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NVE Corporation (NASDAQ:NVEC)

F1Q 2013 Earnings Call

July 18, 2012 5:00 p.m. ET

Executives

Daniel Baker - President and CEO

Curt Reynders - CFO

Analysts

Steven Crowley - Craig-Hallum Capital Group

Operator

Good day ladies and gentlemen and welcome to the NVE conference call of first quarter results. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today’s conference Mr. Dan Baker. Please go ahead.

Daniel Baker

Good afternoon and welcome to our conference call for the quarter ended June 30th 2012 which was the first quarter of fiscal 2013. 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.

In the past hour following the close of market, we filed our press release with quarterly results and our quarterly report on Form 10-Q with the SEC. The filings are available through our website or the SEC's 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 other such factors as risk in continued profitability, uncertainties relating to future revenue and growth, risks related to developing marketable products, uncertainties relating to the revenue potential of new products, risks of losses on our marketable securities, risks in the enforcement 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 by our quarterly report on Form 10-Q filed this afternoon. The company undertakes no obligation to update forward-looking statements we may make.

We’re pleased to report strong earnings for the quarter and our highest first-quarter product sales ever. Product sales were $7.03 million, a slight increase over our record quarter a year ago. We had record gross pre-tax and net margins. Gross margin was a record 76% and net income was $0.69 per diluted share.

Now I’ll turn the call over to Curt for details of our financial results.

Curt Reynders

Thanks Dan. Total revenue for the first quarter of fiscal 2013 decreased 9% to $7.46 million due to a 64% decrease in contract research and development revenue, partially offset by a slight increase in product sales. Product sales increased a 10th of a percent from a record quarter a year ago to $7.03 million. The increase was due to increased sales into medical device markets, partially offset by decreased sales into industrial markets. Industrial markets may have been impacted by a sluggish global economy.

Growth in the medical device markets may have been tempered by softness of pacemakers and ICDs. The large percentage decrease in contract R&D was due to the completion of certain contracts and contract activities and the challenging government funding environment.

Contract R&D was 6% of total revenue and it is not a major part of our growth vision. Gross margin increased to a record 76% of revenue compared to 68% last year due to a more favorable revenue mix and more efficient product manufacturing. The more favorable revenue mix was a higher percentage of revenue from product sales compared to contract R&D and a more favorable product mix. The more efficient product manufacturing included manufacturing processes deployed late in the calendar year which we discussed in previous calls.

Total expenses increased 10% for the first quarter of fiscal 2013 compared to the prior year quarter due to a 39% increase in R&D expenditures partially offset by a 13% decrease in selling, general and administrative expense. The decrease in selling, general and administrative expense was due to a decrease in legal expenses. The first increase in research and development expense was due to increased product development activities. We believe the investment in R&D will pay off in future revenues. Dan will highlight R&D in a few minutes.

Income before taxes for the quarter was $5 million. Net income for the first quarter was $3.38 million or $0.69 per diluted share compared to $0.70 last year. Pre-tax and net margins were records. Pre-tax margin was 67% and net margin was 45%.

NVE ranked third in return on revenue or net margin in the Star Tribune's list of the 100 largest companies in Minnesota published in the past quarter. Operating cash flow was $4.1 million for the quarter, which strengthened our balance sheet. As of June 30, cash plus marketable securities was $77.1 million, an increase of $3.52 million in the quarter.

Despite widely publicized bond downgrades in the past quarter, our bond portfolio has performed well with a net unrealized gain on our marketable securities $1.57 million as of June 30, which is the difference between the fair market value of our portfolio and its adjusted cost. There are details in our recently filed 10-Q.

Income taxes payable increased $1.4 million, because we had no estimated income tax payments due in the most recent quarter. There are two payments due in the quarter ending September 30. Purchases of fixed assets were $445,000 for the quarter compared to $199,000 for the prior year quarter. Capital investments were primarily for production equipment as we continued to expand and upgrade our production capabilities to support potential new products and growth. We are planning additional facilities investments this quarter and in the remainder of the fiscal year.

Now I will turn it over to Dan for his perspectives on our business. Dan?

