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  **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 February 25, 2006.****   o **Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.******For the transition period from ___to ___.******Commission File Number 0-10078****HEI, Inc.**(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.)   PO Box 5000, 1495 Steiger Lake Lane, Victoria, MN  55386   (Address of principal executive offices) (Zip Code)(952) 443-2500Registrant’s telephone number, including area codeIndicate by check mark whether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes þ No oIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer ora non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule12b-2 of the Exchange Act.     Large accelerated filer o Accelerated filer o Non-accelerated filer þIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o No þAs of April 7, 2006, 9,479,567 Common Shares, par value $.05 per share, were outstanding.  
 

 
**TABLE OF CONTENTS**         Table of Contents HEI, Inc.         Part I – Financial Information (unaudited)  3   Item 1. Financial Statements  3     Consolidated Balance Sheets  3     Consolidated Statements of Operations  4     Consolidated Statements of Cash Flows  5     Notes to Consolidated Financial Statements  6   Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations  15   Item 3. Quantitative and Qualitative Disclosures About Market Risk  19   Item 4. Controls and Procedures  20 Part II – Other Information  21   Item 4. Submission of Matters to a Vote of Security Holders  21   Item 6. Exhibits  22   Signature  23  Certification of CEO Pursuant to Section 302 Certification of CFO Pursuant to Section 302 Certification of CEO Pursuant to Section 906 Certification of CFO Pursuant to Section 906
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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)*           **February25,**  **August 31,**   **2006**  **2005**   **(Unaudited)**  **(Audited)** **ASSETS**        Current assets:        Cash and cash equivalents $160  $351 Accounts receivable, net of allowance for doubtful accountsof $151 and $157, respectively  7,379   9,278 Inventories  8,142   8,044 Security deposit  —   1,350 Other current assets  802   1,136        Total current assets  16,483   20,159        Property and equipment:        Land  216   216 Building and improvements  4,323   4,323 Fixtures and equipment  23,813   23,214 Accumulated depreciation  (21,853)  (20,864)       Net property and equipment  6,499   6,889        Developed technology, less accumulated amortizationof $406 and $352, respectively  8   62 Security deposit  322   230 Other long-term assets  657   337        Total assets $23,969  $27,677                 **LIABILITIES AND SHAREHOLDERS’ EQUITY**        Current liabilities:        Line of credit $1,400  $2,563 Current maturities of long-term debt  545   484 Accounts payable  3,487   4,019 Accrued liabilities  3,685   4,129        Total current liabilities  9,117   11,195        Other long-term liabilities, less current maturities  919   873 Long-term debt, less current maturities  1,706   1,813        Total other long-term liabilities, less current maturities  2,625   2,686        Total liabilities  11,742   13,881        Commitments and contingencies        Shareholders’ equity:        Undesignated stock; 5,000,000 and 1,833,000 shares authorized; none issued  —   — Convertible preferred stock, $.05 par; 167,000 shares authorized; 32,000shares issued and outstanding; liquidation preference at $26 per share(total liquidation preference $832)  2   2 Common stock, $.05 par; 20,000,000 and 13,000,000 shares authorized;9,479,000 and 9,379,000 shares issued and outstanding  474   469 Paid-in capital  27,305   26,701 Accumulated deficit  (15,487)  (13,169)Notes receivable-related parties-officers and former directors  (67)  (207)       Total shareholders’ equity  12,227   13,796        Total liabilities and shareholders’ equity $23,969  $27,677        See accompanying notes to unaudited consolidated financial statements.
