Jan 18, 2012
Executives
Daniel Baker – President, CEO, Director Curt Reynders – CFO
Analysts
Steven Crowley – Craig-Hallum Capital Jon Jung – Trailhead Asset Management William Driscoll – RMB Capital Management Kevin Sonich – RK Capital
Operator
Good day, ladies and gentlemen, and thank you for standing by. And welcome to the NVE conference call on third quarter results.
At this time, all participants will be in a listen-only mode. Later we’ll conduct a question-and-answer session, and instructions will follow at that time.
If anyone should require assistance during the call, you may press star then 0 on your touchtone telephone for a live operator. As a reminder, this conference may be recorded.
I now will turn the program over to Daniel Baker. Sir, the floor is yours.
Daniel Baker
Good afternoon, and welcome to our conference call for the quarter ended December 31, 2011, the third 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’ll cover business items, and we’ll 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. 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 relating to future revenue and growth, uncertainties in converting product order backlog into sales, risks related to developing marketable products, uncertainties relating to the revenue potential of new products, risks related to the loss of supply from our packaging vendors, risks in the enforcement of our patents, 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. We reported solid earnings for the quarter despite significant challenges from supply chain disruptions and economic conditions the past two quarters.
Net income was $0.47 per diluted share despite a 23% decrease in total revenue due to decreases in product sales and contract R&D revenue. I’ll turn the call over to Curt for details.
Curt Reynders
Thanks, Dan. Total revenue for the third quarter of fiscal 2012 decreased 23% to $6.2 million due to a 19% decrease in product sales and a 40% decrease in contract research and development revenue.
Product sales were $5.39 million with lower sales in the both industrial and medical device markets. The decrease was from what was a record quarter in the prior year.
As previously reported, flooding in Thailand shut down one of our packaging vendors in early October, and they still are not operating. Alternate vendors were slow to ramp and had less capacity because other companies were switching vendors as well.
Flooding also had ripple effects on the supply chain, compromising the availability of materials used for packaging our parts. These disruptions delayed many of our product shipments in the past quarter and prevented us from shipping our entire product order backlog in the quarter.
Nevertheless, we were able to ramp up another packager to minimize the impact. We were unable to ship some lower-volume specialized parts that didn’t have alternate packagers that we are now qualifying packagers for those.
Also contributing to the product sales decline in the past quarter were possible inventory adjustments by some of our medical device customers due to weakness in the medical device industry. In addition to affecting our supply chain, flooding in Southeast Asia and other industry disruptions have slowed the semiconductor business.
Other factors impacting the industry’s lowdown may include excess distributor inventories and the global economic slowdown. Although we would have liked to have seen year-over-year growth, we were pleased to have had solid profits as we have through good times and bad for 39 consecutive quarters.
That’s every quarter for nearly 10 years. Although most product orders are cancelable, there haven’t been many cancelations.
Therefore, our product order backlog is strong, especially for medical device markets, and some customers shifted orders from the past quarter into the current quarter. The unusual supply chain challenges appeared to be mostly behind us.
We entered the quarter with adequate materials and packaging capacity, and a higher shipment rate late in the quarter bodes well. Most importantly, we continue to see a bright future for existing and potential new products.
Contract R&D revenue decreased 40% to -- excuse me, $764,000 due to the completion of certain contracts and contract activities and the continuation of a challenging government funding environment, especially for small business innovation research or SBIRs. We received approximately $2.35 million in SBIR awards last fiscal year.
As a result of the challenging funding environment, we’ve been concentrating on non-government and non-small business contracts. The enactment of the SBIR Reauthorization Bill at the end of 2011 removed some of the uncertainty relating to those contracts.
Gross margin remained strong, although it decreased to 65% of revenue compared to 69% last year due to lower volume and increased labor cost. The increased labor costs were from adding production personnel needed to support future products.
Total expenses increased 28% for the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011 due to 117% in R&D expenditures, partially offset by a 19% decrease in SG&A. The decrease in SG&A expense was due to a decrease in sales commission and performance-based compensation as a result of lower sales and net income.
Legal expense related to preparations for a patent infringement lawsuit did not significantly impact SG&A expense. Dan will discuss the legal proceedings in a few minutes.
The increase in research and development expense was due to increased company-funded product development activities as we redeployed resources from contract R&D. We believe the investment in R&D will pay off in future revenues and profits.
Interest income increased 16% due to an increase in interest-bearing marketable securities. Income before taxes for the quarter was $3.3 million and pretax margin was 54%.
