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Hutchinson Technology Inc. (NASDAQ:HTCH)

F1Q10 (Qtr End 12/27/09) Earnings Call

January 26, 2010 5:00 pm ET

Executives

Wayne Fortun - CEO

Kathleen Skarvan - President, Disk Drive Components Division

Rick Penn - President, BioMeasurement Division

John Ingleman - SVP, CFO

Dave Radloff - Corporate Controller

Chuck Ives – Director, IR

Analysts

Rich Kugele - Needham & Company

Tom Lewis - High Road Value Research

Peter Kim - ISI Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Hutchinson Technology’s first quarter results conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions)

I’d now like to turn the conference over to Mr. Chuck Ives, Director of Investor Relations. Please go ahead, sir.

Chuck Ives

Good afternoon, everyone. Welcome to our first quarter results conference call. On the call with me today are Wayne Fortun, our CEO; Kathleen Skarvan, President of our Disk Drive Components Division; Rick Penn, President of our BioMeasurement Division; John Ingleman, our CFO; and Dave Radloff, our Corporate Controller.

As a reminder, we will be providing forward-looking information on demand for and shipments of the company’s products, production capabilities, capital spending, worldwide disk drive and suspension assembly demand and shipments; pricing; product cost, our plans to establish an assembly operation in Thailand, our BioMeasurement Division’s revenue, product commercialization and adoption, customer education, the company’s results of operations and operating performance.

These forward-looking statements involve risks and uncertainties as they are based on our current expectations. Our actual 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 nonpublic information through any other means. We issued our first quarter results announcement just after the market closed this afternoon and it is now posted on our website at www.htch.com.

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

Wayne Fortun

Thanks, Chuck. Good afternoon, everyone, and thank you for joining us today. We are pleased to report that the improvement in our operating performance and financial position that became evident in our fourth quarter results continued in the first quarter of our new fiscal year.

When we ended fiscal 2008 to the first of the quarter of fiscal 2010, we have substantially improved our gross margin despite a decline in net sales. The improvement is the result of the actions we took to restructure the business and reduce our cost as well as the turnaround in demand that began in the later half of fiscal 2009.

The sequential quarter growth in shipments and net sales, our first quarter gross profit grew to $20.8 million compared with $17.5 million in the preceding quarter and represents an increase of more than 200 basis points. The first quarter of fiscal 2010 was a strong period for cash generation as well and our cash from operations was about $24 million. We added about $15 million of that to our cash and investment balance, which now totals $242 million. We also use some cash to repurchase $4.5 million of our convertible subordinated notes that are due in March.

Over the past five quarters, we have reduced the principle balance of our debt by approximately $83 million and our net debt by more than $61 million. We look forward to sustaining the positive momentum on adoption of our TSA+ technology, establishing our operation in Thailand and turning the growing the InSpectra StO2 into growing revenue. While the fluctuations demand typically in our business to make our progress less than steady, we are better positioned to accommodate those fluctuations than we were a year ago.

I’ll turn it over to Kathleen now for an update on the Disk Drive Components Division.

Kathleen Skarvan

Thanks, Wayne. During our fiscal 2010 first quarter we shipped 155 million suspension assemblies, up about 7% from the preceding quarter and about flat with last year’s first quarter. We estimate that our volume growth in the quarter was about comparable to the overall market growth for the suspension assembly.

Compared with the preceding quarter, our shipments of suspension assemblies were 3.5inch ATA and enterprise applications increased 20% and 9% respectively. Shipments for 2.5inch ATA applications were up 1% and shipments for 1.8inch applications were down 52% and this seasonally typical for that application.

For the quarter of mix of product shipped was as follows. Suspensions for 3.5inch ATA application accounted for 42% of our shipments, compared to 37% in the preceding quarters. Suspensions for mobile applications accounted for 39% of our shipments, compared with 44% in the preceding quarter. And enterprise application accounted for 19% of our shipments, same as the preceding quarter.

Average selling price in the fiscal 2010 first quarter was $0.68 down from $0.70 for the preceding quarter, and $0.76 in last year’s first quarter. The price decline reflects the competitive pricing environment and mixed product shipped.

The first quarter suspension assembly shipment included $25 million TSA+ suspension or 16% of total shipments up from $18 million or about 13% in the preceding quarter. TSA+ suspensions will increase of the percent of our shipments as fiscal year progresses and could be nearly 50% of our volume by the end of the year.

