10KSB

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-KSB

/x/	Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for fiscal year ended August 31, 2000.
/ /	Transition report under 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.
(Name of Small Business Issuer in Its Charter)

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

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

Securities registered pursuant to Section 12(b) of the Exchange Act: None

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

COMMON STOCK, PAR VALUE $.05 PER SHARE
(Title of Class)

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

    Indicate if no disclosure of delinquent filers in response to Item 405 of Regulation S-B is contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB. / /

    HEI, Inc. revenues for the fiscal year ended August 31, 2000 were $42,799,000.

    The aggregate market value as of November 16, 2000 (based on the closing price as reported by The Nasdaq National Market) of the voting stock held by non-affiliates was approximately $67,000,000.

    As of November 16, 2000, 4,782,196 Common Shares, par value $.05 per share, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

    Portions of the Proxy Statement for Registrant's Annual Meeting of Shareholders to be held January 24, 2001 are incorporated by reference into Part III.

Forward-Looking Statements

This Annual Report includes forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements contain information regarding technology, markets, growth and earnings expectations based on the Company's current assumptions, which involve a number of risks and uncertainties. There are certain important factors that can cause actual results to differ materially from the forward-looking statements, including, without limitation, adverse business or market conditions; the ability of the Company to secure and satisfy customers; the availability and cost of materials from HEI's suppliers; adverse competitive developments; change in or cancellation of customer requirements; and other factors discussed from time to time in the Company's filings with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on forward-looking statements; HEI undertakes no obligation to update these statements to reflect ensuing events or circumstances, or subsequent actual results.

    HEI, Inc. is referred to herein as the Company, unless the context indicates otherwise.

PART I

Item 1. DESCRIPTION OF BUSINESS

(a)

Business Development

HEI, Inc., a Minnesota corporation, was incorporated as Hybrid Electronics Inc. in 1968 and changed its name to HEI, Inc. in 1969. During fiscal year 1999, the Company formed a subsidiary, HEI Export, Inc., as a foreign sales corporation. During fiscal year 2000, the Company acquired Cross Technology, Inc. (Cross), now a wholly-owned subsidiary of HEI. Under the terms of the acquisition, 600,000 shares of HEI common stock were exchanged for all of the outstanding stock of Cross. The transaction has been accounted for as a pooling of interests and, accordingly, all prior period financial information has been restated to include the combined results.

(b)

Business of the Company

Principal Products and Services—HEI, Inc.'s microelectronics division is a designer and manufacturer of ultraminiature microelectronic devices and high technology products incorporating these devices. HEI's custom-built microelectronics are employed in the hearing, medical, telecommunications and industrial markets. The Company's subsidiary, Cross, makes wireless smart cards and other ultra-miniature radio frequency (RF) applications. The Company's Mexico division offers full contract manufacturing services using state of the art equipment and assembly processes. Additionally, the Company's high density interconnect division manufactures and designs high density, high quality flex circuits and high-performance laminate-based substrates.

On November 2, 2000 HEI, Inc. announced the completion of qualification testing for a new line of products to be known as HFC Series. The HFC Series are high frequency chip carriers designed for applications in high speed fiber optic and wireless communications. The new package provides superior performance up to 47GHz. HEI has filed for patent protection on this HFC Series technology as well as the method for high speed electrical testing of completed packages.

On August 24, 2000 HEI, Inc. announced the receipt of a production order for performing alignment of fiber optic devices. HEI's fiber optic alignment process has been qualified by the customer, and HEI has shipped product from two of its divisions; however, the ramp up to production volume has been delayed due to a shortage in customer supplied materials.

Distribution Methods—HEI sells through its Company-employed sales force based at its facilities in Minnesota and Arizona. The Company also sells through independent sales representatives.

Sources and Availability of Raw Materials—There are many sources of raw material supplies available nationally and internationally for Company operations. The manufacture of Company products involves assembly of components purchased from a wide variety of vendors.

Dependence on Single or Few Customers—Following is the approximate percentage of the Company's sales to major customers which accounted for more than 10% of total sales in fiscal years 2000, 1999, and 1998.

Customer	2000		1999		1998
Customer A	42	%	52	%	50	%
Customer B	15	%	—		—
Customer C	11	%	—		—
Customer D	—		13	%	12	%

Competition—In each of its product lines, the Company has significant competition, including users who may produce their own alternative devices. The Company obtains new business by identifying customer needs and engineering its products to meet those needs. It competes on the basis of engineering expertise, quality, service and price to obtain new and repeat orders.

Research and Development—The estimated amount spent on Company-sponsored research and development activities was approximately $1,764,000, $1,343,000 and $852,000 for the years ended August 31, 2000, 1999 and 1998, respectively.

Employees—On August 31, 2000, the Company employed approximately 222 persons of whom one was part-time.

Item 2. DESCRIPTION OF PROPERTY

    The Company owns a 48,000 square foot facility for administration and microelectronics production in Victoria, Minnesota, which was originally completed in August 1981. The facility was expanded during fiscal 1996 from the original 25,000 square feet with an addition of 23,000 square feet to increase production capacity. The Company mortgaged the property to secure the credit facility with LaSalle Business Credit, Inc. In early January, 1999, the Company began leasing a 30,000 square foot facility and a 3,000 square foot facility in Empalme, Mexico and Tucson, Arizona, respectively, for its contract assembly business. In July, 1999, the Company began leasing a 14,000 square foot facility in Tempe, Arizona for its high density interconnect business. In July, 2000, the Company began leasing a 10,000 square foot facility in Chanhassen, Minnesota, for part of its laminate business. The Empalme, Mexico and Tucson, Arizona facilities are leased until January, 2004 and the Tempe, Arizona and Chanhassen, Minnesota facilities are leased until August, 2005.

Item 3. LEGAL PROCEEDINGS

    As of November 16, 2000 there are no material legal proceedings pending against the Company or its properties. From time to time the Company may become involved in routine litigation incidental to its business.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

    None.

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

    The Company's common stock is currently traded on The Nasdaq National Market under the symbol HEII. Below are the high and low closing bid prices for each quarter of fiscal year 2000 and 1999, as reported by Nasdaq.

2000	High		Low
First Quarter	$	6-7/8	$	5-1/4
Second Quarter		16-5/8		6-7/16
Third Quarter		16-1/8		9-1/16
Fourth Quarter		23-1/4		11

1999	High		Low
First Quarter	$	5-5/8	$	4-3/8
Second Quarter		6-1/4		5
Third Quarter		7-1/2		4-3/8
Fourth Quarter		6-15/16		4-7/16

    As of August 31, 2000, the Company had 336 shareholders of record. The Company has not paid any dividends on its common stock since its initial public offering on March 24, 1981 and expects that for the foreseeable future it will follow a policy of retaining earnings in order to finance the continued development of its business. Payment of dividends is within the discretion of the Company's board of directors and will depend upon, among other things, the earnings, capital requirements and operating and financial condition of the Company. In addition, the terms of the Company's agreement with LaSalle Business Credit, Inc. contain restrictions on the Company's ability to pay dividends.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS

HEI, Inc.

Five Year Summary of Selected Financial Information

(In thousands, except per share amounts)

Years Ended August 31		2000			1999		1998			1997			1996
Net sales		$	42,799		$	29,089	$	24,766		$	34,193		$	23,170
Cost of sales			35,544			22,378		19,104			26,320			16,295
Gross profit			7,255			6,711		5,662			7,873			6,875
Operating expenses:
	Selling, general and administrative		6,338			4,623		3,498			3,495			3,273
	Research, development and engineering		1,764			1,343		852			843			849
Acquisition transaction costs			453			—		—			—			—
Severance costs			—			490		—			—			—
Proxy/change of control costs			—			—		5,664			—			—
Gain on sale of product line, net			—			—		—			(215	)		(45	)
Operating income (loss)			(1,300	)		255		(4,352	)		3,750			2,798
Income (loss) before income taxes			(1,527	)		635		(3,772	)		4,197			3,054
Income tax expense (benefit)			(372	)		242		(1,354	)		1,497			764
Net income (loss)		$	(1,155	)	$	393	$	(2,418	)	$	2,700		$	2,290
Net income (loss) per basic share		$	(.24	)	$	.08	$	(.52	)	$	.57		$	.50
Net income (loss) per diluted share		$	(.24	)	$	.08	$	(.52	)	$	.55		$	.49
Weighted average common shares Outstanding:
	Basic		4,726			4,698		4,685			4,735			4,542
	Diluted		4,726			4,701		4,685			4,879			4,698
Balance sheet:
	Working capital	$	5,902		$	8,333	$	12,175		$	15,540		$	10,556
	Total assets		28,936			23,739		23,878			26,264			24,018
	Long-term debt, less current maturities		3,894			3,415		3,835			4,787			5,521
	Shareholders' equity		15,116			15,566		15,135			17,580			14,541

FINANCIAL CONDITION

    The Company's net cash flow used for operating activities for the year ended August 31, 2000, was $5,521,000. A significant component of this operating net cash flow was $1,110,000 from operations before changes in current operating items mainly associated with the start up of the Mexico and high density interconnect divisions and non-capitalized costs associated with the implementation of a new enterprise resource planning system. Additional components include a $5,275,000 increase in accounts receivable, and a $3,623,000 increase in inventories partially offset by a $2,697,000 increase in accounts payable. The increase in accounts receivable and inventories is attributable primarily to the actual and expected increases in revenue. The increase in accounts payable is mainly due to higher levels of inventory and expenses and timing of payments.

    Accounts receivable average days outstanding was 49 days for the year ended August 31, 2000 compared to 36 days for the same period a year ago. Inventory turns were 7.4 turns and 8.7 turns for the years ended August 31, 2000 and 1999, respectively. The increased days outstanding and reduced inventory turns were primarily due to the start up of operations in Mexico.

    Costs and equipment purchases for microelectronics and the high density interconnect business expansion were, in part, funded through the Company's short-term investments, primarily commercial paper, of $3,744,000 from a year ago. The current ratio at the end of fiscal 2000 was 1.6:1 as compared to 2.9:1 at the end of fiscal 1999. The reduced current ratio is principally due to decreased cash and

cash equivalents and short-term investments resulting from investments in the newly established Mexico and High Density Interconnect divisions, increased revolving line of credit and increased accounts payable, partially offset by increased accounts receivable and inventories.

    The Company has available a $5,000,000 revolving line of credit and a $5,000,000 capital expenditure term loan which both expire in August 2003 (see Notes 5 and 6 under Notes to Consolidated Financial Statements). As of August 31, 2000, there were $2,943,000 and $1,665,000 of borrowings under the line of credit and capital expenditure term loan, respectively.

    During fiscal 2000, the Company purchased $4,329,000 of property and equipment primarily for production equipment for the Company's new facilities in Tempe, Arizona, Enpalme, Mexico and Chanhassen, Minnesota. The Company also purchased and implemented a new Enterprise Resource Planning (ERP) applications software system in fiscal 2000.

    During fiscal 2001, the Company intends to expend approximately $3.0 million for manufacturing and facility improvements and capital equipment. These additions will increase manufacturing capacity to meet the anticipated production requirements. It is expected that these expenditures will be funded from operations and external financing.

    The Company believes that its current lending capacity and cash generated from operations will provide sufficient cash flow for the Company to meet its short and long-term debt obligations.

RESULTS OF OPERATIONS

    Sales. 2000 vs. 1999:  Sales in fiscal 2000 increased $13,710,000, or 47%, as compared to fiscal 1999. This increase was primarily in the hearing aid market for microelectronics. Each division (Microelectronics, Cross Technology, Mexico and High Density Interconnect) contributed to the growth in sales. The largest customer accounted for 42% of sales in 2000. The reason for the decrease in the percentage of sales to the Company's largest customer is primarily due to the diversification of the Company's customer base as well as the start up of operations in Mexico.

    1999 vs. 1998:  Sales in fiscal 1999 increased $4,323,000, or 17%, as compared to fiscal 1998. This increase was primarily in the hearing aid and communications markets. The largest customer accounted for 52% of sales in 1999, with sales to this customer up 21% over the prior fiscal year. The business with this customer has grown steadily over the last five years, and currently the Company is producing over 20 different devices for this customer for shipment to multiple locations, both domestic and international.

PERCENTAGE OF SALES

	2000		1999		1998
Sales	100	%	100	%	100	%
Gross profit	17	%	23	%	23	%
Selling, general and Administrative	15	%	16	%	14	%
Research, development and engineering	4	%	5	%	3	%
Acquisition transaction costs	1	%	—		—
Severance costs	—		2	%	—
Proxy/change of control costs	—		—		23	%

    Gross Profit. 2000 vs. 1999:  The Company's gross profit as a percentage of sales was 17% in fiscal 2000, as compared to 23% in fiscal 1999. The reduction in gross profit as a percentage of sales was primarily due to lower margin sales for the Company's Mexico division and Cross operations and start-up costs for the high density interconnect facility. The lower margins for the Company's Mexico division are primarily a result of higher material content on revenue and lower than anticipated sales volumes. The Company expects its gross profit as a percentage of sales will improve in fiscal 2001.

    1999 vs. 1998:  The Company's gross profit as a percentage of sales was 23% in fiscal 1999 and fiscal 1998.

    Operating Expenses. 2000 vs. 1999:  Fiscal 2000 selling, general and administrative and research, development and engineering expenses increased $2,136,000, or 36%, over the previous year. This increase was due to increased selling costs to develop new business and support new operations, non-capitalizable costs associated with implementing a new enterprise resource planning (ERP) system and start-up costs related to the high density interconnect division (which are expensed as incurred) and increased development costs to support future business opportunities. In addition to these costs, the Company incurred $453,000 of acquisition transaction costs related to the acquisition of Cross in March, 2000.

    1999 vs. 1998:  Fiscal 1999 selling, general and administrative and research, development and engineering expenses increased $1,616,000 or 37% over the previous fiscal year. This increase was due to higher legal expense, increased selling expenses, start up costs related to Mexico and high density interconnect operations (which are expensed as incurred) and increased development costs to support future business opportunities. In addition, during the first quarter of fiscal year 1999 the Company incurred $490,000 of costs related to the severance agreement between the Company and Eugene W. Courtney, former Chief Executive Officer. These costs are being paid over a two year period.

    Other Income (Expense), Net. 2000 vs. 1999:  Other income decreased $607,000 to a net expense of $227,000 in fiscal 2000 as compared to fiscal 1999 primarily due to lower investment balances and increased short and long-term debt resulting in higher interest costs.

    1999 vs. 1998:  Other income decreased $200,000, or 34%, in fiscal 1999 as compared to fiscal 1998 primarily due to lower investment balances and less cash received from previously reserved notes receivable.

    Net Income (Loss). 2000 vs. 1999:  The Company had a net loss of $1,155,000 in fiscal 2000 compared to net income of $393,000 in fiscal 1999. The loss in fiscal 2000 was a result of lower gross profit and higher expenses associated with the ramp up of the Mexico and high density interconnect facilities, ERP implementation costs, the Cross acquisition costs and higher debt.

    1999 vs. 1998:  The Company had a net income of $393,000 in fiscal 1999 compared to a net loss of $2,418,000 in fiscal 1998. The increase in fiscal 1999 was primarily a result of increased revenues partially offset by a one-time severance cost of $490,000 and increased costs and expenses associated with new business initiatives, including the start up of the Company's new manufacturing facility in Mexico.

ISSUES AND UNCERTAINTIES

    This Annual Report contains forward-looking statements that are based on the Company's current expectations and involve a number of risks and uncertainties. Factors that may materially affect revenues, expenses and operating results include, without limitation, adverse business or market conditions, the ability of the Company to secure and satisfy customers, the availability and cost of materials from suppliers, adverse competitive developments, and change in or cancellation of customer requirements.

    The forward-looking statements included herein are based on current assumptions that the Company will continue to develop, market, manufacture and ship products on a timely basis, that competitive conditions within the Company's markets will not change materially or adversely, that the Company will continue to identify and satisfy customer needs for products and services, that the Company will be able to retain and hire key personnel, that its equipment, processes, capabilities and resources will remain competitive and compatible with the current state of technology, that risks due to shifts in customer demand will be minimized, and that there will be no material adverse change in the Company's operations or business. Assumptions relating to the foregoing involve judgments that are based on incomplete information and are subject to many factors that can materially affect results. The Company operates in a volatile segment of high technology markets and applications that are subject to rapid change and technical obsolescence.

    Because of these and other factors affecting the Company's operating results, past financial performance should not be considered an indicator of future performance, and investors should not use

historical trends to anticipate results or trends in future periods. The following factors also may materially affect results and therefore should be considered.

    Substantial Fluctuations in Future Operating Results:  The Company has experienced substantial fluctuations in its annual and quarterly operating results, and such fluctuations may continue in future periods. The Company's operating results are affected by a number of factors, many of which are beyond the Company's control. All products manufactured by the Company 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. The Company typically incurs significant start-up costs in the production of a particular product, which costs are expensed as incurred and for which the Company attempts to seek reimbursement from the customer. Accordingly, the Company's level of experience in manufacturing a particular product and its efficiency in minimizing start-up costs will affect the Company's operating results during the periods in which production begins and ramp-up occurs. The efficiencies of the Company in managing inventories and fixed assets, shortages of components or labor, the degree of automation used in the assembly process, fluctuations in material costs and the mix of materials, labor, manufacturing, and overhead costs are also significant factors affecting annual and quarterly operating results. Other factors contributing to fluctuations in the Company's operating results include unforeseen design or manufacturing problems, price competition, functional competition (other means of accomplishing the same or similar packaging end result), the inability to pass on cost overruns, the timing of expenditures in anticipation of increased sales, customer product delivery requirements, and the range of services provided. In addition, the amount and timing of orders placed by a customer may vary 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. Any one of these factors, or a combination thereof, could adversely affect the Company's annual and quarterly results of operations.

    The Company's customers generally require short delivery cycles, and a substantial portion of the Company's backlog is typically scheduled for delivery within 90 days. Quarterly sales and operating results therefore depend in large part on the volume and timing of bookings received during or immediately prior to the quarter, which are difficult to forecast in advance of that time. The short lead-time for the Company's backlog also affects its ability to accurately project production and inventory levels. In addition, a significant portion of the Company's operating expenses is relatively fixed in nature and planned expenditures are based in part on anticipated orders. Any inability to adjust spending quickly enough to compensate for any revenue shortfall may magnify the adverse impact of such revenue shortfall on the Company's results of operations.

    Dependence on Single Industry:  During the past several years, the Company has had significant dependence on a single market. In fiscal 2000, 60% of the Company's revenues came from sales to hearing instrument manufacturers. In addition, the Company has made significant sales in the medical products industry. Each of these industries is characterized by intense competition, relatively short product life cycles, rapid technological change, significant fluctuations in product demand, and significant pressure on vendors to reduce or minimize cost. Although the Company is attempting to reduce its dependence on any single industry, the Company does not expect this historic dependence to change dramatically or quickly. Accordingly, the Company will likely be affected by trends in the industries it serves.

    Customer Concentration:  The Company's customer base is highly concentrated. In fiscal 2000, 1999 and 1998, the Company's two largest customers accounted for 57%, 65% and 62%, respectively, of net sales. Although the Company is reducing this concentration, the Company expects that sales to a relatively small number of original equipment manufacturers ("OEMs") will continue to account for a substantial portion of net revenues for the foreseeable future, and the loss of, or a decline in orders from, one of the Company's key customers would have a material adverse effect on the Company's financial and operating results. The Company is working for diversification such that no one market would account for 40% or more in revenue, no one customer at 25% or greater revenue and no one program at 10% or greater during fiscal year 2001.

    Competition:  The Company operates in a highly competitive industry and competes against several domestic and foreign providers of similar microelectronics design and/or manufacturing services. The Company also faces competition from the internal operations of its current and potential OEM customers and from offshore contract manufacturers, which, because of their lower labor rates and other related factors, enjoy a comparative advantage over the Company with respect to high-volume production. However, the Company believes it can now also offer similar advantages through its new operation in Mexico. The Company expects to continue to encounter competition from other electronics manufacturers that currently provide or may begin to provide contract design and manufacturing services. A number of the Company's competitors may have substantially greater manufacturing, financial, technical, marketing, and other resources than does the Company, and may offer a broader scope and presence of operations on a worldwide basis.

    Significant competitive factors in the microelectronics market include price, quality, design capabilities, responsiveness, testing capabilities, the ability to manufacture in very high volumes and proximity to the customers final assembly facilities. While the Company has competed favorably in the past with respect to these factors, this is a particularly fast changing market, and there can be no assurance that the Company will continue to do so in the future. The trends toward increasingly shorter product cycles and to off-shore production are expected to result in more intense competition as each new customer program is generally open to bidding by the Company's competitors, increasingly including those with off-shore facilities and capabilities. Further, the Company is often one of two or more suppliers on any particular customer requirement and is therefore subject to continuing competition on existing programs. In order to remain competitive in any of its markets, the Company must continually provide timely and technologically advanced design capabilities and manufacturing services, ensure the quality of its products, and compete favorably with respect to turnaround and price. If the Company were to fail to compete favorably with respect to the principal competitive factors in its markets served, the Company's business and operating results would be adversely affected.

    Component Supply and Sources:  Substantially all of the Company's manufacturing services are provided on a turnkey basis in which the Company, in addition to providing design, assembly and testing services, is responsible for the procurement of the components that are assembled by the Company for its customers. Although the Company attempts to minimize margin erosion as a result of component price increases, in certain circumstances it is required to bear some or all of the risk of such price fluctuations, which could adversely affect the Company's profits. To date, the Company has generally been able to negotiate contracts that allow it to shift much of the impact of price fluctuations to the customer; however, there can be no assurance that the Company will be able to do so in all cases. In addition, in order to assure an adequate supply of certain key components that have long procurement lead times, such as integrated circuits, the Company occasionally must order such components prior to receiving formal customer purchase orders for the assemblies that require such components. Failure to accurately anticipate the volume or timing of customer orders can result in component shortages or excess component inventory, which in either case could adversely affect the Company's financial and operating results.

    Some of the assemblies manufactured by the Company require one or more components that are ordered from, or which may be available from, only one source or a limited number of sources. Delivery problems relating to components purchased from any of the Company's key suppliers could have a material adverse impact on the financial performance of the Company. From time to time, the Company's suppliers allocate components among their customers in response to supply shortages. In some cases, supply shortages will substantially curtail production of all assemblies using a particular component. In addition, at various times there have been industry-wide shortages of electronic components. While the Company has not experienced sustained periods of shortages of components in the recent past, there can be no assurance that substantial component shortages will not occur in the future. Any such shortages could have a material adverse effect on the Company's operating results.

    Variability of Customer Requirements and Customer Financing:  The level and timing of orders placed by customers vary due to the customers' attempts to balance their inventory, changes in customers' manufacturing strategies, and variations in demand for the customers' products. Due in part

to these factors, most of the Company's customers do not commit to firm production schedules for more than several weeks in advance of requirements. The Company's inability to forecast the level of customers' orders with certainty makes it difficult to schedule production and optimize utilization of manufacturing capacity. In the past, the Company has been required to increase staffing and incur other expenses in order to meet the anticipated demands of its customers. From time to time, anticipated orders from some of the Company's customers have failed to materialize and delivery schedules have been deferred as a result of changes in a customer's business needs, both of which have adversely affected the Company's operating results. On other occasions, customers have required rapid increases in production that have placed an excessive burden on the Company's resources. There can be no assurance that the Company will not experience similar fluctuations in customer demand in the future. In addition, the Company may carry significant accounts receivable in connection with providing manufacturing services to its customers. Although the Company has not encountered significant problems in collecting on such accounts receivable, if one or more of the Company's principal customers were to become insolvent, or otherwise fail to pay for the services and materials provided by the Company, the Company's operating results and financial condition would be adversely affected.

    Rapid Technological Change:  The Company's customers compete in markets that are characterized by rapid technological change and short product life cycles. In particular, the hearing, medical and telecommunications markets are prone to rapid product obsolescence by new technologies. The microelectronics industry could experience future competition from new or emerging technologies that render existing technology less competitive or obsolete. The inability of the Company to develop technologies or acquire capability to meet the evolving market requirements of its customers could have a material adverse effect on the Company's business, financial condition and results of operations, including the Company's ability to maintain its revenue base.

    Management of Growth:  The Company's sales have varied significantly as customer demand for the Company's products increases and decreases. The Company's future operating results will depend on management's ability to manage periods of both growth and downturn, to be able to hire, train and retain the appropriate number of qualified employees, and to forecast revenues and control expenses. Unexpected declines in revenues, without corresponding and timely reductions in expenses, could have a material adverse effect on the Company's business, results of operations, or financial condition.

    Hiring and Retention of Employees:  The Company's continued growth and success depend to a significant extent on the continued service of senior management and other key employees and the hiring of new qualified employees. Competition for skilled business, product development, technical and other personnel is intense. There can be no assurance that the Company will be successful in recruiting new personnel and retaining existing personnel. None of the Company's employees are subject to a long-term employment agreement, although several key employees are subject to non-competition agreements. The loss of one or more key employees could have a material adverse effect on the growth of the Company.

    Possible Volatility of Stock Price:  The market price of the Company's Common Stock has experienced significant fluctuations and may continue to fluctuate in the future. The market price of the Common Stock may be significantly affected by factors such as changes in requirements or demands for the Company's services, the announcement of new products or product enhancements by the Company or its competitors, technological innovations by the Company or its competitors, quarterly variations in the Company's or its competitors' results of operations, changes in prices of the Company's or its competitors' products and services, changes in revenue and revenue growth rates of the Company, changes in earnings estimates by market analysts, speculation in the press or analyst community, and general market conditions or market conditions specific to particular industries. The stock prices for many companies in the technology sector have experienced wide fluctuations that often have been unrelated to their operating performance. Such fluctuations may adversely affect the market price of the Company's Common Stock.

    Market Risk:  The Company has a limited market risk in terms of the variability of the interest rate on its industrial development revenue bonds. The bonds bear interest at a rate which varies weekly, based on comparative tax exempt issues, and is limited to a maximum of 10%.

ITEM 7. FINANCIAL STATEMENTS

HEI, Inc.

Consolidated Balance Sheets

(Dollars in thousands, except per share amounts)

		August 31, 2000			August 31, 1999
Assets
Current assets:
	Cash and cash equivalents	$	484		$	2,043
	Short-term investments		—			3,744
	Restricted cash		86			295
			570			6,082
	Accounts receivable, net		8,582			3,382
	Inventories		5,869			2,246
	Income taxes receivable		—			109
	Other current assets		807			908
Total current assets			15,828			12,727
Property and equipment:
	Land		216			216
	Building and improvements		4,170			4,030
	Fixtures and equipment		17,265			13,898
	Accumulated depreciation		(10,457	)		(8,904	)
Net property and equipment			11,194			9,240
Restricted cash			—			83
Investment in MSC			1,358			1,468
Other long-term assets			556			221
Total assets		$	28,936		$	23,739
Liabilities and Shareholders' Equity
Current liabilities:
	Revolving line of credit	$	2,943		$	—
	Current maturities of long-term debt		1,107			742
	Accounts payable		4,326			1,629
	Accrued employee related costs		947			1,283
	Accrued liabilities		603			740
Total current liabilities			9,926			4,394
Long-term liabilites, less current maturities			3,894			3,415
Deferred tax liability			—			364
Shareholders' equity:
	Undesignated stock; 5,000,000 shares authorized; none issued		—			—
	Common stock, $.05 par; 10,000,000 shares authorized; 4,776,696 and 4,701,965 shares issued and outstanding		239			235
	Paid-in capital		8,606			7,905
	Retained earnings		6,271			7,426
Total shareholders' equity			15,116			15,566
Total liabilities and shareholders' equity		$	28,936		$	23,739

The accompanying notes are an integral part of the consolidated financial statements.

HEI, Inc.

Consolidated Statements of Operations

(In thousands, except per share amounts)

Years Ended August 31		2000			1999		1998
Net sales		$	42,799		$	29,089	$	24,766
Cost of sales			35,544			22,378		19,104
	Gross profit		7,255			6,711		5,662
Operating expenses:
	Selling, general and administrative		6,338			4,623		3,498
	Research, development and engineering		1,764			1,343		852
Acquisition transaction costs			453			—		—
Severance costs			—			490		—
Proxy/change of control costs			—			—		5,664
Operating income (loss)			(1,300	)		255		(4,352	)
Other income (expense), net			(227	)		380		580
Income (loss) before income taxes			(1,527	)		635		(3,772	)
Income tax expense (benefit)			(372	)		242		(1,354	)
Net income (loss)		$	(1,155	)	$	393	$	(2,418	)
Net income (loss) per common share
	Basic	$	(0.24	)	$	0.08	$	(0.52	)
	Diluted	$	(0.24	)	$	0.08	$	(0.52	)
Weighted average common shares outstanding
	Basic		4,726			4,698		4,685
	Diluted		4,726			4,701		4,685

The accompanying notes are an integral part of the consolidated financial statements.

HEI, Inc.

Statements of Changes in

Consolidated Shareholders' Equity

(Dollars in thousands)

		Common Stock Shares Outstanding		Common Stock Amount Outstanding			Additional Paid-In Capital			Retained Earnings			Total Equity
Balance, August 31, 1997, as previously reported		4,103,176		$	205		$	7,518		$	9,272		$	16,995
Cross Technology, Inc. pooling of interests		600,000			30			376			179			585
Balance, August 31, 1997		4,703,176			235			7,894			9,451			17,580
	Net loss	—			—			—			(2,418	)		(2,418	)
	Issuance of common shares under employee stock purchase and option plans	26,619			1			159			—			160
	Common shares repurchased and retired	(34,600	)		(1	)		(186	)		—			(187	)
Balance, August 31, 1998		4,695,195			235			7,867			7,033			15,135
	Net income	—			—			—			393			393
	Issuance of common shares under employee stock purchase plan	6,770			—			38			—			38
Balance, August 31, 1999		4,701,965			235			7,905			7,426			15,566
	Net loss	—			—			—			(1,155	)		(1,155	)
	Issuance of common shares under employee stock purchase and option plans	74,731			4			438			—			442
	Tax benefit of nonqualified stock options	—			—			199			—			199
	Stock-based compensation	—			—			64			—			64
Balance, August 31, 2000		4,776,696		$	239		$	8,606		$	6,271		$	15,116

The accompanying notes are an integral part of the consolidated financial statements.

HEI, Inc.

Consolidated Statements of Cash Flows

(In thousands)

Years ended August 31		2000			1999			1998
Cash flow from operating activities:
	Net income (loss)	$	(1,155	)	$	393		$	(2,418	)
	Equity in net loss of MSC		110			32			—
	Depreciation and amortization		2,407			1,577			1,530
	Accounts receivable allowance		75			(90	)		(53	)
	Deferred income tax expense (benefit)		(571	)		103			(222	)
	Stock-based compensation and other		244			4			1
Changes in operating assets and liabilities:
	Accounts receivable		(5,275	)		736			(1,100	)
	Inventories		(3,623	)		(531	)		64
	Income taxes		(14	)		1,243			(1,056	)
	Other current assets		(66	)		242			(557	)
	Accounts payable		2,697			(387	)		1,132
	Accrued employee related costs and accrued liabilities		(350	)		31			(155	)
Net cash flow provided by (used for) operating activities			(5,521	)		3,353			(2,834	)
Cash flow from investing activities:
	Purchases of investments		—			(9,536	)		(15,165	)
	Maturities of investments		3,744			13,962			16,170
	Additions to property and equipment		(4,329	)		(3,886	)		(1,072	)
	Investment in MSC		—			(1,500	)		—
	Licensing agreement		—			(129	)		—
	Proceeds from sales of product lines		—			55			237
	Decrease (increase) in restricted cash		292			(378	)		389
Net cash flow provided by (used for) investing activities			(293	)		(1,412	)		559
Cash flow from financing activities:
	Issuance of common stock and other		506			38			159
	Issuance of long-term debt		1,665			250			—
	Repayment of long-term debt		(821	)		(628	)		(900	)
	Increase in deferred financing fees		(38	)		(41	)		(47	)
	Borrowings on revolving line of credit		2,943			—			—
	Repurchase of common shares		—			—			(186	)
Net cash flow provided by (used for) financing activities			4,255			(381	)		(974	)
Net increase (decrease) in cash and cash equivalents			(1,559	)		1,560			(3,249	)
Cash and cash equivalents, beginning of year			2,043			483			3,732
Cash and cash equivalents, end of year		$	484		$	2,043		$	483
Supplemental disclosures of cash flow information:
Interest paid		$	294		$	160		$	201
Income taxes paid			279			229			165

The accompanying notes are an integral part of the consolidated financial statements.

Notes to Consolidated Financial Statements

NOTE 1
Summary of Significant Accounting Policies

    HEI, Inc. and its subsidiaries (the Company) specialize in the design and manufacture of ultraminiature microelectronic devices and high technology products incorporating those devices. The Company also operates a contract manufacturing facility in Mexico as well as a producer of quality flex circuits and high performance laminate based substrates in Arizona.

    Principles of Consolidation.  The consolidated financial statements include the accounts of the Company, HEI Export, Inc. and Cross Technology, Inc., its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

    Business Combination.  On March 3, 2000 HEI acquired Cross Technology, Inc. (Cross), a manufacturer and marketer of wireless Smart Cards and other ultra-miniature radio frequency (RF) applications. Under the terms of the agreement, 600,000 shares of HEI common stock were exchanged for all of the outstanding common stock of Cross. The transaction has been accounted for as a pooling of interests and, accordingly, all prior period consolidated financial statements have been restated to include the combined results of operations, financial position and cash flows of Cross Technology, Inc.

    The following information presents certain income statement data of the separate companies for the periods preceding the acquisition:

			Six Months Ended March 4, 2000			Year Ended August 31, 1999			Year Ended August 31, 1998
(In thousands)
Revenues
	HEI		$	14,127		$	24,323		$	20,805
	Cross Technology			3,359			4,766			3,961
		Consolidated		17,486			29,089			24,766
Operating income (loss)
	HEI			(2,126	)		(718	)		(4,678	)
	Cross Technology			(11	)		973			326
		Consolidated		(2,137	)		255			(4,352	)
Net income (loss)
	HEI			(1,968	)		(223	)		(2,627	)
	Cross Technology			(7	)		616			209
		Consolidated	$	(1,975	)	$	393		$	(2,418	)

    Cash, Cash Equivalents and Short-Term Investments.  The Company considers its investments in all highly liquid debt instruments with original maturities of three months or less at date of purchase to be cash equivalents. The carrying amount approximates fair value because of the short maturity of those instruments. Short-term investments consist mainly of high quality commercial paper with maturities of less than one year. The short-term investments are carried at amortized cost which approximates fair value and are classified as held to maturity.

    Inventories.  Inventories are stated at the lower of cost or market and include materials, labor and overhead costs. The first-in, first-out cost method is used to value inventories.

    Property and Equipment.  Property and equipment are stated at cost. Depreciation and amortization are provided on the straight-line method over the estimated useful lives of the property and equipment. The approximate useful lives of building and improvements are 10-39 years and fixtures and equipment are 3-10 years.

    Maintenance and repairs are charged to expense as incurred. Major improvements and tooling costs are capitalized and depreciated over their estimated useful lives. The cost and accumulated depreciation of property and equipment retired or otherwise disposed of are removed from the related accounts, and any resulting gain or loss charged or credited to operations.

    Capitalized Software.  The Company capitalizes certain costs associated with significant software obtained and developed for internal use. Certain costs are capitalized when both the preliminary project stage is completed and management deems the project will be completed and used to perform the internal function. Capitalization of such costs ceases no later than the point at which the project is substantially complete and ready for its intended purpose.

    Capitalized software costs are amortized over the estimated useful life of the project which is generally 3 years. Capitalized software costs of approximately $1,113,000 and $517,000 are included in fixtures and equipment as of August 31, 2000 and 1999, respectively.

    Long-Lived Assets.  Long-lived assets and certain identifiable intangibles are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. As of August 31, 2000, the Company did not consider any of its assets to be impaired.

    Income Taxes.  Deferred income tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred income tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using currently enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense (benefit) is the tax payable (receivable) for the periods and the change during the period in deferred income tax assets and liabilities.

    Stock-based Compensation.  The Company accounts for stock based compensation under Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees." APB 25 requires compensation cost to be recorded on the date of the grant only if the current market price of the underlying stock exceeds the exercise price. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards Board (SFAS) No. 123, "Accounting for Stock-based Compensation."

    Revenue Recognition.  Revenue and related cost of sales are recognized upon shipment.

    Net Income (Loss) Per Weighted Average Common Share.  Basic earnings per share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding during each period. Diluted earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding assuming the exercise of dilutive stock options. The dilutive effect of the stock options is computed using the average market price of the Company's stock during each period under the treasury stock method.

    Use of Estimates.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

    New Accounting Pronouncements.  In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which, as amended, becomes effective for fiscal years beginning after June 15, 2000.

    SFAS No. 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from change in the value of those derivatives would be accounted for depending on the use and whether the derivatives qualify for hedge accounting. The

effect of adopting SFAS No. 133 is not expected to have a material effect on the Company's financial position or results of operations.

    In December, 1999, the Securities and Exchange Commission (SEC) staff issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101). SAB 101 summarizes certain SEC staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB 101 will be effective for the Company in the fourth quarter of fiscal year 2001. The adoption is not expected to have a material impact on the Company's financial position or results of operations.

NOTE 2
Proxy/Change of Control Costs

    In fiscal year 1998, the Company incurred $5,664,000 of one-time expenses related to proxy contest and change of control costs which resulted from the efforts of Fant Industries Inc. in the second half of the year to gain control of the Board of Directors. These expenses included preparation of proxy materials and other information to shareholders and litigation expenses related to the takeover activity, cash-out payments made to all stock option holders which were required as a result of the change of control and reimbursement to Fant Industries Inc. for its expenses as agreed to by the shareholders. These one-time expenses of $5,664,000 were entirely a cash outlay with the final amounts paid out in the first quarter of fiscal 1999.

NOTE 3
Major Customers, Concentration of Credit Risk and Geographic Data

    Major customers, each of which accounted for more than 10% of the Company's net sales for the years ended August 31, were as follows:

	2000		1999		1998
Customer A	42	%	52	%	50	%
Customer B	15	%	—		—
Customer C	11	%	—		—
Customer D	—		13	%	12	%

    The Company generally sells its products to original equipment manufacturers in the United States and abroad in accordance with supply contracts specific to certain manufacturer product programs. The Company performs ongoing credit evaluations of its customers' financial conditions and, generally, does not require collateral from its customers. The Company's continued sales to these customers are often dependent upon the continuance of the customers' product programs. The Company's ten largest customers accounted for approximately 89%, 90% and 91% of net sales in fiscal years 2000, 1999 and 1998, respectively, and approximately 88% and 89% of accounts receivable at August 31, 2000 and 1999, respectively.

    The Company had net sales of $17,687,000, $14,190,000 and $10,407,000 that were shipped to Singapore in fiscal 2000, 1999 and 1998. Net export sales were $20,026,000, $16,658,000 and $12,761,000 in fiscal 2000, 1999 and 1998, respectively. The majority of the international sales were to multinational companies who instructed HEI to ship products to their own off-shore assembly facilities.

NOTE 4
Other Financial Statement Data

    The following provides additional information concerning selected consolidated balance sheet accounts at August 31, 2000 and 1999:

		2000			1999
(In thousands)
Accounts receivable, net:
	Trade accounts receivable	$	8,797		$	3,522
	Less allowance for doubtful accounts		(215	)		(140	)
		$	8,582		$	3,382
Inventories:
	Purchased parts	$	5,158		$	1,201
	Work in process		418			812
	Finished goods		293			233
		$	5,869		$	2,246
Other current assets:
	Deferred tax assets	$	506		$	673
	Other current assets		301			235
		$	807		$	908
Accrued liabilities:
	Real estate taxes	$	86		$	82
	Income taxes payable		86			209
	Other		431			449
		$	603		$	740

NOTE 5
Long-Term Debt

    Long-term debt consists of the following:

	2000		1999
(Dollars in thousands)
Industrial Development Revenue Bonds payable on a yearly basis with principal installments from $95 to $700 through April, 2011 and variable interest ranging from 3.60% to 5.85% during fiscal year 2000.	$	3,135	$	3,835
Commercial loan payable in fixed monthly installments of $5 at 8.19% interest maturing June, 2004; secured with certain machinery and equipment.		201		239
Capital expenditure note payable on a monthly basis with principal installments of $28 and interest due monthly at the prime rate plus 1/4% (9.75% at August 31, 2000); secured by machinery and equipment and cross collateralized with revolving line of credit and letter of credit facilities.		1,665		—
Employment agreement with monthly payments of $21 and no interest over a two-year period from January, 1998 to December, 2000.		—		83
Total		5,001		4,157
Less current maturities		1,107		742
Total long-term debt	$	3,894	$	3,415

    The notes above are subject to certain restrictive financial covenants, including but not limited to, tangible net worth interest coverage, debt service coverage, annual loss limitations and the ability to declare or pay dividends. The Company was in compliance with all applicable financial covenants at August 31, 2000.

