Dot Hill Dots Its I's

Dot Hill Systems Corp. (Nasdaq: HILL) became the latest technology vendor to restate its financials last night, packaging the news with earlier-than-expected earnings figures for the fourth quarter (see Dot Hill Restates 2004).

A series of accounting problems, which execs blamed in part on an outdated ERP (enterprise resource planning) system that couldn't keep up with growth, caused the company to restate the first three quarters of 2004.

"It's an old system," said Dot Hill CFO Preston Romm in an earnings briefing originally scheduled for next week. "I would characterize it as adequate in the pre-Sarbanes-Oxley world, adequate for the size of the company we were a couple years ago, but the transactions have gotten very complicated."

Romm added that the company hopes to fix the situation this year by beefing up IT and other resources, which might include replacing the accounting system altogether.

Among the snafus: understated costs of goods sold in the first quarter, overstated earnings for the first three quarters, and misclassified costs of goods sold as operating expenses for the first three quarters. Dot Hill execs maintain that these errors affect less than 1 percent of revenues, with little or no impact on gross profits and net income.The company is still auditing its books and expects to issue a final assessment with its year-end 2004 filing.

The restatement follows that of Brocade Communications Systems Inc. (Nasdaq: BRCD) and carries a similar impact -- noteworthy but not earth-shattering (see Brocade Switches CEOs, Restates ). So far, though, Dot Hill differs from Brocade in that it's kept its management team intact.

Dot Hill's accounting revelations somewhat overshadowed preliminary fourth-quarter figures, also discussed on the call. For the fourth quarter, the company expects revenue to come in at $65.5 million, up 13 percent from $57 million sequentially and 12 percent from $57.5 million year-over-year. Net income is expected at $3.9 million, or $0.08 per share. That figure is up 10 percent from $3.5 million and $0.07 per share in the third quarter, but down 43 percent from $6.8 million and $0.14 EPS year-over-year.

For the full year, 2004 revenues jumped 28 percent to $239.3 million, compared with $187.4 million in 2003. However, net income dipped 5 percent to $11.5 million from $12.1 million the previous year.

The company attributes its revenue growth to increased shipments of its SANnet II SATA array, as well as stronger overall sales in the telecom sector and by channel partners. The company saw double-digit gains in OEM business; Sun accounts for 85 percent of Dot Hill's OEM revenue, but sales from others increased at a faster rate.But while SANnet II contributed to revenues, slim margins resulted in little impact on the bottom line. Analysts on the call seized on that theme, peppering Romm and CEO Jim Lambert with questions about how the company will improve in that area. The execs admitted that margins on the SATA line are in the single digits, but they hope to boost that to the teens with cost reductions that include shifting some manufacturing from California to Asia.

Brett Mendel, Senior Analyst, Byte and Switch Insider