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Hutchinson Technology Inc. (NASDAQ:HTCH)

F4Q08 (Qtr End 09/28/08) Earnings Call Transcript

November 6, 2008, 5:00 pm ET

Executives

John Ingleman – SVP and CFO

Wayne Fortun – President and CEO

Kathleen Skarvan – VP and President of Disk Drive Components Division

Rick Penn – SVP and President of BioMeasurement Division

Analysts

Sean Hannan – Needham & Company

Sherri Scribner – Deutsche Bank

Christian Schwab – Craig-Hallum Capital Group

Joel Inman – Robert W. Baird

Jason Bernstein [ph] – Quattro [ph]

Ingrid Aja – Merrill Lynch

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Hutchinson Technology fourth quarter results conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions) This conference is being recorded today, Thursday, November 6, 2008. I would now like to turn the conference over to Mr. John Ingleman, CFO. Please go ahead, sir.

John Ingleman

Good afternoon, everyone. Welcome to our fourth quarter results conference call. With me today is Wayne Fortun, our CEO; Kathleen Skarvan, President of our Disk Drive Components Division; Rick Penn, President of our BioMeasurement Division; Dave Radloff, our Vice President of Corporate Finance; and Chuck Ives, our Investment Relations Manager.

As a reminder, we will be providing forward-looking information on demand for and shipments of the company's products; demand for design and product development; production capabilities; product costs; capital expenditures; worldwide storage, disk drive and suspension assembly demand and shipments; average selling prices; our BioMeasurement Division's revenue; product commercialization and adoption; results of operations; operating performance; and cash management. These forward-looking statements involve risks and uncertainties as they are based on our current expectations.

Our results could differ materially as a result of several factors that are described in our periodic reports on file with the SEC. In connection with the adoption of SEC rules governing fair disclosure, the company provides financial information and projections only through means that are designed to provide broad distribution of the information to the public. The company will not make projections or provide material non-public information through any other means. We issued our third quarter results announcement just after the market closed this afternoon. The announcement is now posted on our website at www.htch.com as well.

I'll turn the call over to Wayne for his opening remarks.

Wayne Fortun

Thanks, John. Obviously, we are disappointed with our reporting losses for the fourth quarter and fiscal year. These losses are due in part to the long-term investments we’ve been making in our TSA+ flexure manufacturing processes and in our BioMeasurement Division. In our Disk Drive Components Division, we are incurring costs related to the initial ramp of our TSA+ processes, which are not yet running at optimum efficiency, yield or volume. In the BioMeasurement Division, we are investing in the marketing and clinical education efforts that are required to broaden adoption and use of our InSpectra StO2 Tissue Oxygenation Monitor, which is providing a new and valuable metric to the healthcare industry.

We are not yet fully leveraging these investments, and this is primarily responsible for the operating losses that we incurred in the quarter and the year. This pivotal time in our business is converging with challenging conditions in the credit markets and global economy. Given these circumstances, we are managing our cash with exceptional care, while continuing the investments required to sustain progress in our TSA+ BioMeasurement initiatives. These initiatives are important to our future success, and we are pleased with the progress we are making in both areas.

I’ll turn the call over to Kathleen now for a review of the Disk Drive Components Division’s fourth quarter performance.

Kathleen Skarvan

Thanks, Wayne. We shipped 209 million suspension assemblies in our fiscal 2008 fourth quarter, up about 11% compared with the preceding quarter. The sequential quarter volume growth reflects holding our overall market share about flat with the preceding quarter. Compared with last year’s fourth quarter, which was a 14-week quarter, our suspension assembly shipments declined about 15%.

On an average weekly shipment basis, the shipments declined about 8% year-over-year. Our shipments of suspension assemblies for mobile applications increased about 16% sequentially and 27% year-over-year. 46% of our total unit shipments in the fiscal 2008 fourth quarter were for the mobile applications, up from 44% in the preceding quarter and 31% in last year’s fourth quarter. Our shipments of suspension assemblies for 3.5-inch ATA disk drives increased about 7% sequentially and accounted for 32% of our fourth quarter unit shipments compared to with 33% in the preceding quarter and 51% in last year’s fourth quarter.

