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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 1-13317
DOT HILL SYSTEMS CORP.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
New York 13-3460176
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
161 Avenue of the Americas, New York, NY 10013
- ---------------------------------------- -------------
(Address of principal executive offices) (Zip Code)
(212) 989-4455
----------------------------------------------------
(Registrant's telephone number, including area code)
Box Hill Systems Corp.
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. X Yes __ No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $.01 par value, 23,827,697 shares outstanding as of August 11,
1999.
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DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
f/k/a Box Hill Systems Corp.
INDEX
Page
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements (unaudited):
Condensed Consolidated Balance Sheets - June 30, 1999
and December 31, 1998 1
Condensed Consolidated Statements of Income - Three and Six
months ended June 30, 1999 and 1998 2
Condensed Consolidated Statements of Cash Flows -
Six months ended June 30, 1999 and 1998 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 6
Item 3. Quantitative and Qualitative Disclosure About Market Risk 15
Part II. Other Information
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults upon senior securities 16
Item 4. Submission of matters to a vote of security holders 16
Item 5. Other information 17
Item 6. Exhibits and reports on Form 8-K 17
Signatures 18
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Item 1. Condensed Consolidated Financial Statements
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
f/k/a Box Hill Systems Corp.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
June 30, December 31,
1999 1998
----------- ------------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents......................... $ 58,436 $ 54,214
Short-term investments............................ 2,800 3,500
Accounts receivable, net.......................... 11,187 13,601
Inventories....................................... 8,475 8,091
Prepaid expenses and other........................ 1,690 1,220
Prepaid income taxes.............................. 180 737
Deferred income taxes............................. 984 984
-------- --------
Total current assets............................ 83,752 82,347
Property and equipment, net....................... 1,232 1,331
Deferred income taxes............................. 191 191
-------- --------
$ 85,175 $ 83,869
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................. $ 11,147 $ 9,796
Accrued expenses.................................. 3,286 4,008
Customer deposits................................. 1,507 2,173
Deferred revenue.................................. 2,818 2,455
-------- --------
Total current liabilities....................... 18,758 18,432
-------- --------
Deferred rent....................................... 297 287
-------- --------
Shareholders' equity:
Preferred stock, $.01 par value, 5,000,000
shares authorized, none issued.................. -- --
Common stock, $.01 par value, 40,000,000 shares
authorized, 14,363,588 and 14,327,081 shares
issued and outstanding.......................... 144 143
Additional paid-in capital........................ 57,202 57,157
Retained earnings................................. 8,774 7,850
-------- --------
Total shareholders' equity...................... 66,120 65,150
-------- --------
$ 85,175 $ 83,869
======== ========
The accompanying notes are an integral part of these statements.
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DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
f/k/a Box Hill Systems Corp.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share information)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------- ------------------
1999 1998 1999 1998
-------- -------- -------- --------
Net revenue............................ $ 13,980 $ 19,802 $ 28,265 $ 35,847
Cost of goods sold..................... 9,745 12,509 19,138 23,028
-------- -------- -------- --------
Gross profit....................... 4,235 7,293 9,127 12,819
-------- -------- -------- --------
Operating expenses:
Engineering and product development.. 649 662 1,322 1,308
Sales and marketing.................. 1,832 2,131 3,950 4,130
General and administrative........... 1,634 1,456 3,260 2,738
-------- -------- -------- --------
4,115 4,249 8,532 8,176
-------- -------- -------- --------
Operating income................... 120 3,044 595 4,643
Interest income........................ 466 479 908 985
-------- -------- -------- --------
Income before income taxes......... 586 3,523 1,503 5,628
Income tax provision................... 226 1,417 579 2,227
-------- -------- -------- --------
Net income............................. $ 360 $ 2,106 $ 924 $ 3,401
======== ======== ======== ========
Basic net income per share............. $ .03 $ .15 $ .06 $ .24
======== ======== ======== ========
Diluted net income per share........... $ .02 $ .14 $ .06 $ .23
======== ======== ======== ========
The accompanying notes are an integral part of these statements.
