Jan 21, 2009
Executives
Daniel A. Baker, President and Chief Executive Officer; Director Curt A.
Reynders, Chief Financial Officer
Analysts
Steven Crowley - Craig Hallum Bob Mitchell - Conestoga Capital
Operator
Good day, everyone, and welcome to the NVE conference call on 2009 fiscal year third quarter results. Today's conference is being recorded.
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
The company undertakes no obligation to update forward-looking statements we may make. I'm pleased to report record earnings in our best third quarter ever.
Total revenue increased 23%, including a 150% increase in contract R&D revenue. Net margin was an extraordinary 42%, and earnings increased 44% to a record $0.52 per diluted share.
Curt Reynders
Thanks, Dan, and good afternoon. As many of you know, the third fiscal quarter is historically our weakest quarter of the fiscal year.
Despite that, and despite an apparently significant quarter-on-quarter decline in the semiconductor industry, we had record earnings -- our best third quarter revenue ever and our 13th consecutive quarter of year-over-year earnings increases. Revenue for the quarter ended December 31, the third quarter of fiscal 2009, increased 23% to $5.88 million due to an 8% increase in product sales and a 150% increase in contract R&D.
The increase in product sales was due to both the addition of new customers and increased purchases by existing customers. As we also noted in the first two quarters of the fiscal year, strength in the medical device market in the most recent quarter more than offset weakness in the industrial market.
The industrial market appears to be suffering from the weak macroeconomic environment, particularly the worldwide manufacturing slowdown. Despite the challenging environment, this was our 16th consecutive increase in year-over-year product sales.
We had a remarkably strong quarter in contract R&D, despite a tough funding environment. We are particularly pleased with the interest in our anti-tamper and anti-tamper MRAM technologies.
Dan will discuss a new patent on an invention in this area. Gross margin in the quarter increased to 70% of revenue compared to 66% in the prior-year quarter.
The increase was due to higher margins on both product sales and contract R&D revenue. Research and development expense decreased 25% compared to the third quarter of fiscal 2008.
The decrease was due to the completion of certain R&D projects in the past year and the increase in funded R&D, which tends to pull resources from company-funded R&D to customer-funded R&D. Because we receive revenue for these activities, customer-funded R&D is included in cost of sales.
We have said that R&D expense, both in dollar terms and as a percentage of revenue, could increase, as we identify additional company-funded product development programs. With the increased revenue, increased gross margins and decreased expenses, operating income increased to $3.35 million in the quarter.
Interest income increased 18% to $307,000 for the quarter due to an increasing in interest-bearing marketable securities. Other income in the prior-year quarter consisted primarily of a $61,000 net gain on maturities and sales of federal taxable marketable securities.
We had less than $1,000 in other income for the most recent quarter. Income before taxes for the quarter increased 42% to $3.66 million compared to $2.59 million for the third quarter of fiscal 2008.
Our effective tax rate was 33% of pretax income for the quarter compared to 34% for the prior-year quarter. Net income for the most recent quarter increased 45% to $2.47 million or $0.52 per diluted share, compared to $0.36 last year.
In addition to the strong gross margin of 70%, other quarterly profitability metrics were all records. Operating margin was 57% of revenue; pretax margin, 62%; and net margin, 42%.
For the first nine months of the fiscal year, total revenue increased 14% to $16.5 million, driven by a 9% increase in product sales and the 49% increase in research and development revenue, compared with the same period in fiscal 2008. Diluted net income per share increased to $1.40 for the first nine months of this fiscal year from $1.04 for the same period last year.
Strong operating cash flow of $7.4 million for the first nine months helped continue to strengthen our balance sheet, as cash plus marketable securities increased to more than $32 million. Capital expenditures were $401,000 in the first nine months of fiscal 2009 compared to $642,000 in the same period last fiscal year.
Most of the expenditures were for sputtering machines, which deposit the very thin layers used in our products. The new machines will increase our capacity and further our goal of continually improving our manufacturing efficiency.
