-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B+kYE4sWuMmz8OpfJ+bHzH5HJH3szac2Tx9eQmpX8YPkPikMPGBLH0qYzCfvxmZc 0CzAnA8kQ1sgdph3EQ7uYQ== 0000912057-96-027455.txt : 19961126 0000912057-96-027455.hdr.sgml : 19961126 ACCESSION NUMBER: 0000912057-96-027455 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19960831 FILED AS OF DATE: 19961125 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HEI INC CENTRAL INDEX KEY: 0000351298 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 410944876 STATE OF INCORPORATION: MN FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: 1934 Act SEC FILE NUMBER: 000-10078 FILM NUMBER: 96671520 BUSINESS ADDRESS: STREET 1: 1495 STEIGER LAKE LN STREET 2: P O BOX 5000 CITY: VICTORIA STATE: MN ZIP: 55386 BUSINESS PHONE: 6124432500 MAIL ADDRESS: STREET 1: P O BOX 5000 STREET 2: 1495 STEIGER LAKE LANE CITY: VICTORIA STATE: MN ZIP: 55386 10KSB40 1 10KSB40 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, 1996. --------------- [ ] 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 41-0944876 - --------- ---------- (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) P.O. Box 5000, 1495 Steiger Lake Lane, Victoria, MN 55386 - --------------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Issuer's telephone number, including area code: (612)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) RIGHTS TO PURCHASE COMMON STOCK ------------------------------- (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. [X] HEI, Inc. revenues for the fiscal year ended August 31, 1996 were $20,680,000. The aggregate market value as of November 1, 1996 (based on the closing price as reported by The Nasdaq National Market) of the voting stock held by non- affiliates was approximately $35,000,000. As of November 1, 1996, 4,072,427 Common Shares (par value $.05) were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Shareholders for the fiscal year ended August 31, 1996 are incorporated by reference into Parts I and II. Portions of the Proxy Statement for Registrant's Annual Meeting of Shareholders to be held January 22, 1997 are incorporated by reference in Part III. 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. (b) BUSINESS OF THE COMPANY PRINCIPAL PRODUCTS AND SERVICES - HEI, Inc. is a designer and manufacturer of ultraminiature microelectronic devices and high technology products incorporating these devices. HEI's custom-built microelectronics are employed in medical, industrial and computer markets. The light pen product line, which represented a minor part of the Company's sales, was sold in August 1996 to FTG Data Systems. DISTRIBUTION METHODS - HEI sells through its Company-employed sales force based at corporate headquarters. 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. The Company's business is not dependent on any single supplier. 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 1996, 1995 and 1994. Customer 1996 1995 1994 -------- ---- ---- ---- Customer A 38% 12% 19% Customer B 16% Customer C 10% Customer D 27% Customer E 30% 49% - 2 - 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-sponsered research and development activities was approximately $849,000, $754,000 and $679,000 for the years ended August 31, 1996, 1995 and 1994. EMPLOYEES - At August 31, 1996, the Company employed 131 full-time and 19 temporary persons. ITEM 2. DESCRIPTION OF PROPERTY The Company owns a 48,000 square foot facility for administration and production in Victoria, Minnesota, which was 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. Also, the Company leases, with an option to buy, a facility of 11,600 square feet in Sauk Centre, Minnesota. The lease was renewed for 3 years in fiscal 1993. ITEM 3. LEGAL PROCEEDINGS There are no legal proceedings pending against the Company or its properties. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS None. - 3 - PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information called for by Item 5 is incorporated by reference from the Annual Report on page 16. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS The information called for by Item 6 is incorporated by reference from the Annual Report on pages 4-5. ITEM 7. FINANCIAL STATEMENTS The information called for by Item 7 is incorporated by reference from the Annual Report on pages 6-14 as follows: Page in Annual Report: -------------- Balance Sheet as of August 31, 1996 and 1995 6 Statement of Operations for the Years Ended August 31, 1996, 1995 and 1994 7 Statement of Changes in Shareholders' Equity for the Years Ended August 31, 1996, 1995 and 1994 8 Statement of Cash Flows for the Years Ended August 31, 1996, 1995 and 1994 9 Notes to Financial Statements 10-13 Report of Independent Accountants 14 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. - 4 - 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." The following is a list of HEI, Inc. executive officers, their ages, positions and offices as of November 1, 1996. NAME AGE POSITION - ---- --- -------- Eugene W. Courtney 60 President, Chief Executive Officer Jerald H. Mortenson 62 Vice President of Finance and Administration, Chief Financial Officer and Treasurer Dale A. Nordquist 42 Vice President of Sales and Marketing BUSINESS EXPERIENCE EUGENE W. COURTNEY became President and Chief Executive Officer of the Company in June 1990. He had served as Executive Vice President and Operating Officer since August 1988 and has served as a Director since 1989. From 1980 to 1988, Mr. Courtney served as Vice President and Group Vice President of National Computer Systems. JERALD H. MORTENSON joined the Company in March 1990. Prior thereto he had spent ten years with CTS Fabri-tek, first as Chief Financial Officer and the last five years as Group President. DALE A. NORDQUIST joined the Company on July 16, 1981 as Western Regional Manager. In December 1986, he was appointed Vice President of Sales. ITEM 10. EXECUTIVE COMPENSATION The information called for by Item 10 is contained in the Proxy Statement under the captions "Executive Compensation" and "Proposal No. 1 Election of Directors." ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information called for by Item 11 is incorporated in the Proxy Statement under the caption "Shares and Principal Shareholders." ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: See Exhibit Index on Page 7 (b) Reports files on Form 8-K: No reports on Form 8-K were filed during the fourth quarter of the fiscal year ended August 31, 1996. - 5 - 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/ Eugene W. Courtney ----------------------------------- Eugene W. Courtney, President and Chief Executive Officer Date: November 8, 1996 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/ Eugene W. Courtney November 8, 1996 - ----------------------------------------------- ---------------- Eugene W. Courtney, Director Date /s/ Jerald H. Mortenson - ----------------------------------------------- Jerald H. Mortenson, Vice President of Finance November 8, 1996 and Administration, Chief Financial Officer and ---------------- Treasurer Date /s/ Craig E. Roble November 8, 1996 - ----------------------------------------------- ---------------- Craig E. Roble, Company Controller Date /s/ Robert L. Brueck November 8, 1996 - ----------------------------------------------- ---------------- Robert L. Brueck, Director Date /s/ William R. Franta November 8, 1996 - ----------------------------------------------- ---------------- William R. Franta, Director Date /s/ Kenneth A. Schoen November 8, 1996 - ----------------------------------------------- ---------------- Kenneth A. Schoen, Director Date /s/ Frederick M Zimmerman November 8, 1996 - ----------------------------------------------- ---------------- Frederick M Zimmerman, Director Date - 6 - EXHIBIT INDEX Page Number or (a) EXHIBIT NUMBER Description Incorporated by -------------- ----------- Reference --------- 3.1 Restated Articles of Incorporation, as amended. Note 1 3.2 Bylaws, as amended. Note 2 4.1 Rights Agreement dated May 27, 1988 between HEI, Inc. and Norwest Bank Minnesota, N.A., as amended. Note 3 4.2 Credit Agreement with Norwest Bank Minnesota, N.A. dated March 7, 1995. Note 4 4.3a Credit Agreement with Norwest Bank Minnesota, N.A. dated April 1, 1996. Note 5 4.3b Current Note and Security Agreement with Norwest Bank Minnesota, N.A. dated April 1, 1996. Note 5 4.4a Reimbursement Agreement by and between HEI, Inc. and Norwest Bank, Minnesota, N.A. dated April 1, 1996. Note 5 4.4b Mortgage Security Agreement Fixture Financing Statement and Assignment of Leases and Rents by HEI, Inc. as Mortgagor to Norwest Bank, Minnesota, N.A. as Mortgagee dated April 1, 1996. Note 5 4.4c Security Agreement by HEI, Inc. in favor of Norwest Bank, Minnesota, N.A. dated April 1, 1996. Note 5 10.1a Lease between Sauk Centre Opportunities Incorporated and HEI, Inc. dated October 16, 1978 (the Lease). Note 6 10.1b Second Addendum to the Lease, dated May 31,1988. Note 2 10.1c Third Addendum to the Lease, dated June 1, 1993. Note 7 10.2 Form of Indemnification Agreement between HEI and officers and directors. Note 8 *10.3 HEI 1989 Omnibus Stock Compensation Plan adopted April 3, 1989, as amended to date (1989 Plan). *10.4 1991 Stock Option Plan for Non-employee Directors, as amended to date. *10.5 Form of Non-qualified Stock Option agreement between HEI and executive officers under 1989 Plan. Note 9 *10.6 Form of Incentive Stock Option agreement between HEI and executive officers under 1989 Plan. Note 9 13 Annual Report to Shareholders for the year ended August 31, 1996. 23 Consent of Independent Accountants. 27 Financial Data Schedule. - 7 - 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 Annual Report on Form 10-K for the year ended August 31, 1988, and incorporated herein by reference. [3] Filed as an exhibit to Registration Statement on Form 8-A filed May 31, 1988, as amended by Form 8 filed June 27, 1988, and incorporated herein by reference. [4] Filed as an exhibit to Form 10-QSB for the quarter ended February 25, 1995, and incorporated herein by reference. [5] Filed as an exhibit to Form 10-QSB for the quarter ended June 1, 1996, and incorporated herein by reference. [6] Filed as an exhibit to a Registration Statement of the Company on Form S-18 which was filed with the SEC on February 23, 1981, and incorporated herein by reference. [7] Filed as an exhibit to Annual Report on Form 10-KSB for the year ended August 31, 1993, and incorporated herein by reference. [8] Filed as an exhibit to Registration Statement on Form S-2 (SEC no. 33-37285) filed October 15, 1990, and incorporated herein by reference. [9] Filed as an exhibit to Form 10-K for the year ended August 31, 1989, and incorporated herein by reference. * Denotes management contract or compensation plan or arrangement. - 8 - EX-10.3 2 EXHIBIT 10.3 HEI, INC. 1989 OMNIBUS STOCK COMPENSATION PLAN AS AMENDED AND RESTATED EFFECTIVE NOVEMBER 15, 1991 AND AMENDED EFFECTIVE APRIL 29, 1992, MAY 11, 1994, AND OCTOBER 31, 1996 TABLE OF CONTENTS ITEM DESCRIPTION PAGE - ---- ----------- ---- SECTION 1. Purpose; Definitions . . . . . . . . . . . . . . . . . . . . . 2 SECTION 2. Administration . . . . . . . . . . . . . . . . . . . . . . . . 4 SECTION 3. Stock Subject to Plan. . . . . . . . . . . . . . . . . . . . . 6 SECTION 4. Eligibility. . . . . . . . . . . . . . . . . . . . . . . . . . 6 SECTION 5. Stock Options. . . . . . . . . . . . . . . . . . . . . . . . . 7 SECTION 6. Stock Appreciation Rights. . . . . . . . . . . . . . . . . . .10 SECTION 7. Restricted Stock . . . . . . . . . . . . . . . . . . . . . . .12 SECTION 8. Deferred Stock . . . . . . . . . . . . . . . . . . . . . . . .13 SECTION 9. Stock Purchase Rights. . . . . . . . . . . . . . . . . . . . .14 SECTION 10. Other Stock-Based Awards . . . . . . . . . . . . . . . . . . .17 SECTION 11 Change in Control Provisions . . . . . . . . . . . . . . . . .18 SECTION 12. Amendments and Termination . . . . . . . . . . . . . . . . . .19 SECTION 13. Unfunded Status of Plan. . . . . . . . . . . . . . . . . . . .20 SECTION 14. General Provisions . . . . . . . . . . . . . . . . . . . . . .21 SECTION 15. Effective Date of Plan . . . . . . . . . . . . . . . . . . . .22 SECTION 16. Term of Plan . . . . . . . . . . . . . . . . . . . . . . . . .23 SECTION 17. Applicability to Grants under Other Company Plans. . . . . . .23 1 HEI, INC. 1989 OMNIBUS STOCK COMPENSATION PLAN AS AMENDED AND RESTATED EFFECTIVE NOVEMBER 15, 1991 AND AMENDED EFFECTIVE APRIL 29, 1992 AND MAY 11, 1994, AND OCTOBER 31, 1996 SECTION 1. PURPOSE; DEFINITIONS The purpose of the HEI, Inc. 1989 Omnibus Stock Compensation Plan (the "Plan") is to enable HEI, Inc. (the "Company") to attract, retain, and reward employees of the Company and its Parents, Subsidiaries, and Affiliates, and strengthen the mutuality of interests between such employees and the Company's shareholders, by offering such employees performance-based stock incentives and/or other equity interests or equity-based incentives of the Company. In addition to definitions that may be contained elsewhere in this Plan, for purposes of the Plan, the following terms shall be defined as set forth below: (a) "Affiliate" means any entity other than the Company and its Parents and Subsidiaries that is designated by the Board as a participating employer under the Plan, provided that the Company directly or indirectly owns at least 20% of the combined voting power of all classes of stock of such entity or at least 20% of the ownership interests in such entity. (b) "Award" means any Option, Stock Appreciation Right, Restricted Stock Award, Deferred Stock Award, Stock Purchase Right, or Other Stock-Based Award, or any other right, interest, or option relating to Stock or other securities of the Company granted pursuant to the provisions of this Plan. (c) "Award Agreement" means any written agreement, contract, or other instrument or document evidencing any Award granted by the Committee hereunder and signed by both the Company and the Participant. (d) "Board" means the Board of Directors of the Company. (e) "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. (f) "Committee" means the Committee referred to in Section 2 of the Plan. If at any time no Committee shall be in office, then the functions of the Committee specified in the Plan shall be exercised by the Board. Where the Board has retained administrative authority with respect to the Plan, references herein to the "Committee" shall refer to the Board. (g) "Company" means HEI, Inc., a corporation organized under the laws of the State of Minnesota, or any successor corporation. 