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Executives

Chuck Ives – Treasurer and Director, Investor Relations

Wayne Fortun – Chief Executive Officer

Rick Penn – President, Disk Drive Components Division

Dave Radloff – Chief Financial Officer

Analysts

Sherri Scribner – Deutsche Bank

Hutchinson Technology Inc. (HTCH) F3Q2012 Results Earnings Call July 26, 2012 5:00 PM ET

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Hutchinson Technology Third 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, Thursday, June 26, 2012. I would now like to turn the conference over to Mr. Chuck Ives, Treasurer and Director of Investor Relations. Please go ahead, sir.

Chuck Ives

Good afternoon, everyone. Welcome to our third 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, ramping new programs, product mix, pricing, production capabilities and volumes, the restoration of our assembly operation in Thailand, capital spending, product costs, operating expenses, product commercialization and adoption, clinical study results 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 third 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 we reported in late June, we saw demand for suspension assemblies weaken in the final weeks of our fiscal third quarter.

Our average weekly shipments in the quarter, in the last five weeks were more than 15% lower than they were in the first eight weeks. Our total shipments for the quarter did increased slightly compared with the preceding quarter, but less than we expected them to. The slight recovery in volume resulted in lower than expected fixed costs leverage in the quarter and prevented us from improving gross margin.

At our assembly operation in Thailand, we have resume production and have shift product for customer qualification. We expect the qualification process to be completed in a matter of days. We are bringing new units online at our Thailand assembly operation, as we steadily increase capacity there.

In our BioMeasurement division, we continue to focus on controlling the costs of operating the business and we're looking forward to the results of a number of critical care studies becoming publicly available in September.

I’ll turn the call over to Rick now for a recap of the Disk Drive Components Division's third quarter.

Rick Penn

Thanks, Wayne. During our fiscal 2012 third quarter, we shipped 100.1 million suspension assemblies, an increase of 3% from 96.9 million suspension assemblies in the preceding quarter, but short of our initial expectations which were for shipment of about 105 million to 115 million.

All of the volume increase in the fiscal third quarter was attributable to growth in shipments of suspensions for 3.5-inch ATA applications. Shipments of suspensions for mobile and enterprise applications declined compared to the preceding quarter.

For the fiscal 2012 third quarter, our mix of products shipped was as follows. Suspensions for 3.5-inch ATA applications increased 31% sequentially and accounted for 42% of our shipments, up from 33% in the preceding quarter.

Shipments for mobile applications declined 9% sequentially and accounted for 37% of our shipments, compared with 42% in the preceding quarter. And then shipments for enterprise applications declined 13% sequentially and accounted for 21% of our shipments, compared with 25% in the preceding quarter.

Our average selling price in the third quarter was $0.58, down from $0.63 in the preceding quarter. The decline primarily reflects a comparison to a second quarter ASP that benefited from a higher volume of development products for new disk drive programs.

Also contributing to the decline in AFP was the shift in product mix towards suspension assemblies for 3.5-inch ATA applications. We had anticipated that this mix shift would occur, as the industry supply chain continue to recover from last year’s flooding.

TSA+ suspensions accounted for 70% of our third quarter shipments, up from 55% in the preceding quarter. As a result of this shift to a higher mix of TSA+ and our improving TSA+ costs, our variable cost per part declined. The migration towards TSA+ should continue and we expect TSA+ suspensions to account for more than 80% of our volume by the end of the fiscal year.

DSA or dual stage suspensions accounted for a bit less than 1% of our fiscal third quarter volume. We currently expect DSA suspensions to become an increasing portion of our shipments at the beginning of fiscal 2013 and beyond, as programs that use DSA suspensions transition into volume production.

As Wayne mentioned, we resume production at our Thailand assembly operation during the third quarter as planned and begin shipping products for customer qualification, we continued to put additional units into production and ramp our Thailand assembly capacity.

We expect to have about half of our pre-flood capacity installed by the end of fiscal 2012 and to fully return to pre-flood capacity levels by the middle of fiscal ’12. The flood, while being installed around the industrial part in which our assembly operation is located is also on schedule.

As we stated previously, we expect to spend about $35 million over the course of fiscal 2012 and 2013 to restore our Thai assembly operation to pre-flood capacity levels and to cover the incremental costs of manufacturing in the U.S. during the recovery period.

Through the end of the third quarter, we spent approximately $23 million, including about $4 million of incremental costs in the third quarter. The incremental costs associated with manufacturing in U.S. rather than in Thailand and care the Thailand operation through the flood recovery period, we'll begin to abate as we enter fiscal 2013. At the end of fiscal 2013, we expect to begin utilizing the full capacity at our Thailand site and realizing the cost benefits we initially expected for the operation.