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DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
f/k/a Box Hill Systems Corp.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended
June 30,
--------------------
1999 1998
------- --------
Operating activities:
Net income............................................. $ 924 $ 3,401
Adjustments to reconcile net income to net cash
provided by (used in) operating activities--
Depreciation and amortization...................... 187 164
Other.............................................. 8 20
Changes in assets and liabilities--
Accounts receivable.............................. 2,414 (4,752)
Inventories...................................... (384) (1,833)
Prepaid expenses and other....................... (470) (714)
Prepaid income taxes............................. 557 --
Accounts payable................................. 1,351 738
Accrued expenses................................. (722) 568
Customer deposits................................ (666) 39
Deferred revenue................................. 363 258
Income taxes payable............................. -- (36)
------- --------
Net cash provided by (used in)operating
activities................................... 3,562 (2,147)
------- --------
Investing activities:
Sale of short-term investments......................... 700 3,805
Purchases of property and equipment.................... (88) (158)
------- --------
Net cash provided by investing activities...... 612 3,647
------- --------
Financing activities:
Proceeds from exercise of stock options................ 23 100
Proceeds from Employee Stock Purchase Plan............. 25 75
Distributions to S Corporation shareholders............ -- (227)
------- --------
Net cash provided by (used in) financing
activities................................... 48 (52)
------- --------
Net increase in cash and cash equivalents................ 4,222 1,448
Cash and cash equivalents, beginning of period........... 54,214 40,897
------- --------
Cash and cash equivalents, end of period................. $58,436 $42,345
======= ========
Supplemental cash flow disclosure:
Cash paid for income taxes............................. $ -- $ 2,272
------- --------
The accompanying notes are an integral part of these statements.
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DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
f/k/a Box Hill Systems Corp.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation:
On August 2, 1999, Box Hill Systems Corp. ("Box Hill") and Artecon, Inc.
("Artecon") merged in a stock-for-stock transaction which shall be accounted for
as a pooling-of-interests. Upon consummation of the transaction, Artecon became
a wholly-owned subsidiary of Box Hill. On that same day, Box Hill changed its
name to Dot Hill Systems Corp. ("Dot Hill"). See "Note 4-Subsequent Event."
The accompanying financial statements are those of Box Hill and do not include
those of Artecon.
The accompanying unaudited condensed consolidated financial statements of Dot
Hill, formerly known as Box Hill, and its subsidiaries (the "Company"), as of
June 30, 1999, 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 to current year
financial statement presentation.
Operating results for the three and six month periods 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.
2. Earnings Per Share:
Basic and diluted net income per share have been computed under the guidelines
of Statement of Financial Accounting Standards No. 128, "Earnings per Share."
Basic net income per share is computed by dividing net income by the weighted
average number of shares of common stock outstanding for the period. Diluted net
income per share is computed by dividing net income by the weighted average
number of shares of common stock outstanding for the period, adjusted for the
dilutive effect of common stock equivalents, consisting of dilutive common stock
options using the treasury stock method. The following table sets forth the
reconciliation of basic to diluted shares used in computing net income per share
(in thousands):
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Three Months Ended Six Months Ended
June 30, June 30,
---------------- ----------------
1999 1998 1999 1998
------ ------ ------ ------
Shares used in computing basic
net income per share................. 14,362 14,263 14,350 14,242
Dilutive effect of options............. 649 789 651 817
------ ------ ------ ------
Shares used in computing diluted
net income per share................. 15,011 15,052 15,001 15,059
====== ====== ====== ======
For the three and six months ended June 30, 1999, options to purchase 255,500
shares of the Company's common stock were outstanding at exercise prices ranging
from $6.25 to $15.00, but were not included in the computation of diluted net
income per share because the exercise price of the options was greater than the
average market price of the common stock.
