NVE Corporation
Q1 2011 Earnings Call Transcript

Published: 22 Jul 2010

[Operator:]

Good day ladies and gentlemen and welcome to the NVE Corporation’s first quarter results call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instruction) I would now like to introduce your host for today’s conference Mr. Daniel Baker, President and CEO.

[Daniel Baker:]

Good afternoon and welcome to our conference call for the quarter ended June 30th, 2010 or the first quarter of fiscal 2011. As always, I am joined by Curt Reynders, our Chief Financial Officer. This call is being webcast live and being recorded. A replay will be available through our website nve.com. After my opening comments, Curt will present a financial review of the quarter. I will highlight some business items and then we’ll open the call to questions. We filed our press release with the quarterly results and our quarterly report on Form 10-Q with the SEC in the past hour following the close of the market. Those filings are available through our website. Comments we may make that relate to future plans, events, financial results or performance are forward-looking statements that are subject to certain risks and uncertainties including among others, such factors as risks in continued growth and revenue and profits, uncertainties related to agreements with large customers, uncertainties related to research and development contract funding, risks related to developing marketable products, uncertainties relating to the revenue potential of new products, risks of losses on our marketable securities and uncertainties related to economic environments, as well as the risk factors listed from time-to-time in our filings with the SEC including our most recent Annual Report on Form 10-K is updated in our recently filed quarterly report on Form 10-Q. The company undertakes no obligation to update forward-looking statements we may make. We are pleased to report increased revenue and earnings for the quarter driven by solid product sales. Product sales increased 12% to $6.19 million. Total revenue increased 6% to $7.24 million and net income increased 6% to $0.64 per diluted share. Now I’ll turn the call over to Curt to just cover details of our financial results.

[Curt Reynders:]

Thanks Dan and good afternoon. As Dan mentioned total revenue for the quarter increased 6% to $7.24 million, our 19th consecutive quarterly year-over-year increase in total revenue. The increase was despite a comparison to an extraordinary year ago quarter, its contract research and development revenue more than quadrupled. The revenue increase was due to a 12% increase in product sales to $6.19 million, our 22nd consecutive year-over-year increase in product sales, very robust sales into industrial markets more than offset weakness in medical device markets. The strength of industrial markets was encouraging and we continue to be quite optimistic about the medical device markets long term. Demographics are favorable in health care reform, could make medical devices available to more people. Quarterly contract R&D revenue decreased 20% to $1.05 million due to the successful completion of certain contracts and contract activities. Dan will talk more about contracts in a few minutes. Gross margin remained very strong, although it decreased to 71% of revenue compared to 72% last year due to a slightly less favorable product mix with the particularly strong sales into industrial markets. Total expenses increased 7% for the first quarter of fiscal 2011, compared to the first quarter of fiscal 2010 due to a 28% increase in research and development expense. The increase in research and development expense was due to a decrease in contract research and development activities which caused resources to be reallocated to expense R&D. We also increased product development activities. Interest income increased 29% to $476,000 for the quarter due to an increase in interest bearing marketable securities. Income before taxes for the quarter increased 6% compared to the first quarter of fiscal 2010 to $4.67 million and pre-tax margin with 65%. The provision for income taxes was a slightly higher percentage than the prior year quarter, 34% of income before taxes compared to 33% last year because of a higher federal effective tax rate. Net income for the first quarter increased 6% to $3.1 million or $0.64 per diluted share compared to $0.61 last year and net margin was 43%. Our exceptional profitability is a credit to our employees’ productivity and a validation of the value of our products and services. In the past quarter NVE was included in a list on the website of Investor’s Business Daily of the top five companies in the semi-conductors industry ranked by operating margin. Also in the past quarter, our return on revenue or net margin ranked first among the 100 largest companies in Minnesota according to the Star Tribune. Cash flow strengthened our balance sheet considerably and a strong balance sheet allows us to defend our intellectual property if necessary and allows for contingencies. Operating cash flow was $5.42 million for the quarter, as of June 30th, cash plus marketable securities was $54.7 million, an increase of $5.13 million in the quarter to exceed $50 million for the first time. Income taxes payable increased $1.54 million because we had no estimated income tax payments due in the most recent quarter. We have two payments due in the current quarter, the quarter ending September 30th. Purchases of fixed assets were approximately $62,000 for the quarter. Capital expenditures could be several $100,000 during the rest of the fiscal year as we complete our major capacity expansion. Our previous Agilent agreement amendment, amendment number two provided a non-refundable payment of $250,000 by Avago to us. In accordance with accounting rules, we recognized the payment as revenue over the amendment term at a rate of approximately $210,000 per quarter, ending in the past quarter. In the past quarter, we began converting underutilized space into a new production test area and a new R&D lab. We expect costs related to that phase of our expansion to be covered by a tenant improvement allowance that was part of the extension to our building lease that we signed in 2007. We expect however that including a planned expansion of our production clean room space, that cost will exceed the tenant improvement allowance by $500,000 to $1 million. We expect to account for costs not covered by the tenant improvement allowance by advertising them as leasehold improvements over the remaining lease which is through December 31st, 2015. Dan will provide some details on our expansion as well as his perspective on our business. Dan?

