NVE Corp (NVEC) 2007 Q2 法說會逐字稿

Welcome to the second-quarter 2007 NVE Corporation earnings conference call. My name is Shanique and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today's call, Mr. Daniel Baker, President and CEO. Please proceed.

Thank you and good morning. This is Dan Baker. Welcome to our second-quarter conference call. With me on the call today is Curt Reynders, our CFO. This call is being webcast live and also being recorded. An archive will be available through our website, nve.com.

Our press release with quarterly results and our quarterly report on Form 10-Q were both filed yesterday and are available through our website. On our call this morning, Curt will present a financial review of our fiscal second quarter. I will give a business review, and then we will open the call to your questions.

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 revenue growth and profitability, risks associated with our reliance on several large customers, uncertainties related to the awarding of future government contracts, uncertainties related to the acquisition of MRAM licensees including Freescale, risks in the enforcement of our patents, risks related to requirements to evaluate our internal controls under Section 404 of the Sarbanes-Oxley Act, risks related to shareholder lawsuits, risks associated with the volatility of our stock price, as well as risk factors listed from time to time in our filings with the SEC, including our annual report on Form 10-K and quarterly report on Form 10-Q.

We're very pleased with our record results in the second quarter. Product sales increased 87%. Net income more than tripled to $0.27 per share, and that was reduced $0.02 by FAS 123(R). Cash plus investments increased to nearly $14 million as of September 30.

Now, I would like to turn the call over to Curt to discuss details of our financial results.

Thanks, Dan, and good morning. Total revenue for the second quarter was $4.4 million, topping $4 million in a quarter for the first time in NVE's history. As Dan mentioned, the solid revenue increase was driven by an 87% increase in product sales in the quarter, which more than offset a decrease in contract R&D revenue.

Our emphasis on product sales is reflected in our mix of total revenue. Product sales accounted for 86% of revenue in the most recent quarter, compared to 66% in the prior-year quarter.

Contract R&D revenue decreased 40% compared to the prior-year quarter, due to a decline in government contract revenue. Our strategy, as we have discussed before, is to reduce our dependence on contract R&D, [toward] a future of products and licensing as our principal revenue sources. Products and licensing are more profitable sources of revenue with, we believe, much better growth potential for NVE.

Gross margin increased to 67% from 47% in the prior-year quarter, our eighth consecutive quarter of sequential margin increases. The increased margins are the result of a shift in revenue mix toward product sales; some higher prices due to the value our products provide; lower-cost product designs; and more efficient production, including new equipment.

On the expense side, our shift to Company-funded R&D contributed to a 9% increase in R&D expense compared to the prior year. SG&A expense increased 36%, primarily due to the effect of stock-based compensation. Most of the increase was due to the issuance of automatic stock options to our Directors on their election or reelection to our Board of Directors. The effect of stock-based compensation for the quarter was to reduce net income by $0.02 per diluted share.

Although the Directors' options resulted in increased expense this quarter, we believe options provide incentives to improve shareholder value, and options rather than cash compensation improves our cash flow. The number of shares granted to our Directors has remained the same for a number of years, but the higher the share price and the higher our stock price volatility, the larger the expense. There is more information on the effects of FAS 123(R) in our 10-Q filed yesterday.

With the higher R&D expense and the effect of FAS 123(R), total expenses increased 21% in the quarter, although they decreased as a percentage of revenue to 25% from 30%.

On the strength of higher revenue and margins, operating income increased more than 250% in the quarter. Operating margin increased to more than 42%. Net interest and other income increased to nearly $175,000 for the quarter, primarily due to an increase in interest-bearing cash and investments.

Income before taxes increased to 46% of revenue, and net income to 29% of revenue. After tax and including the effect of stock-based compensation, net income more than triple to $0.27 per diluted share for the quarter, compared to $0.08 last year. All of our provision for income tax for the quarter was non-cash.

September 30 was the halfway point in our fiscal year. For the first six months, product sales increased 79% to just over $8 million. Total revenue increased 32% compared with the first half of fiscal 2006. Diluted net income per share increased to $0.45 for the first half, from $0.17 for the same period last year.

Our increased profitability strengthened our balance sheet. Cash plus investments increased by $1.9 million during the quarter to $13.69 million as of September 30.

