Hutchinson Technology's CEO Discusses F1Q2014 (Qtr End 12/29/13) Results - Earnings Call Transcript

Jan.28.14 | About: Hutchinson Technology (HTCH)

Hutchinson Technology Incorporated (NASDAQ:HTCH)

F1Q 2014 Earnings Call

January 28, 2014 5:00 PM ET

Executives

Chuck Ives - Director, IR

Richard Penn - President and CEO

David Radloff - VP and CFO

Analysts

Christian Schwab - Craig-Hallum Capital Group

Richard Kugele - Needham & Company

Mark Miller - Noble Financial Group

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hutchinson Technology First Quarter 2014 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). This conference is being recorded today, Tuesday, January 28, 2014.

I would 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 Rick Penn, our Chief Executive Officer; and Dave Radloff, our Chief Financial Officer.

As a reminder, we will be providing forward-looking information on demand for and shipments of the company's products, our market position, program ramps, product mix and adoption, pricing, production capabilities and volumes, product costs, our operations in Thailand and the United States, capital spending, operating expenses, and the company's business model, operating performance and financial results.

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 non-public information through any other means.

We issued our first quarter results announcement just after the market close this afternoon, and it is now posted on our website at www.htch.com.

I'll turn the call over to Rick now.

Richard Penn

Thanks Chuck. Good afternoon everyone and thank you for joining us today. In our fiscal first quarter, we were pleased to see healthier demand for suspension assemblies. Our suspension shipments increased about 13% compared with the preceding quarter, exceeding our prior expectations of demand being flat to up 5%. Suspension demand for 2.5 inch mobile drives was particularly strong, and we responded quickly to meet the higher than expected demand.

Industry sources estimate that hard disk drive shipments increased 1% to 2% sequentially, and we estimate that the suspension assembly TAM increased 5% to 6% over the previous quarter. Given the amount of our sequential increases in shipments, we estimate that we regained a little more market share during the quarter.

Our gross margin improved to 8% of net sales, compared with a gross loss in the preceding quarter. In addition to the increased volume, the measures we took to improve our operating performance were evident and improved yields at our Thailand assembly operation and in our component manufacturing processes. The yield improvements at our Thailand operation were achieved, while also increasing output there, by nearly 20%. The Thai operation accounted for more than half of our assembly production in the first quarter, and nearly 80% of our dual-stage actuated or DSA production.

We expect the Thailand operation to account for about 60% of assembly production in the second quarter, as we continue to ship volume there, to realize the related cost and customer service advantages.

Looking ahead, we are optimistic about our outlook, despite some near term softness in demand, but we continue to be encouraged by the level and breadth of activity with our key customers.

Our DSA suspensions continue to perform well for our customers, helping them achieve performance goals for their products, and enabling us to provide greater value, as our DSA volumes increase. The actions we are taking to improve our manufacturing yields and efficiency are working. There is room for more improvement and we expect to make further progress towards our targets in the coming quarters.

Finally, we are not yet realizing the full cost benefits, that shifting more assembly production to our Thailand plant and consolidating our US operations will deliver. We have moved most of our development center operations to our headquarters building, and we have begun to move our stamping operation from Plymouth, Minnesota, to our Hutchinson headquarters. The benefits of our manufacturing consolidation will become more material to our financial performance in the latter part of calendar 2014.

In summary, we are encouraged by our improving market position and are pleased with our improving manufacturing execution.

I will turn the call over to Dave now, for a more detailed review of our financial results.

David Radloff

Thanks Rick. Our first quarter suspension assembly shipments totaled $115.7 million, up 13% compared with $102.6 million in the previous quarter. Our mix of products shipped in the quarter was as follows; suspension shipments for 3.5 inch ATA applications were flat sequentially, and accounted for 34% of our shipments, compared with 38% of our shipments in the preceding quarter. Shipments from our 2.5 inch mobile applications increased 26% sequentially, and accounted for 46% of our shipments, compared with 41% in the preceding quarter; and shipments for performance optimized enterprise applications increased 9% sequentially, and accounted for 20% of our shipments, compared with 21% in the preceding quarter.

Our average selling price was $0.59, down from $0.60 in the preceding quarter, as certain DSA suspensions transition from low volume development pricing to high volume pricing. Shipments of DSA suspensions increased 12% sequentially and accounted for 23% of our first quarter shipments, which was unchanged compared to the preceding quarter.