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**HEI, Inc.****Consolidated Statements of Operations (Unaudited)***(In thousands, except per share data)*                   **Three Months Ended**  **Six Months Ended**   **February 25, 2006**  **February 26, 2005**  **February 25, 2006**  **February 26, 2005** Net sales **$****11,718**  **$****13,736**  **$****25,505**  **$****27,808** Cost of sales  **9,972**   **10,869**   **21,035**   **21,984**              Gross profit  **1,746**   **2,867**   **4,470**   **5,824**              Operating expenses:                Selling, general and administrative  **2,350**   **2,344**   **4,513**   **4,387**                  Research, development and engineering  **984**   **934**   **2,077**   **1,771**              Total Operating expenses  **3,334**   **3,278**   **6,590**   **6,158**              Operating loss  **(1,588****)**  **(411****)**  **(2,120****)**  **(334****)**             Other income (expenses):                Interest expense, net  **(96****)**  **(180****)**  **(223****)**  **(349****)**Litigation recovery  **—**   **—**   **—**   **481** Other income (expense), net  **(4****)**  **54**   **25**   **80**              Loss before income taxes  **(1,688****)**  **(537****)**  **(2,318****)**  **(122****)**Income taxes  **—**   **—**   **—**   **—**              Net loss **$****(1,688****)** **$****(537****)** **$****(2,318****)** **$****(122****)**             Net loss per common share:                Basic **$****(0.18****)** **$****(0.06****)** **$****(0.25****)** **$****(0.01****)**Diluted **$****(0.18****)** **$****(0.06****)** **$****(0.25****)** **$****(0.01****)**             Weighted average common shares outstanding:                Basic  **9,480**   **8,357**   **9,440**   **8,357** Diluted  **9,480**   **8,357**   **9,440**   **8,357**              See accompanying notes to unaudited consolidated financial statements.
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**HEI, Inc.****Consolidated Statements of Cash Flows (Unaudited)***(In thousands)*           **Six Months Ended**   **February 25, 2006**  **February 26 2005** Cash flow from operating activities:        Net loss **$****(2,318****)** **$****(122****)**Adjustments to reconcile net loss to net cash provided by (used in)operating activities:        Depreciation and amortization  **1,206**   **1,307** Loss on disposal of property and equipment  **—**   **24** Stock based compensation expense  **273**   **—** Changes in operating assets and liabilities:        Restricted cash related to deferred litigation  **—**   **481** Accounts receivable  **1**,**899**   **(2,046****)**Inventories  **(98****)**  **(1,145****)**Other current assets  **474**   **150** Accounts payable  **(532****)**  **879** Accrued liabilities and other long-term liabilities  **(398****)**  **(845****)**       Net cash flow provided by (used in) operating activities  **506**   **(1,317****)**       Cash flow from investing activities:        Additions to property and equipment  **(527****)**  **(768****)**Proceeds from sale of assets  **8**   **—** Additions to patents  **(2****)**  **(80****)**Refund of security deposit, net  **1,258**   **—**        Net cash flow provided by (used in) investing activities  **737**   **(848****)**       Cash flow from financing activities:        Note repayment-related parties-officers and former directors  **—**   **—** Repayment of long-term debt  **(271****)**  **(195****)**Net borrowings (repayments) on line of credit  **(1,163****)**  **2,229**        Net cash flow provided by (used in) financing activities  **(1,434****)**  **2,054**        Net increase in cash and cash equivalents  **(191****)**  **(131****)**Cash and cash equivalents, beginning of period  **351**   **200**        Cash and cash equivalents, end of period **$****160**  **$****69**        ***Supplemental disclosures of cash flow information:***        Interest paid **$****239**  **$****349** Capital lease obligations related to equipment acquisitions **$****225**   **—** Issuance of common stock to landlord recognized as long-term asset **$****336**   **—** Reclassification of notes receivable-related parties to other current assets **$****140**  **$****227** See accompanying notes to unaudited consolidated financial statements.