In the enterprise segment, our unit shipments increased about 7% sequentially, accounting for 22% of our overall shipments compared with 23% in the preceding quarter and 18% in last year’s fourth quarter. Our average selling price for suspension assemblies in the quarter as $0.78, down $0.01 from the preceding quarter and down $0.03 compared with last year’s fourth quarter. We continue to ramp our volume from our TSA+ processes. We shipped 5 million of TSA+ suspension assemblies in the fourth quarter, which was a fourfold increase compared with the preceding quarter.

We are currently in the process of qualifying a second TSA+ program and we remain focused on further increasing market adoption of TSA+ suspension assemblies. Our TSA+ manufacturing processes are key to sustaining our ability to deliver the features and capabilities required in next generation suspension assemblies, and we expect TSA+ to contribute to lowering our product costs in the long-term future – in the long-term.

We’ve stated previously that to maintain our cost leadership, we intend to transition some of our assembly operations to Asia. As we disclosed last quarter, we have been considering different sites for our Asia operation, and we can now tell you that Thailand has been selected as the location. In light of the uncertain market and economic conditions, we are currently assessing the pace of our investment in this operation.

With respect to the outlook for demand, storage industry analysts and certain industry participants are expecting calendar fourth quarter disk drive shipments to be flat to slightly up. Our current demand forecast for suspension assemblies is more cautious and reflects the sequential quarter decline in volume. While we expect to maintain our overall market share, our forecast is based on assumptions about customer build plan, their reluctance to enter the seasonally weaker first half of the calendar year with high inventory levels, and of course, the high degree of uncertainty in the market right now.

For fiscal year 2009, we expect to regain some market share in the 2.5-inch ATA segment, but we will likely lose some share in the 2.5-inch mobile segment as we have not been designed into a follow-on 2.5-inch program at one of the major disk drive makers. We believe we will be able to maintain our overall market share over the course of the year. And we expect the downward pressure on average selling price will continue. We expect the initial gross margin burden of ramping TSA+ flexure production to diminish, as TSA+ volume grows and as we continue to improve our TSA+ yield and productivity over the next several quarters.

I’ll turn the call over to Rick now for an update on our BioMeasurement Division.

Rick Penn

Thanks, Kathleen. Fiscal 2008 was our first full year in the market with our InSpectra StO2 Tissue Oxygenation Monitor. And with a strong finish, we generated more than $1 million in revenue in the year. Our fourth quarter sales nearly doubled compared with the preceding quarter, adding 12 new customers and nearly tripling the number of centers sold.

In addition to adding new customers, existing customers are placing repeat order for monitors and sensors. It’s also worth noting that some of these customers are purchasing our products in order to conduct their own independent research into the benefits of monitoring StO2 in a broad range of clinical setting. Our revenue growth is just one sign of the momentum we are building in the marketplace.

Over the course of the fiscal year, our number of customers more than doubled, expanding the installed base for recurring sensor sales. Also, more than a dozen new studies attesting to the value of StO2 monitoring were published in the past year. And several influential positions addressed the clinical utility of StO2 in presentations at medical conferences in the United States and Europe.

The evidence that demonstrates the clinical and economic value of monitoring StO2 is growing and the benefits, both clinical and economic, are significant. They include benefits like more effective and reduced use of fluids and blood products, avoidance of invasive procedures and associated infections and complications, and improved patient management and resuscitation. Other added benefits are shorter ICU and hospital stays, as well as overall increase in staff productivity.

We believe that InSpectra StO2 will an established vital sign, routinely used with patients in a wide range of critical care setting from trauma and emergency medicine, where we are already making progress, to emergency medical transport peri-operative care and intensive care. As the evidence and the value of StO2 monitoring continued to grow, we are intensifying our marketing and clinician education efforts to broaden clinicians' understanding of the uses for InSpectra StO2 as an indicator of patient status and a guide to managing treatment.

Entering the new fiscal year, we have more than 100 customers evaluating our system or moving towards purchase and we expect our bio [ph] business sales will be $3 million to $5 million in fiscal year ’09. Revenue growth will come from both broader reduction of InSpectra in targeted clinical care applications as well as increased interest among hospitals that are initiating their own research into the value of StO2 monitoring across several clinical setting.

