##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 ****
 FORM 10-Q
 ****
 þ
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended November 26, 2005.
 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 For the transition period fromto.
 Commission
File Number 0-10078
 HEI, Inc.
  Minnesota
    
    41-0944876(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)PO Box 5000, 1495 Steiger Lake Lane, Victoria, MN
    
    55386(Address of principal executive offices)
    
    (Zip Code)
 (952) 443-2500
 þ o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer þ
 o þ




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##### 



TABLE OF CONTENTS
 Table of Contents
    
    HEI, Inc.Part I  Financial Information (unaudited)
    
    
    3Item 1. Financial Statements
    
    
    3Consolidated Balance Sheets
    
    
    3Consolidated Statements of Operations
    
    
    4Consolidated Statements of Cash Flows
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    18Item 4. Controls and Procedures
    
    
    18Part II  Other Information
    
    
    19Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    19Item 6. Exhibits
    
    
    19Signature
    
    
    20Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  2




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PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 HEI, Inc.
 
 Consolidated Balance Sheets
 (In thousands, except per share and share data)
 November 26 ,
    
    
    August 31,2005
    
    
    2005(Unaudited)
    
    
    (Audited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    826
    
    
    $
    351Accounts receivable, net of allowance for doubtful accounts
of $157
    
    
    8,227
    
    
    
    9,278Inventories
    
    
    7,797
    
    
    
    8,044Security deposit
    
    
    
    
    
    
    1,350Other current assets
    
    
    730
    
    
    
    1,136Total current assets
    
    
    17,580
    
    
    
    20,159Property and equipment:Land
    
    
    216
    
    
    
    216Building and improvements
    
    
    4,323
    
    
    
    4,323Fixtures and equipment
    
    
    23,393
    
    
    
    23,214Accumulated depreciation
    
    
    (21,394
    )
    
    
    (20,864
    )Net property and equipment
    
    
    6,538
    
    
    
    6,889Developed technology, less accumulated amortization
of $383 and $352, respectively
    
    
    31
    
    
    
    62Security deposit
    
    
    230
    
    
    
    230Other long-term assets
    
    
    649
    
    
    
    337Total assets
    
    $
    25,028
    
    
    $
    27,677LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Line of credit
    
    $
    1,143
    
    
    $
    2,563Current maturities of long-term debt
    
    
    500
    
    
    
    484Accounts payable
    
    
    3,354
    
    
    
    4,019Accrued liabilities
    
    
    3,729
    
    
    
    4,129Total current liabilities
    
    
    8,726
    
    
    
    11,195Other long-term liabilities, less current maturities
    
    
    913
    
    
    
    873Long-term debt, less current maturities
    
    
    1,771
    
    
    
    1,813Total other long-term liabilities, less current maturities
    
    
    2,684
    
    
    
    2,686Total liabilities
    
    
    11,410
    
    
    
    13,881Commitments and contingencies
Shareholders equity:Undesignated stock; 1,833,000 shares authorized; none issued
    
    
    
    
    
    
    Convertible preferred stock, $.05 par; 167,000 shares
authorized; 32,000 shares issued and outstanding; liquidation
preference at $26 per share (total liquidation preference
$832)
    
    
    2
    
    
    
    2Common stock, $.05 par; 13,000,000 shares authorized;
9,479,000 and 9,379,000 shares issued and
outstanding
    
    
    474
    
    
    
    469Paid-in capital
    
    
    27,148
    
    
    
    26,701Accumulated deficit
    
    
    (13,799
    )
    
    
    (13,169
    )Notes receivable-related parties-officers and former directors
    
    
    (207
    )
    
    
    (207
    )Total shareholders equity
    
    
    13,618
    
    
    
    13,796Total liabilities and shareholders equity
    
    $
    25,028
    
    
    $
    27,677
  3




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HEI, Inc.
 
