<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
August 2, 1999
---------------------------------
Date of Report
(Date of earliest event reported)
DOT HILL SYSTEMS CORP.
(Exact name of registrant as specified in its charter)
New York 001-13317 13-3460176
--------------- ------------ -------------------
(State or other (Commission (IRS Employer
jurisdiction of File Number) Identification No.)
incorporation)
6305 El Camino Real Carlsbad, California 92009-1606
----------------------------------------------------
(Address of registrant's principal executive offices)
(760) 931-5500
--------------
(Registrant's telephone number, including area code)
<PAGE>
Item 7. Financial Statements and Exhibits.
This Form 8-K/A amends Item 7 of the Current Report on Form 8-K
(Commission File No. 001-13317) filed by the Registrant on August 6, 1999, by
providing the financial information required as set forth below.
(a) Financial Statements of Business Acquired.
The financial statements of Artecon, Inc. ("Artecon") were
previously filed for the periods specified in Rule 3-05(b) of Regulation S-X as
part of the Registration Statement on Form S-4, Commission FIle No. 333-80395
(the "S-4"), originally filed by the Registrant on June 10, 1999 and declared
effective as of July 8, 1999. The S-4 is incorporated herein by reference.
(b) Pro Forma Financial Information.
The pro forma financial information required to be filed
pursuant to Article 11 of Regulation S-X was previously filed as part of the
S-4.
The merger of the Registrant and Artecon was accounted for as
a pooling-of-interests transaction. Accordingly, the Registrant's consolidated
financial statements have been retroactively restated to reflect the Merger, and
are attached hereto as Exhibit 99.2.
(c) 10.1 Merger Agreement, dated as of April 29, 1999,
between Box Hill Systems Corp., BH Acquisition Corp.,
and Artecon, Inc.**
24.1 Consent of Arthur Andersen, LLP
24.2 Consent of Deloitte & Touche, LLP
99.1 Dot Hill Systems Corp. Press Release dated
August 3, 1999.**
99.2 Restated Financial Statements of Dot Hill Systems Corp.
** Previously filed
<PAGE>
SIGNATURE
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 hereunto duly authorized.
DOT HILL SYSTEMS CORP.
By: /s/ James L. Lambert
James L. Lambert
Co-Chief Executive Officer
Date: September 30, 1999
2
<PAGE>
Dot Hill Systems Corp.
Selected Supplemental Financial Data
The following data is presented on a supplemental basis to reflect the
retroactive restatement of the financial statements of Dot Hill Systems Corp.,
formerly Box Hill Systems Corp. ("Box Hill"), for its merger with Artecon, Inc.
("Artecon") on August 2, 1999 (the "Merger"), which was accounted for using the
pooling-of-interests method. Subsequent to the Merger, the combined Company
changed its name to Dot Hill Systems Corp. ("Dot Hill" or the "Company"). These
supplemental financial statements do not include estimated charges related to
the Merger, which will be charged to expense in the quarter ended September 30,
1999. The selected supplemental financial data has been derived from the
Company's audited supplemental financial statements for the years ended December
31, 1998, 1997 and 1996 and from the Company's unaudited financial statements
for the six months ended June 30, 1999 and 1998 and for the years ended December
31, 1995 and 1994. Operating results for the six months ended June 30, 1999 are
not necessarily indicative of the results that may be expected for the entire
year ending December 31, 1999. These financial statements combine the results of
operations of Box Hill for each of the years ended December 31, 1998, 1997,
1996, 1995 and 1994 and for the six-month periods ended June 30, 1999 and 1998
with the results of operations of Artecon for the years ended March 31, 1999 and
1998, March 29, 1997, March 30, 1996 and March 25, 1995 and for the six-month
periods ended March 31, 1999 and 1998, respectively, and the balance sheets of
Box Hill as of their calendar year ends with that of Artecon as of their fiscal
year ends. The following selected supplemental consolidated financial data set
forth below is only a summary and should be read in conjunction with the
"Supplemental Management's Discussion and Analysis of Financial Condition and
Results of Operations," the Company's supplemental audited financial statements,
the notes thereto, and the other financial and statistical information included
herein.
(continued)
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended
June 30, Year Ended December 31,
--------------------- ------------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
--------- --------- --------- --------- --------- --------- -------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C>
Income statement data:
Net revenue............................ $ 65,749 $ 76,531 $ 168,355 $ 136,684 $ 105,344 $ 87,397 $ 103,065
Cost of goods sold..................... 43,344 53,710 109,764 96,473 75,419 58,784 71,815
--------- --------- --------- --------- --------- --------- ---------
Gross profit...................... 22,405 22,821 58,591 40,211 29,925 28,613 31,250
--------- --------- --------- --------- --------- --------- ---------
Operating expenses:
Sales and marketing.................. 12,962 14,123 34,839 18,121 12,968 10,078 8,497
Engineering and product development 3,716 4,273 9,946 5,523 4,463 3,039 2,554
General and administrative........... 5,735 4,854 9,981 7,049 4,011 3,927 3,146
Shareholder officers' compensation... -- -- 1,275 7,538 6,347 9,067 15,174
Acquired in-process research and
development costs ................. -- 14,500 -- 18,200 -- -- --
Restructuring expenses............... -- -- 1,404 -- -- -- --
Write-down of intangible assets...... 287 -- 867 -- -- -- --
--------- --------- --------- --------- --------- --------- --------
Total operating expenses.......... 22,700 37,750 58,312 56,431 27,789 26,111 29,371
--------- --------- --------- --------- --------- --------- ---------
Operating income (loss)........... (295) (14,929) 279 (16,220) 2,136 2,502 1,879
Interest (expense) income, net....... 403 406 906 (139) (138) (33) (62)
Other income (expense)............... 396 347 395 (124) (10) -- --
Gain (loss) on foreign currency
translations, net ................. (12) 21 (14) (141) 45 -- --
---------- --------- ---------- ---------- --------- --------- --------
Income (loss) before income taxes.... 492 (14,155) 1,566 (16,624) 2,033 2,469 1,817
Income taxes......................... 156 49 982 (2,394) 566 847 538
--------- --------- --------- --------- --------- --------- ---------
Net income (loss).................... $ 336 $ (14,204) $ 584 $ (14,230) $ 1,467 $ 1,622 $ 1,279
========= ========= ========= ========= ========= ========= =========
Basic net income (loss) per share.... $ .01 $ (.62) $ .03 $ (1.06) $ .12 $ .14 $ .11
========= ========= ========= ========= ========= ========= =========
Diluted net income (loss) per share.. $ .01 $ (.62) $ .02 $ (1.06) $ .10 $ .12 $ .10
========= ========= ========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
As of June 30, ---------------------------------------------------------
1999 1998 1997 1996 1995 1994
---------- --------- --------- --------- --------- -------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance sheet data:
Cash, cash equivalents and short-
term investments ............... $ 62,946 $ 59,807 $ 58,194 $ 1,740 $ 4,271 $ 2,336
Working capital................... 81,017 78,867 74,259 32,510 14,041 15,580
Total assets...................... 126,872 127,030 131,162 14,879 28,327 29,911
Long-term debt.................... 11,963 11,908 10,484 2,921 2,941 2,500
Shareholders' equity.............. 81,494 79,964 78,227 13,866 12,663 11,464
</TABLE>
2
<PAGE>
Dot Hill Systems Corp.
Supplemental Management's Discussion And Analysis of
Financial Condition And Results Of Operations
Overview
Dot Hill Systems Corp. ("Dot Hill" or the "Company") designs, manufactures,
markets and supports high performance data storage systems for the open systems
computing environment. In the United States, the Company employs a direct
marketing strategy aimed at data-intensive industries which, to date, include
financial services, telecommunications, internet service providers, multimedia,
healthcare, government/defense and academia. The Company's international
strategy is to sell directly to end users, when possible, and to use
distributors. The Company focuses on providing storage solutions to high-end
customers, primarily in the UNIX, Windows NT and Novell environment. The
Company's strategy is to leverage its expertise as a company focused exclusively
on storage solutions.
Effective August 2, 1999, Box Hill Systems Corp. ("Box Hill") and Artecon, Inc.
("Artecon") completed a Merger ("the Merger") in which the two companies were
merged in a tax-free, stock-for-stock transaction. The Merger will be accounted
for as a pooling-of-interests. The combined Company changed its name to Dot Hill
Systems Corp. Under the terms of the merger agreement, Box Hill issued 8,734,523
shares of its Common stock to the former Artecon shareholders, representing .4
shares of Box Hill Common stock in exchange for each share of Artecon Common
stock outstanding. Additionally, Artecon's convertible preferred A shares were
converted into 719,037 shares of Box Hill's Common stock. The historical
financial statements of the Company have been restated on a supplemental basis
to reflect the Merger. The accompanying supplemental consolidated financial
statements do not include estimated charges related to the Merger, which will be
charged to expense in the quarter ended September 30, 1999.
During fiscal 1997, Artecon and Storage Dimensions, Inc. (SDI) completed a
reverse merger whereby SDI acquired Artecon for legal and tax purposes. For
financial reporting purposes, the SDI merger was accounted for as an acquisition
of SDI by Artecon, and, as such, the historical financial results of Artecon for
all years prior to the SDI merger, which are included within the accompanying
supplemental consolidated financial statements, are those of Artecon. The
SDI/Artecon combination was accounted for as a purchase. Additionally, in August
1997, Artecon acquired substantially all of the assets and liabilities of
Falcon. The acquisition was accounted for as a purchase.
The Company's manufacturing operations consist primarily of the assembly and
integration of components and subassemblies into the Company's products, with
certain of those subassemblies manufactured by independent contractors. The
Company's operations are primarily conducted from its facilities in California
and New York City. Generally, the Company extends to its customers the
warranties provided to the Company by its suppliers. To date, the Company's
suppliers have reimbursed the majority of the Company's warranty
3
<PAGE>
costs. On a quarterly and annual basis the Company's gross margins have been and
will continue to be affected by a variety of factors, including competition,
product configuration, product mix, the availability of new products and product
enhancements, and the cost and availability of components.
Competitive pricing pressures exist in the data storage market, and have had and
may in the future continue to have an adverse effect on the Company's revenue
and earnings. The Company believes that pricing pressures are likely to continue
as competitors develop more competitive product offerings.
Box Hill completed an initial public offering of its Common stock on September
16, 1997. The offering consisted of the sale of 5,500,000 shares of Common stock
at $15.00 per share, of which 3,300,000 were issued and sold by Box Hill and
2,200,000 shares were sold by individuals who were the founders and sole
shareholders of Box Hill prior to the initial public offering. Additionally,
825,000 shares of Common stock were purchased from Box Hill at $15.00 per share
by the underwriters upon the exercise of an over-allotment option. The net
proceeds to Box Hill, after deducting estimated underwriting discounts and
offering expenses, were approximately $56.6 million.
4
<PAGE>
Results of Operations
<TABLE>
<CAPTION>
Six Months
Ended
June 30, Year Ended December 31,
---------------------- -------------------------------
1999 (1) 1998 1998 (1) 1997 1996
---------- ---------- ----------- ---------- --------
<S> <C> <C> <C> <C> <C>
Net Value ....................................... 100% 100.0 100% 100.0 100%
Cost of goods sold............................... 65.9 70.2 65.2 70.6 71.6
-------- -------- -------- -------- --------
Gross Profit ............................. 34.1 29.8 34.8 29.4 28.4
-------- -------- -------- -------- --------
Operating Expenses:
Sales and marketing........................... 19.7 18.5 20.7 13.3 12.3
Engineering and product development 5.7 5.6 5.9 4.0 4.3
General and administrative.................... 8.7 6.3 5.9 5.2 3.8
Shareholder officers' compensation............ -- -- .8 5.5 6.0
Acquired in-process research and
development costs ......................... -- 18.9 -- 13.3 --
Restructuring expenses........................ -- -- .8 -- --
Write-down of intangible assets............... .4 -- .5 -- --
-------- --------- -------- --------- --------
Total operating expenses........................ 34.5 49.3 34.6 41.3 26.4
-------- -------- -------- -------- --------
Operating income (loss)......................... (.4)% (19.5)% .2% (11.9)% 2.0%
======== ======== ======== ======== ========
</TABLE>
(1) As a result of the Merger between Box Hill and Artecon and the resulting
change in Artecon's fiscal year-end, the results of Artecon for the three
months ended March 31, 1999, which are included in Dot Hill's results of
operations for the year ended December 31, 1998, are also included in Dot
Hill's results of operations for the six months ended June 30, 1999.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Net Revenue
Net revenue was approximately $65.7 million for the six months ended June 30,
1999, representing a decrease of 14.1% from approximately $76.5 million for the
six months ended June 30, 1998. The decrease primarily resulted from a decrease
in volume of sales to all market segments served by the Company, coupled with
price reductions. For the six months ended June 30, 1999, net revenue from sales
of Fibre Channel and Storage Area Network (SAN) networking equipment increased,
while net revenue from sales of legacy storage products, RAID products and
back-up products decreased.
