NVE Corp (NVEC) 2010 Q3 法說會逐字稿

Good day and welcome to today's NVE 2010 third quarter results conference call. Today's conference is being recorded. At this time I would like to turn the call over to Mr. Daniel Baker, President and CEO of NVE.

Good afternoon, and welcome to our conference call for the third quarter of fiscal 2010. 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'll highlight some business items, and then we'll open the call to questions.

We filed our press release with quarterly results and our quarterly report on Form 10-Q with the SEC in the past hour, following the close of market. Both 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 in revenue and profitability, risks associated with our reliance on several large customers, uncertainties related to research and development contract funding, risks related to developing marketable products, uncertainties in the possible issuance of patents, uncertainties related to seasonal patterns to our business, uncertainties related to economic environments, and risks related to buying our stock, 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 as updated, and our just 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 revenue, product sales and earnings that were records for the seasonally weak third fiscal quarter. Revenue increased 13%, driven by a 15% increase in product sales, and net income increased 12% to $0.57 per diluted share.

Before I turn the call over to Curt, I want to congratulate him on again being named one of the hardest working CFOs in the past quarter by the Minneapolis/St. Paul Business Journal. This was Curt's third consecutive year on the list. Congratulations, Curt, and now we will let you get to work discussing the details of our financial results.

Thanks Dan, and good afternoon. As Dan mentioned, total revenue for the quarter increased 13% to $6.62 million. The increase was primarily due to a 15% increase in product sales to $5.29 million. Sales appear to have benefited from an improving economy, especially for the industrial control markets late in the calendar year, although economists are saying it may take a while for the economy to return to historical levels.

2009 has been reported to be one of the worst years in the semiconductor industry in 25 years. In a year when semiconductor industry revenues declined more than 11%, according to preliminary estimates, and many companies in the industry have reported sharp declines, we are pleased to have delivered increases in product sales each of the three quarters of the fiscal year, and a 14% increase for the first nine months.

The December quarter, our third fiscal quarter, has historically been the weakest quarter of the fiscal year. Until this year our product sales have been less in the third quarter than the second quarter every year since fiscal 2005, but this year there was actually a sequential increase of approximately $115,000, or 2%.

The departure from seasonal weakness this year may be due to the improving economic environment overcoming adversity seasonal patterns such as distributor ordering or customer shutdowns late in the calendar year.

Industry inventory data can be tricky, but some channel inventories appeared to decrease in recent months, which would be positive because distributors and others might order more parts to replenish inventories they reduced in response to the economic downturn. Some semiconductor manufacturers reduced capacity and capital expenditures during the downturn. We even saw signs of shortages in allocations of certain types of parts.

We did not reduce capacity and used the downturn as an opportunity to add capital equipment. As a result we are well-positioned with parts in stock, and we may be benefiting from competitor shortages of parts such as couplers.

Contract R&D revenue increased 4% to $1.33 million even compared to a remarkably strong quarter for contracts last year. This was our highest quarterly contract R&D revenue since fiscal 2005.

Total expenses increased 4% to $801,000. Expenses are broken down into SG&A and R&D. Selling, general and administrative expense increased 8% compared to the third quarter of fiscal 2009, primarily due to commissions and the timing of professional services. Research and development expense decreased 3% compared to the third quarter of fiscal 2009 due to an increase in contract research and development activities which caused resources to be reallocated from expense research and development activities.

Gross margin remained strong although it decreased to 68% of revenue from 70% last year due to a less favorable product mix. With good margins on increased revenue, operating income increased 11% to $3.72 million in the quarter, and operating margin was 56% of revenue.

Interest income increased 35% to $415,000 for the quarter due to an increase in interest-bearing marketable securities.

Income before taxes for the quarter increased 13% compared to the third quarter of fiscal 2009 to $4.14 million, and pretax margin was 62%.

The effective tax rate remained about the same as the prior year quarter at 33% of income before taxes.

Net income for the most recent quarter increased 12% to $2.77 million, or $0.57 per diluted share, compared to $0.52 last year, and net margin was 42%.