2 (h) "Deferred Stock" means an Award made pursuant to Section 8 below of the right to receive Stock at the end of a specified deferral period. (i) "Disability" means disability as determined under procedures established by the Committee for purposes of this Plan or, as applied to Incentive Stock Options, as defined in Section 22(e)(3) of the Code. (j) [deleted] (k) "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time. (1) "Fair Market Value" means as of any given date, unless otherwise determined by the Committee in good faith, the average for the preceding five business days of the closing bid prices of the Stock as reported on the National Association of Securities Dealers, Inc. Automated Quotations System ("NASDAQ") or, if the Stock is then traded on the NASDAQ National Market System ("NASDAQ/NMS") or a national or regional securities exchange, the average for the preceding five business days of the closing prices of the Stock on NASDAQ/NMS or such exchange. (m) "Incentive Stock Option" means any Stock Option intended to be and designated as an "Incentive Stock Option" within the meaning of Section 422 of the Code. (n) "Nonqualified Stock Option" means any Stock Option that is not an Incentive Stock Option. (o) "Other Stock-Based Award" means an Award under Section 10 below that is valued in whole or in part by reference to, or is otherwise based on, Stock. (p) "Parent" means any corporation (other than the Company) in an unbroken chain of corporations ending with the Company if, at the time of the granting of an Award, each of the corporations other than the Company owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in the chain. (q) "Participant" means an employee of the Company or any Subsidiary, Parent, or Affiliate of the Company who is selected by the Committee to receive an Award under the Plan. (r) "Plan" means this HEI, Inc. 1989 Omnibus Stock Compensation Plan, as hereafter amended from time to time. (s) "Restricted Stock" means an Award made pursuant to Section 7 below of Stock that is subject to restrictions. 3 (t) "Stock" means the Common Stock, $.05 par value per share, of the Company. (u) "Stock Appreciation Right" or "SAR" means the right to receive to receive a payment in cash, Stock, Restricted Stock, or Deferred Stock as determined by the Committee. (v) "Stock Option" or "Option" means any option to purchase shares of Stock (including Restricted Stock and Deferred Stock, if the Committee so determines) granted pursuant to Section 5 below. (w) "Stock Purchase Right" means the right to purchase Stock pursuant to Section 9 below. (x) "Subsidiary" means any corporation (other than the Company) in an unbroken chain of corporations beginning with the Company if, at the time of the granting of an Award, each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in the chain. In addition, the terms "Change in Control" and "Change in Control Price" shall have the meanings set forth, respectively, in Sections 11(b) and (c) below. SECTION 2. ADMINISTRATION The Plan shall be administered by a Committee of not fewer than two members of the Board, who shall be appointed by the Board and serve at the pleasure of the Board. Initially, the Committee shall consist of the three nonemployee directors. The functions of the Committee specified in the Plan shall be exercised by the Board, if and to the extent that no Committee exists that has the authority to so administer the Plan, or to the extent that the Board retains authority to administer the Plan under specified circumstances. As to the selection of and grants of Awards to persons who are not subject to Sections 16(a) and 16(b) of the Exchange Act, the Committee may delegate any or all of its responsibility to members of the Company's administration. The grants of Awards and determination of the terms thereof to persons who are subject to Sections 16(a) and 16(b) of the Exchange Act shall be made in a manner that satisfies the requirements of Rule 16b-3 under the Exchange Act, or any successor rule. The Committee shall have full power and authority, consistent with the provisions of the Plan and subject to such orders or resolutions not inconsistent with the provisions of the Plan as may be adopted by the Board: (a) to select the employees of the Company and any Parent, Subsidiary, or Affiliate to whom Awards may from time to time be granted hereunder; (b) to determine the type or types of Awards to be granted to employees hereunder; 4 (c) to determine the number of shares of Stock to be covered by each Award granted hereunder; (d) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any Award granted hereunder; (e) to determine whether, to what extent, and under what circumstances an Award may be settled in cash, Stock, or other property or canceled or suspended; (f) to determine whether, to what extent, and under what circumstances cash, Stock, and other property and other amounts payable with respect to an Award shall be deferred either automatically or at the election of the Participant; (g) to interpret and administer the Plan and any instrument or agreement entered into thereunder; (h) to establish such rules and regulations and appoint such agents as it shall deem appropriate for proper administration of the Plan; and (i) to make any other determination and take any other action that the Committee deems necessary or desirable for administration of the Plan. Members of the Board and of the Committee acting under the Plan shall be fully protected in relying in good faith upon the advice of counsel and shall incur no liability except for gross negligence or willful misconduct in the performance of their duties. Decisions of the Committee shall be made in the Committee's sole discretion and shall be final, conclusive, and binding on all persons, including the Company, any Participant, any shareholder, and any employee of the Company or any Parent, Subsidiary, or Affiliate. SECTION 3. STOCK SUBJECT TO PLAN The total number of shares of Stock reserved and available for distribution under the Plan shall be 1,200,000 shares of Stock. Such shares may consist, in whole or in part, of authorized and unissued shares or treasury shares. Subject to the possible adjustments described in the last paragraph of this Section 3, the total number of shares of Stock reserved and authorized for issuance upon exercise of Incentive Stock Options shall be 900,000. To the extent that such shares are not used for Incentive Stock Options, they shall be available for other Awards to be granted under the Plan. If any shares of Stock subject to an Award are not issued to a Participant because an Option or SAR is not exercised or an Award is otherwise forfeited or any such Award otherwise terminates without a payment being made to the Participant in the form of Stock, such shares shall again be available for distribution in connection with future Awards under the Plan. 5 In the event of any merger, reorganization, consolidation, recapitalization, Stock dividend, Stock split, or other change in corporate structure affecting the Stock, such substitution or adjustment shall be made in the aggregate number of shares reserved for issuance under the Plan, in the number and option price of shares subject to outstanding Options granted under the Plan, in the number and purchase price of shares subject to outstanding Stock Purchase Rights under the Plan, and in the number of shares subject to other outstanding Awards granted under the Plan as may be determined to be appropriate by the Board, in its sole discretion, provided that the number of shares subject to any Award shall always be a whole number. Any such adjusted option price shall also be used to determine the amount payable by the Company upon the exercise of any Stock Appreciation Right associated with any Stock Option. SECTION 4. ELIGIBILITY Except as otherwise provided herein with respect to a specific Award under Section 9, officers, management, or highly compensated employees of the Company and any Subsidiary, Parent, or Affiliate (but excluding members of the Committee) are eligible to be granted Awards under the Plan. The Committee shall have the exclusive authority to determine what constitutes management or a "highly compensated employee" and in making such a determination shall take into consideration guidelines established by the Department of Labor and court decisions as to what constitutes a "select group of management or highly compensated employees." SECTION 5. STOCK OPTIONS Stock options may be granted alone, in addition to or in tandem with other Awards granted under the Plan. Any Stock Option granted under the Plan shall be in such form as the Committee may from time to time approve. Stock Options granted under the Plan may be of two types: (i) Incentive Stock Options and (ii) Nonqualified Stock Options. Options may be issued with or without Stock Appreciation Rights. Options granted under the Plan shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee shall deem desirable: (a) EXERCISE PRICE. Except as provided in Section 5(i), the exercise price per share of Stock purchasable under a Stock Option shall be determined by the Committee at the time of grant but shall be not less than 85% of the Fair Market Value of the Stock on the date of grant. (b) OPTION TERM. Except as provided in Section 5(i) hereof, the term of each Stock Option shall be fixed by the Committee. (c) EXERCISABILITY. Stock Options shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee at or after grant; provided, however, that, except as provided in Sections 5(f), (g), and (h) and 6 Section 11, unless otherwise determined by the Committee at or after grant, no Stock Option shall be exercisable prior to the first anniversary date of the granting of the Option. If the Committee provides, in its sole discretion, that any Stock Option is exercisable only in installments, the Committee may waive such installment exercise provisions at any time at or after grant in whole or in part, based on such factors as the Committee shall determine, in its sole discretion. (d) METHOD OF EXERCISE. Subject to whatever installment exercise provisions apply under Section 5(c), Stock Options may be exercised in whole or in part at any time during the option period. Payment of the exercise price may be made by check, note (if approved by the Board), or such other instrument or method as the Committee may accept. If so provided in the related Award Agreement, payment in full or in part may also be made in the form of Stock already owned by the optionee or Restricted Stock or Deferred Stock subject to an Award hereunder (based, in each case, on the Fair Market Value of the Stock on the date the Option is exercised, as determined by the Committee). Payment of the exercise price may be made through exercise of either Tandem SARS or Freestanding SARS held by the optionee. With the prior approval of the Committee, the exercise price of an Option may be paid through the delivery of Stock acquired by successive exercises of the Option ("pyramiding"). If payment of the exercise price of a Stock Option is made in whole or in part in the form of Restricted Stock or Deferred Stock, such Restricted Stock or Deferred Stock (and any replacement shares relating thereto) shall remain (or be) restricted or deferred, as the case may be, in accordance with the original terms of the Restricted Stock Award or Deferred Stock Award in question, and any additional Stock received upon the exercise shall be subject to the same forfeiture restrictions or deferral limitations, unless otherwise determined by the Committee, in its sole discretion, at or after grant. No shares of Stock shall be issued until full payment therefor has been made. An optionee shall generally have the rights to dividends or other rights of a shareholder with respect to shares subject to the Option after the optionee has given written notice of exercise, has paid in full for such Stock, and, if requested, has given the representation described in Section 14(a). (e) NONTRANSFERABILITY OF OPTIONS. Subject to Section 5(i), and unless otherwise provided by the related Award Agreement, no Stock Option shall be transferable by the optionee otherwise than by the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act, or the rules thereunder, and all Stock Options shall be exercisable during the optionee's lifetime only by the optionee. (f) TERMINATION BY DEATH. Subject to Section 5(i), if an optionee's employment by the Company or any Subsidiary, Parent, or Affiliate terminates by reason of death, any Stock Option held by such optionee may thereafter be exercised, to the 7 extent such option was exercisable at the time of death or on such accelerated basis as the Committee may determine at or after grant (or as may be determined in accordance with procedures established by the Committee), by the legal representative of the optionee's estate or by any person who acquired the Option by will or the laws of descent and distribution, for a period of one year (or such other period as the Committee may specify at grant) from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (g) TERMINATION BY REASON OF DISABILITY. Subject to Section 5(i), if an optionee's employment by the Company or any Subsidiary, Parent, or Affiliate terminates by reason of Disability, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the time of termination or on such accelerated basis as the Committee may determine at or after grant (or as may be determined in accordance with procedures established by the Committee), until the expiration of the stated term of such Stock Option (unless otherwise specified by the Committee at the time of grant); provided, however, that, if the optionee dies prior to such expiration (or within such other period as the Committee shall specify at grant), any unexercised Stock Option held by such optionee shall thereafter be exercisable to the extent to which it was exercisable at the time of death for a period of one year from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (h) OTHER TERMINATION. Subject to Section 5(i), unless otherwise determined by the Committee (or pursuant to procedures established by the Committee) at or after grant, if an optionee's employment by the Company or any Subsidiary, Parent, or Affiliate terminates for any reason other than death or Disability, the Stock Option shall be exercisable, to the extent otherwise then exercisable, for the lesser of three months from the date of termination of employment or the balance of such Stock Option's term. (i) INCENTIVE STOCK OPTIONS. Anything in the Plan to the contrary not withstanding, no term of this Plan relating to Incentive Stock Options shall be