With that, I’ll turn the call over to John now for a recap of our fourth quarter financial results.

John Ingleman

Thanks, Rick. Net sales for the fiscal 2008 fourth quarter totaled $164.3 million, up 9% from the preceding quarter and down 18% from last year's 14-week fourth quarter. Net sales for the BioMeasurement Division were $445,000, up from $230,000 in the preceding quarter and $154,000 in the prior year’s fourth quarter. As Rick mentioned, BioMeasurement Division sales for the full year exceeded $1 million.

Revenue percentages for our top customers in the quarter were as follows. SAE/TDK, 40%; Western Digital, 30%; Seagate, 25%; Fujitsu, 4%; and Hitachi, 1%. Gross profit in the fourth quarter was $17.1 million or 10% of net sales and was reduced by $11 million due to the cost of ramping our TSA+ flexure processes.

Gross profit was also dampened by higher costs associated with a more difficult product mix as a number of new products ramped in volume during the quarter. In the preceding quarter, gross profit was $16.5 million or 11% of net sales and was reduced by $10.2 million due to the cost of preparing for and initiating TSA+ volume production.

Capacity utilization in the fiscal 2008 fourth quarter was nearly 80% compared with 70% in the preceding quarter and 75% in the fiscal 2007 fourth quarter. We ended the fourth quarter with about 3.5 weeks of finished goods inventory on hand, and that’s unchanged in the preceding quarter. Depreciation and amortization expenses in the fourth quarter were $28 million, unchanged from the preceding quarter and down from $33 million in last year’s fourth quarter.

R&D expenses in the fourth quarter were $9.3 million or 6% of net sales, down from $9.7 million in the third quarter and $10.4 million in the last year’s fourth quarter. SG&A expenses for the 2008 fourth quarter totaled $18.7 million or about 11% of net sales compared to $17.8 million or 12% of net sales in the preceding quarter. Sequential increase of $900,000 was primarily related to expenses for the future establishment of an Asian assembly operation. Compared with last year’s fourth quarter, SG&A spending was down about $600,000 with a decrease in the Disk Drive Components Division offset partially by increases in the BioMeasurement Division.

Our fiscal 2008 fourth quarter operating loss was $10.5 million compared with an operating loss of $12.0 million in the preceding quarter and an operating profit of $6.0 million in last year’s fourth quarter. In our BioMeasurement Division, we incurred a $6.1 million operating loss in the fiscal 2008 fourth quarter compared with an operating loss of $5.6 million in the preceding quarter and $5.7 million in last year’s fourth quarter.

Interest expense in the fourth quarter was flat sequentially at $2.9 million and down about $100,000 from last year’s fourth quarter. Interest income in the fourth quarter was $1.2 million compared with $1.4 million in the preceding quarter and $4.1 million in last year’s fourth quarter. The year-over-year decline in interest income results from shifting many of our investments to more secure US treasuries that earned lower rates of interest than our previous investments.

The loss for the quarter also included two non-operating items. First, as we disclosed in our earnings release, we recorded a charge of $8.5 million related to an other-than-temporary impairment of our long-term investments. As we have disclosed previously, our long-term investments include highly rated auction rate securities substantially collateralized by student loans that are 97% guaranteed by the US government. We previously reduced the value of these securities from a par value of $101 million to an estimated fair value of $95 million. This impairment in value is identified as temporary and recorded as an unrealized loss within shareholders’ equity.

In light of the uncertain market and economic conditions, we have now concluded that we may decide not to hold these investments until final maturity if the opportunity arises to sell them on terms that are reasonable to us. This change in intent requires that we adjust to – requires an adjustment to the auction rate securities carrying value be reclassified as another – other than a temporary impairment. Consequently, $8.5 million impairment to long-term investments was recorded in other income in the fourth quarter to reflect the reduction in the ARS carrying value and a par value of $101 million to an estimated fair value of $92 million.

Excluding the impairment of our long-term investments, our fourth quarter loss before income taxes would have been $11.8 million. As also announced in our earnings release, we recorded a non-cash charge of $92.5 million to establish a full valuation allowance against our deferred tax assets. Our announcement addresses the accounting standards the necessitated establishing this allowance, which I won’t repeat here.