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**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**(In thousands, except share and per share data)(1) Basis of Financial Statement PresentationThe accompanying unaudited interim consolidated financial statements have been prepared by HEI,Inc. pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Thesefinancial statements contain all normal recurring adjustments, which are, in our opinion, necessaryfor a fair presentation of the financial position, results of operations and cash flows inaccordance with accounting principles generally accepted in the United States of America (“GAAP”).Certain information and footnote disclosures normally included in financial statements prepared inaccordance with GAAP have been condensed or omitted. We believe, however, that the disclosures areadequate to make the information presented not misleading. The year-end balance sheet data wasderived 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 thefinancial statements and accompanying notes included in our Annual Report on Form 10-K for ourfiscal year ended August 31, 2005 (“Fiscal 2005”). Interim results of operations for thethree-month and six-month periods ended February 25, 2006, may not necessarily be indicative of theresults to be expected for the full year.The unaudited interim consolidated financial statements include the accounts of our wholly-ownedsubsidiary. All significant intercompany transactions and balances have been eliminated inconsolidation.Our quarterly periods end on the Saturday closest to the end of each quarter of our fiscal yearending August 31.Summary of Significant Accounting Policies*Revenue Recognition.*Revenue for manufacturing and assembly contracts is recognized upon shipmentwhen the risk and rewards of ownership have passed to the customer without special acceptanceprotocols or payment contingencies. We have a number of customer arrangements in which we retainownership of inventory until customer receipt or customer acceptance, and in one instance until thecustomer pulls inventory into production at its offshore facility. Revenue is deferred for thesearrangements until the risks and rewards of ownership pass to the customer upon receipt oracceptance. Our Advanced Medical Operations (“AMO”) provides service contracts for some of itsproducts. Billings for services contracts are based on published renewal rates and revenue isrecognized on a straight-line basis over the service period.AMO’s development contracts are discrete time and materials projects that generally do not involveseparate deliverables. Development contract revenue is recognized ratably as development activitiesoccur based on contractual per hour and material reimbursement rates. Development contracts are aninteractive process with customers as different design and functionality is contemplated during thedesign phase. Upon reaching the contractual billing maximums, we defer revenue until contractextensions or purchase orders are received from customers. We occasionally have contractualarrangements in which part or all of the payment or billing is contingent upon achieving milestonesor customer acceptance. For those contracts we evaluate whether the contract should be accountedusing the completed contract method, as the term of the arrangement is short-term, or using thepercentage of completion method for longer-term contracts.*Use of Estimates.*The preparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ significantly from thoseestimates.(2) LiquidityThe accompanying unaudited consolidated financial statements have been prepared assuming that therealization of assets and the satisfaction of liabilities will occur in the normal course ofbusiness. We incurred a net loss of $1,688 for the three months ended February 25, 2006, a net lossof $2,318 for the six months ended February 25, 2006 and net income of $355 for the year endedAugust 31, 2005.We have historically financed our operations through the public and private sale of equitysecurities, bank borrowings, operating equipment leases and cash generated by operations.
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At February 25, 2006, our sources of liquidity consisted of $160 of cash and cash equivalents andour accounts receivable agreement (“Credit Agreement”) with Beacon Bank of Shorewood, Minnesota,which provides borrowing capacity up to $5.0 million subject to availability based on our accountsreceivable. The Credit Agreement is due to expire in September 2006. There was $1,400 outstandingdebt under the Credit Agreement at February 25, 2006.On May 9, 2005, we sold 130,538 shares of our Series A Convertible Preferred Stock which providednet proceeds of $3.2 million to the Company. In addition, on November 23, 2005, we received $1,350refund of our security deposit on our Boulder facility. These actions enabled us to fund workingcapital requirements and acquire manufacturing equipment. We have entered into additionalfinancing agreements primarily in the form of operating and capital leases for the acquisition ofapproximately $2.2 million of equipment which will be capitalized upon release of the equipmentinto production which