    Principal maturities of long-term debt at August 31, 2000 are as follows (in thousands):

Years ending August 31,
2001	$	1,107
2002		1,083
2003		1,726
2004		400
2005		115
Thereafter		570
	$	5,001

    In April 1996, the Company received proceeds of $5,625,000 from the issuance of Industrial Development Revenue Bonds. Of these funds, approximately $1,500,000 was used for the construction of the new addition to the Company's manufacturing facility, and the remainder was used for equipment purchases. The bonds related to the facility expansion require annual principal payments of $90,000 in the first year and $95,000 on April 1 of each year thereafter through 2011. The bonds related to the purchased equipment require payments over seven years from the date of purchase of the equipment through April 1, 2005. In April and May 2000 and April 1999 the Company repaid $700,000 each year of the construction and equipment bonds. The bonds bear interest at a rate which varies weekly, based on comparable tax exempt issues, and is limited to a maximum rate of 10%. The interest rate at August 31, 2000 was 4.70%. The bonds are collateralized by two irrevocable letters of credit and essentially all property and equipment. A commitment fee is paid annually to the bank at a rate of 1.25% of the letters of credit

    In August 2000, the Company arranged for financing of a capital expenditure loan. According to the terms of the loan, the Company will receive up to $5,000,000 reimbursement for capital equipment expenditures and will make equal monthly payments based on a term of 60 months from when the money is borrowed. The capital expenditure loan is due and payable in August, 2003 or later, contingent on the renewal of the bank agreement.

NOTE 6
Short Term Bank Borrowings

    The Company has a revolving commitment with a financial institution for total borrowings of the lesser of $5,000,000 or the borrowing base, as defined in the agreement, with interest, based on the Company's option, at the prime rate of interest or 2.5% above the LIBOR rate. At August 31, 2000 and during fiscal year 2000 the interest rate on the revolving commitment was 9.5%. The balance outstanding under this commitment was $2,943,000 at August 31, 2000. There was no balance outstanding under this commitment at August 31, 1999. The agreement requires the Company to maintain certain financial covenants. The Company was in compliance with these covenants at August 31, 2000.

NOTE 7
Investment in Micro Substrates Corporation

    On June 24, 1999, the Company obtained an exclusive, worldwide license from Micro Substrates Corporation (MSC) to manufacture and market a new high-frequency chip carrier for applications in Local Multipoint Distribution Services, ultra high-speed Internet routing and satellite communications. In a related transaction, the Company made an initial cash equity investment of $1.5 million in MSC (28%) and will supply goods and services, such as thin film substrate processing, to MSC. The Company's investment in MSC is being accounted for under the equity method. For the years ended August 31, 2000 and 1999, the Company's equity in net losses of MSC were $110,000 and $32,000, respectively, and are included in other income (expense), net.

NOTE 8
Income Taxes

    Income tax expense (benefit) for the years ended August 31 consisted of the following:

(In thousands)		2000			1999		1998
Current:
	Federal	$	—		$	103	$	(1,146	)
	State		—			36		14
Deferred			(372	)		103		(222	)
Income tax expense (benefit)		$	(372	)	$	242	$	(1,354	)

    The components of the deferred tax assets and liabilities at August 31, 2000 and 1999 are as follows:

(In thousands)		2000			1999
Deferred tax assets (short-term):
	Receivables	$	79		$	52
	Inventories		266			213
	Accrued liabilities		161			176
	Net operating loss carry-forward		—			232
			506			673
Deferred tax assets (long-term):
	Net operating loss carry-forward		910			—
	AMT credit carryforward		86			—
	Other		4			—
			1,000			—
Deferred tax liabilities (long-term):
	Property and equipment		(626	)		(364	)
Net deferred tax asset		$	880		$	309

    In the recognition of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Based upon the level of historical taxable income and projections for future taxable income over the periods during which the deferred tax assets are deductible, the Company believes it is more likely than not that the benefit of these deductible differences will be realized.

    Actual income tax expense (benefit) differs from the expected amount based upon the statutory federal tax rates as follows:

	2000		1999		1998
Federal statutory tax rate	(34.0	)%	34.0	%	(34.0	)%
State income tax rate (net of federal tax effect)	(1.9	)	5.0		(3.1	)
Non-deductible acquisition costs	10.1		—		—
Other	1.4		(.9	)	1.2
Effective tax rate	(24.4	)%	38.1	%	(35.9	)%

NOTE 9
Stock Benefit Plans

    1998 Plan.  Under the Company's 1998 Stock Option Plan (the "1998 Plan"), a maximum of 600,000 shares of common stock may be issued pursuant to qualified and nonqualified stock options.

    Stock options granted become exercisable in varying increments with a portion tied to the closing stock price or up to a maximum of eight years, whichever comes first. The exercise price for options granted is equal to the average closing market price of the common stock on the date of the grant.

    At August 31, 2000 and 1999, the number of shares available for grant were 1,800 and 63,700, respectively.

    1989 Plan.  Under the Company's 1989 Omnibus Stock Compensation Plan (the "1989 Plan"), a maximum of 2,000,000 shares of common stock may be issued pursuant to qualified and nonqualified stock options, stock purchase rights and other stock-based awards.

    Stock options granted become exercisable in varying increments with a portion tied to the closing stock price or up to a maximum of eight years, whichever comes first. Generally, the exercise price for options granted is equal to the average closing market price of the common stock on the date of the grant or for the five days preceding the date of grant. At August 31, 2000 there were 150,000 outstanding options under the 1989 Plan.

    Under the 1989 Plan, substantially all regular full-time employees are given the opportunity to designate up to 10% of their annual compensation to be withheld, through payroll deductions, for the purchase of common stock at 85% of the lower of (i) the market price at the beginning of the plan year, or (ii) the market price at the end of the plan year. During fiscal 2000, 1999 and 1998, 14,431, 6,770 and 11,619 shares at prices of $4.59, $4.68 and $5.79, respectively, were purchased under the 1989 Plan.

    At August 31, 2000, 1999 and 1998, the number of shares available for grant were 126,861, 291,292 and 298,062, respectively.

    Directors' Plan.  During fiscal year 1999, the shareholders approved the 1998 Stock Option Plan for Non-employee Directors. This plan replaced and superceded the Company's prior Stock Option Plan for Non-employee Directors. Under the new directors' plan, 425,000 shares are authorized for issuance, with an initial year grant of 55,000 shares and an annual grant thereafter of 10,000 shares to each non-employee director. These grants are effective on the day of the annual shareholders' meeting upon adjournment at an exercise price equal to the market price on the date of grant. The options become exercisable at the earlier of seven years after the grant date or on the first day the market value equals or exceeds $25.00. These options expire ten years after the grant date. Options to purchase 30,000 shares were granted to the three non-employee directors at $10.75 in 2000. Options to purchase 275,000 shares were granted to the five non-employee directors at $5.50 per share in 1999. At August 31, 2000, 295,000 shares remain outstanding and 120,000 shares are available for grant.

    Change of Control.  Under the terms and conditions of the Company's 1989 Plan and the Directors' Plan, a change of control in the Company's Board of Directors, under certain circumstances, requires a liquidation of all unexercised stock options. In fiscal 1998, all stock options were liquidated under this provision. The required payments relating to stock options outstanding due to the change of control liquidation made in fiscal 1998 were approximately $3,700,000 which are included in proxy/change of control costs in the statement of operations.

    Summary of Activity.  The following is a summary of all activity involving options:

	Options Outstanding		Weighted Average Exercise Price Per Share
Balance, August 31, 1997	447,000		$	5.680
Granted	575,000			5.160
Exercised	(15,000	)		5.308
Change of control liquidation	(972,000	)		5.397
Cancelled	(35,000	)		5.305
Balance, August 31, 1998	0			0.000
Granted	629,300			5.610
Cancelled	(18,000	)		5.875
Balance, August 31, 1999	611,300			5.602
Granted	481,000			10.886
Exercised	(60,300	)		6.049
Cancelled	(39,100	)		7.949
Balance, August 31, 2000	992,900		$	8.042

    The following table summarizes information about stock options outstanding as of August 31, 2000:

	Options Outstanding
					Options Exercisable
				Weighted Average Remaining Contractual Life
Range of Exercise Prices	Number of Options	Weighted Average Exercise Price			Number of Options	Weighted Average Exercise Price
$4.438 - $5.75	321,750	$	5.33	8.3	283,750	$	5.43
$5.875 - $7.625	243,900		6.04	8.6	86,400		5.97
$10.00 - $11.75	346,250		10.76	9.5	105,000		10.75
$13.125 - $14.563	81,000		13.21	9.5	20,250		13.21
$4.438 - $14.563	992,900	$	8.04	8.9	495,400	$	6.97

    Accounting for Stock-based Compensation.  Had the Company used the fair-value-based method of accounting for its stock option plans beginning in fiscal year 1997 and charged compensation cost against income over the vesting period, net income (loss) for fiscal years 2000, 1999 and 1998 would have been changed to the following pro forma amounts:

	2000			1999		1998
Net income (loss)	$	(1,899,000	)	$	155,000	$	(2,427,000	)
Net income (loss) per share, diluted	$	(.46	)	$	.04	$	(.59	)

    The weighted average grant-date fair value of options granted during 2000, 1999 and 1998 was $4.48, $3.30 and $1.22, respectively. The weighted average grant-date fair value of options was determined separately for each grant under the Company's various plans by using the fair value of each option grant on the date of grant, utilizing the Black-Scholes option-pricing model and the following key weighted average assumptions:

	2000	1999	1998
Risk-free interest rates	6.00% to 6.70%	6.00% to 6.00%	5.00% to 5.5%
Expected life	.5 to 8 years	.5 to 8 years	.5 to 3 years
Expected volatility	62%	61%	62%
Expected dividends	None	None	None

NOTE 10
Employee Benefit Plans

    The Company has a 401(k) plan covering all eligible employees. Employees can make voluntary contributions to the plan of up to 20% of their compensation not to exceed the maximum specified by the Internal Revenue Code. The plan also provides for a discretionary contribution by the Company. During fiscal years 2000, 1999 and 1998, the Company contributed $130,000, $87,000 and $93,000, respectively, to the plan.

    The Company has a defined benefit cash balance pension plan which was available to all eligible employees of Cross Technology, Inc. prior to the acquisition by the Company. Plan benefits were based upon the employees' years of service and compensation.

		2000			1999
(In thousands)
Change in benefit obligation:
Benefit obligation at beginning of year		$	682		$	446
Service cost			138			203
Interest cost			51			33
Benefit obligation at end of year		$	871		$	682
Change in plan assets:
	Fair value of plan assets at the beginning of year	$	589		$	326
	Actual return on plan assets		88			79
	Employer contribution		207			184
Fair value of plan assets at end of year		$	884		$	589
Funded status:
	Unrecognized actuarial gain	$	(93	)	$	(58	)
	Unrecognized prior service cost		—			66
	Additional liability		—			(8	)
Net amount recognized		$	(93	)	$	—
Amounts recognized in the statement of financial position consist of:
	Accrued benefit liability	$	80		$	93
Weighted-average assumptions as of August 31:
	Discount rate		7.5	%		7.5	%
	Expected return on plan assets		7.5	%		7.5	%
	Rate of compensation increase		—			—
Components of net periodic benefit cost:
	Service cost	$	138		$	203
	Interest cost		51			33
	Expected return on plan assets		(53	)		(31	)
	Amortization of prior service costs		6			7
	Termination, settlement and curtailment costs		60			—
Total benefit cost		$	202		$	212

    The Company intends to terminate the plan and distribute all funds to the participants during fiscal year 2001. As a result, termination, settlement and curtailment costs of $60,000 were recorded for the year ended August 31, 2000.

NOTE 11
Commitments

    Future commitments under non-cancelable operating leases, primarily for manufacturing equipment, are approximately $488,000 in 2001, $422,000 in 2002, $245,000 in 2003, $202,000 in 2004,

$188,000 in 2005. Total expense under non-cancelable operating leases was approximately $533,000 in 2000, $457,000 in 1999 and $227,000 in 1998.

NOTE 12
Severance Costs

    In fiscal year 1999, the Company incurred $490,000 of severance costs related to the severance agreement between the Company and Eugene W. Courtney, former Chief Executive Officer. These costs are being paid over a two year period. Restricted cash on the balance sheet represents an investment pledged as payment on a severance agreement, is held in a separate account, and will be released to the Company's regular accounts in fiscal years 2000 and 2001 as the obligation is paid.

NOTE 13
Net Income (Loss) Per Weighted Average Share Computation

    The components of net income (loss) per basic and diluted share are as follows:

	2000			1999		1998
(In thousands, except per share amounts)
Basic:
Net income (loss)	$	(1,155	)	$	393	$	(2,418	)
Net income (loss) per share	$	(.24	)	$	.08	$	(.52	)
Weighted average number of common shares outstanding		4,726			4,698		4,685
Diluted:
Net income (loss)	$	(1,155	)	$	393	$	(2,418	)
Net income (loss) per share	$	(.24	)	$	.08	$	(.52	)
Weighted average number of common shares outstanding		4,726			4,698		4,685
Assumed conversion of stock options		—			3		—
Weighted average common and assumed conversion shares		4,726			4,701		4,685

    During fiscal year 2000, 1999 and 1998 approximately 993,000, 608,000 and 0 stock options, respectively, have been excluded from the diluted net income (loss) per common share calculation as they are antidilutive.

NOTE 14
Segment Information

    The Company has concluded that it operates in one operating segment.

    The Company has a plant in Empalme, Mexico which began operations in fiscal year 2000. This plant had net sales of $3,326,000 in fiscal year 2000. Net property plant and equipment as of August 31, 2000 located at the Empalme, Mexico facility is $1,172,000.

NOTE 15
Subsequent Event

    During the first quarter of fiscal year 2001, the Company intended to acquire and subsequently merge with Colorado MEDtech, Inc. (CMED) by initially agreeing to purchase approximately 10% of CMED's outstanding shares from CMED's largest shareholder, Anthony J. Fant, CEO of HEI, Inc. Later in the quarter the Company and CMED's largest shareholder mutually agreed to rescind and unwind its purchase of those shares. In connection with this proposed transaction, the Company will incur approximately $161,000 of non-cash expenses in the first quarter of fiscal year 2001.

Report of Independent Auditors'

To the Shareholders of HEI, Inc.:

    We have audited the accompanying consolidated balance sheets of HEI, Inc. and subsidiaries as of August 31, 2000 and 1999 and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended August 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

    We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

    In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial positions of HEI, Inc. and subsidiaries as of August 31, 2000 and 1999 and the results of their operations and their cash flows for each of the years in the three-year period ended August 31 2000, in conformity with accounting principles generally accepted in the United States of America.

KPMG LLP

Minneapolis, Minnesota
October 20, 2000

Statement of Financial Responsibility

    The accompanying consolidated financial statements, including the notes thereto, and other financial information presented in this Annual Report, were prepared by management, which is responsible for their integrity and objectivity. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include amounts that are based upon management's best estimates and judgments.

    The Company maintains a system of internal accounting controls designed to provide reasonable assurance that the Company's assets are protected and that transactions are executed in accordance with established authorizations and are recorded properly. The reasonable assurance concept is based on recognition that the cost of a system of internal accounting controls should not exceed the benefit derived.

    The Audit Committee of the Board of Directors is responsible for recommending the independent accounting firm to be retained for the coming year. The Audit Committee meets periodically and privately with the independent accountants, as well as with management, to review accounting, auditing, and financial reporting matters.

    The Company's independent certified public accountants, KPMG LLP, are engaged to audit the consolidated financial statements of the Company and to issue their report thereon. See the accompanying Report of Independent Auditors'.

Summary of Quarterly Operating Results (unaudited)
(In thousands, except per share amounts)

Fiscal Year 2000		First			Second			Third		Fourth
Net sales		$	8,094		$	9,392		$	11,589	$	13,724
Gross profit			1,299			1,025			2,386		2,545
Acquisition transaction costs			—			453			—		—
Operating income (loss)			(447	)		(1,690	)		342		495
Net income (loss)			(319	)		(1,656	)		361		459
Net income (loss) per share
	Basic	$	(.07	)	$	(.35	)	$	.08	$	.10
	Diluted	$	(.07	)	$	(.35	)	$	.07	$	.09

Fiscal Year 1999		First			Second		Third			Fourth
Net sales		$	7,437		$	8,301	$	6,329		$	7,022
Gross profit			1,601			2,060		1,392			1,658
Severance costs			490			—		—			—
Operating income (loss)			(198	)		540		(8	)		(79	)
Net income (loss)			(88	)		398		131			(48	)
Net income (loss) per share
	Basic	$	(.02	)	$	.08	$	.03		$	(.01	)
	Diluted	$	(.02	)	$	.08	$	.03		$	(.01	)

NOTE:

The summation of quarterly net income (loss) per share for 2000 does not equate to the calculation for the year on a diluted basis since the quarterly calculations are performed on a discrete basis.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

    On September 3, 1998, PricewaterhouseCoopers LLP resigned as independent accountants for the Company. During the two most recent years through the date of resignation, there were no disagreements with PricewaterhouseCoopers LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. PricewaterhouseCoopers LLP's report on the Company's consolidated financial statements for the two most recent years through the date of resignation did not contain an adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles.

    The Company selected KPMG LLP, upon the approval of the Board, to be its independent certified public accountants for fiscal 1998, 1999 and again for 2000. The Board has also approved the selection of KPMG LLP to be its independent certified public accountants for fiscal 2001.

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT

    The information regarding directors called for by Item 9 is contained in the Proxy Statement under the caption "Election of Directors" and is incorporated herein by reference.

    The following is a list of HEI, Inc. executive officers, their ages, positions and offices as of November 16, 2000.

Name	Age	Position
Anthony J. Fant	40	Chairman and Chief Executive Officer
Donald R. Reynolds	42	President and Chief Operating Officer
Steve E. Tondera, Jr.	37	Chief Financial Officer, Treasurer, Secretary, Vice President Finance and Director
W. Thomas Goodnow	47	Vice President Sales and Marketing
Stephen K. Petersen	48	Vice President Operations

BUSINESS EXPERIENCE

    ANTHONY J. FANT became Chief Executive Officer of the Company in November 1998. Mr. Fant has been a director, President and Chief Executive Officer of Fant Industries, LLC, and Fant Broadcasting Company (including, for these purposes, various affiliated companies engaged primarily in television and radio broadcasting) since 1986. From 1986 to 1996, Fant Broadcasting Company acquired, built or managed a number of television and radio stations. Mr. Fant currently owns a number of businesses in diverse industries.

    DONALD R. REYNOLDS joined the Company in March 1998 as Executive Vice President and was appointed President in April 1998 and Chief Operating Officer in January 1999. Before joining the Company, he was employed with BF Goodrich Aerospace in senior executive positions in product engineering, marketing and business unit management, and most recently as Business Unit Director for a business unit having approximately $30 million in revenues. This business unit designed and manufactured high technology products (sensors, electronics, software) for the aerospace industry.

    STEVE E. TONDERA, JR. joined the Company in January, 1999 as Managing Director of HEI-Mexico Division and became Chief Financial Officer and Treasurer in June, 2000. Mr. Tondera has been Senior Vice President and Chief Financial Officer of Fant Broadcasting Company (including, for these purposes, various affiliated companies engaged primarily in television and radio broadcasting) since 1994.

    WILLIAM T. GOODNOW joined the Company in June of 1999 as Vice President of Sales and Marketing. He was made an officer in September 2000. Before joining the Company, he was employed as the Director of Sales for GSI Incorporated, Laser Systems Division.

    STEPHEN K. PETERSEN joined the Company in March 1998 as Director of Manufacturing. He was appointed Vice President of Operations in September 2000. Before joining the Company, he was employed with Sheldahl in a variety of positions ranging from Engineer to Plant Manager and most recently as the Operations Manager.

    The information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 called for by Item 9 is contained in the Proxy Statement under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" and is incorporated herein by reference.

ITEM 10. EXECUTIVE COMPENSATION

    The information called for by Item 10 is contained in the Proxy Statement under the captions "Executive Officers and Executive Compensation" and is incorporated herein by reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

    The information called for by Item 11 is contained in the Proxy Statement under the caption "Shares and Principal Shareholders" and is incorporated herein by reference.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

    The information called for by Item 12 is contained in the Proxy Statement under the caption "Executive Officers and Executive Compensation—Change in Control Agreements" and "Certain Relationships and Related Transactions" and is incorporated herein by reference.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a)

The following documents are filed as part of this report:



(1)

Financial Statements—see Part II




(b)

Reports on Form 8-K: HEI filed one Form 8-K during the fourth quarter of FY2000 on August 31, 2000.

(c)

Exhibits:

2.1	Cross Technology, Inc., Agreement and Plan of Reorganization	Note 7
3.1	Restated Articles of Incorporation, as amended.	Note 1
3.2	Bylaws, as amended.	Note 6
†4.1	Loan and Security Agreement with LaSalle Bank, N.A. dated July 31, 2000.	Note 2
†4.2	Capital Expenditure Note with LaSalle Bank, N.A. dated July 31, 2000.	Note 2
†4.3	Reimbursement Agreement by and between HEI, Inc. and LaSalle Bank, N.A. dated July 31, 2000.	Note 2
†4.4	Mortgage, Security Agreement, Fixture Financing Statement and Assignment of Leases and Rents by HEI, Inc. as Mortgagor to LaSalle Bank, N.A. as Mortgagee dated July 31, 2000.	Note 2
†4.5	Patent, Trademark and License Mortgage by HEI, Inc. in favor of LaSalle Bank, N.A. dated July 31, 2000.	Note 2
†4.6	Security Agreement with LaSalle Bank, N.A. dated July 31, 2000.	Note 2
†4.7	Revolving Note with LaSalle Bank, N.A. dated July 31, 2000.	Note 2
10.1	Form of Indemnification Agreement between HEI and officers and directors.	Note 3
*10.2	HEI 1989 Omnibus Stock Compensation Plan adopted April 3, 1989, as amended to date.	Note 4
*10.3	1991 Stock Option Plan for Non-employee Directors, as amended to date.	Note 5
*10.4	1998 Stock Option Plan adopted November 18, 1998.	Note 6
*10.5	1998 Stock Option Plan for Non-employee Directors adopted November 18, 1998.	Note 6
†21	Subsidiaries of the Registrant
†23	Consent of KPMG LLP.
27	Financial Data Schedule

Notes to Exhibits above:

(1)

Filed as an exhibit to Annual Report on Form 10-K for the year ended August 31, 1990, and incorporated herein by reference.

(2)

Filed as an exhibit to this Form 10-KSB for the fiscal year ended August 31, 2000.

(3)

Filed as an exhibit to Registration Statement on Form S-2 (SEC No. 33-37285) filed October 15, 1990, and incorporated herein by reference.

(4)

Filed as an exhibit to Annual Report on Form 10-KSB for the year ended August 31, 1996 and incorporated herein by reference.

(5)

Filed as an exhibit to Annual Report on Form 10-KSB for the year ended August 31, 1997 and incorporated herein by reference.

(6)

Filed as an exhibit to Annual Report on Form 10-KSB for the year ended August 31, 1998 and incorporated herein by reference.

(7)

Filed as a Form 8-K on March 21, 2000.

*

Denotes management contract or compensation plan or arrangement.

†

Filed herewith.

SIGNATURES

    In accordance with Section 13 or 15(c) of the Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized

HEI, INC.
BY:	/s/ ANTHONY J. FANT Anthony J. Fant Chairman and Chief Executive Officer
Date:	November 29, 2000

    In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

/s/ ANTHONY J. FANT Anthony J. Fant, Chairman and Chief Executive Officer	November 29, 2000 Date
/s/ STEVE E. TONDERA, JR. Steve E. Tondera, Jr., Chief Financial Officer, Treasurer, Secretary, Vice President of Finance and Director	November 29, 2000 Date
/s/ CRAIG E. ROBLE Craig E. Roble, Company Controller	November 29, 2000 Date
/s/ EDWIN W. FINCH, III Edwin W. Finch, Director	November 29, 2000 Date
/s/ DAVID W. ORTLIEB David W. Ortlieb, Director	November 29, 2000 Date
/s/ MACK V. TRAYNOR, III Mack V. Traynor, III, Director	November 29, 2000 Date

Corporate Information

Board of Directors

Anthony J. Fant, Chairman
Chief Executive Officer of the Company,
President and Chief Executive Officer,
Fant Industries LLC

Edwin W. Finch, III
President, FHL Capital Corporation

David W. Ortlieb
Independent Management Consultant
Chairman of Cronus BioPharma, Inc.

Steve E. Tondera, Jr.
Chief Financial Officer of the Company

Mack V. Traynor, III
President
Manitou Investments

Corporate Officers and Management

Anthony J. Fant
Chief Executive Officer

Donald R. Reynolds
President and Chief Operating Officer

Steve E. Tondera, Jr.
Chief Financial Officer, Treasurer, Secretary
and Vice President of Finance

W. Tom Goodnow
Vice President of Sales and Marketing

Stephen K. Petersen
Vice President of Operations

Scott M. Stole
Director of Advanced Process Development

Robert R. Shue
Director of Design Engineering

Wray A. Wentworth
Director of Corporate Quality

Tim Love
General Manager of HEI-Mexico Division

Jeffrey Flammer
General Manager of HEI-High Density
Interconnect Division

General Counsel
Weil, Gotshal & Manges LLP
New York, New York

Gray Plant Mooty
Minneapolis, Minnesota

Independent Certified Public
Accountants
KPMG LLP
Minneapolis, Minnesota

Stock Transfer Agent
and Registrar
Wells Fargo Bank Minnesota, N.A.
Box 64854
161 North Concord Exchange
South St. Paul
Minnesota 55075-0738

Corporate Headquarters
HEI, Inc.
P.O. Box 5000
1495 Steiger Lake Lane
Victoria, Minnesota 55386-5000
(952) 443-2500
E-mail: headqtrs@heii.com
Internet: www.heii.com

Form 10-KSB
A copy of the Company's Annual Report to the Securities and Exchange Commission on Form 10-KSB is available without charge by written or oral request to:

Shareholder Relations
HEI, Inc.
P.O. Box 5000
Victoria, Minnesota 55386
Phone (952) 443-2500
Facsimile (952) 443-2668

Annual Meeting of Shareholders
The Company's annual meeting of shareholders will be held on January 24, 2001 at 3:00 PM at The Planets (50th floor), IDS Center, 80 South Eighth Street, Minneapolis, Minnesota

QuickLinks

PART I
PART II

FINANCIAL CONDITION
RESULTS OF OPERATIONS
PERCENTAGE OF SALES
ISSUES AND UNCERTAINTIES

Notes to Consolidated Financial Statements

NOTE 1 Summary of Significant Accounting Policies
NOTE 2 Proxy/Change of Control Costs
NOTE 3 Major Customers, Concentration of Credit Risk and Geographic Data
NOTE 4 Other Financial Statement Data
NOTE 5 Long-Term Debt

NOTE 6 Short Term Bank Borrowings
NOTE 7 Investment in Micro Substrates Corporation
NOTE 8 Income Taxes
NOTE 9 Stock Benefit Plans

NOTE 10 Employee Benefit Plans
NOTE 11 Commitments
NOTE 12 Severance Costs
NOTE 13 Net Income (Loss) Per Weighted Average Share Computation
NOTE 14 Segment Information
NOTE 15 Subsequent Event

Report of Independent Auditors'

Statement of Financial Responsibility

Summary of Quarterly Operating Results (unaudited) (In thousands, except per share amounts)

PART III

SIGNATURES

EX-4.1

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EXHIBIT 4.1

LOAN AND SECURITY AGREEMENT

Dated as of July 31, 2000

among

HEI, Inc., a Minnesota corporation

as Borrower

and

LASALLE BUSINESS CREDIT, INC.
as Lender

$5,000,000 Revolving Line of Credit

$5,000,000 Non-Revolving Capital Expenditure Line of Credit

$3,500,000 Irrevocable Standby Letter of Credit Facility

TABLE OF CONTENTS

1.	DEFINITIONS	1
2.	REVOLVING LOANS	9
3.	CAPITAL EXPENDITURE LOANS	9
4.	LETTERS OF CREDIT	10
5.	INTEREST, FEES AND CHARGES	11
6.	LOAN ADMINISTRATION	12
7.	GRANT OF SECURITY INTEREST TO LASALLE	15
8.	PRESERVATION OF COLLATERAL AND PERFECTION OF SECURITY INTERESTS THEREIN	15
9.	POSSESSION OF COLLATERAL AND RELATED MATTERS	15
10.	COLLECTIONS	16
11.	SCHEDULES AND REPORTS	17
12.	TERMINATION	19
13.	REPRESENTATIONS AND WARRANTIES	19
14.	COVENANTS	23
15.	CONDITIONS PRECEDENT	27
16.	DEFAULT	28
17.	REMEDIES UPON AN EVENT OF DEFAULT	29
18.	INDEMNIFICATION	30
19.	NOTICES	30
20.	CHOICE OF GOVERNING LAW AND CONSTRUCTION	30
21.	FORUM SELECTION AND SERVICE OF PROCESS	31
22.	MODIFICATION AND BENEFIT OF AGREEMENT	31
23.	HEADINGS OF SUBDIVISIONS	31
24.	POWER OF ATTORNEY	31
25.	WAIVER OF JURY TRIAL; OTHER WAIVERS; CONFIDENTIALITY	31
EXHIBIT A—BUSINESS AND COLLATERAL LOCATIONS
EXHIBIT B—OFFICER'S CERTIFICATE
SCHEDULE 1(A)—PERMITTED LIENS
SCHEDULE 13(I)—LITIGATION
SCHEDULE 13(Q)—INDEBTEDNESS
SCHEDULE 13 (S)—PARENTS, SUBS, JOINT VENTURES AND PARTNERSHIPS
SCHEDULE 13(V)—BENEFIT PLANS; NON-COMPLIANCE
SCHEDULE 14(P)—BONUS PLAN
SCHEDULE 15(A)(I)—CLOSING AGENDA

i

LOAN AND SECURITY AGREEMENT

THIS LOAN AND SECURITY AGREEMENT ("Agreement") is made as of this 31st day of July, 2000, by and between LASALLE BUSINESS CREDIT,  INC., a Delaware corporation ("LaSalle"), with a principal office at 135 South LaSalle Street, Chicago, Illinois 60603, and HEI, Inc., a Minnesota corporation ("Borrower"), with its principal office at 1495 Steiger Lake Lane, Victoria, Minnesota 55386.

WITNESSETH:

WHEREAS, from time to time Borrower may request LaSalle to make loans and advances to and extend certain credit accommodations to Borrower, and the parties wish to provide for the terms and conditions upon which such loans, advances and credit accommodations shall be made;

NOW, THEREFORE, in consideration of any loans, advances and credit accommodations (including any loans by renewal or extension) hereafter made to Borrower by LaSalle, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged by Borrower, the parties agree as follows:

1.

DEFINITIONS

(a)

General Definitions

    "Account," "Account Debtor," "Chattel Paper," "Documents," "Equipment," "General Intangibles," "Goods," "Instruments," "Investment Property," and "Inventory," shall have the respective meanings assigned to such terms, as of the date of this Agreement, in the Minnesota Uniform Commercial Code.

    "Affiliate" shall mean any Person directly or indirectly controlling, controlled by or under common control with Borrower.

    "Benefit Plan" shall mean an employee pension benefit plan of any Borrower or an ERISA Affiliate, as defined in Section 3(2) of ERISA, which is subject to Title IV of ERISA, each of which is specified on Schedule 13(v) attached hereto.

    "Bond Documents" shall mean, collectively, the Loan Agreement and the Indenture.

    "Bonds" shall mean the $5,625,000 Variable Rate Demand Industrial Development Revenue Bonds, Series 1996 A and B (HEI, Inc. Project) issued by the City of Victoria, Minnesota.

    "Borrowing Base" shall have the meaning specified in paragraph 2(b)(i) hereof.

    "Breakage Costs" shall have the meaning specified in paragraph 6(c)(iv) hereof.

    "Business Day" shall mean (i) any day other than a Saturday, Sunday, or such other day as banks in Chicago, Illinois are authorized or required to be closed for business, and (ii) with respect to notices and determinations in connection with LIBOR Loans, any day included in (i) above and which is also a day for trading by and between banks in U.S. dollar deposits in London, England.

    "Capex Loan" shall have the meaning specified in paragraph 3 hereof.

    "Capex Note" shall mean, collectively or individually, as the context requires, the capital expenditure notes in the maximum aggregate original principal amount equal to the amount of the Capex Loan, to be executed by Borrower to the order of LaSalle from time to time pursuant to paragraph 3(a) hereof, in the form attached hereto as Exhibit C.

    "Capital Expenditures" shall mean, with respect to any period, the aggregate of all expenditures (whether paid in cash or accrued as liabilities and including expenditures for capitalized lease obligations) by Borrower and all Affiliates of Borrower, during such period that are required by GAAP to be included in or reflected by the property, plant or equipment or similar fixed asset accounts (or in intangible accounts subject to amortization) in the balance sheet of Borrower and all such Affiliates.

    "Closing Agenda" shall have the meaning specified in paragraph 15(a)(i) hereof.

    "Closing Date" shall mean the date first stated above.

    "Collateral" shall mean all of the personal property of Borrower described in paragraph 7 hereof, all of the real property of Borrower described in the Mortgage and all other real or personal property of any Obligor or any other Person now or hereafter pledged to LaSalle to secure, either directly or indirectly, repayment of any of the Liabilities.

    "Continuation" shall have the meaning specified in paragraph 6 hereof.

    "Conversion" shall have the meaning specified in paragraph 6 hereof.

    "Debt Service Coverage Ratio" shall mean, with respect to any period, and on an aggregate basis including the Borrower and all Affiliates of the Borrower, the ratio of (i) net income after taxes for such period (excluding any after-tax gains or losses on the sale of assets (other than the sale of Inventory in the ordinary course of business) and excluding other after-tax extraordinary gains or losses), plus deferred taxes, plus depreciation and amortization deducted in determining net income for such period, minus Capital Expenditures for such period not financed, minus any cash dividends paid or accrued and cash withdrawals paid or accrued to shareholders or other Affiliates for such period which were not calculated in determining net income after taxes, and plus the after-tax increase in LIFO reserves or minus the after tax decrease in LIFO reserves, to (ii) current principal maturities of long term debt and capitalized leases paid or scheduled to be paid during such period, plus any prepayments on indebtedness owed to any Person (except trade payables and revolving loans) and paid during such period.

    "Default" shall mean any event, condition or default which with the giving of notice, the lapse of time or both would be an Event of Default.

    "Dilution" shall mean, with respect to any period, the percentage obtained by dividing: (a) the sum of non-cash credits against Accounts of Borrower for such period, plus pending or probable, but not yet applied, non-cash credits against Accounts of Borrower for such period, as determined by LaSalle, by (b) gross invoiced sales of Borrower for such period.

    "EBITDA" shall mean, with respect to any period, and on an aggregate basis including the Borrower and all Affiliates of the Borrower, net income after taxes for such period (excluding any after-tax gains or losses on the sale of assets and excluding other after-tax extraordinary gains or losses) plus interest expense, income tax expense, depreciation and amortization for such period, less gains and losses attributable to any fixed asset sales made during such period, plus or minus any other non-cash charges or gains which have been subtracted or added in calculating net income after taxes for such period.

    "Eligible Account" shall mean an Account owing to Borrower which is acceptable to LaSalle in its sole discretion for lending purposes. LaSalle shall, in general, consider an Account to be an Eligible Account if it meets, and so long as it continues to meet, the following requirements:

     (i) it is genuine and in all respects is what it purports to be;

    (ii) it is owned by Borrower and Borrower has the right to subject it to a security interest in favor of LaSalle;

    (iii) it arises from (A) the performance of services by Borrower and such services have been fully performed and acknowledged and accepted by the Account Debtor thereunder; or (B) the sale of Goods by Borrower, and such Goods have been completed in accordance with the Account Debtor's specifications (if any) and delivered to and accepted by the Account Debtor, such Account Debtor has not refused to accept and has not returned or offered to return any of the Goods, or has not refused to accept any of the services, which are the subject of such Account,

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and Borrower has possession of, or has delivered to LaSalle at LaSalle's request, shipping and delivery receipts evidencing delivery of such Goods;

    (iv) it is evidenced by an invoice rendered to the Account Debtor thereunder, is due and payable within sixty (60) days after the stated invoice date thereof and does not remain unpaid more than ninety (90) days past the stated invoice date thereof; provided, however, that if more than twenty-five percent (25%) of the aggregate dollar amount of invoices owing by a particular Account Debtor remain unpaid for more than ninety (90) days past the respective invoice dates thereof, then all Accounts owing to Borrower by that Account Debtor shall be deemed ineligible; provided, further, that the ninety (90) day periods set forth above shall instead be sixty (60) days with respect to Accounts owed by Sonic Innovations;

    (v) it is not subject to any prior assignment, claim, lien, security interest or encumbrance whatsoever, other than Permitted Liens;

    (vi) it is a valid, legally enforceable and unconditional obligation of the Account Debtor thereunder, and is not subject to setoff, counterclaim, credit, allowance or adjustment by such Account Debtor, or to any claim by such Account Debtor denying liability thereunder in whole or in part;

   (vii) it does not arise out of a contract or order which fails in any material respect to comply with the requirements of applicable law;

   (viii) the Account Debtor thereunder is not a director, officer, employee or agent of Borrower, or a Subsidiary, Parent or Affiliate of Borrower;

    (ix) it is not an Account with respect to which the Account Debtor is the United States of America or any department, agency or instrumentality thereof, unless Borrower assigns its right to payment of such Account to LaSalle pursuant to, and in full compliance with, the Assignment of Claims Act of 1940, as amended;

    (x) it is not an Account with respect to which the Account Debtor is located in a state which requires Borrower, as a precondition to commencing or maintaining an action in the courts of that state, either to (A) receive a certificate of authority to do business and be in good standing in such state, or (B) file a notice of business activities report or similar report with such state's taxing authority, unless (x) Borrower has taken one of the actions described in clauses (A) or (B), (y) the failure to take one of the actions described in either clause (A) or (B) may be cured retroactively by Borrower at its election, or (z) Borrower has proven, to LaSalle's satisfaction, that it is exempt from any such requirements under any such state's laws;

    (xi) it is an Account which arises out of a sale made in the ordinary course of Borrower's business;

   (xii) the Account Debtor is a resident or citizen of, and is located within, the United States of America or Canada; provided, however, that Siemens Medical Instruments and its subsidiaries shall be excluded from the requirement set forth in this clause (xii);

   (xiii) it is not an Account with respect to which the Account Debtor's obligation to pay is conditional upon the Account Debtor's approval of the Goods or services or is otherwise subject to any repurchase obligation or return right, as with sales made on a bill-and-hold, guaranteed sale, sale on approval, sale or return or consignment basis;

   (xiv) it is not an Account (A) with respect to which any representation or warranty contained in this Agreement is untrue or (B) which violates any of the covenants of Borrower contained in this Agreement;

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   (xv) it is not an Account which, when added to a particular Account Debtor's other indebtedness to Borrower, exceeds the lesser of ten percent (10%) of the aggregate of Borrower's Accounts or a credit limit determined by LaSalle in its reasonable credit judgment for that Account Debtor, provided, however, that the 10% credit limit set forth herein shall instead be (A) 20% for Accounts owed by Lucent Technologies, (B) 15% for Accounts owed by AMP, Inc., (C) 50% for Accounts owed by Siemens Medical Instruments, through the date which is one (1) year after the Closing Date, and 40% thereafter, and (D) 20% for Accounts owed by Sonic Innovations which are paid within sixty (60) days after the applicable stated invoice date; provided, further, that Accounts excluded from Eligible Accounts solely by reason of this paragraph 1(a)(xv) shall be Eligible Accounts to the extent of the applicable credit limit;

   (xvi) it is not an Account with respect to which the prospect of payment or performance by the Account Debtor is or will be impaired, as determined by LaSalle in its sole discretion.

    "Environmental Laws" shall mean all federal, state, district, local and foreign laws, rules, regulations, ordinances, and consent decrees relating to health, safety, hazardous substances, pollution and environmental matters, as now or at any time hereafter in effect, applicable to Borrower's business or facilities owned or operated by Borrower, including laws relating to emissions, discharges, releases or threatened releases of pollutants, contamination, chemicals, or hazardous, toxic or dangerous substances, materials or wastes into the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata) or otherwise relating to the generation, manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of Hazardous Materials.

    "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended, and all references to sections thereof shall include such sections and any predecessor and successor provisions thereto.

    "ERISA Affiliate" shall mean any member of a controlled group of entities as determined under Section 414(b), (c), (m), or (o) of the IRC, of which the Borrowers are a member.

    "Event of Default" shall have the meaning specified in paragraph 16 hereof.

    "Excess Availability" shall mean, as of any date of determination by LaSalle, the excess, if any, of (i) the Borrowing Base over (ii) the outstanding Revolving Loans and Letter of Credit Obligations, in each case as of the close of business on such date. For purposes of calculating Borrower's Excess Availability and the amount of the Borrowing Base relating thereto, all of Borrower's trade payables and outstanding debt, other than the Liabilities hereunder, which remain unpaid more than thirty (30) days after the due dates thereof shall, on the date of the determination of Excess Availability, be deemed to have been paid by Borrower.

    "Exhibit A" shall mean the exhibit entitled "Exhibit A—Business and Collateral Locations" which is attached hereto and made a part hereof.

    "Exhibit B" shall mean the exhibit entitled Exhibit B—Officer's Certificate, which is attached hereto and made a part hereof.

