##### 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 March 3, 2007.
 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 For the transition period from  to.
 Commission File Number 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)
 (952) 443-2500
 þ o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer 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
    
    
    15Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    19Item 4. Controls and Procedures
    
    
    20Part II  Other InformationItem 1. Legal Proceedings
    
    
    20Item 4. Submission of Matters to a Vote of Security Holders
    
    
    21Item 5. Other Information
    
    
    21Item 6. Exhibits
    
    
    21Signature
    
    
    22CertificationCertification
 2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 
 HEI, Inc.
Consolidated Balance Sheets
 March 3,
    
    
    September 2,2007
    
    
    2006(Unaudited)
    
    
    (Audited)(In thousandsexcept per share and share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    1,575
    
    
    $
    674Accounts receivable, net of allowance for doubtful accounts
of $445 and $124, respectively
    
    
    6,264
    
    
    
    9,205Inventories
    
    
    6,159
    
    
    
    7,000Deferred income taxes
    
    
    830
    
    
    
    830Other current assets
    
    
    387
    
    
    
    316Total current assets
    
    
    15,215
    
    
    
    18,025Property and equipment:Land
    
    
    216
    
    
    
    216Building and improvements
    
    
    4,374
    
    
    
    4,374Fixtures and equipment
    
    
    24,052
    
    
    
    24,406Accumulated depreciation
    
    
    (21,913
    )
    
    
    (21,279
    )Net property and equipment
    
    
    6,729
    
    
    
    7,717Security deposit
    
    
    550
    
    
    
    550Other long-term assets
    
    
    524
    
    
    
    580Total assets
    
    $
    23,018
    
    
    $
    26,872LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Line of credit
    
    $
    1,500
    
    
    $
    5,948Related party note payable
    
    
    5,000
    
    
    
    Current maturities of long-term debt
    
    
    973
    
    
    
    1,038Accounts payable
    
    
    3,130
    
    
    
    3,735Accrued liabilities
    
    
    1,884
    
    
    
    2,184Total current liabilities
    
    
    12,487
    
    
    
    12,905Deferred income taxes
    
    
    830
    
    
    
    830Other long-term liabilities, less current maturities
    
    
    1,635
    
    
    
    1,549Long-term debt, less current maturities
    
    
    2,367
    
    
    
    2,824Total other long-term liabilities, less current maturities
    
    
    4,832
    
    
    
    5,203Total liabilities
    
    
    17,319
    
    
    
    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 March 3, 2007 and September 2, 2006; liquidation preference at $26 per share
(total liquidation preference $832,000) at both March 3, 2007 and September 2, 2006
    
    
    2
    
    
    
    2Common stock, $.05 par; 20,000,000 shares authorized; 9,534,000 and 9,545,000 shares issued and
9,514,000 and 9,504,000 shares outstanding at both March 3, 2007 and September 2, 2006,
respectively
    
    
    476
    
    
    
    475Paid-in capital
    
    
    27,677
    
    
    
    27,581Accumulated deficit
    
    
    (22,405
    )
    
    
    (19,226
    )Notes receivable-related parties-officers and former directors
    
    
    (51
    )
    
    
    (68
    )Total shareholders equity
    
    
    5,699
    
    
    
    8,764Total liabilities and shareholders equity
    
    $
    23,018
    
    
    $
    26,872
  3




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HEI, Inc.
Consolidated Statements of Operations (Unaudited)
 Three Months Ended
    
    
    Six Months EndedMarch 3, 2007
    
    
    February 25, 2006
    
    
    March 3, 2007
    
    
    February 25, 2006(In thousands)
    
    
    (In thousands)Net sales
    
    $
    10,556
    
    
    $
    11,718
    
    
    $
    23,501
    
    
    $
    25,505Cost of sales
    
    
    9,663
    
    
    
    9,972
    
    
    
    21,160
    
    
    
    21,035Gross profit
    
    
    893
    
    
    
    1,746
    
    
    
    2,341
    
    
    
    4,470Operating expenses:Selling, general and administrative
    
    
    1,417
    
    
    
    2,350
    
    
    