[Daniel Baker:]

Thanks Curt. Now I’ll cover our expansion, customer agreements, new products, R&D, patents and governance. As Curt said, in the past quarter we began converting underutilized space to a new production test area and a new R&D lab. We moved into the new R&D lab in the past quarter and we plan to finish the new production test area this quarter. The current expansion allows for a future growth by converting approximately 1,900 square feet to production about a 40% increase in production space. The space being vacated will be converted to production clean room space. The clean room expansion could begin as soon as this quarter and could be done as soon as late this calendar year. A brief summary of what we do in the two areas we’ve expanded. The new R&D lab is specifically designed for spintronic R&D. In complete circuit, spintronics and spin dependent tunnel junctions are extremely rugged. But because of their nanoscale dimensions, vast spin dependent tunnel junctions are sensitive to static electricity. The new lab has grounding rods and a special static dissipative floor. It will allow more productive R&D on more complex spintronic structures. In production tests, we test 100% of our sensors and couplers to ensure that they meet the most demanding requirements. For example, we test most of our couplers at 3,200 volt AC or 4,500 volts peak, that’s the equivalent of 3,000 diesel batteries which would be a 600-foot long flashlight. We also test parts at greater temperature which is up to 125 degree Celsius or 257 degrees Fahrenheit. This is done with custom equipment and now those production tests which were scattered around the building will be consolidated. There are currently two sections in our clean room

[Operator:]

Thank you. (Operator Instructions) Our first question comes from Steven Crowley of Craig-Hallum Capital.

[Steven Crowley:]

A couple of questions driven by the performance in your prepared commentary. You spoke to the character of products business in the first quarter with quite strong activity out of the industrial side your business and some weakness on the medical device side of the equation over the short term. Should we view the weakness in the medical business as a temporary phenomenon that we have just lived through, is it an ongoing phenomenon? What can you tell us about the ingredient shift for that side of your business as we look forward?

[Daniel Baker:]

Steve, as I mentioned we continue to be quite optimistic about the medical device markets. I think it’s just a short term inventory deal, the demographics in the medical device area are quite favorable and sometimes because we sell to distributors and customers that maintain significant inventories, they may be looking at, they may predict an increase in demand down the road and they might buy more or they might forecast less of a demand, they might buy less. Customer inventories can be borrowable, can be volatile, perhaps it’s distributors and customers wrestling with the economic uncertainties, but like I said, despite the near term uncertainties and volatilities, our product sales have consistently grown and we are optimistic in the long term and we just had our 22nd consecutive year-over-year increase in product sales.

[Steven Crowley:]

So from that, although it’s probably difficult to calibrate, it wouldn’t seem that there’s anything structurally presenting itself as a major impediment to ongoing success in the medical device arena. Looking back at the performance of your product’s business, and in the fourth quarter you had real strength out of that segment in that vertical market. Now you’ve had a somewhat less than strong quarter out of a medical. Is it at least reasonable for me to think that one strong quarter, one less strong quarter, you get back to a more normalized picture out of the vertical market over the relative near term?

