**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**Form10-KSB**

** **

**(MarkOne)**

| **ý**                                                                                                                                                                                                                                                                                                                            | **ANNUAL  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                  |
| **For the fiscal year ended March 31,  2004**                                                                                                                                                                                                                                                                                         |
|                                                                                                                                                                                                                                                                                                                                  |                                                                                    |
| **o**                                                                                                                                                                                                                                                                                                                                 | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                                                  |                                                                                    |
| **For the transition period  from                        to                        ** |

 

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

 

**NVECorporation**

(Name of smallbusiness issuer in its charter)

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

 

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

 

Securities registeredunder Section 12(b) of the Exchange Act:  **None**

 

Securities registeredunder Section 12(g) of the Exchange Act:  **Common stock, $0.01 par value (“Common Stock”)**

 

Checkwhether the issuer: (1) filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the past 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.      YES ý        NO o

 

Check here if there is nodisclosure of delinquent filers in response to Item 405 of Regulation S-B isnot contained in this form, and no disclosure will be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or any amendment tothis Form 10-KSB.  o

 

State issuer’s revenues for the most recent fiscalyear:  **$12,010,851**

 

Theaggregate market value of the voting stock (Common Stock) held bynon-affiliates of the Registrant, as of May 14, 2004, was approximately $108million based on the last sale price reported for such date on The NASDAQSmallCap Market.

 

The number of shares ofthe Registrant’s Common Stock (par value $0.01) outstanding as of May 14, 2004was 4,494,245.

 

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**DOCUMENTSINCORPORATED BY REFERENCE**

 

Parts of our ProxyStatement for our 2004 Annual Meeting of Stockholders are incorporated byreference into Items 10, 11, 12 and 13 hereof.

 

Transitional Small Business Disclosure Format (Checkone):  Yes o;  No ý

 

 

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**NVE CORPORATION**

**FORM 10-KSB**

**FOR THE FISCAL YEAR ENDED MARCH 31,2004**

 

**INDEX**

 
| **PART I**                           |                                                                                                                      |
|--------------------------------------|---------------------------------------------------------------------------------------------------------------------------|
|                                 | Item 1. Description of Business                                                                                           |   |
|                                 |                                                                                                                      | Our Strategy |   |
|                                 |                                                                                                                      | Our  Products and Markets |   |
|                                 |                                                                                                                      |   | Sensor  Products and Markets |   |
|                                 |                                                                                                                      |   | Coupler  Products and Markets |   |
|                                 |                                                                                                                      |   | MRAM  Products and Markets |   |
|                                 |                                                                                                                      | Manufacturing |   |
|                                 |                                                                                                                      | Distribution |   |
|                                 |                                                                                                                      | New Product  Status |   |
|                                 |                                                                                                                      | Our Competition |   |
|                                 |                                                                                                                      | Principal  Suppliers |   |
|                                 |                                                                                                                      | Major Customers |   |
|                                 |                                                                                                                      | Intellectual  Property |   |
|                                 |                                                                                                                      | Research and  Development Activities |   |
|                                 |                                                                                                                      | Governmental  Regulations |   |
|                                 |                                                                                                                      | Our Employees |   |
|                                 |                                                                                                                      | Web Site  Access to Our Commission Filings |   |
|                                 | Item 2. Description of Property                                                                                           |   |
|                                 | Item 3. Legal Proceedings                                                                                                 |   |
|                                 | Item 4. Submission of Matters to a Vote of  Security Holders                                                              |   |
|                                 |                                                                                                                      |   |   |   |
| **PART II**                          |                                                                                                                      |
|                                 | Item 5. Market for Common Equity and Related  Stockholder Matters                                                         |   |
|                                 | Item 6. Management’s Discussion and Analysis or  Plan of Operation                                                   |   |
|                                 |                                                                                                                      | Critical Accounting  Policies |   |
|                                 |                                                                                                                      | Results  From Operations |   |
|                                 |                                                                                                                      | Liquidity and Capital  Resources |   |
|                                 |                                                                                                                      | Outlook |   |
|                                 |                                                                                                                      | Risk Factors |   |
|                                 | Item 7. Financial Statements                                                                                              |   |
|                                 | Item 8. Changes In and Disagreements With  Accountants on Accounting and Financial Disclosure.                            |   |
|                                 | Item 8A. Controls and Procedures.                                                                                         |   |
|                                 |                                                                                                                      |   |   |   |
| **PART III**                         |                                                                                                                      |
|                                 | Item 9. Directors, Executive Officers,  Promoters and Control Persons; Compliance With Section 16(a) of the Exchange  Act |   |
|                                 |                                                                                                                      | Directors and  Executive Officers |   |
|                                 |                                                                                                                      | Key Employees |   |
|                                 |                                                                                                                      | Audit Committee  Financial Expert |   |
|                                 |                                                                                                                      | Code of Ethics |   |
|                                 | Item 10. Executive Compensation                                                                                           |   |
|                                 | Item 11. Security Ownership of Certain  Beneficial Owners and Management                                                  |   |
|                                 | Item 12. Certain Relationships and Related  Transactions                                                                  |   |
|                                 | Item 13. Exhibits and Reports on Form 8-K.                                                                                |   |
|                                 | Item 14. Principal Accountant Fees and  Services.                                                                         |   |
|                                 |                                                                                                                      |   |   |   |
| **SIGNATURES**                       |                                                                                                                      |
| **REPORT OF INDEPENDENT  AUDITORS**  |                                                                                                                      |
| **CONSENT OF INDEPENDENT  AUDITORS** |                                                                                                                      |
|                                 |                                                                                                                      |   |   |   |
| **FINANCIAL  STATEMENTS**            |                                                                                                                      |
|                                 |                                                                                                                      | BALANCE SHEET |   |
|                                 |                                                                                                                      | STATEMENT  OF OPERATIONS |   |
|                                 |                                                                                                                      | STATEMENT OF  SHAREHOLDERS’ EQUITY |   |
|                                 |                                                                                                                      | STATEMENT  OF CASH FLOWS |   |
| NOTES TO FINANCIAL  STATEMENTS       |                                                                                                                      |
|                                 |                                                                                                                      |   |   |   |   |

 

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**GLOSSARY OF KEY TERMS**

 
| **Coupler**                               |   | A device which  transmits data between electronic systems. NVE makes spintronic couplers that  transmit information much faster than the fastest optical couplers. Couplers  are also known as “isolators” because they electrically isolate the coupled  systems.                                                                                                                                                                                                              |
|-------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **DRAM (Dynamic Random Access Memory)**   |   | The largest-capacity  and most common type of conventional memory. MRAM has the potential to match  DRAM bit density but would be faster and nonvolatile.                                                                                                                                                                                                                                                                                                                                 |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Electron Spin**                         |   | Electrons have two  stable spins (up and down). Electron spin causes magnetism on the atomic  level; spintronics encodes data in electron spin.                                                                                                                                                                                                                                                                                                                                           |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Embedded Memory**                       |   | Memory combined with  other electronics on the same integrated circuit, such as a cellphone on a  chip. It is virtually impossible to embed the various types of conventional  memory required for a total system together on one IC; however, MRAM replaces  all the different memory types (DRAM, SRAM, Flash), and can be embedded.                                                                                                                                                    |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Free Layer**                            |   | A layer in SDT or GMR  structures where the spin polarization of electrons can be switched, usually  by magnetic energy. This is the layer where data is sensed or stored.                                                                                                                                                                                                                                                                                                                |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Flash Memory**                          |   | The leading  conventional nonvolatile memory. Used in cellphones for permanent storage.  Versions are used in memory cards and sticks, but these are much too slow for  program execution. MRAM has the potential to meet and exceed Flash bit  density but with unlimited life and much higher speed.                                                                                                                                                                                    |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Giant Magnetoresistor (GMR)**           |   | A spintronic device  that produces a large change in resistance of a conducting layer. “Giant”  refers to its very large electrical signal. GMR is at the heart of NVE’s  sensors and couplers, and can also be used for a basic type of MRAM.                                                                                                                                                                                                                             |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **IsoLoop®**                         |   | NVE’s spintronic  coupler brand name. Refers to a microscopic coil combined with GMR elements.  The coil creates a small magnetic field that is picked up by the GMR elements  transmitting data almost instantly.                                                                                                                                                                                                                                                                   |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **MRAM  (Magnetic Random Access Memory)** |   | A revolutionary memory  fabricated using nanotechnology which uses electron spin to encode data. MRAM  has been called the “holy grail” of memory because it has the potential to  combine the speed of SRAM, the density of DRAM, and the nonvolatility of  flash.                                                                                                                                                                                                             |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Magneto-Thermal MRAM**                  |   | An MRAM design that  uses a combination of magnetic fields and ultra-fast heating from electrical  current pulses to increase density and reduce the energy required to write  data. NVE has patents and research programs in this area, which has the  potential to increase MRAM bit densities.                                                                                                                                                                                         |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Nonvolatile**                           |   | A memory that retains  its data even when the power is removed. MRAM is inherently nonvolatile.                                                                                                                                                                                                                                                                                                                                                                                           |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Optical Coupler  (also Opto-Coupler)**  |   | A conventional coupler  which uses the combination of a light-emitting diode and photo detector to  transmit information. NVE couplers are faster and denser than optical  couplers, and unlike optical couplers which where out, spintronic couplers  last indefinitely.                                                                                                                                                                                                                 |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **SRAM  (Static Random Access Memory)**   |   | A conventional memory  that is faster than DRAM but lower density. Used for high-speed operations  such as digital signal processing in cellphones and caches in computers. MRAM  has the potential to match the speed of SRAM but with nonvolatility and much  higher bit density.                                                                                                                                                                                                       |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Sensor**                                |   | A device which acquires  information such as position or speed. NVE makes ultra-precise spintronic  sensors which report data such as the position of a robot arm.                                                                                                                                                                                                                                                                                                                        |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Spin-Dependent Tunnel (SDT)  Junction** |   | A spintronic  nanotechnology device that produces a large change in resistance through a  normally insulating layer, depending on the predominant spin in a free layer.  This allows electron spin to be sensed as electrical resistance for interface  to conventional electronics. SDT devices use a layer as thin as a few atoms.  SDT devices are at the heart of MRAM and low-field sensors. Also known as  Magnetic Tunnel Junctions (MTJs) or Tunneling Magnetic Junctions (TMJs). |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Spin Valve**                            |   | A spintronic switch  with two stable resistance states. Spin valves are used in many of NVE’s  products.                                                                                                                                                                                                                                                                                                                                                                             |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Spintronics**                           |   | A nanotechnology which  utilizes electron spin rather than electron charge to acquire, store and  transmit information.                                                                                                                                                                                                                                                                                                                                                                   |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Tunneling Magnetoresistance (TMR)**     |   | The change in  resistance between two stable states of a spin-dependent tunnel junction at  room temperature. NVE scientists recently demonstrated a record Spin  Dependent Tunnel junction, which could make MRAM faster and more cost  effective                                                                                                                                                                                                                                        |
|                                      |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| **Wafer**                                 |   | Thin (less than 1  millimeter thick), circular material, most often silicon, used to manufacture  semiconductors and other devices. Often contains thousands of devices.                                                                                                                                                                                                                                                                                                                  |

 

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**PART I**

 

**FORWARD-LOOKINGSTATEMENTS**

Someof the statements made in this Report and the documents incorporated byreference in this Report under Item 1 “Description of Business” and Item 6“Management’s Discussion and Analysis or Plan of Operation” constituteforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. These statements are subject to the safe harborprovisions of the reform act. Forward-looking statements may be identified bythe use of the terminology such as may, will, expect, anticipate, intend,believe, estimate, should, or continue or the negatives of these terms or othervariations on these words or comparable terminology. To the extent that thisReport contains forward-looking statements regarding the financial condition,operating results, business prospects or any other aspect of NVE, you should beaware that our actual financial condition, operating results and businessperformance may differ materially from that projected or estimated by us in theforward-looking statements. We have attempted to identify, in context, some ofthe factors that we currently believe may cause actual future experience andresults to differ from their current expectations. These differences may becaused by a variety of factors, including but not limited to adverse economicconditions, intense competition, including entry of new competitors, ourability to obtain sufficient financing to support our operations, progress inresearch and development activities by us and others, variations in costs thatare beyond our control, adverse federal, state and local governmentregulations, unexpected costs, lower sales and net income, or higher net lossesthan forecasted, price increases for equipment, our dependence on significantsuppliers, including Taiwan Semiconductor Manufacturing Corporation for foundrysemiconductor wafers, our ability to meet stringent customer technicalrequirements, our ability to consummate additional license agreements, ourability to continue eligibility for SBIR awards, our inability to raise prices,failure to obtain new customers, the possible fluctuation and volatility of ouroperating results and financial condition, inability to carry out marketing andsales plans, loss of key executives, and other specific risks that may bealluded to in this Report.