    3,365
    
    
    
    4,513Research, development and engineering
    
    
    657
    
    
    
    984
    
    
    
    1,412
    
    
    
    2,077Total Operating expenses
    
    
    2,074
    
    
    
    3,334
    
    
    
    4,777
    
    
    
    6,590Operating loss
    
    
    (1,181
    )
    
    
    (1,588
    )
    
    
    (2,436
    )
    
    
    (2,120
    )Other income (expenses):Interest expense, net
    
    
    (409
    )
    
    
    (96
    )
    
    
    (769
    )
    
    
    (223
    )Other income (expense), net
    
    
    19
    
    
    
    (4
    )
    
    
    26
    
    
    
    25Net loss
    
    $
    (1,571
    )
    
    $
    (1,688
    )
    
    $
    (3,179
    )
    
    $
    (2,318
    )Net loss per common share:Basic and Diluted
    
    $
    (0.17
    )
    
    $
    (0.18
    )
    
    $
    (0.33
    )
    
    $
    (0.25
    )Weighted average common shares outstanding:Basic and Diluted
    
    
    9,509
    
    
    
    9,480
    
    
    
    9,507
    
    
    
    9,440
  4




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HEI, Inc.
Consolidated Statements of Cash Flows (Unaudited)
 Six Months EndedMarch 3, 2007
    
    
    February 25, 2006(In thousands)Cash flow from operating activities:Net loss
    
    $
    (3,179
    )
    
    $
    (2,318
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    1,064
    
    
    
    1,206Loss on disposal of property and equipment
    
    
    6
    
    
    
    Stock based compensation expense
    
    
    97
    
    
    
    273Changes in operating assets and liabilities:Accounts receivable
    
    
    2,941
    
    
    
    1,899Inventories
    
    
    841
    
    
    
    (98
    )Other current assets
    
    
    (71
    )
    
    
    474Accounts payable
    
    
    (605
    )
    
    
    (532
    )Accrued liabilities and other long-term liabilities
    
    
    (214
    )
    
    
    (398
    )Net cash flow provided by operating activities
    
    
    880
    
    
    
    506Cash flow from investing activities:Additions to property and equipment
    
    
    (195
    )
    
    
    (527
    )Proceeds from sale of assets
    
    
    175
    
    
    
    8Additions to patents
    
    
    (6
    )
    
    
    (2
    )Refund of security deposit
    
    
    
    
    
    
    1,258Net cash flow provided by (used in) investing activities
    
    
    (26
    )
    
    
    737Cash flow from financing activities:Former director note repayment
    
    
    17
    
    
    
    Repayment of long-term debt
    
    
    (522
    )
    
    
    (271
    )Proceeds from note payable  related party
    
    
    5,000
    
    
    
    Net repayments on line of credit
    
    
    (4,448
    )
    
    
    (1,163
    )Net cash flow provided by (used in) financing activities
    
    
    47
    
    
    
    (1,434
    )Net increase in cash and cash equivalents
    
    
    901
    
    
    
    (191
    )Cash and cash equivalents, beginning of period
    
    
    674
    
    
    
    351Cash and cash equivalents, end of period
    
    $
    1,575
    
    
    $
    160Supplemental disclosures of cash flow information:Interest paid
    
    $
    728
    
    
    $
    239Capital lease obligations related to equipment acquisitions
    
    $
    
    
    
    $
    225Issuance of common stock to landlord recorded as long-term asset
    
    $
    
    
    
    $
    336Reclassification of notes receivable-related parties to other current assets
    
    $
    
    
    
    $
    140
  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.
    
    Expansion of the sales organization in the Microelectronics and AMO divisions to
expand our sales efforts to existing customers and to find new customers for our
products.
    
