Oct 21, 2009
Executives
Dr. Daniel Baker – President, Chief Executive Officer Curt Reynders – Chief Financial Officer
Analysts
Steven Crowley – Craig-Hallum Capital [Greg Greenburg – Private Investor]
Operator
Welcome to the NVE conference call on second quarter results. (Operator Instructions) With us today from the company is the President and Chief Executive, Dr.
Daniel Baker and the Chief Financial Officer Mr. Curt Reynders.
At this time I would like to turn the call over to Dr. Daniel Baker.
Dr. Daniel Baker
Good afternoon and welcome to our conference call for the second quarter of fiscal 2010. As always I’m joined by Curt Reynders our Chief Financial Officer.
This call is being webcast live and being recorded. A replay will be available through MVE.com.
After my opening comments, Curt will present a financial review of the quarter. I’ll highlight some business items and then we’ll take questions.
We filed our press release with the quarterly results and our quarterly report on Form 10-Q with the SEC in the past hour following the close of the 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, uncertainties related to research and development contract funding, risks in meeting technical challenges required to produce new marketable products, uncertainties on the possible issuance of patents and uncertainties related to the economic environment in the industries we serve 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. The company undertakes no obligation to update forward-looking statements we may make.
We’re pleased to report solid financial results for the quarter and first half of the fiscal year. For the quarter, net income increased 17% to $0.55 per diluted share including a reduction of $0.01 due to stock based compensation relating to options.
Revenue increased 14% for the quarter. For the first half of our fiscal year, net income increased 34% to $5.63 million and cash plus marketable securities increased $9.3 million.
Now I’ll turn the call over to Curt to discuss details of our financial results.
Curt Reynders
Good afternoon. As Dan said, revenue for the quarter ended September 30, the second quarter of fiscal 2010 increased 14% to $6.51 million.
The product sales increase was 6% to $5.81 million despite a challenging economy for both the industrial control and medical markets. Although we see short term economic pressures signs of an upturn are being reported.
We’re optimistic that an improving macro economic environment will help both our industrial and medical businesses. Contract R&D revenue increased 55% to $1.3s million which is the highest it’s been since fiscal 2005.
The increase was made possible by new contracts, follow on funding and added staff since last year. Dan will discuss our R&D program in more detail.
Total expenses increased 5.5% to $914,000. Expenses are broken down into SG&A and R&D.
Selling, general and administrative expense increased 6% compared to the second quarter of fiscal 2009. The increase was primarily due to increased commissions, salaries and stock based compensation.
Stock based compensation expenses for the quarter ended September 30, 2009 and 2008 were primarily due to the issuance of automatic stock options to our non employed directors on their re-election to our Board. The increase in stock based compensation for the quarter ended September 30, 2009 compared to the prior year quarter was primarily due to a higher stock price at the date of grant compared to the prior year date of grant.
Option related expense was $95,000 for the quarter. Research and development expense increased 4% compared to the second quarter of fiscal 2009 due to increased sensor and coupler product development.
Gross margin in the quarter remained at a solid 69.5% of revenue despite a less favorable revenue mix consisting of a higher percentage of contract R&D. With stable margins on the increased revenue, operating income increased 16% to $3.61 million in the quarter.
Interest income increased 42% to $393,000 for the quarter due to an increase in interest bearing marketable securities. Income before taxes for the quarter increased 18% compared to the second quarter of fiscal 2009 to just over $4 million.
The provision for income taxes increased to 33% of income before taxes compared to 32% for the prior year quarter. Net income for the most recent quarter increased 17% to $2.69 million or $0.55 per diluted share compared to $0.48 last year.
Earnings both quarters were reduced $0.01 by non cash stock based compensation expenses. Key profitability metrics improved for the quarter.
Operating margin was 55% versus 54% in the prior year quarter. Pre-tax margin was 61% versus 59% and net margin 41% versus 40%.
Comprehensive income for the quarter calculated as net income plus a $438,000 unrealized gain from marketable securities net of tax was $3.13 million. September 30 was the half way point in our 2010 fiscal year.
For the first half of fiscal year, total revenue increased 26% to $13.3 million. Product sales increased 14% and contract R&D increased 124% compared with the first half of fiscal 2009.
Diluted net income per share increased to $1.16 for the first six months of the fiscal year compared to $0.88 for the same period last year. Driven primarily by strong operating cash flow, our balance sheet strengthened considerably and total assets exceeded $50 million for the first time.
