**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

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** **

**Form 10-KSB**

 

**(Mark One)**
| **ý** | ** ** | **ANNUAL REPORT UNDER  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                             |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                      |
| ** ** | ** ** | **For  the fiscal year ended March 31, 2005**                                                                                                                                                                        |
|       |       |                                                                                                                                                                                                                      |
| **o**      | ** ** | **TRANSITION REPORT UNDER  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                         |
| ** ** | ** ** | ** **                                                                                                                                                                                                                |
| ** ** | ** ** | **For  the transition period from               to               ** |
| ** ** | ** ** | ** **                                                                                                                                                                                                                |
| ** ** | ** ** | **Commission  file number  000-12196**                                                                                                                                                                               |

 

**NVECorporation**

(Nameof small business issuer in its charter)

 
| **Minnesota**                                                   | ** ** | **41-1424202**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification No.) |
|                                                            |       |                                  |
| **11409 Valley View Road, Eden Prairie, Minnesota**             | ** ** | **55344**                             |
| (Address  of principal executive offices)                       |       | (Zip  Code)                           |

 

Issuer’s telephone number  **(952) 829-9217**

 

Securities registered under Section 12(b) ofthe Exchange Act:  **None**

 

Securities registered under Section 12(g) ofthe Exchange Act:  **Commonstock, $0.01 par value (“Common Stock”)**

 

Check whether the issuer: (1) filedall reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.    Yes ý   No o

 

Check here if there is no disclosure ofdelinquent filers in response to Item 405 of Regulation S-B is not contained inthis form, and no disclosure will be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.   o

 

Issuer’s revenues for themost recent fiscal year:  **$11,615,570**

 

The aggregate market valueof the voting stock (Common Stock) held by non-affiliates of the issuer as of May 23,2005, was approximately $73 million based on the last sale price reported forsuch date on The NASDAQ SmallCap Market.

 

The number of shares of theissuer’s Common Stock (par value $0.01) outstanding as of May 23, 2005 was4,569,784.

 

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**DOCUMENTS INCORPORATED BY REFERENCE**

 

Parts of our Proxy Statementfor our 2005 Annual Meeting of Stockholders are incorporated by reference intoItems  10, 11, and 14 hereof.

 

Transitional Small BusinessDisclosure Format (Check one):  Yes o;  No ý

 

 

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**NVE CORPORATION**

**INDEX TO FORM 10-KSB**

 
| **PART I**                                                                                                                     |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1. Description of  Business                                                                                                    |   |
| Our Strategy                                                                                                                        |   |
| Our Products and Markets                                                                                                            |   |
| Sensor Products and Markets                                                                                                         |   |
| Coupler Products and  Markets                                                                                                       |   |
| MRAM Products and Markets                                                                                                           |   |
| Product Manufacturing                                                                                                               |   |
| Product  Distribution                                                                                                               |   |
| New  Product Status                                                                                                                 |   |
| Our  Competition                                                                                                                    |   |
| Principal  Suppliers                                                                                                                |   |
| Major  Customers                                                                                                                    |   |
| Intellectual Property                                                                                                               |   |
| Research and  Development Activities                                                                                                |   |
| Government Regulations                                                                                                              |   |
| Our Employees                                                                                                                       |   |
| Website Access to Our  SEC Filings                                                                                                  |   |
| Item 2. Description of  Property                                                                                                    |   |
| Item 3. Legal Proceedings                                                                                                           |   |
| Item  4. Submission of Matters to a Vote of Security Holders                                                                        |   |
|                                                                                                                                |   |
| **PART II**

Item  5. Market for Common Equity and Related Stockholder Matters                                                 |   |
|                                                                                                                                |
| Item  6. Management’s Discussion and Analysis or Plan of Operation                                                             |   |
| Application  of Critical Accounting Policies and Estimates                                                                          |   |
| Results From Operations                                                                                                             |   |
| Liquidity and Capital  Resources                                                                                                    |   |
| Outlook                                                                                                                             |   |
| Item 7. Financial  Statements                                                                                                       |   |
| Item  8. Changes In and Disagreements With Accountants on Accounting and Financial  Disclosure                                      |   |
| Item  8A. Controls and Procedures                                                                                                   |   |
|                                                                                                                                |   |
| **PART III**                                                                                                                   |   |
| Item 9. Directors,  Executive Officers, Promoters and Control Persons; Compliance With  Section 16(a) of the Exchange Act |   |
| Audit Committee  Financial Experts                                                                                                  |   |
| Code of Ethics                                                                                                                      |   |
| Item 10. Executive  Compensation                                                                                                    |   |
| Item 11. Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                           |   |
| Item 12. Certain Relationships  and Related Transactions                                                                            |   |
| Item 13. Exhibits                                                                                                                   |   |
| Item 14. Principal  Accountant Fees and Services                                                                                    |   |
| Signatures                                                                                                                          |   |
| Report  of Independent Registered Public Accounting Firm                                                                            |   |
|                                                                                                                                |   |
| **FINANCIAL  STATEMENTS**                                                                                                           |   |
| Balance Sheet                                                                                                                       |   |
| Statements  of Income                                                                                                               |   |
| Statement of  Shareholders’ Equity                                                                                             |   |
| Statements of Cash Flows                                                                                                            |   |
| Notes to Financial  Statements                                                                                                      |   |

 

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**PART I**

 

**FORWARD-LOOKINGSTATEMENTS**

Some of thestatements made in this Report and the documents incorporated by reference inthis Report under Item 1 “Description of Business” and Item 6 “Management’sDiscussion and Analysis or Plan of Operation” constitute forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995. These statements are subject to the safe harbor provisions of thereform act. Forward-looking statements may be identified by the use of theterminology such as may, will, expect, anticipate, intend, believe, estimate,should, or continue, or the negatives of these terms or other variations onthese words or comparable terminology. To the extent that this Report containsforward-looking statements regarding the financial condition, operatingresults, business prospects or any other aspect of NVE, you should be awarethat our actual financial condition, operating results and business performancemay differ materially from that projected or estimated by us in theforward-looking statements. We have attempted to identify, in context, some ofthe factors that we currently believe may cause actual future experience andresults to differ from their current expectations. These differences may becaused by a variety of factors, including but not limited to adverse economicconditions, intense competition including entry of new competitors, our abilityto obtain sufficient financing to support our operations, progress in researchand development activities by us and others, variations in costs that arebeyond our control, adverse federal, state and local government regulations,unexpected costs, lower sales and net income or higher net losses thanforecasted, price increases for equipment, our dependence on significantsuppliers including Taiwan Semiconductor Manufacturing Corporation for foundrysemiconductor wafers, our ability to meet stringent customer technicalrequirements, our ability to consummate additional license agreements, ourability to continue eligibility for SBIR awards, our inability to raise prices,failure to obtain new customers, the possible fluctuation and volatility of ouroperating results and financial condition, inability to carry out marketing andsales plans, loss of key executives, and other specific risks that may bealluded to in this report and those discussed in Exhibit 99 to this AnnualReport on Form 10-KSB.

 

**ITEM 1. DESCRIPTION OF BUSINESS.**

 

**In General**

NVE Corporation develops andsells devices using spintronics, a nanotechnology we helped pioneer, whichutilizes electron spin rather than electron charge to acquire, store andtransmit information. We are a licensor of spintronic magnetoresistive randomaccess memory technology, commonly referred to as MRAM, which we believe hasthe potential to revolutionize electronic memory. We also manufacturehigh-performance spintronic products including sensors and couplers which areused to acquire and transmit data in automated factories.

 

**NVEHistory and Background**

We werefounded in 1989 primarily as a government contract research company. Since ourfounding, we have been awarded more than $50 million in government researchcontracts, including more than 30 MRAM development contracts. These contractshave helped us build our intellectual property portfolio.

 

We havelicensed our MRAM intellectual property to others, including CypressSemiconductor Corporation, Honeywell International, and Motorola, Inc. Wemanufacture spintronic sensors and couplers, which are sold through a worldwidenetwork of distributors. We also have an agreement with Agilent Technologies, Inc.to distribute our couplers under their brand.

 

**OurEnabling Technology**

Our designsuse one of two nano-scale spintronic structures: giant magnetoresistors orspin-dependent tunnel junctions. Both structures produce a large change inelectrical resistance depending on the electron spin orientation in a freelayer.

 

In giantmagnetoresistance (GMR) devices, resistance changes due to conduction electronsscattering at interfaces within the devices. The GMR effect is only significantif the layer thicknesses are less than the mean free path of conductionelectrons, which is approximately five nanometers. Our critical GMR conductorlayers are less than two nanometers thick.

 

The secondtype of spintronic structures we use are spin-dependent tunnel junctions, whichare also known as SDT junctions, Magnetic Tunnel Junctions (MTJs), or TunnelingMagnetic Junctions (TMJs). SDT junctions use tunnel barriers that are so thinthat electrons can “tunnel” through a normally insulating material to cause aresistance change. The SDT barrier thicknesses are in the range of one to twonanometers or approximately five molecules. Technological advances in recentyears have made it practical to manufacture such small dimensions.

 

In ourproducts the spintronic elements are connected to integrated circuitry andpackaged in much the same way as conventional integrated circuits.

 

**IndustryBackground**

Much of theelectronics industry is devoted to the acquisition, storage and transmission ofinformation. Global trends such as richer data, more video, and remote datacollection test the speed and capacity of conventional electronics.

 

The 1970sbrought microelectronic devices including Hall-effect sensors for dataacquisition, semiconductor random access memory (commonly referred to as RAM)for data storage, and light-emitting diode-based optical couplers for datatransmission. There have been incremental improvements to these devices overthe years, but the basic limitations of charge-based electronics remain.

 

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We believespintronics represents the first major change in microelectronic technologysince the advent of these devices a generation ago. We believe memories,sensors, and couplers together represent a significant portion of theelectronics industry, which can be addressed by spintronics.

 

Memories are acritical part of almost every electronic device. For some electronic devicefunctions speed is required; others require a large amount of memory; and somerequire nonvolatility. No single semiconductor memory meets all three of theserequirements. For example, a cellphone requires the bit density of DRAM for theoperating software, the speed of SRAM for digital signal processing, and thenonvolatility of flash memory for phone books and other permanent storage. Thethree memories consume power and space. Because they use incompatiblematerials, the three memories are very difficult to combine with each other orwith other cellphone circuitry in a single integrated circuit.

 

Near-termpotential MRAM applications include mission-critical storage such as militaryand industrial applications. As its density increases and cost per bitdecreases, MRAM could replace semiconductor memories in cellphones, computers,and other electronic devices enabling smaller, faster, and more power-efficientelectronics.

 

Sensors areused to detect small changes in magnetic fields. They can be used to detect theposition or speed of robotics and mechanisms, or to acquire information inmedical devices or automobiles. As factories become more automated, there is aneed for more precise position sensing. We believe our spintronic sensors aresmaller, more precise, and more reliable than existing devices. We believe thisallows more efficient production of products such as automobiles. We believethat better sensors will also enable smaller, more reliable medical devices andsafer automobiles.

 

Like sensors,couplers are widely used in factory automation. Couplers provide reliabledigital communication between the various electronic subsystems in factories.For example, couplers are used to send data between robots and centralcontrollers at very high speed. As manufacturing complexity increases, there isa need for higher speed data and more data channels. Because of their uniqueproperties, we believe our couplers transmit more data at higher speeds andover longer distances than conventional devices.

 

**Our Strategy**

Our goal is tobecome the leading developer of practical spintronics technology and devices.We plan to do that by pursuing additional MRAM license agreements, expandingcommercial product sales, and building intellectual property.

 

***Monetize MRAM Intellectual Property ThroughLicensing***

Because of thelarge capital investment required to make large-scale memories, our strategy isto monetize our MRAM intellectual property by licensing others to make devicesusing our technology.

 

Subject tocertain terms and conditions, we could receive royalties if Motorola sells MRAMproducts under its license agreement with us. Motorola has said that it mayhave such devices made by Freescale Semiconductor, Inc., its formersemiconductor division, and Freescale has said that pilot production couldbegin in 2005.

 

Rather thanroyalties, our agreement with Cypress gives us rights to Cypress’ productiondesigns and intellectual property, as well as rights to use Cypress factoriesto manufacture MRAMs for us. Cypress has notified us that it has discontinuedMRAM development, so we are unlikely to commercialize the Cypress designs.