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:
On August 2, 1999, Box Hill and Artecon, Inc. 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. As a result
of the Merger, Artecon became a wholly-owned subsidiary of Box Hill. The
combined company is now called Dot Hill Systems Corp., and is trading under the
ticker symbol HIL on the New York Stock Exchange. Under the terms of the Merger
agreement, Box Hill issued 0.4 shares of its common stock in exchange for each
share of Artecon common stock outstanding. Additionally, Artecon's convertible
preferred A stock was converted into 719,037 shares of the Company's common
stock
The following is a summary of the Company's pro forma results of operations as
if Box Hill and Artecon were combined for all periods presented.
Three Months Ended Six Months Ended
June 30, June 30,
---------------- ----------------
1999 1998 1999 1998
------- ------- ------- -------
Net revenue............................ $33,137 $46,747 $65,749 $76,531
Net income (loss)...................... 925 2,175 336 (14,204)
Basic net income (loss) per share...... .04 .10 .01 (.62)
Diluted net income (loss) per share.... .04 .09 .01 (.62)
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The above pro forma financial information does not include estimated direct
charges of $5.0 million related to the Merger, which will be charged to expense
in the quarter ended September 30, 1999. The pro forma financial information for
the six months ended June 30, 1998 includes a $14.5 million charge for
acquired in-process research and development.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations:
Cautionary Statement for Forward-Looking Information
Certain statements contained in this report, including statements regarding the
anticipated development and expansion of the Company's business, the successful
integration of the operations and businesses of Box Hill and Artecon, the
intent, belief or current expectations of the Company, its directors or its
officers, primarily with respect to the future operating performance of the
Company and the products it expects to offer and other statements contained
herein regarding matters that are not historical facts, are "forward-looking"
statements within the meaning of the Private Securities Litigation Reform Act
(the "Reform Act"). Future filings with the Securities and Exchange Commission,
future press releases and future oral or written statements made by or with the
approval of the Company which are not statements of historical fact, may contain
forward-looking statements under the Reform Act. Because such statements include
risks and uncertainties, actual results may differ materially from those
expressed or implied by such forward-looking statements. Factors that could
cause actual results to differ materially from those expressed or implied by
such forward-looking statements follow. For a more detailed listing of some of
the risks and uncertainties facing the Company, please see the most recent Forms
8-K and Forms 10-K filed by Box Hill and Artecon, and the registration / joint
proxy statement filed in connection with the Merger.
The Open Systems storage market in which the Company operates is characterized
by rapid technological change, frequent new product introductions, increasing
competition and evolving industry standards. Customer preferences in that market
are difficult to predict. The introduction of products embodying new
technologies and the emergence of new industry standards could render the
Company's existing products, as well as its new products, including Fibre
Channel and Storage Area Network (SAN) technologies, obsolete and unmarketable.
Also, a number of mergers and acquisitions have taken place among open systems
storage companies recently, and that type of activity may continue. Such
corporate transactions may quickly and unpredictably alter the market, including
the competitive landscape and the availability of key components and third party
products. Such constant changes makes accurate market predictions difficult. In
recent periods, the Company's revenue and earnings results have fallen short of
market projections; in this current period, earnings and revenue results fell
short of certain market projections, and such shortfalls could occur again in
the future. The Company relies on other companies to supply components for its
products, and certain products that it resells, which are available only from
limited sources in the quantities and quality demanded by the Company. The
Company has historically targeted industries requiring high-end storage
products, and a material portion of the Company's net revenue to date has been
derived from sales to
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customers in the financial services industry and the telecommunications
industry. Historically, a majority of the Company's net revenue in each year has
been derived from a limited number of customers. The Merger and the Company's
growth and expansion may place a significant strain on its administrative,
operational and financial resources and increased demands on its manufacturing,
sales and customer service functions, especially as the Company attempts to
expand its geographic reach. The Company's future operating results depend in
part upon its ability to attract, train, retain and motivate qualified
management, technical, manufacturing, sales and support personnel for its
operations. The Company has no patent protection for its products and has
attempted to protect its proprietary software and other intellectual property
rights through copyrights, trade secrets and other measures, which measures may
prove to be inadequate.
