Jan 23, 2013
Executives
Daniel Baker – President & Chief Executive Officer Curt Reynders – Chief Financial Officer
Analysts
Steven Crowley – Craig-Hallum Capital Group [Jay Friedlander] – Investor
Operator
Good day, ladies and gentlemen, and welcome to the NVE Conference Call on F3Q Results. (Operator instructions.)
As a reminder, this conference call may be recorded. I would now like to turn the call over to Mr.
Daniel Baker, NVE President and CEO. Sir, you may begin.
Daniel Baker
Good afternoon and welcome to our conference quall for the quarter ended December 31, 2012, F3Q 2013. 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 www.nve.com.
After my opening comments Curt will present a financial review of the quarter and of the fiscal year-to-date. 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 uncertainties related to the economic environments and the industries we serve; risks and continued profitability; uncertainties related to the future of revenue and growth; risks related to developing marketable products; uncertainties relating to the revenue potential of new products; risks and the enforcements of our patents; litigation risks as well as the risk factors listed from time to time in our filings with the SEC, including our Annual Report on Form 10(k) for the year ended March 31, 2012, as updated in our Quarterly Report on Form 10(q) for the quarter ended June 30, 2012. The company undertakes no obligation to update forward-looking statements we may make.
We’re pleased to report net income increased 27% to $0.60 per diluted share compared to $0.47 last year driven by increased product sales and gross margins. Product sales increased 7% and gross profit margin increased to 73% compared to 65% last year.
Now I’ll turn the call over to Curt for details on our financial results.
Curt Reynders
Thanks, Dan. Total revenue for F3Q 2013 increased 6% to $6.53 million due to a 7% increase in product sales with contract research and development revenue roughly flat.
Sequential quarter total revenue increased 12% compared to the September quarter. The increase in product sales from the prior year quarter was encouraging in light of weak economic conditions.
Sales into medical device and industrial markets both increased. Customer inventory adjustments, which have negatively impacted previous quarters this fiscal year, didn’t appear to be a significant issue this past quarter.
Our increase in product sales was despite what market researcher IHS Eye Supply recently called “distressing conditions” for the semiconductor industry due to pressure from a weak global economy. Gross profit margin increased eight percentage points to 73% of revenue for F3Q 2013 compared to 65% for F3Q 2012 due to a more favorable revenue mix and more efficient product manufacturing.
Total expenses decreased 13% for F3Q 2013 compared to F3Q 2012 due to a 30% decrease in research and development expense, partially offset by a 10% increase in selling, general, and administrative expense. The decrease in research and development expense was due to the completion of certain research and development projects.
The increase in selling, general and administrative expense was primarily due to increases in sales commissions and legal expenses. Interest income increased slightly as an increase in our interest-bearing marketable securities was partially offset by lower interest rates.
Income before taxes for the quarter was $4.31 million compared to $3.34 million in the prior year; and pre-tax margin was 66% versus 54% in the prior-year quarter. The provision for income taxes was a higher percentage than the prior-year quarter, 32.8% of income before taxes compared to 31.4% last year due to a higher federal effective tax rate.
Net income for F3Q was $2.9 million or $0.60 per diluted share compared to $0.47 last year, and net margin was 44% versus 37% in the prior-year quarter despite the higher tax rates. Product sales were up slightly for the first nine months of the fiscal year despite decreases in the first half of the year.
Total revenue decreased 6% due to a 40% decrease in contract R&D. Gross profit margin increased to 74% of revenue for the first nine months compared to 66% for the first nine months of F2012 due to a more favorable revenue mix, a more favorable product sales mix, and more efficient product manufacturing.
Net income increased 5% to $8.72 million compared to $8.28 million for the prior-year period. The increase in net income in the first nine months of F2013 compared to the prior-year period was primarily due to increased gross profit margin partially offset by decreased contract R&D revenue.
Earnings per share increased to $1.80 for the first nine months of this fiscal year compared to $1.71 for last year. Operating cash flow was $8.42 million for the first nine months of the fiscal year and cash plus marketable securities stood at $81.2 million as of December 31.
Cash plus marketable securities increased $7.69 million in the first nine months of the fiscal year. Comprehensive income increased 21% to $9.23 million for the first nine months of the fiscal year.
Our comprehensive income consists of net income and the unrealized gain or loss for marketable securities net of tax. Purchases of fixed assets were $1.61 million for the first nine months of the fiscal year, primarily for production, equipment, and leasehold improvements.