    "Exhibit C" shall mean the exhibit entitled Exhibit C—Form of Capex Note, which is attached hereto and made a part hereof.

    "Fiscal Year" shall mean with respect to Borrower, the twelve (12) month accounting period of Borrower commencing September 1 of each calendar year and ending August 31 of such calendar year.

    "GAAP" shall mean generally accepted accounting principles and policies in the United States as in effect from time to time.

    "Guarantor" shall mean Cross Technology, Inc., a Minnesota corporation.

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    "Guaranty" shall mean the guaranty by corporation of even date herewith, executed by the Guarantor in favor of LaSalle.

    "Hazardous Materials" shall mean any hazardous, toxic or dangerous substance, materials and wastes, including, without limitation, hydrocarbons (including naturally occurring or man-made petroleum and hydrocarbons), flammable explosives, asbestos, urea formaldehyde insulation, radioactive materials, biological substances, polychlorinated biphenyls, pesticides, herbicides and any other kind and/or type of pollutants or contaminants (including, without limitation, materials which include hazardous constituents), sewage, sludge, industrial slag, solvents and/or any other similar substances, materials, or wastes and including any other substances, materials or wastes that are or become regulated under any Environmental Law (including, without limitation, any that are or become classified as hazardous or toxic under any Environmental Law).

    "Indemnified Party" shall have the meaning specified in paragraph 18 hereof.

    "Indenture" shall mean that certain Indenture of Trust dated as of April 1, 1996 by and between the City of Victoria, Minnesota and the Trustee, relating to the Bonds.

    "Interest Period" shall mean for any LIBOR Rate Loan the period commencing on the date of the borrowing thereof and ending three, six or nine months thereafter; provided, however, that Borrower may not select any Interest Period that ends after the Original Term, or if applicable, the Renewal Term. Whenever the last day of an Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall be extended to occur on the next succeeding Business Day; provided, that if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Business Day.

    "Kind" shall mean, with respect to any Loan, whether such Loan is a Revolving Loan or a Capex Loan.

    "Letters of Credit" shall mean those documentary or stand-by letters of credit issued for Borrower's account in accordance with the terms of paragraph 4 hereof.

    "Letter of Credit Obligations" shall mean, as of any dated of determination, the sum of (i) the aggregate undrawn face amount of all Letters of Credit and (ii) the aggregate unreimbursed amount of all drawn Letters of Credit not already converted to a Loan hereunder.

    "Liabilities" shall mean any and all obligations, liabilities and indebtedness of Borrower to LaSalle or to any parent, affiliate or subsidiary of LaSalle of any and every kind and nature, howsoever created, arising or evidenced and howsoever owned, held or acquired, whether now or hereafter existing, whether now due or to become due, whether primary, secondary, direct, indirect, absolute, contingent or otherwise (including, without limitation, obligations of performance), whether several, joint or joint and several, and whether arising or existing under written or oral agreement or by operation of law.

    "LIBOR Rate" shall mean, with respect to the Interest Period applicable to the borrowing of a LIBOR Rate Loan, the rate obtained (rounded upwards to the nearest 1/100 of 1%) by dividing (i) the rate of interest per annum offered to LaSalle in the London interbank foreign currency deposits market as of approximately 9:00 A.M. (Chicago time) two (2) Business Days prior to the commencement of such Interest Period for U.S. dollar deposits of amounts in immediately available funds comparable to the principal amount of the LIBOR Rate Loan for which the LIBOR Rate is being determined with maturities comparable to the Interest Period for which such LIBOR Rate will apply, by (ii) a percentage equal to 1 minus the stated reserve (expressed as a decimal), if any, required to be maintained against "Eurocurrency liabilities" as specified in Regulation D of the Board of Governors of the Federal Reserve System as from time to time shall be in effect (or against any other category of liabilities, which includes deposits, by reference to which the interest rate on LIBOR Rate

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Loans is determined or any category of extensions of credit on other assets, which includes loans by a non-U.S. office of LaSalle to U.S. Residents). In the absence of manifest error, each determination by LaSalle of the applicable LIBOR Rate shall be deemed conclusive.

    "LIBOR Rate Capex Loan" shall mean that portion of the Capex Loan that bears interest based on the LIBOR Rate.

    "LIBOR Rate Loan" shall mean a Revolving Loan or portion of the Capex Loan that bears interest based on the LIBOR Rate.

    "LIBOR Rate Revolving Loan" shall mean a Revolving Loan that bears interest based on the LIBOR Rate.

    "Loan" or "Loans" shall mean any and all Revolving Loans and Capex Loans made by LaSalle to Borrower pursuant to paragraphs 2 and 3 hereof and all other loans, advances and financial accommodations made by LaSalle to or on behalf of Borrower hereunder.

    "Loan Agreement" shall mean that certain Loan Agreement dated as of April 1, 1996 by and between the City of Victoria, Minnesota and the Borrower, relating to the Bonds.

    "Lock Box" and "Blocked Account" shall have the meanings specified in paragraph 10 hereof.

    "M&E Availability" shall mean the amount equal to the lesser of (i) eighty percent (80%) of the orderly liquidation value of Borrower's qualified equipment as shown and identified on an appraisal of such equipment dated March 16, 2000, prepared by Norman Levy and Associates, Inc., minus the orderly liquidation value of any equipment included on said appraisal pertaining to computer equipment and any outstanding operating or capital leases, or (ii) one million six hundred seventy-two thousand six hundred twenty and 00/100 dollars ($1,672,620.00), reduced by an amount equal to 1/60th thereof (which amount is $27,877) on the first day of each calendar month, beginning on September 1, 2000.

    "Material Adverse Effect" shall mean with respect to any event, act, condition or occurrence of whatever nature (including any adverse determination in any litigation, arbitration or governmental investigation or proceeding), whether singly or in conjunction with any other event or events, act or acts, condition or conditions, occurrence or occurrences, whether or not related, a material adverse change in, or a material adverse effect upon, any of the business, property, assets, operations, condition (financial or otherwise) or prospects of Borrower.

    "Mortgage" shall mean each mortgage or deed of trust executed by Borrower in favor of LaSalle to secure the Liabilities including without limitation, the Victoria Mortgage.

    "Multiemployer Plan" shall mean a plan described in Section 4001(a)(3) of ERISA which covers employees of any Borrower or any ERISA Affiliate.

    "Note" shall mean the Revolving Note or the Capex Note.

    "Obligor" shall mean Borrower and each Person who is or shall become primarily or secondarily liable for any of the Liabilities; provided, however, that such term shall not include any Account Debtor.

    "Original Term" shall have the meaning specified in paragraph 12 hereof.

    "Other Agreements" shall mean all agreements, instruments and documents including, without limitation, guaranties, mortgages, trust deeds, pledges, powers of attorney, consents, assignments, contracts, notices, security agreements, leases, financing statements and all other writings heretofore, now or from time to time hereafter executed by or on behalf of Borrower or any other Person and delivered to LaSalle or to any parent, affiliate or subsidiary of LaSalle in connection with the Liabilities or the transactions contemplated hereby.

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    "Parent" shall mean any Person now or at any time or times hereafter owning or controlling (alone or with any other Person) at least a majority of the issued and outstanding stock or other similar ownership interest of Borrower or any Subsidiary.

    "Permitted Liens" shall mean (i) statutory liens of landlords, carriers, warehousemen, mechanics, materialmen or suppliers incurred in the ordinary course of business and securing amounts not yet due or declared to be due by the claimant thereunder, (ii) liens or security interests in favor of LaSalle, (iii) zoning restrictions and easements, rights of way, licenses, covenants and other restrictions affecting the use of real property that do not individually or in the aggregate have a Material Adverse Effect on Borrower's ability to use such real property for its intended purpose in connection with Borrower's business, (iv) liens securing the payment of taxes or other governmental charges not yet delinquent or being contested in good faith and by appropriate proceedings, (v) liens incurred or deposits made in the ordinary course of Borrower's business in connection with capitalized leases or purchase money security interests for purchase of, and applying only to, Equipment included in the permitted borrowings under paragraph 13(q) or permitted as Capital Expenditures under paragraph 14(n), the documents relating to such liens to be in form and substance acceptable to LaSalle, (vi) liens securing indebtedness owing by any Subsidiary to Borrower to the extent such indebtedness is permitted under paragraph 14(l), or to any other Subsidiary of Borrower, (vii) deposits to secure performance of bids, trade contracts, leases and statutory obligations (to the extent not excepted elsewhere herein); (viii) liens specifically permitted by LaSalle in writing as set forth on Schedule 1(a) attached hereto; (ix) any lien arising out of the refinancing, extension, renewal or refunding of any indebtedness secured by an lien permitted by any of the foregoing subparagraphs (i) through (viii) inclusive; provided, that (a) such indebtedness is not secured by any additional assets, and (b) the amount of such indebtedness is not increased, (x) pledges or deposits in connection with worker's compensation, unemployment insurance and other social security legislation, (xi) securities and other properties held at banks or financial institutions to secure the payment or reimbursement under overdraft, acceptance and other facilities, and (xii) rights of setoff, banker's lien and other similar rights arising solely by operation of law.

    "Person" shall mean any individual, sole proprietorship, partnership, limited liability company venture, trust, unincorporated organization, association, corporation, institution, entity, party or foreign or United States government (whether federal, state, county, city, municipal or otherwise), including, without limitation, any instrumentality, division, agency, body or department thereof.

    "Prime Rate" shall mean the publicly announced prime rate of LaSalle Bank N.A., Chicago, Illinois, in effect from time to time. The Prime Rate is not intended to be the lowest or most favorable rate of LaSalle Bank N.A. in effect at any time.

    "Prime Rate Capex Loan" shall mean that portion of the Capex Loan that bears interest based on the Prime Rate.

    "Prime Rate Loan" shall mean a Revolving Loan or portion of the Capex Loan that bears interest based on the Prime Rate.

    "Prime Rate Revolving Loan" shall mean a Revolving Loan that bears interest based on the Prime Rate.

    "Real Estate Availability" shall mean the amount equal to the lesser of (i) seventy-five percent (75%) of the fair market value of Borrower's real estate located at 1495 Steiger Lake Lane, Victoria, Minnesota, 55386, as shown on the appraisal thereof dated February 29, 2000, prepared by Dahlen & Dwyer, Inc., or (ii) one million six hundred fifty thousand and 00/100 dollars ($1,650,000.00), reduced by an amount equal to 1/84th thereof (which amount is $19,642.86) on the first day of each calendar month, beginning on September 1, 2000.

    "Renewal Term" shall have the meaning specified in paragraph 12 hereof.

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    "Revolving Loans" shall have the meaning specified in paragraph 2 hereof.

    "Revolving Loan Commitment" shall mean the sum of $5,000,000.00.

    "Revolving Note" shall mean the revolving note in the maximum original principal amount of $5,000,000.00, executed by Borrower to the order of LaSalle, dated as of the Closing Date.

    "Subsidiary" shall mean any corporation or company of which more than fifty percent (50%) of the outstanding capital stock having ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether at the time stock of any other class of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time, directly or indirectly, owned by Borrower or by any partnership or joint venture of which more than fifty percent (50%) of the outstanding equity interests are at the time, directly or indirectly, owned by Borrower.

    "Tangible Net Worth" shall mean, on an aggregate basis, including the Borrower and all Affiliates of the Borrower (i) shareholders' equity (including retained earnings) less (ii) the book value of all intangible assets, prepaid assets, amounts due from officers, affiliates and employees, deferred tax assets, equity investments and the net book value of leasehold improvements, determined by LaSalle on a consistent basis, plus (iii) deferred tax liabilities and the amount of any debt subordinated to LaSalle on terms and conditions acceptable to LaSalle in its sole judgment, all as determined in accordance with GAAP, consistently applied.

    "Total Credit Facility" shall mean the sum of $13,500,000.00.

    "Trustee" shall mean U.S. Bank National Association, and any co-trustee or successor trustee appointed, qualified and then acting as such under the provisions of the Indenture.

    "Type" shall mean, with respect to any (i) Revolving Loan, whether such Revolving Loan is a LIBOR Rate Revolving Loan or a Prime Rate Revolving Loan and (ii) Capex Loan, whether any portion thereof is a LIBOR Rate Capex Loan or a Prime Rate Capex Loan.

    "Victoria Letter of Credit" shall mean, collectively, (i) the Irrevocable Letter of Credit No. S524150 issued by LaSalle Bank N.A. to the Trustee for the account of Borrower in the original stated amount of $2,181,331.00, and (ii) the Irrevocable Letter of Credit No. S524151 issued by LaSalle Bank N.A. to the Trustee for the account of the Borrower in the original stated amount of $1,090,666.00.

    "Victoria Mortgage" shall mean that certain Mortgage, Security Agreement, Fixture Financing Statement and Assignment of Leases and Rents of even date herewith executed by the Borrower in favor of LaSalle Bank N.A.

    (b)  Accounting Terms and Definitions.  Unless otherwise defined or specified herein, all accounting terms used in this Agreement shall be construed in accordance with GAAP, applied on a basis consistent in all material respects with the financial statements delivered by Borrower to LaSalle on or before the Closing Date. All accounting determinations for purposes of determining compliance with the financial covenants contained in paragraph 14(n) shall be made in accordance with GAAP as in effect on the Closing Date and applied on a basis consistent in all material respects with the audited financial statements delivered to LaSalle by Borrower on or before the Closing Date. The financial statements required to be delivered hereunder from and after the Closing Date, and all financial records, shall be maintained in accordance with GAAP. If GAAP shall change from the basis used in preparing the audited financial statements delivered to LaSalle by Borrower on or before the Closing Date, the certificates required to be delivered pursuant to paragraph 14(b) demonstrating compliance with the covenants contained herein shall include, at the election of Borrower or upon the request of LaSalle, calculations setting forth the adjustments necessary to demonstrate how Borrower is in compliance with the financial covenants based upon GAAP as in effect on the Closing Date.

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2.REVOLVING LOANS.  Subject to the terms and conditions of this Agreement and the Other Agreements, during the Original Term and any Renewal Term, absent the existence of an Event of Default:

    (a) LaSalle shall make such revolving loans and advances (the "Revolving Loans") to Borrower as Borrower shall from time to time request, in accordance with the terms of paragraph 2(b) hereof. The aggregate unpaid principal amount of all Revolving Loans outstanding at any one time made to Borrower shall not exceed the lesser of (i) the Borrowing Base or (ii) the Revolving Loan Commitment. All Revolving Loans shall be repaid in full upon the earlier to occur of (A) the end of the Original Term or any Renewal Term, if either LaSalle or Borrower elects to terminate this Agreement as of the end of any such term and (B) the acceleration of the Liabilities pursuant to paragraph 17 of this Agreement. If at any time the outstanding principal balance of the Revolving Loans made to Borrower exceeds (i) the Borrowing Base or (ii) the Revolving Loan Commitment, Borrower shall immediately, and without the necessity of a demand by LaSalle, pay to LaSalle such amount as may be necessary to eliminate such excess, and LaSalle shall apply such payment against the outstanding principal balance of the Revolving Loans. In addition, if at any time the sum of (A) the outstanding principal balance of the Loans and (B) the outstanding Letter of Credit Obligations exceeds the Total Credit Facility, Borrower shall immediately and without the necessity of a demand by LaSalle pay to LaSalle such amount as may be necessary to eliminate such excess, and LaSalle shall apply such payment against the outstanding principal balance of the Loans in such order as LaSalle shall determine in its sole discretion. Borrower hereby authorizes LaSalle to charge any of Borrower's accounts to make any payments of principal or interest required by this Agreement. All Revolving Loans shall, in LaSalle's sole discretion, be evidenced by one or more promissory notes in form and substance satisfactory to LaSalle. However, if such Revolving Loans are not so evidenced, such Revolving Loans may be evidenced solely by entries upon the books and records maintained by LaSalle.

    (b) LaSalle shall make Revolving Loans to Borrower up to the lesser of the following amounts, the amount calculated pursuant to subparagraph (i) below being the "Borrowing Base":

     (i) an amount up to eighty percent (80%) of the face amount of Eligible Accounts, less such reserves as LaSalle elects to establish from time to time in the exercise of its sole discretion including, without limitation, a Dilution reserve if Dilution exceeds five percent (5%), minus the aggregate amount of the Letter of Credit Obligations in excess of the sum of (A) the M&E Availability, plus (B) the Real Estate Availability, minus an amount equal to 3 months' lease payments under any and all leases (or subleases, as the case may be), with respect to which LaSalle has not received an executed Landlord Agreement (and Sublandlord Agreement(s), where applicable) in form and substance acceptable to LaSalle; or

    (ii) the Revolving Loan Commitment.

3.  CAPEX LOANS.

    (a) From and after the Closing Date, LaSalle shall make non-revolving loans and advances (collectively, the "Capex Loan") to Borrower as Borrower shall from time to time request in an aggregate amount of up to but not exceeding Five Million and 00/100 ($5,000,000.00), in accordance with the terms of this paragraph 3(a). Each request for a Capex Loan advance shall be made in writing, together with invoices and other documentation acceptable to LaSalle evidencing the hard costs of the machinery and equipment acquired or to be acquired with the proceeds of the requested Capex Loan advance ("Acquired M&E"). Each Capex Loan advance shall be in an amount not less than $100,000 (and in increments of $1,000 in excess thereof) and shall be limited to no more than 80% of the hard costs of the Acquired M&E for which such advance is requested. Borrower shall execute and deliver to LaSalle a Capex Note from time to time when the aggregate amount of Capex Loans made but not

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evidenced by a Capex Note equals or exceeds $500,000; provided, however, that notwithstanding the aggregate amount of Capex Loans made but not evidenced by a Capex Note, Borrower shall execute and deliver to LaSalle a Capex Note on each August 31 during the term of this Agreement in an amount equal to the then-outstanding amount of Capex Loans made but not evidenced by a Capex Note. Principal payable on account of the Capex Loan shall be payable in successive monthly installments (i) payable on the first day of each month, the first of which installments shall be due and payable on the first day of the month immediately following the date of each Capex Note and (ii) based on an amortization schedule consisting of sixty (60) equal and level payments under each Capex Note; provided, however, that the entire unpaid principal balance of the Capex Loan shall be due and payable in full upon the expiration of the Original Term of this Agreement; and, provided further, that in the event that the Original Term of this Agreement is initially or subsequently renewed in accordance with paragraph 12 hereof, then Borrower shall continue to make such equal and level monthly principal payments under each Capex Note, with a final installment equal to the unpaid principal balance of the Capex Loan and any other amounts outstanding due and payable upon the expiration of the Renewal Term. Notwithstanding anything hereinabove to the contrary, the entire unpaid principal balance of the Capex Loan, and any accrued and unpaid interest thereon, shall be immediately due and payable upon the earlier to occur of (i) the last day of the Original Term or the last day of any Renewal Term, if either LaSalle or Borrower elects to terminate this Agreement as of the end of any such Original or Renewal Term and (ii) the acceleration of the Liabilities pursuant to paragraph 17 of this Agreement.

    (b) If Borrower sells any Equipment, or if Borrower sells any real property subject to a Mortgage or if any of the Collateral is damaged, destroyed or taken by condemnation, Borrower shall pay to LaSalle, unless otherwise specifically provided herein or otherwise agreed to by LaSalle, as and when received by Borrower and as a mandatory prepayment of the Capex Loan, to be applied against the last maturing installments of principal thereof, in the inverse order thereof (or, at LaSalle's option, such of the other Liabilities of Borrower as LaSalle may elect), a sum equal to the proceeds received by Borrower from (i) such sale or (ii) such damage, destruction or condemnation; provided, however, that without LaSalle's consent, unless and until an Event of Default has occurred and is continuing:

     (i) obsolete or worn out Equipment may be sold or otherwise disposed of by Borrower and the proceeds thereof may be retained by Borrower, so long as the fair market value of any such Equipment sold or otherwise disposed of in any single transaction is less than $5,000, and the fair market value, in the aggregate, of all such Equipment sold or otherwise disposed of by Borrower during any twelve-month period is less than $20,000; and

    (ii) proceeds of Collateral arising from the damage, destruction or condemnation thereof may be retained by Borrower and used by Borrower to repair, restore or replace such Collateral, as the case may be, so long as the fair market value of any such Collateral damaged, destroyed or condemned in any single incident is less than $5,000, and the fair market value, in the aggregate, of all such Collateral owned by Borrower and damaged, destroyed or condemned during any twelve-month period is less than $20,000.

4.LETTERS OF CREDIT.  Subject to the terms and conditions of this Agreement, and the Other Agreements, during the Original Term or any Renewal Term, LaSalle shall, absent the existence of an Event of Default, from time to time cause the issuance of and co-sign for, upon Borrower's request, Letters of Credit, including without limitation the Victoria Letter of Credit; provided, that the Letters of Credit shall be in form and substance acceptable to LaSalle in its sole discretion and that the aggregate undrawn face amount of all such Letters of Credit shall at no time exceed three million five hundred thousand and 00/100 dollars ($3,500,000.00); and provided, further, that no Letter of Credit (other than the Victoria Letter of Credit) shall have any expiry date (a) more than 365 days from the

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date of issuance or (b) beyond five (5) days prior to the expiration of the Original Term or the Renewal Term, as the case may be.

5.  INTEREST, FEES AND CHARGES

    (a)  Rates of Interest.  Interest accrued on all Loans shall be due on the earliest of: (i) the first day of each month (for the immediately preceding month), computed through the last calendar day of the preceding month, and also, in the case of a LIBOR Rate Loan, in addition to monthly, at the end of the Interest Period applicable thereto; (ii) the occurrence of an Event of Default in consequence of which LaSalle elects to accelerate the maturity and payment of the Liabilities; or (iii) termination of this Agreement pursuant to paragraph 12 hereof. At Borrower's election, except as otherwise provided in paragraph 6 (c) hereof, interest shall accrue on: (A) the unpaid principal balance of the Capex Loan made to Borrower outstanding at the end of each day at (x) a fluctuating rate per annum equal to one-fourth of one percent (0.25%) above the Prime Rate or (y) a fixed rate per annum equal to two and three-fourths percent (2.75%) above the LIBOR Rate; and (B) the principal amount of the Revolving Loans made to Borrower outstanding at the end of each day at (x) a fluctuating rate per annum equal to the Prime Rate or (y) a fixed rate per annum equal to two and one-half percent (2.50%) above the LIBOR Rate. Notwithstanding the foregoing, the interest rates set forth in clauses (A)(x), (A)(y) and (B)(y) above shall be reduced by one-fourth of one percent (0.25%) on the first day of the first calendar month following LaSalle's receipt and satisfactory review of the Borrower's financial statements for the fiscal year ending August 31, 2000 (the "Rate Reduction Date") if such financial statements, delivered to LaSalle in accordance with paragraph 11 hereof, reflect that the Borrower's net after-tax income for such fiscal year equals or exceeds $800,000. The rate of interest payable on Prime Rate Loans shall increase or decrease by an amount equal to any increase or decrease in the Prime Rate, effective as of the opening of business on the day that any such change in the Prime Rate occurs. Upon and after the occurrence of an Event of Default, and during the continuation thereof, the principal amount of all Loans shall bear interest on demand at a rate per annum equal to (1) with respect to the Capex Loan, the rate of interest then in effect under paragraph 5 (a)(A) plus two percent (2.0%) and (2)  with respect to Revolving Loans, the rate of interest then in effect under paragraph 5 (a)(B) plus two percent (2.0%).

    (b)  Computation of Interest and Fees.  Interest and collection charges hereunder shall be calculated daily and shall be computed on the actual number of days elapsed over a year consisting of three hundred and sixty (360) days. For the purpose of computing interest hereunder, all items of payment received by LaSalle shall be deemed applied by LaSalle on account of the Liabilities (subject to final payment of such items) on the Business Day of receipt by LaSalle of good funds in LaSalle's account located in Chicago, Illinois.

    (c)  Maximum Interest.  It is the intent of the parties that the rate of interest and the other charges to Borrower under this Agreement shall be lawful; therefore, if for any reason the interest or other charges payable under this Agreement are found by a court of competent jurisdiction, in a final determination, to exceed the limit which LaSalle may lawfully charge Borrower, then the obligation to pay interest and other charges shall automatically be reduced to such limit and, if any amount in excess of such limit shall have been paid, then such amount shall be refunded to Borrower.

    (d)  Letter of Credit Fees.  Borrower shall remit to LaSalle a letter of credit fee equal to one and one-fourth percent (1.25%) per annum on the aggregate undrawn face amount of the Victoria Letter of Credit, which fee shall be payable monthly in arrears on each day that interest is payable hereunder.

    (e)  Closing Fee.  Borrower shall pay to LaSalle a closing fee of Thirty-three Thousand Seven Hundred Fifty and 00/100 Dollars ($33,750.00), which shall be fully earned, nonrefundable and due on the Closing Date.

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    (f)  Unused Line Fee.  Borrower shall pay to LaSalle at the end of each month, in arrears, an Unused Line Fee equal to one-fourth of one percent (0.25%) per annum on the daily average amount by which (1) an amount equal to (i) $4,500,000, from the date hereof through the date which is six (6) months after the date hereof, and (ii) the Revolving Loan Commitment at all times following the date which is six (6) months after the date here, exceeds (2) the outstanding principal balance of the Revolving Loans. The Unused Line Fee shall accrue from the Closing Date until the last day of the Original Term, and if applicable, from the first day to the last day of each Renewal Term.

    (g)  Examination and Appraisal Fees.  In addition to the costs and expenses described in paragraph 14(o) hereof, Borrower shall pay to LaSalle an examination fee of $700 per day, plus out-of-pocket expenses incurred by LaSalle for each examination performed by or at LaSalle's direction of Borrower's books and records and Collateral and such other matters as LaSalle shall deem appropriate in its commercially reasonable judgment, each such fee to be paid upon the completion of each such examination; provided, that LaSalle agrees that it shall not perform or cause to be performed more than three (3) such examinations per calendar year, so long as no Default or Event of Default occurs or exists during such calendar year.

    (h)  Capital Adequacy Charge.  If LaSalle shall have determined that the adoption of any law, rule or regulation regarding capital adequacy, or any change therein or in the interpretation or application thereof, or compliance by LaSalle with any request or directive regarding capital adequacy (whether or not having the force of law) from any central bank or governmental authority enacted after the Closing Date, does or shall have the effect of reducing the rate of return on LaSalle's capital as a consequence of its obligations hereunder to a level below that which LaSalle could have achieved but for such adoption, change or compliance (taking into consideration LaSalle's policies with respect to capital adequacy) by a material amount, then from time to time, after submission by LaSalle to Borrower of a written demand therefor ("Capital Adequacy Demand") together with the certificate described below, Borrower shall pay to LaSalle such additional amount or amounts ("Capital Adequacy Charge") as will compensate LaSalle for such reduction, such Capital Adequacy Demand to be made with reasonable promptness following such determination. A certificate of LaSalle claiming entitlement to payment as set forth above shall be conclusive in the absence of manifest error. Such certificate shall set forth the nature of the occurrence giving rise to such reduction, the amount of the Capital Adequacy Charge to be paid to LaSalle, and the method by which such amount was determined. In determining such amount, LaSalle may use any reasonable averaging and attribution method, applied on a non-discriminatory basis.

    (i)  Minimum Interest Charge.  Regardless of the amount of interest otherwise due and payable under subparagraphs 5 (a), (b) and (c) (the "Actual Interest Amount"), Borrower shall pay to LaSalle at the end of each month, in arrears, commencing September 1, 2000, a minimum interest charge equal to (A) $20,000 minus the Actual Interest Amount for each month after August during the calendar year 2000, and (B) $25,000 minus the Actual Interest Amount for each month thereafter. Nothing herein shall entitle Borrower to any reduction, offset or refund whatsoever in the event the Actual Interest Amount for any month exceeds the applicable dollar amount set forth above.

6.  LOAN ADMINISTRATION

    (a)  Loan Requests.  A request for a Revolving Loan and for a Capex Loan shall be made or shall be deemed to be made, each in the following manner: (i) Borrower shall give LaSalle same day notice, no later than 10:30 A.M. (Chicago time) of such day, of its intention to borrow a Prime Rate Revolving Loan or a Prime Rate Capex Loan, and at least three (3) Business Days prior notice of its intention to borrow a LIBOR Rate Revolving Loan or a LIBOR Rate Capex Loan, in which notice Borrower shall specify (in addition to any other requirements specified in paragraph 2 or paragraph 3 hereof) the amount of the proposed borrowing and the proposed borrowing date; provided, however, that no such request may be made at a time when there exists a Default or an Event of Default; and

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(ii) the coming due of any amount required to be paid under this Agreement or any Note, whether on account of interest or for any other Liability, shall be deemed irrevocably to be a request for a Prime Rate Revolving Loan on the due date thereof in the amount required to pay such interest or other Liability. As an accommodation to Borrower, LaSalle may permit telephone requests for Revolving Loans and electronic transmittal of instructions, authorizations, agreements or reports to LaSalle by Borrower. Unless Borrower specifically directs LaSalle in writing not to accept or act upon telephonic or electronic communications from Borrower, LaSalle shall have no liability to Borrower for any loss or damage suffered by Borrower as a result of LaSalle's honoring of any requests, execution of any instructions, authorizations or agreements or reliance on any reports communicated to it telephonically or electronically and purporting to have been sent to LaSalle by Borrower and LaSalle shall have no duty to verify the origin of any such communication or the authority of the Person sending it. Each notice of borrowing shall be irrevocable by and binding on Borrower, and if such notice requests the borrowing of a LIBOR Rate Revolving Loan or a LIBOR Rate Capex Loan, such notice shall state the Interest Period with respect thereto. Borrower, at its option, may choose Prime Rate Revolving Loans, Prime Rate Capex Loans, LIBOR Rate Revolving Loans or LIBOR Rate Capex Loans; provided, that any LIBOR Rate Loan shall be in a minimum amount of $1,000,000 or an integral multiple of $250,000 in excess thereof; and provided further, that the right of Borrower to choose any LIBOR Rate Loan is subject to the provisions of paragraph 6(c) hereof.

    (b)  Disbursement.  Borrower hereby irrevocably authorizes LaSalle to disburse the proceeds of each Revolving Loan and each Capex Loan requested by Borrower, or deemed to be requested by Borrower, as follows: (i) the proceeds of each Revolving Loan and each Capex Loan requested under paragraph 6(a)(i) shall be disbursed by LaSalle in lawful money of the United States of America in immediately available funds, in the case of the initial borrowing, in accordance with the terms of the written disbursement letter from Borrower, and in the case of each subsequent borrowing, by wire transfer to such bank account as may be agreed upon by Borrower and LaSalle from time to time, or elsewhere if pursuant to a written direction from Borrower; and (ii) the proceeds of each Revolving Loan requested under paragraph 6(a)(ii) shall be disbursed by LaSalle by way of direct payment of the relevant interest or other Liability.

    (c)  Notice of Continuation and Notice of Conversion.

     (i) Subject to the provisions of subparagraph (iii) hereof, Borrower may elect to maintain any borrowing by it consisting of the same Kind of LIBOR Rate Loans, or any portion thereof, as a LIBOR Rate Loan by selecting a new Interest Period for such borrowing, which new Interest Period shall commence on the last day of the then existing Interest Period. Each selection of a new Interest Period (a "Continuation") shall be made on three (3) Business Days prior notice, given by Borrower to LaSalle not later than 9:30 A.M. (Chicago time) on the third Business Day preceding the date of any proposed Continuation. If Borrower elects to maintain more than one borrowing consisting of LIBOR Rate Loans of the same Kind by combining such borrowings into one borrowing and selecting a new Interest Period pursuant to this clause, each of the borrowings so combined shall consist of Loans of the same Kind having Interest Periods ending on the same date. If Borrower shall fail to select a new Interest Period for any borrowing by it consisting of LIBOR Rate Loans of the same Kind in accordance with this clause, such LIBOR Rate Loans will automatically convert into Prime Rate Loans.

    (ii) Subject to the provisions of subparagraph (iii) hereof, Borrower may on three (3) Business Days prior notice given to LaSalle convert the entire amount of or a portion of all Loans of the same Kind and Type into Loans of the same Kind and another Type (a "Conversion"); provided, that no Default or Event of Default shall have occurred and be continuing; and provided further, that any Conversion of any LIBOR Rate Loans into Prime Rate Loans may only be made on the last day of the Interest Period for such LIBOR Rate Loans, and upon Conversion of any Prime Rate Loans into LIBOR Rate Loans, Borrower shall pay accrued interest to the date of

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Conversion on the principal amount converted on the first day of the following month. Each such notice shall be given not later than 9:30 A.M. (Chicago time) on the third Business Day preceding the date of any proposed Conversion. Each Conversion shall be in an aggregate amount of not less than $1,000,000 or an integral multiple of $250,000 in excess thereof. Borrower may elect to convert the entire amount of or a portion of all Loans made to Borrower of the same Kind and Type comprising more than one borrowing into Loans of the same Kind and another Type by combining such borrowings into one borrowing consisting of Loans of the same Kind and another Type; provided, however, that if the borrowings so combined consist of LIBOR Rate Loans, such LIBOR Rate Loans shall have Interest Periods ending on the same date.

    (iii) Notwithstanding anything contained in paragraph 5(a) hereof or contained in subparagraphs (i) and (ii) above to the contrary:

    A.  if LaSalle is unable to determine the LIBOR Rate for LIBOR Rate Loans comprising any requested borrowing, Continuation or Conversion, the right of Borrower to select or maintain LIBOR Rate Loans for such borrowing or any subsequent borrowing shall be suspended until LaSalle shall notify Borrower that the circumstances causing such suspension no longer exist, and each Loan comprising such borrowing shall be automatically converted into a Prime Rate Loan;

    B.  if at any time LaSalle shall notify Borrower that the LIBOR Rate for Loans comprising such borrowing by Borrower will not adequately reflect the cost to LaSalle of making such Loans, the right of Borrower to select, maintain, continue or convert to LIBOR Rate Loans for such borrowing shall be suspended until LaSalle shall notify Borrower that the circumstances causing such suspension no longer exist, and each Loan comprising such borrowing shall be automatically converted into a Prime Rate Loan;

    C.  there shall not be outstanding at any one time more than an aggregate of two (2) LIBOR Rate Revolving Loans and two (2) LIBOR Rate Capex Loans;

    D.  any LIBOR Rate Capex Loan shall be in a minimum amount of $1,000,000 or an integral multiple of $250,000 in excess thereof; and

    E.  the amount of interest payable by Borrower during any Interest Period shall be calculated on the full amount of each LIBOR Rate Loan borrowed by Borrower at the commencement of the applicable Interest Period, regardless of any reductions in the principal amount of such LIBOR Rate Loan which occur during such Interest Period, and Borrower shall not be credited for any part of such interest until such interest is actually paid by Borrower. To the extent the aggregate repayments of principal on Revolving Loans received by LaSalle during the pendency of an Interest Period applicable to a then outstanding LIBOR Rate Revolving Loan exceed the aggregate unpaid principal amount of all Prime Rate Revolving Loans outstanding during such Interest Period, LaSalle shall, to the extent of such excess, credit to a special suspense account the amount of such repayments received during such Interest Period, and at the expiration of such Interest Period, LaSalle shall apply all such amounts credited to such account against the unpaid principal balance of the LIBOR Rate Revolving Loans then outstanding. Borrower shall not earn interest on any credit balance which may be deemed to exist in favor of Borrower by virtue of this subparagraph (E).

    (iv) Each notice of Continuation or Conversion shall be irrevocable and binding on Borrower. In the case of (A) any borrowing of a Loan, Continuation, or Conversion that the related notice of borrowing, notice of Continuation or notice of Conversion specifies is to be comprised of LIBOR Rate Loans, or (B) any payment of principal of, or Conversion or Continuation of, any LIBOR Rate Loan made other than on the last day of the Interest Period for such Loan as a result of a payment, prepayment, Conversion or Continuation of such Loan or acceleration of the maturity of

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any of the Liabilities pursuant to paragraph 17 hereof, or for any other reason, then in any such case, upon LaSalle's demand, Borrower shall pay to LaSalle and indemnify LaSalle from and against the following (collectively "Breakage Costs"): (x) any loss, cost or expense incurred by LaSalle as a result of any failure to fulfill, on or before the date for such borrowing, Continuation or Conversion, the applicable conditions set forth in paragraph 15 hereof, and (y) any additional losses, costs or expenses which it may reasonably incur as a result of such payment, including, without limitation in each such case, any loss (excluding loss of anticipated profits), cost or expense incurred by reason of the liquidation or redeployment of deposits or other funds acquired by LaSalle to fund the Loan to be made as part of such borrowing, Continuation or Conversion.

7.GRANT OF SECURITY INTEREST TO LASALLE.  As security for the payment of all Loans now or in the future made by LaSalle to Borrower hereunder and for the payment or other satisfaction of all other Liabilities, Borrower hereby assigns to LaSalle and grants to LaSalle a continuing security interest in the following property of Borrower, whether now or hereafter owned, existing, acquired or arising and wherever now or hereafter located: (a) all Accounts (whether or not Eligible Accounts) and all Goods whose sale, lease or other disposition by Borrower has given rise to Accounts and have been returned to or repossessed or stopped in transit by Borrower; (b) all Chattel Paper, Instruments, investment property, Documents and General Intangibles (including, without limitation, all patents, patent applications, trademarks, trademark applications, tradenames, trade secrets, goodwill, copyrights, registrations, licenses, franchises, customer lists, tax refund claims, claims against carriers and shippers, guarantee claims, contracts rights, security interests, security deposits and any rights to indemnification); (c) all Inventory; (d) all Goods (other than Inventory) including, without limitation, Equipment, vehicles and fixtures; (e) all deposits and cash and any other property of Borrower now or hereafter in the possession, custody or control of LaSalle or any agent or any parent, affiliate or subsidiary of LaSalle or any participant with LaSalle in the Loans for any purpose (whether for safekeeping, deposit, collection, custody, pledge, transmission or otherwise); and (f) all additions and accessions to, substitutions for, and replacements, products and proceeds of the foregoing property, including, without limitation, proceeds of all insurance policies insuring the foregoing property, and all of Borrower's books and records relating to any of the foregoing and to Borrower's business.

8.PRESERVATION OF COLLATERAL AND PERFECTION OF SECURITY INTERESTS THEREIN.  Borrower shall, at LaSalle's request, at any time and from time to time, execute and deliver to LaSalle such financing statements, documents and other agreements and instruments (and pay the cost of filing or recording the same in all public offices deemed reasonably necessary or desirable by LaSalle) and do such other acts and things as LaSalle may deem necessary or desirable in order to establish and maintain a valid, attached and perfected security interest in the Collateral in favor of LaSalle (free and clear of all other liens, claims and rights of third parties whatsoever, whether voluntarily or involuntarily created, except Permitted Liens) to secure payment of the Liabilities, and in order to facilitate the collection of the Collateral. Borrower irrevocably hereby makes, constitutes and appoints LaSalle (and all Persons designated by LaSalle for that purpose) as Borrower's true and lawful attorney and agent-in-fact to execute such financing statements, documents and other agreements and instruments and do such other acts and things as may be necessary to preserve and perfect LaSalle's security interest in the Collateral. Borrower further agrees that a carbon, photographic, photostatic or other reproduction of this Agreement or of a financing statement shall be sufficient as a financing statement.

9.POSSESSION OF COLLATERAL AND RELATED MATTERS.  Until an Event of Default has occurred, Borrower shall have the right, except as otherwise provided in this Agreement, in the ordinary course of Borrower's business, to (a) sell, lease or furnish under contracts of service any of Borrower's Inventory normally held by Borrower for any such purpose, and (b) use and consume any raw materials, work in process or other materials normally held by Borrower for such purpose;

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provided, however, that a sale in the ordinary course of business shall not include any transfer or sale in satisfaction, partial or complete, of a debt owed by Borrower.

10.COLLECTIONS.

