** | ** **                                                                                                                                                                                                                                                                                                                                  |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                             |
| 2.1        |       | Agreement and Plan of Merger dated May 28, 1998  among the Company, Jolt Technology, Inc. and the shareholders of Jolt  Technology, Inc. (incorporated by reference to Appendix A of the  Company’s Definitive Proxy Statement filed on June 12, 1998)                                                        |
| 2.2        |       | Stock Purchase Agreement  dated January 24, 1999 between SMTEKInternational, Inc. and the  shareholders of Technetics, Inc. (incorporated by reference to  Exhibit 99.1 of the Company’s Current Report on Form 8-K  filed on February 12, 1999).                                                        |
| 2.3        |       | Agreement dated  November 12, 1999 between DDL Europe, Ltd. (a former subsidiary of the  Company) and Fast Track Circuits, Ltd. for the sale of the capital stock of  Irlandus Circuits, Ltd. incorporated by reference to Exhibit 10.1 of the  Company’s Current Report on Form 8-K filed on December 28,  1999.) |
| 2.4        |       | Stock Purchase  Agreement, dated January 9, 2004, by and between Jolt Technology  Acquisition, Inc. and SMTEK International, Inc. (incorporated by  reference to Exhibit 2.1 of the Company’s Current Report on 8-K  filed on January 20, 2004.)                                                              |
| 3.1+       |       | Amended and Restated Certificate  of Incorporation of SMTEK International, Inc.                                                                                                                                                                                                                                                        |
| 3.2        |       | Bylaws of the Company,  amended and restated effective August  23, 2000 (incorporated by  reference to Exhibit 3.2 of the Company’s 2000 Annual Report on  Form 10-K, filed on August 28, 2000).                                                                                                                   |
| 4.1        |       | Indenture dated  July 15, 1988, applicable to the Company’s 81¤2%  Convertible Subordinated Debentures due August 1, 2008 (incorporated by  reference to Exhibit 4-c of the Company’s 1988 Annual Report on  Form 10-K, filed on September 22, 1988).                                               |

28

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| 4.2   |   | Supplemental Indenture  relating to the Company’s 81¤2%  Convertible Subordinated Debentures due August 1, 2008(incorporated by  reference to Exhibit 4-b of the Company’s 1991 Annual Report on  Form 10-K, filed on September 25, 1991).                                                                                                                                                                                     |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.3   |   | Certificate of  Designations (incorporated by reference to Exhibit 4.1 of the Company’s  current report on Form 8-K filed on September 8, 2003).                                                                                                                                                                                                                                                                                              |
| 10.1* |   | 1993 Stock Incentive  Plan (incorporated by reference to Exhibit 4.7 of the Company’s  Registration Statement on Form S-8, Commission file No. 33-74400).                                                                                                                                                                                                                                                                                     |
| 10.2* |   | Amended and Restated  1996 Stock Incentive Plan (incorporated by reference to Exhibit A of the  Company’s Definitive Proxy Statement for the fiscal 1999 Annual Stockholders  Meeting filed on November 29, 1999).                                                                                                                                                                                                                                 |
| 10.3* |   | Amended and Restated  1998 Non-Employee Directors Stock Plan (incorporated by reference to  Exhibit B of the Company’s Proxy Statement for the fiscal 2000 Annual  Stockholders Meeting).                                                                                                                                                                                                                                                               |
| 10.4* |   | SMTEK  International, Inc. 2003 Equity Incentive Plan (incorporated by reference  to Appendix C to the Company’s Definitive Proxy Statement on  Schedule 14A filed on October 20, 2003.)                                                                                                                                                                                                                                                 |
| 10.5  |   | Standard  Industrial/Commercial Multi-Tenant Lease—Modified  Net dated December 20, 2000 between Technetics, Inc. and Pomerado  Leasing No. 8 L.P. (including Addendum) (incorporated by reference to  Exhibit 10.8 of the Company’s 2001 Annual Report on Form 10-K  filed on September 26, 2001).                                                                                                                       |
| 10.6  |   | Standard  Industrial/Commercial Tenant Lease—dated  July 20, 2001 between SMTEK, Inc. and Moorpark Venture, L.P.  (including Addendum, Sublease and Attornment/Non-Disturbance Agreement Among  Parker-Hannifan, SWS Partners, MVLP and SMTEK, Inc.) (incorporated by  reference to Exhibit 10.9 of the Company’s 2001 Annual Report on  Form 10-K filed on September 26, 2001).                                          |
| 10.7  |   | Amendment No. 1 of  Standard Industrial/Commercial Tenant-Lease, Dated May 6, 2002 between  SMTEK, Inc. and Moorpark Venture, L.P. (incorporated by reference to  Exhibit 10.9.1 of the Company’s 2002 Annual report on Form 10-K  filed on September 26, 2002).                                                                                                                                                               |
| 10.8  |   | Credit and Security  Agreement dated September 19, 2003, by and among Wells Fargo Business  Credit, Inc., SMTEK International, Inc., Jolt  Technology, Inc., SMTEK New England, Inc., SMTEK Santa  Clara, Inc. and Technetics, Inc. (incorporated by reference to  Exhibit 10.1 of the Company’s Quartely Report on Form 10-Q  for the quarter ended September 30, 2003, filed on October 31,  2003). |
| 10.9+ |   | First Amendment to  Credit and Security Agreement, datedJune 25, 2004, by and among Wells  Fargo Business Credit, Inc., SMTEK International, Inc., SMTEK New  England, Inc., SMTEK Santa Clara, Inc. and Technetics, Inc.                                                                                                                                                                                                           |
| 10.10 |   | Credit Facility  Agreement, dated May 6, 2004, by andbetween Bank Thai Public Company  Limited and SMTEK International (Thailand) Company limited (incorporated by  reference to Exhibit 10.1 of the Company’s Quarterly Report on  Form 10-Q for the quarter ended March 31, 2004, filed on  May 10, 2004).                                                                                                                        |

29

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| 10.11   |   | Guarantee Agreement,  dated May 6, 2004, by and between Bank Thai Public Company Limited and SMTEK  International, Inc. (incorporated by reference to Exhibit 10.2 or  the Company’s Quarterly Report onForm 10-Q for the quarter ended  March 31, 2004, filed on May 10, 2004). |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.12   |   | Lease between SMTEK New  England and Cedar Marlboro Realty Corporation dated November 1, 2002  (including Guaranty) (incorporated by reference to Exhibit 10.1 of the  Company’s Quarterly Report on Form 10-Q for the quarter ended  December 31, 2001, filed on February 11, 2002). |
| 10.13   |   | Single-Tenant Commercial  Space Lease Between SMTEK Santa Clara and Deerfield Scott LLC dated  June 10, 2002.                                                                                                                                                                                                  |
| 10.14*+ |   | Amended and Restated  Employment Agreement between the Company and Edward J. Smith.                                                                                                                                                                                                                            |
| 10.15*+ |   | Amended and Restated  Employment Agreement between the Company and Kirk A. Waldron.                                                                                                                                                                                                                            |
| 10.16*+ |   | Employment Agreement  between the Company and Richard E. Fitzgerald.                                                                                                                                                                                                                                           |
| 10.17   |   | Series A Preferred  Stock Purchase Agreement, dated as ofSeptember 8, 2003, by and between  the Company and The Gene HaasTrust (incorporated by reference to  Exhibit 10.1 of the Company’s Current Report on Form 8-K  filed on September 8, 2003).                                  |
| 10.18   |   | Registration Rights  Agreement, dated as of September 8, 2003, by and between the Company and  The Gene Haas Trust (incorporated byreference to Exhibit 4.1 of the  Company’s Current Report on Form 8-K filed on September 8,  2003).                                                     |
| 21+     |   | Subsidiaries of the  Registrant.                                                                                                                                                                                                                                                                                    |
| 23.1+   |   | Consent of Independent  Registered Public Accounting Firm, PricewaterhouseCoopers LLP.                                                                                                                                                                                                                              |
| 23.2+   |   | Consent of Independent  Registered Public Accounting Firm, KPMG LLP.                                                                                                                                                                                                                                                |
| 31.1+   |   | Rule 13a-14(a)/15d-14(a) Certification  of Principal Executive Officer.                                                                                                                                                                                                                                   |
| 31.2+   |   | Rule 13a-14(a)/15d-14(a) Certification  of Principal Financial Officer.                                                                                                                                                                                                                                   |
| 32.1+   |   | Section 1350  Certification of Principal Executive Officer.                                                                                                                                                                                                                                                    |
| 32.2+   |   | Section 1350  Certification of Principal Financial Officer.                                                                                                                                                                                                                                                    |

 

----

*                    Indicatesmanagement compensation plan, contract or arrangement required to be filed asan exhibit pursuant to applicable rules of the Securities and ExchangeCommission.

+                Filed herewith

(b)          Reportson Form 8-K:

On September 1, 2004, we filed a current reporton Form 8-K announcing the resignation of our Chief ExecutiveOfficer and President and the appointment of an interim President.

30

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, on September 2,2004.
|        | SMTEK INTERNATIONAL, INC.                               |
|--------|---------------------------------------------------------|
|   |                                                    |
|   | /s/ Edward  J. Smith                                    |
|   | Edward J. Smith*Chief Executive Officer, and President* |

 

POWER OF ATTORNEY: Know all persons these presents,that each person whose signature appears below constitutes and appoints EdwardSmith and Kirk Waldron, his attorney in fact, each with power of substitution,for him in any and all capacities, to sign any amendments to this Report on Form 10-K,and to file the same with Exhibits thereto and other documents in connectiontherewith with the Securities and Exchange Commission, hereby ratifying andconfirming all that each of said attorneys-in-fact substitute(s) may do orcause to be done by virtue thereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

|                        | **Signature** | ** **                                         | ** ** | ** **             | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------|---------------|----------------------------------------------------|------------|------------------------|-----------|------------|------------|------------|----------|------------|
| /s/ Edward J. Smith    |          | Director, Chief  Executive Officer and President   |       | September 2, 2004 |
| Edward J. Smith        |          | (principal executive officer)                      |       |                   |
| /s/ Kirk A. Waldron    |          | Senior Vice President and  Chief Financial Officer |       | September 2, 2004 |
| Kirk A. Waldron        |          | (principal financial and accounting officer)       |       |                   |
| /s/ James P. Burgess   |          | Chairman of the Board                              |       | September 2, 2004 |
| James P. Burgess       |          |                                               |       |                   |
| /s/ Kimon Anemogiannis |          | Director                                           |       | September 2, 2004 |
| Kimon  Anemogiannis    |          |                                               |       |                   |
| /s/ Steven M. Waszak   |          | Director                                           |       | September 2, 2004 |
| Steven M. Waszak       |          |                                               |       |                   |
| /s/ Robert T. Howard   |          | Director                                           |       | September 2, 2004 |
| Robert T. Howard       |          |                                               |       |                   |

 

 

31

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**SMTEKINTERNATIONAL, INC. AND SUBSIDIARIESINDEX TO CONSOLIDATED FINANCIAL STATEMENTS**
|                                                                                                                                             | ** ** | **Page** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report  of Independent Registered Public Accounting Firm, PricewaterhouseCoopers LLP                                                        |       | F-1      |
| Report  of Independent Registered Public Accounting Firm, KPMG LLP                                                                          |       | F-2      |
| Consolidated  balance sheets as of June 30, 2004 and 2003                                                                              |       | F-3      |
| Consolidated  statements of operations for the years ended June 30, 2004, 2003, 2002                                                   |       | F-4      |
| Consolidated  statements of cash flows for the years ended Juned 30, 2004, 2003 and 2002                                                    |       | F-6      |
| Consolidated  statements of stockholders’ equity and comprehensive income (loss)for the  years ended June 30, 2004, 2003 and 2002 |       | F-8      |
| Notes to consolidated financial  statements                                                                                                 |       | F-9      |

 

32

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

The Board of Directors and StockholdersSMTEK International, Inc.:

In our opinion, the accompanying consolidated balancesheets and the related consolidated statements of operations, cash flows and stockholders’equity and comprehensive income (loss) present fairly, in all materialrespects, the financial position of SMTEK International, Inc. and itssubsidiaries at June 30, 2004 and 2003, and the results of theiroperations and their cash flows for each of the two years in the period ended June 30,2004 in conformity with accounting principles generally accepted in the UnitedStates of America. These financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits. We conducted our audits of thesestatements in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

As discussed in Note 1 to the consolidated financial statements,effective July 1, 2002, the Company adopted Statement of FinancialAccounting Standards No. 142, Goodwill and Other Intangible Assets.
| /s/ PricewaterhouseCoopers  LLP |   |
|---------------------------------|--------|
|                            |   |
| Los Angeles, California         |   |
| August 5, 2004             |   |

 

F-1

----

 

**Report of Independent Registered Public AccountingFirm**

The Board of Directors and StockholdersSMTEK International, Inc.:

We have audited the accompanying consolidatedstatements of operations, cash flows and stockholders’ equity and comprehensiveincome (loss) of SMTEK International, Inc. and subsidiaries (“the Company”)for the year ended June 30, 2002. These consolidated financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudit.