Daniel Baker

Thanks Curt. I'll cover biosensors, consumer-electronics, private-label couplers and governance. We've said before, we have a customer who is planning to use our custom spintronic biosensor in a new medical diagnostic instrument. The customer continued to purchase preproduction parts in the most recent quarter, and we believe they are continuing to optimize their design and pursuing regulatory approvals. We don't have a production schedule from our customer, 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.

As evidenced by our record gross margins, we are well positioned to take on large price-sensitive markets, such as private-label, automotive and consumer electronics. We continue to develop and market next-generation solid-state compassing technology for consumer electronics. In the past quarter, we fabricated prototypes with the promise of even better precision than our previous prototypes and samples.

Also in the past quarter, we introduced the new isolated controller area network transceiver combining our spintronic coupler technology with conventional semiconductors provided by a large semiconductor company Controller area network or CAN is a bus used for applications, such as automotive system interconnects, vehicle diagnostics and industrial control systems.

NVE offers what we built as the world's smallest isolated CAN transceivers. The new parts have 10% less power consumption compared to our older offerings for that market. That could mean less battery drain in a car, or simplified power supply design. We've had interest in the parts which we began marketing under our brand.

More importantly, we see the potential to sell these or similar parts to the company that makes the semiconductor transceivers we’re using. That company is evaluating the parts now and so far the feedback has been quite positive. We see such private-label partnerships as a means to significantly expand our addressable market and reach markets such as automotive electronics that can take a long time for a small company to penetrate on its own. The private label business model also makes sense for our partners that find it's cheaper to buy or license our technology rather than try to develop new technology themselves.

Finally, turning to governance, our annual meeting has been scheduled for August 9 here in Eden Prairie. The materials, our proxy statement, letter to shareholders and annual report on Form 10-K have been filed with the SEC, sent to shareholders and are available from the investors section of our website. We are pleased to be part of a select group of public companies with a perfect governance score from ISS. The board reviews our governance practices on an ongoing basis to ensure they promote shareholder value.

As result of this ongoing review, during the last fiscal year, the board adopted a hedging policy that prohibits directors or executive officers from hedging against declines in the market value of our stock. There are details in our proxy statement. For good corporate practice, our entire Board of Directors stands for election every year. We’re fortunate to have an exceptionally experienced, successful and hard-working board.

Our chairman Terry Glarner, for example, has made the Minneapolis-St. Paul business Journal's list of hardest working Board Directors for six consecutive years, including the most recent list published last month. He ranked first in total committee activity and first in average tenure.

Our annual meetings are generally well attended and we look forward to seeing many of you there. As some of you know, each year we pick a meeting theme. This year, our theme is the Olympics and so we plan to overuse some sports clichés.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Steven Crowley from Craig-Hallum Capital. Your line is open.

Steven Crowley - Craig-Hallum Capital Group

Good afternoon gentlemen, and kudos on the really strong margin performance in the quarter. In terms of some of the things that played into that top line, you mentioned that the beneficial product mix was consistent with what that has meant historically, meaning stronger medical product sales. Can you give us any color as to whether or not, the relatively good performance in medical was due to existing customers, or had a sizable element of new customer volumes?

Daniel Baker

This is Dan. It was -- there was a change in the mix towards newer products. Some of those are with existing customers. However our goal is to continue to provide the absolute best for our customers as they expand and increase the performance of their offerings. So often those are higher value, higher revenue and higher margin. And also we mentioned that it was – that Curt mentioned that it was a challenging market – a soft market for pacemakers and ICDs. So other markets, medical markets took up the slack and more than offset that. So we were certainly pleased with that. And in the long run, pacemakers and ICDs, we believe, will grow, the demographics are favorable and they are excellent products and we have a strong benefit proposition.

Steven Crowley - Craig-Hallum Capital Group

Now over the quarters and the years you've mentioned about other target markets, in medical and you’ve had some obvious success in hearing aids. You’ve talked about other neuromodulation, or neurostimulation markets. Are those some of the ponds we’re talking about where you've had success, or are there other ponds or neighborhoods that you haven't yet talked about that are delivering some of the growth?

