Dot Hill Accelerates

Dot Hill (HILL) reported on its second quarter today, and it was quite a quarter. The long-promised turn-around has begun with a thundering 34% increase in revenue over the first quarter. See my Dot Hill analyst conference summary for September 6, 2008 to get the gist of what management said about Q2, including its answers to analyst questions.

Be warned, I own some HILL stock because I suspected this was going to happen. The company was in pretty dire straights a couple of years ago. Its stock has been dirt cheap since then, and still is. Management tried a number of initiatives while burning carefully through a pile of cash. The problem was that most of their business was supplying SAN storage products to Sun. First Sun had its well-publicized difficulties, then Sun bought a storage company and so started phasing out Dot Hill products. Adding to diffuculties, Dot Hill settled a patent dispute with rival Crossroads, giving up a substantial amount of cash in the process.

Dot Hill used its cash to support a research and development drive that took a while to pay off. Its improved storage devices first sold to a number of small equipment manufacturers and specialty shops. Then NetApp picked them up in late 2007. But the big driver of Q2 revenues was a partnership with HP, which generated about $23 million in revenues for Hill in Q2. Also a plus, Dot Hills old products are so good that Sun customers continue to buy them, to the tune of about $20 million in revenues for Dot Hill during the quarter. The Sun revenue is ramping down, but revenue from HP, NetApp and smaller vendors is ramping up much more quickly.

Dot Hill still has a ways to go to guarantee it won't become another tech has-been. It lost money on its $71 million in Q2 sales. From my point of view this is okay. The money was used to develop new products and market them. HP had special modifications made to the equipment it bought, which was expensive. Now those expenses should ramp down, although in technology there is always the next product cycle to think of. The key to profitability is decreasing production costs. Part of this happens naturally as the product cycle lengthens and the number of units sold increases. Part of it must be driven by engineering for value.

As I see it, while things can always go wrong, we are looking at a company that will soon have $300 million in annual revenues. With cost reductions there is no reason $30 million in annual net income can't be generated, maybe not in 2009, but certainly in 2010. Give that a modest PE ratio of 15, and you have a company that could have a market capitalization of $450 million within a reasonable time horizon.

What was the market capitalization at the close of trading today? Less than $114 million.

Hill has disappointed investors on a regular basis for a few years. It might disappoint again. But with $62 million in cash, guidance to $73 to $78 million in revenues for Q3, and such a low stock price, I think the upside potential far outweighs the down side.

Note again that I own some Dot Hill stock.

Keep diversified!

More data:

www.dothill.com