Dot Hill Systems Management Discusses Q1 2013 Results - Earnings Call Transcript

May. 9.13 | About: Dot Hill (HILL)

Dot Hill Systems (NASDAQ:HILL)

Q1 2013 Earnings Call

May 09, 2013 11:00 am ET

Executives

Jodi Bochert

Dana W. Kammersgard - Chief Executive Officer, President and Director

Hanif I. Jamal - Chief Financial Officer, Principal Accounting Officer, Senior Vice President, Corporate Secretary and Treasurer

Analysts

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Dorsey R. Gardner - Kelso Management Company, Inc.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Operator

Good day, ladies and gentlemen, and thank you for your patience. You've joined Dot Hill First Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the call over to your host, Ms. Jodi Bochert. Ma'am, you may begin.

Jodi Bochert

Thank you, Latif. Good morning. Thank you for joining us today for the Dot Hill conference call and webcast for our first quarter 2013 results. Before we begin, I would like to advise you that we will be referring to slides that can be found in the Investor Relations section of our website. I encourage you to access them now.

I would like to remind everyone that certain statements made during this call regarding matters that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Because such statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by the statements. To learn more about such risks and uncertainties, you should read the risk factors set forth in Dot Hill's most recent annual and quarterly filings with the Securities and Exchange Commission.

All forward-looking statements made during this call speak only as of the time they are made. Dot Hill undertakes no obligation to update such statements to reflect events that occur or circumstances that exist after they are made.

Today's call will provide you with certain financial results determined on a non-GAAP basis for income statement metrics for the quarters ended March 31, 2013, December 31, 2012 and March 31, 2012. These income statement non-GAAP financial metrics, together with reconciliations to the company's comparable GAAP financial measures, are contained in today's financial results press release and Form 8-K, which are posted on the Dot Hill website at www.dothill.com in the Investor Relations section and filed with the Securities and Exchange Commission. Joining us today are President and CEO, Dana Kammersgard; and CFO, Hanif Jamal. I will now turn the call over to Dana.

Dana W. Kammersgard

Thanks, Jodi. Good morning, everyone, and thanks for joining us. I'm pleased with our performance in the first quarter of 2013.

We posted revenues of $44.9 million, which were at the high end of our revised guidance from April 8. We delivered gross margins of 32.1%, our highest gross margin in over 5 years, due primarily to a more favorable customer mix. We maintained operating expenses essentially flat to the year ago quarter. And as a result, we achieved non-GAAP breakeven. Hanif will review the financial details in just a moment.

As we stated in our Analyst Day, we believe that we are in an inflection point, and 2013 is a year of execution into that inflection. Our focus is on executing our strategic initiatives that will grow top line, diversify revenue and increase gross margins. We believe we are now gaining traction with our vertical markets and new product initiatives, and our financials are just beginning to reflect this traction.

Let me briefly review our revenue streams and in that context, our strategic initiatives. As you may know, we classify our revenue into server OEMs and vertical markets. Our server OEM customers are the cornerstone of our business, that we have painstakingly rebuilt over the last several years. 

7 years ago, this foundation was basically Sun Microsystems. And we have substantially transformed it now to include Hewlett-Packard, Lenovo, Stratus, Acer, Wipro and Meganet, all with our AssuredSAN storage arrays, and Dell and AMD with our AssuredVRA software. This server OEM revenue platform is designed to drive volume, and therefore, economies of scale, as well as validate our technology and provide financial stability.

While this group may not drive significant growth, we have intentionally developed it to form a solid platform to support investment in and the resulting growth stemming from our vertical market efforts and our product expansion into the midrange. At the same time, server OEMs do have potential for modest revenue growth.

At our Analyst Day, our largest customer affirmed its intention to leverage our next generation technology to refresh its entry level product line and suggested that at least, historically, these refresh cycles tend to drive incremental revenue.

