##### 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 November 30, 2002.

[   ] 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                         |  | (I.R.S. Employer Identification No.)
|of incorporation or organization)                    |  |                                     
|                                                     |  |                                     
|6385 Old Shady Oak Road, Suite 280, Eden Prairie, MN |  | 55344                               
|(Address of principal executive offices)             |  | (Zip Code)                          

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

None
Former name, former address and former fiscal year, if changed since last report.

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

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date: as of January 14, 2003,
6,011,756 shares of common stock, par value $.05.





---

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)     
|                                                   |                                                                                                              | Notes to Consolidated Financial Statements (Unaudited)
|                                                   | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations (In thousands)
|                                                   | Item 3. Qualitative and Quantitative Disclosures About Market Risk                                          
|                                                   | Item 4. Controls and Procedures                                                                             
|PART II  OTHER INFORMATION                       
|                                                   | Item 6. Exhibits and Reports on Form 8-K                                                                    
|SIGNATURES                                        
|CERTIFICATIONS                                    
|Exhibit Index                                     
|EX-10.1 7th Amendment to Loan & Security Agreement
|EX-10.2 Amended and Restated Revolving Note       
|EX-99.1 Certifications of CEO & CFO               



---



##### Table of Contents



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

|                                           |                                                                                               |                                            |  |      |       | 
|------------------------------------------ | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  | ---- | ----- | 
|Part I  Financial Information (unaudited) |                                                                                               |                                            |  |     
|                                           | Item 1. Financial Statements                                                                  |                                            |  |      |      
|                                           |                                                                                               | Consolidated Balance Sheets                |  |      | 3     | 
|                                           |                                                                                               | Consolidated Statements of Operations      |  |      | 4     | 
|                                           |                                                                                               | Consolidated Statements of Cash Flows      |  |      | 5     | 
|                                           |                                                                                               | Notes to Consolidated Financial Statements |  |      | 6-8   | 
|                                           | Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations |                                            |  | 9-15 |      
|                                           | Item 3. Quantitative and Qualitative Disclosures About
Market Risk                            |                                            |  | 16   |      
|                                           | Item 4. Controls and Procedures                                                               |                                            |  | 17   |      
|Part II  Other Information                |                                                                                               |                                            |  |     
|                                           | Item 6. Exhibits and Reports on Form 8-K                                                      |                                            |  | 18   |      
|                                           |                                                                                               | Signatures                                 |  |      | 19    | 
|                                           |                                                                                               | Certifications                             |  |      | 20-21 | 

2



---



##### Table of Contents












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

|                                           |                                                                                                 |   |                   |         |                 |   |        |         |  
|------------------------------------------ | ----------------------------------------------------------------------------------------------- | - | ----------------- | ------- | --------------- | - | ------ | ------- | -
|                                           |                                                                                                 |   | November 30, 2002 |         | August 31, 2002
|                                           |                                                                                                 |   |                   |         |                
|Assets                                     |                                                                                                 |   |                   |         |                 |   |        |        
|Current assets:                            |                                                                                                 |   |                   |         |                 |   |        |        
|                                           | Cash and cash equivalents                                                                       |   | $                 | 1,144   |                 |   | $      | 2,372   |  
|                                           | Restricted cash                                                                                 |   |                   | 1,000   |                 |   |        | 1,000   |  
|                                           | Accounts receivable, net                                                                        |   |                   | 3,871   |                 |   |        | 3,533   |  
|                                           | Inventories                                                                                     |   |                   | 3,651   |                 |   |        | 4,027   |  
|                                           | Other current assets                                                                            |   |                   | 540     |                 |   |        | 383     |  
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Total current assets                       |                                                                                                 |   | 10,206            |         |                 |   | 11,315 |        
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Property and equipment:                    |                                                                                                 |   |                   |         |                 |   |        |        
|                                           | Land                                                                                            |   |                   | 216     |                 |   |        | 216     |  
|                                           | Building and improvements                                                                       |   |                   | 4,316   |                 |   |        | 4,316   |  
|                                           | Fixtures and equipment                                                                          |   |                   | 21,287  |                 |   |        | 21,259  |  
|                                           | Accumulated depreciation                                                                        |   |                   | (15,177 | )               |   |        | (14,439 | )
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Net property and equipment                 |                                                                                                 |   | 10,642            |         |                 |   | 11,352 |        
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Other long-term assets                     |                                                                                                 |   | 376               |         |                 |   | 322    |        
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Total assets                               |                                                                                                 | $ | 21,224            |         |                 | $ | 22,989 |        
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Liabilities and Shareholders Equity       |                                                                                                 |   |                   |         |                 |   |        |        
|Current liabilities:                       |                                                                                                 |   |                   |         |                 |   |        |        
|                                           | Revolving line of credit                                                                        |   | $                 | 1,702   |                 |   | $      | 1,589   |  
|                                           | Current maturities of long-term debt                                                            |   |                   | 2,441   |                 |   |        | 2,441   |  
|                                           | Accounts payable                                                                                |   |                   | 1,647   |                 |   |        | 1,815   |  
|                                           | Accrued employee related costs                                                                  |   |                   | 337     |                 |   |        | 655     |  
|                                           | Accrued liabilities                                                                             |   |                   | 395     |                 |   |        | 446     |  
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Total current liabilities                  |                                                                                                 |   | 6,522             |         |                 |   | 6,946  |        
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Long-term debt, less current maturities    |                                                                                                 |   | 1,287             |         |                 |   | 1,473  |        
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Total liabilities                          |                                                                                                 |   | 7,809             |         |                 |   | 8,419  |        
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Shareholders equity:                      |                                                                                                 |   |                   |         |                 |   |        |        
|                                           | Undesignated stock; 5,000 shares authorized; none issued                                        |   |                   |        |                 |   |        |        |  
|                                           | Common stock, $.05 par; 10,000 shares authorized;
6,012 and 5,956 shares issued and outstanding |   |                   | 301     |                 |   |        | 301     |  
|                                           | Paid-in capital                                                                                 |   |                   | 16,349  |                 |   |        | 16,349  |  
|                                           | Accumulated deficit                                                                             |   |                   | (1,969  | )               |   |        | (814    | )
|                                           | Notes receivable                                                                                |   |                   | (1,266  | )               |   |        | (1,266  | )
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Total shareholders equity                 |                                                                                                 |   | 13,415            |         |                 |   | 14,570 |        
|                                           |                                                                                                 |   |                   |         |                 |   |        |        
|Total liabilities and shareholders equity |                                                                                                 | $ | 21,224            |         |                 | $ | 22,989 |        
|                                           |                                                                                                 |   |                   |         |                 |   |        |        

See accompanying notes to unaudited consolidated financial statements.

