Hutchinson Technology's CEO Discusses F2Q 2011 Results - Earnings Call Transcript

Apr.26.11 | About: Hutchinson Technology (HTCH)

Hutchinson Technology Incorporated (NASDAQ:HTCH)

F2Q 2011 Earnings Conference Call

April 26, 2011 5:00 PM EST

Executives

Chuck Ives – Treasurer and Director of IR

Wayne Fortun – CEO

Rick Penn – President, Disk Drive Components Division

Dave Radloff – CFO

Analysts

Sherri Scribner – Deutsche Bank

Eric Reubel – MTR Securities

Tom Lewis – High Road Value Research

Mark Miller – Noble Financial Capital Markets

David Epstein – CRT

Jeremy Skrezyna [ph] – Andalusia Capital Partners

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by, and welcome to the Hutchinson Technology second quarter results conference call.

At this time, all participants are in a listen-only mode. And following the presentation, instructions will be given for the question-and-answer session. (Operator Instructions).

And as a reminder, this conference is being recorded today, April 26th, 2011.

I would now like to turn the conference over to Chuck Ives. Please go ahead.

Chuck Ives

Good afternoon, everyone. Welcome to our second quarter results conference call. On the call with me today are Wayne Fortun, our Chief Executive Officer; Rick Penn, President of our Disk Drive Components Division; and Dave Radloff, our Chief Financial Officer.

Wayne will provide an overview of the business as well as a brief update on our BioMeasurement Division; Rick will provide an update on our Disk Drive Components Division; and Dave will speak to our financial results and guidance.

As a reminder we will be providing forward-looking information on-demand for and shipments of disk drives and the company’s products, market position, product mix, pricing, production capabilities and capacity, capacity utilization, assembly operations in Thailand, capital spending, product costs, manufacturing consolidation and restructuring, operating expenses, our BioMeasurement Division’s revenue and expenses, clinical evidence, product commercialization and adoption, and the company’s cost structure, 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 second 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. As you know, in early March, we announced a manufacturing consolidation and restructuring plan. The actions we are taking under this plan combined with the cost reductions achieved through our TSA+ and Thailand assembly initiatives should position us as the industry’s lowest cost producer of suspension assemblies and strengthen our competitive position.

Under the plan, which we are implanting over the next nine months, we are consolidating our Hutchinson component operations into our Eau Claire operations and resizing the company to reduced costs and improved cash flow. Our Hutchinson site will remain our headquarters in center for research and development and other specialized operations. In addition to these structural changes in our business, operating efficiency improvements are contributing to the progress we’re making in reducing our cost structure.

For example, during our second quarter, we continued to improve both yields and outputs for our TSA+ suspension assemblies and to reduce our TSA+ cost per part. We are also steadily increasing volume at our assembly operation in Thailand, enabling us to lower our global cost structure. As a part of our restructuring plan, we are also minimizing the cost in our BioMeasurement Division, as we shift more of our sales to a distribution model and focus on two initiatives we believe can improve the Division’s revenue growth and shareholder value.

The two initiatives include supporting the global introduction of our InSpectra StO2 Spot Check, which received marketing clearance from the US Food and Drug Administration in March. This new product enables clinicians to quickly and cost effectively experience the clinical and economic benefits of using StO2 to identify at-risk patients in a wide variety of clinical settings, and we believe could lead to wider adoption of StO2 monitoring.

In addition, an independent randomized multi-site outcomes based study is being conducted to research the possible benefits of using StO2 to guide resuscitation of shock patients. And initial studies show that using StO2 to guide patient treatment resulted in improved outcomes in the form of shorter ICU and hospital stays. If the multi-site outcome study demonstrates these results in a larger patient population, it could add significantly to the growing body of evidence that supports wider adoption of StO2 monitoring. All together, our consolidation and restructuring effort should result in a $50 million to $55 million reduction in our costs on an annualized basis by the start of fiscal 2012 second quarter.

We believe we have the right plans in place to provide compelling combination of cost, technology, service, and supply assurance to our customers, and profitable growth to our shareholders.

I’ll turn it over to Rick now for a recap of the Disk Drive Component Division second quarter.

Rick Penn

Thanks Wayne. During our fiscal 2011 second quarter, we shipped 102.3 million suspension assemblies, down 4% from a 106.5 million in the preceding quarter. This decline was in line with our revised guidance as well as the estimated reduction in the overall hard disk drive and suspension assembly TAM or total available market.

For the quarter, our mix of product shipped was as follows. Suspensions for 3.8-inch ATA applications increased 5% sequentially and accounted for 63% of our shipments, which is up from 58% in the preceding quarter.

