-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F1H2t2IAMhM5qdcxHQf6pcLHgQ9jKBft0UPEB8UstYiZpwqi7H6AFdtSiJoNKgwK dLEMv9uj1sIp7HGgRM6eDw== 0000912057-01-505897.txt : 20010402 0000912057-01-505897.hdr.sgml : 20010402 ACCESSION NUMBER: 0000912057-01-505897 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DOT HILL SYSTEMS CORP CENTRAL INDEX KEY: 0001042783 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER STORAGE DEVICES [3572] IRS NUMBER: 133460176 STATE OF INCORPORATION: NY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-13317 FILM NUMBER: 1588147 BUSINESS ADDRESS: STREET 1: 6305 EL CAMINO REAL CITY: CARLSBAD STATE: CA ZIP: 92009 BUSINESS PHONE: 2129894455 MAIL ADDRESS: STREET 1: 6305 EL CAMINO REAL CITY: CARLSBAD STATE: CA ZIP: 92009 FORMER COMPANY: FORMER CONFORMED NAME: BOX HILL SYSTEMS CORP DATE OF NAME CHANGE: 19970722 10-K405 1 a2041983z10-k405.txt 10-K405 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 Commission file number 1-13317 ------------------------ DOT HILL SYSTEMS CORP. (Exact name of registrant as specified in its charter) NEW YORK 13-3460176 (State of incorporation) (IRS Employer Identification No.) 6305 EL CAMINO REAL 92009 CARLSBAD, CA (zip code) (Address of principal executive offices)
(760) 931-5500 (Registrant's telephone number, including area code) ------------------------ Securities registered pursuant to Section 12(b) of the Act:
SHARES OUTSTANDING NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS AT MARCH 19, 2001 WHICH REGISTERED ------------------- ------------------ ------------------------ Common stock, $.01 par value...................... 24,612,272 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes /X/ No / / The aggregate market value of the voting stock held by non-affiliates of the registrant at March 19, 2001 was $48,243,772. Documents incorporated by reference: Portions of Dot Hill's definitive Proxy Statement for its 2001 Annual Meeting of Shareholders are incorporated by reference into Part III of Form 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- DOT HILL SYSTEMS CORP. INDEX TO ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2000 PART I Item 1. Business.................................................... 4 Item 2. Properties.................................................. 25 Item 3. Legal Proceedings........................................... 25 Item 4. Submission of Matters to Vote of Security Holders........... 25 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................................... 26 Item 6. Selected Financial Data..................................... 26 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 28 Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................................................ 37 Item 8. Financial Statements and Supplementary Data................. 38 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.................................... 38 PART III Item 10. Directors and Executive Officers of the Registrant.......... 39 Item 11. Executive Compensation...................................... 39 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 39 Item 13. Certain Relationships and Related Transactions.............. 39 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................................... 39
2 FORWARD LOOKING STATEMENTS Certain statements contained in this report, including, but not limited to, statements regarding the development, growth and expansion of Dot Hill Systems Corp.'s ("Dot Hill" or the "Company") business, the intent, belief or current expectations of the Company, its directors or its officers, primarily with respect to the future operating performance of the Company and the products it expects to offer and other statements contained herein regarding matters that are not historical facts, are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the "safe harbor" created by those sections. Future filings with the Securities and Exchange Commission, future press releases and future oral or written statements made by or with the approval of the Company, which are not statements of historical fact may also contain forward-looking statements. Because such statements include risks and uncertainties, many of which are beyond the control of the Company, actual results may differ materially from those expressed or implied by such forward-looking statements. Some of the factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements are set forth at the end of this Item 1 in "Certain Risk Factors Related to the Company's Business," in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere throughout this Annual Report on Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements. The forward-looking statements speak only as of the date on which they are made, and, except as required by applicable law, the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. GLOSSARY OF TERMS
Carrier class................................ Providing the same high level of reliability as telephone networks or carriers, built to remain operational during and after a disaster Disk array (or array)........................ An arrangement of two or more hard disks, in RAID or daisy-chain configuration, organized to improve speed and provide protection of data against loss. Failover..................................... The transfer of operation from a failed component (i.e. controller, disk drive) to a similar, redundant component to ensure uninterrupted data flow and operability. Fault tolerance.............................. The ability of a system to cope with internal hardware problems (e.g., a disk drive failure) and still continue to operate with minimal impact, such as by bringing a backup system online. Fibre Channel................................ A high-speed storage/networking interface that offers higher performance, greater capacity and cabling distance, increased system configuration flexibility and scalability, and simplified cabling. GB........................................... Gigabyte. Approximately one billion bytes, 1,024 megabytes. Host attached storage........................ A storage system that is connected directly to the network server; also referred to as server-attached storage or direct attached storage.
3
Hot swappable................................ The ability to replace a component (e.g., disk drive, controller, fan, power source) while the system is on line, without having to power down; also referred to as hot-plug removable Internet..................................... A worldwide system of linked computer networks JBOD......................................... An acronym for "just a bunch of disks" - a disk array without a controller. LUN.......................................... Logical unit number, an addressing scheme used to define SCSI devices on a single SCSI bus. LVD.......................................... Low voltage differential MB........................................... Megabyte. 1,048,576 bytes, a unit of measurement for data storage NEBS......................................... Network Equipment-Building System. Equipment standards set forth by Bell Communications Research (Bellcore) for electromagnetic compatibility, thermal robustness, fire resistance, earthquake and office vibration resistance, transportation and handling durability, acoustics and illumination, and airborne contaminant resistance Open systems................................. Computing environments incorporating computers that act as servers interconnected over a network to client workstations and a variety of other system components and peripherals based on a series of published or open interface specifications. RAID......................................... Redundant Array of Independent (or inexpensive) Disks; a collection of storage disks with a controller (or controllers) to manage the storage of data on the disks. SAN.......................................... Storage Area Network; a network infrastructure of shared multi-host storage, linking all storage devices as well as interconnecting remote sites. SCSI......................................... Small Computer Systems Interface; an interface that serves as an expansion bus that can be used to connect hard disk drives, tape drives, and other hardward components.. Telco........................................ Abbreviation for "telecommunications company." TB........................................... Terabyte. Approximately one trillion bytes, 1,024 gigabytes. One SANnet cabinet can hold up to 5.8 TBs, and systems can scale up to 58 TBs Ultra 2 Ultra 3.............................. Types of SCSI interfaces UNIX......................................... A popular multi-user computer operating system commonly used on open systems.
PART I ITEM 1. BUSINESS The Company is an independent provider of high-performance data storage and SAN solutions. The Company designs, manufactures, markets and supports data storage products and systems for the Open systems computing environment, including Windows NT, Solaris, Linux, HP-UX, IRIX and 4 others. The Company's storage solutions encompass a broad range of scalable products and services targeting high-end customers. With information becoming an increasingly critical business tool, these customers demand certain characteristics in their storage systems, particularly high reliability, availability, performance, manageability and fault-tolerance, as well as the highest level of customer and technical support. The Company has a history of providing high-end storage solutions that meet these requirements by combining extensive design and implementation experience with leading edge technologies. The Company is one of the few in the industry to offer NEBS Level 3 certified, carrier-class storage systems. The NEBS standard was developed by Bellcore for telephone equipment and speaks to system ruggedness and reliability. In the United States, the Company primarily employs a direct marketing strategy and targets data-intensive industries, which to date include telecommunications, enterprise internet applications, financial services, health care, government/defense and academia. Abroad, the Company sells directly to end-users in certain regions, and sells through local resellers in others. The Company has four hubs, located in Carlsbad, California, New York City, the Netherlands and Japan. The Company has other offices across the United States, in France and in the United Kingdom. INDUSTRY OVERVIEW The rapid proliferation of data-intensive applications, such as the Internet, intranets, digital broadcasting, data warehousing, data mining, and the migration of mission-critical applications of mainframe computers, has fueled the demand for open-systems data storage. High-end disk storage systems, tape backup systems and storage management software designed to operate on multiple platforms are increasingly becoming a critical part of a company's management information systems and computer purchasing decisions are increasingly becoming "storage centric." In many instances, capital expenditures on storage systems are equal to or greater than those made on computer processing hardware. The high end of the open systems market is characterized by large capacity UNIX variants such as Solaris (Sun), HPUX (Hewlett Packard), AIX (IBM), IRIX (SGI)), LINUX, and Windows NT (Microsoft) servers operating in multi-platform environments, generally running mission-critical applications. HOST-ATTACHED STORAGE AND FIBRE CHANNEL INTERFACES The open systems market's current host-attached storage options include disk arrays, RAID storage systems and tape backup systems. Generally, each of these storage options is attached to the host by a SCSI bus. SCSI, including Ultra SCSI, Ultra 2 and Ultra 3, which were designed to transfer data at increasingly higher rates with enhanced reliability and lower error rates, has been the interface most commonly used in storage systems. Fibre Channel is a high-speed serial interface that became commercially available in 1997 and has since gained acceptance. Fibre Channel enables the transfer of data between computers and peripherals at increased rates and cabling lengths, and among a greater number of hosts. Fibre Channel also enables SANs, which generally cannot be configured using the SCSI standard. SAN BASED ON FIBRE CHANNEL A SAN is a network that sits between servers and storage devices and is commonly based on the Fibre Channel protocol. SANs may be used to create centralized pools of storage and backup devices that are accessed at high speeds by multiple and disparate hosts. SANs may also be used to create redundant data paths to the same storage systems and backup devices, thereby improving a system's fault-tolerance and transfer rates. The Company was among the first storage vendors to provide SANs to its customers. In September 1999, the Company launched its new line of storage systems, SANnet-TM-, which is engineered 5 to operate in SAN environments. SANnet comes bundled with SANscape-TM-, a Dot Hill-developed storage management software package that greatly enhances the benefits and performance of SANs. While SANs appear to be gaining industry acceptance, SAN technology is in its infancy and the Company cannot predict the timing and magnitude of customer demand for SANs. THE DOT HILL SOLUTION Dot Hill develops and markets a comprehensive range of data storage products and systems designed to meet the requirements of the open systems market. The Company's products and services are intended to provide users with the following benefits: RELIABILITY The Company designs redundancy, reliability and high-performance into its storage systems. Redundant components, such as power inlets, fans and controllers, are hot-swappable, which means that there are at least two of the components in the system and customers can replace, upgrade or service the components in the field without interrupting network activity. Certain of the Company's products are NEBS Level 3 certified, including the SANnet line of systems. The carrier class standard known as NEBS Level 3 was developed by Bellcore to test the technology ruggedness of products. This strict reliability standard is required by certain global telephone networks to ensure that equipment remains operational during and after a disaster. In order to pass certification, products are subjected to 99 degree F temperature fluctuations, 15,000 volts of electrical discharge, the need to self-extinguish when on fire, humidity fluctuations from 5% to 90%, air born contaminants comparable to a 400 mph dust storm, and the stress of an 8.3 earthquake. CAPACITY AND DENSITY The Company's disk storage systems scale from a few hundred GB up to seven TB in a single 72-inch cabinet. The Company's tape backup solutions scale from a few hundred GBs up to 41.2 TBs in a library. The Company believes that its new SANnet line of storage systems is among the densest in the industry. The SANnet 2200 can house ten drives in a single, 3u(unit) enclosure. The SANnet 3200, 4200 and 7100 uses up to ten drives, plus two hot-swappable and redundant hardware RAID controllers in a single 4u(unit) enclosure. ALL-ENCOMPASSING SOLUTIONS The Company delivers all-encompassing solutions and professional services, including design consulting, installation, integration, training, and 24-hour, post-sales service and technical support, as well as software-based management tools. The Company employs a full staff of applications engineers to assist customers in making appropriate and effective storage system purchases and in addressing, analyzing and solving complex, pre-deployment storage issues. The Company believes this value-added capability fosters customer loyalty and allows the Company to identify emerging customer requirements. MULTI-PLATFORM SUPPORT As an independent provider of storage products, Dot Hill is well positioned to provide storage solutions on a variety of platforms including UNIX, Windows, Linux and Novell. The Company's new SANnet line of systems supports multiple servers operating on different platforms simultaneously. This cross-platform capability allows customers to standardize on a single storage system that can readily be reconfigured and re-deployed at minimal cost as the customer's operating systems or other open systems components change. 6 SCALABILITY The Company's products are designed to be flexible and modular, thereby allowing the Company to size and configure storage systems to meet the specific requirements of individual customers. This modular architecture also allows the Company to expand or reconfigure a customer's system as the customer's needs change, thereby allowing customers to retain capital value in their underlying systems. MANAGEABILITY The Company believes that the ability to manage storage systems, particularly through storage management software, is becoming a key differentiator among storage vendors. The Company has a team of software engineers focused on software management efforts. The Company's storage management software offerings enable customers to more easily manage, configure and respond to their systems. SANpath-TM- and SANscape offer various management tools, including: automatic balancing of data loads among multiple data paths; automatic routing of data from non-functioning paths; LUN masking; remote monitoring of multi-site systems; and remote configuration of multi-site systems. PRODUCTS AND SYSTEMS The Company sells storage in two fundamental ways: as solution packages or, for those customers who prefer to buy particular products, as modular building blocks. Either way, Dot Hill's storage solutions range from SCSI Disk Array configurations to multi-terabyte Ultra2 RAID storage systems to Fibre Channel-based SANs. Dot Hill's backup solutions incorporate "best of breed" tape libraries and backup management software, most of which are manufactured and developed by third parties. In September 1999, the Company launched a new line of storage systems, SANnet, which comes bundled with SANscape, a storage management software. The Company also offers legacy products from Artecon and Box Hill. Both the new SANnet product line and the legacy lines are flexible and highly scalable. SANNET PRODUCT LINE. SANnet is the Company's core line of SAN-ready disk storage solutions, designed with the reliability, flexibility, and performance necessary to meet the needs of today's data-intensive, Internet-generation applications. SANnet solutions support single or multiple servers simultaneously and are compatible with many of today's popular open systems server platforms. The Company offers SANnet storage systems in many topologies, including SCSI, Ultra3, and Fibre Channel. All critical components of the SANnet systems, including RAID controllers, battery backups and power supplies, are hot-swappable, redundant and field-replaceable, which allow for upgrades and servicing to occur without server interruptions. SANNET 7000 SERIES is a carrier-class pure Fibre Channel RAID storage system for one to many servers in data-intensive environments and on virtually any platform. It provides transfer rates up to 400 MB/second and can be used with stand along servers, server clusters or in a SAN. It supports RAID levels 0, 1, 3, 5, 10, 30, 50 and partitioning. SANNET 4000 SERIES is a carrier-class RAID storage system for one-to-many servers. Featuring Fibre Channel technology, SANnet 4200 provides transfer rates up to 400MB/second on multiple loops and support for RAID levels 0, 1, 0+1, 3 and 5. The SANnet 4200 supports single or multiple servers simultaneously and supports a number of operating systems including UNIX, Windows NT, Windows 2000 and Linux. Each system can hold from 3 to 10 drives, and with attached JBOD's a system can store from 27 GB to 3.7 TB of data. 7 SANNET 3000 SERIES is a carrier-class RAID storage solution for single or dual servers. Using Ultra2 LVD technology, this product provides transfer rates up to 160MB/second on dual loops and supports RAID levels 0, 1, 0+1, 3 and 5. Each system holds from 3 to 10 drives, and stores 27GB to 3.7 TB of data. SANNET 2000 SERIES is a carrier-class RAID storage solution for single servers. Using Ultra3 LVD technology, SANnet 2200 supports dual-channel transfer rates up to 320MB/second on dual loops. SANnet 2200 works directly with Windows, Solaris, or Linux server operating systems as a JBOD (Just a Bunch of Disks) or as an expansion chassis in conjunction with a 3200 or 4200 RAID subsystem. Each system holds 1 to 10 drives and has a capacity of 9GB to 730GB of data. SANNET SUITE OF SOFTWARE The Company's SANnet suite of software consists of two key software packages developed by Dot Hill, SANpath and SANscape. SANPATH helps to ensure availability and also failover and failback of data across a SAN and enhances network-server bandwidth by balancing data loads among functioning data paths and automatically routing data away from non-functioning paths. Once a non-functioning path is healed, the software automatically rebalances the data load. SANpath also enables modifications to the SAN without server restarts, and provides LUN masking capabilities. SANSCAPE is a Java-based software utility that combines SAN configuration, maintenance, and monitoring tools into a single application. SANscape allows customers to administer Dot Hill's storage systems located worldwide from a single console by sending system information across the Internet, intranets, or telephone lines. SANscape also notifies customers of issues with their systems by email, beeper or other means and allows for remote configuration and trouble-shooting through an interactive graphic user interface ("GUI"). BACKUP SOLUTIONS Backup solutions consist of tape libraries and backup management software, which, Dot Hill purchases from third parties and then integrates and delivers to customers. Third parties that Dot Hill works with to provide backup solutions include Storage Tek, Overland Data, Qualstar Veritas and Legato. These solutions may also consist of bridges & routers, and often demand Dot Hill Systems professional services experts. Dot Hill's backup solutions deliver a seamless solution for archiving and managing the growing information needs of our customers. The best-of-breed back up products selected by Dot Hill are of exceptional quality, scalability and reliability, giving our customers' unequalled plug and play solution. PROFESSIONAL SERVICES Dot Hill's team of applications engineers offers professional services designed to maximize customers' investments in their Dot Hill storage solutions. Professional services will assess a customer's needs through a pre-sales evaluation; custom tailor a solution design pre-tested in Dot Hill's Customer Integration Lab; install the solution; and provide training, giving clients the option to operate, service and support their system. 8 LEGACY PRODUCTS Since the merger that formed the Company (the "Merger"), the Company has continued to offer a number of legacy products developed by its predecessor companies, Box Hill and Artecon. Those products include, but are not limited to, the following: THE LYNXARRAY II is a NEBS Level 3 certified Fibre Channel-compatible RAID storage system that comes in two models: High Performance and High Capacity. The High Performance system uses a dual-channel backplane and supports up to 16 disk drives with a capacity up to 576 GB. The High Capacity system uses a single-channel backplane and supports up to 43 disk drives with a capacity of 1.55TB. Both systems achieve aggregate transfer rates of up to 200 MB/second and come with the option of redundant RAID controllers, which support RAID levels 0, 1, 0+1, 3 CUSTOMERS Dot Hill markets its products principally to high-end users in the open systems market. The Company has installed storage systems primarily in data-intensive industries where companies require reliable, high-performance, high-availability storage solutions, such as Internet, Applications, and Storage Service Providers ("xSPs"), financial services, telecommunications, health care, government/ defense and academia. Since the Merger, the Company's strategy has been to target customers running Internet-generation applications, which the Company defines as applications that are related to the Internet or have arisen during this time of the Internet, such as digital broadcasting and video editing. The Company historically has targeted xSPs, financial services and telecommunications companies, and a material portion of the Company's net revenues to date have been derived from sales to customers in those industries. Direct sales to customers in the xSPs, telecommunications and e-commerce; and financial services industries were approximately, 39% and 11%, respectively, of Dot Hill's 2000 net revenues. Direct sales to customers in the telecommunications and financial services industries were approximately 21% and 18%, respectively, of 1999 net revenues and 20% and 27%, respectively, of 1998 net revenues. Historically, a significant percentage of the Company's annual net revenues each year have been derived from a limited number of customers. For the years ended December 31, 2000, 1999 and 1998, the Company's top five customers, including distributors, accounted for approximately 37%, 25% and 22%, respectively, of the Company's net revenues. Sales to one customer, UUNET Technologies, Inc. a wholly owned subsidiary of MCI WorldCom, accounted for 17% and 10%, respectively, of the Company's net revenues for the years ended December 31, 2000 and 1999; no sales to one customer exceeded 10% of total net revenues for the year ended December 31, 1998. The Company generally does not enter into long-term contracts with its customers, and customers generally have certain rights to extend, delay or cancel shipment of their orders without penalty. A significant amount of the Company's revenues to date have been concentrated in the UNIX marketplace, and within the UNIX marketplace, a significant portion of the Company's revenues are associated with versions of UNIX manufactured by Sun Microsystems, Inc. SALES AND MARKETING During 2000, the Company began to re-focus its efforts on the telecommunications markets, and in addition those companies that required telco-intensive solutions. The Company also continued to target customers that are running Internet-generation applications. Historically, the Company has focused on xSPs, financial service and telecommunication companies. The Company has a sales force, which it complements with applications engineers, who are generally highly qualified storage experts. As of December 31, 2000, the Company employed 36 applications engineers, both domestically and 9 internationally, to provide a variety of professional services to customers, including pre-sales and pre-deployment consulting, installation services, training and support. Feedback from the applications engineers allows the Company to better identify emerging customer requirements for future data storage products. Design engineers also receive feedback from the Company's technical support, marketing managers and production engineering teams, which helps contribute to the quality, manufacturability and usability of products from design to deployment. DOMESTIC SALES AND MARKETING The Company's primary domestic marketing strategy is to sell directly to end-users to act as an OEM and to sell through value added resellers. As of December 31, 2000, the Company's domestic sales team consisted of 88 sales and support employees, 15 marketing employees, and 50 technical service and support employees. There are eleven sales offices located in the United States, and a number of sales representatives work from their homes to cover local territories. Domestic sales represented approximately 80%, 88%, and 92% of the Company's net revenues for 2000, 1999, and 1998, respectively. The vast majority of the Company's domestic sales are directly to end-users. INTERNATIONAL SALES AND MARKETING The Company's international marketing strategy is to sell directly to end-users in certain regions and to use local distributors in others. The Company provides marketing and technical support services in connection with international sales. As of December 31, 2000, the Company's international sales team consisted of 16 sales employees and 24 technical service and support employees. There are five international Dot Hill sales offices: two in Japan, one in the United Kingdom, one in the Netherlands and one in France. The Company's distributors are located in approximately twenty different countries. International sales accounted for approximately 20%, 12%, and 8% of the Company's net revenues for 2000, 1999, and 1998, respectively. ENGINEERING AND PRODUCT DEVELOPMENT The Company's research, engineering and product development teams are focused on developing innovative storage and SAN solutions, along with storage management software, for the open systems market. The Company's areas of expertise include UNIX, Windows and Linux driver and system software design; SAN storage resource management software design; data storage system design and integration; high-speed interface design for SCSI, Ultra SCSI, Ultra2, Ultra3 and Fibre Channel; and design, qualification and integration of disk drives, tape drives, robotics and other storage components. The Company has a history of industry firsts, including the first successfully commercialized hot-swappable SCSI Disk Array and RAID storage system for the UNIX environment, the first Fibre Channel storage system, one of the first turnkey SAN solutions for the open systems market and the first NEBS Level 3 certified line of storage systems. The Company generally designs its products to have a modular architecture that is readily modified to respond to technological developments and paradigm shifts in the open systems computing environment. This flexibility also allows the Company to focus research and development resources on specific product innovations and advancements. The modular architecture allows solutions to be tailored to customers' specific needs and products to be adapted to changes in technology and in customers' computing environments. The Company is currently focusing development efforts on its SANnet line of systems and storage management software. Projects include improvements to the features, functions and performance of the SANnet line, the Company's SANpath and SANscape storage management software offerings and next generation high speed solutions that take advantage of the latest transports and technologies. The 10 Company has contracted with a software engineering team in China that helps write code for the Company. Engineering and product development expenses of the Company (which do not include compensation for applications and technical support engineers, which is recorded as sales and marketing expenses) for fiscal years 2000, 1999 and 1998 were $8.8 million, $7.4 million and $9.9 million, respectively. As of December 31, 2000, the Company had 43 full-time employees engaged in engineering research and development activities. CUSTOMER SERVICE AND SUPPORT Dot Hill recognizes that providing comprehensive, proactive and responsive support is essential to establishing new customer accounts and securing repeat business. Dot Hill is committed to providing the highest level of customer service and support aimed at simplifying installation, reducing field failures, minimizing system downtime and streamlining administration. As a standard Dot Hill service, Dot Hill maintains a global network of professional engineers and technicians who provide continuous telephone technical support from its strategically-located Global Response Centers. All customers receive seven-day, 24-hour telephone technical support, and the Company offers support in a variety of different languages. Dot Hill also offers additional intensive on-site maintenance and support programs for a quarterly or annual fee, under which the Company will dispatch either its own technical personnel or those of a global third-party service provider to visit customer sites, typically within a few hours. Dot Hill offers four additional levels of customer service: Dot Plus Support, Dot Superior Support, Dot Ultra Support, and Dot Custom Support. The Company provides standard warranties, which typically run from one to five years, with all products sold. Under the standard warranty, the Company typically ships replacement hardware components to customers in advance of receiving returns of defective components. The Company occasionally issues credit in lieu of replacing a piece of equipment. A customer may also contract for an extended warranty on any product. MANUFACTURING Dot Hill's manufacturing is conducted in 43,000 square feet of its 70,000 square-foot facility in Carlsbad, California. The products are manufactured in a progressive build operation utilizing a configure-to-order manufacturing strategy. The manufacturing process consists of assembling and testing various subassemblies and the systems integration and test of the Company's storage solution products. Certain of those subassemblies are manufactured by independent contractors. Before the Company ships an order, the product is subjected to Accelerated Stress Testing. These test methods include thermal testing, margin testing and firmware revision controls to ensure performance to specification in the anticipated end-user computing environment. Test results are continuously measured and monitored to support the continuous improvement efforts. Key components are tracked by individual product serial numbers and logged in the Company's database for tracking purposes. The Company strives to develop close relationships with its suppliers, exchanging critical information and implementing joint corrective action programs to maximize the quality of its components, reduce costs and reduce inventory investments. The Company believes that its current facilities and capital equipment are adequate to meet its manufacturing needs in the foreseeable future. In July 1998, the Company earned the ISO 9002 registration from the International Standards Organization for its manufacturing facility in Carlsbad, California. The ISO 9002 certification covers the manufacture, distribution and support of the Company's products. Attaining the ISO 9002 certification 11 entailed examination of the Company's manufacturing standards and processes. The Company has undergone periodic assessments by independent auditors in order to retain the ISO 9002 certification. The Company subcontracts some of its manufacturing, such as plastic molding, sheet metal bending, PCB ("printed circuit board") fabrication and certain assembly to qualified suppliers in the United States and Asia. The Company owns the design and tools/molds associated with the manufacture of these parts. The third parties that the Company relies on for these production activities include, but are not limited to SMS Technologies ("SMS") for printed circuit board assemblies ("PCBA") and National Manufacturing Technologies, Inc. ("NMT")/Escon for sheet metal assemblies. If the Company were required to have other third parties provide subassembly products and services, it may take a few months to achieve the same levels of productivity with the new third party suppliers. The Company relies on other companies to supply certain key components of its products and products that it resells. Many of these components and third-party products are available only from limited sources in the quantities and quality demanded by the Company. The Company purchases a substantial amount of its disk drives from Seagate Technology Inc. ("Seagate"), and purchases a substantial amount of its RAID controllers were from Infortrend. Approximately 14%, 23%, and 22% of the Company's total raw material purchases were from Seagate, and approximately 10%, 4% and 2% were from Infortrend for the years ended December 31, 2000, 1999 and 1998, respectively. Approximately 10% of the Company's raw material purchases in 1999 were from IBM. The Company purchases substantially all of its raw materials pursuant to purchase orders, rather than long-term purchase agreements. The Company maintains minimum inventory levels. With respect to certain components, such as disk drives and controllers, if Dot Hill had to seek alternative sources of supply, the incorporation of such components from alternative suppliers and the manufacture and shipment of the Company's products could be delayed while modifications to such products and the accompanying software were made to accommodate the introduction of the alternative suppliers' components. The Company estimates that replacing Infortrend RAID controllers with those of another supplier would involve several months of hardware and software modification. The Company resells the tape libraries and other products of StorageTek, among other companies. Approximately 12%, 17%, and 15% of the Company's total purchases were from StorageTek products for the years ended December 31, 2000, 1999 and 1998, respectively. These products were then resold to customers. If Dot Hill were to face a shortage of StorageTek products in the future, Dot Hill believes it could, after some modification, integrate the products of other manufacturers into its storage solutions. However, due to the market acceptance of StorageTek, the Company believes that a substantial number of customers may not be satisfied with the products of an alternate manufacturer. BACKLOG The Company's sales are generated by purchase orders from customers for shipment of the Company's products. The Company generally operates with a limited order backlog of such orders, because its products typically ship shortly after orders are received. However, orders from OEM customers often add to the Company's backlog, and the Company has been focusing on securing OEM customers. The customers have certain rights to extend or delay shipment of their orders, as well as the right to return products and cancel orders in some circumstances. The Company does not believe that its backlog as of any particular date is a reliable indicator of future revenue levels. COMPETITION The market for open systems storage is growing, and is intensely competitive. The Company competes primarily with traditional suppliers of computer systems including, but not limited to, Compaq Corporation, Hewlett-Packard, Sun Microsystems, IBM, Hitachi and Dell Computer Corporation, which market storage systems as well as other computer products and which the Company 12 believes have become more focused on storage during the past few years. The Company also competes against independent storage system suppliers to the high-end open systems market, including, but not limited to, EMC Corporation, Network Appliance, Inc., Ciprico Inc., nStor Technologies, MTI Technologies, Inc, Eurologic, Raid Power, Amdahl, and Storage Technologies, Inc. In providing tape backup, the Company competes with suppliers of tape-based storage systems such as ADIC, Datalink Corporation, MTI Technologies, Inc., Dallas Digital and Cranel, Inc. and numerous resellers. Competitive pricing pressures exist in the data storage market, which have had and may have in the future an adverse effect on the Company's revenues and earnings. There has also been and may continue to be a willingness on the part of certain large competitors to reduce prices in order to preserve or gain market share. The Company believes these pricing pressures are likely to continue as competitors develop more competitive product offerings. Many of the Company's current and potential competitors are significantly larger than the Company and have significantly greater financial, technical, marketing, purchasing and other resources. As a result, competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the development, promotion and sale of products, or to deliver competitive products at lower end-user prices than the Company. The Company also expects that competition will increase as a result of industry consolidations and the formation of new independent storage providers offering new technology. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of the Company's prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. For example, Network Attached Storage ("NAS") has gained popularity recently as an alternative to SANs. The Company does not have a NAS solution at this time. Increased competition is likely to result in price reductions, reduced operating margins and loss of market share, any of which could have a material adverse effect on the Company's business, operating results and financial condition. PROPRIETARY TECHNOLOGY AND INTELLECTUAL PROPERTY Dot Hill's success depends significantly upon its proprietary technology. The Company has limited patent protection for its products and has attempted to protect its intellectual property rights primarily through copyrights, trade secrets, employee and third-party nondisclosure agreements and other measures. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. The Company generally enters into confidentiality agreements with its employees and with key vendors and suppliers. As of December 31, 2000, the Company had been awarded a total of seven U.S. patents covering certain elements of its products. It is unlikely that the seven aforementioned patents will provide the Company with competitive advantages or will not be challenged by third parties. The patents of the Company's competitors may have a material adverse effect on the Company's ability to do business. The Company expects that competitors in the storage system market will increasingly be subject to infringement claims as the number of products and competitors in the market grows. Although Dot Hill believes that its products and trade designations do not infringe on the proprietary rights of third parties, there can be no assurance that third parties will not assert infringement claims against the Company in the future. From time to time, the Company receives letters from patent owners asserting possible infringement and requesting to explore a licensing relationship. In 1999, the Company received two such letters, one of which is being actively pursued by the sender. The Company is in the process of negotiating a licensing agreement with the sender of the lettter, which may have a material impact on the Company's future financial results. If a licensing agreement is not secured, the sender will likely file a formal claim of patent infringement. There can be no assurance that the Company will be able to successfully defend against any such assertions or obtain 13 licenses to use such technology or that licenses could be obtained on terms that would not have a material adverse effect on the Company's business, operating results and financial condition. If the Company or its suppliers are unable to license protected technology, the Company may be prohibited from marketing products that incorporate such technology. The Company could also incur substantial costs to redesign its products or to defend legal actions asserted against it. Should the Company's products be found to infringe protected technology, Dot Hill could be required to pay damages to the infringed third party or be enjoined from manufacturing and selling such products. The Company has registered numerous trademarks and will continue to evaluate the registration of additional trademarks as appropriate. Recently, the Company applied for registered trademark protection for the marks SANman-TM-, SANnet, SANpath, SANscape, Dot Hill and the Dot Hill logo. The Company claims common law protection for, and may seek to register many other trademarks. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. In addition, the laws of some foreign countries do not protect proprietary rights to as great an extent as do the laws of the United States. There can be no assurance that Dot Hill's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology, duplicate the Company's products or design around patents issued to the Company, or the intellectual property rights of the Company. EMPLOYEES As of December 31, 2000, Dot Hill had a total of 417 employees, substantially all of whom are full-time. Of the total employees, 43 employees were engaged in research, engineering and product development; 86 in applications and technical support engineering and customer support; 138 in marketing and sales; 108 in manufacturing; and 42 in general management and administration. The Company's future operating results depend in significant part upon its ability to attract, train, retain and motivate qualified management, technical, manufacturing, sales and support personnel for its operations, which has been particularly difficult over the last year due, in part, to restructuring activities, the enhanced recruiting efforts of competitors, and the generally low unemployment rates. The Company provides equity incentives, in addition to salary and benefits, to attract and retain qualified employees. Most members of the Company's sales force are compensated in a manner that includes a commission-based component. EXECUTIVE OFFICERS OF THE REGISTRANT AT DECEMBER 31, 2000
