Oct 19, 2011
Executives
Daniel A. Baker – President, Chief Executive Officer, Director Curt A.
Reynders – Chief Financial Officer, Treasurer & Secretary
Analysts
Steven Crowley – Craig-Hallum Capital Patrick Kirksey – Perimeter Capital Jon Jung – Trailhead Asset
Operator
Good day, ladies and gentlemen. And welcome to the 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 on how to participate will be given at that time.
(Operator Instructions) And as a reminder, today’s conference call is being recorded. Now, I would like to turn the conference over to your host Daniel Baker.
Daniel A. Baker
Good afternoon and welcome to our conference call for the quarter ended September 30, 2011, the second quarter of fiscal 2012. 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 our website, nve.com.
After my opening comments, Curt will present a financial review of the quarter, I will cover business items and we will open the call to questions. We filed our press release with quarterly results plus 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 and our 10-Q includes XPRL format data. 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 profitability, uncertainties related to future revenue and growth, risks related to developing marketable products, uncertainties relating to the revenue potential of new products, risks related to loss of supply from our packaging vendors, 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 in Part II, Item 1A of our just filed quarterly report on Form 10-Q.
The company undertakes no obligation to update forward-looking statements we may make. In a challenging quarter we reported solid earnings despite decreases in product sales and total revenue, net income was $0.52 per diluted share on total revenue of $6.6 million.
Now I’ll turn the call over to Curt for details.
Curt A. Reynders
Thanks Dan. Total revenue for the second quarter of fiscal 2012 decreased 16% to $6.6 million due to a 13% decrease in product sales and a 26% decrease in contract, research and development revenue.
Product sales were $5.56 million with lower sales into industrial markets. According to industry analysts chip sales have been slowing rapidly and supply chain inventory levels have been elevated.
Other analysts have reported that capital intensive industries including our core industrial manufacturing markets appear to be canceling or pushing back their spending until there is more certainty in the global economy. Additionally, there appear to have been inventory adjustments by certain of our medical device customers perhaps in response to revised sales forecast.
Also contributing to the product sales decline the past quarter, shipments of certain types of couplers were delayed by manufacturing process changes that ultimately increased production efficiency, and we believe those changes have now been successfully implemented. Although we would have liked to have seen year-over-year growth of course, we were pleased to have solid profits as we have through good times and bad for 38 consecutive quarters, that's every quarter for nearly 10 years.
Despite the difficult comparisons, our order backlog is strong especially for medical device markets and some customer orders shifted from the past quarter into the current quarter. So although we faced a variety of factors that reduced product sales in the most recent quarter, we see the challenges as temporary and continue to see a bright future for existing and potential new products.
Contract R&D revenue decreased 26% to $1.04 million due to the completion of certain contracts and contract activities. It has been a challenging environment for government funding.
Gross margin remained strong although it decreased to 65% of revenue compared to 67% last year due to lower volume and increased labor costs. The increased labor costs were from adding production personnel needed to support future products.
Total expenses increased 29% for the second quarter of fiscal 2012 compared to the second of fiscal 2011, due to a near doubling of a 97% increase in research and development expenditures. The increase in research and development expense was due to increased product development activities.
We redeployed resources from contract R&D to company sponsored R&D. We believe the investment in R&D will pay off in future revenues and profits.
Dan will give R&D highlights in a few minutes. Interest income increased to 20% due to an increase in interest bearing marketable securities.
Income before taxes for the quarter was $3.7 million and pre-tax margin was 56%. The provision for income taxes was a slightly lower percentage than the prior year quarter.
31% of income before taxes compared to 33% last year, because of lower state and federal effective tax rates. Net income for the second quarter was $2.56 million or $0.52 per diluted share compared to $0.66 last year and net margin was 39%.
September 30 was the halfway point in our 2012 fiscal year. For the first half of the fiscal year, product sales were about the same as last year and total revenue was down slightly 2% due to a decrease in contract R&D.
