<PAGE> 1
================================================================================
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 September 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)
<TABLE>
<S> <C>
New York 13-3460176
- -------------------------------------------------------------- ------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
6305 El Caminio Real, Carlsbad, CA 92009
- -------------------------------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
</TABLE>
(760) 931-5500
- --------------------------------------------------------------------------------
(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, 23,870,459 shares outstanding as of November 10,
1999.
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<PAGE> 2
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(FORMERLY BOX HILL SYSTEMS CORP.)
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited):
Condensed Consolidated Balance Sheets-September 30,1999
and December 31, 1998 1
Condensed Consolidated Statements of Operations-Three and Nine
months ended September 30, 1999 and 1998 3
Condensed Consolidated Statements of Cash Flows-
Nine months ended September 30, 1999 and 1998 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosure About Market Risk 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 3. Defaults upon senior securities 19
Item 4. Submission of matters to a vote of security holders 19
Item 5. Other information 20
Item 6. Exhibits and reports on Form 8-K 20
SIGNATURES 21
</TABLE>
<PAGE> 3
PART I. - FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(FORMERLY BOX HILL SYSTEMS CORP.)
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- -------------
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents ..... $ 42,906 $ 56,307
Short-term investments ........ 4,100 3,500
Accounts receivable, net ...... 22,783 25,832
Inventories ................... 13,122 19,764
Prepaid expenses and other .... 2,410 3,190
Prepaid income taxes .......... 737 737
Deferred income taxes ......... 6,770 4,223
------------- -------------
Total current assets ... 92,828 113,553
Property and equipment, net ...... 2,448 2,967
Deferred income taxes ............ 7,311 8,085
Goodwill, net .................... 580 1,252
Other intangible assets, net ..... 378 1,059
Other assets ..................... 48 114
------------- -------------
$ 103,593 $ 127,030
============= =============
</TABLE>
(continued)
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<PAGE> 4
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(FORMERLY BOX HILL SYSTEMS CORP.)
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY (unaudited)
<S> <C> <C>
Current liabilities:
Current portion of long-term debt ................................ $ -- $ 483
Accounts payable ................................................. 15,813 19,459
Accrued expenses ................................................. 6,061 6,690
Restructuring accruals ........................................... 4,265 1,254
Customer deposits ................................................ 1,710 2,173
Deferred revenue ................................................. 3,408 3,842
Income taxes payable ............................................. 786 785
------------- -------------
Total current liabilities ................................ 32,043 34,686
Borrowings under lines of credit .................................... 278 10,552
Long-term debt ...................................................... - 1,356
Deferred rent and other long-term liabilities ....................... 443 420
Minority interest ................................................... 42 52
------------- -------------
Total liabilities ................................................... 32,806 47,066
------------- -------------
Shareholders' equity:
Convertible preferred A shares, $.005 par value, 2,494,159 shares
issued and outstanding, at December 31, 1998 ..................... -- 12
Preferred stock $.01 par value, 5,000,000 shares
authorized, none issued
Common stock, $.01 par value, 40,000,000 shares
authorized, 23,845,350 and 23,009,881 shares issued
and outstanding ................................................ 238 230
Additional paid-in capital ....................................... 96,952 96,775
Foreign currency translation adjustment .......................... (68) (62)
Accumulated Deficit .............................................. (26,335) (16,991)
------------- -------------
Total shareholders' equity ............................... 70,787 79,964
------------- -------------
$ 103,593 $ 127,030
============= =============
</TABLE>
The accompanying notes are an integral part of these statements.