[Daniel Baker:]

Steve, this is Dan. Yeah, we don’t see anything structural there in the medical business. We see continued underlying strength and as Curt said with the medical business they tend to have large inventories because of the critical nature of their products. They can’t run out of things for obvious reasons and so that can cause some volatility but we see the underlying strength continuing.

[Steven Crowley:]

Okay. And then, your comments about the industrial side of the business certainly sound encouraging at first blush, besides it being quite strong in the period, what you can tell us about the ingredient set going forward there, are those drivers whether their applications or products or particular customers seemingly still on good stead.

[Curt Reynders:]

Yeah, the underlying fundamentals appear to be strong, and I guess there is always a concern about the economic uncertainty down the road, our products go into industrial automation, factory automation and industrial controls. And so, it depends on people building factories and ultimately people building the capital goods or the durable goods often that those factories produced. But we are seeing strong economic conditions. We have also been successful at acquiring customers and introducing new products. We have highlighted in the past, our control area network products which go into industrial markets. So, we see it as a very encouraging sign. There is always the concern will the economic recovery continue and that’s difficult for us to project, but so far we are seeing some very encouraging strengths in those industrial markets.

[Steven Crowley:]

And we’ve certainly talked about some higher profile, new product programs and have some regular updates about those programs and I want to come back to that. But in terms of your growth and/or traction in the industrial marketplace right now, have you seen any substantial new applications for your standard products into the industrial domain, really gain some significant traction here, whether in automotive or a new segment of manufacturing? Or is it more market recovery and more customers in those same segments that you have been successful in before?

[Daniel Baker:]

I think it’s in those segments that we’ve talked about by definition industrial control and factory automation, but what we are seeing is an upturn in the economic conditions and the economic environment. And a lot of what we believe our gains are at the expense of conventional technology or older technology or competitive devices and we believe winning design sockets through better performance, through better lead times, having parts available as lead times have stretched out and having new types of products such as controller area and network and other products that is still a unique need. So, we are continuing to grow, we believe by gaining share and gaining against our competition and because of the increase in investments that we are seeing in industrial markets.

[Steven Crowley:]

Okay and then in terms of the contract research and development and the variability we saw in that revenue line in the first quarter, I am trying to rationalize some of your comments about kind of the definitive completion of some projects, contracts that should lead to commercial product revenues in the future. I mean that’s kind of the move of revenues from one category to another and hopefully substantially more over time as you generate product revenues, but there is also the phenomenon of getting more contracts in that revenue segment and you are referring some success on that government front. What kind of visibility do you have for a better performance in absolute dollars in the contract R&D business moving forward versus what we saw in the first quarter or as what can you tell us about the prospects for that revenue category?

[Daniel Baker:]

Maybe what we could do is I could first talk about the possible transition from contract R&D to production and then maybe Curt can talk about what we see for prospects going forward or what our visibility is there. And if we successfully complete an R&D project we hope to demonstrate the feasibility of a particular part or device or approach. But there can be a gap in between the completion of the R&D and that product moving into production. I think as you correctly point out all those production revenue can generally be much larger and grow much more quickly than contract R&D. And the reason we do contract R&D is twofold to do. To get products into production and products into production that can drive future growth and the second is to build intellectual properties that’s applicable in other areas. So, we do see a potential for production products that results in these contracts although they may not immediately replace the revenue from the contract R&D because it takes time to get the products into production, that’s generally not a funded activity. And then it takes time for the products to ramp up, but we think it bodes very well for the long term. And Curt, do you want to address the visibility of contract R&D revenue?

[Curt Reynders:]

Steve, contract R&D is really, really hard to predict and as you probably noticed over years it can be lumpy. Revenue can be affected, by not only when contracts and when we may get follow-on contracts, but also could be affected by particular tasks within contracts. The timing is tough to predict, some of it depends on the government, if there are government contracts, a lot of times there’s not money available until a new government fiscal year. But we are continuing to pursue contracts and win, and also win contracts in some of the strategic areas that Dan talked about and we have also spent more on company-sponsored product R&D. And as we have said for several years, products and IP is what will drive the future growth of NVE.