For the first nine months of fiscal 2010, total revenue increased 21% to $20 million, product sales increased 14%, and contract R&D increased 61% compared with the same period last fiscal year.

Net income increased 26% for the first nine months to $8.4 million, and comprehensive income, calculated as net income plus the unrealized after-tax net gain from marketable securities, was $9.69 million. Diluted net income per share increased to $1.73 for the first nine months of this fiscal year compared to $1.40 for the same period last year.

High earnings quality and strong operating cash flow strengthened our balance sheet considerably. Shareholders' equity exceeded $50 million for the first time. As of December 31, cash plus marketable securities stood at $46.4 million. The increase during the fiscal year was primarily due to $9.39 million in operating cash flow, a $2.01 million net increase in the value of marketable securities, and $622,000 in net proceeds from sale of common stock related to option exercises.

Purchases of fixed assets were approximately $258,000 for the first nine months of fiscal 2010. The economic environment helped us purchase capital equipment at favorable prices. Investments included capacity for testing TDFN 2.5 millimeter square parts; a new tester for our smallest packages, which are 1.1 millimeters square, or less than 0.05 of an inch; and a piece of equipment to help process die, which our unpackaged wafer pieces that are even smaller than our packaged parts.

With that, I'll turn it back to Dan for his perspective on our business.

Thanks Curt. I'll cover product sales, R&D, patents and review 2009.

Starting with product sales, as we've said before, our near-term growth strategy has been new products and broader distribution, and longer term to expand into larger markets such as consumer or automotive electronics. We sell standard products primarily through catalog Internet distributors supplemented by specialized face-to-face distributors in select territories. Our primary market for custom products are medical devices.

We were pleased to renew our St. Jude Medical supplier partnering agreement in the past quarter. An amendment extended our agreement to supply spintronic GMR sensors through the end of 2010.

We summarize our product advantages in the medical market with four B's -- boxes or miniaturization; bits or precision; bulletproof, meaning inherent reliability; and batteries for low power consumption. Validating our product advantages, our latest generation of sensors for implantable medical devices -- these are the sensors that fit on the head of a pin -- were honored as one of the top products of 2009 by Medical Product Manufacturing News.

We believe we've earned St. Jude's continuing business with the excellent products, with superb reliability, and a great track record for dependability as a supplier. We have filed our St. Jude agreements and amendments, and they are available on the SEC's website or via our website.

NVE products are available in more than 75 countries, and our distributors speak countless languages. We recently added a Chinese language isolator website in cooperation with Shanghai Channel, our new distributor in China. The Chinese website is at NVE-China.com.CN. Like our English site, the Chinese site has extensive product information, selector guides and applications information. Shanghai Channel also provides hotline applications support by native Mandarin Chinese speakers.

As we've said before, the continuation of much of our contract R&D is contingent on us meeting project goals. Our R&D staff has done a great job on these projects, and we've received significant additional contract commitments. We focused our contract work in areas that are strategic to us in terms of future growth and revenue potential.

Three long-term strategic development areas we've discussed include biosensors, magnetic compassing sensors, and MRAM.

Our biosensors are designed to combine spintronics with biological components, with the potential we believe to significantly improve analytical equipment and eventually enable laboratories on chips. We are pleased to report that based on evaluation of prototypes, a customer has told us they plan to use custom NVE biosensors in a piece of analytical equipment it's developing. Our sensors will be part of a disposable, so one will be sold for each clinical test. The customer has said it plans to have the machinery in production within two years. In that time our customer will complete development of the machine, and we will finalize a high-volume production process for the sensor.

The second long-term strategic development area is solid-state compasses to determine heading direction by using low field spintronic sensors to measure the angle of the earth's magnetic field. According to a recent study by iSuppli, electronic compasses for GPS equipped handsets is a major new product category that will accelerate to 2013.

Our spintronic tunnel junction technology may have the potential to be more accurate in compasses than the semiconductor sensors such as Hall effect sensors. Tunnel junctions are spintronic structures that use tunnel barriers that are so thin that electrons can tunnel through a normally insulating material to cause a resistance change.

