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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 þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o No þ

The aggregate market value, in thousands, of the voting and non-voting common equity held by nonaffiliates as of the last business day of the registrant’s most recently completed second fiscal quarter (based on the closing price as reported by The NASDAQ National Market): $12,907,000.

As of December 15, 2003, 7,045,791 Common Shares, par value $.05 per share, were outstanding.

Portions of the Definitive Proxy Statement for the Registrant’s 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission are incorporated by reference into Part III of this Annual Report on Form 10-K.

Some of the information included in this Annual Report on Form 10-K contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “intend,” “estimate,” “continue,” and similar words. You should read statements that contain these words carefully for the following reasons: such statements discuss our future expectations, such statements contain projections of future earnings or financial condition and such statements state other forward-looking information. Although it is important to communicate our expectations, there may be events in the future that we are not accurately able to predict or over which we have no control. The risk factors included in Item 7 of this Annual Report on Form 10-K provide examples of such risks, uncertainties and events that may cause actual results to differ materially from our expectations and the forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, as we undertake no obligation to update these forward-looking statements to reflect ensuing events or circumstances, or subsequent actual results.

HEI, Inc. and subsidiaries are referred to herein as “HEI,” the “Company,” “us,” “we” or “our,” unless the context indicates otherwise. All dollar amounts are in thousands of US dollars except for per share amounts.

We are a Minnesota corporation and were incorporated as Hybrid Electronics Inc. in 1968 and changed our name to HEI, Inc. in 1969. During our fiscal year ended August 31, 2000 (“Fiscal 2000”), we acquired Cross Technology, Inc. (“Cross”), now our wholly owned subsidiary. The acquisition of Cross was a strategic move to expand our product offerings in the ultraminiature markets that we serve. We opened our Mexico operation in Fiscal 2000 focusing on low cost contract assembly and closed this facility during our fiscal year ended August 31, 2001 (“Fiscal 2001”), primarily as a result of lack of profitability, disposing of some assets and relocating some assets to our other facilities.

On January 24, 2003, we acquired certain assets and assumed certain liabilities of Colorado MEDtech, Inc.’s (“CMED”) Colorado operations (“Advance Medical Operations” or “AMO”) in a business combination accounted for as a purchase. In connection with this acquisition, we issued one million shares of our common stock and assumed approximately $900 of AMO liabilities, as well as an operating lease and other contractual commitments. The purchase price of AMO was $2,600 based upon the closing market price of a share of our common stock the day the acquisition was finalized and consummated, as quoted on the NASDAQ National Market. The excess of the fair value of net assets over the purchase price in the amount of $3,760 has been allocated to reduce the carrying value of identifiable long-lived tangible and intangible assets.

HEI provides a comprehensive range of engineering, product design, automation and test, manufacturing and fulfillment services and solutions to our customers in the hearing, medical device, medical equipment, communications, computing and industrial equipment industries. We provide these services and solutions on a global basis through four integrated facilities in North America. These services and solutions support our customers’ products from initial product development and design through manufacturing to worldwide distribution and aftermarket support. HEI uses the leverage created by its various technology platforms to

provide bundled solutions to the markets served. In doing so, the Company uses much of its internal manufacturing capacity to create these solutions. For example, the “Link-it^TM connectivity solution” uses flex circuitry, circuit board assembly, radio frequency (“RF”), software code and engineering services developed and delivered by our different internal capabilities. All of our facilities are ISO 9001:2000 certified.

In our Victoria, Minnesota facility we design and manufacture ultra miniature microelectronic devices and high technology products incorporating these devices. These custom microelectronic devices typically consist of placing or assembling one or more integrated circuits (“IC”) commonly referred to as “chips,” and other passive electrical components onto a ceramic or organic substrate. The microelectronic assembly typically embodies the primary functions of the end products of our customers, such as hearing aids, defibrillators and communication components. For example, in hearing aids the microelectronic assemblies we design and make are contained within a shell and connected to a microphone, receiver and battery. For some customers, we procure the microphone, receiver and battery from outside vendors and assemble all of the components into further assemblies; and we may sell only the microelectronic assembly to other customers. Our custom-built microelectronics are employed in the hearing, medical, telecommunications and ultra miniature radio frequency markets. Our microelectronics facilities achieved ISO 9001:2000 certification in August 2003.

Certain proprietary technology employed in our Victoria facility allows us to manufacture miniature packages that are specially designed to hold and protect high frequency chips for broadband communications. This package, with the enclosed chip, may then be easily and inexpensively attached to a circuit board without degrading the high-frequency performance of the chip. These packages, and the high-frequency chips that they contain, are specifically designed for applications in high-speed optical communication devices — the individual parts of the fiber-optic telecommunications network that companies and individuals use to transmit data, voice and video across both short and very long distances. We manufacture our products by fabricating a substrate and placing integrated circuits and passive electrical components onto that substrate. Substrates are made of multi-layer ceramic or laminate materials. The process of placing components onto the substrate is automated using sophisticated equipment that picks an IC from a wafer or waffle pack and places it onto a substrate with very high precision. Many of the components require wire bonding to electrically connect them to the substrate. We then electrically test the microelectronic assemblies to ensure required performance.

In our Boulder, Colorado facility we provide four primary products and services. First, we provide custom design and development outsourcing services for customers ranging from large medical device original equipment manufacturers (“OEMs”) to emerging medical device companies worldwide. Our design and development projects generally include product concept definition, development of specifications for product features and functions, product engineering specifications, instrument design, development, prototype production and testing, and development of test specifications and procedures. We also perform various forms of verification and validation testing for software application and medical devices. We maintain a technical staff of engineers with backgrounds focused in electrical, mechanical, software and manufacturing disciplines. Second, Boulder’s medical imaging group designs, develops and manufactures a broad range of advanced application software and major subsystem hardware. Our work includes the development of leading edge MRI software, cardiac and vascular diagnostic application software and high-density RF amplifier systems. Contracts in this business are undertaken with major OEMs in the medical imaging system market that integrate the power subsystems into their imaging systems. Third, we provide medical device manufacturing outsourcing services. We manufacture complex electronic and electromechanical medical devices. We are a registered device manufacturer with the Food and Drug Administration (the “FDA”) and are required to meet the FDA’s Quality System Regulation (“QSR”). This facility’s quality system is certified to, and meets, ISO 9001:1994 and ISO 13485 standards. Our manufacturing projects include pre-production engineering and commercialization services, turnkey manufacturing of FDA Class I, Class II and Class III devices and system test services. Our manufacturing outsourcing services generally involve complex high-end devices, as opposed to commodity or high-volume products. In providing outsourcing services, we manufacture products for use in blood analysis, women’s health therapies, and cancer detection systems. Fourth, Boulder provides a connectivity solution consisting of both hardware and software. This technology enables medical device Original

Equipment Manufactures (OEMs) and Health Care Information Technology (HCIT) vendors to add wired and wireless web server connectivity to their products quickly and cost-effectively.

Our Chanhassen, Minnesota facility manufactures wireless smart cards and other ultra-miniature RF applications. Ultra miniature electronic modules are connected to an RF coil, creating an assembly. This assembly is contained within a smart card or wireless card (about the same size as a credit card) that is used for financial, security access and identification or tacking applications.

In our Tempe, Arizona facility, we manufacture and design high density, high quality flex circuits and high-performance laminate-based substrates. We utilize specialized tooling strategies and advanced procedures to minimize circuit handling and ensure that consistent processing parameters are maintained throughout the assembly process. Significant portions of the substrates produced at this facility are transformed into custom-built microelectronics at our facility in Victoria, Minnesota.

Customers: We sell our products through our company-employed sales force based at our facilities in Minnesota, Arizona and Colorado, as well as through our independent sales representatives. In addition, we promote our services through industry advertising and exhibition at industry trade shows.

We currently have annual agreements with our three largest customers, Siemens, Inc., GN ReSound AS and GE Medical Systems (“GEMS”), a subsidiary of General Electric Company, along with several other customers. These agreements typically include basic understandings that relate to estimated needs of the customer, as well as a range of prices for the products for the current year. These agreements generally are cancelable by either party for any reason upon advanced notice given within a relatively short time period (eight to twelve weeks) and, upon such cancellation, the customer is liable only for any residual inventory purchased in accordance with the agreement. Although these annual agreements do not commit our customers to order specific quantities of products, they set the sale price and are useful as they enable us to forecast our customer’s orders for the upcoming year.

Actual orders from our customers with whom we have annual agreements are made through customer supplied purchase orders (“POs”). POs specify quantity, price, product lead times, material and quality requirements and other general business terms and conditions. For customers with lower demand requirements we commonly use their POs only to plan production and procure materials. These programs are subject to our standard terms and conditions including cancellation clauses, whereby either party may cancel such POs for any reason upon advanced notice given within a relatively short time period.

Component Supply Operations: For all application specific or custom material, we try to match the quantities and terms related to the supply of such product of the customer and all major vendors. Although we prefer to have long-term agreements with our vendors, we do not currently have any long-term agreements with vendors in place. Typically, there are many sources of raw material supplies available nationally and internationally; however, many raw materials we use are customer specified and we are required to use customer specified vendors, or the customer supplies materials to us. The ICs that we assemble onto circuit boards are an example of a raw material that is commonly customer specified and available from specified vendors or supplied by the customer.

Proprietary Technology: We use proprietary technology and proprietary processes to incorporate such technology into many of our products. We protect this technology through patents, proprietary information agreements with our customers and vendors and non-disclosure agreements with substantially all of our employees. We have approximately 20 different inventions across the spectrum of our activities, which are either granted as patents or in some stage of active patent pursuit. We pursue new patentable technologies whenever practicable. We have a total of seven active and ten pending patents. Two of our most significant patents are the High Density Stacked Circuit Module and the Interconnection Device. The High Density Stacked Circuit Module is a method of stacking two or more ICs and then electrically interconnecting them. This approach allows us to use the thickness of the circuit to add capabilities rather than increase the width and length. The result is a more compact device than can be attained using conventional methods. The primary application is in our hearing market, where smaller circuits make it possible to fit more people with hearing aides and makes the hearing aid less obtrusive. Our latest design patent, the Interconnection Device,

allows for the cost effective use of high-speed millimeter wave ICs by placing them into surface mount packages. These surface mount packages allow our customers to cost effectively incorporate those packages into their products, and also permits a rapid increase to high volume manufacturing, using standard high volume assembly equipment.

Government Regulations: Certain end products of our customers that we manufacture in our facilities are subject to federal governmental regulations (such as FDA regulations). The Boulder facility is a registered device manufacturer with the FDA. The Medical Device Amendments of 1976 to the Food, Drug and Cosmetic Act (the “FDC Act”), and regulations issued or proposed under the FDC Act, including the Safe Medical Devices Act of 1990, provide for regulation by the FDA of the marketing, design, manufacturing, labeling, packaging and distribution of medical devices. These regulations apply to products that are outsourced to us for manufacture, which include many of our customers’ products, but not to our imaging and power generation products. The FDC Act and the regulations include requirements that manufacturers of medical products and devices register with, and furnish lists of products and devices manufactured by them, to the FDA. Prior to marketing a medical product or device, the company selling the product or device must obtain FDA clearance. Tests to be performed for approval range from bench-test data and engineering analysis to potentially expensive and time-consuming clinical trials. The types of tasks for a particular product submission are indicated by the classification of the device and previous approvals for similar devices. There are also certain requirements of other federal laws and of state, local and foreign governments, which may apply to the manufacture and marketing of our products. We are not directly subject to any governmental regulations or industry standards at our Victoria, Chanhassen and Tempe facilities. However, we are subject to certain industry standards in connection with our ISO 9001:2000 certification. Our products and manufacturing processes at such facilities are subject to customer review for compliance with such customer’s specific requirements. The main purpose of such customer reviews is to assure manufacturing compliance with customer specifications and quality. All facilities are subject to local environmental regulations.

The FDA’s Quality System Regulation for medical devices sets forth requirements for the design and manufacturing processes that require the maintenance of certain records and provide for unscheduled inspections of our Boulder facilities. The FDA reviewed our procedures and records during routine general inspections in 1995 and each year from 1997 to 2003.

Over 90 countries have adopted the ISO 9000 series of quality management and quality assurance standards. ISO standards require that a quality system be used to guide work to assure quality and to produce quality products and services. ISO 9001, the most comprehensive of the standards, covers 20 elements. These elements include management responsibility, design control, training, process control and servicing. ISO 9001 is the quality systems standard used by companies providing design, development, manufacturing, installation and servicing. The quality systems for our AMO are ISO 9001 and ISO 13485 certified, and our Victoria, Chanhassen, and Tempe facilities achieved ISO 9001:2000 certification in August 2003.

There are no material costs or expenses associated with our compliance with federal, state and local environmental laws. As a small generator of hazardous substances, we are subject to local governmental regulations relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances, such as waste oil, acetone and alcohol that are used in very small quantities to manufacture our products. We are currently in compliance with these regulations and we have valid permits for the storage and disposal of the hazardous substances we generate. If we fail to comply with these regulations, substantial fines could be imposed on us and we could be required to suspend production, alter manufacturing processes or cease operations.

Dependence on Single or Few Customers and Backlog: The table below shows the percentage of our net sales to major customers that accounted for more than 10% of total net sales in our fiscal years ended August 31, 2003, 2002, and 2001.

Sonic Innovations, Inc. and Siemens, Inc. operate in the human hearing-aid market. The decrease in percent of sales and sales dollars with both Sonic Innovations, Inc and Siemens, Inc. during our fiscal year ended August 31, 2003 (“Fiscal 2003”), is largely a result of their increased internal manufacturing capabilities and off shore out sourcing. GE Medical Systems, a subsidiary of General Electric Company, is a customer in the MRI component market of our Advanced Medical Operations and, although AMO was new to HEI in Fiscal 2003, GEMS was a customer of CMED during CMED’s fiscal years ended June 30, 2003, 2002 and 2001. Triquint Optoelectronics is a customer in the communications market. Reduced revenue from Triquint Optoelectronics is attributed to the overall downturn in the telecommunications market. For financial information about revenues from external customers attributed to specific geographic areas see Item 8 — Note 17 to Consolidated Financial Statements.

The following table illustrates the approximate percentage of our net sales by market segment served.

We believe that diversification between our key markets is important. Our goals are to have no one market account for 40% or more of our net sales, no one customer greater than 25% of net sales and no one program exceeding 10% of net sales. Our plans to achieve our goals include increasing our product offerings, customer base and programs to increase revenue, which will result in more diversification.

At August 31, 2003, our backlog of orders for revenue for our fiscal year ending August 31, 2004 (“Fiscal 2004”) was approximately $18,645 compared to approximately $5,400 at August 31, 2002. We expect to ship our backlog as of August 31, 2003, during Fiscal 2004. This increase in backlog is mainly due to increased order activity from the overall stronger economic conditions in our markets and $10,864 from the acquisition of AMO.

Competition: In each of our product lines, we face significant competition, including customers who may produce the same or similar products themselves. Our competitive advantage starts with knowledge of the market requirements and our investment in technology to meet those demands. We use proprietary technology and proprietary processes to create unique solutions for our customers’ product development and manufacturing requirements. We believe that customers engage HEI because they view us to be the leading edge in designing and manufacturing products that help them, in turn, delivering better products faster and cheaper than they could do by themselves. Finally, we compete on the basis of full service to obtain new and repeat orders. We are a full-service supplier and partner with our customers, providing full “turn-key” capability.

Research and Development: The amount that we spent on company-sponsored research and development activities aggregated approximately $2,580, $2,516 and $2,433 for our fiscal years ended August 31, 2003, 2002 and 2001, respectively.

Employees: On August 31, 2003, we employed 284 full-time persons and 1 part-time person.

We own a 48,000 square foot facility for administration and microelectronics production in Victoria, Minnesota, a suburb of Minneapolis, which was originally built in August 1981. The facility was expanded during our fiscal year ended August 31, 1996 from the original 25,000 square feet with an addition of 23,000 square feet to increase production capacity. The addition was financed through the issuance of Industrial Development Revenue Bonds (“IDRBs”) with the City of Victoria on the property and certain equipment. On March 14, 2003, the outstanding principal and interest on these IDRBs were paid from the proceeds of the subordinated promissory note issued to CMED in connection with the acquisition of our AMO (the “Subordinated Promissory Note”) In October 2003, the Company completed a $1,200 financing that is secured with a mortgage on the Victoria, Minnesota facility.

We lease a 14,000 square foot facility in Tempe, Arizona for our high density interconnect business. We lease two properties in Minnesota: a 20,000 square foot facility in Chanhassen, Minnesota, for part of our RFID business, and a 3,100 square foot facility in Eden Prairie, Minnesota, that was formerly used for corporate offices. In April 2003, we re-located our corporate offices to our Victoria facility and sub-leased the Eden Prairie facility The Tempe and Chanhassen facilities are leased until July 2005 and June 2012, respectively, and the Eden Prairie facility is leased until March 2005.

We lease a 150,022 square foot facility in Boulder, Colorado for our Advanced Medical Operations. The Boulder facility is leased until April 2013. As a part of the purchase accounting for the acquisition of our AMO, HEI has established a $3,110 reserve related to the future estimated lease payments of the Boulder facility, which is currently not being fully utilized. In addition, we intend to reduce our occupancy costs at this facility by sub-leasing the 50,000 square foot addition.

On June 30, 2003, we commenced litigation against Anthony J. Fant, our former Chairman of the Board, Chief Executive Officer and President and a current director, in the State of Minnesota, Hennepin County District Court, Fourth Judicial District. The complaint alleged breach of contract, conversion, breach of fiduciary duty, unjust enrichment and corporate waste resulting from, among other things, Mr. Fant’s default on his promissory note to us and other loans and certain other matters. On August 12, 2003, we obtained a judgment against Mr. Fant on our breach of contract count in the amount of approximately $606. On August 12, 2003, the Court did not rule on the other counts in the complaint, reserving to a later time such determination. On November 24, 2003, the Court granted us an additional judgment against Mr. Fant in the amount of approximately $993 on the basis of our conversion, breach of fiduciary duty, unjust enrichment and corporate waste claims. We are engaged in efforts to collect on the judgment and plan to continue to collect on the judgment in due course. We have obtained, through garnishments, in excess of approximately $112 from Mr. Fant’s accounts. Such amount partially reduces the judgment amount. We continue to seek to collect on the remaining judgment amount in Minnesota and other states where it is believed that Mr. Fant may have non-exempt and unencumbered assets.

There were no matters submitted to a vote of shareholders during the fourth quarter of our fiscal year ended August 31, 2003.

The following is a list of our executive officers, their ages and offices as of December 16, 2003. Each executive officer serves a term of one year or until his successor is appointed and qualified.

Mack V. Traynor, III has served as our Chief Executive Officer and President since March 2003, and has served on our Board of Directors since 1998. Mr. Traynor currently serves as President of Manitou Investments, a private investment and business management firm, a position he has held since 1998. Although Mr. Traynor currently serves in such capacity with Manitou Investments, he devotes substantially all of his efforts to his duties and responsibilities at the Company. Since June 2003, Mr. Traynor has served on the Board of Directors of ACT Telecommunications (NASDAQ: ACTT), an international teleconferencing service provider. Previously, Mr. Traynor served as President and Chief Executive Officer of Supreme Companies, Inc., a privately held landscape and grounds maintenance company, from February 2002 to September 2003. Mr. Traynor also previously served as Chief Executive Officer of Do The Good, Inc., a philanthropic software development company, from May 2001 until October 2001, and as Chief Financial Officer of 10K Partners, Inc., private investment company, from April 2000 until June 2000. Mr. Traynor served as President and Chief Executive Officer of NeoNetworks, a privately-held development stage company designing high-speed data communications equipment, from October 1998 to April 2000. Mr. Traynor was a director of Telident, Inc., a publicly-held telecommunications products and services company, from 1998 to 2000. Mr. Traynor also served as a director of Eltrax Systems, Inc., a publicly-held networking products and services company, from 1995 to 1999, serving as Chief Financial Officer from 1995 to 1996 and President, Chief Executive Officer and Chief Operating Officer from 1995 to 1997. Mr. Traynor served as President and Chief Operating Officer of Military Communications Center, Inc., a company that provided telecommunications services to U.S. Military personnel, from 1988 to 1995. He also served as President of U.S. West Enterprises, a division of U.S. West, Inc.

Douglas J. Nesbit has served as our Chief Financial Officer since June 2003. Prior to joining HEI, Mr. Nesbit served as the Chief Financial Officer, Secretary and Treasurer of LecTec Corporation, a publicly-held consumer health care company, from 2000 to 2003, as the Corporate Treasurer at Secure Computing Corporation, a provider of computing system security tools and devices, from 1997 to 2000, and as Corporate Controller of ValueRX, a pharmacy benefit management firm, from 1996 to 1997. Mr. Nesbit’s professional background also includes public accounting experience with the big four firm of KPMG LLP. Mr. Nesbit also serves as a Director of the Minnesota Society of Certified Public Accountants and a participant on the CPE advisory committee for the AICPA.

Stephen K. Petersen Vice President of the Micro Electronics Operation joined us in March 1998 as Director of Manufacturing. He was appointed Vice President of Operations in September 2000. Before joining us, he was employed with Sheldahl, a manufacturer of electronic materials and derivatives, in a variety of positions ranging from Engineer to Plant Manager and most recently as the Operations Manager. Mr. Petersen was responsible for production and manufacturing engineering departments.

Scott M. Stole Ph.D. joined us in October 2000 as Director of Advanced Process Development. In June 2003, he was promoted to Chief Technical Officer. Prior to joining HEI, Dr. Stole served as President & CEO of Questek Innovations, Inc., a developer of advanced hardware technologies for the disk drive industry, from May 1997 to October 2000, where he oversaw technology development, intellectual property protection,

corporate strategy and strategic alliances. Dr. Stole received his Ph.D. from Iowa State University and his Bachelors degree from Concordia College, and has 13 years of experience in the design, development and manufacture of a wide range of microelectronics and advanced materials-related products.

Simon F. Hawksworth joined us in September 2002 as Vice President of Sales and Marketing. Prior to joining us, he served as Vice President of Sales and Marketing at InnovaComm Technologies, Inc, a microelectronics manufacturing company and a spin-off of Maxtek, a wholly-owned subsidiary of Tektronix, from February 2000 to August 2002. Mr. Hawksworth also served, from August 1998 to August 2002, in a variety of positions at Maxtek from Business Development Manager through Director and Vice President of Sales and Marketing. Prior to joining us, Mr. Hawksworth’s positions focused on winning new business requiring high frequency electronics packaging solutions.

James C. Vetricek joined us in January 2003 in connection with our acquisition of our AMO as Vice President of our AMO. Prior to such acquisition, Mr. Vetricek served as Vice President, Quality and Regulatory Affairs of CMED from February 2001 to January 2003. Mr. Vetricek has over 20 years of experience as a medical device professional managing facilities with multi-site operations. His responsibilities have included research and development, regulatory affairs, pilot manufacturing, and proprietary and contract manufacturing operations. Mr. Vetricek’s product experience includes sterile single use devices, implants, bio absorbable surgical materials, electromechanical surgical systems, anesthesia systems and cardiovascular monitoring devices. Prior to joining CMED, he served as Vice President of Regulatory Affairs & Quality Management at Linvatec, a division of Conmed a medical equipment manufacturer from February 1999 to February 2001. Mr. Vetricek also serve from September 1994 to June 1998 as Vice President of Regulatory Affairs & Quality Assurance and R&D at Ohmeda Medical Device, a division of BOC Group an industrial producer of gases.

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

Our common stock is currently traded on the NASDAQ National Market under the symbol HEII. Below are the high and low sales prices for each quarter of our fiscal years ending August 31, 2003 and 2002, for our common stock, as reported by NASDAQ National Market.

As of December 12, 2003, we had 310 shareholders of record. We have not paid any dividends on our common stock since our initial public offering on March 24, 1981. We expect that for the foreseeable future we will follow a policy of retaining earnings in order to finance our continued development. Payment of dividends is within the discretion of our board of directors and will depend upon, among other things, our earnings, capital requirements and operating and financial condition. In addition, the terms of our loan agreements with our lender provides that we cannot, without the lender’s prior written consent, pay any dividend or make any distribution of assets to our shareholders or affiliates.


(a)	For Fiscal 2003 unusual charges consisted of an impaired asset write-down of $331. Other expense included costs related to the non-cash write off of bank fees of $181 related to the terminated revolving line of credit with LaSalle Business Credit and a reserve of $841 for Mr. Fant’s promissory note and other amounts due from Mr. Fant.

(b)	Income tax expense reflects the establishment of a $3,420 valuation allowance of which $3,188 was included in income tax expense.

(c)	For Fiscal 2001 unusual charges consisted of costs related to the closure of the Mexico product line of $425 and a $1,268 loss on the write-off of accounts receivable primarily related to customers of the Mexico product line and other expense included the write-off of the investment in MSC.

(d)	For Fiscal 2000 unusual charges of $453 consisted of acquisition transaction costs related to the Cross acquisition.

(e)	For our fiscal year ended August 31, 1999, unusual charges of $490 related to the severance agreement between the Company and the former Chief Executive Officer.

Fiscal 2003 started off slow but was bolstered by the acquisition of our AMO in the second quarter. Revenue in the first quarter began the year with the lowest revenue we have experienced in thirteen quarters at $5,490. That was a 10% drop in revenue from our first quarter of our fiscal year ended August 31, 2002 (“Fiscal 2002”). The cost reduction plan implemented in second quarter of Fiscal 2002 continued into Fiscal 2003. It is important to note that our variable costs have historically represented as much as approximately 75% of our revenue, which makes us extremely volume sensitive The cost reduction plan has lowered our quarterly breakeven point to approximately $13,000 as of the end of Fiscal 2003. We will continue to manage our costs and have a goal to lower the quarterly breakeven point by the end of Fiscal 2004. Our commitment to research and development continued in Fiscal 2003 and we have and will continue this effort to maintain and increase our propriety technology and manufacturing process. With revenue continuing to be our biggest issue in Fiscal 2003 we have streamlined and improved our sales and marketing efforts with renewed focus and talent. We are experiencing positive results from this effort and will continue to concentrate on this during Fiscal 2004 to not only increase our sales, but to increase our diversification of revenue.

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

We recognize revenue upon shipment of products to customers, when all contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. For inventory shipped on consignment, revenue is recognized upon transfer of title when the customer uses the inventory. In the normal course of business we enter into a number of contracts with our customers under which we provide engineering services on a per project basis. We recognize revenue on these services based upon meeting certain milestones and or benchmarks that are attributable to the different contractual elements of the overall contract. Based on the accomplishments of these goals we use the percentage of completion methodology to recognize the revenue and related costs to generate the revenues. Sales, payment terms and pricing extended to customers are governed by the respective contract agreements or binding POs for each transaction and provide no right of return outside of contractual warranty terms. Payment terms are seven days for consignment program sales and from four to 60 days for other customers. For items delivered with contingent payment terms, revenue is deferred for the greater of the amount of the contingent payment or the fair value of the undelivered elements and recognized when the contingency is resolved. We provide engineering and product development services to our customers pursuant to written contracts. The majority of these arrangements are time and material contracts. We recognize revenue as time is incurred or materials are consumed. To a lesser extent we have fixed-price contracts which are accounted for using either the completed contract method or the percentage of completion method.

We record provisions against net sales for estimated product returns. These estimates are based on factors that include, but are not limited to, historical sales returns, analyses of credit memo activities, current economic trends and changes in the demands of our customers. Provisions are also recorded for warranty claims that are based on historical trends and known warranty claims. Should actual product returns exceed

estimated allowances, additional reductions to our net sales would result. As of August 31, 2003 and 2002, warranty and product return reserves were $122 and $200, respectively.

We estimate the collectibility of trade receivables and note receivables, which requires considerable amount of judgment in assessing the realization of these receivables, including the current credit-worthiness of each customer and related aging of the past due balances. In order to assess the collectibility of these receivables, we perform ongoing credit evaluations of our customers’ financial condition. Through these evaluations, we may become aware of a situation where a customer may not be able to meet its financial obligations due to a deterioration of its financial viability, credit ratings or bankruptcy. The reserve requirements are based on the best facts available to us and reevaluated and adjusted as additional information is received. We are not able to predict changes in the financial condition of our customers and, if circumstances related to our customers deteriorate, our estimates of the recoverability of our receivables could be materially affected and we may be required to record additional allowances for uncollectible accounts. Alternatively, if we provide more allowances than we need, we may reverse a portion of such provisions in future periods based on changes in estimates from our actual collection experience. As of August 31, 2003 and 2002, we had accounts receivable allowances of $92 and $85, respectively.

We record inventories at the lower of cost, using the standard and average cost method or market value. Generally, all inventory purchases are for customized parts for customer specific programs. Contractual arrangements are typically agreed to with the customer prior to ordering customized parts to protect us in cases where the demand decreases, as often times the parts cannot be consumed in other programs. Even though contractual arrangements may be in place, we are still required to assess the utilization of inventory. In assessing the ultimate realization of inventories, judgments as to future demand requirements are made and compared to the current or committed inventory levels and contractual inventory holding requirements. Reserve requirements generally increase as projected demand requirements decrease due to market conditions, technological and product life cycle changes as well as longer than previously expected usage periods. It is possible that significant charges to record inventory at the lower of cost or market may occur in the future if there is a further decline in market conditions. As of August 31, 2003 and 2002, we have reduced the carrying value to the lower of cost or market for excess and obsolete inventory by $1,511 and $311, respectively.

We continually evaluate whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets may warrant revision, or that the remaining balance of these assets may not be recoverable. We evaluate the recoverability of our long-lived assets in accordance with Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” When deemed necessary, we complete this evaluation by comparing the carrying amount of the assets against the estimated undiscounted future cash flows associated with them. If such evaluations indicate that the future undiscounted cash flows of long-lived assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their estimated fair values. During Fiscal 2003 we recorded asset impairment charges of $331. For Fiscal 2002 we did not record any long-lived asset impairment charges. During Fiscal 2001 we recorded asset impairment charges of $125 for leasehold improvements and fixed assets related to the Mexico facilities closing.

Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. We record a current provision for income taxes based on amounts payable or refundable. Deferred tax assets and liabilities are recognized for the future tax consequences of differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.

Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. The overall change in deferred tax assets and liabilities for the period measures the deferred tax expense or benefit for the period. We recognize a valuation allowance for deferred tax assets when it is more likely than not that deferred assets are not recoverable.

At August 31, 2003 and 2002, we had valuation allowances of approximately $5,400 and $3,400, respectively, because of uncertainties related to the ability to utilize certain Federal and state net loss carryforwards due to the Company’s historical losses and net tax operating loss carryforward position. The valuation allowance is based on estimates of taxable income by jurisdiction and the period over which our deferred tax assets are recoverable.

The accompanying statements set forth in Note 6 to our Consolidated Financial Statements reflect a preliminary allocation of the purchase price of our AMO. This allocation includes an accrual of $730 related to an unfavorable operating lease, $2,380 for future estimated lease payments and a $600 accrual to fulfill estimated contractual manufacturing obligations. The $2,380 accrued for estimated lease payments consists of $5,910 for future lease obligations less estimated sublease payments of $3,530 on unoccupied space for which we are in the process of reviewing alternative uses. We have entered into an agency agreement with Julien J. Studley, Inc., a national commercial real estate services firm, to assist HEI in reducing its occupancy costs at this facility by sub-leasing the 50,000 square foot addition. The final allocation of the consideration to be paid may differ from those assumptions reflected in the accompanying audited consolidated financial statements. In our opinion, all adjustments necessary to present fairly such financial statements have been made based on the terms and structure of the AMO acquisition. We continue the process of gathering information to complete our analysis of the excess lease capacity and the contractual manufacturing obligations. Any reductions in these liabilities will result in a decrease in the carrying value of the intangible assets and fixed assets. Conversely, an increase in these liabilities increases the carrying values of long-lived assets. At August 31, 2003, the carrying value of long-lived assets has been reduced by a net of $3,760 by the allocation of negative goodwill.

The following table illustrates the approximate percentage of our net sales by market segment served.

Our net sales for Fiscal 2003, increased $9,908 or 35%, compared to Fiscal 2002. This increase in net sales from Fiscal 2002 was the result of $14,429 in net sales generated by our AMO , which we acquired in January 2003. The increase in sales associated with the addition of our AMO was partially offset by a decrease in sales of approximately $6,300 to two of our major medical/ hearing customers. Net sales in Fiscal 2002 decreased $16,300 or 36%, compared to Fiscal 2001. The decrease in net sales from Fiscal 2001 was largely a result of the general economic slowdown and the resulting impact in the medical/ hearing, communications, RFID and electronic contract manufacturing markets. Additionally, during the fourth quarter of Fiscal 2002, the internal manufacturing capacity of one of our customers increased, resulting in approximately $3,800 reduced sales of our products in Fiscal 2003.

The communications and RFID markets remain soft as our customers are awaiting market acceptance of new products and increased demand for existing products. As the demand for these products increases, we believe that we are positioned for an increase in sales in these markets. In addition, we are experiencing continued interest in our proprietary products which have received design approval for numerous applications with increasing low volume production. We continue to work on new designs, qualification testing and continue to receive prototype orders from numerous customers.

Sales to medical/ hearing customers represents 82% of total net sales for Fiscal 2003 and increased from $21,558 to $31,691 or by $10,133 or 47% compared to Fiscal 2002. The increase is primarily a result of the addition of our Advanced Medical Operations, which contributed $14,429 for the year in medical revenue. The increase associated with our AMO addition was partially offset as we continued to experience fluctuations in demand for our hearing products. The decreases in our hearing products are mainly due to excess inventory positions at significant hearing customers and reflect the general economic slowdown, which continues to negatively impact the hearing related contract manufacturing markets. During the latter part of Fiscal 2002, a major customer’s internal manufacturing capabilities increased, which reduced annual revenues for Fiscal 2003 by approximately $3,800. Also a significant customer advised us in June 2003 that it intended to discontinue a significant program with us in order to place it offshore. This program was discontinued in the first quarter of Fiscal 2004 and had net sales of $6,709, $9,273 and $11,271 in Fiscal 2003, Fiscal 2002, and Fiscal 2001, respectively. This program discontinuance will reduce but not eliminate sales to this customer. During the first quarter of Fiscal 2002, we entered into a program with Siemens in which our finished goods inventory is held at Siemens and we recognize revenue when they use the product. In connection with this program, certain raw materials used by us for Siemens products are being consigned to us by Siemens. The result of this program is that our finished goods inventory has increased, while raw materials for these programs have decreased.

Fiscal 2002 sales to medical/hearing customers decreased from $27,356 in Fiscal 2001 to $21,558, or by $5,798, or 21%. The decrease in demand comparing Fiscal 2002 to Fiscal 2001 is a result of the general economic slowdown impacting the hearing contract manufacturing markets. Also, during the latter part of Fiscal 2002 one of our customer’s internal manufacturing capabilities increased, negatively impacting revenue by approximately $1,450 in Fiscal 2002.

Net sales to the communications and industrial products market decreased from $4,004 in Fiscal 2002 to $3,864 in Fiscal 2003, or $140 or 3%. The Fiscal 2003 decrease as compared to Fiscal 2002 is largely a result of the current weakness in the telecommunications markets. We are experiencing increased activity in this market with numerous low volume purchase orders. In September 2002, we realigned our sales emphasis to narrowly focus our efforts to key niche customers to obtain the best margin revenue while improving the efficiencies in developing new business. Net sales decreased in Fiscal 2002 from $6,342 in Fiscal 2001 to $4,004 in Fiscal 2002, or by $2,338 or 37%. This decrease comparing Fiscal 2002 to Fiscal 2001 is largely a result of weakness in the telecommunications markets.

Net sales to the RFID products market represents decreased from $2,970 in Fiscal 2002 to $2,885 in Fiscal 2003 or by $85 or 3%. This decrease was driven by a drop in orders from a major customer that, in Fiscal 2002, sold one division and terminated operations of another. We are also experiencing competition from overseas manufacturers in this market. New products have been developed and capabilities have been

expanded to improve revenue; however, the actual level of market acceptance of these initiatives is currently unknown. RFID sales decreased in Fiscal 2002 from $6,389 in Fiscal 2001 to $2,970, or by $3,419 or 54%, primarily due to the above mentioned drop in orders from one major customer.

At August 31, 2003, our backlog of orders for revenue in Fiscal 2004 was approximately $18,645, compared to approximately $5,400 and $11,000 at August 31, 2002 and 2001, respectively. We expect to ship our backlog as of August 31, 2003 during Fiscal 2004. This increase in backlog is mainly due to increased order activity from the overall stronger economic conditions in our markets and $10,864 from the acquisition of AMO. The backlog from our AMO includes customer commitments that have longer terms, as compared to our historical customer commitments. Our backlog is not necessarily a firm commitment from our customers and can change, in some cases materially, beyond our control.

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

Our gross profit as a percentage of net sales was 18.5% in Fiscal 2003, as compared to 18.1% in Fiscal 2002 and 17.8% in Fiscal 2001. Our gross margin percent of net sales increased slightly in Fiscal 2003 due to overall material costs improvement resulting in an improvement of 2.6% of net sales offset by increases in direct labor of 1.1% and manufacturing costs of 1.1%. In future periods, we expect gross margins to be impacted in a similar manner as revenues fluctuate.

Our gross profit as a percentage of sales was 18.1% in Fiscal 2002, as compared to 17.8% in Fiscal 2001. While our gross margin percentages are heavily impacted by revenue, due to the fixed nature of many of our manufacturing costs, we were able to improve gross margins in Fiscal 2002 from Fiscal 2001 despite a 36% decrease in net sales. This improvement is due to a reduction of 35 direct labor and manufacturing employees in Fiscal 2002 resulting in a savings of $649 in direct labor and $77 in administrative salary costs, improved manufacturing yields to 94.4% in Fiscal 2002 from 92.7% in Fiscal 2001, reduced scrap expense to 3.8% in Fiscal 2002 from 4.5% in Fiscal 2001 (calculated as a percentage of gross sales), and from the closure of the Mexico product line, which generated negative gross margins of $624 during Fiscal 2001.

Selling, general and administrative expenses in total were 20% of net sales in Fiscal 2003, compared to 19% and 13% in Fiscal 2002 and Fiscal 2001, respectively. Selling, general and administrative expenses in Fiscal 2003 increased $2,304 when compared to Fiscal 2002. The increase is mainly due to the acquisition of our AMO in January 2003, which contributed $2,206 in expenses for the year. In addition, excluding the depreciation related to AMO fixed assets, depreciation costs decreased in Fiscal 2003 as some of our assets, mainly computer software and equipment, were fully depreciated during the year. These reductions were mitigated by increases in advertising, travel and board of director fees. During Fiscal 2002, selling, general and administrative expenses decreased by $471 when compared to Fiscal 2001, due to the closure of the Mexico operations and other cost reductions, including reduction of employees, travel and other operational costs. These reductions were offset by increases in professional fees and insurance costs totaling $196. An 11-employee reduction during Fiscal 2002 resulted in decreased selling, general and administrative expenses of $178 during Fiscal 2002. These overall decreasing expenses are a result of our continued efforts to size our cost structure to revenue while balancing our commitment to maintain our research and development efforts and continued sales and marketing focus.

Research, development, and engineering expenses increased $64 in Fiscal 2003, when compared to Fiscal 2002, and increased $147, when compared to Fiscal 2001. Comparing Fiscal 2002 to Fiscal 2001, costs increased in Fiscal 2002 by $83 or 3%, compared to Fiscal 2001. In Fiscal 2003 and Fiscal 2002, the increases in research, development and engineering expenses are a result of our commitment to maintain our design capabilities to support future programs and continue the development and enhancement of our proprietary products and manufacturing processes.

The unusual charges of $331 in the current year relate to the impairment of equipment. The asset impairment was triggered in the fourth quarter of Fiscal 2003 by the development of alternative testing that was more efficient than what could be performed by our existing equipment and notification in the same quarter that a large portion of a significant customer program will be moved offshore in the first quarter of Fiscal 2004. The unusual charges of $1,693 incurred in Fiscal 2001 relate to the write-off of accounts receivable related to customers of the Mexico operations and the closure of those operations.

Other expenses of $1,213 in Fiscal 2003 increased $1,107 from Fiscal 2002, which reflects a decrease of $969 when compared to Fiscal 2001. The current-year increase is due primarily to costs related to the non-cash write off of deferred financing bank fees of $181 related to the terminated revolving line of credit with LaSalle Business Credit, and establishment of a reserve of $841 for Mr. Fant’s promissory note and other amounts that were determined to be uncollectible. Other expense in Fiscal 2002 of $106 decreased by $626 as compared to Fiscal 2001, primarily due to lower interest expense. Net interest expense for Fiscal 2002 decreased by $158 from Fiscal 2001 as a result of the lower average debt in Fiscal 2002 of approximately $2,000, and higher average cash balances of approximately $4,000, along with average interest rates of approximately 2% lower during Fiscal 2002 compared to Fiscal 2001. The lower average debt and higher average cash balances are the result of the net offering proceeds of $6,222 received in August 2001. In addition, other expense, net for Fiscal 2001 of $732 includes a non-cash charge of $161 ($106 net of tax) related to costs associated with the abandoned CMED transaction.

Management performs an analysis of the realization of the deferred tax asset each fiscal quarter. During Fiscal 2003 we recognized an income tax benefit of $21 compared to an income tax expense of $1,092 in Fiscal 2002. During Fiscal 2003, we did not recognize a tax benefit for any of the Company’s losses. The Fiscal 2002 tax expense resulted from the establishment of a deferred tax valuation allowance to fully reserve all of our deferred tax assets. During the fourth quarter of Fiscal 2002, we determined that a valuation allowance of $3,420 should be established for all of our deferred tax assets due to the softness in our markets, the results of operations for the fourth quarter, uncertainties about visibility to customer order rates and a general economic recovery. An aggregate of $233 of tax valuation allowance was reflected as an adjustment to additional paid-in capital as it represents the tax asset benefit from stock option exercises that are included in our net operating loss carryforwards. The Fiscal 2002 deferred tax expense was partly offset by a federal income tax benefit of $459.

Comparing Fiscal 2002 to Fiscal 2001, we recognized tax expense of $1,092 during Fiscal 2002 compared to a tax benefit of $930 in Fiscal 2001. During Fiscal 2001 we benefited the net operating loss carryforwards created by the Company resulting in a $930 tax benefit. As noted above, we established a deferred tax valuation allowance for all the deferred income tax assets as of August 31, 2002.

At the end of Fiscal 2003, we had net operating loss carryforwards expiring at various dates ranging from 2012 through 2023. Even though valuation allowances have been established, we still retain all the economic benefits of the net operating loss in future years.

Our net cash flow provided by operating activities for Fiscal 2003 was $322 compared to $1,077 and $3,930 for Fiscal 2002 and Fiscal 2001, respectively. For Fiscal 2003, cash flow from operating activities was generated as a result of a decrease of $581 in inventories, an increase in accounts payable of $2,136 and accrued liabilities of $504, offset by an increase in accounts receivable of $2,488, and a $737 increase in the net loss from $3,892 in Fiscal 2002 to $4,629 in Fiscal 2003. Non-cash expenses for Fiscal 2003 consist of depreciation of $3,295. The increases in non-cash expenses were primarily the result of increased depreciation from the acquisition of our AMO, the establishment of an allowance for note receivable of $597 and impaired assets charges of $331. The Fiscal 2003 increase in accounts receivable, accounts payable and accrued liability balances is attributable primarily to the post acquisition activity of our AMO. The decrease in inventory is due to reduced requirements at year end for major programs from two significant customers, Sonic Innovations, Inc and Siemens, Inc. Net cash provided by operating activities totaled $1,077 and $3,930,respectively, in Fiscal 2002 and Fiscal 2001. This decrease was a result of higher revenue in Fiscal 2001, which caused higher accounts receivable and inventory balances when compared to Fiscal 2002.

Our net cash flow used in investing activities was $634, $2,423 and $3,889 for Fiscal 2003, Fiscal 2002 and Fiscal 2001, respectively. We spent $580 on capital expenditures and patent costs in Fiscal 2003 compared to $2,423 in Fiscal 2002. During Fiscal 2001 we spent $3,533 on capital expenditures. The capital expenditures in all three years relate to facility improvements and purchases of manufacturing equipment to enhance our production capabilities and quality control systems. Our net cash flow used in financing activities was $1,254 and $675, respectively for Fiscal 2003 and Fiscal 2002, and our net cash flow provided by financing activities was $3,868 for Fiscal 2001. Cash generated from issuance of common stock was $53, $275 and $6,336 for Fiscal 2003, Fiscal 2002 and Fiscal 2001, respectively. During Fiscal 2003, in connection with the purchase of AMO, we issued the Subordinated Promissory Note to CMED in the principal amount of $2,600. The $1,000 decrease in restricted cash for Fiscal 2003 was used to prepay long-term debt as a result of the December 13, 2002, loan modification. During Fiscal 2001, we completed a private placement of common stock that generated $6,200 in net proceeds. Other issuances of common stock during the past three Fiscal years were from the exercise of stock options. The majority of other year-to-year changes relate to the borrowings and repayment under the Company’s revolving line of credit and term debt agreements.

The result of these activities was a decrease in cash by $1,566 and $2,021 during Fiscal 2003 and Fiscal 2002, respectively, and an increase in cash of $3,909 during Fiscal 2001. At the end of Fiscal 2003 our unrestricted cash balance was $806.

Accounts receivable average days outstanding were 46 days at August 31, 2003, compared to 53 and 74 days at August 31, 2002 and 2001, respectively. Inventory turns were 5.7, 5.0 and 7.0, for the Fiscal 2003, Fiscal 2002 and Fiscal 2001, respectively. The decreased days outstanding are mainly due to two significant customers that pay seven or less day terms. Increased inventory turns for Fiscal 2003 were primarily due to the increase in revenue with associated cost of sales in the last quarter of the Fiscal 2003 as compared to Fiscal 2002. The decreased days outstanding and decreased inventory turns in Fiscal 2002 were primarily due to the slow down in revenue in the last quarter of Fiscal 2002 as compared to Fiscal 2001.

The Company’s current ratio at the end of Fiscal 2003 was 1.7:1 as compared to 1.6:1 and 2.7:1 at the end of Fiscal 2002 and Fiscal 2001, respectively. The increase in Fiscal 2003 to Fiscal 2002 is slight and is principally due to increased accounts receivable and inventories offset by increased accounts payable and accrued liabilities due to the acquisition of our AMO. The decrease in Fiscal 2002 as compared to Fiscal 2001 is principally due to the receipt of $6,200 from the closing of a private placement in August 2001, off set by additions to property and equipment and payments on long-term debt with the $1,000 increase in current maturities of long-term debt exceeding the $1,100 generated by operating activities in Fiscal 2002. Based on the modified bank covenants, amended December 13, 2002, and the required repayment of $1,000 of long-term debt, the current ratio at the end of Fiscal 2002 would have been 1.7:1.

During Fiscal 2003 and early Fiscal 2004, we have undertaken a number of activities to restructure our term-debt. The following is a summary of those transactions:

We originally issued IDRBs in April 1996 in connection with the construction of a new addition to our manufacturing facility in Victoria, Minnesota, and for the purchase of production equipment. On March 14, 2003, an aggregate of approximately $1,735 of debt proceeds from the Subordinated Promissory Note were used to fund the repayment of principal and interest on the IDRBs. We also used $845 of the proceeds from the Subordinated Promissory Note to retire our capital expenditure notes with LaSalle Business Credit LLC.

The Subordinated Promissory Note was funded by CMED at the time of our AMO acquisition in January 2003. On May 8, 2003 the Subordinated Promissory Note was sold by CMED to Whitebox Hedged High Yield Partners (“Whitebox”) for $1,820 and continued with the same terms as the original agreement with CMED until August 15, 2003. To encourage early repayment, the terms of the Subordinated Promissory Note were modified on May 16, 2003 and subsequently modified on September 12, 2003. On October 15, 2003, we prepaid the Subordinated Promissory Note for a discount on the principal amount outstanding of $360, the payment of accrued interest totaling $167 with 47,700 unregistered common shares of HEI stock valued at $3.50 per share and forgiveness of interest from September 15, 2003 through October 15, 2003. As a result of the prepayment of the Subordinated Promissory Note, the Company will recognize a gain on the early extinguishment of the Subordinated Promissory Note totaling $472 during the first quarter of Fiscal 2004.

The funds to prepay the Subordinated Promissory Note were obtained from two separate loans in the aggregate amount of $2,350 under new Term Credit Facilities with Commerce Bank, a Minnesota state banking association, and its affiliate, Commerce Financial Group, Inc., a Minnesota corporation. The first note, with Commerce Bank, in the amount of $1,200 was executed on October 14, 2003. This note is secured by our Victoria, Minnesota facility. The term of the first note is six years with interest rate at a nominal rate of 6.50% per annum for the first three years. Thereafter the interest rate will be adjusted on the first date of the fourth loan year to a nominal rate per annum equal to the then Three Year Treasury Base Rate (as defined) plus 3.00%; provided, however, that in no event will the interest rate be less than the Prime Rate plus 1.0% per annum. Monthly payment of principal and interest will be based on a twenty-year amortization with a final payment of approximately $980 due on November 1, 2009. The second note, with Commerce Financial Group, Inc., in the amount of $1,150 was executed on October 28, 2003. The second note is secured by our Victoria facility and equipment located at our Tempe facility. The term of the second note is four years, with an interest rate of 8.975% per year through September 27, 2007. Monthly payments of principal and interest in the amount of $28 will be paid over a forty-eight month period beginning on October 28, 2003.

On May 29, 2003, we entered into an accounts receivable agreement (the “Credit Agreement”) with Beacon Bank of Shorewood, Minnesota for a period of twelve months. On December 12, 2003, the Company extended the Credit Agreement to September 1, 2004. The Credit Agreement is an accounts receivable backed facility and is additionally secured by inventory, intellectual property and other general intangibles. The Credit Agreement replaced our revolving line of credit with LaSalle Business Credit, LLC, and is not subject to any restrictive financial covenants. We have a maximum of $3,000 available under the Credit Agreement, with the actual borrowings based on eligible accounts receivable. As of August 31, 2003, there were $490 of borrowings under the Credit Agreement. The Credit Agreement bears an immediate processing fee of 0.50% of each assigned amount, a daily per diem equal to 1/25% on any uncollected accounts receivable and a monthly minimum of $1.5 in processing fees for the first six months the Credit Agreement is in place. Borrowings are reduced as collections and payments are received into a lock box by the bank. The effected interest rate based on our average DSO of 46 days would be 18.3% annualized.

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company incurred net losses of $4,629, $3,892 and $3,193 for the years ended August 31, 2003, 2002 and 2001, respectively.

We have historically financed our operations through the public and private sale of debt and equity securities, bank borrowings under lines of credit, operating equipment leases and cash generated by operations. Significant financial restructuring occurred during our fiscal year ended August 31, 2003, and early in our current fiscal year ending August 31, 2004, transforming our capital structure to a lower interest rate and less restrictive structure. We replaced a revolving line of credit with LaSalle Business Credit, LLC with an accounts receivable backed credit agreement with Beacon Bank that does not have restrictive covenants.

On October 29, 2003 we completed the funding of two separate loans in the aggregate amount of $2,350 under new Term Credit Facilities with Commerce Bank, a Minnesota state banking corporation, and its affiliate, Commerce Financial Group, a Minnesota corporation. The first note, with Commerce Bank in the amount of $1,200, is secured by our Victoria, Minnesota facility. The second note, with Commerce Financial Group, Inc. in the amount of $1,150, is secured by our Victoria facility and equipment located at our Tempe facility. These loans provided us with the necessary resources to prepay the subordinated promissory note from the Colorado MEDtech, Inc. (“CMED”) acquisition held by Whitebox Hedged High Yield Partners (see note 8). The terms of the new loans have an average interest rate of 7.75% as compared to 12.00% for the retired debt.

At August 31, 2003, our sources of liquidity consisted of $806 of cash and cash equivalents and our revolving credit line agreement, which was due to expire in May 2004. On December 12, 2003 the revolving line was extended to September 1, 2004. The credit line agreement allows for borrowings of up to $3,000 subject to availability based on accounts receivable. There was $490 outstanding debt at August 31, 2003, leaving an available credit of $2,510 at year-end. Our liquidity is affected by many factors, some of which are based on the normal ongoing operations of our business, the most significant of which include the timing of the collection of receivables, the level of inventories and capital expenditures. In the event cash flows are not sufficient to fund operations at the present level numerous measures can be taken to reduce the expenditure levels including but not limited to reduction of spending for research and development elimination of budgeted raises, and reduction of non-strategic employees.

During Fiscal 2004, we intend to spend approximately $750 for manufacturing equipment, extend the SAP Software Solution to our AMO and minor facility improvements. These additions, if made, will increase efficiency though the further integration of the Boulder operations and increase manufacturing capacity to meet anticipated production requirements and add technological capabilities. It is expected that these expenditures will be funded from operations, existing cash and cash equivalents and available debt financing for the next 12 months.

We generated cash flows from operating activities of $653, during fourth quarter of Fiscal 2003. We believe that existing cash and cash equivalents, current lending capacity and cash generated from operations will supply sufficient cash flow to meet short- and long-term debt obligations and operating requirements during the next 12 months.

Management believes that, as a result of the financial restructuring actions it has taken to reduce cash expenditures, the continuing efforts to increase revenues from continuing customers and to generate new customers in various industry sectors, the replacement and subsequent extension of its revolving and term credit facilities it has obtained, it will meet for its fiscal year ending August 31, 2004.

Giving effect to the refinancing in the first quarter of Fiscal 2004 of our Subordinated Promissory Note with the two notes from Commerce Bank and its affiliate, Commerce Financial Group, Inc., and the resulting $472 gain that has been reflected below as a reduction of contractual obligations, our contractual obligations at August 31, 2003, are summarized in the following table:

This Annual Report on Form 10-K contains forward-looking statements that are based on our current expectations and involve a number of risks and uncertainties. Factors that may materially affect revenues, expenses and operating results include, without limitation, adverse business or market conditions, our ability to secure and satisfy customers, the availability and cost of materials from suppliers, adverse competitive developments and change in or cancellation of customer requirements.

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

Because of these and other factors affecting our operating results, past financial performance should not be considered an indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. The following factors also may materially affect results and therefore should be considered.

If we are unable to integrate, operate and manage the Advanced Medical Operations, our operating results and business condition may be reduced. On January 24, 2003, we acquired our Colorado business unit from CMED. This business unit incurred substantial losses during CMED’s fiscal years ended June 30, 2002 and 2001 and for the six-months ended December 31, 2002. We may not be able to successfully and profitably integrate, operate, maintain and manage our Advanced Medical Operations in a competitive environment. In addition, we may not be able to integrate the newly hired employees and operational issues may arise as a result of a lack of integration or our lack of familiarity with issues specific to this operation. Further, certain of our assumptions relating to the timing of the integration and the use of the leased facility in Boulder, Colorado, may not prove to be accurate, causing increased costs at this facility. The inability to integrate the operations could impair our combined revenue opportunity and reduce the return on the assets purchased. The consolidated integration technology could take longer than anticipated, limiting the speed of the business combination, not allowing costs to be removed as quickly as originally forecasted.

If the components that we design and manufacture are the subject of product recalls or a product liability claim, our business may be damaged, we may incur significant legal fees and our results of operations and financial condition may be adversely affected. Certain of the components we design or manufacture are used in medical devices, several of which may be used in life-sustaining or life-supporting roles. The tolerance for error in the design, manufacture or use of these components and products may be small or nonexistent. If a component we designed or manufactured is found to be defective, whether due to design or manufacturing defects, improper use of the product or other reasons, the product may need to be recalled, possibly at our expense. Further, the adverse effect of a product recall on our business might not be limited to the cost of the recall. Recalls, especially if accompanied by unfavorable publicity or termination of customer contracts, could result in substantial costs, loss of revenues and damage to our reputation, each of which would have a material adverse effect on our business, results of operations and financial condition.

The manufacture and sale of the medical devices involves the risk of product liability claims. Although we generally obtain indemnification from our customers for components that we manufacture to the customers’ specifications and we maintain product liability insurance, there can be no assurance that the indemnities will be honored or the coverage of our insurance policies will be adequate. Further, we generally provide a design defect warranty and indemnify to our customers for failure of a product to conform to design specifications and against defects in materials and workmanship. Product liability insurance is expensive and

in the future may not be available on acceptable terms, in sufficient amounts, or at all. A successful product liability claim in excess of our insurance coverage or any material claim for which insurance coverage was denied or limited and for which indemnification was not available could have a material adverse effect on our business, results of operations and financial condition.

Our customer base is highly concentrated and the loss of a key customer may reduce our operating results and financial condition. Our customer base is highly concentrated. In Fiscal 2003, Fiscal 2002, and Fiscal 2001, our three largest customers, Siemens, Inc., Sonic Innovations, Inc., and GE Medical Systems, in the aggregate accounted for 45%, 65%, and 51%, respectively, of net sales. Each of these customers has multiple programs in production with us. Although we are reducing this concentration, we expect that sales to a relatively small number of OEMs will continue to account for a substantial portion of net revenues for the foreseeable future. The loss of, or a decline in orders from, any one of our key customers would materially adversely affect our operating results and financial condition. We are working for diversification such that no one market would account for 40% or more in revenue, no one customer at 10% or greater revenue and no one program at 25% or greater.

If we are unable to develop new products and services our revenue could decrease. Our products are subject to rapid obsolescence and our future success will depend upon our ability to develop new products and services that meet changing customer and marketplace requirements. Our products are based upon specifications from our customers. We may not be able to satisfactorily design and manufacture customer products based upon these specifications.

If we fail to properly anticipate the market for new products and service we may lose revenue. Even if we are able to successfully identify, develop and manufacture as well as introduce new products and services, there is no assurance that a market for these products and services will materialize to the size and extent that we anticipate. If a market does not materialize as we anticipate, our business, operating results and financial condition could be materially adversely affected. The following factors could affect the success of our products and services in the microelectronic and other marketplaces:


	•	the failure to adequately equip our manufacturing plant in anticipation of increasing business;

	•	the failure of our design team to develop products in a timely manner to satisfy our present and potential customers; and

	•	our limited experience in specific market segments in marketing our products and services, specifically in the telecom industry.

We may fail to have enough liquidity to operate our business because we may not adequately adjust our expenses to predicted revenue in any given period, which may dramatically and negatively impact our cash flow. Our basis for determining our ability to fund our operations depends on our ability to accurately estimate our revenue streams and our ability to accurately predict, our related expenditures. Furthermore, our borrowing base is fixed. As a result, we may fail to adequately adjust our expenses to actual revenue in any given period or we may experience significant fluctuations in quarterly revenue, either of which may dramatically and negatively affect our cash flow.

We may fail to adequately adjust our expenses to predicted revenue in any given period or we may experience significant fluctuations in quarterly revenue because the sales cycle for our products and services is lengthy and unpredictable. While our sales cycle varies from customer to customer, it historically has ranged from two to 12 months. Our pursuit of sales leads typically involves an analysis of our prospective customer’s needs, preparation of a written proposal, one or more presentations and contract negotiations. Our sales cycle may also be affected by the complexity of the product to be developed and manufactured as well as a prospective customer’s budgetary constraints and internal acceptance reviews, over which we have little or no control. As a result of these things combined with the fact that our expenses are fixed, we may fail to adequately adjust our expenses to predicted revenue in any given period or we may experience significant fluctuations in quarterly revenue.

Our business may suffer and cause our stock price to decline if we are unable to protect our intellectual property rights. Intellectual property rights are important to our success and our competitive position. It is our policy to protect all proprietary information through the use of a combination of nondisclosure agreements and other contractual provisions and patent, trademark, trade secret and copyright law to protect our intellectual property rights. There is no assurance that these agreements, provisions and laws will be adequate to prevent the imitation or unauthorized use of our intellectual property. Policing unauthorized use of proprietary systems and products is difficult and, while we are unable to determine the extent to which infringement of our intellectual property exists, we expect infringement to be a persistent problem. In addition, the laws of some foreign countries do not protect our products to the same extent that the laws of the United States protect our products. If our intellectual property rights are not protected our business may suffer if a competitor uses our technology to capture our business, which could cause our stock price to decline. Furthermore, even if the agreements, provisions and intellectual property laws prove to be adequate to protect our intellectual property rights, our competitors may develop products or technologies that are both non-infringing and substantially equivalent or superior to our products or technologies.

Third-party intellectual property infringement claims may be costly and may prevent the future sale of our products. Substantial litigation and threats of litigation regarding intellectual property rights exist in our industry. Third parties may claim that our products infringe upon their intellectual property rights. In particular, defending against third-party infringement claims may be costly and divert important management resources. Furthermore, if these claims are successful, we may have to pay substantial royalties or damages, remove the infringing products from the marketplace or expend substantial amounts in order to modify the products so that they no longer infringe on the third party’s rights.

We may pursue future acquisitions and investments that may adversely affect our financial position or cause our earnings per share to decline. In the future we may continue to make acquisitions of and investments in businesses, products and technologies that could complement or expand our business. Such acquisitions, though, involve certain risks:


	•	we may not be able to negotiate or finance the acquisition successfully,

	•	the integration of acquired businesses, products or technologies into our existing business may fail, and

	•	we may issue equity securities, incur debt, assume contingent liabilities or have amortization expenses and write-downs of acquired assets which could cause our earnings per share to decline.

If our customers are unable to gain market acceptance for the products that we develop or manufacture for them, we may lose revenue. We design and manufacture components for other companies. We also sell proprietary products that contain components to other companies and end-user customers. For products we manufacture (manufactured for others or those we sell directly), our success is dependent on the acceptance of those products in their markets. We have no control over the products or marketing of products that we sell to our customers. Market acceptance may depend on a variety of factors, including educating the target market regarding the use of a new procedure. Market acceptance and market share are also affected by the timing of market introduction of competitive products. Some of our customers, especially emerging growth companies, have limited or no experience in marketing their products and may be unable to establish effective sales and marketing and distribution channels to rapidly and successfully commercialize their products. If our customers are unable to gain any significant market acceptance for the products we develop or manufacture for them, our business will be adversely affected.

If we fail to comply with environmental laws and regulations we may be fined and prohibited from manufacturing products. As a small generator of hazardous substances, we are subject to local governmental regulations relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances, such as waste oil, acetone and alcohol that are used in very small quantities to manufacture our products. While we are currently in compliance with applicable regulations, if we fail to comply with these regulations substantial fines could be imposed on us and we could be required to suspend production, alter manufacturing processes or cease operations.

Future quarterly and annual operating results may fluctuate substantially due to a number of factors, many of which are beyond our control, which may cause our stock price to decline. We have experienced substantial fluctuations in our annual and quarterly operating results, and such fluctuations may continue in future periods. Our operating results are affected by a number of factors, many of which are beyond our control, including the following:


	•	we may manufacture products that are custom designed and assembled for a specific customer’s requirement in anticipation of the receipt of volume production orders from that customer, which may not always materialize to the degree anticipated, if at all;

	•	we may incur significant start-up costs in the production of a particular product, which costs are expensed as incurred and for which we attempt to seek reimbursement from the customer;

	•	we may experience fluctuations and inefficiencies in managing inventories, fixed assets, components and labor, in the degree of automation used in the assembly process, in the costs of materials, and the mix of materials, labor, manufacturing, and overhead costs;

	•	we may experience unforeseen design or manufacturing problems, price competition or functional competition (other means of accomplishing the same or similar packaging end result);

	•	we may be unable to pass on cost overruns;

	•	we may not have control over the timing of expenditures in anticipation of increased sales, customer product delivery requirements and the range of services provided; and

	•	we may experience variance in the amount and timing of orders placed by a customer due to a number of factors, including inventory balancing, changes in manufacturing strategy, and variation in product demand attributable to, among other things, product life cycles, competitive factors, and general economic conditions.

Any one of these factors, or a combination of one or more factors, could adversely affect our annual and quarterly operating results, which in turn may cause our stock price to decline.

We are dependent on a single industry and adverse trends in that industry may reduce our revenues. During the past several years, we have been significantly dependent on a single market. In Fiscal 2003, Fiscal 2002, and Fiscal 2001, 82%, 76%, and 61%, respectively of our net sales came from the hearing instrument and medical device manufacturers. These industries are characterized by intense competition, relatively short product life cycles, rapid technological change, significant fluctuations in product demand and significant pressure on vendors to reduce or minimize cost. Accordingly, we may be adversely affected by these industry trends to the extent that they reduce our revenues. In particular, if the hearing instrument manufacturers develop new technologies that do not incorporate our products, or if our competitors offer similar products at a lower cost to such manufacturers, our revenues may decrease and our business would be adversely affected.

Although we are attempting to reduce our dependence on a single industry, we do not expect this historic dependence to change dramatically or quickly. Moreover, a significant amount of our non-hearing instrument industry sales are made in the medical products industry, which is characterized by trends similar to those in the hearing instrument manufacturer industry.

