- Quarterly Report of Financial Condition (10QSB)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-QSB

(MARK ONE)

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the quarterly period ended August 31, 2008

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from ______________ to __________________

Commission file number 001-12810 --------- Hi-Shear Technology Corporation --------------------------------------------------------------------------------

(Exact name of small business issuer as specified in its charter)

Delaware 22-2535743 -------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization)

24225 Garnier Street, Torrance, CA 90505-5355
(Address of principal executive offices)

(Issuer's telephone number) [phone]

---

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: Approximately 6,819,291 of Common Stock, $.001 par value as of October 3, 2008.

Transitional Small Business Disclosure Format (Check one): [ ] Yes [X] No

---

HI-SHEAR TECHNOLOGY CORPORATION

INDEX

PAGE NO. -------- PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS Balance Sheets ......................................................1 August 31, 2008 (unaudited) and May 31, 2008 Statements of Operations ............................................2 Three-months ended August 31, 2008 (unaudited) and August 31, 2007 (unaudited) Statements of Cash Flows.............................................3 Three-months ended August 31, 2008 (unaudited) and August 31, 2007 (unaudited) Notes to Financial Statements (unaudited) ...........................4 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ..............10 CONDITION AND RESULTS OF OPERATIONS ITEM 3 - CONTROLS AND PROCEDURES.........................................14 PART II - OTHER INFORMATION ITEM 5 - BOARD OF DIRECTORS APPROVAL FOR CASH DIVIDEND PAYMENT ..........14 ITEM 6 - EXHIBITS .......................................................14 SIGNATURES ..............................................................15

i

---

PART I FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS BALANCE SHEETS AUGUST 31, MAY 31, 2008 2008 (UNAUDITED) ----------- ----------- ASSETS: Current Assets: Cash and cash equivalents $ 6,858,000 $ 1,655,000 Accounts receivable, net (Note 2) 9,769,000 14,474,000 Inventories, net 2,094,000 1,345,000 Deferred income taxes 2,251,000 2,430,000 Prepaid expenses and other current assets 318,000 182,000 ----------- ----------- TOTAL CURRENT ASSETS $21,290,000 $20,086,000 Land 846,000 846,000 Equipment, net 1,973,000 2,003,000 ----------- ----------- TOTAL ASSETS $24,109,000 $22,935,000 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY: Current Liabilities: Bank line of credit/note payable (Note 3) $ 0 $ 0 Trade accounts payable 678,000 740,000 Accrued liabilities (Note 4) 6,182,000 5,872,000 Deferred revenue (Note 5) 930,000 1,204,000 Current portion of obligations under capital leases 40,000 40,000 ----------- ----------- TOTAL CURRENT LIABILITIES $ 7,830,000 $ 7,856,000 Deferred income taxes 302,000 315,000 Obligation under capital leases (less current portion) 24,000 34,000 ----------- ----------- TOTAL LIABILITIES $ 8,156,000 $ 8,205,000 Stockholders' Equity Preferred stock, $1.00 par value; 500,000 shares authorized; no shares issued 0 0 Common stock, $.001 par value - 25,000,000 shares authorized; 6,819,291 and 6,817,541 shares issued and outstanding at August 31, 2008 and May 31, 2008 respectively 7,000 7,000 Additional paid-in capital 7,880,000 7,823,000 Retained earnings 8,066,000 6,900,000 ----------- ----------- TOTAL STOCKHOLDERS' EQUITY $15,953,000 $14,730,000 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $24,109,000 $22,935,000 =========== =========== See Notes to Financial Statements. 1

---

HI-SHEAR TECHNOLOGY CORPORATION STATEMENTS OF OPERATIONS (UNAUDITED) THREE-MONTH PERIOD ENDED AUGUST 31, 2008 2007 ---------- ---------- REVENUES $6,044,000 $5,659,000 Cost of Revenues 3,073,000 2,837,000 ---------- ---------- GROSS MARGIN 2,971,000 2,822,000 Selling, General and Administrative Expenses 1,019,000 958,000 ---------- ---------- OPERATING INCOME 1,952,000 1,864,000 Interest Income, Net 11,000 12,000 ---------- ---------- INCOME BEFORE INCOME TAX EXPENSE 1,963,000 1,876,000 Income Tax Expense 797,000 746,000 NET INCOME $1,166,000 $1,130,000 ========== ========== Earnings per Common Share - Basic $ 0.17 $ 0.17 ---------- ---------- Earnings per Common Share - Diluted $ 0.17 $ 0.17 ---------- ---------- Weighted # Common Shares Outstanding: Basic 6,818,000 6,790,000 ---------- ---------- Diluted 6,833,000 6,806,000 ---------- ---------- See Notes to Financial Statements. 2

