10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2006

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to

Commission file number 1-13317

DOT HILL SYSTEMS CORP.

(Exact name of registrant as specified in its charter)

Delaware	13-3460176
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
2200 Faraday Avenue, Suite 100, Carlsbad, CA	92008
(Address of principal executive offices)	(Zip Code)

(760) 931-5500
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

     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 þ No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o      Accelerated filer þ      Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     The registrant had 44,610,949 shares of common stock, $0.001 par value, outstanding as of May 9, 2006.

DOT HILL SYSTEMS CORP.

FORM 10-Q

For the Quarter Ended March 31, 2006

INDEX

Part I. Financial Information		1
Item 1.	Financial Statements (unaudited)	1
	Condensed Consolidated Balance Sheets-December 31, 2005 and March 31, 2006	1
	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)-Three Months Ended March 31, 2005 and 2006	2
	Condensed Consolidated Statements of Cash Flows-Three Months Ended March 31, 2005 and 2006	3
	Notes to Unaudited Condensed Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
Item 4.	Controls and Procedures	24
Part II. Other Information		25
Item 1.	Legal Proceedings	25
Item 1A.	Risk Factors	26
Item 6.	Exhibits	35
Signatures		36
EXHIBIT 10.4
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

Part I. Financial Information

Item 1. Financial Statements

DOT HILL SYSTEMS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands Except Per Share Amounts)

(Unaudited)

	December 31,			March 31,
	2005			2006
ASSETS
Current Assets:
Cash and cash equivalents	$	108,803		$	100,218
Short-term investments		13,431			14,535
Accounts receivable, net of allowance of $294 and $466		34,312			44,555
Inventories		2,804			2,893
Prepaid expenses and other		4,539			5,206
Deferred tax assets		5,762			5,762
Total current assets		169,651			173,169
Property and equipment, net		7,891			9,929
Goodwill		40,725			40,725
Other intangible assets, net		7,414			6,569
Deferred tax assets		41,379			43,949
Other assets		234			173
Total assets	$	267,294		$	274,514
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	25,732		$	34,511
Accrued compensation		3,561			3,362
Accrued expenses		3,633			4,695
Deferred revenue		1,327			450
Income taxes payable		60			27
Restructuring accrual		45			11
Total current liabilities		34,358			43,056
Other long-term liabilities		885			2,213
Total liabilities		35,243			45,269
Commitments and Contingencies (Note 11)
Stockholders’ Equity:
Preferred stock, $0.001 par value, 10,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $0.001 par value, 100,000 shares authorized, 44,417 and 44,610 shares issued and outstanding at December 31, 2005 and March 31, 2006, respectively		44			45
Additional paid-in capital		285,377			287,559
Accumulated other comprehensive loss		(118	)		(132	)
Accumulated deficit		(53,252	)		(58,227	)
Total stockholders’ equity		232,051			229,245
Total liabilities and stockholders’ equity	$	267,294		$	274,514

See accompanying notes to condensed consolidated financial statements.

1

DOT HILL SYSTEMS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(In Thousands, Except Per Share Amounts)

(Unaudited)

	Three Months Ended
	March 31,
	2005			2006
NET REVENUE	$	58,011		$	58,686
COST OF GOODS SOLD		44,734			47,525
GROSS PROFIT		13,277			11,161
OPERATING EXPENSES:
Sales and marketing		4,651			4,153
Research and development		4,713			9,712
General and administrative		2,631			6,153
Total operating expenses		11,995			20,018
OPERATING INCOME (LOSS)		1,282			(8,857	)
OTHER INCOME:
Interest income, net		634			1,312
Other income, net		75			—
Total other income, net		709			1,312
INCOME (LOSS) BEFORE INCOME TAXES		1,991			(7,545	)
INCOME TAX BENEFIT		(111	)		(2,570	)
NET INCOME (LOSS)	$	2,102		$	(4,975	)
NET INCOME (LOSS) PER SHARE:
Basic	$	0.05		$	(0.11	)
Diluted	$	0.05		$	(0.11	)
WEIGHTED AVERAGE SHARES USED TO CALCULATE NET INCOME (LOSS) PER SHARE:
Basic		43,741			44,518
Diluted		45,717			44,518
COMPREHENSIVE INCOME (LOSS):
Net income (loss)	$	2,102		$	(4,975	)
Foreign currency translation adjustments		16			(40	)
Net unrealized gain (loss) on short-term investments		(133	)		26
Comprehensive income (loss)	$	1,985		$	(4,989	)

See accompanying notes to condensed consolidated financial statements.

2

DOT HILL SYSTEMS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

	Three Months Ended
	March 31,
	2005			2006
Cash Flows From Operating Activities:
Net income (loss)	$	2,102		$	(4,975	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		2,048			1,659
Loss on disposal of property and equipment		39			19
Provision for doubtful accounts		(21	)		15
Stock-based compensation expense		5			1,228
Gain on sale of short-term investments		(8	)		—
Deferred taxes		—			(2,570	)
Changes in operating assets and liabilities:
Accounts receivable		2,537			(10,240	)
Inventories		624			(89	)
Prepaid expenses and other assets		(441	)		(597	)
Accounts payable		(7,719	)		7,487
Accrued compensation and expenses		(780	)		844
Deferred revenue		(33	)		(886	)
Income taxes payable		(279	)		(33	)
Restructuring accrual		(7	)		(34	)
Other long-term liabilities		(21	)		1,356
Net cash used in operating activities		(1,954	)		(6,816	)
Cash Flows From Investing Activities:
Purchases of property and equipment		(375	)		(1,642	)
Sales and maturities of short-term investments		21,177			7,775
Purchases of short-term investments		(42,268	)		(8,853	)
Net cash used in investing activities		(21,466	)		(2,720	)
Cash Flows From Financing Activities:
Proceeds from sale of stock to employees		550			603
Proceeds from exercise of stock options and warrants		132			351
Net cash provided by financing activities		682			954
Effect of Exchange Rate Changes on Cash		15			(3	)
Net Decrease in Cash and Cash Equivalents		(22,723	)		(8,585	)
Cash and Cash Equivalents, beginning of period		67,496			108,803
Cash and Cash Equivalents, end of period	$	44,773		$	100,218
Supplemental Disclosures of Cash Flow Information:
Construction in progress costs incurred but not paid	$	—		$	1,227
Cash paid for interest	$	—		$	—
Cash paid for income taxes	$	350		$	19

See accompanying notes to condensed consolidated financial statements.

3

DOT HILL SYSTEMS CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements have been prepared by Dot Hill Systems Corp. (referred to herein as Dot Hill, we, our or us) pursuant to the rules and regulations of the Securities and Exchange Commission, or the SEC. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States, or GAAP, for complete financial statements. Certain reclassifications have been made to prior periods to conform to current presentations. In the opinion of management, all adjustments and reclassifications considered necessary for a fair and comparable presentation have been included and are of a normal recurring nature. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005. Operating results for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

     The preparation of our financial statements in conformity with GAAP requires management to make 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.

     Revenues are recognized pursuant to applicable accounting standards, including SEC Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition and Statement of Position (SOP) No. 97-2, Software Revenue Recognition.

     We recognize revenue for non-software product sales upon transfer of title to the customer. Reductions to revenue for estimated sales returns are also recorded at that time. These estimates are based on historical sales returns, changes in customer demand and other factors. If actual future returns and allowances differ from past experience, additional allowances may be required. Certain of our sales arrangements include multiple elements. Generally, these arrangements include delivery of the product, installation, training and product maintenance. Maintenance related to product sales entitles the customer to basic product support and significantly greater response time in resolving warranty related issues. We allocate revenue to each element of the arrangement based on its relative fair value. For maintenance contracts this is typically the price charged when such contracts are sold separately or renewed. Because professional services related to installation and training can be provided by other third party organizations, we allocate revenue related to professional services based on the Company’s stated billing rates which are consistent with amounts charged separately and other companies providing similar services, i.e., the market rate for such services. Revenue from product maintenance contracts is deferred and recognized ratably over the contract term, generally 12 months. Revenue from installation, training and consulting is recognized as the services are performed.

     For software sales, we apply SOP No. 97-2, whereby revenue is recognized from software licenses at the time the product is delivered, provided there are no significant 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. For arrangements with multiple elements, we allocate revenue to each element using the residual method based on vendor specific objective evidence of the undelivered items. A portion of the arrangement fee equal to the fair value of the undelivered elements, typically software maintenance contracts, is deferred and recognized ratably over the contract term, generally 12 months. Vendor specific objective evidence is based on the price charged when the element is sold separately. A typical arrangement includes a software-licensing fee and maintenance agreement.

2. Change in Accounting for Stock-Based Compensation

     On January 1, 2006, we adopted Statement of Financial Accounting Standard (SFAS) No. 123(R), Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees, directors and consultants, including stock option grants and purchases of stock made pursuant to our 2000 Amended and Restated Equity Incentive Plan, or the 2000 EIP, our 2000 Amended and Restated Non-Employee Directors’ Stock Option Plan, or the 2000 NEDSOP, and our 2000 Amended and Restated Employee Stock Purchase Plan, or the 2000 ESPP, based on estimated fair values. SFAS No. 123(R) supercedes our previous accounting under Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees. In March 2005, the SEC issued SAB No. 107, Share-Based Payment, and we have applied SAB No. 107’s provisions in our adoption of SFAS No. 123(R).

     We adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006 as further described below. In accordance with the modified prospective transition method, our unaudited

4

condensed consolidated financial statements for the three months ended March 31, 2005 have not been restated to reflect, and do not include, the impact of the adoption of SFAS No. 123(R).

     SFAS No. 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the award’s portion that is ultimately expected to vest is recognized as expense over the requisite service periods in the accompanying unaudited condensed consolidated financial statements for the three months ended March 31, 2006. Prior to the adoption of SFAS No. 123(R), we accounted for share-based awards to employees and directors using the intrinsic value method in accordance with APB No. 25 as allowed under SFAS No. 123, Accounting for Stock-Based Compensation. Under the intrinsic value method, share-based compensation expense was only recognized by Dot Hill if the exercise price of the grant was less than the fair market value of the underlying stock at the date of grant. No stock-based compensation expense was recorded by Dot Hill in 2005.

     As of March 31, 2006, total unrecognized share-based compensation cost related to unvested stock options was $6.1 million, which is expected to be recognized over a weighted average period of approximately 3.4 years. We have included the following amounts for share-based compensation cost, including the cost related to the 2000 EIP, 2000 NEDSOP and 2000 ESPP, in the accompanying unaudited condensed consolidated statement of operations for the three months ended March 31, 2006 (amounts in thousands):

	Three Months Ended
	March 31, 2006
Cost of goods sold	$	51
Sales and marketing		87
Research and development		180
General and administrative		910
Share-based compensation expense before taxes		1,228
Related deferred income tax benefits		(183	)
Share-based compensation expense, net of income taxes	$	1,045
Net share-based compensation expense per basic and diluted common share	$	0.02

     Share-based compensation expense recognized under SFAS No. 123(R) for the quarter ended March 31, 2006 included $1.0 million from stock options and $0.2 million from the 2000 ESPP. Share-based compensation expense recognized during the three months ended March 31, 2006 included (1) compensation expense for awards granted prior to, but not yet fully vested as of January 1, 2006, and (2) compensation expense for the share-based payment awards granted subsequent to December 31, 2005, based on the grant date fair values estimated in accordance with the provisions of SFAS No. 123(R). SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In our pro forma disclosures required under SFAS No. 123 for the periods prior to 2006, we accounted for forfeitures as they occurred. We have historically and continue to estimate the fair value of share-based awards using the Black-Scholes option-pricing model. Total unrecognized share-based compensation cost related to unvested stock options has been adjusted for estimated forfeitures.

Stock Incentive Plans

     2000 EIP. During 2006 and 2005, we primarily granted options to purchase common stock to our employees and consultants under the 2000 EIP. These options expire 10 years from the date of grant and typically vest over four years, with 25% of the shares subject to the option vesting one year from the date of grant and the remaining shares subject to the option vesting ratably thereafter on a monthly basis. The number of shares of common stock reserved for issuance under the 2000 EIP is increased annually on the date of our meeting of stockholders by an amount equal to the lesser of (A) two percent of our outstanding shares as of the date of our annual meeting of stockholders, (B) 1,000,000 shares or (C) an amount determined by our board of directors. If an option is surrendered or for any other reason ceases to be exercisable in whole or in part, the shares with respect to which the option was not exercised shall continue to be available under the 2000 EIP. As of March 31, 2006, options to purchase 5,085,668 shares of common stock were outstanding under the 2000 EIP and the options to purchase 351,447 shares of common stock remained available for grant under the 2000 EIP.

     2000 NEDSOP. Under the 2000 NEDSOP, nonqualified stock options to purchase common stock are automatically granted to our non-employee directors upon appointment to our board of directors (initial grants) and upon each of our annual meeting of stockholders (annual grants). Options granted under the 2000 NEDSOP expire 10 years from the date of the grant. Initial grants vest over four years, with 25% of the shares subject to the option vesting one year from the date of grant and the remaining shares subject to the option vesting ratably thereafter on a monthly basis. Annual grants are fully vested on the date of grant. 500,000 shares of common stock are reserved for issuance under the 2000 NEDSOP. As of March 31,

5

2006, options to purchase 324,917 shares of common stock were outstanding under the 2000 NEDSOP and options to purchase 102,499 shares of common stock remained available for grant under the 2000 NEDSOP.

     2000 ESPP. The 2000 ESPP qualifies under the provisions of Section 423 of the Internal Revenue Code, or IRC, and provides our eligible employees, as defined in the 2000 ESPP, with an opportunity to purchase shares of our common stock at 85% of fair market value, as defined in the 2000 ESPP. There were 102,621 and 121,341 shares issued for the 2000 ESPP periods that ended in the three months ended March 31, 2005 and 2006, respectively.

     Share-Based Compensation Cost under SFAS No. 123

     Prior to January 1, 2006, we disclosed compensation cost in accordance with SFAS No. 123. The provisions of SFAS No. 123 require Dot Hill to disclose the assumptions used in calculating the fair value pro forma expense. Had compensation expense for the plans been determined based on the fair value of the options at the grant dates for awards under the plans consistent with SFAS No. 123, our net income for the three months ended March 31, 2005 would have been as follows (amounts in thousands, except per share data):

	Three Months Ended
	March 31, 2005
Net income as reported	$	2,102
Stock-based compensation, as reported		5
Total stock-based compensation determined under fair value based method for all awards		(1,393	)
Pro forma income	$	714
Basic net income per share, as reported	$	0.05
Diluted net income per share, as reported	$	0.05
Basic net income per share, SFAS No. 123 adjusted	$	0.02
Diluted net income per share, SFAS No. 123 adjusted	$	0.02

     Pro forma disclosures for the three months ended March 31, 2006 are not presented because the amounts are recognized in the unaudited condensed consolidated statement of operations.

     To estimate compensation expense which would have been recognized under SFAS No. 123 for the three months ended March 31, 2005 and the compensation cost that was recognized under SFAS No. 123(R) for the three months ended March 31, 2006, we use the Black-Scholes option-pricing model with the following weighted-average assumptions for equity awards granted:

	2000 EIP and 2000 NEDSOP						2000 ESPP
	Three Months Ended						Three Months Ended
	March 31,						March 31,
	2005			2006			2005			2006
Risk-free interest rate		3.71	%		4.81	%		3.36	%		4.40	%
Expected dividend yield		—	%		—	%		—	%		—	%
Volatility		81	%		68	%		85	%		68	%
Expected life	4.0 years			5.6 years			1 year			1 year

6

     The risk-free interest rate is based on the implied yield available on U.S. Treasury issues with an equivalent remaining term. We have not paid dividends in the past and do not plan to pay any dividends in the future. The expected volatility is based on implied volatility of our stock for the related vesting period. The expected life of the equity award is based on historical experience.

     Activity and pricing information regarding all options to purchase shares of common stock are summarized as follows:

						Weighted average
				Weighted		remaining		Aggregate
				average		contractual term		intrinsic value
	Number of shares			exercise price		(in years)		(in millions)
Outstanding at December 31, 2005		4,830,811		$	6.52
Granted		1,002,500			6.82
Forfeited		(373,685	)		6.14
Exercised		(47,041	)		5.76
Outstanding at March 31, 2006		5,412,585		$	6.61		7.54	$	8.6
Exercisable at March 31, 2006		3,520,948		$	6.82		6.58	$	6.9

     The weighted average grant-date fair values of options granted during the three months ended March 31, 2006 and 2005 were $4.32 per share and $3.75 per share, respectively. The total intrinsic value of options exercised during each of the three months ended March 31, 2006 and 2005 was $0.1 million.

     A summary of the status of our non-vested stock options as of March 31, 2006 and changes during the quarter then ended are presented below.

			Weighted average
			grant-date fair value
	Number of Shares		per share
Nonvested at December 31, 2005		1,703,142	$	3.49
Granted		1,002,500	$	4.32
Vested		(458,922)	$	3.54
Forfeited		(355,083)	$	3.71
Nonvested at March 31, 2006		1,891,637	$	3.87

     During the three months ended March 31, 2006, financing cash generated from share-based compensation arrangements amounted to $0.3 million for the purchase of shares upon exercise of options and $0.6 million collected for the purchase of shares through the 2000 ESPP. We issue new shares from the respective plan share reserves upon exercise of options to purchase common stock and for purchases through the 2000 ESPP.

     Additional information regarding options outstanding for all plans as of March 31, 2006, is as follows:

	Options Outstanding						Options Exercisable
			Weighted
			Average		Weighted				Weighted
			Remaining		Average				Average
	Number		Contractual		Exercise		Number		Exercise
Range of Exercise Prices	Outstanding		Life (yrs.)		Price		Exercisable		Price
$1.34 — 3.10		1,057,964		5.98	$	2.41		1,011,539	$	2.38
$3.15 — 5.50		912,433		6.42		4.67		554,318		4.45
$5.70 — 6.25		957,500		8.37		6.12		568,123		6.09
$6.36 — 6.87		1,119,405		9.57		6.71		96,685		6.41
$6.88 — 12.49		967,133		7.10		10.02		892,133		10.28
$12.81 — 17.14		398,150		7.66		14.79		398,150		14.79
Total		5,412,585		7.54	$	6.61		3,520,948	$	6.82

7

     The aggregate intrinsic value in the table above is based our closing stock price of $7.10 per share as of the last business day of the three months ended March 31, 2006, which amount would have been received by the optionees had all options been exercised on that date. The total fair value of options to purchase common stock that vested during the three months ended March 31, 2006 and 2005 was $1.6 million and $2.0 million, respectively.

3. Net Income (Loss) Per Share

     Basic net income (loss) per share is calculated by dividing net income 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 and stock warrants in the weighted average number of common shares outstanding for a period, if dilutive.

     The following table sets forth a reconciliation of the basic and diluted number of weighted average shares outstanding used in the calculation of net income (loss) per share (in thousands):

	Three Months Ended
	March 31,
	2005		2006
Shares used in computing basic net income (loss) per share		43,741		44,518
Dilutive effect of warrants and common stock equivalents		1,976		—
Shares used in computing diluted net income (loss) per share		45,717		44,518

     For the three months ended March 31, 2005, outstanding options to purchase 2,084,498 shares of common stock with exercises prices ranging from $6.25 to $17.14 per share were outstanding, but were not included in the calculation of diluted loss per share because their effect was antidilutive.

     For the three months ended March 31, 2006, outstanding options to purchase 5,001,319 shares of common stock with exercises prices ranging from $1.34 to $17.14 per share and outstanding warrants to purchase 1,714,679 shares of common stock at prices ranging from $2.97 to $4.50 were not included in the calculation of diluted loss per share because their effect was antidilutive.

4. Short-Term Investments

     The following table summarizes our short-term investments as of March 31, 2006 (in thousands):

			Unrealized			Unrealized
	Cost		Losses			Gains		Fair Value
U.S. Government securities	$	5,699	$	(15	)	$	—	$	5,684
Corporate debt		8,850		—			1		8,851
	$	14,549	$	(15	)	$	1	$	14,535

     For the three months ended March 31, 2006, we did not recognize any gross realized gains on these investments.

     Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. The cost and fair value of short-term investments at March 31, 2006 by contractual maturity are shown below (in thousands).

	Cost		Fair Value
Due in one year or less	$	8,850	$	8,851
Due after one year through five years		5,699		5,684
Total	$	14,549	$	14,535

8

     The following table shows the gross unrealized losses and fair values of our investments in individual securities that have been in a continuous unrealized loss position, deemed to be temporary, for less than and greater than 12 months, aggregated by investment category, at March 31, 2006 (in thousands):

	Less Than 12 Months				12 Months or Greater					Total
	Fair		Unrealized		Fair		Unrealized			Fair		Unrealized
	Value		Losses		Value		Losses			Value		Losses
U.S. Government securities	$	—	$	—	$	5,684	$	(15	)	$	5,684	$	(15	)
Corporate debt		8,851		—		—		—			8,851		—
Total	$	8,851	$	—	$	5,684	$	(15	)	$	14,535	$	(15	)

     U.S. Government Securities. The unrealized losses on our investments in U.S. Government securities were caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at March 31, 2006.

     Corporate Debt Securities. Our investments in debt securities consist primarily of investments in corporate bonds.

5. Inventories

     Inventories are stated at the lower of cost (first-in, first-out) or market value. The following is a summary of inventories (in thousands):

	December 31, 2005		March 31, 2006
Purchased parts and materials	$	1,058	$	652
Finished goods		1,746		2,241
	$	2,804	$	2,893

6. Goodwill and Other Intangible Assets

     Under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and intangible assets with indefinite lives are not amortized, but instead are tested for impairment at least annually or more frequently if impairment indicators arise. All of our remaining identified intangible assets are considered to have finite lives and are being amortized in accordance with this statement.

     Intangible assets that are subject to amortization under SFAS No. 142 consist of the following as of March 31, 2006 (in thousands):

			Accumulated
	Gross		Amortization			Net
Core technology	$	5,000	$	(2,315	)	$	2,685
Developed technology		2,600		(2,168	)		432
Customer relationships		2,500		(1,487	)		1,013
Backlog		100		(100	)		—
Licensed Patent Portfolio		2,570		(131	)		2,439
Total other intangible assets	$	12,770	$	(6,201	)	$	6,569

     As of March 31, 2006, the weighted average amortization period for the above intangibles is 4.0 years.

9

     Estimated future amortization expense related to other intangible assets as of March 31, 2006 is as follows (in thousands):

Years ending December 31,
2006 (remaining 9 months)	$	2,188
2007		2,101
2008		1,255
2009		514
2010		511
Total	$	6,569

7. Product Warranties

     We generally extend to our customers the warranties provided to us by our suppliers and, accordingly, the majority of our warranty obligations to customers are covered by supplier warranties. For warranty costs not covered by our suppliers, we provide for estimated warranty costs in the period the revenue is recognized. There can be no assurance that our suppliers will continue to provide such warranties to us in the future, which could have a material adverse effect on our operating results and financial condition. Estimated liabilities for product warranties are included in accrued expenses. The changes in our aggregate product warranty liability are as follows for the three months ended March 31, 2006 (in thousands):

	Three Months Ended
	March 31, 2006
Balance, beginning of period	$	746
Charged to operations		630
Deductions for costs incurred		(676	)
Balance, end of period	$	700

8. Restructurings

     Restructuring liabilities at March 31, 2006 were originally recorded in 2001 and 2002 and pertain to leases for former offices located in New York, Chicago and Carlsbad that extend through 2006. As of March 31, 2006, the remaining restructuring liability pertains to only the Carlsbad office.

     The following is a summary of restructuring activity recorded during the three months ended March 31, 2006 (in thousands):

March 2001 Restructuring

								Accrued
	Accrued							Restructuring
	Restructuring		Additional		Current			Expenses at
	Expenses at		Restructuring		Amounts			March 31,
	December 31, 2005		Expenses		Utilized			2006
Facility closures and related costs	$	45	$	—	$	(34	)	$	11

     We believe that there are no unresolved issues or additional liabilities that may result in a significant adjustment to restructuring expenses accrued as of March 31, 2006.

9. Income Taxes

     We recorded an income tax benefit of $0.1 and $2.6 million for the three months ended March 31, 2005 and 2006, respectively. Our effective income tax rate was 34.1% for the three months ended March 31, 2006.

     Our income tax benefit for the three months ended March 31, 2005 included the receipt by our European subsidiary of $0.2 million from European taxing authorities related to a 2002 loss that was carried back to the years 1998 through 2001.

     We currently anticipate an effective income tax rate of approximately 34.1% for the year ended December 31, 2006.

     At December 31, 2005, based on the weight of available evidence, including cumulative profitability in recent years, we determined that it was more likely than not that a portion of our United States deferred tax assets would be realized and, at December 31, 2005, eliminated $47.1 million of valuation allowance associated with our United States deferred tax assets. The elimination of valuation allowance resulted in a $16.4 million decrease to goodwill to the extent of our acquired net deferred tax assets, a $5.4 million increase to equity for net operating losses arising from stock option deductions, with the remaining $25.3 million recognized as an increase in earnings for the year ended December 31, 2005. As a result of our elimination of valuation allowance associated with United States deferred tax assets, our effective tax rate in subsequent periods is likely to more closely resemble the applicable federal and state statutory tax rates.

     Excluding the impact of the loss carryback, our effective income tax rate was 2.5% for the three months ended March 31, 2005.

10

     As of December 31, 2005, a valuation allowance of $3.6 million has been provided for the foreign deferred tax assets based upon our assessment of the future realizability of certain foreign deferred tax assets, as it is more likely than not, that sufficient taxable income will not be generated to realize these temporary differences.

     As of December 31, 2005, we had federal and state net operating losses of approximately $113.1 million and $49.0 million, which begin to expire in the tax years ending 2009 and 2006, respectively. In addition, we have federal tax credit carryforwards of $2.9 million, of which approximately $0.5 million can be carried forward indefinitely to offset future taxable income, and the remaining $2.4 million will begin to expire in the tax year ending 2008. We also have state tax credit carryforwards of $3.1 million, of which $2.9 million can be carried forward indefinitely to offset future taxable income, and the remaining $0.2 million will begin to expire in the tax year ending 2006.