    (a) Borrower shall direct all of its Account Debtors to make all payments on the Accounts directly to a post office box ("Lock Box") with a financial institution acceptable to, and in the name and under exclusive control of, LaSalle. Borrower shall establish an account ("Blocked Account") in LaSalle's name for the benefit of Borrower with a financial institution acceptable to LaSalle, into which all payments received in the Lock Box shall be deposited, and into which Borrower will immediately deposit all payments made for Inventory or services sold or rendered by Borrower and received by Borrower in the identical form in which such payments were made, whether by cash or check. If Borrower, any Affiliate or Subsidiary of Borrower, or any shareholder, officer, director, employee or agent of Borrower or any Affiliate or Subsidiary, or any other Person acting for or in concert with Borrower shall receive any monies, checks, notes, drafts or other payments relating to or as proceeds of Accounts or other Collateral, Borrower and each such Person shall receive all such items in trust for, and as the sole and exclusive property of, LaSalle and, immediately upon receipt thereof, shall remit the same (or cause the same to be remitted) in kind to the Blocked Account. Each financial institution with which a Lock Box and Blocked Account are established shall acknowledge and agree, in a manner satisfactory to LaSalle, that the amounts on deposit in such Lock Box and Blocked Account are the sole and exclusive property of LaSalle, that such financial institution has no right to setoff against such Lock Box or Blocked Account or against any other account maintained by such financial institution into which the contents of such Blocked Account are transferred, and that such financial institution shall wire, or otherwise transfer in immediately available funds in a manner satisfactory to LaSalle, funds deposited in the Blocked Account on a daily basis as such funds are collected. Borrower agrees that all payments made to the Blocked Account established by Borrower or otherwise received by LaSalle, whether in respect of the Accounts of Borrower or as proceeds of other Collateral of Borrower or otherwise, will be applied on account of the Liabilities of Borrower in accordance with the terms of this Agreement. Borrower agrees to pay all fees, costs and expenses which Borrower incurs in connection with opening and maintaining a Lock Box and Blocked Account. All of such fees, costs and expenses which remain unpaid by Borrower pursuant to any Lock Box or Blocked Account Agreement with Borrower, to the extent same shall have been paid by LaSalle hereunder, shall constitute Revolving Loans hereunder, shall be payable to LaSalle by Borrower upon demand, and, until paid, shall bear interest at the highest rate then applicable to Revolving Loans hereunder. All checks, drafts, instruments and other items of payment or proceeds of Collateral delivered to LaSalle in kind shall be endorsed by Borrower to LaSalle, and, if that endorsement of any such item shall not be made for any reason, LaSalle is hereby irrevocably authorized to endorse the same on Borrower's behalf. For the purpose of this paragraph, Borrower irrevocably hereby makes, constitutes and appoints LaSalle (and all Persons designated by LaSalle for that purpose) as Borrower's true and lawful attorney and agent-in-fact (i) to endorse Borrower's name upon said items of payment and/or proceeds of Collateral of Borrower and upon any Chattel Paper, document, instrument, invoice or similar document or agreement relating to any Account of Borrower or goods pertaining thereto; (ii) to take control in any manner of any item of payment or proceeds thereof; (iii) to have access to any lock box or postal box into which any of Borrower's mail is deposited; and (iv) open and process all mail addressed to Borrower and deposited therein; provided, however, that LaSalle shall not exercise any such powers described in subparagraphs (i), (ii)(except for routine Lock Box payments/proceeds) and (iv) unless and until an Event of Default has occurred.

    (b) LaSalle may, at any time and from time to time after the occurrence of an Event of Default, whether before or after notification to any Account Debtor and whether before or after the maturity of any of the Liabilities, (i) enforce collection of any of Borrower's Accounts or contract rights by suit or otherwise; (ii) exercise all of Borrower's rights and remedies with respect to proceedings brought to

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collect any Accounts; (iii) surrender, release or exchange all or any part of any Accounts of Borrower, or compromise or extend or renew for any period (whether or not longer than the original period) any indebtedness thereunder; (iv) sell or assign any Account of Borrower upon such terms, for such amount and at such time or times as LaSalle deems advisable; (v) prepare, file and sign Borrower's name on any proof of claim in bankruptcy or other similar document against any Account Debtor indebted on an Account of Borrower; and (vi) do all other acts and things which are necessary, in LaSalle's sole discretion, to fulfill Borrower's obligations under this Agreement and to allow LaSalle to collect the Accounts. In addition to any other provision hereof, LaSalle may at any time on or after the occurrence of an Event of Default, at Borrower's expense, notify any parties obligated on any of the Accounts of Borrower to make payment directly to LaSalle of any amounts due or to become due thereunder.

    (c) For the purpose of determining Borrower's Borrowing Base hereunder, LaSalle shall, upon receipt by LaSalle at its office in Chicago, Illinois, of cash or other immediately available funds from collections of items of payment and proceeds of any Collateral, apply the whole or any part of such collections or proceeds against the Liabilities in such order as LaSalle shall determine in its sole discretion.

    (d) In its sole credit judgment, without waiving or releasing any obligation, liability or duty of Borrower under this Agreement or the Other Agreements or any Event of Default, at any time or times hereafter, LaSalle may (but shall not be obligated to) pay, acquire or accept an assignment of any security interest, lien, encumbrance or claim asserted by any Person in, upon or against the Collateral. All sums paid by LaSalle in respect thereof and all costs, fees and expenses (including, without limitation, reasonable attorney fees for both inside and outside counsel, all court costs and all other charges relating thereto) incurred by LaSalle shall constitute Revolving Loans, payable by Borrower to LaSalle on demand and, until paid, shall bear interest at the highest rate then applicable to Revolving Loans hereunder.

    (e) Immediately upon Borrower's receipt of any portion of the Collateral evidenced by an agreement, Instrument or Document including, without limitation, any Chattel Paper, Borrower shall deliver the original thereof to LaSalle together with an appropriate endorsement or other specific evidence of assignment thereof to LaSalle (in form and substance acceptable to LaSalle). If an endorsement or assignment of any such items shall not be made for any reason, LaSalle is hereby irrevocably authorized, as Borrower's attorney and agent-in-fact, to endorse or assign the same on Borrower's behalf.

    (f)  LaSalle shall render to Borrower each month a statement of Borrower's account or accounts, as the case may be, which shall constitute an account stated and shall be deemed to be correct and accepted by and be binding upon Borrower unless LaSalle receives a written statement of Borrower's exceptions thereto within thirty (30) days after such statement was rendered to Borrower.

11.SCHEDULES AND REPORTS.  Borrower shall furnish or cause to be furnished to LaSalle the following:

    (a)  Daily Reports.  Borrower shall provide LaSalle with an executed daily loan report and certificate in LaSalle's then current form on each day on which Borrower requests a Revolving Loan, and in any event at least one each week, which shall be accompanied by copies of Borrower's sales journal, cash receipts journal and credit memo journal for the relevant period. Such report shall reflect the activity of Borrower with respect to Accounts for the immediately preceding week, and shall be in a form and with such specificity as is satisfactory to LaSalle and shall contain such additional information as LaSalle may reasonably require concerning Accounts and Inventory included, described or referred to in such report and any other documents in connection therewith requested by LaSalle including, without limitation, but only if specifically requested by LaSalle, copies of all invoices prepared in connection with such amounts.

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    (b)  Monthly Financial Statements.  As soon as practicable and in any event within thirty (30) days following the end of each fiscal month: (1) statements of income and statements of cash flow of Borrower for each such month and for the period from beginning of the then current Fiscal Year of Borrower to the end of such month, (2) balance sheets of Borrower as of the end of such month, and (3) with respect to such statements of income and balance sheets, in comparative form, figures for the corresponding periods in the preceding Fiscal Year of Borrower, all in reasonable detail and certified by the chief financial officer of Borrower that such statements fairly present the financial condition of Borrower in accordance with GAAP, subject to changes resulting from normal year-end computations of Borrower's compliance with the covenants set forth in this Agreement.

    (c)  Monthly Reports.  In addition to any other reports, as soon as practicable and in any event: (i) within fifteen (15) days after the end of each fiscal month, (a) a detailed trial balance of Borrower's Accounts aged per invoice date, in form and substance reasonably satisfactory to LaSalle including, without limitation, the names and addresses of all Account Debtors of Borrower, and (b) a summary and detail of accounts payable (such Accounts and accounts payable divided into such time intervals as LaSalle may require in its sole discretion), including a listing of any held checks; and (2) within fifteen (15) days after the end of each fiscal month, the general ledger inventory account balance, a perpetual inventory report and LaSalle's standard form of Inventory report then in effect or the form most recently requested from Borrower by LaSalle, for Borrower by each category of Inventory, together with a description of the monthly change in each category of Inventory.

    (d)  Annual Financial Statements.  As soon as practicable and in any event within ninety (90) days after the end of each Fiscal Year of Borrower: (a) statements of income of Borrower for such Fiscal Year, and a balance sheet of Borrower as of the end of such Fiscal Year, and (2) statements of cash flow of Borrower for such Fiscal Year, such statements to be presented in accordance with GAAP and certified by independent certified public accountants of recognized national standing selected by Borrower and satisfactory to LaSalle, whose opinion shall be unqualified, in form and substance reasonably satisfactory to LaSalle. Commencing with the Fiscal Year ending on or about August 31, 2000, such financial statements shall set forth in comparative form, corresponding figures for the period covered by the preceding annual audit and as of the end of the preceding Fiscal Year of Borrower.

    (e)  Annual Projections.  As soon as practicable and in any event prior to the beginning of each Fiscal Year of Borrower, projected balance sheets, statements of income and cash flow for Borrower, for each of the twelve (12) months during such Fiscal Year, which shall include the assumptions used therein, together with appropriate supporting details as reasonably requested by LaSalle.

    (f)  Accountant's Reports.  As soon as practicable and in any event within ten (10) days of delivery to Borrower, a copy of any letter issued by Borrower's independent public accountants or other management consultants with respect to Borrower's financial or accounting systems or controls, including all so-called "management letters".

    (g)  Explanation of Budgets and Projections.  In conjunction with the delivery of the annual presentation of projections or budgets referred to in paragraph 11(e) above, a letter signed by the President or a Vice President of Borrower and by the Treasurer or Chief Financial Officer of Borrower, describing, comparing and analyzing, in detail, all changes and developments between the anticipated financial results included in such projections or budgets and the historical financial statements of Borrower.

    (h)  Other Information.  With reasonable promptness, such other business or financial data, reports, appraisals and projections as LaSalle may reasonably request.

    (i)  Accompanying Certificates.  All financial statements delivered to LaSalle pursuant to the requirements of this paragraph (except where otherwise expressly indicated) shall be prepared in accordance with GAAP as provided in this Agreement. Together with each delivery of financial

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statements required by paragraph 11 (b) and (d) above, Borrower shall deliver to LaSalle an officer's certificate in the form attached hereto as Exhibit B, which shall include a calculation of financial covenants in the schedule attached to such officer's certificate in form satisfactory to LaSalle.

12.TERMINATION.

    (a) This Agreement shall be in effect from the date hereof until August 1, 2003 ("Original Term") and shall automatically renew itself from year to year thereafter (each such one year renewal being referred to herein as a "Renewal Term") unless (i) the due date of the Liabilities is accelerated pursuant to paragraph 17 hereof; or (ii) Borrower elects or LaSalle elects to terminate this Agreement at the end of the Original Term or at the end of any Renewal Term by giving the other party written notice of such election at least ninety (90) days prior to the end of the Original Term or the then current Renewal Term, in which case Borrower shall pay all of the Liabilities in full on the last day of such term. If one or more of the events specified in subparagraphs (i) or (ii) occurs, this Agreement shall terminate on the date thereafter that the Liabilities are paid in full; provided, however, that the security interests and liens created under this Agreement and the Other Agreements shall survive such termination until the date upon which payment and satisfaction in full of the Liabilities shall have occurred. At such time as Borrower has repaid all of the Liabilities and this Agreement has terminated, (A) Borrower shall deliver to LaSalle a release, in form and substance reasonably satisfactory to LaSalle, of all obligations and liabilities of LaSalle and its officers, directors, employees, agents, parents, subsidiaries and affiliates to Borrower, and if Borrower is obtaining new financing from another lender, Borrower shall deliver such lender's indemnification of LaSalle, in form and substance satisfactory to LaSalle, for checks which LaSalle has credited to Borrower's account, but which subsequently are dishonored for any reason and (B) upon Borrower's request, LaSalle shall deliver to Borrower a release in form and substance reasonably satisfactory to Borrower.

    (b) If, for any reason, this Agreement is terminated prior to the end of the Original Term or any Renewal Term including, in the sole discretion of LaSalle, if an effective termination results from Borrower prepaying all or substantially all of the Liabilities, Borrower agrees to pay to LaSalle, as a prepayment fee, in addition to the payment of all other Liabilities owing by Borrower, an amount equal to: (i) three percent (3.0%) of the Total Credit Facility if this Agreement is terminated during the first year of the Original Term; (ii) two percent (2.0%) of the Total Credit Facility if this Agreement is terminated during the second year of the Original Term; and (iii) one percent (1.0%) of the Total Credit Facility if this Agreement is terminated during the third year of the Original Term or any Renewal Term, except, if terminated at the end of the Original Term or any Renewal Term pursuant to the terms set forth herein. In light of the extreme difficulty of accurately calculating actual damages arising out of any early termination, LaSalle and Borrower have agreed that the prepayment fee provided for above is a reasonable estimate of actual damages that would be incurred.

13.REPRESENTATIONS AND WARRANTIES.  Borrower hereby makes the following representations, warranties and covenants:

    (a) the financial statements delivered or to be delivered by Borrower to LaSalle at or prior to the date of this Agreement and at all times subsequent thereto accurately reflect the financial condition of Borrower, and since the date of the Borrower's financial statements delivered to LaSalle most recently prior to the date of this Agreement, no event or condition has occurred which has had, or is reasonably likely to have, a Material Adverse Effect;

    (b) the office where Borrower keeps its books, records and accounts (or copies thereof) concerning the Collateral, Borrower's principal place of business and all of Borrower's other places of business, locations of Collateral and post office boxes are as set forth in Exhibit A; Borrower shall promptly (but in no event less than ten (10) days prior thereto) advise LaSalle in writing of the proposed opening of any new place of business, the closing of any existing place of business, any

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change in the location of Borrower's books, records and accounts (or copies thereof) or the opening or closing of any post office box of Borrower;

    (c) the Collateral, including without limitation the Equipment (except any part thereof which prior to the date of this Agreement Borrower shall have advised LaSalle in writing consists of Collateral normally used in more than one state) is and shall be kept, or, in the case of vehicles, based, only at the addresses set forth on the first page of this Agreement or on Exhibit A, and at other locations within the continental United States of which LaSalle has been advised by Borrower in writing;

    (d) Borrower shall immediately give written notice to LaSalle of any use of any such Goods in any state other than a state in which Borrower has previously advised LaSalle such Goods shall be used, and such Goods shall not, unless LaSalle shall otherwise consent in writing, be used outside of the continental United States;

    (e) no security agreement, financing statement or analogous instrument exists or shall exist with respect to any of the Collateral other than any security agreement, financing statement or analogous instrument evidencing Permitted Liens;

    (f)  each Account or item of Inventory which Borrower shall, expressly or by implication, request LaSalle to classify as an Eligible Account, shall, as of the time when such request is made, conform in all respects to the requirements of such classification as set forth in the definition of Eligible Account and as otherwise established by LaSalle from time to time, and Borrower shall promptly notify LaSalle in writing if any such Eligible Account shall subsequently become ineligible;

    (g) Borrower is and shall at all times during the Original Term or any Renewal Term be the lawful owner of all Collateral now purportedly owned or hereafter purportedly acquired by Borrower, free from all liens, claims, security interests and encumbrances whatsoever, whether voluntarily or involuntarily created and whether or not perfected, other than the Permitted Liens;

    (h) Borrower has the right and power and is duly authorized and empowered to enter into, execute and deliver this Agreement and the Other Agreements and perform its obligations hereunder and thereunder; Borrower's execution, delivery and performance of this Agreement and the Other Agreements does not and shall not conflict with the provisions of any statute, regulation, ordinance or rule of law, or any agreement, contract or other document which may now or hereafter be binding on Borrower, and Borrower's execution, delivery and performance of this Agreement and the Other Agreements shall not result in the imposition of any lien or other encumbrance upon any of Borrower's property under any existing indenture, mortgage, deed of trust, loan or credit agreement or other agreement or instrument by which Borrower or any of its property may be bound or affected;

    (i)  except as otherwise disclosed on Schedule 13 (i), there are no actions or proceedings which are pending or, to the best of Borrower's knowledge, threatened against Borrower which are reasonably likely to have a Material Adverse Effect and Borrower shall, promptly upon becoming aware of any such pending or threatened action or proceeding, give written notice thereof to LaSalle;

    (j)  Borrower has obtained all licenses, authorizations, approvals and permits, the lack of which would have a Material Adverse Effect on the operation of its business, and Borrower is and shall remain in compliance in all material respects with all applicable federal, state, local and foreign statutes, orders, regulations, rules and ordinances (including, without limitation, Environmental Laws and statutes, orders, regulations, rules and ordinances relating to taxes, employer and employee contributions and similar items, securities, ERISA or employee health and safety), the failure to comply with which would have a Material Adverse Effect on its business, property, assets, operations or condition, financial or otherwise;

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    (k) all written information now, heretofore or hereafter furnished by Borrower to LaSalle is and shall be true and correct in all material respects as of the date with respect to which such information was or is furnished (except for financial projections, which have been prepared in good faith based upon reasonable assumptions);

    (l)  Borrower is not conducting, permitting or suffering to be conducted, nor shall it conduct, permit or suffer to be conducted, any activities pursuant to or in connection with which any of the Collateral is now, or will (while any Liabilities remain outstanding) be owned by any Affiliate;

    (m) Borrower's name has always been as set forth on the first page of this Agreement and Borrower uses no tradenames or division names in the operation of its business, except as otherwise disclosed in writing to LaSalle; Borrower shall notify LaSalle in writing within ten (10) days of the change of its name or the use of any tradenames or division names not previously disclosed to LaSalle in writing;

    (n) with respect to Borrower's Equipment: (i) Borrower has good and indefeasible and merchantable title to and ownership of all Equipment, including, without limitation, the Equipment described or listed on the appraisal schedule of Equipment prepared by Norman Levy and Associates, Inc. and dated March 16, 2000, delivered to LaSalle prior to the date of this Agreement; (ii) Borrower shall keep and maintain the Equipment in good operating condition and repair and shall make all necessary replacements thereof and renewals thereto so that the value and operating efficiency thereof shall at all times be preserved and maintained, ordinary wear and tear excepted; (iii) Borrower shall not permit any such items to become a fixture to real estate or an accession to other personal property; (iv) from time to time Borrower may sell, exchange or otherwise dispose of obsolete, unused or worn out Equipment, but only to the extent provided in paragraph 3 (b)(i) hereof; and (v) Borrower, immediately on demand by LaSalle, shall deliver to LaSalle any and all evidence of ownership of, including, without limitation, certificates of title and applications of title to, any of the Equipment;

    (o) this Agreement and the Other Agreements to which Borrower is a party are the legal, valid and binding obligations of Borrower and are enforceable against Borrower in accordance with their respective terms, except to the extent that such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting the rights of creditors generally;

    (p) Borrower is solvent, is able to pay its debts as they become due and has capital sufficient to carry on its business, now owns property having a value both at fair valuation and at present fair saleable value greater than the amount required to pay its debts, and will not be rendered insolvent by the execution and delivery of this Agreement or any of the Other Agreements or by completion of the transactions contemplated hereunder or thereunder;

    (q) Borrower is not now obligated, whether directly or indirectly, for any loans or other indebtedness for borrowed money other than (i) the Liabilities; (ii) indebtedness disclosed to LaSalle on Schedule 13 (q); (iii) unsecured indebtedness to trade creditors arising in the ordinary course of Borrower's business and (iv) unsecured indebtedness arising from the endorsement of drafts and other instruments for collection, in the ordinary course of Borrower's business.

    (r) Borrower does not own any margin securities, and none of the proceeds of the Loans hereunder shall be used for the purpose of purchasing or carrying any margin securities or for the purpose of reducing or retiring any indebtedness which was originally incurred to purchase any margin securities or for any other purpose not permitted by Regulation G or Regulation U of the Board of Governors of the Federal Reserve System as in effect from time to time;

    (s) except as otherwise disclosed on Schedule 13(s), Borrower has no Parents, Subsidiaries or divisions, nor is Borrower engaged in any joint venture or partnership with any other Person;

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    (t)  Borrower is duly organized and in good standing in its state of organization and Borrower is duly qualified and in good standing in all states where the nature and extent of the business transacted by it or the ownership of its assets makes such qualification necessary, except for such other states in which the failure to so qualify would not have a Material Adverse Effect;

    (u) Borrower is not in default under any material contract, lease or commitment to which it is a party or by which it is bound, nor does Borrower know of any dispute regarding any contract, lease or commitment which is material to the continued financial success and well-being of Borrower;

    (v) there are no controversies pending or threatened between Borrower and any of its employees, other than employee grievances arising in the ordinary course of business which are not, in the aggregate, material to the continued financial success and well-being of Borrower, and Borrower is in compliance in all material respects with all federal and state laws respecting employment and employment terms, conditions and practices, except where the failure to so comply would not have a Material Adverse Effect;

    (w) Borrower possesses, and shall continue to possess, adequate licenses, patents, patent applications, copyrights, service marks, trademarks, trademark applications, tradestyles and tradenames to continue to conduct its business as heretofore conducted by it.

    (x) except as set forth on Schedule 13(x), no Benefit Plan is in violation in any material respect of any of the provisions of ERISA or any of the qualification requirements of Section 401(a) of the IRC within the immediately preceding five (5) year period; no Prohibited Transaction or Reportable Event has occurred with respect to any Benefit Plan has been the subject of a waiver of the minimum funding standard under Section 412 of the IRC, no Benefit Plan has experienced an accumulated funding deficiency under Section 412 of the IRC, no lien has been imposed upon the such Borrower or any ERISA Affiliate of such Borrower under Section 412(n) of the IRC, no Benefit Plan has been amended in such a way that the security requirements of Section 401(a)(29) of the IRC apply; no notice of intent to terminate a Benefit Plan has been distributed to affected parties or filed with the PBGC under Section 4041 of ERISA; the PBGC has not instituted proceedings to terminate, or appoint a trustee to administer, a Benefit Plan and no event has occurred or condition exists which might constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Benefit plan; neither Borrower nor any ERISA Affiliate of Borrower would be liable for any amount in the aggregate in excess of $5,000 pursuant to Sections 4062, 4063 or 4064 of ERISA if all Benefit Plans terminated as of the most recent valuation dates of such Benefit Plans; neither Borrower nor any ERISA Affiliate of borrower maintains any employee welfare benefit plan, as defined in Section 3(1) of ERISA, which provides any benefits to an employee or the employee's dependents with respect to claims incurred after the employee separates from service other than is required by applicable law; and neither Borrower or any ERISA Affiliate of Borrower has incurred or expects to incur any withdrawal liability to any Multiemployer Plan;

    (y) (i) Borrower has not generated, used, stored, treated, transported, manufactured, handled, produced or disposed of any Hazardous Materials, on or off its premises (whether or not owned by it) in any manner which at any time violates any Environmental Law or any license, permit, certificate, approval or similar authorization thereunder and the operations of the Borrower comply in all material respects with all Environmental Laws and all licenses, permits, certificates, approvals and similar authorizations thereunder; (ii) there has been no investigation, proceeding, complaint, order, directive, claim, citation or notice by any governmental authority or any other Person, nor is any pending or to the best of the Borrower's knowledge threatened, and Borrower shall immediately notify LaSalle upon becoming aware of any such investigation, proceeding, complaint, order, directive, claim, citation or notice and take prompt and appropriate actions to respond thereto, with respect to any non-compliance with or violation of the requirements of any Environmental Law by the Borrower or the release, spill or discharge, threatened or actual, of any Hazardous Materials or the generation, use, storage,

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treatment, transportation, manufacture, handling, production or disposal of any Hazardous Materials or any other environmental, health or safety matter, which affects the Borrower or its business, operations or assets or any properties at which the Borrower has transported, stored, disposed of any Hazardous Materials; (iii) Borrower has no material liability (contingent or otherwise) in connection with a release, spill or discharge, threatened or actual, of any Hazardous Materials or the generation, use, storage, treatment, transportation, manufacture, handling, production or disposal of any Hazardous Materials; and (iv) without limiting the generality of the foregoing, Borrower shall, following the determination by LaSalle that there is non-compliance, or any condition which requires any action by or on behalf of Borrower in order to avoid any non-compliance, with any Environmental Law, at Borrower's expense, cause an independent environmental engineer acceptable to LaSalle to conduct such tests of the relevant site(s) as are appropriate and prepare and deliver a report setting forth the result of such tests, a proposed plan for remediation and an estimate of the costs thereof; and

    Borrower represents, warrants and covenants to LaSalle that all representations, warranties and covenants of Borrower contained in this Agreement (whether appearing in paragraphs 13 or 14 hereof or elsewhere) shall be true at the time of Borrower's execution of this Agreement, shall survive the execution, delivery and acceptance hereof by the parties hereto and the closing of the transactions described herein or related hereto, shall remain true until the repayment in full of all of the Liabilities and termination of this Agreement, and shall be remade by Borrower at the time each Revolving Loan is made and each Letter of Credit is issued pursuant to this Agreement.

14.COVENANTS.  Until payment or satisfaction in full of all Liabilities and termination of this Agreement, unless Borrower obtains LaSalle's prior written consent waiving or modifying any of Borrower's covenants hereunder in any specific instance, Borrower agrees as follows:

    (a) Borrower shall at all times keep accurate and complete books, records and accounts with respect to all of Borrower's business activities, in accordance with sound accounting practices and generally accepted accounting principles consistently applied, and shall keep such books, records and accounts, and any copies thereof, only at the addresses indicated for such purpose on Exhibit A;

    (b) Borrower agrees to deliver to LaSalle the following financial information, all of which shall be prepared in accordance with generally accepted accounting principles consistently applied: (i) no later than thirty (30) days after each fiscal month, copies of internally prepared financial statements of Borrower and its Subsidiaries, on a consolidated and consolidating, monthly and year-to-date basis including, without limitation, balance sheets and statements of income, retained earnings and cash flow of Borrower and its Subsidiaries, certified by the chief financial officer of Borrower and accompanied by an officer's certificate certifying that no Event of Default exists hereunder and (ii) no later than ninety (90) days after the end of each of Borrower's fiscal years, annual financial statements of Borrower and its Subsidiaries on a consolidated and consolidating basis certified by independent certified public accountants selected by Borrower and reasonably satisfactory to LaSalle, together with such accountants' "management letter";

    (c) LaSalle, or any Persons designated by it, shall have the right, at any time, in the exercise of its commercially reasonable credit judgment, to call at Borrower's places of business at any reasonable times, and, without hindrance or delay, to inspect the Collateral and to inspect, audit, check and make extracts from Borrower's books, records, journals, orders, receipts and any correspondence and other data relating to Borrower's business, the Collateral or any transactions between the parties hereto, and shall have the right to make such verification concerning Borrower's business as LaSalle may consider reasonable under the circumstances. Borrower shall furnish to LaSalle such information relevant to LaSalle's rights under this Agreement as LaSalle shall at any time and from time to time reasonably request. Borrower authorizes LaSalle to discuss the affairs, finances and business of Borrower with any officers or directors of Borrower or any Affiliate, or with those employees of Borrower with whom LaSalle has determined in its commercially reasonable judgment to be necessary or desirable to

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converse, and to discuss the financial condition of Borrower with Borrower's independent public accountants. Any such discussions shall be without liability to LaSalle or to such accountants. Borrower shall pay to or reimburse LaSalle for all reasonable fees, costs, and out-of-pocket expenses incurred by LaSalle in the exercise of its rights hereunder (in addition to the fees payable by Borrower pursuant to paragraph 5(g) hereof in connection with LaSalle's examination of Borrower's books and records and Collateral) and all of such costs, fees and expenses shall constitute Revolving Loans hereunder, shall be payable on demand and, until paid, shall bear interest at the highest rate then applicable to Loans hereunder;

    (d) (i)  Borrower shall: keep the Collateral properly housed and shall keep the Collateral insured against such risks and in such amounts as are customarily insured against by Persons engaged in businesses similar to that of Borrower with such companies, in such amounts and under policies in such form as shall be reasonably satisfactory to LaSalle. Originals or certified copies of such policies of insurance have been, or within fifteen (15) days after the Closing Date, shall be, delivered to LaSalle together with evidence of payment of all premiums therefor, and shall contain an endorsement, in form and substance acceptable to LaSalle, showing loss under such insurance policies payable to LaSalle. Such endorsement, or an independent instrument furnished to LaSalle, shall provide that the insurance company shall give LaSalle at least thirty (30) days written notice before any such policy of insurance is altered or cancelled and that no act, whether willful or negligent, or default of Borrower or any other Person shall affect the right of LaSalle to recover under such policy of insurance in case of loss or damage. Borrower hereby directs all insurers under such policies of insurance to pay all proceeds payable thereunder directly to LaSalle. Borrower irrevocably, makes, constitutes and appoints LaSalle (and all officers, employees or agents designated by LaSalle) as Borrower's true and lawful attorney (and agent-in-fact) for the purpose of making, settling and adjusting claims under such policies of insurance, endorsing the name of Borrower on any check, draft, instrument or other item of payment for the proceeds of such policies of insurance and making all determinations and decisions with respect to such policies of insurance; provided, however, that LaSalle shall exercise such rights only upon the occurrence of an Event of Default;

    (ii) Borrower shall maintain, at its expense, such public liability and third party property damage insurance as is customary for Persons engaged in businesses similar to that of Borrower with such companies and in such amounts, with such deductibles and under policies in such form as shall be reasonably satisfactory to LaSalle and originals or certified copies of such policies have been, or within fifteen (15) days after the Closing Date, shall be, delivered to LaSalle together with evidence of payment of all premiums therefor; each such policy shall contain an endorsement showing LaSalle as additional insured thereunder and providing that the insurance company shall give LaSalle at least thirty (30) days written notice before any such policy shall be altered or cancelled; and

    (iii) If Borrower at any time or times hereafter shall fail to obtain or maintain any of the policies of insurance required above or to pay any premium in whole or in part relating thereto, then LaSalle, without waiving or releasing any obligation or default by Borrower hereunder, may (but shall be under no obligation to) obtain and maintain such policies of insurance and pay such premiums and take such other actions with respect thereto as LaSalle deems advisable. All sums disbursed by LaSalle in connection with any such actions, including, without limitation, court costs, expenses, other charges relating thereto and reasonable attorneys' fees, shall constitute Revolving Loans hereunder and, until paid, shall bear interest at the highest rate then applicable to Revolving Loans hereunder;

    (e) Borrower shall not use the Collateral, or any part thereof, in any unlawful business or for any unlawful purpose or use or maintain any of the Collateral in any manner that does or could result in material damage to the environment or a violation of any applicable environmental laws, rules or regulations; Borrower shall keep the Collateral in good condition, repair and order, ordinary wear and

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tear excepted; Borrower shall not permit the Collateral, or any part thereof, to be levied upon under execution, attachment, distraint or other legal process; Borrower shall not sell, lease, grant a security interest in or otherwise dispose of any of the Collateral except as expressly permitted by this Agreement; and Borrower shall not secrete or abandon any of the Collateral, or remove or permit removal of any of the Collateral to Mexico or otherwise outside of the United States or from any of the locations listed on Exhibit A (other than the Mexico location listed) or in any written notice to LaSalle pursuant to paragraph 13(c) hereof, except for the removal of Inventory sold in the ordinary course of Borrower's business as permitted herein;

    (f)  all monies and other property obtained by Borrower from LaSalle pursuant to this Agreement will be used solely for business purposes of Borrower;

    (g) Borrower shall, at the request of LaSalle, indicate on its records concerning the Collateral a notation, in form satisfactory to LaSalle, of the security interest of LaSalle hereunder, and Borrower shall not maintain duplicates or copies of such records at any address other than Borrower's principal place of business set forth on the first page of this Agreement; provided, however, that Borrower, in the ordinary course of its business, may furnish copies of such records to its accountants, attorneys and other agents or advisors as it may determine to be necessary or desirable, in the exercise of its commercially reasonable judgment;

    (h) Borrower shall file all required tax returns and pay all of its taxes when due, including, without limitation, taxes imposed by federal, state or municipal agencies, and shall cause any liens for taxes to be promptly released; provided, that Borrower shall have the right to contest the payment of such taxes in good faith by appropriate proceedings so long as (i) the amount so contested is shown on Borrower's financial statements, (ii) the contesting of any such payment does not give rise to a lien for taxes, (iii) upon the occurrence of an Event of Default, Borrower keeps on deposit with LaSalle (such deposit to be held without interest) an amount of money which, in the sole judgment of LaSalle, is sufficient to pay such taxes and any interest or penalties that may accrue thereon, and (iv) if Borrower fails to prosecute such contest with reasonable diligence, LaSalle may apply the money so deposited in payment of such taxes. If Borrower fails to pay any such taxes and in the absence of any such contest by Borrower, LaSalle may (but shall be under no obligation to) advance and pay any sums required to pay any such taxes and/or to secure the release of any lien therefor, and any sums so advanced by LaSalle shall constitute Revolving Loans hereunder, shall be payable by Borrower to LaSalle on demand, and, until paid, shall bear interest at the highest rate then applicable to Revolving Loans hereunder;

    (i)  Borrower shall not (i) incur, create, assume or suffer to exist any indebtedness other than (A) indebtedness arising under this Agreement, (B) unsecured indebtedness owing in the ordinary course of business to trade suppliers, and (C) any other indebtedness described in paragraph 13(q)(ii) hereof; or (ii) assume, guarantee or endorse, or otherwise become liable in connection with, the obligations of any Person, except by endorsement of instruments for deposit or collection or similar transactions in the ordinary course of business;

    (j)  Borrower shall not enter into any merger or consolidation, or sell, lease or otherwise dispose of all or substantially all of its assets; Borrower shall not create any new Subsidiary or Affiliate or issue any shares of, or warrants or other rights to receive or purchase any shares of, any class of its stock; Borrower shall not enter into any transaction outside the ordinary course of Borrower's;

    (k) Borrower shall not (i) declare or pay any dividend or other distribution (whether in cash or in kind) on, purchase, redeem or retire any shares of any class of its stock, or make any payment on account of, or set apart assets for the repurchase, redemption, defeasance or retirement of, any class of its stock; or (ii) make any optional payment or prepayment on or redemption (including without limitation by making payments to a sinking fund or analogous fund) or repurchase of any indebtedness for borrowed money other than indebtedness pursuant to this Agreement;

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    (l)  Borrower shall not make any loans to, or investment in, any Person, whether in cash, securities or other property of any kind, other than investments that are direct obligations of the United States;

    (m) Borrower shall not amend its organizational documents or change its fiscal year;

    (n) Borrower shall maintain and keep in full force and effect each of the financial covenants set forth below. The calculation and determination of each such financial covenant, and all accounting terms contained therein, shall be so calculated and construed in accordance with GAAP, applied on a basis consistent with the financial statements of Borrower delivered on or before the Closing Date:

     (i) Tangible Net Worth.  Borrower shall maintain, on an aggregate basis with all Affiliates of Borrower, as of the end of (A) each fiscal quarter, commencing with the fiscal quarter ending December 2, 2000 a Tangible Net Worth of not less than ninety percent (90%) of the actual Tangible Net Worth for the most recently ended fiscal year, and (B) the fiscal year ending August 31, 2001, a Tangible Net Worth of not less than five hundred thousand dollars ($500,000) in excess of the actual Tangible Net Worth as of the fiscal year ending August 31, 2000, and (C) the fiscal year ending August 31, 2002 and each fiscal year thereafter, a Tangible Net Worth of not less than one million dollars ($1,000,000) in excess of the actual Tangible Net Worth as of the previous fiscal year end;

    (ii) Interest Coverage Ratio.  Borrower shall maintain, on an aggregate basis with all Affiliates of Borrower, as of the end of each fiscal quarter, commencing with the fiscal quarter ending December 2, 2000, a ratio of (A) net income, plus interest, taxes, depreciation and amortization, less unfinanced Capital Expenditures, on a year-to-date basis through such fiscal quarter to (B) year-to-date interest expense through such fiscal quarter, of not less than 1.50 to 1.00;

    (iii) Debt Service Coverage Ratio.  Borrower shall maintain, on an aggregate basis with all Affiliates of Borrower, a Debt Service Coverage Ratio, as of the end of each fiscal quarter, commencing with the fiscal quarter ending December 2, 2000, of not less than 1.25 to 1.00; and

    (iv) Year to Date Net Loss.  Borrower shall have a net loss, measured on a fiscal year to date basis (and for purposes of this covenant, exclusive of Guarantor), of not more than (A) $2,300,000 as of June 3, 2000, and (B) $2,000,000 as of August 31, 2000.

    (o) Borrower shall reimburse LaSalle for all costs and expenses including, without limitation, legal expenses and reasonable attorneys' fees (both in-house and outside counsel), incurred by LaSalle in connection with the documentation and consummation of this transaction and any amendments or modifications of this Agreement or the Other Agreements or other transactions between Borrower and LaSalle, including, without limitation, Uniform Commercial Code and other public record searches, lien filings, Federal Express or similar express or messenger delivery, appraisal costs, surveys, title insurance and environmental audit or review costs, and in seeking to collect, protect or enforce any rights in or to the Collateral or incurred by LaSalle in seeking to collect any Liabilities and to administer and enforce any of LaSalle's rights under this Agreement. Borrower shall also pay all normal service charges with respect to accounts maintained by LaSalle for the benefit of Borrower. All such costs, expenses and charges shall constitute Revolving Loans hereunder, shall be payable by Borrower to LaSalle on demand, and, until paid, shall bear interest at the highest rate then applicable to Revolving Loans hereunder;

    (p) Borrower shall not (i) pay any management fees or consulting fees (other than consulting fees paid in the Borrower's ordinary course of business) to any Persons, or make any loan to any Person except travel advances made to employees in the ordinary course of business and loans to employees not exceeding Ten Thousand Dollars ($10,000) to any single Person and Fifty Thousand Dollars ($50,000) in the aggregate outstanding for all Persons at any one time; provided, that no Event of Default shall have occurred prior to, or would occur as a result of, any such payment, or (ii) pay

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annual aggregate compensation, whether as salary, bonus or otherwise, to all directors or officers of Borrower in excess of one hundred ten percent (110%) of the aggregate compensation in effect on the date of this Agreement for the first year and one hundred ten percent (110%) of the prior year's aggregate compensation amount for subsequent years; provided, however, that the Borrower may pay compensation and bonuses in conjunction with the Borrower's bonus plan in effect on the date of this Agreement, a copy of which is attached hereto as Schedule 14(p). The aggregate annual compensation amount(s) shall be adjusted each year for the net addition or loss of directors or officers;

    (q) Borrower shall not enter into or be a party to, or permit any Subsidiary to enter into or be a party to, any transaction with any Affiliate of Borrower except in the ordinary course of business in a manner and to an extent consistent with past practices of Borrower and necessary or desirable for the prudent operation of its business, for fair consideration and on terms no less favorable to Borrower or such Subsidiary as are available from unaffiliated third parties;

    (r) Borrower shall promptly advise LaSalle in writing of any Material Adverse Effect or the occurrence of any Default or Event of Default; and

    (s) Borrower shall maintain Excess Availability, at all times during the period from the date hereof through the date which is six (6) months after the date hereof, in an amount not less than $500,000.

15.  CONDITIONS PRECEDENT.

    (a) The obligation of LaSalle to fund the Term Loan, to fund the initial Revolving Loan, and to co-sign as applicant for the initial Letter of Credit, is subject to the satisfaction or waiver on or before the Closing Date of the following conditions precedent:

     (i) LaSalle shall have received each of the agreements, opinions, reports, approvals, consents, certificates and other documents set forth on the closing document list attached hereto as Schedule 15(a)(i) (the "Closing Agenda");

    (ii) Since March 31, 2000, no event shall have occurred which has had or could reasonably be expected to have a Material Adverse Effect, as determined by LaSalle in its sole discretion;

    (iii) LaSalle shall have received payment in full of all fees and expenses payable to it by Borrower on or before the Closing Date;

    (iv) LaSalle shall have determined that immediately after giving effect to (A) the making of the initial Loans, including without limitation the Term Loan and the Revolving Loans, if any, requested to be made on the Closing Date, (B) the issuance of the initial Letter of Credit, if any, requested to be made on the Closing Date and (C) the payment or reimbursement by Borrower of LaSalle for all closing costs and expenses incurred in connection with the transactions contemplated hereby, on a pro forma basis the Excess Availability of Borrower shall not be less than One Million Dollars ($1,000,000);

    (v) LaSalle shall have received a certificate from Borrower's chief executive officer or chief financial officer, pursuant to which such officer shall certify that in calculating the Excess Availability described in clause (iv) above, Borrower's outstanding trade payables were (and are) current and not past due in any material respect; and

    (vi) The Obligors shall have executed and delivered to LaSalle all documents which LaSalle determines are reasonably necessary to consummate the transactions contemplated hereby.

    After the Closing Date, the obligation of LaSalle to make any requested Revolving Loan or to co-sign as applicant for any requested Letter of Credit is subject to the satisfaction of the conditions

27

precedent set forth below. Each such request shall constitute a representation and warranty that such conditions are satisfied:

     (i) All representations and warranties contained in this Agreement and the Other Agreements shall be true and correct on and as of the date of such request, as if then made, other than representations and warranties that relate solely to an earlier date;

    (ii) No Default or Event of Default shall have occurred, or would result from the making of the requested Revolving Loan or the issuance of the requested Letter of Credit, which has not been waived; and

    (iii) Since March 31, 2000, no event has occurred which has had or could reasonably be expected to have a Material Adverse Effect.