NAME AGE POSITION OFFICER SINCE ---- -------- ---------------------------------- -------------- James L. Lambert.................. 47 Chief Executive Officer, August 1999 President, Chief Operating Officer, and Director Preston Romm...................... 47 Chief Financial Officer, Treasurer November 1999 and Assistant Secretary Benjamin Monderer................. 42 Executive Vice President of April 1988 Strategic Development and Director Dana Kammersgard.................. 45 Chief Technical Officer August 1999
All officers are elected by the Board of Directors and serve at the pleasure of the Board of Directors as provided in the By-laws. JAMES L. LAMBERT has served as Director, President, Chief Operating Officer and Chief Executive Officer of the Company since August 2000. From the date of the Merger to August 2000, Mr. Lambert serviced as President, Chief Operating Officer and Co-Chief Executive Officer. A founder of Artecon, 14 Mr. Lambert served as President, Chief Executive Officer and Director of Artecon from its inception in 1984 until the Merger. From 1979 to 1984, Mr. Lambert served in various positions at CALMA, a division of General Electric Company, most recently from 1981 to 1984 as Vice President of Research and Development. Mr. Lambert currently serves as a Director of the Nordic Group of Companies, a group of privately held companies. He holds a B.S. and a M.S. in Civil and Environmental Engineering from the University of Wisconsin, Madison. PRESTON ROMM joined the Company in November 1999 as Vice President of Finance and Chief Financial Officer. From January 1997 to November 1999, Mr. Romm was Vice President of Finance, Chief Financial Officer and Secretary of Verteq, Inc., a privately-held semiconductor equipment manufacturer. From November 1994 to January 1997, Mr. Romm was Vice President of Finance and Chief Financial Officer of STM Wireless, Inc. (NASD:STMI), a wireless data and voice equipment manufacturer. From July 1990 to November 1994, Mr. Romm was Vice President and Controller of MTI Technology Corporation (NASD:MTIC), a provider of data storage systems. Mr. Romm has over 20 years of experience as a financial executive at high technology companies. Mr. Romm holds a B.S. from the University of Maryland and an M.B.A. from American University. DR. BENJAMIN MONDERER, ENG.SC.D. has served as Executive Vice President of Strategic Development and a Director of the Company since August 2000. From the date of the Merger to August 2000, Dr. Monderer served as Executive Vice President of Applications Engineering/Professional Services and Director. Dr. Monderer was a co-founder of Box Hill, as well as President and a Director since Box Hill's incorporation in 1988 until the Merger. He became Chairman of the Board of Box Hill in July 1997. Dr. Monderer was a member of the technical staff at Hewlett-Packard in 1980 and 1981, and was a Research Scientist at Columbia University from 1986 to 1989. Dr. Monderer holds a Bachelor of Science in Electrical Engineering from Princeton University and a Master of Science degree in Electrical Engineering and a Doctor of Engineering Science from Columbia University. DANA KAMMERSGARD has served as Chief Technical Officer since the Merger. Mr. Kammersgard was a founder of Artecon and served as a Director from its inception in 1984 until the Merger. At Artecon, he served in various positions since 1984 including Secretary and Senior Vice President of Engineering from March 1998 until August 1999 and as Vice President of Sales and Marketing from March 1997 until March 1998. Prior to co-founding Artecon, Mr. Kammersgard was the Director of Software development at CALMA, a division of General Electric Company. Mr. Kammersgard holds a B.A. in Chemistry from the University of California, San Diego. CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS In addition to those risks identified elsewhere in this Annual Report on Form 10-K, the Company's business and results of operations are subject to numerous risks and uncertainties, including the following. THE OPEN SYSTEMS STORAGE MARKET IS RAPIDLY CHANGING AND DOT HILL MAY BE UNABLE TO KEEP PACE OR PROPERLY PREPARE FOR THE EFFECTS OF THOSE CHANGES. The open systems data storage market in which Dot Hill operates is characterized by rapid technological change, frequent new product introductions and evolving industry standards. Customer preferences in this market are difficult to predict and changes in those preferences could render Dot Hill's current or future products unmarketable. The introduction of products embodying new technologies by Dot Hill's competitors and the emergence of new industry standards also could render existing products as well as new products, such as the SANnet line of systems, obsolete and unmarketable. For example, if customers were to turn away from open systems computing, Fibre Channel or SANs in general, or fail to embrace the Company's SANnet line of systems in particular, Dot Hill's revenue would dramatically decline. 15 The success of Dot Hill depends upon its ability to address the increasingly sophisticated needs of customers, to enhance existing products and to develop and introduce, on a timely basis, new competitive products (including new software and hardware, and enhancements to existing software and hardware) that keep pace with technological developments and emerging industry standards. If the Company cannot successfully identify, manage, develop, manufacture or market product enhancements or new products, its business will be materially and adversely affected. A number of mergers and acquisitions have taken place among open systems storage companies recently, and that type of activity may continue. Such corporate transactions may quickly and unpredictably alter the market, including the competitive landscape and the availability of key components and third party products. Such constant changes make accurate predictions difficult. THE LOSS OF ONE OR MORE SUPPLIERS COULD ADVERSELY AFFECT DOT HILL'S ABILITY TO MANUFACTURE AND SELL PRODUCTS. The Company relies on third parties to supply certain key components of its products and products that it resells. Many of these components and third party products are available only from limited sources in the quantities and quality demanded by the Company. The Company purchases the large majority of its disk drives from Seagate, and purchases a substantial amount of its RAID controllers from Infortrend. Approximately 14%, 23%, and 22% of the Company's total raw material purchases were from Seagate, and approximately 12%, 4% and 2% were from Infortrend for the years ended December 31, 2000, 1999 and 1998, respectively. Approximately 10% of the Company's raw material purchases during the year ended December 31, 1999 were from IBM. The Company purchases a significant portion of its raw materials pursuant to purchase orders, rather than pursuant to long-term purchase agreements. The Company maintains minimum inventory levels. There is currently a significant market demand for disk drives, tape drives and RAID controllers, and from time to time the Company may experience component shortages, selective supply allocations and increased prices of such components. With respect to certain components, such as disk drives and controllers, even if alternative sources of supply became available, the incorporation of such components from alternative suppliers could delay the manufacture and shipment of the Company's products while modifications to such products and accompanying software were made to accommodate the introduction of the alternative suppliers' components. The Company estimates that replacing Infortrend's RAID controllers with those of another supplier would involve several months of hardware and software modification. The Company subcontracts some of its manufacturing, such as plastic molding, sheet metal bending, PCB fabrication and certain assembly to qualified suppliers in the United States and Asia. The Company owns the design and tools/molds associated with the manufacture of these parts. The third parties that the Company relies on for these production activities include, but are not limited to, SMS for PCBA assemblies and NMT/Escon for sheet metal assemblies. If the Company were required to have other third parties provide subassembly products and services work, it may take a few months to achieve the same levels of productivity with new third party suppliers The Company resells the tape libraries and other products of StorageTek, among other companies. Approximately 12%, 17%, and 15% of the Company's total purchases were for StorageTek products for the years ended December 31, 2000, 1999 and 1998, respectively. If Dot Hill were to face a shortage of StorageTek products in the future, Dot Hill could, after some modification, integrate the products of other manufacturers into its storage solutions. However, due to the market acceptance of StorageTek, the Company believes that a substantial number of customers may not be satisfied with the products of an alternate manufacturer. DOT HILL MAY HAVE DIFFICULTY PREDICTING RESULTS AND MAY EXPERIENCE OPERATING LOSSES, EITHER OF WHICH WOULD LIKELY RESULT IN A DECLINE IN THE COMPANY'S STOCK PRICE. In each of the years ended December 31, 2000 and 1999, the Company incurred a loss. There can be no assurance that the Company will be profitable on a quarterly or annual basis. If the Company is unable to generate net income from operations, its business will be adversely affected and its stock price will likely decline. 16 The Company's quarterly operating results have in the past varied and may in the future vary significantly depending on a number of factors, including: - the level of competition; - the size, timing, cancellation or rescheduling of significant orders; - product configuration, mix and any quality issues; - market acceptance of new products and product enhancements such as the new SANnet line of systems; - new product announcements or introductions by competitors; - deferrals of customer orders in anticipation of new products or product enhancements or a downturn in market conditions, which the Company has experienced since the start of 2001; - changes in pricing by the Company or its competitors; - the ability of the Company to develop, introduce and market new products and product enhancements on a timely basis; - hardware component costs and availability, particularly with respect to hardware components obtained from sole sources; - hardware supply constraints; - the Company's success in expanding its sales and marketing programs; - technological changes in the open systems storage market; - levels of expenditures on research, engineering and product development; - changes in the Company's business strategies; - personnel changes; and - general economic trends and other factors. Sales for any future quarter are not predictable and have a significant degree of uncertainty. The Company generally operates with limited order backlog, because its products are typically shipped shortly after orders are received. Further, the Company does not generally enter into long-term purchase contracts with customers, and customers have certain rights to extend or delay shipment of their orders, as well as the right to return products and cancel orders in some circumstances. As a result, sales in any quarter are generally dependent on orders booked and shipped in that quarter. Sales are also difficult to forecast because the open systems storage market is rapidly evolving and the Company's sales cycles vary substantially from customer to customer. Further, in late 1999 the Company launched the SANnet line of products, and is actively encouraging customers to move from legacy products to these new product lines, which may affect sales cycles and the predictability of orders. Also, since the economic downturn at the start of 2001, customers have deferred purchasing decisions and sales cycles have been lengthened. Due to the unpredictable timing of customer orders, the Company may ship products representing a significant portion of its net sales for a quarter during the last month of that quarter. Any significant deferral of these sales could have a material adverse effect on the results of operations in any particular quarter. To the extent that the Company completes significant sales earlier than expected, operating results for subsequent quarters may be adversely affected. The Company's expense levels are based, in part, on its expectations as to future sales. As a result, if sales levels are below expectations, net income may be disproportionately affected. There is no assurance that the Company will experience sales growth with respect to its legacy and new line of products in future periods. 17 Fluctuating operating results may increase the likelihood of the Company becoming involved in expensive, time-consuming litigation. If the Company becomes involved in litigation, the Company's operating results for one or more quarters, as well as the price of the Company's common stock, could be materially adversely affected. A SIGNIFICANT PERCENTAGE OF THE COMPANY'S EXPENSES ARE FIXED, WHICH MAY AFFECT ITS OPERATING RESULTS. The Company's expense levels are based in part on its expectations as to future sales, and a significant percentage of the Company's expenses are fixed, which limits its ability to reduce expenses quickly in response to any revenue shortfalls. As a result, if revenues do not meet the Company's revenue projections, operating results may be disproportionately affected. The Company may experience revenue shortfalls for various reasons, including: - significant pricing pressures that occur because of declines in selling prices over the life of a product or because of increased competition; - sudden shortages of raw materials or fabrication, test or assembly capacity constraints that lead the Company's suppliers to allocate available supplies or capacity to other customers, which, in turn, may harm the Company's ability to meet its sales obligations; and - the reduction, rescheduling or cancellation of customer orders. In addition, the Company typically plans its production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. From time to time, in response to anticipated long lead times to obtain inventory and materials from its outside suppliers, the Company may order materials in advance of anticipated customer demand. This advance ordering may result in excess inventory levels or unanticipated inventory write-downs if expected orders fail to materialize. THE COMPANY MAY NOT HAVE ACCESS TO SUFFICIENT FUNDING TO SUPPORT ITS OPERATIONS. The Company has expended and will continue to be required to expend substantial funds to pursue research and development, enhance marketing efforts and other aspects of the Company's business. Although the Company believes it has access to resources sufficient to fund its operations for at least the next twelve months, the Company may need or elect to raise additional capital. The Company's future capital requirements will depend on, and could increase substantially as a result of, many factors, including: - the problems, delays, expenses and complications frequently encountered by technology companies; - the progress of the Company's research, development and product testing programs; - the success of the Company's sales and marketing efforts; - costs in filing, prosecuting, defending and enforcing intellectual property rights; - the extent and terms of any development, manufacturing, marketing or other arrangements; and - changes in economic, regulatory or competitive conditions. To satisfy its capital requirements, the Company may seek to raise funds through public or private equity or debt financings or other financing sources. The Company's ability to raise additional funds in the public or private capital markets will be adversely affected if the results of the Company's ongoing or future research and development programs are not favorable and may also be adversely affected by the concentration of ownership of the Company's common stock by management. The Company cannot guarantee that any additional funding will be available when needed or that available financing will be 18 on favorable terms. If the Company raises additional funds by issuing equity or convertible debt securities, the Company's current shareholders may experience substantial dilution, and debt financing, if available, may involve restrictive covenants. AN ECONOMIC DOWNTURN IN AN INDUSTRY IN WHICH THE COMPANY IS CONCENTRATED COULD MATERIALLY AND ADVERSELY AFFECT REVENUES AND OPERATING RESULTS. Dot Hill's revenues have been derived primarily from sales to customers in the xSPs, telecommunications, e-commerce, and financial services industries. For the year ended December 31, 2000, direct sales to customers in the xSPs, telecommunications, and e-commerce; and financial services industries, as a percentage of net revenues were 39% and 11%, respectively. For the year ended December 31, 1999, direct sales to customers in the telecommunications and financial services industries as a percentage of net revenues were 21% and 18%, respectively. For the year ended December 31, 1998, direct sales to customers in the telecommunications and financial services industries as a percentage of net revenues were 20% and 27%, respectively. In fiscal year 2000, the Company derived a significant portion of its revenues from the sale of its products to Internet-related businesses. The Company cannot predict with any certainty whether the Internet will be a viable commercial marketplace or whether the demand for Internet-related products and services will increase or decrease in the future. Any decrease in the growth of the Internet, in the demand for the Company's products by Internet-related businesses, in the number of Internet-related businesses or in the financial resources available to Internet-related businesses to purchase the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. Historically, a material percentage of the Company's net revenues in each year has been derived from a limited number of customers. For the years ended December 31, 2000, 1999 and 1998, the Company's top five customers, including distributors, accounted for approximately 37%, 25% and 22%, respectively, of the Company's net revenues. Sales to one customer, UUNET Technologies, Inc. accounted for 17% and 10%, respectively, of the Company's net revenue for the years ended December 31, 2000 and 1999. Sales to any one customer did not exceed 10% of total net revenues for the year ended December 31, 1998. A very significant portion of the Company's revenues to date have been concentrated in the UNIX marketplace, and within the UNIX marketplace, a significant portion of the Company's revenues are associated with versions of UNIX manufactured by Sun Microsystems, Inc. If Sun Microsystems were to change its policy of supporting open systems computing environments, and if Dot Hill's products were thereby rendered incompatible with Sun Microsystems' products, Dot Hill's business, financial position and results of operations would be materially and adversely affected. The Company expects that a high percentage of the Company's sales for the foreseeable future will continue to come from a relatively small number of customers. There can be no assurance that orders from existing customers will continue at their historical levels, or that the Company will be able to obtain orders from new customers. An economic downturn in any industry targeted by the Company, or the loss of one or more customers, particularly a significant customer, could result in a material decrease in revenues, thereby adversely affecting Dot Hill's business. At the start of 2001, a nationwide downturn resulted in a delay of purchasing decisions by a large number of Dot Hill customers and a revenue shortfall for the first quarter of 2001. It is unclear when, or if, these delayed purchasing decisions will be made, and the deferral of orders is likely to continue to affect the Company in the future. 19 BECAUSE THE COMPANY GENERALLY DOES NOT ENTER INTO LONG-TERM CONTRACTS WITH ITS CUSTOMERS AND SALES CYCLES CAN BE LENGTHY, DELAYS OR CANCELLATIONS OF CUSTOMER ORDERS COULD MATERIALLY AND ADVERSELY AFFECT DOT HILL'S OPERATING RESULTS. The Company generally does not enter into long-term volume purchase contracts with its customers, and customers generally have certain rights to extend or to delay the shipment of their orders without penalty. The Company's distributors and value-added resellers ("VARs") may also carry competing product lines and could reduce or discontinue sales of the Company's products, which could have a material adverse effect on the Company's operating results. Although the Company believes that it provides adequate allowances for product returns, there can be no assurance that actual returns will not exceed recorded allowances, which could have a material adverse effect on the Company's operating results. In addition, there can be no assurance that existing end-user customers will not purchase their storage equipment from the manufacturer that provides their network computing systems and, as a result, reduce or eliminate purchases from the Company. The loss of one or more of the Company's current customers, particularly a principal customer, or cancellation or rescheduling of orders already placed, could materially and adversely affect the Company's business, operating results or financial condition. Customer orders for the Company can range in value from a few thousand dollars to over a million dollars. The length of time between initial contact with a potential customer and sale of a product, or the "sales cycle," can also vary greatly and lasts between three to twenty-four months. This is particularly true during times of economic slowdown and true for the sale and installation of complex, turnkey solutions, which are often sold directly to end users, and for new products, such as SANnet. Revenue for Dot Hill is directly affected by the timing of large orders, which makes it difficult for the Company to predict such revenue. Revenue for a quarter may be lower than predicted if large orders forecasted for a certain quarter are delayed or are not realized. Factors that may delay or defer an order, particularly orders for new products, such as the SANnet line of systems, include: - time needed for technical evaluations by customers; - customers' budget constraints and changes to customers' budgets during the course of the sales cycle; - a slowdown in the overall economy or in the particular industries into which the Company sells; - customers' internal review and testing procedures; and - engineering work by the Company to integrate a storage solution with a customers' system. DOT HILL'S BUSINESS AND OPERATING RESULTS WILL MATERIALLY SUFFER IF IT ENCOUNTERS SIGNIFICANT PRODUCT DEFECTS. Storage system products like those offered by the Company may contain undetected software errors or failures when first introduced or as new versions are released. There can be no assurance that, despite testing, errors will not be found in products after shipments (particularly new products, such as the SANnet line of systems), resulting in a loss of or delay in market acceptance, which could have a material adverse effect on the Company's business, operating results or financial condition. The Company's standard warranty provides that if the system does not function to published specifications, the Company will repair or replace the defective component without charge. Significant warranty costs, particularly those that exceed reserves, could have a material adverse effect on the Company's business, operating results and financial condition. Although the Company has not received any product liability claims to date, the sale and support of products by the Company and the incorporation of products from other companies may entail the 20 risk of such claims. A successful product liability claim against the Company could have a material adverse effect on the Company's business, operating results or financial condition. DOT HILL LAUNCHED A NEW LINE OF PRODUCTS AND IS ENCOURAGING CUSTOMERS TO MOVE FROM LEGACY PRODUCTS TO THE NEW LINE, WHICH ENTAILS MANY RISKS AND UNCERTAINTIES. In late 1999, the Company introduced a number of new products including its SANnet line of systems, and two software packages, SANpath and SANscape. The Company is continuing to encourage customers to move from the Company's various legacy products to the new product lines. These activities entail a number of risks and uncertainties, all of which could have a material and adverse affect on the Company's business. Those risks and uncertainties, include, but are not limited to, the following: - customer orders may be delayed while customers evaluate new products; - customers may be disturbed by Company actions to encourage the use of the new products and they may choose not to do business with the Company; - the new line of products may contain defects or bugs that are unknown by the Company, but are discovered after shipment of products has occurred; - customers may not purchase the new products; - the Company will most likely find it more difficult to accurately predict future financial performance. DOT HILL'S BUSINESS AND RESULTS OF OPERATIONS WILL BE MATERIALLY AND ADVERSELY AFFECTED IF IT CANNOT ATTRACT OR RETAIN KEY PERSONNEL. The Company's future performance depends in significant part upon the continued service of its senior management and key personnel. The Company provides incentives such as competitive salaries and bonuses, benefits and option grants (which are typically subject to vesting over four years) to attract and retain qualified employees. In recent periods, the Company has experienced difficulties retaining existing, and attracting and training new, skilled personnel. Any inability to attract, train and retain skilled sales personnel in future periods or the loss of the services of one or more of the Company's officers or other key employees could have a material adverse effect on the Company's business, operating results and financial condition. Competition for such personnel is intense, and there can be no assurance that the Company can retain its key sales, technical and management employees or that it can attract, assimilate or retain other highly qualified sales, technical and management personnel in the future. THE COMPUTER STORAGE MARKET IS HIGHLY COMPETITIVE. The storage system market is intensely competitive. The Company competes with various companies, including, but not limited to, Hewlett Packard, Sun Microsystems, IBM, Hitachi, Compaq Corporation, and Dell Computer Corp., which market storage systems as well as other computer products, and which have become more focused on storage during the past few years. The Company also competes against independent storage system suppliers to the high-end market including, but not limited to, EMC Corporation, Network Appliance, Ciprico, nStor Technologies, MTI Technology, Eurologic, Raid Power, Amdahl, and Storage Technologies, Inc. In providing tape backup, the Company competes with suppliers of tape-based storage systems including, but not limited to, ADIC, Datalink Corporation, MTI Technologies, Dallas Digital, Cranel, Inc., StorageTek and numerous resellers. Many of these competitors are significantly larger than Dot Hill and have significantly greater name recognition, engineering, manufacturing and marketing capabilities, as well as greater financial 21 and personnel resources. As a result, competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the development, promotion and sale of products or to deliver competitive products at a lower end-user price than the Company. The Company also expects that competition will increase as a result of industry consolidations and the formation of new companies with new, innovative offerings. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of the Company's prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. For example, NAS has gained popularity recently as an alternative to SANs. The Company does not have a NAS solution at this time. Increased competition is likely to result in price reductions, reduced operating margins and loss of market share, any of which could have a material adverse effect on the Company's business, operating results and financial condition. In fact, competitive pricing pressures have had, and may continue to have, an adverse effect on Dot Hill's revenue and earnings. The Company believes that the principal competitive factors affecting its markets include fault-tolerance, reliability, performance, ease of use, scalability, manageability, price and customer service and support. There can be no assurance that the Company will be able to successfully incorporate these factors into its products and to compete against current or future competitors or that competitive pressures faced by the Company will not materially and adversely affect its business, operating results and financial condition. If Dot Hill is unable to develop and market products to compete with the products of competitors, the Company's business and operating results will be materially and adversely affected. In addition, if major customers who are also competitors cease purchasing Dot Hill products in order to concentrate on sales of their own products, the Company's business and operating results will be adversely affected. Dot Hill sells its products through distributors and VARs internationally and, to a lesser extent, domestically. These distributors and VARs may also carry competing product lines, and may reduce or discontinue sales of the Dot Hill's products, which could have a material adverse effect on the Company's business and operating results. In addition, the Company cannot ensure that existing end-user customers will not purchase storage equipment from the manufacturer that provides their network computing systems and, as a result, reduce or eliminate purchases from Dot Hill. DOT HILL'S INTERNATIONAL BUSINESS ACTIVITIES SUBJECT IT TO RISKS THAT COULD ADVERSELY AFFECT ITS BUSINESS AND OPERATING RESULTS. Dot Hill's international sales represented approximately 20% of net revenues for the year ended December 31, 2000 and the Company currently has sales offices in Japan, France, the United Kingdom, and the Netherlands. Dot Hill believes that continued growth and profitability will require expansion of international operations, particularly in Europe and the Pacific Rim. As a result of this expansion of international operations, the Company will incur additional expenditures for facility expenses, personnel, and other related operating expenses. The Company's international operations are subject to a variety of risks associated with conducting business internationally, including the following, any of which could have a material adverse effect on the Company's business, operating results and financial condition: - longer payment cycles; - unexpected changes in regulatory requirements; - import and export restrictions and tariffs, and increases in tariffs, duties, price controls or other restrictions on foreign currencies; 22 - the burden of complying with a variety of foreign laws; - potentially adverse tax consequences; - currency exchange rate fluctuations; - the imposition of trade barriers or price controls; - political and economic instability abroad; - difficulties in staffing and managing international operations; - seasonal reductions in business activity during the summer months in Europe and other times in other parts of the world; and - problems in collecting accounts receivable. A portion of the Company's international business is presently conducted in currencies other than the U.S. dollar. Foreign currency transaction gains and losses arising from normal business operations are credited to or charged against earnings in the period incurred. As a result, fluctuations in the value of the currencies in which the Company conducts its business relative to the U.S. dollar will cause currency transaction gains and losses, which Dot Hill has experienced in the past and continues to experience. Due to the substantial volatility of currency exchange rates, among other factors, the Company cannot predict the effect of exchange rate fluctuations upon future operating results. There can be no assurance that the Company will not experience currency losses in the future. The Company has not previously undertaken hedging transactions to cover its currency exposure nor does it intend to engage in hedging activities in the future. Proprietary rights and intellectual property may be more difficult to protect outside of the United States. Also, the Company has limited experience in marketing and distributing its products internationally. Dot Hill cannot be certain that it will be able to successfully grow its international presence in a timely manner, which could have a material adverse effect on the business, operating results and financial condition of the Company. DOT HILL'S LACK OF INTELLECTUAL PROPERTY PROTECTION AND CLAIMS OF PATENT INFRINGEMENT MAY MATERIALLY AND ADVERSELY AFFECT THE COMPANY'S BUSINESS, OPERATING RESULT AND FINANCIAL CONDITION. Dot Hill's success depends significantly upon its proprietary technology. The Company has limited patent protection for its products and has attempted to protect its intellectual property rights primarily through copyrights, trade secrets, nondisclosure agreements and other measures. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which affords only limited protection. The Company generally enters into confidentiality agreements with its employees and with key third parties. As of December 31, 2000, the Company was awarded a total of seven U.S. patents covering certain elements of its products. The Company does not have any patents pending or current plans to seek additional patents at this time. It is unlikely that the seven aforementioned patents will provide the Company with competitive advantages or will not be challenged by third parties. The patents of others may have a material adverse effect on the Company's ability to do business. The Company expects that competitors in the storage system market increasingly will be subject to infringement claims as the number of products and competitors in the market grows. Although Dot Hill believes that its products and trade designations do not infringe on the proprietary rights of third parties, there can be no assurance that third parties will not assert infringement claims against the Company in the future. From time to time, the Company receives letters from patent owners that indicate a possible infringement and request to explore a licensing relationship. In 1999, the Company received two such letters, one of which is being actively pursued by the sender. The Company is in the 23 process of negotiating a licensing agreement with the sender of the letter, which may have a material impact on the Company's future financial results. If a licensing agreement is not secured, the sender will likely file a formal claim of patent infringement. If such inquiries result in the lodging of formal claims, the Company will evaluate such claims as they relate to its products and, if appropriate, may seek licenses to use the protected technology. There can be no assurance that the Company will be able to obtain licenses to use such technology or that licenses could be obtained on terms that would not have a material adverse effect on the Company. If the Company or its suppliers are unable to license protected technology, the Company could be prohibited from marketing products that incorporate such technology. The Company could also incur substantial costs to redesign its products or to defend any legal action taken against it. Should the Company's products be found to infringe protected technology, Dot Hill could be required to pay damages to the infringed party or be enjoined from manufacturing and selling such products. The Company has registered numerous trademarks and will continue to evaluate the registration of additional trademarks as appropriate. Recently, the Company has applied for registered trademark protection for the marks SANman, SANnet, SANpath, SANscape, Dot Hill and the Dot Hill logo. The Company claims common law protection for and may seek to register many other marks. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. In addition, the laws of some foreign countries do not protect proprietary rights to as great an extent as the laws of the United States. There can be no assurance that Dot Hill's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology, duplicate the Company's products or design around patents issued to the Company. THE COMPANY'S EXECUTIVE OFFICERS AND DIRECTORS AND THEIR AFFILIATES OWN MORE THAN HALF OF THE COMPANY'S OUTSTANDING SHARES, WHICH COULD PREVENT A CHANGE IN CONTROL OF THE COMPANY, AND ADVERSELY AFFECT DOT HILL'S STOCK PRICE. As of March 19, 2001, the Company's executive officers, directors and their affiliates beneficially owned approximately 51% of the Company's outstanding shares of common stock. As a result, these stockholders, if acting together, are able to influence matters requiring approval by the stockholders of the Company, including the election of a majority of the directors. The voting power of these stockholders under certain circumstances could have the effect of delaying or preventing a change in control of the Company. This concentration of ownership may also make it more difficult or expensive for the Company to obtain financing. Further, the Company's Certificate of Incorporation, as amended, and Bylaws, as amended, contain a number of provisions that could impede a takeover or change in control of the Company, including but not limited to a classified Board of Directors. If the shareholders adopt various proposals at the next annual meeting of the shareholders scheduled for May 18, 2001, the newly adopted Certificate of Incorporation and Bylaws will contain other provisions that could impede a takeover or change in control of the Company, including but not limited to, the elimination of the stockholders' ability to take action by written consent and limitations on the ability of stockholders to remove a director from office without cause. The Board of Directors may issue additional shares of Common Stock or establish one or more classes or series of Preferred Stock with such designations, relative voting rights, dividend rates, liquidation and other rights, preferences and limitations as determined by the Board without stockholder approval. 24 Each of the foregoing provisions gives the Board of Directors, acting without stockholder approval, the ability to prevent, or render more difficult or costly, the completion of a takeover transaction that stockholders might view as being in their best interests. OUR STOCK PRICE IS VOLATILE, WHICH MAY INCREASE THE LIKELIHOOD OF THE COMPANY BECOMING INVOLVED IN EXPENSIVE, TIME-CONSUMING LITIGATION. The market price of the Company's common stock has been, and is expected to continue to be, volatile. This volatility may result from a number of factors, including fluctuations in the Company's quarterly revenues and net income, announcements of products by the Company or its competitors, and conditions in the open systems storage market. Also, the stock market has experienced and continues to experience extreme price and volume fluctuations, which have affected the market prices of securities, particularly those of technology companies, and which often have been unrelated to the operating performance of these companies. These broad market fluctuations, as well as general economic and political conditions, may adversely affect the market price of the Company's common stock in future periods. Stock price volatility may increase the likelihood of the Company becoming involved in expensive, time-consuming litigation. ITEM 2. PROPERTIES Dot Hill's headquarters and ISO 9002 certified manufacturing operations are located in approximately 70,000 square feet of space in Carlsbad, California, including approximately 43,000 square feet of manufacturing space. This facility is leased through December 2001. The Company anticipates that it will extend the lease on this facility. The Company also has a major office in New York City, which consists of approximately 52,000 square-feet of space and is occupied under a long-term lease expiring in 2007. In addition, the Company leases eleven offices throughout the United States, and five offices in Japan, France, the United Kingdom, and the Netherlands. The aggregate rent for the year ended December 31, 2000 for all facilities was approximately $2.1 million. The Company believes that its existing facilities have the capacity to double their current production and therefore are adequate to meet its current needs. ITEM 3. LEGAL PROCEEDINGS On January 5, 2001, a final settlement in the class action lawsuit filed against Box Hill Systems Corp., certain of its officers and directors, and the underwriters of the Company's September 16, 1997 initial public offering was approved by the United States District Court for the Southern District of New York, and the action was dismissed with prejudice. No plaintiffs objected to the settlement, no plaintiffs opted-out of the settlement, and no appeal was taken from the judgment. Therefore, the action has been finalized. The Company is subject to various other legal proceedings and claims, asserted or unasserted, which arise in the ordinary course of business. The outcome of the claims against the Company cannot be predicted with certainty. The Company believes that such litigation and claims will not have a material adverse effect on the Company's financial condition or operating results. ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS None 25 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock has been listed on the New York Stock Exchange since September 16, 1997. The following table sets forth, for the fiscal quarters indicated, the range of high and low sale prices per share of the Company's common stock as reported on the New York Stock Exchange.
