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 September 30, 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	(I.R.S. Employer Identification No.)
or organization)
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 44,998,622 shares of common stock, $0.001 par value, outstanding as of November 2, 2006.

DOT HILL SYSTEMS CORP.

FORM 10-Q

For the Quarter Ended September 30, 2006

INDEX

 EXHIBIT 4.6

 EXHIBIT 4.7

 EXHIBIT 10.3

 EXHIBIT 10.4

 EXHIBIT 10.5

 EXHIBIT 10.6

 EXHIBIT 10.7

 EXHIBIT 31.1

 EXHIBIT 31.2

 EXHIBIT 32.1

2

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,			September 30,
	2005			2006
ASSETS
Current Assets:
Cash and cash equivalents	$	108,803		$	107,206
Short-term investments		13,431			1,249
Accounts receivable, net of allowance of $294 and $638		34,312			36,281
Inventories		2,804			2,359
Prepaid expenses and other		4,539			4,537
Deferred tax assets		5,762			—
Total current assets		169,651			151,632
Property and equipment, net		7,891			10,315
Goodwill		40,725			40,725
Other intangible assets, net		7,414			4,967
Deferred tax assets		41,379			—
Other assets		234			145
Total assets	$	267,294		$	207,784
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	25,732		$	30,166
Accrued compensation		3,561			3,447
Accrued expenses		3,633			5,571
Accrued legal settlement		—			1,475
Deferred revenue		1,327			345
Income taxes payable		60			15
Restructuring accrual		45			—
Total current liabilities		34,358			41,019
Other long-term liabilities		885			2,039
Total liabilities		35,243			43,058
Commitments and Contingencies (Note 12)
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 44,946 shares issued and outstanding at December 31, 2005 and September 30, 2006, respectively		44			45
Additional paid-in capital		285,377			289,926
Accumulated other comprehensive loss		(118	)		(306	)
Accumulated deficit		(53,252	)		(124,939	)
Total stockholders’ equity		232,051			164,726
Total liabilities and stockholders’ equity	$	267,294		$	207,784

See accompanying notes to condensed consolidated financial statements.

3

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						Nine Months Ended
	September 30,						September 30,
	2005			2006			2005		2006
NET REVENUE	$	53,616		$	54,846		$	177,524	$	179,797
COST OF GOODS SOLD		41,263			47,813			135,749		147,833
GROSS PROFIT		12,353			7,033			41,775		31,964
OPERATING EXPENSES:
Sales and marketing		5,180			3,607			14,920		11,904
Research and development		6,280			8,221			16,335		30,053
General and administrative		3,158			4,181			8,555		14,305
Legal settlement		—			45			—		3,395
Total operating expenses		14,618			16,054			39,810		59,657
OPERATING INCOME (LOSS)		(2,265	)		(9,021	)		1,965		(27,693	)
OTHER INCOME:
Interest income, net		791			1,417			2,189		4,103
Other income (expense), net		7			(14	)		93		12
Total other income, net		798			1,403			2,282		4,115
INCOME (LOSS) BEFORE INCOME TAXES		(1,467	)		(7,618	)		4,247		(23,578	)
INCOME TAX EXPENSE (BENEFIT)		(192	)		52,468			124		48,109
NET INCOME (LOSS)	$	(1,275	)	$	(60,086	)	$	4,123	$	(71,687	)
NET INCOME (LOSS) PER SHARE:
Basic	$	(0.03	)	$	(1.34	)	$	0.09	$	(1.60	)
Diluted	$	(0.03	)	$	(1.34	)	$	0.09	$	(1.60	)
WEIGHTED AVERAGE SHARES USED TO CALCULATE NET INCOME (LOSS) PER SHARE:
Basic		43,949			44,880			43,832		44,678
Diluted		43,949			44,880			45,613		44,678
COMPREHENSIVE INCOME (LOSS):
Net income (loss)	$	(1,275	)	$	(60,086	)	$	4,123	$	(71,687	)
Foreign currency translation adjustments		46			(27	)		192		(227	)
Net unrealized gain on short-term investments		51			4			30		39
Comprehensive income (loss)	$	(1,178	)	$	(60,109	)	$	4,345	$	(71,875	)

See accompanying notes to condensed consolidated financial statements.

4

DOT HILL SYSTEMS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)

	Nine Months Ended
	September 30,
	2005			2006
Cash Flows From Operating Activities:
Net income (loss)	$	4,123		$	(71,687	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		6,017			5,405
Loss on disposal of property and equipment		461			75
Provision for doubtful accounts		969			246
Stock-based compensation expense		8			2,718
Gain on sale of short-term investments		(5	)		—
Deferred taxes		—			47,141
Changes in operating assets and liabilities:
Accounts receivable		4,331			(2,007	)
Inventories		773			457
Prepaid expenses and other assets		(1,052	)		138
Accounts payable		(17,214	)		2,292
Accrued compensation and expenses		(683	)		1,787
Legal settlement payable		—			1,475
Deferred revenue		670			(989	)
Income taxes payable		(243	)		(46	)
Restructuring accrual		(92	)		(45	)
Other long-term liabilities		48			1,152
Net cash used in operating activities		(1,889	)		(11,888	)
Cash Flows From Investing Activities:
Purchases of property and equipment		(3,008	)		(3,998	)
Sales and maturities of short-term investments		50,632			22,575
Purchases of short-term investments		(25,200	)		(10,337	)
Net cash provided by investing activities		22,424			8,240
Cash Flows From Financing Activities:
Proceeds from sale of stock to employees		1,040			1,055
Proceeds from exercise of stock options and warrants		738			777
Net cash provided by financing activities		1,778			1,832
Effect of Exchange Rate Changes on Cash		192			219
Net Increase (Decrease) in Cash and Cash Equivalents		22,505			(1,597	)
Cash and Cash Equivalents, beginning of period		67,496			108,803
Cash and Cash Equivalents, end of period	$	90,001		$	107,206
Supplemental Disclosures of Cash Flow Information:
Construction in progress costs incurred but not paid	$	770		$	1,464
Cash paid for interest	$	—		$	—
Cash paid for income taxes	$	540		$	1,482

See accompanying notes to condensed consolidated financial statements.

5

DOT HILL SYSTEMS CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements of Dot Hill Systems Corp. (referred to herein as Dot Hill, we, our or us) have been prepared pursuant to the instructions to Securities and Exchange Commission, or SEC, Form 10-Q. 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. 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 and nine months ended September 30, 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.

     We recognize revenue for 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 our 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.

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 condensed consolidated financial statements for the three and nine months ended September 30, 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 and nine months ended

6

September 30, 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 September 30, 2006, total unrecognized share-based compensation cost related to unvested stock options was $6.9 million, which is expected to be recognized over a weighted average period of approximately 1.6 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 and nine months ended September 30, 2006 (amounts in thousands):

	Three Months Ended		Nine Months Ended
	September 30, 2006		September 30, 2006
Cost of goods sold	$	81	$	221
Sales and marketing		66		210
Research and development		188		493
General and administrative		322		1,700
Share-based compensation expense before taxes		657		2,624
Related deferred income tax benefits		—		—
Share-based compensation expense, net of income taxes	$	657	$	2,624
Net share-based compensation expense per basic and diluted common share	$	0.01	$	0.06
Share-based compensation expense is derived from:
Stock options	$	575	$	2,325
2000 ESPP		82		299
Total	$	657	$	2,624

     Share-based compensation expense recognized during the three and nine months ended September 30, 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 as of September 30, 2006 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 September 30, 2006, options to purchase 5,482,966 shares of common stock were outstanding under the 2000 EIP and options to purchase 785,575 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. 1,000,000 shares of common stock are reserved for issuance under the 2000 NEDSOP. As of September 30, 2006, options to purchase 454,292 shares of common stock were outstanding under the 2000 NEDSOP and options to purchase 473,124 shares of common stock remained available for grant under the 2000 NEDSOP.

7

     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 199,438 and 289,073 shares issued for the 2000 ESPP purchase periods that ended in the nine months ended September 30, 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 and nine months ended September 30, 2005 would have been as follows (amounts in thousands, except per share data):

	Three Months Ended			Nine Months Ended
	September 30, 2005			September 30, 2005
Net income (loss) as reported	$	(1,275	)	$	4,123
Stock-based compensation, as reported		—			8
Total stock-based compensation determined under the fair value based method for all awards		(1,343	)		(3,783	)
Pro forma net income (loss)	$	(2,618	)	$	348
Basic net income (loss) per share, as reported	$	(0.03	)	$	0.09
Diluted net income (loss) per share, as reported	$	(0.03	)	$	0.09
Basic net income (loss) per share, SFAS No. 123 adjusted	$	(0.06	)	$	0.01
Diluted net income (loss) per share, SFAS No. 123 adjusted	$	(0.06	)	$	0.01

     Pro forma disclosures for the three and nine months ended September 30, 2006 are not presented because the amounts are recognized in the unaudited condensed consolidated statement of operations in accordance with SFAS No. 123(R).

     To estimate compensation expense which would have been recognized under SFAS No. 123 for the nine months ended September 30, 2005 and the compensation cost that was recognized under SFAS No. 123(R) for the nine months ended September 30, 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
	Nine Months Ended						Nine Months Ended
	September 30,						September 30,
	2005			2006			2005			2006
Risk-free interest rate		3.80	%		4.90	%		4.08	%		5.00	%
Expected dividend yield		—	%		—	%		—	%		—	%
Volatility		78	%		68	%		75	%		68	%
Expected life	4.0		years	5.5		years	0.5		year	0.5		year

     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 grant behavior to management and non-management employee groups.

8

     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 thousands)
Outstanding at December 31, 2005		4,830,811		$	6.52
Granted		2,072,501			5.23
Exercised		(215,615	)		3.23
Forfeited		(846,450	)		6.23
Expired		(301,988	)		7.69
Outstanding at September 30, 2006		5,539,259		$	6.14		7.49	$	1,668
Vested and expected to vest at September 30, 2006		5,139,786		$	6.23		3.14	$	1,617
Exercisable at September 30, 2006		3,359,494		$	6.81		6.39	$	1,428

     The weighted average grant-date fair values of options granted during the nine months ended September 30, 2006 and 2005 were $3.30 per share and $3.45 per share, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2006 and 2005 was $0.2 million and $0.7 million, respectively.

     During the nine months ended September 30, 2006, financing cash generated from share-based compensation arrangements amounted to $0.7 million for the purchase of shares upon exercise of options and $1.1 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 September 30, 2006, is as follows:

	Options Outstanding						Options Exercisable
			Weighted
			Average		Weighted				Weighted
			Remaining		Average				Average
Range of Exercise	Number		Contractual		Exercise		Number		Exercise
Prices	Outstanding		Life (yrs.)		Price		Exercisable		Price
$1.34 - 3.10		1,130,187		6.38	$	2.53		875,003	$	2.38
$3.15 - 4.33		1,002,248		8.64		3.83		279,519		3.67
$4.51 - 6.10		1,125,081		7.41		5.66		743,672		5.74
$6.12 - 6.87		1,013,460		8.65		6.55		268,017		6.32
$6.88 - 13.13		928,633		6.57		9.99		853,633		10.26
$13.50 - 17.14		339,650		7.15		14.83		339,650		14.83
Total		5,539,259		7.49	$	6.14		3,359,494	$	6.81

     The aggregate intrinsic value in the table above is based our closing stock price of $3.90 per share as of the last business day of the nine months ended September 30, 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 nine months ended September 30, 2006 and 2005 was $2.4 million and $3.6 million, respectively.

3. Stock Option Expense related to Historical Grant Practices

     In response to recently reported industry issues around option pricing, our Audit Committee, which is comprised of independent directors, began a self-initiated review of our historical stock option grant practices and related accounting. This review was proactive and voluntary. Our Audit Committee reviewed our option grant practices dating back to our merger with Artecon, Inc. in 1999 and identified certain immaterial errors relating to our accounting for stock options during our 2000 through 2002 fiscal years. As a result, we recognized $0.1 million of cost of goods sold and sales and marketing expenses for the three months ended June 30, 2006 associated with the errors identified by our Audit Committee’s review that was not recognized in prior periods. The expenses associated with the errors were not material in any of the prior periods during which the expenses should have been recognized nor was the cumulative adjustment material to the three or six months ended June 30, 2006. The $0.1 million stock option expense recognized for the three months ended June 30, 2006 was in addition to the $0.7 million and $2.6 million share-based compensation cost resulting from SFAS No. 123(R) for the three and nine months ended September 30, 2006, respectively, as discussed in note 2.

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4. Net Income (Loss) Per Share

     Basic net income (loss) per share is calculated by dividing net income (loss) 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				Nine Months Ended
	September 30,				September 30,
	2005		2006		2005		2006
Shares used in computing basic net income (loss) per share		43,949		44,880		43,832		44,678
Dilutive effect of warrants and common stock equivalents		—		—		1,781		—
Shares used in computing diluted net income (loss) per share		43,949		44,880		45,613		44,678

     For the three months ended September 30, 2005, outstanding options to purchase 5,041,468 shares of common stock with exercise prices ranging from $1.34 to $17.14 per share and outstanding warrants to purchase 1,966,849 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. For the nine months ended September 30, 2005, outstanding options to purchase 2,703,599 shares of common stock with exercise prices ranging from $5.80 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 September 30, 2006, outstanding options to purchase 5,547,751 shares of common stock with exercise prices ranging from $1.34 to $17.14 per share and outstanding warrants to purchase 1,696,081 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. For the nine months ended September 30, 2006, outstanding options to purchase 5,396,582 shares of common stock with exercise prices ranging from $1.34 to $17.14 per share and outstanding warrants to purchase 1,702,212 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.

5. Short-Term Investments

     The following table summarizes our short-term investments as of September 30, 2006 (in thousands):

			Unrealized			Unrealized
	Cost		Losses			Gains		Fair Value
U.S. Government securities	$	1,250	$	(1	)	$	—	$	1,249

     For the three and nine months ended September 30, 2006, we did not recognize any gross realized gains on sale of 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 September 30, 2006 by contractual maturity are shown below (in thousands).

	Cost		Fair Value
Due in one year or less	$	—	$	—
Due after one year through five years		1,250		1,249
Total	$	1,250	$	1,249

10

     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 September 30, 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	$—	$—	$	1,249	$	(1	)	$	1,249	$	(1	)

     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 at maturity, we do not consider these investments to be other-than-temporarily impaired at September 30, 2006.

6. 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		September 30, 2006
Purchased parts and materials	$	1,058	$	794
Finished goods		1,746		1,565
	$	2,804	$	2,359

7. 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 September 30, 2006 (in thousands):

			Accumulated
	Gross		Amortization			Net
Core technology	$	5,000	$	(2,871	)	$	2,129
Developed technology		2,600		(2,600	)		—
Customer relationships		2,500		(1,844	)		656
Backlog		100		(100	)		—
Licensed Patent Portfolio		2,570		(388	)		2,182
Total other intangible assets	$	12,770	$	(7,803	)	$	4,967

     As of September 30, 2006, the weighted average amortization period for the above intangibles is 2.8 years.

     Estimated future amortization expense related to other intangible assets as of September 30, 2006 is as follows (in thousands):

Years ending December 31,
2006 (remaining 3 months)	$	586
2007		2,101
2008		1,255
2009		514
2010		511
Total	$	4,967

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8. 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 and nine months ended September 30, 2006 (in thousands):

	Three Months Ended			Nine Months Ended
	September 30, 2006			September 30, 2006
Balance, beginning of period	$	630		$	746
Charged to operations		460			1,581
Deductions for costs incurred		(511	)		(1,748	)
Balance, end of period	$	579		$	579

9. Restructurings

     Restructuring liabilities 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 September 30, 2006, all amounts related to restructuring have been utilized.

     The following is a summary of restructuring activity recorded during the nine months ended September 30, 2006 (in thousands):

March 2001 Restructuring

								Accrued
	Accrued							Restructuring
	Restructuring		Additional		Current			Expenses at
	Expenses at		Restructuring		Amounts			September 30,
	December 31, 2005		Expenses		Utilized			2006
Facility closures and related costs	$	45	$	—	$	(45	)	$	—

10. Income Taxes

     We recorded an income tax expense (benefit) of $52.5 million and $(0.2) million for the three months ended September 30, 2006 and 2005, respectively. Our effective income tax rate was (688.7)% for the three months ended September 30, 2006. Our effective income tax rate for the three months ended September 30, 2006 differs from the United States federal statutory rate due to a $47.1 million discrete tax expense associated with the establishment of valuation allowances related to United States deferred tax assets, our valuation allowance against operations taxed in foreign jurisdictions, foreign taxes and state taxes.

     For the nine months ended September 30, 2006 and 2005, we recorded an income tax expense of $48.1 million and $0.1 million, respectively. Our effective income tax rate of (204.0)% for the nine months ended September 30, 2006 differs from the United States federal statutory rate due to a $47.1 million discrete tax expense associated with the establishment of valuation allowances related to United States deferred tax assets, our valuation allowance against operations taxed in foreign jurisdictions, foreign taxes and state taxes.

     We currently anticipate an effective income tax rate of approximately (4.1)% for the year ended December 31, 2006.

     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 the future realization of the deferred tax assets is judged to be more likely than not. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings (loss) experience by taxing jurisdiction, expectations of future taxable income (loss), the carryforward periods available to us for tax reporting purposes and other relevant factors. At September 30, 2006, based on the weight of available evidence, including current year losses, cumulative losses in recent years and expectations of future taxable income (loss), we determined that it was not more likely than not that our United States deferred tax assets would be realized and established a $47.1 million valuation allowance associated with our United States deferred tax assets. This determination resulted in a $47.1 million discrete tax expense for the three months ended September 30, 2006.

     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.

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     As of December 31, 2005, we had federal and state net operating losses of approximately $112.1 million and $49.0 million, respectively, which begin to expire in the tax years ending 2019 and 2006, respectively. In addition, we have federal tax credit carryforwards of $3.7 million, which will begin to expire in the tax year ending 2006. We also have state tax credit carryforwards of $4.7 million, of which $4.6 million can be carried forward indefinitely to offset future taxable income, and the remaining $0.1 million will begin to expire in the tax year ending 2007.

     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.

11. Accumulated Other Comprehensive 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	)
Quarterly change		(160	)		9			(151	)
Balance, June 30, 2006		(278	)		(5	)		(283	)
Quarterly change		(27	)		4			(23	)
Balance, September 30, 2006	$	(305	)	$	(1	)	$	(306	)

12. Commitments and Contingencies

  Commitments

  Consulting Agreements with Former Executives

     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 nine months ended September 30, 2006.

     In July 2006, we entered into a consulting agreement with our former Chief Operating Officer, Patrick E. Collins. Pursuant to the consulting letter agreement, Mr. Collins will perform consulting services for us during a six-month period beginning as of July 17, 2006 for a consulting fee of $21,666 per month plus payments totaling up to $150,000 upon the achievement of certain milestones related to augmenting our outsourced supply chain model. Mr. Collins will be restricted from competing with us during the consulting period. The consulting period may be terminated early by either party with prior written notice, with or without cause, but in the event we terminate the consulting period early without cause, Mr. Collins will receive a lump sum payment equal to the lesser of $60,000 or the remaining amount he would have been eligible to receive if the consulting period continued for the full original six-month period.

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     Change of Control Agreements

     On April 6, 2006, we amended our change of control agreement with Dana W. Kammersgard and entered into a change of control agreement with Philip A. Davis. 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. 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.

     On July 31, 2006, we appointed Hanif I. Jamal as our Senior Vice President, Chief Financial Officer and Corporate Secretary. We entered into a change of control agreement with Mr. Jamal which provides that if Mr. Jamal’s employment with us is terminated, other than for cause, in connection with an acquisition of Dot Hill or similar corporate event, Mr. Jamal’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.

  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. 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 protocol and Patent Number 6,425,035 involves the interface of any one-transport medium and a second transport medium. We were served with the lawsuit on October 27, 2003. Chaparral was added as a party to the lawsuit in March 2004.

     On June 28, 2006, we entered into a Settlement and License Agreement with Crossroads Systems, Inc. that settles the lawsuit and licenses to us the family of patents from which it stemmed. We concurrently entered into an Agreement Between Dot Hill Systems and Infortrend Re Settlement of Crossroads Lawsuit with Infortrend Technology, Inc. (which superseded certain indemnification clauses of a previous supplier agreement). In accordance with the Crossroads and Infortrend agreements, on July 14, 2006, we paid $3.35 million to Crossroads for alleged past damages and Crossroads agreed to dismiss, with prejudice, all patent claims against us. In addition, Infortrend paid Crossroads an additional $7.15 million on our behalf, from which $1.43 million was withheld for Taiwan taxes and is included in income tax expense on our statement of operations. Going forward, Crossroads will receive a running royalty of 2.5% based on a percentage of net sales of RAID products sold by us, but only those with functionality that is covered by US Patents No. 5,941,972 and No. 6,425,035 and other patents in the patent family. For RAID products that use a controller sourced by Infortrend, we will pay 0.8125% of the 2.5% royalty, and Infortrend will be responsible for the remainder. For RAID products that use our proprietary controller, we alone will be paying the 2.5% running royalty. No royalty payments will be required with respect to the sale of storage systems that do not contain RAID controllers, known as JBOD systems, or systems that use only the SCSI protocol end-to-end, even those that perform RAID. Further, royalty payments with respect to the sale of any products that are made, used and sold outside of the United States will only be required if and when Crossroads is issued patents that cover the products and that are issued by countries in which the products are manufactured, used or sold.

     On July 24 and 25th, 2006, respectively, Crossroads filed another lawsuit against us in the United States District Court for the Western District of Texas as well as a Motion to Enforce in the aforementioned lawsuit. Both the new lawsuit and motion alleged that Dot Hill had breached the June 28, 2006 Settlement and License Agreement by deducting $1.43 million of the lump sum payment of $10.50 million as withholding against any potential Taiwan tax liability arising out of Dot Hill’s indemnification by Infortrend, a Taiwan company. On September 28, 2006 the Court indicated that it would grant Crossroads’ Motion to Enforce. Therefore, on October 5, 2006, Crossroads and Dot Hill amended the original Settlement and License Agreement to state that Dot Hill would pay to Crossroads the $1.43 million, plus $45,000 in late fees, and would not make deductions based on taxes on royalty payments in the future. The payment of the $1.475 million was made on October 5, 2006. As required by the amended settlement, Crossroads has dismissed with prejudice the original patent action as well as the second lawsuit based on the enforcement of the original settlement.

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     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 September 30, 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 complaints were consolidated into a single action, and the Court appointed as lead plaintiff a group comprised of the Detroit Police and Fire Retirement System and the General Retirement System of the City of Detroit. The consolidated complaint was filed on August 25, 2006, and we filed a motion to dismiss on October 5, 2006. A ruling on this motion is expected sometime after January 8, 2007.

     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. Our demurrer to one of those cases, in which we sought dismissal, was overruled (i.e., denied). We have formed a Special Litigation Committee, or SLC, of disinterested directors to investigate the alleged wrongdoing and all derivative actions were stayed until October 30, 2006 pending that investigation. Negotiations are currently underway to continue this stay through December 29, 2006 to allow the SLC to complete its investigation. The outcome is uncertain, and no amounts have been accrued as of September 30, 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.

15

13. Credit Facility

     Effective July 1, 2006, we amended our 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, 2007. 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 September 30, 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 and annual capital expenditures to an amount less than $10.0 million.

14. Warrants

     During July 2006, a fully vested warrant held by an original equipment manufacturer, or OEM, customer to purchase 154,742 shares of our common stock at $3.25 per share was assigned to a third party.

15. 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 OEM customer accounted for approximately 81% and 86% of our net revenue during the three months ended September 30, 2006 and 2005, respectively, and 85% and 86% for the nine months ended September 30, 2006 and 2005, respectively.

     Information concerning revenue and gross profit by reportable segment is as follows (in thousands):

	SANnet		Legacy and
	Family		Other		Services		Total
Three months ended:
September 30, 2006:
Net revenue	$	53,473	$	513	$	860	$	54,846
Gross profit	$	6,389	$	49	$	595	$	7,033
September 30, 2005:
Net revenue	$	51,496	$	1,391	$	729	$	53,616
Gross profit	$	11,446	$	380	$	527	$	12,353

	SANnet		Legacy and
	Family		Other		Services		Total
Nine months ended:
September 30, 2006:
Net revenue	$	174,394	$	2,801	$	2,602	$	179,797
Gross profit	$	30,377	$	366	$	1,221	$	31,964
September 30, 2005:
Net revenue	$	170,882	$	4,406	$	2,236	$	177,524
Gross profit	$	39,153	$	1,058	$	1,564	$	41,775

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     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:
September 30, 2006	$	202,248	$	2,750	$	2,786	$	207,784
December 31, 2005	$	256,028	$	8,240	$	3,026	$	267,294

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

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2005			2006			2005			2006
Net revenue:
United States	$	49,307		$	49,897		$	165,440		$	167,861
Europe		2,851			3,435			8,256			7,904
Asia		1,458			1,514			3,828			4,032
	$	53,616		$	54,846		$	177,524		$	179,797
Operating income (loss):
United States	$	(2,506	)	$	(4,886	)	$	3,390		$	(22,590	)
Europe		162			(4,107	)		(1,201	)		(4,954	)
Asia		79			(28	)		(224	)		(149	)
	$	(2,265	)	$	(9,021	)	$	1,965		$	(27,693	)

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

16. 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. We do not expect the adoption of Statement No. 154 to significantly affect our financial condition or results of operations.

     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 was effective for our first reporting period beginning after February 3, 2006. The adoption of FSP No. FAS 123(R)-4 did not have a material effect on our results of operations or financial condition.

17

     In June 2006, FASB issued Interpretation Number (FIN) No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109. This Interpretation introduces an accounting model under which companies will record uncertain tax positions in the financial statements, and establishes the criteria for recognizing, derecognizing and classifying such positions. Further, the interpretation addresses disclosure requirements relating to uncertain tax positions and requires a detailed roll-forward of the amounts of unrecognized tax benefits. FIN No. 48 is effective for the fiscal year beginning after December 15, 2006. We are currently assessing the impact that FIN No. 48 will have on our results of operations and financial condition.

     In September 2006, the SEC staff issued SAB Topic 1N, Financial Statements — Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (SAB No. 108). SAB No. 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB No. 108 requires registrants to quantify misstatements using both the balance sheet and income statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The guidance in SAB No. 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. Upon adoption, we do not expect SAB No. 108 to have a material impact on our results of operations or financial condition.

     In September 2006, the FASB issued Statement No. 157, Fair Value Measurements, which establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. Statement No. 157 does not require any new fair value measurements but rather it eliminates inconsistencies in the guidance found in various prior accounting pronouncements. Statement No. 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is encouraged, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. Although we are still evaluating the potential effects of this standard, we do not expect the adoption of Statement No. 157 to have a material impact on our results of operations or financial condition.

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 applicable, 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 customers, 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.

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     Sales to Sun accounted for approximately 81% and 86% of our net revenue during the three months ended September 30, 2006 and 2005, respectively, and 85% and 86% for the nine months ended September 30, 2006 and 2005, respectively. 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. On August 3, 2006, we amended the agreement to address enhancements to current offerings available to NetApp under the agreement, and to grant rights to NetApp for the potential use of certain Dot Hill technology. 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 increase, our revenue dependence upon Sun will be further reduced.

     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.

     Gross profit is the difference between our net revenues and our cost of goods sold for a particular period. Our gross margins are determined in large part based on our manufacturing costs, our component costs and our ability to bundle RAID controllers, software and low cost value added features into our products, as well as the prices at which we sell our products. As we begin to derive a greater portion of our net revenues from sales of products to customers other than Sun, a greater percentage of products may be sold without RAID controllers, software or other margin enhancing features. Our costs to manufacture these products may decline if we can shift manufacturing to lower costs countries and when the manufacturing processes mature. However despite efforts to reduce our manufacturing costs, our gross margins and operating results are likely to be adversely affected because of pricing pressures and mix of product sales.

     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, Hungary and the United Kingdom.

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     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 and estimated effective tax rates, 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, or SAB, No. 104, Revenue Recognition.

     We recognize revenue for 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.

  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.

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  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 operating 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.

     Our assessment of whether goodwill has been impaired may be affected by a number of factors, including our continued profitability. To the extent we experience operating losses and reduce our estimated future cash flows, we may be required to recognize significant charges for impairment of our goodwill, which would adversely affect our operating results.

  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 (loss) experience by taxing jurisdiction, expectations of future taxable income, the carryforward periods available to us for tax reporting purposes, and other relevant factors.

     Our ongoing assessment of the future realizability of our United States deferred tax assets will be dependent on a number of factors, including our continued profitability. To the extent we experience operating losses or determine that the future realization of the deferred tax assets is judged not to be more likely than not, we may be required to recognize substantial additional valuations allowances with respect to our United States deferred tax assets.

     At September 30, 2006, based on the weight of available evidence, including current year losses, cumulative losses in recent years and expectations of future taxable income or losses, we determined that it was not more likely than not that our United States deferred tax assets would be realized and established a $47.1 million valuation allowance associated with our United States deferred tax assets. This determination resulted in a $47.1 million discrete tax expense for the three months ended September 30, 2006.

     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.

  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

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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.

     On January 1, 2006, 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 nine months 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 December 31, 2005 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 September 30, 2006, total unrecognized share-based compensation cost related to unvested stock options was $6.9 million, which is expected to be recognized over a weighted average period of approximately 1.6 years.

     In response to recently reported industry issues around option pricing, our Audit Committee, which is comprised of independent directors, began a self-initiated review of our historical stock option grant practices and related accounting. This review was proactive and voluntary. Our Audit Committee reviewed our option grant practices dating back to our merger with Artecon, Inc. in 1999 and identified certain immaterial errors relating to our accounting for stock options during our 2000 through 2002 fiscal years. As a result, we recognized $0.1 million of cost of goods sold and sales and marketing expenses for the three months ended June 30, 2006 associated with the errors identified by our Audit Committee’s review that was not recognized in prior periods. The expenses associated with the errors was not material in any of the prior periods during which the expenses should have been recognized nor was the cumulative adjustment material to the three or six months ended June 30, 2006. The $0.1 million stock option expense recognized for the three months ended June 30, 2006 was in addition to the $0.7 million and $2.6 million share-based compensation cost resulting from SFAS No. 123(R) for the three and nine months ended September 30, 2006, respectively.

  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 12 to our condensed consolidated financial statements for further information regarding contingencies.

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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						Nine Months Ended
	September 30,						September 30,
	2005			2006			2005			2006
Net revenue:		100.0	%		100.0	%		100.0	%		100.0	%
Cost of goods sold		77.0			87.2			76.5			82.2
Gross profit		23.0			12.8			23.5			17.8
Operating expenses:
Sales and marketing		9.7			6.6			8.4			6.6
Research and development		11.7			15.0			9.2			16.7
General and administrative		5.9			7.6			4.8			8.0
Legal settlement		—			—			—			1.9
Total operating expenses		27.3			29.3			22.4			33.2
Operating income (loss)		(4.2	)		(16.4	)		1.1			(15.4	)
Other income, net		1.5			2.6			1.3			2.3
Income tax expense (benefit)		(0.4	)		95.7			0.1			26.8
Net income (loss)		(2.4	)%		(109.6	)%		2.3	%		(39.9	)%

(percentages may not aggregate due to rounding)

Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005

Net Revenue

     Net revenue increased $1.2 million, or 2.2%, to $54.8 million for the three months ended September 30, 2006 from $53.6 million for the three months ended September 30, 2005. The increase in net revenue was attributable to shipments of our new 2730 storage products which are based on our proprietary RAID controller technology. 2730 storage RAID units shipped were 655 for the three months ended September 30, 2006 compared to none for the three months ended September 30, 2005. Fibre Channel units shipped were 2,473 for the three months ended September 30, 2006 compared to 2,522 units for the three months ended September 30, 2005. Small Computer Systems Interface, or SCSI, units shipped were 2,774 for the three months ended September 30, 2006 compared to 2,952 units for the three months ended September 30, 2005. Blade units shipped were 2,921 for the three months ended September 30, 2006 compared to 1,060 units for the three months ended September 30, 2005. SATA units shipped were 431 for the three months ended September 30, 2006 compared to 728 units for the three months ended September 30, 2005. Sun accounted for 81% of our net revenue for the three months ended September 30, 2006 compared to 86% for the three months ended September 30, 2005. Non-Sun revenue was $10.2 million for the three months ended September 30, 2006 compared to $7.7 million for the three months ended September 30, 2005.

