NVE Corporation's (NVEC) CEO Daniel Baker on Q3 2016 Results - Earnings Call Transcript

| About: NVE Corporation (NVEC)

NVE Corporation (NASDAQ:NVEC)

Q3 2016 Results Earnings Conference Call

January 20, 2015 05:00 PM ET

Executives

Daniel Baker - President and CEO

Curt Reynders - CFO

Analysts

Charles Haff - Craig Hallum

John Preizler - RH Capital

Jeff Bernstein - Cowen Prime Advisors

Operator

Good day, ladies and gentlemen, and welcome to the NVE Corporation Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the speakers' remarks we will host a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded.

I would now like to introduce Mr. Daniel Baker, President and CEO. Sir, you may begin your conference.

Daniel Baker

Thank you. Good afternoon, and welcome to our conference call for the quarter ended December 31, 2015, the third quarter of fiscal 2016. As always, I am 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 issued our press release and filed our Quarterly Report on Form 10-Q in the past hour following the close of market. Links to documents are available through the SEC's website, our website and on twitter.com/NVE Corporation. 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 future revenue, risks related to our reliance on several large customers for a significant percentage of revenue, uncertainties related to future dividends and stock repurchases, 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, 2015.

The company undertakes no obligation to update forward-looking statements we may make. We're pleased to report a large increase in contract R&D revenue, solid results and strong cash flow for the past quarter despite an expected decrease in product sales. We also announced a $1 a share dividend.

I'll turn it over to Curt to cover details of our financial results.

Curt Reynders

Thanks, Dan. For the third quarter of fiscal 2016 total revenue decreased 4% due to a 15% decrease in product sales partially offset by a 143% increase in contract R&D revenue. The decrease in product sales was due to decreased purchase volume by existing customers, and a more aggressive pricing strategy in certain markets. The decrease in product sales was consistent with the outlook we have provided on previous calls and we believe our more aggressive pricing, product pricing strategy will help drive long-term growth.

We also faced a challenging global economic environment in the quarter and as we've seen in recent years, seasonally weak product sales late in the calendar year, possibly due to ordering patterns or customer vacations and shutdowns. The large increase in R&D revenue was due to new contracts, particularly anti-tamper development contracts.

Gross profit margin remained a strong 75% of revenue for the third quarter of fiscal 2016 compared to 77% for the third quarter of fiscal 2015, despite a less profitable revenue mix. Total expenses decreased 7% for the third quarter of fiscal 2016 compared to the third quarter of fiscal 2015, due to a 24% decrease in SG&A partially offset by a 6% increase in R&D expense. The decrease in SG&A was primarily due to decreased sales commissions. The increase in R&D expense was planned and discussed on our last call, as we increased product development related to Internet of Things and node sensors.

We currently expect research and development expense to increase in the fourth quarter from the immediately prior quarter and the fourth quarter of last year as our new programs have a full quarter of expenses. The increase in Company funded R&D along with an increase in customer funded contract R&D should facilitate future growth.

Interest income decreased 16% for the third quarter due to a decrease in interest bearing marketable securities. As marketable securities mature, we have used some of the proceeds to help fund cash dividends and share repurchases. Net income for the third quarter was $2.58 million or $0.53 per diluted share compared to $2.79 million or $0.57 per share for the prior year quarter. For the first nine months of fiscal 2016, total revenue decreased 6% to $21.6 million. The decrease was due to a 14% decrease in product sales, partially offset by 263% increase in contract R&D.

Gross profit margin decreased to 76% of revenue for the first nine months compared to 80% for the first nine months of fiscal 2015, due to a less profitable revenue mix. Net income decreased 9% to $9.69 million or $2 per share for the nine months compared to $10.7 million or $2.20 per share last year. Despite the net income decrease, operating cash flow and free cash flow are up considerably from the prior year. Cash provided by operating activities increased 10% to $11.9 million in the first nine months compared to $10.8 million for the prior year period.

Free cash flow, which is net cash provided by operating activities less fixed asset purchases, was $11.7 million compared to $10.7 million in the prior year. We've returned conservatively more than our free cash flow, $16.4 million, to our shareholders through cash dividends and stock repurchases so far this fiscal year. Through the first nine months of the fiscal year, we paid $14.6 million in dividends and repurchased $1.8 million of stock.

