10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-Q

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þ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 2, 2007.

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from                     to                     .

Commission File Number 0-10078

HEI, Inc.

(Exact name of Registrant as Specified in Its Charter)

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

(952) 443-2500

Registrant’s telephone number, including area code

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o           Accelerated filer o           Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of July 16, 2007, 9,514,317 Common Shares, par value $.05 per share, were outstanding.

TABLE OF CONTENTS

Table of Contents

	Page
Part I – Financial Information (Unaudited)
Item 1. Financial Statements
Consolidated Balance Sheets		3
Consolidated Statements of Operations		4
Consolidated Statements of Cash Flow		5
Notes to Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3. Quantitative and Qualitative Disclosures About Market Risk		20
Item 4. Controls and Procedures		21
Part II – Other Information
Item 1. Legal Proceedings		21
Item 1A. Risk Factors		22
Item 6. Exhibits		22
Signature		23
Form of Credit and Security Agreement
Form of Credit and Security Agreement
302 Certification of CEO and CFO
906 Certification of CEO and CFO

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HEI, Inc.

Consolidated Balance Sheets

	June 2,			September 2,
	2007			2006
	(Unaudited)			(Audited)
	(In thousands
	except per share and share data)
ASSETS
Current assets:
Cash and cash equivalents	$	96		$	674
Accounts receivable, net of allowance for doubtful accounts of $116 and $124, respectively		5,604			9,205
Inventories		4,717			7,000
Deferred income taxes		830			830
Other current assets		262			316
Total current assets		11,509			18,025
Property and equipment:
Land		216			216
Building and improvements		4,388			4,374
Fixtures and equipment		23,638			24,406
Accumulated depreciation		(21,740	)		(21,279	)
Net property and equipment		6,502			7,717
Security deposit		524			550
Other long-term assets		593			580
Total assets	$	19,128		$	26,872
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Line of credit	$	—		$	5,948
Current maturities of long-term debt		854			1,038
Accounts payable		2,856			3,735
Accrued liabilities		1,704			2,184
Total current liabilities		5,414			12,905
Deferred income taxes		830			830
Other long-term liabilities, less current maturities		1,676			1,549
Long-term debt, less current maturities		7,159			2,824
Total other long-term liabilities, less current maturities		9,665			5,203
Total liabilities		15,079			18,108
Commitments and contingencies
Shareholders’ equity:
Undesignated stock; 5,000,000 shares authorized; none issued		—			—
Convertible preferred stock, $.05 par; 167,000 shares authorized; 32,000 shares issued and outstanding at both June 2, 2007 and September 2, 2006; liquidation preference at $26 per share (total liquidation preference $832,000) at both June 2, 2007 and September 2, 2006		2			2
Common stock, $.05 par; 20,000,000 shares authorized; 9,562,000 and 9,504,000 shares issued and 9,514,000 and 9,504,000 shares outstanding at June 2, 2007 and September 2, 2006, respectively		476			475
Paid-in capital		27,748			27,581
Accumulated deficit		(24,160	)		(19,226	)
Notes receivable-related parties-officers and former directors		(17	)		(68	)
Total shareholders’ equity		4,049			8,764
Total liabilities and shareholders’ equity	$	19,128		$	26,872

See accompanying notes to unaudited consolidated financial statements.

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HEI, Inc.

Consolidated Statements of Operations (Unaudited)

	Three Months Ended						Nine Months Ended
	June 2, 2007			May 27, 2006			June 2, 2007			May 27, 2006
	(In thousands)						(In thousands)
Net sales	$	9,830		$	13,219		$	33,331		$	38,724
Cost of sales		9,631			10,781			30,791			31,816
Gross profit		199			2,438			2,540			6,908
Operating expenses:
Selling, general and administrative		1,533			2,247			4,898			6,759
Research, development and engineering		547			1,062			1,959			3,140
Total operating expenses		2,080			3,309			6,857			9,899
Operating loss		(1,881	)		(871	)		(4,317	)		(2,991	)
Other income (expenses):
Interest expense, net		(350	)		(206	)		(1,119	)		(429	)
Other income (expense), net		476			(34	)		502			(9	)
Net loss	$	(1,755	)	$	(1,111	)	$	(4,934	)	$	(3,429	)
Net loss per common share:
Basic and Diluted	$	(0.18	)	$	(0.12	)	$	(0.52	)	$	(0.36	)
Weighted average common shares outstanding:
Basic and Diluted		9,514			9,491			9,509			9,457

See accompanying notes to unaudited consolidated financial statements.

4

HEI, Inc.

Consolidated Statements of Cash Flows (Unaudited)

	Nine Months Ended
	June 2, 2007			May 27, 2006
	(In thousands)
Cash flow from operating activities:
Net loss	$	(4,934	)	$	(3,429	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		1,529			1,848
Loss on disposal of property and equipment		4			33
Stock based compensation expense		168			387
Changes in operating assets and liabilities:
Accounts receivable		3,601			1,231
Inventories		2,283			222
Other current assets		54			323
Accounts payable		(879	)		474
Accrued liabilities and other long-term liabilities		(353	)		(1,247	)
Net cash flow provided by (used in) operating activities		1,473			(158	)
Cash flow from investing activities:
Additions to property and equipment		(384	)		(923	)
Proceeds from sale of assets		177			83
Additions to patents		(9	)		(7	)
Refund of security deposit		26			1,166
Net cash flow provided by (used in) investing activities		(190	)		319
Cash flow from financing activities:
Proceeds from issuance of stock, net		—			47
Former director note repayment		51			139
Repayment of long-term debt		(914	)		(386	)
Proceeds form long-term debt, net of debt issuance costs		4,950			—
Net repayments on line of credit		(5,948	)		(143	)
Net cash flow provided by (used in) financing activities		(1,861	)		(343	)
Net increase (decrease) in cash and cash equivalents		(578	)		(182	)
Cash and cash equivalents, beginning of period		674			351
Cash and cash equivalents, end of period	$	96		$	169
Supplemental disclosures of cash flow information:
Interest paid	$	1,089		$	435
Capital lease obligations related to equipment acquisitions	$	—		$	2,144
Issuance of common stock to landlord recorded as long-term asset	$	—		$	336

See accompanying notes to unaudited consolidated financial statements.

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HEI, Inc.

Notes to Unaudited Consolidated Financial Statements

(1) Basis of Financial Statement Presentation

The accompanying unaudited interim consolidated financial statements have been prepared by HEI, Inc. pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These financial statements contain all normal recurring adjustments, which are, in our opinion, necessary for a fair presentation of the financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. We believe, however, that the disclosures are adequate to make the information presented not misleading. The year-end balance sheet data was derived from audited financial statements but does not include all disclosures required by GAAP. These unaudited interim consolidated financial statements should be read in conjunction with the financial statements and accompanying notes included in our Annual Report on Form 10-K for our fiscal year ended September 2, 2006 (“Fiscal 2006”). Interim results of operations for the three-month and nine-month periods ended June 2, 2007, may not necessarily be indicative of the results to be expected for the full year.

The unaudited interim consolidated financial statements include the accounts of our wholly-owned subsidiary. All significant intercompany transactions and balances have been eliminated in consolidation.

Our quarterly periods end on the Saturday closest to the end of each quarter of our fiscal year. During fiscal year 2006, the Company changed its fiscal year end to a 52 or 53 week period ending on the Saturday closest to August 31. Fiscal year 2006 ended on September 2, 2006 and fiscal year 2007 will end on September 1, 2007.

Summary of Significant Accounting Policies

Revenue Recognition. Revenue for manufacturing and assembly is recognized upon shipment to the customer which represents the point at which the risks and rewards of ownership have been transferred to the customer. Previously, we had a limited number of arrangements with customers which required that we retain ownership of inventory until it was received by the customer or until it was accepted by the customer. There were no additional obligations or other rights of return associated with these agreements. Accordingly, revenue for these arrangements was recognized upon receipt by the customer or upon acceptance by the customer.

AMO’s development contracts are typically discrete time and materials projects that generally do not involve separately priced deliverables. Development contract revenue is recognized ratably as development activities occur based on contractual per hour and material reimbursement rates. Development contracts are an interactive process with customers as different design and functionality is contemplated during the design phase. Upon reaching the contractual billing maximums, we defer revenue until contract extensions or purchase orders are received from customers. We occasionally have contractual arrangements in which part or all of the payment or billing is contingent upon achieving milestones or customer acceptance. For those contracts we evaluate whether the contract should be accounted using the completed contract method if the term of the arrangement is short-term or using the percentage of completion method for longer-term contracts.

Inventories. Inventories are stated at the lower of cost or market and include materials, labor, and overhead costs. Cost is determined using the first-in-first-out method (FIFO). The majority of the inventory is purchased based on contractual forecasts and customer purchase orders, and in these cases, excess or obsolete inventory may be 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. Depreciation and amortization expense on property and equipment and other long-term assets was $465,000 and $642,000 for the three months ended June 2, 2007 and May 27, 2006, respectively, and $1,529,000 and $1,848,000 for the nine months ended June 2, 2007 and May 27, 2006, respectively.

Maintenance and repairs are charged to expense as incurred. Major improvements and tooling costs are capitalized and depreciated using the straight-line method 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.

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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.

Reclassifications. The Company has elected to reclassify certain balance sheet amounts for comparative purposes. The reclassifications specifically relate to the classification of long-term lease accounting valuations that were previously recorded as current liabilities and have been broken out as both current and long-term liabilities to reflect their nature.

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.

(2) Liquidity

We incurred a net loss of $1,755,000 and $1,111,000 for the three months ended June 2, 2007 and May 27, 2006, respectively. For the nine months ended June 2, 2007 and May 27, 2006, we incurred a net loss of $4,934,000 and $3,429,000, respectively. The Company experienced an increase in sales in Fiscal 2005 compared to Fiscal 2004 and anticipated the sales increase to continue during Fiscal 2006. As a result, our costs were structured to support the higher level of anticipated sales including selling, general and administrative costs and research, development and engineering costs. The higher sales levels were not achieved during Fiscal 2006 or the first nine months of Fiscal 2007 and cost reductions were not implemented until late in Fiscal 2006 and throughout the first nine months of Fiscal 2007. These cost reductions had little to no impact in reducing the operating loss during Fiscal 2006 and the severance costs and inventory adjustments negatively impacted results during the first nine months of Fiscal 2007. In addition, during Fiscal 2007, a change in the sales mix at our RFID and AMO divisions reduced the overall gross margin contribution on the sales that were achieved at those divisions. During Fiscal 2006, the operating losses were funded in part by the refund of the security deposit on our AMO facility in the amount of $1.35 million (net of additional security deposits on other debt of $320,000). The operating losses sustained during the nine months ended June 2, 2007 have been funded through borrowing under our various line of credit facilities and the Company has excess borrowing capacity under its current line of credit facility to fund the operation through its turnaround efforts over the next several quarters.

In April 2006, the Company entered into a $2,000,000 revolving line of credit with Beacon Bank that is secured by a portion of our inventory and our foreign accounts receivable and guaranteed by the Small Business Administration (the “Line of Credit”). The Line of Credit expired on April 18, 2007 and was paid off in April and May 2007.

On November 3, 2006, Thomas F. Leahy, the Chairman of the Board of Directors of the Company, loaned the Company $5,000,000 dollars (the “Secured Loan”). The Company’s obligations under the Secured Loan were evidenced by a promissory note (the “Note”) and a security agreement. The Note had an original principal amount of $5,000,000, and required the Company to pay monthly installments of interest, and a maturity of November 2, 2007. The Company used $2,200,000 of the proceeds of the Secured Loan to satisfy the Company’s obligations under its accounts receiveable agreement with Beacon Bank of Shorewood, Minnesota dated May 29, 2003, as amended. The remainder of the proceeds were available for general working capital needs. The Secured Loan was paid off in full on May 15, 2007. During the period of time that this related party Note was outstanding, the Company paid Mr. Leahy a total of $451,000 in interest payments.

On May 15, 2007, the Company entered into a three year $8.0 million revolving credit facility pursuant to a Credit and Security Agreement with Wells Fargo Business Credit, and a three year $340,000 term loan. Borrowings under these facilities were used to repay the $5 million loan to the Company by Thomas F. Leahy, the Company’s Chairman of the Board, to repay certain obligations of the Company and for general operating purposes. Mr. Leahy guaranteed the financing package in an amount not to exceed $4 million and provided collateral to secure the guarantee in the amount of $4 million. In return, he will be paid a guarantee fee in the amount of $8,000 per month by the Company for six months in consideration for the guarantee and collateral pledge. The revolving credit facilities are secured by accounts receivable and inventories and a third mortgage position on the Company’s Victoria Minnesota production facility. The term loan is secured by a first priority security interest in all non-leased assets at the Company’s Tempe Arizona production facility. The revolving line of credit advance rates are based on outstanding balances of both domestic and foreign accounts receivable and certain inventory balances. The interest rate on the revolving line of credit advances is 2% over prime and the

7

term loan interest rate is 2.25% over prime, except upon an event of default. The current prime rate is 8.25%. The term loan has a 60 month amortization period with monthly payments beginning June 1, 2007 with the balance due and payable in full on May 15, 2010. The credit facilities require a minimum interest charge of $150,000 per year and there is an unused line fee of 0.25% under the revolving credit facility with a term date of May 15, 2010.

These credit facilities with Wells Fargo Business Credit (“Wells”) contain customary affirmative and negative covenants. The financial covenants include a limitation on capital expenditures, a maximum/minimum cumulative net loss/net income position through February 2008 and a minimum debt service coverage ratio beginning with the Company’s fiscal year 2008. The creation of indebtedness outside the credit facility, creation of liens, making of certain investments, sale of assets, and incurrence of debt are all either limited or require prior approval from Wells under those facilities. These credit facilities also contain customary events of default such as nonpayment, bankruptcy, and change in the Company’s Chairman of the Board, which if they occur may constitute an event of default. The Company was in compliance with all covenants under the credit facilities with Wells at June 2, 2007.

As a result of these events, at June 2, 2007 our sources of liquidity consisted of $96,000 of cash and cash equivalents and approximately $2,000,000 of borrowing capacity under our revolving credit facility. Our liquidity, however, 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.

Beginning in mid-Fiscal 2006, the Company focused efforts on changing its cost structures and operating structures in an effort to reduce costs and strengthen the operational performance of each of segment. The most significant change was to shift from a centralized management of our segments to setting up a general manager for each of our operations. Some additional cost reductions were further undertaken at our Victoria and Chanhassen facilities towards the end of Fiscal 2006. The impacts of these changes along with the reduction of overall sales levels were not adequate to move the Company to a level of profitability by the end of the Fiscal 2006 and negatively impacted the first quarter of Fiscal 2007. Further cost reductions were undertaken during the first nine months of Fiscal 2007 to better align costs with current revenue levels. These reductions also had a negative impact on the first nine months of Fiscal 2007 due in part to severance obligations in certain instances and inventory adjustments.

Beginning in Fiscal 2007, the Company hired a new Chief Executive Officer, who was hired as the Company’s Chief Financial Officer in June 2006. He continues to fulfill that dual role and his efforts are targeted on cost structures and operational improvements. Additional cost reductions have already been initiated in addition to operational improvement initiatives at each of our segments. Revised operating budgets have been established to allow us to focus our efforts on our operating activity and expenses and to improve gross margins and minimize costs. Initiatives include:

• Refinancing our debt to improve cash flow.

• Emphasis on sales efforts in all of our business segments.

• Focusing on gross margin improvements at all segments by focusing on our material costs, labor costs and overhead structures.

• Structuring our staffing to work within our current sales levels for all of our general and administrative costs and engineering costs, and to reorganize the staff as necessary to position the Company for growth.

• Pursuing additional sublease tenants for the excess space in our Boulder facility while allowing for adequate room for expansion in that the AMO segment. This will help to offset a portion of the operating costs and lease costs of that facility.

• Reduction in inventories by reviewing buying procedures and reducing any excess on hand inventory while maintaining the required inventories to meet customer demand. Our initiatives targeted a reduction in inventories by a total of $1 million by the end of Fiscal 2007, and we exceeded that target by over $500,000 during the first nine months of Fiscal 2007.

For the remainder of Fiscal 2007, we intend to limit spending for manufacturing equipment. All expenditures will be made on an as needed basis and future capital expenditures will be budgeted as part of the strategic planning and budgeting process for Fiscal 2008 as we determine our needs to expand our manufacturing capacity and our technological capabilities in order to meet the expanding needs of our customers. It is expected that these expenditures will be funded from existing cash, cash generated from operations, lease financing and available debt financing.

In the event future cash flows and borrowing capacities are not sufficient to fund operations at the present level, additional measures will be taken including efforts to further reduce expenditure levels that may include reduction of spending for research and development, engineering, elimination of budgeted raises, and reduction of non-strategic employees and the deferral or elimination of

8

capital expenditures. In addition, we believe that other sources of liquidity are available including issuance of the Company’s stock, the expansion of our credit facilities and the issuance of long-term debt.

Management believes that existing, current and future lending capacity and cash generated from operations will supply sufficient cash flow to meet short-term and long-term debt obligations, working capital, capital expenditure and operating requirements during the next 12 months.

(3) Stock Based Compensation

On December 16, 2004, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment”, which is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be expensed over the applicable vesting period. Pro forma disclosure of the income statement effects of share-based payments is no longer an alternative. For the Company, SFAS No. 123(R) is effective for all share-based awards granted on or after September 1, 2005. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date. Compensation expense for the unvested awards is measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS No. 123. We implemented SFAS No. 123(R) on September 1, 2005 using the modified prospective method.

Stock Options

As more fully described in our annual report on Form 10-K for the year ended September 2, 2006, we have granted stock options over the years to employees and directors under various shareholder approved stock plans. The fair value of each option grant was determined as of grant date, utilizing the Black-Scholes option pricing model. The Company calculates expected volatility for stock options and awards using historical volatility as the Company believes the expected volatility will approximate historical volatility. The Company estimates the forfeiture rate for stock options using 10% for key employees and 15% for non-key employees. As of June 2, 2007, and September 2, 2006, respectively, 941,000 and 1,336,975 stock options were outstanding. We recognized compensation expense of $44,000 ($0.00 per share) for the quarter ended June 2, 2007 and $102,000 ($0.01 per share) for the comparative quarter ended May 27, 2006. We recognized compensation expense of $133,000 ($0.01 per share) for the nine months ended June 2, 2007 and $375,000 ($0.04 per share) for the comparative nine months ended May 27, 2006. The expense recognized of $44,000 and $133,000 for the quarter and nine months ended June 2, 2007 was lower than projected as disclosed as of the fiscal year ended September 2, 2006 due to employee terminations subsequent to the end of the fiscal year that resulted in forfeiture of certain stock options during the three and nine months ended June 2, 2007. During the three and nine months ended June 2, 2007, no options were granted. During the three and nine months ended May 27, 2006, 0 and 4,000 options were granted, respectively.

The amortization of the granted stock options will continue over the remaining vesting periods. The future stock based compensation expense for options as of June 2, 2007 will be approximately $42,000 for the remainder of fiscal year 2007 and $109,000, $38,000, $10,000 and $0 in each of the next four fiscal years, respectively.

Restricted Stock

We awarded restricted stock grants to employees and directors in fiscal year 2006 and 2007. The 2006 restricted stock grants were valued at the stock price on the grant date and vest prorata on the anniversary date over a four year period. The 2007 restricted stock grants were awarded to directors on March 5, 2007 and vest over six months. As of June 2, 2007 and September 2, 2006, respectively, 57,820 shares and 58,800 of restricted stock remained unvested. During the three and nine months ended June 2, 2007, we recognized $27,000 and $35,000 in compensation expense, respectively. During the three and nine months ended May 27, 2006, we recognized $12,000 compensation expense related to the restricted stock grants.

The amortization of the restricted stock grants will continue over the remaining vesting lives. The future stock based compensation expense for restricted stock as of June 2, 2007 will be approximately $28,000 for the remainder of fiscal year 2007 and $31,000, $31,000, $16,000 and $0 in each of the next four fiscal years, respectively.

(4) Other Financial Statement Data

The following provides additional information concerning selected consolidated balance sheet accounts at June 2, 2007 and September 2, 2006:

9

	June 2,		September 2,
	2007		2006
Inventories:
Purchased parts	$	3,436	$	4,735
Work in process		346		671
Finished goods		935		1,594
	$	4,717	$	7,000
Accrued liabilities:
Employee related costs (1)	$	1,214	$	1,346
Accrued taxes		148		396
Accrued audit, professional, board, public reporting and interest		161		120
Current maturities of other long-term liabilities		80		79
Other accrued liabilities		101		243
	$	1,704	$	2,184
Other long-term liabilities:
Remaining lease obligation, less estimated sublease proceeds	$	484	$	513
Accrued lease expense		774		588
Unfavorable operating lease, net		498		527
Total		1,756		1,628
Less current maturities		80		79
Total other long-term liabilities	$	1,676	$	1,549

⁽¹⁾ This total includes Accrued Severance Related Expenses. During the first three quarters of 2007, the Company reduced its workforce in an effort to reduce operating expenses. The Company recorded $182,000 and $582,000 in expense for these staff reductions of which $145,000 related to the resignation of the former CEO, during three and nine months ended June 2, 2007, respectively. At June 2, 2007, the remaining balance of the Accrued Severance Related Expenses was $96,000 and will be paid prior to the end of Fiscal 2007.

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(5) Long-Term Debt

Our long-term debt consists of the following:

	June 2,		September 2,
	2007		2006
	(In thousands)
Commerce Bank mortgage payable in monthly installments of principal and interest of $9 based on a twenty-year amortization with a final payment of approximately $1,050 due in November 2009; collateralized by our Victoria facility	$	1,104	$	1,122
Commerce Financial Group, Inc. equipment loan which was paid in full during Fiscal 2007		—		361
Wells Fargo Business Credit Term Loan payable in monthly installments of $6 through May 2010 based on a 60 month amortization with a final payment of approximately $150 due in May 2010; collateralized by equipment located at our Tempe facility		340		—
Wells Fargo Business Credit Revolving Line of Credit with a three year term through May; available borrowing is based on advance rates of accounts receivable and certain inventories; collateralized by substantially all assets of the Company and additional collateral provided by Mr. Leahy, the Company’s chairman		4,724		—
Capital lease and commercial loan obligations; payable in installments of $83 with periods ending July 2008 through February 2010; collateralized with certain machinery and equipment		1,845		2,379
Total		8,013		3,862
Less current maturities		854		1,038
Total long-term debt	$	7,159	$	2,824

The Company has two separate loans in the original aggregate amount of $2,350,000 under Term Loan Agreements with Commerce Bank, a Minnesota state banking association, and its affiliate, Commerce Financial Group, Inc., a Minnesota corporation. The first loan, with Commerce Bank, in the amount of $1,200,000 was executed on October 14, 2003. This loan is secured by our Victoria, Minnesota facility. The term of the first loan is six years with a nominal interest rate of 6.50% per year for the first three years. The rate was adjusted per the original agreement on November 1, 2006 to 9.25% per year. Monthly payment of principal and interest is based on a twenty-year amortization with a final payment of approximately $1,039,000 due on November 1, 2009. The second loan, with Commerce Financial Group, Inc., in the amount of $1,150,000 was executed on October 28, 2003. The second loan was secured by our Victoria facility and certain equipment located at our Tempe facility. The second loan was due October 27, 2007, but the loan was paid off early through the use of the proceeds from the Wells Fargo Business Credit revolving line of credit and term loan facilities that were entered into on May 15, 2007. There was no outstanding balance under the second loan as of June 2, 2007.

The Company has not been in compliance with the debt service coverage ratios required by these two agreements beginning with the quarter ended May 27, 2006. The Company has received waivers for any violations of its debt covenants with Commerce Bank and Commerce Financial Group, Inc. through September 1, 2007.

During Fiscal 2006, the Company entered into several capital lease agreements to fund the acquisition of machinery and equipment, primarily at our Tempe facility. Most of these leases were entered into with Commerce Financial Group and are secured by the equipment being leased and a secured interest in our Victoria building. The total principal amount of these leases as of June 2, 2007 is $1,449,000 with an average effective interest rate of 12.5%. These agreements are for 36 to 45 months with reduced payments in the last year of the lease. At the end of the lease we have the option to purchase the equipment for $1 or at an agreed upon value which is generally not less than 15% nor greater than 20% of the original equipment cost.

On May 15, 2007, the Company entered into a three year $8.0 million revolving credit facility pursuant to a Credit and Security Agreement with Wells Fargo Business Credit, and a three year $340,000 term loan. Borrowings under these facilities were used to repay the $5 million loan to the Company by Thomas F. Leahy, the Company’s Chairman of the Board, to repay certain obligations of the Company and for general operating purposes. Mr. Leahy guaranteed the financing package in an amount not to exceed $4 million and provided collateral to secure the guarantee in the amount of $4 million. In return for the guarantee and collateral pledge, he will be

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paid a guarantee fee in the amount of $8,000 per month by the Company for the next six months. The revolving credit facilities are secured by accounts receivable and inventories and a third mortgage position on the Company’s Victoria Minnesota production facility. The term loan is secured by a first priority security interest in all non-leased assets at the Company’s Tempe Arizona production facility. The revolving line of credit advance rates are based on outstanding balances of both domestic and foreign accounts receivable and certain inventory balances. The interest rate on the revolving line of credit advances is 2% over prime and the term loan interest rate is 2.25% over prime, except upon an event of default. The current prime rate is 8.25%. The term loan has a 60 month amortization period with monthly payments beginning June 1, 2007 with the balance due and payable in full on May 15, 2010. The revolving credit facilities are due on May 15, 2010. The credit facilities require a minimum interest charge of $150,000 per year and there is an unused line fee of 0.25% under the revolving credit facility.

(6) Line of Credit

In April 2006, the Company entered into a $2,000,000 revolving line of credit with Beacon Bank that was secured by a portion of our inventory and our foreign accounts receivable and guaranteed by the Small Business Administration (the “Line of Credit”). The Line of Credit was paid off in April and May 2007.

(7) Related Party Note Payable, Guarantee by Related Party and Notes Receivable-Related Parties-Officers and Former Directors

On November 3, 2006, Thomas F. Leahy, the Chairman of the Board of Directors of the Company, loaned the Company $5,000,000 dollars (the “Secured Loan”). The Company’s obligations under the Secured Loan were evidenced by a promissory note (the “Note”) and a security agreement. The Note had an original principal amount of $5,000,000, required the Company to pay monthly installments of interest, and was due and payable on November 2, 2007. The unpaid principal of the Note was repayable at any time without prepayment penalty or premium. Unpaid principal due under the Note bore interest at the rate of fifteen percent (15%) per annum, commencing on November 3, 2006 with such interest rate increasing by one percent (1%) each calendar month, beginning January 1, 2007, up to a maximum of twenty percent (20%) per annum. The Note was paid off on May 15, 2007 through the use of the proceeds from the Wells Fargo Busienss Credit revolving line of credit and term loan facilites entered into on May 15, 2007. During the period of time that this related party Note was outstanding, the Company paid Mr. Leahy a total of $451,000 in interest payments.

In order to provide an inducement to Wells Fargo Business Credit to advance funds sufficient to pay off his outstanding loan while providing the Company with adequate working capital access under the revolving line of credit facility, Mr. Leahy guaranteed the financing package in an amount not to exceed $4 million and provided collateral to secure the guarantee in the amount of $4 million. In return for the guarantee and collateral pledge, he will be paid a guarantee fee in the amount of $8,000 per month by the Company for the next six months. After six months, the Company and Mr. Leahy will revisit the guarantee fee and determine if a revised amount is warranted at that time.

In Fiscal 2001, the Company recorded notes receivable of $1,266,000 from certain officers and directors in connection with the exercise of stock options. The balance due as of September 2, 2006 was $68,000 from Edwin W. Finch, III, a former director. Payments totaling $51,000 were received during the nine months ended June 2, 2007. The remaining balance of $17,000 was due April 2, 2007. No reserve has been made for subsequent collectability at this time. As of June 2, 2007, the amount owed on this note was $17,000 which is presented as a reduction to shareholders’ equity.

(8) Deferred Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of our deferred tax assets and liabilities consist of timing differences related to allowance for doubtful accounts, depreciation, reserves for excess and obsolete inventory, accrued warranty reserves, and the future benefit associated with Federal and state net operating loss carryforwards. A valuation allowance has been set at approximately $11,250,000 and $9,821,000 at June 2, 2007 and September 2, 2006, respectively, because of uncertainties related to the ability to utilize certain Federal and state net loss carryforwards as determined in accordance with GAAP. The valuation allowance is based on estimates of taxable income by jurisdiction and the period over which our deferred tax assets are recoverable.

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(9) Net Loss per Share Computation

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

	Three Months Ended						Nine Months Ended
	June 2, 2007			May 27, 2006			June 2, 2007			May 27, 2006
Basic and Diluted:
Net loss	$	(1,755	)	$	(1,111	)	$	(4,934	)	$	(3,429	)
Net loss per share	$	(0.18	)	$	(0.12	)	$	(0.52	)	$	(0.36	)
Weighted average number of common shares outstanding		9,514			9,491			9,509			9,457

Approximately 1,893,000 and 2,372,000 shares of our Common Stock under stock options and warrants have been excluded from the calculation of diluted net loss per common share as they are antidilutive for the three-month and nine-month periods ended June 2, 2007 and May 27, 2006, respectively.

(10) Major Customers

For the three months ended June 2, 2007, no customers accounted for more than 10% of our revenues. For the nine-month period ended June 2, 2007, one customer accounted for 14% of net sales.

Net sales from one customer represented 18% of our revenue for the three months ended May 27, 2006. For the nine months ended May 27, 2006, two customers accounted for 13% and 10% of net sales, respectively.

As of June 2, 2007 one customer represented 11% of our accounts receivable balance and as of September 2, 2006, one customer represented 18% of accounts receivable balance.

(11) Geographic Data (In Thousands)

Sales to customers by geographic region as a percentage of net sales are as follows:

	Three Months Ended										Nine Months Ended
	June 2, 2007					May 27, 2006					June 2, 2007					May 27, 2006
	Dollars		% of Sales			Dollars		% of Sales			Dollars		% of Sales			Dollars		% of Sales
United States	$	7,501		76	%	$	9,333		71	%	$	25,724		77	%	$	27,667		71	%
Canada / Mexico	$	215		2	%	$	278		2	%	$	490		1	%	$	1,155		3	%
Europe	$	1,096		11	%	$	1,166		9	%	$	3,288		10	%	$	4,102		11	%
Asia-Pacific	$	1,009		11	%	$	2,431		18	%	$	3,801		12	%	$	5,773		15	%
South America	$	9		0	%	$	11		0	%	$	28		0	%	$	27		0	%
Total	$	9,830				$	13,219				$	33,331				$	38,724

(12) Segments (In Thousands)

Microelectronics Operations: This segment consists of three facilities — Victoria, Chanhassen, and Tempe — that design, manufacture and sell ultra miniature microelectronic devices and high technology products incorporating these devices.

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Advanced Medical Operations: This segment consists of our Boulder facility that provides design and manufacturing outsourcing of complex electronic and electromechanical medical devices.

Corporate Operations: This includes sales, marketing, and general and administrative expenses that benefit the Company as a whole and are not specifically related to either of the business segments.

Segment information is as follows:

	Three Months Ended June 2, 2007												Nine Months Ended June 2, 2007
							Advanced												Advanced
				Microelectronics			Medical									Microelectronics			Medical
	Corporate			Operations			Operations			Total			Corporate			Operations			Operations			Total
Net sales	$	0		$	5,872		$	3,958		$	9,830		$	0		$	21,124		$	12,207		$	33,331
Gross profit		0			492			(293	)		199			0			2,754			(214	)		2,540
Operating Expense		804			1,108			168			2,080			2,957			3,391			509			6,857
Operating loss		(804	)		(616	)		(461	)		(1,881	)		(2,957	)		(637	)		(723	)		(4,317	)
Total assets		0			14,078			5,050			19,128			0			14.078			5,050			19,128
Depr. and amortization		0			399			66			465			0			1,396			133			1,529
Capital expenditures		0			149			40			189			0			297			87			384

	Three Months Ended May 27, 2006											Nine Months Ended May 27, 2006
						Advanced											Advanced
				Microelectronics		Medical									Microelectronics		Medical
	Corporate			Operations		Operations			Total			Corporate			Operations		Operations		Total
Net sales	$	0		$	9,049	$	4,170		$	13,219		$	0		$	25,332	$	13,392	$	38,724
Gross profit		0			2,317		121			2,438			0			5,310		1,598		6,908
Operating Expense		2,204			954		151			3,309			6,670			2,627		602		9,899
Op income (loss)		(2,204	)		1,363		(30	)		(871	)		(6,670	)		2,683		996		(2,991	)
Total assets		0			19,952		6,047			25,999			0			19,952		6,047		25,999
Depr. and amortization		0			572		70			642			0			1,579		269		1,848
Capital expenditures		0			102		294			396			0			598		325		923

(13) Commitments and Contingencies

We lease a 13,200 square foot production facility and 3,000 square foot office and engineering facility in Tempe, Arizona for our high density flexible substrates business. The lease extends through July 31, 2010. Base rent is approximately $140,000 per year. We lease one property in Minnesota: a 15,173 square foot facility in Chanhassen, Minnesota, for our RFID business. The Chanhassen facility is leased through August 31, 2012 with an option to extend the lease for an additional four years. Base rent is approximately $97,000 per year. In addition to the base rent, we pay our proportionate share of common area maintenance expenses estimated to be $59,000 per year.

We lease a 152,002 square foot facility in Boulder, Colorado for our AMO segment. Our base rent is approximately $1,443,000 for Fiscal 2007. In addition to the base rent, we pay all operating costs associated with this building. The annual base rent increases each year by 3%. The Boulder facility is leased until September 2019. Currently, we occupy approximately 77,000 square feet of the facility and approximately 54,000 square feet are vacant. During the third quarter of Fiscal 2007, the Company consolidated its operations to reduce the space we occupied from 104,000 square feet to 77,000 square feet and focused on additional subleasing activities to lease out the excess space. In April 2005, we entered into a ten year sublease agreement for approximately 21,000 square feet with a high quality tenant. This is a ten year lease which provides for rental payments and reimbursement of operating costs. Aggregate rental and operating cost payments to be received by the Company of approximately $281,000 per year commenced November 2006. We continue to look for sublease tenants for the remaining 54,000 square feet of vacant space.

Our Boulder lease provided for the refund of $1,350,000 of our security deposit after completing four consecutive quarters of positive earnings before interest, taxes, depreciation and amortization, derived in accordance with GAAP and verified by an independent third party accountant and delivery to our landlord of the greater of 100,000 shares of our common stock or 0.11% of the outstanding shares

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of our common stock. In November 2005, we delivered the required documents and a certificate for 100,000 shares of our common stock. On November 23, 2005, we received the $1,350,000 refund. The value of the additional stock consideration issued to our landlord was $336,000 and is being amortized over the remaining term of our lease.

(14) Litigation Recovery

During Fiscal 2003, we commenced litigation against Mr. Fant, our former Chief Executive Officer and Chairman. 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. During Fiscal 2003 and 2004, we obtained judgments against Mr. Fant totaling approximately $2,255,000, excluding interest. During Fiscal 2004 and 2005, we obtained, through garnishments and through sales of common stock previously held by Mr. Fant, approximately $1,842,000 of recoveries. In Fiscal 2005 and 2004 we recognized $481,000 and $1,361,000 of these recoveries, respectively.

During Fiscal 2006 and 2007, the Company continued to seek to collect additional amounts from Mr. Fant and other parties relating to the litigation. In March 2007, the Company received a final settlement of $275,000 before deducting accumulated legal fees of approximately $50,000, which is included in other income in the consolidated statements of operations for the three and nine months ended June 2, 2007. Following the receipt of the settlement, the Company ceased all further action in this matter.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

Some of the information included in this Quarterly Report on Form 10-Q 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 1A of our Annual Report on Form 10-K for the fiscal year ended September 2, 2006 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.

This Quarterly Report of Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended September 2, 2006.

Overview

We provide a comprehensive range of engineering services including product design, design for manufacturability, cost reduction and optimization, testing and quality review. In addition, HEI serves it customers in the medical, communications and industrial markets with automated test, and fulfillment and distribution services. We provide these services on a global basis through four facilities in the United States. These services support our customers’ product plans from initial design, through manufacturing, distribution and service to end of life services. We leverage several proprietary platforms to provide unique solutions to our target markets. Our current focus is on expanding our revenue with new and existing customers and improving profitability with operational enhancements.

We operate the business under two business segments. These segments are:

Microelectronics Operations: This segment consists of three facilities — Victoria and Chanhassen, Minnesota and Tempe, Arizona — that design, manufacture and sell ultra miniature microelectronic devices, Radio Frequency Identification (“RFID”) solutions and complex flexible substrates.

Advanced Medical Operations: This segment consists of our Boulder facility that provides design and manufacturing outsourcing of complex electronic and electromechanical medical devices.

Results of Operations

Three Months and Nine Months Ended June 2, 2007 and May 27, 2006:

Net Sales

Net sales for the quarter ended June 2, 2007 were $9,830,000, or a decrease of $3,389,000 or 26% compared to net sales in the same prior year period of $13,219,000. The decrease was a result of several factors. The largest decrease came from our Microelectronics division, which experienced a reduction in legacy business resulting from a series of consolidations in the telecommunications industry and off-shore outsourcing by one of our medical products customers during the current quarter (approximately $1.4 million). Net sales at our flexible substrate business were also lower in the current period due to a reduction in orders from our primary external customer that reduced orders to consume excess inventories of our product (approximately $1.8 million). We presently expect the reduction at our Tempe facility to affect the remainder of the current fiscal year before the volumes are expected to begin to increase. In addition, it is possible the customer might tighten controls over inventory which could cause volumes to be decreased from prior amounts.

For the nine months ended June 2, 2007, net sales were $33,331,000 or a decrease of $5,393,000 or 14% compared to the same prior year period net sales of $38,724,000. The year-to-date reductions were a result of the same factors as in the current quarter and the reduction from our AMO division, which experienced a reduction in design and development contracts during the current fiscal year.

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For Fiscal 2007, the sales staff and business development efforts are expanding in all of our divisions in an effort to replace legacy business. The success of these efforts cannot be predicted at this time, but management believes that these efforts will produce expanded sales opportunities in the future and will contribute to future revenues at all of our divisions.

At June 2, 2007, our backlog of orders for sales was estimated at approximately $10 million and we expect to ship our backlog as of June 2, 2007 during the remainder of Fiscal 2007 and into the first quarter of Fiscal 2008. 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 their products, 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 and year over year.

Gross Profit

Gross profit was $199,000 (2% of net sales) for the three-months ended June 2, 2007 compared to $2,438,000 (18% of net sales) for the same prior year period. The Company recorded a reduction in its capitalized inventory overhead in the third quarter that impacted the gross profit by $536,000 or 5% of net sales for the quarter. The capitalized overhead is a factor of overhead costs associated with processing and handling each of the inventory categories as well as a factor of the inventory turnover rates. The Company has reduced its overhead costs and has increased its inventory turnover rates during the current fiscal year, which resulted in a lower calculation of capitalized inventory overhead. The reduction in the capitalized overhead resulted in a direct adjustment to cost of goods sold for the quarter. For the nine months ended for the same comparative periods, gross profit was $2,540,000 (8% of net sales) compared to $6,908,000 (18% of net sales). The same adjustment relating to inventory overhead that affected the third quarter impacted the year to date gross profit by 1%. The reduction in percentage of net sales was a result of lower sales volumes, which did not contribute as much to covering fixed operating costs. In addition, the decline in gross margin in the current fiscal year compared to the prior fiscal year was a result of a lower volume of higher margin design, development, verification, and validation contracts at the AMO segment. In addition, our prior year’s levels of fixed overhead costs were structured in anticipation of significantly higher sales volumes than were actually achieved. Cost reductions were made in the later part of Fiscal 2006 and again throughout the first three quarters of Fiscal 2007, but have not had a material impact on the margins for the first three quarters of Fiscal 2007. The Company expects the impact of the cost reductions will be more evident in the operating results for the remainder of the current fiscal year and into Fiscal 2008.

Our gross margins are heavily impacted by fluctuations in net sales, due to the fixed nature of many of our manufacturing costs, and by the mix of products manufactured in any particular quarter. We anticipate that our gross profit margins will remain relatively constant and start to improve over the next fiscal year. We continue to work to improve our sales and manufacturing processes which we believe will enable us to see improved gross profit margins in the future.

Operating Expenses

Selling, general and administrative expenses

For the three month-period ended June 2, 2007, selling, general and administrative expenses were $1,533,000 (16% of net sales), a decrease of $714,000 compared to $2,247,000 (17% of net sales) for the three months ended May 27, 2006. For the nine months ended for the same comparative periods, selling, general and administrative expenses were $4,898,000 (15% of net sales), a decrease of $1,861,000 compared to $6,759,000 (17% of net sales), respectively. The decrease in actual dollars of net sales is reflective of the focus on cost reductions implemented at the end of the first quarter of Fiscal 2007 and continuing into the third quarter of Fiscal 2007. We are focusing on reducing all of our fixed costs to be more in line with current revenue levels, while expanding the sales and business development activities in all of our divisions. Specific cost reductions came in the areas of payroll and payroll related expenses through the reduction in staff in all divisions and corporate departments, reduction in stock related expenses, elimination of image consulting expenses and a tightening of travel and entertainment expenses.

Research, development, and engineering expenses

Research, development, and engineering expenses decreased by $515,000 for the third quarter of Fiscal 2007 compared to the third quarter of Fiscal 2006. As a percentage of net sales, expenses were 6% and 8% for the quarters ended June 2, 2007 and May 27, 2006, respectively. For the nine months ended June 3, 2007 and May 27, 2006, research, development, and engineering expenses decreased

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by $1,181,000 to 6% of net sales compared to 8% of net sales, respectively. The decrease in actual dollars is reflective of the change in the engineering structure that focuses more heavily on supporting the contract manufacturing nature of our business units instead of a focus on separable research and development. General cost reductions were also made in the first three quarters of Fiscal 2007 as part of the Company’s overall cost reduction efforts.