 

**ITEM1.****  DESCRIPTION OF BUSINESS.**

 

**InGeneral**

NVECorporation develops and sells devices using “spintronics,” a nanotechnology wehelped pioneer, which utilizes electron spin rather than electron charge toacquire, store and transmit information. We are a licensor of spintronicmagnetic random access memory technology, commonly referred to as MRAM, whichwe believe has the potential to revolutionize electronic memory. We alsomanufacture high-performance spintronic products including sensors and couplerswhich are used to acquire and transmit data in automated factories.

 

**NVEHistory and Background**

Wewere founded in 1989 primarily as a government contract research company. Wehave licensed our MRAM intellectual property to others, including CypressSemiconductor Corporation, Honeywell International, and Motorola, Inc. We alsomanufacture spintronic sensor and couplers which are sold through a worldwidenetwork of manufacturers’ representatives and distributors. We also have anagreement with Agilent Technologies, Inc. to distribute our couplers undertheir brand. Our commercial product revenues have been growing rapidly in thepast two fiscal years.

 

InNovember 2000, our shareholders approved our merger with and into PremisCorporation, a publicly-traded and reporting corporation, with Premis survivingunder the new name NVE Corporation. We executed a one-for-five reverse split ofour common stock to shareholders of record at the close of business on November21, 2002, and on January 22, 2003 our common stock began trading on the NASDAQSmallCap Market.

 

**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, the 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 less than two nanometers thick.

 

Thesecond type of spintronic structures we use is called spin-dependent tunneljunctions, also known as SDT junctions, Magnetic Tunnel Junctions (MTJs), orTunneling Magnetic Junctions (TMJs). SDT junctions use tunnel barriers whichmust be so thin that electrons can “tunnel” through a normally insulatingmaterial to cause a resistance change. The SDT barrier thicknesses are in therange of one to two nanometers or approximately five molecules. Technologicaladvances in recent years have made it practical to manufacture such smalldimensions.

 

BothSDT junctions and GMR provide sensitivity that was previously possible onlywith super-cooling. In our products the spintronic elements are connected tointegrated circuitry and packaged in much the same way as conventionalintegrated circuits.

 

**IndustryBackground**

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

 

The1970s brought microelectronic devices including Hall effect sensors for dataacquisition, semiconductor random access memory (commonly referred to as RAM)for data storage, and light-emitting diode-based opto-couplers for datatransmission. There have been incremental improvements to these devices overthe years, but the basic limitations of charge-based electronics remain.

 

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Webelieve spintronics represents the first major change in microelectronictechnology since the advent of these devices a generation ago. We believememories, sensors, and couplers together represent a significant portion of theelectronics industry, which can be addressed by spintronics.

 

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 one semiconductor memory meets all three ofthese requirements. For example, a cellphone requires the bit density of DRAMfor the operating software, the speed of SRAM for digital signal processing,and the nonvolatility of flash memory for phone books and other permanentstorage. The three memories consume power and space. Because they use incompatiblematerials, the three memories are very difficult to combine with each other orwith other cellphone circuitry in a single integrated circuit.

 

Potentialnear-term 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.

 

Sensorsare used to detect the position or speed of robotics and mechanisms in a numberof applications. As factories and industrial controls become more automated,there is a need for more precise position sensing. We believe our spintronicsensors acquire information such as the position of a robot arm or the speed ofa motor, faster and more accurately than existing devices. We believe thisallows higher quality, lower-cost production of products such as automobiles.

 

Likesensors, couplers are also 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 complexity increases,there is a need for higher speed data and more data channels. Because of theirunique properties, we believe our couplers transmit more data at higher speedsand over longer distances than conventional devices.

 

**Our Strategy**

Ourgoal is to become the leading developer of practical spintronics technology anddevices. We plan to do that through entering into new MRAM manufacturingpartnerships, pursuing additional MRAM license agreements, expanding commercialproduct sales, and building intellectual property.

 

***Monetize MRAM Intellectual Property Through ManufacturingPartnerships***

Becauseof the large capital investment required to make large-scale memories, ourstrategy is to use manufacturing partnerships to monetize our MRAM intellectualproperty.

 

Weexpect to receive royalties, subject to certain terms and conditions, afterMotorola goes into production, which is currently expected to occur in late2004. Motorola has announced plans for stand-alone MRAM, as well as systems onchips for cellphones and other applications, which could contain embedded MRAM.

 

Ratherthan royalties, our agreement with Cypress gives us rights to their productiondesigns and intellectual property, as well as rights to use Cypress factoriesto manufacture MRAMs for us. We plan to sell these devices in niche marketswhere we have a strong presence such as factory automation or militaryapplications. We expect sales into such high value-added niches to commandpremium prices.

 

***Pursue Additional MRAM License Agreements***

Wewill pursue new license agreements. With technical feasibility of MRAM now moreclearly demonstrated, we expect new agreements to be on more favorable termsthan existing agreements. We have stepped up efforts to contact potentiallicensees. These discussions are mostly in early stages, and there can be noassurance when or if we will consummate additional agreements.

 

***Expand Commercial Product Sales***

Weplan to broaden our sensor and coupler product lines using our proven buildingblocks and designs. We plan to promote new products with advertising and directmail targeted primarily at factory/industrial controls and instrumentationmarkets. Our campaigns highlight the advantages of NVE devices compared toconventional devices. Examples include our “Hate Optos” and “Think Multi-Channel”campaigns.

 

***Build Intellectual Property and Support Product DevelopmentWith Contract Research and Development***

Contractresearch and development was the source of our underlying patents and productdevelopments, and still accounts for most of our revenues. As commercialproduct growth accelerates, we expect contract revenues as a percentage oftotal revenues to decline. We view repositioning contract research anddevelopment as a means of supporting product development rather than to remainmerely a revenue source.

 

**Our Products and Markets**

Ourproduct portfolio consists of three lines:

***1. Sensors*** to quickly and precisely determineposition;

***2. Couplers*** which transmit digital data at highspeed; and

***3. MRAM,***a revolutionary new type of memory.

 

Thus our productsacquire, store, and transmit information.

 

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***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. Our sensors are quite small, very sensitive to magnetic fields,precise, and repeatable. This combination of attributes allows them to be usedin a variety of industrial control applications such as robotics.

 

Wehave concentrated our sensor marketing efforts on pneumatic cylinder positionsensing (CPS) components and assemblies, which are used in robotics and similarsystems. Most of the leading CPS suppliers are currently using our sensors. Inthe past year we introduced several new sensor products, including rotationalspeed sensors and angle sensors.

 

Becauseof their small size and precise switching points, our sensors are also beingused in implantable medical devices. We are developing sensors for otherminiature medical devices, and we are developing automotive sensors as apotential future market.

 

***Coupler Productsand******Markets***

Ourspintronic couplers, which are also known as “isolators” because theyelectrically isolate the coupled systems, add an “IsoLoop,” an integratedmicroscopic coil, to our basic GMR sensor element. The coil creates a smallmagnetic field that is picked up by the spintronic sensor, transmitting dataalmost instantly. IsoLoop couplers are more than twice as fast as the fastestoptical couplers (110 million bits per second compared to 50 million bits persecond).

 

Ourcouplers are sold primarily for factory and industrial networks, with broadbandand telecommunications anticipated 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.

 

MRAMhas been called the “holy grail” of memory because it has the potential tocombine the speed of SRAM, the density of DRAM, and the nonvolatility of flashmemory.

 

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 magnetism. We have invented several types of MRAM memorycells and modes of operation.

 

In thenear-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.

 

In themedium term, MRAM could find application in cellphones, where it can replacethree types of memory and enable embedded designs such as cellphones on chips.

 

Longterm, MRAM could address the market for ubiquitous high-density memory, whereit could offer higher speed and nonvolatility, enabling a new generation ofcomputers and other products.

 

**Manufacturing**

Ourfactory is a clean-room area with specialized equipment to pattern, deposit,etch, and process spintronics materials. Most of our products are fabricated inour facility using either raw wafers or wafers containing conventionalelectronics, known as foundry wafers. Foundry wafers contain electronics thatperform housekeeping functions such as voltage regulation and signalconditioning in our products.

 

Awafer includes thousands of devices. We add spintronics structures to thewafers in our factory, and then send the completed wafers to the Far East forcutting and packaging. The packaged parts are returned to us for testing,stocking, and shipment.

 

**Distribution**

Werely primarily on indirect channels to sell our products. We have distributorswho stock and sell our products throughout the world, including Digi-KeyCorporation, one of this country’s largest electronic component distributors.We also have a number of manufacturers’ representatives in the United Stateswho sell but do not stock our products under agreements which are generally renewedannually. Agilent, a major supplier of solid-state couplers, distributesprivate-labeled versions of our couplers under an agreement that expires in2008.

 

Weplan to distribute MRAM through our existing distribution channels, as well asdirect sales to the United States military and other large accounts. We mayalso add new representatives and distributors geared toward specialized andhigh-value memory products.

 

**New Product Status**

Wehave announced and begun sampling several new products, including spintronicangle sensors, rotational speed sensors, low-power couplers, and five-channelcouplers for factory and industrial markets.

 

InOctober 2003 Motorola announced it was sampling a 4-megabit MRAM. Motorola hassaid it expects to begin MRAM pilot production by late 2004. We believe that ifMotorola commercializes devices described in their technical papers, they woulduse our intellectual property and we would therefore be due royalties.

 

Cypresshas released preliminary data sheets for 64 kilobit and 256 kilobit MRAMs whichare pin-for-pin replacements for their SRAM. In March 2004, Cypress reported ithad made working MRAM and was close to production-ready product.

 

6

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**Our Competition**

 

***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” memories and ferroelectric random accessmemories (FRAMs). MRAMs are potentially faster and use less power than existingnonvolatile memories. Furthermore, existing nonvolatile memories can be writtenonly a limited number of times before they wear out while MRAMs have virtuallyunlimited life.

 

Webelieve MRAM is potentially higher density than FRAM. Flash memory may besubject to scalability limitations which could limit its density in comingyears. We do not believe MRAM is subject to such limitations.

 

Flashmemory manufacturers include Advanced Micro Devices, Inc., Intel Corporation,Samsung Electronics Ltd., and STMicroelectronics NV. Current and potential FRAMmanufacturers include Ramtron International Corporation, Infineon TechnologiesAG, Samsung Electronics Ltd., and STMicroelectronics NV, and Texas InstrumentsInc.

 

Emergingtechnologies competing with MRAM include polymeric ferroelectric random accessmemory (PFRAM) ovonic unified memories (OUM), and carbon nanotubes. We believethat MRAM has advantages over these technologies and that it is closer tocommercialization. Companies developing PFRAM include Thin Film ElectronicsASA, Coatue, and Intel Corporation. Companies developing OUM include Ovonyx,Inc., Macronics International Co. Ltd., and Intel Corporation. Companiesdeveloping carbon nanotube memory include Nantero, Inc. and Intel Corporation.

 

Anumber of companies are competing with our licensees to develop MRAM products.Those competitors include Fujitsu Limited, Hewlett-Packard Company, IBMCorporation, Infineon Technologies AG, NEC Corporation, Samsung ElectronicsLtd., Sony Corporation, Taiwan Semiconductor Manufacturing Corporation, andToshiba Corporation.

 

Mostof our MRAM competitors and potential competitors are established companiesthat have significantly greater financial, technical, and marketing resourcesthan us.

