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NVE CEO Discusses F3Q2011 Results – Earnings Call Transcript

NVE Corporation (NVEC) F3Q2011 Earnings Call January 19, 2011 5:00 pm ET

Operator

Good day, ladies and gentlemen, and welcome to NVE conference call on second quarter results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) And as a reminder, today’s call is being recorded. At this time, I would like to turn the conference over the host, President and CEO, Dan Baker. Please begin sir.

Dan Baker

Thank you and good afternoon. Welcome to our conference call for the quarter ended December 31, 2010, the third quarter of fiscal 2011. As always, I am joined by Curt Reynders, our Chief Financial Officer. This call is being web-cast 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 and nine months. I’ll highlight some business items and highlights of calender 2010, 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 and revenue and profit, uncertainties related to agreements with large customers, uncertainties related to research and development contract funding, risks related to developing marketable products, uncertainties relating to the revenue potential of new products, and uncertainties relating to economic environments as well as the risk factors listed from time-to-time in our filings with the SEC, including our most recent annual report on Form 10-K as updated on our quarterly reports on Form 10-Q, including our quarterly report on Form 10-Q filed this afternoon. The company undertakes no obligation to update forward-looking statements we may make.

We’re pleased to report record product sales 26% higher than last year. The record product sales drove a 20% increase in total revenue and a 22% increase in net income to $0.70 per diluted share.

Now, I’ll turn the call over to Curt to cover details of our financial results.

Curt Reynders

Thanks Dan, and good afternoon. As Dan mentioned, total revenue for the quarter increased 20% to $7.96 million. The increase was due to a 26% increase in product sales, which more than offset a 4% decrease in contract R&D revenue. Product sales were $6.69 million driven by strong sales into industrial markets. Record product sales were despite our history of the December quarter, our third fiscal quarter, being the weakest quarter of the fiscal year. Until last year, our product sales had been less in the third quarter than the second quarter every year since fiscal 2005.

There was a sequential increase last year and a 4% sequential increase this year. The departure from seasonal weakness is encouraging and may be due to increased sales to existing customers, new customers, or improving economic environments, overcoming adverse seasonal patterns such as distributor ordering or customer shutdowns late in the calendar year. The slight decrease in quarterly contract R&D revenue from $1.33 million to $1.28 million was due to the completion of certain contracts and contact activities. Dan will talk more about contract activities in a few minutes. Gross margin increased to 69% of revenue, compared to 68% in the prior year quarter due to a more profitable revenue mix with a higher portion or product sales.

Total expenses increased 21% for the third quarter of fiscal 2011, compared to the third quarter of fiscal 2010 due to a 16% increase in selling, general, and administrative expense and a 31% increase in research and development expense. The increase in selling, general, and administrative expense was due to an increase in performance-based compensation and commissions and the timing of professional services. The increase in research and development expense was due to increased product development activities. Operating income, which is gross profit less expenses, increased 22% compared to the third quarter of fiscal 2010 to $4.3 million to $4.53 million and operating margin was 57%.

Interest income increased 24% to $512,000 for the quarter due to an increase in interest-bearing securities. Income before taxes, which is operating income plus interest income, for the quarter increased 22% compared to the third quarter of fiscal 2010 to $5.05 million, and pre-tax margin was 63%. Taxes were 33% of income before taxes for the quarter, the same as last year. Net income from the last quarter increased 22% to $3.38 million, or $0.70 per diluted share compared to $0.57 last year, and that margin was 42%. For the first nine months of the fiscal year, total revenue increased 15% to $23 million. Diluted net income per share increased to $2 for the first nine months of this fiscal year compared to $1.73 for the same period last year.

Operating cash flow strengthened our balance sheet primarily due to $8.95 million of cash flow from operations. Cash plus marketable securities was $58.3 million as of December 31, an increase of $8.77 million in nine months. A $2.89 million increase in short-term marketable securities in the first nine months of fiscal 2011 was due to marketable securities previously classified as long-term approaching maturity. We expect short-term securities to increase over the next several quarters as more securities approach maturity. Accounts receivable decreased $750,000 due to the timing of payments by our customers. Purchases of fixed assets stood at approximately $502,000 through three quarters of the fiscal year primarily for production equipment to expand our capacity. Now I’ll turn it over to Dan for his perspective on our business.