---

HI-SHEAR TECHNOLOGY CORPORATION STATEMENTS OF CASH FLOWS (UNAUDITED) THREE-MONTH PERIOD ENDED AUGUST 31, 2008 2007 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,166,000 $ 1,130,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 113,000 122,000 Accrued losses on uncompleted contracts (50,000) 0 Provision for inventory reserves 0 15,000 Deferred income taxes, net 167,000 71,000 Stock based compensation 52,000 2,000 Changes in assets and liabilities: Accounts receivable 4,705,000 (685,000) Inventories (699,000) (432,000) Prepaid expenses and other assets (136,000) (149,000) Trade accounts payable (62,000) 157,000 Accrued liabilities 310,000 571,000 Deferred revenue (274,000) 207,000 ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES 5,292,000 1,009,000 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of equipment (83,000) (158,000) ----------- ----------- NET CASH USED IN INVESTING ACTIVITIES (83,000) (158,000) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from equipment line of credit 0 295,000 Proceeds from stock options exercised 4,000 75,000 Payment of stock dividends 0 0 Payment on capital lease obligations (10,000) (10,000) ----------- ----------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (6,000) 360,000 ----------- ----------- NET INCREASE IN CASH 5,203,000 1,211,000 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,655,000 997,000 ----------- ----------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 6,858,000 $ 2,208,000 =========== =========== Supplemental Disclosure of Cash Flow Information: Cash paid for interest 1,000 3,000 Cash paid for taxes 244,000 265,000 Non-cash investing and financing activities Stock based compensation 52,000 2,000 See Notes to Financial Statements. 3

---

NOTES TO FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION

Reference is made to the Company's Annual Report on Form 10-KSB for the year ended May 31, 2008. The unaudited Financial Statements included in this Form 10-QSB have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. These rules and regulations permit some of the information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) to be condensed or omitted. Operating results for the three-month period ended August 31, 2008 are not necessarily indicative of the results that may be expected for the year ending May 31, 2009. In management's opinion, the unaudited Financial Statements contain all adjustments, which are of a normal recurring nature, necessary for a fair statement of the results for the three-month period ended August 31, 2008. These unaudited Financial Statements should be read in conjunction with the Financial Statements and notes thereto included in the Company's Annual Report on Form 10-KSB for the year ended May 31, 2008.

In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an interpretation of FAS 109, Accounting for Income Taxes" ("FIN 48"), to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on deregulation, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 on June 1, 2007. The application of FIN 48 did not have a significant effect on the Company's financial position and results of operations for the quarter ended August 31, 2008. The Company's management has considered the various tax positions subject to potential examination in accordance with FIN 48, and as a result, the Company's management does not anticipate any material adjustments that may arise as the result of such examination. Accordingly, no adjustments have been made to the accompanying financial statements. The Company is currently under audit by the Internal Revenue Service for its 2006 tax return. The Company has reviewed the possible outcomes of this audit and does not believe a material adjustment will result.

2. ACCOUNTS RECEIVABLE

Accounts receivable consists of billed and unbilled amounts due from the United States Government, prime and subcontractors under short and long term contracts. Billed and unbilled receivables at August 31, 2008 were $3,099,000 and $6,670,000, respectively, compared to billed and unbilled receivables at May 31, 2008 of $8,111,000 and $6,363,000 respectively.

Unbilled receivables include revenues recognized from fixed priced contracts under the percentage-of-completion method, but in advance of completing billable events.

4

---

3. BANK LINE OF CREDIT AND NOTES PAYABLE

The Company has a business loan agreement with a bank for the purpose of obtaining a revolving line of credit and term loans. Borrowings under this business loan agreement are collateralized by the Company's assets. At both August 31, 2008 and May 31, 2008, the Company did not have any bank debt related to the revolving line of credit. The revolving line of credit, under which the Company can borrow up to a maximum limit of $5,000,000, is set to mature on December 15, 2009. Outstanding balances under the line of credit bear interest based on prime less .25% (4.75% at August 31, 2008) or at the Company's option LIBOR plus 2% (5.17% at August 31, 2008). The Company also has available a $1,000,000 equipment line of credit maturing January 31, 2009, and bearing interest under the same terms as the revolving line of credit. As of August 31, 2008, the balance on this instrument was $0. The business loan agreement contains various financial covenants that have not been modified during the current fiscal year. The Company is in compliance with all bank covenants as of August 31, 2008.

