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UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





Form 10-K


|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934    
|  
|   |  | For the fiscal year ended August 31, 2005.                                                  
|  
|or
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|  
|   |  | For the transition period
    from           to                                             

Commission file number: 0-10078





HEI, Inc.


(Exact name of registrant as specified in its Charter)


|                                                                                                    |  |                                         
|--------------------------------------------------------------------------------------------------- |  | ----------------------------------------
|Minnesota                                                                                           |  | 41-0944876                              
|(State or other jurisdiction of
    incorporation or organization)                                  |  | (I.R.S. Employer
    Identification No.)
|                                                                                                   
|P.O. Box 5000,
    1495 Steiger Lake Lane,
    Victoria, MN(Address of principal executive offices) |  | 55386(Zip Code)                         

Registrants telephone number, including area code:


(952) 443-2500


Securities registered pursuant to Section 12(b) of the
Act:


None


Securities registered pursuant to Section 12(g) of the
Act:


Common Stock, Par Value $.05 Per Share


(Title of Class)


þ o


þ


o þ


o þ






DOCUMENTS INCORPORATED BY REFERENCE












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TABLE OF CONTENTS


|                                             |  |                                                                                           |    |        |    | 
|-------------------------------------------- |  | ----------------------------------------------------------------------------------------- | -- | ------ | -- | 
|                                             |  |                                                                                           |    | PAGE # |   
|                                             |  |                                                                                           |    |        |   
|PART I                                      
|ITEM 1.                                      |  | BUSINESS                                                                                  |    |        | 4  | 
|ITEM 2.                                      |  | PROPERTIES                                                                                |    |        | 18 | 
|ITEM 3.                                      |  | LEGAL PROCEEDINGS                                                                         |    |        | 19 | 
|ITEM 4.                                      |  | SUBMISSION OF MATTERS TO VOTE OF SECURITY
    HOLDERS                                     |    |        | 19 | 
|                                            
|PART II                                     
|ITEM 5.                                      |  | MARKET FOR REGISTRANTS COMMON EQUITY
    AND RELATED STOCKHOLDER MATTERS                 |    |        | 20 | 
|ITEM 6.                                      |  | SELECTED FINANCIAL DATA                                                                   |    |        | 21 | 
|ITEM 7.                                      |  | MANAGEMENTS DISCUSSION AND ANALYSIS
    OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |    |        | 22 | 
|ITEM 7A.                                     |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES
    ABOUT MARKET RISK                            |    |        | 34 | 
|ITEM 8.                                      |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                               |    |        | 35 | 
|ITEM 9.                                      |  | CHANGES IN AND DISAGREEMENTS WITH
    ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE  |    |        | 66 | 
|ITEM 9A.                                     |  | CONTROLS AND PROCEDURES                                                                   |    |        | 66 | 
|ITEM 9B.                                     |  | OTHER INFORMATION                                                                         |    |        | 68 | 
|                                            
|PART III                                    
|ITEM 10.                                     |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE
    REGISTRANT                                    |    |        | 68 | 
|ITEM 11.                                     |  | EXECUTIVE COMPENSATION                                                                    |    |        | 68 | 
|ITEM 12.                                     |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
    OWNERS AND MANAGEMENT                        |    |        | 68 | 
|ITEM 13.                                     |  | CERTAIN RELATIONSHIPS AND RELATED
    TRANSACTIONS                                        |    |        | 68 | 
|ITEM 14.                                     |  | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                    |    |        | 68 | 
|                                            
|PART IV                                     
|ITEM 15.                                     |  | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                |    |        | 68 | 
|SIGNATURES                                   |  |                                                                                           | 73 |       
|Subsidiaries of the Registrant              
|Consent of Virchow, Krause & Company, LLP   
|Consent of KPMG LLP                         
|Certification of CEO Pursuant to Section 302
|Certification of CFO Pursuant to Section 302
|Certification of CEO Pursuant to Section 906
|Certification of CFO Pursuant to Section 906



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FORWARD-LOOKING STATEMENTS


Some of the information included in this Annual Report on
Form 10-K contains forward-looking statements made pursuant
to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995 that involve substantial risks and
uncertainties. You can identify these statements by
forward-looking words such as may, will,
expect, anticipate, believe,
intend, estimate, continue,
and similar words. You should read statements that contain these
words carefully for the following reasons: such statements
discuss our future expectations, such statements contain
projections of future earnings or financial condition and such
statements state other forward-looking information. Although it
is important to communicate our expectations, there may be
events in the future that we are not accurately able to predict
or over which we have no control. The risk factors included in
Item 1 of this Annual Report on Form 10-K provide
examples of such risks, uncertainties and events that may cause
actual results to differ materially from our expectations and
the forward-looking statements. Readers are cautioned not to
place undue reliance on forward-looking statements, as we
undertake no obligation to update these forward-looking
statements to reflect ensuing events or circumstances, or
subsequent actual results.


GENERAL INFORMATION




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PART I





Item 1. Business.


Business Development




Business of the Company


Overview:










| |                            
| | ---------------------------
| | Microelectronics Operations





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| |                            
| | ---------------------------
| | Advanced Medical Operations



Customers:




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Component Supply Operations:


Proprietary Technology:


Government Regulations:


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Dependence on Single or Few Customers and Backlog:


|                       |  |                    |    |   |      |  |    |      |  |  |    |  
|---------------------- |  | ------------------ | -- | - | ---- |  | -- | ---- |  |  | -- | -
|                       |  | Fiscal Years Ended |   
|                       |  | August 31,         |   
|                       |  |                    |   
|Customer               |  | 2005               |    |   | 2004 |  |    | 2003 | 
|                       |  |                    |    |   |      |  |    |      | 
|GE Medical Systems     |  |                    | 12 | % |      |  | 17 | %    |  |  | 14 | %
|Siemens, Inc.          |  |                    | 6  | % |      |  | 8  | %    |  |  | 14 | %
|Sonic Innovations, Inc |  |                    | 0  | % |      |  | 2  | %    |  |  | 17 | %



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|                 |  |                    |     |  |      |  |     |      |  |  |     | 
|---------------- |  | ------------------ | --- |  | ---- |  | --- | ---- |  |  | --- | 
|                 |  | Fiscal Years Ended |    
|                 |  | August 31,         |    
|                 |  |                    |    
|Market           |  | 2005               |     |  | 2004 |  |     | 2003 | 
|                 |  |                    |     |  |      |  |     |      | 
|Medical/ Hearing |  |                    | 81% |  |      |  | 84% |      |  |  | 82% | 
|Communications   |  |                    | 10% |  |      |  | 6%  |      |  |  | 6%  | 
|Industrial       |  |                    | 9%  |  |      |  | 10% |      |  |  | 12% | 





Competition:


Engineering, Research and Development:


Employees:


Website and Available Information: www.heii.com




RISK FACTORS




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We may lose business and revenues if we fail to successfully
compete for our customers business.






Fluctuations in the price and supply of components used to
manufacture our products may reduce our profits.






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Our costs may increase significantly if we are unable to
forecast customer orders and production schedules.


We may be unable to realize revenue from our backlog.


Future quarterly and annual operating results may fluctuate
substantially due to a number of factors, many of which are
beyond our control, which may cause our stock price to
decline.




| |   |                                                                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | we may manufacture products that are custom designed and
    assembled for a specific customers requirement in
    anticipation of the receipt of volume production orders from
    that customer, which may not always materialize to the degree
    anticipated, if at all;                                                                      
|
| |  | we may incur significant start-up costs in the production of a
    particular product, which costs are expensed as incurred and for
    which we attempt to seek reimbursement from the customer;                                                                                                                                                   
|
| |  | we may experience fluctuations and inefficiencies in managing
    inventories, fixed assets, components and labor, in the degree
    of automation used in the assembly process, in the costs of
    materials, and the mix of materials, labor, manufacturing, and
    overhead costs;                                                             
|
| |  | we may experience unforeseen design or manufacturing problems,
    price competition or functional competition (other means of
    accomplishing the same or similar packaging end result);                                                                                                                                                         
|
| |  | we may be unable to pass on cost overruns;                                                                                                                                                                                                                                                                                                          
|
| |  | we may not be able to gain the benefits expected out of
    lean-flow manufacturing at our Victoria facility;                                                                                                                                                                                                                                     
|
| |  | we may not have control over the timing of expenditures in
    anticipation of increased sales, customer product delivery
    requirements and the range of services provided; and                                                                                                                                                                  
|
| |  | we may experience variance in the amount and timing of orders
    placed by a customer due to a number of factors, including
    inventory balancing, changes in manufacturing strategy, and
    variation in product demand attributable to, among other things,
    product life cycles, competitive factors, and general economic
    conditions.

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We may fail to adequately adjust our expenses to predicted
revenue in any given period or we may experience significant
fluctuations in quarterly revenue because the sales cycle for
our products and services is lengthy and unpredictable.


We may have a significant accounts receivable write-off as
well as an increase in inventory reserve due to the inability of
our customers to pay their accounts.


Our business success may be adversely affected by our ability
to hire and retain employees.


We operate in a regulated industry, and our products and
revenue are subject to regulatory risk.






If our customers do not promptly obtain regulatory approval
for their products, our projects and revenue may be adversely
affected.


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Failure to comply with our debt covenants may require us to
immediately repay our outstanding balances and/or may affect our
ability to borrow funds in the future, either of which may
adversely affect our future operating results.




| |   |                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------
| |  | Further increase borrowing rates;                                                                         
|
| |  | Incur amendment fees;                                                                                     
|
| |  | Incur additional restrictions on our ability to borrow
    additional funds;                              
|
| |  | Immediately repay our outstanding balances; and                                                           
|
| |  | Find a new lender, which may cause us to incur costs in
    connection with such new lending relationship.



We may fail to have enough liquidity to operate our business
because we may not adequately adjust our expenses to actual
revenue in any given period, which may dramatically and
negatively impact our cash flow.


If the components that we design and manufacture are the
subject of product recalls or a product liability claim, our
business may be damaged, we may incur significant legal fees and
our results of operations and financial condition may be
adversely affected.


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The loss of a key customer may reduce our operating results
and financial condition.


If we are unable to develop new products and services our
revenue could decrease.


If we fail to properly anticipate the market for new products
and service we may lose revenue.




| |   |                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------
| |  | the failure to adequately equip our manufacturing plant in
    anticipation of increasing business;                               
|
| |  | the failure of our design team to develop products in a timely
    manner to satisfy our present and potential customers; and     
|
| |  | our limited experience in specific market segments in marketing
    our products and services, specifically in the telecom market.

Our business may suffer if we are unable to protect our
intellectual property rights.


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Third-party intellectual property infringement claims may be
costly and may prevent the future sale of our products.


We may pursue future acquisitions and investments that may
adversely affect our financial position or cause our earnings
per share to decline.




| |   |                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | we may not be able to negotiate acceptable terms or finance the
    acquisition successfully,                                                                                                              
|
| |  | the integration of acquired businesses, products or technologies
    into our existing business may fail, and                                                                                              
|
| |  | we may issue equity securities, incur debt, assume contingent
    liabilities or have amortization expenses and write-downs of
    acquired assets which could cause our earnings per share to
    decline.

If our customers are unable to gain market acceptance for the
products that we develop or manufacture for them, we may lose
revenue.


If we fail to comply with environmental laws and regulations
we may be fined and prohibited from manufacturing products.


We are dependent on a single market and adverse trends in
that market may reduce our revenues.


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If government or insurance company reimbursements for our
customers products change, our products, revenues and
profitability may be adversely affected.


We have customers located in foreign countries and our
unfamiliarity of the laws and business practices of such foreign
countries could cause us to incur increased costs.


Our Amended and Restated Articles of Incorporation and our
Amended and Restated Bylaws, as amended, may discourage lawsuits
and other claims against our directors.


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We have issued numerous options to acquire our common stock
that could have a dilutive effect on our common stock.


The market price of our common stock may be reduced by future
sales of our common stock in the public market.




| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | 467,610 shares beneficially owned by our executive officers
    and directors; and
|
| |  | approximately 2,656,000 shares issuable to option and
    warrant holders.        



The trading dynamics of our common stock makes it subject to
large fluctuations in the per share value.


Our Amended and Restated Articles of Incorporation contain
provisions that could discourage or prevent a potential
takeover, even if such transaction would be beneficial to our
shareholders.






| |   |                                                                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | to approve the merger or consolidation of us or any subsidiary
    with or into any person that directly or indirectly beneficially
    owns, or owned at any time in the preceding 12 months, five
    percent or more of the outstanding shares of our stock entitled
    to vote in elections of directors, referred to as a
    Related Person;
|
| |  | to authorize the sale of substantially all of our assets to a
    Related Person;                                                                                                                                                                                                                                                                    

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| |   |                                                                                                                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | to authorize the issuance of any of our voting securities in
    exchange or payment for the securities or assets of any Related
    Person, if such authorization is otherwise required by law or
    any agreement;                                                                          
|
| |  | to adopt any plan for the dissolution of us; and                                                                                                                                                                                                                                               
|
| |  | to adopt any amendment, change or repeal of certain articles of
    the Amended and Restated Articles of Incorporation, including
    the articles that establish the authority of the Board of
    Directors, the supermajority voting requirements and the
    classified Board of Directors.



If we are not able to establish an effective control
environment in Fiscal 2007, we will not comply with
Section 404 of the Sarbanes-Oxley Act relating to internal
controls over financial reporting.


The market price of our shares may experience significant
price and volume fluctuations for reasons over which we have
little control.




| |   |                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------
| |  | new products or services offered by us or our competitors;                                                                                
|
| |  | failure to meet any publicly announced revenue projections;                                                                               
|
| |  | actual or anticipated variations in quarterly operating results;                                                                          
|
| |  | changes in financial estimates by securities analysts;                                                                                    
|
| |  | announcements of significant acquisitions, strategic
    partnerships, joint ventures or capital commitments by us or our
    competitors;
|
| |  | issuances of debt or equity securities;                                                                                                   
|
| |  | changes in requirements or demands for our services;                                                                                      
|
| |  | technological innovations by us or our competitors;                                                                                       
|
| |  | quarterly variations in our or our competitors operating
    results;                                                                    
|
| |  | changes in prices of our or our competitors products and
    services;                                                                   
|
| |  | changes in our revenue and revenue growth rates;                                                                                          

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| |   |                                                                                          
| | - | -----------------------------------------------------------------------------------------
| |  | changes in earnings estimates by market analysts;                                        
|
| |  | speculation in the press or analyst community;                                           
|
| |  | general market conditions or market conditions specific to
    particular industries; and
|
| |  | other events or factors, many of which are beyond our control.                           








|        |            
|------- | -----------
|Item 2. | Properties.














|        |                   
|------- | ------------------
|Item 3. | Legal Proceedings.