Our vertical markets are where we expect more material revenue growth, typically at higher margins, both through embedded solution OEMs and branded partners. Within these markets, we realized a 20% sequential revenue increase over the fourth quarter of 2012. Our year-over-year vertical markets revenue declined 22%, however, due to a large spike in demand from a telco OEM in the first quarter of last year. You may recall this. We do expect both sequential and year-over-year growth in the second quarter of 2013 from these customers. We believe our vertical market's focus is particularly appropriate given our view of the macro environment. Spending in EMEA remains soft. The U.S. Federal sector is partially paralyzed by sequestration and economic and secular headwinds abound. Yet film studios keep producing 3D movies, smartphone users keep generating and sharing data of all sorts and big data is big business. And over the last few years, we have maintained our investment in products and features that are particularly well suited to these high-growth storage markets. Our products offer unique feature advantages tuned to these markets, such as NEBS level 3 and DC Power for telco central office applications,

predictable high-speed throughput for frame rate video applications in media and entertainment. Randomized sequential performance for various big data applications and workloads and RealStor software with real-time autonomic tiering between solid-state and hard disk drives in our Pro 5000 Series hybrid arrays that is ideally suited to dynamic workloads typically found in virtual server environments.

At the same time, the transport server virtualization and cloud architectures favor products like ours. That is very high performance, modestly priced, modular block storage. We are very well positioned for these transitions. Let's take a quick look now at our pipeline charts and the deck that Jodi referred to earlier.

Slide 4 is the status of our new OEM pipeline on April 8, when we discussed it at our Analyst Day. Slide 5 is the same pipeline status as of today. You can see some movement on the few of the deals towards the right, which of course, we like to see. Quantum and Acer are now launching and ramping, and we have seen some excellent progress with a larger prospect in Phase I as well. Similarly, Slides 6 and 7 show the progress since our Analyst Day of new programs with existing OEM customers.

Overall, we are very pleased with both the potential revenue opportunity and the continued momentum in our revenue pipeline.

Our new product efforts are also bearing fruit. As stated at our Analyst Day, we have 8 OEMs taking our 4000 Series and 3 who are evaluating our Pro 5000 Series.

One of the Pro 5000 OEMs is a telco equipment provider building out a new cloud service for messaging. Both of these product lines are at higher average selling prices and margins than our 3,000 product lineup and are a big part of our margin expansion plans.

Further, our next generation entry-level products are on track to launch this summer, and we have a number of OEMs considering these products as well. Both Stratus and HP talked about forthcoming refresh opportunities with us at our Analyst Day.

We believe our product lineup has never been richer or more competitive, and it aligns well with areas of growth in our target vertical markets. In addition to the expected benefits from our strategic initiatives, we believe that the storage market itself is expanding, albeit, slowly. Industry analysts agree noting that while there continues to be macroeconomic and secular challenges that continuing data explosion will fuel storage market growth, especially for products that can solve additional challenges related to power, density, performance and simplicity of use and management.

All things considered, for us, it boils down primarily to our execution in 2013 and 2014.

We believe we have set the stage for growth that is not governed exclusively by market conditions or by economic and/or secular headwinds. Of course, these challenges do play a part, but we believe that our company-specific growth catalysts give us the opportunity to increase share and establish markets and grow at faster rates in new markets. We believe we have largely and successfully worked our way through the transformation period, and we have validated our strategic initiatives. Now it is a matter of continued focus on execution. And I can assure you, we remain intently focused on that front. As a result, we believe we are in the path to achieve the revenue growth goals that Hanif, presented at our Analyst Day for 2013, higher growth in 2014 and with significant earnings returns as well. With that, let me turn it over to Hanif. Hanif?

Hanif I. Jamal

Thank you, Dana. And thank you, all, for joining us this morning. I will once again only focus on our non-GAAP income statement results. As our GAAP financial results have been summarized in the press release and Form 8-K issued earlier today and will also be available in greater detail later today when we file our Form 10-Q with the SEC.

Consequently, only the balance sheet metrics will be based on GAAP. A summary of our first quarter financial results can be downloaded from our website at www.dothill.com and was filed this morning with the SEC together with the press release.

Before I present our financial results, I want to encourage you to attend or listen to the webcast from our presentation at the 14th Annual B. Riley Investor Conference Discovery Day in Santa Monica on May 20, or the Sidoti Semi-Annual New York Microcap Conference on June 7. Let me now discuss the details of the first quarter's non-GAAP financial results.