Specifically we are developing sensors using spin-dependent tunnel junctions with magnesium oxide tunnel barriers, which are even more sensitive than aluminum oxide based junctions, which is what we used in the tunnel junction based sensor products we introduced about a year ago.

The Earth's magnetic field changes the spin of electrons in the sensor, which changes the resistance of the tunnel junction. The information from three tunnel junctions oriented in three different axes can be converted into the magnetic heading.

The third long-term strategic development area is anti-tamper MRAM. Anti-tamper technology is in demand for defense and commercial applications. Recent public disclosures that Iranian-backed insurgents intercepted US drone video feeds highlights the importance of this type of encryption technology.

Our anti-tamper technology uses MRAM intellectual property we've developed over the years and expands the technology and specialized know-how that we can eventually bring to bear on large-scale MRAM.

I mentioned last quarter that we had completed several custom anti-tamper MRAM integrated circuit designs. We are building MRAM in a similar way to how we build production sensors and couplers. We design conventional semiconductor ICs, which we have fabricated at outside foundries. Then we add the spintronic structures, in this case spin-dependent tunnel junction memory cells, in our factory.

In the past quarter we've received a number of the foundry wafers we designed, and we are in the process of adding MRAM to the wafers. The prototypes look promising so far, although a fair amount of development remains before production.

We continue to strengthen our patent portfolio. As expected in the past quarter, we were granted our 52nd US patent, [titled] (technical difficulty) Magnetic Particle Flow Detector. The patent describes biomolecular detection methods including detecting DNA and disease-causing organisms.

In addition to the particle flow detector patent, in the past quarter we received a Notice of Allowance for a US patent application titled Superparamagnetic Platelets Field Sensing Devices, which discusses a novel sensor for magnetic fields. Possible uses referenced in the application include digital memories and magnetic sensing devices.

The application had previously been subject to an ex parte Quayle action. An ex parte Quayle action indicates that prosecution on the application's merits is closed, but there may be amendments on formal matters.

A Notice of Allowance is a written notification that a patent application has cleared a Patent Office review and is nearing issuance.

There are links to the particle flow detector patent and the superparamagnetic platelets application from our website. We have a number of pending patents and published applications, and those are also available on our website.

In addition to the financial information filed in our 10-Q today, we updated legal proceedings. In the past quarter, actions in Hennepin County District Court related to a lawsuit that was dismissed by a federal court in 2007 were ordered dismissed by the Hennepin County court. The dismissals support our long-standing position that these lawsuits were wholly without merit.

As we begin calendar 2010 I would like to summarize highlights from a very successful 2009. We outperformed the industry with year-over-year increases in revenues and earnings each quarter, in a year when many semiconductor companies reported significant declines. We strengthened R&D with the addition of two talented PhD's. We received patents relating to couplers and biosensors. We introduced world-class products including a new current sensor, a new tunneling magnetoresistive angle sensor, and more parts that fit on the head of a pin. We expanded distribution in central Europe, Eastern Europe and China. And our stock price increased by more than 50%.

Our exceptional growth was recognized with a number of prestigious awards and accolades 2009, including one of Minnesota's 25 fastest-growing public companies as ranked by the Minneapolis/St. Paul Business Journal; the Fortune small business list of America's 100 fastest-growing small public companies; and one of Forbes top 10 on their 2009 list of 200 best small companies in America. There are links to more information on these and other lists on the awards and accolades page of NVE.com.

We were also included in several merit-based stock indices in 2009 including the Barron's 400, the IBD 100, the IBD New America Index, and several market greater indexes. There are links to stock indexes that include NVE on NVE.com.

Now I would like to open the call for questions.

(Operator Instructions). Steven Crowley, Craig-Hallum Capital Group.

Good afternoon gentlemen. Congratulations on another really good performance.

A couple intriguing things I want to pick up on in your prepared comments. I'm going to maybe jump to the most intriguing disclosure, which is that you made some notable progress it sounds like with the biosensor new product initiative.