16.  DEFAULT.  The occurrence of any one or more of the following events shall constitute an "Event of Default" hereunder:

    (a) the failure of any Obligor to pay when due, declared due, or demanded by LaSalle in accordance with the terms hereof, any of the Liabilities;

    (b) the failure of any Obligor to perform, keep or observe any of the covenants, conditions, promises, agreements or obligations of such Obligor under this Agreement or any of the Other Agreements;

    (c) the making or furnishing by any Obligor to LaSalle of any representation, warranty, certificate, schedule, report or other communication within or in connection with this Agreement or the Other Agreements or in connection with any other agreement between such Obligor and LaSalle, which is untrue or misleading in any respect, or the failure of any Obligor to perform, keep or observe any of the covenants, conditions, promises, agreement of such Obligor under any other agreement with any Person if such failure has or is reasonably likely to have a Material Adverse Effect;

    (d) the creation (whether voluntary or involuntary) of, or any attempt to create, any lien or other encumbrance upon any of the Collateral, other than the Permitted Liens, or the making or any attempt to make any levy, seizure or attachment thereof;

    (e) the commencement of any proceedings (i) in bankruptcy by or against any Obligor, (ii) for the liquidation or reorganization of any Obligor, (iii) alleging that such Obligor is insolvent or unable to pay its debts as they mature, or (iv) for the readjustment or arrangement of any Obligor's debts, whether under the United States Bankruptcy Code or under any other law, whether state or federal, now or hereafter existing for the relief of debtors, or the commencement of any analogous statutory or non-statutory proceedings involving any Obligor; provided, however, that if such commencement of proceedings against such Obligor is involuntary, such action shall not constitute an Event of Default unless such proceedings are not dismissed within sixty (60) days after the commencement of such proceedings;

    (f)  the appointment of a receiver or trustee for any Obligor, for any of the Collateral or for any substantial part of any Obligor's assets or the institution of any proceedings for the dissolution, or the full or partial liquidation, or the merger or consolidation, of any Obligor which is a corporation or a partnership; provided, however, that if such appointment or commencement of proceedings against such Obligor is involuntary, such action shall not constitute an Event of Default unless such appointment is not revoked or such proceedings are not dismissed within thirty (30) days after the commencement of such proceedings;

    (g) the entry of any judgment or order in excess of $100,000 against any Obligor which remains unsatisfied or undischarged and in effect for thirty (30) days after such entry without a stay of enforcement or execution;

28

    (h) the occurrence of an event of default under, or the revocation or termination of, any agreement, instrument or document executed and delivered by any Person to LaSalle pursuant to which such Person has guaranteed to LaSalle the payment of all or any of the Liabilities or has granted LaSalle a security interest in or lien upon some or all of such Person's real and/or personal property to secure the payment of all or any of the Liabilities;

     (i) the occurrence of an event of default under any other agreement or instrument evidencing indebtedness for borrowed money in excess of $50,000 executed or delivered by Borrower or pursuant to which agreement or instrument Borrower or its properties is or may be bound;

     (j) intentionally omitted;

    (k) if any Reportable Event shall have occurred or any Benefit Plan shall be terminated within the meaning of title IV of ERISA, or a trustee shall be appointed by the appropriate United States District Court to administer any Benefit Plan, the PBGC shall institute proceedings to terminate any Benefit Plan, or there shall be a withdrawal from any Multiemployer Plan, and there shall be a Material Adverse Effect in the case of any event described in this paragraph 16(k);

     (l) default by the Borrower under any of the Bond Documents; or

    (m) the occurrence of any event or condition which has or is reasonably likely to have a Material Adverse Effect.

    Notwithstanding anything contained in this paragraph 16 or contained in any other provision of this Agreement or Other Agreements to the contrary, in the event of the institution of any proceedings described in paragraph 16(e) hereof against Borrower, LaSalle shall not be obligated to make advances to Borrower during the sixty (60) day grace period provided in paragraph 16(e).

17.  REMEDIES UPON AN EVENT OF DEFAULT.

    (a) Upon the occurrence of an Event of Default described in paragraph 16(e) hereof, all of the Liabilities shall immediately and automatically become due and payable, without notice of any kind. Upon the occurrence of any other Event of Default, all of the Liabilities may, at the option of LaSalle, and without demand, notice or legal process of any kind, be declared, and immediately shall become, due and payable.

    (b) Upon the occurrence of an Event of Default, LaSalle may exercise from time to time any rights and remedies available to it under the Uniform Commercial Code and any other applicable law in addition to, and not in lieu of, any rights and remedies expressly granted in this Agreement or in any of the Other Agreements and all of LaSalle's rights and remedies shall be cumulative and non-exclusive to the extent permitted by law. In particular, but not by way of limitation of the foregoing, LaSalle may, without notice, demand or legal process of any kind, take possession of any or all of the Collateral (in addition to Collateral of which it already has possession), wherever it may be found, and for that purpose may pursue the same wherever it may be found, and may enter into any of Borrower's premises where any of the Collateral may be, and search for, take possession of, remove, keep and store any of the Collateral until the same shall be sold or otherwise disposed of, and LaSalle shall have the right to store the same at any of Borrower's premises without cost to LaSalle. At LaSalle's request, Borrower shall, at Borrower's expense, assemble the Collateral and make it available to LaSalle at one or more places to be designated by LaSalle and reasonably convenient to LaSalle and Borrower. Borrower recognizes that if Borrower fails to perform, observe or discharge any of its Liabilities under this Agreement or the Other Agreements, no remedy at law will provide adequate relief to LaSalle, and Borrower agrees that LaSalle shall be entitled to temporary and permanent injunctive relief in any such case without the necessity of proving actual damages. Any notification of intended disposition of any of the Collateral required by law will be deemed reasonably and properly given if given at least ten (10) calendar days before such disposition. Any proceeds of any disposition by LaSalle of any of the

29

Collateral may be applied by LaSalle to the payment of expenses in connection with the Collateral including, without limitation, legal expenses and reasonable attorneys' fees (both in-house and outside counsel) and any balance of such proceeds may be applied by LaSalle toward the payment of such of the Liabilities, and in such order of application, as LaSalle may from time to time elect.

18.  INDEMNIFICATION.  Borrower agrees to defend (with counsel reasonably satisfactory to LaSalle), protect, indemnify and hold harmless LaSalle, each affiliate or subsidiary of LaSalle, and each of their respective officers, directors, employees, attorneys and agents (each an "Indemnified Party") from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements of any kind or nature (including, without limitation, the disbursements and the reasonable fees of counsel for each Indemnified Party in connection with any investigative, administrative or judicial proceeding, whether or not the Indemnified Party shall be designated a party thereto), which may be imposed on, incurred by, or asserted against, any Indemnified Party (whether direct, indirect or consequential and whether based on any federal, state or local laws or regulations including, without limitation, securities, environmental and commercial laws and regulations, under common law or in equity, or based on contract or otherwise) in any manner relating to or arising out of this Agreement or any Other Agreement, or any act, event or transaction related or attendant thereto, the making and the management of the Loans or any Letters of Credit or the use or intended use of the proceeds of the Loans or any Letters of Credit; provided, however, that Borrower shall not have any obligation hereunder to any Indemnified Party with respect to matters caused by or resulting from the willful misconduct or gross negligence of such Indemnified Party. To the extent that the undertaking to indemnify set forth in the preceding sentence may be unenforceable because it is violative of any law or public policy, Borrower shall satisfy such undertaking to the maximum extent permitted by applicable law. Any liability, obligation, loss, damage, penalty, cost or expense covered by this indemnity shall be paid to each Indemnified Party on demand, and, failing prompt payment, shall, together with interest thereon at the highest rate then applicable to Revolving Loans hereunder from the date incurred by each Indemnified Party until paid by Borrower, be added to the Liabilities of Borrower and be secured by the Collateral. The provisions of this paragraph 18 shall survive the satisfaction and payment of the other Liabilities and the termination of this Agreement.

19.  NOTICES.  All written notices and other written communications with respect to this Agreement shall be sent by ordinary, certified or overnight mail, by telecopy or delivered in person, and in the case of LaSalle shall be sent to it at Two Honey Creek Corporate Center, 115 South 84th Street, Suite 220, Milwaukee, WI 53214, Attention: Credit Manager (if by telecopy to (414) 256-5099), and in the case of Borrower shall be sent to Borrower at its principal place of business as set forth on the first page of this Agreement (if by telecopy to (612) 443-2668).

20.  CHOICE OF GOVERNING LAW AND CONSTRUCTION.  This Agreement and the Other Agreements are submitted by Borrower to LaSalle for LaSalle's acceptance or rejection at LaSalle's principal place of business as an offer by Borrower to borrow monies from LaSalle now and from time to time hereafter, and shall not be binding upon LaSalle or become effective until accepted by LaSalle, in writing, at said place of business. If so accepted by LaSalle, this Agreement and the Other Agreements shall be deemed to have been made at said place of business. THIS AGREEMENT AND THE OTHER AGREEMENTS SHALL BE GOVERNED AND CONTROLLED BY THE INTERNAL LAWS OF THE STATE OF MINNESOTA AS TO INTERPRETATION, ENFORCEMENT, VALIDITY, CONSTRUCTION, EFFECT, AND IN ALL OTHER RESPECTS, INCLUDING, WITHOUT LIMITATION, THE LEGALITY OF THE INTEREST RATE AND OTHER CHARGES, BUT EXCLUDING PERFECTION OF THE SECURITY INTERESTS IN THE COLLATERAL, WHICH SHALL BE GOVERNED AND CONTROLLED BY THE LAWS OF THE RELEVANT JURISDICTION. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law,

30

such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or remaining provisions of this Agreement.

21.  FORUM SELECTION AND SERVICE OF PROCESS.  To induce LaSalle to accept this Agreement, Borrower irrevocably agrees that, subject to LaSalle's sole and absolute election, ALL ACTIONS OR PROCEEDINGS IN ANY WAY, MANNER OR RESPECT, ARISING OUT OF OR FROM OR RELATED TO THIS AGREEMENT, THE OTHER AGREEMENTS OR THE COLLATERAL SHALL BE LITIGATED IN COURTS HAVING SITUS WITHIN THE COUNTY OF HENNEPIN, STATE OF MINNESOTA. BORROWER HEREBY CONSENTS AND SUBMITS TO THE JURISDICTION OF ANY LOCAL, STATE OR FEDERAL COURTS LOCATED WITHIN SAID COUNTY AND STATE. Borrower hereby irrevocably appoints and designates the Secretary of State of Minnesota, whose address is St. Paul, Minnesota (or any other person having and maintaining a place of business in such state whom Borrower may from time to time hereafter designate upon ten (10) days written notice to LaSalle and who LaSalle has agreed in its sole discretion in writing is satisfactory and who has executed an agreement in form and substance satisfactory to LaSalle agreeing to act as such attorney and agent), as Borrower's true and lawful attorney and duly authorized agent for acceptance of service of legal process; provided, however, that the Lender shall provide to Borrower a copy of such legal process, at the address specified under Section 19 hereof, in the event such legal process is not served directly upon Borrower. Borrower agrees that service of such process upon such person in such manner shall constitute personal service of such process upon Borrower. BORROWER HEREBY WAIVES ANY RIGHT IT MAY HAVE TO TRANSFER OR CHANGE THE VENUE OF ANY LITIGATION BROUGHT AGAINST BORROWER BY LASALLE IN ACCORDANCE WITH THIS PARAGRAPH.

22.  MODIFICATION AND BENEFIT OF AGREEMENT.  This Agreement and the Other Agreements may not be modified, altered or amended except by an agreement in writing signed by Borrower and LaSalle. Borrower may not sell, assign or transfer this Agreement, or the Other Agreements or any portion thereof including, without limitation, Borrower's rights, titles, interest, remedies, powers or duties thereunder. Borrower hereby consents to LaSalle's sale, assignment, transfer or other disposition, at any time and from time to time hereafter, of this Agreement, or the Other Agreements, or of any portion thereof, or participations therein including, without limitation, LaSalle's rights, titles, interest, remedies, powers and/or duties thereunder. Borrower agrees that it shall execute and deliver such documents as LaSalle may request in connection with any such sale, assignment, transfer or other disposition.

23.  HEADINGS OF SUBDIVISIONS.  The headings of subdivisions in this Agreement are for convenience of reference only, and shall not govern the interpretation of any of the provisions of this Agreement.

24.  POWER OF ATTORNEY.  Borrower acknowledges and agrees that its appointment of LaSalle as its attorney and agent-in-fact for the purposes specified in this Agreement is an appointment coupled with an interest and shall be irrevocable until all of the Liabilities are paid in full and this Agreement is terminated.

25.  WAIVER OF JURY TRIAL; OTHER WAIVERS; CONFIDENTIALITY

    (a) LASALLE AND BORROWER HEREBY WAIVE ALL RIGHTS TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING WHICH PERTAINS DIRECTLY OR INDIRECTLY TO THIS AGREEMENT, ANY OF THE OTHER AGREEMENTS, THE LIABILITIES, THE COLLATERAL, ANY ALLEGED TORTIOUS CONDUCT OF BORROWER OR LASALLE OR WHICH, IN ANY WAY, DIRECTLY OR INDIRECTLY, ARISES OUT OF OR RELATES TO THE RELATIONSHIP BETWEEN BORROWER AND LASALLE. IN NO EVENT SHALL LASALLE BE LIABLE FOR LOST PROFITS OR OTHER SPECIAL OR CONSEQUENTIAL DAMAGES.

31

    (b) BORROWER HEREBY WAIVES ALL RIGHTS TO NOTICE AND HEARING OF ANY KIND PRIOR TO THE EXERCISE BY LASALLE OF ITS RIGHTS TO REPOSSESS THE COLLATERAL OF BORROWER WITHOUT JUDICIAL PROCESS OR TO REPLEVY, ATTACH OR LEVY UPON SUCH COLLATERAL WITHOUT PRIOR NOTICE OR HEARING.

    (c) Borrower hereby waives demand, presentment, protest and notice of nonpayment, and further waives the benefit of all valuation, appraisal and exemption laws.

    (d) LaSalle's failure, at any time or times hereafter, to require strict performance by Borrower of any provision of this Agreement or any of the Other Agreements shall not waive, affect or diminish any right of LaSalle thereafter to demand strict compliance and performance therewith. Any suspension or waiver by LaSalle of an Event of Default under this Agreement or any default under any of the Other Agreements shall not suspend, waive or affect any other Event of Default under this Agreement or any other default under any of the Other Agreements, whether the same is prior or subsequent thereto and whether of the same or of a different kind or character. No delay on the part of LaSalle in the exercise of any right or remedy under this Agreement or any Other Agreement shall preclude other or further exercise thereof or the exercise of any right or remedy. None of the undertakings, agreements, warranties, covenants and representations of Borrower contained in this Agreement or any of the Other Agreements and no Event of Default under this Agreement or default under any of the Other Agreements shall be deemed to have been suspended or waived by LaSalle unless such suspension or waiver is in writing, signed by a duly authorized officer of LaSalle and directed to Borrower specifying such suspension or waiver.

    (e) Borrower has furnished and will furnish to LaSalle certain information concerning Borrower which Borrower has advised is non-public, proprietary or confidential in nature ("Confidential Information"). LaSalle confirms to the Borrower that it is LaSalle's policy and practice to maintain in confidence all Confidential Information which is provided to it under agreements providing for the extension of credit and which is identified to it as such, and that it will protect the confidentiality of Confidential Information submitted to it with respect to Borrower under this Agreement, commensurate with its efforts to maintain the confidentiality of its own Confidential Information, provided, however, that (i) nothing contained herein shall prevent LaSalle from disclosing Confidential Information (A) to its Affiliates and their respective directors, officers, and employees and to any legal counsel, auditors, appraisers, consultants or other persons retained by it or its Affiliates as professional advisors, on the condition that such information not be further disclosed except in compliance with this paragraph 25(e); (B) under color of legal authority, including, without limitation, to any regulatory authority having jurisdiction over it or its operations or to, or under the authority of, any court deemed by it to be of competent jurisdiction; (C) to any actual or potential assignee of or participant in LaSalle's rights and obligations under this Agreement to the extent such actual potential assignee or participant has agreed to maintain such information in confidence on the basis set forth in this paragraph 25(e); and (D) as necessary in connection with the exercise of its remedies under this Agreement or any of the Other Agreements; (ii) the terms of this paragraph 25(e) shall be inapplicable to any information furnished to it which is in possession prior to the delivery to it of such information by Borrower or any other authorized Person, or otherwise has been obtained by it on a non-confidential basis, or which was or becomes available to the public or otherwise part of the public domain (other than as a result of LaSalle's failure or any prospective participant's or assignee's failure to abide hereby), or which was not non-public, proprietary or confidential when Borrower or any other authorized Person delivered it to LaSalle; and (iii) the determination by LaSalle as to the application of any of the circumstances described in the foregoing clauses (i) and (ii) will be conclusive and binding if made in good faith.

    (f)  Notwithstanding subparagraph (e) above, Borrower consents to LaSalle publishing a tombstone or similar advertising material relating to the financing transaction contemplated by this Agreement.

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IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the 31st day of July, 2000.

	LASALLE BUSINESS CREDIT, INC.
	/s/ DALE GRZENIA By: Dale Grzenia Title: Vice President
ATTEST:	HEI, INC.
	/s/ ANTHONY J. FANT
By: Title: Vice President	By: Anthony J. Fant Title: Chairman and CEO

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EXHIBIT A—BUSINESS AND COLLATERAL LOCATIONS

    Attached to and made a part of that certain Loan and Security Agreement of even date herewith among BORROWER, LASALLE BUSINESS CREDIT, INC. and LASALLE BANK N.A.

a.

Borrower's business locations (please indicate which location is the principal place of business and at which locations originals and all copies of Borrower's books, records and accounts are kept):



1.

Microelectronics Division and Headquarters (and principal place of business)
1495 Steiger Lake Lane
Victoria, MN 55386



2.

High Density Interconnect Division
610 South Rockford Drive
Tempe, AZ 85281



3.

Mexico Division (Administrative Office)
HEI Inc.—c/o Offshore International
777 E. MacArthur Circle
Tucson, AZ 85714



4.

Mexico Division (Manufacturing Facility)
Carretera Internacional KM 1969
Guadalajara-Nogales KM 2
Empalme, Sonora, Mexico
C.P. 85340



5.

Cross Technology, Inc., a wholly owned subsidiary of HEI, Inc.
(Note: This facility will be vacated by September 1, 2000)
5201 Eden Circle
Suite 102
Edina, MN 55436



6.

Cross Technology, Inc., a wholly owned subsidiary of HEI, Inc.
1495 Steiger Lake Lane
Victoria, MN 55386




7.

Cross Technology, Inc., a wholly owned subsidiary of HEI, Inc.
1546 Lake Drive West
Chanhassen, MN 55317
(Note: Leased Facility)




b.

Other locations of Collateral owned by Borrower (including, without limitation, warehouse locations, processing locations, consignment locations) and all post office boxes of Borrower. Please indicate the relationship of such location to Borrower (i.e. public warehouse, processor, etc.).

EXHIBIT B—OFFICER'S CERTIFICATE

THIS CERTIFICATE is submitted pursuant to paragraph 11(i) of the Loan and Security Agreement dated July 31, 2000 ("Loan Agreement") among LaSalle Business Credit, Inc., LaSalle Bank N.A. (together, "LaSalle") and HEI, Inc. ("Borrower").

    The undersigned hereby certifies to LaSalle that as of the date of this Agreement:

    1.  The undersigned is the            of the Borrower.

    2.  There exits no event or circumstance which is or which with the passage of time, the giving of notice, or both would constitute an Event of Default, as that term is defined in the Loan Agreement, or, if such an event or circumstance exists, a writing attached hereto specifies the nature thereof, the period of existence thereof and the action that Borrower has taken or proposes to take with respect thereto.

    3.  No material adverse change in the condition, financial or otherwise, business, property, or results of operations of Borrower has occurred since            , or, if such a change has occurred, a writing attached hereto specifies the nature thereof and the action that Borrower has taken or proposes to take with respect thereto.

    4.  All insurance premiums due as of such date have been paid.

    5.  All taxes due as of such date have been paid or, for those taxes which have not been paid, a writing attached hereto describes the nature and amount of such taxes, and sets forth Borrower's rationale for not paying such taxes and the action that Borrower has taken or proposes to take with respect thereto.

    6.  To the best of the undersigned's knowledge, after appropriate inquiry, except as previously disclosed to LaSalle in writing, no litigation, investigation or proceeding, or injunction writ or restraining order is pending or threatened against the Borrower or, if any litigation, investigation or proceeding, or injunction, writ or restraining order is pending or threatened against the Borrower, a writing attached hereto specifies the nature thereof and the action that Borrower has taken or proposes to take with respect thereto.

    7.  Borrower is in compliance with the representations, warranties and covenants in the Loan Agreement, or, if Borrower is not in compliance with any representations, warranties or covenants in the Loan Agreement, a writing attached hereto specifies the nature thereof, the period of existence thereof and the action that Borrower has taken or proposes to take with respect thereto.

    8.  Attached hereto is a true and correct calculation of the financial covenants contained in paragraph 14(n) of the Loan Agreement.

HEI, INC.

By:                                (SEAL)
Name: Anthony J. Fant
Title: Chairman and CEO

EXHIBIT C—FORM OF CAPEX NOTE

SCHEDULE 1(A)—PERMITTED LIENS

1.

City of Victoria—$5,625,000 Variable Rate Demand Industrial Development Revenue Bonds (Series 1996 A & B).

•

Loan Agreement between City of Victoria, MN and HEI, Inc. dated April 1, 1996

•

Indenture of Trust between City of Victoria, MN and First Trust National Association dated April 1, 1996

•

remaining unpaid balances of the original $5,625,000 balance are $1,045,000 (Building) and $2,090,000 (Equipment), for a total of $3,135,000

2.

Capital Lease between Cross Technology, Inc. and U.S. Bank dated May 20, 1999

•

coil winding machine costing $250,000; five-year lease, ending May, 2004; present unpaid balance is approximately $208,000

SCHEDULE 13(i)—LITIGATION

     NONE

SCHEDULE 13(q)—INDEBTEDNESS

1.

Industrial Development Revenue Bonds (as of June 3, 2000)

•

Building $1,045,000

•

Equipment $2,090,000

•

TOTAL $3,135,000

2.

Cross Technology capital lease with U.S. Bank

•

approximate unpaid balance as of June 3, 2000 is $208,000

3.

Revolving Line of Credit with Norwest Bank (as of June 3, 2000)

•

$3,000,000

SCHEDULE 13 (s)—PARENTS, SUBS, JOINT VENTURES AND PARTNERSHIPS

    Cross Technology, Inc.—a wholly owned subsidiary of HEI, Inc.

    Lincoln Acquisition Corporation—(no assets or liabilities—will be dissolved)

SCHEDULE 13(x)—BENEFIT PLAN NON-COMPLIANCE

     NONE

SCHEDULE 14(p)—BONUS PLAN

    SEE ATTACHED November 11, 1999 memorandum from Anthony Fant to David Ortlieb, Chairman of the Compensation Committee.

SCHEDULE 15(a)(i)—CLOSING AGENDA

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TABLE OF CONTENTS
LOAN AND SECURITY AGREEMENT
WITNESSETH:
EXHIBIT A—BUSINESS AND COLLATERAL LOCATIONS
EXHIBIT B—OFFICER'S CERTIFICATE
EXHIBIT C—FORM OF CAPEX NOTE
SCHEDULE 1(A)—PERMITTED LIENS
SCHEDULE 13(i)—LITIGATION
SCHEDULE 13(q)—INDEBTEDNESS
SCHEDULE 13 (s)—PARENTS, SUBS, JOINT VENTURES AND PARTNERSHIPS
SCHEDULE 13(x)—BENEFIT PLAN NON-COMPLIANCE
SCHEDULE 14(p)—BONUS PLAN
SCHEDULE 15(a)(i)—CLOSING AGENDA

EX-4.2

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EXHIBIT 4.2

CAPITAL EXPENDITURE NOTE

Executed as of the 31st of July, 2000 Amount $1,665,000

FOR VALUE RECEIVED, the undersigned ("Borrower"), hereby promises to pay to the order of LASALLE BUSINESS CREDIT, INC., a Delaware corporation ("Lender"), in such coin or currency of the United States which shall be legal tender in payment of all debts and dues, public and private, at the time of payment, the principal sum of ONE MILLION SIX HUNDRED SIXTY-FIVE THOUSAND AND 00/100 DOLLARS ($1,665,000.00), together with interest from and after the date hereof on the unpaid principal balance outstanding at the Prime Rate plus One-Fourth Percent (0.25%), as the same changes in accordance with this Note, or as otherwise set forth in the Loan and Security Agreement between Borrower and Lender dated the same date hereof ("Loan Agreement").

    This Capital Expenditure Note ("Note") is one of the Capex Notes referred to in, and is issued pursuant to, the Loan Agreement and is entitled to all of the benefits and security of the Loan Agreement. All of the terms, covenants and conditions of the Loan Agreement and all other instruments evidencing or securing the indebtedness hereunder are hereby made a part of this Note and are deemed incorporated herein in full. All capitalized terms used herein, unless otherwise specifically defined in this Note, shall have the meanings ascribed to them in the Loan Agreement.

    Borrower acknowledges and understands that the Prime Rate merely serves as a basis upon which effective rates of interest are calculated for loans making reference to the per annum rate of interest publicly announced by LaSalle National Bank at its office in Chicago, Illinois, from time to time as its Prime Rate for commercial loans and that such rate may not be the lowest or best rate at which such bank calculates interest or extends credit. The Prime Rate as of the date of this Note is Nine and One-Half Percent (9.50%) per annum and, accordingly, the interest rate in effect hereunder as of the date hereof, expressed in simple interest terms, is Nine and Three-Fourths Percent (9.75%). After the date hereof, the rate of interest in effect hereunder shall be increased or decreased, as the case may be, by an amount equal to any increase or decrease in the Prime Rate, with such adjustments to be effective as of the opening of business on the date that any such change in the Prime Rate becomes effective. The Prime Rate in effect on the date hereof shall be the Prime Rate effective as of the opening of business on the date hereof, but if this Note is executed on a day that is not a business day, the Prime Rate in effect on the date hereof shall be the Prime Rate effective as of the opening of business on the last business day immediately preceding the date hereof. Interest hereunder shall be computed on the basis of actual days elapsed over the period of a 360-day year. If any Event of Default shall occur then, at Lender's option, the outstanding principal balance of this Note shall bear interest from and after the occurrence of such Event of Default at a variable rate per annum equal to the default rate set forth in the Loan Agreement until either the Event of Default is cured with Lender's permission and to Lender's satisfaction or the principal balance of this Note is paid in full.

    In no contingency or event whatsoever, whether by reason of advancement of the proceeds hereof or otherwise, shall the amount paid or agreed to be paid to Lender for the use, forbearance or detention of money advanced hereunder exceed the Highest Lawful Rate permissible under any law which a court of competent jurisdiction may deem applicable hereto.

    Regardless of any provision contained herein, the holder hereof shall never be entitled to receive, collect, or apply as interest on this Note, any amount in excess of the Highest Lawful Rate and, in the event the holder hereof ever receives, collects, or applies as interest, any such excess, such amount which would be excessive interest shall be deemed a partial prepayment of principal and treated hereunder as such; and, if the principal hereof is paid in full, any remaining excess shall forthwith be paid to the Undersigned. In determining whether or not the interest paid or payable, under any specific contingency, exceeds the Highest Lawful Rate, the Undersigned and the holder hereof shall, to the maximum extent permitted under applicable law, (a) treat all advances hereunder as but a single extension of credit, (b) characterize any nonprincipal payment as an expense, fee, or premium rather

than as interest, (c) exclude voluntary prepayments and the effects thereof, and (d) "spread" the total amount of interest throughout the entire contemplated term hereof; provided that, if the principal hereof is paid in full prior to the end of the full contemplated term hereof, and if the interest received for the actual period of existence thereof exceeds the Highest Lawful Rate, the holder hereof shall refund to the Undersigned the amount of such excess, and, in such event, the holder hereof shall not be subject to any penalties provided by any laws for contracting for, charging, taking, reserving, or receiving interest in excess of the Highest Lawful Rate. As used herein, the term the "Highest Lawful Rate" means the maximum rate of interest (or, if the context so requires, an amount calculated at such rate) which the holder hereof is allowed to contract for, charge, take, reserve, or receive under applicable law after taking into account, to the extent required by applicable law, any and all relevant payments or charges made in connection with this Note.

    For so long as no Event of Default shall have occurred under the Loan Agreement, the principal amount and accrued interest of this Note shall be due and payable on the dates and in the manner hereinafter set forth:

(a)

Interest shall be due and payable monthly, in arrears, on the first day of each month, commencing on August 1, 2000, and continuing until such time as the full principal balance, together with all other amounts owing hereunder, shall have been paid in full;



(b)

Commencing on September 1, 2000, and continuing on the first day of each month thereafter to and including the first day of August, 2005, principal payments in the amount of TWENTY SEVEN THOUSAND SEVEN HUNDRED FIFTY AND 00/100 DOLLARS ($27,750.00) each;



(c)

On August 1, 2005, a final principal payment equal to the entire unpaid principal balance hereof, together with any and all other amounts due hereunder.

    Any payments applied to principal under this Note are intended to permanently reduce the outstanding amount of the Note and may not be re-borrowed. Notwithstanding the foregoing, the entire unpaid principal balance and accrued interest on this Note shall be due and payable immediately upon any termination of the Loan Agreement. Borrower may voluntarily prepay this Note in whole at any time, from time to time, provided that such prepayment shall be made together with accrued interest on the principal amount so prepaid at the prepayment date plus the early termination fee as set forth in the Loan Agreement.

    The occurrence of an Event of Default under the Loan Agreement, including the failure to pay any installment of principal or interest in full on the due date thereof in accordance with the terms of this Note, shall constitute an event of default under this Note and shall entitle Lender, at its option, to declare the then outstanding principal balance and accrued interest hereof to be, and the same shall thereupon become, immediately due and payable without notice to or demand upon Borrower, all of which Borrower hereby expressly waives. If this Note is collected by or through an attorney at law, then Borrower shall be obligated to pay, in addition to the principal balance and accrued interest hereof, reasonable attorney's fees, not to exceed Fifteen Percent (15%) of such principal and interest, and court costs.

    Borrower represents and warrants that the proceeds of this note are to be used by Borrower exclusively for non-consumer purposes.

    Time is of the essence of this Note. To the fullest extend permitted by applicable law, Borrower, for itself and its legal representatives, successors and assigns, expressly waives presentment, demand, protest, notice of dishonor, notice of non-payment, notice of maturity, notice of protest, presentment for the purpose of accelerating maturity, diligence in collection, and the benefit of any exemption or insolvency laws.

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    Wherever possible each provision of this Note shall be interpreted in such a manner as to be effective and valid under applicable law, but if any provision of this Note shall be prohibited or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity without invalidating the remainder of such provision or remaining provisions of this Note. No delay or failure on the part of Lender in the exercise of any right or remedy hereunder shall operate as a waiver thereof, nor as an acquiescence in any default, nor shall any single or partial exercise by Lender of any right or remedy preclude any other right or remedy. Lender, at its option, may enforce its rights against any collateral securing this Note without enforcing its rights against Borrower, any guarantor of the indebtedness evidenced hereby or any other property or indebtedness due or to become due to Borrower. Borrower agrees that, without releasing or impairing Borrower's liability hereunder, Lender may at any time release, surrender, substitute or exchange any collateral securing this Note and may at any time release any party primarily or secondarily liable for the indebtedness evidenced by this Note.

    This Note shall be governed by, and construed and enforced in accordance with, the laws of the State of Illinois, and is intended to take effect as an instrument under seal.

IN WITNESS WHEREOF, Borrower has caused this Note to be duly executed, sealed and delivered on the date first above written.

HEI, INC. a Minnesota corporation
	/s/ ANTHONY J. FANT By: Anthony J. Fant Title: Chairman and CEO

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ACKNOWLEDGMENT OF SIGNATURE

STATE OF MINNESOTA	)
	) SS.
COUNTY OF RAMSEY	)

    I, James W. Dierking, a Notary Public in and for the state and county aforesaid, do hereby certify that before me this day personally appeared Anthony J. Fant, the Chairman and CEO of HEI, Inc., known to me to be the same person whose name is subscribed to the foregoing Capital Expenditure Note, and acknowledged to me that he executed and delivered the foregoing Capital Expenditure Note as his free and voluntary act, for the uses set forth therein.

IN WITNESS WHEREOF, I have hereunto set my hand and official seal this 27th day of July, 2000.

	/s/ JAMES W. DIERKINGNotary Public
[SEAL]
	My Commission Expires: 1/31/05

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CAPITAL EXPENDITURE NOTE

ACKNOWLEDGMENT OF SIGNATURE

EX-4.3

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EXHIBIT 4.3

REIMBURSEMENT AGREEMENT

BY AND AMONG

HEI, INC.

AND

LASALLE BANK N.A.

AND

LASALLE BUSINESS CREDIT, INC.

Dated As Of: July 31, 2000

This Instrument Was Drafted By:
WINTHROP & WEINSTINE, P.A.
3000 Dain Rauscher Plaza
60 South Sixth Street
Minneapolis, Minnesota 55402
Attn: James W. Dierking

TABLE OF CONTENTS

ARTICLE I. DEFINITIONS			1
	SECTION 1.1.	Defined Terms	1
	SECTION 1.2.	Other Terms	3
	SECTION 1.3.	Reimbursement Agreement Controlling	3
ARTICLE II. COMMITMENT TO ISSUE THE LETTERS OF CREDIT			3
	SECTION 2.1.	Letters of Credit	3
	SECTION 2.2.	Expiration, Renewal of Letters of Credit	3
	SECTION 2.3.	Draw Under Letters of Credit to Redeem or Defease Bonds	4
ARTICLE III. CONDITIONS PRECEDENT			4
	SECTION 3.1.	Conditions Precedent to Issuance of Letters of Credit	4
ARTICLE IV. REIMBURSEMENTS AND OTHER PAYMENTS, LENDER'S RIGHT TO CURE			4
	SECTION 4.1.	Obligation of Reimbursement	4
	SECTION 4.2.	Payment of Letter of Credit Fee	5
	SECTION 4.3.	Capital Adequacy/Change in Law	5
	SECTION 4.4.	Computation of Letter of Credit Fee and Interest	5
	SECTION 4.5.	Right of Lender to Cure Defaults Under Bond Documents	5
	SECTION 4.6.	Payments	6
	SECTION 4.7.	Collateral	6
	SECTION 4.8.	Fees	6
	SECTION 4.9.	Redemptions Under Series A Bonds and Series B Bonds	6
ARTICLE V. WARRANTIES, REPRESENTATIONS AND COVENANTS			6
	SECTION 5.1.	Warranties and Representations	6
	SECTION 5.2.	Covenants	7
ARTICLE VI. EVENTS OF DEFAULT; RIGHTS AND REMEDIES UPON EVENT OF DEFAULT			8
	SECTION 6.1.	Events of Default	8
	SECTION 6.2.	Rights and Remedies	8
ARTICLE VII. MISCELLANEOUS			10
	SECTION 7.1.	Indemnification by Borrower	10
	SECTION 7.2.	Addresses for Notice	10
	SECTION 7.3.	Fees	11
	SECTION 7.4.	Time of Essence	11
	SECTION 7.5.	Binding Effect and Assignment	11
	SECTION 7.6.	Waivers	11
	SECTION 7.7.	Remedies Cumulative	12
	SECTION 7.8.	Governing Law; Construction	12
	SECTION 7.9.	Jurisdiction	12
	SECTION 7.10.	Interest Rate	12
	SECTION 7.11.	Counterparts	12
	SECTION 7.12.	Not Joint Venturers	12
	SECTION 7.13.	Obligations Absolute	12
	SECTION 7.14.	Transfer of Letters of Credit	13
	SECTION 7.15.	Liability of the Lender	13
	SECTION 7.16.	Security Interest in Funds and Bonds	13
	SECTION 7.17.	Term	14
	SECTION 7.18.	Redemption of the Bonds under Casualty or Condemnation Laws	14

SIGNATURES

SCHEDULE OF REQUIRED PRINCIPAL PAYMENTS UNDER SERIES A BONDS (EXHIBIT A)

SCHEDULE OF REQUIRED PRINCIPAL PAYMENTS UNDER SERIES B BONDS (EXHIBIT B)

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REIMBURSEMENT AGREEMENT

    THIS REIMBURSEMENT AGREEMENT, made as of the 31st day of July, 2000, by and among HEI, INC., a Minnesota corporation (the "Borrower"), LASALLE BANK N.A., a national banking association the ("Bank") and LASALLE BUSINESS CREDIT, INC., a Delaware corporation (the "Lender").

ARTICLE I.

DEFINITIONS

    SECTION 1.1.  Defined Terms.  As used in this Agreement, the following terms shall have the meanings set out respectively after each except where the context clearly requires otherwise (such meanings to be equally applicable to both the singular and plural forms of the terms defined):

    (a)  Bond Counsel:  Briggs & Morgan, P.A., or such other bond counsel which is acceptable to the Lender

    (b)  Bond Documents:  individually or collectively, as the context requires, the Loan Agreement and the Indenture.

    (c)  Bonds:  the $5,625,000 Variable Rate Demand Industrial Development Revenue Bonds, Series 1996 A and B (HEI, Inc. Project) issued by the Issuer.

    (d)  Borrower Documents:  collectively, this Reimbursement Agreement, the Credit Agreement, the Certificate, the Mortgage, the Financing Statements and any and all other documents and instruments executed by the Borrower and delivered to the Lender in connection with the financing transaction contemplated hereby and/or by the Credit Agreement.

    (e)  Cash Collateral Account:  shall have the meaning assigned thereto in Section 6.2(c) hereof.

    (f)  Certificate:  the certificate of no hazardous material of even date herewith executed by the Borrower and delivered to the Lender.

    (g)  Collateral Securities:  shall have the meaning assigned thereto in Section 6.2(c)(1) hereof.

    (h)  Credit Agreement:  the Loan and Security Agreement of even date herewith by and between the Borrower and the Lender.

    (i)  Eligible Securities:  shall have the meaning assigned thereto in Section 6.2(c)(1) hereof.

    (j)  Event of Default:  shall have the meaning assigned thereto in Section 6.1 hereof.

    (k)  Facility:  the approximately 45,496 square foot manufacturing facility which exists on the Project Premises, together with all additions to, replacements of and substitutions for the foregoing which may be made as permitted or required by the Lender.

    (l)  Financing Statements:  the UCC-1 Financing Statements executed by the Borrower to be filed of record in the office of the Minnesota Secretary of State and the Hennepin County Recorder, serving to perfect a valid first lien on the property subject to the Security Agreement and the personal property subject to the Mortgage.

    (m)  Indenture:  the Indenture of Trust dated as of April 1, 1996 by and between the Issuer and the Trustee relating to the Bonds.

    (n)  Issuer:  City of Victoria, Minnesota.

    (o)  Letter of Credit Fee:  shall have the meaning assigned thereto in Section 4.2 hereof.

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    (p)  Letters of Credit:  collectively, the Series A Letter of Credit and the Series B Letter of Credit.

    (q)  Loan Agreement:  the Loan Agreement dated as of April 1, 1996 by and between the Issuer and the Borrower.

    (r)  Mortgage:  the Mortgage, Security Agreement, Fixture Financing Statement and Assignment of Leases and Rents of even date herewith executed by the Borrower for the benefit of the Lender securing payment of all amounts which may be advanced by the Lender and/or the Bank under or in connection with Letters of Credit and constituting a valid first lien on a good and marketable fee simple title to the Project Premises.

    (s)  Obligation of Reimbursement:  shall have the meaning assigned thereto in Section 4.1 hereof.

    (t)  Organizational Documents:  collectively, the following documents each of which shall be in form and substance acceptable to the Lender;

    (1) a copy of the Articles of Incorporation of the Borrower, duly certified by the Secretary of State of the State of Minnesota;

    (2) a copy of the Certificate of Good Standing of the Borrower, duly issued by the Secretary of State of the State of Minnesota;

    (3) a copy of the Bylaws of the Borrower, duly certified by an officer of the Borrower;

    (4) a copy of the resolutions of the Borrower authorizing the execution, delivery and performance of the Borrower Documents, duly certified by an officer of the Borrower; and

    (5) an opinion of counsel for the Borrower dated as of the date hereof and acceptable in form and substance to the Lender.

    (u)  Project Premises:  the real estate described in Exhibit A attached to the Mortgage.

    (v)  Related Documents:  shall have the meaning assigned thereto in Section 7.13(a) hereof.

    (w)  Series A Letter of Credit:  the Irrevocable Letter of Credit No. S524150 issued by the Bank to the Trustee for the account of the Borrower in the original stated amount of $2,181,331.00.

    (x)  Series B Letter of Credit:  the Irrevocable Letter of Credit No. S524151 issued by the Bank to the Trustee for the account of the Borrower in the original stated amount of $1,090,666.00.

    (y)  Title Company:  Commercial Partners Title, LLC, as agent for Chicago Title Insurance Company, or such other title company as is acceptable to the Lender.