5
<PAGE>
Gross Profit
Gross profit decreased $.4 million to $22.4 million for the six months ended
June 30, 1999, from $22.8 million for the comparable period of 1998, primarily
as a result of lower revenue. As a percentage of net revenues, gross profit
increased from 29.8% to 34.1%. The increase is primarily due to larger
provisions for inventory obsolescence at Artecon in the 1998 period, which
adversely effected margins.
Sales and Marketing
Sales and marketing expenses consist primarily of salaries and commissions,
advertising and promotional costs and travel expenses. Sales and marketing
expenses decreased 7.8 % to $13.0 million for the six months ended June 30, 1999
from $14.1 million for the six months ended June 30, 1998. The decrease was
primarily due to a decrease in sales commissions based on the decrease in net
revenue, partially offset by an increase in the direct sales force and field
service staff. As a percentage of net revenue, sales and marketing expenses
increased slightly to 19.7% for the six months ended June 30, 1999 from 18.5%
for the comparable period of 1998.
Engineering and Product Development
Engineering and product development expenses consist primarily of employee
compensation, engineering equipment and supply expenses and fees paid for
third-party design services. To date, no software development expenses have been
capitalized since the period between achieving technological feasibility and
completion of such software is relatively short and software development costs
qualifying for such capitalization have been relatively insignificant. Due to a
decrease in research and development equipment purchases, engineering and
product development expenses decreased 14.0% to $3.7 million for the six months
ended June 30, 1999, from $4.3 million for the same period in 1998. As a
percentage of net revenue, engineering and product development expenses
increased slightly to 5.7% for the six months ended June 30, 1999 from 5.6% for
the comparable period of 1998.
General and Administrative Including Shareholder Officers' Compensation
General and administrative expenses consist primarily of compensation to the
officers and employees performing Dot Hill's administrative functions and
expenditures for the Company's administrative facilities. General and
administrative expenses increased 16.3% to $5.7 million for the six months ended
June 30, 1999 from $4.9 million for the six months ended June 30, 1998. As a
percentage of net revenue, general and administrative expenses increased to 8.7%
for the six months ended June 30, 1999 from 6.3% for the comparable period of
1998. The increase is primarily due to additional rents and office expenses from
expanded facilities, professional fees related to the Box Hill shareholder class
action lawsuit described herein, payroll increases and additional staff seminars
and training.
6
<PAGE>
Acquired In Process Research and Development
In connection with Artecon's acquisition of SDI in fiscal 1997, management
determined that certain hardware and software products in development had no
alternative future use. Accordingly, Artecon recognized a change of $14.5
million for the six months ended June 30, 1998 for the write-off of in-process
research and development costs relating to the reverse merger with SDI. No such
charges were recorded for the six months ended June 30, 1999.
Other Income
Other income is comprised of interest expense, interest income, the majority of
which is exempt from federal income taxes, from income earned on the Company's
cash and cash equivalents and short-term investments, and other income and
expense items. Other income remained constant at $.8 million for the six months
ended June 30, 1999 and 1998.
Income Tax Provision
The Company's effective income tax rate was 31.7% for the six months ended June
30, 1999 and (.3)% for the comparable period of 1998. The effective income tax
rate for the 1999 period reflects federal, state and local taxes, partially
offset by research and development credits and a tax benefit from the Company's
foreign sales corporation. The income tax rate for the 1998 period reflects the
impact of non-deductible charges, primarily the acquired in-process research and
development charges recorded in the SDI/Artecon combination.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Net Revenue
Net revenue increased 23.2% to $168.4 million for the year ended December 31,
1998, compared to $136.7 million for the year ended December 31, 1997. The
increase in net revenue is primarily attributable to an increase in volume,
mostly as a result of the SDI acquisition, partially offset by price reductions.
The increase in volume was also due to increases in sales of back-up products,
Fibre Channel and RAID products, partially offset by a decrease in sales of
legacy storage products. The increase in sales of back-up products was the
result of the additional focus on backing-up mission critical data by the
Company's traditional customer base, and the successful sales efforts in
obtaining new customers requiring the Company's knowledge and experience in
back-up integration.
Gross Profit
Gross profit increased 45.8% to $58.6 million from $40.2 million for the
comparable period of 1997. As a percentage of net revenues, gross profit
increased from 29.4% to 34.8%, principally as a result of a different product
mix and inventory write-offs which adversely effected margins in the comparable
period.
7
<PAGE>
Sales and Marketing
Sales and marketing expenses increased 92.3% to $34.8 million for the year ended
December 31, 1998 from $18.1 million for the year ended December 31, 1997. As a
percentage of net revenue, sales and marketing expenses increased to 20.7% in
1998 from 13.3% in 1997. The increase was primarily due to an increase in the
direct sales force and field service staff, increased commissions based on the
increase in sales and increased sales management overhead as a result of the SDI
acquisition.
Engineering and Product Development
Engineering and product development expenses increased 80.0% to $9.9 million for
the year ended December 31, 1998 from $5.5 million for the comparable period of
1997. As a percentage of net revenue, engineering and product development
increased to 5.9% in 1998 from 4.0% in 1997. The increase is primarily due to an
increase in the number of employees engaged in research and development
activities.
General and Administrative
General and administrative expenses increased 42.9% to $10.0 million for the
year ended December 31, 1998 from $7.0 million for the year ended December 31,
1997. As a percentage of net revenue, general and administrative expenses
increased to 5.9% in 1998 from 5.2% in 1997. The increase is primarily due to
additional depreciation and amortization expense of $1.5 million and $1.7
million, respectively, for goodwill and other intangible assets associated with
the SDI and Falcon acquisitions and additional rent expense resulting from an
expanded facility in New York.
Shareholder Officers' Compensation
Shareholder officers' compensation consists of salaries and bonuses paid to Box
Hill's three shareholder officers. Shareholders officers' compensation decreased
82.7% to $1.3 million for the year ended December 31, 1998, compared to $7.5
million for the year ended December 31, 1997. The decrease in shareholder
officers' compensation is attributable to new employment agreements entered into
with the shareholder officers in connection with Box Hill's initial public
offering. See Note 14 of Notes to the Company's Supplemental Financial
Statements.
Acquired In Process Research and Development
In connection with Artecon's acquisitions of SDI and Falcon, management
determined that certain hardware and software products in development had no
future alternative use. Accordingly, Artecon recognized a charge of $14.5
million and $3.7 million for the year ended December 31, 1997 for the write-off
of in-process research and development costs relating to the reverse merger with
SDI and the acquisition of Falcon, respectively. No such charges were recorded
for the year ended December 31, 1998.
8
<PAGE>
Restructuring Expenses and Impairment of Intangible Assets
In December 1998, Artecon's Board of Directors approved a plan for Artecon to
consolidate one of its engineering facilities from Milpitas, California, to
Carlsbad, California, to consolidate certain domestic sales and service
locations, and to eliminate certain product lines and development activities.
The Company recorded pre-tax restructuring charges of $1.8 million to cover the
costs associated with these actions. The major components of the charges and the
remaining accrual balance as of June 30, 1999 were as follows:
<TABLE>
<CAPTION>
Accrued
Restructuring Amounts Restructuring
Charge Utilized Costs
------------- ------------ -------------
(in thousands)
<S> <C> <C> <C>
Employee termination costs .................... $ 254 $ (244) $ 10
Inventory write-downs.......................... 403 (399) 4
Facility closures and related expenses......... 715 (673) 42
Tooling write-off.............................. 135 (135) -
Intangible asset impairment.................... 300 (300) -
------ -------- ------
Total............................... $1,807 $(1,751) $ 56
====== ======== ======
</TABLE>
Employee termination costs consist primarily of severance payments for 43
employees, all of which were terminated as of December 31, 1998. The majority of
the employees terminated were employed at the engineering facility in Milpitas,
California and at the various domestic sales and service locations. Remaining
costs associated with bi-weekly payroll amounts are expected to be paid by
September 30, 1999. Inventory write-downs and the tooling write-off primarily
relate to the discontinuance of certain low-volume and low-profit product lines.
Of the total restructuring charge associated with the inventory write-downs,
$403,000 has been included as a separate component of cost of sales in the
accompanying financial statements. Facility closures and related expenses
consist of lease termination costs and the write-off of certain property and
equipment which was disposed of associated with the closures. The majority of
the remaining accrued costs are expected to be paid in 1999.
In connection with Artecon's acquisitions of Falcon and SDI, the Company
allocated $420,000 and $1,600,000, respectively, to an assembled workforce
intangible asset. The Company recorded an impairment of these intangible assets
of $300,000 during the year ended December 31, 1998, which has been included as
a component of the restructuring charge, as the impairment was a direct result
of employee terminations associated with activities that were exited.
Furthermore, as a result of significant attrition and terminations of employees
which had been utilized as the basis for the assembled workforce valuation, the
Company recognized a write-down of the intangible assets associated with the
workforce of $867,000.
In connection with the merger with SDI, Artecon recorded a reserve for
acquisition related costs of $6.6 million, of which $5.8 million was outstanding
at December 31, 1997. All of the acquisition related costs were included in the
purchase price allocation performed at December 31, 1997. The following is a
summary of the accrued merger costs (continued):
9
<PAGE>
<TABLE>
<CAPTION>
Balance Balance
December 31, Amounts June 30,
1997 Utilized 1999
------------ ---------- ----------
(in thousands)
<S> <C> <C> <C>
Employee termination costs..................... $2,858 $(2,766) $ 92
Professional service fees...................... 1,726 (1,410) 316
Other costs.................................... 1,181 (1,044) 137
------ -------- ------
Total................................ $5,765 $(5,220) $ 545
====== ======= ======
</TABLE>
The Company anticipates that the remaining merger costs will be paid in 1999 and
believes that there are no unresolved issues or additional liabilities that may
result in an adjustment to the purchase price allocation for the SDI merger.
Other Income, net
Other income increased $1.7 million to $1.3 million for the year ended December
31, 1998 from a loss of $404,000 for the comparable 1997 period. The increase is
primarily the result of interest income earned on the proceeds from Box Hill's
initial public offering in September 1997 and legal settlement income received
in 1998.
Income Taxes
The Company's effective income tax rate was 62.7% for the year ended December
31, 1998 versus (14.4)% for the comparable 1997 period. The 1998 effective
income tax rate reflects federal, state and local taxes, partially offset by
research and development credits and a tax benefit from the Company's foreign
sales corporation. The effect of state and local taxes was 54.6% during the 1998
period as a result of the various jurisdictions in which the Company's taxable
income was earned. The 1997 effective income tax rate reflects federal, state
and local taxes on Artecon's taxable income, the Box Hill C Corporation's pro
rata portion of Box Hill's 1997 taxable income, state franchise taxes, a
one-time tax benefit of $855,000 related to the recognition of the net deferred
tax asset recorded by Box Hill upon terminating its S Corporation status and the
impact of non-deductible charges for acquired in-process research and
development.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Net Revenues
Net revenues increased 29.8% to $136.7 million for the year ended December 31,
1997, compared to $105.3 million for the year ended December 31, 1996. The
increase resulted from an increase in volume, primarily as a result of increases
in sales of back-up and RAID products and the Falcon acquisition. These volume
increases were partially offset by price reductions.
10
<PAGE>
Gross Profit
Gross profit increased 34.4% to $40.2 million from $29.9 million for the
comparable period of 1996. As a percentage of net revenues, gross profit
increased slightly from 28.4% to 29.4%, principally as a result of a more
favorable product mix.
Sales and Marketing
Sales and marketing expenses increased 39.2% to $18.1 million for the year ended
December 31, 1997 from $13.0 million for the year ended December 31, 1996. As a
percentage of net revenue, sales and marketing expenses increased to 13.3% in
1997 from 12.3% in 1996. The increase was primarily due to an increase in the
direct sales forces and field service staff, partially due to the Falcon
acquisition, and increased commissions based on the increase in sales.
Engineering and Product Development
Engineering and product development increased 22.2% to $5.5 million for the year
ended December 31, 1997 from $4.5 million for the comparable period of 1996,
primarily due to an increase in the number of employees engaged in engineering
and product development activities. As a percentage of net revenue, engineering
and product development decreased to 4.0% in 1997 from 4.3% in 1996.
General and Administrative
General and administrative expenses increased 75.0% to $7.0 million for the year
ended December 31, 1997 from $4.0 million for the year ended December 31, 1996.
As a percentage of net revenue, general and administrative expenses increased to
5.2% in 1997 from 3.8% in 1996. The increase was due to an increase in support
staff to support the Company's growth.
Shareholder Officers' Compensation
Shareholders officers' compensation increased 19.0% to $7.5 million for the year
ended December 31, 1997 as compared to $6.3 million for the year ended December
31, 1996. The increase in shareholder officers' compensation is attributable to
higher bonuses for the period from January 1, 1997 to September 16, 1997. In
connection with its initial public offering, Box Hill entered into new
employment agreements with the shareholder officers. See Note 14 of Notes to the
Company's Financial Statements.