4. ACCRUED LIABILITIES

As of August 31, 2008 and May 31, 2008, accrued liabilities consisted of the following:

August 31, May 31, 2008 2008 ---------- ---------- Accrued vacation $1,283,000 $1,238,000 Accrued salaries, wages and bonus 677,000 653,000 Deferred compensation 111,000 112,000 Accrued commissions 80,000 239,000 Accrued facilities rent 67,000 61,000 Accrued professional fees 63,000 54,000 Accrued Alliance litigation costs 3,275,000 3,275,000 Accrued income taxes 608,000 218,000 Miscellaneous 18,000 22,000 ---------- ---------- Total accrued liabilities $6,182,000 $5,872,000 ========== ========== 5. DEFERRED REVENUE

Deferred revenue is composed of amounts billed to customers in excess of revenues earned and cost incurred and recognized on the related contracts at the end of a financial period. As the Company continues to perform work on those contracts in process, revenue is earned and "deferred revenue" on the balance sheet is reclassified to earned "revenue" on the statements of operations. Deferred revenue at August 31, 2008 was $930,000, compared to deferred revenue at May 31, 2008 of $1,204,000.

6. STOCK-BASED COMPENSATION:

Since June 01, 2006, the Company accounts for stock-based employee and non employee transactions under the requirements of SFAS No. 123R "Share Based Payments" which requires compensation to be recorded based on the fair value of the securities issued or the services received, whichever is more reliably measurable. The Company adopted this statement using a modified prospective application. Prior to June 01, 2006, the Company accounted for stock-based compensation based on the intrinsic value of options at the grant date.

5

---

The Company uses the Black-Scholes option-pricing model to calculate the fair value of the stock options. Stock based compensation expense of $52,000 is included in selling, general and administrative expense for the period ended August 31, 2008.

7. EARNINGS PER SHARE:

Earnings per share (EPS) are computed as net income divided by the weighted-average number of common shares outstanding for the period. EPS assuming dilution reflects the potential dilution that could occur from common shares issuable through stock options. The dilutive effect from outstanding options for both the three months ended August 31, 2008 and August 31, 2007 did not change the earnings per share for either of those periods. Earnings per share for the three month periods ended August 31, 2008 and August 31, 2007 for comparative purposes are provided below.

The following is a reconciliation of the numerators and denominators used to calculate earnings per common share, as presented in the statements of operations:

THREE-MONTH PERIOD ENDED AUGUST 31, 2008 2007 ---------- ---------- EARNINGS PER COMMON SHARE - BASIC: Numerator: earnings available for common Stockholders $1,166,000 $1,130,000 Denominator: weighted average shares - basic 6,818,000 6,790,000 Earnings per common share - basic $ 0.17 $ 0.17 EARNINGS PER COMMON SHARE - DILUTED: Numerator: earnings available for common Stockholder $1,166,000 $1,130,000 Denominator: weighted average shares - diluted 6,833,000 6,806,000 Earnings per common share - diluted $ 0.17 $ 0.17 CALCULATION OF WEIGHTED AVERAGE COMMON SHARE - DILUTED: Weighted Average Number of Common Shares Outstanding During the Period 6,818,000 6,790,000 Effect of Dilutive Securities Options 15,000 16,000 ---------- ---------- Weighted Number of Common Shares and Dilutive Potential Common Stock used in Diluted EPS 6,833,000 6,806,000 ========== ========== Antidilutive shares not included in above calculation because the option price is less than the weighted average 3-month price: Stock options outstanding 0 4,000 ========== ==========

6

---

8. COMMITMENTS AND CONTINGENCIES

Hi-Shear filed suit against United Space Alliance, LLC, a Delaware limited liability company ("Alliance"), and USBI Co., a Delaware corporation ("USBI"), in November 2000 in the Circuit Court of the Eighteenth Judicial Circuit, Brevard County, Florida. Hi-Shear sought to recover damages in excess of $1,500,000, excluding interest, costs, and attorneys' fees, alleging Alliance and USBI breached contracts for Hi-Shear to manufacture and deliver certain hardware for use on the Space Shuttle. Hi-Shear also sought damages based on claims alleging that Alliance and USBI fraudulently induced Hi-Shear to enter into certain contracts to manufacture and deliver certain hardware for use on the Space Shuttle. In addition, Hi-Shear sought damages for claims that defendants misappropriated Hi-Shear's proprietary information and/or trade secrets in certain technical data and information. Hi-Shear also alleged a claim for a declaratory judgment.