At September 30, cash plus marketable securities stood at $43.6 million. The increase from March 31 was primarily due to $6.62 million in operating cash flow, $622,000 in net proceeds from sale of common stock related to option exercises and a $1.95 million net increase in the value of marketable securities in the first half of the fiscal year.
Cash taxes for the quarter were $2.61 million. Cash taxes have been higher in the second fiscal quarter than other quarters because our two estimated tax payments due, one in July and the other in September.
The weak economy provided opportunities to add equipment at favorable prices and expand production, so we hope to emerge from this industry downturn well positioned for the future. Purchases of fixed assets were approximately $168,000 for the first half of fiscal 2010 compared to $118,000 for the first half of fiscal 2009.
Capital equipment investments included a new tester for our smallest packages which are 1.1 millimeter square or less than 5/100’s of an inch and a piece of equipment to help process die which are unpackaged wafer pieces that are even smaller than our package parts. In the past quarter we continued the first phase of an expansion of our production areas, making room for the two new pieces of production equipment by converting some office space to production space.
As we’ve discussed before the first expansion phase involves converting under utilized office and technical space to production. The second phase which we plan to start when necessary is convert production space to clean room space.
With that I’ll turn it back to Dan for his perspective on our business.
Dr. Daniel Baker
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 secured additional contract commitments for the current quarter and beyond.
We focused our contract work in the areas that are strategic to us in terms of future growth and revenue potential. Three long term strategic development areas we’ve discussed include bio-sensors, magnetic compassing sensors, and anti-tamper MRAM.
Our bio-sensors are designed to combine spintronics with biological components with the potential we believe to significantly improve analytical equipment and eventually enable laboratories of shifts. In the past quarter we began exploring production methods for a bio-sensor based on results of testing by a potential customer.
We also expect to be granted a patent titled Magnetic Particle Flow Detector which is related to bio-sensor systems. I’ll talk more about patents in a few minutes.
Second, our compassing sensors could enhance location based services and cell phones and smart phones and enable smaller, more precise or more power efficient navigation modules for consumer devices compared to competing technologies such as hall effect sensors. We are continuing to optimize a sensor designed for a potential.
And third, anti-tamper MRAM is the type of MRAM that’s in demand for defense and aerospace applications. MRAM is a spintronic based memory that combines some of the best attributes of different types of conventional memory.
We’ve completed several IC designs and we continue to develop products for several potential customers. As I mentioned on our call in July, in the past quarter we hired an experienced PhD Physicist.
We’ve hired two PhD’s this year to strengthen our top research team. As I mentioned, were recently notified by the U.S.
Patent and Trademark office of the expected issuance of a patent titled Magnetic Particle Flow Detector. The patent application describes bio-molecular detection methods including detecting DNA and disease causing organisms.
We expect the patent to be issued next week and it will be our fifty second U.S. patent.
In addition to the Particle Flow Detector patent, in the past quarter we received an exparte [quail] action on the U.S. patent application title Super Paramagnetic Platelets Field Sensing Devices.
An exparte [quail] action indicates the prosecution on the application’s merits is closed but there may be amendments on formal matters and we requested such amendments. The application discusses the invention of a novel sensor for magnetic fields.
There are links to the Particle Flow Detector and Super Paramagnetic patent applications as well as our issued U.S. patents from our website NV.com and there will be a link to the Particle Flow Detector patent when it is granted.
Turning to 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. Our distribution strategy is primarily focuses on catalog internet distributors supplemented by specialized face to face distributors in select territories.
We recently added two new distributors for our coupler products, reinforcing our position as a global leader. The distributors are Shanghai Channel Electronic Science and Technology Company in China and Masters SP which is based in Poland.
Masters is a leading distributor of electronic components in central eastern Europe. They will provide face to face sales support and supplement Alpha AD catalog internet distributor for Poland and Northern Europe that we announced in 2007.
Shanghai Channel is our fourth distributor in China. MV products are available in more than 75 countries and our distributors speak countless languages.
In addition to the financial information filed in our 10-Q today, we reported the results of our annual shareholders meeting last quarter. For good corporate practice, each of our Directors has stood for election every year and we submit our auditors for ratification.
At our annual meeting NV shareholders re-elected our Board of Directors and ratified Ernst & Young as our auditor. Details are contained in the 10-Q.
We had an exceptional turn out for the annual meeting. It was standing room only with shareholder coming from around the country.
Some of the shareholders have attended most or all of our nine meetings as a public company. We appreciated the chance to meet some of you and we’re gratified to have so many shareholders share our passion for MVE.