Diluted net income per share was $1.22 for the first six months of this fiscal year compared to $1.30 for last year. The decrease in net income for the fiscal year was due to decreased contract R&D revenue and increased R&D expense, partially offset by increased interest income.
Cash flow strengthened our balance sheet. Operating cash flow was $6.38 million for the first half of the fiscal year.
As of September 30, cash plus marketable securities was $67.6 million, an increase of $5.4 million in the first half of the fiscal year. Cash paid during the quarter for income taxes was $2.95 million.
Cash paid for income taxes has been higher in the second fiscal quarter than other quarters because that our two estimated tax payments due, one in July and one in September. Purchases of fixed assets were $294,000 for the first half of the fiscal year primarily for production equipment.
In the past quarter we signed an amendment to our building lease, which would have expired December 31, 2015. The amendment extends the lease for an additional five years through 2020.
This is part of our long-term capacity plan and allows us to make investments to expand production, capacity to build high volumes of new and existing products. We filed the lease amendment with the SEC on a current report on Form 8-K/A.
It’s available via the SEC website or our website. With the lease extension sign, we recently began phase construction of a larger production clean room.
The expansion will be in phases to minimize disruption. We estimate the completion to be late this fiscal year or early next fiscal year.
As we’ve said on previous calls, we may spend on the order of $1 million to expand the clean room. We will amortize these leasehold improvement costs over five years.
Most of our products are fabricated in our facility using either raw silicon wafers or foundry wafers and rebuild the spintronics structures and wafers in our production clean room fabrication facility. The clean room has specialized equipment to deposit, pattern, etch and process spintronic materials.
We expect our current building to be able to meet our production needs for the foreseeable future. As Dan mentioned on our last call, if we need to expand production beyond the phase underway now, we would plan to expand in our current building or perhaps relocating other functions such as R&D to another location to make room.
We updated risk factor in our 10-Q because of the affects of recent widespread flooding in Thailand. First of all, our sympathies to people affected by the tragedy and the loss of life in Thailand.
We have several device packaging vendors that dice and package our wafers to make many of the parts we sell. One of those vendors in a hard hit, Ayutthaya has reported their production was temporarily shut down by the flood.
The great majority of our product sales that go through the affected vendor can’t and are being packaged elsewhere. There are some low volume specialized parts without established alternate vendors.
We’re developing alternatives for those. We’re setting up alternate vendors and in some cases our customers may be able to substitute other parts we sell.
Now, I will turn it over to Dan for his perspective on our business. Dan?
Daniel A. Baker
Thanks, Curt. As Curt said, we’ve significantly increased our R&D investments over the past year.
Three research areas we’ve highlighted include biosensors, consumer electronics and MRAM memory. We’d said before, we have a customer who is planning to use a custom spintronic biosensor in the new in vitro medical diagnostic instrument.
Our customer had said they expect to begin production with the biosensors in late 2011. We shipped relatively small quantities of preproduction sensors in the most recent quarter.
Our customer ordered more preproduction units for the quarter and our customer has said, it’s now planning production in the first quarter of next calendar year. We continue to believe that this could be the start of an important new market for us.
The goal of a spintronic compass is to determine heading using low field tunnel junction sensors to measure the angle of the earth’s magnetic field. We have compass technology for near-term use and we will continue to develop the technology to make it even smaller.
We continue to evaluate customer needs for our current technology or new technology. In the past quarter, we submitted a proposal with the National Science Foundation for a second phase development project.
We previously announced, we had successfully completed a contract with NSF demonstrating the feasibility of reducing the size of sensors with applicability to navigation and consumer electronics. MRAM is spintronic magnetoresistive memory, which is fabricated with nano technology and uses electrons spin to store data.
Our MRAM strategy is to build small MRAMs for demanding applications such as anti-tamper and use what we learned to strengthen our MRAM technology portfolio applicable to large scale memory. In the past quarter, we successfully completed a feasibility demonstration contract awarded in late 2010 with the office of the Secretary of Defense titled Field Programmable Gate Array Physical Unclonable Functions.
