##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
****
FORM 10-Q
****

[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended March 1, 2003.

[   ] 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.
(Exact name of Registrant as Specified in Its Charter)

|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Minnesota                                                      |  | 41-0944876                          
|(State or other jurisdiction
of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               |  |                                     
|1495 Steiger Lake Lane, Victoria, Minnesota                    |  | 55386                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

(952) 443-2500
Registrants telephone number, including area code

6385 Old Shady Oak Road, Suite 280, Eden Prairie, MN 55344
Former name, former address and former fiscal year, if changed since last report.

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No

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

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date: as of April 18, 2003,
7,011,756 shares of common stock, par value $.05.





---

TABLE OF CONTENTS



|                                                  |                                                                                               |                                                        |  |  |  |  |  | 
|------------------------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------------------ |  |  |  |  |  | 
|Part I. FINANCIAL INFORMATION                    
|                                                  | Item 1. Financial Statements                                                                 
|                                                  |                                                                                               | Consolidated Balance Sheets (Unaudited)               
|                                                  |                                                                                               | Consolidated Statements of Operations (Unaudited)     
|                                                  |                                                                                               | Consolidated Statements of Cash Flows (Unaudited)     
|                                                  |                                                                                               | Notes to Consolidated Financial Statements (Unaudited)
|                                                  | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                                  | Item 3. Qualitative and Quantitative Disclosures About Market Risk                           
|                                                  | Item 4. Controls and Procedures                                                              
|PART II  OTHER INFORMATION                      
|                                                  | Item 2. Changes in Securities and Use of Proceeds                                            
|                                                  | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                                                  | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                                       
|CERTIFICATIONS                                   
|Exhibit Index                                    
|EX-10.1  8th Amendment to Loan and Security Agmt.
|EX-99.1 Certifications of CEO and CFO            



---



##### Table of Contents



|                  |  |          
|----------------- |  | ---------
|Table of Contents |  | HEI, Inc.

---

|                                           |                                                                                    |                                            |       |    |       | 
|------------------------------------------ | ---------------------------------------------------------------------------------- | ------------------------------------------ | ----- | -- | ----- | 
|Part I  Financial Information (unaudited) |                                                                                    |                                            |       |   
|                                           | Item 1. Financial Statements                                                       |                                            |       |    |      
|                                           |                                                                                    | Consolidated Balance Sheets                |       |    | 3     | 
|                                           |                                                                                    | Consolidated Statements of Operations      |       |    | 4     | 
|                                           |                                                                                    | Consolidated Statements of Cash Flows      |       |    | 5     | 
|                                           |                                                                                    | Notes to Consolidated Financial Statements |       |    | 6-12  | 
|                                           | Item 2. Managements Discussion and Analysis of Financial Condition
and Results of |                                            |       |    |      
|                                           |                                                                                    | Operations                                 |       |    | 13-22 | 
|                                           | Item 3. Quantitative and Qualitative Disclosures About
Market Risk                 |                                            |       | 23 |      
|                                           | Item 4. Controls and Procedures                                                    |                                            |       | 23 |      
|Part II  Other Information                |                                                                                    |                                            |       |   
|                                           | Item 2. Changes in Securities and Use of Proceeds                                  |                                            |       | 24 |      
|                                           | Item 4. Submission of Matters to a Vote of Security Holders                        |                                            |       | 24 |      
|                                           | Item 6. Exhibits and Reports on Form 8-K                                           |                                            |       | 24 |      
|Signature                                  |                                                                                    |                                            | 25    |   
|Certifications                             |                                                                                    |                                            | 26-27 |   

2



---



##### Table of Contents












PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HEI, Inc.Consolidated Balance Sheets (Unaudited)(In thousands)

|                                                           |                                                                                                 |                             |        |               |       |                 |        |         |       | 
|---------------------------------------------------------- | ----------------------------------------------------------------------------------------------- | --------------------------- | ------ | ------------- | ----- | --------------- | ------ | ------- | ----- | 
|                                                           |                                                                                                 |                             |        | March 1, 2003 |       | August 31, 2002
|                                                           |                                                                                                 |                             |        |               |       |                
|Assets                                                     |                                                                                                 |                             |        |               |       |                 |        |        
|Current assets:                                            |                                                                                                 |                             |        |               |       |                 |        |        
|                                                           | Cash and cash equivalents                                                                       |                             | $      | 13            |       |                 | $      | 2,372   |      
|                                                           | Restricted cash                                                                                 |                             |        | 1,800         |       |                 |        | 1,000   |      
|                                                           | Accounts receivable, net                                                                        |                             |        | 5,404         |       |                 |        | 3,533   |      
|                                                           | Inventories, net                                                                                |                             |        | 6,192         |       |                 |        | 4,027   |      
|                                                           | Other current assets                                                                            |                             |        | 614           |       |                 |        | 383     |      
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Total current assets                                       |                                                                                                 |                             | 14,023 |               |       |                 | 11,315 |        
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Property and equipment:                                    |                                                                                                 |                             |        |               |       |                 |        |        
|                                                           | Land                                                                                            |                             |        | 216           |       |                 |        | 216     |      
|                                                           | Building and improvements                                                                       |                             |        | 4,397         |       |                 |        | 4,316   |      
|                                                           | Fixtures and equipment                                                                          |                             |        | 23,121        |       |                 |        | 21,259  |      
|                                                           | Accumulated depreciation                                                                        |                             |        | (15,885       | )     |                 |        | (14,439 | )    
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Net property and equipment                                 |                                                                                                 |                             | 11,849 |               |       |                 | 11,352 |        
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Developed technology, net                                  |                                                                                                 |                             | 568    |               |       |                 |       |        
|Security deposits                                          |                                                                                                 |                             | 1,580  |               |       |                 |       |        
|Other long-term assets                                     |                                                                                                 |                             | 443    |               |       |                 | 322    |        
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Total assets                                               |                                                                                                 | $                           | 28,463 |               |       | $               | 22,989 |        
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Liabilities and Shareholders Equity                       |                                                                                                 |                             |        |               |       |                 |        |        
|Current liabilities:                                       |                                                                                                 |                             |        |               |       |                 |        |        
|                                                           | Revolving line of credit                                                                        |                             | $      |              |       |                 | $      | 1,589   |      
|                                                           | Current maturities of long-term debt                                                            |                             |        | 1,878         |       |                 |        | 2,441   |      
|                                                           | Accounts payable                                                                                |                             |        | 3,749         |       |                 |        | 1,815   |      
|                                                           | Warranty reserve                                                                                |                             |        | 416           |       |                 |        | 200     |      
|                                                           | Accrued liabilities                                                                             |                             |        | 2,351         |       |                 |        | 901     |      
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Total current liabilities                                  |                                                                                                 |                             | 8,394  |               |       |                 | 6,946  |        
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Other long-term liabilities, less current maturities:      |                                                                                                 |                             |        |               |       |                 |        |        
|                                                           |                                                                                                 | Other long-term liabilities |        |               | 2,723 |                 |        |         |      | 
|                                                           |                                                                                                 | Long-term debt              |        |               | 2,667 |                 |        |         | 1,473 | 
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Total other long-term liabilities, less current maturities |                                                                                                 |                             | 5,390  |               |       |                 | 1,473  |        
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Total liabilities                                          |                                                                                                 |                             | 13,784 |               |       |                 | 8,419  |        
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Shareholders equity:                                      |                                                                                                 |                             |        |               |       |                 |        |        
|                                                           | Undesignated stock; 5,000 shares authorized; none issued                                        |                             |        |              |       |                 |        |        |      
|                                                           | Common stock, $.05 par; 10,000 shares authorized;
7,012 and 6,012 shares issued and outstanding |                             |        | 351           |       |                 |        | 301     |      
|                                                           | Paid-in capital                                                                                 |                             |        | 18,899        |       |                 |        | 16,349  |      
|                                                           | Accumulated deficit                                                                             |                             |        | (3,305        | )     |                 |        | (814    | )    
|                                                           | Notes receivable                                                                                |                             |        | (1,266        | )     |                 |        | (1,266  | )    
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Total shareholders equity                                 |                                                                                                 |                             | 14,679 |               |       |                 | 14,570 |        
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        
|Total liabilities and shareholders equity                 |                                                                                                 | $                           | 28,463 |               |       | $               | 22,989 |        
|                                                           |                                                                                                 |                             |        |               |       |                 |        |        

See accompanying notes to unaudited interim consolidated financial statements.

3



---



##### Table of Contents






HEI, Inc.Consolidated Statements of Operations (Unaudited)(In thousands, except per share amounts)