First quarter net sales were $70.3 million, up 10% from the prior quarter. Revenue percentages for our top customers in the quarter were as follows; Western Digital, 56%; Seagate, 18%; SAE-TDK, 17%; and Hitachi 6%. At the OEM level, our sales to each of our customers increased sequentially.

Gross profit in the first quarter was $5.5 million or 8% of net sales. As Rick noted earlier, the sequential improvement resulted from the higher volume in the quarter, and the progress we made in improving manufacturing yields and efficiencies.

First quarter depreciation and amortization totaled $10.1 million, compared with $9.4 million in the prior quarter, and it continues to be about $10 million per quarter in the near term. R&D expenses in the first quarter were $3.9 million, and SG&A expenses totaled $5.9 million.

In connection with the consolidation of our operations, we recorded a $4.5 million asset impairment charge in the first quarter on our assembly building on Eau Claire, Wisconsin, and $600,000 of site consolidation expenses, down from $900,000 in the preceding quarter.

We expect to complete the consolidation of our US operations over the next three to four quarters. This consolidation process includes vacating the portion of our Eau Claire facility, currently used for assembly production, as we transition more production to Thailand, as well as relocating our stamping operation and our developments in our operations to our headquarters building. Once completed, these consolidation measures and the benefit of operating in Thailand are expected to generate P&L improvements of $2.5 million per quarter.

Our operating loss in the first quarter, which included the $4.5 million asset impairment was $9.3 million, down from $10.7 million in the fourth quarter. Interest expense was $3.8 million and included $800,000 of non-cash interest expense, both flat in the preceding quarter. Other expenses in the first quarter, included a $3.2 million foreign currency loss. The loss was primarily related to US dollar denominated intercompany liabilities owed to the company by our Thai subsidiary.

Our first quarter results also included a tax benefit of $868,000; of which $859,000 was recognized as reserves, where certain tax refunds were released. Our first quarter net loss totaled $15.3 million or $0.55 per share. On a non-GAAP basis, our net loss was $7.2 million or $0.26 per share, compared to a non-GAAP net loss of $11 million or $0.40 per share in the preceding quarter. The non-GAAP net loss in the first quarter excludes the asset impairment charge in the foreign currency loss, the $859,000 tax benefit, $800,000 of non-cash interest expense and $600,000 of site consolidation costs.

Our share count at the end of the quarter was 28 million. Cash generated by operations in the first quarter totaled $2 million and capital spending totaled $7.4 million, resulting in negative free cash flow of $5.4 million. This was partially offset by $4.9 million of lease financing that we secured during the quarter.

Cash and investments at quarter end totaled $40.2 million compared with $40.6 million at the end of the preceding quarter. We have outstanding borrowings of $2 million under our revolving line of credit at quarter end, down from $4 million at the end of the preceding quarter. We ended the quarter with a long term debt principle balance of $131 million, of which $39.8 million as a first put date, is January 2015 and $91.1 million is due in 2017.

Turning now to our outlook; while demand has been strong in January, we expect our shipments in the seasonally slower second quarter to be 105 million to 110 million. DSA suspension assembly should account for 25% to 30% of our second quarter shipments, compared to 23% in the first quarter, and we believe DSA suspensions will make up about half of our shipments by the end of our fiscal year.

Over the course of the fiscal year, our average selling price is expected to stay relatively flat, as an increase in DSA suspension shipment is offset by the transition from higher price development phase DSA suspension to lower priced high volume DSA suspensions.

We currently expect our second quarter gross margin percentage to be similar to our first quarter gross margin. While we are expecting lower shipments and revenues, we expect to realize further improvements in yields and efficiencies, and we currently plan to build inventory ahead of further product transfers to Thailand.

Our SG&A expenses should be approximately $6 million per quarter, and our R&D expenses should be about $4 million per quarter. Interest expense is expected to be approximately $3.8 million per quarter, with the non-cash portion of $800,000 per quarter. Excluded in the first quarter tax benefit, our tax rate is expected to be near zero on fiscal 2014.

Our fiscal 2014 capital expenditures should total about $20 million to $25 million and are expected to be slightly front-end loaded within the year. The expenditures will be primarily for customer specific program tooling and DSA manufacturing equipment.

