Jul 28, 2008
Executives
Daniel Baker - President and CEO Curt Reynders - CFO
Analysts
Steven Crowley - Craig-Hallum Capital
Operator
Good day everyone and welcome to the NVE Conference Call and First Quarter Results. (Operator Instructions).
At this time I would like to turn the conference over to the President and Chief Executive Officer, Mr. Daniel Baker.
Please go ahead sir.
Daniel Baker
Good afternoon. This is Dan Baker, welcome to our quarterly conference call.
With me on the call is Curt Reynders, our CFO. This call is being webcast live and being recorded.
A replay will be available though nve.com. Our press release with quarterly results and our quarterly report on Form 10-Q were both filed with the SEC in the past hour, following the close of the market and are available through our website.
As always, both filings contain unaudited financials. After my opening comments, Curt will present a financial review of the quarter, I will highlight some business items, and then we will open the call to 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 continued profitability. Risks associated with our reliance on several large customers, risks of quarter-to-quarter variations in revenue and income, uncertainties related to the awarding of future government contracts, 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 as updated in our just filed quarterly report on Form 10-Q.
The company undertakes no obligation to update forward-looking statements we may make. I am pleased to report solid quarterly results; earnings per share increased more than 20% to $0.40 per diluted share, gross margins increased to a record 71% of revenue, and we had record net margin of 39%.
Before I turn the call over to Curt, I want to congratulate him on recently being named, one of the hardest working CFOs by the Minneapolis, St. Paul Business Journal.
Curt has now been on the list in both of the year, since he was promoted to CFO in 2006. Congratulations Curt, and now we will let you get to work discussing the details of our financial results.
Curt Reynders
Thanks Dan, and good afternoon. As Dan said, we had a solid quarter despite a challenging economic environment.
Increased product sales more than offset a decrease in contract R&D revenue. Total revenue for the quarter ended June 30th, the first quarter of fiscal 2009 increased 3% to $4.86 million, our 11th consecutive quarter with a year-over-year revenue increase.
Product sales were $4.55 million, an increase of 7% from the prior year quarter. The increase was due to both the addition of new customers, and increased purchases by existing customers.
This was our 14th consecutive quarter with a year-over-year product sales increase. Contract R&D revenue, which is primarily military-related contracts, decreased 28% to $316,000.
As we had said for several years, our vision is to rely less on contract R&D, as we move towards a vision of a future of commercial products and licensing. Gross margin in the quarter increased to a record 71% of revenue, compared to 69% in the prior year quarter, due primarily to a more favorable mix consisting of a higher percentage of products sales and higher products margins.
SG&A expense decreased 6% primarily due to decreased audit and legal expenses. Research and development expense decreased 24% compared to the first quarter of fiscal 2008; the decrease was due to the completion of certain R&D projects in the past year.
We have said that R&D expense both in dollar terms and as a percentage of revenue could increase as we identify additional product development programs. R&D expense was up 21% sequentially from the immediately prior quarter to 8% of revenue from 5%.
Dan will cover some of the new products that have resulted from our R&D efforts. With increased revenue and decreased expenses, operating income increased to $2.54 million in the quarter.
Net interest and other income increased 15% to $258,000 for the quarter. An increase in interest-bearing marketable securities more than offset a decrease in the average interest rate.
The decrease in average interest rates was primarily due to our shift towards federally tax-exempt investments. Income before taxes for the quarter increased 16% to $2.8 million, compared to $2.42 million for the first quarter of fiscal 2008.
Our effective tax rate decreased to 32% of pre-tax income for the quarter, compared to 34% for the prior year quarter. Our effective tax rate can fluctuate due to a number of factors.
Net income for the most recent quarter increased 20% to $1.9 million or $0.40 per diluted share, compared to $0.33 last year. This was our 25th consecutive profitable quarter and our 11th consecutive year-over-year earnings increase.
Quarterly profitability metrics were quite good. As I mentioned, gross margin increased to 71% of revenue, operating margin was 52%, pretax margin was 58%, and net margin was 39%.
Strong operating cash flow of $3.52 million for the quarter helped continue to strengthen our balance sheet, as cash plus marketable securities increased to $28.2 million. Accounts receivables decreased to $1.17 million in the quarter due to the collection of receivables related to revenue that occurred late in the fiscal year ended March 31st, 2008.
With that I'll turn it back to Dan for his perspective on our business.
Daniel Baker
Thanks Curt. In the past quarter, we expanded our product line, strengthened distribution, and added to our patent portfolio.
I'll cover some highlights. Our products can provide the eyes and nerves of electronic systems, and they are smaller and more precise than conventional electronics.