3



---



##### Table of Contents






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

|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |       |       |  
|------------------------------------------ | ------------------------------------- | ------- |  | ------------------ |  | ---------------- | ------ | ----- | ----- | - | ------ | ----- | ----- | -
|                                           |                                       |         |  | Three Months Ended
|                                           |                                       |         |  | November 30, 2002  |  | December 1, 2001
|                                           |                                       |         |  |                    |  |                 
|Net sales                                  |                                       |         |  |                    |  | $                | 5,490  |       |       | $ | 6,126  |      
|Cost of sales                              |                                       |         |  |                    |  |                  | 4,878  |       |       |   | 5,741  |      
|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|                                           | Gross profit                          |         |  |                    |  |                  |        | 612   |       |   |        | 385   |      
|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|Operating expenses:                        |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|                                           | Selling, general and administrative   |         |  |                    |  |                  |        | 1,257 |       |   |        | 1,362 |      
|                                           | Research, development and engineering |         |  |                    |  |                  |        | 495   |       |   |        | 660   |      
|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|Operating loss                             |                                       |         |  |                    |  |                  | (1,140 | )     |       |   | (1,637 | )    
|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|Other expense, net                         |                                       |         |  |                    |  |                  | (34    | )     |       |   | (21    | )    
|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|Loss before income taxes                   |                                       |         |  |                    |  |                  | (1,174 | )     |       |   | (1,658 | )    
|Income tax benefit                         |                                       |         |  |                    |  |                  | 19     |       |       |   | 564    |      
|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|Net loss                                   |                                       |         |  |                    |  |                  | (1,155 | )     |       |   | (1,094 | )    
|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|Net loss per common share                  |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|                                           |                                       | Basic   |  |                    |  |                  |        | $     | (0.19 | ) |        | $     | (0.18 | )
|                                           |                                       | Diluted |  |                    |  |                  |        | $     | (0.19 | ) |        | $     | (0.18 | )
|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|Weighted average common shares outstanding |                                       |         |  |                    |  |                  |        |       |       |   |        |      
|                                           |                                       | Basic   |  |                    |  |                  |        |       | 6,012 |   |        |       | 5,971 |  
|                                           |                                       | Diluted |  |                    |  |                  |        |       | 6,012 |   |        |       | 5,971 |  
|                                           |                                       |         |  |                    |  |                  |        |       |       |   |        |      

See accompanying notes to unaudited consolidated financial statements.

4



---



##### Table of Contents






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

|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |        |  
|--------------------------------------------------------- | ------------------------------------------------------ |  | ------------------ |  | ---------------- | - | ------ | ------ | - | - | ------ | ------ | -
|                                                          |                                                        |  | Three Months Ended
|                                                          |                                                        |  | November 30, 2002  |  | December 1, 2001
|                                                          |                                                        |  |                    |  |                 
|Cash flow from operating activities:                      |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|                                                          | Net loss                                               |  |                    |  |                  |   | $      | (1,155 | ) |   | $      | (1,094 | )
|                                                          | Depreciation and amortization                          |  |                    |  |                  |   |        | 755    |   |   |        | 685    |  
|                                                          | Deferred income tax benefit                            |  |                    |  |                  |   |        |       |   |   |        | (293   | )
|                                                          | Other                                                  |  |                    |  |                  |   |        |       |   |   |        | 14     |  
|Changes in operating assets and liabilities:              |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|                                                          | Accounts receivable                                    |  |                    |  |                  |   |        | (338   | ) |   |        | 1,542  |  
|                                                          | Inventories                                            |  |                    |  |                  |   |        | 376    |   |   |        | 329    |  
|                                                          | Other current assets                                   |  |                    |  |                  |   |        | (157   | ) |   |        | (245   | )
|                                                          | Accounts payable                                       |  |                    |  |                  |   |        | (168   | ) |   |        | (300   | )
|                                                          | Accrued employee related costs and accrued liabilities |  |                    |  |                  |   |        | (369   | ) |   |        | 19     |  
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|Net cash flow provided by (used for) operating activities |                                                        |  |                    |  |                  |   | (1,056 | )      |   |   | 657    |       
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|Cash flow from investing activities:                      |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|                                                          | Additions to property and equipment                    |  |                    |  |                  |   |        | (28    | ) |   |        | (1,597 | )
|                                                          | Additions to patents                                   |  |                    |  |                  |   |        | (71    | ) |   |        | (59    | )
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|Net cash flow used for investing activities               |                                                        |  |                    |  |                  |   | (99    | )      |   |   | (1,656 | )     
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|Cash flow from financing activities:                      |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|                                                          | Issuance of common stock                               |  |                    |  |                  |   |        |       |   |   |        | 135    |  
|                                                          | Repayment of long-term debt                            |  |                    |  |                  |   |        | (186   | ) |   |        | (242   | )
|                                                          | Deferred financing costs                               |  |                    |  |                  |   |        |       |   |   |        | (7     | )
|                                                          | Borrowings on revolving line of credit                 |  |                    |  |                  |   |        | 113    |   |   |        | 1,455  |  
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|Net cash flow provided by (used for) financing activities |                                                        |  |                    |  |                  |   | (73    | )      |   |   | 1,341  |       
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|Net increase (decrease) in cash and cash equivalents      |                                                        |  |                    |  |                  |   | (1,228 | )      |   |   | 342    |       
|Cash and cash equivalents, beginning of period            |                                                        |  |                    |  |                  |   | 2,372  |        |   |   | 4,393  |       
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|Cash and cash equivalents, end of period                  |                                                        |  |                    |  |                  | $ | 1,144  |        |   | $ | 4,735  |       
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|Supplemental disclosures of cash flow information:        |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       
|Interest paid                                             |                                                        |  |                    |  |                  | $ | 84     |        |   | $ | 85     |       
|Income taxes received                                     |                                                        |  |                    |  |                  |   | (19    | )      |   |   | (271   | )     
|                                                          |                                                        |  |                    |  |                  |   |        |        |   |   |        |       

See accompanying notes to unaudited consolidated financial statements.

