NVE Corporation (NVEC) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the NVE Conference Call on Third Quarter Fiscal 2015 Results. At this time, all participant lines are in a listen-only mode to reduce background noise. Later, we will be conducting a question-and-answer session and instructions will follow at that time. [Operator Instructions]. I would now like to introduce your host for today, President and CEO of NVE Corporation, Dan Baker. Sir, you may go ahead.

Thank you. Good afternoon, and welcome to our conference call for the quarter ended December 31, 2014, the third quarter of fiscal 2015. 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 Web site, nve.com. After my opening comments, Curt will present a financial review of the quarter and fiscal year-to-date; I’ll cover business items and we’ll open the call to questions. We issued our press release with quarterly results and filed our quarterly report on Form 10-Q in the past hour following the close of market. Both documents are available through our Web site and the SEC’s Web site. We have also begun providing links to our earnings reports along with some less important information via Twitter at NveCorporation. Please refer to the legal privacy notice on our Web site regarding the materials on our Web sites and social media sites. 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 future contract R&D revenue, risks related to our reliance on several large customers for a significant percentage of revenue, risks related to material weaknesses and our internal controls, uncertainties and risks 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, 2014 as updated in our recently filed quarterly report on Form 10-Q. The company undertakes no obligation to update forward-looking statements we may make. Summarizing our quarterly results, net income increased 1% despite a 3% decrease in total revenue due to expected year-end customer inventory adjustments and we declared a $10 million cash dividend. Now, I’ll turn the call over to Curt to discuss details of our financial results.