Shipments for mobile applications declined 14% sequentially and accounted for 16% of our shipments, down from 17% in the preceding quarter, and shipments for enterprise applications declined 18% compared with the preceding quarter and accounted for 21% of our shipments compared with 25% in the preceding quarter. This change in product mix in the continuation of a competitive pricing environment caused our average selling price to decline to $0.60 in the fiscal 2011 second quarter compared to $0.62 in the preceding quarter and $0.66 in last year’s second quarter.

Our second quarter shipments of TSA+ suspension assemblies increased 13% sequentially to $54 million and accounted for 53% of our shipments, up from 45% in the preceding quarter. In last year’s second quarter, TSA+ suspension assemblies accounted for only 15% of our volume. The additive flexures that we manufacture in our TSA+ process are a critical component of a suspension assembly, both in terms of functionality and cost, and we are one of only two producers of additive flexures and the only suspension assembly manufacturer with this capability, and we believe that this will be an important factor as customer evaluate the supply chain and supply assurance.

Our TSA+ process continues to perform well. Over the course of the quarter, our TSA+ yields and output further improved. And the continuing shift our product mix from subtractive TSA suspensions to additive TSA+ suspensions will cause our overall cost per part to further decline as well further improvements in our TSA+ process efficiency and capacity utilization. We currently expect TSA+ suspension assemblies to account for about two-thirds or more of our volume by the end of the fiscal year.

Our cost position as well as our ability to serve our customers’ operations in Asia is also benefiting from the continued ramp of production volume at our assembly operation in Thailand, which has exceeded our initial expectations. As we transition more of our assembly operations to our Thailand site, our cost position will improve further adding to our confidence that we will be the industry’s lowest cost supplier of suspension assemblies.

The consolidation of our Hutchinson components operation into our Eau Claire plant will be underway during the current quarter. This change will improve utilization of our high-volume manufacturing locations and the related support infrastructure.

We’re not currently experiencing any components or material shortages for our operations as a result of the tragic events in Japan. That said, the full impact of the Japan earthquake continues to be evaluated and sales of hard drives could be affected by disruptions in the disk drive or PC supply chains.

Regarding the outlook for demand, we expect our third quarter suspension assembly shipments to be relatively flat compared to the second quarter. In our fiscal fourth quarter, we expect to see modest market share growth in the new hard disk drive program on which we are qualified begins ramping to higher volume.

Growth in volume and substantial improvements in our cost position will help us return to positive cash flow and profitability.

I’ll turn the call over to Dave now for a discussion of our financial results.

Dave Radloff

Thanks Rick. Net sales for the fiscal 2011’s second quarter totaled $63.3 million, down 7% from $68.2 million in the preceding quarter, and down 28% from $87.6 million in last year’s second quarter. Revenue percentages for our top customers in the quarter were as follows: Western Digital 60%; SAE/TDK 17%; Hitachi 12%; and Seagate 9%. In the preceding quarter, a greater percentage of the suspensions that we manufactured for the vertically integrated HDD OEMs were shipped directly to those OEMs.

Net sales for the quarter included BioMeasurement Division revenue of $719,000 up from $542,000 from the preceding quarter and $687,000 in last year’s second quarter. The revenue growth resulted primarily from repeat sales to existing customers in the introduction of our Spot Check product.

We had a gross loss of $2.3 million in the second quarter compared with gross profit of $3.3 million in the preceding quarter and $7.3 million in last year’s second quarter. The gross loss resulted from the lower net sales from the inclusion of manufacturing expenses from our Thailand operation in cost of goods sold that in previous quarters were treated as startup costs and were included in our SG&A expenses.

Depreciation and amortization expense was $12.8 million and included accelerated depreciation of $0.7 million related for the manufacturing and consolidation and restructuring plant. Depreciation and amortization was $11.8 million in the preceding quarter and $13.3 million in last year’s second quarter.

R&D expenses in the quarter were $3.9 million, down from $4 million in the preceding quarter and $5.4 million in last year’s second quarter.

SG&A expenses decreased to $10.5 million from $13.6 million the preceding quarter, primarily as a result of lower administrative expenses for our Thailand assembly operations. As I just mentioned, manufacturing expenses for our Thailand operation were treated as startup costs. In previous quarters they were included in our SG&A expenses. And last year’s quarter, our SG&A expenses totaled $13.2 million.

We recorded severance cost of $6.7 million in the second quarter for the positions that will be eliminated as a result of our manufacturing consolidation and restructuring plan. We expect a majority of the severance to be paid out in our fiscal third quarter and the reminder paid out in our fourth quarter.