We conducted our auditin accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the results of operations and cash flows ofSMTEK International, Inc. and subsidiaries for the year ended June 30,2002, in conformity with accounting principles generally accepted in the UnitedStates of America.
| /s/ KPMG LLP                                                                                                                                                                                                        |   |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                                                                                                                |   |   |
| Los Angeles, California                                                                                                                                                                                             |   |   |
| August 16, 2002, except for the restatement for  discontinued operations as described in the second paragraph of note 3 to the  consolidated financial statements, which is as of September 24, 2003 |   |   |

 

F-2

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**SMTEK INTERNATIONAL, INC.AND SUBSIDIARIESConsolidated Balance Sheets(In thousands except share amounts)**
| ** **                                                                                                                                  | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                                  | ** ** | **2004**          | ** ** | **2003** | ** ** |
| **Assets**                                                                                                                                  |       |              |       |   |   |
| Current assets:                                                                                                                             |       |              |       |   |   |
| Cash and cash equivalents                                                                                                                   |       | $                 | 406        |   | $ | 583 |   |
| Marketable securities                                                                                                                       |       | 210               |       | — |   |
| Accounts receivable, less allowance for doubtful  accounts of $406 and $657 in 2004 and 2003, respectively                                  |       | 13,734            |       | 11,096 |   |
| Inventories                                                                                                                                 |       | 12,971            |       | 9,377 |   |
| Prepaid expenses                                                                                                                            |       | 608               |       | 446 |   |
| Total current assets                                                                                                                        |       | 27,929            |       | 21,502 |   |
| Property, equipment and improvements, net of  accumulated depreciation and amortization                                                     |       | 6,103             |       | 5,541 |   |
| Other assets, net                                                                                                                           |       | 471               |       | 763 |   |
|                                                                                                                                        |       | $                 | 34,503     |   | $ | 27,806 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                              |       |              |       |   |   |
| Current liabilities:                                                                                                                        |       |              |       |   |   |
| Current portion of long-term debt                                                                                                           |       | $                 | 1,371      |   | $ | 2,495 |   |
| Accounts payable                                                                                                                            |       | 13,536            |       | 9,598 |   |
| Other accrued liabilities                                                                                                                   |       | 2,943             |       | 3,708 |   |
| Total current liabilities                                                                                                                   |       | 17,850            |       | 15,801 |   |
| Long-term  liabilities:                                                                                                                     |       |              |       |   |   |
| Long-term bank lines of credit payable                                                                                                      |       | 8,648             |       | 5,452 |   |
| Long-term debt                                                                                                                              |       | 3,264             |       | 5,675 |   |
| Total liabilities                                                                                                                           |       | 29,762            |       | 26,928 |   |
| Commitments and  contingencies                                                                                                              |       |              |       |   |   |
| Stockholders’  equity:                                                                                                                 |       |              |       |   |   |
| Preferred stock, $1 par value; 1,000,000 shares  authorized; 250,000 shares issued and outstanding at June 30, 2004                    |       | 475               |       | — |   |
| Common stock, $.01 par value; 20,000,000 shares  authorized; 2,386,016 and 2,284,343 issued and outstanding in 2004 and 2003,  respectively |       | 24                |       | 23 |   |
| Additional paid-in capital                                                                                                                  |       | 37,465            |       | 37,028 |   |
| Accumulated deficit                                                                                                                         |       | (33,279           | )          | (36,232 | ) |
| Accumulated other comprehensive income                                                                                                      |       | 56                |       | 59 |   |
| Total stockholders’ equity                                                                                                             |       | 4,741             |       | 878 |   |
|                                                                                                                                        |       | $                 | 34,503     |   | $ | 27,806 |   |

 

 

See accompanying notes to consolidated financial statements.

F-3

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**SMTEKINTERNATIONAL, INC. AND SUBSIDIARIESConsolidated Statements of Operations(In thousands except per share amounts)**

| ** **                                                                | ** ** | **Year ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues                                                                  |       | $                                      | 93,283     |   | $ | 70,723 |   | $ | 64,558 |   |
| Cost of goods  sold                                                       |       | 81,819                                 |       | 63,720 |   | 59,902 |   |
| Gross profit                                                              |       | 11,464                                 |       | 7,003 |   | 4,656 |   |
| Operating expenses:                                                       |       |                                   |       |   |   |   |   |
| Administrative and selling                                                |       | 8,457                                  |       | 9,774 |   | 9,246 |   |
| Goodwill amortization                                                     |       | —                                 |       | — |   | 37 |   |
| Total operating  expenses                                                 |       | 8,457                                  |       | 9,774 |   | 9,283 |   |
| Operating income  (loss)                                                  |       | 3,007                                  |       | (2,771 | ) | (4,627 | ) |
| Non-operating income  (expense):                                          |       |                                   |       |   |   |   |   |
| Interest income                                                           |       | 2                                      |       | 4 |   | 7 |   |
| Interest expense                                                          |       | (734                                   | )          | (945 | ) | (999 | ) |
| Other income, net                                                         |       | 789                                    |       | 710 |   | 236 |   |
| Total  non-operating income (expense)                                     |       | 57                                     |       | (231 | ) | (756 | ) |
| Income (loss)  from continuing operations before income taxes             |       | 3,064                                  |       | (3,002 | ) | (5,383 | ) |
| Income tax  provision (benefit)                                           |       | 111                                    |       | — |   | (225 | ) |
| Income (loss)  from continuing operations                                 |       | 2,953                                  |       | (3,002 | ) | (5,158 | ) |
| Loss from  discontinued operations, net of tax                            |       | —                                 |       | (1,300 | ) | (826 | ) |
| Gain on sale of  discontinued operations                                  |       | —                                 |       | 106 |   | — |   |
| Income (loss)  before cumulative effect of change in accounting principle |       | 2,953                                  |       | (4,196 | ) | (5,984 | ) |
| Cumulative effect  of change in accounting principle                      |       | —                                 |       | (420 | ) | — |   |
| Net income (loss)                                                         |       | $                                      | 2,953      |   | $ | (4,616 | ) | $ | (5,984 | ) |
| Basic earnings (loss)  per share:                                         |       |                                   |       |   |   |   |   |
| Income (loss) from continuing operations                                  |       | $                                      | 1.17       |   | $ | (1.31 | ) | $ | (2.26 | ) |
| Loss from discontinued operations                                         |       | —                                 |       | (0.57 | ) | (0.36 | ) |
| Gain on sale of discontinued operations                                   |       | —                                 |       | 0.04 |   | — |   |
| Cumulative effect of change in accounting principle                       |       | —                                 |       | (0.18 | ) | — |   |
| Net income (loss) per share                                               |       | $                                      | 1.17       |   | $ | (2.02 | ) | $ | (2.62 | ) |
| Diluted earnings (loss)  per share:                                       |       |                                   |       |   |   |   |   |
| Income (loss) from continuing operations                                  |       | $                                      | 1.07       |   | (1.31 | ) | $ | (2.26 | ) |
| Loss from discontinued operations                                         |       | —                                 |       | (0.57 | ) | (0.36 | ) |
| Gain on sale of discontinued operations                                   |       | —                                 |       | 0.04 |   | — |   |
| Cumulative effect of change in accounting principle                       |       | —                                 |       | (0.18 | ) | — |   |
| Net income (loss) per share                                               |       | $                                      | 1.07       |   | $ | (2.02 | ) | $ | (2.62 | ) |
| Shares used in computing  basic and diluted earnings (loss) per share:    |       |                                   |       |   |   |   |   |
| Basic                                                                     |       | 2,525                                  |       | 2,284 |   | 2,284 |   |
| Diluted                                                                   |       | 2,764                                  |       | 2,284 |   | 2,284 |   |

 

See accompanying notes to consolidated financial statements.

