NVE Corp (NVEC) 2007 Q3 法說會逐字稿

Good day, everyone, and welcome to the NVE third quarter fiscal year 2007 financial results conference call. Today's call is being recorded. At this time I'd like to turn the call over to the President and Chief Executive Officer, Mr. Daniel Baker.

Please go ahead, sir.

Good morning. This is Dan Baker. Welcome to our third-quarter conference call. With me on the call, as usual, is Curt Reynders, our CFO. The call is being webcast live and recorded. A replay 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 third 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 and 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 license fees, risks in the enforcement of our patents, risks related to the requirements to evaluate our internal controls under section 404 of the Sarbanes-Oxley Act. Risks related to class action lawsuits, risks associated with the volatility of our stock price as well as the risk factors listed from time to time in our filings with the SEC, including our annual report on Form 10-K and our quarterly reports on Form 10-Q.

We are very pleased with our results in the third quarter. Product sales nearly doubled. Net income more than doubled to $0.22 per share from $0.09, our third consecutive quarter of triple digit earnings increases and cash plus investment increased to nearly $16 million as of December 31st.

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

Thanks, Dan, and good morning.

Total revenues for the third quarter were $3.86 million driven by 95% increase in product sales in the quarter, which more than offset a decrease in contract R&D revenue. The 95% increase in product sales was the largest year-over-year increase in three years and the 48% increase in total revenue was the largest increase in four years.

Contract R&D revenue decreased 47% compared to the prior year quarter due to a decline in government contract revenue. Our strategy as we have said 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.

Our revenue mix reflects the success of our strategy to emphasize product sales. Product sales accounted for 88% of revenue in the most recent quarter, compared to 67% in the prior year quarter. As we noted in our last conference call, product sales have historically declined in December quarters compared to September quarters. This may be due in part to distributor ordering patterns or customer vacations and shutdowns late in the calendar year.

Furthermore, inventory levels industrywide have been high by some metrics. This can cause distributors and end users to reduce purchases to bring inventories in line with their desired levels. As expected, certain customers decreased their orders because of their inventory status. This may have been at least in part due to a slowdown in ICD sales in 2006, although the market appears to the recovering.

Gross margin increased to 64% from 50% in the prior year quarter due to higher product margins and a more profitable revenue mix.

On the expense side our shift to Company-funded R&D contributed to a 59% increase in R&D expense compared to the prior year. We invest in developments that we believe have good payback potential. The expense increase was modest as a percentage of revenue. R&D expense was 14% of revenue in the current year quarter, compared to 13% last year.

SG&A expense increased 10%, primarily due to our first Sarbanes-Oxley section 404 audit. Expenses related to Sarbanes-Oxley section 404 compliance matters were [at] approximately $58,000 in the quarter; and we had no such expenses in the prior year quarter.

As we discussed in our last call, we are planning to perform a controlled space audit because with the increase in our share price in the past year, the value of our float appears to have exceeded the accelerated [filer] threshold. Preparations for the controlled based audits are proceeding well and we anticipate being able to implement SOX 404 requirements in a timely fashion.

Despite higher R&D and SG&A dollar expenses, total expenses decreased as a percentage of revenue to 27% from 30%. On the strength of increased product sales and higher margins, operating income increased 177% in the quarter and operating margin increased to 38% from 20%. Interest and other income increased 75% to approximately $157,000 for the quarter, primarily due to an increase in our interest-bearing cash and investments.

Income before taxes increased to 42% of revenue and net income to 27% of revenue. Net income increased 162% to $0.22 per diluted share for the quarter, compared to $0.09 last year. As Dan said in his opening, this was our third consecutive second quarter of triple digit earnings increases. All of our provision for income tax for the quarter was non-cash.

For the first nine months of fiscal 2007, product sales increased 84% to more than $10.2 million compared with just over $5.5 million for the first nine months of fiscal 2006. Product sales for the first nine months of $10.2 million were well above sales for all of last fiscal year with a quarter to go. Product sales were $8.35 million for all of last fiscal year.

