**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

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**Form 10-K**

 

**(Mark One)**

 

**ý****    ****ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thefiscal year ended March 31,2006**

 

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

 

**For the transition period from                to               **

 

**Commission file number ****000-12196**

 

**NVE Corporation**

(Exact name of registrant asspecified 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)                           |

 

Registrant’s telephonenumber, including area code  **(952) 829-9217**

 

Securities registeredpursuant to Section 12(b) of the Act: **None**

 

Securities registeredpursuant to Section 12(g) of the Act: **Common stock, $0.01 par value (“CommonStock”)**

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.

Yes  o   No  ý

 

Indicate by check mark if the registrant is not required to filereports pursuant to Section 13 or Section 15(d) of the Act.

Yes  o   No  ý

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding12 months (or for suchshorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.

Yes  ý   No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K (§229.405 of this chapter) is not contained herein,and will not be contained, to the best of the registrant’s knowledge, indefinitive proxy or information statements incorporated by reference inPart III of this Form 10-K or any amendment to this Form 10-K.
|   | ý |
|--------|--------|

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-accelerated filer.See definition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

 
| Large accelerated  filer  o | Accelerated filer  o | Non-accelerated filer  ý |
|---------------------------------------|--------------------------------|-----------------------------------------|

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

 

The aggregate market value of the voting andnon-voting common equity held by non-affiliates as of the last business day ofthe registrant’s most recently completed second fiscal quarter was $67 millionbased on the last sale price of $15.27 per share as reported by The NASDAQCapital Market for September 30, 2005.

 

The number of shares of the registrant’sCommon Stock (par value $0.01) outstanding as of May 16, 2006 was4,616,703.

 

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**DOCUMENTSINCORPORATED BY REFERENCE**

 

Parts of our Proxy Statementfor our 2006 Annual Meeting of Stockholders are incorporated by reference intoItems  10, 11, 12, and 14 of Part IIIhereof.

 

 

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**NVECORPORATION**

**INDEX TO FORM 10-K**

 
| **PART I**                                                                                          | ** ** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|
| Item 1. Business                                                                                         |       |       |
| Our Strategy                                                                                             |       |       |
| Our Products and Markets                                                                                 |       |       |
| Sensor  Products and Markets                                                                             |       |       |
| Coupler  Products and Markets                                                                            |       |       |
| MRAM  Products and Markets                                                                               |       |       |
| Product Manufacturing                                                                                    |       |       |
| Sales and Product  Distribution                                                                          |       |       |
| New Product Status                                                                                       |       |       |
| Our Competition                                                                                          |       |       |
| Principal  Suppliers and Raw Materials                                                                   |       |       |
| Intellectual Property                                                                                    |       |       |
| Working Capital Items                                                                                    |       |       |
| Major Customers                                                                                          |       |       |
| Backlog                                                                                                  |       |       |
| Seasonality                                                                                              |       |       |
| Research and  Development Activities                                                                     |       |       |
| Government Regulations                                                                                   |       |       |
| Our Employees                                                                                            |       |       |
| Financial Information About Geographical Areas                                                           |       |       |
| Available  Information                                                                                   |       |       |
| Item 1A.  Risk Factors                                                                                   |       |       |
| Item 1B. Unresolved Staff Comments                                                                       |       |       |
| Item 2.  Properties                                                                                      |       |       |
| 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. Selected Financial Data                                                                         |       |       |
| Item 7. Management’s Discussion and Analysis of  Financial Condition and Results of Operation       |       |       |
| Application of Critical Accounting Policies and  Estimates                                               |       |       |
| Results  of Operations                                                                                   |       |       |
| Liquidity  and Capital Resources                                                                         |       |       |
| Outlook                                                                                                  |       |       |
| Item 7A. Quantitative and Qualitative Disclosures  About Market Risk                                     |       |       |
| Item 8. Financial Statements and Supplementary Data                                                      |       |       |
| Item  9A. Controls and Procedures                                                                        |       |       |
|                                                                                                     |       |       |
| **PART III**                                                                                        | ** ** | ** ** |
| Item 10. Directors and  Executive Officers of the Registrant                                             |       |       |
| Item 11. Executive  Compensation                                                                         |       |       |
| Item 12. Security Ownership  of Certain Beneficial Owners and Management and Related Stockholder Matters |       |       |
| Item 13. Certain  Relationships and Related Transactions                                                 |       |       |
| Item 14. Principal  Accountant Fees and Services                                                         |       |       |
|                                                                                                     |       |       |
| **PART IV**                                                                                         | ** ** | ** ** |
| Item 15. Exhibits,  Financial Statement Schedules                                                        |       |       |
| Signatures                                                                                               |       |       |
| Report  of Independent Registered Public Accounting Firm                                                 |       |       |
|                                                                                                     |       |       |
| **FINANCIAL STATEMENTS**                                                                                 | ** ** | ** ** |
| Balance Sheets                                                                                           |       |       |
| Statements of  Income                                                                                    |       |       |
| Statement  of Shareholders’ Equity                                                                  |       |       |
| Statement of Cash  Flows                                                                                 |       |       |
| Notes  to Financial Statements                                                                           |       |       |

 

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**PART I**

 

**FORWARD-LOOKINGSTATEMENTS**

 

Someof the statements made in this Report or in the documents incorporated byreference in this Report and in other materials filed or to be filed by us withthe Securities and Exchange Commission as well as information included inverbal or written statements made by us constitute forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995.These statements are subject to the safe harbor provisions of the reform act.Forward-looking statements may be identified by the use of the terminology suchas may, will, expect, anticipate, intend, believe, estimate, should, orcontinue, or the negatives of these terms or other variations on these words orcomparable terminology. To the extent that this Report contains forward-lookingstatements regarding the financial condition, operating results, businessprospects or any other aspect of NVE, you should be aware that our actualfinancial condition, operating results and business performance may differmaterially from that projected or estimated by us in the forward-lookingstatements. We have attempted to identify, in context, some of the factors thatwe currently believe may cause actual future experience and results to differfrom their current expectations. These differences may be caused by a varietyof factors, including but not limited to adverse economic conditions, intensecompetition including entry of new competitors, progress in research anddevelopment activities by us and others, variations in costs that are beyondour 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, our ability to meet stringent customer technical requirements, ourability to consummate additional license agreements, our ability to continueeligibility for SBIR awards, our inability to raise prices, failure to obtainnew customers, the possible fluctuation and volatility of our operating resultsand financial condition, inability to carry out marketing and sales plans, lossof key executives, and other specific risks that may be alluded to in thisReport. For further information regarding our risks and uncertainties, see Item1A “Risk Factors” of this Report.

 

**ITEM 1. BUSINESS.**

 

**In General**

 

NVECorporation, referred to as NVE, we, us, or our, develops and sells devicesusing spintronics, a nanotechnology we helped pioneer, which utilizes electronspin rather than electron charge to acquire, store and transmit information. Weare a licensor of spintronic magnetoresistive random access memory technology,commonly known as MRAM, which we believe has the potential to revolutionizeelectronic memory. We also manufacture high-performance spintronic productsincluding sensors and couplers that are used to acquire and transmit data.

 

**NVE Historyand Background**

 

NVEis a Minnesota corporation headquartered in a suburb of Minneapolis. We werefounded in 1989 primarily as a government contract research company. Our stockbecame publicly traded in 2000 in a reverse merger and became NASDAQ listed in2003. Since our founding, we have been awarded more than $50 million ingovernment research contracts, including more than 30 MRAM developmentcontracts. These contracts have helped us build our intellectual propertyportfolio. Over the years our product sales have increased and we have reducedour dependence on research contracts.

 

**OurEnabling Technology**

 

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

 

Ingiant magnetoresistance (GMR) devices, resistance changes due to conductionelectrons scattering at interfaces within the devices. The GMR effect is onlysignificant if the layer thicknesses are less than the mean free path ofconduction electrons, which is approximately five nanometers. Our critical GMRconductor layers are generally less than two nanometers thick.

 

Thesecond type of spintronic structures we use are spin-dependent tunneljunctions, which are also known as SDT junctions, Magnetic Tunnel Junctions(MTJs), or Tunneling Magnetic Junctions (TMJs). SDT junctions use tunnelbarriers that are so thin that electrons can “tunnel” through a normallyinsulating material to cause a resistance change. The SDT barrier thicknessesare in the range of one to two nanometers or approximately five molecules.Technological advances in recent years have made it practical to manufacturesuch small dimensions.

 

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

 

**IndustryBackground**

 

Muchof the electronics industry is devoted to the acquisition, storage and transmissionof information. Global trends such as richer data, more video, and remote datacollection test the speed and capacity of conventional electronics.

 

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Webelieve spintronics represents the first major change in microelectronictechnology since the advent of these devices a generation ago. 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 (LED)-based optical couplers fordata transmission. There have been incremental improvements to these devicesover the years, but the inherent limitations of charge-based electronicsremain. We believe spintronics can address these significant markets.

 

Memoriesare a critical part of almost every electronic device. For some electronicdevice functions speed is required; others require a large amount of memory;and some require nonvolatility. No single semiconductor memory meets all threeof these requirements. For example, a cellphone requires the bit density ofDRAM for the operating software, the speed of SRAM for digital signalprocessing, and the nonvolatility of flash memory for phone books, ring tones,and other permanent storage. The three memories consume power and space.Because they use incompatible materials, the three memories are difficult tocombine with each other or with other cellphone circuitry in a singleintegrated 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.

 

Oursensors are used to detect small changes in magnetic fields. We believe ourspintronic sensors are smaller, more precise, and more reliable than competingdevices. They can be used to detect the position or speed of robotics andmechanisms, or to acquire information in medical devices or automobiles. Asfactories become more automated, there is a need for more precise positionsensing. Better sensors could also enable smaller, more reliable medical devicesand more efficient automobiles.

 

Likesensors, couplers are widely used in factory automation. Couplers providereliable digital communication between the various electronic subsystems infactories. For example, couplers are used to send data between robots andcentral controllers at very high speed. As manufacturing automation expands,there is a need for higher speed data higher channel density. Because of theirunique properties, we believe our couplers transmit more data at higher speedsand over longer distances than conventional devices.

 

**Our Strategy**

 

Ourvision is to become the leading developer of practical spintronics technologyand devices. We plan to do that by selling products and licensing MRAMtechnology. Our strategy is to continue to reduce our dependence on governmentcontracts and transition toward product sales and licensing as our principalrevenue sources.

 

***Grow Product Sales***

 

Weplan to broaden our sensor and coupler product lines, expand our distributionnetwork, and promote our products with advertising or direct mail campaigns.

 

***Monetize MRAM Intellectual Property Through Licensing***

 

Becauseof the large capital investment required to make large-scale memories, ourstrategy is to monetize our MRAM intellectual property by licensing othercompanies to make devices using our technology. We intend to pursue new licenseagreements, although there can be no assurance as to when or if we willconsummate additional agreements. For a discussion regarding our existinglicense agreements, see Item 1 “Business—Intellectual Property—Licenses.”

 

***Transition to Product Sales and License Revenue from Contract Research***

 

Governmentresearch and development contracts were the source of some of our patents andproduct developments, and our primary source of revenue for much of ourhistory. We have redeployed personnel from contract research to company-fundedproduct research because we believe company-funded research will have a higherrate of return.

 

**Our Products and Markets**

 

Weoperate in one reportable segment. For financial information concerning thissegment see Note 6 “Segment Information” of the Financial Statements includedelsewhere in this Report.

 

***Sensor Products and Markets***

 

Oursensor products detect the presence of a magnet or metal to determine positionor speed. The GMR changes its electrical resistance depending on the magneticfield. In our devices, GMR is combined with conventional foundry integratedcircuitry and packaged in much the same way as conventional integratedcircuits. We sell standard, or catalog sensors, and custom sensors designed tomeet customers’ exact requirements. Our sensors are quite small, very sensitiveto magnetic fields, precise, and reliable. These advantages have allowed us toestablish a presence in industrial control applications such as robotics andmore recently in the medical device market.

 

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*Standardsensors*

 

Ourstandard or catalog sensors are generally used to detect the presence of amagnet or metal to determine position or speed. We believe our spintronicsensors are smaller, more precise, and more reliable than competing devices.Our major market for standard sensors is factory automation.

 

*Custom andmedical sensors*

 

Ourprimary custom products are sensors for medical devices, which are customizedto our customers’ requirements and manufactured in accordance with stringentmedical device quality standards. Most are used to replace electromechanicalmagnetic switches. We believe our sensors have important advantages in medicaldevices compared to electromechanical switches, including no moving parts forinherent reliability, and being smaller, more sensitive, and more precise. Oursensors can be customized using customer-specific integrated signal processingand design variations that can include the range and sensitivity to magneticfields, electrical resistance, and multi-sensor elements configuration.Anticipated future custom sensor markets include consumer and automotivemarkets.

 

***Coupler Products and Markets***

 

Ourspintronic couplers add an “IsoLoop” integrated microscopic coil to our basicGMR sensor element. The coil creates a small magnetic field that is picked upby the spintronic sensor, transmitting data almost instantly. Couplers are alsoknown as “isolators” because they electrically isolate the coupled systems. OurIsoLoop couplers are much faster than the fastest optical couplers.

 

Wehave two main series of couplers: the original IsoLoop 700 Series, and thenewer, award-winning IsoLoop 600 Series. The newer couplers use spintronicinput stages while our original products use semiconductor input stages. Ourcouplers are sold primarily for factory and industrial networks. Broadband,telecommunications, and automotive applications are possible in the future.

 

***MRAM Products and Markets***

 

MRAMuses spintronics to store data, combining the speed of semiconductor memorywith the nonvolatility of magnetic disk drives. MRAM is inherently nonvolatile,meaning the data remains even if power is removed. MRAM has been called theideal or universal memory because it has the potential to combine the speed ofSRAM, the density of DRAM, and the nonvolatility of flash memory.

 

Datais stored in the spin of the electrons in thin metal alloy films, and read withspin-dependent tunnel junctions. Unlike electrical charge, the spin of anelectron is inherently permanent. In MRAMs, the spin of the electrons is setwith tiny bursts of energy. We have invented several types of MRAM memory cellsand modes of operation.

 

AdvancedMRAM designs that we are developing include Vertical transport MRAM (also knownas VMRAM), magnetothermal MRAM, and spin-momentum transfer MRAM. We believeeach of these three design approaches have the potential to increase thescalability of MRAM.

 

Inthe near term, MRAM could replace battery-backed-up SRAMs in mission-criticalsystems such as military, factory control, point-of-sale terminals, and gamingelectronics. MRAM has the potential advantages of being simpler, lower cost,and more reliable than battery/memory systems. Long term, MRAM could addressthe market for ubiquitous high-density memory.

 

**Product Manufacturing**

 

Ourfabrication facility is a clean-room area with specialized equipment todeposit, pattern, etch, and process spintronic materials. Most of our productsare fabricated in our facility using either raw wafers or foundry wafers.Foundry wafers contain conventional electronics that perform housekeepingfunctions such as voltage regulation and signal conditioning in our products.

 

Eachwafer includes thousands of devices. We build spintronics structures on wafersin our fabrication facility and send the completed wafers to Asia for dicingand packaging. The packaged parts are returned to us to be tested, inventoried,and shipped.

 

**Sales and Product Distribution**

 

Werely primarily on distributors who stock and sell our products throughout theworld, including Digi-Key Corporation, one of the largest electronic componentdistributors in the United States. Our agreements with distributors aregenerally renewed annually. In addition, Avago, the company comprised of theformer Agilent Technologies, Inc. Semiconductor Product Group, and one ofthe world’s leading suppliers of solid-state couplers, distributes Agilent- andAvago-branded versions of our couplers under an agreement that expires in June 2007.Avago uses its own network of distributors.

 

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**New Product Status**

 

Inthe past year we began selling several new products including a number of newmembers of the IsoLoop 600 coupler series. The IsoLoop 600 Series usesspintronic input stages, while our older IsoLoop 700 coupler series usessemiconductor input stages. IsoLoop 600 Series devices are smaller thanour older products and provide a simpler interface for markets such as factoryautomation. We also began selling the AFL-Series digital spintronicswitches for use in medical and other markets for advanced sensors.