Dan Baker

Thank you, Curt. I’ll cover customer and distribution agreements, R&D, and some highlights of 2010. We were pleased to have recently extended our supply agreement with Phonak AG. The agreement applies to Phonak and the entire Sinoca Group which specializes in hearing and wireless systems and is a worldwide leader. The Phonak amendment is pursuant to a letter of intent we discussed previously. The amendment extends our supply agreement through – extends the terms through March 31, 2015, expands NVE products under the scope of the agreement, and provides for minimum purchases by Phonak. We filed the amendment and the agreement with the FCC and they are available on the FCC’s website or via our website. Risks related to the expiration of the agreement were updated in the 10-Q filed today.

In the past quarter, we strengthened our distribution in Asia. CS Company Limited has joined NVE’s world-class distribution network and will provide sales, marketing, and application support for isotope isolators in Korea. NVE’s award-winning products are available in more than 75 countries, and our distributors speak countless languages, including Korean.

We had previously reported shipping tested spintronic compass samples to a customer in the September quarter. We shipped additional samples in the most recent quarter, and look forward to customer feedback. As we said, our goal is to offer best- in-class accuracy as well as low-power consumption, and small size. In addition to those samples, in the past quarter we continued work on a research contract from the National Science Foundation to the goal of reducing the size of sensors with applicability to navigation and consumer electronics. In addition to determine direction, solid state compasses generally require a measure of tilt, which increases the sensor size by requiring a perpendicular sensor. The goal of our research is further miniaturization with a novel, third active sensor.

We’ve done a significant amount of research into MRAM for many – MRAM is Medtronic Magnetoresistive Memory, which is fabricated with nanotechnology and which uses electron spin to forward data. As a result of those efforts, just last week we were granted a new patent titled Vortex Spin-momentum Transfer Magnetoresistive Device. The patent discusses, among other things, nanopillar devices, spin-momentum transfer, and magnetic tunnel junction with applicability to magnetic memory devices, or MRAM. The invention was made with government support under a contract awarded by the Missile Defense Agency. This is an example of value created by our government contract, and under federal legislation companies normally may retain the principal worldwide patent rights to any invention developed with U. S. government support. Our MRAM strategy is to license our technology for large-scale memories rather than build them ourselves. Our goal is to build innovative small-scale anti-tamper MRAMs ourselves however, and to use what we learned from their development to strengthen our MRAM technology portfolio as we did with the new patent.

As we begin calendar 2011, I’d like to summarize highlights from a very successful 2010. We had year-over-year increases in revenues and earnings each quarter, we received patents relating to MRAM, file sensors, couplers, and magnetic sensors, we introduced world-class products including several new spintronic couplers for controller-area networks, and new medical device sensors. We expanded our production space. We expanded distribution to China and Korea, and our stock price increased more than 40%.

Our exceptional growth and innovation was recognized with several prestigious awards and accolades in 2010, including one of America’s 100 best small companies for 2010 according to Forbes, a top-five semiconductor company according to The Street, one of the top 100 largest Minnesota-based public companies for the first time, according to the Star Tribune, one of Minnesota’s fastest growing public companies as ranked by the Minneapolis St. Paul Business Journal, and a product-of-the-month awarded by a German trade magazine for NVE magnetic switches. There are links to more information about this and other recognition on the awards and accolades page of nve.com. Now I’d like to open the call for questions.

Operator

Thank you, sir. Ladies and gentlemen on the phones (operator instructions). Our first question comes from Steven Crowley – Craig-Hallum Capital with Craig-Hallum Capital.

Steven Crowley – Craig-Hallum Capital

Good afternoon Dan and Curt.

Dan Baker and Curt Reynders

Good afternoon, Steve.

Steven Crowley – Craig-Hallum Capital

Congrats on having a great quarter.

Dan Baker and Curt Reynders

Thank you.

Steven Crowley – Craig-Hallum Capital

A few questions. In terms of the contract R&D business, you spent a little time on the prepared comments talking about how that can be quite productive downstream in your product development and your product sales. There has been a little bit of variability in that business line year-to-date. It seems to have stabilized in the $1.2 to $1.4 million range in the last two quarters. What can you tell us about the pipeline for those projects, and what kind of revenue component we should plan on from that segment of your operations?

