##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 ****
 FORM 10-Q
 ****
 þ
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended June 2, 2007.
 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 For the transition period fromto.
 Commission
File Number 0-10078
 HEI, Inc.
  Minnesota
    
    41-0944876(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)PO Box 5000, 1495 Steiger Lake Lane, Victoria, MN
    
    55386(Address of principal executive offices)
    
    (Zip Code)
 
  þ o
  o o þ
 o þ




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##### Table of Contents



TABLE OF CONTENTS
  PagePart I  Financial Information (Unaudited)Item 1. Financial StatementsConsolidated Balance Sheets
    
    
    3Consolidated Statements of Operations
    
    
    4Consolidated Statements of Cash Flow
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    20Item 4. Controls and Procedures
    
    
    21Part II  Other InformationItem 1. Legal Proceedings
    
    
    21Item 1A. Risk Factors
    
    
    22Item 6. Exhibits
    
    
    22Signature
    
    
    23Form of Credit and Security AgreementForm of Credit and Security Agreement302 Certification of CEO and CFO906 Certification of CEO and CFO
 2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 HEI, Inc.
 
 Consolidated Balance Sheets
 June 2,
    
    
    September 2,2007
    
    
    2006(Unaudited)
    
    
    (Audited)(In thousandsexcept per share and share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    96
    
    
    $
    674Accounts receivable, net of allowance for doubtful accounts
of $116 and $124, respectively
    
    
    5,604
    
    
    
    9,205Inventories
    
    
    4,717
    
    
    
    7,000Deferred income taxes
    
    
    830
    
    
    
    830Other current assets
    
    
    262
    
    
    
    316Total current assets
    
    
    11,509
    
    
    
    18,025Property and equipment:Land
    
    
    216
    
    
    
    216Building and improvements
    
    
    4,388
    
    
    
    4,374Fixtures and equipment
    
    
    23,638
    
    
    
    24,406Accumulated depreciation
    
    
    (21,740
    )
    
    
    (21,279
    )Net property and equipment
    
    
    6,502
    
    
    
    7,717Security deposit
    
    
    524
    
    
    
    550Other long-term assets
    
    
    593
    
    
    
    580Total assets
    
    $
    19,128
    
    
    $
    26,872LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Line of credit
    
    $
    
    
    
    $
    5,948Current maturities of long-term debt
    
    
    854
    
    
    
    1,038Accounts payable
    
    
    2,856
    
    
    
    3,735Accrued liabilities
    
    
    1,704
    
    
    
    2,184Total current liabilities
    
    
    5,414
    
    
    
    12,905Deferred income taxes
    
    
    830
    
    
    
    830Other long-term liabilities, less current maturities
    
    
    1,676
    
    
    
    1,549Long-term debt, less current maturities
    
    
    7,159
    
    
    
    2,824Total other long-term liabilities, less current maturities
    
    
    9,665
    
    
    
    5,203Total liabilities
    
    
    15,079
    
    
    
    18,108Commitments and contingenciesShareholders equity:Undesignated stock; 5,000,000 shares authorized; none issued
    
    
    
    
    
    
    Convertible preferred stock, $.05 par; 167,000 shares authorized; 32,000 shares issued and
outstanding at both June 2, 2007 and September 2, 2006; liquidation preference at $26 per share
(total liquidation preference $832,000) at both June 2, 2007 and September 2, 2006
    
    
    2
    
    
    
    2Common stock, $.05 par; 20,000,000 shares authorized; 9,562,000 and 9,504,000 shares issued and
9,514,000 and 9,504,000 shares outstanding at June 2, 2007 and September 2, 2006,
respectively
    
    
    476
    
    
    
    475Paid-in capital
    
    
    27,748
    
    
    
    27,581Accumulated deficit
    
    
    (24,160
    )
    
    
    (19,226
    )Notes receivable-related parties-officers and former directors
    
    
    (17
    )
    
    
    (68
    )Total shareholders equity
    
    
    4,049
    
    
    
    8,764Total liabilities and shareholders equity
    
    $
    19,128
    
    
    $
    26,872
  3




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##### Table of Contents



HEI, Inc.
 
