-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DHKWMt/LxOotX8jExKLwtpL8N3KCPuC8yiIbakAJUIFle6vO24k16Lg70CArp1mf s9Ulh6Pts2/rz4RQEVfxGg== 0001047469-97-006391.txt : 19971202 0001047469-97-006391.hdr.sgml : 19971202 ACCESSION NUMBER: 0001047469-97-006391 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19970831 FILED AS OF DATE: 19971201 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HEI INC CENTRAL INDEX KEY: 0000351298 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 410944876 STATE OF INCORPORATION: MN FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-10078 FILM NUMBER: 97730539 BUSINESS ADDRESS: STREET 1: 1495 STEIGER LAKE LN STREET 2: P O BOX 5000 CITY: VICTORIA STATE: MN ZIP: 55386 BUSINESS PHONE: 6124432500 MAIL ADDRESS: STREET 1: P O BOX 5000 STREET 2: 1495 STEIGER LAKE LANE CITY: VICTORIA STATE: MN ZIP: 55386 10KSB 1 10-KSB SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 **** FORM 10-KSB **** [X] Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for fiscal year ended August 31, 1997. [ ] Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from _________ to ______. Commission File Number 0-10078 HEI, INC. ----------------- (Name of Small Business Issuer in Its Charter) Minnesota 41-0944876 - --------- ---------- (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) P.O. Box 5000, 1495 Steiger Lake Lane, Victoria, MN 55386 - --------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Issuer's telephone number, including area code: (612)443-2500 -------------- Securities registered pursuant to Section 12(b) of the Exchange Act: None ---- Securities registered pursuant to Section 12(g) of the Exchange Act: COMMON STOCK, PAR VALUE $.05 PER SHARE --------------------------------------- (Title of Class) RIGHTS TO PURCHASE COMMON STOCK -------------------------------- (Title of Class) Indicate by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . ---- ---- Indicate if no disclosure of delinquent filers in response to Item 405 of Regulation S-B is contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB. [ ] HEI, Inc. revenues for the fiscal year ended August 31, 1997 were $30,962,000. The aggregate market value as of November 1, 1997 (based on the closing price as reported by The Nasdaq National Market) of the voting stock held by non-affiliates was approximately $18,000,000. As of November 21, 1997, 4,068,576 Common Shares (par value $.05) were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Shareholders for the fiscal year ended August 31, 1997 are incorporated by reference into Parts I and II. Portions of the Proxy Statement for Registrant's Annual Meeting of Shareholders to be held January 21, 1998 are incorporated by reference in Part III. HEI, Inc. is referred to herein as the Company, unless the context indicates otherwise. PART I ITEM 1. DESCRIPTION OF BUSINESS (a) BUSINESS DEVELOPMENT HEI, Inc., a Minnesota corporation, was incorporated as Hybrid Electronics Inc. in 1968 and changed its name to HEI, Inc. in 1969. (b) BUSINESS OF THE COMPANY PRINCIPAL PRODUCTS AND SERVICES - HEI, Inc. is a designer and manufacturer of ultraminiature microelectronic devices and high technology products incorporating these devices. HEI's custom-built microelectronics are employed in medical, industrial and computer markets. The optical switch product line and light pen product line, which represented minor parts of the Company's sales, were sold in August 1997 and August 1996, respectively. DISTRIBUTION METHODS - HEI sells through its Company-employed sales force based at corporate headquarters. SOURCES AND AVAILABILITY OF RAW MATERIALS - There are many sources of raw material supplies available nationally and internationally for Company operations. The manufacture of Company products involves assembly of components purchased from a wide variety of vendors. The Company's business is not dependent on any single supplier. DEPENDENCE ON SINGLE OR FEW CUSTOMERS - Following is the approximate percentage of the Company's sales to major customers which accounted for more than 10% of total sales in fiscal years 1997, 1996 and 1995. Customer 1997 1996 1995 -------- ---- ---- ---- Customer A 55% 16% Customer B 27% 38% 12% Customer C 10% Customer D 30% Customer E 27% -2- COMPETITION - In each of its product lines, the Company has significant competition, including users who may produce their own alternative devices. The Company obtains new business by identifying customer needs and engineering its products to meet those needs. It competes on the basis of engineering expertise, quality, service and price to obtain new and repeat orders. RESEARCH AND DEVELOPMENT - The estimated amount spent on Company-sponsored research and development activities was approximately $843,000 and $849,000 for the years ended August 31, 1997 and 1996. EMPLOYEES - At August 31, 1997, the Company employed approximately 120 persons of which 2 were part-time. ITEM 2. DESCRIPTION OF PROPERTY The Company owns a 48,000 square foot facility for administration and production in Victoria, Minnesota, which was completed in August 1981. The facility was expanded during fiscal 1996 from the original 25,000 square feet with an addition of 23,000 square feet to increase production capacity. Due to the sale of the optical switch business in August 1997, the Company no longer leases a facility in Sauk Centre, Minnesota. ITEM 3. LEGAL PROCEEDINGS There are no legal proceedings pending against the Company or its properties. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS None. -3- PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information called for by Item 5 is incorporated by reference from the Annual Report on page 20. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS The information called for by Item 6 is incorporated by reference from the Annual Report on pages 4-8. ITEM 7. FINANCIAL STATEMENTS The information called for by Item 7 is incorporated by reference from the Annual Report on pages 9-18 as follows: Page in Annual Report: -------------- Balance Sheet as of August 31, 1997 and 1996 9 Statement of Operations for the Years Ended August 31, 1997, 1996 and 1995 10 Statement of Changes in Shareholders' Equity for the Years Ended August 31, 1997, 1996 and 1995 11 Statement of Cash Flows for the Years Ended August 31, 1997, 1996 and 1995 12 Notes to Financial Statements 13-17 Report of Independent Accountants 18 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. -4- PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT The information regarding directors called for by Item 9 is contained in the Proxy Statement under the caption "Election of Directors." The following is a list of HEI, Inc. executive officers, their ages, positions and offices as of November 1, 1997. NAME AGE POSITION - ---- --- -------- Eugene W. Courtney 61 President, Chief Executive Officer Jerald H. Mortenson 63 Vice President of Finance and Administration, Chief Financial Officer and Treasurer Dale A. Nordquist 43 Vice President of Sales and Marketing BUSINESS EXPERIENCE EUGENE W. COURTNEY became President and Chief Executive Officer of the Company in June 1990. He had served as Executive Vice President and Operating Officer since August 1988 and has served as a Director since 1989. From 1980 to 1988, Mr. Courtney served as Vice President and Group Vice President of National Computer Systems. JERALD H. MORTENSON joined the Company in March 1990. Prior thereto he had spent ten years with CTS Fabri-tek, first as Chief Financial Officer and the last five years as Group President. DALE A. NORDQUIST joined the Company on July 16, 1981 as Western Regional Manager. In December 1986, he was appointed Vice President of Sales. ITEM 10. EXECUTIVE COMPENSATION The information called for by Item 10 is contained in the Proxy Statement under the captions "Executive Compensation" and "Proposal No. 1 Election of Directors." ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information called for by Item 11 is incorporated in the Proxy Statement under the caption "Shares and Principal Shareholders." ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: See Exhibit Index on Page 7 (b) Reports on Form 8-K: No reports on Form 8-K were filed during the fourth quarter of the fiscal year ended August 31, 1997. -5- SIGNATURES In accordance with Section 13 or 15(c) of the Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized HEI, Inc. BY: /s/ Eugene W. Courtney ------------------------------------------ Eugene W. Courtney, President and Chief Executive Officer Date: November 24, 1997 In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ Eugene W. Courtney November 24, 1997 - ----------------------------------------------- ----------------- Eugene W. Courtney, Director Date /s/ Jerald H. Mortenson - ----------------------------------------------- Jerald H. Mortenson, Vice President of Finance and Administration, Chief Financial Officer and November 24, 1997 Treasurer ----------------- Date /s/ Craig E. Roble November 24, 1997 - ----------------------------------------------- ----------------- Craig E. Roble, Company Controller Date /s/ Robert L. Brueck November 24, 1997 - ----------------------------------------------- ----------------- Robert L. Brueck, Director Date /s/ William R. Franta November 24, 1997 - ----------------------------------------------- ----------------- William R. Franta, Director Date /s/ Kenneth A. Schoen November 24, 1997 - ----------------------------------------------- ----------------- Kenneth A. Schoen, Director Date /s/ Frederick M Zimmerman November 24, 1997 - ----------------------------------------------- ----------------- Frederick M Zimmerman, Director Date -6- EXHIBIT INDEX
Page Number or Exhibit Number Description Incorporated by - -------------- ----------- Reference --------- 3.1 Restated Articles of Incorporation, as amended. Note 1 *3.2 Bylaws, as amended. 4.1 Rights Agreement dated May 27, 1988 between HEI, Inc. and Norwest Note 2 Bank Minnesota, N.A., as amended. 4.2a Credit Agreement with Norwest Bank Minnesota, N.A. dated April 1, 1996. Note 3 4.2b Current Note and Security Agreement with Norwest Bank Minnesota, Note 3 N.A. dated April 1, 1996. 4.3a Reimbursement Agreement by and between HEI, Inc. and Norwest Bank Note 3 Minnesota, N.A. dated April 1, 1996. 4.3b Mortgage Security Agreement Fixture Financing Statement and Note 3 Assignment of Leases and Rents by HEI, Inc. as Mortgagor to Norwest Bank Minnesota, N.A. as Mortgagee dated April 1, 1996. 4.3c Security Agreement by HEI, Inc. in favor of Norwest Bank Minnesota, Note 3 N.A. dated April 1, 1996. 10.1 Form of Indemnification Agreement between HEI and officers and directors. Note 4 **10.2 HEI 1989 Omnibus Stock Compensation Plan adopted April 3, 1989, as Note 5 amended to date. ***10.3 1991 Stock Option Plan for Non-employee Directors, as amended to date. ***10.4 Form of Agreement regarding Employment/Compensation upon change in control with Messrs. Courtney, Mortenson and Nordquist. *13 Annual Report to Shareholders for the year ended August 31, 1997. 23 Consent of Independent Accountants. *27 Financial Data Schedule.
-7- Notes to Exhibits above: [1] Filed as an exhibit to Annual Report on Form 10-K for the year ended August 31, 1990, and incorporated herein by reference. [2] Filed as an exhibit to Registration Statement on Form 8-A filed May 31, 1988, as amended by Form 8 filed June 27, 1988, and incorporated herein by reference. [3] Filed as an exhibit to Form 10-QSB for the quarter ended June 1, 1996, and incorporated herein by reference. [4] Filed as an exhibit to Registration Statement on Form S-2 (SEC no. 33-37285) filed October 15, 1990, and incorporated herein by reference. [5] Filed exhibit to Annual Report on Form 10-KSB for the year ended August 31, 1996 and incorporated herein by reference. * Filed herein as an exhibit. ** Denotes management contract or compensation plan or arrangement. *** Denotes management contract or compensation plan or arrangement and filed herein as an exhibit. -8- EX-3.2 2 EXHIBIT 3.2 BYLAWS OF HEI BYLAWS OF HEI, INC. EXHIBIT 3.2 (AS AMENDED THROUGH NOVEMBER 19, 1997) ARTICLE I OFFICES - CORPORATE SEAL Section 1.01. REGISTERED OFFICE. The registered office of the corporation in Minnesota shall be that set forth in the Articles of Incorporation or in the most recent amendment of the Articles of Incorporation or resolution of the directors filed with the Secretary of State of Minnesota changing the registered office. Section 1.02. OTHER OFFICES. The corporation may have such other offices, within or without the State of Minnesota, as the directors shall, from time to time, determine. Section 1.03. CORPORATE SEAL. The corporation may, in the discretion of the Board of Directors, have a corporate seal. Any such seal shall have inscribed thereon the name of the corporation and the word "Minnesota" and the words "Corporate Seal." ARTICLE II MEETINGS OF SHAREHOLDERS Section 2.01. PLACE AND TIME OF MEETINGS. Except as provided otherwise by Minnesota Statutes Chapter 302A, meetings of the shareholders may be held at any place, within or without the State of Minnesota, as may from time to time be designated by the directors and, in the absence of such designation, shall be held at the registered office of the corporation in the State of Minnesota. The directors shall designate the time of day for each meeting. Section 2.02. REGULAR MEETINGS. (a) A regular meeting of the shareholders shall be held on such date as the Board of Directors shall by resolution establish. (b) At the regular meeting, the shareholders, voting as provided in the Articles of Incorporation and these Bylaws, shall designate the number of directors to constitute the Board of Directors (subject to the authority of the Board of Directors thereafter to increase or decrease the number of directors as permitted by law), shall elect qualified successors for directors who serve for an indefinite term or whose terms have expired or are due to expire within six months after the date of the meeting, and shall transact such other business as may properly come before them. Section 2.03 SPECIAL MEETINGS. Special meetings of the shareholders may be held at any time and for any purpose and may be called by the Chief Executive Officer, Chief Financial Officer, any two directors, or by a shareholder or shareholders holding 10% or more of the shares entitled to vote (except that a special meeting for the purpose of considering any action to directly or indirectly effect a business combination, including any action to change or otherwise affect the composition of the Board of Directors for that purpose, must be called by shareholders holding not less than 25% of all shares of the corporation entitled to vote), who shall demand such special meeting by written notice given to the Chief Executive Officer or the Chief Financial Officer of the corporation specifying the purposes of such meeting. Section 2.04. QUORUM, ADJOURNED MEETINGS. The holders of a majority of the shares entitled to vote shall constitute a quorum for the transaction of business at any regular or special meeting. In case a quorum shall not be present at a meeting, those present may adjourn to such day as they shall, by majority vote, agree upon. If a quorum is present, a meeting may be adjourned from time to time without notice other than announcement at the meeting. At adjourned meetings at which a quorum is present, any business may be transacted which might have been transacted at the meeting as originally noticed. If a quorum is present at the beginning of the meeting, the shareholders may continue to transact business until adjournment notwithstanding the withdrawal of enough shareholders to leave less than a quorum. Section 2.05. VOTING. At each meeting of the shareholders every shareholder having the right to vote shall be entitled to vote either in person or by proxy. Each shareholder, unless the Articles of Incorporation or statute provide otherwise, shall have one vote for each share having voting power registered in such shareholder's name on the books of the corporation. Jointly owned shares may be voted by any joint owner unless the corporation receives written notice from any one of them denying the authority of that person to vote those shares. Upon the demand of any shareholder, the vote upon any question before the meeting shall be by ballot. All questions shall be decided by a majority vote of the number of shares entitled to vote and represented at the meeting at the time of the vote except if otherwise required by statute, the Articles of Incorporation, or these Bylaws. Section 2.06. CLOSING OF BOOKS. The Board of Directors may fix a time, not exceeding 60 days preceding the date of any meeting of shareholders, as a record date for the determination of the shareholders entitled to notice of, and to vote at, such meeting, notwithstanding any transfer of shares on the books of the corporation after any record date so fixed. The Board of Directors may close the books of the corporation against the transfer of shares during the whole or any part of such period. If the Board of Directors fails to fix a record date for determination of the shareholders entitled to notice of, and to vote at, any meeting of shareholders, the record date shall be the 20th day preceding the date of such meeting. Section 2.07. NOTICE OF MEETINGS. Notice of each shareholders' meeting shall be mailed to each shareholder, shown by the books of the corporation to be a holder of record of voting shares, at his address as shown by the books of the corporation, setting out the time and place of the meeting, except where the meeting is an adjourned meeting and the date, time and place of the meeting were announced at the time of adjournment, except that notice of a meeting at which an agreement of merger or exchange is to be considered shall be mailed to all shareholders of record, whether entitled to vote or not, at least fourteen days prior thereto. Every notice of any special meeting called pursuant to Section 2.03 hereof shall state the purpose or purposes for which the meeting has been called, and the business transacted at all special meetings shall be confined to the purpose stated in the notice. Section 2.08. WAIVER OF NOTICE. Notice of any regular or special meeting may be waived by any shareholder either before, at or after such meeting orally or in a writing signed by such 2 shareholder or a representative entitled to vote the shares of such shareholder. A shareholder, by his attendance at any meeting of shareholders, shall be deemed to have waived notice of such meeting, except where the shareholder objects at the beginning of the meeting to the transaction of business because the item may not lawfully be considered at the meeting and does not participate in the consideration of the item at that meeting. Section 2.09. WRITTEN ACTION. Any action which might be taken at a meeting of the shareholders may be taken without a meeting if done in writing and signed by all of the shareholders entitled to vote on that action. Section 2.10. ADVANCE NOTICE REQUIREMENTS. Only persons who are nominated in accordance with the procedures set forth in this Section 2.10 shall be eligible for election as directors. Nominations of persons for election to the Board of Directors of the