There are certain risks involved with the Merger, including, among others, the
combined company's ability to integrate the businesses following the Merger. For
a more detailed list of some of the risks and uncertainties related to the
Merger, please see the registration / joint proxy statement filed in connection
with the Merger.
In the course of business, the Company is subject to legal proceedings and
claims, both asserted or unasserted. The Company and four of its principal
officers and directors were named defendants in shareholder lawsuits filed on
and after December 4, 1998, which allege various securities law violations and
seek monetary damages. See "Part II Item 1. Legal Proceedings".
All forward-looking statements speak only as of the date on which they are made.
The Company undertakes no obligation to update such statements to reflect events
that occur or circumstances that exist after the date on which they are made.
Overview
The Company is an independent provider of high performance storage and Storage
Area Network ("SAN") solutions to the open systems computing market. The Company
designs, manufactures, markets and supports data storage systems, and markets
and supports data storage back-up systems for the Open Systems computing
environment. For financial reporting purposes, the Company operates in one
business segment. In the United States, the Company employs a direct marketing
strategy aimed at data-intensive industries. Targeted industries, to date,
include financial services, telecommunications, health care, government/defense
and academia. The Company's international strategy has been to use distributors
located outside of the United States for product distribution. Since its
inception, the Company has focused exclusively on providing storage solutions
for high-end customers, primarily in the UNIX environment. The Company initially
focused on the financial services industry in response to that industry's need
for high-availability, high- performance, fault-tolerant storage systems and
high levels of customer and technical support. The Company believes that it has
been able to leverage its position as a company focused exclusively on storage
solutions to bring new products to market faster than certain competitors. The
Company has financed its growth primarily with cash generated from operations
and from its initial public offering of its common stock on September 16, 1997.
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The Company's manufacturing operations consist primarily of assembly and
integration of components and subassemblies into its products, with certain of
those components and subassemblies manufactured by independent contractors.
Generally the Company extends to its customers the warranties provided to the
Company by its suppliers. To date, the Company's suppliers have covered the
majority of its warranty 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.
On August 2, 1999, Box Hill and Artecon, Inc. 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. As a result
of the Merger, Artecon became a wholly-owned subsidiary of Box Hill. The
combined company is now called Dot Hill Systems Corp., and is trading under the
ticker symbol HIL on the New York Stock Exchange.
Results of Operations
The following table sets forth certain items from the Company's income
statements as a percentage of net revenue for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
---------------- ----------------
1999 1998 1999 1998
------ ------ ------ ------
Net revenue............................. 100.0% 100.0% 100.0% 100.0%
Cost of goods sold...................... 69.7 63.2 67.7 64.2
------ ------ ------ ------
Gross profit........................ 30.3 36.8 32.3 35.8
------ ------ ------ ------
Operating expenses:
Engineering and product development... 4.6 3.3 4.7 3.6
Sales and marketing................... 13.1 10.8 14.0 11.5
General and administrative............ 11.7 7.3 11.5 7.7
------ ------ ------ ------
Total operating expenses............ 29.4 21.4 30.2 22.8
------ ------ ------ ------
Operating income...................... 0.9% 15.4% 2.1% 13.0%
====== ====== ====== ======
Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998:
NET REVENUE - Net revenue decreased 29.3% to approximately $14.0 million for the
three months ended June 30, 1999 from approximately $19.8 million for the three
months ended June 30, 1998. The decrease resulted primarily from a decrease in
sales volume to all market segments served by the Company coupled with price
reductions.