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



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PART II







|        |                                                                                                                      
|------- | ---------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity, Related
    Stockholder Matters and Issuer Purchases of Equity
    Securities.



|                                  |  |      |      |  |     |   |      | 
|--------------------------------- |  | ---- | ---- |  | --- | - | ---- | 
|Fiscal Year Ended August 31, 2005 |  | High |      |  | Low |  
|                                  |  |      |      |  |     |  
|First Quarter                     |  | $    | 2.46 |  |     | $ | 1.62 | 
|Second Quarter                    |  |      | 3.12 |  |     |   | 1.78 | 
|Third Quarter                     |  |      | 3.33 |  |     |   | 2.71 | 
|Fourth Quarter                    |  |      | 3.93 |  |     |   | 2.88 | 
|Fiscal Year Ended August 31, 2004 |  |      |      |  |     |   |      | 
|First Quarter                     |  | $    | 4.65 |  |     | $ | 2.95 | 
|Second Quarter                    |  |      | 3.97 |  |     |   | 2.70 | 
|Third Quarter                     |  |      | 3.68 |  |     |   | 2.30 | 
|Fourth Quarter                    |  |      | 2.78 |  |     |   | 1.20 | 







Equity Compensation Plan Information




|                                                       |  |                     |           |           |                  |                  |                     |                     |  |  |         | 
|------------------------------------------------------ |  | ------------------- | --------- | --------- | ---------------- | ---------------- | ------------------- | ------------------- |  |  | ------- | 
|                                                       |  |                     |           |           |                  | Number of Shares |                    
|                                                       |  |                     |           | Weighted- |                  |                  | Remaining Available |                    
|                                                       |  | Number of Shares to |           |           | Average Exercise |                  |                     | for Future Issuance | 
|                                                       |  | be Issued Upon      |           |           | Price of         |                  |                     | Under Equity        | 
|                                                       |  | Exercise of         |           |           | Outstanding      |                  |                     | Compensation Plans  | 
|                                                       |  | Outstanding         |           |           | Options,         |                  |                     | (Excluding Shares   | 
|                                                       |  | Options, Warrants   |           |           | Warrants and     |                  |                     | Reflected in the    | 
|Plan Category                                          |  | and Rights          |           |           | Rights           |                  |                     | First Column)       | 
|                                                       |  |                     |           |           |                  |                  |                     |                     | 
|Equity compensation plans approved by shareholders     |  |                     | 1,656,975 |           |                  | $                | 4.59                |                     |  |  | 191,045 | 
|Equity compensation plans not approved by shareholders |  |                     |          |           |                  |                  |                    |                     |  |  |        | 
|                                                       |  |                     |           |           |                  |                  |                     |                     | 
|Total                                                  |  |                     | 1,656,975 |           |                  | $                | 4.59                |                     |  |  | 191,045 | 
|                                                       |  |                     |           |           |                  |                  |                     |                     | 

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|        |                         
|------- | ------------------------
|Item 6. | Selected Financial Data.



|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |        |        |  |   |        |        | 
|------------------------------------------------------- | --------------------------------------- | ---------------------------------------- | ------ | ------ | ------- | - | ------ | ------- |  | - | ------- | ------ |  | ------- | ------ | ------ |  | - | ------ | ------ | 
|                                                        |                                         | Fiscal Years Ended August 31,            |       
|                                                        |                                         |                                          |       
|                                                        |                                         | 2005(a)                                  |        |        | 2004(b) |   |        | 2003(c) |  |   | 2002(d) |        |  | 2001(e) |       
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|                                                        |                                         | (In thousands, except per share amounts) |       
|Net sales                                               |                                         | $                                        | 56,631 |        |         | $ | 43,320 |         |  | $ | 38,440  |        |  | $       | 28,532 |        |  | $ | 44,832 |       
|Cost of sales                                           |                                         |                                          | 45,047 |        |         |   | 39,197 |         |  |   | 31,327  |        |  |         | 23,375 |        |  |   | 36,841 |       
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Gross profit                                            |                                         |                                          | 11,584 |        |         |   | 4,123  |         |  |   | 7,113   |        |  |         | 5,157  |        |  |   | 7,991  |       
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Operating expenses:                                     |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |        |        |  |   |        |       
|                                                        | Selling, general and administrative     |                                          |        | 8,383  |         |   |        | 8,113   |  |   |         | 7,639  |  |         |        | 5,335  |  |   |        | 5,806  | 
|                                                        | Research, development and engineering   |                                          |        | 3,264  |         |   |        | 3,165   |  |   |         | 2,580  |  |         |        | 2,516  |  |   |        | 2,433  | 
|                                                        | Unusual charges (gains)                 |                                          |        | (300   | )       |   |        | 1,359   |  |   |         | 331    |  |         |        |       |  |   |        | 1,693  | 
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Operating income (loss)                                 |                                         |                                          | 237    |        |         |   | (8,514 | )       |  |   | (3,437  | )      |  |         | (2,694 | )      |  |   | (1,941 | )     
|Other income (expense), net                             |                                         |                                          | 118    |        |         |   | 1,505  |         |  |   | (1,213  | )      |  |         | (106   | )      |  |   | (2,182 | )     
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Income (loss) before income taxes                       |                                         |                                          | 355    |        |         |   | (7,009 | )       |  |   | (4,650  | )      |  |         | (2,800 | )      |  |   | (4,123 | )     
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Income tax expense (benefit)                            |                                         |                                          |       |        |         |   |       |         |  |   | (21     | )      |  |         | 1,092  |        |  |   | (930   | )     
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Net income (loss)                                       |                                         |                                          | 355    |        |         |   | (7,009 | )       |  |   | (4,629  | )      |  |         | (3,892 | )      |  |   | (3,193 | )     
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Deemed dividend on preferred stock                      |                                         |                                          | 1,072  |        |         |   |       |         |  |   |        |        |  |         |       |        |  |   |       |       
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Net loss attributable to common stock holders           |                                         | $                                        | (717   | )      |         | $ | (7,009 | )       |  | $ | (4,629  | )      |  | $       | (3,892 | )      |  | $ | (3,193 | )     
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Net income (loss) per common share  Basic and Diluted: |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |        |        |  |   |        |       
|Net income (loss)                                       |                                         | $                                        | 0.04   |        |         | $ | (0.90  | )       |  | $ | (0.70   | )      |  | $       | (0.65  | )      |  | $ | (0.65  | )     
|Deemed dividend on preferred stock                      |                                         |                                          | (0.13  | )      |         |   |       |         |  |   |        |        |  |         |       |        |  |   |       |       
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Net loss attributable to common stockholders            |                                         | $                                        | (0.09  | )      |         | $ | (0.90  | )       |  | $ | (0.70   | )      |  | $       | (0.65  | )      |  | $ | (0.65  | )     
|                                                        |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |       
|Weighted average common shares outstanding:             |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |        |        |  |   |        |       
|                                                        | Basic                                   |                                          |        | 8,382  |         |   |        | 7,745   |  |   |         | 6,629  |  |         |        | 5,992  |  |   |        | 4,881  | 
|                                                        | Diluted                                 |                                          |        | 8,958  |         |   |        | 7,745   |  |   |         | 6,629  |  |         |        | 5,992  |  |   |        | 4,881  | 
|Balance sheet as of year end:                           |                                         |                                          |        |        |         |   |        |         |  |   |         |        |  |         |        |        |  |   |        |       
|                                                        | Working capital                         |                                          | $      | 8,964  |         |   | $      | 3,414   |  |   | $       | 5,728  |  |         | $      | 4,369  |  |   | $      | 8,793  | 
|                                                        | Total assets                            |                                          |        | 27,677 |         |   |        | 25,112  |  |   |         | 26,503 |  |         |        | 22,989 |  |   |        | 27,528 | 
|                                                        | Long-term debt, less current maturities |                                          |        | 1,813  |         |   |        | 1,833   |  |   |         | 2,555  |  |         |        | 1,473  |  |   |        | 3,972  | 
|                                                        | Shareholders equity                    |                                          |        | 13,796 |         |   |        | 9,957   |  |   |         | 13,191 |  |         |        | 14,570 |  |   |        | 18,420 | 






|    |                                                                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Fiscal 2005 includes an unusual gain of $300 from the settlement
    of an outstanding claim against the seller of the AMO operations
    that we acquired in January 2003.



|    |  |                                                                                                                                                                                                                                                                                                                                                                                            
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(b) |  | Fiscal 2004 unusual charges consisted of $894 in outside legal
    and accounting costs in connection with our litigation against,
    and other issues involving, Mr. Fant and $465 of an asset
    impairment. Other income included $1,361 of judgment recovery
    against Mr. Fant and a $472 gain recognized in connection
    with the prepayment of a subordinated promissory note.

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|    |  |                                                                                                                                                                                                                                                                                                                                                                      
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(c) |  | Fiscal 2003 unusual charges consisted of an impaired asset
    write-down of $331. Other expense included costs related to the
    non-cash write off of bank fees of $181 related to the
    terminated revolving line of credit with LaSalle Business
    Credit, LLC and a reserve of $841 for Mr. Fants
    promissory note and other amounts due from Mr. Fant.
|   
|(d) |  | Income tax expense reflects the establishment of a $3,420
    valuation allowance of which $3,188 was included in income tax
    expense.                                                                                                                                                                                                                            
|   
|(e) |  | Fiscal 2001 unusual charges consisted of costs related to the
    closure of the Mexico product line of $425 and a $1,268 loss on
    the write-off of accounts receivable primarily related to
    customers of the Mexico product line and other expense included
    the write-off of the investment in MSC.                                                      






|        |                                                                                           
|------- | ------------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations.









OVERVIEW




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CRITICAL ACCOUNTING POLICIES




Revenue recognition, sales returns and warranty








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Allowance for Uncollectible Accounts




Inventories






| |                  
| | -----------------
| | Long-lived Assets





| |   |                                                                                               
| | - | ----------------------------------------------------------------------------------------------
| |  | Significant underperformance relative to historical or projected
    future operating results;
|
| |  | Significant changes in the manner of use of our assets or our
    overall business strategy;  
|
| |  | Significant negative market or economic trends; and                                           

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| |   |                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------
| |  | Significant decline in our stock price for a sustained period
    changing our market capitalization relative to our net book
    value.





| |                            
| | ---------------------------
| | Valuation of Deferred Taxes







| |                    
| | -------------------
| | Purchase Accounting



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RESULTS OF OPERATIONS


Percentage of Net Sales


|                                      |  |                   |     |    |      |  |     |      |  |  |     |  
|------------------------------------- |  | ----------------- | --- | -- | ---- |  | --- | ---- |  |  | --- | -
|                                      |  | Fiscal Year Ended |    
|                                      |  | August 31,        |    
|                                      |  |                   |    
|                                      |  | 2005              |     |    | 2004 |  |     | 2003 | 
|                                      |  |                   |     |    |      |  |     |      | 
|Net Sales                             |  |                   | 100 | %  |      |  | 100 | %    |  |  | 100 | %
|Cost of Sales                         |  |                   | 80  | %  |      |  | 90  | %    |  |  | 81  | %
|                                      |  |                   |     |    |      |  |     |      | 
|Gross profit                          |  |                   | 20  | %  |      |  | 10  | %    |  |  | 19  | %
|Selling, general and administrative   |  |                   | 15  | %  |      |  | 19  | %    |  |  | 20  | %
|Research, development and engineering |  |                   | 6   | %  |      |  | 7   | %    |  |  | 7   | %
|Other                                 |  |                   | (1  | )% |      |  | 2   | %    |  |  | 4   | %



|                 |  |                   |    |   |      |  |    |      |  |  |    |  
|---------------- |  | ----------------- | -- | - | ---- |  | -- | ---- |  |  | -- | -
|                 |  | Fiscal Year Ended |   
|                 |  | August 31,        |   
|                 |  |                   |   
|Market           |  | 2005              |    |   | 2004 |  |    | 2003 | 
|                 |  |                   |    |   |      |  |    |      | 
|Medical/ Hearing |  |                   | 81 | % |      |  | 84 | %    |  |  | 82 | %
|Communications   |  |                   | 10 | % |      |  | 6  | %    |  |  | 6  | %
|Industrial       |  |                   | 9  | % |      |  | 10 | %    |  |  | 12 | %

Net Sales










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Gross Profit








Operating Expenses




| |                                    
| | -----------------------------------
| | Selling, general and administrative



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| |                                                
| | -----------------------------------------------
| | Research, development, and engineering expenses





| |                   
| | ------------------
| | Gain on Settlement





| |                
| | ---------------
| | Unusual Charges



Other Income (Expense), Net




Income Tax Expense (Benefit)




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Deemed Dividend on Preferred Stock




FINANCIAL CONDITION










29



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TERM-DEBT


Long-term debt








30



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Short-term debt




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FISCAL 2005 LIQUIDITY
















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Contractual Obligations




|                              |  |                        |        |           |        |   |       |       |  |     |       |  |        |      |       |  |  |   |        | 
|----------------------------- |  | ---------------------- | ------ | --------- | ------ | - | ----- | ----- |  | --- | ----- |  | ------ | ---- | ----- |  |  | - | ------ | 
|                              |  | Payments Due by Period |       
|                              |  |                        |       
|                              |  |                        |        | More      |       
|                              |  |                        |        | Less Than |        |   | 1-3   |       |  | 3-5 |       |  | Than 5 |     
|                              |  | Total                  |        |           | 1 Year |   |       | Years |  |     | Years |  |        | Year |      
|                              |  |                        |        |           |        |   |       |       |  |     |       |  |        |      |      
|Long-term debt obligations    |  | $                      | 2,245  |           |        | $ | 469   |       |  | $   | 708   |  |        | $    | 1,068 |  |  | $ |       | 
|Capital lease obligations     |  |                        | 594    |           |        |   | 214   |       |  |     | 380   |  |        |      |       |  |  |   |        | 
|Operating lease obligations   |  |                        | 24,903 |           |        |   | 1,770 |       |  |     | 4,830 |  |        |      | 1,676 |  |  |   | 16,627 | 
|                              |  |                        |        |           |        |   |       |       |  |     |       |  |        |      |      
|Total contractual obligations |  | $                      | 27,742 |           |        | $ | 2,453 |       |  | $   | 5,918 |  |        |      | 2,744 |  |  | $ | 16,627 | 
|                              |  |                        |        |           |        |   |       |       |  |     |       |  |        |      |      

New Accounting Pronouncements










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|         |                                                                
|-------- | ---------------------------------------------------------------
|Item 7A. | Qualitative and Quantitative Disclosures About Market
    Risk.