corporation may be made at a meeting of shareholders (a) by or at the direction of the Board of Directors or (b) by any shareholder of the corporation entitled to vote for the election of directors at the meeting who complies with the notice procedures set forth in this Section 2.10. Nominations by shareholders shall be made pursuant to timely notice in writing to the Secretary of the corporation. To be timely, a shareholder's notice must be delivered to or mailed and received at the principal executive offices of the corporation not less than 50 days prior to the meeting; provided, however, that in the event that less than 60 days' notice or prior public disclosure of the date of the meeting is given or made to shareholders, notice by the shareholder to be timely must be so received not later than the close of business on the 10th day following the first day on which such notice of the date of the meeting was mailed or such public disclosure was made. Such shareholder's notice shall set forth (x) as to each person whom the shareholder proposes to nominate for election or re-election as a director, (i) such person's name and (ii) all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (including such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); and (y) as to the shareholder giving the notice, (i) the name and address, as they appear on the corporation's books, of such shareholder and (ii) the class and number of shares of the corporation which are beneficially owned by such shareholder. At the request of the Board of Directors, any person nominated by the Board of Directors for election as a director shall furnish to the Secretary of the corporation that information required to be set forth in a shareholder's notice of nomination which pertains to a nominee. Notwithstanding anything in these Bylaws to the contrary, no person shall be eligible for election as a director of the corporation unless nominated in accordance with the procedures set forth in this Section 2.10. The Chairman of the meeting shall, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the procedures prescribed in this Section 2.10 and, if the Chairman should so determine, the Chairman shall so declare to the meeting and the defective nomination shall be disregarded. At any regular or special meeting of shareholders, only such business shall be conducted as shall have been brought before the meeting (a) by or at the direction of the Board of Directors or (b) by any shareholder of the corporation who complies with the notice procedures set forth in this Section 2.10. For business to be properly brought before any regular or special meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the Secretary of 3 the corporation. To be timely, a shareholder's notice must be delivered to or mailed and received at the principal executive offices of the corporation not less than 50 days prior to the meeting, provided, however, that in the event that less than 60 days' notice or prior public disclosure of the date of the meeting is given or made to shareholders, notice by the shareholder to be timely must be received not later than the close of business on the 10th day following the first day on which either such notice of the date of the regular or special meeting was mailed or such public disclosure was made. A shareholder's notice to the Secretary shall set forth as to each matter the shareholder proposes to bring before the regular or special meeting (w) a brief description of the business desired to be brought before the meeting and the reasons for conducting such business at the meeting, (x) the name and address, as they appear on the corporation's books, of the shareholder proposing such business, (y) the class and number of shares of the corporation which are beneficially owned by the shareholder and (z) any material interest of the shareholder in such business. Notwithstanding anything in these Bylaws to the contrary, no business shall be conducted at any regular or special meeting except in accordance with the procedures set forth in this Section 2.10 and, as an additional limitation, the business transacted at any special meeting shall be limited to the purposes stated in the notice of the special meeting. The Chairman of the meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting in accordance with the provisions of this Section 2.10 and, if the Chairman should so determine, the Chairman shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. ARTICLE III DIRECTORS Section 3.01. GENERAL POWERS. The business and affairs of the corporation shall be managed by or under the direction of the Board of Directors, except as otherwise permitted by statute. Section 3.02. NUMBER, QUALIFICATION AND TERM OF OFFICE. Until the first meeting of shareholders, the number of directors shall be the number named in the Articles of Incorporation or, if no such number is named therein, the number elected by the incorporator. Thereafter, the number of directors shall be established by resolution of the shareholders (subject to the authority of the Board of Directors to increase or decrease the number of directors as permitted by law). In the absence of such shareholder resolution, the number of directors shall be the number last fixed by the shareholders, the Board of Directors, the incorporator or the Articles of Incorporation. Directors need not be shareholders. Each of the directors shall hold office until the regular meeting of shareholders next held after such director's election and until such director's successor shall have been elected and shall qualify, or until the earlier death, resignation, removal, or disqualification of such director; provided, however, that no director shall be elected to a term in excess of five years. Section 3.03. BOARD MEETINGS. Meetings of the Board of Directors may be held from time to time at such time and place within or without the State of Minnesota as may be designated in the notice of such meeting. 4 Section 3.04. CALLING MEETINGS; NOTICE. Meetings of the Board of Directors may be called by the Chairman of the Board by giving at least twenty-four hours' notice, or by any other director by giving at least five days' notice, of the date, time and place thereof to each director by mail, telephone, telegram or in person. Section 3.05. WAIVER OF NOTICE. Notice of any meeting of the Board of Directors may be waived by any director either before, at, or after such meeting orally or in a writing signed by such director. A director, by his attendance at any meeting of the Board of Directors, shall be deemed to have waived notice of such meeting, except where the director objects at the beginning of the meeting to the transaction of business because the meeting is not lawfully called or convened and does not participate thereafter in the meeting. Section 3.06. QUORUM. A majority of the directors holding office immediately prior to a meeting of the Board of Directors shall constitute a quorum for the transaction of business at such meeting. Section 3.07. ABSENT DIRECTORS. A director may give advance written consent or opposition to a proposal to be acted on at a meeting of the Board of Directors. If such director is not present at the meeting, consent or opposition to a proposal does not constitute presence for purposes of determining the existence of a quorum, but consent or opposition shall be counted as a vote in favor of or against the proposal and shall be entered in the minutes or other record of action at the meeting, if the proposal acted on at the meeting is substantially the same or has substantially the same effect as the proposal to which the director has consented or objected. Section 3.08. CONFERENCE COMMUNICATIONS. Any or all directors may participate in any meeting of the Board of Directors, or of any duly constituted committee thereof, by any means of communication through which the directors may simultaneously hear each other during such meeting. For the purposes of establishing a quorum and taking any action at the meeting, such directors participating pursuant to this Section 3.08 shall be deemed present in person at the meeting, and the place of the meeting shall be the place of origination of the conference communication. Section 3.09. VACANCIES; NEWLY CREATED DIRECTORSHIP. Vacancies in the Board of Directors of this corporation occurring by reason of death, resignation, removal or disqualification shall be filled for the unexpired term by a majority of the remaining directors of the Board although less than a quorum; newly created directorships resulting from an increase in the authorized number of directors by action of the Board of Directors as permitted by Section 3.02 may be filled by a two-thirds vote of the directors serving at the time of such increase; and each director elected pursuant to this Section 3.09 shall be a director until such director's successor is elected by the shareholders at their next regular or special meeting. Section 3.10. REMOVAL. Any or all of the directors may be removed from office at any time, with or without cause, by the affirmative vote of the shareholders holding a majority of the shares entitled to vote at an election of directors, except as otherwise provided by Minnesota Statutes Section 302A.223, as amended, when the shareholders have the right to cumulate their votes. A director named by the Board of Directors to fill a vacancy may be removed from office 5 at any time, with or without cause, by the affirmative vote of the remaining directors if the shareholders have not elected directors in the interim between the time of the appointment to fill such vacancy and the time of the removal. In the event that the entire Board or any one or more directors be so removed, new directors shall be elected at the same meeting. Section 3.11. COMMITTEES. A resolution approved by the affirmative vote of a majority of the Board of Directors may establish committees having the authority of the board in the management of the business of the corporation to the extent provided in the resolution. A committee shall consist of one or more persons, who need not be directors appointed by affirmative vote of a majority of the directors present. Committees are subject to the direction and control of, and vacancies in the membership thereof shall be filled by, the Board of Directors, except as provided by Minnesota Statutes Section 302A.243. A majority of the members of the committee present at a meeting is a quorum for the transaction of business. Section 3.12. WRITTEN ACTION. Any action which might be taken at a meeting of the Board of Directors, or any duly constituted committee thereof, may be taken without a meeting if done in writing and signed by all of the directors or committee members, unless the Articles provided otherwise and the action need not be approved by the shareholders. Section 3.13. COMPENSATION. Directors who are not salaried officers of this corporation shall receive such fixed sum per meeting attended or such fixed annual sum as shall be determined, from time to time, by resolution of the Board of Directors. The Board of Directors may, by resolution, provide that all directors shall receive their expenses, if any, of attendance at meetings of the Board of Directors or any committee thereof. Nothing herein contained shall be construed to preclude any director from serving this corporation in any other capacity and receiving proper compensation therefor. ARTICLE IV OFFICERS Section 4.01. NUMBER. The officers of the corporation shall consist of a Chairman of the Board (if one is elected by the Board), a Chief Executive Officer, a Chief Financial Officer, a Secretary (if one is elected by the Board) and such other officers and agents as may, from time to time, be elected or appointed by the Board of Directors. Any number of offices may be held by the same person. Section 4.02. ELECTION, TERM OF OFFICE AND QUALIFICATIONS. The Board of Directors shall elect or appoint by resolution approved by the affirmative vote of a majority of the directors present, from within or without their number, the Chief Executive Officer, Chief Financial Officer, and such other officers as may be deemed advisable, each of whom shall have the powers, rights, duties, responsibilities, and terms in office provided for in these Bylaws or a resolution of the Board of Directors not inconsistent therewith. Officers who may be directors shall continue to hold office until the election and qualification of their successors, notwithstanding an earlier termination of their directorship. 6 Section 4.03. REMOVAL AND VACANCIES. Any officer may be removed from his office by the Board of Directors at any time, with or without cause. Such removal, however, shall be without prejudice to the contract rights of the person so removed. If there be a vacancy among the officers of the corporation by reason of death, resignation or otherwise, such vacancy shall be filled for the unexpired term by the Board of Directors. Section 4.04. CHAIRMAN OF THE BOARD. The Chairman of the Board, if one is elected, shall preside at all meetings of the shareholders and directors and shall have such other duties as may be prescribed, from time to time, by the Board of Directors. Section 4.05. CHIEF EXECUTIVE OFFICER. The Chief Executive Officer shall have general active management of the business of the corporation. In the absence of the Chairman of the Board, he/she shall preside at all meetings of the shareholders and directors. He/she shall see that all orders and resolutions of the Board of Directors are carried into effect. He/she shall execute and deliver, in the name of the corporation, any deeds, mortgages, bonds, contracts or other instruments pertaining to the business of the corporation unless the authority to execute and deliver is required by law to be exercised by another person or is expressly delegated by the Articles or Bylaws or by the Board of Directors to some other officer or agent of the corporation. He/she shall maintain records of and, whenever necessary, certify all proceedings of the Board of Directors and the shareholders, and in general, shall perform all duties usually incident to the office of the Chief Executive Officer. He/she shall have such other duties as may, from time to time, be prescribed by the Board of Directors. Section 4.06. VICE PRESIDENT. Each Vice President, if one or more are elected, shall have such powers and perform such duties as may be specified in the Bylaws or prescribed by the Board of Directors or by the Chief Executive Officer. In the event of the absence or disability of the Chief Executive Officer, Vice Presidents shall succeed to this power and duties in the order designated by the Board of Directors. Section 4.07. SECRETARY. The Secretary, if one is elected, shall give proper notice of meetings of shareholders and directors. He/she shall perform such other duties as may, from time to time, be prescribed by the Board of Directors or by the Chief Executive Officer. Section 4.08. CHIEF FINANCIAL OFFICER. The Chief Financial Officer shall keep accurate financial records for the corporation. He/she shall deposit all moneys, drafts and checks in the name of, and to the credit of, the corporation in such banks and depositories as the Board of Directors shall, from time to time, designate. He/she shall have power to endorse, for deposit, all notes, checks and drafts received by the corporation. He/she shall disburse the funds of the corporation, as ordered by the Board of Directors, making proper vouchers therefor. He/she shall render to the Chief Executive Officer and the directors, whenever requested, an account of all his/her transactions as Chief Financial Officer and of the financial condition of the corporation, and shall perform such other duties as may, from time to time, be prescribed by the Board of Directors or by the Chief Executive Officer. 7 Section 4.09. COMPENSATION. The officers of this corporation shall receive such compensation for their services as may be determined, from time to time, by resolution of the Board of Directors. ARTICLE V SHARES AND THEIR TRANSFER Section 5.01. CERTIFICATES FOR SHARES. All shares of the corporation shall be certificated shares. Every owner of shares of the corporation shall be entitled to a certificate, to be in such form as shall be prescribed by the Board of Directors, certifying the number of shares of the corporation owned by such shareholder. The certificates for such shares shall be numbered in the order in which they shall be issued and shall be signed, in the name of the corporation, by the Chief Executive Officer, and by the Secretary or an Assistant Secretary or by such officers as the Board of Directors may designate. If the certificate is signed by a transfer agent or registrar, such signature of the corporate officers may be by facsimile if authorized by the Board of Directors. Every certificate surrendered to the corporation for exchange or transfer shall be cancelled, and no new certificate or certificates shall be issued in exchange for any existing certificate until such existing certificate shall have been so cancelled, except in cases provided for in Section 5.04. Section 5.02. ISSUANCE OF SHARES. The Board of Directors is authorized to cause to be issued shares of the corporation up to the full amount authorized by the Articles of Incorporation in such amounts as may be determined by the Board of Directors and as may be permitted by law. No shares shall be allocated except in consideration of cash or other property, tangible or intangible, received or to be received by the corporation under a written agreement, of services rendered or to be rendered to the corporation under a written agreement, or of an amount transferred from surplus to stated capital upon a share dividend. At the time of such allotment of shares, the Board of Directors making such allotment shall state, by resolution, their determination of the fair value to the corporation in monetary terms of any consideration other than cash for which shares are allotted. Section 5.03. TRANSFER OF SHARES. Transfer of shares on the books of the corporation may be authorized only by the shareholder named in the certificate, or the shareholder's legal representative, or the shareholder's duly authorized attorney-in-fact, and upon surrender of the certificate or the certificates for such shares. The corporation may treat as the absolute owner of shares of the corporation, the person or persons in whose name shares are registered on the books of the corporation. Section 5.04. LOSS OF CERTIFICATES. Except as otherwise provided by Minnesota Statutes Section 302A.419, any shareholder claiming a certificate for shares to be lost, stolen or destroyed shall make an affidavit of that fact in such form as the Board of Directors shall require and shall, if the Board of Directors so requires, give the corporation a bond of indemnity in form, in an amount, and with one or more sureties satisfactory to the Board of Directors, to indemnify the corporation against any claim which may be made against it on account of the reissue of such certificate, whereupon a new certificate may be issued in the same tenor and for the same number of shares as the one alleged to have been lost, stolen or destroyed. 