interpreted, amended, or altered, nor shall any discretion or authority granted under the Plan be so exercised, so as to disqualify the Plan under Section 422 of the Code or, without the consent of the optionee(s) affected, to disqualify any Incentive Stock Option under such Section 422. To the extent required for "incentive stock option" status under Section 422 of the Code (taking into account applicable Internal Revenue Service regulations and pronouncements and court decisions), the Plan shall be deemed to provide: (i) that Incentive Stock Options may be granted only to employees of the Company or any Parent or Subsidiary of the Company; (ii) that the exercise price of any Incentive Stock Option shall not be less than 100% of the Fair Market Value of the Stock as of the date of grant 8 (110% for an optionee who owns stock possessing more than 10% of the voting power of all classes of stock of the Company or of a Parent or Subsidiary); (iii) that the maximum term of exercise for any Incentive Stock Option shall not exceed ten years (five years in the case of an optionee who owns stock possessing more than 10% of the voting power of all classes of stock of the Company or of a Parent or Subsidiary); and (iv) that Incentive Stock Options shall not be transferable by the optionee otherwise than by will or the laws of descent and distribution and shall be exercisable, during the optionee's lifetime, only by the optionee. To the extent permitted under Section 422 of the Code or applicable regulations thereunder or any applicable Internal Revenue Service pronouncements: (i) if a Participant's employment is terminated by reason of death or disability and the portion of any Incentive Stock Option that becomes exercisable during the post-termination period specified in Section 5(f) or (g) hereof exceeds the $100,000 limitation contained in Section 422(d) of the Code, such excess shall be treated as a Nonqualified Stock Option; and (ii) if the exercise of an Incentive Stock Option is accelerated by reason of a Change in Control, any portion of such Option that exceeds the $100,000 limitation contained in Section 422(d) of the Code shall be treated as a Nonqualified Stock Option. (j) NO TANDEM OPTIONS. Options consisting of both an Incentive Stock Option and a Nonqualified Stock Option shall not be granted under the Plan. SECTION 6. STOCK APPRECIATION RIGHTS (a) GRANT AND EXERCISE. Stock Appreciation Rights may be granted either alone ("Freestanding SAR") or in addition to other Awards granted under the Plan and may, but need not, relate to all or part of any Stock Option granted under the Plan ("Tandem SAR"). In the case of a Nonqualified Stock Option, a Tandem SAR may be granted either at or after the time of the grant of such Stock Option. In the case of an Incentive Stock Option, a Tandem SAR may be granted only at the time of the grant of such Stock Option. A Tandem SAR shall terminate and no longer be exercisable upon the termination or exercise of the related Stock Option, subject to such provisions as the Committee may specify at grant where a Tandem SAR is granted with respect to less than the full number of shares covered by a related Stock Option. Stock Options relating to exercised Tandem SARs shall no longer be exercisable to the extent that the related Tandem SARs have been exercised. 9 A Stock Appreciation Right may be exercised, subject to Section 6(b), in accordance with the procedures established by the Committee for such purpose and as set forth in the related Award Agreement. Upon such exercise, the optionee shall be entitled to receive an amount determined in the manner prescribed in Section 6(b). (b) TERMS AND CONDITIONS. Stock Appreciation Rights shall be subject to such terms and conditions, not inconsistent with the provisions of the Plan, as shall be determined from time to time by the Committee, including the following: (i) The exercise price of a Tandem SAR shall be the exercise price of the related Option. The exercise price of a Freestanding SAR shall be not less than 100% of the Fair Market Value of the Stock on the date of grant of the Freestanding SAR. Notwithstanding the foregoing, the Committee may unilaterally limit the appreciation in value of Stock attributable to an SAR at any time prior to its exercise. (ii) Stock Appreciation Rights shall be exercisable only at such time or times and to the extent provided in the related Award Agreement; provided, however, that the exercise provisions of an SAR granted in tandem with an Incentive Stock Option shall be the same as the related Option. (iii) Upon the exercise of a Stock Appreciation Right, the holder shall be entitled to receive an amount in cash or shares of Stock equal in value to the excess of the Fair Market Value of one share of Stock on the date of exercise, or such other date as the Committee shall specify in the Award Agreement, over the exercise price per share specified in the related Award Agreement multiplied by the number of shares in respect of which the Stock Appreciation Right shall have been exercised, with the Committee having the right to determine the form of payment. When payment is to be made in Stock, the number of shares to be paid shall be calculated on the basis of the Fair Market Value of the Stock on the date of exercise. (iv) Except as may be otherwise provided in the related Award Agreement, Stock Appreciation Rights shall not be transferable except under the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act, or the rules thereunder, and shall be exercisable during the lifetime of the Participant only by the Participant. (v) Upon the exercise of a Stock Appreciation Right, any related Stock Option or part thereof to which such Stock Appreciation Right is related shall be deemed to have been exercised for the purpose of the limitation set forth in Section 3 of the Plan on the number of shares of Stock to be issued under the Plan. 10 (vi) The Committee, in its sole discretion, may also provide that, in the event of a Change in Control, the amount to be paid upon the exercise of a Stock Appreciation Right shall be based on the Change in Control Price, subject to such terms and conditions as the Committee may specify at grant. SECTION 7. RESTRICTED STOCK (a) ADMINISTRATION. Restricted Stock Awards may be granted either alone, in addition to, or in tandem with other Awards granted under the Plan for no consideration or for such minimum consideration as may be required by applicable law. The Committee shall determine the persons to whom, and the time or times at which, grants of Restricted Stock will be made, the number of shares to be awarded, the price (if any) to be paid by the recipient of Restricted Stock, the time or times within which such Awards may be subject to forfeiture, and all other terms and conditions of the Awards. The Committee may condition the grant of Restricted Stock upon the attainment of specified performance goals or such other factors or criteria as the Committee shall determine, in its sole discretion, and the Committee may, after grant, change the Restriction Period or waive the restrictive limitations for all or any part of any Restricted Stock Award. The provisions of Restricted Stock Awards need not be the same with respect to each recipient. All Awards of Restricted Stock shall be evidenced by appropriate Award Agreements. (b) CERTIFICATES. Any Restricted Stock issued hereunder may be evidenced in such manner as the Committee, in its sole discretion, shall deem appropriate, including, without limitation, book-entry registration or issuance of a stock certificate or certificates. Any such certificate shall be registered in the name of the Participant and shall bear an appropriate legend referring to the terms, conditions, and restrictions applicable to such Award. The committee shall require that the stock certificates evidencing such shares be held in custody by the Company until the restrictions thereon shall have lapsed and that, as a condition of any Restricted Stock Award, the Participant shall have delivered a stock power, endorsed in blank, relating to the Stock covered by such Award. (c) RESTRICTIONS AND CONDITIONS. Except as may be otherwise provided in the related Award Agreement, during a period set by the Committee commencing with the date of such Award (the "Restriction Period"), the Participant shall not be permitted to sell, transfer, pledge, or assign shares of Restricted Stock awarded under the Plan but shall have all of the rights of a shareholder of the Company, including the right to vote the shares and the right to receive any dividends. The Committee, in its sole discretion, as determined at the time of award, may permit or require the payment of cash or stock dividends to be deferred and, if the Committee so determines, reinvested, subject to Section 14(f) hereof, in additional 11 Restricted Stock subject to the same restrictions and other terms and conditions that apply to the shares with respect to which such dividends are issued, to the extent shares are available under Section 3, or otherwise reinvested. Upon termination of a Participant's employment with the Company or any Subsidiary, Parent, or Affiliate for any reason during the Restriction Period, all or a portion of the shares still subject to restriction may vest, or be forfeited, in accordance with the terms and conditions established by the Committee at or after grant. SECTION 8. DEFERRED STOCK (a) ADMINISTRATION. Deferred Stock may be awarded either alone, in addition to, or in tandem with other Awards granted under the Plan. The Committee shall determine the persons to whom and the time or times at which Deferred Stock shall be awarded, the number of shares of Deferred Stock to be awarded to any person, the duration of the period (the "Deferral Period") during which, and the conditions under which, receipt of the Stock will be deferred, and the other terms and conditions of the Award in addition to those set forth in Section 8(b). The Committee may condition the grant of Deferred Stock upon the attainment of specified performance goals or such other factors or criteria as the Committee shall determine, in its sole discretion, and the Committee may, after grant, change the vesting period or waive the deferral limitations for all or any part of any Deferred Stock Award. The provisions of Deferred Stock Awards need not be the same with respect to each recipient. All Awards of Deferred Stock shall be evidenced by appropriate Award Agreements. (b) TERMS AND CONDITIONS. Except as may be otherwise provided in the related Award Agreement, Deferred Stock Awards may not be sold, assigned, transferred, pledged, or otherwise encumbered during the Deferral Period. At the expiration of the Deferral Period (or the Elective Deferral Period referred to below, where applicable), share certificates shall be delivered to the Participant, or his legal representative, representing the number of shares covered by the Deferred Stock Award. Any dividends declared during the Deferral Period with respect to shares covered by a Deferred Stock Award will be paid to the Participant currently, or deferred and deemed to be reinvested in additional Deferred Stock, or otherwise reinvested, all as determined at or after the time of the grant of the Award by the Committee, in its sole discretion. Upon termination of a Participant's employment with the Company or any Subsidiary, Parent, or Affiliate for any reason during the Deferral Period for a given Award, all or a portion of the Deferred Stock subject to the Award may vest, or be 12 forfeited, in accordance with the terms and conditions established by the Committee at or after grant. A Participant may elect to further defer receipt of an Award (or an installment of an Award) for a specified period or until a specified event (the "Elective Deferral Period"), subject in each case to the Committee's approval and to such terms as are determined by the Committee, all in its sole discretion. Subject to any exceptions adopted by the Committee, such election must generally be made at least 12 months prior to completion of the Deferral Period for such Deferred Stock Award (or such installment). SECTION 9. STOCK PURCHASE RIGHTS (a) ELIGIBLE EMPLOYEES. Any employee who has been continuously in the employment of the Company or any Parent or Subsidiary since the January 1 preceding a particular Purchase Period (as defined in Section 9(k)(ii)), except (i) any employee customarily employed less than 20 hours weekly and (ii) any employee who, immediately after a right to purchase is granted, owns stock possessing 5% or more of the total combined voting power or value of all classes of stock of the Company or any Parent or Subsidiary (applying the rules of Section 425(d) of the Code to determine such stock ownership and treating the shares of Stock that the employee may purchase under outstanding options under this or any other plan of the Company or any Parent or Subsidiary as owned by the employee), shall be eligible to receive options under this Section 9 for a given Purchase Period. Subject to the provisions of Section 9(d), an employee will continue to be eligible to receive options under this Section 9 so long as he or she remains eligible as defined herein. (b) GRANT OF OPTION. Each eligible employee who elects to participate is granted an option as of the first business day of the Purchase Period to purchase on the last business day of the Purchase Period that number of whole shares of Stock as could be purchased at a price equal to the price specified in Section 9(c) with the entire credit balance in the Participant's Stock Purchase Account (as defined) on such date; provided, however, that no right will be deemed to be granted or received hereunder which would permit a Participant to purchase Stock under this Plan and under all other stock purchase plans, if any, of the Company at a rate which exceeds $25,000 in Fair Market Value of Stock (determined as of the date the option is granted) for each calendar year. (c) PURCHASE PRICE. The purchase price will be the lesser of (i) 85% of the Fair Market Value (as defined in Section 1(l) hereof) of the Stock on the first business day of the Purchase Period or (ii) 85% of the Fair Market Value (as defined in Section 1(l) hereof) of the Stock on the last business day of the Purchase Period, in each case rounded up to the next higher full cent. (d) ELECTION TO PARTICIPATE. An eligible employee may elect to participate in the Plan for a given Purchase Period by filing with the Committee or a person designated 13 by the Committee on or before the 30th day following commencement of that Purchase Period an appropriate