We also added a piece of analytical equipment and installed a much larger storage tank adjacent to our building. The silver lining of the current economic slowdown is that we've been able to purchase equipment at favorable prices.
Lastly, in light of our continued excellent financial results, our strong balance sheet, and current market conditions, our Board of Directors has authorized a stock buyback. Information about the buyback is in the press release issued today and disclosed in our current report on Form 8-K filed today.
Now I'll turn it back to Dan for a review of our products and technology, and a summary of 2008.
Daniel Baker
Thanks, Curt. As we’ve said before, we summarize our product advantages with four B's, boxes, or a small footprint; bps, more precise; bulletproof inherent reliability; and batteries, meaning low power and long battery life.
Highlighting the first and third B's, boxes and bulletproof, in the past quarter, we announced that our Micro-Small Outline Package, or MSOP, couplers were approved by the International Electrotechnical Commission for standard 120 volt applications. And they're rated at a remarkable 2.3 kilovolts of isolation.
The devices are less than an eighth of an inch square, and we build them as the smallest isolators of their type. To meet IEC requirements, we developed a custom test system that checks each part at more than 2.3 kilovolts, which is the equivalent of more than 1,000 flashlight batteries.
Last month, the new IsoLoop IL-500 Series couplers were named the Hot 100 Product of 2008 by EDN, a leading electronic design publication. According to EDN, the annual listing highlights the electronic industry's most innovative and significant products.
Also in the past quarter, we introduced a new member of the IL500-Series, the IL515, which is the unique four-channel part with an output enable and external clocking option. There is more information on the new part on nve.com or isoloop.com.
The IL500-Series is designed to be cost-effective optocoupler replacements that are smaller, have higher channel densities, and are more reliable than semiconductor optical couplers. We now have nine part sites in the new family.
IL500 parts are available on our online store and through distributors, such as Digi-Key. Finally, rounding out an exceptional period for product announcements, earlier this month, we introduced a new Giant Magnetoresistive current sensor.
The new device is less than one-tenth of an inch square, and has superb accuracy. Current sensors are used in a wide range of industrial and instrumentation applications, such as motor control.
We're fortunate to have a pipeline of revolutionary technology; some of it is in the products I just talked about and some is for future products, such as laboratories-on-chips. Looking to the future, we were granted two patents in the past quarter.
The first patent is titled Method for Detecting Magnetic Particles in a Fluid Using Thin Film Magnetic Field Sensor, and is related to spintronic biosensor technology, which could be used in laboratory-on-a-chip systems. In proposed laboratory-on-a-chip systems, spintronic sensors detect magnetic [inaudible] from nano-beads with biological markers when a targeted biological agent is present.
This can detect and quantify the presence of very low levels of biological or chemical materials. Our sensors have been tested with one micron diameter nano-beads, that's about one five million the size of a BB gun pellet.
An article the past quarter in the Journal of Analytical Chemistry summarizes recent developments of laboratory-on-a-chip systems. There is a link to the summary article on the In the News section of our website, and links to two detailed papers from the Papers and Presentations section of our website.
We've worked with universities to create a device that Professor Marc Porter of the University of Utah says can ultimately serve as the reader for what is envisioned to be, quote, a wellness card a disposable coupon that would diagnose specific diseases from a drop of saliva or a pinprick of blood. Professor Porter and his colleagues demonstrated remarkable sensitivity, the ability to accurately detect as few as 800 binding events.
And we have a number of other patents related to spintronic biosensor technology. The second patent granted in the past quarter is titled Enclosure Tamper Detection and Protection, and relates to MRAM for anti-tamper applications.
As we've said before, we see anti-tamper as a promising application for MRAM. The two new patents bring the number of U.S patents issued and assigned to us to an even 50.
We also have a number of foreign patents, a number of U.S and foreign patents pending, and patents licensed from others. So, NVE technology is protected by more than 100 patents worldwide, either issued, pending, or licensed from others.