Regarding the outlook for demand, we expect our suspension assembly shipments for our fiscal 2012 fourth quarter to be relatively flat compared to our third quarter shipments, despite an extra week in the 14-week fourth quarter.

In response to current demand softness, we suspended operations during the first week of July and we are planning to produce less on a weekly basis in the fourth quarter than we did in our third quarter. As a result, our fixed cost leverage will be sequentially lower.

Beyond our fourth quarter, we are well-positioned on a number of our customer’s future disk drive programs. Thanks to development initiatives that have been in progress throughout the preceding quarters. Based on these program wins and our customer’s forecasts, we currently expect to ramp seven programs in fiscal 2013 that should improve our market share.

These two programs combined with our efforts doing large locations on existing programs, should help restore volume growth as we enter the new fiscal year. Compared to a quarter ago, we are even more encouraged about the opportunities and support that we are seeing from our customers.

So, now I will turn the call to Dave for discussion of our financial results.

Dave Radloff

Thanks, Rick. Net sales for the fiscal 2012 third quarter totaled $61 million, down $4.5 million or 7% from $65.5 million in the preceding quarter.

The revenue percentages for our top customers in the quarter were as follows, SAE/TDK at 44%, Western Digital 30%, Hitachi GST 12% 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 $342,000 from the BioMeasurement division, compared with $375,000 in the preceding quarter. We incurred an overall gross loss of $1.2 million or 2% of sales in the third quarter, compared with the gross profit of $2.6 million or 4% of sales in the preceding quarter.

On a quarter-over-quarter basis, the slight recovery in shipment volume and the decline in variable costs were not enough to offset the sequential decline in average selling price. The lower than expected volume and resulting lower fixed costs leverage prevented us from meeting our expected -- our expectations for gross margin.

We also incurred approximately $4 million an incremental costs to manufacture products in the U.S. rather than Thailand during the quarter.

Third quarter depreciation and amortization totaled $9.8 million, compared with $10.3 million in the preceding quarter.

R&D expenses in the third quarter were $4.2 million, compared with $4.3 million in the preceding quarter.

Third quarter SG&A expenses totaled $6.5 million, down from $7.9 million in the preceding quarter. The decline was primarily due to a reversal of previously accrued incentive compensation costs.

Our fiscal 2012 third quarter operating loss totaled $16.4 million, compared with $4.1 million in the preceding quarter. The sequential quarter change reflects the benefit to the $11.3 million of the flood insurance recoveries in the preceding quarter’s results. There were no such recoveries in the third quarters.

All insurance proceeds have been received as of January 2012. The fiscal 2012 third quarter operating loss included the following unusual items. $3.6 million of flood-related restoration and operating cost in Thailand and $0.4 million of debt refinancing cost related to exchange offer, tender offers and private offering completed in April.

Our BioMeasurement Division’s operating loss was $1.2 million compared with $1.5 million in the preceding quarter. Interest expense in the third quarter was $4 million compared with $4.3 million in the preceding quarter and included $1.1 million of non-cash interest expense compared with $1.7 million in the preceding quarter.

A net loss for the quarter totaled $13.9 million or $0.59 per share, compared with $7.5 million or $0.32 per share in the preceding quarter. Excluding the unusual items and non-cash interest expense mentioned previously, and a $5.9 million gain on debt extinguishment, our non-GAAP net loss for the quarter was $14.6 million or $0.62 per share, compared with the non-GAAP net loss of $11.2 million, $0.48 per share in the preceding quarter.

Our share count at the end of the third quarter increased to approximately $23.9 million as a result of shares issued through the exercise of warrants resulting in book value per share of $7.62.

We are good cash management quarter, reducing are days accounts receivable sales outstanding from $52 million to $37 million. This reduced receivable by $17.3 million, which coupled with $4.8 million reduction in inventories resulted in $12.1 million of cash generated from operations.

Capital expenditures in the quarter totaled $7.7 million and we also paid $2.5 million of debt refinancing cost. We ended the quarter with a cash and investment balance of $61.7 million, up from $56.1 million at the end of the preceding quarter.

Turning now to our outlook, as Rick mentioned, we expect our fourth quarter suspension assembly shipments to be about flat compared to our third quarter shipments of 100 million units. Pricing is expected to remain competitive. We expect our gross loss to increase in the fourth quarter due to lower plan weekly production volume, which will result in lower fixed cost leverage.