document authorizing regular payroll deductions from Current Compensation (as defined herein) beginning with the first payday in the Purchase Period and continuing through the last payday in the Purchase Period or until the employee withdraws from the Plan or ceases to be eligible to participate in the Plan. (e) METHOD OF PAYMENT. A Participant may elect payroll deductions of any whole percentage from 2% through 10% of Current Compensation. During the Purchase Period, the Participant may not reduce or increase his payroll deductions. However, the Participant may cease making payroll deductions at any time by providing written notice to the Committee. Payroll deductions will be credited to a separate bookkeeping account established by the Company for each Participant (the "Stock Purchase Account") on each payday. Payroll deductions will not earn interest. The Stock Purchase Account is established solely for bookkeeping purposes, and all amounts credited to the Stock Purchase Account will remain part of the general assets of the Company. A Participant may not make any separate cash payment into his Stock Purchase Account. (f) PURCHASE OF STOCK. On the last business day of the Purchase Period, the entire credit balance in each Participant's Stock Purchase Account will be used to purchase the largest number of whole shares of Stock purchasable with such amount unless, prior to such date, the Participant elects to purchase a specified number of whole shares of Stock which is less than the number described above or elects to receive the entire credit balance in cash. Any amount remaining in a Participant's Stock Purchase Account after such purchase (or the entire credit balance thereof if the Participant elects not to purchase any Stock) will be paid to the Participant in cash within 30 days after the end of the Purchase Period. As soon as practicable after each Purchase Period, the Company will cause to be delivered to the Participant a certificate representing the Stock purchased. The Company will not be required to issue or deliver any certificate representing Stock purchased hereunder prior to registration under the Securities Act of 1933, as amended, or registration or qualification under any state law if such registration or qualification is required. (g) TERMINATION OF EMPLOYMENT. Upon termination of employment for any reason other than death, retirement or sale of a portion or all of the Company's business, the Company will pay to the Participant in cash within thirty (30) days the entire credit balance in the Participant's Stock Purchase Account. Upon termination as a result of a sale of all or a portion of the Company's business, if so determined by the Board, in its sole discretion, the Participant may, within thirty (30) days after such termination, elect to purchase some or all of the shares of Stock he could have purchased with the balance in his Stock Purchase Account as of the date of 14 termination. The purchase price for any shares so purchased shall be the price described in Section 9(c)(i) hereof. If such election is not made, the Company will pay to the Participant in cash within sixty (60) days of the termination, the entire balance remaining in the Participant's Stock Purchase Account. Upon termination due to death or retirement, the Participant or his estate may, within 180 days after such termination (60 days after termination in the case of retirement), elect to purchase some or all of the shares of Stock he could have purchased with the balance in his Stock Purchase Account as of the date of termination. The purchase price for any shares so purchased shall be the price described in Section 9(c)(i) hereof. If such election is not made, the Company will pay to the Participant or his estate in cash within thirty (30) days of the failure to elect, the entire balance remaining in the Participant's Stock Purchase Account. For purposes of this Plan, an approved leave of absence or temporary layoff will not be deemed a termination of employment. (h) NONTRANSFERABILITY. An option granted pursuant to this Section 9 shall not be transferable by the optionee otherwise than by will or the laws of descent and distribution and shall be exercisable, during the optionee's lifetime, only by the optionee. The amounts credited to a Stock Purchase Account may not be assigned, transferred, pledged, or hypothecated in any way, and any attempted assignment, transfer, pledge, hypothecation, or other disposition of such amounts will be null and void and without effect. (i) NO RIGHTS AS SHAREHOLDER. An employee will have no interest in the Stock purchased until full payment has been made and a share certificate representing the same has been issued. (j) DEFINITIONS. For purposes of this Section 9, the following terms have the meanings set forth below: (i) "CURRENT COMPENSATION" means the basic gross cash compensation (wage, salary, and sales incentives, including bonuses and commissions) paid by the Company or any Parent or Subsidiary to a Participant in accordance with the terms of employment, but excluding all overtime earnings, bonus payments, severance pay, and all other forms of compensation, and all remuneration which is not a term of the employment relationship (whether or not paid pursuant to a voluntary plan established by the Company or any Parent or Subsidiary). (ii) "PURCHASE PERIOD" means the 12-month period beginning on April 1 of each year. 15 SECTION 10. OTHER STOCK-BASED AWARDS (a) ADMINISTRATION. Other Awards of Stock and other Awards that are valued in whole or in part by reference to, or are otherwise based on, Stock ("Other Stock-Based Awards"), including, without limitation, performance shares, convertible preferred stock, convertible debentures, or exchangeable securities, may be granted either alone or in addition to or in tandem with Stock Options, Stock Appreciation Rights, Restricted Stock, Deferred Stock, or Stock Purchase Rights granted under the Plan. Subject to the provisions of the Plan, the Committee shall have authority to determine the persons to whom and the time or times at which such Awards shall be made, the number of shares of Stock to be awarded pursuant to such Awards, and all other conditions of the Awards. The Committee may also provide for the grant of Stock upon the completion of a specified performance period. The provisions of Other Stock-Based Awards need not be the same with respect to each recipient. (b) TERMS AND CONDITIONS. Unless otherwise provided in the related Award Agreement, Stock subject to Awards made under this Section 10 may not be sold, assigned, transferred, pledged, or otherwise encumbered prior to the date on which the Stock is issued or, if later, the date on which any applicable restriction, performance, or deferral period lapses. The Participant shall be entitled to receive, currently or on a deferred basis, interest or dividends or interest or dividend equivalents with respect to the Stock covered by the Award, as determined at the time of the Award by the Committee, in its sole discretion, and the Committee may provide that such amounts (if any) shall be deemed to have been reinvested in additional Stock or otherwise reinvested. Any Award under Section 10 and any Stock covered by any such Award shall vest or be forfeited to the extent so provided in the Award Agreement, as determined by the Committee, in its sole discretion. In the event of the Participant's retirement, Disability, or death, or in cases of special circumstances, the Committee may, in its sole discretion, waive in whole or in part any or all of the remaining limitations imposed with respect to any or all of an Award under this Section 10. Each Award under this Section 10 shall be confirmed by, and subject to the terms of, an Award Agreement or other instrument entered into by the Company and the Participant. Stock (including securities convertible into Stock) issued on a bonus basis under this Section 10 may be issued for no cash consideration. The purchase price of any Stock (including securities convertible into Stock) subject to a purchase right awarded under 16 this Section 10 shall be at least 85% of the Fair Market Value of the Stock on the date of grant. SECTION 11. CHANGE IN CONTROL PROVISIONS (a) IMPACT OF EVENT. In the event of a "Change in Control" as defined in Section 11(b), the following provisions shall apply: (i) Any Award, if so provided in the related Award Agreement, shall become fully exercisable and vested. (ii) The value of all outstanding Awards shall, unless otherwise determined by the Committee in its sole discretion at or after grant but prior to any Change in Control, be cashed out on the basis of the "Change in Control Price" as defined in Section 11(c) as of the date such Change in Control is determined to have occurred or such other date as the Committee may determine prior to the Change in Control. (b) DEFINITION OF "CHANGE IN CONTROL". For purposes of Section 11(a), a "Change in Control" means the happening of any of the following: (i) When any "person" as defined in Section 3(a)(9) of the Exchange Act and as used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) of the Exchange Act, but excluding the Company or any Subsidiary or Parent or any employee benefit plan sponsored or maintained by the Company or any Subsidiary or Parent (including any trustee of such plan acting as trustee), directly or indirectly, becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act, as amended from time to time), of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities; (ii) When, during any period of 24 consecutive months during the existence of the Plan, the individuals who, at the beginning of such period, constitute the Board (the "Incumbent Directors") cease for any reason other than death to constitute at least a majority thereof; provided, however, that a director who was not a director at the beginning of such 24-month period shall be deemed to have satisfied such 24-month requirement (and be an Incumbent Director) if such director was elected by, or on the recommendation of, or with the approval of, at least 60% of the directors who then qualified as Incumbent Directors either actually (because they were directors at the beginning of such 24-month period) or by prior operation of this Section 11(b)(ii); or (iii) The approval by the shareholders of an acquisition of the Company by an entity other than the Company or a Subsidiary or Parent through purchase of assets, or by merger, or otherwise. 17 (c) CHANGE IN CONTROL PRICE. For purposes of this Section 11, "Change in Control Price" means the highest price per share paid in any transaction reported on any market on which the Company's Stock is traded or paid or offered in any bona fide transaction related to the Change in Control of the Company at any time during the 60-day period immediately preceding the occurrence of the Change in Control, except that, in the case of Incentive Stock Options and Stock Appreciation Rights relating to Incentive Stock Options, such price shall be based only on transactions reported for the date on which the optionee exercises such Stock Appreciation Rights or, where applicable, the date on which a cashout occurs under Section 11(a)(ii). SECTION 12. AMENDMENTS AND TERMINATION The Board may amend, alter, discontinue, or terminate the Plan, or any portion thereof, but no amendment, alteration, or discontinuation shall be made which would impair the vested rights of a Participant under any Award theretofore granted, without the Participant's consent, or which, without the approval of the Company's stockholders, would: (a) except as expressly provided in this Plan, increase the total number of shares reserved for the purpose of the Plan; (b) authorize an increase in the total number of shares reserved for issuance upon exercise of Incentive Stock Options; (c) decrease the option price of any Incentive Stock Option to less than 100% of the Fair Market Value on the date of grant or change the pricing terms of Section 9(c); (d) increase the rate of payroll deductions under Section 9 to more than 15% of Current Compensation; (e) permit the issuance of Stock prior to payment in full therefor; (f) change the employees or class of employees eligible to participate in the Plan; or (g) extend the maximum option period under Section 5(i) of the Plan or extend a Participant's right to purchase Stock pursuant to the grant of an option under Section 9 hereof to a date more than five years from the date of such grant. The Committee may amend the terms of any Award theretofore granted, prospectively or retroactively, but, subject to Section 3 above, no such amendment shall impair the vested rights of any holder without the holder's consent. The Committee may also substitute new Stock Options for previously granted Stock Options (on a one-for-one or other basis), including previously granted Stock Options having higher option exercise prices. 