Dan Baker

Well, Steve, we don’t have specifics to provide but as you know our contract R&D revenue can fluctuate depending on timing and availability of awards, as well as follow-on funding. Follow-on funding is dependent on results, and we have had some promising results on certain contracts which has enabled us to receive additional funding.

Steven Crowley – Craig-Hallum Capital

Okay, well that sounds encouraging that we shouldn’t be expecting a big drop-off in that business to say the least, or how should we think about that new component? As this year it’s progressed, clearly the baton for growth has been passed to the product side of the business, and that seems to be appropriate but it doesn’t sound like there’s a slippery slope on the contract R&D side?

Dan Baker

Well, as we have said in the past, our vision is to increase the product sales and rely as much on contract R&D. We do pursue R&D contracts in strategic areas, and we have seen this year, we have seen some additional funding from those efforts.

Steven Crowley – Craig-Hallum Capital

Now in terms of your product sales that had a very good quarter, you pointed out the industrial side of your business, but can you tell us a little bit about the performance of the medical side of your business? Was it solid? Was it dampened by any strange factors that appeared? How would you characterize it?

Dan Baker

We were pleased with our sales into the medical sector, Steve. When we were commenting on the excellent year-over-year growth, particularly in a historically weak quarter, I think we found the industrial market has recovered pretty well, and that may have been the reason for the reversal of the seasonal pattern, and we’re seeing some signs of improvement in the manufacturing economy, which is very encouraging. But I think we were pleased with our results across the board including our sales into the medical markets.

Steven Crowley – Craig-Hallum Capital

On the industrial side, besides some maybe encouraging macro trends, have you seen acceptance of some newer products like the controller-area network stuff, or some new applications via a noticeable component of your success in that market?

Dan Baker

We have seen some excellent interest in the controller-area network products and other new products, such as the new sensors in the very small packages that I alluded to when we talked about the calender 2010 accomplishments, and so we were pleased with that. We’re seeing some strength in manufacturing automation, as I alluded to, and we’re also seeing some strength in environmental controls, which is a very fast growing area, that would be controls that help save energy, that support some alternative energy systems such as solar and wind power, where efficiency and converting that energy into electricity is becoming more and more important. So those would be the ones that I’d highlight.

Steven Crowley – Craig-Hallum Capital

Interesting. Now in terms of the response you’ve had to the electronic compass products that you’re sampling, what kind of color can you give us there as to whether or not it’s been a response in the clear path to initial production volume, orders, or whether it’s in a pack of numerous companies who are just nibbling on the idea, how can you help us understand what’s going on out there with the test drive of your sample products?

Dan Baker

Well we have a particular customer that we shipped these samples to both in the September quarter and the most recent quarter that I alluded to in our prepared remarks, and they’re a company that specializes in modules for the cell phone and handset markets, so we see that as a promising market. We see additional markets for precise navigation, and we’re looking at evaluating, along with our customer, our prospects there. But as we said, our goal is to leapfrog available technology with size, power, and particularly precision, or the angular accuracy of the compass, and we continue to see that as a very promising area, and we’re very pleased with the performance of the device, and based on the feedback from our customer, we continue to be very pleased with how that’s going and with the quality of the product that our R&D team has designed.

Steven Crowley – Craig-Hallum Capital

Great. My final question in this (inaudible). I’ll get into queue and maybe come back is I noticed in the balance sheet detail that there was a noticeable increase in raw material purchases within inventory. Are those kind of purchases more geared towards new products or just higher volumes anticipated in existing products, and maybe talk a little bit about what goes in your thought process for doing that.

Dan Baker

Steve, it’s really both new products as well as some our legacy products. The increase in raw materials is partly due to purchase timing as well as to support our increased product sales, and also we’ve been able to take advantage of some volume discounts.

Operator

(Operator instructions). We have a follow-up from Steven Crowley – Craig-Hallum Capital from Craig-Hallum.

Steven Crowley – Craig-Hallum Capital

Well guys, I didn’t expect to be with you that quick, but I didn’t want to miss out because there are some other things I wanted to ask about. You mention that the professional services component of your expense mix went up a bit this quarter, and I’m wondering what that correlates with, what kind of activities at the company do you utilize those professional services for?