 

***Pursue Additional MRAM License Agreements***

We will pursuenew license agreements, and we expect licensing activity to accelerate onceMRAM sales begin. There can be no assurance as to when or if we will consummateadditional agreements, however.

 

***Expand Product Sales***

We plan tobroaden our sensor and coupler product lines using our proven building blocksand designs. We plan to promote new products with advertising campaignstargeted primarily at factory/industrial controls and instrumentation markets.Our campaigns highlight the advantages of NVE devices compared to conventionaldevices. Examples include our “World’s Smallest” and “World’s Fastest” couplercampaigns.

 

***Fund Basic Technology Development WithResearch and Development Contracts***

Governmentresearch and development contracts were the source of some of our underlyingpatents and product developments. Such contracts account for a large butdeclining portion of our revenue. We are focusing our contract research inthree strategic areas:

1. Ultra-highdensity MRAM;

2. Spin-dependenttunneling (SDT) junctions; and

3. Biomedicalnanosensors for “laboratories-on-chips”

 

The moststrategic of these three research areas is ultra-high density MRAM, whichincludes programs in magnetothermal MRAM, Vertical MRAM, and radiation-hardenedMRAM.

 

**OurProducts and Markets**

We operate inone segment. In addition to licensing MRAM technology, we manufacture and selltwo product lines: sensors to acquire information and data couplers to transmitinformation.

 

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***Sensor Products and Markets***

Our sensor products detectthe presence of a magnet or metal to determine position or speed. The GMRchanges its electrical resistance depending on the magnetic field. In ourdevices, GMR is combined with conventional “foundry” integrated circuitry andpackaged in much the same way as conventional integrated circuits. We sellstandard, or catalog sensors, and custom sensors designed to meet customers’exact requirements.

 

Our sensors are quite small,very sensitive to magnetic fields, precise, and reliable. These advantages haveallowed us to establish a presence in industrial control applications such asrobotics. We are building a medical device market, and we have identifiedminiature medical devices and automobiles as future growth markets.

 

***Coupler Products and Markets***

Our spintronic couplers addan “IsoLoop” integrated microscopic coil to our basic GMR sensor element. Thecoil creates a small magnetic field that is picked up by the spintronic sensor,transmitting data almost instantly. Couplers are also known as “isolators”because they electrically isolate the coupled systems, Our IsoLoop couplers aremore than twice as fast as the fastest optical couplers (110 million bits persecond compared to 50 million bits per second).

 

Our couplers are soldprimarily for factory and industrial networks, with broadband,telecommunications, and automotive applications possible in the future.

 

***MRAM Products and Markets***

MRAM uses spintronics tostore data, combining the speed of semiconductor memory with the nonvolatilityof magnetic disk drives. MRAM is inherently nonvolatile, meaning the dataremains even if power is removed.

 

MRAM has been called theideal memory because it has the potential to combine the speed of SRAM, the densityof DRAM, and the nonvolatility of flash memory.

 

Data is stored in the spinof the electrons in thin metal alloy films, and read with spin-dependent tunneljunctions. Unlike electrical charge, the spin of an electron is inherentlypermanent. In MRAMs, the spin of the electrons is set with tiny bursts ofmagnetism. We have invented several types of MRAM memory cells and modes ofoperation.

 

Advanced MRAM designs we aredeveloping include Vertical MRAM (VMRAM), magnetothermal MRAM, andspin-momentum MRAM. We believe each of these three design approaches have thepotential to increase the scalability of MRAM.

 

In the near term, MRAM couldreplace battery-backed-up SRAMs in mission critical systems such as military,factory control, point-of-sale terminals, and gaming electronics. MRAM has thepotential advantages of being simpler, lower cost, and more reliable thanbattery/memory systems.

 

In the medium term, MRAMcould find application in cellphones and other consumer electronics, where itcould replace three types of memory and enable embedded designs such as systemson chips.

 

Long term, MRAM couldaddress the market for ubiquitous high-density memory, where it could offernonvolatility and higher speed than DRAM or hard-disks, enabling a newgeneration of small, fast, instant-on, computers.

 

**Product Manufacturing**

Our factory is a clean-roomarea with specialized equipment to deposit, pattern, etch, and processspintronic materials. Most of our products are fabricated in our facility usingeither raw wafers or foundry wafers. Foundry wafers contain conventionalelectronics that perform housekeeping functions such as voltage regulation andsignal conditioning in our products.

 

A wafer includes thousandsof devices. We build spintronics structures on wafers in our factory, and thensend the completed wafers to the Far East for sawing and packaging. Thepackaged parts are returned to us for testing and shipment.

 

**Product Distribution**

We rely primarily ondistributors who stock and sell our products throughout the world, includingDigi-Key Corporation, one of the largest electronic component distributors inthe U.S. We also utilize independent manufacturers’ representatives tofacilitate product sales in certain areas, but we plan to rely less on suchrepresentatives as distribution sales grow.

 

Our agreements withdistributors and with sales representatives are generally renewed annually.

 

Agilent, one of the world’sleading suppliers of solid-state couplers, distributes private-labeled versionsof our couplers under an agreement that expires in 2008. Agilent has its ownnetwork of distributors.

 

**New Product Status**

 

***New Standard Products***

In the past year we haveannounced and begun sampling several new standard or “catalog” products forfactory and industrial markets including:

 

•     rotational speed sensors

•     low-power couplers

•     five-channel couplers

•     monolithic couplers

•     new types of isolated RS-485 networktransceivers

 

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***New Custom Products***

In our fiscal year ended March 31,2005 (“fiscal 2005”), we designed and began selling ultra-miniature spintronicsensor integrated circuits to Starkey Laboratories Inc. for hearing aids.

 

***New MRAM Products***

Freescale has said itexpects to begin MRAM pilot production in 2005. There can be no assurance,however, that we will be able to negotiate a license agreement with Freescaleor receive royalties from the sale of devices under our agreements withMotorola.

 

**Our Competition**

 

***Sensor Competition***

Sensor competitors includeAllegro Microsystems, Inc. Honeywell, Royal Philips Electronics, andSensitec GmbH. Allegro makes inexpensive silicon Hall-effect sensors, but webelieve Hall-effect sensors are not as sensitive or precise as our products.Honeywell and Philips make traditional nickel-iron anisotropic magnetoresistive(AMR) sensors. AMR sensors are used in automotive and high-performanceindustrial control systems. Unlike our GMR sensors, AMR sensors have “flipping”artifacts that we believe limit their usability. Flipping is when the devicepolarity is reversed when exposed to a stray magnetic field causing erroneousdata. Sensitec has begun to sell GMR sensors, but we believe we have a broaderproduct line and certain product advantages.

 

***Coupler Competition***

The two main competingdigital couplers are optical couplers and inductive couplers (transformers).Optical couplers use light and light detectors to transmit information;transformers use magnetic fields transmitted between coils of wire. In additionto being a customer, Agilent is a leading producer of high-speed opticalcouplers. Other top optical coupler suppliers are Vishay Intertechnology, NECCorporation, Toshiba Corporation, and Fairchild Semiconductor International.Inductive couplers are made by a number of companies. We believe our couplersare considerably faster than even the fastest optical couplers. Unlike ourIsoLoop couplers, inductive couplers require special encoding to transmit logicsignals. Furthermore, IsoLoop couplers require much less board space than mostoptical or inductive couplers.

 

Analog Devices, Inc.(ADI) markets microelectronic mechanical system (MEMS) inductive couplers.While these devices offer some advantages over our couplers and are smallerthan other inductive couplers, we believe our devices have higher channeldensity per area, are faster, and produce less signal distortion than competingADI devices.

 

We make several networksignal couplers that combine spintronics coupling with network protocolfunctions such as RS-485, in a single package. Our competitors in this areainclude ADI, Linear Technology Inc. (LTI), and Maxim Integrated Products, Inc.Based on a comparison of published specifications, we believe our devices aremuch faster than the LTI and Maxim network signal couplers. We believe we offera wider input voltage interface and a more complete line of network protocolsthan ADI’s network signal couplers.

 

***MRAM Competition***

Most currentlyavailable memories are volatile, meaning data is lost when power is removed.Memories in this category include dynamic random access memory (DRAM) andstatic random access memory (SRAM). MRAM has the potential to match or exceedthe speed of such memories without the volatility. Currently availablenonvolatile memories include flash memories and ferroelectric random accessmemories (FRAMs). MRAMs are potentially faster and use less power than existingnonvolatile memories. Furthermore, existing nonvolatile memories can be writtenonly a limited number of times before they wear out, while MRAMs have virtuallyunlimited life.

 

We believeMRAM is potentially higher density than FRAM. Flash memory may be subject toscalability limitations, which could limit its density in coming years. We donot believe MRAM is subject to such limitations.

 

Flash memorymanufacturers include Advanced Micro Devices, Inc., Intel Corporation,Renesas Technology Corporation, Samsung Electronics Ltd., andSTMicroelectronics NV. Current and potential FRAM manufacturers include FujitsuLimited, Infineon Technologies AG, Ramtron International Corporation, SamsungElectronics Ltd., STMicroelectronics NV, and Texas Instruments Inc.

 

Silicon-oxide-nitride-oxide-silicon(SONOS) memory has been suggested as a possible improvement over conventional “floatinggate” flash memories. Simtek Corporation, Cypress, and possibly Freescale areamong companies believed to be developing SONOS memories.

 

Battery-backed-upSRAM manufacturers include Maxim. We believe that MRAM has the potential ofbeing simpler, lower cost, and more reliable than battery-backed-up SRAM.

 

Emergingtechnologies competing with MRAM include carbon nanotubes, phase-change memory(PCM; also known as ovonic unified memories or OUM), polymer memory, andpolymeric ferroelectric random access memory (PFRAM). We believe that MRAM hasadvantages over these technologies and that it is closer to commercializationand more scalable. Companies developing carbon nanotube memory include Nantero, Inc.Intel. Companies developing PCM include Elpida Memory, Inc., IBMCorporation, Infineon, Intel, Macronix International Co., Ltd., Ovonyx, Inc.,Philips, and STMicroelectronics. Companies developing polymer memory includeThin Film Electronics ASA and Coatue. Intel may be developing PFRAM.

 

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Othercompanies that may be attempting to develop MRAM intellectual property with theintention of licensing to others include Grandis, Inc., Spintec (Grenoble,France), and Spintron (Marseille, France).

 

Many of ourMRAM competitors and potential competitors are established companies that havesignificantly greater financial, technical, and marketing resources than us.

 

**Principal Suppliers**

Our principal suppliersinclude manufacturers of semiconductor wafers that are incorporated into ourproducts. These include Advanced Semiconductor Manufacturing Corporation ofShanghai (China), AMI Semiconductor, Inc., Intersil Corporation, TaiwanSemiconductor Manufacturing Corporation, and Texas Instruments Inc.

 

Other companies supply ourdevice packaging services, including Circuit Electronics Industries (Ayutthaya,Thailand), and NS Electronics Bangkok (Thailand), Ltd.

 

We maintain inventory ofsome critical wafers, but we have not identified or qualified alternatesuppliers for many of the wafers now being obtained from single sources. Someof our products use processes or tooling unique to a particular packagingvendor, and it might be expensive, time-consuming, or impractical to convert toanother vendor in the event of a supply interruption. Supply interruptionscould seriously jeopardize our ability to provide products that are critical toour business and operations.

 

**Major Customers**

We have several majorcustomers including Agilent, St. Jude Medical, Inc., the U.S. Government,and certain distributors including Digi-Key Corporation. Orders from thesecustomers can be cancelled, postponed, or reduced without cause or notice, andthe loss of any of these customers could have a significant impact on ourrevenue and profitability.

 

**Intellectual Property**

 

***Patents***

We were granted four U.S.patents in fiscal 2005, and as of March 31, 2005 we had 33 U.S. patentsissued. Our technology is protected by a total of more than 100 patentsworldwide either issued, pending or licensed from others. We are continuing todevelop and intend to add to our patent portfolio. There are no patents weregard as critical to our business owned by us or licensed to us that expire inthe next 12 months.

 

Certain of our patents coverMRAM cells with transistor selection for data retrieval, which we believe maybe necessary for successful high-density, high-performance MRAMs. We knowof no practical alternative design being pursued by potential MRAM suppliersthat could be sold in commercial quantities in the foreseeable future.