Our fiscal 2011 second quarter operating loss totaled $23.4 million compared to $14.4 million in the preceding quarter, and $11.3 million last year’s second quarter. The operating loss in the BioMeasurement Division included $600,000 of severance expenses and totaled $2.7 million in the second quarter, down from $2.9 million in the preceding quarter and $5.3 million in last year’s second quarter. For the full year, we expect the Division’s net loss to be approximately $8 million and make our net sales of about $3 million. After completing the plant cost reductions, we estimate that the Division’s quarterly operating loss will be less than $1 million a quarter.

Interest expense in the fiscal 2011 second quarter was $3.6 million compared with $3.8 million in the preceding quarter, and $4.2 million in last year’s second quarter. Interest expense in the fiscal 2011 second quarter included $2 million of noncash interest expense, resulting primarily from our adoption of FASB guidance for accounting for convertible debt instruments. This compares to $2.2 million in the preceding quarter and $2.1 million in last year’s second quarter.

As a result of the tender exchange offer that was completed in February, we are for $75.3 million of our 3.25% convertible subordinated notes. We realized that $5.5 million gain on debt extinguishment. We also recorded a gain on investments of $496,000 during the second quarter related to additional recoveries on certain option rate securities.

Our income tax provision was zero resulting in a net loss of $20.5 million or $0.88 a share compared with the net loss of $17 million or $0.73 a share in the preceding quarter. In last year’s second quarter we reported a net loss of $15.6 million or $0.67 a share.

Excluding the severance cost and accelerated depreciation, the gain on the debt extinguishment and the noncash interest expense, our non-GAAP loss was $16.5 million or $0.71 a share. Cash used by operations totaled $5.4 million and capital expenses were $2.7 million, resulting in negative free cash flow of $8.1 million for our fiscal 2011 second quarter.

At quarter-end, our cash and investments balance totaled $61.7 million, down from a $101.2 million in the preceding quarter. During the quarter, we used $31.2 million in cash and issued $40 million of 8.5% convertible senior notes to complete our tender exchange offer for $75.3 million of our 3.25% convertible subordinated notes. The successful completion of the offer improved our financial flexibility by extending the first put date on $40 million of our convertible debt by two years and reduced our overall debt balance to $162 million compared to a $198 million at the end of the preceding quarter.

Our share count at the end of the fiscal 2011 second quarter was approximately $23.4 million, resulting in book value per share of $9.63. This includes $0.78 per share related to the portion of our convertible debt that we are required to classify shareholders’ equity under the accounting guidance for convertible debt instruments.

Turning now to our outlook; as Rick mentioned, we expect suspension assembly shipments in our fiscal 2011 third quarter to be about flat with the second quarter’s volume. Suspension assembly pricing is expected to remain competitive. In the near term, we expect our cost of goods sold to continue to be split about 55/45 between fixed and variable costs. Cost of our manufacturing consolidation and restructuring plan includes estimated accelerated depreciation charges of $2.2 million and $200,000 respectively in our fiscal 2011 third and fourth quarters. We also expect to incur approximately $3 million of expenses over the next three quarters to move TSA+ manufacturing equipment from Hutchinson, Minnesota to Eau Claire, Wisconsin.

As Wayne mentioned, we expect our consolidated and restructuring effort results in an annualized cost reductions of $50 million to $55 million. We estimate that 25% of the quarterly savings or approximately $3 million will be realized in the fiscal 2011 third quarter, 60% by the fiscal 2011 fourth quarter and a 100% by the fiscal 2012 second quarter.

We estimate that the savings will be spread across our P&L as follows: two-thirds to 70% of the savings will be cost of goods sold, 25% to 30% of the savings will be in SG&A, and the remainder will be in R&D. Of the savings in cost of goods sold, 60% to 70% of the savings are a reduction of fixed cost with the remaining 30% to 40% lowering of variable cost. As a result, we estimate that our quarterly fixed costs in cost of goods sold will be reduced from $36 million in our fiscal 2011 second quarter to approximately $30 million by our fiscal 2012 second quarter. R&D expenses are expected to total about $15 million for fiscal 2011 and $14 million on an annualized basis after the completion of our cost reductions.

SG&A expenses should be about $40 million for fiscal 2011, including $4.7 million of startup expenses that were incurred in our first quarter for our Thailand operation. After the completion of our consolidation and restructuring efforts, we expect SG&A expenses to be about $28 million on an annualized basis.

Depreciation and amortization expense in fiscal 2011 is expected to be a little less than $50 million. Our tax rate is expected to be near zero for fiscal 2011.

Finally, we estimate that our capital expenditures for fiscal 2011 will total $20 million to $25 million.

I’ll turn the call over to Wayne now for his closing comments.

Wayne Fortun

With the course of the next nine months, we will be implementing the consolidation and restructuring plan we announced early in March. As we said today, we expect this effort to reduce our operating costs on an annualized basis by $50 million to $55 million. We recognize that we must be the lowest cost producer of suspension assemblies to be positioned to compete profitably for market share and to return to positive cash flow generation.