Thanks, Dan. I’ll cover quarterly results, year-to-date results, the balance sheet and our dividend plans. First, details for our quarterly results. As Dan said, net income for the third quarter of fiscal 2015 increased 1% to 2.79 million, our third consecutive quarterly increase in net income. The increase was despite a 3% decrease in total revenue to $6.29 million from $6.47 million in the prior year quarter. A 16-fold increase in contract R&D revenue offset most of a 9% decrease in product sales. The decrease in product sales from the prior year quarter was due to decreased purchased volume by existing customers and unfavorable order timing. As we expected and discussed in our last call, year-end inventory adjustments by medical device customers appear to have caused unfavorable order timing and negatively impacted revenue. This is not unusual and we currently expect product sales to increase from this level in coming quarters. Contract R&D increased significantly to $408,000 from $25,000 last year due to a new project. We hope this marks return to higher contract revenues. Dan will provide details on new contracts in a few minutes. Gross profit margin decreased to 77% of revenue for the third quarter of fiscal 2015 compared to 78% for the third quarter of fiscal 2014, due to a less favorable revenue mix with a higher percentage of revenue from contract R&D. Total expenses decreased 15% for the third quarter of fiscal 2015 compared to the prior year quarter due to a 23% decrease in R&D expense and a 2% decrease in selling, general and administrative expense. The decrease in R&D expense was due to the completion of certain product development activities and an increase in contract R&D activities, which caused resources to be reallocated from expensed R&D. Income from operations increased slightly to 3.59 million and operating margin increased to 57% compared to 55% in the prior year quarter. Interest income increased 5% for the quarter primarily due to an increase in interest-bearing marketable securities partially offset by a decrease in interest rates on reinvested funds. Interest income may decrease in future quarters because we plan to use proceeds from maturities and marketable securities to help fund quarterly dividends rather than reinvesting proceeds and marketable securities as we have generally done in the past. Income before taxes increased 1% to $4.15 million for the quarter compared to $4.11 million in the prior year quarter and pre-tax margin was 66% compared to 63% in the prior year. Net income for the third quarter of fiscal 2015 was 2.793 million or $0.57 per diluted share compared to 2.777 million or $0.57 per share for the prior year quarter. Net margin was 44% compared to 43% in the prior year. For the fiscal year so far, the first nine months of fiscal 2015, total revenue is up 15%, product sales increased 14% and contract R&D revenue increased 124%. Gross profit margin increased to 80% of revenue for the first nine months compared to 78% for the first nine months of fiscal 2014, due to a more favorable product sales mix. Net income for the first nine months increased 25% to $10.7 million or $2.20 per share compared to $8.57 million or $1.76 per share in the prior year period and compared to $2.29 per share for the entire year last year. The increase in net income in the first nine months of fiscal 2015 was due to increased product sales, increased contract research and development revenue, increased gross margin, decreased R&D expense and increased interest income. Operating cash flow or net cash provided by operating activities increased 10% to $10.8 million for the first nine months of the fiscal year compared to $9.82 million in the prior year. Cash and cash equivalents were $11.8 million at December 31, 2014 compared to $1.26 million at March 31, 2014 primarily due to cash provided by operating activities. At December 31, 2014, we had 94.4 million in short-term and long-term marketable securities, about the same as the beginning of the fiscal year. We did not purchase any securities in the quarter ended December 31 in preparation for the possibility of returning cash to shareholders. Purchases of fixed assets were 114,139 in the first nine months of fiscal 2015 compared to 33,893 in the first nine months of fiscal 2014. Investments in both periods were less than historical levels because we completed an upgrade of our production capabilities in 2013. Our financial performance and strong balance sheet have increased shareholder value and our stock hit a number of new all-time highs in the past quarter. With our strong balance sheet and history of cash generation, we’re pleased to announce that our Board declared our first dividend, which will be $10 million or approximately $2.06 per share payable to shareholders of record as of February 2, 2015. We plan to continue quarterly dividends in the future quarters in excess of our free cash flow in order to return cash to our shareholders and decrease marketable securities. We plan to fund these dividends through cash provided by operating activities as well as proceeds from maturities and marketable securities. Returning cash as our marketable securities mature avoids early sales of bonds with commissions and spreads that would diminish shareholder value. We expect to fund the first dividend with cash and cash equivalents on hand at the end of the quarter. I’d like to cover the details of our planned quarterly dividend schedule. As we did today, we’ve typically reported earnings the Wednesday after the third Monday of the quarter, that is the Wednesday between the 17th and 23rd of the first month of the quarter. Fiscal year-end earnings reports have been two weeks later, the first Wednesday in May. As we did today, we plan to announce dividends as part of our earnings announcement. In compliance with NASDAQ rules, we plan to set a dividend record date 12 calendar days after the announcement, which would be the sixth Monday of the quarter. The ex-dividend date will be two business days before the record date, which would be a week from tomorrow this quarter. Our transfer agent will pay the dividends the last business day of the second month of the quarter, which is February 27 for the dividend we just announced. There is additional time to mail checks or for brokers to credit shareholders’ accounts and the schedule is subject to change at any time. So we plan to declare our next quarterly dividend in May. We’re currently planning an amount based on our free cash flow for the fourth quarter plus marketable security maturities less a contingency. Our estimate is that it will be in the range of $3 million to $5 million. In summary, our plan for capital allocation is to continue large cash dividends and opportunistic share repurchases until we significantly decrease our marketable securities. We’re planning to return tens of millions of dollars in total to shareholders before we might decrease or eliminate dividends. We plan to continue to maintain a very strong balance sheet with enough cash and marketable securities to fund our operations, defend our intellectual property if necessary for opportunistic strategic investments and for contingencies. As noted in our press release and SEC filings, future dividends will be subject to Board approval and are subject to a number of factors. Furthermore, our stock repurchase program may be modified or discontinued at any time without notice. Now, I’ll turn it over to Dan for this perspective on our business. Dan?