Leasehold improvements were primarily for the expansion of our production clean room. Investments in fixed assets were historically high as we continue to expand and upgrade our production capabilities to support future growth.
Dan will provide details on the expansion. I’ll turn it over to Dan for his perspective on our business.
Dan?
Daniel Baker
Thanks, Curt. Starting with our expansion we have substantially completed a major clean room expansion and infrastructure upgrade which is a key element of our growth strategy.
The expansion gives us a third clean room bay with a 40% increase in total clean room space. The infrastructure upgrades support additional equipment and capacity including increased clean air handling, higher capacity electrical service and more processed cooling water.
With the expansion and infrastructure upgrades we added several pieces of new equipment in the past quarter, including specialized batch equipment and more automated photolithographic equipment. The new machines will increase our capacity and improve our manufacturing efficiency when they’re deployed.
Turning to product development, one of the major advantages to our technology is miniaturization. Extending that advantage, just last week we introduced new isolated transceivers that are half the size of existing parts.
The smaller sizes are what we call the dash 3 parts. The new products extend NVE’s miniaturization advantages, save valuable circuit board space, reduce systems costs and simplify interfaces.
The new dash 3’s are based on a major new coupler redesign project that also simplifies our manufacturing process. Two new part types were introduced last week, one for high-speed RS-485 networks and one for high-speed PROFIBUS.
These are both popular networks in industrial control, process automation, and other applications. We also offer evaluation boards for each of the new parts to demonstrate the miniaturization.
We plan to introduce a third part type for cost-sensitive RS-485 networks late this quarter or next quarter. This will be an important element of our strategy to more aggressively pursue higher volume, more price-sensitive business, especially in China.
We’ve previously disclosed a customer was planning to use our custom Spintronic Biosensor in a new medical diagnostic instrument and that the customer’s program is behind schedule. Although we don’t have an updated schedule we have no indication the program has been cancelled or there are showstopper problems.
As we’ve reported, the customer has demonstrated significantly increased sensitivity for in-vitro diagnostics with our Biosensor technology compared to conventional methods. We continue to believe our Biosensor technology can open important new markets for us and we’re pursuing other opportunities and potential customers for the technology in parallel.
As evidenced by our excellent gross margins, we are well positioned to take on larger, more price-sensitive markets such as automotive and consumer electronics. One example is Controller Area Networks or CAN, which is the BUS used for applications such as automotive system interconnects.
This quarter we expect first silicon of a third-generation controller area network transceiver from our partner. These will be targeted primarily at battery management systems in high-volume hybrid electric vehicles.
We’ve done a preliminary design based on the expected chip layout. We’ll combine the transceivers, which use conventional semiconductors with our Spintronic Coupler technology.
We currently plan to sample these third-generation parts either this quarter or next, then begin the automotive certification and qualification process. We’re seeing an example of the importance of battery management systems with the grounding of the Boeing-787 Dreamliners for battery fires, possibly related to battery management.
Our CAN partner is a large semiconductor company with a significant presence in the automotive market. It plans to market our third-generation parts under its brand.
This private label strategy reduces the barriers for us to enter the automotive market and it could significantly reduce our time to market. Now I’d like to open the call for questions.
Saied?
Operator
Thank you. (Operator instructions.)
We have a question from Steven Crowley from Craig-Hallum.
Steven Crowley – Craig-Hallum Capital Group
Good afternoon, gentlemen, and congratulations for battling through the difficult backdrop.
Daniel Baker
Thanks, Steve.
Steven Crowley – Craig-Hallum Capital Group
You seemed to intimate that both the medical and the industrial side of your business did grow. Were those comments year-over-year and sequentially?
I would think the math works to that effect.
Curt Reynders
Yes, Steve, that is correct – both year-over-year and sequentially.
Steven Crowley – Craig-Hallum Capital Group
Is there any color that you can give us to what was behind that growth? Did it just encompass a return to normalcy by mostly existing customers or were there new customer additions that played a noticeable role in the growth?
Daniel Baker
This is Dan. It was both, Steve.
Some of our customers fought a few less headwinds, both in their industries and just in the global economic outlook which is still challenging but seems to be improving. We did add some new customers.
I don’t think we could point to any that by themselves dramatically moved the needle but there were several new customers that helped us in the near term and more importantly, as they grow we’ll grow.
Steven Crowley – Craig-Hallum Capital Group
Okay. And then obviously the contract R&D business bounced back.
How anomalous is the $0.75 million run rate? It doesn’t seem anomalous in one respect in that it was that a year ago but it has bounced around quite a bit.