11
<PAGE>
Acquired In Process Research and Development
In connection with Artecon's acquisitions of SDI and Falcon, management
determined that certain hardware and software products in development had no
future alternative use. Accordingly, Artecon recognized a charge of $14.5
million and $3.7 million for the year ended December 31, 1997 for the write-off
of in-process research and development costs relating to the reverse merger with
SDI and the acquisition of Falcon, respectively.
Other Income, net
Other expense increased $.3 million to $.4 million for the year ended December
31, 1997 from $.1 for the comparable 1996 period. The increase is the primarily
the result of interest expense related to the promissory note issued in
connection with the Falcon acquisition and increased borrowings under Artecon's
credit line, partially offset by interest income earned on the proceeds from Box
Hill's initial public offering from September 1997 through December 31, 1997.
Income Taxes
The Company's effective income tax rate was (14.4)% for the year ended December
31, 1997 versus 27.8% for the comparable 1996 period. The 1997 effective income
tax rate reflects federal, state and local taxes on Artecon's taxable income,
the Box Hill C Corporation's pro rata portion of Box Hill's 1997 taxable income,
state franchise taxes, a one-time tax benefit of $855,000 related to the
recognition of the net deferred tax asset recorded by Box Hill upon terminating
its S Corporation status and the impact of non-deductible charges for acquired
in-process research and development. The 1996 effective income tax rate reflects
federal, state and local taxes on Artecon's taxable income and state franchise
taxes on Box Hill's taxable income.
Liquidity and Capital Resources
As of June 30, 1999, the Company had $62.9 million of cash, cash equivalents and
short-term investments. As of June 30, 1999, working capital was $81.0 million.
For the six months ended June 30, 1999, cash provided by operating activities
was $3.2 million compared to cash used in operating activities of $10.5 million
for the same period in 1998. The increase in cash provided by operating
activities is primarily due to decreases in accounts receivable and inventories.
Cash provided by investing activities of $570,000 and $3.3 million for the six
months ended June 30, 1999 and 1998, respectively, primarily consist of the sale
of short-term investments. Short-term investments generally consist of variable
rate securities that provide for early redemption within twelve months.
Net cash provided by financing activities decreased to $122,000 for the six
months ended June 30, 1999 from $1.8 million for the six months ended June 30,
1998, primarily due to lower borrowings under the Company's line of credit.
Proceeds from the exercise of stock
12
<PAGE>
options under the 1995 Stock Incentive Plan and from the 1997 Employee Stock
Purchase Plan totaled $59,000 for the six months ended June 30, 1999.
In May 1998, Artecon entered into a revolving credit facility with LaSalle
National Bank which permits borrowings of up to $15 million. Subsequent to the
Merger on August 2, 1999, the Company repaid all outstanding debt under this
facility.
In October 1997, Box Hill obtained a $10 million revolving line of credit
facility from a commercial bank. Box Hill has not made any borrowings under this
facility. Borrowings under the facility will be collateralized by a pledge of
substantially all of its assets and borrowings greater than $5 million will also
be required to be secured by short-term investments. Additionally, Box Hill is
required to comply with certain financial covenants. The line of credit is
currently being renegotiated.
Artecon's Japanese subsidiary has two lines of credit with a Japanese bank for
borrowings of up to an aggregate of 35 million Yen (approximately US $295,000 at
June 30, 1999) at interest rates ranging from 1.8% to 2.5%. Interest is due
monthly, with principal due and payable on various dates through August 2005.
Borrowings are secured by the inventories of the Japanese subsidiary. As of June
30, 1999, the total amount outstanding under the three credit lines was 33
million Yen (approximately US $275,000 at June 30, 1999).
In December 1998, four shareholder class action lawsuits were filed against Box
Hill, certain of its officers and directors, and the underwriters of Box Hill's
1997 initial public offering (the "Offering"). The actions were filed on behalf
of purchasers of the Common stock of the Company during the period from
September 16, 1997 to April 14, 1998 and allege that the Company made
misrepresentations of material fact and omitted material facts required to be
disclosed in the Company's registration statement and prospectus issued in
connection with the Offering and in statements allegedly made by the Company and
certain of its officers and directors subsequent to the Offering. The Company
believes that it has meritorious defenses to plaintiffs' claims and intends to
vigorously defend against those claims. Legal costs to defend the claims are
expected to be material and will be charged to expense as incurred.
The Company currently expects that cash, cash equivalents and short-term
investments, cash generated from operations and availability under its revolving
line of credit, will be sufficient to meet its foreseeable operating and capital
requirements for the next twelve months. However, the Company may need
additional capital to pursue acquisitions or significant capital improvements,
neither of which is currently contemplated.
Many of the Company's current and potential competitors are significantly larger
than the Company and have significantly greater financial, technical, marketing,
purchasing, and other resources than the Company, and, as a result, may be able
to respond more quickly to new or emerging technologies and changes in customer
requirements, or devote greater resources to the development, promotion and sale
of products than the Company, or to deliver competitive products at a lower
end-user price. The Company also expects that competition will increase as a
result of industry consolidations. 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 the
13
<PAGE>
Company's prospective customers. Increased competition is likely to result in
price reduction, reduced operating margins and loss of market share, any of
which could have a material adverse effect on the Company's business, operating
results or financial condition.
Year 2000 Compliance
The "Year 2000 problem" describes the world-wide concern that certain computer
applications, which use two digits rather than four to represent dates, will
interpret the year 2000 as the year 1900 and malfunction on January 1, 2000 or
thereafter. In this section, Dot Hill summarizes the anticipated impact of the
Year 2000 on the Company.
About this Statement
Evaluations concerning the Year 2000 problem are periodically evolving.
Accordingly, to the extent that this statement contradicts earlier statements
made by Box Hill or Artecon, this statement supercedes those prior statements.
Readers should also be aware that Box Hill's and Artecon's evaluation of certain
aspects of its Year 2000 readiness is based on statements by other parties. Box
Hill and Artecon often cannot verify the veracity of those statements, which may
have been made in error.
Dot Hill's Products
Box Hill believes the current version of all products manufactured by Box Hill
will function normally after the Year 2000.
Most of Box Hill's products do not keep track of dates as part of their normal
operation and, therefore, are Year 2000 compliant by nature. Products currently
manufactured by Box Hill that use dates are Box Hill's RAID Box 5300 Turbo and
RAID Box 5300 Turbo HS systems. While these products keep track of dates for
system management purposes, their normal function is not affected by dates. The
system only notes the date when it sends a message (usually read by a member of
a MIS department) about the system. That message displays the date, for
informational purposes only, in a two digit form. After the year 2000, that two
digit number will read 000, 01, and so on. Box Hill offers a new version of
Firmware that customers can download themselves, free of charge, which allows
the system to display the year in a four-digit format. Customers, and not Box
Hill, are responsible for implementation of the new version of Firmware.
Box Hill does not know of any earlier products of material significance that it
has manufactured that will not operate normally after the year 2000. However,
Box Hill has not evaluated all such products. Box Hill continues to answer Year
2000 questions about specific products previously manufactured by Box Hill. Box
Hill does not warrant or represent that obsolete, unsupported Box Hill products
are Year 2000 compliant, and Box Hill will not support such products for Year
2000 purposes.
In 1996, Artecon started a comprehensive Y2K program for its data storage
products. This program includes verification testing of existing products,
implementation of date code programming policies, and the integration of
compliance tests for all enhancements and future products. Artecon established
certain criteria to obtain Y2K compliance, expanding
14
<PAGE>
year fields to four digits, windowing, date encoding techniques, and absence of
date code dependency. Artecon's technology generally lends itself to being Y2K
compliant based on the absence of date dependencies in the hardware, software,
and firmware developed, manufactured and distributed by Artecon is Y2K
compliant. In addition, Artecon's products also recognized Y2K as a leap year.
Management believes that all of Artecon's data storage products are Y2K
compliant.
The rights and remedies of customers as to the Year 2000 compliance of any Box
Hill or Artecon products are governed by applicable law and agreements between
customers and Box Hill or Artecon. The statements made herein do not enlarge the
rights and remedies of any customers as to Year 2000 compliance and Dot Hill
makes no warranties or representations to its customers and suppliers by virtue
of this disclosure or otherwise regarding Year 2000 compliance.
Dot Hill's Internal Systems
Box Hill has evaluated its information technology infrastructure, made
modifications and identified necessary upgrades. Box Hill believes that its
infrastructure is Year 2000 compliant. Box Hill also has evaluated or received
information regarding its non-information technology infrastructure (office
building systems, copiers, telephone systems, etc.) for Year 2000 readiness and
believes those systems are Year 2000 compliant. The machinery used by Box Hill
to manufacture its products does not use dates, and is Year 2000 compliant by
nature.
In 1997, Artecon implemented a Y2K assessment program for its internal
processing systems. The program currently includes an inventory and assessment
of information systems, testing and implementation. Artecon has identified and
completed the major systems that will require modification to make them Y2K
compliant.
Readiness of Third Parties and Third Party Products Resold or Licensed by Dot
Hill
Box Hill has requested confirmation of the Year 2000 readiness of third party
products of material significance to Box Hill, which Box Hill currently resells,
licenses or uses to manufacture its own products. However, Box Hill does not and
will not take responsibility for Year 2000 compliance of such products, and
continues to direct customers to the respective manufacturers of those products
for final Year 2000 compliance information and assurances.
Box Hill has not confirmed the Year 200 readiness of all third party products
resold or integrated by Box Hill and has not confirmed the readiness of products
which are not resold or licensed by Box Hill but which may, in some way,
interface or interconnect with Box Hill products or products manufactured by
third parties that Box Hill either resells or licenses. Box Hill does not, and
will not, take responsibility for Year 2000 compliance of such products.
Box Hill is in the process of requesting information about the internal Year
2000 readiness of third parties that supply Box Hill with key products and
services. To date, all third parties
15
<PAGE>
contacted have stated that believe they will be compliant. However, Box Hill is
incapable of testing or knowing the accuracy of such statements and has not
received information from all such third parties.
Artecon may include software from third party vendors as a part of its data
storage products. Artecon has received compliance statements from such software
vendors and has conducted internal testing to verify their Y2K compliance
statements. Artecon has initiated communications with its significant supplier
to determine the extent to which Artecon may be impacted by those third party
suppliers who fail to remedy their own Year 2000 issues. To date Artecon has
contacted 90% of its significant suppliers and has received assurance of Year
2000 compliance from a number of those contacted. Most suppliers under existing
contracts with Artecon are under no contractual obligation to provide such
information to Artecon. Artecon is taking steps with respect to new supplier
agreements to assure that the suppliers' products and internal systems are Year
2000 compliant.
Costs Associated With Year 2000 Compliance
To date, Box Hill has not hired any additional employees or made any significant
purchases to carry out its Year 2000 compliance program. At this time, Box Hill
is not aware of any material future expenses that will be required to enable
Year 2000 compliance.
While it is difficult to quantify the total cost to Artecon of Y2K compliance
activities, Artecon's best estimate of resources that are allocated to this
program is approximately $500,000. However, there can be no assurance that Y2K
issues will not have a material adverse impact on Artecon's business, results of
operations or financial condition.
Risks Associated with the Year 2000
The full impact of the Year 2000 will not be known until January 1, 2000. Again,
Dot Hill is not aware, at this time, of any Year 2000 non-compliance that will
not be substantially corrected by the Year 2000 and that will materially affect
Dot Hill. However, some risks that Dot Hill may encounter include: the failure
of its internal information system, limitations in its work environment, a slow
down in orders due to customers' business failures, a slow down in customers'
ability to make payments, the inability of suppliers to provide necessary
materials, the inability to receive heat, electricity, water treatment services
or other products or services, and the inability of carriers to ship Dot Hill's
products to customers. Even if Dot Hill and its products are ready for the Year
2000, it still may be unable to conduct business after January 1, 2000 due to
failures beyond its control, such as failures of transportation, local and
nationwide, banking systems, municipal services and other parties. Dot Hill
believes that the Year 2000 issue may affect the purchasing patterns of
customers and potential customers in a variety of ways. Many companies are
expending significant resources to correct or patch their current software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to purchase products such as those offered by Dot Hill. Conversely,
Year 2000 issues may cause other companies to accelerate purchases, thereby
causing an increase in short-term demand and consequent decrease in long-term
demand for products. Additionally, Year 2000 issues could cause a significant
number of companies, including current customers, to reevaluate their current
information system needs, and as a result consider switching to other systems or
suppliers.
16
<PAGE>
Any of the foregoing could result in a material adverse effect on Dot Hill's
business, operating results and financial condition.
Contingency Plans
Dot Hill has certain contingency plans in place to conduct business in the event
of Year 2000 malfunctions. If certain third party suppliers become unable to
provide materials or services, Dot Hill will utilize substitute providers who
have been identified to provide the necessary materials and services. Should Dot
Hill's internal information systems fail, Dot Hill plans to manually perform the
paperwork necessary to conduct business.