Dan Baker

Basically, Steven, it can relate to timing to our audit fees as well as some of our legal fees related to patents. We find that they can vary just depending on the timing of the service.

Steven Crowley – Craig-Hallum Capital

Okay. Those don’t sound like they’re kind of outside marketing or outside research and development fees, they’re more on the legal admin side?

Dan Baker

Correct.

Steven Crowley – Craig-Hallum Capital

Okay. In terms of some of the other initiatives, Dan, that you’ve talked about on recent calls, you mentioned continuing plans to begin manufacturing lower density MRAM parts for anti-tamper data security. Where do you sit on that curb in terms of starting up manufacturing and being to market with some parts?

Dan Baker

Well, we’re pleased with our progress there. We’ve reported previously that we’ve made prototypes of devices that have working MRAM bits, and we’re continuing development. We’ve had some limited shipments, I’m not sure I’d classify them as production but more as prototypes or pre-production devices. These would be relatively limited volumes and in specified niche applications initially, but in the prepared remarks we see them as providing a vehicle to develop MRAM technology, and we believe we have excellent technology that’s continually developed, and also as a possible bridge to some large-volume to anti-tamper applications such as to prevent identity theft or improve the security of credit cards and smart cards. So we’re a ways from those types of production, but we’ve made some very good headway on some of these high-value-added niche applications that we’ve talked about and security and protecting high-value targets.

Steven Crowley – Craig-Hallum Capital

It also seems like you’ve established an ability to actually manufacture these parts? So for us outsiders looking in, it seems like if there was a technological risk in your ability to manufacture, it seems like that’s lessened with the progress you’ve made? Is that a fair inference?

Dan Baker

Yeah, I would agree with that. I think there are or have been technological challenges in making MRAM. We’ve overcome many of them, and they are amazing devices to watch them work, to actually see a bit switch, and then you remove the power and the data remains there, and you can power it back up and read the data. So they’re truly remarkable devices that rely on very small, very precise dimensions, and the countable number of atoms or atomic layer range. So we’ve developed processes to make those devices consistently, and to control the critical parameters in their manufacture and so we believe that we’re very well positioned there.

Steven Crowley – Craig-Hallum Capital

Great, and in terms of the one of new products and new applications that you talked about, there is an application in the in-vitro diagnostic world. Are there any updates or changes in that opportunity and/or its potential timing with that next generation IVD systems?

Dan Baker

We continue to prepare for production planned for later this year or late 2011, and we believe we’ve developed excellent biosensor technology. You’re referring to a particular design that we’ve talked about before, but we continue to develop that type of technology. We see other markets, but in that particular opportunity, we continue to prepare for planned production late this year.

Steven Crowley – Craig-Hallum Capital

Great, one final question from me. We don’t get to talk to you about this stuff very often. I asked about controller-area networks earlier. It seemed like you’d received a pretty good response from customers. If I recall the game plan there, the initial application is oftentimes on the factory floor and the factory automation, but the longer- term vision is in some of those factors making automobiles for those parts to work their way into the vehicle. What can you tell us about how your thinking has evolved in terms of the role they can play in either conventional or hybrid or electric vehicles and if you’re making progress on that front?

Dan Baker

We continue to see an excellent opportunity in hybrid electric vehicles. There aren’t a lot of hybrid electric vehicles being built right now, but there is a lot of interest in that, and some exciting new vehicles that have been recently introduced and so we see that as an excellent growth area, and we continue to see interest particularly in the battery management systems of hybrid electric vehicles. Managing those systems is key to improving the efficiency and range of the vehicle, and that’s a key to their success. So our devices allow the battery systems to communicate with a central control system without having a direct electrical connection, and because hybrid electric vehicle batteries might be several volts, it’s really not possible to have a direct connection way of without destroying the central control system. So we continue to see interest in hybrid electric vehicles, and in this particular subset, which is the battery management system and the communication between the battery monitoring systems and the central control system to improve their efficiency. So we’re working on that, we’re working on trying to address that market, to address the market needs, to address the certifications and qualifications that are required for the automotive market, and as you’ve correctly pointed out, that’s a longer term market for us but we continue to work on that and to position ourselves for when hybrid electric vehicles become more mainstream.

Steven Crowley – Craig-Hallum Capital

Is your approach to market pretty analogous to what you’re trying to do in wireless, to try and find a tier-one or a high-level supplier to that marketplace and win them over as a sponsoring customer that brings the functionality to the end-customer?