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<PAGE> 5
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(FORMERLY BOX HILL SYSTEMS CORP.)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(in thousands, except per share information)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenue .......................................... $ 28,333 $ 41,357 $ 94,082 $ 135,117
--------- --------- --------- ---------
Cost of goods sold ................................... 19,020 27,741 62,364 87,354
Inventory write-downs ................................ 5,033 403 5,033 403
--------- --------- --------- ---------
Total cost of goods sold .......................... 24,053 28,144 67,397 87,757
--------- --------- --------- ---------
Gross profit ................................. 4,280 13,213 26,685 47,360
--------- --------- --------- ---------
Operating expenses:
Sales and marketing ............................... 4,904 9,402 17,866 27,093
Engineering and product development ............... 1,749 2,518 5,465 7,990
General and administrative ........................ 2,866 2,999 8,601 8,197
Impairment of intangible assets ................... 937 580 1,224 580
Restructuring and merger-related expenses ......... 7,392 1,404 7,392 1,404
--------- --------- --------- ---------
Total operating expenses ..................... 17,848 16,903 40,548 45,264
--------- --------- --------- ---------
Operating income (loss) ...................... (13,568) (3,690) (13,863) 2,096
--------- --------- --------- ---------
Interest income ...................................... 451 455 1,365 1,440
Interest expense ..................................... (140) (282) (651) (754)
Other income(expense), net ........................... (11) 10 385 15
Loss on foreign currency transactions, net ........... (59) (1) (71) (25)
--------- --------- --------- ---------
241 182 1,028 676
--------- --------- --------- ---------
Income (loss) before income taxes ............ (13,327) (3,508) (12,835) 2,772
Income tax provision (benefit) ....................... (2,494) (1,160) (2,338) 1,368
--------- --------- --------- ---------
Net income (loss) .................................... $ (10,833) $ (2,348) $ (10,497) $ 1,404
========= ========= ========= =========
Basic and diluted net income (loss) per share ........ $ (0.46) $ (0.10) $ (0.45) $ .06
========= ========= ========= =========
COMPREHENSIVE OPERATIONS:
Net income (loss) .................................... $ (10,833) $ (2,348) $ (10,497) $ 1,404
Foreign currency translation adjustments, net
of tax ......................................... (6) (291) 12 72
--------- --------- --------- ---------
Comprehensive income (loss) .......................... $ (10,839) $ (2,639) $ (10,485) $ 1,476
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
-3-
<PAGE> 6
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(FORMERLY BOX HILL SYSTEMS CORP.)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------
1999 1998
-------- --------
<S> <C> <C>
Operating activities:
Net income (loss) ............................................ $(10,497) $ 1,404
Adjustments to reconcile net income (loss) to net cash used
in operating activities--
Depreciation and amortization .......................... 1,151 3,658
Adjustment for change in Artecon year-end .............. 1,153 --
Deferred income taxes .................................. (1,773) (2,166)
Inventory write-down ................................... 5,033 403
Impairment of intangible assets ........................ 937 880
Changes in operating assets and liabilities:
Accounts receivable .................................. 3,049 (3,320)
Inventories .......................................... 1,609 (3,081)
Prepaid expenses and other ........................... 831 (456)
Accounts payable ..................................... (3,646) (1,410)
Accrued expenses ..................................... (629) 173
Accrued restructuring liability ...................... 3,011 (4,175)
Customer deposits .................................... (463) (255)
Deferred revenue ..................................... (434) 165
Long-term liabilities ................................ 23 186
Income taxes payable ................................. 1 (345)
-------- --------
Net cash used in operating activities ........... (644) (8,339)
-------- --------
Investing activities:
Sale (purchase) of short-term investments .................... (600) 3,805
Purchases of property and equipment .......................... (211) (978)
-------- --------
Net cash (used in) provided by investing
activities ................................... (811) 2,827
-------- --------
Financing activities:
Distribution to S Corporation shareholders ................... -- (227)
Proceeds from exercise of stock options ...................... 51 172
Proceeds from Employee Stock Purchase Plan ................... 122 274
Proceeds from borrowings under line of credit ................ 23,139 40,754
Payments on bank and other borrowings ........................ (35,252) (37,784)
-------- --------
Net cash (used in) provided by financing activities ....... (11,940) 3,189
-------- --------
Effect of exchange rate changes on cash ......................... (6) 72
-------- --------
Net decrease in cash and cash equivalents ....................... (13,401) (2,251)
Cash and cash equivalents, beginning of period .................. 56,307 48,889
-------- --------
Cash and cash equivalents, end of period ........................ $ 42,906 $ 46,638
======== ========
Supplemental cash flow disclosure:
Cash paid for income taxes ................................... $ 39 $ 3,976
======== ========
Cash paid for interest ....................................... $ 642 $ 554
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
-4-
<PAGE> 7
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
(FORMERLY BOX HILL SYSTEMS CORP.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except per share data)
(unaudited)
1. BASIS OF PRESENTATION:
Effective August 2, 1999, Box Hill Systems Corp. ("Box Hill") and Artecon, Inc.