Interest Expense, Net

Interest expense was $350,000 and $206,000 for the three months ended June 2, 2007 and May 27, 2006, respectively. For the nine months ended June 2, 2007 and May 27, 2006, interest expense was $1,119,000 and $429,000, respectively. The increase reflects the interest expense on the capital leases entered into by the Company during Fiscal 2006 and the increased borrowing under the Company’s line of credit and note from a related party, which were at higher levels compared to the prior year period. During the third quarter of Fiscal 2007, the Company finalized a debt refinancing arrangement and repaid its prior line of credit and repaid the note from a related party. This refinancing reduced the interest rate payable on a substantial portion of the Company’s variable debt.

Income Taxes

We did not record a tax provision in Fiscal 2007 or Fiscal 2006 due to the operating loss in each of these periods. We have established a valuation allowance to fully reserve the deferred tax assets because of uncertainties related to our ability to utilize certain federal and state loss carryforwards as measured by GAAP. This allowance is based on estimates of taxable income by jurisdiction during the period over which the deferred tax assets are recoverable. The economic benefits of our net operating loss carryforwards to future years will continue until expired.

FINANCIAL CONDITION AND LIQUIDITY

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.

In April 2006, the Company entered into a $2,000,000 revolving line of credit with Beacon Bank that was secured by a portion of our inventory and our foreign accounts receivable and guaranteed by the Small Business Administration (the “Line of Credit”). The Line of Credit was paid off in April and May 2007.

On November 3, 2006, Thomas F. Leahy, the Chairman of the Board of Directors of the Company, loaned the Company $5,000,000 dollars (the “Secured Loan”). The Company’s obligations under the Secured Loan were evidenced by a promissory note (the “Note”) and a security agreement. The Note had an original principal amount of $5,000,000, required the Company to pay monthly installments of interest, and was due and payable on November 2, 2007. The unpaid principal of the Note was repayable at any time without prepayment penalty or premium. Unpaid principal due under the Note bore interest at the rate of fifteen percent (15%) per annum, commencing on November 3, 2006 with such interest rate increasing by one percent (1%) each calendar month, beginning January 1, 2007, up to a maximum of twenty percent (20%) per annum. The Note was paid off on May 15, 2007 through the use of the proceeds from the Wells Fargo Busienss Credit revolving line of credit and term loan facilites entered into on May 15, 2007.

On May 15, 2007, the Company entered into a three year $8.0 million revolving credit facility pursuant to a Credit and Security Agreement with Wells Fargo Business Credit, and a three year $340,000 term loan. Borrowings under these facilities were used to repay the $5 million loan to the Company by Thomas F. Leahy, the Company’s Chairman of the Board, to repay certain obligations of the Company and for general operating purposes. Mr. Leahy guaranteed the financing package in an amount not to exceed $4 million and provided collateral to secure the guarantee in the amount of $4 million. In return for the guarantee and collateral pledge, he will be paid a guarantee fee in the amount of $8,000 per month by the Company for the next six months. The revolving credit facilities are secured by accounts receivable and inventories and a third mortgage position on the Company’s Victoria Minnesota production facility. The term loan is secured by a first priority security interest in all non-leased assets at the Company’s Tempe Arizona production facility. The revolving line of credit advance rates are based on outstanding balances of both domestic and foreign accounts receivable and certain inventory balances. The interest rate on the revolving line of credit advances is 2% of over prime and the term loan interest rate is 2.25% over prime, except upon an event of default. The current prime rate is 8.25%. The term loan has a 60 month amortization period with monthly payments beginning June 1, 2007 with the balance due and payable in full on May 15, 2010. The revolving credit facilities are due on May 15, 2010. The credit facilities require a minimum interest charge of $150,000 per year and there is an unused line fee of 0.25% under the revolving credit facility.

As a result of these events, at June 2, 2007 our sources of liquidity consisted of $96,000 of cash and cash equivalents and approximately $2 million of available borrowing capacity under our line of credit facility. Our liquidity, however, is affected by many

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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.

Beginning in mid-Fiscal 2006, the Company focused efforts on changing its cost structures and operating structures in an effort to reduce costs and strengthen the operational performance of each of segment. The most significant change was to shift from a centralized management of our segments to setting up a general manager for each of our operations. Some additional cost reductions were further undertaken at our Victoria and Chanhassen facilities towards the end of Fiscal 2006. The impacts of these changes along with the reduction of overall sales levels were not adequate to move the Company to a level of profitability by the end of the Fiscal 2006 and negatively impacted the first quarter of Fiscal 2007. Further cost reductions were undertaken during the first nine months of Fiscal 2007 to better align costs with current revenue levels. These reductions also had a negative impact on the first nine months of Fiscal 2007 due in part to severance obligations in certain instances and inventory adjustments.

Beginning in Fiscal 2007, the Company hired a new Chief Executive Officer, who was hired as the Company’s Chief Financial Officer in June 2006. He continues to fulfill that dual role and his efforts are targeted on cost structures and operational improvements. Additional cost reductions have already been initiated in addition to operational improvement initiatives at each of our segments. Revised operating budgets have been established to allow us to focus our efforts on our operating activity and expenses and to improve gross margins and minimize costs. Initiatives include:

• Refinancing our debt to improve cash flow.

• Emphasis on sales efforts in all of our business segments.

• Focusing on gross margin improvements at all segments by focusing on our material costs, labor costs and overhead structures.

• Structuring our staffing to work within our current sales levels for all of our general and administrative costs and engineering costs, and to reorganize the staff as necessary to position the Company for growth.

• Pursuing additional sublease tenants for the excess space in our Boulder facility while allowing for adequate room for expansion in the AMO segment. This will help to offset a portion of the operating costs and lease costs of that facility.

• Reduction in inventories by reviewing buying procedures and reducing any excess on hand inventory while maintaining the required inventories to meet customer demand. Our initiatives targeted a reduction in inventories by a total of $1 million by the end of Fiscal 2007, and we exceeded that target by over $500,000 during the first nine months of Fiscal 2007.

For the remainder of Fiscal 2007, we intend to limit spending for manufacturing equipment. All expenditures will be made on an as needed basis and future capital expenditures will be budgeted as part of the strategic planning and budgeting process for Fiscal 2008 as we determine our needs to expand our manufacturing capacity and our technological capabilities in order to meet the expanding needs of our customers. It is expected that these expenditures will be funded from existing cash, cash generated from operations, lease financing and available debt financing for the next 12 months.

The Company is currently in violation of its debt service coverage ratio covenant under its bank agreement with Commerce Bank. The Company has received waivers for any violations of its debt covenants with Commerce Bank through September 1, 2007 and no demand has been made by the lender for the outstanding principal balance under the Agreement. There is no assurance the debt covenants will be met or waived in the future.

In the event future cash flows and borrowing capacities are not sufficient to fund operations at the present level, additional measures will be taken including efforts to further reduce expenditure levels such as reduction of spending for research and development, engineering, elimination of budgeted raises, reduction of non-strategic employees and the deferral or elimination of capital expenditures. In addition, we believe that other sources of liquidity are available including issuance of the Company’s stock, the expansion of our credit facilities and the issuance of long-term debt, but no assurance can be given that we will be successful in raising this capital.

Management believes that existing, current and future lending capacity and cash generated from operations will supply sufficient cash flow to meet short-term and long-term debt obligations, working capital, capital expenditure and operating requirements during the next 12 months.

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CRITICAL ACCOUNTING POLICIES

The accompanying unaudited interim consolidated financial statements are based on the selection and application of United States generally accepted accounting principles (“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.

Revenue recognition, sales returns and warranty

Revenue for manufacturing and assembly is recognized upon shipment to the customer which represents the point at which the risks and rewards of ownership have been transferred to the customer. Previously, we had a limited number of arrangements with customers which require that we retained ownership of inventory until it was received by the customer or until it is accepted by the customer. There were no additional obligations or other rights of return associated with these agreements. Accordingly, revenue for these arrangements was recognized upon receipt by the customer or upon acceptance by the customer. Our AMO segment provides service contracts for some of its products. Billings for services contracts are based on published renewal rates and revenue is recognized on a straight-line basis over the service period.

AMO’s development contracts are typically discrete time and materials projects that generally do not involve separately priced deliverables. Development contract revenue is recognized ratably as development activities occur based on contractual per hour and material reimbursement rates. Development contracts are an interactive process with customers as different design and functionality is contemplated during the design phase. Upon reaching the contractual billing maximums, we defer revenue until contract extensions or purchase orders are received from customers. We occasionally have contractual arrangements in which part or all of the payment or billing is contingent upon achieving milestones or customer acceptance. For those contracts we evaluate whether the contract should be accounted using the completed contract method, if the term of the arrangement is short-term, or using the percentage of completion method for longer-term contracts. We may establish one or more contractual relationships with one customer that involves multiple deliverables including development, manufacturing and service. Each of these deliverables may be considered a separate unit of accounting and we evaluate if each element has sufficient evidence of fair value to allow separate revenue recognition. If we cannot separately account for the multiple elements in an arrangement, we may be required to account for the arrangement as one unit of accounting with recognition over an extended period of time or upon delivery of all of the contractual elements.

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.

Item 3. Qualitative and Quantitative Disclosures About Market Risk

Market Risk

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.

Interest Rate Risk

On May 15, 2007, the Company entered into a three year $8.0 million revolving credit facility pursuant to a Credit and Security Agreement with Wells Fargo Business Credit, and a three year $340,000 term loan. Borrowings under these facilities were used to repay the $5 million loan to the Company by Thomas F. Leahy, the Company’s chairman of the board, to repay certain obligations of the Company and for general operating purposes. Mr. Leahy guaranteed the financing package in an amount not to exceed $4 million and provided collateral to secure the guarantee in the amount of $4 million. In return for the guarantee and collateral pledge, he will be paid a guarantee fee in the amount of $8,000 per month by the Company for six months . The revolving credit facilities are secured by accounts receivable and inventories and a third mortgage position on the Company’s Victoria Minnesota production facility. The term loan is secured by a first priority security interest in all non-leased assets at the Company’s Tempe Arizona production facility. The revolving line of credit advance rates are based on outstanding balances of both domestic and foreign accounts receivable and certain inventory balances. The interest rate on the revolving line of credit advances is 2% over prime and the term loan interest rate is 2.25% over prime, except upon an event of default. The current prime rate is 8.25%. The term loan has a 60 month amortization period with

20

monthly payments beginning June 1, 2007 with the balance due and payable in full on May 15, 2010. The credit facilities require a minimum interest charge of $150,000 per year and there is an unused line fee of 0.25% under the revolving credit facility.

A change in interest rate for the credit facilities with Wells Fargo Business Credit is not expected to have a material adverse effect on our near-term financial condition or results of operation. A 1% change in the interest rate based on the balance outstanding at June 2, 2007 would represent an increase in annual interest expense of approximately $47,000. Our other financing arrangements, which include our lease financings, do not fluctuate with the movement of general interest rates.

Item 4. Controls and Procedures

During the course of the audit of the consolidated financial statements for Fiscal 2006, our independent registered public accounting firm, Virchow, Krause & Company, LLP, did not identify any deficiencies in internal controls which were considered to be “material weaknesses” as defined under standards established by the American Institute of Certified Public Accountants.

There were no changes in our system of internal controls during the third quarter of Fiscal 2007. In July 2006, Mark Thomas replaced Timothy Clayton as the Company’s Chief Financial Officer. In October 2006, Mark Thomas also became the Company’s Chief Executive Officer.

Our management team, including our Chief Executive Officer/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) as of the end of the period covered by this Form 10-Q. Based on such evaluation, our Chief Executive Officer/Chief Financial Officer has concluded that the disclosure controls and procedures did provide reasonable assurance of effectiveness as of the end of such period.

We are currently in the process of reviewing and formalizing our internal controls and procedures for financial reporting in accordance with the Securities and Exchange Commission’s rules implementing the internal control reporting requirements included in Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”). We are dedicating resources, including senior management time and effort, and incurring costs in connection with our ongoing Section 404 assessment. We are in the process of documenting our internal controls and considering whether any improvements are necessary for maintaining an effective control environment at our Company. The evaluation of our internal controls is being conducted under the direction of our senior management. In addition, our senior management is regularly discussing any proposed improvements to our control environment with our Audit Committee. We expect to assess our controls and procedures on a regular basis. We will continue to work to improve our controls and procedures and to educate and train our employees on our existing controls and procedures in connection with our efforts to maintain an effective controls infrastructure at our Company. Despite the mobilization of significant resources for our Section 404 assessment, we, however, cannot provide any assurance that we will timely complete the evaluation of our internal controls or that, even if we do complete the evaluation of our internal controls, we will do so in time to permit our independent registered public accounting firm to test our controls and timely complete their attestation procedures of our controls in a manner that will allow us to comply with applicable Securities and Exchange Commission rules and regulations.

Beginning with our filing deadline for our Annual Report on Form 10-K for Fiscal 2008, we will have to include management’s evaluation of internal control over financial reporting (Item 308T(a) of Regulation S-K) and the full text-version of the CEO and CFO certifications referencing management’s responsibility for internal controls. However, in this first year the Company will not have to include the auditor attestation on internal control required by Item 308(b) of Regulation S-K. Management’s evaluation will have to disclose that the annual report does not include such an auditor attestation and that it was not subject to attestation pursuant to temporary rules of the Securities and Exchange Commission. Beginning with our Annual Report on Form 10-K for Fiscal 2009, we will have to include both management’s evaluation of internal control and the auditor attestation.

In addition, there can be no assurances that our disclosure controls and procedures will detect or uncover a failure to report material information otherwise required to be set forth in the reports that we file with the Securities and Exchange Commission.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings.

During Fiscal 2003, we commenced litigation against Mr. Fant, our former Chief Executive Officer and Chairman. 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. During Fiscal 2003 and 2004, we

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obtained judgments against Mr. Fant totaling approximately $2,255,000, excluding interest. During Fiscal 2004 and 2005, we obtained, through garnishments and through sales of common stock previously held by Mr. Fant, approximately $1,842,000 of recoveries. In Fiscal 2005 and 2004 we recognized $481,000 and $1,361,000 of these recoveries, respectively.

During Fiscal 2006 and 2007, the Company continued to seek to collect additional amounts from Mr. Fant and other parties relating to the litigation. In March 2007, the Company received a final settlement of $275,000 before deducting accumulated legal fees of approximately $50,000. Following the receipt of the settlement, the Company ceased all further action in this matter.

Item 1A. Risk Factors.

In addition to the Risk Factors included in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 2, 2006, the Company has added the following risk factor which should be read in conjunction with the other information in this report.

Guarantee from our Chairman of the Board of Directors. The Company may incur guarantee fees to Mr. Leahy past the first six months of the guarantee period and it is unknown what those fees will be at this time.

Item 6. Exhibits

a) Exhibits

10.1	Form of Credit and Security Agreement by and between HEI, Inc. and Wells Fargo Bank, National Association, acting through its Wells Fargo Business Credit operating division dated May 15, 2007.
10.2	Form of Credit and Security Agreement for the Export-Import Bank Guaranteed Credit Facility by and among HEI, Inc. and Wells Fargo Bank, National Association, acting through its Wells Fargo Business Credit operating division dated May 15, 2007.
31.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

	HEI, Inc.
Date: July 16, 2007	/s/ Mark B. Thomas
	Mark B. Thomas Chief Executive Officer and Chief Financial Officer

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EX-10.1

Exhibit 10.1

CREDIT AND SECURITY AGREEMENT

BY AND BETWEEN

HEI, INC.

AND

WELLS FARGO BANK, NATIONAL ASSOCIATION
Acting through its Wells Fargo Business Credit operating division

May 15, 2007

Table of Contents

	Page
ARTICLE I DEFINITIONS		1
Section 1.1 Definitions		1
Section 1.2 Other Definitional Terms; Rules of Interpretation		12
ARTICLE II AMOUNT AND TERMS OF THE CREDIT FACILITY		13
Section 2.1 Revolving Advances		13
Section 2.2 Procedures for Requesting Advances		13
Section 2.3 Term Advance		13
Section 2.4 Payment of Term Note		14
Section 2.5 Interest; Minimum Interest Charge; Default Interest Rate; Application of Payments; Participations; Usury		14
Section 2.6 Fees		15
Section 2.7 Time for Interest Payments; Payment on Non-Business Days; Computation of Interest and Fees		17
Section 2.8 Lockbox and Collateral Account; Sweep of Funds		17
Section 2.9 Voluntary Prepayment; Reduction of the Maximum Line Amount; Termination of the Credit Facility by the Borrower		18
Section 2.10 Mandatory Prepayment		18
Section 2.11 Revolving Advances to Pay Indebtedness		18
Section 2.12 Use of Proceeds		18
Section 2.13 Liability Records		18
ARTICLE III SECURITY INTEREST; OCCUPANCY; SETOFF		19
Section 3.1 Grant of Security Interest		19
Section 3.2 Notification of Account Debtors and Other Obligors		19
Section 3.3 Assignment of Insurance		19
Section 3.4 Occupancy		20
Section 3.5 License		20
Section 3.6 Financing Statement		21
Section 3.7 Setoff		21
Section 3.8 Collateral		21
ARTICLE IV CONDITIONS OF LENDING		22
Section 4.1 Conditions Precedent to the Initial Advances		22
Section 4.2 Conditions Precedent to All Advances		24
ARTICLE V REPRESENTATIONS AND WARRANTIES		24
Section 5.1 Existence and Power; Name; Chief Executive Office; Inventory and Equipment Locations; Federal Employer Identification Number and Organizational Identification Number		24

	Page
Section 5.2 Capitalization		24
Section 5.3 Authorization of Borrowing; No Conflict as to Law or Agreements		25
Section 5.4 Legal Agreements		25
Section 5.5 Subsidiaries and Affiliates		25
Section 5.6 Financial Condition; No Adverse Change		25
Section 5.7 Litigation		25
Section 5.8 Regulation U		25
Section 5.9 Taxes		26
Section 5.10 Titles and Liens		26
Section 5.11 Intellectual Property Rights		26
Section 5.12 Plans		27
Section 5.13 Default		27
Section 5.14 Environmental Matters		27
Section 5.15 Submissions to the Lender		28
Section 5.16 Financing Statements		28
Section 5.17 Rights to Payment		29
ARTICLE VI COVENANTS		29
Section 6.1 Reporting Requirements		29
Section 6.2 Financial Covenants		32
Section 6.3 Permitted Liens; Financing Statements		33
Section 6.4 Indebtedness		33
Section 6.5 Guaranties		34
Section 6.6 Investments and Subsidiaries		34
Section 6.7 Dividends and Distributions		34
Section 6.8 Salaries		35
Section 6.9 Books and Records; Collateral Examination, Inspection and Appraisals		35
Section 6.10 Account Verification		35
Section 6.11 Compliance with Laws		35
Section 6.12 Payment of Taxes and Other Claims		36
Section 6.13 Maintenance of Properties		36
Section 6.14 Insurance		37
Section 6.15 Preservation of Existence		37
Section 6.16 Delivery of Instruments, etc		37
Section 6.17 Sale or Transfer of Assets; Suspension of Business Operations		37
Section 6.18 Consolidation and Merger; Asset Acquisitions		37
Section 6.19 Sale and Leaseback		38
Section 6.20 Restrictions on Nature of Business		38
Section 6.21 Accounting		38
Section 6.22 Discounts, etc.		38
Section 6.23 Plans		38
Section 6.24 Place of Business; Name		38
Section 6.25 Constituent Documents; S Corporation Status		38
Section 6.26 Performance by the Lender		38
ARTICLE VII EVENTS OF DEFAULT, RIGHTS AND REMEDIES		39

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	Page
Section 7.1 Events of Default		39
Section 7.2 Rights and Remedies		41
Section 7.3 Certain Notices		42
ARTICLE VIII MISCELLANEOUS		42
Section 8.1 No Waiver; Cumulative Remedies; Compliance with Laws		42
Section 8.2 Amendments, Etc		43
Section 8.3 Notices; Communication of Confidential Information; Requests for Accounting		43
Section 8.4 Further Documents		43
Section 8.5 Costs and Expenses		44
Section 8.6 Indemnity		44
Section 8.7 Participants		45
Section 8.8 Execution in Counterparts; Telefacsimile Execution		45
Section 8.9 Retention of the Borrower’s Records		45
Section 8.10 Binding Effect; Assignment; Complete Agreement; Sharing Information		45
Section 8.11 Severability of Provisions		46
Section 8.12 Headings		46
Section 8.13 Governing Law; Jurisdiction, Venue; Waiver of Jury Trial		46
Section 8.14 Attorneys’ Fees		46

iii 

CREDIT AND SECURITY AGREEMENT
Dated as of May 15, 2007

     HEI, Inc., a Minnesota corporation (the “Borrower”), and WELLS FARGO BANK, NATIONAL ASSOCIATION (as more fully defined in Article I herein, the “Lender”) acting through its Wells Fargo Business Credit operating division, hereby agree as follows:

ARTICLE I

DEFINITIONS

     Section 1.1 Definitions. Except as otherwise expressly provided in this Agreement, the following terms shall have the meanings given them in this Section:

     “Accounts” shall have the meaning given it under the UCC.

     “Accounts Advance Rate” means up to eighty-five percent (85%), or such lesser rate as the Lender in its sole discretion may deem appropriate from time to time; provided that, as of the date of each quarterly audit, the Accounts Advance Rate shall be reduced by one (1) percentage point for each percentage by which Dilution is in excess of three percent (3.0%).

     “Advance” means a Revolving Advance.

     “Affiliate” or “Affiliates” means any other Person controlled by, controlling or under common control with the Borrower, including any Subsidiary of the Borrower. For purposes of this definition, “control,” when used with respect to any specified Person, means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise.

     “Agreement” means this Credit and Security Agreement.

     “Availability” means the amount, if any, by which the Borrowing Base exceeds the sum of the outstanding principal balance of the Revolving Note.

     “Bond Advance Rate” means up to fifty percent (50%), or such lesser rate as the Lender in its sole discretion may deem appropriate from time to time.

     “Borrowing Base” means at any time the lesser of:

     (a) The Maximum Line Amount less the Ex-Im Amount; or

     (b) Subject to change from time to time in the Lender’s sole discretion, the sum of:

     (i) The product of the Accounts Advance Rate times Eligible Accounts, plus

     (ii) The lesser of (A) the product of the Inventory Advance Rate times Eligible Inventory or (B) $750,000.00, less

     (iii) The product of the Bonds Advance Rate times Eligible marketable Bonds, less

     (iv) The Borrowing Base Reserve, less

     (v) The Ex-Im Reserve, less

     (vi) Indebtedness that the Borrower owes to the Lender that has not yet been advanced on the Revolving Note and the dollar amount that the Lender in its reasonable discretion then determines to be a reasonable determination of the Borrower’s credit exposure with respect to any swap, derivative, foreign exchange, hedge, deposit, treasury management or other similar transaction or arrangement offered to the Borrower by the Lender that is not described in Article II of this Agreement and any indebtedness owed by the Borrower to Wells Fargo Merchant Services, L.L.C.

     “Borrowing Base Reserve” means, as of any date of determination, such amounts (expressed as either a specified amount or as a percentage of a specified category or item) as the Lender may from time to time establish and adjust in reducing Availability (a) to reflect events, conditions, contingencies or risks which, as determined by the Lender, do or may affect (i) the Collateral or its value, (ii) the assets, business or prospects of the Borrower, or (iii) the security interests and other rights of the Lender in the Collateral (including the enforceability, perfection and priority thereof), or (b) to reflect the Lender’s judgment that any collateral report or financial information furnished by or on behalf of the Borrower to the Lender is or may have been incomplete, inaccurate or misleading in any material respect, or (c) in respect of any state of facts that the Lender determines constitutes a Default or an Event of Default.

     “Business Day” means a day on which the Federal Reserve Bank of New York is open for business.

     “Capital Expenditures” means for a period, any expenditure of money during such period for the lease, purchase or other acquisition of any capital asset, or for the lease of any other asset whether payable currently or in the future.

     “Collateral” means all of the Borrower’s Accounts, chattel paper and electronic chattel paper, deposit accounts, documents, Machinery, Equipment, General Intangibles, goods, instruments, Intellectual Property Rights, Inventory, Investment Property, letter-of-credit rights, letters of credit, all sums on deposit in any Collateral Account, and any items in any Lockbox; together with (i) all substitutions and replacements for and products of any of the foregoing; (ii) in the case of all goods, all accessions; (iii) all accessories, attachments, parts, equipment and repairs now or hereafter attached or affixed to or used in connection with any goods; (iv) all warehouse receipts, bills of lading and other documents of title now or hereafter covering such goods; (v) all collateral subject to the Lien of any Security Document; (vi) any money, or other assets of the Borrower that now or hereafter come into the possession, custody, or control of the Lender; (vii) proceeds of any and all of the foregoing; (viii) books and records of the Borrower, including all mail or electronic mail addressed to the Borrower; and (ix) all of the foregoing, whether now owned or existing or hereafter acquired or arising or in which the Borrower now has or hereafter acquires any rights.

     “Collateral Account” means the “Lender Account” as defined in the Wholesale Lockbox and Collection Account Agreement.

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     “Commitment” means the Lender’s commitment to make Advances to the Borrower.

     “Constituent Documents” means with respect to any Person, as applicable, such Person’s certificate of incorporation, articles of incorporation, by-laws, certificate of formation, articles of organization, limited liability company agreement, management agreement, operating agreement, shareholder agreement, partnership agreement or similar document or agreement governing such Person’s existence, organization or management or concerning disposition of ownership interests of such Person or voting rights among such Person’s owners.

     “Control Agreement” means the Notice to Securities Intermediary and Control Agreement executed by Thomas F. Leahy, the Lender and Wells Fargo Investments, LLC, as securities intermediary, and dated the date hereof, in the form required by the Lender, as the same may be amended, restated or otherwise modified from time to time.

     “Credit Facility” means the credit facility under which Revolving Advances may be made available to the Borrower by the Lender under Article II.

     “Cut-off Time” means 12:00 p.m. Minneapolis, Minnesota time or 11:00 a.m. Minneapolis time on the last business day of each month.

     “Debt” means of a Person as of a given date, all items of indebtedness or liability which in accordance with GAAP would be included in determining total liabilities as shown on the liabilities side of a balance sheet for such Person and shall also include the aggregate payments required to be made by such Person at any time under any lease that is considered a capitalized lease under GAAP.

     “Debt Service Coverage Ratio” means (i) the sum of (A) Funds from Operations and (B) Interest Expense minus (C) unfinanced Capital Expenditures divided by (ii) the sum of (A) Current Maturities of Long Term Debt and (B) Interest Expense.

     “Default” means an event that, with giving of notice or passage of time or both, would constitute an Event of Default.

     “Default Period” means any period of time beginning on the day a Default or Event of Default occurs and ending on the date identified by the Lender in writing as the date that such Default or Event of Default has been cured or waived.

     “Default Rate” means an annual interest rate in effect during a Default Period or following the Termination Date, which interest rate shall be equal to three percent (3%) over the applicable Floating Rate, as such rate may change from time to time.

     “Dilution” means, as of any date of determination, a percentage, based upon the experience of the trailing six (6) month period ending on the date of determination, which is the result of dividing (a) actual bad debt write-downs, discounts, advertising allowances, credits, or other dilutive items with respect to the Accounts as determined by the Lender in its sole discretion during such period, by (b) the Borrower’s net sales during such period (excluding extraordinary items) plus the amount of subclause (a).

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     “Director” means a director if the Borrower is a corporation, a governor or manager if the Borrower is a limited liability company, or a general partner if the Borrower is a partnership.

     “Earnings Before Taxes” means pretax earnings from operations, excluding extraordinary gains, but including extraordinary losses.

     “Eligible Accounts” means all unpaid Accounts of the Borrower arising from the sale or lease of goods or the performance of services, net of any credits, but excluding any such Accounts having any of the following characteristics:

     (i) That portion of Accounts unpaid 60 days or more after the due date or more than 120 days past invoice date;

     (ii) That portion of Accounts related to goods or services with respect to which the Borrower has received notice of a claim or dispute, which are subject to a claim of offset or a contra account, or which reflect a reasonable reserve for warranty claims or returns;

     (iii) That portion of Accounts not yet earned by the final delivery of goods or rendition of services, as applicable, by the Borrower to the customer, including progress billings, and that portion of Accounts for which an invoice has not been sent to the applicable account debtor;

     (iv) Accounts constituting (i) proceeds of copyrightable material unless such copyrightable material shall have been registered with the United States Copyright Office, or (ii) proceeds of patentable inventions unless such patentable inventions have been registered with the United States Patent and Trademark Office;

     (v) Accounts owed by any unit of government, whether foreign or domestic (provided, however, that there shall be included in Eligible Accounts that portion of Accounts owed by such units of government for which the Borrower has provided evidence satisfactory to the Lender that (A) the Lender has a first priority perfected security interest and (B) such Accounts may be enforced by the Lender directly against such unit of government under all applicable laws);

     (vi) Accounts denominated in any currency other than United States dollars;

     (vii) Accounts owed by an account debtor located outside the United States which are not (A) backed by a bank letter of credit naming the Lender as beneficiary or assigned to the Lender, in the Lender’s possession or control, and with respect to which a control agreement concerning the letter-of-credit rights is in effect, and acceptable to the Lender in all respects, in its sole discretion, or (B) covered by a foreign receivables insurance policy acceptable to the Lender in its sole discretion;

     (viii) Accounts owed by an account debtor that is insolvent, the subject of bankruptcy proceedings or has gone out of business;

4

     (ix) Accounts owed by an Owner, Subsidiary, Affiliate, Officer or employee of the Borrower;

     (x) Accounts not subject to a duly perfected security interest in the Lender’s favor or which are subject to any Lien in favor of any Person other than the Lender;

     (xi) That portion of Accounts that has been restructured, extended, amended or modified;

     (xii) That portion of Accounts that constitutes advertising, finance charges, service charges or sales or excise taxes;

     (xiii) Accounts owed by an account debtor, regardless of whether otherwise eligible, to the extent that the aggregate balance of such Accounts exceeds fifteen percent (15%) (but in the case of Irvine Biomedical and Valley Lab, 20%) of the aggregate amount of Eligible Accounts;

     (xiv) Accounts owed by an account debtor, regardless of whether otherwise eligible, if twenty-five percent (25%) or more of the total amount of Accounts due from such debtor is ineligible under clauses (i), (ii), or (xi) above;

     (xv) Accounts that represent milestone or progress billings;

     (xvi) Accounts, or portions thereof, otherwise deemed ineligible by the Lender in its sole discretion; and

     (xvii) That portion of Accounts consisting of Ex-Im Accounts.

     “Eligible Equipment” means that Equipment of the Borrower designated by the Lender as eligible from time to time in its sole discretion.

     “Eligible Finished Goods” means Finished Goods of the Borrower designated by the Lender as eligible from time to time.

     “Eligible Inventory” means all Inventory of the Borrower, valued at the lower of cost or market in accordance with GAAP; but excluding any Inventory having any of the following characteristics:

     (i) Inventory that is in-transit; located at any warehouse, job site or other premises not approved by the Lender in writing; not subject to a duly perfected first priority security interest in the Lender’s favor; covered by any negotiable or non-negotiable warehouse receipt, bill of lading or other document of title; on consignment from any Person; on consignment to any Person or subject to any bailment unless such consignee or bailee has executed an agreement with the Lender;

     (ii) Supplies, packaging, parts or sample Inventory, or customer supplied parts or Inventory;

5

     (iii) Work-in-process Inventory;

     (iv) Fabricated Parts Inventory;

     (v) Inventory that is damaged, defective, obsolete, slow moving or not currently saleable in the normal course of the Borrower’s operations, or the amount of such Inventory that has been reduced by shrinkage;

     (vi) Inventory that the Borrower has returned, has attempted to return, is in the process of returning or intends to return to the vendor thereof;

     (vii) Inventory that is perishable or live;

     (viii) Inventory manufactured by the Borrower pursuant to a license unless the applicable licensor has agreed in writing to permit the Lender to exercise its rights and remedies against such Inventory;

     (ix) Inventory that is subject to a Lien in favor of any Person other than the Lender;

     (x) Inventory stored at locations in amounts less than $100,000.00;

     (xi) Inventory otherwise deemed ineligible by the Lender in its sole discretion; and

     (xii) Inventory consisting of routers and drill bits.

     “Eligible Marketable Bonds” means bonds (a) owned on a fully-paid basis by Thomas F. Leahy, (b) carried in the Securities Account, (c) properly classified as “current assets” according to GAAP and (d) of a type agreed to by the Bank in its sole discretion.

     “Eligible Raw Materials” means Raw Materials of the Borrower designated by the Lender as eligible from time to time.

     “Environmental Law” means any federal, state, local or other governmental statute, regulation, law or ordinance dealing with the protection of human health and the environment.

     “Equipment” shall have the meaning given it under the UCC.

     “ERISA” means the Employee Retirement Income Security Act of 1974, as amended from time to time.

     “ERISA Affiliate” means any trade or business (whether or not incorporated) that is a member of a group which includes the Borrower and which is treated as a single employer under Section 414 of the IRC.

     “Event of Default” is defined in Section 7.1.

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     “Ex-Im Accounts” means “Eligible Export-Related Accounts Receivable” as defined in the Ex-Im Agreement.

     “Ex-Im Agreement” means the Credit and Security Agreement for the Export-Import Bank Guaranteed Credit Facility by and between the Borrower and Lender dated as of May 15, 2007.

     “Ex-Im Amount” means the sum of the outstanding principal balance of the “Notes” (as defined in the Ex-Im Agreement).

     “Ex-Im Borrowing Base” means the “Borrowing Base” as defined in the Ex-Im Agreement.

     “Ex-Im Credit Facility” means the “Credit Facility” as defined in the Ex-Im Agreement.

     “Ex-Im Documents” means the “Loan Documents” as defined in the Ex-Im Agreement.

     “Ex-Im Inventory” means “Eligible Export-Related Inventory” as defined in the Ex-Im Agreement.

     “Ex-Im Reserve” means ten percent (10%) of any amount outstanding under the Ex-Im Credit Facility, which amount may be increased or decreased from time to time as determined by the Lender in its sole discretion.

     “Financial Covenants” means the covenants set forth in Section 6.2.

     “Floating Rate” means, (i) with respect to Revolving Advances evidenced by the Revolving Note, an annual interest rate equal to the sum of the Prime Rate plus two percent (2.0%), and (ii) with respect to Term Advances evidenced by the Term Note, an annual interest rate equal to the sum of the Prime Rate plus two and one quarter percent (2.25%), which interest rate shall change when and as the Prime Rate changes.

     “Floating Rate Advance” means an Advance bearing interest at the Floating Rate.

     “Funding Date” is defined in Section 2.1.

     “Funds from Operations” means for a given period, the sum of (i) Net Income, (ii) depreciation and amortization, (iii) any increase (or decrease) in deferred income taxes, (iv) any increase (or decrease) in lifo reserves, and (v) other non-cash items, each as determined for such period in accordance with GAAP.

     “GAAP” means generally accepted accounting principles, applied on a basis consistent with the accounting practices applied in the financial statements described in Section 5.6.

     “General Intangibles” shall have the meaning given it under the UCC.

     “Guarantor” means Thomas F. Leahy or any other person who executes a Guaranty in favor of the Lender.

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     “Guaranty” means each unconditional guaranty executed by a Guarantor in favor of the Lender.

     “Hazardous Substances” means pollutants, contaminants, hazardous substances, hazardous wastes, petroleum and fractions thereof, and all other chemicals, wastes, substances and materials listed in, regulated by or identified in any Environmental Law.

     “Indebtedness” is used herein in its most comprehensive sense and means any and all advances, debts, obligations and liabilities of the Borrower to the Lender, heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, including under any swap, derivative, foreign exchange, hedge, deposit, treasury management or other similar transaction or arrangement at any time entered into by the Borrower with the Lender or with Wells Fargo Merchant Services, L.L.C., and whether the Borrower may be liable individually or jointly with others, or whether recovery upon such Indebtedness may be or hereafter becomes unenforceable.

     “Indemnified Liabilities” is defined in Section 8.6.

     “Indemnitees” is defined in Section 8.6.

     “Infringement” or “Infringing” when used with respect to Intellectual Property Rights means any infringement or other violation of Intellectual Property Rights.

     “Insolvency Event” is defined in Section 7.1(e).

     “Intangible Assets” means all intangible assets as determined in accordance with GAAP and including Intellectual Property Rights, goodwill, accounts due from Affiliates, Directors, Officers or employees, prepaid expenses, deposits, deferred charges or treasury stock or any securities or Debt of the Borrower or any other securities unless the same are readily marketable in the U.S. or entitled to be used as a credit against federal income tax liabilities, non-compete agreements and any other assets designated from time to time by the Lender, in its sole discretion.

     “Intellectual Property Rights” means all actual or prospective rights arising in connection with any intellectual property or other proprietary rights, including all rights arising in connection with copyrights, patents, service marks, trade dress, trade secrets, trademarks, trade names or mask works.

     “Interest Expense” means for a fiscal year-to-date period, the Borrower’s total gross interest expense during such period (excluding interest income), and shall in any event include (i) interest expensed (whether or not paid) on all Debt, (ii) the amortization of debt discounts, (iii) the amortization of all fees payable in connection with the incurrence of Debt to the extent included in interest expense, and (iv) the portion of any capitalized lease obligation allocable to interest expense.

     “Interest Payment Date” is defined in Section 2.7(a).

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     “Inventory” shall have the meaning given it under the UCC but for purposes of this Agreement shall include Raw Materials and Finished Goods.

     “Inventory Advance Rate” means fifteen percent (15%) of Eligible Raw Materials or Eligible Finished Goods, not to exceed $750,000 (“Inventory Cap”), or such lesser rate or amount as the Lender in its sole discretion may deem appropriate from time to time.

     “Investment Property” shall have the meaning given it under the UCC.

     “IRC” means the Internal Revenue Code of 1986, as amended from time to time.

     “Leahy Pledge Agreement” means the Collateral Pledge Agreement executed by Thomas F. Leahy in favor of the Lender and dated the date hereof, as the same may be amended, restated or otherwise modified from time to time.

     “Lender” means Wells Fargo Bank, National Association in its broadest and most comprehensive sense as a legal entity, and is not limited in its meaning to the Lender’s Wells Fargo Business Credit operating division, or to any other operating division of the Lender.

     “Licensed Intellectual Property” is defined in Section 5.11(c).

     “Lien” means any security interest, mortgage, deed of trust, pledge, lien, charge, encumbrance, title retention agreement or analogous instrument or device, including the interest of each lessor under any capitalized lease and the interest of any bondsman under any payment or performance bond, in, of or on any assets or properties of a Person, whether now owned or subsequently acquired and whether arising by agreement or operation of law.

     “Loan Documents” means this Agreement, the Revolving Note, the Term Note, each Subordination Agreement, and the Security Documents, together with every other agreement, note, document, contract or instrument to which the Borrower now or in the future may be a party and which is required by the Lender.

     “Loan Year” is defined in Section 2.5(b).

     “Lockbox” means “Lockbox” as defined in the Wholesale Lockbox and Collection Account Agreement.

     “Material Adverse Effect” means any of the following:

     (i) A material adverse effect on the business, operations, results of operations, prospects, assets, liabilities or financial condition of the Borrower;

     (ii) A material adverse effect on the ability of the Borrower to perform its obligations under the Loan Documents;

     (iii) A material adverse effect on the ability of the Lender to enforce the Indebtedness or to realize the intended benefits of the Security Documents, including a material adverse effect on the validity or enforceability of any Loan Document, or on the

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status, existence, perfection, priority (subject to Permitted Liens) or enforceability of any Lien securing payment or performance of the Indebtedness; or

     (iv) Any claim against the Borrower or threat of litigation which if determined adversely to the Borrower would cause the Borrower to be liable to pay an amount exceeding $100,000 or would result in the occurrence of an event described in clauses (i), (ii) and (iii) above.

     “Maturity Date” means, with respect to the Credit Facility, May 15, 200___.

     “Maximum Line Amount” means $8,000,000, unless this amount is reduced pursuant to Section 2.9, in which event it means such lower amount.

     “Minimum Interest Charge” is defined in Section 2.5(b).

     “Mortgagee’s Disclaimer and Consent” means that agreement dated May 15, 2007 executed by Commerce Bank in favor of the Lender.

     “Multiemployer Plan” means a multiemployer plan (as defined in Section 4001(a)(3) of ERISA) to which the Borrower or any ERISA Affiliate contributes or is obligated to contribute.

     “Net Forced Liquidation Value” means a professional opinion of the estimated most probable Net Cash Proceeds which could typically be realized at a properly advertised and conducted public auction sale without reserve, held under forced sale conditions and under economic trends current within 60 days of the appraisal. The opinion may consider physical location, difficulty of removal, adaptability, specialization, marketability, physical condition, overall appearance and psychological appeal.

     “Note” means the Revolving Note or the Term Note, and “Notes” means the Revolving Note and the Term Note.

     “OFAC” is defined in Section 6.11(c).

     “Officer” means with respect to the Borrower, an officer if the Borrower is a corporation, a manager if the Borrower is a limited liability company, or a partner if the Borrower is a partnership.

     “Overadvance” means the amount, if any, by which the outstanding principal balance of the Revolving Note is in excess of the then-existing Borrowing Base.

     “Owned Intellectual Property” is defined in Section 5.11(a).

     “Owner” means with respect to the Borrower, each Person having legal or beneficial title to an ownership interest in the Borrower or a right to acquire such an interest.

     “Patent and Trademark Security Agreement” means each Patent and Trademark Security Agreement now or hereafter executed by the Borrower in favor of the Lender.

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     “Pension Plan” means a pension plan (as defined in Section 3(2) of ERISA) maintained for employees of the Borrower or any ERISA Affiliate and covered by Title IV of ERISA.