 Consolidated Statements of Operations (Unaudited)
 Three Months Ended
    
    
    Nine Months EndedJune 2, 2007
    
    
    May 27, 2006
    
    
    June 2, 2007
    
    
    May 27, 2006(In thousands)
    
    
    (In thousands)Net sales
    
    $
    9,830
    
    
    $
    13,219
    
    
    $
    33,331
    
    
    $
    38,724Cost of sales
    
    
    9,631
    
    
    
    10,781
    
    
    
    30,791
    
    
    
    31,816Gross profit
    
    
    199
    
    
    
    2,438
    
    
    
    2,540
    
    
    
    6,908Operating expenses:Selling, general and administrative
    
    
    1,533
    
    
    
    2,247
    
    
    
    4,898
    
    
    
    6,759Research, development and engineering
    
    
    547
    
    
    
    1,062
    
    
    
    1,959
    
    
    
    3,140Total operating expenses
    
    
    2,080
    
    
    
    3,309
    
    
    
    6,857
    
    
    
    9,899Operating loss
    
    
    (1,881
    )
    
    
    (871
    )
    
    
    (4,317
    )
    
    
    (2,991
    )Other income (expenses):Interest expense, net
    
    
    (350
    )
    
    
    (206
    )
    
    
    (1,119
    )
    
    
    (429
    )Other income (expense), net
    
    
    476
    
    
    
    (34
    )
    
    
    502
    
    
    
    (9
    )Net loss
    
    $
    (1,755
    )
    
    $
    (1,111
    )
    
    $
    (4,934
    )
    
    $
    (3,429
    )Net loss per common share:Basic and Diluted
    
    $
    (0.18
    )
    
    $
    (0.12
    )
    
    $
    (0.52
    )
    
    $
    (0.36
    )Weighted average common shares outstanding:Basic and Diluted
    
    
    9,514
    
    
    
    9,491
    
    
    
    9,509
    
    
    
    9,457
  4




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HEI, Inc.
 
 Consolidated Statements of Cash Flows (Unaudited)
 Nine Months EndedJune 2, 2007
    
    
    May 27, 2006(In thousands)Cash flow from operating activities:Net loss
    
    $
    (4,934
    )
    
    $
    (3,429
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    1,529
    
    
    
    1,848Loss on disposal of property and equipment
    
    
    4
    
    
    
    33Stock based compensation expense
    
    
    168
    
    
    
    387Changes in operating assets and liabilities:Accounts receivable
    
    
    3,601
    
    
    
    1,231Inventories
    
    
    2,283
    
    
    
    222Other current assets
    
    
    54
    
    
    
    323Accounts payable
    
    
    (879
    )
    
    
    474Accrued liabilities and other long-term liabilities
    
    
    (353
    )
    
    
    (1,247
    )Net cash flow provided by (used in) operating activities
    
    
    1,473
    
    
    
    (158
    )Cash flow from investing activities:Additions to property and equipment
    
    
    (384
    )
    
    
    (923
    )Proceeds from sale of assets
    
    
    177
    
    
    
    83Additions to patents
    
    
    (9
    )
    
    
    (7
    )Refund of security deposit
    
    
    26
    
    
    
    1,166Net cash flow provided by (used in) investing activities
    
    
    (190
    )
    
    
    319Cash flow from financing activities:Proceeds from issuance of stock, net
    
    
    
    
    
    
    47Former director note repayment
    
    
    51
    
    
    
    139Repayment of long-term debt
    
    
    (914
    )
    
    
    (386
    )Proceeds form long-term debt, net of debt issuance costs
    
    
    4,950
    
    
    
    Net repayments on line of credit
    
    
    (5,948
    )
    