     Due to our equity transactions, an ownership change, within the meaning of IRC Section 382, occurred on September 18, 2003. As a result, annual use of our federal net operating loss and credit carry forwards is limited to (i) the aggregate fair market value of Dot Hill immediately before the ownership change multiplied by (ii) the long-term tax-exempt rate (within the meaning of IRC Section 382 (f)) in effect at that time. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the IRC Section 382 limitation for those years.

     As a result of our acquisition of Chaparral Network Storage, Inc., or Chaparral, an ownership change, within the meaning of IRC Section 382, occurred on February 23, 2004. As a result, annual use of Chaparral’s federal net operating loss and credit carry forwards acquired in the transaction may be limited. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the IRC Section 382 limitation for those years.

     We have not provided for any residual United States income taxes on the earnings from our foreign subsidiaries because such earnings are intended to be indefinitely reinvested. Such residual United States income taxes, if any, would be insignificant.

10. Accumulated Other Comprehensive Income (Loss)

     The components of accumulated other comprehensive loss are as follows (in thousands):

	Foreign			Unrealized
	Currency			Gain (Loss) on
	Items			Securities			Total
Balance, December 31, 2005	$	(78	)	$	(40	)	$	(118	)
Quarterly change		(40	)		26			(14	)
Balance, March 31, 2006	$	(118	)	$	(14	)	$	(132	)

11. Commitments and Contingencies

Commitments

Consulting Agreement with Former Executive

     In March 2006, we entered into a consulting agreement with our former Chief Executive Officer, James L. Lambert. Pursuant to the consulting letter agreement, Mr. Lambert will perform consulting services for us during a three-year period beginning as of March 1, 2006 for a consulting fee of $16,666 per month. The vesting of 218,125 of Mr. Lambert’s stock options, with an average exercise price of $5.63 per share, was accelerated in full in connection with the consulting agreement, and such stock options will continue to be exercisable during the consulting period in accordance with their terms. Mr. Lambert will be restricted from competing with us during the consulting period, and the consulting period will terminate early upon an acquisition of us, Mr. Lambert’s election or Mr. Lambert’s death or permanent disability. In the event of any such early termination, Mr. Lambert will receive a lump sum payment equal to the amount he would have been eligible to receive if the consulting period continued for the full original three-year period. Based on the terms of this agreement, we recognized a non-cash stock option expense of $0.7 million related to the acceleration of stock options and consulting fees of $0.6 million during the three months ended March 31, 2006.

      Effective July 1, 2004, we entered into a credit agreement with Wells Fargo Bank, National Association, or Wells Fargo, which allows us to borrow up to $30.0 million under a revolving line of credit that expires July 1, 2006. Amounts loaned under the credit agreement bear interest at our option at a fluctuating rate per annum equal to the Prime Rate in effect from time to time, or at a fixed rate per annum determined by Wells Fargo to be 0.65% above LIBOR in effect on the first day of the applicable fixed rate term. In connection with the credit agreement, to the extent we have outstanding borrowings, we have granted Wells Fargo a security interest in our investment management account maintained with Wells Capital Management Incorporated. As of December 31, 2005 and March 31, 2006, there were no balances outstanding under this line of credit. The credit agreement limits any new borrowings, loans, or advances outside of the credit agreement to an amount less than $1.0 million.

Contingencies

Crossroads Systems Litigation

     On October 17, 2003, Crossroads Systems, Inc., or Crossroads, filed a lawsuit against us in the United States District Court in Austin, Texas, alleging that our products infringe two United States patents assigned to Crossroads, Patent Numbers 5,941,972 and 6,425,035. We were served with the lawsuit on October 27, 2003. Chaparral was added as a party to the lawsuit in March 2004. The patents involve storage routers and methods for providing virtual local storage. Patent Number 5,941,972 involves the interface of Small Computer Systems Interface, or SCSI, storage devices and the Fibre Channel

11

protocol and Patent Number 6,425,035 involves the interface of any one-transport medium and a second transport medium. We believe that we have meritorious defenses to Crossroads’ claims and are in the process of vigorously defending against them. The outcome is uncertain and no amounts have been accrued as of March 31, 2006. However, we expect to incur significant legal expenses in connection with this litigation. These defense costs, and other expenses related to this litigation, will be expensed as incurred and will negatively affect our operating results. A trial in the matter is expected to commence on June 5, 2006.

Chaparral Securities Class Action

     In August 2004, a class action lawsuit was filed against, among others, Chaparral and a number of its former officers and directors in the United States District Court for the Central District of California. The lawsuit, among other things, alleges violations of federal and state securities laws and purports to seek damages on behalf of a class of shareholders who held interests in limited liability companies that had purchased, among other securities, Chaparral stock during a defined period prior to our acquisition of Chaparral. In May 2005, the Second Amended Complaint was dismissed with leave to amend. Plaintiffs filed a Third Amended Complaint, which the Court again dismissed with leave to amend in November of 2005 as to Chaparral and certain other defendants. Plaintiffs declined to amend within the proscribed period, and final judgment was entered in February 2006. Plaintiffs filed a notice of appeal in the United States District Court of Appeals for the Ninth Circuit, though they have not filed their opening papers.

     Plaintiffs filed a related action in the Superior Court of the State of California, Orange County, in December of 2005, alleging many of the same claims. That action has been stayed pending the outcome of the federal appeal. We believe that the claims against Chaparral and its former officers and directors are without merit and are in the process of vigorously defending against them. The outcome is uncertain and no amounts have been accrued as of March 31, 2006.

Dot Hill Securities Class Actions and Derivative Suits

     In late January and early February 2006, numerous purported class action complaints were filed against us in the United States District Court for the Southern District of California. The complaints allege violations of federal securities laws related to alleged inflation in our stock price in connection with various statements and alleged omissions to the public and to the securities markets and declines in our stock price in connection with the restatement of certain of our quarterly financial statements for fiscal year 2004, and seeking damages therefore. The court should approve a lead plaintiff(s) and approve lead counsel within the next 30 days. After the lead plaintiff files a consolidated class action complaint, or a consolidated complaint, we will move to dismiss the consolidated complaint.

     In addition, three complaints purporting to be derivative actions have been filed in California state court against certain of our directors and executive officers. These complaints are based on the same facts and circumstances described in the federal class action complaints and generally allege that the named directors and officers breached their fiduciary duties by failing to oversee adequately our financial reporting. Each of the complaints generally seeks an unspecified amount of damages. The cases are in the very preliminary stages. We believe the allegations against us and certain of our directors and executive officers in this action are without merit and we intend to vigorously defend against these claims. We are seeking dismissal of each derivative action by demurring to the complaints. The outcome is uncertain and no amounts have been accrued as of March 31, 2006.

Other Litigation

     We are 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 our financial condition or operating results.

Other

     In the fourth quarter of 2004, we made a payment of approximately $0.4 million to the State of New York to settle amounts related to a field audit of our franchise tax return. During the quarter ended March 31, 2005 we submitted tax returns to the City of New York and made a payment as an offer to settle in an amount similar to that accepted by the State of New York as described above. New York City is currently reviewing the returns, and we are waiting for a reply as to whether or not they have accepted the revised liability and payment as submitted. Amounts related to this matter have been previously accrued for.

12

12. Segments and Geographic Information

     Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by our chief operating decision-maker, or decision making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision-maker is our Chief Executive Officer. Our operating segments are managed separately because each segment represents a strategic business unit that offers different products or services.

     Our operating segments are organized on the basis of products and services. We have identified operating segments that consist of our SANnet® family of systems, legacy and other systems, and services. We currently evaluate performance based on stand-alone segment revenue and gross margin. Because we do not currently maintain information regarding operating income at the operating segment level, such information is not presented.

     Sales to our largest channel partner accounted for approximately 86% and 88% of our net revenue during the three months ended March 31, 2005 and March 31, 2006, respectively.

     Information concerning revenue by product and service is as follows (in thousands):

	SANnet		Legacy and
	Family		Other		Services		Total
Three months ended:
March 31, 2006:
Net revenue	$	57,146	$	639	$	901	$	58,686
Gross profit	$	10,598	$	62	$	501	$	11,161
March 31, 2005:
Net revenue	$	55,644	$	1,586	$	781	$	58,011
Gross profit	$	12,389	$	338	$	550	$	13,277

     Information concerning operating assets by product and service, derived by specific identification for assets related to specific segments and an allocation based on segment volume for assets related to multiple segments, is as follows (in thousands):

	SANnet		Legacy and
	Family		Other		Services		Total
As of:
March 31, 2006	$	270,677	$	1,629	$	2,208	$	274,514
December 31, 2005	$	256,028	$	8,240	$	3,026	$	267,294

13

     Information concerning principal geographic areas in which we operate is as follows (in thousands):

	Three Months Ended
	March 31,
	2005			2006
Net revenue:
United States	$	54,066		$	55,019
Europe		2,473			2,234
Asia		1,472			1,433
	$	58,011		$	58,686
Operating income (loss):
United States	$	1,778		$	(8,724	)
Europe		(473	)		(135	)
Asia		(23	)		2
	$	1,282		$	(8,857	)

     Net revenue is recorded in the geographic area in which the sale is originated.

13. Recent Accounting Pronouncements

     In May 2005, the Financial Accounting Standards Board, or FASB, issued Statement No. 154, Accounting Changes and Error Corrections, which requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle and that a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. Statement No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

     In June 2005, the FASB issued Staff Position (FSP) No. 143-1, Accounting for Electronic Equipment Waste Obligations, which provides guidance on the accounting for obligations associated with the Directive on Waste Electrical and Electronic Equipment, or the WEEE Directive, which was adopted by the European Union. FSP No. 143-1 provides guidance on accounting for the effects of the WEEE Directive with respect to historical waste and waste associated with products on the market on or before August 13, 2005. FSP No. 143-1 requires commercial users to account for their WEEE obligation as an asset retirement liability in accordance with FASB Statement No. 143, Accounting for Asset Retirement Obligations. FSP No. 143-1 was required to be applied to the later of the first reporting period ending after June 8, 2005 or the date of the adoption of the WEEE Directive into law by the applicable European Union member country. The WEEE Directive has been adopted into law by the majority of European Union member countries in which we have significant operations. We adopted the provisions of FSP No. 143-1 as it relates to these countries with no material impact on our financial statements. We will apply the guidance of FSP No. 143-1 as it relates to the remaining European Union member countries in which we operate when those countries have adopted the WEEE Directive into law. The effect of applying FSP No. 143-1 in the remaining countries in future periods is not expected to have a material effect on our results of operations or financial condition.

     On February 23, 2006, the FASB issued FSP No. FAS 123(R)-4, Classification of Options or Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement Upon the Occurrence of a Contingent Event. FSP No. FAS No. 123(R)-4 requires that an award of stock options or similar instruments that otherwise meet the criteria for equity classification, but contains a cash settlement feature that can require the entity to settle the award in cash only upon the occurrence of a contingent event that is outside the employee’s control, should be classified as a liability only when the event is probable of occurring. FSP No. FAS 123(R)-4 is effective for our first reporting period beginning after February 3, 2006. We do not believe that the adoption of FSP No. FAS 123(R)-4 will have a material effect on our results of operations or financial condition.

14. Subsequent Events

     On April 6, 2006, we amended our change of control agreement with Dana W. Kammersgard, President and Chief Executive Officer, and entered into change of control agreements with Patrick E. Collins, Chief Operating Officer, and Philip A. Davis, Senior Vice President of Sales and Marketing. Mr. Kammersgard’s amended change of control agreement provides that, in the event of an acquisition of Dot Hill or similar corporate event, Mr. Kammersgard’s then remaining unvested stock and options will become fully vested and he will be entitled to a lump sum cash payment equal to 125% of his annual base salary then in effect, reduced by any severance payments payable under his employment agreement. Mr. Collins’ change of control agreement provides that if Mr. Collins’ employment with us is terminated, other than for cause, in connection with an acquisition of Dot Hill or similar corporate event, Mr. Collins’ then remaining unvested stock and options will become fully vested and he will be entitled to a lump sum cash payment equal to 125% of his annual base

14

salary then in effect. Mr. Davis’ change of control agreement provides that if Mr. Davis’ employment with us is terminated, other than for cause, in connection with an acquisition of Dot Hill or similar corporate event, Mr. Davis’ then remaining unvested stock and options will become fully vested and he will be entitled to a lump sum cash payment equal to 125% of his annual base salary then in effect.

     Also on April 6, 2006, we entered into a severance agreement with Shad L. Burke, Interim Chief Financial Officer, Vice President of Finance, Corporate Controller and Assistant Secretary, that provides that if, within the next two years, we terminate Mr. Burke’s employment with us, other than for cause, or Mr. Burke terminates his employment with us for good reason, Mr. Burke will be entitled to a single lump sum payment equal to six months of his base salary as in effect at the time of such termination.

     On April 25, 2006, we were informed by Sun Microsystems, Inc., or Sun, of its decision to move potential future supply of a new, low-end, entry-level storage product to another party. The project had previously been directed solely to Dot Hill. We believe that Sun’s decision to re-direct the award to another party will not impact our current SE3000 product line being sold to Sun. As a result of Sun’s decision to re-direct the low-end, entry-level storage product to another party, the fair value of our reporting units has been affected. As a result of this impairment indicator, during the quarter ended June 30, 2006 we will need to evaluate whether goodwill and other intangibles have been impaired under SFAS No. 142. Additionally, we considered the likelihood of future realization of our deferred tax assets and concluded that based on the weight of available evidence, including cumulative profitability in recent years, it was more likely than not that our United States deferred tax assets will be realized.

15

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement for Forward-Looking Information

     Certain statements contained in this report, including, statements regarding the development, growth and expansion of our business, our intent, belief or current expectations, primarily with respect to our future operating performance and the products we expect to offer, and other statements 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, or the Exchange Act, and are subject to the “safe harbor” created by these sections. Because such forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, 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 can be found in Part II, Item 1A, “Risk Factors” and in our reports filed with the Securities and Exchange Commission, or SEC, including our Annual Report on Form 10-K for the year ended December 31, 2005. Readers are cautioned not to place undue reliance on forward-looking statements. The forward- looking statements speak only as of the date on which they are made, and we undertake no obligation to update such statements to reflect events that occur or circumstances that exist after the date on which they are made.

     The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and notes thereto included elsewhere in this quarterly report on Form 10-Q and our consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2005.

Overview

     We are a provider of storage systems for organizations requiring high reliability, high performance networked storage and data management solutions in an open systems architecture. Our storage solutions consist of integrated hardware and software products employing a modular system that allows end-users to add capacity as needed. Our broad range of products, from medium capacity stand-alone storage units to complete turn-key, multi-terabyte storage area networks, provides end-users with a cost-effective means of addressing increasing storage demands without sacrificing performance.

     Our products and services are sold worldwide to end-users primarily through our channel partners, including original equipment manufacturers, or OEMs, systems integrators, or SIs, and value added resellers, or VARs. In May 2002, we entered into a product purchase agreement with Sun Microsystems Inc., or Sun, to provide our storage hardware and software products for private label sales by Sun. That agreement has since been extended so that it expires on January 1, 2011 and now provides for automatic renewals for additional one-year periods unless either party notifies the other of its intent not to renew within a certain period of time. We have been shipping our products to Sun for resale to Sun’s customers since October 2002. Since the start of the relationship, we have continued to develop new products for resale by Sun and others. Our agreement with Sun was most recently amended in September 2005 to provide for discounts for prompt payment by Sun of amounts due to us and an extended repair warranty for repaired or replacement products that we deliver to Sun. Because of the significance of our relationship with Sun, we are subject to seasonality associated with Sun’s business. Typically, sales in the second quarter of our fiscal year reflect the positive impact associated with Sun’s fiscal year-end. Conversely, sales in the third quarter of our fiscal year typically reflect the impact of lower Sun first quarter sales compared to the historically stronger sales of Sun’s June year-end quarter. On April 25, 2006, we were informed by Sun of its decision to move potential future supply of a new, low-end, entry-level storage product to another party. The project had previously been directed solely to Dot Hill. We believe that Sun’s decision to re-direct the award to another party will not impact our current SE3000 product line being sold to Sun.

     On July 26, 2005, we entered into a Development and OEM Supply Agreement with Network Appliance, Inc. and Network Appliance B.V., collectively, NetApp. Under the Agreement, we will design and develop general purpose disk arrays for a variety of products to be developed for sale to NetApp. We believe that once sales under this agreement increase, which is expected to occur over the next several quarters, our revenue dependence upon Sun will be significantly reduced.

     On January 28, 2006, we entered into a Master Purchase Agreement with Fujitsu Siemens Computers GmbH and Fujitsu Siemens Computers (Holding) B.V., collectively, Fujitsu. Under the agreement, Dot Hill and Fujitsu will jointly develop storage solutions utilizing key components and patented technologies from Dot Hill. We believe that once sales under this agreement commence, our revenue dependence upon Sun will be further reduced.

16

     As part of our focus on indirect sales channels, we have outsourced substantially all of our manufacturing operations to Solectron Corporation, or Solectron, a leading electronics manufacturing services company. Our agreement with Solectron allows us to reduce sales cycle times and manufacturing infrastructure, enhance working capital and improve margins by taking advantage of Solectron’s manufacturing and procurement economies of scale.

     We derive a portion of our revenue from services associated with the maintenance service we provide for our installed products. In May 2003, we entered into a services agreement with Anacomp, Inc. to provide all maintenance, warranty and non-warranty services for our SANnet I and certain legacy products.

     Cost of goods sold includes costs of materials, subcontractor costs, salary and related benefits for the production and service departments, depreciation and amortization of equipment used in the production and service departments, production facility rent and allocation of overhead.

     Sales and marketing expenses consist primarily of salaries and commissions, advertising and promotional costs and travel expenses. Research and development expenses consist primarily of project-related expenses and salaries for employees directly engaged in research and development. General and administrative expenses consist primarily of compensation to officers and employees performing administrative functions, expenditures for administrative facilities and expenditures for legal and accounting services. Restructuring expenses consist primarily of employee severance, lease termination costs and other office closure expenses related to the consolidation of excess facilities.

     Other income is comprised primarily of interest income earned on our cash, cash equivalents, and short-term investments and other miscellaneous income and expense items.

     In August 1999, Box Hill Systems Corp. merged with Artecon, Inc. and we changed our name to Dot Hill Systems Corp. We reincorporated in Delaware in 2001. Our headquarters are located in Carlsbad, California, and we maintain international offices in Germany, Japan, the Netherlands, Singapore, Israel, Hungary and the United Kingdom.

     On February 23, 2004, we completed the acquisition of Chaparral Network Storage, Inc., or Chaparral, a privately held developer of specialized storage appliances as well as high-performance, midrange redundant arrays of independents disks, or RAID, controllers and data routers. The total transaction cost of approximately $67.6 million consisted of a payment of approximately $62 million in cash, the assumption of approximately $4.1 million related to obligations due certain employees covered by change in control agreements, approximately $0.8 million of direct transaction costs and approximately $0.7 million of accrued integration costs. The acquisition of Chaparral is expected to enable Dot Hill to increase the amount of proprietary technology within its storage systems, broaden its product line and diversify its customer base.

Critical Accounting Policies and Estimates

     Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and use judgment that may impact the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. As a part of our on-going internal processes, we evaluate our estimates, including those related to inventory write-downs, warranty cost accruals, revenue recognition, bad debt allowances, long-lived assets valuation, goodwill and intangible assets valuation, income taxes, including deferred income tax asset valuation, litigation and contingencies. We base these estimates upon both historical information and other assumptions that we believe are valid and reasonable under the circumstances. These assumptions form the basis for making judgments and determining the carrying values of assets and liabilities that are not apparent from other sources. Actual results could vary from those estimates under different assumptions and conditions.

     We believe that the policies set forth below may involve a higher degree of judgment and complexity in their application than our other accounting policies and represent the critical accounting policies used in the preparation of our financial statements.

Revenue Recognition

     Revenues are recognized pursuant to applicable accounting standards, including SEC Staff Accounting Bulletin No. 104, Revenue Recognition and Statement of Position (SOP) No. 97-2, Software Revenue Recognition.

17

     We recognize revenue for non-software product sales upon transfer of title to the customer. Reductions to revenue for estimated sales returns are also recorded at that time. These estimates are based on historical sales returns, changes in customer demand and other factors. If actual future returns and allowances differ from past experience, additional allowances may be required. Certain of our sales arrangements include multiple elements. Generally, these arrangements include delivery of the product, installation, training and product maintenance. Maintenance related to product sales entitles the customer to basic product support and significantly greater response time in resolving warranty related issues. We allocate revenue to each element of the arrangement based on its relative fair value. For maintenance contracts this is typically the price charged when such contracts are sold separately or renewed. Because professional services related to installation and training can be provided by other third party organizations, we allocate revenue related to professional services based on rates that are consistent with other like companies providing similar services, i.e., the market rate for such services. Revenue from product maintenance contracts is deferred and recognized ratably over the contract term, generally 12 months. Revenue from installation, training and consulting is recognized as the services are performed.

     For software sales, we apply SOP No. 97-2, whereby revenue is recognized from software licenses at the time the product is delivered, provided there are no significant 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. For arrangements with multiple elements, we allocate revenue to each element using the residual method based on vendor specific objective evidence of the undelivered items. A portion of the arrangement fee equal to the fair value of the undelivered elements, typically software maintenance contracts, is deferred and recognized ratably over the contract term, generally 12 months. Vendor specific objective evidence is based on the price charged when the element is sold separately. A typical arrangement includes a software-licensing fee and maintenance agreement.

     The cost of maintenance contracts entered into with third parties is deferred and recognized as expense over the contract term. The balance of deferred costs for maintenance contracts is included in prepaid expenses, other current assets and other long-term assets.

Valuation of Inventories

     Inventories are comprised of purchased parts and assemblies, which include direct labor and overhead. We record inventories at the lower of cost or market value, with cost generally determined on a first-in, first-out basis. We perform periodic valuation assessments based on projected sales forecasts and analyzing upcoming changes in future configurations of our products and record inventory write-downs for excess and obsolete inventory. Although we strive to ensure the accuracy of our forecasts, we periodically are faced with uncertainties. The outcomes of these uncertainties are not within our control, and may not be known for prolonged periods of time. Any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventories and commitments, and consequently, on our operating results. If actual market conditions become less favorable than those forecasted, additional inventory write-downs might be required, adversely affecting operating results.

Valuation of Goodwill

     We review goodwill for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable in accordance with Statement of Financial Accounting Standards, or SFAS, No. 142, Goodwill and Other Intangible Assets. The provisions of SFAS No. 142 require that a two-step impairment test be performed on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. Our reporting units are consistent with the reportable segments identified in the notes to our consolidated financial statements. We determine the fair value of our reporting units using the income approach. Under the income approach, we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step in order to determine the implied fair value of the reporting unit’s goodwill and compare it to the carrying value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we must record an impairment loss equal to the difference.

     The income approach is dependent on a number of factors including estimates of future market growth and trends, forecasted revenue and costs, expected periods the assets will be utilized, appropriate discount rates and other variables. We base our fair value estimates on assumptions we believe to be reasonable, but which are unpredictable and inherently uncertain. Actual future results may differ from those estimates.

18

Deferred Income Taxes

     We account for income taxes under the asset and liability method, under which deferred tax assets, including net operating loss carryforwards, and liabilities are determined based on temporary differences between the book and tax basis of assets and liabilities. We periodically evaluate the likelihood of the realization of deferred tax assets, and adjust the carrying amount of the deferred tax assets by the valuation allowance to the extent we believe a portion will be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, the carryforward periods available to us for tax reporting purposes, and other relevant factors.

     Due to our equity transactions, an ownership change, within the meaning of Internal Revenue Code, or IRC, Section 382, occurred on September 18, 2003. As a result, annual use of our federal net operating loss and credit carry forwards is limited to (i) the aggregate fair market value of Dot Hill. immediately before the ownership change multiplied by (ii) the long-term tax-exempt rate (within the meaning of IRC Section 382 (f)) in effect at that time. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the IRC Section 382 limitation for those years.

     As a result of our acquisition of Chaparral, a second ownership change, within the meaning of IRC Section 382, occurred on February 23, 2004. As a result, annual use of the acquired Chaparral’s federal net operating loss and credit carry forwards may be limited. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the IRC Section 382 limitation for those years.

     At December 31, 2005, based on the weight of available evidence, including cumulative profitability in recent years, we determined that it was more likely than not that a portion of our United States deferred tax assets would be realized and, at December 31, 2005, eliminated $47.1 million of valuation allowance associated with our United States deferred tax assets. The elimination of valuation allowance resulted in a $16.4 million decrease to goodwill to the extent of our acquired net deferred tax assets, a $5.4 million increase to equity for net operating losses arising from stock option deductions, with the remaining $25.3 million recognized as a one-time non-cash increase in earnings for the year ended December 31, 2005. As a result of our elimination of valuation allowance associated with United States deferred tax assets, our effective tax rate in subsequent periods is likely to more closely resemble the applicable federal and state statutory tax rates.

Stock-Based Compensation

     We account for stock-based compensation in accordance with SFAS No. 123(R), Share-Based Payment, which requires us to record stock compensation expense for equity based awards granted, including stock options, for which expense will be recognized over the service period of the equity based award based on the fair value of the award, at the date of grant. SFAS No. 123(R) revises SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.

     We adopted the provisions of SFAS No. 123(R) using the modified prospective transition method. In accordance with this transition method, our consolidated financial statements for prior periods have not been restated to reflect the impact of SFAS No. 123(R). Under the modified prospective transition method, share-based compensation expense for the first quarter of 2006 includes compensation expense for all share-based compensation awards granted prior to, but for which the requisite service has not yet been performed as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123. Share-based compensation expense for all share-based compensation awards granted after January 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R) using the Black-Scholes option-pricing model.