 

We believe our 6,275,411 and6,349,053 U.S. patents, both entitled “Spin Dependent Tunneling Memory,” areparticularly important. Both patents cover MRAMs using arrays of Spin DependentTunnel Junctions. Based on their public disclosures, we believe severalcompanies are pursuing the approach described in these patents. The 6,275,411patent expires in 2019 and the 6,349,053 patent expires in 2021.

 

We have patents on advancedMRAM designs that we believe are important including patents that relate tomagnetothermal MRAM, spin-momentum MRAM, and synthetic antiferromagneticstorage.

 

***Trademarks***

Our trademarks include “GMRSwitch” and “GT Sensor.” “IsoLoop” is our registered trademark.

 

***Licenses***

We have licensed certainMRAM intellectual property to several companies. Our current MRAM licenseesinclude Cypress, Honeywell, Union Semiconductor Technology Corporation, andMotorola. We have received advance payments in conjunction with the Honeywell,USTC, and Motorola agreements, and we expect to receive royalties under the Motorolaand USTC agreements if and when those licensees begin selling devices using ourintellectual property. Both agreements contain royalty limitations,specifically minimum quantities before royalties are paid and ceilings on theroyalties we will receive. As a further royalty limitation, the Motorolaagreement provides for royalties only on the portion of the die containing ourMRAM technology.

 

*Agreementswith Honeywell*

Under our agreements withHoneywell we will not be paid royalties by Honeywell if they utilize our MRAMintellectual property, and we do not expect to pay royalties to Honeywell forthe use of their MRAM intellectual property.

 

*MotorolaLicense*

Motorola has anon-exclusive, non-transferable, and non-assignable license to our MRAMintellectual property. Motorola has since separated Freescale. Motorola andFreescale asked us to consent to Motorola’s assignment of the Patent LicenseOption Agreement to Freescale. We have declined to provide such consent withoutadditional consideration.

 

Motorola has indicated to usthat it may attempt to have MRAMs manufactured by Freescale for Motorola underthe so-called “have made” rights in our agreement with Motorola. We believeMotorola will likely have terminated this agreement and so relinquish its have-maderights at the end of calendar 2005, as a result of having transferred its MRAMmanufacturing capability to Freescale. We hope to, before then, negotiate a newagreement with Freescale, or an assignment of the Motorola agreement toFreescale, though only with amendments thereto, but there can be no

 

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assurances that we willcomplete such an agreement or assignment.

 

*CypressTechnology Exchange Agreement*

Under our technologyexchange agreement with Cypress, each party gained rights to the other party’sMRAM intellectual property and patents. We have rights to all of Cypress’ MRAMintellectual property existing now and in the future, including MRAM designsand mask works. Cypress informed us in April 2005 that it has discontinuedits efforts to develop MRAM, so we are unlikely to commercialize the Cypressdesigns.

 

*RoyaltyAgreement*

We have licensed rights toanother organization’s GMR-related patent, and that agreement calls for us topay royalties on our sales of certain products. Payments under this agreementhave not been material to date. The agreement could remain in force untilcumulative royalties of $1.2 million have been paid.

 

**Research and Development Activities**

We invested $5,860,200 and$6,382,865 in the years ended March 31, 2005 and 2004 on research anddevelopment. All but $841,731 and $737,447 or the expenditures were funded bycustomers through research and development contracts. Most of our research anddevelopment contracts are with the U.S. government, and most of our U.S.government contracts are with the Department of Defense.

 

Our near-term researchprograms include sensors and couplers. Long-term research programs are focusedin three strategic areas: ultra-high density MRAM; spin-dependent tunneling(SDT) junctions; and biomagnetic sensors.

 

We invested in thedevelopment of new sensors and couplers, including a new family of monolithiccouplers called the IL600-series and new types of isolated RS-485 networktransceivers. We also invested in designs to improve the manufacturing yield ofour couplers. We believe higher manufacturing yields will reduce our costs,allowing us to improve our margins or reduce our selling prices.

 

The goal of our SDT junctionresearch is to optimize high-sensitivity junctions. SDT junctions are keyspintronics building blocks used in MRAM, ultra-sensitive sensors, andbiomagnetic sensors.

 

Our biomagnetic sensorresearch covers the use of nanoscale magnetics at the cellular molecular level.Applications include ultra-miniature biological warfare agent detectors,real-time DNA testers, and laboratory-on-a-chip diagnostic systems.

 

**Government Regulations**

We are subject to variouslocal, state and federal laws, regulations and agencies that affect businessesgenerally. These include regulations promulgated by federal and state environmentaland health agencies, the federal Occupational Safety and Health Administration,and laws pertaining to the hiring, treatment, safety and discharge ofemployees.

 

With certain exceptions,federal regulations require a business to be at least 51% owned by one or moreindividuals to be eligible to compete for Small Business Innovation Researchawards. While we believe we currently meet the 51% ownership criterion, changesin our capital structure or purchases by entities in the open market or byother means could cause us to become ineligible.

 

Much of our intellectualproperty has been developed with U.S. government support. In accordance withfederal legislation, companies normally may retain the principal worldwidepatent rights to any invention developed with U.S. government support.

 

**Our Employees**

As of March 31, 2005,we had 64 employees, 60 of whom were full-time. Of our full-time employees,there were six general and administrative employees, six sales and marketingemployees, 23 technicians, and 25 scientists. Twelve employees have earneddoctorate degrees. None of our employees is represented by a labor union or issubject to a collective bargaining agreement, and we believe we maintain goodrelations with our employees.

 

**EnvironmentalMatters**

We are subject toenvironmental laws and regulations, particularly with respect to industrialwaste and emissions. Compliance with these laws and regulations has not had amaterial impact on our capital expenditures, earnings, or competitive position.

 

**Website Access to Our SEC Filings**

All reports we file with theSecurities and Exchange Commission (SEC), including our annual reports on Form 10-KSB,quarterly reports on Form 10-QSB, and current event reports on Form 8-K,as well as any amendments to those reports, are accessible at no cost throughthe “Investors” section of our website at www.nve.com. These filings arealso accessible on the SEC’s website at www.sec.gov.

 

**RiskFactors**

We discuss certain riskfactors that may affect our business and financial results in Exhibit 99to this Annual Report on Form 10-KSB.

 

**ITEM 2. DESCRIPTION OF PROPERTY.**

Our principal executiveoffices and manufacturing facility are located at 11409 Valley View Road, EdenPrairie, Minnesota, 55344. The space consists of 21,362 square feet of offices,laboratories, and production areas. The space is owned and managed byGlenborough Properties, L.P. and is leased to us under an agreement expiring December 31,2008. We believe the building is adequately insured.

 

8

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In fiscal 2005 we expandedour clean-room production area by converting office areas. We financed theexpansion through operating profits and a rent credit for that purpose providedby our building’s owner. We believe the expansion will allow us to meet ournear-term facility needs, and we have no additional significant near-termexpansion plans.

 

We hold no investments inreal estate, real estate mortgages or securities of persons primarily engagedin real estate activities.

 

**ITEM 3. LEGAL PROCEEDINGS.**

In the ordinary course ofbusiness we may become involved in litigation. At this time, we are not awareof any material pending or threatened legal proceedings or other proceedingscontemplated by governmental authorities that would have a material impact uponus.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.**

No matters were submitted toour shareholders during the quarter ended March 31, 2005.

 

**PART II**

 

**ITEM 5. MARKET FOR COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS.**

Our common stock trades onThe NASDAQ SmallCap Market under the symbol NVEC. The following data set forth,for the quarters indicated, a summary of the high and low sales price of ourcommon stock as reported on the NASDAQ SmallCap Market without retail mark-up,markdown or commissions, and may not represent actual transactions.

 

 

**Holders andDividends**

As of March 31, 2005 wehad approximately 140 shareholders of record and approximately 10,870 totalshareholders. We have never paid or declared any cash dividends on our commonstock. We do not anticipate paying any dividends in the foreseeable future, andintend to retain any earnings we may generate to provide for the operation andprojected expansion of our business.

 

**ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLANOF OPERATION.**

You should read thisMD&A together with our financial statements and the notes to thosefinancial statements included in this Report. In addition to historicalinformation, the following discussion contains forward-looking information thatinvolves risks and uncertainties. Our actual future results could differmaterially from those presently anticipated due to a variety of factors,including those discussed in Exhibit 99 to this Annual Report on Form 10-KSB.

 

**General**

We develop and sell devicesusing “spintronics,” a technology we helped pioneer, which utilizes electronspin rather than electron charge to acquire, store, and transmit information.Our products include magnetic sensors to acquire ultra-precise data such as theposition of a robot arm, and couplers to transmit data between electronicsystems at very high speed. We are also a licensor****of spintronic magnetoresistive random access memory technology,commonly referred to as MRAM, which we believe has the potential torevolutionize electronic memory.

 

Our strategy is to expandproduct revenue while relying on U.S. government contracts for basic technologydevelopment. The expansion of product revenue will require additional productdevelopment and marketing expenditures as well as working capital to fundreceivables and inventories.

 

**Application of Critical Accounting Policies andEstimates**

In accordance with SECguidance, those material accounting policies that we believe are the mostcritical to an investor’s understanding of our financial results and conditionand require complex management judgment are discussed below.

 

***Product Warranty Estimation***

We maintain a reserve forwarranty claims based on the trend in the historical ratio of claims to sales,releases of new products and other factors. The warranty period for ourproducts is generally one year. Although we believe the likelihood to berelatively low, claims experience could be materially different from actualresults because of the introduction of new products, manufacturing changes thatcould impact product quality, or as yet unrecognized defects in products sold.As of March 31, 2005 and 2004 estimated warranty claims are not materialto the financial statements.

 

***Inventory Reserves Estimation***

We maintain reserves forpotentially excess, obsolete, and slow-moving inventory. The amounts of thesereserves are based upon expected product lives, competitive conditions,industry conditions, and forecasted sales demand. Our results could bematerially different if demand for our products decreased because of economicor competitive conditions, length of the industry downturn, or if productsbecome obsolete because of technical

 

9

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advancements by us or in theindustry. Alternatively, if we are able to sell previously reserved inventory,we reverse a portion of the reserve. Changes in inventory reserves are recordedas a component of cost of sales. At March 31, 2005 our obsolesce reservewas $180,000, compared to $240,000 at March 31, 2004. The decrease was dueto sales of parts that were previously included in the reserve calculation.

 

***Allowance for Doubtful Accounts Estimation***

We must make estimates ofthe uncollectibility of our accounts receivable. The most significant risk isthe risk of sudden unexpected deterioration in financial condition of asignificant customer that is not considered in the allowance. We specificallyanalyze accounts receivable, historical bad debts, and customercredit-worthiness when evaluating the adequacy of the allowance for doubtfulaccounts. Our results could be materially impacted if the financial conditionof a significant customer deteriorated and related accounts receivable aredeemed uncollectible. At March 31, 2005 our allowance for doubtfulaccounts was $15,000, unchanged from March 31, 2004. We expect ourallowance for doubtful accounts to remain a relatively small percentage of ouraccounts receivable because much of our receivables are with U.S. governmentagencies, which we consider very credit worthy. Most of our product sales arethrough distributors, which generally assume the credit risk of the end-usercustomers. Our allowance for doubtful accounts could increase in the future iflarger portions of our sales come from end users.

 

***Deferred Tax Asset Estimation***

In determining the carryingvalue of our net deferred tax assets, we must assess the likelihood ofsufficient future taxable income in certain tax jurisdictions, based onestimates and assumptions to realize the benefit of these assets. We evaluatethe realizability of the deferred assets quarterly and assess the need forvaluation allowances or reduction of existing allowances quarterly. In fiscal2005 we reduced the amount of our valuation allowance based upon our cumulativeincome over the past three years and our expectation of income in our fiscalyear ending March 31, 2006 (“fiscal 2006”).