Capital expenditures were approximately $173,000 in the quarter, mostly for equipment to enable higher volumes of our smallest package, the 2.5-mm TDFN package. Capital investments will also support expanded medical sensor production. With these relatively modest capital investments, we believe we have adequate manufacturing capacity to support our sales.

Our stock price more than doubled in the quarter. This was probably a good thing for most of you, but it had several counterintuitive side effects. Higher share price and higher volatility tend to increase the non-cash expense we recognize under FAS 123(R). The share price increase also means an increase in diluted shares and, therefore, an impact on earnings per share, although it did not affect our shares outstanding. For the same number of options outstanding, a higher share price results in more diluted shares.

We expect to be required to perform a controls-based audit under Sarbanes-Oxley Section 404 this fiscal year. One of the effects of the increase in our stock price in the past quarter is that the test for accelerated filer status is at the end of the second fiscal quarter. Our public float was more than the $75 million threshold at September 30, so we expect to be an accelerated filer with respect to our Form 10-K for the year ending March 31, 2007.

Being an accelerated filer this fiscal year means we expect to have a Sarbanes-Oxley Section 404 controls-based audit in association with our fiscal 2007 audit. Otherwise, we would have had another year to comply with the provisions of SOX 404.

Last year, our public float was less than $75 million on September 30, 2005, so we were not an accelerated filer and were not required to perform a controls-based audit. We do not know the costs associated with the SOX 404 audit yet. But we expect to incur expenses in the balance of this fiscal year.

We are already generally meeting the accelerated filer deadlines for our SEC periodic reports. For example, the accelerated filer deadline for last quarter's 10-Qs is November 9th, 40 days after quarter end; but we filed our 10-Q yesterday, only 18 days after quarter end. Since we are currently a nonaccelerated filer, the deadline for us filing our 10-Q is 45 days after quarter end or November 14.

We updated legal proceedings in our recent 10-Q. In the past quarter, three lawsuits filed in U.S. District Court in the fourth quarter of last fiscal year were consolidated into a single case. This means we only have to deal with one District Court case rather than three. We reiterated in our filing that we believe these suits are wholly without merit.

Looking forward, we are optimistic about product sales and profits for the quarter ending December 31, compared to the prior year, due in part to our revenue mix moving to a higher percentage of product sales. We face a tough comparison for the December quarter compared to the quarter just ended, however.

As we have said in our SEC filings, product sales have historically been weak in the December quarters. This may be due in part to distributor ordering patterns or customer vacations and shutdowns late in the calendar year.

Furthermore, we rely on several large customers for a large percentage of our revenue, and we expect certain customers to decrease their orders in the balance of the fiscal year compared to previous quarters, because of their inventory status.

Contract research and development revenue will likely continue to decrease in fiscal 2007 compared to the prior year, due to more limited availability of government research funds; our shift in emphasis from contract-funded to Company-funded research, particularly new product development; and our focusing of contract research on certain strategic areas.

We expect gross profit margins to continue to increase compared to the prior year. But margins are somewhat volume dependent, and there can be no assurance the margin increases in sequential quarters will continue.

Now, I will turn it back to Dan.

Thanks, Curt. Let me give you an update on our business. MRAM, as many of you know, is a revolutionary spintronic memory made with nanotechnology. MRAM has been called the ideal memory because it has the potential to combine the speed of SRAM, the density of DRAM, and the nonvolatility of flash memory.

We believe we have developed technology for the MRAM of the past, present, and future. By that, we mean we have inventions related to an early form of MRAM based on giant magnetoresistance, or GMR. We have inventions relating to the type of MRAM currently being pursued, which is based on spin-dependent tunnel junctions, also known as magnetic tunnel junctions. And we have inventions relating to important MRAM technology of the future, including magnetothermal MRAM, spin momentum MRAM, and vertical MRAM.

As we discussed on our previous conference call last quarter, Freescale Semiconductor announced that the first commercial MRAM device was in volume production, an impressive accomplishment by a talented Freescale team.

In order to protect our MRAM patent rights, shortly after Freescale made their announcement we notified them that we believe Freescale's MRAM came within the scope of claims in a number of NVE patents.

Our goal is to reach a licensing agreement with Freescale; but it's impossible to predict if or when that will occur. In the meantime, we believe we have taken appropriate steps to protect our rights to the inventions that we believe, based on our analysis, are incorporated in Freescale's MRAM designs.