5



---



##### Table of Contents






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

(1) Basis of Financial Statement Presentation

Under the rules and regulations of the Securities and Exchange Commission (the
SEC), we have prepared the accompanying unaudited interim consolidated
financial statements. These 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 (GAAP).

The consolidated financial statements include our accounts and our 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 GAAP have been condensed or omitted under such rules and
regulations. We believe, however, that the disclosures are adequate to make
the information presented not misleading. The year-end balance sheet data was
derived from audited financial statements, but does not include all disclosures
required by GAAP. These unaudited financial statements should be read in
conjunction with the financial statements and notes included in our Annual
Report to Shareholders on Form 10-K for the year ended August 31, 2002, as
amended by the Amendment No. 1, filed with the SEC on December 20, 2002, and
Amendment No. 2, filed with the SEC on January 7, 2003. Interim results of
operations for the three-month period ended November 30, 2002, may not
necessarily be indicative of the results to be expected for the full year.

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

We record provisions against net sales for estimated product returns. These
estimates are based on factors that include, but are not limited to, historical
sales returns, analyses of credit memo activities, current economic trends and
changes in our customers demand. We also record estimated provisions for
warranty claims based on historical trends and known warranty claims. Should
our actual product returns exceed our estimated allowances, additional
reductions to our revenue would result. As of November 30, 2002 and August 31,
2002, we had an aggregate of $200 in our warranty and product return reserves.

The SECs Staff Accounting Bulletin
(SAB) No. 101, Revenue Recognition
provides guidance on the application of GAAP to selected revenue recognition
issues, and our revenue recognition policies are in compliance with SAB 101.
We recognize revenue upon shipment of product to our customers when all
contractual obligations have been satisfied and collection of the resulting
receivable is reasonably assured. In fiscal 2002, we began a consignment
program with a significant customer, where revenue is recognized when the
customer uses the inventory. Our sales terms to our customers provide no right
of return outside of contractual warranty claims. Sales, payment terms and
pricing extended to our customers are governed by the respective contract
agreements, together with binding purchase orders for each transaction.
Payment terms are seven days for consignment program sales and 30 to 45 days
for other customers.

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

6



---



##### 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:

|                |  |                   |       |                 |  |   |       | 
|--------------- |  | ----------------- | ----- | --------------- |  | - | ----- | 
|                |  | November 30, 2002 |       | August 31, 2002
|                |  |                   |       |                
|Purchased parts |  | $                 | 1,978 |                 |  | $ | 1,944 | 
|Work in process |  |                   | 310   |                 |  |   | 597   | 
|Finished goods  |  |                   | 1,363 |                 |  |   | 1,486 | 
|                |  |                   |       |                 |  |   |       | 
|                |  | $                 | 3,651 |                 |  | $ | 4,027 | 
|                |  |                   |       |                 |  |   |       | 

(3) Deferred Tax Asset

Significant management judgment is required in determining the provision for
incomes taxes, deferred tax assets and liabilities and any valuation allowance
recorded against net deferred tax assets. We are required to estimate our
income taxes in each jurisdiction where we operate. This process involves
estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as the
depreciable life of fixed assets, for tax and accounting purposes. These
differences result in deferred tax assets and liabilities, which are included
in our consolidated balance sheets. We then assess the likelihood that our
deferred tax assets will be recovered from future taxable income, and to the
extent we believe recovery is unlikely, we must establish a valuation
allowance.

We had a valuation allowance of $3,800 and $3,400 at November 30, 2002 and
August 31, 2002, respectively, due to uncertainties related to our ability to
utilize certain federal and state net loss carryforwards. The valuation
allowance is based on our estimates of taxable income by jurisdiction and the
period over which our deferred tax assets are recoverable.

(4) Long-Term Debt

Our capital expenditure notes, revolving line of credit and letters of credit
are subject to certain restrictive financial covenants, including but not
limited to, tangible net worth, interest coverage, debt service coverage, net
loss limitations and the ability to declare or pay dividends. We were not in
compliance with the tangible net worth and year-to-date net loss covenants at
November 30, 2002. We amended the agreement with our financial institution on
December 13, 2002, to waive the November 30, 2002 defaults and reset the
covenants for the remainder of fiscal 2003. One of these reset covenants requires
our net loss, adjusted for certain items, not to exceed $1,750 on a
year-to-date basis through the third quarter of fiscal 2003 and not to exceed
$1,500 for the year ending August 31, 2003. Also, the reset bank covenants
reduced the overall revolving line of credit from a maximum amount of $5,000 to
$3,000, increased the interest rate by 1% and required us to prepay $1,000 of
long-term debt relating to the financing of manufacturing equipment. Based on
current projections, we believe that we will meet these reset bank covenants
going forward and have classified the debt per the terms of the respective
agreements. At November 30, 2002, we classified the $1,000 long-term
prepayment within current maturities of long-term debt and reclassified an
equal amount of cash to restricted cash. Based on our financial projections,
the $3,000 available under the revolving credit line is adequate for funding
our working capital needs.

