Logo of jester cap with thought bubble with words 'Fool Transcripts' below it

Image source: The Motley Fool.

NVE (NASDAQ:NVEC)
Q2 2019 Earnings Conference Call
Oct. 17, 2018 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, Ladies and gentlemen, and welcome to the NVE conference call on second-quarter results. [Operator instructions] As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Daniel Baker, president and CEO. Mr.

Baker, you may begin.

Daniel Baker -- President and Chief Executive Officer

Good afternoon, and welcome to our conference call for the quarter ended September 30, 2018. 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 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 on Monday, earlier than planned due to an administrative error by the service provider. We also filed a Form 10-Q/A to amend the incomplete original filing. Links to all of the 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, uncertainties related to the impact of federal tax reform, 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 10-K for the year ended March 31. The company undertakes no obligation to update forward-looking statements we may make. We are pleased to report a strong increase in product sales, a 35% increase in net income and record earnings of $0.88 per share, up from $0.65 last year. Curt will cover the details of our financial results.

Curt?

Curt Reynders -- Chief Financial Officer

Thanks, Dan. Total revenue for the second quarter increased 7% to $7.51 million compared to $7 million for the year-ago quarter, driven by a 10% increase in product sales to $7.05 million, up from $6.39 million last year. The increase in product sales was due to new customers plus increased purchases by existing customers. Contract R&D revenue decreased 26% due to the completion of contracts.

Contract R&D is a small percentage of our revenue, and as we've said before, much of it is for custom spintronic anti-tamper sensors where revenue can fluctuate with contract timing. Gross margin increased to a record 82% of revenue due to a more profitable revenue mix driven by product sales growth. Total expenses decreased 2% due to a decrease in R&D expense, partially offset by an increase in SG&A. The increase in SG&A was primarily due to a $52,000 increase in stock-based compensation.

Stock-based compensation was entirely automatic stock options granted our directors on their reelection to our Board. The number of options granted was unchanged and the increase in stock-based compensation was due to a large increase in our stock price in the past year, as well as an increase in the Black-Scholes calculated stock volatility. As discussed in our proxy statement, we don't overpay our directors or officers. Interest income increased 14% for the quarter due to higher bond yields.

The increase was despite a decrease in our marketable securities as we used some of our maturing securities to fund dividends. Pretax income increased 13% and pre-tax margin increased to 70% for the quarter compared to 66% last year. Our effective tax rate decreased to approximately 18% compared to 32% in the prior year quarter. The decrease was primarily due to the decrease in the federal rates.

We currently expect our effective rate to be about 18% for the full fiscal year. After tax, net income for the most recent quarter increased 35% to a record $4.28 million or $0.88 per diluted share compared to $3.16 million or $0.65 a share last year. The large increase in profits was primarily due to an increase in product sales and a decrease in tax rates. Net margin for the quarter increased to a record 57% of revenue compared to 45% last year, which is among the best returns on revenue in the industry.

Comprehensive income, which includes a $51,000 unrealized gain on our available-for-sale securities, increased 37% to $4.33 million for the quarter compared to $3.17 million last year. Despite a tough compare for the first quarter of the fiscal year, total revenue increased slightly for the first two quarters to $14.61 million versus $14.60 million for the prior year. A 5% increase in product sales in the first half of this fiscal year more than offset a 48% decrease in contract R&D. Net income for the first half increased 27% to $8.23 million or $1.70 per share compared to $6.46 million or $1.33 per share last fiscal year.

Cash flow from operations was $8.27 million in the first half compared to $7.32 million last year. Exceptional operating cash flow and modest fixed asset purchases drove strong free cash flow. Fixed asset purchases were a modest $38,000 in the first half, and we expect fixed asset purchases for the full fiscal year to be less than the $605,000 we spent last year. In addition to the dividend paid in the past quarter, we announced that our Board declared another quarterly dividend of $1 per share, payable November 30 to shareholders of record as of October 29.

Now I'll turn it over to Dan to cover the business. Dan?

Daniel Baker -- President and Chief Executive Officer

Thanks, Curt. I'll cover R&D and new products and the trade show that just wrapped up. On our Department of Agriculture biosensor grant, we've successfully built prototypes of most of the components including biosensors, magnetic nanoparticles, electronics and microfluidics. We ran into some challenges with the aptamers system and we're looking for solutions, but we've demonstrated the scalability of our technology from the laboratory scale devices we did before.

We're also in the early stages of studying the possibilities for medical applications, such as exosome detection for cancer diagnosis. In the past quarter, we received orders and shipped couplers for the Europa Clipper mission. The mission is to look for conditions for life on one of the moons of Jupiter. The launch is probably at least four years away, but the Chairman of House Commerce, Justice and Science Subcommittee called it vitally important, and we're proud to be part of such a demanding and important mission.