 

**Our Competition**

 

***Industrial Sensor Competition***

 

Severalcompetitors make solid-state industrial magnetic sensors including siliconHall-effect sensors and anisotropic magnetoresistive (AMR) sensors. We believethose types of sensors are not as sensitive or precise as our sensors.

 

***Medical Sensor Competition***

 

Ourmedical sensors face competition from electromechanical magnetic sensors suchas reed switches. Reed switches have been in use for several decades. A reedswitch uses a pair of contacts that pull together when subjected to a magneticfield, closing an electrical circuit. Our medical sensor competitors includeHermetic Switch, Inc., which manufactures miniature magnetically operatedreed switches. Additionally, Meder Electronic AG (Engen/Welschingen, Germany)and Memscap SA (Grenoble, France) manufacture microelectromechanical system(MEMS) reed switches. Because our sensors have no moving parts, we believe theyare inherently more reliable than miniature and MEMS reed switches. We alsobelieve our sensors are smaller than the smallest reed switches, more precisein their magnetic switch points, and more sensitive to small magnetic fields.

 

***Coupler Competition***

 

Thetwo main competing digital coupler technologies are optical couplers andinductive couplers (transformers). Optical couplers use light and lightdetectors to transmit information; transformers use magnetic fields transmittedbetween coils.

 

Inaddition to being a customer, Avago is a leading producer of high-speed opticalcouplers. Other prominent optical coupler suppliers are Fairchild SemiconductorInternational, NEC Corporation, Sharp Corporation, Toshiba Corporation, andVishay Intertechnology. We believe our couplers are considerably faster thaneven the fastest optical couplers.

 

Inductivecouplers are made by a number of companies. Unlike our IsoLoop couplers,inductive couplers require special encoding to transmit logic signals.Furthermore, IsoLoop couplers require much less board space than most opticalor inductive couplers. Analog Devices, Inc. and Silicon Laboratories, Inc.market MEMS inductive couplers. While these devices offer some advantages overour couplers and are smaller than other inductive couplers, we believe ourdevices have higher channel density per area, are faster, and produce lesssignal distortion.

 

TexasInstruments Inc. has begun marketing capacitive couplers. We believe we have abroader product line and higher channel density than Texas Instruments’couplers.

 

Wemake several network signal couplers that combine spintronics coupling withnetwork protocol functions such as RS-485, in a single package. Our competitorsin this area include ADI, Linear Technology Inc. (LTI), and Maxim IntegratedProducts, Inc. Based on a comparison of published specifications, webelieve our devices are much faster than the LTI and Maxim network signal couplers.We believe we offer a wider input voltage interface and a more complete line ofnetwork protocols than ADI’s network signal couplers.

 

***MRAM Competition***

 

Mostcurrently available memories are volatile, meaning data is lost when power isremoved. Memories in this category include dynamic random access memory (DRAM)and static random access memory (SRAM). MRAM has the potential to match orexceed the speed of such memories without the volatility. Currently availablenonvolatile memories include flash memory and ferroelectric random accessmemory (FRAM). MRAM is potentially faster and uses less power than existingnonvolatile memories. Furthermore, existing nonvolatile memories can be writtenonly a limited number of times before they wear out, while MRAM has virtuallyunlimited life. Additionally, flash memory may be subject to scalabilitylimitations that could limit its density in coming years. We do not believeMRAM is subject to those limitations.

 

Thereare many flash memory manufacturers, most of which are large semiconductorcompanies. Silicon-oxide-nitride-oxide-silicon (SONOS) and thin-film storage(TFS) have been proposed as improvements to flash memories. Simtek Corporationand Cypress Semiconductor Corporation are among companies reported to bedeveloping SONOS memory; Freescale Semiconductor, Inc. has said it isdeveloping TFS memory. Both types of memory appear to have many of thelimitations of conventional flash memory, including limited speed andendurance.

 

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Battery-backed-up SRAM manufacturers includeMaxim. We believe that MRAM has the potential of being simpler, lower cost, andmore reliable than battery-backed-up SRAM.

 

Emergingtechnologies competing with MRAM include carbon nanotubes, phase-change memory(PCM; also known as chalcogenide or ovonic memory), polymer memory, andpolymeric ferroelectric random access memory (PFRAM). We believe that MRAM hasadvantages over these technologies and that it is closer to commercialization,more easily manufacturable, more scalable, and has virtually unlimitedendurance. Companies developing carbon nanotube memory include Nantero, Inc.Companies developing PCM include Elpida Memory, Inc., IBM Corporation,Infineon, Intel, Macronix International Co., Ltd., Ovonyx, Inc., Philips,and STMicroelectronics. Companies developing polymer memory include Thin FilmElectronics ASA and Coatue. Intel may be developing PFRAM.

 

Othercompanies that may compete with us for MRAM research and development or servicebusiness, or that may be attempting to develop MRAM intellectual property withthe intention of licensing to others, include Grandis, Inc., Spintec(Grenoble, France), and Spintron (Marseille, France).

 

**Principal Suppliers and Raw Materials**

 

Ourprincipal suppliers include manufacturers of semiconductor wafers that areincorporated into our products. These include Advanced SemiconductorManufacturing Corporation of Shanghai (China), AMI Semiconductor, Inc.,Intersil Corporation, Silicon Quest International, Inc., TaiwanSemiconductor Manufacturing Corporation, and Texas Instruments Inc. Othercompanies supply our device packaging services, including CIRTEK ElectronicsCorporation (Laguna, The Philippines), Circuit Electronics Industries(Ayutthaya, Thailand), and NS Electronics Bangkok (Thailand), Ltd.

 

Wemaintain inventory of some critical wafers, but we have not identified orqualified alternate suppliers for many of the wafers now being obtained fromsingle sources. Some of our products use processes or tooling unique to aparticular packaging vendor, and it might be expensive, time-consuming, orimpractical to convert to another vendor in the event of a supply interruption.Supply interruptions could seriously jeopardize our ability to provide productsthat are critical to our business and operations.

 

**Intellectual Property**

 

***Patents***

 

Asof March 31, 2006 we had 35 issued U.S. patents assigned to us. We alsohave a number of foreign patents, a number of U.S. and foreign patents pending,and we have licensed patents from others. Our technology is protected by morethan 100 patents worldwide either issued, pending or licensed from others. Weare continuing to develop inventions and expect to add to our patent portfolio.There are no patents we regard as critical to our business owned by us orlicensed to us that expire in the next 12 months.

 

Muchof our intellectual property has been developed with U.S. Government support.In accordance with federal legislation, companies normally may retain theprincipal worldwide patent rights to any invention developed with U.S.Government support.

 

Certainof our patents cover MRAM cells with transistor selection for data retrieval,which we believe may be necessary for successful high-density, high-performanceMRAMs. We believe our 6,275,411 and 6,349,053 U.S. patents, both titled “SpinDependent Tunneling Memory,” are particularly important. Both patents coverMRAMs using arrays of Spin Dependent Tunnel Junctions. Based on their publicdisclosures, we believe several companies are pursuing the approach describedin these patents. The 6,275,411 patent expires in 2019 and the 6,349,053 patentexpires in 2021. We also have patents on advanced MRAM designs that we believeare important, including patents that relate to magnetothermal MRAM,spin-momentum MRAM, and synthetic antiferromagnetic storage.

 

***Trademarks***

 

Ourtrademarks include “AT-MRAM,” “GMR Switch,” and “GT Sensor.” “IsoLoop” is ourregistered trademark.

 

***Licenses***

 

Wehave licensed certain MRAM intellectual property to several companies. Ourcurrent MRAM licensees include Cypress, Honeywell, Union SemiconductorTechnology Corporation, and Motorola, Inc. We received advance payments inconjunction with the Honeywell, USTC, and Motorola agreements. The Motorola andUSTC agreements define royalties if and when those licensees begin sellingdevices using our intellectual property. Both agreements contain royaltylimitations, specifically minimum quantities before royalties are paid andceilings on the royalties we will receive.

 

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*Agreementswith Honeywell*

 

Underour agreements with Honeywell, we do not expect to pay royalties to Honeywellfor the use of their MRAM intellectual property. Honeywell has rights tocertain of our MRAM intellectual property up to a certain point in time. Webelieve Honeywell does not currently have rights to our more recently developedMRAM intellectual property.

 

*MotorolaLicense*

 

Motorolahas a non-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. We believe the Motorola agreement likely terminatedin 2005 because Motorola transferred manufacturing to Freescale.

 

*RoyaltyAgreement*

 

Wehave licensed rights to another organization’s GMR-related patent family, andthat agreement calls for us to pay royalties on our sales of certain products.Payments under this agreement have not been material to date. The agreementremains in force until the expiration of the last patent, which is in 2009, oruntil cumulative royalties of $1.2 million have been paid, whichever isearlier.

 

**Working Capital Items**

 

Likecompanies in the semiconductor industry, we have historically invested incapital equipment for manufacturing and testing our products, as well asresearch and development equipment. We have historically deployed significantcapital in inventories to have products available from stock, to receive morefavorable pricing for raw materials, and to guard against raw materialshortages.

 

**Major Customers**

 

Werely on several large customers for a large percentage of our revenue; theseinclude Avago Technologies (the company comprised of the former AgilentTechnologies, Inc. Semiconductor Product Group); St. Jude Medical, Inc.;the U.S. Government; Digi-Key Corporation, and certain other distributors. Theloss of any one or more of these customers could have a material adverse effecton us. For the purposes of this disclosure, all agencies of the U.S. Governmentare considered a single customer.

 

**Backlog**

 

Asof March 31, 2006 and 2005 we had $682,685 and $2,450,823 of contractresearch and development backlog we believed to be firm. Of the firm backlog asof March 31, 2006, all is expected to be filled within fiscal 2007.Approximately 90% and 96% of our backlog as of March 31, 2006 and 2005 wasfrom agencies of the U.S. Government. U.S. Government orders that are not yetfunded, or contracts awarded but not yet signed are not included in firmbacklog. The portion of orders already included in operating revenues on thebasis of percentage of completion or program accounting are excluded. We do notbelieve any material portion of our business is subject to renegotiation ofprofits or termination of contracts or subcontracts at the election of the U.S.Government. There can be no assurance, however of additional contracts orfollow-on contracts for expired or completed U.S. Government contracts.

 

Wedo not believe product sales backlog as of any particular date is indicative offuture results. Our product sales are made primarily under standard purchaseorders for delivery of standard products. We have certain agreements thatrequire customers to forecast purchases, however these agreements do notgenerally obligate the customer to purchase any particular quantity ofproducts. Shipment schedules and quantities actually purchased by customers areoften revised to reflect changes in customers needs. In light of semiconductorindustry practice and our experience, we do not believe that such agreementsare meaningful for determining backlog amounts. We believe that only a smallportion of our product order backlog is non-cancelable and that the dollaramount associated with the non-cancelable portion is not significant.

 

**Seasonality**

 

Thepast two fiscal years our product business has been less in the quarters ended December 31than the immediately preceding or following quarters. This may be due in partto distributor ordering patterns or customer vacations and shutdowns late inthe calendar year. We do not know if this pattern constitutes a seasonal trendor whether it will continue.

 

**Research and Development Activities**

 

Weinvested $4,914,348, $5,860,200, and $6,382,865 on research and development forthe years ended March 31, 2006, 2005, and 2004. All but $1,096,970,$841,731, and $737,447 of the expenditures for those years were funded bycustomers through research and development contracts. Our research anddevelopment contracts are with other companies and various agencies of the U.S.Government. Over the past three fiscal years we invested in the development ofnew sensors and couplers including rotational speed sensors, a new family ofmonolithic couplers called the IL600 Series, and new types of isolated RS-485network transceivers. We also invested in lower-cost product designs.

 

8

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**Government Regulations**

 

Weare subject to various local, state, and federal laws, regulations and agenciesthat affect businesses generally. These include regulations promulgated byfederal and state environmental and health agencies, the federal OccupationalSafety and Health Administration, and laws pertaining to the hiring, treatment,safety, and discharge of employees.

 

**Our Employees**

 

Wehad 50 employees as of March 31, 2006, compared to 64 as of March 31,2005. The reduction in employees was primarily due to a shift in revenue mixtoward product sales, a shift to a distribution-based sales strategy, andincreased manufacturing productivity. These changes allowed us to increase ourrevenue per employee. None of our employees is represented by a labor union oris subject to a collective bargaining agreement, and we believe we maintaingood relations with our employees.

 

**Financial Information About Geographical Areas**

 

Internationalsales accounted for approximately 32%, 24%, and 18% of our revenue in fiscal2006, 2005, and 2004. More information about geographical areas is contained in“Note 6. Segment Information” of the Financial Statements.

 

**Environmental Matters**

 

Weare subject to environmental laws and regulations, particularly with respect toindustrial waste. Compliance with these laws and regulations has not had amaterial impact on our capital expenditures, earnings, or competitive position.

 

**Available Information**

 

Allreports we file with the Securities and Exchange Commission (SEC), includingour annual reports on Forms 10-K and 10-KSB, quarterly reports on Forms 10-Qand 10-QSB, current reports on Form 8-K, proxy statements on Form 14A,as well as any amendments to those reports, are accessible at no cost throughthe “Investors” section of our Website (www.nve.com). These filings arealso accessible on the SEC’s Website (www.sec.gov).

 

**ITEM 1A. RISK FACTORS.**

 

Wecaution readers that the following important factors, among others, couldaffect our financial condition, operating results, business prospects or anyother aspect of NVE, and could cause our actual results to differ materiallyfrom that projected or estimated by us in the forward-looking statements madeby us or on our behalf. Although we have attempted to list below the importantfactors which do or may affect our financial condition, operating results,business prospects or any other aspect of NVE, other factors may in the futureprove to be more important. New factors emerge from time to time and it is notpossible for us to predict all of such factors. Similarly, we cannotnecessarily assess or quantify the impact of each such factor on the businessor the extent to which any factor, or combination of factors, may cause actualresults to differ materially from those contained in forward-lookingstatements.

 

**RisksRelated to Our Business**

 

***We may lose revenue if any of our large customers cancel, postpone, orreduce their purchases.***

 

Werely on several large customers for a large percentage of our revenue; these includeAvago Technologies (the company comprised of the former Agilent Technologies, Inc.Semiconductor Product Group), St. Jude Medical, Inc., the U.S. Government,Digi-Key Corporation, and certain other distributors. In fiscal 2006 we reducedour number of manufacturers’ representatives, which increased our dependence onour North American distributors. Orders from these large customers can becancelled, postponed, or reduced without cause, and the loss of any of thesecustomers could have a significant impact on our revenue and our profitability.

 

***We rely on government contracts for a significant percentage of ourrevenue and we will lose revenue if government funding is reduced oreliminated.***

 

U.S.Government contracts accounted for the majority of our fiscal 2005 revenue, andalthough U.S. Government contracts decreased as a percentage of our revenues infiscal 2006, such contracts remain a significant portion of our revenue. Amaterial decrease in U.S. Government funding research or disqualification as avendor to the U.S. Government for any reason would likely hamper futureresearch and development activity as well as related revenue.

 

***Failure to qualify as a small business under federal regulations couldmake us ineligible for some government-funded research grants which could havea significant impact on our revenue and our ability to make research anddevelopment progress.***

 

Federalregulations place a number of criteria for a business to be eligible to competefor Small Business Innovation Research (SBIR) awards. Those criteria includenumber of employees and ownership structure. While we believe we meet thecriteria, changes in our ownership beyond our control could cause us to loseour eligibility to compete for SBIR awards, which in turn could have a materialadverse effect on our revenue, profits, and research and development efforts.

 

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***Our backlog may not result in future revenue.***

 

Whilewe evaluate each order to determine qualification for inclusion in our firmbacklog, there can be no assurance that amounts included in our firm backlogultimately will result in future revenue. A reduction in our firm backlogduring any particular period, or the failure of our firm backlog to result infuture revenue, could harm our business and revenue.