QUARTERLY PERIOD HIGH LOW - ---------------- -------- -------- Fiscal year ended December 31, 2000: 1st Quarter............................................... $17.19 $4.88 2nd Quarter............................................... 13.00 5.88 3rd Quarter............................................... 12.25 6.38 4th Quarter............................................... 5.00 2.75 Fiscal year ended December 31, 1999: 1st Quarter............................................... $ 7.13 $4.00 2nd Quarter............................................... 6.38 4.50 3rd Quarter............................................... 8.18 5.00 4th Quarter............................................... 7.13 4.63
As of March 19, 2001, there were 6,457 holders of record of the Company's common stock. The Company has never paid any cash dividends on its common stock, and currently intends to retain future earnings, if any, to fund the development and growth of its business. The Company does not anticipate paying any cash dividends in the foreseeable future. The last sales price for the Company's common stock, as reported by the New York Stock Exchange on March 19, 2001 was $3.99 per share. During the period covered by this Annual Report on Form 10-K, the Company did not issue or sell any equity securities that were not registered under the Securities Act of 1933, as amended. ITEM 6. SELECTED FINANCIAL DATA The accompanying financial statements of Dot Hill have been retroactively restated to reflect the Merger of Box Hill and Artecon, which was accounted for as a pooling of interests. The following selected financial information (except for the pro forma 1996 and certain pro forma 1997 information) with respect to these consolidated financial statements has been derived from the Company's audited financial statements. The data set forth below should be read in conjunction with the Company's financial statements and related notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K. As a result of changing Artecon's fiscal year-end from March 31 to conform with the Company's December 31 year-end, Artecon's results of operations for the three months ended March 31, 1999 are identical in the combined results of operations for both the years ended December 31, 1999 and 1998 and are reflected as an adjustment in the consolidated statements of shareholders' equity for the year ended December 31, 1999. Artecon's total revenue and net income for this period were $18.3 million and $1.7 million, respectively. Artecon's cash flows used in operating, investing, and financing activities for this period were $2.6 million, $39,000 and $1.8 million, respectively. 26 SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, ---------------------------------------------------- 2000 1999 1998 1997 (1) 1996 -------- -------- -------- -------- -------- STATEMENT OF OPERATIONS DATA: Net revenue............................... $121,197 $124,216 $168,355 $136,684 $105,344 ======== ======== ======== ======== ======== Gross margin.............................. $ 43,467 $ 37,604 $ 58,591 $ 40,211 $ 29,925 Operating expenses: Sales and marketing....................... 31,747 24,204 34,839 18,121 12,968 Engineering and product development....... 8,798 7,401 9,946 5,523 4,463 General and administrative................ 6,891 10,837 9,981 7,049 4,011 Shareholder officers' compensation........ -- -- 1,275 7,538 6,347 Impairment of intangible assets........... -- 1,224 867 -- -- Merger and restructuring expenses......... -- 7,392 1,404 -- -- Acquired in-process research and development............................. -- -- -- 18,200 -- -------- -------- -------- -------- -------- Operating (loss) income................... $ (3,969) $(13,454) $ 279 $(16,220) $ 2,136 ======== ======== ======== ======== ======== Net (loss) income......................... $ (948) $ (9,047) $ 584 $(14,230) $ 1,467 ======== ======== ======== ======== ======== Net (loss) income per share (2): Basic..................................... $ (0.04) $ (0.39) $ 0.03 $ (1.06) $ 0.12 ======== ======== ======== ======== ======== Diluted................................... $ (0.04) $ (0.39) $ 0.02 $ (1.06) $ 0.10 ======== ======== ======== ======== ========
DECEMBER 31, ------------------------------------------------------ 2000 1999 1998 1997 1996 -------- -------- ---------- -------- -------- BALANCE SHEET DATA: Cash, cash equivalents and short-term investments................................ $33,653 $47,951 $59,807 $58,194 $1,740 Working capital.............................. 54,454 58,946 78,867 74,259 32,510 Total assets................................. 102,879 103,658 127,030 131,162 14,879 Total long-term debt......................... 186 272 11,908 10,484 2,921 Total shareholders' equity................... 73,770 72,823 79,964 78,227 13,866
- ------------------------ (1) Concurrent with the initial public offering of Box Hill in 1997, the Company terminated its status as an S Corporation. Had the Company been a C Corporation for the entire year, the proforma net loss and net loss per basic and diluted share would have been $15,924 and $1.18, respectively, based on the tax laws in effect during the period. The pro forma information presented in this paragraph is unaudited. (2) See Note 1 of Notes to Consolidated Financial Statements of Dot Hill Systems Corp. for the years ended December 31, 2000, 1999 and 1998 for an explanation of shares used in computing basic and diluted net (loss) income per share. 27 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the consolidated financial statements and the related notes thereto included herein. The discussion in this Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, without limitation, those discussed in this section and the section entitled "Business," as well as those discussed elsewhere in this Annual Report on Form 10-K. OVERVIEW The Company designs, manufactures, markets and supports high performance data storage systems for the open systems computing environment. In the United States, the Company employs a direct marketing strategy aimed at data-intensive industries which, to date, include financial services, telecommunications, xSPs, multimedia, healthcare, government/defense and academia. The Company's international strategy is to sell directly to end-users in certain regions, and to use local distributors in others. The Company focuses on providing storage solutions to high-end customers, primarily in the UNIX, Windows, Linux and Novell environment. The Company's strategy is to leverage its expertise and focus exclusively on storage solutions. Effective August 2, 1999, Box Hill Systems Corp. ("Box Hill") and Artecon, Inc. ("Artecon") completed a Merger in which the two companies were merged in a tax-free, stock-for-stock transaction. The Merger was accounted for as a pooling-of-interests. The combined company changed its name to Dot Hill Systems Corp. Under the terms of the merger agreement, the Company issued 8,734,523 shares of its common stock to the former Artecon shareholders, representing 0.4 shares of the Company's common stock in exchange for each share of Artecon common stock outstanding. Additionally, Artecon's convertible preferred Series A shares were converted into 719,037 shares of the Company's common stock. The historical financial statements of the Company have been restated to reflect the Merger. During fiscal 1997, Artecon and SDI completed a reverse merger whereby SDI acquired Artecon for legal and tax purposes. For financial reporting purposes, the SDI merger was accounted for as an acquisition of SDI by Artecon, and, as such, the historical financial results of Artecon for all years prior to the SDI merger are those of Artecon. The SDI/Artecon combination was accounted for as a purchase and the purchase price included an allocation to goodwill and other intangible assets of $7.4 million. Additionally, in August 1997, Artecon acquired substantially all of the assets and liabilities of Falcon Systems. The acquisition was accounted for as a purchase and the purchase price included an allocation to goodwill and other intangible assets of $638,000. Box Hill completed an initial public offering of its common stock on September 16, 1997. The offering consisted of the sale of 5,500,000 shares of common stock at $15.00 per share, of which 3,300,000 were issued and sold by the Company and 2,200,000 shares were sold by individuals who were the founders and sole shareholders of the Company prior to the initial public offering. Additionally, 825,000 shares of common stock were purchased from the Company at $15.00 per share by the underwriters upon the exercise of an over-allotment option. The net proceeds to Box Hill, after deducting estimated underwriting discounts and offering expenses, were approximately $56.6 million. The Company's manufacturing operations consist primarily of the assembly and integration of components and subassemblies into the Company's products, with certain of those subassemblies manufactured by independent contractors. The Company's operations are primarily conducted from its facilities in Carlsbad, California. Generally, the Company extends to its customers the warranties provided to the Company by its suppliers. To date, the Company's suppliers have reimbursed the majority of the Company's warranty costs. On a quarterly and annual basis the Company's gross 28 margins have been and will continue to be affected by a variety of factors, including competition, product configuration, product mix, the availability of new products and product enhancements, and the cost and availability of components. Competitive pricing pressures exist in the data storage market, and have had and may in the future continue to have an adverse effect on the Company's revenue and earnings. The Company believes that pricing pressures are likely to continue as competitors develop more competitive product offerings. The Company markets and distributes its products and services through its direct sales force employed in 11 domestic offices and 5 overseas sales offices located in Japan, France, England and the Netherlands. Domestically, the vast majority of the Company's sales are made directly to end-users. Internationally, the Company teams up with local resellers in certain regions, and sells directly to end-users in other regions. Revenue generated from product sales is recognized upon shipment. Revenue generated from service contracts is recognized ratably over the term of the contract. Operating expenses consist primarily of rent, payroll, commissions, other selling and administrative expenses, and engineering and product development costs, and are recognized in the period incurred. The following table sets forth certain items from Dot Hill's consolidated statements of operations as a percentage of net revenue for the periods indicated:
YEAR ENDED DECEMBER 31 ------------------------------------ 2000 1999 1998 -------- -------- -------- Net revenue................................................ 100.0% 100.0% 100.0% Gross margin............................................... 35.9 30.3 34.8 Operating expenses: Sales and marketing........................................ 26.2 19.5 20.7 Engineering and product development........................ 7.3 6.0 5.9 General and administration................................. 5.7 8.7 5.9 Shareholder officers' compensation......................... -- -- .8 Impairment of intangible assets............................ -- 1.0 .5 Merger and restructuring expenses.......................... -- 6.0 .8 Operating (loss) income.................................... (3.3) (10.9) .2 Net (loss) income.......................................... (0.8)% (7.3)% .3%
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 NET REVENUE Net revenues reflect the invoiced amounts for products shipped, less reserves for estimated returns and revenue from service contracts. Net revenues for the year ended December 31, 2000 were $121.2 million compared to $124.2 million for the year ended December 31, 1999, a decrease of approximately 2.4%. The decrease in net revenues is primarily attributable to a decrease in sales of legacy products, offset by an increase in the SANnet product line that was introduced in late 1999. Comparisons of the Company's 2000 and 1999 results are difficult due to the significant corporate restructuring that Dot Hill underwent in connection with the Merger. For 2000, sales of the Company's SANnet product line accounted for approximately 25% of net revenues, tape backup for approximately 10% of net revenues, and service for approximately 7% of net revenues; the remaining 58% of net revenues was comprised of legacy disk and RAID solutions and other. For 2000, sales to xSPs, telecommunications, and e-commerce customers aggregated approximately 39% of net revenue, sales to financial and banking customers represented approximately 11% of net revenue, and the remaining 50% of net revenue was comprised of sales to commercial, government and other. Comparable reliable 29 information for both product and market revenue, as a percentage of total revenue for the year ended December 31, 1999 is not available and, accordingly has not been provided. GROSS MARGIN Gross margin for 2000 was $43.5 million, or 35.9% of net revenues, compared to a gross margin of $37.6 million, or 30.3% of net revenues, for 1999. The increase in gross margin as a percentage of net revenues from 2000 to 1999 was primarily attributable to a $5.0 million inventory write-down associated with the Company's product line consolidation and related price reductions implemented during 1999 and increased sales of higher-margin SANnet products during 2000. Excluding inventory write downs of $5.0 million for 1999, gross margin was 34.3% of net revenues for 1999, compared to a gross margin of net revenues of 35.9% for 2000. SALES AND MARKETING EXPENSES Sales and marketing expenses are primarily comprised of salaries, commissions and marketing costs. Sales and marketing expenses increased to $31.7 million for 2000 from $24.2 million for 1999. As a percentage of net revenues, sales and marketing expenses increased to 26.2% for 2000 from 19.5% for 1999. The increase in sales and marketing expenses is primarily attributable to two factors: increased sales compensation expenses related to the increase in sales and support staff and increased sales facilities costs related to opening four additional sales offices during 2000. ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES Engineering and product development expenses are comprised primarily of prototype expenses, salaries for employees directly engaged in research and other costs associated with product development. Engineering and product development expenses increased to $8.8 million for 2000 compared to $7.4 million for 1999. As a percentage of net revenues, engineering and product development expenses increased to 7.3% for 2000 compared to 6.0% for 1999. The increase in engineering and product development expenses is primarily attributable to an increase in prototype and test equipment expenses. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses are comprised primarily of compensation and overhead costs associated with Dot Hill's finance and administrative staff. General and administrative expenses, including shareholder officers' compensation, for 2000 were $6.9 million, or 5.7% of net revenues, compared to $10.8 million, or 8.7% of net revenues, for 1999. General and administrative expenses for 2000 include a one-time severance and compensation payment of approximately $560,000. The decrease in general and administrative expenses in 2000 is primarily attributable to the efficiencies gained from consolidating Box Hill and Artecon's administrative operations, partially offset by the severance and compensation payment recorded in 2000. 30 MERGER AND RESTRUCTURING EXPENSES AND IMPAIRMENT OF INTANGIBLE ASSETS During the third quarter of 1999, and in connection with the Merger, the Company recorded expenses totaling $13.4 million related to the Merger and management's restructuring and integration plan associated with the Merger, as follows (in thousands): Inventory write-downs, reported with cost of goods sold..... $ 5,033 Professional fees........................................... 4,029 License termination......................................... 1,000 Employee termination costs.................................. 1,100 Write-down of intangibles................................... 937 Facility closures and related costs......................... 647 Other integration costs..................................... 616 ------- Total..................................................... $13,362 =======
Management's restructuring and integration plan relates primarily to the consolidation and discontinuance of product lines, which resulted in inventory and intangible asset write-downs of $5.0 million and $937,000, respectively. As a result of the product line consolidation, the Company also terminated a license agreement with a third-party vendor, resulting in license termination costs of $1.0 million. Additionally, management's plan included consolidating the Company's manufacturing operations and other functions into the Company's headquarters in Carlsbad, California, which resulted in employee termination charges of $1.1 million, consisting primarily of severance payments for 38 employees, facility closure costs of $647,000 and other integration costs of $616,000. The Company completed the plan during the fourth quarter of 1999. The following is a summary of the major components of the accrued merger costs utilized during 1999 and 2000 and the balance as of December 31, 1999 and 2000 (in thousands):
ACCRUED ACCRUED RESTRUCTURING AMOUNT RESTRUCTURING AMOUNT COSTS AT RESTRUCTURING UTILIZED COSTS AT UTILIZED DECEMBER 31, COSTS IN 1999 DECEMBER 31, 1999 IN 2000 2000 ------------- -------- ----------------- -------- ------------- Professional services.............. $4,029 $(4,029) $ -- $ -- $ -- License termination................ 1,000 (1,000) -- -- -- Employee termination costs......... 1,100 (620) 480 (480) -- Facility closures and related costs............................ 647 (125) 522 (522) -- Other integration costs............ 616 (526) 90 (90) -- ------ ------- ------ ------- ---- Total.............................. $7,392 $ 6,300 $1,092 $(1,092) $ -- ====== ======= ====== ======= ====
The Company believes that there are no unresolved issues or additional liabilities that may result in an adjustment to the Merger and restructuring charge. In December 1998, the Artecon Board of Directors approved a plan to consolidate one of Artecon's engineering facilities from Milpitas, California, to Carlsbad, California, to consolidate certain domestic sales and service locations, and to eliminate certain product lines and development activities. Artecon recorded pre-tax restructuring charges of $1.8 million to cover the costs associated with these actions. Such charges consisted primarily of employee termination costs, inventory write-downs, facility closures and related expenses, intangible asset impairment and tooling machinery write-offs. Employee termination costs consisted primarily of severance payments for 43 employees, all of whom were terminated as of December 31, 1998. The majority of the employees terminated were employed at the engineering facility in Milpitas, California, and at various domestic sales and service locations. Inventory write-downs and the tooling write-off primarily related to the discontinuance of 31 certain low-volume and low-profit product lines. Of the total restructuring charge associated with the inventory write-downs, $403,000 has been included as a separate component of cost of goods sold in the accompanying consolidated statement of operations and comprehensive operations for the year ended December 31, 1998. Facility closures and related expenses consisted of lease termination costs and the write-off of certain property and equipment, which was disposed of in connection with the closures. All of the restructuring charges were utilized during 1998 and 1999. In connection with the acquisitions of Falcon and SDI, Artecon allocated $420,000 and $1.6 million, respectively, to an assembled workforce intangible asset. Artecon recorded an impairment of these intangible assets of $300,000 during the year ended December 31, 1998, which has been included as a component of the restructuring charge, as the impairment was a direct result of employee terminations associated with restructuring activities. Furthermore, as a result of significant attrition and terminations of employees, which were the basis for the assembled workforce valuation, Artecon recognized additional amortization of $287,000 during 1999 based on the attrition and termination of specific additional employees who were the basis for the valuation of the assembled workforce intangible asset. In connection with the merger with SDI, Artecon recorded a reserve for acquisition-related costs of $6.6 million, of which $661,000 was outstanding at December 31, 1998. All of the acquisition-related costs were included in the purchase price allocation performed during 1997. The major components of the reserve and the reconciliation of the accrual activity during 1999 and 2000 were as follows (in thousands):
ACCRUED MERGER AMOUNTS ACCRUED MERGER AMOUNTS ACCRUED MERGER COSTS AT UTILIZED COSTS AT UTILIZED COSTS AT DECEMBER 31, 1998 IN 1999 DECEMBER 31, 1999 IN 2000 DECEMBER 31, 2000 ----------------- -------- ----------------- -------- ----------------- Employee termination costs (80 employees)............ $162 $(162) $ -- $ -- $ -- Professional service fees... 316 -- 316 (316) -- Other costs................. 183 (117) 66 (66) -- ---- ----- ---- ----- --------- Total....................... $661 $(279) $382 $(382) $ -- ==== ===== ==== ===== =========
The Company believes that there are no unresolved issues or additional liabilities that may result in an adjustment to the purchase price allocation for the SDI merger. OTHER INCOME Total other income is comprised of interest income earned on the Company's cash and cash equivalents, and other miscellaneous income and expense items. Other income increased $1.4 million for 2000 to $2.8 million compared to $1.4 million for 1999. The increase in other income is attributable to three factors: reduction in interest expense associated with repayment of Artecon's previously outstanding line of credit in the third quarter of 1999; cash being invested in taxable securities yielding a higher interest rate than the tax-exempt securities where the majority of the cash balance was previously invested; and other income recorded as a result of a settlement reached with a vendor. INCOME TAXES The Company's effective income tax rate was (16.8)% for the year ended December 31, 2000 compared to (24.8)% for the comparable 1999 period. The 2000 effective income tax rate reflects federal, state and local income tax benefits, partially offset by permanent items, primarily a valuation allowance provided for deferred income tax assets, foreign income taxes and non-deductible business expenses. 32 As of December 31, 2000, the Company has federal and state net operating loss carryforwards of approximately $29.5 million and $20.9 million, respectively, which will begin to expire in 2009 and 2001, respectively. In addition, the Company has federal income tax credit carryforwards of approximately $1.4 million, of which $136,000 can be carried forward indefinitely to offset future taxable income, and the remaining $1.3 million will begin to expire in 2008. The Company also has state income tax credit carryforwards of approximately $1.1 million, of which $1.0 million can be carried forward indefinitely to offset future taxable income, and the remaining $78,000 will begin to expire in 2006. YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998 NET REVENUE Net revenues reflect the invoiced amounts for products shipped, less reserves for estimated returns and revenue from service contracts. Net revenues for the year ended December 31, 1999 were $124.2 million compared to $168.4 million for the year ended December 31, 1998, a decrease of approximately 26.2%. The decrease in net revenues is primarily attributable to a decrease in the volume of sales, coupled with price reductions. Comparisons of the Company's 1999 and 1998 results are difficult due to the significant corporate restructuring that the Company and Artecon have undergone over the last several years, as a result of the Merger, and Artecon's acquisition of Storage Dimensions in March 1998 and of Falcon in August 1997. The decrease in net revenue was due in part to the Company's focus on the Merger and integration and restructuring issues, efforts to merge the sales and product lines of Artecon and Box Hill, and the unwillingness of certain customers to purchase storage products due to Year 2000 concerns. For 1999, sales of SCSI-based solutions were 64% of revenues, sales of backup solutions were 15% of revenues, services were 10% of revenues, and sales of other products and services were approximately 11% of revenues. GROSS MARGIN Gross margin for 1999 was $37.6 million, or 30.3% of net revenues, compared to a gross margin of $58.6 million, or 34.8% of net revenues, for 1998. The decrease in gross margin as a percentage of net revenues from 1998 to 1999 was primarily attributable to a $5.0 million inventory write-down associated with the Company's product line consolidation and related price reductions. Excluding inventory write downs of $5.0 million and $403,000 for 1999 and 1998, respectively, gross margin was 34.3% of net revenues for 1999 compared to 35.0% of net revenues for 1998. SALES AND MARKETING EXPENSES Sales and marketing expenses are comprised primarily of salaries, commissions and marketing costs. Sales and marketing expenses decreased to $24.2 million for 1999 from $34.8 million for 1998. The decrease in sales and marketing expenses was primarily due to a reduction of the direct sales force and field service staff as a result of Artecon's restructuring and operational consolidations, which took place during fiscal 1998 after Artecon's merger with Storage Dimensions. As a percentage of net revenues, sales and marketing expenses decreased to 19.5% for 1999 from 20.7% for 1998, primarily as a result of the reductions in personnel noted above. ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES Engineering and product development expenses are comprised primarily of prototype expenses, salaries for employees directly engaged in research and other costs associated with product development. Engineering and product development expenses decreased to $7.4 million for 1999 compared to $9.9 million for 1998. The decrease in research and development expenses is primarily attributable to Artecon's restructuring and operational consolidations during fiscal 1998. As a 33 percentage of net revenues, engineering and product development expenses increased slightly to 6.0% for 1999 compared to 5.9% for 1998. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses are comprised primarily of compensation and overhead costs associated with Dot Hill's finance and administrative staff. General and administrative expenses, including shareholder officers' compensation, for 1999 were $10.8 million, or 8.7% of net revenues, compared to $11.3 million, or 6.7% of net revenues, for 1998. The decrease in general and administrative expenses is primarily attributable to the restructuring and operational consolidation, which took place in 1998 after Artecon's merger with Storage Dimensions and at Dot Hill after the Merger. MERGER AND RESTRUCTURING EXPENSES AND IMPAIRMENT OF INTANGIBLE ASSETS See "Item 7, Results of Operations, Year Ended December 31, 2000 Compared to Year Ended December 31, 1999, Merger and Restructuring Expenses and Impairment of Intangible Assets." OTHER INCOME Total other income is comprised of interest income earned on the Company's cash and cash equivalents, the majority of which is exempt from federal income taxes, and interest expense and other miscellaneous income and expense items. Total other income for 1999 was $1.4 million compared to $1.3 million for 1998. The increase in total other income was primarily attributable to a reduction in interest expense associated with repayment of Artecon's previously outstanding line of credit in the third quarter of 1999. INCOME TAXES The Company's effective income tax rate was (24.8)% for the year ended December 31, 1999 compared to 62.7% for the comparable 1998 period. The 1999 effective income tax rate reflects federal, state and local income tax benefits, partially offset by non-deductible permanent items, primarily merger and restructuring costs. The effect of state and local taxes was 54.6% of net income during the 1998 period as a result of the various jurisdictions in which the Company's taxable income was earned. As of December 31, 1999 and 1998, the Company had federal and state net operating loss carryforwards of approximately $20.4 million and $10.2 million, which begin to expire in the years ending 2009 and 2001, respectively. The Company also has federal and state tax credit carryforwards of approximately $1.2 million and $774,000, respectively. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2000, the Company had $33.7 million of cash and cash equivalents. As of December 31, 2000, working capital was $54.5 million. For the year ended December 31, 2000, cash used in operating activities was $12.9 million compared to cash used in operating activities of $747,000 for the same period in 1999. The increase in net cash used by operating activities is primarily attributable to a $11.8 million increase in inventory, the majority of which is inventory required to support the SANnet product line, increases in evaluation and demonstration equipment and increases in customer service inventory. Cash provided by investing activities in 2000 was $299,000 compared to cash used in investing activities of $896,000 for the same period in 1999 as a result of a $3.5 million sale of short-term investments offset by $3.2 million for purchases of property and equipment. 34 Cash provided by financing activities was $1.8 million for 2000 from exercises of stock options under the Company's 2000 Stock Incentive Plan and the Company's 2000 Employee Stock Purchase Plan. The Company's Japanese subsidiary has two lines of credit with a Japanese bank for borrowings of up to an aggregate of 35 million yen (approximately US $305,000 at December 31, 2000) at interest rates ranging from 1.8% to 2.5%. Interest is due monthly, with principal due and payable on various dates through August 2005. Borrowings are secured by the inventories of the Japanese subsidiary. As of December 31, 2000, the total amount outstanding under the two credit lines was 21 million yen (approximately US $186,000 at December 31, 2000). On February 6, 2001, the Company entered into an agreement with a commercial bank (the "Line of Credit"), which provides for borrowings up to $15 million under a two-year revolving line of credit. Borrowings under the facility are collateralized by a pledge of the Company's deposits held at the bank. The Line of Credit incurs interest at the bank's prime rate or 50 basis points above LIBOR. Monthly payments consist of interest only, with the principal due at maturity. In May 1998, Artecon entered into a revolving credit facility with LaSalle National Bank, which permitted borrowings of up to $15,000,000. Subsequent to the Merger on August 2, 1999, the Company repaid all outstanding debt of approximately $11.0 million due under this credit facility. In August 1997, prior to the Merger, Artecon acquired Falcon Systems for $3.5 million. That purchase price included $1.0 million in cash and a promissory note in the original principal amount of $1.3 million, which was later amended by Artecon and Falcon to $750,000 (the "Artecon Note"). Concurrently, Falcon transferred the Falcon Technology to Founding Partners, a California general partnership ("Founding Partners"), in exchange for a promissory note with a principal amount of $1.8 million (the "Founding Partners Note"). Dana Kammersgard, James Lambert and W.R. Sauey, each of whom is an executive officer and/or director of the Company, were the general partners of Founding Partners. Founding Partners was considered a "special purpose entity" and, accordingly, has been consolidated with the Company for financial reporting purposes. The purchase price of Falcon consisted of $10.2 million for other assets acquired, $638,000 for goodwill and other tangible assets, $14.1 million for liabilities assumed and in-process research and development expenses of $3.7 million, which had no future alternative use, based on management assumptions. Under the terms of the Artecon Note and the Founding Partners Note (collectively, the "Notes"), Artecon and Founding Partners were required to make monthly payments to Falcon of $15,935 and $37,182, respectively, through August 2002. Each of the Notes bore interest at the rate of 10% per annum. After the Merger in August 1999, the Company paid all outstanding debt of approximately $505,000 on these Notes to Founding Partners. On December 27, 1999, Founding Partners was dissolved. As of December 31, 2000, the Company's future commitments under its operating leases totaled approximately $8.1 million. On January 5, 2001, a final settlement in the class action lawsuit filed against Box Hill Systems Corp., certain of its officers and directors, and the underwriters of the Company's September 16, 1997 initial public offering was approved by the United States District Court for the Southern District of New York, and the action was dismissed with prejudice. No plaintiffs objected to the settlement, no plaintiffs opted-out of the settlement, and no appeal was taken from the judgment. Therefore, the action has been finalized. 35 The Company's sales and operating results have in the past fluctuated from quarter to quarter and may vary in the future depending on a number of factors, including: - the size and timing of significant purchase orders; - the timing of hardware shipments by third-party vendors necessary to recognize revenues; - the Company's ability to continue to design, develop and market new products and services; - market acceptance of new products, such as the new SANnet line of systems; - the Company's success in increasing its domestic and foreign sales force; - the size and number of new accounts; - technological changes in the storage systems market; - the growth of the telecommunications and Internet/intranet industry; - reduction in demand for the Company's products as a result of new product introductions by competitors; - levels of expenditure on research and development; - the amount of additional capital needed by the Company and the timing of such needs; - product quality problems; - fluctuations in foreign currency exchange rates; and - general economic trends and other factors. Sales and operating results for past periods are not necessarily indicative of future periods and a period-to-period comparison of its sales or results of operations are not necessarily meaningful and should not be relied upon as an indicator of future performance. The Company presently expects cash and cash equivalents, cash generated from operations, and amounts available under the Line of Credit are sufficient to meet its operating and capital requirements for at least the next twelve months. However, the Company may need additional capital to pursue acquisitions or significant capital improvements, neither of which is currently contemplated. The actual amount and timing of working capital and capital expenditures that Dot Hill may incur in future periods may vary significantly and will depend upon numerous factors, including the amount and timing of the receipt of revenues from continued operations, the increase in manufacturing capabilities, the timing and extent of the introduction of new products and services, and growth in personnel and operations. SUBSEQUENT EVENT On March 20, 2001, the Company announced plans to reduce its full-time workforce by up to 30% and reduce other expenses in response to delays in customer orders, lower than expected revenues and slowing market conditions. The cost reduction actions are designed to enable the Company to reduce its breakeven point in light of current economic uncertainties. The cost reduction efforts will result in a charge for severance and restructuring costs. The Company also anticipates a related increase in its deferred income tax asset valuation allowance. The Company is still analyzing the impact of this situation; accordingly, no estimate of its impact on the Company's financial statements has been made. THE EURO CONVERSION On January 1, 1999, eleven of the fifteen member countries of the European Union established fixed conversion rates between their existing sovereign currencies and the euro. These countries have 36 agreed to adopt the euro as their common legal currency on that date. The euro will then trade on currency exchanges and be available for non-cash transactions. These countries will issue sovereign debt exclusively in euro and will re-denominate outstanding sovereign debt. Effective on this date, these countries will no longer control their own monetary policies by directing independent interest rates for their legacy currencies. Instead, the authority to direct monetary policy, including money supply and official interest rates for the euro, will be exercised by the new European Central Bank. Following introduction of the euro, the legacy currencies are scheduled to remain legal tender in these countries as denominations of the euro between January 1, 1999 and January 1, 2002 (the "transition period"). During the transition period, public and private parties may pay for goods and services using either the euro or the country's legacy currency on a "no compulsion, no prohibition" basis. However, conversion rates no longer will be computed directly from one legacy currency to another. Instead a "triangulation" process will be applied whereby an amount denominated in one legacy currency first will be converted into an amount denominated in euro, and the resultant euro-denominated amount is converted into the second legacy currency. Two countries that will convert to the euro, the Netherlands and France, generated revenue of approximately $8.4 million and $703,000, respectively, or a combined 7.5% of Dot Hill's total revenue for 2000. Based on this percentage of revenue generated from these two countries, Dot Hill does not anticipate that this conversion of the euro will have a significant impact on its financial statements. The Company is continuing to evaluate the impact this conversion will have on its operating results and financial condition. RECENT ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), REVENUE RECOGNITION IN FINANCIAL STATEMENTS. SAB 101 provides guidance in applying generally accepted accounting principles to revenue recognition issues in financial statements. The Company adopted SAB 101 in the fourth quarter of 2000, and the adoption of SAB 101 did not have a material impact on the Company's financial condition or operating results. In March 2000, the FASB issued Interpretation No. 44 ("FIN 44"), ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION. FIN 44 is an interpretation of Accounting Principals Board Opinion No. 25("APB 25"), ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Among other matters, FIN 44 clarifies the application of APB 25 regarding the definition of an employee for the purposes of applying APB 25, the criteria for determining whether a plan qualifies as non-compensatory and the accounting consequences of modifications to the terms of previously issued stock options or similar awards. The Company adopted the provisions of FIN 44 in the third quarter of 2000. The adoption of FIN 44 did not have a material impact on the Company's financial condition or operating results for the year ended December 31, 2000. In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This statement, as amended, which is effective for the Company on January 1, 2001, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Company does not currently invest in derivative instruments and does not presently engage in nor does it intend to engage in hedging activities. Adoption of SFAS 133 did not have a material impact on the Company's financial statements as of January 1, 2001. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary investment strategy is to preserve the principal amounts invested, maximize investment yields, and to maintain liquidity to meet projected cash requirements. Accordingly, the Company invests in instruments such as money market funds, certificates of deposit, U.S. 37 Government/Agencies bonds, notes, bills and municipal bonds that meet high credit quality standards, as specified in the Company's investment policy guidelines. The Company's investment policy also limits the amount of credit exposure to any one issue, issuer, and type of instruments. The Company does not currently use derivative financial instruments in its investment portfolio. The Company's exposure to market rate risk for changes in interest rates relates primarily to the Company's investment portfolio. The Company does not expect to incur any material losses with respect to its investment portfolio. The following table provides information about the Company's investment portfolio at December 31, 2000 and 1999. For investment securities, the table presents carrying value at December 31, and related weighted average interest rates by expected maturity dates.
DECEMBER 31, ------------------- 2000 1999 -------- -------- Cash equivalents............................................ $25,773 $39,923 Average interest rate....................................... 4.2% 3.3% Short-term investments...................................... -- $ 3,500 Average interest rate....................................... -- 3.6% Total portfolio............................................. $25,773 $43,423 Average interest rate....................................... 4.2% 3.3%
The Company considers the carrying value of its investment securities to approximate their fair value due to the relatively short period of time between origination of the investments and their expected realization. Accordingly, changes in the market interest rate would not have a material effect on the fair value of such investments. The Company's lines of credit with a Japanese bank are at fixed interest rates, therefore, the Company does not have any interest rate risk exposure on this debt. As of February 2, 2001, the Company entered into a line of credit agreement, which incurs interest at a variable rate. The Company does not currently have any borrowings on this line, however, if the Company were to borrow funds under this line of credit, the Company would be exposed to interest rate risk on this debt. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item is incorporated by reference from pages F-1 through F-29 of this Annual Report on Form 10-K. ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None 38 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Some of the information required by this item is incorporated by reference to the Registrant's Definitive Proxy Statement to be filed with the Commission pursuant to Regulation 14A in connection with the 2001 Annual Meeting (the "Proxy Statement") under the headings "Proposal 1" and "Section 16(a) Beneficial Ownership Reporting Compliance." Other information required by this item is incorporated by reference to Item 1 of Part I of this Annual Report on Form 10-K under the heading "Executive Officers of the Registrant at December 31, 2000." ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference to the Proxy Statement under the heading "Executive Compensation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference to the Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference to the Proxy Statement under the heading "Certain Transactions." PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (1) Financial statements: The consolidated balance sheets as of December 31, 2000 and 1999, and the consolidated statements of operations and comprehensive operations, shareholders' equity and cash flows for the years ended December 31, 2000, 1999 and 1998, together with notes thereto. (2) Financial statement schedules required to be filed by Item 8 of this Form: Schedule II--Valuation and Qualifying Accounts. All other schedules have been omitted from this annual report because they are not applicable or because the information required by any applicable schedule is included in the consolidated financial statements or the notes thereto. (3) Exhibits:
EXHIBIT NUMBER DESCRIPTION - --------------------- ----------- 3.1 Amended and Restated Certificate of Incorporation of the Company. (3) 3.2 Amended and Restated By-laws of the Company.(1) 4.1 Form of Common Stock certificate of the Company.(1) 9.1 Voting Agreement dated July 31, 1997 among Dr. Monderer, Ms. Turchin and Mr. Mays.(1) 10.1 Compensation Plan and agreement between the Company and Philip Black.(1)
39
EXHIBIT NUMBER DESCRIPTION - --------------------- ----------- 10.2 Employment Agreement between the Company and Carol Turchin.(1) 10.3 Employment Agreement between the Company and Benjamin Monderer.(1) 10.4 Employment Agreement between the Company and Mark Mays.(1) 10.5 License Agreement with Emulex Corporation.(1) 10.6 Lease Agreement, dated as of December 23, 1993, as extended and modified, related to the Company's facilities in New York City.(1) 10.7 Lease Modification Agreement.(2) 10.8 1999 Compensation Plan and Agreement between the Company and Philip Black.(2) 10.9 Separation letter agreement dated October 13, 1999 between the Company and Elizabeth Strong. (3) 10.10 Employment letter agreement dated August 2, 1999 between the Company and James L. Lambert. (3) 10.11 Employment letter agreement dated August 2, 1999 between the Company and Dana W. Kammersgard. (3) 10.12 Employment offer letter dated November 12, 1999 between the Company and Preston Romm. (3) 10.13 Amendment dated August 2, 1999 to compensation plan and agreement between the Company and Philip Black.(3) 10.14 Employment letter agreement dated August 2, 1999 between the Company and Benjamin Monderer.(3) 10.15 2000 Amended and Restated Equity Incentive Plan. (4) 10.16 Form of Stock Option Agreement (Incentive and Nonstatutory Stock Options) used in connection with the 2000 Amended and Restated Equity Incentive Plan. (4) 10.17 Form of Stock Option Grant Notice used in connection with the 2000 Amended and Restated Equity Incentive Plan. (4) 10.18 2000 Amended and Restated Employee Stock Purchase Plan. (4) 10.19 2000 Non-Employee Directors' Stock Option Plan. (5) 10.20 Form of Stock Option Agreement used in connection with the 2000 Non-Employee Directors' Stock Option Plan. (5) 10.21 Voluntary Resignation Agreement dated December 31, 1999 between the Registrant and Carol Turchin. (6) 10.22 Letter Agreement of Termination of Employment dated August 30, 2000 between the Registrant and Philip Black 10.23 Credit Agreement dated February 6, 2001 among the Registrant, Silicon Alley Management, Inc. ("Silicon Alley) and Wells Fargo Bank, National Association ("Wells Fargo"). 10.24 Revolving Line of Credit Note dated February 6, 2001 issued by the Registrant and Silicon Alley to Wells Fargo.
40
EXHIBIT NUMBER DESCRIPTION - --------------------- ----------- 10.25 Third Party Security Agreement dated February 6, 2001 made by the Registrant and Silicon Alley in favor of Wells Fargo. 10.26 2001 Executive Compensation Plan for James L. Lambert, effective January 1, 2001. 10.27 2001 Executive Compensation Plan for Benjamin Monderer, effective January 1, 2001. 10.28 2001 Executive Compensation Plan for Dana K. Kammersgard, effective January 1, 2001. 10.29 2001 Executive Compensation Plan for Preston Romm, effective January 1, 2001. 10.30 2001 Executive Compensation Plan for Mark Mays, effective January 1, 2001. 10.31 Employment letter agreement dated August 2, 1999 between the Company and Mark Mays. 23.1 Consent of Deloitte & Touche LLP. 23.2 Consent of Arthur Andersen LLP. 24.1 Power of Attorney. Reference is made to page 42.
- ------------------------ (1) Filed as an exhibit to the Registrant's Registration Statement on Form S-1 (No. 333-31873) or amendments thereto and incorporated herein by reference. (2) Filed as an exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference. (3) Filed as an exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. (4) Filed as an exhibit to the Registrant's Current Report on Form 8-K dated August 23, 2000 and incorporated herein by reference. (5) Filed as an exhibit to the Registrant's Registration Statement on Form S-8 (No. 333-43834) and incorporated herein by reference. (6) Filed as an exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000 and incorporated herein by reference. (b) Reports on Form 8-K: None 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DOT HILL SYSTEMS CORP. (Registrant) By: /s/ JAMES L. LAMBERT ----------------------------------------- James L. Lambert (CHIEF EXECUTIVE OFFICER) Date: March 30, 2001
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James L. Lambert and Preston Romm, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their or his substitute or substituted, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Registration Statement has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE ---- ----- ---- Chief Executive Officer, /s/ JAMES L. LAMBERT President, Chief Operating ------------------------------------------- Officer and Director March 30, 2001 James L. Lambert (Principal Executive Officer) Chief Financial Officer and /s/ PRESTON ROMM Treasurer (Principal ------------------------------------------- Financial and Accounting March 30, 2001 Preston Romm Officer) /s/ CHARLES CHRIST ------------------------------------------- Chairman of the Board of March 30, 2001 Charles Christ Directors /s/ CAROL TURCHIN ------------------------------------------- Vice Chairman of the Board of March 30, 2001 Carol Turchin Directors /s/ BENJAMIN MONDERER Executive Vice President of ------------------------------------------- Strategic Development and March 30, 2001 Benjamin Monderer Director
42
NAME TITLE DATE ---- ----- ---- /s/ BENJAMIN BRUSSELL ------------------------------------------- Director March 30, 2001 Benjamin Brussell /s/ NORMAN R. FARQUHAR ------------------------------------------- Director March 30, 2001 Norman R. Farquhar /s/ DR. CHONG SUP PARK ------------------------------------------- Director March 30, 2001 Dr. Chong Sup Park /s/ W.R. SAUEY ------------------------------------------- Director March 30, 2001 W.R. Sauey
43 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - --------------------- ----------- 3.1 Amended and Restated Certificate of Incorporation of the Company. (3) 3.2 Amended and Restated By-laws of the Company.(1) 4.1 Form of Common Stock certificate of the Company.(1) 9.1 Voting Agreement dated July 31, 1997 among Dr. Monderer, Ms. Turchin and Mr. Mays.(1) 10.1 Compensation Plan and agreement between the Company and Philip Black.(1) 10.2 Employment Agreement between the Company and Carol Turchin.(1) 10.3 Employment Agreement between the Company and Benjamin Monderer.(1) 10.4 Employment Agreement between the Company and Mark Mays.(1) 10.5 License Agreement with Emulex Corporation.(1) 10.6 Lease Agreement, dated as of December 23, 1993, as extended and modified, related to the Company's facilities in New York City.(1) 10.7 Lease Modification Agreement.(2) 10.8 1999 Compensation Plan and Agreement between the Company and Philip Black.(2) 10.9 Separation letter agreement dated October 13, 1999 between the Company and Elizabeth Strong. (3) 10.10 Employment letter agreement dated August 2, 1999 between the Company and James L. Lambert. (3) 10.11 Employment letter agreement dated August 2, 1999 between the Company and Dana W. Kammersgard. (3) 10.12 Employment offer letter dated November 12, 1999 between the Company and Preston Romm. (3) 10.13 Amendment dated August 2, 1999 to compensation plan and agreement between the Company and Philip Black.(3) 10.14 Employment letter agreement dated August 2, 1999 between the Company and Benjamin Monderer.(3) 10.15 2000 Amended and Restated Equity Incentive Plan. (4) 10.16 Form of Stock Option Agreement (Incentive and Nonstatutory Stock Options) used in connection with the 2000 Amended and Restated Equity Incentive Plan. (4) 10.17 Form of Stock Option Grant Notice used in connection with the 2000 Amended and Restated Equity Incentive Plan. (4) 10.18 2000 Amended and Restated Employee Stock Purchase Plan. (4) 10.19 2000 Non-Employee Directors' Stock Option Plan. (5) 10.20 Form of Stock Option Agreement used in connection with the 2000 Non-Employee Directors' Stock Option Plan. (5)
44
EXHIBIT NUMBER DESCRIPTION - --------------------- ----------- 10.21 Voluntary Resignation Agreement dated December 31, 1999 between the Registrant and Carol Turchin. (6) 10.22 Letter Agreement of Termination of Employment dated August 30, 2000 between the Registrant and Philip Black 10.23 Credit Agreement dated February 6, 2001 among the Registrant, Silicon Alley Management, Inc. ("Silicon Alley) and Wells Fargo Bank, National Association ("Wells Fargo"). 10.24 Revolving Line of Credit Note dated February 6, 2001 issued by the Registrant and Silicon Alley to Wells Fargo. 10.25 Third Party Security Agreement dated February 6, 2001 made by the Registrant and Silicon Alley in favor of Wells Fargo. 10.26 2001 Executive Compensation Plan for James L. Lambert, effective January 1, 2001. 10.27 2001 Executive Compensation Plan for Benjamin Monderer, effective January 1, 2001. 10.28 2001 Executive Compensation Plan for Dana K. Kammersgard, effective January 1, 2001. 10.29 2001 Executive Compensation Plan for Preston Romm, effective January 1, 2001. 10.30 2001 Executive Compensation Plan for Mark Mays, effective January 1, 2001. 10.31 Employment letter agreement dated August 2, 1999 between the Company and Mark Mays. 23.1 Consent of Deloitte & Touche LLP. 23.2 Consent of Arthur Andersen LLP. 24.1 Power of Attorney. Reference is made to page 42.