 

***Sensor Competition***

Ourthree main sensor competitors are: 1) Honeywell, 2) Royal Philips Electronics, and3) Allegro Microsystems, Inc. Honeywell and Philips make traditionalnickel-iron anisotropic magnetoresistive (AMR) sensors. AMR sensors are used inautomotive and high-performance industrial control systems. Unlike our GMRsensors, AMR sensors have “flipping” artifacts that we believe limit theirusability. Flipping is when the device polarity is reversed when exposed to astray magnetic field causing erroneous data. Allegro makes inexpensive siliconHall sensors, but we believe Hall sensors are not as sensitive or precise asour products.

 

***Coupler Competition***

Thetwo main competing digital couplers are opto-couplers and inductive couplers(transformers). Opto-couplers use light and light detectors to transmitinformation; transformers use magnetic fields transmitted between coils ofwire. In addition to being a customer, Agilent, a Hewlett Packard spin-off, isa leading producer of high-speed opto-couplers. Other top opto-couplersuppliers are Vishay Intertechnology (formerly Infineon, a Siemens AG spin-off),NEC Corporation, Toshiba Corporation, and Fairchild SemiconductorInternational. Inductive couplers are made by a number of companies. We believeour couplers are considerably faster than even the fastest opto-couplers.Unlike our IsoLoop couplers, inductive couplers require special encoding totransmit logic signals. Furthermore, IsoLoop couplers require much less boardspace than most opto- or inductive couplers.

 

AnalogDevices, Inc. (ADI) markets microelectronic mechanical system (MEMS) inductivecouplers. While these devices are smaller than other inductive couplers, webelieve our devices still offer more channel density, they are twice as fast asADI’s competing devices at the most common supply voltage, and they produceless signal distortion than ADI devices.

 

Wemake several network signal couplers that combine spintronics coupling withnetwork protocol functions in a single package. Our competitors in this areainclude Linear Technology Inc. and Maxim Products. Based on a comparison of publishedspecifications, we believe our devices are 100 times faster than the LinearTechnology Inc. and Maxim Products network signal couplers.

** **

**Principal Suppliers**

Ourprincipal suppliers include manufacturers of semiconductor wafers which areincorporated into our products. These include Advanced SemiconductorManufacturing Corporation of Shanghai (China), AMI Semiconductor, Inc.,Intersil Corporation, Taiwan Semiconductor Manufacturing Corporation, and TexasInstruments Inc.

 

Othercompanies supply our device packaging services, including Circuit ElectronicsIndustries (Ayutthaya, Thailand), and NS Electronics Bangkok (Thailand), Ltd.

 

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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.

** **

**Major Customers**

Wehave several major customers including Agilent Technologies, Inc., St. JudeMedical, Inc., the United States Government, and certain distributors. Ordersfrom these customers can be cancelled, postponed, or reduced without cause ornotice, and the loss of any of these customers could have a significant impacton our commercial revenues and our profitability.

** **

**Intellectual Property**

***Patents***

As ofMarch 31, 2004 we had 29 United States patents issued, and our technology isprotected by more than 100 patents worldwide either issued, pending or licensedfrom others. We are continuing to develop and intend to add to our patentportfolio. There are no patents we regard as critical to our business owned byus or licensed to us that expire in the next 12 months.

 

Webelieve our 6,275,411 and 6,349,053 patents, both of which are entitled “SpinDependent Tunneling Memory”. Both patents cover MRAMs using arrays of MagneticTunnel Junctions. Based on their public disclosures, we believe severalcompanies are pursuing the approach described in these patents. The 6,275,411patent expires in 2019 and the 6,349,053 patent expires in 2021.

 

***Trademarks***

Ourtrademarks include “GMR Switch” and “GT Sensor.” IsoLoop is our registeredtrademark.

*** ***

***Licenses***

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

 

*Agreementswith Honeywell*

Underour agreements with Honeywell we will not be paid royalties by Honeywell ifthey utilize our MRAM intellectual property, and we do not expect to payroyalties to Honeywell for the use of their MRAM intellectual property.

* *

*CypressTechnology Exchange Agreement*

Underour technology exchange agreement with Cypress, each party gained rights to theother party’s MRAM intellectual property and patents. We believe the Cypresspartnership significantly strengthens our intellectual property portfolio bygiving us rights to large-scale MRAM designs as well as rights to interface circuitryneeded for large-scale memories. We also have rights to all of Cypress’ MRAMintellectual property existing now and in the future, including MRAM designsand mask works.

 

*RoyaltyAgreement*

Wehave licensed rights to another organization’s GMR-related patent, and thatagreement calls for us to pay royalties on our sales of certain products.Payments under this agreement have not been material to date. The agreementcould remain in force until cumulative royalties of $1.2 million have beenpaid.

 

**Research and Development Activities**

Weinvested $6,382,865 and $5,888,781 in the years ended March 31, 2004 and 2003on research and development. All but $1,103,062 and $1,308,129 were funded bycustomers through research and development contracts. Most of our research anddevelopment contracts are with the U.S. government.

 

Near-termresearch programs include advanced sensors and couplers. Long-term researchprograms include ultrahigh density MRAM, bio-sensors, and spintronics insemiconductors (also known as SPINS). Eventually, SPINS could enable quantumcomputing, displacing conventional semiconductors.

 

**Governmental Regulations**

We aresubject to various local, state and federal laws, regulations and agencies thataffect businesses generally. These include regulations promulgated by federaland state environmental and health agencies, the federal Occupational Safetyand Health Administration, and laws pertaining to the hiring, treatment, safetyand discharge of employees.

 

Federalregulations require a business to be at least 51% owned by one or moreindividuals to be eligible to compete for Small Business Innovation Research(SBIR) awards. While we believe we currently meet the 51% ownership rule,changes in our capital structure or purchases by entities in the open market orby other means could cause us to become ineligible.

 

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**Our Employees**

As ofMarch 31, 2004, we had 70 employees, 63 of whom were full-time. Of ourfull-time employees, there were six general and administrative employees, fivesales and marketing employees, 28 technicians, and 24 scientists. Twelveemployees have earned doctorate degrees. None of our employees is representedby a labor union or is subject to a collective bargaining agreement, and webelieve we maintain good relations with our employees.

 

**Web Site Access to Our CommissionFilings**

Allreports we file with the Securities and Exchange Commission, including ourannual reports on Form 10-KSB, quarterly reports on Form 10-QSB, and currentevent reports on Form 8-K, as well as any amendments to those reports, areaccessible at no cost through the Investor Relations section of our Web site atwww.nve.com. These filings are also accessible on the SEC’s Web site atwww.sec.gov.

 

**ITEM2.****  DESCRIPTION OF PROPERTY.**

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 Glenborough Properties, L.P. and is leased to us under anagreement expiring December 31, 2008. We believe the building is adequatelyinsured.

 

Weplan to expand our clean-room production area in the coming year to supportcontinued growth in product sales. We plan to finance the expansion throughoperating profits and a rent credit for that purpose from the building owner.

 

NVEholds no investments in real estate, real estate mortgages or securities ofpersons primarily engaged in real estate activities.

 

**ITEM3.****  LEGAL PROCEEDINGS.**

In theordinary course of business we may become involved in litigation. At this time,we are not aware of any material pending or threatened legal proceedings orother proceedings contemplated by governmental authorities that would have a materialimpact upon us.

 

**ITEM4.****  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

No matters were submittedto security holders during the quarter ended March 31, 2004.

 

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**PART II**

 

**ITEM5.****  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.**

Ourcommon stock trades on The NASDAQ SmallCap Market under the symbol NVEC. Priorto January 22, 2003, our Common Stock was traded on the Over-the-CounterBulletin Board. The following data set forth, for the fiscal quartersindicated, a summary of the high and low sales price of our Common Stock asreported on NASDAQ SmallCap Market or the Over-the-Counter Bulletin Boardwithout retail mark-up, mark-down or commissions, and may not represent actualtransactions. Data prior to our one-for-five reverse split effective November22, 2002 are adjusted for the split.

 

 

Wehave never paid or declared any cash dividends on our common stock. We do notanticipate paying any dividends in the foreseeable future, and intend to retainany earnings we may generate to provide for the operation and projectedexpansion of our business.

 

OnNovember 11, 2002, we announced that our board of directors had authorized therepurchase of up to 50,000 shares of our Common Stock. The program expired May25, 2003 and we did not repurchase any shares under the program.

 

As ofMarch 31, 2004 we had approximately 144 shareholders of record andapproximately 11,200 total shareholders.

 

**ITEM6.****  MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OFOPERATION.**

 

**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 alicensor****of spintronics/magneticrandom access memory technology, commonly referred to as MRAM, which we believehas the potential to revolutionize electronic memory.

 

Ourstrategy is to continue to rapidly expand our product revenues while relying ongovernment contracts for basic technology development. The expansion of productrevenue will require additional product development and marketing expendituresas well as working capital to fund receivables and inventories.

 

**Critical Accounting Policies**

It isimportant to understand our significant accounting policies in order tounderstand our financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Theseaccounting principles require us to make estimates and assumptions that affectamounts reported in our financial statements and the accompanying notes. Actualresults are likely to differ from those estimates, but we do not believe suchdifferences will materially affect our financial position or results ofoperations for the periods presented in this report.

 

***Revenue Recognition***

Revenuefrom product sales is recognized when title transfers, generally upon shipment.Revenue from licensing and technology development programs, which isnonrefundable and for which no significant future obligations exist, isrecognized when the license is signed. Revenue from licensing and technology developmentprograms, which is refundable, recoupable against future royalties, or forwhich future obligations exist, is recognized when we complete our obligationsunder the terms of the agreements. Revenue from royalties is recognized uponthe shipment of product from our technology license partners to directcustomers. Certain research and development activities are conducted for thirdparties and such revenue is recognized as the services are performed. Paymentsreceived from licensing and technology development programs relating to futureobligations as well as prepayments for future discounts on product sales arerecorded as deferred revenue.

 

***Bad Debt***

Wemaintain an allowance for doubtful accounts for estimated losses resulting fromthe inability of our customers to make required payments. If the financialcondition of our customers were to deteriorate resulting in an impairment oftheir ability to make payments, additional allowances may be required.

 

***Inventory***

Wereduce the stated value of our inventory for excess quantities or obsolescencein an amount equal to the difference between the cost of inventory and theestimated market value based upon assumptions about future demand and marketconditions. Additional reductions in stated value may be required if actualfuture demand or market conditions are less favorable than we projected.

 

***Income Taxes***

Indetermining the carrying value of our net deferred tax assets, we must assessthe likelihood of sufficient future taxable income in certain tax jurisdictions,based on estimates and assumptions to realize the benefit of these assets. Weevaluate the realizability of the deferred assets quarterly and assess the needfor valuation allowances or reduction of existing allowances quarterly. Infiscal 2004 we reduced the amount of our valuation allowance based upon ourcumulative income over the past three years and our expectation of income infiscal 2005.

 

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**Results From Operations**

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

 
|                     |   | **Year  Ended March 31** |   |
|--------------------------|--------|--------------------------|--------|
|                     |   | **2004**                 |   | **2003** |   |
| Revenue:                 |   |                     |   |   |   |
| Research and development |   | 55.1                     | %      | 69.4 | % |
| Product sales            |   | 44.9                     |   | 26.5 |   |
| License fees             |   | 0.0                      |   | 4.1 |   |
| Total revenue            |   | 100.0                    |   | 100.0 |   |
|                     |   |                     |   |   |   |
| Cost of sales            |   | 62.0                     |   | 62.6 |   |
| Gross profit             |   | 38.0                     |   | 37.4 |   |
|                     |   |                     |   |   |   |
| Total expenses           |   | 22.4                     |   | 30.6 |   |
| Income tax benefit       |   | (1.9                     | )      | — |   |
| Net income               |   | 17.5                     | %      | 6.8 | % |

 

Revenuefor the year ended March 31, 2004 (fiscal 2004) was $12,010,851, an increase of27% from revenue of $9,447,490 for the year ended March 31, 2003 (fiscal 2003).The revenue increase was due to increases in commercial product sales andresearch and development revenue. Commercial product sales increased 115% to$5,393,540 from $2,503,096. The increase was due in part to increased sales toSt. Jude Medical, Inc. to fill supply pipelines related to the expanded use ofour parts.