As you can see from Slide 8 in the presentation, revenue for the first quarter of 2013 was at the high end of our revised guidance range at $44.9 million compared to $46.2 million for the prior quarter and $54.6 million in Q1 '12. This represents a seasonally expected decline of about 3% sequentially and a decline of 18% on a year-over-year basis, primarily due to a large spike in demand of about $7 million in the first quarter of 2012 from one of our telco OEM partners. Within our first quarter 2013 revenue streams, vertical markets grew 20% sequentially to $13.3 million and declined 22% on a year-over-year basis, due to the spike I just mentioned. Server OEM's revenues were down 11% sequentially to $30 million and 14% year-over-year.

Within our server OEM group, our non-HP customers grew 52% year-over-year but declined 29% sequentially.

HP declined 18% year-over-year and 9% sequentially. The sequential growth in our vertical markets business successfully lowered this revenue concentration with our largest customer to 61% of total revenues compared to 65% in the fourth quarter of 2012.

The remaining $1.5 million of Q1 '13 revenue was from services. Gross margins for the first quarter 2013 was 32.1%, up from 28.3% in Q4 '12 and up from 29.3% in Q1 '12. This marks the first quarter we have reported gross margins about 30% in over 5 years.

The sequential increase in gross margin percent benefited from a more favorable customer mix, as well as some costs incurred in the fourth quarter of 2012 that did not recur in Q1 and some cost recoveries in the first quarter. This is early evidence of the execution of our strategic intent to focus on higher margin products and markets.

Operating expenses for Q1 '13 were down to $14.3 million compared to $14.7 million in Q4 '12 and up just slightly from $14.2 million for the first quarter of 2012.

We continue to tightly manage operating expenses given the subdued macro-environment. The result was a small profit that is at the top end of our revised guidance.

We recorded a net profit of $37,000 or $0.00 per share for the first quarter of 2013 compared to a net loss of $2 million or $0.03 in Q4 '12 and a net profit of $1.9 million or $0.03 in Q1 '12.

Non-GAAP EBITDA for the first quarter was at positive $0.8 million compared to a deficit of $1 million in Q4 '12 and positive $2.3 million in Q1 '12.

We ended the first quarter of 2013 with cash and cash equivalents of $40.3 million, which included $2.8 million of drawdown from our working capital line. Thus, cash net of short-term borrowings of $37.5 million was flat compared to the balance as of December 31, 2012.

We continue to be happy with the overall management of our cash and working capital resources.

Now let me turn to forward guidance. It has been summarized in Slide 9 of the presentation.

At our Analyst Day, we provided second quarter 2013 and full year 2013 non-GAAP net revenue and EPS guidance. At this stage, we still anticipate second quarter 2013 non-GAAP revenues and EPS to be within those same ranges of $47 million to $53 million and a loss of $0.01 to a profit of $0.02, respectively. Furthermore, we are reiterating our guidance for full year 2013 of non-GAAP revenue of $205 million to $227 million, non-GAAP gross margin of 30% to 31%, non-GAAP operating expenses of $60 million to $64 million and non-GAAP EPS of $0.02 to $0.10.

We are off to a solid start in 2013, given the tough economic climate. We are pleased with the traction in our vertical markets business, the significant improvements in gross margins and the discipline we demonstrated in managing working capital and operating expenses during the first quarter. The result was a small non-GAAP net profit for the first quarter of 2013. I will now turn the call back to Latiff for a question-and-answer session, after which, Dana will make some concluding remarks. Latif?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Eric Martinuzzi of Lake Street Capital.

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Dana, question specifically regarding the pipeline. You talked about how the -- and I'm referring to Slide 5, this is the movement of those larger deals. I want to focus on that kind of above $20 million. At the Analyst Day, you talked about how these things can -- you know they're there, you've sort of been selected verbally at the Phase I point. But let's talk about that large deal up into the left there. Why is it still in Phase 1 but showing progress? And then the other large deal, the big data opportunity that's in Phase 3, any incremental insight on those 2, I'd appreciate.