F-4

----

**SMTEK INTERNATIONAL, INC.AND SUBSIDIARIESConsolidated Statements of Cash Flows(In thousands)**
| ** **                                                                                                        | ** ** | **Year ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from operating  activities:                                                                            |       |                                   |       |   |   |   |   |
| Income (loss) from continuing operations                                                                          |       | $                                      | 2,953      |   | $ | (3,002 | ) | $ | (5,158 | ) |
| Adjustments  to reconcile income (loss) from continuing operations to net cash provided by  operating activities: |       |                                   |       |   |   |   |   |
| Depreciation and amortization                                                                                     |       | 1,827                                  |       | 2,109 |   | 2,032 |   |
| Gain on retirement of debt                                                                                        |       | (880                                   | )          | (514 | ) | — |   |
| Unrealized loss on marketable securities                                                                          |       | 126                                    |       | — |   | — |   |
| Loss on sale of subsidiary                                                                                        |       | 85                                     |       | — |   | — |   |
| Expense of warrants issued for professional services                                                              |       | 26                                     |       | — |   | — |   |
| Loss (gain) on sale of assets                                                                                     |       | —                                 |       | 6 |   | (196 | ) |
| Charge for leasehold abandonment                                                                                  |       | —                                 |       | 1,025 |   | — |   |
| Write-off of leasehold improvements                                                                               |       | —                                 |       | 370 |   | — |   |
| Equity securities received in settlement of claim  against prior customer                                         |       | —                                 |       | (336 | ) | — |   |
| Changes  in operating assets and liabilities net of assets disposed                                               |       |                                   |       |   |   |   |   |
| Accounts receivable                                                                                               |       | (3,267                                 | )          | (2,700 | ) | 1,489 |   |
| Costs and estimated earnings in excess of  billings on uncompleted contracts                                 |       | —                                 |       | — |   | 7,965 |   |
| Inventories                                                                                                       |       | (3,954                                 | )          | 296 |   | (3,914 | ) |
| Accounts payable                                                                                                  |       | 4,012                                  |       | 2,726 |   | 1,432 |   |
| Other accrued liabilities                                                                                         |       | (738                                   | )          | (836 | ) | 460 |   |
| Other, net                                                                                                        |       | (99                                    | )          | 232 |   | 44 |   |
| Cash provided by (used in) operating activities—discontinued  operations                                     |       | —                                 |       | 2,186 |   | (1,351 | ) |
| Net cash provided by operating activities                                                                         |       | 91                                     |       | 1,562 |   | 2,803 |   |
| Cash flows from  investing activities:                                                                            |       |                                   |       |   |   |   |   |
| Capital expenditures                                                                                              |       | (1,810                                 | )          | (761 | ) | (3,742 | ) |
| Purchase of Century Thailand, net of cash received                                                                |       | —                                 |       | — |   | (129 | ) |
| Proceeds from sale of assets                                                                                      |       | —                                 |       | — |   | 325 |   |
| Capital expenditures—discontinued  operations                                                                |       | —                                 |       | (275 | ) | (138 | ) |
| Proceeds from sale of subsidiary                                                                                  |       | 940                                    |       | — |   | — |   |
| Net cash used in investing activities                                                                             |       | (870                                   | )          | (1,036 | ) | (3,684 | ) |
| Cash flows from  financing activities:                                                                            |       |                                   |       |   |   |   |   |
| Proceeds from (repayments of) bank lines of credit                                                                |       | 3,196                                  |       | 1,447 |   | (633 | ) |
| Proceeds from long-term debt                                                                                      |       | —                                 |       | — |   | 2,465 |   |
| Proceeds from issuance of preferred stock                                                                         |       | 500                                    |       | — |   | — |   |
| Cost related of issuance of preferred stock                                                                       |       | (25                                    | )          | — |   | — |   |
| Costs related to new credit facility                                                                              |       | (164                                   | )          | — |   | — |   |
| Repayments of long-term debt                                                                                      |       | (3,287                                 | )          | (2,255 | ) | (1,659 | ) |
| Proceeds from the exercise of stock options                                                                       |       | 385                                    |       | — |   | 7 |   |
| Cash inflows from financing activities—discontinued  operations                                              |       | —                                 |       | — |   | 1,277 |   |
| Net cash provided by (used in) financing activities                                                               |       | 605                                    |       | (808 | ) | 1,457 |   |
| Effect of exchange rate changes on cash                                                                           |       | (3                                     | )          | 49 |   | 16 |   |
| (Decrease) increase in cash and cash equivalents                                                                  |       | (177                                   | )          | (233 | ) | 592 |   |
| Cash and cash equivalents at beginning of year                                                                    |       | 583                                    |       | 816 |   | 224 |   |
| Cash and cash equivalents at end of year                                                                          |       | $                                      | 406        |   | $ | 583 |   | $ | 816 |   |
| Supplemental cash  flow information:                                                                              |       |                                   |       |   |   |   |   |
| Interest paid                                                                                                     |       | $                                      | 759        |   | $ | 830 |   | $ | 889 |   |
| Income taxes paid                                                                                                 |       | $                                      | —     |   | $ | — |   | $ | 45 |   |
| Non-cash investing  activities:                                                                                   |       |                                   |       |   |   |   |   |
| Capital expenditures financed by lease obligations  and notes payable                                             |       | $                                      | 637        |   | $ | — |   | $ | — |   |
| Other                                                                                                             |       | $                                      | —     |   | $ | — |   | $ | 1 |   |

 

 

See accompanying notes to consolidated financial statements.

F-5

----

 

**SMTEK INTERNATIONAL, INC.AND SUBSIDIARIESConsolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)Years ended June 30, 2004, 2003 and 2002(In thousands except share amounts)**
| ** **                                                            | ** ** | ** **            | ** ** | ** ** | ** ** | ** **     | ** ** | ** **  | ** ** | **Accumulated**                                                                            | ** ** | ** **             | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|----------------|------------|-------------|------------|--------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                            | ** ** | **Common Stock** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **  | ** ** | **other**                                                                                  | ** ** | **Total**              | ** ** |
| ** **                                                            | ** ** | ** **            | ** ** | **Par**    | ** ** | **Preferred**  | ** ** | **paid-in** | ** ** | **Accumulated**                                                                            | ** ** | **comprehensive**      | ** ** | **stockholders’** | ** ** |
| ** **                                                            | ** ** | **Shares**            | ** ** | **value**  | ** ** | **stock**      | ** ** | **capital** | ** ** | **deficit**                                                                                | ** ** | **income (loss)** | ** ** | **equity** | ** ** |
| Balance at June 30, 2001                                    |       | 2,282,339             |       |       | $          | 23             |       |        |       | $                                                                                          | —     |                   |       |   | $ | 37,018 |   |   |   | $ | (25,632 | ) |   |   | $ | (189 | ) |   |   | $ | 11,220 |   |   |
| Exercise of stock options and issuance of director  shares            |       | 2,004                 |       |       | —     |           |       |        | —     |                                                                                       |       |                   | 10         |   |   |   | — |   |   |   | — |   |   |   | 10 |   |   |
| Comprehensive loss:                                                   |       |                  |       |       |       |           |       |        |       |                                                                                       |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                              |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | (5,984 | ) |   |   | — |   |   |   | (5,984 | ) |   |
| Foreign currency translation adjustments                              |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | — |   |   |   | 107 |   |   |   | 107 |   |   |
| Unrealized gain on forward exchange contracts                         |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | — |   |   |   | 72 |   |   |   | 72 |   |   |
| Total comprehensive loss                                              |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (5,805 | ) |   |
| Balance at June 30, 2002                                    |       | 2,284,343             |       |       | 23         |           |       |        | —     |                                                                                       |       |                   | 37,028     |   |   |   | (31,616 | ) |   |   | (10 | ) |   |   | 5,425 |   |   |
| Comprehensive  loss:                                                  |       |                  |       |       |       |           |       |        |       |                                                                                       |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                              |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | (4,616 | ) |   |   | — |   |   |   | (4,616 | ) |   |
| Foreign currency translation adjustments                              |       | —                |       |       | —     |           |       |        | —     |                 |       |                   | —     |   |   |   | — |   |   |   | 141 |   |   |   | 141 |   |   |
| Change in unrealized gain on close-out of forward  exchange contracts |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | — |   |   |   | (72 | ) |   |   | (72 | ) |   |
| Total comprehensive loss                                              |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | (4,547 | ) |   |
| Balance at June 30, 2003                                    |       | 2,284,343             |       |       | 23         |           |       |        | —     |                                                                                       |       |                   | 37,028     |   |   |   | (36,232 | ) |   |   | 59 |   |   |   | 878 |   |   |
| Sales of preferred stock                                              |       | —                |       |       | —     |           |       |        | 475        |                                                                                       |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 475 |   |   |
| Exercise of stock options                                        |       | 101,673               |       |       | 1          |           |       |        | —     |                                                                                       |       |                   | 384        |   |   |   | — |   |   |   | — |   |   |   | 385 |   |   |
| Issuance of warrants                                                  |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | 89         |   |   |   | — |   |   |   | — |   |   |   | 89 |   |   |
| Dividends on preferred stock                                          |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | (36        | ) |   |   | — |   |   |   | — |   |   |   | (36 | ) |   |
| Comprehensive loss:                                                   |       |                  |       |       |       |           |       |        |       |                                                                                       |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                            |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | 2,953 |   |   |   | — |   |   |   | 2,953 |   |   |
| Foreign currency translation adjustments                              |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | — |   |   |   | (3 | ) |   |   | (3 | ) |   |
| Total comprehensive income                                            |       | —                |       |       | —     |           |       |        | —     |                                                                                       |       |                   | —     |   |   |   | — |   |   |   | — |   |   |   | 2,950 |   |   |
| Balance at  June 30, 2004                                   |       | 2,386,016             |       |       | $          | 24             |       |        |       | $                                                                                          | 475        |                   |       |   | $ | 37,465 |   |   |   | $ | (33,279 | ) |   |   | $ | 56 |   |   |   | $ | 4,741 |   |   |

 

 

See accompanying notes to consolidated financial statements.

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**SMTEKINTERNATIONAL, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements**

**NOTE 1—SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

**Description of Business**

SMTEK International, Inc. (the “Company,” “we,” “us”or “our”) is an electronics manufacturing services (“EMS”) provider servingoriginal equipment manufacturers (“OEMs”) in the medical, industrialinstrumentation, telecommunications, security, financial services automationand 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; SMTEK Santa Clara, located in Santa Clara, California; and SMTEKInternational Thailand Limited, located in Ayutthya, Thailand.

On January 9, 2004, we sold our subsidiary JoltTechnology, Inc. (aka SMTEK Fort Lauderdale), located in Fort Lauderdale,Florida, for approximately $940,000 in cash to the president of Jolt and anaffiliated investor of the Company. The loss on the sale of Jolt wasapproximately $85,000 and has been recognized for the year ended June 30,2004 as a non-operating expense in the accompanying Consolidated Statement ofOperations. The results of operations of Jolt through the date of sale and forthe years ended June 30, 2003 and 2002 are included in the accompanyingConsolidated Statement of Operations. 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. This transition was completed as of March 31,2003.

On April 9, 2003, we sold our facility inNorthern Ireland. This is shown in our audited financial statements as adiscontinued operation. For further discussion, see Note 3.

As more fully described inNote 2, on October 24, 2001, we completed a transaction to purchasecertain assets, but not assume any liabilities, of Century ElectronicsManufacturing, Inc. (“Century”), an EMS company that filed for bankruptcy.As part of this transaction, we also purchased substantially all of the commonstock of Century’s subsidiary in Thailand. The aggregate purchase price of thistransaction was approximately $3.2 million.

**AccountingPeriod**

We utilize a 52-53 weekfiscal year ending on the Friday closest to June 30 which, for fiscalyears 2004, 2003 and 2002, fell on June 25, June 27 and June 28,respectively. In these consolidated financial statements, the fiscal year-endfor all years is shown as June 30 for clarity of presentation, exceptwhere the context dictates a more specific reference to the actual year-enddate. Fiscal 2004, 2003 and 2002 consisted of 52 weeks.

**Basis of Presentation**

The accompanying consolidated financial statementscontemplate the realization of assets and the satisfaction of liabilities inthe normal course of business.

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The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

Certain reclassificationshave been made to the fiscal year 2003 and 2002 financial statements to conformwith the fiscal year 2004 financial statement presentation. Suchreclassifications had no effect on our results of operations or stockholders’equity.

**Principles of Consolidation**

The consolidated financialstatements include the accounts of SMTEK International, Inc. and itswholly owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated in consolidation.

**CashEquivalents**

For financial reportingpurposes, cash equivalents consist primarily of money market instruments andbank certificates of deposit that have original maturities of three months orless.

**Fair Value of Financial Instruments**

As of June 30, 2004and 2003, the carrying amount of our cash and cash equivalents, accountsreceivable, accounts payable, accrued liabilities and bank lines of creditapproximate their fair value because of the short maturity of those instruments.At June 30, 2004 and 2003, the carrying amount of long-term debt(including the current portion thereof but excluding the bank lines of credit)was $4.6 million and $8.2 million, respectively, and the fair value was $4.1million and $7.7 million, respectively. The fair value of our long-term debt isestimated based on the quoted market prices for the same or similar issues oron the current rates offered to us for debt of the same remaining maturities. Allfinancial instruments are held for purposes other than trading.