17
<PAGE>
INDEX TO SUPPLEMENTAL FINANCIAL STATEMENTS
Page
----
Reports of Independent Public Accountants.............................. F-2
Supplemental Consolidated Balance Sheets, December 31, 1998 and 1997... F-4
Supplemental Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996...................................... F-5
Supplemental Consolidated Statements of Shareholders' Equity for
the years ended December 31, 1998, 1997 and 1996...................... F-6
Supplemental Consolidated Statements of Cash Flows for the years
ended December 31, 1998, 1997 and 1996................................ F-8
Notes to Supplemental Consolidated Financial Statements F-10
Supplemental Unaudited Consolidated Balance Sheets, June 30, 1999 and
December 31, 1998..................................................... F-30
Supplemental Unaudited Consolidated Statements of Operations for the
six months ended June 30, 1999 and 1998............................... F-31
Supplemental Unaudited Consolidated Statements of Shareholders' Equity
for the six months ended June 30,1999................................. F-32
Supplemental Unaudited Consolidated Statements of Cash Flows for the
six months ended June 30, 1999 and 1998............................... F-33
Notes to Supplemental Unaudited Consolidated Financial Statements...... F-34
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Dot Hill Systems Corp.
We have audited the accompanying supplemental consolidated balance sheets of Dot
Hill Systems Corp. (formerly Box Hill Systems Corp., a New York Corporation) and
subsidiaries as of December 31, 1998 and 1997, and the related supplemental
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1998. The supplemental
consolidated statements give retroactive effect to the merger with Artecon, Inc.
on August 2, 1999, which has been accounted for as a pooling-of-interests as
described in Note 1. These supplemental financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these supplemental financial statements based on our audits. We did
not audit the financial statements of Artecon, Inc. as of March 31, 1999 and
1998 and for each of the three years in the period ended March 31, 1999, which
statements reflect total assets and total revenue of 34% and 57%, respectively,
in fiscal 1998, and 44% and 49%, respectively, in fiscal 1997, of the related
supplemental consolidated totals. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the amounts included for Artecon, Inc., is based solely on the report
of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audit and the report of other auditors, the
supplemental consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Dot Hill Systems Corp. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, after giving retroactive effect to the merger with Artecon,
Inc. as described in Note 1, all in conformity with generally accepted
accounting principles.
/s/ ARTHUR ANDERSEN LLP
Philadelphia, Pa.,
August 2, 1999
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of Artecon, Inc.
We have audited the consolidated balance sheets of Artecon, Inc. and its
subsidiaries (the "Company") as of March 31, 1999 and 1998, and the related
consolidated statements of operations, comprehensive operations, shareholders'
equity, and cash flows for each of the three years in the period ended March 31,
1999 (none of which are presented separately herein). These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Artecon, Inc. and its subsidiaries
at March 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended March 31, 1999, in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Costa Mesa, California
May 6, 1999
F-3
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
<TABLE>
<CAPTION>
December 31,
1998 1997
------------- -------------
ASSETS
<S> <C> <C>
Current Assets:
Cash and cash equivalents............................................... $ 56,307 $ 48,889
Short-term investments.................................................. 3,500 9,305
Accounts receivable, net of allowance of $1,657 and $1,160.............. 25,832 32,281
Inventories............................................................. 19,764 19,705
Prepaid expenses and other.............................................. 3,190 1,998
Prepaid income taxes.................................................... 737 --
Deferred income taxes................................................... 4,223 4,231
------------- -------------
Total current assets............................................ 113,553 116,409
Property and equipment, net............................................. 2,967 4,925
Other assets............................................................ 114 133
Goodwill, net........................................................... 1,252 4,668
Other intangible assets, net............................................ 1,059 3,291
Deferred income taxes................................................... 8,085 1,736
------------- -------------
$ 127,030 $ 131,162
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt....................................... $ 483 $ 791
Accounts payable........................................................ 19,459 22,341
Accrued expenses........................................................ 8,729 13,880
Customer deposits....................................................... 2,173 2,143
Deferred revenue........................................................ 3,842 2,011
Income taxes payable.................................................... -- 757
Distribution payable.................................................... -- 227
------------- -------------
Total current liabilities....................................... 34,686 42,150
Borrowings under line of credit............................................ 10,552 7,899
Long-term debt 1,356 2,585
Deferred rent and other long-term liabilities.............................. 420 238
Minority interest.......................................................... 52 63
------------- -------------
Total liabilities............................................... 47,066 52,935
------------- -------------
Commitments and Contingencies (Note 14)
Shareholders' Equity:
Convertible preferred A shares, $.005 par value, 2,494,159 shares issued
and outstanding, liquidation preference of $4,988 .................... 12 12
Common stock $.01 par value, 40,000,000 shares authorized, 23,009,881
and 22,693,671 shares issued and outstanding ......................... 230 227
Additional paid-in capital.............................................. 96,775 95,660
Foreign currency translation adjustments................................ (62) (97)
Accumulated deficit..................................................... (16,991) (17,575)
------------- -------------
Total shareholders' equity...................................... 79,964 78,227
------------- -------------
$ 127,030 $ 131,162
============= =============
</TABLE>
The accompanying notes are integral part of these statements.
F-4
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE OPERATIONS
(in thousands, except per share information)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net revenue ............................................ $168,355 $136,684 $105,344
Cost of goods sold ..................................... 109,764 96,473 75,419
-------- -------- --------
Gross profit ........................................... 58,591 40,211 29,925
-------- -------- --------
Operating expenses:
Sales and marketing .................................. 34,839 18,121 12,968
Engineering and product development .................. 9,946 5,523 4,463
General and administrative ........................... 9,981 7,049 4,011
Shareholder officers' compensation ................... 1,275 7,538 6,347
Acquired in-process research and development costs ... -- 18,200 --
Restructuring expenses ............................... 1,404 -- --
Write-down of intangible assets ...................... 867 -- --
-------- -------- --------
Total operating expenses ........................ 58,312 56,431 27,789
-------- -------- --------
Operating income (loss) ......................... 279 (16,220) 2,136
Interest income (expense), net ......................... 906 (139) (138)
Other income (expense), net ............................ 395 (124) (10)
Gain (loss) on foreign currency transactions, net ...... (14) (141) 45
--- ---- --
Income (loss) before income taxes ............... 1,566 (16,624) 2,033
Income tax provision (benefit) ......................... 982 (2,394) 566
-------- -------- --------
Net income (loss) ...................................... $ 584 $(14,230) $ 1,467
======== ======== ========
Basic net income (loss) per share ...................... $ 0.03 $ (1.06) $ 0.12
======== ======== ========
Diluted net income (loss) per share .................... $ 0.02 $ (1.06) $ 0.10
======== ======== ========
Comprehensive operations:
Net income (loss) ............................... $ 584 $(14,230) $ 1,467
Foreign currency translation adjustments ............... 35 233 (18)
-------- -------- --------
Comprehensive income (loss) ............................ $ 619 $(13,997) $ 1,449
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share information)
<TABLE>
<CAPTION>
Convertible Foreign
Convertible Preferred A Shares Common Stock Additional Currency
Preferred --------------------- ---------------------- Paid-In Translation
Stock Shares Amount Shares Amount Capital Adjustments
----------- ---------- --------- ----------- --------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995................. $ 5,229 -- $ -- 11,984,000 $ 120 $ 580 $ (312)
Purchase and retirement of
Common stock........................... (200) -- -- (6,800) -- -- --
Foreign currency translation adjustment.. -- -- -- -- -- -- (18)
Net income............................. -- -- -- -- -- -- --
---------- --------- -------- ---------- -------- --------- ----------
Balance, December 31, 1996................. 5,029 -- -- 11,977,200 120 580 (330)
Sale of Common stock, net of
offering costs......................... -- -- -- 4,125,000 41 56,514 --
Distribution to S Corporation
shareholders........................... -- -- -- -- -- -- --
Termination of S Corporation status...... -- -- -- -- -- (115) --
Issuance of Common stock................. (125) -- -- 340,400 3 814 --
Conversion of Preferred stock............ (4,904) 2,494,159 12 11,600 1 4,891 --
Assumed issuance of Common stock in
connection with acquisition of SDI..... -- -- -- 6,125,600 61 32,884 --
Exercise of stock options................ -- -- -- 113,871 1 92 --
Foreign currency translation adjustment.. -- -- -- -- -- -- 233
Net loss............................... -- -- -- -- -- -- --
---------- --------- -------- ---------- -------- --------- ----------
Balance, December 31, 1997................. -- 2,494,159 12 22,693,671 227 95,660 (97)
Acquisition of Box Hill Europe........... -- -- -- 4,959 -- 52 --
Issuance of Common stock warrants........ -- -- -- -- -- 213 --
Exercise of stock options, including
tax benefit............................ -- -- 232,070 2 506 -- --
Sale of Common stock under
employee stock purchase plan........... -- -- -- 79,181 1 344 --
Foreign currency translation adjustment.. -- -- -- -- -- -- 35
Net income............................... -- -- -- -- -- -- --
---------- --------- -------- ---------- -------- --------- ----------
<CAPTION>
Retained
Earnings Total
(Accumulated Shareholders
Deficit) Equity
------------ ------------
<S> <C> <C>
Balance, December 31, 1995................. $ 7,046 $ 12,663
Purchase and retirement of
Common stock........................... (46) (246)
Foreign currency translation adjustment.. -- (18)
Net income............................. 1,467 1,467
--------- -----------
Balance, December 31, 1996................. 8,467 13,866
Sale of Common stock, net of
offering costs......................... -- 56,555
Distribution to S Corporation
shareholders........................... (11,927) (11,927)
Termination of S Corporation status...... 115 --
Issuance of Common stock................. -- 692
Conversion of Preferred stock............ -- --
Assumed issuance of Common stock in
connection with acquisition of SDI..... -- 32,945
Exercise of stock options................ -- 93
Foreign currency translation adjustment.. -- 233
Net loss............................... (14,230) (14,230)
--------- -----------
Balance, December 31, 1997................. (17,575) 78,227
Acquisition of Box Hill Europe........... -- 52
Issuance of Common stock warrants........ -- 213
Exercise of stock options, including
tax benefit............................ -- 508
Sale of Common stock under
employee stock purchase plan........... -- 345
Foreign currency translation adjustment.. -- 35
Net income............................... 584 584
--------- -----------
</TABLE>
F-6
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998............... $ -- 2,494,159 $ 12 23,009,881 $ 230 $ 96,775 $ (62)
========== ========= ======== ========== ======== ========= ==========
<CAPTION>
<S> <C> <C>
Balance, December 31, 1998............... $ (16,991) $ 79,964
========= ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------------------
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Operating Activities:
Net income (loss)................................................ $ 584 $ (14,230) $ 1,467
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities, excluding
effect from acquisitions:
Depreciation and amortization.............................. 5,541 1,280 921
Asset impairment charges................................... 623 -- --
Acquired in-process research and development costs......... -- 18,200 --
Provision for doubtful accounts............................ 123 271 10
Deferred income taxes...................................... (3,627) (3,688) (59)
Stock-based compensation expense........................... 213 699 --
Other...................................................... 64 70 45
Changes in operating assets and liabilities:
Accounts receivable...................................... 6,326 (4,370) (3,763)
Inventories.............................................. (59) 2,039 (2,870)
Prepaid expenses and other............................... (1,184) (709) (269)
Prepaid income taxes..................................... (565) -- --
Accounts payable......................................... (2,738) 3,032 1,330
Accrued expenses......................................... (5,243) (27) 736
Customer deposits........................................ 30 797 551
Deferred revenue......................................... 1,831 995 420
Income taxes payable..................................... (757) 757 --
Long-term liabilities.................................... 120 (91) (13)
Other 57 (15) 36
----------- ------------ -----------
Net cash provided by (used in) operating
activities........................................ 1,339 5,010 (1,458)
----------- ------------ -----------
</TABLE>
The accompanying notes are an integral part of these statements.
(Continued)
F-8
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Continued)
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------
1998 1997 1996
-------- -------- -------
<S> <C> <C> <C>
Investing Activities:
Purchases of property and equipment.............................. $ (1,159) $ (1,291) $ (544)
Sales (purchases) of short-term investments...................... 5,805 (9,305) --
Cash received in acquisitions, net............................... -- 7,351 --
-------- -------- -------
Net cash provided by (used in) investing
activities...................................... 4,646 (3,245) (544)
-------- -------- -------
Financing Activities:
Distributions to S Corporation shareholders...................... (227) (11,700) --
Net proceeds from initial public offering........................ -- 56,555 --
Proceeds from exercise of stock options.......................... 198 93 --
Proceeds from sale of stock to employees......................... 345 -- --
Proceeds from bank and other borrowings.......................... 48,292 24,988 23,116
Payments on bank and other borrowings............................ (47,210) (24,802) (23,381)
Issuance of common shares........................................ -- 17 --
Purchase and retirement of Common and Preferred shares........... -- -- (246)
-------- -------- -------
Net cash provided by (used in) financing
activities...................................... 1,398 45,151 (511)
-------- -------- -------
Effect of exchange rate changes on cash.......................... 35 233 (18)
-------- -------- -------
Net increase (decrease) in cash and cash equivalents............. 7,418 47,149 (2,531)
Cash and cash equivalents, beginning of year..................... 48,889 1,740 4,271
-------- -------- -------
Cash and cash equivalents, end of year........................... $ 56,307 $ 48,889 $ 1,740
======== ======== =======
Supplemental cash flow disclosure:
Cash paid for interest........................................... $ 817 $ 663 $ 307
======== ======== =======
Cash paid for income taxes....................................... $ 4,498 $ 1,328 $ 545
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these statements.