Net revenue from the sales of Fibre Channel and SAN Networking equipment
decreased $0.2 million to $0.9 million for the three months ended June 30, 1999,
from $1.1 million for
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the three months ended June 30, 1998. The decrease is due to price reductions,
offset by the introduction of SAN Networking equipment. Net revenue from the
sales of RAID products decreased $1.0 million to $3.0 million for the three
months ended June 30, 1999, from $4.0 million for the three months ended June
30, 1998, due to a decrease in sales volume coupled with price reductions. Net
revenue from the sales of legacy (SCSI-JBOD) disk storage products and
services decreased $1.8 million to $6.8 million for the three months ended June
30, 1999, from $8.6 million for the comparable period of 1998, also due to a
decrease in sales volume coupled with price reductions. Net revenue from the
sales of back-up products decreased $2.8 million to $3.3 million for the three
months ended June 30, 1999, from $6.1 million for the three months ended June
30, 1998, due to a decrease in volume.
GROSS PROFIT - Gross profit decreased 42.5% to $4.2 million for the three months
ended June 30 1999, from $7.3 million for the comparable period of 1998. As a
percentage of net revenue, gross profit decreased from 36.8% to 30.3%. The
decrease was primarily a result of increased competition and related price
reductions, a different product mix and the impact of fixed costs as a
percentage of net revenue.
ENGINEERING AND PRODUCT DEVELOPMENT - Engineering and product development
expenses consist primarily of employee compensation, engineering equipment, cost
of supplies 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, partially offset by an increase in the number of employees
engaged in research and development, engineering and product development
expenses decreased 14.3% to $0.6 million for the three months ended June 30,
1999, from $0.7 million for the same period in 1998. As a percentage of net
revenue, engineering and product development expenses increased to 4.6% for the
three months ended June 30, 1999 from 3.3% for the comparable period of 1998.
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 14.3% to $1.8 million for the three months
ended June 30, 1999 from $2.1 million for the three months ended June 30, 1998.
The decrease was due primarily 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 to 13.1% for the three months ended June 30, 1999
from 10.8% for the comparable period of 1998.
GENERAL AND ADMINISTRATIVE - General and administrative expenses consist
primarily of compensation to the officers and employees performing the Company's
administrative functions and expenditures for its administrative facilities.
General and administrative expenses increased 6.7% to $1.6 million for the three
months ended June 30, 1999 from $1.5 million for the three months ended June 30,
1998. As a percentage of net revenue, general and administrative expenses
increased to 11.7% for the three months ended June 30, 1999 from 7.3% for the
comparable period of 1998. The increase is primarily due to professional fees
related to the shareholder class action lawsuit described herein.
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INTEREST INCOME - Interest income, the majority of which is exempt from federal
income taxes, consists primarily of income earned on the Company's cash and cash
equivalents and short-term investments. Interest income remained constant at
$0.5 million for the three months ended June 30, 1999 and 1998.
INCOME TAX PROVISION - The Company's effective income tax rate was 38.5% for the
three months ended June 30, 1999, reflecting federal, state and local taxes,
partially offset by research and development credits and a favorable tax benefit
from the Company's foreign sales corporation. The Company's effective income tax
rate was 40.2% for the three months ended June 30, 1998, reflecting federal,
state and local taxes, and a charge for estimated prior years' taxes as a result
of a voluntary disclosure agreement entered into with one state, partially
offset by research and development credits and a favorable tax benefit from the
Company's foreign sales corporation.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998:
NET REVENUE - Net revenue decreased 20.9% to $28.3 million for the six months
ended June 30, 1999, from $35.8 million for the six months ended June 30, 1999.
The decrease resulted from a decrease in volume from sales to all market
segments served by the Company, coupled with price reductions.
Net revenue from sales of Fibre Channel and SAN Networking equipment increased
$0.6 million to $1.9 million for the six months ended June 30, 1999, compared to
$1.3 million for the six months ended June 30, 1998. The increase is due to the
introduction of SAN Networking equipment, partially offset by price reductions.
Net revenue from sales of RAID products decreased $1.3 million, to $5.4 million
for the six months ended June 30, 1999, compared to $6.7 million for the six
months ended June 30, 1998, due to price reductions and slower than anticipated
growth, particularly in the financial services market and in the Northeast
region of the country. Net revenue from sales of legacy (SCSI-JBOD) disk
storage products and services decreased $2.8 million to $13.2 million for the
six months ended June 30, 1999, compared to $16.0 million for the comparable
period of 1998, also due to price reductions and slower than anticipated growth.