("Artecon") were merged in a tax-free, stock-for-stock transaction which was
accounted for as a pooling of interests (the "Merger") (see Note 4). In
connection with the Merger, the combined company changed its name to Dot Hill
Systems Corp ("Dot Hill" or the "Company"). The accompanying historical
financial statements of Dot Hill have been retroactively restated to reflect the
Merger. The financial statements for the three months and nine months ended
September 30, 1999 reflect the results of Dot Hill from the August 2, 1999
Merger date through September 30, 1999, in addition to the combined results of
Box Hill and Artecon from January 1, 1999 through the Merger date. The financial
statements for the 1998 periods reflect Box Hill's results of operations for the
three and nine month periods ended September 30, 1998 combined with Artecon's
results of operations for their three and nine month periods ended December 31,
1998, respectively. As a result of the Merger, Artecon changed its fiscal year
end to December 31. Artecon's net loss of $1,153 for the three months ended
March 31, 1999, which is included in the Company's results of operations for the
nine months ended September 30, 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:
<TABLE>
<S> <C>
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)
</TABLE>
The accompanying unaudited condensed consolidated financial statements of Dot
Hill, formerly known as Box Hill, and its subsidiaries, as of September 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
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 nine month periods ended September 1999 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. For further information, refer to the consolidated
financial statements and notes thereto included in the Company's Current Report
on Form 8-K/A, filed October 1, 1999, for the year ended December 31, 1998,
which presents Supplemental Financial Data to reflect the retroactive
restatement of the financial statements of Dot Hill and Artecon.
-5-
<PAGE> 8
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 and convertible preferred stock using the treasury stock method.
Dilutive securities are not considered in periods with a loss. The following
table sets forth the reconciliation of basic to diluted shares used in computing
net income per share (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
1999 1998 1999 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
Shares used in computing basic net income
(loss) per share .......................... 23,566 22,933 23,221 22,865
Dilutive effect of options ................... - - - 902
Convertible preferred stock .................. - - - 719
------ ------ ------ ------
Shares used in computing diluted net income
(loss) per share .......................... 23,566 22,933 23,221 24,486
====== ====== ====== ======
</TABLE>
For the three and nine months ended September 30, 1999, all common stock
equivalents were excluded from the computation of diluted net loss per share
because a loss was incurred for the three and nine months periods. At September
30, 1999, options to purchase 1,269,800 shares of the Company's common stock
were outstanding at exercise prices ranging from $.50 to $18.13. For the three
months ended September 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. At September 30, 1998, options to purchase 1,134,111 shares of the
Company's common stock were outstanding at exercise prices ranging from $8.44 to
$18.13.
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. The following
is a summary of inventories (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- -------------
<S> <C> <C>
Purchased parts and materials .... $ 9,781 $ 15,740
Work-in-process .................. 741 162
Finished goods ................... 2,600 3,862
------------ -------------
$ 13,122 $ 19,764
============= =============
</TABLE>
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<PAGE> 9
4. BOX HILL/ARTECON MERGER:
The Merger
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 was accounted for as a pooling of interests. 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 common stock outstanding.
Additionally, Artecon's convertible preferred A shares were exchanged for
719,037 shares of the Company's common stock.
Net revenue and net income (loss) for periods preceding the Merger were as
follows (in thousands):
<TABLE>
<CAPTION>
Six Months Ended Nine Months Ended Three Months Ended
June 30, 1999 September 30, 1998 September 30, 1998
---------------- ------------------ ------------------
<S> <C> <C> <C>
Revenue:
Box Hill $ 28,265 $ 57,565 $ 21,718
Artecon 37,484 77,552 19,639
------------- ------------- -------------
Total $ 65,749 $ 135,117 $ 41,357
============= ============= =============
Net income (loss)
Box Hill $ 924 $ 5,601 $ 2,200
Artecon (588) (4,197) (4,548)
------------- ------------- -------------
Total $ 336 $ 1,404 $ (2,348)
============= ============= =============
</TABLE>
Box Hill/Artecon Restructuring and Integration Plan
During the third quarter of 1999, the Company recorded expenses totaling $13,362
related to the Merger and management's restructuring and integration plan
associated with the Merger, as follows (in thousands):
<TABLE>
<S> <C>
Inventory write-downs ............... $ 5,033
Professional fees ................... 4,029
License termination ................. 1,102
Employee termination costs .......... 1,100
Write-down of intangibles ........... 937
Facility closures and related costs . 647
Other integration costs ............. 514
-------
Total .......................... $13,362
=======
</TABLE>
Management's restructuring and integration plan relates primarily to the
consolidation and discontinuance of product lines, which resulted in inventory
and intangible assets write-downs of $5,033 and $937, respectively. As a result
of the product line consolidation, the Company also terminated a license
agreement with a third-party vendor, resulting in license termination costs of
$1,102. Additionally, management's plan includes consolidating the Company's
manufacturing operations and other functions into the Company's headquarters in
Carlsbad, California, which resulted in employee termination charges of $1,100,
facility closure costs of $647 and other integration costs of $514. The Company
expects to complete the plan during the fourth quarter of 1999. Management
expects to incur additional merger and integration charges for severance and
other costs that will be incurred during the fourth quarter of 1999. The major
components of the charges and the remaining accrual balance as of September 30,
1999 are as follows (in thousands):
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<PAGE> 10
<TABLE>
<CAPTION>
Accrued
Restructuring
Expenses Paid Costs
------------- ------------- -------------
<S> <C> <C> <C>
Professional services .................. $ 4,029 $ (2,535) $ 1,494
License termination .................... 1,102 (400) 702
Employee termination costs ............. 1,100 (113) 987
Facility closures and related costs .... 647 (83) 564
Other integration costs ................ 514 (410) 104
------------- ------------- -------------
Total ............................... $ 7,392 $ (3,541) $ 3,851
============= ============= =============
</TABLE>
The balance of the restructuring accrual at September 30, 1999 in the
accompanying Financial Statements also includes reserves totaling $414 related
to Artecon's restructurings in the first and third quarters of fiscal 1998.