Dana W. Kammersgard

Eric, this is Dana. So I thought you -- somebody was going to ask about that one on the far left. But I want to start by saying that we don't count those ones in Phase 1 in any of the numbers that we provided. On Phase 1, they tend to be more volatile and therefore -- we haven't gotten a verbal award, there is no contract negotiation yet going on, et cetera. Having said that, there is a pretty big opportunity looming in the horizon in that particular one, at the moment at least is moving very fast. Now it could go away tomorrow but we are very encouraged by the progress that we have made with that particular opportunity. As you can tell from the coloring, it's kind of a telco big data mix and it's obviously a very sizable. One of the things that is happening, and I mentioned it in the prepared remarks, is that we are seeing an undercurrent, if you will, or a countertrend back in the direction of high performance, relatively low-cost, and by that I mean, bands 2, 3, 4, maybe $25,000 and lower, modular block storage that feeds very well into cloud, that feeds very well into server virtualization and there's just not that many competitors out there anymore that have high -- very high performance modular block-based storage. And so we're seeing opportunities come up fairly quickly. We're seeing opportunities evolve very quickly. And that one is moving fast. Now we don't have a verbal award at this point in time, we don't have a contract, we haven't discussed all the customizations that may be necessary but it is moving very quickly. With respect to the other larger one, as you can see, that's getting close to being on the cusp of transitioning from Phase 3 or Stage 3, where we have been involved in customization for quite a long time, on that particular one and about to move across the line into ramp and launch by then. Another words, then beginning to start to actively sell the product. That one has moved substantially slower. And so these 2 kind of book end, the opportunity set from a lifecycle point of view, with respect to some of these larger opportunities. We've been working on that one for a couple of years. It is a big data opportunity, it has moved very slowly, it is a customer that has very high expectations with respect to reliability and performance in their particular environment. We're very excited about that one, it's getting close to the finish line. And whether we'll be able to actually announce the customer and identify who it is, that's going to be a function largely of them as much as it is a function of us. Certainly, we'd like to but at this point in time, we have agreed to keep the name of that particular customer confidential. Does that answer your question?

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Yes. Just a point of clarification. The guidance that you've given, that is composed of pretty -- kind of the installed base plus these opportunities in Phase 2, 3 and 4. Is that correct?

Dana W. Kammersgard

That is correct.

Hanif I. Jamal

That's correct.

Eric Martinuzzi - Lake Street Capital Markets, LLC, Research Division

Okay. And then, just curious, I mean, congratulations on the adjusted gross margins, that's phenomenal. Just wanted to try and as I'm modeling this for 2013, you just had a quarter with 32% gross margin. You've given an outlook for 30% to 31%. What's pulling that back kind of...

Hanif I. Jamal

Eric, this is Hanif. So some of it goes back to some of the comments we made at the Analyst Day that as you look at our -- we look at our pipeline and we look at the -- our forecasted revenue, we're expecting revenue from some large or larger customers that typically take disk drives. And I think as we indicated when large customers have us purchase disk drives for them, it tends to be a little bit dilutive. It tends to lower the overall margin structure. So that's a part of it. And then of course, some of it is what we talked about on the -- in prepared remarks. There were some sort of onetime things that benefited us in Q1.

Operator

Our next question comes from Steven Sachony [ph] of Needham & Company.

Unknown Analyst

So my gross margin question was asked there. Just -- could you talk a little bit about the entry-level product launch? What's the go-to-market going to there? Just an indication of maybe the server OEM mix versus new vertical markets? And when do you expect to see a meaningful revenue contribution?

Dana W. Kammersgard

Yes, so as you know, Steve, we go through cycles in our business that are not dissimilar to any other high-tech. Intel has a tick-tock product cycle where they introduce a new core platform and then iterations on it. In our world, we certainly have to take into account the CPU generational motion, but we also have to work with the protocol inflection points. And at this point, we are at the cusp above the next technology inflection cycle of the components that drive our own cycles. And so in this case, its Fiber Channel currently at 8 gig, fiber going to 16 gig, fiber SaaS currently at 6 gig going to 12 gig and those will drive doubling the protocol speeds and fundamental increments in our own performance at the storage array level as well. So we are at the -- on the verge of doing that with respect to the next generation of entry-level product. We expect -- if we are not first to market, we will be early to market with those launches and announcements, and we will continue to serve the market through our OEM customers, which include all the names that I've already identified. Now what we are seeing on top of that, as I indicated, is a counter current, if you will, back towards very high performance modular block-based storage. There has been a time and there is a market, just to be clear, for scale out iSCSI. There has been a time and there is a market for unified NAS-end storage. But there is also a time and there is a growing market for very high performance modular SAN block product that is relatively modestly priced by comparison. It tends to serve the cloud very well, it tends to serve virtualized servers very well, it tends to serve big data very well. And so our go-to-market with these next gen products is likely not to be limited to existing OEMs, but we will see opportunity in growth within our vertical markets as well.