 Consolidated Statements of Operations (Unaudited)  (In thousands, except per share data)
 Three Months EndedNovember 26, 2005
    
    
    November 27, 2004Net sales
    
    $
    13,787
    
    
    $
    14,071Cost of sales
    
    
    11,063
    
    
    
    11,115Gross profit
    
    
    2,724
    
    
    
    2,956Operating expenses:Selling, general and administrative
    
    
    2,163
    
    
    
    2,042Research, development and engineering
    
    
    1,093
    
    
    
    837Total Operating expenses
    
    
    3,256
    
    
    
    2,879Operating income (loss)
    
    
    (532
    )
    
    
    77Other income (expenses):Interest expense, net
    
    
    (127
    )
    
    
    (169
    )Litigation recovery
    
    
    
    
    
    
    481Other income (expense), net
    
    
    29
    
    
    
    26Income (loss) before income taxes
    
    
    (630
    )
    
    
    415Income taxes
    
    
    
    
    
    
    Net income (loss)
    
    $
    (630
    )
    
    $
    415Net income (loss) per common share:Basic
    
    $
    (0.07
    )
    
    $
    0.05Diluted
    
    $
    (0.07
    )
    
    $
    0.05Weighted average common shares outstanding:Basic
    
    
    9,400
    
    
    
    8,357Diluted
    
    
    9,400
    
    
    
    8,425
  4




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HEI, Inc.
 
 Consolidated Statements of Cash Flows (Unaudited)  (In thousands)
 Three Months EndedNovember 26, 2005
    
    
    November 27, 2004Cash flow from operating activities:Net income (loss)
    
    $
    (630
    )
    
    $
    415Adjustments to reconcile net income (loss) to net cash used in operating activities:Depreciation and amortization
    
    
    585
    
    
    
    645Loss on disposal of property and equipment
    
    
    
    
    
    
    15Stock based compensation expense
    
    
    116
    
    
    
    Changes in operating assets and liabilities:Restricted cash related to deferred litigation
    
    
    
    
    
    
    481Accounts receivable
    
    
    1,051
    
    
    
    (1,476
    )Inventories
    
    
    247
    
    
    
    (808
    )Other current assets
    
    
    406
    
    
    
    444Accounts payable
    
    
    (665
    )
    
    
    281Accrued liabilities and other long-term liabilities
    
    
    (360
    )
    
    
    (795
    )Net cash flow provided by (used in) operating activities
    
    
    750
    
    
    
    (798
    )Cash flow from investing activities:Additions to property and equipment
    
    
    (58
    )
    
    
    (338
    )Additions to patents
    
    
    
    
    
    
    (54
    )Refund of security deposit
    
    
    1,350
    
    
    
    Net cash flow provided by (used in) investing activities
    
    
    1,292
    
    
    
    (392
    )Cash flow from financing activities:Note repayment
    
    
    
    
    
    
    20Repayment of long-term debt
    
    
    (147
    )
    
    
    (103
    )Net borrowings (repayments) on line of credit
    
    
    (1,420
    )
    
    
    1,377Net cash flow provided by (used in) financing activities
    
    
    (1,567
    )
    
    
    1,294Net increase in cash and cash equivalents
    
    
    475
    
    
    
    104Cash and cash equivalents, beginning of period
    
    
    351
    
    
    
    200Cash and cash equivalents, end of period
    
    $
    826
    
    
    $
    304Supplemental disclosures of cash flow information:Interest paid
    
    $
    143
    
    
    $
    169Capital lease obligations related to equipment acquisitions
    
    $
    121
    
    
    
    Issuance of
common stock to landlord recorded as long-term asset
    
    $
    336
    
    
    
    
  5




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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
        Revenue Recognition.
  Use of Estimates.
    6




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November 27, 2004Net income (loss) as reported
    
    $
    415Add: Stock-based employee compensation included in
reported net income (loss), net of related tax effects
    
    
    Deduct: Total stock-based employee compensation income
(expense) determined under fair value based method for
all awards
    
    
    (407
    )Net income (loss) pro forma
    
    $
    8Basic and diluted net income (loss) per share as reported
    
    $
    0.05Stock-based compensation expense
    
    
    (0.05
    )Basic and diluted net income (loss) per share pro forma
    
    $
    
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##### Table of Contents



November 26,
    
    
    August 31,2005
    
    
    2005Inventories:Purchased parts
    
    $
    5,415
    
    
    $
    5,881Work in process
    
    
    666
    
    
    
    590Finished goods
    
    
    1,716
    
    
    
    1,573$
    7,797
    
    
    $
    8,044Accrued liabilities:Employee related costs
    
    $
    1,566
    
    
    $
    1,786Deferred revenue
    
    
    92
    
    
    
    440Real estate taxes
    
    
    165
    
    
    
    130Customers deposits
    
    
    772
    
    
    
    589Current maturities of long-term liabilities
    
    
    273
    
    
    
    247Warranty reserve
    
    
    70
    
    
    
    132Other accrued liabilities
    
    
    791
    
    
    
    805$
    3,729
    
    
    $
    4,129Other long-term liabilities:Remaining lease obligation, less estimated sublease
proceeds
    