Thanks, Curt. I’ll cover R&D contracts, patents, product development and review some of our accomplishments in 2014. Starting with contract R&D, in the past quarter, we successfully completed a project under a National Science Foundation grant to develop sensors for faster detection of food-borne pathogens. We successfully demonstrated Salmonella detection in a system based on our spintronic sensor, which was the major goal for the project. We were able to demonstrate the feasibility of each of the three key areas of the project; spintronic sensors, nanobeads with aptamers and microfluidics. We’re in discussions about commercial deployment with companies in the food industry. As Curt said, contract revenue increased significantly in the past quarter. This was due to a new R&D project with a major defense contractor to develop spintronic memory commonly known as MRAM. R&D contracts provide modest income but more importantly help us advance new technology, in this case MRAM. This new program could enhance the value of our intellectual property portfolio and help us develop new commercial products. Turning to patents in the past quarter, the Board of Patent Appeals and Interferences of the U.S. Patent and Trademark Office ruled in our favor and reversed an examiner’s rejection of an important patent application. The application was titled, Thin-Film Structure Magnetizable Bead Detector and relates to a system for detecting the presence of selected molecular species, which could be used in biosensors. The ruling was in response to an appeal we filed in 2011 and the application has had a long journey since it was filed in 2008. But we persistently believed in the patent’s merits and we were pleased the Board of Appeals judges supported our position. The patent will strengthen the value of our biosensor intellectual property portfolio. Also, in the past quarter, we were granted a patent tilted, Inverted Magnetic Isolator. The patent relates to couplers, which are also known as isolators because they electrically isolate coupled systems. Couplers are an important product line for NVE and we continue to invest in new versions and models. Specifically, in coupler product development in the past quarter, we extended our line of couplers with best-in-class high voltage performance. They are tested to work at line voltages up to 1,000 volts; most line voltage is 120 or 220 volts, so that’s an impressive figure of merit. We talked about the introduction of the first of what we call the V-series couplers in our call last July. In the past quarter, we introduced two channel versions providing a broader line of extremely rugged parts for applications such as smart grids and medical instruments. We also announced a new coupler line what we call our V-1 series couplers, which extend our distinction of the world’s smallest couplers. The new V-1 series uses our unique Micro-Small Outline Package or MSOP but has doubled the isolation voltage of our previous parts. The higher ratings allow the new couplers to replace parts that are twice as large while still meeting the widely used 2.5 kilovolt standard defined by Underwriters Laboratories. Applications of the new couplers include industrial controls and energy saving power management. As we begin 2015, we look back on 2014 as one of the most productive years in our history for product development. New products the past year included angle sensors for energy and resource management, current sensors for energy management, high voltage coupler models for smart grid and medical instruments, quarter-size data couplers and network couplers, several custom sensors for medical devices and as we discussed for the most recent quarter, high voltage Micro-Small Outline Package couplers. We were also granted two new patents in the year; one related to anti-tamper systems and one relating to couplers. Now, we’ll open the call for questions. Andrew?

Thank you. [Operator Instructions]. Our first question is from the line of Charles Haff from Craig-Hallum. Your line is open.

Hi. Thanks for taking my questions. Can you hear me okay?

Absolutely. Good afternoon, Charles.

Hi. So, on the contract R&D side, the NSF grant, congratulations on proceeding with that. Is it going to go to the Phase II process now, now that you’ve completed this stage? And if so, what could be the revenue contribution from something like that and how long will it take to see that revenue contribution?

We’re looking at the possibility of filing an application for a Phase II grant. These are very selective grants that the National Science Foundation does. They’re held to very high standards. We haven’t filed an application yet and it’s not certain that we will. And then if we do, of course it’s not certain that we’ll win. But in any case, we’re pleased with the progress that we’ve made on this technology and we plan to pursue its commercial deployment with or without NSF funding. Curt, do you have a rough idea of the potential timing and potential funding might be on a Phase II?

Yes. It could typically be six months from now and Phase IIs are generally in the $750,000 range.

Okay, great. Thank you, Curt. And then a couple more questions here. On the volatility in product sales, is that a function of NVE pursuing more non-healthcare short cycle businesses? Would you expect more volatility in future periods relative to what you’ve had in past periods? I’m thinking back a few years when things used to be less volatile on the quarterly fluctuations.

