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Davis Consultants Asia

Hutchinson Technology Incorporated (NASDAQ:HTCH)

F2Q07 Earnings Call

April 24, 2007 5.00 pm ET

Executives

John Ingleman - CFO

Wayne Fortun - CEO

Kathleen Skarvan - VP and President of Disk Drive Division

Rick Penn - President of BioMeasurement Division

Analysts

Mark Moskowitz - JP Morgan

Kevin Hunt - Thomas Weisel Partners

Christian Schwab - Craig-Hallum

Sherri Scribner - Deutsche Bank

Rich Kugele - Needham & Company

Matt Kathera - WR Hambrecht

Joel Inman - Robert W. Baird

David Fondrie - Heartland

Presentation

Operator

Good afternoon ladies and gentlemen, and thank you for standing by. Welcome to the Hutchinson Technology's Second 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). This conference is being recorded today Tuesday April 24, 2007.

I would now like to turn the conference over to John Ingleman, CFO. Please go ahead sir.

John Ingleman

Good afternoon everyone. Welcome to our second quarter results conference call. With me is Wayne Fortun our CEO who will provide an over view of our second quarter results shortly; Kathleen Skarvan, President of our Disk Drive division will provide additional information on that portion of our business; Rick Penn, President of our BioMeasurement Division, who will update you on our InSpectra product launch, and I will provide details on the second quarter financial performance later in the call.

Also on the call this afternoon is Chris Temperante, Vice President and General Manager of our BioMeasurement division; Dave Radloff, our Vice President of Corporate Finance; Todd Bradley, our Corporate Controller, and Chuck Ives, our Investor Relations Manager.

As a reminder, we will be providing forward-looking information on demand for and shipments for the company’s product, our manufacturing capacity, our investment in research and development, capital expenditures, the number of suspension assemblies used for disk drive, the worldwide disk drive and suspension assembly demand and shipments, average selling prices, BioMeasurement operations, 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 non-public information through any other means. We issued our second quarter results announcement just after the close of trading this afternoon. The announcement is now posted on our website at www.htch.com as well.

Now, I will turn the call over to Wayne for his remarks on the quarter.

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Wayne Fortun

Thanks John. Those of you who follow the disk drive industry know that that weaker demand is being reported for the March quarter, particularly for 3.5-inch ATA disk drives. That weaker demand was evident in our results for the quarter. We shipped approximately 205 million suspension assemblies in our fiscal 2007 second quarter, down about 9% from our record 225 million suspensions shipped in our first quarter.

With that reduction in volume, the utilization of our manufacturing capacity in the second quarter was below 80%, as these levels of capacity utilization and in light of our strategic investments in both our BioMeasurement Division and the development of the additive capabilities required for our TSA+ suspensions, our margins remained under pressure. We are pleased with the progress we are making with our TSA development. We are meeting critical milestones including delivery of TSA suspensions for a customers' disk drive program that is currently in development.

The core equipment for our volume production line has been installed and is being tested for internal qualification, and we expect to have the volume production capabilities in place to fulfill customers' requirements as the transition to TSA+ suspension assemblies begin. In our BioMeasurement Division, we are very encouraged by the market reception we are seeing for our InSpectra StO2 Tissue Oxygenation Monitor, which is in the initial months of the commercial introduction of that system.

As we began our fiscal third quarter, we announced that Rick Penn has assumed the role of President of the BioMeasurement Division. Putting Rick in this critical role, Rick reflects our commitment to the growth of our medical device business. Chris Temperante, who has led the division through the product development phase, will play a key role for the division as Vice President and General Manager.

Preceding Rick as President of our Disk Drive Components Division is Kathleen Skarvan. Kathleen previously served as Vice President of Sales and Marketing for the division and has been with the company in a variety of management positions since 1980. We feel that these executive appointments will help us take advantage of the growth opportunities that lie ahead for both our divisions.

I'll turn it over to Kathleen now for an update on the Disk Drive Component Divisions' second quarter performance.

Kathleen Skarvan

Thanks Wayne. As Wayne noted we shipped approximately 205 million suspension assemblies in our fiscal 2007 second quarter. Of our second quarter shipments, suspensions for 3.5-inch ATA disk drives were about 62% of our unit volume, mobile application were about 20%, and performance applications were about 18%. As we pointed out in our earnings announcement, our average selling price declined to $0.79 per suspension assembly in the second quarter compared to $0.80 in the preceding quarter.

As in the first quarter, our second quarter sales mix included a high percentage of matured products for disk drive programs experiencing longer market life. In particular, some customers are expanding the use of 80-gigabyte per-platter technology better than transitioning quickly to the higher capacity technology.