Cost of Goods Sold

     Cost of goods sold increased $6.5 million, or 15.7%, to $47.8 million for the three months ended September 30, 2006 from $41.3 million for the three months ended September 30, 2005. As a percentage of net revenue, cost of goods sold increased to 87.2% for the three months ended September 30, 2006 from 77.0% for the three months ended September 30, 2005. The increase in cost of goods sold was attributable to greater volume of lower margin product sales during the three months ended September 30, 2006 compared to the three months ended September 30, 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 (see gross profit section below for further explanation).

Gross Profit

     Gross profit decreased $5.4 million, or 43.5%, to $7.0 million for the three months ended September 30, 2006 from $12.4 million for the three months ended September 30, 2005. As a percentage of net revenue, gross profit decreased to 12.8% for the three months ended September 30, 2006 from 23.0% for the three months ended September 30, 2005. The decrease in the dollar amount of gross profit is attributable to increased spending related to our product sales mix and additional headcount.

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     The decrease in gross profit as a percentage of our net revenue for the three months ended September 30, 2006 when compared to the three months ended September 30, 2005 is attributable principally to a difference in our product mix, increased headcount in operations in support of new product launches and sales of prototypes and new products to our new OEM customers. During the three months ended September 30, 2006, we began shipping a new modular enterprise storage platform. Because this new storage platform is in the early launch phase, the manufacturing processes have not been fully developed and as a result, production costs are higher for this product when compared to our other products.

Sales and Marketing Expenses

     Sales and marketing expenses decreased $1.6 million, or 30.8%, to $3.6 million for the three months ended September 30, 2006 from $5.2 million for the three months ended September 30, 2005. As a percentage of net revenue, sales and marketing expenses decreased to 6.6% for the three months ended September 30, 2006 from 9.7% for the three months ended September 30, 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 not exceed spending levels incurred during 2005.

Research and Development Expenses

     Research and development expenses increased $1.9 million, or 30.2%, to $8.2 million for the three months ended September 30, 2006 from $6.3 million for the three months ended September 30, 2005. As a percentage of net revenue, research and development expenses increased to 15.0% for the three months ended September 30, 2006 from 11.7% for the three months ended September 30, 2005. The increase in research and development expenses is primarily due to the investment in prototypes and project materials for products under development for our new OEM customers of $1.1 million, payroll related expenses of $0.3 million, testing expense of $0.3 million and stock option expense and employee stock purchase plan expense of $0.2 million related to the adoption of SFAS 123(R).

General and Administrative Expenses

     General and administrative expenses increased $1.0 million, or 31.3%, to $4.2 million for the three months ended September 30, 2006 from $3.2 million for the three months ended September 30, 2005. As a percentage of net revenue, general and administrative expenses increased to 7.6% for the three months ended September 30, 2006 from 5.9% for the three months ended September 30, 2005. The increase is primarily attributable to accounting, auditing, and tax consulting expense of $0.5 million, costs associated with our on-going compliance efforts related to the Sarbanes-Oxley Act of 2002 of $0.3 million, stock option and employee stock purchase plan expense of $0.3 million related to the adoption of SFAS No. 123(R), legal expense of $0.1 million and implementation expenses of $0.1 million related to our new enterprise resource planning, or ERP, software package, which became operational in January 2006. This is offset by a $0.3 million decrease in bad debt expense which primarily relates to our subsidiary in Europe.

Other Income

     Other income increased by $0.6 million, or 75.0%, to $1.4 million for the three months ended September 30, 2006 from $0.8 million for the three months ended September 30, 2005. The increase was primarily attributable to an increase in interest income of $0.6 million due to higher interest rates.

Income Taxes

     We recorded income tax expense of $52.5 million for the three months ended September 30, 2006 which was attributable to a discrete tax expense associated with the establishment of full valuation allowances for United States deferred tax assets and revising our estimated effective tax rate to (4.1)% for the year ending December 31, 2006. Our effective income tax rate of (688.7)% for the three months ended September 30, 2006 differs from the United States federal statutory rate due to a $47.1 million discrete tax expense associated with the establishment of valuation allowances related to United States deferred tax assets, our valuation allowance against operations taxed in foreign jurisdictions, foreign taxes and state taxes. For the nine months ended September 30, 2005, we recorded an income tax benefit of $0.2 million, reflecting an effective tax rate of (13.1)%. Our effective income tax rate for the three months ended September 30, 2005 is primarily attributable to federal and state minimum tax liabilities as well as local and foreign taxes and was significantly reduced through the use of net operating loss carryforwards for which a valuation allowance had previously been recorded.

     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 the future realization of the deferred tax assets is judged to be more likely than not. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative

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earnings experience by taxing jurisdiction, expectations of future taxable income or loss, the carryforward periods available to us for tax reporting purposes, and other relevant factors. At September 30, 2006, based on the weight of available evidence, including current year losses, cumulative losses in recent years and expectations of future taxable income or loss, we determined that it was not more likely than not that our United States deferred tax assets would be realized and established a $47.1 million of valuation allowance associated with our United States deferred tax assets. This determination resulted in a $47.1 million discrete tax expense for the three months ended September 30, 2006.

     As of December 31, 2005, we had federal and state net operating losses of approximately $112.1 million and $49.0 million, respectively, which begin to expire in the tax years ending 2019 and 2006, respectively. In addition, we have federal tax credit carryforwards of $3.7 million, which will begin to expire in the tax year ending 2006. We also have state tax credit carryforwards of $4.7 million, of which $4.6 million can be carried forward indefinitely to offset future taxable income, and the remaining $0.1 million will begin to expire in the tax year ending 2007.

     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.

     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.

     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.

Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005

Net Revenue

     Net revenue increased $2.3 million, or 1.3%, to $179.8 million for the nine months ended September 30, 2006 from $177.5 million for the nine months ended September 30, 2005. The increase in net revenue was attributable to shipments of our new 2730 storage products which are based on our proprietary RAID controller technology. 2730 storage RAID units shipped were 655 for the nine months ended September 30, 2006 compared to none for the nine months ended September 30, 2005. Fibre Channel units shipped were 7,726 for the nine months ended September 30, 2006 compared to 8,028 units for the nine months ended September 30, 2005. SCSI units shipped were 9,853 for the nine months ended September 30, 2006 compared to 10,445 units for the nine months ended September 30, 2005. Blade units shipped were 8,729 for the nine months ended September 30, 2006 compared to 3,634 units for the nine months ended September 30, 2005. SATA units shipped were 1,848 for the nine months ended September 30, 2006 compared to 2,104 units for the nine months ended September 30, 2005. Sun accounted for 85% of our net revenue for the nine months ended September 30, 2006 compared to 86% for the nine months ended September 30, 2005. Non-Sun revenue was $27.9 million for the nine months ended September 30, 2006 compared to $24.5 million for the nine months ended September 30, 2005.

Cost of Goods Sold

     Cost of goods sold increased $12.1 million, or 8.9%, to $147.8 million for the nine months ended September 30, 2006 from $135.7 million for the nine months ended September 30, 2005. As a percentage of net revenue, cost of goods sold increased to 82.2% for the nine months ended September 30, 2006 from 76.5% for the nine months ended September 30, 2005. The increase in cost of goods sold was attributable to greater volume of product sales during the nine months ended September 30, 2006 compared to the nine months ended September 30, 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 (see gross profit section below for further explanation).

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Gross Profit

     Gross profit decreased $9.8 million, or 23.4%, to $32.0 million for the nine months ended September 30, 2006 from $41.8 million for the nine months ended September 30, 2005. As a percentage of net revenue, gross profit decreased to 17.8% for the nine months ended September 30, 2006 from 23.5% for the nine months ended September 30, 2005. The decrease in the dollar amount of gross profit is attributable to increased spending related to our product sales mix, additional headcount and consulting fees.

     The decrease in gross profit as a percentage of our net revenue for the nine months ended September 30, 2006 when compared to the nine months ended September 30, 2005 is attributable principally to a difference in our product mix, increased headcount in operations in support of new product launches and sales of prototypes and new products to our new OEM customers. During the three months ended September 30, 2006, we began shipping a new modular enterprise storage platform. Because this new storage platform is in the early launch phase, the manufacturing processes have not been fully developed and as a result, production costs are higher for this product when compared to our other products.

Sales and Marketing Expenses

     Sales and marketing expenses decreased $3.0 million, or 20.1%, to $11.9 million for the nine months ended September 30, 2006 from $14.9 million for the nine months ended September 30, 2005. As a percentage of net revenue, sales and marketing expenses decreased to 6.6% for the nine months ended September 30, 2006 from 8.4% for the nine months ended September 30, 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 not exceed spending levels incurred during 2005.

Research and Development Expenses

     Research and development expenses increased $13.8 million, or 84.7%, to $30.1 million for the nine months ended September 30, 2006 from $16.3 million for the nine months ended September 30, 2005. As a percentage of net revenue, research and development expenses increased to 16.7% for the nine months ended September 30, 2006 from 9.2% for the nine months ended September 30, 2005. The increase in research and development expenses is primarily due to the investment in prototypes and project materials for products under development for our new OEM customers of $10.0 million, payroll related expenses of $1.8 million, testing expense of $1.1 million, facility related expenses of $0.4 million, and stock option expense and employee stock option purchase plan expense of $0.5 million related to the adoption of SFAS 123(R).

General and Administrative Expenses

     General and administrative expenses increased $5.8 million, or 67.4%, to $14.4 million for the nine months ended September 30, 2006 from $8.6 million for the nine months ended September 30, 2005. As a percentage of net revenue, general and administrative expenses increased to 8.0% for the nine months ended September 30, 2006 from 4.8% for the nine months ended September 30, 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 $1.9 million, stock option expense and employee stock purchase plan expense of $1.0 million related to the adoption of SFAS No. 123(R), accounting, auditing, and tax consulting expense of $1.0 million, costs associated with our on-going compliance efforts related to the Sarbanes-Oxley Act of 2002 of $0.5 million, implementation expenses of $0.3 million related to our new ERP software package, which became operational in January 2006, facility related expenses of $0.2 million, and payroll related expenses of $0.2 million. This is offset by a $0.6 decrease in bad debt expense which primarily relates to our subsidiary in Europe.

Legal Settlement Expense

     On June 28, 2006, we entered into a Settlement and License Agreement with Crossroads that settles Crossroads’ lawsuit against us and licenses to us the family of patents from which it stemmed. We concurrently entered into an Agreement between Dot Hill Systems and Infortrend Re Settlement of Crossroads Lawsuit with Infortrend. In accordance with the Crossroads and Infortrend agreements, on July 14, 2006, we paid $3.35 million to Crossroads for alleged past damages and Crossroads agreed to dismiss all patent claims against us. As part of the agreement between Dot Hill and Infortrend, Infortrend paid Crossroads an additional $7.15 million on July 17, 2006, from which $1.43 million was withheld for Taiwan taxes and is included in income tax expense on our statement of operations. On October 5, 2006, we made a $1.475 million payment to Crossroads representing the remaining settlement amount due plus late fees. Please refer to note 12 in the accompanying condensed consolidated financial statements.

Other Income

     Other income increased by $1.8 million, or 78.3%, to $4.1 million for the nine months ended September 30, 2006 from $2.3 million for the nine months ended September 30, 2005. The increase was attributable to an increase in interest income of $1.9 million due to higher interest rates, offset by a decrease in other income, net of $0.1 million.

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Income Taxes

     We recorded income tax expense of $48.1 million for the nine months ended September 30, 2006 which was attributable to a discrete tax expense associated with the establishment of full valuation allowances for United States deferred tax assets and revising our estimated effective tax rate to (4.1)% for the year ending December 31, 2006. Our effective income tax rate of (204.0)% for the nine months ended September 30, differs from the United States federal statutory rate due to a $47.1 million discrete tax expense associated with the establishment of valuation allowances related to United States deferred tax assets, our valuation allowance against operations taxed in foreign jurisdictions, foreign taxes and state taxes. For the nine months ended September 30, 2005, we recorded tax expense of $0.1 million, reflecting an effective tax rate of 2.9%. Our effective income tax rate for the nine months ended September 30, 2005 is primarily attributable to federal and state minimum tax liabilities as well as local and foreign taxes and was significantly reduced through the use of net operating loss carryforwards for which a valuation allowance had previously been recorded.

     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 the future realization of the deferred tax assets is judged to be more likely than not. 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. At September 30, 2006, based on the weight of available evidence, including current year losses, cumulative losses in recent years and expectations of future taxable income or loss, we determined that it was not more likely than not that our United States deferred tax assets would be realized and established a $47.1 million of valuation allowance associated with our United States deferred tax assets. This determination resulted in a $47.1 million discrete tax expense for the nine months ended September 30, 2006.

     As of December 31, 2005, we had federal and state net operating losses of approximately $112.1 million and $49.0 million, respectively, which begin to expire in the tax years ending 2019 and 2006, respectively. In addition, we have federal tax credit carryforwards of $3.7 million, will begin to expire in the tax year ending 2006. We also have state tax credit carryforwards of $4.7 million, of which $4.6 million can be carried forward indefinitely to offset future taxable income, and the remaining $0.1 million will begin to expire in the tax year ending 2007.

     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.

     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.

     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.

Liquidity and Capital Resources

     As of September 30, 2006, we had $108.5 million of cash, cash equivalents and short-term investments. We had $110.1 million of working capital as of September 30, 2006.

     For the nine months ended September 30, 2006, cash used in operating activities was $11.9 million compared to $1.9 million for the same period in 2005. The net cash used in operating activities for the nine months ended September 30, 2006 is primarily attributable to a net loss $72.2 million, an increase in accounts receivable of $2.0 million primarily due from Sun, and a decrease in deferred revenue of $1.0 million. These amounts were offset by a decrease in deferred taxes of $47.1 million, depreciation and amortization of fixed and intangible assets of $5.4 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 $1.6 million and employee stock purchase

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plan expense of $0.3 million attributable to the adoption of SFAS No. 123(R), $0.1 million related to our historical stock option grant practices during our 2000 to 2002 fiscal years, an increase in accounts payable of $2.3 million primarily due to Solectron, an increase in accrued compensation and expenses of $1.8 million, a legal settlement payable of $1.5 million, and an increase in other long-term liabilities of $1.2 million primarily related to deferred rent on our new corporate headquarters.

     Cash provided by investing activities for the nine months ended September 30, 2006 was $8.2 million compared to $22.4 million for the same period in 2005. The cash used in the nine months ended September 30, 2006 is attributable to purchases related to our new corporate headquarters and machinery and equipment of $4.0 million, and purchases of short-term investments of $10.3 million, which was more than offset by the proceeds received from the maturity of short-term investments of $22.6 million.

     Cash provided by financing activities for the nine months ended September 30, 2006 and 2005 was $1.8 million. 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 $0.7 million and the proceeds received from the sale of common stock to employees under our employee stock purchase plan of $1.1 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.

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. We do not expect the adoption of Statement No. 154 to significantly affect our financial condition or results of operations.

     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 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 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 was effective for our first reporting period beginning after February 3, 2006. The adoption of FSP No. FAS 123(R)-4 did not have a material effect on our results of operations or financial condition.

     In June 2006, FASB issued Interpretation Number (FIN) No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109. This Interpretation introduces an accounting model under which companies will record uncertain tax positions in the financial statements, and establishes the criteria for recognizing, derecognizing and classifying such positions. Further, the interpretation addresses disclosure requirements relating to uncertain tax positions and requires a detailed roll-forward of the amounts of unrecognized tax benefits. FIN No. 48 is effective for the fiscal year beginning after December 15, 2006. We are currently assessing the impact that FIN No. 48 will have on our results of operations and financial condition.

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     In September 2006, the SEC staff issued SAB Topic 1N, Financial Statements — Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (SAB No. 108). SAB No. 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB No. 108 requires registrants to quantify misstatements using both the balance sheet and income statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The guidance in SAB No. 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. Upon adoption, we do not expect SAB No. 108 to have a material impact on our results of operations or financial condition.

     In September 2006, the FASB issued Statement No. 157, Fair Value Measurements, which establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. Statement No. 157 does not require any new fair value measurements but rather it eliminates inconsistencies in the guidance found in various prior accounting pronouncements. Statement No. 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is encouraged, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. Although we are still evaluating the potential effects of this standard, we do not expect the adoption of Statement No. 157 to have a material impact 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 September 30, 2006. For investment securities, the table presents carrying values at December 31, 2005 and September 30, 2006 and, as applicable, related weighted average interest rates by expected maturity dates.

	December 31, 2005			September 30, 2006
	(amounts in thousands)
Cash equivalents	$	99,899		$	93,900
Average interest rate		4.3	%		5.3	%
Short-term investments	$	13,431		$	1,249
Average interest rate		3.2	%		5.0	%
Total portfolio	$	113,330		$	95,149
Average interest rate		4.2	%		5.3	%

     We have a line of credit agreement, which accrues interest at a variable rate. As of September 30, 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 may not engage in hedging activities in the future.

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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 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 September 30, 2006. Based upon that evaluation, the chief executive officer and the 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

     There was no change in our internal control over financial reporting that occurred during the period 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.

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. 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 protocol and Patent Number 6,425,035 involves the interface of any one-transport medium and a second transport medium. We were served with the lawsuit on October 27, 2003. Chaparral was added as a party to the lawsuit in March 2004.

     On June 28, 2006, we entered into a Settlement and License Agreement with Crossroads Systems, Inc. that settles the lawsuit and licenses to us the family of patents from which it stemmed. We concurrently entered into an Agreement Between Dot Hill Systems and Infortrend Re Settlement of Crossroads Lawsuit with Infortrend Technology Inc., or Infortrend (which superseded certain indemnification clauses of a previous supplier agreement). In accordance with the Crossroads and Infortrend agreements, on July 14, 2006, we paid $3.35 million to Crossroads for alleged past damages and Crossroads agreed to dismiss, with prejudice, all patent claims against us. In addition, Infortrend paid Crossroads an additional $7.15 million on our behalf, from which $1.43 million was withheld for Taiwan taxes and is included in income tax expense on our statement of operations. Going forward, Crossroads will receive a running royalty of 2.5% based on a percentage of net sales of RAID products sold by us, but only those with functionality that is covered by US Patents No. 5,941,972 and No. 6,425,035 and other patents in the patent family. For RAID products that use a controller sourced by Infortrend, we will pay 0.8125% of the 2.5% royalty, and Infortrend will be responsible for the remainder. For RAID products that use our proprietary controller, we alone will be paying the 2.5% running royalty. No royalty payments will be required with respect to the sale of storage systems that do not contain RAID controllers, known as JBOD systems, or systems that use only the SCSI protocol end-to-end, even those that perform RAID. Further, royalty payments with respect to the sale of any products that are made, used and sold outside of the United States will only be required if and when Crossroads is issued patents that cover the products and that are issued by countries in which the products are manufactured, used or sold.

     On July 24 and 25th, 2006, respectively, Crossroads filed another lawsuit against us in the United States District Court for the Western District of Texas as well as a Motion to Enforce in the aforementioned lawsuit. Both the new lawsuit and motion alleged that Dot Hill had breached the June 28, 2006 Settlement and License Agreement by deducting $1.43 million of the lump sum payment of $10.50 million as withholding against any potential Taiwan tax liability arising out of Dot Hill’s indemnification by Infortrend, a Taiwan company. On September 28, 2006 the Court indicated that it would grant Crossroads’ Motion to Enforce. Therefore, on October 5, 2006, Crossroads and Dot Hill amended the original Settlement and License Agreement to state that Dot Hill would pay to Crossroads the $1.43 million, plus $45,000 in late fees, and would not make deductions based on taxes on royalty payments in the future. The payment of the $1.475 million was made on October 5, 2006. As required by the amended settlement, Crossroads has dismissed with prejudice the original patent action as well as the second lawsuit based on the enforcement of the original settlement.

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          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 September 30, 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 complaints were consolidated into a single action, and the Court appointed as lead plaintiff a group comprised of the Detroit Police and Fire Retirement System and the General Retirement System of the City of Detroit. The consolidated complaint was filed on August 25, 2006, and we filed a motion to dismiss on October 5, 2006. A ruling on this motion is expected sometime after January 8, 2007.

     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. Our demurrer to one of those cases, in which we sought dismissal, was overruled (i.e., denied). We have formed a Special Litigation Committee, or SLC, of disinterested directors to investigate the alleged wrongdoing and all derivative actions were stayed until October 30, 2006 pending that investigation. Negotiations are currently underway to continue this stay through December 29, 2006 to allow the SLC to complete its investigation. The outcome is uncertain, and no amounts have been accrued as of September 30, 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.

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 and subsequent filings with the SEC. 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.

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

     Our business is highly dependent on our relationship with Sun, and we believe could also be dependent, in the future, on our relationship with NetApp, once sales to that customer begin to increase. For example, sales to Sun accounted for 86% of our net revenue for the year ended December 31, 2005 and 85% for the nine months ended September 30, 2006. As a result, if our relationship with Sun,

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NetApp or our other OEM customers were disrupted, we would lose a significant portion of our anticipated net revenue and our business could be materially harmed. We cannot guarantee that our relationship with Sun, NetApp or other OEM customers will be maintained or not otherwise be disrupted. Factors that could influence our relationship with significant OEM customers, 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 OEM customers;

• our ability to produce, ship and deliver a sufficient quantity of our products in a timely manner to meet the needs of our OEM customers; and

• the ability of Sun, NetApp, or our other OEM customers to effectively launch, ramp, ship sell and market their own products based on our products.

Our contracts with our OEM customers do not include minimum purchase requirements and are not exclusive, and we cannot assure you that our relationship with these major customers will not be terminated or will generate significant sales.

     None of our contracts with our existing OEM customers, including Sun and NetApp, contain any minimum purchasing commitments and our customers may cancel purchase orders at any time. Further, we do not expect that future contracts with OEM customers, 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 OEM customers to purchase our products exclusively or on a preferential basis over the products of any of our competitors. Consequently, our OEM customers 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. 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. The decision by any of our OEM customers to cancel purchase orders, cease making purchases or terminate their respective contracts could cause our revenues to decline substantially, and our business and result of operations could be significantly harmed.

The market for our products is subject to substantial pricing pressure that may harm our net revenues, gross margins and operating results.

     Pricing pressures exist in the data storage market and have harmed and may, in the future, continue to harm our net revenues, gross margin and operating results. 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 highly competitive nature of our industry, the narrowing of functional differences among competitors, which forces companies to compete more on price rather than product features, and the introduction of new technologies, which leaves older technology more vulnerable to pricing pressures. To the extent we are forced to reduce the prices of our products sold as a result of these pressures, our net revenues, gross margins and operating results will decline.

Our inability to lower product costs or changes in the mix of products we sell may significantly impact our gross margins and operating results.

     Our gross margins are determined in large part based on our manufacturing costs, our component costs and our ability to bundle RAID controllers, software and low cost value added features into our products, as well as the prices at which we sell our products. If we are unable to lower production costs to be consistent with any decline in selling prices, our gross margins and operating results will suffer. Several of the new products we are currently shipping or expect to begin shipping are at the early launch phase. Until our manufacturing processes for these new products are more fully developed, product costs for these new products will be higher than for more mature products. We are pursuing strategies to offset gross margin erosion, including shifting our manufacturing to lower labor cost countries. Until we have successfully implemented this shift, we will not be able to take advantage of the lower labor costs in those countries nor can we be certain as to the magnitude of these cost savings. In addition, as we begin to derive a greater portion of our net revenues from sales of products to customers other than Sun, a greater percentage of products may be sold without RAID

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controllers, software or other margin enhancing features. All of these factors, together with increasing pricing pressures, are likely to adversely affect our gross margins and operating results.

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 most likely incur a loss for 2007, caused, in part, by lower than previously expected revenues, by on-going investment in research and development and new product production costs as several of the new products we are currently shipping or expect to begin shipping are at the early launch phase and our manufacturing processes for these products are not fully matured. 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.

     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;

• our ability to achieve acceptable gross profit margins;

• 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 September 30, 2006 totaled $108.5 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 inability 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.

Our operating results are subject to substantial quarterly and annual fluctuations, our period to period comparisons are not necessarily meaningful and we may not meet the expectations of public market analysts and investors.

     Our revenues in any quarter are substantially dependent upon customer orders in that quarter. We attempt to project future orders based in part on estimates from our OEM customers. For this purpose, arrangements with OEM customers will usually include the estimated future volume requirements of that customer. Our OEM customers’ estimated requirements are not always accurate and we therefore cannot predict our quarterly revenues with any degree of certainty. Moreover, we cannot predict or control our customers’ product launch dates, volume ramps and other factors that may result in substantial fluctuations on a quarterly or annual basis. 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. It is likely that NetApp’s sales of any storage products supplied by us will fluctuate on a quarterly or seasonal basis as well, which fluctuations will affect our financial results. Due to the infancy of the relationship, we cannot be certain of what affect these fluctuations will have on our quarterly results, if any.

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     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)
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	)
Second Quarter 2006		66.3		(6.6	)
Third Quarter 2006**		54.8		(60.1	)

*	Includes deferred tax benefit from reversal of valuation allowance of $25.3 million.
**	Includes income tax expense related to establishing valuation allowance of $47.1 million.

     Accordingly, comparisons of our quarterly results of operations or other period to period comparisons are not necessarily meaningful and should not be relied on as an indication of our future performance. In addition, the announcement of financial results that fall short of the results anticipated by public market analysts and investors 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;

• our ability to improve the costs of manufacturing products;

• our ability to identify and establish a relationship with an alternative product manufacturing supplier;

• 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;

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

• the level of competition;

• our ability to win business with new customers;

• potential reductions in inventories held by OEM customers;

• slowing sales of the products of our OEM customers;

• technological changes in the open systems storage market;

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

• changes in our business strategies;

• personnel changes;

• the mix of revenues from our customers; and

• general economic trends and other factors.

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 36 months. This is particularly true during times of economic slowdown, for sales to OEM customers and for the sale and installation of complex solutions. We have shifted our business strategy to focus primarily on OEM customers, with whom sales cycles are generally lengthier, more costly and less certain than direct sales to end-users, or sales through VARs.

     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.

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 that we obtained in our acquisition of Chaparral into certain of our storage systems resulting in the introduction of new, integrated systems.

     Our new 2730 integrated storage 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

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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, including Dot Hill’s proprietary RAID controller, 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.

Manufacturing disruptions could harm our business.

     We rely on Solectron to manufacture substantially all of our products. If our agreement with Solectron is terminated, if Solectron does not perform its obligations under our agreement or if we otherwise determine to transition manufacturing of our products to another third party manufacturer, it could take several months to establish and qualify alternative manufacturing for our products and we may not be able to fulfill our customers’ orders in a timely manner. Any such transition would also require establishing new electronic data interface linkages and would require a significant amount of our management’s attention, and could thus disrupt business operations. Under our OEM agreements with Sun and NetApp, Sun and NetApp have the right to require that we use a third party to manufacture our products. Such an external manufacturer must meet the engineering, qualification and logistics requirements of both Sun and NetApp. If our agreement with Solectron terminates or we otherwise determine to transition manufacturing of our products to another third party manufacturer, we may be unable to find another external manufacturer that meets those 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. To the extent we establish a relationship with an alternative manufacturer for our products, we may be able to partially mitigate potential disruptions to our business. We may also suffer manufacturing disruptions as we ramp up manufacturing processes for our new integrated storage systems, which could result in delays in delivery of these products to our OEM customers and adversely effect our results of operations.

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 can surpass 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 such shortages exist, 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.

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

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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.

     In addition, third parties may assert infringement claims against us, which would require us to incur substantial license fees, legal fees and other expenses, and distract management from the operations of our business. For example, on October 17, 2003, 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 and in March 2004, Chaparral was added as a party to the lawsuit. On June 28, 2006, we entered into a Settlement and License Agreement with Crossroads that settles the lawsuit and licenses to us the family of patents from which it stemmed. In connection with the settlement, we paid $4.825 million to Crossroads and Crossroads agreed to dismiss, with prejudice, all patent claims against us. Going forward, Crossroads will receive a running royalty of 2.5% based on a percentage of net sales of RAID products sold by us, but only those with functionality that is covered by US Patents No. 5,941,972 and No. 6,425,035 and other patents in the patent family. For RAID products that use a controller sourced by Infortrend, we will pay 0.8125% of the 2.5% royalty, and Infortrend will be responsible for the remainder. For RAID products that use our proprietary controller, we alone will be paying the 2.5% running royalty. We incurred significant legal expenses in connection with these matters. 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.

     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. 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 market share. Increased competition is likely to result in price reductions, and could lead to 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:

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• 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 OEM customers 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;

• 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 our competitors, 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.

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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, Hanif Jamal, our Chief Financial 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 September 30, 2006, our executive officers, directors and their affiliates beneficially owned approximately 9.1% 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.

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 September 30, 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, which has resulted in litigation.

     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

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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. 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.

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 OEM customers, 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.

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 Global 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.

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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)
4.6	Warrant to Purchase Shares of Common Stock dated June 22, 2006.
4.7	Warrant to Purchase Shares of Common Stock dated July 26, 2006.
10.1	Offer letter agreement dated July 5, 2006 between Dot Hill Systems Corp. and Hanif I. Jamal. (4)†
10.2	Change of Control agreement dated July 14, 2006 between Dot Hill Systems Corp. and Hanif I. Jamal. (4)†
10.3	First Amendment to Credit Agreement dated July 1, 2006 by and between Dot Hill Systems Corp. and Wells Fargo Bank, National Association.
10.4	Second Amendment to Credit Agreement dated September 14, 2006 by and between Dot Hill Systems Corp. and Wells Fargo Bank, National Association.
10.5	Revolving Line of Credit Note dated July 1, 2006 issued by Dot Hill Systems Corp. to Wells Fargo Bank, National Association.
10.6	Security Agreement and Addendum dated July 1, 2006 by and between Dot Hill Systems Corp. and Wells Fargo Bank, National Association.
10.7	First Amendment dated August 3, 2006 to Development and OEM Supply Agreement dated July 26, 2005 by and among Dot Hill Systems Corp., Dot Hill Systems B.V., Network Appliance, Inc., Network Appliance Holding and Manufacturing 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 July 17, 2006 and incorporated herein by reference.

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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: November 9, 2006	By	/s/ DANA W. KAMMERSGARD
		Dana W. Kammersgard
		Chief Executive Officer and President (Principal Executive Officer)
Date: November 9, 2006	By	/s/ HANIF I. JAMAL
		Hanif I. Jamal
		Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

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EX-4.6

EXHIBIT 4.6

THIS WARRANT HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED OR ANY STATE SECURITIES LAWS. NO SALE OR DISPOSITION MAY BE EFFECTED WITHOUT (i) EFFECTIVE REGISTRATION STATEMENTS RELATED THERETO, (ii) AN OPINION OF COUNSEL OR OTHER EVIDENCE, REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATIONS ARE NOT REQUIRED, (iii) RECEIPT OF NO-ACTION LETTERS FROM THE APPROPRIATE GOVERNMENTAL AUTHORITIES, OR (iv) OTHERWISE COMPLYING WITH THE PROVISIONS OF SECTION 7 OF THIS WARRANT.