|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |        |       |  
|------------------------------------------- | ------------------------------------- | ------- | ----- | ------------------ | ----- | ---------------- | ----- | ------------- | ----- | ------------- | ------ | ------ | ----- | - | ------ | ------ | ----- | -
|                                            |                                       |         |       | Three Months Ended |       | Six Months Ended
|                                            |                                       |         |       |                    |       |                 
|                                            |                                       |         |       | March 1, 2003      |       | March 2, 2002    |       | March 1, 2003 |       | March 2, 2002
|                                            |                                       |         |       |                    |       |                  |       |               |       |              
|Net sales                                   |                                       | $       | 8,144 |                    |       | $                | 7,799 |               |       | $             | 13,634 |        |       | $ | 13,925 |       
|Cost of sales                               |                                       |         | 7,282 |                    |       |                  | 6,260 |               |       |               | 12,160 |        |       |   | 12,001 |       
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|                                            | Gross profit                          |         |       | 862                |       |                  |       | 1,539         |       |               |        | 1,474  |       |   |        | 1,924  |      
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|Operating expenses:                         |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|                                            | Selling, general and administrative   |         |       | 1,612              |       |                  |       | 1,245         |       |               |        | 2,869  |       |   |        | 2,607  |      
|                                            | Research, development and engineering |         |       | 592                |       |                  |       | 706           |       |               |        | 1,087  |       |   |        | 1,366  |      
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|                                            | Operating loss                        |         |       | (1,342             | )     |                  |       | (412          | )     |               |        | (2,482 | )     |   |        | (2,049 | )    
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|Other income (expense), net                 |                                       |         | 6     |                    |       |                  | (61   | )             |       |               | (28    | )      |       |   | (82    | )     
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|                                            | Loss before income taxes              |         |       | (1,336             | )     |                  |       | (473          | )     |               |        | (2,510 | )     |   |        | (2,131 | )    
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|Income tax benefit                          |                                       |         |      |                    |       |                  | 163   |               |       |               | 19     |        |       |   | 727    |       
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|                                            | Net loss                              |         |       | (1,336             | )     |                  |       | (310          | )     |               |        | (2,491 | )     |   |        | (1,404 | )    
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|Net loss per common share:                  |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|                                            |                                       | Basic   |       | $                  | (0.21 | )                |       | $             | (0.05 | )             |        | $      | (0.40 | ) |        | $      | (0.23 | )
|                                            |                                       | Diluted |       | $                  | (0.21 | )                |       | $             | (0.05 | )             |        | $      | (0.40 | ) |        | $      | (0.23 | )
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|Weighted average common shares outstanding: |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       
|                                            |                                       | Basic   |       |                    | 6,418 |                  |       |               | 5,986 |               |        |        | 6,216 |   |        |        | 5,978 |  
|                                            |                                       | Diluted |       |                    | 6,418 |                  |       |               | 5,986 |               |        |        | 6,216 |   |        |        | 5,978 |  
|                                            |                                       |         |       |                    |       |                  |       |               |       |               |        |        |       |   |        |       

See accompanying notes to unaudited interim consolidated financial statements.

4



---



##### Table of Contents






HEI, Inc.Consolidated Statements of Cash Flows (Unaudited)(In thousands, except share amounts)

|                                                                                                                                                          |                                                         |   |                  |        |               |   |        |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------- | - | ---------------- | ------ | ------------- | - | ------ | ------ | -
|                                                                                                                                                          |                                                         |   | Six Months Ended
|                                                                                                                                                          |                                                         |   |                 
|                                                                                                                                                          |                                                         |   | March 1, 2003    |        | March 2, 2002
|                                                                                                                                                          |                                                         |   |                  |        |              
|Cash flow from operating activities:                                                                                                                      |                                                         |   |                  |        |               |   |        |       
|                                                                                                                                                          | Net loss                                                |   | $                | (2,491 | )             |   | $      | (1,404 | )
|                                                                                                                                                          | Depreciation and amortization                           |   |                  | 1,447  |               |   |        | 1,413  |  
|                                                                                                                                                          | Deferred income tax benefit                             |   |                  |       |               |   |        | (456   | )
|Changes in operating assets and liabilities, net of affects of acquisition:                                                                               |                                                         |   |                  |        |               |   |        |       
|                                                                                                                                                          | Accounts receivable                                     |   |                  | (1,571 | )             |   |        | 1,087  |  
|                                                                                                                                                          | Inventories                                             |   |                  | 689    |               |   |        | 186    |  
|                                                                                                                                                          | Other current assets                                    |   |                  | (121   | )             |   |        | (361   | )
|                                                                                                                                                          | Other assets                                            |   |                  | 34     |               |   |        | 100    |  
|                                                                                                                                                          | Accounts payable                                        |   |                  | 1,637  |               |   |        | 261    |  
|                                                                                                                                                          | Accrued liabilities                                     |   |                  | 88     |               |   |        | 105    |  
|                                                                                                                                                          |                                                         |   |                  |        |               |   |        |       
|Net cash flow provided by (used for) operating activities                                                                                                 |                                                         |   | (288             | )      |               |   | 931    |       
|                                                                                                                                                          |                                                         |   |                  |        |               |   |        |       
|Cash flow from investing activities:                                                                                                                      |                                                         |   |                  |        |               |   |        |       
|                                                                                                                                                          | Additions to property and equipment                     |   |                  | (43    | )             |   |        | (2,090 | )
|                                                                                                                                                          | Additions to patents                                    |   |                  | (64    | )             |   |        | (74    | )
|                                                                                                                                                          | AMD acquisition costs paid                              |   |                  | (1,198 | )             |   |        |       |  
|                                                                                                                                                          | Cash acquired from AMD                                  |   |                  | 1,215  |               |   |        |       |  
|                                                                                                                                                          |                                                         |   |                  |        |               |   |        |       
|Net cash flow used for investing activities                                                                                                               |                                                         |   | (90              | )      |               |   | (2,164 | )     
|                                                                                                                                                          |                                                         |   |                  |        |               |   |        |       
|Cash flow from financing activities:                                                                                                                      |                                                         |   |                  |        |               |   |        |       
|                                                                                                                                                          | Issuance of common stock                                |   |                  |       |               |   |        | 135    |  
|                                                                                                                                                          | Promissory note payable                                 |   |                  | 2,600  |               |   |        |       |  
|                                                                                                                                                          | Repayment of long-term debt                             |   |                  | (2,101 | )             |   |        | (428   | )
|                                                                                                                                                          | Deferred financing costs                                |   |                  | (91    | )             |   |        | (22    | )
|                                                                                                                                                          | Restricted cash                                         |   |                  | (800   | )             |   |        |       |  
|                                                                                                                                                          | Net borrowings (repayments) on revolving line of credit |   |                  | (1,589 | )             |   |        | 1,455  |  
|                                                                                                                                                          |                                                         |   |                  |        |               |   |        |       
|Net cash flow provided by (used for) financing activities                                                                                                 |                                                         |   | (1,981           | )      |               |   | 1,140  |       
|                                                                                                                                                          |                                                         |   |                  |        |               |   |        |       
|Net decrease in cash and cash equivalents                                                                                                                 |                                                         |   | (2,359           | )      |               |   | (93    | )     
|Cash and cash equivalents, beginning of period                                                                                                            |                                                         |   | 2,372            |        |               |   | 4,393  |       
|                                                                                                                                                          |                                                         |   |                  |        |               |   |        |       
|Cash and cash equivalents, end of period                                                                                                                  |                                                         | $ | 13               |        |               | $ | 4,300  |       
|Supplemental disclosures of cash flow information:                                                                                                        |                                                         |   |                  |        |               |   |        |       
|Interest paid                                                                                                                                             |                                                         | $ | 119              |        |               | $ | 173    |       
|Income taxes received                                                                                                                                     |                                                         |   | (19              | )      |               |   |       |       
|Supplemental disclosures of non-cash investing and financing activities:                                                                                  |                                                         |   |                  |        |               |   |        |       
|As more fully described in Note 1 and 12, the Company issued 1,000,000 shares
of its
common stock valued at $2,600 in connection with the AMD acquisition |                                                         |   |                  |        |               |   |        |       

See accompanying notes to unaudited interim consolidated financial statements.

5



---



##### Table of Contents






|                                                       |  |          
|------------------------------------------------------ |  | ---------
|Notes to Consolidated Financial Statements (Unaudited) |  | HEI, Inc.
|                                                      
|(in thousands, except share and per share amounts)     |  |          

(1)  Basis of Financial Statement Presentation

The accompanying unaudited interim consolidated financial statements have been
prepared by HEI, Inc. (HEI) pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC). These financial statements contain
all normal recurring adjustments, which are, in the opinion of management,
necessary for a fair presentation of the financial position, results of
operations and cash flows in accordance with accounting principles generally
accepted in the United States of America (GAAP).

Certain information and footnote disclosures normally included in financial
statements prepared in accordance with GAAP have been condensed or omitted. We
believe, however, that the disclosures are adequate to make the information
presented not misleading. The year-end balance sheet data was derived from
audited financial statements, but does not include all disclosures required by
GAAP. These unaudited interim consolidated financial statements should be read
in conjunction with the financial statements and notes thereto included in our
Annual Report on Form 10-K for the year ended August 31, 2002, as amended by
the Amendment No. 1, filed with the SEC on December 20, 2002, and Amendment No.
2, filed with the SEC on January 7, 2003. Interim results of operations for
the three- and six-month periods ended March 1, 2003, may not necessarily be
indicative of the results to be expected for the full year.

The unaudited interim consolidated financial statements include our acquisition
on January 24, 2003, of certain assets and liabilities of Colorado MEDtech,
Inc.s (CMED) Colorado Operations (a business unit of CMED) or Advanced
Medical Division (AMD), in a business combination accounted for as a
purchase. The accompanying unaudited interim consolidated financial statements
have been prepared on the basis of assumptions discussed in Note 12, including
a preliminary allocation of the consideration paid for the assets and
liabilities of AMD based on valuations of their fair value.

The unaudited interim consolidated financial statements include our accounts
and our wholly owned subsidiaries. All significant intercompany transactions
and balances have been eliminated in consolidation.

HEIs quarterly periods end on the Saturday closest to the end of each quarter
of our fiscal year ending August 31.

(2)  Inventories

Inventories are stated at the lower of cost, using the average cost method, or
market and include materials, labor and overhead costs. Inventories consist of
the following:

|                  |  |               |       |                 |  |   |       | 
|----------------- |  | ------------- | ----- | --------------- |  | - | ----- | 
|                  |  | March 1, 2003 |       | August 31, 2002
|                  |  |               |       |                
|Purchased parts   |  | $             | 3,719 |                 |  | $ | 1,944 | 
|Work in process   |  |               | 835   |                 |  |   | 597   | 
|Finished goods    |  |               | 1,638 |                 |  |   | 1,486 | 
|                  |  |               |       |                 |  |   |       | 
|Total inventories |  | $             | 6,192 |                 |  | $ | 4,027 | 
|                  |  |               |       |                 |  |   |       | 

6



---



##### Table of Contents



(3)  Deferred Taxes

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of our deferred tax assets and liabilities consist of timing
differences related to allowance for doubtful accounts, reserves for excess and
obsolete inventory, accrued warranty reserves, and
the future benefit associated with Federal and state net operating loss
carryforwards.