As we begin calendar 2009, I'd like to summarize highlights from a very successful 2008. We delivered strong financial performance with year-over-year increases in revenues and earnings each quarter, despite an apparent decline in the worldwide semiconductor market in 2008.
We introduced new world class products, including the award winning new series of couplers and a new family of sensors smaller than the head of a pin. We installed new equipment to expand our production capacity, and we added five U.S patents in 2008, including patents applicable to solid-state compassing, MRAM, anti-tamper MRAM, and laboratory-on-a-chip technology.
Our strong performance was recognized with MBE names at two prestigious national lists for 2008, Forbes' 2008 list of 200 Best Small Companies; and Deloitte's 2008 Technology Fast 500. The Forbes list is based on return on equity, sales growth and profit growth over the past 12 months and also over five years.
The Fast 500 ranks North America's fastest growing technology, media, telecommunication, and life sciences companies based on percentage revenue growth over five years. There are links to more information on these and other lists on the Awards and Accolades page of NVE.com.
Now I'd like to open the call for questions. Operator?
Operator
Thank you, sir. (Operator Instructions).
Steven Crowley, with Craig Hallum.
Steven Crowley - Craig Hallum
Good afternoon gentlemen.
Daniel Baker
Good afternoon Steve.
Steven Crowley - Craig Hallum
Congratulations. Fantastic performance in a pretty challenging macroeconomic context.
Obviously, one of the stars of the quarter was the contract R&D business. And I know historically, you've spoken to the volatility of that business and some inherent unpredictability, but I mean, it's running at significant levels here and I'm wondering a couple of things about that business.
How sustainable is a robust level of contract research and development work for you guys over the next -- let's call it a couple of quarters, but we could call it five quarters? And then, is the nature of this contract R&D work that you're doing now materially different than what you'd precursor to more contract R&D or product?
Help us understand the good story that seems to be growing there.
Daniel Baker
Steve, as we've said in the past, our contract R&D can fluctuate quarter-on-quarter due to contract timing and a number of other factors that are beyond our control. Most of the contracts that we're working on right now are related to anti-tamper MRAM, and it's truly hard to tell if there will be follow-on contracts or what the timing may be of those contracts.
Steven Crowley - Craig Hallum
Are those with government agencies? Or are there some commercial partners paying for you to do contract research on anti-tamper?
Daniel Baker
There's actually both, Steve. We've got both government contracts as well as some commercial contracts in that area.
Steven Crowley - Craig Hallum
And is the nature of this contract R&D on kind of high-level technology and technology approaches? Or is it more on productization of the technology?
And then does it differ based on whose -- is government more up at the high research level and commercial companies trying to get a product out of this work or --? Obviously, we're just asking for some help in understanding what you have going on here.
Daniel Baker
Yes, well, I think ultimately with both, the goal is to get a product out of the work. But obviously, it's pretty high-tech work that we're working on with anti-tamper.
And it's difficult to tell if we will or will not end up with the product.
Steven Crowley - Craig Hallum
And Okay. And in terms of a timeline for product revenues potentially out of this anti-tamper technology that's attracting lots of attention, are we talking quarters or years or --?
Daniel Baker
You know, that's really hard to predict. It could be -- it just depends on how the research goes.
There's no way we can really give a timeline on that.
Steven Crowley - Craig Hallum
And for us who are trying to model your company, we have that category of revenue fluctuate from $300,000 in the quarter to $1.3 million. I think that in and of itself highlights the challenge in trying to understand what kind of flow you could have there.
It's turned into a pretty significant growth category year-to-date. It looks like it will necessarily be that way for the year.
Do you think it can continue to be a growth category for you? Or how should we think about that business?
Daniel Baker
You know, it's really hard to predict when we might get future contracts or follow-on contracts; though, as we've said in the past, our long-term strategy is to become more of a product company and to license our technology.
Steven Crowley - Craig Hallum
Okay. On the product front, you seem to go out of your way with discussing the growth in products being driven both by new customers and more sales to existing customers.