8 ARTICLE VI DIVIDENDS; RECORD DATE Section 6.01. DIVIDENDS. Subject to the provisions of the Articles of Incorporation, of these Bylaws, and of law, the Board of Directors may declare dividends whenever, and in such amounts as, is deemed advisable. Section 6.02. RECORD DATE. Subject to any provision of the Articles of Incorporation, the Board of Directors may fix a date not exceeding 120 days preceding the date fixed for the payment of any dividend to the shareholders entitled to receive payment of the dividend and, in such case, only shareholders of record on the date so fixed shall be entitled to receive payment of such dividend notwithstanding any transfer of shares on the books of the corporation after the record date. The Board of Directors may close the books of the corporation against the transfer of shares during the whole or any part of such period. ARTICLE VII BOOKS AND RECORDS; FISCAL YEAR Section 7.01. SHARE REGISTER. The Board of Directors of the corporation shall cause to be kept at its principal executive office, or at another place or places within the United States determined by the Board: (1) a share register not more than one year old, containing the names and addresses of the shareholders and the number and classes of shares held by each shareholder; and (2) a record of the dates on which certificates or transaction statements representing shares were issued. Section 7.02. OTHER BOOKS AND RECORDS. The Board of Directors shall cause to be kept at its principal executive office, or, if its principal executive office is not in Minnesota, shall make available at its registered office within ten days after receipt by an officer of the corporation of a written demand for them made by a shareholder or other person authorized by Minnesota Statutes Section 302A.461, originals or copies of: (1) records of all proceedings of shareholders for the last three years; (2) records of all proceedings of the board for the last three years; (3) its Articles of Incorporation and all amendments currently in effect; (4) its Bylaws and all amendments currently in effect; (5) financial statements required by Minnesota Statutes Section 302A.463 and the financial statement for the most recent interim period prepared in the course of the operation of the corporation for distribution to the shareholders or to a governmental agency as a matter of public record; 9 (6) reports made to shareholders generally within the last three years; (7) a statement of the names and usual business addresses of its directors and principal officers; (8) any shareholder voting or control agreements of which the corporation is aware; and (9) such other records and books of account as shall be necessary and appropriate to the conduct of the corporation's business. Section 7.03. FISCAL YEAR. The fiscal year of the corporation shall be determined by the Board of Directors. ARTICLE VIII LOANS, GUARANTEES, SURETYSHIP Section 8.01. The corporation may lend money to, guarantee an obligation of, become a surety for, or otherwise financially assist a person if the transaction, or a class of transactions to which the transaction belongs, is approved by the affirmative vote of a majority of the directors present and: (1) is in the usual and regular course of business of the corporation; (2) is with, or for the benefit of, a related corporation, an organization in which the corporation has a financial interest; an organization with which the corporation has a business relationship; or an organization with which the corporation has the power to make donations; (3) is with, or for the benefit of, an officer or other employee of the corporation or a subsidiary, including an officer or employee who is a director of the corporation or a subsidiary, and may reasonably be expected, in the judgment of the Board, to benefit the corporation; or (4) has been approved by the affirmative vote of the holders of two-thirds of the outstanding shares. The loan, guarantee, surety contract or other financial assistance may be with or without interest, and may be unsecured, or may be secured in such manner as a majority of the directors approve, including, without limitation, a pledge of or other security interest in shares of the corporation. Nothing in this Section shall be deemed to deny, limit, or restrict the powers of guaranty or warranty of the corporation at common law or under a statute of the State of Minnesota. ARTICLE IX INDEMNIFICATION OF CERTAIN PERSONS Section 9.01. RIGHT TO INDEMNIFICATION. Each person who was or is made a party or is threatened to be made a party to or is involved, as a non-party witness or otherwise, in any action, 10 suit or proceeding, whether civil, criminal, administrative or investigative, including a proceeding by or in the right of the corporation (hereinafter a "proceeding"), by reason of the fact that he or she, or a person for whom he or she is the legal representative, is or was a director or officer of the corporation or, while a director or officer of the corporation, is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise, including service with respect to employee benefit plans, where the basis of such proceeding is alleged action in an official capacity as a director, officer, employee or agent or in any other capacity while serving as a director, officer, employee or agent, shall be indemnified and held harmless by the corporation to the fullest extent authorized by the Minnesota Business Corporation Act, as the same exists or may hereafter be amended (but in the case of any such amendment, only to the extent that such amendment permits the corporation to provide broader indemnification rights than said law permitted the corporation to provide prior to such amendment), by common law or by administrative or judicial interpretation, against all expense, liability and loss (including attorneys' fees, expert witness fees, bonds prospective or retroactive, insurance premiums or costs, out-of-pocket expenses related to a proceeding, judgments, fines, including without limitation, excise taxes or penalties assessed against such person with respect to any employee benefit plan, or amounts paid or to be paid in settlement, including any interest payable thereon) reasonably incurred or suffered by such person in connection therewith. Such indemnification shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of his or her heirs, executors and administrators; provided, however, that except as provided in Section 9.02 hereof, the corporation shall indemnify any such person seeking indemnification in connection with a proceeding (or part thereof) initiated by such person only if such proceeding (or part thereof) was authorized by the Board of Directors of the corporation. The right to indemnification conferred in this Section shall be a contract right and shall include the right to be paid by the corporation the expenses incurred in defending any such proceeding in advance of its final disposition; provided, however, that payment of such expenses in advance of the final disposition of a proceeding shall be made only upon (i) delivery to the corporation of a written affirmation, by the person seeking such payment in advance, of a good faith belief that the criteria for indemnification set forth in the Minnesota Business Corporation Act have been satisfied, (ii) a determination that the facts then known to those making the determination would not preclude indemnification under the Minnesota Business Corporation Act or these Bylaws, and (iii) delivery to the corporation of an undertaking, by or on behalf of such person, to repay all amounts so advanced if it shall ultimately be determined that such person is not entitled to be indemnified under this Section or otherwise. Such written undertaking to repay shall be a general obligation of the person making it, shall not be secured, and shall be accepted without reference to financial ability to make the repayment. The corporation may, by action of its Board of Directors, provide indemnification to other classes of employees and agents of the corporation with the same scope and effect as the foregoing indemnification of directors and officers. Section 9.02. RIGHT OF CLAIMANT TO BRING SUIT. If a claim under Section 9.01 of this Article is not paid in full by the corporation within sixty days after a written claim has been received by the corporation the claimant may at any time thereafter bring suit against the corporation to recover the unpaid amount of the claim and, whether or not the claimant is successful in whole or in part, the claimant shall be entitled to be paid also the expense of 11 prosecuting such claim. It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in defending any proceeding in advance of its normal disposition where the required undertaking, if any is required, has been tendered to the corporation) that the claimant has not met the standards of conduct which make it permissible under the Minnesota Business Corporation Act for the corporation to indemnify the claimant for the amount claimed, but the burden of proving such defense shall be on the corporation. Neither the failure of the corporation (including its Board of Directors, Committee for the Board of Directors, special legal counsel, or its shareholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because claimant met the applicable standard of conduct set forth in the Minnesota Business Corporation Act, nor an act or determination by the corporation (including its Board of Directors, Committee of the Board of Directors, special legal counsel, or its shareholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that the claimant has not met the applicable standard of conduct. Section 9.03. NON-EXCLUSIVITY OF RIGHTS. The right to indemnification and payment of expenses incurred in defending a proceeding in advance of its final disposition conferred in this Article IX shall not be exclusive of any other right which any person may have or hereafter acquire under any statute, common law or administrative or judicial interpretation, provisions of the Articles of Incorporation, Bylaws, agreement, vote of shareholders or disinterested directors, or otherwise. Section 9.04. INSURANCE. The corporation may maintain insurance, at its expense, to protect itself and any director, officer, employee or agent of the corporation or another corporation, partnership, joint venture, trust or other enterprise against any such expense, liability or loss, whether or not the corporation would have the power to indemnify such person against such expense, liability or loss under the Minnesota Business Corporation Act. Section 9.05. INDEMNIFICATION AGREEMENTS. The corporation shall enter into agreements with its directors further providing the terms and conditions of their indemnification. Section 9.06. AMENDMENTS LIMITED. Any amendment to this Article IX shall only apply prospectively and shall in no way affect the corporation's obligations to indemnify and make advances pursuant to the Minnesota Business Corporation Act, this Article IX, or any contract of the corporation for actions or events which occurred before such amendment. 12 ARTICLE X AMENDMENTS Section 10.01. These Bylaws may be amended or altered by a vote of the majority of the whole Board of Directors at any meeting, provided that notice of such proposed amendment shall have been given in the notice given to the Directors of such meeting. Such authority in the Board of Directors is subject to the power of the shareholders to change or repeal such Bylaws by a majority vote of the shareholders present or represented at any regular or special meeting of shareholders called for such purpose, and the Board of Directors shall not make or alter any Bylaws fixing a quorum for meetings of shareholders, prescribing procedures for removing Directors or filling vacancies in the Board of Directors, or fixing the number of directors or their classifications, qualifications, or terms of office, except that the Board of Directors may adopt or amend any Bylaw to increase its number. ARTICLE XI SECURITIES OF OTHER CORPORATIONS Section 11.01. VOTING SECURITIES HELD BY THE CORPORATION. Unless otherwise ordered by the Board of Directors, the Chief Executive Officer shall have full power and authority on behalf of the corporation (a) to attend any meeting of security holders of other corporations in which the corporation may hold securities and to vote such securities on behalf of this corporation; (b) to execute any proxy for such meeting on behalf of the corporation; or (c) to execute a written action in lieu of a meeting of such other corporation on behalf of this corporation. At such meeting, the President shall possess and may exercise any and all rights and powers incident to the ownership of such securities that the corporation possesses. The Board of Directors may, from time to time, grant such power and authority to one or more other persons and may remove such power and authority from the Chief Executive Officer or any other person. Section 11.02 PURCHASE AND SALE OF SECURITIES. Unless otherwise ordered by the Board of Directors, the Chief Executive Officer shall have full power and authority on behalf of the corporation to purchase, sell, transfer or encumber any and all securities of any other corporation owned by the corporation and may execute and deliver such documents as may be necessary to effectuate such purchase, sale, transfer or encumbrance. The Board of Directors may, from time to time, confer like powers upon any other person or persons. 13 EX-10.3 3 EXHIBIT 10.3 STOCK OPTION PLAN Exhibit 10.3 HEI, Inc. STOCK OPTION PLAN FOR NONEMPLOYEE DIRECTORS As Amended Effective May 11, 1994, October 31, 1996 and November 19, 1997 1. PURPOSE. This Stock Option Plan (the "Plan") for HEI, Inc., a Minnesota corporation (the "Company"), is intended to advance the interests of the Company by providing members of the Board of Directors, who are responsible for the direction of the Company, with additional incentive to promote the success of the business, to increase their proprietary interest in the success of the Company, and to attract, reward and retain them as directors of the Company. These goals will be effectuated through the granting of nonqualified options to purchase Common Stock of the Company. 2. DEFINITIONS. In addition to definitions that may be contained elsewhere herein, for purposes of this Plan, the following terms shall be defined as set forth below: (a) "Option Agreement" means any written agreement, contract, or other instrument or document evidencing any Option granted hereunder and signed by both the Company and the Participant. (b) "Board" means the Board of Directors of the Company. (c) "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. (d) "Committee" means the Committee referred to in Section 3 of the Plan. (e) "Disability" means disability as determined under procedures established by the Board for purposes of this Plan or as defined in Section 22(e)(3) of the Code. (f) [DELETED] (g) "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time. (h) "Fair Market Value" means as of any given date, unless otherwise determined by the Committee in good faith, the average for the preceding five business days of the closing bid prices of the Stock as reported on the National Association of Securities Dealers, Inc. Automated Quotations System ("NASDAQ") or, if the Stock is then traded on the NASDAQ/National Market System ("NASDAQ/NMS") or on a national or regional securities exchange, the average for the preceding five business days of the closing prices of the Stock on NASDAQ/NMS or such exchange. (i) "Participant" means any person entitled to participate in this Plan as set forth in Section 4 hereof. (j) "Stock" means the Common Stock, $.05 par value per share, of the Company. (k) "Stock Option" or "Option" means any option to purchase shares of Stock granted pursuant to Section 5 below. 3. ADMINISTRATION. The Plan shall be administered by the Board, which, in its discretion, may delegate authority to a committee consisting of two or more directors appointed by the Board. The members of any such committee shall qualify as required under Rule 16b-3 of the Exchange Act, as it may be amended from time to time. Grants of Options under the Plan shall be made automatically as provided in Section 5. However, the Board shall have full authority to interpret the Plan, to promulgate such rules and regulations with respect to the Plan as it deems desirable and to make all other determinations necessary or appropriate for the administration of the Plan, and such determinations shall be final and binding upon all persons having an interest in the Plan. 4. ELIGIBILITY. Options will be granted only to persons who at the time of the grant are directors of the Company and who are not otherwise employees of the Company or any affiliate of the Company ("Nonemployee Director" or "Nonemployee Directors"). 5. OPTIONS. (a) ANNUAL GRANT. Each year, on the first business day following the annual meeting of the Company's shareholders (but in no event later than April 1 or the first business day thereafter), each person serving on such date as a Nonemployee Director of the Company shall be granted an Option to purchase Ten Thousand (10,000) shares of Stock. Except as otherwise may be provided herein, each Option (a) shall be subject to all terms of the Plan, (b) shall be granted for a term of ten years, and (c) shall vest and become fully exercisable on the earlier of the date of the next annual meeting of the shareholders or the date one year from the date of grant; provided, in each instance, that the Participant has continuously served as a Nonemployee Director of the Company during such period or until the election of directors next following the date of grant, whichever shall first occur (and, if not, said Option shall be forfeited in its entirety). (b) EXERCISE PRICE. The exercise price per share of Stock purchasable under an Option shall be not less than 100% of the Fair Market Value of the Stock on the date of grant. (c) METHOD OF EXERCISE. Stock Options may be exercised in whole or in part at any time during the term of the Option. Payment of the exercise price shall be made by (i) cash or certified bank check, (ii) delivery of shares of Stock already owned by the Participant, or (iii) any combination of the foregoing. For purposes of this paragraph, shares of Stock that are delivered in payment of the exercise price shall be valued at their 2 Fair Market Value as of the date of the exercise of the Option. The Company's obligation to deliver shares upon the exercise of Options shall be subject to applicable federal, state, and local tax withholding requirements. Unless otherwise determined by the Board, withholding obligations may be settled with Stock, including Stock received as part of the exercise giving rise to the withholding requirement. (d) RESTRICTIONS ON TRANSFER OF OPTION. Unless otherwise provided in the related Option Agreement and approved in advance by the Board, each Option granted under this Plan shall be transferable only by will or the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act ("ERISA"), or the rules thereunder. Except as permitted by the preceding sentence, no Option granted under the Plan or any of the rights and privileges thereby conferred shall be transferred, assigned, pledged, or hypothecated in any way (whether by operation of law or otherwise), and no such Option, right, or privilege shall be subject to execution, attachment, or similar process. Unless otherwise provided in the related Option Agreement and approved in advance by the Board, an Option may be exercised during the Participant's lifetime only by the Participant or his or her guardian or legal representative. (e) PRIOR GRANTS. Effective November 19, 1997, all Options then outstanding held by currently serving Nonemployee Directors shall be extended for an additional five years and shall expire ten years from the original date of grant. 