Total revenue for the first nine months increased 37% to $11.9 million. After tax and including the effect of stock-based compensation net income for the nine-month period increased 174% to $0.67 from $0.25 for the same period last year.

Cash flow strengthened our balance sheet. Cash plus investments increased more than $5 million in the fiscal year thus far, to $15.97 million as of December 31st. We believe profitability and a strong balance sheet has a deterrent effect on potential infringers and reduces the likelihood of having to resort to litigation to enforce intellectual property rights.

Capital expenditures were approximately $23,000 in the quarter and $253,000 for the fiscal year-to-date. We have added equipment to handle our smallest parts [bare die], leases packages and Micro small outline packages. Most of our parts are packaged in conventional semiconductor type plastic packages with leads for soldering to a printed circuit board. Die are unpackaged devices cut from wafers. They are usually connected using gold wire about 1000th of an inch in diameter. Much smaller than a human hair.

We sell die to our most sophisticated customers and they allow more miniaturization than possible with the smallest packaged parts.

We updated legal proceedings in our recent 10-Q. We had previously reported three federal lawsuits filed last fiscal year were consolidated into a single case. In our most recent 10-Q we reported that two related derivative actions filed in County District Court were consolidated into a single case.

So we are down to one federal case and one state case. We continue to believe the lawsuits are wholly without merit.

Looking forward, our fiscal year -- which ends March 31st -- is shaping up to be a great year. We are optimistic about net income for the fourth fiscal quarter compared to the prior year due in part to our higher margins and a more profitable revenue mix. Inventory levels industrywide our high by some metrics and this could tend to reduce our product sales in the first half of calendar 2007 [as] stocking distributors reduce their purchases to adjust their inventories.

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

Now I will turn it back to Dan.

Thanks Curt.

Much of the electronics industry is devoted to the acquisition, transmission and storage of information. Sensors acquire information, couplers transmit information and memories store information. Thus our technology can provide the eyes, nerves and brains of electronic systems. Global trends such as richer data, more video and remote data collection test the speed and capacity of conventional electronics. We believe our technology addresses these global trends.

Starting with our spintronic memory or MRAM technology, last month we were granted a MRAM patent containing 27 claims. That brings our U.S. patent total to 39 and some of our patents have dozens of claims. 21 of our patents relate directly to MRAM. Some of our other U.S. patents relate to materials or structures that could be used in MRAM. We have a total of more than 100 patents worldwide either issued, pending or licensed from others.

The new patent titled "magnetoresistive memory SOI cell" is No. 7148531. The invention by Doctors Jim [Daughten], Jim [Deek] and Art [Palm] relates to MRAM sales using [siliconon] insulator commonly known as SOI materials. The intention could allow smaller MRAM sales and lower power consumption by reducing the electrical current required to write data to the memory cells.

SOI materials are often pure crystal silicon and silicon oxide. SOI is presently used to reduce leakage currents but it may reduce thermal energy leakage. Also in the quarter, we received notice of allowance of two MRAM patent applications assigned to us. A notice of allowance is a written notification that a patent application has cleared a patent office review and is nearing issuance. There can be no assurance if or when patents will issue, however.

The first allowed application is titled "magnetic memory layers thermal pulse transitions" and contains 52 claims. This is in addition to similarly titled patent No. 7023723 which was granted last April. The allowed application relates to duel film magneto thermal MRAM cells, which could allow smaller MRAM cells and lower power consumption which would allow MRAM to scale down in the future.

The second notice of allowance is titled "radio field generating selection conductor device" and relates to addressing memory bits in an MRAM configuration, commonly known as vertical transport MRAM or VMRAM. Professor Jimmy [Tsu] of Carnegie Mellon University was a coinventor; and the invention is assigned to NVE.

There are links to the new patent, the allowed applications, other issued U.S. patents and published applications in the "About NVE" section of our website. The published applications give an idea of the breadth of patents that could be coming.

We have an excellent portfolio of MRAM technology. As we said last call, we have notified Freescale semiconductor; that we believe Freescale's MRAM comes within the scope of claims in a number of NVE patents.

