##### 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 December 1, 2001.

[ ] 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 in Its Charter)

|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Minnesota                                                      |  | 41-0944876                          
|                                                              
|                                                              
|                                                              
|                                                              
|(State or other jurisdiction
of incorporation or organization) |  | (I.R.S. Employer Identification No.)

|                                                    |  |           
|--------------------------------------------------- |  | ----------
|P.O. Box 5000, 1495
Steiger Lake Lane, Victoria, MN |  | 55386     
|                                                   
|                                                   
|                                                   
|                                                   
|(Address of principal executive offices)            |  | (Zip Code)

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

None

Former name, former address and former fiscal year, if changed since last
report.

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act 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 [ ].

State the number of shares outstanding of each of the issuers classes of
common equity, as of the latest practicable date: as of January 15, 2002,
5,985,710 shares of common stock, par value $.05.

This Form 10-Q consists of 14 pages.





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TABLE OF CONTENTS



|                              |                                                                                               |                                                   |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------------- |  |  |  |  |  | 
|Part I. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | CONSOLIDATED BALANCE SHEETS                      
|                              |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
|                              |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Qualitative and Quantitative Disclosures About Market Risk                           
|PART II OTHER INFORMATION   
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                   



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

|                                                                                                           |                                            |  |      |     |  |  |  |  | 
|---------------------------------------------------------------------------------------------------------- | ------------------------------------------ |  | ---- | --- |  |  |  |  | 
|Part I  Financial Information                                                                            
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Item 1. Financial Statements                                                                              
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                           | Consolidated Balance Sheets                |  |      | 3   | 
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                           | Consolidated Statements of Operations      |  |      | 4   | 
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                           | Consolidated Statements of Cash Flows      |  |      | 5   | 
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                           | Notes to Consolidated Financial Statements |  |      | 6-8 | 
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Item 2. Managements Discussion and Analysis of Financial
             Condition and Results of Operations |                                            |  | 9-12 |    
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Item 3. Quantitative and Qualitative Disclosures About
Market Risk                                         |                                            |  | 12   |    
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Part II  Other Information                                                                               
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Item 6. Exhibits and Reports on Form 8-K                                                                   |                                            |  | 13   |    
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Signatures                                                                                                 |                                            |  | 14   |    

2



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Part I. FINANCIAL INFORMATIONItem 1. Financial Statements
HEI, Inc.Consolidated Balance Sheets
(In thousands, except per share amounts)