Net revenue from sales of back-up products decreased $4.0 million to $7.8
million for the six months ended June 30, 1999, compared to $11.8 million for
the comparable period of 1998, due to a decrease in volume.
GROSS PROFIT - Gross profit decreased 28.9% to $9.1 million for the six months
ended June 30, 1999, from $12.8 million for the comparable period of 1998. As a
percentage of net revenue, gross profit decreased from 35.8% to 32.3%, primarily
as a result of increased competition and related sales price reductions, a
different product mix and the impact of fixed costs as a percentage of net
revenue.
ENGINEERING AND PRODUCT DEVELOPMENT - Engineering and product development
remained constant at $1.3 million for the six months ended June 30, 1999 and
1998. As a percentage of net revenue, engineering and product development
increased to 4.7% for the six months ended June 30, 1999 from 3.6% for the
comparable period of 1998.
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SALES AND MARKETING - Sales and marketing expenses decreased slightly to $4.0
million for the six months ended June 30, 1999 from $4.1 million for the six
months ended June 30, 1998. The decrease was due primarily 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 revenues, sales and marketing expenses increased to 14.0% for the six months
ended June 30, 1999 from 11.5% for the comparable period of 1998.
GENERAL AND ADMINISTRATIVE - General and administrative expenses increased 22.2%
to $3.3 million for the six months ended June 30, 1999 from $2.7 million for the
six months ended June 30, 1998. As a percentage of net revenues, general and
administrative expenses increased to 11.5% for the six months ended June 30,
1999 from 7.7% 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 shareholder class action lawsuit described herein, payroll
increases and additional staff seminars and training.
INTEREST INCOME - Interest income consists primarily of income earned on the
Company's cash and cash equivalents and short-term investments. Interest income
decreased 10.0% to $0.9 million for the six months ended June 30, 1999 from $1.0
million for the six months ended June 30, 1998, as a result of general
short-term interest rate fluctuations.
INCOME TAX PROVISION - For the six months ended June 30, 1999, the Company's
effective income tax rate was 38.5%, reflecting federal, state and local taxes,
partially offset by research and development credits and a favorable tax benefit
from the company's foreign sales corporation. For the six months ended June 30,
1998, the Company's effective income tax rate was 39.6%, reflecting federal,
state, and local taxes, and a charge for estimated prior years' taxes as a
result of a voluntary disclosure agreement entered into with one state,
partially offset by research and development credits and a favorable tax benefit
from the Company's foreign sales corporation.
Liquidity and Capital Resources
As of June 30, 1999, the Company had $61.2 million of cash and cash equivalents
and short-term investments and no bank indebtedness. As of June 30, 1999,
working capital was $65.0 million.
For the six months ended June 30, 1999, cash provided by operating activities
was $3.6 million compared to cash used in operating activities of $2.1 million
for the same period in 1998. The increase in net cash provided by operating
activities is mainly due to a decrease in accounts receivable and a smaller
increase in inventories as compared to the 1998 period, partially offset by a
decrease in net income.
Cash provided by investing activities of $0.6 million and $3.6 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.
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Cash provided by financing activities was $48,000 for the six months ended June
30, 1999, as a result of proceeds from the exercise of stock options under the
Company's 1995 Stock Incentive Plan and from the Company's 1997 Employee Stock
Purchase Plan.
In October 1997, the Company obtained a $10 million revolving line of credit
facility from a commercial bank. The Company has not made any borrowings under
this facility. 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. The line of credit was renewed May 1998.
As of August 5, 1999, the Company paid approximately $12.7 million of debt of
Artecon. In addition, the Company expects to incur approximately $5.0 million of
direct charges related to the Merger, which will be charged to expense in the
quarter ended September 30, 1999.