     “Permitted Lien” and “Permitted Liens” are defined in Section 6.3(a).

     “Person” means any individual, corporation, partnership, joint venture, limited liability company, association, joint-stock company, trust, unincorporated organization or government or any agency or political subdivision thereof.

     “Plan” means an employee benefit plan (as defined in Section 3(3) of ERISA) maintained for employees of the Borrower or any ERISA Affiliate.

     “Premises” means all locations where the Borrower conducts its business or has any rights of possession, including the locations legally described in Exhibit D attached hereto.

     “Prime Rate” means at any time the rate of interest most recently announced by the Lender at its principal office as its Prime Rate, with the understanding that the Prime Rate is one of the Lender’s base rates, and serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto, and is evidenced by the recording thereof in such internal publication or publications as the Lender may designate. Each change in the rate of interest shall become effective on the date each Prime Rate change is announced by the Lender.

     “Reportable Event” means a reportable event (as defined in Section 4043 of ERISA), other than an event for which the 30-day notice requirement under ERISA has been waived in regulations issued by the Pension Benefit Guaranty Corporation.

     “Revolving Advance” is defined in Section 2.1.

     “Revolving Note” means the Borrower’s revolving promissory note, payable to the order of the Lender in substantially the form of Exhibit A hereto, as same may be renewed and amended from time to time, and all replacements thereto.

     “Securities Account” means the securities account numbered 6436-2579 maintained by Wells Fargo Investments, LLC on behalf of Thomas F. Leahy.

     “Security Documents” means this Agreement, the Wholesale Lockbox and Collection Account Agreement, the Patent and Trademark Security Agreement(s),each Guaranty, the Leahy Pledge Agreement, the Control Agreement and any other document delivered to the Lender from time to time to secure the Indebtedness.

     “Security Interest” is defined in Section 3.1.

     “Subordinated Creditor” means each Person now or in the future who agrees to subordinate indebtedness of the Borrower held by that Person to the payment of the Indebtedness.

     “Subsidiary” means any Person of which more than fifty percent (50%) of the outstanding ownership interests having general voting power under ordinary circumstances to

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elect a majority of the board of directors or the equivalent of such Person, regardless of whether or not at the time ownership interests of any other class or classes shall have or might have voting power by reason of the happening of any contingency, is at the time directly or indirectly owned by the Borrower, by the Borrower and one or more other Subsidiaries, or by one or more other Subsidiaries.

     “Term Advance” is defined in Section 2.3.

     “Term Note” means the Borrower’s Equipment promissory note, payable to the order of the Lender in substantially the form of Exhibit B hereto, in an amount up to $340,000 but not exceeding 100% of the net forced sale liquidation value of equipment as same may be renewed and amended from time to time, and all replacements thereto.

     “Termination Date” means the earliest of (i) the Maturity Date, (ii) the date the Borrower terminates the Credit Facility, or (iii) the date the Lender demands payment of the Indebtedness, following an Event of Default, pursuant to Section 7.2.

     “Trademark Security Agreement” means each Trademark Security Agreement now or hereafter executed by the Borrower in favor of the Lender.

     “UCC” means the Uniform Commercial Code in effect in the state designated in this Agreement as the state whose laws shall govern this Agreement, or in any other state whose laws are held to govern this Agreement or any portion of this Agreement.

     “Unused Amount” is defined in Section 2.6(b).

     “Wholesale Lockbox and Collection Account Agreement” means the Wholesale Lockbox and Collection Account Agreement by and between the Borrower and the Lender, dated the same date as this Agreement.

     Section 1.2 Other Definitional Terms; Rules of Interpretation. The words “hereof”, “herein” and “hereunder” and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement. All accounting terms not otherwise defined herein have the meanings assigned to them in accordance with GAAP. All terms defined in the UCC and not otherwise defined herein have the meanings assigned to them in the UCC. References to Articles, Sections, subsections, Exhibits, Schedules and the like, are to Articles, Sections and subsections of, or Exhibits or Schedules attached to, this Agreement unless otherwise expressly provided. The words “include”, “includes” and “including” shall be deemed to be followed by the phrase “without limitation”. Unless the context in which used herein otherwise clearly requires, “or” has the inclusive meaning represented by the phrase “and/or”. Defined terms include in the singular number the plural and in the plural number the singular. Reference to any agreement (including the Loan Documents), document or instrument means such agreement, document or instrument as amended or modified and in effect from time to time in accordance with the terms thereof (and, if applicable, in accordance with the terms hereof and the other Loan Documents), except where otherwise explicitly provided, and reference to any promissory note includes any promissory note which is an extension or renewal thereof or a substitute or replacement therefor. Reference to any law, rule, regulation, order, decree, requirement, policy, guideline, directive or interpretation means as

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amended, modified, codified, replaced or reenacted, in whole or in part, and in effect on the determination date, including rules and regulations promulgated thereunder.

ARTICLE II

AMOUNT AND TERMS OF THE CREDIT FACILITY

     Section 2.1 Revolving Advances. The Lender agrees, subject to the terms and conditions of this Agreement, to make advances (“Revolving Advances”) to the Borrower from time to time from the date that all of the conditions set forth in Section 4.1 are satisfied (the “Funding Date”) to and until (but not including) the Termination Date in an amount not in excess of the Maximum Line Amount less the Ex-Im Amount and as to Raw Materials and Finished Goods Inventory, not in excess of the Inventory Cap. The Lender shall have no obligation to make a Revolving Advance to the extent that the amount of the requested Revolving Advance exceeds Availability. The Borrower’s obligation to pay the Revolving Advances shall be evidenced by the Revolving Note and shall be secured by the Collateral. Within the limits set forth in this Section 2.1, the Borrower may borrow, prepay pursuant to Section 2.9, and reborrow.

     Section 2.2 Procedures for Requesting Advances. The Borrower shall comply with the following procedures in requesting Revolving Advances:

          (a) Time for Requests. The Borrower shall request each Advance not later than the Cut-off Time on the Business Day on which the Advance is to be made. Each request that conforms to the terms of this Agreement shall be effective upon receipt by the Lender, shall be in writing or by telephone, and shall be confirmed in writing by the Borrower if so requested by the Lender, by (i) an Officer of the Borrower; or (ii) a Person designated as the Borrower’s agent by an Officer of the Borrower in a writing delivered to the Lender; or (iii) a Person whom the Lender reasonably believes to be an Officer of the Borrower or such a designated agent. The Borrower shall repay all Advances even if the Lender does not receive such confirmation and even if the Person requesting an Advance was not in fact authorized to do so. Any request for an Advance, whether written or telephonic, shall be deemed to be a representation by the Borrower that the conditions set forth in Section 4.2 have been satisfied as of the time of the request.

          (b) Disbursement. Upon fulfillment of the applicable conditions set forth in Article IV, the Lender shall disburse the proceeds of the requested Advance by crediting the same to the Borrower’s demand deposit account maintained with the Lender unless the Lender and the Borrower shall agree in writing to another manner of disbursement.

     Section 2.3 Term Advance.

     (a) The Lender agrees, subject to the terms and conditions of this Agreement, to make a single advance to the Borrower on the Funding Date (the “Term Advance”) in an amount not exceeding the lesser of $340,000 or one hundred percent (100%) of the Net Forced Liquidation Value of the Borrower’s Eligible Equipment. The Borrower’s obligation to pay the Term Advance shall be evidenced by the Term Note and shall be secured by the Collateral as provided in Article III.

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     (b) Upon fulfillment of the applicable conditions set forth in Article IV, the Lender shall deposit the proceeds of the requested Term Advance by crediting the same to the Borrower’s demand deposit account specified in Section 2.2(b) unless the Lender and the Borrower shall agree in writing to another manner of disbursement.

     Section 2.4 Payment of Term Note. The outstanding principal balance of the Term Note shall be due and payable as follows:

     (a) In equal monthly installments of $5,666.67, beginning on June 1, 2007, and on the first day of each month thereafter, in 60 equal monthly installments sufficient to fully amortize the principal balance of the Term Note with the balance due and payable in full on the Maturity Date.

     (b) If the Lender at any time obtains an appraisal of the Equipment as permitted under Section 6.9(d) herein, and the appraisal shows the aggregate outstanding principal balance of the Term Note to exceed Net Forced Liquidation Value of Eligible Equipment, then the Borrower, upon demand by the Lender, shall make additional monthly principal payments in an amount equal to the amount of such excess divided by 60 months, together with any prepayment fee.

     (c) All prepayments of principal with respect to the Term Note shall be applied to the most remote principal installment or installments then unpaid.

     (d) On the Termination Date of the Credit Facility, the entire unpaid principal balance of the Term Note and all unpaid interest accrued thereon shall also be fully due and payable.

     Section 2.5 Interest; Minimum Interest Charge; Default Interest Rate; Application of Payments; Participations; Usury.

          (a) Interest. Except as provided in Section 2.5(c), the principal amount of each Advance shall bear interest as a Floating Rate Advance.

          (b) Minimum Interest Charge. Notwithstanding any other terms of this Agreement to the contrary, the Borrower shall pay to the Lender interest of not less than $150,000 per “Loan Year,” paid quarterly, (the “Minimum Interest Charge”) during the term of this Agreement, and the Borrower shall pay any deficiency between the Minimum Interest Charge and the amount of interest otherwise calculated under Section 2.5(a) on the first day of each quarter following the Funding Date and each anniversary of the Funding Date and on the Termination Date. “Loan Year” means each one year period ending on the anniversary of the Funding Date. When calculating this deficiency, the Default Rate, if applicable, shall be disregarded, and any interest that accrues on a payment following its receipt on those days specified in Section 2.5(d) shall be excluded in determining the total amount of interest otherwise calculated under Section 2.5(a).

          (c) Default Interest Rate. At any time during any Default Period or following the Termination Date, in the Lender’s sole discretion and without waiving any of its other rights or remedies, the principal of the Revolving Note and the Term Note shall bear interest at the

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Default Rate or such lesser rate as the Lender may determine, effective as of the date the Event of Default occurs through the last day of such Default Period, or any shorter time period that the Lender may determine. The decision of the Lender to impose a rate that is less than the Default Rate or to not impose the Default Rate for the entire duration of the Default Period shall be made by the Lender in its sole discretion and shall not be a waiver of any of its other rights and remedies, including its right to retroactively impose the full Default Rate for the entirety of any such Default Period or following the Termination Date.

          (d) Application of Payments. Payments shall be applied to the Indebtedness on the Business Day of receipt by the Lender in the Lender’s general account, but the amount of principal paid shall continue to accrue interest at the interest rate applicable under the terms of this Agreement from the calendar day the Lender receives the payment, and continuing through the end of the first Business Day following receipt of the payment.

          (e) Participations. If any Person shall acquire a participation in the Advances or the Obligation of Reimbursement, the Borrower shall be obligated to the Lender to pay the full amount of all interest calculated under this Section 2.5, along with all other fees, charges and other amounts due under this Agreement, regardless if such Person elects to accept interest with respect to its participation at a lower rate than that calculated under this Section 2.5, or otherwise elects to accept less than its prorata share of such fees, charges and other amounts due under this Agreement.

          (f) Usury. In any event no rate change shall be put into effect which would result in a rate greater than the highest rate permitted by law. Notwithstanding anything to the contrary contained in any Loan Document, all agreements which either now are or which shall become agreements between the Borrower and the Lender are hereby limited so that in no contingency or event whatsoever shall the total liability for payments in the nature of interest, additional interest and other charges exceed the applicable limits imposed by any applicable usury laws. If any payments in the nature of interest, additional interest and other charges made under any Loan Document are held to be in excess of the limits imposed by any applicable usury laws, it is agreed that any such amount held to be in excess shall be considered payment of principal hereunder, and the indebtedness evidenced hereby shall be reduced by such amount so that the total liability for payments in the nature of interest, additional interest and other charges shall not exceed the applicable limits imposed by any applicable usury laws, in compliance with the desires of the Borrower and the Lender. This provision shall never be superseded or waived and shall control every other provision of the Loan Documents and all agreements between the Borrower and the Lender, or their successors and assigns.

     Section 2.6 Fees.

          (a) Closing Fee. The Borrower shall pay the Lender a fully earned and non-refundable origination fee of $20,000.00, due and payable upon the execution of this Agreement.

          (b) Unused Line Fee. For the purposes of this Section 2.6(b), “Unused Amount” means the Maximum Line Amount reduced by outstanding Revolving Advances. The Borrower agrees to pay to the Lender an unused line fee at the rate of one quarter of one percent (0.25%) per annum on the average daily Unused Amount from the date of this Agreement to and

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including the Termination Date, due and payable monthly in arrears on the first day of the month and on the Termination Date.

          (c) Collateral Exam Fees. The Borrower shall pay the Lender fees in connection with any collateral exams, audits or inspections conducted by or on behalf of the Lender of any Collateral or the Borrower’s operations or business at the rates established from time to time by the Lender as its collateral exam fees which fees are currently $850 per eight hour day per collateral examiner plus actual out of pocket expenses. Collateral exam fees will include a pre-loan survey as well as Collateral exams thereafter. Collateral exams are typically performed on a quarterly basis, but the Lender reserves the right to perform Collateral exams at any time in its sole discretion.

          (d) Termination and Line Reduction Fees. If (i) the Lender terminates the Credit Facility during a Default Period, or if (ii) the Borrower terminates or reduces the Credit Facility on a date prior to the Maturity Date, then the Borrower shall pay the Lender as liquidated damages and not as a penalty a termination fee in an amount equal to a percentage of the Maximum Line Amount (or the reduction of the Maximum Line Amount, as the case may be) calculated as follows: (A) three percent (3%) if the termination or reduction occurs on or before the first anniversary of the Funding Date; (B) two percent (2%) if the termination or reduction occurs after the first anniversary of the Funding Date, but on or before the second anniversary of the Funding Date; and (C) one percent (1%) if the termination or reduction occurs after the second anniversary of the Funding Date.

          (e) Waiver of Termination and Prepayment Fees. The Borrower will be excused from the payment of termination and prepayment fees otherwise due under this Agreement if such termination or prepayment is made because of refinancing through another one of the Lender’s operating divisions more than eighteen (18) months after the Funding Date.

          (f) Overadvance Fees. The Borrower shall pay an Overadvance fee in the amount of $500.00 for each day or portion thereof during which an Overadvance exists, regardless of how the Overadvance arises or whether or not the Overadvance has been agreed to in advance by the Lender. The acceptance of payment of an Overadvance fee by the Lender shall not be deemed to constitute either consent to the Overadvance or a waiver of the resulting Event of Default, unless the Lender specifically consents to the Overadvance in writing and waives the Event of Default on whatever conditions the Lender deems appropriate.

          (g) Ex-Im Fees. The Borrower shall pay the Lender, on demand, all fees due and payable from time to time under the Ex-Im Documents.

          (h) Other Fees and Charges. The Lender may from time to time impose additional fees and charges as consideration for Advances made in excess of Availability or for other events that constitute an Event of Default or a Default hereunder, including fees and charges for the administration of Collateral by the Lender, and fees and charges for the late delivery of reports, which may be assessed in the Lender’s sole discretion on either an hourly, periodic, or flat fee basis, and in lieu of or in addition to imposing interest at the Default Rate. Borrower shall also be responsible for all out of pocket expenses in connection with the contemplated financing including without limitation legal fees and expenses, closing costs,

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appraisal fees, UCC search and recording fees, costs for individual corporate credit reports, mortgage recording fees, fees to initiate electronic reporting, as well as collateral examination costs. Such costs are to be funded by Borrower and shall survive.

     Section 2.7 Time for Interest Payments; Payment on Non-Business Days; Computation of Interest and Fees.

          (a) Time For Interest Payments. Accrued and unpaid interest shall be due and payable on the first day of each month and on the Termination Date (each an “Interest Payment Date”), or if any such day is not a Business Day, on the next succeeding Business Day. Interest will accrue from the most recent date to which interest has been paid or, if no interest has been paid, from the date of advance to the Interest Payment Date. If an Interest Payment Date is not a Business Day, payment shall be made on the next succeeding Business Day.

          (b) Payment on Non Business Days. Whenever any payment to be made hereunder shall be stated to be due on a day which is not a Business Day, such payment may be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of interest on the Advances or the fees hereunder, as the case may be.

          (c) Computation of Interest and Fees. Interest accruing on the outstanding principal balance of the Advances and fees hereunder outstanding from time to time shall be computed on the basis of actual number of days elapsed in a year of 360 days.

     Section 2.8 Lockbox and Collateral Account; Sweep of Funds.

     (a) Lockbox and Collateral Account.

     (i) The Borrower shall instruct all account debtors to pay all Accounts directly to the Lockbox. If, notwithstanding such instructions, the Borrower receives any payments on Accounts, the Borrower shall deposit such payments into the Collateral Account. The Borrower shall also deposit all other cash proceeds of Collateral regardless of source or nature directly into the Collateral Account. Until so deposited, the Borrower shall hold all such payments and cash proceeds in trust for and as the property of the Lender and shall not commingle such property with any of its other funds or property. All deposits in the Collateral Account shall constitute proceeds of Collateral and shall not constitute payment of the Indebtedness.

     (ii) All items deposited in the Collateral Account shall be subject to final payment. If any such item is returned uncollected, the Borrower will immediately pay the Lender, or, for items deposited in the Collateral Account, the bank maintaining such account, the amount of that item, or such bank at its discretion may charge any uncollected item to the Borrower’s commercial account or other account. The Borrower shall be liable as an endorser on all items deposited in the Collateral Account, whether or not in fact endorsed by the Borrower.

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          (b) Sweep of Funds. The Lender shall from time to time, in accordance with the Wholesale Lockbox and Collection Account Agreement, cause funds in the Collateral Account to be transferred to the Lender’s general account for payment of the Indebtedness. Amounts deposited in the Collateral Account shall not be subject to withdrawal by the Borrower, except after payment in full and discharge of all Indebtedness.

     Section 2.9 Voluntary Prepayment; Reduction of the Maximum Line Amount; Termination of the Credit Facility by the Borrower. Except as otherwise provided herein, the Borrower may prepay the Advances in whole at any time or from time to time in part. The Borrower may terminate the Credit Facility or reduce the Maximum Line Amount at any time if it (i) gives the Lender at least 90 days advance written notice prior to the proposed Termination Date, and (ii) pays the Lender applicable termination and Maximum Line Amount reduction fees in accordance with the terms of this Agreement. Any reduction in the Maximum Line Amount shall be in multiples of $100,000, and with a minimum reduction of at least $500,000. If the Borrower terminates the Credit Facility or reduces the Maximum Line Amount to zero, all Indebtedness shall be immediately due and payable, and if the Borrower gives the Lender less than the required 90 days advance written notice, then the interest rate applicable to borrowings evidenced by the Revolving Note shall be the Default Rate for the period of time commencing 90 days prior to the proposed Termination Date through the date that the Lender actually receives such written notice. If the Borrower does not wish the Lender to consider renewal of the Credit Facility on the next Maturity Date, then the Borrower shall give the Lender at least 90 days written notice prior to the Maturity Date that it will not be requesting renewal. If the Borrower fails to give the Lender such timely notice, then the interest rate applicable to borrowings evidenced by the Revolving Note shall be the Default Rate for the period of time commencing 90 days prior to the Maturity Date through the date that the Lender actually receives such written notice.

     Section 2.10 Mandatory Prepayment. Without notice or demand, if the sum of the outstanding principal balance of the Revolving Advances shall at any time exceed the Borrowing Base, the Borrower shall immediately prepay the Revolving Advances to the extent necessary to eliminate such excess. Any prepayment received by the Lender under this Agreement may be applied to the Indebtedness, in such order and in such amounts as the Lender in its sole discretion may determine from time to time.

     Section 2.11 Revolving Advances to Pay Indebtedness. Notwithstanding the terms of Section 2.1, the Lender may, in its discretion at any time or from time to time, without the Borrower’s request and even if the conditions set forth in Section 4.2 would not be satisfied, and so long as this does not create an overadvance, make a Revolving Advance in an amount equal to the portion of the Indebtedness from time to time due and payable, and may deliver the proceeds of any such Revolving Advance to Wells Fargo Merchant Services, L.L.C. in satisfaction of any unpaid obligations due to Wells Fargo Merchant Services, L.L.C.

     Section 2.12 Use of Proceeds. The Borrower shall use the proceeds of Advances for ordinary working capital purposes, and to repay debts to Commerce Bank and Thomas F. Leahy.

     Section 2.13 Liability Records. The Lender may maintain from time to time, at its discretion, records as to the Indebtedness. All entries made on any such record shall be

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presumed correct until the Borrower establishes the contrary. Upon the Lender’s demand, the Borrower will admit and certify in writing the exact principal balance of the Indebtedness that the Borrower then asserts to be outstanding. Any billing statement or accounting rendered by the Lender shall be conclusive and fully binding on the Borrower unless the Borrower gives the Lender specific written notice of exception within 30 days after receipt.

ARTICLE III

SECURITY INTEREST; OCCUPANCY; SETOFF

     Section 3.1 Grant of Security Interest. The Borrower hereby pledges, assigns and grants to the Lender, for the benefit of itself and as agent for Wells Fargo Merchant Services, L.L.C., a lien and security interest (collectively referred to as the “Security Interest”) in the Collateral, as security for the payment and performance of: (a) all present and future Indebtedness of the Borrower to the Lender; (b) all obligations of the Borrower and rights of the Lender under this Agreement; and (c) all present and future obligations of the Borrower to the Lender of other kinds. Upon request by the Lender, the Borrower will grant to the Lender, for the benefit of itself and as agent for Wells Fargo Merchant Services, L.L.C., a security interest in all commercial tort claims that the Borrower may have against any Person. In addition, the Borrower to further secure all such Indebtedness shall execute a Mortgage of $1,000,000 on property in Victoria, Minnesota.

     Section 3.2 Notification of Account Debtors and Other Obligors. The Lender may at any time after an Event of Default, notify any account debtor or other Person obligated to pay the amount due that such right to payment has been assigned or transferred to the Lender for security and shall be paid directly to the Lender. The Borrower will join in giving such notice if the Lender so requests. At any time after the Borrower or the Lender gives such notice to an account debtor or other obligor, the Lender may, but need not, in the Lender’s name or in the Borrower’s name, demand, sue for, collect or receive any money or property at any time payable or receivable on account of, or securing, any such right to payment, or grant any extension to, make any compromise or settlement with or otherwise agree to waive, modify, amend or change the obligations (including collateral obligations) of any such account debtor or other obligor. The Lender may, in the Lender’s name or in the Borrower’s name, as the Borrower’s agent and attorney-in-fact, notify the United States Postal Service to change the address for delivery of the Borrower’s mail to any address designated by the Lender, otherwise intercept the Borrower’s mail, and receive, open and dispose of the Borrower’s mail, applying all Collateral as permitted under this Agreement and holding all other mail for the Borrower’s account or forwarding such mail to the Borrower’s last known address.

     Section 3.3 Assignment of Insurance. Except for insurance obtained or pledged to a Landlord covering leased premises, as additional security for the payment and performance of the Indebtedness, the Borrower hereby assigns to the Lender any and all monies (including proceeds of insurance and refunds of unearned premiums) due or to become due under, and all other rights of the Borrower with respect to, any and all policies of insurance now or at any time hereafter covering the Collateral or any evidence thereof or any business records or valuable papers pertaining thereto, and the Borrower hereby directs the issuer of any such policy to pay all such monies directly to the Lender. At any time, whether or not a Default Period then exists, the Lender may (but need not), in the Lender’s name or in the Borrower’s name, execute and deliver

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proof of claim, receive all such monies, endorse checks and other instruments representing payment of such monies, and adjust, litigate, compromise or release any claim against the issuer of any such policy. Any monies received as payment for any loss under any insurance policy mentioned above (other than liability insurance policies) or as payment of any award or compensation for condemnation or taking by eminent domain, shall be paid over to the Lender to be applied, at the option of the Lender, either to the prepayment of the Indebtedness or shall be disbursed to the Borrower under staged payment terms reasonably satisfactory to the Lender for application to the cost of repairs, replacements, or restorations. Any such repairs, replacements, or restorations shall be effected with reasonable promptness and shall be of a value at least equal to the value of the items or property destroyed prior to such damage or destruction.

     Section 3.4 Occupancy.

     (a) To the greatest extent possible under existing or future leases and consistent with any Landlord Waivers and Mortgagee Disclaimers, but subject to the mortgage of Commerce Bank, the Borrower hereby irrevocably grants to the Lender the right to take exclusive possession of the Premises at any time during a Default Period without notice or consent.

     (b) The Lender may use the Premises only to hold, process, manufacture, sell, use, store, liquidate, realize upon or otherwise dispose of items that are Collateral and for other purposes that the Lender may in good faith deem to be related or incidental purposes.

     (c) The Lender’s right to hold the Premises shall cease and terminate upon the earlier of (i) payment in full and discharge of all Indebtedness and termination of the Credit Facility, and (ii) final sale or disposition of all items constituting Collateral and delivery of all such items to purchasers.

     (d) The Lender shall not be obligated to pay or account for any rent or other compensation for the possession, occupancy or use of any of the Premises; provided, however, that if the Lender does pay or account for any rent or other compensation for the possession, occupancy or use of any of the Premises, the Borrower shall reimburse the Lender promptly for the full amount thereof. In addition, the Borrower will pay, or reimburse the Lender for, all taxes, fees, duties, imposts, charges and expenses at any time incurred by or imposed upon the Lender by reason of the execution, delivery, existence, recordation, performance or enforcement of this Agreement or the provisions of this Section 3.4.

     Section 3.5 License. Without limiting the generality of any other Security Document, the Borrower hereby grants to the Lender a non-exclusive, worldwide and royalty-free license to use or otherwise exploit all Intellectual Property Rights of the Borrower for the purpose of: (a) completing the manufacture of any in-process materials during any Default Period so that such materials become saleable Inventory, all in accordance with the same quality standards previously adopted by the Borrower for its own manufacturing and subject to the Borrower’s reasonable exercise of quality control; and (b) selling, leasing or otherwise disposing of any or all Collateral during any Default Period.

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     Section 3.6 Financing Statement. The Borrower authorizes the Lender to file from time to time, such financing statements against collateral described as “all personal property” or “all assets” or describing specific items of collateral including commercial tort claims as the Lender deems necessary or useful to perfect the Security Interest. All financing statements filed before the date hereof to perfect the Security Interest were authorized by the Borrower and are hereby re-authorized. A carbon, photographic or other reproduction of this Agreement or of any financing statements signed by the Borrower is sufficient as a financing statement and may be filed as a financing statement in any state to perfect the security interests granted hereby. For this purpose, the Borrower represents and warrants that the following information is true and correct:

Name and address of Debtor:
HEI, Inc.
1495 Steiger Lake Lane
Victoria, Minnesota 55386
Federal Employer Identification No. 41-0944876
Organizational Identification No. MN 1P-877
Name and address of Secured Party:
Wells Fargo Bank, National Association
MAC N9312-040
Sixth and Marquette
Minneapolis, Minnesota 55479

     Section 3.7 Setoff. The Lender may at any time or from time to time, at its sole discretion and without demand and without notice to anyone, setoff any liability owed to the Borrower by the Lender, whether or not due, against any Indebtedness, whether or not due. In addition, each other Person holding a participating interest in any Indebtedness shall have the right to appropriate or setoff any deposit or other liability then owed by such Person to the Borrower, whether or not due, and apply the same to the payment of said participating interest, as fully as if such Person had lent directly to the Borrower the amount of such participating interest.

     Section 3.8 Collateral. This Agreement does not contemplate a sale of accounts, contract rights or chattel paper, and, as provided by law, the Borrower is entitled to any surplus and shall remain liable for any deficiency. The Lender’s duty of care with respect to Collateral in its possession (as imposed by law) shall be deemed fulfilled if it exercises reasonable care in physically keeping such Collateral, or in the case of Collateral in the custody or possession of a bailee or other third Person, exercises reasonable care in the selection of the bailee or other third Person, and the Lender need not otherwise preserve, protect, insure or care for any Collateral. The Lender shall not be obligated to preserve any rights the Borrower may have against prior parties, to realize on the Collateral at all or in any particular manner or order or to apply any cash proceeds of the Collateral in any particular order of application. The Lender has no obligation to clean-up or otherwise prepare the Collateral for sale. The Borrower waives any right it may have to require the Lender to pursue any third Person for any of the Indebtedness.

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ARTICLE IV

CONDITIONS OF LENDING

     Section 4.1 Conditions Precedent to the Initial Advances. The Lender’s obligation to make the initial Advances shall be subject to the condition precedent that the Lender shall have received all of the following, each properly executed by the appropriate party and in form and substance satisfactory to the Lender:

     (a) This Agreement.

     (b) The Revolving Note and the Term Note.

     (c) The Ex-Im Documents.

     (d) A true and correct copy of any and all leases pursuant to which the Borrower is leasing the Premises, together with a landlord’s disclaimer and consent with respect to each such lease.

     (e) A true and correct copy of any and all mortgages pursuant to which the Borrower has mortgaged the Premises, together with a mortgagee’s disclaimer and consent with respect to each such mortgage.

     (f) A true and correct copy of any and all agreements pursuant to which the Borrower’s property is in the possession of any Person other than the Borrower, together with, in the case of any goods held by such Person for resale, (i) a consignee’s acknowledgment and waiver of Liens, (ii) UCC financing statements sufficient to protect the Borrower’s and the Lender’s interests in such goods, and (iii) UCC searches showing that no other secured party has filed a financing statement against such Person and covering property similar to the Borrower’s other than the Borrower, or if there exists any such secured party, evidence that each such secured party has received notice from the Borrower and the Lender sufficient to protect the Borrower’s and the Lender’s interests in the Borrower’s goods from any claim by such secured party.

     (g) An acknowledgment and waiver of Liens from each warehouse in which the Borrower is storing Inventory.

     (h) An acknowledgment and agreement from SAP as licensor and any other licensor in favor of the Lender, together with a true, correct and complete copy of any such license agreements, except the expired Syteline License.

     (i) The Wholesale Lockbox and Collection Account Agreement.

     (j) Control agreements with each bank at which the Borrower maintains deposit accounts.

     (k) The Patent and Trademark Security Agreement.

     (l) The Mortgagee’s Disclaimer and Consent.

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     (m) Current searches of appropriate filing offices showing that (i) no Liens have been filed and remain in effect against the Borrower except Permitted Liens or Liens held by Persons who have agreed in writing that upon receipt of proceeds of the initial Advances, they will satisfy, release or terminate such Liens in a manner satisfactory to the Lender, and (ii) the Lender has duly filed all financing statements necessary to perfect the Security Interest, to the extent the Security Interest is capable of being perfected by filing.

     (n) A certificate of the Borrower’s Secretary or Assistant Secretary certifying that attached to such certificate are (i) the resolutions of the Borrower’s Directors and, if required, Owners, authorizing the execution, delivery and performance of the Loan Documents, (ii) true, correct and complete copies of the Borrower’s Constituent Documents, and (iii) examples of the signatures of the Borrower’s Officers or agents authorized to execute and deliver the Loan Documents and other instruments, agreements and certificates, including Advance requests, on the Borrower’s behalf.

     (o) A current certificate issued by the Secretary of State of Minnesota certifying that the Borrower is in compliance with all applicable organizational requirements of the State of Minnesota.

     (p) Evidence that the Borrower is duly licensed or qualified to transact business in all jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary.

     (q) A certificate of an Officer of the Borrower confirming, in his personal capacity, the representations and warranties set forth in Article V.

     (r) Certificates of the insurance required hereunder, with all hazard insurance containing a lender’s loss payable endorsement in the Lender’s favor and with all liability insurance naming the Lender as an additional insured.

     (s) Payment of all fees due under the terms of this Agreement through the date of the initial Advance, the Term Advance, and payment of all expenses incurred by the Lender through such date and that are required to be paid by the Borrower under this Agreement.

     (t) Evidence that after making the initial Revolving Advance, satisfying all obligations owed to the Borrower’s prior lender, satisfying all trade payables older than 60 days from invoice date, book overdrafts and closing costs, Availability shall be not less than $1,750,000.

     (u) A Customer Identification Information form and such other forms and verification as the Lender may need to comply with the U.S.A. Patriot Act.

     (v) The Guaranty of Thomas F. Leahy.

     (w) The Leahy Pledge Agreement.

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     (x) The Control Agreement.

     (y) With respect to the real estate that is encumbered by the mortgage of the Lender (i) a flood hazard determination form, confirming whether or not the parcel is in a flood hazard area and whether or not flood insurance must be obtained, and, if the real estate is located in a flood hazard area, (ii) a policy of flood insurance.

     (z) The Securities Account shall have been established.

     (aa) Such other documents as the Lender in its sole discretion may require.

     (bb) All conditions set forth in Section 4 of the Ex-Im Agreement shall have been effectively completed (unless such conditions have been waived by the Lender).

     Section 4.2 Conditions Precedent to All Advances. The Lender’s obligation to make each Advance shall be subject to the further conditions precedent that:

     (a) the representations and warranties contained in Article V are correct on and as of the date of such Advance as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date; and

     (b) no event has occurred and is continuing, or would result from such Advance which constitutes a Default or an Event of Default.

ARTICLE V

REPRESENTATIONS AND WARRANTIES

The Borrower represents and warrants to the Lender as follows:

     Section 5.1 Existence and Power; Name; Chief Executive Office; Inventory and Equipment Locations; Federal Employer Identification Number and Organizational Identification Number. The Borrower is a corporation, duly organized, validly existing and in good standing under the laws of the State of Minnesota and is duly licensed or qualified to transact business in all jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary. The Borrower has all requisite power and authority to conduct its business, to own its properties and to execute and deliver, and to perform all of its obligations under, the Loan Documents. During its existence, the Borrower has done business solely under the names set forth in Schedule 5.1. The Borrower’s chief executive office and principal place of business is located at the address set forth in Schedule 5.1, and all of the Borrower’s records relating to its business or the Collateral are kept at that location. All Inventory and Equipment is located at that location or at one of the other locations listed in Schedule 5.1. The Borrower’s federal employer identification number and organization identification number are correctly set forth in Section 3.6.

     Section 5.2 Capitalization. Schedule 5.2 constitutes a correct and complete list of all ownership interests of the Borrower and rights to acquire ownership interests including the record holder, number of interests and percentage interests on a fully diluted basis, and an organizational chart showing the ownership structure of all Subsidiaries of the Borrower.

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     Section 5.3 Authorization of Borrowing; No Conflict as to Law or Agreements. The execution, delivery and performance by the Borrower of the Loan Documents and the borrowings from time to time hereunder have been duly authorized by all necessary corporate action and do not and will not (i) require any consent or approval of the Borrower’s Owners; (ii) require any authorization, consent or approval by, or registration, declaration or filing with, or notice to, any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, or any third party, except such authorization, consent, approval, registration, declaration, filing or notice as has been obtained, accomplished or given prior to the date hereof; (iii) violate any provision of any law, rule or regulation (including Regulation X of the Board of Governors of the Federal Reserve System) or of any order, writ, injunction or decree presently in effect having applicability to the Borrower or of the Borrower’s Constituent Documents; (iv) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other material agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected; or (v) result in, or require, the creation or imposition of any Lien (other than the Security Interest) upon or with respect to any of the properties now owned or hereafter acquired by the Borrower.

     Section 5.4 Legal Agreements. This Agreement constitutes and, upon due execution by the Borrower, the other Loan Documents will constitute the legal, valid and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms.

     Section 5.5 Subsidiaries and Affiliates. Except as set forth in Schedule 5.5 hereto, the Borrower has no Subsidiaries and no Affiliates.

     Section 5.6 Financial Condition; No Adverse Change. The Borrower has furnished to the Lender its audited financial statements for its fiscal year ended September 2, 2006 and unaudited financial statements for the fiscal-year-to-date period ended March 31, 2007, and those statements fairly present the Borrower’s financial condition on the dates thereof and the results of its operations and cash flows for the periods then ended and were prepared in accordance with GAAP. Since the date of the most recent financial statements, there has been no material adverse change in the Borrower’s business, properties or condition (financial or otherwise) which has had a Material Adverse Effect.

     Section 5.7 Litigation. Except as set forth in Schedule 5.7, there are no actions, suits or proceedings pending or, to the Borrower’s knowledge, threatened against or affecting the Borrower or any of its Affiliates or the properties of the Borrower or any of its Affiliates before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, which, if determined adversely to the Borrower or any of its Affiliates, would have a material adverse effect on the financial condition, properties or operations of the Borrower or any of its Affiliates.

     Section 5.8 Regulation U. The Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U of the Board of Governors of the Federal Reserve System), and no part of the proceeds of any Advance will be used to purchase or carry any margin stock or to extend credit to others for the purpose of purchasing or carrying any margin stock.

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     Section 5.9 Taxes. The Borrower and its Affiliates have paid or caused to be paid to the proper authorities when due all federal, state and local taxes required to be withheld by each of them. The Borrower and its Affiliates have filed all federal, state and local tax returns which to the knowledge of the Officers of the Borrower or any Affiliate, as the case may be, are required to be filed, and the Borrower and its Affiliates have paid or caused to be paid to the respective taxing authorities all taxes as shown on said returns or on any assessment received by any of them to the extent such taxes have become due.

     Section 5.10 Titles and Liens. The Borrower has good and absolute title to all Collateral free and clear of all Liens other than Permitted Liens. No financing statement naming the Borrower as debtor is on file in any office except to perfect only Permitted Liens.

     Section 5.11 Intellectual Property Rights.

          (a) Owned Intellectual Property. Schedule 5.11 is a complete list of all patents, applications for patents, trademarks, applications to register trademarks, service marks, applications to register service marks, mask works, trade dress and copyrights for which the Borrower is the owner of record (the “Owned Intellectual Property”). Except as disclosed on Schedule 5.11, (i) the Borrower owns the Owned Intellectual Property free and clear of all restrictions (including covenants not to sue a third party), court orders, injunctions, decrees, writs or Liens, whether by written agreement or otherwise, (ii) no Person other than the Borrower owns or has been granted any right in the Owned Intellectual Property, (iii) all Owned Intellectual Property is valid, subsisting and enforceable and (iv) the Borrower has taken all commercially reasonable action necessary to maintain and protect the Owned Intellectual Property.

          (b) Agreements with Employees and Contractors. The Borrower has entered into a legally enforceable agreement with each of its employees and subcontractors obligating each such Person to assign to the Borrower, without any additional compensation, any Intellectual Property Rights created, discovered or invented by such Person in the course of such Person’s employment or engagement with the Borrower (except to the extent prohibited by law), and further requiring such Person to cooperate with the Borrower, without any additional compensation, in connection with securing and enforcing any Intellectual Property Rights therein; provided, however, that the foregoing shall not apply with respect to employees and subcontractors whose job descriptions are of the type such that no such assignments are reasonably foreseeable.

          (c) Intellectual Property Rights Licensed from Others. Schedule 5.11 is a complete list of all agreements under which the Borrower has licensed Intellectual Property Rights from another Person (“Licensed Intellectual Property”) other than readily available, non-negotiated licenses of computer software and other intellectual property used solely for performing accounting, word processing and similar administrative tasks (“Off-the-shelf Software”) and a summary of any ongoing payments the Borrower is obligated to make with respect thereto. Except as disclosed on Schedule 5.11 and in written agreements, copies of which have been given to the Lender, the Borrower’s licenses to use the Licensed Intellectual Property are free and clear of all restrictions, Liens, court orders, injunctions, decrees, or writs, whether by written agreement or otherwise. Except as disclosed on Schedule 5.11, the Borrower

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is not obligated or under any liability whatsoever to make any payments of a material nature by way of royalties, fees or otherwise to any owner of, licensor of, or other claimant to, any Intellectual Property Rights.

          (d) Other Intellectual Property Needed for Business. Except for Off-the-shelf Software and as disclosed on Schedule 5.11, the Owned Intellectual Property and the Licensed Intellectual Property constitute all Intellectual Property Rights used or necessary to conduct the Borrower’s business as it is presently conducted or as the Borrower reasonably foresees conducting it.

          (e) Infringement. Except as disclosed on Schedule 5.11, the Borrower has no knowledge of, and has not received any written claim or notice alleging, any Infringement of another Person’s Intellectual Property Rights (including any written claim that the Borrower must license or refrain from using the Intellectual Property Rights of any third party) nor, to the Borrower’s knowledge, is there any threatened claim or any reasonable basis for any such claim.

     Section 5.12 Plans. Except as disclosed to the Lender in writing prior to the date hereof, neither the Borrower nor any ERISA Affiliate (a) maintains or has maintained any Pension Plan, (b) contributes or has contributed to any Multiemployer Plan or (c) provides or has provided post-retirement medical or insurance benefits with respect to employees or former employees (other than benefits required under Section 601 of ERISA, Section 4980B of the IRC or applicable state law). Neither the Borrower nor any ERISA Affiliate has received any notice or has any knowledge to the effect that it is not in full compliance with any of the requirements of ERISA, the IRC or applicable state law with respect to any Plan. No Reportable Event exists in connection with any Pension Plan. Each Plan which is intended to qualify under the IRC is so qualified, and no fact or circumstance exists which may have an adverse effect on the Plan’s tax qualified status. Neither the Borrower nor any ERISA Affiliate has (i) any accumulated funding deficiency (as defined in Section 302 of ERISA and Section 412 of the IRC) under any Plan, whether or not waived, (ii) any liability under Section 4201 or 4243 of ERISA for any withdrawal, partial withdrawal, reorganization or other event under any Multiemployer Plan or (iii) any liability or knowledge of any facts or circumstances which could result in any liability to the Pension Benefit Guaranty Corporation, the Internal Revenue Service, the Department of Labor or any participant in connection with any Plan (other than routine claims for benefits under the Plan).

     Section 5.13 Default. The Borrower is in compliance with all provisions of all agreements, instruments, decrees and orders to which it is a party or by which it or its property is bound or affected, the breach or default of which could have a Material Adverse Effect on the Borrower’s financial condition, properties or operations.