    Focusing on gross margin improvements at all segments. We will accomplish this by
focusing on our costs and looking at all areas for improvements including 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.
These initiatives are targeted to reduce inventories by a total of $1 million by the end
of Fiscal 2007, of which over $750,000 has already been achieved during the first six
months of Fiscal 2007.
 8




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(3) Stock Based Compensation
  Stock Options
   Restricted Stock
  9




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(4) Other Financial Statement Data
  March 3, 2007
    
    
    September 2, 2006Inventories:Purchased parts
    
    $
    4,114
    
    
    $
    4,735Work in process
    
    
    481
    
    
    
    671Finished goods
    
    
    1,564
    
    
    
    1,594$
    6,159
    
    
    $
    7,000Accrued liabilities:Employee related costs (1)
    
    $
    1,133
    
    
    $
    1,346Accrued taxes
    
    
    322
    
    
    
    396Accrued audit, professional, board, public
reporting and interest
    
    
    151
    
    
    
    120Current maturities of other long-term liabilities
    
    
    79
    
    
    
    79Other accrued liabilities
    
    
    199
    
    
    
    243$
    1,884
    
    
    $
    2,184Other long-term liabilities:Remaining lease obligation, less estimated sublease
proceeds
    
    $
    494
    
    
    $
    513Accrued lease expense
    
    
    712
    
    
    
    588Unfavorable operating lease, net
    
    
    508
    
    
    
    527Total
    
    
    1,714
    
    
    
    1,628Less current maturities
    
    
    79
    
    
    
    79Total other long-term liabilities
    
    $
    1,635
    
    
    $
    1,549
 
 (1)
    
    This total includes Accrued Severance Related Expenses. During the first and second
quarters of 2007, the Company reduced its workforce in an effort to lower its operating expenses.
The Company recorded $52,000 and $400,000 in expense for these staff reductions of which $145,000
related to the resignation of the former CEO, during three and six months ended March 3, 2007,
respectively. At March 3, 2007, the remaining balance of the Accrued Severance Related Expenses
was $28,100 and will be paid prior to the end of Fiscal 2007. 10




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(5) Long-Term Debt
  March 3, 2007
    
    
    September 2, 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
    
    $
    1,111
    
    
    $
    1,122Commerce Financial Group, Inc. equipment loan
payable in fixed monthly principal and
interest installments of $28 through September
2007; collateralized by our Victoria facility
and equipment located at our Tempe facility
    
    
    206
    
    
    
    361Capital lease and commercial loan obligations;
payable in installments of $83 with periods
ending July 2007 through February 2010;
collateralized with certain machinery and
equipment
    
    
    2,023
    
    
    
    2,379Total
    
    
    3,340
    
    
    
    3,862Less current maturities
    
    
    973
    
    
    
    1,038Total long-term debt
    
    $
    2,367
    
    
    $
    2,824
    (6) Line of Credit
  11




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(7) Related Party Note Payable
    (8) Deferred Taxes
  (9) Net Loss per Share Computation
  Three Months Ended
    
    Six Months EndedMarch 3, 2007
    
    February 25, 2006
    
    March 3, 2007
    
    February 25, 2006Basic and Diluted:Net loss
    
    $
    (1,571
    )
    
    $
    (1,688
    )
    
    $
    (3,179
    )
    
    $
    (2,318
    )Net loss per share
    
    $
    (0.17
    )
    
    $
    (0.18
    )
    
    $
    (0.33
    )
    
    $
    (0.25
    )Weighted average
number of common
shares outstanding
    
    
    9,509
    
    
    
    9,480
    
    
    
    9,505
    
    
    
    9,440
  (10) Major Customers
  12




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(11) Geographic Data (In Thousands)
  Three Months Ended
    
    
    Six Months EndedMarch 3, 2007
    
    
    February 25, 2006
    
    
    March 3, 2007
    
    
    February 25, 2006Dollars
    
    
    % of Sales
    
    
    Dollars
    
    
    % of Sales
    
    
    Dollars
    
    
    % of Sales
    
    
    Dollars
    
    
    % of SalesUnited States
    
    $
    7,912
    
    
    
    75
    %
    
    $
    8,426
    
    
    
    72
    %
    
    $
    18,223
    
    
    
    78
    %
    
    $
    18,334
    
    
    
    72
    %Canada / Mexico
    
    $
    168
    
    
    
    2
    %
    
    $
    223
    
    
    
    2
    %
    
    $
    275
    
    
    