- ------------------------ (1) Filed as an exhibit to the Registrant's Registration Statement on Form S-1 (No. 333-31873) or amendments thereto and incorporated herein by reference. (2) Filed as an exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference. (3) Filed as an exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. (4) Filed as an exhibit to the Registrant's Current Report on Form 8-K dated August 23, 2000 and incorporated herein by reference. (5) Filed as an exhibit to the Registrant's Registration Statement on Form S-8 (No. 333-43834) and incorporated herein by reference. (6) Filed as an exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000 and incorporated herein by reference. 45 INDEX TO FINANCIAL STATEMENTS
PAGE -------- INDEPENDENT AUDITORS' REPORT................................ F-2 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.................... F-3 INDEPENDENT AUDITORS' REPORT................................ F-4 FINANCIAL STATEMENTS: Consolidated balance sheets as of December 31, 2000 and 1999.................................................... F-5 Consolidated statements of operations and comprehensive operations for the years ended December 31, 2000, 1999 and 1998................................................ F-6 Consolidated statements of shareholders' equity for the years ended December 31, 2000, 1999 and 1998............ F-7 Consolidated statements of cash flows for the years ended December 31, 2000, 1999 and 1998........................ F-8 Notes to consolidated financial statements for the years ended December 31, 2000, 1999 and 1998.................. F-9 Independent Auditors' Report.............................. S-1 Report of Independent Public Accountants.................. S-2 Schedule II--Valuation and Qualifying Accounts............ S-3
F-1 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Dot Hill Systems Corp.: We have audited the accompanying consolidated balance sheets of Dot Hill Systems Corp. and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of operations and comprehensive operations, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Dot Hill Systems Corp. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP San Diego, California January 24, 2001 (March 20, 2001 as to the subsequent events in Notes 8 and 17) F-2 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Dot Hill Systems Corp.: We have audited the accompanying consolidated statements of operations and comprehensive operations, shareholders' equity and cash flows of Dot Hill Systems Corp. (formerly Box Hill Systems Corp., a New York Corporation) and subsidiaries for the year ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of Artecon, Inc., a company acquired during 1999 in a transaction accounted for as a pooling of interests, as discussed in Note 1, for the year ended March 31, 1999. Such statements are included in the consolidated financial statements of Dot Hill Systems Corp. and reflect total revenue of 57%, in fiscal 1998 of the consolidated total. These statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Artecon, Inc., is based solely on the report of the other auditors. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit and the report of other auditors provides a reasonable basis for our opinion. In our opinion, based on our audit and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Dot Hill Systems Corp. and subsidiaries for the year ended December 31, 1998, in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP Philadelphia, Pennsylvania August 2, 1999 F-3 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Artecon, Inc.: We have audited the consolidated statements of operations and comprehensive operations, shareholders' equity, and cash flows of Artecon, Inc., and subsidiaries (the "Company") for the year ended March 31, 1999 (none of which are presented separately herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of Artecon, Inc. and subsidiaries for the year ended March 31, 1999 in conformity with accounting principles generally accepted in the United States of America. /s/DELOITTE & TOUCHE LLP San Diego, California May 5, 1999 F-4 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2000 AND 1999 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2000 1999 -------- -------- ASSETS CURRENT ASSETS: Cash and cash equivalents................................... $ 33,653 $ 44,451 Short-term investments...................................... -- 3,500 Accounts receivable, net of allowance of $1,593 and $1,727.................................................... 19,341 20,403 Inventories................................................. 24,109 12,279 Prepaid expenses and other.................................. 1,948 2,503 Deferred income taxes....................................... 4,067 5,879 -------- -------- Total current assets...................................... 83,118 89,015 PROPERTY AND EQUIPMENT, net................................. 4,814 2,675 OTHER ASSETS................................................ 94 46 GOODWILL, net............................................... 448 554 OTHER INTANGIBLE ASSETS, net................................ 49 258 DEFERRED INCOME TAXES....................................... 14,356 11,110 -------- -------- $102,879 $103,658 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable............................................ $ 17,803 $ 15,094 Accrued compensation........................................ 2,748 2,120 Accrued expenses............................................ 1,858 4,524 Merger and restructuring accrual............................ -- 1,474 Customer deposits........................................... -- 1,692 Deferred revenue............................................ 2,866 3,626 Income taxes payable........................................ 3,389 1,539 -------- -------- Total current liabilities................................. 28,664 30,069 BORROWINGS UNDER LINES OF CREDIT............................ 186 272 DEFERRED RENT AND OTHER LONG-TERM LIABILITIES............... 259 494 -------- -------- Total liabilities......................................... 29,109 30,835 -------- -------- COMMITMENTS AND CONTINGENCIES (Note 14) SHAREHOLDERS' EQUITY: Preferred stock, $.01 par value, 5,000 shares authorized, none issued............................................... -- -- Common stock, $.01 par value, 40,000 shares authorized, 24,608 and 23,888 shares issued and outstanding........... 246 239 Additional paid-in capital.................................. 99,026 97,137 Accumulated other comprehensive loss........................ (216) (215) Accumulated deficit......................................... (25,286) (24,338) -------- -------- Total shareholders' equity................................ 73,770 72,823 -------- -------- $102,879 $103,658 ======== ========
See accompanying notes to consolidated financial statements. F-5 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
2000 1999 1998 -------- -------- -------- NET REVENUE................................................. $121,197 $124,216 $168,355 COST OF GOODS SOLD.......................................... 77,730 81,579 109,361 INVENTORY WRITE-DOWN........................................ -- 5,033 403 -------- -------- -------- GROSS MARGIN................................................ 43,467 37,604 58,591 -------- -------- -------- OPERATING EXPENSES: Sales and marketing......................................... 31,747 24,204 34,839 Engineering and product development......................... 8,798 7,401 9,946 General and administrative.................................. 6,891 10,837 9,981 Shareholder officers' compensation.......................... -- -- 1,275 Impairment of intangible assets............................. -- 1,224 867 Merger and restructuring expenses........................... -- 7,392 1,404 -------- -------- -------- Total operating expenses.................................... 47,436 51,058 58,312 -------- -------- -------- OPERATING (LOSS) INCOME..................................... (3,969) (13,454) 279 -------- -------- -------- OTHER INCOME (EXPENSE): Interest income, net........................................ 2,096 1,136 906 Other income, net........................................... 739 381 395 Loss on foreign currency transactions, net.................. (6) (94) (14) -------- -------- -------- Total other income........................................ 2,829 1,423 1,287 -------- -------- -------- (LOSS) INCOME BEFORE INCOME TAX (BENEFIT) PROVISION......... (1,140) (12,031) 1,566 INCOME TAX (BENEFIT) PROVISION.............................. (192) (2,984) 982 -------- -------- -------- NET (LOSS) INCOME........................................... $ (948) $ (9,047) $ 584 ======== ======== ======== Basic net (loss) income per share........................... $ (0.04) $ (0.39) $ 0.03 ======== ======== ======== Weighted average shares used to calculate basic net (loss) income per share.......................................... 24,253 23,385 22,903 ======== ======== ======== Diluted net (loss) income per share......................... $ (0.04) $ (0.39) $ 0.02 ======== ======== ======== Weighted average shares used to calculate diluted net (loss) income per share.......................................... 24,253 23,385 24,442 ======== ======== ======== COMPREHENSIVE OPERATIONS: Net (loss) income........................................... $ (948) $ (9,047) $ 584 Foreign currency translation adjustments.................... (1) (153) 35 -------- -------- -------- Comprehensive (loss) income................................. $ (949) $ (9,200) $ 619 ======== ======== ========
See accompanying notes to consolidated financial statements. F-6 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS)
CONVERTIBLE PREFERRED A ACCUMULATED RETAINED SHARES COMMON STOCK ADDITIONAL OTHER EARNINGS TOTAL ------------------- ------------------- PAID-IN COMPREHENSIVE (ACCUMULATED SHAREHOLDERS' SHARES AMOUNT SHARES AMOUNT CAPITAL LOSS DEFICIT) EQUITY -------- -------- -------- -------- ---------- ------------- ------------ ------------- BALANCE, January 1, 1998.................... 2,494 $ 12 22,694 $ 227 $95,660 $ (97) $(17,575) $78,227 Acquisition of Box Hill Europe.................. 5 52 52 Issuance of common stock option to consultant.... 213 213 Exercise of stock options, including tax benefit... 232 2 506 508 Sale of common stock under employee stock purchase plan.................... 79 1 344 345 Foreign currency translation adjustment.............. 35 35 Net income................ 584 584 ------ ------ ------ ----- ------- ----- -------- ------- BALANCE, December 31, 1998.................... 2,494 12 23,010 230 96,775 (62) (16,991) 79,964 Conversion of preferred shares.................. (2,494) (12) 719 7 5 -- Exercise of stock options, including tax benefit... 119 1 235 236 Sale of common stock under employee stock purchase plan.................... 40 1 122 123 Foreign currency translation adjustment.............. (153) (153) Net loss.................. (9,047) (9,047) Adjustment to conform Artecon to the Company's year-end................ 1,700 1,700 ------ ------ ------ ----- ------- ----- -------- ------- BALANCE, December 31, 1999.................... -- $ -- 23,888 239 97,137 (215) (24,338) 72,823 Exercise of stock options, including tax benefit... 687 7 1,709 1,716 Sale of common stock under employee stock purchase plan.................... 33 180 180 Foreign currency translation adjustment.............. (1) (1) Net loss.................. (948) (948) ------ ------ ------ ----- ------- ----- -------- ------- BALANCE, December 31, 2000.................... -- $ -- 24,608 $ 246 $99,026 $(216) $(25,286) $73,770 ====== ====== ====== ===== ======= ===== ======== =======
See accompanying notes to consolidated financial statements. F-7 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS)
2000 1999 1998 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income........................................... $ (948) $(9,047) $ 584 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities, excluding effect from acquisitions: Depreciation and amortization............................. 1,401 1,757 4,674 Asset impairment charges.................................. -- 937 1,490 Provision for doubtful accounts........................... (134) 70 123 Deferred income taxes..................................... (1,434) (4,681) (3,627) Stock-based compensation expense.......................... -- -- 213 Changes in operating assets and liabilities, net of effects from acquisitions: Accounts receivable..................................... 1,196 5,359 6,326 Inventories............................................. (11,830) 7,485 (59) Prepaid expenses and other.............................. 483 748 (1,184) Prepaid income taxes.................................... -- 737 (565) Accounts payable........................................ 2,709 (4,365) (2,738) Accrued expenses........................................ (2,038) (46) (5,243) Merger and restructuring accrual........................ (1,474) 220 -- Customer deposits....................................... (1,692) (481) 30 Deferred revenue........................................ (760) (216) 1,831 Income taxes payable.................................... 1,850 754 (757) Long-term liabilities................................... (235) 22 120 Other................................................... -- -- 121 ------- ------- ------- Net cash (used in) provided by operating activities....... (12,906) (747) 1,339 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment......................... (3,201) (896) (1,159) Sales of short-term investments............................. 3,500 -- 5,805 ------- ------- ------- Net cash provided by (used in) investing activities....... 299 (896) 4,646 ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Distributions to S corporation shareholders................. -- -- (227) Proceeds from exercise of stock options..................... 1,716 236 198 Proceeds from sale of stock to employees.................... 180 123 345 Proceeds from bank and other borrowings..................... -- 23,139 48,292 Payments on bank and other borrowings....................... (86) (35,258) (47,210) ------- ------- ------- Net cash provided by (used in) financing activities......... 1,810 (11,760) 1,398 ------- ------- ------- EFFECT OF EXCHANGE RATE CHANGES ON CASH..................... (1) (153) 35 ------- ------- ------- ADJUSTMENT FOR CHANGE IN ARTECON YEAR-END................... -- 1,700 -- ------- ------- ------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........ (10,798) (11,856) 7,418 CASH AND CASH EQUIVALENTS, beginning of year................ 44,451 56,307 48,889 ------- ------- ------- CASH AND CASH EQUIVALENTS, end of year...................... $33,653 $44,451 $56,307 ======= ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest.................................................. $ 5 $ 642 $ 817 ======= ======= ======= Income taxes.............................................. $ 94 $ 129 $ 4,498 ======= ======= =======
See accompanying notes to consolidated financial statements. F-8 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 1. BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BACKGROUND--Dot Hill Systems Corp. ("Dot Hill" or the "Company") designs, manufactures, markets and supports high performance data storage systems for the open systems computing environment. In the United States, the Company generally employs a direct marketing strategy aimed at data-intensive industries which, to date, include financial services, telecommunications, internet applications and storage service providers ("xSPs"), e-commerce, multimedia, healthcare, government/ defense and academia. The Company's international strategy is to sell directly to end users, when possible, and to use local distributors. The Company's manufacturing operations consist primarily of assembly and integration of components and subassemblies into the Company's products. The Company's manufacturing, principal engineering and product development, and principal sales and marketing operations are conducted from the Company's Carlsbad, California facility. BASIS OF PRESENTATION--On August 2, 1999, Box Hill Systems Corp. ("Box Hill") and Artecon, Inc. ("Artecon") completed a merger (the "Merger") in which the two companies were merged in a tax-free, stock-for-stock transaction. The Merger was accounted for using the pooling-of-interests method. Subsequent to the Merger, the combined Company changed its name to Dot Hill Systems Corp. The accompanying consolidated financial statements set forth a presentation of the Company's financial statements retroactively restated to reflect the combination of Box Hill and Artecon. The historical financial statements of Box Hill for the year ended December 31, 1998 have been combined with the financial statements of Artecon for the year ended March 31, 1999. As a result of changing Artecon's fiscal year-end from March 31 to conform with the Company's December 31 year-end, Artecon's results of operations for the three months ended March 31, 1999 are included in the combined results of operations for both the years ended December 31, 1999 and 1998, and are reflected as an adjustment in the consolidated statements of shareholders' equity. Artecon's total revenue and net loss for this period was $18.3 million and $1.7 million, respectively. Artecon's cash flows used in operating, investing, and financing activities for this period were $2.6 million, $39,000 and $1.8 million, respectively. During the third quarter of 1999, and in connection with the Merger, the Company recorded expenses totaling $13.4 million related to the Merger and management's restructuring and integration plan associated with the Merger (Note 5). INITIAL PUBLIC OFFERING--Box Hill completed an initial public offering (the "Offering") of its common stock, effective September 16, 1997. The offering consisted of the sale of 5.5 million shares of common stock at an initial public offering price of $15.00, of which 3.3 million shares were issued and sold by Box Hill and 2.2 million shares were sold by individuals who were the only shareholders of Box Hill prior to the Offering. Additionally, 825,000 shares of common stock were purchased from Box Hill at $15.00 per share by the underwriters upon the exercise of an over-allotment option. The net proceeds to Box Hill, after deducting estimated underwriting discounts and offering expenses, were approximately $56.6 million. PRINCIPLES OF CONSOLIDATION--The accompanying consolidated financial statements include the accounts of Dot Hill Systems Corp. and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. USE OF ACCOUNTING ESTIMATES--The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make F-9 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 1. BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS--Cash and cash equivalents include highly liquid investments purchased with an original maturity of three months or less. Cash equivalents consist principally of money market mutual funds. SHORT-TERM INVESTMENTS--The Company accounts for investments in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. Short-term investments have been categorized as available for sale and, as a result, are stated at fair value. Short-term investments are generally comprised of variable rate securities that provide for early redemption within twelve months. Unrealized gains and losses on available for-sale securities are immaterial to the Company's financial statements. ACCOUNTS RECEIVABLE--The allowance for doubtful accounts represents management's estimate of potential loss on accounts receivable balances. This estimate is calculated using a percentage based on historical write-offs and recoveries of accounts receivable. In addition, the Company also estimates potential losses for specific accounts. INVENTORIES--Inventories are comprised of purchased parts and assemblies, which include direct labor and overhead, and are valued at the lower of cost (first-in, first-out) or market value. PROPERTY AND EQUIPMENT--Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets (two to seven years). Leasehold improvements are amortized on a straight-line basis over the lesser of the remaining term of the lease or the estimated useful life of the asset. Significant improvements are capitalized and expenditures for maintenance and repairs are charged to expense as incurred. GOODWILL AND OTHER INTANGIBLE ASSETS--Goodwill related to acquisitions is being amortized on a straight-line basis over a period of seven years. Accumulated amortization was $528,000 and $422,000 at December 31, 2000 and 1999, respectively. Other intangible assets related to acquisitions are being amortized on a straight-line basis over two to four years. Accumulated amortization was $1.6 million and $1.4 million at December 31, 2000 and 1999, respectively. Goodwill and other intangible assets are periodically reviewed for events or changes, which may indicate that their carrying value may not be recoverable. The Company periodically reviews the carrying value of goodwill and other intangible assets utilizing expected future undiscounted cash flows to determine whether or not impairment to such values has occurred. During the years ended December 31, 1999 and 1998, the Company recorded impairments associated with certain intangible assets of $1.2 million and $867,000, respectively. During the year ended December 31, 2000, no impairment was recorded (Note 5). FAIR VALUE OF FINANCIAL INSTRUMENTS--Pursuant to SFAS No. 107, DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, the Company is required to estimate the fair value of all financial instruments included on its balance sheets. The Company considers the carrying value of its financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, accounts payable, and accrued expenses to approximate their fair value due to the relatively short period of time between origination of the instruments and their expected realization. The carrying value of the lines of credit F-10 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 1. BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) approximate their fair value based on the terms and rates available to the Company for similar instruments. LONG-LIVED ASSETS--The Company accounts for the impairment and disposition of long-lived assets in accordance with SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. In accordance with SFAS No. 121, long-lived assets to be held and used are reviewed whenever events or changes in circumstances indicate that their carrying value may not be recoverable. The Company periodically reviews the carrying value of long-lived assets utilizing expected future undiscounted cash flows to determine whether or not an impairment to such value has occurred. During the years ended December 31, 1999 and 1998, the Company recognized an impairment of certain long-lived assets in connection with the Merger and restructuring activities (Note 5). Based on its most recent analysis, the Company believes that no additional impairment exists at December 31, 2000. REVENUE RECOGNITION--The Company recognizes revenue on product sales when products are shipped, net of any allowances for estimated product returns. Revenue from maintenance contracts is deferred and recognized on a straight-line basis over the contract term, generally twelve months. The cost of maintenance contracts purchased from third-parties for resale is deferred and recognized as expense over the contract term. At December 31, 2000 and 1999, the balances of deferred costs for purchased maintenance contracts were $917,000 and $968,000, respectively, and the balances are included in prepaid expenses and other assets. For product sales that include a software element, the Company applies Statement of Position No. 97-2, SOFTWARE REVENUE RECOGNITION, whereby revenue is recognized from software licenses at the time the product is shipped, provided there are no significant Company obligations related to the sale, the resulting receivable is deemed collectible, and there is vendor-specific objective evidence supporting the value of the separate contract elements. Revenue from software maintenance agreements is recognized ratably over the term of the related agreement. Revenue from consulting and other software-related services is recognized as the services are rendered. PRODUCT WARRANTIES--The Company generally extends to its customers the warranties provided to the Company by its suppliers. The Company provides for the estimated cost that may be incurred for product warranties in the period the related revenue is recognized. To date, the Company's suppliers have reimbursed the majority of the Company's warranty costs. There can be no assurance that such suppliers will continue to reimburse such costs in the future, which could have a material adverse effect on the Company's operating results and financial condition. ADVERTISING COSTS--The Company expenses advertising costs as incurred. For the years ended December 31, 2000, 1999, and 1998, advertising expenses were $1.2 million, $768,000, and $1.3 million, respectively. ENGINEERING AND PRODUCT DEVELOPMENT--Engineering and product development costs are expensed as incurred. In conjunction with the development of its products, the Company incurs certain software development costs. No costs have been capitalized pursuant to SFAS No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED, OR OTHERWISE MARKETED, because the period between achieving technological feasibility and completion of such software is relatively short and software development costs qualifying for capitalization have been insignificant. F-11 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 1. BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STOCK-BASED COMPENSATION--The Company accounts for stock-based awards to employees, using the intrinsic value method in accordance with Accounting Principles Board ("APB") No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and has adopted the disclosure provisions of SFAS No 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. FOREIGN CURRENCY TRANSLATION--A portion of the Company's international business is presently conducted in currencies other than the U.S. dollar. Foreign currency transaction gains and losses arising from normal business operations are included in current period earnings. Where the functional currency of a foreign subsidiary of the Company is the U.S. dollar, inventories, property, plant and equipment, cost of products sold, and depreciation are remeasured from the foreign currency into U.S. dollars at historical exchange rates; all other accounts are translated at current exchange rates, and gains and losses resulting from those remeasurements are included in current period earnings. Where the functional currency of a foreign subsidiary of the Company is the local currency, assets and liabilities are translated into U.S. dollars at year-end exchange rates; revenues and expenses, and gains and losses are translated at rates of exchange that approximate the rates in effect on the transaction date. Resulting remeasurement gains and losses are recognized as a component of other comprehensive income. As a result, fluctuations in the value of the currencies in which the Company conducts its business relative to the U.S. dollar will cause currency transaction gains and losses, which the Company has experienced in the past and continues to experience. Due to the substantial volatility of currency exchange rates, among other factors, the Company cannot predict the effect of exchange rate fluctuations upon future operating results. The Company has not previously undertaken hedging transactions to cover its currency exposure nor does it intend to engage in hedging activities in the future. INCOME TAXES--The Company accounts for its income taxes under the provisions of SFAS No. 109, ACCOUNTING FOR INCOME TAXES. Deferred income taxes result from temporary differences between the reporting of income for financial statement and tax reporting purposes. Measurement of the deferred income tax items is based on enacted tax laws and rates. In the event the future consequences of differences between financial reporting bases and tax bases of the Company's assets and liabilities result in a deferred income tax asset, SFAS No. 109 requires an evaluation of the probability the Company will be able to realize the future benefits of such asset. A valuation allowance related to a deferred income tax asset is recorded when it is more likely than not that some portion or all of the deferred income tax asset will not be realized. NET INCOME PER SHARE--Basic net income (loss) per share is calculated by dividing net income or loss available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share reflects the potential dilution of securities by including common stock equivalents, such as stock options, in the weighted average number of common shares outstanding during a period, if dilutive. F-12 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 1. BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The table below sets forth the reconciliation of the denominator of the net income (loss) per share calculation for the years ended December 31 (in thousands):
2000 1999 1998 -------- -------- -------- Weighted average shares used to calculate basic net income (loss) per share.......................................... 24,253 23,385 22,903 Conversion of preferred stock............................... -- -- 719 Dilutive effect of stock options............................ -- -- 820 ------ ------ ------ Weighted average shares used to calculate diluted net income (loss) per share.......................................... 24,253 23,385 24,442 ====== ====== ======
As of December 31, 2000, options to purchase 2,767,938 shares of common stock with exercise prices ranging from $0.50 to $15.94 per share were outstanding, but were not included in the calculation of diluted net loss per share because their effect was antidilutive. As of December 31, 1999, options to purchase 2,219,037 shares of common stock with exercise prices ranging from $0.50 to $17.50 per share were outstanding, but were not included in the calculation of dilutive net loss per share because their effect was antidilutive. Additionally, preferred stock convertible into 419,438 shares of common stock (based on the weighted average of such shares under SFAS No. 128) has also been excluded from the calculation of diluted net loss per share because its effect was antidilutive. As of December 31, 1998, options to purchase 1,105,007 shares of common stock with exercise prices ranging from $9.50 to $18.13 per share were outstanding, but were not included in the calculation of diluted net income per share for the entire year because the exercise price of the options was greater than the average market price of the common shares. RECENT ACCOUNTING PRONOUNCEMENTS--In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), REVENUE RECOGNITION IN FINANCIAL STATEMENTS. SAB 101 provides guidance in applying generally accepted accounting principles to revenue recognition issues in financial statements. The Company adopted SAB 101 during the fourth quarter of 2000, and the adoption of SAB 101 did not have a material impact on the Company's financial condition or operating results. In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This statement, as amended, which was effective for the Company as of January 1, 2001, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Company does not currently invest in derivative instruments and does not presently engage in nor does it intend to engage in hedging activities. Consequently, the adoption of SFAS No. 133 did not have a material impact on the Company's financial statements as of January 1, 2001. In March 2000, the FASB issued Interpretation No. 44 ("FIN 44"), ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION. FIN 44 is an interpretation of Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"). Among other matters, FIN 44 F-13 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 1. BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) clarifies the application of APB 25 regarding the definition of an employee for the purposes of applying APB 25, the criteria for determining whether a plan qualifies as non-compensatory and the accounting consequences of modifications to the terms of previously issued stock options or similar awards. The Company adopted the provisions of FIN 44 in the third quarter of 2000. The adoption of FIN 44 did not have a material impact on the Company's financial condition or operating results. RECLASSIFICATIONS--Certain prior year amounts have been reclassified to conform to the current year presentation. 2. ACQUISITIONS STORAGE DIMENSIONS, INC.--During fiscal 1997, Artecon completed a reverse merger into Storage Dimensions, Inc. ("SDI"). Immediately following the merger, SDI changed its name to Artecon. The merger was treated as a purchase of SDI by Artecon for accounting purposes. During the year ended December 31, 1998, Artecon recorded adjustments associated with certain income tax-related matters that existed at the time of the merger with SDI. The amount of the purchase price allocated to goodwill was reduced by approximately $581,000 as a result of these adjustments. FALCON SYSTEMS, INC.--During fiscal 1997, Artecon acquired certain net assets of Falcon Systems, Inc. ("Falcon"), a manufacturer and distributor of computer peripheral equipment, in a transaction accounted for as a purchase. In connection with the Falcon acquisition, a partnership was created to purchase certain assets from Falcon, the partners of which were the majority shareholders of the Company. The partnership was considered to be a Special Purpose Entity and, accordingly, was included in the Company's consolidated financial statements from the acquisition date through December 31, 1999. Effective December 31, 1999, the partnership was terminated. The termination of the partnership did not have a material effect on the Company's financial condition or operating results for the year ended December 31, 1999. 3. RISKS AND UNCERTAINTIES GENERAL BUSINESS RISKS AND UNCERTAINTIES--The Company's future results of operations involve a number of risks and uncertainties. Factors that could affect the Company's future operating results and cause actual results to differ materially from expectations include, but are not limited to, dependence on new products, dependence on a limited number of suppliers of high quality components, reliance on a limited number of principal customers, concentration of customers in targeted industries, difficulties in managing growth, difficulties in attracting and retaining qualified personnel, competition, competitive pricing, dependence on key personnel, enforcement of the Company's intellectual property rights, intellectual property claims made by third parties upon the Company, dependence on a limited number of production facilities, global economic conditions, the lengthening of sales cycles, and an uneven pattern of quarterly results. CONCENTRATION OF CREDIT RISK--Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company does not require collateral or other securities to support customer receivables. A significant portion of the Company's net revenue is derived from sales to customers in the xSPs, telecommunications, and e-commerce industries; and the financial services industries. For the year ended December 31, 2000, F-14 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 3. RISKS AND UNCERTAINTIES (CONTINUED) direct sales to customers in the xSPs, telecommunications, and e-commerce; and financial services industries, as a percentage of net revenues were approximately 39% and 11%, respectively. Direct sales to customers in the telecommunications and financial services industries as a percentage of net revenues were approximately 21% and 18%, respectively, for 1999, and approximately 20% and 27%, respectively, for 1998. For the years ended December 31, 2000 and 1999, one customer accounted for approximately 17% and 10%, respectively, of total net revenues. For the year ended December 31, 1998, no single customer accounted for greater than 10% of the Company's net revenue. CASH CONCENTRATIONS--The Federal Deposit Insurance Corporation ("FDIC") insures a corporation's funds deposited in a bank up to a maximum of $100,000 in the event of a bank failure. The Company's cash held in checking accounts at two commercial banks exceeds the FDIC insured amount by approximately $986,000 and $15,000, respectively. The Company has not experienced any losses in relation to cash in excess of FDIC insurance limits. EXPORT SALES--The following table summarizes export sales by geographic region as a percentage of net revenue for the years ended December 31:
2000 1999 1998 -------- -------- -------- Europe...................................................... 16.6% 9.8% 6.1% Asia........................................................ 1.3 3.8 3.3 Other....................................................... 4.6 2.2 0.7 ---- ---- ---- Total export sales.......................................... 22.5% 15.8% 10.1% ==== ==== ====
DEPENDENCE ON SUPPLIERS--The Company purchases substantially all of its disk drives, a critical component of its storage products, from one supplier. Approximately 14%, 23%, and 22% of the Company's total component purchases were made from this supplier for the years ended December 31, 2000, 1999 and 1998, respectively. The Company resells the products of various third parties including one supplier of tape libraries and other products. During 2000, 1999 and 1998, approximately 12%, 17%, and 15%, respectively, of total purchases were from this supplier. There are a limited number of suppliers for certain of the Company's other components. Any shortage of key components, and any delay or other difficulty in obtaining such components from other suppliers and integrating them into the Company's products, or lack of supply from sole source suppliers could have a material adverse effect on the Company's financial condition and operating results. F-15 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 4. COMPREHENSIVE OPERATIONS The Company's accumulated other comprehensive loss balance consists entirely of foreign currency translation adjustments. Changes in the accumulated other comprehensive loss balance for the years ended December 31, 2000, 1999 and 1998 are detailed as follows (in thousands): Balance, January 1, 1998.................................... $ (97) Foreign currency translation adjustment..................... 35 ----- Balance, December 31, 1998.................................. (62) Foreign currency translation adjustment..................... (153) ----- Balance, December 31, 1999.................................. (215) Foreign currency translation adjustment..................... (1) ----- Balance, December 31, 2000.................................. $(216) =====
5. MERGER AND RESTRUCTURING COSTS AND IMPAIRMENT OF LONG-LIVED ASSETS During the third quarter of 1999, and in connection with the Merger of Box Hill and Artecon, the Company recorded expenses totaling $13.4 million related to the Merger and management's restructuring and integration plan associated with the Merger, as follows (in thousands): Inventory write-downs....................................... $ 5,033 Professional fees........................................... 4,029 License termination......................................... 1,000 Employee termination costs.................................. 1,100 Write-down of intangibles................................... 937 Facility closures and related costs......................... 647 Other integration costs..................................... 616 ------- Total..................................................... $13,362 =======
Management's restructuring and integration plan related primarily to the consolidation and discontinuance of product lines, which resulted in inventory and intangible assets write-downs of $5.0 million and $937,000, respectively. As a result of the product line consolidation, the Company also terminated a license agreement with a third-party vendor, resulting in license termination costs of $1.0 million. Additionally, management's plan included consolidating the Company's manufacturing operations and other functions into the Company's headquarters in Carlsbad, California, which resulted in employee termination charges of $1.1 million, consisting primarily of severance payments for 38 employees, facility closure costs of $647,000 and other integration costs of $616,000. The following is a F-16 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 5. MERGER AND RESTRUCTURING COSTS AND IMPAIRMENT OF LONG-LIVED ASSETS (CONTINUED) summary of accrued merger and restructuring cost activity during the year ended December 31, 2000 related to the Merger of Box Hill and Artecon (in thousands):
ACCRUED ACCRUED RESTRUCTURING AMOUNT RESTRUCTURING AMOUNT COSTS AT RESTRUCTURING UTILIZED COSTS AT UTILIZED DECEMBER 31, COSTS IN 1999 DECEMBER 31, 1999 IN 2000 2000 ------------- -------- ----------------- -------- ------------- Professional services.............. $4,029 $(4,029) $ -- $ -- $ -- License termination................ 1,000 (1,000) -- -- -- Employee termination costs......... 1,100 (620) 480 (480) -- Facility closures and related costs............................ 647 (125) 522 (522) -- Other integration costs............ 616 (526) 90 (90) -- ------ ------- ------ ------- ---- Total.............................. $7,392 $ 6,300 $1,092 $(1,092) $ -- ====== ======= ====== ======= ====
The Company believes that there are no unresolved issues or additional liabilities related to the Merger of Box Hill and Artecon. In December 1998, Artecon's Board of Directors approved a plan for Artecon to consolidate one of its engineering facilities from Milpitas, California, to Carlsbad, California, to consolidate certain domestic sales and service locations and to eliminate certain product lines and development activities. The Company recorded a pre-tax restructuring charge of $1.8 million to cover the costs associated with these actions. This charge consisted primarily of employee termination costs, inventory write-downs, facility closures and related expenses, an intangible asset impairment and tooling machinery write-offs. Employee termination costs consisted primarily of severance payments for 43 employees, all of whom were terminated as of December 31, 1998. The majority of the employees terminated were employed at the engineering facility in Milpitas, California, and at various domestic sales and service locations. Inventory write-downs and the tooling write-off primarily related to the discontinuance of certain low-volume and low-profit product lines. Of the total restructuring charge associated with the inventory write-downs, $403,000 has been included as a separate component of cost of goods sold in the accompanying consolidated statement of operations and comprehensive operations for the year ended December 31, 1998. Facility closures and related expenses consisted of lease termination costs and the write-off of certain property and equipment, which was disposed of in connection with the closures. All of the restructuring charges were utilized during 1998 and 1999. In connection with Artecon's acquisitions of Falcon and SDI during 1997, Artecon allocated $420,000 and $1.6 million, respectively, to an assembled workforce intangible asset. The Company recorded an impairment of these intangible assets of $300,000 during the year ended December 31, 1998, which has been included as a component of the restructuring charge, as the impairment was a direct result of employee terminations associated with activities that were exited. Furthermore, as a result of significant attrition and terminations of employees, which the Company considered the basis for the assembled workforce valuation, the Company recognized a write-down of the intangible assets associated with the workforce of $867,000 during the year ended December 31, 1998. F-17 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 5. MERGER AND RESTRUCTURING COSTS AND IMPAIRMENT OF LONG-LIVED ASSETS (CONTINUED) In connection with the merger with SDI in 1997, Artecon recorded a reserve for acquisition-related costs of $6.6 million. All of the acquisition-related costs were included in the purchase price allocation performed during 1997. The following is a summary of the accrued SDI merger and restructuring cost activity during the years ended December 31, 2000, 1999 and 1998 (in thousands):
BALANCE AT AMOUNTS BALANCE AT AMOUNTS BALANCE AT AMOUNTS BALANCE AT JANUARY 1, UTILIZED DECEMBER 31, UTILIZED DECEMBER 31, UTILIZED DECEMBER 31, 1998 IN 1998 1998 IN 1999 1999 IN 2000 2000 ---------- -------- ------------ -------- ------------ -------- ------------ Employee termination costs... $2,923 $(2,761) $162 $(162) $ -- $ -- $ -- Professional fees............ 2,225 (1,909) 316 -- 316 (316) -- Other costs.................. 1,433 (1,250) 183 (117) 66 (66) -- ------ ------- ---- ----- ---- ----- ---- Total........................ $6,581 $(5,920) $661 $(279) $382 $(382) $ -- ====== ======= ==== ===== ==== ===== ====
6. INVENTORIES Inventories consist of the following at December 31:
2000 1999 -------- -------- Purchased parts and materials............................... $15,968 $ 9,093 Work-in-process............................................. 519 438 Finished goods.............................................. 7,622 2,748 ------- ------- Total inventory............................................. $24,109 $12,279 ======= =======
The Company has determined the obsolescence of certain parts and materials based on product life cycles. 7. PROPERTY AND EQUIPMENT Property and equipment consist of the following at December 31:
2000 1999 -------- -------- Machinery and equipment..................................... $10,180 $7,237 Furniture, fixtures, and computer equipment................. 695 636 Leasehold improvements...................................... 930 930 ------- ------ 11,805 8,803 Less accumulated depreciation............................... (6,991) (6,128) ------- ------ $ 4,814 $2,675 ======= ======