It’s important to understand that establishing the valuation allowance does not have an impact on our cash does it preclude us from using our loss carry-forwards, tax credits, or other deferred tax assets in the future, and it is not the result of any significant change in our view of the company’s long-term financial outlook. Including the full valuation allowance of our deferred tax assets, we recorded a tax provision of $85.2 million in the fourth quarter compared with a tax benefit of $4.6 million in the preceding quarter and a tax benefit of $10.9 million in last year’s fourth quarter.

Our net loss for the fiscal fourth quarter totaled $105.5 million or $4.60 per share. Cash generated in the fourth quarter from operations totaled $2.1 million, down from $14.5 million in the preceding quarter, primarily as a result of increases in our receivables. Our capital spending in the quarter totaled $11.8 million resulting in a negative free cash flow of $9.7 million in the fourth quarter.

Our cash and investment balance at year-end totaled $263 million, down from $275 million at the end of the preceding quarter. No share repurchases were completed during the quarter. Our share count at the end of the quarter was approximately 22.9 million resulting in a book value per share of $19.05.

Now turning to our outlook, in our Disk Drive Division we are currently forecasting a sequential decline in volume in the quarter ending December. We believe we will hold our overall market share about flat in the current quarter and in fiscal 2009 with some positive and negative share movements within various disk drive segments, as Kathleen mentioned.

Downward pressure on average selling prices will continue. Improving our gross profit continues to be largely dependent on leveraging our fixed cost, which in cost of goods sold totals about $70 million per quarter, as well as improving our leverage and efficiency in our TSA+ processes. Depreciation and amortization expense for fiscal 2009 should be around $100 million compared with $112 million in 2008.

Our R&D expenses and SG&A expenses for fiscal year 2009 are currently expected to be about $40 million and $70 million respectively, although we continue to look for ways to reduce these costs. Due to having a full valuation allowance on our deferred tax assets, we expect to record an effective tax rate of approximately 0% against the pretax loss for fiscal 2009. Capital expenditures in the year 2009 are expected to be about $60 million. That compares to $66 million in fiscal 2008.

Now Wayne has a few concluding remarks before we take your questions.

Wayne Fortun

As I said earlier, we are currently navigating through a pivotal period for our company, at a time that would be challenging under normal circumstances as may have been made more difficult by uncertain global economic conditions. In light of this, we are managing our cash with particular care while continuing the investments required to sustain progress in our TSA+ and BioMeasurement initiatives. Both of these initiatives are key to our future success, and we are pleased with the progress we’ve made in both areas in the past year.

In our Disk Drive Components Division, we will continue to benefit from anticipated growth in the demand for storage. We will need to continue to invest in improving our overall performance of TSA+ processes, and the period of peak investments to develop these processes is behind us. As TSA+ program is in early stages of development transition to high volume, we will begin to leverage and generate a return on our TSA+ investment.

In our BioMeasurement Division, we have a product to deliver significant clinical economic value in a number of applications. We believe the StO2 measurement that our device provides will become an accepted vital sign in a wide range of clinical settings. As such, the total available market for StO2 monitoring totals in the multiple billions of dollars and we have only begun to tap it. We are mindful of the challenges presented by current business and economic conditions, but we are also confident in our ability to manage through the current challenges and realize the very attractive opportunities that exist for both our Disk Drive Components and BioMeasurement divisions.

That concludes our prepared remarks. Nicole, we’ll take questions now.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question comes from the line of Sean Hannan with Needham & Company. Please go ahead.

Sean Hannan – Needham & Company

Yes, thank you. Good evening. First question, just in terms of the sequential decline that you are indicating for the December quarter, just is there a way to get a sense in terms of the order of magnitude of what we’re actually thinking in your forecast? Is this really kind of more in the 1% to 2% range, or we actually perhaps think it could be more severe in mid or higher single digits?

Wayne Fortun

Well, it’s probably, I would say, would be higher than the low-single digits. Let’s put it that way. All the pause that hearing here is really because there's so much we don’t know in terms of what is the ultimate build plan, sell-through, and so forth. We only have early indications and there is just so much afoot here that really we’d rather than everyone look at it conservatively. And so in the – probably the mid-to-upper single digits is a better place to be.