DOT HILL SYSTEMS CORP.

WARRANT TO PURCHASE SHARES
OF COMMON STOCK

     THIS CERTIFIES THAT, for value received, OTA LLC and its assigns are entitled to subscribe for and purchase 1,239,527 shares of the fully paid and nonassessable Common Stock (as adjusted pursuant to Section 4 hereof, the “Shares”) of Dot Hill Systems Corp., a Delaware corporation (the “Company”), at the price of $2.97 per share, the average of the Company’s closing price as reported by the New York Stock Exchange 60 trading days before the Date of Grant (such price and such other price as shall result, from time to time, from the adjustments specified in Section 4 hereof is herein referred to as the “Warrant Price”), subject to the provisions and upon the terms and conditions hereinafter set forth. As used herein, the term “Date of Grant” shall mean May 24, 2002, and (b) the term “Other Warrants” shall mean any other warrants issued by the Company in connection with the transaction with respect to which this Warrant was issued, and any warrant issued upon transfer or partial exercise of this Warrant. The term “Warrant” as used herein shall be deemed to include Other Warrants unless the context clearly requires otherwise.

     1. Exercisability; Term. Subject to Section 10.1 below, the purchase right represented by this Warrant is exercisable as to 413,175 shares immediately, and an additional 413,176 shares on each of the first anniversary and second anniversary of the Date of Grant, in whole or in part, at any time and from time to time from the Date of Grant through Five (5) years after the Date of Grant.

     2. Method of Exercise; Payment; Issuance of New Warrant. Subject to Section 1 hereof, the purchase right represented by this Warrant may be exercised by the holder hereof, in whole or in part and from time to time, at the election of the holder hereof, by (a) the surrender of this Warrant (with the notice of exercise substantially in the form attached hereto as Exhibit A-1 duly completed and executed) at the principal office of the Company and by the payment to the Company, by certified or bank check, or by wire transfer to an account designated by the Company (a “Wire Transfer”) of an amount equal to the then applicable Warrant Price multiplied by the number of Shares then being purchased, or (b) if in connection with a registered public offering of the Company’s securities, the surrender of this Warrant (with the notice of exercise

form attached hereto as Exhibit A-2 duly completed and executed) at the principal office of the Company together with notice of arrangements reasonably satisfactory to the Company for payment to the Company either by certified or bank check or by Wire Transfer from the proceeds of the sale of shares to be sold by the holder in such public offering of an amount equal to the then applicable Warrant Price per share multiplied by the number of Shares then being purchased or (c) exercise of the “net issuance” right provided for in Section 10.2 hereof. The person or persons in whose name(s) any certificate(s) representing the Shares shall be issuable upon exercise of this Warrant shall be deemed to have become the holder(s) of record of, and shall be treated for all purposes as the record holder(s) of, the shares represented thereby (and such shares shall be deemed to have been issued) immediately prior to the close of business on the date or dates upon which this Warrant is exercised. In the event of any exercise of the rights represented by this Warrant, certificates for the shares of stock so purchased shall be delivered to the holder hereof as soon as practicable and, if requested by the holder of this Warrant, the Company shall cause its transfer agent to deliver the certificate representing Shares issued upon exercise of this Warrant to a broker or other person (as directed by the holder exercising this Warrant) within the time period required to settle any trade made by the holder after exercise of this Warrant.

     3. Stock Fully Paid; Reservation of Shares. All Shares that may be issued upon the exercise of the rights represented by this Warrant will, upon issuance pursuant to the terms and conditions herein, be fully paid and nonassessable, and free from all taxes, liens and charges with respect to the issue thereof. During the period within which the rights represented by this Warrant may be exercised, the Company will at all times have authorized, and reserved for the purpose of the issue upon exercise of the purchase rights evidenced by this Warrant, a sufficient number of shares of its Common Stock to provide for the exercise of the rights represented by this Warrant.

     4. Adjustment of Warrant Price and Number of Shares. The number and kind of securities purchasable upon the exercise of this Warrant and the Warrant Price shall be subject to adjustment from time to time upon the occurrence of certain events, as follows:

          (a) Reclassification or Merger. In case of any reclassification or change of securities of the class issuable upon exercise of this Warrant (other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination), or in case of any merger of the Company with or into another corporation (other than a merger with another corporation in which the Company is the acquiring and the surviving corporation and which does not result in any reclassification or change of outstanding securities issuable upon exercise of this Warrant), or in case of any sale of all or substantially all of the assets of the Company, the Company, or such successor or purchasing corporation, as the case may be, shall duly execute and deliver to the holder of this Warrant a new Warrant (in form and substance satisfactory to the holder of this Warrant), or the Company shall make appropriate provision without the issuance of a new Warrant, so that the holder of this Warrant shall have the right to receive upon exercise of this Warrant, at a total purchase price not to exceed that payable upon the exercise of the unexercised portion of this Warrant, and in lieu of the shares of Common Stock theretofore issuable upon exercise of this Warrant, the kind and amount of shares of stock, other securities, money and property receivable upon such reclassification, change or merger by a holder of the number of shares of Common Stock then purchasable under this Warrant. Such new Warrant shall provide for adjustments that shall be as nearly equivalent as

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may be practicable to the adjustments provided for in this Section 4. The provisions of this subparagraph (a) shall similarly apply to successive reclassifications, changes, mergers and transfers.

          (b) Subdivision or Combination of Shares. If the Company at any time while this Warrant remains outstanding and unexpired shall subdivide or combine its outstanding shares of Common Stock, the Warrant Price shall be proportionately decreased and the number of Shares issuable hereunder shall be proportionately increased in the case of a subdivision or and the Warrant Price shall be proportionately increased and the number of Shares issuable hereunder shall be proportionately decreased in the case of a combination.

          (c) Stock Dividends and Other Distributions. If the Company at any time while this Warrant is outstanding and unexpired shall (i) pay a dividend with respect to its Common Stock payable in Common Stock, then the Warrant Price shall be adjusted, from and after the date of determination of shareholders entitled to receive such dividend or distribution, to that price determined by multiplying the Warrant Price in effect immediately prior to such date of determination by a fraction (A) the numerator of which shall be the total number of shares of Common Stock outstanding immediately prior to such dividend or distribution, and (B) the denominator of which shall be the total number of shares of Common Stock outstanding immediately after such dividend or distribution; or (ii) make any other distribution with respect to Common Stock (except any distribution specifically provided for in Sections 4(a) and 4(b)), then, in each such case, provision shall be made by the Company such that the holder of this Warrant shall receive upon exercise of this Warrant a proportionate share of any such dividend or distribution as though it were the holder of the Shares as of the record date fixed for the determination of the shareholders of the Company entitled to receive such dividend or distribution.

          (d) Adjustment of Number of Shares. Upon each adjustment in the Warrant Price, the number of Shares purchasable hereunder shall be adjusted, to the nearest whole share, to the product obtained by multiplying the number of Shares purchasable immediately prior to such adjustment in the Warrant Price by a fraction, the numerator of which shall be the Warrant Price immediately prior to such adjustment and the denominator of which shall be the Warrant Price immediately thereafter.

     5. Notice of Adjustments. Whenever the Warrant Price or the number of Shares purchasable hereunder shall be adjusted pursuant to Section 4 hereof, the Company shall make a certificate signed by its chief financial officer setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the Warrant Price and the number of Shares purchasable hereunder after giving effect to such adjustment, and shall cause copies of such certificate to be mailed (without regard to Section 13 hereof, by first class mail, postage prepaid) to the holder of this Warrant at such holder’s last known address.

     6. Fractional Shares. No fractional shares of Common Stock will be issued in connection with any exercise hereunder, but in lieu of such fractional shares the Company shall make a cash payment therefor based on the fair market value of the Common Stock on the date of exercise as reasonably determined in good faith by the Company’s Board of Directors.

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     7. Compliance with Securities Act; Disposition of Warrant or Shares of Common Stock.

          (a) Compliance with Securities Act. The holder of this Warrant, by acceptance hereof, agrees that this Warrant, and the Shares to be issued upon exercise hereof are being acquired for investment and that such holder will not offer, sell or otherwise dispose of this Warrant, or any Shares except under circumstances which will not result in a violation of the Securities Act of 1933, as amended (the “Act”) or any applicable state securities laws. Upon exercise of this Warrant, unless the Shares being acquired are registered under the Act and any applicable state securities laws or an exemption from such registration is available, the holder hereof shall confirm in writing that the Shares so purchased are being acquired for investment and not with a view toward distribution or resale in violation of the Act and shall confirm such other matters related thereto as may be reasonably requested by the Company. This Warrant and all Shares issued upon exercise of this Warrant (unless registered under the Act and any applicable state securities laws) shall be stamped or imprinted with a legend in substantially the following form:

“THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAWS. NO SALE OR DISPOSITION MAY BE EFFECTED WITHOUT (i) EFFECTIVE REGISTRATION STATEMENTS RELATED THERETO, (ii) AN OPINION OF COUNSEL OR OTHER EVIDENCE, REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATIONS ARE NOT REQUIRED, (iii) RECEIPT OF NOACTION LETTERS FROM THE APPROPRIATE GOVERNMENTAL AUTHORITIES, OR (iv) OTHERWISE COMPLYING WITH THE PROVISIONS OF SECTION 7 OF THE WARRANT UNDER WHICH THESE SECURITIES WERE ISSUED, DIRECTLY OR INDIRECTLY.”

     Said legend shall be removed by the Company, upon the request of a holder, at such time as the restrictions on the transfer of the applicable security shall have terminated. In addition, in connection with the issuance of this Warrant, the holder specifically represents to the Company by acceptance of this Warrant as follows:

                    (1) The holder is aware of the Company’s business affairs and financial condition, and has acquired information about the Company sufficient to reach an informed and knowledgeable decision to acquire this Warrant. The holder is acquiring this Warrant for its own account for investment purposes only and not with a view to, or for the resale in connection with, any “distribution” thereof in violation of the Act.

                    (2) The holder understands that this Warrant has not been registered under the Act in reliance upon a specific exemption therefrom, which exemption depends upon, among other things, the bona fide nature of the holder’s investment intent as expressed herein.

                    (3) The holder further understands that this Warrant must be held indefinitely unless subsequently registered under the Act and qualified under any applicable

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state securities laws, or unless exemptions from registration and qualification are otherwise available. The holder is aware of the provisions of Rule 144, promulgated under the Act.

                    (4) The holder is an “accredited investor” as such term is defined in Rule 501 of Regulation D promulgated under the Act.

          (b) Disposition of Warrant or Shares. With respect to any offer, sale or other disposition, in whole or in part, of this Warrant or of any Shares acquired pursuant to the exercise of this Warrant prior to registration of such Warrant or Shares, the holder hereof agrees to give written notice to the Company prior thereto, describing briefly the manner thereof, together with a written opinion of such holder’s counsel, or other evidence, if reasonably satisfactory to the Company, to the effect that such offer, sale or other disposition may be effected without registration or qualification (under the Act as then in effect or any federal or state securities law then in effect) of this Warrant , the Shares or any portion thereof and indicating whether or not under the Act certificates for this Warrant, the Shares or any portion thereof to be sold or otherwise disposed of require any restrictive legend as to applicable restrictions on transferability in order to ensure compliance with such law. Upon receiving such written notice and reasonably satisfactory opinion or other evidence, the Company, as promptly as practicable but no later than fifteen (15) days after receipt of the written notice, shall take such steps as necessary for such holder to sell or otherwise dispose of this Warrant, such Shares or any portion thereof, all in accordance with the terms of the notice delivered to the Company. If a determination has been made pursuant to this Section 7(b) that the opinion of counsel for the holder or other evidence is not reasonably satisfactory to the Company, the Company shall so notify the holder promptly with details thereof after such determination has been made. Notwithstanding the foregoing, this Warrant, such Shares or any portion thereof, may, as to such federal laws, be offered, sold or otherwise disposed of in accordance with Rule 144 or 144A under the Act, provided that the Company shall have been furnished with such information as the Company may reasonably request to provide a reasonable assurance that the provisions of Rule 144 or 144A have been satisfied. Each certificate representing this Warrant, the Shares or any portion thereof thus transferred (except a transfer pursuant to Rule 144 or 144A) shall bear a legend as to the applicable restrictions on transferability in order to ensure compliance with such laws, unless in the aforesaid opinion of counsel for the holder, such legend is not required in order to ensure compliance with such laws. The Company may issue stop transfer instructions to its transfer agent in connection with such restrictions.

          (c) Applicability of Restrictions. Neither any restrictions of any legend described in this Warrant nor the requirements of Section 7(b) above shall apply to any transfer or grant of a security interest in, this Warrant (or the Common Stock obtainable upon exercise thereof) or any part hereof (i) to a partner of the holder if the holder is a partnership or to a member of the holder if the holder is a limited liability company, (ii) to a partnership of which the holder is a partner or a limited liability company of which the holder is a member, or (iii) to any affiliate of the holder if the holder is a corporation; provided, however, in any such transfer, if applicable, the transferee shall on the Company’s request agree in writing to be bound by the terms of this Warrant as if an original holder hereof.

     8. Rights as Shareholders; Information. No holder of this Warrant, as such, shall be entitled to vote or receive dividends or be deemed the holder of Common Stock or any other

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securities which may at any time be issuable upon the exercise hereof for any purpose, nor shall anything contained herein be construed to confer upon the holder of this Warrant, as such, any of the rights of a shareholder of the Company or any right to vote for the election of directors or upon any matter submitted to shareholders at any meeting thereof, or to receive notice of meetings, or to receive dividends or subscription rights or otherwise until this Warrant shall have been exercised and the Shares purchasable upon the exercise hereof shall have become deliverable, as provided herein. Notwithstanding the foregoing, the Company will transmit to the holder of this Warrant such information, documents and reports as are generally distributed to the holders of any class or series of the securities of the Company concurrently with the distribution thereof to the shareholders.

     9. Registration Rights.

          (a) Registration.

               (i) On or before the date six months after the Date of Grant, the Company shall prepare and file with the Securities and Exchange Commission (“SEC”) a registration statement under Rule 415 of the Act to register the resale of the Common Stock issuable upon exercise of this Warrant (the “Registrable Shares”) and shall thereafter use all reasonable efforts to cause such registration statement to become effective as promptly as practicable.

               (ii) The Company shall, until the date 30 months after the Date of Grant, keep such registration statement for the Registrable Shares in effect and current and from time to time amend or supplement the registration statement and the prospectus in connection therewith in compliance with the Act to permit the sale or distribution of the Registrable Shares with respect to which such registration statement shall have become effective. If at any time the SEC should institute or threaten to institute any proceedings for the purpose of issuing, or should issue a stop order suspending the effectiveness of any such registration statement, the Company will promptly notify the holder of this Warrant (which term shall include any holder of the Shares) and will use its reasonable best efforts to prevent the issuance of any such stop order or to obtain the withdrawal thereof as soon as possible. The Company will advise the holder of this Warrant promptly of any order or communication of any public board or body addressed to the Company suspending or threatening to suspend the registration or qualification of any of the Registrable Shares for sale in any jurisdiction.

               (iii) The holder of this Warrant agrees, by acceptance of this Warrant, that, upon receipt of any notice from the Company of (A) the happening of any event which makes any statements made in the registration statement or related prospectus filed pursuant to this Section 9, or any document incorporated or deemed to be incorporated therein by reference, untrue in any material respect or which requires the making of any changes in such registration statement or prospectus so that, in the case of such registration statement, it will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, and that in the case of the prospectus, it will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading or (B) that, in the judgment of the

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Company’s Board of Directors, it is advisable to suspend use of the prospectus for a discrete period of time due to pending corporate developments, public filings with the SEC or similar events, the holder will forthwith discontinue, for a period not to exceed sixty (60) days, disposition of such Registrable Shares covered by such registration statement or prospectus until it is advised in writing by the Company that use of the applicable prospectus may be resumed, and has received copies of any additional or supplemented filings that are incorporated or deemed to be incorporated by reference in such prospectus. The Company shall use all reasonable efforts to insure that the use of the prospectus may be resumed as soon as practicable, and in any event shall not be entitled to require the holder to suspend use of any prospectus for more than ninety (90) days in any twelve month period.

          (b) Company Obligations. Whenever any Registrable Shares become subject to a registration statement pursuant to this Section 9, the Company shall:

               (i) Promptly notify the holder of this Warrant and confirm such advice in writing (i) when such registration statement becomes effective, (ii) when any post-effective amendment to any such registration statement becomes effective and (iii) of any request by the SEC for any amendment or supplement to such registration statement or any prospectus relating thereto or for additional information;

               (ii) Furnish to the holder of this Warrant such number of copies of any registration statement or any amendment or supplement thereto, and any prospectus (including any preliminary prospectus) contained therein in conformity with the requirements of the Act as the holder of this Warrant may reasonably request in order to effect the offering and sale of the Registrable Shares being offered and sold by the holder of this Warrant, but only while the Company is required under the provisions hereof to cause the registration statement to remain current;

               (iii) Use its reasonable best efforts to register or qualify not later than the effective date of such registration statement the Registrable Shares registered thereunder under the “blue sky” laws of such states as the holder of this Warrant may reasonably request; provided, however, that the Company shall not be obligated to qualify as a foreign corporation or as a dealer in securities or to execute or file any general consent to service of process under the laws of any such state where it is not at such time so qualified or subject;

               (iv) Immediately notify the holder of this Warrant, at any time when a prospectus relating to a sale of Registrable Shares is required by law to be delivered in connection with sales thereof, of the occurrence of an event requiring the preparation of a supplement or amendment to such prospectus so that, as thereafter delivered to the purchasers of such Registrable Shares, such prospectus will not contain an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading and promptly make available to the holder of this Warrant and to the underwriters any such amendment or supplement;

               (v) The Company and the holder of this Warrant will enter into customary agreements (including an underwriting or indemnity agreement in customary form)

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and take such other actions as are reasonably required in order to expedite or facilitate the sale of the Registrable Shares;

               (vi) In the event of an underwritten offering (in the Company’s sole discretion), the Company will use its reasonable best efforts to cause to be furnished to the holder of this Warrant a signed counterpart, addressed to the holder of this Warrant or such underwriter, of (i) an opinion or opinions of counsel to the Company and (ii) a comfort letter or comfort letters from the Company’s independent accountants, each in customary form and covering such matters of the type customarily covered by opinions or comfort letters as the case may be, as the holder of this Warrant reasonably requests;

               (vii) In the event of an underwritten offering (in the Company’s sole discretion), the Company will make generally available to its security holders, as soon as reasonably practicable, an earnings statement covering the period of twelve months, beginning within three months after the effective date of the registration statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Act; and

               (viii) The Company will use its reasonably best efforts to cause all Common Stock to be listed on each securities exchange (or the Nasdaq National Market System) on which similar securities issued by the Company are then listed.

          (c) Expenses. The Company shall bear the out-of-pocket costs and expenses incurred in connection with any registration pursuant to this Section 9. The costs and expenses of any such registration shall include, without limitation, the reasonable fees and expenses of the Company’s counsel and its accountants and all other out-of-pocket costs and expenses of the Company incident to the preparation, printing and filing under the Act of the registration statement and all amendments and supplements thereto and the cost of furnishing copies of each preliminary prospectus, each final prospectus and each amendment or supplement thereto to underwriters, dealers and other purchasers of the securities so registered, the costs and expenses incurred in connection with the qualification of such securities so registered under the “blue sky” laws of various jurisdictions, the fees and expenses of the Company’s transfer agent and all other costs and expenses of complying with the foregoing provisions of this Section 9. The holder of this Warrant shall pay any underwriting fees, discounts or commissions attributable to the sale of Registrable Shares. The Company shall pay internal Company expenses (including, without limitation, all salaries and expenses of its officers and employees performing legal or accounting duties).

          (d) Indemnification.

               (i) In the case of any offering registered pursuant to Section 9(a), the Company hereby indemnifies and agrees to hold harmless the holder of this Warrant (or the Registrable Shares) and each person, if any, who controls the holder of this Warrant (or the Registrable Shares) within the meaning of either Section 15 of the Act or Section 20 of the Securities and Exchange Act of 1934, as amended. (the “Exchange Act”) from and against any losses, claims, damages or liabilities, joint or several, to which any such persons may be subject, under the Act, the Exchange Act or otherwise, and to reimburse any of such persons for any legal or other expenses reasonably incurred by them in connection with investigating any claims or

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defending against any actions, insofar as such losses, claims, damages or liabilities arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the registration statement under which such Registrable Shares were registered under the Act pursuant to this Section 9, any prospectus (including any preliminary prospectus) contained therein, if used during the period appropriate for such prospectus, or any amendment or supplement thereto, or the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading; provided that the indemnification agreement contained in this Section 9(d)(i) shall not apply to such losses, claims, damages or liabilities which shall arise out of the sale of Registrable Shares to any person to the extent such losses, claims, damages or liabilities arise out of or are based upon any such untrue statement or omission or alleged untrue statement or omission if such statement or omission shall have been made (A) in reliance upon information furnished to the Company in writing by the holder of this Warrant specifically for use therein, or (B) in any preliminary prospectus, and the prospectus contained in the registration statement as declared effective or in the form filed by the Company with the SEC pursuant to Rule 424 under the Act corrected such statement or omission and a copy of such final prospectus shall not have been sent or otherwise delivered to such person at or prior to the confirmation of such sale to such person or to the holder of this Warrant for delivery to such person. The Company also agrees to indemnify the underwriters (as defined in the Act) of the Registrable Shares, their officers and directors and each person who controls such underwriters on substantially the same basis as that of the indemnification of the holder of this Warrant provided in this Section 9(d)(i).

               (ii) By acceptance of this Warrant, the holder of this Warrant agrees, in the same manner and to the same extent as set forth in the preceding paragraph, to indemnify and to hold harmless the Company and its directors and officers against any losses, claims, damages or liabilities, joint or several, to which any of such persons may be subject under the Act or otherwise, and to reimburse any of such persons for any legal or other expenses incurred in connection with investigating or defending against any such losses, claims, damages or liabilities, but only to the extent it arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission of a material fact in any registration statement under which the Registrable Shares were registered under the Act pursuant to this Section 9, any prospectus contained therein, or any amendment or supplement thereto, which was based upon and made in conformity with information furnished to the Company in writing by the holder of this Warrant expressly for use therein. The holder of this Warrant also agrees to indemnify and hold harmless any underwriter (as defined in the Act) of the Registrable Shares, its officers and directors and each person who controls such underwriter on substantially the same basis as that of the indemnification of the Company provided in this Section 9(d)(ii). Provided however, that the obligations of the holder of this Warrant hereunder shall be limited to an amount equal to the net proceeds after expenses and commissions to such holder of Registrable Shares sold as contemplated herein.

               (iii) Each party indemnified under this Section 9 shall, promptly after receipt of notice of the commencement of any action against such indemnified party in respect of which indemnity may be sought, notify the indemnifying party in writing of the commencement thereof. The omission of any indemnified party so to notify an indemnifying party of any such action shall not relieve the indemnifying party from any liability in respect of such action which

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it may have to such indemnified party on account of the indemnity agreement contained in this Section 9, unless the indemnifying party was materially prejudiced by such omission, and in no event shall relieve the indemnifying party from any other liability which it may have to such indemnified party. In case any such action shall be brought against any indemnified party and it shall notify an indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to the indemnified party. In any such action, any indemnified party shall have the right to retain its own counsel, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (A) the indemnifying party and the indemnified party shall have mutually agreed to the retention of such counsel or (B) the named parties to any such action (including any impleaded parties) include both the indemnified party and the indemnifying party and representation of both parties by the same counsel would be inappropriate due to actual or potential differing interests between them. It is understood that the indemnifying party shall not, in connection with any proceeding in the same jurisdiction, be liable for the fees and expenses of more than one separate firm of attorneys (in addition to any local counsel) at any time for all such indemnified parties, and that all such fees and expenses shall be reimbursed as they are incurred.

               (iv) If the indemnification provided for in this Section 9 as between the holder of this Warrant and the Company is unavailable to the holder of this Warrant and each person, if any, who controls the holder of this Warrant within the meaning of either Section 15 of the Act or Section 20 of the Exchange Act or to the Company in respect of any losses, claims, damages or liabilities referred to herein, then each indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities in such proportion as is appropriate to reflect the relative fault of the Company and of the holder of this Warrant in connection with such statements or omissions, as well as other relevant equitable considerations. The relative fault of the Company on the one hand and of the holder of this Warrant on the other shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of material fact or the omission or alleged omission to state a material fact relates to information supplied by such party and the parties’ relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission.

               (v) The Company and holder of this Warrant agree that it would not be just and equitable if contribution pursuant to this Section 9(d)(iv) were determined by pro rata allocation (even if the underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities referred to in the immediately preceding paragraph shall be deemed to include, subject to the limitations set forth above, any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 9(d)(iv), the holder of this Warrant shall not be required to contribute any amount in excess of the amount by which the net proceeds of the offering (before deducting expenses) received by the holder of this Warrant exceeds the amount of any damages which the holder of this Warrant would have or has been required to pay by reason of the relevant fault in connection with such untrue or alleged

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untrue statement or omission or alleged omission allocated to the holder of this Warrant. Notwithstanding the foregoing, the obligations of the holder of this Warrant hereunder shall be limited to an amount equal to the net proceeds after expenses and commissions to such holder of Registrable Shares sold as contemplated herein. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation.

     9. Additional Rights.

     10.1 Mergers. The Company shall provide the holder of this Warrant with at least twenty (20) days’ written notice prior to the closing thereof of the terms and conditions of any of the following transactions (an “Acquisition”): (i) the sale, lease, exchange, conveyance or other disposition of all or substantially all of the Company’s property or business, or (ii) its merger into or consolidation with any other corporation (other than a wholly-owned subsidiary of the Company), or any transaction (including a merger or other reorganization) or series of related transactions, in which more than 50% of the voting power of the Company is disposed of. In the event of an Acquisition, the purchase rights represented by this Warrant shall be fully exercisable.

     10.2 Right to Convert Warrant into Stock: Net Issuance.

          (a) Right to Convert. In addition to and without limiting the rights of the holder under the terms of this Warrant, the holder shall have the right to convert this Warrant or any portion thereof (the “Conversion Right”) into shares of Common Stock as provided in this Section 10.2 at any time or from time to time the number of shares of Common Stock for which this Warrant is exercisable pursuant to Section 1 and 10.1 above, during the term of this Warrant. Upon exercise of the Conversion Right with respect to a particular number of shares subject to this Warrant (the “Converted Warrant Shares”), the Company shall deliver to the holder (without payment by the holder of any exercise price or any cash or other consideration) that number of shares of fully paid and nonassessable Common Stock as is determined according to the following formula:

X = B — A   Y

Where:	X =	the number of shares of Common Stock that may be issued to the holder
	Y =	the fair market value of one share of Common Stock
	A =	the aggregate Warrant Price of the specified number of Converted Warrant Shares immediately prior to the exercise of the Conversion Right (i.e., the number of Converted Warrant Shares multiplied by the Warrant Price)
	B =	the aggregate fair market value of the specified number of converted Warrant Shares (i.e., the number

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of Converted Warrant Shares multiplied by the fair market value of one Converted Warrant Shares)

     No fractional shares shall be issuable upon exercise of the Conversion Right, and, if the number of shares to be issued determined in accordance with the foregoing formula is other than a whole number, the Company shall pay to the holder an amount in cash equal to the fair market value of the resulting fractional share on the Conversion Date (as hereinafter defined). For purposes of Section 9 of this Warrant, shares issued pursuant to the Conversion Right shall be treated as if they were issued upon the exercise of this Warrant.

          (b) Method of Exercise. The Conversion Right may be exercised by the holder by the surrender of this Warrant at the principal office of the Company together with a written statement (which may be in the form of Exhibit A-1 or Exhibit A-2 hereto) specifying that the holder thereby intends to exercise the Conversion Right and indicating the number of shares subject to this Warrant which are being surrendered (referred to in Section 10.2(a) hereof as the Converted Warrant Shares) in exercise of the Conversion Right. Such conversion shall be effective upon receipt by the Company of this Warrant together with the aforesaid written statement, or on such later date as is specified therein (the “Conversion Date”), and, at the election of the holder hereof, may be made contingent upon the closing of the sale of the Company’s Common Stock to the public in a public offering pursuant to a Registration Statement under the Act (a “Public Offering”). Certificates for the shares issuable upon exercise of the Conversion Right and, if applicable, a new warrant evidencing the balance of the shares remaining subject to this Warrant, shall be issued as of the Conversion Date and shall be delivered to the holder within thirty (30) days following the Conversion Date.

          (c) Determination of Fair Market Value. For purposes of this Section 10.2, “fair market value” of a share of Common Stock as of a particular date (the “Determination Date”) shall mean:

               (i) If the Conversion Right is exercised in connection with and contingent upon a Public Offering, and if the Company’s Registration Statement relating to such Public Offering (“Registration Statement”) has been declared effective by the Securities and Exchange Commission, then the initial “Price to Public” specified in the final prospectus with respect to such offering.

               (ii) If the Conversion Right is not exercised in connection with and contingent upon a Public Offering, then as follows:

     (A) If traded on a securities exchange, the fair market value of the Common Stock shall be deemed to be the average of the closing prices of the Common Stock on such exchange over the five trading days immediately prior to the Determination Date;

     (B) If traded on the Nasdaq Stock Market or other over-the-counter system, the fair market value of the Common Stock shall be deemed to be the average of the closing bid prices of the Common Stock over the five trading days immediately prior to the Determination Date; and

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     (C) If there is no public market for the Common Stock, then fair market value shall be determined by mutual agreement of the holder of this Warrant and the Company.

If closing prices or closing bid prices are no longer reported by a securities exchange or other trading system, the closing price or closing bid price shall be that which is reported by such securities exchange or other trading system at 4:00 p.m. New York City time on the applicable trading day.

     10.3 Exercise Prior to Expiration. To the extent this Warrant is not previously exercised as to all of the Shares subject hereto, and if the fair market value of one share of the Common Stock is greater than the Warrant Price then in effect, this Warrant shall be deemed automatically exercised pursuant to Section 10.2 above (even if not surrendered) immediately before its expiration. For purposes of such automatic exercise, the fair market value of one share of the Series Preferred upon such expiration shall be determined pursuant to Section 10.2(c). To the extent this Warrant or any portion thereof is deemed automatically exercised pursuant to this Section 10.3, the Company agrees to promptly notify the holder hereof of the number of Shares, if any, the holder hereof is to receive by reason of such automatic exercise.

     10. Representations and Warranties. The Company represents and warrants to the holder of this Warrant as follows:

          (a) This Warrant has been duly authorized and executed by the Company and is a valid and binding obligation of the Company enforceable in accordance with its terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and the rules of law or principles at equity governing specific performance, injunctive relief and other equitable remedies;

          (b) The Shares have been duly authorized and reserved for issuance by the Company and, when issued in accordance with the terms hereof will be validly issued, fully paid and non-assessable;

          (c) The execution and delivery of this Warrant are not, and the issuance of the Shares upon exercise of this Warrant in accordance with the terms hereof will not be, inconsistent with the Company’s Charter or by-laws, do not and will not contravene any law, governmental rule or regulation, judgment or order applicable to the Company, and do not and will not conflict with or contravene any provision of, or constitute a default under, any indenture, mortgage, contract or other instrument of which the Company is a party or by which it is bound or require the consent or approval of, the giving of notice to, the registration or filing with or the taking of any action in respect of or by, any Federal, state or local government authority or agency or other person, except for the filing of notices pursuant to federal and state securities laws, which filings will be effected by the time required thereby; and

          (d) There are no actions, suits, audits, investigations or proceedings pending or, to the knowledge of the Company, threatened against the Company in any court or before any governmental commission, board or authority which, if adversely determined, will have a material adverse effect on the ability of the Company to perform its obligations under this Warrant.