We have Industrial Development Revenue Bonds (IDRBs) outstanding totaling
$1,735 at November 30, 2002. These bonds were originally issued in April 1996
in connection with the construction of a new addition to our manufacturing
facility in Victoria, Minnesota, and for production equipment purchases. In
April of each year, these bonds require principal payments of $700. We have
limited market risk with 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 are limited to a maximum rate of 10%. The
interest rate at November 30, 2002 and August 31, 2002 was 1.26% and 1.44%,
respectively. Two irrevocable letters of credit and essentially all of our
property and equipment collateralize the bonds. A commitment fee is paid
monthly to the bank at a rate of 4.25% per annum, based on the outstanding
balance of the IDRBs.

7



---



##### Table of Contents



(5) Net Loss Per Weighted Average Common Share

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

|                                 |  |                    |       |                  |  |  |       | 
|-------------------------------- |  | ------------------ | ----- | ---------------- |  |  | ----- | 
|                                 |  | Three Months Ended
|                                 |  |                   
|                                 |  | November 30, 2002  |       | December 1, 2001
|                                 |  |                    |       |                 
|Basic common shares              |  |                    | 6,012 |                  |  |  | 5,971 | 
|Dilutive effect of stock options |  |                    |      |                  |  |  |      | 
|                                 |  |                    |       |                  |  |  |       | 
|Diluted common shares            |  |                    | 6,012 |                  |  |  | 5,971 | 
|                                 |  |                    |       |                  |  |  |       | 

(6) Workforce Reductions

With the continued sluggish economy in all of our markets, we continued to size
our cost structure with anticipated revenue during the first quarter of fiscal
2003. We reduced our employee base by 28 persons at the end of the first
quarter of fiscal 2003, and have reduced an additional 24 persons through
December 16, 2002. A total of 52 positions have been eliminated in fiscal 2003
with annual salaries and wages of $2,004. The breakdown by employee category
with annual wages and salaries in parentheses is as follows: 32 direct labor
($853), 9 manufacturing ($428), 5 engineering ($272), and 6 administrative
positions ($451). The amount of savings from workforce reductions are tied to
the timing within a quarter and the amount of associated severance cost.

For the positions eliminated through November 30, 2002, we had net realized
savings in the first quarter, which are in line with our expectations, of:

|                                    |  |                    |    | 
|----------------------------------- |  | ------------------ | -- | 
|                                    |  | Three Months Ended
|                                    |  | November 30, 2002 
|                                    |  |                   
|Manufacturing                       |  | $                  | 48 | 
|Selling, General and Administrative |  | $                  | 27 | 
|Research and Development            |  | $                  | 25 | 

We paid an aggregate of $96 related to severance through November 30, 2002.
Substantially all of the severance charges were paid in the same period the
charges were recorded.

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

(7) Significant Customers

The table below sets forth the customers that represent over 10% of our
revenue. The percentages below for revenue represent the customers percentage
to total net revenue for the quarter and the accounts receivable (A/R)
percentage represents the customers percentage to the total net accounts
receivables outstanding at the end of each quarter. It is important to note
that the revenue from these two customers is from 14 different production
programs that produce over 200 different parts.

|           |       |  |                   |  |                  |  |           |      |               |  |      |      |   |  |  |  |  |  |      |      |   |  |      |      |  
|---------- | ----- |  | ----------------- |  | ---------------- |  | --------- | ---- | ------------- |  | ---- | ---- | - |  |  |  |  |  | ---- | ---- | - |  | ---- | ---- | -
|           |       |  | November 30, 2002 |  | December 1, 2001
|           |       |  | Revenue %         |  | A/R Balance %    |  | Revenue % |      | A/R Balance %
|           |       |  |                   |  |                  |  |           |      |              
|Customer A |       |  |                   |  |                  |  | 27.5      | %    |               |  | 26.2 | %    |   |  |  |  |  |  | 30.7 | %    |   |  | 31.0 | %   
|Customer B |       |  |                   |  |                  |  | 19.3      | %    |               |  | 16.2 | %    |   |  |  |  |  |  | 41.1 | %    |   |  | 21.2 | %   
|           | Total |  |                   |  |                  |  |           | 46.8 | %             |  |      | 42.4 | % |  |  |  |  |  |      | 71.8 | % |  |      | 52.2 | %

8



---



##### Table of Contents






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

OVERVIEW

Fiscal year 2002 was a very difficult year for us. Revenue in the first
quarter of fiscal 2002 began the year with the lowest revenue we have
experienced in nine quarters and was over a 50% drop in revenue from the first
quarter of fiscal 2001. During the second quarter of fiscal 2002, we
implemented a cost reduction plan to better match our cost structure with our
anticipated revenues. This plan continues into fiscal 2003. It is important
to note that our variable costs are approximately 50% to 55% of our revenue,
which makes us extremely volume or revenue dependent. The cost reduction plan
has lowered our quarterly breakeven point from $10,000 at the beginning of
fiscal 2002 to $7,500 at the end of fiscal 2002. We have continued to manage
our costs and it is our goal to lower the quarterly breakeven point to $7,000
by the end of fiscal 2003. Our commitment to research and development
continues in fiscal 2003 and we have and will continue this effort to maintain
and increase our propriety technology and manufacturing process.

With revenue being our biggest issue in fiscal 2002, we have streamlined and
improved our sales and marketing efforts with renewed focus and talent. We are
experiencing positive results from this effort and will continue to concentrate
on this during fiscal 2003 in attempt to not only increase our sales, but to
improve our diversification of revenue. Our backlog was $8,089 and $16,360 as
of November 30, 2002 and December 1, 2001, respectively. Our backlog is
subject to modifications, up and down, by our customers on short-term notice.
Additionally, over the past year we have experienced delays in receiving
longer-term commitments from our customers due the uncertainty of the
marketplace. We continue to have customer concentration with 46.8% of total
revenue from two customers in the first quarter of fiscal 2003. We continue to
experience fluctuations in demand for our products and visibility from our
customers is limited.