 

Researchand development revenue increased 1% to $6,617,311 from $6,552,730 due toincreased government contract revenue. Increases in commercial product salesand research and development revenue were partially offset by the cessation oflicense revenues, which were $391,664 in fiscal 2003. The lack of licenserevenue was due to completion of revenue recognition for our MRAM licenseagreements.

 

Researchand development expenses decreased by 16% to $1,103,062 for fiscal 2004 ascompared to $1,308,129 in fiscal 2003. The decrease was due to lowerdevelopment expenses early in the fiscal year.

 

Grossprofit margins increased to 38% for fiscal 2004 as compared to 37% for fiscal2003. Gross profit on commercial product sales increased due to higher yieldson commercial products.

 

Selling,general and administrative expenses remained relatively constant for fiscal2004 at $1,831,542 compared to $1,837,549 for fiscal 2003.

 

Incometax benefit for fiscal 2004 is primarily the result of $250,000 of theremaining valuation allowance reversed due to our assessment that it is morelikely than not that we will earn sufficient operating income to realize$250,000 of the remaining deferred tax assets.

 

Netincome totaled $2,107,720 for fiscal 2004 compared to net income of $646,850for fiscal 2003. The increase in net income was due to the increase incommercial product sales and higher gross profit on commercial product sales.

 

**Liquidity and Capital Resources**

AtMarch 31, 2004 we had $7,544,643 in cash and available-for-sale securities,consisting of marketable fixed-income investments. The increase in cash andavailable-for-sale securities was due to operating profits and proceeds fromthe exercise of incentive stock options, partially offset by investments inproperty, plant and equipment. We believe our working capital is adequate forour needs at least through the year ending March 31, 2005 (fiscal 2005).

 

**Outlook**

Weexpect commercial product revenues to continue to grow in fiscal 2005. We planto continue our business strategy, including the support of a planned ramp-upin shipments to Agilent, new products, and possible sales of MRAM as a resultof our technology agreement with Cypress.

 

Salesto St. Jude Medical began to drop off in early calendar year 2004 as some oftheir purchases in calendar year 2003 were to fill supply pipelines related totheir expanded use of our products. We hope to replace those revenues with newsales to Agilent, sensors, couplers, or MRAM.

 

Grossprofit margins could decrease in fiscal 2005 as competitive pressures couldforce us to decrease our selling prices.

 

Researchand development expenses increased in the latter half of fiscal 2004. We expectexpenses to continue at higher levels in fiscal 2005 as we develop newproducts.

 

Wehave been profitable for eight consecutive quarters and expect to be profitablein fiscal 2005, however we expect expenses to increase in fiscal 2005 if werollout MRAM manufactured under our technology agreement with Cypress. We mayalso increase expenditures relating to pursuing additional MRAM licenseagreements. Our legal expenses relating to enforcing our MRAM intellectualproperty may also increase. These additional expenses could lead to operatinglosses.

 

Ourgrowth has required expanding our manufacturing capacity. We have purchasedseveral new pieces of production equipment in the past year. We plan to purchaseadditional production equipment and expand our clean-room factory in the comingyear to support continued growth in product sales, to reduce labor costs and toincrease manufacturing yields.

 

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**ForeignCurrency Transactions**

Due toproduct sales abroad, we have some limited revenue risks from fluctuations invalues of foreign currency. Foreign sales are generally made in United Statescurrency, and currency transaction gains or losses in the past two fiscal yearswere not 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 United States Government on research and development contracts areadjustable with inflation.

 

**Risk Factors**

 

***Risks Related to Our Business***

 

*Althoughwe were profitable in the most recent fiscal years, we have a history ofoperating losses and could suffer further losses in the future.*

We had an accumulateddeficit of $2,699,768 as of March 31, 2004. Although we reported positive netincome in fiscal 2004 and fiscal 2003, prior to fiscal 2003 we had a history oflosses. Additional expenditures could lead to operating losses in fiscal 2005and beyond. Possible expenditures include start-up costs associated withmanufacturing, marketing, and selling MRAM devices, expenditures relating topursuing additional MRAM license agreements, and legal expenses relating toenforcing our MRAM intellectual property.

 

*Werely on government contracts for a large percentage of our revenues and we willlose revenue if we lose these contracts.*

During fiscal 2004 UnitedStates government contracts accounted for approximately 54% of our revenues.Disqualification as a vendor to the United States government for any reason ora material decrease in government funding research would cause serious setbacksand would likely hamper both future research and development activity, as wellas related revenues.

 

*Failureto qualify as a small business under federal regulations could make usineligible for some government-funded research grants which could have asignificant impact on our revenue and our ability to make research anddevelopment progress.*

Federal regulations placea number of criteria for a business to be eligible to compete for SmallBusiness Innovation Research (SBIR) awards. Those criteria include number ofemployees and ownership structure. While we believe we meet the criteria,changes in our ownership beyond our control could cause us to lose oureligibility to compete for SBIR awards, which in turn could have a materialadverse effect on our revenues profits, and research and development efforts.

 

*Wemay lose revenue if any of our large customers cancel, postpone, or reducetheir purchases.*

We rely on several largecustomers for a large percentage of our commercial revenues; these include AgilentTechnologies, Inc., St. Jude Medical, Inc., the United States Government, andcertain distributors. Orders from these customers can be cancelled, postponed,or reduced without cause or notice, and the loss of any of these customerscould have a significant impact on our commercial revenues and ourprofitability.

 

*Weface a difficult and uncertain economic environment in our industry which couldadversely affect our business and operations.*

The semiconductor andelectronics industries in general have experienced a significant economicdownturn during the past two years. The poor economic environment may haveadversely affected the sales of many of our customers’ products, thus limitingour sales. Economic conditions may not improve in the near term or at all. Anyfailure of the economic environment to improve or a future downturn wouldlikely have a material adverse impact on our business and revenues.

 

*Ourreputation could be damaged and we could lose revenue if we fail to meettechnical challenges required to produce marketable products.*

Our products use newtechnology and we are continually researching and developing product designsand production processes. Our production processes require control of magneticand other parameters that are not required in conventional semiconductorprocesses. If we are unable to develop stable designs and production processeswe may not be able to produce products that meet our customers’ requirements,which could cause damage to our reputation and loss of revenues.

 

*Wemay lose business and revenue if our critical production equipment fails.*

Our production processrelies on certain critical pieces of equipment for defining, depositing, andmodifying the magnetic properties of very thin metal films. Some of this equipmentwas designed or customized by us, and some may no longer be in production.While we have back-ups for some of the equipment, an in-house maintenancestaff, some critical spare parts, and maintenance agreements for certain piecesof equipment, we cannot be sure we could repair or replace criticalmanufacturing equipment were it to fail.

 

*Ourfailure to meet stringent customer technical requirements could result in theloss of key customers and potential reduced sales.*

Some of our customers,including Agilent and St. Jude Medical, have stringent technical requirementswhich require our products to pass certain test and qualification criteriabefore they are accepted by such customers. Failure to meet those criteriacould result in the loss of current sales revenue, customers and future sales.

 

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*Ifwe are unable to deliver products we face penalties, including loss of certainexclusive manufacturing rights.*

Our Agilent supplyagreement allows Agilent to gain rights to manufacture couplers based on ourtechnology if we are unable to deliver products on time. The imposition of thispenalty could have a material impact on future sales of our products.Furthermore, on reaching certain sales goals, Agilent could gain exclusiverights to distribute certain couplers based on our technology, which couldreduce our product sales and leave us partially or totally dependent on Agilentfor future coupler sales.

 

*Theloss of supply from any of our key single-source suppliers could impact ourability to produce and deliver products and cause loss of revenue.*

Critical suppliersinclude our suppliers of certain semiconductor wafers which are incorporated inour products. These critical suppliers include Advanced SemiconductorManufacturing Corporation of Shanghai (China), AMI Semiconductor, Inc.,Intersil Corporation, Taiwan Semiconductor Manufacturing Corporation, and TexasInstruments Inc. We maintain inventory of some critical wafers, but we have notidentified or qualified alternate suppliers for many of the wafers now beingobtained from single sources. We are also dependent on our packaging vendors,including Circuit Electronics Industries (Ayutthaya, Thailand), and NSElectronics Bangkok (Thailand), Ltd. Some of our products use processes ortooling unique to a particular packaging vendor, and it might be expensive,time-consuming, or impractical to convert to another vendor in the event of asupply interruption. Supply interruptions could seriously jeopardize ourability to provide products that are critical to our business and operationswhich may cause us to lose revenue.

 

*Becausewe are significantly smaller than the majority of our competitors, we may lackthe financial resources needed to increase our market share and future revenue.*

Our known competitors andpotential competitors include Advanced Micro Devices, Inc., AgilentTechnologies, Inc., Allegro Microsystems, Inc., NEC Corporation, AnalogDevices, Inc., Fujitsu Limited, Hewlett-Packard Company, IBM Corporation,Infineon Technologies AG, Intel Corporation, NEC Corporation, RamtronInternational Corporation, Royal Philips Electronics, Samsung Electronics,Ltd., Sony Corporation, Texas Instruments Inc., Vishay Intertechnology, Xicor,Inc., and others. We believe that our competition has increased in the pastyear as the technology matures. This has meant more competitors and more severepricing pressure. Furthermore, our competitors are narrowing or eliminatingperformance advantages we may have had. We expect these trends to continue, andour future competiveness will depend on our ability to develop new products andreduce our product costs. Most of our competitors and potential competitors areestablished companies that have significantly greater financial, technical, andmarketing resources than us. While we believe that our products have importantcompetitive advantages, our competitors may succeed in developing and marketingproducts that perform better or are less expensive than ours, or that wouldrender our products and technology obsolete or noncompetitive.

 

*Ourlicense agreements include revenue minimums and royalty limits which couldlimit the total amount of revenue we can derive under these agreements.*

Our existing licenseagreements do not provide for us to receive royalties until revenue minimumsare met by licensees. In addition, some of these agreements place limits onfuture royalty and license payments. These provisions could substantially delayour potential revenues and profits from these licensing arrangements and couldlimit the total amount of revenue that we can derive under these licenseagreements. Such limits are common practice in our industry, but they couldlimit our potential MRAM revenues and profits even if our intellectual propertyis widely adopted.

 

*Ourbusiness may suffer because we have limited influence over the rate of adoptionof our technology, and MRAM technology may not build into a large orsignificant market* Asignificant portion of our future revenues and profits is dependent on ourlicensees and manufacturing partners 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 and manufacturing partners may have other priorities that detractattention and resources from introduction of MRAM products using ourtechnology. Furthermore, competing technologies could prevent or supplant MRAMfrom becoming an important memory technology.

 

*Ourlicensees may not be able to make commercially viable MRAMs, which would limitour revenue from MRAM and likely cause our stock price to decline.*

MRAM is a new technology,and we are almost completely dependent on our licensees to convert ourintellectual property into commercially viable MRAM. While our licensees havemade prototypes and samples, several technical and manufacturing issues must beresolved before commercially viable devices can be produced, and these problemsmay never successfully be solved. Cypress has said they have made working MRAM,but has missed several schedule targets for sample devices, and further delayscould have a material impact on our revenues from MRAM. Motorola has announcedplans for pilot production by late 2004, but any delays could have a materialimpact on our potential MRAM license revenues.

 

*Weare highly dependent on Motorola to combine our MRAM technology withconventional semiconductors and we may lose potential revenue if Motorola isunsuccessful.*

“Embedded” MRAM, that is,MRAM combined with conventional semiconductors, is a major market for MRAM andour primary potential source of royalties from Motorola. We are highlydependent on Motorola’s success embedding MRAM into processor and cellphoneintegrated circuits. Technical difficulties with embedding, productiondifficulties, high production costs, or other problems, almost all of which areoutside our control, could limit our potential MRAM royalties.

 

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*Weare highly dependent on Cypress for potential supply of MRAM devices usingtheir designs and may lose revenue if we need to replace Cypress as a supplier.*

Although we have rightsto Cypress’ MRAM designs, mask works, and other intellectual property, it couldbe difficult for us to fabricate devices based on those designs andintellectual property at a foundry other than Cypress. This is because otherpotential foundries might not have the needed equipment, and Cypress’ designsare tailored for their factories. If Cypress is unable to manufacture devicesfor us for any reason, it could be difficult for us to find anothermanufacturer for their designs.