18 Subject to the above provisions, the Board shall have broad authority to amend the Plan to take into account changes in applicable securities and tax laws and accounting rules, as well as other developments. SECTION 13. UNFUNDED STATUS OF PLAN The Plan is intended to constitute an "unfunded" plan for incentive and deferred compensation. With respect to any payments not yet made to a Participant by the Company, nothing contained herein shall give any such Participant any rights that are greater than those of a general creditor of the Company. In its sole discretion, the Committee may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver Stock or payments in lieu of or with respect to Awards hereunder; provided, however, that, unless the Committee otherwise determines with the consent of the affected Participant, the existence of such trusts or other arrangements is consistent with the "unfunded" status of the Plan. SECTION 14. GENERAL PROVISIONS (a) The Committee may require each person purchasing shares pursuant to a Stock Option or receiving shares pursuant to any other Award under the Plan to represent to and agree with the Company in writing that the Participant is acquiring the shares without a view to distribution thereof. The certificates for such shares may include any legend which the Committee deems appropriate to reflect any restrictions on transfer. All certificates for shares of Stock or other securities delivered under the Plan shall be subject to such stop transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations, and other requirements of the Securities and Exchange Commission, any over-the-counter market on which the Stock is quoted, any stock exchange upon which the Stock is then listed, and any applicable federal or state securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. (b) The Committee may at any time offer to buy out for a payment in cash, Stock, Deferred Stock, or Restricted Stock an Award previously granted, based on such terms and conditions as the Committee shall establish and communicate to the Participant at the time that such offer is made. (c) Nothing contained in this Plan shall prevent the Board from adopting other or additional compensation arrangements, subject to shareholder approval if such approval is required; and such arrangements may be either generally applicable or applicable only in specific cases. (d) Neither the adoption of the Plan nor the grant of any Award hereunder shall confer upon any employee of the Company or any Subsidiary, Parent, or Affiliate any right to continued employment with the Company or a Subsidiary, Parent, or 19 Affiliate, as the case may be, or interfere in any way with the right of the Company or a Subsidiary, Parent, or Affiliate to terminate the employment of any of its employees at any time. (e) No later than the date as of which an amount first becomes includible in the gross income of the Participant for federal income tax purposes with respect to any Award under the Plan, the Participant shall pay to the Company, or make arrangements satisfactory to the Committee regarding the payment of, any federal, state, or local taxes of any kind required by law to be withheld with respect to such amount. The obligations of the Company under the Plan shall be conditional on such payment or arrangements, and the Company and any Subsidiary, Parent, or Affiliate shall, to the extent permitted by law, have the right to deduct any such taxes from any payment of any kind otherwise due to the Participant. Unless otherwise determined by the Committee, withholding obligations may be settled with Stock, including Stock that is part of the Award that gives rise to the withholding requirement. (f) The actual or deemed reinvestment of dividends or dividend equivalents in additional Restricted Stock (or in Deferred Stock or other types of Plan Awards) at the time of any dividend payment shall only be permissible if sufficient shares of Stock are available under Section 3 for such reinvestment (taking into account then outstanding Stock Options, Stock Purchase Rights, and other Plan Awards). (g) To the extent that federal laws (such as the Code, the Exchange Act, or the Employee Retirement Income Security Act of 1974) do not otherwise control, this Plan and all Awards made and actions taken hereunder shall be governed by and construed in accordance with the laws of the State of Minnesota. (h) Unless otherwise provided by the related Award Agreement, no rights granted hereunder may be assigned, transferred, pledged, or hypothecated (whether by operation or otherwise) or be subject to execution, attachment, or similar process, and any attempted assignment, transfer, pledge, hypothecation, or other disposition or levy of attachment or similar process upon any such right will be null and void and without effect. (i) If any term, provision, or portion of this Plan or any Award granted hereunder shall be deemed unenforceable or in violation of applicable law, such term, provision, or portion of the Plan or the Award shall be deemed severable from all other terms, provisions, or portions of this Plan or the Award or any other Awards granted hereunder, which shall otherwise continue in full force and effect. SECTION 15. EFFECTIVE DATE OF PLAN The Plan shall be effective as of April 3, 1989, subject to the approval of the Plan by a majority of the votes cast by the holders of the Company's Common Stock at the annual shareholders' meeting next following adoption of the Plan. Any grants made under the Plan prior 20 to such approval shall be effective when made (unless otherwise specified by the Committee at the time of grant), but shall be conditioned on, and subject to, such approval of the Plan by such shareholders. SECTION 16. TERM OF PLAN No Incentive Stock Option shall be granted pursuant to the Plan on or after the tenth anniversary of the date of adoption of the Plan, but Incentive Stock Options granted prior to such tenth anniversary may extend beyond that date. All other Awards may be granted at any time and for any period unless otherwise provided by the Plan. SECTION 17. APPLICABILITY TO GRANTS UNDER OTHER COMPANY PLANS Subject to shareholder approval of the Plan (in accordance with Section 15 above), no further options shall be granted under the 1981 Incentive Stock Option Plan and the 1984 Nonqualified Stock Option Plan, both of which shall remain in effect until all options granted pursuant thereto have been exercised or have expired or terminated by their terms. The share authorization provisions of the 1981 Incentive Stock Option Plan and the 1984 Nonqualified Stock Option Plan shall operate independently of Section 3 of the Plan. 21 EX-10.4 3 EXHIBIT 10.4 HEI, Inc. STOCK OPTION PLAN FOR NONEMPLOYEE DIRECTORS As Amended Effective May 11, 1994 and October 31, 1996 1. PURPOSE. This Stock Option Plan (the "Plan") for HEI, Inc., a Minnesota corporation (the "Company"), is intended to advance the interests of the Company by providing members of the Board of Directors, who are responsible for the direction of the Company, with additional incentive to promote the success of the business, to increase their proprietary interest in the success of the Company, and to attract, reward and retain them as directors of the Company. These goals will be effectuated through the granting of nonqualified options to purchase Common Stock of the Company. 2. DEFINITIONS. In addition to definitions that may be contained elsewhere herein, for purposes of this Plan, the following terms shall be defined as set forth below: (a) "Option Agreement" means any written agreement, contract, or other instrument or document evidencing any Option granted hereunder and signed by both the Company and the Participant. (b) "Board" means the Board of Directors of the Company. (c) "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. (d) "Committee" means the Committee referred to in Section 3 of the Plan. (e) "Disability" means disability as determined under procedures established by the Board for purposes of this Plan or as defined in Section 22(e)(3) of the Code. (f) [DELETED] (g) "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time. (h) "Fair Market Value" means as of any given date, unless otherwise determined by the Committee in good faith, the average for the preceding five business days of the closing bid prices of the Stock as reported on the National Association of Securities Dealers, Inc. Automated Quotations System ("NASDAQ") or, if the Stock is then traded on the NASDAQ/National Market System ("NASDAQ/NMS") or on a national or regional securities exchange, the average for the preceding five business days of the closing pr ices of the Stock on NASDAQ/NMS or such exchange. (i) "Participant" means any person entitled to participate in this Plan as set forth in Section 4 hereof. (j) "Stock" means the Common Stock, $.05 par value per share, of the Company. (k) "Stock Option" or "Option" means any option to purchase shares of Stock granted pursuant to Section 5 below. 3. ADMINISTRATION. The Plan shall be administered by the Board, which, in its discretion, may delegate authority to a committee consisting of two or more directors appointed by the Board. The members of any such committee shall qualify as required under Rule 16b-3 of the Exchange Act, as it may be amended from time to time. Grants of Options under the Plan shall be made automatically as provided in Section 5. However, the Board shall have full authority to interpret the Plan, to promulgate such rules and regulations with respect to the Plan as it deems desirable and to make all other determinations necessary or appropriate for the administration of the Plan, and such determinations shall be final and binding upon all persons having an interest in the Plan. 4. ELIGIBILITY. Options will be granted only to persons who at the time of the grant are directors of the Company and who are not otherwise employees of the Company or any affiliate of the Company ("Nonemployee Director" or "Nonemployee Directors"). 5. OPTIONS. (a) ANNUAL GRANT. Each year, on the first business day following the annual meeting of the Company's shareholders (but in no event later than April 1 or the first business day thereafter), each person serving on such date as a Nonemployee Director of the Company shall be granted an Option to purchase Ten Thousand (10,000) shares of Stock, except as otherwise may be provided herein, each Option (a) shall be subject to all terms of the Plan, (b) shall be granted for a term of five years, and (c) shall vest and become fully exercisable on the earlier of the date of next annual meeting of the shareholders or the date one year from the date of grant; provided, in each instance, that the Participant has continuously served as a Nonemployee Director of the Company during such period or until the election of directors next following the date of grant, whichever shall first occur (and, if not, said Option shall be forfeited in its entirety). (b) EXERCISE PRICE. The exercise price per share of Stock purchasable under an Option shall be not less than 100% of the Fair Market Value of the Stock on the date of grant. (c) METHOD OF EXERCISE. Stock Options may be exercised in whole or in part at any time during the term of the Option. Payment of the exercise price shall be made by (i) cash or certified bank check, (ii) delivery of shares of Stock already owned by the Participant, or (iii) any combination of the foregoing. For purposes of this paragraph, shares of Stock that are delivered in payment of the exercise price shall be valued at their 2 Fair Market Value as of the date of the exercise of the Option. The Company's obligation to deliver shares upon the exercise of Options shall be subject to applicable federal, state, and local tax withholding requirements. Unless otherwise determined by the Board, withholding obligations may be settled with Stock, including Stock received as part of the exercise giving rise to the withholding requirement. (d) RESTRICTIONS ON TRANSFER OF OPTION. Unless otherwise provided in the related Option Agreement and approved in advance by the Board, each Option granted under this Plan shall be transferable only by will or the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act ("ERISA"), or the rules thereunder. Except as permitted by the preceding sentence, no Option granted under the Plan or any of the rights and privileges thereby conferred shall be transferred, assigned, pledged, or hypothecated in any way (whether by operation of law or otherwise), and no such Option, right, or privilege shall be subject to execution, attachment, or similar process. Unless otherwise provided in the related Option Agreement and approved in advance by the Board, an Option may be exercised during the Participant's lifetime only by the Participant or his or her guardian or legal representative. 6. SHARES OF STOCK SUBJECT TO THE PLAN. There shall be reserved and available for issuance upon the exercise of Options granted from time to time under the Plan an aggregate of 400,000 shares of Stock. Such shares may consist, in whole or in part, of authorized but unissued shares of Stock or issued shares that have been reacquired by the Company. If any shares subject to an Option are not issued because the Option is not exercised, such shares shall again be available for distribution in connection with future Options. In the event of any merger, reorganization, consolidation, recapitalization, Stock dividend, Stock split, or other change in corporate structure affecting the Stock, such substitution or adjustment shall be made in the aggregate number of shares reserved for issuance under the Plan and in the number and option price of shares subject to outstanding Options granted under the Plan as may be determined to be appropriate by the Board, in its sole discretion, provided that the number of shares subject to any Option shall always be a whole number. 7. DEATH OR DISABILITY OF PARTICIPANT. (a) TERMINATION BY DEATH. If a Participant's service to the Company terminates by reason of death, any Stock Option held by such Participant will immediately become fully exercisable and may thereafter be exercised by the legal representative of the Participant's estate or by any person who acquired the Option by will or the laws of descent and distribution for a period of one year from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (b) TERMINATION BY REASON OF DISABILITY. If a Participant's service to the Company terminates by reason of Disability, any Stock Option held by such Participant 3 shall immediately become fully exercisable and may thereafter be exercised by the Participant until the expiration of the stated term of such Stock Option; provided, however, that, if the Participant dies prior to the expiration of the Option, any unexercised Stock Option held by such Participant shall thereafter be exercisable to the extent to which it was exercisable at the time of death for a period of one year from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. 8. RESTRICTIONS ON TRANSFER OF STOCK. Unless a registration statement under the Securities Act of 1933 is in effect with respect to Stock to be purchased upon exercise of Options to be granted under the Plan, the Company may require that the Participant represent to and agree with the Company in writing that he or she is acquiring such shares of Stock for the purpose of investment and with no present intention to transfer, sell, or otherwise dispose of such shares of Stock. Further, in the absence of such registration, no shares of Stock acquired pursuant to exercise of an option may be transferred unless, in the opinion of counsel to the Company, such transfer is in compliance with applicable securities laws, and each certificate representing any shares of Stock issued to a Participant hereunder shall have endorsed thereon an appropriate legend referring to the restrictions against transfer. 