Sean Hannan – Needham & Company

Okay. And from an ASP standpoint, obviously pressures continue, you commented on that a little bit earlier. Perhaps – is there a way you can provide perhaps a little bit of color, maybe I had missed it, indications for at least how to think about that in terms of the December quarter and as we enter calendar 2009?

Kathleen Skarvan

No, we continue to see, as we said in our prepared comments, downward pressure. Some of the best indicators for ASP decline have been history. Other than that, it’s difficult for us to be more specific than that at this point.

Wayne Fortun

And just a reminder, the history would be about – if you look over a seven-year period, that was about 3% decline a year and this last year it was a little bit north of that. And so probably something in that blend is a reasonable consideration.

Sean Hannan – Needham & Company

That’s helpful. And then lastly if you could just ask – when you look at your balance sheet, the debt that you are holding, the converts specifically, they are due in 2010. Does it make sense at this point for you folks to consider even just buying this debt back or would there be any restrictions around there? Is there a way you can provide a little bit of color on some thoughts there?

John Ingleman

Sean, I think the best way to look at it is that, number one, as Wayne said earlier, we are certainly concentrating on managing cash in this time. We certainly will look at bonds, stock, whatever it might be, and valuate that as time goes forward. And if that makes some sense, we may do that. And we also know that we need to make sure that we have the proper cash and don’t get ourselves too stretched out.

Wayne Fortun

But clearly, though, just to be sure – we fully recognize the coming maturity of that convert. And so, of course, that weighs on any of our thinking, as we look at the management of that cash and weighing that against pricing that one sees and so forth. Secondarily, your question is to, are we prohibited or is there anything that prevents us. Actually, no, we can go as high as I think – I think we –

Rick Penn

We certainly have the ability to do that. And I’m not sure where we start triggering and we need to look at what that might be with respect to how much we could buy back.

Wayne Fortun

Yes. So there is some notable portion that would be – that were not prohibited at all, and we would of course be adjusting our activities accordingly.

Sean Hannan – Needham & Company

Okay. So, if I were to understand you correctly, it sounds like it could theoretically be an option, given the pricing though of the – in the market today, though, it’s not something that’s at the forefront of your agenda?

Rick Penn

I don’t know that I would go as far as to say that. I think the pricing is certainly somewhat attractive. And it’s one of those things that we have to put into the mix and try to decide whether that makes more sense or some other things where we might want to look at.

Sean Hannan – Needham & Company

That’s fair. That’s fair. Thanks very much.

Operator

Thank you. Our next question comes from the line of Sherri Scribner with Deutsche Bank. Please go ahead.

Sherri Scribner – Deutsche Bank

Thank you. Just actually following up on that question. How much cash do you actually need to run your business? If we look at the cash number on your balance sheet of $62 million, how much of that do you need to actually run your business?

Wayne Fortun

Well, Sherri, you’ve been around this industry for a long time and you’ve seen the ups and downs and certainly what happens when companies have to weather through technical changes. We think that we’ve made that investment. We’ve got about $171 million either in cash or securities available for sale and another $92 million in auction rates which are longer term in nature. We historically thought about this as, you know, it would be nice to have $100 million or $150 million. We believe that we – where we are in technology transition that we could do it with less than that and we will continue to try to evaluate that.

Sherri Scribner – Deutsche Bank

Okay. That’s helpful. And then in terms of the fixed cost base, John, I know you’ve talked about it last quarter and this quarter being about $17 million. Is that a number that you can reduce over time? Is there anything that you can do there other than a restructuring to make that number go down a bit, or are you pretty much stuck with that in fiscal ’09?

John Ingleman

I think it’s fair to say that we’ve worked on it and that it’s come down to some extent. And there’s certainly opportunities to reduce it further. I think that, of that $17 million there is probably $15 million or $16 million a quarter that’s depreciation. That’s a little difficult to deal with. But there are other pieces of it that we certainly look at and it partially depends on what the demand is and what kind of product mix we’re running.