Market Risk




Interest Rate Risk








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|        |                                             
|------- | --------------------------------------------
|Item 8. | Financial Statements and Supplementary Data.



|                                                           |  |          |       | 
|---------------------------------------------------------- |  | -------- | ----- | 
|                                                           |  | Page No. |      
|                                                           |  |          |      
|Consolidated Balance Sheets                                |  |          | 36    | 
|Consolidated Statements of Operations                      |  |          | 37    | 
|Consolidated Statements of Changes in Shareholders Equity |  |          | 38    | 
|Consolidated Statements of Cash Flows                      |  |          | 39    | 
|Notes to Consolidated Financial Statements                 |  |          | 41-63 | 
|Report of Independent Registered Public Accounting Firm    |  |          | 64    | 
|Report of Independent Registered Public Accounting Firm    |  |          | 65    | 

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HEI, INC.


CONSOLIDATED BALANCE SHEETS


|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |   |        |         |  
|-------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | ------ | ------- | ---------- | - | ------ | ------- | -
|                                                                                       |                                                                                                                                                                                                             | August 31,                  |        |         | August 31, |  
|                                                                                       |                                                                                                                                                                                                             | 2005                        |        |         | 2004       |  
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|                                                                                       |                                                                                                                                                                                                             | (In thousands, except share |       
|                                                                                       |                                                                                                                                                                                                             | and per share data)         |       
|ASSETS                                                                                
|Current assets:                                                                        |                                                                                                                                                                                                             |                             |        |         |            |   |        |        
|                                                                                       | Cash and cash equivalents                                                                                                                                                                                   |                             | $      | 351     |            |   | $      | 200     |  
|                                                                                       | Restricted cash                                                                                                                                                                                             |                             |        |        |            |   |        | 481     |  
|                                                                                       | Accounts receivable, net of allowance for doubtful accounts of
    $157 and $121, respectively                                                                                                              |                             |        | 9,278   |            |   |        | 6,770   |  
|                                                                                       | Inventories                                                                                                                                                                                                 |                             |        | 8,044   |            |   |        | 6,787   |  
|                                                                                       | Security deposit                                                                                                                                                                                            |                             |        | 1,350   |            |   |        |        |  
|                                                                                       | Other current assets                                                                                                                                                                                        |                             |        | 1,136   |            |   |        | 1,221   |  
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Total current assets                                                                   |                                                                                                                                                                                                             |                             | 20,159 |         |            |   | 15,459 |        
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Property and equipment:                                                                |                                                                                                                                                                                                             |                             |        |         |            |   |        |        
|                                                                                       | Land                                                                                                                                                                                                        |                             |        | 216     |            |   |        | 216     |  
|                                                                                       | Building and improvements                                                                                                                                                                                   |                             |        | 4,323   |            |   |        | 4,323   |  
|                                                                                       | Fixtures and equipment                                                                                                                                                                                      |                             |        | 23,214  |            |   |        | 21,432  |  
|                                                                                       | Accumulated depreciation                                                                                                                                                                                    |                             |        | (20,864 | )          |   |        | (18,580 | )
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Net property and equipment                                                             |                                                                                                                                                                                                             |                             | 6,889  |         |            |   | 7,391  |        
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Developed technology, less accumulated amortization of $352 and
    $231, respectively |                                                                                                                                                                                                             |                             | 62     |         |            |   | 185    |        
|Security deposit                                                                       |                                                                                                                                                                                                             |                             | 230    |         |            |   | 1,580  |        
|Other long-term assets                                                                 |                                                                                                                                                                                                             |                             | 337    |         |            |   | 497    |        
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Total assets                                                                           |                                                                                                                                                                                                             | $                           | 27,677 |         |            | $ | 25,112 |        
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|                                                                                      
|LIABILITIES AND SHAREHOLDERS EQUITY                                                  
|Current liabilities:                                                                   |                                                                                                                                                                                                             |                             |        |         |            |   |        |        
|                                                                                       | Line of credit                                                                                                                                                                                              |                             | $      | 2,563   |            |   | $      | 1,310   |  
|                                                                                       | Current maturities of long-term debt                                                                                                                                                                        |                             |        | 484     |            |   |        | 403     |  
|                                                                                       | Accounts payable                                                                                                                                                                                            |                             |        | 4,019   |            |   |        | 5,663   |  
|                                                                                       | Accrued liabilities                                                                                                                                                                                         |                             |        | 4,129   |            |   |        | 4,669   |  
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Total current liabilities                                                              |                                                                                                                                                                                                             |                             | 11,195 |         |            |   | 12,045 |        
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|                                                                                       | Other long-term liabilities, less current maturities                                                                                                                                                        |                             |        | 873     |            |   |        | 1,277   |  
|                                                                                       | Long-term debt, less current maturities                                                                                                                                                                     |                             |        | 1,813   |            |   |        | 1,833   |  
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Total other long-term liabilities, less current maturities                             |                                                                                                                                                                                                             |                             | 2,686  |         |            |   | 3,110  |        
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Total liabilities                                                                      |                                                                                                                                                                                                             |                             | 13,881 |         |            |   | 15,155 |        
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Commitments and contingencies                                                          |                                                                                                                                                                                                             |                             |        |         |            |   |        |        
|Shareholders equity:                                                                  |                                                                                                                                                                                                             |                             |        |         |            |   |        |        
|                                                                                       | Undesignated stock; 1,833,000 and 4,000,000 shares
    authorized; none issued                                                                                                                              |                             |        |        |            |   |        |        |  
|                                                                                       | Convertible preferred stock, $.05 par; 167,000 and 0 shares
    authorized; 32,000 and 0 shares issued and outstanding;
    liquidation preference at $26 per share (total liquidation
    preference $832) |                             |        | 2       |            |   |        |        |  
|                                                                                       | Common stock, $.05 par; 13,000,000 and 11,000,000 shares
    authorized; 9,379,000 and 8,357,000 shares issued and
    outstanding                                                                          |                             |        | 469     |            |   |        | 418     |  
|                                                                                       | Paid-in capital                                                                                                                                                                                             |                             |        | 26,701  |            |   |        | 22,426  |  
|                                                                                       | Accumulated deficit                                                                                                                                                                                         |                             |        | (13,169 | )          |   |        | (12,452 | )
|                                                                                       | Notes receivable-related parties-officers and former directors                                                                                                                                              |                             |        | (207    | )          |   |        | (435    | )
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Total shareholders equity                                                             |                                                                                                                                                                                                             |                             | 13,796 |         |            |   | 9,957  |        
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  
|Total liabilities and shareholders equity                                             |                                                                                                                                                                                                             | $                           | 27,677 |         |            | $ | 25,112 |        
|                                                                                       |                                                                                                                                                                                                             |                             |        |         |            |  



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HEI, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


|                                           |                                                     |                             |        |           |      |   |        |           |   |   |        |           |  
|------------------------------------------ | --------------------------------------------------- | --------------------------- | ------ | --------- | ---- | - | ------ | --------- | - | - | ------ | --------- | -
|                                           |                                                     | Years Ended August 31,      |       
|                                           |                                                     |                             |       
|                                           |                                                     | 2005                        |        |           | 2004 |   |        | 2003      |  
|                                           |                                                     |                             |        |           |      |   |        |           |  
|                                           |                                                     | (In thousands, except share |       
|                                           |                                                     | and per share data)         |       
|Net sales                                  |                                                     | $                           | 56,631 |           |      | $ | 43,320 |           |   | $ | 38,440 |          
|Cost of sales                              |                                                     |                             | 45,047 |           |      |   | 39,197 |           |   |   | 31,327 |          
|                                           |                                                     |                             |        |           |      |   |        |           |  
|                                           | Gross profit                                        |                             |        | 11,584    |      |   |        | 4,123     |   |   |        | 7,113     |  
|                                           |                                                     |                             |        |           |      |   |        |           |  
|Operating expenses:                        |                                                     |                             |        |           |      |   |        |           |   |   |        |          
|                                           | Selling, general and administrative                 |                             |        | 8,383     |      |   |        | 8,113     |   |   |        | 7,639     |  
|                                           | Research, development and engineering               |                             |        | 3,264     |      |   |        | 3,165     |   |   |        | 2,580     |  
|                                           | Gain on settlement                                  |                             |        | (300      | )    |   |        |          |   |   |        |          |  
|                                           | Asset impairment charges                            |                             |        |          |      |   |        | 465       |   |   |        | 331       |  
|                                           | Costs related to investigation                      |                             |        |          |      |   |        | 894       |   |   |        |          |  
|                                           |                                                     |                             |        |           |      |   |        |           |  
|Operating income (loss)                    |                                                     |                             | 237    |           |      |   | (8,514 | )         |   |   | (3,437 | )        
|                                           |                                                     |                             |        |           |      |   |        |           |  
|                                           | Former officer note and other receivables write off |                             |        |          |      |   |        |          |   |   |        | (841      | )
|                                           | Bank fees                                           |                             |        |          |      |   |        |          |   |   |        | (181      | )
|                                           | Gain on prepayment of promissory note               |                             |        |          |      |   |        | 472       |   |   |        |          |  
|                                           | Litigation recovery                                 |                             |        | 481       |      |   |        | 1,361     |   |   |        |          |  
|                                           | Interest expense                                    |                             |        | (667      | )    |   |        | (364      | ) |   |        | (328      | )
|                                           | Other income (expense), net                         |                             |        | 304       |      |   |        | 36        |   |   |        | 137       |  
|                                           |                                                     |                             |        |           |      |   |        |           |  
|Income (loss) before income taxes          |                                                     |                             | 355    |           |      |   | (7,009 | )         |   |   | (4,650 | )        
|Income tax expense (benefit)               |                                                     |                             |       |           |      |   |       |           |   |   | (21    | )        
|                                           |                                                     |                             |        |           |      |   |        |           |  
|Net income (loss)                          |                                                     | $                           | 355    |           |      | $ | (7,009 | )         |   | $ | (4,629 | )        
|Deemed dividend on preferred stock         |                                                     |                             | 1,072  |           |      |   |       |           |   |   |       |          
|                                           |                                                     |                             |        |           |      |   |        |           |  
|Loss attributable to common stockholders   |                                                     | $                           | (717   | )         |      | $ | (7,009 | )         |   | $ | (4,629 | )        
|                                           |                                                     |                             |        |           |      |   |        |           |  
|Net income (loss) per common share         |                                                     |                             |        |           |      |   |        |           |   |   |        |          
|                                           | Basic and Diluted:                                  |                             |        |           |      |   |        |           |   |   |        |           |  
|                                           | Net income (loss)                                   |                             | $      | 0.04      |      |   | $      | (0.90     | ) |   | $      | (0.70     | )
|                                           | Deemed dividend on preferred stock                  |                             |        | (0.13     | )    |   |        |          |   |   |        |          |  
|                                           |                                                     |                             |        |           |      |   |        |           |  
|                                           | Net loss attributable to common stockholders        |                             | $      | (0.09     | )    |   | $      | (0.90     | ) |   | $      | (0.70     | )
|                                           |                                                     |                             |        |           |      |   |        |           |  
|Weighted average common shares outstanding |                                                     |                             |        |           |      |   |        |           |   |   |        |          
|                                           | Basic                                               |                             |        | 8,382,000 |      |   |        | 7,745,000 |   |   |        | 6,629,000 |  
|                                           |                                                     |                             |        |           |      |   |        |           |  
|                                           | Diluted                                             |                             |        | 8,958,000 |      |   |        | 7,745,000 |   |   |        | 6,629,000 |  
|                                           |                                                     |                             |        |           |      |   |        |           |  



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HEI, INC.


CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS
EQUITY


|                         |                                                                           |                                   |           |           |        |             |           |              |  |             |           |         |            |         |         |    |             |         |        |            |        |   |          |        |   |   |        |     |  |   |        |        |  
|------------------------ | ------------------------------------------------------------------------- | --------------------------------- | --------- | --------- | ------ | ----------- | --------- | ------------ |  | ----------- | --------- | ------- | ---------- | ------- | ------- | -- | ----------- | ------- | ------ | ---------- | ------ | - | -------- | ------ | - | - | ------ | --- |  | - | ------ | ------ | -
|                         |                                                                           |                                   |           |           |        | Convertible |           |              |  |             |           |         |            |         | Related |    |             | Total   |       
|                         |                                                                           | Common                            |           |           |        |             | Preferred |              |  | Convertible |           |         | Additional |         |         |    |             | Party  |        |            | Share- |  
|                         |                                                                           | Stock Shares                      |           |           | Common |             |           | Stock Shares |  |             | Preferred |         |            | Paid-In |         |    | Accumulated |         |        | Notes      |        |   | Holders |       
|                         |                                                                           | Outstanding                       |           |           | Stock  |             |           | Outstanding  |  |             | Stock     |         |            | Capital |         |    | Deficit     |         |        | Receivable |        |   | Equity   |       
|                         |                                                                           |                                   |           |           |        |             |           |              |  |             |           |         |            |         |         |    |             |         |        |            |        |   |          |       
|                         |                                                                           | (In thousands, except share data) |          
|Balance, August 31, 2002 |                                                                           |                                   | 6,012,000 |           |        | $           | 301       |              |  |             |          |         |            | $       |        |    |             | $       | 16,349 |            |        | $ | (814     | )      |   | $ | (1,266 | )   |  | $ | 14,570 |       
|                         | Net loss                                                                  |                                   |           |          |        |             |           |             |  |             |           |        |            |         |         |   |             |         |        |           |        |   |          | (4,629 | ) |   |        |    |  |   |        | (4,629 | )
|                         | Note receivable write off                                                 |                                   |           |          |        |             |           |             |  |             |           |        |            |         |         |   |             |         |        |           |        |   |          |       |   |   |        | 587 |  |   |        | 587    |  
|                         | Payments on officers loans                                                |                                   |           |          |        |             |           |             |  |             |           |        |            |         |         |   |             |         |        |           |        |   |          |       |   |   |        | 10  |  |   |        | 10     |  
|                         | Issuance of common shares  CMED                                          |                                   |           | 1,000,000 |        |             |           | 50           |  |             |           |        |            |         |         |   |             |         |        | 2,550      |        |   |          |       |   |   |        |    |  |   |        | 2,600  |  
|                         | Issuance of common shares under stock benefit plans and option
    plans  |                                   |           | 34,000    |        |             |           | 1            |  |             |           |        |            |         |         |   |             |         |        | 52         |        |   |          |       |   |   |        |    |  |   |        | 53     |  
|                         |                                                                           |                                   |           |           |        |             |           |              |  |             |           |         |            |         |         |    |             |         |        |            |        |   |          |       
|Balance, August 31, 2003 |                                                                           |                                   | 7,046,000 |           |        |             | 352       |              |  |             |          |         |            |         |        |    |             |         | 18,951 |            |        |   | (5,443   | )      |   |   | (669   | )   |  |   | 13,191 |       
|                         |                                                                           |                                   |           |           |        |             |           |              |  |             |           |         |            |         |         |    |             |         |        |            |        |   |          |       
|                         | Net loss                                                                  |                                   |           |          |        |             |           |             |  |             |           |        |            |         |         |   |             |         |        |           |        |   |          | (7,009 | ) |   |        |    |  |   |        | (7,009 | )
|                         | Note receivable write off                                                 |                                   |           |          |        |             |           |             |  |             |           |        |            |         |         |   |             |         |        |           |        |   |          |       |   |   |        | 64  |  |   |        | 64     |  
|                         | Payments on officers loans                                                |                                   |           |          |        |             |           |             |  |             |           |        |            |         |         |   |             |         |        |           |        |   |          |       |   |   |        | 170 |  |   |        | 170    |  
|                         | Issuance of common shares in lieu of interest 
    Whitebox              |                                   |           | 48,000    |        |             |           | 3            |  |             |           |        |            |         |         |   |             |         |        | 164        |        |   |          |       |   |   |        |    |  |   |        | 167    |  
|                         | Private equity placement                                                  |                                   |           | 1,180,000 |        |             |           | 59           |  |             |           |        |            |         |         |   |             |         |        | 3,180      |        |   |          |       |   |   |        |    |  |   |        | 3,239  |  
|                         | Issuance of common shares under stock benefit plans and option
    plans  |                                   |           | 83,000    |        |             |           | 4            |  |             |           |        |            |         |         |   |             |         |        | 131        |        |   |          |       |   |   |        |    |  |   |        | 135    |  
|                         |                                                                           |                                   |           |           |        |             |           |              |  |             |           |         |            |         |         |    |             |         |        |            |        |   |          |       
|Balance, August 31, 2004 |                                                                           |                                   | 8,357,000 |           |        |             | 418       |              |  |             |          |         |            |         |        |    |             |         | 22,426 |            |        |   | (12,452  | )      |   |   | (435   | )   |  |   | 9,957  |       
|                         |                                                                           |                                   |           |           |        |             |           |              |  |             |           |         |            |         |         |    |             |         |        |            |        |   |          |       
|                         | Net income                                                                |                                   |           |          |        |             |           |             |  |             |           |        |            |         |         |   |             |         |        |           |        |   |          | 355    |   |   |        |    |  |   |        | 355    |  
|                         | Payments on officers loans                                                |                                   |           |          |        |             |           |             |  |             |           |        |            |         |         |   |             |         |        |           |        |   |          |       |   |   |        | 228 |  |   |        | 228    |  
|                         | Issuance of Convertible Preferred Stock and warrants, net of
    expenses |                                   |           |          |        |             |           |             |  |             |           | 130,538 |            |         |         | 7  |             |         |        | 3,155      |        |   |          |       |   |   |        |    |  |   |        | 3,162  |  
|                         | Conversion of Convertible Preferred Stock into common stock               |                                   |           | 985,000   |        |             |           | 49           |  |             |           | (98,538 | )          |         |         | (5 | )           |         |        | (44        | )      |   |          |       |   |   |        |    |  |   |        |       |  
|                         | Issuance of common shares under stock benefit plans and option
    plans  |                                   |           | 37,000    |        |             |           | 2            |  |             |           |        |            |         |         |   |             |         |        | 92         |        |   |          |       |   |   |        |    |  |   |        | 94     |  
|                         | Deemed dividend on preferred stock                                        |                                   |           |          |        |             |           |             |  |             |           |        |            |         |         |   |             |         |        | 1,072      |        |   |          | (1,072 | ) |   |        |    |  |   |        |       |  
|                         |                                                                           |                                   |           |           |        |             |           |              |  |             |           |         |            |         |         |    |             |         |        |            |        |   |          |       
|Balance, August 31, 2005 |                                                                           |                                   | 9,379,000 |           |        | $           | 469       |              |  |             | 32,000    |         |            | $       | 2       |    |             | $       | 26,701 |            |        | $ | (13,169  | )      |   | $ | (207   | )   |  | $ | 13,796 |       
|                         |                                                                           |                                   |           |           |        |             |           |              |  |             |           |         |            |         |         |    |             |         |        |            |        |   |          |       



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HEI, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                                                                |                                                                                         |                        |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------- | ---------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                |                                                                                         | Years Ended August 31, |  
|                                                                                |                                                                                         |                        |  
|                                                                                |                                                                                         | 2005                   |   |        | 2004 |  |   | 2003   |  
|                                                                                |                                                                                         |                        |   |        |      |  |   |        |  
|                                                                                |                                                                                         | (In thousands)         |  
|Cash flow from operating activities:                                            |                                                                                         |                        |   |        |      |  |   |        |   |  |   |       
|                                                                                | Net income (loss)                                                                       |                        | $ | 355    |      |  | $ | (7,009 | ) |  | $ | (4,629 | )
|                                                                                | Depreciation and amortization                                                           |                        |   | 2,454  |      |  |   | 2,862  |   |  |   | 3,295  |  
|                                                                                | Accounts receivable allowance                                                           |                        |   | 36     |      |  |   | 29     |   |  |   | 7      |  
|                                                                                | Reserve for note receivable from former officers                                        |                        |   |       |      |  |   | 64     |   |  |   | 597    |  
|                                                                                | Asset impairment charges                                                                |                        |   |       |      |  |   | 465    |   |  |   | 331    |  
|                                                                                | Gain on prepayment of promissory note                                                   |                        |   |       |      |  |   | (472   | ) |  |   |       |  
|                                                                                | Gain (loss) on disposal of property and equipment and other                             |                        |   | (130   | )    |  |   |       |   |  |   | 69     |  
|Changes in operating assets and liabilities, net of impacts of
    acquisition: |                                                                                         |                        |   |        |      |  |   |        |   |  |   |       
|                                                                                | Restricted cash related to deferred litigation recovery                                 |                        |   | 481    |      |  |   | (481   | ) |  |   |       |  
|                                                                                | Accounts receivable                                                                     |                        |   | (2,544 | )    |  |   | (485   | ) |  |   | (2,488 | )
|                                                                                | Inventories                                                                             |                        |   | (1,257 | )    |  |   | 77     |   |  |   | 581    |  
|                                                                                | Other current assets                                                                    |                        |   | 85     |      |  |   | (836   | ) |  |   | (81    | )
|                                                                                | Other long-term assets                                                                  |                        |   | 152    |      |  |   |       |   |  |   |       |  
|                                                                                | Accounts payable                                                                        |                        |   | (1,644 | )    |  |   | 1,712  |   |  |   | 2,136  |  
|                                                                                | Accrued liabilities                                                                     |                        |   | (944   | )    |  |   | 137    |   |  |   | 504    |  
|                                                                                |                                                                                         |                        |   |        |      |  |   |        |  
|                                                                                | Net cash flow provided by (used in) operating activities                                |                        |   | (2,956 | )    |  |   | (3,937 | ) |  |   | 322    |  
|                                                                                |                                                                                         |                        |   |        |      |  |   |        |  
|Cash flow from investing activities:                                            |                                                                                         |                        |   |        |      |  |   |        |   |  |   |       
|                                                                                | Additions to property and equipment                                                     |                        |   | (1,314 | )    |  |   | (743   | ) |  |   | (442   | )
|                                                                                | Proceeds from the sale of assets                                                        |                        |   | 155    |      |  |   | 25     |   |  |   |       |  
|                                                                                | Additions to patents                                                                    |                        |   | (90    | )    |  |   | (84    | ) |  |   | (138   | )
|                                                                                | AMO acquisition costs paid                                                              |                        |   |       |      |  |   |       |   |  |   | (1,486 | )
|                                                                                | Cash acquired from CMED                                                                 |                        |   |       |      |  |   |       |   |  |   | 1,215  |  
|                                                                                | Proceeds from the sale of technology                                                    |                        |   |       |      |  |   | 323    |   |  |   |       |  
|                                                                                | Other long-term assets                                                                  |                        |   |       |      |  |   |       |   |  |   | 217    |  
|                                                                                |                                                                                         |                        |   |        |      |  |   |        |  
|                                                                                | Net cash flow used in investing activities                                              |                        |   | (1,249 | )    |  |   | (479   | ) |  |   | (634   | )
|                                                                                |                                                                                         |                        |   |        |      |  |   |        |  
|Cash flow from financing activities:                                            |                                                                                         |                        |   |        |      |  |   |        |   |  |   |       
|                                                                                | Issuance of common stock under stock plans                                              |                        |   | 94     |      |  |   | 135    |   |  |   | 53     |  
|                                                                                | Proceeds from private placement                                                         |                        |   |       |      |  |   | 3,239  |   |  |   |       |  
|                                                                                | Proceeds from issuance of convertible preferred stock and
    warrants, net of expenses |                        |   | 3,162  |      |  |   |       |   |  |   |       |  
|                                                                                | Officer note repayment                                                                  |                        |   | 228    |      |  |   | 170    |   |  |   |       |  
|                                                                                | Proceeds from long-term debt                                                            |                        |   |       |      |  |   | 2,282  |   |  |   | 2,804  |  
|                                                                                | Repayments of long-term debt                                                            |                        |   | (381   | )    |  |   | (2,788 | ) |  |   | (3,906 | )
|                                                                                | Deferred financing fees                                                                 |                        |   |       |      |  |   | (48    | ) |  |   | (106   | )
|                                                                                | Decrease (increase) in restricted cash                                                  |                        |   |       |      |  |   |       |   |  |   | 1,000  |  
|                                                                                | Net borrowings on (repayments of) line of credit                                        |                        |   | 1,253  |      |  |   | 820    |   |  |   | (1,099 | )
|                                                                                |                                                                                         |                        |   |        |      |  |   |        |  

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|                                                         |  |                        |       |  |      |   |       |      |  |   |        |  
|-------------------------------------------------------- |  | ---------------------- | ----- |  | ---- | - | ----- | ---- |  | - | ------ | -
|                                                         |  | Years Ended August 31, |      
|                                                         |  |                        |      
|                                                         |  | 2005                   |       |  | 2004 |   |       | 2003 | 
|                                                         |  |                        |       |  |      |   |       |      | 
|                                                         |  | (In thousands)         |      
|Net cash flow provided by (used in) financing activities |  |                        | 4,356 |  |      |   | 3,810 |      |  |   | (1,254 | )
|                                                         |  |                        |       |  |      |   |       |      | 
|Net increase (decrease) in cash and cash equivalents     |  |                        | 151   |  |      |   | (606  | )    |  |   | (1,566 | )
|Cash and cash equivalents, beginning of year             |  |                        | 200   |  |      |   | 806   |      |  |   | 2,372  |  
|                                                         |  |                        |       |  |      |   |       |      | 
|Cash and cash equivalents, end of year                   |  | $                      | 351   |  |      | $ | 200   |      |  | $ | 806    |  
|                                                         |  |                        |       |  |      |   |       |      | 
|Supplemental disclosures of cash flow information:       |  |                        |       |  |      |   |       |      |  |   |        |  
|Interest paid                                            |  | $                      | 645   |  |      | $ | 364   |      |  | $ | 328    |  
|Income taxes paid (received)                             |  |                        |      |  |      |   | 6     |      |  |   | (21    | )
|                                                         |  |                        |       |  |      |   |       |      | 

Supplemental disclosures of non-cash financing and
investing activities:










40



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Amounts in thousands except share and per share data)


Note 1




| |         
| | --------
| | Overview





| |                                           
| | ------------------------------------------
| | Summary of Significant Accounting Policies

Principles of Consolidation.


Revenue Recognition.




Cash Equivalents.


Accounts Receivable.


41



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##### Table of Contents



HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Inventories.


Property and Equipment.




Intangible Assets.


Patents.


Impairment of Notes Receivable.


Impairment of Long-lived and Intangible Assets.


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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |   |                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Significant underperformance relative to historical or projected
    future operating results;                                                              
|
| |  | Significant changes in the manner of use of the acquired assets
    or the Companys overall business strategy;                                             
|
| |  | Significant negative market or economic trends; and                                                                                                         
|
| |  | Significant decline in the Companys stock price for a
    sustained period changing the Companys market
    capitalization relative to its net book value;



Research, Development and Engineering.


Shipping and Handling.


Advertising.


Income Taxes.


Stock-based Compensation.


43



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                                                                                                      |  |                               |        |   |      |   |        |      |  |   |        |  
|--------------------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                                                      |  | Fiscal Years Ended August 31, |       
|                                                                                                                      |  |                               |       
|                                                                                                                      |  | 2005                          |        |   | 2004 |   |        | 2003 | 
|                                                                                                                      |  |                               |        |   |      |   |        |      | 
|Loss attributable to common stockholders as reported                                                                  |  | $                             | (717   | ) |      | $ | (7,009 | )    |  | $ | (4,629 | )
|Add: Stock-based employee compensation included in reported net
    loss, net of related tax effects                  |  |                               |       |   |      |   |       |      |  |   |       |  
|Deduct: Total stock-based employee compensation (expense
    determined under fair value based method for all awards) |  |                               | (2,974 | ) |      |   | (1,940 | )    |  |   | (2,170 | )
|                                                                                                                      |  |                               |        |   |      |   |        |      | 
|Loss attributable to common stockholders pro forma                                                                    |  | $                             | (3,691 | ) |      | $ | (8,949 | )    |  | $ | (6,799 | )
|                                                                                                                      |  |                               |        |   |      |   |        |      | 
|Basic and diluted loss attributable to common stockholders per
    share as reported                                  |  | $                             | (0.09  | ) |      | $ | (0.90  | )    |  | $ | (0.70  | )
|Stock-based compensation expense                                                                                      |  |                               | (0.35  | ) |      |   | (0.26  | )    |  |   | (0.33  | )
|                                                                                                                      |  |                               |        |   |      |   |        |      | 
|Basic and diluted loss attributable to common stockholders per
    share pro forma                                    |  | $                             | (0.44  | ) |      | $ | (1.16  | )    |  | $ | (1.03  | )
|                                                                                                                      |  |                               |        |   |      |   |        |      | 



Customer Deposits.


Net Income (Loss) Per Common Share.


Use of Estimates.


Financial Instruments.


Reclassifications.


Recent Accounting Pronouncements.