We believe our vertically integrated model provides the best means to get to and sustain the lowest cost position while sustaining the capability’s core to competitive position in future growth. The benefits of the strategic initiatives in which we have invested heavily over the past several years will significantly improve our cost structure over the next couple of years.

As our TSA+ processors are performing well and will enable us to continue to reduce our overall cost per part particularly as additive suspensions become a higher percentage of our product mix.

Our Thailand assembly operation is ahead of its initial plan. And as we continue to shift to assembly capacity to their site, we will realize more cost savings and further improve our customer service. While realizing the full benefits of our consolidation and cost reduction efforts is a few quarters away, the past and positive cash flow and profitability is now clear and closer and within reach.

That concludes our prepared remarks. Craig, please open and begin the polling for questions.

Question-and-Answer Session

Operator

Thank you very much. (Operator Instructions). And our first question does come from the line of Sherri Scribner with Deutsche Bank. Please go ahead.

Sherri Scribner – Deutsche Bank

Hi, thank you. I was curious about the restructuring charges. It seems like they changed a bit from the margin announcement, and I’m not sure are you now including BioMeasurement, are you just tightening up the range, because I think the range before was $45 million to $60 million in savings.

Wayne Fortun

Hi Sherri. Yes, we are just tightening up the range. BioMeasurement was in the initial numbers previously. And as we’ve continued to work through and put more effort into the transition plan, we just have a clear picture of what we think those savings will be.

Sherri Scribner – Deutsche Bank

Okay. And then in terms of the share gains you’re expecting in fiscal 4Q, I think you said you have one customer. I’m just curious what type of platform is that. Is that a new customer win in terms of something you had been doing in the past, or can you give us a little more detail?

Rick Penn

Yes, Sherri, this is Rick. It’s a desktop program at a customer where some other programs have really moved to end of life, and our position at that customer has declined, and now we’re getting back on track with them, and we’ve won a significant desktop program. And that should – we think tick our share up a bit as we move to the end of this year.

Sherri Scribner – Deutsche Bank

And I assume that would be a TSA+ win?

Rick Penn

Yes.

Sherri Scribner – Deutsche Bank

Yes, okay. And then just finally on the consolidation we’ve seen in the industry, Western Digital and Hitachi getting together, now Seagate announcing they’re buying Samsung. Do you think the industry consolidation of your customers is a positive for you or a negative?

Rick Penn

Any time there is fewer customers and the same number of suspension suppliers, we’ve lacked fewer places to go and there is – if you just step back there is fundamentally some pretty strong buyer power there and lots of leverage that those few customers have. But we’re pretty consolidated down anyway at this point. So I think overall for the industry, it’s probably a good thing. I think you’ve listened to the drive guys by now and there is probably some pricing stability that results and some other advantages.

For us, we feel – I’ll go back to just all of the things that we’re doing to restructure HDI and the fact that not too many months ago, TSA+ wasn’t up and running like it is today and it’s really running and under control. The same thing is true for Asia assembly. The consolidation is underway.

And so when you put all of that together and look at what’s happening to our cost structure as we’ve said in the prepared remarks, we really are competitively positioned in our customers, whether they’re combined now or not, are really viewing us with much more confidence, and are pleased that there is a second source of flexure supply in the industry, and believe that our cost model will be better than the other guys. And so we think we’ve positioned and have momentum at all of the players that are actually quite positive whether they’re combined or not. And, I guess, I’ll leave it at that, unless you have any follow-on questions.

Wayne Fortun

I would just add one thing, Sherri. This is Wayne. I would say that you can’t speak to all of the consolidation, but I would say that our relationship with WD is very, very good. Our share there is significant, while our share at Hitachi is very small down in the 5%. And so I think that acquisition is likely to be very good for us that I can’t imagine us not picking up some portion of that assembly volume or that Hitachi volume as it starts to be brought into WD, but we’ll have to see. And then what Rick says is right, all the rest of it is, is that you just can’t count on consolidation to workforce. What we have to do is get our cost where it is we are the lowest cost producer and our technology will win as it always has.

Rick Penn

Yes, there will be three suspension guys now competing for three customers. And so we’re going to have to work real hard to earn that business and try to earn a stronger position in this industry. But we think we’re – we’ve got a structure and a game plan here that that really helps stack the deck to do that.

Sherri Scribner – Deutsche Bank

Okay. Great, thank you.

Operator

And our next question does come from the line of Anj Singh [ph] with Needham & Company. Excuse me, Mr. Singh, if your line is muted, please unmute at this time. I’m getting no response from the line. I’ll go to the next question. And our next question does come from the line of Eric Reubel with MTR Securities.