     On December 1, 2005, we accelerated vesting of certain unvested and “out-of-the-money” stock options with exercise prices equal to or greater than $6.74 per share that were previously awarded under our equity compensation plans to our employees. These options were accelerated to avoid recording future compensation expense with respect to such options following adoption of SFAS No. 123(R). Our management believes that because such options had exercise prices in excess of the current market value of our common stock, the options were not achieving their original objective. The acceleration of vesting was effective for stock options outstanding as of December 1, 2005. Options to purchase 0.6 million shares of common stock were subject to the acceleration and the weighted average exercise price of the options subject to the acceleration was $11.71. Due to this acceleration, an additional $2.8 million was included in the pro forma stock-based compensation expense for the year ended December 31, 2005.

     As of March 31, 2006, total unrecognized share-based compensation cost related to unvested stock options was $7.0 million, which is expected to be recognized over a weighted average period of approximately 2.8 years.

19

Contingencies

     We are subject to various legal proceedings and claims and tax matters, the outcomes of which are subject to significant uncertainty. SFAS No. 5, Accounting for Contingencies, requires that an estimated loss from a loss contingency should be accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. We evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial position or our results of operations. See Note 11 to our condensed consolidated financial statements for further information regarding contingencies.

Results of Operations

     The following table sets forth certain items from our statements of operations as a percentage of net revenue for the periods indicated:

	Three Months Ended
	March 31,
	2005			2006
Net revenue:		100.0	%		100.0	%
Cost of goods sold		77.1			81.0
Gross profit		22.9			19.0
Operating expenses:
Sales and marketing		8.0			7.1
Research and development		8.1			16.5
General and administrative		4.5			10.5
Total operating expenses		20.7			34.1
Operating income (loss)		2.2			(15.1	)
Other income, net		1.2			2.2
Income tax benefit		(0.2	)		(4.4	)
Net income (loss)		3.6	%		(8.5	)%

(percentages may not aggregate due to rounding)

Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005

Net Revenue

     Net revenue increased $0.7 million, or 1.2%, to $58.7 million for the three months ended March 31, 2006 from $58.0 million for the three months ended March 31, 2005. The increase in net revenue was attributable to increased orders for our products from our channel partner, Sun, which accounted for 87.7% of our net revenue for the three months ended March 31, 2006. Fibre Channel units shipped were 2,284 for the three months ended March 31, 2006 compared to 2,789 units for the three months ended March 31, 2005. Small Computer Systems Interface, or SCSI, units shipped were 3,265 for the three months ended March 31, 2006 compared to 3,570 units for the three months ended March 31, 2005. Blade units shipped were 1,958 for the three months ended March 31, 2006 compared to 926 units for the three months ended March 31, 2005. SATA units shipped were 674 for the three months ended March 31, 2006 compared to 566 units for the three months ended March 31, 2005. Additionally, the increase in revenue is attributable to sales of pre-production units related to our new product offerings. Non-Sun revenue was $7.2 million for the three months ended March 31, 2006 compared to $8.2 million for the three months ended March 31, 2005.

Cost of Goods Sold

     Cost of goods sold increased $2.8 million, or 6.3%, to $47.5 million for the three months ended March 31, 2006 from $44.7 million for the three months ended March 31, 2005. As a percentage of net revenue, cost of goods sold increased to 81.0% for the three months ended March 31, 2006 from 77.1% for the three months ended March 31, 2005. The increase in cost of goods sold was attributable to greater volume of product sales during the three months ended March 31, 2006 compared to the three months ended March 31, 2005. The increase in cost of goods sold, as a percentage of our net revenue is primarily attributable to a difference in our product mix and increased headcount.

20

Gross Profit

     Gross profit decreased $2.1 million, or 15.8%, to $11.2 million for the three months ended March 31, 2006 from $13.3 million for the three months ended March 31, 2005. As a percentage of net revenue, gross profit decreased to 19.0% for the three months ended March 31, 2006 from 22.9% for the three months ended March 31, 2005. The decrease in the dollar amount of gross profit is attributable to increased spending related to the product sales mix, additional headcount and consulting fees.

     The decrease in gross profit as a percentage of our net revenue for the three months ended March 31, 2006 when compared to the three months ended March 31, 2005 is attributed principally to a difference in our product mix, including the transition of our largest customer from 160MB SCSI to Ultra 320 SCSI, increased headcount in operations in support of new product launches and sales of prototypes to our new OEM customers.

Sales and Marketing Expenses

     Sales and marketing expenses decreased $0.5 million, or 10.6%, to $4.2 million for the three months ended March 31, 2006 from $4.7 million for the three months ended March 31, 2005. As a percentage of net revenue, sales and marketing expenses decreased to 7.1% for the three months ended March 31, 2006 from 8.0% for the three months ended March 31, 2005. The decrease in sales and marketing expenses is primarily attributable to a decrease in headcount at our subsidiaries in Japan and Europe. We expect sales and marketing expenses for the year ending December 31, 2006 will exceed spending levels incurred during 2005 due to our continued efforts to increase our market share and expand both our non-OEM commercial sales and channel partners.

Research and Development Expenses

     Research and development expenses increased $5.0 million, or 106.4%, to $9.7 million for the three months ended March 31, 2006 from $4.7 million for the three months ended March 31, 2005. As a percentage of net revenue, research and development expenses increased to 16.5% for the three months ended March 31, 2006 from 8.1% for the three months ended March 31, 2005. The increase in research and development expenses is primarily due to the investment in prototypes and project materials for products under development for the company’s new OEM customers of $3.7 million and payroll related expenses of $0.7 million. We expect research and development expenses for the year ending December 31, 2006 will exceed spending levels incurred during 2005 due to activities related to future product offerings.

General and Administrative Expenses

     General and administrative expenses increased $3.6 million, or 138.5%, to $6.2 million for the three months ended March 31, 2006 from $2.6 million for the three months ended March 31, 2005. As a percentage of net revenue, general and administrative expenses increased to 10.5% for the three months ended March 31, 2006 from 4.5% for the three months ended March 31, 2005. The increase is primarily attributable to $1.3 million of expenses associated with the acceleration of vesting of stock options of our former chief executive officer and his consulting agreement, legal expense of $0.8 million, stock option expense and employee stock purchase plan expense of $0.2 million related to the adoption of SFAS No. 123(R), implementation expenses related to our new enterprise resource planning, or ERP, software package, which became operational in January 2006, of $0.2 million, and consulting expenses related to the compliance with the Sarbanes-Oxley Act of 2002 of $0.2 million.

Other Income

     Other income increased by $0.6 million, or 85.7%, to $1.3 million for the three months ended March 31, 2006 from $0.7 million for the three months ended March 31, 2005. The increase was primarily attributable to an increase in interest income of $0.6 million due to rising interest rates.

Income Taxes

     We recorded an income tax benefit of $2.6 million for the three months ended March 31, 2006 attributable to the net loss for the three months ended March 31, 2006. Our effective income tax rate of 34.1% for the three months ended March 31, 2006 differs from the US federal statutory rate due to our valuation allowance against operations taxed in foreign jurisdictions, state taxes, and the impact of share based compensation expense recognized under SFAS 123(R). At March 31, 2005, we recorded a tax benefit of $0.1 million, reflecting an effective tax rate of (5.6%). Our effective tax rate for the three months ended March 31, 2005 differs from the US federal statutory rate primarily due to our US and foreign valuation

21

allowance position, federal and state minimum tax, and a discrete tax benefit of $0.2 million associated with the receipt by our European subsidiary of $0.2 million from European taxing authorities related to a 2002 loss that was carried back to the years 1998 through 2001.

     As of December 31, 2005, a valuation allowance of $3.6 million has been provided for our foreign deferred tax assets based upon our assessment of the future realizability of certain foreign deferred tax assets, as it is more likely than not that sufficient taxable income will not be generated to realize these deferred tax assets.

     As of December 31, 2005, we have federal and state net operating losses of approximately $113.1 million and $49.0 million, which begin to expire in the tax years ending 2009 and 2006, respectively. In addition, we have federal tax credit carryforwards of $2.9 million, of which $0.5 million can be carried forward indefinitely to offset future taxable income, and the remaining $2.4 million will begin to expire in the tax year ending 2008. We also have state tax credit carryforwards of $3.1 million, of which $2.9 million can be carried forward indefinitely to offset future taxable income, and the remaining $0.2 million will begin to expire in the tax year ending 2006.

     As a result of our equity transactions, an ownership change, within the meaning of IRC Section 382, occurred on September 18, 2003. As a result, annual use of our federal net operating loss and credit carry forwards is limited to (i) the aggregate fair market value of Dot Hill immediately before the ownership change multiplied by (ii) the long-term tax-exempt rate (within the meaning of IRC Section 382 (f)) in effect at that time. The annual limitation is cumulative and, therefore, if not fully utilized in a year, can be utilized in future years in addition to the IRC Section 382 limitation for those years.

     We have not provided for any residual U.S. income taxes on the earnings from our foreign subsidiaries because such earnings are intended to be indefinitely reinvested. Such residual U.S. income taxes, if any, would be insignificant.

Liquidity and Capital Resources

     As of March 31, 2006, we had $114.8 million of cash, cash equivalents and short-term investments. We had $130.1 million of working capital as of March 31, 2006.

     For the three months ended March 31, 2006, cash used in operating activities was $6.8 million compared to cash used in operating activities of $2.0 million for the same period in 2005. The net cash used in operating activities for the three months ended March 31, 2006 is primarily attributable to a net loss $5.0 million, an increase in accounts receivable of $10.2 million primarily due from Sun, an increase in our deferred tax assets of $2.6 million, a decrease in deferred revenue of $0.9 million, and an increase in prepaid expenses and other assets of $0.6 million. These amounts were offset by depreciation and amortization of $1.7 million, stock option expense related to the acceleration of our former chief executive officer’s stock options of $0.7 million, stock option expense of $0.3 million and employee stock purchase plan expense of $0.2 million attributable to the adoption of SFAS No. 123(R), an increase in accounts payable of $7.5 million primarily due to Solectron, and an increase in other long-term liabilities of $1.4 million primarily attributable to deferred rent related to our new corporate headquarters.

     Cash used in investing activities for the three months ended March 31, 2006 was $2.7 million compared to $21.5 million for the same period in 2005. The cash used in the three months ended March 31, 2006 is attributable to purchases related to our new corporate headquarters and machinery and equipment of $1.6 million, and purchases of short-term investments of $8.9 million, offset by the proceeds received from the maturity of short-term investments of $7.8 million.

     Cash provided by financing activities for the three months ended March 31, 2006 was $1.0 million compared to cash provided by financing activities of $0.7 million for same period in 2005. The cash provided by financing activities is attributable to the proceeds received from the exercises of stock options under our equity incentive plans and warrants of $0.4 million and the proceeds received from the sale of common stock to employees under our employee stock purchase plan of $0.6 million.

     We presently expect cash, cash equivalents, short-term investments and cash generated from operations to be sufficient to meet our operating and capital requirements for at least the next 12 months and to enable us to pursue acquisitions or significant capital improvements. The actual amount and timing of working capital and capital expenditures that we 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, our ability to manage our relationships with third party manufacturers, the status of our relationships with key customers, partners and suppliers, the timing and extent of the introduction of new products and services and growth in personnel and operations.

22

Recent Accounting Pronouncements

     In May 2005, the Financial Accounting Standards Board, or FASB, issued Statement No. 154, Accounting Changes and Error Corrections, which requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle and that a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. Statement No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

     In June 2005, the FASB issued Staff Position (FSP) No. 143-1, Accounting for Electronic Equipment Waste Obligations, which provides guidance on the accounting for obligations associated with the Directive on Waste Electrical and Electronic Equipment, or the WEEE Directive, which was adopted by the European Union. FSP No. 143-1 provides guidance on accounting for the effects of the WEEE Directive with respect to historical waste and waste associated with products on the market on or before August 13, 2005. FSP No. 143-1 requires commercial users to account for their WEEE obligation as an asset retirement liability in accordance with FASB Statement No. 143, Accounting for Asset Retirement Obligations. FSP No. 143-1 was required to be applied to the later of the first reporting period ending after June 8, 2005 or the date of the adoption of the WEEE Directive into law by the applicable European Union member country. The WEEE Directive has been adopted into law by the majority of European Union member countries in which we have significant operations. We adopted the provisions of FSP 143-1 as it relates to these countries with no material impact on its financial statements. We will apply the guidance of FSP No. 143-1 as it relates to the remaining European Union member countries in we operate when those countries have adopted the WEEE Directive into law. The effect of applying FSP No. 143-1 in the remaining countries in future periods is not expected to have a material effect on our results of operations or financial condition.

     On February 23, 2006, the FASB issued FSP No. FAS 123(R)-4, Classification of Options or Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement Upon the Occurrence of a Contingent Event. FSP No. FAS 123(R)-4 requires that an award of stock options or similar instruments that otherwise meet the criteria for equity classification, but contains a cash settlement feature that can require the entity to settle the award in cash only upon the occurrence of a contingent event that is outside the employee’s control, should be classified as a liability only when the event is probable of occurring. FSP No. FAS 123(R)-4 is effective for our first reporting period beginning after February 3, 2006. We do not believe that the adoption of FSP No. FAS 123(R)-4 will have a material effect on our results of operations or financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate and Credit Risk

     Our exposure to market rate risk for changes in interest rates relates to our investment portfolio. Our primary investment strategy is to preserve the principal amounts invested, maximize investment yields, and maintain liquidity to meet projected cash requirements. Accordingly, we invest in instruments such as money market funds, certificates of deposit, United States government/agencies bonds, notes, bills and municipal bonds that meet high credit quality standards, as specified in our investment policy guidelines. Our investment policy also limits the amount of credit exposure to any one issue, issuer, and type of instrument. We do not currently use derivative financial instruments in our investment portfolio and we do not enter into market risk sensitive instruments for trading purposes. We do not expect to incur any material losses with respect to our investment portfolio.

     The following table provides information about our investment portfolio at December 31, 2005 and March 31, 2006. For investment securities, the table presents carrying values at December 31, 2005 and March 31, 2006 and, as applicable, and related weighted average interest rates by expected maturity dates.

	December 31, 2005			March 31, 2006
	(amounts in thousands)
Cash equivalents	$	99,899		$	94,061
Average interest rate		4.3	%		4.6	%
Short-term investments	$	13,431		$	14,535
Average interest rate		3.2	%		4.2	%
Total portfolio	$	113,330		$	108,596
Average interest rate		4.2	%		4.7	%

23

     We have a line of credit agreement, which accrues interest at a variable rate. As of March 31, 2006, we had no balance under this line. Were we to incur a balance under this line of credit, we would be exposed to interest rate risk on such debt.

Foreign Currency Exchange Rate Risk

     A portion of our international business is presently conducted in currencies other than the United States 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 we conduct our business relative to the United States dollar will cause currency transaction gains and losses, which we have experienced in the past and continue to experience. Due to the substantial volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations upon future operating results. There can be no assurances that we will not experience currency losses in the future. We have not previously undertaken hedging transactions to cover currency exposure and we do not intend to engage in hedging activities in the future.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

     We conducted an evaluation, under the supervision and with the participation of our management, including our chief executive officer and interim chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), as of March 31, 2006. Based upon that evaluation, the chief executive officer and the interim chief financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report on Form 10-Q.

Changes in Internal Controls

     An evaluation was also performed under the supervision and with the participation of our management, including our chief executive officer and our interim chief financial officer, of any change in our internal control over financial reporting that occurred during our last quarter and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. During the three months ended March 31, 2006, we implemented a new ERP software package. While we have not finalized the documentation or performed testing of the related internal controls, we believe the implementation of our new ERP system has improved and will improve our internal controls over financial reporting by increasing the availability of data used in the financial closing process and through simplifying our closing process by decreasing the amount of manual processes previously required by our previous system. While we have not finalized the documentation or performed testing of the related internal controls, we believe the implementation of our new ERP system also has improved and will improve our internal control over inventory processing for the same reasons. Except as described above, the evaluation concluded that there has been no change in our internal control over financial reporting that occurred during the quarter covered by this quarterly report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

     Our management, including our chief executive officer and our interim chief financial officer, does not expect that our disclosure controls will prevent all errors or potential fraud. A control system, no matter how well conceived and operated, can provide only reasonable and not absolute assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their cost. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons or by collusion of two or more people. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

24

Part II. Other Information

Item 1. Legal Proceedings

     Crossroads Systems Litigation

     On October 17, 2003, Crossroads Systems, Inc., or Crossroads, filed a lawsuit against us in the United States District Court in Austin, Texas, alleging that our products infringe two United States patents assigned to Crossroads, Patent Numbers 5,941,972 and 6,425,035. We were served with the lawsuit on October 27, 2003. Chaparral was added as a party to the lawsuit in March 2004. The patents involve storage routers and methods for providing virtual local storage. Patent Number 5,941,972 involves the interface of SCSI storage devices and the Fibre Channel protocol and Patent Number 6,425,035 involves the interface of any one-transport medium and a second transport medium. We believe that we have meritorious defenses to Crossroads’ claims and are in the process of vigorously defending against them. The outcome is uncertain and no amounts have been accrued as of March 31, 2006. However, we expect to incur significant legal expenses in connection with this litigation. These defense costs, and other expenses related to this litigation, will be expensed as incurred and will negatively affect our operating results. A trial in the matter is expected to commence on June 5, 2006.

     Chaparral Securities Class Action

     In August 2004, a class action lawsuit was filed against, among others, Chaparral and a number of its former officers and directors in the United States District Court for the Central District of California. The lawsuit, among other things, alleges violations of federal and state securities laws and purports to seek damages on behalf of a class of shareholders who held interests in limited liability companies that had purchased, among other securities, Chaparral stock during a defined period prior to our acquisition of Chaparral. In May 2005, the Second Amended Complaint was dismissed with leave to amend. Plaintiffs filed a Third Amended Complaint, which the Court again dismissed with leave to amend in November of 2005 as to Chaparral and certain other defendants. Plaintiffs declined to amend within the proscribed period, and final judgment was entered in February 2006. Plaintiffs filed a notice appeal in the United States District Court of Appeals for the Ninth Circuit, though they have not filed their opening papers.

     Plaintiffs filed a related action in the Superior Court of the State of California, Orange County, in December of 2005, alleging many of the same claims. That action has been stayed pending the outcome of the federal appeal. We believe that the claims against Chaparral and its former officers and directors are without merit and are in the process of vigorously defending against them. The outcome is uncertain and no amounts have been accrued as of March 31, 2006.

     Dot Hill Securities Class Actions and Derivative Suits

     In late January and early February 2006, numerous purported class action complaints were filed against us in the United States District Court for the Southern District of California. The complaints allege violations of federal securities laws related to alleged inflation in our stock price in connection with various statements and alleged omissions to the public and to the securities markets and declines in our stock price in connection with the restatement of certain of our quarterly financial statements for fiscal year 2004, and seeking damages therefore. The court should approve a lead plaintiff(s) and approve lead counsel within the next 30 days. After the lead plaintiff files a consolidated class action complaint, or a consolidated complaint, we will move to dismiss the consolidated complaint.

     In addition, three complaints purporting to be derivative actions have been filed in California state court against certain of our directors and executive officers. These complaints are based on the same facts and circumstances described in the federal class action complaints and generally allege that the named directors and officers breached their fiduciary duties by failing to oversee adequately our financial reporting. Each of the complaints generally seeks an unspecified amount of damages. The cases are in the very preliminary stages. We believe the allegations against us and certain of our directors and executive officers in this action are without merit and we intend to vigorously defend against these claims. We are seeking dismissal of each derivative action by demurring to the complaints. The outcome is uncertain and no amounts have been accrued as of March 31, 2006.

     Other Litigation

     In addition to the actions discussed above, we are subject to various legal proceedings and claims, asserted or unasserted, which arise in the ordinary course of business. The outcome of the claims against us cannot be predicted with certainty. We believe that such litigation and claims will not have a material adverse effect on our financial condition or operating results.

25

Item 1A. Risk Factors

     The following sets forth risk factors that may affect our future results, including certain revisions to the risk factors included in our annual report on Form 10-K for the fiscal year ended December 31, 2005. Our business, results of operations and financial condition may be materially and adversely affected due to any of the following risks. The risks described below are not the only ones we face. Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations. The trading price of our common stock could decline due to any of these risks. In assessing these risks, you should also refer to the other information contained or incorporated by reference in this quarterly report on Form 10-Q, including our financial statements and related notes.

Under our OEM agreements with Sun, NetApp and others, our customers are not required to make minimum purchases or purchase exclusively from us, and we cannot assure you that our relationship with these key customers will not be terminated or will generate significant sales.

     Our business is highly dependent on our relationship with Sun, and we believe will be dependent, in the future, on our relationship with NetApp, once sales to that customer begin to increase. Sales to Sun accounted for 86.2% and 87.7% of our net revenue for the year ended December 31, 2005 and the three months ended March 31, 2006, respectively. Our OEM agreement with Sun had an initial term of three years and was extended in September 2005 for an additional five years through January 2011. Our OEM agreement with NetApp has a term of three years from the first commercial product shipments by NetApp, which is currently scheduled for the second half of 2006. There are no minimum purchase requirements or guarantees in our agreement with Sun or NetApp, the agreements do not obligate those customers to purchase storage solutions exclusively from us on a continual basis and either customer may cancel purchase orders submitted under the agreement at any time. Further, either customer may terminate the entire contract prior to the contract expiration date upon the occurrence of certain events that are not remedied within a specified cure period. The decision by these customers to terminate their respective contracts, to cease making purchases or to cancel purchase orders would cause our revenues to decline substantially. We cannot be certain if, when or to what extent any customer might cancel purchase orders, cease making purchases or elect not to renew the applicable contract upon the expiration of the current term. For example, on April 25, 2006, we were informed by Sun of its decision to move potential future supply of a new, low-end, entry-level storage product to another party. The project had previously been directed solely to Dot Hill. We expect to receive a substantial majority of our projected net revenue for the year ended December 31, 2006 from sales of our products to Sun and NetApp. We cannot assure you that we will achieve these expected sales levels. If we do not achieve the sales levels we expect to receive from these customers, our business and result of operations will be significantly harmed.

Any decline in Sun’s or NetApp’s sales could harm our business.

     A substantial majority of our revenues are generated by sales to Sun, and we expect a substantial majority of our future revenues to be generated by a combination of sales to Sun and NetApp. If Sun’s or NetApp’s storage-related sales decline, our revenues will also decline and our business could be materially harmed. In addition, Sun’s quarterly operating results typically fluctuate downward in the first quarter of their fiscal year when compared with the immediately preceding fourth quarter. Further, in June 2005, Sun acquired StorageTek, which is a fellow provider of storage systems. Additionally, Sun purchases products from Engenio Information Technologies, Inc., or Engenio. During October 2004, Engenio announced that it had broadened its OEM agreement with Sun. Under terms of the expanded agreement, Engenio will provide Sun with new modular storage technology and will co-develop future Sun storage products. While we do not currently believe that Engenio’s relationship with Sun or Sun’s acquisition of StorageTek will impact our sales or our relationship with Sun, we cannot predict with certainty the impact that these circumstances will have, if any, on our future sales to Sun.

     In addition, it is likely that NetApp’s sales of any storage products supplied to it by us will fluctuate on a quarterly or seasonal basis, which fluctuations will affect our financial results. Due to the infancy of the relationship, we can not be certain of what affect these fluctuations will have on our quarterly results, if any.

Lower than anticipated sales to NetApp could harm our business and render our expectations inaccurate, which could lead to a decrease in our stock price.

     During the third quarter of 2005, we entered into a Development and OEM Supply Agreement with NetApp pursuant to which we will design and develop general purpose disk arrays for a variety of products to be developed for sale to NetApp. We expect that sales to NetApp will increase, and have predicted that in the future, sales to NetApp will reduce our dependence upon Sun significantly and increase our revenue substantially. There are no guarantees that our relationship with NetApp will be successful, or that we will achieve the expected volume of sales to NetApp. Our agreement with NetApp does not provide for minimum purchase quantities, and allows NetApp to terminate the contract or stop purchasing from us upon the occurrence of certain events. If our sales to NetApp fall substantially short of our predictions, to the extent that our current stock price reflects anticipated increases in our revenue or profits based on sales to NetApp, our stock price likely will fall.

26

We are dependent on sales to a relatively small number of customers.

     While we intend to expand sales to channel partners, we expect to experience continued concentration in our customer base. As a result, if our relationship with any of our customers were disrupted, we would lose a significant portion of our anticipated net revenue. We cannot guarantee that our relationship with Sun, NetApp or other channel partners will expand or not otherwise be disrupted. Factors that could influence our relationship with significant channel partners, including Sun and NetApp, include:

• our ability to maintain our products at prices that are competitive with those of other storage system suppliers;

• our ability to maintain quality standards for our products sufficient to meet the expectations of our channel partners; and

• our ability to produce, ship and deliver a sufficient quantity of our products in a timely manner to meet the needs of our channel partners.

     None of our contracts with our existing channel partners, including Sun and NetApp, contain any minimum purchasing commitments. Further, we do not expect that future contracts with channel partners, if any, will include any minimum purchasing commitments. Changes in the timing or volume of purchases by our major customers could result in lower revenue. In addition, our existing contracts do not require our channel partners to purchase our products exclusively or on a preferential basis over the products of any of our competitors. Consequently, our channel partners may sell the products of our competitors. For example, on April 25, 2006, we were informed by Sun of its decision to move potential future supply of a new, low-end, entry-level storage product to another party. The project had previously been directed solely to Dot Hill.

Our business and operating results may suffer if we encounter significant product defects due to the introduction of our new, integrated systems.

     We completed the integration of RAID controller technology we obtained in our acquisition of Chaparral into certain of our storage systems resulting in the introduction of new, integrated systems.