Last month Freescale announced the completion of its merger with an entity controlled by a consortium of private equity funds. We believe, postmerger, Freescale retains responsibility for selling MRAM that comes within the scope of claims of our patents.

Our intellectual property often comes from our R&D activities. We have a superb team devoted to R&D; and NVE was well represented at the prestigious MMM Intermag conference last week. Four papers were either authored or co-authored by NVE Ph.D.s. Papers presented at such conferences frequently qualify to be published in peer review journals such as The Journal of Applied Physics or the IEEE Transactions on Magnetics. And we often post links to the abstracts or papers in the R&D section of our website after publication.

As Curt mentioned, our product sales continue strong year-over-year growth. Sensors acquire information and couplers transmit information. Couplers are also known as isolators, because they isolate the coupled systems. In sensors we are especially pleased with the response to our medical sensors. In medical device applications our sensors are inherently reliable, very small, sensitive and tolerant of large magnetic fields, such as those generated by magnetic resonance imaging or MRI.

For couplers, we have discussed the goals of extending our product advantages on three fronts -- bits or channels per device, BAUD or speed, and boxes or small packages. On the first b, bits -- we had unique by channel couplers which allowed for example a half bite of data plus a clock signal in a single .15 inch wide package. For the second b, BAUD -- last quarter we introduced a spintronic coupler called the IsoLoop 700S Series. The S stands for speed and S Series couplers transmit up to two channels of data and up to 150 megabaud or a million bits per second through each channel.

Prior to the S Series our fastest coupler was rated at 110 million bits per second. The S Series was recently lifted as a top 20 product by E/E Product News. The accompanying article was titled "NVE's Digital Isolators Break Speed Records."

For the third b -- boxes -- we recently announced versions of some of our IsoLoop 700 parts in micro small outline packages, commonly known as MSOPs. As Curt mentioned we had invested in capital equipment to handle MSOP. Our IsoLoop 600 Series couplers have been available in that package which is less than 1/8th of an inch square.

Our smallest products are worth their weight in gold. Let me explain. An MSOP weighs about 25 mg. The thousand piece price for an IO 610-1E on the NVE online store is $2.45 which is a good price for what it does. But that works out to more than $3000 per troy ounce compared to $630 per ounce, for the price of gold.

Although R&D contracts have become a smaller part of our business as we emphasize product sales, in the past quarter, we announced the DOD Phase II contract enhancement by the U.S. Air Force for approximately $430,000 which was awarded following a successful Phase II development contract. The enhancement is to continue development of smart sensor adapters.

Smart sensors provide richer information than conventional sensors. The contract includes a goal of construction of a preproduction system. The smart sensor adapters will be for use on board aircraft to enable better-performing aircraft designs.

In addition to the Phase II enhancement we were selected for a NASA Phase I contract titled "Magnetic Logic Circuits for Extreme Environments". The work seeks to prove novel gate designs based on spin-dependent tunnel junctions. The spin-dependent tunnel junctions are spintronic structures which are also used in MRAM and sensors. We cited several potential non NASA commercial applications in the proposal.

Phase I contracts are generally for less than $100,000 but they help us advance our technology. And in accordance with federal legislation companies normally may retain the principal patent rights to any intention developed with U.S. government support.

So in summary we are very pleased with our strong results. We continue to strengthen our balance sheet. We improved our capability to make our smallest parts. And we broadened our product line with our fastest couplers ever.

Our fiscal year ends March 31st; but some highlights of calendar 2006, we presented or published a number of papers including a paper on 60 nm MRAM cells. We were granted four U.S. patents. We introduced unique new products including S Series couplers. We signed a two-year supplier partnership agreement with St. Jude Medical. We saw an announcement of the first commercial MRAM device in volume production. Trailing four quarter earnings were $0.81 per share in 2006; and our stock price more than doubled.

Now I'd like to open the call for questions. Felicia.

(OPERATOR INSTRUCTIONS) [Dick Smith]. [Al Bardley] Investments.

