Dot Hill Picks Up Chaparral

In a bid to improve its technological edge and expand its market reach, Dot Hill Systems Corp. (Nasdaq: HILL) has spent $62 million in cash and taken on about $10.4 million in liabilities to acquire Chaparral Network Storage Inc. (see Dot Hill Acquires Chapparal).

Dot Hill, headquartered in Carlsbad, Calif., will make Chaparral's Longmont, Colo., facility the Dot Hill Controller Technology Center, retaining about 50 engineers working there. By early 2005, Dot Hill hopes to integrate Chaparral's SAN controller technology into its line of SAN and NAS systems.

One thing: Chaparral's CEO since 2001, Victor Perez, won't be staying on board, but plans to retire.

Chaparral's controller was a selling point for Dot Hill, which now has a controller supply agreement with Infortrend Technology Inc. Indeed, Dot Hill execs admit trying to acquire Infortrend, to no avail, before sealing the Chaparral deal.

"Owning our own controller technology will allow us to fully control our own destiny," said Dot Hill CEO Jim Lambert on a call with financial analysts today. Chaparral, which also makes SAN systems and storage routers, has about 19 patents and patents pending on its controller. In contrast, Dot Hill has fewer than ten.Lambert concedes the financial community has criticized Dot Hill in the past for not owning its own technology, as well as for its reliance on Sun Microsystems Inc. (Nasdaq: SUNW) for most of its revenue. In its latest earnings announcing January 28, Dot Hill reported that Sun accounted for $48.5 million in quarterly revenue, representing 85 percent of overall sales.

Sun seems pleased with the deal. "We are supportive of any acquisition that a partner makes that will result in bringing more functionality in house," says spokeswoman Samantha Moulton.

On today's call, Lambert also hinted that Dot Hill may soon close an expanded OEM deal with Sun for "high volume data" storage arrays that includes more than the StorEdge 3000, to which it contributes today.

Does Dot Hill's access to a new controller of its very own carry any weight in Sun's decision? For its part, Sun won't comment on any pending deals. And Lambert says for the time being, Infortrend remains the controller supplier for Dot Hill. Infortrend, he says, was considered as a merger candidate, but "didn't have an interest in any type of business combination."

Infortrend spokesman Thomas Bayens says he's not aware of any past merger talks, but agrees it's "business as usual" with Dot Hill. It remains to be seen how things play out in light of any future supply deals with Sun.Analysts on today's call asked several questions relating to this complex web of supplier relationships and potential interactions among Dot Hill, Chaparral, Sun, and others (including Xyratex, which OEMs controllers from Dot Hill), but Dot Hill execs remained noncommittal. Within the next few weeks, they will be reviewing OEM requirements in light of the acquisition, however, and more should be revealed.

Dot Hill's acquisition of Chaparral will be dilutive to earnings in 2004, to the tune of about 16 cents per share. By the first quarter of 2005, however, the company predicts the acquisition will result in 10 cents to 12 cents per share, with improvements in gross margin.

Dot Hill may still be in acquisitive mode. Lambert says that buying Chaparral takes care of "80 percent" of what Dot Hill needs for future success, but admits the company's looking at other possible buys, particularly in the area of software.

Mary Jander, Site Editor, Byte and Switch