What kind of visibility for a run rate let’s say in this neighborhood or you know, $600,000 – how should we think about that business on a go forward basis?
Curt Reynders
Well Steve, we don’t have a lot of visibility as far as timing of contracts or follow-on work, but I think over the last five quarters we’ve been below the $1 million range. I think we’ve ranged from in the $430,000’s up to where we reported this last quarter in the $760,000 range which was similar to last year’s quarter.
I would say going out probably just into the next quarter we would look at something in between that range, the $430,000 and the $760,000.
Steven Crowley – Craig-Hallum Capital Group
Okay, that’s helpful. And your commentary about research and development expense being down in F3Q due to the completion of certain research and development projects, does that tie back to the completion of certain contract R&D projects that absorbed R&D costs?
Or were these your own funded R&D projects that came to completion and were less costly and they’ll be starting… How should we think about R&D I guess is the ultimate question going forward?
Daniel Baker
Right, this is Dan. It was primarily internal R&D, company-funded R&D projects.
And we mentioned one of them, the project that resulted in the new parts that we introduced last week for RS-485 and PROFIBUS networks. So that was based on a new set of silicon designs.
These are the housekeeping circuits that we use and surround with Spintronics to handle the network protocol. So those tend to be significant projects and significant expenses both internally, and then we end up buying wafers and mask sets and there are other expenses that are out-of-pocket expenses in addition to personnel.
So that project was completed which was one of the bigger projects which we had – there were others. And we don’t try to strictly adhere to an R&D budget.
We look for opportunities and if the opportunities look like they’re going to pay back for our shareholders we’re going to want to take advantage of those opportunities. So our R&D can be rather volatile but I think probably a year ago as a percentage of revenue it was on the high side, and part of that was the opportunities that we had, and some of which we’ve already taken advantage of.
Steven Crowley – Craig-Hallum Capital Group
Okay. Just kind of looking at it, if we even out a big F1Q and a lighter F3Q, something a bit above where you just reported – maybe in the $600,000 area – would look to be a reasonable dart to throw in terms of a more normalized run rate for R&D?
It doesn’t sound like I want to use what you had for F3Q as a normalized level.
Curt Reynders
Yeah, I think that would make sense, Steve. That was the lowest we’ve been in oh, about the last six quarters.
So I think we may have some opportunities coming up that could force that R&D expense up a little bit in this quarter.
Steven Crowley – Craig-Hallum Capital Group
That makes sense. One direct follow-up and then I’ll get back in the queue and come back with a few more things if there’s room.
In terms of the product announcement that you had last week and the commentary you just gave us about I guess the RS-485 product that might be more geared to some price-sensitive markets, international markets – I trust maybe something like the automotive market – is that the next iteration of these products that are coming? Also do they play into this OEM/private label partnership that you have that’s brewing or is this a separate endeavor to get at some of the higher volume/lower price point applications?
Daniel Baker
To the last part of your question, these are a separate endeavor from what we were talking about with controller area networks or CAN transceivers. These are a slightly different network protocol.
RS-485 and then PROFIBUS is a protocol that sits on RS-485, so they’re similar and they’re both three-channel network protocols as opposed to CAN BUS which is a two-channel protocol. But with all of that inside baseball background we do see the potential for an OEM strategy with this although it’s not the one that we were talking about where we have a specific partner lined up and we’re targeting the automotive market, in particular for battery management system.
That market is more for controller area networks. The RS-485 and PROFIBUS market is primarily for industrial control, process automation and a few other applications, but particularly in some markets it’s very price-sensitive, in China.
And so the part that we’re planning to introduce this quarter and next will be an important part of that strategy. One of the things that we did with this new silicon we developed was reduce the size of the part so we get more dye per wafer and our cost is therefore lower.
So it allows us to go after some of those more cost-sensitive markets and in addition, we have pretty good margins on the parts even without those improvements. So our goal with the 485 and PROFIBUS is to offer better miniaturization.
These parts are half the size of comparable parts and to introduce a lower-cost, lower-price version that’ll get after some of those high volume/low cost markets. We’re primarily targeting industrial control for these, not automotive.
Steven Crowley – Craig-Hallum Capital Group
Okay, thanks for the clarification. I’ll hop back in the queue and come back with a few questions later.
Daniel Baker
Thanks, Steve.
Operator
Thank you. (Operator instructions.)
We have a question from [Jay Friedlander].
[Jay Friedlander] – Investor
Good afternoon, fellas, good afternoon. I hope you guys are staying warm up there.