Sherri Scribner – Deutsche Bank

Okay. And then in terms of the SG&A picking up a bit this quarter because of the expansion in Thailand, how does that ramp over next year? I mean, you’ve guidance for SG&A. I think you said $70 million for fiscal ’09. Would you see SG&A continuing at these levels because of those expansion plans, or do you think it will be relative –? Do you think it will be front-end loaded? Do you think that will be sort of balanced over the fiscal year, but maybe some guidance on how that pans out?

John Ingleman

Sherri, I think it’s probably going to be pretty balanced over the year. I don’t know that we have to incur any additional costs at any one particular time during the year. We still haven’t decided how quickly we’re going to get over there. We need to continue to evaluate that given the whole economic conditions that are going on worldwide in addition to our demand.

Sherri Scribner – Deutsche Bank

Okay. And then, Kathleen, if I could just ask you on the TSA+, are those numbers included in the desktop business, because I know the customer win is in the desktop, I think, if that’s correct?

Kathleen Skarvan

Yes, it is desktop, Sherri. You’re right.

Sherri Scribner – Deutsche Bank

Okay. And then in terms of the customer not renewing the 2.5-inch product, was there a particular reason there or any more color you could give us on that?

Kathleen Skarvan

Actually – yes, I think that was a strategic allocation decision by that particular customer.

Sherri Scribner – Deutsche Bank

Okay, that’s helpful.

John Ingleman

Hey, Sherri.

Sherri Scribner – Deutsche Bank

Yes.

John Ingleman

This is John Ingleman again. I gave you an incorrect number. The depreciation number is closer to $23 million in fixed cost a quarter.

Sherri Scribner – Deutsche Bank

Okay. I thought that sounded a little low.

John Ingleman

Yes. Maybe if you translated it into percentages, it would have worked out.

Sherri Scribner – Deutsche Bank

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Christian Schwab with Craig-Hallum Capital Group. Please go ahead.

Christian Schwab – Craig-Hallum Capital Group

Great. Thank you. Just a few quick questions. On BioMeasurement, it kind of looks like we are going to – if we take the midpoint, generate $1 million in revenue per quarter, what type of revenue run rate do you need to be at in your models to be breakeven in that business?

John Ingleman

Chris, we need to get to something over $30 million annually to break even, that kind of pace, the $30 million, $40 million, somewhere in that range.

Christian Schwab – Craig-Hallum Capital Group

Great. How many years away is that?

John Ingleman

It’s real tough to see what kind of curve we can get this thing on. We’ve given you essential – we think this year is going to be, and we think the next year is substantially higher than that, but it’s tough to predict the curve here. So –

Wayne Fortun

But just to make sure that we’re talking apples-to-apples here, this last quarter we had roughly just under $0.5 million. And if we’re talking $3 million to $5 million, you sure wouldn’t want to think of the shape of the year as $1 million a quarter. It will be – and so we’re saying $3 million to $5 million. You will be seeing that escalating throughout the year. And so by the time we end the year, it helps you to get an idea of what we think is the starting point for the following year as well.

Christian Schwab – Craig-Hallum Capital Group

Yes. I was just trying to get the order of magnitude, Wayne, that you’re going to have to increase that business on an annual business to make money. So, to make $1 million on average in revenue this year, it needs to be up as much as ten times larger just to break even. I was just trying to get that magnitude. That was very helpful. On the TSA+ at 5 million suspensions and then still costing us $10 million in gross margin costs, at what point and what type of unit numbers – I know that that’s kind of hard to do with yields and efficiencies, but just rough estimate? At what point is that not gross margins?

Kathleen Skarvan

Well, now we’re looking at sometime in early 2010.

Wayne Fortun

And just to help –

Kathleen Skarvan

And by the way, that will depend a lot on the customer and how quickly they want to ramp and how their forecast in share, gains and so forth. So that can move depending on them maybe having a faster ramp on the programs we’re developing.

Wayne Fortun

Right. And then I was just going to say that the current capacity of the line, the high volume line that’s in place, it’s I would say roughly $3 million to $5 million a week. And so then if you take that over – we’re talking quarterly numbers right now, so that puts you at – what would that be – almost $40 million a week to 65 – $40 million a quarter to almost $65 million a quarter, Christian. And so, when we are talking about that time frame, that’s sort of giving you a view of how much we think is the anticipated growth in that demand as we see it today.