In the aggregate, starting with the second quarter of fiscal 2002 through
December 16, 2002, we eliminated 98 positions. With the continued sluggish
economy in all of our markets during the first quarter of fiscal 2003 we
continue to size our cost structure with anticipated revenue. We reduced our
employee base by 28 persons as of the end of the first quarter of fiscal 2003
and reduced an additional 24 through December 16, 2002. A total of 52 positions
have been eliminated in fiscal 2003. The number of employees by category with
annual cost saving in parenthesis is as follows: 32 direct labor ($853), 9
manufacturing ($428), 5 engineering ($272), and 6 administrative positions
($451). Annualized wages and salaries for the 52 positions that were
eliminated are $2,004. The amount of savings from workforce reductions are
tied to the timing within a quarter and the amount of associated severance
cost. As of November 30, 2002, we had 156 employees compared to 203 employees
as of December 1, 2001. These reductions in work force lower our salaries and
wages expense by $267 in the first quarter of fiscal 2003 compared to the same
period a year ago.

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

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements are based on the selection and
application of accounting principles generally accepted in the United States,
which require us to make estimates and assumptions about future events that
affect the amounts reported in our financial statements and the accompanying
notes. Future events and their effects cannot be determined with absolute
certainty. Therefore, the determination of estimates requires the exercise of
judgment. Actual results could differ from those estimates, and any such
differences may be material to the financial statements. We believe that the
following accounting policies may involve a higher degree of judgment and
complexity in their application and represent the critical accounting policies
used in the preparation of our financial statements. If different assumptions
or conditions were to prevail, the results could be materially different from
our reported results.

9



---



##### Table of Contents



Revenue recognition, Sales returns and Warranty

The SECs Staff Accounting Bulletin (SAB) No. 101, Revenue recognition
provides guidance on the application of GAAP to selected revenue recognition
issues, and our revenue recognition policies are in compliance with SAB 101.
We recognize revenue upon shipment of products to our customers when all
contractual obligations have been satisfied and collection of the resulting
receivable is reasonably assured. In fiscal 2002, we began a consignment
program with a significant customer, where revenue is recognized when the
customer uses the inventory. Our sales terms to our customers provide no right
of return outside of contractual warranty terms. Sales, payment terms and
pricing extended to our customers are governed by the respective contract
agreements or binding purchase orders for each transaction. Payment terms are
7 days for consignment program sales and 30 to 45 days for other customers.

We record provisions against net sales for estimated product returns. These
estimates are based on factors that include, but are not limited to, historical
sales returns, analyses of credit memo activities, current economic trends and
changes in our customers demand. We also record estimated provisions for
warranty claims based on historical trends and known warranty claims. Should
our actual product returns exceed our estimated allowances, additional
reductions to our revenue would result. As of November 30, 2002 and August 31,
2002 we had an aggregate of $200 in our warranty and product return reserves.

Allowance for uncollectible accounts

We estimate the collectibility of our trade receivables and notes receivable
which requires considerable amount of judgment in assessing the realization of
these receivables, including the current credit-worthiness of each customer and
related aging of the past due balances. In order to assess the collectibility
of these receivables, we perform ongoing credit evaluations of our customers
financial condition. Through these evaluations, we may become aware of a
situation where a customer may not be able to meet its financial obligations
due to a deterioration of its financial viability, credit ratings or
bankruptcy. The reserve requirements are based on the best facts available to
us and reevaluated and adjusted as additional information is received. We are
not able to predict changes in the financial condition of our customers, and if
circumstances related to our customers deteriorate, our estimates of the
recoverability of our receivables could be materially affected and we may be
required to record additional allowances. Alternatively, if we provide more
allowances than we need, we may reverse a portion of such provisions in future
periods based on changes in estimates from our actual collection experience.
As of November 30, 2002 and August 31, 2002 we had an aggregate of $85 in our
accounts receivable allowance.

Inventories

We record our inventories at the lower of cost or market value. Generally all
inventory purchases are for customized parts for a specific customer program.
As such, contractual arrangements are typically agreed to with the customer in
order to protect us in cases were the demand decreases, as often times the
parts cannot be consumed in other programs. Even though contractual
arrangements may be in place we are still required to assess the utilization of
our inventory. In assessing the ultimate realization of inventories, we make
judgments as to future demand requirements and compare that with the current or
committed inventory levels and contractual inventory holding requirements. Our
reserve requirements generally increase as our projected demand requirements
decrease due to market conditions, technological and product life cycle changes
as well as longer than previously expected usage periods. We have experienced
significant changes in required reserves in recent periods due primarily to
declining market conditions. It is possible that significant changes in
required inventory reserves may continue to occur in the future if there is a
further decline in market conditions. As of November 30, 2002 and August 31,
2002 we had an aggregate of $311 in our reserve for excess and obsolete
inventory.

Valuation of Deferred Taxes

Significant management judgment is required in determining the provision for
income taxes, deferred tax assets and liabilities and any valuation allowance
recorded against net deferred tax assets. We are required to estimate our
income taxes in each jurisdiction where we operate. This process involves
estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as the
depreciable life of fixed assets for tax and accounting purposes. These
differences result

10



---



##### Table of Contents



in deferred tax assets and liabilities, which are included in our consolidated
balance sheet. We then assess the likelihood that our deferred tax assets will
be recovered from future taxable income, and to the extent we believe recovery
is unlikely, we must establish a valuation allowance. To the extent we
establish a valuation allowance or increase the valuation allowance in a given
period, we must increase tax expense within our statement of operations.

We had a valuation allowance of $3,800 and $3,400 at November 30, 2002 and
August 31, 2002, respectively, due to uncertainties related to our ability to
utilize certain federal and state net loss carryforwards. The valuation
allowance is based on our estimates of taxable income by jurisdiction and the
period over which our deferred tax assets are recoverable. In the event actual
results differ from these estimates we will adjust these estimates in future
periods.