will occur in the third quarter of Fiscal 2006.Our liquidity, however, is affected by many factors, some of which are based on the normal ongoingoperations of our business, the most significant of which include the timing of the collection ofreceivables, the level of inventories and capital expenditures. In the event cash flows are notsufficient to fund operations at the present level measures can be taken to reduce the expenditurelevels including but not limited to reduction of spending for research and development,engineering, elimination of budgeted raises, and reduction of non-strategic employees and thedeferral or elimination of capital expenditures. In addition, we believe that other sources ofliquidity are available including issuance of the Company’s stock, the expansion of our CreditAgreement and the issuance of long-term debt.(3) Stock Based CompensationOn December 16, 2004, the Financial Accounting Standards Board, or FASB, issued Statement ofFinancial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment”, which is a revision ofSFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-based paymentsto employees, including grants of employee stock options, to be valued at fair value on the date ofgrant, and to be expensed over the applicable vesting period. Pro forma disclosure of the incomestatement effects of share-based payments is no longer an alternative. For the company, SFAS No.123(R) is effective for all share-based awards granted on or after September 1, 2005. In addition,companies must also recognize compensation expense related to any awards that are not fully vestedas of the effective date. Compensation expense for the unvested awards will be measured based onthe fair value of the awards previously calculated in developing the pro forma disclosures inaccordance with the provisions of SFAS No. 123. We implemented SFAS No. 123(R) on September 1, 2005using the modified prospective method.As more fully described in our Annual Report on Form 10-K for the year ended August 31, 2005, wehave granted stock options over the years to employees and Directors under various stockholderapproved stock option plans. As of February 25, 2006, 1,621,975 stock options are outstanding.The fair value of each option grant was determined as of grant date, utilizing the Black-Scholesoption pricing model. Based on these valuations, we recognized compensation expense of $115 and$231 ($.01 and $.02 per share) in the three and six months ended February 25, 2006 related to theamortization of the unvested portion of these options as of September 1, 2005. Theamortization of each option grant will continue over the remainder of the vesting period of eachoption grant . We expect that the impact on earnings for the remainder of Fiscal 2006 for stockbased compensation will be approximately $225, and estimate the impact on future earnings to beapproximately $400. In addition, during the three months ended February 25, 2006, we modified theterms of 100,000 options to accelerate vesting on any unvested portion of these grants and toextend the exercise period on 25,000 options for 90 days beyond normal terms. The effect of theseactions was an additional non-cash expense of $42,000 which was recorded in the quarter endedFebruary 25, 2006.In prior years, we applied the intrinsic-value method prescribed in Accounting Principles Board(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for the issuance ofstock incentives to employees and directors. No compensation expense related to employees’ anddirectors’ stock incentives were recognized in the prior year financial statements, as all optionsgranted under stock incentive plans had an exercise price equal to the market value of theunderlying common stock on the date of grant. Had we applied the fair value recognition provisionsof “SFAS” No. 123, “Accounting for Stock-Based Compensation,” to stock based employee compensationfor periods prior to Fiscal 2006, our net loss per share would have increased to the pro formaamounts indicated below:
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           **Three- Months Ended**  **Six Months Ended**   **February 26, 2005**  **February 26, 2005** Net loss as reported $(537) $(122)Add: Stock-based employee compensation includedin reported net loss, net of related taxeffects      — Deduct: Total stock-based employee compensationexpense determined under fair value basedmethod for all awards  (407)  (815)       Net loss pro forma $(944) $(937)       Basic and diluted net loss per share as reported $(0.06) $(0.01)Stock-based compensation expense  (0.05)  (0.10)       Basic and diluted net loss per share pro forma $(0.11) $(0.11)       There were no options granted in the three months ended February 25, 2006 or February 26, 2005.There were 5,000 options granted in the six months ended February 25, 2006 and no options grantedin the six months ended February 26, 2005.During the three month period ended February 25, 2006, the Company granted 73,800 shares ofrestricted stock to several officers, key employees and directors. These shares vest over fouryears. The value of the shares at the date of grant was $242 which will be expensed over thevesting period.