Daniel Baker - President and CEO Curt Reynders - CFO.

Jeff Bernstein - Cowen Lucas Baranowski - Craig-Hallum Capital.

Good day, ladies and gentlemen, and welcome to the NVE Conference Call on Second Quarter Fiscal 2018. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, today’s conference call may be recorded.

I would now like to turn the call over to Dan Baker, President and CEO. Sir, you may begin..

Good afternoon, and welcome to our conference call for the quarter ended September 30, 2017, the second quarter of fiscal 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 Web site, nve.com.

After my opening comments, Curt will present a financial review of the quarter and half, I’ll cover business and governance items, and we’ll open the call to questions. We issued our press release and filed our quarterly report on Form 10-Q in the past hour following the close of market.

Links to documents are available through the SEC’s Web site, our Web site, nve.com, and on twitter.com/nvecorporation.

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 our reliance on several large customers for a significant percentage of revenue, risks and uncertainties related to the economic environments and the industries we serve, risks and uncertainties related to future sales and revenue, 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 fiscal year ended March 31, 2017.

The Company undertakes no obligation to update forward-looking statements we may make. We’re pleased to report solid earnings for the quarter with net income of $0.65 per share despite an expected decline in revenue from a strong year-ago quarter and large investments in R&D. Curt will cover details of our financial results..

Thanks, Dan. As Dan mentioned, second quarter total revenue decreased 4% to $7 million compared to a strong year-ago quarter. The decrease was due to a 6% decrease in product sales partially offset by a 25% increase in contract research and development revenue.

The decrease in product sales was due in part to order timing between the first quarter and second quarter. The increase in R&D revenue was due to new contracts. Gross margin was an especially strong 81% of revenue compared to 76% last year due to increased gross profit margins on both product sales and contract research and development.

Gross profit increased to 5.64 million in the quarter. Total expenses increased 24% for the second quarter of fiscal 2018 compared to the prior year quarter due to a 1% increase in SG&A expense and a 34% increase in R&D expense.

The large increase in R&D expense for the quarter was due to new projects, including developing Internet of Things n-node sensors that are key to our growth strategy and are expected to provide an excellent return on investment.

Interest income decreased 10% for the second quarter due to a decrease in interest-bearing marketable securities and a decrease in the average interest rates on those securities. Net income for the quarter decreased 4% to $3.16 million or $0.65 per diluted share compared to $3.31 million or $0.68 last year. Net margin for the quarter was 45%.

Comprehensive income, which includes unrealized gains and losses from our marketable securities, increased 4% over the prior year quarter to $3.17 million. For the first six months of fiscal 2018, total revenue increased 4% to $14.6 million.

The increase was due to a 5% increase in product sales, partially offset by a 1% decrease in contract R&D revenue. Net income for the first six months of fiscal 2018 increased slightly to $6.46 million or $1.33 per share compared to $6.44 million or $1.33 per share last fiscal year.

Fixed asset purchases were $526,000 for the first half of the year primarily for more efficient production equipment. Halfway through the year that’s already slightly more than the $520,000 we spent last year.

It’s still a modest investment considering the revenue we generate with our machinery and equipment assets and we expect our total fixed asset purchases for the full fiscal year to be less than $1 million.

Cash provided by operating activities increased 29% to $7.32 million in the first six months of fiscal 2018 compared to $5.67 million for the prior year period.

In addition to the dividend paid in the past quarter, we announced today that our Board declared another quarterly dividend of $1 per share payable November 30 to shareholders of record as of October 30. Now, I’ll turn it over to Dan to cover business and governance.

Dan?.

Thanks, Curt. Now I’ll cover new product development, our automotive strategy, R&D contracts and governance. As Curt noted, we had significant R&D expenditures in the past quarter and we’re happy to report some impressive results of that R&D.

In the past quarter we introduced three new products; a high-sensitivity magnetic switch, high-field magnetic sensors and a new angle sensor. The new high-sensitivity magnetic switch allows precise detection of extremely low magnetic fields for more precise position sensing in robotics and mechatronics.

High-field sensor applications include detection of the very high magnetic fields present in MRI imaging. This can help implement MRI tolerant medical devices and MRI tolerance and safety is increasingly important. Industrial applications include motor sensors and high-current sensing for smart grids.