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 third quarter was $2.3 million or $0.47 per diluted share compared to $0.70 last year, and net margin was 37%.
Diluted net income per share was $1.71 for the first nine months of this fiscal year compared to $2 for last year. Cash flow strengthened our balance sheet.
Operating cash flow was $8.6 million for the first nine months of the fiscal year. As of December 31, cash plus marketable securities was $68.9 million, an increase of $6.7 million in the first nine months of the fiscal year.
Purchases of fixed assets were $762,000 for the first nine months of the fiscal year, primarily for production equipment. We’ve nearly completed, in addition, to our production clean room space, which was a key part of our expansion strategy.
The new space will increase capacity for important operations and free up clean room space for other equipment. We’re planning the details for a further expansion of the clean rooms that could start in the next few months.
Now I will turn it over to Dan for his perspective on our business. Dan?
Daniel Baker
Thanks, Curt. As Curt said, we’ve significantly increased our R&D investments over the past year.
I’d like to highlight couplers, biosensors and MRAM. In the past quarter, we announced even better versions of our award-winning IsoLoop RAM spintronic couplers.
Due to an improved manufacturing process, the new parts are more robust at extremes of high temperature, low power supplies, and speed. They extend our IsoLoop RAM couplers advantages for key parameters including small size, high channel density, low distortion, ruggedness, and low power consumption, or as we sometimes say, boxes, bits, [vod], bulletproof and batteries.
We said in our last call, we have a customer who is planning to use custom spintronic biosensors in a new medical device, medical diagnostic instrument with biosensor production to start in the first calendar quarter. We recently made another shipment of pre-production biosensors to that customer.
We don’t have a more detailed production schedule update, but we continue to plan for volume production and we continue to believe this could be the start of an important new market for us. We’d said before, we see private label products as a means to significantly expand our marketing reach and target new markets such as automotive electronics.
This business model also makes sense for other companies that are finding it’s cheaper to buy or license our technology rather than to try to develop new technology themselves. In the past quarter, we had discussions with several interested potential private label product partners and we’re developing custom prototypes.
MRAM continues to be a significant part of our research and development activities. Some of that activity is customer-funded.
MRAM is spintronic magnetoresistive memory which uses electron spin to store data. We’ve invested significant resources in MRAM R&D over the years, and we’re defending our rights to protect these investments.
Earlier this month, we filed a patent infringement lawsuit against Everspin Technologies in US district court in Minneapolis. The suit alleges infringement of our 6275411, 6349053 and 6538921 patents.
The 411 and 053 patents are for spin-dependent tunneling memory, the 921 patent is for circuit selection of magnetic memory cells and related structures. There are links to those patents from the About NVE section of our website.
We are seeking an injunction for Everspin to cease using our patented technology and provide compensation for damages caused by the infringement. The suit seeks damages of at least the reasonable royalty plus interest, and we see triple damages for willful infringement.
We also ask the court to award our cost and attorney’s fees to prosecute this case. We consider our MRAM technology important intellectual property.
In addition to Everspin, we’ve said in our SEC filings that companies have described designs that we believe would infringe on our patents if commercialized. Additionally, we have strong technology and intellectual property relating to Spin Momentum MRAM, also known as spin torque transfer MRAM that could enable dramatic increases in MRAM bit density and open much larger markets.
Now I’d like to open the call to questions. [Huey]?
Operator
Thank you, sir. Ladies and gentlemen on the phone lines, to queue up for a question, please press star then 1 on your touchtone phone.
If your question has been answered or wish to remove yourself from the queue, you may press the pound key. Again, if you would like to ask a question, please press star then 1 on your touchtone phone.
Our first questioner in queue is Steven Crowley with Craig-Hallum Capital. Please go ahead, your line is now open.
Steven Crowley – Craig-Hallum Capital
Good afternoon, gentlemen.
Daniel Baker
Afternoon, Steve.
Steven Crowley – Craig-Hallum Capital
A couple of questions really revolving around better understanding the continued weakness in the December quarter and where we go from here quite frankly. In terms of the inventory correction that you continued to experience in the quarter, that seems somewhat counter to the impressions you had and communicated in the last conference call.
Did this linger a bit longer than you expected? Were there complicating factors in certain segments?
Help put some more color on what transpired in December.
Daniel Baker
Well, we believe the challenges, most of the challenges are behind us with some of the special factors that we talked about such as the problems that we’ve had relating to the flooding in Thailand. The economic conditions and conditions in the medical industry, it’s hard for us to predict, it’s hard for anyone to predict.
We’re hopeful that they’re going to improve. It’s a complicated environment, as you know.