 

*Cypresscould cancel their MRAM development program, which would reduce our futurerevenue because we could no longer sell devices based on their designs.*

Cypress could canceltheir MRAM development program at any time because of financial or otherconsideration. A cancellation of their MRAM program would likely eliminate ouropportunity to sell devices based on their designs.

 

*Ourfuture business may suffer because we may not be able to consummate additionalMRAM license agreements.*

Although there arepotential licensees for our MRAM intellectual property in addition to ourcurrent licensees and partners, we may never be able to consummate additionallicense agreements. Potential licensees for our MRAM intellectual propertymight not be interested unless and until the commercial viability of thetechnology is demonstrated. Potential licensees could also use their own or athird party’s MRAM intellectual property rather than ours. In addition, ourexisting agreements place restrictions on future license agreements.Specifically, one of our agreements allows one of our licensees to approvelicenses with certain other potential licensees. Each of these limitationscould hinder our ability to consummate additional MRAM license agreements.

 

*Wewill not receive royalties if our licensees do not use our intellectualproperty.*

Our license agreements donot require our licensees to use our intellectual property. Although webelieve, based on their public disclosures, that the devices that Motorola,Inc. and Cypress Semiconductor Corporation have demonstrated would use ourintellectual property at least to some extent, our licensees could circumventor find alternatives to all or some of our technology, and our licenseagreements require royalty payments only if our licensees use our intellectualproperty in their devices. It is possible that our licensees might make MRAMdevices without using our technology or infringing on our patents, and we wouldnot receive royalties on such devices.

 

*Wemay not be able to enforce our intellectual property rights or our technologymay prove to infringe upon patents or rights owned by others which may preventthe future sale of our products or increase the cost of such sales.*

We protect ourproprietary technology and intellectual property by seeking patents,trademarks, and copyrights, and by maintaining trade secrets through enteringinto confidentiality agreements with employees, suppliers, customers, andprospective customers depending on the circumstances. We hold patents or arethe licensee of others owning patented technology covering certain aspects ofour 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.

 

*Ourfuture business may suffer if we are unable to enforce our intellectualproperty rights with existing licensees.*

Our success in enforcingour intellectual property rights may be dependent on our ability to enforce ourcontract rights under existing license agreements. Our existing licensees couldclaim without merit that they do not use our intellectual property or claimthat one or more of our patents are invalid. In 2000 we were forced to resortto litigation to enforce our intellectual property rights with Motorola, and weplan to continue to vigorously defend our intellectual property rights.

 

*Ourbusiness success may be adversely affected if we are unable to attract andretain highly-qualified management and technical employees.*

We have no employmentagreements with any of our management other than our Chief Executive Officer,Dr. Baker, and have no key-person insurance covering employees. Competition forhighly-qualified management and technical personnel is generally intense and wemay not be able to attract and retain the personnel necessary for thedevelopment and operation of our business. The loss of the services of keypersonnel could have a material adverse effect on our business, financialcondition and results of operations. Our Chief Technology Officer, Dr.Daughton, may decide to retire at any time in the next several years, and wemay not be able to replace his technical or contract development expertise.

 

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***Risks Related to Buying Our Stock***

 

*Ourstock has been more volatile than other technology sector stocks.*

The market price of ourcommon stock has experienced significant fluctuations and may continue tofluctuate in the future. These fluctuations have been greater on a percentagebasis than other technology sector stocks.

 

*Ourstock may be subject to volatility because it is not listed on a nationalmarket.*

Our common stock istraded on the NASDAQ SmallCap Market, which has less daily trading volume onaverage than the average trading market for companies quoted on the NASDAQNational Market or the New York Stock Exchange. A public trading market havingthe desired characteristics of depth, liquidity and orderliness depends on thepresence in the marketplace of willing buyers and sellers of our common stockat any given time. This presence depends on the individual decisions ofinvestors and general economic and market conditions over which we have nocontrol.

 

*Theprice of our common stock may be adversely affected by significant pricefluctuations due to a number of factors, many of which are beyond our control.*

The market price of thecommon stock may be significantly affected by many factors, including:

 

•                 technologicalinnovations by us, our licensees, or our competitors;

 

•                 the announcement ofnew products or product enhancements by us, our licensees, or our competitors;

 

•                 changes inrequirements or demands for our products;

 

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

 

•                 quarterly variationsin our operating results;

 

•      changes in our revenue and revenuegrowth rates;

 

•      changes in revenue estimates, earningsestimates, or market projections by market analysts, speculation in the pressor analyst community;

 

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

 

•                 general marketconditions or market conditions specific to particular industries.

 

The stock prices for manycompanies in the technology sector have experienced wide fluctuations thatoften have been unrelated to their operating performance. Such fluctuations mayadversely affect the market price of our common stock.

 

**ITEM7.****  FINANCIAL STATEMENTS.**

FinancialStatements and Notes are in this report following the signature page.

 

**ITEM8.****  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE.**

None.

 

**ITEM 8A.****  CONTROLS AND PROCEDURES.**

**Evaluationof Disclosure Controls and Procedures.**

Underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer, we evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the endof the period covered by this annual report (the Evaluation Date). Based uponthat evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that, as of the Evaluation Date, our disclosure controls andprocedures were effective in timely alerting them to the material informationrelating to us required to be included in our periodic SEC filings.

 

**Changesin Internal Controls.**

Therewere no significant changes made to our internal control over financialreporting (as defined in Rule 13 a-15(f) under the Exchange Act) during theperiod covered by this report that materially affected or are reasonably likelyto materially affect our internal control over financial reporting.

 

15

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**PART III**

 

**ITEM9.****  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROLPERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.**

 

**ShareholderProposals for Nominations to Our Board**

Thediscussion under the section entitled “Nominating/Corporate GovernanceCommittee—Shareholder Nominees” to be included in our Proxy Statement for our2004 Annual Meeting of Shareholders is incorporated herein by reference.

 

**Directorsand Executive Officers**

Thefollowing table sets forth certain information regarding our executive officersand directors. Each director and executive officer is elected annually andserves for a term of one year or until his successor is duly elected andqualified.

 
| **NAME  AND POSITION**                           |   | **AGE** |   |
|--------------------------------------------------|--------|---------|--------|
| Terrence W. Glarner                              |   | 61      |   |
| Director and Chairman of the Board               |   |    |   |
|                                             |   |    |   |
| Daniel A. Baker                                  |   | 46      |   |
| Director, President, and Chief Executive Officer |   |    |   |
|                                             |   |    |   |
| Richard L. George                                |   | 60      |   |
| Treasurer and Chief Financial Officer            |   |    |   |
|                                             |   |    |   |
| James M. Daughton                                |   | 67      |   |
| Director and Chief Technical Officer             |   |    |   |
|                                             |   |    |   |
| Robert H. Irish                                  |   | 64      |   |
| Director                                         |   |    |   |
|                                             |   |    |   |
| Jeffrey K. Kaszubinski                           |   | 48      |   |
| Director                                         |   |    |   |

 

***Terrence W. Glarner*******has been a director since August 1999,and Chairman of the Board since January 2001. Since February 1993, Mr. Glarnerhas been the President of West Concord Ventures, Inc. Mr. Glarner also consultswith Norwest Venture Partners. Prior to starting West Concord Ventures, Mr.Glarner was the President of North Star Ventures, Inc. from 1988 to February1993, a firm which he joined in 1976. From 1968 to 1976, Mr. Glarner was aSecurities Analyst and Vice President in the Research Department of DainBosworth, Inc. Mr. Glarner has a B.A. in English from the University of St.Thomas, a J.D. from the University of Minnesota School of Law and is aChartered Financial Analyst. Mr. Glarner supervised investments inapproximately 100 small companies during his involvement with North StarVentures. Mr. Glarner currently serves as a director of the following publicly-heldcompanies: Aetrium Inc., CIMA Laboratories Inc., Datakey Inc., and FSIInternational Inc. He is also a director of privately-held Oncotech, Inc.

 

***Daniel A. Baker*** has been a director and the Presidentand Chief Executive Officer since January 2001. From 1993 until joining NVE, hewas President and CEO of Printware, Inc., now known as Printware LLC, whichmakes high-speed laser imaging systems. Dr. Baker has over 25 years ofexperience in high-tech industries, including executive positions with MinntechCorporation and Percom Data Corporation. Dr. Baker has Ph.D. and M.S. degreesin engineering from the University of Minnesota, an M.B.A. in finance from theUniversity of Minnesota, and a B.S. in engineering from Case Western ReserveUniversity.

 

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

 

***James M. Daughton*** has been a director since our inceptionin 1989 and Chief Technical Officer since January 2001. He served as Chairmanof the Board and Chief Executive Officer from 1991 to January 2001. From 1974to 1989, Dr. Daughton held various research and product development positionsat Honeywell, Inc. including Vice President of The Solid State DevelopmentCenter. From 1964 to 1974, he developed magnetic and semiconductor memorydevices at IBM Corporation. Dr. Daughton holds a doctorate in electricalengineering from Iowa State University and is an adjunct professor of physicsat the University of Minnesota.

 

***Robert H. Irish*******has been a director since 1992. Mr. Irishhas been a consultant since 1999. From 1994 to 1999 he held various sales andsales management positions at Compuware and Prodea Software. From 1988 to 1994,Mr. Irish acted as a consultant and co-investor with Norwest Venture Partners.From 1981 to 1988, he was the Executive Vice President of Centron DPL,responsible for technical marketing, product marketing and research anddevelopment. Mr. Irish worked at IBM in management, sales and systems from 1966to 1981. Mr. Irish attended Rensselaer Polytechnic Institute and received aB.S. in Physics from Syracuse University.

 

***Jeffrey K. Kaszubinski*** has been a director since July 2002. Mr.Kaszubinski is currently President and Chief Executive Officer of SiliconMagnetic Systems, a Cypress subsidiary corporation which is developing MRAMtechnology and products. He has worked in the semiconductor memory business for25 years, the past 15 at Cypress Semiconductor in a variety of executivepositions, including product line management, manufacturing, quality assurance,and engineering. Prior to joining Cypress, Mr. Kaszubinski worked at TexasInstruments Inc., where he led the development of groundbreaking nonvolatilememories. Mr. Kaszubinski received a BSEE degree in 1978 from the University ofNew Orleans and holds five nonvolatile memory patents.

 

16

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**Key Employees**

***John K. Myers***, Vice President of Development, age 55,joined NVE in 1997 as Vice President of New Business Development. Mr. Myers hasover 30 years of experience in management and new business development in thesemiconductor and other industries. Prior to joining NVE he held managementpositions with FSI International and the Allen-Bradley Company. Mr. Myers holdsBSEE and M.B.A. degrees from the University of Minnesota.

 

***Jay L. Brown***, Vice President, Sensor Business Unit,age 45, has been with NVE for over ten years, and responsible for NVE’s sensorbusiness for the past six years. He was promoted to Vice President in 2000. Inhis current position he manages sensor sales and marketing, customerengineering, and product engineering. Previously at NVE, Mr. Brown designedcircuits and managed a number of key programs. Prior to joining NVE, he was anengineer at St. Jude Medical, Inc. Mr. Brown earned a B.S. degree in electricalengineering from Minnesota State University-Mankato.

 

***Anthony F. Leali***, Director of Standard Product Sales, age46, has been with has been with NVE since 2001 and has over 15 years of salesand engineering experience. Prior to joining NVE, he held sales managementpositions with Unique Technologies and Future Electronics, Inc., bothdistributors of semiconductor devices. He has a B.S. in Electrical Engineeringfrom the University of Minnesota and an M.B.A. from the University of St.Thomas.

 

***Curt A. Reynders***, age 41, has been NVE’s Controller since2001. From 1987 through 2001, Mr. Reynders served in various accounting andaccounting management positions with public accounting and industry firms. Mr.Reynders is a Certified Public Accountant and earned a B.S. in Accounting andEconomics from Morningside College.

 

**Audit Committee Financial Expert**

OurBoard of Directors has determined that Terrence W. Glarner qualifies as an auditcommittee financial expert, as such term is defined in recently adopted rulesof the Securities and Exchange Commission implementing requirements of theSarbanes-Oxley Act of 2002, and that Mr. Glarner is “independent” under thecorporate governance rules of the Nasdaq Stock Market.