Alliance subsequently filed a counterclaim seeking damages of over $450,000, excluding interest, costs, and attorneys' fees, alleging Hi-Shear breached its contracts to manufacture and deliver certain hardware for use on the Space Shuttle. Alliance also alleged a claim for conversion and an accounting relating to certain items of alleged government furnished equipment, and a claim for a declaratory judgment. As part of its defense in the litigation, Alliance claimed that it was coerced through duress to enter into a contract with Hi-Shear where Hi-Shear was the qualified successful lowest bidder. In addition, Alliance demanded that Hi-Shear ship uncertified flight hardware to it for use on the United States Space Shuttle, ahead of its normal certification schedule. USBI did not file a counterclaim against the Company.

In July 2004, Hi-Shear filed a separate but related suit against Pacific Scientific Energetic Materials Company, a Delaware corporation, in the Circuit Court of the Eighteenth Judicial Circuit, Brevard County, Florida. Hi-Shear sought to recover damages, alleging that defendant misappropriated Hi-Shear's proprietary information and/or trade secrets in certain technical data and information, conspired to misappropriate trade secrets, and interfered with Hi-Shear's advantageous business relationships. After defendant filed, and the court ruled on a motion to dismiss, and Hi-Shear filed an amended complaint against Pacific Scientific, the court entered an order staying all further proceedings in the case until the appeals from the suit between Hi-Shear and Alliance and USBI are resolved, and the court enters a subsequent order lifting the stay.

Prior to the trial between Hi-Shear, Alliance, and USBI, the court made legal rulings that the Company did not have trade secrets in certain technical data and information, which the Company alleged had been misappropriated by Alliance and USBI. As a result, the court granted in part Alliance's and USBI's motions for summary judgment on that issue. Prior to trial, the court also made legal rulings that USBI did not fraudulently induce Hi-Shear to enter into a contract to manufacture and deliver certain flight hardware for use on the Space Shuttle. As a result, the court granted Alliance's and USBI's motions for summary judgment on that issue.

Trial before a jury of Hi-Shear's remaining claims against Alliance and USBI, and Alliance's counterclaim against Hi-Shear, commenced on July 5, 2005 in Titusville, Florida. Shortly after the trial began, the court made additional legal rulings, which resulted in its granting the remainder of Alliance's and USBI's motions for summary judgment on the trade secrets issues. As a consequence of those rulings and based on other circumstances, Hi-Shear dismissed its remaining claims against USBI. As a result, USBI was no longer a participant in the trial.

7

---

The jury trial continued through September 2, 2005. Some of Hi-Shear's claims were disposed of by the court based on legal rulings made during the course of trial. Of the remaining claims that the jury was asked to decide, the jury rendered a verdict in favor of Hi-Shear on one of its breach of contract claims, and awarded the Company damages of $57,781, exclusive of interest, costs, and attorneys' fees. The jury found in favor of Alliance on Hi-Shear's remaining breach of contract claims and thus awarded Hi-Shear no damages on those claims. The jury also found in favor of Alliance on its counterclaim for breach of contracts but awarded it no damages. In addition, the jury determined that Hi-Shear converted certain government furnished equipment pursuant to Alliance's conversion counterclaim.

In August 2005, the court entered final judgment on Hi-Shear's claims against USBI. After hearing and denying post-trial motions by both Hi-Shear and Alliance, in May 2006 the court entered final judgment on Hi-Shear's and Alliance's respective claims against each other.

In September 2005, Hi-Shear appealed the final judgment entered on its claims against USBI to Florida's Fifth District Court of Appeal. Alliance participated in that appeal as an appellee based on its having joined in the trade secrets and fraudulent inducement summary judgment motions at the trial level. In February 2007, after hearing oral argument, the court of appeal affirmed the trial court's rulings and final judgment in favor of USBI. The appellate court denied motions by Hi-Shear and Alliance to recover attorneys' fees incurred on appeal.