    
    (143
    )Net cash flow provided by (used in) financing activities
    
    
    (1,861
    )
    
    
    (343
    )Net increase (decrease) in cash and cash equivalents
    
    
    (578
    )
    
    
    (182
    )Cash and cash equivalents, beginning of period
    
    
    674
    
    
    
    351Cash and cash equivalents, end of period
    
    $
    96
    
    
    $
    169Supplemental disclosures of cash flow information:Interest paid
    
    $
    1,089
    
    
    $
    435Capital lease obligations related to equipment acquisitions
    
    $
    
    
    
    $
    2,144Issuance of common stock to landlord recorded as long-term asset
    
    $
    
    
    
    $
    336
  5




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HEI, Inc.
 
 Notes to Unaudited Consolidated Financial Statements
 (1) Basis of Financial Statement Presentation
     Summary of Significant Accounting Policies
 Revenue Recognition.
  Inventories.
 Property and Equipment.
  6




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Use of Estimates.
 Reclassifications.
 Income Taxes.
 (2) Liquidity
     7




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
    
    Refinancing our debt to improve cash flow.
    
    Emphasis on sales efforts in all of our business segments.
    
    Focusing on gross margin improvements at all segments by focusing on our material
costs, labor costs and overhead structures.
    
    Structuring our staffing to work within our current sales levels for all of our
general and administrative costs and engineering costs, and to reorganize the staff as
necessary to position the Company for growth.
    
    Pursuing additional sublease tenants for the excess space in our Boulder facility
while allowing for adequate room for expansion in that the AMO segment. This will help
to offset a portion of the operating costs and lease costs of that facility.
    
    Reduction in inventories by reviewing buying procedures and reducing any excess on
hand inventory while maintaining the required inventories to meet customer demand. Our
initiatives targeted a reduction in inventories by a total of $1 million by the end of
Fiscal 2007, and we exceeded that target by over $500,000 during the first nine months
of Fiscal 2007.
   8




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(3) Stock Based Compensation
  Stock Options
   Restricted Stock
   (4) Other Financial Statement Data
  9




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June 2,
    
    
    September 2,2007
    
    
    2006Inventories:Purchased parts
    
    $
    3,436
    
    
    $
    4,735Work in process
    
    
    346
    
    
    
    671Finished goods
    
    
    935
    
    
    
    1,594$
    4,717
    
    
    $
    7,000Accrued liabilities:Employee related costs (1)
    
    $
    1,214
    
    
    $
    1,346Accrued taxes
    
    
    148
    
    
    
    396Accrued audit, professional, board, public
reporting and interest
    
    
    161
    
    
    
    120Current maturities of other long-term liabilities
    
    
    80
    
    
    
    79Other accrued liabilities
    
    
    101
    
    
    
    243$
    1,704
    
    
    $
    2,184Other long-term liabilities:Remaining lease obligation, less estimated sublease
proceeds
    
    $
    484
    
    
    $
    513Accrued lease expense
    
    
    774
    
    
    
    588Unfavorable operating lease, net
    
    
    498
    
    
    
    527Total
    
    
    1,756
    
    
    
    1,628Less current maturities
    
    
    80
    
    
    
    79Total other long-term liabilities
    
    $
    1,676
    
    
    $
    1,549
 
 (1) This total includes Accrued Severance Related Expenses. During the first three
quarters of 2007, the Company reduced its workforce in an effort to reduce operating expenses.
The Company recorded $182,000 and $582,000 in expense for these staff reductions of which $145,000
related to the resignation of the former CEO, during three and nine months ended June 2, 2007,
respectively. At June 2, 2007, the remaining balance of the Accrued Severance Related Expenses was
$96,000 and will be paid prior to the end of Fiscal 2007. 10




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(5) Long-Term Debt
  June 2,
    
