Dot Hill Does Well By HP, Looks For More Partners

Dot Hill (Nasdaq: HILL), a data storage equipment manufacturer, had a very interesting analyst call reporting Q1 2011 results last Thursday. Until December NetApp had been Dot Hill's second largest customer. But profit margins for that particular relationship for Dot Hill were negative, and negotitions with NetApp were not fruitfull. So Dot Hill dropped NetApp.

The result was a pretty steep drop in revenue to $49.2 million, down 25% sequentially from $65.4 million in Q4, and down 18% from $60.0 million year-earlier. Q1 is typically the slowest quarter for Dot Hill. However, the profit hit was much less. GAAP Net income was negative $1.2 million, down sequentially from $0.3 million, but up from negative $6.4 million year-earlier. Non-GAAP net income was $0.1 million for EPS of $0.00, better than I expected.

HP, which buys storage arrays from Dot Hill and resells them under its own brand, was responsible for 76% of Hill's revenues in the quarter. Sales to HP grew 20% y/y. But Dot Hill knows the danger of manufacturing mainly for one customer. They used to make equipment almost exclusively for Sun Microsystems. That business disappeared several years ago.

In fact Hill already supplies to several other major players including Lenovo and Samsung. But in none of these cases is it the exclusive storage supplier. It also sells through a large number of smaller systems integrators, but in the quarter that only amounted to $1.2 million in revenue.

There are three relatively large opportunies for Dot Hill going forward, aside from just selling more through HP. LSI's storage division Engenio is being acquired by NetApp. Some of LSI's Engenio clients are NetApp competitors. Some have begun discussions with Hill about switching to Hill as a first or second source. The second opportunity is selling more software with its hardware solutions, which brings higher profit margins. The third is the industry is consolidating, and Hill is an attractive acquisition candidate, although no discussions have been announced.

Q2 is looking better than Q1, partly due to orders late in Q1 that did not ship until Q2. Revenues for Q2 are projected at between $49 and $53 million, with non-GAAP net income and EPS expected in the vicinity of break-even. When Hill takes on new major OEM clients it does customization for them, which incurs increased engineering costs.

It is notable that GAAP gross margins increased from 13.5% year-earlier to 24.6% in Q1. This was partly from dropping NetApp, partly from a higher-margin mix in the rest of the business, and partly from increasing sales of storage management software.

For a greater level of detail see my Dot Hill Q1 2011 analyst call summary.

I own Dot Hill stock.

See also www.dothill.com