In June 2006, Hi-Shear appealed the final judgment entered on its claims against Alliance, and Alliance's counterclaims against Hi-Shear, to Florida's Fifth District Court of Appeal challenging the legal basis of the lower court's final judgment including the amounts of the recovery of Hi-Shear's damages on contracts for manufactured components and other claims at trial. The appeal encompasses issues evident throughout the court proceedings, including the legal basis of the trial court's judgments and questionable adverse rulings by the court during the entire course of the trial. Alliance has filed its cross-appeal, parties' briefs on appeal have been filed, and the oral arguments to the appellate court were completed on June 25, 2008. The Florida Fifth District Court of Appeal will issue its decision regarding this appeal in due course. The Company is not able to estimate when the decision will be issued or the ultimate outcome of such decision.

In the final judgments, the trial court retained jurisdiction to consider motions by the parties to recover attorneys' fees and litigation costs. In December 2006, the trial court entered an order denying Hi-Shear's motion for entitlement to recover its attorneys' fees and costs from Alliance, even though Hi-Shear was the only party to have been awarded damages by the jury. In that same order, the court determined that instead, Alliance had prevailed on its claims for breach on three of four contracts and thus was entitled to recover from Hi-Shear its reasonable attorneys' fees incurred relating to count I of its counterclaim against Hi-Shear for breach of contracts. The court also ordered that both Alliance and USBI were entitled to recover their

8

---

respective litigation costs from Hi-Shear. Alliance has claimed the amount of reasonable attorneys' fees it should recover from Hi-Shear is approximately $2,900,000, and the amount of litigation costs it should recover from Hi-Shear is approximately $453,000. USBI has claimed the amount of litigation costs it should recover from Hi-Shear is approximately $48,000. Hi-Shear has opposed these claims, believing that the amounts sought by Alliance and USBI are excessive. In addition, as described below, the Court awarded to Alliance and USBI pre-judgment interest on litigation costs in the amount of approximately $90,000 through August 31, 2008. The Court may also award pre-judgment interest on any attorneys fees awarded at the statutory rate.

On March 13-14, 2008, the trial court held an evidentiary hearing on the amount of reasonable attorneys' fees to be awarded to Alliance. At the hearing, Hi-Shear offered evidence and expert testimony to establish that Alliance's request for reasonable attorneys' fees and costs are excessive and that they should not have exceeded approximately $400,000. The trial court also issued an order requiring memoranda of law by the parties on the amount of costs to be awarded to Alliance and USBI.

On July 28, 2008, the trial court sent a letter to Alliance's attorneys asking them to prepare a form of order regarding attorneys' fees. Hi-Shear received a copy of the letter on July 31, 2008. The letter does not specify the final amount of attorneys' fees to be awarded, and it indicates than an additional hearing will be required on specific issues. However, the letter also indicates that the trial court will make favorable rulings for Alliance on several issues, and it appears that the trial court may award to Alliance substantial amounts of the attorneys' fees it seeks. On August 7, 2008, the trial court sent an additional letter to Alliance's attorneys addressing taxable costs that Alliance and USBI are entitled to recover. On September 15, 2008, the trial court sent an additional letter to Alliance's attorneys addressing interest on litigation costs that Alliance and USBI are entitled to recover.

The final outcome of Hi-Shear's pending appeal and Alliance's pending cross-appeal may have an effect on an award of attorneys' fees and costs to Alliance. Although Hi-Shear believes that it will prevail on its appeal and that the trial court's order that it pay Alliance's attorneys' fees and costs will be reversed, Hi-Shear believed that it was appropriate under generally accepted accounting principles to accrue an estimate of the fees, costs and pre-judgment interest on fees and costs described in the court's letters. Although Hi-Shear is unable to determine the precise amount of attorney fees that will be awarded at this time, it believed that it was appropriate under generally accepted accounting principles to accrue approximately $3,275,000 associated with the litigation for its year ended May 31, 2008.

The Company believes that the ultimate award of an amount of attorneys' fees costs and interest against Hi-Shear, if any, will not have a material adverse impact on the Company's financial position and results of operations in the period a final fee and cost decision is made because an accrual of the estimated cost has been reflected in the fiscal year 2008 financial results. The accrual is based, in part, on the Company's estimate of attorneys' fees that the Court may award Alliance, based on letters from the Court instructing that a subsequent hearing be held to determine the amount of reductions to the Alliance's attorneys' fees. If, however, the Court were to award Alliance the entirety of the attorneys' fees they seek, as well as pre-judgment interest on such fees, the Company would be required to accrue an additional amount of approximately $675,000.