With the increased volume in quarter one, we reduced our TSA+ cost a part by 16% compared to the preceding quarters. However, the TSA+ cost on gross profits increased to $7.4 million from $7.1 million in the preceding quarter. This was due to lower than expected yield. The TSA+ yield declined slightly in the first quarter as we began implementing certain process improvements that we expect to create long-term benefits.

This continued growth in TSA+ volume and improvement in our TSA+ manufacturing efficiencies in yield, we believe we can eliminate the cost burden that’s associated with our production in the second half of the fiscal year. As we’ve noted previously, we expect our TSA+ flexures will ultimately have a cost advantage over current subtractive TSA+ flexures.

We continue to be actively involved in the design and prototyping of dual stage actuated suspensions for several of our customers. Our leading-hedge designs, proven DSA capability and installed capacity position us well to meet our customers future needs for this technology.

Regarding our future assembly operation in Thailand, construction has began as well as the hiring of management and support staff, we expect to began operations fairly in the second half of the calendar year. Capital spending related to Thailand operation will total around $15 million in fiscal 2010. We also will incur about $10 million in start up expenses. This operation will include our ability to serve our customers operations in Asia, enable us to reduce our labor costs, freight costs and future income taxes.

With respect to our demand and pricing, we believe worldwide demand for suspension assemblies in calendar 2010 will close in track the growth in worldwide shipments of drive, which have been estimated at anywhere between 10% and 20% for storage industry analyst and participants. Pricing for suspension assemblies is expected to remain competitive.

For the full year we expect to benefit from the overall growth in worldwide demand and maintain to grow our market shares. However, in March quarter we expect worldwide suspension assembly demand to decline in line with historical seasonality based on our understanding of customers build plan and a temporary reduction in suspension assembly for Disk Drive and transition to higher aerial density point to occur.

Over the last four years, we estimate that average sequential decline in worldwide demand for Hard Disk Drives and suspension assemblies in the March quarters has been about 6% and 10% respectively. As seasonality occurs in parts because suspension assembly shipments tend to partially align with customers build plans and the drives that were shipped in the seasonally slower June quarter. This suspension demand proves to be stronger than our current expectations, we’re prepared to meet it.

Finally, we continue to evaluate ways to derive additional values from our unique combination of precision manufacturing expertise and capability, coupled with leading edge design, test measurement and engineering services. Some targeted customers in other industries have shown interest in our capabilities and we’ll continue to keep you updated on our progress as more into future costs.

I’ll turn the call over to Rick now for a review of BioMeasurement Division.

Rick Penn

Thanks, Kathleen. Net sales for the BioMeasurement Division in the fiscal 2010 first quarter totaled $509,000, compared with $624,000 in the preceding quarter and $265,000 in the last year’s first quarter. The sequential quarter decline in net sales was primarily the result at delays in sales to new customers. Overall our U.S. revenue continued to grow, but sales in Europe and sales through distributors declined somewhat sequentially.

On a year-over-year basis, however, our net sales number of customers and installed based of InSpectra StO2 monitors have all doubled or nearly doubled, with the number of customers growing to more than 100 worldwide and the installed base of monitors reaching nearly 250.

Build on with year-over-year momentum, we have been increasing our customer education and training encouraging protocol development and sponsoring clinical studies to build further evidence of the value of StO2 monitoring across a broad range clinical studies from initial patient precipitation room discharge from hospital.

Thanks to our prior work to promote the value and utility of StO2 we increasing find that we know longer need to educate clinicians on what StO2 to met. Instant we are shipping clinicians education focus on how do you use as better StO2 in various patient care study. We are specially encouraged by the growing demand among physicians for our education program. More than 100 physicians will participate in this training in the first two quarters of fiscal 2010. StO2 three times the number of physicians they’re participating in all of fiscal ’09.

Moving to as a number of physicians who understand the use and value of StO2 reading in patient care growth InSpectra StO2 usage for increase.

As I mentioned earlier, the division sales for the 2010 first quarter were nearly double those of the prior year’s first quarter and put a balance of fiscal 2010 we expect similar year-over-year growth to continue the quarterly sales more than doubling compare to fiscal ’09 sales. Net result we continue to believe we can deliver a full year net sales of 4 to $6 million.

I’ll turn the call over to John now for discussing of our financial results.

John Ingleman

Thanks, Rick. Net sales for the fiscal 2010 first quarter totaled $108 million up $403 million in the preceding quarter, but down $119 million in last year’s first quarter. Revenue percentages for our top customers in the quarter were as follows. Western Digital, 24%; SAE/TDK 39%; Seagate, 10%; and Hitachi, 6%.