6. SHARES OF STOCK SUBJECT TO THE PLAN. There shall be reserved and available for issuance upon the exercise of Options granted from time to time under the Plan an aggregate of 400,000 shares of Stock. Such shares may consist, in whole or in part, of authorized but unissued shares of Stock or issued shares that have been reacquired by the Company. If any shares subject to an Option are not issued because the Option is not exercised, such shares shall again be available for distribution in connection with future Options. In the event of any merger, reorganization, consolidation, recapitalization, Stock dividend, Stock split, or other change in corporate structure affecting the Stock, such substitution or adjustment shall be made in the aggregate number of shares reserved for issuance under the Plan and in the number and option price of shares subject to outstanding Options granted under the Plan as may be determined to be appropriate by the Board, in its sole discretion, provided that the number of shares subject to any Option shall always be a whole number. 7. DEATH OR DISABILITY OF PARTICIPANT. (a) TERMINATION BY DEATH. If a Participant's service to the Company terminates by reason of death, any Stock Option held by such Participant will immediately become fully exercisable and may thereafter be exercised by the legal representative of the Participant's estate or by any person who acquired the Option by will or the laws of descent and distribution for a period of one year from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. 3 (b) TERMINATION BY REASON OF DISABILITY. If a Participant's service to the Company terminates by reason of Disability, any Stock Option held by such Participant shall immediately become fully exercisable and may thereafter be exercised by the Participant until the expiration of the stated term of such Stock Option; provided, however, that, if the Participant dies prior to the expiration of the Option, any unexercised Stock Option held by such Participant shall thereafter be exercisable to the extent to which it was exercisable at the time of death for a period of one year from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. 8. RESTRICTIONS ON TRANSFER OF STOCK. Unless a registration statement under the Securities Act of 1933 is in effect with respect to Stock to be purchased upon exercise of Options to be granted under the Plan, the Company may require that the Participant represent to and agree with the Company in writing that he or she is acquiring such shares of Stock for the purpose of investment and with no present intention to transfer, sell, or otherwise dispose of such shares of Stock. Further, in the absence of such registration, no shares of Stock acquired pursuant to exercise of an option may be transferred unless, in the opinion of counsel to the Company, such transfer is in compliance with applicable securities laws, and each certificate representing any shares of Stock issued to a Participant hereunder shall have endorsed thereon an appropriate legend referring to the restrictions against transfer. 9. AMENDMENT OF THE PLAN. The Board of Directors may suspend or terminate the Plan or any portion thereof at any time, and the Board of Directors may amend the Plan from time to time as may be deemed to be in the best interests of the Company; provided, however, that no such amendment, alteration or discontinuation shall be made (a) that would impair the rights of a Nonemployee Director with respect to Options theretofore awarded, without such person's consent, or (b) without the approval of the stockholders (i) if such approval is necessary to comply with any legal, tax, or regulatory requirement, including any approval requirement that is a prerequisite for exemptive relief from Section 16(b) of the Exchange Act; or (ii) to increase the maximum number of shares of Stock subject to this Plan, increase the maximum number of shares issuable to any Nonemployee Director under this Plan, or change the definition of persons eligible to receive Options under this Plan. 10. APPLICABILITY OF PLAN TO OUTSTANDING STOCK OPTIONS. This Plan shall not affect the terms and conditions of any stock options currently outstanding to any director of the Company, nor shall it affect any of the rights of any director to whom such a stock option was granted. 11. EFFECTIVE DATE OF PLAN. This Plan shall become effective upon the date of its adoption by the Board of Directors of the Company, subject to approval of the shareholders of the Company at the 1992 annual meeting. 4 12. CHANGE IN CONTROL PROVISIONS. (a) IMPACT OF EVENT. In the event of a "Change in Control" as defined in Section 12(b), the following provisions shall apply: (i) All Options granted hereunder shall become fully exercisable and vested. (ii) At the option of the holder thereof, the value of any outstanding Option shall be cashed out on the basis of the "Change in Control Price" as defined in Section 12(c) as of the date such Change in Control is determined to have occurred or such other date as the Committee may determine prior to the Change in Control. (b) DEFINITION OF "CHANGE IN CONTROL." For purposes of Section 12(a), a "Change in Control" means the happening of any of the following: (i) When any "person" as defined in Section 3(a)(9) of the Exchange Act and as used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) of the Exchange Act, but excluding the Company or any subsidiary or parent or any employee benefit plan sponsored or maintained by the Company or any subsidiary or parent (including any trustee of such plan acting as trustee), directly or indirectly, becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act, as amended from time to time), of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities; (ii) When, during any period of 24 consecutive months during the existence of the Plan, the individuals who, at the beginning of such period, constitute the Board (the "Incumbent Directors") cease for any reason other than death to constitute at least a majority thereof; provided, however, that a director who was not a director at the beginning of such 24-month period shall be deemed to have satisfied such 24-month requirement (and be an Incumbent Director) if such director was elected by, or on the recommendation of, or with the approval of, at least 60% of the directors who then qualified as Incumbent Directors either actually (because they were directors at the beginning of such 24-month period) or by prior operation of this Section 12(b)(ii); or (iii) The approval by the shareholders of an acquisition of the Company by an entity other than the Company or a subsidiary or parent through purchase of assets, or by merger, or otherwise. 5 (c) CHANGE IN CONTROL PRICE. For purposes of this Section 12, "Change in Control Price" means the highest price per share paid in any transaction reported on any market on which the Company's Stock is traded or paid or offered in any bona fide transaction related to the Change in Control of the Company at any time during the 60-day period immediately preceding the occurrence of the Change in Control. 13. NONEXCLUSIVITY OF THE PLAN. The adoption of this Plan shall not be construed as limiting the power of the Board of Directors to adopt such other incentive arrangements as it may deem desirable, including, without limitation, the granting of stock options otherwise than under this Plan, and such arrangements may be either generally applicable or applicable only in specific cases. 14. MISCELLANEOUS. (a) GOVERNING LAW. This Plan shall be governed by and construed in accordance with the laws of the State of Minnesota, and all terms shall be interpreted and construed so that there shall not be committed any violation of applicable state or federal securities laws. (b) NO ADDITIONAL RIGHTS OF SERVICE. Participation in or eligibility for participation in the Plan does not grant any person any right of service as a director, and the Company retains the right to terminate service of any director pursuant to the Company's Articles, Bylaws, and applicable law. --------------------------------------- APPROVED and adopted by the Board of Directors of HEI, lnc. on November 15, 1991 and amended effective May 11, 1994, October 31, 1996 and November 19, 1997. 6 EX-10.4 4 EXHIBIT 10.4 FORM OF AGMT FORM OF AGREEMENT EXHIBIT 10.4 REGARDING EMPLOYMENT/COMPENSATION UPON CHANGE IN CONTROL THIS AGREEMENT is entered into as of ____________, 1997, by and between HEI, INC., a Minnesota corporation (herein called the "Company"), and ____________________ (herein called the "Executive"). WHEREAS, Executive has been employed by the Company for several years and is currently its _____________________; and WHEREAS, Executive is a very important and valuable employee and the Company desires to keep Executive in its service; and WHEREAS, the Company desires to provide suitable compensation to the Executive should his employment be terminated or substantially changed as a result of a "Change in Control" as defined herein; and WHEREAS, Executive acknowledges that this is not an employment agreement, but is solely intended to provide for employment security and compensation in the event of any Change in Control of the Company in accordance with the terms and conditions of this Agreement. NOW, THEREFORE, in consideration of the premises and the mutual covenants contained herein, the parties hereto agree as follows: 1. DEFINITIONS. For the purposes of this Agreement, the following words and phrases shall have the following meanings: (a) "Change in Control" shall mean: (i) the consummation of any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of the Company's common stock would be converted into cash, securities, or other property, other than a merger of the Company in which the holders of the Company's common stock immediately prior to the merger have the same proportionate ownership of common stock of the surviving corporation immediately after the merger; or (ii) any sale, lease, exchange, or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company; or (iii) approval by the shareholders of the Company of any plan or proposal for the liquidation or dissolution of the Company; or (iv) any person (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")), shall become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act) of 50% or more of the Company's outstanding stock; or (v) during any period of two consecutive years, individuals who at the beginning of such period constitute the entire Board of Directors shall cease for any reason to constitute a majority thereof unless the election, or the nomination for election by the Company's shareholders, of each new director was approved by a vote of at least two- thirds of the directors then still in office who are directors at the beginning of the period; or (vi) the adoption by the Board of Directors of a resolution declaring that a Change in Control has occurred. (b) "Cause" shall mean clear and convincing evidence of: (i) material dishonesty by the Executive involving the employer; (ii) failure or refusal to perform a material requirement of the Executive's duties, or failure or refusal to comply with a reasonable, important general policy of the Company, after receipt by the Executive of written notice specifying in detail the failure or refusal, and a reasonable time in which to perform; or (iii) Executive's (a) death or (b) disability (by reason of physical or mental disease, defect, accident or illness) such that Executive is or, in the opinion of two independent physicians, one selected by the Company and one by the Executive or his representative, for purposes of making this determination, will be unable for an aggregate of 180 or more days during any continuous 12- month period to render the services required of him in his then current position with the Company. (c) "Competitive Activities" shall mean: (i) directly or indirectly engaging in, continuing in, or carrying on any business which substantially competes with the business conducted by the Company; 2 (ii) soliciting or accepting orders for business from any persons (whether individuals or entities) who were customers of the Company during the one-year period prior to Executive's termination of employment or inducing or attempting to induce such persons to terminate or modify their relationship with the Company for such business; or (iii) offering, soliciting or agreeing to employ an employee of the Company, or inducing or attempting to induce such an employee to quit his or her employ with the Company, without the prior written consent of the Company; Provided, however, that the term "Competitive Activities" shall not include the ownership of securities of corporations which are listed on a national securities exchange or quoted on a national over-the- counter market in an amount not exceeding 2% of the outstanding shares of any such corporation. (d) "Confidential Information" shall mean confidential business information, which information gives, or has the potential of giving, actual or potential economic value to the Company by not being generally known, or readily ascertainable, by the Company's competitors, and which information the Company has taken, and will continue to take, reasonable steps to maintain confidential vis-a-vis its competitors; provided, however, nothing in this Agreement shall limit the time periods during which Executive and others shall not misappropriate or threaten to misappropriate the Company's trade secrets as protected under Minnesota law. (e) "Date of Termination" shall mean: (i) if this Agreement is terminated by the Company for disability, 90 days after Notice of Termination is given to the Executive (provided that the Executive shall not have returned to the performance of the Executive's duties on a full-time basis during such 90 day period); or (ii) if the Executive's employment is terminated by the Company for any other reason, 90 days after Notice of Termination is given; provided, however, that if within 90 days after any Notice of Termination is given to the Executive by the Company the Executive notifies the Company that a dispute exists concerning the termination, the Date of Termination shall be the date the dispute is finally determined, whether by mutual agreement by the parties or upon final judgment, order, or decree of a court of competent jurisdiction (the time for appeal therefrom having expired and no appeal having been perfected). 3 (f) "Good Reason" shall mean any of the following (without Executive's express written consent): (i) Assignment to Executive by the Company of duties inconsistent with Executive's position, duties, responsibilities, and status with the Company immediately prior to a Change in Control of the Company, or a change in Executive's titles or offices as in effect immediately prior to a Change in Control of the Company, or any removal of Executive from or any failure to reelect or reappoint Executive to any of such positions, except in connection with the termination of his employment for disability, retirement, or Cause or as a result of Executive's death or by Executive other than for Good Reason; (ii) A reduction by the Company of Executive's base salary as in effect on the date hereof or as the same may be increased from time to time during the term of this Agreement or the Company's failure to increase Executive's base salary (within 12 months of Executive's last increase in base salary) after a Change in Control of the Company in an amount which at least equals, on a percentage basis, the average percentage increase in base salary for all executive officers of the Company effected during the preceding 12 months; (iii) Any failure by the Company to continue in effect, or to provide a comparable substitute for, any benefit plan or arrangement (including, without limitation, any profit sharing plan, executive supplemental medical plan, group life insurance plan, and medical, dental, accident, and disability plans) in which Executive is participating at the time of a Change in Control of the Company (or any other plans providing Executive with substantially similar benefits) (hereinafter referred to as "Benefit Plans"), the taking of any action by the Company that would adversely affect Executive's participation in or materially reduce Executive's benefits under any such Benefit Plan or deprive Executive of any material fringe benefit enjoyed by Executive at the time of a Change in Control of the Company; (iv) Any failure by the Company to continue in effect, or to provide a comparable substitute for, any incentive plan or arrangement (including, without limitation, any incentive compensation plan, long- term incentive plan, bonus or contingent bonus arrangements or credits, the right to receive performance awards, or similar incentive compensation benefits) in which Executive is participating, or is eligible to participate, at the time of a Change in Control of the Company (or any other plans or arrangements providing him with substantially similar benefits) (hereinafter referred to as "Incentive Plans") or the taking of any action by the Company which would adversely affect Executive's participation in any 4 such Incentive Plan, expressed as a percentage of his base salary, by more than ten percentage points in any fiscal year as compared to the immediately preceding fiscal year; (v) Any failure by the Company to continue in effect, or to provide a comparable substitute for, any plan or arrangement to receive securities of the Company (including, without limitation, any stock option plan or any other plan or arrangement to receive and exercise stock options, stock appreciation rights, restricted stock, or grants thereof) in which Executive is participating, or is eligible to participate, at the time of a Change in Control of the Company (or plans or arrangements providing him with substantially similar benefits) (hereinafter referred to as "Securities Plans") or the taking of any action by the Company which would adversely affect Executive's participation in or materially reduce Executive's benefits under any such Securities Plan; (vi) If at the time of a Change in Control of the Company Executive is employed at the Company's principal executive offices, a relocation of such principal executive offices to a location more than fifty miles outside of the Minneapolis-St. Paul Metropolitan Area or, if Executive is not employed at the Company's principal executive offices, Executive's relocation to any place other than the location at which the Executive performed Executive's duties prior to a Change in Control of the Company, except for required travel by Executive on the Company's business to an extent substantially consistent with Executive's business travel obligations at the time of a Change in Control of the Company; (vii) Any failure by the Company to provide Executive with at least the number of paid vacation days to which the Executive is entitled at the time of a Change in Control of the Company; (viii) Any material breach by the Company of any provision of this Agreement; (ix) Any failure by the Company to obtain the assumption of this Agreement by any successor or assign of the Company; or (x) Any purported termination of Executive's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 1(g) hereof. (g) "Notice of Termination" shall mean a written notice which shall indicate those specific termination provisions in this Agreement relied upon and which sets forth in reasonable detail the facts and circumstances claiming to provide a basis for termination of the Executive's employment under the 5 provisions so indicated. Any termination by the Company pursuant to this Agreement shall be communicated by Notice of Termination. For purposes of this Agreement, no such purported termination by the Company shall be effective without such Notice of Termination. 