9

---

If the Company prevails in its appeal, and the Court determines that its award of attorneys' fees is therefore in error, the Company would reverse the accrual. A reversal of this accrual amount in whole or in part in a subsequent period would have a positive impact on that period's financial results.

In addition, the Company is subject to other claims and legal actions that may arise in the ordinary course of business. In the opinion of the Company, after consultation with counsel, the ultimate liability, if any, with respect to these other claims and legal actions will not have a material effect on the financial position or on the results of operations.

9. SUBSEQUENT EVENTS

On October 9, 2008, the Company's Board of Directors approved a cash dividend of $0.50 per share to shareholders of record as of the close of business October 24, 2008. The dividend will be paid on October 27, 2008, and is estimated at $3,410,000 for the 6,819,291 outstanding shares. The ex-dividend date is October 22, 2008.

ITEM 2 - MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

Hi-Shear Technology Corporation designs and manufactures high reliability pyrotechnic, mechanical and electronic products for the aerospace industry, national defense and other applications where pyrotechnic power is desirable. Its products are primarily used in space satellites and satellite launch vehicles, exploration missions, strategic missiles, tactical weapons, advanced fighter aircraft and military systems. Customers such as the military, satellite manufacturers, launch vehicle assemblers, U.S. Government departments and agencies (including NASA), foreign space agencies, and others in the aerospace business widely use the Company's aerospace products.

The following discussion of Hi-Shear's financial condition and results of operations should be read in conjunction with the financial statements and notes thereto included elsewhere in this report. This report, including this discussion, may contain forward-looking statements about the Company's business that involve risks and uncertainties. The Company's actual results may differ materially from those anticipated in these forward-looking statements. The statements are based on certain factors including the acceptance and pricing of the Company's new products, the development and nature of its relationships with key strategic partners, the allocation of the federal budget for government sponsored military and aerospace programs and the economy in general.

THREE MONTHS ENDED AUGUST 31, 2008 COMPARED WITH THREE MONTHS ENDED
AUGUST 31, 2007

Revenues recognized during the first quarter ended August 31, 2008 were $6,044,000, which is an increase of $385,000 or 7% from the revenue recognized during the same quarter last year. Revenues, which are calculated by the Company on a percentage-of-completion basis, increased as efforts were expended on a wide range of customer backlog. Increased activity on military aircraft products accounted for the increased revenues in the quarter.

10

---

Cost of revenues for the quarter ended August 31, 2008 was $3,073,000, or 51% of revenues, compared to $2,837,000, or 50% of revenues, for the same quarter last year. The increase in cost of revenues by $236,000 corresponds to the increase in revenues between the same two quarters, as noted above. The percentage cost of revenue also increased. This slight increase is attributable to the variability in the mix of contracts serviced during the quarter.

Gross margin for the quarter ended August 31, 2008 increased $149,000 to $2,971,000, and 49% of revenues, from $2,822,000, and 50% of revenues, reported for the same quarter last year. Gross margin increased due to the increased volume of manufacturing activity during the quarter. Gross margin as a percentage of revenue was slightly less because of an increase in lower margin military aircraft components being processed during the quarter.

Selling, general and administrative expenses increased by $61,000 from $958,000 during the quarter ended August 31, 2007 to $1,019,000 during the quarter ended August 31, 2008. While selling, general and administrative expenses increased by dollars, it remained the same as a percentage of gross margin consistent with cost cutting measures for fixed administrative costs.

The Company realized pre-tax income of $1,963,000, or 32% of revenues, for the quarter ended August 31, 2008, compared to pre-tax income of $1,876,000, or 33% of revenues, for the same quarter last year. The $87,000 and 1% decrease is the result of increases in revenue and increases in cost of revenues described above.

Income tax expense for the first quarter ended August 31, 2008 was $797,000 and 41% of pre- tax income, compared to $746,000 and 40% of pre-tax income for the first quarter ended August 31, 2007. The $51,000 increase in income tax expense wholly corresponds to the increase in pre-tax income, upon which reported income tax expense is principally based.