**Marketable Securities**

Our marketable securitiesconsist of an investment in common stock of a public company which, foraccounting purposes, is classified as trading securities. Accordingly, theinvestment is marked to market quarterly with the change in value beingrecorded in the statement of operations. For the fiscal year ended June 30,2004, we recognized an unrealized loss on marketable securities of $126,000that was recorded as a non-operating expense in the accompanying ConsolidatedStatement of Operations. Management’s intention is to sell off the shares ofsuch public company as the market for those shares allows. At June 25,2004, the last business day of our fiscal 2004, we held approximately 169,000shares with a fair market value of $1.25 per share.

**Concentrations of Credit Risk**

Financial instruments that potentially subject us toconcentrations of credit risk consist principally of money market instrumentsand trade receivables. Cash is invested in money market instruments andcertificates of deposit with high credit quality financial institutions and, bypolicy, we limit the amount of credit exposure to any one issuer.

Concentrations of credit risk with respect to tradereceivables exist because our EMS operations rely heavily on a relatively smallnumber of customers. We perform ongoing credit evaluations of our customers andgenerally do not require collateral. We maintain reserves for potential creditlosses.

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At June 30, 2004, wehad no customers representing more than 10% of our consolidated accountsreceivable balance. At June 30, 2003, we had two customers eachrepresenting approximately 11% of our accounts receivable balance.

**AccountsReceivable**

We perform ongoing creditevaluations of our customers and adjust credit limits based upon each customer’spayment history and current credit worthiness, as determined by creditinformation available at that time. We continuously monitor collections andpayments from our customers and we maintain allowances for doubtful accountsfor estimated losses resulting from the inability of our customers to makerequired payments. If the financial condition of our customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances may be required.

**Inventories**

Inventoriesare stated at the lower of cost or net realizable value, with cost determinedby use of the first-in, first-out method. We write down inventory forslow-moving and obsolete inventory based on assessments of future demands,market conditions and customers which may be experiencing financialdifficulties. If these factors are less favorable than those projected,additional inventory write downs may be required. Inventories consist of thefollowing (in thousands):

| ** **        | ** ** | **June 30,** | ** ** |
|-------------------|------------|-------------------|------------|
| ** **        | ** ** | **2004**          | ** ** | **2003** | ** ** |
| Raw materials     |       | $                 | 7,209      |   | $ | 5,810 |   |
| Work in process   |       | 5,285             |       | 3,298 |   |
| Finished goods    |       | 477               |       | 269 |   |
| Total inventories |       | $                 | 12,971     |   | $ | 9,377 |   |

 

**Property, Equipment and Improvements**

Property,equipment and improvements are stated at cost. Depreciation and amortizationare computed on the straight-line method. The principal estimated useful livesare:  buildings—20 years; improvements—5 to 10years; and plant, office and other equipment—3to 7 years. Fixed assets consist of the following (in thousands):

| ** **                                      | ** ** | **June 30,** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|
| ** **                                      | ** ** | **2004**          | ** ** | **2003** | ** ** |
| Land                                            |       | $                 | 498        |   | $ | — |   |
| Buildings and  improvements                     |       | 1,835             |       | 1,450 |   |
| Plant equipment                                 |       | 13,265            |       | 13,075 |   |
| Office and other  equipment                     |       | 1,704             |       | 1,581 |   |
| Less accumulated  depreciation and amortization |       | (11,199           | )          | (10,565 | ) |
| Total property,  equipment and improvements     |       | $                 | 6,103      |   | $ | 5,541 |   |

 

We purchased the building and land at our Thailandfacility in fiscal 2004 and also began construction to expand that facility,such construction is scheduled to be completed in October 2004. See Note 6for more details on the financing of the land, building and construction.

The capitalized cost ofthe related assets (primarily plant equipment), which are pledged as securityunder the capital leases, was $1.9 million and $1.3 million at June 30,2004 and 2003, respectively. Accumulated amortization on assets under capitalleases amounted to $0.7 million and $0.8 million at June 30, 2004 and2003, respectively.

F-9

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**Goodwill**

In adopting Statement of Financial AccountingStandards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, theCompany ceased amortizing goodwill in the first quarter of fiscal 2003. Goodwillrepresents the excess of acquisition cost over the fair value of net assets ofa purchased business. The goodwill was acquired at a cost of $544,000 and hadpreviously been amortized on a straight-line basis over 15 years. Goodwillamortization for fiscal 2002 was $37,000. Accumulated amortization of goodwillwas $124,000 at June 30, 2002. If no amortization had been recorded infiscal 2002, the pro forma net loss would have been $(5,947,000).

During the quarter ended December 31,2002, the Company completed its assessment of the impairment of goodwill underthe transitional rules of SFAS No. 142 as of July 1, 2002 anddetermined the goodwill was fully impaired and recorded an impairment charge of$420,000 as a cumulative effect of a change in accounting principle. No incometax benefit has been recognized for this charge as the goodwill is not deductiblefor income tax purposes.

**LongLived Assets**

The recoverability oflong-lived assets is evaluated whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable, and iffuture undiscounted cash flows expected to result from the use of such assetsare believed insufficient to recover the carrying value of the asset, thecarrying value is written down to fair value in the period the impairment isidentified.

**RevenueRecognition**

All of our subsidiaries recognize revenues once all ofthe following conditions have been met: a) an authorized purchase orderhas been received in writing, b) the customer’s credit worthiness has beenestablished, c) shipment of the product has occurred, d) title andrisk of ownership has transferred, e) if stipulated by the contract,customer acceptance has occurred and f) all significant vendorobligations, if any, have been satisfied. We ship products FOB shipping pointand, accordingly, title and risk of ownership pass to the customer uponshipment.

In years prior to fiscal 2003, our Moorpark subsidiaryhistorically used the percentage of completion method to recognize revenues andcost of sales on certain of its long-term contracts with suppliers ofelectronic components and products. Percentage of completion is determined onthe basis of costs incurred to total estimated costs. Contract costs includeddirect material and direct labor costs and those indirect costs related to theassembly process, such as indirect labor, supplies, tools, repairs anddepreciation costs. Selling and administrative costs were charged to expense asincurred. In the period in which it is determined that a loss will result fromthe performance of a contract, the entire amount of the estimated loss wascharged to cost of goods sold. Other changes in contract price and estimates ofcosts and profits at completion were recognized prospectively. A portion of theasset “costs and estimated earnings in excess of billings on uncompletedcontracts” contains revenues recognized in excess of amounts billed.

During fiscal 2002, ourMoorpark facility entered into sales contracts consistent with our otherlocations, and as such, recognizes revenue on these new arrangements uponshipment of products rather than on a percentage of completion method. As aresult, during fiscal 2002, the Moorpark facility was recognizing revenue uponshipment of products as well as under the percentage of completion method. At June 30,2002 there were no existing sales contracts with customers under the percentageof completion method of accounting.

F-10

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**Shipping and Handling Costs**

All shipping and handling costs are recorded as acomponent of Cost of Goods Sold in the accompanying Consolidated Statement ofOperations.

**Marketing andAdvertising**

All costs related to marketing and advertising theCompany’s services are expensed as incurred. Advertising costs were notmaterial in each of the three years in the period ended June 30, 2004.

**Income Taxes**

Income taxes are accounted for under the asset andliability method. Deferred tax assets and liabilities are recognized for theexpected future tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax bases and operating loss and tax credit carryforwards. Inestimating future tax consequences, all expected future events other thanenactments of changes in tax law or statutorily imposed rates are considered. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date. Avaluation allowance is recorded to reduce deferred tax assets to theirestimated realizable amount.

**Earnings (Loss) Per Share**

Basic earnings (loss) per share is computed bydividing net income (loss) available to common stockholders by the weightedaverage number of common shares outstanding during the period. The weightedaverage number of common shares outstanding includes the effect of theparticipating preferred shares convertible into 250,000 common shares. 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).

**Foreign CurrencyTranslation**

The financial statements of our foreign operatingunits have been translated into U.S. dollars from the functional currency ofthe Thai Baht or British pounds sterling, in the accompanying consolidatedfinancial statements. Balance sheet amounts have been translated at theexchange rate on the balance sheet date and income statement amounts have beentranslated at average exchange rates in effect during the period. The nettranslation adjustment is recorded as a separate component of stockholders’equity.

**DerivativeFinancial Instruments**

It is our policy not toenter into derivative financial instruments for speculative purposes. We may,from time to time, enter into foreign currency forward exchange contracts in aneffort to protect us from adverse currency rate fluctuations on foreigncurrency commitments entered into in the ordinary course of business. Thesecommitments are generally for terms of less than one year. The foreign currencyforward exchange contracts are executed with banks believed to be creditworthyand are denominated in currencies of major industrial countries. In accordancewith SFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities,” as amended by SFAS No. 138 and SFAS No. 149, all derivativefinancial instruments are measured at fair value and are recognized as eitherassets or liabilities in the balance sheet. The accounting treatment of changesin fair value is dependent upon whether or not a derivative financialinstrument 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. Derivativefinancial instruments not qualifying for hedge accounting treatment under SFAS 

F-11

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No. 133 arerecognized as assets or liabilities with gains or losses recognized in currentresults of operations. At June 30, 2004 and 2003 we had no forward foreigncurrency contracts. At June 30, 2002 we had forward foreign currencycontracts to sell $1.3 million for approximately 870,000 British poundssterling between July 12, 2002 through December 24, 2002. The U.S.dollar to British pounds sterling exchange rate at June 30, 2002 was 1.53.These forward foreign currency contracts were designated as cash flow hedgeinstruments. In accordance with SFAS No. 133, we recognized a gain of$72,000 in other comprehensive income at June 30, 2002, related to thesecontracts.

**Stock Based Compensation**

SFAS No. 123,“Accounting for Stock-Based Compensation” allows entities to continue to applythe provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” and provide pro forma net income and pro formaearnings per share disclosures for stock-based awards as if thefair-value-based method defined in SFAS No. 123 had been applied. Inaccordance with APB Opinion No. 25 and related interpretations,compensation expense would generally be recorded for fixed option grants onlyif, on the date of grant, the current market price of the underlying stockexceeded 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 beenrecognized for our employee stock option plans and award of options tonon-employee directors. Had compensation expense for stock-based awards beendetermined consistent with SFAS No.123, our results of operation would havebeen reduced to the pro forma amounts indicated below (in thousands except pershare amounts):
| ** **                          | ** ** | **Year ended June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|
| ** **                          | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income (loss):                  |       |                                   |       |   |   |   |   |
| As reported                         |       | $                                      | 2,953      |   | $ | (4,616 | ) | $ | (5,984 | ) |
| Stock option compensation expense   |       | (717                                   | )          | (351 | ) | (387 | ) |
| Pro forma                           |       | $                                      | 2,236      |   | $ | (4,967 | ) | $ | (6,371 | ) |
| Basic earnings (loss)  per share:   |       |                                   |       |   |   |   |   |
| As reported                         |       | $                                      | 1.17       |   | $ | (2.02 | ) | $ | (2.62 | ) |
| Pro forma                           |       | $                                      | 0.89       |   | $ | (2.17 | ) | $ | (2.79 | ) |
| Diluted earnings (loss)  per share: |       |                                   |       |   |   |   |   |
| As reported                         |       | $                                      | 1.07       |   | $ | (2.02 | ) | $ | (2.62 | ) |
| Pro forma                           |       | $                                      | 0.81       |   | $ | (2.17 | ) | $ | (2.79 | ) |

 

For purposes of the pro forma disclosure under SFAS No. 123,the “fair value” of each option is estimated on the date of grant using theBlack-Scholes option-pricing model with the following assumptions used forgrants in 2004, 2003 and 2002:  dividendyield of 0.0% for all years;  expectedvolatility of 120%, 100% and 90% for 2004, 2003 and 2002, respectively;  risk-free interest rates ranging from 2.8% to3.8% for 2004, 2.2% to 3.1% for 2003 and 3.5% to 5.3% for 2002;  and expected lives of five years for allyears.