(4) Developed TechnologyAmortization expense for developed technology for the three-months ended February 25, 2006 andFebruary 26, 2005 was $23 and $31, respectively. Amortization expense for the six-month periods was$54 in Fiscal 2006 and $62 in Fiscal 2005. Amortization expense for developed technology will be$62 for our fiscal year ending August 31, 2006.(5) Other Financial Statement DataThe following provides additional information concerning selected consolidated balance sheetaccounts at February 25, 2006 and August 31, 2005:           **February 25,**  **August 31,**   **2006**  **2005** Inventories:        Purchased parts $5,722  $5,881 Work in process  559   590 Finished goods  1,861   1,573          $8,142  $8,044        Accrued liabilities:        Employee related costs $1,551  $1,786 Deferred revenue  120   440 Real estate taxes  229   130 Customers deposits  639   589 Current maturities of long-term liabilities  280   247 Warranty reserve  86   132 Other accrued liabilities  780   805          $3,685  $4,129        Other long-term liabilities:        Remaining lease obligation, less estimated subleaseproceeds $651  $552 Unfavorable operating lease, net  548   568        Total  1,199   1,120 Less current maturities  280   247        Total other long-term liabilities $919  $873        
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(6) Warranty ObligationsSales of our products are subject to limited warranty guarantees that typically extend for a periodof twelve months from the date of manufacture. Warranty terms are included in customer contractsunder which we are obligated to repair or replace any components or assemblies deemed defective dueto workmanship or materials. We do, however, reserve the right to reject warranty claims where wedetermine that failure is due to normal wear, customer modifications, improper maintenance, ormisuse. Warranty provisions are based on estimated returns and warranty expenses applied to currentperiod revenue and historical warranty incidence over the preceding twelve-month period. Both theexperience and the warranty liability are evaluated on an ongoing basis for adequacy. Warrantyprovisions and claims for the first three and six months of Fiscal 2006 and 2005 were as follows:                       **Warranty** **Warranty**    **Beginning Balance** **Provisions** **Claims** **Ending Balance****For the Three MonthsEnded**                February 25, 2006 $70  $(24) $10  $36 February 26, 2005 $140  $83  $63  $160 **For the Six MonthsEnded**                February 25, 2006 $132  $(60) $36  $36 February 26, 2005 $139  $103  $82  $160 
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(7) Long-Term DebtOur long-term debt consists of the following:           **February 25**  **August 31,**   **2006**  **2005** Commerce Bank mortgage payable inmonthly installments of principal andinterest of $9 based on a twenty-yearamortization with a final payment ofapproximately $1,050 due in November2009; collateralized by our Victoriafacility $1,136  $1,145 Commerce Financial Group, Inc.equipment loan payable in fixed monthlyprincipal and interest installments of$28 through September 2007;collateralized by our Victoria facilityand equipment located at our Tempefacility  509   673 Capital lease obligation; payable ininstallments of $1 through February2009; collateralized with equipment  22   25 Commercial loans payable in fixedmonthly principal installments of $1through May 2009; collateralized withcertain machinery and equipment  20   22 Commercial loans payable in fixedmonthly principal installments of $12through July 2005; collateralized withcertain machinery and equipment  0   9 Capital lease obligations; payable infixed monthly installments of $16through July 2008; collateralizedwith certain machinery and equipment  360   423 Capital lease obligations; payable infixed monthly installments of $4through September 2008; collateralizedwith certain machinery and equipment  105   0 Capital lease obligations; payable infixed monthly installments of $1through November 2008; collateralizedwith certain machinery and equipment  20   0 Capital lease obligations; payable infixed monthly installments of $3through January 2009; collateralizedwith certain machinery and equipment  79   0        Total  2,251   2,297 Less current maturities  545   484        Total long-term debt $1,706  $1,813        The Company has two primary long-term debt obligations with Commerce Bank, a Minnesota statebanking association, and its affiliate, Commerce Financial Group, Inc., a Minnesota corporation.The first note, with Commerce Bank, in the original principal amount of $1,200 was executed onOctober 14, 2003. This note is collaterialized by our Victoria, Minnesota facility. The term of thefirst note is six years. The original interest rate on this note was a nominal rate of 6.50% perannum for the first three years, and thereafter the interest rate will be adjusted on the firstdate of the fourth loan year to a nominal rate per annum equal to the then Three Year Treasury BaseRate (as defined) plus 3.00%; provided, however, that in no event will the interest rate be lessthan the Prime Rate plus 1.0% per annum. Monthly