Physical Unclonable Functions or PUF is a function that some bodies in a physical structure and it’s easy to evaluate but hard to predict. Possible applications of particular interest are commercial high speed encryption such as high speed cryptographic key exchange for quantum cryptography.
Unlike non-quantum or so-called classical method, quantum data is disturbed when improperly read. The project was based on a combination of our MRAM and spintronic coupler technology, there is a link to the contract abstract from the in the news page of our website.
Our annual meeting was held last quarter; we had excellent turnout with shareholders coming from all around the country. We appreciated the chance to meet some of you and we’re gratified to have so many shareholders who share our passion for NVE.
ISS proxy advisory services evaluates company’s governance before annual meeting NVE received the highest rating in all four governance risk indicators as board, audit, compensation and shareholder rights. According to a recent article in the Minneapolis/St.
Paul Business Journal, there were only three companies with perfect ISS governance scores in the entire state. For a good corporate practice, each of our directors has stood for election every year and we submit our auditors for ratification.
Under new rules this year, we had a shareholder stay on pay resolution and a vote on the frequency to stay on pay votes. Shareholders overwhelmingly voted to re-elect all five of our directors, to approve our executive officer compensation in favor of our Board’s recommendation of stay on pay resolutions every year and ratified Ernst & Young as our auditors.
After the meeting, our Board resolved the whole shareholder stay on pay votes every year. Details are contained in two reports on Form 8-K, which we filed with the SEC in the days following the meeting.
Now, I’d like to open the call for questions, Matthew.
Operator
Thank you. (Operator Instructions) Our first question comes from Steven Crowley from Craig-Hallum.
Your line is open.
Steven Crowley – Craig-Hallum Capital
Good afternoon, gentlemen.
Daniel A. Baker
Hi Steve.
Curt A. Reynders
Hi Steve.
Steven Crowley – Craig-Hallum Capital
Couple questions for you. You attempted to or you did give us some reasons or factors that played into the weakness in the company’s top line relative to historical norm and maybe some expectations out there, and really broken down into four buckets; macro, macroeconomic factors impacting your industrial business.
Also on the industrial side, a coupler manufacturing change which delayed some shipments from Q2 into future quarter, so kind of those two issues on the industrial side of your business, and then there was mention of an inventory correction of certain medical device customers and the timing of orders from certain large customers especially some in medical devices. And I'm wondering if you can help us understand the relative contribution or the magnitude of the negative distortions created by each of these factors?
Daniel A. Baker
Right. And I think you hit on those factors that all of which we consider temporary.
It’s hard to break down specifically how much each of them contributed, but in general for a small company, we have a relatively diversified business. We have industrial customers, we have medical customers and we have contract R&D business.
So in most quarters one might be a little bit weak and is offset or more than offset by something else, and I think this was just one of those quarters where a number of the factors were negative and in most cases you know in the past, they’ve been offset by something else. So it was a combination of factors that’s unusual.
We believe that they are all temporary and despite all of that, we reported solid earnings, we have a strong backlog for some of factors that you mentioned and an excellent pipeline of products. So we’re pleased where we are under some pretty difficult circumstances.
Steven Crowley – Craig-Hallum Capital
And in terms of some of the macro factors that affected your industrial business, an overall supply chain inventory correction, do you think you saw the brunt of that activity by your distributors in Q3, or do we have to look forward to some more of that in calendar Q4.
Daniel A. Baker
We’re hopeful that we’ve seen the brunt of that. As Curt mentioned in the prepared remarks, ship sales have been slowing rapidly and so what happens then as you can imagine is that the supply chain tends to adjust down their inventories to match up their inventories with the sales as they are.
So once they make those adjustments, then things tend to stabilize. And so, it’s always difficult to predict the macroeconomic factors, but we’re hopeful that the downturn I think, took a number of supply chain distributors a little bit by surprise and so they reacted, they reacted sharply to reduce their inventories.
So the effects of the macroeconomic changes tend to be magnified, but then once those corrections are made, things can return to a more historic level and that’s what we’re hoping that we’ve seen.