 

***We face an uncertain economic environment in our industry that couldadversely affect our business and operations.***

 

Thesemiconductor market, which is the primary market for our products, has beensubject to sudden downturns in the past. Any future downturn in the economicenvironment would likely have a material adverse impact on our business andrevenue.

 

***Our reputation could be damaged and we could lose revenue if we fail tomeet technical challenges required to produce marketable products.***

 

Ourproducts use new technology and we are continually researching and developingproduct designs and production processes. Our production processes requirecontrol of magnetic and other parameters that are not required in conventionalsemiconductor processes. If we are unable to develop stable designs andproduction processes we may not be able to produce products that meet ourcustomers’ requirements, which could cause damage to our reputation and loss ofrevenue.

 

***Our failure to meet stringent customer technical requirements couldresult in the loss of key customers and potentially reduce our sales.***

 

Someof our customers, including Avago (the company comprised of the former AgilentTechnologies, Inc. Semiconductor Product Group), St. Jude Medical, andStarkey Laboratories, have stringent technical requirements which require ourproducts to pass certain test and qualification criteria before they areaccepted by such customers. Failure to meet those criteria could result in the lossof current sales revenue, customers and future sales.

 

***Our sensors are incorporated into medical devices, which could exposeus to a risk of product liability claims and such claims could seriously harmour business and financial condition.***

 

Certainof our sensor products are used in medical devices, including cardiacpacemakers and implantable cardioverter defibrillators (ICDs) made by St. JudeMedical, which help sustain human life. We are also marketing our sensortechnology to other manufacturers of cardiac pacemakers and ICDs. Although wehave an indemnification agreement with a St. Jude Medical company withprovisions designed to limit our exposure to product liability claims, therecan be no assurance that we will not be subject to losses, claims, damages,liabilities, or expenses resulting from bodily injury or property damagearising from the incorporation of our sensors in products sold by St. JudeMedical or others. Existing or future laws or unfavorable judicial decisionscould limit or invalidate the provisions of our indemnification agreement, orthe agreement may not be enforceable in all instances. A successful productliability claim could require us to pay, or contribute to payment of,substantial damage awards, which would have a significant negative effect onour business and financial condition.

 

***Federal legislation may not protect us against liability for the use ofour sensors in medical devices and a successful liability claim could seriouslyharm our business and financial condition.***

 

Althoughthe Biomaterials Access Assurance Act of 1998 may provide us some protectionagainst potential liability claims, that Act includes significant exceptions tosupplier immunity provisions, including limitations relating to negligence orwillful misconduct. A successful product liability claim could require us topay, or contribute to payment of, substantial damage awards, which would have asignificant negative effect on our business and financial condition. Anyproduct liability claim against us, with or without merit, could result incostly litigation, divert the time, attention and resources of our managementand have a material adverse impact on our business.

 

***Changes in the interaction between our sensors and our customers’medical devices could cause the medical devices to fail, exposing us to a riskof product liability claims that could seriously harm our business andfinancial condition.***

 

Oursensors function in interaction with our customers’ medical devices. Oursensors are manufactured to meet various electrical, magnetic, and otherspecifications, but the actual performance of the products is dependent on howthey are used in the customers’ devices over the lifetime of the devices. Thisinteraction could be different than expected for a number of reasons.Consequently, it is possible that customers may experience problems with theirmedical devices that could require device recall or other corrective action,where our sensors met the specification at delivery, and for reasons that are notrelated primarily or at all to any failure by our product to perform inaccordance with specifications. It is possible that our customers or ourcustomers’ patients may assert that our sensors caused or contributed to devicefailure where our product was not the primary cause of the device performanceissue.

 

***Any malfunction of our sensors in existing medical devices could leadto the need to recall devices incorporating our sensors from the market, whichmay be harmful to our reputation and cause a significant loss of revenue.***

 

Anymalfunction of our sensors could lead to the need to recall existing medicaldevices incorporating our sensors from the market, which may be harmful to ourreputation which is dependent on product safety and efficacy. Even if assertionsthat our sensors caused or contributed to device failure do not lead to productliability or contract claims, such assertions could

 

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harm our reputation and ourcustomer relationships. Any damage to our reputation and/or the reputation ofour products, or the reputation of our customers or their products could limitthe market for our and our customers’ products and harm our results ofoperations.

 

***We may lose business and revenue if our critical production equipmentfails.***

 

Ourproduction process relies on certain critical pieces of equipment for defining,depositing, and modifying the magnetic properties of very thin metal films.Some of this equipment was designed or customized by us, and some may no longerbe in production. While we have an in-house maintenance staff, maintenanceagreements for certain equipment, some critical spare parts, and back-ups forsome of the equipment, we cannot be sure we could repair or replace criticalmanufacturing equipment were it to fail.

 

***If we are unable to deliver products we face penalties, including lossof certain exclusive manufacturing rights.***

 

OurAgilent supply agreement allows Agilent to gain rights to manufacture couplersbased on our technology if we are unable to deliver products on time. Theimposition of this penalty could have a material impact on future sales of ourproducts. Furthermore, on reaching certain sales goals, Agilent could gainexclusive rights to distribute certain couplers based on our technology, whichcould reduce our product sales and leave us partially or totally dependent onAgilent for future coupler sales. Agilent may be able to assign its rightsunder our agreement to Avago, the company comprised of the former Agilent SemiconductorProduct Group.

 

***The loss of supply from any of our key single-source wafer supplierscould impact our ability to produce and deliver products and cause loss ofrevenue.***

 

Criticalsuppliers include our suppliers of certain raw silicon and semiconductor wafersthat are incorporated in our products. We maintain inventory of some criticalwafers, but we have not identified or qualified alternate suppliers for many ofthe wafers now being obtained from single sources. Any supply interruptionscould seriously jeopardize our ability to provide products that are critical toour business and operations and may cause us to lose revenue.

 

***The loss of supply of any critical chemicals or supplies could impactour ability to produce and deliver products and cause loss of revenue.***

 

Thereare a number of critical chemicals and supplies that we require to makeproducts. These include certain photoresists, polymers, metals, and alloys. Wemaintain inventory of critical chemicals and materials, but in many cases weare dependant on single sources, and some of the materials could bediscontinued by their suppliers at any time. Any supply interruptions couldseriously jeopardize our ability to provide products that are critical to ourbusiness and operations and may cause us to lose revenue.

 

***The loss of supply from any of our single-source packaging vendorscould impact our ability to produce and deliver products and cause loss ofrevenue.***

 

Weare dependent on our packaging vendors including Circuit Electronic IndustriesPublic Co., Ltd. (“CEI,” Ayutthaya, Thailand). Some of our products useprocesses or tooling unique to a particular packaging vendor, and it might beexpensive, time-consuming, or impractical to convert to another vendor in theevent of a supply interruption. CEI had been operating under voluntary debtrehabilitation under Thailand law. We have potential alternate vendors in caseCEI’s ability to serve our needs becomes impaired, however it could proveexpensive or time-consuming, or technically challenging to convert to analternate vendor. If one of our packaging vendors were to become insolvent wemight not be able to recover work in process or finished goods in theirpossession. Any supply interruptions or loss of inventory could seriouslyjeopardize our ability to provide products that are critical to our businessand operations and may cause us to lose revenue. Higher packaging costs with analternate vendor could have a significant impact on our profitability.

 

***Because we are significantly smaller than the majority of ourcompetitors, we may lack the financial resources needed to increase our marketshare and future revenue.***

 

Ourknown competitors and potential competitors include Avago, Analog Devices, Inc.,Fairchild Semiconductor International, Fujitsu Limited, Grandis, Inc.,Hermetic Switch, Inc., IBM Corporation, Infineon Technologies AG, IntelCorporation, Linear Technology Inc., Macronix International Co., Ltd., MaximIntegrated Products, Inc., Meder Electronic AG, Memscap SA, Nantero, Inc.,NEC Corporation, Ovonyx, Inc., Ramtron International Corporation, SiliconLaboratories, Inc., Simtek Corporation, Spintec, Spintron, TexasInstruments Inc., Thin Film Electronics ASA, Toshiba Corporation, VishayIntertechnology, and others. We believe that we face particularly aggressivecompetition in our coupler business, and we believe that our competition isincreasing as the technology matures. This has meant more competitors and moresevere pricing pressure. Furthermore, our competitors are narrowing or eliminatingperformance advantages we may have had. We expect these trends to continue, andour future competitiveness will depend on our ability to develop new productsand reduce our product costs. Most of our competitors and potential competitorsare established companies that have significantly greater financial, technical,and marketing resources than us. While we believe that our products haveimportant

 

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competitive advantages, ourcompetitors may succeed in developing and marketing products that performbetter or are less expensive than ours, or that would render our products andtechnology obsolete or noncompetitive.

 

***Our business may suffer because we have limited influence over the rateof adoption of our technology, and MRAM technology may not build into a largeor significant market.***

 

Asignificant portion of our future revenue and profits is dependent on ourcurrent and future licensees introducing MRAM products. Productiondifficulties, technical barriers, high production costs, poor market receptionor other problems, almost all of which are outside our control, could preventthe deployment of MRAM or limit its market potential. In addition, ourlicensees may have other priorities that detract attention and resources fromintroduction of MRAM products using our technology. Furthermore, competingtechnologies could prevent or supplant MRAM from becoming an important memorytechnology.

 

***Our license agreements include revenue minimums and royalty limits,which could limit the total amount of revenue we can derive under theseagreements.***

 

Ourexisting license agreements do not provide for us to receive royalties untilrevenue minimums are met by licensees. In addition, some of these agreementsplace limits on future royalty and license payments. These provisions couldsubstantially delay our potential revenue and profits from these licensingarrangements and could limit the total amount of revenue that we can deriveunder these license agreements. Such provisions could limit our potential MRAMrevenue and profits under existing agreements.

 

***Our licensees may not be able to make commercially viable MRAMs, whichwould limit our revenue from MRAM and likely cause our stock price to decline.***

 

MRAMis a new technology, and we are almost completely dependent on licensees toconvert our intellectual property into commercially viable MRAM. While ourlicensees have made samples, there may be technical and manufacturing issues tobe resolved before commercially viable devices can be produced, and theseproblems may never successfully be solved.

 

***Our future business may suffer because we may not be able to consummateadditional MRAM license agreements.***

 

Althoughthere are potential licensees for our MRAM intellectual property in addition toour current licensees, we may never be able to consummate additional licenseagreements. Potential licensees for our MRAM intellectual property might not beinterested unless and until the commercial viability of the technology is demonstrated.Potential licensees could also use their own or a third party’s MRAMintellectual property rather than ours. In addition, our existing agreementsplace restrictions on future license agreements. Specifically, one of ouragreements allows one of our licensees to approve licenses with certain otherpotential licensees. Each of these limitations could hinder our ability toconsummate additional MRAM license agreements.

 

***We will not receive royalties if our licensees do not use ourintellectual property.***

 

Ourlicense agreements do not require our licensees to use our intellectualproperty. Although we believe, based on their public disclosures, that devicesFreescale and Motorola have described use our intellectual property at least tosome extent, our licensees could circumvent or find alternatives to all or someof our technology, and our license agreements require royalty payments only ifour licensees use our intellectual property in their devices. It is possiblethat our licensees might make MRAM devices without using our technology orinfringing on our patents, and we would not receive royalties on such devices.

 

***We may not be able to enforce our intellectual property rights or ourtechnology may prove to infringe upon patents or rights owned by others, whichmay prevent the future sale of our products or increase the cost of such sales.***

 

Weprotect our proprietary technology and intellectual property by seekingpatents, trademarks, and copyrights, and by maintaining trade secrets throughentering into confidentiality agreements with employees, suppliers, customers,and prospective customers depending on the circumstances. We hold patents orare the licensee of others owning patented technology covering certain aspectsof our sensor, coupler, and MRAM technology. These patent rights may bechallenged, rendered unenforceable, invalidated or circumvented. In addition,rights granted under the patents or under licensing agreements may not providea competitive advantage to us. At least several potential MRAM competitors havedescribed designs that we believe would infringe on our patents if such designswere to be commercialized. Efforts to legally enforce patent rights can involvesubstantial expense, which we may not be able to afford and in any case may notbe successful. Further, others may independently develop similar, superior, orparallel technologies to any technology developed by us, or our technology mayprove to infringe upon patents or rights owned by others. Thus the patents heldby or licensed to us may not afford us any meaningful competitive advantage.Also, our confidentiality agreements may not provide meaningful protection ofour proprietary information. Our inability to maintain our proprietary rightscould have a material adverse effect on our business, financial condition andresults of operations.

 

***Our future business may suffer if we are unable to enforce ourintellectual property rights with existing licensees.***

 

Ourexisting license agreements have not generated royalties and may never becomeactive or generate significant royalties. Furthermore, our success in enforcingour intellectual property rights may be dependent on our ability to enforce

 

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our contract rights underexisting license agreements. Our existing licensees could claim without meritthat they do not use our intellectual property or claim that one or more of ourpatents are invalid. In 2000 we were forced to resort to litigation to enforceour intellectual property rights with Motorola, and we plan to continue tovigorously defend our intellectual property rights. Our limited capitalresources could put us at a disadvantage if we take legal action to enforce ourintellectual property rights.

 

***We may not be able to negotiate a new MRAM licensing agreement withFreescale.***

 

OurPatent License Option Agreement with Motorola provided for termination December 31,2005 or on the date Motorola ceases manufacturing MRAM Products whichever islater. We believe such a termination is likely to have occurred as a result ofMotorola apparently having eliminated its ability to manufacture MRAM Productsthrough its spinoff of Freescale. We are free to negotiate a new agreement withFreescale or an assignment of the Motorola Patent License Option Agreement toFreescale, but would do so only with amendments thereto. There can be noassurance, however, that any such agreement can be reached with Freescale, orthat any such agreement with Freescale would be on more favorable terms to NVEthan the present agreement with Motorola, or that NVE would receive any valueunder the existing Patent License Option Agreement or any value under any suchfurther agreement with Freescale.

 

***Our business success may be adversely affected if we are unable toattract and retain highly qualified management and technical employees.***

 

Wehave no employment agreements with any of our management other than our ChiefExecutive Officer and Chief Financial Officer, and have no key-person insurancecovering employees. Competition for highly qualified management and technicalpersonnel is generally intense and we may not be able to attract and retain thepersonnel necessary for the development and operation of our business. The lossof the services of key personnel could have a material adverse effect on ourbusiness, financial condition and results of operations. While our ChiefTechnology Officer, Dr. Daughton, no longer generally works full time, hestill makes his technical and contract development expertise available to us.If that arrangement terminates, we may not be able to replace his expertise.

 

***While we believe that we currently have adequate internal control overfinancial reporting in place, in the future our management will be required toevaluate our internal control over financial reporting under Section 404of the Sarbanes-Oxley act of 2002 and any adverse results from such evaluationcould result in a loss of investor confidence in our financial reports and havean adverse affect on our financial results and the market price of our commonstock.***

 

Asrequired by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adoptedrules requiring each public company to include a management reportassessing the effectiveness of its internal control over financial reporting inAnnual Reports on Form 10-KSB or 10-K, and the independent registeredpublic accounting firm auditing such company’s financial statements must attestto and report on management’s assessment of the effectiveness of the internalcontrol over financial reporting. This requirement will apply to our AnnualReport for the fiscal year ending March 31, 2007 if we meet the tests forbeing an “Accelerated Filer” as of September 30, 2006. If we are notdeemed to be an Accelerated Filer on that date, under current regulations wewill be required to comply with Section 404 in our Annual Report for thefiscal year ending March 31, 2008. While we currently anticipate beingable to fully implement the requirements relating to compliance with Section 404in a timely fashion, we cannot be certain as to the timing of completion of ourevaluation, testing and remediation actions or the impact of such activities onour operations due in large part to the lack of precedent available by which tomeasure compliance with such requirements. If we are not able to implement therequirements of Section 404 in a timely manner or with adequatecompliance, investors could lose confidence in the reliability of our financialstatements, which could result in a decrease in the market price of our commonstock. In addition, to the extent we or our independent registered publicaccounting firm identify a significant deficiency in our internal control overfinancial reporting, the resources and costs required to remediate such deficiencycould have a material adverse impact on our future results of operations.

