Friday, March 14, 2008

Dot Hill Q4 2007 Results

Dot Hill (HILL) stock plunged today on the news that ... there was no real news. I always wonder who is being stupid here, the people who bid up the stock when Dot Hill announced a new deal with HP, or the people who dumped the stock when the HP deal did not retroactively make Q4 2007 a wonderful quarter. Maybe they are the same people.

There was, of course, the illusion of news, or lack thereof, and the analyst conference did offer some insight into the trajectory of Dot Hill, a storage technology company. It was mostly glass half full stuff.

The biggest item was a non-cash write-down of goodwill. At $40.7 million it swamped everything else. I've seen quite a few of these lately, mostly at companies that have made acquisitions and then seen their stock prices drop. They are required when reporting GAAP (Generally Accepted Accounting Principles) numbers under rule SFAS 142. This is one of the rare cases when I think GAAP numbers are misleading. Goodwill is mostly an accounting fiction, and writing down a chunk in a single quarter tells you nothing about how a company performed in that actual quarter.

Revenue was $51.8 million, up 13% sequentially from $45.7 million in Q3 but down 14% from $59.4 million year-earlier. Non-GAAP net revenue loss was $5.7 million or $0.12 per share. See my summary of the Dot Hill Q4 2007 analyst conference for more data.

On the one hand Dot Hill management always seems to think profitability is just over the horizon. Years of losses keep the stock price low, with occasional bouts of optimism. The company had $82 million in cash at the end of the quarter, but it used to have a lot more and cash has been draining out quarter by quarter.

On the glass-half-full side, Dot Hill has transitioned out of a difficult situation and shown truly substantial progress on this. Dot Hill is in the data storage component business. A few years ago most of its business was acting as a supplier to Sun. Even then the situation was competitive, but then Sun bought a storage equipment company and is gradually phasing out the Dot Hill products. Yet the Dot Hill products were quite good. Sun is still the single largest customer, and sales to Sun were better than expected in Q4.

So Dot Hill has been looking for new customers and creating new products for them. They reported they now have 26 customers, mostly relatively small OEMs. But they work with big OEMS too. NetApp (formerly Network Appliances) became their second biggest customer after carrying a new line of products starting in Q4.

The problem with the transition has been the time required to develop new products, and the cost. Dot Hill has handled this well, conserving their cash better than most companies would. R&D expense in Q4 was only $5.9 million. They have also been finding cheaper ways to manufacture their products (while keeping quality high), which helps them compete and have a chance at being profitable.

It costs money to service any new customer, and quite a bit of money to get started on a volume ramp, as they have done with NetApp and are doing with HP. There is the danger that you can spend this money and then not sell enough goods to recoup costs, much less make a profit.

If Sun sales continue to ramp down slowly and HP and NetApp and other OEM sales ramp up relatively quickly, I believe management is right that Dot Hill can become (non-GAAP) profitable in some quarter of 2008. Want me to guess? I'll pick Q3.

I own a bit of HILL, so I might be overly optimistic, but I think I'm being pretty cautious. At this moment market capitalization (number of shares times price per share) is $119 million. That is for a company with $82 million cash, ballpark $200 million annual sales, and new contracts with NetApp and HP. I call that undervalued, but risky, since profitability is the key to real value.

Keep diversified.

More data:

My main Dot Hill page

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