Our customers are permitted to cancel their orders, change production quantities, delay production and terminate their contracts and any such event or series of events may adversely affect our gross margins and operating results. We, as a medical device development and manufacturing service provider, must provide product output that matches the needs of their customers, which can change from time to time. We generally do not obtain long-term commitments from our customers and we continue to experience reduced lead times in customer orders. Customers may cancel their orders, change production quantities, delay production, or terminate their contracts for a number of reasons. In certain situations, cancellations, reductions in quantities, delays or terminations by a significant customer could adversely affect our operating results. Such cancellations, reductions or delays have occurred and may continue to occur in response to slowdowns in our customers’ businesses or for other reasons. In addition, we make significant decisions, including determining

the levels of business that we will seek and accept, production schedules, parts procurement commitments, and personnel needs based on our estimates of customer requirements. Because many of our costs and operating expenses are relatively fixed, a reduction in customer demand or a termination of a contract by a customer could adversely affect our gross margins and operating results.

Inventory risk and production delay may adversely affect our financial performance. Most of our contract manufacturing services are provided on a turnkey basis, where we purchase some or all of the materials required for product assembling and manufacturing. We bear varying amounts of inventory risk in providing services in this manner. In manufacturing operations, we need to order parts and supplies based on customer forecasts, which may be for a larger quantity of product than is included in the firm orders ultimately received from those customers. While many of our customer agreements include provisions that require customers to reimburse us for excess inventory which we specifically order to meet their forecasts, we may not actually be reimbursed or be able to collect on these obligations. In that case, we could have excess inventory and/or cancellation or return charges from our suppliers. Our imaging and medical device manufacturing customers continue to experience fluctuating demand for their products, and in response they may ask us to reduce or delay production. If we delay production, our financial performance may be adversely affected.

We may lose business and revenues if we fail to successfully compete with our customers for business. We face competition from the internal operations of our current and potential OEM customers and from offshore contract manufacturers, which, because of their lower labor rates and other related factors, may enjoy a competitive advantage over us with respect to high-volume production. We expect to continue to encounter competition from other electronics manufacturers that currently provide or may begin to provide contract design and manufacturing services.

A number of our competitors may have substantially greater manufacturing, financial, technical, marketing, and other resources than we have, and may offer a broader scope and presence of operations on a worldwide basis. Significant competitive factors in the microelectronics market include price, quality, design capabilities, responsiveness, testing capabilities, the ability to manufacture in very high volumes and proximity to the customers final assembly facilities. While we have competed favorably in the past with respect to these factors, this is a particularly fast changing market, and there can be no assurance that we will continue to do so in the future.

We are often one of two or more suppliers on any particular customer requirement and are, therefore, subject to continuing competition on existing programs. In order to remain competitive in any of our markets, we must continually provide timely and technologically advanced design capabilities and manufacturing services, ensure the quality of our products, and compete favorably with respect to turnaround and price. If we fail to compete favorably with respect to the principal competitive factors in the markets we serve, we may lose business and our operating results may be reduced.

Fluctuations in the price and supply of components used to manufacture our products may reduce our profits. Substantially all of our manufacturing services are provided on a turnkey basis in which we, in addition to providing design, assembly and testing services, are responsible for the procurement of the components that are assembled by us for our customers. Although we attempt to minimize margin erosion as a result of component price increases, in certain circumstances we are required to bear some or all of the risk of such price fluctuations, which could adversely affect our profits. To date, we have generally been able to negotiate contracts that allow us to shift much of the impact of price fluctuations to the customer; however, there can be no assurance that we will be able to do so in all cases.

In order to assure an adequate supply of certain key components that have long procurement lead times, such as ICs, we occasionally must order such components prior to receiving formal customer purchase orders for the assemblies that require such components. Failure to accurately anticipate the volume or timing of customer orders can result in component shortages or excess component inventory, which in either case could adversely affect our operating results and financial condition.

Certain of the assemblies manufactured by us require one or more components that are ordered from, or which may be available from, only one source or a limited number of sources. Delivery problems relating to

components purchased from any of our key suppliers could have a material adverse impact on our financial performance. From time to time, our suppliers allocate components among their customers in response to supply shortages. In some cases, supply shortages will substantially curtail production of all assemblies using a particular component. In addition, at various times there have been industry-wide shortages of electronic components. While we have not experienced sustained periods of shortages of components in the recent past, there can be no assurance that substantial component shortages will not occur in the future. Any such shortages could reduce our operating results.

Our costs may increase significantly if we are unable to forecast customer orders and production schedules. The level and timing of orders placed by customers vary due to the customers’ attempts to balance their inventory, changes in customers’ manufacturing strategies, and variations in demand for the customers’ products. Due in part to these factors, most of our customers do not commit to firm production schedules more than several weeks in advance of requirements. Our inability to forecast the level of customers’ orders with certainty makes it difficult to schedule production and optimize utilization of manufacturing capacity. This uncertainty could also significantly increase our costs related to manufacturing product. In the past, we have been required to increase staffing and incur other expenses in order to meet the anticipated demands of our customers. From time to time, anticipated orders from some of our customers have failed to materialize and delivery schedules have been deferred as a result of changes in a customer’s business needs, both of which have adversely affected our operating results. On other occasions, customers have required rapid increases in production that has placed an excessive burden on our resources. There can be no assurance that we will not experience similar fluctuations in customer demand in the future.

We may be unable to realize revenue from our backlog. We compute our backlog from purchase orders received from our customers and from other contractual agreements. Our backlog is typically not a firm commitment from the customers. As such, even though we may have contractual agreements or purchase orders for future shipments, there is no guarantee that this backlog will be realized as revenue.

We may have a significant accounts receivable write-off as well as an increase in inventory reserve due to the inability of our customers to pay their accounts. We may carry significant accounts receivable and inventory in connection with providing manufacturing services to our customers. If one or more of our principal customers were to become insolvent, or otherwise fail to pay for the services and materials provided by us, our operating results and financial condition would be adversely affected.

Our business success may be adversely affected by our ability to hire and retain employees. Our continued growth and success depend to a significant extent on the continued service of senior management and other key employees and the hiring of new qualified employees. We rely upon the acquisition and retention of employees with extensive technological experience. Competition for skilled business, product development, technical and other personnel is intense. There can be no assurance that we will be successful in recruiting new personnel and retaining existing personnel. Our executive officers are subject to employment agreements that can be terminated upon providing 90 days advance, written notice by either party. The loss of one or more key employees may materially adversely affect our growth.

We operate in a regulated industry, and our products and revenue are subject to regulatory risk. We are subject to a variety of regulatory agency requirements in the United States and foreign countries relating to many of the products that we develop and manufacture. The process of obtaining and maintaining required regulatory approvals and otherwise remaining in regulatory compliance can be lengthy, expensive and uncertain.

The FDA inspects manufacturers of certain types of devices before providing a clearance to manufacture and sell such device, and the failure to pass such an inspection could result in delay in moving ahead with a product or project. We are required to comply with the FDA’s QSR for the development and manufacture of medical products. In addition, in order for devices we design or manufacture to be exported and for us and our customers to be qualified to use the “CE” mark in the European Union, we maintain ISO 9001/EN 46001 certification which, like the QSR, subjects our operations to periodic surveillance audits. To ensure compliance with various regulatory and quality requirements, we expend significant time, resources and effort in the areas of training, production and quality assurance. If we fail to comply with regulatory or quality

regulations or other FDA or applicable legal requirements, the governing agencies can issue warning letters, impose government sanctions and levy serious penalties.

Noncompliance or regulatory action could have a negative impact on our business, including the increased cost of coming into compliance, and an adverse effect on the willingness of customers and prospective customers to do business with us. Such noncompliance, as well as any increased cost of compliance, could have a material adverse effect on our business, results of operations and financial condition.

If our customers do not promptly obtain regulatory approval for their products, our projects and revenue may be adversely affected. The FDA regulates many of our customers’ products, and requires certain clearances or approvals before new medical devices can be marketed. As a prerequisite to any introduction of a new device into the medical marketplace, our customers must obtain necessary product clearances or approvals from the FDA or other regulatory agencies. This can be a slow and uncertain process, and there can be no assurance that such clearances or approvals will be obtained on a timely basis, if at all. In addition, products intended for use in foreign countries must comply with similar requirements and be certified for sale in those countries. A customer’s failure to comply with the FDA’s requirements can result in the delay or denial of approval to proceed with the product. Delays in obtaining regulatory approval are frequent and, in turn, can result in delaying or canceling customer orders. There can be no assurance that our customers will obtain or be able to maintain all required clearances or approvals for domestic or exported products on a timely basis, if at all. The delays and potential product cancellations inherent in the regulatory approval and ongoing regulatory compliance of products we develop or manufacture may have a material adverse effect on our projects and revenue, as well as our business, reputation, results of operations and financial condition.

If government or insurance company reimbursements for our customers’ products change, our products, revenues and profitability may be adversely affected. Governmental and insurance industry efforts to reform the healthcare industry and reduce healthcare spending have affected, and will continue to affect, the market for medical devices. There have been several instances of changes in governmental or commercial insurance reimbursement policies that have significantly impacted the markets for certain types of products or services or that have had an impact on entire industries, such as recent policies affecting payment for nursing home and home care services. Adverse governmental regulation relating to our components or our customers’ products that might arise from future legislative, administrative or insurance industry policy cannot be predicted and the ultimate effect on private insurer and governmental healthcare reimbursement is unknown. Government and commercial insurance companies are increasingly vigorous in their attempts to contain healthcare costs by limiting both coverage and the level of reimbursement for new therapeutic products even if approved for marketing by the FDA. If government and commercial payers do not provide adequate coverage and reimbursement levels for uses of our customers’ products, the market acceptance of these products and our revenues and profitability would be adversely affected.

We have customers located in foreign countries and our unfamiliarity of the laws and business practices of such foreign countries could cause us to incur increased costs. We currently have customers located in foreign countries and anticipate additional customers located outside the United States. Our lack of knowledge and understanding of the laws of, and the customary business practices in, foreign counties could cause us to incur increased costs in connection with disputes over contracts, environmental laws, collection of accounts receivable, holding excess and obsolete inventory, duties and other import and export fees, product warranty exposure and unanticipated changes in governmental regimes.

The price of our common stock may be adversely affected by significant price fluctuations due to a number of factors, many of which are beyond our control. The market price of our common stock has experienced significant fluctuations and may continue to fluctuate in the future. The market price of the common stock may be significantly affected by many factors, including:


	•	changes in requirements or demands for our services;

	•	the announcement of new products or product enhancements by us or our competitors;

	•	technological innovations by us or our competitors;


	•	quarterly variations in our or our competitors’ operating results;

	•	changes in prices of our or our competitors’ products and services;

	•	changes in our revenue and revenue growth rates;

	•	changes in earnings estimates by market analysts, speculation in the press or analyst community; and

	•	general market conditions or market conditions specific to particular industries.

The stock prices for many companies in the technology sector have experienced wide fluctuations that often have been unrelated to their operating performance. Such fluctuations may adversely affect the market price of our common stock.

Our Amended and Restated Articles of Incorporation and our Amended and Restated Bylaws, as amended, may discourage lawsuits and other claims against our directors. Our articles of incorporation provide, to the fullest extent permitted by Minnesota law, that our directors shall have no personal liability for breaches of their fiduciary duties to us. In addition, our bylaws provide for mandatory indemnification of directors and officers to the fullest extent permitted by Minnesota law. These provisions may reduce the likelihood of derivative litigation against directors and may discourage shareholders from bringing a lawsuit against directors for a breach of their duty.

We have issued numerous options to acquire our common stock that could have a dilutive effect on our common stock. As of December 15, 2003, we had options outstanding to acquire 1,399,600 shares of our common stock, exercisable at prices ranging from $1.680 to $20.375 per share, with a weighted average exercise price of approximately $7.054 per share. During the terms of these options, the holders will have the opportunity to profit from either an increase in the market price of our common stock with resulting dilution to the holders of shares who purchased shares for a price higher than the respective exercise or conversion price. In addition, the increase in the outstanding shares of our common stock as a result of the exercise or conversion of these options could result in a significant decrease in the percentage ownership of our common stock by the purchasers of our common stock.

The market price of our common stock may be reduced by future sales of our common stock in the public market. Sales of substantial amounts of common stock in the public market that are not currently freely tradable, or even the potential for such sales, could have an adverse effect on the market price for shares of our common stock and could impair the ability of purchasers of our common stock to recoup their investment or make a profit. As of December 15, 2003, these shares consist of:


	•	approximately 866,000 shares beneficially owned by our executive officers and directors; and

	•	approximately 1,447,100 shares issuable to option and warrant holders.

Unless the shares of our outstanding common stock owned by our executive officers and directors are further registered under the securities laws, they may not be resold except in compliance with Rule 144 promulgated by the SEC, or some other exemption from registration. Rule 144 does not prohibit the sale of these shares but does place conditions on their resale that must be complied with before they can be resold.

The trading dynamics of our common stock makes it subject to large fluctuations in the per share value. Our common stock is a micro-stock that is thinly traded on the NASDAQ National Market. In some cases, our common stock may not trade during any given day. Small changes in the demand for shares of our common stock can have a material impact, both negatively and positively, in the trading share price of our stock.

Our Amended and Restated Articles of Incorporation contain provisions that could discourage or prevent a potential takeover, even if such transaction would be beneficial to our shareholders. Our Amended and Restated Articles of Incorporation authorize our Board of Directors to issue up to 10,000,000 shares of common stock and 5,000,000 shares of undesignated stock, the terms of which may be determined at the time of issuance by the Board of Directors, without further action by our shareholders. Undesignated stock authorized by the Board of Directors may include voting rights, preferences as to dividends and liquidation,

conversion and redemptive rights and sinking fund provisions that could affect the rights of the holders of our common stock and reduce the value of our common stock. The issuance of preferred stock could also prevent a potential takeover because the terms of any issued preferred stock may require the approval of the holders of the outstanding shares of preferred stock in order to consummate a merger, reorganization or sale of substantially all of our assets or other extraordinary corporate transaction.

Our Amended and Restated Articles of Incorporation provide for a classified Board of Directors with staggered, three-year terms. Our Amended and Restated Articles of Incorporation also require the affirmative vote of a supermajority (80%) of the voting power for the following matters:


	•	to approve the merger or consolidation of HEI or any subsidiary with or into any person that directly or indirectly beneficially owns, or owned at any time in the preceding 12 months, five percent or more of the outstanding shares of our stock entitled to vote in elections of directors (a Related Person);

	•	to authorize the sale of substantially all of our assets to a Related Person;

	•	to authorize the issuance of any of our voting securities in exchange or payment for the securities or assets of any Related Person, if such authorization is otherwise required by law or any agreement;

	•	to adopt any plan for the dissolution of HEI; and

	•	to adopt any amendment, change or repeal of certain articles of the Amended and Restated Articles of Incorporation, including the articles that establish the authority of the Board of Directors, the supermajority voting requirements and the classified Board of Directors.

These provisions may have the effect of deterring a potential takeover or delaying changes in control or our management.

We do not have material exposure to market risk from fluctuations in foreign currency exchange rates because all sales are denominated in U.S. dollars.

We are exposed to a floating interest rate risk from our new Term Credit Facilities with Commerce Bank, a Minnesota state banking association. We obtained two separate loans in the aggregate amount of $2,350. The first note, with Commerce Bank, in the amount of $1,200, was executed on October 14, 2003. This note has a floating interest rate. The term of the first note is six years with interest rate at a nominal rate of 6.50% per annum for the first three years. Thereafter the interest rate will be adjusted on the first date of the fourth loan year to a nominal rate per annum equal to the then Three Year Treasury Base Rate (as defined) plus 3.00%; provided, however, that in no event will the interest rate be less than the Prime Rate plus 1.0% per annum. Monthly payment of principal and interest will be based on a twenty-year amortization with a final payment of approximately $980 due on November 1, 2009. The second note, with Commerce Financial Group, Inc., in the amount of $1,150 was executed on October 28, 2003. The term of the second note is four years, with a fixed interest rate of 8.975% per year through September 27, 2007. Monthly payments of principal and interest in the amount of $28 will be paid over a forty-eight month period beginning on October 28, 2003. A change in interest rates is not expected to have a material adverse effect on our near-term financial condition or results of operation as the first note has a fixed rate for its first three years and the second note has a fixed rate for its term.

Our financial statements as of August 31, 2003 and 2002, and for each of the years in the three-year period ended August 31, 2003, 2002 and 2001, together with the Independent Auditors’ Reports are included in this Form 10-K on the pages indicated below.

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

HEI, Inc. and its subsidiaries specialize in the design and manufacture of ultraminiature microelectronic devices and high technology products incorporating those devices. HEI, Inc. and subsidiaries are referred to herein as “HEI”, the “Company,” “us,” “we” or “our,” unless the context indicates otherwise. All dollar amounts are in thousands of US dollars except for per share amounts. The Company produces quality flex circuits and high performance laminate based substrates. HEI is also a provider of advanced medical products and comprehensive engineering and manufacturing outsourcing services for healthcare companies worldwide. The Company’s products are system components that are sold to medical imaging original equipment manufacturers (“OEMs”). The Company’s services include development and manufacturing of electronic and electromechanical devices and instrumentation, product definition, rapid prototyping, engineering, risk analysis, agency submissions, validation testing and value engineering.

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

Revenue Recognition. The Company recognizes revenue upon shipment of products to customers, when all contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. For inventory shipped on consignment, revenue is recognized upon transfer of title when the customer uses the inventory. In the normal course of business we enter into a number of contracts with our customers under which we provide engineering services on a per project basis. The Company recognizes revenue on these services based upon meeting certain milestones and or benchmarks that are attributable to the different contractual elements of the overall contract. Based on the accomplishments of these goals we use the percentage of completion methodology to recognize the revenue and related costs to generate said revenues. Sales, payment terms and pricing extended to customers are governed by the respective contract agreements or binding POs for each transaction and provide no right of return outside of contractual warranty terms. Payment terms are seven days for consignment program sales and four to 60 days for other customers. For items delivered with contingent payment terms, revenue is deferred for the greater of the amount of the contingent payment or the fair value of the undelivered elements and recognized when the contingency is resolved. We provide engineering and product development services to our customers pursuant to written contracts. The majority of these arrangements are time and material contracts. We recognize revenue as time is incurred or materials are consumed. To a lesser extent we have fixed-price contracts which are accounted for using either the completed contract method or the percentage of completion method.

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.

Inventories. Inventories are stated at the lower of cost or market and include materials, labor, and overhead costs. The majority of the inventory is purchased based upon contractual forecasts and customer POs, in which case excess or obsolete inventory is generally the customers’ responsibility.

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

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

Intangible Assets. Intangible assets are related to the acquisition of our AMO and are amortized on a straight-line basis over periods ranging from three to four years.

Patents. External costs associated with patents are capitalized and amortized over 60 months or the remaining life of the patent, whichever is shorter.

Impairment of Notes Receivable. The Company routinely performs an analysis as to the probability that the receivable is collectable. A note receivable is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the note receivable agreement including scheduled interest payments. When a note receivable is impaired we measure impairment based on the present value of expected future cash flows discounted at the note receivable effective interest rate, the Company may measure impairment based on a note receivables observable market price, or the fair value of the collateral if the note receivable is collateral dependent. Regardless of the measurement method, we shall measure impairment based on the fair value of the collateral when we determine that foreclosure is probable. A note receivable is collateral dependent if the repayment of the note is expected to be provided solely by the underlying collateral. We may choose a measurement method on a note-by-note basis. When an impairment is recognized a reserve is created for note losses.

Impairment of Long-lived and Intangible Assets. The Company accounts for impairment of long-lived assets in accordance with the provisions of Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 requires that long-lived and intangible assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

Research, Development and Engineering. The Company expenses all engineering and development costs as incurred.

Capitalized Software Development Costs. The Company has not capitalized software development costs for marketable software (Link-It) as the costs incurred in the period between the establishment of technical feasibility and its market launch was not significant. There were no costs capitalized during the periods presented.

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 income 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 amounts more likely than not to be realized. Income tax expense (benefit) is the tax payable (receivable) for the period and the change during the period in deferred income tax assets and liabilities.

Stock-based Compensation. We apply the intrinsic-value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for the issuance of stock incentives to employees and directors. No compensation expense related to employees’ and directors’

stock incentives has been recognized in the financial statements, as all options granted under stock incentive plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Had we applied the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123, “Accounting for Stock-Based Compensation,” to stock based employee compensation, our net loss per share would have increased to the pro forma amounts indicated below:

Customer Deposits. Customer deposits result from cash received in advance of services performed.

Net Loss Per Common Share. Basic earnings loss per share (“EPS”) is computed by dividing net loss by the weighted average number of common shares outstanding during each period. Diluted earnings per share are computed by dividing net income by the weighted average number of common shares outstanding assuming the exercise of dilutive stock options. The dilutive effect of the stock options is computed using the average market price of the Company’s stock during each period under the treasury stock method. During periods of loss, options are dilutive and are thus excluded from the calculation.

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

Financial Instruments. The fair value of cash equivalents, accounts receivable and payable approximate their carrying value due to the short-term nature of these instruments. The fair market values of the Company’s borrowings outstanding approximate their carrying values based upon current market rates of interest.

Reclassifications. Certain amounts reported in the prior years have been reclassified to conform to the current year presentation.

Recent Accounting Pronouncements. In November 2002, FASB issued Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements, Including Guarantees of Indebtedness of Others.” FIN No. 45 requires that upon issuance of certain types of guarantees, a guarantor recognize and account for the fair value of the guarantee as a liability. FIN No. 45 contains exclusions to this requirement, including the exclusion of a parent’s guarantee of its subsidiaries’ debt to a third party. The initial recognition and measurement provisions of FIN No. 45 is required to be applied on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN No. 45 are effective for financial statements of both interim and annual periods ending after December 31, 2002, which we adopted in the quarter ended March 1, 2003. The adoption of FIN 45 did not have a material impact on our financial position, results of operations or cash flows.

In November 2002, Emerging Issues Task Force (“EITF”) finalized its consensus on EITF Issue 00-21, “Revenue Arrangements with Multiple Deliverables,” which provides guidance on the timing of revenue recognition for sales undertaking to deliver more that one product or service. The Company is required to adopt EITF Issue 00-21 on transactions occurring after September 1, 2003. The Company does not expect the adoption of EITF 00-21 will have a material effect on its financial statements since revenue associated with these projects during its fiscal year ending August 31, 2004, is projected to be immaterial.

In January 2003, FASB issued FIN No. 46, “Consolidation of Variable Interest Entities,” which addresses accounting for special-purpose and variable interest entities. The adoption of FIN 46 did not have a impact on our financial position, results of operations or cash flows.

In December 2002, FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”. This statement, which is an amendment of SFAS No. 123, provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported financial results. The Company currently accounts for stock-based compensation using the intrinsic value method defined in Accounting Principles Board No. 25 and do not currently intend to voluntarily change to the fair value method described in SFAS No. 123. As a result, the Company does not expect the new guidelines found in SFAS No. 148 will have a material effect upon our financial statements at its adoption. The new interim reporting requirements are effective for interim periods beginning after December 15, 2002. The Company has adopted the disclosure provisions.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging,” which amends and clarifies financial accounting and reporting for derivative instruments. The adoption of SFAS No. 149 did not have an impact on the Company’s financial statements.

On May 15, 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”. The Statement requires issuers to classify as liabilities (or assets in some circumstance) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, the Statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. We adopted the provisions of the Statement on October 1, 2003. The adoption of SFAS No. 150 did not have an impact on the Company’s financial statements.

The following provides additional information concerning selected consolidated balance sheet accounts at August 31, 2003 and 2002:

Sales of our products are subject to limited warranty guarantees that typically extend for a period of twelve months from the date of manufacture. Warranty terms are included in customer contracts under which we are obligated to repair or replace any components or assemblies it deems defective due to workmanship or materials. We do, however, reserve the right to reject warranty claims where we determine that failure is due to normal wear, customer modifications, improper maintenance, or misuse. Warranty provisions are based on an estimated returns and warranty expenses applied to current period revenue and historical warranty

incidence over the preceding twelve-month period. Both the experience and the warranty liability are evaluated on an ongoing basis for adequacy. The following is a roll forward of the Company’s product warranty accrual for each of the fiscal years in the three-year period ending August 31, 2003, 2002 and 2001:

The unusual charges of $331 in the current year relate to the impairment of equipment. The asset impairment was triggered in the fourth quarter of our fiscal year ended August 31, 2003, by the development of alternative testing that was more efficient than what could be performed by our existing equipment and notification in the same quarter that a large portion of a significant customer program will be moved offshore in the first quarter of our current fiscal year ending August 31, 2004. The unusual charges of $1,693 incurred in our fiscal year ending August 31, 2001, relate to the write-off of accounts receivable related to customers of the Mexico products and the closure of that operation.

During our fiscal year ended August 31, 2001, unusual charges consist of $1,268 write-off of accounts receivable primarily related to Mexico customers, which occurred in the second quarter and $425 of costs related to the closing of the Mexico operations in the third quarter. The Mexico closure costs consisted of $150 in severance costs, $185 in facilities costs and $90 of other costs. The severance costs relate to contractual severance obligations to contract employees located in Mexico and non-contract obligations to employees located in Tucson. The facilities costs relate to the negotiated settlement of non-cancelable lease payments of $60 on the closed facilities and the write off of leasehold improvements and fixed assets of $125. At August 31, 2001, there were no remaining future cash obligations related to the Mexico closing.

On January 24, 2003, the Company acquired certain assets and assumed certain liabilities of CMED’s Colorado operations (a business unit of CMED) (the “Advanced Medical Operation” or “AMO”) in a business combination accounted for as a purchase. In exchange for certain assets of AMO, we issued 1,000 shares of our common stock and assumed approximately $900 of liabilities related to our AMO, as well as an operating lease and other contractual commitments. The consolidated financial statements of the Company include the results of this operation since January 24, 2003. Our purposes for acquiring AMO were to immediately gain access to the more stable medical sector, to consolidate marketing and sales efforts, and to expand our resources to become more full service or “one stop shop” to our customers and target markets. The design, development and manufacturing capabilities for medical devices at AMO coupled with our microelectronic design, development and manufacturing improves our offerings to the market to retain and gain customers.

Below is a table of the estimated acquisition consideration, preliminary purchase price allocation and annual amortization of the intangible assets acquired:

The intangible asset value for the developed technology was determined utilizing discounted cash flow analyses. The discounted cash flow analyses was based on three to five-year cash flow projections. The expected future cash flows attributable to developed technology was discounted to present value at discount rates ranging from 23% to 40%, taking into account risks related to the characteristics and applications of the developed technology, our anticipated courses of business activities, historical financial market rates of return, and assessments of the stage of the technology’s life cycle. The developed technology had reached technological feasibility and therefore was capitalized.

On October 31, 2003, MKS Instruments, Inc. (NASDAQ: MKSI) and HEI, Inc. signed an agreement wherein MKS purchased HEI’s solid state radio frequency power amplifier technology. The technology is focused on Tesla 1.5 magnetic resonance imaging (“MRI”) applications but can be scaled for use in other MRI equipment. The value of the transaction is $423,000. The first two milestone payments ($323,000) were paid by wire transfer on October 31, 2003. The remaining payment ($100,000) will become due upon HEI’s completion of the engineering support milestone. The engineering support milestone is targeted for completion in May 2004.

Amortization expense for developed technology for the fiscal year ended August 31, 2003, was $111. Amortization expense is estimated to be $137 during our fiscal year ending August 31, 2004, $137 during our fiscal year ending August 31, 2005, $63 during our fiscal year ending August 31, 2006 and $4 thereafter.

The preliminary purchase allocation includes an accrual of $730 related to an unfavorable operating lease; $2,380 for future estimated lease payments and a $600 accrual to fulfill estimated contractual manufacturing obligations. The $2,380 accrued for estimated lease payments consists of $5,910 for future lease obligations less estimated sublease payments of $3,530 on unoccupied space for which we are in the process of reviewing alternative uses since we do not intend to occupy. We have entered into an agency agreement with Julien J. Studley, Inc., a national commercial real estate services firm, to assist HEI in reducing its occupancy costs at this facility by sub-leasing the 50,000 square foot addition. The final allocation of the consideration to be paid may differ from those assumptions reflected in the accompanying audited consolidated financial statements. In our opinion, all adjustments necessary to present fairly such financial statements have been made based on the terms and structure of the acquisition of our AMO. We continue the process of gathering information to complete our analysis of the excess lease capacity and the contractual manufacturing obligations. Any reductions in these liabilities will result in a decrease in the carrying value of the intangible assets and fixed assets. Conversely, an increase in these liabilities increases the carrying values of long-lived assets. At

August 31, 2003, the carrying value of long-lived assets has been reduced by a net of $3,760 by the allocation of negative goodwill. We anticipate completing the purchase price allocation prior to January 24, 2004.

The following table presents the unaudited pro forma consolidated results of operations of the Company for the fiscal years ended August 31, 2003, 2002 and 2001, as if the acquisition of our AMO took place on October 1, 2002, 2001 and 2000, respectively:

As our AMO had a June 30 year-end and the Company has an August 31 fiscal year-end, the pro forma information reflects the combination of different periods for the Company and our AMO. The twelve-month 2003, 2002 and 2001 pro forma information includes unaudited results of operations for the twelve-month periods ended August 31, 2003, 2002 and 2001, respectively, for the Company and unaudited results of operations for the twelve-month periods ended June 30, 2003, 2002 and 2001, for our AMO, respectively.

The unaudited pro forma amounts have been derived by applying pro forma adjustments to the historical consolidated financial information of the Company and AMO. The unaudited pro-forma results are for comparative purposes only and do not necessarily reflect the results that would have been recorded had the acquisition occurred at the beginning of the period presented or the results which might occur in the future.

During our fiscal year ended August 31, 2003 and our current fiscal year ending August 31, 2003, we have undertaken a number of activities to restructure our term-debt. The following is a summary of those transactions:

We originally issued Industrial Development Revenue Bonds (“IDRBs”) in April 1996 in connection with the construction of a new addition to our manufacturing facility in Victoria, Minnesota, and for the purchase of production equipment. On March 14, 2003, an aggregate of approximately $1,735 of debt proceeds from the Subordinated Promissory Note were used to fund the repayment of principal and interest on the IDRBs. We also used $845 of the proceeds from the Subordinated Promissory Note to retire our capital expenditure notes with LaSalle Business Credit LLC.

The funds to prepay the Subordinated Promissory Note were obtained from two separate loans in the aggregate amount of $2,350 under new Term Credit Facilities with Commerce Bank, a Minnesota state banking association, and, its affiliate, Commerce Financial Group, Inc., a Minnesota corporation. The first note, with Commerce Bank, in the amount of $1,200 was executed on October 14, 2003. This note is secured by our Victoria, Minnesota facility. The term of the first note is six years with interest rate at a nominal rate of 6.50% per annum for the first three years. Thereafter the interest rate will be adjusted on the first date of the fourth loan year to a nominal rate per annum equal to the then Three Year Treasury Base Rate (as defined) plus 3.00%; provided, however, that in no event will the interest rate be less than the Prime Rate plus 1.0% per annum. Monthly payment of principal and interest will be based on a twenty-year amortization with a final payment of approximately $980 due on November 1, 2009. The second note, with Commerce Financial Group, Inc., in the amount of $1,150 was executed on October 28, 2003. The second note is secured by our Victoria facility and equipment located at our Tempe facility. The term of the second note is four years, with an interest rate of 8.975% per year through September 27, 2007. Monthly payments of principal and interest in the amount of $28 will be paid over a forty-eight month period beginning on October 28, 2003.

Principal maturities of long-term debt at August 31, 2003, giving effect to the refinancing in October 2003 of our Subordinated Promissory Note with the two notes from Commerce Bank, and related reduction in principal payments, are as follows:

The above table of principal maturities of long-term debt has been reduced by $472 from the Company’s August 31, 2003, balance to reflect a gain of early repayment of the debt refinancing in October 2003.

On May 29, 2003, we entered into an accounts receivable agreement (the “Credit Agreement”) with Beacon Bank of Shorewood, Minnesota for a period of twelve months. On December 12, 2003, the Company extended the Credit Agreement to September 1, 2004. The Credit Agreement is an accounts receivable backed facility and is additionally secured by inventory, intellectual property and other general intangibles. The Credit Agreement replaced our revolving line of credit with LaSalle Business Credit, LLC, and is not subject to any restrictive financial covenants. We have a maximum of $3,000 available under the Credit Agreement, with the actual borrowings based on eligible accounts receivable. As of August 31, 2003, there were $490 of borrowings under the Credit Agreement. Effective August 31, 2003, the Credit Agreement bears an immediate processing fee of 0.50% of each assigned amount, a daily per diem equal to 1/25% on any uncollected accounts receivable and a monthly minimum of $1.5 in processing fees for the first six months the Credit Agreement is in place. Borrowings are reduced as collections and payments are received into a lock box by the bank. The effected interest rate based on our average DSO of 46 days would be 18.3% annualized.

On June 24, 1999, the Company obtained an exclusive, worldwide license from Micro Substrates Corporation (“MSC”) to manufacture and market a new high-frequency chip carrier for applications in Local Multipoint Distribution Services, ultra high-speed Internet routing and satellite communications. In a related transaction, the Company made an initial cash equity investment of $1,500 in MSC for a 28% equity ownership and the right to supply goods and services, such as thin film substrate processing, to MSC. The Company’s investment in MSC was accounted for under the equity method.

During the fourth quarter of our fiscal year ended August 31, 2001, certain material adverse changes occurred in MSC’s business, including a weakening of the economy and demand for MSC’s products. The Company wrote-off the remaining value of the investment in MSC and the related license agreement. Circuit Components Inc. (“CCI”), the majority stockholder in MSC ultimately exercised its call options for the Company’s 28% interest in MSC under the stock purchase agreement between the Company and CCI. This

call provided the Company with a $750 five-year interest-bearing note, payable in quarterly installments. This note is secured by 700,000 shares of MSC, which is released to CCI prorata as the Company receives payments. The Company has fully reserved the $750 note, therefore, the payments on the note are being recognized as other income when the principal and interest payments are received. The Company adopted a cash basis of accounting for the loan due to the unsecured nature of the note and the inability to obtain CCI financial data.

For the fiscal year ended August 31, 2003, the Company recognized $150 in other income and $28 in interest income related to payments under this note. At August 31, 2003, $525 remains outstanding on the note.

For the fiscal year ended August 31, 2001 the Company’s losses associated with MSC were $1,450 and are included in loss on equity investment on the statement of operations.

Income tax expense (benefit) for the fiscal years ended August 31, 2003, 2002 and 2001 consisted of the following:

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

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at August 31, 2003 and 2002 are as follows:

The Company has a federal net operating loss carry-forward at August 31, 2003, of approximately $13,235, which is available to reduce income taxes payable in future years. If not used, this carry-forward will expire in years 2012 through 2023. Under the Tax Reform Act of 1986, the utilization of this tax loss carry-forward may be limited as a result of significant changes in ownership. In addition, the Company has a capital loss carry-forward of $84 which is available to offset any future capital gains. If not used, this carry-forward will expire in 2007.

The valuation allowance for deferred tax assets as of August 31, 2003, was $5,405 and as of August 31, 2002, was $3,420. The total valuation allowance for the fiscal year ended August 31, 2003, increased by $1,985 and the valuation allowance for the fiscal year ended August 31, 2002, increased by $2,910. In assessing the recovery of the deferred tax asset, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in the periods in which those temporary differences become deductible. Management considers the scheduled reversals of future deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.

1998 Plan. Under the Company’s 1998 Stock Option Plan (the “1998 Plan”), a maximum of 1,300,000 shares of common stock may be issued pursuant to qualified and nonqualified stock options. Stock options

granted become exercisable in varying increments with a portion tied to the closing stock price or up to a maximum of ten years, whichever comes first. The exercise price for options granted is equal to the closing market price of the common stock on the date of the grant. At August 31, 2003, the number of shares available for grant was 41,825.

1989 Plan. Under the Company’s 1989 Omnibus Stock Compensation Plan (the “1989 Plan”), a maximum of 2,000,000 shares of common stock may be issued pursuant to qualified and nonqualified stock options, stock purchase rights and other stock-based awards. Stock options granted become exercisable in varying increments with a portion tied to the closing stock price or up to a maximum of ten years, whichever comes first. Generally, the exercise price for options granted is equal to the closing market price of the common stock on the date of the 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 our fiscal years ended August 31, 2003, 2002, and 2001, 34,035, 20,271 and 1,639 shares at prices of $1.59, $5.12, and $7.97, respectively, were purchased under the 1989 Plan in connection with the employee stock purchase plan. At August 31, 2003, the number of shares available for grant was 151,041.

Directors’ Plan. During Fiscal 1999, the shareholders approved the 1998 Stock Option Plan for Non-employee Directors (the “Director’s Plan”). Under the Director’s Plan, 425,000 shares are authorized for issuance, with an initial year grant of 55,000 shares and an annual grant thereafter of 10,000 shares to each non-employee director. These grants are effective each year upon adjournment of the annual shareholders’ meeting at an exercise price equal to the market price on the date of grant. The options become exercisable at the earlier of seven years after the grant date or on the first day the market value equals or exceeds $25.00. These options expire ten years after the grant date. Options to purchase 30,000 shares, in the aggregate, were granted to the three non-employee directors at $2.16, $5.95, and $13.875 during our fiscal years ended August 31, 2003, 2002 and 2001, respectively. At August 31, 2003, 30,000 shares were available for grant.

Change of Control. Under the terms and conditions of the Company’s 1989 Plan and the Director’s Plan, a change of control in the Company’s Board of Directors, under certain circumstances, requires a liquidation of all unexercised stock options.

Summary of Activity. The following is a summary of all activity involving the above stock option plans:

The following table summarizes information about stock options outstanding as of August 31, 2003:

The weighted average grant-date fair value of options granted during our fiscal years ended August 31, 2003, 2002 and 2001, was $1.84, $3.37 and $8.27, respectively. The weighted average fair value of options was determined separately for each grant under the Company’s various plans by using the fair value of each option

and warrant grant on the date of grant, utilizing the Black-Scholes option-pricing model and the following key weighted average assumptions:

Stock Warrants. In August 2001, the Board of Directors authorized the Company to issue up to 100,000 Common Stock Purchase Warrants (“Warrants”). In August 2001, the Company issued 47,700 Warrants in connection with a financing transaction. The Warrants vested immediately at an exercise price of $8.05 per share of Common Stock and expire five-years from date of grant.

Approximately 1,447,100 1,540,000 and 1,156,000 shares under stock options and warrants have been excluded from the calculation of diluted net loss per common share as they are antidilutive for our fiscal years ended August 31, 2003, 2002 and 2001, respectively.

On August 29, 2001, the Company completed a $6,700 private placement of its common stock. HEI sold 950,000 shares of common stock at $7.00 per share. The Company received net proceeds of approximately $6,336.

During April 2001, the Company recorded notes receivable of $1,266 from certain officers and directors in connection with the exercise of stock options. These notes were amended on July 2002 and provide for full recourse to the individuals, bear interest at Prime with the exception of one individual at prime plus 1/2 per annum and have a term of five years with interest only payments to be made annually (November 2, 2002 and April 2, 2003) for the first (2) years and annual principal and interest installments through April 2, 2006. These notes receivable are classified as a reduction to shareholders’ equity on the consolidated balance sheet. As of August 31, 2003, the interest due the Company on these notes was $10 and is payable April 2, 2004. As of August 31, 2003, notes receivable of $1,256 remains outstanding with $587 reserved due to its uncollectible nature.

On June 30, 2003, we commenced litigation against Anthony J. Fant, the former Chairman of the Board, Chief Executive Officer and President and a current director, in the State of Minnesota, Hennepin County District Court, Fourth Judicial District. The complaint alleged breach of contract, conversion, breach of fiduciary duty, unjust enrichment and corporate waste resulting from, among other things, Mr. Fant’s default on his promissory note to us and other loans and certain other matters. On August 12, 2003, we obtained a judgment against Mr. Fant on our breach of contract count in the amount of approximately $606. On August 12, 2003, the Court did not rule on the other counts in the complaint, reserving to a later time such determination. On November 24, 2003, the Court granted us an additional judgment against Mr. Fant in the amount of approximately $993 on the basis of our conversion, breach of fiduciary duty, unjust enrichment and corporate waste claims. We are engaged in efforts to collect on the judgment and plan to continue to collect on the judgment in due course. We have obtained, through garnishments, in excess of approximately $112 from Mr. Fant’s accounts. Such amount partially reduces the judgment amount. We continue to seek to collect on the remaining judgment amount in Minnesota and other states where it is believed that Mr. Fant may have non-exempt and unencumbered assets.

The Company has a 401(k) plan covering all eligible employees. Employees can make voluntary contributions to the plan of up to 90% 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 our fiscal years ended August 31, 2003, 2002 and 2001, the Company contributed $77, $45 and $119, respectively, to the plan.

The Company leases certain office and manufacturing space and equipment under noncancelable operating leases. Giving effect to the acquisition of AMO and the assumed operating lease and other

contractual commitments, future minimum lease payments, excluding executory costs such as real estate taxes, insurance and maintenance expense, by year and in the aggregate are as follows:

The table below sets forth the approximate percentage of net sales to major customers that represented over 10% of our revenue.

Sonic Innovations, Inc. has verbally advised us that it intends to discontinue a significant program with us in order to place it offshore. This program discontinuance will reduce but not eliminate sales to this customer.

Accounts receivable from these customers represented 28%, 28%, and 52% respectively, of the total accounts receivable at August 31, 2003, 2002 and 2001, respectively.

The Company generally sells its products to OEMs in the United States and abroad in accordance with supply contracts specific to certain manufacturer product programs. The Company performs ongoing credit evaluations of its customers’ financial conditions and, generally, does not require collateral from its customers. The Company’s continued sales to these customers are often dependent upon the continuance of the customers’ product programs.

The Company had net sales of $5,298, $9,062 and $11,209 that were shipped to Singapore during its fiscal years ended August 31, 2003, 2002 and 2001, respectively. Total net export sales were $10,823, $11,475, and $14,711 during the Company’s fiscal years ended August 31, 2003, 2002 and 2001, respectively. The majority of the international sales were to multinational companies who instructed HEI to ship products to their offshore assembly facilities.

The agreement contains a non-compete clause restricting HEI from developing and selling competing solid state amplifiers in the MRI market for a period of two years. The non-compete clause does not restrict HEI from fulfilling its traditional role as a contract manufacturer of third party solid state MRI amplifiers.

On November 17, 2003, we entered into a Settlement Agreement and Mutual Release (the “Settlement Agreement”) with Becton Dickinson (“BD”), pursuant to which, among other things, we agreed to pay to BD the sum of $400,000. Such amount will be paid in five installments of $80,000, the first of which was paid on November 17, 2003, and the remainder of which will be paid on January 31, 2004, April 30, 2004, July 31, 2004 and September 30, 2004, respectively. Except for cash flow, the Settlement Agreement will not impact our financial statements since a full reserve existed based on the purchase accounting entry at time of acquisition of CMED. The dispute was based upon certain equipment that was shipped prior to the acquisition of our AMO and did not meet the acceptance criteria per agreement with the customer. The Settlement Agreement will settle all claims know and unknown regarding the 5ml equipment.

Prior to commencing the litigation against Mr. Fant, our board of directors established a special committee of independent directors (the “Special Committee”) to address all issues related to Mr. Fant. The Special Committee has reported to us that it has completed a thorough internal investigation of such issues, including an accounting review relating to certain expenses incurred by us on behalf of Mr. Fant.

The Special Committee also reviewed the actions taken by us to address the issues related to Mr. Fant’s actions, which included our litigation against Mr. Fant, enhancement of our controls over expense reporting and setting a proper tone at the top from our new CEO, and concluded that such actions were appropriate. The Special Committee believes that our only remaining actions with respect to Mr. Fant include (i) continuing to seek to collect on the remaining judgment amount in Minnesota and other states where it is believed that Mr. Fant may have non-exempt and unencumbered assets and (ii) nominating a person other than Mr. Fant to fill the director position currently held by Mr. Fant when Mr. Fant’s current term ends at our 2005 Annual Meeting of Shareholders.

We have audited the accompanying consolidated balance sheets of HEI, Inc. and subsidiaries as of August 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended August 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HEI, Inc. and subsidiaries as of August 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended August 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

Under date of December 12, 2003, we reported on the consolidated balance sheets of HEI, Inc. and subsidiaries as of August 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended August 31, 2003, as contained in the annual report on Form 10-K for the fiscal year ended August 31, 2003. In connection with our audits of the aforementioned consolidated financial statements, we have also audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.

In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

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

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

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

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

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

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

During the course of their audit of our Consolidated Financial Statements for the fiscal year ended August 31, 2003, our independent auditors, KPMG LLP, advised management and Audit Committee of our Board of Directors that they had identified a deficiency in internal control. The deficiency is considered to be a “material weakness” as defined under standards established by the American Institute of Certified Public Accountants. The material weakness relates to the overriding, by our former Chief Executive Officer and Chief Financial Officer, of internal controls relating to the payment of certain expenses not supported by proper documentation.

Prior to the identification of such deficiency, we had already undertaken, or began to undertake, a number of steps to establish a proper control environment, including:


	•	the replacement of the chief executive officer and chief financial officer,

	•	the establishment of a special committee of independent directors to address all issues relating to the former chief executive officer;

	•	the completion of an accounting review by an independent accounting firm relating to the payment of certain expenses not supported by proper documentation;

	•	the elimination of opportunities to override appropriate controls over expense reporting by elimination of substantially all corporate credits cards and the requirement of approved expense reports for any travel reimbursement; and

	•	the establishment by our current Chief Executive Officer of a tone at the top that overriding of internal controls will not be tolerated.

In addition, we are in the process of establishing a whistle blower policy and process. We will continue to evaluate the effectiveness of our internal controls and procedures on an ongoing basis, we will implement actions to enhance our resources and training in the area of financial reporting and disclosure responsibilities and we will review such actions with our Audit Committee and KPMG LLP.

We have discussed our corrective actions and plans with the Audit Committee and KPMG LLP and, as of the date of this report, we believe the actions outlined have corrected the deficiencies in internal controls that are considered to be a material weakness. Further, our management, including the Chief Executive Officer and President and Chief Financial Officer, have conducted an evaluation of the effectiveness of disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and President and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective.

Notwithstanding the foregoing, there can be no assurances that our disclosure controls and procedures will detect or uncover all failure of persons with the Company and its consolidated subsidiaries to report material information otherwise required to be set forth in the reports that we file with the Securities and Exchange Commission.

Information regarding executive officers required by this Item 10 is set forth in Part I of this Annual Repot on Form 10-K pursuant to Instruction 3 to Item 401(b) of Regulation S-K. The other information required by this Item 10 is incorporated herein by reference to the discussions under the sections captioned

“Proposal No. 1 — Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” to be included in HEI’s Definitive Proxy Statement for its 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.

The information required by this Item 11 is incorporated herein by reference to the discussions under the sections captioned “Director Compensation” and “Executive Compensation,” but excluding the discussions included under the subsections captioned “Executive Compensation — Report of the Compensation Committee on Executive Compensation,” “Executive Compensation — Stockholder Return Performance Presentation” and “Executive Compensation — Certain Relationships and Related Transactions,” to be included HEI’s definitive Proxy Statement for its 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.

The information required by this Item 12 is incorporated herein by reference to the discussion under the section captioned “Shares Beneficially Owned” to be included in HEI’s Definitive Proxy Statement for its 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.

The information required by this Item 13 is incorporated herein by reference to the discussion under the section captioned “Executive Compensation — Certain Relationships and Related Transactions” to be included in HEI’s Definitive Proxy Statement for its 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.


	(1) Financial Statements — see Part II

	(2) Schedule II — Valuation and Qualifying Accounts — See Part II

On June 3, 2003, we filed a Current Report on Form 8-K reporting, under Item 9 — Regulation FD Disclosure, that certain officers delivered an investor presentation

On July 15, 2003, we filed a Current Report on Form 8-K reporting, under Item 7 — Financial Statements and Exhibits, that we issued a press release regarding our results for our third quarter of our fiscal year ending August 31, 2003.

On July 17, 2003, we filed a Current Report on Form 8-K reporting, under Item 5 — Other Events, that we issued several press releases regarding the following: (i) that we signed a value-added reseller (VAR) agreement with SAMSys Technologies Inc.; (ii) that we entered into a Credit Agreement with Beacon Bank of Shorewood, Minnesota; (iii) that we would attend the Medical Design and Manufacturing Conference and Exposition East in New York, NY, on June 2-4, 2003, to demonstrate our combined microelectronic packaging, high density interconnection and advanced medical device development and manufacturing capabilities; (iv) that Steve Tondera resigned as our Chief Financial Officer and as a member of our Board of Directors and that Douglas Nesbit was appointed to replace Mr. Tondera effective as of June 30, 2003; (v) that we commenced litigation against Anthony J. Fant, our former Chairman of the Board, Chief Executive Officer and President and a current member of the Board of Directors, and established a special committee of the independent members of the Board of Directors to address all issues related to

Mr. Fant,; (vi) that Scott Stole was promoted to the position of Chief Technical Officer; and (vii) that we signed an agreement with Cerner Corporation to develop and supply certain bedside healthcare integration products.

On August 13, 2003, we filed a Current Report on Form 8-K reporting, under Item 5 — Other Events, that we issued a press release announcing that we had received a default judgment in our lawsuit against Anthony J. Fant, our former Chairman, Chief Executive Officer and President and a current member of our Board of Directors.

On August 28, 2003, we filed a Current Report on Form 8-K reporting, under Item 5 — Other Events, that we issued a press release announcing that we successfully completed our external assessment to the international standard for Quality Management Systems, ISO9001:2000 by the NSAI.


(1)	Filed as an exhibit to the Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 21, 2000, and incorporated herein by reference.

(2)	Filed as an exhibit to the Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 10, 2003, and incorporated herein by reference.

(3)	Filed as an exhibit to the Definitive Proxy Statement on Schedule 14A for the 2002 Annual Meeting of Shareholders, filed with the Securities and Exchange Commission on January 23, 2002, and incorporated herein by reference.

(4)	Filed as an exhibit to the Annual Report on Form 10-KSB for the fiscal year ended August 31, 2000, and incorporated herein by reference.

(5)	Filed as an exhibit to the Annual Report on Form 10-K for the fiscal year ended August 31, 2001, and incorporated herein by reference.

(6)	Filed as an exhibit to the Quarterly Report on Form 10-Q for the quarterly period ending November 30, 2002, and incorporated herein by reference.


(7)	Filed as an exhibit to the Quarterly Report on Form 10-Q for the quarterly period ending February 28, 2003, and incorporated herein by reference.

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

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


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

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

(12)	Filed as an exhibit to the Annual Report on Form 10-K for the fiscal year ended August 31, 2002, and incorporated herein by reference.

(13)	Filed as an exhibit to the Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 4, 2001, and incorporated herein by reference.

(14)	Filed as an exhibit to the Current Report on Form 8-K/ A (Amendment No. 1), filed with the Securities and Exchange Commission on April 10, 2003, and incorporated herein by reference.

(15)	Filed as an exhibit to the Quarterly Report on Form 10-Q for the quarterly period ended May 31, 2003, and incorporated herein by reference.

In accordance with Section 13 or 15(c) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized


	By:	/s/ MACK V. TRAYNOR III



	Mack V. Traynor III
	Chief Executive Officer and President

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.