9. AMENDMENT OF THE PLAN. The Board of Directors may suspend or terminate the Plan or any portion thereof at any time, and the Board of Directors may amend the Plan from time to time as may be deemed to be in the best interests of the Company; provided, however, that no such amendment, alteration or discontinuation shall be made (a) that would impair the rights of a Nonemployee Director with respect to Options theretofore awarded, without such person's consent, or (b) without the approval of the stockholders (i) if such approval is necessary to comply with any legal, tax, or regulatory requirement, including any approval requirement that is a prerequisite for exemptive relief from Section 16(b) of the Exchange Act; or (ii) to increase the maximum number of shares of Stock subject to this Plan, increase the maximum number of shares issuable to any Nonemployee Director under this Plan, or change the definition of persons eligible to receive Options under this Plan. 10. APPLICABILITY OF PLAN TO OUTSTANDING STOCK OPTIONS. This Plan shall not affect the terms and conditions of any stock options currently outstanding to any director of the Company, nor shall it affect any of the rights of any director to whom such a stock option was granted. 11. EFFECTIVE DATE OF PLAN. This Plan shall become effective upon the date of its adoption by the Board of Directors of the Company, subject to approval of the shareholders of the Company at the 1992 annual meeting. 12. CHANGE IN CONTROL PROVISIONS. (a) IMPACT OF EVENT. In the event of a "Change in Control" as defined in Section 12(b), the following provisions shall apply: (i) All Options granted hereunder shall become fully exercisable and vested. 4 (ii) At the option of the holder thereof, the value of any outstanding Option shall be cashed out on the basis of the "Change in Control Price" as defined in Section 12(c) as of the date such Change in Control is determined to have occurred or such other date as the Committee may determine prior to the Change in Control. (b) DEFINITION OF "CHANGE IN CONTROL." For purposes of Section 12(a), a "Change in Control" means the happening of any of the following: (i) When any "person" as defined in Section 3(a)(9) of the Exchange Act and as used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) of the Exchange Act, but excluding the Company or any subsidiary or parent or any employee benefit plan sponsored or maintained by the Company or any subsidiary or parent (including any trustee of such plan acting as trustee), directly or indirectly, becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act, as amended from time to time), of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities; (ii) When, during any period of 24 consecutive months during the existence of the Plan, the individuals who, at the beginning of such period, constitute the Board (the "Incumbent Directors") cease for any reason other than death to constitute at least a majority thereof; provided, however, that a director who was not a director at the beginning of such 24-month period shall be deemed to have satisfied such 24-month requirement (and be an Incumbent Director) if such director was elected by, or on the recommendation of, or with the approval of, at least 60% of the directors who then qualified as Incumbent Directors either actually (because they were directors at the beginning of such 24-month period) or by prior operation of this Section 12(b)(ii); or (iii) The approval by the shareholders of an acquisition of the Company by an entity other than the Company or a subsidiary or parent through purchase of assets, or by merger, or otherwise. (c) CHANGE IN CONTROL PRICE. For purposes of this Section 12, "Change in Control Price" means the highest price per share paid in any transaction reported on any market on which the Company's Stock is traded or paid or offered in any bona fide transaction related to the Change in Control of the Company at any time during the 60-day period immediately preceding the occurrence of the Change in Control. 13. NONEXCLUSIVITY OF THE PLAN. The adoption of this Plan shall not be construed as limiting the power of the Board of Directors to adopt such other incentive arrangements as it may deem desirable, including, without limitation, the granting of stock options otherwise than under this Plan, and such arrangements may be either generally applicable or applicable only in specific cases. 5 14. MISCELLANEOUS. (a) GOVERNING LAW. This Plan shall be governed by and construed in accordance with the laws of the State of Minnesota, and all terms shall be interpreted and construed so that there shall not be committed any violation of applicable state or federal securities laws. (b) NO ADDITIONAL RIGHTS OF SERVICE. Participation in or eligibility for participation in the Plan does not grant any person any right of service as a director, and the Company retains the right to terminate service of any director pursuant to the Company's Articles, Bylaws, and applicable law. --------------------------------------- APPROVED and adopted by the Board of Directors of HEI, lnc. on November 15, 1991 and amended effective May 11, 1994, and October 31, 1996. 6 EX-13 4 EXHIBIT 13 HEI, INC. FIVE YEAR SUMMARY OF SELECTED FINANCIAL INFORMATION (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED AUGUST 31 1996 1995 1994 1993 1992 Net sales $20,680 $23,423 $17,295 $18,893 $14,138 Cost of sales 14,957 17,263 12,497 12,174 9,491 Gross profit 5,723 6,160 4,798 6,719 4,647 - --------------------------------------------------------------------------------------------------- Operating expenses: Selling, general and administrative 2,342 2,401 2,094 2,130 1,963 Research, development and engineering 849 754 679 614 565 Gain on sale of product line, net (45) Operating income 2,577 3,005 2,025 3,975 2,119 - --------------------------------------------------------------------------------------------------- Income before income taxes 2,833 3,250 2,102 3,997 2,012 Income taxes 720 1,210 777 1,459 150 Net income $ 2,113 $ 2,040 $ 1,325 $ 2,538 $ 1,862 - --------------------------------------------------------------------------------------------------- Net income per common share $.52 $.52 $.34 $.66 $.57 - --------------------------------------------------------------------------------------------------- Weighted average number of common and common equivalent shares 4,098 3,899 3,858 3,822 3,285 - --------------------------------------------------------------------------------------------------- Balance sheet: Working capital $10,088 $ 8,380 $ 5,927 $ 4,211 $ 2,147 Total assets 22,414 12,857 10,905 8,564 5,850 Long-term debt, less current maturities 5,271 308 Shareholders' equity 13,816 10,982 8,671 6,762 3,635 - ---------------------------------------------------------------------------------------------------
PHOTOGRAPH 1 TO OUR SHAREHOLDERS Fiscal year 1996 was a building year for HEI - establishing a foundation for future growth. Having nearly reached the limits of our Victoria, Minnesota plant capacity in fiscal 1995, we undertook a major construction and capacity expansion program throughout the past year. Manufacturing floor space was more than doubled by a 23,000 square foot building addition featuring designed-in flexibility to accommodate production line layout changes, and extensive environmental controls critical to the maintenance of our precision and quality standards. In addition, we installed over $2 million of new continuous flow processing equipment and expanded our technical support staff accordingly. As one result, HEI's capabilities have been enhanced to include a greater variety of ultraminiature microelectronic packaging solutions - ceramic, flexible circuit and laminate - to better satisfy our customers' requirements. We closed the year on the upswing; revenue for the fourth quarter of fiscal 1996 was $6,397,000, setting a company record and comparing favorably to revenue of $5,418,000 for the fourth quarter of the previous year. Net income for the fourth quarter of fiscal 1996 was $1,329,000, or $.32 per share. Of the $.32 recorded, $.07 was due to a one-time favorable adjustment in a deferred tax item. Net income for the fourth quarter of fiscal 1995 was $314,000, or $.08 per share. Revenue For the 1996 fiscal year was $20,680,000, compared to $23,423,000 for fiscal 1995. Net income for fiscal 1996 was $2,113,000, or $.52 per share, compared to net income of $2,040,000, or $.52 per share for fiscal 1995. Fourth quarter performance reflected the beginning of higher volume production on a previously announced program to manufacture microelectronic devices for high density disk drives. We were pleased to see volumes on this program increase, and are aggressively pursuing improved production efficiencies to meet the significantly lower cost objectives required when the program reaches full volume pricing. We do not expect the fourth quarter's higher gross margin rates to continue throughout fiscal year 1997. At present, we anticipate this program reaching full volume production sometime during the first or second quarter of fiscal 1997. As we have seen in the past, these relatively large and dynamic programs can increase the volatility of our quarter-to quarter performance. The phase- out of one such program resulted in a downturn in fourth quarter results for fiscal 1995, and had a continuing negative impact on the first three quarters of fiscal 1996. During that period, however, we were gratified by the substantial growth of shipments to the hearing and medical instrument markets, reflecting previous efforts targeting these sectors. It is strategically important that we continue to keep these segments of our business in balance with the more volatile and unpredictable computer portion. On August 29, 1996, we announced the sale of our FastPoint-Registered Trademark- Light Pen product line. This product, while a good application of HEI's technology, represented a relatively small and divergent part of our overall business, and we anticipate no substantial effect of the sale on our ongoing performance. We believe that it is increasingly important and potentially rewarding to focus all our energies and resources on the growth opportunities in HEI's mainstream business - the design and manufacture of custom microelectronic devices for selected niche markets. We have continued to strengthen our financial position. The recent facility expansion, and certain of the manufacturing process equipment to be housed therein, have been financed through the issuance of $5.6 million of Industrial Development Revenue Bonds by the City of Victoria. As of August 31, 1996, we had $2,455,000 of unexpended proceeds from these bonds, which have a maturity of seven to fifteen years. HEI's shareholders' equity was $13,816,000 at August 31, 1996, up $2,834,000 from the end of the previous fiscal year. 2 1997 PLANS Major objectives for 1997 will be growth and productivity improvements as enabled by the augmentation of our manufacturing capabilities and the expansion of our base of business - to enhance the stability of our future performance. The facility addition is expected to help alleviate customer concerns related to our size and open the door for new opportunities. We will continue to focus on target applications in the computer, industrial, medical and hearing instrumentation markets, and continue efforts to strengthen and expand a balanced base of accounts for long-term growth. As before, we will pursue goals of quality and productivity improvement. We know that growth brings with it change and challenge, and we expect the ISO 9001 quality standard and our internal quality programs to continue to serve us well, providing a foundation for these and future improvements. [PHOTOGRAPH] With strong financial position, we expect to be well positioned to deal with the potential uncertainties of our markets, and to be able to finance the growth and expansion opportunities available to us in fiscal 1997. A foundation of talented employees and loyal customers provides the basis for our growth and continuous improvement. We expect that the recent facility and equipment additions will enhance our ability to compete profitably on larger contracts, and we look forward to the challenges of 1997 and beyond with enthusiasm and optimism. Eugene W. Courtney PRESIDENT AND CHIEF EXECUTIVE OFFICER 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 INVOLVING 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; 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. 3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION The Company's net cash flow provided by operating activities for the year ended August 31, 1996, was $2,316,000. The significant components of this operating net cash flow were positive cash flow of $2,884,000 from operations before changes in current operating items offset by a $1,539,000 increase in accounts receivable. The increase in accounts receivable is attributable primarily to higher shipment volumes in the fourth quarter of 1996 compared to the fourth quarter of 1995. Accounts receivable average days outstanding were 41 days as of August 31, 1996 compared to 42 days for the same period a year ago. Inventory turns were 7.7 turns as of August 31, 1996 compared to 7.5 turns for the same period a year ago. The inventory turn increase is primarily due to higher shipments in the fourth quarter of fiscal 1996 and lower inventory levels at August 31, 1996. In addition to purchasing $2,464,000 of fixtures and equipment and completing a building addition of $2,377,000, the Company increased short-term investments, primarily in treasury bills, to $5,488,000, up $1,668,000 from a year ago. The current ratio at the end of 1996 was 4.4:1 as compared to 6.2:1 at the end of last year. The lower current ratio is principally due to over $2 million of internally generated funds invested in the Company's plant expansion and to the increase in current liabilities including current portion of long- term debt and increased accounts payable, accrued liabilities and income taxes payable. In April 1996, the Company completed a new financing agreement which provides for a $3,000,000 revolving line of credit. As of August 31, 1996, there were no borrowings under the line. Borrowings under this agreement would be collateralized by accounts receivable. The agreement contains certain restrictive covenants including limitations on other borrowings and maintenance of specified financial levels and ratios for net income, tangible net worth and debt to tangible net worth. Borrowings are limited to the lesser of $3,000,000 or the borrowing base, which is 80% of eligible accounts receivable. Interest on the borrowings is based, at the Company's option, on the lender's prime rate of interest or 2% above the lender's LIBOR rate. During fiscal 1996, the Company purchased $4,841,000 of property and equipment, including a facility addition, manufacturing facility improvements and capital equipment. These additions will increase manufacturing capacity to meet anticipated requirements for continued revenue growth. These expenditures were funded primarily through the issuance of Industrial Development Revenue Bonds of $5,625,000, which was completed in April 1996. Restricted cash of $2,455,000 at August 31, 1996 represents the unexpended funds from the bonds which are available to the Company for qualifying capital expenditures during the next three years. During fiscal 1997, the Company intends to expend approximately $1.8 million for manufacturing facility improvements and capital equipment. These additions will increase manufacturing capacity to meet anticipated requirements for continued revenue growth. It is expected that these expenditures will be funded primarily through long-term financing. RESULTS OF OPERATIONS SALES BY PRODUCT LINE (IN THOUSANDS) 1996 1995 1994 Microelectronics $18,545 $21,187 $14,888 Peripheral products 2,060 2,157 2,334 Other 75 79 73 Total $20,680 $23,423 $17,295 - -------------------------------------------------------------- SALES. 