And finally the new angle sensor uses what’s called a full bridge configuration which allows direct replacement of semiconductor sensors providing larger output signals and lower power. There are demonstrations of most of our new products on our Web site at nv.com/videos and our YouTube channel at youtube/nvecorporation.

The video section of our Web site is popular and is a great way to show our products unique features and benefits. We upgraded the section in the past quarter with a new layout and the new server to make the videos more accessible and easier to search.

In addition to product introductions, we met a significant smart sensor development milestone in the past quarter. Smart sensors provide plug and play functionality enabling our customers to deploy pervasive sensors quickly and cost effectively. Forecasts are for a huge increase in sensors in the coming years.

The milestone was releasing an IC design to our foundry, a milestone often called tape out. Making a simple interface requires making a complex IC, including analog to digital conversion, digital signal processing and mathematic calculations.

The IC represents the culmination of a lot of hard work and ingenuity by our engineers, scientists and contracts. We expect the first wafers this quarter. We need to test and characterize them, combine them with our sensors and characterize the finished parts. If all goes well, we’ll sample prototypes by the end of the fiscal year.

Target markets are sensor-rich systems like factories and cars. As we have said before, automotive electronics is an excellent growth market for us.

Summarizing our automotive strategy, we’re targeting automotive because the electronic content of cars is projected to increase rapidly, particularly with the advent of hybrid, electric and self-driving vehicles. Our sensors and couplers have important advantages compared to conventional electronics in the automotive market.

They are smaller, more precise, more rugged and lower power. And with the new smart sensor interface I just described, they’ll be smarter too. I’m pleased to report that in the past quarter, our Quality Management System was certified to the rigorous new ISO9001:2015 standard, which is the foundation of the international automotive taskforce standard.

We’re preparing for the next step which is IATF 16949 certification which will help establish our credibility in the demanding automotive market. As we discussed for the first time on our call in May, we have a new private label partnership with a company with a strong automotive market position.

One of our challenges to growth is the limited distribution inherent with being a smaller company. The new partnership gives our partner our innovative products and gives us their strong distribution, sales support and brand awareness. In the past quarter, we expanded the products under the partnership which now covers about a half dozen products.

Each part needed a strong business case and had to pass rigorous product qualification tests. Our partner committed significant resources to marketing and sales collaterals. Revenues are still modest but we continue to see this partnership as a strategic growth driver.

Turning to contract R&D, in late September we were awarded a research contract from the U.S. Navy Naval Sea Systems Command for a circular technology for full integration at the monolithic microwave integrated circuit level. A microwave circulator is an ultra-miniature signal router.

The project will demonstrate the feasibility of a monolithic microwave integrated circuit also called MMIC or a mimic to make microwave isolators and circulators that will be significantly smaller than conventional devices. In addition to military applications, there are potential commercial applications such as 5G cellular infrastructure.

The winning proposal was based on innovative ideas by the Principal Investigator, Dr. Joe Davies and the rest of our R&D team. The contract is for approximately $125,000 and six months through March 2018.

We had a very aggressive goal of building all of the required prototype components in the past quarter for our Department of Agriculture biosensor grant. We completed some but not all of the prototype components and we hope to finish all of the components this quarter.

We have plans to make up the lost time to meet the main milestone which is live pathogen testing on schedule by next August. The project is also a bit over budget as we committed additional resources but this is a strategic program and our primary consideration is time to market.

Prototype components include biosensors, magnetic nanoparticles, aptamers, microfluidic manifolds, cartridges and control electronics. Moving on to governance. Our annual meeting was held last quarter. For good corporate practice, our entire Board of Directors stands for election every year and each of our directors was overwhelmingly reelected.

We’ve been holding annual say-on-pay votes and our shareholders selected continuation of annual votes. After the shareholder vote, our Board of Directors determined to continue annual say-on-pay votes.

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 for this fiscal year was ratified.

Details of the shareholder 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 new product demonstrations, including a blueberry powered sensor, a low-power coupler, a rotational sensor and high-sensitivity magnetic switch.

A video showing two of those demonstrations is on our Web site and YouTube channel. Now, I’d like to open the call for questions.

Victor?.

Yes, sir. [Operator Instructions]. Our first question comes from the line of Jeff Bernstein from Cowen. You may begin..

Hi. Good afternoon, guys..

Hi, Jeff..

Just a couple of questions for you.

Could you give us an update on the med device market in general and the Abbott cardiac rhythm management in particular?.