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     11. Modification and Waiver. This Warrant and any provision hereof may be changed, waived, discharged or terminated only by an instrument in writing signed by the party against which enforcement of the same is sought.

     12. Notices. Any notice, request, communication or other document required or permitted to be given or delivered to the holder hereof or the Company shall be delivered, or shall be sent by certified or registered mail, postage prepaid, to each such holder at its address as shown on the books of the Company or to the Company at the address indicated therefor on the signature page of this Warrant.

     13. Binding Effect on Successors. This Warrant shall be binding upon any corporation succeeding the Company by merger, consolidation or acquisition of all or substantially all of the Company’s assets, and all of the obligations of the Company relating to the Shares issuable upon the exercise or conversion of this Warrant shall survive the exercise, conversion and termination of this Warrant and all of the covenants and agreements of the Company shall inure to the benefit of the successors and assigns of the holder hereof.

     14. Lost Warrants or Stock Certificates. The Company covenants to the holder hereof that, upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant or any stock certificate and, in the case of any such loss, theft or destruction, upon receipt of an indemnity reasonably satisfactory to the Company, or in the case of any such mutilation upon surrender and cancellation of such Warrant or stock certificate, the Company will make and deliver a new Warrant or stock certificate, of like tenor, in lieu of the lost, stolen, destroyed or mutilated Warrant or stock certificate.

     15. Descriptive Headings. The descriptive headings of the several paragraphs of this Warrant are inserted for convenience only and do not constitute a part of this Warrant. The language in this Warrant shall be construed as to its fair meaning without regard to which party drafted this Warrant.

     16. Governing Law. This Warrant shall be construed and enforced in accordance with, and the rights of the parties shall be governed by, the laws of the State of California.

     17. Survival of Representations, Warranties and Agreements. All representations and warranties of the Company and the holder hereof contained herein shall survive the Date of Grant, the exercise or conversion of this Warrant (or any part hereof) or the termination or expiration of rights hereunder. All agreements of the Company and the holder hereof contained herein shall survive indefinitely until, by their respective terms, they are no longer operative.

     18. Remedies. In case any one or more of the covenants and agreements contained in this Warrant shall have been breached, the holders hereof (in the case of a breach by the Company), or the Company (in the case of a breach by a holder), may proceed to protect and enforce their or its rights either by suit in equity and/or by action at law, including, but not limited to, an action for damages as a result of any such breach and/or an action for specific performance of any such covenant or agreement contained in this Warrant.

     19. No Impairment of Rights. The Company will not, by amendment of its Charter or through any other means, avoid or seek to avoid the observance or performance of any of the

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terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the holder of this Warrant against impairment.

     20. Severability. The invalidity or unenforceability of any provision of this Warrant in any jurisdiction shall not affect the validity or enforceability of such provision in any other jurisdiction, or affect any other provision of this Warrant, which shall remain in full force and effect.

     21. Recovery of Litigation Costs. If any legal action or other proceeding is brought for the enforcement of this Warrant, or because of an alleged dispute, breach, default, or misrepresentation in connection with any of the provisions of this Warrant, the successful or prevailing party or parties shall be entitled to recover reasonable attorneys’ fees and other costs incurred in that action or proceeding, in addition to any other relief to which it or they may be entitled.

[Remainder of page intentionally left blank]

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     22. Entire Agreement; Modification. This Warrant constitutes the entire agreement between the parties pertaining to the subject matter contained in it and supersedes all prior and contemporaneous agreements, representations, and undertakings of the parties, whether oral or written, with respect to such subject matter.

DOT HILL SYSTEMS CORP.
By:	/s/ Shad L. Burke
Title: Interim Chief Financial Officer
Address:		2200 Faraday Avenue
		Suite 100
		Carlsbad, CA 92008
Date: June 22, 2006

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EXHIBIT A-1

NOTICE OF EXERCISE

To: DOT HILL SYSTEMS CORP. (the “Company”)

     1. The undersigned hereby:

q	elects to purchase                     shares of Common Stock of the Company pursuant to the terms of the attached Warrant, and tenders herewith payment of the purchase price of such shares in full, or
q	elects to exercise its net issuance rights pursuant to Section 10.2 of the attached Warrant with respect to                     shares of Common Stock.

     2. Please issue a certificate or certificates representing said shares in the name of the undersigned or in such other name or names as are specified below:

(Name)

(Address)

     3. The undersigned represents that the aforesaid shares are being acquired for the account of the undersigned for investment and not with a view to, or for resale in connection with, the distribution thereof and that the undersigned has no present intention of distributing or reselling such shares, all except as in compliance with applicable securities laws.

OTA LLC

(Signature)

                                                            
(Date)

EXHIBIT A-2

NOTICE OF EXERCISE

To: DOT HILL SYSTEMS CORP. (the “Company”)

     1. Contingent upon and effective immediately prior to the closing (the “Closing”) of the Company’s public offering contemplated by the Registration Statement on Form S, filed, 19, the undersigned hereby:

q	elects to purchase                     shares of Common Stock of the Company (or such lesser number of shares as may be sold on behalf of the undersigned at the Closing) pursuant to the terms of the attached Warrant, or
q	elects to exercise its net issuance rights pursuant to Section 10.2 of the attached Warrant with respect to ___                    Shares of Common Stock.

     2. Please deliver to the custodian for the selling shareholders a stock certificate representing such shares.

     3. The undersigned has instructed the custodian for the selling shareholders to deliver to the Company $                    or, if less, the net proceeds due the undersigned from the sale of shares in the aforesaid public offering. If such net proceeds are less than the purchase price for such shares, the undersigned agrees to deliver the difference to the Company prior to the Closing.

OTA LLC

(Name)

(Address)

                                                            
(Date)

EX-4.7

EXHIBIT 4.7

THIS WARRANT AND THE SECURITIES ISSUABLE UPON EXERCISE OF THIS WARRANT HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED OR ANY STATE SECURITIES LAWS. NO SALE OR DISPOSITION OF THIS WARRANT OR THE SECURITIES ISSUABLE UPON EXERCISE OF THIS WARRANT MAY BE EFFECTED WITHOUT (i) EFFECTIVE REGISTRATION STATEMENTS RELATED THERETO, (ii) AN OPINION OF COUNSEL OR OTHER EVIDENCE, REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATIONS ARE NOT REQUIRED, (iii) RECEIPT OF NO-ACTION LETTERS FROM THE APPROPRIATE GOVERNMENTAL AUTHORITIES, OR (iv) OTHERWISE COMPLYING WITH THE PROVISIONS OF SECTION 7 OF THIS WARRANT.

DOT HILL SYSTEMS CORP.

WARRANT TO PURCHASE SHARES
OF COMMON STOCK

THIS WARRANT (this “Warrant”) CERTIFIES THAT, for value received, OTA LLC and its assigns are entitled to subscribe for and purchase 154,748 shares of the fully paid and nonassessable Common Stock of Dot Hill Systems Corp., a Delaware corporation (the “Company”) (as adjusted pursuant to Section 4 hereof, the “Shares”) at the price of $3.25 per share (such price and such other price as shall result, from time to time, from the adjustments specified in Section 4 hereof is herein referred to as the “Warrant Price”), subject to the provisions and upon the terms and conditions hereinafter set forth. As used herein, the term “Date of Grant” shall mean February 14, 2003.

1. Exercisability; Term. This Warrant may be exercised, in whole or in part, at any time and from time to time from the Date of Grant through five (5) years after the Date of Grant.

2. Method of Exercise; Payment; Issuance of New Warrant. The purchase right represented by this Warrant may be exercised by the holder hereof, in whole or in part and from time to time, at the election of the holder hereof, by (a) delivery of a notice of exercise substantially in the form attached hereto as Exhibit A-1 duly completed and executed at the principal office of the Company and payment to the Company, by certified or bank check, or by wire transfer to an account designated by the Company (a “Wire Transfer”) of an amount equal to the then applicable Warrant Price multiplied by the number of Shares then being purchased, or (b) if in connection with a registered public offering of the Company’s securities, the surrender of this Warrant (with the notice of exercise form attached hereto as Exhibit A-2 duly completed and executed) at the principal office of the Company together with notice of arrangements reasonably satisfactory to the Company for payment to the Company either by certified or bank check or by Wire Transfer from the proceeds of the sale of shares to be sold by the holder in such public offering of an amount equal to the then applicable Warrant Price per share multiplied by the number of Shares then being purchased or (c) exercise of the “net issuance” right provided for in Section 10.2 hereof. The person or persons in whose name(s) any certificate(s) representing the

Shares shall be issuable upon exercise of this Warrant shall be deemed to have become the holder(s) of record of, and shall be treated for all purposes as the record holder(s) of, the shares represented thereby (and such shares shall be deemed to have been issued) immediately prior to the close of business on the date or dates upon which this Warrant is exercised. In the event of any exercise of the rights represented by this Warrant, certificates for the shares of stock so purchased shall be delivered to the holder hereof as soon as practicable and, if requested by the holder of this Warrant, the Company shall cause its transfer agent to deliver the certificate representing Shares issued upon exercise of this Warrant to a broker or other person (as directed by the holder exercising this Warrant) within the time period required to settle any trade made by the holder after exercise of this Warrant.

3. Stock Fully Paid; Reservation of Shares. All Shares that may be issued upon the exercise of the rights represented by this Warrant will, upon issuance pursuant to the terms and conditions herein, be fully paid and nonassessable, and free from all taxes, liens and charges with respect to the issue thereof. During the period within which the rights represented by this Warrant may be exercised, the Company will at all times have authorized, and reserved for the purpose of the issue upon exercise of the purchase rights evidenced by this Warrant, a sufficient number of shares of its Common Stock to provide for the exercise of the rights represented by this Warrant.

4. Adjustment of Warrant Price and Number of Shares. The number and kind of securities purchasable upon the exercise of this Warrant and the Warrant Price shall be subject to adjustment from time to time upon the occurrence of certain events, as follows:

          (a) Reclassification or Merger. In case of any reclassification or change of securities of the class issuable upon exercise of this Warrant (other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination), or in case of any merger of the Company with or into another corporation (other than a merger with another corporation in which the Company is the acquiring and the surviving corporation and which does not result in any reclassification or change of outstanding securities issuable upon exercise of this Warrant), or in case of any sale of all or substantially all of the assets of the Company, the Company, or such successor or purchasing corporation, as the case may be, shall duly execute and deliver to the holder of this Warrant a new Warrant (in form and substance satisfactory to the holder of this Warrant), or the Company shall make appropriate provision without the issuance of a new Warrant, so that the holder of this Warrant shall have the right to receive upon exercise of this Warrant, at a total purchase price not to exceed that payable upon the exercise of the unexercised portion of this Warrant, and in lieu of the shares of Common Stock theretofore issuable upon exercise of this Warrant, the kind and amount of shares of stock, other securities, money and property receivable upon such reclassification, change or merger by a holder of the number of shares of Common Stock then purchasable under this Warrant. Such new Warrant shall provide for adjustments that shall be as nearly equivalent as may be practicable to the adjustments provided for in this Section 4. The provisions of this subparagraph (a) shall similarly apply to successive reclassifications, changes, mergers and transfers.

          (b) Subdivision or Combination of Shares. If the Company at any time while this Warrant remains outstanding and unexpired shall subdivide or combine its outstanding shares of Common Stock, the Warrant Price shall be proportionately decreased and the number of Shares issuable hereunder shall be proportionately increased in the case of a subdivision or

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and the Warrant Price shall be proportionately increased and the number of Shares issuable hereunder shall be proportionately decreased in the case of a combination.

          (c) Stock Dividends and Other Distributions. If the Company at any time while this Warrant is outstanding and unexpired shall (i) pay a dividend with respect to its Common Stock payable in Common Stock, then the Warrant Price shall be adjusted, from and after the date of determination of shareholders entitled to receive such dividend or distribution, to that price determined by multiplying the Warrant Price in effect immediately prior to such date of determination by a fraction (A) the numerator of which shall be the total number of shares of Common Stock outstanding immediately prior to such dividend or distribution, and (B) the denominator of which shall be the total number of shares of Common Stock outstanding immediately after such dividend or distribution; or (ii) make any other distribution with respect to Common Stock (except any distribution specifically provided for in Sections 4(a) and 4(b)), then, in each such case, provision shall be made by the Company such that the holder of this Warrant shall receive upon exercise of this Warrant a proportionate share of any such dividend or distribution as though it were the holder of the Shares as of the record date fixed for the determination of the shareholders of the Company entitled to receive such dividend or distribution.

          (d) Certain Issuances of Securities. Except as expressly provided in Sections 4(a) through (c) hereof, if after the date hereof the Company issues any Additional Stock (as defined below) for no consideration or for a consideration per share less than the Warrant Price in effect immediately prior to the time of such issuance, then the Warrant Price shall be reduced to the price determined by dividing:

               (i) an amount equal to the sum of (x) the number of shares of Common Stock outstanding immediately prior to such issuance or sale multiplied by the then existing Warrant Price, and (y) an amount equal to the aggregate “consideration actually received” (as defined below) by the Company upon such issuance or sale, by

               (ii) the number of shares of Common Stock outstanding immediately after such issuance or sale.

For purposes of adjusting the Warrant Price pursuant to this Section 4(d):

                    (A) The term “Additional Stock” shall mean any Common Stock, Convertible Securities (as defined below) or Options (as defined below) issued by the Company after the Commencement Date, other than (1) Common Stock issuable upon the conversion of Convertible Securities issued by the Company on or before the Commencement Date; (2) Options issued by the Company to any of its officers, directors, employees, consultants or agents after the Commencement Date pursuant to any compensation or benefit plan approved by the Board or, if not pursuant to such a plan, then pursuant to any other resolution of the Company’s Board of Directors (the “Board”), or the Common Stock issuable upon exercise of such Options; (3) Common Stock issued in connection with the purchase of assets or businesses, whether by merger, consolidation, purchase of assets or stock or otherwise; (4) shares of the Company’s Preferred Stock, warrants or shares of Common Stock issuable upon conversion or exercise of such Preferred Stock or warrants issued or issuable in accordance with the terms of that certain Securities Purchase Agreement dated December 19, 2002 (the “December Purchase

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Agreement”); (5) any shares of Common Stock, Convertible Securities or Options issued at any time to Sun Microsystems, Inc. and any shares of Common Stock issued in connection with the exercise of such Convertible Securities or Options; (6) securities issued in connection with a merger, consolidation, acquisition, strategic transaction, licensing arrangement, business partnership or joint venture approved by the Board; or (7) securities issued pursuant to any equipment loan or leasing arrangement, real property leasing arrangement, commercial credit arrangement or debt financing from a bank or similar financial institution approved by the Board. As used herein, the term “Option” means any right, warrant, or option to subscribe for or purchase shares of Common Stock or Convertible Securities, and the term “Convertible Securities” means evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable for, with or without payment of additional consideration, shares of Common Stock.

                    (B) In the case of an issuance or sale for cash of shares of Common Stock, the “consideration actually received” by the Company therefor shall be deemed to be the amount of cash received, before deducting therefrom any commissions or expenses paid by the Company in connection with such issuance.

                    (C) In the case of the issuance (other than upon conversion or exchange of obligations or shares of stock of the Company) of shares of Common Stock for a consideration other than cash or a consideration partly other than cash, the amount of the non-cash “consideration actually received” by the Company shall be deemed to be the fair market value of such consideration as determined in good faith by the Board.

                    (D) In the case of the issuance by the Company in any manner of Options, all shares of Common Stock or Convertible Securities to which the holders of such Options shall be entitled to subscribe for or purchase pursuant to such Options shall be deemed issued as of the date of the grant or sale of such Options, and the minimum aggregate consideration named in such Options for the shares of Common Stock or Convertible Securities covered thereby, plus the consideration, if any, received by the Company for such Options, shall be deemed to be the “consideration actually received” by the Company (as of the date of the granting or sale of such Options) for the issuance of such Options.

                    (E) In the case of the issuance by the Company in any matter of Convertible Securities, all shares of Common Stock issuable upon the conversion or exchange of such Convertible Securities shall be deemed issued as of the date such Convertible Securities are issued, and the amount of the “consideration actually received” by the Company for such Convertible Securities shall be deemed to be the sum of (1) the amount of consideration received by the Company upon the issuance of such Convertible Securities, plus (2) the minimum aggregate consideration, if any, other than such Convertible Securities, receivable by the Company upon conversion or exchange of such Convertible Securities, except in adjustment of dividends.

                    (F) The amount of “consideration actually received” by the Company upon the issuance of any Options referred to in subparagraph (D) above or upon the issuance of Convertible Securities as described in subparagraph (E) above, and the amount of the consideration, if any, other than Convertible Securities, receivable by the Company upon exercise, conversion, or exchange thereof shall be determined in the same manner provided in

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subparagraphs (B) and (C) above with respect to the consideration received by the Company in the case of the issuance of additional shares of Common Stock; provided, however, that if such Convertible Securities are issued in payment or satisfaction of any dividend upon any stock of the Company other than Common Stock, the amount of the “consideration actually received” by the Company upon the original issuance of such Convertible Securities shall be deemed to be the value of such obligations or shares of stock, as of the date of the adoption of the resolution declaring such dividend, as reasonably determined in good faith by the Board at or as of that date.

                    (G) On the expiration of any Options referred to in subparagraph (D) above, or the termination of any right of conversion with respect to Convertible Securities referred to in subparagraph (E) above, or any change in the number of shares of Common Stock deliverable upon the exercise of such Options or upon conversion or exchange of such Convertible Securities, the Warrant Price then in effect shall be adjusted to such Warrant Price as would have been obtained had the adjustments made upon the issuance of such Options or Convertible Securities been made upon the basis of the delivery of the adjusted number of shares of Common Stock actually delivered or to be delivered upon the exercise of such Options or upon the conversion or exchange of such Convertible Securities.

          (e) Adjustment of Number of Shares. Upon each adjustment in the Warrant Price, the number of Shares purchasable hereunder shall be adjusted, to the nearest whole share, to the product obtained by multiplying the number of Shares purchasable immediately prior to such adjustment in the Warrant Price by a fraction, the numerator of which shall be the Warrant Price immediately prior to such adjustment and the denominator of which shall be the Warrant Price immediately thereafter.

          (f) Notwithstanding anything to the contrary herein, this Warrant shall not be exercisable for any shares of Common Stock issued to the Preferred Investors as a result of adjustments made pursuant to provisions applicable to the Preferred Investors having a similar effect to those set forth in this Section 4. For purposes of clarification, this Section 4(f) is intended to avoid any circumstances whereby this Warrant could become exercisable for shares of Common Stock exceeding five percent (5%) of the shares of Common Stock issued to the Preferred Investors.

5. Notice of Adjustments. Whenever the Warrant Price or the number of Shares purchasable hereunder shall be adjusted pursuant to Section 4 hereof, the Company shall make a certificate signed by its chief financial officer setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the Warrant Price and the number of Shares purchasable hereunder after giving effect to such adjustment, and shall cause copies of such certificate to be mailed (without regard to Section 13 hereof, by first class mail, postage prepaid) to the holder of this Warrant at such holder’s last known address.

6. Fractional Shares. No fractional shares of Common Stock will be issued in connection with any exercise hereunder, but in lieu of such fractional shares the Company shall make a cash payment therefor based on the fair market value of the Common Stock on the date of exercise as reasonably determined in good faith by the Board.

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7. Compliance with Securities Act; Disposition of Warrant or Shares of Common Stock.

          (a) Compliance with Securities Act. The holder of this Warrant, by acceptance hereof, agrees that this Warrant, and the Shares to be issued upon exercise hereof are being acquired for investment and that such holder will not offer, sell or otherwise dispose of this Warrant, or any Shares except under circumstances which will not result in a violation of the Securities Act of 1933, as amended (the “Act”) or any applicable state securities laws. Upon exercise of this Warrant, unless the Shares being acquired are registered under the Act and any applicable state securities laws or an exemption from such registration is available, the holder hereof shall confirm in writing that the Shares so purchased are being acquired for investment and not with a view toward distribution or resale in violation of the Act and shall confirm such other matters related thereto as may be reasonably requested by the Company. This Warrant and all Shares issued upon exercise of this Warrant (unless registered under the Act and any applicable state securities laws) shall be stamped or imprinted with a legend in substantially the following form:

“THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAWS. NO SALE OR DISPOSITION MAY BE EFFECTED WITHOUT (i) EFFECTIVE REGISTRATION STATEMENTS RELATED THERETO, (ii) AN OPINION OF COUNSEL OR OTHER EVIDENCE, REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATIONS ARE NOT REQUIRED, (iii) RECEIPT OF NOACTION LETTERS FROM THE APPROPRIATE GOVERNMENTAL AUTHORITIES, OR (iv) OTHERWISE COMPLYING WITH THE PROVISIONS OF SECTION 7 OF THE WARRANT UNDER WHICH THESE SECURITIES WERE ISSUED, DIRECTLY OR INDIRECTLY.”

Said legend shall be removed by the Company, upon the request of a holder, at such time as the restrictions on the transfer of the applicable security shall have terminated. In addition, in connection with the issuance of this Warrant, the holder specifically represents to the Company by acceptance of this Warrant as follows:

                    (1) The holder is aware of the Company’s business affairs and financial condition, and has acquired information about the Company sufficient to reach an informed and knowledgeable decision to acquire this Warrant. The holder is acquiring this Warrant for its own account for investment purposes only and not with a view to, or for the resale in connection with, any “distribution” thereof in violation of the Act.

                    (2) The holder understands that this Warrant has not been registered under the Act in reliance upon a specific exemption therefrom, which exemption depends upon, among other things, the bona fide nature of the holder’s investment intent as expressed herein.

                    (3) The holder further understands that this Warrant must be held indefinitely unless subsequently registered under the Act and qualified under any applicable state securities laws, or unless exemptions from registration and qualification are otherwise available. The holder is aware of the provisions of Rule 144, promulgated under the Act.

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                    (4) The holder is an “accredited investor” as such term is defined in Rule 501 of Regulation D promulgated under the Act.

          (b) Disposition of Warrant or Shares. With respect to any offer, sale or other disposition, in whole or in part, of this Warrant or of any Shares acquired pursuant to the exercise of this Warrant prior to registration of such Warrant or Shares, the holder hereof agrees to give written notice to the Company prior thereto, describing briefly the manner thereof, together with a written opinion of such holder’s counsel, or other evidence, if reasonably satisfactory to the Company, to the effect that such offer, sale or other disposition may be effected without registration or qualification (under the Act as then in effect or any federal or state securities law then in effect) of this Warrant , the Shares or any portion thereof and indicating whether or not under the Act certificates for this Warrant, the Shares or any portion thereof to be sold or otherwise disposed of require any restrictive legend as to applicable restrictions on transferability in order to ensure compliance with such law. Upon receiving such written notice and reasonably satisfactory opinion or other evidence, the Company, as promptly as practicable but no later than fifteen (15) days after receipt of the written notice, shall take such steps as necessary for such holder to sell or otherwise dispose of this Warrant, such Shares or any portion thereof, all in accordance with the terms of the notice delivered to the Company. If a determination has been made pursuant to this Section 7(b) that the opinion of counsel for the holder or other evidence is not reasonably satisfactory to the Company, the Company shall so notify the holder promptly with details thereof after such determination has been made. Notwithstanding the foregoing, this Warrant, such Shares or any portion thereof, may, as to such federal laws, be offered, sold or otherwise disposed of in accordance with Rule 144 or 144A under the Act, provided that the Company shall have been furnished with such information as the Company may reasonably request to provide a reasonable assurance that the provisions of Rule 144 or 144A have been satisfied. Each certificate representing this Warrant, the Shares or any portion thereof thus transferred (except a transfer pursuant to Rule 144 or 144A) shall bear a legend as to the applicable restrictions on transferability in order to ensure compliance with such laws, unless in the aforesaid opinion of counsel for the holder, such legend is not required in order to ensure compliance with such laws. The Company may issue stop transfer instructions to its transfer agent in connection with such restrictions.

          (c) Applicability of Restrictions. Neither any restrictions of any legend described in this Warrant nor the requirements of Section 7(b) above shall apply to any transfer or grant of a security interest in, this Warrant (or the Common Stock obtainable upon exercise thereof) or any part hereof (i) to a partner of the holder if the holder is a partnership or to a member of the holder if the holder is a limited liability company, (ii) to a partnership of which the holder is a partner or a limited liability company of which the holder is a member, or (iii) to any affiliate of the holder if the holder is a corporation; provided, however, in any such transfer, if applicable, the transferee shall on the Company’s request agree in writing to be bound by the terms of this Warrant as if an original holder hereof.

8. Rights as Shareholders; Information. No holder of this Warrant, as such, shall be entitled to vote or receive dividends or be deemed the holder of Common Stock or any other securities which may at any time be issuable upon the exercise hereof for any purpose, nor shall anything contained herein be construed to confer upon the holder of this Warrant, as such, any of the rights of a shareholder of the Company or any right to vote for the election of directors or upon any matter submitted to shareholders at any meeting thereof, or to receive notice of meetings, or

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to receive dividends or subscription rights or otherwise until this Warrant shall have been exercised and the Shares purchasable upon the exercise hereof shall have become deliverable, as provided herein. Notwithstanding the foregoing, the Company will transmit to the holder of this Warrant such information, documents and reports as are generally distributed to the holders of any class or series of the securities of the Company concurrently with the distribution thereof to the shareholders.

9. Registration Rights.

          (a) Registration.

               (i) On or before the date six months after the Date of Grant, the Company shall , prepare and file with the Securities and Exchange Commission (“SEC”) a registration statement under Rule 415 of the Act to register the resale of the Common Stock issuable upon exercise of this Warrant (the “Registrable Shares”) and shall thereafter use all reasonable efforts to cause such registration statement to become effective as promptly as practicable.

               (ii) The Company shall, until the date 30 months after the Date of Grant, keep such registration statement for the Registrable Shares in effect and current and from time to time amend or supplement the registration statement and the prospectus in connection therewith in compliance with the Act to permit the sale or distribution of the Registrable Shares with respect to which such registration statement shall have become effective. If at any time the SEC should institute or threaten to institute any proceedings for the purpose of issuing, or should issue a stop order suspending the effectiveness of any such registration statement, the Company will promptly notify the holder of this Warrant (which term shall include any holder of the Shares) and will use its reasonable best efforts to prevent the issuance of any such stop order or to obtain the withdrawal thereof as soon as possible. The Company will advise the holder of this Warrant promptly of any order or communication of any public board or body addressed to the Company suspending or threatening to suspend the registration or qualification of any of the Registrable Shares for sale in any jurisdiction.

               (iii) The holder of this Warrant agrees, by acceptance of this Warrant, that, upon receipt of any notice from the Company of (A) the happening of any event which makes any statements made in the registration statement or related prospectus filed pursuant to this Section 9, or any document incorporated or deemed to be incorporated therein by reference, untrue in any material respect or which requires the making of any changes in such registration statement or prospectus so that, in the case of such registration statement, it will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, and that in the case of the prospectus, it will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading or (B) that, in the judgment of the Board, it is advisable to suspend use of the prospectus for a discrete period of time due to pending corporate developments, public filings with the SEC or similar events, the holder will forthwith discontinue, for a period not to exceed sixty (60) days, disposition of such Registrable Shares covered by such registration statement or prospectus until it is advised in writing by the Company that use of the applicable prospectus may be resumed, and has received copies of any

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additional or supplemented filings that are incorporated or deemed to be incorporated by reference in such prospectus. The Company shall use all reasonable efforts to insure that the use of the prospectus may be resumed as soon as practicable, and in any event shall not be entitled to require the holder to suspend use of any prospectus for more than ninety (90) days in any twelve month period.

          (b) Company Obligations. Whenever any Registrable Shares become subject to a registration statement pursuant to this Section 9, the Company shall:

               (i) Promptly notify the holder of this Warrant and confirm such advice in writing (i) when such registration statement becomes effective, (ii) when any post-effective amendment to any such registration statement becomes effective and (iii) of any request by the SEC for any amendment or supplement to such registration statement or any prospectus relating thereto or for additional information;

               (ii) Furnish to the holder of this Warrant such number of copies of any registration statement or any amendment or supplement thereto, and any prospectus (including any preliminary prospectus) contained therein in conformity with the requirements of the Act as the holder of this Warrant may reasonably request in order to effect the offering and sale of the Registrable Shares being offered and sold by the holder of this Warrant, but only while the Company is required under the provisions hereof to cause the registration statement to remain current;

               (iii) Use its reasonable best efforts to register or qualify not later than the effective date of such registration statement the Registrable Shares registered thereunder under the “blue sky” laws of such states as the holder of this Warrant may reasonably request; provided, however, that the Company shall not be obligated to qualify as a foreign corporation or as a dealer in securities or to execute or file any general consent to service of process under the laws of any such state where it is not at such time so qualified or subject;

               (iv) Immediately notify the holder of this Warrant, at any time when a prospectus relating to a sale of Registrable Shares is required by law to be delivered in connection with sales thereof, of the occurrence of an event requiring the preparation of a supplement or amendment to such prospectus so that, as thereafter delivered to the purchasers of such Registrable Shares, such prospectus will not contain an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading and promptly make available to the holder of this Warrant and to the underwriters any such amendment or supplement;

               (v) The Company and the holder of this Warrant will enter into customary agreements (including an underwriting or indemnity agreement in customary form) and take such other actions as are reasonably required in order to expedite or facilitate the sale of the Registrable Shares;

               (vi) In the event of an underwritten offering (in the Company’s sole discretion), the Company will use its reasonable best efforts to cause to be furnished to the holder of this Warrant a signed counterpart, addressed to the holder of this Warrant or such

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underwriter, of (i) an opinion or opinions of counsel to the Company and (ii) a comfort letter or comfort letters from the Company’s independent accountants, each in customary form and covering such matters of the type customarily covered by opinions or comfort letters as the case may be, as the holder of this Warrant reasonably requests;

               (vii) In the event of an underwritten offering (in the Company’s sole discretion), the Company will make generally available to its security holders, as soon as reasonably practicable, an earnings statement covering the period of twelve months, beginning within three months after the effective date of the registration statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Act; and

               (viii) The Company will use its reasonably best efforts to cause all Common Stock to be listed on each securities exchange (or the Nasdaq National Market System) on which similar securities issued by the Company are then listed.

          (c) Expenses. The Company shall bear the out-of-pocket costs and expenses incurred in connection with any registration pursuant to this Section 9. The costs and expenses of any such registration shall include, without limitation, the reasonable fees and expenses of the Company’s counsel and its accountants and all other out-of-pocket costs and expenses of the Company incident to the preparation, printing and filing under the Act of the registration statement and all amendments and supplements thereto and the cost of furnishing copies of each preliminary prospectus, each final prospectus and each amendment or supplement thereto to underwriters, dealers and other purchasers of the securities so registered, the costs and expenses incurred in connection with the qualification of such securities so registered under the “blue sky” laws of various jurisdictions, the fees and expenses of the Company’s transfer agent and all other costs and expenses of complying with the foregoing provisions of this Section 9. The holder of this Warrant shall pay any underwriting fees, discounts or commissions attributable to the sale of Registrable Shares. The Company shall pay internal Company expenses (including, without limitation, all salaries and expenses of its officers and employees performing legal or accounting duties).