5. CLASS ACTION LAWSUIT
In December 1998, four shareholders class action lawsuits were filed against the
Company, certain of its officers and directors, and the underwriters of the
Company's September 16, 1997 initial public offering (the "Offering"). These
actions have since been consolidated into a single action. The actions were
filed on behalf of purchasers of the Company's common stock 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 has meritorious defenses to plaintiffs claims and intends to
vigorously defend itself against those claims. Legal costs to defend the claims
are expected to be material and will be charged to expenses as incurred.
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, growth 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 are set forth below in this Item 2. For a more
detailed listing of some of the risks and uncertainties facing the Company,
please see the most recent Forms 8-K, 10-K, and 10-Q filed by Dot Hill and
Artecon, and the registration / joint proxy statement filed in connection with
the Merger.
-8-
<PAGE> 11
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
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 environments. 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 was 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, Box Hill 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 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 retroactively restated to reflect the Merger. During the third quarter of
1999, the Company recorded expenses totaling $13.3 million related to the Merger
and management's restructuring and integration plan associated with the Merger.
Management expects to incur additional merger and integration charges for
severance and other costs that will be incurred during the fourth quarter of
1999.
During fiscal 1997, Artecon and Storage Dimensions, Inc. ("SDI") completed a
reverse merger accounted for as a purchase of SDI by Artecon, and changed its
name to Artecon. As such, the historical financial results of Artecon for all
years prior to the SDI merger are those of Artecon. 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 Carlsbad,
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 a significant portion of the Company's 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. 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, and as larger, all-purpose computer
vendors become more focused on their storage offerings.
-9-
<PAGE> 12
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's statements of
operations as a percentage of net revenue for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenue .................................... 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ............................. 67.1 67.1 66.3 64.6
Inventory write-downs .......................... 17.8 1.0 5.3 0.3
--------- --------- --------- ---------
Gross profit ........................... 15.1 31.9 28.4 35.1
--------- --------- --------- ---------
Operating expenses:
Sales and marketing ........................ 17.3 22.7 19.0 20.1
Engineering and product development ........ 6.2 6.1 5.8 5.9
General and administrative ................. 10.1 7.3 9.1 6.1
Impairment of intangible assets ............ 3.3 1.4 1.3 0.4
Restructuring and merger-related expenses .. 26.1 3.4 7.9 1.0
--------- --------- --------- ---------
Total operating expenses ............... 63.0 40.9 43.1 33.5
--------- --------- --------- ---------
Operating income ........................... (47.9)% (9.0)% (14.7)% 1.6%
========= ========= ========= =========
</TABLE>
The financial statements for the three and nine months ended September 30, 1999
reflect the results of Dot Hill from the August 2, 1999 Merger date through
September 30, 1999, in addition to the combined results of Box Hill and Artecon
from January 1, 1999 through the Merger date. The financial statements for the
1998 periods reflect Box Hill's results of operations for the three and nine
months ended September 30, 1998 combined with Artecon's results of operations
for their three and nine month fiscal periods ended December 31, 1998,
respectively.