The Company currently expects that cash and 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, other than the Merger, or significant
capital improvements, neither of which is currently contemplated.
Competitive pricing pressures exist in the data storage market, and have had and
may in the future have an adverse effect on the Company's revenues and earnings.
The Company believes that pricing pressures are likely to continue as
competitors of the Company develop more competitive product offerings.
Many of the Company's current and potential competitors are significantly larger
than the Company and have significantly greater financial, technical, marketing,
purchasing, and other resources 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. Consolidations may also limit the supply of
key components or third party products available to the Company. Current and
potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address the needs of the Company's prospective customers.
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.
-12-
<PAGE>
Year 2000
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, the Company 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 the Company, this statement supersedes those prior statements. Readers
should also be aware that the Company's evaluation of certain aspects of its
Year 2000 readiness is based on statements by other parties. The Company often
cannot verify the veracity of those statements, which may have been made in
error.
The Company's Products
The Company believes the current version of all products manufactured by the
Company will function normally after the Year 2000.
Most of the Company'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 the Company that use dates are the Company'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 systems only note 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 00, 01, and so on. The Company offers new
versions 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 the Company, are responsible for implementation of the new version of
Firmware.
The Company does not know of any earlier products of material significance that
it has manufactured that will not operate normally after the year 2000. However,
the Company has not evaluated all such products. The Company continues to answer
Year 2000 questions about specific products previously manufactured by the
Company. The Company does not warrant or represent that obsolete, unsupported
Company products are Year 2000 compliant, and the Company will not support such
products for Year 2000 purposes.
The rights and remedies of customers as to Year 2000 date data functionality as
to any the Company products are governed by applicable law and agreements
between customers and the Company. The statements made herein by the Company do
not enlarge the rights and remedies of any customers as to Year 2000 date data
functionality and the Company makes
-13-
<PAGE>
no warranties or representations by virtue of this disclosure or otherwise
regarding Year 2000 data functionality.
The Company's Internal Systems
The Company has evaluated its information technology infrastructure, made
modifications and identified necessary upgrades. The Company expects that its
infrastructure will be Year 2000 compliant by the third quarter of 1999. The
Company also has evaluated or received information regarding its non-information
technology infrastructure (office building systems, copiers, telephone system,
etc.) for Year 2000 readiness and believes those systems are Year 2000
compliant. The machinery used by the Company to manufacture its products does
not use dates, and therefore, is Year 2000 compliant by nature.
Readiness of Third Parties and Third Party Products Resold or Licensed by The
Company
The Company has requested confirmation of the Year 2000 readiness of third party
products of material significance to the Company, which the Company currently
resells, licenses or uses to manufacture its own products. However, the Company
does not and will not take responsibility for the 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.
The Company has not confirmed the Year 2000 readiness of all third party
products resold or integrated by the Company and has not confirmed the readiness
of products which are not resold or licensed by the Company but which may, in
some way, interface or interconnect with the Company products or products
manufactured by third parties that the Company either resells or licenses. The
Company does not, and will not, take responsibility for Year 2000 compliance of
such products.
The Company is in the process of requesting information about the internal Year
2000 readiness of those third parties that supply the Company with key products
and services. To date, all third parties contacted have stated they believe
their products will be compliant. However, the Company is incapable of testing
or knowing the accuracy of such statements and has not received information from
all such third parties.
Costs Associated with Year 2000 Compliance
To date, the Company has not hired any additional employees or made any
significant purchases to carry out its Year 2000 compliance program. At this
time, the Company is not aware of any material future expenses that will be
required to enable Year 2000 compliance.
Risks Associated with the Year 2000
The full impact of the Year 2000 will not be known until January 1, 2000. Again,
the Company 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 the Company. However, some risks that the Company may encounter include:
the failure of its internal
-14-
<PAGE>
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 the Company's
products to customers. Even if the Company and its products are ready for the
Year 2000, the Company 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.