44



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)










Note 2




| |          
| | ---------
| | Liquidity





45



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)














46



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 3




| |                               
| | ------------------------------
| | Other Financial Statement Data



|                                  |                                                              |           |       |       |      |   |       |       | 
|--------------------------------- | ------------------------------------------------------------ | --------- | ----- | ----- | ---- | - | ----- | ----- | 
|                                  |                                                              | August 31 |      
|                                  |                                                              |           |      
|                                  |                                                              | 2005      |       |       | 2004 |  
|                                  |                                                              |           |       |       |      |  
|Inventories:                      |                                                              |           |       |       |      |   |       |      
|                                  | Purchased parts                                              |           | $     | 5,881 |      |   | $     | 4,673 | 
|                                  | Work in process                                              |           |       | 590   |      |   |       | 789   | 
|                                  | Finished goods                                               |           |       | 1,573 |      |   |       | 1,325 | 
|                                  |                                                              |           |       |       |      |  
|                                  |                                                              | $         | 8,044 |       |      | $ | 6,787 |      
|                                  |                                                              |           |       |       |      |  
|Accrued liabilities:              |                                                              |           |       |       |      |   |       |      
|                                  | Employee related costs                                       |           | $     | 1,786 |      |   | $     | 1,474 | 
|                                  | Deferred revenue                                             |           |       | 440   |      |   |       | 804   | 
|                                  | Real estate taxes                                            |           |       | 130   |      |   |       |      | 
|                                  | Customers deposits                                           |           |       | 589   |      |   |       | 418   | 
|                                  | Current maturities of long-term liabilities                  |           |       | 247   |      |   |       | 805   | 
|                                  | Warranty reserve                                             |           |       | 132   |      |   |       | 139   | 
|                                  | Other accrued liabilities                                    |           |       | 805   |      |   |       | 1,029 | 
|                                  |                                                              |           |       |       |      |  
|                                  |                                                              | $         | 4,129 |       |      | $ | 4,669 |      
|                                  |                                                              |           |       |       |      |  
|Other long-term liabilities:      |                                                              |           |       |       |      |   |       |      
|                                  | Remaining lease obligation, less estimated sublease proceeds |           | $     | 552   |      |   | $     | 1,471 | 
|                                  | Unfavorable operating lease, net                             |           |       | 568   |      |   |       | 611   | 
|                                  |                                                              |           |       |       |      |  
|Total                             |                                                              |           | 1,120 |       |      |   | 2,082 |      
|Less current maturities           |                                                              |           | 247   |       |      |   | 805   |      
|                                  |                                                              |           |       |       |      |  
|Total other long-term liabilities |                                                              | $         | 873   |       |      | $ | 1,277 |      
|                                  |                                                              |           |       |       |      |  

Note 4




| |                     
| | --------------------
| | Warranty Obligations



47



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|            |  |                   |     |  |            |   |     |        |            |   |             |  |  |   |     | 
|----------- |  | ----------------- | --- |  | ---------- | - | --- | ------ | ---------- | - | ----------- |  |  | - | --- | 
|            |  | Balance at        |     |  |            |   |     |        | Balance at |  
|            |  | Beginning of Year |     |  | Provisions |   |     | Claims |            |   | End of Year | 
|            |  |                   |     |  |            |   |     |        |            |   |             | 
|Fiscal 2005 |  | $                 | 139 |  |            | $ | 125 |        |            | $ | 132         |  |  | $ | 132 | 
|Fiscal 2004 |  |                   | 122 |  |            |   | 133 |        |            |   | 116         |  |  |   | 139 | 
|Fiscal 2003 |  |                   | 200 |  |            |   | 168 |        |            |   | 246         |  |  |   | 122 | 

Note 5




| |                         
| | ------------------------
| | Asset Impairment Charges



Note 6




| |            
| | -----------
| | Acquisition





48



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                           |                                      |        |       |        |  
|-------------------------- | ------------------------------------ | ------ | ----- | ------ | -
|                           |                                      | Amount |      
|                           |                                      |        |      
|Purchase price allocation: |                                      |        |       |       
|                           | Cash                                 |        | $     | 1,215  |  
|                           | Accounts receivable                  |        |       | 300    |  
|                           | Inventories                          |        |       | 3,418  |  
|                           | Property and equipment               |        |       | 1,348  |  
|                           | Prepaids, deposits and other assets  |        |       | 1,690  |  
|                           | Developed technology                 |        |       | 738    |  
|                           | Customer deposits and other reserves |        |       | (1,504 | )
|                           | Operating lease reserves             |        |       | (3,110 | )
|                           | Transaction costs                    |        |       | (1,495 | )
|                           |                                      |        |      
|                           |                                      | $      | 2,600 |       
|                           |                                      |        |      











49



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                   |  |                   |        |  
|------------------ |  | ----------------- | ------ | -
|                   |  | Fiscal Year Ended |       
|                   |  | August 31, 2003   |       
|                   |  |                   |       
|Net sales          |  | $                 | 54,710 |  
|Net loss           |  |                   | (6,096 | )
|                   |  |                   |       
|Net loss per share |  | $                 | (0.31  | )
|                   |  |                   |       





Note 7




| |               
| | --------------
| | Long-Term Debt



|                                                                                                                                                                                                                                           |  |            |       |  |      |   |       | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------- | ----- |  | ---- | - | ----- | 
|                                                                                                                                                                                                                                           |  | August 31, |      
|                                                                                                                                                                                                                                           |  |            |      
|                                                                                                                                                                                                                                           |  | 2005       |       |  | 2004 |  
|                                                                                                                                                                                                                                           |  |            |       |  |      |  
|Commerce Bank mortgage payable in monthly installments of
    principal and interest of $9 based on a twenty-year amortization
    with a final payment of approximately $1,048 due in November
    2009; secured by our Victoria facility |  | $          | 1,145 |  |      | $ | 1,174 | 
|Commerce Financial Group, Inc. equipment loan payable in fixed
    monthly principal and interest installments of $28 through
    September 2007; secured by our Victoria facility and equipment
    located at our Tempe facility         |  |            | 673   |  |      |   | 916   | 
|Capital lease obligation; payable in installments of $1 through
    February 2009; secured with machinery and equipment                                                                                                                    |  |            | 25    |  |      |   | 34    | 
|Commercial loans payable in fixed monthly installments of $1
    through May 2009; secured with certain machinery and equipment                                                                                                            |  |            | 22    |  |      |   | 33    | 
|Commercial loans payable in fixed monthly installments of $12
    through July 2005; secured with certain machinery and equipment                                                                                                          |  |            | 9     |  |      |   | 79    | 
|Capital lease obligations; payable in fixed monthly installments
    of $15 through July 2008; secured with certain machinery and
    equipment                                                                                            |  |            | 423   |  |      |   |      | 
|                                                                                                                                                                                                                                           |  |            |       |  |      |  
|Total                                                                                                                                                                                                                                      |  |            | 2,297 |  |      |   | 2,236 | 
|Less current maturities                                                                                                                                                                                                                    |  |            | 484   |  |      |   | 403   | 
|                                                                                                                                                                                                                                           |  |            |       |  |      |  
|Total long-term debt                                                                                                                                                                                                                       |  | $          | 1,813 |  |      | $ | 1,833 | 
|                                                                                                                                                                                                                                           |  |            |       |  |      |  

50



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)














51



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                               |  |   |       | 
|------------------------------ |  | - | ----- | 
|Fiscal Years Ending August 31, |  |  
|                               |  |  
|2006                           |  | $ | 333   | 
|2007                           |  |   | 343   | 
|2008                           |  |   | 67    | 
|2009                           |  |   | 27    | 
|2010                           |  |   | 1,048 | 
|                               |  |   |      
|Total                          |  | $ | 1,818 | 
|                               |  |   |      



|                                                  |  |   |      |  
|------------------------------------------------- |  | - | ---- | -
|Fiscal Years Ending August 31,                    |  |  
|                                                  |  |  
|2006                                              |  | $ | 214  |  
|2007                                              |  |   | 198  |  
|2008                                              |  |   | 172  |  
|2009                                              |  |   | 10   |  
|                                                  |  |   |     
|Total                                             |  |   | 594  |  
|Less: amount representing interest                |  |   | (115 | )
|                                                  |  |   |     
|Present value of future minimum lease payments    |  |   | 479  |  
|Less: current portion                             |  |   | (151 | )
|                                                  |  |   |     
|Capital lease obligations, net of current portion |  | $ | 328  |  
|                                                  |  |   |     

Note 8




| |               
| | --------------
| | Line of Credit



52



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 9




| |             
| | ------------
| | Income Taxes



|                             |         |                   |   |      |  |      |   |   |  |   |     |     |  
|---------------------------- | ------- | ----------------- | - | ---- |  | ---- | - | - |  | - | --- | --- | -
|                             |         | Fiscal Year Ended |  
|                             |         | August 31,        |  
|                             |         |                   |  
|                             |         | 2005              |   | 2004 |  | 2003 |  
|                             |         |                   |   |      |  |      |  
|                             |         | (In thousands)    |  
|Current:                     |         |                   |   |      |  |      |   |   |  |   |     |    
|                             | Federal |                   | $ |     |  |      | $ |  |  |   | $   | (21 | )
|                             | State   |                   |   |     |  |      |   |  |  |   |     |    |  
|Deferred                     |         |                   |  |      |  |      |  |   |  |   |    |    
|                             |         |                   |   |      |  |      |   |   | 
|Income tax expense (benefit) |         | $                 |  |      |  | $    |  |   |  | $ | (21 | )  
|                             |         |                   |   |      |  |      |   |   | 



|                                                  |  |                   |       |   |      |  |       |      |  |  |       |   
|------------------------------------------------- |  | ----------------- | ----- | - | ---- |  | ----- | ---- |  |  | ----- | --
|                                                  |  | Fiscal Year Ended |      
|                                                  |  | August 31,        |      
|                                                  |  |                   |      
|                                                  |  | 2005              |       |   | 2004 |  |       | 2003 | 
|                                                  |  |                   |       |   |      |  |       |      | 
|Federal statutory tax rate                        |  |                   | 34.0  | % |      |  | (34.0 | )%   |  |  | (34.0 | )%
|State income tax rate (net of federal tax effect) |  |                   |      |   |      |  |      |      |  |  |      |   
|Reversal of reserve for contingencies             |  |                   |      |   |      |  |      |      |  |  |      |   
|Change in valuation allowance                     |  |                   | (34.0 | ) |      |  | 34.0  |      |  |  | 33.0  |   
|Write-off of equity investment                    |  |                   |      |   |      |  |      |      |  |  |      |   
|Other                                             |  |                   |      |   |      |  |      |      |  |  | 1.1   |   
|                                                  |  |                   |       |   |      |  |       |      | 
|Effective tax rate                                |  |                   |      | % |      |  |      | %    |  |  | (0.1  | )%
|                                                  |  |                   |       |   |      |  |       |      | 



|                                 |                                  |                |     |       |      |  |     |       | 
|-------------------------------- | -------------------------------- | -------------- | --- | ----- | ---- |  | --- | ----- | 
|                                 |                                  | August 31      |    
|                                 |                                  |                |    
|                                 |                                  | 2005           |     |       | 2004 | 
|                                 |                                  |                |     |       |      | 
|                                 |                                  | (In thousands) |    
|Deferred tax assets (current):   |                                  |                |     |       |      |  |     |      
|                                 | Receivables                      |                | $   | 59    |      |  | $   | 32    | 
|                                 | Inventories                      |                |     | 365   |      |  |     | 524   | 
|                                 | Accrued liabilities              |                |     | 393   |      |  |     | 258   | 
|                                 |                                  |                |     |       |      | 
|                                 |                                  |                | 817 |       |      |  | 814 |      
|                                 |                                  |                |     |       |      | 
|Deferred tax assets (long-term): |                                  |                |     |       |      |  |     |      
|                                 | Net operating loss carry-forward |                |     | 6,423 |      |  |     | 6,961 | 
|                                 | Capital loss carry-forward       |                |     | 235   |      |  |     | 235   | 
|                                 | Licensing agreement reserve      |                |     | 196   |      |  |     | 196   | 
|                                 | Other                            |                |     | 270   |      |  |     | 293   | 
|                                 |                                  |                |     |       |      | 

53



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                              |  |                |        |   |      |   |        |  
|--------------------------------------------- |  | -------------- | ------ | - | ---- | - | ------ | -
|                                              |  | August 31      |       
|                                              |  |                |       
|                                              |  | 2005           |        |   | 2004 |  
|                                              |  |                |        |   |      |  
|                                              |  | (In thousands) |       
|Gross deferred tax assets (long-term)         |  |                | 7,124  |   |      |   | 7,685  |  
|Less: Deferred tax assets valuation allowance |  |                | (7,195 | ) |      |   | (7,642 | )
|                                              |  |                |        |   |      |  
|Net deferred tax assets (long-term)           |  |                | (71    | ) |      |   | 43     |  
|                                              |  |                |        |   |      |  
|Deferred tax liabilities (long-term):         |  |                |        |   |      |   |        |  
|Property and equipment                        |  |                | (746   | ) |      |   | (795   | )
|Patents                                       |  |                |       |   |      |   | (62    | )
|                                              |  |                |        |   |      |  
|Net deferred tax asset                        |  | $              |       |   |      | $ |       |  
|                                              |  |                |        |   |      |  





Note 10




| |                    
| | -------------------
| | Stock Benefit Plans

1998 Plan.


1989 Plan.




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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Directors Plan.


Change of Control.