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1998:
Net revenue - Net revenue decreased 31.6% to $28.3 million for the three months
ended September 30, 1999 from $41.4 million for the three months ended September
30, 1998. The decrease resulted from a decrease in volume of from sales coupled
with price reductions. Comparisons of the Company's 1999 and 1998 three month
results are difficult due to the significant corporate restructuring that the
individual companies have undergone over the last several years, including
Artecon's acquisition of Storage Dimensions in March 1998. The decrease in
revenue was due in part to the Company's focus on the Merger and
integration/restructuring issues, and the unwillingness of certain customers to
purchase storage products due to Year 2000 concerns also played a role. During
the third quarter of 1999, Dot Hill's sales of SCSI-based solutions accounted
for approximately 55% of revenues, backup solutions accounted for 16% of
revenues, services for approximately 8% of revenues, SANs for 5%, and other
products and services for approximately 16% of revenues.
Gross profit - Gross profit decreased 67.4% to $4.3 million for the three months
ended September 30, 1999, from $13.2 million for the comparable period of 1998,
primarily as a result of lower revenue. As a percentage of net revenue, costs of
goods sold remained flat at 67.1%, excluding inventory write-downs attributable
to the Company's product line consolidation.
-10-
<PAGE> 13
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 47.9% to $4.9 million for the three months
ended September 1999 from $9.4 million for the three months ended September 30,
1998. As a percentage of net revenue, sales and marketing expenses decreased to
17.3% for the three months ended September 30, 1999 from 22.7% for the
comparable period of 1998. The decrease was primarily due to a decrease in the
direct sales force and field service staff as a result of Artecon's
restructuring and operational consolidations, which took place in fiscal 1998
after Artecon's merger with Storage Dimensions.
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. Engineering and product development expenses decreased
32% to $1.7 million for the three months ended September 30, 1999, from $2.5
million for the same period in 1998. The decrease is primarily due to Artecon's
restructuring and operational consolidations in fiscal 1998. As a percentage of
net revenue, engineering and product development expenses increased slightly to
6.2% for the three months ended September 30, 1999 from 6.1% 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 decreased slightly to $2.9 million for the
three months ended September 30, 1999 from $3.0 million for the three months
ended September 30, 1998. As a percentage of net revenue, general and
administrative expenses increased to 10.1% for the three months ended September
30, 1999 from 7.3% for the comparable period of 1998 due to decreased revenue
and the relatively fixed nature of these expenses.
Box Hill/Artecon Restructuring and Integration Plan
During the third quarter of 1999, the Company recorded expenses totaling $13,362
related to the Merger and management's restructuring and integration plan
associated with the Merger, as follows (in thousands):
<TABLE>
<S> <C>
Inventory write-downs ................ $ 5,033
Professional fees .................... 4,029
License termination .................. 1,102
Employee termination costs ........... 1,100
Write-down of intangibles ............ 937
Facility closures and related costs .. 647
Other integration costs .............. 514
-------
Total ............................. $13,362
=======
</TABLE>
Management's restructuring and integration plans relates primarily to the
consolidation and discontinuance of product lines, which resulted in inventory
and intangible asset write-downs of $5,033 and $937, respectively. As a result
of the product line consolidation, the Company also terminated a license
agreement with a third-party vendor, resulting in license termination costs of
$1,102. Additionally, management's plan includes consolidating the Company's
manufacturing operations and other functions into the Company's headquarters in
Carlsbad, California, which resulted in employee termination charges of $1,100,
facility closure costs of $647 and other integration costs of $514. The Company
expects to complete the plan during the fourth quarter of
-11-
<PAGE> 14
1999. Management expects to incur additional merger and integration charges for
severance and other costs that will be incurred during the fourth quarter of
1999. The major components of the charges and the remaining accrual balance as
of September 30, 1999 is as follows (in thousands):
<TABLE>
<CAPTION>
Initial Accrued
Restructuring Amounts Restructuring
Charge Utilized Costs
------------- ---------- -------------
<S> <C> <C> <C>
Professional services ................ $ 4,029 $ (2,535) $ 1,494
License termination .................. 1,102 (400) 702
Employee termination costs ........... 1,100 (113) 987
Facility closures and related costs .. 647 (83) 564
Other integration costs .............. 514 (410) 104
---------- ---------- ----------
Total ............................. $ 7,392 $ (3,541) $ 3,851
========== ========== ==========
</TABLE>
Artecon's Restructuring - fiscal 1998 Third Quarter
In December 1998, Artecon's Board of Directors approved a plan to consolidate
one of Artecon's engineering facilities from Milpitas, California, to Carlsbad,
California, to consolidate certain domestic sales and service locations, and to
eliminate certain product lines and development activities. Artecon recorded
pre-tax restructuring charges of $1.8 million to cover the costs associated with
these actions. The major components of the 1998 charges and the remaining
accrual balance as of September 30, 1999 were as follows (in thousands):
<TABLE>
<CAPTION>
Initial Accrued
Restructuring Amounts Restructuring
Charge Utilized Costs
------------- --------- -------------
(in thousands)
<S> <C> <C> <C>
Employee termination costs ..... $ 254 $ (254) --
Inventory write-downs .......... 403 (403) --
Facility closures and related
expenses .................... 715 (689) 26
Tooling write-off .............. 135 (135) --
Intangible asset impairment .... 300 (300) --
--------- --------- ---------
Total ..................... $ 1,807 $ (1,781) $ 26
========= ========= =========
</TABLE>
Employee termination costs consisted 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. Inventory
write-downs and the tooling write-offs primarily related to the discontinuance
of certain low-volume and low-profit product lines. Of the total restructuring
charge associated with the inventory write-downs, $403 has been included as a
separate component of cost of sales in the accompanying financial statements.