Good morning. I have a couple of questions. My first question goes to Curt. Curt, I think last conference call I had asked you about your long-term investments and you had said your minimum rating on these short and intermediate term notes and bonds were AAA. Is that correct?

Our minimum, did you say?

Yes.

No, it's AA.

AA. Okay. And also, Curt, do you happen to have an average maturity in yield on this particular fund?

I don't have that on hand. On our balance sheet, we show short-term investments which are our bonds that mature within one-year timeframe and that is approximately $838,000. And our investments that are long-term more than one-year maturity are approximately $14.7 million.

But at this particular time, you don't have an average maturity or an average yield on those particular vehicles?

Right. I don't have that with me right now.

Would you say it would be -- just as a framework here -- would you say it was under 6%?

Generally we invest in corporate bonds and U.S. Treasury securities that have maturities up to five years and the rate on those high-grade investments has been below 6% for some time now.

And also does the Company own the land and building that it operates on?

No. We don't.

So it's leased. I just couldn't find that in the last 10-Q. I guess that is only stated in the 10-K.

Right.

Dan, my second question. Considering the fact that over 60% of your total assets are in this long-term investment category, could you share with us some of the short- and long-term thinking, and intentions of the Board of Directors as to how they plan to put these monies to work?

What we've said is that we believe that having a strong balance sheet and solid profitability provides a deterrent effect for potential infringers. Beyond that, our goals are capital preservation and as Curt mentioned, we invest in high-grade bonds, either high-grade corporate securities, or government and government agency bonds in accordance with that philosophy.

Nikolay Tishchenko of Global Crown Capital.

(indiscernible) I have three questions. The first one relates to government contracts. I overestimate your revenues by about $150,000 because I overestimated this part of the business. Here is my question.

Usually you have about two years' visibility in this concept as they go in phases. Phase I, Phase II. Can you share with us your outlook for this part of the business going forward?

Well, as we've said, our strategy is to reduce our dependence on contract R&D toward a future of products and licensing because -- as you know -- product and licensing are more profitable sources of revenue and have better growth potential for NVE.

We did say that we -- Curt said that we expect contract R&D to continue to decrease in the fourth quarter compared to the prior year quarter due to limited government research funds and our shift in emphasis from contract-funded to Company-funded research. We believe that that Company-funded research new product development will pay off well for us in the future and that is how we make those judgments.

In terms of our visibility you are right. The contracts -- Phase II contracts -- are typically two years. Phase I contracts can be six months typically. However we have a continuous flow of contracts where we have contracts expiring, and then new contracts coming in. So we don't always have the visibility as to what our contract R&D will be in coming quarters; and I think as Curt mentioned it is -- it's just not an area where we have been focusing strategically.

Yes I understand this; but still it is more than 10% of your total business. I am not asking about quarterly numbers but maybe some outlook on an annual basis because saying that it would be below than last year quarter it is like saying that the lady is closer to 30 than to 20 and you find out that the Lady is 80 years old.

I appreciate your colorful metaphors. We do report backlog in our 10-K. Our backlog is generally contracts because, in the electronics industry, product orders can be canceled or postponed. So we generally don't classify those as backlog. So we will report that number; but as you know we don't provide revenue guidance as a matter of policy. And we are emphasizing product sales which, typically, have much higher margins and much higher growth potential.

Talking about margins. What is typical margins for this R&D contract?

Typically they are considerably lower than product sales margins. It varies with the agency and sometimes we -- it depends on whether a contract is particularly strategic to us. We might quote it more aggressively. So it's difficult to give a particular number. However, it is not generally something that we are going to go into in order to make money. We do it because it's an area where we want to develop intellectual property or we have particular expertise that we believe can be developed with government assistance.

Can you give a ballpark?

We really couldn't. We just don't break that out and there are particular rules about segmenting that we try to follow.

Last question. You mentioned about inventory of your customers both in 10-Q that you filed yesterday and during this call earlier. Can you provide a bit more details of what are the product lines? What are the metrics that you are mentioning? Any more details that you can provide for us?