Summary of Activity.


|                         |  |             |           |          |                |   |      | 
|------------------------ |  | ----------- | --------- | -------- | -------------- | - | ---- | 
|                         |  |             |           | Weighted |               
|                         |  |             |           | Average  |               
|                         |  | Options     |           |          | Exercise Price |  
|                         |  | Outstanding |           |          | Per Share      |  
|                         |  |             |           |          |                |  
|Balance, August 31, 2002 |  |             | 1,492,525 |          |                | $ | 9.30 | 
|                         |  |             |           |          |                |  
|Granted                  |  |             | 519,035   |          |                |   | 2.90 | 
|Exercised                |  |             | (34,035   | )        |                |   | 1.59 | 
|Cancelled                |  |             | (577,925  | )        |                |   | 9.43 | 
|                         |  |             |           |          |                |  
|Balance, August 31, 2003 |  |             | 1,399,600 |          |                |   | 7.02 | 
|                         |  |             |           |          |                |  
|Granted                  |  |             | 577,814   |          |                |   | 2.77 | 
|Exercised                |  |             | (83,314   | )        |                |   | 1.62 | 
|Cancelled                |  |             | (448,000  | )        |                |   | 8.78 | 
|                         |  |             |           |          |                |  
|Balance, August 31, 2004 |  |             | 1,446,100 |          |                |   | 5.05 | 
|                         |  |             |           |          |                |  
|Granted                  |  |             | 384,000   |          |                |   | 2.96 | 
|Exercised                |  |             |          |          |                |   |     | 
|Cancelled                |  |             | (173,125  | )        |                |   | 5.01 | 
|                         |  |             |           |          |                |  
|Balance, August 31, 2005 |  |             | 1,656,975 |          |                | $ | 4.59 | 
|                         |  |             |           |          |                |  



55



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                         |  |                     |           |          |                     |   |           |             |  |  |           |          |  |          |         |  |  |   |       | 
|------------------------ |  | ------------------- | --------- | -------- | ------------------- | - | --------- | ----------- |  |  | --------- | -------- |  | -------- | ------- |  |  | - | ----- | 
|                         |  | Options Outstanding |           |          |                    
|                         |  |                     |           |          | Options Exercisable |  
|                         |  |                     |           | Weighted |                     |   |           |            
|                         |  |                     |           | Weighted |                     |   | Average   |             |  |  |           | Weighted | 
|                         |  |                     |           | Average  |                     |   | Remaining |             |  |  |           | Average  | 
|                         |  | Number of           |           |          | Exercise            |   |           | Contractual |  |  | Number of |          |  | Exercise |        
|Range of Exercise Prices |  | Options             |           |          | Price               |   |           | Life        |  |  | Options   |          |  | Price    |        
|                         |  |                     |           |          |                     |   |           |             |  |  |           |          |  |          |        
|$1.28-2.75               |  |                     | 482,500   |          |                     | $ | 2.04      |             |  |  | 8.6       |          |  |          | 242,825 |  |  | $ | 1.93  | 
|$2.99-3.30               |  |                     | 394,000   |          |                     |   | 3.06      |             |  |  | 9.7       |          |  |          | 39,900  |  |  |   | 3.21  | 
|$3.40-4.38               |  |                     | 324,500   |          |                     |   | 3.78      |             |  |  | 8.6       |          |  |          | 122,375 |  |  |   | 4.06  | 
|$5.50-6.85               |  |                     | 188,925   |          |                     |   | 5.81      |             |  |  | 4.2       |          |  |          | 166,925 |  |  |   | 5.79  | 
|$7.70-10.75              |  |                     | 132,200   |          |                     |   | 9.20      |             |  |  | 5.5       |          |  |          | 128,450 |  |  |   | 9.15  | 
|$11.62-20.38             |  |                     | 134,850   |          |                     |   | 13.88     |             |  |  | 5.6       |          |  |          | 114,850 |  |  |   | 13.88 | 
|                         |  |                     |           |          |                     |   |           |             |  |  |           |          |  |          |        
|                         |  |                     | 1,656,975 |          |                     | $ | 4.59      |             |  |  | 7.9       |          |  |          | 815,325 |  |  | $ | 5.92  | 
|                         |  |                     |           |          |                     |   |           |             |  |  |           |          |  |          |        



|                         |  |                               |          |  |      |  |                |      |  |  |                 | 
|------------------------ |  | ----------------------------- | -------- |  | ---- |  | -------------- | ---- |  |  | --------------- | 
|                         |  | Fiscal Years Ended August 31, |         
|                         |  |                               |         
|                         |  | 2005                          |          |  | 2004 |  |                | 2003 | 
|                         |  |                               |          |  |      |  |                |      | 
|Risk-free interest rates |  |                               | 3.72%    |  |      |  | 2.74% to 3.74% |      |  |  | 2.31% to 3.52%  | 
|Expected life            |  |                               | 8  years |  |      |  | 5 to 10 years  |      |  |  | 7 to 8.5  years | 
|Volatility               |  |                               | 72%      |  |      |  | 73%            |      |  |  | 73%             | 
|Expected dividends       |  |                               | None     |  |      |  | None           |      |  |  | None            | 

Common Stock Warrants.


56



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 11




| |                                        
| | ---------------------------------------
| | Net Income (Loss) Per Share Computation



|                                                     |  |                               |           |   |      |   |           |      |  |   |           |  
|---------------------------------------------------- |  | ----------------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                     |  | Fiscal Years Ended August 31, |          
|                                                     |  |                               |          
|                                                     |  | 2005                          |           |   | 2004 |   |           | 2003 | 
|                                                     |  |                               |           |   |      |   |           |      | 
|Basic:                                               |  |                               |           |   |      |   |           |      |  |   |           |  
|Net income (loss)                                    |  | $                             | 355       |   |      | $ | (7,009    | )    |  | $ | (4,629    | )
|Loss attributable to common stockholders             |  | $                             | (717      | ) |      | $ | (7,009    | )    |  | $ | (4,629    | )
|Net income (loss) per share                          |  | $                             | 0.04      |   |      | $ | (0.90     | )    |  | $ | (0.70     | )
|Deemed dividend on convertible preferred stock       |  | $                             | (0.13     | ) |      | $ |          |      |  | $ |          |  
|                                                     |  |                               |           |   |      |   |           |      | 
|Loss attributable to common stockholders per share   |  | $                             | (0.09     | ) |      | $ | (0.90     | )    |  | $ | (0.70     | )
|Weighted average number of common shares outstanding |  |                               | 8,382,000 |   |      |   | 7,745,000 |      |  |   | 6,629,000 |  
|Diluted:                                             |  |                               |           |   |      |   |           |      |  |   |           |  
|Net income (loss)                                    |  | $                             | 355       |   |      | $ | (7,009    | )    |  | $ | (4,629    | )
|Loss attributable to common stockholders             |  | $                             | (717      | ) |      | $ | (7,009    | )    |  | $ | (4,629    | )
|Net income (loss) per share                          |  | $                             | 0.04      |   |      | $ | (0.90     | )    |  | $ | (0.70     | )
|Deemed dividend on convertible preferred stock       |  | $                             | (0.13     | ) |      | $ |          |      |  | $ |          |  
|                                                     |  |                               |           |   |      |   |           |      | 
|Loss attributable to common stockholders per share   |  | $                             | (0.09     | ) |      | $ | (0.90     | )    |  | $ | (0.70     | )
|Weighted average number of common shares outstanding |  |                               | 8,382,000 |   |      |   | 7,745,000 |      |  |   | 6,629,000 |  
|Effect of convertible preferred stock                |  |                               | 382,000   |   |      |   |          |      |  |   |          |  
|Effect of dilutive stock options                     |  |                               | 194,000   |   |      |   |          |      |  |   |          |  
|                                                     |  |                               |           |   |      |   |           |      | 
|Weighted average shares assuming dilution            |  |                               | 8,958,000 |   |      |   | 7,745,000 |      |  |   | 6,629,000 |  
|                                                     |  |                               |           |   |      |   |           |      | 



Note 12




| |                                     
| | ------------------------------------
| | Equity Offerings and Deemed Dividend



| |                                    
| | -----------------------------------
| | Sale of Convertible Preferred Stock





57



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##### Table of Contents



HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




.




| |                                               
| | ----------------------------------------------
| | Deemed Dividend on Convertible Preferred Stock





| |                                  
| | ---------------------------------
| | Private Placement of Common Stock



Note 13




| |                                                                       
| | ----------------------------------------------------------------------
| | Notes Receivable  Related
    Parties  Officers and Former Directors

1 2


58



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##### Table of Contents



HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






Note 14




| |                      
| | ---------------------
| | Litigation Recoveries





Note 15




| |                       
| | ----------------------
| | Employee Benefit Plans



Note 16




| |                              
| | -----------------------------
| | Commitments and Contingencies



59



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)










|                             |  |                   |        | 
|---------------------------- |  | ----------------- | ------ | 
|                             |  | Minimum Operating |       
|Year Ending August 31,       |  | Lease Commitments |       
|                             |  |                   |       
|2006                         |  | $                 | 1,770  | 
|2007                         |  |                   | 1,596  | 
|2008                         |  |                   | 1,598  | 
|2009                         |  |                   | 1,636  | 
|2010                         |  |                   | 1,676  | 
|Thereafter                   |  |                   | 16,627 | 
|                             |  |                   |       
|Total minimum lease payments |  | $                 | 24,903 | 
|                             |  |                   |       





60



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##### Table of Contents



HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 17




| |                                                                      
| | ---------------------------------------------------------------------
| | Major Customers, Concentration of Credit Risk and
    Geographic Data



|                        |  |                    |    |   |      |  |    |      |  |  |    |  
|----------------------- |  | ------------------ | -- | - | ---- |  | -- | ---- |  |  | -- | -
|                        |  | Fiscal Years Ended |   
|                        |  | August 31,         |   
|                        |  |                    |   
|                        |  | 2005               |    |   | 2004 |  |    | 2003 | 
|                        |  |                    |    |   |      |  |    |      | 
|GE Medical Systems      |  |                    | 12 | % |      |  | 17 | %    |  |  | 14 | %
|Siemens, Inc.           |  |                    | 6  | % |      |  | 8  | %    |  |  | 14 | %
|Sonic Innovations, Inc. |  |                    |   |   |      |  | 2  | %    |  |  | 17 | %
|                        |  |                    |    |   |      |  |    |      | 
|Total                   |  |                    | 18 | % |      |  | 27 | %    |  |  | 45 | %
|                        |  |                    |    |   |      |  |    |      | 





Note 18




| |                
| | ---------------
| | Geographic Data



|               |  |                              |        |  |            |  |     |         |  |   |            |  |  |         |     |   |            |   |        |  |  |  |     |  
|-------------- |  | ---------------------------- | ------ |  | ---------- |  | --- | ------- |  | - | ---------- |  |  | ------- | --- | - | ---------- | - | ------ |  |  |  | --- | -
|               |  | Fiscal Year Ended August 31, |       
|               |  |                              |       
|               |  | 2005                         |        |  | 2004       |  |     | 2003    | 
|               |  |                              |        |  |            |  |     |         | 
|               |  | Dollars                      |        |  | % of Sales |  |     | Dollars |  |   | % of Sales |  |  | Dollars |     |   | % of Sales |  
|               |  |                              |        |  |            |  |     |         |  |   |            |  |  |         |     |   |            |  
|United States  |  | $                            | 39,498 |  |            |  | 70  | %       |  | $ | 31,974     |  |  |         | 74  | % |            | $ | 27,616 |  |  |  | 72  | %
|Canada/ Mexico |  |                              | 3,661  |  |            |  | 6   | %       |  |   | 2,694      |  |  |         | 6   | % |            |   | 3,856  |  |  |  | 10  | %
|Europe         |  |                              | 5,863  |  |            |  | 10  | %       |  |   | 4,025      |  |  |         | 9   | % |            |   | 1,105  |  |  |  | 3   | %
|Asia-Pacific   |  |                              | 7,361  |  |            |  | 13  | %       |  |   | 4,588      |  |  |         | 11  | % |            |   | 5,827  |  |  |  | 15  | %
|South America  |  |                              | 248    |  |            |  | 0   | %       |  |   | 39         |  |  |         | 0   | % |            |   | 36     |  |  |  | 0   | %
|               |  |                              |        |  |            |  |     |         |  |   |            |  |  |         |     |   |            |  
|Total          |  | $                            | 56,631 |  |            |  | 100 | %       |  | $ | 43,320     |  |  |         | 100 | % |            | $ | 38,440 |  |  |  | 100 | %
|               |  |                              |        |  |            |  |     |         |  |   |            |  |  |         |     |   |            |  

Note 19




| |                    
| | -------------------
| | Segment Information



Microelectronics Operations:


Advanced Medical Operations:


61



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##### Table of Contents



HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                              |  |                  |        |   |                  |   |        |       |  |   |        | 
|----------------------------- |  | ---------------- | ------ | - | ---------------- | - | ------ | ----- |  | - | ------ | 
|                              |  | Fiscal 2005      |       
|                              |  |                  |       
|                              |  | Microelectronics |        |   | Advanced Medical |   |        |      
|                              |  | Operations       |        |   | Operations       |   |        | Total | 
|                              |  |                  |        |   |                  |   |        |       | 
|Net sales                     |  | $                | 33,377 |   |                  | $ | 23,254 |       |  | $ | 56,631 | 
|Gross profit                  |  |                  | 6,669  |   |                  |   | 4,915  |       |  |   | 11,584 | 
|Operating income (loss)       |  |                  | (1,763 | ) |                  |   | 2,000  |       |  |   | 237    | 
|Total assets                  |  |                  | 18,260 |   |                  |   | 9,417  |       |  |   | 27,677 | 
|Depreciation and amortization |  |                  | 2,049  |   |                  |   | 405    |       |  |   | 2,454  | 
|Capital expenditures          |  |                  | 1,708  |   |                  |   | 119    |       |  |   | 1,827  | 

|                              |  |                  |        |   |                  |   |        |       |  |   |        |  
|----------------------------- |  | ---------------- | ------ | - | ---------------- | - | ------ | ----- |  | - | ------ | -
|                              |  | Fiscal 2004      |       
|                              |  |                  |       
|                              |  | Microelectronics |        |   | Advanced Medical |   |        |      
|                              |  | Operations       |        |   | Operations       |   |        | Total | 
|                              |  |                  |        |   |                  |   |        |       | 
|Net sales                     |  | $                | 22,748 |   |                  | $ | 20,572 |       |  | $ | 43,320 |  
|Gross profit                  |  |                  | 158    |   |                  |   | 3,965  |       |  |   | 4,123  |  
|Operating loss                |  |                  | (8,142 | ) |                  |   | (372   | )     |  |   | (8,514 | )
|Total assets                  |  |                  | 15,846 |   |                  |   | 9,266  |       |  |   | 25,112 |  
|Depreciation and amortization |  |                  | 2,405  |   |                  |   | 457    |       |  |   | 2,862  |  
|Capital expenditures          |  |                  | 593    |   |                  |   | 150    |       |  |   | 743    |  

|                              |  |                  |        |   |                  |   |        |       |  |   |        |  
|----------------------------- |  | ---------------- | ------ | - | ---------------- | - | ------ | ----- |  | - | ------ | -
|                              |  | Fiscal 2003      |       
|                              |  |                  |       
|                              |  | Microelectronics |        |   | Advanced Medical |   |        |      
|                              |  | Operations       |        |   | Operations       |   |        | Total | 
|                              |  |                  |        |   |                  |   |        |       | 
|Net sales                     |  | $                | 24,011 |   |                  | $ | 14,429 |       |  | $ | 38,440 |  
|Gross profit                  |  |                  | 4,052  |   |                  |   | 3,061  |       |  |   | 7,113  |  
|Operating income (loss)       |  |                  | (3,662 | ) |                  |   | 225    |       |  |   | (3,437 | )
|Total assets                  |  |                  | 16,835 |   |                  |   | 9,668  |       |  |   | 26,503 |  
|Depreciation and amortization |  |                  | 2,705  |   |                  |   | 590    |       |  |   | 3,295  |  
|Capital expenditures          |  |                  | 442    |   |                  |   |       |       |  |   | 442    |  