But we don’t -- we never really know for sure. We always plan for the upside.
We want to have capacity and we want to be sure that when our customers order parts, they can get them from us, and that we minimize the possibility of conditions turn around quickly, and we’re unable to deliver, because we haven’t planned on capacity or haven’t identified supplies of raw materials. So, we plan for capacity planning for a fairly optimistic scenario.
We don’t count on it. We try not to incur fixed costs unless we feel that they’re going to be justified that we can’t always predict the future.
Steven Crowley – Craig-Hallum Capital
Now, in terms of the back order situation that you're shipping against that you said was relatively healthy, how does that back order situation compare now versus three months ago in terms of magnitude and composition?
Curt Reynders
Well, Steve, what I can say is that, at the end of the quarter, we had very good product backlog. We had some issues with being able to deliver due to our -- to the flooding in Thailand the first part of the quarter.
But toward the end of the quarter, in December, we had pretty strong finish to the quarter, which bodes well I think into the future for the company. The usual caveats are that our backlog may not be indicative of future sales, but it is, I would say, it is strong going into this fourth quarter.
Steven Crowley – Craig-Hallum Capital
Now we got -- at least I got the impression that exiting last quarter, you had a backlog equation that was encouraging. It sounds like the extent of that backlog situation at the end of Q3, the December quarter, is substantially higher than where it was at the end of the September quarter.
Or is that not a correct inference?
Curt Reynders
It’s kind of difficult to say because, you know, sometimes customers pull in orders, sometimes they push out orders. So it’s tough to say exactly where it was at the end of September compared to the end of December.
But it was very strong at the end of December.
Steven Crowley – Craig-Hallum Capital
And then, about your comment regarding delivery problems early in the quarter, delivery challenges early in the quarter relating to flooding-related issues in Thailand, was the bigger influence the specific packaging vendor that went down because of the flood and where you couldn’t replace that specific packaging capacity? Or was it the other impacts that impacted your other products that weren’t directly in those crosshairs with that vendor that was the bigger influence during the quarter?
Daniel Baker
This is Dan. I think the bigger influence was the direct impact of having one of our major packagers shut down by flooding.
The other factors helped complicate the quarter and the logistics. So there are a number of parts that go into, in addition to our wafers that we make here, there are a number of components and raw materials that go into a finished part before we sell it.
So, there are metals, the specialized metals that go into the lead frame, the part of -- the part that actually connects to the circuit board. There are plastics that go into that.
There are tubes in some cases that our parts go into. And there’s a cluster of suppliers for those materials around the packaging houses in Thailand, and many of them were disrupted.
And then those disruptions caused ripple effects because there were capacity shortages for some of these. But the dominant effect was that we lost one of our major packagers.
We have other packagers, but they were in a situation where other companies were in the same situation as us, looking for alternate packagers, so they found themselves short of capacity and the other complications we talked about. And then finally, the other side effect was it slowed down the market demand for many of our products and slowed down the -- appears to have slowed down the industry.
So, if our customers can’t get other components to build the sub-assemblies that they sell for factory automation, industrial control or whatever market they’re in, then they don’t need to buy our parts. So, the ripple effect there is that they have to wait to recover other parts that are unrelated to ours but that might have been impacted by flooding in Thailand before they can build a complete sub-assembly, and then they don’t need our parts.
So, it was a -- it really did complicate the supply chain in the quarter. But for us, the biggest difficulty was to have one of major suppliers shut down.
Steven Crowley – Craig-Hallum Capital
Right. Well, thanks for the color.
Now, the last question before I hop back in the queue really relates to the significant capacity expansion that you’ve been undergoing at the company. We’re talking about rather significant moves certainly by historical standards and relative to your capacity before the move.
I'm trying to rationalize or reconcile that, with a revenue number that’s gone the wrong way for two quarters in a row and really we have to go back three years to see a quarterly revenue total, below the number that you just put up, that seems to be a very inconsistent maneuver by a management team that’s historically been very conservative. Now, you made some comments earlier in the call about needing to be ready for an uptick in demand, but are there major new products also -- help us -- help me rationalize what’s going on here please.
Daniel Baker
Well, that is a good point. We’re planning for the future and we believe that we’re going to need additional capacity.
So, some of that is based on some specifics, specific opportunities such as the biosensor that I alluded to, such as private label products that I -- that we talked about in our prepared remarks. Some of it is existing customers that are providing us with forecasts or we’re looking at it saying that we believe that these are anomalies.