F-9
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share information)
1. Background and Summary of Significant Accounting Policies
Background
Dot Hill Systems Corp. ("Dot Hill" or the "Company"), designs, manufactures,
markets and supports high performance data storage systems for the open systems
computing environment. In the United States, the Company employs a direct
marketing strategy aimed at data-intensive industries which, to date, include
financial services, telecommunications, internet service providers, multimedia,
healthcare, government/defense and academia. The Company's international
strategy is to sell directly to end users, when possible, and to use
distributors. The Company's manufacturing operations consist primarily of
assembly and integration of components and subassemblies into the Company's
products. The Company's manufacturing, principal research and development and
principal sales and marketing operations are conducted from the Company's
California and New York City facilities.
Basis of Presentation
On August 2, 1999, Box Hill Systems Corp. ("Box Hill") and Artecon, Inc.
("Artecon"), completed a Merger ("the Merger") in which the two companies were
merged in a tax-free, stock-for-stock transaction. The Merger was accounted for
using the pooling-of-interests method. Subsequent to the Merger, the combined
Company changed its name to Dot Hill Systems Corp. Accounting Principles Board
Opinion No. 16 precludes the restatement of financial statements for a
pooling-of-interests transaction prior to the issuance of financial statements
covering a period encompassed by the transaction. Accordingly, the accompanying
consolidated financial statements set forth a supplemental presentation of the
Company's financial statements retroactively restated to reflect the combination
with Artecon (see Note 16). The accompanying supplemental consolidated financial
statements do not include estimated charges related to the Artecon acquisition,
which will be charged to expense in the quarter ended September 30, 1999. The
historical financial statements of Box Hill as of December 31, 1998 and 1997 and
for each of the three years in the period ended December 31, 1998 have been
combined with the financial statements of Artecon as of March 31, 1999 and 1998
and for each of the three years in the period ended March 31, 1999,
respectively.
Initial Public Offering
Box Hill completed an initial public offering (the "Offering") of its Common
stock effective September 16, 1997. The offering consisted of the sale of 5.5
million shares of Common stock at an initial public offering price of $15.00, of
which 3.3 million shares were issued and sold by Box Hill and 2.2 million shares
were sold by individuals who were the only shareholders of Box Hill prior to the
Offering. Additionally, 825,000 shares of Common stock were purchased from
F-10
<PAGE>
Box Hill at $15.00 per share by the underwriters upon the exercise of an
over-allotment option. The net proceeds to Box Hill, after deducting estimated
underwriting discounts and offering expenses, were approximately $56.6 million.
Use of Accounting Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles 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.
Revenue Recognition and Product Warranty
The Company recognizes revenue on product sales when products are shipped.
Revenue from maintenance contracts is deferred and recognized on a straight-line
basis over the contract term, generally twelve months. The cost of maintenance
contracts purchased from third-parties for resale is deferred and recognized as
expense over the contract term. At December 31, 1998, the balance of deferred
costs of purchase maintenance contracts was $711 and is included in prepaid
expenses and other assets.
The Company generally extends to its customers the warranties provided to the
Company by its suppliers. The Company provides for the estimated cost that may
be incurred for product warranties in the period the related revenue is
recognized. To date, the Company's suppliers have reimbursed the majority of the
Company's warranty costs. There can be no assurance that such suppliers will
continue to reimburse such costs in the future, which could have a material
adverse effect on the Company's financial position and results of operations.
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid investments purchased with an
original maturity of three months or less. Cash equivalents consist principally
of money market mutual funds.
Short-term Investments
The Company accounts for investments in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities". Short-term investments have been categorized as
available for sale and, as a result, are stated at fair value. Short-term
investments are generally comprised of variable rate securities that provide for
early redemption within twelve months.
F-11
<PAGE>
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market and
consist principally of purchased components used as raw materials.
Property and Equipment
Property and equipment are recorded at cost. Equipment and furniture are
depreciated using straight-line and accelerated methods over their estimated
useful lives (two to seven years). Leasehold improvements are amortized on a
straight-line basis over the life of the lease. Significant improvements are
capitalized and expenditures for maintenance and repairs are charged to expense
as incurred. Upon the sale or retirement of these assets, the applicable cost
and related accumulated depreciation are removed from the accounts and any gain
or loss is included in the statements of income.
Goodwill and Other Intangible Assets
Goodwill is being amortized on a straight-line basis over a period of seven
years. Accumulated amortization was $679 and $12 at December 31, 1998 and 1997,
respectively. Other intangible assets related to acquisitions are being
amortized on a straight-line basis over two to four years. Goodwill and other
intangible assets are periodically reviewed for events or changes which may
indicate that their carrying value may not be recoverable. The Company
periodically reviews the carrying value of goodwill and other intangible assets
to determine whether or not an impairment to such values has occurred. During
the year ended December 31, 1998, the Company recorded an impairment associated
with certain other intangible assets of $300 and additional amortization of $867
associated with a change in estimate of the remaining useful lives of such
assets (see Note 5).
Long-Lived Assets
The Company accounts for the impairment and disposition of long-lived assets in
accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of". In accordance with SFAS
No.121, long-lived assets to be held are reviewed whenever events or changes in
circumstances indicate that their carrying value may not be recoverable. The
Company periodically reviews the carrying value of long-lived assets to
determine whether or not an impairment to such value has occurred. Based on its
most recent analysis, the Company believes that no impairment exists at December
31, 1998. During the year ended December 31, 1998 and 1997, the Company
recognized certain impairment charges (see Note 5).
Advertising Costs
The Company expenses advertising costs as incurred. For the years ended December
31, 1998, 1997 and 1996, advertising expense was $1,340, $996, and $991,
respectively.
F-12
<PAGE>
Product Development
Research and development costs are expensed as incurred. In conjunction with the
development of its products, the Company incurs certain software development
costs. No costs have been capitalized pursuant to SFAS No. 86, "Accounting for
the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed," since
the period between achieving technological feasibility and completion of such
software is relatively short and software development costs qualifying for
capitalization have been insignificant.
Income Taxes
Deferred tax assets and liabilities are determined based on differences between
the financial reporting and tax bases of assets and liabilities and are measured
using enacted tax rates that are expected to be in effect when the differences
reverse.
Box Hill was subject to taxation under Subchapter "S" of the Internal Revenue
Code and the New York State Tax Code until the termination of its S Corporation
status concurrent with its initial public offering in September 1997.
Accordingly, prior to the offering, no provision was made for federal or state
income taxes on Box Hill's taxable income and the Box Hill shareholders were
taxed directly on their proportionate share of the Company's taxable income. In
connection with the offering, Box Hill terminated its S Corporation status and
was subject to federal and state income taxes for the C Corporation's pro rata
share of Box Hill's 1997 taxable income. Upon terminating its S Corporation
status, the Company recorded a $855 tax benefit for the recognition of a net
deferred tax asset (see Note 9).
Net Income Per Share
In 1997, the Company adopted SFAS No. 128, "Earnings Per Share". This statement
requires that the Company report basic and diluted earnings per share for all
periods reported. Basic and diluted earnings per share are calculated by
dividing net income by the weighted average and diluted weighted average number
of shares outstanding, respectively. Diluted earnings per share is not presented
in periods with a loss. Dilutive securities consist of stock options, using the
treasury stock method, and convertible preferred stock.
The table below sets forth the reconciliation of the numerators and denominators
of the earnings per share calculation:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------- --------------------------------- -----------------------------
Net Per share Net Per share Net Per share
Income Shares Amount Loss Shares Amount Income Shares Amount
------ ------ ------ ---- ------- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic net income (loss).......... $ 584 22,903 $ .03 $ (14,230) 13,456 $ (1.06) $ 1,467 11,981 $ .12
Effect of dilutive securities:
Stock options.................... -- 820 -- -- -- -- -- 791 (.01)
Convertible Preferred
stock.......................... -- 719 (0.01) -- -- -- -- 1,283 (.01)
------ ------- ------- --------- ------- ------- ------- ------- -------
Diluted net income (loss)........ $ 584 24,442 $ 0.02 $ (14,230) 13,456 $ (1.06) $ 1,467 14,055 $ 0.10
====== ======= ======= ========= ======= ======= ======= ======= =======
</TABLE>
F-13
<PAGE>
For the year ended December 31, 1998, options to purchase 1,105,007 shares of
common stock with exercise prices ranging from $9.50 to $18.13 per share were
outstanding, but were not included in the computation of diluted net income per
share for the entire year because the exercise price of the options was greater
than the average market price of the common shares. These options expire at
various times through November 2008. For the year ended December 31, 1997,
options to purchase 1,980,527 shares of common stock with exercise prices
ranging from $.20 to $18.13 were outstanding, but were not included in the
computation of dilutive net loss per share because a net loss was incurred for
the year.
Foreign Currency Translation
The accounts of foreign subsidiaries have been translated from their respective
functional currencies at appropriate exchange rates in accordance with SFAS No.
52, "Foreign Currency Translation." Cumulative translation adjustments are
included as a separate component of shareholders' equity. Gains and losses on
short-term intercompany foreign currency transactions are recognized through
income as incurred.
Recent Accounting Pronouncement
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information." This statement establishes additional
standards for segment reporting in the financial statements and is effective for
fiscal years beginning after December 15, 1997. Management believes that the
Company will operate in a single reportable segment following the integration of
Box Hill and Artecon. See Note 16 for separate segment information for Box Hill
and Artecon.
2. Acquisitions
Storage Dimensions, Inc.
During fiscal 1997, Artecon completed a reverse merger into Storage Dimensions,
Inc. ("SDI"). Immediately following the merger, SDI changed its name to Artecon.
In the merger, shareholders of the former Artecon received approximately 62% of
the total issued and outstanding Common stock, and 100% of the total issued and
outstanding Preferred Stock of the merged company. Therefore, the merger was
treated as a purchase of SDI by Artecon for accounting purposes. The purchase
price for accounting purposes was determined based on the fair market value of
the outstanding SDI stock on December 18, 1997 using the average bid and ask
price of $3.96875. The purchase price was allocated $17,281 to assets acquired
(consisting primarily of cash and cash equivalents, accounts receivable,
inventories, property and equipment, deferred tax assets, and other assets),
$7,438 to goodwill and other intangible assets, $14,057 to liabilities assumed
and $14,500 to in-process research and development expenses, which had no future
alternative use. During the year ended December 31, 1998, the Company recorded
adjustments associated with certain tax-related matters that existed at the time
of the merger with SDI (see Note 9). The amount of the purchase price allocated
to goodwill was decreased by approximately $581 as a result of these
adjustments.
F-14
<PAGE>
Falcon Systems, Inc.
On August 21, 1997, Artecon acquired certain net assets of Falcon Systems, Inc.
(Falcon), a manufacturer and distributor of computer peripheral equipment. The
purchase price of $3,500 included $1,000 in cash and $2,500 of promissory notes
(Note 8). The acquisition was accounted for as a purchase and Falcon's results
of operations for the period from August 21, 1997 are included in the
accompanying consolidated financial statements. The purchase price was allocated
$10,232 to assets acquired (consisting primarily of inventories, accounts
receivable, property and equipment and other current assets), $638 to goodwill
and other intangible assets, $14,138 to debt and liabilities assumed, and $3,700
to in-process research and development expenses, which had no future alternative
use. In connection with the acquisition, a partnership was created to purchase
certain assets from Falcon. The partners are majority shareholders of the
company. The partnership is considered to be a Special Purpose Entity and,
accordingly, the accompanying consolidated financial statements include the
accounts of the partnership and all intercompany transactions have been
eliminated.
The following table displays the assets and liabilities that were acquired as a
result of these acquisitions:
SDI Falcon
-------- ---------
Fair value of other assets acquired ............... $ 17,281 $ 10,232
Acquired in-process research and development
costs............................................. 14,500 3,700
Other intangible assets............................ 2,400 420
Goodwill........................................... 4,538 127
Acquired developed technology...................... 500 91
Note to Falcon shareholder......................... -- (2,500)
Fair market value of SDI stock..................... (32,945) --
Cash paid for acquisition, net of cash acquired.... 7,783 (432)
-------- --------
Liabilities assumed.......................... $ 14,057 $ 11,638
======== ========
Unaudited pro forma supplemental results of operations of the Company for the
year ended December 31, 1997 are included below. Such pro forma presentation has
been prepared assuming that the acquisitions had occurred as of January 1, 1997:
Net revenue ............................................. $ 214,939
Net loss................................................. $ (5,884)
Pro forma basic and diluted net loss per share........... $ (.30)
Weighted average shares used to calculate pro
forma basic and diluted net loss per share.............. 19,387
The pro forma results include pro forma adjustments, including, amortization of
goodwill and other intangible assets, and interest expense related to the
promissory notes issued to Falcon's previous shareholder. In-process research
and development expense has been excluded from the pro forma results of
operations for the year ended December 31, 1997.