|                                           |                                                                                                      |   |                  |         |                 |   |        |         |  
|------------------------------------------ | ---------------------------------------------------------------------------------------------------- | - | ---------------- | ------- | --------------- | - | ------ | ------- | -
|                                           |                                                                                                      |   | December 1, 2001 |         | August 31, 2001
|                                           |                                                                                                      |   |                  |         |                
|                                           |                                                                                                      |   | (unaudited)      |         |                
|Assets                                     |                                                                                                      |   |                  |         |                 |   |        |         |  
|                                          
|                                          
|                                          
|                                          
|Current assets:                            |                                                                                                      |   |                  |         |                 |   |        |        
|                                           | Cash and cash equivalents                                                                            |   | $                | 4,735   |                 |   | $      | 4,393   |  
|                                          
|                                          
|                                          
|                                          
|                                           | Accounts receivable, net                                                                             |   |                  | 3,074   |                 |   |        | 4,617   |  
|                                          
|                                          
|                                          
|                                          
|                                           | Inventories, net                                                                                     |   |                  | 3,955   |                 |   |        | 4,284   |  
|                                          
|                                          
|                                          
|                                          
|                                           | Other current assets                                                                                 |   |                  | 1,173   |                 |   |        | 635     |  
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Total current assets                       |                                                                                                      |   | 12,937           |         |                 |   | 13,929 |        
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Property and equipment:                   
|                                          
|                                          
|                                          
|                                          
|                                           | Land                                                                                                 |   |                  | 216     |                 |   |        | 216     |  
|                                          
|                                          
|                                          
|                                          
|                                           | Building and improvements                                                                            |   |                  | 4,316   |                 |   |        | 4,316   |  
|                                          
|                                          
|                                          
|                                          
|                                           | Fixtures and equipment                                                                               |   |                  | 20,352  |                 |   |        | 18,810  |  
|                                          
|                                          
|                                          
|                                          
|                                           | Accumulated depreciation                                                                             |   |                  | (12,346 | )               |   |        | (11,714 | )
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Net property and equipment                 |                                                                                                      |   | 12,538           |         |                 |   | 11,628 |        
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Other long-term assets                     |                                                                                                      |   | 2,026            |         |                 |   | 1,971  |        
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Total assets                               |                                                                                                      | $ | 27,501           |         |                 | $ | 27,528 |        
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Liabilities and Shareholders Equity      
|                                          
|                                          
|                                          
|                                          
|Current liabilities:                       |                                                                                                      |   |                  |         |                 |   |        |        
|                                           | Revolving line of credit                                                                             |   | $                | 1,465   |                 |   | $      | 10      |  
|                                          
|                                          
|                                          
|                                          
|                                           | Current maturities of long-term debt                                                                 |   |                  | 1,441   |                 |   |        | 1,441   |  
|                                          
|                                          
|                                          
|                                          
|                                           | Accounts payable                                                                                     |   |                  | 1,612   |                 |   |        | 1,912   |  
|                                          
|                                          
|                                          
|                                          
|                                           | Accrued employee related costs                                                                       |   |                  | 750     |                 |   |        | 839     |  
|                                          
|                                          
|                                          
|                                          
|                                           | Accrued liabilities                                                                                  |   |                  | 1,042   |                 |   |        | 934     |  
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Total current liabilities                  |                                                                                                      |   | 6,310            |         |                 |   | 5,136  |        
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Long-term debt, less current maturities    |                                                                                                      |   | 3,730            |         |                 |   | 3,972  |        
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Total liabilities                          |                                                                                                      |   | 10,040           |         |                 |   | 9,108  |        
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Shareholders equity:                     
|                                          
|                                          
|                                          
|                                          
|                                           | Undesignated stock; 5,000 shares authorized; none issued                                             |   |                  |        |                 |   |        |        |  
|                                          
|                                          
|                                          
|                                          
|                                           | Common stock, $.05 par; 10,000 shares authorized;
5,986      and 5,956 shares issued and outstanding |   |                  | 298     |                 |   |        | 298     |  
|                                          
|                                          
|                                          
|                                          
|                                           | Paid-in capital                                                                                      |   |                  | 16,445  |                 |   |        | 16,310  |  
|                                          
|                                          
|                                          
|                                          
|                                           | Retained earnings                                                                                    |   |                  | 1,984   |                 |   |        | 3,078   |  
|                                          
|                                          
|                                          
|                                          
|                                           | Notes receivable                                                                                     |   |                  | (1,266  | )               |   |        | (1,266  | )
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Total shareholders equity                 |                                                                                                      |   | 17,461           |         |                 |   | 18,420 |        
|                                           |                                                                                                      |   |                  |         |                 |   |        |        
|Total liabilities and shareholders equity |                                                                                                      | $ | 27,501           |         |                 | $ | 27,528 |        
|                                           |                                                                                                      |   |                  |         |                 |   |        |        

See accompanying notes to unaudited consolidated financial statements.