1996 VS. 1995: Sales in 1996 decreased $2,743,000 or 12% from fiscal 1995. Sales of microelectronic circuits, which include opto-electronic circuits, decreased 12% from $21.2 million to $18.5 million. This decrease was primarily due to reduced shipments to the high density disk drive market as two large programs were completed in late 1995 and early 1996 and was partially offset by the ramp up in the late second half of fiscal 1996 of shipments to another computer disk drive manufacturer. Shipments to the hearing aid and other medical markets more than doubled over fiscal year 1995 as a result of increased demand by current customers and shipments to new accounts. Because the Company's sales to the computer disk drive market are generally tied to the customers' projected sales and production of the related product, the Company's sales levels are subject to fluctuations outside the Company's control. To the extent that sales to any one customer represent a significant portion of the Company's sales, any change in the level of sales to that customer can have a significant impact on the Company's total revenues. In addition, 4 production for one customer may conclude while production for a new customer has not yet begun or is not yet at full volume. These factors may result in significant fluctuations in sales from quarter to quarter. Shipments of peripheral products, primarily light pens, decreased 4% from fiscal 1995. The light pen product line was sold to FTG Data Systems in August 1996. 1995 VS. 1994: Sales in 1995 increased 35% from fiscal 1994, from $17.3 million to $23.4 million. Sales of microelectronic circuits increased 42% from the prior year from $14.9 million to $21.2 million. This increase was primarily due to increased shipments in 1995 of microelectronic devices to the computer disk drive market, primarily to the IBM Corporation and another disk drive manufacturer. PERCENTAGE OF SALES 1996 1995 1994 Sales 100% 100% 100% Gross profit 28% 26% 28% Selling, general and administrative 11% 10% 12% Research, development and engineering 4% 3% 4% GROSS PROFIT. 1996 VS. 1995: The Company's gross profit as a percentage of sales was 28% in 1996, compared to 26% in 1995. The increased gross profit rate reflects primarily the impact of a higher number of products built utilizing customer supplied materials. While the gross margin rate for fourth quarter fiscal 1996 was 36%, the Company does not expect that rate to continue throughout fiscal 1997. 1995 VS. 1994: The Company's gross profit as a percentage of sales was 26% in 1995, compared to 28% in 1994. The reduced gross profit rate reflected primarily the impact of increased competitive pressures to lower prices on new programs. OPERATING EXPENSES. 1996 VS. 1995: Fiscal year 1996 selling, general and administrative expenses decreased 2% from 1995 and research, development and engineering expenses increased 13%. The decrease in selling, general and administrative expense was primarily due to a reduction in bad debt expense in 1996. The increase in research, development and engineering was primarily in support of increased product development for new disk drive, hearing aid and medical products. As a percentage of sales, selling, general and administrative expenses for fiscal 1996 increased to 11% versus 10% for fiscal 1995 reflecting decreased sales. The $45,000 net gain on sale of product line represents the gain on the sale of the light pen product line to FTG Data Systems, which was completed in August 1996, partially offset by costs to close down the light pen product line (see Note 3). 1995 VS. 1994: Fiscal year 1995 selling, general and administrative expenses increased 15% and research, development and engineering expenses increased 11% from the prior year. Both increases were in support of increased product development and production. As a percentage of sales, selling, general and administrative expenses for fiscal 1995 decreased to 10% versus 12% for fiscal 1994 reflecting increased sales. OTHER INCOME. 1996 VS. 1995: Other income increased $11,000 over fiscal year 1995 primarily due to increased interest income from higher short-term investment balances, partially offset by interest expense on the IDRB. 1995 VS. 1994: Other income increased $168,000 primarily due to increased interest income. NET INCOME. 1996 VS. 1995: The Company had net income of $2,113,000 for 1996 compared to net income of $2,040,000 for 1995. Operating income of $2,577,000 was down $428,000 from 1995 reflecting a revenue decrease of $2,743,000. The increase in net income was primarily due to lower income tax expense. The valuation allowance for the deferred tax asset of $274,000 was eliminated in the fourth quarter of 1996 as a result of the sale and disposal of the light pen inventory and the determination that the deferred tax assets related to the remaining inventory allowance will most likely be recoverable. The elimination of the remaining deferred tax asset valuation allowance resulted in a reduced effective tax rate in fiscal 1996. The effective tax rate for fiscal 1996 was 25% versus 37% for 1995. 1995 VS. 1994: The Company had net income of $2,040,000 for 1995 compared to net income of $1,325,000 for 1994. This increase was due to a sales increase of 35%, partially offset by a reduced gross profit rate of 26% in fiscal 1995 compared to 28% in fiscal 1994, and an operating expense increase of $382,000. 5 HEI, INC. BALANCE SHEET (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
AS OF AUGUST 31 1996 1995 ASSETS Current assets: Cash and cash equivalents $ 1,186 $ 1,438 Short-term investments 5,488 3,820 6,674 5,258 Accounts receivable, net 4,039 2,525 Inventories 1,561 1,851 Other, principally deferred tax assets 764 349 Total current assets 13,038 9,983 - ------------------------------------------------------------------------------------- Property and equipment: Land 216 184 Building and improvements 3,767 1,398 Fixtures and equipment 7,667 5,475 Accumulated depreciation (4,868) (4,183) Net property and equipment 6,782 2,874 Restricted cash 2,455 Deferred financing costs 139 Total assets $22,414 $12,857 - ------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 354 Accounts payable 673 $ 385 Accrued liabilities 1,354 1,043 Income taxes payable 569 175 Total current liabilities 2,950 1,603 - ------------------------------------------------------------------------------------- Long-term debt 5,271 Deferred tax liability 377 272 Shareholders' equity: Undesignated stock; 5,000,000 shares authorized, none issued Common stock, $.05 par; 10,000,000 shares authorized; 4,030,427 and 3,791,597 shares issued and outstanding 202 190 Paid-in capital 6,892 6,183 Retained earnings 6,722 4,609 Total shareholders' equity 13,816 10,982 Total liabilities and shareholders' equity $22,414 $12,857 - -------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS. 6 HEI, INC. STATEMENT OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) YEARS ENDED AUGUST 31 1996 1995 1994 Net sales $20,680 $23,423 $17,295 Cost of sales 14,957 17,263 12,497 Gross profit 5,723 6,160 4,798 - -------------------------------------------------------------------------------- Operating expenses: Selling, general and administrative 2,342 2,401 2,094 Research, development and engineering 849 754 679 Gain on sale of product line, net (45) Operating income 2,577 3,005 2,025 - -------------------------------------------------------------------------------- Other, principally interest income (256) (245) (77) Income before income taxes 2,833 3,250 2,102 - -------------------------------------------------------------------------------- Income taxes 720 1,210 777 Net income $2,113 $2,040 $1,325 - -------------------------------------------------------------------------------- Net income per common share $0.52 $0.52 $0.34 - -------------------------------------------------------------------------------- Weighted average number of common and common equivalent shares 4,097,765 3,898,662 3,857,737 - -------------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS. 7 HEI, INC. STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
COMMON STOCK COMMON STOCK PAID-IN RETAINED SHARES AMOUNT CAPITAL EARNINGS OUTSTANDING OUTSTANDING BALANCE, AUGUST 31, 1993 3,633,435 $182 $5,336 $1,244 Net income 1,325 Issuance of common shares under employee stock purchase and option plans 52,085 2 124 Tax benefit of nonqualified stock options 458 BALANCE, AUGUST 31, 1994 3,685,520 184 5,918 2,569 Net income 2,040 Issuance of common shares under employee stock purchase and option plans 106,077 6 215 Tax benefit of nonqualified stock options 50 BALANCE, AUGUST 31, 1995 3,791,597 190 6,183 4,609 Net income 2,113 Issuance of common shares under employee stock purchase and option plans 238,830 12 636 Tax benefit of nonqualified stock options 73 BALANCE, AUGUST 31, 1996 4,030,427 $202 $6,892 $6,722 - -----------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS. 8 HEI, INC. STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEARS ENDED AUGUST 31 1996 1995 1994 Cash flow provided by operating activities: Net income $2,113 $2,040 $1,325 Depreciation and amortization 938 759 640 Provision for doubtful accounts 25 141 150 Deferred income tax benefit (198) Other 6 3 4 Changes in current operating items: Accounts receivable (1,539) 755 (1,248) Inventories 290 (22) (739) Other current assets (112) 21 30 Accounts payable 88 (319) 140 Accrued liabilities 311 179 3 Income taxes payable 394 (191) 306 Net cash flow provided by operating activities 2,316 3,366 611 - ----------------------------------------------------------------------------------------------- Cash flow used for investing activities: Purchases of short-term investments (7,033) (6,910) (936) Maturities of short-term investments 5,365 3,808 1,044 Additions to property and equipment (4,621) (634) (825) Increase in restricted cash (2,455) Net cash flow used for investing activities (8,744) (3,736) (717) - ----------------------------------------------------------------------------------------------- Cash flow provided by financing activities: Proceeds from long-term debt 5,625 Increase in deferred financing costs (170) Principal payments for obligations under capital leases (42) (47) Issuance of common stock 648 221 126 Tax benefit of nonqualified stock options 73 50 458 Net cash flow provided by financing activities 6,176 229 537 - ----------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (252) (141) 431 Cash and cash equivalents, beginning of year 1,438 1,579 1,148 Cash and cash equivalents, end of year $1,186 $1,438 $1,579 - ----------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $ 80 $ 2 $ 6 Income taxes paid 515 1,351 429
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS. 9 NOTES TO FINANCIAL STATEMENTS NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES HEI, Inc. (the Company) specializes in the design and manufacture of ultraminiature microelectronic devices and high technology products incorporating those devices. CASH AND CASH EQUIVALENTS. 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. 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. The allowance for excess or obsolete stock is determined based on the Company's continuing analysis of inventory levels in excess of current requirements or considered to be obsolete. The Company has established an allowance to record such inventories at estimated net realizable value. 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. 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. 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 is the tax payable for the periods and the change during the period in deferred income tax assets and liabilities. REVENUE RECOGNITION. Revenue is recognized at the time of shipment. NET INCOME PER COMMON SHARE. Net income per common share is based on the weighted average number of common and common equivalent shares, assuming the exercise of stock options, when dilutive. USE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles 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 expenses during the reporting period. Actual results could differ from those estimates. NOTE 2 MAJOR CUSTOMERS, CONCENTRATION OF CREDIT RISK AND GEOGRAPHIC DATA Major customers, each of which accounted for more than 10% of the Company's total sales for the years ended August 31, were as follows: 1996 1995 1994 Customer A 38% 12% 19% Customer B 16% Customer C 10% Customer D 27% Customer E 30% 49% 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 is often dependent upon the continuance of the customers' product programs. The Company's ten largest customers accounted for approximately 88% of sales in 1996, 89% in 1995, and 86% in 1994 and approximately 90% and 87% of accounts receivable at August 31, 1996 and 1995, respectively. The Company had sales of $5,924,000 and $2,230,000 to Singapore in 1996 and 1994, respectively, and $2,493,000 to Hong Kong in 1995. Total export sales were $7,278,000, $4,995,000 and $2,749,000 in 1996, 1995 and 1994, respectively. 