F-15
<PAGE>
3. Risks and Uncertainties
The Company's future results of operations involve a number of risks and
uncertainties. Factors that could affect the Company's future operating results
and cause actual results to vary materially from expectations include, but are
not limited to, dependence on new products, dependence on a limited number of
suppliers of high quality components, reliance on a limited number of principal
customers, concentration of customers in targeted industries, difficulties in
managing growth, difficulties in attracting and retaining qualified personnel,
competition, competitive pricing, dependence on key personnel, enforcement of
the Company's intellectual property rights, dependence on a limited number of
production facilities, and an uneven pattern of quarterly results.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk consist primarily of trade accounts receivable. The Company does not
require collateral or other securities to support customer receivables. A
significant portion of the Company's net revenue is derived from sales to
customers in the financial services and telecommunications industries. For the
year ended December 31, 1998, direct sales to customers in the financial
services and telecommunications industries were approximately 26.8% and 20.3%,
respectively, of the Company's net revenue and for the year ended December 31,
1997 were approximately 20.9% and 24.4%, respectively, of the Company's net
revenue. For the years ended December 31, 1998 and 1997, no single customer
accounted for greater than 10% of the Company's net revenue. For the year ended
December 31, 1996, one customer accounted for 13.2% of the Company's net
revenue.
Export Sales
The following table summarizes export sales by geographical region as a
percentage of net revenue:
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Asia...................... 3.3% 5.6% 8.1%
Europe.................... 6.1% 8.4% 7.0%
Other..................... .7% 0.6% 0.3%
------ ------ -----
10.1% 14.6% 15.4%
====== ====== =====
</TABLE>
Dependence on Suppliers
The Company purchases substantially all of its disk drives, a critical component
of its storage products, from one supplier. Approximately 20.2%, 26.3%, and
41.5% of the Company's total component purchases were made from this supplier
for the years ended December 31, 1998, 1997 and 1996, respectively. The Company
resells the products of various third parties including one supplier of tape
libraries and other products. During 1998, approximately 14.3% of total
purchases were from this supplier.
F-16
<PAGE>
There are a limited number of suppliers for certain of the Company's other
components and management believes that other suppliers could provide certain
similar products on comparable terms. Any shortage of key components and any
delay or other difficulty in obtaining such components from other suppliers and
integrating them into the Company's products or lack of supply from sole source
suppliers could have a material adverse effect on the Company's financial
position and results of operations.
4. Other Comprehensive Operations
Accumulated other comprehensive operations for each of the three years in the
period ended December 31, 1998 is comprised of the following:
Foreign
Currency
Translation
Adjustments
-----------
Balance, January 1, 1996 .......................... $ (312)
Foreign currency translation adjustment ........... (18)
-------
Balance, December 31, 1996 ........................ (330)
Foreign currency translation adjustment ........... 233
-------
Balance, December 31, 1997 ........................ (97)
Foreign currency translation adjustment ........... 35
-------
Balance, December 31, 1998 ........................ $ (62)
=======
5. Accrued Merger and Restructuring Costs and Impairment of Long-Lived Assets
In December 1998, Artecon's Board of Directors approved a plan for Artecon to
consolidate one of its engineering facilities from Milpitas, California, to
Carlsbad, California, to consolidate certain domestic sales and service
locations and to eliminate certain product lines and development activities. The
Company recorded pre-tax restructuring charges of $1,807 to cover the costs
associated with these actions. The major components of the charges and the
remaining accrual balance as of December 31, 1998 were as follows:
F-17
<PAGE>
<TABLE>
<CAPTION>
Accrued
Restructuring Amounts Restructuring
Charge Utilized Costs
------------- ---------- -------------
<S> <C> <C> <C>
Employee termination costs.................. $ 256 $ (200) $ 54
Inventory write-downs....................... 403 (103) 300
Facility closures and related expenses...... 715 (476) 239
Tooling write-off........................... 135 (135) --
Intangible asset impairment................. 300 (300) --
------- ------- ------
Total................................ $ 1,807 $(1,214) $ 593
======= ======= ======
</TABLE>
Employee termination costs consist primarily of severance payments for 43
employees, all of which were terminated as of December 31, 1998. The majority of
the employees terminated were employed at the engineering facility in Milpitas,
California and at the various domestic sales and service locations. Remaining
costs associated with bi-weekly payroll amounts are expected to be paid by June
30, 1999. Inventory write-downs and the tooling write-off primarily relate to
the discontinuance of certain low-volume and low-profit product lines. Of the
total restructuring charge associated with the inventory write-downs, $403 has
been included as a separate component of cost of sales in the accompanying
financial statements. Facility closures and related expenses consist of lease
termination costs and the write-off of certain property and equipment which was
disposed of in connection with the closures. The majority of the remaining costs
are expected to be paid in 1999.
In connection with Artecon's acquisitions of Falcon and SDI, Artecon allocated
$420 and $1,600, respectively, to an assembled workforce intangible asset. The
Company recorded an impairment of these intangible assets of $300 during the
year ended December 31, 1998, which has been included as a component of the
restructuring charge, as the impairment was a direct result of employee
terminations associated with activities that were exited. Furthermore, as a
result of significant attrition and terminations of employees, which had been
utilized as the basis for the assembled workforce valuation, the Company
recognized a write-down of the intangible assets associated with the workforce
of $867.
In connection with the merger with SDI, the Company recorded a reserve for
acquisition related costs of $6,581, of which $5,765 was outstanding at December
31, 1997. All of the acquisition related costs were included in the purchase
price allocation performed at December 31, 1997. The following is a summary of
the accrued merger costs:
<TABLE>
<CAPTION>
Balance Amounts Balance
December 31, 1997 Utilized December 31, 1998
---------------------- ----------- -----------------------
<S> <C> <C> <C>
Employee termination costs ...... $ 2,858 $ (2,691) $ 167
Professional service fees ....... 1,726 (1,410) 316
Other exit costs ................ 1,181 (998) 183
------- -------- ------
Total ........................... $ 5,765 $ (5,099) $ 666
======= ======== ======
</TABLE>
F-18
<PAGE>
The Company anticipates that the remaining merger costs will be paid in 1999 and
believes that there are no unresolved issues or additional liabilities that may
result in an adjustment to the purchase price allocation for the SDI merger.
6. Property and Equipment
December 31,
---------------------
1998 1997
------- -------
Equipment and furniture................. $ 7,010 $ 7,598
Leasehold improvements.................. 949 862
------- -------
7,959 8,460
------- -------
Less- Accumulated depreciation.......... (4,992) (3,535)
------- -------
$ 2,967 $ 4,925
======= =======
Depreciation expense was $2,760, $1,138 and $921 for the years ended December
31, 1998, 1997 and 1996, respectively.
7. Credit Facilities
Box Hill Facility
In October 1997, Box Hill entered into an agreement with a commercial bank which
provides for a $10 million revolving line of credit. Box Hill did not have any
borrowings under this facility in 1998 or 1997. Borrowings under the facility
will be collateralized by a pledge of substantially all of the Company's assets
and borrowings greater than $5 million will also be required to be secured by
short-term investments. Additionally, the Company is required to comply with
certain financial covenants, as defined. The revolver expired in May 1999 and is
in the process of being renewed.
Artecon Facilities
Artecon had a $15 million revolving credit facility with a domestic commercial
bank (the "Agreement"). The Agreement provided for financing collateralized by
all assets of Artecon, as defined by the Agreement, and matures on May 14, 2001,
unless otherwise renewed. The line of credit bore interest at the bank's prime
rate. Monthly payments consisted of interest only, with the principal due at
maturity. The Agreement required that Artecon comply with certain covenants
including quarterly and annual profitability covenants. Artecon was not in
compliance with the net income covenants at December 31, 1998 and obtained a
waiver from the bank which included a modification of the future net income
requirements. Subsequent to the Merger with Artecon on August 2, 1999, the
Company repaid all outstanding debt under this facility.
F-19
<PAGE>
Artecon's Japanese subsidiary has two lines of credit with a Japanese bank for
borrowings up to an aggregate 35 million Yen (US$295 at December 31, 1998) at
rates ranging from 1.8% to 2.5%. At December 31, 1998, 33 million Yen
(approximately US$275) were outstanding. Interest is due monthly with the
principal due on various dates through August 2005. Borrowings are
collateralized by inventories of the Japanese subsidiary.
At December 31, 1998, the Company's borrowings under lines of credit were as
follows:
Artecon bank line, variable interest at prime
(8.75% at December 31, 1998).......................... $10,277
Japanese bank lines, interest ranging from
1.8% to 2.5%.......................................... 275
-------
$10,552
=======
8. Long-Term Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31,
--------------------
1998 1997
------- -------
<S> <C> <C>
Promissory notes payable to former shareholder of Falcon
(Note 2), bearing interest at 10% per annum, monthly
installments of principal and interest of $53
through August 2002 ........................................... $ 1,839 $ 2,268
Term loan payable to bank, bearing interest at 7.72% per annum,
collateralized by property and equipment and monies in
possession of the bank, paid in full in May 1998 .............. -- 190
Term loan payable to bank, bearing interest at 8.5% per annum,
collateralized by substantially all of the assets of the
Company, paid in full in May 1998 ............................. -- 883
Other ............................................................ -- 35
------- -------
1,839 3,376
Less- Current portion ............................................ (483) (791)
------- -------
$ 1,356 $ 2,585
======= =======
</TABLE>
F-20
<PAGE>
Long-term debt at December 31, 1998 matures as follows:
Fiscal Year Ending:
1999.....................$ 483
2000..................... 525
2001..................... 580
2002..................... 251
-------
$ 1,839
9. Income Taxes
The components of the income tax provision are as follows:
Year Ended December 31
-------------------------------
1998 1997 1996
------- ------- -----
Current:
Federal ................................. $ 3,081 $ 884 $ 245
State, local and foreign ................ 1,528 410 380
------- ------- -----
4,609 1,294 625
------- ------- -----
Deferred:
Federal ................................. $(3,054) $(2,150) $ 53
State, local and foreign ................ (573) (683) (112)
Recognition of deferred tax asset upon
termination of S-Corp. status ......... -- (855) --
------- ------- -----
(3,627) (3,688) (59)
------- ------- -----
$ 982 $(2,394) $ 566
======= ======= =====
The provision for income taxes for the year ended December 31, 1998, consists of
federal, state and local income taxes. The provision for income taxes for the
year ended December 31, 1997, consists of federal, state and local income taxes
on Artecon's taxable income and the Box Hill C Corporation's pro rata portion of
Box Hill's 1997 taxable income, state franchise taxes and a one-time tax benefit
of $855 related to the recognition of the net deferred tax asset recorded by Box
Hill upon terminating its S Corporation status. For the year ended December 31,
1996, the provision for income taxes consists of federal, state and local taxes
on Artecon's taxable income and state franchise taxes on Box Hill's taxable
income.
F-21
<PAGE>
The reconciliation of the federal statutory income tax rate and the effective
income tax rate is as follows:
Year Ended December 31
--------------------------
1998 1997 1996
---- ---- ----
Federal statutory rate ....................... 34.0% (34.0)% 34.0
State and local income taxes, net of federal
benefit .................................... 54.6 (.8) 7.3
Impact of Box Hill's "S" Corporation status .. -- (4.3) (14.6)
In-process research and development .......... -- 29.7 --
Recognition of deferred tax asset ............ -- (5.1) --
Amortization of goodwill and intangible
assets ..................................... 14.0 -- --
Interest income .............................. (21.9) (.1) --
Tax credits and other ........................ (18.0) .2 1.1
---- ---- ----
62.7% (14.4)% 27.8%
==== ==== ====
The tax effect of temporary differences that give rise to deferred income taxes
are as follows:
December 31
----------------------
1998 1997
-------- --------
Warranty accrual.................................. $ 372 $ 228
Inventory reserve and uniform capitalization...... 1,890 2,455
Vacation accrual.................................. 113 86
Allowance for bad debts........................... 233 114
Depreciation...................................... 77 378
Deferred rent..................................... 123 97
Other accruals and reserves....................... 1,351 1,969
In-process research and development............... 1,418 1,523
Net operating losses and tax credits.............. 7,538 2,838
Restructuring reserve............................. 231 --
State taxes....................................... (784) (537)
Acquired intangibles.............................. (254) (1,189)
-------- --------
12,308 7,962
Valuation allowance............................... -- (1,995)
-------- --------
$ 12,308 $ 5,967
======== ========
A valuation allowance of $1,995 was established at the date of Artecon's merger
with SDI in order to reflect limitations on the Company's usage of SDI's net
operating loss carryforwards associated with, among other factors, SDI
continuing to be a separate subsidiary of Artecon. The valuation allowance has
been reduced to zero in 1998, as a result of the Company dissolving the
subsidiary structure of SDI and making the determination that it is now more
likely than not that these losses will be utilized. The reduction in the
valuation allowance of $1,995 has reduced goodwill related to the SDI
acquisition.