          (d) Indemnification.

               (i) In the case of any offering registered pursuant to Section 9(a), the Company hereby indemnifies and agrees to hold harmless the holder of this Warrant (or the Registrable Shares) and each person, if any, who controls the holder of this Warrant (or the Registrable Shares) within the meaning of either Section 15 of the Act or Section 20 of the Securities and Exchange Act of 1934, as amended. (the “Exchange Act”) from and against any losses, claims, damages or liabilities, joint or several, to which any such persons may be subject, under the Act, the Exchange Act or otherwise, and to reimburse any of such persons for any legal or other expenses reasonably incurred by them in connection with investigating any claims or defending against any actions, insofar as such losses, claims, damages or liabilities arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the registration statement under which such Registrable Shares were registered under the Act pursuant to this Section 9, any prospectus (including any preliminary prospectus) contained therein, if used during the period appropriate for such prospectus, or any amendment or supplement thereto, or the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in

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which they were made, not misleading; provided that the indemnification agreement contained in this Section 9(d)(i) shall not apply to such losses, claims, damages or liabilities which shall arise out of the sale of Registrable Shares to any person to the extent such losses, claims, damages or liabilities arise out of or are based upon any such untrue statement or omission or alleged untrue statement or omission if such statement or omission shall have been made (A) in reliance upon information furnished to the Company in writing by the holder of this Warrant specifically for use therein, or (B) in any preliminary prospectus, and the prospectus contained in the registration statement as declared effective or in the form filed by the Company with the SEC pursuant to Rule 424 under the Act corrected such statement or omission and a copy of such final prospectus shall not have been sent or otherwise delivered to such person at or prior to the confirmation of such sale to such person or to the holder of this Warrant for delivery to such person. The Company also agrees to indemnify the underwriters (as defined in the Act) of the Registrable Shares, their officers and directors and each person who controls such underwriters on substantially the same basis as that of the indemnification of the holder of this Warrant provided in this Section 9(d)(i).

               (ii) By acceptance of this Warrant, the holder of this Warrant agrees, in the same manner and to the same extent as set forth in the preceding paragraph, to indemnify and to hold harmless the Company and its directors and officers against any losses, claims, damages or liabilities, joint or several, to which any of such persons may be subject under the Act or otherwise, and to reimburse any of such persons for any legal or other expenses incurred in connection with investigating or defending against any such losses, claims, damages or liabilities, but only to the extent it arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission of a material fact in any registration statement under which the Registrable Shares were registered under the Act pursuant to this Section 9, any prospectus contained therein, or any amendment or supplement thereto, which was based upon and made in conformity with information furnished to the Company in writing by the holder of this Warrant expressly for use therein. The holder of this Warrant also agrees to indemnify and hold harmless any underwriter (as defined in the Act) of the Registrable Shares, its officers and directors and each person who controls such underwriter on substantially the same basis as that of the indemnification of the Company provided in this Section 9(d)(ii). Provided however, that the obligations of the holder of this Warrant hereunder shall be limited to an amount equal to the net proceeds after expenses and commissions to such holder of Registrable Shares sold as contemplated herein.

               (iii) Each party indemnified under this Section 9 shall, promptly after receipt of notice of the commencement of any action against such indemnified party in respect of which indemnity may be sought, notify the indemnifying party in writing of the commencement thereof. The omission of any indemnified party so to notify an indemnifying party of any such action shall not relieve the indemnifying party from any liability in respect of such action which it may have to such indemnified party on account of the indemnity agreement contained in this Section 9, unless the indemnifying party was materially prejudiced by such omission, and in no event shall relieve the indemnifying party from any other liability which it may have to such indemnified party. In case any such action shall be brought against any indemnified party and it shall notify an indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to the indemnified party. In any such action, any indemnified party shall have the

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right to retain its own counsel, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (A) the indemnifying party and the indemnified party shall have mutually agreed to the retention of such counsel or (B) the named parties to any such action (including any impleaded parties) include both the indemnified party and the indemnifying party and representation of both parties by the same counsel would be inappropriate due to actual or potential differing interests between them. It is understood that the indemnifying party shall not, in connection with any proceeding in the same jurisdiction, be liable for the fees and expenses of more than one separate firm of attorneys (in addition to any local counsel) at any time for all such indemnified parties, and that all such fees and expenses shall be reimbursed as they are incurred.

               (iv) If the indemnification provided for in this Section 9 as between the holder of this Warrant and the Company is unavailable to the holder of this Warrant and each person, if any, who controls the holder of this Warrant within the meaning of either Section 15 of the Act or Section 20 of the Exchange Act or to the Company in respect of any losses, claims, damages or liabilities referred to herein, then each indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities in such proportion as is appropriate to reflect the relative fault of the Company and of the holder of this Warrant in connection with such statements or omissions, as well as other relevant equitable considerations. The relative fault of the Company on the one hand and of the holder of this Warrant on the other shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of material fact or the omission or alleged omission to state a material fact relates to information supplied by such party and the parties’ relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission.

               (v) The Company and holder of this Warrant agree that it would not be just and equitable if contribution pursuant to this Section 9(d)(iv) were determined by pro rata allocation (even if the underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities referred to in the immediately preceding paragraph shall be deemed to include, subject to the limitations set forth above, any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 9(d)(iv), the holder of this Warrant shall not be required to contribute any amount in excess of the amount by which the net proceeds of the offering (before deducting expenses) received by the holder of this Warrant exceeds the amount of any damages which the holder of this Warrant would have or has been required to pay by reason of the relevant fault in connection with such untrue or alleged untrue statement or omission or alleged omission allocated to the holder of this Warrant. Notwithstanding the foregoing, the obligations of the holder of this Warrant hereunder shall be limited to an amount equal to the net proceeds after expenses and commissions to such holder of Registrable Shares sold as contemplated herein. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation.

10. Additional Rights.

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10.1 Mergers. The Company shall provide the holder of this Warrant with at least twenty (20) days’ written notice prior to the closing thereof of the terms and conditions of any of the following transactions (an “Acquisition”): (i) the sale, lease, exchange, conveyance or other disposition of all or substantially all of the Company’s property or business, or (ii) its merger into or consolidation with any other corporation (other than a wholly-owned subsidiary of the Company), or any transaction (including a merger or other reorganization) or series of related transactions, in which more than 50% of the voting power of the Company is disposed of. In the event of an Acquisition, the purchase rights represented by this Warrant shall be fully exercisable.

10.2 Right to Convert Warrant into Stock: Net Issuance.

          (a) Right to Convert. In addition to and without limiting the rights of the holder under the terms of this Warrant, if at any time after the date one year from the Date of Grant there is no effective registration statement registering the resale of the Shares by the holder, then, the holder shall have the right to convert this Warrant or any portion thereof (the “Conversion Right”) into shares of Common Stock as provided in this Section 10.2 at any time or from time to time the number of shares of Common Stock for which this Warrant is exercisable pursuant to Section 1 and 10.1 above, during the term of this Warrant. Upon exercise of the Conversion Right with respect to a particular number of shares subject to this Warrant (the “Converted Warrant Shares”), the Company shall deliver to the holder (without payment by the holder of any Warrant Price or any cash or other consideration) that number of shares of fully paid and nonassessable Common Stock as is determined according to the following formula:

X = B — A   Y

Where:	X =	the number of shares of Common Stock that may be issued to the holder
	Y =	the fair market value of one share of Common Stock
	A =	the aggregate Warrant Price of the specified number of Converted Warrant Shares immediately prior to the exercise of the Conversion Right (i.e., the number of Converted Warrant Shares multiplied by the Warrant Price)
	B =	the aggregate fair market value of the specified number of converted Warrant Shares (i.e., the number of Converted Warrant Shares multiplied by the fair market value of one Converted Warrant Shares)

No fractional shares shall be issuable upon exercise of the Conversion Right, and, if the number of shares to be issued determined in accordance with the foregoing formula is other than a whole number, the Company shall pay to the holder an amount in cash equal to the fair market value of the resulting fractional share on the Conversion Date (as hereinafter defined). For purposes of Section 9 of this Warrant, shares issued pursuant to the Conversion Right shall be treated as if they were issued upon the exercise of this Warrant.

          (b) Method of Exercise. The Conversion Right may be exercised by the holder by delivery of written notice in the form of Exhibit A-1 or Exhibit A-2 hereto specifying

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that the holder thereby intends to exercise the Conversion Right and indicating the number of shares subject to this Warrant which are being surrendered (referred to in Section 10.2(a) hereof as the Converted Warrant Shares) in exercise of the Conversion Right. Such conversion shall be effective upon receipt by the Company of the aforesaid written notice, or on such later date as is specified therein (the “Conversion Date”), and, at the election of the holder hereof, may be made contingent upon the closing of the sale of the Company’s Common Stock to the public in a public offering pursuant to a Registration Statement under the Act (a “Public Offering”). Certificates for the shares issuable upon exercise of the Conversion Right shall be issued as of the Conversion Date and shall be delivered to the holder within thirty (30) days following the Conversion Date.

          (c) Determination of Fair Market Value. For purposes of this Section 10.2, “fair market value” of a share of Common Stock as of a particular date (the “Determination Date”) shall mean:

               (i) If the Conversion Right is exercised in connection with and contingent upon a Public Offering, and if the Company’s Registration Statement relating to such Public Offering (“Registration Statement”) has been declared effective by the Securities and Exchange Commission, then the initial “Price to Public” specified in the final prospectus with respect to such offering.

               (ii) If the Conversion Right is not exercised in connection with and contingent upon a Public Offering, then as follows:

                    (A) If traded on a securities exchange, the fair market value of the Common Stock shall be deemed to be the average of the closing prices of the Common Stock on such exchange over the five trading days immediately prior to the Determination Date;

                    (B) If traded on the Nasdaq Stock Market or other over-the-counter system, the fair market value of the Common Stock shall be deemed to be the average of the closing bid prices of the Common Stock over the five trading days immediately prior to the Determination Date; and

                    (C) If there is no public market for the Common Stock, then fair market value shall be determined by mutual agreement of the holder of this Warrant and the Company.

If closing prices or closing bid prices are no longer reported by a securities exchange or other trading system, the closing price or closing bid price shall be that which is reported by such securities exchange or other trading system at 4:00 p.m. New York City time on the applicable trading day.

10.3 Exercise Prior to Expiration. To the extent this Warrant is not previously exercised as to all of the Shares subject hereto, and if the fair market value of one share of the Common Stock is greater than the Warrant Price then in effect, this Warrant shall be deemed automatically exercised pursuant to Section 10.2 above (even if not surrendered) immediately before its expiration. For purposes of such automatic exercise, the fair market value of one share of the Series Preferred upon such expiration shall be determined pursuant to Section 10.2(c). To the

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extent this Warrant or any portion thereof is deemed automatically exercised pursuant to this Section 10.3, the Company agrees to promptly notify the holder hereof of the number of Shares, if any, the holder hereof is to receive by reason of such automatic exercise.

11. Representations and Warranties. The Company represents and warrants to the holder of this Warrant as follows:

          (a) This Warrant has been duly authorized and executed by the Company and is a valid and binding obligation of the Company enforceable in accordance with its terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and the rules of law or principles at equity governing specific performance, injunctive relief and other equitable remedies;

          (b) The Shares have been duly authorized and reserved for issuance by the Company and, when issued in accordance with the terms hereof will be validly issued, fully paid and non-assessable;

          (c) The execution and delivery of this Warrant are not, and the issuance of the Shares upon exercise of this Warrant in accordance with the terms hereof will not be, inconsistent with the Company’s Charter or by-laws, do not and will not contravene any law, governmental rule or regulation, judgment or order applicable to the Company, and do not and will not conflict with or contravene any provision of, or constitute a default under, any indenture, mortgage, contract or other instrument of which the Company is a party or by which it is bound or require the consent or approval of, the giving of notice to, the registration or filing with or the taking of any action in respect of or by, any Federal, state or local government authority or agency or other person, except for the filing of notices pursuant to federal and state securities laws, which filings will be effected by the time required thereby; and

          (d) There are no actions, suits, audits, investigations or proceedings pending or, to the knowledge of the Company, threatened against the Company in any court or before any governmental commission, board or authority which, if adversely determined, will have a material adverse effect on the ability of the Company to perform its obligations under this Warrant.

12. Modification and Waiver. This Warrant and any provision hereof may be changed, waived, discharged or terminated only by an instrument in writing signed by the party against which enforcement of the same is sought.

13. Notices. Any notice, request, communication or other document required or permitted to be given or delivered to the holder hereof or the Company shall be delivered, or shall be sent by certified or registered mail, postage prepaid, to each such holder at its address as shown on the books of the Company or to the Company at the address indicated therefor on the signature page of this Warrant.

14. Binding Effect on Successors. This Warrant shall be binding upon any corporation succeeding the Company by merger, consolidation or acquisition of all or substantially all of the Company’s assets, and all of the obligations of the Company relating to the Shares issuable upon the exercise or conversion of this Warrant shall survive the exercise, conversion and termination

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of this Warrant and all of the covenants and agreements of the Company shall inure to the benefit of the successors and assigns of the holder hereof.

15. Lost Warrants or Stock Certificates. The Company covenants to the holder hereof that, upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant or any stock certificate and, in the case of any such loss, theft or destruction, upon receipt of an indemnity reasonably satisfactory to the Company, or in the case of any such mutilation upon surrender and cancellation of such Warrant or stock certificate, the Company will make and deliver a new Warrant or stock certificate, of like tenor, in lieu of the lost, stolen, destroyed or mutilated Warrant or stock certificate.

16. Descriptive Headings. The descriptive headings of the several paragraphs of this Warrant are inserted for convenience only and do not constitute a part of this Warrant. The language in this Warrant shall be construed as to its fair meaning without regard to which party drafted this Warrant.

17. Governing Law. This Warrant shall be construed and enforced in accordance with, and the rights of the parties shall be governed by, the laws of the State of California.

18. Survival of Representations, Warranties and Agreements. All representations and warranties of the Company and the holder hereof contained herein shall survive the Date of Grant, the exercise or conversion of this Warrant (or any part hereof) or the termination or expiration of rights hereunder. All agreements of the Company and the holder hereof contained herein shall survive indefinitely until, by their respective terms, they are no longer operative.

19. Remedies. In case any one or more of the covenants and agreements contained in this Warrant shall have been breached, the holders hereof (in the case of a breach by the Company), or the Company (in the case of a breach by a holder), may proceed to protect and enforce their or its rights either by suit in equity and/or by action at law, including, but not limited to, an action for damages as a result of any such breach and/or an action for specific performance of any such covenant or agreement contained in this Warrant.

20. No Impairment of Rights. The Company will not, by amendment of its Charter or through any other means, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the holder of this Warrant against impairment.

21. Severability. The invalidity or unenforceability of any provision of this Warrant in any jurisdiction shall not affect the validity or enforceability of such provision in any other jurisdiction, or affect any other provision of this Warrant, which shall remain in full force and effect.

22. Recovery of Litigation Costs. If any legal action or other proceeding is brought for the enforcement of this Warrant, or because of an alleged dispute, breach, default, or misrepresentation in connection with any of the provisions of this Warrant, the successful or prevailing party or parties shall be entitled to recover reasonable attorneys’ fees and other costs

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incurred in that action or proceeding, in addition to any other relief to which it or they may be entitled.

[Remainder of page intentionally left blank]

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23. Entire Agreement; Modification. This Warrant constitutes the entire agreement between the parties pertaining to the subject matter contained in it and supersedes all prior and contemporaneous agreements, representations, and undertakings of the parties, whether oral or written, with respect to such subject matter. The Prior Warrant is hereby terminated and of no further force and effect.

DOT HILL SYSTEMS CORP.
By:	/s/ Shad L. Burke
Title: Interim Chief Financial Officer
Address:		2200 Faraday Avenue
		Suite 100
		Carlsbad, California 92008
Date: July 26, 2006

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EXHIBIT A-1

NOTICE OF EXERCISE

To: DOT HILL SYSTEMS CORP. (the “Company”)

1. The undersigned hereby:

q	elects to purchase                     shares of Common Stock of the Company pursuant to the terms of the attached Warrant, and tenders herewith payment of the purchase price of such shares in full, or
q	elects to exercise its net issuance rights pursuant to Section 10.2 of the attached Warrant with respect to                     shares of Common Stock.

2. Please issue a certificate or certificates representing said shares in the name of the undersigned or in such other name or names as are specified below:

(Name)

(Address)

3. The undersigned represents that the aforesaid shares are being acquired for the account of the undersigned for investment and not with a view to, or for resale in connection with, the distribution thereof and that the undersigned has no present intention of distributing or reselling such shares, all except as in compliance with applicable securities laws.

OTA LLC

(Signature)

                                                            
(Date)

EXHIBIT A-2

NOTICE OF EXERCISE

To: DOT HILL SYSTEMS CORP. (the “Company”)

1. Contingent upon and effective immediately prior to the closing (the “Closing”) of the Company’s public offering contemplated by the Registration Statement on Form S, filed                     , 20___, the undersigned hereby:

q	elects to purchase                                 shares of Common Stock of the Company (or such lesser number of shares as may be sold on behalf of the undersigned at the Closing) pursuant to the terms of the attached Warrant, or
q	elects to exercise its net issuance rights pursuant to Section 10.2 of the attached Warrant with respect to                      Shares of Common Stock.

2. Please deliver to the custodian for the selling shareholders a stock certificate representing such shares.

3. The undersigned has instructed the custodian for the selling shareholders to deliver to the Company $                     or, if less, the net proceeds due the undersigned from the sale of shares in the aforesaid public offering. If such net proceeds are less than the purchase price for such shares, the undersigned agrees to deliver the difference to the Company prior to the Closing.

OTA LLC

(Name)

(Address)

                                                            
(Date)

EX-10.3

EXHIBIT 10.3

FIRST AMENDMENT TO CREDIT AGREEMENT

     THIS AMENDMENT TO CREDIT AGREEMENT (this “Amendment”) is entered into as of July 1, 2006, by and between DOT HILL SYSTEMS CORP., a Delaware corporation (“Borrower”), and WELLS FARGO BANK, NATIONAL ASSOCIATION (“Bank”).

RECITALS

     WHEREAS, Borrower is currently indebted to Bank pursuant to the terms and conditions of that certain Credit Agreement between Borrower and Bank dated as of July 1, 2004, as amended from time to time (“Credit Agreement”).

     WHEREAS, Bank and Borrower have agreed to certain changes in the terms and conditions set forth in the Credit Agreement and have agreed to amend the Credit Agreement to reflect said changes.

     NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree that the Credit Agreement shall be amended as follows:

     1. Section 1.1.(a) is hereby amended by deleting “July 1, 2006” as the last day on which Bank will make advances under the Line of Credit, and by substituting for said date “July 1, 2007,” with such change to be effective upon the execution and delivery to Bank of a promissory note dated as of July 1, 2006 (which promissory note shall replace and be deemed the Line of Credit Note defined in and made pursuant to the Credit Agreement) and all other contracts, instruments and documents required by Bank to evidence such change.

     2. The first sentence of Section 1.2.(a) is hereby deleted in its entirety, and the following substituted therefor:

     “Subject to the terms and conditions of this Agreement, Bank hereby agrees to make available to Borrower a facility (the “Foreign Exchange Facility”) under which Bank, from time to time up to and including July 1, 2007, will enter into foreign exchange contracts for the account of Borrower for the purchase and/or sale by Borrower in United States dollars of foreign currencies designated by Borrower; provided however, that the maximum amount of all outstanding foreign exchange contracts shall not at any time exceed an aggregate of Five Million United States Dollars (US$5,000,000.00).”

     3. The following is hereby added to the Credit Agreement as Section 5.4:

     “SECTION 5.4. CAPITAL EXPENDITURES. Make any additional investment in fixed assets in any fiscal year in excess of an aggregate of $1,000,000.00.”

     4. Section 7.2 is hereby amended by deleting the reference to “6305 El Camino Real, Carlsbad, CA 92009” as the Borrowers address, and by substituting in its place “2200 Faraday, Suite 100, Carlsbad, CA 92008.”

1.

     5. Except as specifically provided herein, all terms and conditions of the Credit Agreement remain in full force and effect, without waiver or modification. All terms defined in the Credit Agreement shall have the same meaning when used in this Amendment. This Amendment and the Credit Agreement shall be read together, as one document.

     6. Borrower hereby remakes all representations and warranties contained in the Credit Agreement and reaffirms all covenants set forth therein. Borrower further certifies that as of the date of this Amendment there exists no Event of Default as defined in the Credit Agreement, nor any condition, act or event which with the giving of notice or the passage of time or both would constitute any such Event of Default.

     IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the day and year first written above.

		WELLS FARGO BANK,
DOT HILL SYSTEMS CORP.		NATIONAL ASSOCIATION
By:	/s/ Dana Kammersgard	By:	/s/ Brian P. Chambers
	Dana Kammersgard		Brian P. Chambers
	Chief Executive Officer		Vice President
By:	/s/ Shad Burke
	Shad Burke
	Chief Financial Officer

2.

EX-10.4

EXHIBIT 10.4

SECOND AMENDMENT TO CREDIT AGREEMENT

     THIS AMENDMENT TO CREDIT AGREEMENT (this “Amendment”) is entered into as of September 14, 2006, by and between DOT HILL SYSTEMS CORP., a Delaware corporation (“Borrower”), and WELLS FARGO BANK, NATIONAL ASSOCIATION (“Bank”).

RECITALS

     WHEREAS, Borrower is currently indebted to Bank pursuant to the terms and conditions of that certain Credit Agreement between Borrower and Bank dated as of July 1, 2004, as amended from time to time (“Credit Agreement”).

     WHEREAS, Bank and Borrower have agreed to certain changes in the terms and conditions set forth in the Credit Agreement and have agreed to amend the Credit Agreement to reflect said changes.

     NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree that the Credit Agreement shall be amended as follows:

     1. Section 5.4. is hereby deleted in its entirety, and the following substituted therefor:

     “SECTION 5.4. CAPITAL EXPENDITURES. Make any additional investment in fixed assets in any fiscal year in excess of an aggregate of $10,000,000.00.”

     2. Except as specifically provided herein, all terms and conditions of the Credit Agreement remain in full force and effect, without waiver or modification. All terms defined in the Credit Agreement shall have the same meaning when used in this Amendment. This Amendment and the Credit Agreement shall be read together, as one document.

     3. Borrower hereby remakes all representations and warranties contained in the Credit Agreement and reaffirms all covenants set forth therein. Borrower further certifies that as of the date of this Amendment there exists no Event of Default as defined in the Credit Agreement, nor any condition, act or event which with the giving of notice or the passage of time or both would constitute any such Event of Default.

1.

     IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the day and year first written above.

		WELLS FARGO BANK,
DOT HILL SYSTEMS CORP.		NATIONAL ASSOCIATION
By:	/s/ Dana Kammersgard	By:	/s/ Brian P. Chambers
	Dana Kammersgard		Brian P. Chambers
	Chief Executive Officer		Vice President
By:	/s/ Shad Burke
	Shad Burke
	Chief Financial Officer

2.

EX-10.5

EXHIBIT 10.5

WELLS FARGO	REVOLVING LINE OF CREDIT NOTE
$30,000,000.00	San Diego, California
	July 1, 2006

FOR VALUE RECEIVED, the undersigned Dot Hill Systems Corp. (“Borrower”) promises to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION (“Bank”) at its office at San Diego RCBO, 401 B Street, Suite #2201, San Diego, CA 92101, or at such other place as the holder hereof may designate, in lawful money of the United States of America and in immediately available funds, the principal sum of $30,000,000.00, or so much thereof as may be advanced and be outstanding, with interest thereon, to be computed on each advance from the date of its disbursement as set forth herein.

1. DEFINITIONS:

     As used herein, the following terms shall have the meanings set forth after each, and any other term defined in this Note shall have the meaning set forth at the place defined:

1.1 “Business Day” means any day except a Saturday, Sunday or any other day on which commercial banks in California are authorized or required by law to close.

1.2 “Fixed Rate Term” means a period commencing on a Business Day and continuing for 1, 2, 3, 6 or 12 months, as designated by Borrower, during which all or a portion of the outstanding principal balance of this Note bears interest determined in relation to LIBOR; provided however, that no Fixed Rate Term may be selected for a principal amount less than $100,000.00; and provided further, that no Fixed Rate Term shall extend beyond the scheduled maturity date hereof. If any Fixed Rate Term would end on a day which is not a Business Day, then such Fixed Rate Term shall be extended to the next succeeding Business Day.

1.3 “LIBOR” means the rate per annum (rounded upward, if necessary, to the nearest whole 1/8 of 1%) determined by dividing Base LIBOR by a percentage equal to 100% less any LIBOR Reserve Percentage.

(a) “Base LIBOR” means the rate per annum for United States dollar deposits quoted by Bank as the Inter-Bank Market Offered Rate, with the understanding that such rate is quoted by Bank for the purpose of calculating effective rates of interest for loans making reference thereto, on the first day of a Fixed Rate Term for delivery of funds on said date for a period of time approximately equal to the number of days in such Fixed Rate Term and in an amount approximately equal to the principal amount to which such Fixed Rate Term applies. Borrower understands and agrees that Bank may base its quotation of the Inter-Bank Market Offered Rate upon such offers or other market indicators of the Inter-Bank Market as Bank in its discretion deems appropriate including, but not limited to, the rate offered for U.S. dollar deposits on the London Inter-Bank Market.

(b) “LIBOR Reserve Percentage” means the reserve percentage prescribed by the Board of Governors of the Federal Reserve System (or any successor) for “Eurocurrency Liabilities” (as defined in Regulation D of the Federal Reserve Board, as amended), adjusted by Bank for expected changes in such reserve percentage during the applicable Fixed Rate Term.

1.

1.4 “Prime Rate” means at any time the rate of interest most recently announced within Bank at its principal office as its Prime Rate, with the understanding that the Prime Rate is one of Bank’s base rates and serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto, and is evidenced by the recording thereof after its announcement in such internal publication or publications as Bank may designate.

2. INTEREST:

2.1 Interest. The outstanding principal balance of this Note shall bear interest (computed on the basis of a 360-day year, actual days elapsed) either (a) at a fluctuating rate per annum equal to the Prime Rate in effect from time to time, or (b) at a fixed rate per annum determined by Bank to be 0.65000% above LIBOR in effect on the first day of the applicable Fixed Rate Term. When interest is determined in relation to the Prime Rate, each change in the rate of interest hereunder shall become effective on the date each Prime Rate change is announced within Bank. With respect to each LIBOR selection option selected hereunder, Bank is hereby authorized to note the date, principal amount, interest rate and Fixed Rate Term applicable thereto and any payments made thereon on Bank’s books and records (either manually or by electronic entry) and/or on any schedule attached to this Note, which notations shall be prima facie evidence of the accuracy of the information noted.

2.2 Selection of Interest Rate Options. At any time any portion of this Note bears interest determined in relation to LIBOR, it may be continued by Borrower at the end of the Fixed Rate Term applicable thereto so that all or a portion thereof bears interest determined in relation to the Prime Rate or to LIBOR for a new Fixed Rate Term designated by Borrower. At any time any portion of this Note bears interest determined in relation to the Prime Rate, Borrower may convert all or a portion thereof so that it bears interest determined in relation to LIBOR for a Fixed Rate Term designated by Borrower. At such time as Borrower requests an advance hereunder or wishes to select a LIBOR option for all or a portion of the outstanding principal balance hereof, and at the end of each Fixed Rate Term, Borrower shall give Bank notice specifying: (a) the interest rate option selected by Borrower; (b) the principal amount subject thereto; and (c) for each LIBOR selection, the length of the applicable Fixed Rate Term. Any such notice may be given by telephone (or such other electronic method as Bank may permit) so long as, with respect to each LIBOR selection, (i) if requested by Bank, Borrower provides to Bank written confirmation thereof not later than 3 Business Days after such notice is given, and (ii) such notice is given to Bank prior to 10:00 a.m. on the first day of the Fixed Rate Term, or at a later time during any Business Day if Bank, at it’s sole option but without obligation to do so, accepts Borrower’s notice and quotes a fixed rate to Borrower. If Borrower does not immediately accept a fixed rate when quoted by Bank, the quoted rate shall expire and any subsequent LIBOR request from Borrower shall be subject to a redetermination by Bank of the applicable fixed rate. If no specific designation of interest is made at the time any advance is requested hereunder or at the end of any Fixed Rate Term, Borrower shall be deemed to have made a Prime Rate interest selection for such advance or the principal amount to which such Fixed Rate Term applied.

2.3 Taxes and Regulatory Costs. Borrower shall pay to Bank immediately upon demand, in addition to any other amounts due or to become due hereunder, any and all (a) withholdings, interest equalization taxes, stamp taxes or other taxes (except income and franchise taxes) imposed by any domestic or foreign governmental authority and related in any manner to LIBOR, and (b) future, supplemental, emergency or other changes in the LIBOR Reserve Percentage, assessment rates imposed by the Federal Deposit Insurance Corporation, or similar requirements or costs imposed by any domestic or foreign governmental authority or resulting from compliance by Bank with any request or directive (whether or not having the force of law) from any central bank or other governmental authority and related in any manner to

2.

LIBOR to the extent they are not included in the calculation of LIBOR. In determining which of the foregoing are attributable to any LIBOR option available to Borrower hereunder, any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower.

2.4 Payment of Interest. Interest accrued on this Note shall be payable on the 1st day of each month, commencing August 1, 2006.

2.5 Default Interest. From and after the maturity date of this Note, or such earlier date as all principal owing hereunder becomes due and payable by acceleration or otherwise, the outstanding principal balance of this Note shall bear interest until paid in full at an increased rate per annum (computed on the basis of a 360-day year, actual days elapsed) equal to 4% above the rate of interest from time to time applicable to this Note.

3. BORROWING AND REPAYMENT:

3.1 Borrowing and Repayment. Borrower may from time to time during the term of this Note borrow, partially or wholly repay its outstanding borrowings, and reborrow, subject to all of the limitations, terms and conditions of this Note and of the Credit Agreement between Borrower and Bank defined below; provided however, that the total outstanding borrowings under this Note shall not at any time exceed the principal amount stated above. The unpaid principal balance of this obligation at any time shall be the total amounts advanced hereunder by the holder hereof less the amount of principal payments made hereon by or for Borrower, which balance may be endorsed hereon from time to time by the holder. The outstanding principal balance of this Note shall be due and payable in full on July 1, 2007.

3.2 Advances. Advances hereunder, to the total amount of the principal sum available hereunder, may be made by the holder at the oral or written request of (a) Dana Kammersgard or Shad Burke, any one acting alone, who are authorized to request advances and direct the disposition of any advances until written notice of the revocation of such authority is received by the holder at the office designated above, or (b) any person, with respect to advances deposited to the credit of any deposit account of Borrower, which advances, when so deposited, shall be conclusively presumed to have been made to or for the benefit of Borrower regardless of the fact that persons other than those authorized to request advances may have authority to draw against such account. The holder shall have no obligation to determine whether any person requesting an advance is or has been authorized by Borrower.

3.3 Application of Payments. Each payment made on this Note shall be credited first, to any interest then due and second, to the outstanding principal balance hereof. All payments credited to principal shall be applied first, to the outstanding principal balance of this Note which bears interest determined in relation to the Prime Rate, if any, and second, to the outstanding principal balance of this Note which bears interest determined in relation to LIBOR, with such payments applied to the oldest Fixed Rate Term first.

4. PREPAYMENT:

4.1 Prime Rate. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to the Prime Rate at any time, in any amount and without penalty.