payment of principal and interest will be based ona twenty-year amortization with a final payment of approximately $1,050 due on November 1, 2009.The second note, with Commerce Financial Group, Inc., in the original principal amount of $1,150was executed on October 28, 2003. The second note is secured by our Victoria facility and equipmentlocated at our Tempe facility. The term of the second note is four years. The original interestrate on this note was 8.975% per year through September 27, 2007. Monthly payments of principaland interest in the amount of $28 are paid over a forty-eight month period beginning on October 28,2003.We entered into a waiver and amendments on December 3, 2004 which increased the interest rate to bepaid under the Commerce Bank note beginning March 1, 2005, to and including October 31, 2006, from6.5% to 7.5%, and increased the interest rate to be paid under the Commerce Financial Group, Inc.note beginning March 1, 2005, to and including September 28, 2007, from 8.975% to 9.975%.The Company is in compliance with all covenants as of February 25, 2006.During Fiscal 2005, the Company entered into several capital lease agreements to fund theacquisition of machinery and equipment. The total principal amount of these leases is $442 with anaverage effective interest rate of 16%. These agreements are for three years with reduced paymentterms over the life of the lease. At the end of the lease, we have the option to purchase theequipment at an agreed upon value which is generally approximately 20% of the original equipmentcost. However, this amount may be reduced to 15% if our equity increases by $4.0 million within 18months of the date of these leases. In Fiscal 2006, the Company entered into capital leaseagreements to fund the acquisition of $2.7 million of equipment. The terms of these leases areapproximately the same as
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the Fiscal 2005 capital leases. The Company has received and placed into service $225 ofequipment financed by these leases. The remainder will be recognized in the third quarter as theequipment is released into production.(8) Line of CreditSince early in Fiscal 2003, we have had an accounts receivable agreement (the “Credit Agreement”)with Beacon Bank of Shorewood, Minnesota. The Credit Agreement expires on September 1, 2006. TheCredit Agreement provides for a maximum amount of credit $5,000. The Credit Agreement is anaccounts receivable backed facility and is additionally collateralized by inventory, intellectualproperty and other general intangibles. The Credit Agreement is not subject to any restrictivefinancial covenants. The balance on the line of credit was $1,400 as of February 25, 2006. TheCredit Agreement as amended on July 7, 2005 bears an interest rate of Prime plus 2.75%. There isalso an immediate discount of .85% for processing. The effective borrowing rate is approximately10.5% as of March 31, 2006. Borrowings are reduced as collections and payments are received into alock box by the bank. As of February 25, 2006, the Company is in compliance with all covenants ofthe Credit Agreement.(9) Deferred TaxesDeferred income taxes reflect the net tax effects of temporary differences between the carryingamount of assets and liabilities for financial reporting purposes and the amounts used for incometax purposes. The significant components of our deferred tax assets and liabilities consist oftiming differences related to allowance for doubtful accounts, depreciation, reserves for excessand obsolete inventory, accrued warranty reserves, and the future benefit associated with Federaland state net operating loss carryforwards. A valuation allowance has been set at approximately$8,100 and $7,195, at February 25, 2006, and August 31, 2005, respectively, because ofuncertainties related to the ability to utilize certain Federal and state net loss carryforwards asdetermined in accordance with GAAP. The valuation allowance is based on estimates of taxable incomeby jurisdiction and the period over which our deferred tax assets are recoverable.(10) Net Loss per Share ComputationThe components of net loss per basic and diluted share are as follows:                   **Three Months Ended** **Six Months Ended**  **February 25, 2006** **February 26, 2005** **February 25, 2006** **February 26, 2005****Basic:**                Net loss $(1,688) $(537) $(2,318) $(122)Net loss per share $(0.18) $(0.06) $(0.25) $(0.01)Weighted averagenumber of commonshares outstanding  9,480   8,357   9,440   8,357                  **Diluted:**                Net loss $(1,688) $(537) $(2,318) $(122)Net loss per share $(0.18) $(0.06) $(.25) $(0.01)Weighted averagenumber of commonshares outstanding  9,480   8,357   9,440   8,357 Assumed conversionof stock options  —   —   —   — Weighted averagecommon and assumedconversion shares  9,480   8,357   9,440   8,357                  Approximately 2,621,000 and 1,830,900 shares of our Common Stock under stock options and warrantshave been excluded from the calculation of diluted net loss per common share as they areantidilutive for the three-month and six-month periods ended February 25, 2006 and February 26,2005, respectively.