That concludes our prepared remarks. Saul, please open the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from the line of Christian Schwab with Craig-Hallum Capital Group. Please go ahead.

Christian Schwab - Craig-Hallum Capital

Great. Guys. What is our manufacturing yields currently at the Thailand assembly operation?

Richard Penn

Chris, we don't give out that information really, just for competitive reasons. But they are good, we are a little below our targets. But we definitely came on to [hold], that we were in about a quarter ago. So we are relatively pleased, not quite hitting targets, and those targets keep moving up. So we are expecting more and more each quarter out of them.

Christian Schwab - Craig-Hallum Capital

If we were at the target level of manufacturing yields, what would their gross margins have been this quarter?

Richard Penn

I would say that, yeah, if we were hitting targets across the board, we'd probably be about 1 million plus better off for the targets for the preceding quarter.

David Radloff

Yes.

Christian Schwab - Craig-Hallum Capital

Right. Right. So can you walk us through the scenario of exactly what it's going to take to, to kind of get it back into the high teens gross margin, just so we are all on the same page?

Richard Penn

Sure. So first of all, we have got to get the facility consolidation and the transition of ramping assemblies down in the US to a significant (inaudible) ramping up in Thailand. That's the big --

Christian Schwab - Craig-Hallum Capital

And that will be done when?

Richard Penn

More or less by the end of this fiscal year. Could trickle a little into the early part of next fiscal year. But this calendar year for sure, should be -- at a good pace.

Christian Schwab - Craig-Hallum Capital

Okay. Then, continue to work on yields and outputs and then ramp on?

Richard Penn

And get higher volumes, which we have talked about, needing to be -- certainly north of 130 million a quarter.

Christian Schwab - Craig-Hallum Capital

Perfect. Great. No other questions. Thanks guys.

Richard Penn

Okay. Thanks Christian.

Operator

Thank you. Our next question comes from the line of Rich Kugele with Needham & Company.

Richard Kugele - Needham & Company

Thank you. Good afternoon. A couple of questions. I guess first, David, just from an accounting perspective, I suppose there is nothing you can do with the intercompany currency losses, you can't really hedge yourself, right?

David Radloff

I mean, you could choose to hedge them. We just think that that's -- because it's an intercompany liability, and its not something that's going to be paid off all in one point in time, the cost to hedge, doesn't really benefit us.

Richard Kugele - Needham & Company

Okay.

David Radloff

So we are choosing to just -- at this point, take that accounting hit. It's not a cash hit.

Richard Kugele - Needham & Company

Okay. And then, the (inaudible) inventory exiting the quarter, I suppose, it wasn't where you needed to be, to complete the transition. Is that why you are building inventory this quarter?

Richard Penn

Yeah. Yeah, we used some finished goods this past quarter, with the high shipments, and we are still in the process of transitioning. So we just feel for supply assurance, it makes sense to build that inventory up, as we -- gives us more flexibility, frankly, Rich, to transfer products.

Richard Kugele - Needham & Company

Okay. And then, as you look at the share that you did gain in the quarter, those programs, do you expect to be able to maintain those, or even deepen that relationship further, or what has been the competitive response, if any?

Richard Penn

I think we can, at least for the most part, hold those gains. It can bounce a little bit, Rich, but we are just lined up on the programs that we want to be, and those are growing, and so depending on how the programs do, that can flex the share up or down a little bit. But I think we will -- as we said, we are going after sort of one share point at a time, and we are moving it up slowly but surely and that's really how this business is, when you look at the way programs ramp. So we feel pretty good about how we are positioned, I guess it’s the way to coming up.

Richard Kugele - Needham & Company

Okay. Then lastly, just one the $2.5 million of ultimate savings, once the transition to Thailand is complete, that's not including whatever yield improvements you are getting, right? And that is primarily just a gross margin change you are talking about, right?

David Radloff

Yeah the $2.5 million is, I think we talked previously about $1 million of facility savings a quarter, as we consolidate the facilities and then $1.5 million of -- you are right, primarily labor savings, if we would transition. Its not the yield and output improvements.

Richard Kugele - Needham & Company

Okay. So all else being equal, that alone should be able to get you into the 10%-12% range?

David Radloff

Yes.

Richard Penn

Yes.

Richard Kugele - Needham & Company

Okay. All right. Thank you very much.

Richard Penn

Thank you, Rich.