NEW ACCOUNTING PRONOUNCEMENTS

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

FINANCIAL CONDITION

Our net cash flow used by operating activities was $1,056 for the three-months
ended November 30, 2002, compared to cash flow provided by operating activities
of $657 in the same prior-year period. The main difference between the periods
was that accounts receivable generated cash of $1,542 during the first quarter
of fiscal 2002 compared to a cash usage of $338 for the first quarter of fiscal
2003. This change was the result of dramatically lower revenues from the
fourth quarter of fiscal 2001 versus the first quarter of fiscal 2002 compared
to a more level revenue from the fourth quarter of fiscal 2002 versus the first
quarter of fiscal 2003. Net cash flows used for investing activities were $99
and $1,656 for the first quarters of fiscal 2003 and 2002, respectively. The
decrease during the first quarter of fiscal 2003 was mostly due to reduction in
capital expenditures. Net cash flow used for financing activities was $73
during the first quarter of fiscal 2003, compared to net cash provided by
financing activities of $1,341 for the first quarter of fiscal 2002. The
majority of this difference is due to the increase in the revolving line of
credit to fund capital expenditures during the first quarter of fiscal 2002.
As a result of the December 13, 2002 amendment to our banking facilities, we
will repay an additional $1,000 of long-term debt during the quarter ending
March 1, 2003. This amount was classified as restricted cash at November 30,
2002.

Our accounts receivable average days outstanding of 52 at November 30, 2002 was
a slight improvement from 53 days as of August 31, 2002.

Annualized inventory turns were 5.0 for the three-month period ending November
30, 2002, compared to 5.4 for the same period a year ago. This decrease is
mainly the result of the very low sales of $5,490 for the first quarter of
fiscal 2003 and the increase of raw materials and supplies for anticipated
increased sales demand in the second quarter of fiscal 2003.

We have a maximum of $3,000 available under the revolving line of credit, based
on the accounts receivable balance outstanding, and a $4,456 capital
expenditure term loan, subject to certain restrictions listed below, each of
which expire in August 2004. As of November 30, 2002, there were $1,702 and
$1,902 of borrowings under the line of credit and capital expenditure term loan
facility, respectively. The capital expenditure term loan was reduced by
$1,000 in December 2002 due to the waiver of the debt covenants discussed
below. These borrowings are subject to certain restrictive financial
covenants, including but not limited to: tangible net worth, interest coverage
ratio, debt service coverage ratio, net loss limitations and the ability to
declare or pay dividends. The general economic slowdown in the hearing, RFID
and other electronic contract manufacturing markets in which we operate have
resulted in adverse operating results in the first quarter of fiscal 2003. Due

11



---



##### Table of Contents



to these adverse operating results, we were not in compliance with the
covenants at November 30, 2002. On December 13, 2002, we amended these
agreements with our bank to waive the defaults as of November 30, 2002, and
reset the covenants for the remainder of fiscal 2003. One of these reset
covenants requires our net loss, adjusted for certain items, not to exceed
$1,750 through the third quarter of fiscal 2003 and not to exceed $1,500 for
the year ended August 31, 2003. Also, these reset bank covenants reduce the
overall revolving line of credit from maximum amount of $5,000 to $3,000 and
require us to prepay long-term debt relating to the financing of manufacturing
equipment in the amount of $1,000 on December 13, 2002. We are currently in
compliance with the new bank covenants and, based on current financial
projections and new covenants, we believe that we will meet the bank covenants
going forward and have classified the debt per the terms of the respective
agreements. At November 30, 2002, we classified the $1,000 long-term
prepayment within current maturities of long-term debt and reclassified an
equal amount of cash to restricted cash. Based on our financial projections,
the $3,000 available under this line is adequate for funding our working
capital needs.

At various times over the past two years we have not been in compliance with
our bank covenants. We have successfully been able to obtain waivers and reset
the covenants in the past. We have experienced substantial fluctuations in our
quarterly operating results and such fluctuations may continue in future
periods. Adverse operating results could result in an event of default with
our bank agreement for not meeting certain financial and other restrictive
covenants, such as, tangible net worth, interest coverage ratio, debt service
coverage ratio and net loss limitations. Failure to meet these covenants could
require us to: immediately repay our outstanding balances; find a new lender,
which may cause us to incur costs in connection with such new lending
relationship; incur increased borrowing rates and amendment fees; incur
additional restrictions on our ability to borrow additional funds. Any one of
these factors, or a combination of one or more could adversely affect our
ability to borrow funds or adversely affect future operating results.

Although we are in compliance with the bank covenants, the financial
institution has put certain restrictions on our ability to borrow additional
funds under the capital expenditure term loan facility. These restrictions
require us to be profitable for four consecutive quarters prior to allowing
additional borrowings under the 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 continue to work to
increase sales and improve our operating results to meet this covenant and
regain the ability to borrow additional funds under the capital expenditure
loan facility.

We have Industrial Development Revenue Bonds (IDRBs) outstanding totaling
$1,735 at November 30, 2002. These bonds were originally issued in April 1996
in connection with the construction of a new addition to our manufacturing
facility in Victoria, Minnesota, and for production equipment purchases. In
April of each year, these bonds require annual principal payments of $700. We
have limited market risk with 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 are limited to a maximum rate of 10%. The
interest rate at November 30, 2002 and August 31, 2002 was 1.26% and 1.44%,
respectively. Two irrevocable letters of credit and essentially all of our
property and equipment collateralize the bonds. A commitment fee is paid
monthly to the bank at a rate of 4.25% per annum, based on the outstanding
balance of the IDRBs.

During fiscal 2003, we intend to expend approximately $900 for manufacturing
and facility improvements and capital equipment, of which $28 has been expended
during the first quarter of fiscal 2003. These additions will only be made to
increase manufacturing capacity to meet near-term production requirements and
add technological capabilities, if necessary. We expect that these
expenditures will be funded from operations, existing cash and cash equivalents
and available debt financing.

We believe that our existing cash and cash equivalents, current lending
capacity and cash generated from operations will provide sufficient cash flow
for us to meet our short and long-term debt obligations and operating
requirements for at least the next twelve months. If we fail to meet our bank
covenants and are not able to obtain a waiver, we may be required to
immediately repay our outstanding balances and find a new lender, which may
cause us to incur additional costs, including higher interest costs, in
connection with establishing a new lending relationship.