Lastly we were pleased that for the second consecutive year MVE was included in Forbes list of the 200 best small companies in America. The list is in the November 2 issue on newsstands now and there’s a link from our website.
This year we were featured as one of the top ten of the 200 best. Rankings are based on earnings growth, sales growth and return on equity in the past 12 months and over five years.
The article noted that we were one of the most profitable of the 200 best. Now I’d like to open the call for questions.
Operator
(Operator Instructions) Your first question comes from Steven Crowley – Craig-Hallum Capital.
Steven Crowley – Craig-Hallum Capital
I noticed in the NV&A section of your 10-Q that you just posted this afternoon that you talk about having increased R&D for sensor and coupler product development. I sense that’s rather regular activity for you, but I want to ask if there’s any color that you can provide us on some of that increased R&D investment in those areas.
Curt Reynders
We have been working on a number product in sensors and couplers and just in general what we try to do is extend the advantages that we have in those areas. In couplers it’s usually channel density and small size and for sensors it’s magnetic sensitivity and size.
So those are things that we’re continuously working on extending and in particular, I think Curt mentioned we have a piece of equipment to test what we call the ULLGA packages which are 1.1 millimeter square of less than five one hundredths of an inch, and we’ve been expanding our product offerings in that package which extends our advantages in size. We already feel like we have some of the smallest products of their type in the industry, but we’re always looking to extend those advantages.
So that’s one example of the types of efforts that we’re undertaking. So there was as you point out, a modest increase in our R&D expenses which had been decreasing for awhile.
Steven Crowley – Craig-Hallum Capital
My understanding is often the standard sensors and couplers that you sell are into industrial market places and applications. Can we talk a little bit about what you’re seeing out there in the more industrial side of your business, whether or not there are some signs of improvement, what those might be and what that might mean for you?
Curt Reynders
I think we’ve seen signs of an upturn and experts have said the recession is likely over. As far as our industrial customers, we did see that especially towards the end of the second quarter, although information from our customers is mixed.
Although if inventory levels are becoming lower, that could bode well for us as it tends to increase purchases by distributors and others and we’re hopeful that an improving macro economic environment will help our business, especially in the factory automation.
Steven Crowley – Craig-Hallum Capital
Historically you’ve seen some seasonality to your product sales where they decreased from September to your December quarter sequentially. But there have been years where some of that decrease has happened sooner and we haven’t seen nearly as much of a decrease.
How does it look and feel to you. Do you think we saw that typical seasonal decrease that we see in the December quarter a bit earlier this year so we can be a bit more optimistic about product sales hanging in there at comparable levels?
Help us see what you’re seeing at least to some degree.
Dr. Daniel Baker
What we’re seeing as Curt said, we’re seeing signs of an improving macro economic environment which helps us. That will probably be superimposed on the usual seasonality that we have which seems to be related to plant shut downs late in the calendar year and holidays late in the calendar year.
But in this case, we’re seeing a recovery in the economy, at least a modest recovery in the economy and a modest recovery in the semiconductor industry. We’re seeing in the semiconductor industry, we’re seeing that channel inventories are coming down and although they may not reach historical levels right away, lower inventories do bode well because it tends to increase purchases by distributors and others.
So we have two factors working in different directions for the third fiscal quarter. One is the usual seasonality, but the other is that the economy does seem to be improving and so hopefully that will help.
Steven Crowley – Craig-Hallum Capital
Clearly last year in the third quarter relative to second quarter you had both factors working in a negative direction.
Dr. Daniel Baker
Yes, we were fighting a little bit more in the headwinds as you know with the macro economic environment last year. So we’re seeing a little bit more promising economic environment this year.
Steven Crowley – Craig-Hallum Capital
On the medical side of your business, you certainly made reference to some challenges the economic environment has provided even in medical land. There has been some noise and confusion for some life support medical devices and some life support medical companies, the management companies.
Do you feel like you’ve experienced some of that noise already? Is it likely in front of you?
How are you looking at some of the news flow out of that arena and what it might mean to you?
Dr. Daniel Baker
The medical device market has been challenging but it seems to have been more resistant to the economic downturn although it’s not immune from it. Short term it’s hard to predict as we have limited visibility with some customers.
The long term however, we’re very optimistic about medical devices, new medical devices and favorable demographics, so we think the long term prospects are good in our medical markets.