What additional color can you give us on the success you're having in the product business? Any tidbits would be appreciated.
Daniel Baker
Steve, this is Dan. We have a number of new customers that we've added in the past quarter, and we do in most quarters -- we do have new customers, including customers making industrial control platforms, industrial instruments, drilling systems.
Those are our traditional markets. They've been challenging recently, but one of the things that is very encouraging is that we're continuing to see interest in our products.
I think it's a credit to the advantages of our products that, despite the tight environment and the difficulties facing manufacturing industries, is that customers are continuing to evaluate our products. Of course, those initial customers or those new customers start out small, but it bodes well for the future.
So, we were pleased that in a tough environment, our sales -- product sales held up pretty well, and that we saw continued interest from new customers.
Steven Crowley - Craig Hallum
And on the medical side, have you seen new types of customers? Have you had success both on the life-support medical and the non-life support medical?
How can you better characterize the success there? And then I'll hop back in queue and come back around with some more questions, if there's time.
Daniel Baker
Okay. We've had success in both life-support and non-life-support medical.
And that's been, as Curt alluded to, that's been – that was a strong point of the most recent quarter. And that seems to have held up pretty well, despite the challenging macroeconomic environment.
So, we're pleased with our progress there and we're fortunate that we have businesses that can do well in a tough economic environment like that. So we're pleased with our progress in the past quarter and the future in medical.
Steven Crowley - Craig Hallum
Were you able to add new customers on both sides of your medical business?
Daniel Baker
I'm not sure I could say for sure that we've added customers, but we were pleased with the increase in revenue. So customers in that end of the business tend to be – it tends to be kind of lumpy, because we rely more on a smaller number of large customers than we do in the industrial market.
Steven Crowley - Craig Hallum
But do you still believe there are prospects over the longer-term to grow customer counts on both sides of your medical business?
Daniel Baker
Yes, absolutely. I just can't say that we added customers in the past quarter.
Steven Crowley - Craig Hallum
Okay. All right.
I'll hop back in the queue. Thanks for taking my questions.
Daniel Baker
Thank you.
Operator
There's currently no one else in the queue. (Operator Instructions) Gentlemen, we’ll take a follow-up from Steven Crowley, Craig Hallum.
Steven Crowley - Craig Hallum
All right, guys. Well I’m going to come back with two more questions.
In terms of the solid-state compassing initiative that you've talked about on these calls, what kind of progress/traction have you been able to make? And what kind of expectations from us on this side of the call are reasonable, to hear more about your efforts there?
Daniel Baker
Yes. We mentioned that several times as an initiative for consumer electronics and particularly for navigation systems for cell phones.
And several companies are evaluating our parts for that type of application, for a consumer-type application. The feedback has been positive.
We continue to work on making the devices smaller and more precise, but we're encouraged with where we are. We're not to the point where we can sell a product for a consumer/commercial application, but we're making good progress.
And we see an unserved need for that type of product as navigation becomes more sophisticated in cell phones and we can offer a smaller, more precise device that uses less power.
Steven Crowley - Craig Hallum
As an alternative to current systems or to complement some of the technology in those phones now?
Daniel Baker
Well, I guess it would be both. There are currently magnetic compassing systems, but they aren't very precise.
Ours are precise. They're not quite as small as we'd like them to be, as our customers and perspective prospective customers would like them to be.
So we continue to work on that. And for systems that don't have compassing, we would offer a way to have a more precise and a more useful navigation system combining, say, GPS, perhaps accelerometers, and compassing, so that you could tell what direction you're pointing and what direction you've been going.
So, it would make for a much more useful, we believe, navigation system.
Steven Crowley - Craig Hallum
And in terms of a go-to-market strategy to penetrate the cell phone customers, either manufacturers or ODMs, would you work through a partner there? And is that something that you would knock down upfront?
Or – and talk about? Or would we hear about it when you were actually selling parts into that marketplace?