In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an interpretation of FAS 109, Accounting for Income Taxes" ("FIN 48"), to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on deregulation, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 on June 1, 2007. The application of FIN 48 did not have a significant effect on the Company's financial position and results of operations for the quarter ended August 31, 2008. The Company's management has considered the various tax positions subject to potential examination in accordance with FIN 48, and as a result, the Company's management does not anticipate any material adjustments that may arise as the result of such examination. Accordingly, no adjustments have been made to the accompanying financial statements. The Company is currently under audit by the Internal Revenue Service for its 2006 tax return. The Company has reviewed the possible outcomes of this audit and does not believe a material adjustment will result.

Net income for the quarter ended August 31, 2008 was $1,166,000, or $0.17 per share, compared to net income of $1,130,000, or $0.17 per share, for the quarter ended August 31, 2007.

11

---

In recognition of the Company's strong operational results, a dividend in the amount of $0.50 per share was declared payable to shareholders of record as of the close of business October 24, 2008.

FINANCIAL CONDITION

Accounts receivable balances, which consist of billed and unbilled amounts, plus claims receivable, were $9,769,000 and $14,474,000 at August 31, 2008 and May 31, 2008, respectively. The billed component of the total accounts receivable balance at August 31, 2008 was $3,099,000 compared to $8,111,000 at May 31, 2008. The total accounts receivable balances at both August 31, 2008 and May 31, 2008 include $58,000 for the amount of a jury verdict in the Company's lawsuit against the United Space Alliance ("Alliance"). The Company has filed a Notice of Appeal of that jury verdict (See Note 8). The accounts receivable balances at both August 31, 2008 and May 31, 2008 were not reduced for reserves on doubtful accounts due to the Company's past experience on collecting monies due. Billed accounts receivable decreased $5,012,000 from the balance as of May 31, 2008 due to prompt cash collection.

Unbilled receivables represent revenues recognized from long term fixed priced contracts based upon percentage-of-completion, but in advance of completing billable events for which invoices are submitted to customers. As billing events occur for such contracts, previously unbilled receivables are converted to billed accounts receivable with the preparation and submission of invoices to customers. Unbilled receivables at August 31, 2008 were $6,670,000 compared to $6,363,000 at May 31, 2008. Unbilled accounts receivable increased $307,000; the increase is due to work completed on programs whose billing events have not yet been achieved.

The total accounts receivable balance is 46% of current assets and 41% of total assets. Other than the lawsuit regarding unpaid balances with United Space Alliance, the Company has yet to experience significant collection issues with its other customers nor has it reason to anticipate any collection issues; as a result, there are no reserves for uncollectible amounts against the total receivable balance.

Inventories, net of reserves, increased from $1,345,000 at May 31, 2008 to $2,094,000 at August 31, 2008. The $749,000 increase in net inventory balance was primarily the result of the cumulative cost of acquiring long lead time materials for contracts and performing efforts on building units in anticipation of allocation to current and future contracts. Inventory reserves in the amount of $526,000, which are established in accordance with management's estimates regarding the extent to which inventory items will ultimately be used to generate future revenues, remained unchanged at August 31, 2008 from the balance at May 31, 2008.

Trade accounts payable decreased from $740,000 at May 31, 2008 to $678,000 at August 31, 2008. There are no disputed amounts included in accounts payable at August 31, 2008.

Accrued liabilities increased by $310,000 due mostly to the increase in accrued income taxes. The accrued income taxes balance at August 31, 2008 includes the estimate of the first quarter taxes due; the balance at May 31, 2008 included only the estimated remaining payment of taxes due for fiscal year 2008.

12

---

At both August 31, 2008 and May 31, 2008 the Company did not have any bank debt on its revolving line of credit or equipment loan.

The Company has considered the implications and risks associated with the current banking financial environment and have taken steps to ensure its cash balances are protected from loss.

LIQUIDITY AND CAPITAL RESOURCES

Net cash generated by operating activities during the quarter ended August 31, 2008 was $5,292,000, compared to net cash of $1,009,000 that was provided by operating activities during the same quarter last year. The $4,283,000 increase in net operating cash flows between the two quarters is primarily the result of an increase in billings and collections from billed accounts receivable during the quarter ended August 31, 2008 compared to the same quarter last year.