A valuation allowance has been set at approximately $4,300 and 3,400,
respectively, at March 1, 2003 and August 31, 2002, respectively, because of
uncertainties related to the ability to utilize certain Federal and state net
loss carryforwards. The valuation allowance is based on estimates of taxable
income by jurisdiction and the period over which our deferred tax assets are
recoverable.

(4)  Accrued Liabilities

|                                         |  |               |       |                 |  |   |     | 
|---------------------------------------- |  | ------------- | ----- | --------------- |  | - | --- | 
|                                         |  | March 1, 2003 |       | August 31, 2002
|                                         |  |               |       |                
|Accrued employee related costs           |  | $             | 777   |                 |  | $ | 655 | 
|Contractual manufacturing obligations    |  |               | 600   |                 |  |   |    | 
|Customer deposits                        |  |               | 522   |                 |  |   |    | 
|Current portion of long-term liabilities |  |               | 80    |                 |  |   |    | 
|Other accrued expenses                   |  |               | 372   |                 |  |   | 246 | 
|                                         |  |               |       |                 |  |   |     | 
|Total accrued expenses                   |  | $             | 2,351 |                 |  | $ | 901 | 
|                                         |  |               |       |                 |  |   |     | 

The allocation of the AMD purchase price includes a $600 accrual to fulfill
certain contractual manufacturing obligations and $522 in acquired AMD customer
deposits.

(5)  Long-Term Debt

Long-term debt consists of the following:

|                                     |  |               |       |                 |  |   |       | 
|------------------------------------ |  | ------------- | ----- | --------------- |  | - | ----- | 
|                                     |  | March 1, 2003 |       | August 31, 2002
|                                     |  |               |       |                
|Subordinated promissory note         |  | $             | 2,732 |                 |  | $ |      | 
|Industrial development revenue
bonds |  |               | 1,735 |                 |  |   | 1,735 | 
|Commercial loan                      |  |               | 78    |                 |  |   | 104   | 
|Capital expenditure notes            |  |               |      |                 |  |   | 2,075 | 
|                                     |  |               |       |                 |  |   |       | 
|Total                                |  |               | 4,545 |                 |  |   | 3,914 | 
|Less current maturities              |  |               | 1,878 |                 |  |   | 2,441 | 
|                                     |  |               |       |                 |  |   |       | 
|Total long-term debt                 |  | $             | 2,667 |                 |  | $ | 1,473 | 
|                                     |  |               |       |                 |  |   |       | 

HEIs revolving line of credit and letters of credit are subject to certain
restrictive financial covenants, including but not limited to, tangible net
worth, interest coverage, debt service coverage, net loss limitations and the
ability to declare or pay dividends. As of March 1, 2003, we were not in
compliance with the net loss limitation covenant. On April 9, 2003, we amended
the agreement with our financial institution to waive the March 1, 2003 default
and to add an additional covenant to the agreement. The new covenant requires
our liabilities to

7



---



##### Table of Contents



tangible net worth ratio, as defined, to be not greater than .75 to 1.00. In
addition, the financial institution has required us to exercise our
commercially reasonable efforts to obtain alternative financing, repay any
outstanding debt to the financial institution and terminate the agreement on or
before June 30, 2003. If this debt is not repaid by June 30, 2003, we will
incur a fee of $50 on July 1, 2003. The maturity date of the revolving line of
credit remains August 1, 2004. We are currently in compliance with the new
covenant and, based on current financial projections, believe we will meet bank
covenants going forward. However, we have a history of not meeting financial
debt covenants.

We are currently discussing options with various local financial institutions.
There can be no assurance that a new credit facility will be available or, if
available, that such new credit facility will be at terms acceptable to us.
We believe that
existing cash and cash equivalents, current lending capacity and cash generated
from operations will provide sufficient cash flow to meet short- and long-term
debt obligations and operating requirements until a credit facility with a new
financial institution can be established.

In connection with the purchase of AMD, we issued a Subordinated Promissory
Note to CMED in the principal amount of $2,600 (the Subordinated Promissory
Note). The terms of the Subordinated Promissory Note include an interest rate
of 10% (increasing to 12% and 14%, in July 2003 and January 2004,
respectively) and a due date for all principal and interest on September 30,
2004. There are no prepayment penalties associated with this Subordinated
Promissory Note. We also recorded a net $132 premium on the Subordinated
Promissory Note, reflecting the difference between existing market rates of
interest and the Subordinated Promissory Note interest rate.

We had outstanding Industrial Development Revenue Bonds (IDRBs) totaling
$1,735 at March 1, 2003. These bonds were originally issued in April 1996 in
connection with the construction of a new addition to the manufacturing
facility in Victoria, Minnesota, and the purchase of production equipment. On
March 14, 2003, an aggregate of approximately $1,735 of the debt proceeds from
the Subordinated Promissory Note was used to repay the outstanding principal
and interest on the IDRBs. At March 1, 2003, we classified $1,735 as current
long-term debt and set aside $1,800 in restricted cash for the principal and
interest payment. On March 14, 2003, the IDRBs were repaid.

A portion of the debt proceeds from the Subordinated Promissory Note was also
used to fund the full repayment of our capital expenditure notes.

Other long-term liabilities consist of the following:

|                                                            |  |               |       |                 |  |   |   | 
|----------------------------------------------------------- |  | ------------- | ----- | --------------- |  | - | - | 
|                                                            |  | March 1, 2003 |       | August 31, 2002
|                                                            |  |               |       |                
|Remaining lease obligation less
estimated sublease proceeds |  | $             | 2,010 |                 |  | $ |  | 
|Unfavorable operating lease, net                            |  |               | 793   |                 |  |   |  | 
|                                                            |  |               |       |                 |  |   |   | 
|Total                                                       |  |               | 2,803 |                 |  |   |  | 
|Less current maturities                                     |  |               | 80    |                 |  |   |  | 
|                                                            |  |               |       |                 |  |   |   | 
|Total long-term liabilities                                 |  | $             | 2,723 |                 |  | $ |  | 
|                                                            |  |               |       |                 |  |   |   | 

The allocation of the AMD purchase price includes $2,010 for future estimated
lease payments ($5,910 for future lease obligations less estimated sublease
payments of $3,900 on excess manufacturing capacity for which we are in the
process of reviewing alternative uses) and a net accrual of $793 related to an
unfavorable operating lease.

8



---



##### Table of Contents



(6)  Net Loss Per Weighted Average Common Share

Basic loss per share is computed by dividing net loss by the weighted average
number of common shares outstanding. Diluted losses per share are computed by
dividing net loss by the weighted average number of common shares outstanding
assuming the exercise of dilutive stock options. The dilutive effect of stock
options is computed using the average market price per share during each period
under the treasury stock method. In periods where losses have occurred,
options are considered anti-dilutive and have not been included in the diluted
loss per share calculations.

|                                              |  |                    |       |                  |  |               |       |               |  |  |       |  |  |  |       | 
|--------------------------------------------- |  | ------------------ | ----- | ---------------- |  | ------------- | ----- | ------------- |  |  | ----- |  |  |  | ----- | 
|                                              |  | Three Months Ended |       | Six Months Ended
|                                              |  |                    |       |                 
|                                              |  | March 1, 2003      |       | March 2, 2002    |  | March 1, 2003 |       | March 2, 2002
|                                              |  |                    |       |                  |  |               |       |              
|Basic common shares                           |  |                    | 6,418 |                  |  |               | 5,986 |               |  |  | 6,216 |  |  |  | 5,978 | 
|Dilutive effect of stock options
and warrants |  |                    |      |                  |  |               |      |               |  |  |      |  |  |  |      | 
|                                              |  |                    |       |                  |  |               |       |               |  |  |       |  |  |  |       | 
|Fully diluted shares                          |  |                    | 6,418 |                  |  |               | 5,986 |               |  |  | 6,216 |  |  |  | 5,978 | 
|                                              |  |                    |       |                  |  |               |       |               |  |  |       |  |  |  |       | 

Due to the closing of the AMD transaction on January 24, 2003, the full effect
of the issuance of 1,000,000 shares of common stock to CMED were not realized
in the March 1, 2003 periods noted above. This issue will have a material
impact on fully diluted shares in future periods.

(7)  Workforce Reductions

With the continued sluggish economy in all markets, revenues continue to be
unstable. In our continued effort to size our cost structure with anticipated
revenues, we reduced our workforce by 28 persons at the end of the first
quarter of fiscal 2003, and an additional 15 persons through second quarter of
2003, for a total of 43 positions and accumulated savings of $347 during the
first two quarters of fiscal 2003. Annualized wages and salaries for the 43
positions that were eliminated was $1,751. The breakdown by employee category
(with annualized wages and salaries in parentheses) was: 25 direct labor ($669), 8
manufacturing ($402), 4 engineering ($229), and 6 administrative positions
($451). The amount of savings from workforce reductions are affected by the
timing of reductions within the quarter and the amount of associated severance
cost. A total of $132 in severance costs was paid during the first six months
of fiscal 2003. Substantially all of the severance charges were paid in the
same period the charges were recorded.

We continue to evaluate further reductions along with other cost containment
measures as revenues fluctuate. At the same time, we seek to balance our
ongoing development of new products and to maintain our ability to react
quickly to favorable market demands and opportunities. In addition, these
costs savings will not be realized in their entirety if increased production
demand requires the hiring of additional personnel.

(8)  Intangible Assets

Information regarding intangible assets acquired in the AMD transaction
follows:

|                     |  |               |     |                 |  |     |    |       |  |              |     |             |  |   |   |  |  |   |   |  |  |   |   | 
|-------------------- |  | ------------- | --- | --------------- |  | --- | -- | ----- |  | ------------ | --- | ----------- |  | - | - |  |  | - | - |  |  | - | - | 
|                     |  | March 1, 2003 |     | August 31, 2002
|                     |  |               |     |                
|                     |  | Carrying      |     | Accumulated     |  |     |    |       |  | Carrying     |     | Accumulated |  |   |   | 
|                     |  | Value         |     | Amortization    |  | Net |    | Value |  | Amortization |     | Net        
|                     |  |               |     |                 |  |     |    |       |  |              |     |            
|Developed technology |  | $             | 584 |                 |  | $   | 16 |       |  | $            | 568 |             |  | $ |  |  |  | $ |  |  |  | $ |  | 

9



---



##### Table of Contents



Amortization expense for years ending August 31, 2003, 2004, 2005, 2006 and
2007 will be $111, $190, $190, $87, and $6, respectively.