Daniel Baker

We've had success in getting into some of the early stages of neurostimulators. These would be non-CRM noncardiac neurostimulators which we look at as a different market non-life-support. So that's very encouraging, it probably wasn't a huge contributor to the revenue mix in the most recent quarter, but we see that as an excellent growth potential and many of those markets, neurostimulator markets are growing – seem to be growing considerably faster than a CRM or other traditional markets that you alluded to, such as are hearing aids.

Steven Crowley - Craig-Hallum Capital Group

And you gave us an update on the biosensor equation which seems to, if I were to characterize those comments, present a picture of a customer who continues to move down the path to being a full-blown production volume customer, that's been a little bit slower than we might have anticipated a year ago. But it seems like the destination continues to be what you thought in terms of the outcome there?

Daniel Baker

Yes. And we continue -- as I said in the prepared remarks, we continue to ship pre-production quantities and there are factors that we've discussed before that are beyond our control, including regulatory approvals. But we believe that for our part, the sensors are working very well. The customer continues to use parts. And we presume to test and to get data that they need in order to bring the product to market. So we remain very optimistic with this particular customer and with the technology in general.

Steven Crowley - Craig-Hallum Capital Group

Should we think about -- because you do not have an exclusive deal into the IVD market with this one particular customer that you're working on other opportunities in this sector? Or is it – does it need to be in serial fashion where you have notable success with one customer, which is likely to lead to other activities in the sector?

Daniel Baker

It's really both, Steve. Success in this sector with this particular customer, we believe, will establish even more credibility in that market and will help us get more sales and more customers. But we’re not waiting for that. We are developing the technology, we’re pursuing other customers and related applications. So we see it as something where it’s going to be important to get that first production sensor design out there. But there are other early adopters that aren't waiting for that. So we see potential that could accelerate once we start seeing the first products at the market.

Steven Crowley - Craig-Hallum Capital Group

And then a couple of questions here on the industrial side of your business and I will hop back in the queue. I don’t know that I caught the color on some of the challenges in the industrial marketplace. But was it more driven by geography or certain end markets and where do you think you are in terms of those challenges, whether that’s psychology of the customer, inventory levels of the customer? Just some context for what’s going on there would be helpful.

Daniel Baker

Well, I think the thing that we noted was a sluggish global economy and that affects consumption of durable goods which in many cases is where our devices go to automate the factories that make durable goods, such as cars and appliances and things like that. And the folks aren't building houses or other things, then ultimately it comes back as weakness in the markets that we serve, the industrial market we serve. I don't know, maybe Curt can chime in, but I don't know that we could put our finger on a particular market that's been weak. I think we've seen some weakness in Europe, and at least not quite as much strength as we have seen previously in China and other parts of Asia.

Curt Reynders

That's exactly right. We were -- we did see some weakness in Europe and the growth that we'd seen in China seems to have slowed down.

Steven Crowley - Craig-Hallum Capital Group

Fortunately or unfortunately that doesn't seem to be an NVE specific set of conditions right now.

Curt Reynders

No, not at all.

Steven Crowley - Craig-Hallum Capital Group

And in terms of geographies that you're bringing up new markets outside the U.S. is there anything to report in terms of other markets that could be sources of strength over the balance of the year versus the two we just talked about?

Daniel Baker

What we see -- we see potential despite the recent weakness in Asia and China, we’re going to be focusing some of our time and Tim Hazelton, our vice president of sales is be focusing some of his time on that market segment along with Europe. As the economy recovers and that we hope it will, we want to be sure that we’re well positioned when the economies pick up, when the factories start to be built and we want them to include our technology of course, and that will make for more efficient factories. So those are markets that -- that we see as having some rebound potential.

Steven Crowley - Craig-Hallum Capital Group

Great. I’ll hop back in the queue with a few more questions.

Operator

(Operator Instructions) We have follow-up questions from Steven Crowley from Craig-Hallum Capital.

Steven Crowley - Craig-Hallum Capital Group

I tried to wait a little bit, to ping back in, even I think your operator was also kind of check the rest of the field, because I didn’t want to monopolize the Q&A if there were queues out there. But we only get to do this once a quarter guys, so I am going to ask a couple more questions. You mentioned private label and kind of new channels of access for your products in the marketplace in the industrial sector. It sounds like you have a bit of a template with the product form factor with some of your newer NVE label products.