     Our new, integrated systems, as well as our legacy products, may contain undetected errors or failures, which may be discovered after shipment, resulting in a loss of revenue or a loss or delay in market acceptance, which could harm our business. Even if the errors are detected before shipment, such errors could result in the halting of production, the delay of shipments, loss of goodwill, tarnishment of reputation or a substantial decrease in revenue. Our standard warranty provides that if our systems do not function to published specifications, we will repair or replace the defective component or system without charge. Significant warranty costs, particularly those that exceed reserves, could adversely impact our business. In addition, defects in our products could result in our customers claiming property damages, consequential damages, personal injury or even death, which could also result in our loss of customers and goodwill. Any such claim could distract management’s attention from operating our business and, if successful, result in damage claims against us that might not be covered by our insurance.

The loss of one or more suppliers could slow or interrupt the production and sales of our products.

     Solectron, our third party manufacturer, relies on third parties to supply key components of our storage products. Many of these components are available only from limited sources in the quantities and quality we require. Solectron purchases the majority of our RAID controllers from Infortrend Technology, Inc., or Infortrend. Solectron may not be able to purchase the type or quantity of components from third party suppliers as needed in the future.

     From time to time there is significant market demand for disk drives, RAID controllers and other components, and we may experience component shortages, selective supply allocations and increased prices of such components. In such event, we may be required to purchase our components from alternative suppliers. Even if alternative sources of supply for critical components such as disk drives and controllers become available, incorporating substitute components into our products could delay our ability to deliver our products in a timely manner. For example, we estimate that replacing Infortrend’s RAID controllers with those of another supplier would involve several months of hardware and software modification, which could significantly harm our ability to meet our customers’ orders for our products, damage our customer relationships and result in a loss of sales.

27

Manufacturing disruptions could harm our business.

     We rely on Solectron to manufacture substantially all of our products. If our agreement with Solectron is terminated or if Solectron does not perform its obligations under our agreement, it could take several months to establish alternative manufacturing for our products and we may not be able to fulfill our customers’ orders in a timely manner. Under our OEM agreement with Sun, Sun has the right to require that we use a third party to manufacture our products. Such an external manufacturer must meet Sun’s engineering, qualification and logistics requirements. If our agreement with Solectron terminates, we may be unable to find another external manufacturer that meets Sun’s requirements. With our increased use of third-party manufacturers, our ability to control the timing of shipments has continued and will continue to decrease. Delayed shipment could result in the deferral or cancellation of purchases of our products. Any significant deferral or cancellation of these sales would harm our results of operations in any particular quarter. Net revenue for a period may be lower than predicted if large orders forecasted for that period are delayed or are not realized, which could result in cash flow problems or a decline in our stock price.

Any shortage of disk drives or other components could increase our costs or harm our ability to manufacture and deliver our storage products to our customers in a timely manner.

     Demand for disk drives recently surpassed supply, forcing drive manufacturers, including those who supply the disk drives integrated into many of our storage products, to manage allocation of their inventory. If this shortage is prolonged, we may be forced to pay higher prices for disk drives or may be unable to purchase sufficient quantities of disk drives to meet our customers’ demand for our storage products in a timely manner or at all. Similar circumstances could occur with respect to other necessary components.

We may experience losses in the future.

     For the years ended December 31, 2005, 2004 and 2003 we recorded net income of $26.6 million, $11.6 million and $12.1 million, respectively; however, for the years ended December 31, 2002 and 2001, we incurred net losses of $34.3 million and $43.4 million, respectively. Further, our latest forecast predicts that we will incur a loss for 2006, fueled, in part, by an increased investment in research and development and significant legal fees associated with our current legal matters. We cannot assure you that we will be profitable in any future period. Our future capital requirements will depend on, and could increase substantially as a result of, many factors, including:

• our plans to maintain and enhance our engineering, research, development and product testing programs;

• the success of our manufacturing strategy;

• the success of our sales and marketing efforts;

• the extent and terms of any development, marketing or other arrangements;

• changes in economic, regulatory or competitive conditions; and

• costs of filing, prosecuting, defending and enforcing intellectual property rights.

     Our available cash, cash equivalents, and short-term investments as of March 31, 2006 totaled $114.8 million. We presently expect cash, cash equivalents, short-term investments and cash generated from operations to be sufficient to meet our operating and capital requirements through at least the next 12 months. However, unanticipated events, such as Sun’s or NetApp’s failure to meet its product purchase forecast or extraordinary expenses or operating expenses in excess of our projections, may require us to raise additional funds. We may not be able to raise additional funds on commercially reasonable terms or at all. Any sales of our debt or equity securities in the future may have a substantial dilutive effect on our existing stockholders. If we are able to borrow funds, we may be required to grant liens on our assets to the provider of any source of financing or enter into operating, debt service or working capital covenants with any provider of financing that could hinder our ability to operate our business in accordance with our plans. As a result, our ability to borrow money on a secured basis may be impaired, and we may not be able to issue secured debt on commercially reasonable terms or at all.

28

Our quarterly operating results have fluctuated significantly in the past and are not a good indicator of future performance.

     Our quarterly operating results have fluctuated significantly in the past as shown in the following table and are not a good indicator of future performance (in millions).

Quarter	Net Revenue		Net Income (Loss)
First Quarter 2002	$	10.9	$	(6.2	)
Second Quarter 2002		11.2		(8.9	)
Third Quarter 2002		8.6		(7.3	)
Fourth Quarter 2002		16.3		(11.9	)
First Quarter 2003		30.5		(1.5	)
Second Quarter 2003		48.4		2.6
Third Quarter 2003		51.0		4.3
Fourth Quarter 2003		57.5		6.6
First Quarter 2004		47.9		(2.6	)
Second Quarter 2004		69.0		6.7
Third Quarter 2004		57.0		3.5
Fourth Quarter 2004		65.5		4.0
First Quarter 2005		58.0		2.1
Second Quarter 2005		65.9		3.3
Third Quarter 2005		53.6		(1.3	)
Fourth Quarter 2005*		56.3		22.5
First Quarter 2006		58.7		(5.0	)

* Includes deferred tax benefit from reversal of valuation allowance of $25.3 million.

     In addition, the announcement of financial results that fall short of the results anticipated by the public markets could have an immediate and significant negative effect on the trading price of our common stock in any given period.

We may have difficulty predicting future operating results due to both internal and external factors affecting our business and operations, which could cause our stock price to decline.

     Our operating results may vary significantly in the future depending on a number of factors, many of which are out of our control, including:

• the size, timing, cancellation or rescheduling of significant orders;

• the cost of litigation and settlements involving intellectual property and other issues;

• product configuration, mix and quality issues;

• market acceptance of our new products and product enhancements and new product announcements or introductions by our competitors;

• manufacturing costs;

• deferrals of customer orders in anticipation of new products or product enhancements;

• changes in pricing by us or our competitors;

• our ability 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 Infortrend, a sole-source provider;

• our success in creating brand awareness and in expanding our sales and marketing programs;

• the level of competition;

29

• potential reductions in inventories held by channel partners;

• slowing sales of the products of our channel partners;

• technological changes in the open systems storage market;

• levels of expenditures on research, engineering and product development;

• changes in our business strategies;

• personnel changes; and

• general economic trends and other factors.

If our customers delay or cancel orders or return products, our results of operations could be harmed.

     We generally do not enter into long-term purchase contracts with customers, and customers usually have the right to extend or delay shipment of their orders, return products and cancel orders. As a result, sales in any period are generally dependent on orders booked and shipped in that period. Delays in shipment orders, product returns and order cancellations in excess of the levels we expect would harm our results of operations.

Our sales cycle varies substantially and future net revenue in any period may be lower than our historical revenues or forecasts.

     Our sales are difficult to forecast because the open systems storage market is rapidly evolving and our sales cycle varies substantially from customer to customer. Customer orders for our products 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 the sale of our product may last from six to 24 months. This is particularly true during times of economic slowdown, for sales to channel partners and for the sale and installation of complex solutions. We have shifted our business strategy to focus primarily on channel partners, with whom sales cycles are generally lengthier, more costly and less certain than direct sales to end-users.

     Additional factors that may extend our sales cycle, particularly orders for new products, include:

• the amount of time needed for technical evaluations by customers;

• customers’ budget constraints and changes to customers’ budgets during the course of the sales cycle;

• customers’ internal review and testing procedures; and

• our engineering work necessary to integrate a storage solution with a customer’s system.

     Our net revenue is difficult for us to predict since it is directly affected by the timing of large orders. Due to the unpredictable timing of customer orders, we may ship products representing a significant portion of our net sales for a quarter during the last month of that quarter. In addition, our expense levels are based, in part, on our expectations as to future sales. As a result, if sales levels are below expectations, our operating results may be disproportionately affected. We cannot assure you that we will experience sales growth in future periods.

The market for our products is subject to substantial pricing pressure that may decrease our margins.

     Pricing pressures exist in the data storage market and have harmed and may, in the future, continue to harm our net revenue and earnings. These pricing pressures are due, in part, to continuing decreases in component prices, such as those of disks and RAID controllers. Decreases in component prices are customarily passed on to customers by storage companies through a continuing decrease in the price of storage hardware systems. In addition, because we expect to continue to make most of our sales to a small number of customers, we are subject to continued pricing pressures from our customers, particularly our OEM customers. Pricing pressures are also due, in part, to the current difficult economic conditions, which have led many companies in our industry to pursue a strategy of decreasing prices in order to win sales, the narrowing of functional differences among competitors, which forces companies to compete on price as opposed to features of products, and the introduction of new technologies, which leaves older technology more vulnerable to pricing pressures. To the extent

30

we are unable to offset those pressures with commensurate cost reductions from our suppliers or by providing new products and features, our margins will be harmed.

Our success depends significantly upon our ability to protect our intellectual property and to avoid infringing the intellectual property of third parties, which has already resulted in costly, time-consuming litigation and could result in the inability to offer certain products.

     We rely primarily on patents, copyrights, trademarks, trade secrets, nondisclosure agreements and common law to protect our intellectual property. For example, we have registered trademarks for SANnet, SANpath®, SANscape®, Stratis®, Dot Hill®, Dot Hill Systems® and the Dot Hill logo. Despite our efforts to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. In addition, the laws of foreign countries may not adequately protect our intellectual property rights. Our efforts to protect our intellectual property from third party discovery and infringement may be insufficient and third parties may independently develop technologies similar to ours, duplicate our products or design around our patents.

     On October 17, 2003, Crossroads Systems filed a lawsuit against us in the United States District Court in Austin, Texas alleging that our products infringe two United States patents assigned to Crossroads, Patent Numbers 5,941,972 and 6,425,035. We were served with the lawsuit on October 27, 2003. In March 2004, Chaparral was added as a party to the lawsuit. The patents involve storage routers and methods for providing virtual local storage. Patent Number 5,941,972 involves the interface of SCSI storage devices and the Fibre Channel protocol and Patent Number 6,425,035 involves the interface of any one transport medium and a second transport medium. We believe that we have meritorious defenses to Crossroads’ claims and intend to vigorously defend against them. A trial in the matter is expected to commence on June 5, 2006. We have already incurred, and expect to continue to incur, significant legal expenses in connection with this litigation. These defense costs, and other expenses related to this litigation, will be expensed as incurred and will negatively affect our future operating results. If we are not successful in our defense of Crossroads’ claims, we may be required to pay significant amounts in the form of damages for past infringement. We also could be required to pay significant amounts in the form of licensing fees to allow us to continue to market certain products in the future, or Crossroads may deny us a license, which could lead to our inability to offer certain features on our products thereby rendering them less desirable or even unmarketable, or we may be denied the ability to distribute the product in any form. Further, other third parties may assert additional infringement claims against us in the future, which would similarly require us to incur substantial license fees, legal fees and other expenses, and distract management from the operations of our business.

     We expect that providers of storage products will increasingly be subject to infringement claims as the number of products and competitors increases. In addition to the formal claims brought against us by Crossroads, we receive, from time to time, letters from third parties suggesting that we may require a license from such third parties to manufacture or sell our products. We evaluate all such communications to assess whether to seek a license from the patent owner. We may be required to purchase licenses that could have a material impact on our business, or, we may not be able to obtain the necessary license from a third party on commercially reasonable terms, or at all.

     Consequently, we could be prohibited from marketing products that incorporate the protected technology or incur substantial costs to redesign our products in a manner to avoid infringement of third party intellectual property rights.

The market for storage systems is intensely competitive and our results of operations, pricing and business could be harmed if we fail to maintain or expand our market position.

     The storage market is intensely competitive and is characterized by rapidly changing technology. We compete primarily against independent storage system suppliers, including EMC, Hitachi, Engenio, and Xyratex.

     Many of our existing and potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical, sales, marketing and other resources than us. As a result, they may have more advanced technology, larger distribution channels, stronger brand names, better customer service and access to more customers than we do. Other large companies with significant resources could become direct competitors, either through acquiring a competitor or through internal efforts. Additionally, a number of new, privately held companies are currently attempting to enter the storage market, some of which may become significant competitors in the future. Any of these existing or potential 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 deliver competitive products at lower prices than us.

31

     We could also lose current or future business to any of our suppliers or manufacturers, some of which directly and indirectly compete with us. Currently, we leverage our supply and manufacturing relationships to provide a significant share of our products. Our suppliers and manufacturers are very familiar with the specific attributes of our products and may be able to provide our customers with similar products. We also expect that competition will increase as a result of industry consolidation and the creation of companies with new, innovative product offerings. For example, on June 2, 2005, Sun purchased StorageTek. 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 our prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition is likely to result in price reductions, reduced operating margins and potential loss of market share, any of which could harm our business. We believe that the principal competitive factors affecting the storage systems market include:

• product performance, features, scalability and reliability;

• price;

• product breadth;

• timeliness of new product introductions; and

• interoperability and ease of management.

     We cannot assure you that we will be able to successfully incorporate these factors into our products and compete against current or future competitors or that competitive pressures we face will not harm our business. If we are unable to develop and market products to compete with the products of competitors, our business will be materially and adversely affected. In addition, if major channel partners who are also competitors cease purchasing our products in order to concentrate on sales of their own products, our business will be harmed.

The open systems storage market is rapidly changing and we may be unable to keep pace with or properly prepare for the effects of those changes.

     The open systems data storage market in which we operate is characterized by rapid technological change, frequent new product introductions, evolving industry standards and consolidation among our competitors, suppliers and customers. Customer preferences in this market are difficult to predict and changes in those preferences and the introduction of new products by our competitors or us could render our existing products obsolete. Our success will depend upon our 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 we cannot successfully identify, manage, develop, manufacture or market product enhancements or new products, our business will be harmed. In addition, consolidation among our competitors, suppliers and customers may harm our business by increasing the resources of our competitors, reducing the number of suppliers available to us for our product components and increasing competition for customers by reducing customer-purchasing decisions.

A significant percentage of our expenses are fixed, and if we fail to generate revenues in associated periods, our operating results will be harmed.

     Although we have taken a number of steps to reduce operating costs, we may have to take further measures to reduce expenses if we experience operating losses or do not achieve a stable net income. A number of factors could preclude us from successfully bringing costs and expenses in line with our net revenue, such as the fact that our expense levels are based in part on our expectations as to future sales, and that a significant percentage of our expenses are fixed, which limits our ability to reduce expenses quickly in response to any shortfalls in net revenue. As a result, if net revenue does not meet our projections, operating results may be negatively affected. We may experience shortfalls in net revenue 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;

32

• sudden shortages of raw materials or fabrication, test or assembly capacity constraints that lead our suppliers and manufacturers to allocate available supplies or capacity to other customers, which, in turn, may harm our ability to meet our sales obligations;

• the reduction, rescheduling or cancellation of customer orders; and

• our inability to market products with competitive features, or the inability to market certain products in any form, due to the patents or other intellectual property rights of third parties.

     In addition, we typically plan our 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 our outside suppliers, we may order materials in advance of anticipated customer demand. This advance ordering has continued and may result in excess inventory levels or unanticipated inventory write-downs due to expected orders that fail to materialize.

Our success depends on our ability to attract and retain key personnel.

     Our performance depends in significant part on our ability to attract and retain talented senior management and other key personnel. Our key personnel include Dana Kammersgard, our Chief Executive Officer and President, Patrick Collins, our Chief Operating Officer, and Phil Davis, our Senior Vice President of Worldwide Sales and Marketing. If any of these individuals were to terminate his employment with us, we would be required to locate and hire a suitable replacement. Competition for attracting talented employees in the technology industry is intense. We may be unable to identify suitable replacements for any employees that we lose. In addition, even if we are successful in locating suitable replacements, the time and cost involved in recruiting, hiring, training and integrating new employees, particularly key employees responsible for significant portions of our operations, could harm our business by delaying our production schedule, our research and development efforts, our ability to execute on our business strategy and our client development and marketing efforts.

     Many of our customer relationships are based on personal relationships between the customer and our sales representatives. If these representatives terminate their employment with us, we may be forced to expend substantial resources to attempt to retain the customers that the sales representatives serviced. Ultimately, if we were unsuccessful in retaining these customers, our net revenue would decline.

Our executive officers and directors and their affiliates own a significant percentage of our outstanding shares, which could prevent us from being acquired and adversely affect our stock price.

     As of March 31, 2006, our executive officers, directors and their affiliates beneficially owned approximately 10.5% of our outstanding shares of common stock. These individual stockholders may be able to influence matters requiring approval by our stockholders, including the election of a majority of our directors. The voting power of these stockholders under certain circumstances could have the effect of delaying or preventing a change in control of us. This concentration of ownership may also make it more difficult or expensive for us to obtain financing. Further, any substantial sale of shares by these individuals could depress the market price of our common stock and impair our ability to raise capital in the future through the sale of our equity securities.

Protective provisions in our charter and bylaws and the existence of our stockholder rights plan could prevent a takeover which could harm our stockholders.

     Our certificate of incorporation and bylaws contain a number of provisions that could impede a takeover or prevent us from being acquired, including, but not limited to, a classified board of directors, the elimination of our stockholders’ ability to take action by written consent and limitations on the ability of our stockholders to remove a director from office without cause. Our 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 our board of directors without stockholder approval. In addition, we adopted a stockholder rights plan in May 2003 that is designed to impede takeover transactions that are not supported by our board of directors. Each of these charter and bylaw provisions and the stockholder rights plan gives our board of directors, acting without stockholder approval, the ability to prevent, or render more difficult or costly, the completion of a takeover transaction that our stockholders might view as being in their best interests.

33

The exercise of outstanding warrants may result in dilution to our stockholders.

     Dilution of the per share value of our common stock could result from the exercise of outstanding warrants. As of March 31, 2006 there were outstanding warrants to purchase 1,696,081 shares of our common stock. The warrants have exercise prices ranging from $2.97 to $4.50 per share and expire at various dates through March 14, 2008. When the exercise price of the warrants is less than the trading price of our common stock, exercise of the warrants would have a dilutive effect on our stockholders. The possibility of the issuance of shares of our common stock upon exercise of the warrants could cause the trading price of our common stock to decline.

Our stock price may be highly volatile and could decline substantially and unexpectedly.

     The trading price of our shares of common stock has been affected by the factors disclosed in this section as well as prevailing economic and financial trends and conditions in the public securities markets. Share prices of companies in technology-related industries, such as ours, tend to exhibit a high degree of volatility. The announcement of financial results that fall short of the results anticipated by the public markets could have an immediate and significant negative effect on the trading price of our shares in any given period. Such shortfalls may result from events that are beyond our immediate control, can be unpredictable and, since a significant proportion of our sales during each fiscal quarter tend to occur in the latter stages of the quarter, may not be discernible until the end of a financial reporting period. These factors may contribute to the volatility of the trading value of our shares regardless of our long-term prospects. The trading price of our shares may also be affected by developments, including reported financial results and fluctuations in trading prices of the shares of other publicly held companies, in our industry generally and our business segment in particular, which may not have any direct relationship with our business or prospects.

     In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. For example, in late January and early February 2006, numerous purported class action complaints were filed against us in the United States District Court for the Southern District of California. The complaints allege violations of federal securities laws related to alleged inflation in our stock price in connection with various statements and alleged omissions to the public and to the securities markets and declines in our stock price in connection with the restatement of certain of our quarterly financial statements for fiscal year 2004, and seeking damages therefore. In addition, three complaints purporting to be derivative actions have been filed in California state court against certain of our directors and executive officers. These complaints are based on the same facts and circumstances described in the federal class action complaints and generally allege that the named directors and officers breached their fiduciary duties by failing to oversee adequately our financial reporting. Each of the complaints generally seeks an unspecified amount of damages. The cases are in the very preliminary stages. We believe the allegations against us and certain of our directors and executive officers in this action are without merit and we intend to vigorously defend against these claims. Securities litigation could result in the expenditure of substantial funds, divert management’s attention and resources, harm our reputation in the industry and the securities markets and reduce our profitability.

Future sales of our common stock may hurt our market price.

     A substantial number of shares of our common stock may become available for resale. If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could decline. These sales might also make it more difficult for us to sell equity securities in the future at times and prices that we deem appropriate. In addition, we are obligated to file a registration statement with respect to the resale of up to 1,394,269 shares of our common stock issuable upon exercise of warrants held by Sun.

Geopolitical military conditions, including terrorist attacks and other acts of war, may materially and adversely affect the markets on which our common stock trades, the markets in which we operate, our operations and our profitability.

     Terrorist attacks and other acts of war, and any response to them, may lead to armed hostilities and such developments would likely cause instability in financial markets. Armed hostilities and terrorism may directly impact our facilities, personnel and operations that are located in the United States and internationally, as well as those of our channel partners, suppliers, third party manufacturer and customers. Furthermore, severe terrorist attacks or acts of war may result in temporary halts of commercial activity in the affected regions, and may result in reduced demand for our products. These developments could have a material adverse effect on our business and the trading price of our common stock.

34

Compliance with Sarbanes-Oxley Act of 2002.

     We are exposed to significant costs and risks associated with complying with increasingly stringent and complex regulation of corporate governance and disclosure standards. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ Stock Market rules require growing expenditure of management time and external resources. In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and evaluation of our internal controls, and attestations of the effectiveness of our internal controls by our independent auditors. This process has required us to hire additional personnel and outside advisory services and has resulted in significant accounting and legal expenses. We expect to continue to incur significant expense in future periods to comply with regulations pertaining to corporate governance as described above. In addition, we have recently implemented an ERP system. This process is extremely complicated, time consuming and expensive, and while we believe the implementation was successful, it may not be sufficient to address all of our accounting system management needs.

Item 6. Exhibits

The following exhibits are included as part of this quarterly report on Form 10-Q:

Exhibit
Number	Description
3.1	Certificate of Incorporation of Dot Hill Systems Corp. (1)
3.2	Bylaws of Dot Hill Systems Corp. (1)
4.1	Certificate of Incorporation of Dot Hill Systems Corp. (1)
4.2	Bylaws of Dot Hill Systems Corp. (1)
4.3	Form of Common Stock Certificate. (2)
4.4	Certificate of Designation of Series A Junior Participating Preferred Stock, as filed with the Secretary of State of Delaware on May 19, 2003. (3)
4.5	Form of Rights Certificate. (3)
10.1	Offer letter agreement dated February 22, 2006 between Dot Hill Systems Corp. and Patrick Collins. (4)†
10.2	Consulting letter agreement effective March 1, 2006 and dated March 2, 2006 between Dot Hill Systems Corp. and James L. Lambert. (5)
10.3	Description of 2006 Executive Compensation Plan. (5)†
10.4	Master Purchase Agreement effective January 13, 2006 by and among Dot Hill Systems Corp., Dot Hill Systems B.V., Fujitsu Siemens Computers GmbH and Fujitsu Siemens Computers (Holding) B.V.*
31.1	Certification pursuant to 17 CFR 240.13a-14(a) or 17 CFR 240.15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification pursuant to 17 CFR 240.13a-14(a) or 17 CFR 240.15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

†	Indicates management or compensatory plan or arrangement required to be identified pursuant to Item 15(b).
*	Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the SEC.
(1)	Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on September 19, 2001 and incorporated herein by reference.
(2)	Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on January 14, 2003 and incorporated herein by reference.
(3)	Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on May 19, 2003 and incorporated herein by reference.
(4)	Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on February 24, 2006 and incorporated herein by reference.
(5)	Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on March 8, 2006 and incorporated herein by reference.

35

SIGNATURES

     Pursuant to the requirements 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.
Date: May 10, 2006	By	/s/ DANA W. KAMMERSGARD
		Dana W. Kammersgard
		Chief Executive Officer and President (Principal Executive Officer)
Date: May 10, 2006	By	/s/ SHAD L. BURKE
		Shad L. Burke
		Interim Chief Financial Officer, Vice President of Finance, Corporate Controller and Assistant Secretary (Principal Financial and Accounting Officer)

36

EX-10.4

Confidential

Exhibit 10.4
***Text Omitted and Filed Separately
with the Securities and Exchange Commission.
Confidential Treatment Requested
Under 17 C.F.R. Sections 200.80(b)(4)
and 240.24b-2.

MASTER PURCHASE AGREEMENT

by and between

Dot Hill Systems, B.V.

with a place of business at
Marssteden 95, 7547 TD Enschede, The Netherlands

and Dot Hill Systems Corp.

with a place of business at
6305 El Camino Real, Carlsbad, CA 92009
as well as all its subsidiaries

(-hereinafter collectively “VENDOR”-)

and

Fujitsu Siemens Computers GmbH

with a place of business at
Domagkstrasse 28, 80807 München, Germany

and RELATED COMPANIES

(-hereinafter “FSC”-)

(FSC and VENDOR are also referred to hereinafter singularly as “Party” or together as “Parties”)

Effective Date: January 13, 2006

Page 1 of 21

RECITALS

(A)	Whereas, VENDOR owns and manufactures products defined below as CP in which FSC is interested to buy for its own use and for SELLING PURPOSES.
(B)	Whereas, VENDOR is willing to deliver such CP to FSC in accordance with the terms and subject to the conditions stated herein.
(C)	Whereas FSC shall be entitled to resell such CP to other parties.

NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged,

THE PARTIES HEREBY AGREE AS FOLLOWS:

1.	DEFINITIONS
	“AGREEMENT” shall mean this AGREEMENT and all attached ANNEXES, all documents or DOCUMENTATION referenced in this AGREEMENT, and all numbered Amendments to this AGREEMENT that are executed by authorized representatives of the PARTIES in the future.
	“CONFIRMED DELIVERY DATE” is the date for delivery of CP according to agreed Incoterms that has been confirmed by VENDOR.
	“CONFIDENTIAL INFORMATION” shall mean information and data of a confidential nature, whether in oral, written or electronic form or any other form whatsoever, including but not limited to business, commercial, research, developmental, manufacturing, operating, performance, process, product and any other technical information, know how, intellectual property rights, samples, models, apparatus and all data bearing media containing or disclosing such information and techniques which are made available pursuant to this Agreement and includes the provisions of this Agreement and the subject matter relating thereto.
	“CP” shall mean the Contractual Product(s) presently named as stated, described and specified in ANNEX 1 CONTRACTUAL PRODUCTS and ANNEX 2 DOCUMENTATION, including all future improvements or modifications to same that are made available by VENDOR to FSC under this AGREEMENT. CP shall mean complete equipment(s), units, FRUs, Spare Parts, and SOFTWARE incorporated therein -if any.
	“DOCUMENTATION” shall mean any SYSTEM DOCUMENTATION, USER DOCUMENTATION and other documentation that is related to the CP as listed in ANNEX 2 DOCUMENTATION.
	“EMS” (Electronic Manufacturing Service) /”ODM” (Original Design Manufacturer) shall mean any third party to this agreement who manufactures products for FSC.
	“EFFECTIVE DATE” shall mean the date stated on the cover page or — if unspecified — the last-to-occur date of the signing of this AGREEMENT by the PARTIES.

Page 2 of 21

	“EPIDEMIC FAILURE” shall mean defects or malfunctions in the CPs exceeding the failure rates or percentages detailed in ANNEX 7 QUALITY ASSURANCE.
	“FRU” or “Field Replaceable Unit” shall mean a subassembly of a CP, or Spare Part, which can be replaced at the customer site.
	“INVENTORY” shall mean CPs in stock at the premises of FSC which are in the ownership of FSC.
	“ORDERING PROCEDURE” means the procedure specified in section 2 of this AGREEMENT.
	“REQUESTED DELIVERY DATE” is the date that FSC has requested for the delivery of an order placed by FSC to VENDOR.
	“RELATED COMPANIES” shall mean subsidiaries of Fujitsu Siemens Computers (Holding) B.V., Netherlands and its subsidiaries. For the purpose of this definition, “subsidiaries” shall mean companies in which a parent company has the majority of votes and/or stock.
	“SELLING PURPOSES” in the context of this AGREEMENT shall include the right of FSC to sell or resell CP on its own or to incorporate CP into other products of FSC.
	“SOFTWARE” –if any- shall mean any computer software program in machin-readable form made available by VENDOR to FSC.
	“SPARE PARTs” shall mean those are listed in the BASIC SPARE PARTS LIST as attached to ANNEX 6 SPARE PARTS AND REPAIR.
	“SYSTEM DOCUMENTATION” shall mean the current and updated version(s) of the technical documentation for the manufacturing, engineering and maintenance of CP as well as packaging and transportation instructions, as listed in ANNEX 2 DOCUMENTATION.
	“USER DOCUMENTATION” shall mean all User Manuals and/or Reference Guides for the CP as described in ANNEX 2 DOCUMENTATION as updated upon notification.
	“WARRANTY PERIOD” is the period of time, starting at the date of first delivery from VENDOR to FSC, during which CPs are warranted by VENDOR and which is specified in ANNEX 1 CONTRACTUAL PRODUCTS.
2.	ORDERING PROCEDURE
2.1	Purchase order(s) shall be placed by FSC in accordance with the provisions of this Section 2 of the AGREEMENT.
2.1.1	FSC written or electronic purchase order(s) shall be issued in the scope of this AGREEMENT and shall then form the basis of VENDOR’s delivery obligations.
	Each purchase order will include the following particulars:

Page 3 of 21

Purchase Order number and date

- CP quantity to be delivered

- Specification number and revision level

- Part number and revision level

- Item description

- Unit price

- REQUESTED DELIVERY DATE

- Shipping instructions and delivery place

	FSC may also issue purchase order(s) under this Agreement for services or Spare Parts that are to be performed by VENDOR pursuant to the terms and conditions set forth on ANNEX 6.
	All other terms and conditions on any purchase orders submitted under this Agreement shall be void and of no effect.
2.1.2	VENDOR shall accept each purchase order in writing or by electronic means [***] or reject such purchase order within the same time frame, but only if it is not in conformance with the terms and conditions of this AGREEMENT.
2.1.3	The confirmation of each purchase order will include the following particulars:

- purchase order number and date

- CP quantity to be delivered

- Item description

- VENDOR Part number

- Unit price

- CONFIRMED DELIVERY DATE

	In the event that the confirmation does not state a CONFIRMED DELIVERY DATE, the REQUESTED DELIVERY DATE shall be deemed to be the CONFIRMED DELIVERY DATE. All orders will be governed by this Agreement regardless of whether an order references this Agreement.
2.1.4	If the Purchase Order is neither expressly accepted nor rejected within the period stated in Section 2.1.2 of this AGREEMENT, it shall be deemed accepted. Acceptance or rejection notices shall be sent to the respective departments/personnel to be designated by the Parties for this purpose.
2.1.5	Emergency Orders
	FSC may purchase [***] on an emergency basis and VENDOR [***]. Deliveries of emergency orders shall be effected separately according to the Lead Times stated in ANNEX 3 FORECAST, LEAD TIMES. If VENDOR is the party to arrange for shipping, VENDOR will provide the dispatch data to FSC after shipment (flight number, AWB-number, Bill of Lading by FAX). FSC shall be notified by VENDOR when shipments have been delivered to VENDOR’s carrier.
2.1.6	Cancellation or Rescheduling
	Even after acceptance of a purchase order FSC may cancel or reschedule such purchase order in writing [***] pursuant to the terms in ANNEX 3. Details, in particular cancellation or rescheduling charges, if any, are specified in ANNEX 3 FORECAST, LEAD TIMES.

***CONFIDENTIAL TREATMENT REQUESTED

Page 4 of 21

2.1.7	Forecast
	FSC will provide a non-binding rolling forecast regarding its requirement of CP for VENDOR’s planning purposes only. The details are stated in ANNEX 3 FORECAST, LEADTIMES.
2.1.8	Lead times
	Lead times for CP are stated in ANNEX 3 FORECAST, LEAD TIMES.
2.2	Drop Shipments
	Only upon expressly written FSC instruction and upon VENDOR’s mutual agreement shall VENDOR make direct deliveries to FSC customers. Should drop shipments be requested by FSC, the procedure for the execution of and agreement upon such shipments is defined in ANNEX 14 DROP SHIPMENT.
2.3	In order to optimize the supply-chain process, the Parties will co-operate in establishing an e-planning and e-ordering system. Provided the purchasing volume reaches a reasonable level, the Parties agree to invest the necessary resources and to review each others requirements to set up the e-planning and e-ordering process, subject to mutual agreement on the necessary technical infrastructure and, if necessary, commercial terms and conditions.
3.	DELIVERY
3.1	VENDOR shall deliver the CP according to the ORDERING PROCEDURE to the designated delivery place at the CONFIRMED DELIVERY DATE according to the lead times set out in Annex 3 FORECAST, LEAD TIMES. Delivery shall be affected according to Incoterms as specified in ANNEX 1 CONTRACTUAL PRODUCTS.
3.2	VENDOR shall comply with FSC directions concerning carrier(s) and means of transportation or routing. If FSC fails to indicate a specific carrier, VENDOR shall itself arrange for appropriate and agreed transportation.
3.3	In those instances where VENDOR is responsible for arranging for shipment, prior to each shipment VENDOR shall notify FSC in writing of the dispatch data (e.g. flight number, AWB number, bill of lading). VENDOR shall notify FSC when a shipment has been delivered to FSC’s carrier.
3.4	[***], VENDOR shall keep records of the shipment(s) and the related serial numbers and shall make them available to FSC on request.
3.5	Each shipment shall be accompanied with the appropriate shipping papers. All shipping papers and related invoices must inter alia state the correct purchase order number, and the FSC material number. VENDOR’s shipping containers and packing slips shall include the serial numbers of CPs shipped.

***CONFIDENTIAL TREATMENT REQUESTED

Page 5 of 21

3.6	Late Delivery
	Should circumstances arise and become recognizable to VENDOR which may lead to a late delivery, VENDOR shall notify FSC [***].
	If Vendor fails to meet the CONFIRMED DELIVERY DATE for CPs which was not subsequently rescheduled or reconfigured at the request of FSC, and such failure is not cured [***], FSC may cancel the shipment.
	[***] in meeting a respective CONFIRMED DELIVERY DATE, then FSC may elect to [***].
	If Vendor fails to meet the CONFIRMED DELIVERY DATE for CPs which was not subsequently rescheduled or reconfigured at the request of FSC, and FSC informs VENDOR [***] about existing FSC customer orders which would [***], and if FSC is actually required [***], then VENDOR agrees to [***].
4.	TITLE, RISK OF LOSS
	If not otherwise agreed, title and risk of loss shall pass per terms and site specified by the agreed Incoterm.
5.	PRICES
5.1	Prices for CP are set out in in the Price List (ANNEX 1 CONTRACTUAL PRODUCTS), are quoted in US-$ and are net prices unless specified otherwise. The prices for CP are on basis of the respective Incoterm agreed in ANNEX 1 CONTRACTUAL PRODUCTS and include appropriate packaging suitable for airfreight or seafreight, whichever way of transportation has been agreed upon or is stated in the purchase order. Prices do not include, and [***]. Notwithstanding the foregoing, [***].
5.2	The prices stated in the Price List shall be updated [***]. In the event that there are major changes in the market conditions and/or prices for such or similar products or if there are major changes in the market conditions and/or prices of materials, labor or overhead costs used by VENDOR or otherwise related to the manufacture of the CP, [***].
5.3	If the PARTIES [***], FSC may [***]. Notwithstanding such [***], VENDOR shall [***]

***CONFIDENTIAL TREATMENT REQUESTED

Page 6 of 21

	[***].
5.4	VENDOR will provide FSC with a price forecast covering [***] in advance, which will be updated [***]. The applicable price is the price of the day upon which ownership of CP is being transferred to FSC according to the agreed upon Incoterms.
5.5	Omitted.
6.	PAYMENT
6.1	Payment shall be due [***]. Data bearing material (e.g. tapes, floppies) shall be [***]. If FSC makes any payment due [***].
6.2	Payment shall not constitute acceptance of the CP by FSC. FSC reserves the right to deduct any amounts due to FSC.
6.3	Deleted
6.4	Either Party shall be entitled to set off any amounts due from the other under this Agreement or any other existing contracts.
6.5	Withholding of German tax will be handled according to the Double Taxation Convention if existing- between VENDOR’s country and Germany. In such case VENDOR may be required to provide a certificate of tax exemption from the German Tax Authorities with respect to such license fees required to be paid by FSC to VENDOR in order to avoid the imposition of such German withholding taxes. Unless such certificate is submitted by VENDOR to FSC, FSC may be obligated to withhold respective German tax amounts thereon.
7.	TRADENAMES, TRADEMARKS, IDENTIFICATION, DOCUMENTATION
7.1	FSC shall use and market CP under its own trade name, trademarks, symbol, logo and shall not use VENDOR’s trade names, trademarks, symbols, logos without prior written approval of VENDOR.
7.2	VENDOR grants FSC a limited, personal, non-exclusive, non-transferable license, to use the SYSTEM DOCUMENTATION for FSC own business purposes according to this AGREEMENT, including to revise or have revised, to reproduce or have reproduced or to private label the SYSTEM DOCUMENTATION in unaltered or altered form. Notwithstanding the foregoing, FSC shall obtain VENDOR’s prior written consent to revise or alter the substance of the SYSTEM DOCUMENTATION, which consent shall not be unreasonably withheld.
7.3	VENDOR grants FSC a limited, personal, non-exclusive license, to reproduce or have reproduced, to use or have used or to apply an FSC-brand the USER

***CONFIDENTIAL TREATMENT REQUESTED

Page 7 of 21

7.4	DOCUMENTATION in unaltered or altered form and to revise or have revised and to translate or have translated such USER DOCUMENTATION. FSC shall be entitled to grant its customers or distributors the non-exclusive, non-transferable right to use the USER DOCUMENTATION. Notwithstanding the foregoing, FSC shall obtain VENDOR’s prior written consent to revise or alter the substance of the USER DOCUMENTATION, which consent shall not be unreasonably withheld.
7.5	VENDOR shall permanently affix its serial number on CP for identification purposes at a location mutually agreed to.
8.	QUALITY ASSURANCE; TEST REQUIREMENTS; INTELLECTUAL PROPERTY RIGHTS; MARKETING FUNDS
8.1	Each Party agrees to comply with its obligations relating to quality assurance as set out in ANNEX 2 DOCUMENTATION and ANNEX 7 QUALITY ASSURANCE.
8.2	Each Party agrees to comply with its testing obligations as set out in ANNEX 15 TEST REQUIREMENTS.
8.3	Each Party agrees to comply with packaging and labeling obligations of CP as set out in ANNEX 16 PACKAGING AND LABELING.
8.4	The Parties agree that the terms and conditions set forth in ANNEX 18 INTELLECTUAL PROPERTY RIGHTS shall govern ownership and other rights regarding intellectual property created under this AGREEMENT.
8.5	The Parties agree to be bound by the terms and conditions set forth in ANNEX 19 MARKETING FUNDS regarding the provision of marketing funds by VENDOR to FSC.
9.	DEAD ON ARRIVAL
9.1	FSC may perform inspection/test at a FSC facility or the place of destination or in FSC customer field based on random samples.
9.2	In the event that

a)	FSC finds out in such inspection/test that CP does not fully conform in all material respects to the specification stated in ANNEX 1 CONTRACTUAL PRODUCTS, the standards and criteria stated in ANNEX 7 QUALITY ASSURANCE and VENDOR’s USER DOCUMENTATION, and VENDOR’s feature description -if any-, attached to or made part of ANNEX 2 DOCUMENTATION, or
b)	CP cannot be put into initial operation within the time frame defined in Appendix 1 to ANNEX 7 QUALITY ASSURANCE.

	FSC will notify VENDOR without undue delay, in order to accelerate the correction.
9.3	Furthermore, in a Dead On Arrival situation, FSC may – in addition to its rights under Section 16 Product Warranty:

Page 8 of 21

1)	after prior written agreement: [***] or
2)	return such CP to VENDOR [***], or
3)	request VENDOR to replace affected CP, or
4)	If the DOA defect rates exceed the values (dpm) as specified in Appendix 1 to ANNEX 7 QUALITY ASSURANCE, VENDOR will [***].

10.	SPARE PARTS, REPAIR
	VENDOR shall deliver SPARE PARTS to FSC and carry out a Repair Service for the CPs and SPARE PARTS according to the terms and conditions stipulated under ANNEX 6 SPARE PARTS & REPAIR.
11.	SOFTWARE
11.1	The provisions relating to SOFTWARE as specified in ANNNEX 5 SOFTWARE shall apply.
11.2	VENDOR warrants that none of the SOFTWARE supplied to FSC –if any- is or includes open source software.
12.	EMERGENCY MANUFACTURING RIGHTS
	VENDOR agrees to grant FSC Emergency Manufacturing Rights as specified in and according to the terms and conditions stated in ANNEX 8 EMERGENCY MANUFACTURING RIGHT.
13.	INFRINGEMENT OF THIRD PARTY INTELLECTUAL PROPERTY RIGHTS
13.1	VENDOR warrants that VENDOR is the owner of or has the right to license to FSC all rights, title, and interest in and to the CP listed in ANNEX 1 CONTRACTUAL PRODUCTS and to the DOCUMENTATION listed in ANNEX 2 DOCUMENTATION and any other documentation provided by VENDOR under this Agreement, and that there are no infringement claims, disputes, or proceedings pending or anticipated which may detrimentally affect either the rights granted to FSC hereunder or the warranties and representation made to FSC under this Section 13.1. Notwithstanding the foregoing, [***]. The Parties acknowledge and agree that the sole and exclusive remedy for FSC, and sole and exclusive obligation of VENDOR, with respect to a breach of this warranty is the infringement indemnification provisions that are set forth below in Section 13.2.
13.2	VENDOR agrees to defend, indemnify and hold FSC and its RELATED COMPANIES its distributors and its/their customers harmless from any and all claims, proceedings, cost, expenses, damages, penalties, and losses (including

***CONFIDENTIAL TREATMENT REQUESTED

Page 9 of 21

reasonable attorneys’ fees) resulting from any breach of the above warranty in section 13.1, provided that FSC:

1)	notifies VENDOR in writing of all such claims, disputes or and/or proceedings [***];
2)	provides VENDOR with [***]; and
3)	[***].

13.2(a)

To the extent that VENDOR may do so without violating an obligation of confidentiality or other similar obligation to a third party, VENDOR shall give FSC prompt written notice of any and all claims, disputes, proceedings or threats of the same, involving the infringement by the CPs or Spare Parts of any third party intellectual property rights Without prejudice to the indemnity obligations of VENDOR as set forth in Section 13.2, the parties will promptly confer regarding any such claims, disputes, proceedings or threats, and mutually agree upon a reasonable plan of action with respect to the circumstances.

13.3

Independent of the foregoing, in the event that VENDOR is enjoined by a court from distributing or marketing any CP, VENDOR shall use its best reasonable efforts to, at VENDOR’s option:

1)	acquire from such third party a license grant for the intellectual property right in question at VENDOR’s cost; or
2)	replace such infringing CP by non-infringing CP; or
3)	take back such enjoined CP and reimburse the related purchase price to FSC [***].

13.4	VENDOR shall not be responsible for solving any infringement of CP concerning third party’s intellectual property right(s) caused by or resulting from FSC or FSC customer(s)´ modification of CP or caused by the combination of the CP with other equipment but only where the combination of the CP with other equipment renders the CP to be a component of a different type of equipment and it is the new or different type of the equipment that is infringing.
14.	NECESSARY LICENSE FOR IMPORTATION
14.1	VENDOR warrants that it has all necessary licenses (including without limitation patent, trademark, logo and any other intellectual property rights of whatsoever nature and however existing) with the relevant third party licensors required for the import of the CP and DOCUMENTATION to deliver within the EU (“Necessary Licenses”).
14.2	VENDOR agrees to provide FSC with written proof which is reasonably satisfactory to FSC of all Necessary Licenses or written confirmation that

***CONFIDENTIAL TREATMENT REQUESTED

Page 10 of 21

Necessary Licenses are not required [***]. For the avoidance of doubt, failure to provide such information shall be deemed to be a severe breach of this Agreement under 27.2 allowing FSC to terminate this Agreement pursuant to the provisions as set out in section 27.

14.3

VENDOR agrees to defend, indemnify and hold FSC and its RELATED COMPANIES, its distributors and its/their customers harmless from any and all claims, proceedings, costs, expenses, damages, penalties and losses including without limitation reasonable attorney’s fees, costs arising from disruptions at FSC’s factory sites, additional transportation charges, costs of securing replacement goods and other losses resulting from a breach of the above warranty in section 14.1 provided that FSC:

1)	notifies VENDOR of any such claim, dispute or proceeding [***]; and
2)	[***]

15.	[***]
15.1	VENDOR acknowledges, that FSC is [***]

a)	CP that are [***] and
b)	[***].

15.2	VENDOR warrants, that all CPs are [***]. VENDOR shall deliver the related [***]. VENDOR agrees to indemnify FSC for all damages that result from CP [***].
16.	PRODUCT WARRANTY
16.1	VENDOR warrants that the New CPs (as opposed to refurbished) when first delivered by VENDOR to FSC are new, that they meet in all material respects all of the specifications and standards agreed upon by VENDOR and FSC hereunder as set forth in ANNEX 1 CONTRACTUAL PRODUCTS, ANNEX 2 DOCUMENTATION, ANNEX 7 QUALITY ASSURANCE, ANNEX 9 STANDARDS and ENVIRONMENTAL PROTECTION and that they are free from defects in design, material and workmanship.
16.2	FSC will use its reasonable efforts to identify the defects prior to advising VENDOR of the defects and requiring VENDOR’s technical involvement to correct such defects. In the event any defect in the CPs is discovered and reported by FSC to VENDOR within the WARRANTY PERIOD, VENDOR agrees to correct such defects at VENDOR’s costs and expense following receipt of notice thereof.

***CONFIDENTIAL TREATMENT REQUESTED

Page 11 of 21

In particular, during the WARRANTY PERIOD, FSC may return

a) defective CP for RMA handling. VENDOR shall choose one of the following options at its sole discretion, whereas the provisions and processes described in Attachment 2 to ANNEX 6 shall apply accordingly :

• VENDOR shall repair such defective CP or

• VENDOR shall deliver to FSC an equivalent CP to replace such defective CP or

• VENDOR shall deliver to FSC the FRU(s) or Spare Part(s) necessary to repair the CP or

• VENDOR shall refund the purchase price FSC paid for the defective CP

or

b) defective parts which FSC has removed from warranted CP. VENDOR shall choose one of the following options at its sole discretion, whereas the provisions and processes described in Attachment 2 to ANNEX 6 shall apply accordingly:

• repair the defective parts which FSC has removed from warranted CP or

• replace/exchange defective parts or

• refund the purchase price for a respective new parts

	The Parties understand and agree that when appropriate, VENDOR will require that FSC return and VENDOR repair or replace a defective Spare Part or FRU as opposed to the return of an entire CP.
16.3	Replaced or repaired CP and replaced or repaired parts thereof are warranted for [***].
16.4	Warranty handling shall be within the lead times defined in ANNEX 3 FORECAST, LEAD TIMES.
16.5	OMITTED.
16.6	Notwithstanding anything to the contrary, the foregoing warranty does not apply to any CP or Spare Part that: (i) has been damaged by accident, misuse, negligence or external factors such as failure or fluctuation of electrical power, fire or flood; (ii) for defects caused by or resulting from unauthorized modification of CP; or (iii) for defects that are directly caused by VENDOR’s adherence to specifications provided to VENDOR by FSC.
16.7	Upon written request by FSC VENDOR agrees, when it is legally able, to provide to FSC [***] as stated in the respective section of ANNEX 6 SPARE PARTS & REPAIR.
16.8	In case a reseller of the CPs supplied under this Agreement is liable to any other reseller or directly to the end user customer (consumer) because of the CP’s lack

***CONFIDENTIAL TREATMENT REQUESTED

Page 12 of 21

	of conformity to a publicly advertised certification or compatability that VENDOR has agreed to meet under this AGREEMENT, VENDOR will accept the return of the CPs and refund any amounts paid to VENDOR for the CPs, provided, however, that VENDOR is notified of the issue [***]. This section is not intended to conflict with or supercede any warranty provisions for technical issues; this section is meant to cover instances where a CP is technically sound, but does not comply with published certifications or other similar representations that VENDOR has agreed upon in its provision of the CPs to FSC under this AGREEMENT. Notwithstanding the foregoing, this shall not apply where the CP has been modified and the lack of conformity is based on or arises or results from such modification.
16.9	If FSC makes any warranties to customers or other third parties that are contrary to, inconsistent with, or greater than the warranties given by VENDOR herein, VENDOR shall not be bound by such warranties and FSC shall indemnify and hold harmless VENDOR from any claims brought against VENDOR based on such FSC warranties.
16.10	The foregoing warranties extend to FCS only. [***].
17.	EPIDEMIC FAILURES AND MISLEADING STATEMENTS
	EACH PARTY SHALL BE RESPONSIBLE TO PERFORM ITS OBLIGATIONS FOR EPIDEMIC FAILURES IN ACCORDANCE WITH THE TERMS AND SUBJECT TO THE CONDITIONS SET FORTH IN ANNEX 7 QUALITY ASSURANCE.
18.	MISLEADING PUBLIC STATEMENTS
	In case of public statements by VENDOR or any of his partners, such as — but not limited to — marketing and advertising statements concerning the CPs supplied to FSC, VENDOR shall indemnify FSC for all damages and liabilities, which customers of FSC are able to recover against FSC, in the event such public statements turn out to be false or misleading.
19.	PRODUCT LIABILITY INDEMNIFICATION
19.1	Subject to limitations of liability and other terms and conditions set forth herein, VENDOR agrees to defend, indemnify and hold FSC and its RELATED COMPANIES harmless from any and all claims, proceedings, cost, expenses, damages and losses (including reasonable attorneys’ fees) to the extent based upon design or manufacturing defects in the CPs that result in bodily injury, death or damage to tangible or real property (“Product Liability”).
19.2	VENDOR shall not be liable if, and to the extent, CPs have been improperly installed, operated, used or maintained by FSC or FSC’s customers or any third party other than VENDOR.

***CONFIDENTIAL TREATMENT REQUESTED

Page 13 of 21

19.3	Vendor shall secure and maintain a product liability insurance policy, providing for levels of coverage that are reasonable and in keeping with those typically provided for in the industry, for Product Liability exposure to third parties resulting from defective CP supplied by VENDOR to FSC. At FSC’s request, VENDOR shall provide FSC a copy of the insurance policy.
20.	LIMITATION OF LIABILITY
20.1	THE WARRANTIES OF VENDOR AS EXPRESSED IN THIS AGREEMENT AND ANNEXES ARE IN LIEU OF ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION, ANY IMPLIED WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE AND ALL SERVICES, CPS, SPARE PARTS, OTHER MATERIALS OR INFORMATION ARE PROVIDED “AS IS.” THE SAME APPLIES MUTATIS MUTANDIS FOR FSC.
20.2	WITH THE EXCLUSION OF WILLFUL OR GROSS NEGLIGENT CONDUCT, PERSONAL INJURY, DEATH, REAL PROPERTY DAMAGE, LIABILITY THAT IS MANDATORY UNDER APPLICABLE LAW OR INDEMNIFICATION OBLIGATIONS ACCORDING TO SECTION 13 (INFRINGEMENT OF THIRD PARTY INTELLECTUAL PROPERTY RIGHTS), VENDOR AND FSC EXCLUDE VIS-à-VIS EACH OTHER ANY AND ALL LIABILITY FOR ALL INDIRECT, INCIDENTAL, EXEMPLARY AND CONSEQUENTIAL DAMAGES (SUCH AS LOSS OF PROFIT; LOSS OF DATA; LOSS OF REVENUES; LOSS OF GOOD WILL; AND VALUE ASSOCIATED WITH LOSS OF REPUTATION and; LOSS OF CONTRACT).
20.3	The Parties acknowledge and agree that the amounts payable under this AGREEMENT have been established based upon the liability limitations set forth herein, and further agree that these limitations shall apply notwithstanding any failure of essential purpose or of any limited remedy.
21.	TECHNICAL AND ENGINEERING CHANGES
21.1	Technical and engineering changes to CP may only be performed by VENDOR in accordance with the procedures detailed in ANNEX 10 TECHNICAL CHANGES.
21.2	VENDOR must supply quantities of changed CPs necessary for testing or qualification as mutually agreed upon free of charge to FSC.
22.	NON-DISCLOSURE
22.1	FSC agrees to maintain in confidence any and all CONFIDENTIAL INFORMATION delivered by VENDOR to FSC. Such information required to be held in confidence shall, if in writing, be marked “Confidential”. Oral information that is confidential shall be reduced to writing and marked “Confidential”, and forwarded to FSC [***]. FSC may disclose CONFIDENTIAL INFORMATION to such employees of FSC or third parties contracting with FSC as may be necessary in the design, manufacture, service, distribution, and licensing -if any-, of the CP, but only, if they are bound by confidentiality obligations at least as stringent as stated herein.

***CONFIDENTIAL TREATMENT REQUESTED

Page 14 of 21

22.2	The obligations hereunder shall not apply to information which is or becomes public domain; or is received by FSC from a third party without confidentiality obligation to VENDOR; is known by FSC without use of VENDOR’s CONFIDENTIAL INFORMATION; is independently developed by FSC without use of VENDOR’s CONFIDENTIAL INFORMATION; or that must be disclosed by law so long as FSC gives VENDOR prompt notice of such legal requirement.
22.3	The obligations in SECTION 22.1 shall apply mutatis mutandis to CONFIDENTIAL INFORMATION delivered or made available by FSC to VENDOR.
22.4	The non-disclosure obligations in SECTIONS 22.1 and 22.2 shall expire [***]. Notwithstanding the foregoing, any obligations of confidentiality with respect to information disclosed to FSC pursuant to [***].
22.5	Press releases or other information on the conclusion/content of this AGREEMENT shall only be made available to third parties/press agencies with the prior written consent of the other PARTY hereto. Notwithstanding the foregoing, each Party may make disclosures regarding this AGREEMENT without the prior written consent of the other Party to the extent that such disclosures are legally required by the party (including any requirements imposed by the United States Securities and Exchange Commission regarding the disclosure of information) but only if the disclosing Party has given the other party notice of the requirement and an opportunity to discuss the circumstances and depth of disclosure with the disclosing Party. The Parties acknowledge that often such legally required disclosures must be made quickly, and the time period between notification and the need to disclose may be limited.
23.	TECHNICAL SUPPORT AND TRAINING
23.1	VENDOR agrees to provide training and technical support to FSC according to the provisions of ANNEX 12 TECHNICAL SUPPORT AND TRAINING.
23.2	Maintenance for CP may be performed by FSC and VENDOR shall give support for REPAIR as stated in ANNEX 6 SPARE PARTS AND REPAIR. FSC shall be entitled to buy SPARE PARTS according to the terms and conditions stated in ANNEX 6 SPARE PARTS & REPAIR and resell them to FSC service partners, e.g. to third party repairers.
24.	GOVERNING LAW AND ARBITRATION
24.1	This AGREEMENT shall be governed by and construed in accordance with the laws of the State of New York, USA. The United Nations Convention on the International Sale of Goods (CISG) shall not apply. With regard to the validity and scope of intellectual property rights the law of the country shall apply, where such intellectual property rights have been originated and/or registered.
24.2	All disputes arising out of or in connection with the present agreement, including any questions regarding its existence, validity or termination, shall be finally settled by binding arbitration under the American Arbitration Association (the “Rules”) by three arbitrators in accordance with said Rules.

***CONFIDENTIAL TREATMENT REQUESTED

Page 15 of 21

24.3	Each Party shall nominate one arbitrator for confirmation by the competent authority under the applicable Rules (Appointing Authority). The two appointed arbitrators shall agree on the third arbitrator [***]. Should the two arbitrators fail, within the above time-limit, to reach agreement on the third arbitrator, he shall be appointed by the Appointing Authority. If there are two or more defendants, any nomination of an arbitrator by or on behalf of such defendants must be by joint agreement between them. If such defendants fail, within the time-limit fixed by the Appointing Authority, to agree on such joint arbitrators the Appointing Authority may appoint such joint arbitrator. The arbitrators must have sufficient experience in the IT industry and in international business transactions
24.4	Notwithstanding the Rules (i) each Party shall have no more than 2 days to present its case and (ii) the arbitrators shall be instructed to render their decision [***] following the conclusion of each Party’s presentation.
24.5	The arbitrators shall specify the basis for their decision. The arbitrators shall not award any punitive damages. The decision of the arbitrators shall be considered as a final and binding resolution of the dispute, shall not be subject of appeal and may be entered as a judgment in any court of competent jurisdiction.
24.6	The seat of arbitration shall be New York, New York, USA. The procedural law of this place shall apply where the Rules are silent, however no pre-trial discovery procedure or jury trial shall be allowed in the arbitration proceedings.
24.7	The language to be used in the arbitration proceedings shall be English. The whole arbitration procedure shall be executed pursuant to a strict non disclosure agreement signed by the Parties and the arbitrators agreeing to conduct such proceedings and maintaining in confidence all confidential information or trade secrets disclosed or produced in the course thereof. All press releases or public statements regarding the status of such proceedings shall be prepared jointly and only by the Parties.
25	EXPORT LICENSE, ADMINISTRATION REGULATIONS CONCERNING US-ORIGIN CP
25.1	FSC shall comply fully with all applicable laws, rules and regulations relating to the export of VENDOR’s hardware and technical data, including, but not limited to, any regulations of the United States Office of Export Administration and other applicable governmental agencies. VENDOR agrees to cooperate in providing information requested by FSC as necessary to obtain any required licenses and approvals.
25.2	VENDOR will provide a written declaration that VENDOR has duly classified hardware in accordance with the United States Export Administration Act and the United States Export Administration Regulations. VENDOR’s written declaration shall contain the applicable CN-Class, Country of Origin, State of Origin, ALNR, Export Control Classification Number (“ECCN”) in accordance with the Commerce Control List (“CCL”), weight, net weight, dimensions as well as any and all applicable License Exceptions. VENDOR is obliged to deliver such declaration as soon as possible but no later than the general availability date of the CPs. If the scope of the contract is extended at a later date, VENDOR likewise undertakes to

***CONFIDENTIAL TREATMENT REQUESTED

Page 16 of 21

	provide the relevant export control details pertinent to the additional products/services, subject to these same conditions.”
26.	CONTACTS
26.1	Any notices to be sent hereunder shall be in writing and delivered personally or sent by fax or mail according to ANNEX 12 CONTACTS.
26.2	Notices sent by fax shall be sent to the respective fax numbers set forth in ANNEX 12 CONTACTS and such notices shall be deemed given as of the date sent by fax if properly addressed and transmitted. Notices concerning issues important for the contractual relationship shall be sent either (i) by commercial express mail, or otherwise (ii) by certified or registered mail or any other means giving sender proof of receipt.
26.3	Notices sent by mail shall be addressed as set forth in ANNEX 12 CONTACTS, postage prepaid, certified or registered mail, and shall be deemed given at the date of receipt.
26.4	During the term hereof VENDOR and/or FSC may designate other addresses or numbers to which such notices shall further on be sent or delivered.
27.	TERM AND TERMINATION
27.1	The term of this AGREEMENT shall commence on the EFFECTIVE DATE, continue thereafter for a period of five (5) years and shall automatically be prolongated in one (1) year increments, unless one of the Parties notifies the other [***] prior to any prolongation of its intent not to prolongate.
27.2	Either PARTY may elect to terminate this AGREEMENT for a breach of a material term or provision of this AGREEMENT by the other PARTY upon delivery of [***] prior written notice to the other PARTY; provided, however, if such breach is cured by the other PARTY within said [***], such election and notice shall be of no further force and effect and this AGREEMENT shall not be terminated thereby.
27.3	Termination of this AGREEMENT shall not affect those provisions of this AGREEMENT that are intended, by their nature, to survive termination.
27.4	In case either Party merges with another company or is acquired by a third Party being a competitor of the other Party in the field of information systems or comes otherwise under an excessive influence of a third party of same nature, either Party will inform the other Party in writing without delay and either Party is entitled within [***] of receipt of such notice to terminate this AGREEMENT.
27.5	For a [***], VENDOR shall offer support to FSC in respect to service and maintenance purposes. In particular, Vendor shall maintain the support for repair and the repair service described in ANNEX 6 SPARE PARTS AND REAPAIR.

***CONFIDENTIAL TREATMENT REQUESTED

Page 17 of 21

27.6	For a [***], and subject to the payment by VENDOR fo all applicable fees and other charges, VENDOR shall make available to FSC SPARE PARTs. [***] the PARTIES will mutually agree upon any continuing obligations of VENDOR to deliver SPARE PARTS or provide support beyond the aforementioned [***] period.
28.	END OF LIFE OR DISCONTINUATION BY VENDOR OF CP
28.1	Should VENDOR request the discontinuation of CP, VENDOR shall so notify FSC in writing explaining the reasons and the PARTIES shall negotiate in good faith an adequate solution, which may include i.e. the transfer of the manufacturing rights for CP and SPARE PARTs according to ANNEX 8 EMERGENCY MANUFACTURING RIGHTS or a last time order of CP.VENDOR shall not request such discontinuation [***].
28.2	VENDOR agrees to provide a written notice to FSC [***] prior to the effective end of life of any CP, which notice shall consist of:

– date of the notice

– the specific CP affected

– last possible date for receipt of an order

– last possible shipment date of the relevant CP(s)

29.	INVENTORY MANAGEMENT
29.1	Due to un-predictable customer decisions, excess inventory held and owned by FSC may occur. Inventory shall be deemed to be excess inventory if the then current manufacturing plan of FSC requires a lesser volume of the respective inventory than the current inventory level shows.
29.2	FSC shall be entitled to resell the excess inventory to third parties in compliance with the requirements specified in ANNEX 14 EXCESS INVENTORY.
30.	SUB-MANUFACTURERS
30.1	VENDOR may require the use of certain sub-manufacturers for whatever task is deemed necessary. VENDOR shall ensure that sub-manufacturers comply with the FSC standards and requirements contained in this AGREEMENT.
30.2	VENDOR shall provide FSC with [***] prior written notice of its intent to change its manufacturing location or transfer of manufacturing plant. Unless FSC approves of the change, VENDOR will [***]. VENDOR will use best efforts to ensure smooth transition. FSC may not unreasonably withhold, delay or condition its approval.

***CONFIDENTIAL TREATMENT REQUESTED

Page 18 of 21

31.	EMS/ODM
31.1	Subject to each EMS/ODM being credit worthy to order CPS and services from VENDOR under the provisions of this Agreement, as reasonably determined by VENDOR, VENDOR agrees to supply CPs and provide services to the EMS/ODM according to the terms and conditions of the AGREEMENT concluded between FSC and VENDOR for the sole purpose of the incorporation of the CPS supplied under this AGREEMENT into the products to be manufactured for FSC by the EMS/ODM and based on the condition, that any deliveries for such purpose shall be governed by a direct business relationship based on the respective POs between VENDOR and the EMS/ODM.
31.2	As part of the agreement between FSC and the EMS/ODM, FSC shall contractually bind the EMS/ODM to use the CPS and provided services supplied by VENDOR according to the terms of the AGREEMENT concluded between FSC and VENDOR exclusively for the manufacture of FSC’s products and for no other purpose.
31.3	FSC shall be entitled to revoke such supply rights granted by VENDOR to the EMS/ODM in its own discretion at any time, especially but not limited to in case the EMS/ODM uses the CP and provided services for other purposes as described in the preceding section. In case FSC revokes such supply rights, VENDOR shall terminate any deliveries or any support to the EMS/ODM, coming from the agreement, within [***] following the receipt of a revocation note provided by FSC.
32.	ETHICAL STANDARDS
32.1	VENDOR agrees to comply with the ethical standards detailed in ANNNEX 17 ETHICAL STANDARDS.
33.	MISCELLANEOUS
33.1	ASSIGNMENT. Neither PARTY may delegate its obligations or assign its rights hereunder without the prior written consent and approval of the other PARTY which consent will not be unreasonably withheld; provided, however: i) a Party hereto may assign this AGREEMENT upon written notice to the other Party, to a successor-in-interest of all or a majority of its outstanding stock or voting securities or to a purchaser of all or substantially all of its assets, and; (ii) upon written notice to VENDOR, FSC may assign, delegate or transfer its obligations and rights hereunder to any RELATED COMPANY which is capable of performing all of FSC’s obligations under this AGREEMENT (as reasonably demonstrated to VENDOR) without the prior written consent of VENDOR. Even if the AGREEMENT has not been formally assigned, any RELATED COMPANY shall be entitled to issue purchase orders according to the terms and conditions of this AGREEMENT. In this case the RELATED COMPANY and VENDOR shall become direct contractual partners. If this AGREEMENT is assigned pursuant to section 33.1(i), above, the other Party shall have the right to terminate the AGREEMENT by giving [***] prior written notice.
33.2	ANNEXES. The Annexes attached to this AGREEMENT form an integral part hereof. In case of a contradiction between the AGREEMENT and the Annexes,

***CONFIDENTIAL TREATMENT REQUESTED

Page 19 of 21

	the AGREEMENT shall prevail, unless explicitly specified otherwise in the Annexes.
33.3	AMENDMENT. This AGREEMENT may not be modified or amended except by a written amendment consecutively numbered and executed by the duly authorized officers of the PARTIES hereto. This requirement can only be waived in a written document that is executed by the duly authorized officers of the Parties hereto. In case of any contradiction between the AGREEMENT wording and the wording of the Annexes, the AGREEMENT shall prevail.
33.4	SEVERABILITY. If a provisions of this AGREEMENT is held invalid, unenforceable or contrary to law then the validity of the remaining provisions of this Agreement shall remain in full force. In such instance, the Parties shall use their best efforts to replace the invalid provision(s) with legally valid provisions approximating to the extent possible the original intent of the Parties.
33.5	FORCE MAJEURE. Neither PARTY shall be liable to the other for failure or inability to perform its obligations hereunder to the extent such failure or inability is due to Force Majeure. For the purpose of this section, “Force Majeure” means all acts of God and Government and general labor disputes beyond the reasonable control of a PARTY. Should the period of Force Majeure exceed six months, each PARTY is entitled to terminate this AGREEMENT.
33.6	PARENT RESPONSIBILITY. Dot Hill Systems Corp. hereby agrees to be a Party to this AGREEMENT and shall be jointly and severally liable together with Dot Hill Systems B.V. for all of the obligations and liabilities of Dot Hill Systems B.V., and all of Dot Hill’s related companies and subsidiaries, arising hereunder.

Dot Hill Systems, B.V.	Dot Hill Systems Corp.
/s/ PRESTON ROMM	/s/ DANA W. KAMMERSGARD
signature	signature
Preston Romm	Dana W. Kammersgard
name	name
Director	President and CEO
title	title
3/3/06	3/2/06
date	date
Fujitsu Siemens Computers GmbH
/s/ HARALD ROBATZEK	/s/ [ILLEGIBLE]
signature	signature
Harald Robatzek	[ILLEGIBLE]
name	name
Director Golbal Sourcing	Director Storage Systems
title	title
13.01.2006	13.01.2006
date	date

Page 20 of 21

ANNEX  1 CONTRACTUAL PRODUCTS
ANNEX  2 DOCUMENTATION
ANNEX  3 FORECAST, LEADTIMES
ANNEX  4 OMITTED
ANNEX  5 SOFTWARE
ANNEX  6 SPARE PARTS AND REPAIR
ANNEX  7 QUALITY ASSURANCE
ANNEX  8 EMERGENCY MANUFACTURING RIGHTS
ANNEX  9 STANDARDS, ENVIRONMENTAL REQUIREMENTS
ANNEX 10 TECHNICAL CHANGES
ANNEX 11 TECHNICAL SUPPORT & TRAINING
ANNEX 12 CONTACTS
ANNEX 13 EXCESS INVENTORY
ANNEX 14 DROP SHIPMENT
ANNEX 15 TEST REQUIREMENTS
ANNEX 16 PACKAGING AND LABELING
ANNEX 17 ETHICAL STANDARDS
ANNEX 18 INTELLECTUAL PROPERTY RIGHTS
ANNEX 19 MARKETING FUNDS

Page 21 of 21

Confidential

ANNEX 1 CONTRACTUAL PRODUCTS

1. The following information is contained on the most current version of the price list (“PRICE LIST”) and product specifications (“SPECIFICATIONS”) that have been formally issued by VENDOR under this AGREEMENT and accepted by FSC (“ACTIVE PRICE LIST” or “ACTIVE SPECIFICATION”). Such documents are made a part hereto by reference. Updated PRICE LISTS and SPECIFICATIONS may be issued, accepted and thereby made a part of this AGREEMENT from time to time throughout the term of this AGREEMENT without the need to formally amend the AGREEMENT.

•	Contractual Product(s) (CP)
	To be found on most recent ACTIVE DH PRICE LIST for FSC.

•	Specification of CP(s)
	To be found on most recent ACTIVE SPECIFICATION

•	Configuration of CP(s)
	To be found on most recent ACTIVE PRICE LIST
•	Price of CP(s)
	To be found on most recent ACTIVE PRICE LIST.
•	Package weight and dimensions
	To be found on most recent ACTIVE SPECIFICATION
2.	Warranty Period for CP(s)
	[***] commencing on the date that VENDOR first delivers the CP.
3.	Incoterm for CP(s) and for Spare Parts
	FCA VENDOR’s shipping dock at VENDOR’s designated facility. Title and risk of loss shall pass to FSC [***].

	***CONFIDENTIAL TREATMENT REQUESTED
GS	1/1

Confidential

ANNEX 2 DOCUMENTATION

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	1/1

Confidential

ANNEX 3 FORECAST, LEAD TIMES, ORDER MANAGEMENT, INVENTORY MANAGEMENT

1. FORECAST

FSC shall issue, [***], a rolling [***] forecast in the same form as that set forth at Appendix 1 to this ANNEX 6 (“Forecast”).

The forecast assumes [***], and VENDOR will be obligated to deliver at a certain point in each month only that amount of CPs or Spare Parts that are equivalent to [***]. For example, if the [***].

The forecast will be updated [***]. Upon issuing a new forecast, FSC will request that VENDOR confirm that it can meet the forecast, including the “Upside Flexibility” requirements [***] of the forecast. The parties will strive to speak on a weekly or bi-weekly basis regarding the forecast and expected timing of shipments during the month.

FSC will be committed to the Upside Flexibility ranges as first and initially forecasted. In other words, VENDOR will not be required to deliver, within “in-forecast” lead times, any amount of CPs or Spare Parts that are greater than the amount of CP or Spare Parts originally (first) forecast by FSC for that month.

FSC’S FORECAST IS NOT A PURCHASE ORDER FOR THE FORECASTED AMOUNTS AND DOES NOT GUARANTEE FSC WILL ISSUE PURCHASE ORDERS AS SET FORTH IN THE FORECAST.

2. LEAD TIMES

Lead times shall be as follows. All lead time periods for delivery of orders start from the time of receipt of the Purchase Order for the applicable CPs or Spare Parts and ends when VENDOR makes the CPs or Spare Parts available [***].

All lead time periods for warranty handling start from the date upon which VENDOR receives the returned CP or Spare Part from FSC and ends when VENDOR makes the CPs or Spare Parts available [***].

   Delivery:

-	CP	for amounts “in-forecast” – [***];
		for amounts greater than forecast –VENDOR to use commercially reasonable efforts to meet the [***] lead time, but not greater than [***]
-	SPARE PARTS	for new Spare Parts (not refurbished) “in-forecast” – [***]

	***CONFIDENTIAL TREATMENT REQUESTED
GS	1/7

Confidential

		for new Spare Parts (not refurbished) greater than forecast – VENDOR will use commercially reasonable efforts to meet the [***] lead time, but not greater than [***].
-	Emergency Orders ([***] units or less)	[***], but such Orders may effect the. delivery dates of existing Orders

In-Warranty Handling (turn around time):

-	CP	[***]
-	Spare Parts	new parts (not refurbished) – [***]
-	Emergency /DOA ([***] units or less	[***], but such Orders may effect the delivery dates of existing Orders.

Out of Warranty Repair or Replace (turn around time):

-	General	[***]
-	Emergency	Using commercially reasonable efforts [***] units or less) [***]
-	Refurbishments of specific returned unit	[***], although VENDOR will use non-binding best efforts to complete within [***].

unless a shorter period of time has been agreed upon in writing.

3. Cancellation or Rescheduling of Purchase Orders and Returns

Even after acceptance of a Purchase Order FSC is entitled to cancel, reschedule or return such Order in writing with regard to the total or partial quantity of CP or Spare Parts ordered according to the following conditions:

a) Rescheduling:

FSC is entitled up to [***] to request a rescheduling [***], to a date within [***].

FSC is entitled within [***] to request a rescheduling [***] to a date within [***], but such rescheduling may be [***].

FSC may not reschedule an Order if it has already been [***].

	***CONFIDENTIAL TREATMENT REQUESTED
GS	2/7

Confidential

b) Cancellation:

FSC is entitled up to [***] to cancel respective Purchase Orders [***].

FSC is entitled within [***] to cancel a Purchase Order, but such cancellation may be [***].

FSC may not cancel an Order if it has already been [***].

c) Returns:

FSC may return CPs or Spare Parts for a credit at the then-current price for said CP or Spare Parts, but only if all of the following conditions are met:

(i) the CP or Spare Part has not been used and is “as new;”

(ii) the CP or Spare Part is in its original packaging and is unopened;

(iii) the CP or Spare Part is in the same condition as it was when delivered to FSC;

(iv) the CP or Spare Part is at the current revision level;

(v) the CP or Spare Part was delivered to FSC within [***]; and

(v) the amount of CP or Spare Part returned [***]. VENDOR, in its discretion, will consider returns [***].

No Returns may be made during the [***].

Any CP or Spare Part returned to VENDOR shall be designated within VENDOR as the first CP or Spare Part of its type to be shipped back to FSC against any new Purchase Order received for that configuration; this will ensure prompt turnover of all returned product.

Each return shall be [***].

d) [***]

Cancellation, Rescheduling or Return [***].

4. Excess and Obsolete Inventory Unique to FSC

4.1 FSC acknowledges its financial responsibility for the materials purchased by VENDOR that are unique to FSC-branded Products in order to support the agreed upon lead times for the forecasted amounts (including Upside Flexibility requirements) (“Chargeable Materials”). Unique materials are set forth on Appendix 2 to this ANNEX 3. It is assumed that VENDOR’s lead times to purchase Chargeable Materials is [***] unless VENDOR receives FSC’s approval to purchase Chargeable Materials with greater lead times.

	***CONFIDENTIAL TREATMENT REQUESTED
GS	3/7

Confidential

4.2 [***] Chargeable Materials. After [***] of remaining in inventory, FSC will [***], but only those purchased or created in order to support the agreed upon lead times for the forecasted amounts, [***].

4.3 [***] Chargeable Materials. After [***] of remaining in inventory, FSC will [***], but only those Chargeable Materials purchased or created in order to support the agreed upon lead times for the forecasted amounts. [***].

4.4 [***] Chargeable Materials. FSC shall [***], but only those Chargeable Materials purchased or created in order to support the agreed upon lead times for the forecasted amounts,[***].

4.5 Expiration or Earlier Termination. In the event that FSC terminates the AGREEMENT for convenience, Dot Hill terminates the AGREEMENT based on FSC’s breach of the AGREEMENT which is not cured, or the AGREEMENT expires and FSC chooses not to renew, then FSC shall[***], but only those Chargeable Materials purchased or created in order to support the agreed upon lead times for the forecasted amounts,[***].

4.6 [***].

4.7 As of the signing of this AGREEMENT, the CPs contain unique materials that are easily removed from FRUs or CPs. If the nature of the CPs change such that VENDOR is required to integrate FSC unique materials into FRUs or CPs and such unique materials are more difficult to strip from the FRUs or CPs, such FRUs or CPs may also be considered Chargeable Materials and the[***]. The[***]. VENDOR will notify FSC of changes to the CPs that trigger this provision.

	***CONFIDENTIAL TREATMENT REQUESTED
GS	4/7

Confidential

APPENDIX 1 to ANNEX 3. SAMPLE FORECAST

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
GS	5/7

Confidential

APPENDIX 2, to ANNEX 3: LIST OF UNIQUE PARTS

[***]

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
GS	6/7

Confidential

ANNEX 4                                                                omitted

GS

Confidential

ANNEX 5                                                    SOFTWARE

1. Where the CP contains SOFTWARE that is provided as part of and incorporated into a CP at no additional charge to FSC, subject to the payment by FSC of applicable charges and fees for the CP, FSC and its customers shall receive a paid-up perpetual, non-exclusive and non-transferable right to use the SOFTWARE on the single CP upon which the SOFTWARE was originally incorporated and loaded, in an unchanged form, and for the sole purpose stated in the accompanying software documentation.

2. VENDOR warrants to FSC that:

     a) VENDOR has the right to grant the license to SOFTWARE as per Section 1;

     b) SOFTWARE conforms in all material respects to its specifications and is substantially free in all material respects from programming errors;

     c) SOFTWARE performs on the configuration of the CP with/ for which it was ordered and/or supplied;

     d) SOFTWARE performs in all material respects the functions and features defined in the accompanying documentation;

      e) as of the date of delivery, SOFTWARE is the most current, fully-tested release version offered by VENDOR, and is no ”alpha”, “beta” or equivalent test version (as such terms are commonly understood in the computer software industry), unless the parties otherwise expressly agree;

     f) SOFTWARE does not contain any lock, clock, timer, counter, copy protection feature or other device, which, after initial installation of SOFTWARE, prevents FSC or its customers from fully utilizing SOFTWARE in accordance with this Agreement without intervention by VENDOR.

3. Title to all SOFTWARE supplied to FSC by VENDOR under this Agreement will remain with VENDOR or its licensor. FSC and its customers obtain no rights to SOFTWARE except for the limited license rights set forth herein.

4. Except as expressly permitted under applicable law, FSC or its customers shall not reverse engineer, decode, decompile, modify, translate, disassemble or attempt to reduce to source code form the CP or SOFTWARE, or cause or help any third party to do the same.

5. SOFTWARE shall be considered the CONFIDENTIAL INFORMATION of VENDOR as that term is defined in the AGREEMENT, regardless of whether it is marked as such.

GS/L+C

Confidential

ANNEX 6                                                   SPARE PARTS AND REPAIR

1.	SUBJECT MATTER OF ANNEX 6
	The subject matter of this Annex is to define the SPARE PARTS procurement for the Contractual Product (CP) described in ANNEX 1 to the AGREEMENT and the REPAIR procedure for such SPARE PARTS as well as for the Contractual Product (CP) described in ANNEX 1 to AGREEMENT.
	Even if not explicitly referenced, the terms and conditions of the AGREEMENT (including its ANNEXES) shall apply accordingly. However, provisions of the AGREEMENT shall in no event supersede provisions of this Annex 6 in case of deviation.
2.	SPARE PARTS

2.1 Definitions

[***]

2.2 SPARE PARTs Lists

2.2.1 Contents of the SPARE PARTs Lists (for Level 0 and 1)

The SPARE PARTs Lists as following shall contain the following and shall be revised immediately if any mutually agreed changes occur. The SPARE PARTS list shall only be compiled with respect to Level 0 and Level 1 SPARE PARTS; they shall not be compiled with respect to Level 2 SPARE PARTS

a) [***]

***CONFIDENTIAL TREATMENT REQUESTED

Page 1 of 21

PRS

Confidential

[***]

b) [***]

c) [***]

2.2.2 Availability of SPARE PARTs information

The BASIC SPARE PARTs List, recommended by VENDOR, shall be made available by VENDOR latest [***] prior to begin of mass production of the applicable CP. At the same time VENDOR shall provide FSC with applicable storage guidelines, in case any special or unusual treatment is necessary.

The Purchase SPARE PARTs List and Planning SPARE PARTS List shall be made available at the latest [***]. FSC may require additional SPARE PARTs to be added to the SPARE PARTs Lists.

3.	SPARE PARTS PROCUREMENT PROCEDURE
	During the term of the AGREEMENT and for the period stated in Clause 27.6 of the AGREEMENT, VENDOR will accept and carry out all purchase orders for SPARE PARTS placed by FSC in accordance with the terms of this Annex 6.

3.1 Purchase Orders

3.1.1 Ordering

FSC will place purchase orders providing VENDOR with the following information:

§ Purchase Order number and date

§ SPARE PART quantity to be delivered

§ Part number and revision level

§ Item description

§ Unit price

§ Date of delivery

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 2 of 21

Confidential

3.1.2 Initial order

VENDOR shall deliver the initial SPARE PARTs to FSC at the latest[***].

FSC will stock approximately [***] of SPARE PARTs at the initial stage.

Initial stock quantities will be determined by either of the following:

[***]

3.1.3 Order Confirmation

Within [***] after receipt of order, VENDOR will send an order confirmation including delivery date for information purposes to FSC. The holidays of the country from which confirmation is issued shall be taken into consideration when determining “working day.”

3.1.4 Cancellation procedure

FSC may cancel or reschedule purchase orders for Spare Parts under the same terms and conditions as those stipulated in ANNEX 3 of the AGREEMENT with respect to CPs.

3.1.5 Lead-time

The lead time for delivery from date of purchase order shall be as stipulated in ANNEX 3 of the AGREEMENT.

VENDOR will confirm the delivery of SPARE PARTs to FSC’s carrier upon Spare Parts leaving VENDOR’s facility dock.

3.1.6 Terms

Terms of delivery: According to Section 3 of the AGREEMENT

Terms of payment: According to Section 6 of the AGREEMENT

3.1.7 Prices

Prices for the SPARE PARTs Procurement (including prices for accelerated orders) are stated in Attachment 1 (SPARE PARTS and REPAIR Prices) to this ANNEX 6 and include appropriate packaging.[***] Section 4 of the AGREEMENT shall apply accordingly. VENDOR agrees[***].

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 3 of 21

Confidential

3.2 Discontinuation of SPARE PARTs

3.2.1 Discontinuation

Prior to the EOL of the applicable CP in which a SPARE PART is used, in case of the discontinuation of a SPARE PART, VENDOR will inform FSC in writing, including the effective date of discontinuation, and offer a substitute or alternative SPARE PART. If the substitute or alternative SPARE PART affects the form, fit, function or compatibility of the CP, then it must be approved by FSC as per ANNEX 10 of the AGREEMENT.

Upon the EOL of a CP, availability of SPARE PARTS for that CP shall be governed by Section 27.6 of the AGREEMENT.

3.2.2 Tooling

VENDOR shall inform FSC before scrapping or changing any tool that is used to create Spare Parts that are unique to FSC and FSC reserves the right to buy such FSC-unique tooling from VENDOR.

3.3 Changes and Upgrades

VENDOR shall notify FSC without undue delay of intended Engineering Changes in SPARE PARTs, which do not result in a discontinuation of SPARE Parts. All such changes that affect the form, fit, function or compatibility of the SPARE PARTs are subject to FSC ´ s approval as per ANNEX 10 of the AGREEMENT.

If any such changes are not Mandatory Changes and are not caused by FSC, the parties will design a program of backward consumption by which the new SPARE PARTs will be phased-in and/or the old SPARE PARTs upgraded in a manner that avoids the purging and/or scraping of the old SPARE PARTs.

In the event that any such changes are Mandatory Changes and are not caused by FSC, VENDOR will [***]

[***]

For purposes of this section, a Mandatory Change is a change that is required to allow the CP to function as per its original specification (prior to the change) and in a safe and legal manner. All other changes are not Mandatory Changes.

VENDOR shall only be required to upgrade to the current revision level those SPARE PARTs that [***]

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 4 of 21

Confidential

For purposes of this ANNEX 6, the MAL (or Minimum Acceptance Level) is the [***].

3.4 Warranty

3.4.1 Warranty Period

VENDOR warrants that newly purchased SPARE PARTS (as opposed to refurbished SPARE PARTS) are new, that they meet all specifications agreed upon by VENDOR and FSC hereunder as set forth in the SPARE PARTS Lists, ANNEX 1, ANNEX 9 (Standards) and ANNEX 7 (Quality Assurance) to AGREEMENT, and that they are free from defects in design, material and workmanship for a period of [***] from receipt of SPARE PARTS by FSC. Refurbished SPARE PARTs are not new, but VENDOR warrants that they otherwise meet the aforementioned specifications and warranties for a period of [***].

3.4.2 Serial number and warranty validation

VENDOR will operate an online warranty tracking system for validation and RMA procedure as well as for product safety purposes.

VENDOR shall provide a serial number on each serial number-controlled SPARE PART and a mechanism of serial number coding online, which allows FSC to determine the beginning of the applicable warranty period.

3.4.3 DOA (Dead on Arrival)

The DOA period is [***] from date of receipt of new SPARE PARTS by FSC.

FSC will request RMA marked as DOA with respect to New (and not refurbished) Spare Parts, whereas the process as described under Clause 3.4.4 shall apply accordingly.

The DOA rate as confirmed by VENDOR (and not just based on FSC’s observations) shall not exceed [***].

3.4.4 In - Warranty Options

In the event a defect is discovered in a SPARE PART and VENDOR is notified of the defect within the warranty period, VENDOR shall execute one of the following warranty actions, in VENDOR’s discretion, within the TAT (Turn Around Time) set out in ANNEX 3 from VENDOR’s receipt of the defect SPARE PART:

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 5 of 21

Confidential

a) VENDOR will provide and ship a replacement/exchange SPARE PART with the same part number or a replacement SPARE PART which part number is explicitly authorised and approved by FSC or

b) VENDOR will issue a credit note and refund the purchase price that FSC paid for the defective SPARE PART or

c) VENDOR will repair the SPARE PART, and if the SPARE PART meets the Minimum Accepted Level, will upgrade the SPARE PART to the latest revision level.

The provisions and processes applicable for In-Warranty Handling are described in Attachment 2 (In-Warranty Handling Process Description) of this ANNEX 6 in detail.

3.5 Failure to comply with contractual obligations

3.5.1 Shipping / Delivery

If VENDOR exceeds the agreed Lead Times (Clause 3.1.5) as stipulated in ANNEX 3 for shipping new or refurbished SPARE PARTS to FSC, or if VENDOR exceeds the confirmed delivery date (Clause 3.1.3), or if VENDOR exceeds the agreed TAT for RMA activity, Clause 3.6 of the AGREEMENT shall apply accordingly.

3.5.2 Response to RMA requests

If VENDOR does not respond to FSC‘s RMA request within [***].

3.5.3 Warranty Handling

If VENDOR exceeds the agreed TAT for warranty handling as stipulated in ANNEX 3, VENDOR shall [***].

3.5.4 DOA Rate

If the DOA Rate measured [***] figure set forth in Section 3.4.3, VENDOR shall [***].

FSC reserves the right to claim further damages resulting from all Dead on Arrivals occurring. VENDOR’s right to prove that FSC has incurred a lower damage shall remain unaffected.

3.5.5 General

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 6 of 21

Confidential

The claiming of contractual penalties or liquidated damages or compensation for

damages by FSC shall not affect FSC` s rights to demand performance. An acceptance of VENDOR`s performance by FSC will not affect FSC‘s right to claim contractual penalty, liquidated damages or compensation for damages, even if no objection is made upon acceptance of any such performance.

In case of default and/or non–performance by VENDOR, FSC may grant an appropriate period of grace to enable performance. Once however this period of grace has expired without VENDOR bringing about the contractually agreed performance and /or results, FSC is entitled to withdraw from the respective order and demand damages for default and/or non-performance.

4. SUPPORT FOR REPAIR

4.1 Documentation

During the term of the AGREEMENT and for the period stated in 27.5 of the AGREEMENT), in order to enable FSC or FSC’s third party repairers to effectively test and screen returns to reduce “No Trouble Found” rates, VENDOR will, in its reasonable discretion, provide to FSC [***] the documentation necessary to allow FSC to accomplish such limited screening and testing. VENDOR may require that FSC or FSC’s third party repairers enter into non-disclosure agreements prior to being provided access to such information

VENDOR will provide the documentation in the English language.

4.2 Technical assistance

VENDOR shall give FSC Level 4 technical assistance pursuant to the terms and conditions set forth on ANNEX 11 of the AGREEMENT.

4.3 Third party repairers

FSC reserves the right to select and authorize [***] third party [***]. VENDOR reserves the right to qualify and approve of the third party repairer. After such approval by VENDOR and the third party repairer’s entering into appropriate non-disclosure agreement(s) protecting VENDOR’s information, VENDOR shall provide the above-mentioned repair documentation and technical assistance directly to third party repairer.

After the third party repairer has entered into the required non-disclosure agreement, FSC shall be allowed to provide documentation referred to Clause 4.1 to such third party repairers for purposes of carrying out repairs on the CPs.

To the extent that FSC wishes VENDOR to take direct orders from the third party repairers, VENDOR may conduct a credit analysis of the third party repairer and impose reasonable credit limits or payment terms upon the third party repairer.

5. SPARE PARTS AND CP REPAIR SERVICE

5.1 General

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 7 of 21

Confidential

During the term of the AGREEMENT and for the period stated in 27.5 of the AGREEMENT, VENDOR will provide to FSC, upon FSC ´ s request, Out of Warranty REPAIR service for SPARE PARTS listed in the SPARE PARTS List as well as for CP at prices mutually agreed upon by the parties.

5.2 Service Deliverables

FSC will issue repair orders (or, in other words, a request for RMA activity) which orders will include the following particulars:

- Repair Order Number

- Counter Number

- Part Number

- Serial Number for serial controlled items

- Failure Mode (reason for failure)

- An indication if a return is only for an upgrade to current levels

- An indication if the item was DOA

- A Request for failure analysis, if appropriate and desired by FSC.

Within [***] after receipt of order, VENDOR will accept order and send an order confirmation including delivery date for information purposes to FSC. VENDOR may only reject an order if it is not in conformance with the terms and conditions of this ANNEX 6 or the AGREEMENT, or it is beyond the period stated in 27.4 of the AGREEMENT and VENDOR does not choose to accept the order. [***]

VENDOR shall carry out the REPAIRS according to the principle “first in first out”, unless requested differently for a specific order by FSC. Furthermore VENDOR is obliged to carry out REPAIRs due to the latest agreed upon revision level as long as the SPARE PART or CP is at or above a Minimum Accepted Revision Level (“MAL”).

Details of all processes between FSC and VENDOR, the scope of services, definition of control processes, definition of technical changes and description of the quality features are defined in Attachment 3 to ANNEX 6.

5.3 Transportation Charges

With respect to repair orders,[***].

5.4 [***]

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 8 of 21

Confidential

[***]

[***]

5.5 REPAIR Prices

Prices for the REPAIR of CPs and SPARE PARTs (including prices for accelerated orders) are stated in Attachment 1 (SPARE PARTS and REPAIR Prices) to ANNEX 6 and include appropriate packaging.[***] Section 4 of the AGREEMENT shall apply accordingly.

5.6 Turn Around Time (TAT)

Turn around Time (TAT) for the REPAIRS of SPARE PARTS/CPs from the date of receipt until the date of dispatch by VENDOR shall not exceed the period stipulated in ANNEX 3 to AGREEMENT.

For urgent deliveries, FSC may request accelerated REPAIRS to be carried out. In this case, a special request will be transmitted by FSC to VENDOR by electronic media. In such cases VENDOR will [***].

5.7 Dead on Arrival

The Dead on Arrival Rate, as verified by VENDOR and not just based on FSC’s observations, for repaired SPARE PARTs/CPs shall not exceed [***]. All such SPARE PARTs/ CPs shall be qualified “Dead on Arrival” which are still defective after REPAIR within [***].

5.9 Warranty

VENDOR warrants that the repaired SPARE PARTS/CPs will be free from defects that were subject of the REPAIR order, for a period of [***].

If VENDOR fails to carry out REPAIR successfully, in particular if a SPARE PART/CP remains defective even after REPAIR, VENDOR shall [***]

5.10 Quality and Environmental Management

VENDOR guarantees to comply with any applicable environmental laws or regulations that apply to its performance under this AGREEMENT.

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 9 of 21

Confidential

VENDOR guarantees that it will apply — through a recognized certification institution (i.e. DQS) — for quality and environmental certification for the REPAIRS in question in accordance with ISO 9001 and ISO 14001. VENDOR is to obtain certification and to maintain this for the period stated in 27.5 of the AGREEMENT.

VENDOR is responsible for the proper disposal (recycling or removal) for CPs returned under warranty according to the legal requirements on site of all waste and/or irreparable equipment and removed parts returned to VENDOR in executing REPAIRs commissioned by FSC. In particular, all legal requirements regarding waste of electrical and electronic equipment, batteries as well as other hazardous waste are to be considered.

VENDOR will keep supporting documentation of all disposal processes in accordance with legal requirements. FSC is entitled to perform audits in order to prove the compliance with the quality and environmental standards.

To maintain the high quality and reliability of SPARE PARTS/CPs VENDOR shall ensure that it adopts any and all necessary precautions while handling ESD parts.

5.11 Data protection

VENDOR shall treat customer data or information about the customer in form of stored data on SPARE PARTs/CPs (DATA), if any, as follows:

DATA will not be copied and will be physically erased completely. The erase procedure is done in such a way that a recovery of the DATA is not possible according technical state of the art.

If VENDOR has access to DATA, VENDOR will ensure that this information is handled confidentially for an unlimited duration: VENDOR will ensure that such DATA will neither be used for business nor for private purposes and that it will not be stored or made accessible to third parties (including employees).

In case that SPARE PARTs/CPs are handled by subcontractors, VENDOR will ensure that the subcontractors will comply with the provisions above.

6. MISCELLANEOUS

6.1 Logistics and Operations Specifications

General Logistics and Operations Specifications, applicable for SPARE PARTS Procurement (Clause 3) as well as for SPARE PARTS/CP REPAIR (Clause 5) are described in Attachment 4 to Annex 6 (Logistics and Operations Specifications).

6.2 RMA Process/Repairs Processing — Handling by Third Party Service Partner

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 10 of 21

Confidential

[***]

6.3 Quality Manager

Notwithstanding FSC` s further rights under this Annex 6, FSC shall have the same rights set forth in ANNEX 7 to the AGREEMENT regarding source assessments and audits with respect to SPARE PARTS as it does for CPs.

6.4 Measurement / Score Card

FSC will measure VENDOR’s performance and quality of service in various categories, particularly the following:

[***]

The results of these VENDOR’s KPI measurements will be combined and listed on a scorecard and may be communicated to VENDOR.

6.5 Communication and Interfaces

The responsible interfaces on FSC’s side are named in Attachment 5 to this Annex 6 (Communication List FSC). All invoicing documents and credit notes have to be sent to the contact as set out in Attachment 5.

7. ATTACHMENTS TO ANNEX 6

Attachment 1 — SPARE PARTs and REPAIR PRICES
Attachment 2 — IN-WARRANTY HANDLING PROCESS DESCRIPTION
Attachment 3 — REPAIR PROCESS AND SERVICE DESCRIPTION
Attachment 4 — Logistics and Operations Specification
Attachment 5 — Communication List FSC PRS

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 11 of 21

Confidential

Attachment 1 — SPARE PARTs and REPAIR PRICES

Has to be attached case by case.

PRS Page 12 of 21

Confidential

Attachment 2 — HANDLING PROCESS DESCRIPTION

1.	General Rules Governing REPAIR and RMA
1.1	For purposes of this ANNEX 6, communications through ELECTRONIC MEDIA shall mean VENDOR’s making available information to FSC through a web-based portal, or through basic email.
1.2	For purposes of this ANNEX 6, where VENDOR is required to confirm an RMA order within [***], the holidays of the country from which the confirmation is issued shall be take into consideration. For example, if RMA confirmation is occurring from the United States, United States holidays shall be taken into consideration.
1.3	When a Failure Analysis is requested, FSC will agree to waive the applicable Turn Around Time for that REPAIR.
1.4	If VENDOR determines that returned CPs or SPARE PARTS satisfy the applicable specification and warranties and there is No Trouble Found (“NTF”), VENDOR will return the item to FSC [***].
1.5	VENDOR shall provide reports to FSC by granting FSC access to a secure, web-based portal and posting the reports to the portal. FSC may then pull reports from the portal in its discretion.

2. In-Warranty Process Description

Responsibility	Action/Process
FSC	Requests RMA from VENDOR.
VENDOR	Confirms if SPARE PART is within warranty and issues a RMA number latest the working day following FSC’s request using the same method of communication.
FSC	Issues a RMA Order and sends it per ELECTRONIC MEDIA. Returns defective SPARE PARTS to VENDOR.
VENDOR	Acknowledges RMA Order per ELECTRONIC MEDIA for information purposes. Acknowledgment will include the RMA number which FSC is to use with respect to that RMA situation, as well as directions as to where to return the defective SPARE PART.
	VENDOR chooses among the following ways to execute RMA action upon receipt of defective SPARE PART :
	1. replace/exchange and send SPARE PART to FSC or 2. release a Credit Note amounting to the purchase price of the defective SPARE PART or

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 13 of 21

Confidential

Responsibility	Action/Process
	3. repair and send SPARE PART to FSC

The above described processes can be changed upon mutual agreement of the PARTIES.

3. Transportation Charges
	Transportation charges in case of In-Warranty shall be [***]. Transportation charges for DOA (Dead on Arrival) SPARE PARTS shall be [***]. Transportation charges in case of Out-Of-Warranty Spare Parts or CPs, or NTF situations, shall be [***].

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 14 of 21

Confidential

Attachment 3 — REPAIR PROCESS AND SERVICE DESCRIPTION

1. Out of Warranty REPAIR— Process Description

     1.1 Out of Warranty Status is clear

Responsibility	Action/Process
FSC	Issues a REPAIR Order per ELECTRONIC MEDIA.
VENDOR	Acknowledges REPAIR Order for information purposes, provides to FSC information regarding the REPAIR price applicable to such REPAIR ORDER and issues a RMA number for REPAIR latest the working day following receipt of FSC’ s order using the same method of communication.
FSC	Sends faulty SPARE PART/CP to VENDOR along with a purchase order indicating the amount of the repair price.
VENDOR	Repairs and returns SPARE PART/CP to FSC.
	VENDOR will mark all repaired SPARE PARTs/CPs with a repair notice (placed on the container of the SPARE PART). VENDOR sends an invoice to FSC.

     1.2 Out of Warranty Status is unclear

Responsibility	Action/Process
FSC	Requests RMA from VENDOR.
VENDOR	Confirms the warranty status. Should SPARE PART/CP be out of warranty, it will offer a REPAIR, and column O.O.W should be filled with the REPAIR price applicable to this SPARE PART/CP, using the same method of communication
FSC	If it decides to repair out of warranty SPARE PART/CP:
	- Issues a REPAIR Order per ELECTRONIC MEDIA.
	- Issues a Purchase Order indicating the REPAIR price.
	- Sends faulty SPARE PART/CP to VENDOR.
VENDOR	Acknowledges REPAIR Order for information purposes and issues a RMA number for REPAIR latest the working day following receipt of FSC’ s order using the same method of communication.
	- Repairs and returns SPARE PART/CP to FSC.
	VENDOR will mark all repaired SPARE PARTs/CPs with a repair notice including the date of REPAIR (placed on the container of the Spare Part). VENDOR sends an invoice to FSC.

PRS Page 15 of 21

Confidential

2. INCOMING INSPECTION / Reporting

2.1 Incoming Inspection

VENDOR shall carry out an incoming inspection, in particular a logistic inspection as well as an optical control on SPARE PARTS/CPs immediately after receipt.

2.2 Wrong Part in Box

If VENDOR receives a SPARE PART/CP that deviates from the declared one, the procedure as described under Clause 1 of Attachment 4 to this ANNEX 6 shall apply.

2.3 Reporting

VENDOR will provide the following reports as joined in Appendixes 1 to this Attachments 3 (REPORTS):

Service Logistics Reports

[***]

Monthly Service Quality Report

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 16 of 21

Confidential

[***]

	VENDOR will provide FSC with the above-mentioned reports by ELECTRONIC MEDIA as mentioned above or upon request. Depending on REPAIR volumes the parties may agree upon a change in the frequency of reports.
	[***]
3.  Service Description (Scope of Services, Control Processes, Technical Changes and Quality Features)

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 17 of 21

Confidential

Appendix 1 to Attachment 3 — REPORTS

1. Service Logistics Reports

[***]

2. Service Quality Report

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 18 of 21

Confidential

Attachment 4 — Logistics and Operations Specifications

1. Wrong part in box

If VENDOR receives a SPARE PART/CP that deviates from the declared one, VENDOR has to inform FSC by email at time of finding differences.

VENDOR can distinguish between the following possibilities:

  [***]

2. Packaging specifications for SPARE PARTs delivery, In-warranty handling and OOW-REPAIR
	SPARE PARTs shall be packed separately from complete CP and shall be specifically labelled as SPARE PARTs in line with the Basic SPARE PARTs List. Any delivery of SPARE PARTs and CP shall identify the content of each package and shall indicate the respective revision level.
2.1 Definitions
	Logistic Units Individual package: shall mean the single carton/box of one single product original or similar to original package, identified by one part number.
	Master carton: shall mean the carton that holds the individual shipping cartons for a same part number.
	Bulk-shipping carton: shall mean the carton that holds parts in bulk identified by different part number.
	P/N The SPARE PART number consists of the prefix ,,XXX:” followed by the supplier part’s number as listed in the BASIC SPARE PARTs List.

	e.g. ABC:12345678
Description	The part description on the label has to be identical to that in the BASIC SPARE PARTs List.
Revision	If a revision is applicable for a part it should be printed on the label. This is mainly for M/Bs (motherboards) or similar products.

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 19 of 21

Confidential

PO Number	FSC ’s Purchase Order Number
RMA Number	Return Material Authorisation Number, issued by VENDOR

2.2	Labelling
	VENDOR’s SPARE PART number must be printed on every part, except small metal and plastic parts. Only the small parts, that are bulk packed, can have a label attached to their packaging. The labels have to be machine printed.

•	Individual package must be labelled as follows:
	P/N, Description, Revision, Serial Number (if serial controlled)
•	Master Carton carton must be labelled as follows:
	P/N, Description, Quantity units inside the box
•	Bulk-shipping carton must be labeled in respect of its contents:
	PO Number or RMA Number
•	Pallets must at least be labeled as follows:
	PO Number or RMA Number
•	Delivery note must show the content of the pallet. Each Delivery note (packing slip) will include the Part Number, Description, Revision, PO Number or RMA Number.

2.3	Seal
	All packaging is supplied with a seal of originality in order to allow documented opening of the packaging (e.g. seal, adhesive tape imprint, wet adhesive tape strengthened with string).

3.	Delivery note
	The delivery note for return of the handled (in warranty) or repaired SPARE PARTs/CPs must contain the following specifications for each delivery position:
	P/N, RMA Number and/or Repair Order Number, Serial Number.

When providing exchange/replacement SPARE PARTs/CPs, VENDOR has to mention the new replacement serial number on the delivery note.

4. Packaging constituents after the In-Warranty Handling or OOW REPAIR

• Individual packaging

• Padding material (Bubble Wrap and Foam)

• Delivery note bag

• Delivery note

• Repairer’s package label

• Product label

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 20 of 21

Confidential

VENDOR has to return each repaired or exchanged SPARE PART/CP, single packed, in new individual authorized packaging.

Attachment 5 — Communication List FSC PRS (SE PRS SO MM)

1. Spares Operation Material Management

[***]

2. Invoicing

Please send all invoicing documents and credit notes to:

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
PRS	Page 21 of 21

Confidential

ANNEX 7    QUALITY ASSURANCE

This ANNEX 7 QUALITY ASSURANCE sets forth and defines the processes to be used by VENDOR in the development and manufacture of Contractual Product(s) (CP) covered by this AGREEMENT and certain quality requirements pertaining to said CP(s).

Abbreviations and Definitions

1.1 Abbreviations

AFR	Annual Failure Rate
AQL	Acceptance Quality Level
ATP	Acceptance Test Procedure
CAR	Corrective Action Report
CP	Contracted Product
DCL	Defect Classification List
DOA	Dead On Arrival
DPM	Defect Per Million
DVT	Design Verification Test
EC	Engineering Change
ECN	Engineering Change Notice
ECR	Engineering Change Request
EF	Epidemic Failure
EOL	End of Life
EVT	Engineering Verification Test
fit	failure in time
FOB	Free On Board
IPC	In Process Control
IQC	Incomming Quality Control
MTBF	Mean Time Between Failure
NDF	No Defect Found
NTF	No Trouble Found
OoBT	Out of Box Test
OQC	Outgoing Quality Control
ORT	Ongoing Reliablity Test
PVT	Production Validation Test
SA	Source Assessment

1.2 Definitions

“Defect(s)” shall mean a defect in a CP that creates hazard, prevents the intended operation (functionality) of the CP or requires part addition, replacement, repair or adjustment not normally encountered during installation.

•	Critical Defect:
	A Critical Defect is a defect that judgment and experience indicate is likely to result in hazardous or unsafe conditions (e.g. endanger human health or life, cause fire,..) for individuals using, maintaining, or depending upon CP.
•	Major Defect:
	A Major Defect is a defect that is likely to result in failure, or to reduce the usability of CP for its intended purpose.

Quality 1/8

Confidential

•	Minor Defect:
	A Minor Defect is a defect that is not likely to reduce the usability of CP for its intended purpose, or is a deviation from established standards according ANNEX 1 CONTRACTUAL PRODUCTS and ANNEX 2 DOCUMENTATION, having minor influence on the effective use, operation of CP or appearance.

“DOA” shall mean a CP that does not comply with the applicable product warranty within the [***].

Quality Statement

VENDOR will establish and maintain an effective Quality Assurance system for all processes relating to the manufacture of CP, including design, material procurement, manufacturing, inspection, storage, and transportation of CP in order to achieve lower failure rates than specified in Appendix 1 to ANNEX 7 QUALITY ASSURANCE.

Quality and technical related documents

Prior to the first general availability shipment of CP to FSC, VENDOR shall use best efforts to submit to FSC in a machine readable format all documents listed in ANNEX 2 DOCUMENTATION and shall implement respective standards.

General Inspection System

VENDOR shall provide and maintain an inspection system reasonably acceptable to FSC covering CP. Records of all inspections performed shall be kept complete and be made available for review by FSC Quality Assurance Representative.

FSC and its subcontractors reserve the right to have access to CP related production facilities at any time on request prior to one day notice in order to inspect CP and CP production process and environment.

Design Verification Test

Different portions of CP DVT will be performed by the applicable party based on and in compliance with the CP design verification test plan mutually agreed upon by the parties. Any obligations of VENDOR to perform DVT will be contingent upon FSC’s providing to VENDOR any assistance, tools or equipment as agreed upon and set forth in the DVT test plan.

Design verification test goals:

The calculated mean time between failure (MTBF) of the CP (as specified in the product specification in ANNEX 1 CONTRACTUAL PRODUCTS and ANNEX 2 DOCUMENTATION) should be confirmed by VENDOR’s DVT. FSC reserves the right to have access to data generated during DVT.

Product Validation Test

The CP PVT will be performed by VENDOR based on and in compliance with VENDOR’ s standard reliability and environment test plan.

Product Validation test goals:

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	2/8

Confidential

The PVT shall be designed to prove, that the CP fully conforms to the agreed specification, the drawings, the functionality and the ATP. FSC reserves the right to have access to applicable data generated during PVT.

Run In / Burn In

Upon the reasonable and mutual agreement of the parties, VENDOR will subject the CPs to a Run In / Burn In period, at VENDOR’s facility. The parties understand that such Run In/Burn In period may increase lead times for the CPs or applicable Spare parts.

Manufacturing Process Controls

8.1 Prior to the first general availability shipment of CPs, VENDOR will establish control on processes according to the requirements of ANNEX 2 DOCUMENTATION.

8.2 VENDOR will continue to provide to FSC for review a written plan covering the major phases of manufacturing process control including but not limited to the following:

     [***]

8.3 VENDOR shall continue to develop, implement and maintain, as necessary, appropriate procedures and/or documentation which will define the methods to be used for process control including but not limited to the following:

     [***]

Mass Production Standard

Mass production has to be done by using common workmanship standards (e.g. ANSI / IPC A-610, Rev C: Class 2) and according to the general state of the art.

Ongoing Reliability Test (ORT)

10.1 VENDOR shall conduct ongoing Mean Time Between Failure (MTBF) verification testing in accordance with Vendor’s standard ORT plan. In addition to this, the conformance of the CP to the ATP (Acceptance Test Procedure) shall be verified ongoing.

10.2 VENDOR will inform FSC of significant changes to the above referenced plan which decrease the quality and/or quantity of data gathered during this test. [***]

10.3 [***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	3/8

Confidential

[***]

10.4 [***]

10.5 [***]

Source Assessment

11.1 For the term of the Agreement FSC shall [***]

VENDOR acknowledges and agrees that Source Assessment by FSC will not relieve VENDOR from its obligation to establish and maintain an effective quality assurance system and from its full and sole responsibility for the manufacturing and delivery of the CPs in agreed quality.

FSC will notify VENDOR of [***]

11.2 In the event FSC informed VENDOR about [***]

VENDOR shall inform [***]

11.3 Source Assessment includes the following activities:

     [***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	4/8

Confidential

Source Assessment will be conducted in accordance with ATP, Workmanship Standard and the DCL, which are mutually agreed for each CP. The ATP includes the level of inspection, AQL and/or sampling plan and the overall testing procedure where applicable.

11.4 Sampling for the Source Assessment will be done according to the following principles (“Sampling Plan”):

[***]

Unless otherwise defined in the ATP, sampling type shall be “normal” and inspection level shall be “II”.

11.5 Source Assessment Testing Results

[***]

11.6 For the avoidance of doubt FSC’s [***].

12. Epidemic Failures

12.1 If EPIDEMIC FAILURES occur, VENDOR shall take immediate and appropriate actions to come up with a strategy for dealing with the EPIDEMIC FAILURE with respect to all affected CPs (and not just those outside of agreed upon quality levels) in agreement with FSC, and subject to the provisions below.

12.2 EPIDEMIC FAILURE and periods of applicability are defined as either of the following:

(a) An EPIDEMIC FAILURE shall mean failures of a CP [***] that meet ALL of the following conditions:

     [***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	5/8

Confidential

     [***]

OR

(b) An EPIDEMIC FAILURE shall mean the failure of a type of CP module as set forth on Appendix 1 of this ANNEX 7 (“Appendix 1”), [***] that meet ALL of the following conditions:

     [***]

[***]

12.4 EPIDEMIC FAILUREs Removal

In the event of an EPIDEMIC FAILURE, VENDOR shall have the discretion to repair or replace the affected CPs according to a reasonable plan of action designed by VENDOR and reasonably approved by FSC. VENDOR agrees to [***]

13. On-Site Audit Requirements

VENDOR shall grant FSC access to VENDOR’s engineering, production and test facilities of CP for on site audits. FSC may audit the engineering, production and test processes on a scheduled basis and with reasonable advance notification [***] to VENDOR.

FSC may, for purposes of periodic monitoring or for lot acceptance, select and test samples at its own expense of completed CP within the area allotted to FSC for such purposes. FSC and

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	6/8

Confidential

VENDOR will mutually agree to sample selection methods and quantities. On-site audits will occur as necessary to insure product quality prior to shipment to FSC.

If VENDOR changes the CP manufacturing location, FSC’s quality assurance organization may conduct a production and process audit.

14. Traceability

VENDOR shall keep records of manufacturing data (date of manufacture, manufacturing lines, serial numbers of parts used, and other mutually agreed items required to ensure the ability to trace defects in quality or errors occurring in the CP, and promptly disclose this data upon request from FSC for [***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	7/8

Confidential

Appendix 1 to Annex 7

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	8/8

Confidential

ANNEX 8    EMERGENCY MANUFACTURING RIGHT

1. If VENDOR is [***], then FSC may send written notice to VENDOR that it wishes to exercise its manufacturing rights hereunder (“Manufacturing Rights”). If within [***] of receiving such notice from FSC VENDOR does not begin [***], then VENDOR hereby grants to FSC [***].

Notwithstanding the foregoing, the right of FSC to exercise such Manufacturing Rights is subject to the following conditions, exclusions and limitations:

     (i) FSC must manage all such manufacture and any related documentation and materials in a confidential manner;

     (ii) The CPs and Spare Parts manufactured by FSC must be used, sold, and distributed to FSC’s customers in FSC’s normal course of business, and not for any other purpose such as (but not limited to) the purpose of [***];

     (iii) If, in exercising the Emergency Manufacturing Rights, FSC uses the same contract manufacturer as VENDOR used just prior to the trigger of the Emergency Manufacturing Rights (and therefore the investment of FSC in exercising the rights is minimal), then the Manufacturing Rights shall terminate upon the earlier of: [***];

     (iv) If, in exercising the Emergency Manufacturing Rights, FSC uses a different contract manufacturer as VENDOR used just prior to the trigger of the Emergency Manufacturing Rights (and therefore the investment of FSC in exercising the rights is more significant), then the Manufacturing Rights shall terminate upon the earlier of: [***].

     (v) Upon the termination of the Manufacturing Rights, FSC shall cease manufacture of CPs and return to VENDOR all documents and materials that were provided to FSC by VENDOR to enable FSC to exercise its manufacturing rights.

2. Upon FSC’s proper exercise of the manufacturing rights set forth herein, VENDOR shall:

(i) submit without delay to FSC an updated and reproducible set of the complete manufacturing and testing documentation in respect of the CP, such documentation to be in the English language and in the metric system;

	***CONFIDENTIAL TREATMENT REQUESTED
GS	1/2

Confidential

(ii) render to FSC in respect of the CP reasonable technical assistance, [***], by training of FSC’s experts and explanation of the above mentioned documentation; and

(iii) provide to FSC those [***].

3. FSC may at any time request that VENDOR will deposit one set of the above mentioned manufacturing and testing documentation with a neutral escrow agent in the United States of America, to be nominated by VENDOR and reasonably approved by FSC and to keep up to date such documentation. In such case FSC shall bear all costs associated with the selection, deposition and maintenance of the deposit.

	***CONFIDENTIAL TREATMENT REQUESTED
GS	2/2

Confidential

ANNEX 9    STANDARDS, ENVIRONMENTAL REQUIREMENTS

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	1/1

Confidential

ANNEX 10    TECHNICAL CHANGES

1. Forms of Communication and Notification.

The parties will set up a Change Control Board (“CCB”) with representatives of both parties, which will meet telephonically on a periodic basis to discuss pending changes that are expected to affect the CPs and Spare Parts. The parties will mutually agree upon the frequency of such CCB meetings. The parties expect that much of the information to be exchanged between the parties regarding engineering changes (“EC”) will be exchanged during the CCB meetings. Further, FSC will be granted access to VENDOR’s AGILE database through which FSC can initiate, track and approve ECs (“Agile”). Any notification that must be made pursuant to this ANNEX by either party to the other regarding ECs may be made by regular email, through Agile or verbally during a CCB meeting.

2. ENGINEERING CHANGES TO CP

Vendor shall use best efforts to give FSC prompt notice, but at least [***] notice, prior to each technical change VENDOR intends to make to the CPs during the term of this Agreement (“EC”). Such notices shall in particular include the article numbers of the relevant CPs, the date of alteration and a complete description of the change. At FSC’s request, VENDOR shall furnish FSC with the information which FSC reasonably considers necessary in connection with these alterations to the CPs. Notwithstanding the foregoing, FSC understands that in certain emergency situations, VENDOR may not be able to give FSC [***] notice of an EC.

3. Conditions Governing Changes

a)	VENDOR is entitled to execute changes, which do not affect the form, fit or functionof the applicable CP or Spare Part without the approval of FSC. VENDOR shall use best efforts to inform FSC of such technical changes [***] prior to delivery of the changed CP or Spare Part. FSC understands that in certain emergency situations, VENDOR may not be able to comply with such notice period.
b)	VENDOR may execute technical changes which do affect the form, fit, or function, but only with the prior consent of FSC. FSC shall grant or refuse its consent through [***] following the receipt of the notification. FSC shall not unreasonably withhold its consent.
c)	Vendor shall use best efforts to give FSC prompt notice but at least [***] prior to making any other types of changes VENDOR intends to make concerning the CPs or Spare Parts, e.g. regarding tooling, processes, procedures, locations, and sub-vendors. Notwithstanding the foregoing, FSC understands that in emergency certain situations, VENDOR may not be able to give FSC [***] notice of such a change.
d)	Even after EOL, VENDOR shall comply with the EC processes stated in this ANNEX 10 TECHNICAL CHANGES.
e)	If FSC does not respond to requests for approval of EC orders within the aforementioned [***], FSC’s consent shall be considered granted to VENDOR.

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	1/5

Confidential

f) If FSC receives CPs or Spare Parts with changes of which it should have been informed but was not, FSC may refuse acceptance of the CP or Spare Part and VENDOR shall be liable for all shipping charges with respect to the return of the units.

4. Modifications to the Specifications of CPs

VENDOR shall use best efforts to provide to FSC with [***] prior notice of VENDOR’s planned intention to modify the specifications for a CP.

Modification by VENDOR of a FSC-custom component [***]. Modification by VENDOR of the specification for a CP which affects the form, fit, or function, may only be made with the prior consent of FSC. FSC shall grant or refuse its consent within [***]. FSC shall not unreasonably withhold its consent. If FSC’s consent is required, FSC and VENDOR will agree on a starting point (e.g. cut in serial number, cut in date etc.) from which the modified CP will be delivered. Up to this point only unmodified CP may be delivered to FSC.

Even after the starting point of modification VENDOR is obliged to supply FSC with SPARE PARTS for a period of [***], corresponding to the earlier specifications, unless the modified specifications do not affect the use of the modified SPARE PARTS for CP with earlier specifications. Further VENDOR shall mark CPs affected by such modifications of the specifications by way of a new part number or other notation.

Proposals submitted by FSC for modifying the CP specifications shall be given due consideration by VENDOR. [***] VENDOR shall communicate its opinion of the proposed modifications to the specifications within [***] following communication of the same by FSC. If VENDOR agrees to modify the CP according to such specifications it shall inform FSC of the resultant price adjustments and of the time necessary to carry out the modifications. Such modifications shall be made only with FSC’s approval.

5. Engineering Change Procedure

Notification of product modifications shall be done by means of an ECR / ECN (Engineering Change Request / Notice) reflecting the new revision level and the reason for the modification according Appendix 1 to ANNEX 10. FSC shall use reasonable efforts to evaluate an ECR as soon as possible.

The EC process is described in Appendix 1 to ANNEX 10. FSC shall respond to an EC request [***]. If an EC requires FSC’s approval and FSC rejects an ECR, VENDOR shall not implement that specific modification.

6. Request for Action due to Technical Issue

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	2/5

Confidential

A modification request by FSC due to a technical failure of a CP or other issue that impacts a CP’s compliance with the applicable specification will be made [***].

VENDOR shall notify FSC of its acceptance or rejection of the RFA [***]. VENDOR shall not unreasonably withhold its consent to an RFA. Mandatory or urgent modifications should be marked accordingly.

Mutually accepted changes may be implemented. The implementation can be notified by an ECN (Engineering Change Notice). The Cut In Date / Cut in Serial Number shall be mutually agreed upon in writing.

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	3/5

Confidential

Appendix 1 to ANNEX 10

1. EC Process

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	4/5

Confidential

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	5/5

Confidential

ANNEX 11    TECHNICAL SUPPORT, TRAINING

1. Training

Upon FSC’s request, VENDOR shall hold [***] an initial training course, [***], as specified below to be conducted in the English language on FSC’s premises in Germany in order to instruct employees of FSC and its designated service partners that are bound by standard non-disclosure agreements (“Designated Service Providers”) in the operation, maintenance and technical features of CPs.

VENDOR shall provide appropriate training documents which may be in the form of CDs and other electronic formats.

FSC may reproduce the training documents for FSC’s internal use only (including FSC’s Designated Service Partners).

For additional training courses which may be requested by FSC, dates and actual costs will be mutually agreed upon for each such additional course.

2. Technical Support

FSC will be responsible for working directly with FSC’s end users and customers, and VENDOR will work directly with FSC, as necessary, to provide technical support with respect to CPs during the Warranty Period. [***] FSC and VENDOR will mutually agree upon terms pursuant to which VENDOR will provide support on CPs beyond the Warranty Period.

FSC represents and warrants that it (or its agents) is experienced in, capable of, and staffed to provide Level 1 Level 2 and Level 3 support (as defined below) for its own products and the CPs. FSC must ensure that its technical support personnel have attended training courses with respect to the CPs to enable such support, including the initial training described in section 1, above. VENDOR will accept calls for technical assistance only from FSC Level 3 engineers who have attended such training.

VENDOR will provide Level 4 support with respect to the CPs during the Warranty Period, as defined below.

3. Support Level Definitions

(a) Level 1 Support

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	1/2

Confidential

[***]

(b) Level 2 Support

[***]

(b) Level 3 Support

[***]

(c) Level 4 Support

[***]

4. On-Site Technical Supp

The parties both understand that VENDOR personnel will be requested to visit end-user customer sites only in extraordinary circumstances, where resolution of an issue is shown to be impossible without such a visit. In such instances, [***] When VENDOR personnel are required to make direct telephone or field contact with FSC’s end-user customer, FSC will designate a customer representative of FSC to be present for the duration of the customer contact.

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	2/2

Confidential

ANNEX 12    CONTACTS

Notices and communications to be transmitted according to Section 26 of the AGREEMENT between VENDOR and FSC shall be given in writing or by fax to the following addresses of the parties or to such other address as the party concerned may subsequently notify in writing to the other party.

VENDOR:

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
GS	1/4

Confidential

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
GS	2/4

Confidential

FSC:

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
GS	3/4

Confidential

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
GS	4/4

Confidential

ANNEX 13    EXCESS INVENTORY

FSC has to give notice to VENDOR [***].

During the [***].

The [***]

Should the [***]

Should FSC receive no timely instructions within the [***] period, FSC is [***]

	***CONFIDENTIAL TREATMENT REQUESTED
GS	1/1

Confidential

ANNEX 14    DROPSHIPMENT

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
GS	1/1

Confidential

ANNEX 15    TEST REQUIREMENTS

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	1/1

Confidential

ANNEX 16    PACKAGING AND LABELING

[***]

	***CONFIDENTIAL TREATMENT REQUESTED
Quality	1/1

Confidential

ANNEX 17    ETHICAL STANDARDS

1. FSC is committed to ethical and responsible conduct in its business operations which respects the rights of the individuals and the environment. At a minimum FSC requires the VENDOR to comply with the following standards and all applicable laws relating to such matters. The VENDOR shall:

1.1	not use child labour or forced or involuntary labour of any kind;
1.2	not discriminate in hiring and employment practices whether based upon race, religion, age, nationality, social or ethnic origin, sexual orientation, gender, disability or political opinion;
1.3	treat all its employees with dignity and respect and not use corporal punishment or threats of violence or other physical or mental abuse;
1.4	provide its employees with a safe and healthy workplace (and where applicable any housing provided for employees) in compliance with applicable laws and standards and ensure reasonable access to drinkable water and sanitary facilities, adequate lighting and ventilation and fire safety; and
1.5	comply with applicable laws and regulations relating to wages, working hours and environmental matters.

2.	VENDOR shall take adequate measures to ensure that the provisions of this clause are communicated to its employees.
3.	VENDOR hereby authorises FSC and its designated agents to engage in monitoring activities to verify compliance with the provisions of this clause including conducting unannounced on-site inspections and review of books and records relating to the above matters.

GS 1/1

Confidential

ANNEX 18    INTELLECTUAL PROPERTY RIGHTS

1. Definitions

1.1	“VENDOR Background IP” shall mean any pre-existing Intellectual Property that VENDOR owns or has the right to license. Unless a certain component or feature is otherwise specifically indicated, the CP and the Spare Parts are VENDOR Background IP.
1.2	“VENDOR Foreground IP” shall mean any Intellectual Property which is developed, conceived or reduced to practice by the employees or contractors of VENDOR as a result of the performance of any development activities under the AGREEMENT or with respect to the CPs or Spare Parts. Except for FSC NEW Ideas that are specifically identified as Jointly Owned IP as per this ANNEX, VENDOR Foreground IP shall include the Intellectual Property developed, conceived or reduced to practice by one or more employees or agents of VENDOR with the aid or contributions of one or more employees or agents of FSC in connection with development activities taken under the AGREEMENT which relates to the CP and Spare Parts.
1.3	“Jointly Owned IP” shall mean FSC New Ideas, but only those that are incorporated into a CP or Spare Part and which are identified and agreed in writing by the Parties. Jointly Owned IP shall not include any underlying or accompanying Background IP or Foreground IP of either party.
1.4	“Intellectual Property” or “IP” shall mean all rights worldwide in Patents, copyrights, trade secrets, Confidential Information or any other Intellectual Property rights, but excluding rights in trademarks, service marks, trade names, service names and Internet domain names and other similar designations.
1.5	“FSC Background IP” shall mean any pre-existing Intellectual Property that FSC owns or has the right to license.
1.6	“FSC New Ideas” shall mean new concepts or other forms of Intellectual Property such as, for example, new features for the CPs, which is conceived of solely by FSC’s employees or agents without the contribution of VENDOR. FSC must follow the guidelines regarding the disclosure of FSC New Ideas as set forth below in this ANNEX 18 in order to take advantage of any applicable exclusive sales period with respect to the FSC New Idea.
1.7	“Patents” shall mean patents, patent applications, design patents and registrations and utility models, along with any reissues, re-examinations, continuations, continuations-in-part, divisions and renewals thereof.

2. FSC and its licensors shall retain title to and all ownership rights and interests in and to the FSC Background IP.

3. VENDOR and its licensors shall retain title to and all ownership rights and interests in and to the VENDOR Background IP and VENDOR Foreground IP.

4. FSC NEW Ideas

GS 1/2

Confidential

4.1	In the event FSC would like to share with VENDOR an FSC New Idea for purposes of having VENDOR include the FSC New Idea in the CPs or Spare Parts, FSC shall [***].
4.2	If, upon disclosing the FSC New Idea to VENDOR, VENDOR [***].
4.3	If, upon disclosing the FSC New Idea to VENDOR, VENDOR [***].
4.4	FSC New Ideas which are identified and agreed by the Parties in writing will be Jointly Owned IP, subject to VENDOR’s underlying ownership rights and interests to VENDOR Background IP and VENDOR Foreground IP and subject to FSC’s rights in Background IP.

5. With respect to Jointly Owned IP which has been identified and agreed by the Parties in writing, neither party will have a duty to [***].

	***CONFIDENTIAL TREATMENT REQUESTED
GS	2/2

Confidential

ANNEX 19    MARKETING FUNDS

1.	VENDOR shall provide [***].
2.	The MDF is expected to be used to pay for, among other things, [***].
3.	FSC shall be required to provide [***].
4.	For the calendar year 2006, the total amount of the MDF shall be [***].

For the calendar year 2007, the total amount of the MDF shall be [***]

6. For the year 2008 and beyond, the parties will negotiate the amount of the MDF in good faith.

	***CONFIDENTIAL TREATMENT REQUESTED
GS	1/1

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Dana W. Kammersgard, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Dot Hill Systems Corp.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

     a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

     b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

     c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

     d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

     a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

     b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 10, 2006

/s/ DANA W. KAMMERSGARD Dana W. Kammersgard

Chief Executive Officer and President

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Shad L. Burke, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Dot Hill Systems Corp.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

     a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

     b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

     c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

     d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

     a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

     b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 10, 2006

/s/ SHAD L. BURKE

Shad L. Burke

Interim Chief Financial Officer, Vice President of Finance, Corporate Controller and Assistant Secretary

EX-32.1

Exhibit 32.1

DOT HILL SYSTEMS CORP.

OFFICERS’ CERTIFICATE

     Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350, as adopted), Dana W. Kammersgard, Chief Executive Officer of Dot Hill Systems Corp. (the “Company”), and Shad L. Burke, the Interim Chief Financial Officer of the Company, each hereby certify that, to the best of his knowledge:

1. The Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2006, to which this Certification is attached as Exhibit 32.1 (the “Periodic Report”) fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended; and

2. The information contained in the Periodic Report fairly presents, in all material respects, the financial condition of the Company at the end of the period covered by the Periodic Report and results of operations of the Company for the period covered by the Periodic Report.

In Witness Whereof, the undersigned have set their hands hereto as of the 10^th day of May, 2006.

/s/ DANA W. KAMMERSGARD Dana W. Kammersgard	/s/ SHAD L. BURKE Shad L. Burke
Chief Executive Officer	Interim Chief Financial Officer

     This certification “accompanies” the Periodic Report, is not deemed filed with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Periodic Report), irrespective of any general incorporation language contained in such filing.