Eric Reubel – MTR Securities

Hi guys. Thanks for taking my questions. You talked about a mix shift that was negative in the quarter turning more towards 3.5 inch versus enterprise and mobile. Is that a customer-specific issue and is that something that can reverse in the current quarter and into the back half of the year?

Rick Penn

Yes, this is Rick. I think that shift will probably hold. And the mix towards desktop will probably stay about as it is for the next quarter or two, something like that.

Eric Reubel – MTR Securities

Okay. And then, Rick, also on the issue of consolidation, you pointed out sort of both sides of the camp. On one side there is fewer customers to sell to, but on the other side the drive guys may see some pricing power. Does that pricing power kind of trickle down to better suspension assembly pricing? It seems like that could be a factor.

Rick Penn

I wouldn’t count on that. The competitive pressures at the suspension level will be I think what really determines where we lay our pricing. But having said that, it certainly help if the drive guys are under less pressure, that might tend to put us under a bit less pressure. So it’s a dynamics that it’s certainly not bad. I just don’t know that it helps much.

Eric Reubel – MTR Securities

Rick, you also mentioned that you’re not seeing any component shortages, but some of the drive guys have said that they are. Is that creating any unique opportunities for you at this point?

Rick Penn

Yes, there is. I think it’s been in public that there is some chip supply for Hitachi or HGST for example that’s affecting their demand or constraining their ability to supply. And so competitors like Toshiba and others maybe at least near-term picking up some demand. And we’re seeing some of that benefit, yes.

Eric Reubel – MTR Securities

Okay. Couple other quick ones if I can. You mentioned a number of changes for 2012. Can you say where depreciation and amortization is going to go for 2012?

Dave Radloff

It’s not going to be materially different –

Eric Reubel – MTR Securities

Okay.

Dave Radloff

Than what you’re seeing today.

Eric Reubel – MTR Securities

Okay. And payables in the cash flow kind of moved against cash in the quarter with the payable days down considerably. Should we – what was going on there? Should we consider the new level – can we keep payables at this level or can they sort of extend it and be a source of cash into the back half of 2012 – sorry, back half of 2011?

Dave Radloff

Yes, I think that was an unusually volume of payables. We don’t pay every week and we happen to hit a time period where we had just paid in at pretty low payables. We expect that will triple off top.

Eric Reubel – MTR Securities

Okay. That’s it from me. Thanks a lot.

Operator

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

Tom Lewis – High Road Value Research

Hi, good afternoon.

Rick Penn

Hi Tom.

Tom Lewis – High Road Value Research

First of all, can you give us any – give us some update on the prognosis of the introduction of dual-stage actuators or otherwise more featured suspensions in the quarters ahead?

Rick Penn

Yes Tom. Dual stage really is being triggered and ramping on the 1 terabyte per platter desktop type drives or it ends up being I think 700, 800 gigabit per square inch aerial density. And so that’s sort of the tipping point where we’re starting to see dual stage being required in desktop and then perhaps to some degree on mobile and the other segments as well at that AD point.

And so that’s coming up and it’s really various sources of vibration is probably the simple way to describe what drives the need. And so looking forward then from there – and when we look at the programs that are moving in that direction, it really – they start to ramp in let’s say the first quarter of 2012, yes fiscal 2012 right, and then move up from there. So that’s sort of what the timing looks like.

Tom Lewis – High Road Value Research

Okay. And I think you characterized as that is having a programs with four to five customers out there, and it’s not looking like five maybe by the time we get to that time period, how does that change and are there any like some cost to write-off or anything like that?

Rick Penn

No, nothing like that. And with the programs that we’re lining up on, look like there is still are in place and we’re moving ahead down to qualification process with three or four depending on how you want to account and the products performing well. And that’s all nothing to write-off, all of that’s holding together as we look at how those programs come together.

Tom Lewis – High Road Value Research

Okay. And as far as getting – ramping up in Thailand, I believe you characterized and it’s kind of obvious you built a great big new building and you’re just getting started, there’s some inherent inefficiencies until you somewhat fill the building up. Can you give us a sense of when that particular drag on profitability [inaudible]? Is there any color you can put on what the production volume or the number of a units in place is likely to be over the next couple of quarters?

Rick Penn

Well, I think – I’ll let Dave comment this.

Dave Radloff

Yes, we’ll have enough volume running by the end of the fiscal year that we’re starting to see benefit including all the fixed cost. And so it just improves throughout the next fiscal year until it’s pretty full by the end of fiscal ’12.

Rick Penn

So at the beginning of the fiscal 2012, we see some cost benefit to some of the redundancies that we sort of have to carry between now and then will evaporate and will start to see some real benefit.

Tom Lewis – High Road Value Research

Okay. And I miss the dollar figure on the BioMeasurement, could you please repeat that?