Unknown Analyst

Okay, great. That's helpful. And then just shifting to the balance sheet. How should we think about cash burn in the second quarter? And maybe for the remainder of the year? And I know you guys are pretty much on a stable point here with OpEx. What's the priorities for cash usage going forward?

Hanif I. Jamal

So I think, Steve, I'm not going put out specific guidance. But let me kind of walk you through the 2 primary levers here. Our cash in a circumstance with the working capital structure remains stable is very closely correlated to operating profit. So given the fact that we've got guidance out there for an operating profit this year of $0.02 to $0.10, you'd say, well, it's likely to go up. The counter to that is as we, and we discussed this again at our Analyst Day, as we engage in some of these new customer wins and we are engaging in launching products for them. One of the things we do is we may be required to hold certain amounts of inventory. Okay? And it's hard to predict how much of that inventory it's going to be. So those are really the 2 drivers so there's potential that it could go down slightly and come back up. Potentially it could go all the way up and keep increasing throughout the year. So that's really hard for me at this stage to provide any significantly more color for it.

Dana W. Kammersgard

Let me add a little historical commentary on that. Back in the day when we launched Hewlett-Packard in...

Hanif I. Jamal

2008.

Dana W. Kammersgard

April, March, April timeframe of 2008, we ended up putting roughly $10 million worth of inventory into their regional hubs across the 3 primary geographies in order to prime the pipe to improve lead times and to ensure that we had a very clean start to their ramp. And in our estimation, that was a very good use of cash back in the day. And I think there is a reasonable likelihood that we may see some utilization of cash in very similar context with one or more of these new partners once they reach that point. And just like them, we believe that's a very good use of cash.

Unknown Analyst

Okay. That's completely understood. And then just building off of that, do you see an appropriate minimum cash balance to run the business? And then just remind us how much availability you would have on [indiscernible]

Hanif I. Jamal

So we have a $30 million line as backed by AR. As indicated, we have about $37.5 million net cash. Quite frankly, to run the business, I need a lot less than that. We -- AR and AP run pretty much in-sync with us. So there's not a lot of timing differences there.

Unknown Analyst

And then maybe just lastly just an update on priorities for cash flow then? Beside the inventory and investment to your customers ...

Hanif I. Jamal

Yes. I mean I don't -- the priorities right now are to support the existing business and to support the growth and to support the revenue. That's kind of how we would like to use the balance sheet. With that said, you asked us why do you still have so much on there? I think I've said -- stated before it's a very important to our customers to see that we have a strong balance sheet. More importantly, it's very important to our suppliers because we actually get nice payment terms from them because of the cash we have on the balance sheet. Then you get asked the question around buybacks, et cetera, Pet cetera. I think you kind of answered that question in the past. And really what we want to do is to use the balance sheet to strategically help us with growth and to help us with new customers at this stage.

Dana W. Kammersgard

One of the things that we're not actively doing is looking at M&A opportunities as a use of cash. We think that we're past that point. We think we have emerged from a transformational period with a very strong strategy that is beginning -- just beginning to show financial evidence to you folks. And in that context it's all about execution at this point in time. So M&A at this point, not something that we are likely going to do nor is it something that we're actively engaged in. Obviously, if something comes along, we might take a look at it. But at this point, with the transformation in the rear view mirror, we're focused on execution.

Operator

[Operator Instructions] Our next question comes from Dorsey Gardner of Kelso Management.

Dorsey R. Gardner - Kelso Management Company, Inc.

