Analyst Conference Call Summary

conference date: November 8, 2012 @ 1:30 PM Pacific Time
for quarter ending: September 30, 2012 (third quarter, Q3 2012)

Forward-looking statements

Overview: About as expected, essentially flat in a normally seasonally higher quarter.

Basic data (GAAP) :

Revenues were $48.2 million, up 1% sequentially from $47.8 million, and up slightly from $48.1 million in the year-earlier quarter.

Net income was negative $3.0 million, improved sequentially from negative $5.0 million, and much improved from negative $12.2 million year-earlier.

EPS (earnings per share) was negative $0.05, up sequentially from negative $0.09, and also up from negative $0.22 year-earlier.

Guidance:

Q4 2012 revenue range $48 to $53 million, with non-GAAP EPS between negative $0.03 and positive $0.02.

Conference Highlights:

"Encouraged with the early response to our new Pro 5000 and 4000 series products." Believes the new products offer high performance and cost-effectiveness for new virtualized environments. Described the economic climate as "tough." Believes some Q3 orders slipped into Q4.

Company-specific factors will drive top-line growth in 2013.

Non-GAAP numbers: gross margin 26.4%, down both y/y and sequentially due to higher warranty related charges. Net income was negative $1.7 million, down from positive $0.5 million year-earlier. EPS negative $0.03 vs. positive $0.01 year-earlier. EBITDA negative $0.9 million.

Vertical market revenue was $10.2 million, up 6% y/y. There was some softness in the channel business in both Europe and the U.S., especially in September. Media and Entertainment vertical is responsible to leading the ramp. Dot Hill provides features customized for several vertical markets, reducing competition. Margins in verticals are higher than in the server OEM business.

Server OEM business revenue was $36.5 million, down 1% y/y. HP relationship remains strong. New marketing programs have been launched. HP represents 68% of revenue vs 73% year-earlier.

Service revenue was $1.5 million.

4000/5000 ramp is basically sampling in Q4 with revenue growth in 2013.

Cash and equivalents ended at $40.5 million. Debt $1.8 million. Cash used in operating activities was $1.0 million.

Cost of goods sold was $36.0 million, leaving gross profit of $12.2 million. Operating expenses were $15.1 million, consisting of: research and development, $9.3 million; sales and marketing $3.6 million; general and administrative $2.3 million; restructuring benefit $0.1 million. Operating income was negative $2.9 million. Income taxes $0.15 million.

Q&A:

Vertical markets revenue history: Q2 2012 $10.0 million, Q2 2011 $8.4 million, Q3 2011 was $9.3 million.

Vertical market projects? Depends on products that have not yet been announced. It should grow faster than the overall market, but it is too early to predict in detail.

Gross margin differential? Will not give specifics, but is significantly higher in vertical markets than in OEM.

Cash in Q4? Gross cash was about flat from Q2, but borrowed $1.2 million on credit line. Accounts payable was up to 70 days vs. 60 in the prior quarter, which is just a timing issue. Cash balance will go down in Q4, and we are likely to borrow more on the credit line.

Headcount? 316, down from 323 in Q2. Should be roughly flat in Q4. We are managing op ex tightly because of the macro environment. We may defer projects to keep op ex down. In addition to full time employees we have contract employee relationships, particularly in India.

4000/5000 ramp? We have about 8 in the field with end users. Average selling price $45,000 to $65,000 (HILL's revenue, not reseller's price to customers).

We were reasonably happy with October sales closings, that included some deals slipped from September. But since in Q3 the last month was weak, we are not sure if that won't happen again in December.

Described the dependence on customers for length of the negotiation and launch cycles, basically 3 to 9 months from signing to first sale, but then there is the partner's own ramping time too.

New customer wins imply customization, which increases the R&D expense budget. The expense comes before the revenue. We are scaling back spend on 4000/5000, but now working on new entry-level products for 2013.

Questioner negative review of HILL history and cash burn, strategy of entering mid-range market. Questioned going into niche market. Suggested "putting everyone out of their misery." Management response: positive spin on launch of 4000/5000 midrange products. 4000 series is geared to OEMs, with 3 OEMs in launch phase and 6 OEMs in sales (pre-launch) cycle. We believe the mid-range product strategy is working, it is just very early in the cycle. Will provide 2013 revenue estimates in first quarter of the year.

Entry level products currently are a 2010 design. Needs to update to stay competive. New products will double performance, with goal of being early to market. Cannot just stop development in this business.

Increased sharecount over last few years came from Cloveleaf purchase and stock-based employee compensation. The lower stock price has meant that executives have felt the pain rather than being paid cash.

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