You mentioned a target customer has some rather definitive plans to go to market with a system where you play a role in a consumable component. Can you tell us a little bit about the general nature of that customer? Are they a major, established diagnostic company? Or a brand-new entrant to the industry? I know you're going to be guarded there, but please paint us whatever picture you can in at least a general sense.

Sure Steve. They are a company with some experience in this industry, that they do make clinical instruments now. And they are looking at making a next-generation of clinical instrument, so a clinical instrument would be used for a test that would be ordered by a medical professional. If we went into a clinic and needed to run a battery of tests, it just would be an instrument that would be probably in an outside lab or perhaps in-house in a large center. So it's geared for relatively high volume of testing. It's geared to do as many tests as quickly as possible. The better the information, the better the diagnostic results.

It's also possibly a step along the way to a laboratory on a chip, although this is a large -- we envision this as a large instrument, so it would be a tabletop instrument, much as the analytical equipment is now. The advantages that we would provide, we believe are faster analysis and an analysis of more possible conditions or more possible disease processes in a limited period of time. And so we see it as important.

I did mention though that they are talking about within two years, and there is development that remains to be done. But we are very encouraged by it, and we believe it's a good validation of the technology, the biosensor technology that we have developed over the years.

Thank you for that additional detail. It does sound like from that detail they have a meaningful, established presence in the business with existing customers and that this is a next-generation system. Is that correct for me to infer from your commentary?

Yes. That's my understanding. I wouldn't be able to say -- we wouldn't be able to say exactly how large a presence they bring to the market, but they do have experience designing these types of instruments. And they know -- they have a feeling of what would be best for a next-generation product in the market, so we feel they were an excellent customer to partner with.

Excellent. Now, in terms of the other two higher profile initiatives you've been talking to us about on a regular basis, I'm trying to figure out from your commentary kind of the order, the timelines for these -- with all the caveats that that could change given any number of factors.

It sounds like you've made meaningful progress on both the magnetic compassing front and the MRAM front. But is it fair for me to infer that maybe the magnetic compassing front, you're a little farther along the path to a truly commercial product, and maybe MRAM -- out of these three initiatives -- is the last? Or is that not very fair at all?

Well, it really is hard to say. We are -- we have made good progress, our R&D team we think has made excellent progress on both fronts. But they're different markets, and they both have challenges remaining.

We do view the anti-tamper market as a relatively specialized market. Primarily it's military applications right now. And I mentioned an example I think that highlights the importance of safeguarding critical technology. So that's a market that we'll develop over the longer term.

We believe that longer term of course that MRAM could be applicable to large-scale memory and that MRAM has tremendous potential there. But this is an intermediate step. It's an important step, and it's an important product area. But it's a smaller-density device that would be used for encryption and anti-tamper.

And compassing is a market that I think we -- we cited an iSuppli -- in our prepared remarks we cited an iSuppli study which said that the market would accelerate to 2013, but there is a market now, a smaller market for GPS equipped handsets that need compasses. So some of this is driven by the markets, some of it is driven by our own technical success, and so we are just not in a very good position to say when these will actually provide meaningful revenue.

In terms of that iSuppli data, in terms of the current modest market size and its expansion to 2013, could you give us a ballpark for the kind of market sizes that they are throwing out there?

Well, they were forecasting a significant market, at least towards the 2013 period, but they were talking about a product -- I don't know if they gave specific numbers. They did say that it was a major new category, and I don't know if that's -- if that was quantified by dollars. And a lot of that depends on how it's positioned by the handset makers and what kind of software and applications that use GPS-equipped handsets are out there. So it's a difficult thing to project.

Our goal is to provide a better sensor. And we are working with a customer who is an expert in this area, and we are going to try to develop the best-in-class sensor. And if that -- if it does indeed turn into a significant market, we hope to be there with the best part.

Great. One more question on the R&D front, and then I'll hop back in queue. As you mentioned in your prepared comments, your robust contract R&D line is a way for you to develop products and capabilities in areas of interest to your own product development efforts. It does have the favorable impact of reducing your income statement expenditures on R&D. So it creates a picture where you're not spending a whole lot more on R&D in the Q3 this year versus Q3 last year. I'm wondering if that's a little bit of a distorted picture.