Turning to new products. In the past quarter, we introduced a smart magnetometer plus several low-power parts, low-power magnetic switches, and a new Tunneling Magnetoresistance isolator. The lower power magnetic switches are the result of efforts to continue to extend our competitive advantages, in this case, to reduce the energy use even more. Low-power is one of the core benefits of spintronics and low-power is important for the Internet of Things because it allows devices to run on batteries or harvested power.

We can demonstrate these parts with a button cell soldered onto a circuit board. There's no need for a power switch, replaceable or rechargeable battery so we can put live demos in our sample kits. There is a video of a sample kit on our website and YouTube channel. We launched Tunneling Magnetoresistance or TMR couplers earlier in the year.

They're the only parts of their type and expand our TMR product line. TMR couplers are lower power than our venerable GMR couplers, and are designed as gateways to the Internet of Things. Smart sensors are another key to our Internet of Things strategy. The new magnetometer is smart because, unlike existing sensors, it includes analog to digital conversion, digital factory calibration and digital interfaces in the IC.

Integrating those features provide simple smart connectivity to the Internet of Things. The versatile magnetometer can be used as a proximity sensor or a current sensor. We promoted the new smart magnetometer and other sensors as the sensors Midwest trade show outside Chicago. Yesterday and today, we demonstrated the new smart magnetometer in an automotive application of motors controlled simulation using a windshield washer pump.

We also previewed a new smart angle sensor and our TMR angle sensors. There are pictures and videos on our website, YouTube channel and Twitter timeline. Finally, I'll cover corporate governance. Our annual shareholders meeting was last quarter.

For good corporate practice, our entire board of directors stands for election every year, and each of our directors was overwhelmingly reelected. Our executive officer compensation supports goals of profitable growth and improving long-term shareholder value without being excessive, and shareholders overwhelmingly voted to approve compensation. And finally, the selection of our auditors was ratified. Details of the shareholders votes were reported on a Form 8-K we filed with the SEC the day after the meeting.

In addition to the formal items of business at the meeting, we had hands-on product demonstrations highlighting the precision, size and smarts of our products. Now I'd like to open the call for questions. David? 

Questions and Answers:

Operator

Yes. [Operator instructions] Our first question comes from Jeff Bernstein with Cowen. Your line is now open.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

Hey, Dan. How are you?

Daniel Baker -- President and Chief Executive Officer

Good, Jeff. How are you?

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

Good. So just wanted to see if we could get a little bit more detail. You talked about the product revenue growth being driven by existing customers and new customers. Could we get just a little bit more detail on maybe some industry breakdown etc.? Maybe you talk about CRM or any progress you're making in automotive etc.

Daniel Baker -- President and Chief Executive Officer

Certainly. So I think the strong markets were our industrial control Internet of Things markets. The medical device market is probably, I describe it as stable, as you probably know. Abbott, for example, reported today a slight decline in rhythm management revenue.

Long-term, the demographics remain favorable for CRM, but there are short-term challenges. But fortunately, some of our other products, the new products that we have for angle sensors, for some -- we got some modest sales from our private-label partnership and some of the new Internet of Things products have been building.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

Great. I know we've talked about the hearing aid market before and maybe you can touch on that. And was curious on kind of a forward-looking basis, I guess, Bose won the right to sell an OTC hearing aid even though I don't think the FDA has completely addressed the whole idea of kind of nonprescription products, but just what are your thoughts here?

Daniel Baker -- President and Chief Executive Officer

Well, there appear to be changes coming, as you know, in the hearing aid market. But an expansion of the hearing aid market, such as over-the-counter or private-label hearing aids could certainly help us if it expands the market. And if we can provide components for those hearing aids, and we're certainly looking at that. Proponents of lower cost and over-the-counter hearing aids point out that many people who need hearing aids don't have them because of the expense or the dispensing inconvenience needing an audiologist.

So these new categories could expand the market.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

And your current business, how's that faring right now?

Daniel Baker -- President and Chief Executive Officer

The current hearing aid business you mean?

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

Yes, yes.

Daniel Baker -- President and Chief Executive Officer

Yes. So that's been a strong stable business that has been growing, albeit perhaps modestly. The demographics are favorable as baby boomers age and need hearing aids. And there is more and more technology being put into hearing aids.

The hearing aid companies are doing some amazing work, and making hearing aids more seamless, more natural and easier to use, and we're a part of that. So we continue to see a growth in the technology that goes into hearing aids as well as a growth in the market itself, the number of people who have hearing aids.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

Great. Thanks. I'll let somebody else ask.

Daniel Baker -- President and Chief Executive Officer

Thanks, Jeff.

Operator

Thank you. [Operator instructions] And we do have a follow-up question from Jeff Bernstein with Cowen. Your line is now open.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

Great. I guess if there is nobody else, I have a couple of more. Just curious, you talked about much of the R&D, the contract R&D being related to tamper-proof sensors, a lot of news just in last couple of weeks about a GAO study of defense electronics being very hackable and the Supermicro server controversy etc. What are your guys expectations over the next couple of years on this area?