 

**Code of Ethics**

Wehave adopted a Code of Business Conduct and Ethics that applies to all of ouremployees and directors, including our principal executive officer, principalfinancial officer and principal accounting officer. The Code of BusinessConduct and Ethics is filed as Exhibit 14 to this report. We have also posted acopy of the Code of Business Conduct and Ethics under the under InvestorRelations section of our Web site (www.nve.com). You may obtain a copy of theCode of Business Conduct and Ethics without charge by contacting Richard L.George, our Chief Financial Officer.

 

Thediscussion under the section entitled “Section 16(a) Beneficial OwnershipReporting Compliance” to be included in our Proxy Statement for our 2004 AnnualMeeting of Shareholders is incorporated herein by reference.

 

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

Theinformation required by Item 10 is incorporated herein by reference to thesections entitled “Executive Compensation” and “Proposal 1. Election of Boardof Directors—Compensation of Our Directors” to be included in our ProxyStatement for our 2004 Annual Meeting of Shareholders.

 

**ITEM 11.****  SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT.**

Theinformation required by Item 11 is incorporated herein by reference to thesections entitled “Ownership of Voting Securities by Principal Holders andManagement” and “Executive Compensation—Equity Compensation Plan Information”to be included in our Proxy Statement for our 2004 Annual Meeting ofShareholders.

 

**ITEM 12.****  CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS.**

Wehave a license agreement with Cypress where each party gained rights to certainof the other party’s patents and other intellectual property, and Cypressagreed to produce semiconductor wafers for us. Cypress was also granted awarrant to purchase up to 400,000 shares of our common stock. Jeffrey K.Kaszubinski, a member of our board of directors, is a Cypress employee and wasdesignated for nomination to our board of directors by Cypress under the termsof our agreement with Cypress.

 

17

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**ITEM 13.****  EXHIBITS AND REPORTS ON FORM8-K.**

 

**(a)Exhibits required by Item 601 of Regulation S-B.**

 
| **Exhibit  #** |   | **Description** |
|----------------|--------|-----------------|
|           | 3.1    |            | Amended and Restated  Articles of Incorporation of the company as amended by the Board of Directors  effective November 21, 2002 (incorporated by reference to our Quarterly  Report on Form 10-QSB for the period ended December 31, 2002). |
|           |   |            |   |
|           | 3.2    |            | By-laws of the company  as amended by the Board of Directors, May 31, 2002 (incorporated by reference  to our Annual Report on Form 10-KSB for the year ended March 31, 2002). |
|           |   |            |   |
|           | 4      |            | Form of Common Stock  Certificate (incorporated by reference to our Registration Statement on Form  S-8 filed July 20, 2001). |
|           |   |            |   |
|           | 10.1   |            | Lease dated October 1,  1998 between the company and Glenborough Properties, L.P. (incorporated by  reference to our Quarterly Report on Form 10-QSB for the period ended  September 30, 2002). |
|           |   |            |   |
|           | 10.2   |            | First amendment to  lease between the company and Glenborough Properties, L.P. dated September  18, 2002 (incorporated by reference to our Quarterly Report on Form 10-QSB  for the period ended September 30, 2002). |
|           |   |            |   |
|           | 10.3   |            | Second amendment to  lease between the company and Glenborough Properties, L.P. dated December 1,  2003 (incorporated by reference to our Quarterly Report on Form 10-QSB for  the period ended December 31, 2003). |
|           |   |            |   |
| *              | 10.4   |            | Employment Agreement  between the company and Daniel A. Baker dated January 29, 2001 (incorporated  by reference to our Annual Report on Form 10-KSB for the year ended March 31,  2001). |
|           |   |            |   |
| *              | 10.5   |            | NVE Corporation 2001  Employee Stock Purchase Plan Summary (incorporated by reference to our  Definitive Proxy Statement on Schedule 14A filed June 1, 2001). |
|           |   |            |   |
|           | 10.6   |            | 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. Confidential treatment has been requested with respect to  portions of this exhibit, and such confidential portions have been deleted  and separately filed with the Securities and Exchange Commission pursuant to  Rule 24b-2 or Rule 406.). |
|           |   |            |   |
|           | 10.7   |            | 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). |
|           |   |            |   |
|           | 10.8   |            | Stock Purchase  Agreement dated April 12, 2002 with Cypress Semiconductor Corporation  (incorporated by reference to our Quarterly Report on Form 10-QSB for the  period ended June 30, 2002). |
|           |   |            |   |
|           | 10.9   |            | Cypress Semiconductor  Corporation Common Stock Purchase Warrant dated April 12, 2002 (incorporated  by reference to our Quarterly Report on Form 10-QSB for the period ended June  30, 2002). |
|           |   |            |   |
|           | 10.10  |            | License Agreement dated  April 12, 2002 with Cypress Semiconductor Corporation (incorporated by  reference to our Quarterly Report on Form 10-QSB for the period ended June  30, 2002. Confidential treatment has been requested with respect to portions  of this exhibit, and such confidential portions have been deleted and  separately filed with the Securities and Exchange Commission pursuant to Rule  24b-2 or Rule 406.). |
|           |   |            |   |
|           | 14     |            | Code of Business  Conduct and Ethics. |
|           |   |            |   |
|           | 23     |            | Consent of Ernst &  Young LLP (incorporated by reference within this Annual Report on Form  10-KSB). |
|           |   |            |   |
|           | 31.1   |            | Certification by Daniel  A. Baker pursuant to Rule 13a-14(a)/15d-14(a). |
|           |   |            |   |
|           | 31.2   |            | Certification by  Richard L. George pursuant to Rule 13a-14(a)/15d-14(a). |
|           |   |            |   |
|           | 32.1   |            | Certification by Daniel  A. Baker pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002. |
|           |   |            |   |
|           | 32.2   |            | Certification by  Richard L. George 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.

 

**(b)Reports on Form 8-K.**

We submitted a Form 8-K on January 20, 2004 includingour press release reporting results for the quarter ended December 31, 2003.This information was furnished under Item 12, Results of Operations andFinancial Condition.

 

18

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**ITEM 14.****  PRINCIPAL ACCOUNTANT FEES ANDSERVICES.**

Theinformation required by Item 14 is incorporated herein by reference to the“Audit Committee Report” and related Exhibit B to be included in our ProxyStatement for our 2004 Annual Meeting of Shareholders.

 

**SIGNATURES**

 

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

 
|   | **NVE  CORPORATION**                            |
|--------|-------------------------------------------------|
|   | (Registrant)                                    |   |
|   |                                            |
|   | /s/ Daniel A. Baker                             |   |
|   | by Daniel A. Baker                              |
|   | President and Chief  Executive Officer          |
|   |                                            |
|   | Date     May  24, 2004 |

 

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

 
|   | **Name**                   |   | **Title**                               |   | **Date**     |   |
|--------|----------------------------|--------|-----------------------------------------|--------|--------------|--------|
|   |                       |   |                                    |   |         |   |
|   | /s/ Terrence W. Glarner    |   | Director and                            |   | May 24, 2004 |   |
|   | Terrence W. Glarner        |   | Chairman of the Board                   |   |         |   |
|   |                       |   |                                    |   |         |   |
|   |                       |   |                                    |   |         |   |
|   | /s/ Daniel A. Baker        |   | Director,                               |   | May 24, 2004 |   |
|   | Daniel A. Baker            |   | President & Chief Executive Officer |   |         |   |
|   |                       |   | (Principal Executive Officer)           |   |         |   |
|   |                       |   |                                    |   |         |   |
|   |                       |   |                                    |   |         |   |
|   | /s/ Richard L. George      |   | Treasurer and                           |   | May 24, 2004 |   |
|   | Richard L. George          |   | Chief Financial Officer                 |   |         |   |
|   |                       |   | (Principal Financial and                |   |         |   |
|   |                       |   | Accounting Officer)                     |   |         |   |
|   |                       |   |                                    |   |         |   |
|   | /s/ James M. Daughton      |   | Director and                            |   | May 24, 2004 |   |
|   | James M. Daughton          |   | Chief Technical Officer                 |   |         |   |
|   |                       |   |                                    |   |         |   |
|   |                       |   |                                    |   |         |   |
|   | /s/ Robert H. Irish        |   | Director                                |   | May 24, 2004 |   |
|   | Robert H. Irish            |   |                                    |   |         |   |
|   |                       |   |                                    |   |         |   |
|   |                       |   |                                    |   |         |   |
|   | /s/ Jeffrey K. Kaszubinski |   | Director                                |   | May 24, 2004 |   |
|   | Jeffrey K. Kaszubinski     |   |                                    |   |         |   |

 

19

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**REPORTOF INDEPENDENT AUDITORS**

 

 

Board of Directors

NVE Corporation

 

Wehave audited the accompanying balance sheet of NVE Corporation as of March 31,2004 and the related statements of income, shareholders’ equity and cash flowsfor the years ended March 31, 2004 and 2003. These financial statements are theresponsibility of the company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

Weconducted our audits in accordance with auditing standards generally acceptedin the United States. Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of NVE Corporation at March 31, 2004and the results of its operations and its cash flows for the years ended March31, 2004 and 2003 in conformity with accounting principles generally acceptedin the United States.

 

 

Ernst & Young LLP

Minneapolis, Minnesota

April 23, 2004

 

**CONSENTOF INDEPENDENT AUDITORS**

 

 

We consent to theincorporation by reference in the Registration Statement (Form S-3) of NVE Corporationand the related Prospectus and in the Registration Statement (Form S-8)pertaining to the NVE Corporation 2000 Stock Option Plan (as amended by theshareholders on July 19, 2001) and the NVE Corporation 2001 Employee StockPurchase Plan of our report dated April 23, 2004, with respect to the financialstatements of NVE Corporation included in its Annual Report (Form 10-KSB) forthe year ended March 31, 2004.

 

 

Ernst & Young LLP

Minneapolis, Minnesota

May 24, 2004

 

20

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**NVE CORPORATION**

**FORM 10-KSB**

**FOR THE FISCAL YEAR ENDED MARCH 31,2004**

 

**INDEX TO FINANCIALSTATEMENTS**

 

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

 

----

 

**NVE CORPORATION**

**BALANCE SHEET**

**MARCH 31, 2004**

 
| ASSETS                                                                       |   |       |       |
|------------------------------------------------------------------------------|--------|------------|------------|
| Current assets:                                                              |   |       |       |
| Cash and cash equivalents                                                    |   | $          | 1,055,796  |   |
| Investment securities                                                        |   | 6,488,847  |       |
| Accounts receivable, net of allowance for  uncollectible accounts of $15,000 |   | 1,739,479  |       |
| Inventories                                                                  |   | 1,149,854  |       |
| Deferred tax asset                                                           |   | 250,000    |       |
| Prepaid expenses and other assets                                            |   | 296,537    |       |
| Total current assets                                                         |   | 10,980,513 |       |
| Fixed assets:                                                                |   |       |       |
| Machinery and equipment                                                      |   | 3,351,676  |       |
| Leasehold improvements                                                       |   | 365,187    |       |
|                                                                         |   | 3,716,863  |       |
| Less accumulated depreciation                                                |   | 2,277,649  |       |
| Net fixed assets                                                             |   | 1,439,214  |       |
| Total assets                                                                 |   | $          | 12,419,727 |   |
|                                                                         |   |       |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                    |   |       |       |
| Current liabilities:                                                         |   |       |       |
| Accounts payable                                                             |   | $          | 327,281    |   |
| Accrued payroll and other                                                    |   | 711,835    |       |
| Deferred revenue                                                             |   | 424,176    |       |
| Capital lease obligations                                                    |   | 122,480    |       |
| Total current liabilities                                                    |   | 1,585,772  |       |
| Capital lease obligations, less current portion                              |   | 100,711    |       |
| Total liabilities                                                            |   | 1,686,483  |       |
|                                                                         |   |       |       |
| Shareholders’ equity:                                                   |   |       |       |
| Common stock                                                                 |   | 44,889     |       |
| Additional paid-in capital                                                   |   | 13,297,753 |       |
| Accumulated other comprehensive income                                       |   | 90,370     |       |
| Accumulated deficit                                                          |   | (2,699,768 | )          |
| Total shareholders’ equity                                              |   | 10,733,244 |       |
| Total liabilities and shareholders’ equity                              |   | $          | 12,419,727 |   |

 

SEE ACCOMPANYING NOTES.