10 NOTE 3 OTHER FINANCIAL STATEMENT DATA The Company had $1,282,000 and $1,608,000 of cash and cash equivalents at August 31, 1996 and 1995, respectively, invested with an affiliate of a single banking institution. Short-term investments consist of U.S. Treasury bills with maturities of less than one year. The short-term investments are carried at amortized cost which approximates fair value. The following provides additional information concerning selected balance sheet accounts at August 31, 1996 and 1995: (DOLLARS IN THOUSANDS) 1996 1995 Accounts receivable, net: Trade accounts receivable $4,309 $2,793 Less allowance for doubtful accounts (270) (268) $4,039 $2,525 - -------------------------------------------------------------------- Inventories: Purchased parts $1,394 $1,670 Work in process 697 907 Finished goods 182 233 Less allowance for excess or obsolete stock (712) (959) $1,561 $1,851 - -------------------------------------------------------------------- Accrued liabilities: Vacation and employee benefits $500 $398 Payroll related 255 220 Real estate taxes 110 75 Warranty 100 Other 489 250 $1,354 $1,043 - -------------------------------------------------------------------- SALE OF LIGHT PEN PRODUCT LINE. In August 1996, the Company sold its light pen product line. Through this transaction, the buyer acquired certain assets including manufacturing equipment and related inventory, received product licenses and assumed all warranties. In connection with the sale, the Company received a cash payment for the assets and an agreement for an additional amount to be paid monthly over the next two years. As a result of the sale of the light pen product line, costs associated with the close down of the light pen product line have been accrued at August 31, 1996 and are included in the $45,000 net gain from the sale of the light pen product line. The Company anticipates no substantial effect of the sale on future operating results. NOTE 4 FINANCING ARRANGEMENTS 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 has been used for the construction of the new addition to the Company's manufacturing facility, and the remainder will be or has been 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 equipment require payments over seven years from the date of purchase of the equipment through no later than April 1, 2006. 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, 1996 was 3.95%. A revolving commitment fee is paid annually to the bank at a rate of 1% of the average daily unused revolving commitment. The agreement contains certain restrictive covenants including limitations on other borrowings and maintenance of specified financial levels and ratios for net income, tangible net worth, debt to tangible net worth, cash flow and indebtedness. The bonds are collateralized by two irrevocable letters of credit and essentially all property and equipment. Restricted cash on the balance sheet represents cash advanced under the bonds which is held by the bond trustee in an interest bearing account and will be released to the Company over the next three years for equipment purchases. To the extent such funds are not expended, they will revert back to the bond holders. Also in April 1996, the Company extended the due date of its $3,000,000 revolving line of credit to April 1998. At August 31, 1996 and 1995, there were no borrowings under the line of credit. Any borrowings under this agreement are collateralized by accounts receivable. The agreement contains certain restrictive covenants including limitations on other borrowings and maintenance of specified financial levels and ratios for net income, tangible net worth and debt to tangible net worth and cash flow. Borrowings are limited to the lesser of $3,000,000 or the borrowing base, which is 80% of eligible accounts receivable. Interest on the borrowings is based, at the Company's option, on the lender's prime rate of interest or at 2% above the lender's LIBOR rate. 11 NOTES TO FINANCIAL STATEMENTS (CONTINUED) Principal maturities of long-term debt, excluding the unexpended funds classified as restricted cash at August 31, 1996 are as follows (in thousands): Years ending August 31, 1997 $ 354 1998 359 1999 359 2000 358 2001 358 Thereafter 1,382 3,170 Restricted cash 2,455 $5,625 - ------------------------------------------------------------ NOTE 5 INCOME TAXES Income tax expense for the years ended August 31 consisted of the following: (DOLLARS IN THOUSANDS) 1996 1995 1994 Current: Federal $829 $1,106 $730 State 89 104 47 Deferred (198) Income tax expense $720 $1,210 $777 - ------------------------------------------------------------ The components of the deferred tax assets and liability at August 31, 1996 and 1995 are as follows: (DOLLARS IN THOUSANDS) 1996 1995 Deferred tax assets: Allowance for doubtful accounts $ 138 $ 99 Inventories 199 274 Accrued liabilities 162 101 Other 76 72 575 546 Valuation allowance (274) $ 575 $ 272 - ------------------------------------------------------------ Deferred tax liability: Depreciation $(377) $ (272) - ------------------------------------------------------------ Management has eliminated the valuation allowance for the deferred tax asset related to the allowance established for excess or obsolete inventories due to the sale and disposal of light pen inventories during the fourth quarter of fiscal 1996 and the determination that the deferred tax asset related to the remaining inventory allowance will most likely be recoverable. A reconciliation of the statutory federal income tax rate for the years ended August 31 is as follows: 1996 1995 1994 Federal statutory tax rate 34.0% 34.0% 34.0% State income tax rate (net of federal tax effect) 2.7 3.2 3.0 Reversal of valuation allowance (9.7) Other (1.6) Effective tax rate 25.4% 37.2% 37.0% - ------------------------------------------------------------ NOTE 6 STOCK BENEFIT PLANS 1989 PLAN. Under the Company's 1989 Omnibus Stock Compensation Plan (the "1989 Plan"), a maximum of 1,200,000 shares of common stock may be issued, including qualified and nonqualified stock options, stock purchase rights and other stock- based awards. Stock options granted become exercisable in varying increments and generally expire five years after date of grant. The exercise price for options granted is equal to the market price of the common stock on the date of grant. 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 1996, 1995 and 1994, 26,330, 22,077 and 12,235 shares at prices of $3.96, $3.95 and $4.74, respectively, were purchased under the 1989 Plan. 12 DIRECTORS' OPTIONS. In fiscal 1990, the Company granted to its directors (including officers who were also directors) options to purchase, in the aggregate, 227,500 shares of common stock at an average price of $1.34 per share. At August 31, 1996, all of these options have been exercised. DIRECTORS' PLAN. Under the plan, 400,000 shares are authorized for issuance, with an annual grant of 10,000 shares to each non-employee director. These grants are effective on the first business day following the annual shareholders' meeting at an exercise price equal to the fair market value on the date of grant. The options become exercisable one year after the grant date and expire five years after the grant date. Options to purchase 40,000 shares were granted each year to the four non-employee directors at $6.00 per share, $4.71 per share and $5.425 per share in 1996, 1995 and 1994, respectively. At August 31, 1996, options on 170,000 shares remain outstanding and options on 200,000 shares are available for grant. SUMMARY OF ACTIVITY. The following is a summary of all activity involving options for the years ended August 31: 1996 1995 1994 Outstanding, beginning of year 692,000 398,500 346,100 Granted 110,000 377,500 92,500 Exercised (212,500) (84,000) (39,850) Cancelled (250) Outstanding, end of year 589,500 692,000 398,500 - --------------------------------------------------------------------------- Exercisable, end of year 253,375 308,500 212,500 Available for grant 214,230 350,560 750,137 Exercise price of options outstanding $.725-$6.60 $.725-$6.60 $.725-$6.60 ACCOUNTING FOR STOCK-BASED COMPENSATION. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, a new standard of accounting and reporting for stock-based compensation plans. The Company is not required to adopt the new standard until fiscal 1997. The Company will continue to measure compensation cost, if any, for its stock option plans using the intrinsic value based method of accounting it has historically used. Therefore, the new standard will have no effect on the Company's operating results. The Company's financial statement disclosures will be expanded in fiscal 1997, as required, to include pro forma disclosures as if the fair value based method of accounting had been followed. RIGHTS PLAN. The Company's shareholder rights plan provides for a dividend distribution of one right for each share of common stock to shareholders of record at the close of business on June 10, 1988. With certain exceptions, the rights will become exercisable only in the event that an acquiring party accumulates 20% or more of the Company's voting stock or a party announces an offer to acquire 30% or more of the voting stock. The rights will expire on June 10, 1998, if not previously redeemed or exercised. Each right will entitle the holder to purchase one-fourth of one common share at a price of $6.00 per share, subject to adjustment under certain circumstances. In addition, upon the occurrence of certain events, holders of the rights will be entitled to purchase a defined number of shares of an acquiring entity or the Company's common stock at half its then current market value. The Company will generally be entitled to redeem the rights at $.05 per right at any time until the tenth day following the acquisition of 20% or more or an offer to acquire 30% or more of the Company's voting stock. NOTE 7 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 1996, 1995 and 1994, the Company contributed $96,000, $75,000 and $65,000, respectively, to the plan. 13 REPORT OF INDEPENDENT ACCOUNTANTS TO THE SHAREHOLDERS OF HEI, INC.: We have audited the accompanying balance sheet of HEI, Inc. as of August 31, 1996 and 1995, and the related statements of operations, changes in shareholders' equity, and cash flows for the years ended August 31, 1996, 1995 and 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 financial statements referred to above present fairly, in all material respects, the financial position of HEI, Inc. as of August 31, 1996 and 1995, and the results of its operations and its cash flows for the years ended August 31, 1996, 1995 and 1994, in conformity with generally accepted accounting principles. Minneapolis, Minnesota October 4, 1996 STATEMENT OF FINANCIAL RESPONSIBILITY The accompanying 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 financial statements have been prepared in accordance with generally accepted accounting principles 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 public accountants, as well as with management, to review accounting, auditing, and financial reporting matters. The Company's independent accountants, Coopers & Lybrand L.L.P., are engaged to audit the financial statements of the Company and to issue their report thereon. Their audit has been performed in accordance with generally accepted auditing standards. 14 SUMMARY OF QUARTERLY OPERATING RESULTS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) FISCAL YEAR 1996 FIRST SECOND THIRD FOURTH Net sales $4,710 $4,917 $4,656 $6,397 Gross profit 1,050 1,255 1,093 2,325 Operating income 267 482 284 1,544 Net income 224 342 218 1,329 - ---------------------------------------------------------------------------- Net income per share $.06 $.08 $.05 $.32 - ---------------------------------------------------------------------------- FISCAL YEAR 1995 FIRST SECOND THIRD FOURTH Net sales $5,947 $5,924 $6,134 $5,418 Gross profit 1,916 1,735 1,328 1,181 Operating income 1,081 952 526 446 Net income 710 652 364 314 - ---------------------------------------------------------------------------- Net income per share $.18 $.17 $.09 $.08 - ---------------------------------------------------------------------------- NOTE: The summation of quarterly net income per share on a primary basis for 1996 does not equate to the calculation for the year since the quarterly calculations are performed on a discrete basis. 15 CORPORATE INFORMATION HEI INC BOARD OF DIRECTORS ROBERT L. BRUECK CONSULTANT EUGENE W. COURTNEY PRESIDENT AND CHIEF EXECUTIVE OFFICER HEI, INC. WILLIAM R. FRANTA FORMER SENIOR VICE PRESIDENT NETWORK SYSTEMS CORPORATION KENNETH A. SCHOEN EXECUTIVE VICE PRESIDENT (RET.) 3M COMPANY FREDERICK M. ZIMMERMAN CHAIR OF MANUFACTURING SYSTEMS ENGINEERING DEPARTMENT UNIVERSITY OF ST. THOMAS CORPORATE OFFICERS AND MANAGEMENT EUGENE W. COURTNEY PRESIDENT AND CHIEF EXECUTIVE OFFICER JERALD H. MORTENSON VICE PRESIDENT OF FINANCE AND ADMINISTRATION, CHIEF FINANCIAL OFFICER AND TREASURER DALE A. NORDQUIST VICE PRESIDENT OF SALES AND MARKETING THOMAS G. EASTER DIRECTOR OF MANUFACTURING SCOTT J. KAZLE DIRECTOR OF ENGINEERING WRAY A. WENTWORTH DIRECTOR OF CORPORATE QUALITY GENERAL COUNSEL Moss & Barnett A Professional Association Minneapolis, Minnesota INDEPENDENT ACCOUNTANTS Coopers & Lybrand L.L.P. Minneapolis, Minnesota STOCK TRANSFER AGENT AND REGISTRAR Norwest Bank Minnesota, N.A. Box 738 161 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 (612) 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 (612) 443-2500 Facsimile (612) 443-2668 ANNUAL MEETING OF SHAREHOLDERS The Company's annual meeting of shareholders will be held on January 22, 1997 at 3:00 PM at the Marquette Hotel (4th floor), 710 Marquette Avenue, Minneapolis, Minnesota. MARKET PRICE AND RELATED 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 1996 and 1995, as reported on The Nasdaq. These quotations represent prices between dealers, do not include retail markups, markdowns or commissions, and may not represent actual transactions. 1996 HIGH LOW ---------------------- First Quarter $6-7/8 $4-3/4 Second Quarter 6-5/8 5-1/4 Third Quarter 8 5-1/2 Fourth Quarter 8 5-1/2 1995 HIGH LOW ---------------------- First Quarter $ 6 $4-1/4 Second Quarter 5-1/2 4-1/8 Third Quarter 5-1/2 4-3/8 Fourth Quarter 6-3/8 4-1/4 As of August 31, 1996, the Company had approximately 3,150 shareholders of which approximately 560 are shareholders of record. The Company does not declare cash dividends. 16 EX-23 5 EXHIBIT 23 Exhibit 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of HEI, Inc. on Forms S-8 (File Nos. 33-33322, 33-46928 and 33-46929) of our report dated October 4, 1996, on our audits of the financial statements of HEI, Inc. as of August 31, 1996 and 1995, and for the years ended August 31, 1996, 1995 and 1994, which report is incorporated by reference in its Annual Report on Form 10- KSB for the year ended August 31, 1996. /S/ Coopers & Lybrand L.L.P. COOPERS & LYBRAND L.L.P. Minneapolis, Minnesota November 21, 1996 EX-27 6 EXHIBIT 27
5 1,000 12-MOS AUG-31-1996 AUG-31-1996 1,186 0 4,039 0 1,561 13,038 11,650 4,868 22,414 2,950 5,271 0 0 202 13,614 22,414 20,680 20,680 14,957 14,957 2,766 25 99 2,833 720 2,113 0 0 0 2,113 .52 .51
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