64 EX-3.3 3 c81087exv3w3.txt EX-3.3 AMENDMENT, DATED MARCH 19, 2003 TO BYLAWS EXHIBIT 3.3 AMENDMENTS TO THE AMENDED AND RESTATED BYLAWS OF HEI, INC. (EFFECTIVE AS OF MARCH 19, 2003) A new Section 3.14 has been added: Section 3.14. Chairman of the Board. The Chairman of the Board, if one is elected by the Board of Directors, shall preside at all meetings of the shareholders and directors and shall have such other duties as may be prescribed, from time to time, by the Board of Directors. The Chairman of the Board shall not be deemed to be an officer or employee of the corporation solely by serving as the Chairman of the Board. Section 4.01 has been deleted in its entirety and replaced with the following: Section 4.01. Officers. The officers of the corporation shall consist of a Chief Executive Officer, a Chief Financial Officer, a Secretary and such other officers and agents as may, from time to time, be elected or appointed by the Board of Directors. Any number of offices may be held by the same person. Section 4.04 of the Bylaws is deleted in its entirety and replaced with the following: Section 4.04. [Reserved.] EX-10.24 4 c81087exv10w24.txt EX-10.24 1998 STOCK OPTION PLAN EXHIBIT 10.24 HEI, INC. 1998 STOCK OPTION PLAN FOR NONEMPLOYEE DIRECTORS (AS AMENDED BY THE BOARD OF DIRECTOR JUNE 7, 1999, AND DECEMBER 12, 2002) 1. Purpose. The purpose of this Plan is to attract and retain qualified individuals to serve as nonemployee members of the Board of Directors of HEI, Inc. (the "Company") and to provide such persons with appropriate incentives. The Company has adopted the Plan effective as of November 18, 1998, subject to the approval of the Company's stockholders, and unless extended by amendment in accordance with the terms of the Plan, no Option Rights will be granted hereunder after the tenth anniversary of such effective date. Upon the approval of the adoption of the Plan by the Company's stockholders, the Plan will replace and supersede the Company's prior Stock Option Plan for Nonemployee Directors (the "1991 Plan"). 2. Definitions. As used in this Plan, "Board" means the Board of Directors of the Company. "Change in Control" means a change in control of the Company, which will be deemed to have occurred after the effective date of this Plan if: (i) any "person" as such term is used in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d) and 14(d) thereof except that such term shall not include (A) the Company or any of its subsidiaries, (B) any trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its affiliates, (C) an underwriter temporarily holding securities pursuant to an offering of such securities, (D) any corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of Common Shares, or (E) any person or group as used in Rule 13d-1(b) under the Exchange Act, is or becomes the Beneficial Owner, as such term is defined in Rule 13d-3 under the Exchange Act, directly or indirectly, of securities of the Company (not including in the securities beneficially owned by such person any securities acquired directly from the Company or its affiliates other than in connection with the acquisition by the Company or its affiliates of a business) representing 50% or more of the combined voting power of the Company's then outstanding securities. (ii) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board, and any new director (other than (A) a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clause (i), (iii), or (iv) of this definition or (B) a director whose initial assumption of office is in connection with an actual or threatened election contest, including but not limited to a consent solicitation, relating to the election of directors of the Company) whose election by the Board or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute at least a majority thereof; (iii) there is consummated a merger or consolidation of the Company or any direct or indirect subsidiary of the Company with any other corporation, other than (A) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or any parent thereof) in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of the Company or any subsidiary of the Company, at least 75% of the combined voting power of the securities of the Company or such surviving entity or any parent thereof outstanding immediately after such merger or consolidation, or (B) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no person (as defined above) is or becomes the beneficial owner, directly or indirectly, of securities of the Company (not including in the securities beneficially owned by such person any securities acquired directly from the Company or its affiliates other than in connection with the acquisition by the Company or its affiliates of a business) representing 25% or more of the combined voting power of the Company's then outstanding securities; or (iv) the stockholders of the Company approve a plan of complete liquidation or dissolution of the Company or there is consummated an agreement for the sale or disposition by the Company of all or substantially all of the Company's assets (or any transaction having a similar effect) other than a sale or disposition by the Company of all or substantially all of the Company's assets to an entity, at least 75% of the combined voting power of the voting securities of which are owned by stockholders of the Company in substantially the same proportions as their ownership of the Company immediately prior to such sale. "Code" means the Internal Revenue Code of 1986, as amended from time to time. "Common Shares" means (i) shares of the voting common stock of the Company and (ii) any security into which Common Shares may be converted by reason of any transaction or event of the type referred to in Section 6 of this Plan. "Date of Grant" means the date specified by the Board on which a grant of Option Rights shall become effective, which shall not be earlier than the date on which the Board takes action with respect thereto. "Disability" means any physical or mental illness, injury or condition that would qualify a Participant for benefits under any long-term disability benefit plan maintained by the Company or any Subsidiary and applicable to such Participant (or, if the Participant is not eligible for any such plan, to senior executive officers of the Company). "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time. "Market Value per Share" means the fair market value of the Common Shares as determined by the Board from time to time. "Option Price" means the purchase price payable upon the exercise of an Option Right. "Option Right" means the right to purchase Common Shares from the Company upon the exercise of a nonqualified stock option granted pursuant to Section 4 of this Plan. "Participant" means an individual who, at the time of any automatic award of Option Rights pursuant to Section 4 below, is a member of the Board and both a "non-employee director" within the meaning of Rule 16b-3 and an "outside director" within the meaning of Section 162(m) of the Code. "Rule 16b-3" means Rule 16b-3, as promulgated and amended from time to time by the Securities and Exchange Commission under the Exchange Act, or any successor rule to the same effect. "Subsidiary" means a corporation, partnership, joint venture, unincorporated association or other entity in which the Company has a direct or indirect ownership or other equity interest. 3. Shares Available under the Plan. Subject to adjustment as provided in Section 6 of this Plan, the number of Common Shares which may be issued or transferred upon the exercise of Option Rights shall not in the aggregate exceed 425,000 Common Shares (including any Common Shares remaining under the 1991 Plan), which may be Common Shares of original issuance or Common Shares held in treasury or a combination thereof. For the purposes of this Section 3: (a) Upon payment in cash of the benefit provided by any award granted under this Plan, any Common Shares that were covered by that award shall again be available for issuance or transfer hereunder; and (b) Upon the full or partial payment of any Option Price by the transfer to the Company of Common Shares or upon satisfaction of tax withholding obligations in connection with any such exercise or any other payment made or benefit realized under this Plan by the transfer or relinquishment of Common Shares, there shall be deemed to have been issued or transferred under this Plan only the net number of Common Shares actually issued or transferred by the Company less the number of Common Shares so transferred or relinquished. 4. Option Rights. Subject to adjustment as provided in Section 6 of this Plan, the Board shall automatically grant to each Participant Option Rights to purchase Common Shares upon such terms and conditions as the Board may determine in accordance with the following provisions: (a) Effective as of November 18, 1998, each individual who was then a Participant shall be granted Option Rights to purchase 55,000 Common Shares. Thereafter, commencing with the annual meeting of the Company's stockholders in January 2000, each individual who is a Participant upon the adjournment of an annual meeting of the Company's stockholders shall be granted Option Rights to purchase 10,000 Common Shares, effective as of the date of such annual meeting. (b) Each grant shall specify an Option Price per Common Share, which shall equal the Market Value per Share on the Date of Grant. (c) Each grant shall specify the form of consideration to be paid in satisfaction of the Option Price and the manner of payment of such consideration, which may include (i) cash in the form of currency or check or other cash equivalent acceptable to the Company, (ii) nonforfeitable, unrestricted Common Shares, which are already owned by the Participant, (iii) any other legal consideration that the Board may deem appropriate, on such basis as the Board may determine in accordance with this Plan and (iv) any combination of the foregoing. (d) Any grant may, if there is then a public market for the Common Shares, provide for deferred payment of the Option Price from the proceeds of sale through a broker of some or all of the Common Shares to which the exercise relates. (e) Successive grants may be made to the same Participant regardless of whether any Option Rights previously granted to the Participant remain unexercised. (f) Each grant shall specify that the Option Rights awarded thereby shall become exercisable in full upon the earliest to occur of (i) the seventh anniversary of the Date of Grant, (ii) the first date after the Date of Grant on which the Market Value per Share of the Common Shares (as adjusted as provided in Section 6 of this Plan) equals or exceeds $25.00, (iii) the date of the Participant's death or Disability, and (iv) the effective date of a Change in Control. (g) Each grant shall specify whether the Participant must remain in continuous service with the Company in order for the Option Rights awarded thereby to become exercisable in full as set forth in Section 4(f) above. (h) Option Rights granted pursuant to this Section 4 shall be nonqualified stock options. (i) No Option Right granted pursuant to this Section 4 may be exercised more than 10 years from the Date of Grant. (j) Each grant shall be evidenced by an agreement, which shall be executed on behalf of the Company by any designated officer thereof and delivered to and accepted by the Participant and shall contain such terms and provisions as the Board may determine consistent with this Plan. 5. Transferability. No Option Right granted under this Plan may be transferred by a Participant, except (i) by will or the laws of descent and distribution, (ii) to one or more members of the Participant's immediate family, or (iii) to a trust established for the benefit of the Participant and/or one or more members of the Participant's immediate family. Option Rights granted under this Plan may not be exercised during a Participant's lifetime except by (i) the Participant, (ii) a transferee of the Participant described in the preceding sentence, or (iii) in the event of the legal incapacity of the Participant or any such transferee, by the guardian or legal representative of the Participant or such transferee (as applicable) acting in a fiduciary capacity on behalf thereof under state law and court supervision. 6. Adjustments. (a) The Board may make or provide for such adjustments in the number of Common Shares covered by outstanding Option Rights granted hereunder, the Option Prices per Common Share applicable to any such Option Rights, and the kind of shares (including shares of another issuer) covered thereby, as the Board may in good faith determine to be equitably required in order to prevent dilution or expansion of the rights of Participants that otherwise would result from (i) any stock dividend, stock split, combination of shares, recapitalization or similar change in the capital structure of the Company or (ii) any merger, consolidation, spin-off, spin-out, split-off, split-up, reorganization, partial or complete liquidation or other distribution of assets, issuance of warrants or other rights to purchase securities or any other corporate transaction or event having an effect similar to any of the foregoing. In the event of any such transaction or event, the Board may provide in substitution for any or all outstanding awards under this Plan such alternative consideration as it may in good faith determine to be equitable under the circumstances and may require in connection therewith the surrender of all awards so replaced. Moreover, the Board may on or after the Date of Grant provide in the agreement evidencing any award under this Plan that the holder of the award may elect to receive an equivalent award in respect of securities of the surviving entity of any merger, consolidation or other transaction or event having a similar effect, or the Board may provide that the holder will automatically be entitled to receive such an equivalent award. The Board may also make or provide for such adjustments in the maximum numbers of Common Shares specified in Section 3 of this Plan as the Board may in good faith determine to be appropriate in order to reflect any transaction or event described in this Section 6. (b) If another corporation is merged into the Company or the Company otherwise acquires another corporation, the Board may elect to assume under this Plan any or all outstanding stock options or other awards granted by such corporation under any stock option or other plan adopted by it prior to such acquisition. Such assumptions shall be on such terms and conditions as the Board may determine; provided, however, that the awards as so assumed do not contain any terms, conditions or rights that are inconsistent with the terms of this Plan. Unless otherwise determined by the Board, such awards shall not be taken into account for purposes of the limitations contained in Section 3 of this Plan. 7. Fractional Shares. The Company shall not be required to issue any fractional Common Shares pursuant to this Plan. The Board may provide for the elimination of fractions or for the settlement thereof in cash. 8. Withholding Taxes. To the extent that the Company is required to withhold federal, state, local or foreign taxes in connection with any payment made or benefit realized by a Participant or other person under this Plan, and the amounts available to the Company for the withholding are insufficient, it shall be a condition to the receipt of any such payment or the realization of any such benefit that the Participant or such other person make arrangements satisfactory to the Company for payment of the balance of any taxes required to be withheld. At the discretion of the Board, any such arrangements may without limitation include voluntary or mandatory relinquishment of a portion of any such payment or benefit or the surrender of outstanding Common Shares. The Company and any Participant or such other person may also make similar arrangements with respect to the payment of any taxes with respect to which withholding is not required. 9. Administration of the Plan. (a) This Plan shall be administered by the Board. A majority of the Board shall constitute a quorum, and the acts of the members of the Board who are present at any meeting thereof at which a quorum is present, or acts unanimously approved by the members of the Board in writing, shall be the acts of the Board. (b) The interpretation and construction by the Board of any provision of this Plan or any agreement, notification or document evidencing the grant of Option Rights, and any determination by the Board pursuant to any provision of this Plan or any such agreement, notification or document, shall be final and conclusive. No member of the Board shall be liable for any such action taken or determination made in good faith. 10. Amendments and Other Matters. (a) This Plan may be amended from time to time by the Board; provided, however, that except as expressly authorized by this Plan, no such amendment shall cause this Plan to cease to satisfy any applicable condition of Rule 16b-3 without the further approval of the stockholders of the Company. (b) With the concurrence of the affected Participant, the Board may cancel any agreement evidencing Option Rights or any other award granted under this Plan. In the event of any such cancellation, the Board may authorize the granting of new Option Rights or other awards hereunder, which may or may not cover the same number of Common Shares as had been covered by the cancelled Option Rights or other award, at such Option Price, in such manner and subject to such other terms, conditions and discretion as would have been permitted under this Plan had the cancelled Option Rights or other award not been granted. (c) This Plan shall not confer upon any Participant any right with respect to continuance of service with the Board, the Company or any Subsidiary and shall not interfere in any way with any right that the Company, its stockholders or any Subsidiary would otherwise have to terminate any Participant's service at any time. (d) Any award that may be made pursuant to an amendment to this Plan that shall have been adopted without the approval of the stockholders of the Company shall be null and void if it is subsequently determined that such approval was required under the terms of the Plan or applicable law. (e) Unless otherwise determined by the Board, this Plan is intended to comply with Rule 16b-3 at all times that awards hereunder are subject to such Rule. EX-10.34 5 c81087exv10w34.txt EX-10.34 SEPARATION AGREEMENT AND RELEASE EXHIBIT 10.34 CONFIDENTIAL SEPARATION AGREEMENT AND RELEASE Steve E. Tondera, Jr. ("Tondera") and HEI, Inc. (the "Company") have reached this Separation Agreement and Release ("Agreement") effective as of the 20 day of June, 2003 (the "Effective Date"). 1. RESIGNATION. Tondera has resigned from his employment and all other roles with the Company, including his positions as Chief Financial Officer and as a member of the Board of Directors and any Board committee, and from all positions with any subsidiary of the Company, effective as of June 20, 2003. 2. SEPARATION PAYMENTS AND BENEFITS. In return for entering into this Agreement, Tondera will receive the following: A. The Company will, on or about eighteen (18) days following Tondera's signing of this Agreement, pay Tondera a gross lump sum payment of Thirty Seven Thousand and No/100 Dollars ($37,000.00). B. For the period of June 20,2003 through August 3 1,2003 (the "Premium Payment Period"), the Company will pay the monthly health, dental and life insurance premiums for Tondera to continue his insurance under the Company's group plans subject to these plans' eligibility requirements. The Premium Payment Period shall run concurrently with Tondera's COBRA and state benefits continuation period. In order to receive the benefits described in this Paragraph 2(B), Tondera must execute all documentation necessary to elect insurance continuation. Tondera agrees he has received appropriate notice regarding his benefits continuation rights. All of the above will be subject to deductions that the Company is obligated, or believes in good faith it is obligated, by law to deduct. No tax representations have been made to Tondera. Tondera will receive the foregoing only if he signs this Agreement and does not cancel it within the fifteen (15) calendar days described below under "Opportunity to Rescind." If he chooses to cancel this Agreement, he shall not be entitled to any of the payments or benefits described in this Agreement. 3. CONSULTING RELATIONSHIP. As further consideration for Tondera entering into this Agreement, Tondera and the Company agree to the following consulting arrangement and payments. 3.1 CONSULTATION SERVICES. Beginning July 1,2003, and continuing for five (5) months through November 30,2003 (the "Consultation Period"), Tondera agrees to provide consulting services to the Company as may be requested by the Company. Such consulting services may include, but are not limited to, reviewing the Company's financial statements, assisting in the Company's preparation of its SEC quarterly and annual filings, negotiating lease transactions, assisting with the Company's transition following the hiring of a Chief Financial Officer, and other consulting services that may be requested by the Company. Tondera agrees to use his best efforts in providing such consultation services to the Company, and shall comply with all reasonable requests for said consultation by the Company. The Company will have the right to immediately terminate its consulting relationship with Tondera if it determines that he is not using his best efforts to provide and perform his consulting services for the Company. 3.2 CONSULTATION PAYMENTS. For the Consultation Period, provided that the consulting relationship has continued, the Company shall pay Tondera a monthly consulting fee on or before the 10th day of the month following the month for which services were rendered in the amount of Fourteen Thousand Four Hundred Twenty Five and No/100 Dollars ($14,425.00). The Company agrees that it will reimburse Tondera for reasonable expenses that he incurs as a result of providing consulting services to the Company, such as travel expenses, provided that Tondera obtains the Company's advance approval before incurring such expenses and provided that Tondera submits documentation to the Company verifying such expenses, including but not limited to original receipts, within forty-five (45) days of incurring the expense. The Company shall issue a Form 1099 with respect to such consultation payments, and Tondera understands and agrees that he shall be solely responsible for the payment of any taxes, which he may owe with respect to his receipt of such consultation payments. Tondera acknowledges and agrees that he has neither received nor relied upon any advice or representations of the Company or its legal counsel concerning the taxability of the consulting payments. 3.3 CONSULTATION PERIOD COMPLETION AND RELEASE AGREEMENT. Upon Tondera's completion of the consulting services to be provided during the Consultation Period, and contingent upon him entering into a release agreement prepared by and in a form acceptable to the Company, the Company shall pay Tondera the sum of Fourteen Thousand Four Hundred Twenty Five and No/100 Dollars ($14,425.00) as consideration for his execution of such release agreement. 3.4 INDEPENDENT CONTRACTOR STATUS. Tondera understands and agrees that he will be an independent contractor and not an employee of the Company during the Consultation Period. Tondera understands that he will not be treated as an employee of the Company for federal or state tax purposes, and that he will not be eligible for or participate in any pension, health, workers compensation or other fringe benefit plans provided by the Company to its employees. Tondera agrees that he shall not hold himself out as an employee of the Company, or as having the power or authority to incur any debt, obligation or liability on behalf of the Company. The Company will not control or direct the details, manner or means by which Tondera executes his obligations and responsibilities with respect to the consulting services described in this Agreement. Unless otherwise prohibited under this Agreement or any other agreement, Tondera shall have the right to provide additional services to any other person when not performing his responsibilities under this Agreement. 3.5 CONDITION OF RELATIONSHIP. Tondera understands and agrees that he shall receive the foregoing consulting arrangement and payments only if he signs this Agreement and does not -2- rescind the Agreement within the fifteen (15) calendar days described below under "Opportunity to Rescind." 4. REPAYMENT OF PROMISSORY NOTE. Tondera shall be obligated to pay the Company the total amount that Tondera owes to the Company under his Promissory Note, dated April 2,200 1, as amended on July 17,2002 (the "Note"). During the Consultation Period and following his execution of the release agreement contemplated by Section 3.3, Tondera shall make payments on the Note by making installment payments to the Company in the amount of Nine Thousand One Hundred Sixty Six and 66/100 Dollars ($9,166.66) each immediately upon his receipt of each payment he receives from the Company under Sections 3.2 and 3.3 of this Agreement until the Note has been paid in full. In the event that Tondera has not paid the Note in full after making the payments required by this Section 4, Tondera shall be obligated to pay any remaining amount owed under the Note in accordance with the terms of the Note. A true and correct copy of the Note is incorporated herein and attached hereto as Exhibit A to this Agreement. 5. STOCK OPTIONS. All stock options that have been granted to Tondera by the Company shall be governed by the terms of the Company's stock option agreements with Tondera, a copy of which agreements are attached hereto and incorporated herein as Exhibit B, and the applicable stock option plans. 6. NO OTHER BENEFITS. Except as set forth in this Agreement, Tondera shall receive no other benefits and shall no longer participate in the Company's benefit plans except as required by benefits continuation laws. All of Tondera's rights shall be governed by the terms of such plans. The Company has provided Tondera applicable summary plan descriptions for its plans. 7. SURVIVAL OF HEI NONDISCLOSURE AND NONCOMPETE AGREEMENT. Tondera agrees that, in consideration of his past employment with the Company and the payments and benefits to be provided to him under this Agreement, his various obligations under the HE1 Nondisclosure and Noncompete Agreement between him and the Company, signed by Tondera on January 20, 1999, shall survive his resignation from his employment and positions with the Company and that he is and shall remain bound by the provisions of that agreement. A copy of the HE1 Nondisclosure and Noncompete Agreement is incorporated herein and attached hereto as Exhibit C to this Agreement. 8. RELEASE OF CLAIMS. 8.1 TONDERA'S RELEASE OF CLAIMS. Tondera agrees he is receiving pay and benefits under this Agreement that he would not otherwise be entitled to receive and that are adequate and sufficient consideration for this Agreement. In return for this pay and benefits, Tondera, for himself and on behalf of all of his past, present and future heirs, executors, administrators, agents, attorneys, insurers, subrogees, lienors, trustees, indemnitors, principals, servants, representatives, employees, partners, predecessors, successors and assigns, hereby releases the Company, its subsidiaries and any affiliated companies, businesses or entities and all of their respective current and former officers, agents, directors, employees, independent contractors, shareholders, attorneys, accountants, insurers, representatives, predecessors, successors and assigns, both individually and in any representative capacity (collectively, the "Released Parties"), from each and every legal claim or demand of any kind, whether known or unknown, -3- existing at any time up to and including the date of this Agreement, including without limitation any claim or demand (a) in any way arising out of or related to any action, conduct, decision or omission taking place during his employment with the Company or its affiliates, (b) in any way arising out of or related to his service as an officer, director, committee member or employee, or his service in any other capacity with the Company or its affiliates or in any way arising out of related to any oral or written agreement between him and the Company related to or entered into during such service (other than the stock option agreements attached hereto as Exhibit B), (c) in any way arising out of or related to his separation from that employment or service with the Company or its affiliates, (d) in any way arising out of or related to his status as a shareholder of the Company, or (e) in any way arising out of or related to his contact with or engagement of any of the Released Parties. Tondera understands and agrees that this Agreement is a full, final and complete settlement and release of the Released Parties of all his claims, whether known or unknown, including but not limited to any claims or rights he may have under the Employment Retirement Income Security Act, 29 U.S.C. Section 1001 et. seq., the Minnesota Human Rights Act, Minn. Stat. Chapter 363, Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C. Section 2000e, et. seq., the Age Discrimination in Employment Act of 1967,29 U.S.C. Section 626 et. seq., the Americans with Disabilities Act, 42 U.S.C. Section 12101, et. seq., The Family and Medical Leave Act, 29 U.S.C. Section 2601 et. seq., the Minnesota Employment, Wages, Conditions, Hours, and Restrictions Laws, Minn. Stat. Chapter 181, the Minnesota Whistleblower Act, Minn. Stat. Section 181.932, Minnesota Worker's Compensation statute Minn. Stat. Section 176.82, the Fair Labor Standards Act, 29 U.S.C. Section 201 et. seq., the Equal Pay Act, 29 U.S.C. Section 206 et. seq., the National Labor Relations Act, 29 U.S.C. Section 1501 et. seq., the Minnesota Business Corporations Act, Chapter 302A, and any other federal, states', or local governments' laws and regulations or any executive orders governing employment, service as an officer or director of a corporation, corporate governance, or shareholder matters. Tondera further understands and agrees that he is releasing any claims he may have, whether known or unknown, for payment of compensation or benefits of any kind, fraud or misrepresentation, promissory estoppel, wrongful or constructive discharge, defamation, invasion of privacy, breach of covenant of good faith and fair dealing, reprisal or retaliation, breach of contract (including but not limited to the HE1 Nondisclosure and Noncompete Agreement), unjust enrichment, negligence, negligent hiring, supervision and retention, intentional or negligent infliction of emotional distress, and any other claims arising under any law. Tondera agrees that if any claim he releases in this Agreement is prosecuted in his name before any court or administrative agency, he will waive any benefits he obtained through such prosecution and will not take any award of money or other damages from such suit. Tondera represents and warrants that the pay and benefits he is receiving under this Agreement fully compensates him for any and all claims against the Released Parties. Notwithstanding the foregoing, this Agreement does not release any rights or claims Tondera may have under the Minnesota Human Rights Act or the Age Discrimination in Employment Act or any of the Company's benefit plans, which arise after he signs this Agreement or which arise from acts occurring after he signs this Agreement, or any claims he may have under applicable law or any Company insurance policy for defense, indemnification and/or contribution with respect to claims made against him in connection with his conduct in the scope of his employment with or services as a director of the Company. -4- 8.2 THE COMPANY'S RELEASE OF ANY KNOWN CLAIMS. In return for Tondera entering into this Agreement, the Company, on behalf of itself and its subsidiaries and any affiliated companies, businesses or entities, hereby releases Tondera from each and every legal claim or demand of any kind of which the Company's Board of Directors, other than Anthony Fant, has actual knowledge as of the Effective Date of this Agreement including without limitation any such known claim or demand (a) in any way arising out of or related to any action, conduct, decision or omission taking place during Tondera's employment with the Company or its affiliates, or (b) in any way arising out of or related to his separation from that employment. The Company represents and warrants that Tondera's entering into this Agreement fully compensates the Company for its above release of claims. 9. NO FUTURE LAWSUITS. A. Tondera, for himself and on behalf of all of his past, present and future heirs, executors, administrators, agents, attorneys, insurers, subrogees, lienors, trustees, indemnitors, principals, servants, representatives, employees, partners, predecessors, successors and assigns, hereby agrees never to commence an action or to authorize anyone else to commence an action against the Released Parties with respect to any matters released in this Agreement. If Tondera breaches this Agreement, he shall pay the Released Parties' reasonable attorneys' fees, disbursements and costs in connection with such action. Tondera agrees that if such an action is commenced that the filing of this Agreement shall constitute sufficient and adequate evidence that any such action should be dismissed with prejudice and that costs, disbursements and attorneys' fees should be awarded to such Release Parties. B. Tondera further agrees not to voluntarily aid, assist or cooperate with any claimants, plaintiffs, adverse parties or their attorneys or agents in any claims or lawsuits commenced against any of the Released Parties; provided, however, that nothing in this Agreement shall prevent Tondera from testifying in response to a lawfully issued subpoena in any litigation or other legal proceeding involving any of the Released Parties. In the event that Tondera receives a subpoena from a party other than the Company, Tondera shall promptly notify the Company and provide it with a copy of the subpoena so that the Company has an opportunity to seek to quash or otherwise respond to the subpoena. This provision is not intended to affect the substance of any testimony that Tondera is required to provide. Rather, Tondera agrees to provide truthful testimony in full compliance with all applicable laws. 10. NONDISPARAGEMENT. Tondera will not, directly or indirectly, at any time, make any disparaging remark, either oral or in writing, regarding any of the Released Parties. 11. LITIGATION. In the event that any litigation or action arises in which the Company deems Tondera's testimony or participation to be relevant or necessary, Tondera agrees to cooperate with the Company in connection with the litigation or action, by providing testimony, through affidavit, in a deposition or at trial, or otherwise assisting the Company with respect to the litigation or action. The Company agrees that it will reimburse Tondera for any reasonable expenses, such as travel expenses, that he incurs in connection with such cooperation provided -5- that Tondera submits documentation to the Company verifying such expenses, including but not limited to original receipts, within forty-five (45) days of incurring the expense. This provision is not intended to affect the substance of any testimony that Tondera is asked to provide. Rather, Tondera agrees to provide truthful testimony and to otherwise assist the Company in light of and in full compliance with all applicable laws. 12. CONSULTATION. In the event that any questions arise following the Consulting Period with regard to any information or subject that Tondera developed, of which he had knowledge or with which he was otherwise involved during the period of his various positions with the Company, he agrees to cooperate with and respond to any request by the Company for advice, opinions or other information responsive to the question posed. 13. CONFIDENTIALITY OF TERMS. The parties agree that this Agreement and its terms shall remain completely confidential, and that they shall share them with no one before or after signing this Agreement, except that (a) Tondera may disclose this Agreement and its terms to his financial advisors and accountants, attorneys, and appropriate governmental agencies, and (b) the Company may disclose this Agreement and its terms to its financial advisors and accountants, insurers, and attorneys, or to its officers, directors or employees with a need to know such information in the course of their duties for the Company. In addition, the Released Parties may disclose this Agreement and its terms to the extent required by any law or regulation or any applicable stock exchange rules, or in the event Tondera violates this Agreement. Tondera recognizes that if he violates his confidentiality obligations under this Agreement, irreparable damage will result to the Company that could not be adequately remedied by monetary damages. As a result, he agrees that in the event of any such breach, or in the event of apparent danger of such breach, the Company shall be entitled, in addition to any other legal or equitable remedies available to the Company, to an injunction to restrain the violation of any and all portions of this Agreement and to its reasonable attorney's fees and costs in enforcing this Agreement. 14. RETURN OF PROPERTY. Tondera warrants that he has returned the originals and all copies of all Company files, documents, software, hardware, keys, credit cards, office equipment, and all other Company property in his possession or under his control. However, if he should locate any Company property after he signs this Agreement, he shall promptly return said property. Notwithstanding the foregoing, the Company agrees that Tondera may keep the Company-owned desk top computer, mouse, and keyboard in Tondera's possession. 15. PERIOD FOR REVIEW AND CONSIDERATION. Tondera understands that he has been given a period of 21 days to review and consider this Agreement before signing it. He further understands that he may use as much of this 21-day period as he wishes prior to signing this Agreement. 16. OPPORTUNITY TO RESCIND. Tondera may cancel this Agreement for any reason within fifteen (15) days after signing it. If he decides to do so and to mail his notice of cancellation, Tondera understands that it must be postmarked within the fifteen (15) day period and addressed to Mack Traynor at HE1 and sent by certified mail, return receipt requested. -6- 17. OPPORTUNITY TO CONSULT. Tondera agrees that he has been advised by the Company to seek the advice of an attorney of his choosing prior to signing this Agreement. 18. COMPLETE AGREEMENT. This Agreement and its exhibits incorporated herein contain the entire agreement between the parties, and there are no other written or oral agreements. 19. MISCELLANEOUS. A. LAW AND VENUE. This Agreement will be construed and interpreted in accordance with the laws of the state of Minnesota, without regard to its choice of law provisions, and any action arising out of related to this Agreement shall be brought only within the state of Minnesota whether or not that forum is then convenient to Tondera. B. NO ADMISSION. Nothing contained in this Agreement is to be construed by anyone as an admission that the Company has violated any law or engaged in any wrongdoing. In fact, the Company denies any wrongdoing of any kind. C. SEVERABILITY. In the event that any paragraph or provision of this Agreement is found to be illegal or unenforceable, it shall not affect the validity or enforceability of the remaining provisions. To the extent that any provision of this Agreement is unenforceable because it is overbroad, that provision shall be limited to the extent required by applicable law and enforced as so limited. D. INTENDED THIRD-PARTY BENEFICIARIES. The Released Parties are intended third party beneficiaries of this Agreement. 20. SIGNATURE. The parties agree that they have read this Agreement, know its contents and have signed it as a free and voluntary act after having had adequate opportunity to consider its terms and conditions and consult with an attorney of their choosing. Date: ------------------------ -------------------------------- STEVE E. TONDERA, JR. -7- Date: HEI, Inc. ------------------------ By -------------------------------- Its -------------------------------- -8- EX-10.35 6 c81087exv10w35.txt EX-10.35 EMPLOYMENT AGREEMENT - DOUGLAS J. NESBIT EXHIBIT 10.35 HEI, INC. EMPLOYMENT AGREEMENT This Employment Agreement is made and entered into effective as of October 1, 2003 (the "Effective Date"), by and among HEI, Inc., a Minnesota corporation (the "Corporation"), and Douglas Nesbit ("Employee"). RECITALS A. Employee is currently employed by the Company as its Chief Financial Officer and Employee is a party to an HEI, Inc. Non-Disclosure, Non-Compete and Inventions Assignment Agreement between Employee and the Company dated July 1, 2003 (the "2003 Employment Agreement") B. Corporation desires to continue to employ Employee in accordance with the terms of this Agreement. C. Employee recognizes that the Corporation operates in a highly competitive environment and the importance to the Corporation of ensuring Employee's loyalty and protecting the Corporation's customers, employees, business information and inventions, and goodwill. Accordingly, Employee has entered into and agrees to be bound by this Agreement in consideration of Employee's employment with the Corporation and being given access to the Corporation's confidential information. D. The Corporation and Employee desire to enter into this Agreement. AGREEMENT In consideration of the above recitals and the mutual promises set forth in this Agreement the parties agree as follows: 1. Termination of 2003 Employment Agreement. The parties agree that the July 2003 Employment Agreement is terminated as of the Effective Date of this Agreement and that this Agreement replaces and supersedes the July 2003 Employment Agreement. 2. Nature and Capacity of Employment. The Corporation hereby agrees to employ Employee as its Chief Financial Officer, subject to the direction of the President/Chief Executive Officer and the Board of Directors of the Corporation and pursuant to the terms and conditions set forth in this Agreement. Employee hereby accepts employment under the terms and conditions set forth in this Agreement. Employee agrees to perform or be available to perform, on a full-time basis, the functions of this position, pursuant to the terms of this Agreement. In addition, Employee will not, during the course of employment by the Corporation, without prior written approval of the Board of 1 Directors of the Corporation, become an employee, director, officer, agent, partner of or consultant to, or a stockholder of (except a stockholder of a public company in which Employee owns less than five percent (5%) of the issued and outstanding capital stock of such company) any company or other business entity which is, as determined by the Board of Directors in its discretion, a significant competitor, supplier, or customer of the Corporation. 2. Term of Employment. Employee's employment hereunder shall commence as of the Effective Date and shall continue for period of one year thereafter until October 1, 2004 (the "Term") unless Employee's employment is earlier terminated pursuant to the terms of Paragraph 5 of this Agreement. Unless Employee's employment has earlier terminated pursuant to the terms of Paragraph 5 of this Agreement, this Agreement shall automatically renew following the Term for successive terms of one year each (each called a "Renewal Term") unless the Corporation provides Employee thirty (30) days advance written notice prior to the expiration of the Term or Renewal Term that this Agreement shall not be renewed. During any Renewal Term, this Agreement may be terminated pursuant to the terms of Paragraph 5 of this Agreement. 3. Compensation. 3.1 Base Salary. As of the Effective Date, the Corporation agrees to pay Employee an annualized base salary of $140,000.00, which amount shall be earned by Employee on a pro rata basis as Employee performs services and which shall be paid according to the Corporation's normal payroll practices. The Corporation may, in its discretion, adjust Employee's base salary from time to time based on Employee's performance and the Corporation's business and financial situation. 3.2 Incentive or Bonus Compensation. The Corporation may, in its sole discretion, pay bonuses or other incentive compensation to Employee in addition to the annual base salary set forth above. 4. Employee Benefits. During Employee's employment with Corporation, Employee shall be entitled to participate in the retirement plans, health plans, and all other employee benefits made available by the Corporation, and as they may be changed from time to time. Employee acknowledges and agrees that the Corporation is under no obligation to Employee to establish and maintain any employee benefit plan in which Employee may participate, and that the terms and provisions of any employee benefit plan of the Corporation are matters within the exclusive province of the Corporation's Board of Directors, subject to applicable law. Upon the termination of Employee's employment, Employee shall be entitled to continue those benefits as may be required by state or federal law. 5. Termination of Employment Prior to the End of the Term or Renewal Term. Employee's employment may be terminated prior to the expiration of the Term or a Renewal Term as follows: 5.1. For Cause Termination, Without Severance. Notwithstanding anything contained herein to the contrary, the Corporation may discharge Employee and terminate this 2 Agreement immediately upon written notice to Employee. For the purposes of this Agreement, "Cause" shall mean the occurrence of any of the following: (i) mismanagement or neglect of Employee's duties which the Corporation's Board of Directors determines is (or will be if continued) materially and adversely affecting the business or affairs of the Corporation; or (ii) conduct by Employee which the Corporation's Board of Directors determines is (or will be if continued) demonstrably and materially injurious to the Corporation, monetarily or otherwise; or (iii) fraud, misappropriation or embezzlement by the Employee; or (iv) conviction of a felony crime or a crime of moral turpitude; or (v) conduct in the course of employment that the Corporation's Board of Directors determines is unethical; or (vi) the material breach of this Agreement by Employee. If the Corporation terminates Employee's employment for Cause pursuant to this Paragraph 5.1, Employee shall not be entitled to severance pay under Paragraph 5.6 or to any bonus or incentive compensation of any kind. 5.2. Without Cause, With Severance. The Corporation may terminate Employee's employment immediately at any time and for any reason without Cause upon providing notice to Employee. However, in such event the Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) three (3) months from the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and 3 (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.3. Resignation by Employee Due to Change of Control, With Severance. For purposes of this Agreement, "Change of Control" means a change in ownership or control of the Corporation effected through any of the following transactions: (a) a merger, consolidation or reorganization approved by the Corporation's stockholders, unless securities representing more than fifty percent (50%) of the total combined voting power of the voting securities of the successor corporation are immediately thereafter beneficially owned, directly or indirectly and in substantially the same proportion, by the persons who beneficially owned the Corporation's outstanding voting securities immediately prior to such transaction; (b) any stockholder-approved transfer or other disposition of all or substantially all of the Corporation's assets; (c) the acquisition, directly or indirectly by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation), of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation's outstanding securities pursuant to a tender or exchange offer made directly to the Corporation's stockholders which the Board recommends such stockholders accept; or (d) a change in the composition of the Board over a period of thirty-six (36) consecutive months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (A) have been Board members continuously since the beginning of such period or (B) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (A) who were still in office at the time the Board approved such election or nomination. Employee shall have the right to terminate Employee's employment for any reason within six (6) months following a Change of Control in the Company upon providing thirty (30) days advance written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 30 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation following a Change of Control under this Paragraph 5.3, Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) twelve (12) months from 4 the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.4 Other Resignation by Employee, Without Severance. The Employee may resign Employee's position upon providing 90 days advance, written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 90 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation under this Paragraph 5.4, Employee shall not be paid any severance pay as provided in Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5.5 Because of Death, Disability or Incapacity of Employee, Without Severance. In the event of Employee's death, or if the Employee is unable to perform Employee's duties and responsibilities for more than 90 days in any consecutive 12-month period, by reason of physical or mental disability or incapacity, the Corporation may terminate Employee's employment upon thirty (30) days advance written notice to Employee. This Paragraph does not relieve the Corporation of any duty to reasonably accommodate a qualifying disability under the Americans with Disabilities Act, any legal duty under the Family Medical Leave Act, or any of its other duties pursuant to applicable law. If Employee's employment is terminated pursuant to this Paragraph, Employee shall not be entitled to severance pay under Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5 5.6 No Other Payments. Other than any severance payment or incentive compensation due to Employee under the terms of this Agreement, if any, Employee shall only be entitled to the following in the event of Employee's termination of employment for any reason: (i) compensation earned through the date of termination; (ii) benefits under any employee benefit plan or program to the extent provided therein; and (iii) continued coverage under Corporation's health and group term life insurance programs to the extent required under state or federal continuation coverage laws 6. Noncompetition/Non-Solicitation. 6.1. Acknowledgement by Employee. Employee acknowledges that (a) Employee's services to be performed for Corporation are of a special and unique nature; (b) Corporation operates in a highly competitive environment and would be substantially harmed if Employee were to compete with Corporation or divulge its confidential information; (c) Employee has received valuable and sufficient consideration for entering into this Agreement, including but not limited to employment with the Corporation, the receipt of Confidential Information and (d) the provisions of this Section 6, including all of its subparts, are reasonable and necessary to protect Corporation's business. 6.2. "Corporate Product" Defined. For purposes of this Agreement, "Corporate Product" means any product or service (including any component thereof and any research to develop information useful in connection with a product or service) that has been or is being designed, developed, manufactured, marketed or sold by the Corporation or with respect to which Employee has acquired Confidential Information. Employee understands and acknowledges that, at the present time, Corporate Products include microelectronics, subsystems, systems, connectivity and software solutions (including, but not limited to, MMIC chip carriers and packages, high linearity power amplifiers, front end RF modules, micro-circuit design, production and value-added assembly services, ultra-miniature multi-chip packaging including chip on flex, ceramic and PWB substrates, and high end flex and rigid flex fabrication). Employee understands and acknowledges that the foregoing description of Corporate Products may change, and the provisions of this Section 6 and all of its subparts shall apply to the Corporate Products of the Corporation in effect upon the termination of Employee' s employment with the Corporation. 6.3 "Competitive Product" Defined. For purposes hereof, "Competitive Product" means any product or service (including any components thereof and any research to develop information useful in connection with the product or service) that is being designed, developed, manufactured, marketed or sold by any person or entity other than the Corporation that is of the same general type, performs similar functions, or is used for the same purpose as a Corporate Product on which Employee worked or assisted the Corporation during Employee's employment with the Corporation or about which Employee has acquired Confidential Information. 6 6.4 Noncompete Obligations. Employee agrees that, during Employee's employment with the Corporation and for a period of eighteen (18) months following Employee's termination of employment with the Company, regardless of the reason for termination, Employee will not, directly or indirectly, render services to any person or entity that designs, develops, manufactures, markets or sells a Competitive Product in any geographic area where the Company designs, develops, manufactures, markets or sells a Corporate Product. Employee understands and acknowledges that, at the present time, the geographic market of the Company includes the entire United States. Employee understands and acknowledges that the foregoing description of the Company's geographic market may change, and the provisions of this section 6 and all of its subparts shall apply to the geographic market of the Company in effect upon the termination of Employee's employment with the Company. 6.5 No Solicitation of Customers. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, solicit business from, work for, or otherwise interfere with or attempt to interfere with Corporation's relationship with any customer or prospective customer of Corporation. 6.6 No Solicitation of Employees or Business Contacts. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, take any action to encourage, solicit or recruit any current or former employee, consultant, independent contractor, subcontractor, supplier, vendor, or other business relation of Corporation to terminate their relationship with Corporation. 6.7 Disclosure of Obligations. Employee agrees that, during Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee shall, prior to accepting employment or any other business relationship with any other person or entity, inform that person or entity of Employee's obligations under this Section 6, including all of its subparts. 7. Protection of Confidential Information. 7.1 Definition of Confidential Information. As used in this Agreement, the term "Confidential Information" shall mean any information which Employee learns or develops during Employee's employment with Corporation that derives independent economic value from being not generally known or readily ascertainable by other persons who could obtain economic value from its disclosure or use, and includes, but is not limited to, trade secrets, Inventions as defined in Paragraph 9 below, financial information, personnel information, and information relating to such matters as existing or contemplated products, services, profit margins, fee schedules, pricing, design, processes, formulae, business plans, sales techniques, marketing techniques, training manuals and materials, policies or practices related to Corporation's 7 business, personnel or other matters, computer databases, computer programs, software and other technology, customer lists and requirements, vendor lists, or supply information. Confidential Information includes such information of Corporation, its customers, vendors, and other third parties or entities with whom Corporation does business. Any information disclosed to Employee or to which Employee has access during the time of Employee's employment that Employee reasonably considers to be Confidential Information, or which the Company treats as Confidential Information, will be presumed Confidential Information. 7.2 Restrictions on Use or Disclosure of Confidential Information. Employee shall keep the Confidential Information in absolute confidence both during Employee's employment with Corporation and after the termination of Employee's employment, regardless of the reason for such termination. Employee agrees that Employee will not, at any time, disclose to others, use for the benefit of any entity or person other than Corporation, or otherwise take or copy any such Confidential Information, whether or not developed by Employee, except as required in Employee's duties to Corporation. 8. Return of Confidential Information and Corporation's Property. When Employee's employment terminates with Corporation, regardless of the reason for such termination, Employee will promptly turn over to Corporation in good condition all Corporation property in Employee's possession or control, including but not limited to all originals, copies of, or electronically stored documents or other materials containing Confidential Information, regardless of who prepared them. In the case of electronically stored information retained by Employee outside of Corporation's electronic systems, Employee will promptly make a hard copy of such information in paper, audio recording, disc format, or other format as appropriate, turn that hard copy over to Corporation, and then destroy Employee's electronically stored information. Further, Employee agrees to execute written confirmation that all Confidential Information in the Employee's possession, or to which the Employee has access, has been turned over to Corporation or destroyed. 9. Inventions. 9.1 Definition of Inventions. As used in this Agreement, "Inventions" means any inventions, improvements, trade names or trademarks, trade secrets, discoveries, designs, formulae, ideas or original works of authorship (whether or not reduced to writing, other media or practice and whether or not patentable or copyrightable), or work product originated, conceived, developed, discovered or made in whole or in part solely by Employee or jointly with others that relate (a) to Corporation's business; (b) to Corporation's actual or demonstrably anticipated research or development; (c) that are made through the use of any of Corporation's equipment, facilities, supplies, trade secrets; (d) that result from any work Employee performs for Corporation; or (e) that are developed on Corporation time. 9.2 Ownership of Inventions. With respect to Inventions originated, conceived, developed, discovered or made in whole or in part solely or jointly by Employee at any time during Employee's employment with Corporation, Employee understands and agrees that Corporation will own all right, title, and interest, including patent rights, copyrights, trade secret rights and all other intellectual property rights of any sort, throughout the world related to 8 all Inventions without further payment beyond Employee's agreed-upon salary or wage. To the maximum extent permitted by law, all Inventions are deemed "works made for hire" under the United States Copyright Act and Corporation is deemed the sole author of any Inventions. To the extent any Inventions are determined not to constitute "works made for hire," Employee hereby assigns and transfers to Corporation all right, title and interest in the Inventions. Employee further agrees to (a) promptly and fully disclose all such Inventions to Corporation; (b) keep accurate, complete, and timely records of all Inventions, which records shall be Corporation's property and shall be maintained on Corporation's premises; (c) at Corporation's expense, assist Corporation to perfect, protect, and use its rights to Inventions, including without limitation, transferring Employee's entire right, title and interest in Inventions and enabling Corporation to obtain patent, copyright or trademark protection for Inventions anywhere in the world; and (c) give affidavits and testimony as to facts within Employee's knowledge in connection with any Inventions in any administrative proceedings, arbitration, litigation or controversy relating thereto. 9.3 Notice Regarding Exception to Inventions Assignment. Employee understands that the assignment of Inventions set forth herein does not apply to any Invention for which no equipment, supplies, facility, or trade secret information of Corporation was used and which was developed entirely on Employee's own time, and which does not relate directly to the business of the Company or to its actual or demonstrably anticipated research or development, or which does not result from any work performed by Employee for the Company. 10. Compliance and Remedies. Employee recognizes that if Employee violates this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement, irreparable damage will result to Corporation that could not adequately be remedied by monetary damages. As a result, Employee hereby agrees that notwithstanding any other dispute resolution provisions of this Agreement, in the event of any breach by Employee of this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement or in the event of apparent danger of such breach, Corporation shall be entitled, in addition to any other legal or equitable remedies available to it, to an injunction to restrain Employee's violation of any portion of this Agreement, as well as Corporation's attorney's fees and costs incurred in enforcing this Agreement. 11. Informal Dispute Resolution. Employee and the Corporation agree to make good faith efforts to resolve internally and without resort to formal dispute resolution any dispute, which may arise out of or relate to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, or any dispute regarding any of the provisions of this Agreement. 12. Arbitration Clause. In the event that informal efforts to resolve disputes pursuant to Paragraph 11 are unsuccessful, any dispute between Employee and the Corporation arising out of or related to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, and any dispute between Employee and the Corporation regarding any of the provisions of this Agreement (other than an action for injunctive relief to enforce Employee's obligations under paragraphs 6, 7, 8, or 9 of this Agreement), shall be determined not in a court of law, but instead by arbitration in the United States, in the State of Minnesota and the County of Hennepin. Such disputes shall be referred in writing to the 9 American Arbitration Association for selection of an arbitrator. Selection of the arbitrator shall be made in accordance with the Rules of the American Arbitration Association, and the arbitrator's decision shall be final and binding in all respects. Except as otherwise provided in this section, arbitration proceedings initiated pursuant to this Agreement shall be conducted in accordance with the Rules of the American Arbitration Association. Prior to the arbitration hearing, the parties may use the following discovery methods: interrogatories in a form consistent with Rule 33 of the Federal Rules of Civil Procedure; requests for production of documents in a form consistent with Rule 34 of the Federal Rules of Civil Procedure; admissions; depositions of witnesses in accordance with Rule 30 of the Federal Rules of Civil Procedure. The arbitrator shall have the right to determine the extent of discovery permitted. The arbitrator shall consider the matter in controversy and may hold hearings regarding the same. The arbitrator may grant any remedy or relief that he or she deems just and equitable, including, but not limited to, any remedy or relief that would have been available to the parties under any applicable statutes or common law. The arbitrator also has the authority to issue an award or partial award on the grounds that there is no claim stated on which relief can be granted or that there is no genuine issue as to any material fact and one party is entitled to judgment as a matter of law consistent with Federal Rules of Civil Procedure 12 or 56. The arbitrator shall enter an award in writing detailing his or her consideration of the relevant facts, the basis and reason for the decision, and his or her adherence to the applicable law. This written decision shall be entered within thirty days after the matter is finally submitted to the arbitrator, and a copy thereof shall be delivered to each party by certified mail. Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. The Corporation shall pay the expense of the arbitrator; each party will bear its own attorneys' fees and expenses. All proceedings under this Paragraph are private and confidential. Notwithstanding the foregoing, the Company may bring a court action for injunctive relief to enforce this Agreement. The parties agree that the Corporation may elect to venue such action in the federal or state courts of the State of Minnesota, whether or not such venue is then convenient to Employee, and that such courts shall have personal jurisdiction over Corporation and Employee and Employee shall not object to the venue or personal jurisdiction of such courts. Employee understands that by signing this Agreement, Employee is forever giving up Employee's right to litigate in a court of law any controversy arising out of Employee's employment relationship with the Corporation, and any controversy regarding any of the provisions of this Agreement, and that he is agreeing instead to arbitrate any claims he may choose to pursue against the Corporation. Nothing in this Agreement, however, prohibits either party from going to a court of law to enforce an award of an arbitrator. 13. Miscellaneous. 13.1. Integration. This Agreement embodies the entire agreement and understanding among the parties relative to subject matter hereof and supersedes all prior agreements and understandings relating to such subject matter, including but not limited to any earlier employment agreements of the Employee. 10 13.2. Applicable Law. This Agreement and the rights of the parties shall be governed by and construed and enforced in accordance with the laws of the state of Minnesota. 13.3. Payments. All amounts paid under this Agreement shall be subject to normal withholdings or such other treatment as required by law. 13.4. Counterparts. This Agreement may be executed in several counterparts and as so executed shall constitute one agreement binding on the parties hereto. 13.5. Binding Effect. Except as herein or otherwise provided to the contrary, this Agreement shall be binding upon and inure to the benefit of the Corporation and its successors, assigns and personal representatives without any requirement of the consent of the employee for assignment of its rights or obligations hereunder. 13.6. Notices. All notices, requests and other communications hereunder shall be given in writing and deemed to have been duly given or served if personally delivered, or sent by first class, certified mail, return receipt requested, postage prepaid, to the party at the address as provided below, or, to such other address as such party may hereafter designate by written notice to the other party: (a) If to the Corporation, to the address of its then principal office. (b) If to Employee, to the address last shown in the records of the Corporation. 13.7. Modification. This Agreement shall not be modified or amended except by a written instrument signed by the parties. 13.8. Severability. The invalidity or partial invalidity of any portion of this Agreement shall not invalidate the remainder thereof, and said remainder shall remain in fully force and effect. 13.9. Headings. The section headings contained in this Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. 13.10. Survival. Employee acknowledges and agrees that Employee's noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement shall survive the Term or any Renewal Term, the non-renewal of this Agreement, and the termination of Employee's employment with the Corporation, regardless of the reason for termination. 13.11. Opportunity to Obtain Advice of Counsel. Employee acknowledges that Employee has been advised by the Corporation to obtain legal advice prior to executing this Agreement, and that Employee had sufficient opportunity to do so prior to signing this Agreement. 11 THIS AGREEMENT was voluntarily and knowingly executed by the parties as of date and year first set forth above. HEI, INC. By: /s/ MACK TRAYNOR ------------------------------ Mack Traynor, President/CEO EMPLOYEE: /s/ DOUGLAS NESBIT ------------------------------ Douglas Nesbit 12 EX-10.36 7 c81087exv10w36.txt EX-10.36 EMPLOYMENT AGREEMENT - STEPHEN K PETERSEN EXHIBIT 10.36 HEI, INC. EMPLOYMENT AGREEMENT This Employment Agreement is made and entered into effective as of October 1, 2003 (the "Effective Date"), by and among HEI, Inc., a Minnesota corporation (the "Corporation"), and Stephen Petersen ("Employee"). RECITALS A. Employee is currently employed by the Company as its Vice President of Operations and Employee is a party to an HEI, Inc. Non-Disclosure and Non-Compete Agreement between him and the Company dated February 26, 1998 (the "1998 Employment Agreement"). B. Corporation desires to continue to employ Employee in accordance with the terms of this Agreement. C. Employee recognizes that the Corporation operates in a highly competitive environment and the importance to the Corporation of ensuring Employee's loyalty and protecting the Corporation's customers, employees, business information and inventions, and goodwill. Accordingly, Employee has entered into and agrees to be bound by this Agreement in consideration of Employee's employment with the Corporation and being given access to the Corporation's confidential information. D. The Corporation and Employee desire to enter into this Agreement. AGREEMENT In consideration of the above recitals and the mutual promises set forth in this Agreement the parties agree as follows: 1. Termination of 1998 Employment Agreement. The parties agree that the 1998 Employment Agreement is terminated as of the Effective Date of this Agreement and that this Agreement replaces and supersedes the 1998 Employment Agreement. 2. Nature and Capacity of Employment. The Corporation hereby agrees to employ Employee as its Vice President of Operations, subject to the direction of the President/Chief Executive Officer and the Board of Directors of the Corporation and pursuant to the terms and conditions set forth in this Agreement. Employee hereby accepts employment under the terms and conditions set forth in this Agreement. Employee agrees to perform or be available to perform, on a full-time basis, the functions of this position, pursuant to the terms of this Agreement. In addition, Employee will not, during the course of employment by the Corporation, without prior written approval of the Board of Directors of the Corporation, become an employee, director, officer, agent, partner of or 1 consultant to, or a stockholder of (except a stockholder of a public company in which Employee owns less than five percent (5%) of the issued and outstanding capital stock of such company) any company or other business entity which is, as determined by the Board of Directors in its discretion, a significant competitor, supplier, or customer of the Corporation. 2. Term of Employment. Employee's employment hereunder shall commence as of the Effective Date and shall continue for period of one year thereafter until October 1, 2004 (the "Term") unless Employee's employment is earlier terminated pursuant to the terms of Paragraph 5 of this Agreement. Unless Employee's employment has earlier terminated pursuant to the terms of Paragraph 5 of this Agreement, this Agreement shall automatically renew following the Term for successive terms of one year each (each called a "Renewal Term") unless the Corporation provides Employee thirty (30) days advance written notice prior to the expiration of the Term or Renewal Term that this Agreement shall not be renewed. During any Renewal Term, this Agreement may be terminated pursuant to the terms of Paragraph 5 of this Agreement. 3. Compensation. 3.1 Base Salary. As of the Effective Date, the Corporation agrees to pay Employee an annualized base salary of $140,000.00, which amount shall be earned by Employee on a pro rata basis as Employee performs services and which shall be paid according to the Corporation's normal payroll practices. The Corporation may, in its discretion, adjust Employee's base salary from time to time based on Employee's performance and the Corporation's business and financial situation. 3.2 Incentive or Bonus Compensation. The Corporation may, in its sole discretion, pay bonuses or other incentive compensation to Employee in addition to the annual base salary set forth above. 4. Employee Benefits. During Employee's employment with Corporation, Employee shall be entitled to participate in the retirement plans, health plans, and all other employee benefits made available by the Corporation, and as they may be changed from time to time. Employee acknowledges and agrees that the Corporation is under no obligation to Employee to establish and maintain any employee benefit plan in which Employee may participate, and that the terms and provisions of any employee benefit plan of the Corporation are matters within the exclusive province of the Corporation's Board of Directors, subject to applicable law. Upon the termination of Employee's employment, Employee shall be entitled to continue those benefits as may be required by state or federal law. 5. Termination of Employment Prior to the End of the Term or Renewal Term. Employee's employment may be terminated prior to the expiration of the Term or a Renewal Term as follows: 5.1. For Cause Termination, Without Severance. Notwithstanding anything contained herein to the contrary, the Corporation may discharge Employee and terminate this 2 Agreement immediately upon written notice to Employee. For the purposes of this Agreement, "Cause" shall mean the occurrence of any of the following: (i) mismanagement or neglect of Employee's duties which the Corporation's Board of Directors determines is (or will be if continued) materially and adversely affecting the business or affairs of the Corporation; or (ii) conduct by Employee which the Corporation's Board of Directors determines is (or will be if continued) demonstrably and materially injurious to the Corporation, monetarily or otherwise; or (iii) fraud, misappropriation or embezzlement by the Employee; or (iv) conviction of a felony crime or a crime of moral turpitude; or (v) conduct in the course of employment that the Corporation's Board of Directors determines is unethical; or (vi) the material breach of this Agreement by Employee. If the Corporation terminates Employee's employment for Cause pursuant to this Paragraph 5.1, Employee shall not be entitled to severance pay under Paragraph 5.6 or to any bonus or incentive compensation of any kind. 5.2. Without Cause, With Severance. The Corporation may terminate Employee's employment immediately at any time and for any reason without Cause upon providing notice to Employee. However, in such event the Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) three (3) months from the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and 3 (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.3. Resignation by Employee Due to Change of Control, With Severance. For purposes of this Agreement, "Change of Control" means a change in ownership or control of the Corporation effected through any of the following transactions: (a) a merger, consolidation or reorganization approved by the Corporation's stockholders, unless securities representing more than fifty percent (50%) of the total combined voting power of the voting securities of the successor corporation are immediately thereafter beneficially owned, directly or indirectly and in substantially the same proportion, by the persons who beneficially owned the Corporation's outstanding voting securities immediately prior to such transaction; (b) any stockholder-approved transfer or other disposition of all or substantially all of the Corporation's assets; (c) the acquisition, directly or indirectly by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation), of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation's outstanding securities pursuant to a tender or exchange offer made directly to the Corporation's stockholders which the Board recommends such stockholders accept; or (d) a change in the composition of the Board over a period of thirty-six (36) consecutive months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (A) have been Board members continuously since the beginning of such period or (B) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (A) who were still in office at the time the Board approved such election or nomination. Employee shall have the right to terminate Employee's employment for any reason within six (6) months following a Change of Control in the Company upon providing thirty (30) days advance written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 30 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation following a Change of Control under this Paragraph 5.3, Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) twelve (12) months from 4 the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.4 Other Resignation by Employee, Without Severance. The Employee may resign Employee's position upon providing 90 days advance, written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 90 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation under this Paragraph 5.4, Employee shall not be paid any severance pay as provided in Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5.5 Because of Death, Disability or Incapacity of Employee, Without Severance. In the event of Employee's death, or if the Employee is unable to perform Employee's duties and responsibilities for more than 90 days in any consecutive 12-month period, by reason of physical or mental disability or incapacity, the Corporation may terminate Employee's employment upon thirty (30) days advance written notice to Employee. This Paragraph does not relieve the Corporation of any duty to reasonably accommodate a qualifying disability under the Americans with Disabilities Act, any legal duty under the Family Medical Leave Act, or any of its other duties pursuant to applicable law. If Employee's employment is terminated pursuant to this Paragraph, Employee shall not be entitled to severance pay under Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5 5.6 No Other Payments. Other than any severance payment or incentive compensation due to Employee under the terms of this Agreement, if any, Employee shall only be entitled to the following in the event of Employee's termination of employment for any reason: (i) compensation earned through the date of termination; (ii) benefits under any employee benefit plan or program to the extent provided therein; and (iii) continued coverage under Corporation's health and group term life insurance programs to the extent required under state or federal continuation coverage laws. 6. Noncompetition/Non-Solicitation. 6.1. Acknowledgement by Employee. Employee acknowledges that (a) Employee's services to be performed for Corporation are of a special and unique nature; (b) Corporation operates in a highly competitive environment and would be substantially harmed if Employee were to compete with Corporation or divulge its confidential information; (c) Employee has received valuable and sufficient consideration for entering into this Agreement, including but not limited to employment with the Corporation, the receipt of Confidential Information and (d) the provisions of this Section 6, including all of its subparts, are reasonable and necessary to protect Corporation's business. 6.2. "Corporate Product" Defined. For purposes of this Agreement, "Corporate Product" means any product or service (including any component thereof and any research to develop information useful in connection with a product or service) that has been or is being designed, developed, manufactured, marketed or sold by the Corporation or with respect to which Employee has acquired Confidential Information. Employee understands and acknowledges that, at the present time, Corporate Products include microelectronics, subsystems, systems, connectivity and software solutions (including, but not limited to, MMIC chip carriers and packages, high linearity power amplifiers, front end RF modules, micro-circuit design, production and value-added assembly services, ultra-miniature multi-chip packaging including chip on flex, ceramic and PWB substrates, and high end flex and rigid flex fabrication). Employee understands and acknowledges that the foregoing description of Corporate Products may change, and the provisions of this Section 6 and all of its subparts shall apply to the Corporate Products of the Corporation in effect upon the termination of Employee's employment with the Corporation. 6.3 "Competitive Product" Defined. For purposes hereof, "Competitive Product" means any product or service (including any components thereof and any research to develop information useful in connection with the product or service) that is being designed, developed, manufactured, marketed or sold by any person or entity other than the Corporation that is of the same general type, performs similar functions, or is used for the same purpose as a Corporate Product on which Employee worked or assisted the Corporation during Employee's employment with the Corporation or about which Employee has acquired Confidential Information. 6 6.4 Noncompete Obligations. Employee agrees that, during Employee's employment with the Corporation and for a period of eighteen (18) months following Employee's termination of employment with the Company, regardless of the reason for termination, Employee will not, directly or indirectly, render services to any person or entity that designs, develops, manufactures, markets or sells a Competitive Product in any geographic area where the Company designs, develops, manufactures, markets or sells a Corporate Product. Employee understands and acknowledges that, at the present time, the geographic market of the Company includes the entire United States. Employee understands and acknowledges that the foregoing description of the Company's geographic market may change, and the provisions of this section 6 and all of its subparts shall apply to the geographic market of the Company in effect upon the termination of Employee's employment with the Company. 6.5 No Solicitation of Customers. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, solicit business from, work for, or otherwise interfere with or attempt to interfere with Corporation's relationship with any customer or prospective customer of Corporation. 6.6 No Solicitation of Employees or Business Contacts. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, take any action to encourage, solicit or recruit any current or former employee, consultant, independent contractor, subcontractor, supplier, vendor, or other business relation of Corporation to terminate their relationship with Corporation. 6.7 Disclosure of Obligations. Employee agrees that, during Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee shall, prior to accepting employment or any other business relationship with any other person or entity, inform that person or entity of Employee's obligations under this Section 6, including all of its subparts. 7. Protection of Confidential Information. 7.1 Definition of Confidential Information. As used in this Agreement, the term "Confidential Information" shall mean any information which Employee learns or develops during Employee's employment with Corporation that derives independent economic value from being not generally known or readily ascertainable by other persons who could obtain economic value from its disclosure or use, and includes, but is not limited to, trade secrets, Inventions as defined in Paragraph 9 below, financial information, personnel information, and information relating to such matters as existing or contemplated products, services, profit margins, fee schedules, pricing, design, processes, formulae, business plans, sales techniques, marketing techniques, training manuals and materials, policies or practices related to Corporation's 7 business, personnel or other matters, computer databases, computer programs, software and other technology, customer lists and requirements, vendor lists, or supply information. Confidential Information includes such information of Corporation, its customers, vendors, and other third parties or entities with whom Corporation does business. Any information disclosed to Employee or to which Employee has access during the time of Employee's employment that Employee reasonably considers to be Confidential Information, or which the Company treats as Confidential Information, will be presumed Confidential Information. 7.2 Restrictions on Use or Disclosure of Confidential Information. Employee shall keep the Confidential Information in absolute confidence both during Employee's employment with Corporation and after the termination of Employee's employment, regardless of the reason for such termination. Employee agrees that Employee will not, at any time, disclose to others, use for the benefit of any entity or person other than Corporation, or otherwise take or copy any such Confidential Information, whether or not developed by Employee, except as required in Employee's duties to Corporation. 8. Return of Confidential Information and Corporation's Property. When Employee's employment terminates with Corporation, regardless of the reason for such termination, Employee will promptly turn over to Corporation in good condition all Corporation property in Employee's possession or control, including but not limited to all originals, copies of, or electronically stored documents or other materials containing Confidential Information, regardless of who prepared them. In the case of electronically stored information retained by Employee outside of Corporation's electronic systems, Employee will promptly make a hard copy of such information in paper, audio recording, disc format, or other format as appropriate, turn that hard copy over to Corporation, and then destroy Employee's electronically stored information. Further, Employee agrees to execute written confirmation that all Confidential Information in the Employee's possession, or to which the Employee has access, has been turned over to Corporation or destroyed. 9. Inventions. 9.1 Definition of Inventions. As used in this Agreement, "Inventions" means any inventions, improvements, trade names or trademarks, trade secrets, discoveries, designs, formulae, ideas or original works of authorship (whether or not reduced to writing, other media or practice and whether or not patentable or copyrightable), or work product originated, conceived, developed, discovered or made in whole or in part solely by Employee or jointly with others that relate (a) to Corporation's business; (b) to Corporation's actual or demonstrably anticipated research or development; (c) that are made through the use of any of Corporation's equipment, facilities, supplies, trade secrets; (d) that result from any work Employee performs for Corporation; or (e) that are developed on Corporation time. 9.2 Ownership of Inventions. With respect to Inventions originated, conceived, developed, discovered or made in whole or in part solely or jointly by Employee at any time during Employee's employment with Corporation, Employee understands and agrees that Corporation will own all right, title, and interest, including patent rights, copyrights, trade secret rights and all other intellectual property rights of any sort, throughout the world related to 8 all Inventions without further payment beyond Employee's agreed-upon salary or wage. To the maximum extent permitted by law, all Inventions are deemed "works made for hire" under the United States Copyright Act and Corporation is deemed the sole author of any Inventions. To the extent any Inventions are determined not to constitute "works made for hire," Employee hereby assigns and transfers to Corporation all right, title and interest in the Inventions. Employee further agrees to (a) promptly and fully disclose all such Inventions to Corporation; (b) keep accurate, complete, and timely records of all Inventions, which records shall be Corporation's property and shall be maintained on Corporation's premises; (c) at Corporation's expense, assist Corporation to perfect, protect, and use its rights to Inventions, including without limitation, transferring Employee's entire right, title and interest in Inventions and enabling Corporation to obtain patent, copyright or trademark protection for Inventions anywhere in the world; and (c) give affidavits and testimony as to facts within Employee's knowledge in connection with any Inventions in any administrative proceedings, arbitration, litigation or controversy relating thereto. 9.3 Notice Regarding Exception to Inventions Assignment. Employee understands that the assignment of Inventions set forth herein does not apply to any Invention for which no equipment, supplies, facility, or trade secret information of Corporation was used and which was developed entirely on Employee's own time, and which does not relate directly to the business of the Company or to its actual or demonstrably anticipated research or development, or which does not result from any work performed by Employee for the Company. 10. Compliance and Remedies. Employee recognizes that if Employee violates this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement, irreparable damage will result to Corporation that could not adequately be remedied by monetary damages. As a result, Employee hereby agrees that notwithstanding any other dispute resolution provisions of this Agreement, in the event of any breach by Employee of this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement or in the event of apparent danger of such breach, Corporation shall be entitled, in addition to any other legal or equitable remedies available to it, to an injunction to restrain Employee's violation of any portion of this Agreement, as well as Corporation's attorney's fees and costs incurred in enforcing this Agreement. 11. Informal Dispute Resolution. Employee and the Corporation agree to make good faith efforts to resolve internally and without resort to formal dispute resolution any dispute, which may arise out of or relate to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, or any dispute regarding any of the provisions of this Agreement. 12. Arbitration Clause. In the event that informal efforts to resolve disputes pursuant to Paragraph 11 are unsuccessful, any dispute between Employee and the Corporation arising out of or related to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, and any dispute between Employee and the Corporation regarding any of the provisions of this Agreement (other than an action for injunctive relief to enforce Employee's obligations under paragraphs 6, 7, 8, or 9 of this Agreement), shall be determined not in a court of law, but instead by arbitration in the United States, in the State of Minnesota and the County of Hennepin. Such disputes shall be referred in writing to the 9 American Arbitration Association for selection of an arbitrator. Selection of the arbitrator shall be made in accordance with the Rules of the American Arbitration Association, and the arbitrator's decision shall be final and binding in all respects. Except as otherwise provided in this section, arbitration proceedings initiated pursuant to this Agreement shall be conducted in accordance with the Rules of the American Arbitration Association. Prior to the arbitration hearing, the parties may use the following discovery methods: interrogatories in a form consistent with Rule 33 of the Federal Rules of Civil Procedure; requests for production of documents in a form consistent with Rule 34 of the Federal Rules of Civil Procedure; admissions; depositions of witnesses in accordance with Rule 30 of the Federal Rules of Civil Procedure. The arbitrator shall have the right to determine the extent of discovery permitted. The arbitrator shall consider the matter in controversy and may hold hearings regarding the same. The arbitrator may grant any remedy or relief that he or she deems just and equitable, including, but not limited to, any remedy or relief that would have been available to the parties under any applicable statutes or common law. The arbitrator also has the authority to issue an award or partial award on the grounds that there is no claim stated on which relief can be granted or that there is no genuine issue as to any material fact and one party is entitled to judgment as a matter of law consistent with Federal Rules of Civil Procedure 12 or 56. The arbitrator shall enter an award in writing detailing his or her consideration of the relevant facts, the basis and reason for the decision, and his or her adherence to the applicable law. This written decision shall be entered within thirty days after the matter is finally submitted to the arbitrator, and a copy thereof shall be delivered to each party by certified mail. Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. The Corporation shall pay the expense of the arbitrator; each party will bear its own attorneys' fees and expenses. All proceedings under this Paragraph are private and confidential. Notwithstanding the foregoing, the Company may bring a court action for injunctive relief to enforce this Agreement. The parties agree that the Corporation may elect to venue such action in the federal or state courts of the State of Minnesota, whether or not such venue is then convenient to Employee, and that such courts shall have personal jurisdiction over Corporation and Employee and Employee shall not object to the venue or personal jurisdiction of such courts. Employee understands that by signing this Agreement, Employee is forever giving up Employee's right to litigate in a court of law any controversy arising out of Employee's employment relationship with the Corporation, and any controversy regarding any of the provisions of this Agreement, and that he is agreeing instead to arbitrate any claims he may choose to pursue against the Corporation. Nothing in this Agreement, however, prohibits either party from going to a court of law to enforce an award of an arbitrator. 13. Miscellaneous. 13.1. Integration. This Agreement embodies the entire agreement and understanding among the parties relative to subject matter hereof and supersedes all prior agreements and understandings relating to such subject matter, including but not limited to any earlier employment agreements of the Employee. 10 13.2. Applicable Law. This Agreement and the rights of the parties shall be governed by and construed and enforced in accordance with the laws of the state of Minnesota. 13.3. Payments. All amounts paid under this Agreement shall be subject to normal withholdings or such other treatment as required by law. 13.4. Counterparts. This Agreement may be executed in several counterparts and as so executed shall constitute one agreement binding on the parties hereto. 13.5. Binding Effect. Except as herein or otherwise provided to the contrary, this Agreement shall be binding upon and inure to the benefit of the Corporation and its successors, assigns and personal representatives without any requirement of the consent of the employee for assignment of its rights or obligations hereunder. 13.6. Notices. All notices, requests and other communications hereunder shall be given in writing and deemed to have been duly given or served if personally delivered, or sent by first class, certified mail, return receipt requested, postage prepaid, to the party at the address as provided below, or, to such other address as such party may hereafter designate by written notice to the other party: (a) If to the Corporation, to the address of its then principal office. (b) If to Employee, to the address last shown in the records of the Corporation. 13.7. Modification. This Agreement shall not be modified or amended except by a written instrument signed by the parties. 13.8. Severability. The invalidity or partial invalidity of any portion of this Agreement shall not invalidate the remainder thereof, and said remainder shall remain in fully force and effect. 13.9. Headings. The section headings contained in this Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. 13.10. Survival. Employee acknowledges and agrees that Employee's noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement shall survive the Term or any Renewal Term, the non-renewal of this Agreement, and the termination of Employee's employment with the Corporation, regardless of the reason for termination. 13.11. Opportunity to Obtain Advice of Counsel. Employee acknowledges that Employee has been advised by the Corporation to obtain legal advice prior to executing this Agreement, and that Employee had sufficient opportunity to do so prior to signing this Agreement. 11 THIS AGREEMENT was voluntarily and knowingly executed by the parties as of date and year first set forth above. HEI, INC. By: /s/ MACK TRAYNOR ----------------------------- Mack Traynor, President/CEO EMPLOYEE: /s/ STEPHEN PETERSEN ----------------------------- Stephen Petersen 12 EX-10.37 8 c81087exv10w37.txt EX-10.37 EMPLOYMENT AGREEMENT - SCOTT M. STOLE EXHIBIT 10.37 HEI, INC. EMPLOYMENT AGREEMENT This Employment Agreement is made and entered into effective as of October 1, 2003 (the "Effective Date"), by and among HEI, Inc., a Minnesota corporation (the "Corporation"), and Scott Stole ("Employee"). RECITALS A. Employee is currently employed by the Company as its Chief Technical Officer and Employee is a party to an HEI, Inc. Non-Disclosure and Non-Compete Agreement between Employee and the Company dated October 2, 2000 (the "2000 Employment Agreement"). B. Corporation desires to continue to employ Employee in accordance with the terms of this Agreement. C. Employee recognizes that the Corporation operates in a highly competitive environment and the importance to the Corporation of ensuring Employee's loyalty and protecting the Corporation's customers, employees, business information and inventions, and goodwill. Accordingly, Employee has entered into and agrees to be bound by this Agreement in consideration of Employee's employment with the Corporation and being given access to the Corporation's confidential information. D. The Corporation and Employee desire to enter into this Agreement. AGREEMENT In consideration of the above recitals and the mutual promises set forth in this Agreement the parties agree as follows: 1. Termination of 2000 Employment Agreement. The parties agree that the 2000 Employment Agreement is terminated as of the Effective Date of this Agreement and that this Agreement replaces and supersedes the 2000 Employment Agreement. 2. Nature and Capacity of Employment. The Corporation hereby agrees to employ Employee as its Chief Technical Officer, subject to the direction of the President/Chief Executive Officer and the Board of Directors of the Corporation and pursuant to the terms and conditions set forth in this Agreement. Employee hereby accepts employment under the terms and conditions set forth in this Agreement. Employee agrees to perform or be available to perform, on a full-time basis, the functions of this position, pursuant to the terms of this Agreement. In addition, Employee will not, during the course of employment by the Corporation, without prior written approval of the Board of Directors of the Corporation, become an employee, director, officer, agent, partner of or 1 consultant to, or a stockholder of (except a stockholder of a public company in which Employee owns less than five percent (5%) of the issued and outstanding capital stock of such company) any company or other business entity which is, as determined by the Board of Directors in its discretion, a significant competitor, supplier, or customer of the Corporation. 2. Term of Employment. Employee's employment hereunder shall commence as of the Effective Date and shall continue for period of one year thereafter until October 1, 2004 (the "Term") unless Employee's employment is earlier terminated pursuant to the terms of Paragraph 5 of this Agreement. Unless Employee's employment has earlier terminated pursuant to the terms of Paragraph 5 of this Agreement, this Agreement shall automatically renew following the Term for successive terms of one year each (each called a "Renewal Term") unless the Corporation provides Employee thirty (30) days advance written notice prior to the expiration of the Term or Renewal Term that this Agreement shall not be renewed. During any Renewal Term, this Agreement may be terminated pursuant to the terms of Paragraph 5 of this Agreement. 3. Compensation. 3.1 Base Salary. As of the Effective Date, the Corporation agrees to pay Employee an annualized base salary of $125,000.00, which amount shall be earned by Employee on a pro rata basis as Employee performs services and which shall be paid according to the Corporation's normal payroll practices. The Corporation may, in its discretion, adjust Employee's base salary from time to time based on Employee's performance and the Corporation's business and financial situation. 3.2 Incentive or Bonus Compensation. The Corporation may, in its sole discretion, pay bonuses or other incentive compensation to Employee in addition to the annual base salary set forth above. 4. Employee Benefits. During Employee's employment with Corporation, Employee shall be entitled to participate in the retirement plans, health plans, and all other employee benefits made available by the Corporation, and as they may be changed from time to time. Employee acknowledges and agrees that the Corporation is under no obligation to Employee to establish and maintain any employee benefit plan in which Employee may participate, and that the terms and provisions of any employee benefit plan of the Corporation are matters within the exclusive province of the Corporation's Board of Directors, subject to applicable law. Upon the termination of Employee's employment, Employee shall be entitled to continue those benefits as may be required by state or federal law. 5. Termination of Employment Prior to the End of the Term or Renewal Term. Employee's employment may be terminated prior to the expiration of the Term or a Renewal Term as follows: 5.1. For Cause Termination, Without Severance. Notwithstanding anything contained herein to the contrary, the Corporation may discharge Employee and terminate this 2 Agreement immediately upon written notice to Employee. For the purposes of this Agreement, "Cause" shall mean the occurrence of any of the following: (i) mismanagement or neglect of Employee's duties which the Corporation's Board of Directors determines is (or will be if continued) materially and adversely affecting the business or affairs of the Corporation; or (ii) conduct by Employee which the Corporation's Board of Directors determines is (or will be if continued) demonstrably and materially injurious to the Corporation, monetarily or otherwise; or (iii) fraud, misappropriation or embezzlement by the Employee; or (iv) conviction of a felony crime or a crime of moral turpitude; or (v) conduct in the course of employment that the Corporation's Board of Directors determines is unethical; or (vi) the material breach of this Agreement by Employee. If the Corporation terminates Employee's employment for Cause pursuant to this Paragraph 5.1, Employee shall not be entitled to severance pay under Paragraph 5.6 or to any bonus or incentive compensation of any kind. 5.2. Without Cause, With Severance. The Corporation may terminate Employee's employment immediately at any time and for any reason without Cause upon providing notice to Employee. However, in such event the Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) three (3) months from the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and 3 (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.3. Resignation by Employee Due to Change of Control, With Severance. For purposes of this Agreement, "Change of Control" means a change in ownership or control of the Corporation effected through any of the following transactions: (a) a merger, consolidation or reorganization approved by the Corporation's stockholders, unless securities representing more than fifty percent (50%) of the total combined voting power of the voting securities of the successor corporation are immediately thereafter beneficially owned, directly or indirectly and in substantially the same proportion, by the persons who beneficially owned the Corporation's outstanding voting securities immediately prior to such transaction; (b) any stockholder-approved transfer or other disposition of all or substantially all of the Corporation's assets; (c) the acquisition, directly or indirectly by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation), of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation's outstanding securities pursuant to a tender or exchange offer made directly to the Corporation's stockholders which the Board recommends such stockholders accept; or (d) a change in the composition of the Board over a period of thirty-six (36) consecutive months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (A) have been Board members continuously since the beginning of such period or (B) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (A) who were still in office at the time the Board approved such election or nomination. Employee shall have the right to terminate Employee's employment for any reason within six (6) months following a Change of Control in the Company upon providing thirty (30) days advance written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 30 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation following a Change of Control under this Paragraph 5.3, Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) twelve (12) months from 4 the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.4 Other Resignation by Employee, Without Severance. The Employee may resign Employee's position upon providing 90 days advance, written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 90 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation under this Paragraph 5.4, Employee shall not be paid any severance pay as provided in Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5.5 Because of Death, Disability or Incapacity of Employee, Without Severance. In the event of Employee's death, or if the Employee is unable to perform Employee's duties and responsibilities for more than 90 days in any consecutive 12-month period, by reason of physical or mental disability or incapacity, the Corporation may terminate Employee's employment upon thirty (30) days advance written notice to Employee. This Paragraph does not relieve the Corporation of any duty to reasonably accommodate a qualifying disability under the Americans with Disabilities Act, any legal duty under the Family Medical Leave Act, or any of its other duties pursuant to applicable law. If Employee's employment is terminated pursuant to this Paragraph, Employee shall not be entitled to severance pay under Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5 5.6 No Other Payments. Other than any severance payment or incentive compensation due to Employee under the terms of this Agreement, if any, Employee shall only be entitled to the following in the event of Employee's termination of employment for any reason: (i) compensation earned through the date of termination; (ii) benefits under any employee benefit plan or program to the extent provided therein; and (iii) continued coverage under Corporation's health and group term life insurance programs to the extent required under state or federal continuation coverage laws 6. Noncompetition/Non-Solicitation. 6.1. Acknowledgement by Employee. Employee acknowledges that (a) Employee's services to be performed for Corporation are of a special and unique nature; (b) Corporation operates in a highly competitive environment and would be substantially harmed if Employee were to compete with Corporation or divulge its confidential information; (c) Employee has received valuable and sufficient consideration for entering into this Agreement, including but not limited to employment with the Corporation, the receipt of Confidential Information and (d) the provisions of this Section 6, including all of its subparts, are reasonable and necessary to protect Corporation's business. 6.2. "Corporate Product" Defined. For purposes of this Agreement, "Corporate Product" means any product or service (including any component thereof and any research to develop information useful in connection with a product or service) that has been or is being designed, developed, manufactured, marketed or sold by the Corporation or with respect to which Employee has acquired Confidential Information. Employee understands and acknowledges that, at the present time, Corporate Products include microelectronics, subsystems, systems, connectivity and software solutions (including, but not limited to, MMIC chip carriers and packages, high linearity power amplifiers, front end RF modules, micro-circuit design, production and value-added assembly services, ultra-miniature multi-chip packaging including chip on flex, ceramic and PWB substrates, and high end flex and rigid flex fabrication). Employee understands and acknowledges that the foregoing description of Corporate Products may change, and the provisions of this Section 6 and all of its subparts shall apply to the Corporate Products of the Corporation in effect upon the termination of Employee's employment with the Corporation. 6.3 "Competitive Product" Defined. For purposes hereof, "Competitive Product" means any product or service (including any components thereof and any research to develop information useful in connection with the product or service) that is being designed, developed, manufactured, marketed or sold by any person or entity other than the Corporation that is of the same general type, performs similar functions, or is used for the same purpose as a Corporate Product on which Employee worked or assisted the Corporation during Employee's employment with the Corporation or about which Employee has acquired Confidential Information. 6 6.4 Noncompete Obligations. Employee agrees that, during Employee's employment with the Corporation and for a period of eighteen (18) months following Employee's termination of employment with the Company, regardless of the reason for termination, Employee will not, directly or indirectly, render services to any person or entity that designs, develops, manufactures, markets or sells a Competitive Product in any geographic area where the Company designs, develops, manufactures, markets or sells a Corporate Product. Employee understands and acknowledges that, at the present time, the geographic market of the Company includes the entire United States. Employee understands and acknowledges that the foregoing description of the Company's geographic market may change, and the provisions of this section 6 and all of its subparts shall apply to the geographic market of the Company in effect upon the termination of Employee's employment with the Company. 6.5 No Solicitation of Customers. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, solicit business from, work for, or otherwise interfere with or attempt to interfere with Corporation's relationship with any customer or prospective customer of Corporation. 6.6 No Solicitation of Employees or Business Contacts. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, take any action to encourage, solicit or recruit any current or former employee, consultant, independent contractor, subcontractor, supplier, vendor, or other business relation of Corporation to terminate their relationship with Corporation. 6.7 Disclosure of Obligations. Employee agrees that, during Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee shall, prior to accepting employment or any other business relationship with any other person or entity, inform that person or entity of Employee's obligations under this Section 6, including all of its subparts. 7. Protection of Confidential Information. 7.1 Definition of Confidential Information. As used in this Agreement, the term "Confidential Information" shall mean any information which Employee learns or develops during Employee's employment with Corporation that derives independent economic value from being not generally known or readily ascertainable by other persons who could obtain economic value from its disclosure or use, and includes, but is not limited to, trade secrets, Inventions as defined in Paragraph 9 below, financial information, personnel information, and information relating to such matters as existing or contemplated products, services, profit margins, fee schedules, pricing, design, processes, formulae, business plans, sales techniques, marketing techniques, training manuals and materials, policies or practices related to Corporation's 7 business, personnel or other matters, computer databases, computer programs, software and other technology, customer lists and requirements, vendor lists, or supply information. Confidential Information includes such information of Corporation, its customers, vendors, and other third parties or entities with whom Corporation does business. Any information disclosed to Employee or to which Employee has access during the time of Employee's employment that Employee reasonably considers to be Confidential Information, or which the Company treats as Confidential Information, will be presumed Confidential Information. 7.2 Restrictions on Use or Disclosure of Confidential Information. Employee shall keep the Confidential Information in absolute confidence both during Employee's employment with Corporation and after the termination of Employee's employment, regardless of the reason for such termination. Employee agrees that Employee will not, at any time, disclose to others, use for the benefit of any entity or person other than Corporation, or otherwise take or copy any such Confidential Information, whether or not developed by Employee, except as required in Employee's duties to Corporation. 8. Return of Confidential Information and Corporation's Property. When Employee's employment terminates with Corporation, regardless of the reason for such termination, Employee will promptly turn over to Corporation in good condition all Corporation property in Employee's possession or control, including but not limited to all originals, copies of, or electronically stored documents or other materials containing Confidential Information, regardless of who prepared them. In the case of electronically stored information retained by Employee outside of Corporation's electronic systems, Employee will promptly make a hard copy of such information in paper, audio recording, disc format, or other format as appropriate, turn that hard copy over to Corporation, and then destroy Employee's electronically stored information. Further, Employee agrees to execute written confirmation that all Confidential Information in the Employee's possession, or to which the Employee has access, has been turned over to Corporation or destroyed. 9. Inventions. 9.1 Definition of Inventions. As used in this Agreement, "Inventions" means any inventions, improvements, trade names or trademarks, trade secrets, discoveries, designs, formulae, ideas or original works of authorship (whether or not reduced to writing, other media or practice and whether or not patentable or copyrightable), or work product originated, conceived, developed, discovered or made in whole or in part solely by Employee or jointly with others that relate (a) to Corporation's business; (b) to Corporation's actual or demonstrably anticipated research or development; (c) that are made through the use of any of Corporation's equipment, facilities, supplies, trade secrets; (d) that result from any work Employee performs for Corporation; or (e) that are developed on Corporation time. 9.2 Ownership of Inventions. With respect to Inventions originated, conceived, developed, discovered or made in whole or in part solely or jointly by Employee at any time during Employee's employment with Corporation, Employee understands and agrees that Corporation will own all right, title, and interest, including patent rights, copyrights, trade secret rights and all other intellectual property rights of any sort, throughout the world related to 8 all Inventions without further payment beyond Employee's agreed-upon salary or wage. To the maximum extent permitted by law, all Inventions are deemed "works made for hire" under the United States Copyright Act and Corporation is deemed the sole author of any Inventions. To the extent any Inventions are determined not to constitute "works made for hire," Employee hereby assigns and transfers to Corporation all right, title and interest in the Inventions. Employee further agrees to (a) promptly and fully disclose all such Inventions to Corporation; (b) keep accurate, complete, and timely records of all Inventions, which records shall be Corporation's property and shall be maintained on Corporation's premises; (c) at Corporation's expense, assist Corporation to perfect, protect, and use its rights to Inventions, including without limitation, transferring Employee's entire right, title and interest in Inventions and enabling Corporation to obtain patent, copyright or trademark protection for Inventions anywhere in the world; and (c) give affidavits and testimony as to facts within Employee's knowledge in connection with any Inventions in any administrative proceedings, arbitration, litigation or controversy relating thereto. 9.3 Notice Regarding Exception to Inventions Assignment. Employee understands that the assignment of Inventions set forth herein does not apply to any Invention for which no equipment, supplies, facility, or trade secret information of Corporation was used and which was developed entirely on Employee's own time, and which does not relate directly to the business of the Company or to its actual or demonstrably anticipated research or development, or which does not result from any work performed by Employee for the Company. 10. Compliance and Remedies. Employee recognizes that if Employee violates this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement, irreparable damage will result to Corporation that could not adequately be remedied by monetary damages. As a result, Employee hereby agrees that notwithstanding any other dispute resolution provisions of this Agreement, in the event of any breach by Employee of this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement or in the event of apparent danger of such breach, Corporation shall be entitled, in addition to any other legal or equitable remedies available to it, to an injunction to restrain Employee's violation of any portion of this Agreement, as well as Corporation's attorney's fees and costs incurred in enforcing this Agreement. 11. Informal Dispute Resolution. Employee and the Corporation agree to make good faith efforts to resolve internally and without resort to formal dispute resolution any dispute, which may arise out of or relate to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, or any dispute regarding any of the provisions of this Agreement. 12. Arbitration Clause. In the event that informal efforts to resolve disputes pursuant to Paragraph 11 are unsuccessful, any dispute between Employee and the Corporation arising out of or related to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, and any dispute between Employee and the Corporation regarding any of the provisions of this Agreement (other than an action for injunctive relief to enforce Employee's obligations under paragraphs 6, 7, 8, or 9 of this Agreement), shall be determined not in a court of law, but instead by arbitration in the United States, in the State of Minnesota and the County of Hennepin. Such disputes shall be referred in writing to the 9 American Arbitration Association for selection of an arbitrator. Selection of the arbitrator shall be made in accordance with the Rules of the American Arbitration Association, and the arbitrator's decision shall be final and binding in all respects. Except as otherwise provided in this section, arbitration proceedings initiated pursuant to this Agreement shall be conducted in accordance with the Rules of the American Arbitration Association. Prior to the arbitration hearing, the parties may use the following discovery methods: interrogatories in a form consistent with Rule 33 of the Federal Rules of Civil Procedure; requests for production of documents in a form consistent with Rule 34 of the Federal Rules of Civil Procedure; admissions; depositions of witnesses in accordance with Rule 30 of the Federal Rules of Civil Procedure. The arbitrator shall have the right to determine the extent of discovery permitted. The arbitrator shall consider the matter in controversy and may hold hearings regarding the same. The arbitrator may grant any remedy or relief that he or she deems just and equitable, including, but not limited to, any remedy or relief that would have been available to the parties under any applicable statutes or common law. The arbitrator also has the authority to issue an award or partial award on the grounds that there is no claim stated on which relief can be granted or that there is no genuine issue as to any material fact and one party is entitled to judgment as a matter of law consistent with Federal Rules of Civil Procedure 12 or 56. The arbitrator shall enter an award in writing detailing his or her consideration of the relevant facts, the basis and reason for the decision, and his or her adherence to the applicable law. This written decision shall be entered within thirty days after the matter is finally submitted to the arbitrator, and a copy thereof shall be delivered to each party by certified mail. Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. The Corporation shall pay the expense of the arbitrator; each party will bear its own attorneys' fees and expenses. All proceedings under this Paragraph are private and confidential. Notwithstanding the foregoing, the Company may bring a court action for injunctive relief to enforce this Agreement. The parties agree that the Corporation may elect to venue such action in the federal or state courts of the State of Minnesota, whether or not such venue is then convenient to Employee, and that such courts shall have personal jurisdiction over Corporation and Employee and Employee shall not object to the venue or personal jurisdiction of such courts. Employee understands that by signing this Agreement, Employee is forever giving up Employee's right to litigate in a court of law any controversy arising out of Employee's employment relationship with the Corporation, and any controversy regarding any of the provisions of this Agreement, and that he is agreeing instead to arbitrate any claims he may choose to pursue against the Corporation. Nothing in this Agreement, however, prohibits either party from going to a court of law to enforce an award of an arbitrator. 13. Miscellaneous. 13.1. Integration. This Agreement embodies the entire agreement and understanding among the parties relative to subject matter hereof and supersedes all prior agreements and understandings relating to such subject matter, including but not limited to any earlier employment agreements of the Employee. 10 13.2. Applicable Law. This Agreement and the rights of the parties shall be governed by and construed and enforced in accordance with the laws of the state of Minnesota. 13.3. Payments. All amounts paid under this Agreement shall be subject to normal withholdings or such other treatment as required by law. 13.4. Counterparts. This Agreement may be executed in several counterparts and as so executed shall constitute one agreement binding on the parties hereto. 13.5. Binding Effect. Except as herein or otherwise provided to the contrary, this Agreement shall be binding upon and inure to the benefit of the Corporation and its successors, assigns and personal representatives without any requirement of the consent of the employee for assignment of its rights or obligations hereunder. 13.6. Notices. All notices, requests and other communications hereunder shall be given in writing and deemed to have been duly given or served if personally delivered, or sent by first class, certified mail, return receipt requested, postage prepaid, to the party at the address as provided below, or, to such other address as such party may hereafter designate by written notice to the other party: (a) If to the Corporation, to the address of its then principal office. (b) If to Employee, to the address last shown in the records of the Corporation. 13.7. Modification. This Agreement shall not be modified or amended except by a written instrument signed by the parties. 13.8. Severability. The invalidity or partial invalidity of any portion of this Agreement shall not invalidate the remainder thereof, and said remainder shall remain in fully force and effect. 13.9. Headings. The section headings contained in this Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. 13.10. Survival. Employee acknowledges and agrees that Employee's noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement shall survive the Term or any Renewal Term, the non-renewal of this Agreement, and the termination of Employee's employment with the Corporation, regardless of the reason for termination. 13.11. Opportunity to Obtain Advice of Counsel. Employee acknowledges that Employee has been advised by the Corporation to obtain legal advice prior to executing this Agreement, and that Employee had sufficient opportunity to do so prior to signing this Agreement. 11 THIS AGREEMENT was voluntarily and knowingly executed by the parties as of date and year first set forth above. HEI, INC. By: /s/ MACK TRAYNOR ----------------------------- Mack Traynor, President/CEO EMPLOYEE: /s/ SCOTT STOLE ----------------------------- Scott Stole 12 EX-10.38 9 c81087exv10w38.txt EX-10.38 EMPLOYMENT AGREEMENT - SIMON F HAWKSWORTH EXHIBIT 10.38 HEI, INC. EMPLOYMENT AGREEMENT This Employment Agreement is made and entered into effective as of October 1, 2003 (the "Effective Date"), by and among HEI, Inc., a Minnesota corporation (the "Corporation"), and Simon Hawksworth ("Employee"). RECITALS A. Employee is currently employed by the Company as its Vice President of Sales and Marketing, and is a party to an HEI, Inc. Confidentiality, Noncompete and Inventions Agreement between Employee and the Company dated September 5, 2002 (the "2002 Employment Agreement") B. Corporation desires to continue to employ Employee in accordance with the terms of this Agreement. C. Employee recognizes that the Corporation operates in a highly competitive environment and the importance to the Corporation of ensuring Employee's loyalty and protecting the Corporation's customers, employees, business information and inventions, and goodwill. Accordingly, Employee has entered into and agrees to be bound by this Agreement in consideration of Employee's employment with the Corporation and being given access to the Corporation's confidential information. D. The Corporation and Employee desire to enter into this Agreement. AGREEMENT In consideration of the above recitals and the mutual promises set forth in this Agreement the parties agree as follows: 1. Termination of 2002 Employment Agreement. The parties agree that the 2002 Employment Agreement is terminated as of the Effective Date of this Agreement and that this Agreement replaces and supersedes the 2002 Employment Agreement. 2. Nature and Capacity of Employment. The Corporation hereby agrees to employ Employee as its Vice President of Sales and Marketing, subject to the direction of the President/Chief Executive Officer and the Board of Directors of the Corporation and pursuant to the terms and conditions set forth in this Agreement. Employee hereby accepts employment under the terms and conditions set forth in this Agreement. Employee agrees to perform or be available to perform, on a full-time basis, the functions of this position, pursuant to the terms of this Agreement. In addition, Employee will not, during the course of employment by the Corporation, without prior written approval of the Board of 1 Directors of the Corporation, become an employee, director, officer, agent, partner of or consultant to, or a stockholder of (except a stockholder of a public company in which Employee owns less than five percent (5%) of the issued and outstanding capital stock of such company) any company or other business entity which is, as determined by the Board of Directors in its discretion, a significant competitor, supplier, or customer of the Corporation. 2. Term of Employment. Employee's employment hereunder shall commence as of the Effective Date and shall continue for period of one year thereafter until October 1, 2004 (the "Term") unless Employee's employment is earlier terminated pursuant to the terms of Paragraph 5 of this Agreement. Unless Employee's employment has earlier terminated pursuant to the terms of Paragraph 5 of this Agreement, this Agreement shall automatically renew following the Term for successive terms of one year each (each called a "Renewal Term") unless the Corporation provides Employee thirty (30) days advance written notice prior to the expiration of the Term or Renewal Term that this Agreement shall not be renewed. During any Renewal Term, this Agreement may be terminated pursuant to the terms of Paragraph 5 of this Agreement. 3. Compensation. 3.1 Base Salary. As of the Effective Date, the Corporation agrees to pay Employee an annualized base salary of $140,000.00, which amount shall be earned by Employee on a pro rata basis as Employee performs services and which shall be paid according to the Corporation's normal payroll practices. The Corporation may, in its discretion, adjust Employee's base salary from time to time based on Employee's performance and the Corporation's business and financial situation. 3.2 Incentive or Bonus Compensation. The Corporation may, in its sole discretion, pay bonuses or other incentive compensation to Employee in addition to the annual base salary set forth above. 4. Employee Benefits. During Employee's employment with Corporation, Employee shall be entitled to participate in the retirement plans, health plans, and all other employee benefits made available by the Corporation, and as they may be changed from time to time. Employee acknowledges and agrees that the Corporation is under no obligation to Employee to establish and maintain any employee benefit plan in which Employee may participate, and that the terms and provisions of any employee benefit plan of the Corporation are matters within the exclusive province of the Corporation's Board of Directors, subject to applicable law. Upon the termination of Employee's employment, Employee shall be entitled to continue those benefits as may be required by state or federal law. 5. Termination of Employment Prior to the End of the Term or Renewal Term. Employee's employment may be terminated prior to the expiration of the Term or a Renewal Term as follows: 5.1. For Cause Termination, Without Severance. Notwithstanding anything contained herein to the contrary, the Corporation may discharge Employee and terminate this 2 Agreement immediately upon written notice to Employee. For the purposes of this Agreement, "Cause" shall mean the occurrence of any of the following: (i) mismanagement or neglect of Employee's duties which the Corporation's Board of Directors determines is (or will be if continued) materially and adversely affecting the business or affairs of the Corporation; or (ii) conduct by Employee which the Corporation's Board of Directors determines is (or will be if continued) demonstrably and materially injurious to the Corporation, monetarily or otherwise; or (iii) fraud, misappropriation or embezzlement by the Employee; or (iv) conviction of a felony crime or a crime of moral turpitude; or (v) conduct in the course of employment that the Corporation's Board of Directors determines is unethical; or (vi) the material breach of this Agreement by Employee. If the Corporation terminates Employee's employment for Cause pursuant to this Paragraph 5.1, Employee shall not be entitled to severance pay under Paragraph 5.6 or to any bonus or incentive compensation of any kind. 5.2. Without Cause, With Severance. The Corporation may terminate Employee's employment immediately at any time and for any reason without Cause upon providing notice to Employee. However, in such event the Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) three (3) months from the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and 3 (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.3. Resignation by Employee Due to Change of Control, With Severance. For purposes of this Agreement, "Change of Control" means a change in ownership or control of the Corporation effected through any of the following transactions: (a) a merger, consolidation or reorganization approved by the Corporation's stockholders, unless securities representing more than fifty percent (50%) of the total combined voting power of the voting securities of the successor corporation are immediately thereafter beneficially owned, directly or indirectly and in substantially the same proportion, by the persons who beneficially owned the Corporation's outstanding voting securities immediately prior to such transaction; (b) any stockholder-approved transfer or other disposition of all or substantially all of the Corporation's assets; (c) the acquisition, directly or indirectly by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation), of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation's outstanding securities pursuant to a tender or exchange offer made directly to the Corporation's stockholders which the Board recommends such stockholders accept; or (d) a change in the composition of the Board over a period of thirty-six (36) consecutive months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (A) have been Board members continuously since the beginning of such period or (B) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (A) who were still in office at the time the Board approved such election or nomination. Employee shall have the right to terminate Employee's employment for any reason within six (6) months following a Change of Control in the Company upon providing thirty (30) days advance written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 30 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation following a Change of Control under this Paragraph 5.3, Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) twelve (12) months from 4 the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.4 Other Resignation by Employee, Without Severance. The Employee may resign Employee's position upon providing 90 days advance, written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 90 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation under this Paragraph 5.4, Employee shall not be paid any severance pay as provided in Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5.5 Because of Death, Disability or Incapacity of Employee, Without Severance. In the event of Employee's death, or if the Employee is unable to perform Employee's duties and responsibilities for more than 90 days in any consecutive 12-month period, by reason of physical or mental disability or incapacity, the Corporation may terminate Employee's employment upon thirty (30) days advance written notice to Employee. This Paragraph does not relieve the Corporation of any duty to reasonably accommodate a qualifying disability under the Americans with Disabilities Act, any legal duty under the Family Medical Leave Act, or any of its other duties pursuant to applicable law. If Employee's employment is terminated pursuant to this Paragraph, Employee shall not be entitled to severance pay under Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5 5.6 No Other Payments. Other than any severance payment or incentive compensation due to Employee under the terms of this Agreement, if any, Employee shall only be entitled to the following in the event of Employee's termination of employment for any reason: (i) compensation earned through the date of termination; (ii) benefits under any employee benefit plan or program to the extent provided therein; and (iii) continued coverage under Corporation's health and group term life insurance programs to the extent required under state or federal continuation coverage laws 6. Noncompetition/Non-Solicitation. 6.1. Acknowledgement by Employee. Employee acknowledges that (a) Employee's services to be performed for Corporation are of a special and unique nature; (b) Corporation operates in a highly competitive environment and would be substantially harmed if Employee were to compete with Corporation or divulge its confidential information; (c) Employee has received valuable and sufficient consideration for entering into this Agreement, including but not limited to employment with the Corporation, the receipt of Confidential Information and (d) the provisions of this Section 6, including all of its subparts, are reasonable and necessary to protect Corporation's business. 6.2. "Corporate Product" Defined. For purposes of this Agreement, "Corporate Product" means any product or service (including any component thereof and any research to develop information useful in connection with a product or service) that has been or is being designed, developed, manufactured, marketed or sold by the Corporation or with respect to which Employee has acquired Confidential Information. Employee understands and acknowledges that, at the present time, Corporate Products include microelectronics, subsystems, systems, connectivity and software solutions (including, but not limited to, MMIC chip carriers and packages, high linearity power amplifiers, front end RF modules, micro-circuit design, production and value-added assembly services, ultra-miniature multi-chip packaging including chip on flex, ceramic and PWB substrates, and high end flex and rigid flex fabrication). Employee understands and acknowledges that the foregoing description of Corporate Products may change, and the provisions of this Section 6 and all of its subparts shall apply to the Corporate Products of the Corporation in effect upon the termination of Employee's employment with the Corporation. 6.3 "Competitive Product" Defined. For purposes hereof, "Competitive Product" means any product or service (including any components thereof and any research to develop information useful in connection with the product or service) that is being designed, developed, manufactured, marketed or sold by any person or entity other than the Corporation that is of the same general type, performs similar functions, or is used for the same purpose as a Corporate Product on which Employee worked or assisted the Corporation during Employee's employment with the Corporation or about which Employee has acquired Confidential Information. 6 6.4 Noncompete Obligations. Employee agrees that, during Employee's employment with the Corporation and for a period of eighteen (18) months following Employee's termination of employment with the Company, regardless of the reason for termination, Employee will not, directly or indirectly, render services to any person or entity that designs, develops, manufactures, markets or sells a Competitive Product in any geographic area where the Company designs, develops, manufactures, markets or sells a Corporate Product. Employee understands and acknowledges that, at the present time, the geographic market of the Company includes the entire United States. Employee understands and acknowledges that the foregoing description of the Company's geographic market may change, and the provisions of this section 6 and all of its subparts shall apply to the geographic market of the Company in effect upon the termination of Employee's employment with the Company. 6.5 No Solicitation of Customers. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, solicit business from, work for, or otherwise interfere with or attempt to interfere with Corporation's relationship with any customer or prospective customer of Corporation. 6.6 No Solicitation of Employees or Business Contacts. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, take any action to encourage, solicit or recruit any current or former employee, consultant, independent contractor, subcontractor, supplier, vendor, or other business relation of Corporation to terminate their relationship with Corporation. 6.7 Disclosure of Obligations. Employee agrees that, during Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee shall, prior to accepting employment or any other business relationship with any other person or entity, inform that person or entity of Employee's obligations under this Section 6, including all of its subparts. 7. Protection of Confidential Information. 7.1 Definition of Confidential Information. As used in this Agreement, the term "Confidential Information" shall mean any information which Employee learns or develops during Employee's employment with Corporation that derives independent economic value from being not generally known or readily ascertainable by other persons who could obtain economic value from its disclosure or use, and includes, but is not limited to, trade secrets, Inventions as defined in Paragraph 9 below, financial information, personnel information, and information relating to such matters as existing or contemplated products, services, profit margins, fee schedules, pricing, design, processes, formulae, business plans, sales techniques, marketing techniques, training manuals and materials, policies or practices related to Corporation's 7 business, personnel or other matters, computer databases, computer programs, software and other technology, customer lists and requirements, vendor lists, or supply information. Confidential Information includes such information of Corporation, its customers, vendors, and other third parties or entities with whom Corporation does business. Any information disclosed to Employee or to which Employee has access during the time of Employee's employment that Employee reasonably considers to be Confidential Information, or which the Company treats as Confidential Information, will be presumed Confidential Information. 7.2 Restrictions on Use or Disclosure of Confidential Information. Employee shall keep the Confidential Information in absolute confidence both during Employee's employment with Corporation and after the termination of Employee's employment, regardless of the reason for such termination. Employee agrees that Employee will not, at any time, disclose to others, use for the benefit of any entity or person other than Corporation, or otherwise take or copy any such Confidential Information, whether or not developed by Employee, except as required in Employee's duties to Corporation. 8. Return of Confidential Information and Corporation's Property. When Employee's employment terminates with Corporation, regardless of the reason for such termination, Employee will promptly turn over to Corporation in good condition all Corporation property in Employee's possession or control, including but not limited to all originals, copies of, or electronically stored documents or other materials containing Confidential Information, regardless of who prepared them. In the case of electronically stored information retained by Employee outside of Corporation's electronic systems, Employee will promptly make a hard copy of such information in paper, audio recording, disc format, or other format as appropriate, turn that hard copy over to Corporation, and then destroy Employee's electronically stored information. Further, Employee agrees to execute written confirmation that all Confidential Information in the Employee's possession, or to which the Employee has access, has been turned over to Corporation or destroyed. 9. Inventions. 9.1 Definition of Inventions. As used in this Agreement, "Inventions" means any inventions, improvements, trade names or trademarks, trade secrets, discoveries, designs, formulae, ideas or original works of authorship (whether or not reduced to writing, other media or practice and whether or not patentable or copyrightable), or work product originated, conceived, developed, discovered or made in whole or in part solely by Employee or jointly with others that relate (a) to Corporation's business; (b) to Corporation's actual or demonstrably anticipated research or development; (c) that are made through the use of any of Corporation's equipment, facilities, supplies, trade secrets; (d) that result from any work Employee performs for Corporation; or (e) that are developed on Corporation time. 9.2 Ownership of Inventions. With respect to Inventions originated, conceived, developed, discovered or made in whole or in part solely or jointly by Employee at any time during Employee's employment with Corporation, Employee understands and agrees that Corporation will own all right, title, and interest, including patent rights, copyrights, trade secret rights and all other intellectual property rights of any sort, throughout the world related to 8 all Inventions without further payment beyond Employee's agreed-upon salary or wage. To the maximum extent permitted by law, all Inventions are deemed "works made for hire" under the United States Copyright Act and Corporation is deemed the sole author of any Inventions. To the extent any Inventions are determined not to constitute "works made for hire," Employee hereby assigns and transfers to Corporation all right, title and interest in the Inventions. Employee further agrees to (a) promptly and fully disclose all such Inventions to Corporation; (b) keep accurate, complete, and timely records of all Inventions, which records shall be Corporation's property and shall be maintained on Corporation's premises; (c) at Corporation's expense, assist Corporation to perfect, protect, and use its rights to Inventions, including without limitation, transferring Employee's entire right, title and interest in Inventions and enabling Corporation to obtain patent, copyright or trademark protection for Inventions anywhere in the world; and (c) give affidavits and testimony as to facts within Employee's knowledge in connection with any Inventions in any administrative proceedings, arbitration, litigation or controversy relating thereto. 9.3 Notice Regarding Exception to Inventions Assignment. Employee understands that the assignment of Inventions set forth herein does not apply to any Invention for which no equipment, supplies, facility, or trade secret information of Corporation was used and which was developed entirely on Employee's own time, and which does not relate directly to the business of the Company or to its actual or demonstrably anticipated research or development, or which does not result from any work performed by Employee for the Company. 10. Compliance and Remedies. Employee recognizes that if Employee violates this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement, irreparable damage will result to Corporation that could not adequately be remedied by monetary damages. As a result, Employee hereby agrees that notwithstanding any other dispute resolution provisions of this Agreement, in the event of any breach by Employee of this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement or in the event of apparent danger of such breach, Corporation shall be entitled, in addition to any other legal or equitable remedies available to it, to an injunction to restrain Employee's violation of any portion of this Agreement, as well as Corporation's attorney's fees and costs incurred in enforcing this Agreement. 11. Informal Dispute Resolution. Employee and the Corporation agree to make good faith efforts to resolve internally and without resort to formal dispute resolution any dispute, which may arise out of or relate to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, or any dispute regarding any of the provisions of this Agreement. 