Steven Crowley – Craig-Hallum Capital
I was encouraged by your commentary about success you’ve had in your contract R&D projects which should bode well for a continuation of later phases or further phases of those projects. Can we feel more comfortable that the recent level of contract R&D which has been the last two quarters rounds to $1.3 million in each of those quarters, that that’s a sustainable level, or how should we think about your successes there and how they translate to the numbers.
Dr. Daniel Baker
We certainly were pleased with some of the results that our team had in the contracts and the new funding is evidence of that. We are optimistic about the future.
It is hard to get too specific because the term of the new contracts varies and further funding is dependant on meeting goals. But our team has done a great job of meeting those goals as I mentioned.
We have new IC designs that look very promising and we’re seeing a great reaction to the work that our guys have done by our customers. In addition to the contract R&D itself, these are contracts that in many cases will lead to, or at least we hope will lead to selling products.
So it bodes very well for the future. We’ll just have to see, but we were certainly pleased with how things went in the past quarter.
Operator
Your next question comes from [Greg Greenburg – Private Investor]
[Greg Greenburg – Private Investor]
It’s been awhile since we’ve heard an update on the Motorola/Freescale/Everspin relationship and it seems that Everspin seems to be finding some commercial success with MRAM revealing clients using the product such as Boeing and Seamans. My question is, does NV have a relationship with Everspin and do you believe that their products use NVE’s intellectual property.
Dr. Daniel Baker
We certainly think that Everspin and others share our vision of a very bright future for MRAM and several memory companies have disclosed plans to commercialize MRAM in the next few years. As you point out Everspin has expanded its product line and has announced some leading customers.
We also continue to develop the technology and have developed the technology in the anti-tamper area. We’ve said before that we believe that the devices that were produced by Freescale at the time fell based on our analysis fell within the scope of claims of a number of our patents.
Beyond that it probably wouldn’t be constructive for us to comment on it, but we believe that there’s a very bright future for MRAM and I think you’re pointing to some evidence of that.
Operator
Your next question comes from Steven Crowley – Craig-Hallum Capital.
Steven Crowley – Craig-Hallum Capital
In your prepared commentary you talked about having added some equipment and expanded some manufacturing capacity, but talked about a couple of phased plans that you’ve had on the drawing board for awhile. You’ve moved through phase one and have phase two on the horizon.
With what you’ve done so far with equipment, was it a baby step in terms of adding some manufacturing capacity, a more significant move? Can you give us some feel for how bold a stroke you’ve made with adding to capacity?
Dr. Daniel Baker
The way the capacity tends to work in our operation is that we have a great deal of overall capacity but then depending on how our product sales go what we try to do is make sure that we anticipate any potential bottlenecks well in advance and try to clear those bottlenecks so that we can clear the decks for large expansion in sales. The way our business is where we have relatively high margins and high value added products, we’re much more concerned about having adequate capacity than using every bit of capacity.
You might hear about in the semiconductor industry where they measure factory utilization as one of their key metrics. For us, the key is to have plenty of capacity so that if our customers expand, we’re gong to be ready for them So in the case of equipment that we purchased that was in two particular areas for the ULLGA parts which are the 1.1 millimeter square parts that Curt talked about and there we dramatically increased our capacity, and those parts are starting to sell and we’ve been very pleased with the reaction they’ve had in the marketplace, and we want to be sure that we have plenty of capacity for when those products take off.
And the same thing with the wafer handling equipment that Curt also mentioned. So those are fairly dramatic increases in our capacity particularly for the testing of the 1.1 millimeter packages.
And while we don’t have an immediate need for it, it will allow those packages to grow for customers to design them into high volume applications with confidence and for us to continue to improve our margins and to work our cost structure down which is a continuous effort for us.
Steven Crowley – Craig-Hallum Capital
In terms of applications that ULLAG package seems to be gaining traction. Is it a certain applications and certain industry spaces?
Dr. Daniel Baker
It cuts across a number of industry spaces. It’s primarily for sensors so we have industrial products in that package.
We also have medical oriented products in that package so it’s more of a platform than a particular part or device, and we see it as an opportunity to move our parts which are already some of the smallest in the industry, some of the densest in the industry to another level of density and miniaturization. So we see it as a potential for cutting across a number of markets for us.
Steven Crowley – Craig-Hallum Capital
Appreciate your attempts to bring us some more color on what you’re doing. I guess the progress that you’re making with those compassing sensors or modules and the anti-tamper MRAM.
I can’t help but want to learn a little more about what you might be doing there. And maybe the right way to go about this is, in terms of the anti-tamper MRAM you mentioned defense and aerospace applications.