Facility closures and related expenses consisted of lease termination costs and
the write-off of certain property and equipment disposed of associated with the
closures. The majority of the remaining accrued costs are expected to be paid in
1999.
SDI Merger Accrual
In connection with the acquisitions of Falcon and SDI, the company allocated
$420 and $1.6 million respectively, to an assembled workforce intangible asset.
The company recorded an impairment of these intangible assets of $300 during the
three-month period ended September 30, 1998 which has
-12-
<PAGE> 15
been included as a component of the restructuring charge, as the impairment was
a direct result of employee terminations associated with restructuring
activities. Furthermore, as a result of significant attrition and terminations
of employees, which was utilized as the basis for the assembled workforce
valuation, the company recognized additional amortization of $580 based on a
change in estimate of the remaining useful life of the assembled workforce.
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 cots 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 September 30, 1999
----------------- ------------- ------------------
(in thousands)
<S> <C> <C> <C>
Employee termination costs.... $ 2,858 $ (2,858) $ --
Professional service fees..... 1,726 (1,410) 316
Other Costs .................. 1,181 (1,109) 72
------------- ------------- -------------
Total ........................ $ 5,765 $ (5,377) $ 388
============= ============= =============
</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 - 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 $0.2 million for the
three months ended September 30, 1999 and 1998.
Income tax benefit - The Company's effective income tax rate was 18.7% for the
three months ended September 30, 1999, reflecting a federal tax benefit
partially offset by the impact of permanent items, primarily non-deductible
merger-related costs and amortization of intangible assets. The Company's
effective income tax rate was 33.1% for the three months ended September 30,
1998, reflecting a federal, state and local tax benefit, partially offset by
permanent items.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1998:
Net revenue - Net revenue decreased 30.3% to $94.1 million for the nine months
ended September 30, 1999, from $135.1 million for the nine months ended
September 30, 1998. The decrease resulted from a decrease in volume of from
sales coupled with price reductions. Comparisons of the Company's 1999 and 1998
nine month results are difficult due to the significant corporate restructuring
that the individual companies have undergone over the last several years,
including Artecon's acquisition of Storage Dimensions in March 1998. The
decrease in revenue was due in part to the Company's focus on the Merger and
integration/restructuring issues, and the unwillingness of certain customers to
purchase storage products due to Year 2000 concerns also played a role.
Gross profit - Gross profit decreased 43.7% to $26.7 million for the nine months
ended September 30, 1999, from $47.4 million for the comparable period of 1998.
As a percentage of net revenue, cost of goods sold increased from 64.6% to
66.3%, excluding inventory write-downs, primarily as a
-13-
<PAGE> 16
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.
Sales and marketing - Sales and marketing expenses decreased 33.9% to $17.9
million for the nine months ended September 30, 1999 from $27.1 million for the
nine months ended September 30, 1998. The decrease was primarily due to a
decrease in the direct sales force and field service staff as a result of
Artecon's restructuring and operational consolidations, which took place in
fiscal 1998 after Artecon's merger with Storage Dimensions. As a percentage
of net revenues, sales and marketing expenses decreased to 19.0% for the nine
months ended September 30, 1999 from 20.1% for the comparable period of 1998.
Engineering and product development - Engineering and product development
expenses decreased 31.3% to $5.5 million for the nine months ended September 30,
1999 from $8.0 million for the nine months ended September 30, 1998. The
decrease is primarily due to Artecon's restructuring and operation
consolidations in fiscal 1998. As a percentage of net revenue, engineering and
product development decreased slightly to 5.8% for the nine months ended
September 30, 1999 from 5.9% for the comparable period of 1998.