12. Arbitration Clause. In the event that informal efforts to resolve disputes pursuant to Paragraph 11 are unsuccessful, any dispute between Employee and the Corporation arising out of or related to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, and any dispute between Employee and the Corporation regarding any of the provisions of this Agreement (other than an action for injunctive relief to enforce Employee's obligations under paragraphs 6, 7, 8, or 9 of this Agreement), shall be determined not in a court of law, but instead by arbitration in the United States, in the State of Minnesota and the County of Hennepin. Such disputes shall be referred in writing to the 9 American Arbitration Association for selection of an arbitrator. Selection of the arbitrator shall be made in accordance with the Rules of the American Arbitration Association, and the arbitrator's decision shall be final and binding in all respects. Except as otherwise provided in this section, arbitration proceedings initiated pursuant to this Agreement shall be conducted in accordance with the Rules of the American Arbitration Association. Prior to the arbitration hearing, the parties may use the following discovery methods: interrogatories in a form consistent with Rule 33 of the Federal Rules of Civil Procedure; requests for production of documents in a form consistent with Rule 34 of the Federal Rules of Civil Procedure; admissions; depositions of witnesses in accordance with Rule 30 of the Federal Rules of Civil Procedure. The arbitrator shall have the right to determine the extent of discovery permitted. The arbitrator shall consider the matter in controversy and may hold hearings regarding the same. The arbitrator may grant any remedy or relief that he or she deems just and equitable, including, but not limited to, any remedy or relief that would have been available to the parties under any applicable statutes or common law. The arbitrator also has the authority to issue an award or partial award on the grounds that there is no claim stated on which relief can be granted or that there is no genuine issue as to any material fact and one party is entitled to judgment as a matter of law consistent with Federal Rules of Civil Procedure 12 or 56. The arbitrator shall enter an award in writing detailing his or her consideration of the relevant facts, the basis and reason for the decision, and his or her adherence to the applicable law. This written decision shall be entered within thirty days after the matter is finally submitted to the arbitrator, and a copy thereof shall be delivered to each party by certified mail. Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. The Corporation shall pay the expense of the arbitrator; each party will bear its own attorneys' fees and expenses. All proceedings under this Paragraph are private and confidential. Notwithstanding the foregoing, the Company may bring a court action for injunctive relief to enforce this Agreement. The parties agree that the Corporation may elect to venue such action in the federal or state courts of the State of Minnesota, whether or not such venue is then convenient to Employee, and that such courts shall have personal jurisdiction over Corporation and Employee and Employee shall not object to the venue or personal jurisdiction of such courts. Employee understands that by signing this Agreement, Employee is forever giving up Employee's right to litigate in a court of law any controversy arising out of Employee's employment relationship with the Corporation, and any controversy regarding any of the provisions of this Agreement, and that he is agreeing instead to arbitrate any claims he may choose to pursue against the Corporation. Nothing in this Agreement, however, prohibits either party from going to a court of law to enforce an award of an arbitrator. 13. Miscellaneous. 13.1. Integration. This Agreement embodies the entire agreement and understanding among the parties relative to subject matter hereof and supersedes all prior agreements and understandings relating to such subject matter, including but not limited to any earlier employment agreements of the Employee. 10 13.2. Applicable Law. This Agreement and the rights of the parties shall be governed by and construed and enforced in accordance with the laws of the state of Minnesota. 13.3. Payments. All amounts paid under this Agreement shall be subject to normal withholdings or such other treatment as required by law. 13.4. Counterparts. This Agreement may be executed in several counterparts and as so executed shall constitute one agreement binding on the parties hereto. 13.5. Binding Effect. Except as herein or otherwise provided to the contrary, this Agreement shall be binding upon and inure to the benefit of the Corporation and its successors, assigns and personal representatives without any requirement of the consent of the employee for assignment of its rights or obligations hereunder. 13.6. Notices. All notices, requests and other communications hereunder shall be given in writing and deemed to have been duly given or served if personally delivered, or sent by first class, certified mail, return receipt requested, postage prepaid, to the party at the address as provided below, or, to such other address as such party may hereafter designate by written notice to the other party: (a) If to the Corporation, to the address of its then principal office. (b) If to Employee, to the address last shown in the records of the Corporation. 13.7. Modification. This Agreement shall not be modified or amended except by a written instrument signed by the parties. 13.8. Severability. The invalidity or partial invalidity of any portion of this Agreement shall not invalidate the remainder thereof, and said remainder shall remain in fully force and effect. 13.9. Headings. The section headings contained in this Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. 13.10. Survival. Employee acknowledges and agrees that Employee's noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement shall survive the Term or any Renewal Term, the non-renewal of this Agreement, and the termination of Employee's employment with the Corporation, regardless of the reason for termination. 13.11. Opportunity to Obtain Advice of Counsel. Employee acknowledges that Employee has been advised by the Corporation to obtain legal advice prior to executing this Agreement, and that Employee had sufficient opportunity to do so prior to signing this Agreement. 11 THIS AGREEMENT was voluntarily and knowingly executed by the parties as of date and year first set forth above. HEI, INC. By: /s/ MACK TRAYNOR ------------------------------ Mack Traynor, President/CEO EMPLOYEE: /s/ SIMON HAWKSWORTH ------------------------------ Simon Hawksworth 12 EX-10.39 10 c81087exv10w39.txt EX-10.39 EMPLOYMENT AGREEMENT - JAMES C. VETRICEK EXHIBIT 10.39 HEI, INC. EMPLOYMENT AGREEMENT This Employment Agreement is made and entered into effective as of October 1, 2003 (the "Effective Date"), by and among HEI, Inc., a Minnesota corporation (the "Corporation"), and James Vetricek ("Employee"). RECITALS A. Employee is currently employed by the Company as its Vice President/General Manager of the Advanced Medical Division. B. Corporation desires to continue to employ Employee in accordance with the terms of this Agreement. C. Employee recognizes that the Corporation operates in a highly competitive environment and the importance to the Corporation of ensuring Employee's loyalty and protecting the Corporation's customers, employees, business information and inventions, and goodwill. Accordingly, Employee has entered into and agrees to be bound by this Agreement in consideration of Employee's employment with the Corporation and being given access to the Corporation's confidential information. D. The Corporation and Employee desire to enter into this Agreement. AGREEMENT In consideration of the above recitals and the mutual promises set forth in this Agreement the parties agree as follows: 1. Termination of Previous Employment Agreement. The parties agree that any previous Employment Agreement is terminated as of the Effective Date of this Agreement and that this Agreement replaces and supersedes any previous Employment Agreement. 2. Nature and Capacity of Employment. The Corporation hereby agrees to employ Employee as its Vice President/General Manager of Advanced Medical Division, subject to the direction of the President/Chief Executive Officer and the Board of Directors of the Corporation and pursuant to the terms and conditions set forth in this Agreement. Employee hereby accepts employment under the terms and conditions set forth in this Agreement. Employee agrees to perform or be available to perform, on a full-time basis, the functions of this position, pursuant to the terms of this Agreement. In addition, Employee will not, during the course of employment by the Corporation, without prior written approval of the Board of Directors of the Corporation, become an employee, director, officer, agent, partner of or consultant to, or a stockholder of (except a stockholder of a public company in which Employee 1 owns less than five percent (5%) of the issued and outstanding capital stock of such company) any company or other business entity which is, as determined by the Board of Directors in its discretion, a significant competitor, supplier, or customer of the Corporation. 2. Term of Employment. Employee's employment hereunder shall commence as of the Effective Date and shall continue for period of one year thereafter until October 1, 2004 (the "Term") unless Employee's employment is earlier terminated pursuant to the terms of Paragraph 5 of this Agreement. Unless Employee's employment has earlier terminated pursuant to the terms of Paragraph 5 of this Agreement, this Agreement shall automatically renew following the Term for successive terms of one year each (each called a "Renewal Term") unless the Corporation provides Employee thirty (30) days advance written notice prior to the expiration of the Term or Renewal Term that this Agreement shall not be renewed. During any Renewal Term, this Agreement may be terminated pursuant to the terms of Paragraph 5 of this Agreement. 3. Compensation. 3.1 Base Salary. As of the Effective Date, the Corporation agrees to pay Employee an annualized base salary of $150,000.00, which amount shall be earned by Employee on a pro rata basis as Employee performs services and which shall be paid according to the Corporation's normal payroll practices. The Corporation may, in its discretion, adjust Employee's base salary from time to time based on Employee's performance and the Corporation's business and financial situation. 3.2 Incentive or Bonus Compensation. The Corporation may, in its sole discretion, pay bonuses or other incentive compensation to Employee in addition to the annual base salary set forth above. 4. Employee Benefits. During Employee's employment with Corporation, Employee shall be entitled to participate in the retirement plans, health plans, and all other employee benefits made available by the Corporation, and as they may be changed from time to time. Employee acknowledges and agrees that the Corporation is under no obligation to Employee to establish and maintain any employee benefit plan in which Employee may participate, and that the terms and provisions of any employee benefit plan of the Corporation are matters within the exclusive province of the Corporation's Board of Directors, subject to applicable law. Upon the termination of Employee's employment, Employee shall be entitled to continue those benefits as may be required by state or federal law. 5. Termination of Employment Prior to the End of the Term or Renewal Term. Employee's employment may be terminated prior to the expiration of the Term or a Renewal Term as follows: 5.1. For Cause Termination, Without Severance. Notwithstanding anything contained herein to the contrary, the Corporation may discharge Employee and terminate this Agreement immediately upon written notice to Employee. For the purposes of this Agreement, "Cause" shall mean the occurrence of any of the following: 2 (i) mismanagement or neglect of Employee's duties which the Corporation's Board of Directors determines is (or will be if continued) materially and adversely affecting the business or affairs of the Corporation; or (ii) conduct by Employee which the Corporation's Board of Directors determines is (or will be if continued) demonstrably and materially injurious to the Corporation, monetarily or otherwise; or (iii) fraud, misappropriation or embezzlement by the Employee; or (iv) conviction of a felony crime or a crime of moral turpitude; or (v) conduct in the course of employment that the Corporation's Board of Directors determines is unethical; or (vi) the material breach of this Agreement by Employee. If the Corporation terminates Employee's employment for Cause pursuant to this Paragraph 5.1, Employee shall not be entitled to severance pay under Paragraph 5.6 or to any bonus or incentive compensation of any kind. 5.2. Without Cause, With Severance. The Corporation may terminate Employee's employment immediately at any time and for any reason without Cause upon providing notice to Employee. However, in such event the Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) three (3) months from the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent 3 contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.3. Resignation by Employee Due to Change of Control, With Severance. For purposes of this Agreement, "Change of Control" means a change in ownership or control of the Corporation effected through any of the following transactions: (a) a merger, consolidation or reorganization approved by the Corporation's stockholders, unless securities representing more than fifty percent (50%) of the total combined voting power of the voting securities of the successor corporation are immediately thereafter beneficially owned, directly or indirectly and in substantially the same proportion, by the persons who beneficially owned the Corporation's outstanding voting securities immediately prior to such transaction; (b) any stockholder-approved transfer or other disposition of all or substantially all of the Corporation's assets; (c) the acquisition, directly or indirectly by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation), of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation's outstanding securities pursuant to a tender or exchange offer made directly to the Corporation's stockholders which the Board recommends such stockholders accept; or (d) a change in the composition of the Board over a period of thirty-six (36) consecutive months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (A) have been Board members continuously since the beginning of such period or (B) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (A) who were still in office at the time the Board approved such election or nomination. Employee shall have the right to terminate Employee's employment for any reason within six (6) months following a Change of Control in the Company upon providing thirty (30) days advance written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 30 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation following a Change of Control under this Paragraph 5.3, Corporation shall pay Employee any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through the Employee's termination date. In addition, provided that Employee meets all of the conditions set forth in this paragraph for receiving severance pay, the Corporation shall pay Employee severance pay in monthly installments equal to 1/12 of Employee's annualized base salary at the time of termination, less applicable withholdings, up to the earlier of (i) twelve (12) months from the date of Employee's date of termination or (ii) the date on which Employee begins earning income from self-employment, employment, consulting, independent contracting, or other work 4 activities. Employee shall only be entitled receive the severance pay described herein if Employee meets all of the following conditions: (a) Employee must sign a Separation Agreement at the time of termination in a form prepared by the Corporation that includes adequate provisions for the following: (i) Employee's general release of any and all legal claims; (ii) Employee's return of all of the Corporation's property in Employee's possession; (iii) nondisparagement of the Corporation and its representatives; (iv) confidentiality of terms; and (v) acknowledgement of Employee's continuing contractual obligations to the Corporation, including Employee's continuing noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement; and (b) Commencing as of Employee's termination date, Employee must diligently search for and try to obtain income producing opportunities through self-employment, employment, consulting, independent contracting or other work opportunities and must, upon request from the Corporation, provide Corporation written proof of such efforts; and (c) Employee must promptly notify the Company in writing of the date(s) on which Employee will and does begin earning income from self-employment, employment, consulting, independent contracting or other work activities. 5.4 Other Resignation by Employee, Without Severance. The Employee may resign Employee's position upon providing 90 days advance, written notice to the Corporation. The Corporation may then elect either (a) to have Employee continue performing work for the Corporation throughout the 90 day notice period; or (b) to accept Employee's resignation effective immediately. In the event of Employee's termination of employment with the Corporation under this Paragraph 5.4, Employee shall not be paid any severance pay as provided in Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5.5 Because of Death, Disability or Incapacity of Employee, Without Severance. In the event of Employee's death, or if the Employee is unable to perform Employee's duties and responsibilities for more than 90 days in any consecutive 12-month period, by reason of physical or mental disability or incapacity, the Corporation may terminate Employee's employment upon thirty (30) days advance written notice to Employee. This Paragraph does not relieve the Corporation of any duty to reasonably accommodate a qualifying disability under the Americans with Disabilities Act, any legal duty under the Family Medical Leave Act, or any of its other duties pursuant to applicable law. If Employee's employment is terminated pursuant to this Paragraph, Employee shall not be entitled to severance pay under Paragraph 5.6, but shall be paid any earned and unpaid bonus or incentive compensation, if any, on a pro rata basis for the period through Employee's termination date. 5 5.6 No Other Payments. Other than any severance payment or incentive compensation due to Employee under the terms of this Agreement, if any, Employee shall only be entitled to the following in the event of Employee's termination of employment for any reason: (i) compensation earned through the date of termination; (ii) benefits under any employee benefit plan or program to the extent provided therein; and (iii) continued coverage under Corporation's health and group term life insurance programs to the extent required under state or federal continuation coverage laws. 6. Noncompetition/Non-Solicitation. 6.1. Acknowledgement by Employee. Employee acknowledges that (a) Employee's services to be performed for Corporation are of a special and unique nature; (b) Corporation operates in a highly competitive environment and would be substantially harmed if Employee were to compete with Corporation or divulge its confidential information; (c) Employee has received valuable and sufficient consideration for entering into this Agreement, including but not limited to employment with the Corporation, the receipt of Confidential Information and (d) the provisions of this Section 6, including all of its subparts, are reasonable and necessary to protect Corporation's business. 6.2. "Corporate Product" Defined. For purposes of this Agreement, "Corporate Product" means any product or service (including any component thereof and any research to develop information useful in connection with a product or service) that has been or is being designed, developed, manufactured, marketed or sold by the Corporation or with respect to which Employee has acquired Confidential Information. Employee understands and acknowledges that, at the present time, Corporate Products include microelectronics, subsystems, systems, connectivity and software solutions (including, but not limited to, MMIC chip carriers and packages, high linearity power amplifiers, front end RF modules, micro-circuit design, production and value-added assembly services, ultra-miniature multi-chip packaging including chip on flex, ceramic and PWB substrates, and high end flex and rigid flex fabrication). Employee understands and acknowledges that the foregoing description of Corporate Products may change, and the provisions of this Section 6 and all of its subparts shall apply to the Corporate Products of the Corporation in effect upon the termination of Employee's employment with the Corporation. 6.3 "Competitive Product" Defined. For purposes hereof, "Competitive Product" means any product or service (including any components thereof and any research to develop information useful in connection with the product or service) that is being designed, developed, manufactured, marketed or sold by any person or entity other than the Corporation that is of the same general type, performs similar functions, or is used for the same purpose as a Corporate Product on which Employee worked or assisted the Corporation during Employee's employment with the Corporation or about which Employee has acquired Confidential Information. 6 6.4 Noncompete Obligations. Employee agrees that, during Employee's employment with the Corporation and for a period of eighteen (18) months following Employee's termination of employment with the Company, regardless of the reason for termination, Employee will not, directly or indirectly, render services to any person or entity that designs, develops, manufactures, markets or sells a Competitive Product in any geographic area where the Company designs, develops, manufactures, markets or sells a Corporate Product. Employee understands and acknowledges that, at the present time, the geographic market of the Company includes the entire United States. Employee understands and acknowledges that the foregoing description of the Company's geographic market may change, and the provisions of this section 6 and all of its subparts shall apply to the geographic market of the Company in effect upon the termination of Employee's employment with the Company. 6.5 No Solicitation of Customers. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, solicit business from, work for, or otherwise interfere with or attempt to interfere with Corporation's relationship with any customer or prospective customer of Corporation. 6.6 No Solicitation of Employees or Business Contacts. During Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee agrees that Employee shall not, directly or indirectly, take any action to encourage, solicit or recruit any current or former employee, consultant, independent contractor, subcontractor, supplier, vendor, or other business relation of Corporation to terminate their relationship with Corporation. 6.7 Disclosure of Obligations. Employee agrees that, during Employee's employment with Corporation and for a period of eighteen (18) months after Employee's termination of employment with Corporation, regardless of the reason for such termination, Employee shall, prior to accepting employment or any other business relationship with any other person or entity, inform that person or entity of Employee's obligations under this Section 6, including all of its subparts. 7. Protection of Confidential Information. 7.1 Definition of Confidential Information. As used in this Agreement, the term "Confidential Information" shall mean any information which Employee learns or develops during Employee's employment with Corporation that derives independent economic value from being not generally known or readily ascertainable by other persons who could obtain economic value from its disclosure or use, and includes, but is not limited to, trade secrets, Inventions as defined in Paragraph 9 below, financial information, personnel information, and information relating to such matters as existing or contemplated products, services, profit margins, fee schedules, pricing, design, processes, formulae, business plans, sales techniques, marketing techniques, training manuals and materials, policies or practices related to Corporation's 7 business, personnel or other matters, computer databases, computer programs, software and other technology, customer lists and requirements, vendor lists, or supply information. Confidential Information includes such information of Corporation, its customers, vendors, and other third parties or entities with whom Corporation does business. Any information disclosed to Employee or to which Employee has access during the time of Employee's employment that Employee reasonably considers to be Confidential Information, or which the Company treats as Confidential Information, will be presumed Confidential Information. 7.2 Restrictions on Use or Disclosure of Confidential Information. Employee shall keep the Confidential Information in absolute confidence both during Employee's employment with Corporation and after the termination of Employee's employment, regardless of the reason for such termination. Employee agrees that Employee will not, at any time, disclose to others, use for the benefit of any entity or person other than Corporation, or otherwise take or copy any such Confidential Information, whether or not developed by Employee, except as required in Employee's duties to Corporation. 8. Return of Confidential Information and Corporation's Property. When Employee's employment terminates with Corporation, regardless of the reason for such termination, Employee will promptly turn over to Corporation in good condition all Corporation property in Employee's possession or control, including but not limited to all originals, copies of, or electronically stored documents or other materials containing Confidential Information, regardless of who prepared them. In the case of electronically stored information retained by Employee outside of Corporation's electronic systems, Employee will promptly make a hard copy of such information in paper, audio recording, disc format, or other format as appropriate, turn that hard copy over to Corporation, and then destroy Employee's electronically stored information. Further, Employee agrees to execute written confirmation that all Confidential Information in the Employee's possession, or to which the Employee has access, has been turned over to Corporation or destroyed. 9. Inventions. 9.1 Definition of Inventions. As used in this Agreement, "Inventions" means any inventions, improvements, trade names or trademarks, trade secrets, discoveries, designs, formulae, ideas or original works of authorship (whether or not reduced to writing, other media or practice and whether or not patentable or copyrightable), or work product originated, conceived, developed, discovered or made in whole or in part solely by Employee or jointly with others that relate (a) to Corporation's business; (b) to Corporation's actual or demonstrably anticipated research or development; (c) that are made through the use of any of Corporation's equipment, facilities, supplies, trade secrets; (d) that result from any work Employee performs for Corporation; or (e) that are developed on Corporation time. 9.2 Ownership of Inventions. With respect to Inventions originated, conceived, developed, discovered or made in whole or in part solely or jointly by Employee at any time during Employee's employment with Corporation, Employee understands and agrees that Corporation will own all right, title, and interest, including patent rights, copyrights, trade secret rights and all other intellectual property rights of any sort, throughout the world related to 8 all Inventions without further payment beyond Employee's agreed-upon salary or wage. To the maximum extent permitted by law, all Inventions are deemed "works made for hire" under the United States Copyright Act and Corporation is deemed the sole author of any Inventions. To the extent any Inventions are determined not to constitute "works made for hire," Employee hereby assigns and transfers to Corporation all right, title and interest in the Inventions. Employee further agrees to (a) promptly and fully disclose all such Inventions to Corporation; (b) keep accurate, complete, and timely records of all Inventions, which records shall be Corporation's property and shall be maintained on Corporation's premises; (c) at Corporation's expense, assist Corporation to perfect, protect, and use its rights to Inventions, including without limitation, transferring Employee's entire right, title and interest in Inventions and enabling Corporation to obtain patent, copyright or trademark protection for Inventions anywhere in the world; and (c) give affidavits and testimony as to facts within Employee's knowledge in connection with any Inventions in any administrative proceedings, arbitration, litigation or controversy relating thereto. 9.3 Notice Regarding Exception to Inventions Assignment. Employee understands that the assignment of Inventions set forth herein does not apply to any Invention for which no equipment, supplies, facility, or trade secret information of Corporation was used and which was developed entirely on Employee's own time, and which does not relate directly to the business of the Company or to its actual or demonstrably anticipated research or development, or which does not result from any work performed by Employee for the Company. 10. Compliance and Remedies. Employee recognizes that if Employee violates this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement, irreparable damage will result to Corporation that could not adequately be remedied by monetary damages. As a result, Employee hereby agrees that notwithstanding any other dispute resolution provisions of this Agreement, in the event of any breach by Employee of this Agreement, including but not limited to Paragraphs 6, 7, 8, or 9 of this Agreement or in the event of apparent danger of such breach, Corporation shall be entitled, in addition to any other legal or equitable remedies available to it, to an injunction to restrain Employee's violation of any portion of this Agreement, as well as Corporation's attorney's fees and costs incurred in enforcing this Agreement. 11. Informal Dispute Resolution. Employee and the Corporation agree to make good faith efforts to resolve internally and without resort to formal dispute resolution any dispute, which may arise out of or relate to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, or any dispute regarding any of the provisions of this Agreement. 12. Arbitration Clause. In the event that informal efforts to resolve disputes pursuant to Paragraph 11 are unsuccessful, any dispute between Employee and the Corporation arising out of or related to Employee's recruitment, employment or the termination of Employee's employment with the Corporation, and any dispute between Employee and the Corporation regarding any of the provisions of this Agreement (other than an action for injunctive relief to enforce Employee's obligations under paragraphs 6, 7, 8, or 9 of this Agreement), shall be determined not in a court of law, but instead by arbitration in the United States, in the State of Minnesota and the County of Hennepin. Such disputes shall be referred in writing to the 9 American Arbitration Association for selection of an arbitrator. Selection of the arbitrator shall be made in accordance with the Rules of the American Arbitration Association, and the arbitrator's decision shall be final and binding in all respects. Except as otherwise provided in this section, arbitration proceedings initiated pursuant to this Agreement shall be conducted in accordance with the Rules of the American Arbitration Association. Prior to the arbitration hearing, the parties may use the following discovery methods: interrogatories in a form consistent with Rule 33 of the Federal Rules of Civil Procedure; requests for production of documents in a form consistent with Rule 34 of the Federal Rules of Civil Procedure; admissions; depositions of witnesses in accordance with Rule 30 of the Federal Rules of Civil Procedure. The arbitrator shall have the right to determine the extent of discovery permitted. The arbitrator shall consider the matter in controversy and may hold hearings regarding the same. The arbitrator may grant any remedy or relief that he or she deems just and equitable, including, but not limited to, any remedy or relief that would have been available to the parties under any applicable statutes or common law. The arbitrator also has the authority to issue an award or partial award on the grounds that there is no claim stated on which relief can be granted or that there is no genuine issue as to any material fact and one party is entitled to judgment as a matter of law consistent with Federal Rules of Civil Procedure 12 or 56. The arbitrator shall enter an award in writing detailing his or her consideration of the relevant facts, the basis and reason for the decision, and his or her adherence to the applicable law. This written decision shall be entered within thirty days after the matter is finally submitted to the arbitrator, and a copy thereof shall be delivered to each party by certified mail. Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. The Corporation shall pay the expense of the arbitrator; each party will bear its own attorneys' fees and expenses. All proceedings under this Paragraph are private and confidential. Notwithstanding the foregoing, the Company may bring a court action for injunctive relief to enforce this Agreement. The parties agree that the Corporation may elect to venue such action in the federal or state courts of the State of Minnesota, whether or not such venue is then convenient to Employee, and that such courts shall have personal jurisdiction over Corporation and Employee and Employee shall not object to the venue or personal jurisdiction of such courts. Employee understands that by signing this Agreement, Employee is forever giving up Employee's right to litigate in a court of law any controversy arising out of Employee's employment relationship with the Corporation, and any controversy regarding any of the provisions of this Agreement, and that he is agreeing instead to arbitrate any claims he may choose to pursue against the Corporation. Nothing in this Agreement, however, prohibits either party from going to a court of law to enforce an award of an arbitrator. 13. Miscellaneous. 13.1. Integration. This Agreement embodies the entire agreement and understanding among the parties relative to subject matter hereof and supersedes all prior agreements and understandings relating to such subject matter, including but not limited to any earlier employment agreements of the Employee. 10 13.2. Applicable Law. This Agreement and the rights of the parties shall be governed by and construed and enforced in accordance with the laws of the state of Minnesota. 13.3. Payments. All amounts paid under this Agreement shall be subject to normal withholdings or such other treatment as required by law. 13.4. Counterparts. This Agreement may be executed in several counterparts and as so executed shall constitute one agreement binding on the parties hereto. 13.5. Binding Effect. Except as herein or otherwise provided to the contrary, this Agreement shall be binding upon and inure to the benefit of the Corporation and its successors, assigns and personal representatives without any requirement of the consent of the employee for assignment of its rights or obligations hereunder. 13.6. Notices. All notices, requests and other communications hereunder shall be given in writing and deemed to have been duly given or served if personally delivered, or sent by first class, certified mail, return receipt requested, postage prepaid, to the party at the address as provided below, or, to such other address as such party may hereafter designate by written notice to the other party: (a) If to the Corporation, to the address of its then principal office. (b) If to Employee, to the address last shown in the records of the Corporation. 13.7. Modification. This Agreement shall not be modified or amended except by a written instrument signed by the parties. 13.8. Severability. The invalidity or partial invalidity of any portion of this Agreement shall not invalidate the remainder thereof, and said remainder shall remain in fully force and effect. 13.9. Headings. The section headings contained in this Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. 13.10. Survival. Employee acknowledges and agrees that Employee's noncompetition, confidentiality, return of property, and invention obligations under Paragraphs 6, 7, 8, and 9 of this Agreement shall survive the Term or any Renewal Term, the non-renewal of this Agreement, and the termination of Employee's employment with the Corporation, regardless of the reason for termination. 13.11. Opportunity to Obtain Advice of Counsel. Employee acknowledges that Employee has been advised by the Corporation to obtain legal advice prior to executing this Agreement, and that Employee had sufficient opportunity to do so prior to signing this Agreement. 11 THIS AGREEMENT was voluntarily and knowingly executed by the parties as of date and year first set forth above. HEI, INC. By: /s/ MACK TRAYNOR ------------------------------ Mack Traynor, President/CEO EMPLOYEE: /s/ JAMES VETRICEK ------------------------------ James Vetricek 12 EX-10.40 11 c81087exv10w40.txt EX-10.40 NOTE PREPAYMENT AGREEMENT EXHIBIT 10.40 NOTE PREPAYMENT AGREEMENT THIS AGREEMENT ("AGREEMENT") is made as of October 15, 2003, between Whitebox Hedged High Yield Partners ("WHITEBOX") and HEI, Inc. (the "COMPANY"). WHEREAS, the Company issued to Colorado Medtech, Inc. ("CMED") the Company's Subordinated Promissory Note dated January 24, 2003 payable to the order of CMED in the original principal amount of $2,600,000 (the "Note"); WHEREAS, on or about May 8, 2003, CMED sold the Note to Whitebox; WHEREAS, pursuant to a letter agreement dated on or about May 16, 2003 (as modified by subsequent agreements between Whitebox and the Company evidenced by a letter agreement dated July 28, 2003 and an exchange of e-mail communications dated September 12, 2003, the "LETTER AGREEMENT"), Whitebox agreed to accept a discounted amount as payment in full of the outstanding principal amount of the Note if such Note is prepaid in accordance with the provisions of the Letter Agreement on or before October 15, 2003; WHEREAS, in connection with the latest modification of the Letter Agreement, the Company paid Whitebox an advance payment of $50,000 (the "ADVANCE PAYMENT"), such Advance Payment to be applied against the outstanding principal amount of the Note in the event the Note is prepaid on or prior to October 15, 2003; WHEREAS, the Letter Agreement also provides that, in the event the Note is prepaid on or prior to October 15, 2003, then (i) Whitebox will forgive interest accrued on the outstanding principal amount of the Note from and after September 15, 2003, and (ii) promptly following such prepayment, the Company will issue, in payment of all interest accrued on the outstanding principal amount of the Note through September 15, 2003, shares of the Company's common stock; and WHEREAS, the Company now desires to so prepay the Note. NOW, THEREFORE, in consideration of the mutual covenants contained herein and other good and valuable consideration, the parties to this Agreement hereby agree as follows: 1. Prepayment of Note. 1.1 Prepayment. Contemporaneously with the signing of this Agreement, to be applied against the outstanding principal amount of the Note and as payment in full of the Note (i) Whitebox will apply the Advance Payment against the Note, and (ii) the Company will pay Whitebox $2,190,000 (the "PAYOFF AMOUNT") by wire transfer of immediately available funds into such account as Whitebox shall designate. 1.2 Payment in Full. Upon Whitebox's receipt of payment in full of the Payoff Amount, the obligations of the Company under the Note or otherwise incurred by the Company in connection with the Note (the "OBLIGATIONS") shall be deemed to have been paid in full, and Whitebox shall be deemed to have forgiven and waived the right to receive payment of any amount by which the Obligations exceed the sum of the Advance Payment and the Payoff Amount. 1.3 Delivery of Note. Promptly following receipt of payment in full of the Payoff Amount (and in any event within 10 days from and after its receipt of such payment), Whitebox shall cancel and deliver the original Note, marked "paid in full," to the Company. 1.4 Issuance of Stock. (a) Whitebox and the Company each acknowledge and agree that the amount of interest accrued under the Note through September 15, 2003, equals $166,940 (the "CONVERSION AMOUNT"). In payment of such Conversion Amount, the Company agrees to issue to Whitebox 47,700 shares of the Company's common stock (the "CONVERSION SHARES"), subject to and promptly following the execution and delivery by Whitebox and the Company of a subscription agreement and such other documentation as the Company may reasonably require (such agreement and other documentation, in each case to be in form and substance reasonably satisfactory to Whitebox and the Company, is herein referred to as the "SUBSCRIPTION DOCUMENTATION"). The Subscription Documentation shall include, among other provisions as to which Whitebox and the Company may agree, a piggyback registration right (but not a demand registration right) with respect to the Conversion Shares, such piggyback registration right to be effective for 24 months following the issuance of the Conversion Shares. (b) Whitebox and the Company agree that they will negotiate in good faith with a view to complete the Subscription Documentation and the issuance of the Conversion Shares on or prior to December 1, 2003. 2. Representations and Warranties of Whitebox. Whitebox represents and warrants to the Company that (i) Whitebox is the owner of the Note, free and clear of liens, encumbrances, purchase rights, claims, pledges, mortgages, security interests or other limitations or restrictions whatsoever, other than the provisions of the Letter Agreement, (ii) Whitebox is an entity duly organized, validly existing and in good standing under the laws of the jurisdiction in which it is formed, (iii) Whitebox has the requisite power and authority to execute this Agreement and to consummate the transactions contemplated by this Agreement, (iv) the execution and delivery of this Agreement by Whitebox and the consummation by Whitebox of the transactions contemplated by this Agreement have been duly authorized by all necessary action on the part of Whitebox, and (v) this Agreement has been duly executed and delivered by Whitebox and, assuming due execution and delivery by the Company, constitutes a valid and binding obligation of Whitebox, enforceable against Whitebox in accordance with its terms. 2 3. Representations and Warranties of the Company. The Company represents and warrants to Whitebox that (i) the Company is an entity duly organized, validly existing and in good standing under the laws of the jurisdiction in which it is formed, (ii) the Company has the requisite power and authority to execute this Agreement and to consummate the transactions contemplated by this Agreement, (iii) the execution and delivery of this Agreement by the Company and the consummation by the Company of the transactions contemplated by this Agreement have been duly authorized by all necessary action on the part of the Company, and (iv) this Agreement has been duly executed and delivered by the Company and, assuming due execution and delivery by Whitebox, constitutes a valid and binding obligation of the Company, enforceable against the Company in accordance with its terms. 4. Mutual Waiver and Release. 4.1 Release by Whitebox. Effective upon Whitebox's receipt of payment in full of the Payoff Amount, Whitebox waives, releases and forever discharges the Company and its past, present and future officers, partners, managers, members, directors, employees, agents and affiliates from any and all claims, obligations, demands, actions, causes of action and liabilities, of whatsoever kind and nature, character and description, whether in law or equity, whether sounding in tort, contract, or under other applicable law, whether known or unknown, and whether anticipated or unanticipated, of or to Whitebox, which Whitebox and its predecessors, successors or assigns ever had, now have, or may have; provided, however, that Whitebox does not waive, release or discharge the Company from any of the Company's obligations under this Agreement. 4.2 Release by the Company. Effective upon Whitebox's receipt of payment in full of the Payoff Amount, the Company waives, releases and forever discharges Whitebox and its past, present and future officers, partners, managers, members, directors, employees, agents and affiliates from any and all claims, obligations, demands, actions, causes of action and liabilities, of whatsoever kind and nature, character and description, whether in law or equity, whether sounding in tort, contract, or under other applicable law, whether known or unknown, and whether anticipated or unanticipated, of or to the Company, which the Company and its predecessors, successors or assigns ever had, now have, or may have; provided, however, that the Company does not waive, release or discharge Whitebox from any of Whitebox's obligations under this Agreement. 4.3 Consequences of Releases. The consequences of the foregoing waiver provisions have been explained to each party by its counsel. Each party acknowledges that it may hereafter discover facts different from, or in addition to, those which they no know or believe to be true with respect to its claims, and agree that this Agreement and the releases contained herein shall be and remain effective in all respects, notwithstanding such different or additional facts or the discovery thereof. 3 5. Further Assurances. Each party agrees that each of them will execute and deliver such further instruments and take such other action as may reasonably be requested by either party hereto to carry out the purposes and intents hereof. 6. Miscellaneous. 6.1 Survival of Representations, Warranties and Covenants. All representations, warranties, covenants and agreements of the parties made herein shall survive the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby. 6.2 Expenses. Each party shall bear its own expenses (including, without limitation, attorney's fees) incurred in connection with the negotiation and execution of this Agreement and the consummation of the transactions contemplated hereby. 6.3 Entire Agreement; Amendments and Waivers. This Agreement represents the entire understanding and agreement between the parties hereto with respect to the subject matter hereof and can be amended, supplemented or changed, and any provision hereof can be waived, only by a written instrument making specific reference to this Agreement signed by the party against whom enforcement of any such amendment, supplement, modification or waiver is sought. 6.4 Governing Law. This Agreement shall in all respects be governed by and interpreted, construed, and determined in accordance with the internal laws of the State of Minnesota (without regard to any conflict of laws provision that would require the application of the law of any other jurisdiction). 6.5 Headings. The section headings of this Agreement are for reference purposes only and are to be given no effect in the construction and interpretation of this Agreement. 6.6 Severability. If any provision of this Agreement is invalid or unenforceable, the balance of this Agreement shall remain in effect. 6.7 Binding Effect; Assignment. This Agreement shall be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns. No assignment of this Agreement or of any rights or obligations hereunder may be made by any party (by operation of law or otherwise) without the prior written consent of the other party hereto and any attempted assignment without the required consent shall be void. 6.8 Counterparts; Facsimile Signatures. This Agreement may be execute in any number of counterparts, each of which shall be deemed to be an original, but all of which together will constitute one and the same instrument. A telecopy of any such executed counterpart shall be deemed valid as an original. 4 [The remainder of this page is intentionally left blank] 5 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first written above. HEI, INC. By: /s/ DOUGLAS J. NESBIT ----------------------------------------- Its: Chief Financial Officer ---------------------------------------- WHITEBOX HEDGED HIGH YIELD PARTNERS By WHITEBOX ADVISORS, LLC, its general partner By: /s/ ANDREW J. REDLEAF ----------------------------------------- Its: Chief Executive Officer ---------------------------------------- .. 6 EX-10.41 12 c81087exv10w41.txt EX-10.41 PROMISSORY NOTE EXHIBIT 10.41 PROMISSORY NOTE $1,200,000.00 October 14, 2003 Edina, Minnesota FOR VALUE RECEIVED, HEI, INC., a Minnesota corporation ("Maker") promises to pay to the order of COMMERCE BANK, a Minnesota state banking corporation ("Payee") or its assigns, at its office located at 7650 Edinborough Way, Suite 150, Edina, Minnesota 55435, or such other place as may be designated from time to time by the holder hereof, in lawful money of the United States of America, the principal sum of ONE MILLION TWO HUNDRED THOUSAND AND NO/100 DOLLARS ($1,200,000.00), or the unpaid principal balance outstanding from all sums advanced against this Note, whichever amount is less, together with interest thereon as hereinafter provided. 1. Interest shall accrue on the principal balance hereof as follows: (a) Commencing on the date hereof, to and including October 31, 2006, interest shall accrue on the outstanding principal balance hereof at the rate of interest equal to 6.50% per annum; and (b) Commencing on November 1, 2006, to and including the Maturity Date (as hereinafter defined), interest shall accrue on the principal balance hereof at a fixed rate per annum, which rate shall be equal to the greater of (i) the Three-Year Treasury Base Rate (as hereinafter defined) plus three percent (3.0%), or (ii) the Prime Rate (as hereinafter defined) plus one percent (1.0%). As used herein, (a) "Three Year Treasury Base Rate" shall mean the average yield rounded up to the nearest one-eighth percent (.125%) on the twenty business days immediately preceding November 1, 2006 of the yield on United States Treasury Notes adjusted to a constant maturity of three years as published the Federal Reserve Board Release H.15 (or from such other appropriate source determined by Payee if such Release is no longer published); and (b) "Prime Rate" shall mean the rate published in the Wall Street Journal as the base rate on corporate loans posted by at least 75% of the nation's thirty largest banks. 2. Maker shall pay the principal of this Note and interest thereon as follows: (a) On the first day of each month, commencing on November 1, 2003, to and including October 1, 2006, there shall be due and Maker shall pay monthly installments of principal and interest in the amount of Nine Thousand Eleven and No/100 Dollars ($9,011.00); and (b) On the first day of each month, commencing on November 1, 2006, to and including October 1, 2009, there shall be due and maker shall pay monthly installments of principal and interest, each of which shall be in an amount equal to the amount that would be required to amortize the remaining principal balance of this Note, over a term ending on November 1, 2023, at the then applicable interest rate provided above. PROMISSORY NOTE Page 2 $1,200,000.00 October 14, 2003 Edina, Minnesota On November 1, 2009 (the "Maturity Date"), the entire remaining principal balance of this Note, together with any accrued, unpaid interest, shall be due and payable in full. 3. Maker may prepay this Note in full at any time by giving Payee sixty (60) days prior written notice. At any time of prepayment, and in consideration of Payee's willingness to accept such prepayment, Maker shall pay, in addition to the then outstanding principal balance plus accrued unpaid interest, a prepayment premium as follows: (a) From the date hereof, to and including October 31, 2005, an amount equal to two percent (2%) of the outstanding principal balance of this Note as of the date of prepayment; and (b) From November 1, 2005, to and including, October 31, 2007, an amount equal to one percent (1%) of the outstanding principal balance of this Note as of the date of prepayment. (c) From and after November 1, 2007, this Note may be prepaid in full at any time without payment of a prepayment premium. 4. Interest charges will be calculated on amounts advanced hereunder on the actual number of days said amounts are outstanding. Such interest shall be computed on the basis of a year comprised of 360 days, but charged for the actual number of days elapsed (including the first day but excluding the last day) occurring in the period for which interest is payable. Payments under this Note shall be applied initially against accrued interest and escrow charges, if any, and thereafter in reduction of principal. 5. This Note is executed and delivered pursuant to, and is entitled to the benefits of, that certain Term Loan Agreement, dated of even date herewith (the "Loan Agreement"), between Maker, as borrower and Payee, as lender and evidences the loan made or to be made pursuant to the terms and conditions of the Loan Agreement. 6. This Note is secured, inter alia, by (a) that certain Combination Mortgage, Security Agreement, Assignment of Rents and Fixture Financing Statement of even date herewith between Maker as Mortgagor and Payee as Mortgagee, covering certain real property in the County of Carver, State of Minnesota, as described therein (the "Mortgage"). 7. Maker acknowledges that if any payment required under this Note is not paid within ten (10) days after the same becomes due and payable, Payee will incur extra administrative expenses (i.e., in addition to expenses incident to receipt of timely payment) in connection with the delinquency in payment. Because, from the nature of the case, the actual damages suffered by Payee in incurring such extra administrative expenses would be impracticable or difficult to ascertain, it is agreed that three percent (3%) of the amount of the PROMISSORY NOTE Page 3 $1,200,000.00 October 14, 2003 Edina, Minnesota delinquency payment shall be the amount of damages to which the Payee is entitled, upon such breach, in compensation for such extra administrative expenses. Therefore, the Maker shall, in such event, without further notice, pay to Payee liquidated damages in the amount of three percent (3%) of the amount of such delinquent payments. The provisions of this paragraph are intended to govern only the determination of the above-described damages in the event of a breach in performance of the obligation of Maker to make timely payments hereunder. Nothing in this Note shall be construed as an express or implied agreement by Payee to forbear in the collection of any delinquent payment, or be construed as in any way giving the undersigned the right, express or implied, to fail to make timely payment hereunder, whether upon payment of such damages or otherwise. The right of Payee to receive payment of such liquidated damages, and receipt thereof, are without prejudice to the right of Payee to collect such delinquent payments and any other amounts required to be paid hereunder or under any security for this Note or to declare a default hereunder or under any security for this Note. 8. Maker hereby waives presentment and demand for payment, notice of intent to accelerate maturity, protest or notice of protest and non-payment, bringing of suit and diligence in taking any action to collect any sums owing hereunder or in proceeding against any of the rights and properties securing payment hereunder, and expressly agree that this Note, or any payment hereunder, may be extended from time to time, and consent to the acceptance of further security or the release of any security for this Note, all without in any way affecting the liability of Maker. No extension of time for the payment of this Note, or any installment thereof, made by agreement by Payee shall affect the original liability under this Note of Maker. 9. It shall be an "Event of Default" under this Note if: (a) Maker fails to pay when due or, if payable on demand, upon demand, any principal of this Note, prepayment premium (if applicable), or interest on this Note, any other amount of money required to be paid pursuant to this Note, or any other obligation of Maker to Payee within ten (10) days after the same becomes due, whether at the stated maturity or at a date fixed for any installment payment or any accelerated payment date or otherwise; or (b) Maker fails to comply with or perform any other term, covenant, agreement or condition of this Note, the Mortgage, the Loan Agreement, or any other document or instrument securing the payment of this Note, and such failure or breach shall continue for a period of thirty (30) days after written notice thereof is delivered by the holder of this Note to Maker; or (c) Maker (i) becomes insolvent or fails to pay its debts generally as they become due, (ii) suspends business, PROMISSORY NOTE Page 4 $1,200,000.00 October 14, 2003 Edina, Minnesota (iii) makes a general assignment for the benefit of creditors, (iv) admits in writing its inability to pay its debt generally as they mature, (v) files a petition in bankruptcy or a petition or answer seeking liquidation of it or a reorganization, arrangement with creditors or other similar relief under the Federal bankruptcy laws or under any other applicable law of the United States of America or any state thereof, whether now or hereafter in effect, (vi) petitions for or applies to any tribunal for, or consents to the appointment of a trustee, custodian, liquidator, receiver or similar official for it or for a substantial part of its property, (vii) is adjudicated a bankrupt or has an involuntary petition in bankruptcy, or a case commenced against it under the Federal bankruptcy laws, as now or hereafter in effect, and an order for relief entered therein, (viii) takes any action for the purpose of effecting or consenting to any of the foregoing, or (ix) has an order, judgment or decree entered appointing without such entity's consent, a trustee, custodian, liquidator, receiver or similar official for it or for a substantial part of its property, or approving a petition in any such proceeding or approving a petition filed or case commenced against it seeking liquidation of it or a reorganization, arrangement with creditors or other similar relief under the Federal bankruptcy laws or under any other applicable law of the United States of America or any State thereof, whether now or hereafter in effect, which order, judgment or decree shall not be vacated or set aside or stayed within 60 days from the date of entry; or (d) Maker is dissolved, liquidated or wound up; or (e) Any representation or warranty made by Maker in the Mortgage or made in connection with the execution and delivery of this Note and the Mortgage, or the making of the loan secured hereby, shall be incorrect or untrue in any material respect; or (g) An "Event of Default" as defined in the Mortgage or the Loan Agreement or any other Loan Document (as defined in the Loan Agreement) shall occur. 10. Upon the occurrence of an Event of Default (after expiration of any applicable cure or grace periods), in addition to any other rights or remedies Payee may have at law or in equity, Payee may, at its option, and without notice to Maker, declare immediately due and payable the entire unpaid principal sum hereof, together with all accrued and unpaid interest thereon at a rate which is three percent (3%) per annum above the interest rate then applicable hereunder on the date of such Event of Default (the "Default Rate"), plus any other sums owing PROMISSORY NOTE Page 5 $1,200,000.00 October 14, 2003 Edina, Minnesota at the time of such Event of Default pursuant to this Note, the Mortgage, the Loan Agreement or any other Loan Document. The failure to exercise the foregoing or any other options shall not constitute a waiver of the right to exercise the same or any other option at any subsequent time in respect of the same event or any other event. The acceptance by the holder of any payment hereunder which is less than payment in full of all amounts due and payable at the time of such payment shall not constitute a waiver of the right to exercise any of the foregoing options at that time or at any subsequent time. 11. This Note shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns, except that Maker may not assign or transfer its rights hereunder without the prior written consent of the Payee, which consent may be withheld in Payee's sole discretion. 12. This Note shall be governed by, interpreted and construed according to the laws of the State of Minnesota. Maker hereby irrevocably submits to the jurisdiction of the Minnesota District Court, Fourth District, and the Federal District Court, District of Minnesota, Fourth Division, over any action or proceeding arising out of or relating to this Note, and Maker hereby agrees that all claims in respect of such action or proceeding may be heard and determined in such Minnesota State or Federal court. 13. The invalidity or unenforceability in particular circumstances of any provision of this Note shall not extend beyond such provision or such circumstances and no other provision of this instrument shall be affected thereby. HEI, INC. By: /s/ Douglas J. Nesbit ---------------------------- Its: Chief Financial Officer EX-10.42 13 c81087exv10w42.txt EX-10.42 TERM LOAN AGREEMENT EXHIBIT 10.42 TERM LOAN AGREEMENT THIS TERM LOAN AGREEMENT ("Agreement") is dated as of October 14, 2003, between HEI, INC., a Minnesota corporation ("Borrower"), located at 1495 Steiger Lake Lane, Victoria, MN 55386 and COMMERCE BANK, a Minnesota state banking corporation ("Lender"), located at 7650 Edinborough Way, Suite 150, Edina, MN 55435. WITNESSETH: WHEREAS, Borrower has applied to Lender for a loan of $1,200,000.00 secured by the Property (as hereinafter defined), the proceeds of which are to be used solely for the purpose of prepaying the Whitebox Subordinated Note and to fund the Payment Reserve Account; and WHEREAS, Lender is willing to make such loan on the terms hereof; NOW, THEREFORE, in consideration of the above premises and the mutual covenants and agreements set forth herein, the parties hereto hereby agree as follows: ARTICLE I DEFINITIONS 1. Definitions. For purposes of this Agreement, the following terms shall have the following meanings: "Affiliate" shall include, with respect to any party, any Person which directly or indirectly controls, is controlled by, or is under common control with such party and, in addition, in the case of Borrower, each officer, director, shareholder, joint venturer and partner of Borrower. A Person shall be deemed to control another Person if the controlling Person owns 10% or more of any class of voting stock of the controlled Person or possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of the controlled Person, whether through ownership of stock, by contract or otherwise. "Borrower" has the meaning set forth in the preamble hereto. "Debt" means (i) indebtedness for borrowed money or for the deferred purchase price of property or services, (ii) obligations as lessee under leases that have been or should be, in accordance with GAAP, recorded as capital leases, including but not limited to that certain capital lease obligation of Borrower to Lender evidenced by the certain Master Equipment Lease dated as of October , 2003 between Borrower, as lessee and Lender, as lessor, (iii) obligations under direct of indirect guaranties in respect of, and obligations (contingent or otherwise) to purchase or otherwise acquire, or otherwise to assure a creditor against loss in respect of, indebtedness or obligations of others of the kinds referred to in (i) or (ii) above, and (vi) liabilities in respect of unfunded vested benefits under plans covered by Title IV of ERISA. -1- "Debt Service Coverage Ratio" for any measurement period means a ratio the numerator of which is (A)(i) the sum of (a) Borrower's after-tax net income (as defined by GAAP); (b) depreciator, (c) amortization, and (d) interest expense on Borrower's term debt; less (ii) any distributions or dividends paid to shareholders and the denominator of which is (B) Borrower's aggregate payments on Debt, including interest, on such Debt (including, without limitation, any payments on capitalized leases allocable to principal and interest in accordance with GAAP) scheduled to have been paid during such measurement period. "Default" means any event, which, with the giving of notice or passage of time or both, would constitute an Event of Default. "Event of Default" has the meaning set forth in Article 8. "GAAP" means generally accepted accounting principles, consistently applied. "Improvements" means the approximate 45,408 square foot office/manufacturing/warehouse facility know as the HEI, Inc. corporate office and manufacturing facility located upon the Property at 1495 Steiger Lake Lane, Victoria, MN 55386. "Lender" has the meaning set forth in the preamble hereto. "Loan Documents" means this Agreement and the other documents listed in Section 2.1(a)-(d) hereof, and any other document that now or hereafter evidences or secures the Obligations. "Loan Year" means a period commencing on November 1, 2003, or any anniversary thereof and ending on the 365th, or in the case of a leap year, the 366th day thereafter. "Mortgage" has the meaning provided in Section 2.1(c) hereof. "Note" has the meaning provided in Section 2.1(b) hereof. "Obligations" means the indebtedness evidenced by the Note and all other advances, debts, liabilities, obligations, covenants and duties owing by Borrower of any kind or nature, present or future, which arise under this Agreement or any other Loan Document, whether or not evidenced by any note, guaranty or other instrument, whether or not for the payment of money, whether joint, several, or joint and several, direct or indirect (including those acquired by assignment or purchase), absolute or contingent, due or to become due, and however acquired. The term includes, but is not limited to, all interest, fees, charges, expenses, attorneys' fees, and any other sum chargeable to Borrower under this Agreement or any other Loan Document. "Payment Reserve Account" has the meaning provided in Section 6.9 hereof. "Person" means any natural person, corporation, firm, association, government, governmental agency or other entity, whether acting in an individual, fiduciary or other capacity. -2- "Project" means the Improvements and the Property. "Property" means the real property located in the County of Carver, State of Minnesota, legally described on Exhibit A attached hereto and made a part hereof. "Title Company" means Stewart Title Company. "Whitebox Subordinated Note" means that certain Subordinated Promissory Note issued by Borrower to Colorado MEDtech, Inc. in the original principal amount of $2,600,000.00 dated as of January 24, 2003, and assigned to Whitebox Hedged High Yield Partners on or about May 8, 2003. ARTICLE II LOAN DOCUMENTS 2. Documents Delivered Herewith. Prior to or contemporaneously with the execution of this Agreement, Borrower has delivered to Lender the following documents and/or instructions: 2.1 The Loan Documents: (a) This Agreement properly executed and delivered on behalf of Borrower; (b) Promissory Note (the "Note") properly executed and delivered on behalf of Borrower in the amount of $1,200,000.00, made payable by Borrower to Lender's order; (c) Combination Mortgage, Security Agreement, Assignment of Rents and Fixture Financing Statement (the "Mortgage") in a form satisfactory to Lender executed by Borrower securing the Note and creating a lien upon the Property and the Project subject only to those encumbrances shown on Exhibit B hereto; and (d) UCC-1 Financing Statement. 2.2 The Title Documents: (a) A title binder, in form and substance satisfactory to Lender, issued by Gibraltar Title Agency, LLC on behalf of Stewart Title Company, at Borrower's expense, with such title binder constituting a commitment by such title company to issue a mortgagee's title policy or policies in favor of Lender as mortgagee under the Mortgage in the amount of $1,200,000.00 that: (i) specifically insures that the Mortgage is a first lien on the Project, subject only to those encumbrances shown on Exhibit B of the Mortgage; and -3- (ii) contains a comprehensive endorsement, a usury endorsement, a zoning endorsement, and such other endorsements as Lender may require in form satisfactory to Lender. (b) Evidence of payment of all required real estate taxes and special assessments, mortgage registration tax, title insurance premiums and costs and recording fees. 2.3 The Project Documents: (a) A FIRREA complying appraisal of the Project, showing an appraised value of not less than $2,200,000 and otherwise satisfactory to Lender, receipt and acceptance of which is hereby acknowledged; and (b) A Phase I environmental report in form and content acceptable to Lender in its sole and absolute discretion, showing no substantial environmental hazards on the Project, receipt and acceptance of which is hereby acknowledged; and (c) Evidence satisfactory to Lender of policies of insurance coverage on the Property and the Project in the amount required by the Mortgage; (d) A policy of flood insurance naming Lender as additional insured, covering the Property and the Improvements in the maximum amount available, or evidence satisfactory to Lender that the Property and Improvements are not located within a designated flood plain; (e) A letter from the appropriate governmental entity stating the zoning classification which is applicable to the Property and stating that the use of the Project is a permitted use under such zoning classification; and 2.4 The Organization Documents: (a) A copy of the Articles of Incorporation of Borrower and all amendments thereto, certified by the Secretary of Borrower to be true, correct and complete; (b) A copy of the Bylaws of Borrower, certified by an officer of Borrower to be true, correct and complete; (c) A resolution of Borrower in form reasonably satisfactory to Lender regarding the execution by Borrower of the Loan Documents and all other documents or instruments required to be executed and delivered in connection herewith and the performance of the covenants and agreements required hereby; and, together with a certificate executed by the Secretary of Borrower indicating -4- the names and titles of persons authorized to execute the Loan Documents and other documents required hereunder; (d) Certificate of Good Standing of recent date for Borrower issued by the Secretary of State of Minnesota; and (e) An opinion of counsel for Borrower with respect to certain matters relating to the transactions contemplated by this Agreement. ARTICLE III TERM LOAN 3.1. Commitment for Term Loan. Subject to the terms and conditions hereof and of the Loan Documents and the other documents delivered herewith, Lender hereby lends to Borrower and Borrower hereby borrows from Lender, the amount of $1,200,000.00 (the "Loan"). 3.2. Use of Proceeds. The proceeds of the Loan shall be used solely by Borrower to fund a portion of the prepayment of the Whitebox Subordinated Note and to fund the Payment Reserve Account. ARTICLE IV CONDITIONS OF LENDING 4.1 Conditions Precedent to Term Loan Advance. Lender shall have no obligation to make the Loan unless on or before the date of disbursement, Lender shall have received the following or confirmation of completion of the following events: (a) The documents for the Loan set forth in Article II of this Agreement properly executed and delivered to Lender; (b) Establishment of the Payment Reserve Account by Borrower; (c) Payment of the loan commitment fee in the amount of $12,000.00; and (d) Evidence satisfactory to Lender that the Whitebox Subordinated Note has been paid in full, or will be paid in full from the proceeds of the Note together with Borrower's funds from other sources. ARTICLE V REPRESENTATIONS AND WARRANTIES 5. Representations and Warranties. In order to induce Lender to enter into this Agreement, Borrower hereby represents and warrants that: -5- 5.1 Organization and Good Standing. Borrower is a duly organized and validly existing Minnesota corporation, in good standing and qualified and licensed to do business under the laws of the State of Minnesota. 5.2 Authority. Borrower has full power, right and authority to execute and deliver the Loan Documents and the other documents required hereby, to borrow the funds herein provided for, and to perform and observe each and all of the matters and things provided for in said documents. The execution and delivery of the Loan Documents and such other documents as are required hereby and the performance or observance of the terms hereof and thereof have been duly authorized by all necessary action of the board of directors of Borrower. 5.3 Binding Obligation. This Agreement is, and the other Loan Documents when delivered hereunder will be, legal, valid and binding obligations of Borrower enforceable against Borrower in accordance with their respective terms. 5.4 Ownership of Property. Borrower is the owner of the Property in fee simple and of all personal property described in the Mortgage and has no knowledge of any unrecorded claims, liens, and encumbrances against the Property or such personal property. 5.5 Compliance with Laws. The Improvements have been approved, to the extent required by any applicable law, statute, including, without limitation, the ADA, ordinance, regulation, or effective restrictive covenant, by all federal, state, regional and local authorities, and the anticipated use of the Property and the Project comply with all applicable zoning and environmental ordinances, regulations and restrictive covenants affecting the Property and the Project and all requirements for such use have been satisfied. No violation of any law, ordinance, regulation or requirement exists with respect to the Property or the Project. 5.6 ERISA. No plan (as that term is defined in the Employee Retirement Income Security Act of 1974 ("ERISA")) of the Borrower (a "Plan") that is subject to Part 3 of Subtitle B of Title 1 of ERISA had an accumulated funding deficiency (as such term is defined in ERISA) as of the last day of the most recent fiscal year of such Plan ended prior to the date hereof, or would have had such an accumulated funding deficiency on such date if such year were the first year of such Plan, and no material liability to the Pension Benefit Guaranty Corporation has been, or is expected by the Borrower to be, incurred with respect to any such Plan. No Reportable Event (as defined in ERISA) has occurred and it continuing in respect to any such Plan. 5.7 Litigation. Except as set forth on Schedule 5.7, there are no actions, suits or proceedings pending, or to the knowledge of Borrower threatened, against or affecting it in an amount in excess of $100,000, or against or affecting the Property or the Project, or involving the validity or enforceability of the Mortgage or the priority of the lien thereof, at law or in equity, except actions, suits and proceedings fully covered by insurance; and -6- Borrower is not in default with respect to any order, writ, injunction, decree or demand of any court or any governmental authority. 5.8 Compliance with Agreements. The consummation of the transaction contemplated hereby and performance of the Loan Documents will not result in any breach of, or constitute a default under, any mortgage, deed of trust, lease, bank loan or credit agreement, corporate agreement, corporate charter, by-law or other instrument to which Borrower is a party or by which it may be bound or affected. 5.9 Absence of Defaults. No Default or Event of Default has occurred and is continuing as of the date hereof hereunder or under the Existing Loan Documents. 5.10 Availability of Utilities. All utility services necessary for the operation of the Improvements for their intended purpose are available to the Project, including water, storm and sanitary sewer, drainage, gas, electric and telephone facilities. 5.11 Accuracy of Financial Information. All financial statements of Borrower heretofore delivered to Lender, are true and correct in all respects, have been prepared in accordance with GAAP, and fairly present the respective financial conditions of the subjects thereof as of the respective dates thereof; no materially adverse change has occurred in the financial conditions reflected therein since the respective dates thereof, and no additional borrowings have been made by Borrower since the date thereof other than the borrowing contemplated hereby. 5.12 Survival of Representations. All representations and warranties contained in this Article 3 shall survive the delivery of the Loan Documents, the making of the Loan, and no investigation at any time made by or on behalf of Lender shall diminish its rights to rely thereon. ARTICLE VI AFFIRMATIVE COVENANTS OF BORROWER 6. Affirmative Covenants. To further induce Lender to make the requested loan, Borrower hereby covenants and agrees that it will: 6.1. Maintenance of Insurance. At all times, insure the Property and the Improvements in the manner set forth in Section 2.01 of the Mortgage, and from time to time, upon Lender's request, furnish it evidence of such coverage in form satisfactory to Lender and its counsel. 6.1. Payment of Taxes, etc. Promptly pay and discharge all taxes, assessments and other governmental charges imposed upon it or upon its income and profits or upon the Project, and any and all claims for labor, material or supplies or rental charges or charges of any other kind which, if unpaid, might by law become a lien or charge upon any of its property, except as Borrower shall contest in good faith and by appropriate proceedings, -7- providing such reserves as appropriate by GAAP. Borrower shall make all required withholding deposits. 6.3 Maintenance of Properties. Maintain all of its properties in good repair, working order and condition, ordinary wear and tear excepted, and from time to time make or cause to be made all needful renewals, replacements and repairs so that at all times Borrower's business can be conducted efficiently. 6.4 Accounting Records. Keep true and complete and accurate books of record and account in accordance with sound accounting principles, and allow Lender upon Lender's request to examine and take extracts from the books and records of Borrower. 6.5 Financial Information. Furnish to Lender: (a) As soon as available and in any event within ninety (90) days after the close of each of its fiscal years, a copy of the annual financial statements of Borrower, including balance sheet, related statements of earnings, stockholders' equity and statements of cash flow for such year, prepared in accordance with GAAP, and reviewed by an independent certified public accountant of recognized standing selected by Borrower and acceptable to Lender; (b) Within forty-five (45) days after the end of Borrower's fiscal quarters, financial statements of Borrower as of the end of each such calendar quarter which statements have been prepared in accordance with GAAP and certified by Borrower's chief financial officer; and (c) From time to time such other information pertaining to Borrower and its properties and financial condition as Lender may reasonably request. Provision of the foregoing, as between Borrower and Lender, shall be at the sole cost and expense of Borrower. 6.6 Conduct of Business. Conduct the same general type of business as it presently conducts, maintain its existence, and continue its compliance with all valid, applicable statutes, laws, rules and regulations. 6.7 Right of Inspection. Permit any person designated by Lender to visit and inspect any of the properties, partnership books and financial records of Borrower to discuss its affairs, finances and accounts with the officers of Borrower, all at such reasonable times and as often as Lender may reasonably request. 6.8 Notices. As soon as practicable, but in no event later than five (5) business days after Borrower obtains knowledge thereof, give notice to Lender of: -8- (a) the commencement of any uninsured litigation relating to Borrower in which the damages claimed exceed $50,000.00 or relate to the Property or the Improvements or the operation thereof; (b) the commencement of any material arbitration or governmental investigation or proceeding not previously disclosed by Borrower to Lender which has been instituted or, to the knowledge of Borrower, is threatened against Borrower or to which any property of Borrower is subject which, if determined adversely to Borrower, would have a material adverse effect upon Borrower; (c) any adverse development which occurs in any litigation, arbitration or government investigation or proceeding previously disclosed by Borrower to Lender which, if determined adversely to Borrower, would have a material adverse effect upon Borrower; or (d) any Default or Event of Default. 6.9 Payment Reserve Account. On the date hereof, establish an account with Lender (the "Payment Reserve Account") in the amount of $100,000.00, which account shall bear interest at a rate not less than the average yield of United States Treasury obligations adjusted to a constant maturity of 30 days as published in the Federal Reserve Board Release H.15 on the first business day of each month. At any time after the occurrence and during the continuation of any Event of Default, Lender may, at any time or from time to time, apply funds in the Payment Reserve Account to cure any Event of Default hereunder, without waiving such Event of Default, or any default, whether or not declared, under any other Loan Document or to the payment of any amounts, in such order as Lender may elect, as shall have become or shall become due and payable by Borrower under this Agreement or any other Loan Document. If Lender so applies funds in the Payment Reserve Account as provided in the preceding sentence, Borrower shall pay to Lender, within ten (10) days after demand therefor, an amount equal to the amount so applied in order to restore the funds in the Payment Reserve Account to $100,000.00. Borrower's failure to restore the funds in the Account to $100,000.00 as provided in this Section 6.9 shall be deemed an Event of Default hereunder and shall entitle Lender to the exercise of all of Lender's rights and remedies under the Loan Documents. No Person, including, without limitation, Borrower, shall have any right to withdraw any of the funds held in the Payment Reserve Account, except that upon payment of all amounts payable by Borrower to Lender under this Agreement or under any other Loan Document, any funds remaining in the Payment Reserve Account shall be returned by Lender to Borrower or paid to whomever may be legally entitled thereto. Notwithstanding the foregoing, provided that there is not then an Event of Default (as defined in the Mortgage) which has occurred and is continuing under the Loan, the amount held by Lender in the Payment Reserve Account will be released by Lender to Borrower upon the earlier of (i) Borrower reporting four consecutive fiscal quarterly periods of positive pre-tax earnings, (ii) Borrower successfully raises additional capital of a least $7,500,000, or -9- (iii) the last day of the second Loan Year. 6.10 Debt Service Coverage Ratio. Beginning as of Borrower's fiscal quarter ended February 28, 2005, and at all times thereafter during the term of the loan, maintain a Debt Service Coverage Ratio equal to or greater than 1.20:1, which ratio shall be calculated based on Borrower's 10-Q and 10-K Reporting and measured as of the last day of each fiscal quarter of Borrower for the immediately preceding twelve-month period. ARTICLE VII NEGATIVE COVENANTS OF BORROWER 7. Negative Covenants. Borrower covenants and agrees that for so long as it is indebted to Lender, it will not, without Lender's prior written consent: 7.1 Liens. Create or suffer to exist any mortgage, pledge, lien, security interest or other lien or encumbrance of any kind, of or upon the Property or the Improvements, or of or upon the income or profits therefrom, except (i) those encumbrances made in favor of Lender, and (ii) a junior mortgage in the amount of $1,000,000.00 on the Property and Improvements in favor of Lender to secure a separate equipment lease financing transaction. 7.2 Defaults. Default upon or fail to pay any contract or fail to pay any of its debts or obligations as the same mature. 7.3 Leases of the Property. Enter into any oral or written leases of the Property or the Improvements without the prior written consent of Lender. 7.4 Dividends, Distributions, etc. Pay any dividend or make any distribution of assets to shareholders of Borrower or any Affiliate of Borrower. 7.5 Consolidation, Merger, Sale of Assets; etc. Consolidate with or merge into or with any other Person, or sell (other than sales in the ordinary course of business), transfer, lease or otherwise dispose of all or a substantial part of its assets. ARTICLE VIII DEFAULT 8.1 Events of Default. The occurrence of any of the following events shall constitute an "Event of Default": (a) If Borrower (i) fails to pay when due or, if payable on demand, upon demand, any principal of the Note, or prepayment premium (if applicable), or (ii) fails to pay when due or, if payable on demand, upon demand, any interest on the Note or fees under this Agreement, and, in the case of a default under this clause such default continues for ten (10) days; or -10- (b) If Borrower defaults in the due performance and observance of any covenants set forth in this Agreement, the Mortgage, or any other Loan Document and such default or breach shall continue for a period of thirty (30) days after written notice thereof to Borrower by Lender; or (c) If any financial statement, certificate, representation, or warranty made by or on behalf of Borrower shall prove to have been incorrect in any material respect or any representation made herein is untrue when made or becomes untrue with the passage of time; or (d) If Borrower (i) becomes insolvent or fails to pay its debts generally as they become due, (ii) suspends business, (iii) makes a general assignment for the benefit of creditors, (iv) admits in writing its inability to pay its debts generally as they mature, (v) files a petition in bankruptcy or a petition or answer seeking liquidation of it or a reorganization, arrangement with creditors or other similar relief under the Federal bankruptcy laws or under any other applicable law of the United States of America or any state thereof, whether now or hereafter in effect, (vi) petitions for or applies to any tribunal for, or consents to the appointment of a trustee, custodian, liquidator, receiver or similar official for it or for a substantial part of its property, (vii) is adjudicated a bankrupt or has an involuntary petition in bankruptcy, or a case commenced against it under the Federal bankruptcy laws, as now or hereafter in effect, and an order for relief entered therein, (viii) takes any action for the purpose of effecting or consenting to any of the foregoing, or (ix) has an order, judgment or decree entered appointing without such entity's consent, a trustee, custodian, liquidator, receiver or similar official for it or for a substantial part of its property, or approving a petition in any such proceeding or approving a petition filed or case commenced against it seeking liquidation of it or a reorganization, arrangement with creditors or other similar relief under the Federal bankruptcy laws or under any other applicable law of the United States of America or any State thereof, whether now or hereafter in effect, which order, judgment or decree shall not be vacated or set aside or stayed within 60 days from the date of entry; or (e) If Borrower fails to pay any Debt (but excluding Debt evidenced by the Note) of the Borrower, or any interest thereon, when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) and such failure shall continue after the applicable grace period, if any, specified in the agreement or instrument relating to such Debt; or any other default under any agreement or instrument relating to such Debt, or any such Debt shall be declared to be due and payable or required to be prepaid (other than by scheduled required prepayment), prior to the stated maturity thereof; or (f) If judgment for the payment of money in excess of $100,000.00 is entered against Borrower and is not stayed, vacated, bonded, paid, discharged or appealed in good faith within 60 day after the entry thereof; or -11- 8.2 Rights and Remedies. If any Event of Default shall occur and be continuing, Lender may, at its option (in addition to Lender's rights under the Note, Mortgage, or any other Loan Document), exercise any or all of the following rights and remedies: (a) Declare the Note, all interest thereon, and all other obligations under, or pursuant to, any Loan Document to be immediately due and payable, and upon such declaration such Note, interest and other obligations shall immediately be due and payable, without presentment, demand, protest or any notice of any kind, all of which are expressly waived; and/or (b) Exercise any right or remedy specified herein and in the other Loan Documents, including (without limiting the generality of the foregoing) the right to foreclose the Mortgage or any other right or remedy available to a mortgagee at law or in equity; and/or (c) Exercise any other right or remedy available to Lender at law, in equity or under statute; and/or (d) Cure the event of default on behalf of Borrower, and, in doing so, may enter upon the Project, and may expend such sums as it may reasonably deem desirable, including attorneys' fees, all of which shall be deemed to be advances hereunder, even though causing the Loan to exceed the face amount of the Note, shall bear interest at the Default Rate (as defined in the Note) and shall be payable by Borrower on demand. ARTICLE IX MISCELLANEOUS 9.1 No Waiver; Cumulative Remedies. No failure or delay on the part of Lender in exercising any right or remedy under, or pursuant to, any Loan Document shall operate as a waiver thereof, nor shall any single or partial exercise of any such right, remedy or power preclude other or further exercise thereof, or the exercise of any other right, remedy or power. The remedies in the Loan Documents are cumulative and are not exclusive of any remedies provided by law. 9.2 Amendments and Waivers. No amendment, change, waiver or modification of this Agreement or any Loan Document shall be valid unless the same is in writing and is signed by Lender, and no waiver by Lender of any breach or default by Borrower of any of its obligations, agreements or covenants under this Agreement or any Loan Document shall be deemed to be a waiver of any subsequent breach of the same or any other obligation, agreement or covenants, nor shall any forbearance by Lender to seek or enforce a remedy of such breach be deemed a waiver of its rights and remedies with respect to such breach. 9.3 Survival of Representations and Warranties. All representations and warranties contained herein or made in writing by or on behalf of Borrower in connection with the transactions contemplated hereby shall survive the execution and delivery of this Agreement and the advances -12- hereunder. All statements contained in any certificate or other instrument delivered by or on behalf of Borrower pursuant thereto or in connection with the transactions contemplated hereby shall constitute representations and warranties by Borrower. 9.4 Notices. All notices and other communications provided under this Agreement shall be in writing (including telecopier communication) and mailed, telecopied or delivered, if to Borrower, at its address stated in the preamble hereof, Attention: CEO & CFO; and if to Lender, at its address stated in the preamble hereof, Attention: James E. Senske; or, as to each party, at such other address as shall be designated by such party in a written notice to the other party. Any such notice shall be deemed effective (a) upon personal delivery; (b) upon the third business day (as hereinafter defined) after the placing thereof in the United States mail, postage prepaid, certified or registered mail; or (c) upon the business day succeeding the day in which said notice is deposited with a national overnight air carrier, fees prepaid. 9.5 Costs and Expenses. Borrower agrees to pay on demand all reasonable costs, expenses and disbursements of Lender in connection with Borrower's application for the Loan, the preparation of the Loan Documents and closing of the Loan, including reasonable attorneys' fees and legal expenses as well as all costs and expenses of Lender in connection with Lender's enforcement of the obligations of Borrower hereunder or under the Note or any other Loan Documents, whether or not suit is commenced including, without limitation, reasonable attorneys' fees and legal expenses in connection with any appeal of a lower court's order or judgment. The obligations of Borrower under this Section 9.5 shall survive any termination of this Agreement. 9.6 Right of Set-off. Upon the occurrence and during the continuance of any Event of Default, Lender is hereby authorized at any time, and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by Lender to or for the credit or the account of Borrower against any and all of the obligations of Borrower, now or hereafter existing under any Loan Document, irrespective of whether or not Lender shall have made any demand under any Loan Document and although such obligations may be unmatured. Lender agrees promptly to notify Borrower after any such set-off and application, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of Lender under this Section 9.6 are in addition to other rights and remedies (including, without limitation, other rights of set-off) that Lender may have. 9.7 Governing Law. This Agreement and all other Loan Documents shall be governed by, interpreted, and construed in accordance with the laws of the State of Minnesota. Any term used in this Agreement and not otherwise defined shall have the definition given that term in Uniform Commercial Code as in effect in the State of Minnesota from time to time, and such definition automatically shall change on the effective date of any amendment to the Uniform Commercial Code that changes such definition. If any term in this Agreement shall be held to be illegal or unenforceable the remaining portions of this Agreement shall not be affected, and this Agreement shall be construed and enforced as if this Agreement did not contain the term held to be illegal or enforceable The Borrower hereby irrevocably submits to the jurisdiction of the Minnesota District Court, Fourth District, and the Federal District Court, District of Minnesota, Fourth Division, -13- over any action or proceeding arising out of or relating to this Agreement and agrees that all claims in respect of such action or proceeding may be heard and determined in any such court. 9.8 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the successors and assigns of the parties hereto except that Borrower's rights hereunder are not assignable. 9.9 Execution in Counterparts. This Agreement may be executed simultaneously in two or more counterparts, each of which shall be an original, but all of which shall constitute one agreement. 9.10 Headings. Section headings contained in this Agreement are for convenience only and shall not be used in construing any provision of this Agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed the date and year first above written. HEI, INC. By: /s/ Douglas J. Nesbit --------------------------------- Its: Chief Financial Officer COMMERCE BANK By: /s/ Jim E. Senske --------------------------------- Its: President -14- EX-10.43 14 c81087exv10w43.txt EX-10.43 COMBINATION MORTGAGE, SECRUITY AGREEMENT EXHIBIT 10.43 COMBINATION MORTGAGE, SECURITY AGREEMENT, ASSIGNMENT OF RENTS AND FIXTURE FINANCING STATEMENT THIS COMBINATION MORTGAGE, SECURITY AGREEMENT, ASSIGNMENT OF RENTS AND FIXTURE FINANCING STATEMENT dated as of October 14th, 2003 (the "Mortgage"), by and between HEI, INC. a Minnesota corporation, whose address is 1495 Steiger Lake Lane, Victoria, MN 55386 (the "Mortgagor"), and COMMERCE BANK, a Minnesota state banking corporation, whose address is 7650 Edinborough Way, Suite 150, Edina, MN 55435 (the "Mortgagee"); WITNESSETH: WHEREAS, Mortgagor is justly indebted to Mortgagee in the principal amount of One Million Two Hundred Thousand and No/100ths Dollars ($1,200,000.00) as evidenced by a certain promissory note in said amount made by Mortgagor payable to the order of Mortgagee dated of even date herewith (the "Note"), which Note shall mature on or before November 1, 2009, and the principal of which Note bears interest as provided therein, which Note is fully incorporated herein by reference; WHEREAS, the total principal amount of the Note is to be advanced pursuant to the terms and conditions of a certain Term Loan Agreement dated of even date herewith by and between Mortgagor, as borrower Mortgagee as lender (the "Loan Agreement"), which Loan Agreement is fully incorporated herein by reference (capitalized terms used herein and not otherwise defined shall have the meaning ascribed to them in the Loan Agreement); WHEREAS, Mortgagor has agreed to mortgage and grant a security interest in the Mortgaged Property, as herein defined, to secure payment of the Note and its obligations under the Loan Agreement, and this Mortgage; NOW, THEREFORE, in consideration of One Dollar ($1.00) and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and to secure the due and punctual payment of the principal, prepayment premium (if applicable) and interest on the Note, as it may be extended, amended or renewed, all other sums due and owing on the Note and the Loan Agreement, and the payment of all fees, sums, expenses and advances of Mortgagee -1- made in accordance with the terms of this Mortgage, with interest thereon at the rate equal to that specified in Note (collectively called the "Indebtedness"), Mortgagor does hereby grant, bargain, sell, convey, release, mortgage and warrant, grant a security interest in and pledge unto Mortgagee, is successors and assigns, forever, the following: A. LAND AND IMPROVEMENTS All of its right, title and interest in and to (i) the tracts, parcels and interests in land, and any street or alleys adjoining said premises heretofore or hereafter vacated, lying and being in the County of Carver, State of Minnesota, as legally described on Exhibit A hereto and made a part hereof (the "Land"); (ii) all of the buildings, including, without limitation, the existing building, structures, fixtures, annexations and other improvements now standing or at any time hereafter constructed or placed upon the Land (the "Improvements"); (iii) all extensions, additions, improvements, betterments, renewals and replacements of any of the foregoing; and (iv) all hereditaments, easements, rights, privileges and appurtenances now or hereafter belonging, attached or in any way pertaining to the Land or to any of the Improvements; and B. PERSONAL PROPERTY All property now or hereafter affixed or attached to or incorporated upon the Land or the Improvement; which is now or hereafter owned by Mortgagor or in which Mortgagor now or hereafter has an interest, which to the fullest extent permitted by law, shall be deemed fixtures and a part of the real property (the "Personal Property"), including but not limited to (i) all building materials, supplies and equipment now or hereafter located on the Land and suitable or intended to be incorporated in any building, structure or other improvement located or to be erected on the Land; (ii) all heating, plumbing and lighting apparatus, screens, awnings, floor coverings, shrubbery, plants, landscaping, motors, engines, machinery, elevators, electrical equipment, incinerator apparatus, air conditioning equipment, water and gas apparatus, pipes, boilers, furnaces, cleaning, communication and sprinkler systems, faucets, fire extinguishing apparatus and equipment, and all other fixtures of every description which are now or may hereafter be placed or used upon the Land or in any building, structure or other improvement now or hereafter located thereon; and (iii) all additions, accessions, increases, parts, fittings, accessories, replacements, substitutions, betterments, repairs, products and proceeds to any of any and all such Personal Property (but excluding therefrom the inventory and removable personal property of the Mortgagor or any tenant of the Land or the Improvements). TO HAVE AND TO HOLD the Land, Improvements and Personal Property (collectively called the "Property" or the "Mortgaged Property"), together with all privileges, hereditaments and appurtenances thereunto now or hereafter belonging, or in any wise appertaining, and the proceeds thereof, unto Mortgagee, forever; PROVIDED, NEVERTHELESS, that these presents are upon the express condition that if Mortgagor shall pay or cause to be paid the Indebtedness, and if Mortgagor shall duly and punctually perform and observe all of the terms, covenants, agreements and conditions contained in this Mortgage, the Loan Agreement, and the Note, then this Mortgage and the estate, right and interest of Mortgagee in and to the Mortgaged Property shall cease and be and become void and of -2- no force and effect, and shall be satisfied at Mortgagor's expense; otherwise this Mortgage shall remain in full force and effect. Mortgagor and Mortgagee further agree as follows: ARTICLE I GENERAL COVENANTS, AGREEMENTS AND WARRANTIES Section 1.01. Warranty of Title; Permitted Encumbrances. Mortgagor covenants, represents and warrants that (a) it is the lawful owner of and has good right and lawful authority to grant, bargain, sell, convey, release, mortgage, grant a security interest in, and pledge the Mortgaged Property as provided herein, (b) it is and will continue to be well and truly seized of good and marketable title to the Mortgaged Property, (c) the Mortgaged Property is and will remain throughout the term of this Mortgage free and clear of all mortgages, liens, pledges, charges and encumbrances, excepting only the lien of this Mortgage and such Permitted Encumbrances as are listed on Exhibit B attached hereto and made a part hereof, and (d) Mortgagor warrants and will defend the title to the Mortgaged Property against all claims and demands whatsoever not specifically excepted herein. Section 1.02. Payment of Indebtedness; Observance of Terms and Convenants. Mortgagor shall duly and punctually (a) pay each and every installment of principal and interest on the Note and all other portions of the Indebtedness, as and when the same shall become due, and (b) perform and observe all of the terms, covenants, agreements and conditions contained in this Mortgage, the Loan Agreement and the Note and all other documents and instruments given as security for the payment of the Note. Section 1.03. Validity; Enforceable Obligations. Mortgagor covenants, represents and warrants that (a) the Note, this Mortgage, the Loan Agreement, and all other documents and instruments executed and delivered by it in connection with the execution and delivery of the Note have been duly executed and delivered and are valid and enforceable obligations of Mortgagor in accordance with the terms thereof and hereof, and (b) this Mortgage does not, nor does the Note, nor does the Loan Agreement, nor does the performance or observance by Mortgagor of any of the matters or things in this Mortgage or the Loan Agreement provided for, contravene any covenant in any indenture or agreement affecting Mortgagor or any of its properties. Section 1.04. Additional Assurances. Mortgagor shall (a) do, execute, acknowledge and deliver all and every further act, deed, conveyance, transfer and assurance reasonably necessary or proper for the carrying out more effectively of the purpose of this Mortgage and the Loan Agreement and, without limiting the foregoing, for conveying, mortgaging, assigning, and confirming unto Mortgagee all of the Mortgaged Property or property intended so to be, whether now owned or hereafter acquired, including without limitation the preparation, execution and filing of any documents, such as financing statements and continuation statements, deemed advisable by Mortgagee for maintaining its lien on any part of the Mortgaged Property, and (b) pay any and all recording fees, filing fees, mortgage registry tax, stamp taxes or other charges -3- arising out of or incident to the filing or recording of this Mortgage, such further assurances and instruments and the issuance and delivery of the Note. Section 1.05. Maintenance and Repairs. Mortgagor shall (a) cause the Mortgaged Property and every part thereof to be maintained, preserved and kept in safe and good repair, working order and condition, and will comply with all laws and regulations of any governmental authority with reference to the Mortgaged Property and the manner of using or operating the same, and with all restrictive covenants, if any, affecting the title to the Mortgaged Property, or any part thereof, (b) from time to time make all necessary and proper repairs, renewals, replacements, additions and betterments to the Mortgaged Property and every part thereof so that the value and efficient use thereof shall be fully preserved and maintained and so that all laws and regulations as aforesaid shall be complied with, and (c) promptly repair and restore the Mortgaged Property and every part thereof which may become damaged or destroyed by fire, casualty or otherwise to their condition prior to any such damage or destruction. Section 1.06. Removal of Mortgaged Property. Mortgagor shall not without the prior written consent of Mortgagee (a) remove the Improvements or Personal Property or any part thereof from the Land, except that as long as no Event of Default, as herein defined, shall occur and be continuing, Mortgagor may remove and dispose of any item or items of Personal Property which have become inadequate, obsolete or worn out, provided Mortgagor immediately replaces said item or items of Personal Property with like property such that the value of the Mortgaged Property will not be materially diminished, which shall become a part of the Mortgaged Property and subject to the lien of this Mortgage, (b) demolish, alter or modify the Improvements or Personal Property or any part thereof nor construct additional improvements on the Land, or (c) abandon or vacate the Mortgaged Property or any part thereof. Section 1.07. Payment of Operating Costs, Prior Mortgages and Liens. Mortgagor shall pay all operating costs and expenses of the Mortgaged Property and keep the same free from mechanics', materialmen's and other liens, levy, execution or attachment. Mortgagor shall also pay when due all indebtedness which may be secured by any mortgage, lien or charge on the Mortgaged Property superior to or equal to the lien of this Mortgage, and upon request exhibit to Mortgagee satisfactory evidence of such payment and discharge. Section 1.08. Payment of Taxes. Mortgagor shall (a) pay when due and before any penalty attaches thereto all taxes, assessments, water charges, sewer charges, and other fees, taxes, charges and assessments of every kind and nature whatsoever assessed or charged against or constituting a lien on the Mortgaged Property or any interest therein, upon or against the Note or the Indebtedness or upon or against the interest of Mortgagee in the Mortgaged Property or in the Note or Indebtedness (the "Taxes"), and (b) upon demand furnish to Mortgagee proof of the payment of any such Taxes. In the event of a court decree or an enactment after the date hereof by any legislative authority of any law imposing upon a mortgagee the payment of the whole or any part of the Taxes herein required to be paid by Mortgagor, or changing in any way the laws relating to the taxation of mortgages or debts secured by mortgages or a mortgagee's interest in mortgaged premises, so as to impose such Tax on Mortgagee or on the interest of Mortgagee in the Mortgaged Property, then, in any such event, Mortgagor agrees that it shall bear and pay the full amount of such Tax. -4- Section 1.09. Contest of Taxes and Liens. Notwithstanding any other provision of this Mortgage to the contrary, Mortgagor will not be required to pay, discharge or remove any Tax, or any lien against the Mortgaged Property or any part thereof, including a mechanic's lien (a "Lien") so long as Mortgagor shall in good faith contest the same or the validity thereof by appropriate legal proceedings which shall operate to prevent the collection of the Tax or Lien so contested and the sale of the Mortgaged Property, or any part thereof, to satisfy the same, provided that Mortgagor shall, prior to the date such Tax or Lien is due and payable, have given to Mortgagee cash or provided such other reasonable security as may be required by Mortgagee to insure such payment and interest and penalties thereon and prevent any sale or forfeiture of the Mortgaged Property by reason of such nonpayment. Any such contest shall be prosecuted with due diligence and Mortgagor shall promptly after final determination thereof pay the amount of any such Tax or Lien so determined, together with all interest and penalties thereon, which may be payable in connection therewith. Notwithstanding the provisions of this Section, Mortgagor shall (and if Mortgagor shall fail so to do, Mortgagee may, but shall not be required to) pay any such Tax or Lien notwithstanding such contest if in the reasonable opinion of Mortgagee the Mortgaged Property, or any part thereof, shall be in jeopardy or in danger of being forfeited or foreclosed. Section 1.10. Protection of Security. Mortgagor shall promptly notify Mortgagee of and appear in and defend any suit, action or proceeding that affects the Mortgaged Property, the Indebtedness or the rights or interest of Mortgagee hereunder. Mortgagee may elect to appear in or defend any such action or proceeding and Mortgagor agrees to indemnify and reimburse Mortgagee from any and all loss, damage, expense or cost arising out of or incurred in connection with any such suit, action or proceeding, including without limitation, all reasonable sums paid by Mortgagee to establish or defend the rights and lien of this Mortgage or to protect the Mortgaged Property or any part thereof, including costs of evidence of title and reasonable attorneys fees, which amounts shall be paid by Mortgagor to Mortgagee upon demand together with interest thereon from the date of payment by Mortgagee at the rate equal to that specified in the Note. Section 1.11. Prohibition of Sale, Lease and Mortgage. In the event: (a) Mortgagor sells, leases conveys, transfers, assigns, further mortgages or encumbers or disposes of the Mortgaged Property or any part thereof, or any interest therein, or agrees to do so, or except as otherwise provided in Section 1.06 hereof; or (b) the Mortgaged Property, or any material part thereof, is condemned or the use or control thereof is taken in any proceedings involving the right of eminent domain; whether occurring by voluntary or involuntary act or by operation of law or otherwise, without the written consent of the Mortgagee being first obtained, then at the sole option of the Mortgagee, Mortgagee may declare an Event of Default to have occurred under this Mortgage, thereby entitling Mortgagee to exercise any and all rights and remedies available to it as provided in this Mortgage upon the occurrence of an Event of Default. In the event Mortgagor shall request the consent of Mortgagee in accordance with this Section 1.11, Mortgagor shall deliver a written request to Mortgagee together with complete information regarding such a conveyance, -5- lease or encumbrance and shall allow Mortgagee 30 days from the date of receipt thereof for evaluation of such request. Such approval may be subject to such other modifications of the loan terms as may be deemed necessary by Mortgagee. Consent as to any one transaction shall not be deemed to be a waiver of the right to require consent to future or successive transactions. Section 1.12. Loan Agreement. This Mortgage is the Mortgage referred to in and is also given as security for the due and punctual performance, observance and payment by Mortgagor of the terms and conditions set forth in the Loan Agreement and the Note. In the event Mortgagor fails to comply with any of such terms and conditions, such failure shall be an Event of Default under this Mortgage entitling Mortgagee to exercise any and all remedies available to it as provided in this Mortgage upon the occurrence of an Event of Default. In addition, Mortgagee may, but shall not be required to, avail itself of any or all of the rights and remedies available to it under the Loan Agreement, and any sums expended by Mortgagee in availing itself of such rights and remedies shall bear interest thereon from the date of such expenditures at the rate equal to that specified in the Note, shall constitute a portion of the Indebtedness secured hereby, and shall be payable to Mortgagee immediately upon demand, provided that, no such payment by Mortgagee shall be considered as waiving the Event of Default. ARTICLE II INSURANCE AND ESCROWS Section 2.01. Insurance. Mortgagor shall procure and keep in full force and effect during the term of this Mortgage, at its sole cost and expense, the following: (a) insurance covering the Mortgaged Property against all risks of loss or damage to the Mortgaged Property, including but not limited to loss or damage caused by fire and extended coverage perils, including the cost of debris removal, together with vandalism, malicious mischief, sprinkler leakage, and agreed amount endorsements, all in amounts of not less than the full replacement cost of the Improvements and Personal Property; (b) to the extent pressure fired boilers are located on the Mortgaged Property, insurance covering the Mortgaged Property against loss or damage by explosion, and providing for full repair and full replacement cost coverage; (c) such other insurance covering the Mortgaged Property against loss or damage by other casualties and contingencies as Mortgagee may from time to time reasonably require, all in such manner and for such amounts as may be satisfactory to Mortgagee; (d) flood insurance in the maximum amount obtainable, unless evidence is provided that the Mortgaged Property is not within a flood plain as defined by the Federal Insurance Administration; (e) use and occupancy insurance covering risk of loss due to the occurrence of any hazards described in the foregoing Subsections (a), (b), (c) and (d) in an amount equal to guaranteed income from the Mortgaged Property for a period of nine (9) -6- months and based upon a reasonable estimate of annual income from Mortgagor's use of the Mortgaged Property; and (f) comprehensive general public liability insurance covering the liability of Mortgagor for claims for bodily injury, death or property damage occurring on, in or about the Mortgaged Property in amounts not less than Two Million Dollars ($2,000,000) per occurrence for bodily injury and Five Hundred Thousand Dollars ($500,000) per occurrence for property damage or such greater amounts as shall, from time to time, be required by Mortgagee. The policy or policies of such insurance shall (i) be written on forms and with insurance companies satisfactory to Mortgagee, (ii) as to property insurance, contain agreed amount endorsements for not less than the full replacement cost of the Improvements and Personal Property, (iii) as to liability insurance, name as the insured parties Mortgagor and Mortgagee as their interests may appear, (iv) bear a mortgagee clause in favor of Mortgagee in form satisfactory to Mortgagee, all with loss proceeds under such policies to be made payable to Mortgagee; and (v) be in such amounts as Mortgagee from time to time may require. All policies of insurance shall specifically provide that Mortgagee shall receive 30 days prior written notice before cancellation of any such policies. In the event of a foreclosure of this Mortgage or any acquisition of the Mortgaged Property by Mortgagee all such policies and any proceeds payable therefrom, whether payable before or after a foreclosure sale, or during the period of redemption, if any, shall become the absolute property of Mortgagee to be utilized at its discretion. In the event of foreclosure or the failure to obtain and keep any insurance required herein, Mortgagor empowers Mortgagee to effect insurance upon the Mortgaged Property at Mortgagor's expense and for the benefit of Mortgagee in the amounts and types aforesaid for a period of time extending through the time of redemption from foreclosure sale, and if necessary therefore, to cancel any or all existing insurance policies. Mortgagor agrees to furnish Mortgagee copies of all inspection reports and insurance recommendations received by Mortgagor from any insurer. Section 2.02. Escrows. From and after the occurrence of any Event of Default, Mortgagor shall deposit with Mortgagee on the first day of each and every month hereafter, an amount equal to one-twelfth (1/12th) of the annual taxes and assessments (the "Charges") due on or relating to the Mortgaged Property as estimated by Mortgagee. From time to time out of such deposits and to the extent such deposits are sufficient Mortgagee will, upon presentation to Mortgagee by Mortgagor of bills therefor, pay the Charges or will upon presentation of receipted bills therefor, reimburse Mortgagor for such payments made by Mortgagor. In the event (a) the deposits on hand are not sufficient to pay all of the Charges when the same become due from time to time, or (b) Mortgagee estimates that the current monthly deposits are less than the estimated monthly amounts necessary to pay the Charges as they become due from time to time, then Mortgagor shall pay to Mortgagee on demand the amount necessary to make up the deficiency. The excess of any such deposits shall be credited to subsequent payments to be made for such items. If an Event of Default, as herein defined, shall occur under the terms of this Mortgage, the Loan Agreement, or the Note, Mortgagee may, at its option, without being required to do so, apply any deposit on hand to the Indebtedness in such order and manner as Mortgagee may elect. -7- When the Indebtedness has been fully paid any remaining deposits shall be returned to Mortgagor or other person entitled thereto. All deposits are hereby pledged as additional security for the Indebtedness and shall be held for the purposes for which made as herein provided. Such deposits may be held by Mortgagee, or its agent, and shall be held without any allowance of interest thereon and shall not be subject to the decision or control of Mortgagor. The enforceability of the covenants relating to taxes and assessments provided in Section 1.08 hereof and the payment of premiums for insurance provided in Section 2.01 hereof shall not be affected except insofar as those obligations have been met by compliance with this Section. Mortgagee may from time to time, at its option, waive, and after such waiver, reinstate any and all of the provisions contained in this Section. While such waiver is in effect, Mortgagor shall pay taxes and assessments and premiums for insurance as herein provided. ARTICLE III APPLICATION OF INSURANCE AND AWARDS Section 3.01. Damage to or Destruction of the Mortgaged Property. Mortgagor shall give Mortgagee prompt notice of any damage to or destruction of the Mortgaged Property or any part thereof (each such occurrence of damage or destruction shall be known as a separate and distinct "Casualty"), and in case of loss covered by policies of insurance, Mortgagee and Mortgagor jointly shall settle and adjust any claim arising out of such policies and collect and receipt for the proceeds payable therefrom, provided, that Mortgagor may itself adjust and collect for any losses arising out of a single occurrence aggregating not in excess of $25,000. Any expense incurred by Mortgagee in the adjustment and collection of insurance proceeds (including without limitation the cost of any independent appraisal of the loss or damage on behalf of Mortgagee) shall be reimbursed to Mortgagee first out of any proceeds. Section 3.02. Condemnation. Mortgagor shall give Mortgagee prompt notice of any action, actual or threatened, in condemnation or eminent domain and hereby assigns, transfers and sets over to Mortgagee the entire proceeds of any award or claim for damages for all or any part of the Mortgaged Property taken or damaged under the power of eminent domain or condemnation. Mortgagee is hereby authorized to intervene in any such action in the name of Mortgagor, to compromise and settle any such action or claim, and to collect and receive from the condemning authorities and give proper receipts and acquittances for such proceeds. Any expenses incurred by Mortgagee in intervening in such action or compromising and settling such action or claim, or collecting such proceeds shall be reimbursed to Mortgagee first out of the proceeds. Section 3.03. Disbursement of Insurance and Condemnation Proceeds. If (i) in the sole opinion of Mortgagee, the proceeds from any insurance claim or condemnation award received pursuant to Section 3.01 or 3.02 (after payment of expenses as contemplated by such Sections), together with any monies deposited by Mortgagee with Mortgagor for the purposes of restoration or repair as hereinafter set forth are sufficient to repair and restore the Mortgaged Property to substantially the same condition as existed immediately prior to such damage, destruction or condemnation, and (ii) Mortgagor is not then in default under the Note, the Loan Agreement or -8- this Mortgage, and (iii) such repair or restoration shall not result in the creation of any lien or encumbrance on the Mortgaged Property, other than Permitted Encumbrances, and (iv) Mortgagor pays Mortgagee's expenses in connection with the foregoing, and (v) the Casualty occurs at least twelve (12) months prior to the expiration of the Note, then Mortgagor shall have the right to use such proceeds to repair and restore the Mortgaged Property; provided, however, that Mortgagee shall have the right to approve (which approval shall not be unreasonably withheld) the plans for such repair and restoration. In the event that any insurance or condemnation proceeds are so applied to the restoration or repair of the Mortgaged Property, the restoration or repair shall be done under the supervision of an architect acceptable to Mortgagee and pursuant to plans and specifications approved by Mortgagee and subject to such other terms, provisions, requirements, safeguards and disbursement procedures as Mortgagee may require. In such case the proceeds shall be held by Mortgagee for such purposes and will from time to time be disbursed by Mortgagee to defray the costs of such restoration or repair under such safeguards and controls as Mortgagee may require to assure completion in accordance with the approved plans and specifications and free of liens or claims. Any insurance or condemnation proceeds which are not applied to repair or restoration of the Mortgaged Property and any surplus which may remain after payment of all costs of restoration or repair may at the option of Mortgagee be applied to reduction of that portion of the Indebtedness then most remotely to be paid, whether due or not, or returned to Mortgagor or other person entitled thereto, the choice of application to be solely at the discretion of Mortgagee. ARTICLE IV LEASES AND RENTS Section 4.01. Mortgagor to Comply with Leases. Mortgagor shall, at its own cost and expense, (a) perform, comply with and discharge all of the obligations of Mortgagor under any leases or agreements for the use of the Mortgaged Property or any part thereof, (b) use its best efforts to enforce or secure the performance of each obligation and understanding of the respective tenants under any such leases, and (c) appear in and defend, any action or proceeding arising out of or in any manner connected with Mortgagor's interest in any leases of the Mortgaged Property or any part thereof. Mortgagor shall permit neither surrender nor assignment of any tenant's interest under said leases unless the right to assign or surrender is expressly reserved under the lease. Mortgagor shall not anticipate any installment of rent for more than one (1) month in advance of its due date, nor execute any mortgage or create or permit a lien which may be or become superior to any such leases, nor permit a subordination of any lease to such mortgage or lien. Mortgagor shall not modify or amend the terms of any such leases, nor borrow against or pledge the rentals from such neither leases nor exercise or waive any default of the tenant thereunder without the prior written consent of the Mortgagee. Section 4.02. Mortgagee's Right to Perform Under Leases. In the event Mortgagor fails to perform, comply with or discharge any obligations of Mortgagor under any lease or should Mortgagee become aware of or be notified by any tenant under any lease of a failure on the part of Mortgagor to so perform, comply with or discharge its obligations under said lease, Mortgagee may, but shall not be obligated to, and without demand upon Mortgagor, and without waiving or releasing Mortgagor from any obligation contained in this Mortgage, remedy such failure. -9- Mortgagor shall pay to Mortgagee upon demand all sums incurred by Mortgagee in remedying any such failure together with interest from the date of advance by Mortgagee at the rate equal to that as specified in the Note. No such advance shall be deemed to relieve Mortgagor from any default hereunder. Section 4.03. Assignment of Leases and Rents. As additional security for the payment of the Indebtedness, Mortgagor does hereby bargain, sell, assign and transfer unto Mortgagee, its successors and assigns, all of the leases which now or hereafter may affect the Mortgaged Property, or any part thereof, during the term of this Mortgage and all of the rents, profits, and other income of any kind now due and which may hereafter become due under or by virtue of any lease or agreement, whether written or verbal, for the use or occupancy of the Mortgaged Property, or any part thereof, whether presently existing or entered into at any time during the term of this Mortgage, whether before or after foreclosure or during the period of redemption. It is the expressed intention of Mortgagor and Mortgagee to establish an absolute transfer and assignment of all such leases and agreements and all of the rents, profits and other income of any kind from the Mortgaged Property unto Mortgagee, its successors and assigns, and Mortgagor does hereby appoint irrevocably Mortgagee its true and lawful attorney in its name and stead, which appointment is coupled with an interest, to collect all of said rents, profits and other income; provided that, unless and until an Event of Default, as herein defined, occurs under this Mortgage, Mortgagor shall have the right to collect and retain said rents, profits and other income. The assignment of rents shall be effective until the payment of all money secured by this Mortgage, or in the event of foreclosure, until the period of redemption expires. Regardless of the extinguishment of the debt by a foreclosure sale, this benefit shall continue for the benefit of the purchaser at such sale. The entering upon and taking possession of the Mortgaged Property and the collection of such rents, profits and other income shall not cure or waive any defaults under this Mortgage nor in any way operate to prevent Mortgagee from pursuing any other remedy which it may now or hereafter have under the terms of this Mortgage nor shall it in any way be deemed to constitute Mortgagee a mortgagee-in-possession. ARTICLE V UNIFORM COMMERCIAL CODE Section 5.01. Security Agreement; Fixture Filing. This Mortgage shall constitute a security agreement as defined in the Minnesota Uniform Commercial Code and all acts amendatory thereof and any similar or replacement statute hereafter enacted (the "Code"), and as to those items of Personal Property described in this Mortgage that are, or are to become fixtures related to the real estate mortgaged herein, it is intended as to those items that this Mortgage shall be effective as a financing statement filed as a fixture filing from the date of its filing in the real estate records of the County where the Mortgaged Property is situate. A photographic or other reproduction of this Mortgage may also be filed as a financing statement. The name of the record owner of said real estate is the Mortgagor as set forth in page one of this Mortgage. Information concerning the security interest created by this instrument may be obtained from Mortgagee, as secured party, at its address as set forth in page one of this Mortgage. The address of Mortgagor, -10- as debtor, is as set forth in page one of this Mortgage. This document covers goods which are or are to become fixtures and other personal property. ARTICLE VI CERTAIN RIGHTS OF MORTGAGEE Section 6.01 Right to Cure Default. If Mortgagor shall fail to comply with any of the terms, covenants, agreements or conditions of this Mortgage, the Note, the Loan Agreement or the other Loan Documents (as defined in the Loan Agreement), Mortgagee may, but shall not be obligated to, without demand upon Mortgagor, and without waiving or releasing Mortgagor from any obligation in this Mortgage or in the Loan Agreement contained, remedy such failure, and Mortgagor agrees to pay upon demand all sums incurred and the cost of performance by Mortgagee in remedying any such failure together with interest on all such sums and the costs of such performance from the date of such advance and performance at the rate equal to that specified in the Note. All such sums and costs, together with interest as aforesaid, shall constitute a portion of the Indebtedness, but no such advance or performance shall be deemed to relieve Mortgagor from any failure hereunder. Section 6.02 Inspection. Mortgagor shall permit Mortgagee's authorized representatives to enter the Mortgaged Property at all reasonable times for the purpose of inspecting the same; however, Mortgagee shall have no duty to make such inspections and shall not incur any liability or obligation for making or not making any such inspections. Section 6.03 Waivers; Releases; Resort to Other Security. Without affecting the liability of Mortgagor for payment of the Indebtedness or performance of any obligation contained herein, and without affecting the rights of Mortgagee with respect to any security not expressly released in writing, Mortgagee may, at any time, and without notice to or the consent of Mortgagor (a) make any agreement extending the time or otherwise altering the terms of payment of all or any part of the Indebtedness or modifying or waiving any obligation, or subordinating, modifying or otherwise dealing with the lien or charge hereof, (b) accept any additional security, (c) release or otherwise deal with any property, real or personal, including any or all of the Mortgaged Property, including making partial releases of the Mortgaged Property; or (d) resort to any security agreements, pledges, contracts of guarantee, assignments of rents and leases or other securities, and exhaust any one or more of said securities and the security hereunder, either concurrently or independently and in such order as it may determine. Section 6.04 Rights Cumulative. Each right, power or remedy herein conferred upon Mortgagee is cumulative and in addition to every other right, power or remedy, express or implied, now or hereafter arising, available to Mortgagee, at law or in equity, or under the Code, or under any other agreement, and each and every right, power and remedy herein set forth or otherwise so existing may be exercised from time to time as often and in such order as may be deemed expedient by Mortgagee and shall not be a waiver of the right to exercise at any time thereafter any other right, power or remedy. No delay or omission by Mortgagee in the exercise of any right, power or remedy arising hereunder or arising otherwise shall impair any such right, power or remedy or the right of Mortgagee to resort thereto at a later date or be construed to be a -11- waiver of any default or Event of Default, as herein defined, under this Mortgage, the Note, the Loan Agreement or any other Loan Document. Section 6.05 Subsequent Agreements. Any agreement hereafter made by Mortgagor and Mortgagee pursuant to this Mortgage shall be superior to the rights of the holder of any intervening lien or encumbrance. Section 6.06 Waiver of Appraisement, Marshaling. Mortgagor hereby waives to the full extent lawfully allowed the benefit of any appraisement, evaluation, stay and extension laws now or hereinafter in force. Mortgagor hereby waives any rights available with respect to marshaling of assets and Mortgagee shall not be required to separately sell any portion of the Mortgaged Property, and Mortgagee shall not be required to exhaust its remedies against a specific portion of the Mortgaged Property before proceeding against the other. Mortgagor does hereby expressly consent to and authorize the sale of the Mortgaged Property or any part thereof as a single unit or parcel or in such other manner as Mortgagee may determine. ARTICLE VII EVENTS OF DEFAULT AND REMEDIES Section 7.01 Events of Default. An "Event of Default" as defined in the Loan Agreement shall constitute an "Event of Default" under this Mortgage. Section 7.02 Certain Remedies; Acceleration, Prepayment Premium and Foreclosure. If an Event of Default shall occur, Mortgagee may immediately declare the entire unpaid principal balance of the Note together with all other portions of the Indebtedness to be immediately due and payable and thereupon all such unpaid principal balance of the Note together with all accrued interest thereon, prepayment premium and all other portions of the Indebtedness secured hereby shall be and become immediately due and payable. If an Event of Default shall occur, then in every such case Mortgagee may (a) proceed to protect and enforce its rights by a suit or suits in equity or at law, either for the specific performance of any term, covenant, agreement or condition contained herein or in the Note or in the Loan Agreement or in any other Loan Document, or in aid of the execution of any power herein or therein granted for collection of the Note or the Indebtedness or for the foreclosure of this Mortgage, or for the enforcement of any other appropriate legal or equitable remedy, and/or (b) foreclose this Mortgage; and Mortgagor hereby authorizes and fully empowers Mortgagee to foreclose the lien of this Mortgage in the manner prescribed by applicable law, and out of the proceeds arising from sale and foreclosure to retain the principal of the Note and interest on the Note and all other portions of the Indebtedness together with all such sums of money as Mortgagee shall have expended or advanced pursuant to this Mortgage or pursuant to statute together with interest thereon as herein provided and all costs and expenses of such foreclosure, including lawful attorneys' fees, with the balance, if any, to be paid to the persons entitled thereto by law. In case of any sale of the Mortgaged Property, or any part thereof, pursuant to any judgment or decree of any court or otherwise in connection with the enforcement of any of the terms of this Mortgage, Mortgagee may become the purchaser, and for the purpose of making settlement for or payment of the purchase price, shall be entitled to deliver and use the Note and any claims for interest and prepayment premium matured and unpaid -12- thereon, together with all other portions of the Indebtedness, in order that there may be credited as paid on the purchase price the sum then due under the Note, including the principal of the Note and prepayment premium and interest thereof and all other portions of the Indebtedness. Section 7.03 Receiver. If an Event of Default shall occur hereunder, it is further covenanted and agreed that if at any time in the opinion of Mortgagee a receivership may be necessary to protect the Mortgaged Property, whether before or after maturity of the Indebtedness or at the time of or after the institution of suit to collect the Indebtedness, or to enforce this Mortgage, Mortgagee shall, as a matter of strict right and regardless of the value of the mortgage security for the amounts due hereunder or secured hereby, or of the solvency of any party bound for the payment of the Indebtedness, have the right to the appointment on ex parte application, and without notice to anyone, by any Court having jurisdiction, of a receiver to take charge of, manage, preserve, protect, operate the Mortgaged Property and to collect the rents, to make all necessary and needed repairs, and to pay all taxes and assessments against the Mortgaged Property and insurance premiums for insurance thereon and after the payment of the expenses of the receivership and management of the Mortgaged Property to apply the net proceeds in reduction of the Indebtedness hereby secured or in such manner as the Court shall direct. Such receivership shall, at the option of Mortgagee, continue until full payment of all sums hereby secured, or until title to said Mortgaged Property shall have passed by sale under this Mortgage, as further provided in any assignment of rents executed by Mortgagor to Mortgagee (whether contained in this Mortgage or in a separate instrument). Section 7.04 Rights Under Uniform Commercial Code. In addition to the rights available to a mortgagee of real property, Mortgagee shall also have all the rights, remedies and recourse available to a secured party under the Code including the right to proceed under the provisions of the Code governing default as to any Collateral which may be included in the Mortgaged Property or which may be deemed non-realty in a foreclosure of this Mortgage or to proceed as to such Collateral in accordance with the procedures and remedies available pursuant to a foreclosure of real estate. Section 7.05 Right to Discontinue Proceeding. In the event Mortgagee shall have proceeded to invoke any right, remedy or recourse permitted under this Mortgage and shall thereafter elect to discontinue or abandon the same for any reason, Mortgagee shall have the unqualified right to do so and in such event Mortgagor and Mortgagee shall be restored to their former positions with respect to the Indebtedness. This Mortgage, the Mortgaged Property and all rights, remedies and recourse of Mortgagee shall continue as if the same had not been invoked. Section 7.06 Acknowledgment of Waiver of Hearing Before Sale. Mortgagor understands and agrees that if an Event of Default occurs under the terms of this Mortgage, Mortgagee has the right, inter alia, to foreclose this Mortgage by advertisement in accordance with applicable law. Mortgagor further understands that in the event of such default Mortgagee may also elect its rights under the Code and take possession of the Collateral, or any part thereof, and dispose of the same by sale or otherwise in one or more parcels provided that at least ten (10) days' prior notice of such disposition must be given, all as provided for by the Code, as hereafter amended or by any similar or replacement statute hereafter enacted. MORTGAGOR HEREBY RELINQUISHES, WAIVES AND GIVES UP ANY CONSTITUTIONAL RIGHTS IT MAY HAVE TO NOTICE -13- AND HEARING EXCEPT AS PROVIDED HEREIN BEFORE SALE OF THE MORTGAGED PROPERTY AND EXPRESSLY CONSENTS AND AGREES THAT THE MORTGAGED PROPERTY MAY BE FORECLOSED BY ADVERTISEMENT AND THAT THE COLLATERAL MAY BE DISPOSED OR PURSUANT TO THE CODE, ALL AS DESCRIBED ABOVE. MORTGAGOR ACKNOWLEDGES THAT IT IS REPRESENTED BY LEGAL COUNSEL; THAT BEFORE SIGNING THIS DOCUMENT THIS SECTION AND MORTGAGOR'S CONSTITUTIONAL RIGHTS WERE FULLY EXPLAINED BY SUCH COUNSEL AND THAT MORTGAGOR UNDERSTANDS THE NATURE AND EXTENT OF THE RIGHTS WAIVED HEREBY AND THE EFFECT OF SUCH WAIVER. ARTICLE VIII ENVIRONMENTAL PROVISIONS Section 8.01 Environmental Concerns. (a) To the best of Mortgagor's knowledge, after the investigation performed in accordance with the letter attached hereto as Exhibit C and made a part hereof, the Mortgaged Property, has never been used by previous owners and/or operators to refine, produce, store, handle, transfer, process or transport "Hazardous Substances", as such term is defined by applicable federal law, except in compliance with applicable laws, and the Mortgagor has not in the past, nor does Mortgagor intend in the future, to use the Mortgaged Property, for the purpose of refining, producing, storing, handling, transferring, processing or transporting said "Hazardous Substances", except in compliance with applicable laws. (b) Mortgagor has not received a summons, citation, directive, letter or other communication, written or oral, from any applicable governmental agency concerning any intentional or unintentional action or omission on Mortgagor's part resulting in the releasing, spilling, leaking, pumping, pouring, emitting, emptying or dumping of Hazardous Substances into the waters or onto the lands of the State, or into the waters outside the jurisdiction of the State resulting in damage to the lands, waters, fish, shellfish, wildlife, biota, air and other resources owned, managed, held in trust or otherwise controlled by the State. (c) Mortgagor shall operate the Mortgaged Property or cause it to be operated in material compliance with all applicable rules and regulations promulgated by all applicable governmental environmental authorities and agencies. Mortgagor shall have the right in good faith to contest or appeal from such laws, ordinances and regulations and any decision adverse to the Mortgagor based thereon, but all costs, fees and expenses incurred in connection with such proceedings shall be borne by the Mortgagor. (d) Mortgagor shall not cause or permit to exist, as a result of an action or omission on its part, a releasing, spilling, leaking, pumping, emitting, pouring, emptying or dumping of a Hazardous Substance into waters of the State or onto the lands from which it might flow or drain into said waters, or into waters outside the jurisdiction of the State where damage may result to the lands, waters, fish, shellfish, wildlife, biota, air and other resources owned, managed, held in trust or otherwise controlled by the State, unless said release, spill, leak, -14- pumping, emitting, pouring, emptying or dumping is pursuant to and in compliance with the conditions of a permit issued by the appropriate federal or state governmental authorities or other applicable laws. (e) Should Mortgagor cause or permit any action or omission resulting in the releasing, spilling, leaking, pumping, pouring, emitting, emptying or dumping of Hazardous Substances into the waters or onto the lands of the State, or into the waters outside the jurisdiction of the State, resulting in damage to the lands, waters, fish, shellfish, wildlife, biota, air or other resources owned, managed or held in trust or otherwise controlled by the State, without having obtained a permit issued by the appropriate governmental authorities, Mortgagor shall promptly clean up the same in accordance with the provisions of applicable State or Federal law. (f) Notwithstanding anything in this Article VIII to the contrary, Mortgagor may store and use on the Mortgaged Property supplies which are used in the normal course of Mortgagor's business. Mortgagor covenants and agrees that it will use and dispose of all such supplies in compliance with all applicable laws and regulations. ARTICLE IX MISCELLANEOUS Section 9.01 Applicable Law. This Mortgage shall be interpreted, construed and enforced according to the laws of the State of Minnesota. Section 9.02 No Implied Waiver. Any delay by Mortgagee in exercising or any failure by Mortgagee to exercise any right or remedy hereunder or afforded by law shall not be a waiver of nor preclude the exercise of any right or remedy hereunder, whether on such occasion or any future occasion. Section 9.03 Successors and Assigns. This Mortgage and each and every term, covenant, agreement, condition and other provision hereof shall be binding upon Mortgagor and its successors and assigns including without limitation each and every from time to time record owner of the Mortgaged Property or any other person having an interest therein, shall run with the land and shall inure to the benefit of Mortgagee and its successors and assigns. As used herein the words "successors and assigns" shall also be deemed to include the heirs, representatives, administrators and executors of any natural person who is a party to this Mortgage. Section 9.04 Notices. Any notice which any party hereto may desire or may be required to give to any other party shall be in writing and the mailing thereof by certified mail to their respective addresses as set forth in page one of this Mortgage, or to such other places any party hereto may hereafter by notice in writing designate, shall constitute service of notice hereunder. Section 9.05 Captions and Headings. The captions and headings of the various sections of this Mortgage are for convenience only and are not to be construed as confining or limiting in any way the scope or intent of the provisions hereof. -15- Section 9.06 Severability and Survival. The unenforceability or invalidity of any provision or provisions hereof shall not render any other provision or provisions herein contained unenforceable or invalid, and all provisions hereof, in all other respects, shall remain valid and enforceable. IN WITNESS WHEREOF, Mortgagor has caused these presents to be executed as of the date first above written. HEI, INC. By: /s/ Douglas J. Nesbit ----------------------- Its: Chief Financial Officer STATE OF MINNESOTA ) ) ss: COUNTY OF HENNEPIN ) The foregoing instrument was acknowledged before me this 14th day of October, 2003, by Douglas J. Nesbit, the Chief Financial Officer of HEI, Inc., on behalf of the corporation. My Commission expires on January 31, 2005 Mary Joel Makepeace ------------------------------ Notary Public This instrument prepared by: [SEAL OF MARY JOEL MAKEPEACE] COMMERCE BANK 7650 Edinborough Way, Suite 150 Edina, MN 55435 -16- EX-10.44 15 c81087exv10w44.txt EX-10.44 ENVIRONMENTAL INVESTIGATION LETTER EXHIBIT 10.44 ENVIRONMENTAL INVESTIGATION LETTER October 14, 2003 Commerce Bank. 7650 Edinborough Way Suite 150 Edina, MN 55435 Re: 1945 Steiger Lake Lane, Victoria, MN Ladies and Gentlemen: This letter will certify that we have conducted a search of the real estate that is the subject of the above-referenced project in an attempt to determine if there are any environmentally hazardous substances on or about the premises. That search has consisted of engaging Braun Intertech Corporation and obtaining a Phase I Environmental Site Assessment. It is therefore our opinion that to the best of the company's information, knowledge, and belief, there are no pollutants or migrating pollutants on or under the Mortgaged Property and that to the best of our information, knowledge, and belief, no Hazardous Substances have been released into the environment from the Mortgaged Property, and if any such Hazardous Substances exist, the company shall and does hereby agree to fully indemnify and hold harmless Commerce Bank from any and all losses caused or attributable to any such Hazardous Substances, and the company shall be willing to execute an indemnity agreement specifically relating to such issue substantially the form attached hereto as Exhibit 1. Sincerely, HEI, INC. By: /s/ Douglas J. Nesbit ----------------------- Its: Chief Financial Officer EX-10.45 16 c81087exv10w45.txt EX-10.45 PROMISSORY NOTE . . . EXHIBIT 10.45 - --------------------------------------------------------------------------------------------------------------------------- HEI, INC. COMMERCE FINANCIAL GROUP, INC. 1495 STEIGER LAKE LANE 7650 EDINBOROUGH WAY, STE 160 Loan Number 200513 VICTORIA, MN 55386 EDINA, MN 55435 ------------------- Date 10-28-2003 -------------------------- Maturity Date 09-28-2007 ----------------- Loan Amount $ 1,150,000.00 ----------------- LENDER'S NAME AND ADDRESS Renewal Of BORROWER'S NAME AND ADDRESS "You" and "your" means the lender, its "I", "me" and "my" means each borrower above, successors and assigns. together and separately. - ---------------------------------------------------------------------------------------------------------------------------