Gross profit totaled $20.8 million or 19% of sales. This is an increase of $3.3 million from the preceding quarter as a result of higher sales. Compare to last year’s first quarter gross profit increase nearly $21 despite in $11 million decline in net sales.

Depreciation and amortization expense was about $15 million in the first quarter compared to $15 in the preceding quarter and about $24 million in last year’s first quarter.

R&D expenses were $5.1 million compare to $4.7 million in the preceding quarter and 8.9 in last year’s first quarter. SG&A expenses totaled $12.5 million, compared to $10.6 in the previous quarter, which included $1.9 million gain on the sale of our Sioux Falls facility. SG&A expenses for the first quarter of fiscal 2010 included about $500, 000 of start up expenses for our Thailand operations, assembly operation.

All the estimated $10 million of start up expenses for fiscal 2010 will be recorded of SG&A whereas previously need expected to account from the majority of these expenses in cost of good sold.

Operating income of the first quarter totaled $3.1 million up from $2.1 million in the preceding quarter. Preceding quarters operating income included that previously mentioned gain on the sale of our Sioux Falls building. The operating loss in the Bio Measurement Division in the first quarter was $4.9 million that’s flat in the preceding quarter, but down from the $6.6 million loss in the last year’s first quarter.

Interest expense was $4.2 million and included a $2.1 million of non-cash interest expenses as a result of our adoption to the Financial Accounting Standard Board guidance for accounting for convertible debt instruments. Our financial statements for fiscal 2006 through fiscal 2009 have also been adjusted reflect the required retrospective adoption of this accounting guidance. Thus our restated interest expense with fiscal 2009 fourth quarter was $4.9 million and it was $4.7 million for last year’s first quarter.

All details of the changes to our fiscal 2006 to 2009 financials will be disclosed in our quarterly report on Form 10-Q to be brought early in February. Interest income was $400,000 that compares with $300,000 in the preceding quarter and about $1.3 million in last year’s first quarter.

Our loss before taxes was 30,000, this loss was offset by a non-recurring income tax benefit of $2.3 million resulting primarily from a recent change in U.S. tax law that enabled us carry back some of our net operating losses to prior years and apply for a refund of taxes paid in those years. Including the tax benefit it was got a net income of $2.2 million or $0.09 per diluted share.

Non-GAAP net income, which excludes both the non-cash interest expense and the income tax benefit would have been $2 million or $0.09 per diluted share.

Our fiscal 2010 first quarter was a strong period for cash flow we generate about $24 million in cash from operations instead of $4 million on capital expenditures resulting in $20 million free cash flow. As we noted in his opening remarks, he continued to reduce our debt and strengthen our balance sheet. With repurchased $4.5 million of our 2.25 Convertible Subordinated Notes due in March of 2010, we have reduced remaining balance on those notes to $41.1 million.

The principle amount of our total debt balance is now down $296 million, of this $98 million is current debt consisting in the $41 million balance on the 2010 comparable notes and $55 million remaining on the one from UBS against the auction rate securities at they go for us.

The remaining $198 million of debt is our 3.25% convertible subordinate notes, which matures in January of 2026, but is first (Inaudible) by holders in January of 2013. Our total cash and investment at quarter end was $242 million up $15 million from the proceeding quarter as a result of our free cash flow that was generated.

Our share account at the end of the quarter was approximately $23.4 million is already in a book value per share of $13.91 this includes a $1.35 per share due to the adoption as I previously mentioned earning guidance.

Now as I look forward as noted in our earnings release, we expect suspension of survive demands for closely track the worldwide demand for hard disk drives in 2010. Pricing environment has been aggressive and we’ll likely continued to be so.

Our fixed cost in good sold and operating expense was in total, were expected to remain relatively flat for that of fiscal 2010 first quarter. Increases in SG&A expenses due to start off cost of the establishment of our tie similarly operations should be offset by decreases in our fixed cost of good sold,

As we have previously disclosed our fiscal 2010 results will include additional non-cash interest expense resulting from the adoption in the new accounting guidance, it referred to early on March. Based on balance of $198 million were 3.25% convertible debt. We estimate that the additional expense will be approximately $8.5 million in 2010 of which $2.1 million is recorded in the first quarter.

Our 2010 effective tax rate is expected to be about zero for the remainder of the year, Depreciation and amortization expense for 2010 is expected to be about $55 million we are currently projecting capital spending of about $35 million, which includes $15 million to establish our operation in Thailand.

I’ll turn the call over to Wayne, for his closing remarks.

