Dot Hill (NASDAQ:HILL) has a long history of supplying data storage systems to OEMs for rebranding. Sun Microsystems once was its main customer. When that relationship ended Hill picked up HP, NetApp, and a number of smaller OEM customers. Dot Hill had to drop NetApp at the end of 2011 because it could not negotiate a deal that gave it workable margins. Needless to say, the data storage market is highly competitive and dominated by companies much larger than Hill, notably EMC, IBM and NetApp, as well as Hill partners Dell and HP. (Note this is a separate market from hard disk drive, SSD and tape drive manufacturers like Western Digital and Seagate.)
HP accounted for 61% of Dot Hill's revenue in Q1 2013, but that percentage is down from past years. Management has worked hard to sell to a variety of other OEMs and system integrators. In many cases Hill is not the exclusive supplier, but rather has targeted a relatively small subset of the data storage market.
For investors it has been a wild ride. While the 52-week high was $1.79 the 52-week low was $0.72. The 5-year high has been $3.72 on February 8, 2011, versus a 5-year low of $0.43 on March 6, 2009. In 2003 it stayed above $15 per share for a while.
A trajectory of fundamental developments - new products, OEM wins, and discussions with more potential OEM customers - indicates that revenues, profits and the stock price should be rising in the 2013-2014 time frame. I don't see a short-term long opportunity for traders since the current stock price range already assumes a return to at least minimal profitability in 2013, as per HILL guidance. At today's price I think the long term, greater than one year picture is very attractive, with a distinct possibility of the stock above $5 per share if newer OEM opportunities work out well.
It helps to understand the data storage end markets to understand the opportunity here. The three critical factors are usually capacity, speed and price. Low cost Small and Medium Business [SMB] and entry-level Enterprise systems are typically slower and have less capacity than higher tier systems, yet they may be quite large and fast compared with home and small network storage devices. Dot Hill traditionally played in the SMB market and bottom tier of the Enterprise market. In other words, in price-sensitive markets. Margins tended to be low.
Over the past two years Hill has reinvented itself as a multi-tier player, partly from working to meet the needs of particular vertical markets, notably telecommunication and video content creation. It has a track record of success as a supplier to OEMs, so it has been winning new business with its higher-tier introductions. It has also been introducing features normally seen in higher tiers, into its lower tiers. It now has four series of devices. Assured SAN 2000, which is the legacy product. The 4000 and 5000 arrays are shipping to the mid-range market already and should see volume ramps through 2014. The 3000 series for the entry-level market should be shipping this summer.
Acer and Quantum are now in the process of launching new products that are designed and manufactured by Dot Hill. The current list of Dot Hill partners is extensive.
If you look at results for the March quarter you might question my growth hypothesis. GAAP revenue compared with the March 2012 quarter was down 19%. However, Q1 2012 saw a spike from an unusually large, one-time order from a telecom. If we move to Q2 2012, revenue was $47.8 million, still above Q1 2013 revenue of $44.5 million, but likely below Q2 2013 revenue guidance of $47 to $53 million.
HP has been the laggard customer. HP is a good customer, and recently signed a 3-year contract with Dot Hill, but is not a growth engine at present.
The growth engine is niche players in vertical markets. Autodesk is a new customer of this type. Vertical market revenue was up 20% sequentially to $13.3 million. That is fast growth.
Without revealing names, Hill's management reported that a number of OEMs are either preparing to release Hill-based products or are in preliminary talks. In the enterprise space it takes some time to go from an agreement through engineering and verifying a product specific to the OEM. Launches take time. So the revenue ramp we see in 2013 will be largely from partners announced in 2012 or even earlier.
A fair concern is the struggle to reach profitability, which has eluded HILL for most quarters of the past few years. Q1 2013 saw a GAAP EPS of negative $0.02, while non-GAAP EPS was zero. Generally speaking the margins are expected to be better on the newer products, and revenue should ramp faster than costs and expenses. Weighing against that is the cost of tweaking products for individual OEMs, which run in front of revenues.
Guidance for full-year 2013 is revenue of $205 to $227 million and non-GAAP EPS of $0.02 to $0.10.
On May 13, 2013, HILL closed at $1.67, down $0.05. Market capitalization at that price is $97.9 million. Dot Hill ended Q1 with cash and equivalents of $40.3 million. Clearly some positive earnings are already built into the stock price.
What is not yet built into the stock price is future OEM customer announcements. Lately management has done a terrific job landing new OEMs, so I would expect that trend to continue. Small new customer announcements may not affect the stock price much, but a mid-size or large deal should, even though deals announced in 2013 are not likely to generate significant revenue until 2014.
The main danger for investors would be a global drop in demand for data storage, which is not likely at this point. Price competition could shave expected margins, but Dot Hill has been working to differentiate its products in a way that may make them more price competitive. In fact consolidation of smaller players in the industry has been to Dot Hill's advantage lately.