     Section 5.14 Environmental Matters.

     (a) Except as disclosed on Schedule 5.14, to the best of the Borrower’s knowledge, there are not present in, on or under the Premises any Hazardous Substances in such form or quantity as to create any material liability or obligation for either the Borrower or the Lender under the common law of any jurisdiction or under any Environmental Law, and to the best of the Borrower’s knowledge, no Hazardous

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Substances have ever been stored, buried, spilled, leaked, discharged, emitted or released in, on or under the Premises in such a way as to create any such material liability.

     (b) Except as disclosed on Schedule 5.14, the Borrower has not disposed of Hazardous Substances in such a manner as to create any material liability under any Environmental Law.

     (c) To the best of the Borrower’s knowledge, and except as disclosed on Schedule 5.14, there are no, (and there have not existed in the past), nor are there any threatened, impending requests, claims, notices, investigations, demands, administrative proceedings, hearings or litigation relating in any way to the Premises or the Borrower, alleging material liability under, violation of, or noncompliance with any Environmental Law or any license, permit or other authorization issued pursuant thereto.

     (d) To the best of the Borrower’s knowledge, and except as disclosed on Schedule 5.14, the Borrower’s businesses are, and to the best of Borrower’s knowledge, have in the past always been, conducted in accordance with all Environmental Laws and all licenses, permits and other authorizations required pursuant to any Environmental Law and necessary for the lawful and efficient operation of such businesses are in the Borrower’s possession and are in full force and effect, nor has the Borrower been denied insurance on grounds related to potential environmental liability. No permit required under any Environmental Law is scheduled to expire within 12 months and there is no threat that any such permit will be withdrawn, terminated, limited or materially changed.

     (e) Except as disclosed on Schedule 5.14, the Premises are not, and to the best of Borrower’s knowledge, have never been listed on the National Priorities List, the Comprehensive Environmental Response, Compensation and Liability Information System or any similar federal, state or local list, schedule, log, inventory or database.

     (f) The Borrower has delivered to the Lender all environmental assessments, audits, reports, permits, licenses and other documents describing or relating in any way to the Premises or the Borrower’s businesses.

     Section 5.15 Submissions to the Lender. All financial and other information provided to the Lender by or on behalf of the Borrower in connection with the Borrower’s request for the credit facilities contemplated hereby (i) is true and correct in all material respects, (ii) does not omit any material fact necessary to make such information not misleading and, (iii) as to projections, valuations or proforma financial statements, presents a good faith opinion as to such projections, valuations and proforma condition and results.

     Section 5.16 Financing Statements. The Borrower has authorized the filing of financing statements sufficient when filed to perfect the Security Interest and the other security interests created by the Security Documents. When such financing statements are filed in the offices noted therein, the Lender will have a valid and perfected security interest in all Collateral which is capable of being perfected by filing financing statements. None of the Collateral is or will become a fixture on real estate, unless a sufficient fixture filing is in effect with respect thereto.

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     Section 5.17 Rights to Payment. Each right to payment and each instrument, document, chattel paper and other agreement constituting or evidencing Collateral is (or, in the case of all future Collateral, will be when arising or issued) the valid, genuine and legally enforceable obligation, subject to no defense, setoff or counterclaim, of the account debtor or other obligor named therein or in the Borrower’s records pertaining thereto as being obligated to pay such obligation, except ordinary course of business returns and credit memos.

ARTICLE VI

COVENANTS

     So long as the Indebtedness shall remain unpaid, or the Credit Facility shall remain outstanding, the Borrower will comply with the following requirements, unless the Lender shall otherwise consent in writing:

     Section 6.1 Reporting Requirements. The Borrower will deliver, or cause to be delivered, to the Lender each of the following, which shall be in form and detail acceptable to the Lender:

          (a) Annual Financial Statements. As soon as available, and in any event within 120 days after the end of each fiscal year of the Borrower, the Borrower’s audited financial statements with the unqualified opinion of independent certified public accountants selected by the Borrower and acceptable to the Lender, which annual financial statements shall include the Borrower’s balance sheet as at the end of such fiscal year and the related statements of the Borrower’s income, retained earnings and cash flows for the fiscal year then ended, prepared, if the Lender so requests, on a consolidating (unaudited) and consolidated (audited) basis to include any Affiliates, all in reasonable detail and prepared in accordance with GAAP, together with (i) copies of all management letters prepared by such accountants; (ii) a report signed by such accountants stating that in making the investigations necessary for said opinion they obtained no knowledge, except as specifically stated, of any Default or Event of Default and all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrower is in compliance with the Financial Covenants; and (iii) a certificate of the Borrower’s chief financial officer stating that such financial statements have been prepared in accordance with GAAP, fairly represent the Borrower’s financial position and the results of its operations, and whether or not such Officer has knowledge of the occurrence of any Default or Event of Default and, if so, stating in reasonable detail the facts with respect thereto.

          (b) Monthly Financial Statements. As soon as available and in any event within 20 days after the end of each month, the unaudited/internal balance sheet and statements of income and retained earnings of the Borrower as at the end of and for such month and for the year to date period then ended, prepared, if the Lender so requests, on a consolidating and consolidated basis to include any Affiliates, in reasonable detail and stating in comparative form the figures for the corresponding date and periods in the previous year, all prepared in accordance with GAAP, subject to year-end audit adjustments and which fairly represent the Borrower’s financial position and the results of its operations; and accompanied by a certificate of the Borrower’s chief financial officer, substantially in the form of Exhibit C hereto stating (i) that such financial statements have been prepared in accordance with GAAP, subject to year-end

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audit adjustments, and fairly represent the Borrower’s financial position and the results of its operations, (ii) whether or not such Officer has knowledge of the occurrence of any Default or Event of Default not theretofore reported and remedied and, if so, stating in reasonable detail the facts with respect thereto, and (iii) all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrower is in compliance with the Financial Covenants.

          (c) Accounts Inventory. Within 15 days after the end of each month, the Borrower shall provide a monthly accounts receivable and accounts payable listing and aging and an inventory report, both of which shall be submitted electronically to the Lender via its vendor Collateral Services Inc. (CSI). Monthly processing fees shall apply to such reporting.

          (d) Collateral Reports. Within 15 days after the end of each month or more frequently if the Lender so requires, the Borrower’s accounts receivable and its accounts payable, a detailed inventory report, an inventory certification report, and a calculation of the Borrower’s Accounts, Eligible Accounts, Inventory and Eligible Inventory as at the end of such month or shorter time period.

          (e) Projections. No later than 30 days before the last day of each fiscal year, the Borrower’s projected balance sheets, income statements, statements of cash flow for each month of the succeeding fiscal year, each in reasonable detail. Such items will be certified by the Officer who is the Borrower’s chief financial officer as being the most accurate projections available and identical to the projections used by the Borrower for internal planning purposes and be delivered with a statement of underlying assumptions and such supporting schedules and information as the Lender may in its discretion require.

          (f) Supplemental Reports. Weekly, or more frequently if the Lender so requires, the Borrower’s “Daily Collateral Reports”, receivables schedules, and collection reports, as well as such additional reports as the Lender may require.

          (g) Litigation. Immediately after the commencement thereof, notice in writing of all litigation and of all proceedings before any governmental or regulatory agency affecting the Borrower (i) of the type described in Section 5.14(c) or (ii) which seek a monetary recovery against the Borrower in excess of $50,000.

          (h) Defaults. When any Officer of the Borrower becomes aware of the probable occurrence of any Default or Event of Default, and no later than 3 days after such Officer becomes aware of such Default or Event of Default, notice of such occurrence, together with a detailed statement by a responsible Officer of the Borrower of the steps being taken by the Borrower to cure the effect thereof.

          (i) Plans. As soon as possible, and in any event within 30 days after the Borrower knows or has reason to know that any Reportable Event with respect to any Pension Plan has occurred, a statement signed by the Officer who is the Borrower’s chief financial officer setting forth details as to such Reportable Event and the action which the Borrower proposes to take with respect thereto, together with a copy of the notice of such Reportable Event to the Pension Benefit Guaranty Corporation. As soon as possible, and in any event within 10 days after the Borrower fails to make any quarterly contribution required with respect to any Pension

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Plan under Section 412(m) of the IRC, the Borrower will deliver to the Lender a statement signed by the Officer who is the Borrower’s chief financial officer setting forth details as to such failure and the action which the Borrower proposes to take with respect thereto, together with a copy of any notice of such failure required to be provided to the Pension Benefit Guaranty Corporation. As soon as possible, and in any event within ten days after the Borrower knows or has reason to know that it has or is reasonably expected to have any liability under Section 4201 or Section 4243 of ERISA for any withdrawal, partial withdrawal, reorganization or other event under any Multiemployer Plan, the Borrower will deliver to the Lender a statement of the Borrower’s chief financial officer setting forth details as to such liability and the action which the Borrower proposes to take with respect thereto.

          (j) Disputes. Promptly upon knowledge thereof, notice of (i) any disputes or claims by the Borrower’s customers exceeding $10,000 individually or $25,000 in the aggregate during any fiscal year; (ii) credit memos exceeding $10,000 individually or $25,000 in the aggregate during any fiscal year;; and (iii) any goods returned to or recovered by the Borrower exceeding $10,000 individually or $25,000 in the aggregate during any fiscal year and excluding valid warranty work.

          (k) Officers and Directors. Promptly upon knowledge thereof, notice of any change in the persons constituting the Borrower’s Officers and Directors.

          (l) Collateral. Promptly upon knowledge thereof, notice of any material loss of or material damage to any Collateral or of any substantial adverse change in any Collateral or the prospect of payment thereof.

          (m) Commercial Tort Claims. Promptly upon knowledge thereof, notice of any commercial tort claims it may bring against any Person, including the name and address of each defendant, a summary of the facts, an estimate of the Borrower’s damages, copies of any complaint or demand letter submitted by the Borrower, and such other information as the Lender may request.

          (n) Intellectual Property.

     (i) 30 days prior written notice of Borrower’s intent to acquire material Intellectual Property Rights; except for transfers permitted under Section 6.17, the Borrower will give the Lender 30 days prior written notice of its intent to dispose of material Intellectual Property Rights and upon request shall provide the Lender with copies of all proposed documents and agreements concerning such rights.

     (ii) Promptly upon knowledge thereof, notice of (A) any Infringement of its Intellectual Property Rights by others, (B) claims that the Borrower is Infringing another Person’s Intellectual Property Rights and (C) any threatened cancellation, termination or material limitation of its Intellectual Property Rights.

     (iii) Promptly upon receipt, copies of all registrations and filings with respect to its Intellectual Property Rights.

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          (o) Reports to Owners. Promptly upon their distribution, copies of all financial statements, reports and proxy statements which the Borrower shall have sent to its Owners.

          (p) SEC Filings. Promptly after the sending or filing thereof, copies of all regular and periodic reports which the Borrower shall file with the Securities and Exchange Commission or any national securities exchange.

          (q) Tax Returns of the Borrower. As soon as possible, and in any event no later than five days after they are due to be filed or after any statutory extension, copies of the state and federal income tax returns and all schedules thereto of the Borrower.

          (r) Violations of Law. Promptly upon knowledge thereof, notice of the Borrower’s violation of any law, rule or regulation, the non-compliance with which could materially and adversely affect the financial condition, properties or operations of the Borrower.

          (s) Other Reports. From time to time, with reasonable promptness, any and all receivables schedules, inventory reports, collection reports, deposit records, equipment schedules, copies of invoices to account debtors, shipment documents and delivery receipts for goods sold, and such other material, reports, records or information as the Lender may request.

     Section 6.2 Financial Covenants.

          (a) Minimum Earnings Before Taxes. The Borrower will achieve Earnings Before Taxes each period defined below of not less than the amount set forth for each such period below:

	Period to Date Pretax
Period	Profit
April, 2007	$(875,000)
April through May, 2007	$(1,325,000)
April through June, 2007	$(1,575,000)
April through July, 2007	$(1,725,000)
April through August, 2007	$(1,775,000)
Fiscal Year 2008 through:
September, 2007	$0
October, 2007	$0
November, 2007	$300,000
December, 2007	$400,000
January, 2008	$500,000
February, 2008	$600,000

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          (b) Minimum Debt Service Coverage Ratio. The Borrower will maintain, as of each year end, a Debt Service Coverage Ratio of not less than 1.1 to 1.0., during each fiscal year ending described below:

	Minimum Debt Service
Period	Coverage Ratio
Through August, 2008	1.1 to 1.00
Through August, 2009	1.1 to 1.00
Through August, 2010	1.1 to 1.00

          (c) Capital Expenditures. The Borrower will not incur or contract to incur Capital Expenditures of more than $500,000 nor more than $100,000 unfinanced Capital Expenditures, in the aggregate during any fiscal year and for the period from April to August, 2007. The Lender and the Borrower will review the Capital Expenditures limits after the first quarter of Fiscal Year 2008 to determine whether an amendment is appropriate.

     Section 6.3 Permitted Liens; Financing Statements.

     (a) The Borrower will not create, incur or suffer to exist any Lien upon or of any of its assets, now owned or hereafter acquired, to secure any indebtedness; excluding, however, from the operation of the foregoing, the following (each a “Permitted Lien”; collectively, “Permitted Liens”):

     (i) In the case of any of the Borrower’s property which is not Collateral, covenants, restrictions, rights, easements and minor irregularities in title which do not materially interfere with the Borrower’s business or operations as presently conducted;

     (ii) Liens in existence on the date hereof and listed in Schedule 6.3 hereto, securing indebtedness for borrowed money permitted under this Agreement;

     (iii) The Security Interest and Liens created by the Security Documents; and

     (iv) Purchase money Liens relating to the acquisition of machinery and equipment of the Borrower not exceeding the lesser of cost or fair market value thereof so long as no Default Period is then in existence and none would exist immediately after such acquisition.

     (b) The Borrower will not amend any financing statements in favor of the Lender except as permitted by law. Any authorization by the Lender to any Person to amend financing statements in favor of the Lender shall be in writing.

     Section 6.4 Indebtedness. The Borrower will not incur, create, assume or permit to exist any indebtedness or liability on account of deposits or advances or any indebtedness for

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borrowed money or letters of credit issued on the Borrower’s behalf, or any other indebtedness or liability evidenced by notes, bonds, debentures or similar obligations, except:

     (a) Any existing or future Indebtedness or any other obligations of the Borrower to the Lender;

     (b) Any indebtedness of the Borrower in existence on the date hereof and listed in Schedule 6.4 hereto; and

     (c) Any indebtedness relating to Permitted Liens.

     Section 6.5 Guaranties. The Borrower will not assume, guarantee, endorse or otherwise become directly or contingently liable in connection with any obligations of any other Person, except:

     (a) The endorsement of negotiable instruments by the Borrower for deposit or collection or similar transactions in the ordinary course of business; and

     (b) Guaranties, endorsements and other direct or contingent liabilities in connection with the obligations of other Persons, in existence on the date hereof and listed in Schedule 6.5 hereto.

     Section 6.6 Investments and Subsidiaries.. The Borrower will not make or permit to exist any loans or advances to, or make any investment or acquire any interest whatsoever in, any other Person or Affiliate, including any partnership or joint venture, nor purchase or hold beneficially any stock or other securities or evidence of indebtedness of any other Person or Affiliate, except:

     (a) Investments in direct obligations of the United States of America or any agency or instrumentality thereof whose obligations constitute full faith and credit obligations of the United States of America having a maturity of one year or less, commercial paper issued by U.S. corporations rated “A 1” or “A 2” by Standard & Poor’s Ratings Services or “P 1” or “P 2” by Moody’s Investors Service or certificates of deposit or bankers’ acceptances having a maturity of one year or less issued by members of the Federal Reserve System having deposits in excess of $100,000,000 (which certificates of deposit or bankers’ acceptances are fully insured by the Federal Deposit Insurance Corporation);

     (b) Travel advances or loans to the Borrower’s Officers and employees not exceeding at any one time an aggregate of $50,000;

     (c) Prepaid rent not exceeding one month or security deposits; and

     (d) Current investments in the Subsidiaries in existence on the date hereof and listed in Schedule 5.5 hereto.

     Section 6.7 Dividends and Distributions. Borrower will not declare or pay any dividends (other than dividends payable solely in stock of the Borrower) on any class of its

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stock, or make any payment on account of the purchase, redemption or other retirement of any shares of such stock, or other securities or evidence of its indebtedness or make any distribution in respect thereof, either directly or indirectly.

     Section 6.8 Salaries. The Borrower will not pay excessive or unreasonable salaries, bonuses, commissions, consultant fees or other compensation; or increase the salary, bonus, commissions, consultant fees or other compensation of any Director, Officer or consultant, or any member of their families, by more than ten percent (10%) in any one year, either individually or for all such persons in the aggregate, or pay any such increase from any source other than profits earned in the year of payment.

     Section 6.9 Books and Records; Collateral Examination, Inspection and Appraisals.

     (a) The Borrower will keep accurate books of record and account for itself pertaining to the Collateral and pertaining to the Borrower’s business and financial condition and such other matters as the Lender may from time to time request in which true and complete entries will be made in accordance with GAAP and, upon the Lender’s request, will permit any officer, employee, attorney, accountant or other agent of the Lender to audit, review, make extracts from or copy any and all company and financial books and records of the Borrower at all times during ordinary business hours, and to discuss the Borrower’s affairs with any of its Directors, Officers, employees or agents.

     (b) The Borrower hereby irrevocably authorizes all accountants and third parties to disclose and deliver to the Lender or its designated agent, at the Borrower’s expense, all financial information, books and records, work papers, management reports and other information in their possession regarding the Borrower.

     (c) The Borrower will permit the Lender or its employees, accountants, attorneys or agents, to examine and inspect any Collateral or any other property of the Borrower at any time during ordinary business hours.

     (d) The Lender may also, from time to time, obtain at the Borrower’s expense an appraisal of Collateral by an appraiser acceptable to the Lender in its sole discretion. The Lender agrees that it will limit the cost of such to one appraisal per year so long as the Borrower is not in default.

     Section 6.10 Account Verification.

     (a) The Lender or its agent may at any time and from time to time send or require the Borrower to send requests for verification of accounts or notices of assignment to account debtors and other obligors. The Lender or its agent may also at any time and from time to time telephone account debtors and other obligors to verify accounts.

     (b) The Borrower shall pay when due each account payable due to a Person holding a Permitted Lien (as a result of such payable) on any Collateral.

     Section 6.11 Compliance with Laws.

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     (a) The Borrower shall (i) comply with the requirements of applicable laws and regulations, the non compliance with which would materially and adversely affect its business or its financial condition and (ii) use and keep the Collateral, and require that others use and keep the Collateral, only for lawful purposes, without violation of any federal, state or local law, statute or ordinance.

     (b) Without limiting the foregoing undertakings, the Borrower specifically agrees that it will comply with all applicable Environmental Laws and obtain and comply with all permits, licenses and similar approvals required by any Environmental Laws, and will not generate, use, transport, treat, store or dispose of any Hazardous Substances in such a manner as to create any material liability or obligation under the common law of any jurisdiction or any Environmental Law.

     (c) The Borrower shall (i) not use or permit the use of the proceeds of the Credit Facility or any other financial accommodation from the Lender to violate any of the foreign asset control regulations of the Office of Foreign Assets Control (“OFAC”) or other applicable law, (ii) comply with all applicable Bank Secrecy Act laws and regulations, as amended from time to time, and (iii) otherwise comply with the USA Patriot Act as required by federal law and the Lender’s policies and practices.

     Section 6.12 Payment of Taxes and Other Claims. The Borrower will pay or discharge, when due, (a) all taxes, assessments and governmental charges levied or imposed upon it or upon its income or profits, upon any properties belonging to it (including the Collateral) or upon or against the creation, perfection or continuance of the Security Interest, prior to the date on which penalties attach thereto, (b) all federal, state and local taxes required to be withheld by it, and (c) all lawful claims for labor, materials and supplies which, if unpaid, might by law become a Lien upon any properties of the Borrower; provided, that the Borrower shall not be required to pay any such tax, assessment, charge or claim whose amount, applicability or validity is being contested in good faith by appropriate proceedings and for which proper reserves have been made.

     Section 6.13 Maintenance of Properties.

     (a) The Borrower will keep and maintain the Collateral and all of its other properties necessary or useful in its business in good condition, repair and working order (normal wear and tear excepted) and will from time to time replace or repair any worn, defective or broken parts; provided, however, that nothing in this covenant shall prevent the Borrower from discontinuing the operation and maintenance of any of its properties if such discontinuance is, in the Borrower’s judgment, desirable in the conduct of the Borrower’s business and not disadvantageous in any material respect to the Lender. The Borrower will take all commercially reasonable steps necessary to protect and maintain its Intellectual Property Rights.

     (b) The Borrower will defend the Collateral against all Liens, claims or demands of all Persons (other than the Lender) claiming the Collateral or any interest therein. The Borrower will keep all Collateral free and clear of all Liens except Permitted Liens. The Borrower will take all commercially reasonable steps necessary to

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prosecute any Person Infringing its Intellectual Property Rights and to defend itself against any Person accusing it of Infringing any Person’s Intellectual Property Rights.

     Section 6.14 Insurance. The Borrower will obtain and at all times maintain insurance with insurers acceptable to the Lender, in such amounts, on such terms (including any deductibles) and against such risks as may from time to time be required by the Lender, but in all events in such amounts and against such risks as is usually carried by companies engaged in similar business and owning similar properties in the same general areas in which the Borrower operates. Without limiting the generality of the foregoing, the Borrower will at all times maintain business interruption insurance including coverage for force majeure and keep all tangible Collateral insured against risks of fire (including so-called extended coverage), theft, collision (for Collateral consisting of motor vehicles) and such other risks and in such amounts as the Lender may reasonably request, with any loss payable to the Lender to the extent of its interest, and all policies of such insurance shall contain a lender’s loss payable endorsement for the Lender’s benefit. All policies of liability insurance required hereunder shall name the Lender as an additional insured.

     Section 6.15 Preservation of Existence. The Borrower will preserve and maintain its existence and all of its rights, privileges and franchises necessary or desirable in the normal conduct of its business and shall conduct its business in an orderly, efficient and regular manner.

     Section 6.16 Delivery of Instruments, etc.. Upon request by the Lender, the Borrower will promptly deliver to the Lender in pledge all instruments, documents and chattel paper constituting Collateral, duly endorsed or assigned by the Borrower.

     Section 6.17 Sale or Transfer of Assets; Suspension of Business Operations. The Borrower will not without prior written consent of the Lender sell, lease, assign, transfer or otherwise dispose of (i) the stock of any Subsidiary, (ii) all or a substantial part of its assets, or (iii) any Collateral or any interest therein (whether in one transaction or in a series of transactions) to any other Person other than the sale of Inventory in the ordinary course of business and will not liquidate, dissolve or suspend business operations. The Borrower will not transfer any part of its ownership interest in any Intellectual Property Rights and will not permit any agreement under which it has licensed Licensed Intellectual Property to lapse, except that the Borrower may transfer such rights or permit such agreements to lapse if it shall have reasonably determined that the applicable Intellectual Property Rights are no longer useful in its business. If the Borrower transfers any Intellectual Property Rights for value, the Borrower will pay over the proceeds to the Lender for application to the Indebtedness. The Borrower will not license any other Person to use any of the Borrower’s Intellectual Property Rights, except that the Borrower may grant licenses in the ordinary course of its business in connection with sales of Inventory or provision of services to its customers.

     Section 6.18 Consolidation and Merger; Asset Acquisitions. The Borrower will not consolidate with or merge into any Person, or permit any other Person to merge into it, or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the assets of any other Person.

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     Section 6.19 Sale and Leaseback. The Borrower will not without the prior written consent of the Lender enter into any arrangement, directly or indirectly, with any other Person whereby the Borrower shall sell or transfer any real or personal property, whether now owned or hereafter acquired, and then or thereafter rent or lease as lessee such property or any part thereof or any other property which the Borrower intends to use for substantially the same purpose or purposes as the property being sold or transferred.

     Section 6.20 Restrictions on Nature of Business. The Borrower will not engage in any line of business materially different from that presently engaged in by the Borrower and will not purchase, lease or otherwise acquire assets not related to its business.

     Section 6.21 Accounting. The Borrower will not adopt any material change in accounting principles other than as required by GAAP without prior written consent of the Lender. The Borrower will not adopt, permit or consent to any change in its fiscal year.

     Section 6.22 Discounts, etc.. After notice from the Lender, the Borrower will not grant any discount, credit or allowance to any customer of the Borrower or accept any return of goods sold. Except in the ordinary course of business, and after written notice to Lender, the Borrower will not at any time modify, amend, subordinate, cancel or terminate the obligation of any account debtor or other obligor of the Borrower.

     Section 6.23 Plans. Except as disclosed to the Lender in writing prior to the date hereof, neither the Borrower nor any ERISA Affiliate will (i) adopt, create, assume or become a party to any Pension Plan, (ii) incur any obligation to contribute to any Multiemployer Plan, (iii) incur any obligation to provide post-retirement medical or insurance benefits with respect to employees or former employees (other than benefits required by law) or (iv) amend any Plan in a manner that would materially increase its funding obligations.

     Section 6.24 Place of Business; Name. The Borrower will not transfer its chief executive office or principal place of business, or move, relocate, close or sell any business location. The Borrower will not permit any tangible Collateral or any records pertaining to the Collateral to be located in any state or area in which, in the event of such location, a financing statement covering such Collateral would be required to be, but has not in fact been, filed in order to perfect the Security Interest. The Borrower will not change its name or jurisdiction of organization.

     Section 6.25 Constituent Documents; S Corporation Status. The Borrower will not amend its Constituent Documents.

     Section 6.26 Performance by the Lender. If the Borrower at any time fails to perform or observe any of the foregoing covenants contained in this Article VI or elsewhere herein, and if such failure shall continue for a period of ten calendar days after the Lender gives the Borrower written notice thereof (or in the case of the agreements contained in Section 6.12 and Section 6.14, immediately upon the occurrence of such failure, without notice or lapse of time), the Lender may, but need not, perform or observe such covenant on behalf and in the name, place and stead of the Borrower (or, at the Lender’s option, in the Lender’s name) and may, but need not, take any and all other actions which the Lender may reasonably deem necessary to cure or

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correct such failure (including the payment of taxes, the satisfaction of Liens, the performance of obligations owed to account debtors or other obligors, the procurement and maintenance of insurance, the execution of assignments, security agreements and financing statements, and the endorsement of instruments); and the Borrower shall thereupon pay to the Lender on demand the amount of all monies expended and all costs and expenses (including reasonable attorneys’ fees and legal expenses) incurred by the Lender in connection with or as a result of the performance or observance of such agreements or the taking of such action by the Lender, together with interest thereon from the date expended or incurred at the Default Rate. To facilitate the Lender’s performance or observance of such covenants of the Borrower, the Borrower hereby irrevocably appoints the Lender, or the Lender’s delegate, acting alone, as the Borrower’s attorney in fact (which appointment is coupled with an interest) with the right (but not the duty) from time to time to create, prepare, complete, execute, deliver, endorse or file in the name and on behalf of the Borrower any and all instruments, documents, assignments, security agreements, financing statements, applications for insurance and other agreements and writings required to be obtained, executed, delivered or endorsed by the Borrower hereunder.

ARTICLE VII

EVENTS OF DEFAULT, RIGHTS AND REMEDIES

     Section 7.1 Events of Default. “Event of Default”, wherever used herein, means any one of the following events:

     (a) Default in the payment of the Revolving Note, the Term Note, or any default with respect to any other Indebtedness due from the Borrower to the Lender as such Indebtedness becomes due and payable;

     (b) Default in the performance, or breach, of any covenant or agreement of the Borrower contained in this Agreement;

     (c) An Overadvance arises as the result of any reduction in the Borrowing Base, or arises in any manner on terms not otherwise approved of in advance by the Lender in writing;

     (d) Any Financial Covenant shall become inapplicable due to the lapse of time and the failure of the Lender and the Borrower to come to an agreement to amend any such covenant to cover future periods that is acceptable to the Lender in the Lender’s sole discretion;

     (e) The Borrower or any Guarantor shall be or become insolvent, or admit in writing its or his inability to pay its or his debts as they mature, or make an assignment for the benefit of creditors; or the Borrower or any Guarantor shall apply for or consent to the appointment of any receiver, trustee, or similar officer for it or him or for all or any substantial part of its or his property; or such receiver, trustee or similar officer shall be appointed without the application or consent of the Borrower or such Guarantor, as the case may be; or the Borrower or any Guarantor shall institute (by petition, application, answer, consent or otherwise) any bankruptcy, insolvency, reorganization, arrangement, readjustment of debt, dissolution, liquidation or similar proceeding relating to it or him

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under the laws of any jurisdiction; or any such proceeding shall be instituted (by petition, application or otherwise) against the Borrower or any such Guarantor; or any judgment, writ, warrant of attachment or execution or similar process shall be issued or levied against a substantial part of the property of the Borrower or any Guarantor (each such occurrence constituting an “Insolvency Event”);

     (f) A petition shall be filed by or against the Borrower or any Guarantor under the United States Bankruptcy Code or the laws of any other jurisdiction naming the Borrower or such Guarantor as debtor;

     (g) Any representation or warranty made by the Borrower in this Agreement, by any Guarantor in any Guaranty delivered to the Lender, or by the Borrower (or any of its Officers) or any Guarantor in any agreement, certificate, instrument or financial statement or other statement contemplated by or made or delivered pursuant to or in connection with this Agreement or any such Guaranty shall be incorrect in any material respect;

     (h) The rendering against the Borrower of an arbitration award, a final judgment, decree or order for the payment of money in excess of $50,000 and the continuance of such arbitration award, judgment, decree or order unsatisfied and in effect for any period of 30 consecutive days without a stay of execution;

     (i) A default under any bond, debenture, note or other evidence of material indebtedness of the Borrower owed to any Person other than the Lender, or under any indenture or other instrument under which any such evidence of indebtedness has been issued or by which it is governed, or under any material lease or other contract, and the expiration of the applicable period of grace, if any, specified in such evidence of indebtedness, indenture, other instrument, lease or contract;

     (j) Any Reportable Event, which the Lender determines in good faith might constitute grounds for the termination of any Pension Plan or for the appointment by the appropriate United States District Court of a trustee to administer any Pension Plan, shall have occurred and be continuing 30 days after written notice to such effect shall have been given to the Borrower by the Lender; or a trustee shall have been appointed by an appropriate United States District Court to administer any Pension Plan; or the Pension Benefit Guaranty Corporation shall have instituted proceedings to terminate any Pension Plan or to appoint a trustee to administer any Pension Plan; or the Borrower or any ERISA Affiliate shall have filed for a distress termination of any Pension Plan under Title IV of ERISA; or the Borrower or any ERISA Affiliate shall have failed to make any quarterly contribution required with respect to any Pension Plan under Section 412(m) of the IRC, which the Lender determines in good faith may by itself, or in combination with any such failures that the Lender may determine are likely to occur in the future, result in the imposition of a Lien on the Borrower’s assets in favor of the Pension Plan; or any withdrawal, partial withdrawal, reorganization or other event occurs with respect to a Multiemployer Plan which results or could reasonably be expected to result in a material liability of the Borrower to the Multiemployer Plan under Title IV of ERISA;

40

     (k) An event of default shall occur under any Security Document;

     (l) Default in the payment of any amount owed by the Borrower to the Lender other than any Indebtedness arising hereunder;

     (m) Any breach, default or event of default shall occur under the Borrower Agreement or any Ex-Im Document;

     (n) The Borrower shall take or participate in any action which would be prohibited under the provisions of any Subordination Agreement or make any payment with respect to indebtedness that has been subordinated pursuant to any Subordination Agreement;

     (o) The Borrower shall fail to employ both a Chief Executive Officer and a Chief Financial Officer which is, in each case, acceptable to the Lender in its sole discretion within 60 days of the date hereof;

     (p) The Lender believes in good faith that the prospect of payment in full of any part of the Indebtedness or that full performance by the Borrower under the Loan Documents, is impaired, or that there has occurred any material adverse change in the business or financial condition of the Borrower;

     (q) There has occurred any breach, default or event of default by, or attributable to, any Affiliate under any agreement between the Affiliate and the Lender; or

     (r) The indictment of any Director, Officer, or any Owner of at least twenty percent (20%) of the issued and outstanding common stock of the Borrower for a felony offence under state or federal law.

     (s) Any Guarantor shall repudiate or purport to revoke its, his or her Guaranty, or any Guaranty for any reason shall cease to be in full force and effect as to the Guarantor executing and delivering the same or shall be judicially declared null and void as to such Guarantor.

     Section 7.2 Rights and Remedies. During any Default Period, the Lender may exercise any or all of the following rights and remedies:

     (a) The Lender may, by notice to the Borrower, declare the Commitment to be terminated, whereupon the same shall forthwith terminate;

     (b) The Lender may, by notice to the Borrower, declare the Indebtedness to be forthwith due and payable, whereupon all Indebtedness shall become and be forthwith due and payable, without presentment, notice of dishonor, protest or further notice of any kind, all of which the Borrower hereby expressly waives;

41

     (c) The Lender may, without notice to the Borrower and without further action, apply any and all money owing by the Lender to the Borrower to the payment of the Indebtedness;

     (d) The Lender may exercise and enforce any and all rights and remedies available upon default to a secured party under the UCC, including the right to take possession of Collateral, or any evidence thereof, proceeding without judicial process or by judicial process (without a prior hearing or notice thereof, which the Borrower hereby expressly waives) and the right to sell, lease or otherwise dispose of any or all of the Collateral (with or without giving any warranties as to the Collateral, title to the Collateral or similar warranties), and, in connection therewith, the Borrower will on demand assemble the Collateral and make it available to the Lender at a place to be designated by the Lender which is reasonably convenient to both parties;

     (e) The Lender may exercise and enforce its rights and remedies under the Loan Documents;

     (f) The Lender may without regard to any waste, adequacy of the security or solvency of the Borrower, apply for the appointment of a receiver of the Collateral, to which appointment the Borrower hereby consents, whether or not foreclosure proceedings have been commenced under the Security Documents and whether or not a foreclosure sale has occurred; and

     (g) The Lender may exercise any other rights and remedies available to it by law or agreement.

     Notwithstanding the foregoing, upon the occurrence of an Event of Default described in Section 7.1(e) or (f), the Indebtedness shall be immediately due and payable automatically without presentment, demand, protest or notice of any kind. If the Lender sells any of the Collateral on credit, the Indebtedness will be reduced only to the extent of payments actually received. If the purchaser fails to pay for the Collateral, the Lender may resell the Collateral and shall apply any proceeds actually received to the Indebtedness.

     Section 7.3 Certain Notices. If notice to the Borrower of any intended disposition of Collateral or any other intended action is required by law in a particular instance, such notice shall be deemed commercially reasonable if given (in the manner specified in Section 8.3) at least ten calendar days before the date of intended disposition or other action.

ARTICLE VIII

MISCELLANEOUS

     Section 8.1 No Waiver; Cumulative Remedies; Compliance with Laws. No failure or delay by the Lender in exercising any right, power or remedy under the Loan Documents or the Ex-Im Documents shall operate as a waiver thereof; nor shall any single or partial exercise of any such right, power or remedy preclude any other or further exercise thereof or the exercise of any other right, power or remedy under the Loan Documents or the Ex-Im Documents. The remedies provided in the Loan Documents or the Ex-Im Documents are cumulative and not exclusive of any remedies provided by law. The Lender may comply with any applicable state

42

or federal law requirements in connection with a disposition of the Collateral and such compliance will not be considered adversely to affect the commercial reasonableness of any sale of the Collateral.

     Section 8.2 Amendments, Etc. No amendment, modification, termination or waiver of any provision of any Loan Document or consent to any departure by the Borrower therefrom or any release of a Security Interest shall be effective unless the same shall be in writing and signed by the Lender, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No notice to or demand on the Borrower in any case shall entitle the Borrower to any other or further notice or demand in similar or other circumstances.

     Section 8.3 Notices; Communication of Confidential Information; Requests for Accounting. Except as otherwise expressly provided herein, all notices, requests, demands and other communications provided for under the Loan Documents shall be in writing and shall be (a) personally delivered, (b) sent by first class United States mail, (c) sent by overnight courier of national reputation, (d) transmitted by telecopy, or (e) sent as electronic mail, in each case delivered or sent to the party to whom notice is being given to the business address, telecopier number, or e mail address set forth below next to its signature or, as to each party, at such other business address, telecopier number, or e mail address as it may hereafter designate in writing to the other party pursuant to the terms of this Section. All such notices, requests, demands and other communications shall be deemed to be an authenticated record communicated or given on (a) the date received if personally delivered, (b) when deposited in the mail if delivered by mail, (c) the date delivered to the courier if delivered by overnight courier, or (d) the date of transmission if sent by telecopy or by e mail, except that notices or requests delivered to the Lender pursuant to any of the provisions of Article II shall not be effective until received by the Lender. All notices, financial information, or other business records sent by either party to this Agreement may be transmitted, sent, or otherwise communicated via such medium as the sending party may deem appropriate and commercially reasonable; provided, however, that the risk that the confidentiality or privacy of such notices, financial information, or other business records sent by either party may be compromised shall be borne exclusively by the Borrower. All requests for an accounting under Section 9-210 of the UCC (i) shall be made in a writing signed by a Person authorized under Section 2.2(a), (ii) shall be personally delivered, sent by registered or certified mail, return receipt requested, or by overnight courier of national reputation, (iii) shall be deemed to be sent when received by the Lender and (iv) shall otherwise comply with the requirements of Section 9-210 of the UCC. The Borrower requests that the Lender respond to all such requests which on their face appear to come from an authorized individual and releases the Lender from any liability for so responding. The Borrower shall pay the Lender the maximum amount allowed by law for responding to such requests.

     Section 8.4 Further Documents. The Borrower will from time to time execute, deliver, endorse and authorize the filing of any and all instruments, documents, conveyances, assignments, security agreements, financing statements, control agreements and other agreements and writings that the Lender may reasonably request in order to secure, protect, perfect or enforce the Security Interest or the Lender’s rights under the Loan Documents (but any failure to request or assure that the Borrower executes, delivers, endorses or authorizes the filing of any such item shall not affect or impair the validity, sufficiency or enforceability of the Loan

43

Documents and the Security Interest, regardless of whether any such item was or was not executed, delivered or endorsed in a similar context or on a prior occasion).

     Section 8.5 Costs and Expenses. The Borrower shall pay on demand all costs and expenses, including reasonable attorneys’ fees, incurred by the Lender in connection with the Indebtedness, this Agreement, the Loan Documents, any Letter of Credit and any other document or agreement related hereto or thereto, and the transactions contemplated hereby, including all such costs, expenses and fees incurred in connection with the negotiation, preparation, execution, amendment, administration, performance, collection and enforcement of the Indebtedness and all such documents and agreements and the creation, perfection, protection, satisfaction, foreclosure or enforcement of the Security Interest.

     Section 8.6 Indemnity. In addition to the payment of expenses pursuant to Section 8.5, the Borrower shall indemnify, defend and hold harmless the Lender, and any of its participants, parent corporations, subsidiary corporations, affiliated corporations, successor corporations, and all present and future officers, directors, employees, attorneys and agents of the foregoing (the “Indemnitees”) from and against any of the following (collectively, “Indemnified Liabilities”):

     (i) Any and all transfer taxes, documentary taxes, assessments or charges made by any governmental authority by reason of the execution and delivery of the Loan Documents or the making of the Advances;

     (ii) Any claims, loss or damage to which any Indemnitee may be subjected if any representation or warranty contained in Section 5.14 proves to be incorrect in any respect or as a result of any violation of the covenant contained in Section 6.11(b); and

     (iii) Any and all other liabilities, losses, damages, penalties, judgments, suits, claims, costs and expenses of any kind or nature whatsoever (including the reasonable fees and disbursements of counsel) in connection with the foregoing and any other investigative, administrative or judicial proceedings, whether or not such Indemnitee shall be designated a party thereto, which may be imposed on, incurred by or asserted against any such Indemnitee, in any manner related to or arising out of or in connection with the making of the Advances and the Loan Documents or the use or intended use of the proceeds of the Advances.

     If any investigative, judicial or administrative proceeding arising from any of the foregoing is brought against any Indemnitee, upon such Indemnitee’s request, the Borrower, or counsel designated by the Borrower and satisfactory to the Indemnitee, will resist and defend such action, suit or proceeding to the extent and in the manner directed by the Indemnitee, at the Borrower’s sole costs and expense. Each Indemnitee will use its best efforts to cooperate in the defense of any such action, suit or proceeding. If the foregoing undertaking to indemnify, defend and hold harmless may be held to be unenforceable because it violates any law or public policy, the Borrower shall nevertheless make the maximum contribution to the payment and satisfaction of each of the Indemnified Liabilities which is permissible under applicable law. The

44

Borrower’s obligations under this Section 8.6 shall survive the termination of this Agreement and the discharge of the Borrower’s other obligations hereunder.

     Section 8.7 Participants. The Lender and its participants, if any, are not partners or joint venturers, and the Lender shall not have any liability or responsibility for any obligation, act or omission of any of its participants. All rights and powers specifically conferred upon the Lender may be transferred or delegated to any of the Lender’s participants, successors or assigns.

     Section 8.8 Execution in Counterparts; Telefacsimile Execution. This Agreement and other Loan Documents may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same instrument. Delivery of an executed counterpart of this Agreement or any other Loan Document by telefacsimile or other electronic means shall be equally as effective as delivery of an original executed counterpart of this Agreement or such other Loan Document. Any party delivering an executed counterpart of this Agreement or any other Loan Document by telefacsimile or other electronic means also shall deliver an original executed counterpart of this Agreement or such other Loan Document but the failure to deliver an original executed counterpart shall not affect the validity, enforceability, and binding effect of this Agreement or such other Loan Document.