We continue to aggressively return cash to shareholders. This afternoon, we announced that our Board declared a quarterly dividend of $1 per share or approximately $4.84 million payable on or about February 29th to shareholders of record as of February 1st. That will bring our dividend this fiscal year to approximately $19.4 million.

Now I'll turn it over to Dan for his perspective on our business. Dan?

Daniel Baker

Thanks, Curt. As we've said before, our growth strategy is new and improved products in the near term and game changing technology for the long-term. Contract R&D supports long term growth with bold new ideas such as biosensors. So, I'll cover contracts, distribution and product development.

We were pleased to extend our long-term supply agreement with Sonova AG formally known as Phonak AG through March 31, 2020. Sonova is headquartered in Switzerland and bills itself as the leading manufacturer of innovative hearing care solutions. We filed the agreement with the SEC and it's available on the SEC's website or via our website. We have continued development of biosensors under a contract that runs through June by the U.S. Department of Agriculture.

The project titled High Throughput Salmonella Detector focuses on detecting live salmonella organisms in industry-relevant large sample volumes, faster, at lower cost and with comparable accuracy to existing methods. The goal is to improve food safety and this contract could help us develop commercial systems. The platform can also be used for other pathogens, such as E-Coli, Staph and Listeria. Our principle investigator on the salmonella detector project Dr. Maria Torija presented a paper titled GMR Based Salmonella Detection Systems approaching one colony forming unit detection at the MMM-Intermag Conference last week. A colony forming unit usually means a single bacterium such as salmonella, which we believe is an important achievable goal with our technology.

This is finding a needle in a haystack. In fact, a salmonella bacterium is one ten thousandth the size of a needle, and could be detected in a milliliter of fluid. So this level of detection is equivalent to finding a needle in 35 million cubic feet, which might be bigger than the Mall of America. There are links to Dr. Torija's abstract on our Twitter timeline and the R&D papers and presentations page of our website.

Turning to distribution, in the past quarter, we added two new distributors, America II and Gentec to extend our product reach. America II electronics is number 15 on Global Purchasing's 2015 list of the top 50 distributors. America II gives us more feet on the street and is a savvy player in the high volume markets, which is a key element of our growth strategy. Gentech is based in South Korea and specializes in transceivers, which are higher value added couplers. Asia is a key long term growth market.

Turning to new products, in the past quarter we introduced a new isolated controller area network transceiver called the IL 410-50 KEY-T. The new product is in response to customer requests. Controller area network markets include cars and car factories but the protocol is also being used in the Internet of Things because of its simplicity. Also in the past quarter we completed the introduction of our 6,000-volt V series couplers with best in class high voltage performance. We now have a full line of products in the new grade. The applications of the high voltage couplers include Internet of Things power management.

As we begin 2016, we look back at 2015 as a productive year for product development. Highlights of the past year include as we just discussed 6-kilovolt high voltage coupler models for smart grid and medical instrument applications, new angle sensors for energy and resource management. We advanced our biosensor technology and we began development of smart sensor interfaces for Internet of Things and nodes. We strengthened our intellectual property portfolio with two new patents granted in the past year, one relating to tamper sensing and the other to biosensors. In addition earlier today we were issued a notice of allowance for a low hysteresis high sensitivity sensor pattern.

Now I'd like to open the call for questions. Trisha?

Question-and-Answer Session

Operator

Thank you, [Operator Instructions] Our first question comes from the line of Charles Haff with Craig Hallum, your line is now open.

Charles Haff

Hi, thanks for taking my questions and good evening. Had a question for you on product sales, the $5 million that you did this quarter was a little bit less than I was looking for. Do you feel like the changes that you've made with the more aggressive pricing strategy and the purchase volume commitments that you have with your customers that this is a good kind of base to look at going forward or do you still have some upcoming challenges that will present challenges to your year-over-year comps in that regard?

Daniel Baker

Charles, yes, this is Dan, we do have some continuing challenges in the semiconductor market but we despite those we hope to grow product sales sequentially from here. We have -- as you pointed out we have new products. We have a more aggressive pricing strategy and we have some visibility. So we're optimistic about the future of product sales.

Charles Haff

Okay. And then in the past you've talked about the backlog that you had in contract R&D and obviously you put in a very impressive performance there. Is your backlog still consistent where it's been for the past couple of quarters or did that come down this quarter?