Contingency Plans
The Company 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, the Company will utilize substitute providers
who have been identified to provide the necessary materials and services. Should
the Company's internal information systems fail, the Company plans to manually
perform the paperwork necessary to conduct business.
Item 3. Quantitative and Qualitative Disclosure About Market Risk:
There have been no significant changes to the quantitative and qualitative
information disclosed in the Company's Form 10-K for the fiscal year ended
December 31, 1998. However, the average interest rate earned on the Company's
cash equivalents and short-term investments decreased from 3.6% for the year
1998 to 3.1% during the six months ended June 30, 1999, resulting in a decrease
in interest income of approximately $77 thousand for the six months ended June
30, 1999 compared to the same period in 1998. The Company does not believe these
changes will have a significant impact on its liquidity and capital resources.
-15-
<PAGE>
DOT HILL SYSTEMS COPR. AND SUBSIDIARIES
f/k/a Box Hill Systems Corp.
Part II - Other Information
Item 1. Legal Proceedings
Four putative shareholder class action law suits were filed, and have since been
consolidated into a single action, against the Company, Philip Black, Carol
Turchin, Benjamin Monderer, Mark Mays, and the underwriters of the Company's
September 16, 1997 initial public offering (the "Offering") in the United States
District Court for the Southern District of New York. The putative class actions
were filed on behalf of purchasers of the stock of the Company during the period
between September 16, 1997 and April 14, 1998. Plaintiffs allege that, in
violation of federal securities laws, defendants 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.
On May 3, 1999, the Company filed a motion to dismiss the consolidated
complaint. The motion has not yet been ruled upon. The Company believes that it
has meritorious defenses to plaintiff's claims and intends to vigorously defend
against those claims. However, the Company expects to incur additional
significant legal expense in 1999 defending this litigation. Such defense costs,
and other amounts incurred in connection with this litigation, will be expensed
as incurred and will reduce the Company's 1999 results.
In addition to the complaints discussed above, the Company is subject to various
legal proceedings and claims against the Company, asserted or unasserted, which
arise in the ordinary course of business. While the outcome of the claims
against the Company cannot be predicted with certainty, management believes that
such other litigation and claims will not have a material adverse effect on the
Company's financial position or results of operations.
Item 2. Changes in Securities
None.
Item 3. Defaults upon senior securities
None.
Item 4. Submission of matters to a vote of security holders
None.
-16-
<PAGE>
Item 5. Other information
On or about July 9, 1999, Box Hill mailed the prospectus/joint proxy
statement to its shareholders with respect to the Merger. At the special meeting
on August 2, 1999, the shareholders of the Company approved (i) the Merger and
the issuance of shares of Common Stock to the Artecon stockholders, (ii) the
change in the name of the Company, (iii) the adoption of a classified board of
directors and (iv) an increase in the number of shares authorized for issuance
under the Company's stock option plan and stock purchase plan.
Item 6. Exhibits and reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K with the Securities
and Exchange Commission on May 7, 1999 describing the Merger Agreement
executed among Box Hill, BH Acquisition Corp. and Artecon.
-17-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on behalf by the undersigned, thereunto duly authorized.
DOT HILL SYSTEMS CORP.
Date: August 16, 1999 By /s/ Philip Black
-------------------------------
Philip Black
Co-Chief Executive Officer
Date: August 16, 1999 By /s/ James L. Lambert
-------------------------------
James L. Lambert
Co-Chief Executive Officer
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, this Report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.
Date: August 16, 1999 By /s/ Philip Black
-------------------------------
Philip Black
Co-Chief Executive Officer
(Principal Executive Officer)
Date: August 16, 1999 By /s/ James L. Lambert
-------------------------------
James L. Lambert
Co-Chief Executive Officer
(Principal Executive Officer)
Date: August 16, 1999 By /s/ R. Robert Rebmann, Jr.
-------------------------------
R. Robert Rebmann, Jr.
Chief Financial Officer and Treasurer
(Principal Financial Officer)
-18-
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