    
    September 2,2007
    
    
    2006(In thousands)Commerce Bank mortgage payable in
monthly installments of principal and
interest of $9 based on a twenty-year
amortization with a final payment of
approximately $1,050 due in November 2009;
collateralized by our Victoria facility
    
    $
    1,104
    
    
    $
    1,122Commerce Financial Group, Inc. equipment
loan which was paid in full during Fiscal
2007
    
    
    
    
    
    
    361Wells Fargo Business Credit Term Loan
payable in monthly installments of $6
through May 2010 based on a 60 month
amortization with a final payment of
approximately $150 due in May 2010;
collateralized by equipment located at our
Tempe facility
    
    
    340
    
    
    
    Wells Fargo Business Credit Revolving Line
of Credit with a three year term through
May; available borrowing is based on advance
rates of accounts receivable and certain
inventories; collateralized by substantially
all assets of the Company and additional
collateral provided by Mr. Leahy, the
Companys chairman
    
    
    4,724
    
    
    
    Capital lease and commercial loan
obligations; payable in installments of $83
with periods ending July 2008 through
February 2010; collateralized with certain
machinery and equipment
    
    
    1,845
    
    
    
    2,379Total
    
    
    8,013
    
    
    
    3,862Less current maturities
    
    
    854
    
    
    
    1,038Total long-term debt
    
    $
    7,159
    
    
    $
    2,824
     11




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(6) Line of Credit
  (7) Related Party Note Payable, Guarantee by Related Party and Notes Receivable-Related
Parties-Officers and Former Directors
    (8) Deferred Taxes
  12




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##### Table of Contents



(9) Net Loss per Share Computation
  Three Months Ended
    
    Nine Months EndedJune 2, 2007
    
    May 27, 2006
    
    June 2, 2007
    
    May 27, 2006Basic and Diluted:Net loss
    
    $
    (1,755
    )
    
    $
    (1,111
    )
    
    $
    (4,934
    )
    
    $
    (3,429
    )Net loss per share
    
    $
    (0.18
    )
    
    $
    (0.12
    )
    
    $
    (0.52
    )
    
    $
    (0.36
    )Weighted average
number of common
shares outstanding
    
    
    9,514
    
    
    
    9,491
    
    
    
    9,509
    
    
    
    9,457
  (10) Major Customers
    (11) Geographic Data (In Thousands)
  Three Months Ended
    
    
    Nine Months EndedJune 2, 2007
    
    
    May 27, 2006
    
    
    June 2, 2007
    
    
    May 27, 2006Dollars
    
    
    % of Sales
    
    
    Dollars
    
    
    % of Sales
    
    
    Dollars
    
    
    % of Sales
    
    
    Dollars
    
    
    % of SalesUnited States
    
    $
    7,501
    
    
    
    76
    %
    
    $
    9,333
    
    
    
    71
    %
    
    $
    25,724
    
    
    
    77
    %
    
    $
    27,667
    
    
    
    71
    %Canada / Mexico
    
    $
    215
    
    
    
    2
    %
    
    $
    278
    
    
    
    2
    %
    
    $
    490
    
    
    
    1
    %
    
    $
    1,155
    
    
    
    3
    %Europe
    
    $
    1,096
    
    
    
    11
    %
    
    $
    1,166
    
    
    
    9
    %
    
    $
    3,288
    
    
    
    10
    %
    
    $
    4,102
    
    
    
    11
    %Asia-Pacific
    
    $
    1,009
    
    
    
    11
    %
    
    $
    2,431
    
    
    
    18
    %
    
    $
    3,801
    
    
    
    12
    %
    
    $
    5,773
    
    
    
    15
    %South America
    
    $
    9
    
    
    
    0
    %
    
    $
    11
    
    
    
    0
    %
    
    $
    28
    
    
    
    0
    %
    
    $
    27
    
    
    
    0
    %Total
    
    $
    9,830
    
    
    
    
    
    
    $
    13,219
    
    
    
    
    