The weighted average fairvalue of options granted during the years ended June 30, 2004, 2003 and2002 was $4.94, $1.03 and $3.50, respectively.

**Recent Accounting Pronouncements**

In November 2002, the Financial AccountingStandards Board issued Interpretation No. 45, Guarantor s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees OfIndebtedness Of Others, an Interpretation of FASB Statements No. 5, 57,and 107 and Rescission of FASB Interpretation No. 34. FIN 45 relates tothe accounting for and disclosure of guarantees. FIN 45 excludes 

F-12

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certain types ofguarantees from its initial recognition and measurement, including guaranteesbetween parents and their subsidiaries or between corporations under commoncontrol. The disclosure requirements of FIN 45 are effective for financialstatements of interim and annual periods ending after December 15, 2002.The initial recognition and initial measurement provisions should be applied onlyon a prospective basis to guarantees issued or modified after December 31,2002. The guarantor s previous accounting for guarantees issued prior to theinitial application date of FIN 45 should not be revised or restated to reflectthe effect of the new recognition and measurement provisions. The Company’sadoption of FIN 45 has not had a material impact on its consolidated financialstatements.

In January 2003, the Financial AccountingStandards Board issued Interpretation No. 46, Consolidation of VariableInterest Entities, an interpretation of ARB No. 51. The objective of FIN46 is to improve financial reporting by companies involved with variableinterest entities. This new model for consolidation applies to an entity inwhich either (1) the powers or rights of the equity holders do not givethem sufficient decision making powers or (2) the equity investment atrisk is insufficient to finance that entity s activities without receivingadditional subordinated financial support from other parties. FIN 46 requires avariable interest entity to be consolidated into the company that is subject toa majority of the risk of loss from the variable interest entity s activitiesor that is entitled to receive a majority of the entity s residual returns orboth. The consolidation requirements of FIN 46 apply immediately to variableinterest entities created after January 31, 2003. The Company adopted theprovisions of FIN 46 in 2003 and such adoption did not have a material impacton the Company s consolidated financial statements since the Company currentlyhas no variable interest entities. In December 2003, the FASB issued FIN46R with respect to variable interest entities created before January 31,2003, which, among other things, revised the implementation date to the firstfiscal year or interim period ending after March 15, 2004, with theexception of Special Purpose Entities ( SPE ). The consolidation requirementsapply to all SPE s in the first fiscal year or interim period ending after December 15,2003. The Company has adopted the provisions of FIN 46R effective December 31,2003, and such adoption did not have a material impact on the Company sconsolidated financial statements since the Company currently has no SPE s.

In March 2004, theEmerging Issues Task Force finalized its consensus on EITF Issue 03-6, “ParticipatingSecurities and the Two-Class Method Under FASB Statement No. 128,Earnings Per share” (EITF 03-6). EITF 03-6 clarifies what constitutes aparticipating security and requires the use of the two-class method forcomputing basic earnings per share when participating convertible securitiesexist. EITF 03-6 is effective for fiscal periods beginning after March 31,2004. Adoption of EITF 03-6 is not expected to have a material effect on ourconsolidated financial statements.

**NOTE 2—ACQUISITIONOF THE ASSETS OF CENTURY ELECTRONICS MANUFACTURING, INC.**

On October 24, 2001, we completed a transactionto purchase certain assets, but not assume any liabilities, of Century, an EMScompany that filed for bankruptcy. As part of this transaction, we alsopurchased substantially all of the common stock of Century’s subsidiary inThailand. The aggregate purchase price of this transaction was approximately$3.2 million in cash and was funded by our existing long-term bank lines ofcredit.

Specifically, we purchased from Century certainequipment and machinery for approximately $1.4 million and inventory forapproximately $900,000. We have and will continue to utilize some of thepurchased assets at our other locations. We negotiated new facility leases inMarlborough, Massachusetts and Santa Clara, California and began operations inMarlborough and Santa Clara in connection with the purchase of these assets.

Aspart of the Century agreement we purchased the common stock of the Centurysubsidiary in Thailand (“Century Thailand”) for approximately $900,000. Theacquisition of the Thailand subsidiary provides us with a low costmanufacturing facility in Southeast Asia. The acquisition of Century Thailand 

F-13

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was accounted for using the purchase method ofaccounting and, accordingly, the consolidated statements of operations includethe results of the Thailand subsidiary from the date of acquisition. The assetsacquired and liabilities assumed were recorded at fair value as determined byus based on information currently available. A summary of the assets acquiredand the liabilities assumed in the acquisition is as follows (in thousands):
| Estimated fair values: |   |   |   |
|------------------------|--------|--------|--------|
| Assets acquired        |   | $      | 1,392  |   |
| Liabilities assumed    |   | 476    |   |
| Purchase price         |   | 916    |   |
| Less cash  received    |   | 787    |   |
| Net cash paid          |   | $      | 129    |   |

 

Unauditedpro forma results of operations for the fiscal year ended June 30, 2002,as if the acquisition of the Thailand subsidiary had occurred at the beginningof the period reported, follow (dollars in thousands). The unaudited pro formaresults are not necessarily indicative of the results which would have occurredif the business combination had occurred on the date indicated.
| ** **                  | ** ** | **Year Ended  June 30, 2002** | ** ** |
|-----------------------------|------------|----------------------------------------------|------------|
| ** **                  | ** ** | **(Unaudited)**                              | ** ** |
| Revenue                     |       |                                         | $          | 65,878 |   |   |
| Net income (loss)           |       |                                         | $          | (5,921 | ) |   |
| Earnings (loss) per  share: |       |                                         |       |   |   |
| Basic                       |       |                                         | $          | (2.59 | ) |   |
| Diluted                     |       |                                         | $          | (2.59 | ) |   |

 

**NOTE 3—DISCONTINUED OPERATIONS**

On April 9, 2003, we sold 100% of the outstandingstock in our subsidiary, SMTEK Europe, for consideration of $1. The purchaseralso assumed all liabilities of SMTEK Europe. The purchaser was a NorthernIreland investor group, which included a director from SMTEK Europe. Asdetailed below, the gain on sale, net of transaction costs of $165,000 but beforeelimination of the foreign currency translation account balance, was $211,000.

Inaccordance with SFAS No. 144, the sale of SMTEK Europe has been accountedfor as a discontinued operation in the accompanying financial statements and asa result, the Company has restated its 2002 consolidated financial statementsfor the discontinued operation. The following represents the condensedfinancial information for SMTEK Europe that is included in the accompanyingconsolidated financial statements as discontinued operations (in thousands):
| ** **          | ** ** | **Year Ended June 30,** | ** ** |
|---------------------|------------|----------------------------------------|------------|
| ** **          | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| Net sales           |       | $                                      | 6,277      |   | $ | 9,664 |   |
| Cost of goods  sold |       | (6,542                                 | )          | (8,858 | ) |
| Operating expense   |       | (867                                   | )          | (1,470 | ) |
| Other expense,  net |       | (168                                   | )          | (162 | ) |
| Net loss            |       | $                                      | (1,300     | ) | $ | (826 | ) |

 

F-14

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Net(liabilities) assets of SMTEK Europe consisted of the following (in thousands):
| ** **                            | ** ** | **April 9, 2003** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **(sale date)**        | ** ** |
| Current assets                        |       |                        | $          | 3,516 |   |   |
| Property,  equipment and improvements |       |                        | 1,486      |   |   |
| Current  liabilities                  |       |                        | (5,312     | ) |   |
| Long-term debt                        |       |                        | (65        | ) |   |
| Net (liabilities)  assets             |       |                        | $          | (375 | ) |   |

 

Thegain on sale of SMTEK Europe, shown in the accompanying consolidated statementsof operations as “Gain on sale of discontinued operations”, is comprised asfollows (in thousands):
| Net costs                                                                         |   | (164 | )      |
|-----------------------------------------------------------------------------------|--------|------|--------|
| Plus net  liabilities of SMTEK Europe                                             |   | 375  |   |
| Gain on sale  before elimination of foreign currency translation account  balance |   | 211  |   |
| Elimination of  SMTEK Europe’s foreign currency translation account  balance |   | (105 | )      |
| Gain on sale of  discontinued operations                                          |   | $    | 106    |   |
|                                                                                   |        |      |        |  |

 

Prior to the sale, SMTEKEurope had an accumulated foreign currency translation loss of $105,000, whichwas carried as a reduction of consolidated stockholders’ equity. In accordancewith SFAS No. 52, “Foreign Currency Translation,” this amount has beenincluded in the determination of the gain on sale of discontinued operationsand in accordance with SFAS No. 130, “Reporting Comprehensive Income,” anequal and offsetting amount is reported as other comprehensive income in theaccompanying consolidated statements of operations and consolidated statementsof stockholders’ equity and comprehensive income (loss).

**NOTE 4—SALE OF SUBSIDIARY**

On January 9,2004, we sold our subsidiary Jolt Technology, Inc. (aka SMTEK FortLauderdale), located in Fort Lauderdale, Florida, for approximately $940,000 incash to the president of Jolt and an affiliated investor of the Company. Theloss on the sale of Jolt was approximately $85,000 and has been recognized forthe year ended June 30, 2004 as a component of non-operating expense in theaccompanying Consolidated Statements of Operations. The results of operationsof Jolt through the date of sale and for the years ended June 30, 2003 and2002 are included in the accompanying Consolidated Statements of Operations.

Netassets of Jolt as of the sale date of January 9, 2004 consisted of thefollowing (in thousands):
| Current assets                        |   | $   | 1,026  |   |
|---------------------------------------|--------|-----|--------|--------|
| Property,  equipment and improvements |   | 58  |   |
| Other assets                          |   | 20  |   |
| Current  liabilities                  |   | (79 | )      |
| Net assets                            |   | $   | 1,025  |   |

 

Jolt revenues were $1.7million in the year ended June 30, 2004 and operating income was $109,000.

F-15

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**NOTE 5—RESTRUCTURING COSTS**

In connection with the closure and transition of theCompany’s San Diego (Poway) facility in the second quarter of 2003, we incurredapproximately $1.6 million in expenses consisting 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.

Thefollowing table summarizes the activity in the provisions and the remainingbalances of the restructuring reserve accounts for the San Diego transition at June 30,2004 and 2003(in thousands):
| ** **                        | ** ** | ** **    | ** ** | **Lease and** | ** ** |
|-----------------------------------|------------|---------------|------------|--------------------|------------|
| ** **                        | ** ** | ** **    | ** ** | **Other**          | ** ** |
| ** **                        | ** ** | **Severance** | ** ** | **Contractual**    | ** ** |
| ** **                        | ** ** | **Costs**     | ** ** | **Commitments**    | ** ** |
| Provision                         |       |          | $          | 287                |       |   |   | $ | 973 |   |   |
| Payments                          |       |          | (287       | )                  |       |   | (233 | ) |   |
| Balance as of  June 30, 2003 |       |          | —     |               |       |   | 740 |   |   |
| Additions to  provision           |       |          | —     |               |       |   | 80 |   |   |
| Payments                          |       |          | —     |               |       |   | (230 | ) |   |
| Balance as of  June 30, 2004 |       |          | $          | —             |       |   |   | $ | 590 |   |   |

 

During fiscal 2002 we moved the operations of SMTEK, Inc.from Thousand Oaks, California to a larger facility in Moorpark, California. Infiscal 2003 and 2002 we recognized $600,000 and $785,000 in losses,respectively, on the lease commitment for the vacated Thousand Oaks facility. Thebalance of the accrual was $574,000 at June 30, 2003 which was fully paidby the end of the lease term in May 2004.

