Dot Hill Expects New Clients in 2012

March 15, 2012

Dot Hill (HILL) is up today after reporting a poor fourth quarter 2012 yesterday. Q4 results were in line with revised guidance given in February. Today's stock price upside came from new customer sign-ups that management hopes will provide both higher revenues and better margins in 2012.

Dot hill manufactures data storage arrays for the low-end of the enterprise market, selling to OEMs that typically rebrand the devices. A few years ago Sun was their main customer, but Sun dropped them, leading to a crisis. HP is now their main customer. While they are happy with the HP relationship, which was extended for five years last year, management has been building an impressive list of other customers, reducing reliance on HP.

Revenue in Q4 was $47.0 million, down 2% sequentially from $48.1 million and down 28% from $65.4 million year-earlier. Part of the y/y decline resulted from the purposeful ditching of NetApp as a client because NetApp would not allow Dot Hill workable margins.

HP represented 67.5% of revenue in Q4. In Q1 2011, after NetApp dropped out, HP accounted for 76% of revenue. Partly there was a drop in revenue from HP, but mainly their share shrank because Hill's sales to smaller, Tier 2 OEMs grew 40% y/y.

Q4 revenue was also hurt by the Thailand flooding and resulting shortage of disk drives. Hill did not raise its prices in Q4, but did raise prices in February largely because of the higher prices of disks due to the shortage. They estimated they could have generated another $4 million in revenue in Q4 if not for the disk shortages. Q1 also has seen supply shortages, but drives are generally available except for the highest-capacity, newest technology drives. The disk supply issue should be over by Q3.

Autodesk and Concurrent Computer were cited as OEMs signed in 2011 that are seeing sales ramps. Official announcements of newer customers should be coming out as the year progresses.

Finally, new storage arrays that have mid-level enterprise features should be released in the second half of the year. OEMs are already excited about them, but a significant revenue ramp of the new products is probably a 2013 story.

Earnings were disappointing. GAAP net income was negative $6.6 million, non-GAAP net income was negative $1.6 million, but some of the charges were non-cash. Cash flow from operations was positive by $1.1 million.

On the whole Dot Hill management was upbeat, particularly about the second half of 2012. The hope would be that with no disasters, a reasonably healthy global economy, and the ramping of lines at newer OEM customers, Dot Hill will be able to enter an era of sustained profitability. Given that the company is debt free and holds $46 million in cash, and that its market capitalization today is just $82.6 million, Dot Hill is highly speculative, but has a lot of upside potential if management can execute according to plan.

Disclaimer: I am long Dot Hill, and sometimes actively trade in the stock. I won't make HILL trades for 1 week after publishing this article. I do not have positions in any of the other companies mentioned.

William P. Meyers

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Copyright 2012 William P. Meyers