I promise to pay you, at your address listed above, the PRINCIPAL sum of ONE MILLION ONE HUNDRED FIFTY THOUSAND AND NO/100 Dollars $1,150,000.00 [X] Single Advance: I will receive all of the loan amount on 10-28-2003. There will be no additional advances under this note. [ ] Multiple Advance: The loan amount shown above is the maximum amount I can borrow under this note. On ____________ I will receive $____________ and future principal advances are permitted. Conditions: The conditions for future advances are ________________________ ___________________________________________________________________________ [ ] Open End Credit: You and I agree that I may borrow up to the maximum amount more than one time. All other conditions of this note apply to this feature. This feature expires on _____ [ ] Closed End Credit: You and I agree that I may borrow up to the maximum only one time (and subject to all other conditions). INTEREST: I agree to pay interest on the outstanding principal balance from 10-28-2003 at the rate of 8.975% per year until 09-28-2007. [ ] Variable Rate: This rate may then change as stated below. [ ] Index Rate: The future rate will be the following index rate: [ ] No Index: The future rate will not be subject to any internal or external index. It will be entirely in your control. [ ] Frequency and Timing: The rate on this note may change as often as _______________________________ A change in the interest rate will take effect ________________ [ ] Limitations: During the term of this loan, the applicable annual interest rate will not be more than _________% or less than ________________%. The rate may not change more than ______% each ______________. Effect of Variable Rate: A change in the interest rate will have the following effect on the payments: [ ] The amount of each scheduled payment will change. [ ] The amount of the final payment will change. ACCRUAL METHOD: You will calculate interest on a ACTUAL/360 basis. POST MATURITY RATE: I agree to pay interest on the unpaid balance of this note owing after maturity, and until paid in full, as stated below: [X] on the same fixed or variable rate basis in effect before maturity (as indicated above). [ ] at a rate equal to ______________________________________________. [X] LATE CHARGE: If I make a payment more than 10 days after it is due, I agree to pay a late charge of 5.000% OF THE LATE AMOUNT WITH A MIN OF $25.00. [ ] ADDITIONAL CHARGES: In addition to interest, I agree to pay the following charges which [ ] are [ ] are not included in the principal amount above: [ ] Authority: The interest rate and other charges for this loan are authorized by ______________________________. PAYMENTS: I agree to pay this note as follows: 48 MONTHLY PAYMENTS OF $28,462.38 BEGINNING 10-28-2003. ADDITIONAL TERMS: THIS NOTE IS SUBJECT TO THE ADDITIONAL TERMS AND CONDITIONS SET FORTH IN THAT CERTAIN TERM LOAN AGREEMENT DATED OF EVEN DATE HEREWITH. - ------------------------------------------------------------------- [X] SECURITY: This note is separately secured by (describe separate PURPOSE: The purpose of this loan is BUSINESS PURPOSES document by type and date): SEPARATE SECURITY AGREEMENT DATED ___________________________________________________________ 10-28-03 SIGNATURES: I AGREE TO THE TERMS OF THIS NOTE (INCLUDING THOSE ON PAGE 2). I have received a copy on today's date. (This section Is for your Internal use. Failure to list a separate security document does not mean the agreement will not secure this note.) HEI, INC. - ------------------------------------------------------------------- /s/ Doug Nesbit Signature for Lender ----------------------------------------------------------- DOUG NESBIT, CHIEF FINANCIAL OFFICER /s/ James Senske - ----------------------------------------------------------- ----------------------------------------------------------- JAMES SENSKE, PRESIDENT - ----------------------------------------------------------- ----------------------------------------------------------- -----------------------------------------------------------