     Section 8.9 Retention of the Borrower’s Records. The Lender shall have no obligation to maintain any electronic records or any documents, schedules, invoices, agings, or other papers delivered to the Lender by the Borrower or in connection with the Loan Documents for more than 30 days after receipt by the Lender. If there is a special need to retain specific records, the Borrower must inform the Lender of its need to retain those records with particularity, which must be delivered in accordance with the notice provisions of Section 8.3 within 30 days of the Lender taking control of same.

     Section 8.10 Binding Effect; Assignment; Complete Agreement; Sharing Information. The Loan Documents shall be binding upon and inure to the benefit of the Borrower and the Lender and their respective successors and assigns, except that the Borrower shall not have the right to assign its rights thereunder or any interest therein without the Lender’s prior written consent. To the extent permitted by law, the Borrower waives and will not assert against any assignee any claims, defenses or set-offs which the Borrower could assert against the Lender. This Agreement shall also bind all Persons who become a party to this Agreement as a borrower. This Agreement, together with the Loan Documents, comprises the complete and integrated agreement of the parties on the subject matter hereof and supersedes all prior agreements, written or oral, on the subject matter hereof. To the extent that any provision of this Agreement contradicts other provisions of the Loan Documents, this Agreement shall control. Without limiting the Lender’s right to share information regarding the Borrower and its Affiliates with the Lender’s participants, accountants, lawyers and other advisors, the Lender may share any and all information they may have in their possession regarding the Borrower and its Affiliates, and the Borrower waives any right of confidentiality it may have with respect to such sharing of information.

45

     Section 8.11 Severability of Provisions. Any provision of this Agreement which is prohibited or unenforceable shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof.

     Section 8.12 Headings. Article, Section and subsection headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose.

     Section 8.13 Governing Law; Jurisdiction, Venue; Waiver of Jury Trial. The Loan Documents shall be governed by and construed in accordance with the substantive laws (other than conflict laws) of the State of Minnesota. The parties hereto hereby (i) consent to the personal jurisdiction of the state and federal courts located in the State of Minnesota in connection with any controversy related to this Agreement; (ii) waive any argument that venue in any such forum is not convenient; (iii) agree that any litigation initiated by the Lender or the Borrower in connection with this Agreement or the other Loan Documents may be venued in either the state or federal courts located in Minneapolis, Hennepin County, Minnesota; and (iv) agree that a final judgment in any such suit, action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law.

     Section 8.14 Attorneys’ Fees. References in the Loan Documents to fees and expenses of attorneys or counsel shall include all such fees and expenses, whether incurred at the trial or appellate level, in an arbitration or administrative proceeding, in bankruptcy (including, without limitation, any adversary proceeding, contested matter or motion) or otherwise incurred.

[The remainder of this page intentionally left blank.]

46

     THE BORROWER AND THE LENDER WAIVE ANY RIGHT TO TRIAL BY JURY IN ANY ACTION AT LAW OR IN EQUITY OR IN ANY OTHER PROCEEDING BASED ON OR PERTAINING TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT.

     Borrower’s Initials /s/ MT ; Lender’s Initials /s/ MG.

     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 above written.

HEI, INC.

1439 Steiger Lake Lane
Victoria, MN 55386
Telecopier: (952) 443-2668
Attention: Mark Thomas
e-mail: Mark.Thomas@heii.com

Wells Fargo Bank, National Association,
Wells Fargo Business Credit
MAC N9312-040
Sixth and Marquette
Minneapolis, Minnesota 55479
Telecopier: (612) 673-8589
Attention: Michael L. Guillou
e-mail: Michael.l.guillou@wellsfargo.com

GUARANTOR:
736 Widsten Circle
Wayzata, MN 55391
Telecopier:                     
e-mail:                     

HEI, INC.
By:	/s/ Mark Thomas
Name: Mark Thomas
Its: Chief Executive Officer
WELLS FARGO BANK, NATIONAL
ASSOCIATION
By:	/s/ Michael L. Guillou
Name: Michael L. Guillou
Its: Relationship Manager
/s/ Thomas F. Leahy
Thomas F. Leahy

[Signature page to Credit and Security Agreement]

Table of Exhibits and Schedules

Exhibit A	Form of Revolving Note
Exhibit B	Form of Term Note
Exhibit C	Compliance Certificate
Exhibit D	Premises
Schedule 5.1	Trade Names, Chief Executive Office, Principal Place of Business, and Locations of Collateral
Schedule 5.2	Capitalization and Organizational Chart
Schedule 5.5	Subsidiaries
Schedule 5.7	Litigation Matters
Schedule 5.11	Intellectual Property Disclosures
Schedule 5.14	Environmental Matters
Schedule 6.3	Permitted Liens
Schedule 6.4	Permitted Indebtedness
Schedule 6.5	Guaranties

Exhibit A to Credit and Security Agreement

REVOLVING NOTE

$8,000,000.00 May                     , 2007

     For value received, the undersigned, HEI, Inc., a Minnesota corporation (the “Borrower”), hereby promises to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION (the “Lender”), acting through its Wells Fargo Business Credit operating division, on the Termination Date referenced in the Credit and Security Agreement dated the same date as this Revolving Note that was entered into by the Lender and the Borrower (as amended from time to time, the “Credit Agreement”), at the Lender’s office located at Minneapolis, Minnesota, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Eight Million Dollars ($8,000,000.00) or the aggregate unpaid principal amount of all Revolving Advances made by the Lender to the Borrower under the Credit Agreement, together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Revolving Note is fully paid at the rate from time to time in effect under the Credit Agreement.

     This Revolving Note is the Revolving Note referenced in the Credit Agreement and is subject to the terms of the Credit Agreement, which provides, among other things, for acceleration hereof. Principal and interest due hereunder shall be payable as provided in the Credit Agreement, and this Revolving Note may be prepaid only in accordance with the terms of the Credit Agreement. This Revolving Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements.

     The Borrower shall pay all costs of collection, including reasonable attorneys’ fees and legal expenses if this Revolving Note is not paid when due, whether or not legal proceedings are commenced.

     Presentment or other demand for payment, notice of dishonor and protest are expressly waived.

HEI, INC.
By:
Name:	Mark Thomas
Its:	Chief Executive Officer and Chief Financial Officer

A-1

Exhibit B to Credit and Security Agreement

TERM NOTE

$340,000.00 May                     , 2007

     For value received, the undersigned, HEI, Inc., a Minnesota corporation (the “Borrower”), hereby promises to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION (the “Lender”), acting through its Wells Fargo Business Credit operating division, on the Termination Date set forth in the Credit and Security Agreement dated the same date as this Term Note that was entered into by the Lender and the Borrower (as amended from time to time, the “Credit Agreement”), at Lender’s office located at Minneapolis, Minnesota, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Three Hundred Forty Thousand Dollars ($340,000.00) or the aggregate unpaid principal amount of all Term Advances made by the Lender to the Borrower under the Credit Agreement together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Term Note is fully paid at the rate from time to time in effect under the Credit Agreement.

     This Term Note is the Term Note referred to in the Credit Agreement, and is subject to the terms of, the Credit Agreement, which provides, among other things, for acceleration hereof. Principal and interest due hereunder shall be payable as provided in the Credit Agreement, and this Term Note may be prepaid only in accordance with the terms of the Credit Agreement. This Term Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements.

     The Borrower hereby agrees to pay all costs of collection, including attorneys’ fees and legal expenses in the event this Term Note is not paid when due, whether or not legal proceedings are commenced.

     Presentment or other demand for payment, notice of dishonor and protest are expressly waived.

By:
Name:	Mark Thomas
Its:	Chief Executive Officer and Chief Financial Officer

B-1

Exhibit C to Credit and Security Agreement

COMPLIANCE CERTIFICATE

To:	Wells Fargo Bank, National Association
Attn:	Michael L. Guillou
Date:	___, 200___
Subject:	Financial Statements

     In accordance with our Credit and Security Agreement dated as of [___] (as amended from time to time, the “Credit Agreement”), attached are the financial statements of ___ (the “Borrower”) as of and for ______, 200 ___ (the “Reporting Date”) and the year-to-date period then ended (the “Current Financials”). All terms used in this certificate have the meanings given in the Credit Agreement.

     I certify that the Current Financials have been prepared in accordance with GAAP, subject to year-end audit adjustments, and fairly present the Borrower’s financial condition as of the date thereof.

     I further hereby certify as follows: Events of Default. (Check one):

o The undersigned does not have knowledge of the occurrence of a Default or Event of Default under the Credit Agreement except as previously reported in writing to the Lender.

o The undersigned has knowledge of the occurrence of a Default or Event of Default under the Credit Agreement not previously reported in writing to the Lender and attached hereto is a statement of the facts with respect to thereto. The Borrower acknowledges that pursuant to Section 2.5(c) of the Credit Agreement, the Lender may impose the Default Rate at any time during the resulting Default Period.

     Material Adverse Change in Litigation Matters of the Borrower. I further hereby certify as follows (check one):

o The undersigned has no knowledge of any material adverse change to the litigation exposure of the Borrower or any of its Affiliates or of any Guarantor.

o The undersigned has knowledge of material adverse changes to the litigation exposure of the Borrower or any of its Affiliates or of any Guarantor not previously disclosed in Schedule 5.7. Attached to this Certificate is a statement of the facts with respect thereto.

Financial Covenants. I further hereby certify as follows (check and complete each of the following):

     1. Minimum Earnings Before Taxes. Pursuant to Section 6.2(a) of the Credit Agreement, the Borrower’s Earnings Before Taxes for the [                    ] period ending on the Reporting Date, was $___, which o satisfies o does not satisfy the requirement that such amount be not less than ___:

C-1

	Minimum Earnings Before
Period	Taxes
April, 2007	$ (875,000)
April through May, 2007	$ (1,325,000)
April through June, 2007	$ (1,575,000)
April through July, 2007	$ (1,725,000)
April through August, 2007	$ (1,775,000)
Fiscal Year 2008 through:
September, 2007	$ 0
October, 2007	$ 0
November, 2007	$ 300,000
December, 2007	$ 400,000
January, 2008	$ 500,000
February, 2008	$ 600,000

     2. Minimum Debt Service Coverage Ratio. Pursuant to Section 6.2(b) of the Credit Agreement, as of the Reporting Date, the Borrower’s Debt Service Coverage Ratio was [___] to 1.00, which o satisfies o does not satisfy the requirement that such ratio be no less than the applicable ratio set forth in the table below on the Reporting Date:

	Minimum Debt Service
Period	Coverage Ratio
Through August, 2008	1.1 to 1.00
Through August, 2009	1.1 to 1.00
Through August, 2010	1.1 to 1.00

     3. Capital Expenditures. Pursuant to Section 6.2(c) of the Credit Agreement, for the year-to-date period ending on the Reporting Date, the Borrower has expended or contracted to expend during the reporting period ended ___, 200___, for Capital Expenditures, $ ___ in the aggregate and at most $ ___ for any nonfinanced Capital Expenditures, which o satisfies o does not satisfy the requirement that such expenditures not exceed $500,000 in the aggregate and $100,000 for any nonfinanced Capital Expenditure during such year.

     4. Salaries. As of the Reporting Date, the Borrower has not paid excessive or unreasonable salaries, bonuses, commissions, consultant fees or other compensation, or increased the salary, bonus, commissions, consultant fees or other compensation of any Director, Officer or consultant, or any member of their families, by more than ten percent (10%) over the amount paid in the Borrower’s previous fiscal year, either individually or for all such persons in the aggregate, and has not paid any increase from any source other than profits earned in the year of payment, and as a consequence o is o is not in compliance with Section 6.8 of the Credit Agreement.

Attached hereto are all relevant facts in reasonable detail to evidence, and the computations of the financial covenants referred to above. These computations were made in accordance with GAAP.

By:
Name:
Its:	Chief Financial Officer

Exhibit D to Credit and Security Agreement

PREMISES

The Premises referred to in the Credit and Security Agreement are legally described as follows:

Victoria Location – 1495 Steiger Lake Lane, Victoria, MN 55386, Legal description – Lot 2, Block 1, Point Victoria, situated in Carver County, Minnesota

Chanhassen Location – 1546 Lake Drive West, Chanhassen, MN 55317

Boulder Location – 4801 North 63^rd Street, Boulder, CO 80301

Tempe Location – 610 South Rockford Drive, Tempe, AZ 85281

D-1

Schedule 5.1 to Credit and Security Agreement

TRADE NAMES, CHIEF EXECUTIVE OFFICE, PRINCIPAL PLACE OF BUSINESS,
AND LOCATIONS OF COLLATERAL
TRADE NAMES

HEI, Inc., Microelectronics Operations (Victoria), Advanced Medical Operations (Boulder), High Density Interconnect Operations (Tempe) and RFID Operations (Chanhassen)

CHIEF EXECUTIVE OFFICE/PRINCIPAL PLACE OF BUSINESS

1495 Steiger Lake Lane, Victoria, MN 55386

OTHER INVENTORY AND EQUIPMENT LOCATIONS

Chanhassen Location – 1546 Lake Drive West, Chanhassen, MN 55317
Boulder Location – 4801 North 63^rd Street, Boulder, CO 80301
Tempe Location – 610 South Rockford Drive, Tempe, AZ 85281

D-2

Schedule 5.2 to Credit and Security Agreement

CAPITALIZATION AND ORGANIZATIONAL CHART

For Holders of more than 5% of outstanding stock on date of Closing.

		No. of shares (after
		exercise of all rights		Percent interest on a
Holder	Type of Rights/Stock	to acquire shares)		fully diluted basis
Thomas F. Leahy	Common and Preferred Stock		1,128,054		11.8	%
Minneapolis Portfolio Management Group LLC	Common Stock		905,246		9.5	%
Perkins Capital Management, Inc.	Common Stock		748,350		7.8	%

HEI, Inc. has one subsidiary, Cross Technology, Inc. that is 100% owned by HEI, Inc.

S-5.2-1

Schedule 5.5 to Credit and Security Agreement

SUBSIDIARIES

HEI, Inc. has one subsidiary, Cross Technology, Inc. that is 100% owned by HEI, Inc.

S-5.5-1

Schedule 5.7 to Credit and Security Agreement

LITIGATION MATTERS

HEI, Inc. is not involved in any litigation at the time of this signing and has not received notice of any threatened litigation as of this signing

S-5.7-1

Schedule 5.11 to Credit and Security Agreement

INTELLECTUAL PROPERTY DISCLOSURES

(Patents, Trademarks, and Copyrights)

Patents

Docket No.	Title	Serial/Patent No.	Status
14605.113	Information Technology System for Health Care Environments (fka Information Technology System that is Suitable for Medical Applications)	10/161, 168 (formerly Provisions #60/295,181)	B — Pending
10139.007-CA-01	Document Reading Apparatus	1,245,765	A — Issued
10139-0008-CA-01	Photo-Optic Transducing Head Assembly	1,265,547	A — Issued
10139.0016-US-01	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	6,646,521	A — Issued
10139.0016-TA-01	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	194018	A — Issued
10139.0016-EP-WO	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	1,968,674	B — Pending
10139.0016-JP-WO	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	2527567	B — Pending
10139.0016-KS-WO	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	37003802	B — Pending
10139.0016-MY-01	Method of Mount DC Block Capacitor for Microwave Circuit and packaging	14267	B — Pending
10139.0016-TH-01	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	68354	B — Pending
10139.0017-US-01	Interconnection Device and Method	6,294,966	A — Issued
10139.0017-US-C1	Interconnection Device and Method	6,469,592	A — Issued
10139.0017-TA-01	Interconnection Device and Method	156859	A — Issued
10139.0017-CC-WO	Interconnection Device and Method	8186499	B — Pending
10139.0017-EP-WO	Interconnection Device and Method	986661.7	B — Pending
10139.0017-IN-WO	Interconnection Device and Method	2702	B — Pending
10139.0017-JP-WO	Interconnection Device and Method	1550811	B — Pending
10139.0017-KS-WO	Interconnection Device and Method	27008541	B — Pending
10139.0017-MY-01	Interconnection Device and Method	6125	B — Pending
10139.0017-PH-01	Interconnection Device and Method	10003580	B — Pending
101039.0017-TH-01	Interconnection Device and Method	62789	B — Pending
10139.0017-US-C2	interconnection Device and Method	10/228,587	B — Pending
10139.0022-US-01	Integrated Mem Switch	10/014,987	B — Pending
10139.0022-US-D1	Low Voltage Mem Switch	10/409,742	B — Pending
10139.0027-TA-01	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Devices	189906	A — Issued
10139.0027-CC-WO	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Devices	18149812	A — Issued
10139.0027-EP-WO	Test Methods, Systems, and Probes for high-Frequency Wireless Communications Devices	1959300.3	B — Pending
10139.0027-IN-WO	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Devices	10503	B — Pending

S-5.11-1

Docket No.	Title	Serial/Patent No.	Status
10139.0027-JP-WO	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Device	2516659	B — Pending
10139.0027-US-C1	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Device	09/725,646	B -Pending
10139.0031-US-01	Flexible Circuit Board having an Integrally Formed Battery	10/789,108	B — Pending
116.002US1	EDGE TERMINALS FOR ELECTRONIC CIRCUIT MODULES	08/542896	A — Issued
116.002CA1	EDGE TERMINALS FOR ELECTRONIC CIRCUIT MODULES	2187582	B — Pending
116.006US1	HIGH DENSITY STACKED CIRCUIT MODULE	09/050318	A — Issued
116.006CA1	HIGH DENSITY STACKED CIRCUIT MODULE	2266980	B — Pending
116.010US1	HEARING-AID ASSEMBLY USING FOLDED FLEX CIRCUITS	09/792700	A — Issued
116.010US2	HEARING-AID ASSEMBLY USING FOLDED FLEX CIRCUITS	10/752414	B — Pending
116.012US1	STRUCTURES AND ASSEMBLY METHODS FOR RADIO-FREQUENCY-IDENTIFICATION MODULES	09/922245	A — Issued
116.012TH1	STRUCTURES AND ASSEMBLY METHODS FOR RADIO-FREQUENCY-IDENTIFICATION MODULES AND METHODS	67473	B — Pending
116.012US2	STRUCTURES AND ASSEMBLY METHODS FOR RADIO-FREQUENCY-IDENTIFICATION MODULES	10/785928	B — Pending
116.015CA1	CODELOCK Design	547638	B — Pending
14605-125P (provisions) 50611-292864 (Utility)	Collaboration Among Health Care Instruments	60/384,902 (provisional) 10/453,442 (utility)	B — Pending
	Driving and Clamping Power Regulation Technique for Continuous, In-Phase, Full-Duration, Switch-Mode Resonant Converter Power Supply	5,267,138	A — Issued
	System and Method for Coupling a Plurality of Medical Devices in a Serverless Grid		B — Pending

Trademarks

Trademark name	Trademark Number	Reference #
Lin iT	76/518,141	File No. 50611-292862
OneSource OutSource	2569474	14605.096
FRESH AIR	75/830,817	14605.09
ID-iT	76/518,124	50611.2930219999
GridView	78/510068	40424.4US01

S-5.11-2

Schedule 5.14 to Credit and Security Agreement

ENVIRONMENTAL MATTERS

HEI, Inc. has received a No Further Action Required letter from the State of Colorado regarding its Boulder location and is not aware of any other environmental issues relating to any of the other listed properties as of this signing.

S-5.14-1

Schedule 6.3 to Credit and Security Agreement

PERMITTED LIENS

HEI, Inc.
Permitted Liens
As of 05-01-07

Valid UCC Filings:

File Date	File No.	Type	Description if needed	Additional Information	Status
5/21/2003	20037526134	UCC-1		Beacon Bank	To be released with the SBA Revolver Payoff at Closing
10/15/2003	2003909557	AMEND	Amendment of 20037526134	Beacon Bank	To be released with the SBA Revolver Payoff at Closing
7/21/2003	20038148897	UCC-1		US Bancorp	Active Operating Lease
6/8/2004	200412104045	UCC-1		CNC Associates Inc.	Active Operating Lease
12/14/2004	200414358590	UCC-1		Commerce Financial Group	To be released with Tempe Equipment Lease Payoff at Closing
3/10/2005	200515537094	UCC-1		Lease Finance Group	Active Capital Lease
9/12/2005	20051793347	ASSIGN	Assingment of 200515537094	First Minnetonka City Bank	Active Capital Lease
4/7/2005	200515938368	UCC-1		Lease Finance Group	Active Capital Lease
9/12/2005	20051793426	AMEND	Expaned Collateral Description of 200515938368	Lease Finance Group	Active Capital Lease
9/12/2005	20051793433	ASSIGN	Assingment of 200515938368	First Minnetonka City Bank	Active Capital Lease
4/7/2005	200515938673	UCC-1		Lease Finance Group	Active Capital Lease
8/16/2005	200517630189	UCC-1		Lease Finance Group	Active Capital Lease
9/19/2005	20051802403	AMEND	Expaned Collateral Description of 2005176030189	Lease Finance Group	Active Capital Lease
9/23/2005	20051810670	AMEND	Addition of Secured Party of 2005176030189	Kevin Roberg	Active Capital Lease
8/16/2005	200517630468	UCC-1		Lease Finance Group	Active Capital Lease
12/21/2005	20051922206	AMEND	Expaned Collateral Description of 200517630468	Lease Finance Group	Active Capital Lease
12/21/2005	20051922224	AMEND	Addition of Secured Party of 200517630468	Kevin Robert	Active Capital Lease
12/21/2005	20051922236	AMEND	Correction of Secured Party of 200517630468	Kevin Roberg	Active Capital Lease
8/16/2005	200517630711	UCC-1		Lease Finance Group	Active Capital Lease
11/29/2005	20051892061	AMEND	Addition of Secured Party of 200517630711	Kevin Roberg	Active Capital Lease
11/29/2005	20051892084	AMEND	Expaned Collateral Description of 200517630711	Kevin Roberg	Active Capital Lease
12/30/2005	200519347755	UCC-1		Farnam Street Financial Inc	Active Operating Lease
1/17/2006	200610221439	UCC-1	This is now a Commerce Financial Capital Lease, but no filing was made by Commerce	Orbotech Inc	Not filed by Commerce Financial when they paid off Orbotech and look over the lease – Active Capital Lease
1/30/2006	200610390897	UCC-1		Lease Finance Group	Lease taken over by Allegiant and not refilled – Active Capital Lease
3/20/2006	200611076803	UCC-1	Believed to be the same as filed for under 200610390897	Lease Finance Group	Believed to be the same as filed for under 200610390897
3/28/2006	200611204728	UCC-1		Key Equipment Finance Inc	Active Operating Lease
7/3/2006	200612598015	UCC-1		Telogy. Inc.	Active Operating Lease
8/1/2006	200612953559	UCC-1		Telogy. Inc.	Active Operating Lease
9/1/2006	200613366278	UCC-1		Telogy. Inc.	Active Operating Lease
Invalid UCC Filings:
11/2/1998	2080454	UCC-1		Norwest Equipment Finance Inc	No Balance Due at 05-01-07 – Needs to be released
9/8/2003	2003866929	CONT		Norwest Equipment Finance Inc	No Balance Due at 05-01-07 – Needs to be released
12/11/1998	2090125	UCC-1		Norwest Equipment Finance Inc	No Balance Due at 05-01-07 – Needs to be released
9/19/2003	2003880308	CONT		Norwest Equipment Finance Inc	No Balance Due at 05-01-07 – Needs to be released
6/2/2003	20037625319	UCC-1		Luther & Maelzer Inc	No Balance Due at 05-01-07 – Needs to be released
12/22/2005	200519252218	UCC-1		Orbotech Inc	Not believed to be active – no balance is shown on our records

S-6.3-1

Schedule 6.4 to Credit and Security Agreement

PERMITTED INDEBTEDNESS

HEI Inc
Schedule of Permitted Indebtedness
Capital Leases and Mortgage
Balances as of March 31, 2007

Creditor

Name

Original Amount

Security

PMY Res

Location

Origination Date

Last Pymt Date

Monthly Payment

Balance 03-31-07

1

Lease Finance Group

LFG 5 CNC Associates

22,926.73

LFG 5

Victoria

3/15/2005

3/15/2008

564.51

14,142.71

2

Lease Finance Group

MyData

212,150.00

Mydata my Hydra speedmount

LFG 5

Victoria

3/15/2005

3/15/2008

7,910.00

105,812.64

3

Lease Finance Group

Ekra

183,165.68

EKRA x5 in line screen printer, Ekra x5 inline screen printer

LFG 5

Victoria

3/15/2005

7/1/2008

6,829.32

91,358.02

4

Lease Finance Group

Sikama

28,154.30

Sikama Falseen S/c Solder Rodow Furance

LFG 2

Victoria

9/5/2005

9/5/2008

1,119.04

11,843.19

5

Lease Finance Group

CyberOptics

120,600.00

CyberOptics DEMO SE 300 inspection system

LFG 4

Victoria

10/1/2005

10/1/2008

4,170.53

64,643.36

6

Lease Finance Group

K&S

21,990.00

Kulcke & Soffa Model 4524 Bad Bonder

LFG 1

Victoria

12/1/2005

12/1/2008

760.45

12,968.45

7

Lease Finance Group

Nu Clean

82,400.00

Technical Devices Nu/Clean 31Bxf

LFG 3

Victoria

2/1/2006

2/1/2009

2,849.51

52,905.40

8

HMP Allegiant

Allegiant Partn HMP_AL

Infinity 2-2c 2.0 megapixel CCD Camera

Victoria

5/1/2006

2/23/2009

880.42

17,368.96

9

OGP Allegiant

OGP_AL

OGP Flash 300 Digital Coord measur system & HMP Infinity 2.0 Megapixesl CCD Camera

Victoria

3/1/2006

3/1/2009

1,782.83

38,014.34

10

Commerce Financial

CF_01Orbotech

875,000.00

Orbotech paragon 8000 imaging system

87,500

Tempe

2/15/2006

2/15/2009

21,272.00

689,127.97

11

Commerce Financial

CF_02Datacon

295,730.00

Datacon 2200 Malti-Chip Die Bonder

29,573

Victoria

3/15/2006

3/15/2009

8,612.00

232,544.08

12

Commerce Financial

CF_03Hirox

52,851.00

HIROX Microscope System & TechCut 4 Prec Saw & Polshing System

5,285

Victoria

5/15/2006

5/15/2009

1,547.00

41,961.51

13

Commerce Financial

CF_04MicroCraft

257,250.00

MicroCraft EMX-6151 Moving Probe Tester

25,725

Tempe

5/15/2006

5/15/2009

6,406.00

215,919.83

14

Commerce Financial

CF_05ESI

355,608.00

Two ESI Mdl 5200 UV YagLaser Dells

35,561

Tempe

4/15/2006

4/15/2009

10,036.00

285,434.01

15

Commerce Financial

CF_06Asymtek

112,625.00

Asymtek Spectrum S-820 Batch Disperser

11,263

Victoria

6/15/2006

6/15/2009

3,296.00

91,157.66

16

Key Leasing

Key - Cubes

62,848.00

Tempe

3/6/2006

3/6/2009

1,822.94

43,058.19

17

Pitney Bowes

Copier Lease-Boulder

33,610.51

Toshiba Copier

Boulder

681.50

15,068.33

18

Commerce Bank

Building Mortgage

1,200,000.00

Corporate Office & Vic Plant Lot 2. Block 1, Point Victoria

$100,000.00

Victoria

10/14/2003

11/1/2009

8,318.68

1,110,686.14

HEI Inc
Schedule of Permitted Indebtedness
Operating Leases
Balances as of March 31, 2007

Account

Start

Ending

Name

Item

Location

Number

Date

Date

Deposit

Payment

Building Rent Monk Properties

1546 Lake Drive West

Chanhassen

6,591.67

12,971.00

Boulder Dev. Corp.

4801 N. 63rd Drive

Boulder

230,000.00

120,222.00

Reynolds Property

610 S Rockford Drive

Tempe

7,260.00

7,582.85

Cutler Commercial

326 South Siesta Lane

Tempe office

3,000.00

2,614.34

Equipment Farnam Street Financial — CTS

Clara view & ClearCube

Tempe

HE122205-001

8/1/2006

2,184.32

Key Leases

Orbotech Discovery

Tempe

3/6/2006

3/6/2009

6,906.39

Mobile Mini

40’ Cargo & DLX Tri Doors

Monthly

145.94

Pitney Bowes Global Financial

Mailing scale A57z

Quarterly

185.31

Pitney Bowes Global Financial

Mailing System

Quarterly

1,166.18

CNC Associates, Inc.

HAAS Tool room mill

Chanhassen

20361001

6/4/2004

6/4/2009

564.51

Computer Equipment Toshiba Business Solutions

Boulder Copier

Boulder

39120896

5/31/2002

6/4/2007

845.68

Hewlett-Packard Financial Services

50020650-01

10/11/2004

140.22

Hewlett-Packard Financial Services

5002064C-001

534.08

US Bank

8/1/2007

759.64

Pitney Bowes INC

DLCQ Copier

812.35

LFG — Marlin Leasing Corporation

HP Compaq Notebook

001-0295999-001

725.24

LFG — Marlin Leasing Corporation

Computer System

001-0295999-002

785.65

DeLage Landen

Misc Equipment

Victoria, Tempe & Boulder

24705927

2,272.69

DeLage Landen

Boulder Copiers

534057

737.10

Miscellaneous DeLage Laden

Forklift

Chanhassen

270266-476532

11/4/2004

11/4/2009

292.27

S-6.4-1

HEI Inc
Schedule of Commitments & Contingencies (Operating Leases)
Telogy

			Account		Start		Ending
Name	Item	Location	Number		Date		Date		Payment
Leases
1 Telogy	KEI 2410			501428		6/7/2006		6/7/2007		1,028.00
2 Telogy	KEI25 10AT			503485		11/3/2006		11/3/2007		448.00
3 Telogy	KEI 2001			507431		11/6/2006		11/6/2007		282.00
Rental — Month to Month
4 Telogy	Various Equipment			487478		10/19/2005				476.00
5 Telogy	KEI (6485)			515172		2/5/2007				100.00

S-6.4-2

Schedule 6.5 to Credit and Security Agreement

GUARANTIES

None

S-6.5-1

EX-10.2

Exhibit 10.2

CREDIT AND SECURITY AGREEMENT
FOR THE EXPORT – IMPORT BANK

GUARANTEED CREDIT FACILITY

BY AND BETWEEN

HEI, INC.

AND

WELLS FARGO BANK, NATIONAL ASSOCIATION
Acting through its Wells Fargo Business Credit operating division

May 15, 2007

Table of Contents

	Page
ARTICLE I DEFINITIONS		1
Section 1.1 Definitions		1
Section 1.2 Other Definitional Terms; Rules of Interpretation		11
ARTICLE II AMOUNT AND TERMS OF THE CREDIT FACILITY		12
Section 2.1 Revolving Advances		12
Section 2.2 Procedures for Requesting Advances		12
Section 2.3 Interest; Minimum Interest Charge; Default Interest Rate; Application of Payments; Participations; Usury		12
Section 2.4 Fees. The fees and expenses charged under this Section shall be without duplication of those paid and performed under Section 2.6 of the Domestic Agreement		14
Section 2.5 Time for Interest Payments; Payment on Non-Business Days; Computation of Interest and Fees		14
Section 2.6 Lockbox and Collateral Account; Sweep of Funds		15
Section 2.7 Voluntary Prepayment; Reduction of the Maximum Line Amount; Termination of the Credit Facility by the Borrower		15
Section 2.8 Mandatory Prepayment		16
Section 2.9 Revolving Advances to Pay Indebtedness		16
Section 2.10 Use of Proceeds		16
Section 2.11 Liability Records		16
ARTICLE III SECURITY INTEREST; OCCUPANCY; SETOFF		17
Section 3.1 Grant of Security Interest		17
Section 3.2 Notification of Account Debtors and Other Obligors		17
Section 3.3 Assignment of Insurance		17
Section 3.4 Occupancy		18
Section 3.5 License		18
Section 3.6 Financing Statement		18
Section 3.7 Setoff		19
Section 3.8 Collateral		19
ARTICLE IV CONDITIONS OF LENDING		20
Section 4.1 Conditions Precedent to the Initial Advances		20
Section 4.2 Conditions Precedent to All Advances		22
ARTICLE V REPRESENTATIONS AND WARRANTIES		22
Section 5.1 Existence and Power; Name; Chief Executive Office; Inventory and Equipment Locations; Federal Employer Identification Number and Organizational Identification Number		22

	Page
Section 5.2   Capitalization		23
Section 5.3   Authorization of Borrowing; No Conflict as to Law or Agreements		23
Section 5.4   Legal Agreements		23
Section 5.5   Subsidiaries and Affiliates		23
Section 5.6   Financial Condition; No Adverse Change		23
Section 5.7   Litigation		23
Section 5.8   Regulation U		24
Section 5.9   Taxes		24
Section 5.10 Titles and Liens		24
Section 5.11 Intellectual Property Rights		24
Section 5.12 Plans		25
Section 5.13 Default		26
Section 5.14 Environmental Matters		26
Section 5.15 Submissions to the Lender		26
Section 5.16 Financing Statements		27
Section 5.17 Rights to Payment		27
ARTICLE VI COVENANTS		27
Section 6.1   Reporting Requirements		27
Section 6.2   Financial Covenants		30
Section 6.3   Permitted Liens; Financing Statements		31
Section 6.4   Indebtedness		32
Section 6.5   Guaranties		32
Section 6.6   Investments and Subsidiaries		32
Section 6.7   Dividends and Distributions		33
Section 6.8   Salaries		33
Section 6.9   Books and Records; Collateral Examination, Inspection and Appraisals		33
Section 6.10 Account Verification		33
Section 6.11 Compliance with Laws		34
Section 6.12 Payment of Taxes and Other Claims		34
Section 6.13 Maintenance of Properties		34
Section 6.14 Insurance		35
Section 6.15 Preservation of Existence		35
Section 6.16 Delivery of Instruments, etc.		35
Section 6.17 Sale or Transfer of Assets; Suspension of Business Operations		35
Section 6.18 Consolidation and Merger; Asset Acquisitions		36
Section 6.19 Sale and Leaseback		36
Section 6.20 Restrictions on Nature of Business		36
Section 6.21 Accounting		36
Section 6.22 Discounts, etc.		36
Section 6.23 Plans		36
Section 6.24 Place of Business; Name		36
Section 6.25 Constituent Documents; S Corporation Status		36
Section 6.26 Performance by the Lender		37
ARTICLE VII EVENTS OF DEFAULT, RIGHTS AND REMEDIES		37

ii

	Page
Section 7.1 Events of Default		37
Section 7.2 Rights and Remedies		40
Section 7.3 Certain Notices		41
ARTICLE VIII MISCELLANEOUS		41
Section 8.1 No Waiver; Cumulative Remedies; Compliance with Laws		41
Section 8.2 Amendments, Etc.		41
Section 8.3 Notices; Communication of Confidential Information; Requests for Accounting		41
Section 8.4 Further Documents		42
Section 8.5 Costs and Expenses		42
Section 8.6 Indemnity		42
Section 8.7 Participants		43
Section 8.8 Execution in Counterparts; Telefacsimile Execution		43
Section 8.9 Retention of the Borrower’s Records		43
Section 8.10 Binding Effect; Assignment; Complete Agreement; Sharing Information		43
Section 8.11 Severability of Provisions		44
Section 8.12 Headings		44
Section 8.13 Governing Law; Jurisdiction, Venue; Waiver of Jury Trial		44
Section 8.14 Attorneys’ Fees		44

iii

CREDIT AND SECURITY AGREEMENT
FOR THE EXPORT-IMPORT CREDIT FACILITY

Dated as of May 15, 2007

     HEI, Inc., a Minnesota corporation (the “Borrower”), and WELLS FARGO BANK, NATIONAL ASSOCIATION (as more fully defined in Article I herein, the “Lender”) acting through its Wells Fargo Business Credit operating division, hereby agree as follows:

ARTICLE I
DEFINITIONS

     Section 1.1 Definitions. Except as otherwise expressly provided in this Agreement, the following terms shall have the meanings given them in this Section:

     “Accounts” shall have the meaning given it under the UCC, including each and every Eligible Export-Related Accounts Receivable.

     “Accounts Advance Rate” means up to ninety percent (90%), or such lesser rate as the Lender in its sole discretion may deem appropriate from time to time; provided that, as of the date of each quarterly audit, the Accounts Advance Rate shall be reduced by one (1) percentage point for each percentage by which Dilution is in excess of three percent (3.0%).

     “Advance” means a Revolving Advance.

     “Affiliate” or “Affiliates” means any other Person controlled by, controlling or under common control with the Borrower, including any Subsidiary of the Borrower. For purposes of this definition, “control,” when used with respect to any specified Person, means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise.

     “Agreement” means this Credit and Security Agreement for the Export-Import Credit Facility.

     “Availability” means the amount, if any, by which the Borrowing Base exceeds the sum of the outstanding principal balance of the Revolving Note.

     “Borrower Agreement” means the Borrower Agreement by the Borrower in favor of the Ex-Im Bank and the Lender, dated as of the date hereof.

     “Borrowing Base” means at any time the lesser of:

     (a) The Maximum Line Amount; or

     (b) Subject to change from time to time in the Lender’s sole discretion, the sum of:

     (i) The product of the Accounts Advance Rate times the Eligible Export-Related Accounts Receivable, plus

     (ii) The product of the Inventory Advance Rate times Export-Related Historical Inventory Value for Borrower’s Inventory, including work in progress, less

     (iii) To the extent not fully reserved under the Domestic Agreement, the Borrowing Base Reserve, less

     (iv) To the extent not fully reserved under the Domestic Agreement, the Indebtedness that the Borrower owes to the Lender that has not yet been advanced on the Revolving Note and the dollar amount that the Lender in its reasonable discretion then determines to be a reasonable determination of the Borrower’s credit exposure with respect to any swap, derivative, foreign exchange, hedge, deposit, treasury management or other similar transaction or arrangement offered to the Borrower by the Lender that is not described in Article II of this Agreement and any indebtedness owed by the Borrower to Wells Fargo Merchant Services, L.L.C.

     “Borrowing Base Reserve” means, as of any date of determination, such amounts (expressed as either a specified amount or as a percentage of a specified category or item) as the Lender may from time to time establish and adjust in reducing Availability (a) to reflect events, conditions, contingencies or risks which, as determined by the Lender, do or may affect (i) the Collateral or its value, (ii) the assets, business or prospects of the Borrower, or (iii) the security interests and other rights of the Lender in the Collateral (including the enforceability, perfection and priority thereof), or (b) to reflect the Lender’s judgment that any collateral report or financial information furnished by or on behalf of the Borrower to the Lender is or may have been incomplete, inaccurate or misleading in any material respect, or (c) in respect of any state of facts that the Lender determines constitutes a Default or an Event of Default.

     “Business Day” means a day on which the Federal Reserve Bank of New York is open for business.

     “Capital Expenditures” means for a period, any expenditure of money during such period for the lease, purchase or other acquisition of any capital asset, or for the lease of any other asset whether payable currently or in the future.

     “Collateral” means all of the Borrower’s Accounts, chattel paper and electronic chattel paper, deposit accounts, documents, Machinery, Equipment, General Intangibles, goods, instruments, Intellectual Property Rights, Inventory, Investment Property, letter-of-credit rights, letters of credit, all sums on deposit in any Collateral Account, and any items in any Lockbox; together with (i) all substitutions and replacements for and products of any of the foregoing; (ii) in the case of all goods, all accessions; (iii) all accessories, attachments, parts, equipment and repairs now or hereafter attached or affixed to or used in connection with any goods; (iv) all warehouse receipts, bills of lading and other documents of title now or hereafter covering such goods; (v) all collateral subject to the Lien of any Security Document; (vi) any money, or other assets of the Borrower that now or hereafter come into the possession, custody, or control of the Lender; (vii) proceeds of any and all of the foregoing; (viii) books and records of the Borrower, including all mail or electronic mail addressed to the Borrower; and (ix) all of the foregoing, whether now owned or existing or hereafter acquired or arising or in which the Borrower now has or hereafter acquires any rights.

2

     “Collateral Account” means the “Lender Account” as defined in the Wholesale Lockbox and Collection Account Agreement.

     “Commitment” means the Lender’s commitment to make Advances to the Borrower.

     “Constituent Documents” means with respect to any Person, as applicable, such Person’s certificate of incorporation, articles of incorporation, by-laws, certificate of formation, articles of organization, limited liability company agreement, management agreement, operating agreement, shareholder agreement, partnership agreement or similar document or agreement governing such Person’s existence, organization or management or concerning disposition of ownership interests of such Person or voting rights among such Person’s owners.

     “Control Agreement” means the Notice to Securities Intermediary and Control Agreement executed by Thomas F. Leahy, the Lender and Wells Fargo Investments, LLC, as securities intermediary, and dated the date hereof in the form required by the Lender, as the same may be amended, restated or otherwise modified from time to time.

     “Credit Facility” means the credit facility under which Revolving Advances may be made available to the Borrower by the Lender under Article II.

     “Cut-off Time” means 12:00 p.m. Minneapolis, Minnesota time or 11:00 a.m. Minneapolis time on the last business day of each month.

     “Debt” means of a Person as of a given date, all items of indebtedness or liability which in accordance with GAAP would be included in determining total liabilities as shown on the liabilities side of a balance sheet for such Person and shall also include the aggregate payments required to be made by such Person at any time under any lease that is considered a capitalized lease under GAAP.

     “Debt Service Coverage Ratio” means (i) the sum of (A) Funds from Operations and (B) Interest Expense minus (C) unfinanced Capital Expenditures divided by (ii) the sum of (A) Current Maturities of Long Term Debt and (B) Interest Expense.

     “Default” means an event that, with giving of notice or passage of time or both, would constitute an Event of Default.

     “Default Period” means any period of time beginning on the day a Default or Event of Default occurs and ending on the date identified by the Lender in writing as the date that such Default or Event of Default has been cured or waived.