Yes. So as you probably know, CRM has been under pressure. For example, Abbott formally St. Jude reported earlier today and they reported calendar Q3 CRM cardiac rhythm management sales were down 12%.

But they also reported that one of the things that impacted that was MR labeling – FDA approval of MR labeling for pacemakers and ICDs and they were able to report those approvals. One is recently as last month.

And then also long term, the demographics are favorable as the population ages and our technology has the strong benefit proposition for medical devices and CRM in particular. We’re also gaining traction in addition to CRM in the broader neurostimulator market.

So we see it as a very important market and encouraging in the long term despite the short-term challenges..

That’s great.

Any update on the hearing aid developments?.

So in hearing aid, some of the longer term developments are an expansion of the markets such as over-the-counter or private label hearing aids and that could help us if it expands the market.

Proponents of over-the-counter hearing aids point out that a large population that could use hearing aids but don’t because of the expense or the inconvenience of dispensing them, of getting a hearing aid.

And then there are also personal sound application products sometimes called PSAPs and that could also be a market for us, although it’s somewhat less attractive than true hearing aids because it’s more price sensitive. But we continue to see this as an excellent market.

We have a strong benefit proposition with low power and small size and we have significant developments underway to extend those advantages to make our devices even smaller and even lower power.

So our folks are working on some really amazing things on reducing power consumption to just tiny little trickles which will extend battery life which is of course important in hearing aids..

And did I hear you said that you thought you were going to get the automotive quality certification this quarter.

Is that right?.

Our hope is this fiscal year. So that would be the end of the March quarter, by March 31. And that’s a goal. It’s not entirely up to us. We want to be very well prepared. There’s a lot of systems that need to be rigorously audited and we’ve been working on that. Our quality team in particular has been working very hard on that.

We think we’re going to be well prepared but it’s also up to the certifying agencies. So that’s the goal though is this fiscal year..

Great. And last one and I’ll hand it over.

You talked about the smart sensor tape out and could you just expand on that a little bit? Is this – there’s some integration of an MCU or something or some memory with your sensors or what is it exactly that’s on the semiconductor?.

Yes, exactly. It’s a very complex IC, so it has analog to digital conversion. So we take the analog signal, the voltage signals that come from our sensors, convert them to digital data so that the rest of the processing chip, the digital signal processing chip can understand the data.

There’s digital signal processing such as digital filtering and mathematical calculations. So, for example, for angle sensors, we have our analog sensors which we’ve talked about here before have what are called QuadBridge [ph] outputs.

So there’s one output that’s proportional to the sign of the angle and one that’s proportional to the cosign of the angle. So as many of us are now recalling from trigonometry, if you divide the sign by the cosign, you get the tangent and then if you take the inverse tangent, the arc tangent, you end up with the angle. And this chip does all that.

It’s amazing what it does. It’s a very complicated chip but the advantage is that it makes the interface to our customers’ integrated circuits and microprocessors very simple.

So rather than having to interpret analog voltages and make these calculations, we will provide a digital signal that is proportional that basically is the angle in the case of an angle sensor. So that’s the paradox of a simple interface requires making a complex IC..

Got you.

So is this the kind of part that could be on like a poll tip of a telephone poll that gets pulled every once in a while, it tells you if it’s leaning over, it’s super low power, that kind of thing?.

That sort of thing, exactly. So the Internet of Things and angle is a very common sensor need, rotation and angle.

So in your example and I’m not familiar with that one specifically, but my guess would be there isn’t an awful lot of power available so one of the advantages of our sensors is they runoff of very low power and they can use harvested power such as solar power or thermal gradient.

And so they’re ideally suited for the Internet of Things for distributed sensing systems where there’s not always a plug around..

That’s great. Thank you..

Thanks, Jeff..

Thank you. Our next question comes from the line of Lucas Baranowski from Craig-Hallum. You may begin..

Hi, Dan. This is Lucas Baranowski on for Charles Haff here at Craig-Hallum. Just was hoping you could provide us some updates on one or two of your other R&D projects. You mentioned on your last call that you were very close to demonstrating MRAM feasibility under your contract with the Army.

Do you have any news for us there?.

So the Army contract was relating to spin-momentum or spin-torque devices which are also very useful for MRAM. And the final report hasn’t been made public yet, but we did complete the research contract with the Army and we successfully demonstrated the feasibility of the spin-torque structure called the spin-torque microwave diode spectrograph.