Yes. Relating to inventories, I think we had mentioned general inventory in the electronics industry and, particularly, in the distribution channel which fluctuates -- and I think there had been reports that inventories had gone up. And that has happened in past years in the third, in our third fiscal quarter, the fourth calendar quarter.

So there are these corrections where distributors will tend to decrease their orders in order to adjust their inventories. I think we saw -- we may have seen some of that in our third fiscal quarter, which appears to be something that has happened before in this time of the year. We also mentioned a specific customer who may have decreased their orders in order to correct inventories.

In general, though, in that environment, our product sales increased 95% compared to the prior year where we had the same sorts of seasonal -- possible seasonal things. And that was the biggest increase in several years.

Then you said you mentioned this customer before and I didn't catch it. So can you repeat it?

Well, we just said certain customers may be decreasing, may have decreased their orders because of their inventory status. So that was part of what might have been -- what might have caused this kind of third-quarter, fourth calendar quarter sales pattern.

I'm trying to get this because I do follow electronics and semiconductors in particular and I'm just wondering what is your assumption based on? Do you personally know the inventory status? Or you are just referring to something that people talk around?

In some cases we have particular comments and insights from distributors and other customers. These tend to be more anecdotal than specific data that we can point to about a number of inventory or something like that. Also, where we had some visibility from particular customers -- that is what we had mentioned that you alluded to the prior 10-Q. Then there is the general trends that you mentioned, that a number of industry analysts look at in terms of the inventories in the electronics supply chain. Of course that is sort of an overall number and it can affect us or not affect us, depending on what the particular distributors we deal with what their inventory status is.

So basically what you are saying -- it is a general statement based on somebody else who talks and makes this forecast (inaudible).

What we are trying to give -- yes, we are trying to give insights based on what we know about the overall industry and then, in particular, about certain of our customers and we try to share that. But it is not a real specific or something that can be adjusted or can be reduced to a number.

I'm sorry that I am pushing this issue but I know that you are very conservative and I'm trying to understand where you have your conservatives (indiscernible) or you know something for sure?

When we said something like a -- like particular customers, then there was something specific their. The comments that I am making, relating to the overall chip inventory status, those are more of a general macroeconomic estimate that we look at and then take with a grain of salt. A number of firms -- for example, Gartner, as you may know expects the current -- .

(MULTIPLE SPEAKERS) Gartner changes their forecast every quarter.

Yes. Yes and so we don't rely on that. That was just the general inventory status in the industry.

Thank you very much. (inaudible) answer my questions. Thank you.

(OPERATOR INSTRUCTIONS) Bruce Foster of Waterstone Financial Group.

I have two questions. The first. Can you expand on the practical applications, the products that use your couplers and sensors and what are the general growth rates associated with those? And are you gaining or maintaining marketshare?

That is a good question. In general, our sensors are used for the acquisition of data. Those -- our legacy industry segment where we started out was an industrial control and factory automation where the devices are used to sense positions such as the position of a robot arm or in electromechanical or mechanical device that is used to automate a factory.

In those applications our devices are more precise than conventional electronics. So they allow more precise and more intricate operations to be performed automatically. The overall sensor market is we believe that we are gaining share; that our sales are growing faster than the industry average. The market is a very large and diverse market but, in general, I think we are increasing our share and the other segment that we've been participating in is the medical sensor market and in that case, in our devices in medical devices provide for inherent reliability.

That is, they have no moving parts and so that they are inherently reliable, which is important in that segment. They are sensitive. They're precise and they're very small.

So our devices take up less board space and less body space, meaning that in something like an ICD or other implantable device, a smaller incision or pocket might need to be made for a device that uses our technology because it is smaller or a smaller circuit board area.

So those are the major segments that we have been participating in in the medical market. That is a market that we identified several years ago. One that we saw as a potential growth market and so far we are pleased with the results.