Wayne Fortun

Thanks, John. We are pleased with the improvement in our operating results and with the continued strengthening our balance sheet and overall financial condition, although there maybe short-term declines in demand, the strong annual long-term growth of digital contents and storage bodes well for the growth of our business.

As we have stated before, our strategies to achieve consistent profitability improving our TSA+ production and efficiency expanding TSA+ adoption establishing operations in Thailand and growing revenue in our BioMeasurement Division. We expect to make significant progress on all of these funds in fiscal 2010.

That concludes our remarks. Now please begin the call for questions.

Question-and-Answer session

Operator

[Operator Instructions]. And our first question comes from line of Rich Kugele with Needham & Company.

Rich Kugele - Needham & Company

Thank you. Good afternoon, guys. Just a two questions, I guess first, Kathleen, can you talk a little bit more about the temporary reduction in suspension count. And then in a broader term about what the suspension count is today and what you’ve expected it to exit calendar in 2010 at?

Kathleen Skarvan

Sure, Rich. As we’ve said in the opening remarks, Peter, it’s our view that with the transitions to the external densities that box capacities probably are driving heads to equivalent to what they were, but there could be a temporary decline, the reason we say temporary again is because we think that the transition to the [external] density will be offset as box capacity then rise again. Again that’s why we’re talking about to be temporary. We’re estimating that for the year are going to be round at 2.9 average. So that’s probably investing side I can give you at this point. And today the average for ’09 is very similar, but as we said when there’s the transition to real density it may take a lot of the box capacities to ask that.

Rich Kugele - Needham & Co.

Okay. So how much of that do you think is factored to, if you’re saying you’re going to fall consistent with the industry in the March quarter, is that incorporate to the clients suspension count?

Kathleen Skarvan

I believe so.

Rich Kugele - Needham & Co.

Okay and then secondly can you talk about what are your utilization is today and then how we should think about when the Thailand facility comes online the second half of the calendar time?

Kathleen Skarvan

That’s the interesting question. So right now again when we refer to our utilization when we bring to that installed base of capacity, I think everyone understands that we have assembly equipment and we also have entering the trace equipment that we taken offline. So the base utilization of our installed based were about 90%. Now when Thailand comes on board we will be bringing some of that what you call (Inaudible) for offline equipment online and so the base is going to change, but I think our expectation is that we’re still going to tried out to run at high utilization.

Operator

And our next question comes from the line of Tom Lewis with High Road Value Research.

Tom Lewis - High Road Value Research

Let me ask the utilization question a little different way. With respect to how you see your capital spending needs, if we would to stay get 15% demand growth this year and another 10% next year with that required you to your capital spending to be any difference in this year?

Kathleen Skarvan

Most of our capital expenditures for capacity improvement will be with our TSA+ operation. I don’t see a lot of capital equipment investment needed for the assembly operation for other component operation.

Tom Lewis - High Road Value Research

To handle that much growth or would you have to…

Kathleen Skarvan

It looks unlikely that new addition of the property investment and handle the growth…

Tom Lewis - High Road Value Research

Okay, let me shift that over on the BioMeasurement side, you talked about sponsoring studies in visiting your side it’s pretty impressive just how many studies have been non, I think I saw 18 (Inaudible) published in 2009 own and I just curies, I imagine in some cases you’re funding the activity and may be can you give a some sense the expensive, which will we see all these studies with agreed which in some cases you might be fully funding it and in other cases these studies side might be done for a phenomenal consideration or perhaps another law?

Rick Penn

Yeah, Tom, this is Rick. Most of these studies are done relatively independently and we made the portion with the product and may be some small amount of funding for net the align share of this study activity but we do sponsor I want one or two studies at this point it's about where we at and there are more focused of course and they are more expensive and one of the key differences is interventional were clinicians are really intervening based on the entity of two measurement further stay design that we have – of course a lot more control and the results can be more compelling but lot of the studies back on you’re looking at was relatively independently done.

Tom Lewis - High Road Value Research

Let me it appears there is a lot of intellectual curiosity out there always actives with all kinds of places.

Rick Penn

Yeah, just in the last few years there were over 70 I think publications and we’ve been I think like presentations of publications what interesting is in lot of cases if you look at other companies to the technologies that we will be heavily weighted to our presentations never end of getting published and when you look at the StO2 evidence in that 70 it's about half and half. Half is actually getting publish showing up in papers and more and more people then get expose due to the information. So, with that I would say that’s one of the curve is actually been accelerating that is modest just StO2 published and presented activity of there.