Daniel Baker
Well, what we would typically do and the strategy that we've used in both consumer and automotive is to go through a system integrator or a Tier one supplier who would take components, integrate them perhaps with additional electronics, and then sell into, in this case, the cell phone market or the automotive market. And that's the most effective way we believe for us to reach that market.
So, in the case of a compassing sensor, it might be combined in a module, say, with a GPS or an accelerometer. And those are functions that we don't really have any special expertise.
What we believe we can do is make an exceptional compassing sensor, a magnetic sensor. So our strategy would be to rely on partners that would have relationships with the end customer.
And we would concentrate on the sensor component itself. So, I'm not -- and I don't know when we'd be able to say something more specific about that, but I think the milestone that we'd be looking for is to have design wins and parts being used in devices, not just approval by an intermediary, because that doesn't generate sales.
So, hopefully, as we proceed and make progress, we can provide some more information about that.
Steven Crowley
And in terms of the anti-tamper MRAM or the anti-tamper applications for MRAM that has stoked a lot of interest on the contract R&D side, how atypical is this kind of reaction to your capability? Has this happened before and caused a flurry of activity and moved onto the next thing?
Or is this a pretty unique experience so far in your history?
Daniel Baker
Well, Steve, it's been not just a challenge in modeling [inaudible], but it's been a challenge in being able to fulfill these contracts. And our folks have done an extraordinary job.
But it has been unusual. Contracts can be lumpy, but these are -- as you know, these are relatively -- this is a relatively large amount of R&D that meant moving some people around and stretching our people and our capabilities; but we believe that it's a great opportunity where we have some uniqueness and where we see some potential, not just for R&D but possibly for selling anti-tamper devices that we might make ourselves down the road.
So we took on that challenge, but this was an unusually large jump in contract R&D, as you probably know.
Steven Crowley
And is there some tail to the activity? Meaning, is some of this work, at least over the very short-term where you have some visibility, likely to continue?
Or really was it just an extraordinary period where you've completed a lot of those projects?
Daniel Baker
Well, our hope is that it will continue. But as Curt mentioned in answer to one of your earlier questions, it really is difficult to tell.
Some of the contracts are not -- they're not necessarily long-term contracts. And the revenue depends on results and depends on circumstances beyond our control and funding levels that's really outside of our control.
So, our hope is that it might continue, but we really don't know. And a lot of it is beyond -- it's really beyond our ability to predict, because we just don't know a lot of the factors that go into these.
But I think we saw an opportunity in the past quarter to fulfill some of these contracts and position ourselves for future research work, as well as for future product work.
Steven Crowley
And in terms of some of the -- last question. In terms of some of the logical applications, anti-tamper applications, I trust this would be for a relatively low density MRAM.
Things that come to mind would be more info security applications where you'd be protecting data and maybe if it was tampered with, you'd -- I don't know, destroy data? Or would you just do a better job of protecting it?
Daniel Baker
Well, it could be both. One of the advantages of MRAM is that the data is very persistent and very and very resistant to power surges, losing power, destroying the data.
So, -- but it can also be erased fairly easily when you want to erase it. And the other application is for what's called volume protection, which is to protect a space or a box or something like that that you want to know if people have been into it.
So, there are applications for IT, but there are also some more familiar applications that might be uses for protecting credit cards, for protecting personal electronics and things like that. So, we'll just have to see; but we see it as technology with some very good potential.
And as the patent that we just got a few weeks ago demonstrates, we're active in that area. We have inventions in that area.
And I think another point that you made, you're exactly right -- these are -- these would be very small MRAMs compared to the types of memory that we might find in computers or cell phones. But the advantage of that for us is that they might be the types of devices that we could build here.
And that would give us some potential for manufacturing devices as well. And we're not -- our strategy has not been to make large-scale memories; we're not set up for that and we don't have the economies of scale to do that.
Steven Crowley - Craig Hallum
Well, thanks for the additional color.