Depreciation expense was $1.1 million, $1.8 million, and $2.8 million for the years ended December 31, 2000, 1999 and 1998, respectively. F-18 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 8. CREDIT FACILITIES BOX HILL FACILITY--In October 1997, Box Hill entered into an agreement with a commercial bank, which provided for a $10 million revolving line of credit. Box Hill did not have any borrowings under this facility during 1999 or 1998. Borrowings under the facility were collateralized by a pledge of substantially all of the Company's assets, and borrowings greater than $5 million were also required to be secured by short-term investments. Additionally, the Company was required to comply with certain financial covenants, as defined. The facility expired in May 1999. ARTECON FACILITY--Artecon had a $15 million revolving credit facility with a domestic commercial bank. The facility provided for financing collateralized by all assets of Artecon, as defined by the agreement, and expires on May 14, 2001, unless otherwise renewed. Borrowings under this credit facility incurred interest at the bank's prime rate. Interest was due monthly, with the principal due at maturity. Subsequent to the Merger with Artecon on August 2, 1999, the Company repaid all outstanding debt under this facility. JAPANESE YEN FACILITIES--The Company's Japanese subsidiary has two lines of credit with a Japanese bank for borrowings up to an aggregate 35 million Yen (US $305,000 at December 31, 2000) at interest rates ranging from 1.8% to 2.5%. At December 31, 2000 and 1999, 21 million Yen (approximately US $186,000) and 28 million Yen (approximately US $272,000), respectively, were outstanding under these lines of credit. Interest is due monthly, with the principal due on various dates through August 2005. Borrowings under these lines of credit are collateralized by inventories of the Japanese subsidiary. LONG-TERM DEBT--Promissory notes payable to a former shareholder of Falcon (Note 2), bearing interest at 10% per annum, were paid in full in August 1999. Interest expense related to this long-term debt for the years ended December 31, 1999 and 1998 was $114,000 and $207,000, respectively. SUBSEQUENT EVENT--In February 2001, the Company entered into an agreement with a commercial bank, which provides for borrowings up to $15 million under a revolving line of credit, expiring in December 2002. Borrowings under the facility are collateralized by a pledge of the Company's deposits held at the bank. Borrowings under the line of credit incur interest at the bank's prime rate or 50 basis points above LIBOR, at the option of the Company. Interest on outstanding borrowings is due monthly, with the principal due at maturity. No amounts have been borrowed under this line of credit. F-19 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 9. INCOME TAXES Components of the income tax (benefit) provision are as follows for the years ended December 31 (in thousands):
2000 1999 1998 -------- -------- -------- Current: Federal..................................................... $ 376 $ 1,366 $3,081 State, local and foreign.................................... 866 337 1,528 ------ ------- ------ 1,242 1,703 4,609 ------ ------- ------ Deferred: Federal..................................................... (1,118) (3,566) (3,054) State, local and foreign.................................... (773) (1,121) (573) ------ ------- ------ (1,891) (4,687) (3,627) ------ ------- ------ Change in deferred income tax asset valuation allowance..... 457 -- -- ------ ------- ------ $ (192) $(2,984) $ 982 ====== ======= ======
A reconciliation of the federal statutory income tax rate and the effective income tax rate is as follows for the years ended December 31:
2000 1999 1998 -------- -------- -------- Federal statutory rate...................................... (35.0)% (35.0)% 34.0% Foreign sales corporation................................... (23.0) -- -- Tax exempt interest income.................................. (15.3) (4.0) (21.9) State and local income taxes, net of federal effect......... (0.5) (4.6) 54.6 Change in deferred income tax asset valuation allowance..... 40.1 -- -- Foreign taxes............................................... 6.2 0.1 -- Meals and entertainment..................................... 5.1 0.3 -- Tax credit carryforwards and other.......................... 3.0 4.2 (18.0) Amortization of goodwill and intangible assets.............. 2.6 2.5 14.0 Merger and restructuring costs.............................. -- 11.7 -- ----- ----- ----- Effective income tax rate................................... (16.8)% (24.8)% 62.7% ===== ===== =====
F-20 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 9. INCOME TAXES (CONTINUED) The income tax effect of temporary differences that give rise to deferred income taxes are as follows at December 31 (in thousands):
2000 1999 -------- -------- Deferred income tax assets: Net operating loss and tax credit carryforwards............. $14,619 $ 9,959 Inventory reserve and uniform capitalization................ 3,583 4,301 Acquisition costs........................................... 826 1,461 Allowance for bad debts..................................... 698 733 In-process research and development......................... 667 723 Vacation accrual............................................ 302 301 Acquired intangibles........................................ 181 93 Warranty accrual............................................ 139 373 Deferred rent............................................... 39 135 Other accruals and reserves................................. -- 510 ------- ------- 21,054 18,589 ------- ------- Deferred income tax liabilities: State taxes................................................. 1,559 1,257 Depreciation and amortization............................... 14 48 Import reserve.............................................. 357 295 Acquired intangibles........................................ 244 -- ------- ------- 2,174 1,600 ------- ------- Deferred income tax asset valuation allowance............... 457 -- ------- ------- Net deferred income tax assets.............................. $18,423 $16,989 ======= ======= Current..................................................... $ 4,067 $ 5,879 Long-term................................................... 14,356 11,110 ------- ------- Total net deferred income tax assets........................ $18,423 $16,989 ======= =======
As of December 31, 2000, a valuation allowance of $457,000 has been provided based upon the Company's assessment of the future realizability of certain of the Company's deferred income tax assets. The Company has not provided for any residual U.S. income taxes on the earnings from its foreign sales because such earnings are intended to be indefinitely reinvested. Such residual U.S. income taxes, if any, would be immaterial to the Company's financial statements. As of December 31, 2000, the Company has federal and state net operating loss carryforwards of approximately $29.5 million and $20.9 million, respectively, which begin to expire in 2009 and 2001, respectively. In addition, the Company has federal income tax credit carryforwards of approximately $1.4 million, of which $136,000 can be carried forward indefinitely to offset future taxable income, and the remaining $1.3 million will begin to expire in 2008. The Company also has state income tax credit F-21 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 9. INCOME TAXES (CONTINUED) carryforwards of approximately $1.1 million, of which $1.0 million can be carried forward indefinitely to offset future taxable income, and the remaining $78,000 will begin to expire in 2006. Pursuant to the Tax Reform Act of 1986, annual use of Artecon's federal net operating loss and tax credit carryforwards is limited as a result of a cumulative change in ownership of more than 50% in connection with the Merger. The annual limitation is equal to (i) the aggregate fair market value of Artecon immediately before the ownership change multiplied by (ii) the long-term tax-exempt rate (within the meaning of Section 382(f) of the Internal Revenue Code) in effect at that time. The annual limitation is cumulative and, therefore, if not fully utilized in a given year, can be utilized in future years, in addition to the Section 382 limitation amount allowable for those years. 10. CONVERTIBLE PREFERRED A SHARES The Company's convertible preferred A shares have voting rights, provide for dividends when and if declared by the Board of Directors and have liquidation preference over common shares. The convertible preferred A shares are convertible into common shares, at the option of the holder, any time after January 1, 1999, at the conversion rate defined in the amended Articles of Incorporation. In connection with the Merger, the convertible preferred A shares were converted into 719,037 shares of the Company's common stock, representing the liquidation value of the preferred A shares. 11. STOCK INCENTIVE PLAN The Company's Stock Incentive Plan (the "Incentive Plan"), as amended, provides for the granting of incentive and nonqualified stock options to employees. The Company's Non-Employee Stock Option Plan (the "Directors' Plan") adopted in March 2000 provides for the granting of nonqualified stock options to non-employee directors. The Company has currently reserved 4,392,500 and 500,000 shares of common stock for issuance pursuant to the Incentive Plan and the Directors' Plan, respectively. The terms and conditions of grants of stock options are determined by the Board of Directors in accordance with the terms of the Incentive Plan and Directors' Plan. F-22 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 Information with respect to options under the Incentive Plan and Directors' Plan, as restated for the combination with Artecon's stock option plan, is as follows:
WEIGHTED NUMBER AVERAGE OF EXERCISE SHARES PRICE --------- -------- BALANCE, January 1, 1998.................................... 1,980,527 $6.90 Grants...................................................... 1,155,500 8.21 Forfeitures................................................. (963,047) 10.95 Exercises................................................... (232,470) 0.85 --------- ----- BALANCE, December 31, 1998.................................. 1,940,510 6.41 Grants...................................................... 1,136,875 5.48 Forfeitures................................................. (739,714) 10.80 Exercises................................................... (118,634) 0.70 --------- ----- BALANCE, December 31, 1999.................................. 2,219,037 4.80 Grants...................................................... 1,483,150 5.38 Forfeitures................................................. (397,085) 7.36 Exercises................................................... (537,164) 0.98 --------- ----- BALANCE, December 31, 2000.................................. 2,767,938 $5.49 ========= =====
The options generally vest ratably over a four or five year period and are exercisable over a period of ten years from the date of grant. Information with respect to options outstanding under the Incentive Plan and Directors' Plan at December 31, 2000 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------- ---------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE CONTRACTUAL LIFE EXERCISE EXERCISE RANGE OF EXERCISE PRICE OUTSTANDING IN YEARS PRICE OUTSTANDING PRICE - ----------------------- ----------- ---------------- -------- ----------- -------- $0.50 -- $3.25......................... 291,478 8.09 $ 2.36 103,169 $0.77 $3.31 -- $3.38......................... 670,120 9.79 3.37 3,927 3.35 $3.44 -- $5.38......................... 268,255 9.14 4.47 49,393 4.94 $5.50 -- $5.50......................... 793,087 8.80 5.50 236,077 5.50 $5.94 -- $9.38......................... 470,850 8.32 8.14 176,925 8.69 $9.50 -- $15.94........................ 274,148 9.28 10.40 17,038 10.60 --------- ----- ------- ------- ----- 2,767,938 8.96 $ 5.49 586,529 $5.72 ========= ===== ======= ======= =====
As of December 31, 1999 and 1998, approximately 739,000 and 732,000 options were exercisable at a weighted average exercise price of $3.60 and $4.68, respectively. The Company applies APB No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and the related interpretations in accounting for its employee stock options. F-23 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 Had compensation cost for the Incentive Plan and Directors' Plan been determined based upon the fair value of the options at the date of grant, as prescribed by SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, the Company's net income and basic and diluted net income per share would have been reduced to the following amounts for the years ended December 31 (net (loss) income amounts in thousands):
2000 1999 1998 -------- -------- -------- Net (loss) income: As reported................................................. $ (948) $(9,047) $ 584 As adjusted................................................. (2,998) (10,180) (1,424) Basic net (loss) income per share: As reported................................................. (0.04) (0.39) 0.03 As adjusted................................................. (0.12) (0.44) (0.06) Diluted net (loss) income per share: As reported................................................. (0.04) (0.39) 0.02 As adjusted................................................. (0.12) (0.44) (0.06)
The weighted average fair value of each stock option granted during the years ended December 31, 2000, 1999, and 1998 was $3.79, $3.86, and $9.29, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for the years ended December 31:
2000 1999 1998 ---------- ---------- --------- Risk free interest........................... 5.2%-6.7% 5.0%-6.0% 5.5% Expected dividend yield...................... -- -- -- Expected life................................ 5 years 5-7 years 5-7 years Expected volatility.......................... 65.0% 65.0% 60.0%
STOCK OPTION ISSUED TO CONSULTANT--In October 1998, the Company issued an option to a sales consultant to purchase 150,000 shares of common stock at an exercise price of $5.00, which was equal to the fair value of the Company's common stock on the date of grant. The option was exercisable immediately. This option was exercised in January 2000. The Company recorded a charge of $213,000 to sales and marketing expenses for the year ended December 31, 1998, for the fair value of the option on the date of grant, which was calculated using the Black-Scholes option-pricing model. 12. RELATED PARTY TRANSACTIONS DISTRIBUTIONS TO S CORPORATION SHAREHOLDERS--Effective June 30, 1997, Box Hill elected to convert from S corporation to C corporation status for income tax purposes. In March 1998, the Company made distributions of $227,000 to the S corporation shareholders of Box Hill, representing the final distribution of taxed, but undistributed, S corporation earnings of the Company as of the date of the conversion to a C corporation. BOX HILL EUROPE--Box Hill Systems Europe Limited ("Box Hill Europe") was formed in 1995 by the Company's founding shareholders to provide marketing and technical support services to the Company in Europe. Effective January 1, 1998, the Company issued 4,959 shares of common stock to Box Hill's founding shareholders, collectively, in exchange for 100% of the shares of Box Hill Europe. F-24 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 12. RELATED PARTY TRANSACTIONS (CONTINUED) The transaction has been accounted for as a merger between entities under common control in a manner similar to a pooling of interests. SALES TO AND PURCHASES FROM RELATED PARTIES--Revenues from sales to affiliated companies for the years ended December 31, 2000, 1999, and 1998 were approximately $2,000, $18,000 and $48,000 respectively. Artecon purchased certain goods from affiliates and was subject to a management fee of approximately $4,000 per month from an affiliate, which was terminated upon completion of Artecon's merger with SDI. Purchases from affiliated companies for the years ended December 31, 2000, 1999 and 1998 were approximately $87,000, $89,000 and $80,000, respectively. 13. EMPLOYEE BENEFIT PLANS BOX HILL RETIREMENT SAVINGS PLAN--Effective August 1, 1995, the Company established a retirement savings plan under the provisions of Section 401(k) of the Internal Revenue Code. The plan covered all employees who were employed on the effective date of the plan or upon the attainment of age 21. The Company can make discretionary contributions to the plan. No contributions were made to the plan for the years ended December 31, 1999 and 1998. ARTECON RETIREMENT SAVINGS PLAN--Artecon had a savings plan, which qualified under Section 401(k) of the Internal Revenue Code. Under the plan, participating U.S. employees may defer up to 15% of their pretax salary, but not more than statutory limits. Artecon matches 50% of participating employees' contributions up to a specified limit ($500). The Company's matching contributions to the savings plan were approximately $49,000 and $67,000 for the years ended December 31, 1999 and 1998, respectively. DOT HILL RETIREMENT SAVINGS PLAN--Effective December 1, 2000, the Company adopted a new plan which combined and replaced the Box Hill and Artecon retirement savings plans. This plan, which qualifies under Section 401(k) of the Internal Revenue Code is open to eligible employees over 21 years of age. Under the plan, participating U.S. employees may defer up to 20% of their pretax salary, but not more than statutory limits. The Company matches 50% of participating employees' contributions up to a specified limit ($1,000). The Company's matching contributions vest to employees as a percentage based on years of employment from one to five years, and matching contributions are fully vested to employees after five years of employment. The Company's matching contributions to the new retirement savings plan were appproximately $101,000 for the year ended December 31, 2000. EMPLOYEE STOCK PURCHASE PLAN--The Company's Employee Stock Purchase Plan (the "Purchase Plan") was adopted in August 1997, and amended and restated in March 2000. The Purchase Plan qualifies under the provisions of Section 423 of the Internal Revenue Code and provides eligible employees of the Company, as defined in the Purchase Plan with an opportunity to purchase shares of the Company's common stock at 85% of fair market value, as defined. The Company has reserved 750,000 shares of common stock for issuance pursuant to the Purchase Plan. During the year ended December 31, 2000, 33,000 shares were issued under the Purchase Plan, and 40,000 shares were issued during the year ended December 31, 1999 under the Purchase Plan and Artecon's employee stock purchase plan. During the year ended December 31, 1998, 79,000 shares were issued under the Purchase Plan. F-25 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 14. COMMITMENTS AND CONTINGENCIES OPERATING LEASES--The Company leases office space and equipment under noncancelable operating leases, which expire at various dates through September 2007. Rent expense for the years ended December 31, 2000, 1999, and 1998, was $2.1 million, $2.2 million, and $2.6 million, respectively. Future minimum lease payments due under all noncancelable operating leases as of December 31, 2000, are as follows (in thousands): 2001........................................................ $2,089 2002........................................................ 1,381 2003........................................................ 1,107 2004........................................................ 1,068 2005........................................................ 1,082 Thereafter.................................................. 1,399 ------ $8,126 ======
EMPLOYMENT AGREEMENTS--In connection with the Merger, effective August 2, 1999, the Company adopted employment contracts with four of its executive officers. These contracts provide for base salaries totaling $1.1 million per year. In addition, each executive was eligible to receive, at the discretion of the Board of Directors, a cash bonus of up to 50% of such executives' then annual base salary. If an executive's employment is terminated under certain circumstances, such executive will be entitled to receive a lump sum cash severance payment of up to 125% of such executive's then annual base salary. Effective January 1, 2001, the Company adopted the Executive Compensation Plan 2001 (the "Plan") for three of its executive officers. The terms of the Plans are in addition to the terms of these executive officers' employment contracts. The Plan provides for annual performance bonus potential of 50% of base salary for two of the officers and 55% of base salary for the remaining officer. The formula for the annual bonus calculation is as follows: Half of the annual performance bonus is based on meeting revenue goals and half of the annual bonus is based on meeting certain net income goals. If the Company attains less than 85% of revenue and net income goals, no bonus will be paid. For each 1% increase above 85% of the revenue and net income goals, a bonus equal to 3.33% of the annual performance bonus potential will be paid, with no cap. The employment contracts may be terminated at the option of either the option of the Company or the employee "for cause" or, upon 30 days written notice, for convenience and "without cause." If the Company terminates for convenience, the employee is entitled to a severance payment equal to the employee's then-current annual base salary. CLASS ACTION LAWSUITS--On January 5, 2001, a final settlement in the class action lawsuit filed against Box Hill Systems Corp., certain of its officers and directors, and the underwriters of the Company's September 16, 1997 initial public offering was approved by the United States District Court for the Southern District of New York, and the action was dismissed with prejudice. No plaintiffs objected to the settlement, no plaintiffs opted-out of the settlement, and no appeal was taken from the judgment. Therefore, the action has been finalized. F-26 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 14. COMMITMENTS AND CONTINGENCIES (CONTINUED) OTHER LITIGATION--The Company is involved in certain other legal actions and claims arising in the ordinary course of business. Management believes that the outcome of such other litigation and claims will not have a material adverse effect on the Company's financial condition or operating results. 15. SEGMENT AND GEOGRAPHIC INFORMATION Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company's chief operating decision-maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company's chief operating decision-maker is its Chief Executive Officer. The operating segments of the Company are managed separately because each segment represents a strategic business unit that offers different products or services. Historically, Artecon reported operating segments in certain market divisions. Following the Merger, the Company operated in a single reporting segment following the integration of Box Hill and Artecon. Since the Merger, the Company's operating segments are organized on the basis of products and services. The Company has identified operating segments that consist of SANnet, Tape, Services, and Legacy and other products. The Company also identifies operating segments by market segment, which consists of xSPs, telecommunications and e-commerce; financial and banking; and commercial, government, and other customers. The Company currently evaluates performance based on stand-alone segment revenue and gross margin. Because the Company does not currently evaluate performance based on segment operating income or return on assets at the operating segment level, such information is not presented. Information concerning revenue by product and service is as follows (in thousands):
LEGACY AND SANNET TAPE SERVICES OTHER TOTAL -------- -------- -------- ---------- -------- Year ended December 31, 2000: Net revenues........................ $29,820 $11,980 $8,670 $70,727 $121,197 ======= ======= ====== ======= ======== Gross margin........................ $12,832 $ 2,413 $4,660 $23,562 $ 43,467 ======= ======= ====== ======= ======== Six-months ended December 31, 1999: Net revenues........................ $ 213 $ 7,445 $4,875 $45,934 $ 58,467 ======= ======= ====== ======= ========
Reliable information prior to July 1, 1999 is not available and, accordingly, has not been provided. Prior to January 1, 2000, product and service stand-alone gross margin was not available, and accordingly has not been provided. F-27 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 15. SEGMENT AND GEOGRAPHIC INFORMATION (CONTINUED) Information concerning revenue by market segment is as follows (in thousands):
E-COMMERCE COMMERCIAL TELECOMMUNICATIONS FINANCIAL GOVERNMENT AND XSPS AND BANKING AND OTHER TOTAL ------------------ ----------- ---------- -------- Year ended December 31, 2000: Net revenues...................... $47,659 $12,958 $60,580 $121,197 ======= ======= ======= ======== Gross margin...................... $16,696 $ 4,788 $21,983 $ 43,467 ======= ======= ======= ========
Reliable information prior to January 1, 2000 is not available and, accordingly, has not been provided. Information concerning principal geographic areas in which the Company operates is as follows (in thousands):
AS OF AND FOR THE YEAR ENDED ---------------------------------- DECEMBER 31, 2000 1999 1998 -------- ------------ -------- Revenue: United States..................................... $ 96,705 $108,922 $155,460 Europe............................................ 15,567 11,965 10,435 Japan............................................. 8,925 3,329 2,460 -------- -------- -------- $121,197 $124,216 $168,355 ======== ======== ======== Income (loss) before income taxes: United States..................................... $ (7,294) $(14,686) $ (421) Europe............................................ 3,897 2,665 2,122 Japan............................................. 2,257 (10) (135) -------- -------- -------- $ (1,140) $(12,031) $ 1,566 ======== ======== ======== Assets: United States..................................... $101,539 $102,206 $126,161 Europe............................................ 691 494 416 Japan............................................. 966 1,259 902 Eliminations...................................... (317) (301) (449) -------- -------- -------- $102,879 $103,658 $127,030 ======== ======== ========
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The unaudited quarterly financial information has been restated for all prior periods to reflect the Merger of Box Hill and Artecon, which was accounted for as a pooling-of-interests. The information presented below reflects all adjustments which, in the opinion of management, are of a normal and F-28 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (CONTINUED) recurring nature necessary to present fairly the results of operations for the periods presented (in thousands).
FIRST SECOND THIRD FOURTH FISCAL QUARTER QUARTER QUARTER QUARTER YEAR -------- -------- --------- -------- -------- Year Ended December 31, 2000: Revenues.............................. $30,853 $33,443 $ 26,186 $30,715 $121,197 Gross margin.......................... 12,022 12,073 8,421 10,951 43,467 Income (loss) before income taxes..... 1,566 1,916 (3,309) (1,313) (1,140) Net income (loss)..................... 955 1,169 (1,984) (1,088) (948) Basic net income (loss) per share..... 0.04 0.05 (0.08) (0.04) (0.04) Diluted net income (loss) per share... 0.04 0.05 (0.08) (0.04) (0.04) Year Ended December 31, 1999: Revenues.............................. 32,612 33,137 28,333 30,134 124,216 Gross margin.......................... 11,400 11,005 4,280 10,919 37,604 Income (loss) before income taxes..... (830) 1,322 (13,327)(a) 804 (12,031) Net income (loss)..................... (590) 926 (10,833) 1,450 (9,047) Basic net income (loss) per share..... (0.03) 0.04 (0.46) 0.06 (0.39) Diluted net income (loss) per share... (0.03) 0.04 (0.46) 0.06 (0.39)
- ------------------------ (a) Includes pre-tax charges of $13,362 related to the Merger and management's restructuring and integration plan associated with the Merger. 17. SUBSEQUENT EVENT On March 20, 2001, the Company announced plans to reduce its full-time workforce by up to 30% and reduce other expenses in response to delays in customer orders, lower than expected revenues and slowing market conditions. The cost reduction actions are designed to enable the Company to reduce its breakeven point in light of current economic uncertainties. The cost reduction efforts will result in a charge for severance and restructuring costs. The Company also anticipates a related increase in its deferred income tax asset valuation allowance. The Company is still analyzing the impact of this situation; accordingly, no estimate of its impact on the Company's financial statements has been made. F-29 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Dot Hill Systems Corp.: We have audited the consolidated financial statements of Dot Hill Systems Corp. and subsidiaries (the "Company") as of December 31, 2000 and 1999, and for the years then ended, and have issued our report thereon dated January 24, 2001 (March 20, 2001 as to the subsequent events in Notes 8 and 17); such report is included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedule of the Company for the years ended December 31, 2000 and 1999, listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule for the years ended December 31, 2000 and 1999, when considered in relation to the basic 2000 and 1999 financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ DELOITTE & TOUCHE LLP San Diego, California January 24, 2001 S-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Dot Hill Systems Corp.: We have audited the consolidated financial statements of Dot Hill Systems Corp. and its subsidiaries (the "Company") for the year ended December 31, 1998. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. We did not audit the financial statements of Artecon, Inc., a company acquired during 1999 in a transaction accounted for as a pooling of interests, as discussed in Note 1, for the year ended March 31, 1999. Such statements are included in the consolidated financial statements of Dot Hill Systems Corp. in fiscal 1998. These statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Artecon, Inc., is based solely on the report of other auditors. The schedule of valuation and qualifying accounts is presented for purposes of additional analysis and is not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, based on our audit and the report of other auditors, is fairly stated in all material respects in relation to the basic financial statements taken as whole. Philadelphia, Pennsylvania August 2, 1999 S-2 DOT HILL SYSTEMS CORP. AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE AT CHARGED TO BEGINNING OF COSTS AND BALANCE AT YEAR EXPENSES DEDUCTIONS END OF YEAR ------------ ---------- ---------- ----------- Allowance for doubtful accounts and sales returns: Year ended December 31, 2000.................... $1,727 $ 700 $ 834(1) $1,593 Year ended December 31, 1999.................... 1,657 752 682(1) 1,727 Year ended December 31, 1998.................... 1,160 1,672 1,175(1) 1,657 Reserve for excess and obsolete inventories: Year ended December 31, 2000.................... 9,548 5,806 7,707(2) 7,647 Year ended December 31, 1999.................... 4,314 6,811 1,577(2) 9,548 Year ended December 31, 1998.................... 5,691 3,627 5,004(2) 4,314
- ------------------------ (1) Uncollectible receivables charged off and credit issued for product returns. (2) Consists primarily of the write-off of excess/obsolete inventories. S-3 EX-10.22 2 a2041983zex-10_22.txt EXHIBIT 10.22 EXHIBIT 10.22 [LETTERHEAD OF DOT HILL SYSTEMS CORP.] August 30, 2000 Philip Black 1718 Midwick Place Montecito, CA 93108 Letter Agreement of Termination of Employment ("Termination Agreement) from Dot Hill Systems Corp. (the "Company"). Dear Philip: This letter confirms written and verbal notice of your termination of employment with the Company. 1. TERMINATION DATE AND EFFECTIVE DATE: Effective the close of business on today, August 30, 2000, (the "Termination Date"), your employment with the Company will end. August 30, 2000 shall be considered your last day of employment for purposes of calculating any time periods that are triggered by your termination. The Effective Date of this Agreement shall be the eighth (8th) day after you sign this Agreement, assuming you do not revoke the Agreement prior to that time ("Effective Date"). You agree that you will resign from your position as a member of the Board of Directors, and any other positions you may have as a member of the Board of the Company's subsidiaries. In furtherance thereof, you agree to execute the Resignation Letter attached hereto as Exhibit A concurrent with the execution of this Agreement. 2. HEALTH CARE: Your participation in health care coverage will end a year after the Termination Date, the date upon which you fail to observe the provisions of your Employment Agreement effective January 1, 1999 and Amended August 2, 1999 (your "Employment Agreement") or the date upon which you become otherwise employed, whichever occurs first. After your participation in Dot Hill's health care programs ends, you may elect to undertake individual (COBRA) participation at your sole expense so long as you are not then eligible to be covered under another health plan that provides you with medical insurance coverage. You will receive information from CobraPro regarding your right to a continuation of coverage under COBRA. Provided you have made the required contributions and are otherwise eligible, COBRA coverage will continue for another 18 months. 3. LIFE INSURANCE: Any life insurance coverage that is currently paid by the Company will end a year after the Termination Date, the date upon which you fail to observe the provisions of your Employment Agreement or the date upon which you become otherwise employed, whichever occurs first. If you are interested in receiving information on converting this coverage to a private policy after coverage ends, please mail your request to Dot Hill, Employee Benefits, 6305 El Camino Real, Carlsbad, CA 92009. 4. 401K: Your employee contributions to the Company's 401K Plan cease as of the Termination Date. Please contact the New York Human Resources Representative if you have any questions about your account in the Company 401K Plan. You will receive help to process any necessary forms. All forms should be returned to the New York Human Resources Representative. Then, at your direction, forms will be submitted to MFS Retirement Services for distribution. 5. COMPANY STOCK & STOCK OPTIONS: Any rights that you may have in any Employee Stock Purchase Plan, Stock Option Plan or similar plan of the Company are determined according to the provisions of the applicable plan and any agreements signed by you. Questions regarding the above should be directed to Valerie Greenberg, Corporate Counsel, or Ms. Weaver. 6. VACATION & EXPENSES: You will receive payment for 371.38 hours of accrued and unused vacation through August 26, 2000 in the amount of $62,491.83, less standard deductions and withholdings. You will also receive reimbursement for all remaining authorized Company business expenses through the Termination Date in the amount of $613.37, however Dot Hill will deduct $1,000 from that amount due to your purchase of a Company laptop computer. These items shall be paid in a lump sum within three days of the Termination Date. 7. SALARY, COMMISSION AND BONUS COMPENSATION: Pursuant to your Employment Agreement, you shall be paid all compensation at your current level of salary, commission and bonus through the Termination Date, the remaining unpaid amounts of which is equal to $15,857.32, less standard deductions and withholdings. This amount shall be payable in a lump sum within three days of the Termination Date. In addition and in exchange for the promises and covenants herein, the Company agrees to pay you an amount equal to $43,925.31, less standard deductions and withholdings and $3,670.00 which you received as an advance at the start of the year, in settlement of any dispute regarding your base salary for the year 2000. Such amount shall also be paid in a lump sum within three days of the Effective Date of this Agreement. 8. SEVERANCE PAYMENTS: In exchange for the promises and covenants herein, you shall be paid a total of $469,544.46, less standard deductions and withholdings. In exchange for the promises and covenants herein, your agreement to be available during the next thirty days to aid the Company in any way reasonably requested, and your waiver of the thirty-day notification requirement of termination set forth in your Employment Agreement, you shall also receive $28,846.15, less standard deductions and withholding. These severance payments shall be paid to you in a lump sum within three days of the Effective Date of this Agreement. During the year following the Effective Date, as additional severance compensation, so long as you are not otherwise employed and you observe the provisions of your Employment Agreement, the Company shall also maintain and provide to you, at the Company's expense, all fringe benefits provided for in Attachment A of the Employment Agreement, subject to the terms of the relevant insurance, benefit or other plans. Such fringe benefits include: any medical and dental benefits for you and your eligible dependents that you received as an employee, any life insurance paid by the Company that you received as an employee, and payment for holidays, sick days, personal days and vacation time. All payments made pursuant to this paragraph are made to you in consideration for your observance of all other provisions of the Employment Agreement including, but not limited to, the confidentiality, non-interference and non-competition provisions of the Employment Agreement. If at any time following the Termination Date you fail to observe the provisions of your Employment Agreement, you shall remit to the Company the amounts that had been paid to you pursuant to this paragraph. Such remittance shall not limit the Company's remedies and rights in the event you fail to observe the provisions of your Employment Agreement. 9. WITHHOLDING, TAXES AND INTEREST: All payments required to be made by the Company pursuant to this letter will be subject to any and all applicable withholdings, including withholdings for any related federal, state or local taxes. You are responsible to pay any and all income taxes or other taxes incurred by you as a result of your receipt of any payments from the Company. In the event that payments are not made when due, such payments shall bear interest at the rate of 10% per annum. Should you incur attorney's fees in connection with the collection of any unpaid amounts that are properly payable to you under this agreement, the Company shall be responsible to pay the attorney's fees. 10. NO CLAIMS: In exchange for the promises and covenants set forth herein, you hereby release, acquit, and forever discharge the Company, its parents and subsidiaries, and their officers, directors, agents, servants, employees, attorneys, shareholders, partners, successors, assigns, affiliates, customers, and clients of and from any and all claims, liabilities, demands, causes of action, costs, expenses, attorneys' fees, damages, indemnities and obligations of every kind and nature, in law, equity, or otherwise, known and unknown, suspected and unsuspected, disclosed and undisclosed, arising out of or in any way related to agreements, acts or conduct at any time prior to the Termination Date, including, but not limited to: all such claims and demands directly or indirectly arising out of or in any way connected with the Company's employment of you, the termination of that employment, and the Company's performance of its obligations as your former employer; claims or demands related to salary, bonuses, commissions, stock, stock options, or any other ownership interests in the Company, vacation pay, fringe benefits, expense reimbursements, severance pay, or any form of compensation; claims pursuant to any federal, state or local law or cause of action including, but not limited to, the New York anti-discrimination laws, the federal Civil Rights Act of 1964, as amended; the federal Age Discrimination in Employment Act of 1967, as amended; the federal Americans With Disabilities Act; tort law; contract law; wrongful discharge; discrimination; harassment; fraud; defamation; emotional distress; and breach of the implied covenant of good faith and fair dealing. Nothing herein shall eliminate or reduce any right that you have to seek indemnification from the Company for claims or actions brought against you based on your conduct or actions taken in the course and scope of your duties as an employee or director of the Company. You further acknowledge that you are knowingly and voluntarily waiving and releasing any rights you may have under the Age Discrimination in Employment Act of 1967 ("ADEA"). You also acknowledge that the consideration given for the waiver and release in the preceding paragraphs hereof is in addition to anything of value to which you were already entitled. You hereby provide the further acknowledgment that you are advised by this writing, as required by the Older Workers Benefit Protection Act, that: (a) your waiver and release do not apply to any rights or claims that may arise after the Effective Date of this Agreement; (b) you have the right to consult with an attorney prior to executing this Agreement (although you may voluntarily choose not to do so); (c) you may have at least twenty-one (21) days to consider this Agreement (although you may by your own choice execute this Agreement earlier); (d) you have seven (7) days following the execution of this Agreement to revoke this Agreement; and (e) this Agreement shall not be effective until the date upon which the revocation period has expired, therefore making the effective date of this Agreement the eighth day after this Agreement is signed by you. 11. OBLIGATIONS: You are reminded of any and all understandings and agreements between you and the Company regarding intellectual property and confidentiality of Company Information, non-competition and non-interference. If you have any questions regarding the terms of these understandings and agreements, please contact Valerie Greenberg, Corporate Counsel. You acknowledge your continuing obligations under your Employee Confidential Information and Invention Agreement, a copy of which is attached hereto as Exhibit B and Employee Non-Disclosure Agreement, a copy of which is attached hereto as Exhibit C. Pursuant to the attached agreements you understand that you must not use or disclose any confidential or proprietary information of the Company, among other things. 