So there are military uses and other uses and the underlying technology as you alluded to is also used in advanced MRAM. So we believe it’s an important milestone. We’ll post the report – we’ll certainly try to post the report when the Army makes it public. They haven’t yet..

Okay. That’s helpful. And then I know one of the other callers asked about hearing aids and I believe you’re in Phase 2 of a contract with NIH to develop technology that would link hearing aids to smartphones.

Do you have any new milestones to report?.

That contract was also successfully completed and that’s part of our portfolio that we can offer hearing aid manufacturers is the ability to elegantly connect hearing aids to smartphones and other smart devices. So that could be good technology for the long term..

Okay, excellent. And then going back to automotive for a moment, you said that revenues were currently modest from that and I know those are probably slightly lower margin. But your gross margin for the quarter came in at almost 81%.

So can you tell us maybe what categories of products drove the outperformance on the gross margin line?.

Yes, we did have a more favorable product line mix. And as Dan mentioned, the revenue for automotive products was – it’s been fairly modest I believe is how we’ve said so far. Typically, some of the higher margin products would be related to medical applications.

We’ve also had some more efficient equipment which has led to more cost effective production and some improved processes and yields. These improvements could be offset though in the future by more aggressive pricing and increased revenue from lower margin private label partnerships which would be automotive-type applications..

Okay. That makes sense. And then one final question here. You talked about smart sensors in your prepared remarks and you said that you expect the sample prototypes before the end of the fiscal year.

So would you start generating revenue from those next fiscal year then?.

Yes. That would be the hope. We have customers who are interesting in this. It’s also a product that has automotive applications. There are many things that rotate and turn in cars and being able to control that motion very precisely can lead to more efficient cars, safer cars. So we see a number of applications. It’s a significant research project.

And the reason we’re taking it on and making that investment is because we see potential markets, excellent markets that we can reach, particularly with the new private label partnership..

Okay. Thank you very much. That’s all I have..

Thanks, Lucas..

[Operator Instructions]. And I am showing no further questions at this time. I would now like to turn the call back to Mr. Dan Baker. We have one question from the line of Jeff Bernstein from Cowen. You may begin, sir..

Hi, Dan. I just had a quick follow up. Of the technologies that you’re developing for the Department of Agriculture project, obviously applicable to some other things and you talked about looking into those.

Do you have any details to give us at this point and have you learned anything from the way you’ve gotten to at this point on developing the sub-technologies?.

Well, I’m glad you asked that, Jeff, because our team has done an amazing job on that. And one of the subassemblies that we’re working on that we hope to have done, at least a prototype done this quarter is the sensor module itself and that’s an amazing module.

It’s got a spintronic die with over 1,000 sensor elements and that connects via an intricate circuit board to other electronics or signal processing electronics. So part of what we’ll be able to demonstrate is the ability to have a lot of sensors. And for medical applications that could mean a panel of tests.

So a test not just for one pathogen which is what we focused our early efforts on detecting a single pathogen such as salmonella but to be able to detect an array of pathogens, a variety of pathogens, so various bacterial contaminations either for food or for medical devices.

So when somebody comes in with flu-like symptoms that could be a variety of causes and a variety of bacteria or viral infection. So being able to detect what kind of pathogen is the problem is an important benefit and it’s one of the benefits that our technology has is the ability to combine these large arrays in a very small size.

So hopefully we’ll be able to demonstrate that capability very soon..

Terrific.

And I’m sorry, just one more on the cyber security front, any kind of developments going on with the unclonable functions?.

We continue to be active in a variety of anti-tamper and some of the contracts and some of the strength that we had in contracts in the most recent quarter was in that general field. Sometimes we can publicize those, sometimes we can’t for obvious reasons.

But physical unclonable functions are physical structures that can make it very hard to predict and replicate or reverse engineer cryptography. So that’s an important part of our portfolio and we’re building a wider portfolio with a variety of ways to detect and introduce countermeasures to tamper.

So as much as we can reasonably talk about on that, we’ll try to do that..

Great. Thanks so much..

And I am showing no further questions at this time. I would now like to turn the call back to Mr. Dan Baker, President and CEO, for closing remarks..

Thank you. If there are no other questions, we were pleased to report solid earnings with significant R&D investments and an important smart sensor milestone. We look forward to speaking with you again in January to discuss third quarter results. Thank you again for participating in the call..

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