3



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

|                                           |                                       |         |        |                    |       |                  |        |       |       | 
|------------------------------------------ | ------------------------------------- | ------- | ------ | ------------------ | ----- | ---------------- | ------ | ----- | ----- | 
|                                           |                                       |         |        | Three Months Ended
|                                           |                                       |         |        | December 1, 2001   |       | December 2, 2000
|                                           |                                       |         |        |                    |       |                 
|Net sales                                  |                                       | $       | 6,126  |                    |       | $                | 13,724 |      
|                                          
|                                          
|                                          
|                                          
|Cost of sales                              |                                       |         | 5,741  |                    |       |                  | 11,170 |      
|                                           |                                       |         |        |                    |       |                  |        |      
|                                           | Gross profit                          |         |        | 385                |       |                  |        | 2,554 |      
|                                           |                                       |         |        |                    |       |                  |        |      
|Operating expenses:                       
|                                          
|                                          
|                                          
|                                          
|                                           | Selling, general and administrative   |         |        | 1,362              |       |                  |        | 1,546 |      
|                                          
|                                          
|                                          
|                                          
|                                           | Research, development and engineering |         |        | 660                |       |                  |        | 520   |      
|                                           |                                       |         |        |                    |       |                  |        |      
|Operating income (loss)                    |                                       |         | (1,637 | )                  |       |                  | 488    |      
|                                           |                                       |         |        |                    |       |                  |        |      
|Other expense, net                         |                                       |         | (21    | )                  |       |                  | (363   | )    
|                                           |                                       |         |        |                    |       |                  |        |      
|Income (loss) before income taxes          |                                       |         | (1,658 | )                  |       |                  | 125    |      
|                                          
|                                          
|                                          
|                                          
|Income tax expense (benefit)               |                                       |         | (564   | )                  |       |                  | 43     |      
|                                           |                                       |         |        |                    |       |                  |        |      
|Net income (loss)                          |                                       | $       | (1,094 | )                  |       | $                | 82     |      
|                                           |                                       |         |        |                    |       |                  |        |      
|Net income (loss) per common share         |                                       |         |        |                    |       |                  |        |      
|                                          
|                                          
|                                          
|                                          
|                                           |                                       | Basic   |        | $                  | (0.18 | )                |        | $     | 0.02  | 
|                                          
|                                          
|                                          
|                                          
|                                           |                                       | Diluted |        | $                  | (0.18 | )                |        | $     | 0.02  | 
|                                           |                                       |         |        |                    |       |                  |        |      
|Weighted average common shares outstanding |                                       |         |        |                    |       |                  |        |      
|                                          
|                                          
|                                          
|                                          
|                                           |                                       | Basic   |        |                    | 5,971 |                  |        |       | 4,779 | 
|                                          
|                                          
|                                          
|                                          
|                                           |                                       | Diluted |        |                    | 5,971 |                  |        |       | 5,079 | 
|                                           |                                       |         |        |                    |       |                  |        |      

See accompanying notes to unaudited consolidated financial statements.

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

|                                                          |                                                        |   |                    |        |                  |   |        |        |  
|--------------------------------------------------------- | ------------------------------------------------------ | - | ------------------ | ------ | ---------------- | - | ------ | ------ | -
|                                                          |                                                        |   | Three Months Ended
|                                                          |                                                        |   | December 1, 2001   |        | December 2, 2000
|                                                          |                                                        |   |                    |        |                 
|Cash flow from operating activities:                      |                                                        |   |                    |        |                  |   |        |        |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Net income (loss)                                      |   | $                  | (1,094 | )                |   | $      | 82     |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Depreciation and amortization                          |   |                    | 685    |                  |   |        | 732    |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Deferred income tax expense (benefit)                  |   |                    | (293   | )                |   |        | 119    |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Other                                                  |   |                    | 13     |                  |   |        | 6      |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Accounts receivable allowance                          |   |                    | 1      |                  |   |        | (36    | )
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Equity in net loss of MSC                              |   |                    |       |                  |   |        | 8      |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Non-cash expenses for CMED transaction                 |   |                    |       |                  |   |        | 161    |  
|                                                         
|                                                         
|                                                         
|                                                         
|Changes in operating assets and liabilities:              |                                                        |   |                    |        |                  |   |        |        |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Accounts receivable                                    |   |                    | 1,542  |                  |   |        | 1,126  |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Inventories                                            |   |                    | 329    |                  |   |        | (189   | )
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Income taxes                                           |   |                    |       |                  |   |        | (86    | )
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Other current assets                                   |   |                    | (245   | )                |   |        | 2      |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Accounts payable                                       |   |                    | (300   | )                |   |        | (109   | )
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Accrued employee related costs and accrued liabilities |   |                    | 19     |                  |   |        | (222   | )
|                                                          |                                                        |   |                    |        |                  |   |        |        |  
|Net cash flow provided by operating activities            |                                                        |   | 657                |        |                  |   | 1,594  |       
|                                                          |                                                        |   |                    |        |                  |   |        |        |  
|Cash flow from investing activities:                      |                                                        |   |                    |        |                  |   |        |        |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Additions to property and equipment                    |   |                    | (1,597 | )                |   |        | (682   | )
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Additions to patents                                   |   |                    | (59    | )                |   |        |       |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Increase in restricted cash                            |   |                    |       |                  |   |        | (1     | )
|                                                          |                                                        |   |                    |        |                  |   |        |        |  
|Net cash flow used for investing activities               |                                                        |   | (1,656             | )      |                  |   | (683   | )     
|                                                          |                                                        |   |                    |        |                  |   |        |        |  
|Cash flow from financing activities:                     
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Issuance of common stock                               |   |                    | 135    |                  |   |        | 39     |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Repayment of long-term debt                            |   |                    | (242   | )                |   |        | (122   | )
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Deferred financing costs                               |   |                    | (7     | )                |   |        |       |  
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Borrowings on (repayments of) revolving line of credit |   |                    | 1,455  |                  |   |        | (1,052 | )
|                                                          |                                                        |   |                    |        |                  |   |        |        |  
|Net cash flow provided by (used for) financing activities |                                                        |   | 1,341              |        |                  |   | (1,135 | )     
|                                                          |                                                        |   |                    |        |                  |   |        |        |  
|Net increase (decrease) in cash and cash equivalents      |                                                        |   | 342                |        |                  |   | (224   | )     
|                                                         
|                                                         
|                                                         
|                                                         
|Cash and cash equivalents, beginning of period            |                                                        |   | 4,393              |        |                  |   | 484    |       
|                                                          |                                                        |   |                    |        |                  |   |        |        |  
|Cash and cash equivalents, end of period                  |                                                        | $ | 4,735              |        |                  | $ | 260    |       
|                                                          |                                                        |   |                    |        |                  |   |        |        |  
|Supplemental disclosures of cash flow information:        |                                                        |   |                    |        |                  |   |        |        |  
|Interest paid                                             |                                                        | $ | 85                 |        |                  | $ | 146    |       
|                                                         
|                                                         
|                                                         
|                                                         
|Income taxes paid (received)                              |                                                        |   | (271               | )      |                  |   | 14     |       
|                                                          |                                                        |   |                    |        |                  |   |        |        |  