Dave Radloff

Which number, the revenues?

Tom Lewis – High Road Value Research

No, the quarterly sales are –

Rick Penn

$719,000.

Tom Lewis – High Road Value Research

Okay. And the – it looks like – yes, you’ve got some incremental – another incremental restructuring going on there in that division, was that – should we understand that is just a part of the overall corporate to see what we can do or is there something else that might have precipitated that position?

Rick Penn

I think that it’s a good deal of the former and that it was generally everybody had to dig deep and figure out how do we pull out enough costs to really get where we wanted to be. But I think also, Tom, the product itself and the base of the knowledge has come to the point where we’re more confident in the ability to sell this through distributors than we would have been a year-ago or two years ago for sure. And so we’re now setting up more with distributors not only as we were as an example in the Middle East, but in Asia or in Europe, as well as in the US. And so, we’re trying to – through these distributors have still the feet on the ground out knock on our doors and not give up the sales effort, but not have to have all of our direct sales force.

Tom Lewis – High Road Value Research

Okay. And when do you expect the multi-site study to provide you with the full quarter results?

Rick Penn

We’re looking at that to be probably the – we may have interim results and there might be something that would be published or spoke off at conference podiums by January of next year. And the completed study perhaps by – something would be in the second quarter of next year. So about this time next year.

Tom Lewis – High Road Value Research

All right. Okay, that’s it from me. Thanks.

Operator

And our next question does come from the line of Mark Miller with Noble Financial Capital Markets.

Mark Miller – Noble Financial Capital Markets

Just looking at your sequential percentage of mobile and enterprise, the 3.5 ships, your – I believe you said your mobile ships fell 14% sequential, and I was curious about that, because your largest customer Western Digital indicated a 6% sequential drop in their shipments, and in the enterprise space I believe you said 18% drop sequentially with no shipments, and Seagate was up. Just was wondering if there is anything going on there in terms of share loss or programs ramping or – ramping up or ramping down?

Rick Penn

Yes. Mark, this is Rick. Our enterprise share is probably in the neighborhood of 50%. That maybe down just a little bit because of the way things are bouncing around. I’m thinking about the mobile and I’m looking around the table also. But some of that maybe what we’ve landed with Toshiba is that business has pulled back, that’s probably the main driver for our mobile share being up.

And if you remember that situation has been declining for a bit more than a year now as their head supplier TDK/SAE has been in there with very aggressive HDA pricing, but using their own suspension. And so our position in Toshiba has been slowly pulling back and that’s affecting that mobile share.

We think by the way the momentum is changing there and we’re holding it not maybe looking at some better position at Toshiba going forward.

Mark Miller – Noble Financial Capital Markets

And maybe I missed. Did you actually give the TSA cost burn in this quarter? You’ve given out in the past quarters in terms of dollars and millions?

Dave Radloff

Yes. No, we demonstrated last quarter for a period that we really don’t have operational yield or other type of issue what we really have is the capacity utilization issue. And so we’re not reporting it as a burden anymore. It’s not different than any other operational capacity utilization cost in our P&L.

Mark Miller – Noble Financial Capital Markets

And finally, we’re still in the industry around 2.8 suspensions per drive.

Dave Radloff

I think that’s moving up to maybe a little over 3, 3.2 something like that, Mark.

Wayne Fortun

I wouldn’t say it’s various [ph], but that’s certainly where we’re expecting it to move to, Mark.

Mark Miller – Noble Financial Capital Markets

Okay. Just getting back to the consolidation moves. Has there been any discussions with you especially in say Western Digital concerning made any changes coming because of these consolidation moves in the industry?

Rick Penn

No, definitely not. And as a matter of fact, you’re probably aware that both parties, and I’m talking Western Digital, Seagate, Hitachi and Samsung, they are careful not to be talking to one another, not to be doing any kind of concerted planning or the like and tell those deals are done. And so we as suppliers behave as good troops and just simply support them and very carefully just as business as usual until the deal is done.

Mark Miller – Noble Financial Capital Markets

Well, I guess, let me pose the question this way. Western Digital has been your largest customer. Hitachi as you noted just a small customer. Would you – you’re looking at an opportunity I estimate with Hitachi of 55 million, 60 million suspensions that they consume, would you be prepared to take in terms of your current capacity utilization and capacity planning, and would you be prepared to take a good portion of that if it was possible?

Rick Penn

Absolutely. Yes, Mark – I’m sorry, I’ll let you finish.

Mark Miller – Noble Financial Capital Markets

Well, I’m just saying without incurring any major costs, you guys would roll on that.