So, some of it is the philosophical, because our business is a high value-added business, our customers depend on us, it’s important to us to be able to fulfill their needs despite the cycles and the ups and downs that their industry and their business might have, but some of it is based on specifics that -- of new products, new opportunities, new market channels that we believe are going to drive future growth, and we talked about several of them in our prepared remarks.
Steven Crowley – Craig-Hallum Capital
Okay. I’ll let some others jump in and then come back with a few.
Thanks for taking my questions.
Daniel Baker
Thanks, Steve.
Operator
Thank you, sir. And just as a reminder, ladies and gentlemen, to queue up for a question, please press star then 1.
Next questioner in queue is Jon Jung with Trailhead Asset Management. Please go ahead, your line is now open.
Jon Jung – Trailhead Asset Management
Good morning, Dan -- or afternoon, Dan. I wonder if you could give me any information about the revenue that Everspin has generated from this patent infringement?
Daniel Baker
Right. That’s a question better answered by Everspin.
I believe that they have said publicly that their revenues are growing very rapidly, or at least their unit sales are growing very rapidly. And that’s something that would come into play, as you can imagine, in the legal proceedings, because we’ve asked for a royalty based on infringement.
In terms of the revenue though, we don’t have enough specific information at this point to say what it is or what a reasonable royalty with the enhancements that I mentioned in the prepared remarks what that would be. We certainly, for our part, see a very bright future for MRAM, not only for what’s sometimes called classic MRAM or conventional MRAM, which is what’s being sold now based on the information that we have, but also on what’s called spin momentum MRAM or spin torque MRAM where we have strong technology and intellectual property.
And that type of technology allows a much more efficient writing of the bit, which reduces the amount of heat that’s dissipated in each bit, and we believe can open a much larger market by dramatically increasing MRAM bit density. And there’s interest in that in the industry.
So we certainly see it as a very good market, and we continue to invest in R&D.
Jon Jung – Trailhead Asset Management
That’s good, I understand. Do you have any timeline on the lawsuit?
Daniel Baker
That’s a tough one to answer because it’s just hard to predict the timing in a legal process. It depends on the courts, it depends on the defendant.
We’re interested in a speedy resolution, but we don’t always control it. We do take a long view.
We see this as an excellent long-term market that could significantly impact the memory market, one of the larger markets, semiconductor markets that there is or ever has been. So, we want to be sure that our investments are protected, the investments that we’d made over the years, and that our shareholders get the benefit of the investments that we’d made for many years.
Jon Jung – Trailhead Asset Management
Okay. Is anybody else other than Everspin shipping an MRAM product that might be infringing?
Daniel Baker
Not that we know of, and we haven’t filed suits against anyone else. As we’ve said in our SEC filings, companies have described designs that we believe would infringe on our patents if they were commercialized.
As you might imagine, we do try to keep an eye on what’s out there, so we might not always know. But we’re always trying to monitor this to make sure that if someone is infringing, that we know about it, we take the actions that are appropriate, and that we do so in timeframes that serve our interest and our shareholders’ interest.
We’d prefer to avoid litigation, so our strategy is to license our memory technology, at least for large-scale memories.
Jon Jung – Trailhead Asset Management
Okay. On another front, do you have any plans to change the capital structure or do we need buybacks with the cash that you’ve been accumulating, or do a stock split or anything?
Daniel Baker
We’re always looking at that. We’re always looking at ways of increasing shareholder value.
As you probably know, we have a stock buyback program that’s been approved. We haven’t reported any repurchases.
We will report them in our SEC filings if we do. As far as stock splits, we do look at things like that.
There’s fees involved with that, so the NASDAQ charges a fee if you increase the number of shares, even if it’s simply through a stock split. So we look at that and we try to avoid expenditures.
So that’s one of the reasons why we might not do something like that. But we’re always looking at what we can do to increase our shareholder value.
We consider that our job as fiduciaries of the company.
Jon Jung – Trailhead Asset Management
Well, we know you take that seriously, and we do appreciate that.
Daniel Baker
Thank you.
Jon Jung – Trailhead Asset Management
That’s all the questions I’ve got. Thank you.
Operator
Thank you, sir. Again, just as a reminder, to queue up for a question, you may press star then 1 on your touchtone phone.
Next questioner in queue is Steven Crowley with Craig-Hallum Capital. Please go ahead, your line is now open.
Steven Crowley – Craig-Hallum Capital
Yes, a few follow-ups. One of the interesting statements you made in your prepared commentary relates to this whole private label opportunity.