See accompanying notes to unaudited consolidated financial statements.

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|                                                       |  |          
|------------------------------------------------------ |  | ---------
|Notes to Consolidated Financial Statements (Unaudited) |  | HEI, Inc.
|                                                       | 

(1) Basis of Financial Statement Presentation

The unaudited interim consolidated financial statements have been prepared by
the Company, under the rules and regulations of the Securities and Exchange
Commission. The accompanying financial statements contain all normal recurring
adjustments which are, in the opinion of management, necessary for a fair
presentation in accordance with accounting principles generally accepted in the
United States of America.

The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation.

Certain information and disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted under such rules and
regulations although the Company believes 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 accounting principles generally accepted in the United
States of America. These unaudited financial statements should be read in
conjunction with the financial statements and notes included in the Companys
Annual Report to Shareholders on Form 10-K for the year ended August 31, 2001.
Interim results of operations for the three-month period ended December 1, 2001
may not necessarily be indicative of the results to be expected for the full
year.

In June 2001, the FASB issued SFAS No. 141, Business Combinations and SFAS
No. 142, Goodwill and Other Intangible Assets. These standards revised the
rules related to the accounting for business combinations, goodwill and other
intangible assets. SFAS No. 141 requires that all business combinations
initiated after June 30, 2001 be accounted for using the purchase accounting
method. SFAS No. 142 states that goodwill is no longer subject to amortization
over its useful life. Rather, goodwill will be subject to annual assessment
for impairment and be written down to its fair value only if the carrying
amount is greater than the fair value. In addition, intangible assets are
separately recognized if the benefit of the intangible asset can be sold,
transferred, licensed, rented or exchanged, regardless of the acquirers intent
to do so. The amount and timing of non-cash charges related to intangibles
acquired in business combinations will change significantly from prior
practice. The effect of adopting SFAS 141 and 142 in fiscal 2002 is not
expected to have an impact on the Companys financial position or results of
operations.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. This statement established accounting standards for recognition
and measurement of a liability for an asset retirement obligation and the
associated asset retirement cost. It requires an entity to recognize the fair
value of a liability for an asset retirement obligation in the period in which
it is incurred if a reasonable estimate can be made. The Company is required
to adopt this statement in its fiscal year 2003. The Company has not yet
quantified the potential effect of adoption of SFAS No. 143.

In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets, which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. The Company is
required to adopt this statement in its fiscal year 2003. The Company has not
yet quantified the potential effect of adoption of SFAS No. 144.

The Companys quarterly periods end on the last Saturday of each quarter of its
fiscal year ending August 31.