Daniel Baker
Thank you.
Operator
And there appear to be no further questions at this time -- actually, we do have a last-minute signal from Bob Mitchell, Conestoga Capital.
Bob Mitchell - Conestoga Capital
Good afternoon, guys. How are you?
Daniel Baker
Good afternoon, Bob.
Bob Mitchell - Conestoga Capital
Good. I wonder if you could talk about a couple of issues.
One, in your medical business, you -- historically, you've talked about the inventory levels of your customer a couple of quarters ago that gave you some -- it was a topic of discussion. I was wondering if you could talk about how you feel about the inventory levels of your customers, and particularly in the medical space?
Curt Reynders
I think the inventory levels, we don't see that as an issue in the medical space, but in the -- as far as -- we've seen excess inventory levels in the semiconductor supply chain in the fourth calendar quarter. And that could have had an impact on our product sales in the industrial market.
Bob Mitchell - Conestoga Capital
Okay. In the industrial space, can you talk -- geographically, are there any areas of the -- in terms of geography that industrial sales are holding up?
And are there areas where they're particularly weak? Or just kind of give us some flavor for that.
Curt Reynders
You know, I don't think we can really quantify it that way. I think it's really overall a worldwide economic slowdown.
Bob Mitchell - Conestoga Capital
Okay. And then your expansion plans.
Are those -- you talked about them last quarter; are they still -- were there any changes to those expansion plans relative to what you said several months ago?
Daniel Baker
There aren't any changes to the plans. I think, as we probably said a few months ago, we don't have a specific timeframe for major expansion.
We've done some expansion. I think Curt mentioned a large storage tank that we expanded next to our building and we've added some additional equipment.
But that hasn't been -- we haven't had to do an expansion of the clean room, which would be the major expansion that we talked about in previous calls. So we'll be continuing to look at that and continuing to look at the demands on our factory and the demands that that places on the clean room space, in particular, and make that evaluation at the right time.
Right now, we haven't been doing anything other than the equipment expansion and some of these other things.
Bob Mitchell - Conestoga Capital
Okay. And then in terms of the stock buyback program, if you could talk a little bit more about the decision to implement that.
Curt Reynders
Yes. As we've said before, our Board looks at a variety of ways to maximize the long-term shareholder value.
And the Board did authorize the buyback in light of our outstanding financial results, strength of our balance sheet, as well as current market conditions.
Bob Mitchell - Conestoga Capital
And would you characterize that as more opportunistic? Is that how you would view it?
Daniel Baker
Well, the circumstances, I guess, have changed in that we didn't do it before because we weren't going to do anything that would weaken our balance sheet, so a combination of circumstances now make it make sense to us. So, that's a combination of the financial results, the strength of our balance sheet, and the market conditions.
The caveat, as you know, and is within our filings, is the program can be discontinued at any time, and there's no particular number or timeframe. So we'll have to see how things develop.
Bob Mitchell - Conestoga Capital
Okay. And you're not going to put on an automated program or a plan?
Is that correct to assume?
Daniel Baker
Well, we're going to be looking at the particular circumstances. And particular in the case of blocks or private transactions, obviously those would be evaluated on a case-by-case basis.
It probably isn't going to make a lot of sense for us to talk about the criteria that we might use, but we see this as an opportunity. We believe that our stock is a very good value.
And otherwise, we wouldn't authorize the buyback.
Bob Mitchell - Conestoga Capital
Great. Thanks, guys.
Appreciate it.
Daniel Baker
Thank you.
Operator
And there are no further questions. I'd like to, at this time, turn the call back to Mr.
Baker for any additional or closing comments.
Daniel Baker
Well, thank you for participating. We are pleased to report a 44% increase in earnings and our best third quarter ever.
We look forward to speaking with you again to report fourth quarter and full fiscal year results, which we are currently planning to report in early May. Thank you for participating in this quarter's call.
Operator
That does conclude today's conference call. Again, we thank you for your participation and you may disconnect at this time.