Christian Schwab – Craig-Hallum Capital Group

What type of capacity utilization do we need to be at for that to be break even?

Wayne Fortun

We’re all kind of sitting here – it so much will be dependent upon the yield at the time and so forth that it’s probably something – 80%, 85%, something like that.

Christian Schwab – Craig-Hallum Capital Group

Okay. So that business needs to ramp if we just assume $50 million at the low end of what you think your capacity is, at the $65 million. We kind of need to go from $5 million a quarter to at least $40 million a quarter. Is that correct?

Wayne Fortun

Right. Right. And with this kind of – with this kind of business and the line of depending on how the drive customers programs go, that’s certainly feasible, as we’ve talked about in the past, in the time frame that Kathleen just described.

Christian Schwab – Craig-Hallum Capital Group

Right. But in order to get to that type of level by early 2010, that would assume more than – likely more than two programs, wouldn’t it?

Kathleen Skarvan

Yes, we certainly believe that. And we’re on – that’s our forecasting, yes.

Christian Schwab – Craig-Hallum Capital Group

Okay. How many programs would you have to be on to get to that level?

Kathleen Skarvan

I – we’re not going to be specific about that, but certainly it’s more than two.

John Ingleman

It depends on the size of the programs. I mean, we’ve had sizable programs in which we’ve had single programs. It will run $5 million, $6 million a week, which – that would fill that line up all by itself, Christian. So you’re wrong when you say surely that’s not one program. It could be one program. We are not suggesting that’s the case. We are certainly trying to make sure that we have an appropriate hedge on this because we are in the process of working with and qualifying with more than one customer so that we continue to fill this line and to extend its capacity accordingly.

Christian Schwab – Craig-Hallum Capital Group

Perfect. And then just lastly, just on the Thailand move, can you just elaborate exactly what the goal of the company there is? Do we just want to do final assembly in Thailand? Do we want to eventually move all of manufacturing in final assembly in jet [ph] hub storage right there in Thailand? What is the strategy?

Kathleen Skarvan

Well, first of all, Christian, we do have jet hubs in Thailand now that we use extensively. We also have 100% inspections that we utilize quite regularly there also in addition to service organization. And so – but the vision that we have at this point is for final assembly. It’s just the suspension assembly process.

Wayne Fortun

So the component build, the etching wet process work would stay in the States.

Christian Schwab – Craig-Hallum Capital Group

Great. And then along that, what is the cost of that going to be roughly?

Rick Penn

It’s not clear yet, Christian. We’ve originally thought that it would take us about $10 million of non-capital to get over there, and we are reviewing that now and we’re trying to – depending on what the time frame is, that was sort of a compressed – that was a compressed time frame. So we think that we need to look at that piece of it. The other piece is whether we need to – whether we can lease a building over there or have one built for us that we could lease back, or whether we are going to have to build the building. I think that if we leased one over there, we’d probably be looking at – I don’t – they’re really rough numbers, maybe another $10 million worth of leasehold improvements, something like that. Who knows what a building would cost? We haven’t really gone there yet.

Christian Schwab – Craig-Hallum Capital Group

Great. That’s very helpful. Thank you.

Operator

Our next question comes from the line of Joel Inman with Robert W. Baird. Please go ahead.

Joel Inman – Robert W. Baird

Hi, thanks. Just on the gross margin line, if you were to say hold the units flat year-over-year or assume some small increase, how fast – at what pace could you increase the gross margin as you kind of work down those costs, let’s say, with TSA+?

John Ingleman

Well, I’m just thinking about that a little bit, Joel. I think if we’ve got about – if we say we have about $11 million right now with reasonable expectation of yield improvement and productivity improvement and increases in volume, it’s reasonable to think that we could pull that $10 million drag out of there by probably second quarter of next year roughly.

Joel Inman – Robert W. Baird

Okay.

John Ingleman

And then don’t hold me to that quarter exactly. That’s approximately, right.

Joel Inman – Robert W. Baird

Sure, sure. Thank you. And my second question is just on the interest expense line, would you expect that to be kind of consistent going forward, the interest expense you reported this quarter?