2. TERM. This Agreement shall become effective immediately upon execution and shall be in effect until August 31, 1998, and shall be renewed automatically for each subsequent one-year period unless either the Executive or the Company gives written notice to the other party on or before the June 1st immediately preceding the expiration date, or, if a Change in Control has occurred, this Agreement shall be in effect for a period of two (2) years following the date of the Change in Control. 3. SEPARATE EMPLOYMENT ARRANGEMENTS. Executive is, and shall be, employed by the Company solely upon the existing arrangements which are separate from this Agreement, as those employment arrangements hereafter may be amended by the parties. The parties expressly acknowledge and agree that this Agreement is not intended to be an employment agreement. 4. PARTICIPATION IN OTHER EXECUTIVE BENEFIT PLANS. Nothing in this Agreement shall in any manner modify, impair, or affect the existing or future rights or interests of Executive (a) to receive any employee benefits from the Company to which he would otherwise be entitled or (b) as a participant in any incentive, profit-sharing or bonus plan, stock option plan or pension plan of the Company. The rights and interests of Executive to any employee benefits or as a participant or beneficiary in or under any or all such plans shall continue in full force and effect. Executive shall have the right at any future time to become a participant or beneficiary under or pursuant to any and all such plans. Any compensation payable under this Agreement shall not be deemed salary or other compensation to Executive for purposes of any retirement plans maintained by the Company or for purposes of any other fringe benefit obligations of the Company. 5. NONASSIGNABILITY OF BENEFITS. Executive shall not transfer, assign, encumber, or otherwise dispose of his right to receive payments hereunder and, in the event of any attempted transfer or assignment, the Company shall have no further liability to Executive under this Agreement. 6. PAYMENTS AND BENEFITS UPON A CHANGE IN CONTROL. If Executive is employed by the Company upon the occurrence of a Change in Control, the following provisions shall govern: (a) The Executive shall continue to be employed for twenty- four (24) months with substantially the same duties, compensation, and benefits in the same geographic location as existed just prior to the Change in Control. 6 (b) The Executive may terminate his employment during the twenty-four (24) months following the Change in Control for Good Reason as defined herein, and, upon such termination, shall receive from the Company in a lump sum, in cash, on the fifth (5th) day following the Date of Termination, an amount equal to two (2) times the Executive's "annualized includable compensation for the base period" (as defined in Section 280G(d) of the Internal Revenue Code of 1986, as amended (the "Code")), but, in any event, the Executive shall not engage in Competitive Activities for two years following the Date of Termination and shall not divulge at any time Confidential Information about the Company. (c) If the Company terminates the Executive's employment other than for Cause as defined herein, the Executive shall receive as severance pay in a lump sum, in cash, on the fifth (5th) day following the Date of Termination, an amount equal to two (2) times the Executive's "annualized includable compensation for the base period" (as defined in Section 280G(d) of the Code), but, in any event, the Executive shall not engage in Competitive Activities for two years following the Date of Termination and shall not divulge at any time Confidential Information about the Company. (d) The Executive may terminate his employment upon at least three months' notice at the end of the first twelve (12) months of employment after the Change in Control for other than Good Reason, thereby waiving any further benefits hereunder except a severance benefit of three months salary and a prorated portion of annual bonus, provided that the Executive then agrees not to hire or attempt to hire any employee of the Company during the twelve (12) month period following the termination of employment, but, in any event, the Executive shall not divulge at any time any Confidential Information about the Company. (e) If the Executive terminates his employment during the 24- month period following the change in Control otherwise than under any of paragraphs (b) or (d) of this Section 6, the Executive shall not be entitled to any payments for any period after the end of the employment, shall not receive any severance benefit, and shall not engage in any Competitive Activities during the balance of the twenty- four (24) month period, but, in any event, the Executive shall not divulge at any time any Confidential Information about the Company. (f) If the Executive holds any options to purchase stock of the Company after a Change in Control, such options shall become immediately exercisable in full and the Executive shall be entitled to exercise such options until the expiration date provided for in the related stock option agreement. 7 (g) If the lump sum severance payment provided for under this Section 6, calculated as set forth above, either alone or together with other payments which the Executive has the right to receive from the Company, would constitute an "excess parachute payment" (as defined in Section 280G of the Code), such lump sum severance payment shall be reduced to the largest amount as will result in no portion of the lump sum severance payment under this Section 6 being subject to the excise tax imposed by Section 4999 of the Code. The determination of any reduction in the lump sum severance payment under this Section 6(g) pursuant to the foregoing sentence shall be made by the Executive in good faith, and such determination shall be conclusive and binding on the Company. (h) In the event of termination of Executive's employment under paragraph (b), (c), or (d) of this Section 6, Executive shall be entitled to continue to participate in the Company's group medical, dental, life and disability plans on the same basis as Executive participated immediately prior to the Notice of Termination for a period of two (2) years following the Date of Termination. Executive shall be responsible for payment of premiums to the same extent as prior to the Notice of Termination. In the event that Executive becomes eligible for or obtains substantially equivalent coverage from another source, the Company's obligation under this paragraph 6(h) shall terminate. 7. ENTIRE AGREEMENT; HEADINGS. This Agreement is the entire Agreement between the parties on its subject matter and shall be deemed to supersede any other agreements allegedly made between the parties regarding the subject matter. The parties represent that no other such agreements or understandings exist. Headings shall not be utilized in any interpretation of this Agreement. 8. RESOLUTION OF DISPUTES. Any dispute or claim arising out of this Agreement, or breach thereof, shall be decided by arbitration, under the commercial arbitration rules of the American Arbitration Association ("AAA"), and shall be conducted in the Minneapolis, Minnesota, metropolitan area. This agreement to arbitrate shall be specifically enforceable. Any decision rendered by the arbitrator shall be final and binding, and judgment may be entered upon it by any court having jurisdiction. Nothing herein contained shall bar either party from seeking equitable remedies in a court of appropriate jurisdiction. 9. NOTICES. Any notice or other communication provided for herein or given hereunder shall be in writing and shall be delivered in person or, in the case of the Company, to the Board of Directors, or mailed by first class registered or certified mail, postage prepaid, addressed to the Company at its registered office in the State of Minnesota and addressed to the Executive or any other person at the last known address of such person appearing on the books of the Company. 8 10. AMENDMENT. This Agreement may not be changed, modified or amended except in writing signed by both parties. 11. WAIVER OF BREACH. The waiver by either party of the breach of any provision of this Agreement shall not operate or be construed as a waiver of any subsequent breach by either party. 12. INVALIDITY OF ANY PROVISION. The provisions of this Agreement are severable, it being the intention of the parties hereto that should any provisions hereof be invalid or unenforceable, such invalidity or unenforceability of any provision shall not affect the remaining provisions hereof, but the same shall remain in full force and effect as if such invalid or unenforceable provision or provisions were omitted. 13. SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon, and inure to the benefit of, the Company, its successors and assigns, and Executive, his heirs, legal representatives and assigns. 14. GOVERNING LAW. This Agreement is being delivered and is intended to be performed in the State of Minnesota and shall be construed and enforced in accordance with the laws of such state. 15. COUNTERPARTS. This Agreement may be executed simultaneously in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute but one and the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. HEI, INC. Dated: , 1997 By -------------------- ------------------------------------ Its -------------------------------- Dated: , 1997 By -------------------- ------------------------------------ Its -------------------------------- 9 EX-13 5 EXHIBIT 13 ANNUAL REPORT HEI, INC. FIVE YEAR SUMMARY OF SELECTED FINANCIAL INFORMATION (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- -------------------------------------------------------------------------------------------- YEARS ENDED AUGUST 31 1997 1996 1995 1994 1993 - -------------------------------------------------------------------------------------------- Net sales $30,962 $20,680 $23,423 $17,295 $18,893 Cost of sales 24,524 14,957 17,263 12,497 12,174 - -------------------------------------------------------------------------------------------- Gross profit 6,438 5,723 6,160 4,798 6,719 - -------------------------------------------------------------------------------------------- Operating expenses: Selling, general and administrative 2,277 2,342 2,401 2,094 2,130 Research, development and engineering 843 849 754 679 614 Gain on sale of product line, net (215) (45) - -------------------------------------------------------------------------------------------- Operating income 3,533 2,577 3,005 2,025 3,975 - -------------------------------------------------------------------------------------------- Income before income taxes 3,980 2,833 3,250 2,102 3,997 - -------------------------------------------------------------------------------------------- Income taxes 1,430 720 1,210 777 1,459 - -------------------------------------------------------------------------------------------- Net income $2,550 $2,113 $2,040 $1,325 $2,538 - -------------------------------------------------------------------------------------------- Net income per common share $.60 $.52 $.52 $.34 $.66 - -------------------------------------------------------------------------------------------- Weighted average number of common and common equivalent shares 4,279 4,098 3,899 3,858 3,822 - -------------------------------------------------------------------------------------------- Balance sheet: Working capital $14,784 $10,088 $8,380 $5,927 $4,211 Total assets 24,511 22,414 12,857 10,905 8,564 Long-term debt, less current maturities 4,537 5,271 Shareholders' equity 16,995 13,816 10,982 8,671 6,762 - --------------------------------------------------------------------------------------------
TO OUR SHAREHOLDERS Fiscal year 1997 was a year of growth for HEI. We achieved record annual revenue and net income results, and ended the year with an even stronger balance sheet. Revenue for fiscal year 1997 was $30,962,000, compared to $20,680,000 for fiscal 1996. Net income for fiscal 1997 was $2,550,000, or $.60 per share, compared to net income of $2,113,000, or $.52 per share, for 1996. Revenue for the fourth quarter of fiscal 1997 was $6,440,000, compared to revenue of $6,397,000 for the fourth quarter of the previous year, but down from revenue of $9,067,000 for the third quarter of fiscal 1997. Net income for the fourth quarter just ended was $410,000, or $.10 per share, compared to net income for the fourth quarter of fiscal 1996 of $1,329,000, or $.32 per share, including a one-time favorable deferred tax adjustment of $.07. Also during the fourth quarter of this past year, we completed the sale of HEI's optoelectronic switch assembly business and related assets located at Sauk Centre, Minnesota, thereby closing out activities at this site. The net gain after tax on this sale contributed approximately $.03 per share to fourth quarter earnings. Since the revenue from this segment was less than 5% of HEI's total for the 1997 fiscal year, we expect the sale to have minimal impact on future earnings. As has been characteristic of our custom design and manufacturing business, growth may be interrupted periodically by a hiatus either to effect expansion or to concentrate on the replacement of phased-out programs. The ramp-down of a large program in the fourth quarter of fiscal 1995 resulted in a downturn in revenue and profit for that period and the ensuing three quarters of fiscal 1996. Similarly, in the fourth quarter of fiscal 1997 we experienced a phase- out of the high volume disk drive program that represented about 55% of our fiscal 1997 revenue. As stated previously, we anticipate significantly decreased fiscal 1998 quarterly revenue and operating income compared to 1997 quarterly results until equivalent replacement business is secured. We have placed a high priority on gaining new business, and are confident that our current marketing activities will lead to significant new growth opportunities. HEI's financial strength and stability continues to grow, enhancing our ability to weather the storms of adverse business circumstances, and enabling the Company to take advantage of a broader range of expansion opportunities as they may arise. Fiscal 1997 closed with a record Shareholders' Equity of $16,995,000, and a Current Ratio of 6.7:1. 1998 PLANS In addition to our continuing efforts to replace business and resume growth, we will strive to increase stability in operations and performance through a broadening of markets served and/or through expansion of technologies and process capabilities. We intend to advance our depth of knowledge and experience in the diverse materials, substrates and interconnect techniques that can contribute to our competence and reputation as a state-of-the-art ultraminiature microelectronics packaging specialist. We anticipate that continuing trends favoring miniaturization, and outsourcing will create increased potential for small-scale implementations such as flip chip, ball grid array and chip scale packages. Further, we believe that applications in medical instrumentation--including implantables--and telecommunications represent emerging growth opportunities for HEI. During the past year we installed and initiated operation of a flexible high volume, continuous flow manufacturing capability, thereby enhancing our productivity on large volume contracts. It is our goal to take advantage of this capability and expanded capacity to develop an improved balance of large and medium volume manufacturing activities. We have been fortunate to serve exceptional customers who have allowed us to do our best work. The entire team at HEI offers sincere thanks to our customers, employees, shareholders and friends for your ongoing support. Eugene W. Courtney PRESIDENT AND CHIEF EXECUTIVE OFFICER FORWARD-LOOKING STATEMENTS THIS ANNUAL REPORT INCLUDES FORWARD-LOOKING STATEMENTS MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THESE STATEMENTS CONTAIN INFORMATION REGARDING TECHNOLOGY, MARKETS, GROWTH AND EARNINGS EXPECTATIONS BASED ON THE COMPANY'S CURRENT ASSUMPTIONS INVOLVING A NUMBER OF RISKS AND UNCERTAINTIES. THERE ARE CERTAIN IMPORTANT FACTORS THAT CAN CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS, INCLUDING, WITHOUT LIMITATION, ADVERSE BUSINESS OR MARKET CONDITIONS; THE ABILITY OF THE COMPANY TO SECURE AND SATISFY CUSTOMERS; THE AVAILABILITY AND COST OF MATERIALS FROM HEI'S SUPPLIERS; ADVERSE COMPETITIVE DEVELOPMENTS; CHANGE IN OR CANCELLATION OF CUSTOMER REQUIREMENTS; AND OTHER FACTORS DISCUSSED FROM TIME TO TIME IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON FORWARD- LOOKING STATEMENTS; HEI UNDERTAKES NO OBLIGATION TO UPDATE THESE STATEMENTS TO REFLECT ENSUING EVENTS OR CIRCUMSTANCES, OR SUBSEQUENT ACTUAL RESULTS. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION The Company's net cash flow provided by operating activities for the year ended August 31, 1997, was $4,869,000. The significant components of this operating net cash flow were positive cash flow of $3,883,000 from operations before changes in current operating items and a $1,701,000 decrease in accounts receivable. The decrease in accounts receivable is attributable primarily to lower shipment volumes in the last month of the current fiscal year versus the same period of last fiscal year. Accounts receivable average days outstanding were 36 days as of August 31, 1997 compared to 41 days for the same period a year ago. Inventory turns were 10.9 turns and 7.7 turns as of August 31, 1997 and 1996, respectively. The Company increased short-term investments, primarily in commercial paper, to $9,175,000, up $3,687,000 from a year ago. The current ratio at the end of 1997 was 6.7:1 as compared to 4.4:1 at the end of last year. The improved current ratio is principally due to increased cash and cash equivalents and short-term investments partially offset by decreased accounts receivable. In April 1996, the Company completed a new financing agreement which provides for a $3,000,000 revolving line of credit. As of August 31, 1997, there were no borrowings under the line. Borrowings under this agreement would be collateralized by accounts receivable. The agreement contains certain restrictive covenants including limitations on other borrowings and maintenance of specified financial levels and ratios for net income, tangible net worth and debt to tangible net worth. Borrowings would be limited to the lesser of $3,000,000 or the borrowing base, which is 80% of eligible accounts receivable. Interest on the borrowings is based, at the Company's option, on the lender's prime rate of interest or 2% above the lender's LIBOR rate. During fiscal 1997, the Company purchased $1,605,000 of property and equipment to increase manufacturing capacity to meet anticipated requirements. These expenditures were funded primarily from the proceeds of the Industrial Development Revenue Bonds issued in April 1996. Restricted cash of $389,000 at August 31, 1997 represents the unexpended funds from the bonds which are available to the Company for qualifying capital expenditures during the next two years. During fiscal 1998, the Company intends to expend approximately $1.4 million for manufacturing facility improvements and capital equipment. These additions will increase manufacturing capacity to meet anticipated requirements for continued revenue growth. It is expected that these expenditures will be funded primarily from internally generated funds and the remaining funds available from the Industrial Development Revenue Bonds. RESULTS OF OPERATIONS SALES BY PRODUCT LINE - -------------------------------------------------------------------------------- (IN THOUSANDS) 1997 1996 1995 - -------------------------------------------------------------------------------- Microelectronics $30,962 $18,545 $21,187 Peripheral products 2,060 2,157 Other 75 79 - -------------------------------------------------------------------------------- Total $30,962 $20,680 $23,423 - -------------------------------------------------------------------------------- SALES. 1997 VS. 1996: Sales in 1997 increased $10,282,000, or 50%, over fiscal 1996. This increase was due to shipments in the high density disk drive business, primarily to one customer. Shipments to this customer constituted 55% of sales during fiscal year 1997. Because the Company's sales to the computer disk drive market are generally tied to the customers' projected sales and production of the related product, the Company's sales levels are subject to fluctuations outside the Company's control. To the extent that sales to any one customer represent a significant portion of the Company's sales, any change in the level of sales to that customer can have a significant impact on the Company's total revenues. In addition, 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. In April 1997, the Company announced that it had received notice from its then largest current customer to begin phasing out production of a microelectronic assembly used in high density disk drives. Phase out of this program commenced late in the third quarter of this year and was complete by the end of the fourth quarter. The phase out is expected to result in significantly decreased revenues and operating income in fiscal 1998 compared to fiscal 1997 until equivalent replacement business is secured. 1996 VS. 1995: Sales in 1996 decreased $2,743,000, or 12%, from fiscal 1995. Sales of microelectronic circuits, which include the optoelectronic switch assembly business, decreased 12% from $21.2 million to $18.5 million. This decrease was primarily due to reduced shipments to the high density disk drive market as two large programs were completed in late 1995 and early 1996 and was partially offset by the ramp up in the late second half of fiscal 1996 of shipments to another computer disk drive manufacturer. Shipments to the hearing aid and other medical markets more than doubled over fiscal year 1995 as a result of increased demand by current customers and shipments to new accounts. Shipments of peripheral products, primarily light pens, decreased 4% from fiscal 1995. The light pen product line was sold to FTG Data Systems in August 1996. PERCENTAGE OF SALES - -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Sales 100% 100% 100% Gross profit 21% 28% 26% Selling, general and administrative 7% 11% 10% Research, development and engineering 3% 4% 3% - -------------------------------------------------------------------------------- GROSS PROFIT. 1997 VS. 1996: The Company's gross profit as a percentage of sales was 21% in 1997, compared to 28% in 1996. The reduced gross profit rate was primarily the result of volume pricing to a customer resulting in lower gross margin rates for sales on a high density disk drive program. 1996 VS. 1995: The Company's gross profit as a percentage of sales was 28% in 1996, compared to 26% in 1995. The increased gross profit rate reflects primarily the impact of a higher number of products built utilizing customer supplied materials. OPERATING EXPENSES. 1997 VS. 1996: Selling, general and administrative expenses decreased 3% in fiscal year 1997 from the prior fiscal year primarily due to the sale of the light pen product line at the end of fiscal year 1996 and the leveraging effects of a significantly higher sales level. Research, development and engineering expenses remained fairly constant in fiscal year 1997 versus fiscal year 1996. Gain on sale of product line of $215,000 in fiscal year 1997 represents the gain on the sale of the optoelectronic switch assembly business in August 1997. The $45,000 net gain on sale of product line in 1996 represents the gain on the sale of the light pen product line, which was completed in August 1996, partially offset by costs to close down the light pen product line (see Note 3 of Notes to Financial Statements). 1996 VS. 1995: Fiscal year 1996 selling, general and administrative expenses decreased 2% from 1995 and research, development and engineering expenses increased 13%. The decrease in selling, general and administrative expense was primarily due to a reduction in bad debt expense in 1996. The increase in research, development and engineering was primarily in support of increased product development for new disk drive, hearing aid and medical products. As a percentage of sales, selling, general and administrative expenses for fiscal 1996 increased to 11% versus 10% for fiscal 1995, reflecting decreased sales. OTHER, PRINCIPALLY INTEREST INCOME. 1997 VS. 1996: Other income increased $191,000 or 75% from fiscal year 1996 primarily due to increased interest income from significantly higher short-term investment balances, partially offset by higher interest expense on the Industrial Development Revenue Bonds. 1996 VS. 1995: Other income increased $11,000 over fiscal year 1995 primarily due to increased interest income from higher short-term investment balances, partially offset by interest expense on the Industrial Development Revenue Bonds. NET INCOME. 1997 VS. 1996: The Company had net income of $2,550,000 for 1997 compared to net income of $2,113,000 for 1996. Operating income of $3,533,000 was up $956,000 from 1996 reflecting the significant 1997 sales increase. The effective tax rate for fiscal year 1997 was 36% versus 25% in fiscal year 1996. The reduced rate in fiscal year 1996 was due to the elimination of a deferred tax asset valuation allowance. 1996 VS. 1995: The Company had net income of $2,113,000 for 1996 compared to net income of $2,040,000 for 1995. Operating income of $2,577,000 was down $428,000 from 1995, reflecting the decrease in sales of $2,743,000. The increase in net income was primarily due to lower income tax expense. The valuation allowance for the deferred tax asset of $274,000 was eliminated in the fourth quarter of 1996 as a result of the sale and disposal of the light pen inventory and the determination that the deferred tax assets related to the remaining inventory allowance will most likely be recoverable. The elimination of the remaining deferred tax asset valuation allowance resulted in a reduced effective tax rate in fiscal 1996. The effective tax rate for fiscal 1996 was 25% versus 37% for 1995. ISSUES AND UNCERTAINTIES This Annual Report contains forward-looking statements that are based on the Company's current expectations and involve a number of risks and uncertainties. Factors that may materially affect revenues, expenses and operating results include, without limitation, adverse business or market conditions, the ability of the Company to secure and satisfy customers, the availability and cost of materials from suppliers, adverse competitive developments, and change in or cancellation of customer requirements. The forward-looking statements included herein are based on current assumptions that the Company will continue to develop, market, manufacture and ship products on a timely basis, that competitive conditions within the Company's markets will not change materially or adversely, that the Company will continue to identify and satisfy customer needs for products and services, that the Company will be able to retain and hire key personnel, that its equipment, process, capabilities and resources will remain competitive and compatible with the current state of technology, that risks due to shifts in customer demand will be minimized, and that there will be no material adverse change in the Company's operations or business. Assumptions relating to the foregoing involve judgments that are based on incomplete information and are subject to many factors that can materially affect results. The Company operates in a volatile segment of high technology markets and applications that are subject to rapid change and technical obsolescence. Because of these and other factors affecting the Company's operating results, past financial performance should not be considered an indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. The following factors also may materially affect results and therefore should be considered. SUBSTANTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS: The Company has experienced substantial fluctuations in its annual and quarterly operating results, and such fluctuations are expected to continue in future periods. The Company's operating results are affected by a number of factors, many of which are beyond the Company's control. All products manufactured by the Company are custom designed and assembled for a specific customer's requirement in anticipation of the receipt of volume production orders from that customer, which may not always materialize to the degree anticipated, if at all. The Company typically incurs significant start-up costs in the production of a particular product, which costs are expensed as incurred and for which the Company attempts to seek reimbursement from the customer. Accordingly, the Company's level of experience in manufacturing a particular product and its efficiency in minimizing start-up costs will affect the Company's operating results during the periods in which production begins and ramp-up occurs. The efficiencies of the Company in managing inventories and fixed assets, shortages of components or labor, the degree of automation used in the assembly process, fluctuations in material costs and the mix of materials, labor, manufacturing, and overhead costs are also significant factors affecting annual and quarterly operating results. Other factors contributing to fluctuations in the Company's operating results include unforeseen design or manufacturing problems, price competition, functional competition (other means of accomplishing the same or similar packaging end result), the inability to pass on cost overruns, the timing of expenditures in anticipation of increased sales, customer product delivery requirements, and the range of services provided. In addition, the amount and timing of orders placed by a customer may vary due to a number of factors, including inventory balancing, changes in manufacturing strategy, and variation in product demand attributable to, among other things, product life cycles, competitive factors, and general economic conditions. Any one of these factors, or a combination thereof, could adversely affect the Company's annual and quarterly results of operations. The Company's customers generally require short delivery cycles, and a substantial portion of the Company's backlog is typically scheduled for delivery within 90 days. Quarterly sales and operating results therefore depend in large part on the volume and timing of bookings received during or immediately prior to the quarter, which are difficult to forecast in advance of that time. The short lead time for the Company's backlog also affects its ability to accurately plan production and inventory levels. In addition, a significant portion of the Company's operating expenses are relatively fixed in nature and planned expenditures are based in part on anticipated orders. Any inability to adjust spending quickly enough to compensate for any revenue shortfall may magnify the adverse impact of such revenue shortfall on the Company's results of operations. DEPENDENCE ON SINGLE INDUSTRY: During the past several years, the Company's principal market has been the hard disk drive ("HDD") industry. In addition, the Company has made significant sales in the medical products industry, with emphasis on hearing instrument manufacturers, and is expanding its sales efforts to include industrial and telecommunications applications. Each of these industries is characterized by intense competition, relatively short product life cycles, rapid technological change, significant fluctuations in product demand, and significant pressure on vendors to reduce or minimize cost. Although the Company is attempting to reduce its dependence on any single industry, the Company does not expect this historic dependence to change dramatically or quickly. Accordingly, the Company will likely be affected by trends in the industries it serves. CUSTOMER CONCENTRATION: The Company's customer base is highly concentrated. In fiscal 1997 and 1996, the Company's two largest customers accounted for 82% and 54%, respectively, of net sales. Although the Company is attempting to reduce its dependence on a limited number of customers, the Company expects that sales to a relatively small number of original equipment manufacturers ("OEMs") will continue to account for a substantial portion of net revenues for the foreseeable future, and the loss of, or a decline in orders from, one of the Company's key customers would have a material adverse effect on the Company's financial and operating results. COMPETITION: The Company operates in a highly competitive industry and competes against several domestic and foreign providers of similar microelectronics design and/or manufacturing services. The Company also faces competition from the internal operations of its current and potential OEM customers, which the Company believes will continue to evaluate the merits of manufacturing components internally versus outsourcing, and from offshore contract manufacturers, which, because of their lower labor rates and other related factors, enjoy a comparative advantage over the Company with respect to high- volume production. The Company expects to encounter future competition from other electronics manufacturers that currently provide or may begin to provide contract design and manufacturing services. A number of the Company's competitors may have substantially greater manufacturing, financial, technical, marketing, and other resources than does the Company, and may offer a broader scope and presence of operations on a worldwide basis. Significant competitive factors in the high density HDD assembly market, for example, include price, quality, responsiveness, testing capabilities, the ability to manufacture in very high volumes and proximity to the customers final assembly facilities. While the Company has competed favorably in the recent past with respect to these factors, this is a particularly fast changing market, and there can be no assurance that the Company will continue to do so in the future. The trends toward increasingly shorter product cycles and to off-shore production are expected to result in more intense competition as each new customer program is generally open to bidding by the Company and its competitors, increasingly including those with off-shore facilities and capabilities. Further, the Company is often only one of two or more suppliers on any particular customer requirement and is therefore subject to continuing competition on existing programs. In order to remain competitive in any of its markets, the Company must continually provide timely and technologically advanced design capabilities and manufacturing services, ensure the quality of its products, and compete favorably with respect to turnaround and price. If the Company were to fail to compete favorably with respect to the principal competitive factors in its markets served, the Company's business and operating results would be adversely affected. COMPONENT SUPPLY AND SOURCES: Substantially all of the Company's manufacturing services are provided on a turnkey basis in which the Company, in addition to providing design, assembly and testing services, is responsible for the procurement of the components that are assembled by the Company for its customers. Although the Company attempts to minimize margin erosion as a result of component price increases, in certain circumstances it is required to bear some or all of the risk of such price fluctuations, which could adversely affect the Company's profits. To date, the Company has generally been able to negotiate contracts that allow it to shift much of the impact of price fluctuations to the customer; however, there can be no assurance that the Company will be able to do so in all cases. In addition, in order to assure an adequate supply of certain key components that have long procurement lead times, such as integrated circuits, the Company occasionally must order such components prior to receiving formal customer purchase orders for the assemblies that require such components. Failure to accurately anticipate the volume or timing of customer orders can result in component shortages or excess component inventory, which in either case could adversely affect the Company's financial and operating results. Some of the assemblies manufactured by the Company require one or more components that are ordered from, or which may be available from, only one source or a limited number of sources. Delivery problems relating to components purchased from any of the Company's key suppliers could have a material adverse impact on the financial performance of the Company. From time to time, the Company's suppliers allocate components among their customers in response to supply shortages. In some cases, supply shortages will substantially curtail production of all assemblies using a particular component. In addition, at various times there have been industry-wide shortages of electronic components. While the Company has not experienced sustained periods of shortages of components in the recent past, there can be no assurance that substantial component shortages will