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(11) Notes Receivable-Related Parties-Officers and Former DirectorsIn Fiscal 2001, the Company recorded notes receivable of $1,266 from certain officers and directorsin connection with the exercise of stock options. These notes were amended in July 2002 and providefor full recourse to the individuals, bear interest at Prime with the exception of one individualat Prime plus 1/2% per annum and have a term of five years with interest only payments to be madeannually for the first (2) years and annual principal and interest installments through April 2,2006. As of February 25, 2006, the amounts owed on these notes was $207 and the interest due theCompany on these notes was $9. Both amounts are payable April 2, 2006.On April 2, 2006, $140 was collected related to these notes and $67.5 owed by Mr. Edwin Finch, aformer director, was refinanced to be repaid over the next nine months. The amount of $67.5 ispresented as a reduction to stockholders equity. The amounts collected have been reclassified asother receivables included in other current assets as of February 25, 2006.(12) Litigation RecoveriesOn June 30, 2003, we commenced litigation against Mr. Fant, our former Chief Executive Officer andChairman, in the State of Minnesota, Hennepin County District Court, Fourth Judicial District. Thecomplaint alleged breach of contract, conversion, breach of fiduciary duty, unjust enrichment andcorporate waste resulting from, among other things, Mr. Fant’s default on his promissory note to usand other loans and certain other matters. On August 12, 2003, we obtained a judgment against Mr.Fant on the breach of contract count in the amount of approximately $606. On November 24, 2003, theCourt granted an additional judgment to us against Mr. Fant in the amount of approximately $993 onthe basis of our conversion, breach of fiduciary duty, unjust enrichment and corporate wasteclaims. On March 29, 2004, we obtained a third judgment against Mr. Fant relating to our claims fordamages for conversion, breach of fiduciary duty, and our legal and special investigation costs inthe amount of approximately $656. As of February 25, 2006, the total combined judgment against Mr.Fant was approximately $2,255, excluding interest.During Fiscal 2004 and 2005, we obtained, through garnishments and through sales of Common Stockpreviously held by Mr. Fant, approximately $1,842 of recoveries which have served to partiallyreduce our total judgment against Mr. Fant. In Fiscal 2005 and 2004 we recognized $481 and $1,361of these recoveries, respectively. Mr. Fant filed for bankruptcy protection on October 14, 2005.The Bankruptcy Court dismissed Mr. Fant’s petition on December 1, 2005, because he had failed tofile all required schedules. The Company continues to seek to collect additional amounts from Mr.Fant. It is not possible to determine whether collection of additional amounts is possible.(13) Major CustomersThere were two customers where net sales represented over 10% of our revenue for the three monthsended February 25, 2006. One of these customers accounted for 14% and the second customeraccounted for 12% of net sales. For the three months ended February 26, 2005, no customersaccounted for over 10% of net sales. For the six-month period ended February 25, 2006, twocustomers accounted for 11% of net sales. There were no customers over 10% of net sales for thesix month period ended February 26, 2005.As of February 25, 2006, two customers represented 14% and 10% of our accounts receivable amounts,respectively. As of August 31, 2005, two customers each represented 11% of our accountsreceivable.
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(14) Geographic DataSales to customers by geographic region as a percentage of net sales are as follows:                                   Three Months Ended February 25.  Six Months Ended February 25.   2006  2005  2006  2005                               % of   Dollars  % of Sales  Dollars  % of Sales  Dollars  % of Sales  Dollars  Sales United States $8,426   72% $9,185   67% $18,334   72% $19,595   70% Canada / Mexico $223   2% $852   6% $877   3% $2,450   9% Europe $1,315   11% $1,649   12% $2,936   12% $2,327   8% Asia-Pacific $1,744   15% $1,835   13% $3,342   13% $3,207   12% South America $10   0% $215   2% $16   0% $229   1%                              Total $11,718      $13,736      $25,505      $27,808     (15) SegmentsMicroelectronics Operations: This segment consists of three facilities — Victoria, Chanhassen, andTempe — that design, manufacture and sell ultra miniature microelectronic devices and hightechnology products incorporating these devices.Advanced Medical Operations: This segment consists of our Boulder facility that provides design andmanufacturing outsourcing of complex electronic and electromechanical medical devices.Corporate Operations: This includes sales, marketing, and general and administrative expenses thatbenefit the Company as a whole and are not specifically related to either of the business segments.