Our product growth strategy has been new products and broader distribution, and longer term to expand into larger markets such as consumer or automotive electronics. We introduced several new sensor systems last quarter at the 2008 Sensor Test Exhibition in Germany.
We've already seen design wins for the new products that might begin to open promising markets, one is for speed sensor in a wind turbine, another is for an automotive sensor. Earlier this month, we announced the new Coupler family, called the IsoLoop IL500 series designed to be a cost effective optical coupler replacement.
These parts are smaller, have higher channel densities and are more reliable than semiconductor optical couplers. They are the lowest priced couplers we've ever offered, and we believe they could open up a large price sensitive market.
In addition to their attractive price, a patented refreshed clock system ensures the outputs are synchronized to the inputs, which customers have told us is important is some applications to replace optical couplers. We have seven part types of the new family currently in stock and available for purchase, with two more part types planned.
Some of them are available in our unique Micro-Small Outline Package, which we bill as the worlds smallest couplers of their type. As we've discussed before, we see the China as an excellent market for our products, and just this month we added another distributor in China, Shenzhen [Guoqian] Technology Company.
They are particularly strong in the important Guangdong, what used to known as Canton Province in Southern China. In the past quarter, we ran a new promotional campaign, in online and electronic newsletters.
The campaign highlighted the advantages of our spintronic couplers, and was targeted to design engineers in the high performance applications. We are fortunate to have a pipeline of revolutionary technology.
Some of it is in the products I just talked about, some of it applies to emerging technologies such as MRAM, and some is for future products. We were granted three US patents in the past quarter, bringing our total to 48, and our US patent total has doubled in about five years.
The first patent in the past quarter which we mentioned in our last call in May is titled Superparamagnetic Field Sensing device. The patent sites one particularly suitable application as a solid state compass, which could be used as a navigation device in cell phones.
Our second patent is titled, Spin Dependent Tunneling devices having reduced topological coupling, and relates to inventions to improve tunnel junctions, MRAM and other spintronic devices. The third patent, magnetic particle flow detector is related to spintronic biosensor technology, which could be used in laboratory-on-a-chip systems.
In proposed laboratory-on-a-chip systems, magnetic biological marker nano-beads adhere to mobilization surface when a targeted biological agent is present. Spintronic biosensors detect magnetic perturbations from the nano-beads that detect and quantify the presence of very low levels of biological or chemical materials.
We received several defense department contracts in the past quarter. These contracts help replace contracts that have been completed or are being completed, but they don’t change our view which Curt summarized, that our future will be in product sales and technology licensing.
One of the recent contracts was made public by the US Navy. Although it's a relatively small contract, approximately $70,000, it illustrates the range of our technology.
The contract is titled Improved Magnetic Shielding for Electronics, and seeks to demonstrate the feasibility of using spintronic sensors as part of systems to protect superconducting electronics or MRAM. There are a number of potential applications listed in the proposal including medical imaging systems, and protecting people on a mission to Mars.
In addition to the financial information filed in our 10-Q today, we updated legal proceedings and deleted the risk factor related to class action litigation. In the past quarter, the US Court of Appeals for the Eighth Circuit affirmed the District Courts' dismissal last year of a shareholder lawsuit that began in 2006.
The ruling supports our long-standing position that the lawsuits were wholly without merit. We've scheduled our annual shareholders meting for August 7th.
Our materials, our proxy statement letter to shareholders and Annual Report on Form 10-K have been filed with the SEC and are available on nve.com. Institutional shareholder services and others evaluate our governance practices after we file our proxy.
As evidence of our commitment to good governance, NVEs ISS Corporate Governance Quotient stands at 98.4%, meaning our Corporate Governance Quotient is better than more than 98% of the company's in the CGQ universe. For good corporate practice, our entire Board stands for election every year.
We feel fortunate to have an exceptionally well-qualified Board of Directors. For example our Chairman, Terrence W.
Glarner recently, once again made the Minneapolis St. Paul Business Journals list of hardest working Board members.
Terry has been a frequent member of the annual list. My letters to shareholders that is part of our Annual Meeting materials highlights our financial performance for fiscal 2006 through 2008, the period covered by our 10-K.
In just that two-year period, our product sales more than doubled and earnings per share more than tripled. Now I'd like to open the call for question.
Robbie?
Operator
Thank you. The question-and-answer session will be conducted electronically.
(Operator Instructions). And we'll take our first question from Steven Crowley with Craig-Hallum Capital.
Steven Crowley - Craig-Hallum Capital
Good afternoon gentlemen.
Daniel Baker
Good afternoon, Steve.
Steve Crowley - Craig-Hallum Capital
A question for you. Curt you mentioned that you were facing some challenges given the macro economy and difficult macroeconomic conditions.