6



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##### Table of Contents



(2) Inventories

Inventories are stated at the lower of cost or market and include materials,
labor and overhead costs. The weighted average cost method is used in valuing
inventories. Inventories consist of the following:

|                |   |                  |  |                 |   |       |  | 
|--------------- | - | ---------------- |  | --------------- | - | ----- |  | 
|(In thousands)  |   | December 1,
2001 |  | August 31,
2001
|                |   |                  |  |                
|Purchased parts | $ | 2,524            |  |                 | $ | 3,209 | 
|               
|               
|               
|               
|Work in process |   | 467              |  |                 |   | 387   | 
|               
|               
|               
|               
|Finished goods  |   | 964              |  |                 |   | 688   | 
|                |   |                  |  |                
|               
|               
|               
|               
|                | $ | 3,955            |  |                 | $ | 4,284 | 
|                |   |                  |  |                

(3) Deferred Tax Asset

At December 1, 2001, the Company has net operating loss carryforwards, expiring
at various dates ranging from 2013 through 2022. The Company has a aggregate
deferred tax asset of $2,135 in connection with these net operating loss
carryforwards and other temporary differences.

Management performs an analysis of the realization of the deferred tax asset
each fiscal quarter and has concluded it is more likely than not that the
Company will realize the aggregate deferred tax asset of $2,135 at December 1,
2001. This analysis largely relies on managements ability to return the
Companys core business to long-term profitability and taking into account
restructuring activities which the Company undertook in fiscal 2001.
Unanticipated negative changes in future operations of the Company will
adversely effect the realization of the Companys deferred tax asset, resulting
in the establishment of a valuation reserve for the deferred tax asset.

(4) Investment in Micro Substrates Corporation (MSC)

During the fourth quarter of fiscal 2001, we wrote-off the remaining value of
our investment in MSC and the related license agreement. Subsequent to
December 1, 2001, we reached an agreement with MSC and Circuit Components, Inc.
(CCI), the majority shareholder in MSC, in which we will receive a $750 note in
exchange for our shares of MSC and the resolution of all disputes and potential
claims related to the original agreement and the litigation. The $750 note
will bear interest, include quarterly interest and principal payments over the
five-year term and is secured by one-million shares of MSC. Due to fact that
there had not been a finalized agreement at December 1, 2001, HEI has not
valued the note receivable or the investment in MSC at December 1, 2001. HEI
will record the quarterly payments as Other Income as they are received.

(5) Long-Term Debt

All of the Companys long-term debt is subject to certain restrictive financial
covenants, including but not limited to, tangible net worth, interest coverage,
debt service coverage, annual loss limitations and the ability to declare or
pay dividends. We are currently in compliance with these covenants and have
classified the debt in accordance with the terms of the respective agreements,
however, we may not meet all of the covenants required for the second quarter
and beyond. If we fail to meet any of the covenants under the respective
agreements, we believe that we will be able to obtain a waiver from the
financial institution and amend future covenants. If we are not able to obtain
such a waiver, we may be required to immediately repay our outstanding balances
and find a new lender, which may cause us to incur costs in connection with
such new lending relationship.

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(6) Net Income (Loss) Per Weighted Average Common Share

Basic income (loss) per share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding. Diluted earnings per
share is computed by dividing net income (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
of the Companys stock during each period under the treasury stock method. In
periods where losses have occurred, options are considered anti-dilutive and
thus have not been included in the diluted loss per share calculations.

|                                 |                  |                    |                  |  |       | 
|-------------------------------- | ---------------- | ------------------ | ---------------- |  | ----- | 
|(In thousands)                   |                  | Three
Months Ended
|                                 | December 1,
2001 |                    | December 2,
2000
|                                 |                  |                    |                 
|Basic common shares              |                  |                    |                  |  | 5,971 | 
|                                
|                                
|                                
|                                
|Dilutive effect of stock options |                  |                    |                  |  |      | 
|                                 |                  |                    |                 
|                                
|                                
|                                
|                                
|Diluted common shares            |                  |                    |                  |  | 5,971 | 
|                                 |                  |                    |                 

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|                                                                                                             |  |          
|------------------------------------------------------------------------------------------------------------ |  | ---------
|Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations (In thousands) |  | HEI, Inc.
|                                                                                                             | 

FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES

The Companys net cash flow provided by operating activities was $657 for the
three months ended December 1, 2001 compared to $1,594 in the prior-year
period. Cash flows from operations in the three-month periods ended December 1,
2001 and December 2, 2000 is primarily a result of each periods net income (loss) of
($1,094) and $82, respectively, adjusted for non-cash depreciation and
amortization of $685 and $732, respectively, and a net decrease of $1,345 and
$522, respectively, in working capital investments, as a result of reduced
accounts receivable balances of $1,542 and $1,126, respectively, during the
first three months of fiscal 2002 and 2001, and net deferred tax expense (benefit)
of ($293) and $119, respectively. Lower accounts receivable balances were the
result of lower sales in the first quarter of fiscal 2002 as compared to the
last quarter of fiscal 2001.

Accounts receivable average days of 48 at December 1, 2001 improved
significantly from 74 days as of August 31, 2001. This improvement is largely
a result of reduced receivables terms for product sold to Siemens under the
consignment program and improved collections.

Annualized inventory turns were 5.4 for the first quarter of fiscal 2001
compared to 7.0 turns for the same period a year ago. The lower inventory
turns is a result of two main factors: the lower revenue experienced in the
first quarter of fiscal 2002 compared to the prior year and the deferral of
shipments under existing purchase orders from Agere, which has resulted in
approximately $600 of inventory which we are carrying on their behalf. We are
currently in discussions with Agere regarding the future production schedule
under these purchase orders and our reimbursement of excess inventory that may
remain if the purchase orders are cancelled. We estimate that this inventory
will be used by the customer and accordingly have not increased our reserve for
excess and obsolete inventory at December 1, 2001.

The Company has Industrial Development Revenue Bonds outstanding totaling
$2,435. These bonds were originally issued in April 1996 in connection with the
construction of a new addition to the Companys manufacturing facility in
Minnesota and for production equipment purchases. In April of each year, these
bonds require annual principal payments of $700. The Company has limited market
risk in terms of the variability of the interest rate on these bonds. The bonds
bear interest at a rate which varies weekly, based on comparable tax exempt
issues, and is limited to a maximum rate of 10%. The interest rate at December
1, 2001 and August 31, 2001 was 1.59% and 2.11%, respectively. The bonds are
collateralized by two irrevocable letters of credit and essentially all of the
Companys property and equipment. A commitment fee is paid annually to the bank
at a rate of 1.25% of the letters of credit.

The Company has a maximum of $5,000 available under a bank revolving line of
credit, based on the eligible accounts receivable balances at December 1, 2001.
The Company also has an $8,500 capital expenditure term loan with the bank.
Both of these agreements expire in August 2004. At December 1, 2001, $1,465 and
$2,594 are outstanding under the revolving line of credit and capital
expenditure term loan, respectively. There are minimum interest requirements
under our agreements, which results in us carrying a balance in the revolving
line of credit. These borrowings are subject to certain restrictive financial
covenants, including but not limited to: tangible net worth, interest coverage
ratio, debt service coverage ratio, annual loss limitations and the ability to
declare or pay dividends. We are currently in compliance with these covenants
and have classified the debt in accordance with the terms of the respective
agreements, however, we may not meet all of the covenants required for the
second quarter and beyond. If we fail to meet any of the covenants under the
respective agreements, we believe that we will be able to obtain a waiver from
the financial institution and amend future covenants. If we are not able to
obtain such

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a waiver, we may be required to immediately repay our outstanding balances and
find a new lender, which may cause us to incur costs in connection with such
new lending relationship.

Although we are currently in compliance with the debt covenants, the bank has
put certain restrictions on our ability to borrow additional funds under the
capital expenditure term loan. These restrictions require us to maintain a Debt
Service Coverage Ratio, as defined in the term-loan agreement, equal to or
greater than 1.15 to 1.0 on a year-to-date basis, prior to allowing additional
borrowings under the $8.5 million capital expenditure term loan facility. As a
result of these restrictions, we are currently not able to borrow additional
funds under the capital expenditure term loan facility. We currently have
sufficient financial resources to implement our business plan, however, we
continue to work to increase sales and improve our operating results to
eliminate this restriction and regain the ability to borrow additional funds
under the capital expenditure loan.