Rick Penn

Yes, we definitely are prepared to take on more. Frankly, we have capacity overall to do something more than 20 million suspensions per week. If you look at our facilities and equipment, now that’s not true for TSA+ equipment, because they were lined up for 10 million to 12 million a week in terms of equipment capacity. But we have lots of, what I’ll call, pent-up ability to flex up near term and longer term, and we’re – we’ll do everything we can to win and earn that business.

Mark Miller – Noble Financial Capital Markets

Thank you.

Rick Penn

Yes.

Operator

And our next question does come from the line of David Epstein with CRT.

David Epstein – CRT

Just wanted to clarify total remaining cash restructuring costs. It’s going to be $6.7 million for severance and $3 million for moving equipment.

Dave Radloff

That’s correct.

David Epstein – CRT

Can you give anymore color? You talked about sort of had a cost savings of write-down over time, can you give any more color on what you think your cash burn might be for the remainder of the year?

Dave Radloff

We certainly will probably – I think a fair way to think about it is those cash cost that you talked to that that will be the cash burn, and then we will generally for the rest of the year be cash neutral except for that.

David Epstein – CRT

And you talked about – you pointed out that Hitachi is not a big customer, so Western Digital is taking them over can hopefully allow you to gain a little share. Can you drill down a little bit more on how that do you think that will play out with Seagate and Samsung, I mean basically the same way or different dynamics with Hitachi-Western Digital?

Rick Penn

Might be a little bit different dynamic. In the case of Seagate and Samsung, we’re currently at a relatively low business level with each of those players. But I think both are pleased with the changes that we’re making and I think there is some momentum that’s improving at each of Seagate and Samsung. And so we’ll just have to see how that plays going forward.

David Epstein – CRT

Thank you very much.

Rick Penn

Yes.

Operator

And our next question does come from the line of Jeremy Skrezyna [ph] with Andalusian Capital Partners.

Jeremy Skrezyna – Andalusian Capital Partners

Hi guys.

Rick Penn

Hello.

Jeremy Skrezyna – Andalusian Capital Partners

A couple of quick questions. First on market share and market dynamics. Correct me if I’m wrong, but I believe that you’ve now gone through four quarters after having lost a large portion of the Seagate business. And the guidance for Q3 is flat to Q2, which would kind of imply double-digit unit shipment decline. Just wondering with all the analysts and everyone calling for at least mid single digit disk drive shipments for the year growing, why are you still kind of going to be in double-digit declines?

Rick Penn

Yes, our share has pulled back, and Toshiba is the biggest piece of that over these last few quarters in that share erosion, and maybe end of life and one other drive company, and a couple of drive programs also. And so we think our share is around 20% or a bit less than that in holding. And again as we look at the – as we look at the quarter that we ended where we think it’s relatively flat compared to last quarter and then maybe we move up some from there.

Jeremy Skrezyna – Andalusian Capital Partners

Okay. So that it’s slightly different than kind of the guidance that was given in the last couple of earnings calls where you had indicated 20% market share, but possibly some uptick from there, but the decline wasn’t really forecasted. Is that accurate?

Rick Penn

That’s not how I would recall that. I think that we’ve been saying we’ve been a little under 20% than we’re thinking that we will move up as we grow primarily into the fourth quarter of the fiscal year.

Jeremy Skrezyna – Andalusian Capital Partners

Okay.

Rick Penn

And I do say pretty consistent with the last couple of calls.

Jeremy Skrezyna – Andalusian Capital Partners

Okay. And I apologize if I missed this. But on the working capital, obviously accounts payable went down quite a bit this quarter and your days payable went in turn – are your vendors tightening terms or what was the reasoning behind that?

Rick Penn

No, it’s none of that all. It’s just we pay basically every other week and kind of a combination of what we owe relative to what we’ve been buying and in the timing of those payments. And so I would expect it will move up next quarter.

Jeremy Skrezyna – Andalusian Capital Partners

Okay. And on the inventory side, I mean the – I know that you had extremely high inventory in the first quarter and we’re expecting work some of that, but your inventory days are still historically very high. Is that something that’s continually worked off or –?

Rick Penn

I think there is a couple of things when you look at that, one is we are – we have some high levels of raw material related to end of life of TSA, and so we actually have worked that down a little bit this past quarter, but that was one of the reasons that our inventory has been high.

The other is that as we’ve been starting up our Thailand operation, we’ve been putting inventory in place that is not finished goods inventory but intermediate type inventory to allow us to ramp that operation and we don’t want to short them and so we’re heavier than we historically have been. And then as we’re doing the consolidation operationally, we’re putting some intermediate inventory and again to allow us to move the TSA+ and [inaudible] operations from Hutchinson to Eau Claire. And so –

Jeremy Skrezyna – Andalusian Capital Partners

Okay.

Rick Penn

There is reason, but it’s not finished goods inventory, it’s other inventory.