Are you talking about a partnership where other, I assume, notable or noteworthy electronic semiconductors companies would look to sell their own line of spintronic-based components under their label, but given your intellectual property and capability, it would be your parts? So, similar to an Avago type relationship.
And did you say you’re in multiple discussions?
Daniel Baker
Yes, that’s correct on both counts. We’re looking at the possibility of private labeling products, particularly couplers, where, for those of you not familiar with our relationship with Avago, Avago is a large diversified semiconductor company that has roots in Hewlett-Packard and spun off of Hewlett-Packard, and they sell our products under their brand.
And that’s a business model that we believe that we can extend. Other companies have distribution that we can’t reach.
They might have a brand awareness, a brand recognition. They might sell other parts to customers that allow us to get a foot in the door and gain access to an important customer that we might not be able to do ourselves.
And I think companies are finding that intellectual property is valuable, that we have excellent intellectual property, and it might be cost-effective to buy or license our technology rather than develop it themselves. So, we’re looking at -- on that front where we would make the part, put someone else’s brand on it, and sell it through their channel.
They would sell it through their channel. We’re also looking at ways that we can enhance the value proposition for our products if a company has particular transceivers or network protocols that we see a market for, then we could see the possibility of combining our isolation technology with their, in this example, with their interface technology to make a product that we can’t make ourselves or that they can’t make themselves.
So that’s a win-win that gives the market a great product that they can’t get otherwise, and allows us to leverage the technology for more markets than we can currently reach.
Steven Crowley – Craig-Hallum Capital
And are these potential opportunities of similar significance potentially downstream as the relationship you have with Avago? And is it about a broader, casting a broader net in the markets you serve now?
Or I think I heard auto. Is this one of your doors to access that market?
When you talked about the applicability of your parts in that market historically, is this one of the place to get into that market?
Daniel Baker
Exactly right. This is one of the ways that we can reach that market.
The automotive market is notoriously difficult to crack, particularly for smaller companies. Auto manufacturers and the tier 1 suppliers, the ones who make the sub-assemblies that they sell to auto companies tend to try to reduce their number of suppliers to simplify their supply chain.
So, we are looking for partners that we can leverage to get into the automotive market faster than we could otherwise. So there are particular certifications that are required that other companies have expertise on.
There’s value-added such as, in some cases, packaging or interfaces with the automotive environment, automotive networks, automotive interface protocols, that we believe the fastest way to get there to leverage our isolation technology, our coupler technology, is to partner with companies that already have that. So, automotive is an excellent example of that.
And in that sense, it’s a bigger opportunity and a broader partnership vision then with Avago. We’ve had an excellent relationship with Avago and they’re a fine company.
But the parts that we private label there are very similar to the parts that we sell on our own brand. So, what they’re bringing there is distribution, customer support, brand reputation, and the ability to provide a one-stop solution for some of their customers with their broad line of semiconductors.
What we’re talking about in some of these other private label products and partnerships is a way to reach markets that we really can’t reach now such as automotive, and to get protocols and interfaces and industry standards that would be difficult for us or would be prohibitively expensive for us to reach.
Steven Crowley – Craig-Hallum Capital
Now, in terms of us recognizing future sign posts of progress with these initiatives, are these the type of relationships that both you and the partner would want to be -- would want to be public and obvious such that they’d be announcing and you’d be announcing them? Or is the only way we’re going to know of progress likely to be seeing other spintronic parts out there and recognizing that they must be NVE?
Daniel Baker
That’s a good question. We would like to talk about it for just for pride and for other reasons.
Sometimes our customers are reluctant to have us do that because it undercuts their -- they might perceive it as undercutting their reputation for innovation, or pointing potential customers directly to us as opposed to through them. So, we try to be respectful of that.
Our primary job is to make sure that we have a good relationship. And then secondarily, if we can, without violating a confidence or customer’s expectation, we’d like to be able to -- we’d like to be able to talk about it.
And we were able to make announcements relating to the Avago partnership, and our hope would be that we’d be able to talk about some future relationships as we have in these calls, albeit in this case just the early stages in developing some custom prototypes and the potential interest. But we see it as an important part of our business model and we’d like to be able to discuss it.
Steven Crowley – Craig-Hallum Capital
And in terms of the timeframe for which you can drive these to actual commercial working relationship and kind of get across the goal line, is this -- is there potential that one or more of these relationships could be fiscal 2012 accomplishments, or is that just plain unrealistic given the timeline necessary?
Daniel Baker
We’re going to push them as fast as we possibly can. We in product development, we look at time and urgency as one of the main ways that we can add value.