F-22
<PAGE>
As of December 31, 1998, the Company has federal and state net operating losses
of $15,612 and $7,512, which begin to expire in the tax years ending 2009 and
2010, respectively. In addition, the Company has federal and state tax credit
carryforwards of $875 and $691, respectively.
Pursuant to the Tax Reform Act of 1986, annual use of Artecon's federal net
operating loss and credit carryforwards is limited as a result of a cumulative
change in ownership of more than 50% as a result of the Merger. The annual
limitation is approximately $3,045 per year, which is equal to (i) the aggregate
fair market value of Artecon immediately before the ownership change multiplied
by (ii) the long-term tax exempt rate (within the meaning of the Section 382(f)
of the Internal Revenue Code) in effect at that time. The Section 382 rate in
effect as of the date of ownership change was 5.18%. The annual limitation is
cumulative and, therefore, if not fully utilized in a year, can be utilized in
future years in addition to the Section 382 limitation for those years.
Management believes that it is more likely than not that future taxable income
will be sufficient to realize the net deferred tax asset.
10. Convertible Preferred A Shares
The convertible Preferred A shares have voting rights, provide for dividends
when and if declared by the Board of Directors and have liquidation preference
over common shares. The convertible Preferred shares are convertible into common
shares, at the option of the holder, any time after January 1, 1999 at the
conversion rate, as defined in the amended Articles of Incorporation. In
connection with the merger between Box Hill and Artecon (see Note 16), the
convertible Preferred A shares were converted into 719,037 shares of the
Company's Common stock, representing the liquidation value of the Preferred A
shares.
11. Stock Incentive Plan
The Company's stock incentive plan (the "Plan"), adopted in May 1995 and amended
in July 1997, provides for the granting of incentive and nonqualified stock
options to employees, non-employee directors, and consultants. The Company has
currently reserved 4,392,500 shares of Common Stock for issuance pursuant to the
Plan. The terms and conditions of grants of stock options are determined by the
Board of Directors in accordance with the terms of the Plan.
Information with respect to options under the Plan, as restated for the
combination with the Artecon plan, is as follows:
Number Weighted
of Average
Shares Exercise Price
--------- --------------
Balance, December 31, 1995 .. 1,227,033 $ .66
Grants ................... 356,147 10.68
Forfeiture ............... (28,000) .50
Exercise ................. (46,400) .93
---------- -------
Balance, December 31, 1996 .. 1,508,780 3.19
Grants ................... 774,650 13.46
F-23
<PAGE>
Forfeitures .............. (130,632) 11.85
Exercises ................ (172,271) 1.24
---------- -------
Balance, December 31, 1997 .. 1,980,527 6.90
Grants ................... 1,155,500 8.21
Forfeitures .............. (963,047) 10.95
Exercises ................ (232,470) .85
---------- -------
Balance, December 31, 1998 .. 1,940,510 6.41
========== =======
The options generally vest ratably over a four or five year periods and are
exercisable over a period of ten years.
Information with respect to options issued under the Plan at December 31, 1998
is as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------- -----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Contractual Exercise Exercise
Exercise price Outstanding Life Price Outstanding Price
-------------- ----------- --------- ------- ----------- -------
<S> <C> <C> <C> <C> <C>
$ .50 - $ .75 766,446 6.6 years $ .67 524,560 $ .67
$ .83 - $5.02 126,883 8.9 years 3.24 21,664 1.73
$5.03 - $18.13 1,047,181 8.9 years 10.94 225,677 14.27
</TABLE>
The Company applies Accounting Principal Board Opinion No. 25," Accounting for
Stock Issued to Employees," and the related interpretations in accounting for
its employee stock options.
Had compensation cost for the Plan been determined based upon the fair value of
the options at the date of grant, as prescribed by SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company's net income and basic and diluted net
income per share would have been reduced to the following amounts:
Year Ended December 31
-------------------------------------
1998 1997 1996
-------- -------- --------
Net income (loss):
As reported........................ $ 584 $(14,230) $ 1,467
As adjusted........................ (1,424) (14,969) 1,455
Basic net income (loss) per share:
As reported........................ $ .03 $ (1.06) $ .12
As adjusted........................ (.06) (1.11) .12
F-24
<PAGE>
Diluted net income (loss) per share:
As reported........................ $ .02 $ (1.06) $ .10
As adjusted........................ (.06) (1.11) .10
The weighted average fair value of each stock option granted during the years
ended December 31, 1998, 1997 and 1996 was $9.29, $8.87 and $2.87, respectively.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
Year Ended December 31
---------------------------------
1998 1997 1996
------ ------ ------
Risk free interest................ 5.5% 6.4% 6.0%
Expected dividend yield........... -- -- --
Expected life..................... 7 years 7 years 7 years
Expected volatility............... 60% 60% --
Because additional option grants are expected to be made each year, the above
pro forma disclosures are not representative of pro forma effects of reported
net income for future years.
Stock Options Issued to Consultant
In October 1998, the Company issued an option to a sales consultant to purchase
150,000 shares of Common Stock at an exercise price of $5.00, which was equal to
the fair value of the Company's stock on the date of grant. The option was
exercisable immediately and expires in January 2000. The Company recorded a
charge of $213 for the year ended December 31, 1998 for the fair value of option
on the date of grant, which was calculated using the Black-Scholes option
pricing model.
12. Related Party Transactions
Distributions to S Corporation Shareholders
In September 1997, the Company made distributions of $10,500 to its S
Corporation shareholders, representing the estimated taxed, but undistributed S
Corporation earnings of the Company as of June 30, 1997. In December 1997, the
Company made distributions of $1,200 to its S Corporation shareholders,
representing the estimated taxed, but undistributed, S Corporation earnings of
the Company as of December 31, 1997. In March 1998, the Company made
distributions of $227, representing the final distribution for taxed, but
undistributed, S Corporation earnings.
Box Hill Europe
Box Hill Systems Europe Limited (Box Hill Europe) was formed in 1995 by the
Company's founding shareholders to provide marketing and technical support
services to the Company in Europe. Effective January 1, 1998, the Company issued
4,959 shares of common stock to Box
F-25
<PAGE>
Hill's founding shareholders, collectively, in exchange for 100% of the shares
of Box Hill Europe (the "BHE Merger"). The transaction has been accounted for as
a merger between entities under common control in accordance with APB No. 16,
"Accounting for Business Combinations".
After the BHE Merger, Box Hill Europe became a wholly owned subsidiary of Box
Hill. On January 1, 1998, the fair value of the 4,959 shares of Box Hill common
stock issued to the founding shareholders was $52; which was equal to the net
book value of Box Hill Europe on that date. No restatement of the Company's
financial statements is required as a result of this transaction because the
results of Box Hill Europe, consisting only of sales and marketing expenses,
which have been included in the Company's statements of operations for all
periods prior to the BHE Merger.
Sales to and Purchases from Related Parties
Revenues from sales to affiliated companies for the years ended December 31,
1998, 1997, and 1996, were approximately $48, $125 and $74, respectively.
Artecon purchased certain goods from affiliates and was subject to a management
fee of approximately $4 per month from an affiliate which was terminated upon
completion of Artecon's merger with SDI. Purchases from affiliated companies for
the years ended December 31, 1998, 1997 and 1996, were approximately $80, $130,
and $85, respectively.
13. Employee Benefit Plans
Box Hill Retirement Savings Plan
Effective August 1, 1995, the Company established a retirement savings plan
under the provisions of Section 401(k) of the Internal Revenue Code. The plan
covers all employees who were employed on the effective date of the plan or upon
the attainment of age 21. The Company can make discretionary contributions to
the plan. No contributions were made to the plan for the years ended December
31, 1998, 1997 and 1996.
Artecon Savings Plan
Artecon has a savings plan, which qualifies under Section 401(k) of the Internal
Revenue Code. Under the plan, participating U.S. employees may defer up to 15%
of their pretax salary, but not more than statutory limits. Artecon matches 50%
of eligible employees' contributions up to a specified limit ($500). The
Company's matching contributions to the savings plan were $67, $38 and $23 for
the years ended December 31, 1998, 1997 and 1996, respectively.
Employee Stock Purchase Plan
In August 1997, the Company adopted an employee stock purchase plan under the
provisions of Section 423 of the Internal Revenue Code. The plan provides
eligible employees of the Company with an opportunity to purchase shares of the
Company's Common Stock at 85% of fair market value, as defined. The Company has
reserved 750,000 shares of Common Stock for issuance pursuant to this plan. For
the year ended December 31, 1998, 79,181 shares were issued under the plan.
F-26
<PAGE>
14. Commitments and Contingencies
Operating Leases
The Company leases office space and equipment under noncancellable operating
leases which expire at various dates through September 2007. One of the leases
provides for a rent abatement which is being amortized over the life of the
lease. Rent expense for the years ended December 31, 1998, 1997 and 1996, was
$2,636, $1,499 and $1,067, respectively.
Future minimum lease payments, on a cash basis, under all noncancelable
operating leases at December 31, 1998, are as follows:
1999 $ 2,231
2000 1,639
2001 1,018
2002 719
2003 726
Thereafter 2,595
-------
$ 8,928
Employment Agreements
In connection with the Box Hill/Artecon Merger, effective August 2, 1999, the
Company entered into employment contracts with its six executive officers. These
contracts provide for base salaries totaling $1,780 per year. In addition, each
executive will be eligible to receive, at the discretion of the Board of
Directors, a cash bonus of up to 50% of such executives then annual base salary.
If an executive's employment is terminated under certain circumstances, such
executive will be entitled to receive a lump sum cash severance payment of up to
125% of such executive's then annual base salary.
Class Action Lawsuits
In December 1998, four shareholder class action lawsuits were filed against Box
Hill, certain of its officers and directors, and the underwriters of Box Hill's
1997 initial public offering (the "Offering"). The actions were filed on behalf
of purchasers of the Common stock of the Company during the period from
September 16, 1997 to April 14, 1998 and allege that the Company made
misrepresentations of material fact and omitted material facts required to be
disclosed in the Company's registration statement and prospectus issued in
connection with the Offering and in statements allegedly made by the Company and
certain of its officers and directors subsequent to the Offering. The Company
believes that it has meritorious defenses to plaintiffs' claims and intends to
vigorously defend against those claims. Legal costs to defend the claims are
expected to be material and will be charged to expense as incurred.
Other Litigation
F-27
<PAGE>
The Company is involved in certain other legal actions and claims arising in the
ordinary course of business. Management believes that the outcome of such other
litigation and claims will not have a material adverse effect on the Company's
financial position or results of operations.
15. Hedging Activities
The Company engaged in limited hedging activity in fiscal 1997 and the Company
does not presently engage in hedging activities.
In the prior year, Artecon's Japanese subsidiary entered into derivative
financial instruments, primarily foreign currency forward exchange contracts, to
manage foreign exchange risk on foreign currency transactions and did not use
the contracts for trading purposes. These financial instruments were used to
protect the Company from the risk that the eventual net cash inflows from the
foreign currency transactions would be adversely affected by changes in exchange
rates. Gains and losses related to hedges of firmly committed transactions were
deferred and recognized when the hedged transaction occurred.
The following table summarizes the notional amount, which approximates fair
market value, of the Company's outstanding foreign exchange contracts at
December 31, 1997 (none outstanding at December 31, 1998):
U.S. Dollar
Equivalent Maturity
---------- --------
U.S. Dollars.......................... $ 100 April 1998
U.S. Dollars.......................... 100 May 1998
U.S. Dollars.......................... 100 June 1998
-----
$ 300
=====
The counterparties to these instruments were major financial institutions. The
Company was exposed to credit losses in the event of nonperformance by
counterparties to its forward exchange contracts but had no off-balance sheet
credit risk of accounting loss. The Company anticipated, however, that the
counterparties would be able to fully satisfy their obligations under the
contracts. The Company did not obtain collateral or other security to support
the forward exchange contracts subject to credit risk but monitored the credit
standing of the counterparties.
16. Box Hill/Artecon Merger Subsequent to December 31, 1998
Effective August 2, 1999, Box Hill and Artecon completed a merger (the
"Merger"), in which the two companies were merged in a tax-free, stock-for-stock
transaction which will be accounted for as a pooling-of-interests. Subsequent to
the Merger, the combined Company changed its name to Dot Hill Systems Corp.
Under the terms of the Merger agreement, the Company issued 8,734,523 shares of
its Common stock to the former Artecon shareholders, representing 0.4 shares of
Box Hill Common stock in exchange for each share of Artecon
F-28
<PAGE>
Common stock outstanding. Additionally, Artecon's convertible preferred A shares
were converted into 719,037 shares of the Company's Common stock.