To supplement cash provided by operating activities, the Company maintains a business loan agreement including a revolving line of credit with a commercial bank, for the purpose of having sufficient cash to meet its cash obligations. The Company's management believes that the current line of credit is sufficient to enable the Company to meet its projected needs for cash throughout the period of time during which the revolving line of credit is available for its use. Furthermore, Hi-Shear's management is confident that the availability of sufficient cash under a revolving line of credit will continue well beyond the maturity date of the current line of credit.

The business loan agreement contains various financial covenants that have not been modified during the current fiscal year. The Company is in compliance with all covenants as of August 31, 2008.

In its attempt to minimize interest expense associated with any outstanding balance that may exist under the revolving line of credit, the Company has arranged with its bank to maintain "zero balances" in its disbursement and depository accounts for the purpose of "sweeping" excess deposited cash to pay down any revolving line of credit balance. Consequently, the reported "cash and cash equivalents" amounts reflected on the Company's balance sheet occasionally are minimal. However, the need to "sweep" excess cash at August 31, 2008 did not exist, and therefore reported "cash and cash equivalents" at that date was $6,858,000.

Effective June 1, 2006, the Company adopted Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), Share Based Payment ("SFAS 123R"). SFAS 123R supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25") and related interpretations and amends SFAS No. 95, Statement of Cash Flows. SFAS 123R requires all share based payments to employees, including grants of employee stock options, restricted stock units and employee stock purchase rights, to be recognized in the financial statements based on their respective grant date fair values and does not allow the previously permitted pro forma disclosure-only method as an alternative to financial statement recognition.

13

---

The estimated value of the Company's stock based awards, less expected forfeitures, is amortized over the awards' respective vesting period on a straight-line basis. In accordance with SFAS No. 123R, net income for the three months ended August 31, 2008 was reduced by $52,000. The implementation of SFAS No. 123R did not have any impact on cash flows from financing activities during the first quarter of fiscal 2009.

The Company had a non-statutory stock option plan, which was in effect from December 23, 1993 through its termination date of December 23, 2003. Under the plan, options to purchase common stock, with a maximum term of ten years, were granted and vested as determined by the Company' Stock Option Committee. Options for up to 500,000 shares could be granted to employees or directors. Termination of the stock option plan did not nullify stock options previously granted, but not exercised. Those options continue to be exercisable through their expiration dates, which occur ten years after their grant dates.

On July 31, 2006 the Company's Board of Directors approved the 2006 Stock Award Plan, which was subsequently accepted by the Company's shareholders for adoption at the October 16, 2006 annual shareholders' meeting. Under the plan, options to purchase common stock, with a maximum term of 10 years, were granted and vested as determined by the Company's Stock Option Committee. Options for up to 500,000 shares could be granted to employees or directors. There were no options granted during the quarter ended August 31, 2008.

ITEM 3 - CONTROLS AND PROCEDURES

The Company conducted an internal evaluation of its disclosure controls and procedures with George W. Trahan, President and Chief Executive Officer (CEO) and Jan L. Hauhe, Chief Financial Officer (CFO). Based upon that evaluation, the CEO and CFO concluded that the Company's disclosure controls and procedures were effective with the on-going improvement being made described in the Company's 2008 annual report. They concluded that the controls and procedures provided the officers, on a timely basis, with all information necessary for them to determine that the Company has disclosed all material information required to be included in the Company's periodic reports filed with the Securities and Exchange Commission. Based upon the officers' evaluation, there were not any significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

PART II - OTHER INFORMATION

ITEM 5 - BOARD OF DIRECTORS APPROVAL FOR A CASH DIVIDEND PAYMENT

On October 9, 2008, the Company's Board of Directors approved a cash dividend of $0.50 per share to shareholders of record as of the close of business October 24, 2008. The dividend will be paid on October 27, 2008, and is estimated at $3,410,000 for the 6,819,291 outstanding shares. The ex-dividend date is October 22, 2008.

ITEM 6 - EXHIBITS

Exhibits: Exhibit 31 Rule 13a-14(a)/15d-14(a) Certifications.

Exhibits 32 Section 1350 Certifications.

14

---

SIGNATURES

In accordance with the requirements of the Exchange Act, the Company caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

HI-SHEAR TECHNOLOGY CORPORATION

Date: October 15, 2008 by: /s/ George W. Trahan ----------------------- --------------------------------- George W. Trahan President, CEO and Chairman Date: October 15, 2008 by: /s/ Jan L. Hauhe ----------------------- --------------------------------- Jan L. Hauhe Chief Financial Officer

15