Can we talk about some of the areas where that negatively impacted you in Q1 here and where are you facing particular headwinds?
Curt Reynders
Sure, Steve. We were pleased to report strong results despite the challenging economic environment.
Our medical market held up well during the quarter, but the industrial market appeared weak with the weak economy.
Steve Crowley - Craig-Hallum Capital
And are there particular applications or segments that were particularly hard hit. I know there has been some weakness in certain segments of kind of industrial automation, factory control, but are there other neighborhoods that you are particularly sensitive to?
Daniel Baker
This is Dan. I think you put your finger on it Steve.
Factory automation such as automotive manufacturing appears to be relatively weak in the short-term. In the longer term, we see a bright future in both medical and industrial and longer-term in consumer automotive.
But, the macroeconomic picture appears to be particularly challenging in factory automation and industrial.
Steve Crowley - Craig-Hallum Capital
And do you think that, those challenges linger for a number of months or a number of quarters? What's your best guess at that?
Daniel Baker
Well, short-term it's hard to predict as you probably know. It's depends on factors beyond our control.
Our goal has been to expand into large fast growing markets such as consumer automotive, and to decrease our dependence on industrial and factory automation. But, in the long run, factories continue to automate.
There continues to be investments in factory and advanced industrial controls. But, it appears that there might be some short-term challenges there, and it's just difficult to predict how long they might last.
Steve Crowley - Craig-Hallum Capital
Now, in terms of one of the other things that jumped out from your prepared comments, and I don’t know if this was just the standard line referencing the addition of new customers as a contributing factor to your sales growth. But is there any color you can give us as to the type of applications that have begun to ramp, and the areas where these new customers operate?
Daniel Baker
Sure. We've had a number of design wins, but in recent months, well we mentioned an automotive supplier, we mentioned a wind power generator.
Wind power generators are a type of industrial control, but one in which is there is fair amount of investment going on. So that’s an area that we feel has excellent growth potential, particularly in Europe.
We have a design win with a large industrial control company in Europe. We have one for telecommunications infrastructure.
One for high-end audio interface; and we have a number of customers who are evaluating our parts, particularly some of our newer parts. We can't count them as design wins, but, in general I think we've received very positive feedback about our new products, about the smaller products, particularly our nanopower sensor which is about a millimeter square, it was introduced at the conference last month.
So, we feel good about the traction that we are gaining in new customers.
Steve Crowley - Craig-Hallum Capital
You reference the solid state compass application. Is that still a developing application or you've gained some traction already with some initial implementations or plans to implement that product.
Daniel Baker
Well, it's in development but it's in cooperation with customers. So, it's not just the laboratory effort.
The efforts that we are working on now are to miniaturize and customize the compassing sensors. So, we demonstrated the capability to compass accurately and to handle three [axes].
One has to be able to tell not just the rotation, the direction, but also the rotation, the (inaudible) if you will. The rotation up and down.
So it's three [axes], a sensing problem, a fairly complicated problem. And I think we are very pleased with the progress that our engineers have made on that front, and now it gets into the specifics of integrating it into a particular system of miniaturizing it, customizing it for needs of particular customers.
So, it's going along pretty well.
Steve Crowley - Craig-Hallum Capital
Great. Final question and then I'll jump in the queue.
You did a great job with profitability, both in terms of gross profitability and then holding the line on expenses. How much of this is sustainable?
Are you going to really crimp down on expense growth, SG&A growth going forward, until the macroeconomic situation clears up, and was there much that was anomalous in the gross profit margin, profitability of the business in Q1?
Daniel Baker
Well, as you know, we work pretty hard to maximize our margins, but we are careful not to sacrifice R&D, which we believe is the long-term future of the company. So, we have said that, R&D expense, both in dollar terms and as a percentage of revenue could increase, and obviously we want a pay-back on those investments, but, we did increase our R&D expense, it was down year-over-year, but it was up sequentially, as I think Curt mentioned in his remarks, a little bit over 20% sequentially from our fourth fiscal quarter, up to 8% of revenue.
On the G&A front, in general we try to hold the line on the G&A part of SG&A. Our sales expenses do tend to go up as we promote our products and expand our distribution, and we continue to work hard to maximize our margins.
The mix toward product sales helps, but also we consider our products premium products. We don’t want to commoditize them; we don’t want to compete with lower cost products directly.
So, in general, we try to maintain our prices. We [didn’t] introduce a new product line, a lower cost productive, the IL500 and we'll continue to do that.
Those could lower average gross margins longer, but we believe that, that will pay back by expanding our market and by allowing us to gain additional economies of scale.