Yes, Charles. Some of our customers, they tend to look at their inventory levels at the calendar year-end and sometimes make adjustments to their purchases. Customer inventory adjustments were more severe than last year, but overall our product sales are still up 14% year-to-date. Indications are that these customer inventory adjustments were completed in our third quarter. As you noted, it doesn’t happen every year but sometimes we do have those adjustments with some of our major customers.

Okay. So this volatility has been created by the inventory adjustments and it’s not really a function of pursuing non-healthcare business more now or short cycle businesses then?

No, not at all.

Okay.

But in fact I think part of what we’re trying to do is to broaden our business, rely less on the medical business. The medical business is an excellent business and it demonstrates the tremendous advantages that our products have and reliability in particular, but it can be a very lumpy business because there’s a lot of inventories in that channel. So, we have a number of initiatives to expand outside of life support business and there are a lot of reasons to do that, but one of them is that that business might tend to counterbalance or smooth out some of the variations that we tend to get quarter-to-quarter.

Okay, great. And two more quick ones here. On CapEx, Curt, for fiscal '16, would you expect that to be at a similar level to fiscal '15?

We’re probably at a historical low that we’ve had this year. We might be looking more in the range of – I would say the last two years were pretty low. If you go back far enough, probably more in the range of $1 million or up to that level, maybe more indicative of what would happen next year.

Okay. Thanks. And then on contract R&D with the robust performance there, would you expect gross margin then to be lower than the 80% that you’re doing now or would you expect 80% to kind of be the right baseline to use?

Well, the more higher percentage of contract R&D that we have, that tends to, as you know, bring down the margins and we’re looking for at least out the next couple of quarters our contract R&D to be in excess of the year-over-year quarters. So, I think the first two quarters we had this fiscal year, we had a pretty low percentage of contract R&D, which tended to have the gross margin increase. This last quarter, it went down a little bit compared to the first two quarters of the fiscal year. So I’d maybe look more at where we were this past quarter, maybe a little bit higher.

Okay. Thank you. Congrats on deciding to do the dividend. I think that’s the right thing for shareholders. And I’ll jump back in the queue and re-queue for other questions. Thank you.

Thanks, Charles.

Thank you. [Operator Instructions]. I have no one else in the queue. Would you like to continue taking questions from Mr. Haff.

Certainly.

Okay. Your line is now open.

Thanks for taking my follow-up questions. Curt, you mentioned in the prepared remarks when you were talking about the dividend that you would be paying that out with free cash flow plus the proceeds from the marketable securities less contingencies. I’m wondering if you could maybe describe how we should be thinking about the contingency part of that?

Well, I think maybe the best way to think about that is I mentioned a number in – the range that we’re looking at would be in the range of $3 million to $5 million on a quarterly basis.

I think the way we look at the contingency is we don’t want to cut it so close that if, say, receivables don’t come in or something else or some other contingency comes up that we’re in a position where we have to sell bonds or where we’re not paying receivables on time or something like that. So, our goal is to return quite a bit more than our free cash flow to shareholders each quarter.

Okay, great. That sounds good. And then just back to the product sales, I understand the order timing problems that you had with inventory adjustments and so forth and you made the comment that we should expect an increase in product sales in the next couple of quarters. Were you talking about year-over-year increases or a rate of growth that’s in excess of what you’ve done for the previous – that 15% that you’ve done in the first nine months of this year or what were you kind of getting at there?

I think what we were getting at was we expect the product sales to increase above the level in the most recent quarter and also above the year-over-year level for the fourth quarter.

Okay, great. I appreciate that. I think that about does it for me. Thank you.

Thank you. [Operator Instructions]. I’m seeing no other questioners in the queue at this time.

Okay. Well, thank you for participating in the call. We were pleased to report increased earnings and our first dividend. We look forward to speaking with you again in May to report our fiscal year results. Thank you, again.