Tom Lewis - High Road Value Research

Right, okay and then same notice for appreciate breaking out the apparent uptick in position interest and your educational offerings can you give us sense of what data might be there you might use in the siding as the year goes by weather this something you need to either dial up or dial down?

Company Representative

Yeah, we know already come, this educations move customer along at much faster phase. So, when we look at the customers have been through this kind of education there usages going up, we are expanding in the other department that kind of thing and if we look at the good customers have not yet gone through the sessions, its much for your use. If an average to probably using 25% less centers that type of thing. This is a big piece of our marketing effort if you want call that and we get a lot of bank for about frankly in these efforts and when I look at the further sales and marketing costs in compared to the education consider cost that is relatively low number.

Operator

Thank you, in the next question is comes from the line of Peter Kim with ISI Capital. Please go ahead.

Peter Kim - ISI Capital

Most of my questions have been answered. So, I just have one last as regarding the BioMeasurements business. Could you speak as to how the InSpectra products are in combatively speaking with some of the other competing products or technologies that seems to be quite handful of smaller private companies that are trying come up with products are any of them actually approved by the FDA for a clinical purposes and do you see that actually things are relative competition right now?

Company Representative

May be with the first thing actually about the competition is the biggest competitor that we’re up against this really that we have been used in clinical care studies today. And with that some heart way blood pressure and lactate other measures to try to get the oxygenation. That’s really the different measures that usually less direct up in times, they are lagging indicators that what’s really happening in the body and so forth. So what we’re really trying to educate clinicians on this parameter StO2 that gives you a very direct non-invasive way to understand whether your tissues are getting oxygen, to trying understand.

There are other products that are somewhat related, some that used infrared spectroscopy, one company has Somanetics taken out there for some time. They are really focused on measuring tissue oxygenation of the brain, the technology is a little different. The requirements of that kind of measurement are different and that getting into the same ground or then getting into (Inaudible). And there are other companies, smaller companies Bioptics for example is really focused on measuring skin, thin layer of skin tissue and reconstructive surgeries. They don’t measure as deeply into tissues as we do with their technology. And there are a few others, but there [0:01:23] no direct competitors that if you wanted to search some of that.

Peter Kim - ISI Capital

Then what would be fair to say that a lot of the current, which I say expenses that are attributable to the BioMeasurement Division. Do you expect that to increase dramatically or if you can give us a sense of how much you expect us to increase to try to get a sense of what the breakeven point for a BioMeasurement Division would be?

Unidentified Company Representative

Yes, sure the infrastructure we got in place should get us to well over $30 million in revenue maybe more towards 50, the current structure breakeven points probably somewhere around $25 million of revenue.

Operator

Thank you. And the next question comes from the line of Edward Line with [indiscernible].

Unidentified Analyst

Yes, hi gentlemen. Just a question given just in light of a strong numbers posted by some of the hard drive manufactures. How do you kind of reconcile your results, I know you had some improvements sequentially, but the magnitude of upside and their numbers and this in to correlate with you guys, can you help reconcile out with respect to things like head per drive at pricing or what’s going on there?

Unidentified Company Representative

So we can probably start with last quarter, if you look at our calendar quarter, I’m telling quarter three, our present if you would compares the pension to drive we were actually higher than what the drive companies were so the first thing we want to start off with the we don’t know with track and in fact most the trends going, that has to do the inventory build it has to be timing and builds schedule– also the health quarters you should talk about. So I think we want to look at this quarter a same as the 30% that due to supply demand seeing down and book to gave in which in digital that there was range where it could be down by 17.5% down on room. So then if you couple that with evenly the temporary decline in head for because of the shifted in the next density point and I think you can get there.

Unidentified Analyst

Okay thank you, by the way in terms of pricing for TSA+ non-TSA+ better pricing given that TSA+ really is trying to take off and becoming much bigger percentage revenues why isn’t they ASP going up?

Unidentified Company Representative

We have actually either the TSA+ between the TSA+ pricing is about the same as TSA might actually be a little lower considering what products that goes on which seen some of that going on desktop in the desktop products are not on common but these slightly lower than the mobile. And so it's not necessarily a defect correlation to, because it's new thus it mean that is going to necessarily be a higher price.

Operator

(Operator Instruction). And I’m sure there are no further questions. I will turn the call back over to Mr. Fortun for closing comments.

Wayne Fortun

Thank you. I really want to thank everyone for joining us on the call today and we look forward to speaking to you next quarter.

Operator

Thank you. Ladies and gentlemen and that conclude today’s Hutchinson Technology first quarter results conference call. Thank you for your participation if using HTC conferencing. You may now disconnect.

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