Note 20




| |                
| | ---------------
| | Settlement Gain



Note 21




| |                 
| | ----------------
| | Subsequent Event



62



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HEI, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Note 22




| |                                                   
| | --------------------------------------------------
| | Summary of Quarterly Operating Results (Unaudited)



|                                         |                                          |                                          |        |      |        |   |        |       |   |   |        |       |   |   |        |      | 
|---------------------------------------- | ---------------------------------------- | ---------------------------------------- | ------ | ---- | ------ | - | ------ | ----- | - | - | ------ | ----- | - | - | ------ | ---- | 
|Fiscal Year 2005                         |                                          | First                                    |        |      | Second |   |        | Third |   |   | Fourth |      
|                                         |                                          |                                          |        |      |        |   |        |       |   |   |        |      
|                                         |                                          | (Unaudited)                              |       
|                                         |                                          | (In thousands, except per share amounts) |       
|Net sales                                |                                          | $                                        | 14,071 |      |        | $ | 13,736 |       |   | $ | 13,755 |       |   | $ | 15,068 |     
|Gross profit                             |                                          |                                          | 2,956  |      |        |   | 2,867  |       |   |   | 2,570  |       |   |   | 3,191  |     
|Operating income (loss)                  |                                          |                                          | 77     |      |        |   | (411   | )     |   |   | 185    |       |   |   | 387    |     
|Net income (loss)                        |                                          |                                          | 415    |      |        |   | (537   | )     |   |   | 273    |       |   |   | 204    |     
|Deemed dividend                          |                                          |                                          |       |      |        |   |       |       |   |   | (1,072 | )     |   |   |       |     
|                                         |                                          |                                          |        |      |        |   |        |       |   |   |        |      
|Loss attributable to common stockholders |                                          | $                                        | 415    |      |        |   | (537   | )     |   | $ | (921   | )     |   | $ | 204    |     
|                                         |                                          |                                          |        |      |        |   |        |       |   |   |        |      
|Net income (loss) per share:             |                                          |                                          |        |      |        |   |        |       |   |   |        |       |   |   |        |     
|                                         | Basic and Diluted:                       |                                          |        |      |        |   |        |       |   |   |        |       |   |   |        |      | 
|                                         | Net income (loss)                        |                                          | $      | 0.05 |        |   | $      | (0.06 | ) |   | $      | 0.03  |   |   | $      | 0.02 | 
|                                         | Deemed dividend                          |                                          |        |     |        |   |        |      |   |   | $      | (0.13 | ) |   |        |     | 
|                                         |                                          |                                          |        |      |        |   |        |       |   |   |        |      
|                                         | Loss attributable to common stockholders |                                          | $      | 0.05 |        |   | $      | (0.06 | ) |   | $      | (0.11 | ) |   | $      | 0.02 | 
|                                         |                                          |                                          |        |      |        |   |        |       |   |   |        |      

|                            |         |                                          |        |       |        |   |        |       |   |   |        |       |   |   |        |       |  
|--------------------------- | ------- | ---------------------------------------- | ------ | ----- | ------ | - | ------ | ----- | - | - | ------ | ----- | - | - | ------ | ----- | -
|Fiscal Year 2004            |         | First                                    |        |       | Second |   |        | Third |   |   | Fourth |      
|                            |         |                                          |        |       |        |   |        |       |   |   |        |      
|                            |         | (Unaudited)                              |       
|                            |         | (In thousands, except per share amounts) |       
|Net sales                   |         | $                                        | 10,916 |       |        | $ | 9,995  |       |   | $ | 11,131 |       |   | $ | 11,278 |      
|Gross profit                |         |                                          | 1,064  |       |        |   | 451    |       |   |   | 1,151  |       |   |   | 1,457  |      
|Asset impairment charges    |         |                                          |       |       |        |   |       |       |   |   |       |       |   |   | 465    |      
|Special investigation costs |         |                                          | 253    |       |        |   | 504    |       |   |   | 94     |       |   |   | 43     |      
|Operating loss              |         |                                          | (1,668 | )     |        |   | (2,971 | )     |   |   | (1,679 | )     |   |   | (2,196 | )    
|Net loss                    |         |                                          | (1,253 | )     |        |   | (2,969 | )     |   |   | (1,029 | )     |   |   | (1,758 | )    
|                            |         |                                          |        |       |        |   |        |       |   |   |        |      
|Net loss per share          |         |                                          |        |       |        |   |        |       |   |   |        |       |   |   |        |      
|                            | Basic   |                                          | $      | (0.18 | )      |   | $      | (0.41 | ) |   | $      | (0.12 | ) |   | $      | (0.21 | )
|                            | Diluted |                                          | $      | (0.18 | )      |   | $      | (0.41 | ) |   | $      | (0.12 | ) |   | $      | (0.21 | )



63



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM














| |                                   
| | ----------------------------------
| | /s/ Virchow, Krause & Company, LLP





64



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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM














| |             
| | ------------
| | /s/ KPMG LLP





65



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##### Table of Contents








|        |                                                                                           
|------- | ------------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosures.









| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | As previously disclosed in our Annual Report on Form 10-K
    for Fiscal 2003, KPMG cited a material weakness in its
    communication to our Audit Committee on December 12, 2003,
    related to the overriding, by our former President, Chief
    Executive Officer and Chairman and former Chief Financial
    Officer, of internal controls relating to the payment of certain
    expenses not supported by proper documentation. On
    December 12, 2003, KPMG also communicated to our Audit
    Committee reportable conditions related to revenue recognition
    at our Boulder facility, and the lack of substantiation of
    general ledger account balances and computer-based vendor
    payment controls.
|
| |  | On January 12, 2005, KPMG cited three material weaknesses
    in its communication to our Audit Committee, relating to
    (i) the control environment at our Boulder facility and, in
    particular, the lack of segregation of duties and financial
    oversight controls, (ii) revenue recognition and
    (iii) financial reporting. On January 12, 2005, KPMG
    also communicated to our Audit Committee reportable conditions
    related to (A) the lack of a formal journal entry approval
    process, and (B) the lack of access controls to our SAP
    system.                                                                                                                                              












Item 9A. Controls and Procedures.




66



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##### Table of Contents











| |   |                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the replacement of our Controller at the Boulder facility;                                                                                                                                
|
| |  | implementing the SAP system for all of our financial reporting,
    including our Boulder facility;                                                                                       
|
| |  | adding controls and moving control related functions to our
    Victoria facility to eliminate opportunities to override
    controls over cash, accounts receivable and accounts payable;
|
| |  | the training of our accounting personnel at a revenue
    recognition seminar;                                                                                                            
|
| |  | providing revenue recognition training for contract
    administration personnel;                                                                                                         
|
| |  | adding revenue recognition review and approval control functions;                                                                                                                         
|
| |  | adding staff to accommodate the changes required; and                                                                                                                                     
|
| |  | evaluating access controls needed within the SAP system.                                                                                                                                  







67



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##### Table of Contents










Item 9B. Other Information







PART III







|         |                                                    
|-------- | ---------------------------------------------------
|Item 10. | Directors and Executive Officers of the Registrant.








|         |                        
|-------- | -----------------------
|Item 11. | Executive Compensation.








|         |                                                                                                   
|-------- | --------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and
    Management and Related Stockholder Maters.






Item 13. Certain Relationships and Related
Transactions.









|         |                                        
|-------- | ---------------------------------------
|Item 14. | Principal Accounting Fees and Services.






PART IV





Item 15. Exhibits, Financial Statement
Schedules.






| |                                                                                       
| | --------------------------------------------------------------------------------------
| | (1) Financial Statements  See Part II,
    Item 8 of this Annual Report on Form 10-K.

Exhibits:


| |   |    |  |                                                                                                                      |  |        
| | - | -- |  | -------------------------------------------------------------------------------------------------------------------- |  | -------
| | 2 | .2 |  | Purchase Agreement, dated as of January 24, 2003, by and
    between HEI, Inc. and Colorado MEDtech, Inc.            |  | Note 1 
| | 2 | .3 |  | Registration Rights Agreement, dated as of January 24,
    2003, by and between HEI, Inc. and Colorado MEDtech, Inc. |  | Note 1 
| | 3 | .1 |  | Amended and Restated Articles of Incorporation of HEI, Inc.                                                          |  | Note 2 
| | 3 | .2 |  | Amended and Restated Bylaws of HEI, Inc.                                                                             |  | Note 2 
| | 3 | .3 |  | Amendments to the Amended and Restated Bylaws of HEI, Inc.,
    effective as of March 19, 2003                       |  | Note 14
| | 3 | .4 |  | Certificate of Designation of Common Stock of HEI, Inc.                                                              |  | Note 15

68



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| |     |     |  |                                                                                                                                                                                                                          |  |        
| | --- | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------
| | 10  | .1  |  | Loan and Security Agreement, dated July 31, 2000, among
    HEI, Inc. and LaSalle Business Credit, Inc.                                                                                                                  |  | Note 3 
| | 10  | .2  |  | First Amendment to Credit Agreement, dated August 31, 2000,
    by and between HEI, Inc. and LaSalle Business Credit, Inc.                                                                                               |  | Note 4 
| | 10  | .3  |  | Second Amendment to Loan and Security Agreement, dated
    April 16, 2001, between HEI, Inc. and LaSalle Business
    Credit, Inc.                                                                                       |  | Note 4 
| | 10  | .4  |  | Third Amendment to Loan and Security Agreement, dated
    October 31, 2001, between HEI, Inc., Cross Technology, Inc.
    and LaSalle Business Credit, Inc.                                                              |  | Note 4 
| | 10  | .5  |  | Seventh Amendment to Loan and Security Agreement, dated
    December 1, 2002, by and among HEI, Inc., Cross Technology,
    Inc. and LaSalle Business Credit, Inc.                                                       |  | Note 5 
| | 10  | .6  |  | Eighth Amendment to Loan and Security Agreement, dated
    April 9, 2003, between HEI, Inc., Cross Technology, Inc.
    and LaSalle Business Credit, LLC.                                                                |  | Note 6 
| | 10  | .7  |  | Capital Expenditure Note, executed as of July 31, 2000, by
    HEI, Inc. in favor of LaSalle Business Credit, Inc.                                                                                                       |  | Note 3 
| | 10  | .8  |  | Amended and Restated Capital Expenditure Note, executed as of
    October 31, 2001, by HEI, Inc. and Cross Technology, Inc.
    in favor of LaSalle Business Credit, Inc.                                                |  | Note 4 
| | 10  | .9  |  | Amended and Restated Capital Expenditure Note, executed as of
    October 31, 2001, by HEI, Inc. and Cross Technology, Inc.
    in favor of LaSalle Business Credit, Inc.                                                |  | Note 4 
| | 10  | .10 |  | Amended and Restated Capital Expenditure Note, executed as of
    October 31, 2001, by HEI, Inc. and Cross Technology, Inc.
    in favor of LaSalle Business Credit, Inc.                                                |  | Note 4 
| | 10  | .11 |  | Amended and Restated Capital Expenditure Note, executed as of
    October 31, 2001, by HEI, Inc. and Cross Technology, Inc.
    in favor of LaSalle Business Credit, Inc.                                                |  | Note 4 
| | 10  | .12 |  | Reimbursement Agreement, dated July 31, 2000, by and
    between HEI, Inc., LaSalle Bank, N.A. and LaSalle Business
    Credit, Inc.                                                                                     |  | Note 3 
| | 10  | .13 |  | Mortgage, Security Agreement, Fixture Financing Statement and
    Assignment of Lease and Rents, dated July 31, 2000, by HEI,
    Inc., as Mortgagor, to LaSalle Business Credit, Inc., as
    Mortgagee.                |  | Note 3 
| | 10  | .14 |  | Patent, Trademark and License Mortgage, dated July 31,
    2000, by HEI, Inc. in favor of LaSalle Business Credit,
    Inc.                                                                                              |  | Note 3 
| | 10  | .15 |  | Amendment No. 1 to Patent, Trademark and License Agreement,
    undated, by HEI, Inc., in favor of LaSalle Business Credit,
    Inc.                                                                                     |  | Note 4 
| | 10  | .16 |  | Security Agreement, dated July 31, 2000, by and between
    HEI, Inc. and LaSalle Business Credit, Inc.                                                                                                                  |  | Note 3 
| | 10  | .17 |  | Revolving Note, executed as of July 31, 2000, by HEI, Inc.
    in favor of LaSalle Business Credit, Inc.                                                                                                                 |  | Note 3 
| | 10  | .18 |  | Amended and Restated Revolving Note, executed as of
    October 31, 2001, by HEI, Inc. and Cross Technology, Inc.
    in favor of LaSalle Business Credit, Inc.                                                          |  | Note 4 
| | 10  | .19 |  | Amended and Restated Revolving Note, executed as of
    December 1, 2002, by HEI, Inc. and Cross Technology, Inc.
    in favor of LaSalle Business Credit, Inc.                                                          |  | Note 5 
| | *10 | .20 |  | Form of Indemnification Agreement between HEI and officers and
    directors.                                                                                                                                            |  | Note 7 
| | *10 | .21 |  | HEI, Inc. 1989 Omnibus Stock Compensation Plan, adopted
    April 3, 1989, and as Amended and Restated effective
    November 15, 1991, and as amended effective April 29,
    1992, May 11, 1994, and October 31, 1996. |  | Note 8 
| | *10 | .22 |  | HEI, Inc. 1998 Stock Option Plan, adopted November 18,
    1998, and amended effective January 20, 2000,
    January 24, 2001, and February 20, 2002.                                                                    |  | Note 9 
| | *10 | .23 |  | HEI, Inc. 1998 Stock Option Plan for Nonemployee Directors,
    adopted November 18, 1998, and amended effective
    June 7, 1999 and December 12, 2002.                                                                 |  | Note 14
| | 10  | .24 |  | Registration Rights Agreement, dated August 29, 2001, by
    and among HEI, Inc. and Certain Investors listed on
    Exhibit A thereto.                                                                                  |  | Note 11
| | 10  | .25 |  | Sample Promissory Note of Certain Officers and Directors in
    connection with the Exercise of Stock Options.                                                                                                           |  | Note 10
| | 10  | .26 |  | Subordinated Promissory Note, dated as of January 24, 2003,
    issued by HEI, Inc. and accepted by Colorado MEDtech, Inc.                                                                                               |  | Note 1 