 

***We are presently involved in class action litigation.***

 

OnFebruary 10, 2006 a lawsuit was filed against NVE and certain of itscurrent and former executive officers and directors in the U.S. District Courtfor the District of Minnesota by an individual shareholder seeking to representa class of purchasers of our common stock during the period from May 22,2003 through February 11, 2005. On March 6 and March 7, 2006,two additional lawsuits were filed in the same court by two additional NVEshareholders, with the same proposed class period, purporting to represent thesame class. All of the complaints make similar allegations that the defendantsviolated the Securities Exchange Act of 1934 by issuing materialmisrepresentations concerning NVE’s projected revenues and product technology,which artificially inflated the market price of our common stock. Two relatedactions brought by individual shareholders who seek to represent NVE derivativelyhave been filed in Hennepin County District Court. Those lawsuits allege thatcertain officers and directors violated their fiduciary duties to the company.We believe the lawsuits are wholly without merit and intend to vigorouslydefend the actions. We have incurred and expect to continue to incur legalexpenses related to these lawsuits. Although insurance may cover a portion ofany judgments, if we do not prevail in these lawsuits we may be required to paysubstantial amounts which could have a material adverse impact on our futureresults of operation and financial condition.

 

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**RisksRelated to Buying Our Stock**

 

***Our stock has been more volatile than other technology sector stocks.***

 

Themarket price of our common stock has experienced significant fluctuations andmay continue to fluctuate in the future. We believe these fluctuations havebeen greater on a percentage basis than other technology sector stocks.

 

***Our stock may be subject to volatility because it is not listed on anational market.***

 

Ourcommon stock is traded on the NASDAQ Capital Market (formerly known as theNASDAQ SmallCap Market), which has less daily trading volume on average thanthe average trading market for companies quoted on other NASDAQ market tiers orthe New York Stock Exchange. A public trading market having the desiredcharacteristics of depth, liquidity and orderliness depends on the presence inthe marketplace of willing buyers and sellers of our common stock at any giventime. This presence depends on the individual decisions of investors andgeneral economic and market conditions over which we have no control.

 

***The price of our common stock may be adversely affected by significantprice fluctuations due to a number of factors, many of which are beyond ourcontrol.***

 

Ourstock price declined in each of the past two fiscal years, and could continueto decline. The market price of our common stock may be significantly affectedby many factors, some of which are beyond our control, including:

 

•      technological innovations by us, ourlicensees, or our competitors;

 

•      the announcement of new products, product enhancements, contracts, orlicense agreements by us, our licensees, or our competitors;

 

•      changes in requirements or demands for our products;

 

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

 

•      quarterly variations in our operating results;

 

•      changes in our revenue and revenue growth rates;

 

•      changes in revenue estimates, earnings estimates, or market projectionsby market analysts, speculation in the press or analyst community;

 

•      short selling and covering of short positions in our stock; and

 

•      general market conditions or market conditions specific to particularindustries.

 

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**ITEM 1B. UNRESOLVED STAFF COMMENTS.**

 

None.

 

**ITEM 2. PROPERTIES.**

 

Ourprincipal executive offices and manufacturing facility are located at 11409Valley View Road, Eden Prairie, Minnesota, 55344. The space consists of 21,362square feet of offices, laboratories, and production areas. The space is ownedand managed by Carlson Real Estate Company, Inc. and is leased to us underan agreement expiring December 31, 2008. We believe the building isadequately insured. We have no significant near-term facility expansion plans.We hold no investments in real estate, real estate mortgages, or securities ofpersons primarily engaged in real estate activities.

 

**ITEM 3. LEGAL PROCEEDINGS.**

 

OnFebruary 10, 2006 a lawsuit was filed against NVE and certain of itscurrent and former executive officers and directors in the U.S. District Courtfor the District of Minnesota by an individual shareholder seeking to representa class of purchasers of our common stock during the period from May 22,2003 through February 11, 2005. On March 6 and March 7, 2006,two additional lawsuits were filed in the same court by two additional NVEshareholders, with the same proposed class period, purporting to represent thesame class. All of the complaints make similar allegations that the defendantsviolated the Securities Exchange Act of 1934 by issuing materialmisrepresentations concerning NVE’s projected revenues and product technology,which artificially inflated the market price of our common stock. Two relatedactions brought by individual shareholders who seek to represent NVEderivatively have been filed in Hennepin County District Court. Those lawsuitsallege that certain officers and directors violated their fiduciary duties to thecompany. We believe the lawsuits are wholly without merit and intend tovigorously defend the actions. We have incurred legal expenses and expect toincur additional legal expenses related to the suits. Based on our evaluationof the likelihood of prevailing we have not recorded a liability on our balancesheet. Insurance may cover a portion of any judgments.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

 

Nomatters were submitted to our shareholders during the quarter ended March 31,2006.

 

**PART II**

 

**ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDERMATTERS.**

 

OurCommon Stock trades on The NASDAQ Capital Market (formerly known as The NASDAQSmallCap Market) under the symbol NVEC. The following table shows the high andlow sales prices of our Common Stock as reported on the NASDAQ Capital Marketfor each quarter within the two most recent fiscal years:

 
| ** ** | ** ** | **Quarter ended** | ** ** |
|------------|------------|-------------------|------------|
| ** ** | ** ** | **3/31/06**       | ** ** | **12/31/05** | ** ** | **9/30/05** | ** ** | **6/30/05** | ** ** | **3/31/05** | ** ** | **12/31/04** | ** ** | **9/30/04** | ** ** | **6/30/04** | ** ** |
| High       |       | $                 | 18.86      |   | $ | 17.90 |   | $ | 19.91 |   | $ | 22.23 |   | $ | 33.25 |   | $ | 38.20 |   | $ | 49.28 |   | $ | 54.85 |   |
| Low        |       | $                 | 14.57      |   | $ | 12.81 |   | $ | 13.55 |   | $ | 11.50 |   | $ | 16.75 |   | $ | 25.94 |   | $ | 28.10 |   | $ | 25.62 |   |

 

**Shareholdersand Dividends**

 

Asof May 1, 2006 we had approximately 8,071 total shareholders,approximately 134 of which were shareholders of record. We have never paid ordeclared any cash dividends on our Common Stock. We do not anticipate payingdividends in the foreseeable future, as we intend to retain any earnings we maygenerate to provide for the projected expansion of our business and thepossible defense of our intellectual property.

 

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**ITEM 6. SELECTED FINANCIAL DATA.**

 

Selectedbalance sheet and income statement financial data from the last five fiscalyears are as follows:

 
| ** **                                          | ** ** | **As of March 31**      | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|
| ** **                                          | ** ** | **2006**                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash, cash  equivalents, and investments            |       | $                            | 10,891,326 |   | $ | 7,717,264 |   | $ | 7,544,643 |   | $ | 6,475,865 |   | $ | 537,258 |   |
| Working  capital and investments                    |       | $                            | 15,535,200 |   | $ | 11,342,300 |   | $ | 9,394,741 |   | $ | 6,535,004 |   | $ | (371,398 | ) |
| Total assets                                        |       | $                            | 17,758,919 |   | $ | 14,190,004 |   | $ | 12,419,727 |   | $ | 9,681,752 |   | $ | 3,595,456 |   |
| Capital  lease obligations, less current portion    |       | $                            | —     |   | $ | 33,281 |   | $ | 100,711 |   | $ | 223,191 |   | $ | 377,399 |   |
| Total  liabilities                                  |       | $                            | 980,808    |   | $ | 1,153,423 |   | $ | 1,686,483 |   | $ | 2,203,438 |   | $ | 3,118,648 |   |
| Total  shareholders’ equity                    |       | $                            | 16,778,111 |   | $ | 13,036,581 |   | $ | 10,733,244 |   | $ | 7,478,314 |   | $ | 476,808 |   |
|                                                |       |                         |       |   |   |   |   |   |   |   |   |
| ** **                                          | ** ** | **Year Ended March 31** | ** ** |
| ** **                                          | ** ** | **2006**                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenue                                             |       |                         |       |   |   |   |   |   |   |   |   |
| Product  sales                                      |       | $                            | 8,345,967  |   | $ | 5,522,250 |   | $ | 5,393,540 |   | $ | 2,503,096 |   | $ | 1,593,182 |   |
| Contract  research and development                  |       | 3,824,559                    |       | 6,093,320 |   | 6,617,311 |   | 6,552,730 |   | 4,816,029 |   |
| License  revenue                                    |       | —                       |       | — |   | — |   | 391,664 |   | 586,114 |   |
| Total  revenue                                      |       | $                            | 12,170,526 |   | $ | 11,615,570 |   | $ | 12,010,851 |   | $ | 9,447,490 |   | $ | 6,995,325 |   |
|                                                |       |                         |       |   |   |   |   |   |   |   |   |
| Gross profit                                        |       | $                            | 5,951,993  |   | $ | 4,604,836 |   | $ | 4,565,945 |   | $ | 3,536,110 |   | $ | 1,172,789 |   |
| Income  (loss) from operations                      |       | $                            | 2,471,026  |   | $ | 1,343,777 |   | $ | 1,631,341 |   | $ | 390,432 |   | $ | (2,217,492 | ) |
| Income  before taxes                                |       | $                            | 2,840,779  |   | $ | 1,619,850 |   | $ | 1,874,698 |   | $ | 646,850 |   | $ | (2,100,442 | ) |
| Net income  (loss)                                  |       | $                            | 1,797,746  |   | $ | 1,758,254 |   | $ | 2,107,720 |   | $ | 646,850 |   | $ | (2,100,442 | ) |
| Pretax  income per diluted share                    |       | $                            | 0.61       |   | $ | 0.34 |   | $ | 0.40 |   | $ | 0.15 |   | $ | (0.62 | ) |
| Net income  per share – diluted                |       | $                            | 0.39       |   | $ | 0.37 |   | $ | 0.45 |   | $ | 0.15 |   | $ | (0.62 | ) |
| Weighted  average shares outstanding – diluted |       | 4,667,994                    |       | 4,733,955 |   | 4,726,759 |   | 4,324,493 |   | 3,405,774 |   |

 

**ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATION.**

 

Youshould read this discussion together with our financial statements and thenotes to those financial statements included in this Report. In addition tohistorical information, the following discussion contains forward-lookinginformation that involves risks and uncertainties. Our actual future resultscould differ materially from those presently anticipated due to a variety offactors, including those discussed in Item 1A of this Report. In this Report werefer to the years ended or ending March 31, 2004, 2005, 2006, and 2007 asfiscal 2004, fiscal 2005, fiscal 2006, and fiscal 2007.

 

**General**

 

Wedevelop and sell devices using “spintronics,” a technology we helped pioneer,which utilizes electron spin rather than electron charge to acquire, store, andtransmit information. Our products include magnetic sensors to acquireultra-precise data such as the position of a robot arm, and couplers totransmit data between electronic systems at very high speed. We are also a licensor****of spintronic magnetoresistive randomaccess memory technology, commonly referred to as MRAM, which we believe hasthe potential to revolutionize electronic memory.

 

**Application of Critical Accounting Policies and Estimates**

 

Inaccordance with SEC guidance, those material accounting policies that webelieve are the most critical to an investor’s understanding of our financialresults and condition and require complex management judgment are discussedbelow.

 

***Product Warranty Estimation***

 

Wemaintain a reserve for warranty claims based on the trend in the historicalratio of claims to sales, releases of new products and other factors. Thewarranty period for our products is generally one year. Although we believe thelikelihood to be relatively low, claims experience could be materiallydifferent from actual results because of the introduction of new

 

16

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products, manufacturingchanges that could impact product quality, or as yet unrecognized defects inproducts sold. As of March 31, 2006 and 2005 our estimated reserve forwarranty claims were not material to our financial statements.

 

***Inventory Reserves Estimation***

 

Wemaintain reserves for potentially excess, obsolete, and slow-moving inventory.The amounts of these reserves are based upon expected product lives,competitive conditions, industry conditions, and forecasted sales demand. Ourresults could be materially different if demand for our products decreasedbecause of economic or competitive conditions, length of an industry downturn,or if products become obsolete because of technical advancements by us or inthe industry. Alternatively, if we are able to sell previously reservedinventory, we reverse a portion of the reserve. Changes in inventory reservesare recorded as a component of cost of sales. As of March 31, 2006 ourobsolescence reserve was $145,000 compared to $180,000 at March 31, 2005.The decrease was due to the disposal of parts that were previously included inour reserve.

 

***Allowance for Doubtful Accounts Estimation***

 

Wemust make estimates of the uncollectibility of our accounts receivable. Themost significant risk is the risk of sudden unexpected deterioration infinancial condition of a significant customer that is not considered in theallowance. We specifically analyze accounts receivable, historical bad debts,and customer credit-worthiness when evaluating the adequacy of the allowancefor doubtful accounts. Our results could be materially impacted if thefinancial condition of a significant customer deteriorated and related accountsreceivable are deemed uncollectible. Our allowance for doubtful accounts was$15,000 at both March 31, 2006 and 2005. We expect our allowance fordoubtful accounts to remain a relatively small percentage of our accountsreceivable because much of our receivables are with U.S. Government agencies,large customers, and distributors, which we consider generally credit-worthy.Our allowance for doubtful accounts could increase in the future if largerportions of our sales come from small end-user customers.

 

***Deferred Tax Assets Estimation***

 

Indetermining the carrying value of our net deferred tax assets, we must assessthe likelihood of sufficient future taxable income in certain taxjurisdictions, based on estimates and assumptions to realize the benefit ofthese assets. We evaluate the realizability of the deferred assets quarterlyand assess the need for valuation allowances or reduction of existingallowances quarterly. In fiscal 2005 and fiscal 2004 we reduced the amounts ofour valuation allowances based upon our history and our expectations fortaxable income.

 

Webegan recognizing tax expenses for reporting purposes in fiscal 2006 because wehad exhausted our net operating losses net of stock based compensation. We donot expect to pay taxes in the near future, however, because we have thecarryforward of prior years’ stock-based compensation deductions available tooffset future taxes. Under Statement of Financial Accounting Standards (SFAS) No. 109,*Accounting for Income Taxes,*stock-based compensation deductions for tax return purposes do not reduce taxesreported for book purposes but are credited to “Additional paid-in capital.” Asof March 31, 2006, our deferred tax assets were $3,432,320 with a relatedvaluation allowance of $1,855,848, compared to $3,984,808 with a valuationallowance of $3,228,734 as of March 31, 2005. Deferred tax assets included$2,866,868 of stock-based compensation deductions as of March 31, 2006compared to $3,363,179 as of March 31, 2005. These amounts could besubject to an Internal Revenue Code Section 382 limitation. We recordprovisions for income tax although we do not pay income tax other thanalternative minimum tax.