    
    $
    33,331
    
    
    
    
    
    
    $
    38,724
 (12) Segments (In Thousands)
  13




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Three Months Ended June 2, 2007
    
    Nine Months Ended June 2, 2007Advanced
    
    
    
    
    
    
    
    
    
    
    
    
    
    AdvancedMicroelectronics
    
    Medical
    
    
    
    
    
    
    
    
    
    Microelectronics
    
    MedicalCorporate
    
    Operations
    
    Operations
    
    Total
    
    Corporate
    
    Operations
    
    Operations
    
    TotalNet sales
    
    $
    0
    
    
    $
    5,872
    
    
    $
    3,958
    
    
    $
    9,830
    
    
    $
    0
    
    
    $
    21,124
    
    
    $
    12,207
    
    
    $
    33,331Gross profit
    
    
    0
    
    
    
    492
    
    
    
    (293
    )
    
    
    199
    
    
    
    0
    
    
    
    2,754
    
    
    
    (214
    )
    
    
    2,540Operating Expense
    
    
    804
    
    
    
    1,108
    
    
    
    168
    
    
    
    2,080
    
    
    
    2,957
    
    
    
    3,391
    
    
    
    509
    
    
    
    6,857Operating loss
    
    
    (804
    )
    
    
    (616
    )
    
    
    (461
    )
    
    
    (1,881
    )
    
    
    (2,957
    )
    
    
    (637
    )
    
    
    (723
    )
    
    
    (4,317
    )Total assets
    
    
    0
    
    
    
    14,078
    
    
    
    5,050
    
    
    
    19,128
    
    
    
    0
    
    
    
    14.078
    
    
    
    5,050
    
    
    
    19,128Depr. and
amortization
    
    
    0
    
    
    
    399
    
    
    
    66
    
    
    
    465
    
    
    
    0
    
    
    
    1,396
    
    
    
    133
    
    
    
    1,529Capital expenditures
    
    
    0
    
    
    
    149
    
    
    
    40
    
    
    
    189
    
    
    
    0
    
    
    
    297
    
    
    
    87
    
    
    
    384
 Three Months Ended May 27, 2006
    
    Nine Months Ended May 27, 2006Advanced
    
    
    
    
    
    
    
    
    
    
    
    
    
    AdvancedMicroelectronics
    
    Medical
    
    
    
    
    
    
    
    
    
    Microelectronics
    
    MedicalCorporate
    
    Operations
    
    Operations
    
    Total
    
    Corporate
    
    Operations
    
    Operations
    
    TotalNet sales
    
    $
    0
    
    
    $
    9,049
    
    
    $
    4,170
    
    
    $
    13,219
    
    
    $
    0
    
    
    $
    25,332
    
    
    $
    13,392
    
    
    $
    38,724Gross profit
    
    
    0
    
    
    
    2,317
    
    
    
    121
    
    
    
    2,438
    
    
    
    0
    
    
    
    5,310
    
    
    
    1,598
    
    
    
    6,908Operating Expense
    
    
    2,204
    
    
    
    954
    
    
    
    151
    
    
    
    3,309
    
    
    
    6,670
    
    
    
    2,627
    
    
    
    602
    
    
    
    9,899Op income (loss)
    
    
    (2,204
    )
    
    
    1,363
    
    
    
    (30
    )
    
    
    (871
    )
    
    
    (6,670
    )
    
    
    2,683
    
    
    
    996
    
    
    
    (2,991
    )Total assets
    
    
    0
    
    
    
    19,952
    
    
    
    6,047
    
    
    
    25,999
    
    
    
    0
    
    
    
    19,952
    
    
    
    6,047
    
    
    
    25,999Depr. and
amortization
    
    
    0
    
    
    
    572
    
    
    
    70
    
    
    
    642
    
    
    
    0
    
    
    
    1,579
    
    
    
    269
    
    
    