69



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| |     |     |  |                                                                                                                                                                                        |  |        
| | --- | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------
| | 10  | .27 |  | Lease, dated as of January 7, 2002, by and between Eastside
    Properties, LLC and Colorado MEDtech, Inc., subsequently
    assigned to HEI, Inc.                                     |  | Note 12
| | 10  | .28 |  | First Addendum to Lease, dated September 12, 2002, by and
    between Eastside Properties, LLC and Colorado MEDtech, Inc.,
    subsequently assigned to HEI, Inc.                      |  | Note 12
| | 10  | .29 |  | Second Addendum to Lease, dated January 23, 2003, by and
    between Eastside Properties, LLC and Colorado MEDtech, Inc.,
    subsequently assigned to HEI, Inc.                       |  | Note 12
| | 10  | .30 |  | Agreement Regarding Additional Security Deposit, undated, by and
    between Eastside Properties, Inc. and HEI, Inc.                                                                   |  | Note 12
| | 10  | .31 |  | Letter Agreement, dated May 16, 2003, between HEI, Inc. and
    Whitebox Hedged High Yield Partners.                                                                                   |  | Note 13
| | 10  | .32 |  | Accounts Receivable Agreement, dated May 29, 2003, by and
    between HEI, Inc. and Beacon Bank.                                                                                       |  | Note 13
| | *10 | .33 |  | Confidential Separation Agreement and Release, dated
    June 20, 2003, between HEI, Inc. and Steve E.
    Tondera, Jr.                                                                |  | Note 14
| | *10 | .34 |  | Employment Agreement, dated October 1, 2003, between HEI,
    Inc. and Douglas Nesbit.                                                                                                 |  | Note 14
| | *10 | .35 |  | Employment Agreement, dated October 1, 2003, between HEI,
    Inc. and Stephen Peterson.                                                                                               |  | Note 14
| | *10 | .36 |  | Employment Agreement, dated October 1, 2003, between HEI,
    Inc. and Scott Stole.                                                                                                    |  | Note 14
| | *10 | .37 |  | Employment Agreement, dated October 1, 2003, between HEI,
    Inc. and Simon Hawksworth.                                                                                               |  | Note 14
| | *10 | .38 |  | Employment Agreement, dated October 1, 2003, between HEI,
    Inc. and James Vetricek.                                                                                                 |  | Note 14
| | 10  | .39 |  | Note Prepayment Agreement, dated October 15, 2003,
    between HEI, Inc. and Whitebox Hedged High Yield Partners.                                                                      |  | Note 14
| | 10  | .40 |  | Promissory Note, dated October 14, 2003, by HEI, Inc. in
    favor of Commerce Bank.                                                                                                   |  | Note 14
| | 10  | .41 |  | Term Loan Agreement, dated October 14, 2003, by HEI, Inc.
    and Commerce Bank.                                                                                                       |  | Note 14
| | 10  | .42 |  | Combination Mortgage, Security Agreement, Assignment of Rents
    and Fixture Financing Statement, dated October 14, 2003, by
    HEI, Inc. in favor of Commerce Bank.                 |  | Note 14
| | 10  | .43 |  | Environmental Investigation Letter, dated October 14, 2003,
    by HEI, Inc. in favor of Commerce Bank.                                                                                |  | Note 14
| | 10  | .44 |  | Promissory Note, dated October 28, 2003, by HEI, Inc. in
    favor of Commerce Financial Group, Inc.                                                                                   |  | Note 14
| | 10  | .45 |  | Term Loan Agreement, dated October 28, 2003, by HEI, Inc.
    and Commerce Financial Group, Inc.                                                                                       |  | Note 14
| | 10  | .46 |  | Commercial Security Agreement, dated October 28, 2003, by
    HEI, Inc. in favor of Commerce Financial Group, Inc.                                                                     |  | Note 14
| | 10  | .47 |  | Combination Mortgage, Security Agreement, Assignment of Rents
    and Fixture Financing Statement, dated October 28, 2003, by
    HEI, Inc. in favor of Commerce Financial Group, Inc. |  | Note 14
| | 10  | .48 |  | Environmental Investigation Letter, dated October 28, 2003,
    by HEI, Inc. in favor of Commerce Financial Group, Inc.                                                                |  | Note 14
| | 10  | .49 |  | Asset Purchase Agreement, dated October 31, 2003, by HEI,
    Inc. and MKS Instruments, Inc.                                                                                           |  | Note 14
| | 10  | .50 |  | Amendment dated December 12, 2003, to Accounts Receivable
    Agreement, dated May 29, 2003, by and among HEI, Inc. and
    Beacon Bank.                                               |  | Note 14
| | 10  | .51 |  | Registration Rights Agreement, dated as of November 5,
    2003, between HEI, Inc. and Whitebox Hedged High Yield Partners.                                                            |  | Note 16
| | 10  | .52 |  | Stock Purchase Agreement, dated February 13, 2004, by and
    among HEI, Inc. and the Investors listed on Exhibit A
    thereto.                                                       |  | Note 17
| | 10  | .53 |  | Registration Rights Agreement, dated February 13, 2004, by
    and among HEI, Inc. and the Purchasers listed on Exhibit A
    thereto.                                                 |  | Note 17

70



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| |     |     |  |                                                                                                                                                                                                            |  |        
| | --- | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------
| | 10  | .54 |  | Form of Registration Rights Agreement, dated as of
    February 23, 2004, among HEI, Inc. and the Purchasers of an
    aggregate of 251,380 shares of HEI, Inc.                                            |  | Note 16
| | 10  | .55 |  | Form of Registration Rights Agreement, dated as of May 7,
    2004, among HEI, Inc. and the Purchasers of an aggregate of
    631,524 shares of HEI, Inc.                                                  |  | Note 15
| | 10  | .56 |  | Amendment dated July 1, 2004, to Accounts Receivable
    Agreement, dated May 29, 2003, and previously amended on
    December 13, 2003, by and among HEI, Inc. and Beacon Bank.                           |  | Note 21
| | 10  | .57 |  | Lease Agreement, dated October 1, 2004, by and between HEI,
    Inc. and Boulder Investors LLC.                                                                                                            |  | Note 18
| | 10  | .58 |  | Waiver and Amendment, dated November 30, 2004, and executed
    as of December 3, 2004, by and between HEI, Inc. and
    Commerce Bank.                                                                    |  | Note 19
| | 10  | .59 |  | Waiver and Amendment, dated November 30, 2004, and executed
    as of December 3, 2004, by and between HEI, Inc. and
    Commerce Financial Group, Inc.                                                    |  | Note 19
| | 10  | .60 |  | Amendment dated December 7, 2004, to Accounts Receivable
    Agreement, dated May 29, 2003, and previously amended on
    December 13, 2003, and July 1, 2004, by and among HEI,
    Inc. and Beacon Bank. |  | Note 20
| | *10 | .61 |  | Employment Agreement, dated April 19, 2004, between HEI
    Inc. and Mack Traynor.                                                                                                                         |  | Note 22
| | 10 | .62 |  | Amendment dated July 7, 2005, to Accounts Receivable
    Agreement, dated May 29, 2003, and previously amended on
    July 1, 2004 and December 13, 2003, by and among HEI,
    Inc. and Beacon Bank.      |  |        
| | 10  | .63 |  | Consulting Agreement, dated January 12, 2005, between
    Emerging Capital and HEI, Inc.                                                                                                                   |  | Note 24
| | 16  |     |  | Letter from KPMG, LLP to the Securities and Exchange Commission
    dated
    December 21, 2004.                                                                                                           |  | Note 23
| | 21 |     |  | Subsidiaries of the Registrant.                                                                                                                                                                            |  |        
| | 23 | .1  |  | Consent of Virchow, Krause & Company, LLP.                                                                                                                                                                 |  |        
| | 23 | .2  |  | Consent of KPMG LLP.                                                                                                                                                                                       |  |        
| | 31 | .1  |  | Certification of Chief Executive Officer pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                    |  |        
| | 31 | .2  |  | Certification of Chief Financial Officer pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                    |  |        
| | 32 | .1  |  | Certification of Chief Executive Officer pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                    |  |        
| | 32 | .2  |  | Certification of Chief Financial Officer pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                    |  |        








|    |                                                                                                                                                                                                                                            
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Filed as an exhibit to the Current Report on Form 8-K,
    filed with the Securities and Exchange Commission on
    February 10, 2003, and incorporated herein by reference.                                                               
|   
|(2) | Filed as an exhibit to the Definitive Proxy Statement on
    Schedule 14A for the 2002 Annual Meeting of Shareholders,
    filed with the Securities and Exchange Commission on
    January 23, 2002, and incorporated herein by reference.
|   
|(3) | Filed as an exhibit to the Annual Report on Form 10-KSB for
    the fiscal year ended August 31, 2000, and incorporated
    herein by reference.                                                                                           
|   
|(4) | Filed as an exhibit to the Annual Report on Form 10-K for
    the fiscal year ended August 31, 2001, and incorporated
    herein by reference.                                                                                             
|   
|(5) | Filed as an exhibit to the Quarterly Report on Form 10-Q
    for the quarterly period ending November 30, 2002, and
    incorporated herein by reference.                                                                                  
|   
|(6) | Filed as an exhibit to the Quarterly Report on Form 10-Q
    for the quarterly period ending February 28, 2003, and
    incorporated herein by reference.                                                                                  

71



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|    |                                                                                                                                                                                                           
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(7) | Filed as an exhibit to the Registration Statement on
    Form S-2 (SEC No. 33-37285), filed with the Securities
    and Exchange Commission on October 15, 1990, and
    incorporated herein by reference.
|   
|(8) | Filed as an exhibit to the Annual Report on Form 10-KSB for
    the fiscal year ended August 31, 1996, and incorporated
    herein by reference.                                                          
|   
|(9) | Filed as an exhibit to the Annual Report on Form 10-KSB for
    the fiscal year ended August 31, 1998, and incorporated
    herein by reference.                                                          



|     |                                                                                                                                                                                                          
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Filed as an exhibit to the Annual Report on Form 10-K for
    the fiscal year ended August 31, 2002, and incorporated
    herein by reference.                                                           
|    
|(11) | Filed as an exhibit to the Current Report on Form 8-K,
    filed with the Securities and Exchange Commission on
    September 4, 2001, and incorporated herein by reference.                             
|    
|(12) | Filed as an exhibit to the Current Report on Form 8-K/ A
    (Amendment No. 1), filed with the Securities and Exchange
    Commission on April 10, 2003, and incorporated herein by
    reference.       
|    
|(13) | Filed as an exhibit to the Quarterly Report on Form 10-Q
    for the quarterly period ended May 31, 2003, and
    incorporated herein by reference.                                                      
|    
|(14) | Filed as an exhibit to the Annual Report on Form 10-K for
    the fiscal year ended August 31, 2003, and incorporated
    herein by reference.                                                           
|    
|(15) | Filed as an exhibit to the Registration Statement on
    Form S-3 (SEC No. 333-115982), filed with the
    Securities and Exchange Commission on May 28, 2004, and
    incorporated herein by reference. 
|    
|(16) | Filed as an exhibit to the Registration Statement on
    Form S-3 (SEC No. 333-113419), filed with the
    Securities and Exchange Commission on March 9, 2004, and
    incorporated herein by reference.
|    
|(17) | Filed as an exhibit to the Current Report on Form 8-K/ A
    (Amendment No. 1), filed with the Securities and Exchange
    Commission on February 19, 2004, and incorporated herein by
    reference.    
|    
|(18) | Filed as an exhibit to the Current Report on Form 8-K,
    filed with the Securities and Exchange Commission on
    December 21, 2004.                                                                   
|    
|(19) | Filed as an exhibit to the Current Report on Form 8-K,
    filed with the Securities and Exchange Commission on
    December 9, 2004, and incorporated herein by reference.                              
|    
|(20) | Filed as an exhibit to the Current Report on Form 8-K,
    filed with the Securities and Exchange Commission on
    December 10, 2004, and incorporated herein by reference.                             
|    
|(21) | Filed as an exhibit to the Annual Report on Form 10-K for
    the fiscal year ended August 31, 2004, and incorporated
    herein by reference.                                                           
|    
|(22) | Filed as an exhibit to the Annual Report on Form 10-K for
    the fiscal year ended August 31, 2004, and incorporated
    herein by reference.                                                           
|    
|(23) | Filed as an exhibit to the Annual Report on Form 10-K for
    the fiscal year ended August 31, 2004, and incorporated
    herein by reference.                                                           
|    
|(24) | Filed as an exhibit to the Current Report on Form 8-K,
    filed with the Securities and Exchange Commission on
    January 18, 2005, and incorporated herein by reference.                              



| |   |                                                                 
| | - | ----------------------------------------------------------------
| | * | Denotes management contract or compensation plan or arrangement.



| |   |                
| | - | ---------------
| |  | Filed herewith.

72



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##### Table of Contents






SIGNATURES






| |          
| | ---------
| | HEI, INC.



| |     |                        
| | --- | -----------------------
| | By: | /s/ MACK V. TRAYNOR III

| |                                      
| | -------------------------------------
| |                                      
| | Mack V. Traynor III                  
| | Chief Executive Officer and President





|                                                   |  |                                       |  |                   |  | 
|-------------------------------------------------- |  | ------------------------------------- |  | ----------------- |  | 
|                                                   |  |                                       |  | Date              |  | 
|                                                   |  |                                       |  |                   |  | 
|                                                  
|/s/ MACK V.
    TRAYNOR IIIMack
    V. Traynor III |  | Chief Executive Officer and President |  | November 23, 2005
|                                                  
|/s/ TIMOTHY C. CLAYTONTimothy
    C. Clayton       |  | Chief Financial Officer               |  | November 23, 2005
|                                                  
|/s/ DENNIS J. LEISZDennis
    J. Leisz             |  | Director                              |  | November 23, 2005
|                                                  
|/s/ TIMOTHY F. FLOEDERTimothy
    F. Floeder       |  | Director                              |  | November 23, 2005
|                                                  
|/s/ MICHAEL J. EVERSMichael
    J. Evers           |  | Director                              |  | November 23, 2005
|                                                  
|/s/ GEORGE M. HEENANGeorge
    M. Heenan           |  | Director                              |  | November 23, 2005
|                                                  
|/s/ ROBERT W. HELLERRobert
    W. Heller           |  | Director                              |  | November 23, 2005

73



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##### Table of Contents



INDEX TO EXHIBITS


| |    |    |  |                                                                                                        
| | -- | -- |  | -------------------------------------------------------------------------------------------------------
| | 21 |    |  | Subsidiaries of the Registrant.                                                                        
| | 23 | .1 |  | Consent of Virchow, Krause & Company, LLP.                                                             
| | 23 | .2 |  | Consent of KPMG LLP.                                                                                   
| | 31 | .1 |  | Certification of Chief Executive Officer pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.
| | 31 | .2 |  | Certification of Chief Financial Officer pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.
| | 32 | .1 |  | Certification of Chief Executive Officer pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.
| | 32 | .2 |  | Certification of Chief Financial Officer pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.

74