John Ingleman

Yes, I expect that would be – yes, the really – the really only variable piece of that is historically part of that’s been capitalizable and we don’t have a lot of CapEx going on right now so that it will stay about where it is at.

Joel Inman – Robert W. Baird

Okay. Thank you very much.

Operator

Thank you. Our next question comes from the line of Jason Bernstein [ph] with Quattro [ph]. Please go ahead.

Jason Bernstein – Quattro

Hi, thanks for taking my question. I have several questions regarding liquidity. One is, I see that the auction rate securities were marked down again. Have you guys seen the news on the UBS settlement with Diodes?

Wayne Fortun

With Diode?

Jason Bernstein – Quattro

Yes.

Wayne Fortun

No, we’ve seen – we know that UBS has an offer out there and we are evaluating right not, but I haven’t seen that news.

Jason Bernstein – Quattro

Okay. Yes, two days ago and they set a little bit par. And another question is, I saw the company bought back stock last quarter – the previous quarter, but not this quarter. Is there any reasoning for that?

Wayne Fortun

I would simply say that as we’ve looked at the uncertainty of the overall financial market, we are just looking at and saying that cash preservation and looking at some of the convert that we know is coming in March of 2010 that we are really looking at saying, where is the smarter investment and trying to assess that, and therefore just maintaining a cash position in order to be able to make a smart decision along those lines.

Jason Bernstein – Quattro

Okay. And one last question, on the filing just now on the amendment to the BofA credit line, is that – go back to the parent [ph], and is there any amount outstanding on that credit facility?

Wayne Fortun

No, there is no amount outstanding on that credit facility and that is parent.

Jason Bernstein – Quattro

Okay. Thank you.

Operator

Thank you. (Operator instructions) Our next question comes from the line of Ingrid Aja with Merrill Lynch. Please go ahead.

Ingrid Aja – Merrill Lynch

Hi, good afternoon. I was wondering if you could a little bit more about the StO2 losses that you had. This was the highest loss you’ve had in a quarter. Do you see that this is the peak and that you are going to be able to start reducing these losses now?

Rick Penn

Yes, Ingrid. We’re going to – yes, from this point forward, we think we can start to bring those down. We’re actually going to, from an accounting standpoint, I think take on some corporate allocation costs. So that may be bump up the costs or keep them about where they are when you see the numbers next time. But from that point forward, we should be bringing it down. And we bumped up a little bit this last quarter really due to some one-time sales and marketing costs related to some adjustments we made that resulted in severance and some other structural things we are doing to expand a bit. And geographically, they are sort of legal expense related. So we think we’re going to start to reduce and chip away at those losses.

Wayne Fortun

So just to be real clear on that, Ingrid, the allocation that Rick is talking about is not an increased expense. It's a total company overhead and we are just now moving more of the corporate allocation to BioMeasurement as it’s starting to look as more real operational entity. And therefore, it is not an increase in the total expense, just simply a shift in some of our allocations.

Ingrid Aja – Merrill Lynch

Great. And then if we could go back to – in your prepared remarks and on the press release, you talked about the quarter-over-quarter decline. Moreover, some of your customers like Seagate and Western are looking for quarter over [ph] increase. Is this just, say, conservatism and a decrease in inventory? Would that be the best way to describe? Or maybe you can give us a little more color on that?

Kathleen Skarvan

Yes. Ingrid, I think you’re thinking well on that comment that even though the drive companies may be indicating or the overall industry may be indicating flat to up this quarter, we see that there seems to be inventory adjustments going on because of anticipated – because they made the anticipating changes to build schedules or just the murkiness of the whole economic situation. And there is also timing that can figure into that also. And our build plans are weak in front of their build plans.

Ingrid Aja – Merrill Lynch

Okay, great. Thank you.

Operator

Thank you. And there are no further questions. I’d like to turn the call back over to management for closing remarks.

Wayne Fortun

Well, that concludes our prepared remarks. We thank you all for calling in. And have a good day if that’s possible in this market. Bye now.

Operator

Thank you. Ladies and gentlemen, that does conclude the Hutchinson Technology fourth quarter results conference call. Thank you for your participation. You may now disconnect.

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Source: Hutchinson Technology Inc. F4Q08 (Qtr End 09/28/08) Earnings Call Transcript
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