In May 2004,we ended our commitment under the Thousand Oaks lease and incurred anadditional $124,000 of expense in the settlement of and release from ourobligations under the same. Other than this $124,000 of accrued expenseremaining to be paid at June 30, 2004, there were no obligations remainingrelated to the Thousand Oaks facility at June 30, 2004.

**NOTE 6—FINANCINGARRANGEMENTS**

**Bank Credit Agreements**

At June 30, 2004, as one component of our creditfacility, we have a $15 million working capital line collateralized by accountsreceivable, inventory and equipment for our domestic operating units thatmatures September 30, 2007. Borrowings under the working capital line bearinterest, at our option, at either the bank’s prime rate (4.0% at June 30,2004) plus 0.75% or a Libor-base rate (1.4% at June 30, 2004) plus 3.50%. AtJune 30, 2004, borrowings under our working capital line amounted to $8.6million, the effective interest rate was 5.0% and our borrowing capacity wasapproximately $3.5 million. Borrowings under our working capital line at June 30,2004 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 a maturity date of September 19, 2006and bears interest, at our option, at either the bank’s prime rate (4.0% at June 30,2004) plus 0.75% or a Libor-base rate (1.4% at June 30, 2004) plus 3.50%. AtJune 30, 2004, the balance outstanding was $750,000 and the effectiveinterest rate was 5.0%. The third component of our credit facility, the capitalexpenditure credit facility of $2.5 million, is being used to finance ourcapital expenditures. Each advance under the capital expenditure creditfacility will have a three year term at either the Bank’s prime rate or, at ouroption, at a fixed rate equal to the Libor rate plus 3.50%. Borrowings underthe capital expenditure credit facility were $139,000 as of June 30, 2004and the effective interest rate was 5.0%. Our bank covenants includerequirements related to net income, stockholders’ equity and debt service ratio.We believe we were in compliance with all covenants on the 

F-16

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above credit facilities atJune 30, 2004. This credit facility, which became effective in September 2003and was amended in June 2004, replaced the credit facility that had beenin effect at June 30, 2003.

At June 30, 2003, we had an $8.5 million workingcapital line of credit collateralized by accounts receivable, inventory andequipment for our domestic operating units which matured September 25,2003. Borrowings under the credit agreement bore interest at either the bank’sprime rate (4.25% at June 30, 2003) plus 1.00% or a Eurodollar-base rate(1.04% at June 30, 2003) plus 3.75%. At June 30, 2003, borrowingsoutstanding under this credit facility amounted to $5.5 million and the effectiveweighted average interest rate was 4.83%. Our available borrowing capacity asof June 30, 2003, was approximately $3.3 million.

On May 6, 2004, wefinalized a Credit Facility Agreement between SMTEK International ThailandCompany Limited (our Thailand subsidiary) and BankThai Public Company Limitedand an unconditional guarantee by SMTEK International, Inc. for thepurpose of funding the growth and expansion of our Thailand facility. Thecredit facility includes a $678,000 mortgage loan for the purchase of thebuilding and land at our Thailand facility. The mortgage has a seven year termwith an initial interest rate of 5.75%, based on Thailand Prime Rate, and amonthly payment of approximately $9,000. The Credit Facility Agreement alsoincludes a $440,000 construction loan for the expansion of the Thailandfacility. The construction loan has a 78 month term with interest at ThailandPrime Rate and will have a monthly payment of approximately $5,000 startingafter the completion of construction which is presently scheduled for September 2004.The Credit Facility Agreement also includes a working capital line ofapproximately $500,000 with interest at Thailand Prime Rate, a one year termand it is secured by all the assets of the Thailand facility. All liabilitiesand obligations under the Credit Facility are denominated in Baht, the currencyof Thailand. As of June 30, 2004, we have a mortgage note of $678,000 forthe purchase of the land and building and have accrued $66,000 for constructionin progress on the new building.

F-17

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**Long-TermDebt**

Long-termdebt, other than the bank line of credit, consists of the following (inthousands):
| ** **                                                                                                                                                                                        | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                        | ** ** | **2004**          | ** ** | **2003** | ** ** |
| Notes payable  collateralized by equipment, interest at 3.90% to 9.60%, payable in monthly  installments through July 2006                                                                   |       | $                 | 610        |   | $ | 1,261 |   |
| Equipment line of  credit, collateralized by equipment, paid off during fiscal 2004                                                                                                               |       | —            |       | 785 |   |
| Equipment line of  credit, collateralized by equipment, due September 2006, interest at  5.00% at June 30, 2004                                                                         |       | 750               |       | — |   |
| Equipment note,  collateralized by equipment, due September 2007, interest at 5.00% at  June 30, 2004                                                                                   |       | 139               |       | — |   |
| Capitalized lease  obligations                                                                                                                                                                    |       | 854               |       | 644 |   |
| Thailand  mortgage, interest at 5.75%, due May 2011                                                                                                                                          |       | 678               |       | — |   |
| Thailand  construction in progress accrued against construction loan, interest at  5.75%, due 78 months after completion of construction                                                          |       | 66                |       | — |   |
| 81¤2%  Convertible Subordinated Debentures, due 2008, interest payable semi-annually  and convertible at holders’ option at a price of $212.50 per share at any  time prior to maturity |       | 1,060             |       | 1,580 |   |
| Obligations to  former officers, employees and directors under consulting and deferred fee  agreements fully retired in fiscal 2004                                                               |       | —            |       | 972 |   |
| IRS note, paid in  full during fiscal 2004                                                                                                                                                        |       | —            |       | 2,448 |   |
| Other                                                                                                                                                                                             |       | 478               |       | 480 |   |
|                                                                                                                                                                                              |       | 4,635             |       | 8,170 |   |
| Less current  maturities                                                                                                                                                                          |       | 1,371             |       | 2,495 |   |
| Total long-term  debt                                                                                                                                                                             |       | $                 | 3,264      |   | $ | 5,675 |   |

 

The aggregate amounts ofminimum maturities of long-term debt for the indicated fiscal years (excludingpresent value of minimum capitalized lease obligations of $854) are as follows(in thousands):
| Fiscal 2005 |   | $     | 931    |   |
|-------------|--------|-------|--------|--------|
| Fiscal 2006 |   | 725   |   |
| Fiscal 2007 |   | 299   |   |
| Fiscal 2008 |   | 187   |   |
| Fiscal 2009 |   | 1,243 |   |
| Thereafter  |   | 396   |   |
|        |   | $     | 3,781  |   |

 

In August 1988, we issued 81¤2%Convertible Subordinated Debentures due 2008. The debentures may be convertedat the holders’ option into shares of our common stock at a conversion price of$212.50 per share at any time prior to maturity. We may redeem the ConvertibleSubordinated Debentures at 100% of the principal amount prior to maturity. TheConvertible Subordinated Debentures are subordinated to the prior payment ofall senior indebtedness as defined in the indenture. During fiscal 2004 we paid$171,000 to retire $520,000 of debentures resulting in a gain on extinguishmentof $349,000.

In March 1996, we entered into a settlementagreement with certain of our former officers, key employees and directors (the“Participants”) to restructure our outstanding obligations under severalconsulting programs and deferred fee arrangements, which had provided forpayments to the Participants after their retirement from us or from our Boardof Directors. Under terms of the settlement, the 

F-18

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Participants agreed torelinquish all future payments due them under these consulting programs anddeferred fee arrangements in return for an aggregate of 29,793 Common Stockpurchase warrants, Series G. We were obligated to pay the Participants$50.00 for each warrant which remained unexercised on the June 1, 1998warrant expiration date, payable in semiannual installments over two to tenyears. As the warrants expired unexercised, at June 1, 1998 we accrued thepresent value of our payment obligations aggregating $836,000.

During fiscal 2003, wesettled with one of these participants by paying an aggregate of $19,000 andfully retiring $64,000 of debt, resulting in a $45,000 gain from extinguishmentof debt. During fiscal 2004, we settled with all remaining participants paying$465,000 to fully retire $996,000 of debt and accrued interest for a gain onextinquishment of debt of $531,000. There was no outstanding indebtedness tothe participants at June 30, 2004.

**LeaseCommitments**

Future minimum leasepayments at June 30, 2004 were as follows (in thousands):
| ** **                               | ** ** | **Capital** | ** ** | **Operating** | ** ** |
|------------------------------------------|------------|-------------|------------|---------------|------------|
| ** **                               | ** ** | **leases**  | ** ** | **leases**    | ** ** |
| Fiscal 2005                              |       |        | $          | 459           |       |   | $ | 2,473 |   |
| Fiscal 2006                              |       |        | 293        |          |       | 2,049 |   |
| Fiscal 2007                              |       |        | 125        |          |       | 2,042 |   |
| Fiscal 2008                              |       |        | —     |          |       | 2,096 |   |
| Fiscal 2009                              |       |        | —     |          |       | 2,134 |   |
| Thereafter                               |       |        | —     |          |       | 4,193 |   |
| Total                                    |       |        | 877        |          |       | $ | 14,987 |   |
| Less: interest                           |       |        | (23        | )             |       |   |   |
| Present value of minimum  lease payments |       |        | $          | 854           |       |   |   |   |

 

Rental expense foroperating leases amounted to $2.2 million, $2.7 million and $2.3 million forfiscal 2004, 2003 and 2002, respectively.

**NOTE7—INCOMETAXES**

In connection with the filing of our federal incometax return for fiscal year 1995, and acting on advice of our tax advisor, wefiled for a refund to carry back losses described in Section 172(f) of theInternal Revenue Code of 1986, as amended (the “IRC”). Section 172(f) ofthe IRC provides for a ten year net operating loss (“NOL”) carryback forspecific losses attributable to (1) a product liability or (2) aliability arising under a federal or state law or out of any tort if the actgiving rise to such liability occurs at least three years before the beginningof the taxable year. As a result of these refund filings, in September andOctober 1995 we received federal income tax refunds totaling $1.9 million,net of costs associated with applying for such refunds, and recognized anincome tax benefit of $1.1 million in the quarter ended December 31, 1995.The balance of the net refunds received, $761,000, was recorded as income taxespayable, pending resolution by the Internal Revenue Service (“IRS”) of theappropriateness and the amount of the 172(f) carryback.

Beginning in May 1997, we came under IRS auditwith respect to such refund claims. In September 1998, we received taxdeficiency notices from the IRS in which the IRS advised us that it wasdisallowing substantially all of the tax refunds received by us in 1995 whichhad been recorded as an income tax benefit.

In December 2001, we reached a settlement withthe Appeals Division of the IRS concerning the Section 172(f) issues andfinalized an installment payment plan in July 2003. At June 30, 2003,we had a 

F-19

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total liability, includingaccrued interest, of $2.4 million of which $454,000 was short term. Installmentpayments that included principal and interest were established at $45,000 permonth for 60 months. In June 2004 we paid approximately $2.0 million tofully retire the IRS liability.