(9)  Warranty Guarantees

Sales of our products are subject to limited warranty guarantees. Product
guarantees typically extend for a period of twelve months from the date of
manufacture. Warranty terms are included in customer contracts under which we
are obligated to repair or replace any components or assemblies we deem
defective due to workmanship or materials. We do, however, reserve the right to
reject warranty claims where it determines that failure is due to normal wear,
customer modifications, improper maintenance, or misuse. Warranty provisions
are based on an estimated returns and warranty expenses applied to current
period revenue and historical warranty incidence over the preceding
twelve-month period. Both the experience and the warranty liability are
evaluated on an ongoing basis for adequacy. Warranty provisions and claims for
the six-month period ended March 1, 2003 follow:

|                                     |  |   |      |  
|------------------------------------ |  | - | ---- | -
|August 31, 2002                      |  | $ | 200  |  
|Balance assumed from AMD acquisition |  |   | 376  |  
|Provisions                           |  |   |     |  
|Claims                               |  |   | (160 | )
|                                     |  |   |      |  
|March 1, 2003                        |  | $ | 416  |  
|                                     |  |   |      |  

(10)  Significant Customers

The table below sets forth the approximate percentage of net sales to major
customers that represented over 10% of our revenue.

|           |  |                    |      |                  |  |               |      |               |  |  |      |   |  |  |      |  
|---------- |  | ------------------ | ---- | ---------------- |  | ------------- | ---- | ------------- |  |  | ---- | - |  |  | ---- | -
|           |  | Three Months Ended |      | Six Months Ended
|           |  |                    |      |                 
|           |  | March 1, 2003      |      | March 2, 2002    |  | March 1, 2003 |      | March 2, 2002
|           |  |                    |      |                  |  |               |      |              
|Customer A |  |                    | 20.0 | %                |  |               | 26.9 | %             |  |  | 23.0 | % |  |  | 28.6 | %
|Customer B |  |                    | 17.1 | %                |  |               | 43.0 | %             |  |  | 18.0 | % |  |  | 42.2 | %
|Customer C |  |                    | 14.5 | %                |  |               |     | %             |  |  | 8.7  | % |  |  |     | %
|           |  |                    |      |                  |  |               |      |               |  |  |      |   |  |  |      |  
|Total      |  |                    | 51.6 | %                |  |               | 69.9 | %             |  |  | 49.7 | % |  |  | 70.8 | %
|           |  |                    |      |                  |  |               |      |               |  |  |      |   |  |  |      |  

Accounts receivable from these customers represented 40% and 50%, respectively,
of total accounts receivable at March 1, 2003 and August 31, 2002,
respectively.

(11)  Subsequent Event

The outstanding Directors and Officers loans dated April 2, 2001, as amended on
July 17, 2002, in the aggregate amount of $1,266, required an interest only
payment to be made to us on April 2, 2003. All interest only payments were
made, except that Mr. Anthony Fant, a director and our former Chief Executive
Officer, President and Chairman, failed to make his payment of $10. We believe
the interest and related note is collectible and we are currently assessing the
circumstances and exploring our alternatives for collecting this unpaid amount.

10



---



##### Table of Contents



(12)  Pro Forma Financial Information

The pro forma information includes HEIs acquisition of AMD, in a business
combination accounted for as a purchase, which was consummated on January 24,
2003. The accompanying pro forma information has been prepared on the basis of
assumptions noted below, including a preliminary allocation of the
consideration paid for the assets and liabilities of AMD based on valuations of
their fair value. This allocation includes an accrual of $800 related to an
unfavorable operating lease; $2,010 for future estimated lease payments ($5,910
for future lease obligations less estimated sublease payments of $3,900 on
excess manufacturing capacity for which we are in the process of reviewing
alternative uses); and a $600 accrual to fulfill estimated contractual
manufacturing obligations. The final allocation of the consideration to be
paid may differ from those assumptions reflected in the accompanying unaudited
interim consolidated financial statements. In our opinion, all adjustments
necessary to present fairly such financial statements have been made based on
the terms and structure of the AMD acquisition. We continue the process of
gathering information to complete our analysis of the excess lease capacity and
the contractual manufacturing obligations. Any reductions in these liabilities
will result in a decrease in the carrying value of the intangible assets and
fixed assets. Conversely, an increase in these liabilities will increase the
carrying values of long-lived assets. At March 1, 2003, the carrying value of
long-lived assets has been reduced by $3,200 by the allocation of negative
goodwill.

The purposes for our acquiring AMD were to immediately gain access to the more
stable medical sector, consolidate marketing and sales efforts, and to expand
our resources to become more full service or one stop shop to all customers.
The design, development and manufacturing capabilities for medical devices at
AMD coupled with the microelectronic design, development and manufacturing at
HEI improves our offerings to the market to retain and gain customers.

The following pro forma information gives effect to HEIs acquisition of AMD in
a business combination accounted for as a purchase, which was closed on January
24, 2003. In exchange for certain assets of AMD, HEI issued 1,000,000 shares
of its common stock and assumed approximately $900 of AMD liabilities, as well
as AMD operating lease and other contractual commitments.

|                   |  |                    |        |                  |  |               |        |               |  |   |        |   |  |   |        |  
|------------------ |  | ------------------ | ------ | ---------------- |  | ------------- | ------ | ------------- |  | - | ------ | - |  | - | ------ | -
|                   |  | Three Months Ended |        | Six Months Ended
|                   |  |                    |        |                 
|                   |  | March 1, 2003      |        | March 2, 2002    |  | March 1, 2003 |        | March 2, 2002
|                   |  |                    |        |                  |  |               |        |              
|Net sales          |  | $                  | 12,917 |                  |  | $             | 19,746 |               |  | $ | 25,820 |   |  | $ | 37,240 |  
|Net loss           |  |                    | (1,901 | )                |  |               | (2,943 | )             |  |   | (4,703 | ) |  |   | (7,696 | )
|Net loss per share |  | $                  | (0.27  | )                |  | $             | (0.42  | )             |  | $ | (0.67  | ) |  | $ | (1.10  | )

As AMD had a June 30 year-end and HEI has an August 31 year-end, the pro forma
information reflects the combination of different periods for HEI and AMD. The
2003 and 2002 pro forma information includes unaudited results of operations
for the three- and six-month periods ended March 1, 2003 and March 2, 2002,
respectively, for HEI and unaudited results of operations for the three- and
six-month periods ended December 31, 2002 and 2001 for AMD, respectively.

The unaudited pro forma amounts have been derived by applying pro forma
adjustments to the historical consolidated financial information of HEI and
AMD.

The pro forma information is not necessarily indicative of what the actual
operating results or financial position would have been for the combined
company had the transaction taken place on September 1, 2001, and do not
purport to indicate the results of future operations.

11



---



##### Table of Contents



Below is a table of the estimated acquisition consideration, purchase price
allocation and annual amortization of the intangible assets and goodwill
acquired:

|                           |                                      |  |        |        |        |  |              |  | 
|-------------------------- | ------------------------------------ |  | ------ | ------ | ------ |  | ------------ |  | 
|                           |                                      |  |        |        |        |  | Amortization
|                           |                                      |  | Amount |        | Period
|                           |                                      |  |        |        |       
|Purchase price allocation: |                                      |  |        |        |        |  |              | 
|                           | Cash                                 |  | $      | 1,215  |        |  |              |  | 
|                           | Accounts receivable                  |  |        | 300    |        |  |              |  | 
|                           | Inventory                            |  |        | 2,854  |        |  |              |  | 
|                           | Property and equipment               |  |        | 1,900  |        |  | 3-10 years  
|                           | Prepaids, deposits and other assets  |  |        | 1,690  |        |  |              |  | 
|                           | Developed technology                 |  |        | 584    |        |  | 3-4 years   
|                           | Customer deposits and other reserves |  |        | (1,638 | )      |  |              |  | 
|                           | Operating lease reserves             |  |        | (2,810 | )      |  |              |  | 
|                           | Accrued transaction costs            |  |        | (1,495 | )      |  |              |  | 
|                           |                                      |  |        |        |        |  |              | 
|                           | Total purchase price                 |  | $      | 2,600  |        |  |              |  | 
|                           |                                      |  |        |        |        |  |              | 

The estimation of intangible asset values for the developed technology was
determined utilizing discounted cash flow analyses. The discounted cash flow
analyses were based upon three to five-year cash flow projections. The
expected future cash flows attributable to existing technologies were
discounted to present value at discount rates ranging from 23% to 40%, taking
into account risks related to the characteristics and applications of the
developed technology, our anticipated courses of business activities,
historical financial market rates of return, and assessments of the stage of
the technologys life cycle. The analyses resulted in a valuation for
developed technologies that had reached technological feasibility and therefore
were capitalized.

The cash flow projections were based on estimates and assumptions about
circumstances and events that have not yet taken place. Such estimates and
assumptions are inherently subject to significant economic and competitive
uncertainties and contingencies beyond our control, including, but not limited
to, those with respect to the future courses of our business activity.
Accordingly, there will usually be differences between projected and actual
results because events and circumstances frequently do not occur as expected,
and those differences may be material.

12



---



##### Table of Contents






Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

(in thousands, except share and per share amounts)


Three and Six Months Ended March 1, 2003 and March 2, 2002

The following discussion highlights the principal factors affecting the changes
in financial condition and results of operations. This review should be read
in conjunction with the Consolidated Financial Statements, Notes to
Consolidated Financial Statements and the Managements Discussion and Analysis
of Financial Condition and Results of Operations included in our Annual Report
on Form 10-K for the fiscal year ended August 31, 2002.