Daniel Baker
We’re trying. It’s been pretty chilly here.
[Jay Friedlander] – Investor
Yeah, I saw it was 10 below yesterday. I’d like to get an update on the lawsuit and also any information about the US Patent Office review of the patent dispute.
And if you could just give us a little breakdown from the SG&A on the legal expense for last quarter.
Daniel Baker
Okay, well let me start with an update and then maybe I’ll ask Curt to give some color as to the legal expenses. So we didn’t update our legal proceedings in this quarterly filing because there was nothing significant in terms of court filings to update.
This can be a fairly long process and there have been some filings and some back-and-forth, but nothing that we considered reportable. I guess what I can say is that we did a thorough analysis before filing suit and we’ve studied a number of documents since as part of the discovery process, and after studying those documents we remain confident in our position.
As you may recall, we’re seeking a reasonable royalty, triple damages for willful infringement. The court hasn’t ruled on that yet and it can take a while, but we feel good about our position in this suit.
[Jay Friedlander] – Investor
Can you give us an update on the US Patent Office’s review of the patent that was in dispute, that Everspin asked for?
Daniel Baker
So Everspin filed interparty reexamination petitions which are petitions that go before the Patent and Trademark Office. And the Patent and Trademark Office then looks at these patents and determines through a fairly long process whether the claims need to be amended or changed.
It’s not unusual for the Patent and Trademark Office to reject claims as part of that process and then we as the patent holder provide evidence and documents supporting why these claims are valid, or suggesting amendments to those claims. So that’s the process that is underway and it’s hard to predict when it will be resolved.
I think the important thing to remember is that we have a number of patents; three of them were cited in the suit and each of them have quite a large number of claims. So we feel good about our intellectual property and our intellectual property position, and we’re responding to the Patent and Trademark Office in a timely manner and in support of those patents and those claims.
Curt, is there anything you can add on the legal expenses?
Curt Reynders
Yeah, as far as the legal fees, for the quarter they were up a little bit in the tens of thousands of dollars more than the prior-year quarter, but overall legal expenses for the nine months were pretty much right in line with where they were last year. That’s legal expenses related to patents as well as the lawsuit and any patent fees that are due, so not a significant amount being spent on the lawsuit itself.
[Jay Friedlander] – Investor
Okay. So there’s no timeframe that you can envision when the Patent Office will complete their review?
Daniel Baker
No, it’s really difficult for us to predict that. It depends on the Patent Office and factor beyond our control as well.
[Jay Friedlander] – Investor
Okay, thank you very much.
Daniel Baker
Thank you.
Operator
Thank you. And our next question comes from Steven Crowley from Craig-Hallum Capital.
Steven Crowley – Craig-Hallum Capital Group
Hey guys, some follow-up questions for clarification or additional layers: on the IBD program, while you don’t have an updated schedule and the kind of visibility you might prefer at this point for going to full scale production of your component, is the program itself kind of in neutral until there’s this regulatory approval or some other development that takes the lid off it? Or is it making forward progress at a modest clip?
What’s going on with that particular program and how far away might you be from other active participants, potential customers in that market buying product from you?
Daniel Baker
Yeah, well we certainly don’t believe that the program has been canceled or that we’ve run into some kind of showstopper issues, so the pace is not what we would like. We are looking at parallel opportunities both in in-vitro diagnostics and possibly in some related areas, so it’s a large potential market.
We’re looking at other markets such as food safety and other potential partners. They aren’t as far along as this customer that we’ve been talking about in in-vitro diagnostics where we provided preproduction units.
So the other opportunities are not that far along but we see them as excellent opportunities. And we’re also targeting opportunities that might have lower regulatory hurdles, and food safety is certainly one of those.
We’ve had incidences here in Minnesota… Minnesota is actually a very large poultry producing state and salmonella contamination is a serious problem – a serious business problem and a serious health problem. So that’s one area that we’re looking at, or one category that we’re looking at.
So we’ve demonstrated advantages of sensitivity, speed, and size. We believe that customer partners are the best way to get these technologies to market but we’re pursuing multiple paths so we don’t have all our eggs in one basket.
Steven Crowley – Craig-Hallum Capital Group
Well that makes a lot of sense. Also, as you know, the University of Minnesota and affiliated groups have a very well-regarded food safety vigilance group there so I would think this is a rather fertile field for interest in your capabilities there.
Daniel Baker
Yes, it is indeed.