The income tax provision(benefit), all current, consists of the following (in thousands):
| ** ** | ** ** | **Year ended June 30,** | ** ** |
|------------|------------|----------------------------------------|------------|
| ** ** | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| Federal    |       | $                                      | 19         |   | $ | — |   | $ | (169 | ) |
| State      |       | 92                                     |       | — |   | (56 | ) |
|       |       | $                                      | 111        |   | $ | — |   | $ | (225 | ) |

 

Temporary differencesbetween financial statement carrying amounts and the tax bases of assets andliabilities that give rise to significant portions of the deferred tax assetsand liabilities relate to the following (in thousands):
| ** **                               | ** ** | **June 30,** | ** ** |
|------------------------------------------|------------|-------------------|------------|
| ** **                               | ** ** | **2004**          | ** ** | **2003** | ** ** |
| Deferred tax assets:                     |       |              |       |   |   |
| Accrued employee benefits                |       | $                 | 131        |   | $ | 481 |   |
| Reserves and allowances                  |       | 529               |       | 570 |   |
| Domestic NOL carryforwards               |       | 15,611            |       | 15,887 |   |
| Foreign NOL carryforwards                |       | 220               |       | 270 |   |
| Depreciation                             |       | 309               |       | 233 |   |
| Other                                    |       | 466               |       | 640 |   |
| Total deferred  tax assets               |       | 17,266            |       | 18,081 |   |
| Less valuation allowance                 |       | (17,266           | )          | (18,081 | ) |
| Net deferred tax assets  after allowance |       | $                 | —     |   | $ | — |   |

 

In assessing the realizability of net deferred taxassets, management considers whether it is more likely than not that someportion or all of the net deferred tax assets will be realized. The ultimaterealization of net deferred tax assets is dependent upon the generation offuture income. Based on the level of historical losses, management believesthat it does not have the basis to conclude that it is more likely than notthat the deferred tax assets will be realized, and therefore, has recorded a100% valuation allowance to offset the net deferred tax assets. The valuationallowance was $17.3 million and $18.1 million as of June 30, 2004 and2003, respectively. The net change in the total valuation allowance for theyears ended June 30, 2004, 2003 and 2002 was a decrease of $0.8 million,increase of $0.3 million and increase of $1.6 million, respectively.

F-20

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Theprovision for income taxes for continuing operations differs from an amountcomputed using the statutory federal income tax rate as follows (in thousands):
| ** **                                                  | ** ** | **Year ended June 30,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                  | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| Federal tax provision/(benefit)  computed at statutory rate |       | $                                      | 1,042      |   | $ | (1,163 | ) | $ | (1,754 | ) |
| State income tax,  net of federal benefit                   |       | 60                                     |       | — |   | (67 | ) |
| Untaxed foreign  earnings                                   |       | (173                                   | )          | (80 | ) | (5 | ) |
| Write-off or  amortization of goodwill                      |       | —                                 |       | 143 |   | 13 |   |
| Reduction in  foreign NOL due to divestiture                |       | —                                 |       | 775 |   | — |   |
| Net change in  valuation allowance                          |       | (815                                   | )          | 317 |   | 1,606 |   |
| Adjustment to the  deferred tax assets                      |       | (24                                    | )          | -— |   | (34 | ) |
| Other                                                       |       | 21                                     |       | 8 |   | 16 |   |
| Income tax provision  (benefit) from continuing operations  |       | $                                      | 111        |   | $ | — |   | $ | (225 | ) |

 

As of June 30, 2004, we had U.S. federal NOLcarryforwards of approximately $43.0 million, expiring in 2005 through 2023,and state NOL carryforwards of $21.3 million, expiring in 2005 through 2013. AtJune 30, 2004, the NOL carryforward for federal alternative minimum taxpurposes was approximately $40.2 million.

The utilization of net operating loss and creditcarryforwards may be limited under the provisions of Internal Revenue Code Section 382and similar state provisions.

Pretax income (loss) from our U.S. continuingoperations for fiscal 2004, 2003 and 2002 was $2.5 million, $(4.4) million and$(5.4) million, respectively. Pretax income from our Thailand operation forfiscal 2004, 2003 and 2002 was $575,000, $267,000 and $14,000, respectively.

Our Thailand operation wasgranted an investment promotion from the Thailand government, which includesexemption from corporate income taxes for a seven year period from the dateoperating income is first derived. This exemption expired in 2004. Prior to thepurchase of our Thailand operation, Thailand had NOLs of approximately $900,000.As a result of the acquisition, we acquired deferred tax assets of $270,000 anda related valuation allowance of $270,000. These NOLs from prior years can becarried forward for at least five years after the expiration of theaforementioned investment promotion. At June 30, 2004, the Thailand NOLsamounted to approximately $735,000.

**NOTE 8—STOCKHOLDERS’EQUITY**

**StockOption Plans**

We have in effect several stock-based plans underwhich non-qualified and incentive stock options and restricted stock awardshave been granted to employees and directors. Subject to the discretion of theBoard of Directors (the “Board”), employee stock options generally becomeexercisable over a period of three years as determined by the Board, andgenerally have a 10-year exercise term when granted.

The exercise price of all incentive stock options mustbe equal to or greater than the market value of the shares on the date of grant.The exercise price of non-statutory stock options must be at least 85% of themarket value of the Common Stock on the date of grant.

In November, 2003, the 2003 Equity Incentive Plan wasadopted, which replaced and terminated, with respect to new awards to employeesand directors, all previous stock-based plans adopted in 1993, 1996 and 1998. Optionswhich were then outstanding under the 1993, 1996 and 1998 Plans were unaffectedby the adoption of the 2003 Plan. Upon the adoption of the 2003 Plan, eligiblenon-employee directors received options to purchase an aggregate of 100,564shares at an exercise price of $6.04, the market value of Common Stock on thegrant date.

F-21

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Prior to its termination in November 2003, underthe Amended and Restated 1998 Non-Employee Directors Stock Plan, each eligibledirector received Company securities (Common Stock or stock options) valued at$1,000 for attendance at each Board meeting and $500 for attendance at eachBoard committee meeting. Additionally, annually each non-employee directorreceived Company securities with a fair market value of $12,000 and eachnon-employee director was granted 5,000 stock options upon initial election orre-election to the board of directors. In fiscal 2003 and 2002, options topurchase a total of 77,061 and 15,516 shares, respectively, were granted to ournon-employee directors at exercise prices ranging from $0.75 to $5.78 in 2003and $2.40 to $7.75 in 2002. No options were granted in fiscal 2004 under the1998 Plan. The fair value of Common Stock issued in connection with thesedirector compensation plans is equal to the market value of Common Stock on thegrant date. For purposes of our SFAS No. 123 disclosure, the fair value ofstock options granted in connection with these director plans is determinedusing the Black-Scholes option pricing model (as discussed in Note 1) usingdata and assumptions as of the grant date. The exercise price of all stock optionsis equal to the market value at the date of grant. In fiscal 2002, we issued254 shares of Common Stock for director compensation under the 1998 Plan.

Activityunder the employee and non-employee director stock option plans for fiscalyears 2004, 2003 and 2002 was as follows:
| ** **                               | ** ** | ** ** | ** ** | **Weighted average  exercise price** | ** ** |
|------------------------------------------|------------|------------|------------|------------------------------------------------|------------|
| ** **                               | ** ** | **Shares** | ** ** | **per share**                             | ** ** |
| Shares under  option, June 30, 2001 |       | 573,757    |       |                                           | $          | 5.37 |   |   |
| Granted                                  |       | 103,516    |       |                                           | 4.97       |   |   |
| Expired or canceled                      |       | (68,330    | )          |                                           | 5.68       |   |   |
| Exercised                                |       | (1,750     | )          |                                           | 4.25       |   |   |
| Shares under option,  June 30, 2002 |       | 607,193    |       |                                           | $          | 5.28 |   |   |
| Granted                                  |       | 274,011    |       |                                           | 1.24       |   |   |
| Expired or canceled                      |       | (321,020   | )          |                                           | 5.17       |   |   |
| Exercised                                |       | —     |       |                                           | —     |   |   |
| Shares under  option, June 30, 2003 |       | 560,184    |       |                                           | $          | 3.19 |   |   |
| Granted                                  |       | 149,064    |       |                                           | 5.78       |   |   |
| Expired or canceled                      |       | (46,891    | )          |                                           | 5.30       |   |   |
| Exercised                                |       | (101,673   | )          |                                           | 3.79       |   |   |
| Shares under option,  June 30, 2004 |       | 560,684    |       |                                           | $          | 3.60 |   |   |

 

Thefollowing table summarizes information about shares under option at June 30,2004:
| ** **                                  | ** ** | **Outstanding** | ** ** | **Exercisable**          | ** ** |
|---------------------------------------------|------------|-----------------|------------|--------------------------|------------|
| **Range of exercise prices** | ** ** | ** **      | ** ** | **Options  outstanding** | ** ** | **Expiration  date  (fiscal year end)** | ** ** | **Weighted  average  exercise  price** | ** ** | **Options  exercisable** | ** ** | **Weighted  average  exercise  price** | ** ** |
| $1.44 - 8.36                                |       |            | 144,064    |                     |       |   | 2014 |   |   |   | $ | 5.95 |   |   |   | 100,564 |   |   |   | $ | 5.62 |   |   |
| $0.70 - 5.78                                |       |            | 246,965    |                     |       |   | 2013 |   |   |   | $ | 1.09 |   |   |   | 83,627 |   |   |   | $ | 1.33 |   |   |
| $2.40 - 7.75                                |       |            | 51,965     |                     |       |   | 2012 |   |   |   | $ | 5.25 |   |   |   | 29,465 |   |   |   | $ | 5.46 |   |   |
| $3.75 - 9.75                                |       |            | 70,153     |                     |       |   | 2011 |   |   |   | $ | 5.40 |   |   |   | 70,153 |   |   |   | $ | 5.40 |   |   |
| $3.38 - 6.50                                |       |            | 38,500     |                     |       |   | 2010 |   |   |   | $ | 3.85 |   |   |   | 38,500 |   |   |   | $ | 3.85 |   |   |
| $7.50 - 10.00                               |       |            | 9,037      |                     |       |   | 2009 |   |   |   | $ | 9.86 |   |   |   | 9,037 |   |   |   | $ | 9.86 |   |   |
| Total                                       |       |            | 560,684    |                     |       |   |   |   |   |   | $ | 3.60 |   |   |   | 331,346 |   |   |   | $ | 4.39 |   |   |
|                                             |            |                 |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-22

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At June 30, 2004,under the 2003 Equity Incentive Plan there were 315,936 options available for future grants.

**PREFERREDSTOCK**

In September 2003, we sold in a private placement250,000 shares of convertible Series A Preferred Stock at $2.00 per sharefor gross offering proceeds of $500,000. The shares are convertible into commonstock initially on a one-to-one basis and are redeemable, solely at the Company’soption, at 1.5 times the purchase price after 180 days from the date ofissuance. Holders of Series A Preferred Stock have voting rights equal toholders of common stock on an as converted basis and enjoy a liquidation preferenceto any junior stock whereby preferred holders receive 1.5 times their initialinvestment plus any accrued dividends before any distributions to juniorstockholders. Preferred holders are entitled to receive, on January 1 ofeach year, out of any assets legally available therefor, payable when, as andif declared by the Board, prior and in preference to any declaration or paymentof any dividend on Junior Securities, dividends at the rate of 9% of thePurchase Price plus any accrued an unpaid dividends per annum. Such dividendsshall accrue annually in arrears whether or not declared by the Board ofDirectors 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 the preferred stock amounted to $36,000 at June 30,2004.