 

We do not expect to paytaxes in the near future because we have stock-based compensation deductions.We expect to begin recognizing tax expenses for reporting purposes in fiscal2006, however, because under Statement of Financial Accounting Standards (SFAS)No. 109, *Accounting for Income Taxes,*stock-based compensation deductions do not reduce taxes reported for bookpurposes. As of March 31, 2005, our deferred assets were $3,984,808 withrelated valuation allowance of $3,228,734. Deferred tax assets include$3,363,179 of stock-based compensation deductions. We expect to use thesedeferred tax assets starting in the first quarter of fiscal 2006 assuming weare profitable. If and when we use stock-based compensation deductions, we willrecord provisions for income tax although we will not be paying income tax otherthan possibly alternative minimum tax. In accordance with SFAS No. 109,stock-based compensation deductions do not reduce taxes reported for bookpurposes but are credited to additional paid-in capital.

 

**Results From Operations**

The table shown below summarizesthe percentage of revenue for the various items for the periods indicated:

 
| ** **               | ** ** | **Year Ended March 31** | ** ** |
|--------------------------|------------|------------------------------|------------|
| ** **               | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| Revenue                  |       |                         |       |   |   |
| Research and development |       | 52.5                         | %          | 55.1 | % |
| Product sales            |       | 47.5                         |       | 44.9 |   |
| Total revenue            |       | 100.0                        |       | 100.0 |   |
|                     |       |                         |       |   |   |
| Cost of sales            |       | 60.4                         |       | 62.0 |   |
| Gross profit             |       | 39.6                         |       | 38.0 |   |
|                     |       |                         |       |   |   |
| Total expenses           |       | 25.7                         |       | 22.4 |   |
| Income tax benefit       |       | (1.2                         | )          | (1.9 | ) |
| Net income               |       | 15.1                         | %          | 17.5 | % |

 

Research and developmentrevenue decreased 8% in fiscal 2005 to $6,093,320 from $6,617,311 for ourfiscal year ended March 31, 2004 (“fiscal 2004”), due to a shift fromgovernment-funded research contracts to company-funded research.

 

Product sales increased 2%to $5,522,250 in fiscal 2005 compared to $5,393,540 in fiscal 2004. Theincrease in product sales was despite a decline in sales to St. Jude Medicaland an industry-wide inventory glut that we believe negatively impacted oursales in the quarter ended December 31, 2004. The decline in sales to St.Jude Medical was due to St. Jude Medical purchasing parts for inventory infiscal 2004 as they expanded their use of our components.

 

Total revenue for fiscal2005 was $11,615,570, a decrease of 3% from revenue of $12,010,851 in fiscal2004. The decrease was due to a decrease in research and development revenuepartially offset by an increase in product sales.

 

Gross profit marginincreased to 40% for fiscal 2005, compared to 38% for fiscal 2004. The increasewas due to a more favorable revenue mix and higher product margins due tolower-cost coupler designs, partially offset by increased costs associated withnew products that began production in fiscal 2005.

 

Research and developmentexpense increased 26% to $1,393,503 for fiscal 2005 compared to $1,103,062 forfiscal 2004. The increase was due to shifting resources from government-fundedresearch contracts to company-funded research. Major company-funded researchand development programs included new sensor and coupler products, and designsto improve the manufacturing yields of our existing couplers.

 

10

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Selling, general, andadministrative expenses for fiscal 2005 increased by 2% to $1,867,556 comparedto $1,831,542 for fiscal 2004. The increase was due to increased patent andauditing expenses, partially offset by lower personnel expenses.

 

Interest income, interestexpense, plus other income totaled $276,073 in fiscal 2005 compared to $243,357in fiscal 2004. The increase in interest income was due to higher interestrates. Lower interest expense was due to a reduction in debt.

 

We recorded pre-tax incomeof $1,619,850 for fiscal 2005, compared to pre-tax income of $1,874,698 forfiscal 2004. The decrease was primarily due to a decrease in research anddevelopment revenue and an increase in research and development expense.

 

Net income in fiscal 2005included a net income tax benefit of $138,404, compared to $233,022 for fiscal2004, from reductions of valuation allowances relating to deferred tax assets.

 

Net income was $1,758,254 infiscal 2005 compared to $2,107,720 in fiscal 2004. The decrease in net incomewas due to a decrease in research and development revenue, an increase inresearch and development expense, and a smaller income tax benefit.

 

**Liquidity and Capital Resources**

Our primary source of workingcapital for fiscal 2005 and 2004 was product sales and research contracts. At March 31,2005 we had $7,717,264 in cash and investments. This compares to $7,544,643 incash and investments at March 31, 2004. The increase in cash andinvestments was due to income from operations and proceeds from the exercise ofincentive stock options, partially offset by investments in property, plant andequipment, increases in inventory and accounts receivable, and a reduction incustomer prepayments.

 

Accounts receivableincreased to $2,285,472 at March 31, 2005 from $1,739,479 at March 31,2004. The increase was due primarily to product shipments weighted toward latein the year after slow product sales in the third quarter. We expect accountsreceivable to decrease in the near term as customers pay for parts shipped latein fiscal 2005. Long term, we expect accounts receivable to tend to increaseapproximately in line with revenue.

 

Inventory increased to$1,572,759 at March 31, 2005 from $1,149,854 at March 31, 2004. Theincrease was due primarily to an increase in foundry wafers we purchased eitherto receive more favorable pricing or to guard against a possible supplyshortage. The risk of a foundry wafer supply shortage appears to have sinceabated. We expect inventory to decrease in the near term, as we expect toreduce our foundry wafer inventories.

 

A significant portion of ourworking capital consists of product inventory finished goods andwork-in-process. Although we maintain a reserve for inventory obsolescence, theliquidity of such inventory could be negatively affected if demand for ourproducts decreased because of economic or competitive conditions, or becomeunsalable because of poor quality or low yields, or if products become obsoletebecause of technical advancements by us or our competitors.

 

We have less than $35,000 inlong-term debt, consisting of the long-term portion of a production equipmentlease. We expect to retire this lease in June 2006. While we are notcurrently planning any additional borrowing, we may have the ability to borrowusing certain of our production equipment assets as collateral if necessary.

 

We currently have nomaterial commitments for capital expenditures. We believe our working capitalis adequate for our needs at least through fiscal 2006.

 

**Outlook**

In fiscal 2006 we plan tocontinue our business strategy, including developing new sensor and couplerproducts and pursuing new MRAM license agreements.

 

We expect research anddevelopment revenue to continue to decline in fiscal 2006 as our emphasisshifts from government-funded to company-funded research, particularly newproduct development, and we focus more of our contract research in certainstrategic areas. Furthermore, available government funding for research and developmentin our areas of expertise may decline due to government budget constraints.

 

After a slow quarter ended December 31,2004, industry conditions appeared to improve in the quarter ended March 31,2005 as excess inventories in the electronic component distribution channelwere burned off. We are therefore cautiously optimistic for product sales infiscal 2006.

 

We expect gross profitmargins to increase in fiscal 2006 as a result of lower-cost product designscompleted in fiscal 2005. Longer term, competitive pressures could force us todecrease our selling prices, which would decrease gross profit margins.

 

Selling, general andadministrative expenses could increase if we negotiate or enforce MRAM licenseagreements.

 

We expect research anddevelopment expenses to increase in fiscal 2006 as we develop new products andcontinue to shift from government-funded to company-funded research anddevelopment.

 

Although we anticipate beingprofitable in fiscal 2006, no assurance can be given that we will be successfulin achieving this goal.

 

11

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We do not expect to paysignificant income taxes in fiscal 2006, but we expect to begin recognizingprovisions for income taxes at a rate of approximately 34% percent of netincome due to our stock-based compensation deductions. Unlike net operatingloss carryforwards, stock-based compensation deductions do not reduce taxesreported for book purposes when realized.

 

We are not currentlyplanning significant capital expenditures for fiscal 2006. We plan to fund anycapital expenditures from operating profits, cash and cash equivalents, or fromthe sale of investments.

 

**ForeignCurrency Transactions**

We have some limited revenuerisks from fluctuations in values of foreign currency due to product salesabroad. Foreign sales are generally made in U.S. currency, and currencytransaction gains or losses in the past two fiscal years were not significant.

 

**Inflation**

Inflation has not had asignificant impact on our operations since our inception. Prices for ourproducts and for the materials and labor going into those products are governedby market conditions. It is possible that inflation in future years couldimpact both materials and labor in the production of our products. Rates paidby the U.S. Government on research and development contracts are generallyadjustable with inflation.

 

**ITEM 7. FINANCIAL STATEMENTS.**

Financial statements andaccompanying notes are in this Report beginning on page F-1 following thesignature page.

 

**ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE.**

None.

 

**ITEM 8A. CONTROLS AND PROCEDURES. Evaluation ofDisclosure Controls and Procedures.**

As of the end of the periodcovered by this Report, we conducted an evaluation, under the supervision andwith the participation of the principal executive officer and principalfinancial officer, of our disclosure controls and procedures (as defined in Rules 13a-14(c) and15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)).Based on this evaluation, the principal executive officer and principalfinancial officer concluded that our disclosure controls and procedures areeffective to ensure that information required to be disclosed by us in reportsthat we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in SEC rules andforms. There was no change in our internal control over financial reportingduring our most recently completed fiscal quarter that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

 

**PART III**

 

**ITEM 9****. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROLPERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.**

 

**ShareholderProposals for Nominations to Our Board**

The discussion under the section entitled“Board and Committee Meetings—Nominating/Corporate GovernanceCommittee—Shareholder Nominees” to be included in our Proxy Statement for our2005 Annual Meeting of Shareholders is incorporated herein by reference.

 

**Directorsand Executive Officers**

Each director is electedannually and serves for a term of one year or until their successor is dulyelected and qualified. The section entitled “Proposal 1. Election of Boardof Directors” to be included in our Proxy Statement for our 2005 Annual Meetingof Shareholders sets forth certain information regarding our directors requiredby Item 9, and is incorporated herein by reference. The following table setsforth certain information regarding our executive officers:

 
| **Name and Position**     | ** ** | **Age** |
|---------------------------|------------|---------|
| Daniel A. Baker           |       | 47      |
| Director,  President, and |       |    |
| Chief  Executive Officer  |       |    |
|                      |       |    |
| Richard L. George         |       | 61      |
| Treasurer  and            |       |    |
| Chief  Financial Officer  |       |    |
|                      |       |    |
| James M. Daughton         |       | 68      |
| Director  and             |       |    |
| Chief  Technology Officer |       |    |

 

***Daniel A. Baker*** has been a director and the President andChief Executive Officer since January 2001. From 1993 until joining NVE,he was President and CEO of Printware, Inc., now known as Printware LLC,which makes high-speed laser imaging systems. Dr. Baker has over 25 yearsof experience in high-tech industries, including executive positions withMinntech Corporation and Percom Data Corporation. Dr. Baker has Ph.D. andM.S. degrees in engineering from the University of Minnesota, an M.B.A. infinance from the University of Minnesota, and a B.S. in engineering from CaseWestern Reserve University.

 

***Richard L. George*** has served as the Treasurer and ChiefFinancial Officer of NVE since March 1995. From 1991 to 1995, Mr. Georgeserved as Controller for NVE. From 1966 to 1991, Mr. George held variousfinancial and financial management positions in the areas of operations andcontracts at Honeywell Inc. Mr. George received a B.A. in economics in1966 from the University of Minnesota, where he later took graduate courses inlaw and management.

 

12

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***James M. Daughton*** has been a director since our inception in1989 and Chief Technology Officer since January 2001. He served as Chairmanof the Board and CEO from 1991 to January 2001. From 1974 to 1989, Dr. Daughtonheld various research and product development positions at Honeywell, Inc.,including Vice President of The Solid State Development Center. From 1964 to1974, he developed magnetic and semiconductor memory devices at IBMCorporation. Dr. Daughton holds a doctorate in electrical engineering fromIowa State University and is an adjunct professor of physics at the Universityof Minnesota.

 

**Audit Committee Financial Experts**

Our Board of Directors hasdetermined that Patricia M. Hollister and Terrence W. Glarner qualify as “auditcommittee financial experts” as that term is defined under Section 407 ofthe Sarbanes-Oxley Act of 2002 and the rules promulgated by the SEC infurtherance of Section 407. Furthermore, Ms. Hollister, Mr. Glarner,and Robert H. Irish are “independent,” as that term is defined under thecorporate governance rules of the NASDAQ Stock Market.

 

**Code of Ethics**

We have adopted a Code ofBusiness Conduct and Ethics that applies to all of our employees and directors,including our principal executive officer, principal financial officer andprincipal accounting officer. The Code of Business Conduct and Ethics isincorporated by reference in this Report, and a copy is available from the “Investors”section of our website (www.nve.com).