    (z)  Title Documents:  collectively, the following documents, each of which shall be acceptable to the Lender:

    (1) a fully paid mortgagee's title insurance policy issued by the Title Company in an amount equal to $3,271,997 insuring the Mortgage as a first lien on a good and marketable fee simple title to the Project Premises, subject only to "Permitted Encumbrances" (as that term is defined in the Mortgage) and, without limiting the generality of the foregoing, insuring the Mortgage against claims for mechanics' liens, rights of parties in possession and matters which would be disclosed by a comprehensive survey and including special assessment searches, UCC searches, judgment searches and all other customary searches, and a long form zoning endorsement and a comprehensive endorsement;

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    (2) written evidence of payment of (i) all real estate taxes relating to the Project Premises presently due and payable, and (ii) all levied and pending assessments relating to the Project Premises (or, in lieu thereof, payment in escrow of an amount determined by the Lender); and

    (3) an ALTA survey of the Project Premises, prepared at the Borrower's expense, certified to the Lender by a licensed, registered surveyor acceptable to the Lender, dated within thirty (30) days of the date hereof and incorporating the legal description and street address of the Project Premises; showing the location of all points and lines referred to in the legal description; identifying the number of square feet and acres contained in the Project Premises and the number of vehicles which may be parked in designated parking areas; showing the actual location of the Facility and related areas (including sidewalks, stoops and parking areas) as being within the exterior boundaries of the Project Premises and in compliance with all setback requirements of the city in which the Project Premises is located; identifying the square footage of all existing structures and the number of stories of all existing structures; showing the location of all easements and encroachments onto or from the Project Premises that are visible on the Project Premises, known to the surveyor preparing the survey or of record and/or making a positive statement that there are no encroachments; identifying easements of record by recording data indicating, if possible, the dimensions of such easement; showing the location of all utilities serving the Project Premises (and tie-in points with respect hereto); showing any flood hazard areas; showing all service roads, highways, bicycle paths, walkways, right-of-way lines, driveways and parking areas on or serving the Project Premises, including the distance from the nearest street; and showing any other matters affecting the title to the Project Premises or the use thereof.

    (aa)  Trustee:  U.S. Bank Trust National Association (successor to First Trust National Association), and any co-trustee or successor trustee appointed, qualified and then acting as such under the provisions of the Indenture.

    SECTION 1.2.  Other Terms.  All capitalized terms used herein and not otherwise defined in this Agreement shall have the respective meanings for purposes of this Agreement as are assigned to such terms in Section 1.1 of the Indenture or Section 1.1 of the Loan Agreement, as the case may be, including, without limitation, the following terms: Prime Rate; Alternate Letter of Credit; Series A Bonds; and Series B Bonds.

    SECTION 1.3.  Reimbursement Agreement Controlling.  To the extent there exists any inconsistencies as between the terms and/or provisions contained in this Reimbursement Agreement and the Bond Documents, the language in this Reimbursement Agreement shall control.

ARTICLE II.

COMMITMENT TO ISSUE THE LETTERS OF CREDIT

    SECTION 2.1.  Letters of Credit.  The Bank hereby agrees that, on the terms and subject to the conditions hereinafter set forth, the Bank will issue the Letters of Credit to secure payment of the Bonds.

    SECTION 2.2.  Expiration, Renewal of Letters of Credit.  The Series A Letter of Credit shall have an initial expiration date of not later than April 1, 2002, but shall be automatically renewable for successive periods of two years each (but in no event to a date later than April 1, 2006) unless the Bank determines not to renew the term of the Series A Letter of Credit and gives written notice of such non-renewal to the Borrower and the Issuer and the Trustee at least sixty (60) calendar days prior to the expiration date of the Series A Letter of Credit. The Series B Letter of Credit shall have an initial expiration date of not later than April 1, 2002, but shall be automatically renewable for

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successive periods of two (2) years each (but in no event to a date later than April 1, 2011) unless the Bank determines not to renew the term of the Series B Letter of Credit and gives written notice of such non-renewal to the Borrower and the Issuer and the Trustee at least sixty (60) days prior to the expiration date of the Series B Letter of Credit. The Borrower acknowledges and agrees that the Bank shall have no obligation to renew either of the Letters of Credit at any time in the future. The Borrower further acknowledges and understands that the Bonds will be subject to mandatory redemption if the Bank does not renew the Letters of Credit thereby resulting in a draw under the Letters of Credit unless an Alternate Letter of Credit is delivered to the Trustee pursuant to the Indenture or unless the Bonds are re-marketed pursuant to the terms of the Indenture.

    SECTION 2.3.  Draw Under Letters of Credit to Redeem or Defease Bonds.  The Borrower acknowledges and agrees that the consent of the Bank is required in order for the Trustee to submit a draft under the Letters of Credit for the purpose of optionally redeeming Bonds or to defease Bonds pursuant to the Indenture. Such consent shall not be required if the Borrower redeems or defeases the Bonds using funds from any other source.

ARTICLE III.

CONDITIONS PRECEDENT

    SECTION 3.1.  Conditions Precedent to Issuance of Letters of Credit.  As a condition precedent to the issuance of the Letters of Credit, the following agreements, documents and other items shall have been executed and/or delivered to the Lender by the party indicated, each of which documents, agreements and other items shall be in form and substance acceptable to the Lender (unless waived in writing by the Lender):

    (a) the Borrower Documents, duly executed and delivered by the Borrower;

    (b) the Bond Documents, duly executed by the parties thereto;

    (c) evidence that the Mortgage has been duly filed of record in the office of the Hennepin County Recorder (a "marked-up" policy of title insurance issued by the Title Company shall satisfy this condition);

    (d) the Organizational Documents;

    (e) the Title Documents;

    (f)  an opinion of Bond Counsel issued in connection with the Bonds which states that the Bonds are validly issued, are not arbitrage bonds, and the interest on the Bonds is not includable in gross income for federal income tax purposes either addressed to the Lender or accompanied by a reliance letter indicating that the Lender is entitled to rely on the opinion;

    (g) evidence of payment of all expenses incurred by the Lender which are payable by the Borrower pursuant to Section 7.3 hereof; and

    (h) such other documents and instruments as the Lender may reasonably request.

ARTICLE IV.

REIMBURSEMENTS AND OTHER PAYMENTS
LENDER'S RIGHT TO CURE

    SECTION 4.1.  Obligation of Reimbursement.  The Borrower hereby agrees to pay the Bank or the Lender, as the case may be (the "Obligation of Reimbursement") (i) on the day that any amount is drawn under the Letters of Credit a sum equal to the amount drawn under the Letters of Credit plus any and all reasonable charges and expenses which the Bank or the Lender may pay or incur relative to

4

such draw, (ii) on demand, any amounts advanced by the Bank or the Lender in its sole discretion to cure any event of default under the Bond Documents, and (iii) on demand, interest on all amounts remaining unpaid by the Borrower to the Bank or the Lender under this Agreement at any time accruing from the date such amounts become payable (in the case of an amount payable on demand, which interest shall accrue from the date the Lender is first entitled to demand payment, regardless of whether a demand for payment is actually made), until payment in full, at an annual rate equal to two percent (2%) per annum in excess of the Prime Rate, as the same changes from time to time; provided, however, that no interest shall accrue or be payable on any amounts paid by the Bank or the Lender pursuant to a draft submitted under the Letters of Credit if the full amount of such draft is reimbursed by the Borrower to the Bank or the Lender, by 2:00 o'clock p.m. on the same day such draft is paid by the Bank or the Lender. The Borrower acknowledges and agrees that the Lender is also obligated to reimburse the Bank for any amounts drawn under the Letters of Credit and, accordingly, the Borrower's Obligation of Reimbursement shall inure to the benefit of both the Bank and the Lender. A schedule of the principal payments required under the Series A Bonds is attached hereto as Exhibit A and a schedule of the principal payments required under the Series B Bonds is attached hereto as Exhibit B.

    SECTION 4.2.  Payment of Letter of Credit Fee.  So long as either of the Letters of Credit is outstanding, the Borrower agrees to pay the Lender a letter of credit fee (the "Letter of Credit Fee") with respect to the Letters of Credit, as and when described in Section 5(d) of the Credit Agreement.

    SECTION 4.3.  Capital Adequacy/Change in Law.  If any change in any law or regulation or in the interpretation thereof by any court or administrative governmental authority charged with the administration thereof shall either (i) impose, modify or deem applicable or modify any capital adequacy, reserve, special deposit or similar requirement against letters of credit issued by, or assets held by, or deposits in or for the account of the Bank or the Lender (including without limitation, a requirement which affects the Bank's or the Lender's allocation of capital resources), or (ii) impose on the Bank or the Lender any other condition regarding this Agreement or either of the Letters of Credit, and the result of any event referred to in the preceding clause (i) or (ii) shall be to increase the cost (including without limitation, reserve or similar cost) to the Bank or the Lender of issuing or maintaining the Letters of Credit or reduce the Bank's or the Lender's return hereunder or all or any of the Bank's or the Lender's capital is reduced (which increase in cost or reduction in return shall be determined by the Bank's or the Lender's reasonable allocation of the aggregate of such cost increases or return reductions resulting from such events), then upon demand by the Bank or the Lender, the Borrower shall immediately pay to the Bank or the Lender, as the case may be, from time to time as specified by the Bank or the Lender, as the case may be, additional amounts which shall be sufficient to compensate the Bank or the Lender for such increased cost, together with interest on each such amount from the date demanded until payment in full thereof at the rate provided for in Section 4.1 hereof. A certificate as to such increased costs incurred by the Bank or the Lender as a result of any event mentioned in clause (i) or (ii) above, submitted by the Bank or the Lender to the Borrower shall be conclusive, absent manifest error, as to the amount thereof.

    SECTION 4.4.  Computation of Letter of Credit Fee and Interest.  The Letter of Credit Fee and interest payable on amounts due under this Agreement shall be computed on the basis of a 360-day year and charged for actual days elapsed.

    SECTION 4.5.  Right of Lender to Cure Defaults Under Bond Documents.  If the Borrower shall fail to make any payments under the Bond Documents on the day such payment is first due and payable by the Borrower, or shall fail to comply with any other covenant or agreement of the Borrower under the Bond Documents, or if any other default or event of default shall occur under the Bond Documents, the Lender shall have the option, in the Lender's sole discretion, to cure any such failure by taking action reasonably required to effect such cure, including, without limitation, making the required payment directly to the Trustee. Any such payment by the Lender shall constitute an advance

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repayable by the Borrower in accordance with Section 4.1 hereof. The Borrower shall be responsible for any costs and/or expenses incurred by the Lender in curing any such default or event of default.

    SECTION 4.6.  Payments.  All payments by the Borrower to the Lender hereunder shall be made in lawful currency of the United States in immediately available funds at the Lender's office at 135 South LaSalle Street, Chicago, Illinois 60603. In addition, the Bank and the Lender shall have the right to debit any of the Borrower's accounts at the Bank without further authorization of the Borrower to make any such payments.

    SECTION 4.7.  Collateral.  The Borrower hereby acknowledges that the Obligation of Reimbursement and each and every other liability and indebtedness of the Borrower hereunder are secured by the security interests and other liens granted to the Lender by the Borrower pursuant to the Credit Agreement, and that the Obligation of Reimbursement with respect to amounts advanced under the Letters of Credit is also secured pursuant to the Mortgage.

    SECTION 4.8.  Fees.  In addition to the Letter of Credit Fee, the Borrower shall pay to the Lender, on demand, such fees as are customarily charged by the Lender from time to time in connection with the amendment and administration of letters of credit, as the same change from time to time. In addition to the foregoing, the Borrower shall pay a customary transfer fee to the Lender if either or both of the Letters of Credit is transferred to a successor trustee under the Indenture.

    SECTION 4.9.  Redemptions Under Series A Bonds and Series B Bonds.  The parties hereto acknowledge that the Series A Bonds have been structured to require no principal payments on the Series A Bonds until the April 1, 2006 maturity date thereof. The Borrower agrees, however, that as of April 1 of each year during the term of the Series A Bonds, it shall, pursuant to the provisions of Section 8.2(a) of the Loan Agreement, direct the Trustee to call for redemption and prepayment of a portion of the Series A Bonds under the provisions of Section 3.1(1) of the Indenture, in the respective amounts set forth in Exhibit A attached hereto and hereby made a part hereof. In addition, the Borrower agrees that it shall make principal payments in respect of the Series B Bonds in the amounts and at the times set forth in Exhibit B attached hereto and hereby made a part hereof.

ARTICLE V.

WARRANTIES, REPRESENTATIONS
AND COVENANTS

    SECTION 5.1.  Warranties and Representations.  The Borrower hereby acknowledges, repeats and reaffirms each and all of the representations and warranties of the Borrower contained in and Credit Agreement, including without limitation those set forth in Section 13 thereof. In addition, the Borrower hereby represents and warrants to the Lender as follows:

    (a) the Project and the present use thereof are permitted by and will comply in all material respects with all presently applicable use or other restrictions and requirements in prior conveyances, zoning ordinances and all development, pollution control, water conservation and other laws, regulations, rules and ordinances of the United States and the State of Minnesota and the respective agencies thereof, and the political subdivision in which the Project is located;

    (b) the Borrower has filed all federal and state tax returns and reports required to be filed, which returns properly reflect the taxes owed by it for the period covered thereby and it has paid or made appropriate provisions for the payment of all taxes which may become due pursuant to said returns and for the payment of all present installments of any assessments, fees and other governmental charges upon it or upon any of its property;

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    (c) each and all of the warranties and representations of the Borrower set forth and contained in each of the Bond Documents are true and correct in all material respects as of the date hereof.

    SECTION 5.2.  Covenants.  In addition to the covenants and agreements of the Borrower set forth and contained in the Credit Agreement and the other Borrower Documents, the Borrower hereby covenants and agrees to and with the Lender as follows, so long as either of the Letters of Credit remains outstanding and any amounts remain due and payable to the Lender by the Borrower pursuant to Article IV hereof, unless otherwise agreed or consented to by the Lender:

    (a) that the Project does and shall comply with all applicable restrictions, conditions, ordinances, regulations and laws of governmental departments and agencies having jurisdiction over the Project, and does not and shall not violate any private restrictions or covenants or encroach upon or interfere with easements affecting the Project Premises;

    (b) to keep, perform, enforce and maintain in full force and effect all of the terms, covenants, conditions and requirements of the Borrower Documents, the Bond Documents, the Title Documents and the Organizational Documents; not to amend, modify, supplement, terminate, cancel or waive any of the terms, covenants, conditions or requirements of any of said documents without the prior written consent of the Lender; and to execute such amendments, modifications, supplements and extensions of said documents as may be reasonably requested by the Lender;

    (c) not to create, permit to be created or to allow to exist, any liens, charges or encumbrances on the Project (other than "Permitted Encumbrances" as defined in the Mortgage) and the lien of general real estate taxes pending and special assessments not due and payable except for such liens, charges and encumbrances which are being diligently contested in good faith by appropriate proceedings and provided that, if requested by the Lender, the Borrower shall have deposited into escrow with the Lender an amount equal to such lien, charge or encumbrance plus any and all penalties accrued thereon;

    (d) not to assign this Agreement or any interest herein;

    (e) to obtain and maintain at all times during the term of the Letters of Credit, if applicable (and, from time to time at the request of the Lender, furnish the Lender with proof of payment of premiums on) the insurance required pursuant to the Credit Agreement;

    (f)  to keep accurate books of record and account for itself in which true and complete entries will be made in accordance with generally acceptable accounting principles consistently applied and, upon request of the Lender will give any representative of the Lender access during normal business hours to, and permit such representative to examine, copy or make extracts from any and all books, records, contracts, plans, drawings, permits, bills and statements of account pertaining to the Project, to inspect any of its properties and to discuss its affairs, finances and accounts with any of its officers, all at such times as often as it may reasonably be requested by the Lender or its officers or representatives;

    (g) to hold the Bank and the Lender harmless, and the Bank and the Lender shall have no liability or obligation of any kind to the Borrower, creditors of the Borrower or any third party, in connection with any defective, improper or inadequate workmanship performed in or about, or materials supplied to, the Project Premises and the Facility, or any mechanics, suppliers or materialmen's liens arising as a result of such defective, improper or inadequate workmanship or materials, and upon the Lender's reasonable request, to replace or cause to be replaced, any such defective, improper or inadequate workmanship or materials;

    (h) to perform each and all of the covenants and agreements set forth and contained in the Bond Documents;

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    (i)  to cause to be prepared and delivered to the Lender the financial and other statement, reports, certificates, notices and the like as are required under the Credit Agreement.

ARTICLE VI.

EVENTS OF DEFAULT; RIGHTS AND REMEDIES UPON
EVENT OF DEFAULT

    SECTION 6.1.  Events of Default.  Any one or more of the events, conditions or circumstances described as an "Event of Default" in the Loan Agreement or the Credit Agreement shall constitute an Event of Default hereunder.

    SECTION 6.2.  Rights and Remedies.  Upon the occurrence and continuance of an Event of Default, the Bank and/or the Lender may, at its option, exercise any and all of the following rights and remedies (and any other rights and remedies available to it or them):

    (a) The Lender shall have the right, in addition to any other rights provided by law, to enforce its rights and remedies under the Borrower Documents and any other documents related hereto.

    (b) To instruct the Trustee to accelerate the Bonds and submit a draft under either of the Letters of Credit pursuant to the Indenture.

    (c) The Lender may make demand upon the Borrower and forthwith upon such demand the Borrower will pay to the Lender in immediately available funds for deposit in a special cash collateral account maintained with the Lender (the "Cash Collateral Account") an amount equal to the maximum amount then available to be drawn under the Letters of Credit (assuming compliance with all conditions for drawing thereunder). The Lender hereby acknowledges the Trustee's security interest in any and all funds deposited by the Borrower hereunder and agrees that, so long as either of the Letters of Credit is outstanding, the Lender's interest in such funds shall be subordinate to the interest of the Trustee.

Notwithstanding the foregoing, the Lender shall have sole discretion in administering such funds, including the right to return such funds to the Borrower if the Lender so elects, until the Obligation of Reimbursement and the Letter of Credit Fee then due shall have been paid in full:

    (1) If requested by the Borrower and subject to the right of the Lender to withdraw funds from the Cash Collateral Account as provided below and subject to the limitations provided below, the Lender will from time to time invest funds on deposit in the Cash Collateral Account, reinvest proceeds and invest interest or other income received from any such investments, in such Eligible Securities (as hereinafter defined) as the Borrower may select and give notice thereof to the Lender. Such proceeds, interest or income which are not so invested or reinvested in Eligible Securities shall, except as otherwise provided in this Section 6.2(c), be deposited and held by the Lender in the Cash Collateral Account. "Eligible Securities" means (A) United States Treasury bills with a remaining maturity not in excess of 90 days, (B) negotiable certificates of deposit of the Lender or of any other bank having combined capital and surplus of at least $10,000,000 with a remaining maturity not in excess of 90 days, and (C) such other instruments as the Borrower may request and the Lender may approve in writing. Eligible Securities from time to time purchased and held pursuant to this subsection (c)(1) shall be referred to as "Collateral Securities" and shall, for purposes of this Agreement, constitute part of the funds held in the Cash Collateral Account in amounts equal to their respective outstanding principal amounts.

    (2) If at any time the Lender determines that any funds held in the Cash Collateral Account are subject to any right or claim of any person or entity other than the Lender or

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that the total amount of such funds is less than the maximum amount at such time available to be drawn under the Letters of Credit, the Borrower will, forthwith upon demand by the Lender, pay to the Lender, as additional funds to be deposited and held in the Cash Collateral Account, an amount equal to the excess of (A) such maximum amount at such time available to be drawn under the Letters of Credit over (B) the total amount of funds, if any, then held in the Cash Collateral Account which the Lender determines to be free and clear of any such right and claim.

    (3) The Borrower hereby pledges and grants to the Lender a security interest in all funds held in the Cash Collateral Account (including Collateral Securities) from time to time and all proceeds thereof, as security for the payment of all amounts due and to become due from the Borrower to the Lender under this Agreement.

    (4) The Lender may, at any time or from time to time after funds are deposited in the Cash Collateral Account or invested in Collateral Securities, after selling (upon ten days' notice to the Borrower), if necessary, any Collateral Securities, apply funds then held in the Cash Collateral Account to the payment of any amounts, in such order as the Lender may elect, as shall have become or shall become due and payable by the Borrower to the Lender under this Agreement. The Borrower agrees that, to the extent notice of sale of any Collateral Securities shall be required by law, at least ten days' notice to the Borrower of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. The Lender may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned.

    (5) Neither the Borrower nor any person or entity claiming on behalf of or through the Borrower shall have any right to withdraw any of the funds held in the Cash Collateral Account, except as otherwise provided in subsection (6) below, except that after the expiration of the Letters of Credit in accordance with its terms and the payment of all amounts payable by the Borrower to the Lender under this Agreement, any funds remaining in the Cash Collateral Account shall promptly be returned by the Lender to the Borrower or paid to whomever may be legally entitled thereto.

    (6) The Borrower agrees that it will not (A) sell or otherwise dispose of any interest in the Cash Collateral Account or any funds held therein, or (B) create or permit to exist any lien, security interest or other change or encumbrance upon or with respect to said account or any funds or Collateral Securities held therein except as provided in or contemplated by this Agreement.

    (7) The Lender shall exercise reasonable care in the custody and preservation of any funds held in the Cash Collateral Account and shall be deemed to have exercised such care if such funds are accorded treatment substantially equivalent to that which the Lender accords its own property, it being understood that the Lender shall not have any responsibility for taking any necessary steps to preserve rights against any parties with respect to any such funds.

    (8) Any amount deposited in the Cash Collateral Account pursuant to Section 2.3 of the Mortgage may be utilized in connection with an Optional Tender Drawing under the terms of the Indenture.

    (d) The Lender, in its sole discretion, may pay any amount owing under the Bond Documents, including without limitation, principal of, interest and premium on the Bonds or the Lender may cure any other event of default under the Bond Documents;

    (e) The Lender may, by written notice to the Borrower in accordance with the terms of such indebtedness declare all indebtedness of every type or description owed by the Borrower to the Lender to be immediately due and payable and the same shall be thereupon be immediately due and payable;

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    (f)  The Lender may offset any deposits of the Borrower held by the Lender (including those held by the Lender in the Cash Collateral Account and any unmatured time deposits) against sums due hereunder or against any other indebtedness then owed by the Borrower to the Lender, whether or not then due.

ARTICLE VII.

MISCELLANEOUS

    SECTION 7.1.  Indemnification by Borrower.

    (a) The Borrower agrees to indemnify and hold harmless the Bank and the Lender, their respective officers, agents and employees, against any and all losses, claims, damages or liability to which they or any of them may become subject under any law in connection with the issuance and sale of the Bonds and the carrying out of the transactions contemplated by the Borrower Documents and the Bond Documents, or the conduct of any activity on the Borrower's premises, other than any such losses, claims, damages or liability resulting from the gross negligence or willful misconduct of the Lender or its officers, directors, agents or employees, and to reimburse the Bank and the Lender, their respective officers, agents and employees, for any reasonable out-of-pocket legal and other expenses (including reasonable counsel fees) incurred by any one or more of them in connection with investigating any such losses, claims, damages or liabilities or in connection with defending any actions relating thereto. The Bank and the Lender agree, at the request and expense of the Borrower, to cooperate in the making of any investigation in defense of any such claim and promptly to assert any or all of the rights and privileges and defenses which may be available to them. The Borrower further releases and agrees to hold harmless the Bank and the Lender, their respective officers, agents and employees, from any liability to the Borrower arising out of any covenant, representation or undertaking contained in the Bond Documents. The provisions of this Section shall survive the payment and redemption of the Bonds.

    (b) The Borrower hereby indemnifies and holds harmless the Bank and the Lender from and against any and all claims, damages, losses, liabilities, costs or expenses whatsoever which the Bank and the Lender may incur (or which may be claimed against the Bank and/or the Lender by any person or entity whatsoever) (i) by reason of any untrue statement or alleged untrue statement of any material fact contained in any official statement or other offering document relating to the offer or sale of the Bonds or the omission or alleged omission to state therein a material fact necessary to make such statements, in light of the circumstances under which they are made, not misleading (except any statement or omission relating to the Bank or the Lender contained in any written materials supplied or approved by the Bank or the Lender), or (ii) by reason of or in connection with the execution and delivery or transfer of, or payment or failure to pay under the Letters of Credit; provided, however, that the Borrower shall not be required to indemnify the Bank or the Lender for any claims, damages, losses, liabilities, costs or expenses to the extent, but only to the extent, caused by the willful misconduct or gross negligence of the Bank or the Lender or their respective officers, directors, agents or employees, in connection with paying or wrongfully dishonoring a draft presented under the Letters of Credit. Nothing in this Section 7.1 is intended to limit the Borrower's Obligation of Reimbursement.

    SECTION 7.2.  Addresses for Notice.  All notices, consents, requests, demands and other communications hereunder shall be given to or made upon the respective parties hereto at their respective addresses specified below or, as to any party, at such other address as may be designated by it in a written notice to the other party. All notices, requests, consents and demands hereunder shall be

10

effective when personally delivered or duly deposited in the United States mails, certified or registered, postage prepaid, sent via facsimile or delivered to the telegraph company addressed as aforesaid:

If to the Lender:

LaSalle Business Credit, Inc.
Two Honey Creek Corporate Center
115 South 84th Street, Suite 220
Attention:
Facsimile No: (414) 256-5099

If to the Bank:

LaSalle Bank N.A.
135 South LaSalle Street
Chicago, Illinois 60603
Attention: Mike Carsella
Facsimile No: (312) 904-6450

If to the Borrower:

HEI, Inc.
1495 Steiger Lake Lane
Victoria, MN 55386
Facsimile No.: (612) 443-2668

    SECTION 7.3.  Fees.  The Borrower will reimburse the Bank and the Lender upon demand for all reasonable costs and expenses, including without limitation, attorney's fees, appraisal fees, survey fees, closing charges, inspection fees, documentary or tax stamps, recording and filing fees, mortgage registration tax, insurance premiums and service charges, paid or incurred by the Bank or the Lender in connection with (i) the preparation, negotiation, approval, execution and delivery of the Letters of Credit, this Agreement, the Mortgage, the Credit Agreement, the Loan Agreement and any other documents and instruments related hereto or thereto; (ii) the negotiation of any amendments or modifications to any of the foregoing documents, instruments or agreements in the preparation of any and all documents necessary to effect such amendments or modifications; (iii) the servicing of the Letters of Credit; (iv) the review of any document submitted to the Bank or the Lender pursuant to Article III hereof; and (v) the enforcement by the Bank or the Lender during the term hereof or thereafter of any of the rights or remedies of the Bank or the Lender hereunder or under any of the foregoing documents, instruments or agreements, including without limitation, costs and expenses of collection in the Event of Default, whether or not suit is filed with respect thereto.

    SECTION 7.4.  Time of Essence.  Time is of the essence in the performance of this Agreement.

    SECTION 7.5.  Binding Effect and Assignment.  This Agreement shall be binding upon and inure to the benefit of the Borrower and its successors and permitted assigns, except that Borrower may not transfer or assign its rights hereunder without the prior written consent of the Lender. This Agreement shall inure to the benefit of the Bank and the Lender and their respective participants, successors and assigns. All rights and powers specifically conferred upon the Bank and/or the Lender may be transferred or delegated by the Bank and/or the Lender to any of their respective participants, successors or assigns.

    SECTION 7.6.  Waivers.  No waiver by the Bank or the Lender of any right, remedy or Event of Default hereunder shall operate as a waiver of any other right, remedy, or Event of Default or of the same right, remedy or Event of Default on a future occasion. No delay on the part of the Bank or the

11

Lender in exercising any right or remedy hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right or remedy preclude other or future exercise thereof or the exercise of any other right or remedy.

    SECTION 7.7.  Remedies Cumulative.  The rights and remedies herein specified of the Bank and the Lender are cumulative and not exclusive of any rights or remedies which the Bank or the Lender would otherwise have at law or in equity or by statute.

    SECTION 7.8.  Governing Law; Construction.  This Agreement shall be governed by and construed in accordance with the internal law, and not the law of conflict, of the State of Minnesota. Whenever possible, each provision of this Agreement and/or any of the other Borrower Documents, and any other statement, instrument or transaction contemplated hereby or thereby or relating hereto or thereto shall be interpreted in such manner as to be effective and valid under such applicable law, but, if any provision of this Agreement and/or any of the other Borrower Documents or any other statement, instrument or transaction contemplated hereby or thereby or relating hereto or thereto should be held to be prohibited or invalid under such applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Agreement and/or any of the Borrower Documents, or any other statement, instrument or transaction contemplated hereby or thereby or relating hereto or thereto. In the event of any conflict within, between or among the provisions of this Agreement, the other Borrower Documents, or any other statement, instrument or transaction contemplated hereby or thereby or relating hereto or thereto, those provisions giving the Bank and/or the Lender the greater right shall govern.

    SECTION 7.9.  Jurisdiction.  THE BORROWER HEREBY SUBMITS ITSELF TO THE JURISDICTION OF THE STATE OF MINNESOTA AND THE FEDERAL COURTS OF THE UNITED STATES LOCATED IN SUCH STATE IN RESPECT OF ALL ACTIONS ARISING OUT OF OR IN CONNECTION WITH THE INTERPRETATION OR ENFORCEMENT OF THIS AGREEMENT AND THE DOCUMENTS RELATED HERETO.

    SECTION 7.10.  Interest Rate.  Anything herein to the contrary notwithstanding, the obligations of the Borrower under this Agreement shall be subject to the limitation that payments of interest shall not be required to the extent that contracting for or receipt thereof would be contrary to the provisions of law applicable to the Lender limiting the highest rate of interest which may be lawfully contracted for, charged or received by the Lender.

    SECTION 7.11.  Counterparts.  This Agreement may be executed in any number of counterparts, each of which when so executed and delivered shall be an original, but such counterparts shall together constitute one and the same instrument.

    SECTION 7.12.  Not Joint Venturers.  The Bank and the Lender are not, and shall not by reason of any provision of any of the Borrower Documents be deemed to be, a joint venturer with or partner or agent of the Borrower.

    SECTION 7.13.  Obligations Absolute.  Subject to Section 7.15 hereof, the obligations of the Borrower under this Agreement shall be absolute, unconditional and irrevocable, and shall be paid and performed strictly in accordance with the terms of this Agreement, under all circumstances whatsoever, including, the following circumstances:

    (a) any lack of validity or enforceability of the Letters of Credit, the Bonds, any of the Bond Documents, or any other agreement or instrument relating thereto (collectively the "Related Documents");

    (b) any amendment or any waiver of or any consent to departure from all or any of the Related Documents;

12

    (c) the existence of any claim, set-off, defense or other right which the Borrower may have at any time against the Issuer, the Trustee, any beneficiary or any transferee of the Letters of Credit (or any person or entity for whom the Issuer, the Trustee, any such beneficiary or any such transferee may be acting), or any other person or entity, whether in connection with this Agreement, the transactions contemplated herein or in the Related Documents or any unrelated transactions;

    (d) any statement or any other document presented under the Letters of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect whatsoever; or

    (e) payment by the Lender under the Letters of Credit against presentation of a draft or certificate which does not comply with the terms of the Letters of Credit.

    SECTION 7.14.  Transfer of Letters of Credit.  The Letters of Credit may only be transferred in accordance with the terms thereof.

    SECTION 7.15.  Liability of the Bank and the Lender.  The Borrower assumes all risks of the acts or omissions of the Issuer, the Trustee or any beneficiary or transferee of the Letters of Credit with respect to its use of the Letters of Credit. Neither the Bank nor the Lender, nor any of their respective employees, officers or directors, in its or their capacity as issuer of the Letters of Credit shall be liable or responsible for:

    (a) the use which may be made of the Letters of Credit or for any acts or omissions of the Issuer, the Trustee or any beneficiary or transferee in connection therewith;

    (b) the validity, sufficiency or genuineness of documents, or of any endorsement thereon, even if such documents should in fact prove to be in any or all respects invalid, insufficient, fraudulent or forged; or

    (c) payment by the Bank against presentation of documents which do not comply with the terms of the Letters of Credit, including failure of any documents to bear any reference or adequate reference to the Letters of Credit;

except that the Borrower shall have a claim against the Bank, and the Bank shall be liable to the Borrower, to the extent, but only to the extent, of any direct, as opposed to consequential, damages (including reasonable attorneys fees, costs and expenses) suffered by the Borrower which were caused by:

    (1) the willful misconduct or gross negligence of the Bank or its officers, directors, agents or employees in determining whether documents presented under the Letters of Credit comply with the terms of the Letters of Credit; or

    (2) the willful failure or gross negligence of the Bank or its officers, directors, agents or employees to pay under the Letters of Credit after the presentation to it by the Trustee or an approved successor trustee of a draft and certificate strictly complying with the terms and conditions of the Letters of Credit.

    SECTION 7.16.  Security Interest in Funds and Bonds.  As additional security for payment of its obligations under this Agreement, the Borrower hereby grants a security interest to the Lender in all securities, assets, deposits in and rights to payment from all funds now or hereafter on deposit in or otherwise a part of any fund created by the Trustee under the Indenture or any and all other accounts created under the Indenture, including Bonds and Bond proceeds held pursuant to the Indenture, and in the proceeds realized from the investment of any such items, and in any and all Bonds and substitutions of such Bonds at any time held by the Trustee; and the Borrower hereby consents to the Lender's appointment of the Trustee as the Lender's agent to perfect the Lender's security interest in

13

such funds and other assets. The security interest granted hereunder shall be subordinate to the Trustee's right to apply such funds in accordance with the Indenture and subordinate to the rights of holders of the Bonds in and to such funds. All payments on Bonds or funds held by the Trustee as agent for the Lender under this Section 7.16, including (without limitation) any payment of principal or interest or proceeds of sale, shall be paid directly to the Lender. All such payments received by the Lender shall be credited against the Borrower's Obligation of Reimbursement. The Lender shall be entitled to exercise all of the rights of an owner of the Bonds held by the Trustee as agent for the Lender with respect to voting, consenting and directing the Trustee as if the Lender were the owner of such Bonds, and the Borrower hereby grants and assigns to the Lender all such rights.

    SECTION 7.17.  Term.  This Agreement shall automatically terminate upon the later of (i) expiration of the Letters of Credit, or (ii) payment in full of the Obligation of Reimbursement and all other amounts due and payable by the Borrower to the Bank and the Lender hereunder or under the documents related hereto.

    SECTION 7.18.  Redemption of the Bonds under Casualty or Condemnation Laws.  To the extent that the Borrower has the right to direct the Issuer to call for redemption of the Bonds under Section 3.1 of the Indenture, the Borrower shall promptly give such direction to the Issuer if (i) the Lender has the right and shall have elected to apply proceeds of insurance or condemnation to redemption of the Bonds pursuant to the Mortgage; and (ii) the Borrower has been instructed in writing by the Lender to give such direction. A copy of any such written direction to the Issuer shall be given by the Borrower to the Lender. If the Borrower shall fail to give such direction to the Issuer within seven (7) calendar days after being instructed to do so by the Lender, the Lender shall have the authority to give such direction to the Issuer on behalf of the Borrower, and if the Borrower fails to deposit with the Trustee the amount required to redeem the Bonds, the Lender may direct the Trustee to submit a draft under the Letters of Credit, in which case the Borrower shall be obligated to repay the same pursuant to Article IV hereof, less the amount of any insurance or condemnation proceeds paid to the Lender pursuant to the Mortgage and available to the Lender for redemption of the Bonds. To facilitate such authority, the Borrower hereby irrevocably appoints (which appointment is coupled with an interest) the Lender or its delegate as the attorney-in-fact to the Borrower with the right to give such direction to the Issuer in the name of and on behalf of the Borrower. If the Lender elects to give such direction to the Issuer, the Lender will give the Borrower a copy of such direction.

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    IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the day and year first above written.

LASALLE BUSINESS CREDIT, INC.

 
/s/ DALE GRZENIA By: Dale Grzenia
   Its: Vice President

 
LASALLE BANK N.A.

 
/s/ BRUCE A. SPRENGER By: Bruce A. Sprenger
   Its: Senior Vice President

 
HEI, INC.

 
/s/ ANTHONY J. FANT By: Anthony J. Fant
   Its: Chairman and CEO

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EXHIBIT A

(Schedule of Principal Payments Required Under Series A Bonds)

Date of Payment		Payment Amount
04/01/01		$	605,000
04/01/02		$	605,000
04/01/03		$	605,000
04/01/04		$	255,000
04/01/05		$	20,000
	Total Principal Payments	$	2,090,000

EXHIBIT B

(Schedule of Principal Payments Required Under Series B Bonds)

Date of Payment		Payment Amount
04/01/01		$	95,000
04/01/02		$	95,000
04/01/03		$	95,000
04/01/04		$	95,000
04/01/05		$	95,000
04/01/06		$	95,000
04/01/07		$	95,000
04/01/08		$	95,000
04/01/09		$	95,000
04/01/10		$	95,000
04/01/11		$	95,000
	Total Principal Payments	$	1,045,000

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TABLE OF CONTENTS
REIMBURSEMENT AGREEMENT
ARTICLE I. DEFINITIONS
ARTICLE II. COMMITMENT TO ISSUE THE LETTERS OF CREDIT
ARTICLE III. CONDITIONS PRECEDENT
ARTICLE IV. REIMBURSEMENTS AND OTHER PAYMENTS LENDER'S RIGHT TO CURE
ARTICLE V. WARRANTIES, REPRESENTATIONS AND COVENANTS
ARTICLE VI. EVENTS OF DEFAULT; RIGHTS AND REMEDIES UPON EVENT OF DEFAULT
ARTICLE VII. MISCELLANEOUS
EXHIBIT A
EXHIBIT B

EX-4.4

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EXHIBIT 4.4

MORTGAGE, SECURITY AGREEMENT,
FIXTURE FINANCING STATEMENT
AND ASSIGNMENT OF LEASES AND RENTS

BY

HEI, INC.

AS MORTGAGOR,

TO

LASALLE BUSINESS CREDIT, INC.

AS MORTGAGEE,

TO SECURE

$3,271,997.00 REIMBURSEMENT OBLIGATION

Dated as of: July 31, 2000

 
Tax statements for the real property
described in this instrument
should be sent to:
HEI, Inc.
1495 Steiger Lake Lane
P.O. Box 5000
Victoria, Minnesota 55386  
This instrument was drafted by:
WINTHROP & WEINSTINE, P.A.
3000 Dain Rauscher Plaza
60 South Sixth Street
Minneapolis, Minnesota 55402
THE MAXIMUM PRINCIPAL
AMOUNT SECURED BY THE
MORTGAGE IS $3,271,997.00

MORTGAGE, SECURITY AGREEMENT,
FIXTURE FINANCING STATEMENT AND
ASSIGNMENT OF LEASES AND RENTS

    THIS MORTGAGE, SECURITY AGREEMENT, FIXTURE FINANCING STATEMENT AND ASSIGNMENT OF LEASES AND RENTS (the "Mortgage") made as of the 31st day of July, 2000, by HEI, Inc., a Minnesota corporation (the "Mortgagor"), in favor of LaSalle Business Credit, Inc. (the "Mortgagee").

W I T N E S S E T H:

    The City of Victoria, Minnesota (the "Issuer"), has issued those certain $5,625,000 Variable Rate Demand Industrial Development Revenue Bonds, Series 1996A and B (HEI, Inc. Project) (the "Bonds") pursuant to that certain Indenture of Trust (the "Indenture") dated as of April 1, 1996, by and between the Issuer and First Trust National Association, predecessor in interest to U.S. Bank Trust National Association (the "Trustee"); and

    WHEREAS, the Issuer has loaned the proceeds of the Bonds to the Mortgagor pursuant to a Loan Agreement dated as of April 1, 1996 by and between the Issuer and the Mortgagor (the "Loan Agreement"), for the purpose of financing the project described therein (the "Project");

    WHEREAS, in order to provide credit and liquidity enhancement with respect to the Bonds, LaSalle Bank N.A. (the "Bank") has determined to issue its Irrevocable Letter of Credit No. S524151 and its Irrevocable Letter of Credit No. S524150, each for the Mortgagor's account, in the respective original stated amounts of $1,090,666.00 and $2,181,331.00 for the benefit of the Trustee (collectively, the "Credit"), which shall initially expire on April 1, 2002, unless extended or renewed by the Bank; and

    WHEREAS, in order to induce the Bank to issue the Credit, the Mortgagee has agreed to co-sign for and to reimburse the Bank for draws under the Credit, and

    WHEREAS, as a condition of issuance of the Credit, the Bank and the Mortgagee have required that the Mortgagor execute the Reimbursement Agreement dated as of July 31, 2000 for the benefit of the Bank and the Mortgagee (the "Reimbursement Agreement") which requires, among other things, that the Mortgagor reimburse the Bank and the Mortgagee for any and all draws made under the Credit.