    $
    628
    
    
    $
    552Unfavorable operating lease, net
    
    
    558
    
    
    
    568Total
    
    
    1,186
    
    
    
    1,120Less current maturities
    
    
    273
    
    
    
    247Total other long-term liabilities
    
    $
    913
    
    
    $
    873
   Warranty
    
    WarrantyBeginning Balance
    
    Provisions
    
    Claims
    
    Ending BalanceFiscal 2006
    
    $
    132
    
    
    $
    (37
    )
    
    $
    25
    
    
    $
    70Fiscal 2005
    
    $
    139
    
    
    $
    20
    
    
    $
    19
    
    
    $
    140
 8




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November 26
    
    
    August 31,2005
    
    
    2005Commerce Bank mortgage payable in monthly installments of principal and interest of $9 based
on a twenty-year amortization with a final payment of approximately $1,050 due in November 2009;
collateralized by our Victoria facility
    
    $
    1,140
    
    
    $
    1,145Commerce Financial Group, Inc. equipment loan payable in fixed monthly principal and interest
installments of $28 through September 2007; collateralized by our Victoria facility and equipment
located at our Tempe facility
    
    
    581
    
    
    
    673Capital lease obligation; payable in installments of $1 through February 2009; collateralized
with equipment
    
    
    23
    
    
    
    25Commercial loans payable in fixed monthly principal installments of $1 through May 2009;
collateralized with certain machinery and equipment
    
    
    21
    
    
    
    22Commercial loans payable in fixed monthly principal installments of $12 through July 2005;
collateralized with certain machinery and equipment
    
    
    0
    
    
    
    9Capital lease obligations; payable in fixed monthly installments of $15 through July 2008; secured
with certain machinery and equipment
    
    
    392
    
    
    
    423Capital lease obligations; payable in fixed monthly installments of $5 through September 2008;
secured
with certain machinery and equipment
    
    
    114
    
    
    
    0Total
    
    
    2,271
    
    
    
    2,297Less current maturities
    
    
    500
    
    
    
    484Total long-term debt
    
    $
    1,771
    
    
    $
    1,813
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Three Months EndedNovember 26, 2005
    
    November 27, 2004Basic:Net income (loss)
    
    $
    (630
    )
    
    $
    415Net income (loss) per share
    
    $
    (0.07
    )
    
    $
    0.05Weighted average number of common shares outstanding
    
    
    9,400
    
    
    
    8,357Diluted:Net income (loss)
    
    $
    (630
    )
    
    $
    415Net income (loss) per share
    
    $
    (0.07
    )
    
    $
    0.05Weighted average number of common shares outstanding
    
    
    9,400
    
    
    
    8,357Assumed conversion of stock options
    
    
    
    
    
    
    68Weighted average common and assumed conversion shares
    
    
    9,400
    
    
    
    8,425
   1 2
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Three Months EndedNovember 26, 2005
    
    
    November 27, 2004Dollars
    
    
    % of Sales
    
    
    Dollars
    
    
    % of SalesUnited States
    
    $
    9,908
    
    
    
    72
    %
    
    $
    10,410
    
    
    
    74
    %Canada / Mexico
    
    $
    654
    
    
    
    5
    %
    
    $
    1,598
    
    
    
    11
    %Europe
    
    $
    1,621
    
    
    
    12
    %
    
    $
    678
    
    
    
    5
    %Asia-Pacific
    
    $
    1,598
    
    
    
    11
    %
    
    $
    1,372
    
    
    
    10
    %South America
    
    $
    6
    
    
    
    0
    %
    
    $
    13
    
    
    
    0
    %Total
    
    $
    13,787
    
    
    
    
    
    
    $
    14,071
 11




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Three Months Ended November 26, 2005Corporate
    
    Microelectronics
    
    Advanced MedicalOperations
    
    Operations
    
    Operations
    
    TotalNet sales
    
    $
    
    
    
    $
    8,920
    
    
    $
    4,867
    
    
    $
    13,787Gross profit
    
    
    
    
    
    
    1,981
    
    
    
    743
    
    
    
    2,724Operating expense
    
    
    2,144
    
    
    
    863
    
    
    
    249
    
    
    
    3,256Operating income (loss)
    
    
    (2,144
    )
    
    
    1,118
    
    
    
    494
    
    
    
    (532
    )Total assets
    
    
    
    
    
    
    18,111
    
    
    
    6,917
    
    
    
    25,028Depreciation and amortization
    
    
    