not occur in the future. Any such shortages could have a material adverse effect on the Company's operating results. VARIABILITY OF CUSTOMER REQUIREMENTS AND CUSTOMER FINANCING: The level and timing of orders placed by customers vary due to the customers' attempts to balance their inventory, changes in customers' manufacturing strategies, and variations and demand for the customers' products. Due in part to these factors, most of the Company's customers do not commit to firm production schedules for more than several weeks in advance of requirements. The Company's inability to forecast the level of customers' orders with certainty makes it difficult to schedule production and optimize utilization of manufacturing capacity. In the past, the Company has been required to increase staffing and incur other expenses in order to meet the anticipated demands of its customers. From time to time, anticipated orders from some of the Company's customers have failed to materialize and delivery schedules have been deferred as a result of changes in a customer's business needs, both of which have adversely affected the Company's operating results. On other occasions, customers have required rapid increases in production that have placed an excessive burden on the Company's resources. There can be no assurance that the Company will not experience similar fluctuations in customer demand in the future. In addition, the Company may carry significant accounts receivable in connection with providing manufacturing services to its customers. Although the Company has not encountered significant problems in collecting on such accounts receivable on a timely basis, if one or more of the Company's principal customers were to become insolvent, or otherwise fail to pay for the services and materials provided by the Company, the Company's operating results and financial condition would be adversely affected. RAPID TECHNOLOGICAL CHANGE: The Company's customers compete in markets that are characterized by rapid technological change and short product life cycles. In particular, the HDD, medical and telecommunications markets are prone to rapid product obsolescence by new technologies. The microelectronics industry could experience future competition from new or emerging technologies that render existing technology less competitive or obsolete. The inability of the Company to develop technologies or acquire capability to meet the evolving market requirements of its customers could have a material adverse effect on the Company's business, financial condition and results of operations, including the Company's ability to maintain its revenue base. MANAGEMENT OF GROWTH: The Company has a recent history of growth, sometimes followed by significant decreases in revenues as customer demands for the Company's products decrease. The Company's future operating results will depend on management's ability to manage periods of both growth and downturn, to be able to hire, train and retain the appropriate number of qualified employees, and to forecast revenues and control expenses. Unexpected declines in revenues, without corresponding and timely reductions in expenses, could have a material adverse effect on the Company's business, results of operations, or financial condition. HIRING AND RETENTION OF EMPLOYEES: The Company's continued growth and success depend to a significant extent on the continued service of senior management and other key employees and the hiring of new qualified employees. Competition for skilled business, product development, technical and other personnel is intense. There can be no assurance that the Company will be successful in recruiting new personnel and retaining existing personnel. None of the Company's employees are subject to a long-term employment agreement, although several key employees are subject to noncompetition agreements. The loss of one or more key employees could have a material adverse effect on the growth of the Company. POSSIBLE VOLATILITY OF STOCK PRICE: The market price of the Company's Common Stock has experienced significant fluctuations and may continue to fluctuate in the future. The market price of the Common Stock may be significantly affected by factors such as changes in requirements or demands for the Company's services, the announcement of new products or product enhancements by the Company or its competitors, technological innovations by the Company or its competitors, quarterly variations in the Company's or its competitors' results of operations, changes in prices of the Company's or its competitors' products and services, changes in revenue and revenue growth rates of the Company, changes in earnings estimates by market analysts, speculation in the press or analyst community, and general market conditions or market conditions specific to particular industries. The stock prices for many companies in the technology sector have experienced wide fluctuations that often have been unrelated to their operating performance. Such fluctuations may adversely affect the market price of the Company's Common Stock. HEI, INC. BALANCE SHEET (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - -------------------------------------------------------------------------------- AS OF AUGUST 31 1997 1996 - -------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $3,458 $1,186 Short-term investments 9,175 5,488 - -------------------------------------------------------------------------------- 12,633 6,674 Accounts receivable, net 2,325 4,039 Inventories 1,575 1,561 Other, principally deferred tax assets 860 764 - -------------------------------------------------------------------------------- Total current assets 17,393 13,038 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Property and equipment: Land 216 216 Building and improvements 3,790 3,767 Fixtures and equipment 8,158 7,667 Accumulated depreciation (5,558) (4,868) - -------------------------------------------------------------------------------- Net property and equipment 6,606 6,782 - -------------------------------------------------------------------------------- Restricted cash 389 2,455 Deferred financing costs 123 139 - -------------------------------------------------------------------------------- Total assets $24,511 $22,414 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $648 $354 Accounts payable 728 673 Accrued liabilities 1,233 1,354 Income taxes payable 569 - -------------------------------------------------------------------------------- Total current liabilities 2,609 2,950 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Long-term debt 4,537 5,271 Deferred tax liability 370 377 - -------------------------------------------------------------------------------- Shareholders' equity: Undesignated stock; 5,000,000 shares authorized, none issued Common stock, $.05 par; 10,000,000 shares authorized; 4,103,176 and 4,030,427 shares issued and outstanding 205 202 Paid-in capital 7,518 6,892 Retained earnings 9,272 6,722 - -------------------------------------------------------------------------------- Total shareholders' equity 16,995 13,816 - -------------------------------------------------------------------------------- Total liabilities and shareholders' equity $24,511 $22,414 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS. HEI, INC. STATEMENT OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - -------------------------------------------------------------------------------- YEARS ENDED AUGUST 31 1997 1996 1995 - -------------------------------------------------------------------------------- Net sales $ 30,962 $ 20,680 $ 23,423 Cost of sales 24,524 14,957 17,263 - -------------------------------------------------------------------------------- Gross profit 6,438 5,723 6,160 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Operating expenses: Selling, general and administrative 2,277 2,342 2,401 Research, development and engineering 843 849 754 Gain on sale of product line, net (215) (45) - -------------------------------------------------------------------------------- Operating income 3,533 2,577 3,005 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Other, principally interest income (447) (256) (245) - -------------------------------------------------------------------------------- Income before income taxes 3,980 2,833 3,250 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Income taxes 1,430 720 1,210 - -------------------------------------------------------------------------------- Net income $ 2,550 $ 2,113 $ 2,040 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Net income per common share $ 0.60 $ 0.52 $ 0.52 - -------------------------------------------------------------------------------- Weighted average number of common and common equivalent shares 4,278,586 4,097,765 3,898,662 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS. HEI, INC. STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------------------------------- COMMON STOCK COMMON STOCK PAID-IN RETAINED SHARES AMOUNT CAPITAL EARNINGS OUTSTANDING OUTSTANDING - --------------------------------------------------------------------------------------------------------- BALANCE, AUGUST 31, 1994 3,685,520 $184 $5,918 $2,569 Net income 2,040 Issuance of common shares under employee stock purchase and option plans 106,077 6 215 Tax benefit of nonqualified stock options 50 - --------------------------------------------------------------------------------------------------------- BALANCE, AUGUST 31, 1995 3,791,597 190 6,183 4,609 Net income 2,113 Issuance of common shares under employee stock purchase and option plans 238,830 12 636 Tax benefit of nonqualified stock options 73 - --------------------------------------------------------------------------------------------------------- BALANCE, AUGUST 31, 1996 4,030,427 202 6,892 6,722 Net income 2,550 Issuance of common shares under employee stock purchase and option plans 177,049 8 799 Common shares repurchased and retired (104,300) (5) (595) Tax benefit of nonqualified stock options 422 - --------------------------------------------------------------------------------------------------------- BALANCE, AUGUST 31, 1997 4,103,176 $ 205 $7,518 $9,272 - --------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS. HEI, INC. STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- YEARS ENDED AUGUST 31 1997 1996 1995 - -------------------------------------------------------------------------------- Cash flow provided by operating activities: Net income $ 2,550 $ 2,113 $ 2,040 Depreciation 1,376 907 759 Amortization 70 31 Accounts receivable and inventory allowances 59 (222) 221 Deferred income tax expense (benefit) 8 (198) Gain on sale of product line, net (215) (45) Other 35 51 3 Changes in current operating items: Accounts receivable 1,701 (1,539) 755 Inventories (60) 537 (102) Other current assets (220) (112) 21 Accounts payable 255 88 (319) Accrued liabilities (121) 311 179 Income taxes payable (569) 394 (191) - -------------------------------------------------------------------------------- Net cash flow provided by operating activities 4,869 2,316 3,366 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Cash flow used for investing activities: Purchases of short-term investments (10,892) (7,033) (6,910) Maturities of short-term investments 7,205 5,365 3,808 Additions to property and equipment (1,605) (4,621) (634) Proceeds on sales of product lines and equipment 494 Decrease (increase) in restricted cash 2,066 (2,455) - -------------------------------------------------------------------------------- Net cash flow used for investing activities (2,732) (8,744) (3,736) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Cash flow provided by financing activities: Proceeds from long-term debt 5,625 Repayment of long-term debt (440) (42) Increase in deferred financing costs (54) (170) Issuance of common stock 807 648 221 Tax benefit of nonqualified stock options 422 73 50 Repurchase of common shares (600) - -------------------------------------------------------------------------------- Net cash flow provided by financing activities 135 6,176 229 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 2,272 (252) (141) Cash and cash equivalents, beginning of year 1,186 1,438 1,579 - -------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 3,458 $ 1,186 $ 1,438 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: - -------------------------------------------------------------------------------- Interest paid $ 218 $ 80 $ 2 Income taxes paid 1,656 515 1,351 - -------------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS. NOTES TO FINANCIAL STATEMENTS NOTE 1 - -------------------------------------------------------------------------------- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES HEI, Inc. (the Company) specializes in the design and manufacture of ultraminiature microelectronic devices and high technology products incorporating those devices. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS. The Company considers its investments in all highly liquid debt instruments with original maturities of three months or less at date of purchase to be cash equivalents. The carrying amount approximates fair value because of the short maturity of those instruments. Short-term investments consist mainly of U.S. Treasury bills and high quality commercial paper with maturities of less than one year. The short- term investments are carried at amortized cost which approximates fair value. The Company had $3,094,000 and $1,282,000 of cash and cash equivalents at August 31, 1997 and 1996, respectively, invested with an affiliate of a single banking institution. INVENTORIES. Inventories are stated at the lower of cost or market and include materials, labor and overhead costs. The first-in, first-out cost method is used to value inventories. The allowance for excess or obsolete stock is determined based on the Company's continuing analysis of inventory levels in excess of current requirements or considered to be obsolete. The Company has established an allowance to record such inventories at estimated net realizable value. PROPERTY AND EQUIPMENT. Property and equipment are stated at cost. Depreciation and amortization are provided on the straight-line method over the estimated useful lives of the property and equipment. Maintenance and repairs are charged to expense as incurred. Major improvements and tooling costs are capitalized and depreciated over their estimated useful lives. The cost and accumulated depreciation of property and equipment retired or otherwise disposed of are removed from the related accounts, and any resulting gain or loss charged or credited to operations. INCOME TAXES. Deferred income tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred income tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using currently enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the periods and the change during the period in deferred income tax assets and liabilities. REVENUE RECOGNITION. Revenue is recognized at the time of shipment. NET INCOME PER COMMON SHARE. Net income per common share is based on the weighted average number of common and common equivalent shares outstanding, assuming the exercise of stock options, when dilutive. In February 1997, Statement of Financial Accounting Standards No. 128 (SFAS No. 128), Earnings per Share (EPS) was issued by the Financial Accounting Standards Board. This standard, which the Company must adopt effective with its second quarter of fiscal 1998, requires dual presentation of basic and diluted EPS on the face of the statement of operations. Net income per common share currently presented by the Company is comparable to the diluted EPS required under SFAS No. 128. Basic EPS for the Company would be calculated based on only weighted average common shares outstanding without considering the dilutive effects of common stock equivalents. USE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. NOTE 2 - -------------------------------------------------------------------------------- MAJOR CUSTOMERS, CONCENTRATION OF CREDIT RISK AND GEOGRAPHIC DATA Major customers, each of which accounted for more than 10% of the Company's net sales for the years ended August 31, were as follows: - -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Customer A 55% 16% Customer B 27% 38% 12% Customer C 10% Customer D 30% Customer E 27% - -------------------------------------------------------------------------------- The Company generally sells its products to original equipment manufacturers in the United States and abroad in accordance with supply contracts specific to certain manufacturer product programs. The Company performs ongoing credit evaluations of its customers' financial conditions and, generally, does not require collateral from its customers. The Company's continued sales to these customers is often dependent upon the continuance of the customers' product programs. Customer A's product program was completed during the fourth quarter of fiscal 1997. The Company's ten largest customers accounted for approximately 95% of net sales in 1997, 88% in 1996, and 89% in 1995 and approximately 87% and 90% of accounts receivable at August 31, 1997 and 1996, respectively. The Company had net sales of $14,970,000 to Thailand in 1997, $6,647,000 and $5,924,000 to Singapore in 1997 and 1996, respectively, and $2,493,000 to Hong Kong in 1995. Net export sales were $22,604,000, $7,278,000 and $4,995,000 in 1997, 1996 and 1995, respectively. The majority of the international sales were to multinational companies who instructed HEI to ship products to their off-shore assembly facilities. NOTE 3 - -------------------------------------------------------------------------------- OTHER FINANCIAL STATEMENT DATA The following provides additional information concerning selected balance sheet accounts at August 31, 1997 and 1996: - -------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) 1997 1996 - -------------------------------------------------------------------------------- Accounts receivable, net: Trade accounts receivable $2,608 $4,309 Less allowance for doubtful accounts (283) (270) - -------------------------------------------------------------------------------- $2,325 $4,039 - -------------------------------------------------------------------------------- Inventories: Purchased parts $1,557 $1,394 Work in process 556 697 Finished goods 220 182 Less allowance for excess or obsolete stock (758) (712) - -------------------------------------------------------------------------------- $1,575 $1,561 - -------------------------------------------------------------------------------- Accrued liabilities: Vacation and employee benefits $482 $500 Payroll related 198 255 Real estate taxes 136 110 Other 417 489 - -------------------------------------------------------------------------------- $1,233 $1,354 - -------------------------------------------------------------------------------- SALE OF PRODUCT LINES. In August 1997 and 1996, the Company sold its optoelectronic switch assembly and light pen product lines, respectively. Through these transactions, the buyers acquired certain assets including manufacturing equipment and related inventory, product licenses and assumed all warranties. In connection with