12. COMPANY PROPERTY: You are required to return all equipment belonging to the Company (except for one Company laptop which you have agreed to purchase from the Company for $1,000), including but not limited to the Company's products, computer equipment and peripherals, phone equipment, keys to Company buildings and/or offices, corporate credit cards and phone cards by the Termination Date. 13. ENTIRE AGREEMENT: This Termination Agreement constitutes the complete, final and exclusive embodiment of the entire Termination Agreement between you and the Company with regard to the subject matter hereof. It is entered into without reliance on any promise or representation, written or oral, other than those expressly contained herein. It may not be modified except in a writing signed by you and a duly authorized officer of the Company. Each party has carefully read this Agreement, has been afforded the opportunity to be advised of its meaning and consequences by his or its respective attorneys, and signed the same of his or its free will. 14. SEVERABILITY: If a court of competent jurisdiction determines that any term or provision of this Agreement is invalid or unenforceable, in whole or in part, the remaining terms and provisions hereof shall be unimpaired. Such court will have the authority to modify or replace the invalid or unenforceable term or provision with a valid and enforceable term or provision that most accurately represents the parties' intention with respect to the invalid or unenforceable term or provision. Very truly yours, /s/ CHARLES CHRIST Charles Christ Chairman of the Board of Directors Signature: /s/ PHILIP BLACK Date: 30 Aug. 2000 Philip Black EX-10.23 3 a2041983zex-10_23.txt EXHIBIT 10.23 EXHIBIT 10.23 CREDIT AGREEMENT THIS AGREEMENT is entered into as of February 6, 2001, by and between DOT HILL SYSTEMS CORP.,a New York corporation ("Dot Hill") and SILICON ALLEY MANAGEMENT, INC., a Delaware corporation ("Silicon Alley," and together with Dot Hill, the "Borrowers"), and WELLS FARGO BANK, NATIONAL ASSOCIATION ("Bank"). RECITALS Borrowers have requested that Bank extend or continue credit to Borrowers as described below, and Bank has agreed to provide such credit to Borrowers on the terms and conditions contained herein. NOW,THEREFORE, for valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Bank and Borrowers hereby agree as follows: ARTICLE 1 CREDIT TERMS SECTION 1.1 LINE OF CREDIT. (a) LINE OF CREDIT. Subject to the terms and conditions of this Agreement, Bank hereby agrees to make advances to either Borrower from time to time up to and including December 31, 2002, not to exceed at any time the aggregate principal amount of Fifteen Million Dollars ($15,000,000.00) ("Line of Credit"), the proceeds of which shall be used to finance Borrowers' working capital requirements. Borrowers' obligation to repay advances under the Line of Credit shall be evidenced by a promissory note substantially in the form of Exhibit A attached hereto ("Line of Credit Note"), all terms of which are incorporated herein by this reference. (b) LETTER OF CREDIT SUBFEATURE. As a subfeature under the Line of Credit, Bank agrees from time to time during the term thereof to issue or cause an affiliate to issue standby and/or sight commercial letters of credit for the account of either Borrower to finance the procurement of material and services (each, a "Letter of Credit" and collectively, "Letters of Credit"); provided however, that the aggregate undrawn amount of all outstanding Letters of Credit shall not at any time exceed One Million Dollars ($1,000,000.00). The form and substance of each Letter of Credit shall be subject to approval by Bank, in its sole discretion. Each Letter of Credit shall be issued for a term not to exceed three hundred sixty-five (365) days, as designated by a Borrower; provided however, that no Letter of Credit shall have an expiration date subsequent to the maturity date of the Line of Credit. The undrawn amount of all Letters of Credit shall be reserved under the Line of Credit and shall not be available for borrowings thereunder. Each Letter of Credit shall be subject to the additional terms and conditions of the Letter of Credit agreements, applications and any related documents required by Bank in connection with the issuance thereof. Each draft paid under a Letter of Credit shall be deemed an advance under the Line of Credit and shall be repaid by Borrowers in accordance with the terms and conditions of this Agreement applicable to such advances; provided however, that if advances under the Line of Credit are not available, for any reason, at the time any draft is paid, then Borrowers shall immediately pay to Bank the full amount of such draft, together with interest thereon from the date such draft is paid to the date such amount is -1- fully repaid by Borrowers, at the rate of interest applicable to advances under the Line of Credit. In such event Borrowers agree that Bank, in its sole discretion, may debit any account maintained by either Borrower with Bank for the amount of any such draft. (c) BORROWING AND REPAYMENT. Each Borrower may from time to time during the term of the Line of Credit borrow, partially or wholly repay its outstanding borrowings, and reborrow, subject to all of the limitations, terms and conditions contained herein or in the Line of Credit Note; provided however, that the total outstanding borrowings under the Line of Credit shall not at any time exceed the maximum principal amount available thereunder, as set forth above. (d) RESERVATION OF FOREIGN EXCHANGE "DELIVERY LIMIT." The largest aggregate outstanding principal amount of Borrowers' foreign exchange contracts (entered into by Bank as set forth in Section 1.2 below) which will mature during any single two (2) day period shall be reserved under the Line of Credit and shall not be available for borrowings thereunder. (e) RESERVATION OF BUSINESS MASTERCARD LINE. The principal balance outstanding under Dot Hill's Business MasterCard Line with Bank shall be reserved under the Line of Credit and shall not be available for borrowings thereunder. SECTION 1.2 FOREIGN EXCHANGE FACILITY. (a) FOREIGN EXCHANGE FACILITY. Subject to the terms and conditions of this Agreement, Bank hereby agrees to make available to Borrowers a facility (the "Foreign Exchange Facility") under which Bank, from time to time up to and including December 31, 2002, will enter into foreign exchange contracts for the account of either Borrower for the purchase and/or sale by a Borrower in United States dollars of foreign currencies designated by such Borrower, provided however, that the maximum amount of all outstanding foreign exchange contracts shall not at any time exceed an aggregate of Five Million United States Dollars (US$5,000,000.00). No foreign exchange contract shall be executed for a term in excess of twelve (12) months or for a term which extends beyond December 21, 2002. Borrowers shall have a "Delivery Limit" under the Foreign Exchange Facility not to exceed at any time the aggregate principal amount of One Million Five Hundred Thousand United States Dollars (US$1,500,000.00), which Delivery Limit reflects the maximum combined principal amount of each Borrower's foreign exchange contracts which may mature during any two (2) day period. All foreign exchange transactions shall be subject to the additional terms of a Foreign Exchange Agreement, substantially in the form of Exhibit B attached hereto ("Foreign Exchange Agreement"), all terms of which are incorporated herein by this reference. (b) SETTLEMENT. Each foreign exchange contract under the Foreign Exchange Facility shall be settled on its maturity date by Bank's debit to any deposit account maintained by either Borrower with Bank. (c) LIMITATION ON AVAILABILITY OF FOREIGN EXCHANGE FACILITY. Notwithstanding anything to the contrary contained herein, Bank shall not enter into foreign exchange contracts for the account of either Borrower if and to the extent that the sum of the aggregate principal balance outstanding under the Line of Credit (including the undrawn amount of any Letters of Credit) plus the amounts described in subsections (d) and (e) of Section 1.1 above exceeds Fifteen Million Dollars ($15,000,000.00). -2- SECTION 1.3 INTEREST/FEES. (a) INTEREST. The outstanding principal balance of each credit subject hereto shall bear interest at the rate of interest set forth in each promissory note or other instrument executed in connection therewith. (b) COMPUTATION AND PAYMENT. Interest shall be computed on the basis of a 360-day year, actual days closed. Interest shall be payable at the times and place set forth in each promissory note or other instrument required hereby. (c) UNUSED COMMITMENT FEE. Borrowers shall pay to Bank a fee equal to one-quarter percent (.25%) per annum (computed on the basis of a 360-day year, actual days elapsed) on the average daily unused amount of the Line of Credit, which fee shall be calculated on a monthly basis by Bank and shall be due and payable by Borrowers in arrears within thirty (30) days after each billing is sent by Bank. (d) LETTER OF CREDIT FEES. Borrowers shall pay to Bank fees upon the issuance of each Letter of Credit, upon the payment or negotiation of each draft under any Letter of Credit and upon the occurrence of any other activity with respect to any Letter of Credit (including without limitation, the transfer, amendment or cancellation of any Letter of Credit) determined in accordance with Bank's standard fees and charges then in effect for such activity. SECTION 1.4 COLLATERAL. As security for all indebtedness of Borrowers to Bank subject hereto, Dot Hill hereby grants to Bank security interests of first priority in Dot Hill's 10671900 Account No. Investment Management Account, maintained with Wells Capital Management Inc. All of the foregoing shall be evidenced by and subject to the terms of such security agreements, financing statements and other documents as Bank shall reasonably require, all in form and substance satisfactory to Bank. Borrowers shall reimburse Bank immediately upon demand for all costs and expenses incurred by Bank in connection with any of the foregoing security. ARTICLE 2 REPRESENTATIONS AND WARRANTIES Each Borrower makes the following representations and warranties to Bank, which representations and warranties shall survive the execution of this Agreement and shall continue in full force and effect until the full and final payment, and satisfaction and discharge, of all obligations of Borrowers to Bank subject to this Agreement. SECTION 2.1 LEGAL STATUS. Dot Hill is a corporation, duly organized and existing and in good standing under the laws of the State of New York. Silicon Alley is a corporation, duly organized and existing and in good standing under the laws of the State of Delaware. Each Borrower is qualified or licensed to do business (and is in good standing as a foreign corporation, if applicable) in all jurisdictions in which such qualification or licensing is required or in which the failure to so qualify or to be so licensed could have a material adverse effect on such Borrower. -3- SECTION 2.2 AUTHORIZATION AND VALIDITY. This Agreement and each promissory note, contract, instrument and other document required hereby or at any time hereafter delivered to Bank in connection herewith (collectively, the "Loan Documents") have been duly authorized, and upon their execution and delivery in accordance with the provisions hereof will constitute legal, valid and binding agreements and obligations of each Borrower or the party which executes the same, enforceable in accordance with their respective terms. SECTION 2.3 NO VIOLATION. The execution, delivery and performance by each Borrower of each of the Loan Documents do not violate any provision of any law or regulation, or contravene any provision of the Articles of Incorporation or By-Laws of such Borrower, or result in any breach of or default under any contract, obligation, indenture or other instrument to which such Borrower is a party or by which such Borrower may be bound. SECTION 2.4 LITIGATION. There are no pending, or to the best of either Borrower's knowledge threatened, actions, claims, investigations, suits or proceedings by or before any governmental authority, arbitrator, court or administrative agency which could have a material adverse effect on the financial condition or operation of either Borrower other than those disclosed by Borrowers to Bank in writing prior to the date hereof. SECTION 2.5 CORRECTNESS OF FINANCIAL STATEMENT. The financial statement of Dot Hill dated June 30, 2000, a true copy of which has been delivered by Dot Hill to Bank prior to the date hereof, (a) is complete and correct and presents fairly the financial condition of Dot Hill, (b) discloses all liabilities of Dot Hill that are required to be reflected or reserved against under generally accepted accounting principles, whether liquidated or unliquidated, fixed or contingent, and (c) has been prepared in accordance with generally accepted accounting principles consistently applied. Since the date of such financial statement there has been no material adverse change in the financial condition of Dot Hill, nor has Dot Hill mortgaged, pledged, granted a security interest in or otherwise encumbered any of its assets or properties except in favor of Bank or as otherwise permitted by Bank in writing. SECTION 2.6 INCOME TAX RETURNS. Neither Borrower has any knowledge of any pending assessments or adjustments of its income tax payable with respect to any year. SECTION 2.7 NO SUBORDINATION. There is no agreement, indenture, contract or instrument to which either Borrower is a party or by which either Borrower may be bound that requires the subordination in right of payment of any of either Borrower's obligations subject to this Agreement to any other obligation of either Borrower. SECTION 2.8 PERMITS, FRANCHISES. Each Borrower possesses, and will hereafter possess, all permits, consents, approvals, franchises and licenses required and rights to all trademarks, trade names, patents, and fictitious names, if any, necessary to enable it to conduct the business in which it is now engaged in compliance with applicable law. SECTION 2.9 ERISA. Each Borrower is in compliance in all material respects with all applicable provisions of the Employee Retirement Income Security Act of 1974, as amended or recodified from time to time ("ERISA"); neither Borrower has violated any provision of any defined employee pension benefit plan (as defined in ERISA) maintained or contributed to by such Borrower (each, a "Plan"); no Reportable Event as defined in ERISA has occurred and is continuing with respect to any Plan initiated by either Borrower; each Borrower has met its minimum funding requirements under ERISA with respect to each Plan; and each Plan will be -4- able to fulfill its benefit obligations as they come due in accordance with the Plan documents and under generally accepted accounting principles. SECTION 2.10 OTHER OBLIGATIONS. Neither Borrower is in default on any obligation for borrowed money, any purchase money obligation or any other material lease, commitment, contract, instrument or obligation. SECTION 2.11 ENVIRONMENTAL MATTERS. Except as disclosed by Borrowers to Bank in writing prior to the date hereof, each Borrower is in compliance in all material respects with all applicable federal or state environmental, hazardous waste, health and safety statutes, and any rules or regulations adopted pursuant thereto, which govern or affect any of such Borrower's operations and/or properties, including without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, the Superfund Amendments and Reauthorization Act of 1986, the Federal Resource Conservation and Recovery Act of 1976, and the Federal Toxic Substances Control Act, as any of the same may be amended, modified or supplemented from time to time. None of the operations of either Borrower is the subject of any federal or state investigation evaluating whether any remedial action involving a material expenditure is needed to respond to a release of any toxic or hazardous waste or substance into the environment. Neither Borrower has any material contingent liability in connection with any release of any toxic or hazardous waste or substance into the environment. ARTICLE 3 CONDITIONS SECTION 3.1 CONDITIONS OF INITIAL EXTENSION OF CREDIT. The obligation of Bank to extend any credit contemplated by this Agreement is subject to the fulfillment to Bank's satisfaction of all of the following conditions: (a) APPROVAL OF BANK COUNSEL. All legal matters incidental to the extension of credit by Bank shall be satisfactory to Bank's counsel. (b) DOCUMENTATION. Bank shall have received, in form and substance satisfactory to Bank, each of the following, duly executed: (i) This Agreement and each promissory note or other instrument required hereby. (ii) Security Agreement: Securities Account. (iii) Securities Account Control Agreement. (iv) Addendum to Security Agreement: Securities Account. (v) Statement of Purpose (form U-1) for Dot Hill. (vi) Authorization for Foreign Exchange Transactions for Dot Hill. (vii) Authorization for Foreign Exchange Transactions for Silicon Alley. (viii) Foreign Exchange Agreement for Dot Hill. (ix) Foreign Exchange Agreement for Silicon Alley. (x) Corporate Borrowing Resolution for Dot Hill. (xi) Corporate Borrowing Resolution for Silicon Alley. (xii) Certificate of Incumbency for Dot Hill. (xiii) Certificate of Incumbency for Silicon Alley. (xiv) Such other documents as Bank may require under any other Section of this Agreement. -5- (c) FINANCIAL CONDITION. There shall have been no material adverse change, as determined by Bank, in the financial condition or business of either Borrower, nor any material decline, as determined by Bank, in the market value of any collateral required hereunder or a substantial or material portion of the assets of either Borrower. (d) INSURANCE. Borrowers shall have delivered to Bank evidence of insurance coverage on all of each Borrower's property, in form, substance, amounts, covering risks and issued by companies satisfactory to Bank, and where required by Bank, with loss payable endorsements in favor of Bank. SECTION 3.2 CONDITIONS OF EACH EXTENSION OF CREDIT. The obligation of Bank to make each extension of credit requested by Borrowers hereunder shall be subject to the fulfillment to Bank's satisfaction of each of the following conditions: (a) COMPLIANCE. The representations and warranties contained herein and in each of the other Loan Documents shall be true on and as of the date of the signing of this Agreement and on the date of each extension of credit by Bank pursuant hereto, with the same effect as though such representations and warranties had been made on and as of each such date, and on each such date, no Event of Default as defined herein, and no condition, event or act which with the giving of notice or the passage of time or both would constitute such an Event of Default, shall have occurred and be continuing or shall exist. (b) DOCUMENTATION. Bank shall have received all additional documents which may be required in connection with such extension of credit. SECTION 3.3 CONDITION SUBSEQUENT. As a condition subsequent to the effectiveness of this Agreement, Dot Hill shall transfer all of its primary operating accounts to Bank within sixty (60) days of executing this Agreement. ARTICLE 4 AFFIRMATIVE COVENANTS Each Borrower covenants that so long as Bank remains committed to extend credit to Borrowers pursuant hereto, or any liabilities (whether direct or contingent, liquidated or unliquidated) of Borrowers to Bank under any of the Loan Documents remain outstanding, and until payment in full of all obligations of Borrowers subject hereto, each Borrower shall, unless Bank otherwise consents in writing: SECTION 4.1 PUNCTUAL PAYMENTS. Punctually pay all principal, interest, fees or other liabilities under any of the Loan Documents at the times and place and in the manner specified therein, and immediately upon demand by Bank, the amount by which the outstanding principal balance of any credit subject hereto at any time exceeds any limitation on borrowings applicable thereto. SECTION 4.2 ACCOUNTING RECORDS. Maintain adequate books and records in accordance with generally accepted accounting principles consistently applied, and permit any representative of Bank, at any reasonable time, to inspect, audit and examine such books and records, to make copies of the same, and to inspect the properties of each Borrower. SECTION 4.3 FINANCIAL STATEMENTS. Provide to Bank all of the following, in form and detail satisfactory to Bank: -6- (a) not later than 90 days after and as of the end of each fiscal year, an audited financial statement of each Borrower, prepared by a certified public accountant acceptable to Bank, to include a balance sheet, an income statement, a statement of cash flow, and all footnotes; (b) not later than 90 days after and as of the end of each fiscal quarter, a financial statement of Dot Hill prepared by Dot Hill, to include a balance sheet, an income statement, a statement of cash flow, and all footnotes; (c) not later than 90 days after and as of the end of each fiscal quarter, an updated operating plan of Dot Hill; (d) from time to time such other information as Bank may reasonably request. SECTION 4.4 COMPLIANCE. Preserve and maintain all licenses, permits, governmental approvals, rights, privileges and franchises necessary for the conduct of its business; and comply with the provisions of all documents pursuant to which each such Borrower is organized and/or which govern each such Borrower's continued existence and with the requirements of all laws, rules, regulations and orders of any governmental authority applicable to each such Borrower and/or its business. SECTION 4.5 INSURANCE. Maintain and keep in force insurance of the types and in amounts customarily carried in lines of business similar to that of each such Borrower, including but not limited to fire, extended coverage, public liability, flood, property damage and workers' compensation, with all such insurance carried with companies and in amounts satisfactory to Bank, and deliver to Bank from time to time at Bank's request schedules setting forth all insurance then in effect. SECTION 4.6 FACILITIES. Keep all properties useful or necessary to each such Borrower's business in good repair and condition, and from time to time make necessary repairs, renewals and replacements thereto so that such properties shall be fully and efficiently preserved and maintained. SECTION 4.7 TAXES AND OTHER LIABILITIES. Pay and discharge when due any and all indebtedness, obligations, assessments and taxes, both real or personal, including without limitation federal and state income taxes and state and local property taxes and assessments, except such (a) as either Borrower may in good faith contest or as to which a bona fide dispute may arise, and (b) for which such Borrower has made provision, to Bank's satisfaction, for eventual payment thereof in the event such Borrower is obligated to make such payment. SECTION 4.8 LITIGATION. Promptly give notice in writing to Bank of any litigation pending or threatened against either Borrower. SECTION 4.9 FINANCIAL CONDITION. Maintain Dot Hill's financial condition as follows using generally accepted accounting principles consistently applied and used consistently with prior practices (except to the extent modified by the definition herein): Net income after taxes not less than $1.00, determined as of December 31, 2001. SECTION 4.10 NOTICE TO BANK. Promptly (but in no event more than five (5) days after the occurrence of each such event or matter) give written notice to Bank in reasonable -7- detail of: (a) the occurrence of any Event of Default, or any condition, event or act which with the giving of notice or the passage of time or both would constitute an Event of Default; (b) any change in the name or the organizational structure of either Borrower; (c) the occurrence and nature of any Reportable Event or Prohibited Transaction, each as defined in ERISA, or any funding deficiency with respect to any Plan; or (d) any termination or cancellation of any insurance policy which either Borrower is required to maintain, or any uninsured or partially uninsured loss through liability or property damage, or through fire, theft or any other cause affecting either Borrower's property. SECTION 4.11 DEPOSIT ACCOUNTS. Dot Hill shall maintain all of its primary operating accounts with Bank (after such accounts have been transferred to Bank pursuant to Section 3.3 above). ARTICLE 5 NEGATIVE COVENANTS Each Borrower further covenants that so long as Bank remains committed to extend credit to Borrower pursuant hereto, or any liabilities (whether direct or contingent, liquidated or unliquidated) of Borrowers to Bank under any of the Loan Documents remain outstanding, and until payment in full of all obligations of Borrowers subject hereto, neither Borrower shall, without Bank's prior written consent: SECTION 5.1 USE OF FUNDS. Use any of the proceeds of any credit extended hereunder except for the purposes stated in Article I hereof. SECTION 5.2 MERGER. Merge into or consolidate with any other entity. ARTICLE 6 EVENTS OF DEFAULT SECTION 6.1 The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: (a) Borrowers shall fail to pay when due any principal, interest, fees or other amounts payable under any of the Loan Documents. (b) Any financial statement or certificate furnished to Bank in connection with, or any representation or warranty made by either Borrower or any other party under this Agreement or any other Loan Document shall prove to be incorrect, false or misleading in any material respect when furnished or made. (c) Any default in the performance of or compliance with any obligation, agreement or other provision contained herein or in any other Loan Document (other than those referred to in subsections (a) and (b) above), and with respect to any such default which by its nature can be cured, such default shall continue for a period of thirty (30) days from its occurrence. (d) Any default in the payment or performance of any obligation, or any defined event of default, under the terms of any contract or instrument (other than any of the Loan Documents) pursuant to which either Borrower has incurred any debt or other liability to any person or entity, including Bank. -8- (e) The filing of a notice of judgment lien against either Borrower; or the recording of any abstract of judgment against either Borrower in any county in which such Borrower has an interest in real property; or the service of a notice of levy and/or of a writ of attachment or execution, or other like process, against the assets of either Borrower; or the entry of a judgment against either Borrower. (f) Either Borrower shall become insolvent, or shall suffer or consent to or apply for the appointment of a receiver, trustee, custodian or liquidator of itself or any of its property, or shall generally fail to pay its debts as they become due, or shall make a general assignment for the benefit of creditors; either Borrower shall file a voluntary petition in bankruptcy, or seeking reorganization, in order to effect a plan or other arrangement with creditors or any other relief under the Bankruptcy Reform Act, Title 11 of the United States Code, as amended or recodified from time to time ("Bankruptcy Code"), or under any state or federal law granting relief to debtors, whether now or hereafter in effect; or any involuntary petition or proceeding pursuant to the Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors is filed or commenced against either Borrower, or either Borrower shall file an answer admitting the jurisdiction of the court and the material allegations of any involuntary petition; or either Borrower shall be adjudicated a bankrupt, or an order for relief shall be entered against either Borrower by any court of competent jurisdiction under the Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors. (g) There shall exist or occur any event or condition which Bank in good faith believes impairs, or is substantially likely to impair, the prospect of payment or performance by Borrowers of their obligations under any of the Loan Documents. (h) The dissolution or liquidation of either Borrower; or either Borrower, or any of its directors, stockholders or members, shall take action seeking to effect the dissolution or liquidation of such Borrower. (i) Any change in ownership during the term of this Agreement of an aggregate of twenty-five percent (25%) or more of the common stock of Borrower. SECTION 6.2 REMEDIES. Upon the occurrence of any Event of Default: (a) all indebtedness of Borrowers under each of the Loan Documents, any term thereof to the contrary notwithstanding, shall at Bank's option and without notice become immediately due and payable without presentment, demand, protest or notice of dishonor, all of which are hereby expressly waived by each Borrower; (b) the obligation, if any, of Bank to extend any further credit under any of the Loan Documents shall immediately cease and terminate; and (c) Bank shall have all rights, powers and remedies available under each of the Loan Documents, or accorded by law, including without limitation the right to resort to any or all security for any credit subject hereto and to exercise any or all of the rights of a beneficiary or secured party pursuant to applicable law. All rights, powers and remedies of Bank may be exercised at any time by Bank and from time to time after the occurrence of an Event of Default, are cumulative and not exclusive, and shall be in addition to any other rights, powers or remedies provided by law or equity. ARTICLE 7 MISCELLANEOUS SECTION 7.1 NO WAIVER. No delay, failure or discontinuance of Bank in exercising any right, power or remedy under any of the Loan Documents shall affect or operate as a waiver -9- of such right, power or remedy; nor shall any single or partial exercise of any such right, power or remedy preclude, waive or otherwise affect any other or further exercise thereof or the exercise of any other right, power or remedy. Any waiver, permit, consent or approval of any kind by Bank of any breach of or default under any of the Loan Documents must be in writing and shall be effective only to the extent set forth in such writing. SECTION 7.2 NOTICES. All notices, requests and demands which any party is required or may desire to give to any other party under any provision of this Agreement must be in writing delivered to each party at the following address: BORROWERS: Dot Hill Systems Corp. 6305 El Camino Real Carlsbad, CA 92004 Silicon Alley Management, Inc. 103 Foulk Road #260 Wilmington, DE 19803 BANK: WELLS FARGO BANK, NATIONAL ASSOCIATION San Diego RCBO 401 B Street Suite 2201 San Diego, CA 92101 or to such other address as any party may designate by written notice to all other parties. Each such notice, request and demand shall be deemed given or made as follows: (a) if sent by hand delivery, upon delivery; (b) if sent by mail, upon the earlier of the date of receipt or three (3) days after deposit in the U.S. mail, first class and postage prepaid; and (c) if sent by telecopy, upon receipt. SECTION 7.3 COSTS, EXPENSES AND ATTORNEYS' FEES. Borrowers shall pay to Bank immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees (to include outside counsel fees and all allocated costs of Bank's in-house counsel), expended or incurred by Bank in connection with (a) the negotiation and preparation of this Agreement and the other Loan Documents to a maximum of $2,500.00, Bank's continued administration hereof and thereof, and the preparation of any amendments and waivers hereto and thereto, (b) the enforcement of Bank's rights and/or the collection of any amounts which become due to Bank under any of the Loan Documents, and (c) the prosecution or defense of any action in any way related to any of the Loan Documents, including without limitation, any action for declaratory relief, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to either Borrower or any other person or entity. SECTION 7.4 SUCCESSORS, ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties; provided however, that neither Borrower may assign or transfer its interest hereunder without Bank's prior written consent. Bank reserves the right to sell, assign, transfer, negotiate or grant participations in all or any part of, or any interest in, Bank's rights and benefits under each of the Loan Documents. In connection therewith, Bank may disclose all documents and information which Bank now has or may hereafter acquire -10- relating to any credit subject hereto, either Borrower or its business, or any collateral required hereunder. SECTION 7.5 ENTIRE AGREEMENT; AMENDMENT. This Agreement and the other Loan Documents constitute the entire agreement between Borrowers and Bank with respect to each credit subject hereto and supersede all prior negotiations, communications, discussions and correspondence concerning the subject matter hereof. This Agreement may be amended or modified only in writing signed by each party hereto. SECTION 7.6 NO THIRD PARTY BENEFICIARIES. This Agreement is made and entered into for the sole protection and benefit of the parties hereto and their respective permitted successors and assigns, and no other person or entity shall be a third party beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Agreement or any other of the Loan Documents to which it is not a party. SECTION 7.7 TIME. Time is of the essence of each and every provision of this Agreement and each other of the Loan Documents. SECTION 7.8 SEVERABILITY OF PROVISIONS. If any provision of this Agreement shall be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity without invalidating the remainder of such provision or any remaining provisions of this Agreement. SECTION 7.9 COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which when executed and delivered shall be deemed to be an original, and all of which when taken together shall constitute one and the same Agreement. SECTION 7.10 GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of California. SECTION 7.11 ARBITRATION. (a) ARBITRATION. The parties hereto agree, upon demand by any party, to submit to binding arbitration all claims, disputes and controversies between or among them (and their respective employees, officers, directors, attorneys, and other agents), whether in tort, contract or otherwise arising out of or relating to in any way (i) the loan and related Loan Documents which are the subject of this Agreement and its negotiation, execution, collateralization, administration, repayment, modification, extension, substitution, formation, inducement, enforcement, default or termination; or (ii) requests for additional credit. (b) GOVERNING RULES. Any arbitration proceeding will (i) proceed in a location in California selected by the American Arbitration Association ("AAA"); (ii) be governed by the Federal Arbitration Act (Title 9 of the United States Code), notwithstanding any conflicting choice of law provision in any of the documents between the parties; and (iii) be conducted by the AAA, or such other administrator as the parties shall mutually agree upon, in accordance with the AAA's commercial dispute resolution procedures, unless the claim or counterclaim is at least $1,000,000.00 exclusive of claimed interest, arbitration fees and costs in which case the arbitration shall be conducted in accordance with the AAA's optional procedures for large, complex commercial disputes (the commercial dispute resolution procedures or the optional procedures for large, complex commercial disputes to be referred to, as applicable, as the "Rules"). If there is any inconsistency between the terms hereof and the Rules, the terms and -11- procedures set forth herein shall control. Any party who fails or refuses to submit to arbitration following a demand by any other party shall bear all costs and expenses incurred by such other party in compelling arbitration of any dispute. Nothing contained herein shall be deemed to be a waiver by any party that is a bank of the protections afforded to it under 12 U.S.C. Section 91 or any similar applicable state law. (c) NO WAIVER OF PROVISIONAL REMEDIES, SELF-HELP AND FORECLOSURE. The arbitration requirement does not limit the right of any party to (i) foreclose against real or personal property collateral; (ii) exercise self-help remedies relating to collateral or proceeds of collateral such as setoff or repossession; or (iii) obtain provisional or ancillary remedies such as replevin, injunctive relief, attachment or the appointment of a receiver, before during or after the pendency of any arbitration proceeding. This exclusion does not constitute a waiver of the right or obligation of any party to submit any dispute to arbitration or reference hereunder, including those arising from the exercise of the actions detailed in sections (i), (ii) and (iii) of this paragraph. (d) ARBITRATOR QUALIFICATIONS AND POWERS. Any arbitration proceeding in which the amount in controversy is $5,000,000.00 or less will be decided by a single arbitrator selected according to the Rules, and who shall not render an award of greater than $5,000,000.00. Any dispute in which the amount in controversy exceeds $5,000,000.00 shall be decided by majority vote of a panel of three arbitrators; provided however, that all three arbitrators must actively participate in all hearings and deliberations. The arbitrator will be a neutral attorney licensed in the State of California or a neutral retired judge of the state or federal judiciary of California, in either case with a minimum of ten years experience in the substantive law applicable to the subject matter of the dispute to be arbitrated. The arbitrator will determine whether or not an issue is arbitratable and will give effect to the statutes of limitation in determining any claim. In any arbitration proceeding the arbitrator will decide (by documents only or with a hearing at the arbitrator's discretion) any pre-hearing motions which are similar to motions to dismiss for failure to state a claim or motions for summary adjudication. The arbitrator shall resolve all disputes in accordance with the substantive law of California and may grant any remedy or relief that a court of such state could order or grant within the scope hereof and such ancillary relief as is necessary to make effective any award. The arbitrator shall also have the power to award recovery of all costs and fees, to impose sanctions and to take such other action as the arbitrator deems necessary to the same extent a judge could pursuant to the Federal Rules of Civil Procedure, the California Rules of Civil Procedure or other applicable law. Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction. The institution and maintenance of an action for judicial relief or pursuit of a provisional or ancillary remedy shall not constitute a waiver of the right of any party, including the plaintiff, to submit the controversy or claim to arbitration if any other party contests such action for judicial relief. (e) DISCOVERY. In any arbitration proceeding discovery will be permitted in accordance with the Rules. All discovery shall be expressly limited to matters directly relevant to the dispute being arbitrated and must be completed no later than 20 days before the hearing date and within 180 days of the filing of the dispute with the AAA. Any requests for an extension of the discovery periods, or any discovery disputes, will be subject to final determination by the arbitrator upon a showing that the request for discovery is essential for the party's presentation and that no alternative means for obtaining information is available. (f) CLASS PROCEEDINGS AND CONSOLIDATIONS. The resolution of any dispute arising pursuant to the terms of this Agreement shall be determined by a separate arbitration -12- proceeding and such dispute shall not be consolidated with other disputes or included in any class proceeding. (g) PAYMENT OF ARBITRATION COSTS AND FEES. The arbitrator shall award all costs and expenses of the arbitration proceeding. (h) REAL PROPERTY COLLATERAL; JUDICIAL REFERENCE. Notwithstanding anything herein to the contrary, no dispute shall be submitted to arbitration if the dispute concerns indebtedness secured directly or indirectly, in whole or in part, by any real property unless (i) the holder of the mortgage, lien or security interest specifically elects in writing to proceed with the arbitration, or (ii) all parties to the arbitration waive any rights or benefits that might accrue to them by virtue of the single action rule statute of California, thereby agreeing that all indebtedness and obligations of the parties, and all mortgages, liens and security interests securing such indebtedness and obligations, shall remain fully valid and enforceable. If any such dispute is not submitted to arbitration, the dispute shall be referred to a referee in accordance with California Code of Civil Procedure Section 638 et seq., and this general reference agreement is intended to be specifically enforceable in accordance with said Section 638. A referee with the qualifications required herein for arbitrators shall be selected pursuant to the AAA's selection procedures. Judgment upon the decision rendered by a referee shall be entered in the court in which such proceeding was commenced in accordance with California Code of Civil Procedure Sections 644 and 645. (i) MISCELLANEOUS. To the maximum extent practicable, the AAA, the arbitrators and the parties shall take all action required to conclude any arbitration proceeding within 180 days of the filing of the dispute with the AAA. No arbitrator or other party to an arbitration proceeding may disclose the existence, content or results thereof, except for disclosures of information by a party required in the ordinary course of its business or by applicable law or regulation. If more than one agreement for arbitration by or between the parties potentially applies to a dispute, the arbitration provision most directly related to the Loan Documents or the subject matter of the dispute shall control. This arbitration provision shall survive termination, amendment or expiration of any of the Loan Documents or any relationship between the parties. SECTION 7.12 JOINT AND SEVERAL LIABILITY (a) Each Borrower has determined and represents to Bank that it is in its best interests and in pursuance of its legitimate business purposes to induce Bank to extend credit pursuant to this Agreement. Each Borrower acknowledges and represents that its business is related to the business of the other Borrower, the availability of the commitments provided for herein benefits both Borrowers, and advances and other credit extensions made hereunder will be for and inure to the benefit of Borrowers, individually and together. (b) Each Borrower has determined and represents to Bank that it has, and after giving effect to the transactions contemplated by this Agreement will have, assets having a fair saleable value in excess of its debts, after giving effect to any rights of contribution or subrogation which may be available to such Borrower, and each Borrower has, and will have, access to adequate capital for the conduct of its business and the ability to pay its debts as such debts mature. (c) Each Borrower agrees that it is jointly and severally liable to Bank for, and each Borrower agrees to pay to Bank when due the full amount of, all indebtedness now existing or hereafter arising to Bank under or in connection with each credit subject hereto and all -13- modifications, extensions and renewals thereof, including without limitation all interest which accrues thereon and all fees, costs and expenses chargeable to Borrowers or either of them in connection therewith. The obligations of Borrowers to Bank for each credit subject hereto shall be in addition to any obligations of Borrowers to Bank under any other agreement heretofore or hereafter given to Bank unless said other agreement is expressly modified or revoked in writing, and this Agreement shall not, unless expressly herein provided, affect or invalidate any such other agreement. (d) The liability of each Borrower for each credit subject hereto shall be reinstated and revived and the rights of Bank shall continue if and to the extent that for any reason any amount at any time paid on account thereof is rescinded or must otherwise be restored by Bank, whether as a result of any proceedings in bankruptcy or reorganization or otherwise, all as though such amount had not been paid. (e) Each Borrower authorizes Bank, without notice to or demand on such Borrower, and without affecting such Borrower's liability for each credit subject hereto, from time to time to: (a) alter, compromise, extend, accelerate or otherwise change the time for payment of; or otherwise change the terms of, the liabilities and obligations of the other Borrower to Bank on account of any credit subject hereto; (b) take and hold security from the other Borrower for the payment of any credit subject hereto, and exchange, enforce, waive, subordinate or release any such security; (c) apply such security and direct the order or manner of sale thereof, including without limitation, a non-judicial sale permitted by the terms of the controlling security agreement or deed of trust, as Bank in its discretion may determine; (d) release or substitute any one or more of the endorsers or any guarantors of any credit subject hereto, or any other party obligated thereon; and (e) apply payments received by Bank from the other Borrower to indebtedness of such other Borrower to Bank other than the credits; subject hereto. (f) Each Borrower represents and warrants to Bank that it has established adequate means of obtaining from the other Borrower on a continuing basis financial and other information pertaining to the other Borrower's financial condition, and each Borrower agrees to keep adequately informed from such means of any facts, events or circumstances which might in any way affect its risks hereunder. Each Borrower further agrees that Bank shall have no obligation to disclose to it any information or material about the other Borrower which is acquired by Bank in any manner. (g) Each Borrower waives any right to require Bank to: (i) proceed against the other Borrower or any other person; (ii) proceed against or exhaust any security held from the other Borrower or any other person; (iii) pursue any other remedy in Bank's power; (iv) apply payments received by Bank from the other Borrower to any credit subject hereto; or (v) make any presentments or demands for performance, or give any notices of nonperformance, protests, notices of protest or notices of dishonor in connection with any credit subject hereto. (h) Each Borrower waives any defense to its liability for any credit subject hereto based upon or arising by reason of: (i) any disability or other defense of the other Borrower or any other person; (ii) the cessation or limitation from any cause whatsoever, other than payment in full, of the liability of the other Borrower for the credits subject hereto; (iii) any lack of authority of any officer, director, partner, agent or other person acting or purporting to act on behalf of the other Borrower or any defect in the formation of the other Borrower; (iv) the application by the other Borrower of the proceeds of any credit subject hereto for purposes other than the purposes intended or understood by Bank or Borrowers; (v) any act or omission by Bank which directly or indirectly results in or aids the discharge of the other Borrower by operation of law or -14- otherwise, or which in any way impairs or suspends any rights or remedies of Bank against the other Borrower; (vi) any impairment of the value of any interest in any security for the credits subject hereto, including without limitation, the failure to obtain or maintain perfection or recordation of any interest in any such security, the release of any such security without substitution, and/or the failure to preserve the value of, or to comply with applicable law in disposing of, any such security; or (vii) any modification of the obligations or liabilities of the other Borrower for any credit subject hereto, including without limitation the renewal, extension, acceleration or other change in time for payment of, or other change in the terms of, the indebtedness of either Borrower for any credit subject hereto, including increase or decrease of the rate of interest thereon. Until each credit subject hereto and all indebtedness of each Borrower to Bank arising under or in connection with this Agreement shall have been paid in full, neither Borrower shall have any right of subrogation. Each Borrower waives all rights and defenses it may have arising out of (A) any election of remedies by Bank, even though that election of remedies, such as a non-judicial foreclosure with respect to any security for the credits subject hereto, destroys its rights of subrogation or its rights to proceed against the other Borrower for reimbursement, or (B) any loss of rights it may suffer by reason of any rights, powers or remedies of the other Borrower in connection with any anti-deficiency laws or any other laws limiting, qualifying or discharging either Borrower's indebtedness for the credits subject hereto, whether by operation of Sections 726 or 580d of the Code of Civil Procedure as from time to time amended, or otherwise. Until the credits subject hereto and all indebtedness of each Borrower to Bank arising under or in connection with this Agreement shall have been paid in full, each Borrower waives any right to enforce any remedy which Bank now has or may hereafter have against the other Borrower or any other person, and waives any benefit of, or any right to participate in, any security now or hereafter held by Bank. -15- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first written above. DOT HILL SYSTEMS CORP. WELLS FARGO BANK, NATIONAL ASSOCIATION By: /s/ JAMES LAMBERT -------------------------------------- James Lambert By: /s/ BRIAN P. CHAMBERS President and Chief Executive Officer --------------------- Brian P. Chambers Vice President By: /s/ PRESTON ROMM -------------------------------------- Preston Romm Vice President, Finance and CFO SILICON ALLEY MANAGEMENT, INC. By: /s/ BENJAMIN MONDERER -------------------------------------- Benjamin Monderer President By: /s/ PRESTON ROMM -------------------------------------- Preston Romm Vice President and Secretary -16- EX-10.24 