General and administrative - General and administrative expenses increased 4.9%
to $8.6 million for the nine months ended September 30, 1999 from $8.2 million
for the nine months ended September 30, 1998. As a percentage of net revenues,
general and administrative expenses increased to 9.1% for the nine months ended
September 30, 1999 from 6.1% for the comparable period of 1998. The increase is
primarily due to professional fees related to the shareholder class action
lawsuit described herein, payroll increases and additional staff seminars and
training.
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 increased to $1.0 million for the nine
months ended September 30, 1999 compared to $0.7 million for the same nine-month
period in 1998. The increase in other income was primarily attributable to
Artecon's legal settlement income recorded in the first quarter of 1999.
Income tax provision (benefit) - For the nine months ended September 30, 1999,
the Company's effective income tax rate was 18.2%, reflecting a federal tax
benefit, partially offset by non-deductible merger related costs and
amortization. For the nine months ended September 30, 1998, the Company's
effective income tax rate was 49.4%, 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 September 30, 1999, the Company had $47.0 million of cash and cash
equivalents and short-term investments. As of September 30, 1999, working
capital was $60.8 million.
For the nine months ended September 30, 1999, cash used in operating activities
was $644 compared to cash used in operating activities of $8.3 million for the
same period in 1998. The decrease in net cash used in operating activities is
primarily due to decreases in accounts receivable and inventories during the
1999 period versus increases during the 1998 period and an increase in accrued
restructuring in 1999 versus a decrease in 1998, partially offset by the net
loss and decreased accounts payable during the 1999 period.
-14-
<PAGE> 17
Cash used by investing activities was $811 for the nine months ended September
30, 1999 compared to cash provided by investing activities of $2.8 million for
the same period in 1998, as a result of the timing of sales of investments and
less fixed assets additions in 1998. Short-term investments generally consist of
variable rate securities that provide for early redemption within twelve months.
Cash used by financing activities was $11.9 million for the nine months ended
September 30, 1999, as a result of payment of Artecon's outstanding debt,
partially offset by proceeds totaling $173,000 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 May 1998, Artecon entered into a revolving credit facility with LaSalle
National Bank, which permits borrowings of up to $15 million. On August 5, 1999,
the Company repaid all outstanding debt under this facility.
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 $331,000 at
September 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
September 30, 1999, the total amount outstanding under the three credit lines
was 29 million Yen (approximately US $278,000 at 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 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 and as
larger all-purpose computer vendors continue to focus on their storage
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.
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 SANnet(TM),
SANpath(TM) and
-15-
<PAGE> 18
SANscape(TM) which are based on 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
make accurate market predictions difficult. In recent periods, the Company's
revenue and earnings results have fallen short of 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 Internet service providers (ISPs) and 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, which, have been
more difficult recently due, in part, to the Merger-related restructuring
activities and the enhanced recruiting efforts of competitors.
At this time, the Company has no significant 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."
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 Dot Hill, Box Hill or Artecon, this statement supercedes those prior
statements. Readers should also be aware that Dot Hill's evaluation
-16-
<PAGE> 19
of certain aspects of its Year 2000 readiness is based on statements by other
parties. Dot Hill often cannot verify the veracity of those statements, which
may have been made in error.
Dot Hill's Products
Dot Hill believes the current version of all products currently manufactured by
Dot Hill will function normally after the Year 2000. Most of Dot Hill's products
do not keep track of dates as part of their normal operation and, therefore, are
Year 2000 compliant by nature.
Dot 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,
Dot Hill has not evaluated all such products. Dot Hill continues to answer Year
2000 questions about specific products previously manufactured by Dot Hill. Dot
Hill does not warrant or represent that obsolete, unsupported Dot Hill, Box Hill
or Artecon products are Year 2000 compliant, and Dot Hill will not support such
products for Year 2000 purposes.
The rights and remedies of customers as to the Year 2000 compliance of any Dot
Hill products are governed by applicable law and agreements between customers
and Dot Hill. 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
Dot Hill has evaluated its information technology infrastructure, made
modifications and identified necessary upgrades. Dot Hill believes that the
critical aspects of its infrastructure are Year 2000 compliant. Dot 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.