    NOW THEREFORE, THIS MORTGAGE FURTHER WITNESSETH, that in consideration of the Bank issuing the Credit for the account of Mortgagor, and the Mortgagee agreeing to co-sign for and to reimburse the Bank for draws under the Credit pursuant to the Reimbursement Agreement, and other good and lawful consideration, the receipt and sufficiency of which are hereby acknowledged, and to secure, and as security for, the payment of principal of and interest on the Obligation of Reimbursement (as that term is defined in the Reimbursement Agreement) and other premiums, penalties and charges due under and pursuant to the Reimbursement Agreement and the performance and observance by the Mortgagor of all of the covenants, agreements, representations, warranties and conditions contained herein, the Mortgagor does hereby grant, bargain, sell, convey, assign, transfer, pledge, set over and confirm unto the Mortgagee, its successors and assigns, forever, and does hereby grant a mortgage lien and security interest to the Mortgagee, its successors and assigns, forever, in and to the tract of land legally described on Exhibit A attached hereto and hereby made a part hereof (hereinafter referred to as the "Land");

    Together with (a) all of the buildings, structures and other improvements now standing or at any time hereafter constructed or placed upon the Land; (b) all heating, plumbing and lighting apparatus, elevators and motors, engines and machinery, electrical equipment, incinerator apparatus, air-conditioning apparatus, water and gas apparatus, pipes, water heaters, refrigerating plant and refrigerators, water softeners, carpets, carpeting, storm windows and doors, window screens, screen doors, storm sash, window shades or blinds, awnings, locks, fences, trees, shrubs, and all other fixtures, equipment and personal property of every kind and nature whatsoever now or hereafter owned by the

Mortgagor and attached or affixed to the Land, including all extensions, additions, improvements, betterments, renewals and replacements of any of the foregoing; (c) all hereditaments, easements, rights, privileges and appurtenances now or hereafter belonging, attached or in any way pertaining to the Land or to any building, structure or improvement now or hereafter located thereon (but specifically excluding any equipment owned by tenants (other than the Mortgagor) occupying space within any improvements to be built upon the Land); (d) the immediate and continuing right to receive and collect all rents, income, issues and profits now due and which may hereafter become due under or by virtue of any lease or agreement (oral or written) for the leasing, subleasing, use or occupancy of all or part of the Land now, heretofore or hereafter made or agreed to by Mortgagor; (e) all of the leases and agreements described in (d) above, together with all guarantees therefor and any renewals or extensions thereof; (f) any and all equipment and furniture now owned or hereafter acquired by Mortgagor and now or hereafter located on or in, or used or intended to be used in connection with, the Land and the buildings and other improvements thereon, (collectively, the "Equipment"); and (g) all insurance and other proceeds of, and all condemnation awards with respect to, the foregoing (all of the foregoing is hereinafter collectively referred to as the "Mortgaged Property").

    The filing of this Mortgage shall constitute a fixture filing in the office where it is filed and a carbon, photographic or other reproduction of this document may also be filed as a financing statement:

Name and Address of Debtor and Record Owner of Real Estate	HEI, Inc. 1495 Steiger Lake Lane Victoria, Minnesota 55386 Federal Tax Identification Number: 41-0944876
Name and Address of Secured Party:	LaSalle Business Credit, Inc. Two Honey Creek Corporate Center 115 South 84th Street, Suite 220 Milwaukee, WI 53214

Description of the Types (or items) of property covered by this financing statement:	See above
Description of real estate to which all or a part of the collateral is attached or upon which it is located:	See Exhibit "A" attached hereto.

    Some of the above described collateral is or is to become fixtures upon or minerals and mineral rights located upon the real estate described on Exhibit "A", and this financing statement is to be filed for record in the public real estate records.

    AND THE MORTGAGOR, for itself, its successors and assigns, does covenant with the Mortgagee, its successors and assigns, that it is lawfully seized of the Mortgaged Property and has good right to sell and convey the same; that the Mortgaged Property is free from all encumbrances except as may be further stated in this Mortgage; that the Mortgagee, its successors and assigns, shall quietly enjoy and possess the Mortgaged Property; and that the Mortgagor will WARRANT AND DEFEND the title to the same against all lawful claims not specifically excepted in this Mortgage.

    PROVIDED, NEVERTHELESS, that if the Mortgagor shall pay the principal balance of the Obligation of Reimbursement in full, plus interest thereon at the rate set forth in the Reimbursement Agreement, as the same changes from time to time and is adjusted in the manner set forth in the Reimbursement Agreement, on the unpaid principal balance, as computed in accordance with the terms and conditions of the Reimbursement Agreement, and any other sums due and owing under the Reimbursement Agreement and shall also pay or cause to be paid all other sums, with interest thereon, as may be advanced by the Mortgagee in accordance with this Mortgage either to protect the lien of

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this Mortgage, or by way of additional loan or for any other purpose, and shall also keep and perform all and singular the covenants herein, required on the part of the Mortgagor to be kept and performed (the Obligation of Reimbursement and all such sums, together with interest thereon, and such covenants herein collectively referred to as the "Indebtedness Secured Hereby"), then this Mortgage shall be null and void, in which event the Mortgagee will execute and deliver to the Mortgagor in form suitable for recording at Mortgagor's expense a full satisfaction of this Mortgage; otherwise this Mortgage shall remain in full force and effect. The maximum principal amount secured hereby shall be $3,271,997.00.

ARTICLE I.

GENERAL COVENANTS, AGREEMENTS, WARRANTIES

    SECTION 1.1.  PAYMENT OF INDEBTEDNESS; OBSERVANCE OF COVENANTS.  Mortgagor shall duly and punctually pay each and every payment of principal, interest and all prepayment premiums and late charges, if any, which constitutes the Indebtedness Secured Hereby, as and when the same shall become due, and shall duly and punctually perform and observe all of the covenants, agreements and provisions contained herein or in any other instrument given as security for the payment of the Obligation of Reimbursement.

    SECTION 1.2.  MAINTENANCE; REPAIRS.  Subject to the provisions of Section 1.3 hereof, Mortgagor shall keep and maintain the Mortgaged Property in good condition, repair and operating condition free from any waste or misuse, and will comply with all requirements of law, municipal ordinances and regulations, restrictions and covenants affecting the Mortgaged Property and its use, and will promptly repair or restore any building, improvements or structures now or hereafter located on the Land which may become damaged or destroyed to their condition prior to any such damage or destruction. Mortgagor shall not acquiesce in any rezoning classification, modification or restriction affecting the Land, without the prior written consent of the Mortgagee, which consent shall not be unreasonably withheld. Mortgagor shall not vacate or abandon the Mortgaged Property.

    SECTION 1.3.  PAYMENT OF UTILITY CHARGES, TAXES AND ASSESSMENTS.  Mortgagor shall, before any penalty attaches thereto, pay or cause to be paid all charges made for electricity, gas, heat, water, sewer and other utilities furnished or used in connection with the Mortgaged Property, and all taxes, installments of special assessments, levies and encumbrances of every nature heretofore or hereafter assessed against the Mortgaged Property and upon demand will furnish the Mortgagee receipted bills evidencing such payment.

    Nothing in this Section 1.3 shall require the payment or discharge of any obligations imposed upon Mortgagor by this Section so long as Mortgagor shall diligently and in good faith and at its own expense contest the same or the validity thereof by appropriate legal proceedings which shall operate to prevent the collection thereof or other realization thereon and the sale or forfeiture of the Mortgaged Property or any part thereof to satisfy the same; provided, however, that during such contest Mortgagor shall, at the reasonable request of Mortgagee, provide security satisfactory to Mortgagee, assuring the discharge of Mortgagor's obligation under this Section and of any additional charge, penalty or expense arising from or incurred as a result of such contest; and provided further, however, that if at any time payment of any obligation imposed upon Mortgagor by this Section shall become necessary to prevent the delivery of a tax deed conveying the Land or any portion thereof because of nonpayment, then Mortgagor shall pay the same in sufficient time to prevent the delivery of such tax deed.

    SECTION 1.4.  LIENS.  Except for liens and encumbrances, if any, listed on Exhibit B attached hereto or consented to in writing by or granted to Mortgagee ("Permitted Encumbrances"), Mortgagor will keep the Mortgaged Property free from all liens (other than liens for taxes, installments of special assessments and mechanics' liens not yet due and payable) and encumbrances of every nature

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whatsoever heretofore or hereafter arising and, upon written demand of Mortgagee, Mortgagor will pay and procure the release of any such lien or encumbrances within thirty (30) days of such demand.

    Nothing in this Section 1.4 shall require the payment or discharge of any obligations imposed upon Mortgagor by this Section so long as Mortgagor shall diligently and in good faith and at its own expense contest the same or the validity thereof by appropriate legal proceedings which shall operate to prevent the collection thereof or other realization thereon and the sale or forfeiture of the Mortgaged Property or any part thereof to satisfy the same; provided, however, that during such contest Mortgagor shall, at the reasonable request of Mortgagee, provide security satisfactory to Mortgagee (including, without limitation, an agreement from the title company issuing title insurance with respect to this Mortgage to issue subsequent policies of title insurance "insuring over" such lien or encumbrance), assuring the discharge of Mortgagor's obligation under this Section and of any additional charge, penalty or expense arising from or incurred as a result of such contest; and provided further, however, that if at any time payment of any obligation imposed upon Mortgagor by this Section shall become necessary to prevent the sale or forfeiture of the Land or any portion thereof because of nonpayment, then Mortgagor shall pay the same in sufficient time to prevent such sale or forfeiture.

    SECTION 1.5.  COMPLIANCE WITH LAW.  Mortgagor will promptly comply with all present and future laws, ordinances, rules and regulations of any governmental authority affecting the Mortgaged Property unless the same is being diligently contested by Mortgagor in good faith and by proper proceedings.

    SECTION 1.6.  RIGHT OF MORTGAGEE TO ENTER.  Upon prior reasonable notice during normal business hours, Mortgagor will permit Mortgagee and its agents to enter, and to authorize others to enter, upon any or all of the Land, at any time and from time to time, during normal business hours, to inspect the Mortgaged Property, to perform or observe any covenants, conditions or terms hereunder which Mortgagor shall fail to perform, meet or comply with, or for any other purpose in connection with the protection or preservation of Mortgagee's security, without thereby becoming liable to Mortgagor or any person in possession under the Mortgage.

    SECTION 1.7.  RIGHT OF THE MORTGAGEE TO PERFORM.  If Mortgagor fails to pay all and singular any taxes, assessments, levies or other similar charges or encumbrances heretofore or hereafter assessed against the Mortgaged Property or fails to obtain the release of any lien or encumbrance (other than a Permitted Encumbrance) of any nature heretofore or hereafter arising upon the Mortgaged Property or fails to perform any other covenants and agreements contained in this Mortgage or if any action or proceeding is commenced which adversely affects or questions the title to or possession of the Mortgaged Property or the interest of Mortgagor or Mortgagee therein, then the Mortgagee, at the Mortgagee's option, after delivery of notice to Mortgagor, may perform such covenants and agreements, investigate and defend against such action or proceeding, and take such other action as the Mortgagee deems necessary to protect the Mortgagee's interest. Any amounts disbursed by the Mortgagee pursuant to this Section 1.7, including without limitation court costs and expenses and reasonable attorneys' fees, with interest thereon, shall become additional indebtedness of Mortgagor and shall be secured by this Mortgage. Such amount shall be payable upon written notice from Mortgagee to Mortgagor requesting payment thereof, and shall bear interest from the date of disbursement at a rate equal to five percent (5%) per annum in excess of the "Prime Rate" (as defined in the Reimbursement Agreement), as the same changes from time to time, or, if such rate is illegal or usurious, at the maximum rate then permitted by law. Nothing contained in this Section 1.7 shall require Mortgagee to incur any expense or to do any act or thing hereunder.

    SECTION 1.8.  ASSUMPTION.  Mortgagor shall not sell, assign, transfer, lease, convey, mortgage or otherwise encumber or dispose of either the legal or equitable title or both to all or any portion of the Mortgaged Property or any other interest therein without the prior written consent of Mortgagee.

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A sale, transfer, assignment or other disposition of all or any of the shares of stock of Mortgagor shall constitute a sale of the Mortgaged Property for purposes of this Section 1.8.

    SECTION 1.9.  ASSIGNMENT OF RENTS.  Mortgagor does hereby sell, assign and transfer unto Mortgagee (i) the immediate and continuing right to receive and collect all rents, income, issues and profits now due and which may hereafter become due under or by virtue of any lease or agreement (oral or written) for the leasing, subleasing, use or occupancy of all or any part of the Mortgaged Property now, heretofore or hereafter made or agreed to by Mortgagor, and (ii) all of such leases and agreements, together with all guarantees therefor and any renewals or extensions thereof, for the purpose of securing payment of the Indebtedness Secured Hereby.

    Mortgagor does hereby irrevocably appoint Mortgagee its true and lawful attorney in its name, place and stead, with or without taking possession of the Mortgaged Property, to rent, lease, sublease, let or sublet all or any portion of the Mortgaged Property to any party or parties at such rental and upon such terms, as it in its discretion may determine, and to collect all of said avails, rents, income, issues and profits arising from or accruing at any time hereafter under each and all of such leases and agreements, with the same rights and powers and subject to the same immunities, exoneration of liability and rights of recourse and indemnity as Mortgagee would have upon taking possession of the Mortgaged Property.

    Mortgagor represents and agrees that no rent has been or will be paid in advance by any persons in possession of all or any portion of the Mortgaged Property for a period of more than one installment or one month plus a reasonable security deposit and that the payment of none of the rents to accrue for all or any portion of the Mortgaged Property has been or will be waived, released, reduced or discounted, or otherwise discharged or compromised, by Mortgagor. Mortgagor waives any right of setoff against any person in possession of all or any portion of the Mortgaged Property. Mortgagor represents that it has not assigned any of said rents or profits to any third party and agrees that it will not so assign any of said rents or profits without the prior written consent of Mortgagee.

    Nothing contained herein shall be construed as constituting Mortgagee "a mortgagee in possession" in the absence of the taking of actual possession of the Mortgaged Property by Mortgagee. In the exercise of the powers herein granted Mortgagee, no liability shall be asserted or enforced against Mortgagee, all such liability being expressly waived and released by Mortgagor.

    Mortgagor further agrees to assign and transfer to Mortgagee all rents from future leases or sublease upon all or any part of the Mortgaged Property and to execute and deliver, immediately upon request of Mortgagee, such further assurances and assignments in the Mortgaged Property as Mortgagee from time to time shall require.

    Although it is the intention of the parties that this assignment of leases and rents shall be a present assignment, it is expressly understood and agreed that, anything herein contained to the contrary notwithstanding, Mortgagee shall not exercise any of the rights and powers conferred upon it herein unless and until an "Event of Default" (as that term is defined in the Reimbursement Agreement) shall occur and nothing herein contained shall be deemed to affect or impair any rights which Mortgagee may have under the Reimbursement Agreement, the Mortgage or any other document or agreement related hereto or thereto.

    At any time after an Event of Default occurs, Mortgagee, without in any way waiving such default, may:

    At Mortgagee's option without notice to Mortgagor and without regard to the adequacy of the security for the Reimbursement Agreement, either in person or by agent, with or without any action or proceeding, or by a receiver appointed by a court of competent jurisdiction pursuant to Minnesota Statutes, Section 559.17, subd. 2, peaceably take possession of the Mortgaged Property and have, hold, manage, lease, sublease and operate the same as a mortgagee in possession; or

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    Mortgagee, without taking possession of the Mortgaged Property, may sue for or otherwise collect and receive all rents, income and profits from the Mortgaged Property to which Mortgagor would otherwise be entitled, including those past due and unpaid with full power to make from time to time all adjustments thereto, as may seem proper to Mortgagee.

    Mortgagee shall not be obligated to perform or discharge, nor does it hereby undertake to perform or discharge, any obligation, duty or liability under any leases, sublease or rental agreements relating to the Mortgaged Property, and Mortgagor shall and does hereby agree to indemnify and hold Mortgagee harmless from and against any and all liability, loss or damage which it may or might incur under any such lease, sublease or agreement or under or by reason of the assignment of the rents thereof and from and against any and all claims and demands whatsoever which may be asserted against it by reason of any alleged obligations or undertakings on its part to perform or discharge any of the terms, covenants or agreements contained in any of such leases, provided that Mortgagor shall not indemnify and hold harmless Mortgagee from any liability, loss or damage resulting from acts or omissions of the Mortgagee which occur on or after the date Mortgagee takes possession of the Mortgaged Property. Should Mortgagee incur any liability, loss or damage by reason of this assignment of leases and rents, or in the defense of any claim or demand, Mortgagor agrees to reimburse Mortgagee for the amount thereof, including costs, expenses and reasonable attorneys' fees, immediately upon demand.

    Mortgagee, or such agent or receiver, in the exercise of the rights and powers conferred upon it by this assignment of leases and rents shall have the full power to use and apply the avails, rents, issues, income and profits of the Mortgaged Property to which Mortgagor would otherwise be entitled to the payment of or on account of the following in the order listed below:

    1.  Reasonable receiver's fees;

    2.  Application of tenant security deposits as required by Minnesota Statutes, Section 504.20;

    3.  Payment, when due, of prior or current real estate taxes or special assessments with respect to the Mortgaged Property, or the periodic escrow for the payment of the taxes or special assessments;

    4.  Payment, when due, of premiums for insurance of the type required by this Mortgage, or the periodic escrow for the payment of the premiums; and

    5.  All expenses for normal maintenance of the Mortgaged Property.

provided, however, that nothing herein shall prohibit the right to reinstate pursuant to Minnesota Statutes, Section 580.30, or the right to redeem granted pursuant to Minnesota Statutes, Sections 580.23 and 581.10.

    Any excess cash remaining after paying the expenses listed in clauses (1.) through (5.) above shall be applied to the payment of the Obligation of Reimbursement and shall be deemed to be credited to the amount required to be paid to effect a reinstatement or redemption or, if the period of redemption ends without redemption, such remaining amounts shall be paid to the purchaser at the foreclosure sale, its successors or assigns.

    Mortgagor does further specifically authorize and instruct each and every present and future lessee, sublessee, tenant or subtenant of the whole or any part of the Mortgaged Property to pay all unpaid rental agreed upon in any lease or sublease to Mortgagee upon receipt of demand from Mortgagee so to pay the same.

    Any tenants, subtenants or other occupants of all or any part of the Mortgaged Property are hereby authorized to recognize the claims of Mortgagee hereunder without investigating the reason for any action taken by Mortgagee, or the validity or the amount of indebtedness owing to Mortgagee, or upon the occurrence or existence of any Event of Default, or the application to be made by Mortgagee

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of any amounts to be paid to Mortgagee. The sole signature of any officer or attorney of Mortgagee shall be sufficient for the exercise of any rights under this assignment of leases and rents and the sole receipt of Mortgagee for any sums received by such tenants, subtenants or other occupants shall be a full discharge and release therefor. Checks for all or any part of the rentals collected under this assignment of leases and rents shall be drawn to the exclusive order of Mortgagee.

    SECTION 1.10.  FURTHER ASSURANCES.  At any time and from time to time, upon request by Mortgagee, Mortgagor will make, execute and deliver or cause to be made, executed and delivered, to Mortgagee, any and all other further instruments, certificates and other documents as may, in the reasonable opinion of Mortgagee, be necessary or desirable in order to effectuate, complete or perfect, or to continue and preserve, the obligations of the Mortgagor hereunder and under the other Borrower Documents (as that term is defined in the Reimbursement Agreement) and the mortgage and security interest granted by this Mortgage. Upon any failure by Mortgagor so to do, Mortgagee may make, execute and record any and all such instruments, certificates and documents for and in the name of Mortgagor and Mortgagor hereby irrevocably appoints Mortgagee its agent and attorney in fact of Mortgagor so to do.

    SECTION 1.11.  EXPENSES.  Mortgagor will pay or reimburse Mortgagee for all reasonable attorneys' fees, costs and expenses incurred by Mortgagee in any legal proceeding or dispute of any kind in which Mortgagee is made a party, or appears as party plaintiff or defendant, affecting the Indebtedness Secured Hereby, this Mortgage, the interest created herein or the Mortgaged Property, including but not limited to the exercise of the power of sale set forth in this Mortgage, any condemnation action involving the Mortgaged Property or any action to protect the security hereof and any such amounts paid by Mortgagee shall be added to the indebtedness secured by this Mortgage. To the extent deemed practicable by Mortgagee and in the event the interests of Mortgagor and Mortgagee in connection with such proceeding or dispute are not adverse, Mortgagee shall cooperate with Mortgagor in an effort to prevent duplication of costs incurred by Mortgagor and Mortgagee in connection with such proceeding or dispute.

    SECTION 1.12.  BOOKS AND RECORDS; FINANCIAL STATEMENTS.  Mortgagor will keep and maintain full, true and accurate books of account adequate to reflect correctly the results of the operation of the Mortgaged Property, all of which books and records relating thereto shall be open to inspection by Mortgagee or its representative during normal business hours.

    SECTION 1.13.  HAZARDOUS SUBSTANCES.  Mortgagor warrants, covenants and represents that there does not exist in or under the Mortgaged Property any pollutant, toxic or hazardous waste or substance, or any other material the release or disposal of which is regulated by any law, regulation, ordinance or code related to pollution or environmental contamination, and, that no part of the Mortgaged Property was ever used for any industrial or manufacturing purpose or as a dump, sanitary landfill, or gasoline service station, and that there exists on the Mortgaged Property no electrical transformers or other equipment containing PCBs or material amounts of asbestos. Mortgagor represents that, other than the Environmental Reports, it has received no summons, citations, directives, letters or other communications, written or oral, from any federal, state or local agency or department concerning the storing, releasing, pumping, pouring, emitting, emptying or dumping of any pollutant, toxic or hazardous waste or substance on the Mortgaged Property.

    Mortgagor covenants and agrees that it shall not, nor shall it permit others to, use the Mortgaged Property for the business of generating, transporting, storing, treating or disposing of any pollutant, toxic or hazardous waste or substance, nor shall it either take or fail to take any action which may result in a release of any hazardous substance from or onto the Mortgaged Property.

    Mortgagor agrees to indemnify and to hold Mortgagee harmless from any and all claims, causes of action, damages, penalties, and costs (including, but not limited to, attorneys' fees, consultants' fees and related expenses) which may be asserted against, or incurred by, Mortgagee resulting from or due to

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release of any hazardous substance or waste on the Mortgaged Property or arising out of any injury to human health or the environment by reason of the condition of or past activity upon the Mortgaged Property. Mortgagor's duty to indemnify and hold harmless includes, but is not limited to proceedings or actions commenced by any person (including, but not limited to, any federal, state, or local governmental agency or entity) before any court or administrative agency. Mortgagor further agrees that pursuant to its duty to indemnify under this section, Mortgagor shall indemnify Mortgagee against all expenses incurred by Mortgagee as they become due and not waiting for the ultimate outcome of the litigation or administrative proceeding. Mortgagor's obligations to indemnify and hold Mortgagee harmless hereunder shall survive repayment of the Indebtedness Secured Hereby and satisfaction or foreclosure of this Mortgage.

    Mortgagee, or any authorized agent or representative of Mortgagee is irrevocably authorized to enter upon the Mortgaged Property at any time and from time to time during the term of this Mortgage for the purpose of performing inspections, taking soil borings or other borings, or conducting any other tests or procedures on, in or about the Mortgaged Property, as Mortgagee deems necessary or appropriate to determine whether any hazardous or toxic substances, including without limitation asbestos or PCBs, are present on, under or about the Mortgaged Property.

ARTICLE II.

INSURANCE, CONDEMNATION AND USE OF PROCEEDS

    SECTION 2.1.  INSURANCE.  Mortgagor shall keep the buildings, structures, fixtures and other improvements now existing or hereafter erected on the Land, insured against loss by fire, vandalism and malicious mischief, perils of extended coverage, and such other hazards, casualties and contingencies as may be reasonably specified by Mortgagee, in an amount not less than the replacement cost. All insurance shall be carried in companies licensed to do business in the State of Minnesota and approved by Mortgagee and the policies and renewals thereof shall (i) contain a waiver of defense based on coinsurance, (ii) be constantly assigned and pledged to and held by Mortgagee as additional security for the Indebtedness Secured Hereby, (iii) have attached thereto loss-payable clauses in favor of and in form acceptable to Mortgagee, and (iv) provide that Mortgagee shall receive at least thirty (30) days' prior written notice of cancellation or any substantial modification of the policy. In default thereof, Mortgagee may effect any insurance required to be maintained by Mortgagor pursuant to this Section 2.1 and the amount paid therefor shall become immediately due and payable with interest at a rate equal to five percent (5%) per annum in excess of the Prime Rate, as the same changes from time to time, or, if such rate is illegal or usurious, at the maximum rate permitted by law, and shall be secured by this Mortgage. In the event of loss or damage to the Mortgaged Property, Mortgagor will give immediate written notice thereof to Mortgagee, who may make proof of loss or damage if not made promptly by Mortgagor. Mortgagor hereby authorizes Mortgagee to settle and compromise all claims on such policies and hereby authorizes and directs each insurance company concerned to make payment for any such loss to Mortgagor and Mortgagee jointly. In the event of foreclosure of this Mortgage, all right, title and interest of Mortgagor in and to any property insurance policies then in force shall pass to the purchaser at the foreclosure sale. Mortgagor shall also maintain such insurance (including, without limitation, liability insurance), in such form and amount, as may reasonably be, specified by Mortgagee.

    SECTION 2.2.  CONDEMNATION.  Mortgagor shall give Mortgagee immediate written notice of the actual or threatened commencement of any proceedings under condemnation or eminent domain affecting all or any part of the Mortgaged Property or any easement therein or appurtenance thereof. If all or any part of the Mortgaged Property is damaged, taken or acquired, either temporarily or permanently, in any condemnation proceeding, or by exercise of the right of eminent domain, the amount of any award or other payment for such taking, acquisition or damages made in consideration thereof, to the extent of the full amount of the remaining unpaid indebtedness secured by this

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instrument, is hereby assigned to Mortgagee, who is empowered to collect and receive the same and to give proper receipts therefor in the name of Mortgagor and the same shall be paid forthwith to Mortgagee, to be applied to the Indebtedness Secured Hereby, and any excess shall be paid to Mortgagor.

    SECTION 2.3.  MORTGAGOR TO REPAIR, REPLACE, REBUILD OR RESTORE.  If any Indebtedness Secured Hereby is outstanding when all or any part of the Mortgaged Property is destroyed or damaged, unless the Mortgagee elects, at its option, which option is hereby irrevocably granted by the Mortgagor to the Mortgagee, to deposit such proceeds in the cash collateral account established pursuant to the terms of the Reimbursement Agreement, to be applied pursuant to the terms of the Reimbursement Agreement:

    (1) Mortgagor shall either deposit such proceeds in the cash collateral account established pursuant to the terms of the Reimbursement Agreement, to be applied pursuant to the terms of the Reimbursement Agreement, or proceed promptly, subject to the provisions of subsection (2) of this Section 2.3, to replace, repair, rebuild and restore the Mortgaged Property to substantially the same condition as existed before the taking or event causing the damage or destruction;

    (2) All proceeds of any insurance claim shall be paid directly to Mortgagee. If Mortgagee has elected to allow Mortgagor to use such insurance proceeds for rebuilding and restoration, and so long as no Event of Default has occurred, Mortgagee shall apply the proceeds, less such sum, if any, required for payment of all expenses incurred in collecting the same ("Net Proceeds"), to payment of the costs of repair, replacement, rebuilding or restoration of the Mortgaged Property upon compliance with such construction and disbursement terms as Mortgagee may deem reasonably necessary, including deposit by Mortgagor with Mortgagee of such funds of Mortgagor as may be required to insure payment of all costs of rebuilding, restoration, repair or replacement. If such deposit is not made when requested by Mortgagee, or if an Event of Default occurs while Mortgagee is retaining the Net Proceeds, Mortgagee may apply the Net Proceeds to the Indebtedness Secured Hereby or direct Mortgagor to apply such proceeds to the redemption of Bonds. The balance of the Net Proceeds remaining after payment of all costs of any repair, rebuilding, replacement or restoration of the Mortgaged Property shall be applied to the redemption of Bonds or as a payment of the Indebtedness Secured Hereby; and

    (3) Mortgagor shall not, by reason of the payment of any costs of repair, rebuilding, replacement or restoration, be entitled to any reimbursement from Mortgagee or any abatement or diminution of the amounts payable on the Bonds or any Indebtedness Secured Hereby.

ARTICLE III.

REMEDIES

    SECTION 3.1.  REMEDIES.  Upon the occurrence of an Event of Default or at any time thereafter, the Mortgagee may, at its option, exercise any and all of the following rights and remedies (and any other rights and remedies available to it under applicable law or any document related hereto):

    (1) the Mortgagee may, without notice to the Mortgagor, declare immediately due and payable all Indebtedness Secured Hereby and the same shall thereupon be immediately due and payable;

    (2) the Mortgagee may foreclose this Mortgage by action or (to the extent permitted by Minnesota law) advertisement upon written notice thereof to the Mortgagor, and the Mortgagor hereby authorizes the Mortgagee to do so, power being herein expressly granted to sell the Mortgaged Property at public auction without any prior hearing thereof and to convey the same to the purchaser, in fee simple, pursuant to the statutes of Minnesota in such case made and

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provided and, out of the proceeds arising from such sale, to pay all Indebtedness Secured Hereby with interest, and all legal costs and charges of such foreclosure and the maximum attorney's fees permitted by law, which costs, charges and fees the Mortgagor herein agrees to pay, and to pay the surplus, if any, to the Mortgagor, its successors or assigns; and

    (3) the Mortgagee may exercise any of the remedies made available to a secured party under the Uniform Commercial Code in effect in the State of Minnesota, or other applicable law, with respect to any of the Mortgaged Property which constitutes personal property, including without limitation the right to take possession thereof, proceeding without judicial process or by judicial process (without a prior hearing or notice thereof, which Mortgagor hereby waives), and the right to sell, lease or otherwise dispose of or use any or all of such personal property. Mortgagee may require Mortgagor to assemble such personal property and make it available to Mortgagee at a place designated by Mortgagee which is reasonably convenient to both Mortgagor and Mortgagee. If notice to Mortgagor of any intended disposition of any of the Mortgaged Property constituting personal property or any other intended action is required by law in a particular instance, such notice shall be deemed commercially reasonable if given (in the manner specified in Section 4.3 hereof) at least ten (10) calendar days prior to the date of intended disposition or other action.

    In the event of a sale under this Mortgage, whether by virtue of judicial proceedings or otherwise, the Mortgaged Property may, at the option of the Mortgagee, be sold as one parcel and as an entirety or in such parcels, manner and order as the Mortgagee in its sole discretion may elect.

    SECTION 3.2.  PURCHASE OF MORTGAGED PROPERTY.  In case of any sale of the Mortgaged Property pursuant to any judgment or decree of any court or otherwise in connection with the enforcement of any of the terms of this Mortgage, the Mortgagee, its successors and assigns, may become the purchaser, and for the purpose of making settlement for or payment of the purchase price, shall be entitled to turn in and use the Obligation of Reimbursement and any claims for interest and late charges matured and unpaid thereon, together with any other Indebtedness Secured Hereby, if any, in order that there may be credited as paid on the purchase price the sum, or any part thereof, then due on the Obligation of Reimbursement, including principal thereof and interest and late charges, if any, thereon, and any other Indebtedness Secured Hereby.

ARTICLE IV.

MISCELLANEOUS

    SECTION 4.1.  SUCCESSORS AND ASSIGNS.  The covenants and agreements herein contained shall bind, and the rights hereunder shall inure to, the respective successors and assigns of the Mortgagor and the Mortgagee, including among the Mortgagor's assigns any purchasers or transferees of the Mortgaged Property.

    SECTION 4.2.  NOTICES.  Any notice, request, demand or other communication permitted or required hereunder shall be deemed duly given if delivered or mailed postage prepaid, certified or registered, addressed to the last known address of such party.

    SECTION 4.3.  HEADINGS.  The headings of the sections contained herein are for convenience only and are not to be construed to be a part of or limit or affect the terms hereof.

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    IN WITNESS WHEREOF, the Mortgagor has caused this Mortgage to be duly executed and delivered to the Mortgagee as of the day and year first above written.

HEI, INC.
	/s/ ANTHONY J. FANT By: Anthony J. Fant     Its: Chairman and CEO

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STATE OF MINNESOTA	)
	) ss
COUNTY OF HENNEPIN	)

    The foregoing instrument was acknowledged before me this 27th day of July, 2000, by Anthony J. Fant, the Chairman and CEO of HEI, Inc., a Minnesota corporation, for and on behalf of said corporation.

[SEAL]

 
/s/ JAMES W. DIERKINGNotary Public

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EXHIBIT A

    (Legal Description)

    Lot Two (2), Block One (1), Point Victoria, according to the plat thereof on file or of record in the office of the Registrar of Titles, Carver County, Minnesota.

EXHIBIT B

    (Permitted Encumbrances)

1.

General and special real estate taxes and assessments not yet due and payable.

2.

Rights or claims of tenants, as tenants only, in possession under unrecorded leases.

3.

Easement for utilities and drainage as shown on the recorded plat.

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MORTGAGE, SECURITY AGREEMENT, FIXTURE FINANCING STATEMENT AND ASSIGNMENT OF LEASES AND RENTS
ARTICLE I. GENERAL COVENANTS, AGREEMENTS, WARRANTIES
ARTICLE II. INSURANCE, CONDEMNATION AND USE OF PROCEEDS
ARTICLE III. REMEDIES
ARTICLE IV. MISCELLANEOUS
EXHIBIT A
EXHIBIT B

EX-4.5

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EXHIBIT 4.5

PATENT, TRADEMARK AND LICENSE MORTGAGE

THIS PATENT, TRADEMARK AND LICENSE MORTGAGE ("Mortgage") made as of this 31st day of July, 2000, by HEI, INC. a Minnesota corporation, with its principal place of business at 1495 Steiger Lake Lane, Victoria, Minnesota ("Mortgagor"), in favor of LASALLE BUSINESS CREDIT, INC., with an office at 135 South LaSalle Street, Chicago, Illinois 60603 ("Mortgagee"):

W I T N E S S E T H:

WHEREAS, Mortgagor and Mortgagee are parties to a certain Loan and Security Agreement ("Security Agreement") and other related loan documents of even date herewith (collectively, with the Security Agreement, "Loan Agreements"), which Loan Agreements provide (i) for Mortgagee to, from time to time, extend credit to or for the account of Mortgagor and (ii) for the grant by Mortgagor to Mortgagee of a security interest in certain of Mortgagor's assets including, without limitation, its patents, patent applications, trademarks, trademark applications, tradenames, service marks, service mark applications, goodwill and licenses;

NOW, THEREFORE, in consideration of the premises set forth herein and for other good and valuable consideration, the receipt, sufficiency and adequacy of which are hereby acknowledged, Mortgagor agrees as follows:

    1.  Capitalized Terms.  All terms capitalized but not otherwise defined herein shall have the same meanings herein as in the Loan Agreements.

    2.  Mortgage of Patents, Trademarks and Licenses.  To secure the complete and timely satisfaction of all of Mortgagor's "Liabilities" (as defined in the Security Agreement), Mortgagor hereby grants, bargains, assigns, mortgages, pledges, sells, creates a security interest in, transfers and conveys to Mortgagee, as and by way of a first mortgage and security interest having priority over all other security interests, with power of sale, to the extent permitted by law or by the specific license agreements, upon the occurrence of an "Event of Default" (as defined in the Security Agreement) all of Mortgagor's right, title and interest in and to all of its now existing and hereafter created or acquired:

     (i) patents and patent applications including, without limitation, the inventions and improvements described and claimed therein, and those patents listed on Exhibit A attached hereto and hereby made a part hereof, and (a) the reissues, divisions, continuations, renewals, extensions and continuations-in-part thereof, (b) all income, damages and payments now and hereafter due or payable under or with respect thereto, including, without limitation, damages and payments for past or future infringements thereof, (c) the right to sue for past, present and future infringements thereof, and (d) all rights corresponding thereto throughout the world (all of the foregoing patents and applications, together with the items described in clauses (a)-(d) of this subsection 2(i), are sometimes hereinafter referred to individually as a "Patent" and, collectively, as the "Patents");

    (ii) trademarks, trademark registrations, trademark applications, tradenames and tradestyles, service marks, service mark registrations and service mark applications including, without limitation, the trademarks, tradenames, service marks and applications and registrations thereof listed on Exhibit B attached hereto and hereby made a part hereof, and (a) renewals or extensions thereof, (b) all income, damages and payments now and hereafter due or payable with respect thereto, including, without limitation, damages and payments for past or future infringements thereof, (c) the right to sue for past, present and future infringements thereof, and (d) all rights corresponding thereto throughout the world (all of the foregoing trademarks, tradenames and tradestyles, service marks and applications and registrations thereof, together with the items described in clauses (a)-(d) of this subsection 2(ii), are sometimes hereinafter referred individually as a "Trademark" and, collectively, as "Trademarks");

    (iii) all license agreements with respect to any of the Patents or the Trademarks or any other patent, trademark, service mark or any application or registration thereof or any other tradename

or tradestyle between Mortgagor and any other party, whether Mortgagor is a licensor or licensee under any such license agreement including, without limitation, the licenses listed on Exhibit C attached hereto and hereby made a part hereof (all of the foregoing license agreements and Mortgagor's rights thereunder are referred to collectively as "Licenses"); and

    (iv) the goodwill of Mortgagor's business connected with and symbolized by the Trademarks.

    3.  Warranties and Representations. Mortgagor warrants and represents to Mortgagee that:

     (i) The Patents, Trademarks and Licenses have not been adjudged invalid or unenforceable and have not been cancelled, in whole or in part, and are presently subsisting;

    (ii) Each of the Patents, Trademarks and Licenses is valid and enforceable;

    (iii) Mortgagor is the sole and exclusive owner of the entire and unencumbered right, title and interest in and to each of the Patents, Trademarks and Licenses, free and clear of any liens, charges and encumbrances including, without limitation, licenses, shop rights and covenants by Mortgagor not to sue third persons;

    (iv) Mortgagor has adopted, used and is currently using all of the Trademarks;

    (v) Mortgagor has no notice of any suits or actions commenced or threatened with reference to the Patents, Trademarks or Licenses; and

    (vi) Mortgagor has the right to execute and deliver this Mortgage and perform its terms and has entered into or will enter into written agreements with each of its present and future employees, agents and consultants which will enable it to comply with the covenants contained herein.

    4.  Restrictions on Future Agreements.  Mortgagor agrees that until Mortgagor's Liabilities shall have been satisfied in full and the Loan Agreements shall have been terminated, Mortgagor shall not sell or assign its interest in, or grant any license under, the Patents, Trademarks or Licenses, or enter into any other agreement with respect to the Patents, Trademarks or Licenses which is inconsistent with Mortgagor's obligations under this Mortgage, without the prior written consent of Mortgagee, and Mortgagor further agrees that it shall not take any action, or permit any action to be taken by others subject to its control, including licensees, or fail to take any action (solely with respect to the Patents and the Tradenames), which would affect the validity or enforcement of the rights transferred to Mortgagee under this Mortgage.

    5.  New Patents, Trademarks, and Licenses.  Mortgagor represents and warrants that, to the best of Mortgagor's knowledge, the Patents, Trademarks and Licenses listed on Exhibits A, B and C, respectively, constitute all of the Patents, Trademarks, and Licenses now owned by Mortgagor. If, before Mortgagor's Liabilities shall have been satisfied in full or before the Loan Agreements have been terminated, Mortgagor shall (i) become aware of any existing Patents, Trademarks or Licenses of which Mortgagor has not previously informed Mortgagee, (ii) obtain rights to any new patentable inventions, Patents, Trademarks or Licenses, or (iii) become entitled to the benefit of any Patents, Trademarks or Licenses or any improvement on any Patent, the provisions of this Mortgage above shall automatically apply thereto and Mortgagor shall give to Mortgagee prompt written notice thereof. Mortgagor hereby authorizes Mortgagee to modify this Mortgage by amending Exhibits A, B and C, as applicable, to include any such Patents, Trademarks and Licenses.

    6.  Royalties; Terms.  The term of the mortgages granted herein shall extend until the earlier of (i) the expiration of each of the respective Patents, Trademarks and Licenses assigned hereunder, and (ii) Mortgagor's Liabilities have been paid in full and the Loan Agreements have been terminated. Upon the occurrence of an Event of Default, Mortgagor agrees that the use by Mortgagee of all

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Patents, Trademarks and Licenses shall be worldwide and without any liability for royalties or other related charges from Mortgagee to the Mortgagor.

    7.  Grant of License to Mortgagor.  Unless and until an Event of Default shall have occurred, Mortgagee hereby grants to Mortgagor the exclusive, nontransferable right and license to use the Trademarks in the ordinary course of its business, to exercise Mortgagee's rights under the Licenses, and to make, have made, use and sell the inventions disclosed and claimed in the Patents for Mortgagor's own benefit and account and for none other. Mortgagor shall use the Trademarks only on goods of at least as high quality as the goods on which Mortgagor or its predecessor used the goods prior to the date hereof. Mortgagor agrees not to sell or assign its interest in, or grant any sublicense under, the license granted to Mortgagor in this Section 7, without the prior written consent of Mortgagee. From and after the occurrence of an Event of Default, Mortgagor's license with respect to the Patents, Trademarks and Licenses set forth in this Section 7 shall terminate forthwith, and Mortgagee shall have, in addition to all other rights and remedies given it by this Mortgage, those allowed by law and the rights and remedies of a secured party under the Uniform Commercial Code as enacted in any of the jurisdictions in which the Patents, Trademarks or Licenses may be located.

    8.  Mortgagee's Right to Inspect.  Mortgagee shall have the right, at any time and from time to time during normal business hours and prior to payment in full of Mortgagor's Liabilities and termination of the Loan Agreements, to inspect Mortgagor's premises and to examine Mortgagor's books, records and operations, including, without limitation, Mortgagor's quality control processes. Mortgagor agrees (i) to maintain the quality of any and all products in connection with which the Trademarks are used, consistent with the quality of said products as of the date hereof and (ii) to provide Mortgagee, upon Mortgagee's request from time to time, with a certificate of an officer of Mortgagor certifying Mortgagor's compliance with the foregoing. Upon the occurrence of an Event of Default, Mortgagor agrees that Mortgagee, or a conservator appointed by Mortgagee, shall have the right to establish such additional product quality controls as Mortgagee, or said conservator, in its sole judgment, may deem necessary to assure maintenance of the quality of products sold by Mortgagor under the Trademarks.