4.2 LIBOR. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to LIBOR at any time and in the minimum amount of $100,000.00; provided however, that if the outstanding principal balance of such portion of this Note is less than said amount, the minimum prepayment amount shall be the entire outstanding principal

3.

balance thereof. In consideration of Bank providing this prepayment option to Borrower, or if any such portion of this Note shall become due and payable at any time prior to the last day of the Fixed Rate Term applicable thereto by acceleration or otherwise, Borrower shall pay to Bank immediately upon demand a fee which is the sum of the discounted monthly differences for each month from the month of prepayment through the month in which such Fixed Rate Term matures, calculated as follows for each such month:

(a) Determine the amount of interest which would have accrued each month on the amount prepaid at the interest rate applicable to such amount had it remained outstanding until the last day of the Fixed Rate Term applicable thereto.

(b) Subtract from the amount determined in (a) above the amount of interest which would have accrued for the same month on the amount prepaid for the remaining term of such Fixed Rate Term at LIBOR in effect on the date of prepayment for new loans made for such term and in a principal amount equal to the amount prepaid.

(c) If the result obtained in (b) for any month is greater than zero, discount that difference by LIBOR used in (b) above.

Borrower acknowledges that prepayment of such amount may result in Bank incurring additional costs, expenses and/or liabilities, and that it is difficult to ascertain the full extent of such costs, expenses and/or liabilities. Borrower, therefore, agrees to pay the above-described prepayment fee and agrees that said amount represents a reasonable estimate of the prepayment costs, expenses and/or liabilities of Bank. If Borrower fails to pay any prepayment fee when due, the amount of such prepayment fee shall thereafter bear interest until paid at a rate per annum 2.000% above the Prime Rate in effect from time to time (computed on the basis of a 360-day year, actual days elapsed).

5. EVENTS OF DEFAULT:

     This Note is made pursuant to and is subject to the terms and conditions of that certain Credit Agreement between Borrower and Bank dated as of July 1 2004, as amended from time to time (the “Credit Agreement”). Any default in the payment or performance of any obligation under this Note, or any defined event of default under the Credit Agreement, shall constitute an “Event of Default” under this Note.

6. MISCELLANEOUS:

6.1 Remedies. Upon the occurrence of any Event of Default, the holder of this Note, at the holder’s option, may declare all sums of principal and interest outstanding hereunder to be immediately due and payable without presentment, demand, notice of nonperformance, notice of protest, protest or notice of dishonor, all of which are expressly waived by Borrower, and the obligation, if any, of the holder to extend any further credit hereunder shall immediately cease and terminate. Borrower shall pay to the holder immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys’ fees (to include outside counsel fees and all allocated costs of the holder’s in-house counsel), expended or incurred by the holder in connection with the enforcement of the holder’s rights and/or the collection of any amounts which become due to the holder under this Note, and the prosecution or defense of any action in any way related to this Note, including without limitation, any action for declaratory relief, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to Borrower or any other person or entity.

4.

6.2 Obligations Joint and Several. Should more than one person or entity sign this Note as a Borrower, the obligations of each such Borrower shall be joint and several.

6.3 Governing Law. This Note shall be governed by and construed in accordance with the laws of the State of California.

IN WITNESS WHEREOF, the undersigned has executed this Note as of the date first written above.

Dot Hill Systems Corp.

By:	/s/ Dana Kammersgard
	Dana Kammersgard, Chief Executive Officer
By:	/s/ Shad Burke
	Shad Burke, Chief Financial Officer

5.

EX-10.6

EXHIBIT 10.6

SECURITY AGREEMENT: SECURITIES ACCOUNT

     1. GRANT OF SECURITY INTEREST. For valuable consideration, the undersigned DOT HILL SYSTEMS CORP., or any of them (“Debtor”), hereby grants and transfers to WELLS FARGO BANK, NATIONAL ASSOCIATION (“Bank”) a security interest in (a) Debtor’s account no. 10671901 (whether held in Debtor’s name or as a Bank collateral account for the benefit of Debtor), and all replacements or substitutions therefor, including any account resulting from a renumbering or other administrative re-identification thereof (collectively, the “Securities Account”) maintained with Wells Capital Management Incorporated (“Intermediary”), (b) all financial assets credited to the Securities Account, (c) all security entitlements with respect to the financial assets credited to the Securities Account, and (d) any and all other investment property or assets maintained or recorded in the Securities Account (with all the foregoing defined as “Collateral”), together with whatever is receivable or received when any of the Collateral or proceeds thereof are sold, collected, exchanged or otherwise disposed of, whether such disposition is voluntary or involuntary, including without limitation, (i) all rights to payment, including returned premiums, with respect to any insurance relating to any of the foregoing, (ii) all rights to payment with respect to any claim or cause of action affecting or relating to any of the foregoing, and (iii) all stock rights, rights to subscribe, stock splits, liquidating dividends, cash dividends, dividends paid in stock, new securities or other property of any kind which Debtor is or may hereafter be entitled to receive on account of any securities pledged hereunder, including without limitation, stock received by Debtor due to stock splits or dividends paid in stock or sums paid upon or in respect of any securities pledged hereunder upon the liquidation or dissolution of the issuer thereof (hereinafter called “Proceeds”). Except as otherwise expressly permitted herein or in the Addendum to Security Agreement: Securities Account attached hereto (the “Addendum”), in the event Debtor receives any such Proceeds, Debtor will hold the same in trust on behalf of and for the benefit of Bank and will immediately deliver all such Proceeds to Bank in the exact form received, with the endorsement of Debtor if necessary and/or appropriate undated stock powers duly executed in blank, to be held by Bank as part of the Collateral, subject to all terms hereof. As used herein, the terms “security entitlement,” “financial asset” and “investment property” shall have the respective meanings set forth in the California Uniform Commercial Code.

     2. OBLIGATIONS SECURED. The obligations secured hereby are the payment and performance of: (a) all present and future indebtedness of Debtor to Bank arising under or in connection with that certain Credit Agreement between Debtor and Bank of even date herewith (as amended or replaced from time to time, the “Credit Agreement”) and all of the other Loan Documents (as defined in the Credit Agreement); and (b) all obligations of Debtor and rights of Bank under this Agreement and the other Loan Documents (collectively, the “Indebtedness”). The word “indebtedness” is used herein in its most comprehensive sense and includes any and all advances, debts, obligations and liabilities of Debtor, or any of them, heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, and whether Debtor may be liable individually or jointly with others, or whether recovery upon such indebtedness may be or hereafter becomes unenforceable.

     3. TERMINATION. This Agreement will terminate upon the performance of all obligations of Debtor to Bank, including without limitation, the payment of all Indebtedness of

1.

Debtor to Bank, and the termination of all commitments of Bank to extend credit to Debtor, existing at the time Bank receives written notice from Debtor of the termination of this Agreement.

     4. OBLIGATIONS OF BANK. Bank shall have no duty to take any steps necessary to preserve the rights of Debtor against prior parties, or to initiate any action to protect against the possibility of a decline in the market value of the Collateral or Proceeds. Bank shall not be obligated to take any action with respect to the Collateral or Proceeds requested by Debtor unless such request is made in writing and Bank determines, in its sole discretion, that the requested action would not unreasonably jeopardize the value of the Collateral and Proceeds as security for the Indebtedness.

     5. REPRESENTATIONS AND WARRANTIES. Debtor represents and warrants to Bank that: (a) Debtor’s legal name is exactly as set forth on the first page of this Agreement, and all of Debtor’s organizational documents or agreements delivered to Bank are complete and accurate in every material respect; (b) Debtor is the owner of the Collateral and Proceeds; (c) Debtor has the exclusive right to grant a security interest in the Collateral and Proceeds; (d) all Collateral and Proceeds are genuine, free from liens, adverse claims, setoffs, default, prepayment, defenses and conditions precedent of any kind or character, except the lien created hereby or as otherwise agreed to by Bank, or heretofore disclosed by Debtor to Bank, in writing, or any lien in favor of the Intermediary as described in the Securities Account Control Agreement among Bank, Debtor and Intermediary of even date herewith (the “Control Agreement”); (e) all statements contained herein and, where applicable, in the Collateral, are true and complete in all material respects; (f) no financing statement or control agreement covering any of the Collateral or Proceeds, and naming any secured party other than Bank, exists or is on file in any public office or remains in effect; (g) no person or entity, other than Debtor, Bank and Intermediary, has any interest in or control over the Collateral; and (h) specifically with respect to Collateral and Proceeds consisting of investment securities, instruments, chattel paper, documents, contracts, insurance policies or any like property, (i) all persons appearing to be obligated thereon have authority and capacity to contract and are bound as they appear to be, and (ii) the same comply with applicable laws concerning form, content and manner of preparation and execution.

     6. COVENANTS OF DEBTOR.

     (a) Debtor agrees in general: (i) to pay Indebtedness secured hereby when due; (ii) to indemnify Bank against all losses, claims, demands, liabilities and expenses of every kind caused by property subject hereto except to the extent such losses, claims, demands, liabilities and expenses are caused directly by Bank’s willful misconduct or gross negligence; (iii) to pay all costs and expenses, including reasonable attorneys’ fees, incurred by Bank in the perfection and preservation of the Collateral or Bank’s interest therein and/or the realization, enforcement and exercise of Bank’s rights, powers and remedies hereunder; (iv) to permit Bank to exercise its powers; (v) to execute and deliver such documents as Bank deems necessary to create, perfect and continue the security interests contemplated hereby; (vi) not to change its name, and as applicable, its chief executive office, its principal residence or the jurisdiction in which it is organized and/or registered without giving Bank prior written notice thereof; (vii) not to change the places where Debtor keeps any Collateral or Debtor’s records concerning the Collateral and Proceeds without giving Bank prior written notice of the address to which Debtor is moving same; and (viii) to cooperate with Bank in perfecting all security interests granted herein and in obtaining such agreements from third parties as Bank deems necessary, proper or convenient in connection with the preservation, perfection or enforcement of any of its rights hereunder.

2.

     (b) Debtor agrees with regard to the Collateral and Proceeds, unless Bank agrees otherwise in writing: (i) that Bank is authorized to file financing statements in the name of Debtor to perfect Bank’s security interest in Collateral and Proceeds; (ii) not to permit any security interest in or lien on the Collateral or Proceeds, except in favor of Bank and except liens in favor of Intermediary to the extent expressly permitted in the Control Agreement; (iii) not to hypothecate or permit the transfer by operation of law of any of the Collateral or Proceeds or any interest therein; (iv) to keep, in accordance with generally accepted accounting principles, complete and accurate records regarding all Collateral and Proceeds, and to permit Bank to inspect the same and make copies thereof at any reasonable time (v) if requested by Bank, and except as provided in the Addendum, to receive and use reasonable diligence to collect Proceeds, in trust and as the property of Bank, and to immediately endorse as appropriate and deliver such Proceeds to Bank daily in the exact form in which they are received together with a collection report in form satisfactory to Bank; (vi) in the event Bank elects to receive payments of Proceeds hereunder, to pay all expenses incurred by Bank in connection therewith, including expenses of accounting, correspondence, collection efforts, filing, recording, record keeping and expenses incidental thereto; and (vii) to provide any service and do any other acts which may be necessary to keep all Collateral and Proceeds free and clear of all defenses, rights of offset and counterclaims. If the Collateral or Proceeds consists of securities and so long as no Event of Default exists, Debtor shall be entitled to vote said securities and to give consents, waivers and ratifications with respect thereto, provided that no vote shall be cast or consent, waiver or ratification given or action taken which would impair Bank’s interests in the Collateral and Proceeds or be inconsistent with or violate any provisions of this Agreement. Debtor further agrees that any party now or at any time hereafter authorized by Debtor to advise or otherwise act with respect to the Securities Account shall be subject to all terms and conditions contained herein and in any control, custodial or other similar agreement at any time in effect among Bank, Debtor and Intermediary relating to the Collateral.

     7. POWERS OF BANK. Debtor appoints Bank its true attorney in fact to perform any of the following powers, which are coupled with an interest, are irrevocable until termination of this Agreement and may be exercised from time to time by Bank’s officers and employees, or any of them, whether or not Debtor is in default with respect to powers relating to the preservation and perfection of the Collateral and Bank’s rights hereunder, but only if an Event of Default has occurred and is continuing with respect to all other powers: (a) to perform any obligation of Debtor hereunder in Debtor’s name or otherwise; (b) to notify any person obligated on any security, instrument or other document subject to this Agreement of Bank’s rights hereunder; (c) to collect by legal proceedings or otherwise all dividends, interest, principal or other sums now or hereafter payable upon or on account of the Collateral or Proceeds; (d) to enter into any extension, modification, reorganization, deposit, merger or consolidation agreement, or any other agreement relating to or affecting the Collateral or Proceeds, and in connection therewith to deposit or surrender control of the Collateral and Proceeds, to accept other property in exchange for the Collateral and Proceeds, and to do and perform such acts and things as Bank may deem proper, with any money or property received in exchange for the Collateral or Proceeds, at Bank’s option, to be applied to the Indebtedness or held by Bank under this Agreement; (e) to make any compromise or settlement Bank deems desirable or proper in respect of the Collateral and Proceeds; (f) to insure, process and preserve the Collateral and Proceeds; (g) to exercise all rights, powers and remedies which Debtor would have, but for this Agreement, with respect to all Collateral and Proceeds subject hereto; and (h) to do all acts and things and execute all documents in the name of Debtor or otherwise, deemed by Bank as necessary, proper and convenient in connection with the preservation, perfection or enforcement of its rights hereunder. To effect the purposes of this Agreement or otherwise upon instructions of Debtor, or any of them, or if an Event of Default has occurred and

3.

is continuing, Bank may cause any Collateral and/or Proceeds to be transferred to Bank’s name or the name of Bank’s nominee. If an Event of Default has occurred and is continuing, any or all Collateral and/or Proceeds consisting of securities may be registered, without notice, in the name of Bank or its nominee, and thereafter Bank or its nominee may exercise, without notice, all voting and corporate rights at any meeting of the shareholders of the issuer thereof, any and all rights of conversion, exchange or subscription, or any other rights, privileges or options pertaining to such Collateral and/or Proceeds, all as if it were the absolute owner thereof. The foregoing shall include, without limitation, the right of Bank or its nominee to exchange, at its discretion, any and all Collateral and/or Proceeds upon the merger, consolidation, reorganization, recapitalization or other readjustment of the issuer thereof, or upon the exercise by the issuer thereof or Bank of any right, privilege or option pertaining to any shares of the Collateral and/or Proceeds, and in connection therewith, the right to deposit and deliver any and all of the Collateral and/or Proceeds with any committee, depository, transfer agent, registrar or other designated agency upon such terms and conditions as Bank may determine. All of the foregoing rights, privileges or options may be exercised without liability on the part of Bank or its nominee except to account for property actually received by Bank. Bank shall have no duty to exercise any of the foregoing, or any other rights, privileges or options with respect to the Collateral or Proceeds and shall not be responsible for any failure to do so or delay in so doing.

     8. PAYMENT OF PREMIUMS, TAXES, CHARGES, LIENS AND ASSESSMENTS. Debtor agrees to pay, prior to delinquency, all insurance premiums, taxes, charges, liens and assessments against the Collateral and Proceeds, and upon the failure of Debtor to do so, Bank at its option may pay any of them and shall be the sole judge of the legality or validity thereof and the amount necessary to discharge the same. Any such payments made by Bank shall be obligations of Debtor to Bank, due and payable immediately upon demand, together with interest at a rate determined in accordance with the provisions of this Agreement, and shall be secured by the Collateral and Proceeds, subject to all terms and conditions of this Agreement.

     9. EVENTS OF DEFAULT. The occurrence of any “Event of Default” under the Credit Agreement shall constitute an “Event of Default” under this Agreement.

     10. REMEDIES. Upon the occurrence and during the continuance of any Event of Default, Bank shall have the right to declare immediately due and payable all or any Indebtedness secured hereby and to terminate any commitments to make loans or otherwise extend credit to Debtor. Bank shall have all other rights, powers, privileges and remedies granted to a secured party upon default under the California Uniform Commercial Code or otherwise provided by law, including without limitation, the right (a) to contact all persons obligated to Debtor on any Collateral or Proceeds and to instruct such persons to deliver all Collateral and/or Proceeds directly to Bank, and (b) to sell, lease, license or otherwise dispose of any or all Collateral. All rights, powers, privileges and remedies of Bank shall be cumulative. No delay, failure or discontinuance of Bank in exercising any right, power, privilege or remedy hereunder shall affect or operate as a waiver of such right, power, privilege or remedy; nor shall any single or partial exercise of any such right, power, privilege or remedy preclude, waive or otherwise affect any other or further exercise thereof or the exercise of any other right, power, privilege or remedy. Any waiver, permit, consent or approval of any kind by Bank of any default hereunder, or any such waiver of any provisions or conditions hereof, must be in writing and shall be effective only to the extent set forth in writing. It is agreed that public or private sales or other dispositions, for cash or on credit, to a wholesaler or retailer or investor, or user of property of the types subject to this Agreement, or public auctions, are all commercially reasonable since differences in the prices generally realized in the different kinds of dispositions are ordinarily offset by the differences in the costs and credit risks of such dispositions. While an Event of Default exists: (a) Debtor will not dispose of any Collateral or Proceeds except on

4.

terms approved by Bank; (b) Bank may appropriate the Collateral and apply all Proceeds toward repayment of the Indebtedness in such order of application as Bank may from time to time elect; (c) Bank may take any action with respect to the Collateral contemplated by any control, custodial or other similar agreement then in effect among Bank, Debtor and Intermediary; and (d) at Bank’s request, Debtor will assemble and deliver all books and records pertaining to the Collateral or Proceeds to Bank at a reasonably convenient place designated by Bank. For any Collateral or Proceeds consisting of securities, Bank shall have no obligation to delay a disposition of any portion thereof for the period of time necessary to permit the issuer thereof to register such securities for public sale under any applicable state or Federal law, even if the issuer thereof would agree to do so. Debtor further agrees that Bank shall have no obligation to process or prepare any Collateral for sale or other disposition.

     11. DISPOSITION OF COLLATERAL AND PROCEEDS; TRANSFER OF INDEBTEDNESS. In disposing of Collateral hereunder, Bank may disclaim all warranties of title, possession, quiet enjoyment and the like. Any proceeds of any disposition of any Collateral or Proceeds, or any part thereof, may be applied by Bank to the payment of expenses incurred by Bank in connection with the foregoing, including reasonable attorneys’ fees, and the balance of such proceeds may be applied by Bank toward the payment of the Indebtedness in such order of application as Bank may from time to time elect. Upon the transfer of all or any part of the Indebtedness, Bank may transfer all or any part of the Collateral or Proceeds and shall be fully discharged thereafter from all liability and responsibility with respect to any of the foregoing so transferred, and the transferee shall be vested with all rights and powers of Bank hereunder with respect to any of the foregoing so transferred; but with respect to any Collateral or Proceeds not so transferred, Bank shall retain all rights, powers, privileges and remedies herein given.

     12. STATUTE OF LIMITATIONS. Until all Indebtedness shall have been paid in full and all commitments by Bank to extend credit to Debtor have been terminated, the power of sale or other disposition and all other rights, powers, privileges and remedies granted to Bank hereunder shall continue to exist and may be exercised by Bank at any time and from time to time irrespective of the fact that the Indebtedness or any part thereof may have become barred by any statute of limitations, or that the personal liability of Debtor may have ceased, unless such liability shall have ceased due to the payment in full of all indebtedness secured hereunder.

     13. MISCELLANEOUS. When there is more than one Debtor named herein: (a) the word “Debtor shall mean all or any one or more of them as the context requires; (b) the obligations of each Debtor hereunder are joint and several; and (c) until all Indebtedness shall have been paid in full, no Debtor shall have any right of subrogation or contribution, and each Debtor hereby waives any benefit of or right to participate in any of the Collateral or Proceeds or any other security now or hereafter held by Bank. Debtor hereby waives any right to require Bank to (i) proceed against Debtor or any other person, (ii) proceed against or exhaust any security from Debtor or any other person, (iii) perform any obligation of Debtor with respect to any Collateral or Proceeds, and (d) make any presentment or demand, or give any notice of nonpayment or nonperformance, protest, notice of protest or notice of dishonor hereunder or in connection with any Collateral or Proceeds. Debtor further waives any right to direct the application of payments or security for any Indebtedness of Debtor or indebtedness of customers of Debtor.

     14. NOTICES. All notices, requests and demands required under this Agreement must be in writing, addressed to Bank at the address specified in any other loan documents entered into between Debtor and Bank and to Debtor at the address of its chief executive office

5.

(or principal residence, if applicable) specified below or to such other address as any party may designate by written notice to each other party, and shall be deemed to have been given or made as follows: (a) if personally delivered, upon delivery; (b) if sent by mail, upon the earlier of the date of receipt or three (3) days after deposit in the U.S. mail, first class and postage prepaid; and (c) if sent by telecopy, upon receipt.

     15. COSTS, EXPENSES AND ATTORNEYS’ FEES. Debtor shall pay to Bank immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys’ fees (to include outside counsel fees and all allocated costs of Bank’s in-house counsel), expended or incurred by Bank in exercising any right, power, privilege or remedy conferred by this Agreement or in the enforcement thereof, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to Debtor or in any way affecting any of the Collateral or Bank’s ability to exercise any of its rights or remedies with respect thereto. All of the foregoing shall be paid by Debtor with interest from the date of demand until paid in full at a rate per annum equal to the greater of ten percent (10%) or the Prime Rate in effect from time to time.

     16. SUCCESSORS; ASSIGNS; AMENDMENT. This Agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties, and may be amended or modified only in writing signed by Bank and Debtor.

     17. OBLIGATIONS OF MARRIED PERSONS. Any married person who signs this Agreement as Debtor hereby expressly agrees that recourse may be had against his or her separate property for all his or her Indebtedness to Bank secured by the Collateral and Proceeds under this Agreement.

     18. SEVERABILITY OF PROVISIONS. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or any remaining provisions of this Agreement.

     19. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of California.

     20. ADDENDUM. Additional terms and conditions relating to the Securities Account are set forth in the Addendum attached hereto and incorporated herein by this reference.

     Debtor warrants that Debtor is an organization registered under the laws of the State of Delaware.

     Debtor warrants that its chief executive office (or principal residence, if applicable) is located at the following address: 2200 Faraday, Ste. 100, Carlsbad, California 92008.

6.

     IN WITNESS WHEREOF, this Agreement has been duly executed as of July 1, 2006.

DOT HILL SYSTEMS CORP.
By:	/s/ Dana Kammersgard
	Dana Kammersgard
	Chief Executive Officer
By:	/s/ Shad Burke
	Shad Burke
	Chief Financial Officer

7.

ADDENDUM TO SECURITY AGREEMENT: SECURITIES ACCOUNT

     THIS ADDENDUM is attached to and made a part of that certain Security Agreement: Securities Account executed by DOT HILL SYSTEMS CORP. (“Debtor”) in favor of WELLS FARGO BANK, NATIONAL ASSOCIATION (“Bank”), dated as of July 1, 2006 (the “Agreement”).

     The following provisions are hereby incorporated into the Agreement:

     1. Securities Account Activity. So long as no Event of Default exists, Debtor, or any party authorized by Debtor to act with respect to the Securities Account, may (a) receive payments of interest and/or cash dividends earned on financial assets maintained in the Securities Account, (b) trade financial assets maintained in the Securities Account, and (c) withdraw financial assets from the Securities Account; provided, however, that no such payment, trade or withdrawal shall be made if the Collateral Value of the Securities Account is or would be less than the amount required hereunder. Without Bank’s prior written consent, except as permitted by the preceding sentence, neither Debtor nor any party other than Bank may withdraw or receive any distribution of any Collateral from the Securities Account. The Collateral Value of the Securities Account shall at all times be equal to or greater than one hundred percent (100%) of the outstanding principal balance of the Indebtedness, including the amount of all issued and outstanding letters of credit, if any, secured hereby. In the event that the Collateral Value, for any reason and at any time, is less than one hundred percent (100%) but more than ninety-one percent (91%) of the required amount, Debtor shall within thirty (30) days make a principal reduction on the Indebtedness or deposit additional assets of a nature satisfactory to Bank into the Securities Account, in either case in amounts or with values sufficient to achieve the required Collateral Value. In the event that the Collateral Value, for any reason and at any time, is less than ninety-one percent (91%) of the required amount, Debtor shall within twenty-four (24) hours make a principal reduction on the Indebtedness or deposit additional assets of a nature satisfactory to Bank into the Securities Account, in either case in amounts or with values sufficient to achieve the required Collateral Value.

     2. Notice of Exclusive Control. Notwithstanding any other provision to the contrary in this Security Agreement or that certain Securities Account Control Agreement (Wells Fargo Bank Intermediary) of even date herewith by and among Customer, Bank and Wells Capital Management Incorporated (“Intermediary”) (as amended or replaced from time to time, the “Control Agreement”), Bank shall not deliver to Intermediary any Notice of Exclusive Control (as such term is defined in Section 3(c) of the Control Agreement) unless at the time of the giving of any such Notice, an Event of Default has occurred and is continuing.

     3. “Collateral Value” means the percentage set forth below of the lower of the face or market value, or the lower of the face or redemption value, as appropriate, for each type of investment property held in the Securities Account at the time of computation, with such value and the classification of any particular investment property in all instances determined by Bank in its sole discretion, and excluding from such computation (a) all WF Securities and Collective Investment Funds, (b) any stock with a market value of $10.00 or less, and (c) all investment property from an issuer if Bank determines such issuer to be ineligible.

1

Type of Investment Property			Percentage
Cash and Cash Equivalents				100	%
U.S. Government Bills, Notes and U.S. Government Sponsored Agency Securities:
(a)	with maturities less than or equal to 5 years			90	%
(b)	with maturities greater than 5 years but less than or equal to 10 years			85	%
(c)	with maturities greater than 10 years			80	%
Corporate and Municipal Bonds and Notes:
(a)	rated AAA/Aaa, AA/Aa or SP-1 by a nationally recognized rating agency with maturities less than or equal to 5 years			85	%
(b)	rated AAA/Aaa, AA/Aa or SP-1 by a nationally recognized rating agency with maturities greater than 5 years but less than or equal to 10 years			80	%
(c)	rated AAA/Aaa, AA/Aa or SP-1 by a nationally recognized rating agency with maturities greater than 10 years			75	%
(d)	rated A, Baa, BBB or SP-2 by a nationally recognized rating agency with maturities less than or equal to 5 years			80	%
(e)	rated A, Baa, BBB or SP-2 by a nationally recognized rating agency with maturities greater than 5 years but less than or equal to 10 years			75	%
(f)	rated A, Baa, BBB or SP-2 by a nationally recognized rating agency with maturities greater than 10 years			70	%
Commercial Paper:
(a)	rated A1 or P1 by a nationally recognized rating agency			80	%
(b)	rated A2 or P2 by a nationally recognized rating agency			70	%
Common and Preferred Stock:
(a)	traded on the New York Stock Exchange			75	%
(b)	traded on NASDAQ, the American Stock Exchange or a regional exchange:
	(i)	with a market capitalization greater than $7.5B and
		** rated A+, A or A- by a nationally recognized rating agency		75	%

2

Type of Investment Property			Percentage
		** rated B+ by a nationally recognized rating agency		60	%
		** rated B, B- or C by a nationally recognized rating agency		50	%
	(ii)	with a market capitalization greater than $1B but less than or equal to $7.5B and
		** rated A+, A or A- by a nationally recognized rating agency		60	%
		** rated B+ by a nationally recognized rating agency		50	%
		** rated B, B- or C by a nationally recognized rating agency		40	%
	(iii)	with a market capitalization greater than or equal to $500MM but less than $1B and
		** rated A+, A or A- by a nationally recognized rating agency		50	%
		** rated B+ by a nationally recognized rating agency		40	%
		** rated B, B- or C by a nationally recognized rating agency		30	%
Mutual Funds:
(a)	Listed Money Market			95	%
(b)	Short Term Taxable or Tax Exempt Bonds			90	%
(c)	Intermediate Term Taxable or Tax Exempt Bonds			85	%
(d)	General Taxable Bonds			80	%
(e)	Municipal Bonds, Single State Bonds or Long Term Corporate Taxable Bonds			75	%
(f)	Balanced Stock and Bond Funds (includes flexible portfolio)			75	%
(g)	Domestic Large Cap Stock			70	%
(h)	Domestic Equity Income Stock			70	%
(i)	Domestic Mortgage Taxable Bonds			70	%
(j)	Multi Cap Growth, Value and Core Stock			60	%
(k)	Mid Cap Growth, Value and Core Stock			60	%
(I)	Small Cap Growth, Value and Core Stock			50	%
(m)	Specialty Equity Stock			50	%
(n)	Sector, International, High Yield Taxable and Tax Exempt Stocks and Bonds			50	%
(o)	Listed NASDAQ Mutual Funds			50	%

3

     4. Exclusion from Collateral. Notwithstanding anything herein to the contrary, the terms “Collateral” and “Proceeds” do not include, and Bank disclaims a security interest in all WF Securities and Collective Investment Funds now or hereafter maintained in the Securities Account.

     5. “Collective Investment Funds” means collective investment funds as described in 12 CFR 9.18 and includes, without limitation, common trust funds maintained by Bank for the exclusive use of its fiduciary clients.

     6. “WF Securities” means stock, securities or obligations of Wells Fargo & Company or of any affiliate thereof (as the term affiliate is defined in Section 23A of the Federal Reserve Act (12 USC 371(c), as amended from time to time).

     IN WITNESS WHEREOF, this Addendum has been executed as of the same date as the Agreement.

		WELLS FARGO BANK,
DOT HILL SYSTEMS CORP.		NATIONAL ASSOCIATION
By:	/s/ Dana Kammersgard	By:	/s/ Brian P. Chambers
	Dana Kammersgard	Brian P. Chambers
	Chief Executive Officer	Vice President
By:	/s/ Shad Burke
	Shad Burke
	Chief Financial Officer

4.

EX-10.7

Exhibit 10.7
*** Text Omitted and Filed Separately
Pursuant to a Confidential Treatment Request
under 17 C.F.R. §§ 200.80(b)(4) and 240.24b-2(b)(1)

FIRST AMENDMENT TO
DEVELOPMENT AND OEM SUPPLY AGREEMENT

     THIS FIRST AMENDMENT (the “First Amendment”) to the Development and OEM Supply Agreement made and entered into on July 26, 2005 (the “Agreement”) is hereby made and entered into as of the last signature date below (the “First Amendment Effective Date”), by and among Dot Hill Systems Corporation, a Delaware corporation, having its principal place of business at 2200 Faraday Avenue, Suite 100, Carlsbad, CA 92008, and Dot Hill Systems B.V., a Netherlands corporation, having its principal place of business at Marssteden 94, 7547 TD Enschede, the Netherlands (hereinafter jointly “Dot Hill”); and Network Appliance, Inc., a Delaware corporation, having its principal place of business at 495 East Java Drive, Sunnyvale, CA, and Network Appliance Holding and Manufacturing, B.V., a Netherlands corporation formerly known as Network Appliance B.V., having its principal place of business at Vision Plaza East, Boeing Avenue 300, 1119 PZ Schiphol-RIJK, the Netherlands (hereinafter jointly “NetApp”). Dot Hill and NetApp may individually be referred to as a “party” and collectively as the “parties” in this First Amendment.