 

We intend to post on ourwebsite any amendment to, or waiver from, a provision of our Code of BusinessConduct and Ethics that applies to our principal executive officer, principalfinancial officer, controller, and other employees performing similar functionswithin four business days following the date of such amendment or waiver.

 

**Section 16(a) BeneficialOwnership Reporting Compliance**

The discussion under the section entitled“Section 16(a) Beneficial Ownership Reporting Compliance” to beincluded in our Proxy Statement for our 2005 Annual Meeting of Shareholders isincorporated herein by reference.

 

**ITEM 10****. EXECUTIVE COMPENSATION.**

The information required byItem 10 is incorporated herein by reference to the sections entitled “ExecutiveCompensation” and “Proposal 1. Election of Board of Directors—Compensation ofOur Directors” to be included in our Proxy Statement for our 2005 AnnualMeeting of Shareholders.

 

**ITEM 11.****SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDER MATTERS.**

The information required byItem 11 is incorporated herein by reference to the sections entitled “Ownershipof Voting Securities by Principal Holders and Management” and “ExecutiveCompensation—Equity Compensation Plan Information” to be included in our ProxyStatement for our 2005 Annual Meeting of Shareholders.

 

**ITEM 12****. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.**

None.

 

13

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**ITEM 13****. EXHIBITS.**

 
| **Exhibit #** | ** ** | **Description**                                                                                                                                                                                                                                             |
|--------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |       |                                                                                                                                                                                                                                                        |
| 3.1                |       | Amended and Restated  Articles of Incorporation of the company as amended by the Board of Directors  effective November 21, 2002 (incorporated by reference to our Quarterly  Report on Form 10-QSB for the period ended December 31, 2002). |
|               |       |                                                                                                                                                                                                                                                        |
| 3.2                |       | By-laws of the company as  amended by the Board of Directors, May 31, 2002 (incorporated by  reference to our Annual Report on Form 10-KSB for the year ended  March 31, 2002).                                                              |
|               |       |                                                                                                                                                                                                                                                        |
| 4                  |       | Form of Common Stock  Certificate (incorporated by reference to our Registration Statement on  Form S-8 filed July 20, 2001).                                                                                                                |
|               |       |                                                                                                                                                                                                                                                        |
| 10.1               |       | Lease dated  October 1, 1998 between the company and Glenborough Properties, L.P.  (incorporated by reference to our Quarterly Report on Form 10-QSB for  the period ended September 30, 2002).                                              |
|               |       |                                                                                                                                                                                                                                                        |
| 10.2               |       | First amendment to lease  between the company and Glenborough Properties, L.P. dated September 18,  2002 (incorporated by reference to our Quarterly Report on Form 10-QSB  for the period ended September 30, 2002).                        |
|               |       |                                                                                                                                                                                                                                                        |
| 10.3               |       | Second amendment to lease  between the company and Glenborough Properties, L.P. dated December 1,  2003 (incorporated by reference to our Quarterly Report on Form 10-QSB  for the period ended December 31, 2003).                          |
|               |       |                                                                                                                                                                                                                                                        |
| 10.4*              |       | Employment Agreement  between the company and Daniel A. Baker dated January 29, 2001  (incorporated by reference to our Annual Report on Form 10-KSB for the  year ended March 31, 2001).                                                    |
|               |       |                                                                                                                                                                                                                                                        |
| 10.5*              |       | NVE Corporation 2000 Stock  Option Plan as Amended July 19, 2001 by the shareholders (incorporated  by reference to our Registration Statement on Form S-8 filed  July 20, 2001).                                                            |
|               |       |                                                                                                                                                                                                                                                        |
| 10.6*              |       | NVE Corporation 2001  Employee Stock Purchase Plan Summary (incorporated by reference to our  Definitive Proxy Statement on Schedule 14A filed June 1, 2001).                                                                                     |
|               |       |                                                                                                                                                                                                                                                        |
| 10.7+              |       | Agreement between the  company and Agilent Technologies, Inc. dated September 27, 2001  (incorporated by reference to our Quarterly Report on Form 10-QSB for  the period ended September 30, 2001).                                    |
|               |       |                                                                                                                                                                                                                                                        |
| 10.8               |       | Amendment dated  October 18, 2002 to Agreement between the company and Agilent  Technologies, Inc. (incorporated by reference to our Quarterly Report on  Form 10-QSB for the period ended December 31, 2002).                          |
|               |       |                                                                                                                                                                                                                                                        |
| 10.9+              |       | License Agreement dated  April 12, 2002 with Cypress Semiconductor Corporation (incorporated by  reference to our Quarterly Report on Form 10-QSB for the period ended  June 30, 2002).                                                      |
|               |       |                                                                                                                                                                                                                                                        |
| 10.10*             |       | Amendment No. 1 dated  March 28, 2005 to Stock Option Agreement dated May 7, 2004 between  the Company and Daniel A. Baker (incorporated by reference to our Current  Report on Form 8-K filed March 30, 2005).                    |
|               |       |                                                                                                                                                                                                                                                        |
| 10.11*             |       | Amendment No. 1 dated  March 28, 2005 to Stock Option Agreement dated August 17, 2004  between the Company and Patricia M. Hollister (incorporated by reference to  our Current Report on Form 8-K filed March 30, 2005).          |
|               |       |                                                                                                                                                                                                                                                        |
| 14                 |       | Code of Business Conduct  and Ethics (incorporated by reference to our Annual Report on Form 10-KSB  for the year ended March 31, 2004).                                                                                                          |
|               |       |                                                                                                                                                                                                                                                        |
| 23                 |       | Consent of  Ernst & Young LLP.                                                                                                                                                                                                                     |
|               |       |                                                                                                                                                                                                                                                        |
| 31.1               |       | Certification by Daniel A.  Baker pursuant to Rule 13a-14(a)/15d-14(a).                                                                                                                                                                                |
|               |       |                                                                                                                                                                                                                                                        |
| 31.2               |       | Certification by Richard  L. George pursuant to Rule 13a-14(a)/15d-14(a).                                                                                                                                                                              |
|               |       |                                                                                                                                                                                                                                                        |
| 32                 |       | Certification by Daniel A.  Baker and Richard L. George pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                |
|               |       |                                                                                                                                                                                                                                                        |
| 99                 |       | Cautionary statements for  purposes of the “safe harbor” provisions of The Private Securities Litigation  Reform Act.                                                                                                                             |

 

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*Indicates a managementcontract or compensatory plan or arrangement.

 

+Confidentialtreatment has been requested with respect to portions of this exhibit, and suchconfidential portions have been deleted and separately filed with the SECpursuant to Rule 24b-2 or Rule 406.

 

Copies of documents filed asexhibits to our Form 10-KSB may be accessed from the “Investors” section ofour website (www.nve.com), or obtained by making a written request to RichardL. George, our Chief Financial Officer.

 

14

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**ITEM 14****. PRINCIPAL ACCOUNTANT FEES AND SERVICES.**

The information required byItem 14 is incorporated herein by reference to the section entitled “FeesBilled to Us by Ernst & Young, LLP During Fiscal 2005 and 2004 andAudit Committee Pre-Approval Policies,” to be included in our Proxy Statementfor our 2005 Annual Meeting of Shareholders.

 

**SIGNATURES**

 

In accordancewith Section 13 or 15(d) of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
| ** ** | **NVE  CORPORATION**                   | ** **        |
|------------|----------------------------------------|-------------------|
|       | (Registrant)                           |              |
|       |                                   |
|       |                                   |
|       | /s/ Daniel A. Baker                    |              |
|       | by Daniel A. Baker                     |
|       | President and Chief  Executive Officer |
|       |                                   |
|       | Date                                   | May 23, 2005 |
|            |                                        |                   |  |  |

 

In accordance with theExchange Act, this report has been signed below by the following persons onbehalf of the registrant and in the capacities and on the dates indicated.

 
| **Name**                   | ** ** | **Title** | ** **                                    | **Date** |
|----------------------------|------------|-----------|-----------------------------------------------|----------|
|                       |       |      |                                          |     |   |
|                       |       |      |                                          |     |   |
| /s/  Terrence W. Glarner   |       |      | Director  and                                 |     |   | May 23,  2005 |   |
| Terrence  W. Glarner       |       |      | Chairman  of the Board                        |     |   |   |
|                       |       |      |                                          |     |   |   |
| /s  / Daniel A. Baker      |       |      | Director,                                     |     |   | May 23,  2005 |   |
| Daniel  A. Baker           |       |      | President &  Chief Executive Officer |     |   |   |
|                       |       |      | (Principal  Executive Officer)                |     |   |   |
|                       |       |      |                                          |     |   |   |
| /s/  Richard L. George     |       |      | Treasurer  and                                |     |   | May 23,  2005 |   |
| Richard  L. George         |       |      | Chief  Financial Officer                      |     |   |   |
|                       |       |      | (Principal  Financial and                     |     |   |   |
|                       |       |      | Accounting  Officer)                          |     |   |   |
|                       |       |      |                                          |     |   |   |
| /s/  James M. Daughton     |       |      | Director  and                                 |     |   | May 23,  2005 |   |
| James  M. Daughton         |       |      | Chief  Technology Officer                     |     |   |   |
|                       |       |      |                                          |     |   |   |
| /s  / Robert H. Irish      |       |      | Director                                      |     |   | May 23,  2005 |   |
| Robert  H. Irish           |       |      |                                          |     |   |   |
|                       |       |      |                                          |     |   |   |
| /s/  Patricia M. Hollister |       |      | Director                                      |     |   | May 23,  2005 |   |
| Patricia  M. Hollister     |       |      |                                          |     |   |   |
|                            |            |           |                                               |          |  |  |  |  |  |  |  |  |

 

15

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

Board of Directors

NVE Corporation

 

We have audited theaccompanying balance sheet of NVE Corporation as of March 31, 2005 and therelated statements of income, shareholders’ equity and cash flows for the yearsended March 31, 2005 and 2004. These financial statements are theresponsibility of the company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. We were not engaged to perform an audit of the Company’sinternal control over financial reporting. Our audits included consideration ofinternal control over financial reporting as a basis for designing auditprocedures that are appropriate in the circumstances, but not for the purposeof expressing an opinion on the effectiveness of the Company’s internal controlover financial reporting. Accordingly, we express no such opinion. An auditalso includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the financial position of NVE Corporation at March 31, 2005 andthe results of its operations and its cash flows for the years ended March 31,2005 and 2004 in conformity with U.S. generally accepted accounting principles.

 

 
| /s/ Ernst & Young  LLP |   |
|---------------------------------|--------|
| Minneapolis, Minnesota          |
| April 25, 2005             |

 

16

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**NVE CORPORATION**

**INDEX TO**

**FINANCIALSTATEMENTS**

 
| BALANCE SHEET                           |   |
|-----------------------------------------|--------|
|                                    |   |
| STATEMENTS  OF INCOME                   |   |
|                                    |   |
| STATEMENT OF  SHAREHOLDERS’ EQUITY |   |
|                                    |   |
| STATEMENTS OF CASH FLOWS                |   |
|                                    |   |
| NOTES TO FINANCIAL  STATEMENTS          |   |

 

F-1

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**NVE CORPORATION**

**BALANCE SHEET**

**MARCH 31, 2005**

 
| ASSETS                                                                       | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|
| Current assets                                                               |       |       |       |
| Cash and cash equivalents                                                    |       | $          | 1,240,205  |   |
| Short-term investments                                                       |       | 252,775    |       |
| Accounts receivable, net of allowance for uncollectible  accounts of $15,000 |       | 2,285,472  |       |
| Inventories                                                                  |       | 1,572,759  |       |
| Deferred tax asset                                                           |       | 756,074    |       |
| Prepaid expenses and other assets                                            |       | 130,873    |       |
| Total current assets                                                         |       | 6,238,158  |       |
| Fixed assets                                                                 |       |       |       |
| Machinery and equipment                                                      |       | 4,140,307  |       |
| Leasehold improvements                                                       |       | 413,482    |       |
|                                                                         |       | 4,553,789  |       |
| Less accumulated depreciation                                                |       | 2,826,227  |       |
| Net fixed assets                                                             |       | 1,727,562  |       |
| Long-term investments                                                        |       | 6,224,284  |       |
| Total assets                                                                 |       | $          | 14,190,004 |   |
|                                                                         |       |       |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                    |       |       |       |
| Current liabilities                                                          |       |       |       |
| Accounts payable                                                             |       | $          | 319,427    |   |
| Accrued payroll and other                                                    |       | 465,930    |       |
| Deferred revenue                                                             |       | 267,355    |       |
| Capital lease obligations                                                    |       | 67,430     |       |
| Total current liabilities                                                    |       | 1,120,142  |       |
| Capital lease obligations, less current  portion                             |       | 33,281     |       |
| Total liabilities                                                            |       | 1,153,423  |       |
|                                                                         |       |       |       |
| Shareholders’ equity                                                    |       |       |       |
| Common stock                                                                 |       | 45,698     |       |
| Additional paid-in capital                                                   |       | 14,064,625 |       |
| Accumulated other comprehensive loss                                         |       | (132,228   | )          |
| Accumulated deficit                                                          |       | (941,514   | )          |
| Total shareholders’ equity                                              |       | 13,036,581 |       |
| Total liabilities and shareholders’ equity                              |       | $          | 14,190,004 |   |

 

See accompanying notes.