As previously mentioned, we expect the customer qualification to be completed very soon for the suspensions that were shipped from our assembly operation in Thailand. Once that process is complete, majority of the Thai operating costs that have been classified as flood related for the last three quarters will now be included in cost of goods sold.

Going forward, we continue to estimate that our SG&A expenses will be approximately $8 million per quarter and our R&D expenses should be about $4 million per quarter.

Depreciation and amortization expense is expected to be approximately $11 million per quarter. Our interest expense is expected to be about $4 million per quarter with the non-cash portion of $1.1 million per quarter.

All of this expense guidance is based on a 13-week quarter. The fourth quarter of fiscal 2012 will be a 14-week quarter. This will result in another week of expenses during the fourth quarter and you should take this into account for modeling purposes.

Our tax rate is expected to be near zero in fiscal 2012. We estimate that our fiscal 2012 capital expenditures will now total approximately $30 million including cost related to restoring operations in Thailand.

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

Wayne Fortun

Thanks, Dave. Through the current softness in demand, we are currently continuing to carefully manage our cost and cash. In the meantime, we’re pleased to have our assembly operation in Thailand back in production.

While we are disappointed by the delay in our market share recovery and weaker than expected volume in the third quarter, the shift in product mix towards our TSA+ products bodes well for our future.

We are very encouraged by the level of activity and the customer response to our products or new disk drive programs. We will compete hard to capture increased volume of our customer -- on our customer’s new and existing programs.

In both of those efforts, we can leverage the lower cost of our TSA+ process. Overall, we remain optimistic about the growth opportunities for hard disk drive storage and the demand for suspension assembly.

That concludes our prepared remarks. [Camile] please begin the polling question -- polling for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from the line of Sherri Scribner with Deutsche Bank. Please go ahead.

Sherri Scribner – Deutsche Bank

Hi. Thank you. I was hoping to get a little bit of detail on the mix shift that you saw this quarter. I guess I’m a bit surprise that 3.5-inch would be up 31% and then 2.5 inch would be down 9%, because that doesn’t really reflect what we think the HDD market we’re seeing. So can you give us some sense of, are you gaining share in 3.5-inch, you’re losing share in 2.5-inch, what’s going on there?

Wayne Fortun

Sherri, the main dynamic there is primarily flood related. And we saw that 3.5-inch pull back as our major customer was most affected by the flood. And now we’re seeing some of that come back.

And so -- look around as a team here but I think maybe they way to think about is sort of a typical mix would be sort of 40:40, 20:40, desktop 40, mobile 20, enterprise or something like that. Just as a general way to think about it and it will bounce around those numbers somewhat but really you are seeing kind of a flood impact in the recent events.

Dave Radloff

And prior to the flood, our mix of 3.5-inch ATA was actually 55% if you go back to quarter four of 2011, we are still not even back to that.

Wayne Fortun

Yeah. Okay.

Sherri Scribner – Deutsche Bank

And why would the mobile piece go down when your units were up a little bit, in terms of the units being down 9%?

Wayne Fortun

Just programs shifting around Sherri. Frankly, when we sort of look at this, go and look ahead we may see some of the opposite effect. So I think it just programs bouncing and where we’re positioned on those programs.

Sherri Scribner – Deutsche Bank

Okay. Can you give us an update on what you think your market share is by those three end markets?

Wayne Fortun

Yeah. We’ll look it up roughly a little under half of the enterprise market. I think 45% of that is something like that. And mobile maybe 15% and I think, desktop something in the same range 15% roughly.

Sherri Scribner – Deutsche Bank

Okay. And in terms of thinking about the 14-week quarter for the fourth quarter, I think it’s pretty straight forward for SG&A and R&D to adjust that to add an extra week, but in terms of COGS impact. How much impact would you expect to see in COGS from the 14th week? Thanks.

Wayne Fortun

Sherri, I think probably easiest think to do is to think that we’re about 50% variable and 50% fixed and that 50% fixed not entirely but generally has an extra week.

Sherri Scribner – Deutsche Bank

Okay. Great. Thank you.

Wayne Fortun

Thanks.

Operator

(Operator Instructions) And I’m showing no questions in the queue at this time. Please continue.

Wayne Fortun

Well, we want to thank everyone for the call -- their attendance today in the call. And we look forward to this coming quarter and that we think that we have some momentum going with the new programs as we described. Thank you.

Operator

Ladies and gentlemen, this concludes the Hutchinson Technology third quarter results conference call. You may now disconnect. Thank you for using ACT conferencing.

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