Dot Hill Nears Inflection Point

| About: Dot Hill (HILL)
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Dot Hill is introducing new advanced data storage technologies.

New customers and new products for vertical markets should drive growth.

Q2 results were weak due to a (likely) one-time event.

Dot Hill's stock price is attractive if you assume a near-term positive inflection point.

Dot Hill (NASDAQ:HILL) is nearing a positive inflection point, according to CEO Dana Kammersgard. This is in addition to coming back in 2013 and 2014 from a long period of losses. The data storage equipment company's revenue in 2012 came mainly from providing low-cost, high capacity disk storage array systems to OEMs for resale, notably HP. But the inflection comes from increasing sales of higher-level systems into vertical markets like Media and Entertainment, Oil & Gas, Telecommunications, and Video Surveillance.

Dot Hill developed a number of technological advantages that are enabling this inflection point. In addition to having built a reputation for both quality and reasonable pricing, Dot Hill has been nimble, regularly among the first of the storage companies to get new product generations to market. It's Automated Tiered Storage system, which allows continuous flow of data between slower and less expensive tiers and the fastest, most expensive tier, SSD (solid state drives), has been a hit among early adopters.

Dot Hill is still a microcap, with all the caveats that implies. Q2 revenue was $48.2 million, down 5% from $50.7 million in the year-earlier quarter. That does not look like a company about to hit an upward inflection point, but the results were skewed by one customer that was between major projects for its own customers in the quarter. The customer generated $1.8 million in the quarter vs. $7.4 million in Q1, and is expected to resume larger buys likely starting in Q3.

Four major product launches by clients are expected before the end of 2014 (without specifying if these which in particular are existing, as opposed to new, customers) [Source: Slide 26, September 10, 2014 investor presentation]:

1. One customer is adding Dot Hill's New Ultra48 array into their mainstream midrange product family.

2. One is introducing a high-end, Level 3 storage system to service provider customers.

3. One is adding Dot Hill RealStor firmware to their lineup "which should boost revenue and margin from this customer."

4. One will roll out new Dot Hill based products on a global scale.

On the whole Dot Hill expects sales to traditional server OEMs to grow slowly, even if its largest single client, HP, gains some market share with Dot Hill's newer offerings.

Vertical market revenue is expected to grow at 40% to 50% on a compounded annual basis through at least 2015. This segment has already grown to about 40% of HILL revenue, and it has better margins than the server OEM business. Note that even this segment had revenue down 2% y/y, due to the drop in sales by the customer mentioned above being in this category.

Non-GAAP EPS was $0.02 in Q2, down from $0.06 year-earlier, which also would be a negative indicator. Part of the drop was due to the decreased revenue mentioned above, and part of it was due to increased R&D and sales and marketing expense.

Dot Hill had $40 million in cash and $2 million in debt at the end of the quarter.

Hill closed on Monday, September 15, 2014 at $3.78, resulting in a market capitalization of $228 million. This compares to a 52-week low of $2.04 and a 52-week high of $6.06.

Investing in Hill at this time is basically a bet that there is indeed an inflection point coming, and sooner rather than later. The inflection would be indicated by new customer announcements this half, including the September 15 announcements of new product offerings in the Media and Entertainment space by Tiger Technology and Blackmagic Design.

The actual revenue and earnings ramp might start in Q3, which is typically seasonally strong, but is more apt to become substantial in 2015. CEO Kammersgard stated "We have more than a dozen additional server and vertical market prospects in our pipeline that we are working to close," when he reported Q2 results. Usually after a deal is announced it is several months to a year before the customer begins to ship the products.

The down side would be if the new customers, or new product introductions by current customers, are cancelled or delayed, or if they do not result in substantial sales.

Overall, I think a positive inflection point is highly likely, based on response to HILL's innovation so far. Investors can wait for actual results, but of course positive results in Q3 or beyond would mean buying in at a higher price.

Disclosure: The author has been long HILL since 2004, but occasionally adjusts his position based on outlook and stock price.