Curt Reynders

We did have some new contracts in the quarter and we also have a strong pipeline of possible contracts. We have some visibility into the next several quarters and we expect to maintain roughly the contract revenue rate we have had so far this fiscal year.

Charles Haff

Okay. You said maintain that rate, you're referring to the next couple of quarters or what time period are you framing that?

Curt Reynders

Yes, over the next several quarters.

Charles Haff

Okay, great. And then question for you on operating margins. You came in a little better than what I was looking for at about 56%. I know that has a lot to do with product mix, but would you help us out a little bit to kind of help us forecast operating margins given the product mix that you have going on? Should we expect some maybe further contractions from this 56% level?

Curt Reynders

I think, well this quarter was probably the -- where we have really started to see some of the adjustments from our pricing strategy. So you know the 56% going forward, I think would be a fairly good number.

Charles Haff

Okay. So you have had the pricing strategy in place for a couple of quarters now, so this is a good base to use going forward do you think?

Curt Reynders

I would think so.

Charles Haff

Okay. And then Dan wanted to ask you about the USDA program, I always have a little bit of trouble trying to understand the financial implications of that and can you kind of talk about the timeframes and where this could go? I know you've talked about coming. You've had interest from commercial partners on salmonella detection. Just wondering, how those are progressing? Just any additional color you could share with us to help us understand the financial implications to the programs that you're working on there.

Daniel Baker

Sure, well first we should say that the financial contribution from the program itself from the grant -- from the contract -- from the Department of Agriculture is relatively modest. That's not why we do it. We do it because it allows us to develop the technology and gives us contacts and creditability within the industry. So, having a program that's under contract with the Department of Agriculture, when the Department of Agriculture is regulating much of the food industry, it gives us some creditability. So, the reaction from potential commercial partners has been very positive. In fact as I mentioned Dr. Torija and several of our staff were at a conference last week and there was interest there. The contract is scheduled to be completed in June. So our goal is to demonstrate feasibility of high volumes, large sample volumes at higher speeds and with comparable accuracy to existing methods, which would be an important milestone. The products would still have to be customized for particular end user or particular food producer in this case and that will take some time and that's a little bit beyond our control. But we're committed to work our end of the program as quickly as possible and get it commercialized as quickly as we can. So the next milestone will be mid-year to demonstrate -- hopefully demonstrate the goals that we have set out, which are to be able to sample, to look for this needle in the haystack I was talking about in the prepared remarks, that demonstrate that we can detect a single colony forming unit or very small numbers of bacteria in very large samples.

Charles Haff

Okay and with the very well publicized pathogen issues that we've had in the food supply, the U.S. food supply at least, do you find that the interest from commercial partners is increasing or holding steady or how would you kind of characterize the interest level that you have had in this product?

Daniel Baker

There is very strong interest and of course it's a bit subjective but it seems to be increasing as you say. There have been some very high profile incidents of food poisoning and pathogens getting into food and the cost of that both in human and people's health and in financial costs and burden that it places on food producers and food distributors is considerable. So, there is a lot of emphasis on ways to detect pathogens, detect them as early as possible to avoid these kinds of recalls that we've seen, which of course get very expensive and damage the reputations of the companies that have to make them. So, we have seen a lot of interest in it and what our devices will do, is to be able to run larger sample volumes faster, which means that we will be able to detect -- more broadly detect any possible contamination because there are lots of places for contamination to enter and it could be small number of bacteria in one isolated spot, but then they can grow. So, we believe this is very important and I'm sure that was partly behind the Department of Agriculture awarding us this contract and we're seeing a lot of interest from potential customers in the food production business.

Charles Haff

Okay, it seems like the speed and accuracy is very high relative to the other tools that food producers have. I'm just wondering, how long before you think it makes it to the commercial marketplace? I know that's a difficult question to answer but I mean, is this to be a back half fiscal '17 event or should we thinking about this more in fiscal '18 or just any help that you can give us to kind of running the timing?

Daniel Baker

Right. We'd like to make it happen as quickly as possible. I guess one way to look at it is this is a Phase 1 program, one that we talked about with the USDA, so that's scheduled to ramp up mid-year and then Phase 2 programs can run -- typically they might run two years. So, those would be getting products that are commercializable but we hope we can do it more quickly. But those are the kinds of time frames that one typically looks at in this industry.

Charles Haff

Okay. Thank you. I'll jump back in the queue.

Operator

Thank you. And our next question comes from the line of John Preizler with RH Capital. Your line is now open.