DEFINITIONS: As used on page 1, "[X]" means the terms that apply to this loan. "1," "me" or "my" means each Borrower who signs this note and each other person or legal entity (including guarantors, endorsers, and sureties) who agrees to pay this note (together referred to as "us"). "You" or "your" means the Lender and its successors and assigns. APPLICABLE LAW: Minnesota law controls this note. Any term of this note which violates Minnesota law is not effective, unless the law permits you and me to agree to a variation. If any provision of this agreement is unenforceable, the rest of the agreement remains in force. I may not change this agreement without your express written consent. Time is of the essence in this agreement. COMMISSIONS OR OTHER REMUNERATION: I understand and agree that any insurance premiums paid to insurance companies as part of this note will involve money retained by you or paid back to you as commissions or other remuneration. In addition, I understand and agree that some other payments to third parties as part of this note may also involve money retained by you or paid back to you as commissions of other remuneration. PAYMENTS: You will apply each payment I make on this note first to any amount I owe you for charges which are neither interest nor principal. You will apply the rest of each payment to any unpaid interest, and then to the unpaid principal. If you and I agree to a different application of payments, we will describe our agreement on this note. I may prepay all or part of this loan without penalty unless we agree to something different on this note. Any partial prepayment I make will not excuse or reduce any later scheduled payment until this note is paid in full (unless, when I make the prepayment, you and I agree in writing to the contrary). INTEREST: Interest accrues on the principal remaining unpaid from time to time, until paid in full. If you give me my loan money in more than one advance, each advance will start to earn interest only when I receive it. The interest rate in effect on this note at any time will apply to all the money you advance at that time. Regardless of anything in this document that might imply otherwise, I will not pay and you will not charge a rate of interest that is higher than the maximum rate of interest you could charge under applicable law for the credit you give me (before or after maturity). If you send any erroneous notice of interest, we mutually agree to correct it. If you collect more interest than the law and this agreement allow, you agree to refund it to me. INDEX RATE: The index will serve only as a device for setting the rate on this note. You do not guarantee by selecting this index, or the margin, that the rate on this note will be the same rate you charge on any other loans or class of loans to me or other borrowers. ACCRUAL METHOD: You will calculate the amount of interest I will pay on this loan using the interest rate and accrual method on page 1 of this note. When calculating interest, you will use the accrual method to determine the number of days in a "year." If you do not state an accrual method, you may use any reasonable accrual method to calculate interest. POST MATURITY RATE: In deciding when the "Post Maturity Rate" (on page 1) applies, "maturity" means: 1.) The date of the last scheduled payment indicated on page 1 of this note, or; 2.) The date you accelerate payment on the note, whichever is earlier. SINGLE ADVANCE LOANS: If this is a single advance loan, you and I expect that you will make only one advance of principal. However, you may add other amounts to the principal if you make any payments described in the "PAYMENTS BY LENDER" paragraph below. MULTIPLE ADVANCE LOANS: If this is a multiple advance loan, you and I expect that you will make more than one advance of principal. If this is closed-end credit, I am not entitled to additional credit if I repay a part of the principal. PAYMENTS BY LENDER: If you are authorized to pay, on my behalf, charges I am obligated to pay (such as property insurance premiums), then you may treat those payments made by you as advances and add them to the unpaid principal under this note. Or, you may demand immediate payment of the charges. SET-OFF: You may set off any amount due and payable under this note against any right I have to receive money from you. "Right to receive money from you" means: (1) any deposit account balance I have with you; (2) any money owed to me on an item presented to you or in your possession for collection or exchange; and (3) any repurchase agreement or other non deposit obligation. "Any amount due and payable under this note" means the total amount of which you are entitled to demand payment under the terms of this note at the time you set off. This total includes any balance the due date for which you properly accelerate under this note. If someone who has not agreed to pay this note also owns my right to receive money from you, your set-off right will apply to my interest in the obligation, and to any other amounts I could withdraw on my sale request or endorsement. Your set-off right does not apply to an account or other obligation where my rights are only as a representative. It also does not apply to any Individual Retirement Account or other tax-deferred retirement account. You will not be liable for the dishonor of any check when the dishonor occurs because you set off this debt against one of my accounts. I will assume the liability and relieve you of all responsibility for any such claim that occurs if you set off this debt against one of my accounts. REAL ESTATE OR RESIDENCE SECURITY: If I am giving you any real estate or a residence that is personal property, as security for this note I have signed a separate security agreement. Default and your remedies for default are determined by applicable law and by the security agreement. Default and your remedies may also be determined by the "Default" and "Remedies" paragraphs below, to the extent they are not prohibited by law or contrary to the security agreement. DEFAULT: I will be in default if any of the following happen: (1) I fail to make a payment on time or in the amount due; (2) I fail to keep the property insured, if required; (3) I fail to pay, or keep any promise, on any debt or agreement I have with you; (4) any other creditors of mine try to collect any debt I owe them through court proceedings; (5) I make any written statement or provide any financial information that is untrue or inaccurate when it was provided; (6) any collateral securing this note is used in a manner or for a purpose which threatens confiscation by a legal authority; (7) I change my name or assume an additional name without first notifying you; (8) any loan proceeds are used for a purpose that will contribute to excessive erosion of highly erodible land, or to the conversion of wetlands to produce an agricultural commodity, as explained in 7 C.F.R. Part 1940, Subpart G, Exhibit M. REMEDIES: If I am in default on this note, you have, but are not limited to, the following remedies: (1) You may demand immediate payment of everything I owe under this note; (2) You may set off this debt against any right I have to the payment of money from you, subject to the terms of the "SET-OFF" paragraph; (3) You may demand security, additional security, or additional parties to be obligated to pay this note as a condition for not using any other remedy; (4) You may refuse to make advances to me or allow me to make credit purchases; (5) You may use any remedy you have under state or federal law. If you choose one of these remedies, you do not give up your right to use any other remedy later. By waiving your right to declare an event to be a default, you do not waive your right to later consider the event a default if it continues or happens again. COLLECTION COSTS AND ATTORNEY'S FEES: I will pay all reasonable costs of collection, replevin (an action for the recovery of property wrongfully taken or detained), or any other or similar type of cost if I am in default. In addition, if you hire an attorney to collect this note, I will pay attorney's fees plus court costs (except where prohibited by law). To the extent permitted by the United States Bankruptcy Code, I will also pay the reasonable attorney's fees and costs you are charged to collect this debt as awarded by any court under the Bankruptcy Code's jurisdiction. WAIVER: I give up my rights to require you to: (1) demand payment of amounts due (presentment); (2) obtain official certification of nonpayment (protest); (3) give notice that amounts due have not been paid (notice of dishonor). I waive any defenses I have based on suretyship or impairment of collateral. OBLIGATIONS INDEPENDENT: I must pay this note even if someone else has also agreed to pay it (by, for example, signing this form or a separate guarantee or endorsement). You may sue" me alone, anyone else obligated on this note, or any number of us together, to collect this note. You may do so without any notice that it has not been paid (notice of dishonor). You may, without notice, release any party to the agreement without releasing any other party. If you give up any of your rights, with or without notice, it will not affect my duty to pay this note. Any extension of new credit to any of us, or renewal of this note by all or less than all of us, will not release me from my duty to pay it. (Of course, you are entitled to only one payment in full.) You may extend this note or the debt represented by this note, or any portion of the note or debt, from time to time without limit or notice. You may do this without affecting my liability for payment of the note. I will not assign my obligation under this agreement without your prior written approval. FINANCIAL INFORMATION: I will provide you, at your request, accurate, correct and complete financial statements or information you need. NOTICE: Unless otherwise required by law, you will give any notice to me by delivering it or mailing it by first class mail to my last known address. My current address is on page 1. I will inform you in writing of any change in my address. I will give any notice to you by mailing it first class to your address stated on page 1 of this agreement, or to any other address you give me.
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EX-10.46 17 c81087exv10w46.txt EX-10.46 TERM LOAN AGREEMENT EXHIBIT 10.46 TERM LOAN AGREEMENT THIS TERM LOAN AGREEMENT ("Agreement") is dated as of October 28, 2003, between HEI, INC., a Minnesota corporation ("Borrower"), located at 1495 Steiger Lake Lane, Victoria, MN 55386 and COMMERCE FINANCIAL GROUP, INC., a Minnesota corporation ("Lender"), located at 7650 Edinborough Way, Suite 160, Edina, MN 55435. WITNESSETH: WHEREAS, Borrower has applied to Lender for a loan of $1,150,000.00 secured by the Collateral (as hereinafter defined); WHEREAS, Lender is willing to make such loan on the terms hereof; NOW, THEREFORE, in consideration of the above premises and the mutual covenants and agreements set forth herein, the parties hereto hereby agree as follows: ARTICLE I DEFINITIONS 1. Definitions. For purposes of this Agreement, the following terms shall have the following meanings: "Affiliate" shall include, with respect to any party, any Person which directly or indirectly controls, is controlled by, or is under common control with such party and, in addition, in the case of Borrower, each officer, director, shareholder, joint venturer and partner of Borrower. A Person shall be deemed to control another Person if the controlling Person owns 10% or more of any class of voting stock of the controlled Person or possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of the controlled Person, whether through ownership of stock, by contract or otherwise. "Bank Note" means that certain $1,200,000 promissory note dated as of October 14, 2003 executed by Borrower in favor of Lender. "Borrower" has the meaning set forth in the preamble hereto. "Collateral" means the Equipment and the Project. "Debt" means (i) indebtedness for borrowed money or for the deferred purchase price of property or services, (ii) obligations as lessee under leases that have been or should be, in accordance with GAAP, recorded as capital leases, (iii) obligations under direct or indirect guaranties in respect of, and obligations (contingent or otherwise) to purchase or otherwise acquire, or otherwise to assure a creditor against loss in respect of, indebtedness or obligations of others of the kinds referred to in -1- (i) or (ii) above, and (vi) liabilities in respect of unfunded vested benefits under plans covered by Title IV of ERISA. "Debt Service Coverage Ratio" for any measurement period means a ratio the numerator of which is (A) (i) the sum of Borrower's trailing twelve-month (a) after-tax net income (as defined by GAAP); (b) depreciation, (c) amortization, and (d) interest expense on Borrower's term debt; less (ii) any cash or asset distributions or dividends paid to shareholders in such twelve-month period and the denominator of which is (B) Borrower's aggregate payments on Debt, including interest, on such Debt (including, without limitation, any payments on capitalized leases allocable to principal and interest in accordance with GAAP) scheduled to have been paid during such twelve-month measurement period. "Default" means any event, which, with the giving of notice or passage of time or both, would constitute an Event of Default. "Equipment" means all equipment of Borrower now or hereafter located at HEI, Inc., High Density Interconnect Division, 610 South Rockford Drive, Tempe, Arizona, including but not limited to, machinery, vehicles, furniture, fixtures, manufacturing equipment, shop equipment, office and record keeping equipment, parts and tools. "Event of Default" has the meaning set forth in Article 8. "GAAP" means accounting principles generally accepted in the United States of America including those promulgated by the Securities and Exchange Commission, consistently applied. "Improvements" means the approximate 45,408 square foot office/manufacturing/warehouse facility known as the HEI, Inc. corporate office and manufacturing facility located upon the Property at 1495 Steiger Lake Lane, Victoria, MN 55386. "Lender" has the meaning set forth in the preamble hereto. "Loan Documents" means this Agreement and the other documents listed in Section 2.1(a)-(f) hereof, and any other document that now or hereafter evidences or secures the Obligations. "Loan Year" means a period commencing on November 1, 2003, or any anniversary thereof and ending on the 365th, or in the case of a leap year, the 366th day thereafter. "Mortgage" has the meaning provided in Section 2.1(f) hereof. "Note" has the meaning provided in Section 2.1(b) hereof. "Obligations" means the indebtedness evidenced by the Note and all other advances, debts, liabilities, obligations, covenants and duties owing by Borrower of any kind or nature, present or future, which arise under this Agreement or any other Loan Document, whether or not evidenced by any note, guaranty or other instrument, whether or not for the payment of money, whether joint, -2- several, or joint and several, direct or indirect (including those acquired by assignment or purchase), absolute or contingent, due or to become due, and however acquired. The term includes, but is not limited to, all interest, fees, charges, expenses, attorneys' fees, and any other sum chargeable to Borrower under this Agreement or any other Loan Document. "Payment Reserve Account" has the meaning provided in Section 6.9 hereof. "Person" means any natural person, corporation, firm, association, government, governmental agency or other entity, whether acting in an individual, fiduciary or other capacity. "Project" means the Improvements and the Property. "Property" means the real property located in the County of Carver, State of Minnesota, legally described on Exhibit A attached hereto and made a part hereof. "Security Agreement" has the meaning provided in Section 2.1(c) hereof. "Title Company" means Stewart Title Company. "Whitebox Subordinated Note" means that certain Subordinated Promissory Note issued by Borrower to Colorado MEDtech, Inc. in the original principal amount of $2,600,000.00 dated as of January 24, 2003, and assigned to Whitebox Hedged High Yield Partners on or about May 8, 2003. ARTICLE II LOAN DOCUMENTS 2. Documents Delivered Herewith. Prior to or contemporaneously with the execution of this Agreement, Borrower has delivered to Lender the following documents and/or instructions: 2.1 The Loan Documents: (a) This Agreement properly executed and delivered on behalf of Borrower; (b) Promissory Note (the "Note") properly executed and delivered on behalf of Borrower in the amount of $1,150,000.00, made payable by Borrower to Lender's order; (c) Commercial Security Agreement (the "Security Agreement") in a form satisfactory to Lender executed by Borrower securing the Note and creating a lien upon the Equipment; (d) Listing of the Equipment in a form satisfactory to Lender; (e) UCC-1 Financing Statement; and -3- (f) Combination Mortgage, Security Agreement, Assignment of Rents and Fixture Financing Statement (the "Mortgage") in a form satisfactory to Lender executed by Borrower securing the Note and creating a lien upon the Property and the Project subject only to those encumbrances shown on Exhibit B hereto. 2.2 The Title Documents: (a) A title binder, in form and substance satisfactory to Lender, issued by Gibraltar Title Agency, LLC on behalf of Stewart Title Company, at Borrower's expense, with such title binder constituting a commitment by such title company to issue a mortgagee's title policy or policies in favor of Lender as mortgagee under the Mortgage in the amount of $1,000,000 that: (i) specifically insures that the Mortgage is a junior lien on the Property subject only to a first lien on the Property in the amount of $1,200,000 in favor of Commerce Bank those encumbrances shown on Exhibit B of the Mortgage; and (ii) contains a comprehensive endorsement, a usury endorsement, a zoning endorsement, and such other endorsements as Lender may require in form satisfactory to Lender. (b) Evidence of payment of all required real estate taxes and special assessments, mortgage registration tax, title insurance premiums and costs and recording fees. 2.3 The Project Documents: (a) A FIRREA complying appraisal of the Project, showing an appraised value of not less than $2,200.000 and otherwise satisfactory to Lender, receipt and acceptance of which is hereby acknowledged; and (b) A Phase I environmental report in form and content acceptable to Lender in its sole and absolute discretion, showing no substantial environmental hazards on the Project, receipt and acceptance of which is hereby acknowledged; and (c) Evidence satisfactory to Lender of policies of insurance coverage on the Property and the Project in the amount required by the Mortgage; (d) A policy of flood insurance naming Lender as additional insured, covering the Property and the Improvements in the maximum amount available, or evidence satisfactory to Lender that the Property and Improvements are not located within a designated flood plain; -4- (e) A letter from the appropriate governmental entity stating the zoning classification which is applicable to the Property and stating that the use of the Project is a permitted use under such zoning classification; and 2.4 The Organization Documents: (a) A copy of the Articles of Incorporation of Borrower and all amendments thereto, certified by the Secretary of Borrower to be true, correct and complete; (b) A copy of the Bylaws of Borrower, certified by an officer of Borrower to be true, correct and complete; (c) A resolution of Borrower in form reasonably satisfactory to Lender regarding the execution by Borrower of the Loan Documents and all other documents or instruments required to be executed and delivered in connection herewith and the performance of the covenants and agreements required hereby; and, together with a certificate executed by the Secretary of Borrower indicating the names and titles of persons authorized to execute the Loan Documents and other documents required hereunder; (d) Certificate of Good Standing of recent date for Borrower issued by the Secretary of State of Minnesota; and (e) An opinion of counsel for Borrower with respect to certain matters relating to the transactions contemplated by this Agreement. ARTICLE III TERM LOAN 3.1. Commitment for Term Loan. Subject to the terms and conditions hereof and of the Loan Documents and the other documents delivered herewith, Lender hereby lends to Borrower and Borrower hereby borrows from Lender, the amount of $1,150,000.00 (the "Loan"). 3.2. Use of Proceeds. The proceeds of the Loan shall be used by Borrower to paydown its working capital line of credit and to fund the Payment Reserve Account. ARTICLE IV CONDITIONS OF LENDING 4.1 Conditions Precedent to Term Loan Advance. Lender shall have no obligation to make the Loan unless on or before the date of disbursement, Lender shall have received the following or confirmation of completion of the following events: -5- (a) The documents for the Loan set forth in Article II of this Agreement properly executed and delivered to Lender; (b) Establishment of the Payment Reserve Account by Borrower; (c) Payment of the loan commitment fee in the amount of $5,750.00; and (d) Evidence satisfactory to Lender that the Whitebox Subordinated Note has been paid in full. ARTICLE V REPRESENTATIONS AND WARRANTIES 5. Representations and Warranties. In order to induce Lender to enter into this Agreement, Borrower hereby represents and warrants that: 5.1 Organization and Good Standing. Borrower is a duly organized and validly existing Minnesota corporation, in good standing and qualified and licensed to do business under the laws of the State of Minnesota. 5.2 Authority. Borrower has full power, right and authority to execute and deliver the Loan Documents and the other documents required hereby, to borrow the funds herein provided for, and to perform and observe each and all of the matters and things provided for in said documents. The execution and delivery of the Loan Documents and such other documents as are required hereby and the performance or observance of the terms hereof and thereof have been duly authorized by all necessary action of the board of directors of Borrower. 5.3 Binding Obligation. This Agreement is, and the other Loan Documents when delivered hereunder will be, legal, valid and binding obligations of Borrower enforceable against Borrower in accordance with their respective terms. 5.4 Ownership of Collateral. Borrower (a) is the owner of the Equipment and has no knowledge of any unrecorded claims, liens, and encumbrances against the Equipment, and (b) is the owner of the Property in fee simple and of all personal property described in the Mortgage and has no knowledge of any unrecorded claims, liens, and encumbrances against the Property or the personal property described in the Mortgage. 5.5 Compliance with Laws. The Improvements have been approved, to the extent required by any applicable law, statute, including, without limitation, the ADA, ordinance, regulation, or effective restrictive covenant, by all federal, state, regional and local authorities, and the anticipated use of the Property and the Project comply with all applicable zoning and environmental ordinances, regulations and restrictive covenants affecting the Property and the Project and all requirements for such use have been satisfied. No violation -6- of any law, ordinance, regulation or requirement exists with respect to the Property or the Project. 5.6 ERISA. No plan (as that term is defined in the Employee Retirement Income Security Act of 1974 ("ERISA")) of the Borrower (a "Plan") that is subject to Part 3 of Subtitle B of Title 1 of ERISA had an accumulated funding deficiency (as such term is defined in ERISA) as of the last day of the most recent fiscal year of such Plan ended prior to the date hereof, or would have had such an accumulated funding deficiency on such date if such year were the first year of such Plan, and no material liability to the Pension Benefit Guaranty Corporation has been, or is expected by the Borrower to be, incurred with respect to any such Plan. No Reportable Event (as defined in ERISA) has occurred and is continuing in respect to any such Plan. 5.7 Litigation. Except as set forth on Schedule 5.7, there are no actions, suits or proceedings pending, or to the knowledge of Borrower threatened, against or affecting it in an amount in excess of $100,000, or against or affecting the Equipment or the Property or the Project, or involving the validity or enforceability of the Security Agreement or the Mortgage or the priority of the lien thereof, at law or in equity, except actions, suits and proceedings fully covered by insurance; and Borrower is not in default with respect to any order, writ, injunction, decree or demand of any court or any governmental authority. 5.8 Compliance with Agreements. The consummation of the transaction contemplated hereby and performance of the Loan Documents will not result in any breach of, or constitute a default under, any mortgage, deed of trust, lease, bank loan or credit agreement, corporate agreement, corporate charter, by-law or other instrument to which Borrower is a party or by which it may be bound or affected. 5.9 Absence of Defaults. No Default or Event of Default has occurred and is continuing as of the date hereof hereunder or under the Existing Loan Documents. 5.10 Availability of Utilities. All utility services necessary for the operation of the Improvements for their intended purpose are available to the Project, including water, storm and sanitary sewer, drainage, gas, electric and telephone facilities. 5.11 Accuracy of Financial Information. All financial statements of Borrower heretofore delivered to Lender, are true and correct in all material respects, have been prepared in accordance with GAAP, and fairly present the respective financial conditions of the subjects thereof as of the respective dates thereof; no materially adverse change has occurred in the financial conditions reflected therein since the respective dates thereof, and no additional borrowings have been made by Borrower since the date thereof other than the borrowing contemplated hereby. 5.12 Survival of Representations. All representations and warranties contained in this Article 3 shall survive the delivery of the Loan Documents, the making of the Loan, and no investigation at any time made by or on behalf of Lender shall diminish its rights to rely thereon. -7- ARTICLE VI AFFIRMATIVE COVENANTS OF BORROWER 6. Affirmative Covenants. To further induce Lender to make the requested loan, Borrower hereby covenants and agrees that it will: 6.1. Maintenance of Insurance. At all times, insure the Equipment and the Property and the Improvements in the manner set forth in the Security Agreement and in Section 2.01 of the Mortgage, and from time to time, upon Lender's request, furnish it evidence of such coverage in form satisfactory to Lender and its counsel. 6.1. Payment of Taxes, etc. Promptly pay and discharge all taxes, assessments and other governmental charges imposed upon it or upon its income and profits or upon the Project, and any and all claims for labor, material or supplies or rental charges or charges of any other kind which, if unpaid, might by law become a lien or charge upon any of its property, except as Borrower shall contest in good faith and by appropriate proceedings, providing such reserves as appropriate by GAAP. Borrower shall make all required withholding deposits. 6.3 Maintenance of Properties. Maintain all of its properties in good repair, working order and condition, ordinary wear and tear excepted, and from time to time make or cause to be made all needful renewals, replacements and repairs so that at all times Borrower's business can be conducted efficiently. 6.4 Accounting Records. Keep true and complete and accurate books of record and account in accordance with GAAP, and allow Lender upon Lender's request to examine and take extracts from the books and records of Borrower. 6.5 Financial Information. Furnish to Lender: (a) As soon as available and in any event within ninety (90) days after the close of each of its fiscal years, a copy of the annual financial statements of Borrower, including balance sheet, related statements of earnings, stockholders' equity and statements of cash flow for such year, prepared in accordance with GAAP, and audited by an independent certified public accountant of recognized standing selected by Borrower and acceptable to Lender; (b) Within forty-five (45) days after the end of Borrower's fiscal quarters, financial statements of Borrower as of the end of each such calendar quarter which statements have been prepared in accordance with GAAP and certified by Borrower's chief financial officer; and -8- (c) From time to time such other information pertaining to Borrower and its properties and financial condition as Lender may reasonably request. Provision of the foregoing, as between Borrower and Lender, shall be at the sole cost and expense of Borrower. 6.6 Conduct of Business. Conduct the same general type of business as it presently conducts, maintain its existence, and continue its compliance with all valid, applicable statutes, laws, rules and regulations. 6.7 Right of Inspection. Permit any person designated by Lender to visit and inspect any of the properties, partnership books and financial records of Borrower to discuss its affairs, finances and accounts with the officers of Borrower, all at such reasonable times and as often as Lender may reasonably request. 6.8 Notices. As soon as practicable, but in no event later than five (5) business days after Borrower obtains knowledge thereof, give notice to Lender of: (a) the commencement of any uninsured litigation relating to Borrower in which the damages claimed exceed $50,000.00 or relate to the Equipment, the Property or the Improvements or the operation thereof; (b) the commencement of any material arbitration or governmental investigation or proceeding not previously disclosed by Borrower to Lender which has been instituted or, to the knowledge of Borrower, is threatened against Borrower or to which any property of Borrower is subject which, if determined adversely to Borrower, would have a material adverse effect upon Borrower; (c) any adverse development which occurs in any litigation, arbitration or governmental investigation or proceeding previously disclosed by Borrower to Lender which, if determined adversely to Borrower, would have a material adverse effect upon Borrower; or (d) any Default or Event of Default. 6.9 Payment Reserve Account. On the date hereof, establish an account with Lender (the "Payment Reserve Account") in the amount of $50,000.00, which account shall bear interest at a rate not less than the average yield of United States Treasury obligations adjusted to a constant maturity of 30 days as published in the Federal Reserve Board Release H.15 on the first business day of each month. At any time after the occurrence and during the continuation of any Event of Default, Lender may, at any time or from time to time, apply funds in the Payment Reserve Account to cure any Event of Default hereunder, without waiving such Event of Default, or any default, whether or not declared, under any other Loan Document or to the payment of any amounts, in such order as Lender may elect, as shall have become or shall become due and payable by Borrower under this Agreement or any other -9- Loan Document. If Lender so applies funds in the Payment Reserve Account as provided in the preceding sentence, Borrower shall pay to Lender, within ten (10) days after demand therefor, an amount equal to the amount so applied in order to restore the funds in the Payment Reserve Account to $50,000.00. Borrower's failure to restore the funds in the Account to $50,000.00 as provided in this Section 6.9 shall be deemed an Event of Default hereunder and shall entitle Lender to the exercise of all of Lender's rights and remedies under the Loan Documents. No Person, including, without limitation, Borrower, shall have any right to withdraw any of the funds held in the Payment Reserve Account, except that upon payment of all amounts payable by Borrower to Lender under this Agreement or under any other Loan Document, any funds remaining in the Payment Reserve Account shall be returned by Lender to Borrower or paid to whomever may be legally entitled thereto. Notwithstanding the foregoing, provided that there is not then an Event of Default (as defined in the Mortgage) which has occurred and is continuing under the Loan, the amount held by Lender in the Payment Reserve Account will be released by Lender to Borrower upon the earlier of (i) Borrower reporting four consecutive fiscal quarterly periods of pre-tax earnings, (ii) Borrower successfully raises additional capital of a least $7,500,000, or (iii) the last day of the second Loan Year. 6.10 Debt Service Coverage Ratio. Beginning as of Borrower's fiscal quarter ended February 28, 2005, and at all times thereafter during the term of the loan, maintain a Debt Service Coverage Ratio equal to or greater than 1.20:1, which ratio shall be calculated based on Borrower's 10-Q and 10-K Reporting and measured as of the last day of each fiscal quarter of Borrower for the immediately preceding twelve-month period. 6.11. Prepaid Loan Payment. On the date hereof, deposit with Lender a prepaid loan payment in the amount of $28,462.50, which shall be applied to the Loan by Lender on the due date of the final loan payment due under the Loan or upon such earlier prepayment of the Loan by Borrower. ARTICLE VII NEGATIVE COVENANTS OF BORROWER 7. Negative Covenants. Borrower covenants and agrees that for so long as it is indebted to Lender, it will not, without Lender's prior written consent: 7.1 Liens. Create or suffer to exist any mortgage, pledge, lien, security interest or other lien or encumbrance of any kind, of or upon (i) the Equipment or, (ii) the Property or the Improvements, or of or upon the income or profits therefrom, except those encumbrances made in favor of Lender or Commerce Bank. 7.2 Defaults. Default upon or fail to pay any contract or fail to pay any of its debts or obligations as the same mature. -10- 7.3 Leases of the Property. Enter into any oral or written leases of the Equipment or the Property or the Improvements without the prior written consent of Lender. 7.4 Dividends, Distributions, etc. Pay any dividend or make any distribution of assets to shareholders of Borrower or any Affiliate of Borrower. 7.5 Consolidation, Merger, Sale of Assets; etc. Consolidate with or merge into or with any other Person, or sell (other than sales in the ordinary course of business), transfer, lease or otherwise dispose of all or a substantial part of its assets. ARTICLE VIII DEFAULT 8.1 Events of Default. The occurrence of any of the following events shall constitute an "Event of Default": (a) If Borrower (i) fails to pay when due or, if payable on demand, upon demand, any principal of the Note or the Bank Note, or prepayment premium (if applicable), or (ii) fails to pay when due or, if payable on demand, upon demand, any interest on the Note or the Bank Note or fees under this Agreement, and, in the case of a default under this clause such default continues for ten (10) days; or (b) If Borrower defaults in the due performance and observance of any covenants set forth in this Agreement, the Mortgage, or any other Loan Document and such default or breach shall continue for a period of thirty (30) days after written notice thereof to Borrower by Lender; or (c) If any financial statement, certificate, representation, or warranty made by or on behalf of Borrower shall prove to have been incorrect in any material respect or any representation made herein is untrue when made or becomes untrue with the passage of time; or (d) If Borrower (i) becomes insolvent or fails to pay its debts generally as they become due, (ii) suspends business, (iii) makes a general assignment for the benefit of creditors, (iv) admits in writing its inability to pay its debts generally as they mature, (v) files a petition in bankruptcy or a petition or answer seeking liquidation of it or a reorganization, arrangement with creditors or other similar relief under the Federal bankruptcy laws or under any other applicable law of the United States of America or any state thereof, whether now or hereafter in effect, (vi) petitions for or applies to any tribunal for, or consents to the appointment of a trustee, custodian, liquidator, receiver or similar official for it or for a substantial part of its property, (vii) is adjudicated a bankrupt or has an involuntary petition in bankruptcy, or a case commenced against it under the Federal bankruptcy laws, as now or hereafter in effect, and an order for relief entered therein, (viii) takes any action for the purpose of effecting or consenting to any of the foregoing, or (ix) has an order, judgment or -11- decree entered appointing without such entity's consent, a trustee, custodian, liquidator, receiver or similar official for it or for a substantial part of its property, or approving a petition in any such proceeding or approving a petition filed or case commenced against it seeking liquidation of it or a reorganization, arrangement with creditors or other similar relief under the Federal bankruptcy laws or under any other applicable law of the United States of America or any State thereof, whether now or hereafter in effect, which order, judgment or decree shall not be vacated or set aside or stayed within 60 days from the date of entry; or (e) If Borrower fails to pay any Debt (but excluding Debt evidenced by the Note) of the Borrower, or any interest thereon, when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) and such failure shall continue after the applicable grace period, if any, specified in the agreement or instrument relating to such Debt; or any other default under any agreement or instrument relating to any such Debt, or any such Debt shall be declared to be due and payable or required to be prepaid (other than by scheduled required prepayment), prior to the stated maturity thereof; or (f) If judgment for the payment of money in excess of $100,000.00 is entered against Borrower and is not stayed, vacated, bonded, paid, discharged or appealed in good faith within 60 days after the entry thereof; or 8.2 Rights and Remedies. If any Event of Default shall occur and be continuing, Lender may, at its option (in addition to Lender's rights under the Note, the Security Agreement, the Mortgage, or any other Loan Document), exercise any or all of the following rights and remedies: (a) Declare the Note, all interest thereon, and all other obligations under, or pursuant to, any Loan Document to be immediately due and payable, and upon such declaration such Note, interest and other obligations shall immediately be due and payable, without presentment, demand, protest or any notice of any kind, all of which are expressly waived; and/or (b) Exercise any right or remedy specified herein and in the other Loan Documents, including (without limiting the generality of the foregoing) the right to foreclose the Mortgage and/or the Security Agreement or any other right or remedy available to a mortgagee or secured party at law or in equity; and/or (c) Exercise any other right or remedy available to Lender at law, in equity or under statute; and/or (d) Cure the event of default on behalf of Borrower, and, in doing so, may enter upon the Project, and may expend such sums as it may reasonably deem desirable, including attorneys' fees, all of which shall be deemed to be advances hereunder, even though causing the Loan to exceed the face amount of the Note, shall bear interest at the Default Rate (as defined in the Note) and shall be payable by Borrower on demand. -12- ARTICLE IX MISCELLANEOUS 9.1 No Waiver; Cumulative Remedies. No failure or delay on the part of Lender in exercising any right or remedy under, or pursuant to, any Loan Document shall operate as a waiver thereof, nor shall any single or partial exercise of any such right, remedy or power preclude other or further exercise thereof, or the exercise of any other right, remedy or power. The remedies in the Loan Documents are cumulative and are not exclusive of any remedies provided by law. 9.2 Amendments and Waivers. No amendment, change, waiver or modification of this Agreement or any Loan Document shall be valid unless the same is in writing and is signed by Lender, and no waiver by Lender of any breach or default by Borrower of any of its obligations, agreements or covenants under this Agreement or any Loan Document shall be deemed to be a waiver of any subsequent breach of the same, or any other obligation, agreement or covenant, nor shall any forbearance by Lender to seek or enforce a remedy for such breach be deemed a waiver of its rights and remedies with respect to such breach. 9.3 Survival of Representations and Warranties. All representations and warranties contained herein or made in writing by or on behalf of Borrower in connection with the transactions contemplated hereby shall survive the execution and delivery of this Agreement and the advances hereunder. All statements contained in any certificate or other instrument delivered by or on behalf of Borrower pursuant thereto or in connection with the transactions contemplated hereby shall constitute representations and warranties by Borrower. 9.4 Notices. All notices and other communications provided under this Agreement shall be in writing (including telecopier communication) and mailed, telecopied or delivered, if to Borrower, at its address stated in the preamble hereof, Attention: CEO & CFO; and if to Lender, at its address stated in the preamble hereof, Attention: James E. Senske; or, as to each party, at such other address as shall be designated by such party in a written notice to the other party. Any such notice shall be deemed effective (a) upon personal delivery; (b) upon the third business day (as hereinafter defined) after the placing thereof in the United States mail, postage prepaid, certified or registered mail; or (c) upon the business day succeeding the day in which said notice is deposited with a national overnight air carrier, fees prepaid. 9.5 Costs and Expenses. Borrower agrees to pay on demand all reasonable costs, expenses and disbursements of Lender in connection with Borrower's application for the Loan, the preparation of the Loan Documents and closing of the Loan, including reasonable attorneys' fees and legal expenses, as well as all costs and expenses of Lender in connection with Lender's enforcement of the obligations of Borrower hereunder or under the Note or any other Loan Documents, whether or not suit is commenced including, without limitation, reasonable attorneys' fees and legal expenses in connection with any appeal of a lower court's order or judgment. The obligations of Borrower under this Section 9.5 shall survive any termination of this Agreement. 9.6 Right of Set-off. Upon the occurrence and during the continuance of any Event of Default, Lender is hereby authorized at any time, and from time to time, to the fullest extent -13- permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by Lender to or for the credit or the account of Borrower against any and all of the obligations of Borrower, now or hereafter existing under any Loan Document, irrespective of whether or not Lender shall have made any demand under any Loan Document and although such obligations may be unmatured. Lender agrees promptly to notify Borrower after any such set-off and application, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of Lender under this Section 9.6 are in addition to other rights and remedies (including, without limitation, other rights of set-off) that Lender may have. 9.7 Governing Law. This Agreement and all other Loan Documents shall be governed by, interpreted, and construed in accordance with the laws of the State of Minnesota. Any term used in this Agreement and not otherwise defined shall have the definition given that term in the Uniform Commercial Code as in effect in the State of Minnesota from time to time, and such definition automatically shall change on the effective date of any amendment to the Uniform Commercial Code that changes such definition. If any term in this Agreement shall be held to be illegal or unenforceable, the remaining portions of this Agreement shall not be affected, and this Agreement shall be construed and enforced as if this Agreement did not contain the term held to be illegal or unenforceable. The Borrower hereby irrevocably submits to the jurisdiction of the Minnesota District Court, Fourth District, and the Federal District Court, District of Minnesota, Fourth Division, over any action or proceeding arising out of or relating to this Agreement and agrees that all claims in respect of such action or proceeding may be heard and determined in any such court. 9.8 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the successors and assigns of the parties hereto except that Borrower's rights hereunder are not assignable. 9.9 Execution in Counterparts. This Agreement may be executed simultaneously in two or more counterparts, each of which shall be an original, but all of which shall constitute one agreement. 9.10 Headings. Section headings contained in this Agreement are for convenience only and shall not be used in construing any provision of this Agreement. THE BALANCE OF THIS PAGE IS INTENTIONALLY LEFT BLANK -14- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed the date and year first above written. HEI, INC. By: /s/ DOUGLAS NESBIT ---------------------------------------- Its: Chief Financial Officer ----------------------------------- COMMERCE FINANCIAL GROUP, INC. By: /s/ JIM E. SENSKE ---------------------------------------- Its: President ----------------------------------- -15- EX-10.47 18 c81087exv10w47.txt EX-10.47 COMMERCIAL SECURITY AGREEMENT EXHIBIT 10.47 - -------------------------------------------------------------------------------- DEBTOR NAME AND ADDRESS SECURED PARTY NAME AND ADDRESS HEI, INC. COMMERCE FINANCIAL GROUP, INC. 1495 STEIGER LAKE LANE 7650 EDINBOROUGH WAY, STE 160 VICTORIA, MN 55386 EDINA, MN 55435 41-0944876 Type: [ ] individual [ ] partnership [X] corporation [ ] ----------------- State of organization/registration (if applicable) MN ---- [ ] If checked, refer to addendum for additional Debtors and signatures. - -------------------------------------------------------------------------------- COMMERCIAL SECURITY AGREEMENT The date of this Commercial Security Agreement (Agreement) is 10-28-2003. SECURED DEBTS. This Agreement will secure all sums advanced by Secured Party under the terms of this Agreement and the payment and performance of the following described Secured Debts that (check one) [X] Debtor [ ] (Borrower) owes to Secured Party: [ ] Specific Debts. The following debts and all extensions, renewals, refinancing, modifications, and replacements (describe): [X] All Debts. All present and future debts, even if this Agreement is not referenced, the debts are also secured by other collateral, or the future debt is unrelated to or of a different type than the current debt. Nothing in this Agreement is a commitment to make future loans or advances. SECURITY INTEREST. To secure the payment and performance of the Secured Debts, Debtor gives Secured Party a security interest in all of the Property described in this Agreement that Debtor owns or has sufficient rights in which to transfer an interest, now or in the future, wherever the Property is or will be located, and all proceeds and products of the Property. "Property" includes all parts, accessories, repairs, replacements, improvements, and accessions to the Property; any original evidence of title or ownership; and all obligations that support the payment or performance of the Property. "Proceeds" includes anything acquired upon the sale, lease, license, exchange, or other disposition of the Property; any rights and claims arising from the Property; and any collections and distributions on account of the Property. This Agreement remains in effect until terminated in writing, even if the Secured Debts are paid and Secured Party is no longer obligated to advance funds to Debtor or Borrower. PROPERTY DESCRIPTION. The Property is described as follows: [ ] ACCOUNTS AND OTHER RIGHTS TO PAYMENT: All rights to payment, whether or not earned by performance, including, but not limited to, payment for property or services sold, leased, rented, licensed, or assigned. This includes any rights and interests (including all liens) which Debtor may have by law or agreement against any account debtor or obligor of Debtor. [ ] INVENTORY: All inventory held for ultimate sale or lease, or which has been or will be supplied under contracts of service, or which are raw materials, work in process, or materials used or consumed in Debtor's business. [ ] EQUIPMENT: All equipment including, but not limited to, machinery, vehicles, furniture, fixtures, manufacturing equipment, farm machinery and equipment, shop equipment, office and record keeping equipment, parts, and tools. The Property includes any equipment described in a list or schedule Debtor gives to Secured Party, but such a list is not necessary to create a valid security interest in all of Debtor's equipment. [ ] INSTRUMENTS AND CHATTEL PAPER: All instruments, including negotiable instruments and promissory notes and any other writings or records that evidence the right to payment of a monetary obligation, and tangible and electronic chattel paper. [ ] GENERAL INTANGIBLES: All general intangibles including, but not limited to, tax refunds, patents and applications for patents, copyrights, trademarks, trade secrets, goodwill, trade names, customer lists, permits and franchises, payment intangibles, computer programs and all supporting information provided in Collection with a transaction relating to computer programs, and the right to use Debtor's name. [ ] DOCUMENTS: All documents of title including, but not limited to, bills of lading, dock warrants and receipts, and warehouse receipts. [ ] FARM PRODUCTS AND SUPPLIES: All farm products including, but not limited to, all poultry and livestock and their young, along with their produce, products, and replacements; all crops, annual or perennial, and all products of the crops; and all feed, seed, fertilizer, medicines, and other supplies used or produced in Debtor's farming operations. [ ] GOVERNMENT PAYMENTS AND PROGRAMS: All payments, accounts, general intangibles, and benefits including, but not limited to, payments in kind, deficiency payments, letters of entitlement, warehouse receipts, storage payments, emergency assistance and diversion payments, production flexibility contracts, and conservation reserve payments under any preexisting, current, or future federal or state government program. [ ] INVESTMENT PROPERTY: All investment property including, but not limited to, certificated securities, uncertificated securities, securities entitlements, securities accounts, commodity contracts, commodity accounts, and financial assets. [ ] DEPOSIT ACCOUNTS: All deposit accounts including, but not limited to, demand, time, savings, passbook, and similar accounts. [X] SPECIFIC PROPERTY DESCRIPTION: The Property includes, but is not limited by, the following (if required, provide real estate description): ALL EQUIPMENT OF DEBTOR WHETHER NOW OR HEREAFTER LOCATED AT HEI, INC., HIGH DENSITY INTERCONNECT DIVISION, 610 S. ROCKFORD DR, TEMPE, AZ 85281. DEBTOR REPRESENTS THAT THE EQUIPMENT LOCATED AT THE ABOVE ADDRESS IS DESCRIBED ON ATTACHED EXHIBIT A. USE OF PROPERTY. The Property will be used for [ ] personal [X] business [ ] agricultural [ ] purposes. - -------------------------------------------------------------------------------- SIGNATURES. Debtor agrees to the terms on pages 1 and 2 of this Agreement and acknowledges receipt of a copy of this Agreement. DEBTOR SECURED PARTY HEI, INC. COMMERCE FINANCIAL GROUP, INC. /s/ Doug Nesbit /s/ James Senske - --------------------------------------- ------------------------------------ DOUG NESBIT JAMES SENSKE CHIEF FINANCIAL OFFICER PRESIDENT - -------------------------------------------------------------------------------- GENERAL PROVISIONS. Each Debtor's obligations under this Agreement are independent of the obligations of any other Debtor. Secured Party may sue each Debtor individually or together with any other Debtor. Secured Party may release any part of the Property and Debtor will remain obligated under this Agreement. The duties and benefits of this Agreement will bind the successors and assigns of Debtor and Secured Party. No modification of this Agreement is effective unless made in writing and signed by Debtor and Secured Party. Whenever used, the plural includes the singular and the singular includes the plural. Time is of the essence. APPLICABLE LAW. This Agreement is governed by the laws of the state in which Secured Party is located. In the event of a dispute, the exclusive forum, venue, and place of jurisdiction will be the state in which Secured Party is located, unless otherwise required by law. If any provision of this Agreement is unenforceable by law, the unenforceable provision will be severed and the remaining provisions will still be enforceable. NAME AND LOCATION. Debtor's name indicated on page 1 is Debtor's exact legal name. If Debtor is an individual, Debtor's address is Debtor's principal residence. If Debtor is not an individual, Debtor's address is the location of Debtor's chief executive offices or sole place of business. If Debtor is an entity organized and registered under state law, Debtor has provided Debtor's state of registration on page 1. Debtor will provide verification of registration and location upon Secured Party's request. Debtor will provide Secured Party with at least 30 days notice prior to any change in Debtor's name, address, or state of organization or registration. WARRANTIES AND REPRESENTATIONS. Debtor has the right, authority, and power to enter into this Agreement. The execution and delivery of this Agreement will not violate any agreement governing Debtor or Debtor's property, or to which Debtor is a party. Debtor makes the following warranties and representations which continue as long as this Agreement is in effect: (1) Debtor is duly organized and validly existing in all jurisdictions in which Debtor does business; (2) the execution and performance of the terms of this Agreement have been duly authorized, have received all necessary governmental approval, and will not violate any provision of law or order; (3) other than previously disclosed to Secured Party, Debtor has not changed Debtor's name or principal place of business within the last 10 years and has not used any other trade or fictitious name; and (4) Debtor does not and will not use any other name without Secured Party's prior written consent. Debtor owns all of the Property, and Secured Party's claim to the Property is ahead of the claims of any other creditor, except as otherwise agreed and disclosed to Secured Party prior to any advance on tile Secured Debts. The Property has not been used for any purpose that would violate any laws or subject the Property to forfeiture or seizure. DUTIES TOWARD PROPERTY. Debtor will protect the Property, and Secured Party's interest against any competing claim. Except as otherwise agreed, Debtor will keep the Property in Debtor's possession at the address indicated on page 1 of this Agreement. Debtor will keep the Property in good repair and use the Property only for purposes specified on page 1. Debtor will not use the Property in violation of any law and will pay all taxes and assessments levied or assessed against the Property. Secured Party has the right of reasonable access to inspect the Property, including the right to require Debtor to assemble and make the Property available to Secured Party. Debtor will immediately notify Secured Party of any loss or damage to the Property. Debtor will prepare and keep books, records, and accounts about the Property and Debtor's business, to which Debtor will allow Secured Party reasonable access. Debtor will not sell, offer to sell, license, lease, or otherwise transfer or encumber the Property without Secured Party's prior written consent. Any disposition of the Property will violate Secured Party's rights, unless the Property is inventory sold in the ordinary course of business at fair market value. If the Property includes chattel paper or instruments, either as original collateral or as proceeds of the Property, Debtor will record Secured Party's interest on the face of the chattel paper or instruments. If the Property includes accounts, Debtor will not settle any account for less than the full value, dispose of the accounts by assignment, or make any material change in the terms of any account without Secured Party's prior written consent. Debtor will collect all accounts in the ordinary course of business, unless otherwise required by Secured Party. Debtor will keep the proceeds of the accounts, and any goods returned to Debtor, in trust for Secured Party and will not commingle the proceeds or returned goods with any of Debtor's other property. Secured Party has the right to require Debtor to pay Secured Party the full price on any returned items. Secured Party may require account debtors to make payments under the accounts directly to Secured Party. Debtor will deliver the accounts to Secured Party at Secured Party's request. Debtor will give Secured Party all statements, reports, certificates, lists of account debtors (showing names, addresses, and amounts owing), invoices applicable to each account, and any other data pertaining to the accounts as Secured Party requests. If the Property includes farm products, Debtor will provide Secured Party with a list of the buyers, commission merchants, and selling agents to or through whom Debtor may sell the farm products. Debtor authorizes Secured Party to notify any additional parties regarding Secured Party's interest in Debtor's farm products, unless prohibited by law. Debtor agrees to plant, cultivate, and harvest crops in due season. Debtor will be in default if any loan proceeds are used for a purpose that will contribute to excessive erosion of highly erodible land or to the conversion of wetland to produce or to make possible the production of an agricultural commodity, further explained in 7 CPR Part 1940, Subpart G, Exhibit M. If Debtor pledges the Property to Secured Party (delivers the Property into the possession or control of Secured Party or a designated third party), Debtor will, upon receipt, deliver any proceeds and products of the Property to Secured Party. Debtor will provide Secured Party with any notices, documents, financial statements, reports, and other information relating to the Property Debtor receives as the owner of the Property. PERFECTION OF SECURITY INTEREST. Debtor authorizes Secured Party to file a financing statement covering the Property. Debtor will comply with, facilitate, and otherwise assist Secured Party in connection with obtaining possession or control over the Property for purposes of perfecting Secured Party's interest under the Uniform Commercial Code. INSURANCE. Debtor agrees to keep the Property insured against the risks reasonably associated with the Property until the Property is released from this Agreement. Debtor will maintain this insurance in the amounts Secured Party reasonably requires. Debtor may choose the insurance company, subject to Secured Party's approval, which will not be unreasonably withheld. Debtor will have the insurance provider name Secured Party as loss payee on the insurance policy. Debtor will give Secured Party and the insurance provider immediate notice of any loss. Secured Party may apply the insurance proceeds toward the Secured Debts. Secured Party may require additional security as a condition of permitting any insurance proceeds to be used to repair, or replace the Property. If Secured Party acquires the Property in damaged condition, Debtor's rights to any insurance policies and proceeds will pass to Secured Party to the extent of the Secured Debts. Debtor will immediately notify Secured Party of the cancellation or termination of insurance. If Debtor fails to keep the Property insured, or fails to provide Secured Party with proof of insurance, Secured Party may obtain insurance to protect Secured Party's interest in the Property. The insurance may include coverages not originally required of Debtor, may be written by a company other than one Debtor would choose, and may be written at a higher rate than Debtor could obtain if Debtor purchased the insurance. AUTHORITY TO PERFORM. If Debtor fails to perform any of Debtor's duties under this Agreement, Secured Party is authorized, without notice to Debtor, to perform the duties or cause them to be performed. These authorizations include, but are not limited to, permission to pay for the repair, maintenance, and preservation of the Property and take any action to realize the value of the Property. Secured Party's authority to perform for Debtor does not create an obligation to perform, and Secured Party's failure to perform will not preclude Secured Party from exercising any other rights under the law or this Agreement. If Secured Party performs for Debtor, Secured Party will use reasonable care. Reasonable care will not include any steps necessary to preserve rights against prior parties or any duty to take action in connection with the management of the Property. If Secured Party comes into possession of the Property, Secured Party will preserve and protect the Property to the extent required by law. Secured Party's duty of care with respect to the Property will be satisfied if Secured Party exercises reasonable care in the safekeeping of the Property or to the selection of a third party in possession of the Property. Secured Party may enforce the obligations of an account debtor or other person obligated on the Property. Secured Party may exercise Debtor's rights with respect to the account debtor's or other person's obligations to make payment or otherwise render performance to Debtor, and enforce any security interest that secures such obligations. PURCHASE MONEY SECURITY INTEREST. If the Property includes items purchased with the Secured Debts, the Property purchased with the Secured Debts will remain subject to Secured Party's security interest until the Secured Debts are paid in full. Payments on any non-purchase money loan also secured by this Agreement will not be applied to the purchase money loan. Payments on the purchase money loan will be applied first to the non-purchase money portion of the loan, if any, and then to the purchase money portion in the order in which the purchase money Property was acquired. If the purchase money Property was acquired at the same time, payments will be applied in the order Secured Party selects. No security interest will be terminated by application of this formula. DEFAULT. Debtor will be in default if: (1) Debtor (or Borrower, if not the same) fails to make a payment in full when due; (2) Debtor fails to perform any condition or keep any covenant on this or any debt or agreement Debtor has with Secured Party; (3) a default occurs under the terms of any instrument or agreement evidencing or pertaining to the Secured Debts; REMEDIES. After Debtor defaults, and after Secured Party gives any legally required notice and opportunity to cure the default, Secured Party may at Secured Party's option do any, one or more of the following: (1) make all or any part of the Secured Debts immediately due and accrue interest at the highest post-majority interest rate; (2) require Debtor to gather the Property and make it available to Secured Party in a reasonable fashion; (3) enter upon Debtor's premises and take possession of all or any part of Debtor's property for purposes of preserving the Property or its value and use and operate Debtor's property to protect Secured Party's interest, all without payment or compensation to Debtor; (4) use any remedy allowed by state or federal law, or provided in any agreement evidencing or pertaining to the Secured Debts. If Secured Party repossesses the Property or enforces the obligations of an account debtor, Secured Party may keep or dispose of the Property as provided by law. Secured Party will apply the proceeds of any collection or disposition first to Secured Party's expenses of enforcement, which includes reasonable attorneys' fees and legal expenses to the extent not prohibited by law, and then to the Secured Debts. Debtor (or Borrower, if not the same) will be liable for the deficiency, if any. By choosing anyone or more of these remedies, Secured Party does not give up the right to use any other remedy. Secured Party does not waive a default by not using a remedy. WAIVER. Debtor waives, all claims for damages caused by Secured Party's acts or omissions where Secured Party acts in good faith. NOTICE AND ADDITIONAL DOCUMENTS. Where notice is required, Debtor agrees that 10 days prior written notice will be reasonable notice to Debtor under the Uniform Commercial Code. Notice to one party is notice to all parties. Debtor agrees to sign, deliver, and file any additional documents and certifications Secured Party considers necessary to perfect, continue, or preserve Debtor's obligations under this Agreement and to confirm Secured Party's lien status on the Property. EX-10.48 19 c81087exv10w48.txt EX-10.48 COMBINATION MORTGAGE, SECRUITY AGREEMENT EXHIBIT 10.48 NOTWITHSTANDING ANYTHING TO THE CONTRARY HEREIN, ENFORCEMENT OF THE MORTGAGES IS LIMITED TO A DEBT AMOUNT OF $1,000,000.00 UNDER CHAPTER 287 OF MINNESOTA STATUTES. COMBINATION MORTGAGE, SECURITY AGREEMENT, ASSIGNMENT OF RENTS AND FIXTURE FINANCING STATEMENT THIS COMBINATION MORTGAGE, SECURITY AGREEMENT, ASSIGNMENT OF RENTS AND FIXTURE FINANCING STATEMENT dated as of October 28, 2003 (the "Mortgage"), by and between HEI, INC. a Minnesota corporation, whose address is 1495 Steiger Lake Lane, Victoria, MN 55386 (the "Mortgagor"), and COMMERCE FINANCIAL GROUP, INC., a Minnesota state banking corporation, whose address is 7650 Edinborough Way, Suite 160, Edina, MN 55435 (the "Mortgagee"); WITNESSETH: WHEREAS, Mortgagor is justly indebted to Mortgagee in the principal amount of One Million One Hundred Fifty Thousand and No/100ths Dollars ($1,150,000.00) as evidenced by a certain promissory note in said amount made by Mortgagor payable to the order of Mortgagee dated of even date herewith (the "Note"), which Note shall mature on or before SEPTEMBER 28, 2007, and the principal of which Note bears interest as provided therein, which Note is fully incorporated herein by reference; WHEREAS, the total principal amount of the Note is to be advanced pursuant to the terms and conditions of a certain Term Loan Agreement dated of even date herewith by and between Mortgagor, as borrower Mortgagee as lender (the "Loan Agreement"), which Loan Agreement is fully incorporated herein by reference (capitalized terms used herein and not otherwise defined shall have the meaning ascribed to them in the Loan Agreement); WHEREAS, Mortgagor has agreed to mortgage and grant a security interest in the Mortgaged Property, as herein defined, to secure payment of the Note and its obligations under the Loan Agreement, and this Mortgage; -1- NOW, THEREFORE, in consideration of One Dollar ($1.00) and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and to secure the due and punctual payment of the principal, prepayment premium (if applicable) and interest on the Note, as it may be extended, amended or renewed, all other sums due and owing on the Note and the Loan Agreement, and the payment of all fees, sums, expenses and advances of Mortgagee made in accordance with the terms of this Mortgage, with interest thereon at the rate equal to that specified in Note (collectively called the "Indebtedness"), Mortgagor does hereby grant, bargain, sell, convey, release, mortgage and warrant, grant a security interest in and pledge unto Mortgagee, its successors and assigns, forever, the following: A. LAND AND IMPROVEMENTS All of its right, title and interest in and to (i) the tracts, parcels and interests in land, and any street or alleys adjoining said premises heretofore or hereafter vacated, lying and being in the County of Carver, State of Minnesota, as legally described on Exhibit A hereto and made a part hereof (the "Land"); (ii) all of the buildings, including, without limitation, the existing building, structures, fixtures, annexations and other improvements now standing or at any time hereafter constructed or placed upon the Land (the "Improvements"); (iii) all extensions, additions, improvements, betterments, renewals and replacements of any of the foregoing; and (iv) all hereditaments, easements, rights, privileges and appurtenances now or hereafter belonging, attached or in any way pertaining to the Land or to any of the Improvements; and B. PERSONAL PROPERTY All property now or hereafter affixed or attached to or incorporated upon the Land or the Improvements which is now or hereafter owned by Mortgagor or in which Mortgagor now or hereafter has an interest, which to the fullest extent permitted by law, shall be deemed fixtures and a part of the real property (the "Personal Property"), including but not limited to (i) all building materials, supplies and equipment now or hereafter located on the Land and suitable or intended to be incorporated in any building, structure or other improvement located or to be erected on the Land; (ii) all heating, plumbing and lighting apparatus, screens, awnings, floor coverings, shrubbery, plants, landscaping, motors, engines, machinery, elevators, electrical equipment, incinerator apparatus, air conditioning equipment, water and gas apparatus, pipes, boilers, furnaces, cleaning, communication and sprinkler systems, faucets, fire extinguishing apparatus and equipment, and all other fixtures of every description which are now or may hereafter be placed or used upon the Land or in any building, structure or other improvement now or hereafter located thereon; and (iii) all additions, accessions, increases, parts, fittings, accessories, replacements, substitutions, betterments, repairs, products and proceeds to and of any and all such Personal Property (but excluding therefrom the inventory and removable personal property of the Mortgagor or any tenant of the Land or the Improvements). TO HAVE AND TO HOLD the Land, Improvements and Personal Property (collectively called the "Property" or the "Mortgaged Property"), together with all privileges, hereditaments and appurtenances thereunto now or hereafter belonging, or in any wise appertaining, and the proceeds thereof, unto Mortgagee, forever; -2- PROVIDED, NEVERTHELESS, that these presents are upon the express condition that if Mortgagor shall pay or cause to be paid the Indebtedness, and if Mortgagor shall duly and punctually perform and observe all of the terms, covenants, agreements and conditions contained in this Mortgage, the Loan Agreement, and the Note, then this Mortgage and the estate, right and interest of Mortgagee in and to the Mortgaged Property shall cease and be and become void and of no force and effect, and shall be satisfied at Mortgagor's expense; otherwise this Mortgage shall remain in full force and effect. Mortgagor and Mortgagee further agree as follows: ARTICLE I GENERAL COVENANTS, AGREEMENTS AND WARRANTIES Section 1.01. Warranty of Title; Permitted Encumbrances. Mortgagor covenants, represents and warrants that (a) it is the lawful owner of and has good right and lawful authority to grant, bargain, sell, convey, release, mortgage, grant a security interest in, and pledge the Mortgaged Property as provided herein, (b) it is and will continue to be well and truly seized of good and marketable title to the Mortgaged Property, (c) the Mortgaged Property is and will remain throughout the term of this Mortgage free and clear of all mortgages, liens, pledges, charges and encumbrances, excepting only the lien of this Mortgage and such Permitted Encumbrances as are listed on Exhibit B attached hereto and made a part hereof, and (d) Mortgagor warrants and will defend the title to the Mortgaged Property against all claims and demands whatsoever not specifically excepted herein. Section 1.02. Payment of Indebtedness; Observance of Terms and Covenants. Mortgagor shall duly and punctually (a) pay each and every installment of principal and interest on the Note and all other portions of the Indebtedness, as and when the same shall become due, and (b) perform and observe all of the terms, covenants, agreements and conditions contained in this Mortgage, the Loan Agreement and the Note and all other documents and instruments given as security for the payment of the Note. Section 1.03. Validity; Enforceable Obligations. Mortgagor covenants, represents and warrants that (a) the Note, this Mortgage, the Loan Agreement, and all other documents and instruments executed and delivered by it in connection with the execution and delivery of the Note have been duly executed and delivered and are valid and enforceable obligations of Mortgagor in accordance with the terms thereof and hereof, and (b) this Mortgage does not, nor does the Note, nor does the Loan Agreement, nor does the performance or observance by Mortgagor of any of the matters or things in this Mortgage or the Loan Agreement provided for, contravene any covenant in any indenture or agreement affecting Mortgagor or any of its properties. Section 1.04. Additional Assurances. Mortgagor shall (a) do, execute, acknowledge and deliver all and every further act, deed, conveyance, transfer and assurance reasonably necessary or proper for the carrying out more effectively of the purpose of this Mortgage and the Loan Agreement and, without limiting the foregoing, for conveying, mortgaging, assigning, and confirming unto Mortgagee all of the Mortgaged Property or property intended so to be, whether now owned or hereafter acquired, including without limitation the preparation, execution and filing of any documents, such as financing statements and continuation statements, deemed advisable by -3- Mortgagee for maintaining its lien on any part of the Mortgaged Property, and (b) pay any and all recording fees, filing fees, mortgage registry tax, stamp taxes or other charges arising out of or incident to the filing or recording of this Mortgage, such further assurances and instruments and the issuance and delivery of the Note. Section 1.05. Maintenance and Repairs. Mortgagor shall (a) cause the Mortgaged Property and every part thereof to be maintained, preserved and kept in safe and good repair, working order and condition, and will comply with all laws and regulations of any governmental authority with reference to the Mortgaged Property and the manner of using or operating the same, and with all restrictive covenants, if any, affecting the title to the Mortgaged Property, or any part thereof, (b) from time to time make all necessary and proper repairs, renewals, replacements, additions and betterments to the Mortgaged Property and every part thereof so that the value and efficient use thereof shall be fully preserved and maintained and so that all laws and regulations as aforesaid shall be complied with, and (c) promptly repair and restore the Mortgaged Property and every part thereof which may become damaged or destroyed by fire, casualty or otherwise to their condition prior to any such damage or destruction. Section 1.06. Removal of Mortgaged Property. Mortgagor shall not without the prior written consent of Mortgagee (a) remove the Improvements or Personal Property or any part thereof from the Land, except that as long as no Event of Default, as herein defined, shall occur and be continuing, Mortgagor may remove and dispose of any item or items of Personal Property which have become inadequate, obsolete or worn out, provided Mortgagor immediately replaces said item or items of Personal Property with like property such that the value of the Mortgaged Property will not be materially diminished, which shall become a part of the Mortgaged Property and subject to the lien of this Mortgage, (b) demolish, alter or modify the Improvements or Personal Property or any part thereof nor construct additional improvements on the Land, or (c) abandon or vacate the Mortgaged Property or any part thereof. Section 1.07. Payment of Operating Costs, Prior Mortgages and Liens. Mortgagor shall pay all operating costs and expenses of the Mortgaged Property and keep the same free from mechanics', materialmen's and other liens, levy, execution or attachment. Mortgagor shall also pay when due all indebtedness which may be secured by any mortgage, lien or charge on the Mortgaged Property superior to or equal to the lien of this Mortgage, and upon request exhibit to Mortgagee satisfactory evidence of such payment and discharge. Section 1.08. Payment of Taxes. Mortgagor shall (a) pay when due and before any penalty attaches thereto all taxes, assessments, water charges, sewer charges, and other fees, taxes, charges and assessments of every kind and nature whatsoever assessed or charged against or constituting a lien on the Mortgaged Property or any interest therein, upon or against the Note or the Indebtedness or upon or against the interest of Mortgagee in the Mortgaged Property or in the Note or Indebtedness (the "Taxes"), and (b) upon demand furnish to Mortgagee proof of the payment of any such Taxes. In the event of a court decree or an enactment after the date hereof by any legislative authority of any law imposing upon a mortgagee the payment of the whole or any part of the Taxes herein required to be paid by Mortgagor, or changing in any way the laws relating to the taxation of mortgages or debts secured by mortgages or a mortgagee's interest in mortgaged premises, so as to impose such Tax on Mortgagee or on the interest of Mortgagee in the Mortgaged Property, then, in any such event, Mortgagor agrees that it shall bear and pay the full amount of such Tax. -4- Section 1.09. Contest of Taxes and Liens. Notwithstanding any other provision of this Mortgage to the contrary, Mortgagor will not be required to pay, discharge or remove any Tax, or any lien against the Mortgaged Property or any part thereof, including a mechanic's lien (a "Lien") so long as Mortgagor shall in good faith contest the same or the validity thereof by appropriate legal proceedings which shall operate to prevent the collection of the Tax or Lien so contested and the sale of the Mortgaged Property, or any part thereof, to satisfy the same, provided that Mortgagor shall, prior to the date such Tax or Lien is due and payable, have given to Mortgagee cash or provided such other reasonable security as may be required by Mortgagee to insure such payment and interest and penalties thereon and prevent any sale or forfeiture of the Mortgaged Property by reason of such nonpayment. Any such contest shall be prosecuted with due diligence and Mortgagor shall promptly after final determination thereof pay the amount of any such Tax or Lien so determined, together with all interest and penalties thereon, which may be payable in connection therewith. Notwithstanding the provisions of this Section, Mortgagor shall (and if Mortgagor shall fail so to do, Mortgagee may, but shall not be required to) pay any such Tax or Lien notwithstanding such contest if in the reasonable opinion of Mortgagee the Mortgaged Property, or any part thereof, shall be in jeopardy or in danger of being forfeited or foreclosed. Section 1.10. Protection of Security. Mortgagor shall promptly notify Mortgagee of and appear in and defend any suit, action or proceeding that affects the Mortgaged Property, the Indebtedness or the rights or interest of Mortgagee hereunder. Mortgagee may elect to appear in or defend any such action or proceeding and Mortgagor agrees to indemnify and reimburse Mortgagee from any and all loss, damage, expense or cost arising out of or incurred in connection with any such suit, action or proceeding, including without limitation, all reasonable sums paid by Mortgagee to establish or defend the rights and lien of this Mortgage or to protect the Mortgaged Property or any part thereof, including costs of evidence of title and reasonable attorneys fees, which amounts shall be paid by Mortgagor to Mortgagee upon demand together with interest thereon from the date of payment by Mortgagee at the rate equal to that specified in the Note. Section 1.11. Prohibition of Sale, Lease and Mortgage. In the event: (a) Mortgagor sells, leases, conveys, transfers, assigns, further mortgages or encumbers or disposes of the Mortgaged Property or any part thereof, or any interest therein, or agrees to do so, or except as otherwise provided in Section 1.06 hereof; or (b) the Mortgaged Property, or any material part thereof, is condemned or the use or control thereof is taken in any proceedings involving the right of eminent domain; whether occurring by voluntary or involuntary act or by operation of law or otherwise, without the written consent of the Mortgagee being first obtained, then at the sole option of the Mortgagee, Mortgagee may declare an Event of Default to have occurred under this Mortgage, thereby entitling Mortgagee to exercise any and all rights and remedies available to it as provided in this Mortgage upon the occurrence of an Event of Default. In the event Mortgagor shall request the consent of Mortgagee in accordance with this Section 1.11, Mortgagor shall deliver a written request to Mortgagee together with complete information regarding such a conveyance, lease or encumbrance and shall allow Mortgagee 30 days from the date of receipt thereof for evaluation of such request. Such approval may be subject to such other modifications of the loan terms as may be deemed -5- necessary by Mortgagee. Consent as to any one transaction shall not be deemed to be a waiver of the right to require consent to future or successive transactions. Section 1.12. Loan Agreement. This Mortgage is the Mortgage referred to in and is also given as security for the due and punctual performance, observance and payment by Mortgagor of the terms and conditions set forth in the Loan Agreement and the Note. In the event Mortgagor fails to comply with any of such terms and conditions, such failure shall be an Event of Default under this Mortgage entitling Mortgagee to exercise any and all remedies available to it as provided in this Mortgage upon the occurrence of an Event of Default. In addition, Mortgagee may, but shall not be required to, avail itself of any or all of the rights and remedies available to it under the Loan Agreement, and any sums expended by Mortgagee in availing itself of such rights and remedies shall bear interest thereon from the date of such expenditures at the rate equal to that specified in the Note, shall constitute a portion of the Indebtedness secured hereby, and shall be payable to Mortgagee immediately upon demand, provided that, no such payment by Mortgagee shall be considered as waiving the Event of Default. ARTICLE II INSURANCE AND ESCROWS Section 2.01. Insurance. Mortgagor shall procure and keep in full force and effect during the term of this Mortgage, at its sole cost and expense, the following: (a) insurance covering the Mortgaged Property against all risks of loss or damage to the Mortgaged Property, including but not limited to loss or damage caused by fire and extended coverage perils, including the cost of debris removal, together with vandalism, malicious mischief, sprinkler leakage, and agreed amount endorsements, all in amounts of not less than the full replacement cost of the Improvements and Personal Property; (b) to the extent pressure fired boilers are located on the Mortgaged Property, insurance covering the Mortgaged Property against loss or damage by explosion, and providing for full repair and full replacement cost coverage; (c) such other insurance covering the Mortgaged Property against loss or damage by other casualties and contingencies as Mortgagee may from time to time reasonably require, all in such manner and for such amounts as may be satisfactory to Mortgagee; (d) flood insurance in the maximum amount obtainable, unless evidence is provided that the Mortgaged Property is not within a flood plain as defined by the Federal Insurance Administration; (e) use and occupancy insurance covering risk of loss due to the occurrence of any hazards described in the foregoing Subsections (a), (b), (c) and (d) in an amount equal to guaranteed income from the Mortgaged Property for a period of nine (9) months and based upon a reasonable estimate of annual income from Mortgagor's use of the Mortgaged Property; and -6- (f) comprehensive general public liability insurance covering the liability of Mortgagor for claims for bodily injury, death or property damage occurring on, in or about the Mortgaged Property in amounts not less than Two Million Dollars ($2,000,000) per occurrence for bodily injury and Five Hundred Thousand Dollars ($500,000) per occurrence for property damage or such greater amounts as shall, from time to time, be required by Mortgagee. The policy or policies of such insurance shall (i) be written on forms and with insurance companies satisfactory to Mortgagee, (ii) as to property insurance, contain agreed amount endorsements for not less than the full replacement cost of the Improvements and Personal Property, (iii) as to liability insurance, name as the insured parties Mortgagor and Mortgagee as their interests may appear, (iv) bear a mortgagee clause in favor of Mortgagee in form satisfactory to Mortgagee, all with loss proceeds under such policies to be made payable to Mortgagee; and (v) be in such amounts as Mortgagee from time to time may require. All policies of insurance shall specifically provide that Mortgagee shall receive 30 days prior written notice before cancellation of any such policies. In the event of a foreclosure of this Mortgage or any acquisition of the Mortgaged Property by Mortgagee all such policies and any proceeds payable therefrom, whether payable before or after a foreclosure sale, or during the period of redemption, if any, shall become the absolute property of Mortgagee to be utilized at its discretion. In the event of foreclosure or the failure to obtain and keep any insurance required herein, Mortgagor empowers Mortgagee to effect insurance upon the Mortgaged Property at Mortgagor's expense and for the benefit of Mortgagee in the amounts and types aforesaid for a period of time extending through the time of redemption from foreclosure sale, and if necessary therefore, to cancel any or all existing insurance policies. Mortgagor agrees to furnish Mortgagee copies of all inspection reports and insurance recommendations received by Mortgagor from any insurer. Section 2.02. Escrows. From and after the occurrence of any Event of Default, Mortgagor shall deposit with Mortgagee on the first day of each and every month hereafter, an amount equal to one-twelfth (1/12th) of the annual taxes and assessments (the "Charges") due on or relating to the Mortgaged Property as estimated by Mortgagee. From time to time out of such deposits and to the extent such deposits are sufficient Mortgagee will, upon presentation to Mortgagee by Mortgagor of bills therefor, pay the Charges or will upon presentation of receipted bills therefor, reimburse Mortgagor for such payments made by Mortgagor. In the event (a) the deposits on hand are not sufficient to pay all of the Charges when the same become due from time to time, or (b) Mortgagee estimates that the current monthly deposits are less than the estimated monthly amounts necessary to pay the Charges as they become due from time to time, then Mortgagor shall pay to Mortgagee on demand the amount necessary to make up the deficiency. The excess of any such deposits shall be credited to subsequent payments to be made for such items. If an Event of Default, as herein defined, shall occur under the terms of this Mortgage, the Loan Agreement, or the Note, Mortgagee may, at its option, without being required to do so, apply any deposits on hand to the Indebtedness in such order and manner as Mortgagee may elect. When the Indebtedness has been fully paid any remaining deposits shall be returned to Mortgagor or other person entitled thereto. All deposits are hereby pledged as additional security for the Indebtedness and shall be held for the purposes for which made as herein provided. Such deposits may be held by Mortgagee, or its agent, and shall be held without any allowance of interest thereon and shall not be subject to the decision or control of Mortgagor. The enforceability of the covenants relating to taxes and assessments provided in -7- Section 1.08 hereof and the payment of premiums for insurance provided in Section 2.01 hereof shall not be affected except insofar as those obligations have been met by compliance with this Section. Mortgagee may from time to time, at its option, waive, and after such waiver, reinstate any and all of the provisions contained in this Section. While such waiver is in effect, Mortgagor shall pay taxes and assessments and premiums for insurance as herein provided. ARTICLE III APPLICATION OF INSURANCE AND AWARDS Section 3.01. Damage to or Destruction of the Mortgaged Property. Mortgagor shall give Mortgagee prompt notice of any damage to or destruction of the Mortgaged Property or any part thereof (each such occurrence of damage or destruction shall be known as a separate and distinct "Casualty"), and in case of loss covered by policies of insurance, Mortgagee and Mortgagor jointly shall settle and adjust any claim arising out of such policies and collect and receipt for the proceeds payable therefrom, provided, that Mortgagor may itself adjust and collect for any losses arising out of a single occurrence aggregating not in excess of $25,000. Any expense incurred by Mortgagee in the adjustment and collection of insurance proceeds (including without limitation the cost of any independent appraisal of the loss or damage on behalf of Mortgagee) shall be reimbursed to Mortgagee first out of any proceeds. Section 3.02. Condemnation. Mortgagor shall give Mortgagee prompt notice of any action, actual or threatened, in condemnation or eminent domain and hereby assigns, transfers and sets over to Mortgagee the entire proceeds of any award or claim for damages for all or any part of the Mortgaged Property taken or damaged under the power of eminent domain or condemnation. Mortgagee is hereby authorized to intervene in any such action in the name of Mortgagor, to compromise and settle any such action or claim, and to collect and receive from the condemning authorities and give proper receipts and acquittances for such proceeds. Any expenses incurred by Mortgagee in intervening in such action or compromising and settling such action or claim, or collecting such proceeds shall be reimbursed to Mortgagee first out of the proceeds. Section 3.03. Disbursement of Insurance and Condemnation Proceeds. If (i) in the sole opinion of Mortgagee, the proceeds from any insurance claim or condemnation award received pursuant to Section 3.01 or 3.02 (after payment of expenses as contemplated by such Sections), together with any monies deposited by Mortgagee with Mortgagor for the purposes of restoration or repair as hereinafter set forth are sufficient to repair and restore the Mortgaged Property to substantially the same condition as existed immediately prior to such damage, destruction or condemnation, and (ii) Mortgagor is not then in default under the Note, the Loan Agreement or this Mortgage, and (iii) such repair or restoration shall not result in the creation of any lien or encumbrance on the Mortgaged Property, other than Permitted Encumbrances, and (iv) Mortgagor pays Mortgagee's expenses in connection with the foregoing, and (v) the Casualty occurs at least twelve (12) months prior to the expiration of the Note, then Mortgagor shall have the right to use such proceeds to repair and restore the Mortgaged Property; provided, however, that Mortgagee shall have the right to approve (which approval shall not be unreasonably withheld) the plans for such repair and restoration. In the event that any insurance or condemnation proceeds are so applied to the restoration or repair of the Mortgaged Property, the restoration or repair shall be done under the -8- supervision of an architect acceptable to Mortgagee and pursuant to plans and specifications approved by Mortgagee and subject to such other terms, provisions, requirements, safeguards and disbursement procedures as Mortgagee may require. In such case the proceeds shall be held by Mortgagee for such purposes and will from time to time be disbursed by Mortgagee to defray the costs of such restoration or repair under such safeguards and controls as Mortgagee may require to assure completion in accordance with the approved plans and specifications and free of liens or claims. Any insurance or condemnation proceeds which are not applied to repair or restoration of the Mortgaged Property and any surplus which may remain after payment of all costs of restoration or repair may at the option of Mortgagee be applied to reduction of that portion of the Indebtedness then most remotely to be paid, whether due or not, or returned to Mortgagor or other person entitled thereto, the choice of application to be solely at the discretion of Mortgagee. ARTICLE IV LEASES AND RENTS Section 4.01. Mortgagor to Comply with Leases. Mortgagor shall, at its own cost and expense, (a) perform, comply with and discharge all of the obligations of Mortgagor under any leases or agreements for the use of the Mortgaged Property or any part thereof, (b) use its best efforts to enforce or secure the performance of each obligation and understanding of the respective tenants under any such leases, and (c) appear in and defend, any action or proceeding arising out of or in any manner connected with Mortgagor's interest in any leases of the Mortgaged Property or any part thereof. Mortgagor shall permit neither surrender nor assignment of any tenant's interest under said leases unless the right to assign or surrender is expressly reserved under the lease. Mortgagor shall not anticipate any installment of rent for more than one (1) month in advance of its due date, nor execute any mortgage or create or permit a lien which may be or become superior to any such leases, nor permit a subordination of any lease to such mortgage or lien. Mortgagor shall not modify or amend the terms of any such leases, nor borrow against or pledge the rentals from such neither leases nor exercise or waive any default of the tenant thereunder without the prior written consent of the Mortgagee. Section 4.02. Mortgagee's Right to Perform Under Leases. In the event Mortgagor fails to perform, comply with or discharge any obligations of Mortgagor under any lease or should Mortgagee become aware of or be notified by any tenant under any lease of a failure on the part of Mortgagor to so perform, comply with or discharge its obligations under said lease, Mortgagee may, but shall not be obligated to, and without demand upon Mortgagor, and without waiving or releasing Mortgagor from any obligation contained in this Mortgage, remedy such failure. Mortgagor shall pay to Mortgagee upon demand all sums incurred by Mortgagee in remedying any such failure together with interest from the date of advance by Mortgagee at the rate equal to that as specified in the Note. No such advance shall be deemed to relieve Mortgagor from any default hereunder. Section 4.03. Assignment of Leases and Rents. As additional security for the payment of the Indebtedness, Mortgagor does hereby bargain, sell, assign and transfer unto Mortgagee, its successors and assigns, all of the leases which now or hereafter may affect the Mortgaged Property, or any part thereof, during the term of this Mortgage and all of the rents, profits, and other income of any kind now due and which may hereafter become due under or by virtue of any lease or agreement, whether written or verbal, for the use or occupancy of the Mortgaged Property, or any -9- part thereof, whether presently existing or entered into at any time during the term of this Mortgage, whether before or after foreclosure or during the period of redemption. It is the expressed intention of Mortgagor and Mortgagee to establish an absolute transfer and assignment of all such leases and agreements and all of the rents, profits and other income of any kind from the Mortgaged Property unto Mortgagee, its successors and assigns, and Mortgagor does hereby appoint irrevocably Mortgagee its true and lawful attorney in its name and stead, which appointment is coupled with an interest, to collect all of said rents, profits and other income; provided that, unless and until an Event of Default, as herein defined, occurs under this Mortgage, Mortgagor shall have the right to collect and retain said rents, profits and other income. The assignment of rents shall be effective until the payment of all money secured by this Mortgage, or in the event of foreclosure, until the period of redemption expires. Regardless of the extinguishment of the debt by a foreclosure sale, this benefit shall continue for the benefit of the purchaser at such sale. The entering upon and taking possession of the Mortgaged Property and the collection of such rents, profits and other income shall not cure or waive any defaults under this Mortgage nor in any way operate to prevent Mortgagee from pursuing any other remedy which it may now or hereafter have under the terms of this Mortgage nor shall it in any way be deemed to constitute Mortgagee a mortgagee-in-possession. ARTICLE V UNIFORM COMMERCIAL CODE Section 5.01. Security Agreement; Fixture Filing. This Mortgage shall constitute a security agreement as defined in the Minnesota Uniform Commercial Code and all acts amendatory thereof and any similar or replacement statute hereafter enacted (the "Code"), and as to those items of Personal Property described in this Mortgage that are, or are to become fixtures related to the real estate mortgaged herein, it is intended as to those items that this Mortgage shall be effective as a financing statement filed as a fixture filing from the date of its filing in the real estate records of the County where the Mortgaged Property is situate. A photographic or other reproduction of this Mortgage may also be filed as a financing statement. The name of the record owner of said real estate is the Mortgagor as set forth in page one of this Mortgage. Information concerning the security interest created by this instrument may be obtained from Mortgagee, as secured party, at its address as set forth in page one of this Mortgage. The address of Mortgagor, as debtor, is as set forth in page one of this Mortgage. This document covers goods which are or are to become fixtures and other personal property. ARTICLE VI CERTAIN RIGHTS OF MORTGAGEE Section 6.01 Right to Cure Default. If Mortgagor shall fail to comply with any of the terms, covenants, agreements or conditions of this Mortgage, the Note, the Loan Agreement or the other Loan Documents (as defined in the Loan Agreement), Mortgagee may, but shall not be obligated to, without demand upon Mortgagor, and without waiving or releasing Mortgagor from any obligation in this Mortgage or in the Loan Agreement contained, remedy such failure, and Mortgagor agrees to pay upon demand all sums incurred and the cost of performance by Mortgagee in remedying any such failure together with interest on all such sums and the costs of such performance from the date -10- of such advance and performance at the rate equal to that specified in the Note. All such sums and costs, together with interest as aforesaid, shall constitute a portion of the Indebtedness, but no such advance or performance shall be deemed to relieve Mortgagor from any failure hereunder. Section 6.02 Inspection. Mortgagor shall permit Mortgagee's authorized representatives to enter the Mortgaged Property at all reasonable times for the purpose of inspecting the same; however, Mortgagee shall have no duty to make such inspections and shall not incur any liability or obligation for making or not making any such inspections. Section 6.03 Waivers; Releases; Resort to Other Security. Without affecting the liability of Mortgagor for payment of the Indebtedness or performance of any obligation contained herein, and without affecting the rights of Mortgagee with respect to any security not expressly released in writing, Mortgagee may, at any time, and without notice to or the consent of Mortgagor (a) make any agreement extending the time or otherwise altering the terms of payment of all or any part of the Indebtedness or modifying or waiving any obligation, or subordinating, modifying or otherwise dealing with the lien or charge hereof, (b) accept any additional security, (c) release or otherwise deal with any property, real or personal, including any or all of the Mortgaged Property, including making partial releases of the Mortgaged Property; or (d) resort to any security agreements, pledges, contracts of guarantee, assignments of rents and leases or other securities, and exhaust any one or more of said securities and the security hereunder, either concurrently or independently and in such order as it may determine. Section 6.04 Rights Cumulative. Each right, power or remedy herein conferred upon Mortgagee is cumulative and in addition to every other right, power or remedy, express or implied, now or hereafter arising, available to Mortgagee, at law or in equity, or under the Code, or under any other agreement, and each and every right, power and remedy herein set forth or otherwise so existing may be exercised from time to time as often and in such order as may be deemed expedient by Mortgagee and shall not be a waiver of the right to exercise at any time thereafter any other right, power or remedy. No delay or omission by Mortgagee in the exercise of any right, power or remedy arising hereunder or arising otherwise shall impair any such right, power or remedy or the right of Mortgagee to resort thereto at a later date or be construed to be a waiver of any default or Event of Default, as herein defined, under this Mortgage, the Note, the Loan Agreement or any other Loan Document. Section 6.05 Subsequent Agreements. Any agreement hereafter made by Mortgagor and Mortgagee pursuant to this Mortgage shall be superior to the rights of the holder of any intervening lien or encumbrance. Section 6.06 Waiver of Appraisement, Marshaling. Mortgagor hereby waives to the full extent lawfully allowed the benefit of any appraisement, evaluation, stay and extension laws now or hereinafter in force. Mortgagor hereby waives any rights available with respect to marshaling of assets and Mortgagee shall not be required to separately sell any portion of the Mortgaged Property, and Mortgagee shall not be required to exhaust its remedies against a specific portion of the Mortgaged Property before proceeding against the other. Mortgagor does hereby expressly consent to and authorize the sale of the Mortgaged Property or any part thereof as a single unit or parcel or in such other manner as Mortgagee may determine. -11- ARTICLE VII EVENTS OF DEFAULT AND REMEDIES Section 7.01 Events of Default. An "Event of Default" as defined in the Loan Agreement shall constitute an "Event of Default" under this Mortgage. Section 7.02 Certain Remedies; Acceleration, Prepayment Premium and Foreclosure. If an Event of Default shall occur, Mortgagee may immediately declare the entire unpaid principal balance of the Note together with all other portions of the Indebtedness to be immediately due and payable and thereupon all such unpaid principal balance of the Note together with all accrued interest thereon, prepayment premium and all other portions of the Indebtedness secured hereby shall be and become immediately due and payable. If an Event of Default shall occur, then in every such case Mortgagee may (a) proceed to protect and enforce its rights by a suit or suits in equity or at law, either for the specific performance of any term, covenant, agreement or condition contained herein or in the Note or in the Loan Agreement or in any other Loan Document, or in aid of the execution of any power herein or therein granted for collection of the Note or the Indebtedness or for the foreclosure of this Mortgage, or for the enforcement of any other appropriate legal or equitable remedy, and/or (b) foreclose this Mortgage; and Mortgagor hereby authorizes and fully empowers Mortgagee to foreclose the lien of this Mortgage in the manner prescribed by applicable law, and out of the proceeds arising from sale and foreclosure to retain the principal of the Note and interest on the Note and all other portions of the Indebtedness together with all such sums of money as Mortgagee shall have expended or advanced pursuant to this Mortgage or pursuant to statute together with interest thereon as herein provided and all costs and expenses of such foreclosure, including lawful attorneys' fees, with the balance, if any, to be paid to the persons entitled thereto by law. In case of any sale of the Mortgaged Property, or any part thereof, pursuant to any judgment or decree of any court or otherwise in connection with the enforcement of any of the terms of this Mortgage, Mortgagee may become the purchaser, and for the purpose of making settlement for or payment of the purchase price, shall be entitled to deliver and use the Note and any claims for interest and prepayment premium matured and unpaid thereon, together with all other portions of the Indebtedness, in order that there may be credited as paid on the purchase price the sum then due under the Note, including the principal of the Note and prepayment premium and interest thereof and all other portions of the Indebtedness. Section 7.03 Receiver. If an Event of Default shall occur hereunder, it is further covenanted and agreed that if at any time in the opinion of Mortgagee a receivership may be necessary to protect the Mortgaged Property, whether before or after maturity of the Indebtedness or at the time of or after the institution of suit to collect the Indebtedness, or to enforce this Mortgage, Mortgagee shall, as a matter of strict right and regardless of the value of the mortgage security for the amounts due hereunder or secured hereby, or of the solvency of any party bound for the payment of the Indebtedness, have the right to the appointment on ex parte application, and without notice to anyone, by any Court having jurisdiction, of a receiver to take charge of, manage, preserve, protect, operate the Mortgaged Property and to collect the rents, to make all necessary and needed repairs, and to pay all taxes and assessments against the Mortgaged Property and insurance premiums for insurance thereon and after the payment of the expenses of the receivership and management of the Mortgaged Property to apply the net proceeds in reduction of the Indebtedness hereby secured or in such manner as the Court shall direct. Such receivership shall, at the option of Mortgagee, continue -12- until full payment of all sums hereby secured, or until title to said Mortgaged Property shall have passed by sale under this Mortgage, as further provided in any assignment of rents executed by Mortgagor to Mortgagee (whether contained in this Mortgage or in a separate instrument). Section 7.04 Rights Under Uniform Commercial Code. In addition to the rights available to a mortgagee of real property, Mortgagee shall also have all the rights, remedies and recourse available to a secured party under the Code including the right to proceed under the provisions of the Code governing default as to any Collateral which may be included in the Mortgaged Property or which may be deemed non-realty in a foreclosure of this Mortgage or to proceed as to such Collateral in accordance with the procedures and remedies available pursuant to a foreclosure of real estate. Section 7.05 Right to Discontinue Proceeding. In the event Mortgagee shall have proceeded to invoke any right, remedy or recourse permitted under this Mortgage and shall thereafter elect to discontinue or abandon the same for any reason, Mortgagee shall have the unqualified right to do so and in such event Mortgagor and Mortgagee shall be restored to their former positions with respect to the Indebtedness. This Mortgage, the Mortgaged Property and all rights, remedies and recourse of Mortgagee shall continue as if the same had not been invoked. Section 7.06 Acknowledgment of Waiver of Hearing Before Sale. Mortgagor understands and agrees that if an Event of Default occurs under the terms of this Mortgage, Mortgagee has the right, inter alia, to foreclose this Mortgage by advertisement in accordance with applicable law. Mortgagor further understands that in the event of such default Mortgagee may also elect its rights under the Code and take possession of the Collateral, or any part thereof, and dispose of the same by sale or otherwise in one or more parcels provided that at least ten (10) days' prior notice of such disposition must be given, all as provided for by the Code, as hereafter amended or by any similar or replacement statute hereafter enacted. MORTGAGOR HEREBY RELINQUISHES, WAIVES AND GIVES UP ANY CONSTITUTIONAL RIGHTS IT MAY HAVE TO NOTICE AND HEARING EXCEPT AS PROVIDED HEREIN BEFORE SALE OF THE MORTGAGED PROPERTY AND EXPRESSLY CONSENTS AND AGREES THAT THE MORTGAGED PROPERTY MAY BE FORECLOSED BY ADVERTISEMENT AND THAT THE COLLATERAL MAY BE DISPOSED OR PURSUANT TO THE CODE, ALL AS DESCRIBED ABOVE. MORTGAGOR ACKNOWLEDGES THAT IT IS REPRESENTED BY LEGAL COUNSEL; THAT BEFORE SIGNING THIS DOCUMENT THIS SECTION AND MORTGAGOR'S CONSTITUTIONAL RIGHTS WERE FULLY EXPLAINED BY SUCH COUNSEL AND THAT MORTGAGOR UNDERSTANDS THE NATURE AND EXTENT OF THE RIGHTS WAIVED HEREBY AND THE EFFECT OF SUCH WAIVER. ARTICLE VIII ENVIRONMENTAL PROVISIONS Section 8.01 Environmental Concerns. (a) To the best of Mortgagor's knowledge, after the investigation performed in accordance with the letter attached hereto as Exhibit C and made a part hereof, the Mortgaged Property, has never been used by previous owners and/or operators to refine, produce, store, handle, transfer, process or transport "Hazardous Substances", as such term is defined by -13- applicable federal law, except in compliance with applicable laws, and the Mortgagor has not in the past, nor does Mortgagor intend in the future, to use the Mortgaged Property, for the purpose of refining, producing, storing, handling, transferring, processing or transporting said "Hazardous Substances", except in compliance with applicable laws. (b) Mortgagor has not received a summons, citation, directive, letter or other communication, written or oral, from any applicable governmental agency concerning any intentional or unintentional action or omission on Mortgagor's part resulting in the releasing, spilling, leaking, pumping, pouring, emitting, emptying or dumping of Hazardous Substances into the waters or onto the lands of the State, or into the waters outside the jurisdiction of the State resulting in damage to the lands, waters, fish, shellfish, wildlife, biota, air and other resources owned, managed, held in trust or otherwise controlled by the State. (c) Mortgagor shall operate the Mortgaged Property or cause it to be operated in material compliance with all applicable rules and regulations promulgated by all applicable governmental environmental authorities and agencies. Mortgagor shall have the right in good faith to contest or appeal from such laws, ordinances and regulations and any decision adverse to the Mortgagor based thereon, but all costs, fees and expenses incurred in connection with such proceedings shall be borne by the Mortgagor. (d) Mortgagor shall not cause or permit to exist, as a result of an action or omission on its part, a releasing, spilling, leaking, pumping, emitting, pouring, emptying or dumping of a Hazardous Substance into waters of the State or onto the lands from which it might flow or drain into said waters, or into waters outside the jurisdiction of the State where damage may result to the lands, waters, fish, shellfish, wildlife, biota, air and other resources owned, managed, held in trust or otherwise controlled by the State, unless said release, spill, leak, pumping, emitting, pouring, emptying or dumping is pursuant to and in compliance with the conditions of a permit issued by the appropriate federal or state governmental authorities or other applicable laws. (e) Should Mortgagor cause or permit any action or omission resulting in the releasing, spilling, leaking, pumping, pouring, emitting, emptying or dumping of Hazardous Substances into the waters or onto the lands of the State, or into the waters outside the jurisdiction of the State, resulting in damage to the lands, waters, fish, shellfish, wildlife, biota, air or other resources owned, managed or held in trust or otherwise controlled by the State, without having obtained a permit issued by the appropriate governmental authorities, Mortgagor shall promptly clean up the same in accordance with the provisions of applicable State or Federal law. (f) Notwithstanding anything in this Article VIII to the contrary, Mortgagor may store and use on the Mortgaged Property supplies which are used in the normal course of Mortgagor's business. Mortgagor covenants and agrees that it will use and dispose of all such supplies in compliance with all applicable laws and regulations. -14- ARTICLE IX MISCELLANEOUS Section 9.01 Applicable Law. This Mortgage shall be interpreted, construed and enforced according to the laws of the State of Minnesota. Section 9.02 No Implied Waiver. Any delay by Mortgagee in exercising or any failure by Mortgagee to exercise any right or remedy hereunder or afforded by law shall not be a waiver of nor preclude the exercise of any right or remedy hereunder, whether on such occasion or any future occasion. Section 9.03 Successors and Assigns. This Mortgage and each and every term, covenant, agreement, condition and other provision hereof shall be binding upon Mortgagor and its successors and assigns including without limitation each and every from time to time record owner of the Mortgaged Property or any other person having an interest therein, shall run with the land and shall inure to the benefit of Mortgagee and its successors and assigns. As used herein the words "successors and assigns" shall also be deemed to include the heirs, representatives, administrators and executors of any natural person who is a party to this Mortgage. Section 9.04 Notices. Any notice which any party hereto may desire or may be required to give to any other party shall be in writing and the mailing thereof by certified mail to their respective addresses as set forth in page one of this Mortgage, or to such other places any party hereto may hereafter by notice in writing designate, shall constitute service of notice hereunder. Section 9.05 Captions and Headings. The captions and headings of the various sections of this Mortgage are for convenience only and are not to be construed as confining or limiting in any way the scope or intent of the provisions hereof. Section 9.06 Severability and Survival. The unenforceability or invalidity of any provision or provisions hereof shall not render any other provision or provisions herein contained unenforceable or invalid, and all provisions hereof, in all other respects, shall remain valid and enforceable. IN WITNESS WHEREOF, Mortgagor has caused these presents to be executed as of the date first above written. HEI, INC. By: /s/ DOUGLAS NESBIT --------------------------------- Its: Chief Financial Officer ----------------------------- -15- STATE OF MINNESOTA ) ) ss: COUNTY OF HENNEPIN ) The foregoing instrument was acknowledged before me this 14th day of October, 2003, by Douglas J. Nesbit, the Chief Financial Officer of HEI, Inc., on behalf of the corporation. My Commission expires on January 31, 2005. /s/ MARY JOEL MAKEPEACE ----------------------------- Notary Public This instrument prepared by: COMMERCE FINANCIAL GROUP, INC. 7650 Edinborough Way, Suite 160 Edina, MN 55435 -16- EX-10.49 20 c81087exv10w49.txt EX-10.49 ENVIRONMENTAL INVESTIGATION LETTER EXHIBIT 10.49 ENVIRONMENTAL INVESTIGATION LETTER October 28, 2003 Commerce Financial Group, Inc. 7650 Edinborough Way Suite 160 Edina, MN 55435 Re: 1945 Steiger Lake Lane, Victoria, MN Ladies and Gentlemen: This letter will certify that we have conducted a search of the real estate that is the subject of the above-referenced project in an attempt to determine if there are any environmentally hazardous substances on or about the premises. That search has consisted of engaging Braun Intertech Corporation and obtaining a Phase I Environmental Site Assessment. It is therefore our opinion that to the best of the company's information, knowledge, and belief, there are no pollutants or migrating pollutants on or under the Mortgaged Property and that to the best of our information, knowledge, and belief, no Hazardous Substances have been released into the environment from the Mortgaged Property, and if any such Hazardous Substances exist, HEI, Inc. shall and does hereby agree to fully indemnify and hold harmless Commerce Financial Group, Inc. from any and all losses caused or attributable to any such Hazardous Substances, and the company shall be willing to execute an indemnity agreement specifically relating to such issue substantially the form attached hereto as Exhibit 1. Sincerely, HEI, INC. By: /s/ Douglas J. Nesbit ---------------------------- Its: Chief Financial Officer EX-10.50 21 c81087exv10w50.txt EX-10.50 ASSET PURCHASE AGREEMENT EXHIBIT 10.50 ASSET PURCHASE AGREEMENT DATED OCTOBER 31, 2003 BETWEEN MKS INSTRUMENTS, INC. AND HEI, INC. TABLE OF CONTENTS
Page ARTICLE I THE ASSET PURCHASE..................................................................................1 1.1 Purchase and Sale of Assets..............................................................................1 1.2 Assumption of Liabilities................................................................................1 1.3 Purchase Price...........................................................................................1 1.4 Further Assurances.......................................................................................1 1.5 Closing..................................................................................................1 1.6 Bulk Transfer Law........................................................................................2 ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE SELLER........................................................2 2.1 Organization, Qualification and Corporate Power..........................................................2 2.2 Authorization of Transaction.............................................................................2 2.3 Noncontravention.........................................................................................3 2.4 Solvency.................................................................................................3 2.5 Ownership and Condition of Assets........................................................................3 2.6 Intellectual Property....................................................................................4 2.7 Litigation...............................................................................................5 2.8 Legal Compliance.........................................................................................5 2.9 Governmental and Third-Party Notices and Consents........................................................5 2.10 Disclosure...............................................................................................5 ARTICLE III REPRESENTATIONS AND WARRANTIES OF THE BUYER.........................................................6 3.1 Organization and Corporate Power.........................................................................6 3.2 Authorization of the Transaction.........................................................................6 3.3 Noncontravention.........................................................................................6 3.4 Litigation...............................................................................................6 ARTICLE IV POST-CLOSING COVENANTS..............................................................................6 4.1 Proprietary Information..................................................................................7 4.2 Non-Competition..........................................................................................7 4.3 Service Contractor Agreements............................................................................7 4.4 Delivery of Assets.......................................................................................8 ARTICLE V INDEMNIFICATION.....................................................................................8 5.1 Indemnification by the Seller............................................................................8 5.2 Indemnification by the Buyer.............................................................................8 5.3 Indemnification Claims...................................................................................9 5.4 Survival of Representations and Warranties..............................................................11 5.5 Limitation of Liability.................................................................................11 ARTICLE VI DEFINITIONS........................................................................................12 ARTICLE VII MISCELLANEOUS......................................................................................14 7.1 Press Releases and Announcements........................................................................14 7.2 No Third Party Beneficiaries............................................................................15 7.3 Entire Agreement........................................................................................15 7.4 Succession and Assignment...............................................................................15 7.5 Counterparts and Facsimile Signature....................................................................15 7.6 Headings................................................................................................15
i 7.7 Notices.................................................................................................15 7.8 Governing Law...........................................................................................16 7.9 Amendments and Waivers..................................................................................16 7.10 Severability............................................................................................16 7.11 Expenses................................................................................................17 7.12 Submission to Jurisdiction..............................................................................17 7.13 Specific Performance....................................................................................17 7.14 Construction............................................................................................17