    1
    %
    
    $
    877
    
    
    
    3
    %Europe
    
    $
    1,111
    
    
    
    10
    %
    
    $
    1,315
    
    
    
    11
    %
    
    $
    2,192
    
    
    
    9
    %
    
    $
    2,936
    
    
    
    12
    %Asia-Pacific
    
    $
    1,354
    
    
    
    13
    %
    
    $
    1,744
    
    
    
    15
    %
    
    $
    2,792
    
    
    
    12
    %
    
    $
    3,342
    
    
    
    13
    %South America
    
    $
    11
    
    
    
    0
    %
    
    $
    10
    
    
    
    0
    %
    
    $
    19
    
    
    
    0
    %
    
    $
    16
    
    
    
    0
    %Total
    
    $
    10,556
    
    
    
    
    
    
    $
    11,718
    
    
    
    
    
    
    $
    23,501
    
    
    
    
    
    
    $
    25,505
 (12) Segments (In Thousands)
     Three Months Ended March 3, 2007
    
    Six Months Ended March 3, 2007Microelectronics
    
    Advanced Medical
    
    
    
    
    
    
    
    
    
    Microelectronics
    
    Advanced MedicalCorporate
    
    Operations
    
    Operations
    
    Total
    
    Corporate
    
    Operations
    
    Operations
    
    TotalNet sales
    
    $
    0
    
    
    $
    6,794
    
    
    $
    3,762
    
    
    $
    10,556
    
    
    $
    0
    
    
    $
    15,252
    
    
    $
    8,249
    
    
    $
    23,501Gross profit
    
    
    0
    
    
    
    1,073
    
    
    
    (180
    )
    
    
    893
    
    
    
    0
    
    
    
    2,262
    
    
    
    79
    
    
    
    2,341Operating Expense
    
    
    840
    
    
    
    1,093
    
    
    
    141
    
    
    
    2,074
    
    
    
    2,153
    
    
    
    2,283
    
    
    
    341
    
    
    
    4,777Operating loss
    
    
    (840
    )
    
    
    (20
    )
    
    
    (321
    )
    
    
    (1,181
    )
    
    
    (2,153
    )
    
    
    (21
    )
    
    
    (262
    )
    
    
    (2,436
    )Total assets
    
    
    0
    
    
    
    17,455
    
    
    
    5,563
    
    
    
    23,018
    
    
    
    0
    
    
    
    17,455
    
    
    
    5,563
    
    
    
    23,018Depr. and
amortization
    
    
    0
    
    
    
    431
    
    
    
    41
    
    
    
    472
    
    
    
    0
    
    
    
    997
    
    
    
    67
    
    
    
    1,064Capital expenditures
    
    
    0
    
    
    
    133
    
    
    
    0
    
    
    
    133
    
    
    
    0
    
    
    
    148
    
    
    
    47
    
    
    
    195
 13




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##### Table of Contents



Three Months Ended February 26, 2006
    
    Six Months Ended February 26, 2006Microelectronics
    
    Advanced Medical
    
    
    
    
    
    
    
    
    
    Microelectronics
    
    Advanced MedicalCorporate
    
    Operations
    
    Operations
    
    Total
    
    Corporate
    
    Operations
    
    Operations
    
    TotalNet sales
    
    $
    0
    
    
    $
    7,363
    
    
    $
    4,355
    
    
    $
    11,718
    
    
    $
    0
    
    
    $
    16,283
    
    
    $
    9,222
    
    
    $
    25,505Gross profit
    
    
    0
    
    
    
    1,012
    
    
    
    734
    
    
    
    1,746
    
    
    
    0
    
    
    
    2,993
    
    
    
    1,477
    
    
    
    4,470Operating Expense
    
    
    2,322
    
    
    
    810
    
    
    
    202
    
    
    
    3,334
    
    
    
    4,466
    
    
    
    1,673
    
    
    
    451
    
    
    
    6,590Op. income (loss)
    
    
    (2,322
    )
    
    
    202
    
    
    
    532
    
    
    
    (1,588
    )
    
    
    (4,466
    )
    