OVERALL

On January 24, 2003, HEI acquired certain assets and liabilities of Colorado
MEDtech, Inc.s (CMED) Colorado Operations (a business unit of CMED) or (the
Advance Medical Division (AMD) in a business combination accounted for as a
purchase. In connection with this acquisition, we issued 1,000,000 shares of
our common stock and assumed approximately $900 of AMD liabilities, as well as
operating lease and other contractual commitments. The purchase price of AMD
was $2,600 based upon the closing market price of a share of HEI common stock
the day the merger was consummated, as quoted on the NASDAQ National Market.
The excess of the fair value of net assets over the purchase price of $3,200
has been allocated to reduce the carrying value of identifiable long-lived
tangible and intangible assets.

Revenues continued their decline during the second quarter but this decline was
mitigated by the acquisition of AMD. The results of operations for the three
and six months ended March 1, 2003 includes the results of AMD since January
24, 2003 and, therefore, the results for the three and six months ended March
1, 2003 are not indicative of the impact of a full three- or six-month period.

We have streamlined and improved our sales and marketing efforts with a more
focused sales plan. Positive results from this effort have already been
achieved. Specifically, we have added three Original Equipment
Manufacture (OEM) customers to date in fiscal 2003, won two accounts and four
new programs in the medical imaging market, leveraged design and
microelectronics talent to gain a medical therapeutic equipment customer and
successfully introduced broadband platforms to the Aerospace industry with two
customers. These efforts will continue during 2003 as we attempt not only to
increase sales, but also to improve diversification of its products and
services. The uncertainty of the market has caused significant delays in our
receipt of longer-term commitments from certain customers. Significant
customer concentration continues with 50% of total revenue coming from three
customers during the six-months ended March 1, 2003.

Excluding the employees added in connection with the AMD transaction, the
employee base was reduced by 28 persons during the first quarter and an
additional 15 through the second quarter of fiscal 2003. A total of 43
positions have been eliminated so far in fiscal 2003. As of March 1, 2003, we
had 289 employees compared to 223 employees as of March 2, 2002, with 141 added
in connection with the AMD transaction.

We intend to reduce and contain costs as revenues fluctuate while balancing our
ongoing development of new products and maintaining our ability to react
quickly to favorable market demands and opportunities. These cost savings,
however, will not be realized in their entirety if increased production demand
requires the re-hiring of additional personnel.

It is important to note that variable costs are approximately 50% to 55% of
revenue, which makes profitability extremely volume or revenue dependent.

CRITICAL ACCOUNTING POLICIES

The accompanying consolidated financial statements are based on the selection
and application of accounting principles generally accepted in the United
States (GAAP), which require estimates and assumptions about future events
that may affect the amounts reported in these financial statements and the
accompanying notes. Future events and their effects cannot be determined with
absolute certainty. Therefore, the determination of

13



---



##### Table of Contents



estimates requires the exercise of judgment. Actual results could differ from
those estimates, and any such differences may be material to the financial
statements. We believe that the following accounting policies may involve a
higher degree of judgment and complexity in their application and represent the
critical accounting policies used in the preparation of our financial
statements. If different assumptions or conditions were to prevail, the
results could be materially different from reported results.

Revenue recognition, Sales returns and Warranty

The SECs Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition
provides guidance on the application of GAAP to selected revenue recognition
issues, and our revenue recognition policies are in compliance with SAB No.
101. We recognize revenue upon shipment of products to customers when all
contractual obligations have been satisfied and collection of the resulting
receivable is reasonably assured. In fiscal 2002, a consignment program was
established with a significant customer where revenue is recognized when the
customer uses the inventory. Sales, payment terms and pricing extended to
customers are governed by the respective contract agreements or binding
purchase orders for each transaction and provide no right of return outside of
contractual warranty terms. Payment terms are seven days for consignment
program sales and four to 45 days for other customers.

We record provisions against net sales for estimated product returns. These
estimates are based on factors that include, but are not limited to, historical
sales returns, analyses of credit memo activities, current economic trends and
changes in the demands of our customers. Provisions are also recorded for
warranty claims that are based on historical trends and known warranty claims.
Should actual product returns exceed estimated allowances, additional
reductions to our revenue would result. As of March 1, 2003 and August 31,
2002, warranty and product reserves were $416 and $200, respectively.

Allowance for uncollectible accounts

We estimate the collectibility of trade receivables and notes receivable which
requires considerable amount of judgment in assessing the realization of these
receivables, including the current credit-worthiness of each customer and
related aging of the past due balances. In order to assess the collectibility
of these receivables, we perform ongoing credit evaluations of our customers
financial condition. Through these evaluations, we may become aware of a
situation where a customer may not be able to meet its financial obligations
due to a deterioration of its financial viability, credit ratings or
bankruptcy. The reserve requirements are based on the best facts available to
us and reevaluated and adjusted as additional information is received. We are
not able to predict changes in the financial condition of our customers, and if
circumstances related to our customers deteriorate, its estimates of the
recoverability of its receivables could be materially affected and we may be
required to record additional allowances. Alternatively, if we provide more
allowances than we need, we may reverse a portion of such provisions in future
periods based on changes in estimates from its actual collection experience.
As of March 1, 2003 and August 31, 2002, we had an accounts receivable
allowance of $75 and $85, respectively.

Inventories

HEI records inventories at the lower of cost or market value. Generally all
inventory purchases are for customized parts for a specific customer program.
As such, contractual arrangements are typically agreed to with the customer in
order to protect us in cases where the demand decreases, as often times the
parts cannot be consumed in other programs. Even though contractual
arrangements may be in place, we are still required to assess the utilization
of inventory. In assessing the ultimate realization of inventories, judgments
as to future demand requirements are made and compared to the current or
committed inventory levels and contractual inventory holding requirements.
Reserve requirements generally increase as projected demand requirements
decrease due to market conditions, technological and product life cycle changes
as well as longer than previously expected usage periods. We have experienced
significant changes in required reserves in recent periods due primarily to
declining market conditions. It is possible that significant changes

14



---



##### Table of Contents



in required inventory reserves may continue to occur in the future if there is
a further decline in market conditions. As of March 1, 2003 and August 31,
2002, we had a reserve for excess and obsolete inventory of $1,763 and $311,
respectively, including $1,414 of inventory reserves at AMD as of March 1, 2003.

Long-lived assets

HEI continually evaluates whether events and circumstances have occurred that
indicate the remaining estimated useful life of long-lived assets may warrant
revision, or that the remaining balance of these assets may not be recoverable.
We evaluate the recoverability of our long-lived assets in accordance with
Statement of Financial Accounting Standards (SFAS) No. 144 Accounting for
the Impairment or Disposal of Long-Lived Assets, which we adopted on July 1,
2002. SFAS No. 144 superseded SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. When deemed
necessary, we complete this evaluation by comparing the carrying amount of the
assets against the estimated undiscounted future cash flows associated with
them. If such evaluations indicate that the future undiscounted cash flows of
long-lived assets are not sufficient to recover the carrying value of such
assets, the assets are adjusted to their estimated fair values. The adoption
of SFAS No. 144 did not have a material impact on our reported results of
operations.

Valuation of Deferred Taxes

Significant management judgment is required in determining the provision for
income taxes, deferred tax assets and liabilities and any valuation allowance
recorded against net deferred tax assets. We record a current provision for
income taxes based on amounts payable or refundable. Deferred tax assets and
liabilities are recognized for the future tax consequences of differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
the period that includes the enactment date. The overall change in deferred tax
assets and liabilities for the period measures the deferred tax expense or
benefit for the period. We recognize a valuation allowance for deferred tax
assets when it is more likely than not that deferred assets are not
recoverable.

We recorded a valuation allowance of approximately $4,300 and $3,400,
respectively, at March 1, 2003 and August 31, 2002, due to uncertainties
related to its ability to utilize certain Federal and state net loss
carryforwards.

Purchase Accounting

The accompanying statements reflect a preliminary allocation of the AMD
purchase price. This allocation includes an accrual of $800 related to an
unfavorable operating lease; $2,010 for future estimated lease payments ($5,910
for future lease obligations less estimated sublease payments of $3,900 on
excess manufacturing capacity for which we are in the process of reviewing
alternative uses); and a $600 accrual to fulfill estimated contractual
manufacturing obligations. We continue the process of gathering information to
complete our analysis of the excess lease capacity and the contractual
manufacturing obligations. Any reductions in these liabilities will result in
a decrease in the carrying value of the intangible assets and fixed assets.
Conversely, an increase in these liabilities will increase the carrying values
of long-lived assets. At March 1, 2003 the carrying value of long-lived and
intangible assets has been reduced by $3,200 due to the allocation of negative
goodwill.

15



---



##### Table of Contents



RECENT ACCOUNTING PRONOUNCEMENTS

In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS No.
146, Accounting for Costs Associated with Exit or Disposal Activities
addressing the financial accounting and reporting for costs associated with
exit and disposal activities and nullifies Emerging Issues Task Force Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in Restructuring).
The provisions of SFAS No. 146 are effective for exit or disposal activities
that are initiated after December 31, 2002, with early application encouraged.
We will utilize the provisions of SFAS No. 146 for exit and disposal activities
occurring January 1, 2003 and thereafter.

In November 2002, FASB issued Interpretation (FIN) No. 45, Guarantors
Accounting and Disclosure Requirements, Including Guarantees of Indebtedness of
Others. FIN No. 45 requires that upon issuance of certain types of guarantees,
a guarantor recognize and account for the fair value of the guarantee as a
liability. FIN No. 45 contains exclusions to this requirement, including the
exclusion of a parents guarantee of its subsidiaries debt to a third party.
The initial recognition and measurement provisions of FIN No. 45 should be
applied on a prospective basis for guarantees issued or modified after December
31, 2002. The disclosure requirements of FIN No. 45 are effective for financial
statements of both interim and annual periods ending after December 31, 2002
and were adopted by HEI in the quarter ended March 1, 2003. The adoption of FIN
45 is not expected to have a material impact on our financial position, results
of operations or cash flows.

