Earnings Call Transcript - NVEC Q1 2020

Operator, Operator

Good day, ladies and gentlemen, and welcome to the NVE First Quarter Results Conference Call. 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. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Daniel Baker, President and CEO. Sir, you may begin.

Daniel Baker, President and CEO

Thank you and good afternoon. Welcome to our conference call for the quarter ended June 30, 2019. As always, I’m joined by Curt Reynders, our Chief Financial Officer. This call is being webcast live and being recorded. A replay will be available through our website nve.com. After my opening comments, Curt will present our financial review of the quarter. I’ll cover product development, trade shows and distribution, and then 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 our Twitter timeline. Comments we may make that relate to future plans, events, financial results or performance are forward-looking statements that are subject to certain risks and uncertainties, including among others, such factors as risks and uncertainties related to future sales and revenue, risks related to changes in tariffs and other trade barriers, 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, 2019. The company undertakes no obligation to update forward-looking statements we may make. We're pleased to report 26% sequential growth in net income and important product launches this past quarter. Curt will cover details of the financial results and then I’ll cover the business. Curt?

Curt Reynders, Chief Financial Officer

Thanks, Dan. For year-over-year comparisons, total revenue for the first quarter of fiscal 2020 decreased 11% to 6.29 million from 7.11 million in the first quarter last year. The decrease was due to an 11% decrease in product sales and a 12% decrease in contract R&D from last year. Anti-tamper product sales were strong, but the medical device market continued to be weak. Sequentially, total revenue increased 13% compared to the quarter ended March 31, driven by a 13% increase in product sales. We’re hoping for a third consecutive sequential revenue increase this quarter, which ends September 30. Gross margin increased to a record 83% for the quarter from 80% in the first quarter last year, due to a more profitable product mix. Expenses decreased 1% from the prior year due to a 2% decrease in R&D as we completed some important new product development projects. Dan will discuss product development in a few minutes. Interest income for the first quarter increased 8% due to an increase in the average interest rates on our marketable securities and money market funds. Net income for the quarter decreased 9% year-over-year to 3.61 million or $0.74 per diluted share compared to 3.95 million or $0.81 per share for the prior year quarter. Net margin was 57% of revenue, the highest ever. Net income increased 26% sequentially compared to the quarter ended March 31. Comprehensive income increased 9% to $4.18 million compared to $3.84 million for the prior year quarter. The increase was due to a $570,000 unrealized gain from marketable securities compared to $107,000 unrealized loss in the prior year quarter, partially offset by a decrease in net income. The unrealized gain was due to a strong bond market. The comprehensive income helped us maintain our strong balance sheet, while paying a generous dividend. Cash flow from operations was $4.54 million in the first quarter. Cash flow is typically higher in the first quarter than in other quarters, because we have no estimated income tax payments due. We have two tax payments due in the current quarter, the quarter ending September 30. The $1 per share or $4.85 million dividend this past quarter brought our total dividends paid to more than $90 million. We announced another quarterly dividend today, payable August 30 to shareholders of record July 29. Now, I'll turn it over to Dan to cover the business.

Daniel Baker, President and CEO

Thanks, Curt. I’ll cover product development, trade shows and sales. We recently introduced our fourth new smart sensor in the past year, a smart TMR magnetometer called the SM225. SM stands for smart magnetometer, which is designed to be used as a proximity current sensor. It's faster, more accurate, and smaller than alternatives. The new sensors are smart because, unlike our legacy raw sensors, they include analog to digital conversion, digital factory calibration and digital interfaces in the IC. These features provide simple, smart connectivity to the Internet of Things. TMR stands for Tunneling Magnetoresistance. Our spintronic technology such as TMR is ideal for smart sensors because of its inherent precision, small size, and low power. In addition to the new smart sensors, we continue to improve raw sensors with a new TMR magnetometer sensor designated the ALT025. TMR generally provides more signal and uses less energy than our venerable giant magnetoresistance or GMR Technology. It can be used in a variety of industrial controls. Our new smart sensors have been well received. As an example, last week, we shipped a batch of smart angle sensors to a new customer for the first production of an Internet of Things design win. We first talked to that customer in April, so it took barely three months to go from concept to production, which is quite remarkable. The new product is a Bluetooth connected smart tape measure. Our smart angle sensor provided fast prototyping with simple interfacing and elegant architecture. It also offered the customer excellent accuracy and measurement speed. The revenues for this specific design win aren’t huge, but the customer plans higher volume connected devices, and it illustrates the power of the Internet of Things paradigm and the benefits of our smart sensors. With the flurry of new products, we stepped up our promotional efforts. In the past quarter, we exhibited at Sensors Expo in San Jose, which is billed as the industry’s largest event dedicated to sensors, connectivity, and systems. There’s a video of three of the demos we featured at the show on our YouTube channel and in the Videos section of nve.com. Additionally, one of our program managers, Dr. Joe Davies, presented a paper on our medical device sensors at the conference. His talk generated interest from several potential customers, and we hope to broaden our medical business. New products were also on display in the past quarter at shows in England and Germany in cooperation with our distributors there. Looking even farther from home, in the past quarter, we shipped Mission Screen couplers for the Europa Clipper to the Jet Propulsion Laboratory. The products held up well under extreme conditions. The trip from NVE to JPL in Pasadena was the first 1,500 miles of the part of several hundred million mile trip to Europa, which is one of Jupiter’s moons. The journey will include a launch in four years and a three to six-year spaceflight. The mission is to look for conditions for life on Europa. Europa has been well studied recently, and now there’s even more to explore. According to a recent study published in the Journal Science Advances, Europa has sodium chloride, which is the principal component of sea salt. According to NASA, this means Europa could be even more similar to Earth than previously thought. Turning to sales here on Earth, we added an exceptionally capable representative in Europe, Dimac, which is based in Northern Italy. This will add a lot of feet on the street for us in Europe. We’ve had several training sessions with Dimac’s key people throughout Europe, and we've been impressed with their sales skill and technical expertise. Our annual shareholders meeting will be August 1 here in Eden Prairie, we'll demonstrate several new products, including smart sensors, which we didn’t have last year. We’ll also celebrate NVE’s 30-year anniversary with a birthday cake, and we’ll have a smart sensor-based mechatronics xylophone playing happy birthday. The materials for the formal meeting, our proxy statement letter to shareholders, and annual report on Form 10-K have been filed with the SEC and are available from the Investors section of our website. Shareholders can still vote their shares via mail, phone, or on proxyvote.com. There are three items on the formal agenda for the meeting. First, to elect Directors; second, advisory approval of the compensation of our named executive officers; and third, to ratify the selection of an accounting firm. For good corporate practice, our entire Board of Directors stands for re-election every year, and we were fortunate to have an exceptionally experienced and accomplished board. The second meeting agenda item is approval of officer compensation. As discussed in our proxy, we don’t overpay our officers; our officers have the same fringe benefits as all other employees, and there are no executive perks or golden parachutes. The third annual meeting agenda item is the ratification of our auditors. Last quarter, we engaged a new accounting firm, Boulay PLLP after six years with Grant Thornton. Shareholders have the opportunity to vote on Boulay as our auditors for the fiscal year ending March 31, 2020. Audit firm rotation is considered good governance and Boulay is smart, efficient, and experienced working with smaller public companies. Our board unanimously recommends a ratification. Boulay representatives will be at the upcoming annual meeting and will be available to answer questions. Now, I'd like to open the call for questions. Operator?

Operator, Operator

And our first question comes from Jeff Bernstein with Cowen.

Jeff Bernstein, Analyst

Just a couple of questions for you. I guess so, Abbott reported and their CRM business continues to be down a little bit, although they were optimistic that they might actually turn that around. Can you just talk about what kind of visibility you have there and talk a little bit about any other med device guys that you have business with now? I know you have mentioned neurostimulators in the past.

Curt Reynders, Chief Financial Officer

Sure. I believe Abbott reported that they did have sequential sales growth in the quarter. We're looking at also having sequential sales growth in our third quarter, which would be our third consecutive quarter of sequential growth, and we’re expecting in the third quarter, we will return to year-over-year growth.

Jeff Bernstein, Analyst

Great. And can you just elaborate a little bit on – Abbott is obviously a very big customer. Is there anybody in this business, any other competitors in CRM that you’re designed into?

Daniel Baker, President and CEO

This is Dan. Good afternoon, Jeff. It might not be ideal for us to discuss other customers, but we can mention Abbott, as we have disclosed that they are a customer in our SEC filings. As you can imagine, we are very strong in the CRM market and also in the medical device market overall. We have an excellent reputation and are willing to invest in businesses that may take several years to secure design wins. You can expect that we will engage with the leaders in that space, working on new devices as well as potential replacements for existing ones. You also mentioned the broader neurostimulator market, which is another strong area for us, and sometimes these devices share common platforms. They often face similar technical challenges, such as battery life, compact size, and the reliability that is crucial for life support medical devices, which are Class III devices. Therefore, this remains a solid market for us. While it has been challenging, as you pointed out, the long-term demographics look very positive. The population is aging, and there will be an increased need for medical devices. The therapies are expanding to address more disease processes, allowing more people to benefit from these devices. Thus, we consider it an excellent long-term market, despite the challenges faced by the device market in the recent past and the near-term future.

Jeff Bernstein, Analyst

Got you. And can you just say in neurostimulators, are you guys particularly focused on applications in pain or depression or is there anything in particular, or are you involved in an array of programs?

Daniel Baker, President and CEO

We’re looking at an array of programs. We do tend to look at, I mean, we’re willing to invest in the long term, and so implantable medical devices, Class III life support medical devices have, as you might expect, as you know, significant regulatory hurdles, and they can often take a long time to get approved. So devices that are less critical can sometimes have shorter design cycles, and obviously, that’s preferable from a business standpoint. So those would include things like pain management, pain stimulators. You mentioned other types of simulators. There is some exciting research going on in neurostimulators relating to brain stimulation to treat neurological and psychiatric disorders. So we have an excellent benefit proposition and a strong market presence in those markets. We’re always looking to see how can we get into the market sooner. So for neurostimulators, it’s the pain stimulators, and for other medical devices, things like hearing aids and devices that are Class I medical devices that we can get to market sooner.

Jeff Bernstein, Analyst

Got you. Okay. And then, I was just wondering, in the K, you talked about — you added power conversion ICs to your list of long-term product development programs, and you took out medical diagnostics. And so I’m just curious about those two changes.

Daniel Baker, President and CEO

Well, you have a sharp eye. So the power control devices are devices that we’re looking at for sophisticated motor controls such as power factor controls. So these are devices that can improve the efficiency and the power utilization of motors and other what are called non-linear devices. So that’s an area where we think our partnership with large semiconductor company can bring some benefits because they have expertise and a market presence in the IC part of it, and we can provide the isolation and sensing. So it’s a great potential area for us, and one that’s becoming more and more important. There is a statistic, and I might not have the exact numbers right, but nearly half of the electric power in the world is used by motors, and that’s an amazing statistic. Some of it’s big, heavy motors, as you might expect, but there’s a lot of little motors that are in a whole bunch of things. So being able to manage those more efficiently is more and more important. It’s getting more and more regulatory attention and scrutiny and more and more attention from companies like ours and our partners. So one of the challenges that we can help with is to efficiently drive the motors with our coupler technology without having to have a direct electrical connection. So the flip side of that was that I think that you mentioned was medical diagnostics. And medical diagnostics remain an area of interest for us. There’s a certain timeframe that might kick into a regulatory filing. But we’ve mentioned in particular, as you know, that our biosensor technology may have applicability to access home detection, which could be used for early-stage cancer detection. That’s a very exciting area, and an area that we’re continuing to pursue. So we certainly wouldn’t want you to read into that, that we’ve abandoned that market — quite the contrary.

Jeff Bernstein, Analyst

Got you. Okay. And just to clarify, so it is isolation, and I guess current sensing in power conversion. You’re not actually doing power conversion ICs yourself.

Daniel Baker, President and CEO

Well, we haven’t defined exactly how the pie will be split, but our core competencies are in current sensing and in isolation. And those are key areas for those power conversion circuits. So the circuitry is getting more and more integrated to reduce the parts count, to get them into smaller devices and into smaller and smaller motors and smaller power supplies. So that’s where we think a lot of the value can be added. There have been power control circuits for some time, but they require ancillary products, and they don’t have the speed and the other advantages that our isolation technology has to improve efficiency.

Jeff Bernstein, Analyst

Got you. Okay. And then one last one, and I’ll hand it over to somebody else. You no longer listed Premier Farnell plc as a distribution partner. Has that relationship changed? Has it been replaced by somebody else or what was going on there?

Daniel Baker, President and CEO

No, the company was purchased. So it’s still a distributor. So in the United States, it would be through Newark element14. I believe that’s still their current branding. The parent company is different, but we’re still on the website and their catalog, and they are a good distributor.

Operator, Operator

And our next question comes from Thomas Cochran with Lake Road Partners.

Thomas Cochran, Analyst

I'm thinking about the biosensor or bacteria detection devices. And I know that NVE only has perhaps 50 employees. If that device, the biosensor device is successful, will NVE be able to supply the market or do you anticipate selling the manufacturing rights and patents to another company? I worry a little that big food companies or medical products companies, people are going to use medical products, might prefer to buy the device, say, your cancer detector from an established machinery maker that knows how to comply with all the government regulations involved in food production or medical products. It seems to me that a company that's new to them, just getting approved as a supplier, could be a long process.

Daniel Baker, President and CEO

Yes, that's a good question, Tom. It's possible that we could license the technology or establish a private label partnership. There's still development work to be done, but we've successfully engaged in private label agreements where we leverage our technology alongside a larger company's sales and marketing capabilities and their support systems. Alternatively, we are prepared to market the product ourselves if necessary, although there are challenges involved in that. Our USDA application included a letter of support from a major food wholesaler, indicating they are willing to collaborate with us despite our limited experience in that market. We are also ready to hire salespeople and additional personnel when the time is right. Ultimately, we will evaluate the best approach to bring the technology to market and are open to both options.

Thomas Cochran, Analyst

If the patents were sold to another company, I believe NVE could establish a passthrough shell to distribute the initial and subsequent payments for the patents directly to NVE shareholders, meaning that those receipts would only be taxed for shareholders and not for NVE. Similar passthrough arrangements might also apply to future uses of the same patent tool. It seems to me this could be another reason to license it out.

Daniel Baker, President and CEO

Yes. Well, there are certainly pros and cons, and we share your goal of returning capital to shareholders as tax-efficiently as possible. So our plan has been to manufacture the equipment and certainly the sensors. We have unique manufacturing capabilities. So licensing is a little bit more of a challenge there than it might be for other technologies such as large scale spintronic memories. But it is a possibility, and we would look at what maximizes our shareholders’ value and do what’s best for our shareholders. That’s what we try to do with every business decision we make.

Operator, Operator

And our next question comes from Jeff Bernstein with Cowen.

Jeff Bernstein, Analyst

I have a few quick follow-up questions. Can you provide more insight into the unclonable functions business? It seems to have returned this quarter. You've mentioned that it's a lumpy business. Is it a high ASP part? Can you give us any idea of the types of hardware it is used in? I understand you need to maintain confidentiality, but does it involve missile sensor aircraft or drone vessels, or could you share where these applications might be found? Any additional information to help us understand it better would be appreciated.

Daniel Baker, President and CEO

Sure. So first for folks who aren’t familiar with it, PUS or physical unclonable functions, and those are functions that are embodied in a physical structure that’s easy to evaluate, but hard to predict and replicate. So they’re an important component in anti-tamper systems. The anti-tamper systems that we work on are designed to protect sensitive data or electronics. We currently sell these for military systems. There are potential commercial applications such as high-speed encryption and security for consumer electronics. But in the near term, they’ve been used for military systems. So what the military has said publicly is that when we, as a country, sell military systems, they need to be protected, because there’s a potential they could fall into unfriendly hands, reverse engineered. So that’s particularly sensitive for exported military systems. So they do tend to be – so you’re asking also about the business and characterizing the business. They do tend to be high value-added systems. As you can imagine, there’s a different price point for something like an anti-tamper system for a military system and commercial applications, such as consumer electronics. And the requirements are much more rigorous. The testing that we do on these devices is extremely precise and rigorous, as you would hope. So those tend to be high value-added systems, where they’re relatively expensive to make. I guess, I would characterize them as the margins can vary. They can be good. But then if one runs into challenges, they can be fairly expensive to remedy. So in that sense, it can be variable. But I think as Curt mentioned, overall, our margins were record, we had record margins in the most recent quarter, and he referred to the mix. And so part of that mix is some strength in the anti-tamper business.

Jeff Bernstein, Analyst

Great. And so I guess you can’t really give us any details on what kinds of hardware these things go into?

Daniel Baker, President and CEO

Probably, I think we've been about as specific as we could. So they’re going into military electronics, sensitive data or electronics, and electronics is an increasingly important part of many military systems, as you can imagine. There is some information and links to information from government agencies such as there’s an abstract that was approved by the Missile Defense Agency for public release in the news section of our website. But beyond that, as you might expect, we’re limited in what we can say about anti-tamper technologies.

Jeff Bernstein, Analyst

Got you. Okay. And then in your K, you also talked about private label couplers that were added to the list of the products that you offer. Can you just explain what private label couplers are? Is that part of your partnership with the large semi company?

Daniel Baker, President and CEO

Yes. And so we sell couplers under other company’s brand names, where we’re making the parts. But as Tom mentioned, in the context of biosensors, there are customers, who would prefer to buy from a bigger name or a bigger company. We certainly feel like we provide our customers with superb support and excellent product quality. But we understand that. And also there are just inherent limits to our reach and accessibility being a relatively small company based here in the United States. So we do see the value of having our products under private label arrangements, and it appeals to a different type of customer. So we don’t believe there’s an awful lot of cannibalization in that type of business model. And it’s one that we think that, as I alluded to in the other question, that we’re open to and where it makes business sense, we’ve been looking at those sorts of arrangements.

Operator, Operator

Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Daniel Baker for any closing remarks.

Daniel Baker, President and CEO

Well, thank you. We were pleased to report strong sequential growth, record margins and two new products. We look forward to seeing some of you at our Annual Shareholders meeting two weeks from tomorrow, and to speaking with you again in October to discuss second quarter results. Thank you for participating in the call.

Operator, Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program, and you may all disconnect. Everyone, have a wonderful day.