Steven Crowley – Craig-Hallum Capital Group
Now speaking of the University, I saw in recent news headlines that they did get some rather significant funding, I think it was $28 million for Spintronics research from a semiconductor consortium. Does that have any implications positive or even negative for your ecosystem?
Does your proximity help or does it matter at all to you?
Daniel Baker
Well, we certainly see it as a positive development because the University of Minnesota is going to be doing quite a lot of Spintronics research. Most of it is longer-term.
We tend to focus… We do some long-term research but our mission of course is to make products and to get them into the market and to sell them, and to make practical Spintronics. But I think having a major center so close to us is helpful.
We recruit from the University of Minnesota. Many of us including myself went to college there or graduate school.
We’ve got some extremely talented individuals, particularly on our Research staff, that come from that program. So while we’re not a direct part of that consortium or funding we see it as a positive.
We see it as a validation of Spintronics technology and we see it as providing some long-term research that could keep Spintronics as one of the leading and most promising technologies for many years to come.
Steven Crowley – Craig-Hallum Capital Group
That’s helpful. Now, in terms of the OEM opportunities that seem to be expanding, maybe we’ll talk about the one that you’ve spoken most prominently about which is into the automotive market with a private label relationship.
One of the points you’ve made in prior conference calls was that early in your relationship, at least in your disclosure of this relationship, this partner was being fairly forthcoming and recommending some of your existing parts under your label to some of their customers. I don’t know if that was just kind of an aside thought but what can you tell us about what kind of work you’ve been able to do on a preliminary basis, whether or not they’ve helped you gain any presence in the marketplace with your industrial products – just help paint the picture there.
Daniel Baker
Yeah, that’s a very good point. While their primary interest is in automotive and in what we call this third-generation product which is geared toward the automotive market, there are industrial applications to these controller area networks and that’s where our own brand and our own marketing network is well positioned.
And this partner has been helpful in introducing us to potential customers for what would be the second-generation products, the ones that we have available now. It’s hard to point to any specific results or significant sales but we believe that these efforts and that courtesy if you will, will pay off.
We have an excellent reputation in the industry but we’re a relatively small company with a very focused product line, and having the recommendation of a large, well-known semiconductor companies I think carries a great deal of weight. So that’s one of the kind of intangible benefits of this partnership, that we are seeing some results from that.
Steven Crowley – Craig-Hallum Capital Group
And then in the different styled parts that are for the PROFIBUS, RS-485 marketplace where you alluded to future product releases positioning you well for certain international markets like China and the potential for another OEM, how significant is that OEM relationship in terms of it developing to you truly being able to access some of those markets? In other words, are we likely to see you go after the Chinese and other Asian markets via that OEM marketplace or will you two-step it and go yourself and then bring on an OEM?
Is that the more likely scenario?
Daniel Baker
I think it would be the second scenario is the more likely scenario. We believe that with our current distribution, we have some excellent distributors throughout the world and several excellent distributors in China.
We believe we can reach those price-sensitive markets and with this new product that we’re planning we believe we’re going to be particularly well positioned. We’re going to have the smallest part of their type available, the best performance specifications in many key respects and an excellent price point.
So we believe that we can reach those markets ourselves. The automotive market is a very difficult vertical to reach for a small company like us that doesn’t have a long résumé of providing parts to the automotive industry, so there we believe the OEM partner is particularly important.
The OEM partner discussions are more general and early stage with respect to the RS-485 and PROFIBUS products but I was answering that in the context of could we private label those products, and I think we could. But we don’t have a specific plan or a particular partner that’s real far along in that.
But we always look at how can we broaden our markets, and if a potential partner can add markets without just cannibalizing our own sales then we look at those things and we’ll see if that makes sense. So we do that currently with [Ivago] where they’re selling a part that we make under their brand and we’ve found that that’s worked very well.
There’s some overlap but they have a different customer set and different markets where they’re particularly strong, and they have excellent brand awareness. So that’s the type of opportunity that we might be looking for there.
Steven Crowley – Craig-Hallum Capital Group
Great, thanks for taking my questions.
Daniel Baker
Thank you, Steve.
Operator
Thank you. And I’m showing no one else in queue at this time gentlemen.
Daniel Baker
Well, if there are no other questions, thank you. We were pleased to report a 27% earnings increase driven by solid product sales growth and we continue to build a pipeline of new products.
We look forward to speaking with you again in early May to report full fiscal year results. Thank you again for participating on the call.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This concludes our program for today.
You may now disconnect and have a wonderful day.
Executive
Thanks!