12



---



##### Table of Contents



RESULTS OF OPERATIONS

Net Sales

Fiscal 2003 vs. 2002:Our net sales for the three-month period ended November
30, 2002 of $5,490 decreased $636 or 10.4% compared to the same period a year
ago. The decrease in net sales in the current-year period is largely a result
of the general economic slowdown and the resulting impact in the hearing,
communications, RFID/Access and electronic contact manufacturing markets. We
continue to have customer concentration with 46.8% of total revenue in the
first quarter of fiscal 2003 from two customers. It is important to note that
with these two customers we have 14 different production programs that produce
over 200 different parts. We continue to experience fluctuations in demand for
our products and visibility from our customers is limited.

Net sales by market for the three-months ended November 30, 2002 and December
1, 2001, respectively, are as follows. HDI represents net sales for the High
Density Interconnect Division in Tempe, Arizona, which manufactures flexible
circuit boards.

|                         |  |                    |       |                  |  |   |       | 
|------------------------ |  | ------------------ | ----- | ---------------- |  | - | ----- | 
|                         |  | Three Months Ended
|                         |  | November 30, 2002  |       | December 1, 2001
|                         |  |                    |       |                 
|Hearing/Medical          |  | $                  | 3,442 |                  |  | $ | 4,504 | 
|RFID/Access              |  |                    | 607   |                  |  |   | 983   | 
|Communication/Industrial |  |                    | 771   |                  |  |   | 403   | 
|HDI                      |  |                    | 670   |                  |  |   | 236   | 
|                         |  |                    |       |                  |  |   |       | 
|Total Net Sales          |  | $                  | 5,490 |                  |  | $ | 6,126 | 
|                         |  |                    |       |                  |  |   |       | 

Net sales to hearing and medical customers decreased by a total of $1,062 for
the first quarter of fiscal 2003 compared to the same quarter a year ago. Net
sales analysis by each market segment is as follows:

Hearing: Net sales to hearing customers of $2,700 during the first quarter of
fiscal 2003 decreased $1,640 compared the same quarter a year ago. This
decrease from prior year reflects the general economic slowdown impacting the
hearing contract manufacturing markets. Also, during the latter part of fiscal
2002, a major customers internal manufacturing capabilities increased, which
we anticipate will negatively impact revenue by approximately $3,000 for fiscal
2003. We are currently experiencing some positive trends in the area but do
not anticipate the sales volume to reach fiscal 2002 levels in the coming
quarters.

Medical: Net sales to medical customers of $742 during the first quarter of
fiscal 2003 were an increase of $578 compared to the same period a year ago.
This increase over last year is a trend we expect to continue during fiscal
2003.

RFID: Net sales for the three-month period of Radio Frequency Identification
(RFID) products of $607 decreased $376 for the quarter ending November 30,
2002, compared to the same period last year. The decrease in quarterly net
sales compared to prior year is primarily due to a significant drop in revenue
from one major customer and competitiveness in this market from overseas
manufacturers. This significant customer sold one division and terminated
operations of another division during the first quarter of fiscal year 2002.
We have developed new products and expanded our capabilities to improve
revenue; however, the actual level of market acceptance is currently unknown.

Communications/Industrial: Net sales for the three-month period to customers
in the Communications and Industrial markets of $771 increased $368 for the
quarter ended November 30, 2002, compared to the same period last year. The
overall market remains depressed, however we did experience higher demand from
a few of our customers this quarter and are seeing slight increased activity in
this market with numerous low volume purchase orders.

HDI: Net sales for the three-month period of HDI products of $670 increased
$434 for the quarter ended November 30, 2002, compared to the same period a
year ago. The majority of this increase is from products supplied to the
medical implantable market.

13



---



##### Table of Contents



We continue to experience fluctuations in demand for our hearing products and
expect this to continue in fiscal 2003. The communications and RFID markets
remain soft as our customers are awaiting market acceptance of new products and
increased demand for exiting products. As the demand for these products
increases, we are positioned for an increase in sales in these markets. In
addition, we are experiencing continued external interest in our proprietary
products, for which we are currently working on new designs, qualification
testing and prototype orders with numerous customers. Our net sales are
generally tied to the customers projected sales and production of the related
products; therefore, our net sales levels are subject to fluctuations beyond
our control. To the extent that sales to any one customer represent a
significant portion of our net sales, any change in the sales levels to that
customer can have a significant impact on our total net 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 net sales from quarter to quarter.

Gross Profit

Fiscal 2003 vs. 2002:For the three-month period ended November 30, 2002, gross
profit of $612 increased $227 from the same period last year. The gross profit
margin as a percent of net sales for the three-months ended November 30, 2002
improved to 11.1% as compared to 6.3% in the comparable period last year. This
improvement is due to reduced employees, improved material content cost, lower
manufacturing expenses and improved product mix. The reduction of employees
during the first quarter of fiscal 2003 resulted in net reduced cost of sales
of $48. Our gross margin percentages are heavily impacted by revenue due to
the fixed nature of many of our manufacturing costs. Consequently, we expect
gross margins to be impacted in a similar manner as revenues increase and
decrease. In addition, as market acceptance of our proprietary broadband
communications products occurs, gross margins should improve, as these products
are expected to have higher gross margin than we have historically experienced.

Operating Expenses

Fiscal 2003 vs. 2002:For the three-month period ended November 30, 2002,
operating expenses of $1,752 decreased $270 from the same period last year.
The operating expenses as a percent of net sales for the three-months ended
November 30, 2002 improved to 31.9% as compared to 33.0% in the comparable
period last year. The decrease in selling, general and administrative expenses of
$105 for the current three-month period as compared to the same period a year
ago was primarily due to cost containment measures, such as reduction of
employees (wages and benefits), decreased insurance, legal and public reporting
costs, offset by increases in advertising, travel costs and severance payments.
Research, development and engineering expense decrease of $165 for the current
three-month period as compared to the same period a year ago which was primarily due
to cost containment measures, such as reduction of employees in prior periods
and general supplies. The cost saving from the reduction of employees during
the first quarter fiscal 2003 were $52.