    
    
    
    482
    
    
    
    103
    
    
    
    585Capital expenditures
    
    
    
    
    
    
    50
    
    
    
    8
    
    
    
    58
 Three Months Ended November 27, 2004Net sales
    
    $
    
    
    
    $
    7,636
    
    
    $
    6,435
    
    
    $
    14,071Gross profit
    
    
    
    
    
    
    1,137
    
    
    
    1,819
    
    
    
    2,956Operating expense
    
    
    1,967
    
    
    
    379
    
    
    
    533
    
    
    
    2,879Operating income (loss)
    
    
    (1,967
    )
    
    
    758
    
    
    
    1,286
    
    
    
    77Total assets
    
    
    
    
    
    
    17,069
    
    
    
    9,238
    
    
    
    26,307Depreciation and amortization
    
    
    
    
    
    
    564
    
    
    
    81
    
    
    
    645Capital expenditures
    
    
    
    
    
    
    323
    
    
    
    15
    
    
    
    338
     12




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Overview
   Results of Operations
 Three Months Ended November 26, 2005 and November 27, 2004:
  Selected Operating Results
 Three Months EndedNovember 26
    
    
    
    
    
    
    November 272005
    
    
    
    
    
    
    2004Net sales
    
    $
    13,787
    
    
    
    100
    %
    
    $
    14,071
    
    
    
    100
    %Cost of sales
    
    
    11,063
    
    
    
    80
    %
    
    
    11,115
    
    
    
    79
    %Gross profit
    
    
    2,724
    
    
    
    20
    %
    
    
    2,956
    
    
    
    21
    %Operating expenses
    
    
    3,256
    
    
    
    24
    %
    
    
    2,879
    
    
    
    20
    %Operating income (loss)
    
    
    (532
    )
    
    
    (4
    %)
    
    
    77
    
    
    
    1
    %Other income (expense)
    
    
    (98
    )
    
    
    (1
    %)
    
    
    338
    
    
    
    2
    %Income (loss) before income taxes
    
    
    (630
    )
    
    
    (5
    %)
    
    
    415
    
    
    
    3
    %Income tax benefit
    
    
    
    
    
    
    0
    %
    
    
    
    
    
    
    0
    %Net income (loss)
    
    $
    (630
    )
    
    
    (5
    %)
    
    
    415
    
    
    
    3
    %
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Three Months EndedNovember 26 2005
    
    
    November 27 2004Medical/Hearing
    
    $
    10,222
    
    
    $
    11,294Communications
    
    
    2,588
    
    
    
    1,574Industrial
    
    
    977
    
    
    
    1,203Total Net Sales
    
    $
    13,787
    
    
    $
    14,071
 Net Sales
      14




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Gross Profit
   Operating Expenses
 Selling, general and administrative expenses
  Research, development, and engineering expenses
  Other Income (Expense), Net
  Income Taxes
  15




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FINANCIAL CONDITION AND LIQUIDITY
        16




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CRITICAL ACCOUNTING POLICIES
  Revenue
Recognition, Sales Returns and Warranty
     Forward-Looking Statements
 Some of
the information included in this Quarterly Report on Form 10-Q contains forward-looking
statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform
Act of 1995 that involve substantial risks and uncertainties. You can identify these statements by
forward-looking words such as may, will, expect, anticipate, believe, intend,
estimate, continue, and similar words. You should read statements that contain these words
carefully for the following reasons: such statements discuss our future expectations, such
statements contain projections of future earnings or financial condition and such statements state
other forward-looking information. Although it is important to communicate our expectations, there
may be events in the future that we are not accurately able to predict or over which we have no
control. The risk factors included in our Annual Report on Form 10-K for the fiscal year
ended August 31, 2005 provide examples of such risks, uncertainties and events that may cause
actual results to differ materially from our expectations and the forward-looking statements.
Readers are cautioned not to
place undue reliance on forward-looking statements, as we undertake no obligation to update these
forward-looking statements to reflect ensuing events or circumstances, or subsequent actual
results.
 17




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Item 3. Qualitative and Quantitative Disclosures About Market Risk
  Market Risk
  Interest Rate Risk
    
 Item 4. Controls and Procedures
     18




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PART II  OTHER INFORMATION
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 6. Exhibits
 a) Exhibits
 31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 19




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SIGNATURES
  HEI, Inc.Date: January 10, 2006
    /s/ Timothy C. ClaytonTimothy C. ClaytonChief Financial Officer 20




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Exhibit Index
 31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 21