Exhibits Exhibit A - General Assignment and Bill of Sale Exhibit B - Patent Assignment Exhibit C - Form of Service Contractor Agreement Schedules Schedule 1.1 - Additional Acquired Assets Schedule 1.3(a) - Wiring Instructions Schedule 1.5(d) - June 2003 Bill of Materials Schedule 2.5(a)(i) - Security Interests and Contractual Obligations Schedule 2.6(a) - Patent Schedule Schedule 2.6(d) - Third Party Intellectual Property Agreements; Licenses Schedule 2.6(e) - Acquired Intellectual Property Owned by Third Parties Schedule 4.3 - Service Contractor Schedule ASSET PURCHASE AGREEMENT This Asset Purchase Agreement is entered into as of October 31, 2003 by and between MKS Instruments, Inc. a Massachusetts corporation (the "Buyer"), having offices located at Six Shattuck Road, Andover, MA 01810, and HEI, Inc., a Minnesota corporation (the "Seller"), having offices located at 4801 N. 63rd Street, Boulder, CO 80301. Capitalized terms used in this Agreement shall have the meanings ascribed to them in Article VI. In consideration of the representations, warranties and covenants herein contained, the Parties agree as follows. ARTICLE I THE ASSET PURCHASE 1.1 Purchase and Sale of Assets. Upon and subject to the terms and conditions of this Agreement, the Buyer hereby purchases from the Seller, and the Seller hereby sells, transfers, conveys, assigns and delivers to the Buyer, at the Closing, for the consideration specified below in this Article I, all right, title and interest in, to and under the Acquired Assets. 1.2 Assumption of Liabilities. Buyer shall not assume or become responsible for any liabilities of Seller. 1.3 Purchase Price. The Purchase Price to be paid by the Buyer for the Acquired Assets at the Closing shall be up to four hundred twenty three thousand dollars ($423,000.00), payable as follows: (a) $223,000 to be paid by wire transfer, in accordance with the instructions set forth on Schedule 1.3(a) attached hereto, at the Closing upon completion of the actions set forth in Section 1.5 hereof; (b) $100,000 upon delivery of all remaining Acquired Assets and related documentation and materials; and (c) $100,000 upon the earlier of (i) the completion of services to be provided by the Service Contractors, as described in Section 4.3, attached hereto; or (ii) the full expenditure of the Service Contractor hours set forth on Schedule 4.3 (provided such services have been provided to the extent requested in accordance with such schedule). 1.4 Further Assurances. At any time and from time to time after the Closing, at the request of the Buyer and without further consideration, the Seller shall execute and deliver such other instruments of sale, transfer, conveyance and assignment and take such actions as the Buyer may reasonably request to more effectively transfer, convey and assign to the Buyer, and to confirm the Buyer's rights to, title in and ownership of, the Acquired Assets and to place the Buyer in actual possession and operating control thereof. 1.5 Closing. At the Closing, the following shall occur: (a) the Buyer and the Seller shall execute and deliver to each other the General Assignment and Bill of Sale in the form attached hereto as Exhibit A; (b) the Seller shall execute and deliver to the Buyer a Patent Assignment in the form attached hereto as Exhibit B; (c) Paul Beaty and each of the other Service Contractors who have been identified at the Closing shall execute Service Contractor Agreements substantially in the form attached hereto as Exhibit C; (d) the Seller shall supply to the Buyer a true and accurate bill of materials relating to the Amplifier Systems, which bill of materials is not materially different from the bill of materials relating to Amplifier Systems delivered by the Seller to Eltech Electronics, Inc. in June 2003, a copy of which is attached hereto as Schedule 1.5(d); and (e) the Seller shall deliver to the Buyer two fully operational Amplifier Systems, along with associated test data providing accurate evidence of such Amplifier Systems' operation to the Amplifier Systems' published specifications. 1.6 Bulk Transfer Law. The Buyer and the Seller each hereby waives compliance with the provisions of the bulk transfer statute in each of the jurisdictions, if any, where such compliance would be required in connection with the transactions contemplated by this Agreement (subject to the indemnity provided for in Article V of this Agreement). ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE SELLER The Seller represents and warrants to the Buyer that the statements contained in this Article II are true and correct, as of the date hereof, except as set forth in the Disclosure Schedule. The Disclosure Schedule shall be arranged in sections and subsections corresponding to the numbered and lettered sections and subsections contained in Article II of this Agreement. The disclosures in any section or subsection of the Disclosure Schedule shall qualify only the corresponding section or subsection in this Article II. For the purposes of this Article II, the phrase "to the knowledge of the Seller" or any phrase of similar import shall be deemed to refer to the actual knowledge of the Executive Officers of the Seller. 2.1 Organization, Qualification and Corporate Power. The Seller is a corporation duly organized, validly existing and in corporate and tax good standing under the laws of the State of Minnesota. The Seller has all requisite corporate power and authority to carry on the businesses in which it is engaged and to own and use the properties owned and used by it. The Seller has furnished to the Buyer complete and accurate copies of its Articles of Incorporation and by-laws. The Seller is not in default under or in violation of any provision of its Articles of Incorporation or by-laws. 2.2 Authorization of Transaction. The Seller has all requisite power and authority to execute and deliver this Agreement and the Ancillary Agreements and to perform its obligations 2 hereunder and thereunder. The execution and delivery by the Seller of this Agreement and the performance by the Seller of this Agreement and the Ancillary Agreements and the consummation by the Seller of the transactions contemplated hereby and thereby have been duly and validly authorized by all necessary corporate action on the part of the Seller. This Agreement has been duly and validly executed and delivered by the Seller and constitutes, and each of the Ancillary Agreements, upon its execution and delivery by the Seller, will constitute, a valid and binding obligation of the Seller, enforceable against the Seller in accordance with its terms. 2.3 Noncontravention. Neither the execution and delivery by the Seller of this Agreement or the Ancillary Agreements, nor the consummation by the Seller of the transactions contemplated hereby or thereby, will (a) conflict with or violate any provision of the Certificate of Incorporation or by-laws of the Seller, (b) require on the part of the Seller any notice to or filing with, or any permit, registration, certificate authorization, consent or approval of, any Governmental Entity, (c) conflict with, result in a breach of, constitute (with or without due notice or lapse of time or both) a default under, result in the acceleration of obligations under, create in any party the right to terminate, modify or cancel, or require any notice, consent or waiver under, any contract or instrument to which the Seller is a party or by which the Seller is bound or to which any of its assets is subject, (d) result in the imposition of any Security Interest upon any assets of the Seller or (e) violate any order, writ, injunction, decree, statute, rule or regulation applicable to the Seller or any of its properties or assets. 2.4 Solvency. As of the date hereof, both before and after giving effect to the transactions contemplated in connection with this Agreement, the Seller is Solvent. For purposes of this Agreement, "Solvent" shall mean that (a) the fair value of the Seller's property is greater than the total amount of its liabilities, including contingent liabilities; (b) the present fair salable value of the Seller's assets is not less than the amount that will be required to pay its probable liability on its debts as they become absolute and matured; (c) the Seller does not intend to, and does not believe that it will, incur debts or liabilities beyond its ability to pay as such debts and liabilities mature; and (d) the Seller is not engaged in a business or transaction for which its property would constitute unreasonable small capital. 2.5 Ownership and Condition of Assets. (a) The Seller is the true and lawful owner, and has good title to, all of the Acquired Assets, free and clear of all Security Interests and contractual obligations, except as set forth in Schedule 2.5(a)(i) attached hereto. No subsidiary of the Seller, and no partnership, joint venture or other business entity in which the Seller has an interest owns assets or technology relating to Amplifier Systems. Upon execution and delivery by the Seller to the Buyer of the instruments of conveyance referred to in Section 1.5, the Buyer will become the true and lawful owner of, and will receive good title to, the Acquired Assets, free and clear of all Security Interests and contractual obligations other than those set forth in Schedule 2.5(a)(i). (b) The Acquired Assets are free from defects that materially affect performance, have been maintained in accordance with normal industry practice, are in good operating condition and are suitable for the respective purposes for which they are presently 3 used. To the knowledge of the Seller, all of the inventory of the Seller that constitutes Acquired Assets consists of a quality and quantity usable and saleable in the ordinary course of business of the Seller consistent with past custom and practice. 2.6 Intellectual Property. (a) Schedule 2.6(a) lists each patent, patent application, copyright registration or application therefor, mask work registration or application therefor, and trademark, service mark and domain name registration or application therefor of the Seller included in the Acquired Intellectual Property. (b) The Seller owns and has the right to use all Acquired Intellectual Property. Upon execution and delivery by the Buyer to the Seller of the instruments of conveyance referred to in Section 1.5, each item of Acquired Intellectual Property will be owned or available for use by the Buyer immediately following the Closing on substantially identical terms and conditions as it was immediately prior to the Closing. The Seller has taken reasonable measures to protect the proprietary nature of each item of Acquired Intellectual Property, and to maintain in confidence all trade secrets and confidential information, that it owns or uses. No other person or entity has any rights to any of the Acquired Intellectual Property (except pursuant to agreements or licenses specified in Schedule 2.6(d)), and, to the knowledge of the Seller, no other person or entity is infringing, violating or misappropriating any of the Acquired Intellectual Property. (c) To the knowledge of the Seller, none of the Acquired Intellectual Property, or the marketing, distribution, provision or use thereof, infringes or violates, or constitutes a misappropriation of, any Intellectual Property rights of any person or entity. To the knowledge of the Seller, none of the Internal Systems, or the use thereof, infringes or violates, or constitutes a misappropriation of, any Intellectual Property rights of any person or entity. The Seller has not received any written complaint, claim or notice, or written threat thereof, alleging any such infringement, violation or misappropriation. The Seller has provided to the Buyer complete and accurate copies of all written documentation in the Seller's possession relating to claims or disputes known to the Seller concerning any Acquired Intellectual Property. (d) The Seller has not entered into any license or other agreement pursuant to which the Seller has licensed, distributed or otherwise granted any rights to any third party with respect to, any Acquired Intellectual Property. The Seller has not agreed to indemnify any person or entity against any infringement, violation or misappropriation of any Intellectual Property rights with respect to any Acquired Intellectual Property. (e) Schedule 2.6(e) identifies each item of Acquired Intellectual Property that is owned by a party other than the Seller, and the license or agreement pursuant to which the Seller uses it (excluding off-the-shelf software programs licensed by the Seller pursuant to "shrink wrap" or "click-through" licenses). (f) The Seller has not disclosed the source code for any software constituting Acquired Intellectual Property or other confidential information constituting, embodied in or 4 pertaining to such software to any person or entity, and the Seller has taken reasonable measures to prevent disclosure of such source code. (g) All of the copyrightable materials (including software) incorporated in or bundled with the Acquired Intellectual Property have been created by employees of the Seller within the scope of their employment by the Seller or by independent contractors of the Seller who have executed agreements expressly assigning all right, title and interest in such copyrightable materials to the Seller. No portion of such copyrightable materials was jointly developed with any third party. (h) The Internal Systems are free from significant defects or programming errors and conform in all material respects to the written documentation and specifications therefore. 2.7 Litigation. There is no Legal Proceeding which is pending or has been threatened in writing against the Seller which (a) relates to the Acquired Assets or (b) in any manner challenges or could prevent, enjoin, alter or delay the transactions contemplated by this Agreement. There are no judgments, orders or decrees outstanding against the Seller relating to the Acquired Assets. 2.8 Legal Compliance. The Seller, and the conduct and operation of its business, is in compliance with, and the Seller has not received any written notice or communication from any Government Entity alleging noncompliance with, applicable law (including rules and regulations thereunder) of any federal, state, local or foreign government, or any Governmental Entity, which affects or relates to (a) this Agreement or the Ancillary Agreements or the transactions contemplated hereby or (b) the Acquired Assets. 2.9 Governmental and Third-Party Notices and Consents. (a) The Seller has obtained all waivers, permits, registrations, certificates, consents, approvals or other authorizations from Governmental Entities, and effected all registrations, filings and notices with or to Governmental Entities, as may be required for it to consummate the transactions contemplated by this Agreement and to otherwise comply with all applicable laws and regulations in connection with the consummation of the transactions contemplated by this Agreement. (b) The Seller has obtained all waivers, consents or approvals from third parties, and effected all notices to third parties, as may be required to consummate the transactions contemplated by this Agreement. 2.10 Disclosure. No representation or warranty by the Seller contained in this Agreement, and no statement contained in the Disclosure Schedule or any other document, certificate or other instrument delivered or to be delivered by or on behalf of the Seller pursuant to this Agreement, contains or will contain any untrue statement of a material fact or omits or will omit to state any material fact necessary, in light of the circumstances under which it was or will be made, in order to make the statements herein or therein not misleading. 5 ARTICLE III REPRESENTATIONS AND WARRANTIES OF THE BUYER The Buyer represents and warrants to the Seller that the statements contained in this Article III are true and correct as of the date hereof. 3.1 Organization and Corporate Power. The Buyer is a corporation duly organized, validly existing and in good standing under the laws of the Commonwealth of Massachusetts. The Buyer has all requisite corporate power and authority to carry on the businesses in which it is engaged and to own and use the properties owned and used by it. 3.2 Authorization of the Transaction. The Buyer has all requisite power and authority to execute and deliver this Agreement and the Ancillary Agreements and to perform its obligations hereunder and thereunder. The execution and delivery by the Buyer of this Agreement and the performance by the Buyer of this Agreement and the Ancillary Agreements and the consummation by the Buyer of the transactions contemplated hereby and thereby have been duly and validly authorized by all necessary corporate action on the part of the Buyer. This Agreement has been duly and validly executed and delivered by the Buyer and constitutes, and each of the Ancillary Agreements, upon its execution and delivery by the Buyer, will constitute, a valid and binding obligation of the Buyer, enforceable against the Buyer in accordance with its terms. 3.3 Noncontravention. Neither the execution and delivery by the Buyer of this Agreement or the Ancillary Agreements, nor the consummation by the Buyer of the transactions contemplated hereby or thereby, will (a) conflict with or violate any provision of the Articles of Incorporation or by-laws of the Buyer, (b) require on the part of the Buyer any filing with, or permit, registration, certificate, authorization, consent or approval of, any Governmental Entity, (c) conflict with, result in breach of, constitute (with or without due notice or lapse of time or both) a default under, result in the acceleration of obligations under, create in any party any right to terminate, modify or cancel, or require any notice, consent or waiver under, any contract or instrument to which the Buyer is a party or by which it is bound or to which any of its assets is subject, except for (i) any conflict, breach, default, acceleration, termination, modification or cancellation which would not adversely affect the consummation of the transactions contemplated hereby or (ii) any notice, consent or waiver the absence of which would not adversely affect the consummation of the transactions contemplated hereby, or (d) violate any order, writ, injunction, decree, statute, rule or regulation applicable to the Buyer or any of its properties or assets. 3.4 Litigation. There is no Legal Proceeding which is pending or has been threatened in writing against the Buyer which in any manner challenges or could prevent, enjoin, alter or delay the transactions contemplated by this Agreement. ARTICLE IV POST-CLOSING COVENANTS 6 4.1 Proprietary Information. From and after the Closing, the Seller and its Affiliates shall hold in confidence all knowledge and information of a confidential nature, and all related documents, with respect to the Acquired Assets and shall not disclose, publish or make use of the same without the prior written consent of the Buyer except to the extent that such knowledge, information or documents shall have become public knowledge other than through improper disclosure by the Seller or an Affiliate of the Seller; provided, however, that, if the Seller is required by any Governmental Entity to disclose such knowledge and information, the Seller shall not be liable for such disclosure provided that (i) the Seller, as promptly as reasonably possible, gives notice to the Buyer of the requirement in order that the Buyer may contest the requirement to provide such knowledge and (ii) the Seller uses best efforts to limit the disclosure of such knowledge and information to that which is required by such Governmental Entity. The Seller shall enforce, for the benefit of the Buyer, all confidentiality, invention assignments and similar agreements relating to the Acquired Assets between the Seller and any employee, contractor or former employee or contractor of the Seller or its affiliates, and the Seller hereby assigns to the Buyer the right to enforce any such agreement between the Seller or its affiliates and any other party. 4.2 Non-Competition. (a) Non-competition Agreement. During the period commencing on the date hereof and ending on the second anniversary hereof, neither the Seller, nor any Affiliate thereof shall directly or indirectly, as a partner, stockholder (other than as a holder of less than five percent (5%) of the outstanding shares of a publicly traded company), consultant, joint venturer, investor or otherwise, (i) design, develop, produce, market or sell products, or render services, that are competitive with any product designed, developed (or under development), manufactured, sold or licensed by, or any service provided by, the Buyer relating to the solid state MRI amplifier market (the "Market"), provided that the provision by the Seller of contract manufacturing services for third party designs within the Market shall not constitute a violation of this Section 4.2(a), or (ii) solicit, divert or take away the business or patronage of any individual, corporation or other entity which was or is a prospective client, customer or account of the Buyer in the Market, or (iii) assist any other person or entity in doing any of the foregoing. (b) The Seller agrees that the duration and geographic scope of the non-competition provision set forth in this Section 4.2 are reasonable. In the event that any court determines that the duration or the geographic scope, or both, are unreasonable and that such provision is to that extent unenforceable, the Parties agree that the provision shall remain in full force and effect for the greatest time period and in the greatest area that would not render it unenforceable. The Parties intend that this non-competition provision shall be deemed to be a series of separate covenants, one for each and every county of each and every state of the United States of America and each and every political subdivision of each and every country outside the United States of America where this provision is intended to be effective. 4.3 Service Contractor Agreements. The Seller shall provide, and shall use reasonable effort to cause the respective Service Contractors to provide, to the Buyer the services of the Service Contractors in accordance with the terms set forth on Schedule 4.3 hereto. Upon determination of the identity of any of the Service Contractors who did not execute a Service 7 Contractor Agreement at the Closing, the Seller shall cause such Service Contractor to execute a Service Contractor Agreement. If the services of any of the Service Contractors becomes unavailable for any reason, the Buyer shall identify, within 30 days of such unavailability, a replacement Service Contractor. The Seller shall pay such replacement Service Contractor for the services provided to the Buyer pursuant to the Service Contractor Agreement, in an amount up to $159.00 per hour. Any amounts owed to the replacement Service Contractor for services provided pursuant to the Service Contract Agreement in excess of $159.00 per hour shall be payable to such Service Contractor directly by the Buyer. Upon the earlier of (i) the completion of services provided by the Service Contractors, as described in Schedule 4.3; or (ii) full expenditure of the Service Contractor hours set forth on Schedule 4.3 (provided that services have been provided to the extent requested in accordance with such schedule), the Buyer shall make a payment to the Seller in accordance with Section 1.3(c) hereof. 4.4 Delivery of Assets. Within thirty (30) days after the Closing, the Seller shall deliver to the Buyer's designated delivery address all of the Acquired Assets and related documentation and materials not delivered at the Closing. ARTICLE V INDEMNIFICATION 5.1 Indemnification by the Seller. The Seller shall indemnify the Buyer in respect of, and hold the Buyer harmless against, Damages incurred or suffered by the Buyer or any Affiliate thereof resulting from, relating to or constituting: (a) any breach of any representation or warranty of the Seller contained in this Agreement, any Ancillary Agreements or any other agreement or instrument furnished by the Seller to the Buyer pursuant to this Agreement; (b) any failure to perform any covenant or agreement of the Seller contained in this Agreement, any Ancillary Agreement or any agreement or instrument furnished by the Seller to the Buyer pursuant to this Agreement; or (c) the failure of the Buyer and the Seller, in connection with the sale of the Acquired Assets by the Seller to the Buyer pursuant to this Agreement, to comply with, and obtain for the Buyer the benefits afforded by compliance with, any applicable bulk transfer laws. 5.2 Indemnification by the Buyer. The Buyer shall indemnify the Seller in respect of, and hold the Seller harmless against, Damages incurred or suffered by the Seller or any Affiliate thereof resulting from, relating to or constituting: (a) any breach of any representation or warranty of the Buyer contained in this Agreement, any Ancillary Agreements or any other agreement or instrument furnished by the Buyer to the Seller pursuant to this Agreement; or 8 (b) any failure to perform any covenant or agreement of the Buyer contained in this Agreement, any Ancillary Agreements or any agreement or instrument furnished by the Buyer to the Seller pursuant to this Agreement. 5.3 Indemnification Claims. (a) An Indemnified Party shall give written notification to the Indemnifying Party of the commencement of any Third Party Action. Such notification shall be given within 20 days after receipt by the Indemnified Party of notice of such Third Party Action, and shall describe in reasonable detail (to the extent known by the Indemnified Party) the facts constituting the basis for such Third Party Action and the amount of the claimed damages; provided, however, that no delay or failure on the part of the Indemnified Party in so notifying the Indemnifying Party shall relieve the Indemnifying Party of any liability or obligation hereunder except to the extent of any damage or liability caused by or arising out of such failure. Within 20 days after delivery of such notification, the Indemnifying Party may, upon written notice thereof to the Indemnified Party, assume control of the defense of such Third Party Action with counsel reasonably satisfactory to the Indemnified Party; provided that (i) the Indemnifying Party may only assume control of such defense if (A) it acknowledges in writing to the Indemnified Party that any damages, fines, costs or other liabilities that may be assessed against the Indemnified Party in connection with such Third Party Action constitute Damages for which the Indemnified Party shall be indemnified pursuant to this Article V and (B) the maximum amount claimed is less than or equal to the amount of Damages for which the Indemnifying Party is liable under this Article V and (ii) without the prior written consent of the Indemnified Partly, the Indemnifying Party may not assume control of the defense of Third Party Action involving criminal liability or in which equitable relief is sought against the Indemnified Party. Notwithstanding the foregoing, no party that is found by a court of competent jurisdiction to have committed or engaged in fraud shall be entitled to indemnification hereunder nor shall any party be entitled to indemnification if the payment of such indemnification is found by a court of competent jurisdiction to be contrary to public policy. If the Indemnifying Party does not, or is not permitted under the terms hereof to, so assume control of the defense of a Third Party Action, the Indemnified Party shall control such defense. The Non-controlling Party may participate in such defense at its own expense. The Controlling Party shall keep the Non-controlling Party advised of the status of such Third Party Action and the defense thereof and shall consider in good faith recommendations made by the Non-controlling Party with respect thereto. The Non-controlling Party shall furnish the Controlling Party with such information as it may have with respect to such Third Party Action (including copies of any summons, complaint or other pleading which may have been served on such party and any written claim, demand, invoice, billing or other document evidencing or asserting the same) and shall otherwise cooperate with and assist the Controlling Party in the defense of such Third Party Action. The fees and expenses of counsel to the Indemnified Party with respect to a Third Party Action shall be considered Damages for purposes of this Agreement if (i) the Indemnified Party controls the defense of such Third Party Action pursuant to the terms of this Section 5.2(b) or (ii) the Indemnifying Party assumes control of such defense and the Indemnified Party reasonably concludes that the Indemnifying Party and the Indemnified Party have conflicting interests or different defenses available with respect to such Third Party Action. The Indemnifying Party shall not agree to any settlement of, or the entry of any judgment arising from, any such Third 9 Party Action without the prior written consent of the Indemnified Party, which shall not be unreasonably withheld, conditioned or delayed. The Indemnified Party shall not agree to any settlement of, or the entry of any judgment arising from, any such Third Party Action without the prior written consent of the Indemnifying Party, which shall not be unreasonably withheld, conditioned or delayed. (b) In order to seek indemnification under this Article V, an Indemnified Party shall deliver a Claim Notice to the Indemnifying Party. (c) Within 20 days after delivery of a Claim Notice, the Indemnifying Party shall deliver to the Indemnified Party the Response, in which the Indemnifying Party shall: (i) agree that the Indemnified Party is entitled to receive all of the Claimed Amount (in which case the Response shall be accompanied by a payment by the Indemnifying Party to the Indemnified Party of the Claimed Amount, by check or by wire transfer), (ii) agree that the Indemnified Party is entitled to receive a portion of the Agreed Amount, in which case the Response shall be accompanied by a payment by the Indemnifying Party to the Indemnified Party of the Agreed Amount, by check or by wire transfer or (iii) dispute that the Indemnified Party is entitled to receive any or all of the Claimed Amount. If the Response creates a Dispute, the Indemnifying Party and the Indemnified Party shall follow the procedures set forth in Section 5.2(d) for the resolution of such Dispute. (d) During the 30-day period following the delivery of a Response that reflects a Dispute, the Indemnifying Party and the Indemnified Party shall use good faith efforts to resolve the Dispute. If the Dispute is not resolved within such 30-day period, the Indemnifying Party and the Indemnified Party shall submit the Dispute to arbitration, unless otherwise mutually agreed to by the Parties. (e) Notwithstanding the other provisions of this Section 5.2, in the event that the Seller has not timely paid to the Buyer amounts that have been finally determined, in accordance with this Article V, to be due as Damages to the Buyer, the Buyer shall have the right, but not the obligation, to elect to satisfy such obligations by setting off from future amounts payable by the Buyer to the Seller pursuant to Sections 1.3(b) or 1.3(c) hereof, the amount of such Damages, or portion thereof. (f) Notwithstanding the other provisions of this Section 5.2, if a third party asserts (other than by means of a lawsuit) that an Indemnified Party is liable to such third party for a monetary or other obligation which may constitute or result in Damages for which such Indemnified Party may be entitled to indemnification pursuant to this Article V, and such Indemnified Party reasonably determines that it has a valid business reason to fulfill such obligation, then (i) such Indemnified Party shall be entitled to satisfy such obligation, without prior notice to or consent from the Indemnifying Party, (ii) such Indemnified Party may subsequently make a claim for indemnification in accordance with the provisions of this Article V, and (iii) such Indemnified Party shall be reimbursed, in accordance with the provisions of this Article V, for any such Damages for which it is entitled to indemnification pursuant to this Article V (subject to the right of the Indemnifying Party to dispute 10 the Indemnified Party's entitlement to indemnification, or the amount for which it is entitled to indemnification, under the terms of this Article V). 5.4 Survival of Representations and Warranties. All representations and warranties contained in this Agreement shall (a) survive the Closing and (b) shall expire on the date one (1) year following the date hereof. If an Indemnified Party delivers to an Indemnifying Party, before expiration of a representation or warranty, either a Claim Notice based upon a breach of such representation or warranty, or an Expected Claim Notice, then the applicable representation or warranty shall survive until, but only for purposes of, the resolution of the matter covered by such notice. If the legal proceeding or written claim with respect to which an Expected Claim Notice has been given is definitively withdrawn or resolved in favor of the Indemnified Party, the Indemnified Party shall promptly so notify the Indemnifying Party. The rights to indemnification set forth in this Article V shall not be affected by any investigation conducted by or on behalf of an Indemnified Party or any knowledge of an Indemnified Party with respect to the inaccuracy or noncompliance with any representation, warranty, covenant or obligation which is the subject of indemnification hereunder. 5.5 Limitation of Liability. The obligations and liabilities of the Indemnifying Party for indemnification hereunder shall be subject to the following limitations: (a) The Indemnified Party's right to indemnification under Section 5.1 shall be limited to an aggregate maximum recovery from the Indemnifying Party of the aggregate amount that is paid to the Seller by the Buyer in accordance with Section 1.3 hereof (including the aggregate amount of any set-offs pursuant to Section 5.3(e) hereof). However, in the event the Indemnified Party assumes control of a Third Party Action solely as a result of the provisions of Section 5.3(a)(ii) hereof, then the Indemnified Party's right to indemnification under Section 5.1 with respect to such Third Party Action shall be limited to an aggregate amount of $150,000. (b) No indemnification shall be required to be made by the Indemnifying Party unless the aggregate cumulative amount of the Indemnified Party's Damages exceeds Twenty-Five Thousand Dollars ($25,000.00), in which case the Indemnifying Party shall be required to pay the full amount of such Damages (and not just such amounts in excess of $25,000). IN NO EVENT WILL EITHER PARTY BE LIABLE FOR ANY LOST PROFITS OR INCIDENTAL OR CONSEQUENTIAL DAMAGES REGARDLESS OF WHETHER SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES, NOR ANY CLAIM AGAINST SUCH PARTY BY ANY OTHER PARTY. 11 ARTICLE VI DEFINITIONS For purposes of this Agreement, each of the following terms shall have the meaning set forth below. "Acquired Assets" shall mean (a) the Acquired Intellectual Property and (b) the Additional Acquired Assets. "Acquired Intellectual Property" shall mean all of the Seller's rights, title and interest in, and all of the assets and properties constituting, all of following that relate to solid state MRI amplifiers: (a) the patents, patent applications, patent disclosures and all related continuations, continuations-in-part, divisionals, reissues, reexaminations, utility models, certificates of invention and design patents, patent applications, registrations and applications for registrations as set forth on Schedule 2.6(a); (b) copyrights and registrations and applications for registration thereof; (c) mask works and registrations and applications for registration thereof; (d) computer software, data and documentation; (e) inventions, trade secrets and confidential business information, whether patentable or nonpatentable and whether or not reduced to practice, manufacturing and product processes and techniques, research and development information, and copyrightable works; (f) other proprietary rights relating to any of the foregoing (including remedies against infringements thereof and rights of protection of interest therein under the laws of all jurisdictions); and (g) copies and tangible embodiments thereof. "Additional Acquired Assets" are those assets, properties and rights of the Seller set forth on Schedule 1.1 attached hereto. "Affiliate" shall mean any affiliate, as defined in Rule 12b-2 under the Securities Exchange Act of 1934. "Amplifier Systems" shall mean the Seller's 1.5 Tesla MRI amplifier systems. "Ancillary Agreements" shall mean the General Assignment and Bill of Sale and any other instruments of conveyance. "Buyer" shall have the meaning set forth in the first paragraph of this Agreement. 12 "Claimed Amount" shall mean the amount of any Damages incurred or reasonably expected to be incurred by the Indemnified Party. "Claim Notice" shall mean written notification which contains (i) a description of the Damages incurred or reasonably expected to be incurred by the Indemnified Party and the Claimed Amount of such Damages, to the extent then known, (ii) a statement that the Indemnified Party is entitled to indemnification under Article V of this Agreement for such Damages and a reasonable explanation of the basis therefor, and (iii) a demand for payment (in the manner provided in Section 5.2(c) of this Agreement) in the amount of such Damages. "Closing" shall mean the closing of the sale of the Acquired Assets contemplated by this Agreement. "Controlling Party" shall mean the party controlling the defense of any suit or proceeding relating to a third party claim for which indemnification is sought pursuant to Article V of this Agreement. "Damages" shall mean any and all debts, obligations and other liabilities (whether absolute, accrued, contingent, fixed or otherwise, or whether known or unknown, or due or to become due or otherwise), diminution in value, monetary damages, fines, fees, penalties, interest obligations, deficiencies, losses and expenses (including amounts paid in settlement, interest, court costs, costs of investigators, fees and expenses of attorneys, accountants, financial advisors and other experts, and other expenses of litigation). "Disclosure Schedule" shall mean the disclosure schedule provided by the Seller to the Buyer on the date hereof and accepted in writing by the Buyer. "Dispute" shall mean the dispute resulting if the Indemnifying Party in the Response disputes its liability for all or part of the Claimed Amount. "Executive Officers" shall mean Mack Traynor, the Chief Executive Officer; Doug Nesbit, the Chief Financial Officer; and James Vetricek, the Vice President of Colorado Operations for the Seller. "Expected Claim Notice" shall mean a notice that, as a result a legal proceeding instituted by or claim made by a third party, the Indemnified Party reasonably expects to incur Damages. "Governmental Entity" shall mean any court, arbitrational tribunal, administrative agency or commission or other governmental or regulatory authority or agency. "Indemnified Party" shall mean the Buyer or Seller, as appropriate. "Indemnifying Party" shall mean the Seller or Buyer, as appropriate. "Internal Systems" shall mean the internal systems of the Seller that are used in its business or operations, including computer hardware systems, software applications and embedded systems that relate to solid state MRI amplifiers. 13 "Legal Proceeding" shall mean any action, suit, proceeding, claim, arbitration or investigation before any Governmental Entity or before any arbitrator. "Non-controlling Party" shall mean the party not controlling the defense of any suit or proceeding relating to a third party claim for which indemnification is sought pursuant to Article V of this Agreement. "Parties" shall mean the Buyer and the Seller. "Purchase Price" shall mean the purchase price to be paid by the Buyer for the Acquired Assets at the Closing, as set forth in Section 1.3 of this Agreement. "Response" shall mean a written response containing the information provided for in Section 5.2(c). "Security Interest" shall mean any mortgage, pledge, security interest, encumbrance, charge or other lien (whether arising by contract or by operation of law), other than (i) mechanic's, materialmen's, and similar liens, (ii) liens arising under worker's compensation, unemployment insurance, social security, retirement, and similar legislation and (iii) liens on goods in transit incurred pursuant to documentary letters of credit, in each case arising in the ordinary course of business of the Seller consistent with past custom and practice and not material to the Seller. "Seller" shall have the meaning set forth in the first paragraph of this Agreement. "Service Contractors" shall mean (i) Paul Beaty and (ii) a software engineer and an RF Engineer, who have experience in connection with the Acquired Assets, each of whom shall be mutually agreed upon by the Seller and the Buyer in accordance with Section 4.3 hereof and Schedule 4.3 attached hereto; along with any contractors who replace such persons in accordance with Section 4.3 hereof. "Service Contractor Agreements" shall mean service contractor agreements executed between the Company and the Service Contractors in the form attached hereto as Exhibit C. "Third Party Action" shall mean any suit or proceeding by a person or entity other than a Party for which indemnification may be sought by a Party under Article V. ARTICLE VII MISCELLANEOUS 7.1 Press Releases and Announcements. Neither Party shall issue any press release or public announcement relating to the subject matter of this Agreement without the prior written approval of the other Party; provided, however, that either Party may make any public disclosure it believes in good faith is required by applicable law, regulation or stock market rule (in which 14 case the disclosing Party shall use reasonable effort to advise the other Party and provide it with a copy of the proposed disclosure prior to making the disclosure). 7.2 No Third Party Beneficiaries. This Agreement shall not confer any rights or remedies upon any person other than the Parties and their respective successors and permitted assigns. 7.3 Entire Agreement. This Agreement (including the documents referred to herein) constitutes the entire agreement between the Parties and supersedes any prior understandings, agreements, or representations by or between the Parties, written or oral, with respect to the subject matter hereof. 7.4 Succession and Assignment. This Agreement shall be binding upon and inure to the benefit of the Parties named herein and their respective successors and permitted assigns. Neither Party may assign either this Agreement or any of its rights, interests, or obligations hereunder without the prior written approval of the other Party. 7.5 Counterparts and Facsimile Signature. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. This Agreement may be executed by facsimile signature. 7.6 Headings. The section headings contained in this Agreement are inserted for convenience only and shall not affect in any way the meaning or interpretation of this Agreement. 7.7 Notices. All notices, requests, demands, claims, and other communications hereunder shall be in writing. Any notice, request, demand, claim, or other communication hereunder shall be deemed duly delivered four business days after it is sent by registered or certified mail, return receipt requested, postage prepaid, or one business day after it is sent for next business day delivery via a reputable nationwide overnight courier service, in each case to the intended recipient as set forth below: If to the Seller: Copy to: ---------------- ------- HEI, Inc. HEI, Inc. 4801 N. 63rd Street 4801 N. 63rd Street Boulder, CO 80301 Boulder, CO 80301 Attn: James Vetricek, Attn: Contracts Manager VP, Colorado Operations facsimile: (303) 530-8291 facsimile: (303) 530-8291 15 If to the Buyer: Copy to: --------------- ------- MKS Instruments, Inc. Hale and Dorr LLP Six Shattuck Road 60 State Street Andover, MA 01810 Boston, MA 02109 Attention: John R. Bertucci, Attention: Mark G. Borden President facsimile: (617) 526-5000 facsimile: (978) 975-3756 Either Party may give any notice, request, demand, claim, or other communication hereunder using any other means (including personal delivery, expedited courier, messenger service, telecopy, telex, ordinary mail, or electronic mail), but no such notice, request, demand, claim, or other communication shall be deemed to have been duly given unless and until it actually is received by the party for whom it is intended. Either Party may change the address to which notices, requests, demands, claims, and other communications hereunder are to be delivered by giving the other Party notice in the manner herein set forth. 7.8 Governing Law. This Agreement shall be governed by and construed in accordance with the internal laws (and not the law of conflicts) of the Commonwealth of Massachusetts, without giving effect to any choice or conflict of law provision or rule (whether of the Commonwealth of Massachusetts or any other jurisdiction) that would cause the application of laws of any jurisdictions other than those of the Commonwealth of Massachusetts. 7.9 Amendments and Waivers. The Parties may mutually amend any provision of this Agreement at any time prior to the Closing; provided, however, that no amendment of any provision of this Agreement shall be valid unless the same shall be in writing and signed by each of the Parties. No waiver by either Party of any right or remedy hereunder shall be valid unless the same shall be in writing and signed by the Party giving such waiver. No waiver by either Party with respect to any default, misrepresentation, or breach of warranty or covenant hereunder shall be deemed to extend to any prior or subsequent default, misrepresentation, or breach of warranty or covenant hereunder or affect in any way any rights arising by virtue of any prior or subsequent such occurrence. 7.10 Severability. Any term or provision of this Agreement that is invalid or unenforceable in any situation in any jurisdiction shall not affect the validity or enforceability of the remaining terms and provisions hereof or the validity or enforceability of the offending term or provision in any other situation or in any other jurisdiction. If the final judgment of a court of competent jurisdiction declares that any term or provision hereof is invalid or unenforceable, the Parties agree that the court making the determination of invalidity or unenforceability shall have the power to limit the term or provision, to delete specific words or phrases, or to replace any invalid or unenforceable term or provision with a term or provision that is valid and enforceable and that comes closest to expressing the intention of the invalid or unenforceable term or provision, and this Agreement shall be enforceable as so modified. 16 7.11 Expenses. Except as set forth in Article V, each Party shall bear its own costs and expenses (including legal fees and expenses) incurred in connection with this Agreement and the transactions contemplated hereby. 7.12 Submission to Jurisdiction. In the event litigation is initiated by Buyer, the jurisdiction and venue shall be the state and federal courts located in the Commonwealth of Massachusetts. In the event litigation is initiated by Seller, the jurisdiction and venue shall be the state and federal courts located in the State of Colorado. Each Party (a) agrees that, in the event litigation is initiated by Buyer, the parties shall submit to the jurisdiction of any state or federal court sitting in the Commonwealth of Massachusetts, and that, in the event litigation is initiated by Seller, the parties shall submit to the jurisdiction of any state or federal courts sitting in the State of Colorado, in any action or proceeding arising out of or relating to this Agreement or the Ancillary Agreements, (b) agrees that all claims in respect of such action or proceeding may be heard and determined in any such court, (c) agrees not to bring any action or proceeding arising out of or relating to this Agreement or the Ancillary Agreements in any other court and (d) waives any right it may have to a trial by jury with respect to any action or proceeding arising out of or relating to this Agreement or the Ancillary Agreements. Each Party hereby waives any defense of inconvenient forum to the maintenance of any action or proceeding so brought. 7.13 Specific Performance. Each Party acknowledges and agrees that the other Party would be damaged irreparably in the event any of the provisions of this Agreement are not performed in accordance with their specific terms or otherwise are breached. Accordingly, each Party agrees that the other Party shall be entitled to an injunction and other equitable relief to prevent breaches of the provisions of this Agreement and to enforce specifically this Agreement and the terms and provisions hereof in any action instituted in any court of the United States or any state thereof having jurisdiction over the Parties and the matter, in addition to any other remedy to which it may be entitled, at law or in equity. 7.14 Construction. The language used in this Agreement shall be deemed to be the language chosen by the Parties to express their mutual intent, and no rule of strict construction shall be applied against either Party. Any reference to any federal, state, local, or foreign statute or law shall be deemed also to refer to all rules and regulations promulgated thereunder, unless the context requires otherwise. 17 IN WITNESS WHEREOF, the Parties hereto have executed this Agreement as of the date first above written. MKS INSTRUMENTS, INC. By: /s/ RONALD C. WEIGNER ---------------------------- Name: Ronald C. Weigner --------------------------- Title: VP & CFO -------------------------- HEI, INC. By: /s/ JAMES VETRICEK ---------------------------- Name: James Vetricek --------------------------- Title: VP, Colorado Operations -------------------------- 18 EX-10.51 22 c81087exv10w51.txt EX-10.51 ACCOUNTS RECEIVABLE AGREEMENT AMENDMENT EXHIBIT 10.51 December 12, 2003 Mr. Mack Traynor, President HEI, Inc. 1495 Steiger Lake Lane Victoria, MN 55386 Dear Mack: Thank you for the on-going opportunity to provide a revolving credit facility for HEI, Inc. This letter serves to confirm the continuing availability of the credit facility provided to HEI, Inc. by Beacon Bank pursuant to the Accounts Receivable Agreement dated May 29, 2003, on the following terms and conditions: MAXIMUM CLIENT ACCOUNT LIMIT: $3,000,000 DISCOUNT: Immediate discount of .50% and a daily discount of 1/25 of 1% PART PAYMENT: 80% of invoice amount, subject to the completion of appropriate verification due diligence TERMS OF CONTRACT: September 1, 2004 ACCOUNT RELATIONSHIP: That the primary deposit relationship for HEI, Inc. be maintained with Beacon Bank while this credit facility is in place CREDIT GUARANTEE: 90 day recourse COLLATERAL: First security interest in all accounts, inventory, and general intangibles GUARANTY: Validity guaranty from key officers It has been our pleasure working with you and your staff during the last year. We congratulate you on the progress you've made this year, and look forward to future successes for HEI. As you know, we will also continue to provide HEI, Inc. accounts receivable credit and collection services, including the management of outstanding accounts receivable balances, assistance in the development of underwriting policies, credit approval procedures, and a full complement of accounts receivable and cash receipts reporting. All terms and conditions are covered in the Accounts Receivable Agreement. Please let me know if you have any questions, or if I can be of any further assistance. As always, we appreciate your business! Sincerely, Dave Peterka Karen Turnquist Beacon Bank Partner Plus EX-21 23 c81087exv21.txt EX-21 SUBSIDIARIES OF THE REGISTRANT . . . EXHIBIT 21 Subsidiaries of the Registrant
Percentage of State of Incorporation Parent Subsidiary Ownership or Organization ~~HEI, Inc. Cross Technology, Inc. 100& Minnesota~~
EX-23 24 c81087exv23.txt EX-23 CONSENT OF KPMG LLP Exhibit 23 INDEPENDENT AUDITORS' CONSENT The Board of Directors HEI, Inc.: We consent to the incorporation by reference in the registration statements (Nos. 33-386338, 33-395529, 33-395551, 33-349489, 33-370426, 33-340026, 33-33322, 33-46928, 33-46929, and 333-104830) on Forms S-8 and S-3 of HEI, Inc. of our reports dated December 12, 2003, relating to the consolidated balance sheets of HEI, Inc. and subsidiaries as of August 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended August 31, 2003 and the related financial statement schedule, which reports appear in the August 31, 2003 annual report on Form 10-K of HEI, Inc. /s/ KPMG LLP Minneapolis, Minnesota December 15, 2003 EX-31.1 25 c81087exv31w1.txt EX-31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER EXHIBIT 31.1 CERTIFICATIONS I, Mack V. Traynor III, certify that: 1. I have reviewed this Annual Report on Form 10-K of HEI, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the period covered by this report based on such evaluation; and c) Disclosed in this report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Mack V. Traynor III -------------------------------------------- Mack V. Traynor III Chief Executive Officer and President Date: December 16, 2003 EX-31.2 26 c81087exv31w2.txt EX-31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER EXHIBIT 31.2 CERTIFICATIONS I, Douglas J. Nesbit, certify that: 1. I have reviewed this Annual Report on Form 10-K of HEI, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the period covered by this report based on such evaluation; and c) Disclosed in this report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Douglas J. Nesbit --------------------------------- Douglas J. Nesbit Chief Financial Officer Date: December 16, 2003 EX-32.1 27 c81087exv32w1.txt EX-32.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of HEI, Inc. (the "Company") on Form 10-K for the fiscal year ended August 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Mack V. Traynor, III, Chief Executive Officer and President of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Mack V. Traynor, III ------------------------------------------- Mack V. Traynor, III Chief Executive Officer and President December 16, 2003 EX-32.2 28 c81087exv32w2.txt EX-32.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of HEI, Inc. (the "Company") on Form 10-K for the fiscal year ended August 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Douglas J. Nesbit, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Douglas J. Nesbit -------------------------------------------- Douglas J. Nesbit Chief Financial Officer December 16, 2003 -----END PRIVACY-ENHANCED MESSAGE-----