Operator

[Operator Instructions]. Our next question comes from the line of Mark Miller with Noble Financial Capital Markets.

Mark Miller - Noble Financial Group

Just wanted to follow-up on Rich's point. As you indicated, you are going to be seeing a $2.5 million improvement from the Thai facility, and this does not include, I think you just said $1 million if you hit target yields. How much would you get from [flowing] the plant going up to this one, over 130 from where you are at now?

Richard Penn

The Thai plant will be more or less built in that $2.5 million savings we referred to Mark.

Mark Miller - Noble Financial Group

Okay. So that includes only the Thai plant. Any new wins this quarter, in terms of programs?

Richard Penn

We have yeah -- I guess I am thinking about how do you define a win. We have got a lot of new-ish programs ramping, Mark, is the way I would describe that, and we are very busy. Our Thai operation is extremely busy. We are bringing up new programs, new production lines, new ramps and also, having to carry, as we have said, some redundant operations in the US, while we sort of cover the activity.

So the new stuff that we were talking about all through last year is really -- it is starting to hit, and some of those programs that pushed out, are starting to happen. And again, overall, we feel real good about how we are positioned across programs, and that's really across WD and Seagate.

David Radloff

We have been engaged on a number of new programs this quarter, and there is a number of programs that are starting to ramp this quarter.

Mark Miller - Noble Financial Group

I know you can't pull out specific customers, but if you look in the future, where the biggest ramp could be for new disk drives, such things as the helium-filled drive, Western Digital, cloud drives, these thin 5 millimeter drives, are you positioned well in those programs?

Richard Penn

Yes, we are. So we see -- we are [starting] to see how the 5 millimeter programs will play, but we are positioned there. We are positioned on the capacity optimized programs, some of the cloud related business. Also, the performance server stuff and so, we are -- we are sort of in cross segments, pretty nicely, Mark.

Mark Miller - Noble Financial Group

Okay. And finally for me, DSA, you are making progress there. How do you feel? Are you leading your competitors, are you even with your competitors on the DSA ramp?

Richard Penn

On some programs, it appears we have a bit of a reliability edge with our product, and that's not necessarily true, in every case and every program. Our competitors are making the current generation of dual-state. But we are generally getting very positive feedback on how our product performs, and as we have said before, its really one of the key reasons why we are moving our way back into these new programs and gaining some ground, it's a key reason for that. So I would say, we may have an edge in some cases. In other cases, we may be a little more at (inaudible). But the requirements also keep moving, and we feel pretty good about just our process capabilities and the technology, being able to sort of move, as those specifications keep tightening. So I think we are in the game very strongly, and because of that, we think we can keep gaining some share.

Mark Miller - Noble Financial Group

I apologize, I have one more question. Western Digital was talking about the MOFCOM discussions, they are going to come back up with China in March, and I am just wondering, in terms of numbers, I thought it was around 60 million suspensions a quarter, that Hitachi was procuring through your competitors, is that accurate?

Richard Penn

Let me check something here. I'd say, it's probably a little higher than that.

Mark Miller - Noble Financial Group

So, do you believe that could be a very significant opportunity in the long term, if these restrictions are eased for you?

Richard Penn

Yeah. We definitely view it as an opportunity. We are on some legacy stuff for HDSD right now and we are having conversations. We will see where this all goes. We will see how the combined entity aligns with different disk drive programs. But we feel like we are in a strong position, and certainly on the WD side of things and over time, we will see if we can win the HDSD stuff. There is nothing I can tell you there right now. Nothing that's going to happen fast. But again, we think we are positioned well, and as they come together, we think that continues to be the case.

Mark Miller - Noble Financial Group

Thanks again for letting me in all the questions.

Richard Penn

Yup. You bet.

Operator

And pardon me Mr. Penn, we have no additional questions. Please continue with any closing remarks.

Richard Penn

Okay everybody. Well thank you for joining us on the call. We appreciate your questions and your interest, and look forward to talking with you again very soon. Thank you very much.

Operator

Ladies and gentlemen, this concludes our conference call for today. Thank for using ATT teleconferencing. You may now disconnect.

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Hutchinson Technology Incorporated (HTCH): FQ1 EPS of -$0.26 misses by $0.01. Revenue of $70.3M (+10.4% Y/Y) beats by $0.2M.