Thank you. My second question relates to MRAM. It has been such a long time; and my concern is that there are other competitive developments emerging. Not that I would understand the technology that will bypass MRAM. The adoption of MRAM. And I would like to have some insight from you on that and any other thoughts you have related to it.

We continue to believe that MRAM is very important space; and MRAM has unique advantages over other memory technologies. It has the potential for the speed of SRAM, the density of DRAM and the nonvolatility of flash or hard disks. So we don't believe that there's anything that has the combination of advantages and the combinations of technology, technological advantages that MRAM has.

We have excellent intellectual property in that very important space and our strategy, as you know, is to license our intellectual property. We can't predict when we would sign additional agreements. But it is certainly one of our strategic goals and industry leaders like Honeywell, Cypress and Agilent have licensed our intellectual properties.

So I think we are pleased with our intellectual property in a very important space.

Are there other companies besides Freescale that are developing products along those lines? Do you have any insight into that and, also, do you have any insight as to how Freescale's product, its offering is actually progressing?

In terms of other companies, there are many other companies that are -- that have reported programs in MRAM development. Technology with this much promise attracts a lot of attention. As far as Freescale and how their product is doing, that is probably a question better answered by Freescale.

Is there another technology that is going to totally bypass MRAM?

We believe in the potential of MRAM and its uniqueness and its unique combination of features. I suppose there is always a risk in a technological area and those are the sorts of risks that we put in our SEC filings. We always encourage you to read those disclosures.

But we believe that we are continuing to advance our technology portfolio. Our patent relating to SOI and the patents that we are allowed in the most recent quarter that I alluded to are examples of that. Those are technologies that could help MRAM increase its density, decrease its power consumption and scale down in the future.

And the other thing that I alluded to in my prepared remarks were the 16 nm MRAM cell design that we reported on the past calendar year in 2006. So it's excellent technology that we are continuing to advance and position for a bright future.

[Ed Kinnard].

Ed Kinnard. Congratulations on a great quarter. I just have a couple questions here, Sir. You mentioned the Freescale was taken over, of course, we know by private equity and I am just wondering if you can enlighten us as to the caliber of negotiations as they stand now. Are they still at a professional level? Or have they stalled because of the buyout with Blackstone or how are they proceeding?

What we have said all along is that we have a professional relationship with Freescale as we had with Motorola. And we continue to have a strategic goal. License our intellectual property. We want an agreement as soon as possible but it has to be until that is fair to NVE and we can't predict the possible timing of agreements because the timetables aren't entirely within our control.

We believe in the excellence of NVE's patent portfolio; and we believe that the technology as I just mentioned in answer to the last question is very important technology.

My last question is regarding the new S coupler series. I just wanted to clarify. That's a two-part question. I want to clarify the best Doppler S coupler there. That's a two channel coupler.

Is the bandwidth 150 Mbps per second channel or total for the two channels?

That is a very good point. It is per channel. So you could get 300 million bits per second through a two-channel device. We have both one and two-channel devices in the MSOP package and it really is an amazing device. If you look at one, they are approximately 3 mm square, which is less than 1/8th of an inch. That is just an amazing amount of information that goes through that device and there's nothing else like it.

And the last part of that question. I know you don't like to necessarily comment on customers and things like that; but I'm just wondering if you could just kind of in general say how was the market reception to that product? Lukewarm, good, if you can make any comments on that?

I think the market reception was very good. As with any new product it takes time for customers to design in new products and they have to -- once they know that a device like that is available it sometimes opens up a whole new class of applications that may not have been possible before. So it is a development that takes -- it takes time to build market share with them.

But for customers who need high density to minimize their board space, and who need speed -- and there are many customers like that in factory and automation, and other market segments -- it is a product that really has no peer. There is no other way to accomplish that kind of function, that kind of channel density at that kind of speed.

Thank you very much and congratulations again.

Mr. Baker, do you have any additional remarks?

There were no other questions in the queue? If not, we appreciate you participating. Our next financial report will include our full fiscal year results and we look forward to updating you then. Thank you again.

That does conclude today's conference call. We thank you for your participation. You may disconnect at this time.