We are competing more aggressively than we have historically to supply these longer running programs nearing the end of their market life and given the current over capacity in the disk drive industry supply chain. While, we produce suspension assemblies for these mature products very efficiently, the average selling price for them is below our overall average as the higher cumulative volumes trigger reduction in price.

As noted in our second quarter results announcement, competition in the industry is expected to be particularly intense in the second half of our fiscal year. We are already seeing a push for lower cost designs from the disk drive makers and suspension assembly pricing is becoming more competitive.

Additionally, our share position in the 3.5-inch ATA segment of the overall drive market is being challenged. On the other hand, we have been improving our position in the faster growing mobile segment of the disk drive market. Our advanced TSA and our forthcoming TSA+ products are particularly well-suited for design and performance requirements of this segment of the market. Regarding the outlook for demand, storage industry analysts are currently forecasting a 12% to 15% increase in disk drive unit shipments for calendar 2007.

In our last quarterly conference call, we said that the rate of growth in worldwide demand for suspension assemblies might be less than the rate of growth in disk drive unit shipments in calendar year 2007. We expected this to happen if the number of suspension assemblies for disk drives trended downward. But as some of the disk drive makers have extended the use of their 80 gigabyte-per-platter technology, we believe the number of suspension assemblies for disk drive has held steady at about 2.8. While this is been official to the overall suspension assembly demand, it will not likely be enough to offset the current challenges to our share position on 3.5-inch ATA disk drive. As a result, we are expecting that our manufacturing capacity utilization for the remainder of the fiscal year may fall below the level we experienced in the 2007 second quarter, resulting in increased pressure on our gross margins. In light of the expected weaker demand, we are taking targeted cost reduction actions in the Disk Drive Components Division.

Now switching to TSA+, we are pleased with the progress we are making in the development of our capabilities. As Wayne mentioned earlier we have been delivering TSA+ suspension for our customers' disk drive program that is currently in development and we are meeting other critical milestones.

The core equipment for our volume production line has been installed and we expect to have volume production capabilities in place to fulfill customer requirements as the transition to TSA+ suspension assembly begins.

I'm turning the call over to Rick now for an update on Bio Measurement Division.

Rick Penn

Thanks Kathleen. We are now about four to five months into the commercial launch of our InSpectra StO2 Tissue Oxygenation Monitor. We are very encouraged by the reception that this system is getting in the marketplace so far.

To date more than 90% of the potential U.S. customers who have seen the initial product demonstrations have advanced to the next step of the sales cycle. This is really good news, it’s better than we anticipated at this early stage and we believe it's a positive sign indicating the potential for wide adoption of this new StO2 metric.

Also we continue to build interest in the InSpectra system through participation in industry conferences and events. And several of these events, the key opinion leaders in trauma and emergency medicine are presenting papers to other physicians and their nurses based on our StO2 trauma study.

All of this helps us educate the healthcare community and the clinical value of measuring StO2. Remember this is a new measurement for clinicians in building confidence and trust in this new metric at this stage is really the key to setting the foundation for the future growth.

Finally, with respect to the production of our InSpectra system, we are meeting our goals for ramping volume of both monitors and sensors.

With that, I'll turn the call back to John now for a recap of second quarter financial results.

John Ingleman

Thanks Rick. Net sales for the fiscal 2007 second quarter totaled $170.7 million, down about 10% from a record $188.9 million in the preceding quarter, and down about 8% from last year's second quarter. The second quarter revenue included component sales of about $7 million or 4% of net sales.

Revenue percentages for our top five customers in the quarter were as follows. Seagate 29%, SAE/TDK 26%, Western Digital 16%, Alps 9% and Fujitsu 7%.

Our gross margin in the second quarter was 18% compared to 19% in the preceding quarter, and 23% in the 2006 second quarter. The decline in gross margin compared to both of the preceding quarters and the prior was primarily the result of under utilization of manufacturing capacity.

Utilization in the 2007 second quarter was below 80%, compared to about 80% in the preceding quarter and more than 90% in the year ago quarter. We also produced more suspension assemblies then we shipped during the second quarter, which increased our capacity utilization during the quarter.

At quarter end our finished goods inventories were in the range of five to six weeks compared with four to five weeks at the end of the first quarter.

Our capital spending in the second quarter totaled $26 million that was down from $37 million in the preceding quarter and about $59 million in the fiscal 2006 second quarter. We now expect our capital spending for fiscal 2007 to be about $120 million, down from our earlier estimate of $140 million.

The distribution in capital spending remains about that same as we previously reported. Roughly half is considered maintenance capital, including program specific tooling for our customers and maintenance of existing equipment, business systems, labs, tool rooms, and facilities.

Approximately $50 million will go towards completion of the volume production line for TSA+ suspensions at our Eau Claire facility, and the remaining $10 million is for new process technology.

Depreciation expense in the second quarter was $29 million. For fiscal 2007 we estimate the deprecation expense will be approximately the same as the total for fiscal 2006, which was $119 million.

R&D expenses in the second quarter were $16.2 million or about 9% of net sales compared with $14.1 million or 7% of net sales in the preceding quarter, and $13.4 million or 7% of net sales in a prior year second quarter. A substantial portion of our R&D spending remained dedicated to development of the additive process required for our TSA+ suspension assemblies.

SG&A expenses in the second quarter were about $19 million compared with $19.5 million in the preceding quarter, and $21.3 million in the 2006 second quarter. As a percent of net sales, SG&A expenses were 11% in this quarter compared with 10% last quarter, and about 11% in last year’s second quarter.

We incurred a loss from operations of $5.3 million for the 2007 second quarter. This included an operating loss of $3.4 million in our BioMeasurement division. Interest expense was $2.5 million in the second quarter compared to $2.3 million in the preceding quarter and $2 million in last year's second quarter. Interest income for the second quarter was $3.9 million compared with $3.7 million in the preceding quarter and $3.2 million in the 2006 second quarter.

Our income tax provision for the quarter was $700,000. We were required to report this expense based on a substantial increase in our estimated tax rate for the entire fiscal year. This resulted in a net loss for the [fiscal 2007] second quarter of $3.6 million or $0.14 per share.

Cash generated from operations in the quarter was about $28 million and as it was in the first quarter, we were about free cash flow neutral for the period. Cash and securities held for sale totaled $297 million at quarter end, up from $295 million at the end of the preceding quarter.

With respect to our outlook for the rest of the fiscal year, as previously noted, our share position in the 3.5-inch ATA segment of the overall disk drive market is currently being challenged. As a result, we expect our manufacturing capacity utilization for the remainder of the fiscal year may fall below the level we experienced in the 2007 second quarter, resulting in further pressures on our gross margins.

We now expect our fiscal 2007 R&D expense will be up about $5 million compared with fiscal 2006 spending of approximately $53 million. The increase primarily results from the requirement to treat the cost associated with TSA+ prototype line as R&D rather than cost to goods sold during the third quarter. This is not due to an increase in spending. I repeat this is not due to an increase in spending, but rather just a change in how the spending is classified on the P&L.

We continue to expect our SG&A expenses to be above 11% of net sales for the fiscal year. This includes our plans to incur increased sales and marketing expenses in our BioMeasurement Division related to the commercial launch of our InSpectra StO2 system.

As a result of the increased pressure on gross margins and our continued strategic investment in our TSA+ capabilities and our BioMeasurement Division, we expect to incur a loss for the current fiscal year. Due to that expected loss, we will record an income tax benefit for the remainder of fiscal 2007 between 40% and 50%.

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

Wayne Fortun

Thank you, John. Clearly, the second half of the fiscal year is going to be a challenge for us. As Kathleen mentioned, we are taking targeted actions to reduce costs in the light of weaker volume that we are now expecting. We will, however, continue to invest in TSA+ production capabilities and in our BioMeasurement Division.

Our customers new discharge programs increasingly require greater levels of miniaturization and precision in critical components. Our TSA+, a platform is designed to meet these requirements.

Our InSpectra StO2 Tissue Oxygenation Monitor is being well received in the market in the early stages of our commercial launch of the system. The device provides a clinically valuable measurement, not previously available to medical professionals in trauma and emergency medicine. We have remained very confident in our quality, technology leadership, in our cost leadership, and in the long-term growth opportunities that lie ahead for both of our divisions.

That concludes our prepared remarks. Operator will open the polling for questions now.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen we will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Mark Moskowitz with JP Morgan. Please go ahead.

Mark Moskowitz - JP Morgan

Yes, thank you. Good afternoon. I have a few questions that I need to ask. Wayne, I guess, may be you could kind of give us some context here as far as the incremental competitive pressures that you are seeing in your traditional 3.5-inch platform, is that because of technology improvement of the competition or increased capacity of the competition or is that more driven by the actual disk drive manufacturers?

Wayne Fortun

I would say it's really starting at the disk drive manufacturers. I would not say that there is any evident shift in technological pairings or matchings to us in the competition in either direction. And it really is one in which we're experiencing some decisions made at the drive levels that are affecting how the mix will move about between from supplier to supplier.

Mark Moskowitz - JP Morgan

Okay. And then either for you or Kathleen, as far as the TSA+ you sound somewhat encouraged about some of your progress, but by most accounts it seems like we are years away from buoyant revenues, was I mistaken? So, how much further are you along in terms of the spending required to the fully ready to attract these customers, to be honest of the initial demo-customer you have right now? I mean are we in the second inning, the third inning or the fourth innings, where are we in the spending perspective?

Wayne Fortun

Well, I may try this first Mark. We have said and we remained confident that we will be production volume capable this fall. And we have been hitting our milestones with the development of the particular program and that will now be dependant upon when the drive makers decides that they want to launch the product, but we will be prepared to do it.

We are now working with other customers in terms of sampling and the initial design work for designing or other programs. So, it's not like this current program will standalone for a long period of time. There will be other smaller ones that we think are pretty briskly behind it. And in fact we've been somewhat trying to manage it so that we didn't just get hit with a bunch of new products in a new line, all at once, and find ourselves overwhelmed with just the typical learning curve that one experiences when starting that up.

And so while the revenue isn't going to be an over night shift, we try to size the current production line and its facilities, so that we probably have something roughly like, let's say about a third of what we think the ultimate capacity could be in that facility as we go through the various phases of expansion. And so that will means some investment that will follow on, but it wont be in the same size as what we have experienced in getting this first quarter in and hopefully we are doing everything else intelligently and thoroughly in getting our processes [cult] by, they are well understood, are self up to learning curve before we are really in the mode of having to try to produce millions of parts per week for multiple customers.

Mark Moskowitz - JP Morgan

I appreciate that. I guess the follow-up to that though would be, I know it's kind of early in terms of you just referencing how some of your customers are continuing to extend the life of 80 gig. How has that, maybe it's too early to spell that, has that changed any of the reception of some of the customers in terms when they will ever come to the table for TSA+.

Kathleen Skarvan

Mark we don't believe so. Much of our additives we think will be applied to those segments where there is higher technical requirement. So, the enterprise are performance segment also the mobile segment, and I've been quite encouraged by the customer interest so far.

Mark Moskowitz - JP Morgan

And then just lastly here, Wayne or Kathleen or may be John can way in as well. Could you may be help us out as far as; you've talked about your focus on cost reductions but we haven't heard a lot about it yet. What mileposts are in place in terms if things don't get better soon, is it a couple of quarters out whereby you would start to consider moving more offshore from a cost perspective?

Wayne Fortun

In our analysis we are not at all satisfied that moving offshore has a significant impact on our cost. As we've been looking at the production in this last year very-very carefully, we were comfortable that we have the lowest cost to producing a suspension anywhere. What really is the issue is that, if the volume shifts the way we have seen it with over the last year or so in terms of ramping up to us, increasing our capacity and so forth, that we are sitting with a cost burden that doesn't match with what we see is the ongoing volume. So that's not a matter of geographics or location, it's a matter of just being sized wrong for the market. And we will take the appropriate steps to deal with that and we will judge it by what we think is the ongoing demand and so forth.

But as an example, we are almost 300 people less today than we were a year ago. And that we have just gradually attrited over that time period, and it was because of our improved efficiencies and overall market demand. And so, we are not unfamiliar, we are taking these actions and we will proceed doing that path. Every step of the way as we progress, it will be really based on how clearly can we see what the future looks like so that we can make intelligent decisions and not incur more cost by being to hasty.

Mark Moskowitz - JP Morgan

Thank you.

Operator

Thank you. Our next question comes from Kevin Hunt with Thomas Weisel Partners. Please go ahead.

Kevin Hunt - Thomas Weisel Partners

Hi, thank you, a couple of questions. Can you comment about the SAE-Alps merger and if that's having any impact on the competitive position you are talking about and then I had a follow-up?

Kathleen Skarvan

Sure, I will take that one Kevin. We have seen a gradual decline in our business with Alps over the last few months. And most to that we would see transitioning to again SAE who we have already a strong position with. So, other than the supply chain in having to fair it out what volume might be in there that is going through that Alps' supply chain, I think we see that as a relatively minor issue for us.

Wayne Fortun

But along that line, I'd just add that in part of the supply chain, there may be a modest amount of inventory that is sitting. There isn't much in our facility anyway.

Kathleen Skarvan

No, not from our perspective, but what might be in the supply chain.

Wayne Fortun

But what might be there at Alps is an example that will have to be worked out, and we'll see our way through that. We don't think that that's more than may be a very small amount, modest amount that could affect some of the volumes. But we feel pretty well prepared. And pardon me, as Kathleen says, our position at SAE is really solid, so we are not troubled by SAE taking over.

Kevin Hunt - Thomas Weisel Partners

Okay. And then I had a follow-up for John, actually I missed what you said about the prototype for the TSA was switching from gross margin to R&D. Could you just explain that again?

John Ingleman

Yeah, we are continuing to classify the cost of that R&D effort in the R&D line, as we work towards qualifying that prototype line. And the issue is that it's more money that's going to show up on the R&D line, but it's not an increase in spending. We had thought we might be able to move that up into the costs-to-goods sold line as that line got closer to being qualified, but we are still not going to be able to do that.

Kevin Hunt - Thomas Weisel Partners

Okay, so you really see doing it the way you always have been doing, but you anticipate that you would maybe shift some of the cost.

John Ingleman

That's correct.

Kevin Hunt - Thomas Weisel Partners

Okay. So, I guess the follow-up to that question. So you are running, going to may be following up on Mark's question a little bit here. You are running about double your R&D levels as you were two years ago on a quarterly basis. So what point do you have to start looking at this and saying, well, we are going losing money quarter-after-quarter here. We have to rethink some things here. Should we expect that R&D is going to stay up at this $16 million plus per quarter levels sort of indefinitely I guess?

John Ingleman

I think what we've said historically is that we would run high this year as a percent of sales and in terms of dollars. But we expected to get our R&D expenditure back down into that 5% to 6% range which we had seen more historically. I think if you go back, I am not sure if its two years but there certainly was a point in there where R&D expense was very low. And it was artificially low because we were essentially being reimbursed by a customer for some R&D work that we were doing that was very specific to them and didn't have general application throughout our customer base.

Wayne Fortun

But I think just to also point out or remind everyone that we had been saying that this timeframe right now was going to be sort of our peak and our timing is not really terrific, I admit. But we've known that this quarter or so was coming all along and I warned everyone that when we start up the line we are going to be throwing away products as we are qualifying the line and so forth. And so, you are looking at it as a peak and then as John said, we think that we will get back down to that typical numbers that he was speaking to.

Kevin Hunt - Thomas Weisel Partners

Okay, and I think part of that also presumption that you will eventually be moving out to like more of a costs-of-goods, sort of an R&D line or is that --?

Wayne Fortun

That's correct.

Kevin Hunt - Thomas Weisel Partners

Okay. Alright, thank you.

Operator

Thank you. Our next question comes from Christian Schwab with Craig-Hallum. Please go ahead.

Christian Schwab - Craig-Hallum

Great. Thanks guys. I just want to make sure I understood John correctly, if utilization will be lower in the second half of the year, I assume you are not shutting down any lines. So, you would expect your June and September quarter, the seasonally shorter September quarter unit shipments to be below current shipments of 2005, is that correct?

John Ingleman

No, I don't think that's what we are saying. I think that we'll see what the unit shipments are in those quarters and that will depend clearly on what the demand is. We believe that we are not going to get to that peak utilization or that higher utilization that we would need to get to.

Christian Schwab - Craig-Hallum

Okay. I thought you guys said the utilization was going to be below the current quarter.

John Ingleman

It could be.

Christian Schwab - Craig-Hallum

I guess, the other way of saying it, are you getting increased efficiencies and still adding capacity, so your capacity is increasing. And then our unit shipments could go up and our utilization still could be below the March quarter?

John Ingleman

We are not adding capacity from an equipment standpoint, Christian. We do expect to get more efficient.

Christian Schwab - Craig-Hallum

Okay. Where would you expect to end the fiscal year as far as weekly capacity, 23 million, 24 million?

John Ingleman

I would say that the 24 is on the high side there. I would say it's more like 22 plus or minus 500,000 or something like that.

Christian Schwab - Craig-Hallum

Okay. Great. And then regarding, on the TSA+ business we expect that business to be targeted more towards enterprise and mobile applications. Is that correct?

Kathleen Skarvan

Certainly Christian, during the onset of that launch.

Christian Schwab - Craig-Hallum

So would you expect that business then to kind of run like your other specialty businesses meaning, kind of like the stuff you do for WD and their [raptor] drive meaning you get to charge them a lot of money, but it's not all that efficient because of the low volume. So, in my estimate you generate lower gross profit dollars than company average doing that for them. Would we assume that TSA+ when it initially rolls out, whatever utilization you end up being as a complete company that your gross margins for those products will run less than the corporate average.

John Ingleman

Well, no I don't think that's a good way to look at it. For one thing is, some of these specialty applications, particularly as an example, some enterprise programs are very profitable because they are very hi-tech and we happen to be in a position in which we've earned a top slot in providing for that niche. And some of the programs that we are working on are actually pretty dogged on high volume programs.

Perhaps more importantly might be just thinking about the learning curve of starting up that new process, also the fact that the capacity comes in fairly large chunks, and so when we churn on that equipment and have to start dealing with that depreciation, there might be a heavier depreciation load on the earliest products, until we start ramping up that volume and being able to match to the depreciation burden at that line with carry.

Christian Schwab - Craig-Hallum

Now that makes sense. Kathleen, would you expect your ASPs to recover into the second half of the year?

Kathleen Skarvan

We actually think that the mature products that we are producing now, they have been drawing that down that ASP, that we will see a stronger mix of newer products as we move into the second half of the year.

Christian Schwab - Craig-Hallum

Right. So, that leading customer, unnamed customer who continues to run that 80 gigabyte platform may be migrating to its next generation technology, which would cause them to buy different suspensions from you. Which would cause two things possibly, may be you can help me out on; would reduce certainly the suspension count and the drives that they shift to their end customers. And then I am wondering if you could comment on your market share position on those programs. I bet the understanding that you have, a very-very significantly market share for that customer, on their current program and competitive issues may have caused that to be less on the next generation program. Just trying to connect those dots to your comments about competitive pressures, and may be CD market share in the 3.5 inch. Am I thinking about that correctly?

Kathleen Skarvan

I really won't comment on specific customer share or programs Christian.

Christian Schwab - Craig-Hallum

Okay. Well that was really helpful, thank you.

Operator

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

Sherri Scribner - Deutsche Bank

Hi, thank you. Can you possibly comment on the linearity of the quarter in terms of the 3.5 inch market? Did you see that slowdown at the end of the quarter or was that sort of across the board? And then I have a follow-up.

Kathleen Skarvan

I would say that we probably did see more of a follow-up in the second half of the quarter.

Sherri Scribner - Deutsche Bank

Okay. And then I am assuming that, and correct me if I am wrong that your desktop share is roughly in line with the overall HDD market, and I think in the past you have said your notebook share is a little bit less, it sound like you are commenting that you are possibly loosing share in 3.5-inch and gaining share on the notebook market. But if I look at your mix in terms of what you announced, it looks like you are holding steady in desktop and that you are loosing share in notebook. Can you help me reconcile what's happening there?

Kathleen Skarvan

Sure, that's a great observation. We would say that we don't believe that there was any share loss in the quarter two that we've just reported; we see the challenges as we go forward.

Sherri Scribner - Deutsche Bank

Okay. So the deals that you are talking to the OEMs about for the next quarter you think that you are possibly loosing share on 3.5-inch and gaining the share of notebook. Is that the way to think about it?

Kathleen Skarvan

That would be correct.

Sherri Scribner - Deutsche Bank

Okay. And then John on the taxes, I think you said for the second half you expect to see a tax benefit. Can you help us with the numbers there?

Wayne Fortun

Well, I said that our tax rate would run at 40% to 50%, and that would result in a tax benefit, if as we said we expect to have a loss for the year.

Sherri Scribner - Deutsche Bank

So the 40% to 50% benefit, if it's negative is that 40% to 50% of that a benefit?

Wayne Fortun

That's correct.

Sherri Scribner - Deutsche Bank

Okay, thank you.

Operator

Thank you. Our next question comes from the Rich Kugele with Needham & Company. Please go ahead.

Rich Kugele - Needham & Company

Thank you. A few questions here. Just to delve in a little bit deeper on some of the new programs. Are you comfortable with your win rate there? Can you give us a sense on what that percentage might be on going forward programs, whether they are TSA or TSA+?

Wayne Fortun

I have no reason to believe it would be any different than our typical win rate.

Rich Kugele - Needham & Company

Which is what?

Wayne Fortun

Well, I would say perhaps a good way to put it is, we bat better than 500.

Rich Kugele - Needham & Company

Okay. And then if we can go and take a step back and look at this in terms of what is the stabilization point in terms of both gross margin and even book value, where do you expect both of those metrics to bottom? Whatever timeframe you want to call it, six month down the road, nine months down the road or year, where do you think the bottom is for both of those metrics?

Wayne Fortun

I don't know. We are not going to make an estimate on that one Rich. So much is dependent on where the volume goes, so much is dependent on our cost reduction efforts, so much is dependent upon the TSA+ and its ramp and success on the BioMeasurement Division side and so on. That's one of the reasons why we stopped giving guidance quite honestly is that there is so many variables that are out of our control, I just don't think I can go there Rich.

Rich Kugele - Needham & Company

Okay. And then I guess just to delve a little bit deeper on this whole demand question. You talk about demand being soft and, obviously everyone knows as you gave the comments. But when you look at these numbers and you talked about how the suspension counts actually stable, it really seems like you are really having a problem with mix and you are having problem with ASPs because of the mix and shift because those other guys who are willing to price aggressive to keep that mix. And then the under utilization that happens because of the share loss, is that incorrect?

Wayne Fortun

That's correct, not incorrect.

Rich Kugele - Needham & Company

Okay.

Wayne Fortun

That's a fair summarization of significant implications of where we are.

Rich Kugele - Needham & Company

Alright. And just lastly here in terms of a breakdown, can you give us a sense what the percentage was of TSA and components, any revenue from the BioMeasurement side and John if you could repeat what the operating loss was for BioMeasurement?

John Ingleman

The components revenue was about 4% of net sales or $7 million dollars. The BioMeasurement operating loss was $3.4 million, $3.5 million.

Rich Kugele - Needham & Company

Any revenue there?

John Ingleman

A small amount, greater than $100,000 but less than $200,000.

Rich Kugele - Needham & Company

Okay. And then the TSA percentage?

John Ingleman

Essentially everything we do is TSA at this point. There might be 5% that's going to sort of call it non-TSA but there is very little left.

Rich Kugele - Needham & Company

Okay, thank you.

Operator

Thank you. Our next question comes from Matt Kathera with WR Hambrecht. Please go ahead.

Matt Kathera - WR Hambrecht

Hi, good afternoon. On the utilization, circling back to that for a second you said it was below 80%, are you able to give us a tighter range of what it was in the quarter and, if not, can you say if it was above or below your September quarter?

Wayne Fortun

I think the way to look at it is that it was probably in the 70% to 80% range. It's difficult to exactly peg utilization because we look at it for probably three different or four different sectors in the company. So, we had sectors that were running in the low 70s, we had some that were running in the closer to 80%, high 70s. And as far as relative to, you said the September quarter?

Matt Kathera - WR Hambrecht

Yes.

Wayne Fortun

It was probably, let's look. It might have been, we call about the same.

Matt Kathera - WR Hambrecht

Okay. On your inventory, you definitely build some in the quarter; can you give us a little bit more color about work in progress versus finished? And if you expect most of that to be flushed out in Q2, just given the Q2 demand that you are seeing from the OEMs right now?

Wayne Fortun

Well we certainly don't have any plans to build anymore inventory, that's for sure. And we will work on getting that inventory better in line than it is right now. We probably called a week or so, we have a week or so more of one week maybe more inventory than we would like to have.

John Ingleman

And I would remind you that as Kathleen described, we saw this thing sort of drop off in the latter part of the quarter, and so that in some ways exacerbates the number of weeks on hand because volume in the inventory may not have changed, but the rate have been changed by what we look at it.

Matt Kathera - WR Hambrecht

Okay. Lot of questions already asked, so let me ask this and last question here. Looking at your new guidance for fiscal year, obviously September looks to be weaker than I think most people were expecting at this point. What is the key factor and really that September weakness after we get through that seasonally slow period and what do you think is the biggest swing factor heading into the December quarter, which is the strongest for your company as well as for the disk drive industry?

Kathleen Skarvan

I think it's the desktop volume that being moved see as we did probably a year ago, and that's relative to share.

Wayne Fortun

And then as we roll into the second half of the year the general volume rises and will be starting, hopefully they will be ramping some of these new products and therefore some of our average sale price shifts somewhat and we'll do our level best to try to lower the costs and that allowed the share whereas that are always present in the guidance.

Matt Kathera - WR Hambrecht

Okay. Thank you.

Operator

Thank you. (Operator Instructions). Our next question comes from Joel Inman with Robert W. Baird. Please go ahead.

Joel Inman - Robert W. Baird

Hi. Thank you. Can you talk a little about your pricing strategy, in other words why do you think you are loosing market shares, is it because you are refusing to kind of compete on price or are there other reason?

Kathleen Skarvan

Actually I think in our comments, we said that we were aggressively competing on price where it makes sense to, and that's sure that there's really a lot more that we comment on that.

Wayne Fortun

Sometimes forcing decisions are made for a number of different reasons and it isn't always based on the number of different reasons and it isn't always based on price.

Joel Inman - Robert W. Baird

Okay, thank you.

Operator

Thank you. Our next question comes from Christian Schwab with Craig-Hallum. Please go ahead.

Christian Schwab - Craig-Hallum

John, can you help us figure out when you think you could return to profitability? I am just playing with my model here, it looks like it would be the second half of next fiscal year that, that would be logical. Am I thinking about that correct or should I be making other assumptions.

John Ingleman

I think the best way to think about this Christian is, that we've given you the guidance that we are going to give you and we are not prepared to go beyond this.

Christian Schwab - Craig-Hallum

Great, fair enough. Thank you.

Operator

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

Sherri Scribner - Deutsche Bank

Hi, sorry John the delay for this. I am trying to understand the taxes a little bit better. You said 40% or 50% benefit for the full year if you are at a loss. Does that include or not include the tax benefit you saw in the first quarter in December?

John Ingleman

40% to 50% rate that we referred to is a go-forward rate, and the rate that we had through the first half is whatever it turned out be, I can't remember the number right now.

Sherri Scribner - Deutsche Bank

Okay, so the 40% to 50% is for June and September.

John Ingleman

Yeah.

Sherri Scribner - Deutsche Bank

Okay, thank you.

Operator

Thank you. Our next question comes from David Fondrie with Heartland. Please go ahead.

David Fondrie - Heartland

Yes, good afternoon. In your comments on BioMeasurement you indicated that 90% are advanced into the next level of sales cycle. Can you give us a little more color on what the sales cycle is, and what do you mean by 90% are going to the next level? What the next level is?

Rick Penn

Yeah, I will start and then Chris can pipe in. What we are really saying is what we get in the door with the demonstration essentially all of those continue on in the sale cycle, and that is movement towards evaluation and then through evaluation hopefully ultimately through purchase. And that cycle we think is about a six-month cycle, maybe six to nine-month cycle, and we are about four-months into that. So, we are encouraged because when we get in the door, we get moving through this cycle essentially everywhere so far, and--

David Fondrie - Heartland

So that--

Rick Penn

Go ahead.

David Fondrie - Heartland

So does that mean that you put equipment into test so to speak or evaluate the equipment in the Trauma center?

Rick Penn

Absolutely.

David Fondrie - Heartland

And does that cost end up in inventory? Where does that, the equipment that you put into the Trauma center on a trial basis, as well as the consumables that are there, where does that cost flow through?

Rick Penn

Depreciation.

Kathleen Skarvan

Its fixed asset for the equipment and the disposables go through as a cost of sale.

David Fondrie - Heartland

So, is there revenue associated with the consumables even in the trial?

Kathleen Skarvan

Yes, it’s not a huge amount, so I don’t want to get overwhelmed with the amount that’s there.

David Fondrie - Heartland

So, it’s more on a cost basis. So you are providing it too on a cost basis so to speak in order to evaluate the equipment?

Kathleen Skarvan

We are providing in the disposables free of charge.

David Fondrie - Heartland

Okay. Thank you.

John Ingleman

One more point by the way, just a point of clarification. When we say that this is a six to nine-months sales cycle, that’s from the time we walk in the door to the time when we think when we have a shipment to the customer that we can build for. And so the time period in which they are actually doing an evaluation and consuming the sensors is two weeks to a month. And so we are not talking about two weeks to a month. And so we are not talking about nine months worth of them. Using the product is the evaluation which is somewhat about paying in a buck for them, so they want to be pretty comfortable with that. In fact, they believe there is some real value to do it. But that usually doesn't take all that long or that many sensors to supply to them either.

David Fondrie - Heartland

Great, thank you.

Operator

Thank you. Our next question comes from Mark Moskowitz with JP Morgan. Please go ahead.

Mark Moskowitz - JP Morgan

Yes, thanks. I may have missed a bit, but can you kind of help us understand how you really expect to go to market with the BioMeasurement products longer term. Obviously, it's a little different than the selling suspension assemblies to seven or so disk drive manufacturers. I am just trying to get a sense are you going to partner with other folks, you have some pretty good knowledge base and lot of folks are already on the ground in terms of partnerships or JVs and how does this work longer term from a go-to market strategy?

Kathleen Skarvan

Right now, we are starting out with the direct sales force. We have got about 25 people more or less between the US and Europe and we think we need to be direct at the beginning in order to really have people who are able to spend full time focus on the products which is the brand new metric to the world. I think if you go forward, then number of options are open to us and we haven't chosen one in particular. But no matter what the go forward part is, we still believe the first thing we need to do is to get the measurement embedded within the hospital that are using it and so we are using direct sales force for that purpose.

Mark Moskowitz - JP Morgan

And then what's the barrier to entry, I mean how far are you ahead of the competition?

Kathleen Skarvan

I think the barrier to entry is probably not just one but a number of different things. It's having a product design for market that is going into. It's having FDA approval and a [CE] mark in Europe. Its clinical studies that prove the value of the product within the clinical setting where its located. So, its bits and pieces I think along the way. Hard to say how far we are ahead of competition, probably a year to two.

Mark Moskowitz - JP Morgan

Okay, thank you.

Operator

Thank you. We have no questions at this time. Do you have any closing remarks?

Wayne Fortun

Yes. We want to say thank you for calling in today. We remain confident in where we stand with our quality, technology and cost leadership, and long-term growth opportunities for both these divisions. And thanks all.

Operator

Thank you. Ladies and gentlemen, this concludes the Hutchinson Technology's second quarter results conference call. If you'd like to listen to a replay of today's conference, please dial 1-800-405-2236, or internationally at 303-590-3000. Please enter access number 11088249. Thank you for your participation today. You may now disconnect.

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Source: Hutchinson Technology F2Q07 (Qtr End 3/25/2007) Earnings Call Transcript
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