In November 2002, Emerging Issues Task Force (EITF) finalized its tentative
consensus on EITF Issue 00-21, Revenue Arrangements with Multiple
Deliverables, which provides guidance on the timing of revenue recognition for
sales undertakings to deliver more that one product or service. We are
required to adopt EITF 00-21 on transactions occurring after June 2003 and are
currently analyzing the impact of its adoption on our financial statements.

In January 2003, FASB issued FIN No. 46, Consolidation of Variable Interest
Entities, which addresses accounting for special-purpose and variable interest
entities. We are required to adopt this guidance for financial statements
issued after December 31, 2002, as required and are currently analyzing the
impact of its adoption on our financial statements.

In December 2002, FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. This statement, which is an
amendment of SFAS No. 123, provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported financial
results. We currently account for stock-based compensation using the intrinsic
value method defined in Accounting Principles Board No. 25 and do not currently
intend to voluntarily change to the fair value method described in SFAS No.
123. As a result, we do not expect the new guidelines found in SFAS No. 148 to
have a material effect upon our financial statements at its adoption. The new
interim reporting requirements are effective for interim periods beginning
after December 15, 2002, and we intend to provide the additional required
information related to stock-based compensation in our quarterly report on Form
10-Q for the quarter ending May 31, 2003.

FINANCIAL CONDITION AND LIQUIDITY

HEIs cash and cash equivalents totaled approximately $13 at March 1, 2003 and
$2,372 at August 31, 2002. We had $1,060 available under our revolving line of
credit at March 1, 2003.

In connection with the purchase of AMD, we issued a Subordinated Promissory
Note to CMED in the amount of $2,600 (the Subordinated Promissory Note). The
terms of the Subordinated Promissory Note include an interest rate of 10%
(increasing to 12% and 14%, in July 2003 and January 2004,
respectively)

16



---



##### Table of Contents



and a due date for all principal and interest on September 30, 2004. There are
no prepayment penalties associated with this Subordinated Promissory Note. The
Subordinated Promissory Note coupled with approximately $1,215 in cash acquired
from CMED, was used to (i) pay the equipment loans of $844, (ii) pay
transaction costs of $1,198 related to the AMD acquisition and (iii) repay the
outstanding Industrial Development Revenue Bonds (IDRBs) totaling $1,735.

Operating activities utilized cash of $288 during the six months ended March 1,
2003, and provided $931 in cash during the six months ended March 2, 2002.
Cash used by operating activities for the six months ended March 1, 2003
resulted primarily from a net loss of $2,491, offset by depreciation and a
decrease in inventory. The increases in accounts receivable and accounts
payable is primarily a result of the AMD acquisition. The accounts receivable
average days outstanding improved to 36 days at March 1, 2003 from 53 days as
of August 31, 2002. This improvement resulted from the contractual
arrangements for a large, newly acquired AMD customer that calls for payment
within four business days, much faster than our other customers.

Investing activities utilized cash of $90 and $2,164 for the six months ended
March 1, 2003 and March 2, 2002, respectively. Cash used by investing
activities during the six months ended March 1, 2003 was primarily attributed
to the payment of $1,198 in transaction costs related to the AMD acquisition
offset by the $1,215 in cash acquired in the AMD transaction.

Financing activities utilized $1,981 in cash during the six months ended March
1, 2003 and provided $1,140 during the six months ended March 2, 2002. The
fiscal 2003 activity reflects the payoff of our equipment loan and net
reductions in the revolving line of credit, an increase in restricted cash (due
to the replacement of $1,000 in restricted cash at August 31, 2002 with $1,800
to fund the repayment of principal and interest on the IDRBs), offset by the
addition of the Subordinated Promissory Note.

HEI has a maximum of $3,000 available under the revolving line of credit, with
the actual lending amount based on accounts receivable balances outstanding.
As of March 1, 2003, there were no borrowings under the line of credit term
loan facility. Any borrowings are subject to certain restrictive financial
covenants, including but not limited to: tangible net worth, interest coverage
ratio, debt service coverage ratio, net loss limitations and the ability to
declare or pay dividends. The general economic slowdown in the hearing, RFID
and other electronic contract manufacturing markets in which we operate has
resulted in adverse operating results in the second quarter of fiscal 2003 and,
as a result, we were in default with the net loss limitation covenant at March
1, 2003. On April 9, 2003, we amended our agreement with the bank to waive the
default and to add an additional covenant requiring our liabilities to tangible
net worth ratio, as defined, not to exceed .75 to 1.00. In addition, the
financial institution has required us to exercise our commercially reasonable
efforts to obtain alternative financing, repay any outstanding debt to the
financial institution and terminate the agreement on or before June 30, 2003.
If this debt is not repaid by June 30, 2003, we will incur a fee of $50 on July
1, 2003. The maturity date of the revolving line of credit remains August 1,
2004. We are currently in compliance with the new covenant and, based on
current financial projections, believe we will meet bank covenants going
forward. However, we have a history of not meeting financial debt covenants.

We are currently discussing options with various local financial institutions.
There can be no assurance that a new credit facility will be available or, if
available, that such new credit facility will be at terms acceptable us. If we
are unable to obtain a new credit facility by June 30, 2003, additional
payments will be required under our existing credit facility. We believe that
existing cash and cash equivalents, current lending capacity and cash generated
from operations will provide sufficient cash flow to meet short- and long-term
debt obligations and operating requirements until a credit facility with a new
financial institution can be established.

HEI had outstanding IDRBs totaling $1,735 at March 1, 2003. These bonds were
originally issued in April 1996 in connection with the construction of a new
addition to the manufacturing facility in Victoria, Minnesota, and for the
purchase of production equipment. On March 14, 2003, an aggregate of
approximately $1,735 of debt proceeds from the Subordinated Promissory Note
were used to fund the repayment of principal and interest on the IDRBs. At
March 1, 2003, we had classified $1,735 as current maturities of long-term debt
and set aside $1,800 in restricted cash for the principal and interest payment.

17



---



##### Table of Contents



During fiscal 2003, we intend to expend no more than $500 for manufacturing and
facility improvements and capital equipment, of which $43 has been expended
during the first and second quarters of fiscal 2003. The remaining additions
will only be made to increase manufacturing capacity to the level sufficient to
meet near-term production requirements and, if necessary, add technological
capabilities and are expected to be funded from operations and available debt
financing.

Giving effect to the AMD transaction and the assumed operating lease and other
contractual commitments, including (i) the Subordinated Promissory Note and
(ii) the rights and obligations of the operating lease and expansion of the
facilities located in Boulder, Colorado, which has a 10-year lease commitment,
our contractual obligations at March 1, 2003 are summarized in the following
table:

|                              |  |                 |       |        |  |        |       |            |  |       |       |  |  |   |        |  |  |   |        | 
|----------------------------- |  | --------------- | ----- | ------ |  | ------ | ----- | ---------- |  | ----- | ----- |  |  | - | ------ |  |  | - | ------ | 
|                              |  | Six             |       |        |  |        |       |            |  |       |       |  |  |   |        |  |  |  
|                              |  | Months          |       | Fiscal |  | Fiscal |       |            |  |       |       |  |  |  
|                              |  | Ending          |       | Year   |  | Year   |       |            |  |       |       |  |  |  
|                              |  | August 31, 2003 |       | 2004   |  | 2005   |       | Thereafter |  | Total
|                              |  |                 |       |        |  |        |       |            |  |      
|Long-term debt                |  | $               | 1,799 |        |  | $      | 140   |            |  | $     | 2,606 |  |  | $ |       |  |  | $ | 4,545  | 
|Operating leases              |  |                 | 947   |        |  |        | 2,076 |            |  |       | 1,898 |  |  |   | 11,611 |  |  |   | 16,532 | 
|                              |  |                 |       |        |  |        |       |            |  |       |       |  |  |   |        |  |  |   |        | 
|Total contractual obligations |  | $               | 2,746 |        |  | $      | 2,216 |            |  | $     | 4,504 |  |  | $ | 11,611 |  |  | $ | 21,077 | 
|                              |  |                 |       |        |  |        |       |            |  |       |       |  |  |   |        |  |  |   |        | 

18



---



##### Table of Contents



RESULTS OF OPERATIONS

The following table indicates the dollars and percentages of total revenues
represented by the selected items in our consolidated statements of
operations:

Selected Operating Results:

|                         |  |                    |        |                  |  |               |     |               |  |   |       |   |  |  |     |    |  |   |        |   |  |  |     |    |  |   |        |   |  |  |     |   
|------------------------ |  | ------------------ | ------ | ---------------- |  | ------------- | --- | ------------- |  | - | ----- | - |  |  | --- | -- |  | - | ------ | - |  |  | --- | -- |  | - | ------ | - |  |  | --- | --
|                         |  | Three Months Ended |        | Six Months Ended
|                         |  |                    |        |                 
|                         |  | March 1, 2003      |        | March 2, 2002    |  | March 1, 2003 |     | March 2, 2002
|                         |  |                    |        |                  |  |               |     |              
|Net Sales                |  | $                  | 8,144  |                  |  |               | 100 | %             |  | $ | 7,799 |   |  |  | 100 | %  |  | $ | 13,634 |   |  |  | 100 | %  |  | $ | 13,925 |   |  |  | 100 | % 
|Cost of Sales            |  |                    | 7,282  |                  |  |               | 89  | %             |  |   | 6,260 |   |  |  | 80  | %  |  |   | 12,160 |   |  |  | 89  | %  |  |   | 12,001 |   |  |  | 86  | % 
|                         |  |                    |        |                  |  |               |     |               |  |   |       |   |  |  |     |    |  |   |        |   |  |  |     |    |  |   |        |   |  |  |     |   
|Gross Profit             |  |                    | 862    |                  |  |               | 11  | %             |  |   | 1,539 |   |  |  | 20  | %  |  |   | 1,474  |   |  |  | 11  | %  |  |   | 1,924  |   |  |  | 14  | % 
|Operating Expenses       |  |                    | 2,204  |                  |  |               | 27  | %             |  |   | 1,951 |   |  |  | 25  | %  |  |   | 3,956  |   |  |  | 29  | %  |  |   | 3,973  |   |  |  | 29  | % 
|                         |  |                    |        |                  |  |               |     |               |  |   |       |   |  |  |     |    |  |   |        |   |  |  |     |    |  |   |        |   |  |  |     |   
|Operating Loss           |  |                    | (1,342 | )                |  |               | (16 | )%            |  |   | (412  | ) |  |  | (5  | )% |  |   | (2,482 | ) |  |  | (18 | )% |  |   | (2,049 | ) |  |  | (15 | )%
|Other (expense) income   |  |                    | 6      |                  |  |               |    | %             |  |   | (61   | ) |  |  | (1  | )% |  |   | (28    | ) |  |  |    | %  |  |   | (82    | ) |  |  |    | % 
|                         |  |                    |        |                  |  |               |     |               |  |   |       |   |  |  |     |    |  |   |        |   |  |  |     |    |  |   |        |   |  |  |     |   
|Loss before income taxes |  |                    | (1,336 | )                |  |               | (16 | )%            |  |   | (473  | ) |  |  | (6  | )% |  |   | (2,510 | ) |  |  | (18 | )% |  |   | (2,131 | ) |  |  | (15 | )%
|Income tax benefit       |  |                    |       |                  |  |               |    | %             |  |   | 163   |   |  |  | 2   | %  |  |   | 19     |   |  |  |    | %  |  |   | 727    |   |  |  | 5   | % 
|                         |  |                    |        |                  |  |               |     |               |  |   |       |   |  |  |     |    |  |   |        |   |  |  |     |    |  |   |        |   |  |  |     |   
|Net loss                 |  |                    | (1,336 | )                |  |               | (16 | )%            |  |   | (310  | ) |  |  | (4  | )% |  |   | (2,491 | ) |  |  | (18 | )% |  |   | (1,404 | ) |  |  | (10 | )%
|                         |  |                    |        |                  |  |               |     |               |  |   |       |   |  |  |     |    |  |   |        |   |  |  |     |    |  |   |        |   |  |  |     |   

Net Sales

HEIs sales fluctuate based on changing product mix and market instability and
are dependent on the level and timing of customer business and other matters
such as customer concentration.

Net sales in the second quarter were $8,144, $345 or 4% higher that the
comparable quarter last year. Net sales for the six months ended March 1, 2003
were $13,634, $291 or 2% less than the first six months of last year. The
second quarter increase related to $2,809 in net sales generated by the AMD
business, which was acquired in January 2003. The six-month decrease was
caused by a continued general economic slowdown and the resulting impact in
certain markets, particularly the hearing, communications, RFID and electronic
contact manufacturing markets and increased internal manufacturing capacity of
customers.

The communications and RFID markets remain soft as customers are awaiting
market acceptance of new products and increased demand for existing products.
As the demand for these products increases, we are well positioned for an
increase in sales in these markets. We are also experiencing continued
external interest in our proprietary products, for which it is working on new
designs, qualification testing and prototype orders with numerous customers.

Because sales are generally tied to the customers projected sales and
production of the related product, our sales are subject to uncontrollable
fluctuations. To the extent that sales to any one customer represent a
significant portion of sales, any change in the sales levels to that customer
can have a significant impact on total sales. In addition, production from one
customer may conclude while production for a new customer may not have begun or
is not yet at full volume. We have significant customer concentration with 52%
of net sales in the second quarter of fiscal 2003 being generated by three
customers. Net sales generated by these customers amounted to 70% for the
second quarter of last year.

19



---



##### Table of Contents



At March 1, 2003 our backlog for future orders was approximately $22,855
compared to approximately $5,387 at August 31, 2002. This increase in backlog
relates to the acquired AMD of business, which had a backlog of $16,600 at
March 1, 2003. The AMD backlog includes customer commitments that have longer terms, as compared to our historical customer commitments. Our backlog is not
necessarily a firm commitment from our customers and can change, in some cases
materially, beyond our control.

Net sales by market for the three and six months ended March 1, 2003 and March
2, 2002, respectively, are as follows:

|                    |  |                    |       |                  |  |               |       |               |  |   |        |  |  |   |        | 
|------------------- |  | ------------------ | ----- | ---------------- |  | ------------- | ----- | ------------- |  | - | ------ |  |  | - | ------ | 
|                    |  | Three Months Ended |       | Six Months Ended
|                    |  |                    |       |                 
|                    |  | March 1, 2003      |       | March 2, 2002    |  | March 1, 2003 |       | March 2, 2002
|                    |  |                    |       |                  |  |               |       |              
|Medical             |  | $                  | 3,398 |                  |  | $             | 482   |               |  | $ | 4,684  |  |  | $ | 826    | 
|Hearing             |  |                    | 3,270 |                  |  |               | 5,683 |               |  |   | 6,006  |  |  |   | 10,015 | 
|RFID/Communications |  |                    | 1,120 |                  |  |               | 1,418 |               |  |   | 2,333  |  |  |   | 2,746  | 
|Industrial/HDI      |  |                    | 356   |                  |  |               | 216   |               |  |   | 611    |  |  |   | 338    | 
|                    |  |                    |       |                  |  |               |       |               |  |   |        |  |  |   |        | 
|Total Net Sales     |  | $                  | 8,144 |                  |  | $             | 7,799 |               |  | $ | 13,634 |  |  | $ | 13,925 | 
|                    |  |                    |       |                  |  |               |       |               |  |   |        |  |  |   |        | 

Net sales analysis by market follows:

Medical. The acquisition of the AMD business accounted for the majority of the
$2,916 and $3,858 increase in medical sales for the three and six-month periods
ended March 1, 2003 and March 2, 2002, respectively.

Hearing.We continue to experience fluctuations in demand for its hearing
products. Hearing sales for the three- and six-month periods ended March 1,
2003 and March 2, 2002 decreased 42% and 40%, respectively, to $3,270 and
$6,006, respectively. These decreases are mainly due to excess inventory
positions at significant hearing customers and reflect the general economic
slowdown, which continue to negatively impact the hearing contract
manufacturing markets. Also, during the latter part of fiscal 2002, a major
customers internal manufacturing capabilities increased, which are expected to
reduce annual revenues by approximately $3,000.

RFID/Communications:Net sales to Radio Frequency Identification (RFID) and
Communications customers decreased by $298 or 21% and $413 or 15% for the
three- and six-month periods ended March 1, 2003 and March 2, 2002,
respectively. This decrease is driven by a significant drop in orders from a
major customer that, in 2002, sold one division and terminated operations of
another. We are also experiencing significant competition from overseas
manufacturers in this market. New products have been developed and
capabilities have been expanded to improve revenue; however, the actual level
of market acceptance of these initiatives is currently unknown.

Industrial/HDI:Net sales to industrial and High Density Interconnect (HDI)
customers for the three-month and six-month period ended March 1, 2003
increased 65% and 81%, respectively, to $356 and $611, respectively. HDI
represents net sales of flexible circuit boards. The overall market remains
depressed, however, demand from a few of our customers increased this quarter
and increased activity is seen in this market with low volume purchase orders.

Gross Profit

Gross profit was $862 (11% of net sales) and $1,539 (11%) for the three and six
months ended March 1, 2003, respectively, compared to $1,474 (20%) and $1,924
(14%) for the three and six months ended March 2, 2002, respectively. An
unfavorable mix of revenue from lower margin manufacturing programs coupled
with lower manufacturing yields drove the decreases in gross margin. Our gross
margins are heavily impacted by fluctuations in revenue, due to the fixed
nature of many of our manufacturing costs. As market acceptance of our
proprietary broadband communications products occurs, gross margins should
improve, as these products are expected to have higher gross margin than we
have historically experienced.

20



---



##### Table of Contents



Operating Expenses

Operating expenses increased by $253 or 13% and decreased by $17 for the three-
and six-month periods ended March 1, 2003, and March 2, 2002, respectively.
The increase for the three months ended March 1, 2003 related to the AMD
business acquired in January 2003, representing $504 for this period. As a
percentage of net sales, operating expenses in total were 27% and 29%,
respectively, for the three and six-month periods ended March 1, 2003,
respectively, compared to 25% and 29%, respectively, for the comparable periods
last year. Factors having an impact on these expenses include our past cost
containment measures, which, in addition to staff reductions, include decreased
insurance, legal and public reporting costs. These reductions were mitigated
by increases in advertising, travel and severance costs. Overall expenses
continue to decline as a result of our continued effort to right-size the
business balanced with our commitment to maintain our research and development
efforts and continued sales and marketing focus.

Other Income (Expenses), net

HEI recorded $6 in net other income and $28 in net other expenses during the
three- and six-month periods ended March 1, 2003, respectively, and $61 and $82
in net other expenses during the six months ended March 2, 2002, respectively.
Net other income and expenses consist mainly of interest income and expense.
The improvement here relates to the reduction in our debt, offset by higher
rates of interest on current and future debt (see Note 5).

Income Taxes

We established a valuation allowance of approximately $4,300 and $3,400,
respectively, at March 1, 2003 and August 31, 2002, respectively, to fully
reserve the deferred tax assets because of uncertainties related to our ability
to utilize certain federal and state loss carryforwards. This allowance is
based on estimates of taxable income by jurisdiction during the period over
which its deferred tax assets are recoverable. In addition, due to the full
valuation allowance, effective with the first quarter of fiscal 2003, we will
no longer record income tax expense or benefit until we have established a
history of taxable income, and have satisfied certain other GAAP requirements.
The economic benefits of our net operating loss carryforwards to future years
will continue. At March 1, 2003, we had Federal net operating loss
carryforwards of $10,761 that expire at various dates ranging from 2013 through
2022.

Income tax benefits for the three- and six-month periods ended March 2, 2002
were $163 and $727, respectively.

Weighted Average Common Shares

Due to the closing of the AMD transaction on January 24, 2003, the full affect
of the issuance of 1,000,000 shares of common stock to CMED were not realized
in the March 1, 2003 periods noted above. This issue will have a material
impact on fully diluted shares in future periods.