Subsequent to June 30,2004, the 250,000 shares of preferred stock and accrued dividends ofapproximately $36,000 were converted into 268,369 shares of common stock.

**WARRANTS**

During fiscal 2004, theCompany issued warrants to purchase 15,000 shares of common stock at $7.95 pershare in exchange for professional services to be rendered over a 14-monthperiod. The fair value of the warrants, which amounted to $91,000 at June 30,2004, is being amortized to expense over the 14-month service period. In 2004,$26,000 was charged to administrative and selling expense.

F-23

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**NOTE 9—EARNINGS (LOSS) PER SHARE**

Theweighted average number of common shares outstanding includes the effect ofpreferred shares convertible into 250,000 common shares. Common stockequivalents used in the determination of diluted earnings per share include theeffect, when such effect is dilutive, of our outstanding employee stockoptions, the 8-1/2% Convertible Subordinated Debentures (which are convertibleinto 7,435 shares of Common Stock at $212.50 per share of Common Stock) andwarrants to purchase 15,000 shares of common stock at $7.95 per share. Thefollowing is a summary of the calculation of basic and diluted earnings pershare (dollars in thousands, except per share data):
| ** **                                                    | ** ** | **Year ended, June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                                | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income (loss)                                             |       | $                                       | 2,953      |   | $ | (4,616 | ) | $ | (5,984 | ) |
| Weighted average shares:                                      |       |                                    |       |   |   |   |   |
| Basic weighted average number of common shares  outstanding   |       | 2,524,517                               |       | 2,284,343 |   | 2,284,018 |   |
| Diluted effect of  outstanding                                |       |                                    |       |   |   |   |   |
| options to purchase common stock                              |       | 239,606                                 |       | — |   | — |   |
| Diluted weighted average number of common shares  outstanding |       | 2,764,123                               |       | 2,284,343 |   | 2,284,018 |   |
| Earnings (loss) per  share:                                   |       |                                    |       |   |   |   |   |
| Basic                                                         |       | $                                       | 1.17       |   | $ | (2.02 | ) | $ | (2.62 | ) |
| Diluted                                                       |       | $                                       | 1.07       |   | $ | (2.02 | ) | $ | (2.62 | ) |

 

Options and warrants to purchase approximately 187,501and 15,000 shares of common stock, respectively, at prices ranging from $6.04to $10.00 that were outstanding at June 30, 2004 are not included in thecomputation of diluted earnings per share for the year ended June 30,2004, because the exercise prices of these options and warrants were greaterthan the average market price of our common stock.

Because we had a net loss for the year ended June 30,2003, there were no common stock equivalents that had a dilutive effect onearnings per share. However, if we had reported net income rather than a lossfor the year ended June 30, 2003, the additional diluted sharesoutstanding would have been 4,322. Further, options to purchase approximately479,436 shares of Common Stock at prices ranging from $0.79 to $10.00 wouldhave been excluded from the computation of diluted earnings per share for theyear ended June 30, 2003, because the impact of their inclusion would beanti-dilutive.

Because we had a net loss for the year ended June 30,2002, there were no common stock equivalents which had a dilutive effect onearnings per share. However, if we had reported net income rather than a lossfor the year ended June 30, 2002, the additional diluted sharesoutstanding would have been 172. Further, options to purchase approximately603,500 shares of Common Stock at prices ranging from $3.38 to $10.00 wouldhave been excluded from the computation of diluted earnings per share for theyear ended June 30, 2003, because the impact of their inclusion would beanti-dilutive.

Convertible subordinateddebentures aggregating $1,060,000 at June 30, 2004 and $1,580,000 at June 30,2003 and 2002, due in 2008 and convertible at a price of $212.50 per shareprior to maturity were outstanding during fiscal 2004, 2003 and 2002 but wereexcluded in the computation of diluted earnings per share because the effectwould be anti-dilutive.

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**NOTE 10—OTHER FINANCIAL INFORMATION**

**Valuation and Qualifying Accounts and Reserves**

Followingis our schedule of valuation and qualifying accounts and reserves for fiscalyears 2004, 2003 and 2002 (in thousands):
| ** **                                          | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------|------------|-------------------|------------|
| **Allowance for Doubtful Accounts:** | ** ** | ** **        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Balance at  beginning of period                     |       | $                 | 657        |   | $ | 380 |   | $ | 407 |   |
| Charged to costs  and expenses                      |       | 59                |       | 521 |   | 70 |   |
| Deductions                                          |       | (49               | )          | (20 | ) | (97 | ) |
| Sale of  subsidiary                                 |       | (261              | )          | (224 | ) | — |   |
| Balance at end of period                            |       | $                 | 406        |   | $ | 657 |   | $ | 380 |   |
|                                                     |            |                   |            |  |  |  |  |  |  |  |  |  |

 

**NOTE 11—COMMITMENTSAND CONTINGENCIES**

**Environmental Matters**

Since the early 1990s, wecontinue to be involved in certain remediation and investigative studiesregarding soil and groundwater contamination at the site of a former printedcircuit board manufacturing plant in Anaheim, California. One of our formersubsidiaries, Aeroscientific Corp., leased the Anaheim facility. Under theterms of a cost sharing agreement, the remaining remediation costs arecurrently being shared on a 50-50 basis with the landlord. We have paid $6,000,$2,000 and $15,000 as our share of the remediation costs for fiscal 2004, 2003and 2002, respectively. There is no environmental insurance coverage for thisremediation. At June 30, 2004, we had a reserve of $416,000 for futureremediation costs. Management, based in part on consultations with outsideenvironmental engineers and scientists, believes that this reserve is adequateto cover its share of future remediation costs at this site. However, thefuture actual remediation costs could differ significantly from the estimates. Further,our portion could potentially exceed the amount of our reserve. Our liabilityfor remediation in excess of our reserve could have a material adverse impacton our business, financial condition and results of operations.

**NOTE 12—GEOGRAPHICINFORMATION**

Weoperate in a single business segment—the EMS industry. Our revenues andlong-lived assets, net of accumulated depreciation, by geographic area are asfollows (in thousands):
| ** **         | ** ** | **Year ended June 30,** | ** ** |
|--------------------|------------|----------------------------------------|------------|
| ** **         | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:          |       |                                   |       |   |   |   |   |
| United States      |       | $                                      | 82,702     |   | $ | 65,643 |   | $ | 63,146 |   |
| Thailand           |       | 10,581                                 |       | 5,080 |   | 1,412 |   |
| Total              |       | $                                      | 93,283     |   | $ | 70,723 |   | $ | 64,558 |   |
| Long-lived assets: |       |                                   |       |   |   |   |   |
| United States      |       | $                                      | 4,448      |   | $ | 5,324 |   |   |   |
| Thailand           |       | 1,655                                  |       | 217 |   |   |   |
| Total              |       | $                                      | 6,103      |   | $ | 5,541 |   |   |   |

 

Northern Ireland revenues of $6,277,000 and $9,664,000in 2003 and 2002, respectively, have been reported as a component of loss fromdiscontinued operations in our consolidated statements of operations.

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We had sales to twocustomers which accounted for 12.7% and 11.1% of revenues in fiscal 2004, salesto three customers which accounted for 16.8%, 11.1% and 8.8% of revenues infiscal 2003, and sales to three customers which accounted for 18.9%, 16.2% and10.4% of revenues in fiscal 2002.

**NOTE 13—QUARTERLYRESULTS OF OPERATIONS (UNAUDITED)**

Thefollowing tables set forth certain unaudited financial data for each of thelast eight quarters. This information, in management’s opinion, reflects alladjustments (consisting only of normal recurring adjustments) necessary for afair presentation of the information for the quarters presented. The operatingresults for any quarter are not necessarily indicative of results for anyfuture period (in thousands except earnings per share).
| ** **                      | ** ** | **Quarters ended** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| **Fiscal 2004**            | ** ** | ** **              | ** ** | **Sep 30** | ** ** | **Dec 31** | ** ** | **Mar 31** | ** ** | **Jun 30** | ** ** | **Total** | ** ** |
| Revenues                        |       | $                       | 20,692     |   | $ | 20,132 |   | $ | 22,556 |   | $ | 29,903 |   | $ | 93,283 |   |
| Gross profit                    |       | $                       | 2,684      |   | $ | 2,209 |   | $ | 2,388 |   | $ | 4,183 |   | $ | 11,464 |   |
| Net Income                      |       | $                       | 1,312      |   | $ | 258 |   | $ | 148 |   | $ | 1,235 |   | $ | 2,953 |   |
| Earnings per  share—basic  |       | $                       | 0.58       |   | $ | 0.11 |   | $ | 0.06 |   | $ | 0.47 |   | $ | 1.17 |   |
| Earning per  share—diluted |       | $                       | 0.56       |   | $ | 0.09 |   | $ | 0.05 |   | $ | 0.42 |   | $ | 1.07 |   |
|                            |       |                    |       |   |   |   |   |   |   |   |   |
|                                 |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                                               | ** ** | **Quarters ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| **Fiscal 2003**                                                                                     | ** ** | ** **              | ** ** | **Sep 30** | ** ** | **Dec 31** | ** ** | **Mar 31** | ** ** | **Jun 30** | ** ** | **Total** | ** ** |
| Revenues                                                                                                 |       | $                       | 17,587     |   | $ | 15,457 |   | $ | 17,430 |   | $ | 20,249 |   | $ | 70,723 |   |
| Gross profit                                                                                             |       | $                       | 1,537      |   | $ | 895 |   | $ | 1,920 |   | $ | 2,651 |   | $ | 7,003 |   |
| (Loss) income from continuing operations before cumulative  effect of change in accounting principle     |       | $                       | (649       | ) | $ | (3,132 | ) | $ | (294 | ) | $ | 1,073 |   | $ | (3,002 | ) |
| Net (loss) income                                                                                        |       | $                       | (1,203     | ) | $ | (3,542 | )(A) | $ | (1,050 | ) | $ | 1,179 |   | $ | (4,616 | ) |
| Basic and diluted  (loss) earnings per share before cumulative effect of change in accounting  principle |       | $                       | (0.29      | ) | $ | (1.36 | ) | $ | (0.13 | ) | $ | 0.47 |   | $ | (1.31 | ) |
| Basic and diluted  (loss) earnings per share                                                             |       | $                       | (0.53      | ) | $ | (1.55 | ) | $ | (0.46 | ) | $ | 0.52 |   | $ | (2.02 | ) |
|                                                                                                          |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(A)       Included in net loss forthe three months ended December 31, 2002 are costs incurred in connection withthe closure and transition of the Company’s San Diego facility of approximately$1.6 million consisting of severance cost of $287,000, write-off of leaseholdimprovements of $370,000 and accrual of remaining lease obligation of$4,011,000, less sublease income of $3,038,000.

The loss from continuing operations for fiscal 2003above does not include the results from our European operations, such resultsbeing aggregated in our consolidated financial statements as “Loss fromdiscontinued operations”. Europe revenues excluded in the table below that werepreviously reported in the first and second quarters of fiscal 2003 on theCompany’s Forms 10-Q for those periods were $3.1 million and $1.8million, respectively.

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