Dot Hill's New Profit Plan
HILL

June 16, 2010

Yesterday Dot Hill revealed more details of its plans for achieving profitability by the 4th quarter of 2010. The big surprise is that they may stop selling to NetApp in 2011. In another announcement, they are selling or licensing their storage software, iSN, to advanced storage provider Xiotech.

Dot Hill used to provide data storage equipment primarily to Sun Microsystems, but that segment started to go away several years ago, and is essentially gone now, representing less than 1% of revenue. In the meantime they designed new storage hardware and sold it to premier OEMs HP and NetApp for rebranding. In 2008 they looked like that strategy was going to make them profitable by 2009. Then the recession hit.

Another problem has always been profit margins. In particular, to get the NetApp business Dot Hill sold devices for less than cost. There was a small margin on the actual price of the devices over the cost of manufacturing, but it did not cover operating costs like corporate overhead, R&D, and sales. It was hoped that costs for the devices could be lowered over time, and they have been, but the profit margin is still not there. Apparently NetApp is not willing to pay more, so they will begin manufacturing the devices themselves in 2011, or discontinue that line.

In Q1 Hill reported that NetApp represented about 30% of revenue, or $18 million. It may be a big deal to give up that much revenue, but I agree that Dot Hill should not stay in the business of subsidizing a larger, profitable company like NetApp.

HP represented 50% of revenue in Q1; without NetApp, Dot Hill will be in the same position with HP that they were with Sun a few years ago. To remedy that they are both working with a large number of small, value-added data storage companies (the channel) and looking for at least one more large OEM customer. Discussion continues to be underway, but even if a deal is made it would take several months for a new OEM to introduce a new line.

The brightest part of the picture is in software. Software has far better margins than hardware, and Dot Hill's new iSN (Intelligent Storage Networking) platform is highly regarded. Dot Hill is already selling some software with its systems through HP, and of course its channel partners will sell this too. Apparently you don't need Hill hardware to run the software; it should work with most storage hardware. The hope is that the new deal with Xiotech is the first of many. Again, it takes time to get a product to market. Dot Hill's R&D costs for software have gone up, so in the short run it makes the profit line look worse, but that should improve in a quarter or two.

The main method for achieving profitability will be the classic: cutting costs. In this case salaries are being cut 5% and 10% of the work force will be laid off. Manufacturing is being consolidated.

Altogether Management (Dan Kammersgard) believes that by Q4 Dot Hill will be able to break even on a EBITDA basis with just $60 to $65 million in revenue. They are projecting Q2 revenue of $62 to $65 million. Prior to the loss of NetApp, my guess is revenue is likely to ramp to more like $70 million by Q4 because of seasonality and the general health of the data storage industry. EBITDA (earnings before interest, taxes, depreciation and amortization) is usually the lowest standard of profitability. Non-GAAP net income would be nicer, and GAAP net income is the gold standard for reporting.

I consider Dot Hill to be one of my most speculative investments. On the other hand the stock is dirt cheap today at about $1.16 per share. That gives it a market capitalization of about $64 million. They expect to have a cash balance of at least $40 million at the end of Q2.

For more data on Q1, see my Dot Hill Q1 2010 Analyst Conference Summary . For past conference summaries and my earlier commentary see my Dot Hill main page.

And of course see www.dothill.com.

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