21



---



##### Table of Contents



Forward-Looking Statements

Information in this document, which is not historical, includes forward-looking
statements made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. In addition, from time to time, we
or our representatives have made or may make forward-looking statements orally
or in writing. These statements are made based on our current views and
assumptions regarding technology, markets, growth and earnings expectations,
and all of such forward-looking statements involve a number of risks and
uncertainties. There are certain important factors that can cause actual
results to differ materially from the forward-looking statements, including,
without limitation, continuing adverse business and market conditions, our
ability to secure and satisfy customers, the availability and cost of materials
from our suppliers, our ability to replace our credit facility, adverse
competitive developments, changes in or cancellations of customer requirements,
integration of AMD and other factors discussed from time to time in our filings
with the Securities and Exchange Commission. Readers are cautioned not to
place undue reliance on forward-looking statements and holders of our
securities are specifically referred to such documents with regard to factors
and conditions that may affect future results. We undertake no obligation to
update these statements to reflect ensuing events or circumstances, or
subsequent actual results.

22



---



##### Table of Contents






Item 3. Qualitative and Quantitative Disclosures About Market Risk
(in thousands, except share amounts)

HEI is exposed to certain market risks with its revolving line of credit,
capital expenditure loans and, to a lesser extent, its IDRBs. At March 1,
2003, the outstanding balance on the revolving line of credit, capital
expenditure loans and IDRBs were $0, $78 and $1,735, respectively. Effective
December 1, 2002, the revolving line of credit agreement bears interest, at our
option, at 2.75% above the prime rate of interest or 5.25% above the LIBOR
rate. The capital expenditure loans bear interest, at our option, at 3.00%
above the prime rate of interest or 5.50% above the LIBOR rate. At March 1,
2003, the interest rates on the revolving commitment and capital expenditure
loans were 7.00% and 7.25%, respectively. The IDRBs bear interest at a rate,
which varies weekly, based on comparable tax-exempt issues, and is limited to a
maximum rate of 10.00%. At March 1, 2003, the interest rate on the IDRBs was
1.14%. Consequently, we are exposed to a change in borrowing costs as interest
rates change. We have completed a market risk sensitivity analysis of these
debt instruments based upon an assumed 1.00% increase in interest rates at
March 1, 2003. If market interest rates had increased by 1% on March 1, 2003,
this would have resulted in an increase to interest expense of approximately
$18 over a one-year period. Because this is only an estimate, any actual
change in expense due to a change in interest rates could differ from this
estimate. The acquisition of the AMD business required us to prepay the
IDRBs, which totaled $1,735. An escrow account was established for $1,800
(principal and interest) for the purpose of paying the IDRBs once the required
prior notice period of 35 days to the bondholders is met. The IDRBs were paid
in full on March 14, 2003.

On January 24, 2003, we acquired AMD from CMED in a business combination
accounted for as a purchase. In connection with this acquisition, we issued
1,000,000 shares of our common stock and assumed approximately $900 of AMD
liabilities, as well as AMD operating lease and other contractual commitments.
The purchase price of AMD was $2,600 based upon the closing market price of a
share of our common stock the day the merger was consummated on January 24,
2003, as quoted on the NASDAQ National Market. The excess of the fair value of
net assets over the purchase price has been allocated to identifiable,
long-lived tangible and intangible assets.

In connection with the AMD acquisition, we issued the Subordinated Promissory
Note. The terms of the Subordinated Note include an interest rate of 10%
(increasing to 12% and 14%, in July 2003 and January 2004,
respectively), and a due date for all principal and interest of September 30,
2004.




Item 4. Controls and Procedures

Based on their evaluation, as of a date within 90 days of the filing date of
this Quarterly Report on Form 10-Q, HEIs principal executive officer and
principal financial officer believe that our disclosure controls and procedures
(as defined in Rules 13a-14(c) and 15d-14(c) under the Exchange Act) are
effective in timely alerting management to material information required to be
included in this Form 10-Q and other Exchange Act filings.

There were no significant changes in our internal controls or in other factors
that could significantly affect those controls subsequent to the date of our
evaluation, and there were no significant deficiencies or material weaknesses
that required corrective actions.

23



---



##### Table of Contents






PART II  OTHER INFORMATION




Item 2. Changes in Securities and Use of Proceeds

(in thousands, except per share amounts)


On January 24, 2003, HEI acquired certain assets and liabilities of AMD from
CMED in a business combination accounted for as a purchase. In connection with
this acquisition, HEI issued 1,000,000 shares of its common stock and assumed
approximately $900 of AMD liabilities, as well as operating lease and other
contractual commitments. The assets we acquired include, among other things,
cash, intellectual property, equipment, inventory and facilities. The purchase
price of AMD was $2,600 based upon the closing market price of a share of our
common stock on the NASDAQ National Market. The excess of the fair value of
net assets over the purchase price of $3,200 has been allocated to reduce the
carrying value of identifiable long-lived tangible and intangible assets The
consideration we paid in connection with the acquisition was determined through
arms-length negotiations and was based, in part, on the book value of the
assets acquired. The issuance of the common stock was not registered under the
Securities Act of 1933, as amended, in reliance upon Section 4(2) promulgated
thereunder. WE INTEND TO REGISTER SUCH SHARES WITH THE SEC ON A REGISTRATION STATEMENT ON FORM S-3.




Item 4. Submission of Matters to a Vote of Security Holders

(in thousands, except share amounts)


At the Annual Meeting of Shareholders held on February 5, 2003, the following
directors were elected to serve a three-year term ending in 2006:

|                     |  |                      |  |                        
|-------------------- |  | -------------------- |  | -----------------------
|Mack V. Traynor, III |  | Votes For: 5,572,613 |  | Votes Withheld: 103,698
|Timothy F. Floeder   |  | Votes For: 5,575,804 |  | Votes Withheld: 100,507

The following directors also continue to serve: Steve E. Tondera, Jr. (term
expires in 2004), Dennis J. Leisz (term expires in 2004) and Anthony J. Fant
(term expires in 2005).




Item 6. Exhibits and Reports on Form 8-K



| | a) |  | Exhibits.
| | -- |  | ---------



| | 10.1 |  | Eighth Amendment to the Loan and Security Agreement Between
HEI, Inc. and LaSalle Business Credit, LLC dated April 9, 2003*     
| | ---- |  | --------------------------------------------------------------------------------------------------------------------------------
|
| | 99.1 |  | Certifications of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
|
| |      |  | * Filed herewith                                                                                                                



| | b) |  | Reports on Form 8-K
| | -- |  | -------------------



| |  |  | On January 7, 2003, HEI filed a Current Report on Form 8-K reporting, under
Item 5  Other Events, certain information relating to the election of
directors and certain changes to the management structure of the Company.                                                                                                                                                                                                                                                         
| |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | On January 14, 2003, HEI filed a Current Report on Form 8-K reporting, under
Item 5  Other Events, its financial results for the first quarter ended
November 30, 2002.                                                                                                                                                                                                                                                                                                             
|
| |  |  | On February 6, 2003, HEI filed a Current Report on Form 8-K reporting, under
Item 9  Regulation FD Disclosure, certain information relating to the
acquisition of the assets of the Colorado operations of CMED, the Annual
Shareholder Meeting held on February 5, 2003, and the issuance of the
Subordinated Promissory Note.                                                                                                                                                     
|
| |  |  | On February 10, 2003, HEI filed a Current Report on Form 8-K reporting, under
Item 2  Acquisitions and Dispositions, certain information relating to the
acquisition of the assets of the Colorado operations of CMED. On April 10,
2003, HEI filed Amendment No. 1 to the Current Report on Form 8-K/A to include,
under Item 7  Financial Statements and Exhibits, the requisite financial
statements of the business acquired and the requisite pro forma financial
information.

24



---



##### Table of Contents






SIGNATURES

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

|      |  |          |  |                                                                                              | 
|----- |  | -------- |  | -------------------------------------------------------------------------------------------- | 
|      |  |          |  | HEI, Inc.                                                                                    | 
|      |  |          |  |                                                                                              | 
|Date: |  | 04/18/03 |  | /s/ Steve E. Tondera, Jr.                                                                    | 
|      |  |          |  |                                                                                              | 
|      |  |          |  | Steve E. Tondera, Jr.                                                                        | 
|      |  |          |  | Vice President of Finance,
Chief Financial Officer and Treasurer
(a duly authorized officer) | 

25



---



##### Table of Contents






CERTIFICATIONS

I, Mack V. Traynor, III, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of HEI, Inc.;                                                                                                                                                                                                                                                              
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data and
have identified for the registrants auditors any material weaknesses
in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                     |  |                                      
|-------------------- |  | -------------------------------------
|                     |  | /s/ Mack V. Traynor, III             
|                     |  |                                      
|                     |  | Mack V. Traynor, III                 
|                     |  | Chief Executive Officer and
President
|Date: April 18, 2003 |  |                                      

26



---



##### Table of Contents



I, Steve E. Tondera, Jr., certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of HEI, Inc.;                                                                                                                                                                                                                                                              
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data and
have identified for the registrants auditors any material weaknesses
in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                     |  |                                                                         
|-------------------- |  | ------------------------------------------------------------------------
|                     |  | /s/ STEVE E. TONDERA, JR.                                               
|                     |  |                                                                         
|                     |  | Steve E. Tondera, Jr.                                                   
|                     |  | Chief Financial Officer, Treasurer, Vice
President Finance and Secretary
|                     |  |                                                                         
|Date: April 18, 2003 |  |                                                                         

27



---



##### Table of Contents






Exhibit Index



| | 10.1 |                  | Eighth Amendment to the Loan any Security Agreement
Between HEI, Inc. and Lasalle Business Credit, LLC dated April 9, 2003.*     
| | ---- | ---------------- | ---------------------------------------------------------------------------------------------------------------------------------
| | 99.1 |                  | Certifications of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
| |      | * Filed herewith

28