I think this touches or maybe asks the same question a different way as the last questions we had on working capital. I mean, if you increased your revenues by $100 million or $200 million, I'm sure you've modeled out however many years or different revenue points, how much can you grow without having to even think of equity capital. Obviously, it depends on taking on inventory for your customers or what have you. But ideally, can you double the company without having to think about building equity?

Hanif I. Jamal

Yes, Dorsey, that's a good question. When we look at the working capital structure of this company, we have a high degree of -- a reasonable degree of predictability and you'll see that it sort of run in parallel and the net of the whole thing is that, okay, we have slightly better payment terms than what we get from our customers. With a net-net, it kind of works out at 0. So unless you're investing in inventory and if we were to invest in inventory, the investments tend to be 1, 2 months worth of inventory, not 6 months or a year at a time. So at this stage, I would say to you that I believe that we have absolutely adequate cash balances. We've got adequate working capital line to support the kinds of growth that you'd indicated.

Dana W. Kammersgard

Okay. So we are working capital light, I guess, is a fair way to put it. Because to the extent that we can leverage the existing product architectures, the existing manufacturing capability. And as you know, we contract with Foxconn, the world's largest contract manufacturer, to supply us with manufacturing capability. And in that view, we think that they could triple, quadruple, quintuple without any significant incremental overhead and to the extent that we can leverage our existing routes to market OEM customers, we don't have to invest largely in incremental sales and marketing uses of cash. So we think that we can self-fund pretty much any growth that we can envision or imagine, and that we should be cash flow positive on that basis. Remember, we've talked about the accretiveness of the business above breakeven at $0.20 to $0.30 of every revenue dollar dropping to the bottom line...

Dorsey R. Gardner - Kelso Management Company, Inc.

And then you'll pay taxes either for a while.

Hanif I. Jamal

Yes.

Dana W. Kammersgard

Significant NOLs going forward as well.

Dorsey R. Gardner - Kelso Management Company, Inc.

Excellent. Okay, and I guess my other question is, if I might ask, how many people are on this call?

Dana W. Kammersgard

About 40, I think.

Operator

Our next question comes from Larry Clibina [ph] of Clibina [ph] Capital.

Unknown Analyst

[indiscernible] if I read your full year guidance on the revenue side, if I did my math right, at the midpoint, you're kind of projecting that by Q4 of this year, if it's linear, it would be something on the order of $65 million on a quarterly basis, is that -- assuming your pipeline keeps playing out, can we project that out further? I mean, is that kind of slope continue on? At $65 million, it seems like you would generate a pretty good net profit.

Hanif I. Jamal

Larry, Hanif here. So I think, again, -- I'm not going to comment on the $65 million. But I don't think that I think it's a very reasonable assumption there. But if you look at the growth rates that we are projecting into 2014, actually, we are projecting an accelerated growth rate. So we're projecting going from midpoint, if you take the midpoint of this year's guidance to the next year from about 216 to about 263 or so. So we're projecting over 20% growth next year. Yet relative for this year, we're projecting about 12% over where we exited. So yes, I think it's a fair assumption to say that we would expect an acceleration in that -- into 2014.

Dana W. Kammersgard

And again remember, Larry, that anything in Phase 1 so though there is you got Phase 2, Phase 3, Phase 4 projections into the outlook for '14. Now let's be clear, some of those deals could drop off, some of those companies could get bought, it's hard to say what could happen on the downside with respect to those. On the other hand, nothing in Phase 1 and nothing to the left of Phase 1 is included or comprehended in any of our numbers. So we're not done finding new opportunities. We're not done winning new deals. We're just not going to project on the basis of something that we don't even know about today. Tomorrow, another $25 million opportunity could come to us on the basis of these trends that I have described. It's because there aren't that many incredible competitors who do what we do anymore because of the competitive attrition and acquisition that is carried over the last 3, 4 years. So there's a lot of stop, prospective stop to the left, that isn't in those numbers either. So yes, the thing about the OEM space is that it is repeatable business once you get ramped, it tends to grow and it tends to grow sustainably. So we're not projecting anything beyond '14, but we're certainly not done winning deals either.

Operator

Our next question comes from Krishna Shankar of Roth Capital.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

And as you look at the second half of 2013, can you give us a sense for the growth prospects in the vertical markets versus your OEM business and the margins for the rest of the year in the 2 businesses?