What I want to ask is you mentioned the opportunities for partners, not singular, and is that the way you're thinking about casting your net from here, versus putting in the hands of one major player, potentially putting it in a couple or is that yet to be determined?

Daniel Baker

No, we do see it as a channel for multiple partnerships. I don't think we’d want to create just a bunch of conflict by having multiple partners that are addressing the same markets. So the particular one that we talked about in the prepared remarks would help us reach markets. We cited automotive electronics, which is a significant market, particularly for hybrid electric vehicles as those start to become more a larger share of the vehicle mix. And so we see potential there and we see potential for private label partnerships in other vertical markets that are difficult for small companies to penetrate.

This one, this relationship, this partnership is particularly far along because we introduced a product under our brand, what’s called the controller area network transceiver recently. And we have products that -- production products that the company is now evaluating. So this one is farther along than other discussions, but we see this as a as you pointed out a template and a business model that can help significantly expand our addressable markets and reach markets that are just tough for us, or time-consuming for us to reach otherwise. And with the efficiencies that we put in place with the good work that our manufacturing engineering, process engineering groups have been able to do, we have the cost structure that allows us to add this layer of distribution and still have a win-win for the private-label partner who's got to make money on it for us to make a fair profit and still provide competitively priced product with better functionality than conventional semiconductors.

Steven Crowley - Craig-Hallum Capital Group

Make sense. Now in terms of the gross margin improvement that was pretty striking in the quarter both year over year and sequentially. You attributed that to both mix and those efficiency improvements. Any sense for was it half mix and half efficiency improvements, or, what kind of flavor can you give us for that?

Daniel Baker

Well, it’s hard to quantify, but I would say a process improvements was the majority of the increase that we were able to show there.

Steven Crowley - Craig-Hallum Capital Group

Good. And given that you have an existing product that would very much resemble a private label product by this partner, the evaluation that they are undergoing certainly wouldn't be about feasibility and whether or not, you can deliver. What kind of things are they looking at in the evaluation process to proceed or not proceed?

Daniel Baker

Well, one of the bigger challenges there is qualification for particularly the automotive market where we're looking at an extremely harsh environment in terms of electrical noise and in terms of temperature ranges and other problems that cars present for electronic. So that’s a lot of what we’re looking at. We’re looking at a speed over wide ranges of temperature. We’re looking at data transmission over simulated harsh conditions with noise and things like that. And so far, the products are performing very well actually in some parameters better than we had designed for and better than we had hoped.

There are still a number of steps that we need to look at in terms of the qualification and then automotive companies have a number of requirements that are unrelated to the product – the formal product itself that are related to failure analysis and internal structures and redundancy and being a reliable supplier. We’re addressing those in parallel, many of them we've already addressed. We sell products, as you know, to some of most demanding customers in the world. So we believe we’re well positioned for that but still there are things that need to be put in place. So those are the sorts of things that we’re looking at now.

Steven Crowley - Craig-Hallum Capital Group

And a significant capacity expansion and manufacturing enhancements that you’ve put in place, are still putting in place, are those a function of needing to show customers like the one we're speaking of here that you have that capacity and capability to produce a bunch of products? Or do you need to be able to produce a bunch of products at the flip of the switch over the next three quarters if they decide to do that?

Daniel Baker

It’s some of both, it’s -- when we’re talking about things like the automotive, we’re taking a longer view of it. It sometimes can take some time to qualify the product, but we want to be well positioned. So some of it is capacity of having the capacity for these very high volume markets and making sure that we can address any issues that our prospective customers might have. Another is redundancy making sure that we have for a – in sort of a simplistic way, it’s having two of everything but it’s having a very robust process that can survive equipment downtime, that can survive process deviations and other things so that we can be an extremely reliable supplier.

So some of it is adding equipment for that, for that reason to be sure that we can be world-class in terms of our reliability and dependability. So some of it is having redundancy alternate processes, having some of the tracking and infrastructure that we need to ensure that, that we have a process that’s extremely rigorous and extremely repeatable.

Steven Crowley - Craig-Hallum Capital Group

And in terms of capital expenditures, there was a pretty significant number, I guess, it’s been running at a more significant number over the last three quarters. Should we look at first quarter being kind of a run rate for CapEx or is that a high watermark for a little while?