Jeremy Skrezyna – Andalusian Capital Partners

Well, on the end of life inventory for the TSA, and then more generally, is there a chance that you might have to write some inventory off?

Rick Penn

It doesn’t look like that at all at this point in time.

Jeremy Skrezyna – Andalusian Capital Partners

Okay. And how about any other kind of asset impairment charges forthcoming?

Dave Radloff

That we – really that’s why we’ve talked about the accelerated depreciation. Because we are using those assets, they aren’t really impaired if you will. But the life of those assets we can forecast a sooner end to those. And so I think we had $700,000 this past quarter, a $2.2 million in the quarter we’re currently in, the third fiscal quarter, and then $200,000 in the fourth quarter. So it’s a little over $3 million in total of debt accelerated depreciation that – if we just weren’t using them right away we would – even would have impaired them.

Jeremy Skrezyna – Andalusian Capital Partners

Okay, thank you. That’s all from me.

Operator

(Operator Instructions). And our next question is a follow-up question from Eric Reubel with MTR Securities.

Eric Reubel – MTR Securities

Hi Rick. Just a quick follow-up. You alluded to this a little in your discussion, but the – one of the things that Japan tragedy has shown or demonstrated is a fragility and the supply chain for hard disk drives. And I was wondering if you could speak a little bit – you alluded to the fact that you’re the second source for flexures, is that really stimulating any significant conversations with your customers, is it something they really want to expand on, can you give any color there?

Rick Penn

Yes, I mean, I think our TSA+ flexure capability that is now a process that’s really up and running, it’s under control, we’re shipping in volume to one player and lining up on others is an advantage. It’s – it offers a second source or another channel for flexures and it’s currently only one or has been up to this point only one.

And it as a vertically – as a part of our vertical integration strategy, it really helps our cost structure and it’s a piece of what helps our total cost we think be lower than the other guys as we move through the next few quarters. So I think all of that has customers interested, has their confidence in our ability to offer good economics to them and still be sound financially on our end has customer confidence building.

Eric Reubel – MTR Securities

That’s helpful. And if I can change gears for a second. You talked to – can you give any more color on the types of distributors that you’re working with for the biomedical division here. Are there – this is – will this also extend to the folks that make the monitors or is it something that you’re just exclusively – if you can give a little more color around the distribution for the biomedical products.

Wayne Fortun

They will sell both monitors and the sensors as we produced them both. And so they will – they really are selected by the – their expertise and of who they call on. And so we’ve been working primarily with those distributors that have relationships and experience with emergency rooms, with emergency medicine, trauma medicine, so that what we’re really addressing is finding distributors that have good relationships with and knowledge about the end of market applications in which we’ve shown the most benefit and where our studies will prove out to be – our outcome studies will prove out to be of greatest apparent value and is therefore the fastest way to growing revenue.

Eric Reubel – MTR Securities

I guess, Wayne, what I was really referring to with respect to monitors was sort of the integrated monitors that are already in the emergency rooms like, are those that are offered by Philips and GE sort of following on along a plug-in application for the monitor into an existing monitor that’s bed sized. Is that something that we can expect to see as a larger distribution strategy that would not necessarily immediately replace the standalone monitor that you have, but it certainly would – that seems to be more the standard practice?

Wayne Fortun

You’re exactly right. And what we’ve – what is not atypical is that when it’s a new technology and when we’re not just replacing somebody, if we were replacing somebody we could directly to those OEMs and sell to those OEMs as to why they should be using us versus the other guy. But when it’s new what you really have to do is get be pulled into it. You end up selling into the ICUs. The ICU doctors are convinced and nurses are convinced. They need this to care for that patient and lower their cost. So they start using our device.

And as that interest in level of use grows, then they start turning to the OEMs in saying would you put this into your main monitor, because it’s more efficient for them to use. And so we are now successfully selling into the ICUs and we actually have an ICU that has made our product the standard of care for use to avoiding the use of central line catheters. And so we think we are – can see the time when we will actually be pulled into that kind of activity and sell into the OEMs.

And because that sale is something that we have a good deal of understanding and there is a lot of customers they have to go deal with, we probably would not use distributors in that case, but go and do that with the direct some of – one of our direct sale people that we still have on as support to the distributor rank.

Eric Reubel – MTR Securities

Okay. Fair enough, thanks very much.

Operator

And management, at this time, there are no further questions. I’d like to turn it back for any closing comments that you may have.

Wayne Fortun

Well, I want to thank everyone for joining us on the call today. We appreciate your questions and interest in the company, and we look forward to speaking to you next quarter, and hopefully with much of this consolidation well underway.

Operator

Thank you. Ladies and gentlemen, this does concludes the conference call for today. We do thank you for your participation. You may disconnect your lines at this time.

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