BACKGROUND:

     WHEREAS, Dot Hill and NetApp entered into the Agreement whereby Dot Hill intends to develop and supply on an OEM basis certain products to NetApp, and NetApp intends to acquire from Dot Hill such products;

     WHEREAS, Dot Hill and NetApp desire to add an additional product to the Agreement that is currently known as the [...***...] product;

     WHEREAS, Dot Hill and NetApp desire to set forth their agreement as to the application of the base terms and conditions, together with certain exhibits to the Agreement, to the [...***...] product; and

     WHEREAS, Dot Hill and NetApp desire to modify, supplement or replace certain existing exhibits to the Agreement, as set forth below.

     NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged by Dot Hill and NetApp, Dot Hill and NetApp hereby agree to the following changes to and do amend the Agreement, as follows:

FIRST AMENDMENT:

     1. Application of Existing Provisions to [...***...] product. Dot Hill and NetApp agree that the base terms and conditions of the Agreement, together with the provisions in the following exhibits thereto, shall apply to the [...***...] product. For purpose of this Amendment, Shasta and [...***...] products shall be defined as set forth in Exhibit B, Rev.1. For purpose of interpretation and construction of the base terms and conditions of the Agreement, and the exhibits in the table below, the term “Shasta” whenever and wherever used therein shall include the [...***...] product:

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

1.

Description of Exhibit	Exhibit Letter
Engineering Specifications	Exhibit A
Mutual Non-Disclosure Agreement	Exhibit I
[...***...]	Exhibit J
NetApp Workmanship Standards	Exhibit K
Manufacturing Test Requirements	Exhibit L
On-Site Support Requirements	Exhibit M
List of NetApp Other Technology	Exhibit O

     2. Modified Exhibits. Dot Hill and NetApp agree that the exhibits attached hereto and described in the column “Replacement Exhibit” in the table below shall replace in their entirety their applicable corresponding exhibits described in the column “Existing Exhibit” in the table below. The provisions contained in the Replacement Exhibits in the table below shall apply to Shasta and [...***...] products.

	Existing	Replacement
Description of Exhibit	Exhibit	Exhibit
Product Price and Bill of Materials Breakdown	Exhibit B	Exhibit B, Rev. 1
Product Forecast	Exhibit D	Exhibit D, Rev. 1
Dot Hill Quality Requirements	Exhibit E	Exhibit E, Rev. 1
Order Replenishment and Logistics Requirements	Exhibit F	Exhibit F, Rev. 1
NetApp Customer Support Requirements	Exhibit G	Exhibit G, Rev. 1
NetApp Designated Technology	Exhibit N	Exhibit N, Rev. 1
Business Continuance Plan	Exhibit P	Exhibit P, Rev. 1

     3. Supplementary Exhibits. Dot Hill and NetApp agree that the exhibits attached hereto and described in the column “Added Exhibit” in the table below shall supplement their applicable corresponding exhibits described in the column “Existing Exhibit” in the table below. The provisions contained in the Added Exhibits below shall apply only to the [...***...] product and not to any other products that may be provided by Dot Hill to NetApp under the Agreement.

Description of Exhibit	Existing Exhibit	Added Exhibit
Statement of Work and Acceptance Criteria	Exhibit C	Exhibit C-1
[...***...]	Exhibit H	Exhibit H-1

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

2.

     4. New Definitions. Dot Hill and NetApp agree to add the following definitions to Section 5, Definitions, of the Agreement:

          a. “Additional Technology” means the source code and binary image file(s) in object code form for the [...***...] for the [...***...] Product.

          b. “DH Engineering Information” means certain Dot Hill drawings, technical information in electronic databases, artwork and tooling specifications which are confidential to Dot Hill and may be reasonably necessary to acquire or produce tooling for the manufacture of the Products. DH Engineering Information shall not include any software, firmware and/or other technology for the Products.

          c. “Dot Hill Procurement Specifications” means technical information that is reasonably necessary to permit a third party to respond to a request for quotation for components that are to be included in Products. This may include component and material drawings, descriptions, bills of materials, and/or specifications therefor.

          d. “Immediately Licensed DH Technology” means those items of Technology that have been provided by Dot Hill to NetApp and are necessary for NetApp or a NetApp DCM to manufacture the NetApp-Manufactured Items in accordance with the rights immediately granted in Section 11.1(f) of this Agreement to NetApp or a NetApp DCM for the manufacture of the NetApp-Manufactured Items on NetApp’s behalf.

          e. “Immediately Licensed [...***...]” means the [...***...] for the Products, the [...***...] for the Products, and the [...***...] for [...***...] for the Products.

          f. “Minimum Terms” means the inclusion in all material respects of all of the terms and conditions of Attachment 1 in a written confidentiality agreement with a [...***...] that covers [...***...] and/or [...***...] disclosed pursuant to the rights described in Subsections 11.1(b)(i) or 11.1(b)(ii), respectively.

          g. “NetApp-Manufactured Items” means the following items for the [...***...] product: [...***...]. Upon mutual written agreement the authorized representatives of the Parties may agree in writing to add additional items to the list of NetApp-Manufactured Items. However, for this purpose, only a person then-currently employed by Dot Hill with the title of [...***...] will be deemed to be an authorized representative of Dot Hill with the authority to agree in writing with NetApp to add any such additional items to such list. Also, any

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

3.

such agreement to add any such additional items must be reflected in a written document that has been signed by the authorized representatives of both Dot Hill and NetApp.

          h. “NetApp First Ship Date” means the date on which units of Products, which are obtained directly or indirectly from Dot Hill, are generally available from NetApp for delivery in volume to NetApp’s customers, either as standalone units or as part of other products.

          i. “RFQ Information” means certain high-level Dot Hill Procurement Specifications that are confidential to Dot Hill and may be distributed and used by certain third parties [...***...].

     5. Intentionally left blank.

     6. Manufacturing Rights. NetApp and Dot Hill agree to delete Section 11.1(b), Manufacturing Rights, in its entirety and replace it with the following:

          “(b) Manufacturing Rights. Subject to the terms and conditions of this Agreement, for each Product Dot Hill hereby grants, on behalf of itself and its Affiliates, to NetApp:

               (i) [...***...] a worldwide, revocable in accordance with Section 11.1(c), non-transferable (except as permitted under Section 19 (“Assignment”)), royalty-free, nonexclusive right and license, without the right to sublicense (except as set forth in Section 11.1(d)), [...***...] including, but not limited to, the agreement by [...***...];

               (ii) [...***...] a worldwide, revocable in accordance with Section 11.1(c), non-transferable (except as permitted under Section 19 (“Assignment”)), royalty-free, nonexclusive right and license, without the right to sublicense (except as set forth in Section 11.1(d)), [...***...], including, but not limited to, the agreement by [...***...]

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

4.

[...***...];

               (iii) [...***...] based on the then-current forecast for an applicable Product, a worldwide, revocable in accordance with Section 11.1(c), non-transferable (except as permitted under Section 19 (“Assignment”)), royalty-free, nonexclusive right and license, without the right to sublicense (except as set forth in Section 11.1(d)): (A) [...***...]; and (B) [...***...]; and

               (iv) upon the occurrence of a Trigger Event relating to such Product, a worldwide, perpetual, revocable in accordance with Section 11.1(c), non-transferable (except as permitted under Section 19 (“Assignment”)), royalty-free, nonexclusive right and license, without the right to sublicense (except as set forth in Section 11.1(d)): (A) [...***...] to perform the Permitted Purposes for such Product; and (B) under the Patents of Dot Hill to use, make, sell, offer to sell import, export and otherwise dispose of such Product.”

     7. Certain Rights of Revocation

          a. Modified Right to Revoke. Dot Hill and NetApp agree to remove Subsection 11.1(c)(1) and replace it with the following:

               “(1) if, during the Initial Purchase Period, NetApp [...***...] and which shall include, without limitation, those requirements for Products that are to be or will be included in or combined with other products to be supplied to NetApp and its Affiliates;”

          b. Additional Right to Revoke. Dot Hill and NetApp agree to add the following at the end of Section 11.1(c), Certain Rights of Revocation:

          “Also, upon written notice to NetApp, Dot Hill may revoke immediately the sublicense rights that are available under this Agreement and have been granted by NetApp to a sublicensee of NetApp in the event that (1) such sublicensee improperly uses any Dot Hill Technology beyond the scope of the sublicense rights described in Section 11.1(d) (and further described in Section 11.1(b)) and (2) any such improper use remains uncured for a period of thirty (30) days after written notice thereof from Dot Hill.

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

5.

          Any revocation made by Dot Hill of any NetApp rights in Section 11.1(b) as a result of any of the events described in Subsection 11.1(c)(1), 11.1(c)(2), 11.1(c)(3) and/or 11.1(c)(4) shall result in the revocation of all related sublicense rights granted by NetApp.”

     8. Sublicense Rights. NetApp and Dot Hill agree to delete Section 11.1(d), Sublicense Rights, in its entirety and replace it with the following:

          “(d) Sublicense Rights. Subject to the provisions in this Section 11.1(d) and other terms and conditions of this Agreement, the rights granted in Section 11.1(b) above may be sublicensed by NetApp to: (i) NetApp DCMs solely to make Products for sale to NetApp and (ii) NetApp’s Affiliates. For avoidance of doubt, it is understood and agreed that a sale by a NetApp DCM to NetApp may include the shipment and delivery of Product directly by a NetApp DCM to a NetApp customer provided that the sale of such Product occurs between the NetApp DCM and NetApp. Prior to the granting by NetApp of any such sublicense rights to NetApp DCMs or NetApp’s Affiliates, NetApp shall obtain the written agreement of NetApp DCMs or NetApp’s Affiliates, as applicable, to hold in confidence all Dot Hill Technology that NetApp may provide and, in the case of a grant of any sublicense rights to any NetApp DCMs, for such NetApp DCMs to use such Dot Hill Technology solely in a manner fully and entirely consistent with the rights granted in Section 11.1(b) and solely to make Products for sale to NetApp. The license rights granted by Dot Hill in this Agreement may not be sublicensed by NetApp to any other third parties without first obtaining the prior written approval of an authorized representative of Dot Hill.”

     9. NetApp License Restrictions. Dot Hill and NetApp agree to add the following to the end of Section 11.1(e), License Restrictions, of the Agreement:

          “NetApp shall not, nor shall NetApp knowingly allow any third party, to: (a) use any Dot Hill Technology, except as expressly permitted by the license rights granted under this Agreement; or (b) reverse engineer, decompile, disassemble, or otherwise attempt to reduce to source code form any object code included in the Dot Hill Technology, except and solely to the extent permitted under applicable law to achieve interoperability with hardware or software to be used therewith.”

     10. Other License Rights. Dot Hill and NetApp agree to add the following provision as Section 11.1(f), Other License Rights, to the Agreement:

          “(f) Other License Rights. Notwithstanding anything to the contrary in the preceding Subsections of this Section 11.1 and subject to the other terms and conditions of this Agreement, Dot Hill, on behalf of itself and its Affiliates, hereby grants to NetApp an immediate, worldwide, perpetual, non-transferable (except as permitted under Section 19 (“Assignment”)), royalty-free, non-sublicensable, nonexclusive right and license under [...***...] to (A) use internally, reproduce, modify or [...***...] of (i) the [...***...] solely to manufacture, and/or have manufactured by NetApp DCMs, the NetApp-Manufactured Items and distribute such NetApp-Manufactured Items for use as part of and within the [...***...] Product and (ii) the Dot Hill [...***...] solely for integration into the [...***...]

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

6.

[...***...] Product, and (B) distribute to NetApp’s customers Dot Hill-designated patch releases of the Additional Technology that are compiled into object code by Dot Hill and provided to NetApp, solely for the purpose of attempting to resolve reported NetApp customer defects or problems with the [...***...] Product; provided, however, that all of such NetApp-Manufactured Items, Dot Hill [...***...] and patch releases of Additional Technology shall at all times during the Initial Purchase Period be incorporated into and used only within a Dot Hill-designed chassis, including [...***...] and drives, all of which have been previously purchased by NetApp or a NetApp DCM only from Dot Hill (and no other party) pursuant to and under the provisions of this Agreement.”

     11. Dot Hill License Restrictions. Dot Hill and NetApp agree to add the following to the end of Section 11.2(d), License Restrictions, of the Agreement:

          “Dot Hill shall not, nor shall Dot Hill knowingly allow any third party, to: (a) use any NetApp Designated Technology or NetApp Other Technology, except as expressly permitted by the license rights granted under this Agreement; or (b) reverse engineer, decompile, disassemble, or otherwise attempt to reduce to source code form any object code included in the NetApp Designated Technology or NetApp Other Technology, except and solely to the extent permitted under applicable law to achieve interoperability with hardware or software to be used therewith.”

     12. [...***...]. Dot Hill and NetApp agree to add the following as Section 11.7, [...***...], to the Agreement:

          “11.7 [...***...]. Upon written request by NetApp, Dot Hill agrees to provide to a mutually agreed third party (the “PS Manufacturer”) a worldwide, non-transferable, non-sublicensable, nonexclusive, royalty-free right and license under the [...***...] to use internally the Immediately Licensed PS Technology during the Initial Purchase Period to manufacture [...***...] for sale and delivery only to Dot Hill or a Dot Hill DCM, as Dot Hill may designate, for incorporation and use in the Product that Dot Hill is to supply to NetApp or a NetApp DCM under this Agreement. After the Initial Purchase Period, NetApp shall have the right to use the [...***...] in accordance with the provisions of Section 11.1(b) set forth above. To receive such right and license, the PS Manufacturer must agree in writing with Dot Hill to treat all [...***...] in strict confidence, not to disclose [...***...] to any third party without Dot Hill’s prior written consent, and not to use during the Initial Purchase Period [...***...] except for the benefit of Dot Hill or a Dot Hill DCM, as Dot Hill may determine. The PS Manufacturer must also agree in writing to provide [...***...] to Dot Hill or a Dot Hill DCM, as Dot Hill may designate, [...***...].”

     13. NRE Expenses. Dot Hill and NetApp agree to insert the following sentences between the first and second sentences in Section 10.1, NRE Expenses:

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

7.

          “Notwithstanding anything to the contrary, [...***...] with the exercise of the rights set forth in Section 11.1 during the [...***...].”

14. Confidential Nature of Dot Hill Technology

          “a. Confidentiality Provisions. NetApp and Dot Hill agree to delete the second complete sentence in Section 13.6, Confidential Nature of Dot Hill Technology, that begins with “Prior to ...” and replace it with the following:

               “Prior to NetApp’s provision of any Dot Hill Technology, NetApp will enter into a written confidentiality agreement that requires such NetApp DCM or other [...***...] to treat such Dot Hill Technology as Confidential Information of Dot Hill and in a manner consistent with the sublicense rights granted in Section 11.1(d) (and within the proper scope of the permitted rights described in Section 11.1(b)), the confidentiality obligations of NetApp in the Non-Disclosure Agreement contained in Exhibit I hereto (the “NetApp NDA”) and, for any [...***...] and/or [...***...] that is to supplied to a [...***...], to be subject to the [...***...]. To the extent that [...***...] are inconsistent or in conflict with the confidentiality obligations of NetApp in the NetApp NDA, then NetApp shall be obligated to include such inconsistent or conflicting [...***...] in confidentiality agreements that it may enter into with [...***...] and which cover the provision of [...***...] and/or [...***...].”

          b. Other Obligations. NetApp and Dot Hill agree to add the following at the end of Section 13.6, Confidential Nature of Dot Hill Technology:

               “NetApp shall include the [...***...] in all confidentiality agreements that NetApp enters into with third parties and which cover the disclosure of any [...***...] and/or [...***...]. NetApp shall also require each of the NetApp DCMs to include the [...***...] in confidentiality agreements that such NetApp DCMs may enter into with third parties and which cover the disclosure of any [...***...] and/or [...***...]. Upon request by Dot Hill, NetApp will (i) disclose immediately to Dot Hill the names, addresses and contact information of all third parties which have received any [...***...] and/or [...***...]; (ii) provide Dot Hill with copies of all existing confidentiality agreements then in effect with all such third parties that cover the use of such [...***...] and/or [...***...]; (iii) inform Dot Hill of any suspected or known misuse of any [...***...] and/or [...***...] by any such third parties; and (iv) reasonably cooperate with Dot Hill in actions undertaken by Dot Hill to enforce the provisions of any existing confidentiality agreements which cover the [...***...] and/or [...***...].”

15. Freedom of Independent Development. Dot Hill and NetApp agree to add the following sentence to the end of Section 32, Freedom of Independent Development, to the Agreement:

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

8.

          “The parties also agree that, [...***...] nothing in this Agreement shall affect the right of either party to either obtain or acquire from other third party sources any components or assemblies for intended inclusion in products which meet both of the following requirements: (i) they are not covered under the provisions of this Agreement as Products and (ii) they do not make use of any of the Intellectual Property Rights or Technology of the other party.”

The modifications made above to the Agreement, including the addition of certain supplementary exhibits and edits to certain existing exhibits to the Agreement, which are included within this First Amendment shall have prospective force and effect on and after the First Amendment Effective Date, and shall not retroactively affect any rights or obligations of any of the parties under the Agreement. This First Amendment may be executed in counterparts by the parties, each of which shall be deemed an original and all of which together shall constitute a single instrument. Each party acknowledges and agrees that such executed counterparts of this First Amendment may be delivered by a party to the other party through the use of facsimile transmission. Except as specifically modified or supplemented by or through this First Amendment, all other terms and conditions of the Agreement, including the terms and conditions in any existing exhibits to the Agreement, shall remain in full force and effect between the parties and shall be unaffected thereby.

[Remainder of Page Intentionally Left Blank]

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

9.

     IN WITNESS WHEREOF, the parties through their duly authorized representatives have executed this First Amendment to become effective as of the last signature date set forth below.

DOT HILL SYSTEMS CORPORATION
By:	/s/ Dana W. Kammersgard
Printed Name: Dana W. Kammersgard
Title: President & CEO
Date:	July 26, 2006
DOT HILL SYSTEMS B.V.
By:	/s/ Shad L. Burke
Printed Name: Shad L. Burke
Title: Vice President, Finance
Date:	July 26, 2006

[Remainder of Page Intentionally Left Blank]

Dot Hill and NetApp CONFIDENTIAL     

10.

NETWORK APPLIANCE, INC.
By:	/s/ Michael Wais
Printed Name:		Michael Wais
Title:	VP Supply Chain Management
Date:	August 2, 2006

[Remainder of Page Intentionally Left Blank]

Dot Hill and NetApp CONFIDENTIAL     

11.

NETWORK APPLIANCE HOLDING AND
MANUFACTURING, B.V.

By:	/s/ Patrick Linehan
Printed Name:		Patrick Linehan
Title:	Senior Vice President & General Manager
Date:	August 3, 2006

[Remainder of Page Intentionally Left Blank]

Dot Hill and NetApp CONFIDENTIAL     

12.

ATTACHMENT 1

(1) The third party shall not use any [...***...] and/or [...***...], except as expressly provided below:

     (a) [...***...], and

     (b) [...***...];

(2) From the [...***...] (the “First Confidentiality Period”), [...***...] and/or [...***...] shall not be further disclosed by any third party, except with the prior written approval of an authorized representative of Dot Hill;

(3) After the First Confidentiality Period, the third party shall be required not to disclose further to other parties the [...***...] and/or [...***...] in a manner that is consistent with the non-disclosure obligations of NetApp in the Non-Disclosure Agreement contained in Exhibit I to the Agreement.

(4) If there is any breach or violation by a third party of the confidentiality or non-use provisions set forth above, then Dot Hill shall be entitled to terminate, either in whole or in part, the confidentiality agreement as to such permitted use of the [...***...] and/or [...***...], and such third party shall return immediately to Dot Hill or destroy all such [...***...] and/or [...***...], including all copies thereof, in the third party’s possession;

(5) Upon request by Dot Hill, the third party will provide immediately to Dot Hill complete information as to how the [...***...] and/or [...***...] was or is to be used by such third party;

(6) The third party shall grant and hereby grants to NetApp the right to disclose to Dot Hill, upon Dot Hill’s request, the existence, terms, conditions and contents of any non-disclosure agreement governing the use of the [...***...] and/or the [...***...] supplied to such third party;

(7) Any breach or violation of the confidentiality and non-use provisions set forth above shall be presumed to cause irreparable harm to Dot Hill and, therefore, Dot Hill

Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

13.

may seek temporary, preliminary and permanent injunctive relief, in addition to any other legal or equitable remedies, to prevent any further breach or violation thereof;

(8) Dot Hill shall be an intended third party beneficiary of the confidentiality and non-use provisions set forth above, together with any other provisions set forth below, and have the right to enforce these provisions against a third party receiving any [...***...] and/or [...***...];

(9) In the event that any litigation or other legal proceeding is commenced between Dot Hill and a third party recipient of [...***...] and/or [...***...] as to such third party recipient’s breach or violation of the confidentiality or non-use provisions respecting the same, then the prevailing party in any litigation or other proceeding between Dot Hill and such third party recipient shall be entitled to recover its reasonable attorneys’ fees and other legal costs incurred in any such litigation or other legal proceeding;

(10) The provisions of the confidentiality agreement, together with the rights and obligations of the parties and any third party beneficiaries, shall be governed, construed and interpreted in accordance with the laws of the State of California, determined without regard to any conflict of law principles that would result in the application of the laws of a different state;

(11) Any and all use by a third party of any [...***...] and/or [...***...] shall be at the third party’s sole and entire risk;

(12) All [...***...] and/or [...***...] are provided “AS IS” and without any express, implied and/or statutory warranties, including, without limitation, any implied warranties of fitness for a particular purpose, merchantability and/or non-infringement of third party rights;

(13) The confidentiality and non-use restrictions set forth above shall be in effect for a period of at least [...***...] from the date of the last disclosure of any [...***...] and/or [...***...] to a third party; and

(14) The foregoing provisions in item Nos. (1) through (13) above shall not be amended, modified or otherwise changed in any material respect by the parties without first obtaining the prior written consent from an authorized representative of Dot Hill.

Additionally, the provisions in each confidentiality agreement shall not contain a limitation of liability provision which (i) disclaims liability on the part of a third party for consequential, incidental, special and/or indirect damages (including lost profits or savings) or (ii) limits the liability of a third party for damages that arise or result from any breach or violation of the confidentiality or non-use provisions and which are applicable to [...***...] and/or [...***...].

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Dot Hill and NetApp CONFIDENTIAL     

*** Confidential Treatment Requested

14.

Exhibit B, Rev. 1

[...***...]

*** Confidential Treatment Requested

Exhibit C-1

[...***...]

STATEMENT OF WORK

[...***...]

*** Confidential Treatment Requested

Exhibit D, Rev. 1

[...***...]

*** Confidential Treatment Requested

Exhibit E, Rev. 1

Dot Hill Quality Requirements

1.

Definitions:

1.1

“Epidemic Failure” shall mean, with respect to a Product that is delivered by Dot Hill to NetApp or a NetApp DCM, as applicable, under the Agreement, the occurrence of any of the following actual or potential failures to the extent that they (i) occur after NetApp’s FCS, (ii) can be shown to be identical and reproducible based on the occurrence of the same or substantially similar cause in the same series of such Product, (iii) impair in any material respect the use of such Product, (iv) are the result of a defect in materials or workmanship occurring no later than [...***...] following the delivery by Dot Hill of such Product to NetApp or a NetApp DCM, as applicable, and (v) are equal to or in excess of [...***...] of the total number of units of such Product obtained from any production lot or delivered to NetApp or a NetApp DCM, as applicable, during any [...***...] period:

¨ A non-conformance of the Product to the Bill of Material (“BOM”);

¨ A non-conformance to Engineering Specifications in Exhibit A, including but not limited to a mechanical and electrical non-conformance.

¨ Defects in material and workmanship, including but not limited to defects in mechanical assembly and parts thereof; and/or

¨ The non-operation of the Product, including but not limited to mechanical and electrical non-operation.

Notwithstanding the foregoing, any failure that arises or results from [...***...], shall be excluded from the definition of Epidemic Failure. For avoidance of doubt, [...***...] shall be included within the definition of an Epidemic Failure.

1.2

“Failure” shall mean, with respect to a Product that is delivered by Dot Hill to NetApp or a NetApp DCM, as applicable, under the Agreement, the occurrence of any of the following failures to the extent that they (i) occur after delivery by Dot Hill to NetApp or a NetApp DCM, as applicable, of SQA units and (ii) are the result of a defect in materials or workmanship occurring no later than [...***...] following the delivery by Dot Hill of such Product to NetApp or a NetApp DCM, as applicable:

¨ A non-conformance of the Product to the Bill of Material (“BOM”);

*** Confidential Treatment Requested

¨ A non-conformance to Engineering Specifications in Exhibit A, including but not limited to a mechanical and electrical non-conformance.

¨ A defect in material and workmanship, including but not limited to defects in mechanical assembly and parts;

¨ The non-operation of the Product, including but not limited to mechanical and electrical non-operation; or

¨ A cosmetic or workmanship non-conformance of a Product to those requirements that Dot Hill has agreed to perform for such Product as set forth in Exhibit K.

1.3	“Failure Analysis” or “FA” — Investigation of field Failures by means of diagnostic testing within a standardized test environment that is performed by Dot Hill or its service providers. Test results will identify the [...***...] assignable cause of a component’s failure where applicable.
1.4	“Root Cause Analysis” or “RCA” — Consists of Failure Analysis as described above followed by a thorough investigation by Dot Hill’s Engineering and/or Dot Hill’s suppliers to diagnose failures to the appropriate component level.
1.5	“Defective Parts Per Million” or “DPPM” — shall be the basis for determining factory integration issues. DPPM is the first pass Failure rate seen by NetApp or a NetApp DCM, as applicable, at integration. Test sample size will be defined in individual sections below. This is one metric that will be used by NetApp to rate the performance of Dot Hill.

          [...***...]

1.6	“On-Going Reliability Test” or “ORT” — shall be a test that is conducted in Dot Hill’s or a Dot Hill DCM’s factory for the purpose of monitoring Product reliability.
1.7	“Out Of Control” shall mean a condition when any of the following exist with respect to Dot Hill or a Dot Hill Designated Contract Manufacturer:

¨ DPPM exceeds the level set forth in Section 4 of this Exhibit E.

¨ Dot Hill’s cumulative yield decreases below the level set forth in Section 4 of this Exhibit E.

¨ ORT failures exceed a predetermined level that has been agreed between the parties.

*** Confidential Treatment Requested

1.8	“Stop Ship Order” – shall mean a process by which NetApp stops a released Product or other item from being shipped from Dot Hill or a Dot Hill DCM to NetApp or any NetApp DCM.
1.9	“Dead On Arrival” or “DOA” — shall mean, for purposes of this Exhibit E, a Failure of a Product which occurs within [...***...] after delivery by Dot Hill to NetApp, NetApp DCM or a NetApp Authorized Purchaser.
1.10	“Pareto” shall mean a histogram sorted from highest frequency of occurrence to lowest frequency of occurrence.
1.11	[...***...]
1.12	“Key Component Level” – A list of certain components included in a Product, which list is to be agreed upon by NetApp and Dot Hill. This list will define those critical sub-assemblies and components for which backward component traceability requirements apply. This list will include only those sub-assemblies and critical devices mutually and jointly agreed to in writing by Engineering and Operations technical teams of the parties.
2.	Test Procedures. The Products are subject to certain mutually agreed inspection test procedures by NetApp, a NetApp DCM and/or NetApp Authorized Service Providers. If a unit of Product has a Failure as determined by such mutually agreed inspection test criteria, then NetApp shall notify Dot Hill of such Failure, the parties will promptly discuss remedial actions to resolve any such Failure, and such Product may be returned by NetApp, a NetApp DCM and/or NetApp Authorized Services Providers to Dot Hill pursuant to the agreed DOA or warranty provisions, as applicable, for such Product.
3.	Inspection rights. [...***...], Dot Hill will allow NetApp to perform vendor qualifications and/or on-site source inspections at Dot Hill, [...***...]. NetApp shall provide reasonable advance written notice of its desire to perform an inspection, with at least [...***...] prior notice for routine visits and with at least [...***...] notice for Dot Hill Out of Control or Stop Ship Order situations. If an inspection or test is made on Dot Hill’s premises, [...***...], Dot Hill shall provide [...***...], NetApp with reasonable access and assistance at no additional charge.
4.	Product and Process Quality Requirements. Manufacturing and quality processes will be implemented at Dot Hill and Dot Hill’s suppliers [...***...].
	If the minimum acceptable quality level defined in the table below is not met in NetApp or a NetApp DCM’s line due to causes within the reasonable control of Dot Hill and which are not

*** Confidential Treatment Requested

otherwise attributable to NetApp, then a service fee of [...***...] will be levied on Dot Hill for each affected defective Product returned to Dot Hill during the period that such quality level is not met. [...***...]

Dot Hill will require that its Dot Hill DCM meet the minimum acceptable quality levels in the table below in the manufacturing process of the Dot Hill DCM for the Products sold by Dot Hill under this Agreement.

	First [...***...] units
	beginning with delivery
DPPM Table	of NetApp Pilot units	Thereafter
[...***...]	[...***...]	[...***...]

• Dot Hill and Dot Hill’s suppliers must be ISO 9001 certified and all manufacturing locations for the Product and its components must be identified and specified to NetApp.

• The Products and its components shall be manufactured in a clean environment with Electro Static Discharge (“ESD”), temperature and humidity controls.

• Processes for defect reduction and continuous improvement for the Products to be supplied by Dot Hill to NetApp must be established and implemented at Dot Hill and Dot Hill’s Suppliers.

• The Products must have backward component traceability from the finished Product supplied by Dot Hill to NetApp for Key Component Levels.

• All operators of a Dot Hill DCM must be fully trained for their responsible processes.

*** Confidential Treatment Requested

• Dot Hill shall pass all mutually agreed upon New Product Introduction (“NPI”) qualification steps of Failure Mode Effect Analysis (“FMEA”), Engineering Verification Test (“EVT”), Design Verification Test (“DVT”), Highly Accelerated Life Testing (“HALT”), Pilot, Design Maturity Test (“DMT”), Design For Manufacturing (“DFM”) and Design For Test (“DFT”) before going into mass production.

• Dot Hill shall perform industry standard operations such as Environmental Stress Screen (“ESS”), Highly Accelerated Stress Screen (“HASS”) and ORT to ensure a high quality Product.

• All exposed PCBA surfaces must be protected from handling damage in a mutually agreed manner.

• Dot Hill shall provide onsite Supplier Quality Engineering support to NetApp, as described in Exhibit M.

	NetApp will have the right to reject those Products that constitute a Failure. Dot Hill and NetApp will discuss any opportunities to improve DPPM levels and will mutually agree on any corrective actions.
5.	Out of Control. If an Out of Control condition occurs, NetApp reserves the right to require Dot Hill to implement [...***...].
6.	Stop Ship process

¨ NetApp will communicate a Stop Ship Order to Dot Hill in writing or by email.

¨ At NetApp’s discretion, NetApp or a NetApp DCM may chose to return any affected Product in transit or in its inventory which contains a Failure.

¨ Affected Product containing a Failure in inventory at Dot Hill will not be delivered by Dot Hill to NetApp or a NetApp DCM unless the Stop Ship Order is rescinded.

¨ Dot Hill will provide serial numbers of systems that are anticipated to be affected by the potential non-conformance mode.

¨ Dot Hill will provide urgent root cause analysis of the non-conformance in accordance with the provisions of Section 10 of this exhibit.

¨ Dot Hill will provide a Stop Ship Order release plan within [...***...] of Stop Ship Order being communicated to Dot Hill. The release plan will propose a potential process to attempt to fix the non-conformance of any affected Product and the resumption of shipments of the affected Products. The release plan will attempt to resume shipment of

*** Confidential Treatment Requested

the Product within an agreed number of days after the submission and acceptance by Network Appliance of such plan.