Dan Baker

Yeah, exactly. We see that as an excellent strategy in the automotive market as well as the handset market that you alluded to. It’s very difficult for companies to qualify as a supplier to the automotive market and we believe that an excellent path would be to partner with a company that’s already qualified and that has experience with dealing with dealing with the automotive market that can help us with the certifications and the testing and the qualifications that will be required for mass production. So we’re exploring relationships with that, like that, and hopefully we’ll have something more to report on that somewhere down the road.

Steven Crowley – Craig-Hallum Capital

Great, we look forward to it. Thanks for taking my questions.

Dan Baker

Thank you, Steve.

Operator

Our next question come from Greg Greenberg – Wells Fargo Advisors with Wells Fargo Advisors.

Greg Greenberg – Wells Fargo Advisors

Just a few questions to issue. One, I want to see if there’s any update to your relationship with Everspin with regards to intellectual property, licenses, or legal? And then sort on a related as far as capital allocation goes, it has been my understanding that you’re sort of building a war chest of cash to defend your intellectual property. So a little bit of what’s enough, and whenever we hit that number, what do we do with all these great profits that you guys are generating and continue to grow to benefit shareholders.

Dan Baker

Okay, good questions. First, with regard to Everspin, Everspin is a company that’s making and selling commercial MRAM and they’re a spinoff of Prescaler, which was a spinoff of Motorola, so we have a long historical relationship. Motorola was an early investor in NVE, and we had research contracts and intellectual property agreements with Motorola, so we believe that they share our vision for a very bright future for MRAM. They’re probably – if you were alluding to the relationship or intellectual property, it’s probably inappropriate to comment on the specifics other than we believe that they share our vision for the bright future for MRAM. They recently have talked about the potential for spin-momentum transfer MRAM and we’ve talked about that for a while. While we believe we have excellent technology in that field, that’s a type of MRAM that has a promise of reducing the cell size and increasing the efficiency, decreasing the power of MRAM, which could help make large-scale MRAM successful in the long-term.

In terms of balance sheet, we continue to strengthen our balance sheet which we believe is helpful in defending our intellectual property against potential infringers. We don’t have a specific target or anything like that for what the balance sheet needs to be. We believe that a strong balance sheet is important for us to be successful in the intellectual propriety segment of our business. We have a program, a stock buyback program that we’ve announced previously, so under certain circumstances we could buy back stock, and that would be one use for the cash and marketable securities on our balance sheet.

Greg Greenberg – Wells Fargo Advisors

To date, have any shares been purchased under that program?

Dan Baker

Not to date.

Greg Greenberg – Wells Fargo Advisors

Okay, thank you.

Operator

Our next question comes from John Young – Trailhead Assets with Trailhead Assets.

John Young – Trailhead Assets

Hello?

Dan Baker

Yes, sir, go ahead please.

John Young – Trailhead Assets

Just wanted to comment We appreciate the efforts. Do have anything you can tell us about customer concentration in the quarter and the nine months?

Dan Baker

As far as customer concentration, we do sell worldwide. Last fiscal year we reported that about 49% of our sales were international. So we’re reaching all over the world. As far as specifics for the quarter, we don’t have any specifics to report at this time.

John Young – Trailhead Assets

So no customers that were over 10%?

Dan Baker

We report 10% customers in the 10-K, the annual report, which is where they’re reported, and we don’t update those quarterly because they’re not part of the 10-K requirement.

John Young – Trailhead Assets

Okay.

Dan Baker

We have talked about some important customers. I mentioned Phonak AG, we’ve talked about other important customers. Because of confidentially, we don’t say what percentage they are or whether that’s going up or down. But we are pleased to have customers who are leaders in their field, leaders in their industry, and very demanding customers. I think it’s a great validation of the technology and quality of products that are employees make.

John Young – Trailhead Assets

Thank you.

Dan Baker

Thank you.

Operator

I’m showing no further questions on the phones.

Dan Baker

Well in that case, I can sum up we were pleased to report record product sales for the quarter, and we look forward to our next call, which is tentatively in early May to report results for the full fiscal year. Thank you for participating in this call.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program, and you may now disconnect. Have a great day.

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