John Preizler

Thanks for taking my questions. I just wanted to know regarding the pricing strategy, is that replacing or taking share from other competitors or are you expanding -- because of lower prices expanding to applications for those products?

Daniel Baker

Well, it's both, there are applications that the second part of your question, there're applications that are price sensitive where we have prospective customers who might be using conventional semiconductors or other technology and would like to go to our benefits. But the -- they would like to take advantage of the benefits of our technology but the economics don't work for them. So, we have a business model now where we can make the economics more attractive and then also the strategy is designed to increase our penetration in existing markets.

John Preizler

Also, if I could follow-up, just you referred in some of your comments about possible sequential growth from this level in revenue. I was wondering, if that's from a higher mix of new products, or perhaps some that you mentioned on the call and/or from visibility we're seeing in design wins or the like?

Daniel Baker

It's both. It's new products and that will allow us to grow where we don't have products now or products that are targeted at different sub-markets and then growth with our existing products. We believe that the pricing strategy that we just talked about will help us grow with existing products and then we have got a number of new products that we talked about on this in previous calls that are -- that we're seeing some visibility for design wins, for socket wins and those start out slowly but then they build.

John Preizler

Are they those for the high volume products that might be more material, is this successful or they all kind of more niche products?

Curt Reynders

No, some are for high volume products and our products are used in wide range of applications, we've talked about some of the target applications that medical devices and then in industrial control and process automation and nodes for Internet of Things. Those are the markets where our products are particularly strong and we have an excellent benefit proposition and some of those are very high volume -- relatively high volume products.

John Preizler

Are you seeing any stability or deterioration in some of the medical device segments that you sell into, just hoping for some color there, just always a lot of noise in the public companies, just trying to figure out how much that affects you guys?

Daniel Baker

It does affect, as medical devices is one of our strong markets and we have some large customers there in those markets and that has been a challenging market, certain medical device markets as you probably know, some of those companies have reported publicly, have been slowing down for a variety of factors and that does affect us and gives us some headwinds. But these are cyclical businesses. In the long term, the demographics are positive, people are getting older, we're getting more and more medical treatments, there are devices that used our products that can do some remarkable things and really improve people's quality of life. So we're proud to be a part of that, but it's also a very good business in the long run. But we take -- we have to take a little bit longer view of it, quarter-to-quarter.

John Preizler

Interest rate consolidation, I don't know if the bases affect you guys at all?

Daniel Baker

There are a lot of factors in the medical device markets that have caused it to slow down, but there are of course -- as you know there's consolidation, there're regulatory issues, changes in the way healthcare is paid for and devices are reimbursed. But if we step back and look at it, we see it as an excellent market where our devices have convincing benefits and where the demographics and the long-term trends are very favorable.

John Preizler

And you gave us some good color on the biosensor program, just wondering, how you envision you selling into that commercially, is that to be a -- some of its handheld or fixed base equipment or be in the food processors or feed processors, if you can give some more color there, just trying to figure out, understand the TAM in the U.S. and the TAM globally and if it's more of a high price low volume item or it can be high volume as well?

Daniel Baker

Right. We've looked at two different ways that our devices would be hooked into these process of food production. One is a continuous mode, where there would be food product or food byproduct going by our sensor and it would be monitored in the same way that temperature or pressure or other critical parameters are monitored. And the other method would be a batch method where they would take samples and they would be analyzed and both have their pros and cons to each and it depends on the type of food industry and what their needs are. As far as the second part of your question, which related to the business model, these are relatively low volume for the equipment because these are big producers typically and relatively small number of them, at least when you compare to say consumer products.

John Preizler

Sure.

Daniel Baker

But we would -- we envision selling equipment and then also selling consumables, which would include things like the aptamers which are the artificial antibodies if you will that are critical to these devices and the nano-beads that allow detection by our sensors. So those are consumables that would allow us to -- we envision participating in the cost of each test that we would indirectly make some money off of each test. So we see it as a very viable business model, but it's not just the equipment.

John Preizler

It's terrific, obviously you saw through this carefully, it was exciting. And just lastly on prior calls, you talked a little about couplers for hybrid electric vehicle and as for good anti-tamper I think today in the past. How would you handicap some of those products getting into higher volume production?