     “Default Rate” means an annual interest rate in effect during a Default Period or following the Termination Date, which interest rate shall be equal to three percent (3%) over the applicable Floating Rate, as such rate may change from time to time.

     “Dilution” means, as of any date of determination, a percentage, based upon the experience of the trailing six (6) month period ending on the date of determination, which is the result of dividing (a) actual bad debt write-downs, discounts, advertising allowances, credits, or other dilutive items with respect to the Accounts as determined by the Lender in its sole

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discretion during such period, by (b) the Borrower’s net sales during such period (excluding extraordinary items) plus the amount of subclause (a).

     “Director” means a director if the Borrower is a corporation, a governor or manager if the Borrower is a limited liability company, or a general partner if the Borrower is a partnership.

     “Domestic Agreement” means the Credit and Security Agreement by and between the Borrower and Lender, dated as of the date hereof.

     “Domestic Borrowing Base” means the “Borrowing Base” as defined in the Domestic Agreement.

     “Domestic Credit Facility” means the “Credit Facility” as defined in the Domestic Agreement.

     “Domestic Documents” means the “Loan Documents” as defined in the Domestic Agreement.

     “Earnings Before Taxes” means pretax earnings from operations, excluding extraordinary gains, but including extraordinary losses.

     “Eligible Export-Related Accounts Receivable” means Eligible Export-Related Accounts Receivable as defined in the Borrower Agreement as enumerated in the Export-Related Borrowing Base Certificate, but excluding any such Accounts having any of the following characteristics:

     (i) That portion of Accounts unpaid 120 days or more after the invoice date;

     (ii) That portion of Accounts related to goods or services with respect to which the Borrower has received notice of a claim or dispute, which are subject to a claim of offset or a contra account, or which reflect a reasonable reserve for warranty claims or returns;

     (iii) That portion of Accounts not yet earned by the final delivery of goods or rendition of services, as applicable, by the Borrower to the customer, including progress billings, and that portion of Accounts for which an invoice has not been sent to the applicable account debtor;

     (iv) Accounts constituting (i) proceeds of copyrightable material unless such copyrightable material shall have been registered with the United States Copyright Office, or (ii) proceeds of patentable inventions unless such patentable inventions have been registered with the United States Patent and Trademark Office;

     (v) That portion of Accounts that is due and payable more than 60 days after the invoice date;

     (vi) Accounts denominated in any currency other than United States dollars;

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     (vii) Accounts owed by an account debtor that is insolvent, the subject of bankruptcy proceedings or has gone out of business;

     (viii) Accounts owed by an Owner, Subsidiary, Affiliate, Officer or employee of the Borrower;

     (ix) Accounts not subject to a duly perfected security interest in the Lender’s favor or which are subject to any Lien in favor of any Person other than the Lender;

     (x) That portion of Accounts that has been restructured, extended, amended or modified;

     (xi) That portion of Accounts that constitutes advertising, finance charges, service charges or sales or excise taxes;

     (xii) Accounts owed by an account debtor, regardless of whether otherwise eligible, to the extent that the aggregate balance of such Accounts exceeds fifteen percent (15%) of the sum of the aggregate amount of all Eligible Export-Related Accounts Receivable plus the aggregate amount of all Eligible Accounts (as defined in the Domestic Agreement);

     (xiv) Accounts owed by an account debtor, regardless of whether otherwise eligible, if ten percent (10%) or more of the total amount of Accounts due from such debtor is ineligible under clauses (i), (ii), or (x) above; and

     (xv) Accounts, or portions thereof, otherwise deemed ineligible by the Lender in its sole discretion.

     “Eligible Export-Related Inventory” means “Eligible Export-Related Inventory” as defined in the Borrower Agreement and calculated using the Export-Related Sales Ratio as defined in the Borrower Agreement and applied in the Export-Related Borrowing Base Certificate, other than Export-Related Inventory, or portions thereof, otherwise deemed ineligible by the Lender in its sole discretion.

     “Environmental Law” means any federal, state, local or other governmental statute, regulation, law or ordinance dealing with the protection of human health and the environment.

     “Equipment” shall have the meaning given it under the UCC.

     “Event of Default” is defined in Section 7.1.

     “Ex-Im Bank” means the Export-Import Bank of the United States.

     “Export-Related Accounts Receivable” means “Export-Related Accounts Receivable” as defined in the Borrower Agreement

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     “Export-Related Accounts Receivable Value” means “Export-Related Accounts Receivable Value” as defined in the Borrower Agreement.

     “Export-Related Borrowing Base Certificate” means the “Export-Related Borrowing Base Certificate” as defined in the Borrower Agreement, a form of which is attached hereto as Exhibit D.

     “Export-Related Inventory” means “Export-Related Inventory” as defined in the Borrower Agreement.

     “Export-Related Historical Inventory Value” means “Export-Related Historical Inventory Value” as defined in the Borrower Agreement.

     “ERISA” means the Employee Retirement Income Security Act of 1974, as amended from time to time.

     “ERISA Affiliate” means any trade or business (whether or not incorporated) that is a member of a group which includes the Borrower and which is treated as a single employer under Section 414 of the IRC.

     “Financial Covenants” means the covenants set forth in Section 6.2.

     “Floating Rate” means with respect to Revolving Advances evidenced by the Revolving Note, an annual interest rate equal to the sum of the Prime Rate plus two percent (2.0%), and which interest rate shall change when and as the Prime Rate changes.

     “Floating Rate Advance” means an Advance bearing interest at the Floating Rate.

     “Funding Date” is defined in Section 2.1.

     “Funds from Operations” means for a given period, the sum of (i) Net Income, (ii) depreciation and amortization, (iii) any increase (or decrease) in deferred income taxes, (iv) any increase (or decrease) in lifo reserves, and (v) other non-cash items, each as determined for such period in accordance with GAAP.

     “GAAP” means generally accepted accounting principles, applied on a basis consistent with the accounting practices applied in the financial statements described in Section 5.6.

     “General Intangibles” shall have the meaning given it under the UCC.

     “Guarantor” means Thomas Leahy or any other person who executes a Guaranty in favor of the Lender.

     “Guaranty” means each unconditional guaranty executed by a Guarantor in favor of the Lender.

     “Hazardous Substances” means pollutants, contaminants, hazardous substances, hazardous wastes, petroleum and fractions thereof, and all other chemicals, wastes, substances and materials listed in, regulated by or identified in any Environmental Law.

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     “Indebtedness” is used herein in its most comprehensive sense and means any and all advances, debts, obligations and liabilities of the Borrower to the Lender, heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, including under any swap, derivative, foreign exchange, hedge, deposit, treasury management or other similar transaction or arrangement at any time entered into by the Borrower with the Lender or with Wells Fargo Merchant Services, L.L.C., and whether the Borrower may be liable individually or jointly with others, or whether recovery upon such Indebtedness may be or hereafter becomes unenforceable.

     “Indemnified Liabilities” is defined in Section 8.6.

     “Indemnitees” is defined in Section 8.6.

     “Infringement” or “Infringing” when used with respect to Intellectual Property Rights means any infringement or other violation of Intellectual Property Rights.

     “Intangible Assets” means all intangible assets as determined in accordance with GAAP and including Intellectual Property Rights, goodwill, accounts due from Affiliates, Directors, Officers or employees, prepaid expenses, deposits, deferred charges or treasury stock or any securities or Debt of the Borrower or any other securities unless the same are readily marketable in the U.S. or entitled to be used as a credit against federal income tax liabilities, non-compete agreements and any other assets designated from time to time by the Lender, in its sole discretion.

     “Intellectual Property Rights” means all actual or prospective rights arising in connection with any intellectual property or other proprietary rights, including all rights arising in connection with copyrights, patents, service marks, trade dress, trade secrets, trademarks, trade names or mask works.

     “Interest Expense” means for a fiscal year-to-date period, the Borrower’s total gross interest expense during such period (excluding interest income), and shall in any event include (i) interest expensed (whether or not paid) on all Debt, (ii) the amortization of debt discounts, (iii) the amortization of all fees payable in connection with the incurrence of Debt to the extent included in interest expense, and (iv) the portion of any capitalized lease obligation allocable to interest expense.

     “Interest Payment Date” is defined in Section 2.5(a).

     “Inventory” shall have the meaning given it under the UCC but for purposes of this Agreement shall include only Eligible Export-Related Inventory.

     “Inventory Advance Rate” means thirty percent (30%) or such lesser rate or amount as the Lender in its sole discretion may deem appropriate from time to time.

     “Investment Property” shall have the meaning given it under the UCC.

     “IRC” means the Internal Revenue Code of 1986, as amended from time to time.

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     “Leahy Pledge Agreement” means the Collateral Pledge Agreement executed by Thomas F. Leahy in favor of the Lender and dated the date hereof, as the same may be amended, restated or otherwise modified from time to time.

     “Lender” means Wells Fargo Bank, National Association in its broadest and most comprehensive sense as a legal entity, and is not limited in its meaning to the Lender’s Wells Fargo Business Credit operating division, or to any other operating division of the Lender.

     “Licensed Intellectual Property” is defined in Section 5.11(c).

     “Lien” means any security interest, mortgage, deed of trust, pledge, lien, charge, encumbrance, title retention agreement or analogous instrument or device, including the interest of each lessor under any capitalized lease and the interest of any bondsman under any payment or performance bond, in, of or on any assets or properties of a Person, whether now owned or subsequently acquired and whether arising by agreement or operation of law.

     “Loan Authorization Agreement” means the “Loan Authorization Agreement” as defined in Borrower Agreement.

     “Loan Documents” means this Agreement, the Revolving Notes, the Loan Authorization Agreement, and the Security Documents, together with every other agreement, note, document, contract or instrument to which the Borrower now or in the future may be a party and which is required by the Lender.

     “Loan Year” is defined in Section 2.3(b).

     “Lockbox” means “Lockbox” as defined in the Wholesale Lockbox and Collection Account Agreement.

     “Master Guarantee Agreement” means the Master Guarantee Agreement dated as of November 1, 2005 by and between Wells Fargo Bank, N.A. and Ex-Im Bank, as the same may be amended, restated or otherwise modified from time to time.

     “Material Adverse Effect” means any of the following:

     (i) A material adverse effect on the business, operations, results of operations, prospects, assets, liabilities or financial condition of the Borrower;

     (ii) A material adverse effect on the ability of the Borrower to perform its obligations under the Loan Documents;

     (iii) A material adverse effect on the ability of the Lender to enforce the Indebtedness or to realize the intended benefits of the Security Documents, including a material adverse effect on the validity or enforceability of any Loan Document, or on the status, existence, perfection, priority (subject to Permitted Liens) or enforceability of any Lien securing payment or performance of the Indebtedness; or

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     (iv) Any claim against the Borrower or threat of litigation which if determined adversely to the Borrower would cause the Borrower to be liable to pay an amount exceeding $100,000 or would result in the occurrence of an event described in clauses (i), (ii) and (iii) above.

     “Maturity Date” means, with respect to the Credit Facility, May 15, 2010.

     “Maximum Line Amount” means $3,000,000, unless this amount is reduced pursuant to Section 2.7, in which event it means such lower amount.

     “Minimum Interest Charge” is defined in Section 2.3(b).

     “Mortgagee’s Disclaimer and Consent” means that agreement dated May 15, 2007 executed by Commerce Bank in favor of the Lender.

     “Multiemployer Plan” means a multiemployer plan (as defined in Section 4001(a)(3) of ERISA) to which the Borrower or any ERISA Affiliate contributes or is obligated to contribute.

     “Net Forced Liquidation Value” means a professional opinion of the estimated most probable Net Cash Proceeds which could typically be realized at a properly advertised and conducted public auction sale without reserve, held under forced sale conditions and under economic trends current within 60 days of the appraisal. The opinion may consider physical location, difficulty of removal, adaptability, specialization, marketability, physical condition, overall appearance and psychological appeal.

     “Note” means the Revolving Note and “Notes” means the Revolving Notes.

     “Obligations” is used herein in its most comprehensive sense and means any and all advances, debts, obligations and liabilities of the Borrower to the Lender, heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, including under any swap, derivative, foreign exchange, hedge, deposit, treasury management or other similar transaction or arrangement at any time entered into by the Borrower with the Lender or with Wells Fargo Merchant Services, L.L.C., and whether the Borrower may be liable individually or jointly with others, or whether recovery upon such Indebtedness may be or hereafter becomes unenforceable.

     “OFAC” is defined in Section 6.11(c).

     “Officer” means with respect to the Borrower, an officer if the Borrower is a corporation, a manager if the Borrower is a limited liability company, or a partner if the Borrower is a partnership.

     “Overadvance” means the amount, if any, by which the outstanding principal balance of the Revolving Note is in excess of the then-existing Borrowing Base.

     “Owned Intellectual Property” is defined in Section 5.11(a).

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     “Owner” means with respect to the Borrower, each Person having legal or beneficial title to an ownership interest in the Borrower or a right to acquire such an interest.

     “Patent and Trademark Security Agreement” means each Patent and Trademark Security Agreement now or hereafter executed by the Borrower in favor of the Lender.

     “Pension Plan” means a pension plan (as defined in Section 3(2) of ERISA) maintained for employees of the Borrower or any ERISA Affiliate and covered by Title IV of ERISA.

     “Permitted Lien” and “Permitted Liens” are defined in Section 6.3(a).

     “Person” means any individual, corporation, partnership, joint venture, limited liability company, association, joint-stock company, trust, unincorporated organization or government or any agency or political subdivision thereof.

     “Plan” means an employee benefit plan (as defined in Section 3(3) of ERISA) maintained for employees of the Borrower or any ERISA Affiliate.

     “Premises” means all locations where the Borrower conducts its business or has any rights of possession, including the locations legally described in Exhibit C attached hereto.

     “Prime Rate” means at any time the rate of interest most recently announced by the Lender at its principal office as its Prime Rate, with the understanding that the Prime Rate is one of the Lender’s base rates, and serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto, and is evidenced by the recording thereof in such internal publication or publications as the Lender may designate. Each change in the rate of interest shall become effective on the date each Prime Rate change is announced by the Lender.

     “Reportable Event” means a reportable event (as defined in Section 4043 of ERISA), other than an event for which the 30-day notice requirement under ERISA has been waived in regulations issued by the Pension Benefit Guaranty Corporation.

     “Revolving Advance” is defined in Section 2.1.

     “Revolving Note” means Borrower’s revolving promissory note, payable to the order of the Lender in the original principal amount of $2,700,000 or the Borrower’s revolving promissory note payable to the order of the Lender in the original principal amount of $300,000, each in substantially the form of Exhibit A hereto, each as may be renewed and amended from time to time, and all replacements thereto and “Revolving Notes” means both the Borrower’s revolving promissory note, payable to the order of Lender, in the original principal amount of $2,700,000 and the Borrower’s revolving promissory note, payable to the order of the Lender, in the original principal amount of $300,000, each in substantially the form of Exhibit A hereto, each as may be renewed and amended from time to time, and all replacements thereto.

     “Securities Account” means the securities account numbered 6436-2579 maintained by Wells Fargo Investments, LLC on behalf of Thomas F. Leahy.

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     “Security Documents” means this Agreement, the Wholesale Lockbox and Collection Account Agreement, the Patent and Trademark Security Agreement(s), each Guaranty, the Leahy Pledge Agreement, the Control Agreement and any other document delivered to the Lender from time to time to secure the Indebtedness.

     “Security Interest” is defined in Section 3.1.

     “Subordinated Creditor” means each Person now or in the future who agrees to subordinate indebtedness of the Borrower held by that Person to the payment of the Indebtedness.

     “Subordination Agreement” means a subordination agreement executed by a Subordinated Creditor in favor of the Lender and acknowledged by the Borrower (together with any other subordination agreement that may be accepted by the Lender from time to time, the “Subordination Agreements”).

     “Subsidiary” means any Person of which more than fifty percent (50%) of the outstanding ownership interests having general voting power under ordinary circumstances to elect a majority of the board of directors or the equivalent of such Person, regardless of whether or not at the time ownership interests of any other class or classes shall have or might have voting power by reason of the happening of any contingency, is at the time directly or indirectly owned by the Borrower, by the Borrower and one or more other Subsidiaries, or by one or more other Subsidiaries.

     “Termination Date” means the earliest of (i) the Maturity Date, (ii) the date the Borrower terminates the Credit Facility, or (iii) the date the Lender demands payment of the Indebtedness, following an Event of Default, pursuant to Section 7.2.

     “UCC” means the Uniform Commercial Code in effect in the state designated in this Agreement as the state whose laws shall govern this Agreement, or in any other state whose laws are held to govern this Agreement or any portion of this Agreement.

     “Wholesale Lockbox and Collection Account Agreement” means the Wholesale Lockbox and Collection Account Agreement by and between the Borrower and the Lender, dated the same date as this Agreement.

     Section 1.2 Other Definitional Terms; Rules of Interpretation. The words “hereof”, “herein” and “hereunder” and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement. All accounting terms not otherwise defined herein have the meanings assigned to them in accordance with GAAP. All terms defined in the UCC and not otherwise defined herein have the meanings assigned to them in the UCC. References to Articles, Sections, subsections, Exhibits, Schedules and the like, are to Articles, Sections and subsections of, or Exhibits or Schedules attached to, this Agreement unless otherwise expressly provided. The words “include”, “includes” and “including” shall be deemed to be followed by the phrase “without limitation”. Unless the context in which used herein otherwise clearly requires, “or” has the inclusive meaning represented by the phrase “and/or”. Defined terms include in the singular number the plural and in the plural number the singular. Reference to any agreement (including the Loan Documents),

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document or instrument means such agreement, document or instrument as amended or modified and in effect from time to time in accordance with the terms thereof (and, if applicable, in accordance with the terms hereof and the other Loan Documents), except where otherwise explicitly provided, and reference to any promissory note includes any promissory note which is an extension or renewal thereof or a substitute or replacement therefor. Reference to any law, rule, regulation, order, decree, requirement, policy, guideline, directive or interpretation means as amended, modified, codified, replaced or reenacted, in whole or in part, and in effect on the determination date, including rules and regulations promulgated thereunder.

ARTICLE II
AMOUNT AND TERMS OF THE CREDIT FACILITY

     Section 2.1 Revolving Advances. The Lender agrees, subject to the terms and conditions of this Agreement, to make advances (“Revolving Advances”) to the Borrower from time to time from the date that all of the conditions set forth in Section 4.1 are satisfied (the “Funding Date”) to and until (but not including) the Termination Date in an amount not in excess of the Maximum Line Amount. The Lender shall have no obligation to make a Revolving Advance to the extent that the amount of the requested Revolving Advance exceeds Availability. The Borrower’s obligation to pay the Revolving Advances shall be evidenced by the Revolving Notes and shall be secured by the Collateral. Within the limits set forth in this Section 2.1, the Borrower may borrow, prepay pursuant to Section 2.7, and reborrow.

     Section 2.2 Procedures for Requesting Advances. The Borrower shall comply with the following procedures in requesting Revolving Advances:

          (a) Time for Requests. The Borrower shall request each Advance not later than the Cut-off Time on the Business Day on which the Advance is to be made. Each request that conforms to the terms of this Agreement shall be effective upon receipt by the Lender, shall be in writing or by telephone, and shall be confirmed in writing by the Borrower if so requested by the Lender, by (i) an Officer of the Borrower; or (ii) a Person designated as the Borrower’s agent by an Officer of the Borrower in a writing delivered to the Lender; or (iii) a Person whom the Lender reasonably believes to be an Officer of the Borrower or such a designated agent. The Borrower shall repay all Advances even if the Lender does not receive such confirmation and even if the Person requesting an Advance was not in fact authorized to do so. Any request for an Advance, whether written or telephonic, shall be deemed to be a representation by the Borrower that the conditions set forth in Section 4.2 have been satisfied as of the time of the request.

          (b) Disbursement. Upon fulfillment of the applicable conditions set forth in Article IV, the Lender shall disburse the proceeds of the requested Advance by crediting the same to the Borrower’s demand deposit account maintained with the Lender unless the Lender and the Borrower shall agree in writing to another manner of disbursement.

     Section 2.3 Interest; Minimum Interest Charge; Default Interest Rate; Application of Payments; Participations; Usury.

          (a) Interest. Except as provided in Section 2.3(c), the principal amount of each Advance shall bear interest as a Floating Rate Advance.

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          (b) Minimum Interest Charge. Notwithstanding any other terms of this Agreement to the contrary, the Borrower shall pay to the Lender interest of not less than $150,000 per “Loan Year,” paid quarterly, (the “Minimum Interest Charge”) during the term of this Agreement, and the Borrower shall pay any deficiency between the Minimum Interest Charge and the amount of interest otherwise calculated under Section 2.3(a) on the first day of each quarter following the Funding Date and each anniversary of the Funding Date and on the Termination Date. “Loan Year” means each one year period ending on the anniversary of the Funding Date. When calculating this deficiency, the Default Rate, if applicable, shall be disregarded, and any interest that accrues on a payment following its receipt on those days specified in Section 2.3(d) shall be excluded in determining the total amount of interest otherwise calculated under Section 2.3(a). Notwithstanding the foregoing, the Minimum Interest Charge set forth in this Section 2.3(b) is intended to be the same charge as, and not an additional charge to, the Minimum Interest Charge set forth in the Domestic Agreement, and no duplication of such Minimum Interest Charge is intended herein or therein.

          (c) Default Interest Rate. At any time during any Default Period or following the Termination Date, in the Lender’s sole discretion and without waiving any of its other rights or remedies, the principal of the Revolving Note shall bear interest at the Default Rate or such lesser rate as the Lender may determine, effective as of the date the Event of Default occurs through the last day of such Default Period, or any shorter time period that the Lender may determine. The decision of the Lender to impose a rate that is less than the Default Rate or to not impose the Default Rate for the entire duration of the Default Period shall be made by the Lender in its sole discretion and shall not be a waiver of any of its other rights and remedies, including its right to retroactively impose the full Default Rate for the entirety of any such Default Period or following the Termination Date. Notwithstanding the foregoing, the amount of default interest required to be paid pursuant to this Section 2.3(c) is intended to be the same amount of default interest required to be paid pursuant to the Domestic Agreement, and no duplication of such defaul interest is intended herein or therein.

          (d) Application of Payments. Payments shall be applied to the Indebtedness on the Business Day of receipt by the Lender in the Lender’s general account, but the amount of principal paid shall continue to accrue interest at the interest rate applicable under the terms of this Agreement from the calendar day the Lender receives the payment, and continuing through the end of the first Business Day following receipt of the payment.

          (e) Participations. If any Person shall acquire a participation in the Advances or the Obligation of Reimbursement, the Borrower shall be obligated to the Lender to pay the full amount of all interest calculated under this Section 2.3, along with all other fees, charges and other amounts due under this Agreement, regardless if such Person elects to accept interest with respect to its participation at a lower rate than that calculated under this Section 2.3, or otherwise elects to accept less than its prorata share of such fees, charges and other amounts due under this Agreement.

          (f) Usury. In any event no rate change shall be put into effect which would result in a rate greater than the highest rate permitted by law. Notwithstanding anything to the contrary contained in any Loan Document, all agreements which either now are or which shall become agreements between the Borrower and the Lender are hereby limited so that in no contingency or

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event whatsoever shall the total liability for payments in the nature of interest, additional interest and other charges exceed the applicable limits imposed by any applicable usury laws. If any payments in the nature of interest, additional interest and other charges made under any Loan Document are held to be in excess of the limits imposed by any applicable usury laws, it is agreed that any such amount held to be in excess shall be considered payment of principal hereunder, and the indebtedness evidenced hereby shall be reduced by such amount so that the total liability for payments in the nature of interest, additional interest and other charges shall not exceed the applicable limits imposed by any applicable usury laws, in compliance with the desires of the Borrower and the Lender. This provision shall never be superseded or waived and shall control every other provision of the Loan Documents and all agreements between the Borrower and the Lender, or their successors and assigns.

     Section 2.4 Fees. The fees and expenses charged under this Section shall be without duplication of those paid and performed under Section 2.6 of the Domestic Agreement.

          (a) Ex-Im Annual Facility Fee. The Borrower agrees to pay the Lender an Ex-Im Annual Facility Fee of 1.5% or $45,000, which fee shall be due and payable on the date hereof, each anniversary of the date hereof, and on the Termination Date.

          (b) Ex-Im Application Fees. The Borrower agrees to pay to the Lender on the date hereof a fully earned Ex-Im Application Fee of $100.

          (c) Overadvance Fees. The Borrower shall pay an Overadvance fee in the amount of $500.00 for each day or portion thereof during which an Overadvance exists, regardless of how the Overadvance arises or whether or not the Overadvance has been agreed to in advance by the Lender. The acceptance of payment of an Overadvance fee by the Lender shall not be deemed to constitute either consent to the Overadvance or a waiver of the resulting Event of Default, unless the Lender specifically consents to the Overadvance in writing and waives the Event of Default on whatever conditions the Lender deems appropriate.

          (d) Domestic Fees. The Borrower shall pay the Lender, on demand, all fees due and payable from time to time under the Ex-Im Documents.

          (e) Other Fees and Charges. The Lender may from time to time impose additional fees and charges as consideration for Advances made in excess of Availability or for other events that constitute an Event of Default or a Default hereunder, including fees and charges for the administration of Collateral by the Lender, and fees and charges for the late delivery of reports, which may be assessed in the Lender’s sole discretion on either an hourly, periodic, or flat fee basis, and in lieu of or in addition to imposing interest at the Default Rate. Borrower shall also be responsible for all out of pocket expenses in connection with the contemplated financing including without limitation legal fees and expenses, closing costs, appraisal fees, UCC search and recording fees, costs for individual corporate credit reports, mortgage recording fees, fees to initiate electronic reporting, as well as collateral examination costs. Such costs are to be funded by Borrower and shall survive.

     Section 2.5 Time for Interest Payments; Payment on Non-Business Days; Computation of Interest and Fees.

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          (a) Time For Interest Payments. Accrued and unpaid interest shall be due and payable on the first day of each month and on the Termination Date (each an “Interest Payment Date”), or if any such day is not a Business Day, on the next succeeding Business Day. Interest will accrue from the most recent date to which interest has been paid or, if no interest has been paid, from the date of advance to the Interest Payment Date.

          (b) Payment on Non Business Days. Whenever any payment to be made hereunder shall be stated to be due on a day which is not a Business Day, such payment may be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of interest on the Advances or the fees hereunder, as the case may be.

          (c) Computation of Interest and Fees. Interest accruing on the outstanding principal balance of the Advances and fees hereunder outstanding from time to time shall be computed on the basis of actual number of days elapsed in a year of 360 days.

     Section 2.6 Lockbox and Collateral Account; Sweep of Funds.

          (a) Lockbox and Collateral Account.

     (i) The Borrower shall instruct all account debtors to pay all Accounts directly to the Lockbox. If, notwithstanding such instructions, the Borrower receives any payments on Accounts, the Borrower shall deposit such payments into the Collateral Account. The Borrower shall also deposit all other cash proceeds of Collateral regardless of source or nature directly into the Collateral Account. Until so deposited, the Borrower shall hold all such payments and cash proceeds in trust for and as the property of the Lender and shall not commingle such property with any of its other funds or property. All deposits in the Collateral Account shall constitute proceeds of Collateral and shall not constitute payment of the Indebtedness.

     (ii) All items deposited in the Collateral Account shall be subject to final payment. If any such item is returned uncollected, the Borrower will immediately pay the Lender, or, for items deposited in the Collateral Account, the bank maintaining such account, the amount of that item, or such bank at its discretion may charge any uncollected item to the Borrower’s commercial account or other account. The Borrower shall be liable as an endorser on all items deposited in the Collateral Account, whether or not in fact endorsed by the Borrower.

          (b) Sweep of Funds. The Lender shall from time to time, in accordance with the Wholesale Lockbox and Collection Account Agreement, cause funds in the Collateral Account to be transferred to the Lender’s general account for payment of the Indebtedness. Amounts deposited in the Collateral Account shall not be subject to withdrawal by the Borrower, except after payment in full and discharge of all Indebtedness.

     Section 2.7 Voluntary Prepayment; Reduction of the Maximum Line Amount; Termination of the Credit Facility by the Borrower. Except as otherwise provided herein, the

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Borrower may prepay the Advances in whole at any time or from time to time in part. The Borrower may terminate the Credit Facility or reduce the Maximum Line Amount at any time if it (i) gives the Lender at least 90 days advance written notice prior to the proposed Termination Date, and (ii) pays the Lender applicable termination and Maximum Line Amount reduction fees in accordance with the terms of this Agreement. Any reduction in the Maximum Line Amount shall be in multiples of $100,000, and with a minimum reduction of at least $500,000. If the Borrower terminates the Credit Facility or reduces the Maximum Line Amount to zero, all Indebtedness shall be immediately due and payable, and if the Borrower gives the Lender less than the required 90 days advance written notice, then the interest rate applicable to borrowings evidenced by the Revolving Note shall be the Default Rate for the period of time commencing 90 days prior to the proposed Termination Date through the date that the Lender actually receives such written notice. If the Borrower does not wish the Lender to consider renewal of the Credit Facility on the next Maturity Date, then the Borrower shall give the Lender at least 90 days written notice prior to the Maturity Date that it will not be requesting renewal. If the Borrower fails to give the Lender such timely notice, then the interest rate applicable to borrowings evidenced by the Revolving Note shall be the Default Rate for the period of time commencing 90 days prior to the Maturity Date through the date that the Lender actually receives such written notice. Notwithstanding the foregoing, the termination and Maximum Line Amount reduction fees set forth in this Section 2.7 are intended to be the same fees as, and not additional fees to, the fees set forth in Section 2.9 of the Domestic Agreement, and no duplication of such fees is intended herein or therein.

     Section 2.8 Mandatory Prepayment. Without notice or demand, if the sum of the outstanding principal balance of the Revolving Advances shall at any time exceed the Borrowing Base, the Borrower shall immediately prepay the Revolving Advances to the extent necessary to eliminate such excess. Any prepayment received by the Lender under this Agreement may be applied to the Indebtedness, in such order and in such amounts as the Lender in its sole discretion may determine from time to time.

     Section 2.9 Revolving Advances to Pay Indebtedness. Notwithstanding the terms of Section 2.1, the Lender may, in its discretion at any time or from time to time, without the Borrower’s request and even if the conditions set forth in Section 4.2 would not be satisfied, and so long as this does not create an overadvance, make a Revolving Advance in an amount equal to the portion of the Indebtedness from time to time due and payable, and may deliver the proceeds of any such Revolving Advance to Wells Fargo Merchant Services, L.L.C. in satisfaction of any unpaid obligations due to Wells Fargo Merchant Services, L.L.C.

     Section 2.10 Use of Proceeds The Borrower shall use the proceeds of each Advance in accordance with the Borrower Agreement.

     Section 2.11 Liability Records. The Lender may maintain from time to time, at its discretion, records as to the Indebtedness. All entries made on any such record shall be presumed correct until the Borrower establishes the contrary. Upon the Lender’s demand, the Borrower will admit and certify in writing the exact principal balance of the Indebtedness that the Borrower then asserts to be outstanding. Any billing statement or accounting rendered by the Lender shall be conclusive and fully binding on the Borrower unless the Borrower gives the Lender specific written notice of exception within 30 days after receipt.

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ARTICLE III
SECURITY INTEREST; OCCUPANCY; SETOFF

     Section 3.1 Grant of Security Interest. The Borrower hereby pledges, assigns and grants to the Lender, for the benefit of itself and as agent for Wells Fargo Merchant Services, L.L.C., a lien and security interest (collectively referred to as the “Security Interest”) in the Collateral, as security for the payment and performance of: (a) all present and future Indebtedness of the Borrower to the Lender; (b) all obligations of the Borrower and rights of the Lender under this Agreement; and (c) all present and future obligations of the Borrower to the Lender of other kinds. Upon request by the Lender, the Borrower will grant to the Lender, for the benefit of itself and as agent for Wells Fargo Merchant Services, L.L.C., a security interest in all commercial tort claims that the Borrower may have against any Person. In addition, the Borrower to further secure all such Indebtedness shall execute a Mortgage of $1,000,000 on property in Victoria, Minnesota.

     Section 3.2 Notification of Account Debtors and Other Obligors. The Lender may at any time after an Event of Default, notify any account debtor or other Person obligated to pay the amount due that such right to payment has been assigned or transferred to the Lender for security and shall be paid directly to the Lender. The Borrower will join in giving such notice if the Lender so requests. At any time after the Borrower or the Lender gives such notice to an account debtor or other obligor, the Lender may, but need not, in the Lender’s name or in the Borrower’s name, demand, sue for, collect or receive any money or property at any time payable or receivable on account of, or securing, any such right to payment, or grant any extension to, make any compromise or settlement with or otherwise agree to waive, modify, amend or change the obligations (including collateral obligations) of any such account debtor or other obligor. The Lender may, in the Lender’s name or in the Borrower’s name, as the Borrower’s agent and attorney-in-fact, notify the United States Postal Service to change the address for delivery of the Borrower’s mail to any address designated by the Lender, otherwise intercept the Borrower’s mail, and receive, open and dispose of the Borrower’s mail, applying all Collateral as permitted under this Agreement and holding all other mail for the Borrower’s account or forwarding such mail to the Borrower’s last known address.

     Section 3.3 Assignment of Insurance. Except for insurance obtained or pledged to a Landlord covering leased premises, as additional security for the payment and performance of the Indebtedness, the Borrower hereby assigns to the Lender any and all monies (including proceeds of insurance and refunds of unearned premiums) due or to become due under, and all other rights of the Borrower with respect to, any and all policies of insurance now or at any time hereafter covering the Collateral or any evidence thereof or any business records or valuable papers pertaining thereto, and the Borrower hereby directs the issuer of any such policy to pay all such monies directly to the Lender. At any time, whether or not a Default Period then exists, the Lender may (but need not), in the Lender’s name or in the Borrower’s name, execute and deliver proof of claim, receive all such monies, endorse checks and other instruments representing payment of such monies, and adjust, litigate, compromise or release any claim against the issuer of any such policy. Any monies received as payment for any loss under any insurance policy mentioned above (other than liability insurance policies) or as payment of any award or compensation for condemnation or taking by eminent domain, shall be paid over to the Lender to be applied, at the option of the Lender, either to the prepayment of the Indebtedness or shall be

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disbursed to the Borrower under staged payment terms reasonably satisfactory to the Lender for application to the cost of repairs, replacements, or restorations. Any such repairs, replacements, or restorations shall be effected with reasonable promptness and shall be of a value at least equal to the value of the items or property destroyed prior to such damage or destruction.

     Section 3.4 Occupancy.

     (a) To the greatest extent possible under existing or future leases and consistent with any Landlord Waivers and Mortgagee Disclaimers, but subject to the mortgages of Commerce Bank or its affiliates, the Borrower hereby irrevocably grants to the Lender the right to take exclusive possession of the Premises at any time during a Default Period without notice or consent.

     (b) The Lender may use the Premises only to hold, process, manufacture, sell, use, store, liquidate, realize upon or otherwise dispose of items that are Collateral and for other purposes that the Lender may in good faith deem to be related or incidental purposes.

     (c) The Lender’s right to hold the Premises shall cease and terminate upon the earlier of (i) payment in full and discharge of all Indebtedness and termination of the Credit Facility, and (ii) final sale or disposition of all items constituting Collateral and delivery of all such items to purchasers.

     (d) The Lender shall not be obligated to pay or account for any rent or other compensation for the possession, occupancy or use of any of the Premises; provided, however, that if the Lender does pay or account for any rent or other compensation for the possession, occupancy or use of any of the Premises, the Borrower shall reimburse the Lender promptly for the full amount thereof. In addition, the Borrower will pay, or reimburse the Lender for, all taxes, fees, duties, imposts, charges and expenses at any time incurred by or imposed upon the Lender by reason of the execution, delivery, existence, recordation, performance or enforcement of this Agreement or the provisions of this Section 3.4.

     Section 3.5 License. Without limiting the generality of any other Security Document, the Borrower hereby grants to the Lender a non-exclusive, worldwide and royalty-free license to use or otherwise exploit all Intellectual Property Rights of the Borrower for the purpose of: (a) completing the manufacture of any in-process materials during any Default Period so that such materials become saleable Inventory, all in accordance with the same quality standards previously adopted by the Borrower for its own manufacturing and subject to the Borrower’s reasonable exercise of quality control; and (b) selling, leasing or otherwise disposing of any or all Collateral during any Default Period.

     Section 3.6 Financing Statement. The Borrower authorizes the Lender to file from time to time, such financing statements against collateral described as “all personal property” or “all assets” or describing specific items of collateral including commercial tort claims as the Lender deems necessary or useful to perfect the Security Interest. All financing statements filed before the date hereof to perfect the Security Interest were authorized by the Borrower and are

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hereby re-authorized. A carbon, photographic or other reproduction of this Agreement or of any financing statements signed by the Borrower is sufficient as a financing statement and may be filed as a financing statement in any state to perfect the security interests granted hereby. For this purpose, the Borrower represents and warrants that the following information is true and correct:

Name and address of Debtor:

HEI, Inc.
1495 Steiger Lake Lane
Victoria, Minnesota 55386
Federal Employer Identification No. 41-0944876
Organizational Identification No. MN 1P-877

Name and address of Secured Party:

Wells Fargo Bank, National Association
MAC N9312-040
Sixth and Marquette
Minneapolis, Minnesota 55479

     Section 3.7 Setoff. The Lender may at any time or from time to time, at its sole discretion and without demand and without notice to anyone, setoff any liability owed to the Borrower by the Lender, whether or not due, against any Indebtedness, whether or not due. In addition, each other Person holding a participating interest in any Indebtedness shall have the right to appropriate or setoff any deposit or other liability then owed by such Person to the Borrower, whether or not due, and apply the same to the payment of said participating interest, as fully as if such Person had lent directly to the Borrower the amount of such participating interest.

     Section 3.8 Collateral. This Agreement does not contemplate a sale of accounts, contract rights or chattel paper, and, as provided by law, the Borrower is entitled to any surplus and shall remain liable for any deficiency. The Lender’s duty of care with respect to Collateral in its possession (as imposed by law) shall be deemed fulfilled if it exercises reasonable care in physically keeping such Collateral, or in the case of Collateral in the custody or possession of a bailee or other third Person, exercises reasonable care in the selection of the bailee or other third Person, and the Lender need not otherwise preserve, protect, insure or care for any Collateral. The Lender shall not be obligated to preserve any rights the Borrower may have against prior parties, to realize on the Collateral at all or in any particular manner or order or to apply any cash proceeds of the Collateral in any particular order of application. The Lender has no obligation to clean-up or otherwise prepare the Collateral for sale. The Borrower waives any right it may have to require the Lender to pursue any third Person for any of the Indebtedness.

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ARTICLE IV
CONDITIONS OF LENDING

     Section 4.1 Conditions Precedent to the Initial Advances. The Lender’s obligation to make the initial Advances shall be subject to the condition precedent that the Lender shall have received all of the following, each properly executed by the appropriate party and in form and substance satisfactory to the Lender:

     (a) This Agreement.

     (b) The Revolving Notes.

     (c) The Domestic Documents.

     (d) The Borrower Agreement and the Ex-Im Bank Application dated prior to Closing.

     (e) The Export-Related Borrowing Base Certificate dated not more than five (5) days prior to Closing.

     (f) A true and correct copy of any and all leases pursuant to which the Borrower is leasing the Premises, together with a landlord’s disclaimer and consent with respect to each such lease.

     (g) A true and correct copy of any and all mortgages pursuant to which the Borrower has mortgaged the Premises, together with a mortgagee’s disclaimer and consent with respect to each such mortgage.

     (h) A true and correct copy of any and all agreements pursuant to which the Borrower’s property is in the possession of any Person other than the Borrower, together with, in the case of any goods held by such Person for resale, (i) a consignee’s acknowledgment and waiver of Liens, (ii) UCC financing statements sufficient to protect the Borrower’s and the Lender’s interests in such goods, and (iii) UCC searches showing that no other secured party has filed a financing statement against such Person and covering property similar to the Borrower’s other than the Borrower, or if there exists any such secured party, evidence that each such secured party has received notice from the Borrower and the Lender sufficient to protect the Borrower’s and the Lender’s interests in the Borrower’s goods from any claim by such secured party.

     (i) An acknowledgment and waiver of Liens from each warehouse in which the Borrower is storing Inventory.

     (j) An acknowledgment and agreement from SAP as licensor and any other licensor in favor of the Lender, together with a true, correct and complete copy of any such license agreements, except the expired Syteline License.

     (k) The Wholesale Lockbox and Collection Account Agreement.

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     (l) Control agreements with each bank at which the Borrower maintains deposit accounts.

     (m) The Patent and Trademark Security Agreement.

     (n) The Guaranty of Thomas F. Leahy.

     (o) The Leahy Pledge Agreement.

     (p) The Control Agreement.

     (q) The Mortgagee’s Disclaimer and Consent.

     (r) Current searches of appropriate filing offices showing that (i) no Liens have been filed and remain in effect against the Borrower except Permitted Liens or Liens held by Persons who have agreed in writing that upon receipt of proceeds of the initial Advances, they will satisfy, release or terminate such Liens in a manner satisfactory to the Lender, and (ii) the Lender has duly filed all financing statements necessary to perfect the Security Interest, to the extent the Security Interest is capable of being perfected by filing.

     (s) A certificate of the Borrower’s Secretary or Assistant Secretary certifying that attached to such certificate are (i) the resolutions of the Borrower’s Directors and, if required, Owners, authorizing the execution, delivery and performance of the Loan Documents, (ii) true, correct and complete copies of the Borrower’s Constituent Documents, and (iii) examples of the signatures of the Borrower’s Officers or agents authorized to execute and deliver the Loan Documents and other instruments, agreements and certificates, including Advance requests, on the Borrower’s behalf.

     (t) A current certificate issued by the Secretary of State of Minnesota certifying that the Borrower is in compliance with all applicable organizational requirements of the State of Minnesota.

     (u) Evidence that the Borrower is duly licensed or qualified to transact business in all jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary.