 

**Results of Operations**

 

Thetable shown below summarizes the percentage of revenue for the various itemsfor the periods indicated:

 
| ** **                         | ** ** | ** **                   | ** ** | **Period-to-Period Change**   | ** ** |
|------------------------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                         | ** ** | **Percentage of Revenue**    | ** ** | **Years Ended March 31** | ** ** |
| ** **                         | ** ** | **Year Ended March 31** | ** ** | **2005 to**                   | ** ** | **2004 to** | ** ** |
| ** **                         | ** ** | **2006**                     | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue                            |       |                         |       |                          |       |   |   |   |   |   |   |
| Product  sales                     |       | 68.6                         | %          | 47.5                          | %          | 44.9 | % | 51.1 | % | 2.4 | % |
| Contract  research and development |       | 31.4                         | %          | 52.5                          | %          | 55.1 | % | (37.2 | )% | (7.9 | )% |
| Total  revenue                     |       | 100.0                        | %          | 100.0                         | %          | 100.0 | % | 4.8 | % | (3.3 | )% |
| Cost of  sales                     |       | 51.1                         | %          | 60.4                          | %          | 62.0 | % | (11.3 | )% | (5.8 | )% |
| Gross profit                       |       | 48.9                         | %          | 39.6                          | %          | 38.0 | % | 29.3 | % | 0.9 | % |
| Total  expenses                    |       | 28.6                         | %          | 28.1                          | %          | 24.4 | % | 6.7 | % | 11.1 | % |
| Income from  operations            |       | 20.3                         | %          | 11.5                          | %          | 13.6 | % | 83.9 | % | (17.6 | )% |
| Net interest  and other income     |       | 3.0                          | %          | 2.4                           | %          | 2.0 | % | 33.9 | % | 13.4 | % |
| Income  before taxes               |       | 23.3                         | %          | 13.9                          | %          | 15.6 | % | 75.4 | % | (13.6 | )% |
| Income tax  provision (benefit)    |       | 8.5                          | %          | (1.2                          | )%         | (1.9 | )% |   |   |   |   |
| Net income                         |       | 14.8                         | %          | 15.1                          | %          | 17.5 | % | 2.2 | % | (16.6 | )% |

 

17

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Totalrevenue for fiscal 2006 was $12,170,526 compared to $11,615,570 in fiscal 2005,an increase of 5%. The increase was due to an increase in product salespartially offset by a decrease in research and development revenue. Totalrevenue in fiscal 2005 decreased 3% from revenue of $12,010,851 for the yearended March 31, 2004. The decrease from fiscal 2004 to fiscal 2005 was dueto a decrease in research and development revenue partially offset by anincrease in product sales.

 

Productsales increased 51% to $8,345,967 in fiscal 2006, following a 2% increase to$5,522,250 in fiscal 2005 from $5,393,540 in fiscal 2004. The increase infiscal 2006 compared to fiscal 2005 was due to increased sales of spintroniccouplers and medical sensors. The increase in fiscal 2005 compared to fiscal2004 was despite a decline in sales to St. Jude Medical and an electronicindustry inventory glut that we believe negatively impacted our sales in thequarter ended December 31, 2004. The decline in sales to St. Jude Medicalin fiscal 2005 compared to fiscal 2004 was due to St. Jude Medical purchasingparts for inventory in fiscal 2004 as it expanded its use of our components.

 

Contractresearch and development revenue decreased 37% in fiscal 2006 to $3,824,559from $6,093,320 in fiscal 2005, which was an 8% decrease from $6,617,311 forfiscal 2004. The decreases in both fiscal years were due to shifts tocompany-funded research from contract-funded research and a decrease in U.S.Government contract awards to us.

 

Grossprofit margin increased to 49% of revenue for fiscal 2006 compared to 40% forfiscal 2005 and 38% for fiscal 2004. The increase in gross profit margin infiscal 2006 from fiscal 2005 was due to a more profitable revenue mixconsisting of a higher percentage of product sales and higher product marginsdue primarily to lower-cost coupler designs. The increase in gross profitmargin in fiscal 2005 from fiscal 2004 was due to a more profitable revenue mixconsisting of a higher percentage of product sales.

 

Researchand development expense increased 24% to $1,724,825 for fiscal 2006 compared to$1,393,503 for fiscal 2005. Research and development expense increased 26% forfiscal 2005 from $1,103,062 for fiscal 2004. The increases in both years weredue to shifting resources to company-funded research from contract-fundedresearch contracts. Company-funded research and development programs includednew spintronic sensor and coupler products.

 

Selling,general, and administrative expense for fiscal 2006 decreased 6% to $1,756,142compared to $1,867,556 for fiscal 2005. The decrease was due to a strategic shiftto distributors selling our products rather than manufacturers’representatives. This shift reduced commissions we paid and expenses associatedwith supporting manufacturers’ representatives. The 2% increase in selling,general, and administrative expense for fiscal 2005 compared to $1,831,542 forfiscal 2004 was due to increased patent and auditing expenses, partially offsetby lower personnel expenses.

 

Interestincome net of interest expense plus other income totaled $369,753 for fiscal2006 compared to $276,073 for fiscal 2005 and $243,357 for fiscal 2004. Theincreases in both years were due to increases in interest-bearing investments,and a decrease in interest expense with debt reductions. Other income consistedprimarily of gains from the sale of excess equipment, which fluctuateddepending on the timing of such sales.

 

Werecorded income before taxes of $2,840,779, $1,619,850, and $1,874,698 forfiscal 2006, 2005, and 2004. The increase in fiscal 2006 compared to fiscal2005 was primarily due to increases in product revenue and gross profit margin.The decrease in income before taxes in fiscal 2005 compared to fiscal 2004 wasprimarily due to an increase in research and development expense and a decreasein research and development revenue.

 

Provisionfor income tax in fiscal 2006 was $1,043,033 compared to tax benefits of$138,404 and $233,022 for fiscal 2005 and 2004. The provision for income taxfor fiscal 2006 was due to the exhaustion of our net operating losses in fiscal2005, although we did not pay significant cash taxes for fiscal 2006 because ofstock-based compensation deductions. Income tax benefits for fiscal 2005 and2004 were from reductions of valuation allowances relating to deferred taxassets for tax return purposes.

 

Netincome for fiscal 2006, 2005, and 2004 was $1,797,746, $1,758,254, and$2,107,720. The increase in net income in fiscal 2006 compared to fiscal 2005was despite a provision for income tax in fiscal 2006 rather than an income taxbenefit in fiscal 2005. The decrease in net income for fiscal 2005 from fiscal2004 was due to a decrease in research and development revenue, an increase inresearch and development expense, and a smaller income tax benefit.

 

Weighted-averagediluted shares outstanding were 4,667,994; 4,733,955; and 4,726,759 shares forfiscal 2006, 2005, and 2004. The decrease for fiscal 2006 compared to fiscal2005 was due to the expiration of a warrant issued to Cypress SemiconductorCorporation for the purchase of up to 400,000 shares of our Common Stock,partially offset by an increase from stock options issued and exercised.

 

Earningsper diluted share were $0.39, $0.37, and $0.45 for fiscal 2006, 2005, and 2004.Diluted earnings per share for fiscal 2005 and fiscal 2004 were reduced by thedilutive effect of the warrant issued to Cypress that expired early in fiscal2006.

 

18

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**Liquidity and Capital Resources**

 

Ourprimary sources of working capital for fiscal years 2004 through 2006 wereproduct sales and research and development contract revenue. At March 31,2006 we had $10,891,326 in cash and investments compared to $7,717,264 at March 31,2005. The increase in cash and investments was primarily due to cash generatedby operations and a decrease in accounts receivable, partially offset by anincrease in inventory.

 

Accountsreceivable decreased to $1,667,029 at March 31, 2006 from $2,285,472 at March 31,2005. The decrease was due to payments received on research and developmentcontracts. We expect accounts receivable to tend to increase in the future asrevenue increases.

 

Inventorywas $2,149,769 at March 31, 2006 compared to $1,572,759 at March 31,2005. The increase was primarily due to increases in finished goods andwork-in-process inventories to support increased product sales. We expectinventories to tend to increase roughly in line with product sales.

 

Thedecrease in deferred revenue in fiscal 2006 was primarily due to our partialsatisfaction of obligations relating to a prepayment under our agreement withAgilent.

 

Wehad $33,281 in debt at March 31, 2006, consisting of a leasecollateralized by production equipment that we expect to retire in June 2006.While we are not currently planning any additional borrowing, we may have theability to borrow using certain of our production equipment assets ascollateral if necessary.

 

Capitalexpenditures were $74,110, $846,281, and $773,966 in fiscal 2006, 2005, and2004. The larger expenditures in fiscal 2005 and fiscal 2004 compared to fiscal2006 were primarily to improve manufacturing efficiency, increase productmanufacturing capacity, and provide redundancy for critical productionequipment.

 

Thefollowing table provides aggregate information about our contractual paymentobligations and the periods in which payments are due:

 
| ** **                  | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------|------------|----------------------------|------------|
| ** **                  | ** ** | ** **                 | ** ** | **Less Than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More Than** | ** ** |
| **Contractual Obligations** | ** ** | **Total**                  | ** ** | **1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **5 Years** | ** ** |
| Operating Lease Obligations |       | $                          | 560,530    |   | $ | 200,411 |   | $ | 360,119 |   | $ | — |   | $ | — |   |
| Purchase Obligations        |       | 145,500                    |       | 145,500 |   | — |   | — |   | — |   |
| Other Long-Term Liabilities |       | —                     |       | — |   | — |   | — |   | — |   |
| Total                       |       | $                          | 706,030    |   | $ | 345,911 |   | $ | 360,119 |   | $ | — |   | $ | — |   |

 

Webelieve our working capital and cash generated from operations will be adequatefor our needs at least through our fiscal year ending March 31, 2007.

 

**Outlook**

 

Infiscal 2007 we plan to continue our business strategy, including developing newsensors and couplers, and pursuing new MRAM license agreements. We expectproduct sales to continue to increase as we expand our customer base and ourexisting customers increase their purchases. We expect contract research anddevelopment revenue to continue to decrease as a percentage of total revenue infiscal 2007 as product sales increase and our emphasis continues to shift tocompany-funded from contract-funded research.

 

Weexpect gross profit margin to increase in fiscal 2007 compared to fiscal 2006due to lower-cost product designs deployed in fiscal 2006, price increases forsome of our products, and a planned shift in our revenue mix to product salesfrom research and development revenue. Our product sales generally have highergross profit margins than our research and development revenue.

 

Wedo not expect to pay significant income taxes in fiscal 2007, but we expect tocontinue to recognize provisions for income taxes due to our stock-basedcompensation deductions for tax purposes. Unlike net operating losscarryforwards, stock-based compensation deductions do not reduce taxes reportedfor book purposes when realized.

 

Weplan to continue to evaluate capital investments as needs and opportunitiesarise. We currently expect capital investments for fiscal 2007 to increase froma relatively low level in fiscal 2006 as we build production capacity tosupport product sales growth.

 

19

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**ForeignCurrency Transactions**

 

Wehave some limited revenue risks from fluctuations in values of foreign currencydue to product sales abroad. Foreign sales are generally made in U.S. currency,and currency transaction gains or losses in the past three fiscal years werenot significant.

 

**Inflation**

 

Inflationhas not had a significant impact on our operations since our inception. Pricesfor our products and for the materials and labor going into those products aregoverned by market conditions. It is possible that inflation in future yearscould impact both materials and labor in the production of our products. Ratespaid by the U.S. Government for research and development contracts are generallyadjustable with inflation.

 

**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK.**

 

Weare subject to interest rate risks on cash, cash equivalents, andavailable-for-sale securities. Our investments in fixed-rate debt securities,which were classified as available-for-sale as of March 31, 2006, haveremaining maturities from one to 59 months, and are exposed to the risk offluctuating interest rates. Available-for-sale securities had a market value of$9,602,964 at March 31, 2006, representing 54% of our total assets. Theprimary objective of our investment activities is to preserve capital. We havenot used derivative financial instruments in our investment portfolio.

 

Weperformed a sensitivity analysis assuming a hypothetical 10% adverse movementin interest rates applicable to fixed-rate instruments maturing during the nexttwelve months that are subject to reinvestment risk. As of March 31, 2006,our analysis indicated that these hypothetical market movements would not havea material effect on our financial position, results of operations, or cashflow.

 

**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.**

 

Financialstatements and accompanying notes are in this Report beginning on page F-1.Selected quarterly financial data for fiscal 2006 and 2005, presented assupplementary financial information, is as follows:

 
| ** **                           | ** ** | **Year Ended March 31, 2006** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|
| ** **                           | ** ** | **Unaudited; Quarter Ended**       | ** ** |
| ** **                           | ** ** | **March 31, 2006**            | ** ** | **Dec. 31, 2005** | ** ** | **Sept. 30, 2005** | ** ** | **June 30, 2005** | ** ** |
| Revenue                              |       |                               |       |   |   |   |   |   |   |
| Product  sales                       |       | $                                  | 2,797,882  |   | $ | 1,742,163 |   | $ | 2,021,672 |   | $ | 1,784,250 |   |
| Contract  research and development   |       | 684,892                            |       | 868,119 |   | 1,030,250 |   | 1,241,298 |   |
| Total  revenue                       |       | 3,482,774                          |       | 2,610,282 |   | 3,051,922 |   | 3,025,548 |   |
| Gross profit                         |       | 1,881,784                          |       | 1,301,530 |   | 1,424,249 |   | 1,344,430 |   |
| Income from  operations              |       | 876,929                            |       | 524,731 |   | 511,330 |   | 558,036 |   |
| Income  before taxes                 |       | 978,493                            |       | 614,664 |   | 592,505 |   | 655,117 |   |
| Net income                           |       | $                                  | 619,744    |   | $ | 401,385 |   | $ | 363,968 |   | $ | 412,649 |   |
|                                 |       |                               |       |   |   |   |   |   |   |
| Net income  per share – diluted |       | $                                  | 0.13       |   | $ | 0.09 |   | $ | 0.08 |   | $ | 0.09 |   |
|                                 |       |                               |       |   |   |   |   |   |   |
| ** **                           | ** ** | **Year Ended March 31, 2005** | ** ** |
| ** **                           | ** ** | **Unaudited; Quarter Ended**       | ** ** |
| ** **                           | ** ** | **March 31, 2005**            | ** ** | **Dec. 31, 2004** | ** ** | **Sept. 30, 2004** | ** ** | **June 30, 2004** | ** ** |
| Revenue                              |       |                               |       |   |   |   |   |   |   |
| Product  sales                       |       | $                                  | 1,590,848  |   | $ | 1,118,210 |   | $ | 1,450,052 |   | $ | 1,363,140 |   |
| Contract research  and development   |       | 1,481,309                          |       | 1,440,262 |   | 1,645,662 |   | 1,526,087 |   |
| Total  revenue                       |       | 3,072,157                          |       | 2,558,472 |   | 3,095,714 |   | 2,889,227 |   |
| Gross profit                         |       | 1,218,927                          |       | 987,646 |   | 1,134,917 |   | 1,263,346 |   |
| Income from  operations              |       | 287,087                            |       | 292,523 |   | 346,676 |   | 417,491 |   |
| Income  before taxes                 |       | 349,209                            |       | 375,172 |   | 423,298 |   | 483,671 |   |
| Net income                           |       | $                                  | 476,113    |   | $ | 375,172 |   | $ | 423,298 |   | $ | 483,671 |   |
|                                 |       |                               |       |   |   |   |   |   |   |
| Net income  per share – diluted |       | $                                  | 0.10       |   | $ | 0.08 |   | $ | 0.09 |   | $ | 0.10 |   |

 

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**ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE.**

 

None.

 

**ITEM 9A.CONTROLS AND PROCEDURES.**

 

**Evaluationof Disclosure 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 inRules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934). Basedon this evaluation, the principal executive officer and principal financialofficer concluded that our disclosure controls and procedures are effective toensure that information required to be disclosed by us in reports that we fileor submit under the Exchange Act is recorded, processed, summarized, andreported within the time periods specified in SEC rules and forms. There was nochange in our internal control over financial reporting during our mostrecently completed fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

**ITEM 9B.OTHER INFORMATION.**

 

None.

 

**PART III**

 

**ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.**

 

**ShareholderProposals for Nominations to Our Board**

 

The discussion under thesection titled “The Board, Board Committees, and Meetings—TheNominating/Corporate Governance Committee—Shareholder Nominees” to be includedin our Proxy Statement for our 2006 Annual Meeting of Shareholders is incorporatedherein by reference.

 

**Directorsand Executive Officers**

 

Each director is electedannually and serves for a term of one year or until his or her successor isduly elected and qualified. The section titled “The Board, Board Committees,and Meetings—The Audit Committee” to be included in our Proxy Statement for our2006 Annual Meeting of Shareholders sets forth certain information regardingour directors required by Item 10, and is incorporated herein by reference. Thefollowing table sets forth certain information regarding our executiveofficers:

 

| **Name and Position**                                    | ** ** | **Age** |
|--------------------------------------------------------------------|------------|---------|
| Daniel A. Baker, Director,  President, and Chief Executive Officer |       | 48      |
| Curt A. Reynders,  Treasurer and Chief Financial Officer           |       | 43      |
| James M. Daughton,  Director and Chief Technology Officer          |       | 69      |

 

***Daniel A. Baker*** has been a director and the President and Chief Executive Officersince January 2001. From 1993 until joining NVE he was President and CEO ofPrintware, Inc., now known as Printware LLC, which manufactures and marketshigh-speed imaging systems. Dr. Baker has nearly 30 years of experience inhigh-tech industry, including executive positions with Minntech Corporation andPercom Data Corporation. Dr. Baker has Ph.D. and M.S. degrees in engineeringfrom the University of Minnesota, an M.B.A. from the University of Minnesota,and a B.S. in engineering from Case Western Reserve University.