 

F-1

----

 

**NVE CORPORATION**

**STATEMENTSOF INCOME**

**YEARS ENDED MARCH 31, 2004 AND 2003**

 
|                                       |   | **Year  Ended March 31** |      |
|--------------------------------------------|--------|--------------------------|-----------|
|                                       |   | **2004**                 |      | **2003** |   |
| Revenue                                    |   |                     |      |   |   |
| Contract research and development          |   | $                        | 6,617,311 |   | $ | 6,552,730 |   |
| Product sales                              |   | 5,393,540                |      | 2,503,096 |   |
| License revenues                           |   | —                   |      | 391,664 |   |
| Total revenue                              |   | 12,010,851               |      | 9,447,490 |   |
|                                       |   |                     |      |   |   |
| Cost of sales                              |   | 7,444,906                |      | 5,911,380 |   |
| Gross profit                               |   | 4,565,945                |      | 3,536,110 |   |
|                                       |   |                     |      |   |   |
| Expenses                                   |   |                     |      |   |   |
| Research and development                   |   | 1,103,062                |      | 1,308,129 |   |
| Selling, general & administrative      |   | 1,831,542                |      | 1,837,549 |   |
| Total expenses                             |   | 2,934,604                |      | 3,145,678 |   |
|                                       |   |                     |      |   |   |
| Income from operations                     |   | 1,631,341                |      | 390,432 |   |
|                                       |   |                     |      |   |   |
| Interest income                            |   | 189,270                  |      | 210,823 |   |
| Interest expense                           |   | (25,996                  | )         | (40,570 | ) |
| Other income                               |   | 80,083                   |      | 86,165 |   |
| Income from operations before income taxes |   | 1,874,698                |      | 646,850 |   |
|                                       |   |                     |      |   |   |
| Income tax benefit                         |   | 233,022                  |      | — |   |
|                                       |   |                     |      |   |   |
| Net income                                 |   | $                        | 2,107,720 |   | $ | 646,850 |   |
|                                       |   |                     |      |   |   |
| Net income per share-basic                 |   | $                        | 0.49      |   | $ | 0.16 |   |
|                                       |   |                     |      |   |   |
| Net income per share-diluted               |   | $                        | 0.45      |   | $ | 0.15 |   |
|                                       |   |                     |      |   |   |
| Weighted average shares outstanding:       |   |                     |      |   |   |
| Basic                                      |   | 4,296,870                |      | 4,131,463 |   |
| Diluted                                    |   | 4,726,759                |      | 4,324,493 |   |

 

SEE ACCOMPANYINGNOTES.

 

F-2

----

 

**NVE CORPORATION**

**STATEMENTOF SHAREHOLDERS’ EQUITY**

**YEARS ENDED MARCH 31, 2004 AND 2003**

 
| ** **                                              | ** ** | **Common Stock** |   | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Other Compre-  hensive Income** |   | **Accumulated  Deficit** | ** ** | **Total**  |   |
|---------------------------------------------------------|------------|------------------|--------|----------------------------------|------------|------------------------------------------------|--------|--------------------------|------------|------------|--------|
| **Shares**                                              |       | **Amount**       |
| Balance, March 31, 2002                                 |       | 3,454,032        |   | $                                | 34,540     |                                           | $      | 5,896,606                |       | $          | — |   | $ | (5,454,338 | ) | $ | 476,808 |   |
|                                                    |       |             |   |                             |       |                                           |   |                     |       |       |   |   |   |
| Exercise of stock options and warrants                  |       | 24,980           |   | 250                              |       | 12,697                                         |   | —                   |       | —     |   | 12,947 |   |
| Shares issued pursuant to employee stock purchase  plan |       | 8,917            |   | 89                               |       | 54,680                                         |   | —                   |       | —     |   | 54,769 |   |
| Sale of common stock                                    |       | 686,849          |   | 6,869                            |       | 6,206,850                                      |   | —                   |       | —     |   | 6,213,719 |   |
| Comprehensive income:                                   |       |             |   |                             |       |                                           |   |                     |       |       |   |   |   |
| Unrealized gain on investment securities                |       | —           |   | —                           |       | —                                         |   | 73,221                   |       | —     |   | 73,221 |   |
| Net income                                              |       | —           |   | —                           |       | —                                         |   | —                   |       | 646,850    |   | 646,850 |   |
| Total comprehensive income                              |       |             |   |                             |       |                                           |   |                     |       |       |   | 720,071 |   |
| 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 |   |

 

SEE ACCOMPANYINGNOTES.

 

F-3

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**NVE CORPORATION**

**STATEMENTSOF CASH FLOWS**

**YEARS ENDED MARCH 31, 2004 AND 2003**

 
|                                                                               |   | **Year  Ended March 31** |      |
|------------------------------------------------------------------------------------|--------|--------------------------|-----------|
|                                                                               |   | **2004**                 |      | **2003** |   |
|                                                                               |   |                     |      |   |   |
| OPERATING ACTIVITIES                                                               |   |                     |      |   |   |
| Net income                                                                         |   | $                        | 2,107,720 |   | $ | 646,850 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |                     |      |   |   |
| Depreciation and amortization                                                      |   | 524,733                  |      | 511,049 |   |
| Deferred tax benefit                                                               |   | (250,000                 | )         | — |   |
| Changes in operating assets and liabilities:                                       |   |                     |      |   |   |
| Accounts receivable                                                                |   | (711,189                 | )         | 232,883 |   |
| Inventories                                                                        |   | (309,078                 | )         | (328,561 | ) |
| Prepaid expenses and other                                                         |   | (126,217                 | )         | (111,115 | ) |
| Accounts payable and accrued expenses                                              |   | 102,703                  |      | 120,931 |   |
| Deferred revenue                                                                   |   | (465,451                 | )         | (675,680 | ) |
| Net cash provided by operating activities                                          |   | 873,221                  |      | 396,357 |   |
|                                                                               |   |                     |      |   |   |
| INVESTING ACTIVITIES                                                               |   |                     |      |   |   |
| Purchases of fixed assets                                                          |   | (773,966                 | )         | (422,547 | ) |
| Purchases of investment securities                                                 |   | (615,081                 | )         | (5,836,274 | ) |
| Net cash used in investing activities                                              |   | (1,389,047               | )         | (6,258,821 | ) |
|                                                                               |   |                     |      |   |   |
| FINANCING ACTIVITIES                                                               |   |                     |      |   |   |
| Net proceeds from sale of common stock                                             |   | 1,130,061                |      | 6,281,435 |   |
| Repayment of note payable and capital lease  obligations                           |   | (154,207                 | )         | (360,461 | ) |
| Net cash provided by financing activities                                          |   | 975,854                  |      | 5,920,974 |   |
|                                                                               |   |                     |      |   |   |
| Increase in cash and cash equivalents                                              |   | 460,028                  |      | 58,510 |   |
| Cash and cash equivalents at beginning of year                                     |   | 595,768                  |      | 537,258 |   |
|                                                                               |   |                     |      |   |   |
| Cash and cash equivalents at end of year                                           |   | $                        | 1,055,796 |   | $ | 595,768 |   |

 

SEE ACCOMPANYINGNOTES.

 

F-4

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**NVE CORPORATION**

**NOTES TOFINANCIAL STATEMENTS**

 

**1. DESCRIPTION OF BUSINESS**

Wedevelop and sell devices using “spintronics,” a technology we helped pioneer,which utilizes electron spin rather than electron charge to acquire, store, andtransmit information.

 

**2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

** **

**Cashand Cash Equivalents**

Weconsider all highly liquid investments with a maturity of three months or lesswhen purchased to be cash equivalents.

 

**Investments**

Weclassify and account for debt and equity securities in accordance withStatement of Financial Accounting Standards (SFAS) No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*. Our entire portfolio consists of government-backed andcorporate bonds and is classified as available for sale; thus, securities arerecorded at fair market value and any associated unrealized gain or loss, netof tax, is included as a separate component of shareholders’ equity,“Accumulated other comprehensive income.”

 

**Inventories**

Inventoriesare stated at lower of cost or market determined on a first-in, first-outmethod.

 

**FixedAssets**

Fixedassets are stated at cost. Depreciation of machinery and equipment, andfurniture and fixtures is recorded over the estimated useful lives of theassets, generally five years, using the straight-line method. Amortization ofleasehold improvements is recorded using the straight-line method over thelesser of the lease term or useful life of five years. We record losses onlong-lived assets used in operations when indicators of impairment are presentand the undiscounted cash flows estimated to be generated by those assets are lessthan the assets’ carrying amount.

 

**RevenueRecognition**

Revenuefrom product sales is recognized when title transfers, generally upon shipment.Revenue from licensing and technology development programs, which isnonrefundable and for which no significant future obligations exist, isrecognized when the license is signed. Revenue from licensing and technologydevelopment programs, which is refundable, recoupable against future royalties,or for which future obligations exist, is recognized when we have completed ourobligations under the terms of the agreements. Revenue from royalties isrecognized upon the shipment of product from our technology license partners todirect customers. Certain research and development activities are conducted forthird parties and such revenue is recognized as the services are performed.During 2004 one customer generated 18% of total revenue.

 

**Stock-BasedCompensation**

Wehave adopted the disclosure-only provisions of SFAS Nos. 123 and 148, *Accounting for Stock-Based Compensation*,but apply Accounting Principles Board (APB) Opinion No. 25,*Accounting for Stock Issued to Employees*,**and related interpretations in accountingfor our plans. Under APB Opinion No. 25, when the exercise price of employeestock options equals or exceeds the market price of the underlying stock on thedate of grant, no compensation expense is recognized.

 

Proforma information regarding net income and income per share is required by SFASNos. 123 and 148, and has been determined as if we had accounted for ouremployee stock options under the fair value method. The fair value for theseoptions was estimated at the date of grant using the Black-Scholes optionpricing model with the following weighted average assumptions: risk-freeinterest rate of 3.1% for fiscal 2004 and 2.7% for fiscal 2003, expectedvolatility of 99% for fiscal 2004 and 55% for fiscal 2003, a weighted averageexpected life of the options of one to five years, and no dividend yield.

 

Optionvaluation models were developed for use in estimating the fair value of tradedoptions, which have no vesting restrictions and are fully transferable. Inaddition, option valuation models require the input of highly subjectiveassumptions. Because our employee stock options have characteristics significantlydifferent from those of traded options, and because changes in the subjectiveinput assumptions can materially affect the fair value estimate, inmanagement’s opinion, the existing models do not necessarily provide a reliablesingle measure of the fair value of our employee stock options.

 

Thepro forma information is as follows:

 
|                                    |   | **Year  Ended March 31** |      |
|-----------------------------------------|--------|--------------------------|-----------|
|                                    |   | **2004**                 |      | **2003** |   |
| Net income applicable to common shares: |   |                     |      |   |   |
| As reported                             |   | $                        | 2,107,720 |   | $ | 646,850 |   |
| Pro forma adjustment for stock options  |   | (430,921                 | )         | (658,838 | ) |
| Pro forma net income (loss)             |   | $                        | 1,676,799 |   | $ | (11,988 | ) |
|                                    |   |                     |      |   |   |
| Earnings per share:                     |   |                     |      |   |   |
| Basic - as reported                     |   | $                        | 0.49      |   | $ | 0.16 |   |
| Basic - pro forma                       |   | 0.39                     |      | 0.00 |   |
|                                    |   |                     |      |   |   |
| Diluted - as reported                   |   | 0.45                     |      | 0.15 |   |
| Diluted - pro forma                     |   | 0.35                     |      | 0.00 |   |

 

F-5

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**IncomeTaxes**

Weaccount for income taxes using the liability method. Deferred income taxes areprovided for temporary differences between the financial reporting and taxbases of assets and liabilities. We provide valuation allowances againstdeferred tax assets when it is determined that it is more likely than not thatwe will not be able to utilize the deferred tax assets.

 

**Researchand Development**

Researchand development costs are expensed as incurred. Customer sponsored research anddevelopment costs included in cost of sales amounted to $5,279,803 and$4,580,652 during fiscal 2004 and 2003.