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Segment information is as follows:                                   **Three Months Ended February 25, 2006** **Six Months Ended February 25, 2006**          **Advanced**             **Advanced**        **Microelectronics** **Medical**         **Microelectronics** **Medical**    **Corporate** **Operations** **Operations** **Total** **Corporate** **Operations** **Operations** **Total**Net sales $0  $7,363  $4,355  $11,718  $0  $16,283  $9,222  $25,505 Gross profit  0   1,012   734   1,746   0   2,993   1,477   4,470 Operating Expense  2,322   810   202   3,334   4,466   1,673   451   6,590 Op. income (loss)  (2,322)  202   532   (1,588)  (4,466)  1,320   1,026   (2,120)Total assets  0   16,786   7,183   23,969   0   16,786   7,183   23,969 Depr. andamortization  0   525   96   621   0   1,007   199   1,206 Capital expenditures  0   446   23   469   0   496   31   527                                    **Three Months Ended February 26, 2005** **Six Months Ended February 26, 2005**          **Advanced**             **Advanced**        **Microelectronics** **Medical**         **Microelectronics** **Medical**    **Corporate** **Operations** **Operations** **Total** **Corporate** **Operations** **Operations** **Total**Net sales $0  $8,401  $5,335  $13,736  $0  $16,038  $11,770  $27,808 Gross profit  0   1,637   1,230   2,867   0   2,775   3,049   5,824 Operating Expense  2,314   483   481   3,278   4,458   1,139   561   6,158 Op. income (loss)  (2,314)  1,154   749   (411)  (4,458)  1,636   2,488   (334)Total assets  0   19,579   7,706   27,285   0   19,579   7,706   27,285 Depr. andamortization  0   561   101   662   0   1,106   201   1,307 Capital expenditures  0   387   43   430   0   733   35   768 (16) Commitments and ContingenciesWe lease a 14,000 square foot production facility in Tempe, Arizona for our high density flexiblesubstrates. The lease extends through July 31, 2010. Base rent is approximately $100 per year. Welease one property in Minnesota: a 20,000 square foot facility in Chanhassen, Minnesota, for ourRFID business. The Chanhassen facility is leased until October 15, 2007. Base rent isapproximately $140 per year.We lease a 152,022 square foot facility in Boulder, Colorado for our AMO. Our base rent isapproximately $1.4 million per year. In addition to the base rent we pay all operating costsassociated with this building. The annual base rent increases each year by 3%. The Boulderfacility is leased until September 2019. Currently, we occupy approximately 100,000 square feet ofthe facility and 25,000 is unimproved vacant space. In April 2005, we entered into a ten yearsublease agreement for approximately 25,000 square feet of unimproved vacant space with a highquality tenant. This is a ten year lease which provides for rental payments and reimbursement ofoperating costs. Aggregate rental and operating cost payments to be received by the Company(following a 9 month free rent period), will be approximately $0.3 million per year. We arecontinuing to look for sublease tenants for the remaining 25,000 square feet of vacant space.Our Boulder lease provided for the refund of $1,350 of our security deposit after completing fourconsecutive quarters of positive earnings before interest, taxes, depreciation and amortization,as derived from our consolidated financial statements and verified by an independent third partyaccountant and delivery to our landlord of the greater of 100,000 shares of our common stock or0.11% of the outstanding shares of our common stock. In November 2005, we delivered the requireddocuments and a certificate for 100,000 shares of our stock. On November 23, 2005, we received the$1,350 refund. The value of the additional stock consideration issued to our landlord isapproximately $336 and will be amortized over the remaining term of our lease.Through March 31, 2006, we have initiated purchase orders for approximately $2.7 million ofequipment which will be financed through operating and capital leases. We have received and placedinto service $225 of this equipment through February 25, 2006. We expect that the remainder willbe released into production and capitalized in the third quarter of Fiscal 2006.
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**Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations**