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Hutchinson Technology Inc. (NASDAQ:HTCH)

F2Q12 Earnings Call

April 24, 2012 05:00 pm ET

Executives

Chuck Ives - Treasurer and Director, IR

Wayne Fortun - CEO

Rick Penn - President, Disk Drive Components Division

Dave Radloff - CFO

Analysts

Sherri Scribner - Deutsche Bank

Rich Kugele - Needham & Company

Mark Miller - Noble Financial

Justin Lu - Zazove Associates

Operator

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

During today's presentation, all participants 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 24th, 2012. And at this time I would now like to turn the conference over to Mr. Chuck Ives, Treasurer and Director of Investor Relations. 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, 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, product mix, pricing, production capabilities, the restoration of our assembly operation in Thailand, capital spending, product costs, operating expenses, 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. Second quarter suspension assembly shipments were in line with our expectations. Our volumes increased compared with the preceding quarter as the disk drive industry supply chain continued to recover from last October's flood-related disruptions. We have been able to meet all of our customer requirements during this recovery period by taking advantage of our vertically-integrated US operations, although at somewhat higher costs and we're responding to further increases in demand as the industry recovery continues.

We are pleased to report that our work to restore production at our assembly operation in Thailand is proceeding on schedule and we plan to resume production there by the end of June. We currently expect to be at pre-flood capacity levels by the middle of fiscal 2013.

After the close of the second quarter, we completed another round of debt refinancing. This refinancing improves our financial position by extending the maturities of a significant portion of our debt and reducing our overall debt balance while maintaining our cash level. I will turn it over to Rick now for a recap of the disk drive components business.

Rick Penn

Thanks Wayne. During our fiscal 2012 second quarter, we shipped ready 96.9 million suspension assemblies, an increased of 9% compared with the first quarter and in line with our expectations. Compared to our first quarter shipment rate for the 11 weeks following the flood, our second quarter shipments of 7.5 million per week represents a 15% increase. Shipments increased in all segments with the largest increase for enterprise applications. We estimate that our overall market share has remained around 20% during this period of supply chain disruption.

For the fiscal 2012 second quarter our mix of products shipped was as follows; suspensions for 3.5-inch ATA applications increased 3% sequentially and accounted for 33% of our shipments compared with 35% in the preceding quarter. Shipments from mobile applications increased 7% sequentially and accounted for 42% of our shipments compared with 43% in the preceding quarter and shipments for enterprise applications increased 20% sequentially and accounted for 25% of our shipments up from 22% in the preceding quarter.

Our average selling price in the second quarter was $0.63 compared with $0.60 in the preceding quarter. The increase was primarily the result of increased volume of development products reflecting a high level of activity on new disk drive programs and without this, our average selling price would have been relatively flat. Our second quarter shipments of TSA+ suspension assemblies accounted for 55% of our shipments, up from 52% in the preceding quarter and as you may recall TSA+ suspensions were 60% of our shipments in the fiscal 2011 fourth quarter before the flood-related supply chain disruptions.

We expect the migration towards TSA+ to continue as the supply chain recovers with TSA+ suspensions accounting for more than 80% of our volume by the end of the current fiscal year. As we reported previously, we continue to work with multiple customers on dual stage actuated or DSA suspension assemblies. DSA suspensions accounted for 1% of our fiscal second-quarter volume and we expect DSA to grow at the percentage of our product mix over the coming quarters.

Our DSA products are performing very well and we have the proficiency and capacity to produce DSA products in volume. We are pleased with the level of activity and the progress we are making on both DSA and single-state suspensions or new disk drive programs. As we mentioned earlier, our restoration efforts at our Thailand assembly operation are on schedule. We have begun to move equipment and people back into the facility and we expect to resume reduction by the end of June.

We estimate that we will spend approximately $30 million in the current fiscal year and an additional $5 million in fiscal 2013 to restore our Thai assembly operation to pre-flood capacity levels and to cover the incremental costs of manufacturing in the US during the recovery period.

These costs will be partially offset by $25 million of insurance proceeds and we've spent approximately $15 million through the second quarter and we have received all of the insurance proceeds. Regarding the outlook for demand, we expect our fiscal 2012 third-quarter suspension assembly shipments will total 105 million to 115 million and we expect further volume growth in our fiscal fourth quarter as the disk drive supply chain continues to recover. Our shipments will begin to shift back towards the segment mix that we had prior to the flood and suspension assembly pricing will remain competitive.

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

Dave Radloff

Thanks Rick. Net sales for the fiscal 2012 second quarter totaled $65.5 million, up $7 million or 12% from $58.5 million in the preceding quarter. The revenue percentages for our top customers in the quarter were as follows. SAE/TDK 60%, Hitachi GST 15%, Western Digital 11% and Seagate 11%. The suspensions that we sold to SAE/TDK were primarily for Western Digital and Toshiba disk drive programs.

Net sales for the quarter included BioMeasurement division revenue of $375,000 compared with $416,000 in the preceding quarter. Our total gross profit in the second quarter was $2.6 million or 4% of net sales compared to2.3 million or 4% of net sales in the preceding quarter. Our cost of goods sold in the second quarter included approximately $3 million of incremental costs to manufacture in the US as opposed to Thailand.

Additionally gross profits was dampened by lower fixed cost leverage as we build fewer components to restock inventory Q2 than we had in Q1. Second-quarter depreciation and amortization totaled $10.3 million compared with $9.3 million in the preceding quarter. R&D expenses in the second quarter were $4.3 million compared with $4 million in the preceding quarter. Second-quarter SG&A expenses totaled $7.9 million compared with $7.2 million in the preceding quarter.

The sequential quarter increase was expected in light of a gain on some asset sales in the preceding quarter that benefited SG&A expenses. Our fiscal 2012 second-quarter operating loss totaled $4.1 million compared with $8.1 million in the preceding quarter. The fiscal 2012 second-quarter operating loss included the following unusual items. $11.3 million of flood-insurance recoveries, $2.4 million flood-related restoration and operating costs and $3.5 million of debt refinancing cost.

Our BioMeasurement division’s operating loss was $1.5 million compared with $1.1 million in the preceding quarter. We expect to lower the division’s quarterly operating loss to below $1 million within this fiscal year.

Interest expense in the second quarter was $4.3 million flat with the preceding quarter and included $1.7 million of non-cash interest on our convertible debt, also flat with the preceding quarters. Our net loss for the quarter totaled $7.5 million or $0.32 per share as compared with a net loss of $12.5 million or $0.53 per share in the preceding quarter. Excluding the unusual items that I mentioned previously, a non-cash interest expense of $1.7 million, our non-GAAP net loss for the quarter was $11.2 million or $0.48 per share. In the preceding quarter, our non-GAAP net loss was $11.5 million or $0.49 per share.

Our share count at the end of the quarter was approximately 23.4 million resulting in book value per share of $7.99. Cash generated from operations in fiscal 2012 second quarter totaled $11 million, including $16 million of insurance proceeds that we received during the quarter. Capital expenditures in the second quarter were $8.5 million and we also paid $1.4 million of debt refinancing costs.

Our cash and short-term investments at quarter end totaled $56.1 million compared with $55.8 million at the end of the preceding quarter. After the close of our fiscal 2012 second quarter, we completed another round of debt refinancing through a tender and exchange offer and a private placement of new debt. As a result of the refinancing, we reduced the principal amount of our outstanding debt with a first put in January 2013 from $76.2 million to a very manageable amount of $11.9 million. The portion of our debt was a first put in 2015 has also been reduced from $85.2 million to $58.5 million. In the par value, our overall debt balance is down to $149.3 million from $161.4 million.

Through the exchange offer in the private placement, we issued 78.9 million of new 8.5% senior secured secondly notes doing 2017. This new debt issuance enables us to maintain our cash level while repurchasing 47.8 million of our outstanding debt for 36.9 million of cash.

The refinancing strengthens our financial position by extending the maturities on a significant portion of our debt and provides us with the time needed to fully implement our initiatives to become the lowest cost producer of suspension assembly.

Turning now to our outlook. As Rick mentioned, we expect third quarter suspension assembly shipments to increase 8% to 19% sequentially to 105 million to 115 million.

Our shipments will be begin to shift back toward the products mix that we had prior to the flood with a higher mix of suspension for 3.5-inch ATA drives, and pricing is likely to remain competitive. We expect the gross profit to improve as higher volume increases our fixed cost leverage and is transitioned to lower cost TSA+ product results.

Our cost and goods sold will be higher while we are reliant on US assembly operations to provide capacity, then we would have had in Thailand if not for the flood. We estimate these higher costs will be approximately $4 million recorded in our fiscal third and fourth quarter. And thereafter we’ll begin to abate as we increase output from our assembly operation in Thailand.

We estimate that our SG&A expenses will be approximately $8 million per quarter and our R&D expense should be about $4 million per quarter. Depreciation and amortization expense is expected to be approximately $11 million to $12 million per quarter. Our interest expense is expected to remain flat at about $4.3 million per quarter with the non-cash portion declining to a little more than million dollar per quarter.

All of this guidance for our quarterly expense is based on a 13 week quarter however the fourth quarter of fiscal 2012 will be a 14 week quarter. This will result in another week of revenue and expenses during the fourth quarter and you should keep this in mind from outlining purposes. A tax rate is expected to be new zero in fiscal 2012. We estimate that our fiscal 2012 capital expenditures will total approximately $35 million including cost related to restoring operations in Thailand.

I will turn the call over to Wayne for his closing comments.

Wayne Fortun

There are a number of encouraging signs in the overall industry environment and our position growing forward. In the industry, suspension assembly demand appears to be growing as it describes supply chain continues to gets recovery from last year’s flood and production of [Inaudible] increases. In our own operations, we have been able to use our vertically integrated U.S. capabilities and capacity to meet customer’s requirements while our assembly operation in Thailand has been off line.

As volume returns and we are well positioned from a competitive standpoint. We have substantially reduced our cost to our restructuring and manufacturing consolidation efforts. In addition, we expect an increase in portion of our shipments will be TSA+ products which will further reduce our cost. Our cost model also will be enhanced by the return to our production of our assembly operation in Thailand, and a steady ramp to higher output there.

Finally, we have significantly restrengthened our financial position with debt re-financing that was accomplished after the close of the second quarter. Overall, we are encouraged by our prospects and we will continue to focus on improving our financial performance. That concludes our prepared remarks. Vince, please begin the polling for questions.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) And our first question is from the line of Sherri Scribner with Deutsche bank. Please go ahead.

Sherri Scribner - Deutsche Bank

Hi, thank you. I want to get a sense of the ASPs that you saw this quarter. You mentioned that they were up on development costs for new programs. I wanted to understand are those new programs related to issues because of the Thailand floods. So I guess what I am saying is, is that because we had designed new drives in order ship drives after the Thailand floods. Are these new programs with new customers potentially help you diversify your customer base?

Rick Penn

Hi Shirley, this is Rick. They’re really new drive programs and the industry is in a cycle where there are customers are sort of moving to the next program levels and the next density points. So these are new programs across customers. That activity has been picking up and we have been performing. I think solidly in that activity and that sort of fostered more activity. So we are very, very busy across customers and that for both dual stage and single stage products for new programs.

Sherri Scribner - Deutsche Bank

Okay. And are the dual stage and the TSA+, are those better margins, and also as we move to the new areas and see is it typical that you moved to the TSA+?

Dave Radloff

Well, on TSA+, first of all everything is moving to additive and to TSA+ and of course a portion of what we supply is also using NITTO DENKO flexure at CIS. We have better margins with TSA+ product than the old TSA product. So directionally, that's good. And on TSA it’s early; there is more value being added to those products. There is piezoelectric motors that micro-actuate the suspension and so there is more value, the pricing is different and the margins are perhaps overtime a bit better than single stage.

Sherri Scribner - Deutsche Bank

And then I guess looking at your market share commentary, you mentioned in the prepared remarks that you didn't think you had lost share, but as I look at your unit growth you are up about 9% sequentially and the industry was up 20% and the enterprise drove a lot of your growth. I am just trying to understand and reconcile why you think you haven't lost share when industry is growing a bit faster than?

Rick Penn

Yeah, there is a few moving parts Sherri, as you know the suspension end of the supply chain doesn’t always move and lock-step with the growth rate so that drive, at the drive level quarter-by-quarter. There is a couple of things when the drive can’t pull back from the flood, our demand to pull back but a little bit less decline. There are some other things going on, we are not sure how to quantify but, we’ve been hearing and think that the disk drive mix has been mixing down in terms of hedge per as the drive companies have been racing like crazy to try to supply their customers. And so there maybe a hedge per factor that has come down perhaps temporarily that affects us at the suspension end of things and we not sure what that effect is quantitatively.

So there are some moving parts, but I think if you look at our levels of shipments just after the flood and compare those net to the levels in the last quarter, we’re up about 15%. So we doesn’t always track exactly with the drive guys, but we think roughly our share has been holding solid in around that 20% range and frankly because of how effective WD was and how large our business is with them. Theoretically, one would have though that share might have taken a more noticeable hit rate or a noticeable hit. But because of some increases at a couple of customers throughout as we think we’ve held about study.

Operator

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

Rich Kugele - Needham & Company

Just a couple of questions; I believe on the last conference call you had talk about potential portion of share gains with some of your vendors in the second half of the calendar year. Do you still see those programs still in place where you can share?

Rick Penn

I am not trying to think to actually what we specifically said Rich, we think that as the industry recovers from the flood impacts and we look at where we’re lined up that we could see at least some modest gains and we also believe that given how we’re participating and active on a number of the new programs that we’re positioned nicely over the long haul to strengthen that share even further. But we’ll have to see how that plays out; we’re very optimistic on how that picture looks when we roll forward though.

Rich Kugele - Needham & Company

And then with the new regulations being imposed on the WD and Hitachi merger, especially regarding product integration, do you now expect those programs to continue, are you getting any signals that at least that being I guess, completely customer specific that you are going to continue supply those lines for the foreseeable future?

Rick Penn

Yeah. We don’t know how the combination is going to play as you roll forward and how quickly that will combine. But we are working across the board with WD programs and like the way that looks and we also have some openings and possibilities on HTST programs looking forward, so we are working with both of those customers. For the moment as though they are separate because they are and lining up pretty well on the upcoming programs. In both cases, we think this is certainly strong at WD. And as those companies come together we think that’s ultimately good for us.

Rich Kugele - Needham & Company

Okay and then just one last one for me and I believe this is not an easy question, what is necessary really to bring the company back to a breakeven, do you need the market to get back to a certain shipment level for you, is it a mix shift, is it just lowering the cost, is it cheesing US production further, how do we get there and what is the new breakeven level to get to reach that level?

Rick Penn

You hear a lot of pieces actually Rich, it is ramping; Asia will be a piece of that. It is recovering the industry at the lines and it’s also ramping TSA+, so all of those things are being piece of that.

Rich Kugele - Needham & Company

So not assuming any share, you know, you could do it at 20% share just you need the industry to grow?

Rick Penn

It depends on your timing I think; more volumes sooner helps that whether that’s industry growth or whether that’s picking up some share volume. So I don’t know that we’re prepared to give you a specific revenue level, that’s a breakeven level, because there are so many moving pieces right now as we recover from the flood. But certainly, those are the three biggest pieces and we are going to continue to keep after the cost and reducing those points, of the cost points within our operations, so can we see that we can do it; we do see that we can reach there, the breakeven point.

Wayne Fortun

Rich it’s Wayne speaking; I think that part of the arm misfortune was that just at the time when we finally completed the consolidation and the last round of restructuring and pulled in cost out we got hit by the flood and so we really never got a chance to see the results of that cost reduction and so we think that as the volume returns and get back towards at least where we were prior to the flood and then maybe what might be an upside from that and general industry, I don’t know that we would have to gain share to start getting the numbers that could be quite interesting.

Rich Kugele - Needham & Company

And the intension still is once Thailand comes back online to shift all the production over to lower US cost again?

Rick Penn

Yeah, I mean, when it comes to the assembly piece of the operation, the intent is to do the lion’s share of that in Asia and grow that all back. Now we will have some assembly in the US as we do our development work and start up programs but we quickly move that to Asia and as the assembly, as the business grows and the assembly piece of the business grows we will keep doing that in Asia and expanding in Asia for that.

Operator

Thank you. Our next question comes from the line of Mark Miller with Noble Financial. Please go ahead.

Mark Miller - Noble Financial

Just wondering if you can just give me one more time the percent of net sales by customer, I didn't get it all.

Dave Radloff

Okay, SAE/TDK are 60% this past quarter Mark, Hitachi GST was 15%, Western Digital was 11% and Seagate was 11%.

Mark Miller - Noble Financial

You had mentioned you are recalling some new programs for Seagate, is it possible that, that looks pretty similar to what you have done before, is it possible to see units to Seagate grow as a percentage of total or as a percent?

Rick Penn

Yeah, Mark. Our momentum with Seagate, it continues to be good. We are working real productively with their teams and making really good progress on qualifying on a bunch of new programs and we believe that over time that, that translates into higher volumes with Seagate, but we really can't tell you anything specifically about that timing and when. We are just working hard and lining up on the programs and we will have to see how that goes, but of course we are optimistic about the volumes, down the road going up with Seagate.

Mark Miller - Noble Financial

You had mentioned margins were kind of flat this quarter, you had about your shipments went up and I am just curious that you mentioned something that was lower fixed-cost absorption because there were less inventory build. What would have been if you had more than the normal amount of inventory build?

Dave Radloff

We think that's maybe about a $1.5 million.

Mark Miller - Noble Financial

Okay so it goes about a million. I'm just trying to understand also you said your comps would be $4 million higher because you are not manufacturing in Thailand so I assume that’s higher than what it would have been pre-flood is that correct?

Rick Penn

No, so that’s a little bit of the difference in the numbers that we talked about last quarter, we talked maybe 2 million which could have been the amount based on the volume we had in Thailand at the time. When we talked the $4 million cost differential that the cost of the portion that we would more or less have in the Thai facility had we not had the flood and so that's getting close to being full and we would have been close to full and we get out to the end of this fiscal year and so that's the 4 million is the opportunity when we fill that facility is the way to think about that Mark.

Mark Miller - Noble Financial

So you will improve about $4 million. Okay, you mentioned gross margins would be higher, anything more specific there next quarter or in this quarter?

Rick Penn

We see that we expect our variable cost to improve next quarter also and part of that TSA+ but there is some other things also as we move forward into the next quarter that are going to improve our variable cost.

Operator

(Operator Instructions) And our next question is a follow up question from the line of Sherri Scribner with Deutsche Bank. Please go ahead.

Sherri Scribner - Deutsche Bank

I just wanted to ask you a quick question about the ASPs excluding the new program of development that you are working on. You mentioned ASPs are relative flat. I guess I am just curious with HDD prices up so much and Seagate talking about, how they are helping out their component suppliers. What are the dynamics in the suspension industry that aren’t allowing you guys to get a bit better on ASPs at this time? Thanks.

Wayne Fortun

Yeah, sure Sherri. Well, first as we talked about before, there was really no shortage of suspension supply to the drive dives after the flood. So the dynamic and the pricing dynamics are just very, very different than what drive dives are realizing at this stage of the game whether that’s substantial shortages and trying to meet those. So we just don’t have that dynamic at our end of the supply chain.

Having said that, then prices have been steadier, so for example volumes have been lower because of the flood overall and so price break point, volume point have reached to have taken longer to reach that kind of thing. There are some situations where because of really jumping through an expediting, we have been able to hang on to the pricing a bit longer, but it’s still competitive. The suspension guys have capacity to meet the requirement and it’s a different dynamic.

As far as customers helping the suppliers, I think we’ve have been helped a bit; as an example, been helped on some faster payment terms in one case which helps cash, but again, it’s different at our end of the supply chain than it is at the disk drive end of the supply chain.

Operator

Thank you. Our next question comes from the line of Justin Lu with Zazove Associates. Please go ahead.

Justin Lu - Zazove Associates

I just want to clarify one thing, the $35 million of CapEx spend this year, does that include the $10 million remaining of insurance proceeds that you had to spend or is that an addition to that?

Dave Radloff

It would include any of the tied CapEx also, so those are not additive Justin.

Operator

Thank you. Our next question is a follow-up question from the line of Mark Miller with Noble Financial. Please go ahead.

Mark Miller - Noble Financial

Just wanted to review the due dates and the amount when the new debt structure; I thought its $78.9 million, was that 2017?

Dave Radloff

That’s correct Mark, so that its $11.9 million in January of 2013; $50.5 is the first put date in for adjusted to or put to us in January 2015 and then the $78.9 million is 2017, January also, they are all January dates.

Operator

(Operator Instructions) And I am showing no further questions at this time. I would like to turn the conference back over for to Mr. Fortun for any closing comments.

Wayne Fortun

Well, thanks to everyone for calling in today and showing your interest and we are pleased with the progress we are making and looking forward to the position is a stronger one for us and stronger one for the industry as well. Thanks.

Operator

Thank you, sir and ladies and gentlemen this does conclude the Hutchinson Technology Second Quarter Results Conference Call. Thank you very much for your participation. You may now disconnect.

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