[Steven Crowley:]

Understood, as we try and build a model we are coming off a March quarter that was a high watermarks for contract R&D and the June quarter represented the lowest quarter in the last I guess seven. It is reasonable to expect as we go forward that the likely performance of that business segment should be kind of between those two goal posts or is there a much wider range of outcomes?

[Curt Reynders:]

It’s really tough to say. I would say it wouldn’t be unreasonable to expect it to be somewhere in between those areas. As I believe and as you had mentioned in the last seven quarters we were somewhere in between the most recent quarter and the March quarter, which was I believe a five year high for us.

[Steven Crowley:]

That’s helpful. And then last line of the questioning and I’ll hop back in the queue. As I mentioned you have done a nice job of updating us on three significant new product programs, and it seems like all three are progressing or in the case of the biosensors, the biosensor is a consumable component of NextGen Diagnostic System, the timelines holding together and it appears that there is revenue potential from sales of those products next year. So, one, I am asking for confirmation that my logic is correct surrounding that opportunity and it seems like there is revenue opportunities for the other two initiatives between now and then as you move forward with the compassing sensor and there is the opportunity for your customer to move from kind of production prototypes to full production products and you scale manufacturing for low density MRAM. That’s a complex question, but I think you get the gist of what the overall question is.

[Daniel Baker:]

Yeah, I think we got the gist and we do see production opportunities and product sales opportunities in each of those three areas. And the timeframe and the volumes vary and it’s difficult to predict a lot of this is beyond our control but we see great potential. In each of those areas, we see large potential markets, we have competitive advantages and we are working with partners who can get it to the market. So, we believe that it’s well worth the R&D that we’ve spent and that we are going to see the results in product sales down the road.

[Steven Crowley:]

When you say you are likely shipping tested prototypes to customers this quarter for the compassing sensor, are those tested prototypes for your customer that’s a tier 1 supplier to the wireless market to go out and cultivate production unit orders from the ultimate customers for these products?

[Daniel Baker:]

Yes, we are worth providing them with prototypes they are going to provide, demonstrators or a module, and they have contacts and channels into handset manufacturers and that’s the way we intend to, we hope to bring this product to market.

[Steven Crowley:]

Thanks, I will hop back in a queue and come back with a couple of questions, but I’ll get out of the way here. Thanks very much for taking my questions

[Operator:]

Our next question comes from David Wu of GC Research.

[David Wu:]

I was just trying to look at the product revenue side. And if you take a look at your past, in the past when you had the hit, it seems to be a one quarter event and inventory correction shouldn’t be allowed longer than that unless the end market mysteriously slows down for a very long time. Do I get these drifts right or is history not good guide?

[Daniel Baker:]

That helps in the history. It’s hard to say definitively that that will continue, because we are relying on our customers and as Curt mentioned, when he was discussing inventories that is not just our customers requirements, it’s their prediction of their requirement and their prediction of their requirements overlaid and what they have for inventories. So, the pattern has been that we get near term quarterly variations, but it’s not inconceivable that those can continue longer, but that has been in the past roughly the time period that we’ve seen for these variations.

[David Wu:]

I would suspect that medicals stuff continually consumed at the end and costumer level and inventory adjustments were approximately minor. Anyway, when you look at the two segments, a big segment of your market, industrial sector automation versus medical, I was wondering, roughly when you look at your June quarter, what do they roughly represent as a percentage of product revenue? And the other thing I wanted to ask is, how did these things fluctuate, but what’s the (inaudible) in the past, a percentage of those two segments?

[Daniel Baker:]

Yes, we just haven’t broken out those percentages and it can be difficult to do it real precisely. I think overall, we know approximate levels of each, but it is just not something that we have broken out in the past.

[David Wu:]

Well, should I assume that medical was your hard market a couple of quarters past year and that it is [comfortable] to have the business? And now it’s under half?