 

***Curt A. Reynders*** has been NVE’s Treasurer and Chief Financial Officer since January2006. From 2001 until his promotion to Chief Financial Officer, Mr. Reynderswas our controller. Before joining NVE he served in various accounting,auditing and accounting management positions with public accounting andindustry firms. Mr. Reynders earned a B.S. in Accounting and Economics fromMorningside College.

 

***James M. Daughton*** has been a director since our inception in 1989 and Chief TechnologyOfficer since January 2001. He served as Chairman of the Board and CEO from1991 to January 2001. From 1974 to 1989, Dr. Daughton held various research andproduct development positions at Honeywell, Inc., including Vice President ofThe Solid State Development Center. From 1964 to 1974, he developed magneticand semiconductor memory devices at IBM Corporation. Dr. Daughton holds adoctorate in electrical engineering from Iowa State University and is anadjunct professor of physics at the University of Minnesota.

 

21

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**AuditCommittee 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 of theSarbanes-Oxley Act of 2002 and the rules promulgated by the SEC in furtheranceof Section 407. Furthermore, Ms. Hollister, Mr. Glarner, and Robert H. Irishare “independent,” as that term is defined under the corporate governance rulesof the NASDAQ Stock Market.

 

**Code ofEthics**

 

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 into 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.

 

**Section16(a) Beneficial Ownership Reporting Compliance**

 

The discussion under thesection titled “Section 16(a) Beneficial Ownership Reporting Compliance” to beincluded in our Proxy Statement for our 2006 Annual Meeting of Shareholders isincorporated herein by reference.

 

**ITEM 11.EXECUTIVE COMPENSATION.**

 

The information required byItem 11 is incorporated herein by reference to the sections titled “Executive Compensation”and “Proposal 1. Election of Board of Directors—Compensation of Our Directors”to be included in our Proxy Statement for our 2006 Annual Meeting ofShareholders.

 

**ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.**

 

The information required byItem 12 is incorporated herein by reference to the sections titled “Ownershipof Voting Securities by Principal Holders and Management” and “ExecutiveCompensation—Equity Compensation Plan Information” to be included in our ProxyStatement for our 2006 Annual Meeting of Shareholders.

 

**ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.**

 

None.

 

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

 

The information required byItem 14 is incorporated herein by reference to the section titled “Fees Billedto Us by Ernst & Young and Audit Committee Pre-Approval Policies,” to beincluded in our Proxy Statement for our 2006 Annual Meeting of Shareholders.

 

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**PART IV**

 

**ITEM 15.EXHIBITS, FINANCIAL STATEMENT SCHEDULES.**

 

**(a)Financial Statements and Schedules**

 

The financial statements areset forth under Item 8 of this Report. Financial statement schedules have beenomitted since they are either not required or not applicable, or the requiredinformation is shown in the financial statements or notes.

 

**(b)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               |       | Notification from  Glenborough Properties, L.P. relating to change in building ownership  (incorporated by reference to our Current Report on Form 8-K filed October  11, 2005).                                                             |
|               |       |                                                                                                                                                                                                                                         |
| 10.5               |       | Notification from Carlson  Real Estate Company, Inc. relating to change in building ownership  (incorporated by reference to our Current Report on Form 8-K filed October  11, 2005).                                                        |
|               |       |                                                                                                                                                                                                                                         |
| 10.6*              |       | 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).                                                    |
|               |       |                                                                                                                                                                                                                                         |
| 10.7*              |       | 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).                                                             |
|               |       |                                                                                                                                                                                                                                         |
| 10.8*              |       | NVE Corporation 2001  Employee Stock Purchase Plan Summary (incorporated by reference to our  Definitive Proxy Statement on Schedule 14A filed June 1, 2001).                                                                                |
|               |       |                                                                                                                                                                                                                                         |
| 10.9*              |       | Termination of the NVE  Corporation 2001 Employee Stock Purchase Plan Summary (incorporated by  reference to our Current Report on Form 8-K filed January 4, 2006).                                                                          |

 

23

----

 
| **Exhibit #** | ** ** | **Description**                                                                                                                                                                                                                                                 |
|--------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |       |                                                                                                                                                                                                                                                            |
| 10.10+             |       | 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).                                                            |
|               |       |                                                                                                                                                                                                                                                            |
| 10.11              |       | 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).                                                  |
|               |       |                                                                                                                                                                                                                                                            |
| 10.12              |       | Notification from Agilent  Technologies of planned sale of Agilent’s Semiconductor Product Group  (incorporated by reference to our Current Report on Form 8-K filed October  19, 2005).                                                                   |
|               |       |                                                                                                                                                                                                                                                            |
| 10.13              |       | Report of completion of  the divestiture of its Agilent’s Semiconductor Products business  (incorporated by reference to our Current Report on Form 8-K/A filed December  6, 2005).                                                                        |
|               |       |                                                                                                                                                                                                                                                            |
| 10.14*             |       | 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).                                                 |
|               |       |                                                                                                                                                                                                                                                            |
| 10.15*             |       | 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).                                       |
|               |       |                                                                                                                                                                                                                                                            |
| 10.16              |       | Indemnification Agreement  by and between Pacesetter, Inc., a St. Jude Medical Company, d.b.a. St. Jude  Medical Cardiac Rhythm Management Division, and the company (incorporated by  reference to our Current Report on Form  8-K filed September 27, 2005).  |
|               |       |                                                                                                                                                                                                                                                            |
| 10.17+             |       | Supplier Partnering  Agreement by and between Pacesetter, Inc., a St. Jude Medical Company, d.b.a.  St. Jude Medical Cardiac Rhythm Management Division, and the company  (incorporated by reference to our Current Report on Form  8-K filed January 4, 2006). |
|               |       |                                                                                                                                                                                                                                                            |
| 10.18*             |       | Verbal agreement with Curt  A. Reynders (incorporated by reference to Item 1.01 of our Current Report on  Form 8-K filed January 18, 2006).                                                                                                                     |
|               |       |                                                                                                                                                                                                                                                            |
| 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 Curt A.  Reynders pursuant to Rule 13a-14(a)/15d-14(a).                                                                                                                                                                                        |
|               |       |                                                                                                                                                                                                                                                            |
| 32                 |       | Certification by Daniel A.  Baker and Curt A. Reynders pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to                                                                                                                                              |
|               |       | Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                 |

 

----

* Indicates a managementcontract or compensatory plan or arrangement.

 

+ Confidential treatment hasbeen requested with respect to portions of this exhibit, and such confidentialportions have been deleted and separately filed with the SEC pursuant to Rule24b-2 or Rule 406.

 

Copies of documents filed asexhibits to our Form 10-K may be accessed from the “Investors” section of ourWebsite (www.nve.com), or obtained by making a written request to Curt A.Reynders, our Chief Financial Officer.

 

24

----

 

**SIGNATURES**

 

Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, the registranthas duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|   | **NVE  CORPORATION**                   |
|--------|----------------------------------------|
|   | (Registrant)                           |
|   |                                   |   |
|   |                                   |   |
|   | /s/ DANIEL A. BAKER                    |   |
|   | by Daniel A. Baker                     |
|   | President and Chief  Executive Officer |
|   |                                   |
|   | Date                                   | May 22, 2006 |
|        |                                        |  |  |  |

 

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, this report has been signed below bythe following persons on behalf of the registrant and in the capacities and onthe dates indicated.

 
| **Name**                       | ** ** | **Title**                                | ** ** | **Date**      |
|--------------------------------|------------|------------------------------------------|------------|---------------|
|                           |       |                                     |       |          |
| /s/ TERRENCE W. GLARNER   |       | Director  and                            |       | May  22, 2006 |
| Terrence  W. Glarner           |       | Chairman  of the Board                   |       |          |
|                           |       |                                     |       |          |
|                           |       |                                     |       |          |
| /s/ DANIEL A. BAKER            |       | Director,                                |       | May  22, 2006 |
| Daniel  A. Baker               |       | President  & Chief Executive Officer |       |          |
|                           |       | (Principal  Executive Officer)           |       |          |
|                           |       |                                     |       |          |
|                           |       |                                     |       |          |
| /s/ CURT A. REYNDERS           |       | Treasurer  and                           |       | May  22, 2006 |
| Curt  A. Reynders              |       | Chief  Financial Officer                 |       |          |
|                           |       | (Principal  Financial and                |       |          |
|                           |       | Accounting  Officer)                     |       |          |
|                           |       |                                     |       |          |
|                           |       |                                     |       |          |
| /s/ JAMES M. DAUGHTON          |       | Director  and                            |       | May  22, 2006 |
| James  M. Daughton             |       | Chief  Technology Officer                |       |          |
|                           |       |                                     |       |          |
|                           |       |                                     |       |          |
| /s/ ROBERT H. IRISH            |       | Director                                 |       | May  22, 2006 |
| Robert  H. Irish               |       |                                     |       |          |
|                           |       |                                     |       |          |
|                           |       |                                     |       |          |
| /s/ PATRICIA M. HOLLISTER |       | Director                                 |       | May  22, 2006 |
| Patricia  M. Hollister         |       |                                     |       |          |

 

25

----

 

 

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Board of Directors

NVE Corporation

 

We have audited theaccompanying balance sheets of NVE Corporation as of March 31, 2006 and 2005,and the related statements of income, shareholders’ equity, and cash flows foreach of the three years in the period ended March 31, 2006. These financialstatements and schedule are the responsibility of the company’s management. Ourresponsibility is to express an opinion on these financial statements andschedule 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. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. We were notengaged to perform an audit of the Company’s internal control over financialreporting. Our audits included consideration of internal control over financialreporting as a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting. Accordingly,we express no such opinion. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable 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, 2006 and 2005,and the results of its operations and its cash flows for each of the threeyears in the period ended March 31, 2006, in conformity with accountingprinciples generally accepted in the United States.

 

 
| /s/ ERNST & YOUNG LLP |   |
|---------------------------|--------|
| Minneapolis, Minnesota    |
| April 21, 2006            |

 

26

----

 

**NVE CORPORATION**

**INDEX TO**

**FINANCIAL STATEMENTS**

 
| Balance Sheets                          |   |   |
|-----------------------------------------|--------|--------|
|                                    |   |   |
| Statements of Income                    |   |   |
|                                    |   |   |
| Statement of Shareholders’  Equity |   |   |
|                                    |   |   |
| Statements of Cash Flows                |   |   |
|                                    |   |   |
| Notes to Financial Statements           |   |   |

 

F-1

----

 

**NVE CORPORATION**

**BALANCE SHEETS**

**MARCH 31, 2006 AND 2005**

 
| ** **                                                                   | ** ** | **March 31** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                   | ** ** | **2006**          | ** ** | **2005** | ** ** |
| ASSETS                                                                       |       |              |       |   |   |
| Current assets                                                               |       |              |       |   |   |
| Cash and cash equivalents                                                    |       | $                 | 1,288,362  |   | $ | 1,240,205 |   |
| Short-term investments                                                       |       | 1,248,103         |       | 252,775 |   |
| Accounts receivable, net of allowance for uncollectible  accounts of $15,000 |       | 1,667,029         |       | 2,285,472 |   |
| Inventories                                                                  |       | 2,149,769         |       | 1,572,759 |   |
| Deferred tax assets                                                          |       | 1,576,472         |       | 756,074 |   |
| Prepaid expenses and other assets                                            |       | 231,412           |       | 130,873 |   |
| Total current assets                                                         |       | 8,161,147         |       | 6,238,158 |   |
| Fixed assets                                                                 |       |              |       |   |   |
| Machinery and equipment                                                      |       | 4,149,080         |       | 4,140,307 |   |
| Leasehold improvements                                                       |       | 413,482           |       | 413,482 |   |
|                                                                         |       | 4,562,562         |       | 4,553,789 |   |
| Less accumulated depreciation                                                |       | 3,319,651         |       | 2,826,227 |   |
| Net fixed assets                                                             |       | 1,242,911         |       | 1,727,562 |   |
| Long-term investments                                                        |       | 8,354,861         |       | 6,224,284 |   |
| Total assets                                                                 |       | $                 | 17,758,919 |   | $ | 14,190,004 |   |
|                                                                         |       |              |       |   |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                    |       |              |       |   |   |
| Current liabilities                                                          |       |              |       |   |   |
| Accounts payable                                                             |       | $                 | 399,762    |   | $ | 319,427 |   |
| Accrued payroll and other                                                    |       | 470,392           |       | 465,930 |   |
| Deferred revenue                                                             |       | 77,373            |       | 267,355 |   |
| Capital lease obligations                                                    |       | 33,281            |       | 67,430 |   |
| Total current liabilities                                                    |       | 980,808           |       | 1,120,142 |   |
| Capital lease obligations, less current  portion                             |       | —            |       | 33,281 |   |
| Total liabilities                                                            |       | 980,808           |       | 1,153,423 |   |
|                                                                         |       |              |       |   |   |
| Shareholders’ equity                                                    |       |              |       |   |   |
| Common stock                                                                 |       | 46,150            |       | 45,698 |   |
| Additional paid-in capital                                                   |       | 16,042,637        |       | 14,064,625 |   |
| Accumulated other comprehensive loss                                         |       | (166,908          | )          | (132,228 | ) |
| Retained earnings (deficit)                                                  |       | 856,232           |       | (941,514 | ) |
| Total shareholders’ equity                                              |       | 16,778,111        |       | 13,036,581 |   |
| Total liabilities and shareholders’ equity                              |       | $                 | 17,758,919 |   | $ | 14,190,004 |   |

 

Seeaccompanying notes.

 

F-2

----

 

**NVECORPORATION**

**STATEMENTS OF INCOME**

**YEARS ENDEDMARCH 31, 2006, 2005, AND 2004**

 
| ** **                           | ** ** | **Year Ended March 31** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                              |       |                                   |       |   |   |   |   |
| Product sales                        |       | $                                      | 8,345,967  |   | $ | 5,522,250 |   | $ | 5,393,540 |   |
| Contract research and development    |       | 3,824,559                              |       | 6,093,320 |   | 6,617,311 |   |
| Total revenue                        |       | 12,170,526                             |       | 11,615,570 |   | 12,010,851 |   |
|                                 |       |                                   |       |   |   |   |   |
| Cost of sales                        |       | 6,218,533                              |       | 7,010,734 |   | 7,444,906 |   |
| Gross profit                         |       | 5,951,993                              |       | 4,604,836 |   | 4,565,945 |   |
|                                 |       |                                   |       |   |   |   |   |
| Expenses                             |       |                                   |       |   |   |   |   |
| Research and development             |       | 1,724,825                              |       | 1,393,503 |   | 1,103,062 |   |
| Selling, general, and administrative |       | 1,756,142                              |       | 1,867,556 |   | 1,831,542 |   |
| Total expenses                       |       | 3,480,967                              |       | 3,261,059 |   | 2,934,604 |   |
|                                 |       |                                   |       |   |   |   |   |
| Income from operations               |       | 2,471,026                              |       | 1,343,777 |   | 1,631,341 |   |
|                                 |       |                                   |       |   |   |   |   |
| Interest income                      |       | 332,784                                |       | 235,341 |   | 189,270 |   |
| Interest expense                     |       | (6,051                                 | )          | (13,256 | ) | (25,996 | ) |
| Other income                         |       | 43,020                                 |       | 53,988 |   | 80,083 |   |
| Income before taxes                  |       | 2,840,779                              |       | 1,619,850 |   | 1,874,698 |   |
|                                 |       |                                   |       |   |   |   |   |
| Provision (benefit) for income taxes |       | 1,043,033                              |       | (138,404 | ) | (233,022 | ) |
|                                 |       |                                   |       |   |   |   |   |
| Net income                           |       | $                                      | 1,797,746  |   | $ | 1,758,254 |   | $ | 2,107,720 |   |
|                                 |       |                                   |       |   |   |   |   |
| Net income per share – basic    |       | $                                      | 0.39       |   | $ | 0.39 |   | $ | 0.49 |   |
|                                 |       |                                   |       |   |   |   |   |
| Net income per share – diluted  |       | $                                      | 0.39       |   | $ | 0.37 |   | $ | 0.45 |   |
|                                 |       |                                   |       |   |   |   |   |
| Weighted average shares outstanding  |       |                                   |       |   |   |   |   |
| Basic                                |       | 4,580,684                              |       | 4,512,247 |   | 4,296,870 |   |
| Diluted                              |       | 4,667,994                              |       | 4,733,955 |   | 4,726,759 |   |

 

Seeaccompanying notes.