Is there a way for you to reference whether or not you're doing more projects this year than a year ago, or you have more people working on development type stuff versus a year ago? Or is that a relatively accurate picture that you're working on about the same amount of stuff as a year ago?

Well, that's a good question. Let me take a crack at it qualitatively, and then maybe Curt might have something to add. But in general we have a pretty high level of activity -- of R&D activity for a company our size. And we will report the specific numbers of company-sponsored and customer-sponsored R&D in our 10-K in our next SEC filing.

But qualitatively I can just say it bounces around, but we've got an awful lot going on here. And we are fortunate that a lot of it is -- that our customers have been willing to sponsor our R&D, which I think is a credit to the quality of our R&D and a credit to the capabilities of our staff.

Curt, did you -- do you have something to add?

Yes. I think, as Dan said, that it's important to remember that most of our R&D is supported by customers and doesn't hit our expense line. For example, total company sponsored and customer sponsored R&D spending increased 21% in the most recent fiscal year and was 17% of revenue.

Is that for the nine-month period? Year-to-date? Or was that for 2009?

That was for fiscal 2009.

Okay. And you said it was up 21% year-over-year, and it was 17% of revenue, in contrast to the 5.2% that you reported on the income statement?

Right.

That's very helpful. Well, I'm going to hop back in the queue, but I do have some more questions, so you will probably hear from me again.

(Operator Instructions). We will now take the follow-up questions from Steven Crowley with Craig-Hallum.

All right, guys, as I said, I do have a couple more, more based on -- or more focused on your industrial business. You mention in your prepared comments that you saw a -- I don't want to put words in your mouth, but the strength on the factory automation and industrial control side of your industrial business. Were there some other areas, semiconductor manufacturing or electronic test or some other areas you might be able to mention that also seemed to demonstrate some strength on the industrial side?

That's a good question. And it's difficult to cut it too fine. I think we saw customers -- we saw new customers in industrial control, things like fluid handling and things like that, so these would be subcomponents that might go into a factory -- a variety of factory systems. So we don't always know exactly what they are going into. They tend to go into things for -- they go into controls for factories to make durable goods. That could be automobiles, that could be durable consumer goods such as white goods.

We also saw -- and this is just qualitative -- we saw some activity in medical instrumentation though. That's different from medical devices. These would be medical instruments which are large instruments as opposed to implantable devices. And we saw some activity there.

So we are seeing some pockets of strength. Our perception is that there are also areas that continue to be weak and might take a while to recover, and things that fall into that category include automotive manufacturing and things like semiconductor capital equipment, which has been fairly depressed.

But I think the good news is that we are starting to see some signs of general economic recovery, and it will probably be a little bit uneven, and there will be pockets of strength and weakness. But we are seeing some positive signs, and we are seeing a pickup in industrial activity.

Great. In terms of another comment you made earlier in the call about having been able to keep in good stead in terms of your inventory on hand and meet the market's requirements for your coupler products in particular and referencing the fact that there may be some -- or may have been some coupler shortages out there on the part of your competition that isn't selling spintronic couplers but other types of couplers, do you think you've been able to pick up some customers at the margin from that situation? -- one. And maybe more importantly, once you've opened the door to a customer using a spintronic-based coupler, has your experience been that you're pretty effective in keeping them using the spintronic couplers versus going back to the other stuff?

The second part of the question is easier to answer. And that's that we do feel that we have a very good customer retention rate. These are devices that are smaller than competing couplers, they have better -- they have less signal distortion, which just makes the design easier. And so we hear from engineers that once they use our couplers that they are very happy with them, they extend them into other designs, and they wonder why they've put up with things like optical couplers previously.

So that's a little bit anecdotal, but I think we have a pretty good retention rate in our customers, and we have some customers who have expanded their use of our couplers and other products over many years, that they develop them in one design, then move them into other designs, and so we get the opportunity to grow with them both in terms of their own organic growth and expanding into more product.