these sales, the Company received cash payments for the assets and an agreement for additional amounts to be paid monthly over the subsequent two years. At August 31, 1996, as a result of the sale of the light pen product line, costs associated with the close down of this product line were accrued and were included in the $45,000 net gain from the sale of product line. The Company anticipates no substantial effect of the sale of these product lines on future operating results. NOTE 4 - -------------------------------------------------------------------------------- FINANCING ARRANGEMENTS In April 1996, the Company received proceeds of $5,625,000 from the issuance of Industrial Development Revenue Bonds. Of these funds, approximately $1,500,000 was used for the construction of the new addition to the Company's manufacturing facility, and the remainder will be or has been used for equipment purchases. The bonds related to the facility expansion require annual principal payments of $90,000 in the first year and $95,000 on April 1 of each year thereafter through 2011. The bonds related to the purchased equipment require payments over seven years from the date of purchase of the equipment through no later than April 1, 2006. In April 1997 the Company repaid $440,000 of the construction and equipment bonds. The bonds bear interest at a rate which varies weekly, based on comparable tax exempt issues, and is limited to a maximum rate of 10%. The interest rate at August 31, 1997 was 3.75%. The bonds are collateralized by two irrevocable letters of credit and essentially all property and equipment. A commitment fee is paid annually to the bank at a rate of 1% of the letters of credit. The letter of credit reimbursement agreement contains certain restrictive covenants including limitations on other borrowings and maintenance of specified financial levels and ratios for net income, tangible net worth, debt to tangible net worth, cash flow and indebtedness. Restricted cash on the balance sheet represents cash advanced under the bonds which is held by the bond trustee in an interest bearing account and will be released to the Company over the next two years for equipment purchases. To the extent such funds are not expended, they will revert back to the bond holders. Also in fiscal 1996, the Company extended the due date of its $3,000,000 revolving line of credit to April 1998. At August 31, 1997 and 1996, there were no borrowings under the line of credit. Any borrowings under this agreement would be collateralized by accounts receivable. The agreement contains certain restrictive covenants including limitations on other borrowings and maintenance of specified financial levels and ratios for net income, tangible net worth and debt to tangible net worth and cash flow. The agreement also includes a covenant which limits the sale of assets not in the ordinary course of business. In accordance with the agreement, the Company received waivers for the sale of each product line. Borrowings are limited to the lesser of $3,000,000 or the borrowing base, which is 80% of eligible accounts receivable. Interest on the borrowings is based, at the Company's option, on the lender's prime rate of interest or at 2% above the lender's LIBOR rate. Principal maturities of long-term debt, excluding the unexpended funds classified as restricted cash, at August 31, 1997 are as follows (in thousands): Years ending August 31, 1998 $648 1999 648 2000 648 2001 648 2002 648 Thereafter 1,556 ---------------------------------------------------------- 4,796 ---------------------------------------------------------- Restricted cash 389 ---------------------------------------------------------- $5,185 ---------------------------------------------------------- NOTE 5 - -------------------------------------------------------------------------------- INCOME TAXES Income tax expense for the years ended August 31 consisted of the following: - -------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) 1997 1996 1995 - -------------------------------------------------------------------------------- Current: Federal $1,279 $829 $1,106 State 143 89 104 Deferred 8 (198) - -------------------------------------------------------------------------------- Income tax expense $1,430 $720 $1,210 - -------------------------------------------------------------------------------- The components of the deferred tax assets and liabilities at August 31, 1997 and 1996 are as follows: - -------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) 1997 1996 - -------------------------------------------------------------------------------- Deferred tax assets: Receivables $160 $138 Inventories 282 199 Accrued liabilities 118 162 Other 76 - -------------------------------------------------------------------------------- $560 $575 - -------------------------------------------------------------------------------- Deferred tax liabilities: Property and equipment $(263) $(377) Deferred gain on sales of product lines (107) - -------------------------------------------------------------------------------- $(370) $(377) - -------------------------------------------------------------------------------- In fiscal 1996, the Company eliminated the valuation allowance of $274,000 for the deferred tax asset related to the allowance established for excess or obsolete inventories due to the sale and disposal of light pen inventories during the fourth quarter of fiscal 1996 and the determination that the deferred tax asset related to the remaining inventory allowance will most likely be recoverable. A reconciliation of the statutory federal income tax rate for the years ended August 31 is as follows: - -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Federal statutory tax rate 34.0% 34.0% 34.0% State income tax rate (net of federal tax effect) 2.4 2.7 3.2 Reversal of valuation allowance (9.7) Other (.5) (1.6) - -------------------------------------------------------------------------------- Effective tax rate 35.9% 25.4% 37.2% - -------------------------------------------------------------------------------- NOTE 6 - -------------------------------------------------------------------------------- STOCK BENEFIT PLANS 1989 PLAN. Under the Company's 1989 Omnibus Stock Compensation Plan (the "1989 Plan"), a maximum of 1,200,000 shares of common stock may be issued pursuant to qualified and nonqualified stock options, stock purchase rights and other stock- based awards. Stock options granted become exercisable in varying increments and generally expire five years after date of grant. The exercise price for options granted is equal to the average closing market price of the common stock for the five days preceding the date of grant. Under the 1989 Plan, substantially all regular full-time employees are given the opportunity to designate up to 10% of their annual compensation to be withheld, through payroll deductions, for the purchase of common stock at 85% of the lower of (i) the market price at the beginning of the plan year, or (ii) the market price at the end of the plan year. During fiscal 1997, 1996 and 1995, 12,049, 26,330 and 22,077 shares at prices of $5.08, $3.96 and $3.95, respectively, were purchased under the 1989 Plan. DIRECTORS' PLAN. Under the directors' plan, 400,000 shares are authorized for issuance, with an annual grant of 10,000 shares to each non-employee director. These grants are effective on the first business day following the annual shareholders' meeting at an exercise price equal to the average closing market price of the common stock for the five days preceding the date of grant. The options become exercisable one year after the grant date and expire five years after the grant date. Options to purchase 40,000 shares were granted each year to the four non-employee directors at $11.325 per share, $6.00 per share and $4.71 per share in 1997, 1996 and 1995, respectively. At August 31, 1997, options for 155,000 shares remain outstanding and 160,000 shares are available for grant. SUMMARY OF ACTIVITY. The following is a summary of all activity involving options: - --------------------------------------------------------------------------- OPTIONS WEIGHTED AVERAGE OUTSTANDING EXERCISE PRICE PER SHARE - --------------------------------------------------------------------------- BALANCE, AUGUST 31, 1994 398,500 $2.884 Granted 377,500 4.713 Exercised (84,000) 1.406 - --------------------------------------------------------------------------- BALANCE, AUGUST 31, 1995 692,000 4.061 - --------------------------------------------------------------------------- Granted 110,000 5.920 Exercised (212,500) 2.473 - --------------------------------------------------------------------------- BALANCE, AUGUST 31, 1996 589,500 4.980 - --------------------------------------------------------------------------- Granted 40,000 11.325 Exercised (165,000) 4.527 Cancelled (17,500) 4.713 - --------------------------------------------------------------------------- BALANCE, AUGUST 31, 1997 447,000 $5.680 - --------------------------------------------------------------------------- At August 31, 1997, 1996 and 1995, the number of shares available for grant were 179,681, 214,230 and 350,560, respectively. The weighted average exercise price and remaining life of the stock options at August 31, 1997 are as follows:
- --------------------------------------------------------------------------------------------------------- OPTIONS OUTSTANDING OPTIONS EXERCISABLE - --------------------------------------------------------------------------------------------------------- EXERCISE PRICE NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED OUTSTANDING AVERAGE AVERAGE EXERCISABLE AVERAGE REMAINING EXERCISE EXERCISE PRICE CONTRACTUAL LIFE PRICE (YEARS) $4.71 - $6.60 407,000 2.52 $5.13 254,500 $5.19 $11.33 40,000 4.42 $11.33 - --------------------------------------------------------------------------------------------------------- $4.71 - $11.33 447,000 254,500 - ---------------------------------------------------------------------------------------------------------
ACCOUNTING FOR STOCK-BASED COMPENSATION. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, a new standard of accounting and reporting for stock-based compensation plans. The Company has adopted the disclosure provisions of the new standard in fiscal 1997. The Company has continued to measure compensation cost, if any, for its stock option plans using the intrinsic value based method of accounting it has historically used and, therefore, the new standard has no effect on the Company's operating results. Had the Company used the fair-value-based method of accounting for its stock option plans beginning in fiscal year 1996 and charged compensation cost against income over the vesting period, net income for fiscal years 1997 and 1996 would have been reduced to the following pro forma amounts: - -------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------- Net income $2,384,000 $2,023,000 Net income per share $.56 $.49 - -------------------------------------------------------------------------------- The weighted-average grant-date fair value of options granted during 1997 and 1996 was $5.59 and $2.92, respectively. The weighted average grant-date fair value of options was determined separately for each grant under the Company's various plans by using the fair value of each option grant on the date of grant, utilizing the Black-Scholes option-pricing model and the following key assumptions: - -------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------- Risk-free interest rates 6.00% TO 6.35% 5.22% to 6.31% Expected life .5 TO 5 YEARS .5 to 5 years Expected volatility 62% 58% Expected dividends NONE None - -------------------------------------------------------------------------------- RIGHTS PLAN. The Company's shareholder rights plan provides for a dividend distribution of one right for each share of common stock to shareholders of record at the close of business on June 10, 1988. With certain exceptions, the rights will become exercisable only in the event that an acquiring party accumulates 20% or more of the Company's voting stock or a party announces an offer to acquire 30% or more of the voting stock. The rights will expire on June 10, 1998, if not previously redeemed or exercised. Each right will entitle the holder to purchase one-fourth of one common share at a price of $6.00 per share, subject to adjustment under certain circumstances. In addition, upon the occurrence of certain events, holders of the rights will be entitled to purchase a defined number of shares of an acquiring entity or the Company's common stock at half its then current market value. The Company will generally be entitled to redeem the rights at $.05 per right at any time until the tenth day following the acquisition of 20% or more or an offer to acquire 30% or more of the Company's voting stock. NOTE 7 - -------------------------------------------------------------------------------- EMPLOYEE BENEFIT PLANS The Company has a 401(k) plan covering all eligible employees. Employees can make voluntary contributions to the plan of up to 20% of their compensation, not to exceed the maximum specified by the Internal Revenue Code. The plan also provides for a discretionary contribution by the Company. During fiscal years 1997, 1996 and 1995, the Company contributed $100,000, $96,000 and $75,000, respectively, to the plan. REPORT OF INDEPENDENT ACCOUNTANTS TO THE SHAREHOLDERS OF HEI, INC.: We have audited the accompanying balance sheet of HEI, Inc. as of August 31, 1997 and 1996, and the related statements of operations, changes in shareholders' equity, and cash flows for the years ended August 31, 1997, 1996 and 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of HEI, Inc. as of August 31, 1997 and 1996, and the results of its operations and its cash flows for the years ended August 31, 1997, 1996 and 1995, in conformity with generally accepted accounting principles. Minneapolis, Minnesota September 26, 1997 STATEMENT OF FINANCIAL RESPONSIBILITY The accompanying financial statements, including the notes thereto, and other financial information presented in this Annual Report, were prepared by management, which is responsible for their integrity and objectivity. The financial statements have been prepared in accordance with generally accepted accounting principles and include amounts that are based upon management's best estimates and judgments. The Company maintains a system of internal accounting controls designed to provide reasonable assurance that the Company's assets are protected and that transactions are executed in accordance with established authorizations and are recorded properly. The reasonable assurance concept is based on recognition that the cost of a system of internal accounting controls should not exceed the benefit derived. The Audit Committee of the Board of Directors is responsible for recommending the independent accounting firm to be retained for the coming year. The Audit Committee meets periodically and privately with the independent accountants, as well as with management, to review accounting, auditing, and financial reporting matters. The Company's independent accountants, Coopers & Lybrand L.L.P., are engaged to audit the financial statements of the Company and to issue their report thereon. Their audit has been performed in accordance with generally accepted auditing standards. SUMMARY OF QUARTERLY OPERATING RESULTS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - -------------------------------------------------------------------------------- FISCAL YEAR 1997 FIRST SECOND THIRD FOURTH - -------------------------------------------------------------------------------- Net sales $6,258 $9,197 $9,067 $6,440 Gross profit 2,383 1,629 1,528 898 Operating income 1,563 809 744 417 Net income 1,010 591 539 410 - -------------------------------------------------------------------------------- Net income per share $.24 $.14 $.13 $.10 - -------------------------------------------------------------------------------- FISCAL YEAR 1996 FIRST SECOND THIRD FOURTH - -------------------------------------------------------------------------------- Net sales $4,710 $4,917 $4,656 $6,397 Gross profit 1,050 1,255 1,093 2,325 Operating income 267 482 284 1,544 Net income 224 342 218 1,329 - -------------------------------------------------------------------------------- Net income per share $.06 $.08 $.05 $.32 - -------------------------------------------------------------------------------- NOTE: The summation of quarterly net income per share on a primary basis for 1997 and 1996 do not equate to the calculation for the year since the quarterly calculations are performed on a discrete basis. CORPORATE INFORMATION HEI INC BOARD OF DIRECTORS ROBERT L. BRUECK Consultant EUGENE W. COURTNEY President and Chief Executive Officer HEI, Inc. WILLIAM R. FRANTA Consultant KENNETH A. SCHOEN Executive Vice President (ret.) 3M Company FREDERICK M. ZIMMERMAN Professor of Manufacturing Systems Engineering University of St. Thomas CORPORATE OFFICERS AND MANAGEMENT EUGENE W. COURTNEY President and Chief Executive Officer JERALD H. MORTENSON Vice President of Finance and Administration, Chief Financial Officer and Treasurer DALE A. NORDQUIST Vice President of Sales and Marketing SCOTT J. KAZLE Director of Engineering WRAY A. WENTWORTH Director of Corporate Quality GENERAL COUNSEL Moss & Barnett A Professional Association Minneapolis, Minnesota INDEPENDENT ACCOUNTANTS Coopers & Lybrand L.L.P. Minneapolis, Minnesota STOCK TRANSFER AGENT AND REGISTRAR Norwest Bank Minnesota, N.A. Box 738 161 North Concord Exchange South St. Paul Minnesota 55075-0738 CORPORATE HEADQUARTERS HEI, Inc. P.O. Box 5000 1495 Steiger Lake Lane Victoria, Minnesota 55386-5000 (612) 443-2500 E-mail: headqtrs@heii.com Internet: www.heii.com FORM 10-KSB A copy of the Company's Annual Report to the Securities and Exchange Commission on Form 10-KSB is available without charge by written or oral request to: Shareholder Relations HEI, Inc. P.O. Box 5000 Victoria, Minnesota 55386 Phone (612) 443-2500 Facsimile (612) 443-2668 ANNUAL MEETING OF SHAREHOLDERS The Company's annual meeting of shareholders will be held on January 21, 1998 at 3:00 PM at the Marquette Hotel (4th floor), 710 Marquette Avenue, Minneapolis, Minnesota. MARKET PRICE AND RELATED MATTERS The Company's common stock is currently traded on The Nasdaq National Market under the symbol HEII. Below are the high and low closing bid prices for each quarter of fiscal year 1997 and 1996, as reported by Nasdaq. 1997 HIGH LOW First Quarter $9-1/2 $6-3/8 Second Quarter 12 8 Third Quarter 9-1/4 4-1/4 Fourth Quarter 6 4-9/16 1996 HIGH LOW First Quarter $6-7/8 $4-3/4 Second Quarter 6-5/8 5-1/4 Third Quarter 8 5-1/2 Fourth Quarter 8 5-1/2 As of August 31, 1997, the Company had approximately 3,150 shareholders of which approximately 490 are shareholders of record. The Company has not declared cash dividends. EX-27 6 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS AUG-31-1997 SEP-01-1996 AUG-31-1997 3,458 0 2,325 0 1,575 17,393 12,164 5,558 24,511 2,609 4,537 0 0 205 16,790 24,511 30,962 30,962 24,524 24,524 2,230 10 218 3,980 1,430 2,550 0 0 0 2,550 .60 .60
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