Although R&D contracts are becoming a smaller part of our business as we emphasize product sales, we had a noteworthy Phase I contract win in the past quarter. The project has a goal of developing secure arrays using an MRAM technology we call AT-MRAM. The new contract is with the United States Missile Defense Agency in cooperation with Oregon State University for, quote, secure configurable gate arrays utilizing anti-tamper memory, end quote.

The contract is a Phase I Department of Defense small-business technology transfer program, or STTR. Phase I contracts are generally less than $100,000 and are to demonstrate feasibility. But they can be important because they can lead to Phase II contracts. They also validate our technology and the innovation of our people. The technology could also provide designs applicable to high-density MRAM for mainstream memories.

Other NVE project abstracts have cited possible AT-MRAM commercial applications including countering fraudulent use in ID tags, ATM cards, or smart cards.

Our products are spintronic sensors and couplers to acquire and transmit information. Our devices are smaller, more precise, and more reliable than conventional electronics. We sell NVE-branded parts through distributors, and Agilent or Avago parts through a private-label agreement with Agilent. We have two lines of sensors -- custom sensors, including medical sensors, and standard or catalog products.

In addition to broad-line distributors such as Digi-Key, we have specialized distributors covering strategic territories. In the past quarter, we added a new sensor distributor for China, Zhichuan Information Tech. This is in addition to a coupler distributor we have had covering China for some time, Takumi Trading.

We plan to continue our efforts to market spintronic sensors in the medical area. We are pleased with our successes in that space.

We are also continuing to broaden our coupler line. Late last quarter, for example, we introduced a new network signal coupler called the IL3522, which combines spintronic coupling with RS422 network protocol functions in a single, very small package. RS422, also known as TIA422, is a popular serial network standard for a variety of applications.

At our annual shareholders meeting in August, Jim Hartman, the chairman of Enpath Medical, was elected to our Board of Directors. He has a broad range of executive experience, particularly in the medical device industry. He has since been elected to our audit committee by our Board. NASDAQ governance standards call for at least one number of the audit committee to be a financial expert. Now all three members of our audit committee have been determined to be experts.

NASDAQ standards also call for a majority of directors to be independent directors. Now, four of our five directors, all but me, are independent.

We strive to meet high standards for corporate governance. Our corporate governance quotient, according to Institutional Shareholder Services, was above the 93rd percentile in the ISS universe of companies as of October 1.

So in summary, we had a very strong quarter -- record product sales, record margins, and sharply increased profits; and we saw an important MRAM announcement from Freescale.

Let me reemphasize our three strategic goals. To continue to grow product sales, particularly medical sensors; and to license our technology for the MRAM of the present; and continue to build technology for the MRAM of the future. Now, I would like to open the call for questions.

(OPERATOR INSTRUCTIONS) Nick Tishchenko.

I have a couple of questions related to the [reported quarter]. The first one, can you elaborate a little bit on the product mix? I know that you don't like to provide the numbers. But in some (indiscernible) way, can you talk about sensors, couplers, and the devices, the sensors that go to medical devices?

Sure, and good morning, Nick. Well, as you know, there are accepted standards for reporting segments; so we follow those guidelines. But just qualitatively, we have highlighted that we are very pleased with our efforts in the medical sensor space.

We have also added new products. It takes a while for new products to result in sales. But they build up some interest in products for the future. We have done some new products for isolators.

Then finally, we have broadened our distribution. We continue to work on that. I mentioned the Chinese distributor for sensors. So we are broadening our product line, we are expanding our distribution, and we are focusing on the medical market, the medical sensor market, as a strategic market.

From historical performance of the Company, the December quarter is usually a down sequentially quarter. This kind of expansion into different markets, does it provide a little bit of cushion during the seasonal (indiscernible)?

That is a very good question, Nick. I suppose it might. We don't know for sure why the third fiscal quarter, the fourth calendar quarter, has traditionally been a weak quarter. But it may be due to ordering patterns, vacations, particular customers, and their inventory status.

I suppose as we expand more worldwide, we will gain some buffering from particular customers and our business will become less lumpy. We are expanding into -- we're making efforts to expand into countries where perhaps the year-end holidays aren't as important as they are here in the United States and Western Europe.

So I guess I don't know for sure. But perhaps as our business grows, that we will see less of that effect.

Thank you. The last question if I may. Can you talk not just about something that is going to happen in the next quarter or the quarter after? Can you elaborate a little bit on the drivers for the growth of the Company in the next, let's say, two, three, five years?