Readiness of Third Parties and Third Party Products Resold or Licensed by Dot
Hill
Dot Hill has requested confirmation of the Year 2000 readiness of third party
products of material significance to Dot Hill, which Dot Hill currently resells,
licenses or uses to manufacture its own products. However, Dot 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.
Dot Hill has not confirmed the Year 2000 readiness of all third party products
resold or integrated by Dot Hill and has not confirmed the readiness of products
which are not resold or licensed by Dot Hill but which may, in some way,
interface or interconnect with Dot Hill products or products manufactured by
third parties that Dot Hill either resells or licenses. Dot Hill does not, and
will not, take responsibility for Year 2000 compliance of such products.
Dot Hill has requested information about the internal Year 2000 readiness of
third parties that supply Dot Hill with key products and services. To date, all
third party information received by Dot Hill has indicated that the third
parties believe they will be compliant. However, Dot Hill is incapable of
testing or knowing the accuracy of such statements and has not received
information from all such third parties.
-17-
<PAGE> 20
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. Further, there can be no assurance that Year 2000 issues
will not have a material adverse impact on Dot Hill'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
slowdown 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. 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.
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 use 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.
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 nine months ended September 30, 1999, resulting in a
decrease in interest income of approximately $75 thousand for the nine months
ended September 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.
-18-
<PAGE> 21
DOT HILL SYSTEMS COPR. AND SUBSIDIARIES
(FORMERLY 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 "Court"). 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 August 16, 1999, the Court ruled upon defendants' motion to dismiss the
action, pursuant to Federal Rule of Civil Procedure 12(b)(6), granting the
motion in part, and denying the motion in part. The ruling decreased the number
of actionable omissions or misrepresentations alleged by plaintiffs from eight
to three.
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 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 operating 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
A special meeting of stockholders of Box Hill Systems Corp. ("Box Hill") was
held on August 2, 1999 (the "Special Meeting"). Box Hill had 14,362,982 shares
of Common Stock outstanding as of July 5, 1999, the record date for the Special
Meeting. At the Special Meeting, holders of a total of 10,519,183 shares of
Common Stock were present in person or represented by proxy.
At the Special Meeting the following proposals, all as more fully described in
the Prospectus/Joint Proxy Statement relating to such meeting, were ratified:
(1) a proposal to approve and adopt an Agreement and Plan of Merger, dated as of
April 29, 1999, among Box Hill, BH Acquisition Corp. ("Merger Sub") and Artecon
and approve the merger of Merger Sub with and into Artecon, (2) a proposal to
approve an amendment to Box Hill's Certificate of Incorporation to change its
name to "Dot Hill Systems Corp." and
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<PAGE> 22
provide for a classified Board of Directors; (3) a proposal to approve an
amendment to Box Hill's 1997 Employee Stock Purchase Plan to increase the number
of shares issuable thereunder by 500,000 shares and (4) a proposal to approve an
amendment to Box Hill's 1995 Stock Incentive Plan, as amended, to increase the
number of shares issuable thereunder by 2,000,000.
The following sets forth information regarding the results of the voting at the
Special Meeting:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN
<S> <C> <C> <C>
Proposal 1: Approval of Merger Agreement and Merger
10,457,457 42,006 19,720
Proposal 2: Approval of Amendment to Certificate
of Incorporation to change name and provide for
classified Board of Directors 10,099,998 394,986 24,199
Proposal 3: Approval of Amendment to 1997
Employee Stock Purchase Plan 10,217,145 269,522 32,516
Proposal 4: Approval of Amendment to 1995
Stock Incentive Plan 9,360,745 1,124,022 34,416
</TABLE>
Item 5. Other information
None.
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 August 24, 1999 regarding a ruling on the motion
to dismiss regarding the Class Action Law Suits.
The Company filed a Current Report on Form-8-K with the Securities and
Exchange Commission on August 6, 1999 relating to the Box Hill/Artecon
Merger.
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<PAGE> 23
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: November 15 , 1999 By /s/ Philip Black
---------------------------------------
Philip Black
Co - Chief Executive Officer
Date: November 15 , 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: November 15 , 1999 By /s/ Philip Black
----------------------------------------
Philip Black
Co - Chief Executive Officer
(Principal Executive Officer)
Date: November 15 , 1999 By /s/ James L. Lambert
----------------------------------------
James L. Lambert
Co - Chief Executive Officer
(Principal Executive Officer)
Date: November 15 , 1999 By /s/ R. Robert Rebmann, Jr.
----------------------------------------
R. Robert Rebmann, Jr.
Chief Financial Officer and Treasurer
(Principal Financial Officer)
-21-
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