 

F-3

----

 

**NVECORPORATION**

**STATEMENT OF SHAREHOLDERS’ EQUITY**

**YEARS ENDEDMARCH 31, 2006, 2005, AND 2004**

 
| ** **                                              | ** ** | ** **            | ** ** | ** **  | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **    | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-------------------|------------|-----------------|------------|---------------|------------|------------|------------|
| ** **                                              | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**    | ** ** | **Other**       | ** ** | **Retained**  | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Comprehensive** | ** ** | **Earnings**    | ** ** | ** **    | ** ** |
| ** **                                              | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**       | ** ** | **Income**      | ** ** | **(Deficit)** | ** ** | **Total**  | ** ** |
| 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  assets 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 |       |
| Exercise of stock  options and warrants                 |       | 38,720                |       | 387         |       | 173,547           |       | —          |       | —        |       | 173,934    |       |
| Shares issued  pursuant to employee stock purchase plan |       | 6,449                 |       | 65          |       | 79,967            |       | —          |       | —        |       | 80,032     |       |
| Comprehensive  income:                                  |       |                  |       |        |       |              |       |            |       |          |       |       |       |
| Unrealized loss  on investment securities               |       | —                |       | —      |       | —            |       | (34,680         | )          |          |       | (34,680    | )          |
| Net income                                              |       | —                |       | —      |       | —            |       | —          |       | 1,797,746     |       | 1,797,746  |       |
| Total  comprehensive income                             |       |                  |       |        |       |              |       |            |       |          |       | 1,763,066  |       |
| Deferred tax  assets from stock-based compensation      |       |                  |       |        |       | 1,724,498         |       |            |       |          |       | 1,724,498  |       |
| Balance, March  31, 2006                                |       | 4,614,953             |       | $           | 46,150     |              | $          | 16,042,637      |       | $             | (166,908   | )          | $          | 856,232 |   | $ | 16,778,111 |   |

 

Seeaccompanying notes.

 

F-4

----

 

**NVECORPORATION**

**STATEMENT OF CASH FLOWS**

**YEARS ENDEDMARCH 31, 2006, 2005, AND 2004**

 
| ** **                                                                         | ** ** | **Year Ended March 31** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| OPERATING ACTIVITIES                                                               |       |                                   |       |   |   |   |   |
| Net income                                                                         |       | $                                      | 1,797,746  |   | $ | 1,758,254 |   | $ | 2,107,720 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                   |       |   |   |   |   |
| Depreciation and amortization                                                      |       | 569,886                                |       | 573,443 |   | 524,733 |   |
| Gain on sale of fixed assets                                                       |       | (24,581                                | )          |   |   |   |   |
| Deferred income taxes                                                              |       | 990,083                                |       | (126,904 | ) | (250,000 | ) |
| Changes in operating assets and  liabilities:                                      |       |                                   |       |   |   |   |   |
| Accounts receivable                                                                |       | 618,443                                |       | (545,993 | ) | (711,189 | ) |
| Inventories                                                                        |       | (577,010                               | )          | (422,905 | ) | (309,078 | ) |
| Prepaid expenses and other                                                         |       | (100,539                               | )          | 165,664 |   | (126,217 | ) |
| Accounts payable and accrued expenses                                              |       | 84,797                                 |       | (253,759 | ) | 102,703 |   |
| Deferred revenue                                                                   |       | (189,982                               | )          | (156,821 | ) | (465,451 | ) |
| Net cash provided by operating activities                                          |       | 3,168,843                              |       | 990,979 |   | 873,221 |   |
|                                                                               |       |                                   |       |   |   |   |   |
| INVESTING ACTIVITIES                                                               |       |                                   |       |   |   |   |   |
| Proceeds from the sale of fixed assets                                             |       | 25,500                                 |       |   |   |   |   |
| Purchases of fixed assets                                                          |       | (74,110                                | )          | (846,281 | ) | (773,966 | ) |
| Purchases of investment securities                                                 |       | (3,258,612                             | )          | (226,320 | ) | (615,081 | ) |
| Net cash used in investing activities                                              |       | (3,307,222                             | )          | (1,072,601 | ) | (1,389,047 | ) |
|                                                                               |       |                                   |       |   |   |   |   |
| FINANCING ACTIVITIES                                                               |       |                                   |       |   |   |   |   |
| Net proceeds from sale of common stock                                             |       | 253,966                                |       | 388,511 |   | 1,130,061 |   |
| Repayment of note payable and capital lease  obligations                           |       | (67,430                                | )          | (122,480 | ) | (154,207 | ) |
| Net cash provided by financing activities                                          |       | 186,536                                |       | 266,031 |   | 975,854 |   |
|                                                                               |       |                                   |       |   |   |   |   |
| Increase in cash and cash equivalents                                              |       | 48,157                                 |       | 184,409 |   | 460,028 |   |
| Cash and cash equivalents at beginning of  year                                    |       | 1,240,205                              |       | 1,055,796 |   | 595,768 |   |
|                                                                               |       |                                   |       |   |   |   |   |
| Cash and cash equivalents at end of year                                           |       | $                                      | 1,288,362  |   | $ | 1,240,205 |   | $ | 1,055,796 |   |
|                                                                               |       |                                   |       |   |   |   |   |
| Supplemental disclosures of cash flow  information:                                |       |                                   |       |   |   |   |   |
| Cash paid (refunded) during the year for:                                          |       |                                   |       |   |   |   |   |
| Interest                                                                           |       | $                                      | 6,051      |   | $ | 13,256 |   | $ | 25,996 |   |
| Income taxes                                                                       |       | $                                      | 52,950     |   | $ | (11,500 | ) | $ | 16,978 |   |

 

Seeaccompanying notes.

 

F-5

----

 

**NVECORPORATION**

**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. SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

** **

**Cash and Cash Equivalents**

** **

We consider all highlyliquid investments with maturities of three months or less when purchased to becash equivalents.

 

**Fair Value of Financial Instruments**

** **

The carrying amount of cashand cash equivalents, accounts receivable, and accounts payable approximatesfair value because of the short maturity of these instruments. Fair values ofshort-term investments and long-term investments are based on quoted marketprices.

 

**Investments**

** **

We classify and account fordebt and equity securities in accordance with Statement of Financial AccountingStandards (SFAS) No. 115, *Accounting forCertain**Investments in Debt andEquity Securities*. Securities with original maturities greater thanthree 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- and corporate-backednotes and 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.”

 

**Concentration of Credit Risk**

** **

We invest our excess cash inU.S. government agency securities, investment grade commercial paper, and othermoney market instruments and have established guidelines relative todiversification and maturities in an effort to maintain safety and liquidity.These guidelines are periodically reviewed to take advantage of trends inyields and interest rates. We have not experienced any significant losses onour cash, cash equivalents, or investments.

 

**Accounts Receivable and Allowance for DoubtfulAccounts**

 

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. We had charges and provisions toallowance for doubtful accounts of $157, $430, and $935 for fiscal years 2006,2005, and 2004.

 

**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.

 

**Product Warranty**

 

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.

 

**Fixed Assets**

** **

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 orfive-year useful life. We record losses on long-lived assets used in operationswhen indicators of impairment are present and the undiscounted cash flowsestimated to be generated by those assets are less than the assets’ carryingamount.

 

**Revenue Recognition**

 

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

 

F-6

----

 

***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 its brand, Agilentprovided a refundable prepayment of $500,000. In accordance with SAB No. 101and SAB Topic 13A as amended by SAB No. 104, we classify the prepayment as “Deferredrevenue.” In accordance with the agreement, we recognize the prepayment asrevenue at a rate equal to a percentage of the sale price to Agilent when weshipped products to Agilent. We continued to recognize the prepayment asrevenue when we shipped products to Avago Technologies after Agilent spun offits Semiconductor Product Group. We reduce deferred revenue by a correspondingamount. Inventory costs associated with amortization of the prepayment arerecognized as “Costs of sales” as revenue is recognized.

 

***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 revenuefacilitated, and such commissions are recorded as selling, general, andadministrative expenses.

 

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 identifiable benefit inexchange for the consideration and the identifiable benefit is sufficientlyseparable from the customer’s purchase of our products such that we could havepurchased the products or services from a third party; and (b) we canreasonably estimate the fair value of the benefit received. Under EITF 01-09 werecognize discounts provided to our distributors as reductions in revenue.

 

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 the disclosure-onlyprovisions of SFAS Nos. 123 and 148, *Accountingfor Stock-Based Compensation*, but apply Accounting Principles BoardOpinion No. 25,*Accounting for Stock Issuedto Employees*,**andrelated interpretations in accounting for our plans. Under APB Opinion No. 25when the exercise price of employee stock options equals or exceeds

 

F-7

----

 

the market price of theunderlying stock on the date of grant, no compensation expense is recognized.We will adopt SFAS No. 123(R), which requires that the fair value of suchequity instruments be recognized as an expense in the historical financialstatements as services are performed, beginning in the fiscal year ending March31, 2007.

 

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 3.9% to 4.8%for fiscal 2006, 3.1% to 4.1% for fiscal 2005, and 3.1% for fiscal 2004;expected volatility of 63% to 86% for fiscal 2006, 88% to 99% for fiscal 2005,and 99% for fiscal 2004; a weighted-average expected life of the options of oneto 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 changes in the subjective input assumptions can materiallyaffect the fair value estimate, in management’s opinion, the existing models donot necessarily provide a reliable single measure of the fair value of ouremployee 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), *Accounting for Stock-Based Compensation*,which requires 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 the effectof decreasing pro forma fiscal 2005 net income by approximately $897,000.

 

The pro forma information isas follows:

 

| ** **                             | ** ** | **Year Ended March 31** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income applicable to common shares |       |                                   |       |   |   |   |   |
| As reported                            |       | $                                      | 1,797,746  |   | $ | 1,758,254 |   | $ | 2,107,720 |   |
| Pro forma adjustment for stock options |       | (478,549                               | )          | (2,744,836 | ) | (430,921 | ) |
| Pro forma net (loss) income            |       | $                                      | 1,319,197  |   | $ | (986,582 | ) | $ | 1,676,799 |   |
|                                   |       |                                   |       |   |   |   |   |
| Earnings per share                     |       |                                   |       |   |   |   |   |
| Basic – as reported               |       | $                                      | 0.39       |   | $ | 0.39 |   | $ | 0.49 |   |
| Basic – pro forma                 |       | $                                      | 0.29       |   | $ | (0.22 | ) | $ | 0.39 |   |
|                                   |       |                                   |       |   |   |   |   |
| Diluted – as reported             |       | $                                      | 0.39       |   | $ | 0.37 |   | $ | 0.45 |   |
| Diluted – pro forma               |       | $                                      | 0.28       |   | $ | (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 if wedetermine that it is more likely than not that we will not be able to utilizethe deferred tax assets.

 

**Researchand Development**

 

Research and developmentcosts are expensed as incurred. Customer-sponsored research and developmentcosts included in cost of sales were $3,189,523, $4,466,696, and $5,279,803during fiscal 2006, 2005, and 2004. In accordance with federal legislation, wenormally may retain the principal worldwide patent rights to any invention developedwith U.S. Government support. Our government contracts generally includecommercialization plans in which we identify potential markets and customers inaddition to U.S. 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 totaling 145,000 and stock warrants totaling 4,000were not included in the computation of diluted earnings per share because theexercise prices of the options and warrants were greater than the market priceof the common stock. The following table reflects the components of commonshares outstanding in accordance with SFAS No. 128:

 

F-8

----

 
| ** **                                                           | ** ** | **Year Ended March 31** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                           | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted average common shares outstanding  – basic             |       | 4,580,684                              |       | 4,512,247 |   | 4,296,870 |   |
| Effect of dilutive securities:                                       |       |                                   |       |   |   |   |   |
| Stock options                                                        |       | 81,927                                 |       | 130,178 |   | 148,434 |   |
| Stock warrants                                                       |       | 5,383                                  |       | 91,530 |   | 281,455 |   |
| Shares used in computing net income per  common share – diluted |       | 4,667,994                              |       | 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.

 

**RecentAccounting Pronouncements**

 

In November 2004 the FASBissued SFAS No. 151 *Inventory Costs*,which amends the guidance in ARB No. 43, Chapter 4, *Inventory Pricing*, to clarify the accounting for abnormalamounts of idle facility expense, freight, handling costs, and wasted material(spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that under somecircumstances, items such as idle facility expense, excessive spoilage, doublefreight, and rehandling costs may be so abnormal as to require treatment ascurrent period charges. SFAS No. 151 requires that those items be recognized ascurrent period charges regardless of whether they meet the criterion of “soabnormal.” In addition, SFAS No. 151 requires that allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities. SFAS No. 151 shall be effective for inventorycosts incurred during fiscal years beginning after June 15, 2005. Earlierapplication is permitted for inventory costs incurred during fiscal yearsbeginning after the date SFAS No. 151 was issued. SFAS No. 151 shall be appliedprospectively. We do not expect the adoption of SFAS No. 151 to have a materialeffect on our financial statements.

 

On December 16, 2004 theFASB issued SFAS No. 123 (revised 2004), *Share-BasedPayment,*which is a revision of FASB SFAS No. 123, *Accounting for Stock-Based Compensation.*SFAS No. 123(R) supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees,* and amends FASB SFAS No. 95, *Statement of Cash Flows.*Generally, theapproach in SFAS No. 123 is similar to the approach described in SFAS No. 123.However, SFAS No. 123 requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the income statementbased on their fair values. Pro forma disclosure is no longer an alternative.Public entities that do not file as small business issuers will be required toapply SFAS No. 123(R) as of the first fiscal year that begins after June 15,2005. Beginning in the first quarter of fiscal 2007 we will adopt theprovisions of SFAS No. 123 under the modified prospective transition method. Weare continuing to evaluate the potential impact of SFAS No. 123 on ourfinancial statements.