Revenue and net income (loss) as previously reported for Box Hill for the years
ended December 31, 1998, 1997 and 1996, and for Artecon for the years ended
March 31, 1999, 1998 and 1997, respectively, and as restated using the
pooling-of-interest method, are as follows:
Year Ended December 31
----------------------------- Total
Revenue Net Income (Loss) Assets
-------- ----------------- ------
1998:
Box Hill................... $ 72,476 $ 5,934 $ 83,869
Artecon.................... 95,879 (5,350) 43,161
-------- -------- --------
Restated................ $168,355 $ 584 $127,030
======== ======== ========
1997:
Box Hill................... $ 70,344 $ 5,058 $ 73,817
Artecon.................... 66,340 (19,288) 57,345
-------- -------- --------
Restated................ $136,684 $(14,230) $131,162
======== ======== ========
1996:
Box Hill................... $ 50,027 $ 826 $ 17,416
Artecon.................... 55,317 641 15,194
-------- -------- --------
Restated................ $105,344 $ 1,467 $ 32,610
======== ======== ========
F-29
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
(unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
--------- ---------
ASSETS
<S> <C> <C>
Current Assets:
Cash and cash equivalents........................................... $ 60,146 $ 56,307
Short-term investments.............................................. 2,800 3,500
Accounts receivable net............................................. 24,597 25,832
Inventories......................................................... 17,763 19,764
Prepaid expenses and other.......................................... 4,263 3,190
Prepaid income taxes................................................ 180 737
Deferred income taxes............................................... 4,223 4,223
--------- ---------
Total current assets........................................ 113,972 113,553
Property and equipment, net......................................... 2,658 2,967
Other assets........................................................ 54 114
Goodwill, net....................................................... 1,200 1,252
Other intangible assets, net........................................ 903 1,059
Deferred income taxes............................................... 8,085 8,085
--------- ---------
$ 126,872 $ 127,030
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt................................... $ 491 $ 483
Accounts payable.................................................... 19,886 19,459
Accrued expenses.................................................... 7,136 8,729
Customer deposits................................................... 1,507 2,173
Deferred revenue.................................................... 3,935 3,842
--------- ---------
Total current liabilities................................... 32,955 34,686
Borrowings under credit line.......................................... 10,730 10,552
Long-term debt 1,233 1,356
Deferred rent and other long-term liabilities......................... 424 420
Minority interest..................................................... 36 52
--------- ---------
Total liabilities.......................................... 45,378 47,066
--------- ---------
Shareholders' Equity:
Convertible preferred A shares, $.005 par value, 2,494,159 shares
issued and outstanding, liquidation preference of $4,988.......... 12 12
Common stock $.01 par value, 40,000,000 shares authorized,
23,072,388 and 23,009,881 shares issued and outstanding........... 231 230
Additional paid-in capital.......................................... 96,833 96,775
Foreign currency translation adjustments............................ (80) (62)
Accumulated deficit................................................. (15,502) (16,991)
--------- ---------
Total shareholders' equity.................................. 81,494 79,964
--------- ---------
$ 126,872 $ 127,030
========= =========
</TABLE>
The accompanying notes are integral part of these statements.
F-30
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
(in thousands, except per share information)
(unaudited)
Six Months Ended
June 30
--------------------
1999 1998
-------- --------
Net revenue............................................ $ 65,749 $ 76,531
Cost of goods sold..................................... 43,344 53,710
-------- --------
Gross profit.................................... 22,405 22,821
-------- --------
Operating expenses:
Sales and marketing.................................. 12,962 14,123
Engineering and product development.................. 3,716 4,273
General and administrative........................... 5,735 4,854
Impairment of intangible assets...................... 287 --
Acquired in-process research and development......... -- 14,500
-------- --------
Total operating expenses........................ 22,700 37,750
-------- --------
Operating income (loss)......................... (295) (14,929)
Interest income (expense), net......................... 403 406
Other income (expense), net............................ 396 347
Gain (loss) on foreign currency transactions, net...... (12) 21
--------- --------
Income (loss) before income taxes............... 492 (14,155)
Income taxes........................................... 156 49
-------- --------
Net income (loss)...................................... $ 336 $(14,204)
======== ========
Basic net income (loss) per share...................... $ .01 $ (.62)
======== ========
Diluted net income (loss) per share.................... $ .01 $ (.62)
======== ========
Comprehensive operations:
Net income (loss).................................... $ 336 $(14,204)
Foreign currency translation adjustment.............. (18) 49
--------- --------
Comprehensive income (loss).......................... $ 318 $(14,155)
======== ========
The accompanying notes are an integral part of these statements.
F-31
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
SUPPLEMENTAL CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands, except share information)
(unaudited)
<TABLE>
<CAPTION>
Convertible Foreign
Convertible Preferred A Shares Common Stock Additional Currency
Preferred --------------------- --------------------- Paid-In Translation
Stock Shares Amount Shares Amount Capital Adjustments
-------- ---------- ------- ---------- ------- ------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 ....... -- 2,494,159 12 23,009,881 230 96,775 (62)
Exercise of stock options ...... -- -- -- 56,671 1 35 --
Sale of common stock under
employee stock purchase plan . -- -- -- 5,836 -- 23 --
Foreign currency translation
adjustment ................... -- -- -- -- -- -- (18)
Adjustment to conform Artecon
to the Company's year-end .... -- -- -- -- -- -- --
Net income ................... -- -- -- -- -- -- --
-------- ---------- ------- ---------- ------- ------- -------
Balance, June 30, 1999 ........... $ -- 2,494,159 $ 12 23,072,388 $ 231 $96,833 $ (80)
======== ========== ======= ========== ======= ======= =======
<CAPTION>
Retained
Earnings Total
(Accumulated Shareholders
Deficit) Equity
------------ ----------
<S> <C> <C>
Balance, December 31, 1998 ....... (16,991) 79,964
Exercise of stock options ...... -- 36
Sale of common stock under
employee stock purchase plan . -- 23
Foreign currency translation
adjustment ................... -- (18)
Adjustment to conform Artecon
to the Company's year-end .... 1,153 1,153
Net income ................... 336 336
---------- ----------
Balance, June 30, 1999 ........... $ (15,502) $ 81,494
========== ==========
</TABLE>
The accompanying notes are an integral part of this statement.
F-32
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
------------------------------
1999 1998
-------- --------
<S> <C> <C>
Operating Activities:
Net income (loss) ............................................................ $ 336 $(14,204)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization ............................................ 647 1,242
Adjustment for change in Artecon year-end ................................ 1,153 17,674
Changes in operating assets and liabilities:
Accounts receivable ...................................................... 1,235 (9,449)
Inventories .............................................................. 2,001 (5,654)
Prepaid expenses and other ............................................... (1,073) (731)
Prepaid income taxes ..................................................... 557 --
Accounts payable ......................................................... 427 3,260
Accrued expenses ......................................................... (1,593) (3,065)
Customer deposits ........................................................ (666) 39
Deferred revenue ......................................................... 93 76
Long-term liabilities .................................................... -- --
Income taxes payable ..................................................... -- --
Other .................................................................... 48 306
-------- --------
Net cash provided by (used in)operating activities ................... 3,165 (10,506)
-------- --------
Investing Activities:
Sales of short-term investments .............................................. 700 3,805
Purchases of property and equipment .......................................... (130) (481)
-------- --------
Net cash provided by investing activities ................................ 570 3,324
-------- --------
Financing Activities:
Proceeds from exercise of stock options ...................................... 36 185
Proceeds from Employee Stock Purchase Plan ................................... 23 75
Proceeds from borrowings under line of credit ................................ 178 3,021
Payments on bank and other borrowings ........................................ (115) (1,211)
Distributions to S Corporation shareholders .................................. -- (227)
-------- --------
Net cash provided by financing activities ................................ 122 1,843
-------- --------
Effect of exchange rate changes on cash ...................................... (18) 61
-------- --------
Net increase (decrease) in cash and cash equivalents ......................... 3,839 (5,278)
Cash and cash equivalents, beginning of period ............................... 56,307 48,889
-------- --------
Cash and cash equivalents, end of period ..................................... 60,146 43,611
======== ========
Supplemental cash flow disclosure:
Cash paid for income taxes ............................................... $ -- $ 2,272
======== ========
Cash paid for interest ................................................... $ 264 $ 146
======== ========
</TABLE>
F-33
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(formerly BOX HILL SYSTEMS CORP.)
NOTES TO SUPPLEMENTAL CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
(unaudited)
1. Basis of Presentation:
The accompanying unaudited supplemental condensed consolidated financial
statements of Dot Hill Systems Corp. and subsidiaries ("Dot Hill" or the
"Company"), have been prepared in accordance with generally accepted accounting
principles for interim financial reporting and the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting only of normal recurring adjustments) considered necessary for fair
presentation have been included. Certain reclassifications have been made to
prior year financial statements to conform with current year financial statement
presentation.
On August 2, 1999, Box Hill Systems Corp. ("Box Hill") and Artecon, Inc.
("Artecon") completed a merger (the "Merger") in which the two companies were
merged in a tax-free, stock-for-stock transaction. The Merger will be accounted
for using the pooling-of-interests method. Subsequent to the Merger, the
combined Company changed its name to Dot Hill Systems Corp. Accounting
Principles Board Opinion No. 16 precludes the restatement of financial
statements for a pooling-of-interests transaction prior to the issuance of
financial statements covering a period encompassed by the transaction.
Accordingly, the accompanying consolidated financial statements set forth a
supplemental presentation of the Company's financial statements retroactively
restated to reflect the combination with Artecon (see Note 4). The accompanying
consolidated financial statements do not include estimated charges related to
the Merger, which will be charged to expense in the quarter ended September 30,
1999. As a result of the merger, Artecon will change its fiscal year end to
December 31. Artecon's net loss of $1,153 for the three months ended March 31,
1999 has also been included in the Company's results of operations for the year
ended December 31, 1998 and, therefore, was adjusted for within shareholder's
equity. The following is a summary of Artecon's results of operations for the
three months ended March 31, 1999:
Revenue.............................................. $ 18,327
Net loss............................................. (1,153)
Cash flows used in operating activities.............. (316)
Cash flows used in investing activities.............. (39)
Cash flows used in financing activities.............. (1,804)
Operating results for the six-months ended June 30, 1999 are not necessarily
indicative of the results that may be expected for the year ended December 31,
1999. For further information, refer to the consolidated financial statements
and notes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1998.
F-34
<PAGE>
2. Earnings Per Share:
Basic and diluted earnings per share has been computed under the guidelines of
Statement and Financial Accounting Standards No. 128, "Earnings per Share."
Basic and diluted earnings per share are calculated by dividing net income by
the weighted average and diluted weighted average number of shares of common
stock outstanding for the period. Diluted earnings per share is not presented in
periods with a loss. Dilutive securities consist of stock options, using the
treasury stock method, and convertible preferred stock. The table below sets
forth the reconciliation of the denominators of the earnings per share
calculation:
Six months ended
June 30,
--------------------
1999 1998
-------- --------
Shares used in computing basic net income
per share............................................. 23,056 22,812
Dilutive effect of options....................... 666 --
Convertible preferred stock...................... 719 --
------ ------
Shares used in computing diluted net income
per share............................................. 24,441 22,812
====== ======
For the six months ended June 30, 1999, options to purchase 745,589 shares of
common stock at exercise prices ranging from $5.31 to $18 were outstanding, but
not included in the computation of diluted net loss per share because the
exercise price was greater than the average market price of the Company's common
stock. For the six months ended June 30, 1998, all common stock equivalents were
excluded from the computation of diluted net loss per share because a loss was
incurred for the period.
3. Inventories:
Inventories are stated at the lower of cost (first-in, first-out) or market and
consist principally of purchased components used as- raw materials.
4. Subsequent Event:
Effective August 2, 1999, the Company and Artecon, Inc. ("Artecon") completed a
merger (the "Merger"), in which the two companies were merged in a tax-free,
stock-for-stock transaction which will be accounted for as a pooling of
interests. Under the terms of the Merger agreement, the Company issued 0.4
shares of its Common stock in exchange for each share of Artecon Common stock
outstanding. Additionally, Artecon's convertible preferred A shares were
converted into 719,037 shares of the Company's Common stock.
F-35
<PAGE>
Revenue and net income (loss) as previously reported for Dot Hill for the six
months ended June 30, 1999 and 1998, as restated using the pooling-of-interests
method, are as follows:
Six months ended
June 30,
----------------------
Revenue Net Income
-------- ----------
1999:
Box Hill.............................. $28,265 $ 924
Artecon............................... 37,484 (588)
------- --------
Restated......................... $65,749 $ 336
======= ========
Box Hill.............................. $35,847 $ 3,401
Artecon............................... 40,684 (17,605)
------- --------
Restated......................... $76,531 $(14,204)
======= ========
F-36
<PAGE>
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 8-K, into the Company's previously filed Form S-8
Registration Statement (File No. 333-35751).
/s/ Arthur Andersen LLP
Philadelphia, Pa.,
October 1, 1999
F-37
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-35751 of Dot Hill Systems Corp. on Form S-8 of our report dated May 6,1999,
relating to the financial statements of Artecon, Inc. and its subsidiaries as of
March 31, 1999 and 1998 and for each of the three years in the period ended
March 31, 1999 (not presented separately herein) appearing in this Current
Report on Form 8-K of Dot Hill Systems Corp.
DELOITTE & TOUCHE LLP
Costa Mesa, California
October 1, 1999
F-38