    
    1,320
    
    
    
    1,026
    
    
    
    (2,120
    )Total assets
    
    
    0
    
    
    
    16,786
    
    
    
    7,183
    
    
    
    23,969
    
    
    
    0
    
    
    
    16,786
    
    
    
    7,183
    
    
    
    23,969Depr. and
amortization
    
    
    0
    
    
    
    525
    
    
    
    96
    
    
    
    621
    
    
    
    0
    
    
    
    1,007
    
    
    
    199
    
    
    
    1,206Capital expenditures
    
    
    0
    
    
    
    446
    
    
    
    23
    
    
    
    469
    
    
    
    0
    
    
    
    496
    
    
    
    31
    
    
    
    527
 (13) Commitments and Contingencies
    (14) Notes Receivable-Related Parties-Officers and Former Directors
  (15) Subsequent Event
  14




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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 Six Months Ended March 3, 2007 and February 25, 2006:
 Net Sales
  15




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Gross Profit
   Operating Expenses
 Selling, general and administrative expenses
  Research, development, and engineering expenses
  16




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Interest Expense, Net
  Income Taxes
  FINANCIAL CONDITION AND LIQUIDITY
       17




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
    
    Expanding our sales efforts to existing customers and to find new customers for our
products. We have restructured our sales staff in Boulder and Victoria and we have added an
additional sales person to support our flexible substrate business in Tempe. We have formed
a new position at the corporate level for a vice president of sales and marketing overseeing
both the Victoria and Tempe sales efforts to expand joint manufacturing efforts for new and
existing customers as well as expanding the number of independent customers for both
divisions. This position was filled by our former general manager of our Victoria operation.
    
    Focusing on gross margin improvements at all segments. We plan to accomplish this by
focusing on our costs and looking at all areas for improvements including 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. We have hired a new general manager for the Victoria
operation to provide an expanded focus on engineering and operations and to reorganize the
engineering function to more actively support the expanding sales efforts.
    
    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.
    
    Refinancing our debt to improve cash flow. To that end, in November 2006, the Company
paid off the Credit Agreement with Beacon Bank and replaced the funding through a $5,000,000
one-year term secured loan from Thomas F. Leahy, the Companys Chairman of the Board. The
new term loan was undertaken to provide the Company with the opportunity to establish a
relationship with a new asset-based lender during Fiscal 2007. This transaction allowed the
Company to have direct access again to the collection of its accounts receivables, which has
reduced the days outstanding and improved cash flow from collections. In addition, the loan
provided additional future working capital of approximately $1.8 million after the Credit
Agreement was repaid and current working capital was funded. The Company is actively working
on the due diligence process to refinance its line of credit and related party note. If the
due diligence process is not complete and refinance funding is not received prior to the
Beacon Bank Line of Credit due date of April 18, 2007, the Company will utilize a portion of
its remaining working capital from the term loan from Thomas Leahy.
    
    Reduction in inventories by reviewing buying procedures and reducing any excess on hand
inventory while maintaining the required inventories to meet customer demand. These
initiatives are targeted to reduce inventories by a total of $1 million by the end of Fiscal
2007, of which over $750,000 has already been achieved during the first six months of Fiscal
2007.
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##### Table of Contents



CRITICAL ACCOUNTING POLICIES
  Revenue recognition, sales returns and warranty
    
 Item 3. Qualitative and Quantitative Disclosures About Market Risk
 Market Risk
  Interest Rate Risk
   19




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##### Table of Contents



Item 4. Controls and Procedures
      
 PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings.
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Item 4. Submission of Matters to a Vote of Security-Holders
  Director
    
    For
    
    Withhold
    
    TotalGeorge M. Heenan
    
    
    8,518,651
    
    
    
    169,012
    
    
    
    8,687,663Thomas F. Leahy
    
    
    8,611,866
    
    
    
    75,797
    
    
    
    8,687,663
 
 Item 5. Other Information
  
 Item 6. Exhibits
 a) Exhibits
 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: April 2, 2007
    /s/ Mark B. ThomasMark B. ThomasChief Executive Officer and Chief Financial Officer 22