Analyst Conference Call Summary

conference date: May 8, 2014 @ 8:00 AM Pacific Time
for quarter ending: March 31, 2014 (first quarter, Q1 2014)

Forward-looking statements

Overview: Within guidance, but investors had hoped for more. Looks pretty good to me, as vertical market revenue climbs nicely y/y.

Basic data (GAAP) :

Revenues were $48.2 million, down 18% sequentially from $58.8 million, and up 8% from $44.5 million in the year-earlier quarter.

Net income was negative $0.4 million , down sequentially from $2.2 million, and down from negative $1.0 million in the year-earlier quarter.

EPS (earnings per share) were negative $0.01, down sequentially from $0.04, and up from negative $0.02 in the year-earlier quarter.

Guidance:

Q2 2014 non-GAAP revenue is expected between $49 million and $54 million. Non-GAAP EPS $0.01 to $0.04.

For full 2014 anticipates 45% growth in Vertical Markets at midpoint of guidance range. This is from existing customers only.

Revenue in 2014 is expected to be more back-end loaded than in 2013.

Conference Highlights:

2014 started well with revenue within guidance and EPS above guidance. For the first time "gross and contribution margin dollars from our Vertical Markets segment" exceeded legacy server OEM contributions. In other words, more than half the gross profit came from sales into the vertical markets segment.

Biggest competitor is signaling it will leave the OEM segment (Engenio, now a subsidiary of NetApp).

Our products are sustantially faster than competing products at similar price points. We deliver first to market advantages with quality for vertical OEMs.

The macro environment is still tough for the storage industry close to flat y/y. Dot Hill can only grow by taking market share, focusing on vertical markets.

HP contributed $23.5 million, 48% of total revenue, down sequentially from $35.6 million. Believes HP is well-positioned to capture market share in 2014. Refreshed offerings; believes still has upside.

The critical vertical markets segment grew 59% y/y to $22.4 million and 21% sequentially from $18.5 million. Growth was fueled by mid-range products. Many customers are still in the early stages of their revenue ramps. Contributed $9.7 million to gross profit.

Overall server OEM revenue (including HP) was $26.5 million, down 35% sequentially from $40.8 million, and down 14% y/y from $30.8 million. Non-HP server OEM revenue was $3 million, down 29% sequentially from $4.2 million. More than one server OEM customer fell short of forecasts. Contributed $6.5 million to gross profit.

Non-GAAP numbers: revenue was $48.9 million, down 18% sequentially from $59.7 million and up 9% from $44.9 million year-earlier. Net income was $1.0 million, down 76% sequentially from $4.2 million and up from $0.0 million year-earlier. EPS was $0.02, down sequentially from $0.07, but up from $0.00 year-earlier. EBITDA was $2.0 million. Gross margin was 33.1%, up sequentially from 31.7%, and up y/y from 32.1%

Cash and equivalents ended at $40.3 million, sequentially from $40.4 million. Cash from operations was $1.1 million. No debt. Accounts receivable ended up at $33.7 million, with inventories up to $7.7 million.

Operating expense was nearly flat sequentially, with R&D increase offset by lower sales, marketing, general and administrative expenses.

Cost of goods sold was $32.9 million, leaving gross profit of $15.3 million. Operating expenses were $15.7 million, consisting of: $9.5 million research and development, $3.3 million sales and marketing, and $2.9 million general and administrative. Leaving operating of loss of $0.4 million. Other expense minimal. Income taxes near zero.

Q&A:

Q2 outlook spooked stock this morning. Server OEM outlook, confidence in? Believe it performed in line with industry in the quarter, at least the ones selling into datacenters. But our largest customer has launched 3 products recently that should give them an advantage of competitors in certain areas. Divestiture (WPM: at IBM) will help competitors (HP and Dell, maybe Cisco). Question is how much will go to the Cloud rather than corpoarte datacenters. This space has sales led by server sales. The processor refresh later this year may also help.

Pressures on HP across product line? We need to see their results to see how our products compared to other product lines there.

Don't know too many companies that posted 9% y/y data storage growth in Q1.

We have certain customers that have not yet hit stride on products they are selling or have announced. There are long lead times. We know their launch dates, but cannot share them.

Our largest competitor appears to be re-aligning from competition with us, so we may pick up more OEMs from that process.

Teradata's lower outlook today? We identified Tektronix as a greater than 10% customer. We will identify such customers. Teradata was not a 10% customer for us in Q1. We think the total available market for that customer is very significant. We will grow by taking share from our largest competitor and others. We believe Teradata is a fairly significant customer of our largest competitor. We think there is plenty of opportunity to grow that customer. We focus intently on executing to to our customers' needs.

How do you see your Teradata ramp? No change in our prior outlook.

Where did your vertical upside beat come from? Textronix, up 102% sequentially, but they are a lumpy business for us. We did well in teleco and other verticals as well.

We don't believe critical corporate data is moving to the Cloud anytime soon. It is mostly consumer data and small businesses. Enterprises will use a private cloud that they have full security control over.

R&D increase? Had to do with timing of need to purchase materials for new products and product launches. It was up just $0.6 million sequentially. So $9 million per quarter is a reasonable run rate.

Lower margins in the server OEM business was mainly due to the lower volume and revenue in the quarter. It also depends on the mix of products.

Industrial vertical? Yes, non-critical workloads could move to the cloud. We provide solutions for their product lineups. If cloud means they can't sell product they will be reluctant to move customers to the cloud. Appliance-based products are not moving to cloud services.

In the 2015, 2016 time frame the Vertical Segment should represent the bulk of revenue, so OEM server Segment sales ups and downs will be less important.

Our strategic initiatives include moving up the value chain, including Band 4 and Band 5. We move Band 5 and 6 features and performance to lower bands, which brings the market to us. We are also moving our products upstream to address more TAM at higher prices and higher margins. We are investing in that.

Exposing our detailed prospects and roadmap to analysts will not do our customers any favors, and we work for our customers. We believe we will continue to take market share within existing customers and by adding new OEM partners.

Yes, we have new customers in the pipeline currently being qualified.

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