 

**NetIncome per Common Share**

Wecalculate our net income per share pursuant to SFAS No. 128, *Earnings per Share*. Basic earnings pershare is computed based upon the weighted average number of common sharesissued and outstanding during each year. Diluted net income per share amountsassume conversion, exercise or issuance of all potential common stock instruments(stock options and warrants). Stock options were not included in thecomputation of diluted earnings per share per share if the exercise prices ofthe options were greater than the market price of the common stock. Thefollowing table reflects the components of common shares outstanding inaccordance with SFAS No. 128:

 
|                                                            |   | **Year  Ended March 31** |   |
|-----------------------------------------------------------------|--------|--------------------------|--------|
|                                                            |   | **2004**                 |   | **2003** |   |
| Weighted average common shares outstanding - basic              |   | 4,296,870                |   | 4,131,463 |   |
| Effect of dilutive securities:                                  |   |                     |   |   |   |
| Stock options                                                   |   | 148,434                  |   | 189,783 |   |
| Stock warrants                                                  |   | 281,455                  |   | 3,247 |   |
| Shares used in computing net income per common share  - diluted |   | 4,726,759                |   | 4,324,493 |   |

 

**Useof Estimates**

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires us to make estimates andassumptions that affect the amounts reported in the financial statements andaccompanying notes. Actual results could differ from those estimates.

 

Wemaintain an allowance for doubtful accounts for estimated losses resulting fromthe inability of our customers to make required payments. If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances may be required.

 

Wereduce the stated value of our inventory for excess quantities or obsolescencein an amount equal to the difference between the cost of inventory and theestimated market value based upon assumptions about future demand and marketconditions. Additional reductions in stated value may be required if actualfuture demand or market conditions are less favorable than we projected.

 

**FairValue of Financial Instruments**

Ourfinancial instruments consist of cash and cash equivalents, investment securities,short-term trade receivables, and accounts payable. The carrying values of ourfinancial instruments approximate fair value due to their short-term nature.

 

**3. INVENTORIES**

Inventoriesconsist of the following:

 

|                      |   | **March  31  2004** |      |
|---------------------------|--------|---------------------|-----------|
| Raw materials             |   | $                   | 421,074   |   |
| Work-in-progress          |   | 519,675             |      |
| Finished goods            |   | 449,105             |      |
|                      |   | 1,389,854           |      |
| Less obsolescence reserve |   | (240,000            | )         |
|                      |   | $                   | 1,149,854 |   |

 

**4. INCOME TAXES**

Theprovision for income tax (benefit) expense for the years ended March 31consisted of the following:

 
|            |   | **Year  Ended March 31** |     |
|-----------------|--------|--------------------------|----------|
|            |   | **2004**                 |     | **2003** |   |
| Current taxes:  |   |                     |     |   |   |
| Federal         |   | $                        | 13,500   |   | $ | — |   |
| State           |   | 3,478                    |     | — |   |
|            |   |                     |     |   |   |
| Deferred taxes: |   |                     |     |   |   |
| Federal         |   | (250,000                 | )        | — |   |
| State           |   | —                   |     | — |   |
|            |   | $                        | (233,022 | ) | $ | — |   |

 

Areconciliation of income tax expense provided at the federal statutory rate(34%) to income tax expense for the years ended March 31 consisted of thefollowing:

 
|                                       |   | **Year  Ended March 31** |     |
|--------------------------------------------|--------|--------------------------|----------|
|                                       |   | **2004**                 |     | **2003** |   |
| Tax expense at U.S. statutory rate         |   | $                        | 637,300  |   | $ | 219,929 |   |
| State income taxes, net of Federal benefit |   | 49,685                   |     | 16,171 |   |
| Other                                      |   | 19,993                   |     | — |   |
| Benefit of NOL carryforward                |   | (690,000                 | )        | (236,100 | ) |
| Change in valuation allowance              |   | (250,000                 | )        | — |   |
|                                       |   | $                        | (233,022 | ) | $ | — |   |

 

Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amount of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. Significant components of ourdeferred tax assets and liabilities are as follows:

 

F-6

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|                                      |   | **March  31  2004** |    |
|-------------------------------------------|--------|---------------------|---------|
| Deferred tax assets:                      |   |                |    |
| Deferred revenue                          |   | $                   | 144,250 |   |
| Vacation accrual                          |   | 85,350              |    |
| Inventory reserve                         |   | 81,600              |    |
| Net operating loss carryforwards          |   | 275,000             |    |
| Tax credits and capital loss carryforward |   | 1,341,800           |    |
| Other                                     |   | 40,000              |    |
|                                      |   | 1,968,000           |    |
| Valuation allowance                       |   | (1,718,000          | )       |
|                                      |   | $                   | 250,000 |   |

 

Avaluation allowance of $2,658,000 as of March 31, 2003 was established fordeferred tax assets. During fiscal 2004, $690,000 of the valuation allowancewas reversed due to the utilization of NOL carryforward, and $250,000 of theremaining valuation allowance was reversed due to our assessment that it ismore likely than not that we will earn sufficient operating income to realize$250,000 of the remaining deferred tax assets. We have provided a valuationallowance of $1,718,000 as of March 31, 2004 because we do not believe that itis more likely than not that we will utilize the remaining deferred tax assetsbefore they expire. Regardless of our expectations, there can be no assurancethat we will generate any specific level of continuing earnings.

 

As ofMarch 31, 2004, we have available for income tax purposes approximately$800,000 in federal net operating loss carryforwards which may be used tooffset future taxable income. These loss carryforwards begin to expire infiscal year 2018. Should we undergo an ownership change as defined in Section382 of the Internal Revenue Code, our net operating loss carryforwardsgenerated prior to the ownership change will be subject to an annual limitationthat could reduce or defer the utilization of these losses.

 

Wehave a $3,082,000 capital loss carryforward amount which can be used to offsetfuture capital gains and other tax credits totaling $291,800 which can be usedto offset future taxable income.

 

Cashpayments for income taxes during fiscal 2004 and 2003 amounted to $16,978 and$0.

 

**5. LEASES**

Welease our facility under an operating lease expiring December 31, 2008. We alsopay operating expenses including maintenance, utilities, real estate taxes, andinsurance. We also lease several pieces of equipment under operating leases.Terms of the leases range from 36 to 60 months through June 2006, with paymentsdue the first of each month. Total rent expense for operating leases, includingbuilding and equipment, was $275,203 and $389,003 for fiscal 2004 and fiscal2003.

 

Wehave a lease payable to a leasing company totaling $60,593 at March 31, 2004.The lease has an effective annual rate of 8.48% with monthly payments of $8,894through October 2004. The lease is for production equipment. We have anotherlease payable to a leasing company totaling $162,598 at March 31, 2004. Thelease has an effective annual rate of 8.96% with monthly payments of $6,123through June 2006 and a payoff amount of $15,000 due June 2006. The lease isfor production equipment. The cost and accumulated amortization at March 31,2004 for assets reported under capital lease obligations amounted to $634,865and $411,530.

 

Ourfuture lease commitments under operating and capital leases are summarized asfollows:

 
| **Year  Ending  March 31** |   | **Operating  Lease  Future Minimum  Payments** |    | **Capital  Lease  Obligations** |    |
|----------------------------|--------|------------------------------------------------|---------|---------------------------------|---------|
| 2005                       |   | $                                              | 194,271 |                            | $       | 135,736 |   |
| 2006                       |   | 203,883                                        |    | 73,481                          |    |
| 2007                       |   | 206,533                                        |    | 33,870                          |    |
| 2008                       |   | 210,140                                        |    | —                          |    |
| 2009                       |   | 160,152                                        |    | —                          |    |
| Total payments             |   | $                                              | 974,979 |                            | 243,087 |   |
| Less interest portion      |   |                                           |    | 19,896                          |    |
|                       |   |                                           |    | 223,191                         |    |
| Less current portion       |   |                                           |    | 122,480                         |    |
|                       |   |                                           |    | $                               | 100,711 |   |

 

**6. STOCK OPTIONS AND WARRANTS**

Our2000 Stock Option Plan, as amended by our shareholders in 2001, provides forissuance to employees, directors, and certain service providers of incentivestock options and nonstatutory stock options. Generally, the options may beexercised at any time prior to expiration,

 
|                      |   | **Shares  Reserved** |   | **Options  Outstanding** |   | **Weighted  Average  Exercise Price  per Share** |   |
|---------------------------|--------|----------------------|--------|--------------------------|--------|--------------------------------------------------|--------|
| Balance at March 31, 2002 |   | 449,030              |   | 499,550                  |   | $                                                | 3.25   |   |
| Granted                   |   | (90,000              | )      | 90,000                   |   | 9.53                                             |   |
| Exercised                 |   | —               |   | (24,980                  | )      | 0.52                                             |   |
| Terminated                |   | 3,000                |   | (3,000                   | )      | 10.01                                            |   |
| 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   |   |

 

F-7

----

 

subject to vesting basedon terms of employment. The period ranges from immediate vesting to vestingover a five-year period. The options have exercisable lives ranging from oneyear to ten years from the date of grant. Exercise prices are not less thanfair market value as determined by our Board of Directors at the date theoptions are granted. A summary of our incentive stock options is shown in thetable at the bottom of the previous page.

 

As ofMarch 31, 2004 and 2003 there were exercisable options outstanding covering166,135 and 372,675 shares, respectively, at a weighted average exercise priceof $5.08 and $3.45 per share. The remaining weighted average exercisable lifewas 4.7 and 3.3 years at March 31, 2004 and 2003.

 

Thefair market value of grants issued was $12.75 and $4.15 in fiscal 2004 and2003.

 

**7. COMMON STOCK**

Ourauthorized stock is stated as six million shares of common stock, $0.01 parvalue and ten million shares of all types. Our Board of Directors may designateany series and fix any relative rights and preferences to authorized butundesignated stock.

 

**8. LICENSE AGREEMENTS**

Wehave entered into two separate license agreements which provided for advancedpayments, plus royalties of 1% based upon revenue generated by the respectiveparties. To date, no royalties have been recognized under either agreement.

 

**9. TECHNOLOGY EXCHANGE AGREEMENT**

InApril 2002 we closed a technology exchange agreement accompanied by aninvestment by Cypress Semiconductor Corporation. Cypress purchased 686,849shares of our common stock for $6.228 million. Cypress also received a warrantfor the purchase of up to an additional 400,000 shares of common stock for $15per share for a term of three years.

 

**10. ROYALTIES**

Wehave licensed rights to another organization’s GMR-related patents in exchangefor payment of royalties of 1.5% of the sales of certain of our products.Payments under this license agreement have not been material.

 

**11. EMPLOYEE BENEFITS**

Allemployees are eligible to participate in our 401(k) savings plan the first quarterafter reaching age 21. Employees may contribute up to 100% of their gross wagesup to the Internal Revenue Service maximum. We make matching contributionsequal to 100% of the first 2% of elective salary deferral contributions made byeligible participants. We made matching contributions of $88,452 and $79,521for fiscal 2004 and fiscal 2003.

 

Our2001 Employee Stock Purchase Plan was approved by shareholders in July 2001 andimplemented October 1, 2001. The plan allows us to issue up to 200,000 sharesof common stock. With certain exceptions, all of our employees who have beenemployed by us for at least one year and who are employed at least 20 hours perweek and at least five months per year, including officers and directors whoare employees, are eligible to participate. The plan consists of periodicofferings for a period determined by our Board of Directors. Under the plan, anemployee may elect to have up to 10% deducted from regular salary to purchaseshares. The price at which the employee’s shares are purchased is the lower of(a) 85% of the closing price of the common stock on the day that the offeringcommences or (b) 85% of the closing price of the common stock on the day thatthe offering terminates. We issued 12,566 and 8,917 shares of common stockunder the plan for fiscal 2004 and fiscal 2003.

 

**12. LEGAL**

We aresubject to various litigation matters from time to time in the normal course ofour business. We currently believe that the ultimate outcome of theseproceedings will not have a material adverse affect on our financial positionor results of operations. However, because of the nature and inherentuncertainties of litigation, should the outcome of these actions beunfavorable, our business, financial position, and results of operations couldbe materially and adversely affected.

 

F-8

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