Steven Crowley – Craig-Hallum Capital
But is there a big bias to these – the factors geographically. In other words, did you see particular weakness out of a certain geographic theatres, or was it really across most of the business?
Daniel A. Baker
You know it’s hard to be very specific on that. I think we saw some particular weakness in the U.S.
and Western Europe and perhaps some relative strength in Asia or parts of Asia, but in general it was a challenging global economy. And particularly in some of the capital intensive industries, industrial manufacturing markets which are all over the world appear to be canceling or pushing back their spending because of the uncertainties in the global economy.
So it appears to be an issue of a global economic slowdown and more of a slowdown and had been expected by most folks.
Steven Crowley – Craig-Hallum Capital
And then your update on your new business opportunity with the novel biosensor for in vitro diagnostic applications and the major customer you’ve been marching them the past with over recent quarters. It sounds like you’re referencing a timing change when that goes that system goes in full production from Q4, calendar Q4, so the current quarter were into the first calendar quarter of next year.
So I’m looking to confirm that that was what you were messaging. And then, the magnitude of the business opportunity and initial orders, well the timing may have changed, has the magnitude of their indications changed?
Daniel A. Baker
Well, to the first question on the timing, that’s correct. We had been told to expect production in late 2011, late this calendar year.
They are now saying first quarter next calendar year 2012. And the potential remains excellent.
We see tremendous potential with this particular customer and then for this biosensor market in general. There are a number of components that go into the instrument and our customer is pleased with our component, the biosensor.
But there are other things that they need to get straightened out, they also have certain regulatory issues, but we’re seeing this as a very modest delay and we’re preparing for production in the first calendar quarter.
Steven Crowley – Craig-Hallum Capital
Okay. And then just one more question that relates to the top line.
I'll hop back in the queue. As to contract manufacturing, what kind of visibility do you have for the project pipeline and potential awards as we look forward here?
Daniel A. Baker
Well, Curt, do you want to answer that?
Curt A. Reynders
Sure, sure. Steve, our contract R&D that can fluctuate from quarter-to-quarter based on timing of our contract wins, government’s budgets as well as commercial customer budgets, results of research we continue to look for opportunities in areas that we think will benefit the company and we’re – we’ve got proposals out there but it’s been particularly with the government funding, it’s been pretty tough environment.
Daniel A. Baker
This is Dan. May be I can amplify also a little bit.
We do have a number of proposals out there, I mentioned one of them relating to compassing, and we have a number of other proposals out there. And I think if there is some a little bit more clarity on the federal budget that we’re hopeful that that’s going to free up a lot of the funding.
Agencies, in an uncertain budgeting environment, agencies don’t know what funding they are going to have, and so things like R&D tends to be one of the ones that they can push off and postpone. So we’re hopeful for some clarity in the federal budget, which will allow the agencies that provide a lot of the funding, the government funding, to start to look at some of these long-term contracts.
And we have some excellent proposals that I think we think have an excellent chance of being funded. It’s just been a fairly uncertain environment.
Steven Crowley – Craig-Hallum Capital
Thanks for taking my questions. I'll let some other folks jump in and then come back.
Daniel A. Baker
Thanks, Steve.
Operator
(Operator Instructions) Our next question is from Patrick Kirksey of Perimeter Capital. Your line is open.
Patrick Kirksey – Perimeter Capital
Thank you. Good evening gentlemen.
This is kind of a high level 30,000-foot view question as it relates to your top line. One of the things that’s very attractive about your company is the long-term fairly consistent growth that you’ve seen in product revenues.
One of the things that I look at is, I look at trailing 12 months of product revenues, because you can kind of have those quarter-to-quarter fluctuations in shipments. It has been really nice way it went from 2.5 million back in what 2002 to 5 million in 2004, kind of add a little bit in 2005 and then there was a very strong run in your trailing 12 months product revenue from five up to 10, 15 and then 20 in early late 2007 or early 2008.