 

**NOTE 3.INVESTMENTS**

 

As of March 31, 2006 and2005 our investments, which consisted of available-for-sale securities, were asfollows:

 
| ** **                           | ** ** | ** **   | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Estimated**        | ** ** |
|--------------------------------------|------------|--------------|------------|----------------|------------|----------------|------------|----------------------|------------|
| ** **                           | ** ** | **Adjusted** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair Market** | ** ** |
| ** **                           | ** ** | **Cost**     | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**            | ** ** |
| As of March 31, 2006                 |       |         |       |           |       |           |       |                 |       |
| U.S. Treasury and agency securities  |       | $            | 7,907,880  |           | $          | —         |       | $                    | (201,660   | ) | $ | 7,706,220 |   |
| Corporate notes and bonds            |       | 1,947,975    |       | $              | —     |           | (51,231    | )                    | 1,896,744  |   |
| Total available-for-sale investments |       | $            | 9,855,855  |           | $          | —         |       | $                    | (252,891   | ) | $ | 9,602,964 |   |
|                                 |       |         |       |           |       |           |       |                 |       |
| As of March 31, 2005                 |       |         |       |           |       |           |       |                 |       |
| 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 |   |

 

The maturities of investmentsecurities as of March 31, 2006 were as follows:

 

| ** **                    | ** ** | **Estimated Fair** | ** ** |
|-------------------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **Market Value**   | ** ** |
| Maturing in less than 1 year  |       | $                       | 1,248,103  |   |
| Maturing in 1 to 2 years      |       | 966,331                 |       |
| Maturing in 2 to 3 years      |       | 3,476,020               |       |
| Maturing in more than 3 years |       | 3,912,510               |       |
| Total                         |       | $                       | 9,602,964  |   |

 

F-9

----

 

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

 

Inventories consisted of thefollowing:

 

| ** **                | ** ** | **March 31** | ** ** | **March 31** | ** ** |
|---------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                | ** ** | **2006**          | ** ** | **2005**          | ** ** |
| Raw materials             |       | $                 | 703,407    |              | $          | 754,456 |   |
| Work-in-process           |       | 740,578           |       | 614,337           |       |
| Finished goods            |       | 850,784           |       | 383,966           |       |
|                      |       | 2,294,769         |       | 1,752,759         |       |
| Less obsolescence reserve |       | (145,000          | )          | (180,000          | )          |
| Total inventories         |       | $                 | 2,149,769  |              | $          | 1,572,759 |   |

 

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

 

The provision for income taxexpense (benefit) for fiscal 2006, 2005, and 2004 consisted of the following:

 

| ** **                     | ** ** | **Year Ended March 31** | ** ** |
|--------------------------------|------------|----------------------------------------|------------|
| ** **                     | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Current taxes                  |       |                                   |       |   |   |   |   |
| Federal                        |       | $                                      | 852,969    |   | $ | (13,500 | ) | $ | 13,500 |   |
| State                          |       | 104,531                                |       | 2,000 |   | 3,478 |   |
|                           |       |                                   |       |   |   |   |   |
| Deferred taxes                 |       |                                   |       |   |   |   |   |
| Federal                        |       | 76,196                                 |       | (126,904 | ) | (250,000 | ) |
| State                          |       | 9,337                                  |       | — |   | — |   |
| Income tax provision (benefit) |       | $                                      | 1,043,033  |   | $ | (138,404 | ) | $ | (233,022 | ) |

 

A reconciliation of incometax provisions provided to income tax expense for fiscal 2006, 2005, and 2004is as follows:

 

| ** **                                 | ** ** | **Year Ended March 31** | ** ** |
|--------------------------------------------|------------|----------------------------------------|------------|
| ** **                                 | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Tax expense at U.S. statutory rate         |       | $                                      | 929,165    |   | $ | 550,749 |   | $ | 637,300 |   |
| State income taxes, net of Federal benefit |       | 113,868                                |       | 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 | ) |
| Income tax provision (benefit)             |       | $                                      | 1,043,033  |   | $ | (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 as of March 31, 2006 and 2005 were as follows:

 

| ** **                          | ** ** | ** ** | ** ** | **March 31** | ** ** | **March 31** | ** ** |
|-------------------------------------|------------|------------|------------|-------------------|------------|-------------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **2006**          | ** ** | **2005**          | ** ** |
| Deferred tax assets                 |       |       |       |              |       |              |       |
| Deferred revenue                    |       |       |       | $                 | 26,307     |              | $          | 90,901 |   |
| Vacation accrual                    |       |       |       | 76,047            |       | 92,263            |       |
| Inventory reserve                   |       |       |       | 49,300            |       | 61,200            |       |
| Tax credits                         |       |       |       | 275,376           |       | 338,165           |       |
| Unrealized loss                     |       |       |       | 85,983            |       | —            |       |
| Other                               |       |       |       | 52,439            |       | 39,100            |       |
|                                |       |       |       | 565,452           |       | 621,629           |       |
| Valuation allowance                 |       |       |       | (102,565          | )          | (244,725          | )          |
|                                |       |       |       | 462,887           |       | 376,904           |       |
| Stock-based compensation deductions |       | 2,866,868  |       | 3,363,179         |       |
| Valuation allowance                 |       | (1,753,283 | )          | (2,984,009        | )          |
| Net deferred tax assets             |       |       |       | $                 | 1,576,472  |              | $          | 756,074 |   |

 

F-10

----

 

At March 31, 2006 and 2005we had tax credits totaling $275,376 and $211,261, which could be used tooffset future taxable income. We also had $8,431,966 and $9,891,703 instock-based compensation deductions at March 31, 2006 and 2005 that can be usedto offset future income. Any realization of these stock-based compensationdeductions will be credited to “Additional paid-in capital.”

 

During fiscal 2006 wereversed $990,083 of our valuation allowance due to the utilization of netoperating loss carryforwards from stock based compensation, and $820,398 of theremaining valuation allowance was reversed due to our assessment that it wasmore likely than not that we would earn sufficient operating income to realize$1,576,472 of the remaining deferred tax assets. We provided a valuation allowanceof $1,855,848 as of March 31, 2006 because we did not believe that it is morelikely than not that we will utilize the remaining deferred tax assets beforethey expire. During fiscal 2005 we reversed $595,462 of our valuation allowancedue to the utilization of net operating loss carryforwards and tax credit, and$506,074 of the remaining valuation allowance was reversed due to ourassessment that it was more likely than not that we would earn sufficientoperating income to realize $756,074 of the remaining deferred tax assets. Weprovided a valuation allowance of $3,228,734 as of March 31, 2005 because wedid not believe that it was more likely than not that we would utilize theremaining deferred tax assets before they expire.

 

We do not expect to pay taxesin the near future, other than possibly alternative minimum tax, because wehave stock-based compensation deductions. However, we began recognizing taxexpenses for reporting purposes in fiscal 2006 because under SFAS No. 109, *Accounting for Income Taxes*, ourstock-based compensation deductions do not reduce the provision for incometaxes reported for book purposes. Tax provisions of $990,083 were credited to “Additionalpaid-in capital” for fiscal 2006.

 

**NOTE****6. SEGMENTINFORMATION**

** **

We operate in one reportablesegment. In addition to licensing MRAM technology, we receive research anddevelopment contracts and we manufacture and sell two product lines: sensors toacquire information and data couplers to transmit information.

 

U.S. Government Agencies accountedfor approximately 22%, 45%, and 53% of total revenue in fiscal 2006, 2005, and2004. Another customer accounted for approximately 18%, 10%, and 18% of totalrevenue in fiscal 2006, 2005, and 2004. Revenue by geographic region was asfollows:

 

| ** **    | ** ** | **Year Ended March 31** | ** ** |
|---------------|------------|----------------------------------------|------------|
| ** **    | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| United States |       | $                                      | 8,254,566  |   | $ | 8,783,590 |   | $ | 9,853,601 |   |
| Europe        |       | 2,160,473                              |       | 1,758,848 |   | 1,378,832 |   |
| Asia          |       | 1,451,903                              |       | 945,429 |   | 733,027 |   |
| Other         |       | 303,584                                |       | 127,703 |   | 45,391 |   |
|          |       | $                                      | 12,170,526 |   | $ | 11,615,570 |   | $ | 12,010,851 |   |

 

**NOTE 7.COMMITMENTS AND CONTINGENCIES**

** **

**Leases**

** **

We lease our facility underan operating lease expiring December 31, 2008. We pay operating expensesincluding maintenance, utilities, real estate taxes, and insurance in additionto rental payments. We also lease equipment under operating leases. Terms ofthe leases are 42 months through September 2009, with payments due quarterly.Total rent expense for operating leases, including building and equipment, was$215,873, $220,070, and $275,203 for fiscal 2006, 2005, and 2004.

 

We have a lease payable to aleasing company of $33,281 and $100,711 at March 31, 2006 and 2005 forproduction equipment. The lease has an effective annual rate of 8.96% withmonthly payments of $6,123 through June 2006 and a final payment of $15,000 dueJune 30, 2006.

 

Cost and accumulatedamortization at March 31, 2006 for assets reported under capital leaseobligations amounted to $310,000 and $273,833. At March 31, 2005 the cost andaccumulated amortization for assets reported under capital lease obligationswere $310,000 and $211,833.

 

F-11

----

 

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

 

| ** **                                       | ** ** | **Operating Lease** | ** ** | ** **             | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|------------------------|------------|
| ** **                                       | ** ** | **Future Minimum**  | ** ** | **Capital Lease** | ** ** |
| **Year Ending March 31**          | ** ** | **Payments**             | ** ** | **Obligations**        | ** ** |
| 2007                                             |       | $                        | 200,411    |                   | $          | 33,870 |   |
| 2008                                             |       | 204,018                  |       | —                 |       |
| 2009                                             |       | 155,426                  |       | —                 |       |
| 2010                                             |       | 675                      |       | —                 |       |
| Total payments                                   |       | $                        | 559,855    |                   | 33,870     |   |
| Less interest portion                            |       |                     |       | 589                    |       |
|                                             |       |                     |       | 33,281                 |       |
| Less current portion                             |       |                     |       | 33,281                 |       |
| Capital lease obligations, less current  portion |       |                     |       | $                      | —     |   |

 

**OtherContingencies**

 

On February 10, 2006 alawsuit was filed against NVE and certain of its current and former executiveofficers and directors in the U.S. District Court for the District of Minnesotaby an individual shareholder seeking to represent a class of purchasers of ourcommon stock during the period from May 22, 2003 through February 11, 2005. OnMarch 6 and March 7, 2006, two additional lawsuits were filed in the same courtby two additional NVE shareholders, with the same proposed class period,purporting to represent the same class. All of the complaints make similarallegations that the defendants violated the Securities Exchange Act of 1934 byissuing material misrepresentations concerning NVE’s projected revenues andproduct technology, which artificially inflated the market price of our commonstock. Two related actions brought by individual shareholders who seek torepresent NVE derivatively have been filed in Hennepin County District Court.Those lawsuits allege that certain officers and directors violated theirfiduciary duties to the company. We believe the lawsuits are wholly withoutmerit and intend to vigorously defend the actions. We have incurred legalexpenses and expect to incur additional legal expenses related to the suits.Based on our evaluation of the likelihood of prevailing we have not recorded aliability on our balance sheet. Insurance may cover a portion of any judgments.In addition to these lawsuits, we are subject to various litigation mattersfrom time to time in the normal course of our business. We currently believethat the ultimate outcome of these proceedings will not have a material adverseaffect on our financial position or results of operations. However, because ofthe nature and inherent uncertainties of litigation, should the outcome ofthese actions be unfavorable, our business, financial position, and results ofoperations could be materially and adversely affected.

 

**NOTE****8. STOCKOPTIONS AND WARRANTS**

** **

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 at the date the options aregranted. A summary of our incentive stock options is shown in the followingtable:

 

| ** **                | ** ** | ** **   | ** ** | ** **      | ** ** | **Weighted Average** | ** ** |
|---------------------------|------------|--------------|------------|-----------------|------------|---------------------------|------------|
| ** **                | ** ** | **Shares**   | ** ** | **Options**     | ** ** | **Exercise Price**   | ** ** |
| ** **                | ** ** | **Reserved** | ** ** | **Outstanding** | ** ** | **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      |   |
| Granted                   |       | (56,500      | )          | 56,500          |       | $                         | 15.48      |   |
| Exercised                 |       | —       |       | (38,720         | )          | $                         | 4.49       |   |
| Terminated                |       | 14,200       |       | (14,200         | )          | $                         | 15.95      |   |
| Balance at March 31, 2006 |       | 198,230      |       | 312,130         |       | $                         | 14.47      |   |

 

Exercisable options wereoutstanding covering 308,630; 266,858; and 166,135 shares at March 31, 2006,2005, and 2004 at weighted-average exercise prices of $14.56, $14.08, and $5.08per share. The remaining weighted-average exercisable life was 7.1, 6.5, and3.3 years. The average fair-market value of grants was $15.48, $19.65, and$12.75 in fiscal 2006, 2005, and 2004.

 

F-12

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A summary of our warrants isshown in the following table:

 

| ** **                | ** ** | ** **      | ** ** | **Weighted Average** | ** ** |
|---------------------------|------------|-----------------|------------|---------------------------|------------|
| ** **                | ** ** | **Warrants**    | ** ** | **Exercise Price**   | ** ** |
| ** **                | ** ** | **Outstanding** | ** ** | **per Share**        | ** ** |
| Balance at March 31, 2003 |       | 405,470         |       | $                         | 14.84      |   |
| Granted                   |       | 8,000           |       | $                         | 11.01      |   |
| Exercised                 |       | (1,581          | )          | $                         | 2.86       |   |
| Terminated                |       | —          |       | $                         | —     |   |
| Balance at March 31, 2004 |       | 411,889         |       | $                         | 14.81      |   |
| Granted                   |       | 2,000           |       | $                         | 37.38      |   |
| Exercised                 |       | —          |       | $                         | —     |   |
| Terminated                |       | —          |       | $                         | —     |   |
| Balance at March 31, 2005 |       | 413,889         |       | $                         | 14.92      |   |
| Granted                   |       | —          |       | $                         | —     |   |
| Exercised                 |       | —          |       | $                         | —     |   |
| Terminated                |       | (401,292        | )          | $                         | 14.96      |   |
| Balance at March 31, 2006 |       | 12,597          |       | $                         | 13.51      |   |

 

Exercisable warrants wereoutstanding covering 12,597; 412,389; and 408,889 shares at March 31, 2006,2005, and 2004 at weighted-average exercise prices of $13.51, $14.94, and$14.86 per share. The remaining weighted-average exercisable life was 5.6, 0.2,and 1.4 years. The average fair-market value of warrants issued was $0, $37.38,and $11.01 in fiscal 2006, 2005, and 2004.

 

**NOTE****9. COMMONSTOCK**

** **

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

 

**NOTE****10.LICENSE AGREEMENTS**

** **

We have entered into twoseparate license agreements, which provided for royalties to us based uponrevenue generated by the respective parties. As of March 31, 2006 no royaltieshad been recognized under either agreement.

 

We have acquired rights toanother organization’s GMR-related patents in exchange for payment of royaltiesby us of 1.5% of the sales of certain of our products. Payments under thislicense agreement were less than $5,000 for fiscal years 2004 through 2006.

** **

**NOTE****11.TECHNOLOGY EXCHANGE AGREEMENT**

** **

In 2002 we closed atechnology exchange agreement accompanied by an investment by CypressSemiconductor Corporation. Cypress purchased 686,849 shares of our Common Stockfor $6,228,000. Cypress also received a warrant for the purchase of up to anadditional 400,000 shares of Common Stock, which expired in April 2005 with no sharesexercised.

 

**NOTE****12.INFORMATION AS TO EMPLOYEE STOCK PURCHASE, SAVINGS AND SIMILAR PLANS**

** **

**EmployeeStock Purchase Plan**

** **

In 2001 our shareholdersapproved and we implemented an Employee Stock Purchase Plan, which allowed usto issue up to 200,000 shares of Common Stock. The Plan was terminatedeffective January 1, 2006 in anticipation of the impact of SFAS No. 123(R),which we believe would have required recognizing expenses associated with theissuance of shares under the plan. With certain exceptions, all of ouremployees who had been employed by us for at least one year and were employedat least 20 hours per week and at least five months per year, includingofficers and directors who were employees, were eligible to participate. Underthe plan, an employee could elect to have up to 10% of their regular salarydeducted to purchase shares. The price at which the employee’s shares werepurchased was the lower of (a) 85% of the closing price of the Common Stock onthe day the offering commenced or (b) 85% of the closing price of the CommonStock on the day the offering terminated. We issued 6,449; 7,009; and 12,566shares of Common Stock under the plan for fiscal 2006, 2005, and 2004.

 

**401(k)Employee Savings Plan**

** **

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. In calendar years 2005, 2004, and 2003 we made matching contributionsequal to 100% of the first 2% of elective salary deferral contributions made byeligible participants. In 2006 we began making matching contributions of 100%of the first 3% of participants’ salary deferral contributions. Our matchingcontributions were $93,606, $81,704, and $88,452 for fiscal 2006, 2005, and2004.

 

F-13

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**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 Curt A.  Reynders pursuant to Rule 13a-14(a)/15d-14(a).                                                                                          |
|               |       |                                                                                                                                                              |
| 32                 |       | Certification by Daniel A.  Baker and Curt A. Reynders pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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