Well, we are very optimistic about our long-term prospects. We believe that spintronics has the potential to revolutionize electronics in a number of areas.

In particular, we have identified medical sensors as a market that has excellent potential; and we are starting to see some of that potential now. We have identified automotive markets as a possible future market, although it is not a significant market for us presently.

Then also, we have alluded to and I mentioned some of the new technologies that we have for MRAM that could allow MRAM to fulfill its promise as the ideal memory. Those include magnetothermal MRAM, spin momentum MRAM, and vertical MRAM. Those are areas where we feel that those technologies have the potential to increase the speed of MRAM, decrease the power consumption of MRAM, and increase its density.

So we are very optimistic about the long-term future of spintronics and the long-term future of NVE.

Thank you very much.

[Tim Bruney].

Great quarter. Glad to see the market is finally realizing the future of MRAM with your Company. Just have a couple questions. Wondering -- with the size of your floats, any thoughts of splitting the stock, since it is up to $36, $37?

Thanks for the kind words, Tim, and good morning. Our Board is always looking at -- always evaluating alternatives and what is appropriate for our stock. Beyond that, I wouldn't want to comment on specifics.

The floats, if we increase the number of shares I presume the stock would go down. But we are looking at a variety of alternatives, and the Board considers that almost continuously.

Last question, Dan, is -- with the discussions with Freescale, is it more now just about the price of the royalties versus the fundamental agreement, or their acceptance of us using your patents?

Well, all I can say is what we believe. We have said that we believe Freescale MRAM comes within the scope of claims of a number of NVE patents. As far as what their view is, that wouldn't be for me to say. Our goal was to license our technology. As we have said before, we will defend our IP if we must.

Great. Well, congratulations, Dan. You have got a lot of happy shareholders out here.

Thanks, Tim.

(OPERATOR INSTRUCTIONS) [Ed Klinard].

Dan, congratulations on the great financial performance.

Thank you, Ed. Good morning.

Dan, two things I have I would like to ask you. You mentioned in the conference call that you put -- or you sent out a notice to Freescale. I was wondering if you could give a little bit more depth to what that entailed.

Second question is on the mention of new distributorship with China. When do you expect that to start taking effect?

Okay. Well, in answer to the second question first, Zhichuan is currently selling our products. These things tend to take a while to get going. Like any market, one relies on contacts. But so far they have been doing very well. Our international sales director was in China recently to provide training and to visit some prospective customers.

As far as the first question relating to Freescale, as I said, we did notify Freescale that we believe that their MRAM comes within the scope of claims in a number of NVE patents. We did that shortly after they made their announcement.

As far as -- I don't know that it would probably be appropriate for me to say anything more beyond that. But we said a number of NVE patents. This was something we also discussed at our last conference call that was based on an analysis -- or at that time a preliminary analysis -- of the Freescale designs.

Would you say that the Freescale negotiations are still on a professional level, as you indicated at the last conference call?

I would say that we have a professional relationship with Freescale, yes.

Great, thanks, Dan. You have a great day, and congratulations again on that quarter.

Thanks, Ed.

[Dick Smith].

Just an absolute great quarter. Certainly beat any estimate that I had. I have got a couple of questions for Curt. Curt, first of all, that $25,000 in other income on the P&L statement, what is that?

We have a -- that can cover a variety of things. Curt had to look up some numbers. But sometimes what that is, is we might sell equipment or there might be some other source of income or revenue.

What it is most commonly -- and I don't think we know specifically, or we don't have that detail right now -- but often what that is, is we will sell a piece of equipment that might be fully depreciated and we realize a gain in that. That is not part of our normal operations.

So those are nonrecurring items that are not part of our core business, and that is where they go. So it could cover several things, but we break them out separately because it is probably not the sort of thing that one ought to assume as part of our business.

But sometimes when we upgrade equipment, we will sell the equipment on the secondary market. Often our equipment, much of our equipment that we would be selling, would be fully depreciated. So any gain that we would make there would probably fall in that category.

Do you guys have a headcount on employees, approximately?

Yes, Dick, we have approximately 50 employees. We are currently looking to hire several new employees in the manufacturing area.

Okay, and what about a headcount on PhDs, approximately?

Curt was pointing to me. We generally don't break it down that way. We have a number of some of the world's best and brightest here, and we have certainly a number of PhDs. But I don't think we have a breakdown that says - by educational background, here are how many employees we have in that category.