These overall decreasing expenses are a result of our continued efforts to
right size the business balanced with our commitment to maintain our research
and development efforts and continued sales and marketing focus.

Other Expense, Net

Fiscal 2003 vs. 2002:Other expense, net increase of $13 for the three-month
period ended November 30, 2002, compared to the same period a year ago, is a
result of lower interest income due to smaller investment cash balances for the
quarter compared to the same period last year. The increase in the interest
rate set by the revised bank agreement on December 13, 2002, will be offset by
the low debt balance due to the prepayment of $1,000 of long-term debt.

Income Taxes

Fiscal 2003 vs. 2002:Income tax benefit of $19 for the three-month period
ended November 30, 2002, is the result of a prior year tax refund. For the
same period last year we reported a tax benefit of $564 based on the
anticipated tax loss carryforward to offset future taxable income. We had a
valuation allowance of $3,800 and $3,400, at November 30, 2002 and August 31,
2002, respectively, to fully reserve the deferred tax assets due to
uncertainties related to our ability to utilize certain federal and state loss
carryforwards. The valuation

14



---



##### Table of Contents



allowance is based on our estimates of taxable income by jurisdiction and the
period over which our deferred tax assets are recoverable. Due to the
valuation allowance for deferred income taxes, effective with the first quarter
of fiscal 2003, we will no longer record income tax expense or benefit until we
have established a history of taxable income and other requirements required by
GAAP are satisfied. Even though this valuation allowance has been established,
we still retain all the economic benefits of the net operating loss in future
years if we generate taxable income. At November 30, 2002, we had net
operating loss carryforwards expiring at various dates ranging from 2013
through 2022.

Net loss

Fiscal 2003 vs. 2002:We had a net loss of $1,155 for the three-month period
ended November 30, 2002, compared to net loss of $1,094 for the same period
last year. Net loss per share for the first quarter of fiscal 2003 was
$.19 per share compared to a loss of $.18 per share for
the same period last year.

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
our 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 for us to secure and satisfy customers, the availability and cost of
materials from our suppliers, adverse competitive developments, change in or
cancellation of customer requirements and other factors discussed from time to
time in our filings with the Securities and Exchange Commission. Readers are
cautioned not to place undue reliance on forward-looking statements. We
undertake no obligation to update these statements to reflect ensuing events or
circumstances, or subsequent actual results.

15



---



##### Table of Contents






Item 3.Qualitative and Quantitative Disclosures About Market Risk

We are exposed to certain market risks with our revolving line of credit,
capital expenditure loans and, to a lesser extent, our IDRBs. At November 30,
2002, the outstanding balance on the revolving line of credit, capital
expenditure loans and IDRBs were $1,702, $1,993 and $1,735, respectively.
Effective December 1, 2002, the revolving line of credit agreement bears
interest, at our option, at 2.75% above the prime rate of interest or 5.25%
above the LIBOR rate. The capital expenditure loans bear interest, at our
option, at 3.00% above the prime rate of interest or 5.50% above the LIBOR
rate. At November 30, 2002, the interest rates on the revolving commitment and
capital expenditure loans were 7% and 7.25%, 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 November 30, 2002, the interest
rate on the IDRBs was 1.26%. Consequently, we are exposed to a change in
borrowing costs as interest rates change. We have completed a market risk
sensitivity analysis of these debt instruments based upon an assumed 1%
increase in interest rates at November 30, 2002. If market interest rates had
increased by 1% on November 30, 2002, this would have resulted in an increase
to interest expense of approximately $54 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.

16



---



##### Table of Contents






Item 4. Controls and Procedures

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

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

17



---



##### Table of Contents









PART II  OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K



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

|     |  |                                                                                                                                
|---- |  | -------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Seventh Amendment to Loan and Security Agreement                                                                               
|    
|10.2 |  | Amended and Restated Revolving Note                                                                                            
|    
|99.1 |  | Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002



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



| |  |  | Not Applicable
| |  |  | --------------

18



---



##### Table of Contents






SIGNATURES

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

|      |          |  |                                       | 
|----- | -------- |  | ------------------------------------- | 
|      |          |  | HEI, Inc.                            
|      |          | 
|Date: | 01/14/03 |  | /s/ Steve E. Tondera, Jr.            
|      |          |  |                                      
|      |          |  | Steve E. Tondera, Jr.                
|      |          |  | Vice President of Finance,           
|      |          |  | Chief Financial Officer and Treasurer
|      |          |  | (a duly authorized officer)          

19



---



##### Table of Contents






CERTIFICATIONS

I, Anthony J. Fant, certify that:



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



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



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



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



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

|                       |  |                                                                   
|---------------------- |  | ------------------------------------------------------------------
|                       |  | /s/ ANTHONY J. FANT                                               
|                       |  |                                                                   
|                       |  | Anthony J. FantChairman and Chief Executive Officer and 
President
|                       |  |                                                                   
|Date: January 14, 2003 |  |                                                                   

20



---



##### Table of Contents



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



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



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



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



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



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

|                       |  |                                                                                              
|---------------------- |  | ---------------------------------------------------------------------------------------------
|                       |  | /s/ STEVE E. TONDERA, JR.                                                                    
|                       |  |                                                                                              
|                       |  | Steve E. Tondera, Jr.Chief Financial Officer, Treasurer, Vice
President Finance and Secretary
|                       |  |                                                                                              
|Date: January 14, 2003 |  |                                                                                              

21



---



##### Table of Contents






Exhibit Index

|     |  |                                                                                                                                                  
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Seventh Amendment to Loan and Security Agreement with LaSalle Business
Credit, Inc., effective December 1, 2002 (filed herewith).                
|    
|10.2 |  | Amended and Restated Revolving Note with LaSalle Business Credit, Inc.,
effective December 1, 2002 (filed herewith).                             
|    
|99.1 |  | Certifications of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed
herewith).

22