Kind of pause there just a little bit, I remember you had some industrial weakness then during the recession. But then really, I mean your growth even was still positive during the recession, and just thinking about this, there are some very unique properties of your technology that really I think can open up and expand in to new markets as more and more industries, companies, government entities or what not get comfortable with the very unique properties that you guys have with your intellectual property, do you think that there is going to be any change in that.
I'm not asking you to forecast, you’re going to continue to grow product revenues for the next 10, 15, 20 years, but it still seems to me that there is a lot of running room, you’ve got a lot of new product, developments, projects that you’re working on whether it’s the biosensors or what not, but do you think that that potential addressable market for your IT is still relatively largely underpenetrated and that you guys can kind of continue to gain some penetration in that market if you will.
Daniel A. Baker
Yeah that was very well said Patrick. And we certainly see some tremendous opportunities; we have a great pipeline of potentially game changing products.
Our R&D folks have done an exceptional job of developing the technology in areas where there is demand and where we have convincing benefits and as you pointed out when you look at our long-term path, we’ve – when we enter new markets such as when we entered the medical device market, we drove some tremendous growth rates because we had an excellent product in what for us was a new market. And we're working on several new markets that we talked about on this call and that we’ve talked about in past calls.
And we’re nearing fruition on several of them, so we really see some fabulous potential for the technology, and we think that we’re just barely scratching the surface with the potential markets for our products and applications. So as you point out, it’s difficult for us to predict the future, but the best way to predict the future is to invent it.
And our folks are very busy and very good at inventing the future.
Patrick Kirksey – Perimeter Capital
Excellent. Thank you very much.
Daniel A. Baker
Thank you.
Operator
Thank you. Our next question in queue is from Jon Jung of Trailhead Asset.
Your line is open.
Jon Jung – Trailhead Asset
Thank you very much. Dan, I wonder if you could give us some color on what’s been going on in the MRAM markets and what if anything the research is doing on developing products into that market place?
Daniel A. Baker
Well in terms of industry wide there has been a fair amount of activity in MRAM announcements of products and announcements of research. In our area as we mentioned in the formal remarks, we – our plan is to make a specialized MRAM ourselves, which we have been doing, it’s amazing technology, it’s non-volatile so we actually have memory arrays that store data, remove the power and it comes back.
It’s truly a remarkable technology. We mentioned some of the applications that we’re looking at for tamper detection and prevention.
The PUF product that I alluded to and those might have potential in consumer electronics to prevent identity fraud, identity theft and to protect assets. And as we do that, we continue to develop the technology and that technology is applicable we believe to large scale memories.
So, we believe that we built an excellent technology portfolio for MRAM, they could be applicable to large scale memories and we’re proving the viability of the technology everyday by making these specialized MRAM devices that can be used in cryptographic and related applications.
Jon Jung – Trailhead Asset
Thank you.
Daniel A. Baker
Thank you.
Operator
Thank you. The next question in queue is from Steven Crowley of Craig-Hallum.
Your line is open.
Steven Crowley – Craig-Hallum Capital
Yes, Dan. In terms of an update on the wireless compass sensor commercial activities, you’ve had a customer who has been looking to bring your design.
I guess your part as part of an overall solution to the wireless handset market. Are you making headway?
Would you expect to have design wins or do have design wins or somewhere to progress there?
Daniel A. Baker
We are making headway. We have a customer now that's looking at potential applications, and the customer is continuing to investigate those applications, they’ve made prototypes and we see it as a long-running opportunity and there may be a much larger market than is being addressed now.
So our goal is to leapfrog existing technology with size and precision and we continue the research to reduce the size even more. So, we are hopeful that the applications are going to demand higher precision and then there is always a need for smaller size and we’ve talked about on previous calls the advantage of having a smaller sensor than is possible with other technology.
So we’re continuing the development on that and our customer is continuing to investigate applications using prototypes that they’ve built using our parts.
Steven Crowley – Craig-Hallum Capital
So this is the customer you’ve been working with for a while whose objective is to find devices in which the solution can go into in volume?