Daniel Baker

Well we see automotive and hybrid electric vehicles in particular as an excellent growth market. The number of sensors in cars is projected to grow rapidly and our parts are smaller and more precise, more rugged and lower power and those are all things that are important in the automotive market in general and hybrid electric vehicles in particular. So one of the products that I just mentioned that's brand new is a new controller area network transceiver which is ideal for hybrid electric vehicles and that's the [I/O-410 15-TT]. And that's in response to customer requests for more reliability than is possible with conventional semiconductors. So we're working with our distributors and our potential customers to evaluate those products and see if we can get them into sub-assemblies, automotive sub-assemblies as quickly as possible. As I mentioned in the prepared remarks they have other applications as well such as the Internet of Things and such as automotive factories automation. But we also see in car applications, which I think is what you're referring to as an excellent growth market, potential growth market.

John Preizler

Terrific. Thanks for answering all my questions.

Daniel Baker

Thanks, John.

Operator

Thank you. [Operator Instructions] And our next question comes from the line of Jeff Bernstein with Cowen Prime Advisors. Your line is now open.

Jeff Bernstein

Hi guys. Just a quick follow-up on the medical devices discussion earlier. Can you talk specifically to St. Jude I don't know if there was a contract that was hung up with them and just wondering what the update is on St. Jude specifically?

Daniel Baker

Right. So with St. Jude we had -- our agreement with St. Jude expired, but we had a relationship with them as you know for many years and we expect that to continue with or without a contract.

Jeff Bernstein

Got you, okay. So was that contract for firm kinds of volumes or pricing indications as something. Is there anything much the changes as a result of sort of being at or more arms length now?

Daniel Baker

Well the contracts have -- they are a matter of public record, but there are a lot of provisions in them. And in general what we've said is that the contracts don't obligate -- generally don't obligate our customers to buy particular volumes. So in that sense they serve a number of needs, but guarantying purchases may not be one of them. So we view these contracts as important, as they are important to our customers, but they aren't required for us to sell for them.

Jeff Bernstein

Got you. Great. And then just in terms of the product pricing discussion. That was really for products generally where you're looking to proliferate into new markets and applications as opposed to price reductions for current customer applications?

Daniel Baker

No, it was -- it's both. In existing applications, we believe it allows us to grow in the long term and to remain competitive with other technologies and alternatives their customers may have. So it was a broad strategic initiative that relates to both new products and in some cases, some existing products. Now obviously we're looking at each product and each product line individually to see what the environment is and where the prices are -- make sense where they are. We don't adjust them. If it makes sense to lower prices and then we look at it. But overall, we looked at a number of prices and made adjustments and I think we'll be seeing the benefits of that.

Jeff Bernstein

And then just lastly on the anti-tamper developments, there are some folks out there trying to do things with thin films addressing things like consumer products, and higher volume lower value items. I think we've talked about things like defense equipment where we'd probably be a lot lower volume, a lot higher value. Is there a particular part of that market that we should think about you being focused on?

Daniel Baker

You're very well informed and you're absolutely right. There are consumer applications and high volume applications for anti-tamper. We've all seen the effects of cyber theft and the importance of credit cards and other identification security. So those are markets that we're looking at. Those tend to be longer term markets but we are developing this technology and focusing some of our contract R&D in the anti-tamper space because we see that kind of high volume potential. And we believe that this technology, while as you correctly pointed out, we're in the near term targeting high value applications such as military, defense, and related equipment and electronics. But in the long run, we see consumer applications and those have been part of some of our government contract proposals as well, where part of the evaluation process is not just can we help the defense industry and related industries in the near-term, but does this technology help in the long run to develop our economy and to make our country stronger. And so those are markets that we're looking at in the long term. In the near term, these products do tend to be very extensive and are used for high value assets.

Jeff Bernstein

But you can see your way to process technology that would get you down to the costs needed for the high volume products?

Daniel Baker

That is the long-term goal, yes.

Jeff Bernstein

That's perfect. Thanks very much.

Daniel Baker

Thank you.

Operator

Thank you. And I am showing no further questions in the queue at this time.

Daniel Baker

Well, if there are no other questions, thank you. We were pleased to report solid results and solid cash flow despite challenges. We look forward to speaking with you again in early May to report fourth quarter and full fiscal year results. Thanks again for participating in the call.

Operator

Ladies and gentlemen, thank you for participating in today's call. That does conclude the conference. You may all disconnect. Everyone have a wonderful day.

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