During fiscal 2002, the Company intends to expend approximately $2,800 for
manufacturing and facility improvements and capital equipment, of which $1,597
has been expended during the first quarter of fiscal 2002. These additions will
increase manufacturing capacity to meet anticipated production requirements and
add technological capabilities. It is expected that these expenditures will be
funded from operations, existing cash and cash equivalents and available debt
financing.

The Company believes that its existing cash and cash equivalents, current
lending capacity and cash generated from operations will provide sufficient
cash flow for the Company to meet its short and long-term debt obligations and
operating requirements. If we fail to meet our bank covenants and are not able
to obtain such a waiver, we may be required to immediately repay our
outstanding balances and find a new lender, which may cause us to incur costs
in connection with such new lending relationship.

REVIEW OF OPERATIONS

Net Sales

Net sales for the three-month period ended December 1, 2001 of $6,124 decreased
$7,598 compared to the same prior-year period, reflecting a decrease in all
markets. Sales by market for the three-months ended December 2, 2001 and
December 1, 2000 are as follows:

|                |  |      |       |      |  |   |       | 
|--------------- |  | ---- | ----- | ---- |  | - | ----- | 
|Market          |  | 2001 |       | 2000
|Hearing/Medical |  | $    | 4,503 |      |  | $ | 7,781 | 
|               
|               
|               
|               
|RFID/Access     |  |      | 983   |      |  |   | 2,424 | 
|               
|               
|               
|               
|Communications  |  |      | 302   |      |  |   | 1,331 | 
|               
|               
|               
|               
|Other           |  |      | 338   |      |  |   | 376   | 
|               
|               
|               
|               
|Mexico          |  |      |      |      |  |   | 1,812 | 

Sales to hearing/medical customers decreased by $3,278, which is largely a
result of excess inventory positions at our significant hearing and medical
customers, as well as the move to consignment inventory for Siemens. During the
quarter, we entered into a program with Siemens in which finished goods
inventory is held by us at Siemens and revenue is recognized when they use the
product. In connection with this program, certain raw materials used for
Siemens products are being consigned by Siemens to us. The result of this
program is that finished goods inventory has increased, while raw materials for
this product has decreased.

The closure of our Mexico division late in fiscal 2001 resulted in reduced
sales of $1,812 compared to the same fiscal 2001 period.

Sales of RFID products declined by $1,441 compared to the prior year period,
due to a decline in sales to a significant customer.

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Sales to customers in the communications market is largely a result of the push
out of purchase orders by Agere and the general slow down in the
telecommunications markets.

We believe that a number of our significant customers in the hearing market
have been reducing their excess inventory in the last half of fiscal
2001 and
first quarter of fiscal 2002 and we have experienced increased sales for each
month during the first quarter of our fiscal 2002. We expect this trend to
continue into the second quarter of fiscal 2002 with customers in our base
businesses, especially hearing, showing increased orders. In the communications
market,
significant customers are awaiting market acceptance of their products. As
these products are accepted, we expect a significant increase in sales in this
market. In addition, we are experiencing significant external interest in our
proprietary products, which we are currently working on prototype orders with
numerous customers.

Because the Companys sales are generally tied to the customers projected
sales and production of the related product, the Companys sales levels are
subject to fluctuations beyond our control. To the extent that sales to any one
customer represent a significant portion of the Companys sales, any change in
the sales levels to that customer can have a significant impact on the
Companys total sales. In addition, production for one customer may conclude
while production for a new customer has not yet begun or is not yet at full
volume. These factors may result in significant fluctuations in sales from
quarter to quarter.

Gross Profit

For the three-month period ended December 1, 2001, gross profit decreased
$2,169 from the same prior-year period. The gross profit margin as a percent of
sales for the three-months ended December 1, 2001 decreased to 6% as compared
to 19% for the comparable period last year. This decrease primarily reflects
decreased economies of scale from fixed manufacturing costs as a result of the
lower sales levels during the current year quarter. Gross margins should
increase as sales increase. In addition, as market acceptance of our
proprietary Broadband communications products occurs, gross margins should
increase, as these products are expected to have higher gross margin than we
have historically experienced.