Daniel Baker -- President and Chief Executive Officer

We continue to see it as an important market and one where we have unique technology. As you know, we have unique spintronics. Inherently nonvolatile technology that's very well suited for anti-tamper. We have Physical Unclonable Functions, sometimes called PUFs, which are excellent for cryptography because they're easy to evaluate, but hard to predict and replicate.

So we have excellent technology. It's not a huge part percentage-wise of our business, but it's an important part where we've got an excellent reputation. Our guys who work in that area do a fabulous job. They're very innovative, and we're respected in that field.

So we're looking forward to strong business there. As Curt mentioned in the prepared remarks, it can be somewhat cyclical or lumpy depending on the timing of contracts, but it's business that we see continuing and growing.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

So is all the revenue in contract R&D and is that where to look for it going forward? Or there are some commercial product-type revenues here already?

Daniel Baker -- President and Chief Executive Officer

Yes. We're selling commercial products. We're selling anti-tamper sensors right now.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

OK. So to the extent that the defense department says, hey, wait a second, we have a real problem here with provenance and with tampering and with all those kinds of things, we should expect that there could be more demand in this area?

Daniel Baker -- President and Chief Executive Officer

Yes. I mean, I'd hate to call that a good thing. But from a business standpoint, we're in a good position to help solve that problem. And as you know, it's a very serious problem.

So and part of the reason why we do it is because it's our opportunity to do some good and to protect the critical equipment for military and other very sensitive equipment.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

OK, great. And then I was interested to hear you mention exosome detection, that the exosome science is very new, and so I'm a little bit curious. You were saying for detecting cancer, is that to sort of differentiate cancer that is metastasizing? Or what's your current understanding of what you're looking for here?

Daniel Baker -- President and Chief Executive Officer

Well, our part of it, Jeff, would be to detect the exosome, so we would be looking at detecting antibody-antigen reactions, those types of reactions, which we can tag with magnetic beads. So it's similar technology to our biosensor technology that we use to detect pathogens, bacteria for example. And as you know, it's an exciting area for early detection of cancer. And exosomes are small cellular particles, and they're released early in the disease process.

So they can give clues to early detection of a disease, which of course could lead to early treatment and better outcomes. So it's a new area, as you correctly point out. The research is in its early stages, but we're certainly excited about the possibilities there and the possibilities of applying our technology to such an important area.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

Right. So now because these things are there, I think a thousandth of the size of a cell, we're talking about the kind of concentrations where the resolutions that you guys can get with your technology are going to be the way to go. Is that what we should understand?

Daniel Baker -- President and Chief Executive Officer

We certainly hope so. Being able to detect very small levels of biological materials is one of the great advantages of our technology. And as you know, exosomes are tiny little pieces of cells. They're part of the cell, and so there's not a lot of material to work with there.

So that's why it's difficult to detect them. So our goal would be to tag them and to detect very small perturbances in the magnetic fields that these beads would create. And we believe that, that technology of course has shown significant promise in detecting very low levels. We gave the analogy of detecting a needle in the Mall of America.

And so this is a similar problem of detecting very small things in a very large volume of fluid.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

All right. And then lastly, can you just give an update on the spin-torque microwave work that you guys are doing? And it seems like that would probably be aimed at sort of advanced beam-forming antennas or whatever, but just whatever color you can give on how you're doing there and the progress.

Daniel Baker -- President and Chief Executive Officer

Right. So we're limited in what we can talk about there. The final report hasn't been made public. That was a U.S.

Army -- we did a U.S. Army contract, which was a matter of public record, but the report itself is not. We did complete the research contract with the Army successfully last year, and we demonstrated the feasibility of the Spin-Torque Microwave Diode Spectrograph. And in addition to military uses, that technology could lead to an order of magnitude increase in coupler speed and isolator speed, perhaps to as much as a gigabyte or a billion bits of information per second.

So that will support emerging Internet of Things applications, such as remote video monitoring, but that's a little bit farther out. We hope if the Army makes the report public, we hope to be able to post it and give some more details.

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

OK. That's great. Thanks so much.

Daniel Baker -- President and Chief Executive Officer

Thanks, Jeff.

Operator

Thank you. [Operator instructions] And I'm showing no further questions in queue. I'd like to turn the call back over to Daniel Baker for any further remarks.

Daniel Baker -- President and Chief Executive Officer

Well, thank you. We were pleased to report strong product sales, record earnings and a successful smart sensor product launch. We look forward to speaking with you again in January to discuss third-quarter results. And thank you again for participating in the call.

Operator

[Operator signoff]

Duration: 24 minutes

Call Participants:

Daniel Baker -- President and Chief Executive Officer

Curt Reynders -- Chief Financial Officer

Jeff Bernstein -- Cowen Prime Advisors -- Analyst

More NVEC analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

Motley Fool Transcribing has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.