Daniel Baker

I would say we’re looking at doing some things this fiscal year, as I've mentioned. So I would think that, that may be our run rate in that order of magnitude for the remainder of the fiscal year.

Steven Crowley - Craig-Hallum Capital Group

And then in your discussion in the prepared comments about contract R&D, you’ve continued to make it clear and it’s been consistent – a consistent message from you guys that growth in that category is not your focus relative to growth in the product sales which are really the future, the company. But I guess we’ve had two quarters now in the same neighborhood for contract R&D, and how should we view the prospects for that revenue component over the balance of the year? Does it stick around here for a little while and go up or if something happens with your backlog of contract R&D that should lead us to be more optimistic or more pessimistic?

Daniel Baker

I think I would characterize it as the – it’s still a very challenging environment. But I think looking out we've got a lot of irons in the fire and looking out maybe a couple of quarters we’d be a little bit more optimistic.

Steven Crowley - Craig-Hallum Capital Group

That would serve a purpose in terms of planting some additional seeds for downstream products but also maybe as a bit of a reduction to your R&D run rate, is that the correct way for us to think about it?

Daniel Baker

That's generally the way it has worked in the past. When we do have contracts we tend to move resources to fulfil those contracts and otherwise we’re working on some internal research and development activities.

Steven Crowley - Craig-Hallum Capital Group

And just a final question or two from me relates to your efforts around MRAM, anti-tamper MRAM in terms of productization and anything else that presents an opportunity for you to monetize your significant IP portfolio around MRAM?

Daniel Baker

We continue to see significant opportunities there. Initially they are for high-value targets, high-value assets that we want to protect such as military hardware. But we are seeing it to become a little bit more widespread. We have a portfolio of products in anti-tamper and in MRAM to offer for various applications depending on the particular need and the level of security required. And it's an area that as we've discussed before, we see some eventual high-volume consumer-related applications. So we see it as a very promising market. It's not a significant revenue contributor right now, but it's the focus of a significant portion of our R&D efforts and we see it as a very, very promising. And that could be with some of these contracts that we’re becoming a little bit more optimistic about might be in that area.

Operator

Our next question comes from Jean Friedlander from – he is a private investor. Please go ahead.

Unidentified Participant

Hi Dan. Hi Curt. Congratulations on a successful quarter margin wise. My question relates to the Everspin lawsuit. It’s noted that legal fees went down, or actually were almost non-existent for the quarter. But I noted on the 10-Q that on May 16, Everspin requested a re-examination of the 6349053 patent. Is that a patent that deserves main dispute that you have with them and main importance?

Daniel Baker

It’s one of the – there are three patents under suit and that’s one of them.

Unidentified Participant

Okay. Well, the other two weren’t after the re-examine, just this one.

Daniel Baker

Right. They could be requested at a future date but this is one that's been requested and exams are almost always granted by the patent office when they requested. So this is one where the re-examination was granted by the patent office.

Unidentified Participant

Could we assume that because they requested this particular patent to be re-examined, that is of key importance for that and for the suit?

Daniel Baker

That’s really hard to say, that's a better question for them. I wouldn't be able to speculate on what their motivation was.

Unidentified Participant

Okay. Just one other question, I know that you answered Mr. Crowley’s question about capital investment. Last quarter you said that it looked like for the balance of the year, there would be $1 million capital expenditures going forward. So with the $400,000 plus that was spent this past quarter, should we anticipate no more than $600,000 being spent to the balance of the year?

Daniel Baker

No, I think right now we are looking at probably that same run rate around $400,000 per quarter – for the remainder of the fiscal year.

Unidentified Participant

But for the balance of the year, do you think it will be more than the run rate that was just experienced this past quarter?

Daniel Baker

I would say it would be in that range.

Operator

And we show no further questions in queue.

Daniel Baker

Well, if there are no other questions, thank you. Thank you, Steve and Jean. We were pleased to report strong earnings, record margins and increased product sales for the quarter. We look forward to seeing some of you at our annual meeting in a few weeks and we plan to speak with you again in October to report our second-quarter results. Thanks again for participating in the call.

Operator

Ladies and gentlemen thanks for participating in today’s program. This concludes the program. You may all disconnect.

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