 

F-2

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**NVE CORPORATION**

**STATEMENTS OF INCOME**

**YEARS ENDED MARCH 31, 2005 AND 2004**

 
| ** **                           | ** ** | **Year Ended March 31** | ** ** |
|--------------------------------------|------------|------------------------------|------------|
| ** **                           | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| Revenue                              |       |                         |       |   |   |
| Contract research and development    |       | $                            | 6,093,320  |   | $ | 6,617,311 |   |
| Product sales                        |       | 5,522,250                    |       | 5,393,540 |   |
| Total revenue                        |       | 11,615,570                   |       | 12,010,851 |   |
|                                 |       |                         |       |   |   |
| Cost of sales                        |       | 7,010,734                    |       | 7,444,906 |   |
| Gross profit                         |       | 4,604,836                    |       | 4,565,945 |   |
|                                 |       |                         |       |   |   |
| Expenses                             |       |                         |       |   |   |
| Research and development             |       | 1,393,503                    |       | 1,103,062 |   |
| Selling, general, and administrative |       | 1,867,556                    |       | 1,831,542 |   |
| Total expenses                       |       | 3,261,059                    |       | 2,934,604 |   |
|                                 |       |                         |       |   |   |
| Income from operations               |       | 1,343,777                    |       | 1,631,341 |   |
|                                 |       |                         |       |   |   |
| Interest income                      |       | 235,341                      |       | 189,270 |   |
| Interest expense                     |       | (13,256                      | )          | (25,996 | ) |
| Other income                         |       | 53,988                       |       | 80,083 |   |
| Income before income taxes           |       | 1,619,850                    |       | 1,874,698 |   |
|                                 |       |                         |       |   |   |
| Income tax benefit                   |       | 138,404                      |       | 233,022 |   |
|                                 |       |                         |       |   |   |
| Net income                           |       | $                            | 1,758,254  |   | $ | 2,107,720 |   |
|                                 |       |                         |       |   |   |
| Net income per share - basic         |       | $                            | 0.39       |   | $ | 0.49 |   |
|                                 |       |                         |       |   |   |
| Net income per share - diluted       |       | $                            | 0.37       |   | $ | 0.45 |   |
|                                 |       |                         |       |   |   |
| Weighted average shares outstanding  |       |                         |       |   |   |
| Basic                                |       | 4,512,247                    |       | 4,296,870 |   |
| Diluted                              |       | 4,733,955                    |       | 4,726,759 |   |

 

See accompanying notes.

 

F-3

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**NVE CORPORATION**

**STATEMENT OF SHAREHOLDERS’ EQUITY**

**YEARS ENDEDMARCH 31, 2005 AND 2004**

 
| ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Other  Comprehen-  sive Income** | ** ** | **Accumulated  Deficit** | ** ** | **Total**  | ** ** |
|---------------------------------------------------------|------------|------------|------------|------------|------------|----------------------------------|------------|-------------------------------------------------|------------|--------------------------|------------|------------|------------|
| ** **                                              | ** ** | ** ** |
| **Common Stock**                                        |
| **Shares**                                              | ** ** | **Amount** |
| Balance, March 31, 2003                            |       | 4,174,778  |       | $          | 41,748     |                             | $          | 12,170,833                                      |       | $                        | 73,221     |       | $          | (4,807,488 | ) | $ | 7,478,314 |   |
|                                                    |       |       |       |       |       |                             |       |                                            |       |                     |       |       |       |
| Exercise of stock options and warrants                  |       | 301,551    |       | 3,016      |       | 1,035,188                        |       | —                                          |       | —                   |       | 1,038,204  |       |
| Shares issued pursuant to employee stock purchase  plan |       | 12,566     |       | 125        |       | 91,732                           |       | —                                          |       | —                   |       | 91,857     |       |
| Comprehensive income:                                   |       |       |       |       |       |                             |       |                                            |       |                     |       |       |       |
| Unrealized gain on investment securities                |       | —     |       | —     |       | —                           |       | 17,149                                          |       |                     |       | 17,149     |       |
| Net income                                              |       | —     |       | —     |       | —                           |       | —                                          |       | 2,107,720                |       | 2,107,720  |       |
| Total comprehensive income                              |       |       |       |       |       |                             |       |                                            |       |                     |       | 2,124,869  |       |
| Balance, March 31, 2004                            |       | 4,488,895  |       | 44,889     |       | 13,297,753                       |       | 90,370                                          |       | (2,699,768               | )          | 10,733,244 |       |
|                                                    |       |       |       |       |       |                             |       |                                            |       |                     |       |       |       |
| Exercise of stock options and warrants                  |       | 73,880     |       | 739        |       | 221,869                          |       | —                                          |       | —                   |       | 222,608    |       |
| Shares issued pursuant to employee stock purchase  plan |       | 7,009      |       | 70         |       | 165,833                          |       | —                                          |       | —                   |       | 165,903    |       |
| Comprehensive income:                                   |       |       |       |       |       |                             |       |                                            |       |                     |       |       |       |
| Unrealized loss on investment securities                |       | —     |       | —     |       | —                           |       | (222,598                                        | )          |                     |       | (222,598   | )          |
| Net income                                              |       | —     |       | —     |       | —                           |       | —                                          |       | 1,758,254                |       | 1,758,254  |       |
| Total comprehensive income                              |       |       |       |       |       |                             |       |                                            |       |                     |       | 1,535,656  |       |
| Deferred tax asset from stock-based compensation        |       |       |       |       |       | 379,170                          |       |                                            |       |                     |       | 379,170    |       |
| Balance, March 31, 2005                            |       | 4,569,784  |       | $          | 45,698     |                             | $          | 14,064,625                                      |       | $                        | (132,228   | )          | $          | (941,514 | ) | $ | 13,036,581 |   |

 

Seeaccompanying notes.

 

F-4

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**NVECORPORATION**

**STATEMENTS OF CASH FLOWS**

**YEARS ENDED MARCH 31, 2005 AND 2004**

 
| ** **                                                                         | ** ** | **Year Ended March 31** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| OPERATING ACTIVITIES                                                               |       |                         |       |   |   |
| Net income                                                                         |       | $                            | 1,758,254  |   | $ | 2,107,720 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                         |       |   |   |
| Depreciation and amortization                                                      |       | 573,443                      |       | 524,733 |   |
| Deferred tax benefit                                                               |       | (126,904                     | )          | (250,000 | ) |
| Changes in operating assets and  liabilities:                                      |       |                         |       |   |   |
| Accounts receivable                                                                |       | (545,993                     | )          | (711,189 | ) |
| Inventories                                                                        |       | (422,905                     | )          | (309,078 | ) |
| Prepaid expenses and other                                                         |       | 165,664                      |       | (126,217 | ) |
| Accounts payable and accrued expenses                                              |       | (253,759                     | )          | 102,703 |   |
| Deferred revenue                                                                   |       | (156,821                     | )          | (465,451 | ) |
| Net cash provided by operating activities                                          |       | 990,979                      |       | 873,221 |   |
|                                                                               |       |                         |       |   |   |
| INVESTING ACTIVITIES                                                               |       |                         |       |   |   |
| Purchases of fixed assets                                                          |       | (846,281                     | )          | (773,966 | ) |
| Purchases of investment securities                                                 |       | (226,320                     | )          | (615,081 | ) |
| Net cash used in investing activities                                              |       | (1,072,601                   | )          | (1,389,047 | ) |
|                                                                               |       |                         |       |   |   |
| FINANCING ACTIVITIES                                                               |       |                         |       |   |   |
| Net proceeds from sale of common stock                                             |       | 388,511                      |       | 1,130,061 |   |
| Repayment of note payable and capital lease  obligations                           |       | (122,480                     | )          | (154,207 | ) |
| Net cash provided by financing activities                                          |       | 266,031                      |       | 975,854 |   |
|                                                                               |       |                         |       |   |   |
| Increase in cash and cash equivalents                                              |       | 184,409                      |       | 460,028 |   |
| Cash and cash equivalents at beginning of  year                                    |       | 1,055,796                    |       | 595,768 |   |
|                                                                               |       |                         |       |   |   |
| Cash and cash equivalents at end of year                                           |       | $                            | 1,240,205  |   | $ | 1,055,796 |   |

 

See accompanying notes.

 

F-5

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**NVE CORPORATION**

**NOTES TO FINANCIAL STATEMENTS**

 

**NOTE****1.DESCRIPTION OF BUSINESS**

We develop and sell devicesusing spintronics, a technology we helped pioneer, which utilizes electron spinrather than electron charge to acquire, store, and transmit information.

 

**NOTE****2. SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

**Cash andCash Equivalents**

We consider allhighly-liquid investments with maturities of three months or less whenpurchased to be cash equivalents.

 

**Investments**

We classify and account fordebt and equity securities in accordance with Statement of Financial AccountingStandards (SFAS) No. 115, *Accountingfor Certain**Investments in Debtand Equity Securities*. Securities with original maturities greaterthan three months and remaining maturities less than one year are classified asshort-term investments; securities with remaining maturities greater than oneyear are classified as long-term investments.

 

Our entire portfolio ofshort-term and long-term investments consists of government-backed andcorporate bonds and is classified as available for sale; thus, securities arerecorded at fair market value and any associated unrealized gain or loss, netof tax, is included as a separate component of shareholders’ equity, “Accumulatedother comprehensive income.”

 

**AccountsReceivable and Allowance for Doubtful Accounts**

Accounts receivable arerecorded net of an allowance for doubtful accounts. We make estimates of theuncollectibility of accounts receivable. We specifically analyze accountsreceivable, historical bad debts, and customer credit-worthiness whenevaluating the adequacy of the allowance for doubtful accounts.

 

**Inventories**

Inventories are stated atthe lower of cost or market determined by the first in, first out method, ornet realizable value. We record reserves for potentially excess, obsolete andslow-moving inventory. The amounts of these reserves are based on expectedproduct lives, competitive conditions, industry conditions, and forecastedsales demand.

 

**ProductWarranty**

In general we warrant ourproducts to be free from defects in material and workmanship for one year. Wemaintain a reserve for the estimated cost of maintaining product warranties.

 

**FixedAssets**

Fixed assets are stated atcost. Depreciation of machinery and equipment, and furniture and fixtures isrecorded over the estimated useful lives of the assets, generally five years,using the straight-line method. Amortization of leasehold improvements isrecorded using the straight-line method over the lesser of the lease term oruseful life of five years. We record losses on long-lived assets used inoperations when indicators of impairment are present and the undiscounted cashflows estimated to be generated by those assets are less than the assets’carrying amount.

 

**RevenueRecognition**

We recognize product revenuein accordance with Securities and Exchange Commission (SEC) Staff AccountingBulletin (SAB) No. 101, *RevenueRecognition in Financial Statements*, as amended by SAB No. 104and codified in SAB Topic 13, *RevenueRecognition*.

 

***Product Revenue Recognition***

We recognize product revenueon shipment because the terms of our sales are FOB shipping point, meaning thatour customers (end users and distributors) take title and assume the risks andrewards of ownership upon shipment. Our customers may return defective productsfor refund or replacement under warranty, and have other very limited rights ofreturn. We maintain reserves based on historical returns.