     (v) A certificate of an Officer of the Borrower confirming, in his personal capacity, the representations and warranties set forth in Article V.

     (w) Certificates of the insurance required hereunder, with all hazard insurance containing a lender’s loss payable endorsement in the Lender’s favor and with all liability insurance naming the Lender as an additional insured.

     (x) Payment of all fees due under the terms of this Agreement through the date of the initial Advance, the Term Advance, and payment of all expenses incurred by the Lender through such date and that are required to be paid by the Borrower under this Agreement.

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     (y) Evidence that after making the initial Revolving Advance, satisfying all obligations owed to the Borrower’s prior lender, satisfying all trade payables older than 60 days from invoice date, book overdrafts and closing costs, Availability shall be not less than $1,750,000.

     (z) A Customer Identification Information form and such other forms and verification as the Lender may need to comply with the U.S.A. Patriot Act.

     (aa) With respect to the real estate that is encumbered by the mortgage of the Lender (i) a flood hazard determination form, confirming whether or not the parcel is in a flood hazard area and whether or not flood insurance must be obtained, and, if the real estate is located in a flood hazard area, (ii) a policy of flood insurance.

     (bb) Such other documents as the Lender in its sole discretion may require.

     (cc) The Securities Account shall have been established.

     (dd) A signed Economic Impact Certificate.

     (ee) Payment of all Ex-Im fees.

     (ff) All conditions set forth in Section 4 of the Domestic Agreement shall have been effectively completed (unless such conditions have been waived by the Lender).

     Section 4.2 Conditions Precedent to All Advances. The Lender’s obligation to make each Advance shall be subject to the further conditions precedent that:

     (a) the representations and warranties contained in Article V are correct on and as of the date of such Advance as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date; and

     (b) no event has occurred and is continuing, or would result from such Advance which constitutes a Default or an Event of Default.

ARTICLE V
REPRESENTATIONS AND WARRANTIES

The Borrower represents and warrants to the Lender as follows:

     Section 5.1 Existence and Power; Name; Chief Executive Office; Inventory and Equipment Locations; Federal Employer Identification Number and Organizational Identification Number. The Borrower is a corporation, duly organized, validly existing and in good standing under the laws of the State of Minnesota and is duly licensed or qualified to transact business in all jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary. The Borrower has all requisite power and authority to conduct its business, to own its properties and to execute and deliver, and to perform all of its obligations under, the Loan Documents. During its existence, the Borrower has done business solely under the names set forth in Schedule 5.1. The Borrower’s chief

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executive office and principal place of business is located at the address set forth in Schedule 5.1, and all of the Borrower’s records relating to its business or the Collateral are kept at that location. All Inventory and Equipment is located at that location or at one of the other locations listed in Schedule 5.1. The Borrower’s federal employer identification number and organization identification number are correctly set forth in Section 3.6.

     Section 5.2 Capitalization. Schedule 5.2 constitutes a correct and complete list of all ownership interests of the Borrower and rights to acquire ownership interests including the record holder, number of interests and percentage interests on a fully diluted basis, and an organizational chart showing the ownership structure of all Subsidiaries of the Borrower.

     Section 5.3 Authorization of Borrowing; No Conflict as to Law or Agreements. The execution, delivery and performance by the Borrower of the Loan Documents and the borrowings from time to time hereunder have been duly authorized by all necessary corporate action and do not and will not (i) require any consent or approval of the Borrower’s Owners; (ii) require any authorization, consent or approval by, or registration, declaration or filing with, or notice to, any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, or any third party, except such authorization, consent, approval, registration, declaration, filing or notice as has been obtained, accomplished or given prior to the date hereof; (iii) violate any provision of any law, rule or regulation (including Regulation X of the Board of Governors of the Federal Reserve System) or of any order, writ, injunction or decree presently in effect having applicability to the Borrower or of the Borrower’s Constituent Documents; (iv) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other material agreement, lease or instrument to which the Borrower is a party or by which it or its properties may be bound or affected; or (v) result in, or require, the creation or imposition of any Lien (other than the Security Interest) upon or with respect to any of the properties now owned or hereafter acquired by the Borrower.

     Section 5.4 Legal Agreements. This Agreement constitutes and, upon due execution by the Borrower, the other Loan Documents will constitute the legal, valid and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms.

     Section 5.5 Subsidiaries and Affiliates. Except as set forth in Schedule 5.5 hereto, the Borrower has no Subsidiaries and no Affiliates.

     Section 5.6 Financial Condition; No Adverse Change. The Borrower has furnished to the Lender its audited financial statements for its fiscal year ended September 2, 2006 and unaudited financial statements for the fiscal-year-to-date period ended March 31, 2007, and those statements fairly present the Borrower’s financial condition on the dates thereof and the results of its operations and cash flows for the periods then ended and were prepared in accordance with GAAP. Since the date of the most recent financial statements, there has been no material adverse change in the Borrower’s business, properties or condition (financial or otherwise) which has had a Material Adverse Effect.

     Section 5.7 Litigation. Except as set forth in Schedule 5.7, there are no actions, suits or proceedings pending or, to the Borrower’s knowledge, threatened against or affecting the

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Borrower or any of its Affiliates or the properties of the Borrower or any of its Affiliates before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, which, if determined adversely to the Borrower or any of its Affiliates, would have a material adverse effect on the financial condition, properties or operations of the Borrower or any of its Affiliates.

     Section 5.8 Regulation U. The Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U of the Board of Governors of the Federal Reserve System), and no part of the proceeds of any Advance will be used to purchase or carry any margin stock or to extend credit to others for the purpose of purchasing or carrying any margin stock.

     Section 5.9 Taxes. The Borrower and its Affiliates have paid or caused to be paid to the proper authorities when due all federal, state and local taxes required to be withheld by each of them. The Borrower and its Affiliates have filed all federal, state and local tax returns which to the knowledge of the Officers of the Borrower or any Affiliate, as the case may be, are required to be filed, and the Borrower and its Affiliates have paid or caused to be paid to the respective taxing authorities all taxes as shown on said returns or on any assessment received by any of them to the extent such taxes have become due.

     Section 5.10 Titles and Liens. The Borrower has good and absolute title to all Collateral free and clear of all Liens other than Permitted Liens. No financing statement naming the Borrower as debtor is on file in any office except to perfect only Permitted Liens.

     Section 5.11 Intellectual Property Rights.

          (a) Owned Intellectual Property. Schedule 5.11 is a complete list of all patents, applications for patents, trademarks, applications to register trademarks, service marks, applications to register service marks, mask works, trade dress and copyrights for which the Borrower is the owner of record (the “Owned Intellectual Property”). Except as disclosed on Schedule 5.11, (i) the Borrower owns the Owned Intellectual Property free and clear of all restrictions (including covenants not to sue a third party), court orders, injunctions, decrees, writs or Liens, whether by written agreement or otherwise, (ii) no Person other than the Borrower owns or has been granted any right in the Owned Intellectual Property, (iii) all Owned Intellectual Property is valid, subsisting and enforceable and (iv) the Borrower has taken all commercially reasonable action necessary to maintain and protect the Owned Intellectual Property.

          (b) Agreements with Employees and Contractors. The Borrower has entered into a legally enforceable agreement with each of its employees and subcontractors obligating each such Person to assign to the Borrower, without any additional compensation, any Intellectual Property Rights created, discovered or invented by such Person in the course of such Person’s employment or engagement with the Borrower (except to the extent prohibited by law), and further requiring such Person to cooperate with the Borrower, without any additional compensation, in connection with securing and enforcing any Intellectual Property Rights therein; provided, however, that the foregoing shall not apply with respect to employees and

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subcontractors whose job descriptions are of the type such that no such assignments are reasonably foreseeable.

          (c) Intellectual Property Rights Licensed from Others. Schedule 5.11 is a complete list of all agreements under which the Borrower has licensed Intellectual Property Rights from another Person (“Licensed Intellectual Property”) other than readily available, non-negotiated licenses of computer software and other intellectual property used solely for performing accounting, word processing and similar administrative tasks (“Off-the-shelf Software”) and a summary of any ongoing payments the Borrower is obligated to make with respect thereto. Except as disclosed on Schedule 5.11 and in written agreements, copies of which have been given to the Lender, the Borrower’s licenses to use the Licensed Intellectual Property are free and clear of all restrictions, Liens, court orders, injunctions, decrees, or writs, whether by written agreement or otherwise. Except as disclosed on Schedule 5.11, the Borrower is not obligated or under any liability whatsoever to make any payments of a material nature by way of royalties, fees or otherwise to any owner of, licensor of, or other claimant to, any Intellectual Property Rights.

          (d) Other Intellectual Property Needed for Business. Except for Off-the-shelf Software and as disclosed on Schedule 5.11, the Owned Intellectual Property and the Licensed Intellectual Property constitute all Intellectual Property Rights used or necessary to conduct the Borrower’s business as it is presently conducted or as the Borrower reasonably foresees conducting it.

          (e) Infringement. Except as disclosed on Schedule 5.11, the Borrower has no knowledge of, and has not received any written claim or notice alleging, any Infringement of another Person’s Intellectual Property Rights (including any written claim that the Borrower must license or refrain from using the Intellectual Property Rights of any third party) nor, to the Borrower’s knowledge, is there any threatened claim or any reasonable basis for any such claim.

     Section 5.12 Plans. Except as disclosed to the Lender in writing prior to the date hereof, neither the Borrower nor any ERISA Affiliate (a) maintains or has maintained any Pension Plan, (b) contributes or has contributed to any Multiemployer Plan or (c) provides or has provided post-retirement medical or insurance benefits with respect to employees or former employees (other than benefits required under Section 601 of ERISA, Section 4980B of the IRC or applicable state law). Neither the Borrower nor any ERISA Affiliate has received any notice or has any knowledge to the effect that it is not in full compliance with any of the requirements of ERISA, the IRC or applicable state law with respect to any Plan. No Reportable Event exists in connection with any Pension Plan. Each Plan which is intended to qualify under the IRC is so qualified, and no fact or circumstance exists which may have an adverse effect on the Plan’s tax qualified status. Neither the Borrower nor any ERISA Affiliate has (i) any accumulated funding deficiency (as defined in Section 302 of ERISA and Section 412 of the IRC) under any Plan, whether or not waived, (ii) any liability under Section 4201 or 4243 of ERISA for any withdrawal, partial withdrawal, reorganization or other event under any Multiemployer Plan or (iii) any liability or knowledge of any facts or circumstances which could result in any liability to the Pension Benefit Guaranty Corporation, the Internal Revenue Service, the Department of Labor or any participant in connection with any Plan (other than routine claims for benefits under the Plan).

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     Section 5.13 Default. The Borrower is in compliance with all provisions of all agreements, instruments, decrees and orders to which it is a party or by which it or its property is bound or affected, the breach or default of which could have a Material Adverse Effect on the Borrower’s financial condition, properties or operations.

     Section 5.14 Environmental Matters.

     (a) Except as disclosed on Schedule 5.14, to the best of the Borrower’s knowledge, there are not present in, on or under the Premises any Hazardous Substances in such form or quantity as to create any material liability or obligation for either the Borrower or the Lender under the common law of any jurisdiction or under any Environmental Law, and to the best of the Borrower’s knowledge, no Hazardous Substances have ever been stored, buried, spilled, leaked, discharged, emitted or released in, on or under the Premises in such a way as to create any such material liability.

     (b) Except as disclosed on Schedule 5.14, the Borrower has not disposed of Hazardous Substances in such a manner as to create any material liability under any Environmental Law.

     (c) To the best of the Borrower’s knowledge, and except as disclosed on Schedule 5.14, there are no, (and there have not existed in the past), nor are there any threatened, impending requests, claims, notices, investigations, demands, administrative proceedings, hearings or litigation relating in any way to the Premises or the Borrower, alleging material liability under, violation of, or noncompliance with any Environmental Law or any license, permit or other authorization issued pursuant thereto.

     (d) To the best of the Borrower’s knowledge, and except as disclosed on Schedule 5.14, the Borrower’s businesses are, and to the best of Borrower’s knowledge, have in the past always been, conducted in accordance with all Environmental Laws and all licenses, permits and other authorizations required pursuant to any Environmental Law and necessary for the lawful and efficient operation of such businesses are in the Borrower’s possession and are in full force and effect, nor has the Borrower been denied insurance on grounds related to potential environmental liability. No permit required under any Environmental Law is scheduled to expire within 12 months and there is no threat that any such permit will be withdrawn, terminated, limited or materially changed.

     (e) Except as disclosed on Schedule 5.14, the Premises are not, and to the best of Borrower’s knowledge, have never been listed on the National Priorities List, the Comprehensive Environmental Response, Compensation and Liability Information System or any similar federal, state or local list, schedule, log, inventory or database.

     (f) The Borrower has delivered to the Lender all environmental assessments, audits, reports, permits, licenses and other documents describing or relating in any way to the Premises or the Borrower’s businesses.

     Section 5.15 Submissions to the Lender. All financial and other information provided to the Lender by or on behalf of the Borrower in connection with the Borrower’s request for the credit facilities contemplated hereby (i) is true and correct in all material respects, (ii) does not

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omit any material fact necessary to make such information not misleading and, (iii) as to projections, valuations or proforma financial statements, presents a good faith opinion as to such projections, valuations and proforma condition and results.

     Section 5.16 Financing Statements. The Borrower has authorized the filing of financing statements sufficient when filed to perfect the Security Interest and the other security interests created by the Security Documents. When such financing statements are filed in the offices noted therein, the Lender will have a valid and perfected security interest in all Collateral which is capable of being perfected by filing financing statements. None of the Collateral is or will become a fixture on real estate, unless a sufficient fixture filing is in effect with respect thereto.

     Section 5.17 Rights to Payment. Each right to payment and each instrument, document, chattel paper and other agreement constituting or evidencing Collateral is (or, in the case of all future Collateral, will be when arising or issued) the valid, genuine and legally enforceable obligation, subject to no defense, setoff or counterclaim, of the account debtor or other obligor named therein or in the Borrower’s records pertaining thereto as being obligated to pay such obligation, except ordinary course of business returns and credit memos.

ARTICLE VI
COVENANTS

     So long as the Indebtedness shall remain unpaid, or the Credit Facility shall remain outstanding, the Borrower will comply with the following requirements, unless the Lender shall otherwise consent in writing:

     Section 6.1 Reporting Requirements. The Borrower will deliver, or cause to be delivered, to the Lender each of the following, which shall be in form and detail acceptable to the Lender:

          (a) Annual Financial Statements. As soon as available, and in any event within 120 days after the end of each fiscal year of the Borrower, the Borrower’s audited financial statements with the unqualified opinion of independent certified public accountants selected by the Borrower and acceptable to the Lender, which annual financial statements shall include the Borrower’s balance sheet as at the end of such fiscal year and the related statements of the Borrower’s income, retained earnings and cash flows for the fiscal year then ended, prepared, if the Lender so requests, on a consolidating (unaudited) and consolidated (audited) basis to include any Affiliates, all in reasonable detail and prepared in accordance with GAAP, together with (i) copies of all management letters prepared by such accountants; (ii) a report signed by such accountants stating that in making the investigations necessary for said opinion they obtained no knowledge, except as specifically stated, of any Default or Event of Default and all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrower is in compliance with the Financial Covenants; and (iii) a certificate of the Borrower’s chief financial officer stating that such financial statements have been prepared in accordance with GAAP, fairly represent the Borrower’s financial position and the results of its operations, and whether or not such Officer has knowledge of the occurrence of any Default or Event of Default and, if so, stating in reasonable detail the facts with respect thereto.

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          (b) Monthly Financial Statements. As soon as available and in any event within 20 days after the end of each month, the monthly Borrowing Base Certificate, the unaudited/internal balance sheet and statements of income and retained earnings of the Borrower as at the end of and for such month and for the year to date period then ended, prepared, if the Lender so requests, on a consolidating and consolidated basis to include any Affiliates, in reasonable detail and stating in comparative form the figures for the corresponding date and periods in the previous year, all prepared in accordance with GAAP, subject to year-end audit adjustments and which fairly represent the Borrower’s financial position and the results of its operations; and accompanied by a certificate of the Borrower’s chief financial officer, substantially in the form of Exhibit hereto stating (i) that such financial statements have been prepared in accordance with GAAP, subject to year-end audit adjustments, and fairly represent the Borrower’s financial position and the results of its operations, (ii) whether or not such Officer has knowledge of the occurrence of any Default or Event of Default not theretofore reported and remedied and, if so, stating in reasonable detail the facts with respect thereto, and (iii) all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrower is in compliance with the Financial Covenants.

          (c) Accounts Inventory. Within 15 days after the end of each month, the Borrower shall provide a monthly accounts receivable and accounts payable listing and aging and an inventory report, both of which shall be submitted electronically to the Lender via its vendor Collateral Services Inc. (CSI). Monthly processing fees shall apply to such reporting.

          (d) Collateral Reports. Within 15 days after the end of each month or more frequently if the Lender so requires, the Borrower’s accounts receivable and its accounts payable, a detailed inventory report, an inventory certification report, a calculation of the Borrower’s Accounts, Eligible Export-Related Accounts Receivable, Export-Related Accounts Receivable Value, Inventory, Eligible Export-Related Inventory and Export-Related Value, an Export-Related Borrowing Base Certificate and all Export Reports issued during such month, each as at the end of such month or shorter time period and any additional reports required under the Ex-Im Documents.

          (e) Projections. No later than 30 days before the last day of each fiscal year, the Borrower’s projected balance sheets, income statements, statements of cash flow for each month of the succeeding fiscal year, each in reasonable detail. Such items will be certified by the Officer who is the Borrower’s chief financial officer as being the most accurate projections available and identical to the projections used by the Borrower for internal planning purposes and be delivered with a statement of underlying assumptions and such supporting schedules and information as the Lender may in its discretion require.

          (f) Supplemental Reports. Weekly, or more frequently if the Lender so requires, the Borrower’s “Daily Collateral Reports”, the Export-Related Borrowing Base Certificate, a schedule of Export Orders (as defined in the Borrower Agreement), receivables schedules, and collection reports, as well as such additional reports as the Lender may require.

          (g) Litigation. Immediately after the commencement thereof, notice in writing of all litigation and of all proceedings before any governmental or regulatory agency affecting the

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Borrower (i) of the type described in Section 5.14(c) or (ii) which seek a monetary recovery against the Borrower in excess of $50,000.

          (h) Defaults. When any Officer of the Borrower becomes aware of the probable occurrence of any Default or Event of Default, and no later than 3 days after such Officer becomes aware of such Default or Event of Default, notice of such occurrence, together with a detailed statement by a responsible Officer of the Borrower of the steps being taken by the Borrower to cure the effect thereof.

          (i) Plans. As soon as possible, and in any event within 30 days after the Borrower knows or has reason to know that any Reportable Event with respect to any Pension Plan has occurred, a statement signed by the Officer who is the Borrower’s chief financial officer setting forth details as to such Reportable Event and the action which the Borrower proposes to take with respect thereto, together with a copy of the notice of such Reportable Event to the Pension Benefit Guaranty Corporation. As soon as possible, and in any event within 10 days after the Borrower fails to make any quarterly contribution required with respect to any Pension Plan under Section 412(m) of the IRC, the Borrower will deliver to the Lender a statement signed by the Officer who is the Borrower’s chief financial officer setting forth details as to such failure and the action which the Borrower proposes to take with respect thereto, together with a copy of any notice of such failure required to be provided to the Pension Benefit Guaranty Corporation. As soon as possible, and in any event within ten days after the Borrower knows or has reason to know that it has or is reasonably expected to have any liability under Section 4201 or Section 4243 of ERISA for any withdrawal, partial withdrawal, reorganization or other event under any Multiemployer Plan, the Borrower will deliver to the Lender a statement of the Borrower’s chief financial officer setting forth details as to such liability and the action which the Borrower proposes to take with respect thereto.

          (j) Disputes. Promptly upon knowledge thereof, notice of (i) any disputes or claims by the Borrower’s customers exceeding $10,000 individually or $25,000 in the aggregate during any fiscal year; (ii) credit memos exceeding $10,000 individually or $25,000 in the aggregate during any fiscal year;; and (iii) any goods returned to or recovered by the Borrower exceeding $10,000 individually or $25,000 in the aggregate during any fiscal year and excluding valid warranty work.

          (k) Officers and Directors. Promptly upon knowledge thereof, notice of any change in the persons constituting the Borrower’s Officers and Directors.

          (l) Collateral. Promptly upon knowledge thereof, notice of any material loss of or material damage to any Collateral or of any substantial adverse change in any Collateral or the prospect of payment thereof.

          (m) Commercial Tort Claims. Promptly upon knowledge thereof, notice of any commercial tort claims it may bring against any Person, including the name and address of each defendant, a summary of the facts, an estimate of the Borrower’s damages, copies of any complaint or demand letter submitted by the Borrower, and such other information as the Lender may request.

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          (n) Intellectual Property.

     (i) 30 days prior written notice of Borrower’s intent to acquire material Intellectual Property Rights; except for transfers permitted under Section 6.17, the Borrower will give the Lender 30 days prior written notice of its intent to dispose of material Intellectual Property Rights and upon request shall provide the Lender with copies of all proposed documents and agreements concerning such rights.

     (ii) Promptly upon knowledge thereof, notice of (A) any Infringement of its Intellectual Property Rights by others, (B) claims that the Borrower is Infringing another Person’s Intellectual Property Rights and (C) any threatened cancellation, termination or material limitation of its Intellectual Property Rights.

     (iii) Promptly upon receipt, copies of all registrations and filings with respect to its Intellectual Property Rights.

          (o) Reports to Owners. Promptly upon their distribution, copies of all financial statements, reports and proxy statements which the Borrower shall have sent to its Owners.

          (p) SEC Filings. Promptly after the sending or filing thereof, copies of all regular and periodic reports which the Borrower shall file with the Securities and Exchange Commission or any national securities exchange.

          (q) Tax Returns of the Borrower. As soon as possible, and in any event no later than five days after they are due to be filed or after any statutory extension, copies of the state and federal income tax returns and all schedules thereto of the Borrower.

          (r) Violations of Law. Promptly upon knowledge thereof, notice of the Borrower’s violation of any law, rule or regulation, the non-compliance with which could materially and adversely affect the financial condition, properties or operations of the Borrower.

          (s) Other Reports. From time to time, with reasonable promptness, any and all receivables schedules, inventory reports, collection reports, deposit records, equipment schedules, copies of invoices to account debtors, shipment documents and delivery receipts for goods sold, and such other material, reports, records or information as the Lender may request.

     Section 6.2 Financial Covenants.

          (a) Minimum Earnings Before Taxes. The Borrower will achieve Earnings Before Taxes each period defined below of not less than the amount set forth for each such period below:

	Period to Date Pretax
Period	Profit
April, 2007	$	(875,000	)
April through May, 2007	$	(1,325,000	)
April through June, 2007	$	(1,575,000	)

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	Period to Date Pretax
Period	Profit
April through July, 2007	$	(1,725,000	)
April through August, 2007	$	(1,775,000	)
Fiscal Year 2008 through:
September, 2007	$	0
October, 2007	$	0
November, 2007	$	300,000
December, 2007	$	400,000
January, 2008	$	500,000
February, 2008	$	600,000

          (b) Minimum Debt Service Coverage Ratio. The Borrower will maintain, as of each year end, a Debt Service Coverage Ratio of not less than 1.1 to 1.0., during each fiscal year ending described below:

	Minimum Debt Service
Period	Coverage Ratio
Through August, 2008	1.1 to 1.00
Through August, 2009	1.1 to 1.00
Through August, 2010	1.1 to 1.00

          (c) Capital Expenditures. The Borrower will not incur or contract to incur Capital Expenditures of more than $500,000 nor more than $100,000 unfinanced Capital Expenditures, in the aggregate during any fiscal year and for the period from April to August, 2007. The Lender and the Borrower will review the Capital Expenditures limits after the first quarter of Fiscal Year 2008 to determine whether an amendment is appropriate.

     Section 6.3 Permitted Liens; Financing Statements.

     (a) The Borrower will not create, incur or suffer to exist any Lien upon or of any of its assets, now owned or hereafter acquired, to secure any indebtedness; excluding, however, from the operation of the foregoing, the following (each a “Permitted Lien”; collectively, “Permitted Liens”):

     (i) In the case of any of the Borrower’s property which is not Collateral, covenants, restrictions, rights, easements and minor irregularities in title which do not materially interfere with the Borrower’s business or operations as presently conducted;

     (ii) Liens in existence on the date hereof and listed in Schedule 6.3 hereto, securing indebtedness for borrowed money permitted under this Agreement;

     (iii) The Security Interest and Liens created by the Security Documents; and

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     (iv) Purchase money Liens relating to the acquisition of machinery and equipment of the Borrower not exceeding the lesser of cost or fair market value thereof so long as no Default Period is then in existence and none would exist immediately after such acquisition.

     (b) The Borrower will not amend any financing statements in favor of the Lender except as permitted by law. Any authorization by the Lender to any Person to amend financing statements in favor of the Lender shall be in writing.

     Section 6.4 Indebtedness. The Borrower will not incur, create, assume or permit to exist any indebtedness or liability on account of deposits or advances or any indebtedness for borrowed money or letters of credit issued on the Borrower’s behalf, or any other indebtedness or liability evidenced by notes, bonds, debentures or similar obligations, except:

     (a) Any existing or future Indebtedness or any other obligations of the Borrower to the Lender;

     (b) Any indebtedness of the Borrower in existence on the date hereof and listed in Schedule 6.4 hereto; and

     (c) Any indebtedness relating to Permitted Liens.

     Section 6.5 Guaranties. The Borrower will not assume, guarantee, endorse or otherwise become directly or contingently liable in connection with any obligations of any other Person, except:

     (a) The endorsement of negotiable instruments by the Borrower for deposit or collection or similar transactions in the ordinary course of business; and

     (b) Guaranties, endorsements and other direct or contingent liabilities in connection with the obligations of other Persons, in existence on the date hereof and listed in Schedule 6.5 hereto.

     Section 6.6 Investments and Subsidiaries. The Borrower will not make or permit to exist any loans or advances to, or make any investment or acquire any interest whatsoever in, any other Person or Affiliate, including any partnership or joint venture, nor purchase or hold beneficially any stock or other securities or evidence of indebtedness of any other Person or Affiliate, except:

     (a) Investments in direct obligations of the United States of America or any agency or instrumentality thereof whose obligations constitute full faith and credit obligations of the United States of America having a maturity of one year or less, commercial paper issued by U.S. corporations rated “A 1” or “A 2” by Standard & Poor’s Ratings Services or “P 1” or “P 2” by Moody’s Investors Service or certificates of deposit or bankers’ acceptances having a maturity of one year or less issued by members of the Federal Reserve System having deposits in excess of $100,000,000 (which certificates of deposit or bankers’ acceptances are fully insured by the Federal Deposit Insurance Corporation);

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     (b) Travel advances or loans to the Borrower’s Officers and employees not exceeding at any one time an aggregate of $50,000;

     (c) Prepaid rent not exceeding one month or security deposits; and

     (d) Current investments in the Subsidiaries in existence on the date hereof and listed in Schedule 5.5 hereto.

     Section 6.7 Dividends and Distributions. Borrower will not declare or pay any dividends (other than dividends payable solely in stock of the Borrower) on any class of its stock, or make any payment on account of the purchase, redemption or other retirement of any shares of such stock, or other securities or evidence of its indebtedness or make any distribution in respect thereof, either directly or indirectly.

     Section 6.8 Salaries. The Borrower will not pay excessive or unreasonable salaries, bonuses, commissions, consultant fees or other compensation; or increase the salary, bonus, commissions, consultant fees or other compensation of any Director, Officer or consultant, or any member of their families, by more than ten percent (10%) in any one year, either individually or for all such persons in the aggregate, or pay any such increase from any source other than profits earned in the year of payment.

     Section 6.9 Books and Records; Collateral Examination, Inspection and Appraisals.

     (a) The Borrower will keep accurate books of record and account for itself pertaining to the Collateral and pertaining to the Borrower’s business and financial condition and such other matters as the Lender may from time to time request in which true and complete entries will be made in accordance with GAAP and, upon the Lender’s request, will permit any officer, employee, attorney, accountant or other agent of the Lender to audit, review, make extracts from or copy any and all company and financial books and records of the Borrower at all times during ordinary business hours, and to discuss the Borrower’s affairs with any of its Directors, Officers, employees or agents.

     (b) The Borrower hereby irrevocably authorizes all accountants and third parties to disclose and deliver to the Lender or its designated agent, at the Borrower’s expense, all financial information, books and records, work papers, management reports and other information in their possession regarding the Borrower.

     (c) The Borrower will permit the Lender or its employees, accountants, attorneys or agents, to examine and inspect any Collateral or any other property of the Borrower at any time during ordinary business hours.

     (d) The Lender may also, from time to time, obtain at the Borrower’s expense an appraisal of Collateral by an appraiser acceptable to the Lender in its sole discretion. The Lender agrees that it will limit the cost of such to one appraisal per year so long as the Borrower is not in default.

     Section 6.10 Account Verification.

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     (a) The Lender or its agent may at any time and from time to time send or require the Borrower to send requests for verification of accounts or notices of assignment to account debtors and other obligors. The Lender or its agent may also at any time and from time to time telephone account debtors and other obligors to verify accounts.

     (b) The Borrower shall pay when due each account payable due to a Person holding a Permitted Lien (as a result of such payable) on any Collateral.

     Section 6.11 Compliance with Laws.

     (a) The Borrower shall (i) comply with the requirements of applicable laws and regulations, the non compliance with which would materially and adversely affect its business or its financial condition and (ii) use and keep the Collateral, and require that others use and keep the Collateral, only for lawful purposes, without violation of any federal, state or local law, statute or ordinance.

     (b) Without limiting the foregoing undertakings, the Borrower specifically agrees that it will comply with all applicable Environmental Laws and obtain and comply with all permits, licenses and similar approvals required by any Environmental Laws, and will not generate, use, transport, treat, store or dispose of any Hazardous Substances in such a manner as to create any material liability or obligation under the common law of any jurisdiction or any Environmental Law.

     (c) The Borrower shall (i) not use or permit the use of the proceeds of the Credit Facility or any other financial accommodation from the Lender to violate any of the foreign asset control regulations of the Office of Foreign Assets Control, (“OFAC”) or other applicable law, (ii) comply with all applicable Bank Secrecy Act laws and regulations, as amended from time to time, and (iii) otherwise comply with the USA Patriot Act as required by federal law and the Lender’s policies and practices.

     Section 6.12 Payment of Taxes and Other Claims. The Borrower will pay or discharge, when due, (a) all taxes, assessments and governmental charges levied or imposed upon it or upon its income or profits, upon any properties belonging to it (including the Collateral) or upon or against the creation, perfection or continuance of the Security Interest, prior to the date on which penalties attach thereto, (b) all federal, state and local taxes required to be withheld by it, and (c) all lawful claims for labor, materials and supplies which, if unpaid, might by law become a Lien upon any properties of the Borrower; provided, that the Borrower shall not be required to pay any such tax, assessment, charge or claim whose amount, applicability or validity is being contested in good faith by appropriate proceedings and for which proper reserves have been made.

     Section 6.13 Maintenance of Properties.

     (a) The Borrower will keep and maintain the Collateral and all of its other properties necessary or useful in its business in good condition, repair and working order (normal wear and tear excepted) and will from time to time replace or repair any worn, defective or broken parts; provided, however, that nothing in this covenant shall prevent the Borrower from discontinuing the operation and maintenance of any of its properties if

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such discontinuance is, in the Borrower’s judgment, desirable in the conduct of the Borrower’s business and not disadvantageous in any material respect to the Lender. The Borrower will take all commercially reasonable steps necessary to protect and maintain its Intellectual Property Rights.

     (b) The Borrower will defend the Collateral against all Liens, claims or demands of all Persons (other than the Lender) claiming the Collateral or any interest therein. The Borrower will keep all Collateral free and clear of all Liens except Permitted Liens. The Borrower will take all commercially reasonable steps necessary to prosecute any Person Infringing its Intellectual Property Rights and to defend itself against any Person accusing it of Infringing any Person’s Intellectual Property Rights.

     Section 6.14 Insurance. The Borrower will obtain and at all times maintain insurance with insurers acceptable to the Lender, in such amounts, on such terms (including any deductibles) and against such risks as may from time to time be required by the Lender, but in all events in such amounts and against such risks as is usually carried by companies engaged in similar business and owning similar properties in the same general areas in which the Borrower operates. Without limiting the generality of the foregoing, the Borrower will at all times maintain business interruption insurance including coverage for force majeure and keep all tangible Collateral insured against risks of fire (including so-called extended coverage), theft, collision (for Collateral consisting of motor vehicles) and such other risks and in such amounts as the Lender may reasonably request, with any loss payable to the Lender to the extent of its interest, and all policies of such insurance shall contain a lender’s loss payable endorsement for the Lender’s benefit. All policies of liability insurance required hereunder shall name the Lender as an additional insured.

     Section 6.15 Preservation of Existence. The Borrower will preserve and maintain its existence and all of its rights, privileges and franchises necessary or desirable in the normal conduct of its business and shall conduct its business in an orderly, efficient and regular manner.

     Section 6.16 Delivery of Instruments, etc. Upon request by the Lender, the Borrower will promptly deliver to the Lender in pledge all instruments, documents and chattel paper constituting Collateral, duly endorsed or assigned by the Borrower.

     Section 6.17 Sale or Transfer of Assets; Suspension of Business Operations. The Borrower will not without prior written consent of the Lender sell, lease, assign, transfer or otherwise dispose of (i) the stock of any Subsidiary, (ii) all or a substantial part of its assets, or (iii) any Collateral or any interest therein (whether in one transaction or in a series of transactions) to any other Person other than the sale of Inventory in the ordinary course of business and will not liquidate, dissolve or suspend business operations. The Borrower will not transfer any part of its ownership interest in any Intellectual Property Rights and will not permit any agreement under which it has licensed Licensed Intellectual Property to lapse, except that the Borrower may transfer such rights or permit such agreements to lapse if it shall have reasonably determined that the applicable Intellectual Property Rights are no longer useful in its business. If the Borrower transfers any Intellectual Property Rights for value, the Borrower will pay over the proceeds to the Lender for application to the Indebtedness. The Borrower will not license any other Person to use any of the Borrower’s Intellectual Property Rights, except that the Borrower

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may grant licenses in the ordinary course of its business in connection with sales of Inventory or provision of services to its customers.

     Section 6.18 Consolidation and Merger; Asset Acquisitions. The Borrower will not consolidate with or merge into any Person, or permit any other Person to merge into it, or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the assets of any other Person.

     Section 6.19 Sale and Leaseback. The Borrower will not without the prior written consent of the Lender enter into any arrangement, directly or indirectly, with any other Person whereby the Borrower shall sell or transfer any real or personal property, whether now owned or hereafter acquired, and then or thereafter rent or lease as lessee such property or any part thereof or any other property which the Borrower intends to use for substantially the same purpose or purposes as the property being sold or transferred.

     Section 6.20 Restrictions on Nature of Business. The Borrower will not engage in any line of business materially different from that presently engaged in by the Borrower and will not purchase, lease or otherwise acquire assets not related to its business.

     Section 6.21 Accounting. The Borrower will not adopt any material change in accounting principles other than as required by GAAP without prior written consent of the Lender. The Borrower will not adopt, permit or consent to any change in its fiscal year.

     Section 6.22 Discounts, etc. After notice from the Lender, the Borrower will not grant any discount, credit or allowance to any customer of the Borrower or accept any return of goods sold. Except in the ordinary course of business, and after written notice to Lender, the Borrower will not at any time modify, amend, subordinate, cancel or terminate the obligation of any account debtor or other obligor of the Borrower.

     Section 6.23 Plans. Except as disclosed to the Lender in writing prior to the date hereof, neither the Borrower nor any ERISA Affiliate will (i) adopt, create, assume or become a party to any Pension Plan, (ii) incur any obligation to contribute to any Multiemployer Plan, (iii) incur any obligation to provide post-retirement medical or insurance benefits with respect to employees or former employees (other than benefits required by law) or (iv) amend any Plan in a manner that would materially increase its funding obligations.

     Section 6.24 Place of Business; Name. The Borrower will not transfer its chief executive office or principal place of business, or move, relocate, close or sell any business location. The Borrower will not permit any tangible Collateral or any records pertaining to the Collateral to be located in any state or area in which, in the event of such location, a financing statement covering such Collateral would be required to be, but has not in fact been, filed in order to perfect the Security Interest. The Borrower will not change its name or jurisdiction of organization.

     Section 6.25 Constituent Documents; S Corporation Status. The Borrower will not amend its Constituent Documents.

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     Section 6.26 Performance by the Lender. If the Borrower at any time fails to perform or observe any of the foregoing covenants contained in this Article VI or elsewhere herein, and if such failure shall continue for a period of ten calendar days after the Lender gives the Borrower written notice thereof (or in the case of the agreements contained in Section 6.12 and Section 6.14, immediately upon the occurrence of such failure, without notice or lapse of time), the Lender may, but need not, perform or observe such covenant on behalf and in the name, place and stead of the Borrower (or, at the Lender’s option, in the Lender’s name) and may, but need not, take any and all other actions which the Lender may reasonably deem necessary to cure or correct such failure (including the payment of taxes, the satisfaction of Liens, the performance of obligations owed to account debtors or other obligors, the procurement and maintenance of insurance, the execution of assignments, security agreements and financing statements, and the endorsement of instruments); and the Borrower shall thereupon pay to the Lender on demand the amount of all monies expended and all costs and expenses (including reasonable attorneys’ fees and legal expenses) incurred by the Lender in connection with or as a result of the performance or observance of such agreements or the taking of such action by the Lender, together with interest thereon from the date expended or incurred at the Default Rate. To facilitate the Lender’s performance or observance of such covenants of the Borrower, the Borrower hereby irrevocably appoints the Lender, or the Lender’s delegate, acting alone, as the Borrower’s attorney in fact (which appointment is coupled with an interest) with the right (but not the duty) from time to time to create, prepare, complete, execute, deliver, endorse or file in the name and on behalf of the Borrower any and all instruments, documents, assignments, security agreements, financing statements, applications for insurance and other agreements and writings required to be obtained, executed, delivered or endorsed by the Borrower hereunder.

     Section 6.27 Credit Facility Subject to Ex-Im Bank Rules. The Borrower acknowledges that the Lender is willing to make the Credit Facility available to the Borrower because Ex-Im Bank is willing to guaranty payment of a significant portion of the Obligations pursuant to the master Guarantee Agreement. Accordingly, in the event of any inconsistency among the Loan Documents and the Guarantee Agreement or related documents, the provision that is the more stringent on the Borrower shall control.

ARTICLE VII
EVENTS OF DEFAULT, RIGHTS AND REMEDIES

     Section 7.1 Events of Default. “Event of Default”, wherever used herein, means any one of the following events:

     (a) Default in the payment of any Note or any default with respect to any other Indebtedness due from the Borrower to the Lender as such Indebtedness becomes due and payable;

     (b) Default in the performance, or breach, of any covenant or agreement of the Borrower contained in this Agreement;

     (c) An Overadvance arises as the result of any reduction in the Borrowing Base, or arises in any manner on terms not otherwise approved of in advance by the Lender in writing;

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     (d) Any Financial Covenant shall become inapplicable due to the lapse of time and the failure of the Lender and the Borrower to come to an agreement to amend any such covenant to cover future periods that is acceptable to the Lender in the Lender’s sole discretion;

     (e) The Borrower or any Guarantor shall be or become insolvent, or admit in writing its or his inability to pay its or his debts as they mature, or make an assignment for the benefit of creditors; or the Borrower or any Guarantor shall apply for or consent to the appointment of any receiver, trustee, or similar officer for it or him or for all or any substantial part of its or his property; or such receiver, trustee or similar officer shall be appointed without the application or consent of the Borrower or such Guarantor, as the case may be; or the Borrower or any Guarantor shall institute (by petition, application, answer, consent or otherwise) any bankruptcy, insolvency, reorganization, arrangement, readjustment of debt, dissolution, liquidation or similar proceeding relating to it or him under the laws of any jurisdiction; or any such proceeding shall be instituted (by petition, application or otherwise) against the Borrower or any such Guarantor; or any judgment, writ, warrant of attachment or execution or similar process shall be issued or levied against a substantial part of the property of the Borrower or any Guarantor;

     (f) A petition shall be filed by or against the Borrower or any Guarantor under the United States Bankruptcy Code or the laws of any other jurisdiction naming the Borrower or such Guarantor as debtor;

     (g) Any representation or warranty made by the Borrower in this Agreement, by any Guarantor in any Guaranty delivered to the Lender, or by the Borrower (or any of its Officers) or any Guarantor in any agreement, certificate, instrument or financial statement or other statement contemplated by or made or delivered pursuant to or in connection with this Agreement or any such Guaranty shall be incorrect in any material respect;

     (h) The rendering against the Borrower of an arbitration award, a final judgment, decree or order for the payment of money in excess of $50,000 and the continuance of such arbitration award, judgment, decree or order unsatisfied and in effect for any period of 30 consecutive days without a stay of execution;

     (i) A default under any bond, debenture, note or other evidence of material indebtedness of the Borrower owed to any Person other than the Lender, or under any indenture or other instrument under which any such evidence of indebtedness has been issued or by which it is governed, or under any material lease or other contract, and the expiration of the applicable period of grace, if any, specified in such evidence of indebtedness, indenture, other instrument, lease or contract;

     (j) Any Reportable Event, which the Lender determines in good faith might constitute grounds for the termination of any Pension Plan or for the appointment by the appropriate United States District Court of a trustee to administer any Pension Plan, shall have occurred and be continuing 30 days after written notice to such effect shall have been given to the Borrower by the Lender; or a trustee shall have been appointed by an

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appropriate United States District Court to administer any Pension Plan; or the Pension Benefit Guaranty Corporation shall have instituted proceedings to terminate any Pension Plan or to appoint a trustee to administer any Pension Plan; or the Borrower or any ERISA Affiliate shall have filed for a distress termination of any Pension Plan under Title IV of ERISA; or the Borrower or any ERISA Affiliate shall have failed to make any quarterly contribution required with respect to any Pension Plan under Section 412(m) of the IRC, which the Lender determines in good faith may by itself, or in combination with any such failures that the Lender may determine are likely to occur in the future, result in the imposition of a Lien on the Borrower’s assets in favor of the Pension Plan; or any withdrawal, partial withdrawal, reorganization or other event occurs with respect to a Multiemployer Plan which results or could reasonably be expected to result in a material liability of the Borrower to the Multiemployer Plan under Title IV of ERISA;

     (k) An event of default shall occur under any Security Document;

     (l) Default in the payment of any amount owed by the Borrower to the Lender other than any Indebtedness arising hereunder;

     (m) Any breach, default or event of default shall occur under the Borrower Agreement or any Domestic Document or any event described in Section 2.11 of the Borrower Agreement.