[Curt Reynders:]

I guess we just aren’t going to get into those percentages, we can’t be real precise with it and it’s something we just don’t breakout.

[Daniel Baker:]

We have talked about in past quarters when we do talk about it qualitatively and we talked about other quarters where we’ve had strong quarters for medical and weak quarters for industrial. So we are fortunate that we have a certain amount of diversification and maybe even a little bit of counter cyclicality and that allows us to smooth out our production workflow and to keep our factory running at a reasonable level. So we will not whip-start the way companies that are either pure medical or pure industrial, semiconductors can be, so we see it as an advantage and we’ve had quarters where we’ve had the reverse situation in terms of the strength or weakness between industrial and medical businesses.

[David Wu:]

The reason I asked that question is because once again into the December quarter, late September or December quarter, hopefully two things happened. The industrial, one hears about the companies that reported numbers, their September guidance is pretty good in the industrial automation side, and if you can get your inventory correction done in the quarter, we could pretty well have both of these end markets go up, sometime either late September or the December quarter. Is that a reasonable scenario?

[Daniel Baker:]

Well, it’s not something we try to predict. We leave it to analysts like yourself, but we are trying to build our capacity to allow for us to be able to build considerably more devices than we can now. We see great long-term strength in our markets and we try to avoid predicting quarter-to-quarter because our plans have to be longer-term than that. When we hire people or make capital investments, we see them as investments for the long-term. So when we look out in those kinds of timeframes, which are the timeframes that are important for our planning purposes, we see bright future in both the medical device segment and in the industrial, factory automation markets. And we are planning for success in those markets as well as the markets, but not longer-term markets that we’ve talked about, if those being things like compassing, automotive and anti-tamper, biosensors. So we do see excellent prospects for the long term and we don’t try to chase that quarter-to-quarter.

[David Wu:]

And if I would look at the capacity planning you are putting in place in that 1900 square feet conversion, should I think about revenues, product revenues capability well in excess of $10 million a quarter?

[Daniel Baker:]

It’s hard to break it down and turn that into a revenue. It’s hard to convert square feet into revenue. What we look at though is we want to have plenty of capacity for the long term, for growth to make sure that we can handle some of the quarter-to-quarter fluctuations that we get and so we are not like a commodity semiconductors company and I know you cover some of them where it’s important that they maximize their capacity utilization. Our view is that we want to have adequate capacity. And so we’re removing some particular bottlenecks. We are clearing a path to expand our clean room which is where we make the spintronic devices and where we do much of the value added that’s inherent of our product. So we want to have adequate capacity and it’s not directly translatable into dollars because it depends on the products, it depends on the mix and it depends on where the space is, but we think that expanding test in the clean room area is that can increase our capacity by quite a bit, just proportionate amount to the amount of square feet. It’s because the area is that can facilitate a lot more production through them.

[David Wu:]

Thank you. Okay. That’s said. I guess there is not much visibility into when the pipelines on contract R&D is, so I was thinking that the number seems to go just looking at the history, they seemed to go to appear of not much growth and then suddenly we have bumps. And there is a step-up sort of thing and we are probably into this lending period. I was wondering whether, when should we think about which fiscal year should we think about a step-up in contract R&D.

[Daniel Baker:]

Well, as Curt said, I guess he eloquently said it can be lumpy, because the contracts can be, they are relative, they can be relatively large compared to the total amount of contract R&D revenues. So, one or two contracts can make fairly large difference in that number. But I think the important thing that, the way we look at it is, we look at contract R&D as a way to do research and development in strategy areas to fund that research in development to do things that are valuable to us that will add value to our company. And we are fortunate and that our customers are willing in many cases to pay for that. So, for example in the last fiscal year, we had 19% of our revenue invested in R&D and a very small portion of that hit our bottom line as an expense. Most of it was customer funded. And the second thing is to develop products and technologies that can eventually be put into production for those customers or for the customers we funded or for others, so that we can build our product sales. So, we’ve seen some lumpiness in contract R&D, but we view our future as a future of growing product sales and longer term in licensing certain of our technologies. So we don’t really view contract R&D as a scalable revenue source.