Steve Crowley - Craig-Hallum Capital
Great. Well thanks for taking my questions.
I'll let some other folks ask some and hop back in the queue. Thanks.
Daniel Baker
Thanks, Steve.
Operator
Thank you. (Operator Instructions).
We'll go back to Steven Crowley with Craig-Hallum.
Steve Crowley - Craig-Hallum Capital
Well guys I was serious about hopping back in the queue, but I do have a few more questions. I just didn’t want to monopolize the time from other folks.
In terms of your contract R&D business, coming out of last quarter, you talked about an objective, a challenge to keep that business relatively stable, flat on a year-over-year basis. You started out the year with a bit of a decline, but I know this business is lumpy.
What's the right way for us to think about the Contract R&D business? I had a trailing off of about 20% year-over-year, but I guess I'm looking for a bit of a temperature check on your outlook there.
Curt Reynders
Sure. Steve, Contract R&D revenue can fluctuate from quarter-to-quarter due to timing and amount of contract awards.
Contract R&D revenue is mostly really to government contracts and depends on a number of factors beyond our control. As we have said, our strategy has been to reduce our dependence on Contract R&D, the future products and licensing and as our principal revenue sources.
Steve Crowley - Craig-Hallum Capital
So that’s good flavor, but I don’t know if it really helps me determine whether or not something in the 20% below last years $2 million or whether or not it's plausible that you could achieve a similar kind of result in that business as a year ago. What kind of visibility do you have or do you think that kind of encapsulates the range of outcomes?
Daniel Baker
This is Dan. We do have some visibility.
I think I mentioned in our prepared remarks that we received several DoD contracts in the past quarter, but we view them as helping to replace contracts that have been completed or are being completed. We have a continuous flow of contracts, and so the trick is, some of them are expiring or being finished and then we add more.
And it's hard to see if the top of the funnel is less than the bottom of the funnel, and it can bounce around in the near-term. I think as Curt said, our long term view really hasn’t changed, which is that, our future isn’t going to be a Defense Department research contractor, it's going to be in product sales, technology licensing, and we see those as more scalable and more profitable.
So, our goal is to maintain the business and be selective about the contracts that we receive, to help build our R&D and our intellectual property portfolio. But in general, we don’t measure ourselves by the amount of the contracts, and we view it as a way to boost our R&D as opposed to a way to grow our company.
Steve Crowley - Craig-Hallum Capital
Makes sense. Now you referenced in your prepared commentary or in the response to one of your questions to me that, the medical business performed largely consistent with your expectations or wasn’t where you saw the impact obviously of macroeconomic factors.
What else can you tell us about the medical business? Do you continue to add your customer set there?
The applications that your products are serving, whatever color you can give us there would be appreciated?
Daniel Baker
Sure. As you know.
St. Jude Medical is a cardiac rhythm management company.
So they make ICDs and pacemakers. That’s one of our strong markets.
Hearing aids is another. The long term outlook for CRM Cardiac Rhythm Management devices appears bright.
There have been some product recalls in past years that may have hurt ICD growth rate, but, some believe that patient pollutions remained under penetrated by ICDs, and there are conditions that might benefit ICDs that are not currently labeled, such as atrial fibrillation and congestive heart failures. And furthermore, long-term, as the population ages, more people are likely to need devices in the markets we serve such as pacemakers, ICDs and hearing aids.
So, we continue to work on expanding our penetration within the markets that we serve now. We've highlighted pacemakers, ICDs and hearing aids.
We also see an excellent opportunity in non-life support neurostimulators. And there has been some customer activity on that front, nothing specific that I can talk about.
But in general the same advantages that we have in pacemakers and CRM; high reliability, small size, long battery life, those are also excellent advantages in non-life support systems. So, we feel very good about that market.
Both in our opportunities to expand our penetration in existing markets, in additional markets and then just the inherit growth rates, the organic growth rates caused by the population demographics, and additional disease conditions that can be treated by these devices.
Steve Crowley - Craig-Hallum Capital
Great. Well thanks again for taking my questions, and I'll circle back with you offline.
Daniel Baker
Thanks, Steve.
Operator
(Operator Instructions). And it appears we have no further questions over the phone at this.
I'd like to turn the program back over to Mr. Baker for any additional or closing comment.
Daniel Baker
Thank you, Robbie. And again we were pleased with our strong results for the quarter.
Record growth in that margins. EPS up more than 20%.
We hope to see some of your Annual Shareholders Meeting, August 7th, and we look forward to speaking with you again in October, when we report second quarter results. Thank you again for participating in this quarters' call.
Operator
That does conclude today's call. You may disconnect your lines at this time.