     (n) The Borrower shall take or participate in any action which would be prohibited under the provisions of any Subordination Agreement or make any payment with respect to indebtedness that has been subordinated pursuant to any Subordination Agreement;

     (o) The Borrower shall fail to employ both a Chief Executive Officer and a Chief Financial Officer which is, in each case, acceptable to the Lender in its sole discretion within 60 days of such cessation;

     (p) The Lender believes in good faith that the prospect of payment in full of any part of the Indebtedness or that full performance by the Borrower under the Loan Documents, is impaired, or that there has occurred any material adverse change in the business or financial condition of the Borrower;

     (q) There has occurred any breach, default or event of default by, or attributable to, any Affiliate under any agreement between the Affiliate and the Lender; or

     (r) The indictment of any Director, Officer, or any Owner of at least twenty percent (20%) of the issued and outstanding common stock of the Borrower for a felony offence under state or federal law.

     (s) Any Guarantor shall repudiate or purport to revoke its, his or her Guaranty, or any Guaranty for any reason shall cease to be in full force and effect as to the Guarantor executing or delivering the same or shall be judicially declared null and void as to such Guarantor.

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     (t) Thomas F. Leahy should at any time cease to be the Chairman of the Board of Directors of the Borrower.

     Section 7.2 Rights and Remedies. During any Default Period, the Lender may exercise any or all of the following rights and remedies:

     (a) The Lender may, by notice to the Borrower, declare the Commitment to be terminated, whereupon the same shall forthwith terminate;

     (b) The Lender may, by notice to the Borrower, declare the Indebtedness to be forthwith due and payable, whereupon all Indebtedness shall become and be forthwith due and payable, without presentment, notice of dishonor, protest or further notice of any kind, all of which the Borrower hereby expressly waives;

     (c) The Lender may, without notice to the Borrower and without further action, apply any and all money owing by the Lender to the Borrower to the payment of the Indebtedness;

     (d) The Lender may exercise and enforce any and all rights and remedies available upon default to a secured party under the UCC, including the right to take possession of Collateral, or any evidence thereof, proceeding without judicial process or by judicial process (without a prior hearing or notice thereof, which the Borrower hereby expressly waives) and the right to sell, lease or otherwise dispose of any or all of the Collateral (with or without giving any warranties as to the Collateral, title to the Collateral or similar warranties), and, in connection therewith, the Borrower will on demand assemble the Collateral and make it available to the Lender at a place to be designated by the Lender which is reasonably convenient to both parties;

     (e) The Lender may exercise and enforce its rights and remedies under the Loan Documents;

     (f) The Lender may without regard to any waste, adequacy of the security or solvency of the Borrower, apply for the appointment of a receiver of the Collateral, to which appointment the Borrower hereby consents, whether or not foreclosure proceedings have been commenced under the Security Documents and whether or not a foreclosure sale has occurred; and

     (g) The Lender may exercise any other rights and remedies available to it by law or agreement.

     Notwithstanding the foregoing, upon the occurrence of an Event of Default described in Section 7.1(e) or (f), the Indebtedness shall be immediately due and payable automatically without presentment, demand, protest or notice of any kind. If the Lender sells any of the Collateral on credit, the Indebtedness will be reduced only to the extent of payments actually received. If the purchaser fails to pay for the Collateral, the Lender may resell the Collateral and shall apply any proceeds actually received to the Indebtedness.

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     Section 7.3 Certain Notices. If notice to the Borrower of any intended disposition of Collateral or any other intended action is required by law in a particular instance, such notice shall be deemed commercially reasonable if given (in the manner specified in Section 8.3) at least ten calendar days before the date of intended disposition or other action.

ARTICLE VIII
MISCELLANEOUS

     Section 8.1 No Waiver; Cumulative Remedies; Compliance with Laws. No failure or delay by the Lender in exercising any right, power or remedy under the Loan Documents or the Domestic Documents shall operate as a waiver thereof; nor shall any single or partial exercise of any such right, power or remedy preclude any other or further exercise thereof or the exercise of any other right, power or remedy under the Loan Documents or the Domestic Documents. The remedies provided in the Loan Documents or the Domestic Documents are cumulative and not exclusive of any remedies provided by law. The Lender may comply with any applicable state or federal law requirements in connection with a disposition of the Collateral and such compliance will not be considered adversely to affect the commercial reasonableness of any sale of the Collateral.

     Section 8.2 Amendments, Etc. No amendment, modification, termination or waiver of any provision of any Loan Document or consent to any departure by the Borrower therefrom or any release of a Security Interest shall be effective unless the same shall be in writing and signed by the Lender, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No notice to or demand on the Borrower in any case shall entitle the Borrower to any other or further notice or demand in similar or other circumstances.

     Section 8.3 Notices; Communication of Confidential Information; Requests for Accounting. Except as otherwise expressly provided herein, all notices, requests, demands and other communications provided for under the Loan Documents shall be in writing and shall be (a) personally delivered, (b) sent by first class United States mail, (c) sent by overnight courier of national reputation, (d) transmitted by telecopy, or (e) sent as electronic mail, in each case delivered or sent to the party to whom notice is being given to the business address, telecopier number, or e mail address set forth below next to its signature or, as to each party, at such other business address, telecopier number, or e mail address as it may hereafter designate in writing to the other party pursuant to the terms of this Section. All such notices, requests, demands and other communications shall be deemed to be an authenticated record communicated or given on (a) the date received if personally delivered, (b) when deposited in the mail if delivered by mail, (c) the date delivered to the courier if delivered by overnight courier, or (d) the date of transmission if sent by telecopy or by e mail, except that notices or requests delivered to the Lender pursuant to any of the provisions of Article II shall not be effective until received by the Lender. All notices, financial information, or other business records sent by either party to this Agreement may be transmitted, sent, or otherwise communicated via such medium as the sending party may deem appropriate and commercially reasonable; provided, however, that the risk that the confidentiality or privacy of such notices, financial information, or other business records sent by either party may be compromised shall be borne exclusively by the Borrower. All requests for an accounting under Section 9-210 of the UCC (i) shall be made in a writing

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signed by a Person authorized under Section 2.2(a), (ii) shall be personally delivered, sent by registered or certified mail, return receipt requested, or by overnight courier of national reputation, (iii) shall be deemed to be sent when received by the Lender and (iv) shall otherwise comply with the requirements of Section 9-210 of the UCC. The Borrower requests that the Lender respond to all such requests which on their face appear to come from an authorized individual and releases the Lender from any liability for so responding. The Borrower shall pay the Lender the maximum amount allowed by law for responding to such requests.

     Section 8.4 Further Documents. The Borrower will from time to time execute, deliver, endorse and authorize the filing of any and all instruments, documents, conveyances, assignments, security agreements, financing statements, control agreements and other agreements and writings that the Lender may reasonably request in order to secure, protect, perfect or enforce the Security Interest or the Lender’s rights under the Loan Documents (but any failure to request or assure that the Borrower executes, delivers, endorses or authorizes the filing of any such item shall not affect or impair the validity, sufficiency or enforceability of the Loan Documents and the Security Interest, regardless of whether any such item was or was not executed, delivered or endorsed in a similar context or on a prior occasion).

     Section 8.5 Costs and Expenses. The Borrower shall pay on demand all costs and expenses, including reasonable attorneys’ fees, incurred by the Lender in connection with the Indebtedness, this Agreement, the Loan Documents, any Domestic Document or agreement related hereto or thereto, and the transactions contemplated hereby, including all such costs, expenses and fees incurred in connection with the negotiation, preparation, execution, amendment, administration, performance, collection and enforcement of the Indebtedness and all such documents and agreements and the creation, perfection, protection, satisfaction, foreclosure or enforcement of the Security Interest.

     Section 8.6 Indemnity. In addition to the payment of expenses pursuant to Section 8.5, the Borrower shall indemnify, defend and hold harmless the Lender, and any of its participants, parent corporations, subsidiary corporations, affiliated corporations, successor corporations, and all present and future officers, directors, employees, attorneys and agents of the foregoing (the “Indemnitees”) from and against any of the following (collectively, “Indemnified Liabilities”):

     (i) Any and all transfer taxes, documentary taxes, assessments or charges made by any governmental authority by reason of the execution and delivery of the Loan Documents or the making of the Advances;

     (ii) Any claims, loss or damage to which any Indemnitee may be subjected if any representation or warranty contained in Section 5.14 proves to be incorrect in any respect or as a result of any violation of the covenant contained in Section 6.11(b); and

     (iii) Any and all other liabilities, losses, damages, penalties, judgments, suits, claims, costs and expenses of any kind or nature whatsoever (including the reasonable fees and disbursements of counsel) in connection with the foregoing and any other investigative, administrative or judicial proceedings, whether or not

42

such Indemnitee shall be designated a party thereto, which may be imposed on, incurred by or asserted against any such Indemnitee, in any manner related to or arising out of or in connection with the making of the Advances and the Loan Documents or the use or intended use of the proceeds of the Advances.

     If any investigative, judicial or administrative proceeding arising from any of the foregoing is brought against any Indemnitee, upon such Indemnitee’s request, the Borrower, or counsel designated by the Borrower and satisfactory to the Indemnitee, will resist and defend such action, suit or proceeding to the extent and in the manner directed by the Indemnitee, at the Borrower’s sole costs and expense. Each Indemnitee will use its best efforts to cooperate in the defense of any such action, suit or proceeding. If the foregoing undertaking to indemnify, defend and hold harmless may be held to be unenforceable because it violates any law or public policy, the Borrower shall nevertheless make the maximum contribution to the payment and satisfaction of each of the Indemnified Liabilities which is permissible under applicable law. The Borrower’s obligations under this Section 8.6 shall survive the termination of this Agreement and the discharge of the Borrower’s other obligations hereunder.

     Section 8.7 Participants. The Lender and its participants, if any, are not partners or joint venturers, and the Lender shall not have any liability or responsibility for any obligation, act or omission of any of its participants. All rights and powers specifically conferred upon the Lender may be transferred or delegated to any of the Lender’s participants, successors or assigns.

     Section 8.8 Execution in Counterparts; Telefacsimile Execution. This Agreement and other Loan Documents may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same instrument. Delivery of an executed counterpart of this Agreement or any other Loan Document by telefacsimile or other electronic means shall be equally as effective as delivery of an original executed counterpart of this Agreement or such other Loan Document. Any party delivering an executed counterpart of this Agreement or any other Loan Document by telefacsimile or other electronic means also shall deliver an original executed counterpart of this Agreement or such other Loan Document but the failure to deliver an original executed counterpart shall not affect the validity, enforceability, and binding effect of this Agreement or such other Loan Document.

     Section 8.9 Retention of the Borrower’s Records. The Lender shall have no obligation to maintain any electronic records or any documents, schedules, invoices, agings, or other papers delivered to the Lender by the Borrower or in connection with the Loan Documents for more than 30 days after receipt by the Lender. If there is a special need to retain specific records, the Borrower must inform the Lender of its need to retain those records with particularity, which must be delivered in accordance with the notice provisions of Section 8.3 within 30 days of the Lender taking control of same.

     Section 8.10 Binding Effect; Assignment; Complete Agreement; Sharing Information. The Loan Documents shall be binding upon and inure to the benefit of the Borrower and the Lender and their respective successors and assigns, except that the Borrower shall not have the right to assign its rights thereunder or any interest therein without the Lender’s prior written consent. To the extent permitted by law, the Borrower waives and will not assert against any

43

assignee any claims, defenses or set-offs which the Borrower could assert against the Lender. This Agreement shall also bind all Persons who become a party to this Agreement as a borrower. This Agreement, together with the Loan Documents, comprises the complete and integrated agreement of the parties on the subject matter hereof and supersedes all prior agreements, written or oral, on the subject matter hereof. To the extent that any provision of this Agreement contradicts other provisions of the Loan Documents, this Agreement shall control. Without limiting the Lender’s right to share information regarding the Borrower and its Affiliates with the Lender’s participants, accountants, lawyers and other advisors, the Lender may share any and all information they may have in their possession regarding the Borrower and its Affiliates, and the Borrower waives any right of confidentiality it may have with respect to such sharing of information. The Borrower acknowledges that the Lender is willing to make the Credit Facility available to the Borrower because Ex-Im Bank is willing to guaranty payment of a significant portion of the Obligations pursuant to the Master Guarantee Agreement. Accordingly, in the event of any inconsistency among the Loan Documents and the Master Guarantee Agreement, or related documents, the provision that is the more stringent on the Borrower shall control. This Agreement and the loans evidenced by the Revolving Notes are sub loans under the Domestic Agreement and are not meant to provide additional credit above the Maximum Line Amount defined therein.

     Section 8.11 Severability of Provisions. Any provision of this Agreement which is prohibited or unenforceable shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof. To the extent that any of the terms of this Agreement conflict with the Borrower Agreement or any of the documents executed in connection with the guaranty by Ex-Im Bank, the terms which are more restrictive to the Borrower shall control.

     Section 8.12 Headings. Article, Section and subsection headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose.

     Section 8.13 Governing Law; Jurisdiction, Venue; Waiver of Jury Trial. The Loan Documents shall be governed by and construed in accordance with the substantive laws (other than conflict laws) of the State of Minnesota. The parties hereto hereby (i) consent to the personal jurisdiction of the state and federal courts located in the State of Minnesota in connection with any controversy related to this Agreement; (ii) waive any argument that venue in any such forum is not convenient; (iii) agree that any litigation initiated by the Lender or the Borrower in connection with this Agreement or the other Loan Documents may be venued in either the state or federal courts located in Minneapolis, Hennepin County, Minnesota; and (iv) agree that a final judgment in any such suit, action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law.

     Section 8.14 Attorneys’ Fees. References in the Loan Documents to fees and expenses of attorneys or counsel shall include all such fees and expenses, whether incurred at the trial or appellate level, in an arbitration or administrative proceeding, in bankruptcy (including, without limitation, any adversary proceeding, contested matter or motion) or otherwise incurred.

[The remainder of this page intentionally left blank.]

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     THE BORROWER AND THE LENDER WAIVE ANY RIGHT TO TRIAL BY JURY IN ANY ACTION AT LAW OR IN EQUITY OR IN ANY OTHER PROCEEDING BASED ON OR PERTAINING TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT.

     Borrower’s Initials /s/ MT                    ;            Lender’s Initials /s/ MG                      .

     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 above written.

HEI, INC.	HEI, INC.
1439 Steiger Lake Lane
Victoria, MN 55386
Telecopier: (952) 443-2668	By:	/s/ Mark Thomas
Attention: Mark Thomas	Name: Mark Thomas
e-mail: Mark.Thomas@heii.com	Its: Chief Executive Officer
Wells Fargo Bank, National Association,	WELLS FARGO BANK, NATIONAL
Wells Fargo Business Credit	ASSOCIATION
MAC N9312-040
Sixth and Marquette
Minneapolis, Minnesota 55479
Telecopier: (612) 673-8589	By:	/s/ Michael L. Guillou
Attention: Michael L. Guillou	Name: Michael L. Guillou
e-mail: Michael.l.guillou@wellsfargo.com	Its: Relationship Manager
GUARANTOR:
736 Widsten Circle
Wayzata, MN 55391
Telecopier:	/s/ Thomas F. Leahy
e-mail:	Thomas F. Leahy

[Signature page to Credit and Security Agreement for the Export-Import Bank]

Table of Exhibits and Schedules

Exhibit A	Form of Revolving Note
Exhibit B	Compliance Certificate
Exhibit C	Premises
Exhibit D	Export-Related Borrowing Base Certificate
Schedule 5.1	Trade Names, Chief Executive Office, Principal Place of Business, and Locations of Collateral
Schedule 5.2	Capitalization and Organizational Chart
Schedule 5.5	Subsidiaries
Schedule 5.7	Litigation Matters
Schedule 5.11	Intellectual Property Disclosures
Schedule 5.14	Environmental Matters
Schedule 6.3	Permitted Liens
Schedule 6.4	Permitted Indebtedness
Schedule 6.5	Guaranties

Exhibit A to Credit and Security Agreement

REVOLVING NOTE

$2,700,000.00/$300,000.00 April ___, 2007

     For value received, the undersigned, HEI, Inc., a Minnesota corporation (the “Borrower”), hereby promises to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION (the “Lender”), acting through its Wells Fargo Business Credit operating division, on the Termination Date referenced in the Credit and Security Agreement dated the same date as this Revolving Note that was entered into by the Lender and the Borrower (as amended from time to time, the “Credit Agreement”), at the Lender’s office located at Minneapolis, Minnesota, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Two Million Seven hundred Thousand/Three Hundred Thousand Dollars ($2,700,000.00/$300,000.00) or the aggregate unpaid principal amount of all Revolving Advances made by the Lender to the Borrower under the Credit Agreement, together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Revolving Note is fully paid at the rate from time to time in effect under the Credit Agreement.

     This Revolving Note is the Revolving Note referenced in the Credit Agreement and is subject to the terms of the Credit Agreement, which provides, among other things, for acceleration hereof. Principal and interest due hereunder shall be payable as provided in the Credit Agreement, and this Revolving Note may be prepaid only in accordance with the terms of the Credit Agreement. This Revolving Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements.

     The Borrower shall pay all costs of collection, including reasonable attorneys’ fees and legal expenses if this Revolving Note is not paid when due, whether or not legal proceedings are commenced.

     Presentment or other demand for payment, notice of dishonor and protest are expressly waived.

HEI, INC.

By:

Name: Mark Thomas

Its: Chief Executive Officer and Chief Financial Officer

A-1

Exhibit B to Credit and Security Agreement

COMPLIANCE CERTIFICATE

To: Wells Fargo Bank, National Association

Attn: Michael L. Guillou

Date:                     , 200___

Subject: Financial Statements

     In accordance with our Credit and Security Agreement dated as of [___] (as amended from time to time, the “Credit Agreement”), attached are the financial statements of                      (the “Borrower”) as of and for                     , 200___(the “Reporting Date”) and the year-to-date period then ended (the “Current Financials”). All terms used in this certificate have the meanings given in the Credit Agreement.

     I certify that the Current Financials have been prepared in accordance with GAAP, subject to year-end audit adjustments, and fairly present the Borrower’s financial condition as of the date thereof.

     I further hereby certify as follows: Events of Default. (Check one):

o The undersigned does not have knowledge of the occurrence of a Default or Event of Default under the Credit Agreement except as previously reported in writing to the Lender.

o The undersigned has knowledge of the occurrence of a Default or Event of Default under the Credit Agreement not previously reported in writing to the Lender and attached hereto is a statement of the facts with respect to thereto. The Borrower acknowledges that pursuant to Section 2.3(c) of the Credit Agreement, the Lender may impose the Default Rate at any time during the resulting Default Period.

     Material Adverse Change in Litigation Matters of the Borrower. I further hereby certify as follows (check one):

o The undersigned has no knowledge of any material adverse change to the litigation exposure of the Borrower or any of its Affiliates or of any Guarantor.

o The undersigned has knowledge of material adverse changes to the litigation exposure of the Borrower or any of its Affiliates or of any Guarantor not previously disclosed in Schedule 5.7. Attached to this Certificate is a statement of the facts with respect thereto.

Financial Covenants. I further hereby certify as follows (check and complete each of the following):

B-1

     1. Minimum Earnings Before Taxes. Pursuant to Section 6.2(a) of the Credit Agreement, the Borrower’s Earnings Before Taxes for the [                    ] period ending on the Reporting Date, was $                    , which o satisfies o does not satisfy the requirement that such amount be not less than                     :

	Minimum Earnings Before
Period	Taxes
April, 2007	$	(875,000	)
April through May, 2007	$	(1,325,000	)
April through June, 2007	$	(1,575,000	)
April through July, 2007	$	(1,725,000	)
April through August, 2007	$	(1,775,000	)
Fiscal Year 2008 through:
September, 2007	$	0
October, 2007	$	0
November, 2007	$	300,000
December, 2007	$	400,000
January, 2008	$	500,000
February, 2008	$	600,000

     2. Minimum Debt Service Coverage Ratio. Pursuant to Section 6.2(b) of the Credit Agreement, as of the Reporting Date, the Borrower’s Debt Service Coverage Ratio was [___] to 1.00, whicho satisfieso does not satisfy the requirement that such ratio be no less than the applicable ratio set forth in the table below on the Reporting Date:

	Minimum Debt Service
Period	Coverage Ratio
Through August, 2008	1.1 to 1.00
Through August, 2009	1.1 to 1.00
Through August, 2010	1.1 to 1.00

     3. Capital Expenditures. Pursuant to Section 6.2(c) of the Credit Agreement, for the year-to-date period ending on the Reporting Date, the Borrower has expended or contracted to expend during the reporting period ended                     , 200___, for Capital Expenditures, $                     in the aggregate and at most $                     for any nonfinanced Capital Expenditures, which o satisfies o does not satisfy the requirement that such expenditures not exceed $500,000 in the aggregate and $100,000 for any nonfinanced Capital Expenditure during such year.

     4. Salaries. As of the Reporting Date, the Borrower has not paid excessive or unreasonable salaries, bonuses, commissions, consultant fees or other compensation, or increased the salary, bonus, commissions, consultant fees or other compensation of any Director, Officer or consultant, or any member of their families, by more than ten percent (10%) over the amount

B-2

paid in the Borrower’s previous fiscal year, either individually or for all such persons in the aggregate, and has not paid any increase from any source other than profits earned in the year of payment, and as a consequence o is o is not in compliance with Section 6.8 of the Credit Agreement.

Attached hereto are all relevant facts in reasonable detail to evidence, and the computations of the financial covenants referred to above. These computations were made in accordance with GAAP.

By:

Name:

Its: Chief Financial Officer

B-3

Exhibit C to Credit and Security Agreement

PREMISES

The Premises referred to in the Credit and Security Agreement are legally described as follows:

Victoria Location – 1495 Steiger Lake Lane, Victoria, MN 55386, Legal description – Lot 2, Block 1, Point Victoria, situated in Carver County, Minnesota

Chanhassen Location – 1546 Lake Drive West, Chanhassen, MN 55317

Boulder Location – 4801 North 63^rd Street, Boulder, CO 80301
Tempe Location – 610 South Rockford Drive, Tempe, AZ 85281

C-1

Schedule 5.1 to Credit and Security Agreement

TRADE NAMES, CHIEF EXECUTIVE OFFICE, PRINCIPAL PLACE OF BUSINESS,
AND LOCATIONS OF COLLATERAL
TRADE NAMES

HEI, Inc., Microelectronics Operations (Victoria), Advanced Medical Operations (Boulder), High Density Interconnect Operations (Tempe) and RFID Operations (Chanhassen)

CHIEF EXECUTIVE OFFICE/PRINCIPAL PLACE OF BUSINESS

1495 Steiger Lake Lane, Victoria, MN 55386

OTHER INVENTORY AND EQUIPMENT LOCATIONS

Chanhassen Location – 1546 Lake Drive West, Chanhassen, MN 55317
Boulder Location – 4801 North 63^rd Street, Boulder, CO 80301
Tempe Location – 610 South Rockford Drive, Tempe, AZ 85281

S. 5-1.1

Schedule 5.2 to Credit and Security Agreement

CAPITALIZATION AND ORGANIZATIONAL CHART
For Holders of more than 5% of outstanding stock on date of Closing.

		No. of shares (after
		exercise of all rights		Percent interest on a
Holder	Type of Rights/Stock	to acquire shares)		fully diluted basis
Thomas F. Leahy	Common and Preferred Stock		1,128,054		11.8	%
Minneapolis Portfolio
Management Group LLC	Common Stock		905,246		9.5	%
Perkins Capital
Management, Inc.	Common Stock		748,350		7.8	%

HEI, Inc. has one subsidiary, Cross Technology, Inc. that is 100% owned by HEI, Inc.

S-5.2.1

Schedule 5.5 to Credit and Security Agreement

SUBSIDIARIES

HEI, Inc. has one subsidiary, Cross Technology, Inc. that is 100% owned by HEI, Inc.

S-5.5-1

Schedule 5.7 to Credit and Security Agreement

LITIGATION MATTERS

HEI, Inc. is not involved in any litigation at the time of this signing and has not received notice of any threatened litigation as of this signing

S-5.7-1

Schedule 5.11 to Credit and Security Agreement

INTELLECTUAL PROPERTY DISCLOSURES

See attached

S-5.11-1

(Patents, Trademarks, and Copyrights)

Patents

Docket No.	Title	Serial/Patent No.	Status
14605.113	Information Technology System for Health Care Environments (fka Information Technology System that is Suitable for Medical Applications)	10/161, 168 (formerly Provisions #60/295,181)	B — Pending
10139.007-CA-01	Document Reading Apparatus	1,245,765	A — Issued
10139-0008-CA-01	Photo-Optic Transducing Head Assembly	1,265,547	A — Issued
10139.0016-US-01	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	6,646,521	A — Issued
10139.0016-TA-01	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	194018	A — Issued
10139.0016-EP-WO	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	1,968,674	B — Pending
10139.0016-JP-WO	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	2527567	B — Pending
10139.0016-KS-WO	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	37003802	B — Pending
10139.0016-MY-01	Method of Mount DC Block Capacitor for Microwave Circuit and packaging	14267	B — Pending
10139.0016-TH-01	Method of Mount DC Block Capacitor for Microwave Circuit and Packaging	68354	B — Pending
10139.0017-US-01	Interconnection Device and Method	6,294,966	A — Issued
10139.0017-US-C1	Interconnection Device and Method	6,469,592	A — Issued
10139.0017-TA-01	Interconnection Device and Method	156859	A — Issued
10139.0017-CC-WO	Interconnection Device and Method	8186499	B — Pending
10139.0017-EP-WO	Interconnection Device and Method	986661.7	B — Pending
10139.0017-IN-WO	Interconnection Device and Method	2702	B — Pending
10139.0017-JP-WO	Interconnection Device and Method	1550811	B — Pending
10139.0017-KS-WO	Interconnection Device and Method	27008541	B — Pending
10139.0017-MY-01	Interconnection Device and Method	6125	B — Pending
10139.0017-PH-01	Interconnection Device and Method	10003580	B — Pending
101039.0017-TH-01	Interconnection Device and Method	62789	B — Pending
10139.0017-US-C2	interconnection Device and Method	10/228,587	B — Pending
10139.0022-US-01	Integrated Mem Switch	10/014,987	B — Pending
10139.0022-US-D1	Low Voltage Mem Switch	10/409,742	B — Pending
10139.0027-TA-01	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Devices	189906	A — Issued
10139.0027-CC-WO	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Devices	18149812	A — Issued

B-2

Docket No.	Title	Serial/Patent No.	Status
10139.0027-EP-WO	Test Methods, Systems, and Probes for high-Frequency Wireless Communications Devices	1959300.3	B — Pending
10139.0027-IN-WO	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Devices	10503	B — Pending
10139.0027-JP-WO	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Device	2516659	B — Pending
10139.0027-US-C1	Test Methods, Systems, and Probes for High-Frequency Wireless Communications Device	09/725,646	B -Pending
10139.0031-US-01	Flexible Circuit Board having an Integrally Formed Battery	10/789,108	B — Pending
116.002US1	EDGE TERMINALS FOR ELECTRONIC CIRCUIT MODULES	08/542896	A — Issued
116.002CA1	EDGE TERMINALS FOR ELECTRONIC CIRCUIT MODULES	2187582	B — Pending
116.006US1	HIGH DENSITY STACKED CIRCUIT MODULE	09/050318	A — Issued
116.006CA1	HIGH DENSITY STACKED CIRCUIT MODULE	2266980	B — Pending
116.010US1	HEARING-AID ASSEMBLY USING FOLDED FLEX CIRCUITS	09/792700	A — Issued
116.010US2	HEARING-AID ASSEMBLY USING FOLDED FLEX CIRCUITS	10/752414	B — Pending
116.012US1	STRUCTURES AND ASSEMBLY METHODS FOR RADIO-FREQUENCY-IDENTIFICATION MODULES	09/922245	A — Issued
116.012TH1	STRUCTURES AND ASSEMBLY METHODS FOR RADIO-FREQUENCY-IDENTIFICATION MODULES AND METHODS	67473	B — Pending
116.012US2	STRUCTURES AND ASSEMBLY METHODS FOR RADIO-FREQUENCY-IDENTIFICATION MODULES	10/785928	B — Pending
116.015CA1	CODELOCK Design	547638	B — Pending
14605-125P (provisions)	Collaboration Among Health Care Instruments	60/384,902 (provisional) 10/453,442 (utility)	B — Pending
50611-292864 (Utility)
	Driving and Clamping Power Regulation Technique for Continuous, In-Phase, Full-Duration, Switch-Mode Resonant Converter Power Supply	5,267,138	A — Issued
	System and Method for Coupling a Plurality of Medical Devices in a Serverless Grid		B — Pending

Trademarks

Trademark name	Trademark Number	Reference #
Lin iT	76/518,141	File No. 50611-292862
OneSource OutSource	2569474	14605.096
FRESH AIR	75/830,817	14605.09
ID-iT	76/518,124	50611.2930219999
GridView	78/510068	40424.4US01

B-3

Schedule 5.14 to Credit and Security Agreement

ENVIRONMENTAL MATTERS

HEI, Inc. has received a No Further Action Required letter from the State of Colorado regarding its Boulder location and is not aware of any other environmental issues relating to any of the other listed properties as of this signing.

S-5.14-1

Schedule 6.3 to Credit and Security Agreement

PERMITTED LIENS

HEI, Inc.
Permited Liens
As of 05-01-07

Valid UCC Filings:

File Date	File No.	Type	Description if needed	Additional Information	Status
5/21/2003	20037526134	UCC-1		Beacon Bank	To be released with the SBA Revolver Payoff at Closing
10/15/2003	2003909557	AMEND	Amendment of 20037526134	Beacon Bank	To be released with the SBA Revolver Payoff at Closing
7/21/2003	20038148897	UCC-1		US Bancorp	Active Operating Lease
6/8/2004	200412104045	UCC-1		CNC Associates Inc	Active Operating Lease
12/14/2004	200414358590	UCC-1		Commerce Financial Group	To be released with Tempe Equipment Lease Payoff at Closing
3/10/2005	200515537094	UCC-1		Lease Finance Group	Active Capital Lease
9/12/2005	20051793347	ASSIGN	Assingment of 200515537094	First Minnetonka City Bank	Active Capital Lease
4/7/2005	200515938368	UCC-1		Lease Finance Group	Active Capital Lease
9/12/2005	20051793426	AMEND	Expaned Collateral Description of 200515938368	Lease Finance Group	Active Capital Lease
9/12/2005	20051793433	ASSIGN	Assingment of 200515938368	First Minnetonka City Bank	Active Capital Lease
4/7/2005	200515938673	UCC-1		Lease Finance Group	Active Capital Lease
8/16/2005	200517630189	UCC-1		Lease Finance Group	Active Capital Lease
9/19/2005	20051802403	AMEND	Expaned Collateral Description of 2005176030189	Lease Finance Group	Active Capital Lease
9/23/2005	20051810670	AMEND	Addition of Secured Party of 2005176030189	Kevin Roberg	Active Capital Lease
8/16/2005	200517630468	UCC-1		Lease Finance Group	Active Capital Lease
12/21/2005	20051922206	AMEND	Expaned Collateral Description of 200517630468	Lease Finance Group	Active Capital Lease
12/21/2005	20051922224	AMEND	Addition of Secured Party of 200517630468	Kevin Robert	Active Capital Lease
12/21/2005	20051922236	AMEND	Correction of Secured Party of 200517630468	Kevin Roberg	Active Capital Lease
8/16/2005	200517630711	UCC-1		Lease Finance Group	Active Capital Lease
11/29/2005	20051892061	AMEND	Addition of Secured Party of 200517630711	Kevin Roberg	Active Capital Lease
11/29/2005	20051892084	AMEND	Expaned Collateral Description of 200517630711	Kevin Roberg	Active Capital Lease
12/30/2005	200519347755	UCC-1		Farnam Street Financial Inc	Active Operating Lease
1/17/2006	200610221439	UCC-1	This is now a Commerce Financial Capital Lease, but no filling was made by Commerce	Orbotech Inc	Not filed by Commerce Financial when they paid off Orbotech and look over the lease – Active Capital Lease
1/30/2006	200610390897	UCC-1		Lease Finance Group	Lease taken over by Allegiant and not refiled – Active Capital Lease
3/20/2006	200611076803	UCC-1	Believed to be the same as filed for under 200610390897	Lease Finance Group	Believed to be the same as filed for under 200610390897
3/28/2006	200611204728	UCC-1		Key Equipment Finance Inc	Active Operating Lease
7/3/2006	200612598015	UCC-1		Telogy, Inc.	Active Operating Lease
8/1/2006	200612953559	UCC-1		Telogy, Inc.	Active Operating Lease
9/1/2006	200613366278	UCC-1		Telogy, Inc.	Active Operating Lease
Invalid UCC Filings:
11/2/1998	2080454	UCC-1		Norwest Equipment Finance Inc	No Balance Due at 05-01-07 – Needs to be released
9/8/2003	2003866929	CONT		Norwest Equipment Finance Inc	No Balance Due at 05-01-07 – Needs to be released
12/11/1998	2090125	UCC-1		Norwest Equipment Finance Inc	No Balance Due at 05-01-07 – Needs to be released
9/19/2003	2003880308	CONT		Norwest Equipment Finance Inc	No Balance Due at 05-01-07 – Needs to be released
6/2/2003	20037625319	UCC-1		Luther & Maelzer Inc	No Balance Due at 05-01-07 – Needs to be released
12/22/2005	200519252218	UCC-1		Orbotech Inc	Not believed to be active – no balance is shown on our records

S-6.3-1

Schedule 6.4 to Credit and Security Agreement

PERMITTED INDEBTEDNESS

HEI Inc
Schedule of Permitted Indebtedness
Capital Leases and Mortgage
Balances as of March 31, 2007

Creditor

Name

Original Amount

Security

PMY Res

Location

Origination Date

Last Pymt Date

Monthly Payment

Balance 03-31-07

1

Lease Finance Group

LFG 5 CNC Associates

22,926.73

LFG 5

Victoria

3/15/2005

3/15/2008

564.51

14,142.71

2

Lease Finance Group

My Data

212,150.00

Mydata my Hydra speedmount

LFG 5

Victoria

3/15/2005

3/15/2008

7,910.00

105,812.64

3

Lease Finance Group

Ekra

183,165.68

EKRA x5 in line screen printer, Ekra x5 inline screen printer

LFG 5

Victoria

3/15/2005

7/1/2008

6,829.32

91,358.02

4

Lease Finance Group

Sikama

28,154.30

Sikama Falseen S/c Solder Rodow Furance

LFG 2

Victoria

9/5/2005

9/5/2008

1,119.04

11,843.19

5

Lease Finance Group

CyberOptics

120,600.00

CyberOptics DEMO SE 300 inspection system

LFG 4

Victoria

10/1/2005

10/1/2008

4,170.53

64,643.36

6

Lease Finance Group

K&S

21,990.00

Kulcke & Soffa Model 4524 Bad Bonder

LFG 1

Victoria

12/1/2005

12/1/2008

760.45

12,968.45

7

Lease Finance Group

Nu Clean

82,400.00

Technical Devices Nu/Clean 31Bxf

LFG 3

Victoria

2/1/2006

2/1/2009

2,849.51

52,905.40

8

HMP Allegiant

Allegiant Partn HMP_AL

Infinity 2-2c 2.0 megapixel CCD Camera

Victoria

5/1/2006

2/23/2009

880.42

17,368.96

9

OGP Allegiant

OGP_AL

OGP Flash 300 Digital Coord measur system & HMP Infinity 2.0 Megapixesl CCD Camera

Victoria

3/1/2006

3/1/2009

1,782.83

38,014.34

10

Commerce Financial

CF_01Orbotech

875,000.00

Orbotech paragon 8000 imaging system

87,500

Tempe

2/15/2006

2/15/2009

21,272.00

689,127.97

11

Commerce Financial

CF_02Datacon

295,730.00

Datacon 2200 Malti-Chip Die Bonder

29,573

Victoria

3/15/2006

3/15/2009

8,612.00

232,544.08

12

Commerce Financial

CF_03Hirox

52,851.00

HIROX Microscope System & TechCut 4 Prec Saw & Polshing System

5,285

Victoria

5/15/2006

5/15/2009

1,547.00

41,961.51

13

Commerce Financial

CF_04MicroCraft

257,250.00

MicroCraft EMX-6151 Moving Probe Tester

25,725

Tempe

5/15/2006

5/15/2009

6,406.00

215,919.83

14

Commerce Financial

CF_05ESI

355,608.00

Two ESI Mdl 5200 UV YagLaser Dells

35,561

Tempe

4/15/2006

4/15/2009

10,036.00

285,434.01

15

Commerce Financial

CF_06Asymtek

112,625.00

Asymtek Spectrum S-820 Batch Disperser

11,263

Victoria

6/15/2006

6/15/2009

3,296.00

91,157.66

16

Key Leasing

Key - Cubes

62,848.00

Tempe

3/6/2006

3/6/2009

1,822.94

43,058.19

17

Pitney Bowes

Copier Lease-Boulder

33,610.51

Toshiba Copier

Boulder

681.50

15,068.33

18

Commerce Bank

Building Mortgage

1,200,000.00

Corporate Office & Vic Plant Lot 2. Block 1, Point Victoria

$100,000.00

Victoria

10/14/2003

11/1/2009

8,318.68

1,110,686.14

HEI Inc
Schedule of Permitted Indebtedness
Operating Leases
Balances as of March 31, 2007

Account

Start

Ending

Name

Item

Location

Number

Date

Date

Deposit

Payment

Building Rent Monk Properties

1546 Lake Drive West

Chanhassen

6,591.67

12,971.00

Boulder Dev. Corp.

4801 N. 63rd Drive

Boulder

230,000.00

120,222.00

Reynolds Property

610 S Rockford Drive

Tempe

7,260.00

7,582.85

Cutler Commercial

326 South Siesta Lane

Tempe office

3,000.00

2,614.34

Equipment Farnam Street Financial — CTS

Claraview & ClearCube

Tempe

HE122205-001

8/1/2006

2,184.32

Key Leases

Orbotech Discovery

Tempe

3/6/2006

3/6/2009

6,906.39

Mobile Mini

40’ Cargo & DLX Tri Doors

Monthly

145.94

Pitney Bowes Global Financial

Mailing scale A57z

Quarterly

185.31

Pitney Bowes Global Financial

Mailing System

Quarterly

1,166.18

CNC Associates, Inc.

HAAS Tool room mill

Chanhassen

20361001

6/4/2004

6/4/2009

564.51

Computer Equipment Toshiba Business Solutions

Boulder Copier

Boulder

39120896

5/31/2002

6/4/2007

845.68

Hewlett-Packard Financial Services

50020650-01

10/11/2004

140.22

Hewlett-Packard Financial Services

5002064C-001

534.08

US Bank

8/1/2007

759.64

Pitney Bowes INC

DLCQ Copier

812.35

LFG — Marlin Leasing Corporation

HP Compaq Notebook

001-0295999-001

725.24

LFG — Marlin Leasing Corporation

Computer System

001-0295999-002

785.65

DeLage Landen

Misc Equipment

Victoria, Tempe & Boulder

24705927

2,272.69

DeLage Landen

Boulder Copiers

534057

737.10

Miscellaneous DeLage Laden

Forklift

Chanhassen

270266-476532

11/4/2004

11/4/2009

292.27

S-6.4-1

HEI Inc
Schedule of Commitments & Contingencies (Operating Leases)
Telogy

			Account		Start		Ending
Name	Item	Location	Number		Date		Date		Payment
Leases
1 Telogy	KEI 2410			501428		6/7/2006		6/7/2007		1,028.00
2 Telogy	KEI2510AT			503485		11/3/2006		11/3/2007		448.00
3 Telogy	KEI 2001			507431		11/6/2006		11/6/2007		282.00
Rental — Month to Month
4 Telogy	Various Equipment			487478		10/19/2005				476.00
5 Telogy	KEI (6485)			515172		2/5/2007				100.00

S-6.4-2

Schedule 6.5 to Credit and Security Agreement

GUARANTIES

None

S-5.14-1

EX-31.1

EXHIBIT 31.1

CERTIFICATION PURSUANT TO

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Mark B. Thomas, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q 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. I am 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 I have:

a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me 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 my conclusions about the effectiveness of the disclosure controls and procedures, as of the end 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. I have disclosed, based on my 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/ Mark B. Thomas  

Mark B. Thomas 

Chief Executive Officer and Chief Financial Officer 

Date: July 16, 2007

24

EX-32.1

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 Quarterly Report of HEI, Inc. (the “Company”) on Form 10-Q for the quarter ended June 2, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Mark B. Thomas, Chief Executive Officer and 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/ Mark B. Thomas  

Mark B. Thomas 

Chief Executive Officer and Chief Financial Officer 

Date: July 16, 2007

A signed original of this written statement required by Section 906 has been provided to HEI, Inc. and will be retained by HEI, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

25