One of the things that we do well is to be able to move quickly and respond to our customer demand. So, in the -- to the extent that we’re looking at network protocols and combining existing modules to reach new markets or new branding options, that’s something that we would hope to be able to do very quickly.
On the automotive market, we’ve highlighted that some of the needs are going to be driven by hybrid electric vehicles, and those are really, in the scheme of things, in their infancy. So, that might be a little bit longer-term, at least in terms of hybrid electric vehicles and devices in the car, which is a market that, as you point out, we’ve identified.
We see it as an excellent long-term market. We have a great benefit proposition there of communicating between the various modules in a car as they get more and more complicated and much higher electronics content.
But that requires a design in-cycle. The industrial side, we see those as narrow-term opportunities where we can replace multiple components with a single integrated solution that provides communication -- of a communication solution for a customer, and that we believe can be done relatively quickly.
Parts have to be qualified, data sheets have to be written. There’s marketing collaterals that have to be done.
But we would endeavor to do that as quickly as possible. And because these products and modules are fairly well-established, we know how to do that.
Steven Crowley – Craig-Hallum Capital
Okay. Two quick follow-ons.
We don’t get to talk that often and there didn’t seem to be a lot of questions in the queue, so I’ll pop them out and then get out of the way. In terms of the electronic compass into wireless applications, what kind of update can you give us on that program and its prospects?
And then just, I want to confirm what you told us about in vitro diagnostics which you continue to march down a timeline that seems consistent with your most, you know, with last quarter’s plan and the opportunity there, how has that evolved if at all versus your prior thinking in terms of in vitro diagnostics?
Daniel Baker
So, to the first part of your question, compasses for consumer electronics, we believe in that market. We’ve demonstrated better performance than the existing technology.
We’re developing smaller compasses for the longer term. We recently filed an important patent relating to compassing.
And we’re exploring options to bring that technology to market as quickly as possible. So that’s just an excellent example of the value that our technology can add in terms of more precision as well as smaller size and less power consumption.
In terms of the in vitro diagnostic, yes, we continue to plan for production in the near term, and we delivered a number of biosensors, what we would call preproduction. So, it’s as prototypes, it’s not quite production, but it’s quantities much higher than would be needed to just do laboratory tests or things like that.
So, based on that, we’re very optimistic with the customer that we talked about, and with the potential for additional customers and additional devices for the biosensor product line.
Steven Crowley – Craig-Hallum Capital
Great. Thanks again for taking my questions.
Daniel Baker
Thank you, Steve.
Operator
Thank you, sir. And again, ladies and gentlemen, if you would like to ask a question, please press star then 1 on your touchtone phone.
Next questioner in queue is William Driscoll of RMB Capital Management. Please go ahead.
William Driscoll – RMB Capital Management
Hi, Dan. How are you?
Daniel Baker
Hi, Bill.
William Driscoll – RMB Capital Management
Just a question on the R&D, as it’s moved up substantially the last couple of quarters as contract sales have gone down. Along the same lines as the question on capacity.
How much of this is kind of this is doing projects, you hoping that at some point it turns to revenue versus actually on a project that’s customer-driven?
Daniel Baker
Well, so, customer-driven, if you mean customer-funded, that would show up in the contract R&D revenue line, so that was down significantly from the prior year. However, what I think you might be getting at is, when we justify an R&D project, whether it’s internally funded, whether we have the resources or don’t have the resources, we have to demonstrate a payback or we’re not going to do it.
So, even if we had, say, people available because we didn’t have as much customer-funded R&D because of the various factors that Curt talked about, the uncertainty in government funding, the SBIR, reauthoritization bill, we still look at it and say, if we invest our shareholders money in R&D, we need to be able to demonstrate a return. It’s not without risk, but we have programs that we believe are going to pay back, and we have the resources to do them.
The resources are not that easy to find. Many of these folks are the best in their field in the world.
They’re an extraordinary group of people. And if we have a customer obligation, we’re going to follow through on that, and sometimes that means that we don’t always get to work on the R&D, the company-funded R&D programs that we have.
But the programs that we have, we believe, are going to pay back, and that’s the reason that we’ve increased our R&D, not just because the people are available, if that’s what you were getting at.
William Driscoll – RMB Capital Management
And was there any other reason for the capacity expansion, tax breaks or anything else that made sense to do it now versus later? Or is it just that you feel that you’ll use it?
Curt Reynders
I can go ahead and answer that. We didn’t do it for the tax, any kind of tax breaks.
We don’t do anything for tax breaks. The expansion was based on what our future expectations are for the business, looking at it in a long-term way.