And in terms of benefiting from our competitors' shortages, that's a little bit more qualitative, but we have heard stories of competitors who didn't have parts in stock or they had long lead times or even allocation, meaning that they didn't have enough parts to go around to fulfill their orders.

That's a situation which we never like to be in and I don't think we've ever really been in. So we have invested in keeping our capacity up, we have invested in inventories, both finished goods and work in process, so that we can respond to the recovery that we have seen so far and the recovery that might be coming down the road. And I think many in the industry have been slow to respond, and they have cut back their capital expenditures, which has led to decreases in capacity.

So we -- it's hard to put a number on it, and it's hard to say how important an effect it is, but we certainly have anecdotal evidence just from customers calling us who might not have talked to us unless there were shortages other places. And we do our best to provide them with a great product, provide great applications for it if they need it, and our hope is that they're going to be customers for a very long time. That's been our experience in the past.

Great. Now switching gears, I just have two more questions, and then I'll let you guys go. On the medical side of your business, what can you tell us about the general complexion of that business and customer base now, and anything on kind of its evolution or growth of the customer base?

Well, as you probably know, Steve, it's been a little bit of a challenging environment for implantable medical devices. And there have been reports of softness in the procedures, the numbers of procedures for implantable medical devices in the past year or so. But that market does appear to be improving.

And as far as our efforts, as we've talked about before, we've targeted other areas of non-life-support medical where the design cycles are shorter than life-support medical and where we believe we have convincing benefits in terms of having -- well, the four B's that I mentioned, where we've got smaller parts, more precise parts, inherent reliability and lower power. So we've been targeting things like neurostimulators, and that's a very broad category. We believe we've made some progress on that front. I don't have any specifics to report.

And also we are finding that the long-term market, medical market seems to be very positive. The demographics are positive, and there are many new therapies that are being developed that really have some amazing potential. And we feel that we can help make those products better, help make them smaller, help make them more reliable, and so we see it as an excellent long-term market, although perhaps in the relative -- in the past year or so, it's been a little bit challenging.

I appreciate that color. And then the final question I have relates to your contract R&D revenue line, which has continued to be robust. And you made some encouraging comments about the performance of your team on the work that you've had, that's typically -- I don't know if it's a precursor, but it allows you to continue on many of those projects. So trying to interpret that as to what it might mean financially. Can we expect some modest growth in that category? Or it continuing to be around -- it's been $1.3 million roughly for the last three quarters. How should we think about that business? Or that revenue line item, I should say?

Well, Steve, the contract R&D revenue can fluctuate based on timing of awards, follow-on contracts. We have been -- we have performed well, and we have been able to get follow-on awards. Additional awards are difficult to predict because we've got to perform to get the follow-on awards, and also they are difficult to predict due to customer budgets. So it's real difficult to say whether our current R&D revenue -- it may -- may not be indicative, may or may not be indicative of the future.

I certainly understand those caveats. At the same time, should I interpret your earlier in the call comments about your performance of that business -- in that business as a pretty positive report card right here and now on how you are doing and how it looks?

We were certainly encouraged, and we are getting good report cards from our customers, which is the most important thing, as to how we are performing, how we are meeting design objectives, how we are meeting schedules and budgets. So we are encouraged, but at as Curt said, we don't have a lot of visibility long-term because these contracts tend to have specific milestones on them. And we need to meet specific milestones or performance criteria in order for them to continue or be extended.

But so far our R&D staff has really done a great job on developing things on tight schedules and some really remarkable technology.

Great. Well, thanks again for taking my questions.

Thank you, Steve.

At this time we have no further questions in the question queue, so I'll turn the call back over to management for any additional or closing remarks.

Well thank you. We were pleased to report our best third quarter ever, with a 12% increase in net income for the quarter, driven by a 15% increase in product sales. And we look forward to our next call, tentatively in early May, to report results for the full fiscal year. Thank you for participating in the call.

This does conclude today's conference. Thank you for your participation.