 

Payments from ourdistributors are not contingent on resale or any other matter other than thepassage of time, and delivery of products is not dependent on the number ofunits resold to the ultimate customer. There are no other significantacceptance criteria, pricing or payment terms that would affect revenuerecognition.

 

Under our agreement withAgilent Technologies, Inc. to distribute our couplers under their brand,Agilent provided a refundable prepayment of $500,000. In accordance with SAB No. 101and SAB Topic 13A as amended by SAB No. 104, we

 

F-6

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classify the prepayment asdeferred revenue. We recognize the prepayment as revenue as products areshipped, and reduce deferred revenue by a corresponding amount. Inventory costsassociated with the prepayment are recognized as costs of sales as revenue isrecognized.

 

***Accounting for Commissions and Discounts***

We sometimes utilizeindependent sales representatives that provide services relating to promotingour products and facilitating product sales but do not purchase our products.We pay commissions to sales representatives based on the amount of revenue facilitated,and such commissions are recorded as selling, general, and administrativeexpenses.

 

Our stocking distributorstake title and assume the risks and rewards of product ownership. We recognizediscounts to our distributors in accordance with Emerging Issues Task ForceIssue No. 01-09, *Accounting forConsideration Given by a Vendor to a Customer*. EITF 01-09 addresseswhether a vendor should recognize consideration given to a customer as anexpense or as an offset to revenue being recognized from that same customer. Wepresume consideration given to a customer is a reduction in revenue unless bothof the following conditions are met: (a) we receive an identifiablebenefit in exchange for the consideration and the identifiable benefit issufficiently separable from the customer’s purchase of our products such thatwe could have purchased the products or services from a third party; and (b) wecan reasonably estimate the fair value of the benefit received. Under EITF 01-09we recognize discounts provided to our stocking distributors as reductions inrevenue.

 

Under certain limitedcircumstances, our distributors may earn commissions for activities unrelatedto their purchases of our products, such as for facilitating the sale of customproducts or research and development contracts with third parties. We recognizeany such commissions as selling, general, and administrative expenses.

 

***Research and Development Contract Revenue Recognition***

We recognize governmentcontract revenue in accordance with Accounting Research Bulletin No. 43,Chapter 11, *Government Contracts*.Revenue and gross profit are recognized as work is performed, based on actualcosts incurred.

 

Our government research anddevelopment contracts may be either firm-fixed-price or cost-plus-fixed-fee.Cost-plus-fixed-fee contracts are cost-reimbursement contracts that alsoprovide for payment to us of a negotiated fee that is fixed at the inception ofthe contract. Cost-plus-fixed-fee contracts normally require us to complete anddeliver the specified end product (such as a final report of researchaccomplishing the goal or target) within the estimated cost, if possible, as acondition for payment of the entire fixed fee. Our research and developmentcontracts do not contain post-shipment obligations.

 

Our commercial research anddevelopment contracts are generally firm-fixed-price contracts.Firm-fixed-price contracts provide for a price that is not subject to anyadjustment on the basis of our cost in performing the contract. We apply thepercentage-of-completion method to these contracts for revenue recognition.

 

***Revenue Recognition of Up-Front Fees***

We account for nonrefundableup-front fees from licensing and technology development programs in accordancewith SAB Topic 13A. Revenue from up-front fees is deferred and recognized overthe periods that the fees are earned. We recognize revenue from licensing andtechnology development programs which is refundable, recoupable against futureroyalties, or for which future obligations exist over the term of theagreement.

 

**Stock-BasedCompensation**

We have adopted thedisclosure-only provisions of SFAS Nos. 123 and 148, *Accounting for Stock-Based Compensation*, but applyAccounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,**and related interpretations in accountingfor our plans. Under APB Opinion No. 25, when the exercise price ofemployee stock options equals or exceeds the market price of the underlyingstock on the date of grant, no compensation expense is recognized.

 

Pro forma informationregarding net income and income per share is required by SFAS Nos. 123 and 148,and has been determined as if we had accounted for our employee stock optionsunder the fair value method. The fair value for these options was estimated atthe date of grant using the Black-Scholes option pricing model with thefollowing weighted average assumptions: risk-free interest rate of 3.1% to 4.1%for fiscal 2005 and 3.1% for fiscal 2004; expected volatility of 88% to 99% forfiscal 2005 and 99% for fiscal 2004; a weighted-average expected life of theoptions of one to five years, and no dividend yield.

 

Option valuation models weredeveloped for use in estimating the fair value of traded options, which have novesting restrictions and are fully transferable. In addition, option valuationmodels require the input of highly subjective assumptions. Because our employeestock options have characteristics significantly different from those of tradedoptions, and because

 

F-7

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changes in the subjectiveinput assumptions can materially affect the fair value estimate, in management’sopinion, the existing models do not necessarily provide a reliable singlemeasure of the fair value of our employee stock options.

 

On March 28, 2005 theCompensation Committee of our Board of Directors approved an immediate and fullacceleration of vesting of all stock options outstanding under our 2000 StockOption Plan, as amended, with an exercise price greater than $20 per share (the“Acceleration”). The Acceleration was approved in anticipation of the impact ofFinancial Accounting Standards Board (FASB) SFAS No. 123(R), whichrequires the expensing unvested options. As a result of the Acceleration,out-of-the-money options to purchase 42,125 shares of our common stock becameimmediately exercisable as of March 28, 2005. The Acceleration had theeffect of decreasing pro forma fiscal 2005 net income by approximately$897,000. The Acceleration had no impact on our financial statements as of andfor the year ended March 31, 2005, and is not expected to have an impacton our results of operations upon adoption of SFAS No. 123(R).

 

The pro forma information isas follows:

 

| ** **                              | ** ** | **Year Ended March 31** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|
| ** **                              | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| Net income applicable to common shares: |       |                         |       |   |   |
| As reported                             |       | $                            | 1,758,254  |   | $ | 2,107,720 |   |
| Pro forma adjustment for stock options  |       | (2,744,836                   | )          | (430,921 | ) |
| Pro forma net (loss) income             |       | $                            | (986,582   | ) | $ | 1,676,799 |   |
|                                    |       |                         |       |   |   |
| Earnings per share:                     |       |                         |       |   |   |
| Basic – as reported                |       | $                            | 0.39       |   | $ | 0.49 |   |
| Basic – pro forma                  |       | $                            | (0.22      | ) | $ | 0.39 |   |
|                                    |       |                         |       |   |   |
| Diluted – as reported              |       | $                            | 0.37       |   | $ | 0.45 |   |
| Diluted – pro forma                |       | $                            | (0.21      | ) | $ | 0.35 |   |

 

**IncomeTaxes**

We account for income taxesusing the liability method. Deferred income taxes are provided for temporarydifferences between the financial reporting and tax bases of assets andliabilities. We provide valuation allowances against deferred tax assets whenit is determined that it is more likely than not that we will not be able toutilize the deferred tax assets.

 

**Researchand Development**

Research and developmentcosts are expensed as incurred. Customer sponsored research and developmentcosts included in cost of sales amounted to $4,466,696 and $5,279,803 duringfiscal 2005 and 2004. In accordance with federal legislation, we normally mayretain the principal worldwide patent rights to any invention developed withGovernment support. Our government contracts generally includecommercialization plans, which identify potential markets and customers inaddition to government agencies.

 

**Net Incomeper Common Share**

We calculate our net incomeper share pursuant to SFAS No. 128, *Earningsper Share*. Basic earnings per share are computed based upon theweighted average number of common shares issued and outstanding during eachyear. Diluted net income per share amounts assume conversion, exercise orissuance of all potential common stock instruments (stock options andwarrants). Stock options were not included in the computation of dilutedearnings per share if the exercise prices of the options were greater than themarket price of the common stock. The following table reflects the componentsof common shares outstanding in accordance with SFAS No. 128:

 

| ** **                                                      | ** ** | **Year Ended March 31** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| Weighted average common shares outstanding -  basic             |       | 4,512,247                    |       | 4,296,870 |   |
| Effect of dilutive securities:                                  |       |                         |       |   |   |
| Stock options                                                   |       | 130,178                      |       | 148,434 |   |
| Stock warrants                                                  |       | 91,530                       |       | 281,455 |   |
| Shares used in computing net income per  common share - diluted |       | 4,733,955                    |       | 4,726,759 |   |

 

**Use ofEstimates**

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States requires us to make estimates and assumptions that affect theamounts reported in the financial statements and accompanying notes. Actualresults could differ from those estimates.

 

F-8

----

 

**RecentAccounting Pronouncements**

In December 2003 theSEC issued SAB No. 104, *RevenueRecognition*. SAB No. 104 supersedes SAB No. 101, *Revenue Recognition in Financial Statements*.SAB No. 104’s primary purpose is to rescind accounting guidance containedin SAB No. 101 related to multiple element revenue arrangements,superseded as a result of the issuance of EITF No 00-21, *Accounting for Revenue Arrangements with MultipleDeliverables*. Additionally, SAB No. 104 rescinds the SEC’s *Revenue Recognition in Financial Statements*Frequently Asked Questions and Answers (FAQ) issued with SAB No. 101 thathad been codified in SEC Topic No. 13, *RevenueRecognition*. Selected portions of the FAQ have been incorporatedinto SAB No. 104. While the wording of SAB No. 104 has changed toreflect the issuance of EITF No. 00-21, the revenue recognition principlesof SAB No. 101 remain largely unchanged by the issuance of SAB No. 104,which was effective upon issuance. The adoption of SAB No. 104 did notimpact our financial statements.

 

In November 2004 theFASB issued SFAS No. 151 *InventoryCosts* amends the guidance in ARB No. 43, Chapter 4, *Inventory Pricing*, to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4,previously stated that under some circumstances, items such as idle facilityexpense, excessive spoilage, double freight, and rehandling costs may be soabnormal as to require treatment as current period charges. SFAS No. 151requires that those items be recognized as current period charges regardless ofwhether they meet the criterion of “so abnormal.” In addition, SFAS No. 151requires that allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facilities. SFAS No. 151shall be effective for inventory costs incurred during fiscal years beginningafter June 15, 2005. Earlier application is permitted for inventory costsincurred during fiscal years beginning after the date SFAS No. 151 wasissued. SFAS No. 151 shall be applied prospectively. We do not expect theadoption of SFAS No. 151 to have a material effect on our financialstatements.

 

In December 2004 theFASB issued SFAS No. 123(R), *Accountingfor Stock-Based Compensation*. SFAS No. 123(R) establishesstandards for the accounting for transactions in which an entity exchanges itsequity instruments for goods or services. This Statement focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions. SFAS No. 123(R) requires that the fairvalue of such equity instruments be recognized as an expense in the historicalfinancial statements as services are performed. Prior to SFAS No. 123(R),only certain pro forma disclosures of fair value were required. Public entitiesthat do not file as small business issuers will be required to apply SFAS No. 123(R)as of the first fiscal year that begins after June 15, 2005. Therefore, ifwe are not eligible to file as a small-business issuer, we will adopt SFAS No. 123(R)beginning in the fiscal year ending March 31, 2007. If we had included thefair value of employee stock options in our financial statements, our netincome for fiscal years 2005 and 2004 would have been as disclosed in theparagraph entitled *Stock-Based Compensation*of these Notes. Accordingly, the adoption of SFAS No. 123(R) could have amaterial effect on our financial statements.