William Driscoll – RMB Capital Management
And on the biosensor, your description of the opportunity and the timeline, it seems like you almost repeated what you said last quarter, and here we are three months forward. Have they slowed down their thoughts on when this is going to ramp, or is there anything outside of their control that’s slowing down their thoughts on when this product will start to have a more substantial demand?
Daniel Baker
They haven’t said anything about slowing down. There are things that are beyond their control, we presume, primarily regulatory approvals and early-stage medical devices, diagnostic instruments.
One has to have approvals, one has to have some infrastructure lined up, and those are things that we rely on our customer for. So, we believe it’s very near term.
There are uncertainties associated with it, as one can imagine, with any big change and these sorts of opportunities tend to have uncertainties and we wouldn’t want to say they don’t. But we’re very optimistic in the near term.
And aside from what they’re saying, we, as I mentioned, we delivered pre-production units. So they’re very serious about this and we believe it’s close to starting production.
William Driscoll – RMB Capital Management
And I'm not sure what regulatory body they’re dealing with, whether it’s here or abroad, but is there anything as far as a timeline that they’re working off of, that if they filed with that body, that that body has to get back to them within a certain amount of time, or is it more of an open issue?
Daniel Baker
I believe it’s more open-ended than that, but it depends on, you know, it depends on what the regulatory body is looking for. They can, in many cases, regulatory agencies can ask for more data, they can ask questions.
And usually the regulatory bodies aren’t constrained as much by schedules as they are by their mandates of ensuring safety and efficacy or whatever their mandate is. So, there is a certain amount of unpredictability in those kinds of situations.
So, that’s just part of what making new products, revolutionary new products that are based on new technology, it’s just inherent in that. So, we try to understand as much as we can, but there are uncertainties in that.
William Driscoll – RMB Capital Management
And then finally, regarding Thailand and your inability to get certain packaging, has that in any way, for customer relationships in a longer-term way, that they feel that maybe if they would have been better off with a larger provider of that particular part, someone that you don’t enough sway that they could get their space? Because I have heard that some smaller providers in the semiconductors, they couldn’t get new capacity where obviously the big guys could, and whether there’s any permanent distraction of those relationships with some of the larger customers that you have?
Daniel Baker
Well, we’ve worked to make sure that there isn’t. Late deliveries is never a good thing, and all we can do is are honest with our customers, we give them the information that we have.
We do whatever we can to make sure that we preserve that relationship and expedite wherever we can. And there are many larger semiconductor companies that were affected by the flooding as well.
And I think we’re overall very pleased with the response of our alternate suppliers and the priority that we got with them. So, I don’t think we’d want to blame the fact that we’re, in the scheme of things, a smaller company, but we’ve worked with our customers to make sure that they understand what we’re doing to prevent this, that we have alternate suppliers.
The mitigation that we’re looking at for the future, both with this particular supplier, what they’re doing to mitigate their flood risks, and what we’re doing to have alternate suppliers for any kind of contingency, whether it’s flooding or any other kinds of natural disasters or shortages or anything else. So, I think we came out of it pretty well despite our relatively small size, compared to some of the sizes of other companies that were affected by flooding.
William Driscoll – RMB Capital Management
All right, Dan. Thanks for your time today.
Daniel Baker
Thank you, Bill.
Operator
Thank you, sir. Next questioner in queue is Kevin Sonich with RK Capital.
Your line is open, please go ahead.
Kevin Sonich – RK Capital
Thanks. Hi, guys.
Daniel Baker
Hi, Kevin.
Curt Reynders
Hi, Kevin.
Kevin Sonich – RK Capital
Understanding that there are several cross-currents to consider, many of which are beyond your control, and compared to how you felt three months ago, today as we sit here, are you more or less confident that we’ve seen the bottom?
Daniel Baker
It’s hard to compare to a prior quarter. We believe that the challenges are, relating to supply, are mostly behind us, and in particular, the strong end of the quarter that we had bodes well, and as Curt talked about, the customer relationships that we preserved and relatively small number of cancelation, are all good omens.
So we’re very optimistic on that front. On the global economic condition, that’s a little harder to -- that’s a little bit harder to predict, as we talked about before in answering to another question.
But certainly in the long run, we’re optimistic, and industry conditions appear to be improving, and particularly towards, you know, in the next couple of quarters, I think a number of experts are predicting an increase in the macroeconomic environment or an improvement in the macroeconomic environment, and some secular improvements and what would be for us fewer headwinds.