Daniel A. Baker
Exactly. And we developed this part in cooperation with them, because they see a market – a potential market and the demand for a more precise compass and we continue to work to reduce the size.
The devices that they have don’t have the dramatically thinner 3-axis compass that we talked about, and that I talked about in the prepared remarks. But it has, we believe more precision than is available with conventional technology, and they believe based on feedback from their customers that there is a demand for that and a need for that.
Steven Crowley – Craig-Hallum Capital
Okay, and in terms of the in vitro or the novel biosensor where you have one sizable IVD customer going into production over the not to distant future here. Do you anticipate over the relative short-term lets say, over the next several quarters or the next year of having other customers for that product or do you have other customers for that product?
Now, how are you thinking about the evolution of that opportunity?
Daniel A. Baker
We see excellent potential for that with other customers. We don't have an exclusive with a particular customer that we're working with.
And we do see potential in similar devices these are in vitro medical diagnostic systems. Long-term, we see the potential that dramatically reduced the size, but even in the near term, we see potential demands for our biosensors in an improved in vitro diagnostic system.
And in particular, one of the things that we think could accelerate this is eventual agency approvals, the US agency approvals, the FDA tends to be slower than other agencies around the world. So we're looking for opportunities that we can get into as quickly as possible and those tend to be ones with lower regulatory hurdles or at least faster regulatory hurdles.
And then we see potential in the US and other markets once the technology is proven and that tends to make the agency approvals, the regulatory approvals go faster. So that’s one of the reasons that we’re optimistic about the future of this is that we see this as a potential to demonstrate the technology, to demonstrate the safety and efficacy of the technology and that opens up, that could potentially open up other larger markets for us.
Steven Crowley – Craig-Hallum Capital
So it sounds like the revenue opportunity for that product over the near-term really will be about exploiting the current opportunity with your existing customer in a growing number of geographies and then branching out from there, is that the way we should think about it?
Daniel A. Baker
Perhaps. I think we’re always looking at market development and we don’t have opportunities that are as far along, where in this case, we’ve got a customer that’s got a machine that’s very far along where they are planning production and they are in the final stages of those plans.
But we have other potential customers and we certainly see this as the first of hopefully many opportunities.
Steven Crowley – Craig-Hallum Capital
Great. One final question, in terms of your intellectual property portfolio, investors have had a growing appetite for companies with sizable and likely valuable intellectual property portfolios, and I think that’s probably helped your company in terms of investor interest.
I’m wondering if that phenomenon is working kind of the real business world where, is it stoking additional partnership product or even technology licensing opportunities for you or have those discussions become more numerous, and are they likely to become a bigger part of the story over the next year or so? How should we think about that?
Daniel A. Baker
Now that's a good point, Steve. And actually we have received increased interest in possible joint development and private-label arrangements as other companies find that it’s cheaper to buy or license unique technology such as ours rather than to try to develop new technology themselves.
So, we’re seeing the value of technology both in selling products that has our unique technology, but also in interest from other companies and so, we do see that trend in that companies are starting to look at make versus buy decisions, recognize the importance of time to market, recognize the value of unique technology of revolutionary technology and we’re working on variety of ways to monetize that. We do have some private label arrangements now almost notably Avago, but that might be a potential area that we can expand by using, by combining our technology for couplers and sensors in particular with companies that have a demand and that have distribution and that have infrastructure, customer facing infrastructure.
Steven Crowley – Craig-Hallum Capital
Great, thanks again for taking my questions.
Daniel A. Baker
Thank you, Steve.
Operator
Thank you. And gentlemen, I'm showing no other questions in queue at this time.
Daniel A. Baker
Well, thank you. If there are no other questions, I’ll just sum up that in a challenging quarter we reported solid earnings with a strong backlog and a pipeline of potentially game changing products.
We look forward to speaking with you again in January to report our third quarter results. Thank you again for participating in the call.
Operator
Ladies and gentlemen, thank you for joining today’s conference. This does conclude the program.
And you may now disconnect.