Hanif I. Jamal

Yes. So when you look at where we are now versus what are we projecting, I mean, I'm just going to use the midpoints of our guidance numbers. So if you just assume a $50 million revenue in Q2 in round numbers, $45 million in Q1 that puts us at $95 million. In order to get to our goal of $216 million, I'm just going to use $215 million here to keep the numbers flat, that would be another -- we would need -- sort of 115 -- about $120 million to get there. That represents 25% or so a little bit more growth rate. So we certainly are expecting that. Now with that said, we also said that we are expecting a fairly significant growth in vertical markets this year, and that we were expecting that the server OEM business to remain relatively flat. So from the data that we provided at the Analyst Day, the server OEM business is about $140 million last year and the remainder of takeout services is roughly $50 million, it's actually $48 million is vertical markets. So we would essentially expect most of this growth going forward to come actually from vertical markets so that would be close to 40% for the year, approximately. I'm just giving you high-level numbers here. And that's really consistent with what we shared at the Analyst Day as well.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Okay. And then there is this thing that traction for these -- some of these so-called hybrid drives? And can you talk about the specs there? That seems to be a very interesting high-growth market [indiscernible]. What vertical markets are you seeing demand for these hybrid type of drives?

Dana W. Kammersgard

Yes, so we don't get involved in hybrid drives per se. So let me make a subtle distinction. We talk in the context of hybrid arrays and hybrid...

Krishna Shankar - Roth Capital Partners, LLC, Research Division

What? Hybrid arrays, right.

Dana W. Kammersgard

Okay. So hybrid arrays for those on the call, who may not know, involve solid-state and possibly near line hard disk drives and primary hard disk drives, trying to blend the greatest performance at the least possible cost. And the hybrid array, we believe, as do a number of analyst firms, I think, Steve, you guys at Needham recently indicated as well, we think hybrid arrays are going to be the majority of deployment of solid-state in the enterprise space. And we have some really unique capability, first to market, only to market capability in this notion of being able to migrate data in real-time up and down the stack. Our competition effectively does a batch migration once every 24 hours. And in this world of real-time everything, doing a batch migration of yesterday's news up to the top of the performance stack is not very effective. Now, we do that every 5 seconds. So if something were to come in to our storage right this moment, and all of a sudden, it became the hottest stuff, 5 seconds from now, we would start moving it up to the fastest medium. Where we are seeing that, to answer your question specifically, is in many of the cloud services. Think of a cloud as a huge heterogeneous disparate collection of data. And at some points in times if eBay wants to do a special offering or Netflix wants to do a special offering or a huge public company were to preannounce results at this point, positive or negative, all of a sudden, that data would be in great demand. And so we would migrate it in real-time up to the solid-state disks. So any of the cloud applications, we see this same thing in media and entertainment. Because when raw film footage comes in, it is generally acted on by several different constituencies on a scene-by-scene basis. So this scene is hot today, tomorrow that scene will be hot. We see it in these messaging services that are now being deployed by the telcos. Because somebody's Twitter feed is going to be really hot in 5 minutes because of something that they said. And so a lot of these services in these various verticals react that way. The digital image capture and archiving, when Hurricane Sandy hit, all eyes literally turned to New York, New Jersey. And everybody from insurance companies, to state and local authorities, to federal authorities, to news outlets wanted digital images of what was going on in that area. And so that data in our application would move immediately to the fastest media to provide the best access. Does that answer your question?

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Yes, it certainly does.

Operator

Thank you. And at this time, I'd like to turn the call back over to President and CEO, Dana Kammersgard, for any closing remarks.

Dana W. Kammersgard

Thanks, Latif, and thanks, all, for joining us today. I want to thank all of our employees whose hard work has led us to this point of inflection. Rest assured, we are all hedged down focused on execution on the opportunities that we have created for ourselves. We look forward to speaking with you all next quarter or at one of the conferences that Hanif identified earlier. Thanks again, have a great day.

Operator

Thank you, sir, and thank you, ladies and gentlemen, for your participation. That does conclude Dot Hill's First Quarter 2013 Earnings Call. You may disconnect your lines at this time. Have a great day.

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