I was just curious percentagewise as to -- I mean, you have a total of 50. I was just curious as a percentagewise whether you have five, 10. I mean, is it a lot of -- is there a lot of PhDs? 25 versus 50? Or is it more in line or what ever?

Gosh, I really don't know. We have a number of PhDs. We have a very highly educated workforce, not just PhDs. But we have people with advanced degrees in a variety of areas. many of the people who work in our production area would be degreed individuals, sometimes bachelor level degrees or associate or certificate level degrees as well.

So there are an awful lot of smart people around here. And I often remark on that, even when they are not listening.

Curt had mentioned that -- in his initial address here to the shareholders, you said that you feel that adequate capacity to handle future sales, in the future, and I guess in the near future.

I would imagine that you guys would have some type of targets of future sales in order to make that statement. So I'm assuming that if sales were to increase 100%, or you are assuming that they are going to increase 100%, or could increase 100%, that in the future your capacity -- or the near future your capacity could handle that, those sales.

I am not sure I would want you to extrapolate all of that. We do look at our current capacity needs. We look at our future capacity needs or our estimates of our future capacity needs.

I think what we were trying to say is that the capital expenditures that we made in the past quarter were for a particular type of equipment that we need to make higher volumes of our smallest package, which is the TDFN package. Those are the types of packages that are used also in medical devices.

So we believe our capacity is adequate. But there are particular areas that we have had to -- that we have wanted to make investments in, in order to increase our capacity and remove some of these bottlenecks.

In fiscal years, it would have been 2004 and 2005, we had much larger capital investments. Those were more geared to increase our general capacity, our capacity to move wafers. What we are finding now is that our needs are in particular pieces of equipment, or particular processes, that depend on the product mix.

So that is the reason for the capital investments. That is the reason for the increase in personnel that we are planning for production and production support. In general, we feel that we have capacity.

Would it be fair to assume, then, in your, say, medical sensors, that in projecting future adequacy as far as handling current production or future production, that you have put into the equation, say, a 25% increase in your medical sensors; and that you feel that you can handle that particular capacity in the future?

Well, as you probably know, we don't give specific guidance as to revenue growth or projections like that. Our folks, our production personnel, are very good at planning. We look out into the future; we try to assess our mix; we try to assess where our growth potential is; and we try to support that with production and with personnel, with equipment to meet our needs and to meet our customer needs.

Many of our customers are in some of the most -- we have medical customers who have some of the most demanding applications in the world. We want to be very sure that they don't run out of parts and that we have adequate capacity for them and for their future needs. So we do look at that. But we are not in a position to give specific numbers or assumptions for growth.

Could Curt almost comment just briefly on the makeup of this -- what is it? In long-term investments, 13 or $14 million, is that basically mostly in government, short-term securities, or what?

Yes, maybe we can have Curt answer that question, and then we probably ought to wrap this up. Curt?

Yes, Dick, the makeup of our investments are a variety of government agency bonds, as well as high-grade corporate bonds.

Okay. So they're intermediate to short?

They go out to a maximum of five years.

Okay, I just want to say comment that when I see a small cap or small company like yourselves that are growing, and revenues are up 44% versus total expenses up 20.7%, that 2 to 1 ratio, that is excellent. So let me just say that my applause could not be loud enough on that.

Also, shares outstanding, as far as dilution is concerned, to myself as your shareholder, I was extremely happy to see what you guys are being very careful and increasing your shares. So I certainly appreciate that.

I did have a question about litigation, as to how you -- do you use the same legal counsel to advise you on intellectual property infringements versus shareholder suits? Give me just a little brief idea of who you're using for legal counsel and how you are using them.

I can answer that one, and then perhaps we really do need to wrap this up. But we do have separate counsel for intellectual property matters and for other matters such as you alluded to, the PRLSA suit. There tends to be specialization in legal field. Our IP counsel is very, very good, as is our other lawyers, but these would be different specialists.

In the case of the shareholder lawsuits, the class action lawsuits, we have retained a firm that specializes in that area. But in general, we feel that we have excellent advisers and excellent legal advisers.

Since this was the last question, I do appreciate your kind words. We do try to run a tight ship here, and run a good business for the benefit of our shareholders.

That will conclude our call for this quarter. We thank you all for participating. We look forward to updating you in January on our vision of leading the spintronics revolution. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.