þ		ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For fiscal year ended August 31, 2003.

or

o		TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the transition period from to .


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

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


FORWARD-LOOKING STATEMENTS
PART I
	Item 2. Properties.
	Item 3. Legal Proceedings.
	Item 4. Submission of Matters to a Vote of Security-Holders
PART II
	Item 6. Selected Financial Data.
	Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. (In thousands of dollars)
CRITICAL ACCOUNTING POLICIES
RESULTS OF OPERATIONS
FINANCIAL CONDITION
TERM-DEBT
FISCAL 2004 LIQUIDITY
CONTRACTUAL OBLIGATIONS
RISK FACTORS
	Item 7A. Qualitative and Quantitative Disclosures About Market Risk. (In thousands)
	Item 8. Financial Statements and Supplementary Data.
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
STATEMENT OF FINANCIAL RESPONSIBILITY
PART III
PART IV
SCHEDULE II
SIGNATURES
EX-3.3 Amendment, dated March 19, 2003 to Bylaws
EX-10.24 1998 Stock Option Plan
EX-10.34 Separation Agreement and Release
EX-10.35 Employment Agreement - Douglas J. Nesbit
EX-10.36 Employment Agreement - Stephen K Petersen
EX-10.37 Employment Agreement - Scott M. Stole
EX-10.38 Employment Agreement - Simon F Hawksworth
EX-10.39 Employment Agreement - James C. Vetricek
EX-10.40 Note Prepayment Agreement
EX-10.41 Promissory Note
EX-10.42 Term Loan Agreement
EX-10.43 Combination Mortgage, Secruity Agreement
EX-10.44 Environmental Investigation Letter
EX-10.45 Promissory Note
EX-10.46 Term Loan Agreement
EX-10.47 Commercial Security Agreement
EX-10.48 Combination Mortgage, Secruity Agreement
EX-10.49 Environmental Investigation Letter
EX-10.50 Asset Purchase Agreement
EX-10.51 Accounts Receivable Agreement Amendment
EX-21 Subsidiaries of the Registrant
EX-23 Consent of KPMG LLP
EX-31.1 Certification of Chief Executive Officer
EX-31.2 Certification of Chief Financial Officer
EX-32.1 Certification of Chief Executive Officer
EX-32.2 Certification of Chief Financial Officer


Fiscal Year Ended
August 31, 2003	High		Low

First Quarter	$	5.55	$	2.77
Second Quarter		3.20		1.70
Third Quarter		2.85		1.65
Fourth Quarter		4.68		2.60


Fiscal Year Ended
August 31, 2002	High		Low

First Quarter	$	8.70	$	6.00
Second Quarter		7.90		5.50
Third Quarter		8.33		5.76
Fourth Quarter		7.80		4.30



	Fiscal Years Ended
	August 31,

Customer	2003			2002			2001

Sonic Innovations, Inc.		17	%		32	%		26	%
Siemens, Inc.		14	%		32	%		25	%
GE Medical Systems		14	%		—			—
Triquint Optoelectronics		—			—			10	%



	Fiscal Years Ended
	August 31,

Market	2003			2002			2001

Medical/ Hearing		82	%		76	%		61	%
Communications		6	%		11	%		17	%
RFID		8	%		10	%		14	%
Other		4	%		3	%		8	%


Name	Age		Position

Mack V. Traynor, III		45	Chief Executive Officer and President
Douglas J. Nesbit		51	Chief Financial Officer
Stephen K. Petersen		51	Vice President of the Micro Electronics Operation
Scott M. Stole		40	Chief Technical Officer
Simon F. Hawksworth		37	Vice President of Sales and Marketing
James C. Vetricek		46	Vice President of the Advanced Medical Operation



		Fiscal Years Ended August 31,

		2003(a)			2002(b)			2001(c)			2000(d)			1999(e)


		(In thousands, except per share amounts)
Net sales		$	38,440		$	28,532		$	44,832		$	42,799		$	29,089
Cost of sales			31,327			23,375			36,841			35,544			22,378

Gross profit			7,113			5,157			7,991			7,255			6,711

Operating expenses:
	Selling, general and administrative		7,639			5,335			5,806			6,338			4,623
	Research, development and engineering		2,580			2,516			2,433			1,764			1,343
Unusual charges			331			—			1,693			453			490

Operating income (loss)			(3,437	)		(2,694	)		(1,941	)		(1,300	)		255
Other income (expense), net			(1,213	)		(106	)		(2,182	)		(227	)		380

Income (loss) before income taxes			(4,650	)		(2,800	)		(4,123	)		(1,527	)		635

Income tax expense (benefit)			(21	)		1,092			(930	)		(372	)		242

Net income (loss)		$	(4,629	)	$	(3,892	)	$	(3,193	)	$	(1,155	)	$	393

Net income (loss) per basic share		$	(0.70	)	$	(0.65	)	$	(0.65	)	$	(0.24	)	$	0.08
Net income (loss) per diluted share		$	(0.70	)	$	(0.65	)	$	(0.65	)	$	(0.24	)	$	0.08
Weighted average common shares outstanding:
	Basic		6,629			5,992			4,881			4,726			4,698
	Diluted		6,629			5,992			4,881			4,726			4,701
Balance sheet as of year end:
	Working capital	$	5,885		$	4,369		$	8,793		$	5,902		$	8,333
	Total assets		26,503			22,989			27,528			28,936			23,739
	Long-term debt, less current maturities		2,689			1,473			3,972			3,894			3,415
	Shareholders’ equity		13,191			14,570			18,420			15,116			15,566


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations. (In thousands of dollars)*


	Fiscal		Fiscal		Fiscal				Total Amount
	2004		2005		2006		Thereafter		Committed

Long-term debt	$	397	$	381	$	330	$	1,454	$	2,562
Contractual obligation		320		80		—		—		400
Operating leases		2,110		1,993		1,853		12,054		18,010

Total contractual obligations	$	2,827	$	2,454	$	2,183		13,508	$	20,972


Item 7A.	*Qualitative and Quantitative Disclosures About Market Risk. (In thousands)*


Item 8.	*Financial Statements and Supplementary Data.*


	Page No.

Consolidated Balance Sheets		30
Consolidated Statements of Operations		31
Consolidated Statements of Changes in Shareholders’ Equity		32
Consolidated Statements of Cash Flows		33
Notes to Consolidated Financial Statements		34
Independent Auditors’ Report		53
Independent Auditors’ Report on Financial Statement Schedule		54
Statement of Financial Responsibility		55



		Years Ended August 31

		2003			2002			2001

Net sales		$	38,440		$	28,532		$	44,832
Cost of sales			31,327			23,375			36,841

	Gross profit		7,113			5,157			7,991

Operating expenses:
	Selling, general and administrative		7,639			5,335			5,806
	Research, development and engineering		2,580			2,516			2,433
	Unusual charges		331			—			1,693

Operating loss			(3,437	)		(2,694	)		(1,941	)

	Former officer note and other receivables write off		(841	)		—			—
	Bank fees		(181	)		—			—
	Loss on equity investment		—			—			(1,450	)
	Interest expense		(328	)		(345	)		(504	)
	Other income (expense), net		137			239			(228	)

Loss before income taxes			(4,650	)		(2,800	)		(4,123	)
Income tax expense (benefit)			(21	)		1,092			(930	)

Net loss		$	(4,629	)	$	(3,892	)	$	(3,193	)

Net loss per common share
	Basic	$	(0.70	)	$	(0.65	)	$	(0.65	)
	Diluted	$	(0.70	)	$	(0.65	)	$	(0.65	)

Weighted average common shares outstanding
	Basic		6,629			5,992			4,881
	Diluted		6,629			5,992			4,881


Item 1.	*Business.*


	*Principal Products and Services*


	Overview


	*Selling, general and administrative*


									Retained
		Common		Common		Additional			Earnings
		Stock Shares		Stock Amount		Paid-In			(accumulated			Notes			Total
		Outstanding		Outstanding		Capital			deficit)			Receivable			Equity


		(In thousands)
Balance, August 31, 2000			4,777	$	239	$	8,606		$	6,271		$	—		$	15,116

	Net loss		—		—		—			(3,193	)		—			(3,193	)
	Issuance of common shares under stock benefit plans and option plans		230		11		1,369			—			—			1,380
	Non-cash CMED expenses		—		—		161			—			—			161
	Notes receivable		—		—		—			—			(1,266	)		(1,266	)
	Private equity placement		950		48		6,174			—			—			6,222

Balance, August 31, 2001			5,957		298		16,310			3,078			(1,266	)		18,420

	Net loss		—		—		—			(3,892	)		—			(3,892	)
	Tax valuation allowance adjustments		—		—		(233	)		—			—			(233	)
	Issuance of common shares under stock benefit plans and option plans		55		3		272			—			—			275

Balance, August 31, 2002			6,012		301		16,349			(814	)		(1,266	)		14,570

	Net loss		—		—		—			(4,629	)		—			(4,629	)
	Note receivable write off		—		—		—			—			587			587
	Payments on officers loans		—		—		—			—			10			10
	Issuance of common shares — CMED		1,000		50		2,550			—			—			2,600
	Issuance of common shares under stock benefit plans and option plans		34		1		52			—			—			53

Balance, August 31, 2003			7,046	$	352	$	18,951		$	(5,443	)	$	(669	)	$	13,191



		Years Ended August 31,

		2003			2002			2001


		(In thousands)
Cash flow from operating activities:
	Net loss	$	(4,629	)	$	(3,892	)	$	(3,193	)
	Equity in net loss from MSC		—			—			1,417
	Depreciation and amortization		3,295			2,909			2,862
	Accounts receivable allowance		7			(186	)		56
	Reserve for note receivable from former officer		597			—			—
	Asset impairment charges		331			—			—
	Deferred income tax expense (benefit)		—			1,609			(930	)
	Non-cash expenses for CMED transaction		—			—			161
	Loss on disposal of property and equipment and other		69			—			188
Changes in operating assets and liabilities, net of acquisition:
	Accounts receivable		(2,488	)		1,270			3,909
	Inventories		581			257			1,585
	Other current assets		(81	)		(110	)		176
	Accounts payable		2,136			(97	)		(2,414	)
	Accrued liabilities		504			(683	)		113

Net cash flow provided by operating activities			322			1,077			3,930

Cash flow from investing activities:
	Additions to property and equipment		(442	)		(2,291	)		(3,418	)
	Additions to patents		(138	)		(132	)		(115	)
	AMO acquisition costs paid		(1,486	)		—			—
	Cash acquired from CMED		1,215			—			—
	Other long-term assets		217			—			(356	)

Net cash flow used in investing activities			(634	)		(2,423	)		(3,889	)

Cash flow from financing activities:
	Issuance of common stock		53			275			6,336
	Proceeds from long-term debt		2,804			—			1,762
	Repayments of long-term debt		(3,906	)		(1,499	)		(1,350	)
	Deferred financing fees		(106	)		(30	)		(33	)
	Decrease (increase) in restricted cash		1,000			(1,000	)		86
	Net borrowings on (repayments of) line of credit		(1,099	)		1,579			(2,933	)

Net cash flow provided by (used in) financing activities			(1,254	)		(675	)		3,868

Net increase (decrease) in cash and cash equivalents			(1,566	)		(2,021	)		3,909
Cash and cash equivalents, beginning of year			2,372			4,393			484

Cash and cash equivalents, end of year		$	806		$	2,372		$	4,393

*Supplemental disclosures of cash flow information:*
Interest paid		$	328		$	395		$	466
Income taxes received			(21	)		(351	)		(48	)

*Supplemental disclosures of non-cash financing and investing activities:*
In connection with the acquisition of AMO, the Company issued one million shares of its common stock, valued at $2.9 million.



		August 31

		2003			2002

Accounts receivable, net:
	Trade accounts receivable	$	6,406		$	3,618
	Less: allowance for doubtful accounts		(92	)		(85	)

		$	6,314		$	3,533

Inventories:
	Purchased parts	$	4,297		$	1,944
	Work in process		958			597
	Finished goods		1,609			1,486

		$	6,864		$	4,027

Accrued liabilities:
	Accrued employee related costs	$	1,085		$	655
	Contractual manufacturing obligations		498			—
	Customers deposits		371			—
	Current maturities of long-term liabilities		741			—
	Interest accrued		156			—
	Warranty reserve		122			200
	Other accrued liabilities		825			246

		$	3,798		$	1,101

Other long-term liabilities:
	Remaining lease obligation, less estimated sublease proceeds	$	2,183		$	—
	Unfavorable operating lease, net		610			—
	Other non-current liabilities		69			—

Total		$	2,862		$	—
Less current maturities			741			—
Total other long-term liabilities		$	2,121		$	—


	Balance at
	Beginning of Year		Provisions		Claims		Balance at End of Year

Fiscal 2003	$	200	$	168	$	246	$	122
Fiscal 2002		40		275		115		200
Fiscal 2001		40		224		224		40


		Amount

Purchase price allocation:
	Cash	$	1,215
	Accounts receivable		300
	Inventories		3,418
	Property and equipment		1,466
	Prepaids, deposits and other assets		1,690
	Developed technology		451
	Customer deposits and other reserves		(1,344	)
	Operating lease reserves		(3,110	)
	Transaction costs		(1,486	)

	Total purchase price	$	2,600


Fiscal Years Ending
August 31,

Refinancing gain in 2004	$	472
2004		397
2005		381
2006		330
2007		360
2008		68
Thereafter		944

	$	2,952



		Fiscal Year Ended August 31

		2003			2002			2001


		(In thousands)
Current:
	Federal	$	(21	)	$	(459	)	$	—
	State		—			(58	)		—
Deferred			—			1,609			(930	)

Income tax expense (benefit)		$	(21	)	$	1,092		$	(930	)


				Weighted
				Average
	Options			Exercise Price
	Outstanding			Per Share

Balance, August 31, 2000		993		$	8.042
Granted		423			13.858
Exercised		(230	)		6.009
Cancelled		(80	)		10.316

Balance, August 31, 2001		1,106			10.523

Granted		528			6.529
Exercised		(55	)		4.977
Cancelled		(86	)		10.446

Balance, August 31, 2002		1,493			9.305

Granted		519			2.898
Exercised		(34	)		1.590
Cancelled		(578	)		9.431

Balance, August 31, 2003		1,400			7,218



	Options Outstanding
							Options Exercisable
					Weighted
			Weighted		Average				Weighted
			Average		Remaining				Average
	Number of		Exercise		Contractual		Number of		Exercise
Range of Exercise Prices	Options		Price		Life		Options		Price

$1.680-3.180		340	$	2.22		9.6		100	$	1.83
$3.181-5.99		433		5.31		7.7		181		5.67
$6.00-9.99		212		7.24		7.9		54		6.90
$10.00-11.99		172		10.75		6.4		121		10.74
$12.00-14.99		227		13.63		7.1		85		13.48
$15.00-20.375		16		18.90		7.0		4		18.90

		1,400	$	7.020		7.9		545	$	7.536


	Minimum Operating
Year Ending August 31,	Lease Commitments

2004	$	2,110
2005		1,993
2006		1,853
2007		1,711
2008		1,712
Thereafter		8,631

Total minimum lease payments	$	18,010


	*Major Customers, Concentration of Credit Risk and Geographic Data*


Fiscal Year 2003		First			Second			Third			Fourth


		(Unaudited)
		(In thousands, except per share amounts)
Net sales		$	5,490		$	8,144		$	12,517		$	12,289
Gross profit			612			862			2,534			3,105
Unusual charges			—			—			—			331
Operating loss			(1,140	)		(1,342	)		(389	)		(566	)
Net loss			(1,155	)		(1,336	)		(1,311	)		(827	)

Net loss per share
	Basic	$	(0.19	)	$	(0.21	)	$	(0.19	)	$	(0.12	)
	Diluted	$	(0.19	)	$	(0.21	)	$	(0.19	)	$	(0.12	)


Fiscal Year 2002		First			Second			Third		Fourth


		(Unaudited)
		(In thousands, except per share amounts)
Net sales		$	6,126		$	7,799		$	8,500	$	6,108
Gross profit			385			1,539			2,154		1,075
Operating income (loss)			(1,637	)		(412	)		206		(850	)
Net income (loss)			(1,094	)		(310	)		115		(2,602	)

Net income (loss) per share
	Basic	$	(0.18	)	$	(0.05	)	$	0.02	$	(0.43	)
	Diluted	$	(0.18	)	$	(0.05	)	$	0.02	$	(0.43	)


Item 12.	*Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.*


2.1	Agreement and Plan of Reorganization, dated February 25, 2000, by and among HEI, Inc., Leonard Acquisition Corp., Cross Technology, Inc., Mart Diana (as Shareholders’ Agent) and the Shareholders of Cross Technology, Inc.	Note 1
2.2	Purchase Agreement, dated as of January 24, 2003, by and between HEI, Inc. and Colorado MEDtech, Inc.	Note 2
2.3	Registration Rights Agreement, dated as of January 24, 2003, by and between HEI, Inc. and Colorado MEDtech, Inc.	Note 2
3.1	Amended and Restated Articles of Incorporation of HEI, Inc.	Note 3
3.2	Amended and Restated Bylaws of HEI, Inc.	Note 3
†3.3	Amendment, dated March 19, 2003, to the Amended and Restated Bylaws of HEI, Inc.
10.1	Loan and Security Agreement, dated July 31, 2000, among HEI, Inc. and LaSalle Business Credit, Inc.	Note 4
10.2	First Amendment to Credit Agreement, dated August 31, 2000, by and between HEI, Inc. and LaSalle Business Credit, Inc.	Note 5
10.3	Second Amendment to Loan and Security Agreement, dated April 16, 2001, between HEI, Inc. and LaSalle Business Credit, Inc.	Note 5
10.4	Third Amendment to Loan and Security Agreement, dated October 31, 2001, between HEI, Inc., Cross Technology, Inc. and LaSalle Business Credit, Inc.	Note 5
10.5	Seventh Amendment to Loan and Security Agreement, dated December 1, 2002, between HEI, Inc., Cross Technology, Inc. and LaSalle Business Credit, Inc.	Note 6
10.6	Eighth Amendment to Loan and Security Agreement, dated April 9, 2003, between HEI, Inc., Cross Technology, Inc. and LaSalle Business Credit, Inc.	Note 7
10.7	Capital Expenditure Note, executed as of July 31, 2000, by HEI, Inc. in favor of LaSalle Business Credit, Inc.	Note 4
10.8	Amended and Restated Capital Expenditure Note, executed as of October 31, 2001, by HEI, Inc. and Cross Technology, Inc. in favor of LaSalle Business Credit, Inc.	Note 5
10.9	Amended and Restated Capital Expenditure Note, executed as of October 31, 2001, by HEI, Inc. and Cross Technology, Inc. in favor of LaSalle Business Credit, Inc.	Note 5
10.10	Amended and Restated Capital Expenditure Note, executed as of October 31, 2001, by HEI, Inc. and Cross Technology, Inc. in favor of LaSalle Business Credit, Inc.	Note 5
10.11	Amended and Restated Capital Expenditure Note, executed as of October 31, 2001, by HEI, Inc. and Cross Technology, Inc. in favor of LaSalle Business Credit, Inc.	Note 5
10.12	Reimbursement Agreement, dated July 31, 2000, by and between HEI, Inc., LaSalle Bank, N.A. and LaSalle Business Credit, Inc.	Note 4
10.13	Mortgage, Security Agreement, Fixture Financing Statement and Assignment of Lease and Rents, dated July 31, 2000, by HEI, Inc., as Mortgagor, to LaSalle Business Credit, Inc., as Mortgagee	Note 4


10.14	Patent, Trademark and License Mortgage, dated July 31, 2000, by HEI, Inc. in favor of LaSalle Business Credit, Inc.	Note 4
10.15	Amendment No. 1 to Patent, Trademark and License Agreement, undated, between HEI, Inc. and LaSalle Business Credit, Inc.	Note 5
10.16	Security Agreement, dated July 31, 2000, by and between HEI, Inc. and LaSalle Business Credit, Inc.	Note 4
10.17	Revolving Note, executed as of July 31, 2000, by HEI, Inc. in favor of LaSalle Business Credit, Inc.	Note 4
10.18	Amended and Restated Revolving Note, executed as of October 31, 2001, by HEI, Inc. and Cross Technology, Inc. in favor of LaSalle Business Credit, Inc.	Note 5
10.19	Amended and Restated Revolving Note, executed as of December 1, 2002, by HEI, Inc. and Cross Technology, Inc. in favor of LaSalle Business Credit, Inc.	Note 6
*10.20	Form of Indemnification Agreement between HEI and officers and directors	Note 8
*10.21	HEI, Inc. 1989 Omnibus Stock Compensation Plan adopted April 3, 1989, as amended to date.	Note 9
*10.22	HEI, Inc. 1991 Stock Option Plan for Non-employee Directors, as amended to date.	Note 10
*10.23	HEI, Inc. 1998 Stock Option Plan adopted November 18, 1998.	Note 11
†*10.24	HEI, Inc. 1998 Stock Option Plan for Non-Employee Directors adopted November 18, 1998, as amended to date.
10.25	Stock Purchase Agreement by and among HEI, Inc. and Certain Investors listed on Exhibit A thereto, dated August 29, 2001.	Note 13
10.26	Sample Promissory Note of Certain Officers and Directors in connection with the Exercise of Stock Options.	Note 12
10.27	Subordinated Promissory Note, dated as of January 24, 2003, issued by HEI, Inc. and accepted by Colorado MEDtech, Inc.	Note 14
10.28	Lease, dated as of January 7, 2002, by and between Eastside Properties, LLC and Colorado MEDtech, Inc., subsequently assigned to HEI, Inc.	Note 14
10.29	First Addendum to Lease, dated September 12, 2002, by and between Eastside Properties, LLC and Colorado MEDtech, Inc., subsequently assigned to HEI, Inc.	Note 14
10.30	Second Addendum to Lease, dated January 23, 2003, by and between Eastside Properties, LLC and Colorado MEDtech, Inc., subsequently assigned to HEI, Inc.	Note 14
10.31	Agreement Regarding Additional Security Deposit by and between Eastside Properties, Inc. and HEI, Inc.	Note 14
10.32	Letter Agreement, dated May 16, 2003, between HEI, Inc. and Whitebox Hedged High Yield Partners.	Note 15
10.33	Accounts Receivable Agreement, dated May 29, 2003, by and between HEI, Inc. and Beacon Bank.	Note 15
†*10.34	Separation Agreement and Release, dated June 20, 2003, between HEI, Inc. and Steve E Tondera, Jr.
†*10.35	Employment Agreement, dated October 1, 2003, between HEI, Inc. and Douglas J. Nesbit.
†*10.36	Employment Agreement, dated October 1, 2003, between HEI, Inc. and Stephen K. Peterson.
†*10.37	Employment Agreement, dated October 1, 2003, between HEI, Inc. and Scott M. Stole.
†*10.38	Employment Agreement, dated October 1, 2003, between HEI, Inc. and Simon F. Hawksworth.
†*10.39	Employment Agreement, dated October 1, 2003, between HEI, Inc. and James C. Vetricek.


	†10.40			Note Prepayment Agreement, dated October 15, 2003, between HEI, Inc. and Whitebox Hedged High Yield Partners.
	†10.41			Promissory Note, dated October 14, 2003, by HEI, Inc. in favor of Commerce Bank.
	†10.42			Term Loan Agreement, dated October 14, 2003, by HEI, Inc. and Commerce Bank.
	†10.43			Combination Mortgage, Security Agreement, Assignment of Rents and Fixture Financing Statement, dated October 14, 2003, by HEI, Inc. in favor of Commerce Bank.
	†10.44			Environmental Investigation Letter, dated October 14, 2003, by HEI, Inc. in favor of Commerce Bank.
	†10.45			Promissory Note, dated October 28, 2003, by HEI, Inc. in favor of Commerce Financial Group.
	†10.46			Term Loan Agreement, dated October 28, 2003, by HEI, Inc. and Commerce Financial Group
	†10.47			Commercial Security Agreement, dated October 28, 2003, by HEI, Inc. in favor of Commerce Financial Group.
	†10.48			Combination Mortgage, Security Agreement, Assignment of Rents and Fixture Financing Statement, dated October 28, 2003, by HEI, Inc. in favor of Commerce Financial Group.
	†10.49			Environmental Investigation Letter, dated October 28, 2003, by HEI, Inc. in favor of Commerce Financial Group.
	†10.50			Asset Purchase Agreement, dated October 31, 2003, by HEI, Inc. and MKS Instruments, Inc.
	†10.51			Accounts Receivable Agreement Amendment, dated December 12, 2003, by and between HEI, Inc. and Beacon Bank.
	†21			Subsidiaries of the Registrant.
	†23			Consent of KPMG LLP.
	†31.1			Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	†31.2			Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	†32.1			Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	†32.2			Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


	*	Denotes management contract or compensation plan or arrangement.


	Balance at		Additions Charged
	Beginning		to Costs and		Deductions		Balance at
	of Period		Expenses		from Reserve(1)		End of Period


	(In thousands of dollars)
Allowance for doubtful accounts:
Year ended August 31, 2003	$	85	$	30	$	23	$	92
Year ended August 31, 2002		271		6		192		85
Year ended August 31, 2001		215		1,268		1,212		271


		Date


/s/ MACK V. TRAYNOR III Mack V. Traynor III	Chief Executive Officer and President	December 15, 2003

/s/ DOUGLAS J. NESBIT Douglas J. Nesbit	Chief Financial Officer	December 15, 2003

/s/ DENNIS J. LEISZ Dennis J. Leisz	Director	December 15, 2003

/s/ TIMOTHY F. FLOEDER Timothy F. Floeder	Director	December 15, 2003

/s/ MIKE EVERS Mike Evers	Director	December 15, 2003

/s/ GEORGE HEENAN George Heenan	Director	December 15, 2003

Anthony J. Fant	Director