7.	Intentionally left blank.
8.	Intentionally left blank.
9.	Epidemic Failures. In the event of a suspected Epidemic Failure, NetApp shall promptly notify Dot Hill, and shall provide the following information, if known and as may then exist: a description of the defect, and the suspected lot numbers, serial numbers or other identifiers, and delivery dates to NetApp or a NetApp DCM of the affected defective Products. NetApp or a NetApp DCM shall deliver or make available to Dot Hill samples of the defective or potentially defective Products for testing and analysis.
	Within [...***...] days of receipt of written notice from NetApp, Dot Hill shall provide its preliminary findings to NetApp regarding the potential cause of the Epidemic Failure. Thereafter, Dot Hill shall perform RCA in accordance with Section 10 and provide the results of its RCA to NetApp, together with Dot Hill’s proposed plan for the identification of and the repair and/or replacement of the affected Products and such other reasonable and appropriate information.
	The parties shall cooperate and work together to expeditiously devise and implement a mutually acceptable corrective action program which is commercially reasonable under the circumstances and minimizes disruption to the end users and NetApp’s direct and indirect distribution channels (the “Corrective Action Program”). [...***...].
	For any such Epidemic Failure which occurs in the Products, Dot Hill shall be responsible for the following costs, expenses and liabilities under the Corrective Action Program incurred within NetApp’s service and distribution chain, including end user locations: [...***...].
10.	Field Returned Failure Analysis and Root Cause Analysis Turnaround Times. NetApp or a NetApp DCM will assign a level of urgency to each failure analysis / root cause analysis request as “routine” or “urgent”.

In a “routine” request for FA Dot Hill shall make commercially reasonable efforts to provide Failure Analysis for returned material within [...***...]. In a “routine” request for

*** Confidential Treatment Requested

	RCA Dot Hill shall make commercially reasonable efforts to provide RCA for returned material within [...***...]
	In an “urgent” request for FA Dot Hill shall use best efforts to provide Failure Analysis for returned material within [...***...]. In an “urgent” request for RCA Dot Hill shall use best efforts to provide RCA for returned material within [...***...].
	A corrective action request (“CAR”) issued to Dot Hill must be fully addressed and returned to NetApp by due date indicated in the CAR. Depending on the situation, if either party finds any difficulty in such target lead-time, NetApp, a NetApp DCM and/or Dot Hill may discuss in good faith a mutually agreeable alternative schedule on a case-by-case basis.
	[...***...]. After this warranty period, NetApp or a a NetApp DCM may request RCA of any discovered defects for such Product, and Dot Hill shall perform the requested RCA and [...***...] for such RCA activities that are requested by NetApp or a NetApp DCM, as applicable.
11.	Quality Metrics. Dot Hill will provide NetApp with quality metrics [...***...] about Dot Hill and Dot Hill’s suppliers. Metrics will include, but are not limited to:
	[...***...]
	ORT testing metrics shall be provided [...***...] and shall include, but are not limited to:
	[...***...]
12.	Component and Process Traceability. Serial numbers of key components which are included on the list of the Key Component Level must be available from Dot Hill or a Dot Hill DCM, upon

*** Confidential Treatment Requested

	written request from NetApp, in order to conduct any potential field recall by NetApp of the Products or for other purposes. Upon written request by NetApp and the provision by NetApp of all necessary information, serial number data of affected key components on the Key Component Level list, and the successful completion of key manufacturing processes for the Products that are documented below in Section 14, will be provided by Dot Hill to NetApp within [...***...] after the date of any such NetApp request. For Printed Circuit Board Assemblies (“PCBA’s”), this will include visual Quality Assurance (“QA”), PCBA cleaning/wash, ICT results, and FVT results. The Product shall have backward component traceability from the finished product for components on the Key Component Level list.
13.	ORT. Dot Hill will perform ORT testing of the Product on an ongoing basis and provide data as required in the Quality Metrics Section 11 of this Exhibit E. The parties shall meet and confer to develop agreed test procedures and sample sizes for ORT. Any changes to the agreed ORT plan are subject to mutual agreement by the parties and may involve changes to the NRE covering such ORT plan.
14.	Quality Plan. Dot Hill shall complete and adhere to the following quality plan:

¨ During the development phase of the Product, Dot Hill shall establish the following:

¨ Supplier qualifications,

¨ Critical parameters/ specifications,

¨ Assurance of critical parameter conformance, and

¨ FMEA.

¨ During the data qualification phase, Dot Hill shall perform the following:

¨ HALT test results of pre-production product,

¨ DVT test procedure and results,

¨ RDT report,

¨ Production DPPM targets of major assys, and

¨ Field DPPM targets of major assys.

¨ During the production phase, Dot Hill shall perform the following:

¨ Assure of conformance to Network Appliance Specifications,

¨ Define plan for proactive communication of problems at Dot Hill,

¨ Define Dot Hill cross functional team/ points of contact,

¨ Define a process flow definition/ capacity analysis (see sample attached below)

à	Receiving audit plan,
à	Statistical Process control of critical/ non-inspected parameters,
à	Inspection checklist for all QA locations, and
à	Out of box audit plan,

¨ Plan for isolation of failed material,

¨ Define plan/frequency of audits of Dot Hill’s suppliers,

¨ Define process for customer approval/communication of Dot Hill initiated Engineering Change Notifications (“ECNs”),

*** Confidential Treatment Requested

¨ Process for customer approval/communication of Mfg location changes,

¨ Provide Dot Hill’s ICT coverage,

¨ Provide FVT coverage, procedure,

¨ Provide serial number traceability,

¨ Provide date code tracking of key components,

¨ Provide burn-in test plan,

¨ Provide ORT test plans,

¨ Provide employee training process/ records, and

¨ Define failure analysis, RCA & CA process.

¨ Dot Hill shall provide the quality metric requirements

[...***...]

*** Confidential Treatment Requested

[...***...]

*** Confidential Treatment Requested

Exhibit F, Rev. 1

Order Replenishment and Logistics Requirements

1	PURCHASE OF PRODUCTS, FORECASTS AND LEAD-TIMES
1.1	Overview. In accordance with the terms and subject to the conditions set forth in this Agreement, Dot Hill agrees to sell the Products to NetApp and the NetApp DCMs, and NetApp and the NetApp DCMs agree to buy Products from Dot Hill. It is expressly understood that, [...***...], NetApp and the NetApp DCMs have no obligation to purchase any Products, or any minimum number of Products, hereunder. This provision shall, however, not limit, diminish or affect any obligations that NetApp or a NetApp DCM has to Dot Hill under [...***...] or Sections 1.13, 1.14 and 1.15 of this Exhibit F.
1.2	Supply Constraint and Allocation. If Dot Hill becomes aware of a potential supply constraint of Product to NetApp or a NetApp DCM, as applicable, Dot Hill will notify promptly NetApp or the NetApp DCM, as applicable, of such potential supply constraint and the parties will work together in good faith to resolve such matter.
	In the event that the supply of a Product to NetApp or a NetApp DCM under this Agreement becomes constrained and Dot Hill cannot meet NetApp’s or the NetApp DCM’s forecasted requirements for such Product during the period of the supply constraint, Dot Hill shall provide NetApp or a NetApp DCM, as applicable, during this period with [...***...], or (ii) [...***...].
	For the purpose of interpretation of the immediately preceding sentence, any units of Product that a Dot Hill DCM (a) [...***...] and (b) [...***...]. Dot Hill represents to NetApp that as of the Effective Date of this Agreement, [...***...]

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	[...***...] Dot Hill will notify promptly NetApp of any [...***...].
1.3	[ ...***... ]. Dot Hill shall provide to NetApp, after NetApp’s First Customer Shipment, [ ...***... ], as mutually agreed to by the parties, to allow for the following conditions:

• a [ ...***... ] to be delivered within [ ...***... ] of a NetApp request occurring no earlier than [ ...***... ] after the date of any previous NetApp [ ...***... ];

• a [ ...***... ] to be delivered within [ ...***... ] of a NetApp request occurring no earlier than [ ...***... ] after the date of any previous NetApp [ ...***... ]; and

• a [ ...***... ] to be delivered within [ ...***... ] of a NetApp request occurring no earlier than [ ...***... ] after the date of any previous NetApp [ ...***... ].

	Those units of Products that Dot Hill maintains for delivery or delivers to NetApp as part of the AutoSwap process described in Attachment 2 to this Exhibit F shall count toward the attainment by Dot Hill [ ...***... ].
	Also, if Dot Hill is unable to achieve such [ ...***... ] due to a Force Majeure Event or the failure by any vendor or supplier operating under any NetApp supply arrangement to deliver on a timely and sufficient basis to Dot Hill any drives or components which NetApp requires for incorporation into Products that are to be made and sold by Dot Hill to NetApp, then Dot Hill’s [ ...***... ].
1.4	[ ...***... ]. In the event that NetApp or a NetApp DCM desire to [ ...***... ] Products covered under Purchase Orders it has placed with Dot Hill, then NetApp or a NetApp DCM, as applicable, shall inform Dot Hill immediately in writing of its desires and provide accurate and complete information to Dot Hill of its [ ...***... ]. In the event of any [ ...***... ], then Dot Hill shall undertake some or all of the following mutually agreed actions for the affected Products:

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     (i) except as otherwise provided in Section 1.13, [ ...***... ];

     (ii) [ ...***... ];

     (iii) promptly [ ...***... ];

     (iv) discontinue any [ ...***... ] provided, however, that NetApp or the NetApp DCM [ ...***... ];

     (v) notify Dot Hill’s DCM and its suppliers to [ ...***... ], and use best efforts to have Dot Hill’s DCM [ ...***... ];

     (vi) use best efforts to have the Dot Hill DCM [ ...***... ];

     (vii) at NetApp’s or a NetApp DCM’s written request and with the assistance of NetApp or a NetApp DCM, as applicable, use commercially reasonable efforts to [ ...***... ];

     (viii) perform or have performed a [ ...***... ], and supply to NetApp or a NetApp DCM, as applicable, reasonably requested documentation of such [ ...***... ] after completion thereof.

Notwithstanding anything to the contrary, Dot Hill shall not be required to continue any of the activities described above beyond a period of [ ...***... ] after the date on which a [ ...***... ] occurs.

1.5 Forecasts. NetApp shall submit forecasts to Dot Hill [...***...], and more frequently on an as-needed basis. These forecasts will provide visibility into NetApp’s forecasted supply demand for Products for [...***...], with updates made to such forecasts [...***...]. Within [...***...] after receipt of the forecast, Dot Hill shall provide the originator of the forecast, whether NetApp or the NetApp DCM, as applicable, with an acknowledgement of the forecast (“Supply Availability”) for the requested quantity of the Products in the forecast or propose a revised quantity or schedule

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for supply of the Products. If a revised quantity or schedule is proposed by Dot Hill, the parties shall confer in good faith and attempt in good faith to agree upon a final Supply Availability for each applicable [...***...].

1.6	Submittal of Purchase Orders. NetApp and the NetApp DCMs shall initiate purchases of Products by submitting to Dot Hill [...***...] blanket Purchase Orders via e-mail to a designated Dot Hill email address based upon the mutually agreed forecast. These Purchase Orders will be submitted by NetApp and the NetApp DCMs to Dot Hill at least [...***...] prior to the beginning of each fiscal NetApp quarter. All [...***...] blanket Purchase Orders shall (a) specify the quantities, applicable Total Price, payment terms, and shipping instructions for each of the Products; and (b) refer to and be governed by the terms and conditions of this Agreement. Blanket Purchase Orders shall be updated, as needed, to reflect agreed-upon Price adjustments and agreed Products revision changes (including, but limited to, agreed engineering changes and deviations).
1.7	Confirmation of Purchase Orders. Dot Hill shall confirm its receipt of the blanket Purchase Order by notifying NetApp or a NetApp DCM, as applicable, electronically within [...***...] after the receipt of the Purchase Order. Dot Hill shall be required to accept all Purchase Orders that conform to a mutually agreed forecast. Dot Hill shall notify NetApp or a NetApp DCM, as applicable, of its acceptance or rejection of the blanket Purchase Order by facsimile or electronic mail within [...***...] after its receipt of NetApp’s or a NetApp DCM’s Purchase Order.
1.8	Kanban Replenishment Process

1.8.1 The “Kanban Replenishment Process” is defined as a [...***...] issued by NetApp or a NetApp DCM, as applicable, to Dot Hill, which is managed by Dot Hill, to request [...***...].

1.8.1.1 [...***...]

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[...***...]

1.8.1.2 [...***...]

[...***...]

1.8.1.3 [...***...]

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[...***...]

1.8.1.4 [...***...]

[...***...]

1.8.1.5 NetApp or a NetApp DCM, as applicable, may require [...***...] as needed. If weekend or staggered deliveries are required, then NetApp or a NetApp DCM, as applicable, shall provide notice to Dot Hill by [...***...].

1.8.2 The Kanban replenishment process will be managed within the NetApp or a NetApp DCM manufacturing location and will issue [...***...]. A representative of Dot Hill or a Dot Hill DCM will monitor the process to manage and identify the quantity of [...***...] in order to satisfy the requirements of the Kanban Replenishment Process. The status of the [...***...] by Dot Hill or a Dot Hill DCM in a [...***...].

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1.8.3	The average expected Kanban [...***...], however, [...***...].
1.8.4	For [...***...] Kanban needs, NetApp requires Dot Hill to have a [...***...]. The Dot Hill [...***...].
1.8.5	Dot Hill’s [...***...].
1.8.6	Dot Hill and NetApp or a NetApp DCM, as applicable, will mutually agree on all [...***...]. All Products must be [...***...] unless otherwise specified by NetApp or a NetApp DCM, as applicable, and must be [...***...] in Attachment 1. Upon each [...***...] back to Dot Hill. Dot Hill is also responsible for [...***...].

1.9	Notification of [...***...]. In the event that Dot Hill is unable to support the agreed Kanban Replenishment Process [...***...] then Dot Hill shall notify NetApp or a NetApp DCM, as applicable, before the [...***...].
1.10	Changes to Purchase Orders. NetApp or a NetApp DCM, as applicable, shall provide notice to Dot Hill of any changes or cancellations to blanket Purchase Orders that NetApp desires. Dot Hill shall notify NetApp or a NetApp DCM, as applicable, of acceptance or rejection of change orders within [...***...] after receipt of NetApp’s or a NetApp DCM’s notification of change or change order request.
1.11	Notice of [...***...]. Dot Hill shall immediately notify NetApp and the NetApp DCM, as applicable, in writing of any anticipated [...***...] as requested by NetApp or the NetApp DCM, as applicable, stating the reason [...***...]. If Dot Hill’s anticipated [...***...], then Dot Hill shall, upon request of NetApp or the NetApp DCM, as applicable, [...***...]

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	[...***...].
1.12	Unanticipated Consumption. If the consumption rate for the current month is greater than that described under the [...***...], Dot Hill shall use commercially reasonable efforts to support the greater demand provided, however, that the parties have mutually agreed in advance upon the [...***...].
1.13	Rescheduling. Each party will attempt to identify and notify the other party of any Excess Material, as defined below, [...***...]. For Products whose delivery is rescheduled later than [...***...] from the original anticipated delivery date to NetApp or a NetApp DCM, as applicable, [...***...], provided these Products were manufactured pursuant to an accepted Purchase Order or manufactured to satisfy NetApp’s or the NetApp DCM’s upside requirements. On the [...***...], NetApp or a NetApp DCM, as applicable, will take Excess Material or Dot Hill will [...***...] on and after such [...***...] and determined based on the Dot Hill [...***...]. NetApp or a NetApp DCM, as applicable, will use its best efforts to clear Excess Material at [...***...] within a maximum period of [...***...]. If any Excess Material is not cleared within such [...***...] period, a non-cancelable Purchase Order to buy all such Excess Material shall be issued by NetApp or a NetApp DCM, as applicable, to Dot Hill prior to the end of such period. NetApp or a NetApp DCM, as applicable, will [...***...] after the end of such [...***...].
1.14	Cancellation of Purchase Orders. Upon cancellation of any Purchase Orders and after the completion by Dot Hill of the agreed upon mitigation efforts in Section 1.4 that are associated with such cancellation, Dot Hill will submit to NetApp or a NetApp DCM, as applicable, a claim for an amount equal to the sum of:

(1)	the amount for [ ...***... ];
(2)	the amount for [ ...***... ]; and

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(3) the amount for [ ...***... ].

NetApp or a NetApp DCM, as applicable, shall not be responsible for any liability for those units of Products which are not (i) covered under Purchase Orders accepted by Dot Hill, or (ii) manufactured by or for Dot Hill to meet NetApp’s or a NetApp DCM’s [ ...***... ]. Under no circumstances shall NetApp or a NetApp DCM be liable for [ ...***... ]. Also, NetApp’s or a NetApp DCM’s liability for [ ...***... ] will be limited to those ordered within agreed lead times that Dot Hill has established and agreed to with third parties for use in the production of Products for intended supply to NetApp or a NetApp DCM, as applicable. Dot Hill has notified NetApp of such lead times. These lead times are included in Exhibit B, and will be updated from time to time by Dot Hill.

NetApp or a NetApp DCM, as applicable, shall acknowledge in writing Dot Hill’s claim within [ ...***... ] after NetApp’s or a NetApp DCM’s receipt thereof, and pay Dot Hill on any such claim made under this section within [ ...***... ] after NetApp’s or a NetApp DCM’s receipt thereof. NetApp or a NetApp DCM, as applicable, shall be entitled to audit the details behind any claim that may be made by Dot Hill under this section. If an audit reveals an overpayment by NetApp or a NetApp DCM of any such claim, then Dot Hill will immediately refund or credit such overpayment to NetApp or a NetApp DCM, as applicable, and, if such overpayment is in excess of [ ...***... ] of such claim, reimburse NetApp or a NetApp DCM, as applicable, for the actual costs incurred in the performance of the audit.

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1.15	Expiration or Earlier Termination. Upon the expiration or earlier termination of this Agreement, Dot Hill will provide to NetApp and a NetApp DCM, as applicable, a summary of descriptions and quantities of Products, including any FRU’s, available at [...***...] locations which are maintained by or for Dot Hill. Upon written request by NetApp or a NetApp DCM, as applicable, Dot Hill will perform mitigation efforts for a period of [...***...] by attempting to sell the components Products, including any FRU’s, to other parties at then-current prices available to NetApp or a NetApp DCM, as applicable, under the Agreement outside of units to be retained for warranty coverage under Section 23 of the Agreement. Upon the expiration of such [...***...] period and the completion of any such requested efforts, Dot Hill will inform NetApp and the NetApp DCM, as applicable, of the amount of units remaining, including any FRUs, at such time and NetApp or a NetApp DCM, as applicable, will issue a non-cancelable Purchase Order to Dot Hill for such units, and will purchase such units at their then-current price for immediate delivery to NetApp or the NetApp DCM, as applicable.
2.	END OF LIFE NOTIFICATION
2.1	Subject to the provisions of the Agreement, Dot Hill agrees to manufacture and supply to NetApp or a NetApp DCM, as applicable, the Products, and NetApp or the NetApp DCM, as applicable, agrees to procure from Dot Hill the Products, during the term of this Agreement. Dot Hill shall provide NetApp and the NetApp DCM, as applicable, written notification of its intention to assign the Products to an End of Life Status (“Notice of EOL”) at least [...***...] prior to the date upon which said Products shall enter an EOL status. NetApp and a NetApp DCM shall be allowed to place final orders for all Products with Dot Hill [...***...] period. Dot Hill shall honor the final Purchase Orders, notifying its suppliers of the EOL status and managing final component purchases such that pricing for the final Purchase Orders shall be [...***...].
3.	LOGISTICS
3.1	The NetApp logistics requirements for the Product are as follows:

3.1.1	Dot Hill will [...***...] following the Kanban Replenishment Process described in Section 1.8 from the Dot Hill [...***...]. The [...***...] will be managed and owned by Dot Hill or Dot Hill’s DCM.
3.1.2	Dot Hill will own the Products until the [...***...], which will occur at the time such Products are [...***...].

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3.1.3	All [ ...***... ] costs are included in the Total Price of each of the Products, as documented in Exhibit B.
3.1.4	NetApp requires an EIA (i.e., Electronics Industry Association) label on all inbound material delivered to NetApp or to any NetApp designated manufacturing location. All packaging and labeling of Products to be delivered by Dot Hill to NetApp or a NetApp DCM shall comply to the NetApp Inbound Packaging Specifications. (See provisions in Attachment 1, which is attached below to this Exhibit F)

4.	REVERSE LOGISTICS
4.1	Returned Products. For units of Product returned by NetApp or a NetApp DCM to Dot Hill that do not conform to the warranty provided by Dot Hill to NetApp in Section 23 of the base terms of the Agreement, Dot Hill will perform its warranty responsibilities as described therein, upon Dot Hill’s authorization for the return of such units of Product. Dot Hill’s response to a properly submitted request for authorization for the return of Products that do not conform to such warranty shall be made within [ ...***... ] after Dot Hill’s receipt of any such request. Upon completion of its warranty responsibilities for the repair or replacement of a Product, Dot Hill will return back a Product, freight prepaid, to NetApp or a NetApp DCM.
4.2	Credit and Re-Invoice Process. Solely to track defective units of Products returned by NetApp or a NetApp DCM to Dot Hill under the warranty provisions in Section 23 of the base terms of the Agreement and the subsequent delivery by Dot Hill of repaired or replacement Products therefore, Dot Hill will: (i) issue a credit to NetApp or a NetApp DCM upon Dot Hill’s authorization for the return of such units; and (ii) re-invoice NetApp or a NetApp DCM in full for the repaired or replacement units of Products delivered by Dot Hill.
4.3	AutoSwap Process. Notwithstanding any inconsistent provisions in Sections 4.1 and 4.2 above, the AutoSwap process in Attachment 2 to this Exhibit F will apply to Products that meet all of the following requirements: (i) they are purchased by NetApp from Dot Hill under this Agreement, (ii) they are delivered by Dot Hill to the NetApp delivery locations [ ...***... ] or such other mutually agreed NetApp locations, (iii) they fail to conform to the warranty provided by Dot Hill as determined by NetApp prior to their intended delivery to third parties, and (iv) they are returned to Dot Hill within [ ...***... ] after NetApp obtains knowledge of a warranty non-conformance for such Products.
4.4	Induced Damage to Products. If Dot Hill reasonably determines that a Product which is returned by NetApp or a NetApp DCM to Dot Hill has customer-induced or NetApp or a NetApp DCM production-induced damage arising from or resulting in a non-conformance of Products to the warranty provided by Dot Hill under this Agreement, then Dot Hill will notify NetApp or a NetApp DCM of such

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	matter, and invoice to NetApp or a NetApp DCM the material and labor costs that Dot Hill incurs for out-of-warranty repair for such units of Products.
4.5	Packaging. Each Product that is authorized for return by Dot Hill will be packaged by NetApp or a NetApp DCM in a mutually agreed manner and returned to Dot Hill [ ...***... ].
4.5	Address Changes. Dot Hill may change, modify or update the address of the local Dot Hill hub, at any time and from time to time, upon written notice to NetApp and a NetApp DCM provided, however, that the [hub location requirements in Section 1.8.4] of this Exhibit F are met.

Attachment 1

[...***...]

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Attachment 2
AutoSwap Process

Purpose: To define the methods and responsibilities relating to the exchange of defective purchased Products, using the AutoSwap process.

Scope: This process pertains to those Products that meet the following requirements: (i) they are purchased by NetApp from Dot Hill under this Agreement, (ii) they are delivered by Dot Hill to the [ ...***... ] or such other mutually agreed NetApp locations, (iii) they fail to conform to the warranty provided by Dot Hill as determined by NetApp prior to their intended delivery to third parties, and (iv) they are returned to Dot Hill within [ ...***... ] after NetApp obtains knowledge of a warranty non-conformance for such Products.

Procedure: The following steps provide guidelines for a generic AutoSwap process and may be modified, through mutual agreement, to accommodate the specific needs of either NetApp or Dot Hill.

1. All Products that have been purchased by NetApp and are eligible for return in the AutoSwap process must fall within the above-described Scope and reside in NetApp’s Materials Review Board (”MRB”), have an associated Incoming Material Discrepancy Report (“IDR”) and have been dispositioned for return to Dot Hill’s designated location.

2. Upon completion of the dispositioning process, the MRB clerk will forward the IDR list to the respective buyer that is responsible for acquiring Products for NetApp hereunder.

3. The buyer that is responsible for acquiring Products for NetApp hereunder will solicit a RMA number from Dot Hill and generate a Purchase Order for [ ...***... ] that fall within the above-described Scope from NetApp inventories to Dot Hill.

4. Dot Hill will replace the discrepant material through a [ ...***... ] which will take place at a mutually agreed predetermined location.

5. Delivery of the Products for AutoSwap will occur within the context of a predetermined [ ...***... ] schedule or as negotiated on a case-by-case basis.

6. Dot Hill will assess quality for the defective Products and the parties will mutually agree on [ ...***... ] for the defective Products. All [ ...***... ] will be completed within [ ...***... ] from the date of failure analysis reporting.

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Exhibit G

NetApp Customer Support Requirements

1.	RMA Requirements
1.1	For the purpose of the construction and interpretation of this Exhibit, the term “Authorized Service Provider” shall mean a third party that performs repair services for NetApp on returned Products that were purchased by NetApp from Dot Hill under this Agreement and sold by NetApp to a NetApp customer.
1.2	The parties shall jointly define a RMA Process workflow among NetApp, NetApp’s Authorized Service Provider(s) and Dot Hill.
1.3	Dot Hill shall provide to NetApp mutually agreed FRU replacement training, and the Parties shall mutually agree upon handling requirements for Field Replacement Units (“FRUs”).
	Dot Hill shall provide NetApp all FRU packaging specifications, packaging test plans, packaging test results and packaging suppliers. As NetApp will have Authorized Service Providers in [...***...], NetApp requires that the sourcing companies have supply capability in [...***...].
1.4	If Dot Hill ceases to provide repair services for those Products acquired from Dot Hill by NetApp, then Dot Hill shall [...***...], and NetApp and NetApp’s Authorized Service Provider(s) may [...***...]. NetApp acknowledges and agrees that such Dot Hill Technology is [...***...].
1.5	The Parties shall define a RMA test process and failure criteria for the Products. NetApp may return Products that NetApp or its Authorized Service Provider(s) have tested (via a standard troubleshooting process to be mutually agreed) and determined to fail the agreed failure criteria.
1.6	NetApp or its Authorized Service Provider(s) will screen Products for failures in accordance with a mutually-agreed test process prior to delivery of units of Products with failures to Dot Hill.

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1.7	If Dot Hill receives Products that Dot Hill determines are NTF, i.e., No Trouble Found, after having been screened by NetApp or its Authorized Service Provider(s) of [...***...], then the parties will review the test processes used for screening used by NetApp, it Authorized Service Provider(s), Dot Hill and the Dot Hill DCM to identify failures and take appropriate actions in a prompt and timely manner to attempt to [...***...].
1.8	NetApp will cause an Authorized Service Provider(s) to allow Dot Hill to perform on-site audits of the Authorized Service Provider’s operations to determine whether it has performed its responsibilities in accordance with the mutually agreed test process.
1.9	Dot Hill shall replace rather than refurbish any Product that has been properly returned [...***...], and retire such RMA Product permanently.
1.10	The parties shall jointly develop a specification for cosmetic defects on RMA returns.
1.11	As of the Effective Date, the repair locations for Product delivered under RMA are as follows:

[...***...]

	A party may change its applicable location. In the event of such change, the party making such change will notify the other.
1.12	For RMA returns under this Agreement, unless otherwise agreed by the parties, repaired or replacement Products shall be delivered to NetApp at the then-current engineering change order (‘ECO”) level.
2.	Dead on Arrival

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2.1	The parties shall jointly define a Dead on Arrival (“DOA”) policy and obligation (including DOA replacement lead-time) between NetApp and Dot Hill.
2.2	The parties shall jointly define DOA Process workflow between NetApp and Dot Hill.
2.3	Dot Hill shall accept RMAs associated with any DOA Product acquired by NetApp from Dot Hill under this Agreement for a period of [...***...]. Dot Hill shall [...***...] to NetApp and NetApp Designated Contract Manufacturers with [...***...].
3.	End of Life Support
3.1	Dot Hill End of Life (“Dot Hill EOL”) begins the day Dot Hill no longer makes the Product available to its customers.
3.2	NetApp End of Life (“NetApp EOL”) begins the day NetApp no longer makes the Product acquired from Dot Hill available to NetApp’s customers.
3.3	Product repair, RCA and RMA support outside of the applicable warranty for a Product purchased by NetApp under the Agreement shall, upon request by NetApp, be provided on a [...***...] at a rate to be mutually agreed by the parties. Post-Dot Hill EOL support for Products acquired under this Agreement from Dot Hill beyond the applicable warranty period [...***...].
3.4	NetApp will [...***...] for a mutually agreed number of Products. For avoidance of doubt, NetApp shall not be obligated to [...***...]. Dot Hill will provide [...***...] information to NetApp as to the status of [...***...].
3.5	Upon written request by Dot Hill, NetApp will [ ...***... ], all then-outstanding [ ...***... ]. Prior to any such [ ...***... ], Dot Hill will:

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     (i) use commercially reasonable efforts to [ ...***... ];

     (ii) use best efforts to have Dot Hill’s DCM attempt [ ...***... ]; and

     (iii) at NetApp’s written request and with the assistance of NetApp, use commercially reasonable efforts to [ ...***... ].

Dot Hill shall initiate the foregoing [...***...] before NetApp has any obligation to [...***...].

3.6 Limitations on Out-of-Warranty Responsibilities. Notwithstanding anything to the contrary, Dot Hill shall not be in breach of any obligations it may have to NetApp under this Agreement to [...***...] arises or results from the inability by Dot Hill to [...***...].

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Exhibit H-1
[...***...]

Exhibit C-1 (the “SOW”) specifies the NRE work that will be performed by Dot Hill for the [...***...] Unique Product. NetApp shall pay Dot Hill for such NRE work based on the total amount of hours spent by Dot Hill’s employees and/or subcontractors in connection with the performance of such NRE work, together with any travel, lodging and other incidental travel expenses incurred to perform such work. The mere payment by NetApp to Dot Hill for NRE work performed by Dot Hill will [...***...]. The total amount of [...***...].

Dot Hill shall be compensated for the performance of such NRE work at a [...***...] rate of [...***...]. Such rate shall be subject to change by Dot Hill on and after [...***...]. NetApp shall also reimburse Dot Hill for all reasonable travel, lodging and incidental expenses incurred to perform such work. After the end of each [...***...], Dot Hill will provide to NetApp a brief description of the NRE performed, the names of individuals who performed such NRE work, the amount of hours spent and a summary of any incurred expenses related to such NRE work, together with an invoice(s) therefore. NetApp will pay Dot Hill on such invoice(s) pursuant to the payment terms in the Agreement.

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Exhibit N, Rev. 1

List of NetApp Designated Technology

What	Comment
[...***...]	[...***...]

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Exhibit P, Rev. 1

[...***...]

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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: November 9, 2006

/s/ DANA W. KAMMERSGARD

Dana W. Kammersgard

Chief Executive Officer and President

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Hanif I. Jamal, 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: November 9, 2006

/s/ HANIF I. JAMAL

Hanif I. Jamal

Chief Financial Officer and Treasurer

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 Hanif I. Jamal, 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 September 30, 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 9^th day of November, 2006.

/s/ DANA W. KAMMERSGARD	/s/ HANIF I. JAMAL
Dana W. Kammersgard	Hanif I. Jamal
Chief Executive Officer	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.