Operating Expenses

Operating expenses for the three-month period ended December 1, 2001 decreased
slightly from the prior-year period. The decrease in selling, general and
administrative expenses of $184 for the three-month period versus the prior
year comparable period was largely a result of cost containment measures and
control over variable expenses as a result of the lower revenue. The increase
in research, development and engineering expenses of $140 for the three-month
period was primarily due to increased development costs to support future
business opportunities. Operating expenses in total were 33% of net sales for
the current year three-month period compared to 15% for the same period last
year, reflecting the impact of decreased revenue. Total operating expenses are
expected to increase slightly throughout fiscal 2002 as sales levels increase
and through increased research and development.

Other Expense, Net

Other expense, net of $21 is a result of the net interest expense for the
quarter. Net interest expense decreased versus the prior year as a result of
the lower average debt and higher average cash balances, along with lower
borrowing rates during the current year period compared to the prior year
period. The prior year balance of $363 includes a non-cash charge of $161
($106,000 net of tax) related to costs associated with the abandoned Colorado
MEDtech transaction.

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Income Taxes

The Company records income tax expense for interim periods based on the
expected effective rate for the full year. The estimated effective income tax
rate for fiscal 2002 and 2001 was 34%. Management performs an analysis of the
realization of the deferred tax asset each fiscal quarter and has concluded it
is more likely than not that the Company will realize the aggregate deferred
tax asset of $2,135 at December 1, 2001. This analysis largely relies on
managements ability to return the Companys core business to long-term
profitability and taking into account restructuring activities which the
Company undertook in fiscal 2001. Unanticipated negative changes in future
operations of the Company will adversely effect the realization of the
Companys deferred tax asset, resulting in the establishment of a valuation
reserve for the $2,135 deferred tax asset..

Net Income

The Company had a net loss of $1,094 for the three-month period ended December
1, 2001 compared to net income of $82 for the same prior year period.

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. These statements are made based on
the Companys current 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, adverse business or market conditions; the
ability of the Company to secure and satisfy customers, the availability and
cost of materials from HEIs suppliers, adverse competitive developments,
change in or cancellation of customer requirements, the ability to generate
income to utilize existing deferred tax assets and other factors discussed from
time to time in the Companys filings with the Securities and Exchange
Commission. Readers are cautioned not to place undue reliance on
forward-looking statements. HEI undertakes no obligation to update these
statements to reflect ensuing events or circumstances, or subsequent actual
results.




Item 3.Qualitative and Quantitative Disclosures About Market Risk

The Company is exposed to certain market risks with its $5,000,000 revolving
line of credit, capital expenditure loans and, to a lesser extent, its
Industrial Development Bonds (IDRBs). At December 1, 2001, the outstanding
balance on the revolving line of credit, capital expenditure loans and IDRBs
were $1,465, $2,594 and $2,435, respectively. The revolving line of credit
agreement bears interest, at the Companys option, at 0.50% above the prime
rate of interest or 3.0% above the LIBOR rate. The capital expenditure loan
bears interest, at the Companys option, at 0.75% above the prime rate of
interest or 3.25% above the LIBOR rate. At December 1, 2001 the interest rates
on the revolving commitment and capital expenditure loans were 5.50% and 5.75%,
respectively. The IDRBs bear interest at a rate which varies weekly, based on
comparable tax exempt issues, and is limited to a maximum rate of 10%. At
December 1, 2001 the interest rate on the IDRBs was 1.59%. Consequently, the
Company is 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% increase in interest rates. If market interest rates
had increased by 1%, this would have resulted in an increase to interest
expense of approximately $53 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.

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PART II  OTHER INFORMATION




Item 6. Exhibits and Reports on
Form 8-K

a) Reports on Form 8-K



| |                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------
| | HEI filed four Form 8-K Current Report with the Securities and Exchange
Commission during the first     quarter of fiscal year 2002 as follows:

|                   
|-------------------
| November 29, 2001
|                   
|                   
|                   
|                   
| October 10, 2001 
|                   
|                   
|                   
|                   
| September 5, 2001
|                   
|                   
|                   
|                   
| September 4, 2001

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SIGNATURES

In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized

|               |  |                                                                                                                   
|-------------- |  | ------------------------------------------------------------------------------------------------------------------
|               |  | HEI, Inc.                                                                                                         
|              
|               |  | (Registrant)                                                                                                      
|              
|Date: 01/15/02 |  | /s/ Steve E. Tondera, Jr.                                                                                         
|               |  | Steve E. Tondera, Jr.
Vice President of Finance,
Chief Financial Officer and Treasurer
(a duly authorized officer)

14