 

**NOTE 3.FINANCIAL INSTRUMENTS**

Our financial instrumentsconsist of cash and cash equivalents, investment securities, short-term tradereceivables, and accounts payable. Because of their short term, the carryingvalues of our financial instruments approximate their fair value. Investmentsecurities as of March 31, 2005 consisted of the following:

 
| ** **                           | ** ** | **Adjusted  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Market  Value** | ** ** |
|--------------------------------------|------------|--------------------|------------|------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|
| U.S. Treasury and agency securities  |       | $                  | 4,654,726  |                         | $          | —                        |       | $                                 | (97,051    | ) | $ | 4,557,675 |   |
| Corporate notes and bonds            |       | 1,954,561          |       | —                       |       | (35,177                       | )          | 1,919,384                         |       |
| Total available-for-sale investments |       | $                  | 6,609,287  |                         | $          | —                        |       | $                                 | (132,228   | ) | $ | 6,477,059 |   |

 

Thematurities of investment securities at March 31, 2005 were as follows:

 

| ** **                    | ** ** | **Estimated Fair  Market Value** | ** ** |
|-------------------------------|------------|----------------------------------|------------|
| Maturing in less than 1 year  |       | $                                | 252,775    |   |
| Maturing in 1 to 2 years      |       | 766,250                          |       |
| Maturing in 2 to 3 years      |       | 969,839                          |       |
| Maturing in more than 3 years |       | 4,488,195                        |       |
| Total                         |       | $                                | 6,477,059  |   |

 

F-9

----

 

**NOTE****4.INVENTORIES**

Inventories consisted of thefollowing:

 

| ** **                | ** ** | **March 31  2005** | ** ** |
|---------------------------|------------|-------------------------|------------|
| Raw materials             |       | $                       | 754,456    |   |
| Work-in-process           |       | 614,337                 |       |
| Finished goods            |       | 383,966                 |       |
|                      |       | 1,752,759               |       |
| Less obsolescence reserve |       | (180,000                | )          |
|                      |       | $                       | 1,572,759  |   |
|                           |            |                         |            |  |  |

 

**NOTE****5. INCOMETAXES**

The provision for income taxexpense (benefit) for fiscal 2005 and 2004 consisted of the following:

 

| ** **      | ** ** | **Year Ended March 31** | ** ** |
|-----------------|------------|------------------------------|------------|
| ** **      | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| Current taxes:  |       |                         |       |   |   |
| Federal         |       | $                            | (13,500    | ) | $ | 13,500 |   |
| State           |       | 2,000                        |       | 3,478 |   |
|            |       |                         |       |   |   |
| Deferred taxes: |       |                         |       |   |   |
| Federal         |       | (126,904                     | )          | (250,000 | ) |
| State           |       | —                       |       | — |   |
|            |       | $                            | (138,404)  |   | $ | (233,022 | ) |
|                 |            |                              |            |  |  |  |  |  |  |

 

A reconciliation of incometax expenses provided at the federal statutory rate of 34% to income taxexpense for fiscal 2005 and 2004 is as follows:

 

| ** **                                 | ** ** | **Year Ended March 31** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| Tax expense at U.S. statutory rate         |       | $                            | 550,749    |   | $ | 637,300 |   |
| State income taxes, net of Federal benefit |       | 40,496                       |       | 49,685 |   |
| Other                                      |       | (4,231                       | )          | 19,993 |   |
| Benefit of tax credits                     |       | (143,374                     | )          | (78,154 | ) |
| Change in valuation allowance              |       | (582,044                     | )          | (861,846 | ) |
|                                       |       | $                            | (138,404)  |   | $ | (233,022 | ) |
|                                            |            |                              |            |  |  |  |  |  |  |

 

Deferred income taxesreflect the net tax effects of temporary differences between the carryingamount of assets and liabilities for financial reporting purposes and theamounts used for income tax purposes. Significant components of our deferredtax assets and liabilities were as follows:

 

| ** **                       | ** ** | **March 31  2005** | ** ** |
|----------------------------------|------------|-------------------------|------------|
| Deferred tax assets:             |       |                    |       |
| Deferred revenue                 |       | $                       | 90,901     |   |
| Vacation accrual                 |       | 92,263                  |       |
| Inventory reserve                |       | 61,200                  |       |
| Tax credits                      |       | 338,165                 |       |
| Other                            |       | 39,100                  |       |
|                             |       | 621,629                 |       |
| Valuation allowance              |       | (244,725                | )          |
|                             |       | 376,904                 |       |
| Stock-based compensation expense |       | 3,363,179               |       |
| Valuation allowance              |       | (2,984,009              | )          |
|                             |       | $                       | 756,074    |   |

 

F-10

----

 

During fiscal 2005, wereversed $595,462 of our valuation allowance due to the utilization of netoperating loss carryforwards and tax credits, and $506,074 of the remainingvaluation allowance was reversed due to our assessment that it was more likelythan not that we would earn sufficient operating income to realize $756,074 ofthe remaining deferred tax assets. We have provided a valuation allowance of$3,228,734 as of March 31, 2005 because we do not believe that it is morelikely than not that we will utilize the remaining deferred tax assets beforethey expire. Regardless of our expectations, there can be no assurance that wewill generate any specific level of continuing earnings.

 

We have tax credits totaling$211,261, which can be used to offset future taxable income. We also have$9,891,703 in stock-based compensation deductions that can be used to offsetfuture income. Any realization of these stock-based compensation deductionswill be credited to additional paid-in capital.

 

Cash payments (refunds) forincome taxes during fiscal 2005 and 2004 amounted to ($11,500) and $16,978.

 

**NOTE****6. LEASES**

We lease our facility underan operating lease expiring December 31, 2008. We also pay operatingexpenses including maintenance, utilities, real estate taxes, and insurance. Wehave also leased several pieces of equipment under operating leases. Terms ofthe leases range from 36 to 60 months through June 2006, with payments duethe first of each month. Total rent expense for operating leases, includingbuilding and equipment, was $220,070 and $275,203 for fiscal 2005 and 2004.

 

We have a lease payable to aleasing company that totaled $100,711 at March 31, 2005 for productionequipment. The lease has an effective annual rate of 8.96% with monthlypayments of $6,123 through June 2006 and a payoff amount of $15,000 due June 2006.The cost and accumulated amortization at March 31, 2005 for assetsreported under capital lease obligations amounted to $310,000 and $211,833.

 

Our future commitments underoperating and capital leases are summarized as follows:

 

| **Year Ending  March 31** | ** ** | **Operating Lease  Future Minimum  Payments** | ** ** | **Capital Lease  Obligations** | ** ** |
|--------------------------------|------------|-----------------------------------------------|------------|--------------------------------|------------|
| 2006                           |       | $                                             | 203,883    |                           | $          | 73,481 |   |
| 2007                           |       | 206,533                                       |       | 33,870                         |       |
| 2008                           |       | 210,140                                       |       | —                         |       |
| 2009                           |       | 160,152                                       |       | —                         |       |
| 2010                           |       | —                                        |       | —                         |       |
| Total payments                 |       | $                                             | 780,708    |                           | 107,351    |   |
| Less interest portion          |       |                                          |       | 6,640                          |       |
|                           |       |                                          |       | 100,711                        |       |
| Less current portion           |       |                                          |       | 67,430                         |       |
|                           |       |                                          |       | $                              | 33,281     |   |
|                                |            |                                               |            |                                |            |  |  |  |

 

**NOTE****7. STOCKOPTIONS**

Our 2000 Stock Option Plan,as amended, provides for issuance to employees, directors, and certain serviceproviders of incentive stock options and nonstatutory stock options. Generally,the options may be exercised at any time prior to expiration, subject tovesting based on terms of employment. The period ranges from immediate vestingto vesting over a five-year period. The options have exercisable lives rangingfrom one year to ten years from the date of grant. Exercise prices are not lessthan fair market value as determined by our Board of Directors at the date theoptions are granted. A summary of our incentive stock options is shown in thefollowing table:

 
| ** **                     | ** ** | **Shares  Reserved** | ** ** | **Options  Outstanding** | ** ** | **Weighted Average  Exercise Price  per Share** | ** ** |
|--------------------------------|------------|----------------------|------------|--------------------------|------------|-------------------------------------------------|------------|
| Balance at March 31, 2003 |       | 362,030              |       | 561,570                  |       | 4.36                                            |       |
| Granted                        |       | (14,500              | )          | 14,500                   |       | 19.23                                           |       |
| Exercised                      |       | —               |       | (300,640                 | )          | 3.55                                            |       |
| Terminated                     |       | 14,000               |       | (14,000                  | )          | 6.68                                            |       |
| Balance at March 31, 2004 |       | 361,530              |       | 261,430                  |       | 5.99                                            |       |
| Granted                        |       | (121,000             | )          | 121,000                  |       | 22.30                                           |       |
| Exercised                      |       | —               |       | (73,880                  | )          | 3.01                                            |       |
| Terminated                     |       | —               |       | —                   |       | —                                          |       |
| Balance at March 31, 2005 |       | 240,530              |       | 308,550                  |       | $                                               | 13.10      |   |
|                                |            |                      |            |                          |            |                                                 |            |  |

 

F-11

----

 

As of March 31, 2005and 2004, there were exercisable options outstanding covering 266,858 and166,135 shares at a weighted-average exercise price of $14.08 and $5.08 pershare. The remaining weighted average exercisable life was 6.5 and 3.3 years atMarch 31, 2005 and 2004. The fair market value of grants issued was $19.65and $12.75 in fiscal 2005 and 2004.

 

**NOTE****8. COMMONSTOCK**

Our authorized stock isstated as six million shares of common stock, $0.01 par value and ten millionshares of all types. Our Board of Directors may designate any series and fixany relative rights and preferences to authorized but undesignated stock.

 

**NOTE****9. LICENSEAGREEMENTS**

We have entered into twoseparate license agreements, which provided for advanced payments plusroyalties based upon revenue generated by the respective parties. To date, noroyalties have been recognized under either agreement.

 

**NOTE****10.TECHNOLOGY EXCHANGE AGREEMENT**

In April 2002 we closeda technology exchange agreement accompanied by an investment by CypressSemiconductor Corporation. Cypress purchased 686,849 shares of our common stockfor $6.228 million. Cypress also received a warrant for the purchase of up toan additional 400,000 shares of common stock for $15 per share for a term ofthree years. The warrant expired on April 11, 2005 with no sharesexercised.

 

**NOTE****11.ROYALTIES**

We have licensed rights toanother organization’s GMR-related patents in exchange for payment of royaltiesof 1.5% of the sales of certain of our products. Payments under this licenseagreement have not been material.

 

**NOTE****12.EMPLOYEE BENEFITS**

All of our employees areeligible to participate in our 401(k) savings plan the first quarter afterreaching age 21. Employees may contribute up to the Internal Revenue Servicemaximum. We make matching contributions equal to 100% of the first 2% ofelective salary deferral contributions made by eligible participants. We madematching contributions of $81,704 and $88,452 for fiscal 2005 and 2004.

 

In 2001 our shareholdersapproved and we implemented an Employee Stock Purchase Plan. The plan allows usto issue up to 200,000 shares of common stock. With certain exceptions, all ofour employees who have been employed by us for at least one year and who areemployed at least 20 hours per week and at least five months per year,including officers and directors who are employees, are eligible toparticipate. The plan consists of periodic offerings for a period determined byour Board of Directors. Under the plan, an employee may elect to have up to 10%of their regular salary deducted to purchase shares. The price at which theemployee’s shares are purchased is the lower of (a) 85% of the closingprice of the common stock on the day that the offering commences or (b) 85%of the closing price of the common stock on the day that the offeringterminates. We issued 7,009 and 12,566 shares of common stock under the planfor fiscal 2005 and 2004.

 

**NOTE****13. LEGAL**

We are subject to various litigationmatters from time to time in the normal course of our business. We currentlybelieve that the ultimate outcome of these proceedings will not have a materialadverse affect on our financial position or results of operations. However,because of the nature and inherent uncertainties of litigation, should theoutcome of these actions be unfavorable, our business, financial position, andresults of operations could be materially and adversely affected. We believethat we are not currently a party in any litigation, which, if adverselydetermined, would have a material adverse effect on our financial condition orresults of operations.

 

F-12

----

 

**EXHIBIT INDEX**

 
| **Exhibit #** | ** ** | **Description**                                                                                                                                                               |
|--------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |       |                                                                                                                                                                          |
| 23                 |       | Consent of  Ernst & Young LLP.                                                                                                                                       |
|               |       |                                                                                                                                                                          |
| 31.1               |       | Certification  by Daniel A. Baker pursuant to Rule 13a-14(a)/15d-14(a).                                                                                                  |
|               |       |                                                                                                                                                                          |
| 31.2               |       | Certification  by Richard L. George pursuant to Rule 13a-14(a)/15d-14(a).                                                                                                |
|               |       |                                                                                                                                                                          |
| 32                 |       | Certification  by Daniel A. Baker and Richard L. George pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|               |       |                                                                                                                                                                          |
| 99                 |       | Cautionary  statements for purposes of the “safe harbor” provisions of The Private  Securities Litigation Reform Act.                                               |

 

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