    1,848Capital expenditures
    
    
    0
    
    
    
    102
    
    
    
    294
    
    
    
    396
    
    
    
    0
    
    
    
    598
    
    
    
    325
    
    
    
    923
 (13) Commitments and Contingencies
    14




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(14) Litigation Recovery
   15




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 FORWARD-LOOKING STATEMENTS
 Some of the information included in this Quarterly Report on Form 10-Q contains forward-looking
statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform
Act of 1995 that involve substantial risks and uncertainties. You can identify these statements by
forward-looking words such as may, will, expect, anticipate, believe, intend,
estimate, continue, and similar words. You should read statements that contain these words
carefully for the following reasons: such statements discuss our future expectations, such
statements contain projections of future earnings or financial condition and such statements state
other forward-looking information. Although it is important to communicate our expectations, there
may be events in the future that we are not accurately able to predict or over which we have no
control. The Risk Factors included in Item 1A of our Annual Report on Form 10-K for the fiscal year
ended September 2, 2006 provide examples of such risks, uncertainties and events that may cause
actual results to differ materially from our expectations and the forward-looking statements.
Readers are cautioned not to place undue reliance on forward-looking statements, as we undertake no
obligation to update these forward-looking statements to reflect ensuing events or circumstances,
or subsequent actual results.
 This Quarterly Report of Form 10-Q should be read in conjunction with our Annual Report on Form
10-K for the fiscal year ended September 2, 2006.
 Overview
     Results of Operations
 Three Months and Nine Months Ended June 2, 2007 and May 27, 2006:
 Net Sales
   16




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Gross Profit
   Operating Expenses
 Selling, general and administrative expenses
  Research, development, and engineering expenses
  17




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Interest Expense, Net
  Income Taxes
  FINANCIAL CONDITION AND LIQUIDITY
      18




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
    
    Refinancing our debt to improve cash flow.
    
    Emphasis on sales efforts in all of our business segments.
    
    Focusing on gross margin improvements at all segments by focusing on our material
costs, labor costs and overhead structures.
    
    Structuring our staffing to work within our current sales levels for all of our
general and administrative costs and engineering costs, and to reorganize the staff as
necessary to position the Company for growth.
    
    Pursuing additional sublease tenants for the excess space in our Boulder facility
while allowing for adequate room for expansion in the AMO segment. This will help to
offset a portion of the operating costs and lease costs of that facility.
    
    Reduction in inventories by reviewing buying procedures and reducing any excess on
hand inventory while maintaining the required inventories to meet customer demand. Our
initiatives targeted a reduction in inventories by a total of $1 million by the end of
Fiscal 2007, and we exceeded that target by over $500,000 during the first nine months
of Fiscal 2007.
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CRITICAL ACCOUNTING POLICIES
  Revenue recognition, sales returns and warranty
    
 Item 3. Qualitative and Quantitative Disclosures About Market Risk
 Market Risk
  Interest Rate Risk
  20




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Item 4. Controls and Procedures
       
 PART
II  OTHER INFORMATION
 
 Item 1. Legal Proceedings.
  21




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##### Table of Contents



Item 1A. Risk Factors.
  Guarantee from our Chairman of the Board of Directors.
 
 Item 6. Exhibits
 a) Exhibits
 10.1
    
    Form of Credit and Security Agreement by and between HEI,
Inc. and Wells Fargo Bank, National Association, acting through
its Wells Fargo Business Credit operating division dated May 15,
2007.10.2
    
    Form of Credit and Security Agreement for the Export-Import
Bank Guaranteed Credit Facility by and among HEI, Inc. and Wells
Fargo Bank, National Association, acting through its Wells Fargo
Business Credit operating division dated May 15, 2007.31.1
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.32.1
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
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SIGNATURES
  HEI, Inc.Date: July 16, 2007
    /s/ Mark B. ThomasMark B. Thomas
Chief Executive Officer and Chief Financial Officer 23