[David Wu:]

That’s your (inaudible) for future better revenues anyway.

[Daniel Baker:]

Exactly.

[Operator:]

Thank you. And our next question comes from the line of Patrick Kirksey of Perimeter.

[Patrick Kirksey:]

Actually I just had more of a comment versus a question, and that is as a top ten institutional shareholder of your stock, I sure would love to see the management have a little bit more stake in the game in terms of stock ownership of your own company. I’d like it if the current holdings for you guys, as well as the Directors, both outright holdings as well as in conjunction with all the different stock options, and it just would really be nice to see if you guys had little bit more stake in the game, maybe bought some stock in the open market or exercise some options, but then didn’t sell those. Just to kind of show that, I mean, you guys do a great job running the company. I have no complaints there. I just would really like to see you guys on a little more stock. Thank you very much.

[Daniel Baker:]

Well, I appreciate the comments. I’d probably make a couple of points. Our company is fairly frugal with option grants. We haven’t granted any options to management in several years. And speaking for myself personally, I have a fair amount of exposure to the company’s stock which is how it should be, and I haven’t changed that exposure in many years. So, we believe in this company and our compensation is tied to the success of the company and that’s as it should be. But I appreciate your comment. Were there any other questions, Patty?

[Operator:]

I’m showing one more question in the queue. Steven Crowley, your line is open.

[Steven Crowley:]

Just a quick follow up as it relates to the anti-tamper MRAM. In terms of your capacity expansion and some of the capabilities that you are adding and detailed in your prepared commentary, I trust having the ability to add advance spintronic structures to products, ducktail the necessary capability for you to manufacture that lower density MRAM in-house or mine mixing apples and oranges there.

[Daniel Baker:]

Now that’s one of the capabilities that we want to have in-house is the ability to make anti-tamper MRAM, smaller scale MRAMs that we’ve talked about before. And our strategy in general is to manufacture those special purpose low density MRAM that would be used for anti tamper similar application and we don’t have any plans to scale up, it’s not practical for us to scale up for large scale MRAM, but we do plan to make that MRAM here, the smaller scale MRAMs, the anti-tamper MRAMs and we want to have capacity to do that and to meet our customers requirements. So that’s one of the things that goes into the planning purpose for the longer-term planning.

[Steven Crowley:]

And in terms of your recent accomplishment of delivering prototypes with working memory bits, you are delivering those prototypes to prospective customers directly in contrast to our prior discussion about wireless.

[Daniel Baker:]

Yes, in that case we are dealing more directly with customers. That tends to be, at least initially that tends to be military aerospace and the protection of high-value assets and longer-term it could move into a more of a business model similar to what we envision for automotive and for consumer electronics with Tier I suppliers, where the end users tend to limit their number of suppliers and look to buy modules from their direct suppliers, the Tier I supplier. So longer-term, that might move that direction, but in the near-term we are more tightly coupled with the customers in that kind of business.

[Steven Crowley:]

And you are targeting, it sounds like multiple customers at this stage with those prototypes?

[Daniel Baker:]

Yes.

[Steven Crowley:]

Okay and then one final question. As it relates to the success you’ve had with a customer with the diagnostic biosensor and the consumable portion of a NextGen system, did your success with that customer preclude you from developing other relationships, in moving down the timeline with other diagnostic customers at this point, is it serial or can you run it in parallel fashion?

[Daniel Baker:]

We can run in parallel fashion. We generally don’t give exclusivities for our technology. We sometimes provide limited exclusivity for certain products or certain implementations of our technology, but our business model is to provide technologies to broad markets. So that would be our goal there. Well, I think we are about out of time. So, I do want to thank you. We were pleased to report strong product growth and strong earnings for the quarter. We look forward to seeing some of you at our annual meeting two weeks from tomorrow and we plan to speak with you again in October to report our second quarter results. Thank you again for participating in the call.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may all disconnect. Everyone have a great day.