4 a2041983zex-10_24.txt EXHIBIT 10.24 EXHIBIT 10.24 WELLS FARGO BANK REVOLVING LINE OF CREDIT NOTE - -------------------------------------------------------------------------------- $15,000,000.00 SAN DIEGO, CALIFORNIA FEBRUARY 6, 2001 FOR VALUE RECEIVED, the undersigned DOT HILL SYSTEMS CORP. AND SILICON ALLEY MANAGEMENT, INC. ("Borrower") promises to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION ("Bank") at its office at SAN DIEGO RCBO, 401 B STREET SUITE 2201, SAN DIEGO, CA 92101, or at such other place as the holder hereof may designate, in lawful money of the United States of America and in immediately available funds, the principal sum of $15,000,000.00, or so much thereof as may be advanced and be outstanding, with interest thereon, to be computed on each advance from the date of its disbursement as set forth herein. DEFINITIONS: As used herein, the following terms shall have the meanings set forth after each, and any other term defined in this Note shall have the meaning set forth at the place defined: (a) "Business Day" means any day except a Saturday, Sunday or any other day on which commercial banks in California are authorized or required by law to close. (b) "Fixed Rate Term" means a period commencing on a Business Day and continuing for 1, 2 OR 3 MONTHS, as designated by Borrower, during which all or a portion of the outstanding principal balance of this Note bears interest determined in relation to LIBOR; provided however, that no Fixed Rate Term may be selected for a principal amount less than $100,000.00; and provided further, that no Fixed Rate Term shall extend beyond the scheduled maturity date hereof. If any Fixed Rate Term would and on a day which is not a Business Day, then such Fixed Rate Term shall be extended to the next succeeding Business Day. (c) "LIBOR" means the rate per annum (rounded upward, if necessary, to the nearest whole 1/8 of 1 %) determined by dividing Base LIBOR by a percentage equal to 100% less any LIBOR Reserve Percentage. (i) "Base LIBOR" means the rate per annum for United States dollar deposits quoted by Bank as the Inter-Bank Market Offered Rate, with the understanding that such rate is quoted by Bank for the purpose of calculating effective rates of interest for loans making reference thereto, on the first day of a Fixed Rate Term for delivery of funds on said date for a period of time approximately equal to the number of days in such Fixed Rate Term and in an amount approximately equal to the principal amount to which such Fixed Rate Term applies. Borrower understands and agrees that Bank may base its quotation of the Inter-Bank Market Offered Rate upon such offers or other market indicators of the Inter-Bank Market as Bank in its discretion deems appropriate including, but not limited to, the rate offered for U.S. dollar deposits on the London Inter-Bank Market. (ii) "LIBOR Reserve Percentage" means the reserve percentage prescribed by the Board of Governors of the Federal Reserve System (or any successor) for "Eurocurrency Liabilities" (as defined in Regulation D of the Federal Reserve Board, as amended), adjusted by Bank for expected changes in such reserve percentage during the applicable Fixed Rate Term. (d) "Prime Rate" means at any time the rate of interest most recently announced within Bank at its principal office as its Prime Rate, with the understanding that the Prime Rate is one of Bank's base rates and serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto, and is evidenced by the recording thereof after its announcement in such internal publication or publications as Bank may designate. INTEREST: (a) INTEREST. The outstanding principal balance of this Note shall bear interest (computed on the basis of a 360-day year, actual days elapsed) either (i) at a fluctuating rate per annum EQUAL TO the Prime Rate in effect from time to time, or (ii) at a fixed rate per annum determined by Bank to be .50000% above LIBOR in effect on the first day of the applicable Fixed Rate Term. When interest is determined in relation to the Prime Rate, each change in the rate of interest Page 1 hereunder shall become effective on the date each Prime Rate change is announced within Bank. With respect to each LIBOR selection option selected hereunder, Bank is hereby authorized to note the date, principal amount, interest rate and Fixed Rate Term applicable thereto and any payments made thereon on Bank's books and records (either manually or by electronic entry) and/or on any schedule attached to this Note, which notations shall be prima facie evidence of the accuracy of the information noted. (b) SELECTION OF INTEREST RATE OPTIONS. At any time any portion of this Note bears interest determined in relation to LIBOR, it may be continued by Borrower at the end of the Fixed Rate Term applicable thereto so that all or a portion thereof bears interest determined in relation to the Prime Rate or to LIBOR for a new Fixed Rate Term designated by Borrower. At any time any portion of this Note bears interest determined in relation to the Prime Rate, Borrower may convert all or a portion thereof so that it bears interest determined in relation to LIBOR for a Fixed Rate Term designated by Borrower. At such time as Borrower requests an advance hereunder or wishes to select a LIBOR option for all or a portion of the outstanding principal balance hereof, and at the end of each Fixed Rate Term, Borrower shall give Bank notice specifying: (i) the interest rate option selected by Borrower; (ii) the principal amount subject thereto; and (iii) for each LIBOR selection, the length of the applicable Fixed Rate Term. Any such notice may be given by telephone (or such other electronic method as Bank may permit) so long as, with respect to each LIBOR selection, (A) if requested by Bank, Borrower provides to Bank written confirmation thereof not later than three (3) Business Days after such notice is given, and (B) such notice is given to Bank prior to 10:00 a.m. on the first day of the Fixed Rate Term, or at a later time during any Business Day if Bank, at it's sole option but without obligation to do so, accepts Borrower's notice and quotes a fixed rate to Borrower. If Borrower does not immediately accept a fixed rate when quoted by Bank, the quoted rate shall expire and any subsequent LIBOR request from Borrower shall be subject to a redetermination by Bank of the applicable fixed rate. If no specific designation of interest is made at the time any advance is requested hereunder or at the end of any Fixed Rate Term, Borrower shall be deemed to have made a Prime Rate interest selection for such advance or the principal amount to which such Fixed Rate Term applied. (c) TAXES AND REGULATORY COSTS. Borrower shall pay to Bank immediately upon demand, in addition to any other amounts due or to become due hereunder, any and all (i) withholdings, interest equalization taxes, stamp taxes or other taxes (except income and franchise taxes) imposed by any domestic or foreign governmental authority and related in any manner to LIBOR, and (ii) future, supplemental, emergency or other changes in the LIBOR Reserve Percentage, assessment rates imposed by the Federal Deposit Insurance Corporation, or similar requirements or costs imposed by any domestic or foreign governmental authority or resulting from compliance by Bank with any request or directive (whether or not having the force of law) from any central bank or other governmental authority and related in any manner to LIBOR to the extent they are not included in the calculation of LIBOR. In determining which of the foregoing are attributable to any LIBOR option available to Borrower hereunder, any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower. (d) PAYMENT OF INTEREST. Interest accrued on this Note shall be payable on the LAST day of each MONTH, commencing FEBRUARY 28, 2001. (e) DEFAULT INTEREST. From and after the maturity date of this Note, or such earlier date as all principal owing hereunder becomes due and payable by acceleration or otherwise, the outstanding principal balance of this Note shall bear interest until paid in full at an increased rate per annum (computed on the basis of a 360-day year, actual days elapsed) equal to 2% above the rate of interest from time to time applicable to this Note. BORROWING AND REPAYMENT: (a) BORROWING AND REPAYMENT. Borrower may from time to time during the term of this Note borrow, partially or wholly repay its outstanding borrowings, and reborrow, subject to all of the limitations, terms and conditions of this Note and of the Credit Agreement between Borrower and Bank defined below; provided however, that the total outstanding borrowings under this Note shall not at any time exceed the principal amount stated above. The unpaid principal balance of this obligation at any time shall be the total amounts advanced hereunder by the holder hereof less the amount of principal payments made hereon by or for any Borrower, which balance may be endorsed hereon from time to time by the holder. The outstanding principal balance of this Note shall be due and payable in full on DECEMBER 31, 2002. (b) ADVANCES. Advances hereunder, to the total amount of the principal sum available hereunder, may be made by the holder at the oral or written request of (i) JAMES LAMBERT OR BENJAMIN MONDERER OR PRESTON ROMM, any one acting alone, who are authorized to request advances and direct the disposition of any advances until written notice of the revocation of such authority is received by the holder at the office designated above, or (ii) any person, with respect to advances deposited to the credit of any deposit account of any Borrower, which advances, when so deposited, shall be conclusively presumed to have been made to or for the benefit of each Borrower regardless of the fact that persons other 2. than those authorized to request advances may have authority to draw against such account. The holder shall have no obligation to determine whether any person requesting an advance is or has been authorized by any Borrower. (c) APPLICATION OF PAYMENTS. Each payment made on this Note shall be credited first, to any interest then due and second, to the outstanding principal balance hereof. All payments credited to principal shall be applied first, to the outstanding principal balance of this Note which bears interest determined in relation to the Prime Rate, if any, and second, to the outstanding principal balance of this Note which bears interest determined in relation to LlBOR, with such payments applied to the oldest Fixed Rate Term first. PREPAYMENT: (a) PRIME RATE. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to the Prime Rate at any time, in any amount and without penalty. (b) LIBOR. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to LlBOR at any time and in the minimum amount of $100,000.00; provided however, that if the outstanding principal balance of such portion of this Note is less than said amount, the minimum prepayment amount shall be the entire outstanding principal balance thereof. In consideration of Bank providing this prepayment option to Borrower, or if any such portion of this Note shall become due and payable at any time prior to the last day of the Fixed Rate Term applicable thereto by acceleration or otherwise, Borrower shall pay to Bank immediately upon demand a fee which is the sum of the discounted monthly differences for each month from the month of prepayment through the month in which such Fixed Rate Term matures, calculated as follows for each such month: (i) DETERMINE the amount of interest which would have accrued each month on the amount prepaid at the interest rate applicable to such amount had it remained outstanding until the last day of the Fixed Rate Term applicable thereto. (ii) SUBTRACT from the amount determined in (i) above the amount of interest which would have accrued for the same month on the amount prepaid for the remaining term of such Fixed Rate Term at LIBOR in effect on the date of prepayment for new loans made for such term and in a principal amount equal to the amount prepaid. (iii) If the result obtained in (ii) for any month is greater than zero, discount that difference by LIBOR used in (ii) above. Each Borrower acknowledges that prepayment of such amount may result in Bank incurring additional costs, expenses and/or liabilities, and that it is difficult to ascertain the full extent of such costs, expenses and/or liabilities. Each Borrower, therefore, agrees to pay the above-described prepayment fee and agrees that said amount represents a reasonable estimate of the prepayment costs, expenses and/or liabilities of Bank. If Borrower fails to pay any prepayment fee when due, the amount of such prepayment fee shall thereafter bear interest until paid at a rate per annurn 2.000% above the Prime Rate in effect from time to time (computed on the basis of a 360-day year, actual days elapsed). Each change in the rate of interest on any such past due prepayment fee shall become eff6ctive on the date each Prime Rate change is announced within Bank. EVENTS OF DEFAULT: This Note is made pursuant to and is subject to the terms and conditions of that certain Credit Agreement between Borrower and Bank dated as of FEBRUARY 6, 2001, as amended from time to time (the "Credit Agreement"). Any default in the payment or performance of any obligation under this Note, or any defined event of default under the Credit Agreement, shall constitute an "Event of Default" under this Note. MISCELLANEOUS: (a) REMEDIES. Upon the occurrence of any Event of Default, the holder of this Note, at the holder's option, may declare all sums of principal and interest outstanding hereunder to be immediately due and payable without presentment, demand, notice of nonperformance, notice of protest, protest or notice of dishonor, all of which are expressly waived by each Borrower, and the obligation, if any, of the holder to extend any further credit hereunder shall immediately cease and terminate. Each Borrower shall pay to the holder immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees (to include outside counsel fees and all allocated costs of the holder's in-house counsel), expended or incurred by the holder in connection with the enforcement of the holder's rights and/or the collection of any amounts which become due to the holder under this Note, and the prosecution or 3. defense of any action in any way related to this Note, including without limitation, any action for declaratory relief, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to any Borrower or any other person or entity. (b) OBLIGATIONS JOINT AND SEVERAL. Should more than one person or entity sign this Note as a Borrower, the obligations of each such Borrower shall be joint and several. (c) GOVERNING LAW. This Note shall be governed by and construed in accordance with the laws of the State of California. DOT HILL SYSTEMS CORP. By: /s/ JAMES LAMBERT ------------------------------------------ James Lambert, President and Chief Executive Officer By: /s/ PRESTON ROMM ------------------------------------------ Preston Romm, Vice President Finance and CFO SILICON ALLEY MANAGEMENT, INC. By: /s/ BENJAMIN MONDERER ------------------------------------------ Benjamin Monderer, President By: /s/ PRESTON ROMM ------------------------------------------ Preston Romm, Vice President and Secretary 4. EX-10.25 5 a2041983zex-10_25.txt EXHIBIT 10.25 EXHIBIT 10.25 THIRD PARTY SECURITY AGREEMENT WELLS FARGO BANK SECURITIES ACCOUNT - -------------------------------------------------------------------------------- 1. GRANT OF SECURITY INTEREST. In consideration of any credit or other financial accommodation heretofore, now or hereafter extended or made to DOT HILL SYSTEMS CORP. AND SILICON ALLEY MANAGEMENT, INC. ("Borrowers"), or any of them, by WELLS FARGO BANK NATIONAL ASSOCIATION ("Bank"), and for other valuable consideration, as security for the payment of all Indebtedness of Borrowers to Bank, the undersigned DOT HILL SYSTEMS CORP. ("Owner") hereby grants and transfers to Bank a security interest in (a) Owner's Investment Management Account Account No. 10671900 (whether held in Owner's name or as a Bank collateral account for the benefit of Owner), and all replacements or substitutions therefor, including any account resulting from a renumbering or other administrative re-identification thereof (collectively, the "Securities Account") maintained with WELLS FARGO BANK, NATIONAL ASSOCIATION, acting through its Investment Group ("Intermediary"), (b) all financial assets credited to the Securities Account, (c) all security entitlements with respect to the financial assets credited to the Securities Account, and (d) any and all other investment property or assets maintained or recorded in the Securities Account (with all the foregoing defined as "Collateral"), together with whatever is receivable or received when any of the Collateral or proceeds thereof are sold, collected, exchanged or otherwise disposed of, whether such disposition is voluntary or involuntary, including without limitation, (i) all rights to payment, including returned premiums, with respect to any insurance relating to any of the foregoing, (ii) all rights to payment with respect to any cause of action affecting or relating to any of the foregoing, and (iii) all stock rights, rights to subscribe, stock splits, liquidating dividends, cash dividends, dividends paid in stock, new securities or other property of any kind which Owner is or may hereafter be entitled to receive on account of any securities pledged hereunder, including without limitation, stock received by Owner due to stock splits or dividends paid in stock or sums paid upon or in respect of any securities pledged hereunder upon the liquidation or dissolution of the issuer thereof (hereinafter called "Proceeds"). Except as otherwise expressly permitted herein, in the event Owner receives any such Proceeds, Owner will hold the same in trust on behalf of and for the benefit of Bank and will immediately deliver all such Proceeds to Bank in the exact form received, with the endorsement of Owner if necessary and/or appropriate undated stock powers duly executed in blank, to be held by Bank as part of the Collateral, subject to all terms hereof. As used herein, the terms "security entitlement," "financial asset" and "investment property" shall have the respective meanings set forth in the California Uniform Commercial Code. The word "Indebtedness" is used herein in its most comprehensive sense and includes any and all advances, debts, obligations and liabilities of Borrowers, or any of them, heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or: unliquidated, determined or undetermined, and whether Borrowers may be liable individually or jointly with others, or whether recovery upon such Indebtedness may be or hereafter becomes unenforceable. 2. CONTINUING AGREEMENT; REVOCATION; OBLIGATION UNDER OTHER AGREEMENTS. This is a continuing agreement and all rights, powers and remedies hereunder shall apply to all past, present and future Indebtedness of each of the Borrowers to Bank, including that arising under successive transactions which shall either continue the Indebtedness, increase or decrease it, or from time to time create new Indebtedness after all or any prior Indebtedness has been satisfied, and notwithstanding the death, incapacity, dissolution, liquidation or bankruptcy of any of the Borrowers or Owner or any other event or proceeding affecting any of the Borrowers or Owner. This Agreement shall not apply to any new Indebtedness created after actual receipt by Bank of written notice of its revocation as to such new Indebtedness; provided however, that loans or advances made by Bank to any of the Borrowers after revocation under commitments existing prior to receipt by Bank of such revocation, and extensions, renewals or modifications, of any kind, of Indebtedness incurred by any of the Borrowers or committed by Bank prior to receipt by Bank of such revocation, shall not be considered new Indebtedness. Any such notice must be sent to Bank by registered U.S. mail, postage prepaid, addressed to its office at SAN DIEGO RCBO, 401 B STREET SUITE 2201, SAN DIEGO, CA 92101, or at such other address as Bank shall from time to time designate. The obligations of Owner hereunder shall be in addition to any obligations of Owner under any other grants or pledges of security for any liabilities or obligations of any of the Borrowers or any other persons heretofore or hereafter given to Bank unless said other grants or pledges of security are expressly modified or revoked in writing; and this Agreement shall not, unless expressly herein provided, affect or invalidate any such other grants or pledges of security. Page 1 3. OBLIGATIONS JOINT AND SEVERAL; SEPARATE ACTIONS; WAIVER OF STATUTE OF LIMITATIONS; REINSTATEMENT OF LIABILITY. The obligations hereunder are joint and several and independent of the obligations of Borrowers, and a separate action or actions may be brought and prosecuted against Owner whether action is brought against any of the Borrowers or any other person, or whether any of the Borrowers or any other person is joined in any such action or actions. Owner acknowledges that this Agreement is absolute and unconditional, there are no conditions precedent to the effectiveness of this Agreement, and this Agreement is in full force and effect and is binding on Owner as of the date written below, regardless of whether Bank obtains collateral or any guaranties from others or takes any other action contemplated by Owner. Owner waives the benefit of any statute of limitations affecting Owner's liability hereunder or the enforcement thereof, and Owner agrees that any payment of any Indebtedness or other act which shall toll any statute of limitations applicable thereto shall similarly operate to toll such statute of limitations applicable to Owner's liability hereunder. The liability of Owner hereunder shall be reinstated and revived and the rights of Bank shall continue if and to the extent that for any reason any amount at any time paid on account of any Indebtedness secured hereby is rescinded or must otherwise be restored by Bank, whether as a result of any proceedings in bankruptcy or reorganization or otherwise, all as though such amount had not been paid. The determination as to whether any amount so paid must be rescinded or restored shall be made by Bank in its sole discretion; provided however, that if Bank chooses to contest any such matter at the request of Owner, Owner agrees to indemnify and hold Bank harmless from and against all costs and expenses, including reasonable attorneys' fees, expended or incurred by Bank in connection therewith, including without limitation, in any litigation with respect thereto. 4. OBLIGATIONS OF BANK. Bank shall have no duty to take any steps necessary to preserve the rights of Owner against prior parties, or to initiate any action to protect against the possibility of a decline in the market value of the Collateral or Proceeds. Bank shall not be obligated to take any actions with respect to the Collateral or Proceeds requested by Owner unless such request is made in writing and Bank determines, in its sole discretion, that the requested action would not unreasonably jeopardize the value of the Collateral and Proceeds as security for the Indebtedness. 5. REPRESENTATIONS AND WARRANTIES. (a) Owner represents and warrants to Bank that: (i) Owner is the sole owner of the Collateral and Proceeds; (ii) Owner has the right to grant a security interest in the Collateral and Proceeds; (iii) all Collateral and Proceeds are genuine, free from liens, adverse claims, setoffs, default, prepayment, defenses and conditions precedent of any kind or character, except the lien created hereby or as otherwise agreed to by Bank, or heretofore disclosed by Owner to Bank, in writing; (iv) all statements contained herein and, where applicable, in the Collateral are true and complete in all material respects; (v) no financing statement or control agreement covering any of the Collateral or Proceeds, and naming any secured party other than Bank, exists or is on file in any public office or remains in effect; (vi) no person or entity, other than Owner, Bank and Intermediary, has any interest in or control over the Collateral; and (vii) specifically with respect to Collateral and Proceeds consisting of investment securities, instruments, chattel paper, documents, contracts, insurance policies or any like property, all persons appearing to be obligated thereon have authority and capacity to contract and are bound as they appear to be, and the same comply with applicable laws concerning form, content and manner of preparation and execution. (b) Owner further represents and warrants to Bank that: (i) the Collateral pledged hereunder is so pledged at Borrowers' request; (ii) Bank has made no representation to Owner as to the creditworthiness of any of the Borrowers; and (iii) Owner has established adequate means of obtaining from each of the Borrowers on a continuing basis financial and other information pertaining to Borrowers' financial condition. Owner agrees to keep adequately informed from such means of any facts, events or circumstances which might in any way affect Owner's risks hereunder, and Owner further agrees that Bank shall have no obligation to disclose to Owner any information or material about any of the Borrowers which is acquired by Bank in any manner. 6. COVENANTS OF OWNER. (a) Owner agrees in general: (i) to indemnify Bank against all losses, claims, demands, liabilities and expenses of every kind caused by property subject hereto; (ii) to pay all costs and expenses, including reasonable attorneys' fees, incurred by Bank in the perfection and preservation of the Collateral or Bank's interest therein and/or the realization, enforcement and exercise of Bank's rights, powers and remedies hereunder; (iii) to permit Bank to exercise its powers; (iv) to execute and deliver such documents as Bank deems necessary to create, Page 2 perfect and continue the security interests contemplated hereby; and (v) not to change Owner's chief place of business (or personal residence, if applicable) or the places where Owner keeps any of the Collateral or Owner's records concerning the Collateral and Proceeds without first giving Bank written notice of the address to which Owner is moving same. (b) Owner agrees with regard to the Collateral and Proceeds, unless Bank agrees otherwise in writing: (i) not to permit any security interest in or lien on the Collateral or Proceeds, except in favor of Bank and except liens in favor of Intermediary to the extent expressly permitted by Bank in writing; (ii) not to hypothecate or permit the transfer by operation of law of any of the Collateral or Proceeds or any interest therein; (iii) to keep, in accordance with generally accepted accounting principles, complete and accurate records regarding all Collateral and Proceeds, and to permit Bank to inspect the same and make copies thereof at any reasonable time; (iv) if requested by Bank, to receive and use reasonable diligence to collect Proceeds, in trust and as the property of Bank, and to immediately endorse as appropriate and deliver such Proceeds to Bank daily in the exact form in which they are received together with a collection report in form satisfactory to Bank; (v) in the event Bank elects to receive payments of Proceeds hereunder, to pay all expenses incurred by Bank in connection therewith, including expenses of accounting, correspondence, collection efforts, reporting to account or contract debtors, filing, recording, record keeping and expenses incidental thereto; (vi) to provide any service and do any other acts which may be necessary to keep all Collateral and Proceeds free and clear of all defenses, rights of offset and counterclaims; and (vii) if the Collateral or Proceeds consists of securities and so long as no Event of Default exists, to vote said securities and to give consents, waivers and ratifications with respect thereto, provided that no vote shall be cast or consent, waiver or ratification given or action taken which would impair Bank's interest in the Collateral and Proceeds or be inconsistent with or violate any provisions of this Agreement. Owner further agrees that any party now or at any time hereafter authorized by Owner to advise or otherwise act with respect to the Securities Account shall be subject to all terms and conditions contained herein and in any control, custodial or other similar agreement at any time in effect among Bank, Owner and Intermediary relating to the Collateral. 7. POWERS OF BANK. Owner appoints Bank its true attorney in fact to perform any of the following powers, which are coupled with an interest, are irrevocable until termination of this Agreement and may be exercised from time to time by Bank's officers and employees, or any of them, whether or not any of the Borrowers or Owner is in default: (a) to perform any obligation of Owner hereunder in Owner's name or otherwise; (b) to notify any person obligated on any security, instrument or other document subject to this Agreement of Bank's rights hereunder; (c) to collect by legal proceedings or otherwise all dividends, interest, principal or other sums now or hereafter payable upon or on account of the Collateral or Proceeds; (d) to enter into any extension, reorganization, deposit, merger or consolidation agreement, or any other agreement relating to or affecting the Collateral or Proceeds, and in connection therewith to deposit or surrender control of the Collateral and Proceeds, to accept other property in exchange for the Collateral and Proceeds, and to do and perform such acts and things as Bank may deem proper, with any money or property received in exchange for the Collateral or Proceeds, at Bank's option, to be applied to the Indebtedness or held by Bank under this Agreement; (e) to make any compromise or settlement Bank deems desirable or proper in respect of the Collateral and Proceeds; (f) to insure, process and preserve the Collateral and Proceeds; (g) to exercise all rights, powers and remedies which Owner would have, but for this Agreement, with respect to all Collateral and Proceeds subject hereto; and (h) to do all acts and things and execute all documents in the name of Owner or otherwise, deemed by Bank as necessary, proper and convenient in connection with the preservation, perfection or enforcement of its rights hereunder. To effect the purposes of this Agreement or otherwise upon instructions of Owner, Bank may cause any Collateral and/or Proceeds to be transferred to Bank's name or the name of Bank's nominee. If an Event of Default has occurred and is continuing, any or all Collateral and/or Proceeds consisting of securities may be registered, without notice, in the name of Bank or its nominee, and thereafter Bank or its nominee may exercise, without notice, all voting and corporate rights at any meeting of the shareholders of the issuer thereof, any and all rights of conversion, exchange or subscription, or any other rights, privileges or options pertaining to such Collateral and/or Proceeds, all as if it were the absolute owner thereof. The foregoing shall include, without limitation, the right of Bank or its nominee to exchange, at its discretion, any and all Collateral and/or Proceeds upon the merger, consolidation, reorganization, recapitalization or other readjustment of the issuer thereof, or upon the exercise by the issuer thereof or Bank of any right, privilege or option pertaining to any shares of the Collateral and/or Proceeds, and in connection therewith, the right to deposit and deliver any and all of the Collateral and/or Proceeds with any committee, depository, transfer agent, registrar or other designated agency upon such terms and conditions as Bank may determine. All of the foregoing rights, privileges or options may be Page 3 exercised without liability on the part of Bank or its nominee except to account for property actually received by Bank. Bank shall have no duty to exercise any of the foregoing, or any other rights, privileges or options with respect to the Collateral or Proceeds and shall not be responsible for any failure to do so or delay in so doing. 8. OWNER'S WAIVERS. (a) Owner waives any right to require Bank to: (i) proceed against any of the Borrowers or any other person; (ii) marshal assets or proceed against or exhaust any security held from any of the Borrowers or any other person; (iii) give notice of the terms, time and place of any public or private sale of personal property security held from any of the Borrowers or any other person, or otherwise comply with the provisions of Section 9504 of the California Uniform Commercial Code; (iv) take any action or pursue any other remedy in Bank's power; or (v) make any presentment or demand for performance, or give any notice of nonperformance, protest, notice of protest or notice of dishonor hereunder or in connection with any obligations or evidences of indebtedness held by Bank as security for or which constitute in whole or in part the Indebtedness secured hereunder, or in connection with the creation of new or additional Indebtedness. (b) Owner waives any defense to its obligations hereunder based upon or arising by reason of: (i) any disability or other defense of any of the Borrowers or any other person; (ii) the cessation or limitation from any cause whatsoever, other than payment in full, of the Indebtedness of any of the Borrowers or any other person; (iii) any lack of authority of any officer, director, partner, agent or any other person acting or purporting to act on behalf of any of the Borrowers which is a corporation, partnership or other type of entity, or any defect in the formation of any of such Borrower; (iv) the application by any of the Borrowers of the proceeds of any Indebtedness for purposes other than the purposes represented by Borrowers to, or intended or understood by, Bank or Owner; (v) any act or omission by Bank which directly or indirectly results in or aids the discharge of any of the Borrowers or any portion of the Indebtedness by operation of law or otherwise, or which in any way impairs or suspends any rights or remedies of Bank against any of the Borrowers; (vi) any impairment of the value of any interest in any security for the Indebtedness or any portion thereof, including without limitation, the failure to obtain or maintain perfection or recordation of any interest in any such security, the release of any such security without substitution, and/or the failure to preserve the value of, or to comply with applicable law in disposing of, any such security; (vii) any modification of the Indebtedness, in any form whatsoever, including any modification made after revocation hereof to any Indebtedness incurred prior to such revocation, and including without limitation the renewal, extension, acceleration or other change in time for payment of, or other change in the terms of, the Indebtedness or any portion thereof, including increase or decrease of the rate of interest thereon; or (viii) any requirement that Bank give any notice of acceptance of this Agreement. Until all Indebtedness shall have been paid in full, Owner shall have no right of subrogation, and Owner waives any right to enforce any remedy which Bank now has or may hereafter have against any of the Borrowers or any other person, and waives any benefit of, or any right to participate in, any security now or hereafter held by Bank. Owner further waives all rights and defenses Owner may have arising out of (A) any election of remedies by Bank, even though that election of remedies, such as a non-judicial foreclosure with respect to any security for any portion of the Indebtedness, destroys Owner's rights of subrogation or Owner's rights to proceed against any of the Borrowers for reimbursement, or (B) any loss of rights Owner may suffer by reason of any rights, powers or remedies of any of the Borrowers in connection with any anti-deficiency laws or any other laws limiting, qualifying or discharging Borrowers' Indebtedness, whether by operation of Sections 726, 580a or 580d of the Code of Civil Procedure as from time to time amended, or otherwise, including any rights Owner may have to a Section 580a fair market value hearing to determine the size of a deficiency following any trustee's foreclosure sale or other disposition of any real property security for any portion of the Indebtedness. 9. AUTHORIZATIONS TO BANK. Owner authorizes Bank either before or after revocation hereof, without notice to or demand on Owner, and without affecting Owner's liability hereunder, from time to time to: (a) alter, compromise, renew, extend, accelerate or otherwise change the time for payment of, or otherwise change the terms of, the Indebtedness or any portion thereof, including increase or decrease of the rate of interest thereon; (b) take and hold security, other than the Collateral and Proceeds, for the payment of the Indebtedness or any portion thereof, and exchange, enforce, waive, subordinate or release the Collateral and Proceeds, or any part thereof, or any such other security; (c) apply the Collateral and Proceeds or such other security and direct the order or manner of sale thereof, including without limitation, a non-judicial sale permitted by the terms of the controlling security agreement, mortgage or deed of trust, as Bank in its discretion may determine; (d) release or Page 4 substitute any one or more of the endorsers or guarantors of the Indebtedness, or any portion thereof, or any other party thereto; and (e) apply payments received by Bank from any of the Borrowers to any Indebtedness of any of the Borrowers to Bank, in such order as Bank shall determine in its sole discretion, whether or not such Indebtedness is covered by this Agreement, and Owner hereby waives any provision of law regarding application of payments which specifies otherwise. Bank may without notice assign this Agreement in whole or in part. 10. PAYMENT OF PREMIUMS, TAXES, CHARGES, LIENS AND ASSESSMENTS. Owner agrees to pay, prior to delinquency, all insurance premiums, taxes, charges, liens and assessments against the Collateral and Proceeds, and upon the failure of Owner to do so, Bank at its option may pay any of them and shall be the sole judge of the legality or validity thereof and the amount necessary to discharge the same. Any such payments made by Bank shall be obligations of Owner to Bank, due and payable immediately upon demand, together with interest at a rate determined in accordance with the provisions of Section 15 hereof, and shall be secured by the Collateral and Proceeds, subject to all terms and conditions of this Agreement. 11. EVENTS OF DEFAULT. The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: (a) any default in the payment or performance of any obligation, or any defined event of default, under (i) any contract or instrument evidencing any Indebtedness, (ii) any other agreement between any of the Borrowers and Bank, including without limitation any loan agreement, relating to or executed in connection with any Indebtedness, or (iii) any control, custodial or other similar agreement in effect among Bank, Owner and Intermediary relating to the Collateral; (b) any representation or warranty made by Owner herein shall prove to be incorrect in any material respect when made; (c) Owner shall fail to observe or perform any obligation or agreement contained herein; (d) any attachment or like levy on any property of Owner; and (e) Bank, in good faith, believes any or all of the Collateral and/or Proceeds to be in danger of misuse, dissipation, commingling, loss, theft, damage or destruction, or otherwise in jeopardy or unsatisfactory in character or value. 12. REMEDIES. Upon the occurrence of any Event of Default, Bank shall have and may exercise without demand any and all rights, powers, privileges and remedies granted to a secured party upon default under the California Uniform Commercial Code or otherwise provided by law, including without limitation, the right to contact all persons obligated to Owner on any Collateral or Proceeds and to instruct such persons to deliver all Collateral and/or Proceeds directly to Bank. All rights, powers, privileges and remedies of Bank shall be cumulative. No delay, failure or discontinuance of Bank in exercising any right, power, privilege or remedy hereunder shall affect or operate as a waiver of such right, power, privilege or remedy; nor shall any single or partial exercise of any such right, power, privilege or remedy preclude, waive or otherwise affect any other or further exercise thereof or the exercise of any other right, power, privilege or remedy. Any waiver, permit, consent or approval of any kind by Bank of any default hereunder, or any such waiver of any provisions or conditions hereof, must be in writing and shall be effective only to the extent set forth in writing. It is agreed that public or private sales, for cash or on credit, to a wholesaler or retailer or investor, or user of property of the types subject to this Agreement, or public auction, are all commercially reasonable since differences in the sales prices generally realized in the different kinds of sales are ordinarily offset by the differences in the costs and credit risks of such sales. While an Event of Default exists: (a) Owner will not dispose of any of the Collateral or Proceeds except on terms approved by Bank; (b) Bank may appropriate the Collateral and apply all Proceeds toward repayment of the Indebtedness in such order as Bank may from time to time elect; (c) Bank may take any action with respect to the Collateral contemplated by any control, custodial or other similar agreement then in effect among Bank, Owner and Intermediary; and (d) at Bank's request, Owner will assemble and deliver all books and records pertaining to the Collateral to Bank at a reasonably convenient place designated by Bank. For any Collateral or Proceeds consisting of securities, Bank shall be under no obligation to delay a sale of any portion thereof for the period of time necessary to permit the issuer thereof to register such securities for public sale under any applicable state or federal law, even if the issuer thereof would agree to do so. 13. DISPOSITION OF COLLATERAL AND PROCEEDS. Upon the transfer of all or any part of the Indebtedness, Bank may transfer all or any part of the Collateral or Proceeds and shall be fully discharged thereafter from all liability and responsibility with respect to any of the foregoing so transferred, and the transferee shall be vested with all rights and powers of Bank hereunder with respect to any of the foregoing so transferred; but with respect to any Collateral or Proceeds not so transferred, Bank shall retain all rights, powers, privileges and remedies herein given. Any proceeds of any disposition of any of the Collateral or Proceeds, or any part Page 5 thereof, may be applied by Bank to the payment of expenses incurred by Bank in connection with the foregoing, including reasonable attorneys' fees, and the balance of such proceeds may be applied by Bank toward the payment of the Indebtedness in such order of application as Bank may from time to time elect. 14. NOTICES. All notices, requests and demands required under this Agreement must be in writing, addressed to Bank at the address specified in Section 2 hereof and to Owner at the address of its chief executive office (or personal residence, if applicable) specified below or to such other address as any party may designate by written notice to each other party, and shall be deemed to have been given or made as follows: (a) if personally delivered, upon delivery; (b) if sent by mail, upon the earlier of the date of receipt or 3 days after deposit in the U.S. mail, first class and postage prepaid; and (c) if sent by telecopy, upon receipt. 15. COSTS, EXPENSES AND ATTORNEYS' FEES. Owner shall pay to Bank immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees (to include outside counsel fees and all allocated costs of Bank's in-house counsel), expended or incurred by Bank in exercising any right, power, privilege or remedy conferred by this Agreement or in the enforcement thereof, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to Owner or in any way affecting any of the Collateral or Bank's ability to exercise any of its rights or remedies with respect thereto. All of the foregoing shall be paid by Owner with interest from the date of demand until paid in full at a rate per annum equal to the greater of ten percent (10%) or Bank's Prime Rate in effect from time to time. 16. SUCCESSORS; ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties; provided however, that Owner may not assign or transfer any of its interests or rights hereunder without Bank's prior written consent. Owner acknowledges that Bank has the right to sell, assign, transfer, negotiate or grant participations in all or any part of, or any interest in, any Indebtedness of Borrowers to Bank and any obligations with respect the thereto, including this Agreement. In connection therewith, Bank may disclose all documents and information which Bank now has or hereafter acquires relating to Owner and/or this Agreement, whether furnished by Borrowers, Owner or otherwise. Owner further agrees that Bank may disclose such documents and information to Borrowers. 17. AMENDMENT. This Agreement may be amended or modified only in writing signed by Bank and Owner. 18. APPLICATION OF SINGULAR AND PLURAL. In all cases where there is but a single Borrower, then all words used herein in the plural shall be deemed to have been used in the singular where the context and construction so require; and when there is more than one Borrower named herein, or when this Agreement is executed by more than one Owner, the word "Borrowers" and the word "Owner" respectively shall mean all or any one or more of them as the context requires. 19. SEVERABILITY OF PROVISIONS. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or any remaining provisions of this Agreement. 20. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 21. ADDENDUM. Additional terms and conditions relating to the Securities Account are set forth in an Addendum attached hereto and incorporated herein by this reference. 22. ARBITRATION. (a) ARBITRATION. The parties hereto agree, upon demand by any party, to submit to binding arbitration all claims, disputes and controversies between or among them (and their respective employees, officers, directors, attorneys, and other agents), whether in tort, contract or otherwise arising out of or relating to in any way (i) the loan and related loan and security documents which are the subject of this Agreement and its negotiation, Page 6 execution, collateralization, administration, repayment, modification, extension, substitution, formation, inducement, enforcement, default or termination; or (ii) requests for additional credit. (b) GOVERNING RULE. Any arbitration proceeding will (i) proceed in a location in California selected by the American Arbitration Association ("AAA"); (ii) be governed by the Federal Arbitration Act (Title 9 of the United States Code), notwithstanding any conflicting choice of law provision in any of the documents between the parties; and (iii) be conducted by the AAA, or such other administrator as the parties shall mutually agree upon, in accordance with the AAA's commercial dispute resolution procedures, unless the claim or counterclaim is at least $1,000,000.00 exclusive of claimed interest, arbitration fees and costs in which case the arbitration shall be conducted in accordance with the AAA's optional procedures for large, complex commercial disputes (the commercial dispute resolution procedures or the optional procedures for large, complex commercial disputes to be referred to, as applicable, as the "Rules"). If there is any inconsistency between the terms hereof and the Rules, the terms and procedures set forth herein shall control. Any party who fails or refuses to submit to arbitration following a demand by any other party shall bear all costs and expenses incurred by such other party in compelling arbitration of any dispute. Nothing contained herein shall be deemed to be a waiver by any party that is a bank of the protections afforded to it under 12 U.S.C. Section 91 or any similar applicable state law. (c) NO WAIVER OF PROVISIONAL REMEDIES, SELF-HELP AND FORECLOSURE. The arbitration requirement does not limit the right of any party to (i) foreclose against real or personal property collateral; (ii) exercise self-help remedies relating to collateral or proceeds of collateral such as setoff or repossession; or (iii) obtain provisional or ancillary remedies such as replevin, injunctive relief, attachment or the appointment of a receiver, before during or after the pendency of any arbitration proceeding. This exclusion does not constitute a waiver of the right or obligation of any party to submit any dispute to arbitration or reference hereunder, including those arising from the exercise of the actions detailed in sections (i), (ii) and (iii) of this paragraph. (d) ARBITRATOR QUALIFICATIONS AND POWERS. Any arbitration proceeding in which the amount in controversy is $5,000,000.00 or less will be decided by a single arbitrator selected according to the Rules, and who shall not render an award of greater than $5,000,000.00. Any dispute in which the amount in controversy exceeds $5,000,000.00 shall be decided by majority vote of a panel of three arbitrators; provided however, that all three arbitrators must actively participate in all hearings and deliberations. The arbitrator will be a neutral attorney licensed in the State of California or a neutral retired judge of the state or federal judiciary of California, in either case with a minimum of ten years experience in the substantive law applicable to the subject matter of the dispute to be arbitrated. The arbitrator will determine whether or not an issue is arbitratable and will give effect to the statutes of limitation in determining any claim. In any arbitration proceeding the arbitrator will decide (by documents only or with a hearing at the arbitrator's discretion) any pre-hearing motions which are similar to motions to dismiss for failure to state a claim or motions for summary adjudication. The arbitrator shall resolve all disputes in accordance with the substantive law of California and may grant any remedy or relief that a court of such state could order or grant within the scope hereof and such ancillary relief as is necessary to make effective any award. The arbitrator shall also have the power to award recovery of all costs and fees, to impose sanctions and to take such other action as the arbitrator deems necessary to the same extent a judge could pursuant to the Federal Rules of Civil Procedure, the California Rules of Civil Procedure or other applicable law. Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction. The institution and maintenance of an action for judicial relief or pursuit of a provisional or ancillary remedy shall not constitute a waiver of the right of any party, including the plaintiff, to submit the controversy or claim to arbitration if any other party contests such action for judicial relief. (e) DISCOVERY. In any arbitration proceeding discovery will be permitted in accordance with the Rules. All discovery shall be expressly limited to matters directly relevant to the dispute being arbitrated and must be completed no later than 20 days before the hearing date and within 180 days of the filing of the dispute with the AAA. Any requests for an extension of the discovery periods, or any discovery disputes, will be subject to final determination by the arbitrator upon a showing that the request for discovery is essential for the party's presentation and that no alternative means for obtaining information is available. (f) CLASS PROCEEDINGS AND CONSOLIDATIONS. The resolution of any dispute arising pursuant to the terms of this Agreement shall be determined by a separate arbitration proceeding and such dispute shall not be consolidated with other disputes or included in any class proceeding. Page 7 (g) PAYMENT OF ARBITRATION COSTS AND FEES. The arbitrator shall award all costs and expenses of the arbitration proceeding. (h) REAL PROPERTY COLLATERAL; JUDICIAL REFERENCE. Notwithstanding anything herein to the contrary, no dispute shall be submitted Ito arbitration if the dispute concerns indebtedness secured directly or indirectly, in whole or in part, by any real property unless (i) the holder of the mortgage, lien or security interest specifically elects in writing to proceed with the arbitration, or (ii) all parties to the arbitration waive any rights or benefits that might accrue to them by virtue of the single action rule statute of California, thereby agreeing that all indebtedness and obligations of the parties, and all mortgages, liens and security interests securing such indebtedness and obligations, shall remain fully valid and enforceable. If any such dispute is not submitted to arbitration, the dispute shall be referred to a referee in accordance with California Code of Civil Procedure Section 638 et seq., and this general reference agreement is intended to be specifically enforceable in accordance with said Section 638. A referee with the qualifications required herein for arbitrators shall be selected pursuant to the AAA's selection procedures. Judgment upon the decision rendered by a referee shall be entered in the court in which such proceeding was commenced in accordance with California Code of Civil Procedure Sections 644 and 645. (i) MISCELLANEOUS. To the maximum extent practicable, the AAA, the arbitrators and the parties shall take all action required to conclude any arbitration proceeding within 180 days of the filing of the dispute with the AAA. No arbitrator or other party to an arbitration proceeding may disclose the existence, content or results thereof, except for disclosures of information by a party required in the ordinary course of its business, by applicable law or regulation, or to the extent necessary to exercise any judicial review rights set forth herein. If more than one agreement for arbitration by or between the parties potentially applies to a dispute, the arbitration provision most directly related to the documents between the parties or the subject matter of the dispute shall control. This arbitration provision shall survive termination, amendment or expiration of any of the documents or any relationship between the parties. Owner warrants that its chief executive office (or personal residence, if applicable) is located at the following address: 6305 EL CAMINO REAL, CARLSBAD, CA 92009 IN WITNESS WHEREOF, this Agreement has been duly executed as of FEBRUARY 6, 2001. DOT HILL SYSTEMS CORP. By: /s/ JAMES LAMBERT -------------------------------------------------------- James Lambert, President and Chief Executive Officer By: /s/ PRESTON ROMM -------------------------------------------------------- Preston Romm, Vice President, Finance and CFO Page 8 EX-10.26 6 a2041983zex-10_26.txt EXHIBIT 10.26 EXHIBIT 10.26 EXECUTIVE COMPENSATION PLAN 2001 EFFECTIVE DATE: JANUARY 1, 2001 NAME: JIM LAMBERT TITLE PRESIDENT/CEO BASE SALARY: $350,000 ON-PLAN BONUS: 55% OF BASE SALARY ($192,500) - -------------------------------------------------------------------------------- EXHIBIT C By signing this Executive Compensation Plan 2001 ("Plan"), you hereby agree that the terms of this Plan shall be in addition to the terms of the Employment Agreement between you and Dot Hill dated August 2, 1999 ("Employment Agreement"), and shall replace and supercede the terms of Exhibit C of the Employment Agreement with respect to your base salary and bonus for the year 2001. Otherwise, the terms of our Employment Agreement remain unchanged. For any period of time after December 31, 2001, your base salary and bonus shall be subject to change, as determined by Dot Hill's Board of Directors and/or Compensation Committee ("BOD"). BASE SALARY Total base salary will be paid in regular periodic payments, in accordance with Company Policy, less required payroll deductions and withholdings. BONUS Bonus is calculated based on a percentage of base salary. Bonus will be paid once annually as soon as practicable after an audit of the Company's fiscal year 2001 results has been completed and after the Dot Hill Board of Directors and/or Compensation Committee ("BOD") has approved the payment. Bonus is tied to Dot Hill's overall 2001 annual operating plan. a. 50% of bonus is tied to achieving on-plan revenue of $160,000,000 for 2001 b. 50% of bonus is tied to achieving on-plan net income of $9,865,000 for 2001 c. If at the end of 2001, the year-end revenue AND the net income is equal to or less than 85% of the on-plan targets, no bonus will be paid. d. For each 1% increase above 85% of on-plan revenue and, separately, on-plan net income, a bonus equal to 3.33% of on-plan bonus will be paid, with no cap. For example, assume that the Company attains 112% of on-plan revenue and 100% of on-plan for net income, and the entire on-plan bonus is $100,000. Bonus based on revenue will be paid by multiplying 3.33 by (112% - 85%), which equals 89.91%, and then multiplying that by the on-plan bonus of $100,000 equaling $89,910. Further, the bonus based on net income would be calculated by multiplying 3.33 by (100% - 85%), which equals 50%, and then multiplying that by the on-plan bonus of $100,000 equaling $50,000. The total bonus payout would be $89,910 + $50,000 or $139,910. e. Overachievement of on-plan bonus is possible based on Dot Hill's exceeding its 2001 revenue and/or net income targets, as per "d" above. TERMS a. You must be an employee in good standing on the date of payout to be eligible for the bonus payout. b. The base salary and bonus structure may be revised by the BOD at any time, with no notice. c. You are eligible for all benefits afforded Regular Full-time Exempt employees as set forth in the most current version of the Dot Hill Employee Handbook. d. The terms, conditions, and benefits of your employment with Dot Hill Systems Corporation are governed by the terms of the Employment Agreement and the standard Company policies and benefits. No verbal promises, verbal commitments, or implied promises will alter the Employment Agreement or these standard policies and benefits. e. The employment relationship between the parties is "at will" and may be terminated by Dot Hill at any time. /s/ PRESTON ROMM /s/ JIM LAMBERT - --------------------------------------- ------------------------------------- Preston Romm, CFO Jim Lambert, President/CEO EX-10.27 7 a2041983zex-10_27.txt EXHIBIT 10.27 EXHIBIT 10.27 EXECUTIVE COMPENSATION PLAN 2001 EFFECTIVE DATE: JANUARY 1, 2001 NAME: BENJAMIN MONDERER TITLE EVP STRATEGIC DEVELOPMENT BASE SALARY: $300,000 ON-PLAN BONUS: 50% OF BASE SALARY ($150,000) - -------------------------------------------------------------------------------- EXHIBIT C By signing this Executive Compensation Plan 2001 ("Plan"), you hereby agree that the terms of this Plan shall be in addition to the terms of the Employment Agreement between you and Dot Hill dated August 2, 1999 ("Employment Agreement"), and shall replace and supercede the terms of Exhibit C of the Employment Agreement with respect to your base salary and bonus for the year 2001. Otherwise, the terms of our Employment Agreement remain unchanged. For any period of time after December 31, 2001, your base salary and bonus shall be subject to change, as determined by Dot Hill's Board of Directors and/or Compensation Committee ("BOD"). BASE SALARY Total base salary will be paid in regular periodic payments, in accordance with Company Policy, less required payroll deductions and withholdings. BONUS Bonus is calculated based on a percentage of base salary. Bonus will be paid once annually as soon as practicable after an audit of the Company's fiscal year 2001 results has been completed and after the Dot Hill Board of Directors and/or Compensation Committee ("BOD") has approved the payment. Bonus is tied to Dot Hill's overall 2001 annual operating plan. a. 50% of bonus is tied to achieving on-plan revenue of $160,000,000 for 2001 b. 50% of bonus is tied to achieving on-plan net income of $9,865,000 for 2001 c. If at the end of 2001, the year-end revenue AND the net income is equal to or less than 85% of the on-plan targets, no bonus will be paid. d. For each 1% increase above 85% of on-plan revenue and, separately, on-plan net income, a bonus equal to 3.33% of on-plan bonus will be paid, with no cap. For example, assume that the Company attains 112% of on-plan revenue and 100% of on-plan for net income, and the entire on-plan bonus is $100,000. Bonus based on revenue will be paid by multiplying 3.33 by (112% - 85%), which equals 89.91%, and then multiplying that by the on-plan bonus of $100,000 equaling $89,910. Further, the bonus based on net income would be calculated by multiplying 3.33 by (100% - 85%), which equals 50%, and then multiplying that by the on-plan bonus of $100,000 equaling $50,000. The total bonus payout would be $89,910 + $50,000 or $139,910. e. Overachievement of on-plan bonus is possible based on Dot Hill's exceeding its 2001 revenue and/or net income targets, as per "d" above. TERMS a. You must be an employee in good standing on the date of payout to be eligible for the bonus payout. b. The base salary and bonus structure may be revised by the BOD at any time, with no notice. c. You are eligible for all benefits afforded Regular Full-time Exempt employees as set forth in the most current version of the Dot Hill Employee Handbook. d. The terms, conditions, and benefits of your employment with Dot Hill Systems Corporation are governed by the terms of the Employment Agreement and the standard Company policies and benefits. No verbal promises, verbal commitments, or implied promises will alter the Employment Agreement or these standard policies and benefits. e. The employment relationship between the parties is "at will" and may be terminated by Dot Hill at any time. /s/ JIM LAMBERT 2/6/2001 /s/ BENJAMIN MONDERER 2/20/01 - --------------------------------------- ------------------------------------- Jim Lambert, President/CEO Benjamin Monderer, EVP EX-10.28 8 a2041983zex-10_28.txt EXHIBIT 10.28 EXHIBIT 10.28 EXECUTIVE COMPENSATION PLAN 2001 EFFECTIVE DATE: JANUARY 1, 2001 NAME: DANA KAMMERSGARD TITLE CTO BASE SALARY: $250,000 ON-PLAN BONUS: 50% OF BASE SALARY ($125,000) - -------------------------------------------------------------------------------- EXHIBIT C By signing this Executive Compensation Plan 2001 ("Plan"), you hereby agree that the terms of this Plan shall be in addition to the terms of the Employment Agreement between you and Dot Hill dated August 2, 1999 ("Employment Agreement"), and shall replace and supercede the terms of Exhibit C of the Employment Agreement with respect to your base salary and bonus for the year 2001. Otherwise, the terms of our Employment Agreement remain unchanged. For any period of time after December 31, 2001, your base salary and bonus shall be subject to change, as determined by Dot Hill's Board of Directors and/or Compensation Committee ("BOD"). BASE SALARY Total base salary will be paid in regular periodic payments, in accordance with Company Policy, less required payroll deductions and withholdings. BONUS Bonus is calculated based on a percentage of base salary. Bonus will be paid once annually as soon as practicable after an audit of the Company's fiscal year 2001 results has been completed and after the Dot Hill Board of Directors and/or Compensation Committee ("BOD") has approved the payment. Bonus is tied to Dot Hill's overall 2001 annual operating plan. a. 50% of bonus is tied to achieving on-plan revenue of $160,000,000 for 2001 b. 50% of bonus is tied to achieving on-plan net income of $9,865,000 for 2001 c. If at the end of 2001, the year-end revenue AND the net income is equal to or less than 85% of the on-plan targets, no bonus will be paid. d. For each 1% increase above 85% of on-plan revenue and, separately, on-plan net income, a bonus equal to 3.33% of on-plan bonus will be paid, with no cap. For example, assume that the Company attains 112% of on-plan revenue and 100% of on-plan for net income, and the entire on-plan bonus is $100,000. Bonus based on revenue will be paid by multiplying 3.33 by (112% - 85%), which equals 89.91%, and then multiplying that by the on-plan bonus of $100,000 equaling $89,910. Further, the bonus based on net income would be calculated by multiplying 3.33 by (100% - 85%), which equals 50%, and then multiplying that by the on-plan bonus of $100,000 equaling $50,000. The total bonus payout would be $89,910 + $50,000 or $139,910. e. Overachievement of on-plan bonus is possible based on Dot Hill's exceeding its 2001 revenue and/or net income targets, as per "d" above. TERMS a. You must be an employee in good standing on the date of payout to be eligible for the bonus payout. b. The base salary and bonus structure may be revised by the BOD at any time, with no notice. c. You are eligible for all benefits afforded Regular Full-time Exempt employees as set forth in the most current version of the Dot Hill Employee Handbook. d. The terms, conditions, and benefits of your employment with Dot Hill Systems Corporation are governed by the terms of the Employment Agreement and the standard Company policies and benefits. No verbal promises, verbal commitments, or implied promises will alter the Employment Agreement or these standard policies and benefits. e. The employment relationship between the parties is "at will" and may be terminated by Dot Hill at any time. /s/ JIM LAMBERT 2/6/01 /s/ DANA KAMMERSGARD - --------------------------------------- ------------------------------------- Jim Lambert, President/CEO Dana Kammersgard, CTO EX-10.29 9 a2041983zex-10_29.txt EXHIBIT 10.29 EXHIBIT 10.29 EXECUTIVE COMPENSATION PLAN 2001 EFFECTIVE DATE: JANUARY 1, 2001 NAME: PRESTON ROMM TITLE: VICE PRESIDENT, FINANCE, CFO BASE: $185,500 BONUS POTENTIAL: 50% TOTAL TARGET COMPENSATION 2001: $278,250 - -------------------------------------------------------------------------------- BASE SALARY Merit Increase of 6% effective January 1, 2001. You will also receive retro pay for December, 2000 of $875.00 Next merit increase due January 1, 2002. BONUS PLAN Total bonus percent (50%) is calculated off base pay, and is paid annually post audit and board approval. 75% of bonus potential is tied to Dot Hill Systems Corporation's 2001 annual operating plan. a. 50% to revenue - $160,000K b. 50% to net income - $9,865K c. If targets achieved are less than 85% of above, no payout for operating plan will be made. d. For each 1% increase above 85%, payout is equal to 3.33% with no cap e. Overachievement to plan is possible per "d" above. 25% of bonus potential is subjective and may be tied to individual departmental goals and performance. This portion will be determined by the President of Dot Hill Systems Corporation. TERMS Salary will be paid bi-weekly, based upon the annual base salary amount indicated above, in U.S. dollars. You must be an employee in good standing on the date of payout to be eligible for the bonus payout. The base salary and bonus structure may be revised by Dot Hill Board of Directors, if they deem it necessary. You are eligible for all benefits afforded Regular Full-time Exempt employees as set forth in the most current version of the Dot Hill Employee Handbook. The terms, conditions, and benefits of your employment with Dot Hill Systems Corporation are governed solely by the standard Company policies and benefits. No promises, verbal commitments, or implied promises will alter these standard policies and benefits. The employment relationship between the parties is "at will" and may be terminated by Dot Hill at any time without obligation or liability to you. /s/ JIM LAMBERT 12/29/2000 /s/ PRESTON ROMM - --------------------------------------- ------------------------------------- Jim Lambert, CEO, President Preston Romm, Vice President, Finance EX-10.30 10 a2041983zex-10_30.txt EXHIBIT 10.30 EXHIBIT 10.30 EXECUTIVE COMPENSATION PLAN 2001 EFFECTIVE DATE: JANUARY 1, 2001 NAME: MARK MAYS TITLE VP, DIRECTOR BACK UP ENGINEERING BASE SALARY: $230,000 ON-PLAN BONUS: 50% OF BASE SALARY ($115,000) - -------------------------------------------------------------------------------- EXHIBIT C By signing this Executive Compensation Plan 2001 ("Plan"), you hereby agree that the terms of this Plan shall be in addition to the terms of the Employment Agreement between you and Dot Hill dated August 2, 1999 ("Employment Agreement"), and shall replace and supercede the terms of Exhibit C of the Employment Agreement with respect to your base salary and bonus for the year 2001. Otherwise, the terms of our Employment Agreement remain unchanged. For any period of time after December 31, 2001, your base salary and bonus shall be subject to change, as determined by Dot Hill's Board of Directors and/or Compensation Committee ("BOD"). BASE SALARY Total base salary will be paid in regular periodic payments, in accordance with Company Policy, less required payroll deductions and withholdings. BONUS Bonus is calculated based on a percentage of base salary. Bonus will be paid once annually as soon as practicable after an audit of the Company's fiscal year 2001 results has been completed and after the Dot Hill Board of Directors and/or Compensation Committee ("BOD") has approved the payment. Bonus is tied to Dot Hill's overall 2001 annual operating plan. a. 50% of bonus is tied to achieving on-plan revenue of $160,000,000 for 2001 b. 50% of bonus is tied to achieving on-plan net income of $9,865,000 for 2001 c. If at the end of 2001, the year-end revenue AND the net income is equal to or less than 85% of the on-plan targets, no bonus will be paid. d. For each 1% increase above 85% of on-plan revenue and, separately, on-plan net income, a bonus equal to 3.33% of on-plan bonus will be paid, with no cap. For example, assume that the Company attains 112% of on-plan revenue and 100% of on-plan for net income, and the entire on-plan bonus is $100,000. Bonus based on revenue will be paid by multiplying 3.33 by (112% - 85%), which equals 89.91%, and then multiplying that by the on-plan bonus of $100,000 equaling $89,910. Further, the bonus based on net income would be calculated by multiplying 3.33 by (100% - 85%), which equals 50%, and then multiplying that by the on-plan bonus of $100,000 equaling $50,000. The total bonus payout would be $89,910 + $50,000 or $139,910. e. Overachievement of on-plan bonus is possible based on Dot Hill's exceeding its 2001 revenue and/or net income targets, as per "d" above. TERMS a. You must be an employee in good standing on the date of payout to be eligible for the bonus payout. b. The base salary and bonus structure may be revised by the BOD at any time, with no notice. c. You are eligible for all benefits afforded Regular Full-time Exempt employees as set forth in the most current version of the Dot Hill Employee Handbook. d. The terms, conditions, and benefits of your employment with Dot Hill Systems Corporation are governed by the terms of the Employment Agreement and the standard Company policies and benefits. No verbal promises, verbal commitments, or implied promises will alter the Employment Agreement or these standard policies and benefits. e. The employment relationship between the parties is "at will" and may be terminated by Dot Hill at any time. /s/ JIM LAMBERT /s/ MARK MAYS - --------------------------------------- ------------------------------------- Jim Lambert, President/CEO Mark Mays, VP, Director Backup Eng EX-10.31 11 a2041983zex-10_31.txt EXHIBIT 10.31 EXHIBIT 10.31 BOX HILL SYSTEMS CORP. August 2, 1999 161 Avenue of the Americas New York, NY 10013 RE: EMPLOYMENT TERMS Dear Mark Mays: Box Hill Systems Corp., a New York corporation, (the "Company") is pleased to offer you employment on the following terms. You will serve as Applications Engineer and Secretary, and will be responsible for such duties as are normally associated with such positions. During your service with the Company, you will devote substantially all of your business time to the Company. You will report to the Chief Executive Officer(s) and will be subject to the direction and policies from time to time reasonably established by the Chief Executive Officer(s). You will work out of our principal offices located in New York. You will be expected to travel as reasonably required by your duties. The Company will reimburse you for your reasonable travel, entertainment, business and other expenses incurred in the course of your employment in accordance with Company policy. You shall receive an initial base salary of $230,000 per year, payable in regular periodic payments in accordance with Company policy, less required payroll deductions and withholdings. The Compensation Committee of the Board ("Compensation Committee") shall determine any changes to your base salary. You will be entitled to not less than 4 weeks of paid vacation per year, in addition to all Company holidays. Upon meeting all applicable eligibility requirements, the Company will provide you with a competitive comprehensive benefits package including health and dental insurance. The Company will also pay for health and dental insurance for your spouse and children under the age of 21. You will be eligible to participate in the Company's 401(k) plan and the Company's equity incentive plans. In addition to the foregoing, you will receive all benefits the Company may provide from time to time to other senior executive level employees. You shall be eligible to receive a performance bonus. The award of any performance bonus shall be at the discretion of the Compensation Committee. Attached as Exhibit C are the bonus levels and criteria for the remainder of fiscal year 1999, and the year 2000. After December 31, 2000, your base salary and annual bonus levels will be subject to changes as determined by the Committee. August 2, 1999 Page 2 Your employment with the Company will be at-will in that you may terminate your employment with the Company at any time and for any reason whatsoever. Likewise, the Company, by a written resolution duly adopted by a majority of the Board, may terminate your employment at any time and for any reason whatsoever. This at-will arrangement may not be changed except by a writing signed by you and a duly authorized officer of the Company. Upon termination of your employment with the Company, you will be paid your then current accrued base salary to and including the date of termination, any accrued vacation pay and other benefits through the date of termination and all compensation previously deferred by you, if any (together with accrued interest and earnings thereon). In addition, if the Company terminates your employment without Cause (defined below) or you resign for Good Reason (defined below), then so long as (i) you (or your representative) shall have furnished to the Company an executed release and waiver of claims in the form attached hereto as Exhibit A (the "Release") and (ii) the Effective Date provided for in the Release shall have occurred, the Company shall pay to you, in a single lump sum payment, an aggregate amount equal to one hundred percent (100%) of your then current annual base salary, with such payment to be made concurrently with the Effective Date provided for in such executed Release (subject to required payroll deductions and withholdings If your employment with the Company is terminated for Cause or you resign, other than for Good Reason, you shall not be entitled to receive any compensation following such termination other than salary and vacation accrued on or prior to the termination date and any reimbursement expenses due to you for which you shall not have been previously reimbursed. For purposes of this letter agreement the following definitions shall apply. (1) "Cause" shall be limited to the occurrence of any of the following events, as set forth in a written resolution duly adopted by a majority of the Board: (i) your personally continuing to engage in conduct which causes material harm to the Company after having been given thirty (30) days written notice of such determination by the Board (ii) your indictment for violation of any Law constituting a felony (including the Foreign Corrupt Practices Act of 1977) or the foreign equivalent thereof, (iii) your continuing failure to perform the lawful directives of the Board (consistent with the terms of this letter) or your duties and responsibilities hereunder, in each case in all material respects and after having been given thirty (30) days written notice of such determination by the Board which written notice shall specifically identify the directive alleged not to have been followed or the provision of this letter which it is alleged you have continually failed to substantially August 2, 1999 Page 3 perform, the bases for the Board's determination thereof and the specific corrective action that the Board proposes that you take; and (iv) your incurable breach of any material element of the Company's Confidential Information and Inventions Agreement. In no event shall your death or disability constitute Cause or the basis for any termination therefor; (2) "Good Reason" shall mean (i) a reduction in your base salary, (ii) the relocation of your full-time office to a location other than within sixty miles of New York City, (iii) a violation or breach by the Company, in any material respect, of any of its obligations under this letter so long as you have given the Company thirty (30) days notice of such breach, and the Company has not cured the breach during that thirty (30) day period, (3) "Disability" shall mean your failure or inability, for reasons of health, to perform your usual and customary duties on behalf of the Company in the usual and customary manner for a total of more then 90 consecutive business days (excluding Saturdays, Sundays and Holidays (days during which the Company is closed due to a recognized a holiday)). In the event of any termination of your employment with the Company other than for death or Disability, the Company shall have the right to retain you as a consultant for a period of one (1) year from the date of such termination (the "Consulting Period"). During the Consulting Period, the Company shall be entitled to require you to be available to render consulting services for up to twelve (12) days of consulting during such one (1) year period, it being understood that the scheduling of such consulting services shall not interfere with your work schedule for your principal employer. The Company shall schedule such consulting for days, or portions thereof, and places reasonably satisfactory to you, and unless you otherwise agree, all consulting services shall be rendered in New York. In exchange for your availability during the Consulting Period (whether or not the Company actually schedules consulting activities), the Company shall pay you, in four (4) equal payments (the "Consulting Payments"), an aggregate amount equal to twenty five percent (25%) of your annual base salary in effect as of the date of your termination, with the first such payment to be made within five (5) business days following commencement of the Consulting Period and the next three (3) payments to be made on the first day of each successive calendar quarter following the date of termination. The Company shall also reimburse you for your reasonable expenses incurred in carrying out your consulting duties hereunder. During the time that you are employed by the Company pursuant hereto, and during the Consulting Period, but (without limitation of your rights and remedies under this letter agreement) only for so long as the Company continues to employ you in accordance with the terms hereof or make Consulting Payments in accordance with the immediately August 2, 1999 Page 4 preceding paragraph, as the case may be, you will not, without the Company's prior written consent, directly or indirectly, (i) own, manage, operate, control or participate in any material way in the ownership, management, operation or control of, whether as an officer, employee, partner or otherwise, any business which directly competes with the business of the Company or (ii) solicit or induce any employee of the Company to leave the employ of the Company (it being understood that placing "help-wanted" or similar ads in newspapers or other media of general circulation or distribution shall not constitute such a solicitation or inducement); provided that nothing in this letter agreement shall restrict you from at any time (A) engaging in any business where your primary focus is not computer storage, whether as an owner, manager, operator, officer, employee, partner, control person or otherwise or (B) beneficially owning less than two percent (2%) of the outstanding equity interests in any publicly traded Company. The Company will indemnify you for all damages and costs that may be incurred by you in connection with claims arising out of or relating to your acts or omissions within the authorized scope of your employment. The Company shall provide such indemnification, and shall advance your expenses incurred in connection with any such claims as reasonably requested by you and as duly approved by the Board from time to time, to the fullest extent permissible under applicable law. As a Company employee, you will be expected to abide by Company rules and regulations. As a condition of employment, you will be required to sign and comply with a Confidential Information and Inventions Agreement, a copy of which is attached hereto as Exhibit B, which, among other things, prohibits unauthorized use or disclosure of Company proprietary information. The employment terms in this letter supersede any other agreements or promises made to you by anyone, whether oral or written, and compromise the final, complete and exclusive agreement between you and the Company. As required by law, this offer is subject to satisfactory proof of your right to work in the United States. Please sign and date this letter, and return it to me as soon as possible if you wish to accept employment at the Company under the terms described above. [Remainder of page intentionally left blank] August 2, 1999 Page 5 We look forward to your favorable reply and to a productive and enjoyable work relationship. Sincerely, BOX HILL SYSTEMS CORP. By: /s/ PHILIP BLACK --------------------------------- Name: Philip Black ------------------------------- Title: CEO ------------------------------ ACCEPTED BY: /s/ MARK MAYS - ------------------------------------ Mark Mays 8/20/99 - ------------------------------------ Date EXHIBIT 10.31 EXHIBIT A RELEASE AND WAIVER OF CLAIMS In consideration of the payments and other benefits set forth in my employment offer letter, to which this form is attached, I hereby furnish Box Hill Systems Corp. (the "Company") with the following release and waiver. I hereby release, and forever discharge the Company, its officers, directors, agents, employees, stockholders, successors, assigns and affiliates, of and from any and all claims, liabilities, demands, causes of action, costs, expenses, attorneys' fees, damages, indemnities and obligations of every kind and nature, in law, equity, or otherwise, known and unknown, suspected and unsuspected, disclosed and undisclosed, arising at any time prior to and including my employment termination date with respect to any claims relating to my employment and the termination of my employment, including but not limited to, claims pursuant to any federal, state or local law relating to employment, including, but not limited to, discrimination claims, claims under the California Fair Employment and Housing Act, and the Federal Age Discrimination in Employment Act of 1967, as amended ("ADEA"), the Federal Americans with Disabilities Act ("AD") or claims for wrongful termination, breach of the covenant of good faith, contract claims, tort claims, and wage or benefit claims, including but not limited to, claims for salary, bonuses, commissions, stock, stock options, vacation pay, fringe benefits, severance pay or any form of compensation. I also acknowledge that I have read and understand Section 1542 of the California Civil Code which reads as follows: "A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor." I hereby expressly waive and relinquish all rights and benefits under that section and any law of any jurisdiction of similar effect with respect to any claims I may have against the Company. I acknowledge that, among other rights, I am waiving and releasing any rights I may have under ADEA, that this waiver and release is knowing and voluntary, and that the consideration given for this waiver and release is in addition to anything of value to which I was already entitled as an employee of the Company. I further acknowledge that I have been advised, as required by the Older Workers Benefit Protection Act, that: (a) the waiver and release granted herein does not relate to claims which may arise after this release and waiver is executed; (b) I have the right to consult with an attorney prior to executing this release and waiver (although I may choose voluntarily not to do so); and (c) if on the date of execution of this release and waiver I am age 40 or older, then (I) I have twenty-one (21) days from the date I receive this release and waiver, in which to consider this release and waiver (although I may choose voluntarily to execute this release and waiver earlier); and (II) I have seven (7) days following the execution of this release and waiver to revoke my consent to this release and waiver. This release and waiver shall be effective as of the date of execution hereof; provided that if on the date of execution of this release and waiver I am age 40 or older, then this release and waiver shall not be effective until the foregoing seven (7) day revocation period has expired. The date as of which this release and waiver is effective as aforesaid shall be deemed the "Effective Date" hereof. Date: By: ------------------ --------------------------------------------- EXHIBIT B CONFIDENTIAL INFORMATION AND INVENTIONS AGREEMENTS For purposes of this Agreement, "Box Hill" shall include Box Hill Systems, Corp., Artecon, Falcon, Storage Dimensions and any past, present or future subsidiaries of those companies. In consideration for my employment by Box Hill: 1. I will not disclose to anyone outside of Box Hill, or use in other than Box Hill's business for the benefit of Box Hill any Box Hill Confidential Information or material relating to the business of Box Hill either during or after my employment at Box Hill, except with Box Hill's written permission. I also understand that information and materials received in confidence from third parties by Box Hill and its subsidiaries is included within the meaning of this paragraph. 2. I will not disclose to Box Hill, or induce Box Hill to use, any confidential information or material belonging to others. 3. I will comply, and do all things necessary for Box Hill to comply, with United States Government regulations and with provisions of contracts between the agencies of the United States Government of their contractors and Box Hill, which relate either to patent rights or to the safeguarding of information pertaining to the defense of the United States. 4. I hereby assign to Box Hill my entire right, title and interest in any invention or idea, patentable or not, hereafter made or conceived solely or jointly by me: (a) While working at Box Hill in an executive, managerial, planning, technical, research or engineering capacity (including development, manufacturing, systems, applied science, sales or customer engineering); and (b) That relates in any manner to the actual or anticipated business of Box Hill or to Box Hill's actual or anticipated research and development, or is suggested by or results from any task assigned to me or work performed by me or on behalf of Box Hill; except any invention or idea which I cannot assign to Box Hill because of prior invention agreement with ____________________ which is effective until ____________________ (give name and date or write "none") 5. I agree that in connection with any invention or idea covered by paragraph 4 (a) I will disclose it promptly to the Box Hill Management; and (b) I will, at Box Hill's request, promptly execute a specific assignment of title to Box Hill, and do anything else reasonably necessary to enable Box Hill to secure patent therefor in the United States and in foreign countries. 6. I represent that I have indicated on the back of this form any inventions or ideas, not covered in paragraph 4, in which I have any right, title or interest, and which were previously conceived either wholly or in part by me, but neither published nor filed in the United State Patent Office, and identified all of these. 7. I agree to comply with Box Hill's Database Policy. The policy states that all information in databases, whether centrally located (e.g. Minx or Informix) or locally (e.g. Act!) are the property of Box Hill Systems and are considered confidential. This information includes but is not limited to customer contacts, customer lists, pricing, inventory, vendors, billing, shipping and customer service data. I will not transfer, reproduce or duplicate this confidential information outside of the Box Hill. This includes, but is not limited to, transmitting database information by email, transferring the information verbally or by hardcopy, or any other means. Additionally, I will not intentionally destroy any information in central or local databases. 8. I understand and acknowledge that any breach of my obligations under this agreement will result in irreparable harm to Box Hill and hereby consent to the entry of injunctive relief to prevent or restrain any further violation of or harm to Box Hill's rights. 9. I acknowledge receipt of a copy of this agreement, and agree that with respect to the subject matter hereof, it is my entire agreement with Box Hill, superceding any previous oral or written communications, representations, understanding or agreements with Box Hill or any official or representative thereof. Signed: -------------------------------------- Employee's Full Name: -------------------------------------- Witness: -------------------------------------- (Employee's Manager or other appropriate Box Hill representative) Date: -------------------------------------- EXHIBIT C QUARTERLY PERFORMANCE BONUS Each quarter, you shall be eligible for a performance bonus of up to 50% of your base salary for such quarter (Quarterly Bonus). The Quarterly Bonus shall be based on the following formula, and on the Company's Business Plan, as approved by the Board of Directors, for such quarter: FORMULA 1. REVENUE-BASED BONUS: Half of the Quarterly Bonus shall be based on revenue. If the Company meets the Business Plan revenue goals for any given quarter, you shall be entitled to half of the Quarterly Bonus (25% of the your base salary for such quarter) for performance during the quarter. If the Company fails to meet the Business Plan revenue goals for a given quarter, then the revenue-based bonus shall be paid as follows: if the Company attains less than 75% of the Business Plan revenue goals, you shall not receive any revenue-based bonus for that quarter. For attaining levels of revenue between 75% and 100% of plan, you shall receive 2% of the total Quarterly Bonus for every 1% of revenue above 75%. 2. INCOME-BASED BONUS: Half of the Quarterly Bonus is to be based on net income. If the Company meets the Business Plan net income goals for any given quarter, then you shall be entitled to half of the Quarterly Bonus (25% of your salary for such quarter) for performance during that quarter. If the Company fails to meet the Business Plan net income goals for a given quarter, then the net income-based bonus shall be paid as follows: 0.5% of the Quarterly Bonus, payable for each 1% achieved of the net income line of the Business Plan, up to a maximum of 100%. BUSINESS PLAN DETERMINATIONS Third Quarter, 1999: You shall be granted full bonus (50% of base salary). Fourth Quarter, 1999: You shall be granted a bonus pursuant to the formula set forth above, based on the Business Plan for the Fourth Quarter, to be approved by the Board during the Fourth Quarter. Fiscal Year 2000: You shall be granted bonus pursuant to the formula set forth above, based on the Business Plan for the Year 2000, to be approved by Board during the First Quarter of 2000. EX-23.1 12 a2041983zex-23_1.txt EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-88635 of Dot Hill Systems Corp. on Form S-8 of our reports dated January 24, 2001 (March 20, 2001 as to the subesequent events in Notes 8 and 17), May 5, 1999 and January 24, 2001 appearing in this Annual Report on Form 10-K of Dot Hill Systems Corp for the year ended December 31, 2000. /s/ Deloitte & Touche LLP San Diego, California March 28, 2001 EX-23.2 13 a2041983zex-23_2.txt EXHIBIT 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into the Company's previously filed Form S-8 Registration Statements File Nos. 333-35751, 333-88635 and 333-43834. /s/ Arthur Andersen LLP Philadelphia, Pennsylvania March 29, 2001 -----END PRIVACY-ENHANCED MESSAGE-----