You mentioned several potential customers. The capability that anti-tamper MRAM in the form factor that you have envisioned and moving toward manufacture, help us understand some of the advantages that might have and what you might potentially be displacing that’s currently being used if something is currently being used in these applications.
Dr. Daniel Baker
That’s a good question. The reason that MRAM is such a good fit for anti-tamper is because it’s inherently non volatile and it’s extremely rugged.
So when one uses an encryption or for something like a crypto key, there’s excellent data integrity and it can withstand radiation and all kinds of potential abuse as opposed to semiconductor memories which in the case of something like a DRAM or an SRAM really aren’t inherently non volatile. They’re only non volatile if you apply power to them.
So they’re easier to defeat and MRAM has the advantage of being inherently non volatile because the spin of the electrons is persistent. The reason that we see it as an excellent opportunity is not only our MRAM expertise but these tend to be relatively small devices.
So for example 256 bits isn’t very big memory when you’re talking about music or storing phone numbers. It obviously isn’t going to store very many MP3’s.
But, it can support excellent encryption; 256 bit encryption is very, very secure. So we see it as a device that we can make that can add a great deal of security first to military and aerospace applications, but perhaps eventually some more common devices such as consumer electronics, gaming systems such as even embedded in phone cards or credit cards.
So we see it as an excellent area because of the demands to protect sensitive electronics. We’re seeing the first applications in defense and aerospace, but long term we see it as an excellent application of MRAM and an excellent application of our intellectual property and our technology and manufacturing capabilities.
Steven Crowley – Craig-Hallum Capital
Your comments seem to imply that you’re making nice progress on the customer front with this product which should enable you to march down the time line of manufacturing and I guess introducing these products. Can you give us any feel for what kind of time line is reasonable or what kind of pace you’ve established relative to your time line six months ago?
Dr. Daniel Baker
As we said overall taking about R&D, we’re pleased with our progress. We mentioned that we completed several IC designs.
Those are important milestones in completing the IC’s. We typically want to finish the IC then we’re also working on some fabrication, some testing and there’s a design and debug and continuing development cycle.
And it’s difficult to predict timing on that, but these are projects that we are working on specific schedules on and our team is working on them with considerable urgency and we’re optimistic with the progress that we’ve made and we’re optimistic about the future of them.
Steven Crowley – Craig-Hallum Capital
In terms of a solid state conference module, from last quarter’s discussion it appears that you were trying to push some size and performance characteristics of that module to get it where you wanted to get it. Can you give us a little bit of an update on your progress there?
It seems like you’re still engaged with a major customer, but any additional color would be appreciated.
Dr. Daniel Baker
As we said last quarter, we have potential advantages in size, power and precision. Those are the three things.
And then based on our customer feedback, we’re seeing that the advantage in precision is particularly important, so by precision we mean that you can detect the position that you’re pointing in with more precision or a less number of degrees if you will than competing technology. So if we think of the compasses in our cars where they might say north or northwest, and that’s about the level of precision that they have, our devices are much more precise than that and based on our communications with our customer and our potential and their testing of our devices, they believe that there is a market for more precise compassing sensors than are available and we think we can do that.
So we also have advantages in power and size. But what’s emerging is that precision could be an important advantage for next generation navigation and location based systems.
Steven Crowley – Craig-Hallum Capital
The sensors that replacement is at least part of your opportunity, what kind of applications have they commonly found themselves in to date? I trust maybe the automobile example you just referenced.
Are there some other examples where the sensors are sitting now?
Dr. Daniel Baker
Automotive is certainly one application and there’s a lot of them around. There’s been some visibility and some early smart phones that have compassing and we’re not in a position to comment what’s in them.
Other people have, so it’s possible that those are hall effect sensors and the advantages that we have over hall effect sensors are in all three of the areas that I mentioned. Our devices are smaller than hall effect sensors.
They use less power and they’re more precise in terms of the angular precision, the compassing precision that hall effects sensors. And we compete against hall effect sensors in a number of applications.
Hall effect sensors are a semiconductor based device as opposed to spintronics spaced or non semiconductor type devices and they’re the incumbent technology. But we’ve been very successful in a number of applications in displacing them because of the advantages of the spintronic sensors and our sensors offer.
Operator
We have no further questions at this time. I would like to turn the call back over to our speakers for any final or additional remarks.
Dr. Daniel Baker
Thank you for participating in the call. We’re pleased to report a 17% increase in net income for the quarter on a 14% revenue increase, and we look forward to our next call in January to report third quarter results.
Thank you.