Kevin Sonich – RK Capital
Okay. And was this -- is the strong backlog at quarter-end and the recently strong order patterns more a reflection of some of the weakness earlier in the quarter and just a catch-up?
So, in other words, what you didn’t ship in October or November and then we’re shipping or we’re getting orders for rather in December, to sort of lay it on top of your regular December orders, did that inflate the order pattern of the backlog, or was it more of a reflection, at least as far as you can tell, of demand getting a little bit better?
Daniel Baker
It was both. It was a reflection of our supply chain strengthening and getting up to speed so that we could ship orders that were backlogged, and an increase in -- and receiving new orders as well.
So, it was both, and that’s part of the reason for our optimism, particularly in the medical device market that we serve that, while that’s been a difficult market recently, that’s starting to show signs of improving.
Kevin Sonich – RK Capital
Would you be willing to comment on the relative underperformance, if you will, or the declines in the two key segments, medical versus industrial?
Daniel Baker
Yeah. The industrial was probably harder-hit.
It’s more susceptible to the global macroeconomic environment, it’s more susceptible to inventory swings within the channel. So, it’s more susceptible to distributors looking at their outlook and saying, perhaps saying that they needed to cut back inventories.
It was challenging in both environments, but the industrial market was particularly challenging. And it’s cyclical.
We’ve had down quarters before, and it comes back. And it was also more affected just because of the nature of where we get things done.
It was much more affected by the floods in Thailand than our medical business was.
Kevin Sonich – RK Capital
Okay. And then just lastly, as it relates to that industrial side of the business where, as you mentioned, it’s somewhat cyclical, it comes back, also thinking about some of the supply side issues and challenges that perhaps just delayed ultimate shipments, or even if orders were lost, that the run rate may not have changed that much compared to a few quarters ago.
If you look at the business now, $6 million in change in revenues in the quarter compared to where we were for the prior year, year-and-a-half, at least before last quarter anyway where revenues were closer to about $8 million a quarter, and then you look forward, are we -- do we need to, you know, when you think of it in the context of the company’s goals and your goals, do we now rebuild off the current level in terms of how you think about what would be good growth? Or are we, you know, maybe there’s a little bit of a period, a couple of quarters to get back to where we were, but you're really thinking about that $8 million-ish or so run rate as more than bar that we build off?
If that makes sense.
Daniel Baker
Yeah, I follow what you're saying. We’re thinking of how do we roll very rapidly.
We’re not looking at it saying, well, if we grow off of this lower level, then we consider that a success. We’re looking at how do we add business, how do we add big chunks of business, enter new markets, and revolutionize our industries.
And those are our goals. There’s always the risks associated with those, with having bold goals like that.
But we’re not looking at it -- we’re not content with being a successful small semiconductor company. That’s not our goal.
Our goal is to revolutionize industries and to make a big difference in every market we enter. So, hopefully that answers your question.
We can’t get into, as you know, we don’t give forward-looking guidance, so we can’t really comment on numbers. But certainly we can comment on our goals and our vision, which is to -- which is to revolutionize the electronics industry.
Kevin Sonich – RK Capital
Okay. I understand that it will be hard to mark progress in the next one or two years even if we’re just thinking about revolutionizing industries.
And I think you answered the question anyway. I guess it would be fair to say, if it takes a year just to get back to the run rate, the prior run rate, that could happen.
I mean, there are obviously lots of factors weighing on the industry and on you. But that would be disappointing.
Is that fair?
Daniel Baker
Well, we wouldn’t quite put it that way, but our goal is to grow. And so, it isn’t to, you know, we’re not looking at it judging our success by saying we want to get back to this level or that level.
We’re judging it by leapfrogging where we have been, entering new markets, gaining new customers, and we believe that the technology and our -- it has that kind of -- has that kind of potential.
Kevin Sonich – RK Capital
Okay. Thank you very much.
Daniel Baker
Thank you, Kevin.
Operator
Thank you, sir. And again, ladies and gentlemen, if you do have a question, please press star then 1.
Presenters, it looks like there’s no additional questioners in the queue. I’ll turn the program back over to you for any additional or closing remarks.
Daniel Baker
Well, thank you. We ran a little longer than we normally do, but we appreciate everyone participating on the call, on the questions.
We are pleased to report solid earnings despite the supply chain disruptions and challenging economy. And to sum up, we continue to see a bright future for new and existing products.
We look forward to speaking with you again in early May to report our fourth quarter and fiscal year results. Thank you again for participating in the call.
Operator
Thank you, sir. Ladies and gentlemen, this does conclude today’s program.
Participants, thank you for your participation. You may now disconnect.