    9.  Release of Mortgage.  This Mortgage is made for collateral purposes only. Upon payment in full of Mortgagor's Liabilities and termination of the Loan Agreements, Mortgagee shall execute and deliver to Mortgagor an instrument in the form attached hereto as Exhibit D, in order to re-vest in Mortgagor full title to the Patents, Trademarks, and Licenses, subject to any disposition thereof which may have been made by Mortgagee pursuant hereto or pursuant to the Loan Agreements.

    10.  Expenses.  All expenses incurred in connection with the performance of any of the agreements set forth herein shall be borne by Mortgagor. All fees, costs and expenses, of whatever kind or nature, including reasonable attorneys' and paralegals' fees and legal expenses, incurred by Mortgagee in connection with the filing or recording of any documents (including all taxes in connection therewith) in public offices, the payment or discharge of any taxes, counsel fees, maintenance fees, encumbrances or otherwise in protecting, maintaining or preserving the Patents, Trademarks and Licenses, or in defending or prosecuting any actions or proceedings arising out of or related to the Patents, Trademarks and Licenses, shall be borne by and paid by Mortgagor on demand by Mortgagee and until so paid shall be added to the principal amount of Mortgagor's Liabilities and shall bear interest at the rate for "Revolving Loans" (as defined in the Security Agreement).

    11.  Duties of Mortgagor.  Mortgagor shall have the duty, to the extent commercially reasonable (i) to prosecute diligently any patent, trademark or service mark applications pending as of the date hereof or thereafter until Mortgagor's Liabilities shall have been paid in full, (ii) to make application on unpatented but patentable inventions and on trademarks and service marks, as appropriate, (iii) to preserve and maintain all rights in the Patents, Trademarks and Licenses, and (iv) to ensure that the Patents, Trademarks and Licenses are and remain enforceable. Any expenses incurred in connection

3

with Mortgagor's obligations under this Section 11 shall be borne by Mortgagor. Mortgagor shall not abandon any right to file a patent, trademark or service mark application, or abandon any pending patent application, or any other Patent, Trademark or License without the consent of Mortgagee, except to the extent it is not commercially reasonable not to so abandon any such right, application, Patent, Trademark or License.

    12.  Mortgagee's Right to Sue.  After the occurrence of an Event of Default, Mortgagee shall have the right, but shall in no way be obligated, to bring suit in its own name to enforce the Patents, Trademarks and Licenses and, if Mortgagee shall commence any such suit, Mortgagor shall, at the request of Mortgagee, do any and all lawful acts and execute any and all proper documents required by Mortgagee in aid of such enforcement and Mortgagor shall promptly, upon demand, reimburse and indemnify Mortgagee for all reasonable costs and expenses incurred by Mortgagee in the exercise of its rights under this Section 12.

    13.  Waivers.  No course of dealing between Mortgagor and Mortgagee, nor any failure to exercise, nor any delay in exercising, on the part of Mortgagee, any right, power or privilege hereunder or under the Loan Agreements shall operate as a waiver thereof; nor shall any single or partial exercise of any right, power or privilege hereunder or thereunder preclude any other or further exercise thereof or the exercise of any other right, power or privilege.

    14.  Severability.  The provisions of this Mortgage are severable, and if any clause or provision shall be held invalid and unenforceable in whole or in part in any jurisdiction, then such invalidity or unenforceability shall affect only such clause or provision, or part thereof, in such jurisdiction, and shall not in any manner affect such clause or provision in any other jurisdiction, or any other clause or provision of this Mortgage in any jurisdiction.

    15.  Modification.  This Mortgage cannot be altered, amended or modified in any way, except as specifically provided in Section 5 hereof or by a writing signed by the parties hereto.

    16.  Cumulative Remedies; Power of Attorney; Effect on Financing Agreement.   All of Mortgagee's rights and remedies with respect to the Patents, Trademarks and Licenses, whether established hereby or by the Loan Agreements, or by any other agreements or by law shall be cumulative and may be exercised singularly or concurrently. Upon the occurrence of an Event of Default, Mortgagor hereby authorizes Mortgagee to make, constitute and appoint any officer or agent of Mortgagee as Mortgagee may select, in its sole discretion, as Mortgagor's true and lawful attorney-in-fact, with power to (i) endorse Mortgagor's name on all applications, documents, papers and instruments necessary or desirable for Mortgagee in the use of the Patents, Trademarks and Licenses, or (ii) take any other actions with respect to the Patents, Trademarks and Licenses as Mortgagee deems to be in the best interest of Mortgagee, or (iii) grant or issue any exclusive or non-exclusive license under the Patents, Trademarks or Licenses to anyone, or (iv) assign, pledge, convey or otherwise transfer title in or dispose of the Patents, Trademarks or Licenses to anyone. Mortgagee hereby ratifies all that such attorney shall lawfully do or cause to be done by virtue hereof. This power of attorney shall be irrevocable until Mortgagor's Liabilities shall have been paid in full and the Security Agreement, including any amendments thereto, has been terminated. Mortgagor acknowledges and agrees that this Mortgage is not intended to limit or restrict in any way the rights and remedies of Mortgagee under the Loan Agreements but rather is intended to facilitate the exercise of such rights and remedies. Mortgagee shall have, in addition to all other rights and remedies given it by the terms of this Mortgage and the Loan Agreements, all rights and remedies allowed by law and the rights and remedies of a secured party under the Uniform Commercial Code as enacted in any jurisdiction in which the Patents, Trademarks or Licenses may be located.

    17.  Binding Effect; Benefits.  This Mortgage shall be binding upon the Mortgagor and its respective successors and assigns, and shall inure to the benefit of Mortgagee, its successors, nominees and assigns.

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    18.  Governing Law.  This Mortgage shall be governed by and construed in accordance with the internal laws of the State of Illinois.

    19.  Headings.  Paragraph headings used herein are for convenience only and shall not modify the provisions which they precede.

    20.  Further Assurances.  Mortgagor agrees to execute and deliver such further agreements, instruments and documents, and to perform such further acts, as Mortgagee shall reasonably request from time to time in order to carry out the purpose of this Mortgage and agreements set forth herein.

    21.  Survival of Representations.  All representations and warranties of Mortgagor contained in this Mortgage shall survive the execution and delivery of this Mortgage and shall be remade on the date of each borrowing under the Loan Agreements.

IN WITNESS WHEREOF, Mortgagor has duly executed this Mortgage in favor of Mortgagee as of the date first written above.

ATTEST:	HEI, INC.
	/s/ ANTHONY J. FANT
Title:	By: Anthony J. Fant
	Title: Chairman and CEO

AGREED AND ACCEPTED this 31st day of July, 2000

LASALLE BUSINESS CREDIT, INC.

 
/s/ DALE GRZENIA By: Dale Grzenia
Title: Vice President

 
THIS INSTRUMENT PREPARED BY AND AFTER FILING RETURN TO:

 
James W. Dierking, Esq.
Winthrop & Weinstine, P.A.
3000 Dain Rauscher Plaza
60 South Sixth Street
Minneapolis, MN 55402-4430

5

ACKNOWLEDGMENT

STATE OF MINNESOTA	)
	) SS.
COUNTY OF HENNEPIN	)

    The foregoing Patent, Trademark and License Mortgage was executed and acknowledged before me this 27tht day of July, 2000, by Anthony J. Fant, personally known to me to be the Chairman and CEO of HEI, INC., a Minnesota corporation, on behalf of such corporation.

/s/ JAMES W. DIERKINGNotary Public

Ramsey County, MN

 
My Commission Expires:

1/31/05

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ACKNOWLEDGMENT

STATE OF WISCONSIN	)
	) SS.
COUNTY OF MILWAUKEE	)

    I, Joanne Muenzenberger, a Notary Public in and for and residing in said County and State, do hereby certify that Dale Grzenia, the Vice President of LaSalle Business Credit, Inc., personally known to me to be the same person whose name is subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he signed and delivered said instrument as his own free and voluntary act and as the free and voluntary act of said bank for the uses and purposes therein set forth.

    GIVEN under my hand and notarial seal this 28TH day of July, 2000.

/s/ JOANNE MUENZENBERGERNotary Public

 
My Commission Expires:

November 2, 2003

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EXHIBIT A
Patents

APPLICANT	SERIAL NO.	ISSUED	DESCRIPTION
HEI, Inc.	5,847,930		Edge Terminals for Electronic Circuit Modules
HEI, Inc.	6,014,320	1/11/00	High Density Stacked Circuit Module
HEI, Inc.	5,936,847		Low Profile Electronic Circuit Modules
HEI, Inc.	08/642,114		Low Profile Electronic Circuit

Applications Pending

APPLICANT	APPLICATION NO.	DESCRIPTION
HEI, Inc.	09/477,048	Interconnection Method and Device
HEI, Inc.	Pending	High Density Circuit Modules using one or more folded flex circuits

EXHIBIT B
Trademarks

APPLICANT
MARK SERIAL NO. FILED

EXHIBIT C
Licenses

Exhibit D
Form of Release of Mortgate of Patents, Trademarks, and Licenses

Exhibit D

RELEASE OF MORTGAGE

    This Release of Mortgage is made by LASALLE BUSINESS CREDIT, INC., having an office at 135 South LaSalle Street, Chicago, Illinois ("LaSalle"); in favor of HEI, INC., having its principal place of business at 1495 Steiger Lake Lane, Victoria, Minnesota ("HEI").

    Pursuant to Section 9 ("Release of Mortgage") of the Patent, Trademark and License Mortgage of            , 2000 by HEI in favor of LaSalle, LaSalle acknowledges payment in full of Mortgagor's Liabilities by HEI and termination of the Loan Agreements. LaSalle re-vests in HEI full title to the Patents, Trademarks, and Licenses (subject to any disposition that may have been made by LaSalle pursuant to the Patent, Trademark and License Mortgage or the Loan Agreements) as if the Patent, Trademark and License Mortgage had never been made. LaSalle and its legal representatives will take whatever further actions are necessary to fulfill the terms of this Release.

    All terms capitalized but not otherwise defined have the same meaning as in the Loan Agreements of            , 2000.

Dated:

LASALLE BUSINESS CREDIT, INC.

 
By:

 
Its:

PATENT ASSIGNMENT

    This Assignment is made by LASALLE BUSINESS CREDIT, INC., having an office at 135 South LaSalle Street, Chicago, Illinois ("LaSalle") to HEI, INC., having its principal place of business at 1495 Steiger Lake Lane, Victoria, Minnesota ("HEI").

    In exchange for valuable and sufficient consideration received from HEI, LaSalle assigns to HEI all right, title and interest in US Patent            as if the Patent, Trademark and License Mortgage of      , 2000 had never been made. LaSalle and its legal representatives will take whatever further actions are necessary to fulfill the terms of this Assignment.

    All terms capitalized but not otherwise defined have the same meaning as in the Loan Agreements of            , 2000.

Dated:

LASALLE BUSINESS CREDIT, INC.

 
By:

 
Its:

Exhibit D
Form of Release of Mortgate of Patents, Trademarks, and Licenses

TRADEMARK AND ASSOCIATED GOODWILL ASSIGNMENT

    This Assignment is made by LASALLE BUSINESS CREDIT, INC., having an office at 135 South LaSalle Street, Chicago, Illinois ("LaSalle") to HEI, INC., having its principal place of business at 1495 Steiger Lake Lane, Victoria, Minnesota ("HEI").

    In exchange for valuable and sufficient consideration received from HEI, LaSalle assigns to HEI all right, title and interest in US Trademark Registration No.             , including all goodwill of LaSalle's and HEI's business connected with such Trademark, as if the Patent, Trademark and License Mortgage of       , 2000 had never been made. LaSalle and its legal representatives will take whatever further actions are necessary to fulfill the terms of this Assignment.

    All terms capitalized but otherwise defined have the same meaning as in the Loan Agreements of            , 2000.

Dated:

LASALLE BUSINESS CREDIT, INC.

 
By:

 
Its:

LICENSE ASSIGNMENT

    This Assignment is made by LASALLE BUSINESS CREDIT, INC., having an office at 135 South LaSalle Street, Chicago, Illinois ("LaSalle") to HEI, INC., having its principal place of business at 1495 Steiger Lake Lane, Victoria, Minnesota ("HEI").

    In exchange for valuable and sufficient consideration received from HEI, LaSalle assigns to HEI all right, title and interest in all Licenses as if the Patent, Trademark and License Mortgage of            , 2000 had never been made. LaSalle and its legal representatives will take whatever further actions are necessary to fulfill the terms of this Assignment.

    All terms capitalized but otherwise defined have the same meaning as in the Loan Agreements of            , 2000.

Dated:

LASALLE BUSINESS CREDIT, INC.

 
By:

 
Its:

UCC-3 forms as required to cancel Mortgagee's Security Interests in any Patents, Trademarks, and Licenses that are specifically indentified in any UCC-1 Financing Statements filed by Mortgagee

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PATENT, TRADEMARK AND LICENSE MORTGAGE
ACKNOWLEDGMENT
ACKNOWLEDGMENT
EXHIBIT A Patents
Applications Pending
EXHIBIT B Trademarks
EXHIBIT C Licenses
Exhibit D Form of Release of Mortgate of Patents, Trademarks, and Licenses
RELEASE OF MORTGAGE
PATENT ASSIGNMENT
TRADEMARK AND ASSOCIATED GOODWILL ASSIGNMENT
LICENSE ASSIGNMENT

EX-4.6

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EXHIBIT 4.6

SECURITY AGREEMENT

THIS SECURITY AGREEMENT ("AGREEMENT") is made as of the 31st day of July, 2000 by and between LASALLE BUSINESS CREDIT, INC., a Delaware corporation with its principal place of business at 135 South LaSalle Street, Suite 400, Chicago, IL 60603 ("Secured Party") and Cross Technology, Inc., a Minnesota corporation with its principal place of business at 1495 Steiger Lake Lane, P.O. Box 5000, Victoria, Minnesota 55386 ("Debtor").

1.

SECURITY INTEREST AND COLLATERAL.To secure the payment and performance of each and every debt, liability and obligation of every type and description which Debtor may now or at any time hereafter owe to Secured Party (whether such debt, liability or obligation now exists or is hereafter created or incurred, and whether it is or may be direct or indirect, due or to become due, absolute or contingent, primary or secondary, liquidated or unliquidated, or joint, several or joint and several; all such debts, liabilities and obligations, being herein collectively referred to as the "Obligations"), Debtor hereby grants Secured Party a security interest (herein called the "Security Interest") in all personal property of Debtor including, but not limited to, all Accounts, Inventory, Equipment, Goods, Instruments, Investment Property, Documents and General Intangibles (as such terms are defined in the Illinois Uniform Commercial Code) (herein collectively called the "Collateral"):

2.

REPRESENTATIONS, WARRANTIES AND AGREEMENTS. Debtor represents, warrants and agrees that:

    (a) Debtor has (or will have at the time Debtor acquires rights in Collateral hereafter arising) absolute title to each item of Collateral free and clear of all security interests, liens and encumbrances (except the Security Interest), the Collateral will be used primarily for business purposes and Debtor will defend the Collateral against all claims or demands of all persons other than Secured Party. Debtor will not sell or otherwise dispose of the Collateral or any interest therein without the prior written consent of Secured Party, except that, until the occurrence of an Event of Default (as defined in Section 6) and the revocation by Secured Party of Debtor's right to do so, Debtor may sell any Inventory constituting Collateral to buyers in the ordinary course of business. This Agreement has been duly and validly authorized by all necessary corporate action, and, the officer executing this agreement has (have) authority to act for the corporation;

    (b) Debtor will not permit any tangible Collateral to be located in any state (and, if county filing is required, in any county) in which a financing statement covering such Collateral is required to be, but has not in fact been, filed in order to perfect the Security Interest;

    (c) Each right to payment and each instrument, document, chattel paper and other agreement constituting or evidencing Collateral is (or will be when arising or issued) the valid, genuine and legally enforceable obligation, subject to no defense, set-off or counterclaim (other than those arising in the ordinary course of business) of the account debtor or other obligor named therein or in Debtor's records pertaining thereto as being obligated to pay such obligation. Debtor will neither agree to any material modification or amendment, nor agree to any cancellation of any such obligation without Secured Party's prior written consent and will not subordinate any such right to payment to claims of other creditors of such account debtor or other obligor;

    (d) Debtor will (i) keep all tangible Collateral in good repair, working order and condition, normal depreciation excepted, and will, from time to time, replace any worn, broken or defective parts thereof; (ii) promptly pay all taxes and other governmental charges levied or assessed upon or against any Collateral or upon or against the creation, perfection or continuance of the Security Interest; (iii) keep all Collateral free and clear of all security interests, liens and encumbrances except the Security Interest; (iv) at all reasonable times, permit Secured Party or its representatives to examine or inspect any Collateral, wherever located, and to examine, inspect and copy Debtor's

books and records pertaining to the Collateral and its business and financial condition; (v) keep accurate and complete records pertaining to the Collateral and pertaining to Debtor's business and financial condition and submit to Secured Party such periodic reports concerning the Collateral and Debtor's business and financial condition and submit to Secured Party such periodic reports concerning the Collateral and Debtor's business and financial condition as Secured Party may from time to time reasonably request; (vi) promptly notify Secured Party of any loss of or material damage to any Collateral or of any adverse change known to Debtor in the prospect of payment of any sums due on or under any instrument, chattel paper, account or contract right constituting Collateral; (vii) if Secured Party at any time so requests (whether the request is made before or after the occurrence of any Event of Default), promptly deliver to Secured Party any instrument, document or chattel paper constituting Collateral, duly endorsed or assigned by Debtor; (viii) at all times keep all tangible Collateral insured against risks of fire (including so-called extended coverage), theft, collision (in case of Collateral consisting of motor vehicles) and such other risks and in such amounts as Secured Party may reasonably request, with any loss payable to Secured Party to the extent of its interest; (ix) from time to time execute such financing statements as Secured Party may reasonably require in order to perfect the Security Interest and, if any Collateral exists of a motor vehicle, execute such documents as may be required to have the Security Interest properly noted on a certificate of title; (x) pay when due to reimburse Secured Party on demand for all costs of collection of any of the Obligations and all other out-of-pocket expenses (including in each case all reasonable attorney's fees) incurred by Secured Party in connection with the creation, perfection, satisfaction or enforcement of the Security Interest or the creation, continuance or enforcement of this Agreement or any or all of the Obligations, and Debtor will indemnify and save Secured Party harmless from all loss, costs, damage, liability or expense, including reasonable attorney's fees that it may sustain or incur by reason of defending or protecting the Security Interest or the priority thereof, or in the prosecution or defense of any action or proceeding concerning any matter growing out of or connected with this Agreement and/or the obligations and/or the Collateral; (xi) execute, deliver or endorse any and all instruments, documents, assignments, security agreements and other agreements, and writings which Secured Party may at any time reasonably request in order to secure, protect, perfect or enforce the Security Interest and Secured Party's rights under this Agreement; (xii) not use or keep any Collateral, or permit it to be used or kept, for any unlawful purpose or in violation of any federal, state or local law, statute or ordinance; and (xiii) not permit any tangible Collateral to become part of or to be affixed to any real property without first assuring to the reasonable satisfaction of Secured Party that the Security Interest will be prior and senior to any interest or lien then held or thereafter acquired by any mortgagee of such real property or the owner or purchaser of any interest therein. If Debtor at any time fails to perform or observe any agreement contained in this Section 2(d), and if such failure shall continue for a period of five (5) calendar days after Secured Party gives Debtor written notice thereof (or, in the case of the agreements contained in clauses (viii) and (ix) of this Section 2(d), immediately upon the occurrence of such failure, without notice or lapse of time), Secured Party may (but need not) perform or observe such agreement on behalf and in the name, place and stead of Debtor (or, at Secured Party's option, in Secured Party's own name) and may (but need not) take any and all other actions which Secured Party may reasonably deem necessary to cure or correct such failure (including, without limitation, the payment of taxes, the satisfaction of security interests, liens, or encumbrances, the performance of obligations under contracts or agreements with account debtors or other obligors, the procurement and maintenance of insurance, the execution of financing statements, the endorsement of instruments and the procurement of repairs, transportation or insurance); and, except to the extent that the effect of such payment would be to render any loan or forbearance of money usurious or otherwise illegal under any applicable law, Debtor shall thereupon pay Secured Party on demand the amount of all monies expended and all costs and expenses (including reasonable attorneys' fees) incurred by Secured Party in connection with or as a result of Secured

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Party's performing or observing such agreements or taking such actions, together with interest thereon from the date expended or incurred by Secured Party at the highest rate then applicable to any of the obligations. To facilitate the performance or observance by Secured Party of such agreements of Debtor, Debtor hereby irrevocably appoints (which appointment is coupled with an interest) Secured Party, or its delegate, as the attorney-in-fact of Debtor with the right (but not the duty) from time to time to create, prepare, complete, execute, deliver, endorse or file, in the name and on behalf of Debtor, any and all instruments, documents, financing statements, applications for insurance and other agreements and writings required to be obtained, executed, delivered or endorsed by Debtor under this Section 2 and Section 3; and

    (e) Debtor will pay promptly when due all indebtedness, liability, or obligation secured hereby with interest.

3.

LOCK BOX, COLLATERAL ACCOUNT. If Secured Party so requests at any time (whether before or after the occurrence of an Event of Default), Debtor will direct each of its account debtors to make payments due under the relevant account or chattel paper directly to a special lock box to be in the name and under the control of Secured Party. Debtor hereby authorizes and directs Secured Party to deposit into a special collateral account to be established and maintained with Secured Party all checks, drafts and cash payments received in said lock box. All deposits in said collateral account shall constitute proceeds of Collateral and shall not constitute payment of any Obligation. At its option, Secured Party may, at any time, apply finally collected funds on deposit in said collateral account to the payment of the Obligations in such order of application as Secured Party may determine, or permit Debtor to withdraw all or any part of the balance on deposit into said collateral account. If a collateral account is so established, Debtor agrees that it will promptly deliver to Secured Party, for deposit into said collateral account, all payments on accounts and chattel paper received by it. All such payments shall be delivered to Secured Party in the form received (except for Debtor's endorsement where necessary). Until so deposited, all payments on accounts and chattel paper received by Debtor shall be held in trust by Debtor for and as the property of Secured Party and shall not be commingled with any funds or property of Debtor.

4.

COLLECTION RIGHTS OF SECURED PARTY. Notwithstanding Secured Party's rights under Section  3 with respect to any and all debt instruments, chattel paper, accounts, and other rights to payment constituting Collateral (including proceeds), Secured Party may, at any time (both before and after the occurrence of an Event of Default) notify any account debtor or any other person obligated to pay any amount due, that such chattel paper, account, or other right to payment has been assigned or transferred to Secured Party for security and shall be paid directly to Secured Party. If Secured Party so requests at any time, Debtor will so notify such account debtors and other obligors in writing and will indicate on all invoices to such account debtors or other obligors that the amount due is payable directly to Secured Party. At any time after Secured Party or Debtor gives such notice to account debtor or other obligor, Secured Party may (but need not), in its own name or in Debtor's name, demand, sue for, collect or receive any money or property at any time payable or receivable on account of, or securing, any such chattel paper, account, or other right to payment, or grant an extension to, make any compromise or settlement with or otherwise agree to waive, notify, amend or change the obligations (including collateral obligations) of any such account debtor or other obligor.

5.

ASSIGNMENT OF INSURANCE. Debtor hereby assigns to Secured Party, as additional security for the payment of the Obligations, any and all moneys (including but not limited to proceeds of insurance and refunds of unearned premiums) due or to become due under, and all other rights of Debtor under or with respect to, any and all policies of insurance covering the Collateral, and Debtor hereby directs the issuer of any such policy to pay any such monies directly to Secured Party. Both before and after the occurrence of an Event of Default, Secured Party may (but need not), in its own name or in Debtor's name, execute and deliver proofs of claim, receive all such

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monies, endorse checks and other instruments representing payment of such monies, and adjust, litigate, compromise or release any claim against the issuer of any such policy.

6.

EVENTS OF DEFAULT. Each of the following occurrences shall constitute an event of default under this Agreement (herein called "Event of Default"): (i) Debtor shall fail to pay any or all of the Obligations when due or (if payable on demand) on demand, or shall fail to observe or perform any covenant or agreement herein binding on it; (ii) any representation or warranty by Debtor set forth in this Agreement or made to Secured Party in any financial statements or reports submitted to Secured Party by or on behalf of Debtor shall prove materially false or misleading; (iii) Debtor or any guarantor of any Obligation shall (A) fail to conduct its business substantially as now conducted, (B) be or become insolvent (however defined), (C) have any judgment entered against it, (D) file or have filed against it, voluntarily or involuntarily, a petition in bankruptcy or for reorganization under the United States Bankruptcy Code, (E) initiate or have initiated against it voluntarily or involuntarily, any act, process or proceeding under any insolvency law or other statute or law providing for the modification or adjustment of the rights of creditors, or (F) if a corporation, partnership or organization be dissolved or liquidated or, if a partnership, suffer the death of a partner or, if an individual, die; (iv) a default exists under any other agreement which may have a material effect on Debtor or its business; (v) Secured Party shall in good faith believe that the prospects of due and punctual payment of any or all of the Obligations is impaired.

7.

REMEDIES UPON EVENT OF DEFAULT. Upon the occurrence of an Event of Default under Section 6 and at any time thereafter, Secured Party may exercise any one or more of the following rights and remedies: (i) declare all unmatured Obligations to be immediately due and payable, and the same shall thereupon be immediately due and payable, without presentment or other notice or demand; (ii) exercise and enforce any or all rights and remedies available upon default to any secured party under the Uniform Commercial Code including, but not limited to, the right to take possession of any Collateral, proceeding without judicial process or by judicial process (without prior hearing or notice thereof, which Debtor hereby expressly waives), and the right to sell, lease or otherwise dispose of any or all of the Collateral, and in connection therewith, Secured Party may require Debtor to assemble the Collateral and make it available to Secured Party at a place to be designated by Secured Party which is reasonably convenient to both parties, and if notice to Debtor of any intended disposition of collateral or any other intended action is required by law in a particular instance, such notice shall be deemed commercially reasonable if given (in the manner specified in Section 9) at least ten (10) calendar days prior to the date of intended disposition or other action; (iii) exercise or enforce any or all other rights or remedies available to Secured Party by law or agreement against the Collateral, against Debtor or against any other person or property.

8.

CHOICE OF LAW; FORUM SELECTION; WAIVER OF JURY TRIAL; SERVICE OF PROCESS. THIS AGREEMENT AND OTHER AGREEMENTS SHALL BE GOVERNED AND CONTROLLED BY THE INTERNAL LAWS OF THE STATE OF MINNESOTA AS TO INTERPRETATION, ENFORCEMENT, VALIDITY, CONSTRUCTION, EFFECT, AND IN ALL OTHER RESPECTS INCLUDING, WITHOUT LIMITATION, THE LEGALITY OF THE INTEREST RATE AND OTHER CHARGES, BUT EXCLUDING PERFECTION OF THE SECURITY INTERESTS IN THE COLLATERAL, WHICH SHALL BE GOVERNED AND CONTROLLED BY THE LAWS OF THE RELEVANT JURISDICTION. TO INDUCE SECURED PARTY TO ACCEPT THIS AGREEMENT, DEBTOR IRREVOCABLY AGREES THAT, SUBJECT TO SECURED PARTY'S SOLE AND ABSOLUTE ELECTION, ALL ACTIONS OR PROCEEDINGS IN ANY WAY, MANNER OR RESPECT, ARISING OUT OF OR FROM OR RELATED TO THIS AGREEMENT, THE OTHER AGREEMENTS OR THE COLLATERAL SHALL BE LITIGATED IN COURTS HAVING SITUS WITHIN THE COUNTY OF HENNEPIN, STATE OF MINNESOTA. BORROWER HEREBY CONSENTS AND SUBMITS TO THE

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JURISDICTION OF ANY LOCAL, STATE OR FEDERAL COURTS LOCATED WITHIN SAID CITY AND STATE.

SECURED PARTY AND DEBTOR HEREBY WAIVE ALL RIGHTS TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING WHICH PERTAINS DIRECTLY OR INDIRECTLY TO THIS AGREEMENT, ANY OF THE OTHER AGREEMENTS, THE LIABILITIES, THE COLLATERAL, ANY ALLEGED TORTIOUS CONDUCT OR DEBTOR OR SECURED PARTY OR WHICH, IN ANY WAY, DIRECTLY OR INDIRECTLY, ARISES OUT OF OR RELATES TO THE RELATIONSHIP BETWEEN DEBTOR AND SECURED PARTY. IN NO EVENT SHALL SECURED PARTY BE LIABLE FOR LOST PROFITS OR OTHER SPECIAL OR CONSEQUENTIAL DAMAGES. DEBTOR HEREBY WAIVES ALL RIGHTS TO NOTICE AND HEARING OF ANY KIND PRIOR TO THE EXERCISE BY SECURED PARTY OF ITS RIGHTS TO REPOSSESS THE COLLATERAL OF DEBTOR WITHOUT JUDICIAL PROCESS OR TO REPLEVY, ATTACH OR LEVY UPON SUCH COLLATERAL WITHOUT PRIOR NOTICE OF HEARING. DEBTOR HEREBY IRREVOCABLY APPOINTS AND DESIGNATES THE SECRETARY OF STATE OF MINNESOTA, LOCATED IN ST. PAUL, MINNESOTA, AS DEBTOR'S TRUE AND LAWFUL ATTORNEY AND DULY AUTHORIZED AGENT FOR ACCEPTANCE OF SERVICE OF LEGAL PROCESS; PROVIDED, HOWEVER, THAT SECURED PARTY SHALL MAIL OR OTHERWISE PROVIDE A COPY TO DEBTOR OF SUCH LEGAL PROCESS AT THE ADDRESS SET FORTH ABOVE, IN THE EVENT SUCH LEGAL PROCESS IS NOT SERVED DIRECTLY UPON DEBTOR. DEBTOR AGREES THAT SERVICE OF SUCH PROCESS UPON SUCH PERSON SHALL CONSTITUTE PERSONAL SERVICE OF SUCH PROCESS UPON DEBTOR.

9.

MISCELLANEOUS. This Agreement does not contemplate a sale of accounts, contract rights or chattel paper and, as provided by law, Debtor is entitled to any surplus and shall remain liable for any deficiency. This Agreement can be waived, modified, amended, terminated or discharged, and the Security Interest can be released, only explicitly in writing signed by Secured Party. A waiver signed by Secured Party shall be effective only in a specific instance and for the specific purpose given. Mere delay or failure to act shall not preclude the enforcement of any of Secured Party's rights or remedies. All rights and remedies of Secured Party shall be cumulative and may be exercised singularly or concurrently, at Secured Party's option, and the exercise or enforcement of any one such right or remedy shall neither be a condition to nor bar the exercise or enforcement of any other. All notices to be given to Debtor shall be deemed sufficiently given if delivered or mailed by registered or certified mail, postage prepaid, to Debtor at its address set forth above or at the most recent address shown on Secured Party's records. Secured Party's duty of care with respect to Collateral in its possession (as imposed by law) shall be deemed fulfilled if Secured Party exercises reasonable care in physically safekeeping such Collateral or, in the case of Collateral in the custody or possession of a bailee or other third person, exercises reasonable care in the selection of the bailee or other third person, and Secured Party need not otherwise preserve, protect, insure or care for any Collateral. Secured Party shall not be obligated to preserve any rights Debtor may have against prior parties, to realize on the Collateral at all or in any particular manner or order, or to apply any cash proceeds of Collateral in any particular order of application. This Agreement shall be binding upon and inure to the benefit of Debtor and Secured Party and their respective heirs, representatives, successors and assigns and shall take effect when signed by Debtor and delivered to Secured Party, and Debtor waives notice of Secured Party's acceptance hereof. Secured Party may execute this Agreement if appropriate for the purpose of filing, but the failure of Secured Party to execute this Agreement shall not affect or impair the validity or effectiveness of this Agreement. If any provision or application of this Agreement is held unlawful or unenforceable in any respect, such illegality or unenforceability shall not affect other provisions or applications which can be given effect, and this Agreement shall be construed herein or prescribed hereby. All representations and warranties contained in this Agreement shall survive the

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execution, delivery and performance of this Agreement and the creation and payment of the Obligations. If this Agreement is signed by more than one person as Debtor, the term "Debtor" shall refer to each of them separately and to both or all of them jointly; all such persons shall be bound both severally and jointly with the other(s); and the Obligations shall include all debts, liabilities and obligations owed to Secured Party by any Debtor solely or by both or several or all Debtors jointly and severally, and all property described in Section 1 shall be included as part of the Collateral, whether it is owned jointly by both or all Debtors or is owned in whole or in part by one (or more) of them.

LASALLE BUSINESS CREDIT, INC. (Secured Party)	CROSS TECHNOLOGY, INC. (Debtor)
/s/ DALE GRZENIA	/s/ ANTHONY J. FANT
By: Dale Grzenia	By: Anthony J. Fant
Title: Vice President	Title:

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SECURITY AGREEMENT

EX-4.7

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EXHIBIT 4.7

REVOLVING NOTE

Executed as of the 31st day of July, 2000 Amount $5,000,000.00

FOR VALUE RECEIVED, the Undersigned promises to pay to the order of LASALLE BUSINESS CREDIT, INC. (hereinafter, together with any holder hereof, called "LaSalle"), at the main office of LaSalle, 135 South LaSalle Street, Chicago, Illinois 60603, the principal sum of FIVE MILLION and 00/100 DOLLARS ($5,000,000.00) plus the aggregate unpaid principal amount of all advances made by LaSalle to the Undersigned pursuant to and in accordance with Paragraph 2 of the Loan Agreement (as hereinafter defined) in excess of such amount, or, if less, the aggregate unpaid principal amount of all advances made by LaSalle to the Undersigned pursuant to and in accordance with Paragraph 2 of the Loan Agreement. The outstanding principal balance shall be payable in accordance with the terms and conditions in the Loan Agreement. The Undersigned further promises to pay interest on the outstanding principal amount hereof on the dates and at the rates provided in the Loan Agreement from the date hereof until payment in full hereof.

    This Revolving Note is referred to in and was delivered pursuant to that certain Loan and Security Agreement, as it may be amended from time to time, together with all exhibits thereto, dated July 31, 2000, between LaSalle and the Undersigned (the "Loan Agreement"). All terms which are capitalized and used herein (which are not otherwise defined herein) shall have the meanings ascribed to such terms in the Loan Agreement.

    The Undersigned hereby authorizes LaSalle to charge any account of the Undersigned for all sums due hereunder. If payment hereunder becomes due and payable on a Saturday, Sunday or legal holiday under the laws of the United States or the State of Minnesota, the due date thereof shall be extended to the next succeeding business day, and interest shall be payable thereon at the rate specified during such extension. Credit shall be given for payments made in the manner and at the times provided in the Loan Agreement. It is the intent of the parties that the rate of interest and other charges to the Undersigned under this Revolving Note shall be lawful and shall be limited to the maximum nonusurious rate of interest permitted by law; therefore, if for any reason the interest or other charges payable hereunder are found by a court of competent jurisdiction, in a final determination, to exceed the limit which LaSalle may lawfully charge the Undersigned, then the obligation to pay interest or other charges shall automatically be reduced to such limit and, if any amount in excess of such limit shall have been paid, then such amount shall be refunded to the Undersigned.

    The principal and all accrued interest hereunder may be prepaid by the Undersigned, in part or in full, at any time; provided, however, that if the Undersigned prepays all of the Liabilities prior to the end of the Original Term or any Renewal Term, the Undersigned shall pay a prepayment fee as provided in the Loan Agreement.

    The Undersigned waives the benefit of any law that would otherwise restrict or limit LaSalle in the exercise of its right, which is hereby acknowledged, to set-off against the Liabilities, without notice and at any time hereafter, any indebtedness matured or unmatured owing from LaSalle to the Undersigned. The Undersigned waives every defense, counterclaim or setoff which the Undersigned may now have or hereafter may have to any action by LaSalle in enforcing this Note and/or any of the other Liabilities, or in enforcing LaSalle's rights in the Collateral and ratifies and confirms whatever LaSalle may do pursuant to the terms hereof and of the Loan Agreement and with respect to the Collateral and agrees that LaSalle shall not be liable for any error in judgment or mistakes of fact or law.

    The Undersigned, any other party liable with respect to the Liabilities and any and all endorsers and accommodation parties, and each one of them, if more than one, waive any and all presentment, demand, notice of dishonor, protest, and all other notices and demands in connection with the enforcement of LaSalle's rights hereunder.

    The loan evidenced hereby has been made and this Note has been delivered at Chicago, Illinois. THIS NOTE SHALL BE GOVERNED AND CONTROLLED BY THE INTERNAL LAWS OF THE STATE OF MINNESOTA AS TO INTERPRETATION, ENFORCEMENT, VALIDITY, CONSTRUCTION, EFFECT, AND IN ALL OTHER RESPECTS, INCLUDING WITHOUT LIMITATION, THE LEGALITY OF THE INTEREST RATE AND OTHER CHARGES, and shall be binding upon the Undersigned and the Undersigned's heirs, legal representatives, successors and assigns. If this Note contains any blanks when executed by the Undersigned, LaSalle is hereby authorized, without notice to the Undersigned to complete any such blanks according to the terms upon which the loan or loans were granted. Wherever possible, each provision of this Note shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Note shall be prohibited by or be invalid under such law, such provision shall be severable, and be ineffective to the extent of such prohibition or invalidity, without invalidating the remaining provisions of this Note, the term "Undersigned" as used herein shall mean all parties signing this Note, and each one of them, and all such parties, their respective heirs, executors, administrators, successors and assigns, shall be jointly and severally obligated hereunder.

    To induce LaSalle to make the loan evidenced by this Note, the Undersigned (i) irrevocably agrees that, subject to LaSalle's sole and absolute election, all actions arising directly or indirectly as a result or in consequence of this Note or any other agreement with LaSalle, or the Collateral, shall be instituted and litigated only in courts having situs in the County of Hennepin, Minnesota, (ii) hereby consents to the exclusive jurisdiction and venue of any State or Federal Court located and having its situs in said city, and (iii) waives any objection based on forum non-conveniens. IN ADDITION, THE UNDERSIGNED HEREBY WAIVES TRIAL BY JURY IN ANY ACTION OR PROCEEDING WHICH PERTAINS DIRECTLY OR INDIRECTLY TO THIS NOTE, THE LIABILITIES, THE COLLATERAL, ANY ALLEGED TORTIOUS CONDUCT BY THE UNDERSIGNED OR LASALLE OR WHICH IN ANY WAY, DIRECTLY OR INDIRECTLY, ARISES OUT OF OR RELATES TO THE RELATIONSHIP BETWEEN THE UNDERSIGNED AND LASALLE, and consents that service of process may be made in accordance with the Loan Agreement; and service so made shall be completed five (5) days after the same has been deposited in the U.S. mails as aforesaid.

    As used herein, all provisions shall include the masculine, feminine, neuter, singular and plural thereof, wherever the context and facts require such construction and in particular the word "Undersigned" shall be so construed.

IN WITNESS WHEREOF, the Undersigned has executed this Note on the date above set forth.

HEI, INC.

 
/s/ ANTHONY J. FANT By: Anthony J. Fant
Title: Chairman and CEO

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ACKNOWLEDGMENT OF SIGNATURE

STATE OF MINNESOTA	)
	) SS.
COUNTY OF RAMSEY	)

    I, James W. Dierking, a Notary Public in and for the state and county aforesaid, do hereby certify that before me this day personally appeared Anthony J. Fant, Chairman and CEO of the HEI, Inc., a Minnesota corporation, known to me to be the same person whose name is subscribed to the foregoing Revolving Note, and acknowledged to me that he executed and delivered the foregoing Revolving Note as his free and voluntary act, for the uses set forth therein.

IN WITNESS WHEREOF, I have hereunto set my hand and official seal this 27th day of July, 2000.

[SEAL]	/s/ JAMES W. DIERKING Notary Public
	My Commission Expires 1/31/05

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REVOLVING NOTE
ACKNOWLEDGMENT OF SIGNATURE

EX-21

EXHIBIT 21

Subsidiaries of the Registrant

Parent	Subsidiary	Percentage of Ownership	State of Incorporation or Organization
HEI, Inc.	Cross Technology, Inc.	100%	Minnesota
HEI, Inc.	HEI Export, Inc.	100%	Barbados

EX-23

EXHIBIT 23

Independent Certified Public Accountants' Consent

The Board of Directors
HEI, Inc.

    We consent to incorporation by reference in the registration statements (Nos. 33-33322, 33-46928, 33-46929, 333-49489 and 333-40026) on Forms S-8 and S-3 of HEI, Inc. of our report dated October 20, 2000, relating to the consolidated balance sheets of HEI, Inc. and subsidiaries, as of August 31, 2000 and 1999, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended August 31, 2000, which report appears in the August 31, 2000 annual report on Form 10-KSB of HEI, Inc.

KPMG LLP

Minneapolis, Minnesota
November 29, 2000

EX-27

 


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